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6:48 AM
An Accounting/Budget Trick You Need To Be Aware Of.

The Victoria Auditor Generals Office (VAGO) recently audited Manningham Council (See minutes for 8 Sept 2015).

It was not a wide reaching audit. It focussed on checking the accuracy of the information in two documents produced by Manningham Council. These were the Financial Report and Performance Statement for 2014/15 (page 8 minutes 8 Sept 2015).

However as part of this audit, the VAGO said they compared the budget documents prepared at the start of the year with the actual figures obtained at the end of the financial year. That is, they compared what the council said they were going to do at the start of the year with what the council actually did.

That got me interested. I thought I should compare what Manningham Council said they were going to do with what they actually did. I compared their budget documents with the 'actuals' seen in their annual report.

And I found something very interesting.

By means of an accounting/budget trick, Manningham Council can have a little more to spend each year on employee costs than they say they do in the budget.

Manningham Council does not always take advantage of this additional money, but sometimes they do.

 

How the trick works.

When a budget document is prepared, the current financial year has not ended. The budget is prepared towards the end of the current financial year but the final expenses and income for that year are not yet known.

However, to prepare a budget and to be able to figure out the increase in costs, the council needs to know what the expenses will be for the current year. But that year has not finished. So they need to forecast (or estimate or guess) what the expenses will be for the current year.

Then they can say that expenses in a certain area will increase 4% next year. For example, they are going to spend 4% more next year on electricity.

This is all fine. But then comes the trick.

If you look at employee expenses over the last three years you will notice that the forecasts (estimates or guesses) used to prepare the budget are always over stated. That is, the guesses or estimates for the last three years are always significantly bigger than what they actually turn out to be at the end of the year when the real figures become known.

I say the last three years because I have only been able to check the relevant documents for the last three years.

Manningham council has overestimated the current year employee costs for the purpose of the budget for the last three years.

So why is that important?

Well, if costs are going to increase next year, but you artificially make the cost for the current year bigger than what they really are, then the increase for the  next year is not that big.

For example. If you estimate a particular expense this year to be $100 and budget to spend $102 next year for the same thing, then there is only a 2% increase in cost. You don't look that bad and can proudly tell everyone how frugal you are.

But if you overestimated the cost for the current year and instead of $100 it was actually only $95 then in reality you could spend around 7% more in the coming year. You told people that you will only increase costs by 2% but behind the scenes you could actually spend 7% more if you choose to. And few would be the wiser.

That is what Manningham Council has been doing with 'Employee Costs'.

For the budget, the council overestimates the amount they will spend for the current year. Then they will say, 'Look, employee costs will only go up 3.4% next year". But when the final figures are in we see that the council started with an overestimate. So in actual fact, the salaries did not go up 3.4%. In reality they could go up 5%, 6% or more.

In this way, Manningham council always has a little bit more in the kitty to pay for employees than they budgeted for.

 

But before we go any further, just what are 'Employee Costs'?

On pages 32 and 33 of the 2014/15 budget we are given a break down of employee costs and we read this:

"Employee costs include all labour expenditure for wages and salaries, and salary on-costs such as leave, superannuation, Workcover, allowances, and provisions for accrued employee entitlements. Contracted agency staff costs, Fringe Benefits Tax, recruitment costs and protective clothing are also included in this category."

So we see that the majority of 'Employee Costs' ends up in the pockets of staff one way or another. The expenditure that does not are things like recruitment costs, FBT and protective clothing, etc.

Now let me give you the figures for this cost for the last three years.

 

2014/2015.

When preparing the 2014/2015 budget, Manningham council estimated that they would finish the year spending $44,060,000 on employee costs (page 65 Budget 2014/15) and budgeted to spend $46,850,000 in the next year. This was an increase of 6.3%.

When the actual figures were in they only spent $43,730,000 at the end of 2013/2014 (page 3187 minutes 19 Aug 2014). This meant that instead of being able to increase employee costs by 6.3%, they were able to increase them by 7.1% if they wanted to.

Manningham council limited their spending on employee costs in 2014/2015 and the actual figure for the end of 2014/2015 was just $45,948,000 or around a million dollars less than budgeted (page 31 Minutes 8 Sept 2015). This gave an actual percentage increase of 5.0% not the possible 7.1%

 

2013/2014.

When preparing the 2013/2014 budget, the council estimated Employee costs would be $41,855,000 for 2012/2013. They budgeted $43,944,000 for the next year. This gave a percentage increase of 5.0% for 2013/14. (page 25 Budget 2013/2014.)

When the actual figures were in we find the employee costs for 2012/2013 were $41,200,000 not $41,855,000. The next year they actually spent $43,730,000. ( page 3187 minutes 19 Aug 2014).

If they chose, the council could have increased employee costs by 6.6% if they spent all that was in the budget.

In actual fact, employee costs went up 6.1%. So in this year the council took advantage of some of the money gained by means of this trick.

 

2012/2013.

When preparing the 2012/2013 budget Manningham council estimated employee costs would be $48,694,000 in 2011/2012. They budgeted $42,170,000 to be spent in the next year. This was a decrease of 13.4% (page 21 Budget 2012/13).

The actual cost for 2011/12 was $46,841,000 (page 103 Annual Report 2012/13) and the actual cost for 2012/13 was $41,200,000. This gave an actual percentage decrease of 12% not the full 13.4% they said they would.

So even in this year of decreasing costs, there was still some additional money in the kitty for employee costs.

If the council chose to spend all that was in the budget, they could have only reduced employee costs by 10% not the 13.4% they said they were going to.

 

Now may I deal with some objections that may be offered.

 

Objection No. 1.

Some may say that if the council planned a 3.4% increase in employee costs then that is what they will do. Even if they overestimated a figure, when the real actual expense comes in, they will simply spend 3.4% more of the actual real figure.

Not really. Generally that does not happen. There are many things that can effect a cost, particularly employee costs. People may resign and you need to replace them and pay the staff placement costs, etc.

The council can, if they so choose, spend the amount that is in the budget and not be criticized for it. In the last three years, Manningham council twice took advantage of this accounting/budget trick to spend more than the percentage increase stated in the budget document.

 

Objection No. 2.

Some will say that everyone makes mistakes. And so some inaccuracy in the estimates is to be expected.

This is quite right and is in fact the plausible defense for this practice.

However the employee costs have consistently been over stated in the last three years. If it were just human error, then you would expect that sometimes they would overestimate and other times underestimate. That has not been the case.

I think this is more a trend or established practice which gives the council more leeway when it comes to employee costs than they say they have.

 

Objection No. 3.

Why didn't the VAGO spot this?

I don't know that the VAGO needs to spot it. Is it wrong? Is it fraud? Is it just human error? That is very hard to say.

Also the VAGO has a very narrow and carefully defined job to do when they audit Manningham Council. They look at the accuracy of only two documents and do not, as far as I can tell, audit other aspects of the council. Also they audit only so far as they need to for 'form an opinion' of the accuracy of these two documents (page 8 minutes 8 Sept 2015).

 

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