Costing and Budgetary Control Methods: Performance Budgeting | Management Optional Notes for UPSC PDF Download

Introduction

In a centrally planned economy, it is reasonable to consider budgeting as an integral part of a well-coordinated system encompassing planning, programming, and budgeting, serving as a management tool. It establishes an information framework for decision-making, coordination, evaluation, and control at the relevant organizational levels. Over the recent years, there has been a substantial rise in public expenditure. The government's engagement in stabilizing the economy, ensuring fair wealth distribution, promoting factors driving economic growth, and addressing increases in price levels are among the factors contributing to the surge in public spending.
The escalating public expenditures, accompanied by increased complexity, raised two essential questions:

• How to effectively control and manage the growing public expenditures?
• How to enhance efficiency in public spending?

Performance Budgeting: Concept and Objectives 

• Performance budgeting is commonly defined as a method of presenting public expenditure in terms of functions, programs, and performance units, including activities and projects. This presentation primarily focuses on governmental output and its associated costs. It is a systematic process that showcases overall government operations through a classification based on functions, programs, and activities. 
• By incorporating suitable narrative statements and workload data, performance budgeting highlights completed work, proposed activities, and the cost of execution. The primary objective of performance budgeting is to provide output-oriented budget information with a long-term perspective, aiming for more efficient resource allocation. 
• Unlike traditional budgeting, it prioritizes accomplishments over the means of achieving them. Under performance budgeting, the significance lies in the purpose of government expenditure rather than the object of expenditure. It functions as a yearly action plan with specific indicators outlining tasks, the means to accomplish them, and the associated costs. 
• Performance budgeting aims to define both the physical and financial aspects of each program and activity, establishing a clear relationship between outputs and inputs. To achieve its goals, performance budgeting operates within a framework of well-defined objectives, requiring the successful implementation of various programs and activities by the relevant agency. This approach involves the development of more sophisticated management tools, such as work measurement, performance standards, unit costs, etc.

Objectives of Performance Budgeting include:

• Correlating the physical and financial aspects of programs and activities;
• Enhancing budget formulation, review, and decision-making across all levels of government management;
• Facilitating better understanding and review by the legislature;
• Enabling more effective performance audit;
• Measuring progress towards long-term objectives outlined in the plan; and
• Unifying annual budgets and developmental plans through a common language.

Components of Performance Budget

Performance budgets consist of essential elements that require ongoing attention:

• A classification of programs and activities, reflecting the scope of each organization's work;
• A framework defining specific objectives for each program;
• The establishment of work or achievement targets; and
• Appropriate workload factors, productivity measures, and performance ratios justifying the financial needs of each program.

Formulation of Performance Budget 

In the formulation of a performance budget, the initial presentation outlines the organizational structure and overarching objectives guiding the administrative agency's work. Subsequently, a crucial component of the performance budget is the Financial Requirements Table, encompassing three fundamental elements:

• A classification of programs and activities, delineating the agency's work in meaningful categories;
• An object-wise classification, allocating the budget among various expenditure categories such as establishment charges; and
• Sources of financing, specifying the budgetary and account heads through which funds are allocated in the budget.

Steps in Performance Budgeting

• The introduction of performance budgeting involves four fundamental steps:
  • Establishing a meaningful classification of public expenditure based on functions.
  • Establishing, improving, and expanding activity schedules for all quantifiable activities of the government.
  • Establishing work output, employee utilization, standard or unit costs through objective methods, aligning the accounting and financial management system with the classification.
  • Creating a related cost and performance recording and reporting system.
• Performance budgeting necessitates a program of action for a specific year, detailing tasks, means of accomplishment, and associated costs. This requirement is present in traditional budgeting processes as well. The key difference lies in performance budgeting, where organizations are compelled to envision their future activities not solely in financial terms but in the context of results, work assignments, and organizational responsibilities. In the planning for economic growth, planning is viewed as a thinking process, and budgeting is perceived as a doing process. Given the interconnectedness of physical and financial aspects and the consistent program structure, performance budgeting facilitates the functional integration of thinking and doing processes.
• The process of formulating programs to achieve organizational goals is a crucial aspect of the budgetary process. A program, which is a segment of a significant function, represents a cohesive type of work. The development of these programs is essential for meeting short-term, medium-term, and long-term plans, involving the creation of schemes, setting targets, and evaluating the financial costs and benefits. The assessment of programs considers both financial and economic factors, ensuring sufficient resources for the chosen program and examining the impact of proposed expenditures on the overall economy through cost-benefit analysis. Complex programs are often divided into sub-programs for more targeted execution. Each program or sub-program consists of numerous activities detailed in respective budgets. For instance, an immunization program falls under the broader function of 'health,' and an activity under this program could involve the provision for vaccine storage.
• The starting point in the budgetary process is resource allocation. In the traditional system, the focus is primarily on previous allocations and expenditures, with minimal emphasis on performance in terms of objectives and the upcoming year's program of action. In contrast, performance budgeting involves the primary agency preparing the budget, presenting requirements based on program classification, detailing past activities, their costs, planned activities for the next year, expected results, and the distribution of responsibilities. Performance budgeting is fundamentally grounded in a commitment to achievement and an awareness of accountability. The prepared budget undergoes review at higher levels, and resource allocation considers proposal priorities. Occasionally, due to financial constraints, full resources may not be available, necessitating budget cuts. However, these cuts are made with a thorough understanding of their implications on the program. Performance budgeting, with its program classification and underlying rationale, already outlines a set of choices with established priorities. This minimizes the disruptive effects of cuts and ensures a clearer identification of their impact on program achievement.
• Following resource allocation, the next step is budget execution. Successful budget execution must guarantee the accomplishment of objectives, and to achieve this, certain budgetary and managerial factors need to be considered:
  (i) Timely communication of grants to various subordinate agencies.
  (ii) Ensuring the initiation of actions to implement the schemes outlined in the budget.
  (iii) Supervising the consistent flow of expenditures.
  (iv) Preventing cost overruns.
  (v) Establishing a time-phased plan for expenditure and work.
• The ultimate stage in the performance budgeting process involves appraisal and evaluation.
• In the current system, the evaluation of physical achievements in specific sectors is conducted by the Programme Evaluation Organisation. However, under performance budgeting, each program is designed to be evaluated by the respective agency itself, even before external organizations undertake the evaluation. A crucial consideration is that the evaluation process should ideally take place after the completion of a program, allowing the administration to formulate its future course of action based on the obtained results.

