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Session 2. Financial management 2: Planning and budgeting

Session guide: Planning and budgeting
Reading note: Financial management 2: Planning and budgeting




Plenary participatory lecture



At the end of session, participants should be able to appreciate:

1. The budgeting process, including drawing up budgets, the role of budgets in controlling expenditure, and the extent to which budgets can be used in creating a sense of responsibility in the heads of the various functional areas of an agricultural research institute.

2. Variance analysis.

3. The roles of internal and external audit.


Exhibit 1

Why cost analysis?

Exhibit 2

Cost classification

Exhibit 3

The planning process

Exhibit 4

Sources of deficit

Exhibit 5

What is a budget?

Exhibit 6

Conditions for implementing a budgetary control system

Exhibit 7

The role of a budget committee

Exhibit 8

Dimensions of overall budgets

Exhibit 9


Exhibit 10

Variance analysis

Exhibit 11

The scope of audit

Exhibit 12

How to find the problem areas


Case study: National Institute of Food Research. (see Module 7 - Session 1)

Reading note: Financial management 2: Planning and budgeting




Overhead projector and chalkboard

Session guide: Planning and budgeting

Initiate discussion on cost analysis. Ask participants "Why should we analyse costs?" Show EXHIBIT 1. Observe that some costs cannot be measured or accurately priced.

Show EXHIBIT 2. Classify costs as total, average or marginal, and define each one of them. Use data from the reading note and illustrate the computation of each cost type.

Costs can also be classified as fixed or variable, according to how they change with volume of output. In discussing fixed costs, distinguish between committed and discretionary costs. Another way of classifying costs is by whether they are capital or recurrent. Recurrent costs are likely to go up as activity levels increase.

Now discuss planning and budgeting. Ask participants "Why should an organization plan and budget?" Show EXHIBIT 3. Observe that without planning the organization is like a black box: there is no knowledge of what is happening inside it, or of the working of interrelationships and interdependencies. Planning provides better management of resources and helps identify potential financial resource problems in the form of expected deficit (EXHIBIT 4). Deficit may arise because of inefficient utilization of resources, an unsustainable scale of activities, or inadequate funding. Observe that inadequate funds are an important constraint in managing research institutes. This issue is further discussed through a case study: the Food Research Institute, Dongal.

Now initiate discussion on the budgeting process. A budget converts the effects of all activities into a common denominator to facilitate the development of an integrated plan. It becomes the basis for utilizing available resources. Show EXHIBIT 5 to emphasize the wide dimensions of a budget.

Successful implementation of budgetary controls requires that certain conditions are met (EXHIBIT 6). A clear statement of goals and objectives provides direction and motivation to individuals and groups. Short-term budgets and plans enable movement towards achieving long-term goals and objectives. A budgeting system has to be established in order to have an effective control system with respect to fulfilment of assigned responsibilities. Ask participants to give some examples of budget centres in their institutes. Library, computer centre, research programmes and central stores would be some examples. Each of these can be treated as a cost centre, as well as a responsibility centre. Costs have to be controlled. Distinguish between engineering costs - which can be estimated with a high degree of reliability - and discretionary costs - which depend upon management judgment.

Accounting controls are an integral part of a budgetary control system whose effectiveness depends on timely availability and supply of information.

Clear communication of (i) goals and objectives, (ii) means for implementing budgets, and (iii) the responsibilities of each departmental head is essential for successful implementation of a budgetary control system. Emphasize the need for flow of accurate and relevant information. Also discuss emphasize conflicts in resource allocation, and how the conflicts can be resolved through effective communication.

Coordination is essential in budgetary control system. It helps in successful implementation and in overcoming conflicts. The joint effort of all departmental heads is required in preparing the budget. This can be achieved through a committee, possibly for budget or for planning, or for both (EXHIBIT 7). Such a committee could assume responsibility for all aspects of budget administration.

Ask participants how the budget is administered in their institutes.

Conclude the discussion on budgeting by showing EXHIBIT 8.

Initiate discussion on control. Show EXHIBIT 9. Controls are exercised through variance analysis and audit (both internal and external). Variance analysis helps measure deviations, comparing what had been desired and budgeted for, and what has been actually achieved (EXHIBIT 10). An unfavourable variance outcome indicates a weakness in the operation, while a favourable variance figure provides insights into capitalizing positive aspects of activities. The variance may be due either due to changes in price or to quantity usage (EXHIBIT 10). Efforts should be made to separate the influence of rising prices from price variance. Observe that variance may be due to changes in the scale of activities and operations.

