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Use it or lose it: it's often claimed that the need to spend budgets by the end of the year leads to wasteful expenditure. In their CIMA-backed research project, Noel Hyndman, Rowan Jones and Maurice Pendlebury examine the effect of annuality on budget-holders in a range of public-sector organisations.

A basic rule of public-sector budgeting is that allocations must be spent by the end of the financial year or be lost to the centre. Not only that, but if an allocation is not used in one year it may be cut for the following year. So there is a strong incentive for budget-holders to use up all their money, even though the outlay may not be strictly necessary.

This rush to spend by 31 March--the end of the financial year for the public sector--also means that suppliers are under pressure to fulfill orders, so quality and value for money may be sacrificed. The main concern over this approach is that it leads to a spending spree that is uneconomic, inefficient and ineffective. The terms people use to refer to annuality--"March madness" or "silly season"--reflect these problems, yet it persists.

With these concerns in mind, we undertook a study to examine the workings and impact of annuality. It consisted of a series of confidential interviews with budget-holders, finance officers and consultants in 17 organisations in England, Wales and Northern Ireland.

Of the 17 interviews, 13 were with controllers or budget-holders in government organisations or local administrative units, two were with firms of consultants, one was with a non-departmental public body and one was with a public-sector-funded charity.

Given the range of entities involved, we expected that attitudes to annuality would vary widely. This they did, but perhaps our most interesting finding was that, although all the budget-holders in the government organisations were aware of its limitations and often referred to their frustration with it, all of them (implicitly or explicitly) supported annuality.

They were generally comfortable with annuality, because they felt the systems that operated in their organisations minimized any of its adverse effects. But many argued that annuality was made more complex when there was a lack of congruity between the fiscal year and the effective management year or the fiscal year of an associated authority--particularly EU funding bodies or other grant-awarding organisations.

Many finance officers pointed to systems they had in place for the early identification of potential underspending. They saw this as possibly the most important way to manage the constraints of annuality, arguing that this proactive behaviour ensured that the adverse consequences of annuality never arose.

Some interviewees put particular emphasis on having carefully prepared projects, which were fully consistent with organisational objectives, that could be quickly implemented to use up any underspending arising towards the end of the financial year.

One interviewee explained this in the context of highway maintenance: "Because the financial year ends on 31 March and the winter is at the end of the financial year, you have to make at the start of the financial year a reasonably prudent allocation for winter maintenance. Obviously, if it's a mild winter you may find yourself at the end of the financial year with unspent resources that you are looking to consume. Normally, in highway terms anyway, that isn't a major problem. If it has been a mild winter, you are able to do resurfacing works, for instance, in March, which is an effective way to spend the money. Certainly, most prudent managers would have a programme ready to pull off the shelf."

Other examples of areas of quick discretionary spending they cited included routine maintenance (because this is one of the first items to be cut when savings are needed); staff overtime (to dear backlogs); and training (including sending more people on a course than would otherwise attend, sending them in March rather than April or using an external course rather than an in-house programme).

Support for annuality from respondents in the non-departmental public body and the charity was much weaker. They provided several examples of how their organisations had benefited from annuality owing to "slippage" in the spending of their sponsoring departments, which meant that funds had become available near the end of the financial year. But they felt the rush that they then faced to ensure the money was spent by the due date was not always consistent with the aim of achieving best value for public money.

The interviews also highlighted the complexity of organisational relationships in the public sector, and of relationships between the public sector and the private or voluntary sectors, that affect annuality. In many cases, paying another organisation in the form of a grant is viewed as spending and is therefore an easy way to ensure that budgets are used.

If such payments are rushed at the yearend, it can add significantly to the pressures imposed on a recipient body that is also constrained by annuality. This problem of accounting boundaries is not a minority issue--one interviewee said that a significant proportion of the budget was spent on transfer payments to other organisations.

One way of overcoming the possibility that annuality will lead to extravagant spending is to permit some, or total, flexibility on carrying forward unspent balances. For many years the UK government restricted this, but since 1997 budget reforms have been introduced, including "end-year flexibility". This permits central government departments to carry forward any underspend on budget allocations in full.

According to the Treasury, this was introduced "to avoid the wasteful end-year surges evident in the past". But the impact of the change has been limited. Interviews with government departments revealed that, although flexibility was enjoyed by the centre of the department in its dealings with the Treasury, this was not passed down to lower levels in the department. They cited a number of reasons for this, but the most common one was that giving flexibility only to the central departmental level made it easier for departments to meet their responsibility for keeping overall spending within the limit.

It's interesting to note that the government has just announced that it will take steps to ensure that end-year flexibility will cascade down to agencies and sponsored bodies in future, ensuring that flexibility is available where it is most needed: at the frontline line.

It's often claimed that the need to spend budgets by the end of the year leads to wasteful expenditure. In their CIMA-backed research project, Noel Hyndman, Rowan Jones and Maurice Pendlebury examine the effect of annuality on budget-holders in a range of public-sector organisations


* More than 80 per cent of small organisations in the UK reforecast throughout the year, compared with only 53 percent in the US.

* Just under half of UK organisations expressed a desire to reforecast their budgets more frequently in order to manage future business performance, compared with 73 per cent in the US. This higher figure reflects policy changes in the US, such as section 409 of the Sarbanes-Oxley Act, which obliges North American companies to disclose immediately any information that could affect their financial performance.

* On average, financial managers take more than three months to produce and sign off their annual budgets. This means that the budgets are out of date almost as soon as they are produced. Nearly half of the managers surveyed considered this to be a major problem.

* Reforecasting using the traditional methods is almost as cumbersome as the annual budget itself. Nearly all of the managers surveyed stated that they had experienced one or more significant problems with this process.

* Traditional methods do not incorporate non-financial information such as operational key performance indicators. The effect of operational events on financial performance is therefore not reflected in the forecast

* Budgets that are not aligned to departmental operational plans allow managers to submit budgets based on unfounded or unrealistic assumptions. More than 40 per cent of those surveyed considered this to be a problem.

* Line managers resist more frequent reforecasting because of the time it takes, the costs involved and the outdated information produced. All but 10 per cent of managers surveyed in the US and the UK rated this as a major problem.

Noel Hyndman FCMA is professor of management accounting at Queen's University, Belfast. Rowan Jones is professor of public-sector accounting at Birmingham University Maurice Pendlebury is professor of accounting at Cardiff Business School

Source: ALG Software
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Title Annotation:Finance Budgeting Annuality; Chartered Institute of Management Accountants
Publication:Financial Management (UK)
Geographic Code:4EUUK
Date:Nov 1, 2003
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