There are a variety of operating budgets that public and private sectors use to track costs and expenditures. While these budgets share the common methodology of measuring cost and projecting expenditures and profits; their individual methods are often very different. Two of the more popular operating budgeting systems include; performance based budgeting and line-item budgeting. While both forms of budget have benefits to their use, they also share deficiencies in accuracy.
Performance based budgeting is a system of budgeting that is growing in popularity. This system of budgeting works on the idea of measuring performance along with cost. This type of budget measures a cost per outcome. The cost going into the particular budget (inputs) are weighed against the outcomes or (outputs). This conversion and comparison of inputs and outputs is the measure used to evaluate the budgets efficiency and success.
Because the performance budget measures outcomes along with cost, the preparation of this form of budget entails the use of different tools than other budgeting systems. For example, the mission and goals of the organization become the most important tools in preparation. The use of these tools focuses the operating budget such that resources are allocated and utilized in order to achieve intended outcomes.
Performance budgets use statements of missions, goals and objectives to explain why the money is being spent. It is a way to allocate resources to achieve specific objectives based on program goals and measured results (Young, 2003).
Performance-based budgeting inputs and outputs are compared against program expectations and goals. This commonly used form of budgeting is used to ascertain whether a program is effective by its ability to meet objectives.
There are disadvantages to performance based budgets. One of the largest disadvantages is that they are fixed and do not react well to sudden changes in costs due to circumstances, such as inflation or recession. These situations can create negative impacts on budget performance (Kelly, 2011). There are many individuals whom believe that performance based budgets are wasteful. This belief is generated from the fact that performance based budgets measure success in terms of achieving goals rather than saving money. In the above example, the costs for intended goals are set in an almost arbitrary way. While lowering a cost by 7% seems to be a good goal how is this number decided upon? This subjectivity tends to make the evaluation of such budgets difficult because of the broad interpretations which can be assigned to these budget outcomes.
Unlike performance based budgeting, activity-based costing systems offer a different method of operating budget. The activity based budgeting system allows the organization to analyze the overall systems with more detail in order to identify cost inefficiencies. In activity-based accounting, organizations prepare their budgets by identifying activities, and then designating a cost to each activity (Cenage, 2009). Once that is completed, a determination of the components of each cost must take place, followed by data collection for every activity. Finally, a determination of the product or service costs can be made by dividing each product or service into unit-level activities (Cenage, 2009). For example, cost per outcome, cost per service, and service-sustaining activities would be types of unit level activities.
As can be seen in the example, more exact figures for budget requirements can be obtained. In general, activity-based budgeting systems are more accurate than performance based budgeting systems. However, this accuracy is questionable depending upon the type of organization. In the public sector it is extremely difficult to utilize the activity-based budgeting system because it is hard to assign values to specific services or to outcomes. In contrast to this difficulty in activity-based budgeting systems, when the organization is measuring product outputs rather than service, activity-based budgets can be extremely accurate. For this reason, activity-based budgeting systems have a greater benefit for large complex organizations which have more costs that are measurable either directly or indirectly. One can see this reality in the sample budget above in that it is taken from large manufacturing facility. It would be difficult to modify this budgeting system for services such as in the public sector (Kelly, 2011).
While both activity-based budgeting and performance budgeting systems have benefits to their use, they also have limitations. When deciding upon the form of budgeting that an organization will use, it would be beneficial to take into account the type of organization, its size, and the type of product or service it offers. In this way, the most accurate form of budgeting can be chosen based upon the needs of the organization.
Cenage. (2009). Encyclopedia of management.
Currie, J. (2010). Activity-based budgeting: A worked example. Retrieved from http://www.cpaireland.ie/UserFiles/File/students/2010 Examinations/Exam Related Articles/Article for P2 SPM 2010.pdf
Kelly, J. M. (2011). Performance budgeting for state and local government. (2 ed.). New York: M.E. Sharpe Inc.
Richard D. Young, “Performance-Based Budget Systems,” Public Policy & Practice, January 2003, p. 12
Strategisys. (2012). Performance-based budgeting . Retrieved from http://strategisys.com/pbb