zero based budgeting

INTRODUCTION

The new administration in Nigeria recognizes that the country’s recurrent   budget (72 percent in 2015) does not leave enough resources to be invested in growth enabling assets such as infrastructure. As a result, it is proposing to adopt zero-based budgeting system for the 2016 budget.

This proposal would be a radical departure from the incremental budgeting that has been in practice in Nigeria for many years

            
            Definition of Zero-Based Budgeting

Chartered institute of management accountant (CIMA), defined zero-based budgeting as; a method of budgeting which requires each cost element to be specifically justified, as though, the budget related were being undertaken for the first time without approval, the budget allowance is zero. Zero-based budgeting is concerned with the evaluation of the costs and benefits of alternatives and implicit in the techniques, is the concept of opportunity cost.

National open university of Nigeria (2010), sees zero-based budgeting as; a systematic application of marginal analysis techniques which evaluate current and new programs on the basis of output, performance, cost, utility, effectiveness, relevance, level, scarce resources and priorities.

Sarant, (2011), defines zero-based budgeting as; “a technique which complements and links to existing planning, budgeting and reviews processes that indentifies alternative and efficient methods of utilizing limited resources and provides a credible rationale for re-allocating resources by focusing on a systematic review and justification of the funding and performance level of current programs.” 

Tayo, T. (2015), defined zero-based budgeting as; a budgeting process that allocates funding to budget items based on efficiency and necessity rather than budget history, it opposed the traditional budgeting practice of automatically including budget items from the current year in the next year’s budget. In zero-based budgeting, budget expenditure is reviewed at the beginning of every budget cycle and each line item must be justified in order to receive funding.

Kaduna state ministry of budget and planning (2015), defined zero-based budgeting as; an integration of planning and budgeting into a single process with the objective of development and redeployment of a budget through scrutiny of programs.

Zero-based budgeting can be thought of as a tool which provides a process to evaluate programs, it allows for budget reductions and permits the re-allocation of resources from low to high priority programs, zero-based budgeting is a cost benefit analysis for all decision making in an organization.

            
            History of Zero-Based Budgeting

Zero-based budgeting, also known simply as ZBB, has a long and sometimes controversial history in the public sector. Zero-based budgeting first rose to prominence in government in the 1970s when U.S. president Jimmy carter promised to balance the federal budget in his first term and reform the federal budgeting system using zero-based budgeting, a system he had used while governor of Georgia. Zero-based budgeting, as carter and budget theorists envisioned it, requires expenditure proposals to complete for funding on an equal basis starting from zero. In theory, the organization’s entire budget needs to be justified and approved, rather than just the incremental change from the prior year.

Interest in zero-based budgeting had been in decline for many years. The large amount of paperwork and data zero-based budgeting generates, along with doubts about the method’s ability to fully meet its theoretical promises, were at least partially responsible. Also, the improving economic conditions from the low points of the late ‘70s and early ‘80s, in the U.S., and the early ‘90s in Canada, probably reduced the perceived need for what was largely regarded as a “cutback budgeting” method.

            
            Why Zero-Based Budgeting

In accounting terms, zero-based budgeting is a method for preparing cash flow budgets and operating plans which every year must start ‘from scratch’ with no pre-authorized funds. Zero-based budgeting helps departments drill down to unit costs for all procurement, ensuring that costs are re-assessed every year for value. Zero-based budgeting also helps to increase the visibility in cost drivers, essentially leading to more effective cost management, by freeing unproductive costs and re-directing them to priority sectors.

This compares to a traditional line-item process where only incremental spending is considered and where there is no ready means to compare the value of one service versus another, and, thus, to determine different reduction in spending for different services on a rational basis. Hence, zero-based budgeting promises to move budget away from the use of across-the-board cuts (a budget reduction method that does not differentiate the value of one service versus another). It gives top management better insights into the detailed workings of departments. It clearly differentiates service level options, the impact of difference service levels on what the community will receive from government (through performance measures), and a detailed plan for the inputs necessary to provide those service  level option.