Introduce the concept of A-B-C analysis. Category A items would include all high-value items, and variance in relation to them prompts careful scrutiny. For B and C category items, which are of comparatively lower value, only large variances need be investigated.

Auditing is well known. Ask participants what auditing systems they have in their institutes. Auditing is a systematic process of evaluating transactions to ensure compliance with prescribed policies and procedures. Show EXHIBIT 11 and discuss the scope of audit and concerns to be covered by audit.

Discuss different forms of audit, namely compliance, operational and programme. Financial audit is the most common form practised in all organizations, perhaps because it is statutory.

Internal audit is always useful in taking preventive actions in relation to faulty practices. Show EXHIBIT 12 and discuss how to identify problem areas, and the process of detailed examination.


· Making choices for optimum utilization of resources
· Improving the efficiency and effectiveness of existing resources
· Evaluating performance
· Measuring the value of output








Clear statement of goals and objectives

Creating budget centres

Developing accounting controls


Budget administration


1. Inefficient use of resources
2. Scale of activities
3. Inadequacy of funding


"It is the only comprehensive approach to managing so far developed which, if utilized with sophistication and good judgment, fully recognizes the dominant role of the manager and provides a framework for implementing such fundamental aspects of scientific management as management by objectives, effective communication, participative management, dynamic control, continuous feedback, responsibility accounting, management by exception and managerial flexibility."

Welsh, 1976.


1. Statement of goals and objectives
2. Creating budget centres
3. Developing accounting control
4. Communication
5. Coordination
6. Budget administration


· Provide general guidelines for preparing budgets and offer technical advice

· Receive and review budgets from each budget centre, suggest changes, reconcile differing views and resolve conflicts, if any

· Coordinate all budgetary activities

· Approve budgets

· Initiate action and follow-up









· The adequacy and reliability of the information and control system

· The fairness of financial statements and performance reports issued by management with the intent of disclosing the current conditions and for results of past operations and programmes of organization

· The efficiency of operations

· The effectiveness of programmes to accomplish their intended results

· The faithfulness of administrators and operating personnel in adhering to prescribed rules and policies and complying with legislative interests


Survey of various activities

Review of management reports

Review of inspection reports

Physical examination

Test examinations of transactions

Discussion with persons concerned

The process of detailed examination:

· Identify the problem

· Determine whether the circumstances are unique or widespread

· Significance of deficiency and faults in terms of costs, adverse performance and other effects

· Ascertain causes

· Identify persons or factors in the organization responsible for deficiency and faults

· Determine possible lines of corrective or preventive action and formulate constructive recommendations

Reading note: Financial management 2: Planning and budgeting

Cost analysis
Components of cost
Planning and budgeting
The budgeting process
Internal and external auditing
Literature sources used in preparing the reading notes

Cost analysis

Analysis of cost information reveals the performance of various programmes and activities. It also becomes a basis for planning and controlling the performance of activities. Cost analysis is useful in:

· making choices among alternatives and planning for optimum utilization of resources;

· improving the efficiency and effectiveness of the present resources;

· evaluating the performance of the executives handling the various programmes or activities, and controlling costs; and

· measuring the value of output, for which a simple value may not exist.

Before further exploring cost analysis, some common terms and jargon needs clarification. We will also explore a cost analysis problem typical of an agriculture research institute.

Cost is a foregoing or a sacrifice, measured in terms of money, incurred or potentially to be incurred to achieve a specific objective. As noted earlier, the basic objective of cost analysis is to help the top executive to choose among alternatives and related resource use, hence - from an economist's point of view - cost as a sacrifice may be treated as the opportunity foregone in using resources in one way rather than in another. Measurements of such sacrifice in monetary terms is very useful, as it provides the basis for measuring such opportunity costs. However, in many instances, particularly the circumstances under which agriculture research institutes operate, monetary measurements do not indicate actual costs. The instances may be:

· when resources are not priced (e.g., grants received by the research institute and on which no charge is payable); or

· where prices charged do not accurately reflect the scarcity value of resources, or their value when used elsewhere (e.g., scientists involved in research).

