HOLES PUNCHED SPINE
Developing and Managing
Internal Budgets
Better Practice Guide
Developing and Managing Inter
nal Budgets
www.anao.gov.au
June 2008
Better Practice Guide
June 2008
embed
allocation
phasing
variation
forecasting
bottom-up
top-down
ISBN No. 0 642 81021 4 © Commonwealth of Australia 2008
COPYRIGHT INFORMATION
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Questions or comments on the Guide may be referred to the ANAO at the address below. The Publications Manager
Australian National Audit Office GPO Box 707
Canberra ACT 2601
Email: [email protected] Website: http://www.anao.gov.au
Foreword
Developing and managing internal budgets is a fundamental element of an organisation’s financial management framework. Effective internal budgeting will significantly contribute to the achievement of an organisation’s goals and objectives, particularly when embedded into corporate planning and aligned to the external budget.
Organisations use internal budgets to establish and communicate funding priorities, support decision making, set financial controls, and monitor and report financial performance. Effective internal budget processes, which underpin the efficient allocation of resources, enable Australian Government organisations to more readily identify and respond to changes in environmental conditions and government priorities.
The purpose of this Better Practice Guide is to assist organisations better manage internal budgeting activities. It discusses a range of principles and techniques designed to embed internal budgeting in an organisation’s planning, control and accountability systems. It also notes the importance of cultivating an environment that encourages effective internal budget practices—an important element of which is to construct internal budgets with direct input from operational managers. Managers are more likely to achieve budget targets that have been agreed with them and are limited to those costs over which they have control.
This guide updates the Better Practice Guide on Internal Budgeting issued in February 2003. This guide reiterates many better practices in the former version and takes into account developments in financial management and budgeting affecting Australian Government organisations since the release of the previous guide. While practices described in this guide generally apply to all Australian Government organisations, it is important that each organisation assess the extent that information provided is relevant, appropriate and cost-effective in light of their circumstances.
The ANAO consulted with many Australian Government organisations and individuals to improve the usefulness of the guide. I particularly appreciated the assistance of the Department of Finance and Deregulation, Department of the Environment, Water, Heritage and the Arts, Australian Taxation Office, National Library of Australia and the Civil Aviation Safety Authority for commenting on previous versions of the guide and/or providing examples of internal budgeting processes and practices.
Ian McPhee Auditor-General June 2008
Contents
Foreword
i
1. Overview of internal budget processes
2
1.1. Introduction 2
1.2. Coverage 2
1.3. Definition of internal budgeting and other common terminology 3
1.4. Acknowledgements 3
1.5. Internal budget processes 4 1.6. Characteristics of effective internal budget processes 6
2. Embedding internal budget processes into organisational
planning and management
8
2.1. Integrate the internal budget into organisational planning 9 2.2. Align internal budgeting with organisational roles and responsibilities 11 2.2.1. Ensure clear accountability for all budget allocations 12 2.2.2. Align organisational structures to outcome, output and
program responsibilities 13 2.2.3. Present full cost of service delivery 14 2.2.4. Show full financial impacts of budget decisions 16 2.3. Integrate operational and capital budgets 20 2.4. Align internal and external budgets 24 2.5. Harmonise budgeting and reporting 25 2.6. Engage stakeholders in internal budget processes 26 2.6.1. Obtain organisational support for the internal budget 26 2.6.2. Supporting operational managers in internal budget processes 26 2.6.3. Internal budget processes for whole of government initiatives 28
3. Developing and implementing a comprehensive internal budget
30
3.1. Effective planning and coordination 30 3.1.1. Set budget policies 31 3.1.2. Establish budget timetables and milestones 32 3.1.3. Allocate responsibility for budget development 34 3.1.4. Document budget processes and disseminate guidelines 34 3.2. Effective budget construction 35 3.2.1. Budget top-down, bottom-up or both 35 3.2.2. Determining the budget approach 36 3.2.3. Automate internal budget processes 39 3.3. Effective oversight, review and communication 41
4. Monitoring and evaluating budgeting performance
44
4.1. Monitor and report against internal budgets 44 4.1.1. Report budget performance 44 4.1.2. Assist managers assess budget performance 45 4.1.3. Phase the budget to provide meaningful comparisons 45 4.1.4. Analyse and explain budget variances 47 4.2. Revising the internal budget 50 4.2.1. Frequency of budget updates 50 4.2.2. Revising internal budget allocations 50 4.2.3. Understanding and tracking changes in internal budgets 51 4.3. Forecasting to manage gaps between budget estimates and actual results 52 4.4. Review and improve internal budget processes 54 4.4.1. Measure internal budget accuracy and timeliness 55 4.4.2. Identify opportunities for improvement 56
Appendices and Glossary of terms
57
A Illustrative template guidelines for internal budget processes 58 B Budget summary—illustrative structure 60 C Internal budget processes—better practice checklist 64
Over
view of internal budget processes
Part 1
Overview of internal
budget processes
Contents
1. Overview of internal budget processes
2
1.1. Introduction 2
1.2. Coverage 2
1.3. Definition of internal budgeting and other common terminology 3
1.4. Acknowledgements 3
1.5. Internal budget processes 4 1.6. Characteristics of effective internal budget processes 6
Overview of internal
1.
budget processes
IntroduCtIon
1.1.
Budget processes within Australian Government organisations are guided by the requirements of the Financial Management and Accountability Act 1997 (FMA Act) and the Commonwealth
Authorities and Companies Act 1997 (CAC Act). For example, Chief Executives of FMA Act
agencies are required to manage the affairs of their agency in a way that promotes the efficient, effective and ethical use of the resources for which they are responsible. Similarly, directors of Australian Government authorities and companies are required to exercise care, diligence and business judgement in carrying out their responsibilities under the CAC Act.
