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June 08, 2012

Accounting and the Budget Framework

Posted by Julie Cooper

For decades the debate has raged on about the applicability for government of what is often referred to as private sector accounting methodology.  Those who argue against its use in government offer up the differences in management focus between the private and public sectors to support their position. They argue that because the private sector is focused on profit generation the underlying concepts of accounting are not valid for government purposes. This argument is simplistic and fails to recognize the overarching purpose of all accounting systems.

Accounting is an information and measurement system that identifies, records, and communicates relevant, reliable, and comparable information about an organization’s activities. Providing information about how an organization performs is an important aim of accounting. This is true for both private and public sectors. Another similarity between the two sectors is that they both focus on the efficient allocation of resources to realize their goals. The difference between these two sectors lay in how that information is reported and used not the accounting per se.

One of the challenges with accounting and reporting in the public sector is that often the budget framework is not clearly defined, or at least not defined in a way that accounting for budget transactions is straight forward. To be able to properly account during budget execution it is necessary to know what to account for. The budget framework must be specific about who will be held accountable, why they will be held accountable (why the public funds will be spent i.e. deliverables to the public) and what funds will be spent. The accounting system needs the control and reporting criteria defined so the chart of accounts can be configured properly.[1]

In developing a simple but effective budget framework the following guidelines will be useful:

  1. Define the roles and responsibilities of government entities including states owned entities
  2. Establish a strategic plan and an activity plan by agencies in its simplest forms giving guidance to spending agencies on how to prioritize their needs (what to achieve) within spending limits
  3. Establish monthly rolling expenditure limits within the limits of the annual budget agreed between spending agencies and the Treasury (some countries the Budget Directorate may do this)
  4. Establish regular meetings between Ministry of Finance and spending agencies to match the cash flow forecasts of the Treasury and the cash needs of the spending agencies. This is important so spending agencies can rely on the availability of fund associated with their activity plan.

While capacity constraints need to be considered when implementing any budget framework, it is also important to consider that the framework itself will be a valuable and effective capacity building tool. Implementing a budget framework that is easy to understand and can be properly executed is an enormous boost to capacity building.

There needs to be a close relationship between budget preparation and budget execution to ensure the budget is prepared in a way that the accounting system can be used to identify and record, measure and communicate meaningful and reliable financial information about the activities of the government. In this way the age old methods of accounting become profoundly useful in the management of government operations.

[1] Cooper, Julie and Sailendra Pattanayak, 2011, Chart of Accounts: A Critical Element of the Public Financial Management Framework, TNM/11/03, Technical Notes and Manuals (Washington: International Monetary Fund.)

Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.


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Thought provoking ideas. No question that the term 'commitment accounting' has little to do with accounting and everything to do with budgets. Although, some governments squeeze budget controls into GL accounts which doesn't provide effective aggregate controls.

It would be very helpful if you could expand on the linkage between capacity and budget frameworks. There isn't enough available and practical field experience in aligning budget practices to capacity, in my opinion.

I agree with Doug, that sometimes the government cross the lines or operating beyond it's jurisdiction. I've notice that almost all countries around the world are still arguing about accounting and the budget framework. As an Accountant, in my opinion, the public and private sectors must set their boundaries about their budget framework.

The issues outlined are topical and germane to public finance today. Accounts are statements of facts with intrinsic reliance on accuracy, integrity and uniformity. Treating these disparately from the budget will tantamount to 'missing the woods for trees' in the context of PFM. However, accounting entities, particularly governments are increasingly getting lost in the technicalities of accounts, viz. cash, accrual, hybrid, etc. while overlooking efficiency in fund utilization against allocation. The budget parameters often go against fund based accounting. For example, funds transferred by a federal government as grants to provinces/ lower tiers of government are typically booked as expenditure. Such input based budgeting encourages the federal government to push more funds to the provinces irrespective of the absorptive capacity of the spending units. It gives a false sense of expenditure while the funds actually lie idle in the pipeline, generally as bank floats. In such a scenario, accounts can hardly provide decision support to public expenditure. While, it is important to match outlays with outputs, no such monitoring will be effective if the accounts are dated. Establishment of a computerized accounting system with limits of allocation will be a crucial beginning. Putting the information in public domain will immensely enhance transparency in public expenditure while ensuring accountability and participatory budget control. Accounts need to be fund based and demystified for greater participation by all stakeholders including civil societies and not remain as exclusive preserve of the finance ministry.

I am rather intrigued that there is no mention of the BASIS OF ACCOUNTING and the BASIS OF BUDGETING in this discussion. This is one of the most basic constructs used in FUND ACCOUNTING.

I. BACKGROUND - All government finance people is based on FUND ACCOUNTING. The statement that "...the applicability for government of what is often referred to as private sector accounting methodology" shows a lack of understanding of FUND ACCOUNTING. The statement that "One of the challenges with accounting and reporting in the public sector is that often the budget framework is not clearly defined, or at least not defined in a way that accounting for budget transactions is straight forward" is incorrect, and such a lack of understanding by finance people working for a United States Federal Government, or State Government, or Municipal Government agency would not be permitted without a reminder to them of the basic constructs of FUND ACCOUNTING to get them on the right track.

