Definition

Accrual budgeting consists of the use of accrual accounting measures in the budgeting process and it entails planning on an accrual basis, that is, budgetary spending authorizations and income forecasts are formulated in accrual terms. Under the accrual basis, the effects of transactions and other economic events are recognized when the underlying economic events occur, regardless of the timing of related cash flows. Following this basis, revenues are recognized when income is earned, and expenses are recognized when liabilities are incurred or resources are consumed. Accrual budgets incorporate in addition to cash flows, all projected noncash transactions and stocks of assets and liabilities.

Introduction

According to the accounting basis used to prepare the budget in public administrations, budgets can be classified into three main kinds: cash and commitments budget, obligation-based budget, and accrual budget. A cash budget shows receipts and expenditures, meaning the cash inflows and cash outflows at the actual collection or payment days. Under a cash-based system, budgets would not include stocks of assets or liabilities. Obligation-based budgeting recognizes legal obligations or commitments entered into a period when a public entity incurs a legal liability, regardless of when cash is paid or collected and regardless of when resources are earned or consumed (United States Government Accountability Office, GAO 2000). It implies the recording of an obligation and setting aside the funds for the actual cash outflow that will take place.

Accrual budgets seek to show the estimated full resource, rather than just the cash implications of the planned government activities. For example, accrual budgets include, as budgeted expenses, noncash items such as depreciation and civil service pension liabilities. This enables accrual budgets to provide information to the parliament and other stakeholders of not just the cash costs but of the full resource implications of the planned government activities. An accrual budget can be presented in the same financial statements as those presented at the end of the year: a budgeted operating statement, a budgeted balance sheet, a budgeted statement of changes in taxpayer’ funds, and a budgeted statement of cash flows and notes to the budgeted financial statements. A budgeted operating statement shows budgeted expenses and revenues, meaning resources consumed or resources generated, irrespective of the collection or payment dates. A capital budget statement can also be presented in order to impose limits on capital expenditure and to limit debt (Robinson 2009).

The countries which have implemented accrual budgets have also changed their budget structures to focus on a performance orientation, with an explicit definition of outputs or services, and outcomes or impacts of public services and programs on citizens and society (Martí 2013). Input information has not been totally replaced because it provides necessary information for parliamentary control over public spending. Under accrual budgets, revenues and funding appropriations that include full accrual-based costs are linked to specifications of planned and actual performance in terms of results, outputs, and/or outcomes.

Different Approaches of Accrual Budgeting

There are different approaches in the application of the accrual basis, which represent different levels of sophistication in public accounting systems. Accrual budgets can be fully implemented at all levels of government, at selected agencies/departments or at some programs. Besides, between the two extremes – accrual and cash – numerous variations can be put into practice, depending on the assets, liabilities, and costs that are recognized. The four main accounting bases are the full accrual basis, the modified accrual basis, the modified cash basis, and the full cash basis (International Federation of Accountants, IFAC 1993).

For some governmental program areas, such as government employees’ salaries, there are not important differences between accrual and cash figures because the lapse of time between the occurrence of a transaction that commits the government to make a payment or generates a resource for government and the cash flow associated is relatively short. For other program areas, the differences can be significant. One of the fundamental differences between cash and accrual bases is the capitalization and depreciation of assets. Governmental entities hold a variety of capital assets, including office buildings, infrastructure, heritage, military equipment, and natural resources. The accounting of these elements as an asset is usually justified on the grounds of transparency, accountability, and effectiveness of public programs. A lot of the indebtedness of public administrations is related to the purchase of infrastructure and other fixed assets. The accounting of these assets in the balance sheets of governments may create incentives for more efficient asset management. If the purpose is to make the budgetary treatment of these assets consistent with their financial reporting treatment, following the accrual basis, it means that the total amount of the investment could be recognized in the capital budget and the depreciations in the operating budget. When they are assets already owned before the implementation of accrual accounting, it may be more complex and costly to account for and value them. The application of the accrual basis in accounting for investments implies the recording of depreciation in public operating budgets, which is a necessary component of public service costs.

A characteristic of accrual budgets is the possibility to include capital charges as a cost measure for the capital assets used by governmental departments, as in New Zealand. Capital charges were also applied in the United Kingdom and in Australia for several years, but they were withdrawn. The objective of capital charges is to ensure that the prices of goods and services produced by government departments includes full production costs, including the government’s cost of capital. In some situations, capital charges function as an incentive to encourage ministries and or departments to make proper use of investments and/or to dispose of unnecessary assets. Cash appropriated to government departments and agencies can include full accrual amounts including expenses that do not involve cash outflows, such as depreciation and capital charges. Alternatively, under a different version of accrual budgeting which is more easily implemented because it implies less changes, cash can be appropriated to departments only for the components of accrual expenses that involve payments.