Since 1999–2000, Australian Government organisations have budgeted under the accrual-based, outcomes and outputs framework. The framework was designed to allow parliamentarians and the public understand the real cost of delivering benefits to the Australian community (outcomes) and goods and services (outputs). Within each organisation, the framework is intended to improve governance and public accountability by driving improvement in the way organisations manage resources and measure results. The adoption of accrual budgeting also aligned financial reporting and budgeting in Australian Government organisations, providing a consistent framework for the measurement and disclosure of budget estimates and actuals and providing enhanced accountability for financial performance.
The 2002 Budget Estimates and Framework Review endorsed the accrual accounting framework but made several recommendations to improve the quality of financial information provided to Government.1 The progressive implementation of these recommendations over the last five years
has seen a renewed emphasis on program budgeting and reporting (in addition to, and as part of, the accrual outputs and outcomes framework) as well as a reaffirmation of the continuing importance of cash information, particularly in terms of Government decision-making.
In 2006, the Australian Government determined that all organisations in the Australian Government General Government Sector (GGS) must report annually on legislative compliance and financial sustainability to their responsible Minister and the Finance Minister. This included a certification from each Chief Executive (or Board) as to their organisation’s ability to meet existing program requirements within agreed resources, including the management of capital and other long-term assets and liabilities. The Certificate of Compliance program has reinforced the importance of organisations adopting a longer-term focus in their internal planning and budgeting considerations.
Coverage
1.2.
The principles and considerations outlined in the guide generally apply to all Australian Government organisations, irrespective of size and legislative framework.
The guide focuses on internal budget processes undertaken by organisations to manage departmental resources. It does not specifically cover those resources administered on behalf of Government. However, many of the better practices outlined in the guide also apply to administered items.
1 Department of Finance and Administration (2002), Budget Estimates and Framework Review, Canberra. The aim of the review was to assess the accuracy, responsiveness and effectiveness of the budget estimates and advice system in meeting the requirements of government.
Over
view of internal budget processes
defInItIon of Internal budgetIng and other
1.3.
Common termInology
The internal budget shows an organisation’s expected financial performance, financial position and cash flows disaggregated by area of responsibility. Developing an internal budget involves making decisions on the allocation, use and administration of resources to achieve the organisation’s objectives.
The guide uses common budget terms outlined below. A comprehensive glossary is at the end of the guide.
Budget allocation Distribution or disaggregation of an organisation’s budget to its various work areas, outputs or programs.
Budget phasing Budget phasing represents the pattern of expenditure (or income) over the budget period (for example, over the twelve months of an annual budget). Budget transfer Moving budgeted funds from one group to another group or from one
account to another account.
Budget variance Difference between a budget projection and an actual result. Budget variances can be expressed in absolute or percentage terms.
Cost attribution Allocation of costs to a particular group, output or program based on pre-defined rules and drivers.
Direct costs A cost that can be directly attributed to an activity or the delivery of an output, program or project (for example, costs associated with employees assessing grant applications under a discretionary grant program).
Indirect costs A cost that cannot be directly attributed to an activity or the delivery of an output, program or project (for example, costs associated with employees providing administrative services across an organisation).
aCknowledgements
1.4.
The ANAO appreciates the assistance provided by KPMG in preparing the guide. In addition, a number of Australian Government organisations contributed information and insights that supported the development of the guide, primarily:
Australian Maritime Safety Authority;
•
Australian Taxation Office;
•
Civil Aviation Safety Authority;
•
Department of the Environment, Water, Heritage and the Arts;
•
Department of Finance and Deregulation;
•
Department of Health and Ageing;
•
National Library of Australia;
•
National Museum of Australia; and
•
National Water Commission.
Internal budget ProCesses
1.5.
Effective internal budget processes typically involve a series of integrated activities designed to align: organisational planning; financial responsibility, accountability and authority; budgeting and reporting; resource allocation; and the monitoring and evaluation of budgeting performance. Accordingly, the guide examines internal budget better practices across the following broad dimensions:
Part Two: Embedding internal budget processes into organisational planning and management;
•
Part Three: Developing and implementing a comprehensive internal budget; and
•
Part Four: Monitoring and evaluating budgeting performance.
•
Figure 1 illustrates the structure and coverage of the guide.
Figure 1: Integrated internal budget processes
Part T
wo Embedding internal budget processes into organisational planning
Align internal budget with roles and
responsibilities
Integrate operational and capital budgets
Align with external budgeting and
reporting
Engage stakeholders in internal budgeting
Part Thr
ee Developing and implementing a comprehensive internal budget
Effective planning and
coordination Effective budget construction
Effective oversight, review and communication
Part Four
Monitoring and evaluating budgeting performance Monitor and report
against internal budgets
Revise the internal budget
Forecasting to manage gaps between
estimates and actual
Review and improve internal budget
Over
view of internal budget processes
Part Two of the guide discusses the link between organisational planning and internal budget processes and the role of the internal budget in financial management.
Planning, budgeting and reporting processes ideally have a cascading effect within an organisation as strategic goals and priorities flow to operational areas. It is important to allocate internal budgets consistent with the organisation’s financial management framework while, at the same time, aligning with managers’ specific responsibilities. Managers are more likely to take ownership of their allocated budget where they have control, not just accountability, over the implementation of the budget. Close integration between the capital budget and the operational budget further assists organisations assess the long-term consequences of budget decisions.
Consistency between internal and external budgets and between reporting of budget estimates and actual results is also important. This helps ensure a close alignment between how an organisation plans and monitors performance internally and how it is held accountable externally.
A critical element in gaining broad acceptance of the internal budget is the involvement of senior management and operational management throughout the budget process. Part Two also discusses better practice principles and approaches involved in engaging relevant stakeholders, including supporting operational managers. Finally, Part Two deals with the management of relationships between Australian Government organisations working on whole of government initiatives. Part Three discusses policies, procedures and systems critical to developing an effective internal budget. It is vital that the internal budget function is supported by robust processes and systems for planning and coordination, and that these are clearly articulated and consistently applied across the organisation. This is likely to generate a budget that is timely and accepted by management. Part Three also suggests some better practice principles and approaches to manage and support the development of internal budgets.
