Reconciliation of Budgeting and Accounting - Budget Deficits Paint Too Rosy a Picture

Frans van Schaik

January 26, 2022

Jan 26

Posted by Frans van Schaik[1]


Since the Covid-19 pandemic started, governments are running deficits greater than ever before. Yet, by publishing the budget deficit as the main fiscal headline, governments may understate the true deficit. Many governments report budget (mainly cash) deficits which look considerably better than accrual deficits, which better reflect economic reality. So, what makes up the difference between the budget deficit and its accrual counterpart?

The answer can be found in a lesser-known part of government financial statements called the reconciliation between budgeting and accounting. It explains line by line what makes up the difference between the budget and accrual deficit (or surplus). In jurisdictions where the budget deficit is prepared on a cash basis mixed with data on short-term commitments the difference may be considerable.

A major cause of the difference is the pension promises governments make to their employees. The accrual deficit includes a charge for pensions earned by public servants during the year, while pensions only show up in the cash budget deficit when payments of benefits are made, which may be years or even decades later. The reconciliation starts out with the budget deficit, eliminates the payments of pension benefits made from the current budget and inserts the usually much larger accrual pensions charge, to arrive at the accrual deficit.

Another cause of the difference between the two deficits, although much smaller, is the provision for environmental clean-up costs and the decommissioning costs of defense installations and government-owned nuclear power stations. To the extent that the government is obliged to rectify damage already caused, environmental and disposal liabilities are recognized on the balance sheet with a related charge to the statement of financial performance in the accrual accounting financial statements. These long-term obligations are typically not budgeted for.

There are mitigating factors, though, such as the treatment of nonfinancial assets, mainly infrastructure. When calculating the accrual deficit, depreciation is deducted, while for the cash budget deficit, payments for newly acquired fixed assets are deducted. In a steady state, depreciation and capital expenditure are equal, but in practice capital spending often exceeds depreciation. This may be because of an expanding asset base.

A high capital to depreciation ratio indicates that the government is investing more heavily in its long-term assets than in the past. In times of inflation, capital spending may also be higher than depreciation, even for straightforward replacement investment, if depreciation charges are based on historical costs while capital spending is measured at current costs. Depreciation may also be artificially low because of overly optimistic expected useful lives of capital, and some assets, for example land, are never depreciated.

These issues are familiar to many governments but can be demonstrated using figures from the US Federal Government which prepares its financial statements in accordance with standards issued by the Federal Accounting Standards Advisory Board, FASAB. The chart below shows net operating cost (accrual) and the budget surplus or deficit (cash) over a 22-year period. Except for 1999 and 2000, the final years of the Clinton administration, each year shows a deficit. The net operating cost consistently exceeds the budget deficit, the headline performance indicator of government. A reconciliation of the two indicators is needed for stakeholders to understand the underlying causes of these persistent differences.

US Federal Government: net operating cost (accrual) and budget deficit (cash) as % of GDP

Source: Financial Report of the United States Government 1999-2020

The second chart shows the reconciliation averaged over a 22-year period and expressed as a percentage of GDP. The average budget deficit is 3.9% and the average net operating cost is 5.9% of GDP. The reconciliation shows that the main cause of the difference is the increase in long-term liabilities for civilian and military employee benefits and veterans’ compensation (pensions and post-employment medical care). These benefits are included in the government’s net operating cost as soon as they are earned, and but will only be included in the budget deficit later, once they are paid.

US Federal Government: Reconciliation of net operating cost (accrual) and budget deficit (cash) - 22-year average as a percentage of GDP

Source: Financial Report of the United States Government 1999-2020

These and other differences between the cash budget deficit and the accrual deficit clearly come out in the reconciliation between budgeting and accounting. Such a reconciliation is a required component of financial statements prepared in accordance with IPSAS, the International Public Sector Accounting Standards, and in national accounting practices not applying IPSAS, such as the United States and France.

Recently published research in Public Money & Management reveals widely divergent practices across countries in presenting reconciliations of budgeting and accounting, limiting comparability even among financial statements that are prepared in compliance with IPSAS. By their nature, reconciliations will rarely be fully consistent across entities because they serve as a bridge between financial statements, which follow international or national standards, and budgets, which generally do not. Budget execution statements and accrual accounting financial statements are complementary but report different revenues, expenses, and deficits. Some differences between budgeting and accounting are unavoidable because their underlying logic is not the same: budgets serve to control government spending while accrual accounting serves to reflect economic reality.

Trying to bring budgeting and accruals accounting closer together by introducing accruals into budgeting is akin to couples’ therapy. To make irreconcilable differences understandable and comparable, the IPSAS Board should consider issuing more specific guidance on the reconciliation of budgeting and accounting.


[1] Professor of Accounting, University of Amsterdam.


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