Accrual Budgeting: What Does it Mean for Fiscal Discipline?

Posted by Mr. Marc Robinson

 

Is accrual budgeting a good idea? This is an highly controversial question in budgeting circles today. Many budgeting experts agree that accrual accounting for fiscal reporting is a good idea, at least for those countries which can afford the costs of running a more sophisticated accounting system. But on the question of whether the budget itself should be moved onto an accrual basis, there is absolutely no consensus. On one side of the boxing ring, there are those who think that the real benefits of accruals can only be realized by putting the budget on an accrual basis. They believe for example, that unless the full costs of programs and inputs are charged to ministry budgets, decisions about program priorities, the input mix and investment vs. maintenance will always be seriously distorted because under cash budgeting they are always based on the wrong “price signals”. Opponents of accrual budgeting, on the other hand, argue that it is unduly complex, confusing, potentially risky to fiscal discipline. They also argue that the efficiency benefits of accrual budgeting have been greatly exaggerated, and point – for example – to the abandonment by countries like Australia and the UK of the “capital charging” regimes as a recent example of the failure of the much-heralded benefits of accrual budgeting systems to become reality.

 

In a forthcoming paper which I’ll be presenting at the OECD Public Sector Accrual Symposium in Paris in March, I look at one important, but neglected, aspect of this debate: the question of whether accrual budgeting can serve the needs of good aggregate fiscal policy. Some of the key points which this paper will make are:

 

·        No budgeting system will work to manage fiscal sustainability unless it imposes limits over line ministry capital expenditure. If you don’t limit the amount of capital expenditure, you can’t manage the level of debt. An accrual budgeting system which imposed budget limits only on the expenses incurred by ministries could therefore never work. Accrual budgeting systems differ in how they limit capital expenditure. The best approach is to do what the UK and New Zealand do, which is to give ministries explicit capital expenditure appropriations as well as expenses budgets.

·        There is strong case in many countries for formulating fiscal policy with reference to accrual rather than cash fiscal aggregates. Accrual accounting provides a broader debt measure (net financial debt) and a matching deficit concept (net lending) which captures financial assets and liabilities which are highly relevant to fiscal sustainability but are ignored under cash accounting. This is why, for example, the deficit measure used to define the deficit limit under the EU Stability and Growth Pact (SGP) is an accrual measure (net lending). These broader accrual measures will be particularly useful in the coming years when the impact on public finances of acquired “toxic assets” and equity in troubled banks will  be of enormous importance.

 

·        However, while accrual budgeting is particularly suited to a fiscal policy which targets accrual aggregates, it is possibly to target these while sticking with a cash budgeting system. Most EU countries do precisely this.

 

·        The most serious potential problem that an accrual budgeting system creates for fiscal discipline arises from its complexity and the fact that under accrual budgeting the Ministry of Finance can no longer use a budgetary ceiling on cash payments as a tool for enforcing the budget. Under accrual budgeting, the cash used by spending ministries become a dependent variable – determined by what they need to execute their accrual budgets. You can’t set limits for both cash and expenses. (Superficially, it might be look as if the UK system does exactly that, but superficial impressions are misleading). In advanced countries, this may not be a problem. However, for many low and even middle income countries, any move to accrual budgeting would run a serious risk of compromising discipline over budget execution.

I plan to return to a few of these points in greater detail on the PFM blog once the paper is released in a few weeks’ time.

Comments

[J-P Dumas]

This is a very good point.
This being said with all these new born keynesians (including in the IMF (at the highest level) why do you want to control expenditure, since "le mot d'ordre" is spend and spend without limit (cash or accrual, never mind...)

[Blogmaster]

Dear readers:

A healthy debate inside FAD!

Before posting this article on the blog, Marc Robinson circulated an earlier draft inside the IMF's Fiscal Affairs Department (FAD). This draft generated a bit of controversy between Marc and a few of our colleagues from the M1 and M2 Divisions. We all thought that PFM Blog's readers could be interested in having access to the terms of this debate. Here it is (see below).

PFM Blog looks forward to additional contributions.

Michel Lazare

-----Original Message-----
From: Robinson, Marc
Sent: Wednesday, February 11, 2009 9:21 AM
To: Allen, Richard Ian Gordon
Cc: Cangiano, Marco; Lazare, Michel; FADM1; FADM2; Khan, Abdul Mudabbir
Subject: RE: Accrual budgeting blog piece

We are in complete agreement on this -- that there is a significant gap between the anticipated benefits of accrual budgeting for the efficiency and effectiveness of public expenditure and what was really achieved.