Performance Budgeting System in India

• The necessity for performance budgeting in India emerged with the advent of the planning era. The existing budgeting and control system were deemed inadequate as it failed to establish a clear input-output relationship between financial allocations and physical targets. The relevance of performance budgeting to India's institutional setup and needs was first explored by Dean Appleby in 1953. 
• Despite its early stages in the federal government, the Estimates Committee of the Lok Sabha, in its 20th report, recommended the gradual implementation of the Performance-cum-Programme System of budgeting for a more comprehensive understanding of schemes and outlays in the budget, particularly for large-scale developmental activities. This recommendation aimed to enhance parliamentary control over expenditures.
• The Estimates Committee reiterated the call for performance budgeting in its 73rd report in 1960, urging its prompt implementation. These recommendations led to action, and in 1961, the Union Finance Ministry accepted the suggestions and instructed public enterprises to adopt performance budgeting. However, due to operational challenges, no undertaking implemented these instructions.
• In 1964, performance budgeting regained attention when the Planning Commission emphasized the need to evolve appropriate methods for its integration into the machinery for planning and supervision over plan fulfillment. To achieve this, a Performance Budgeting unit was established within the Committee on Plan Projects in 1965. The unit conducted studies to identify benefits, providing the database for the Administrative Reforms Commission (ARC). Subsequently, the ARC set up a working group on performance budgeting.
• The working group recommended the phased introduction of performance budgeting in India, starting with developmental departments at both the Centre and in the States. The Administrative Reforms Commission further proposed initiating the introduction of performance budgeting with the 1969-70 budget, to be completed by 1970-71. Following these recommendations, the Union Finance Ministry presented a document titled "Performance Budgets of Selected Organisations 1968-69" to the Lok Sabha in April 1968.
• In response to the ARC's guidance, the Government of India issued guidelines for the adoption of performance budgeting in all ministries, departments, and state governments from the fiscal year 1973-74. American budget experts were also consulted to provide advice on the introduction of performance budgeting in India.

Performance Budgeting System - A Critical Evaluation 

• The government embraced performance budgeting nearly two decades ago, gradually introducing the system in all development departments at the center. Some states, including Maharashtra, Punjab, Rajasthan, Tamil Nadu, and Uttar Pradesh, have implemented performance budgeting in numerous departments. However, progress has been slow in many states, necessitating an evaluation of the benefits and limitations associated with performance budgeting. This assessment aims to consolidate gains, address challenges, and establish performance budgeting as an effective tool for internal financial management across all government levels.
• Performance budgeting enhances legislative review by presenting a comprehensive overview of various government departments and agencies. The system integrates planning and budgeting processes, providing advantages that stem from an organic fusion of these two essential functions.
• Improved public relations result from clearer information, enabling a rational public assessment of responsible government actions. A progressive budget with a welfare-oriented focus on activities strengthens the democratic process and encourages meaningful citizen participation in budget implementation.
• Effective decision-making within an organization, including resource allocation, priority determination, and responsibility structure, relies on an efficient information and communication system. Performance budgeting, coupled with decentralized accounting and systematic reporting, offers the necessary informational support for such decision-making.
• Functional classification facilitates the integration of planning, programming, and budgeting processes. While the traditional budget may not intertwine the physical and financial aspects well, performance budgeting ensures their alignment from the proposal stage to the scheme's finalization.
• In summary, performance budgeting enhances control mechanisms, gives legislative control more significance, facilitates decentralized authority in line with responsibility, and improves public relations.
• Despite its advantages, performance budgeting has limitations:
  • The foundation of performance budgeting relies on the classification of governmental work into functions, programs, and activities, which may not be as well-organized in practice.
  • Program and activity classifications can be overly broad, limiting their ability to reveal significant departmental activities for budgetary decisions and management.
  • The technique tends to focus more on quantitative rather than qualitative evaluation.
  • Allocating cost estimates over program elements can be challenging, leading to less meaningful estimates.
  • Performance budgeting aids but doesn't entirely solve the challenge of comparative evaluation of projects, functions, or activities, requiring additional support from imperfect cost-benefit analysis, especially when indirect and intangible costs and utilities are substantial.

Conclusion

Performance budgeting is a method for presenting public expenditure by delineating functions and programs that mirror government output and associated costs. Its primary objective is to support long-range planning. For it to be operationally effective, it should originate from operating levels of responsibility and be appropriately summarized for higher management tiers. It is essential to recognize that performance budgeting serves as a tool, and its manageability or complexity hinges on the proficiency of the toolmaker. The effectiveness of its application relies on the skill, creativity, energy, and determination of the user. Its role is to provide a meaningful foundation for administrative planning, executive coordination, legislative examination, and administrative accountability across all government levels.