Components of cost

The organization uses inputs, such as land, buildings, people, etc., to produce outputs like goods and services. Inputs are measured in terms of monetary value and represent the cost of producing those outputs. It is very important to have some classification of costs to facilitate the analysis. For this purpose, the cost concept is defined in various ways.

· Total cost provides a single measure of the aggregate resource requirements for a particular scale of activity. Since most organizations would like to decide the scale of activity at which to operate, information about total cost is important.

· Average cost is the cost per unit of output. This is calculated by dividing total costs by output.

· Marginal cost measures the amount of cost which the organization would be required to incur to produce one additional unit of output.

The three cost concepts are very popular, but the application of these concepts in cost analysis, particularly in the case of research institutes, is not really straightforward.

To facilitate useful analysis of cost information, costs can be classified according to whether:

· they vary with change in volume of output produced; or whether

· they yield immediate results rather than long-term consumption benefits.

The first classification is typically scale-related cost, and such costs are classified as fixed or variable. The second classifies costs according to whether they are developmental or capital in nature and bring long-term benefits to the organizations, or costs are recurrent in nature.

Fixed costs

Costs which do not vary with change in the volume or scale of activities are classified as fixed costs. Fixed costs generally constitute committed or discretionary components. Whenever research institutes start a new activity on a long-term basis, they make commitments towards the costs which cannot be changed in the short term. The committed component of fixed costs generally arises out of an organization's commitments for long-term activities. Costs, such as rent of buildings, salaries of permanent staff, etc., are generally unavoidable and cannot be controlled in the short run. A major proportion of recurring costs are committed costs and cannot be influenced in the short term. If an organization wants to control such costs, the only way is through better design of projects and activities.

In contrast, discretionary costs depend on management's discretion or its policy. Funds allocated to research and development, training of people, travel, etc., are examples of discretionary fixed costs. These costs are decided by management, and therefore they are also known as managed or programmed costs. The nature of these costs is such that there is no way of ascertaining the optimum standard output expected from inputs. Management's subjective judgment is needed to establish the 'right' amount of discretionary costs in a given situation.

Variable costs

Costs which vary with change in volume or scale of activities are called variable costs.

In most situations it may not be possible to clearly classify costs as fixed or variable. They often possess qualities both fixed and variable. The fixed component of mixed costs represents the minimum unavoidable amount for any given level of activity. Costs such as maintenance, telephones, repairs, etc., are examples of mixed costs.

Capital or developmental costs

In the beginning, when a project is initiated, all costs associated with the establishment or the basic infrastructure are called capital or development costs. Generally these costs include:

· cost of land;
· construction of buildings;
· purchase of capital equipment; and
· investment in human resources (i.e., initial training).

Recurrent costs

Costs which are incurred in order to keep the activity going and in maintaining assets or facilities are defined as recurrent or operating costs. The following are generally included in this category:

· salaries and wages;
· equipment maintenance and spare parts;
· supplies of consumables; and
· electricity, water and other basic utilities.

Recurrent costs are incurred for the duration of the planned activity. They are likely to increase during the later phases of a programme as maintenance costs are likely to increase.

Planning and budgeting

For administrative purposes, the organization is divided into a number of departments. Each department interacts with the others and cannot function independently. The sum total of activities of all departments helps the organization to achieve its objectives and goals. Management may choose to treat all interactions as 'black-box' events and not prepare plans for future activities and programmes. In that case the net results and interrelationships would not be known. The process of bridging the gap, if any, would be done in an ad hoc manner. The process would look like something like Figure 1.

Arbitrary cuts may be imposed on the supposition that there is more scope for improvements and efficiency. In reality, that may not be the case, and services may get affected. The cuts will have an impact on the goals and objectives of the organization.

Figure 1 Consequences of inadequate planning

The organization should react to such shocks and surprises in some systematic manner. Management must have advance information on possible deficits. For this reason it has to plan and prepare budgets. Planning may also help the organization to establish concrete goals for motivating people to perform better, and provide standards for measuring performance. Without planning, the organization is like a black box: not knowing how things are happening and how interrelationships and interdependencies work. Planning alerts management to potential problems, and the result is better management of resources.

Analysis of deficits helps management to identify reasons and take corrective actions. Sometimes it is argued that all non-profit organizations will have deficits. This may be true, but then how much? All organizations incur certain costs in order to perform their activities. To meet these costs, the organization gets funds from government or other agencies. Whatever activity the organization is performing, it has cost implications (Figure 2). Deficits arise because of a number of reasons, including those considered below.