-----Original Message-----
From: Allen, Richard Ian Gordon
Sent: Wednesday, February 11, 2009 9:17 AM
To: Robinson, Marc
Cc: Cangiano, Marco; Lazare, Michel; FADM1; FADM2; Khan, Abdul Mudabbir
Subject: RE: Accrual budgeting blog piece

I think there is a big difference between the rhetoric and what happens on the ground. Of course, officials will write what they need to say in order to justify what they have done, and the money they have spent. And I am quite prepared to believe there have been some benefits, even though these have not been adequately demonstrated. As noted, this would make for an interesting research study ...

Richard

-----Original Message-----
From: Robinson, Marc
Sent: Tuesday, February 10, 2009 11:59 PM
To: Allen, Richard Ian Gordon
Cc: Cangiano, Marco; Lazare, Michel; FADM1; FADM2; Khan, Abdul Mudabbir
Subject: RE: Accrual budgeting blog piece

Richard,

Your claims that the introduction of accrual budgeting was not motivated by a desire to improve resource allocation, and that it had no connection with increased managerial flexibility, are very surprising and make me wonder whether you are familiar with any of the official literature in any of the countries which have introduced accrual budgeting. This makes very clear that these were from the outset explicit and central aims of the reform. I provide below just a couple of quotations which should make this clear.

Marc

Improved Allocative Efficiency

“One of the key elements of the new resource based approach is that it requires departments to undertake more accurate costing of activities, with expenses and income allocated to each of a department’s objectives. This will assist the Government in ensuring that resources are allocated to priority services in line with the Government’s objectives”(UK Resource Accounting and Budgeting Green Book, 2002, p.7)

“The introduction of cost principles into government budget planning and accounting has to do with improving government effectiveness through visibility, transparency, and cost-conscious behavior. … Transparency of costs provides politicians and administrative leadership a better basis for prioritizing use of resources.” (Danish Ministry of Finance, 2006, Introduction of a Cost-Based Appropriation System)

Link with Increased Spending Ministry Managerial Freedom

“Because of the increased sophistication of the financial data available under the new resource based approach, decision takers have information available to allow them to view the long term consequences of their actions, not just the immediate cash implications. In addition, the new system has incentives built in to reward good decision taking, allowing resources to be redeployed into priority areas. The new resource based approach has thus been a trigger for departments to re-assess and invest in new management information systems in order to best utilise the new resource information in budget planning. This has in turn allowed responsibility for financial management to be delegated to the appropriate level.”.(UK Resource Accounting and Budgeting Green Book, 2002, p.9)

“Accrual budgeting has been used as a tool to support performance-focused management because, in some cases, it more clearly links the total cost of resources used to the performance achieved. For example, New Zealand and Australia8 combined accrual budgeting with output budgeting to support more decentralized management systems that hold managers responsible for results while reducing controls over inputs (specific spending items).” (GAO, Accrual Budgeting, 2000)

{Under the accruals outcome/output framework, managers] “have greater flexibility in the disposition of the resources (inputs) used to deliver the outputs agreed with government.” (Australia, The Outcomes and Output Framework Guidance Document, 2000)

----- Original Message -----
From: Allen, Richard Ian Gordon
To: Robinson, Marc
Cc: Cangiano, Marco; Lazare, Michel; FADM1; FADM2; Khan, Abdul Mudabbir
Sent: Tue Feb 10 19:09:11 2009
Subject: RE: Accrual budgeting blog piece

Marc

One further comment. With one possible exception, noted below, I am skeptical of the claim that accrual budgeting per se can be directly associated with increased flexibility of departmental managers to manage their budgets. In my experience, when senior government officials in countries that have adopted accrual budgeting are asked to explain the benefits of such a reform, they usually scratch their heads for a long time and look puzzled, before making some generalized statement about the improved quality of budgetary information. They will rarely say, even when pressed, that the reform has changed significantly the quality (or nature) of decision-making about resource allocation through the budget. Nor is improved flexibility ever mentioned, in my experience. That doesn't mean to say that there are no benefits in terms of improved decision-making or fiscal outcomes, but these don't seem to be very apparent to those working at the coal face. An interesting subject of research would be to ask: why is this so?