            
             Goals of Zero-Based Budgeting

According to Cornelius, E.T. (2006), in hand book of federal accounting practices, the goals of zero-based budgeting as summarized by the office of management and budget (OMB) in USA are as follows;

a.   To examine the need for an accomplishment and effectiveness of existing government programmes as if they were proposed for the first time.

b.   To allow proposed new programme to complete for resources on a more equal footing with existing programmes.

c.   To focus budget justifications on the evaluation of discrete elements and programmes or activities of each decision unit aid.

d.   To secure extensive management involvement at all levels in the budget process.

            
             Characteristics of Zero-Based Budgeting

a.   Linking of annual budgets to national vision documents

b.   Formulation of decision packages through line-item budgeting

c.   Elimination of overlapping inter-ministerial expenditure

d.   Justification of all expenditure heads from scratch and not merely adding a margin to   the previous year’s figures

e.   Setting operational efficiency targets in order to promote value for money audit (VFM)

f.   All budget items both old and newly proposed are considered totally afresh.

g.  Managers at all levels participate in the zero-based budgeting process and they have corresponding accountabilities

            Steps in Implementing Zero-Based Budgeting

Generally speaking, zero-based budgeting consists of the following important stages, steps/ procedures;

1.      Identification of decision units.

2.      Preparation of decision packages.

3.      Prioritization of decision packages within a decision unit.

4.      Prioritization of decision packages of various decision units.

5.      Allocate resources.

6.      Monitor and evaluate.

Identification of decision units

Each cost center can be a decision unit. Decision units should be a particular activity or a group of activities that can be independent and meaningfully indentified and evaluated. Decision units should not be overlap; the decision units should be discrete entities for management purposes, e.g. sites or programs.

Decision packages

A decision package is a document, which identifies a discrete activity, function or operation within a decision unit for evaluation and comparison with other activities. Each decision package should be “standalone” containing the following information;

Ø  Identification of data program/activity for which the package is made

Ø   Objective of the decision unit

Ø  Objective of decision package

Ø  Feasibility assessment

·         Is the program required?

·         Is the program technically feasible?

·         Is the program operationally viable?

·         Is the program sound?

The benefit-cost-analysis

Ø  Benefit/output (tangible) at existing threshold/optimum level

Ø  Tangible cost at the existing threshold/optimum level

Ø  Yearly phasing of the proposed expenditure

Ø  Consequence of non funding

Ø  Alternatives considered

Ranking/prioritization

The following are example of criteria for ranking a decision package

Ø  Statutory/legally committed active programs

Ø  Emergent programs arising from national events

Ø  Advancement of knowledge or using innovative method

Ø  Application of knowledge or using innovative method

Ø  Development of technology based solutions

Ø  Welfare/safety issues

Ø  Facilitation of policy/ decision making

Allocate resources

Once all the decision packages have been ranked on the basis of pre-determined criteria, the funding decisions for the cost of total decision packages is made. While funding a decision package, it is necessary for management to indicate also the level at which activity/program should be carried out existing threshold or optimum level.

Monitoring and evaluation

Since all the decision packages have to complete for funding, only those which are most relevant to the government are funded. The monitoring and evaluation is done on the basis of the content and particularly the outputs described in the decision package with fixed accountability.

            Advantages of Zero-Based Budgeting

1.     Supports cost reduction by encouraging active resource allocation over automatic          budgets increase.

2.     Increases organizational efficiency by forcing government agencies to work together    in order to activity prioritizes programs.

3.      Improves alignment of resources allocations with strategic goals by forcing cost            centers to identify their mission and priorities.

4.      Improves public perception through perceived increases in transparency and                  accountability, both internally within their organization and externally with the              public.