Part Four discusses the link between preparing the internal budget and reporting and monitoring budgeting performance, including the role of forecasting to manage the gap between budgeted and actual revenues and expenditure. To use resources efficiently and effectively, it is essential organisations build a continuous improvement culture into internal budget processes. Part Four also suggests some better practices to measure, review and refine internal budget processes.
CharaCterIstICs of effeCtIve Internal
1.6.
budget ProCesses
Effective internal budget processes incorporate the key characteristics listed in Table 1.
Table 1: Key characteristics of effective internal budget processes
Characteristic
Reference in guide 1 Internal budget processes are embedded in organisational planning and
align resources with organisational priorities. Part 2.1 2 Budget allocations and accountabilities align with managerial responsibilities
and authority. Part 2.2
3 Operational and capital budgets are seamlessly integrated and multi-year
focused. Part 2.3
4 The internal budget is consistent with the external budget and this
consistency is retained throughout the budget cycle. Part 2.4 5 The recognition, measurement and disclosure of internal budgets is
harmonised with reporting. Part 2.5 6 Relevant stakeholders are engaged throughout internal budget processes. Part 2.6 7 Internal budget processes are carried out in accordance with clearly defined
expectations and assumptions, a coordinated calendar of activity and well-documented and communicated policies and procedures.
Part 3.1 8 The internal budget is constructed with direct input by operational managers
in accordance with strategic targets and priorities established by senior management.
Part 3.2 9 Internal budget processes are overseen and formally approved by senior
management and subject to rigorous quality assurance processes. Part 3.3 10 Managers are provided with relevant, timely and accurate budget-to-actual
information appropriate to their level of responsibility and, in turn, provide clear and consistent feedback in a timely manner about underlying causes and effects of budget variations.
Part 4.1
11 Internal budget revisions are limited to approved formal updates to retain
clear accountability for budgeting performance. Part 4.2 12 Rolling forecasts are prepared to quickly respond to changes and to
manage the gap between budgeted and actual revenues and expenditure in a timely manner.
Part 4.3 13 The organisation adopts a continuous improvement culture, and has an
ongoing training program, to help ensure the internal budget remains relevant to the organisation’s requirements and priorities and is constructed in the most efficient and effective way.
Part 4.4
Embedding internal budget processes
into organisa
tional planning and mana
gement
Part 2
Embedding internal budget
processes into organisational
planning and management
Contents
2. Embedding internal budget processes into organisational
planning and management
8
2.1. Integrate the internal budget into organisational planning 9 2.2. Align internal budgeting with organisational roles and responsibilities 11 2.2.1. Ensure clear accountability for all budget allocations 12 2.2.2. Align organisational structures to outcome, output and
program responsibilities 13 2.2.3. Present full cost of service delivery 14 2.2.4. Show full financial impacts of budget decisions 16 2.3. Integrate operational and capital budgets 20 2.4. Align internal and external budgets 24 2.5. Harmonise budgeting and reporting 25 2.6. Engage stakeholders in internal budget processes 26 2.6.1. Obtain organisational support for the internal budget 26 2.6.2. Supporting operational managers in internal budget processes 26 2.6.3. Internal budget processes for whole of government initiatives 28
Embedding internal budget
2.
processes into organisational
planning and management
Organisations use internal budgets for financial planning, to establish performance expectations and to set financial controls. In addition, the internal budget can be used for purposes such as identifying costs and determining prices (for example, as part of cost recovery arrangements) and assessing individual managers’ financial performance.
The internal budget is a core element of an organisation’s planning and management framework. As shown in Figure 2, an integrated planning and management framework is characterised by close relationships between planning and budgeting and between budgeting and reporting, both within the organisation and externally.
Better practice organisations embed internal budget processes into organisational planning and management by:
integrating the internal budget into organisational planning;
✓
aligning the internal budget with organisational roles and responsibilities;
✓
integrating operational and capital budgets;
✓
aligning internal and external budgets;
✓
harmonising budgeting and reporting; and
✓
engaging stakeholders in the internal budget.
✓ better practice organisations embed internal budget processes into organisational planning and management.
Figure 2: Integrated planning and management framework
Internal Budgeting Internal Reporting Organisational Planning External Budgeting External Reporting
Embedding internal budget processes
into organisa
tional planning and mana
gement
Integrate the Internal budget Into
2.1.
organIsatIonal PlannIng
The strategic (or corporate) plan sets long-term goals and priorities which establish the direction for operational plans within the organisation. Typically, the strategic planning horizon encompasses the next three to five years, although a longer horizon may be appropriate for significant government programs and for capital planning. Ideally, the strategic plan describes and quantifies the direction of the organisation and is endorsed by stakeholders in terms of goals, objectives and timing. Organisations are better positioned to meet their objectives where resources are deployed consistent with organisational priorities. Closely aligning internal budget processes with strategic planning processes will help achieve this. Effective alignment means that organisational plans will be supported by internal budgets which establish funding expectations for the current year and future years consistent with the organisation’s goals and priorities. In this light, organisational plans have an appropriate financial basis and will be costed in a manner consistent with the delivery of the plan. The development of the internal budget enables an assessment of the extent to which goals are attainable or whether change is required.
By integrating the budget setting process into the planning process, organisations are better positioned to determine budgets and allocate resources based on operational needs and consistent with approved strategies and priorities. Effective integration also promotes better understanding among managers of how their individual activities and budgets fit into organisation-wide responsibilities.
The strategic plan is typically supported by a range of operational and specific plans, including business plans, group operational plans, workforce plans, capital plans and individual performance agreements. Each plan or agreement translates one or more areas of the strategic plan into detailed operational objectives, activities and accountabilities. The planning process requires clarity about priorities, targets and metrics such that strategic goals can be cascaded down into each plan and agreement. The internal budget should similarly support each level of planning and performance management within the organisation.