Figure 2 Advantages of planning

Inefficient utilization of resources Planning can alert management as to whether or not resources are being used effectively and efficiently. If there are inefficiencies, this can be overcome by improving performance. For this the organization requires to:

· clearly state the objectives of the activity or programme;
· prepare budgets for each activity or programme;
· have better communication and coordination of activities; and
· control the performance of activities by providing effective measures for performance.

The scale of activities can be another reason for deficits. This arises when the organization is trying to perform more than it is capable of within the given amount of resources. In such situations, management of deficits becomes difficult. To overcome this problem, the scale and level of activities should be regulated.

Inadequate funding appears usually as the problem of scarcity of resources to perform a given level of activity. Management may be required to identify potential sources of revenue in case financial resources are not adequate. Sometimes, because of seasonal and other constraints, projects have to be initiated. New projects are initiated in anticipation of funds available. Budgeting may help management to explore the possibility of stretching funds from other projects. In cases of non-availability of funds, the project may have to be shelved or the scale of the project reduced. A detailed budgeting exercise may help management to utilizing funds in the most effective manner by synchronizing cash inflows and outflows.

The budgeting process

A budget is a statement which indicates a coordinated plan of activities. The effects of all activities are expressed in monetary values so as to facilitate the development of an integrated plan. A budget provides the basis for utilizing scarce resources and directing operation of the organization for achieving specific objectives. The objective is not only to reduce the impact of uncertainty but also to determine priorities in use of the resources. After approving the budget, the people involved in preparing the budget should be motivated to achieve the targets and thus help management to realize expectations.

Welsh (1976) expresses the utility of budgeting in the following words: "It [the budget] is the only comprehensive approach to managing so far developed which, if utilized with sophistication and good judgment, fully recognizes the dominant role of the manager and provides a framework for implementing such fundamental aspects of scientific management as management by objectives, effective communication, participative management, dynamic control, continuous feedback, responsibility accounting, management by exception and managerial flexibility."

For successful implementation of a budgetary control system, certain conditions must be fulfilled, including:

· a statement of goals and objectives;
· creating budget centres;
· developing accounting controls;
· communication;
· coordination; and
· budget administration.

Statement of goals and objectives

All resources have an economic cost and are also scarce. As a result, the organization has to give some thought to prioritizing the allocation of resources. The organization should be very clear in describing the long-term objectives of the organization, which in turn decide these priorities. A clear statement of goals and objectives provides direction and motivation to individuals and groups in channelling their efforts towards a common goal. It is important that the short-term objectives are realistic and should consider all variables, such as availability of faculty, research staff, administrative support, etc. Whenever there is a change' in these variables, they must be incorporated into the plans and budgets.

Creating budget centres

One objective of preparing the budget is to see that goals are achieved in a coordinated and efficient manner. To accomplish this, the organization has to create a sound structure by defining in clear terms the authority and responsibility of each departmental head. The activity and performance of each head is evaluated in terms of assigned authority and responsibility. The organization could use several criteria to define a budget centre, including:

· a designated departmental head is responsible for attaining results in relation to the operations within that centre;

· the outputs by way of services and inputs required are clearly defined; or

· each budget centre is distinct from one another.

For instance, NIFR could create the following budget centres:

· Research programme
· Training and consultancy services
· Library
· Computer centre
· Central stores
· Maintenance and estate
· Telephone and despatch
· Extension, including Publications

Departmental heads should be asked to submit a budget for their activities planned during the coming year. While creating such responsibility, each department or budget centre could be treated as a cost centre. Cost centres are responsibility centres, for which inputs or costs are measured in terms of monetary units, but for which outputs are not measured in monetary terms. The basic objective of creating such cost centres is to control the activities of the organization.

It would be useful to understand the nature of costs. Costs are of two types: engineered costs and discretionary costs. Engineered costs include items for which estimates can be obtained with a reasonable degree of reliability. For example, cost associated with the use of fertilizers is an example of engineered cost. On the other hand, discretionary costs are those for which estimates cannot be arrived at. They generally depend upon management's judgment.

Each departmental head should be responsible for costs or expenses incurred by his or her department. Cost information is important in planning and control. Performance should be evaluated by comparing actual costs with budgeted costs, and is called analysis of variance. This technique is discussed in the next section.