The one possible exception is the management of physical assets (purchases and disposals, stocks and flows) where countries such as the U.K. and New Zealand have introduced new frameworks that have generated a substantial reduction in waste and significant savings. However, this should be seen as an extension of the accrual accounting/budgeting framework, not an integral part of it, e.g., Norway has introduced a similar framework for managing public assets even though it operates a cash budget, and Sweden has also gone some way down this path.

Much more important in relation to improved flexibility are other reforms that have been made in countries such as Australia, New Zealand and the U.K. These include a dramatic reduction in the number of line items (or "votes") in the budget, from hundreds or thousands to a mere handful, combined with generous virement and carryover provisions; delegation of most day-to-day responsibility for managing and executing the budget to line ministries; establishment of executive agencies (or equivalent) with substantial devolved powers; and decentralization of decision-making on pay and grading issues, public procurement; and so on. All these changes - combined with results-oriented budgeting - have dramatically changed the landscape of managerial flexibility and accountability at the line ministry level.

It is important to bear in mind that many of these changes were made well before accrual accounting and budgeting were introduced.

Richard

-----Original Message-----
From: Khan, Abdul Mudabbir
Sent: Tuesday, February 10, 2009 2:31 PM
To: Allen, Richard Ian Gordon; Robinson, Marc
Cc: Cangiano, Marco; Lazare, Michel; FADM1; FADM2
Subject: RE: Accrual budgeting blog piece

I am glad that we appear to be moving toward a convergence. Some remaining observations....

I am not sure that I agree that imposing cash ceilings defeats the whole intended purpose of accrual budgeting. It is possible to visualize an accrual budgeting system where ex ante limits are set on aggregate cash expenditure as shown on an agency's cash flow budget. I do not see why this would necessarily eliminate the benefits of accrual budgeting. Similarly, while flexibility may be considered desirable, this is neither an essential condition nor an exclusive preserve of accrual budgeting. There are cash budgeting frameworks that allow significant flexibility. Conversely, an accrual budgeting system may not have complete flexibility. Thus, the Swiss system controls expenditures/expenses at a detailed level, thus limiting flexibility. Furthermore, once the appropriation related to depreciation type "noncash" accounts are excluded, what you effectively have is the equivalent to ex ante limits on cash expenditure (including accounts payable).

I would suggest that ultimately it depends on what a government wishes to achieve and what kind of framework is feels comfortable with. If a government wishes to adopt accrual based budgeting, but continue to have ex ante cash control and less than full flexibility, it may do so. To an outside observer this may appear to be less than an ideal framework, but that is a different issue. In due course (or as Sir Humphrey would put it "in the fullness of time") one hopes that the government will come to realize the need for more flexibility and modify the framework.

-----Original Message-----
From: Robinson, Marc
Sent: Tuesday, February 10, 2009 1:09 PM
To: Allen, Richard Ian Gordon
Cc: Khan, Abdul Mudabbir; Cangiano, Marco; Lazare, Michel; FADM1; FADM2
Subject: RE: Accrual budgeting blog piece

Richard,

Not a value judgment -- rather, a statement that imposing cash ceilings defeats the whole intended purpose of accrual budgeting. Expressed differently, you can't get the benefits of accrual budgeting if you are not prepared to relinquish cash budgeting.

As for Switzerland, while I am not familiar with their new system, I repeat that the decision to prevent ministries from viring depreciation funding to other expenses is not the same as set a ceiling on the cash payments spending ministries may make in any financial year. So whether the Swiss approach is sensible or not isn't the issue at stake.

Marc

-----Original Message-----
From: Allen, Richard Ian Gordon
Sent: Tuesday, February 10, 2009 1:02 PM
To: Robinson, Marc
Cc: Khan, Abdul Mudabbir; Cangiano, Marco; Lazare, Michel; FADM1; FADM2
Subject: FW: Accrual budgeting blog piece

Marc

I think you are making a value judgment in the first sentence of your third paragraph, namely you are saying that countries SHOULD NOT set ex ante quantitative limits on cash payments (if they are to reap the full benefits of the flexible accrual model), rather than they CANNOT do so - as is plainly the case in Switzerland with their aggregate debt brake rule (cash-based) and detailed line item controls. Of course, the Swiss approach may be misguided and inefficient, but that is the government's choice.

