Budget Lapsing

One common feature in budgeting is budget lapsing. If budgets lapse, funds that have not been spent at year end do not carry over to the next year.

Budget lapsing creates incentives for managers to spend their entire budget. Not only do managers lose the benefits from the unspent funds, but next year’s budget might be reduced by the amount of the under-spending.

Budgets that lapse provide tighter controls on managers than budgets that do not lapse. If budgets do not lapse, managers have the opportunity to choose to make expenditures. When budgets lapse, managers can make the expenditure only in the current year.

One disadvantage of lapsing budgets is less efficient operations. Managers devote substantial time at the end of the year ensuring that their budget is fully expended. This action is taken, even if it means buying items of lower value (and of a higher cost) than those that would be purchased if the budget carried over to the next fiscal year.

Often, these end-of-the-year purchases cause the firm to incur substantial warehousing costs to hold the extra purchases. In many organizations, including universities and governments, year-end purchases of technology and equipment can lead to bulk purchases that are not aligned to long-term plans.

Vendors also take advantage of client’s need to spend their budget, by offering last-minute deliveries, or, in some cases, offering to store equipment until a later date.

For example, managers at a shelter for women purchased a large quantity of non-perishable foods and craft supplies in order to spend their remaining budgets. However, the goods were so bulky that the shelter had to reduce the space available for other activities to have adequate room to store these supplies.

If budgets lapse, managers cannot adjust to changing operating conditions during the year; for example, once managers have spent their entire budget, they cannot ‘borrow’ against next year’s budget to make a bargain purchases or take advantage of new opportunities without getting special approval.

Without budget lapsing, managers could build up substantial balances in their budgets. Toward the end of their careers with the firm, these managers would then be tempted to make large expenditures on perquisites. For example, they could take their staff to the French Riviera for a ‘training retreat.’

Budget lapsing also prevents risk-averse managers from ‘saving’ their budget for a rainy day. If it were optimal for a manager to spend a certain amount of money on a particular activity such as advertising, then saving part of that amount as contingency fund would reduce organizational value. Budget lapsing is one way to prevent the occurrence of these control problems.