Better Practice Tip: Link the internal budget to workforce planning
The employee budget forms a large proportion of the overall internal budget of many Australian Government organisations. As such, assumptions made in relation to staffing levels and staff movements can have a significant impact on the overall budget.
As many organisations face increasingly tight labour markets and higher staff turnover, it is becoming more difficult to prepare a realistic estimate of staff numbers in the internal budget, especially for longer-term projections. A key risk in internal budget processes is that budget assumptions are biased towards current market conditions, including around workforce availability.
The establishment of a workforce plan is an effective way in which organisations can formally plan for the future workforce and link workforce numbers to organisational needs. The workforce plan sets out the organisation’s priorities and strategies for identifying, achieving and maintaining staffing numbers and skills to achieve organisational objectives.
The workforce plan can assist the internal budget by providing a reasonable basis for key employee-related assumptions underpinning budget calculations, including a longer-term perspective on workforce numbers.
by integrating the budget setting process into the planning process, organisations are better positioned to determine budgets and allocate resources based on operational needs and consistent with approved strategies and priorities.
One means of establishing top-down direction in the budget setting process is to use the first-year component of the strategic plan as the basis for the internal budget. Figure 3 illustrates how resources can be directed at achieving organisational goals through the alignment of planning and budgeting at each level within an organisation.
Plan Budget
Strategic plan (also called Corporate plan): High-level plan that identifies the organisation’s role, key goals and targets over the medium to long term (for example, three to five years).
Budgeted financial statements: Key statements showing financial performance, financial position and cash flows. Aligns to external budget.
Operational plan: Outlines expected operational activities to deliver annual strategies.
Operational budget: Shows the impact of operating decisions on the organisation’s sources of income, expenses and cash flows. Workforce plan: Identifies current and future
workforce requirements by assessing the workforce required and workforce available to support the organisation’s objectives.
Employee budget: Shows the cost of employees—generally a component of the operational budget although employees involved in capital projects may instead be included in the capital budget.
Asset management plan: A multi-year plan for capital asset acquisition, maintenance and retirement.
Capital budget: Shows planned asset purchases, construction and disposals. Group plans: Outline expected activities to
be undertaken by each group.
Group budgets: Outline expected
resource allocation and revenue sources for each group.
Individual performance agreements: Outline expected performance for the year including targets and planned development.
Budget allocations: Show allocated budget for particular positions or areas of responsibility.
Figure 3: Integrating the internal budget into organisational planning
Workforce
Plan Operational Plan Strategic Plan Planning Asset Management Plan Group Plans Individual Performance Agreements Employee
Budget Operational Budget Budgeted Financial Statements Budgeting Capital Budget Group Budgets Budget Allocations
Embedding internal budget processes
into organisa
tional planning and mana
gement
Integration is enhanced when planning and budgeting processes source information from the same internal and external data sets. This provides greater visibility in decision-making and consistency in the assumptions made.
The finance area is central to the integration of strategic planning and budget setting processes. The finance area can help operational areas translate strategic goals and performance plans into specific budget elements and drivers. The role of the finance area in supporting operational managers is discussed further in Part 2.6: Engaging stakeholders in the internal budget.
alIgn Internal budgetIng wIth organIsatIonal
2.2.
roles and resPonsIbIlItIes
The internal budget is allocated to areas within an organisation to facilitate detailed planning and performance management and enforce internal accountability. Budget allocations will be more effective when they reflect the organisation’s planning and management framework.
Participants in internal budget processes typically include:
senior management, responsible for the delivery of outputs and programs and accountable for
•
the performance and financial viability of the organisation as a whole;
operational or line managers, responsible for the delivery of specific outputs and programs as
•
well as financial management of their group or team; and
business support managers, including the Chief Financial Officer, responsible for the delivery
•
of certain support functions (such as the provision of financial advice) as well as financial management of their own group or team.
It is important that internal budget allocations are consistent hierarchically such that each lower-level budget can be aggregated consistent with the organisation’s management and accountability structure. However, this does not require the same level of detail to be reported at each level of management. It is preferable for relevant summaries of the internal budget to be prepared for each level of management, such that:
budget reporting to senior management is high-level and strategically focused, for example,
✓
providing budgets for the organisation as a whole with summarised results for each organisational area, output and program; and
budget reporting to operational and financial managers is more detailed than that provided to
✓
senior management to enable these managers to identify factors that influence budget results. Ideally, the internal budget is fully allocated across the organisation. Where the internal budget is not fully allocated there is a risk that there may be components of the budget for which no one has taken responsibility. Similarly, where budget allocations do not reflect organisational roles and responsibilities, there is a risk that managers are responsible for multiple allocations of the same budget or for allocations over which they have no control.
In allocating the internal budget across an organisation, it is prudent to:
clearly assign each budget allocation to an accountable officer with the allocated budget limited
✓
to those items where the officer has the responsibility, and the associated authority, to take action;
align budget allocations with output and program structures in addition to organisational
✓
structures (for example, cost centre structures);
allocate the full cost of goods and services across the organisation, distinguishing between
✓
those items that the accountable officer has direct control over from those where control is indirect; and
allocate all elements of the budget, including balance sheet items, so that officers can view the
✓
full financial impact of their decisions.
budget allocations will be more effective when they reflect the organisation’s planning and management framework.
Ideally, the internal budget is fully allocated across the organisation.
Ensure clear accountability for all budget allocations
2.2.1.
Budget allocations will be more effective when they are assigned to an accountable officer or position. General or broad statements of budget management responsibility are likely to create uncertainty about performance expectations and measures of accountability. Conversely, clearly articulated and communicated budget management responsibilities for financial and operational managers and staff helps ensure these responsibilities are widely and consistently understood. An important consideration for organisations is whether the full budget is allocated across the organisation or whether a component is retained centrally by senior management, for example, as unallocated contingency. The retention of a contingency reserve gives an organisation flexibility to cope with uncertainties and to allow adjustments for unanticipated expenditures. However, there is a risk that the reserve is perceived as a ‘slush fund’ that can be called upon when areas need additional funding. Organisations are also likely to encounter difficulties in allocating contingency reserves to outputs and programs, thereby reducing the accuracy of output and program budgets. As such, it is prudent to keep unallocated contingencies to a minimum and for specific purposes. It is also useful for organisations to have clear protocols in place to specify criteria under which contingency amounts can be accessed.
