The traditional budget was first proposed in James McKinsey’s book “Budgetary Control” published in 1923.  It’s process flow is charted in Horgren’s et al Cost Accounting, Chapter 6, “Master Budget and Responsibility Accounting,”  Exhibit 6.2

Today’s traditional budgeted income statement starts with the budget being developed jointly by Finance and the departments of the line organization.

Next year’s forecast along with all the assumptions appropriate to next year’s budget(e.g., new products, out/in sourcing decisions, changes in suppliers, manufacturing process improvements including cap ex investments)are sent to departments’ managers. They, in turn, create the departmental cost inputs to the budget.

Thus, the budget’s cost inputs are disparate  because they either have  different drivers or no drivers at all

Accordingly,  the traditional budget  can’t be modeled prescriptively.  Further, it can’t be modeled predictively if any of the departments’ cost inputs have no driver

The results are then entered into the Chart of Accounts (CoA) which reflects the firm’s organizational structure.

The budget developed is typically referred to as a static budget.  It does not change even if the underlying activity level of the business differs during the budget period from the level assumed when the budget was constructed.

This process creates a variety of limitations for the budget and also the budget’s income statement.

Since Horngren et al does not describe the process of creating the budget in sufficient detail, the author turned to the another budgeting resource, Bragg,  Budgeting, the Comprehensive Guide,  Third Edition.  The following 6 issues with the static annual budgeting process are quoted directly from Stephen Bragg’s book.

1.  “Inaccuracy: A budget is based on a set of assumptions not too far removed from the conditions under which it was formulated…If conditions change to any significant degree…revenues or cost structures may change so radically…actual results will rapidly depart from original assumptions.”
2. “Gaming: …attempt to introduce budgetary slack, which involves deliberately reducing revenue estimates and increasing expense estimates.”
3. “Time required:  It can be very time-consuming to create a budget… especially where many iterations of the budget may be required.” 
   
4. “Expense allocations: The budget may prescribe that certain amounts of overhead costs be allocated to various departments, and the managers of those departments may take issue with the allocation method used.”
5. “Command and Control System:  “The single most fundamental problem underlying the entire concept of a budget is that it is designed to control a company from the center.  The basic under pinning of the system is that senior management forces managers throughout the company to agree to a specific outcome.”   Examples include targets for revenue, expenses, profit, cash flow or metrics.
6. “Bureaucratic support: Once the budget and bonus plan system takes root within a company, a bureaucracy develops around it that has a natural tendency to support the status quo.”

See how the S&OIS addresses these limitations,