Over-spending and under-spending of the public sector budget

Over-spending and under-spending of the public sector budget The over-spending and under-spending of a budget is the positive or negative variance between what was actually spent and what was budgeted. Overspending Budgets overruns are the underestimation of costs and time or by the nonconformity of budget managers with the spending maximum defined in the budget, when projected. There are several explanations for overspending. Sometimes, it is simply bad forecasting on part of the budget manager. There was incomplete information or poor forecasting methods that led to an underestimation and/or unreal optimism of costs, expenses and revenues. Often there is change in scope of the project and costs associated with scope change are neither captured nor covered in the risk mitigation or contingency plan. Funds are allocated to the cost centers for spending, it is controlled. Overspent fund accumulate in arrears. Overruns could also be a result of off-budget spending which not considered part of the budget and is not included in budget totals. Off budget spending is often for political reasons. For example, after a request from President Reagan, Congress placed strategic petroleum reserve spending off-budget in 1982. Instead of using other means to control the deficit raising revenues or cutting spending placing this program off-budget gave the appearance of a smaller deficit, even though the government still needed to finance this spending. Source: Office of Management and Budget, Budget of the United States Government, Historical Tables and Mid-session Review, FY2006. Sometimes the expenditure processes are complicated and difficult. To circumvent this process exceptional procedures are development to speed to the process to release the funds. These exceptional procedures are tolerated by the treasury for politically sensitive expenditures. The procedures are frequently abused and should be discouraged. These procedures are used my officials to order supplies without making a formal request and much later the year un-forecasted invoices appear. Sometime fund are unavailable to make this invoices which leads to generation of arrears for the following year. The compounding of exceptional procedures also has long-term implications, incentivizing spending agencies to go outside the budget system to avoid control altogether. Such procedures are associated with or result in corruption. Often past experiences can lead to overspending. If a department head under spent the previous year and the budget for the following year was lost. The department is highly likely to spend the entire amount for the fear of losing funds for the next year. The way in which performance is reported can have a significant effect on the camaraderie and coordination between departments. If participation of the managers implementing the budget was absent, then managers can blame this for the file to abide by the budget. In addition impact of inflation and a sense of entitlement towards certain funds are also factors to be considered in budget planning. Overruns can be caused by such deficiencies in budget preparation. Under spending Many governments do not spend their full annual budget. The reasons for this under spending can be various and can result in many outcomes. Lack of timely spending or under spending can affect the citizens not receiving essential government services. Certain areas have more economic impacts such as jobs created through the timely initiation of new infrastructure project. Under spending can often obstruct resources from other departments/managers which/who are spending their budget more productively, preventing them to reach their complete potential of success in delivery of the intended service. Under spending in particular year frequently leads to rollovers and modifications in the subsequent years. These modifications are irregular and are cumbersome to be forecasted leaving the department ill-equipped to spend these rollovers. Factors that result in under spending include insufficiencies in budget preparation and project/program planning, unrealistic projections of revenues, poor governance and off-budget spending. Virement is another factor that fuels under spending: It is the transfer of funds from one budget head to another. To achieve efficiency or prevent the need for a supplementary estimate as an under spending from one head may be transferred to another head which has overspending. One problem with unrestricted virement is that managers would inevitably spend al their budget allocation for fear of a budget reduction in the subsequent year. Example: Within the ministry of education budgets are transferred from primary education to higher education it can result in the delay of programs starting in the K-12 grades. Example: The latest un-audited expenditure reports from the National Treasury indicate that R3.48 billion of the national government budget went unspent in 2000/01 financial year- about R1.7billion on both the recurrent and the capital side of the budget. The under spend in provincial government was far greater at R5.5 billion. The latest available data indicate that this picture has not changed significantly in 2001/02. Although the government is moving in the right direction, most initiatives to address under spending appear rather general and details have yet to emerge on how the Treasury will specifically tackle the problem. In the meantime, under-spending seems set to remain with us. Source: Government under spending remains a problem February 2002 By Marritt Claassens and Paul Whelan, Budget Information Service, Idasa, http://www.idasa.org.za/bis/ Different kinds of variances A variance is the difference between a budgeted, planned or standard amount and the actual amount. Variances can be divided according to their nature of the underlying amounts and is determined by the needs of users of the variance information. These include : Variable cost variances Direct material variance Price variance: is the difference between the standard cost and the actual cost for the actual quantity of material used or purchased. Usage Variance: is the difference between the standard quantity of materials that should have been used for the number of units actually produced, and the actual quantity of materials used, valued at the standard cost per unit of material. Direct labour variance Rate Variance is the difference between the standard cost and the actual cost paid for the actual number of hours. Efficiency variance is the difference between the standard labour hour that should have been worked for the actual number of units produced and the actual number of hours worked when the labour hours are valued at the standard rate. Overhead variances Fixed overhead variances: identifies what proportion of the total fixed overhead variance is due to actual fixed overhead being different from the budgeted fixed overhead. Variable overhead variance measures the change between actual expenditure and the allowed overhead for actual labour hours. Income variance is the difference between actual income and budget income. It is used to measure the performance of a income function, and/or analyze business results to better understand market conditions. Actual income can differ from budgeted income either due to the variance in volume sold or the variance in the price point of the budgeted price point. Best Practices The following are some key good practice for prevention and minimization of the variances: Broad goals should be established to guide government decision making. Budgeting methods are developed to achieve these goals. An appropriate budget is developed to achieve the goals and the performance criterion is determined at the beginning. Close interaction between the financial information system and the budgeting systems is essential. There should be a control on collective spending and any deficit, a overarching prioritization of strategies with regards to expenditures and better use of the budgeted resources. The approved budget should be entered into the financial information system. In addition to a full commitment system, memorandum notes should be included the system that capture records of commitment but does not amend the financial records. Timely comparative financial statements on a regular basis. These statements should include original and revised budget, capture variances and explain major variances. The audited and reliable statements are based in solid accounting standards with regular external reporting. Budget Monitoring: Monitoring and controlling consists of those processes are performed to observe that potential problems can be identified in a timely manner and corrective action can be taken, when necessary. The key benefit is that the actuals are observed and measured regularly to identify variances from the budget. During the course of the year, instance may arise where the income or expenditure is very large that may require and supplementary estimate. The better the level of control and intelligence available the earlier this situations can be detected and more swiftly and appropriate an action can be taken to minimize the variance. However if is determined there has to be a change then the financial information systems can be updated as soon as possible. If a department become aware that it will overspend at any time during the year it must notify the Treasury department immediately. It is possible that a supplement estimate is provided if deemed appropriate. Transparency is key publish the State accounting policies, establish system of internal controls, and keep doors open for public and parliamentary scrutiny. Flexible budgeting is a performance evaluation tool. It is not be prepared before the end of the fiscal period. A flexible budget adjusts the initial budget for the actual level of output. The flexible budget answers the question: If the department had known at the beginning of the period what would the output volume (units delivered or sold) would be, what the budget would have looked like? If the department actually delivered X units, then treasury should compare actual delivery costs for X units to what it should have spent to make X units, not to what the department should have spent to deliver X-1000 units or X+1000 units etc. The flexible budget provides a better opportunity for planning and controlling than does a static (initial) budget.