Figure 4: Better practices in allocating the internal budget
Accountability Authority Full Costs Budget Allocation Income and Expenses Cash Flows Assets and Liabilities Group Program Output Indirect Costs Direct Costs Responsibility
Clearly assign accountability. Align with managerial responsibility and authority
Align organisational structures to output and program responsibilities
Show the full cost of service delivery
Show the full
Embedding internal budget processes
into organisa
tional planning and mana
gement
Ensure budget accountability aligns with responsibilities and authority
Officers should only be held accountable for budgets that they control—that is where they have authority to make decisions, allocate resources and commit the organisation to a course of action. Accountability is enhanced when consistency is maintained between budget allocations and the organisation’s overall financial management framework, in particular the organisation’s delegations framework. It is often desirable to include accountability for budget performance in an officer’s individual performance agreement.
Managers are more likely to take ownership of their allocated budget where they have input into developing the budget as opposed to having a budget attributed to them.
In addition to the allocated budget, responsibility for underlying budget sources and budget assumptions (for example, standard costs) should also be clearly assigned within an organisation to help ensure this data is kept up-to-date. Typically, responsibility for these items would reside in the finance area.
Align organisational structures to outcome, output and
2.2.2.
program responsibilities
Public sector managers have many responsibilities, including to:
allocate funds in accordance with the organisation’s funding limits and delegations;
•
implement and administer government programs;
•
contribute to the delivery of the organisation’s outputs; and ultimately
•
contribute to the achievement of the government’s desired outcomes.
•
An effective internal budget structure helps managers plan for, and measure performance against, each area of responsibility. This provides managers with a clear understanding of, and commitment to, the organisation’s goals.
Aligning organisational structures with output and program responsibilities reduces complexity in linking resources to output and program delivery, as:
managers are held accountable for one rather than multiple budgets;
•
the time required to compile the budget is reduced as consolidation points are reduced;
•
organisations can more readily measure the cost of managing administered programs (that is,
•
there is less attribution); and
there is a direct link between external appropriation sources and internal resource allocation and
•
between external performance measurements (in the Portfolio Budget Statements) and internal budget activities.
Better Practice Tip: Align organisational structures with outcomes,
outputs and programs
This degree of alignment best defines management accountabilities and responsibilities, and enables organisations to directly translate internal activity reporting to external reporting.2
If an organisation is unable to align organisational structures to output and program responsibilities, it is important to clearly map linkages between each organisational unit and the outcomes, outputs, and programs to which they are contributing. Some organisations develop a matrix approach to the internal budget where managers are allocated budgets for one or more organisational units
officers should only be held accountable for budgets that they control.
as well as contributing to specified outputs and programs. Other organisations identify individual managers with specific responsibility for managing outputs and programs across a range of organisational units.
Present full cost of service delivery
2.2.3.
Aligning organisational structures to outputs and programs is less straightforward for internal enabling activities (such as corporate support services) and fixed organisational costs (such as rental costs). Ordinarily, these activities contribute to multiple outputs and programs. Nonetheless, including indirect costs in output and program budgets is necessary to present the full cost of delivering services. One approach to allocating indirect costs to outputs and programs is to require each corporate area to identify the program and output they worked on. However, it is often simpler and more cost-effective for an organisation to adopt attribution rules to allocate indirect costs to output and program budgets.
As shown in Table 2, a range of approaches are available for attributing direct and indirect costs to outputs and programs.3 The most appropriate approach to use will depend on the materiality
of indirect costs, availability of information and nature of the organisation’s activities, outputs and programs—the benefits of better information must outweigh the costs of collecting it. Many Australian Government organisations have automated cost-attribution systems to help support transparent and consistent approach to allocating costs to outputs and programs.
Table 2: Approaches to attributing costs
Attribution
basis Description Suggested use Time
recording systems
Employee costs and associated costs in operational areas are attributed to output and program (or project) based on a time recording method (for example, timesheets). Indirect employee costs (for example, corporate areas) are also allocated based on timesheet activity or are based on another attribution method.
Where staff costs are a
•
significant proportion of overall costs.
In project-based organisations
•
with a large number of small projects.
In organisations recovering costs
•
of activities. Records of
usage
Records are kept on the use of infrastructure, plant and equipment, with costs attributed on the basis of this information.
Where capital usage costs
•
are a significant proportion of overall costs.
Activity snapshot
Cost attribution is based on an analysis of activities over a representative period, rather than continuously. Examples of activity-snapshot approaches include time and motion studies and collecting timesheets for a representative period.
In organisations with a small
•
number of large projects or where the pattern of activity is fairly consistent over the course of a year.
3 Management Advisory Board (1997), Beyond bean counting: effective financial management in the APS—1998 &
beyond, Part 3, pp. 75–81, contains further discussion on cost attribution approaches.
Including indirect costs in output and program budgets is necessary to present the full cost of delivering services.
Embedding internal budget processes
into organisa
tional planning and mana
gement
Attribution
basis Description Suggested use General
ledger cost centre structures
Costs directly attributable to an output or program are identified based on the cost centre or profit centre structure in the general ledger. Indirect costs are then attributed using cost drivers or through another of the approaches listed in this table.
In organisations where there
•
is a close alignment between organisational structures and outputs or programs (that is, a one-to-one mapping).
Activity Based Costing (ABC)
The organisation is broken down into activities with each activity representing one way in which outputs and programs are delivered. Direct costs are allocated directly to outputs and programs (‘cost objects’). The majority of indirect costs are assigned to activities, which are in turn allocated to cost objects.