5.      Reveals inflated or unjustifiable budgets as each line item has to be defended.

6.      Ensures elimination of inefficient or wasteful projects.

7.      It allows for optimum allocation of resource. This is made possible by the                      formulation of alternative courses of action and evaluating each on its own merit.

8.      It provides a better yardstick for the measurement of performance.

9.      It is good for profit-oriented projects.

10.    The technique allows for the participation of the various organs of the decision unit.

            Disadvantages of Zero-Based Budgeting

1.      Implementing zero-based budgeting at all can be a major challenge for public sector    organizations with limited funding, and can constitutes a major risk when potential      cost is high and potential savings are uncertain.

2.     Government agencies may face extreme constrains relating to their ability to                 complete zero-based budgeting within a budget cycle and the availability of                  personnel to drive the process internally.

3.      Prioritization process may be problematic for department with intangible output.

4.      Switching to zero-based budgeting may requires a modification of the system, which    may necessitate a general review, overhauling, adding to or scrapping of activities,        function etc.

5.       It involves the task of analyzing and ranking voluminous data and information             which a number of civil servants find difficult to manage. This situation is further         complicated by lack of qualified and competent personnel in the public sector.

6.       In determining decision packages, there is the problem of fixing the minimum level      of expenditure.

7.       There is the need to make accounting structure conform to the ‘zero-based                     philosophy for the purpose of evaluation and control. Hence, it may necessitate a         general review overhauling, adding or scrapping of activities and functions.

8.       It is not so good for recurrent expenditure; it has not been successful in the public         sector.

9.       Bureaucrats often do not trust the approach and hence frustrate its effectiveness.

  

Double Entry system

Introduction

Dual aspect is the basic concept of accounting. According to this concept, for every debit, there has to be a corresponding credit. In other words, when a transaction is recorded, debit amount has to be equal to the credit amount. This is also known as ‘Double Entry Principle’. The basic principle of double entry system is that each business transaction affects two accounts in the books of a businessman. No transaction is complete without double aspect. The same amount is entered on the debit side as well as credit side of different accounts.

Meaning of double entry

J.R. Batliboy said “Every business transaction has two fold effects and it affects two accounts. In order to keep a complete record of transactions, one account is bound to be debited and the other account is bound to be credited. Recording this twofold account of each transaction is called Double Entry System”.

Every event that is recorded in the accounts affects at least two items; there is no conceivable way of making only a single change in the accounts. Accounting is therefore properly called a "double-entry" system. Anthony (1970),

Put in another way, the “golden principle” of bookkeeping states that “every transaction has at least two parties and these parties can either be “persons” or “accounts”.

In double entry, one of the parties is a giver and the other a receiver. The giver is referred to, as a “creditor”, while the receiver is a “Debtor”. Therefore, the double entry principle says “for every debit, there must be a corresponding credit entry”. Thus, the receiver’s account is credited,

Summary of Double Entry Principle

Dr: Receiver (receiving account)
Cr: Giver (giving account)

Steps involved in Double entry system

A.     Preparation of Journal 

      Journal is called the book of original entry. It
records the effect of all transactions for the first time. Here the job of recording takes place.

B.     Preparation of Ledger

      Ledger is the collection of all accounts used by a
business. Here the grouping of accounts is performed. Journal is posted to ledger.

C.     Trial Balance preparation

      Summarizing. It is a summary of ledge
balances prepared in the form of a list.

D.     Preparation of Final Account

      At the end of the accounting period to
know the achievements of the organization and its financial state of affairs, the final
accounts are prepared.

Advantages of Double entry system

1.   Scientific

The double-entry book-keeping system is a scientific system of book-keeping. Double-entry system has its own set of principles and rules. Under those principles and rules, two aspects of every financial transaction are recorded.

2.   Systematic

A systematic technique is followed in recording financial transaction in double-entry book-keeping system. It records financial transactions in a systematic and chronological order with suitable narration of the financial transaction.

3.   Complete

Double-entry system is a complete system of book-keeping. It records not only each and every financial transaction, but also each aspect of the transaction.

