Government accounting has traveled a long distance during the last two and a half millennia. Writing about government accounts, Kautilya noted, a long time ago, that their purpose was to keep precise and detailed accounts of the king’s landed property, crops, cattle, and other assets and of revenue and expenditure. To serve these purposes, he classified the accounting heads, or chapters, as they have come to be known, under which transactions were to be recorded and how daily accounts were to be submitted on a monthly basis. His framework included the maintenance of accounts of transactions and a list of punishments for the “more than forty ways” of stealing government money.1 Accounting constituted an integral part of the state craft. Since the unveiling of double-entry bookkeeping a little more than five hundred years ago, some governments have moved to this type of system, although many still maintain accounts on a single-entry basis.
Notwithstanding this long history of accounting, it is difficult to find another aspect of government that has been subjected to as much criticism. It would appear that the main function of government accounting was one of solid housekeeping, reviewing the legal aspects of payments made and, as discussed in the previous chapter, ensuring the safekeeping of moneys collected on behalf of the state. From this internal housekeeping function, it developed to a stage where accounts of transactions conducted in a fiscal year were submitted to the legislature for information and, over the years, for its scrutiny and approval. While the primary objectives are not disputed, serving these objectives and doing so effectively have become issues of concern and serious debate. While the debate reflects the public’s growing awareness of a subject that was hitherto considered a part of the arcane world of government, it also shows that the expectations of what accounting systems should do have risen. Popular thinking about government accounts suggests a “trust deficit”: although the public cannot be viewed as homogeneous, it seems that a cross section of people hold the view that accounts conceal more than they reveal and are deliberately couched in language that impedes comprehension.
Some critics contend that over the years government accounting has lost sight of the user. Program managers in government spending agencies, for their part, emphasize that budgetary accounts are legally specified to be maintained for a still undefined “consumer” and are not designed in most cases to serve the interests of policy management. Economists engaged in analyzing the performance of government fiscal policies find many accounting procedures and concepts perplexing, generally out of date, and without solid anchors, and, as such, liable to easy manipulation.2 Each of these segments of public opinion would appear to hold the view that the accounts may be useful to others (presumably as an extension of labor theory of value and benefit of doubt approach, that is, that what is produced should be of some value and should be used by someone).
Although these criticisms are by no means new, several developments have made government accounts and accounting systems more responsive to changing needs and thus more eclectic. First is the widely perceived institutional failure in governments to respond to the demands of macroeconomic management. Pursuit of fiscal policies, either in a market context, in the framework of a structural adjustment, or in countries in the throes of transition from a command to a market-oriented economy, requires a good deal of data to equip managers with a keen eye for anticipation, a capacity for scenario planning, and an ability to reach decisions quickly and, more important, to implement them with minimum delay. As an integral part of this experience, the public wants information, not merely on how much has been collected, spent, and borrowed, but on how the funds have been spent. Attention has shifted to the effectiveness of the services provided and to a search for answers to the perennial question of whether they could have been provided at a lower cost. These concerns have prompted a detailed consideration of existing accounting practices and available options for improvement.
Second, the old debate about the applicability of commercial accounting, which was somewhat theological in the early 1950s, has become more pragmatic. The focus during recent years has been on the modifications needed to apply commercial accounting practices to the unique requirements of a government. A good deal of progress has been made toward this end, lending validity to the popular dictum that it is more productive to engage in practical steps, however small, than to discuss abstracts ad infinitum.
Third, the revolution in computer technology has permitted the exploration of new areas. The relevant question is no longer whether it is possible to apply this technology to government accounting but how it can be applied. Because of these developments, what can be done in accounting is limited not by innovative capability but by technology. Thus, government accounting is at the threshold of major change. This and the following chapters provide background for these changes and discuss their impact on the current and future shape of government accounting.
Commercial and Government Accounting
For several decades, the debate in governmental circles centered on the applicability of commercial accounting formats to the operations of public authorities. It has been argued that commercial accounting, which has been expressed in abstract and general terms, was not applicable to governments, whose operations were directed toward providing goods and services and not toward making profits. The argument was dogmatic and oversimplified the issues. Even as this debate was being conducted in public, the governments of several countries had introduced double-entry bookkeeping and annual balance sheets by the early 1950s. In governments that, in principle, had single-entry bookkeeping and were thus considered uniquely distinguishable from the commercial world, there were pro forma balance sheets and double-entry bookkeeping for what were considered to be commercial activities. For example, in British India, Irrigation (commercial) was distinguished from Irrigation (noncommercial), and the former had different accounting systems that were drawn partly from commercial accounting practices.
In the centrally planned economies, accounting both in government and in publicly owned enterprises (although the techniques took a wide variety of forms) had three functions. The first function was to maintain financial records of revenues, expenses, assets, and liabilities. The second was to maintain an elaborate system (some suggest too elaborate, lending itself to manipulation and imaginative construction of data) for recording and maintaining aggregate economic data, including volume of production, costs of production, productivity, and installed capacity Third, in purely commercial or manufacturing industries, additional record keeping was organized to monitor the stocks of materials and products. Thus, the debate was essentially restricted to the British-type systems, which traditionally used single-entry bookkeeping systems. The argument emphasized that the purposes of accounting in government were to assist the budgetary allocation of funds and related financial management of flows. As a corollary, it was pointed out that the source of funds is not directly related to the provision of goods and services: funds are drawn from the proceeds of general taxation, while the provision of goods and services has its own political and financial rationale and in any event does not entirely hinge on the recovery of costs through a user charge and associated methods of pricing. Further, there was no open market mechanism to determine the demand for government services.