A key advantage of ABC is that it converts indirect costs into direct costs which are directly assigned, rather than allocated, to outputs and programs.
In complex organisations with a
•
range of material indirect costs. In organisations where the data
•
used to capture and measure activities can be generated at little cost and effort.
Proxy cost drivers
Indirect costs are allocated to operational areas (direct cost areas) based on one or only a few key cost drivers which are readily measurable, for example, staff numbers or work space. While there is not a direct relationship between the proxy cost drivers and each indirect cost element, the proxy(s) are representative of the organisation as a whole.
In policy or process oriented
•
organisations with a small range of activities and where indirect costs are not a significant proportion of the overall cost base. Internal user charging or Service Level Agreements (SLA)
Indirect cost areas (for example, corporate areas) record actual costs incurred for each operational area (‘client’), calculate a charge for the service and ‘invoice’ (either physically or notionally) each client on a regular basis.
In organisations where indirect
•
costs are a significant proportion of the organisation’s overall cost base.
In organisations where internal
•
enabling areas operate as autonomous business operations or are outsourced. In organisations where the data
•
used to measure usage can be generated at little cost and effort. Managerial
judgement
Indirect costs are allocated to outputs and programs based on management’s assessment of where costs are incurred.
In organisations where indirect
•
In addition to reflecting the full cost of service delivery, it is important that the allocated budget continues to align with managerial responsibilities and authorities. One way to achieve this is to distinguish in budget reporting between those budget items or activities that the output or program manager has direct control over (direct costs) from those items or activities used by the output or program but where control is indirect (indirect costs). Consistent with external budget and reporting standards, there is also a need to distinguish between departmental and administered activities. The involvement of operational managers in establishing attribution rules and identifying key cost drivers increases the likelihood that they will understand and accept the attribution rules and take ownership of their allocated budget.
The following case study provides an example of the attribution of indirect costs.
Case study: Department of Environment, Water, Heritage and the Arts
A simple and transparent approach to cost attribution
Following a cost-benefit analysis of alternate indirect costing methodologies and taking into account its operational environment, the department concluded that the most appropriate attribution approach for the purpose of overhead allocation was through the use of a single cost-driver based on workpoints (floor space). A workpoint is a point at which a person is able to work, regardless of whether a personal computer is there. It includes storage areas but does not include common areas. In most cases, a workpoint can be attached to an activity.
Indirect costs (that is, indirect activity centres) are attributed to direct activity centres through a two-phased attribution process. Firstly, indirect activities that directly support more than one activity within an output or program (for example, divisional executive) are attributed to the relevant output and program direct activity centres. Secondly, indirect activities that support all programs and outputs (for example, the Office of the Secretary) are attributed to direct activity centres based on workpoints.
Activity centre budget reports show separately those revenues and expenses that relate to direct activities from those items or activities used by the output or program but where control is indirect (indirect activities).
The approach provides a reasonable and cost-effective attribution to support accountability and decision-making by showing the full cost of outputs and programs.
Show full financial impacts of budget decisions
2.2.4.
Consistent with the external budget, Australian Government organisations generally prepare internal budgets which include income statements, balance sheets and cash flows. However, a key consideration for most organisations is the extent to which all elements of the budget are allocated. For example:
whether non-cash items such as depreciation are allocated to operational areas;
•
the extent to which budgeted revenues (for example, appropriation and revenues from independent
•
sources, including sales proceeds) are allocated to operational areas;
whether assets and liabilities are allocated to operational areas or maintained centrally; and
•
the extent to which operational areas are held accountable for cash estimates, accrual estimates
•
or both.
the involvement of operational managers in establishing attribution rules and identifying key cost drivers increases the likelihood that they will understand and accept the attribution rules.
Embedding internal budget processes
into organisa
tional planning and mana
gement
It is prudent to devolve all elements of the budget, including balance sheet items, to managers who have control or stewardship over each element. However, the degree of devolution of budget elements is likely to depend on the nature, size and distribution of the organisation’s assets and liabilities.
Benefits of allocating integrated budgets (that is, inclusive of income statement, balance sheet and cash flow impacts) to operational managers include:
the full financial impact of managers’ decisions are visible to them and they can be held
•
accountable for the full cost of delivering outputs and programs;
managers are able to assess budgetary impacts in the same period the underlying activity is
•
planned;
operational managers are assigned responsibility to focus on, and manage, the organisation’s
•
assets and liabilities;
it encourages consideration of alternate asset acquisition options (for example, leasing);
•
there is greater consistency between budget and actual reporting; and
•
there is increased awareness of longer-term fiscal challenges.
•
The following example illustrates an effective approach for allocating depreciation to operational areas.
Example: Allocating depreciation to operational areas
Depreciation is a non-cash expense which reflects the allocation of the cost of using existing assets over their useful life. The allocation of depreciation provides operational managers with a more complete understanding of the cost of providing services. Being charged with this cost gives managers greater incentive to identify surplus assets and assess useful lives so that the depreciation charge reflects planned asset usage. There is also greater incentive to consider alternate acquisition options, especially in circumstances where assets are unlikely to be fully utilised.
Organisations can support and encourage managers to consider the cost of depreciation when making resource decisions by:
separating depreciation on assets managed by each operational area from depreciation
•
on assets used (but not managed) by the operational area, such as head office buildings or fit out. For budget collection and reporting purposes, managers are only required to act on managed assets;
deriving depreciation from the capital budget so that managers can observe the operational
•
impact of their investment decisions;
distinguishing between capital expenditure on asset replacement (that is, the depreciation
•
component) and asset expansion;
integrating the depreciation budget with the asset register so that managers can drill-down
•
to the underlying assets; and
separating depreciation by class and by nature of funding. For example, some Australian
•
Government organisations are responsible for specialised assets or heritage assets which are long-lived or irreplaceable and subject to specific maintenance and funding agreements. The depreciation associated with these assets should be shown separately from the depreciation charged on other assets.