Apart from short-term liabilities, governments owe long-term obligations such as bonds payable and employee pensions payable. Accrual budgeting moves budget recognition forward for the costs of some programs, such as loans and insurances, which involve future cash flows (Martí 2006). An advantage of budgeting for the accruing costs is the recognition of the government’s costs at the time decisions are being made. This earlier recognition of costs improves the information available to policymakers about the costs associated with current decisions and may improve the incentives to manage these costs. However, this benefit is dependent on reasonable, unbiased estimates of the government’s costs. The application of the accrual basis also allows the provision of indicators of long-term sustainability of public entities such as net equity and self-financing of investments. These measures require that the budget includes all economic transactions carried out by the different public administrations. Tax revenue is an specific public sector element, so there is not reference from the private sector about how to accounting for it. It is sometimes difficult to know when the economic transaction that results in tax revenue takes place. The full accrual treatment of tax revenue requires an accounting adjustment for doubtful tax receivables.

Accrual budgeting offers different possibilities showing that within each system, there is also some degree of heterogeneity. Different accounting bases for different elements of budget systems may also have a significant impact on the measurement of the public deficit and debt.

International Overview of Accrual Budgeting Implementation

Countries such as New Zealand and Australia pioneered the introduction of accruals into governmental accounting systems in the 1990s, motivated by the limitations of traditional cash-based systems for tracking the efficiency of spending. By 1991, the appropriations, accounting, and budgeting of all government departments were on a full accrual basis in New Zealand (Pallot 2001). Various governments in Australia had implemented accrual output budgeting reforms in the 1990s (Carlin and Guthrie 2003). Accrual output-based budgeting are financing systems under which government agencies receive funding for the results -usually outputs- which they deliver. In 2001/2002, the United Kingdom implemented accrual budgeting, under the title of Resource Accounting and Budgeting, together with a framework for analyzing expenditure by departmental objectives, relating these to outputs (Likierman 2003).

Accrual budgeting and accounting systems have already been implemented in several European Union (EU) Member States (e.g., local governments in Germany, federal government in Austria). Many states and local governments in Switzerland apply accrual budgeting and accounting since the mid-1980s (Bergmann 2012). It was assumed that accounting and budgeting should be on the same basis and within a comprehensive system. In the Swedish local authorities, accrual budgeting and accounting were also introduced in the mid-1980s. Sweden weighed up the implementation of accrual budgeting in central government but decided not to implement it because it considered that cash budgeting enables better control over resources, particularly over capital investment. In 2010, the German federal government abandoned its accrual budgeting and accounting reform because parliamentarians feared that the change from an input to an output orientation in the budget, together with the reduction of the number of individual appropriations, would result in a loss of their control over the budget and the government’s finances (Jones and Lüder 2011). The United States applies cash and obligations-based budgeting because it considers that accrual budgeting raises challenges for the management and oversight of capital assets and expenses such as depreciation, and it does not include costs associated with future government operations, related to Social Security, Medicare, and Medicaid (GAO 2007).

In less developed countries, the role played by international organizations, reformers, and donors has been a catalyst for implementing Public Financial Management reforms, such as accrual budgeting, as in Botswana and Philippines. Developing countries face some barriers such as resource, capacity and technology constraints, corruption, and the existence of more urgent priorities. Instead of accrual budgeting, many developing countries have medium-term expenditure frameworks (MTEFs), consisting of setting out projections for both revenues and expenditures over a 3–5 year time horizon. MTEFs aim at guaranteeing the consistency of resource allocation with macroeconomic objectives and increasing the transparency of government operations over a medium-term policy agenda (Martí and Kasperskaya 2015).

Debates About the Impact of Accrual Budgets

There are both advocates and detractors of the impact of accrual budgeting. The major limitation of the cash basis is that while this system accounts for short-term cash flows, receipts and payments, it ignores financial flows that do not involve the movement of cash, such as depreciation, write-off of assets, and accrued interest. The latter elements are important if the full costs of governmental services have to be analyzed. The accounting for depreciation in budgeting follows the intergenerational equity principle, as it implies spreading the costs of capital assets in accordance with the distribution over time of the benefits that they generate. This could contribute to fairness between generations, that is, each generation should finance the cost of the services that it consumes.