Richard

-----Original Message-----
From: Robinson, Marc
Sent: Tuesday, February 10, 2009 11:27 AM
To: Khan, Abdul Mudabbir; Cangiano, Marco; Allen, Richard Ian Gordon
Cc: FADM1; FADM2; Lazare, Michel
Subject: RE: Accrual budgeting blog piece

Again, this is helpful in clarifying the considerable agreement between us. And the comments are helpful in allowing me to edit the blog piece to avoid possible misunderstanding.

But just one final word in the spirit of collegial debate...

My key point is simply that under accrual budgeting, one does set an ex ante quantitative limit to the cash payments made by ministries each year (which is the essence of cash budgeting). Rather, the cash they need is determined by how they chose to deploy their accrual budgets. The managerial freedom which is accorded to agencies as part of the managing-for-results reforms which have always accompanied accrual budgeting in respect to how they spend their budgets translates directly into considerable freedom to determine the level of cash payments that the execution of their accrual budgets involves in any given financial year. In this respect, I don't feel I can really go along with the statement that "There is nothing in an accrual budgeting framework that necessarily dictates more or less control over cash". At least, not if "control over cash" means the center setting and enforcing quantitative limits on ministry cash payments.

We are, however, in full agreement that cash planning and management remain important.

As for Switzerland, my point is that preventing depreciation funding from being used for other purposes (as the British have, approximately speaking, done with their "near-cash" control total) is not the same as setting a quantitative limit on the cash payments which an agency may make.

Thanks,

Marc

-----Original Message-----
From: Khan, Abdul Mudabbir
Sent: Tuesday, February 10, 2009 9:55 AM
To: Robinson, Marc; Cangiano, Marco; Allen, Richard Ian Gordon
Cc: FADM1; FADM2; Lazare, Michel
Subject: RE: Accrual budgeting blog piece

Thank you for the clarification.

Let us try and separate two issues.

- First, can cash control be exercised under accrual budgeting?

- Second, is it desirable to exercise cash control under accrual budgeting?

I was interpreting the sentence quoted by Richard, i.e. "under accrual budgeting the Ministry of Finance can no longer use central control of cash payments or access to cash as a tool for enforcing the budget" as implying that under accrual budgeting cash control cannot be exercised. I think we are all agreeing that this is not correct, in the sense that there is nothing to prevent cash control being exercised under an accrual budgeting system.

The second issue is more complex. One can reasonably argue that to provide flexibility to agencies in an accrual budgeting environment control over cash should not be as rigid as under a traditional cash budgeting system. The extent to which such flexibility is allowed is for each government to decide. I do not agree that cash control should be completely ignored under accrual budgeting, and I am not aware that any government advocates such an approach. However, some flexibility could be allowed. Again this is for each government to decide. There is nothing in an accrual budgeting framework that necessarily dictates more or less control over cash. My own view is that by reporting cash flows within an integrated framework involving revenues, expenses, and assets and liabilities, an accrual framework enhances the management's capacity to exercise cash control and management.

I am not sure why the Swiss example is not relevant, as it clearly shows that cash control can be, and is, exercised in an accrual budgeting environment. This is important for the Swiss as the Swiss fiscal rule--"debt brake"--is based on the cash concept.

-----Original Message-----
From: Robinson, Marc
Sent: Tuesday, February 10, 2009 9:11 AM
To: Khan, Abdul Mudabbir; Cangiano, Marco; Allen, Richard Ian Gordon
Cc: FADM1; FADM2; Lazare, Michel
Subject: RE: Accrual budgeting blog piece

Thanks for the interesting comment. My reactions:

* one can of course impose a cash expenditure limit as well as an expense limit. The point, however, is that this undermines the freedom which accrual budgeting is supposed to give spending ministries to chose how to allocate their expenses budget between different input types. If an agency wanted to shift spending in a direction which involved more up-front cash payments for a given level of expenses, it would run up against the cash budget limit. This is why in none of the four accrual budgeting countries (Australia, NZ, UK and Denmark) is there a cash budget limit. That is, in none of these countries does the government say to a spending ministry: you may only make cash payments of $x million dollars this year, and not a penny more. The UK is the only system in which this even appears superficially to be the case, in the sense that parliament appropriates a "net cash requirement" as well as an expenses limit. But what happens in practice is that if the in the legitimate execution of its expenses budget a spending ministry exceeds its net cash requirement, the latter is increase via supplementary appropriation.