The above practices assist in providing managers with the full cost of delivering their services but do not require managers to calculate or estimate depreciation.
the degree of devolution of budget elements is likely to depend on the nature, size and distribution of the organisation’s assets and liabilities.
The key challenge associated with the allocation of full accrual budgets is the ability of non-financial managers to understand the inter-relationship between the financial statements and, as such, the different measures for which they are accountable. To address this challenge, organisations can:
automate relationships between the income statement, balance sheet and cash flow statement
✓
such that managers do not have to provide the same information in two or more statements. This may include, for example, the automatic derivation of the cash flow statement from the income statement and balance sheet; and
separately disclose budgeted gains and losses which are due to factors outside the manager’s
✓
control (for example, changes in the market value of assets between budget updates).
In circumstances where an organisation determines that central management of a budget element (including cash) is appropriate, it is important to undertake a formal risk assessment and identify appropriate compensating controls to help manage each budget element. This is illustrated in the following two examples.
Example 1:
Each manager is accountable for an employee expense budget, however the employee provision liability budget is maintained centrally. Senior management have established leave balance targets (including maximum leave days and average leave days) and managers are accountable for monitoring and proactively managing staff leave within these targets. Managers receive regular reports showing employee leave balances and are required to explain exceptional balances.
Example 2:
Each manager is accountable for supplier expenses, however the creditor liability is not allocated to operational areas as payment is centrally managed under pre-determined payment terms (for example, 30 days). Under the organisation’s control framework, managers are accountable for the monthly reconciliation of creditor suspense accounts and the review of aged creditors and commitments. All exceptional balances must be explained and actioned.
The following case study illustrates use of a fully integrated budgeting and reporting system.
Case study: Department of the Environment, Water, Heritage and
the Arts
A fully integrated budgeting and reporting system
The Department of the Environment, Water, Heritage and the Arts (DEWHA) has created an integrated budgeting and reporting system that supports budgeting and reporting by organisation, program and output. Key aspects of the department’s integrated internal budget process are discussed below.
An established budget framework
The DEWHA budget process is guided by a framework of financial management policy documents which articulate the department’s principles and approaches to budget management and reporting. These documents include budget policies for the recognition
the key challenge associated with the allocation of full accrual budgets is the ability of non‑financial managers to understand the inter‑relationship between the financial statements and the different measures for which they are accountable.
Embedding internal budget processes
into organisa
tional planning and mana
gement
and allocation of departmental revenue, including priorities for utilising funding sources to meet required payments, and the department’s methodology for allocating and reporting corporate overheads.
The policy framework was established before the implementation of DEWHA’s current budget and reporting system and, as such, provided the overarching functional requirements to be met in the system implementation. Key stakeholders within and external to DEWHA were consulted and their requirements considered in developing the framework. Most importantly there was significant senior executive involvement in, and support for, the framework and system.
Defined roles and responsibilities
The DEWHA financial management framework is underpinned by a shared commitment to financial management across the department. To ensure a consistent approach to financial management, the department has a documented policy which clarifies roles and responsibilities in budget management and reporting. This policy is translated into operational budget guidelines for each internal budget update.
Within the department, budget processes are overseen by the Budget, Finance and Strategy Committee. The Committee’s terms of reference, including roles, responsibilities and accountabilities, are clearly documented in a charter approved by the Secretary.
A flexible financial budgeting and reporting structure
A key requirement for the department’s financial reporting system was the ability to budget and report against multiple accountabilities, including organisational unit, program and output.
To achieve these objectives, the department established a budgeting and reporting structure built around ‘activity centres’. An activity centre represents a particular activity that is sufficiently specific that it can be mapped to an organisational unit, output and program in a one-to-one relationship. Departmental Organisational Unit Administered Program Special Public Moneys Sub-output Activity Centre
Continued from previous page
Activity centres are then classified as direct or indirect (for example, corporate activities). Direct activity centres must be able to map to one organisational unit, program and sub-output. Indirect activity centres are allocated to direct activity centres based on the department’s corporate overhead allocation methodology. Each activity centre has only one accountable manager, but a manager may have multiple activity centres.
This approach provided the department with the flexibility to aggregate activity centre budgets according to different reporting hierarchies, for example, by program, output and division.
Benefits
All budget and financial reports are from the one system ensuring consistency of
•
information.
Readily available information for staff and other stakeholders can be produced.
•
Accountability is understood and recognised for all levels of staff.
•
There is ownership and acceptance of the budget and it is fully automated.
•
Integrate oPeratIonal and CaPItal budgets
2.3.
Capital investment decisions have long-term implications, potentially affecting an organisation’s capital structure and influencing its ability to change operations in the future. Capital investment decisions also commit the organisation to a stream of costs that extend beyond the current year (through depreciation and maintenance costs). As such, having close integration between the capital budget and the operational budget helps ensure an understanding of the long-term consequences of budget decisions.
The management and associated funding of an organisation’s capital requirements involves planning processes that span a number of years. Because of the uneven pattern of capital expenditure, it is important that sufficient funds are created internally (for example, by creating depreciation reserves) to finance replacements. A planned cycle of acquisition and replacement will avoid funding difficulties caused by several major investments taking place in a single financial year and large-scale obsolescence of equipment.
Capital budget processes provide a long-term assessment of an organisation’s capital priorities and associated funding requirements. The capital budget identifies all new asset purchases (that is, expenditure on items that are expected to provide benefits for more than one year), all planned disposals and all costs that are to be capitalised, such as enhancements to existing assets or internally developed assets such as software. The capital budget typically includes:
an overview of proposed capital expenditure by year across the capital planning period;
•
an overview of sources of funding by year (for example, depreciation reserve, reallocated funds
•
and external funding), and accumulated impacts on existing capital reserves such as quarantined depreciation funding; and
a summary listing of proposed capital projects by category, including explanatory detail such as
•
timeframes and milestones.