4.   Accuracy

Double-entry book-keeping system is based on the double-entry principle which means ' for every debit amount there is a corresponding credit amount'. Such a method of debit and credit can help ensure arithmetical accuracy of the recordings of financial transactions.

5.   Profit Or Loss

 Double-entry book-keeping system helps to ascertain the true profit or loss of a business by preparing the profit and loss account for a given period.

6.   Financial Position

Double-entry book-keeping system also helps to reveal information about the financial position of the business by preparing a statement called balance sheet.

7.   Control

   Double-entry book-keeping system keeps a detailed record of financial transactions. Therefore,    the recording of financial transactions in books provides necessary information for the                  purpose of costs control.

8.   Decision Making

     Double-entry book-keeping system communicates financial information that is necessary for        taking decisions by a business. Double-entry book-keeping system also provides necessary          information to different users such as owners, managers and creditors for their decision                making    purposes.

Accounting concept and convention

Definition of accounting concept

The main objective is to maintain uniformity and consistency in accounting records. These concepts constitute the very basis of accounting. All the concepts have been developed over the years from experience and thus they are universally accepted rules.

Accounting concept refers to the basic assumptions and rules and principles which work as the basis of recording of business transactions and preparing accounts.

Accounting concepts are those bases, rules, principles, and procedures adopted in preparing and presenting financial statements.

A substantial number of alternative postulates, assumptions, principles and methods adopted by a reporting entity in the preparation of its accounts can significantly affect its results of operations, financial position and changes thereof. It is therefore, essential to understand, interpret and use financial statements, whenever there are several acceptable accounting methods. This follows that those who prepare them disclose the main assumptions on which they are based.

The fundamental accounting concepts that guide the financial reporting of all enterprises are described below:

      1.               Business entity concept

The business is viewed as a distinctly different and independent of the owner and is to be viewed as an entity on its own. This means that the business transactions are to be recorded and the factors of the dual aspect are to be determined from the point of the view of the business. This means even in the case of a sole trader the owners’ transactions are to be recorded as if it is from any other person like.

2.            Going Concern Concept:

Under this concept, the transactions are recorded assuming that the business will exist for a longer period of time, i.e., a business unit is considered to be a going concern and not a liquidated one. Keeping this in view, the suppliers and other companies enter into business transactions with the business unit. This assumption supports the concept of valuing the assets at historical cost or replacement cost. This concept also supports the treatment of prepaid expenses as assets, although they may be practically unsaleable.

3.            Periodicity Concept or Accounting Period Concept
This simple concept recognizes that profit occurs over time, and we cannot usefully speak of the profit for a period until we define the length of the period. The maximum length in which:

a.                      it is capable of objective measurement, and

b.                      The asset value receivable in exchange is reasonably certain.

For instance, if an asset such as stock is disposed off, either on cash or credit basis, the proceeds should be recognized as revenue realized for that period.

4.            Cost Concept

All business transactions will be recorded on the basis of the costs and not on the basis of its value to the business even though it may be important from the point of the business.

5.            Money Measurement Concept:

In accounting all events and transactions are recode in terms of money. Money is considered as a common denominator, by means of which various facts, events and transactions about a business can be expressed in terms of numbers. In other words, facts, events and transactions which cannot be expressed in monetary terms are not recorded in accounting. Hence, the accounting does not give a complete picture of all the transactions of a business unit. This concept does not also take care of the effects of inflation because it assumes a stable value for measuring.

6.            Dual Aspect Concept

Dual aspect is the foundation or basic principle of accounting. It provides the very basis of recording business transactions in the books of accounts. This concept assumes that every transaction has a dual effect, i.e. it affects two accounts in their respective opposite sides. Therefore, the transaction should be recorded at two places. It means, both the aspects of the transaction must be recorded in the books of accounts. For example, goods purchased for cash has two aspects which are

a.                   Giving of cash

b.                  Receiving of goods

These two aspects are to be recorded.