* expressed differently, if you move to accrual budgeting, you don't retain traditional cash budgeting. It is one or the other.

* this is not, of course, to say that you don't still undertake cash planning and management. You do, although they become more complicated.

* I wonder whether by "accrual type expenses", Abdul may mean expenses such as depreciation which do not involve present or future cash payments -- what the British (rather unfortunately) call non-cash expenses. If so, I expressly consider these in my paper. I pointing out the problem which viring from non-cash to other expenses can create for fiscal policy, and in effect advocate something like what the Swiss appear to have done. But I don't think this is really relevant to the issue under debate -- which is whether, under an accrual budgeting system, it would make any sense to try to retain cash budgeting as well.

Marc

-----Original Message-----
From: Khan, Abdul Mudabbir
Sent: Tuesday, February 10, 2009 8:31 AM
To: Cangiano, Marco; Robinson, Marc; Allen, Richard Ian Gordon
Cc: FADM1; FADM2; Lazare, Michel
Subject: RE: Accrual budgeting blog piece

I do not agree that under accrual budgeting MoF can no longer exercise control over cash. In fact, I can think of several ways in which such control can be exercised. As Richard points out, the Swiss government has devised a particular way of doing this. This involves exercising control at a detailed level, effectively preventing any appropriation for accrual type expense, e.g. depreciation being used for an alternative expenditure. The control can also be exercised by simply limiting the amount of cash released to an agency to that budgeted by the agency through their cash flow budget. There are other ways the objective of cash control can be achieved. It really depends on what control the government wishes to exercise. ( I think we can also debate the interpretation of the UK system).

Accrual is a basis for recognition of revenue, expense, assets and liabilities. An accrual framework provides information about cash flows, revenues and expenses, and asset and liabilities. It is up to the management to decide what kind of control they wish to exercise on each of these elements. Based on these management decisions systems can be configured to facilitate the desired controls.

----- Original Message -----
From: Robinson, Marc
To: Allen, Richard Ian Gordon
Cc: Cangiano, Marco; FADM1; FADM2; Lazare, Michel
Sent: Mon Feb 09 21:00:04 2009
Subject: RE: Accrual budgeting blog piece

Richard,

On the substantive point, I hold to my point, which is explained in detail on pp. 28-31 of the Working Paper. In essence, if you give ministries authorizations to incur certain expenses each year, you have to then finance the pattern of cash payments follows from the manner in which they choose to spend their expenses budget. For example, if a ministry choses during the fiscal to spend less on civil service staff and correspondingly more on outsourced production, its cash requirements will be increased because there will not be the same degree of deferred payments associated with civil service pensions. The ministry of finance will then have to supply that extra cash, without thinking of it as a matter of the spending ministry concerned exceeding its budget. Accrual budgeting means that the time profile of each ministry's cash requirements will depend on how it choses to use the managerial freedom it is given over the input mix etc. The fact that the UK parliamentary appropriations include a cash authorisation does not -- whatever the appearance might superficially be -- contradict this, and the UK system should not be thought of as a dual system of accrual and cash budgeting.

I'm not sure what the fact that cash accounts are part of accrual financial reports has to do with this issue.

As for Switzerland, I'd be interested to have your point elaborated.

Marc

-----Original Message-----
From: Allen, Richard Ian Gordon
Sent: Mon 2/9/2009 7:47 PM
To: Robinson, Marc
Cc: Cangiano, Marco; FADM1; FADM2; Lazare, Michel
Subject: RE: Accrual budgeting blog piece

Marc

This is a nice piece, but I have considerable doubts about whether your statement that "under accrual budgeting the Ministry of Finance can no longer use central control of cash payments or access to cash as a tool for enforcing the budget." is actually true in practice. This is certainly not the way in which the UK Treasury thought about, and presented, the resource "budgeting reform" in the 1990s, and I doubt whether any serious finance ministry would go down the accrual path if cash control was eliminated. The information we were given in Switzerland suggests that this is not the case. Surely finance ministries can control whatever they want to control provided they have the information to do so; and cash flow statements are a natural part of accrual accounts?

Richard