It is very important that management educates staff regarding responsibility centres, the usefulness of the budgetary control system, and the role it plays in achieving objectives. The involvement and cooperation of the employees is sought and developed through the education process.

Developing accounting controls

The recording of transactions should not be just for the purpose of preparing financial statements but should be so developed that significant information for planning and control is produced simultaneously. Accounting controls are an integral part of the budgetary control system. The controls ensure that transactions are implemented only by those authorized to do so by management. Records are maintained; they also describe the accountability of resources, a physical examination and count of organization resources to make it sure that accounts and records are correct, and access to resources is through documented management authority. The effectiveness of a budgetary control system depends on timely availability and supply of information, and good accounting controls ensure this availability.

Development of accounting controls will revolve closely around creating responsibility accounting centres. The system should produce an accounting report for each centre and the data should be useful in the planning and control process.


It goes without saying that there should be top management support in making the budgetary control system successful. Top management should not only educate all involved concerning the usefulness of the system, but also communicate the goals, objectives, means of implementing the budget, and responsibilities of each departmental head. The success of the budgetary control system depends very much on the kind of information which forms the input to the whole process. Management should take care that it creates an atmosphere which leads to a flow of correct and relevant information. The people involved in the process should be encouraged to discuss and draw attention to all facts relevant to the given situation.

One problem which management faces is the accuracy of information supplied by various departments. This problem relates to the need to assess accurately the predictability of future outcomes. This problem is implicit in all planning systems, and can be minimized by emphasizing a reasonable degree of accuracy in prediction. Another problem is related to the kind of interdepartmental conflicts which may arise during the budgeting process. These conflicts generally originate in resource allocation. Through effective communication, the organization can resolve some resource allocation conflicts. The follow-up procedure -to ensure that there is effective implementation of the budget - is also a part of communication.


The development of a budgetary control system is an activity which requires coordinated efforts from different departments and at various levels. To ensure that staff become involved and participate in a useful and meaningful manner, all efforts need to be coordinated. Since different departments are involved, conflicts are likely to arise. The organization should develop mechanisms to resolve such conflicts without affecting the basic objectives. Management must also ensure that people actively participate in the budgeting process. It is only through active participation that staff feel committed, motivated and encouraged to work towards the common goals and objectives.

Budget administration

The complexities involved in preparing the budget and implementing the budgetary control system are many. Management has to put in an effort to ensure that the basic objectives of budgeting are achieved. As discussed earlier, a joint effort on the part of all departmental heads is required in preparing the budget. Management must provide an opportunity to all members to participate in deciding goals and objectives, setting priorities, developing future action plans and formulating general and specific policies. To achieve this, the organization needs to develop some formal mechanisms. One mechanism is to constitute a Budget or Planning and Policy Committee. Management can delegate the task of budget administration to this committee. Budget administration should include setting of priorities, preparing the budgets and follow up. All budget centre heads should be members of this committee. Management should also appoint one coordinator to the committee. The major functions of this committee would be to:

· provide general guidelines for preparing the budget and offer technical advice;

· receive and review budgets from each budget centre, suggest changes, reconcile differences and resolve conflicts, if there are any;

· coordinate all budgetary activities;

· approve budgets; and

· initiate follow-up action.

Through the budget committee system, management ensures that the heads of activities prepare budgets in a coordinated manner and that control mechanisms are effectively implemented. The budget committee should also ensure that there is no conflict among the different activity heads, and should resolve them if there are any.

The budget committee should draw a detailed time schedule for budget preparation, submission, discussion, modification and final approval. These schedules should be strictly adhered to; this will ensure that the budgetary control system is effectively implemented. Sharing of information is an important activity of the budget committee system. Carefully designed formats for preparing the budget and reporting budget performance will highlight actual versus planned levels of activities. The budget committee should also decide about the frequency of submitting reports on actual performance; primarily this depends upon how critical is a particular activity.

The department or cost centre should be required to submit a detailed budget, indicating establishment expenses and other expenses (Figure 3). Establishment expenses would generally include salaries, wages and other staff-related costs. Each cost centre would indicate both plan and non-plan expenditure: non-plan expenditure is incurred on ongoing activities and programmes and is generally recurring, while plan expenditure is on new activities and programmes. Total plan expenditure is what is spent on capital and revenue items. Details of plan expenditure for new activities and programmes are discussed in the next session. Once departmental budgets are obtained, the information can be conformed and collated to provide the basis for the institute budget.