Thus, the duality concept is commonly expressed in terms of fundamental accounting equation:

              Assets = Liabilities + Capital

The above accounting equation states that the assets of a business are always equal to the claims of owner/owners and the outsiders. This claim is also termed as capital or owners’ equity and that of outsiders, as liabilities or creditors’ equity. The knowledge of dual aspect helps in identifying the two aspects of a transaction which helps in applying the rules of recording the transactions in books of accounts. The implication of dual aspect concept is that every transaction has an equal impact on assets and liabilities in such a way that total assets are always equal to total liabilities.

7           Matching Concept:

The essence of the matching concept lies in the view that all costs which are associated to a particular period should be compared with the revenues associated to the same period to obtain the net income of the business. Under this concept, the accounting period concept is relevant and it is this concept (matching concept) which necessitated the provisions of different adjustments for recording outstanding expenses, prepaid expenses, outstanding incomes, incomes received in advance, etc., during the course of preparing the financial statements at the end of the accounting period.

8              Historical Cost Concept
This concept states simply that resources (assets) acquired by the business should be recorded at their original purchased prices. It follows on from the monetary measurement concept discussed further and tells us how the item can actually be measured. This is a well-known concept that has gained a worldwide support in the past; however, it no longer receives such support.

9              Realisation Concept

This concept states that revenue from any business transaction should be included in the accounting records only when it is realised. The term realisation means creation of legal right to receive money. Selling goods is realisation, receiving order is not.

In other words, it can be said that: Revenue is said to have been realised when cash has been received or right to receive cash on the sale of goods or services or both has been created.

10      Accrual Concept
The concept states that all expenses in which the services have been enjoyed but not paid for must be captured in preparing the financial statements of such Entities. For instance, electricity bills for a given period must be considered in drawing up the accounts for the period whether or not payment for consumption has been made.

      Accounting Convention'

An accounting convention consists of the guidelines that arise from the practical application of accounting principles. It is not a legally binding practice; rather, it is a generally accepted convention based on customs and designed to help accountant overcome practical problems that arise out of the preparation of financial statement 

The following conventions are to be followed to have a clear and meaningful
information and data in accounting:

1.      Consistency:

The convention of consistency refers to the state of accounting rules, concepts, principles, practices and conventions being observed and applied
constantly, i.e., from one year to another there should not be any change. If

Consistency is there, the results and performance of one period can he compared easily and meaningfully with the other. It also prevents personal bias as the persons involved have to follow the consistent rules, principles, concepts and conventions. This convention, however, does not completely ignore changes. It admits changes wherever indispensable and adds to the improved and modern techniques of accounting.

2.      Conservatism (Prudence)
This concept refers to the accounting practice of recognizing all possible
losses, but not anticipating possible gains. This will tend to lead to anunderstatement of profits and to an understatement of asset values with no corresponding understatement of liability. This concept seems to contradict the Going Concern, Materiality, Historical Cost and Objectivity concepts (SAS 1- Disclosure of Accounting Policies).

3.      Materiality:

American Accounting Association defines the term materiality as “An item should be regarded as material if there is reason to believe that knowledge of it would influence the decision of informed investor.” It refers to the relative importance of an item or event. Materiality of an item depends on its amount and its nature.

Theoretically, all items, large or small, should be treated alike. Materiality convention implies that the economic significance of an item will to some extent affect its accounting treatment.

Materiality in its essence is of relative significance. In the sense that some of the unimportant items are either left out or included with other items.

4       Disclosure:

This convention requires that accounting statements should be honestly prepared and all significant information should be disclosed therein. That is, while making accountancy records, care should be taken to disclose all material information. Here the emphasis is only on material information and not on immaterial information.

The purpose of this convention is to communicate all material and relevant facts of financial position and the results of operations, which have material interests to proprietor, creditors and investors.