The timeframe covered by the capital budget is dependent on the nature of the organisation’s asset base but should, at least, encompass the expected useful life of current and planned asset purchases.
Figure 5 illustrates the effective integration of the capital budget into organisational planning and management to develop the overall budgeted financial statements.
Integration between the capital budget and the operational budget helps ensure an understanding of the long‑term consequences of budget decisions.
the timeframe covered by the capital budget is dependent on the nature of the organisation’s asset base but should, at least, encompass the expected useful life of current and planned asset purchases.
Embedding internal budget processes
into organisa
tional planning and mana
gement
As illustrated in Figure 5, key inputs in developing an effective capital budget include:
• asset management plan: a multi-year asset management plan provides a framework for decisions to acquire, maintain, replace and retire capital assets. The asset management plan translates the organisation’s long-term priorities and strategic goals (as determined through the strategic planning process) into capital requirements. It is important that the capital budget directly links to, and flows from, the asset management plan to help ensure capital needs are appropriately costed and funded.
asset register:
• the asset register is more than an accounting record of an organisation’s existing asset base—it also provides key information required for forward planning such as expected useful lives, replacement values and the purpose for which assets are being used.
Better Practice Tip: Link the capital budget to the asset register
Use the asset register to construct a long-term rolling projection of asset replenishment requirements based on estimated replacement costs and useful lives of an organisation’s current asset holdings. This provides an overview of projected capital expenditure requirements as well as an indication of annualised funding required to service the replacement cycle.
• operational budget: the operational budget shows the ongoing impact of holding assets through reporting depreciation. An organisation may also utilise ‘off-balance sheet’ assets in its day-to-day operations under leasing agreements or other arrangements that would not show up in the balance sheet. As such, integrating the operating budget and capital budget enables managers to more readily assess ‘whole of life’ costs of purchasing decisions. Furthermore, the operational budget shows consequential costs to the organisation when capital investment decisions are not made, for example through increased repairs and maintenance expenditure.
It is important that the capital budget directly links to, and flows from, the asset management plan.
Integrating the operating budget and capital budget enables managers to more readily assess ‘whole of life’ costs of purchasing decisions.
Figure 5: Integrated capital planning and budgeting
Business Case Capital Bid Process Operational Plans Capital Budget Operational Budget Long-term capital priorities Capital requirements Major Investment decisions Operational priorities Strategic Plans Key priorities Asset Management Plan ‘Off-balance sheet’ capital decisions Depreciation Capital maintenance Asset Register Replacement requirements Replacement costs
business cases:
• given the multi-year significance of capital investment decisions, it would generally be appropriate for organisations to adopt different, and more extensive, submission and approval arrangements for capital decisions than those applied to the operational budget. These arrangements often include requirements to prepare separate capital proposals and establish separate committees to consider and approve the capital budget.
It is prudent that all new major capital investment proposals are supported by an appropriate business case for senior management consideration. It is also prudent to apply business case discipline to major replacement projects to help ensure replacement is appropriate to current priorities. At a minimum, the business case for capital investment should:
justify the need for the capital investment against the organisation’s priorities; –
concisely, clearly and completely specify what is to be delivered, the overall time and cost –
limits, and what benefits those deliverables will support; identify sources of funding;
–
describe the implementation in sufficient detail to provide confidence the project is achievable, –
and set a means for assessing and monitoring progress;
identify risks associated with the project (including risks associated with not proceeding) and –
strategies to address these risks;
obtain validation of the project specification and implementation plan to help ensure that the –
proposed approach is an appropriate way to fulfil the organisation’s requirements; and help ensure that decisions for the project are clearly stated, properly documented and taken –
by the appropriate person.
The extent and depth of each key input into the development of an effective capital budget is dependent on the value, nature and size of the organisation’s asset base.
The following case study illustrates the use of formal governance arrangements over major capital investment decisions.
Embedding internal budget processes
into organisa
tional planning and mana
gement
Case Study: National Library of Australia
Governance over capital budgeting
An important aspect of any capital asset replacement process is that effective governance arrangements are in place throughout the organisation. The National Library of Australia (the Library) achieves this through various sub-committees of the Corporate Management Group. There is a Collection Management Committee, a Building Works Coordination Committee and an Asset Management Committee. The Library Council is responsible for endorsing overall acquisition programs and ministerial approval is required for any individual acquisitions or disposals in excess of $1 million.
Each of the three committees meet at least quarterly throughout the year to develop, amend and monitor progress against annual asset programs. Meetings are also timed to coincide with overall strategy review and budget timetables. Some staff are members of one or more committees, which helps provide an integrated approach across capital and operational budget requirements. Other than the Collections Management Committee, there is a representative from each division on each committee and that person is responsible for presenting divisional proposals and discussing progress against agreed plans.
In October or November each year asset bids for the upcoming year are finalised by the various committees and presented to the Corporate Management Group for consideration as part of the Library’s strategy and budget processes. Major capital projects are managed through the Library’s Balanced Scorecard system.
Planning for capital replacement
As most long-lived assets require active management beyond the budget and forward years it is important to take a long-term view of their ongoing maintenance and replacement. Within the Library, the Building Works program is based on:
a 15 year strategic building asset plan which is revised every three years to identify
•
replacement and maintenance requirements of the various components of the building over that period;
a strategic building master plan that focuses on library service issues (for example,
•
collection delivery issues, reading room locations, public program requirements and staffing issues);
a collection storage plan that aims to optimise collection storage within the Library
•
buildings and identifies when additional external collection storage is required; and a conservation management plan.
•
The Library also has a separate building management system that identifies building asset replacement and maintenance requirements. This system is also used to help manage associated contracts.
Any additional whole of life (for example, maintenance) and depreciation expenses are built into budget proposals as required. Some capital funding is held in reserve each year to take account of major purchases required in future years. These quarantined funds are considered as part of budget processes and are held for major categories of assets and the duration of asset management plans.