If the budget is prepared on an accrual basis, it ensures symmetry with the accrual-based financial statements prepared at the end of the year. The application of dual systems – accrual accounting and cash or modified cash budgeting– requires extensive reconciliations between the two systems and may hinder the acceptance of the accrual-based accounting system. However, the application of the same accounting basis to the budget and to the financial statements allows the comparison of both figures, contributing to accountability.

The implementation of an accrual budget is justified on the grounds of harmonization with the two other macro accounting systems prepared by governments: the National Accounts and the Government Finance Statistics, which are both prepared on an accrual basis. National Accounts are a macro-economic accounting system that is compiled on the basis of a globally harmonized accounting standard. Government Finance Statistics are a macroeconomic statistical system for government finances published by the International Monetary Fund and designed to support fiscal analysis. There is a convergence project between these two systems and the International Public Sector Accounting Standards (IPSAS) of the IFAC in order to reduce differences to the maximum extent possible. In Europe, the National Accounts are based on the European System of National and Regional Accounts (ESA) published by Eurostat. EU member states are obliged to prepare National Accounts based on ESA to meet the convergence criteria of the EU Treaty regarding budgetary discipline. When translating from government accounting (microeconomic perspective) to National Accounts, the cash-accrual adjustments are more diverse and material in relation to the deficit/surplus in countries still having cash-based budgetary reporting (Jesus and Jorge 2015). A number of countries – Australia, New Zealand, and the United Kingdom – aligned the accounting standards across budgets, statistics, and accounts on the accrual basis in order to promote greater transparency and accountability at the national level.

The rate of countries applying accrual budgeting remains lower than that of accrual accounting and there appears to be less consensus regarding the merits of the adoption of accrual budgeting. This reluctance to adopt accrual budgeting can be attributed to its increased complexity, as perceived by politicians that meet to discuss budget appropriations in parliament (Blondal 2004). Parliamentarians may fear that the change from an input to an output orientation together with having to vote on accounting items such as depreciations may result in a loss of control over the budget and the government’s finances. The introduction of accrual budgeting may also involve significant human, financial, and material resources, such as adequate information systems, and it requires the use of legislation to provide formal authority to the changes as well as political and/or managerial commitment, and the driving force of central budgetary units to coordinate the reform.

Many countries that have adopted accrual budgeting did it as part of a context of public sector reforms that were labeled New Public Management reforms, which were intended to introduce “a more business-like public sector.” Accrual budgeting is not usually considered an objective in itself but an accounting reform needed to change from bureaucratic controls to management-oriented public administrations. These reforms may include devolution of responsibility for financial and resource management, outsourcing, managing for results, etc. Some countries (for instance, some sectors in Australia and New Zealand) have also implemented purchaser-provider systems that aim to introduce quasi-market arrangements for governmental agencies by making them competitive suppliers of public sector outputs. In purchaser-provider systems, service-delivery agencies receive funding on the basis of the outputs they deliver to the public with specified quantity, quality, and price in performance targets. If government wants to present performance measures of the efficiency or cost-effectiveness of the services provided, the costs of the outputs must be based on accrual measures even if an accrual-based budget system is not implemented. Decisions that require a comparison of prices with other public- or private-sector providers are usually based on full accrual budgeting measures including costs such as depreciations, because the accrual basis is the underlying assumption for preparing financial information in business entities.

The choice of different accounting bases used to prepare the budget depends on the purposes and functions assigned to the budget. Different management systems may require different budgeting systems, since there is not a one-size-fits-all approach for all countries.

Conclusion

A cash-based budget focuses on the traditional control of legality, trying to assure conformity with the expenditure authorizations, and provides information to evaluate the short-term economic impact of fiscal policy on borrowing needs and cash flow situation. By contrast, an accrual budget can be used to inform decision making about future borrowing needs, the cost of government operations, long-term consequences of current government programs, and it provides incentives for an efficient asset management.

Accrual and cash must not be seen as alternative bases but as complementary systems. In general, financial control of government operations needs to focus on both expenditures and expenses in order to have a complete financial view on the use of government resources. As investors in the private sector need a complete set of financial statements – including an income statement, a balance sheet, a statement of cash flows, a statement of changes in equity, and notes to the financial statements – to understand a business’ financial situation and performance, both accrual and cash measures are important for understanding governments’ financial situation.

Cross-References