Figure 3 Dimensions of the overall budget


Planning is a process of stating what we want to achieve, and trying to achieve what has been planned. Future outcomes are controlled on the basis of what has been achieved in past. Control is possible only if we have established criteria against which the actual accomplishments can be compared. The indices developed for the purpose of evaluating planned tasks and actual accomplishments (Session 1 of this module) provide important insights into achievement efficiency of planning. However, a detailed investigation of the outcome of these indices is required. The ultimate objective would be:

· to ensure that plans are achieved; or
· to lay emphasis on what can be achieved.

To ensure that plans are achieved requires that activities and operations of the organization are coordinated in such a manner that the achievement of plans is given more emphasis. Any departure from the planned figure is treated as serious, and a detailed examination of factors causing such deviation is undertaken. Emphasizing what can be achieved can be an outcome of changed circumstances which have made such achievements possible now.

Variance analysis

Planning and control are future-oriented activities. However, past achievements cannot be altogether ignored, because it is on the basis of past achievements that one draws expectations about the future. This is known as variance analysis. The objective is to strengthen the control process in the future by eliminating negative elements and encouraging positive ones. The analysis draws attention to weaknesses of operations in the past and forces management to make a concentrated effort to minimize them. In situations where variance is favourable, insights into capitalizing positive aspects of activities are provided.

For looking into the reasons for variance, we have to primarily investigate two dimensions. One is the prices paid for various items purchased by the organization, and the other is the quantities of the items used. The actual price and actual quantities used are compared with the budgeted prices and budgeted quantities to assess the variance: first, that arising from price variation, and, second, that from usage. The following expressions can be used in evaluating total variance.

Positive variance in both would imply that the actual price or actual quantity is less than that originally budgeted, and hence the variance would be favourable. In contrast, negative variance implies that the actual state of affairs exceeds the budgeted figures, and hence the variance is unfavourable.

The sum of the two variances would be the total variance. The aim of breaking the total variance into two components is to separate the influence of changes in prices from changes in quantities used.

When analysing variance, two points are important. The first is that change in the scale of activities and operations has an effect on variance. Suppose that a research organization has a research project and plans to employ 10 people temporarily to cultivate 50 plots of land. For a variety of reasons, the project actually employs 18 people and cultivates 100 plots. The actual value is likely to be greater because of a change in the scale of activity. This should not be seen as negative variance. Variance has to be adjusted for a change of scale. Similarly, quantity variances may not be because of inefficient use of resources. The second point to note is that it is very important to separate the influence of rising prices from price variance. A comparison of prices with the base period price may help the analysis. After including these two adjustments if necessary, one can look into the factors responsible for variance.

One practical difficulty which management may face in doing such an analysis is the existence of a large variety of costs and associated variances. It may not be possible to keep track of all variances, both small and large. It would be useful to analyse the variances of those items which involve big sums or have relatively large variances. Management could design the classification system based on grouping all the various costs into A, B or C categories. This is called A-B-C analysis. Class A would include all high-value items. Variances for this class must be investigated in detail. Only large variances would be investigated in the other two categories.

Internal and external auditing

The basic objective of any control system is to provide information about how well things are going and to indicate how better results might be achieved. There will always be an unending search for the best. Each control system should provide feedback about less costly or more efficient ways of working. The organization cannot allow all activities to take place without following general rules, procedures and policies. To make the control system more effective, the organization draws up in advance, policies and procedures which guide and govern decisions and their implementation. These procedures and policies are generally adopted to promote efficient operation and conserve scarce resources. It is very important for management to see that all actions comply with the agreed procedures and policies. Sometimes donor agencies also force the organization to follow a broad set of rules to guide and govern decisions regarding use of funds.

Auditing is a systematic process of evaluating transactions to determine an organization's compliance with prescribed policies and procedures. The objective of auditing is to minimize the likelihood of fraud, misappropriation, waste or inefficiency. The audit procedure should ensure that activities are performed efficiently. The audit report should indicate whether the organization is moving towards the desired goals.

The audit process is conducted by a competent and independent authority, which systematically examines the financial records and other information. In particular, attention is focused on:

· the adequacy and reliability of information and control system;

· the fairness of financial statements and performance reports issued by management with the intent of disclosing present conditions and assessing results of past operations and programmes of the organization;

· the efficiency of operations;

· the effectiveness of programmes in accomplishing their intended results; and

· the faithfulness of administrators and operating personnel in adhering to prescribed rules and policies and complying with legislative interests.