II. GOVERNMENTAL ACCOUNTING AND BUDGET IN THE UNITED STATES - For state and municipal governments in the United States operating under Governmental Accounting Standards Board (GASB) pronouncements, there are three basic categories of differences between the "basis of accounting" and the "basis of budgeting that follows governmental generally accepted accounting principles (GAAP) for state and local

(1) Basis of Accounting--"Cash plus encumbrances" (or "obligations")and "modified accrual" are two of the different ways to define revenue and expenditures;

(2) Perspective-- The budget and accounting reports may have different fund reporting structures, e.g., a budget may account for debt services in the Local Funds, while GAAP
principles require that debt service be recorded in a separate fund;

3) Reporting Component-- the State or Municipal government's Comprehensive Annual Financial Report (CAFR) [most are posted on their websites) typically present "reporting components" and funds in different ways than the budget document.

III. WHAT IS A FUND? This is because a State or Municipality's accounting system is organized and operated on a FUND BASIS. A FUND is a group of functions combined into a separate accounting entity (corresponding to a corporation in the private sector) having its own assets, liabilities, equity, revenue and expenditures/expenses.

IV. FUND TYPES - The types of FUNDS used are determined by governmental generally accepted accounting principles. The number of FUNDS established within each type is determined by sound financial administration (e.g. the State's or Municipality's Financial Policies). Specialized accounting and reporting principles and practices apply to GOVERNMENTAL FUNDS and EXPENDABLE TRUST FUNDS. PROPRIETARY FUNDS and PENSION TRUST FUNDS are accounted for in the same manner as similar business enterprises or nonbusiness organizations.

V. IMPORTANCE OF UNDERSTANDING THE "BASIS OF BUDGETING" USED BY A GOVERNMENT - The BASIS OF BUDGETING refers to the conversions for recognition of costs and revenue in budget development and in establishing and reporting appropriations, that are the legal authority to spend or collect revenues. The State or Municipality in the United States uses a MODIFIED ACCRUAL BASIS for budgeting GOVERNMENTAL FUNDS. PROPRIETARY FUNDS are budgeted using ACCRUAL concepts. All OPERATING and CAPITAL expenditures and revenue are identified in the budgeting process because of the need for appropriation authority.

VI. GOVERNMENT BUDGETS MUST BE RECONCILED TO GOVERNMENT ACCOUNTING - The budget is fully reconciled to the accounting system at the beginning of the fiscal year, and in preparing the CAFR at the end of the fiscal year. A number of GOVERNMENT GAAP adjustments are made to reflect BALANCE SHEET requirements and their effect on the budget. These include changes in designations and recognition, via studies and analysis, of accrued liabilities. Amounts needed for such long-term liabilities as future payoff of accumulated employee vacation is budgeted as they budgeted as projections and once recognized are adjusted for actual amounts.

VII. THE NEED FOR BUDGETARY CONTROLS - States and Municipalities maintain budgetary controls designed to monitor compliance with expenditure limitations contained in the annual appropriated budget approved by their designated legislative body who has "the power of the purse". A project-length financial plan is adopted for the Capital Projects in a CAPITAL IMPROVEMENT PLAN (CIP). The level of BUDGETARY CONTROL (that is, the level at which expenditures cannot legally exceed the appropriated amount) is established by function within the GENERAL FUND.


A. BUDGET (amount appropriated and allocated and apportioned to the Government Org by OBJECT CLASS.

B. COMMITMENT (when requisition to acquire a product or service is "requested".the Budget person reviews the request and affirms that the request is authorized and that the budget of the ORG has sufficient funds in the OBJECT CLASS - this is called "FUND CERTIFICATION" )

C. ENCUMBRANCE or OBLIGATION (In Federal, State and Municipal Governments there are segregation of duties between those who can request, those who can commit, and those who can encumber or obligate funds. Encumbering or obligating is typically done through a CONTRACT, AGREEMENT, PURCHASE ORDER, or MEMORANDUM OF UNDERSTANDING by a Contract Specialist or Purchasing Agent who is "Warranted" -- has delegated authority to obligate the government for certain dollar amounts)

D. OUTLAY (when an INVOICE with the number of the Purchase Order is presented by a Vendor or Contractor, then: 1) the invoice is reviewed to insure that it is "proper" (has the information specified in the Purchase Order); 2) its listing is compared to the product or service ordered, so an inspection is undertaken; 3) it is recommended that Accounts Payable either 3.1) Pay, as it is deemed "acceptable", or 3.2) Do Not Pay, as it is deemed as being "not acceptable" along with the reasons. States and Municipalities also maintain this encumbrance or obligation recording system as one technique of accomplishing budgetary control.

VIII. EXPIRED OR LAPSED FUNDS - Generally, encumbered or obligated amounts lapse at fiscal year-end in the GENERAL FUND but not in the CAPITAL PROJECTS FUND.

IX. IMPORTANT DISTINCTIONS BETWEEN FUND TYPES - The budgetary GENERAL FUND differs from GOVERNMENT GAAP by including the SPECIAL REVENUE FUNDS that are discretely authorized to be utilized by designated governmental component units. This authority, typically in the "Appropriations Language", recognizes budgetary expenditures when orders and contracts are issued rather than when goods and services are received.

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