The audit process - broadly speaking - has four elements: financial, compliance, operational and programme audits. These are considered below.

· The financial audit examines financial records and controls with the purpose of ascertaining whether funds have been used legally and honestly, whether receipts and payments have been recorded properly, and if financial statements are complete and reliable.

· The compliance audit examines whether management has followed policies and procedures and whether it has adhered faithfully to legal and administrative requirements.

· The operational audit examines the efficiency of operations and the effectiveness of operating policies, procedures, practices and controls in promoting operational efficiency.

· The programme audit judges the effectiveness and accomplishments of a programme.

The most pervasive types of audit conducted by most institutions are the financial and compliance audits. The other two types of audit - generally termed performance audit - are desirable under current conditions.

The organization may get its operations audited by an outside agency or appoint an internal committee, or a combination. In most situations, outside auditing is mandatory; sometimes auditors are appointed by the government or the donor agency. When auditing is done internally, the organization sets up an internal audit committee to examine on a regular basis the fairness and authenticity of transactions. The major advantage of setting up an internal team is that control in the organization is strengthened significantly at less cost. It can prove very useful where internal controls are weak. Management should not treat the internal audit committee as a rubber stamp. Rotation of membership of the committee is very helpful.

An internal audit committee should identify problem areas through a combination of approaches, including:

· surveys of various activities;
· reviews of management reports;
· reviews of inspection reports;
· physical examinations;
· sample test examination of transactions; and
· discussions with persons concerned.

For example, the stores and purchase department is of considerable importance in many organizations. In surveying purchasing activities, management should address some key points, such as:

· the quantity and quality of materials purchased;

· the procedure followed to obtaining the best prices; and

· the method of determining whether the correct quantities and quality are actually received.

Problem identification may sometimes indicate that less-than-optimal practices are being followed by the organization. If that is so, further examination would be necessary. Discussing specific findings and suggesting ways to improve lie at the heart of internal audit. This requires analysis of pertinent information, detailed examination of causes, effects and corrective actions, and accumulation of supporting material evidence. Steps in the process could include:

· identifying a problem;

· determining whether the circumstances are unique or general;

· evaluating the significance of deficiencies and faults in terms of costs or adverse effects on performance;

· ascertaining causes;

· identifying the person or persons responsible for the deficiency or faulty operation; and

· determining possible lines of corrective and preventive action, and formulating constructive recommendations.

Internal audit is an independent appraisal activity. For effective internal auditing, independence is vital. Usually government and donor agencies would like - if not actually require - to have the opinion of auditors, external or internal, if not both. Both internal and external audits are prerequisites to sound control system and accountability. The basic objective of getting an operations audit from independent, external auditors is to obtain complete independence and impartiality in audit opinions.

Literature sources used in preparing the reading notes

Anthony, R.N., & Herzlinger, R.E. 1975. Management Control in Non-Profit Organizations. Homewood, IL: Irwin.

Anthony, R.N., & Reece, J.S. 1977. Management Accounting Principles. Bombay, India: D.B. Taraporevala.

Horngren, C.T. 1977. Cost Accounting: A Managerial Emphasis. 4th ed. Englewood Cliffs, NJ: Prentice-Hall.

Dearden, J. 1973. Cost Accounting and Financial Control Systems. Reading, MA: Addison-Wesley.

Gross, M.J., & Warshauer, W. 1979. Accounting Guide for Non-Profit Organizations. New York, NY: John Wiley.

Henke, E.O. 1971. Accounting for Non-Profit Organizations. Belmont, CA: Wadsworth.

Howell, J. (ed.) 1985. Recurrent Costs and Agricultural Development. London: Overseas Development Institute.

Pandey, I.M. 1992. Financial Management. New Delhi: Vikas Publishing House.

Turk, I. 1984. Accounting Analysis of the Efficiency of Public Enterprises. Lublijiana: International Centre for Public Enterprises in Developing Countries.

Vargo, R.J. 1977. Readings in Governmental and Non-Profit Accounting. Belmont, CA.: Wadsworth.

Welsh, C. 1976. Budgeting. Profit Planning and Control. New Delhi: Prentice-Hall of India.

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