These features may be unique to a government but do not necessarily call for a different accounting system as long as the system entails recording, analyzing, classifying, and interpreting financial information relating to government transactions. It is now widely accepted that any accounting system in the government, as in any organization regardless of its commercial orientation, should facilitate the recognition of financial management performance, show the progress made by each agency in achieving its objectives, and highlight areas that require further oversight. Consequently, some elements of commercial accounting have gained gradual acceptance in government circles. A number of concrete events have contributed to the change in attitude that permitted this transformation of government accounting.
First, over the years, the size and complexity of government operations have increased as the government has become engaged in procuring complex machinery and using it for a variety of purposes. This development created the need for a system that would facilitate the maintenance of records of assets as well as data for the computation of fixed and variable costs. Second, economic management has begun to make more demands on the type and timely supply of accounting information. In particular, changes in the domestic economy, such as inflation, hyperinflation, or recession, require adjustments in historical data for analytical purposes.
Third, accounting data became necessary to measure the performance of organizations so as to serve the immediate purpose of policy formulation and the broader purpose of accountability. Accountability has evolved from being limited to the observance of laws and regulations on the flow of resources to being concerned with the uses of allotted resources and the effectiveness with which those resources are used. Fourth, accounting has to address not only immediate liabilities but also those that would be redeemed at a later stage. It became imperative to strengthen accounting systems so that they would be able to measure and disclose these liabilities.
Fifth, the role of external aid and related conditionality required the adoption of internationally accepted government standards for maintenance of accounts. As most of the aid was used for specific commercial or quasi-commercial purposes, it required the introduction of the commercial type of accounting in those areas of government that were funded by foreign aid. Similar insistence on standards by regional organizations, such as the European Union, also contributed to major changes in the accounting practices of member countries as well as those aspiring to become members.
Finally, the extended application of computer technology to the processing of financial information and associated benefits effectively put an end to the debate about the chasm between government and the private sector and the inapplicability of commercial accounting practices to public sector transactions. Although government is different from other entities, standards can be devised to reflect the different approaches and practices of government.
Accounting systems in government are generally divided into four categories, which in turn reveal the nature of the organization and its activities: (1) fund accounting for governmental organizations, such as ministries, departments, bureaus, and agencies, that are primarily engaged in formulating and implementing policies; (2) quasi-fund accounting systems of agencies that are engaged in regulatory and related activities, including the oversight of organizations that provide services. In their orientation, these agencies are not distinguishable from departments and ministries but are usually given an autonomous status, including separate budgets largely funded by the government; (3) quasi-commercial systems dealing with public utilities that function, for all intents and purposes, like commercial organizations but that are obliged to pursue noncommercial objectives specified by the government; and (4) commercial accounting systems in organizations and agencies or enterprises that are largely owned and controlled by the government and that pursue their activities on a commercial basis. Of these four activities, however, the third and fourth would be viewed as belonging to the commercial world and are thus obliged to have commercial accounting systems. The first two categories are relevant to this discussion.
Three accounting bases are recognized for the organizations specified in categories 1 and 2, namely, accrual basis, cash basis, and budgetary accounting. The first two categories are discussed in detail below. Budgetary accounting is used to track the different stages of budget implementation and comes into action after a budget has been approved for the fiscal year. It addresses the implementation of the budget after the requisite legal authority, which differs from one country to another, becomes available. Although the details of budget accounting differ from system to system, the common stages usually include appropriation (a legal authority specifying the amounts available for spending during the fiscal year), apportionment (a time-sliced release of budgetary authority that may take the form of a warrant), obligation (a firm order for the purchase of goods and services invoiced either immediately before or after the transaction or at a specified later date), actual payment, and delivery of goods and services. The emphasis of the system, which is common to all organizations regardless of their ownership, is to show the extent to which appropriations have been encumbered and have been paid.
Single- and Double-Entry Bookkeeping
One of the main distinctions between government3 and commercial accounting is the way in which accounts are maintained. Most transactions in governments are maintained on a single-entry basis.4 Single-entry bookkeeping, which is generally defined in negative terms as the one that is not double-entry bookkeeping, refers to a system of record keeping in which transactions are noted in a single record, such as a checkbook, a cashbook, or a vote book. Although subsidiary records may be maintained to register commitments made and goods and services received, the focus of the system is on the single record. Thus, a spending agency engaged in normal policy formulation and related administration may maintain a single book showing the payments it has made. Such a system has been and continues to be in operation in several countries, largely because most departments do not have an independent source of funding and depend on budgetary appropriations to finance their activities. Accordingly, they maintain a single record that records the outflows. Revenues collected by the agency usually form part of a general pool known as the general account or consolidated funds of the government. The system was designed to be simple in a context where payments were handled in the various corners of a country by entry-level staff with little or no professional training or experience in accounting. Their principal function was to make entries in the chronological sequence in which they occurred, which were then sifted and consolidated into a government account. At a consolidated level, the outflows matched the inflows.
In double-entry bookkeeping, each transaction is recorded as a credit and a debit entry. It records what flows in and what flows out. But such recording takes place at two levels—a journal and a ledger. A journal is a first level of record keeping that registers the transactions as they take place. Such recording is called an entry, and these accounts are viewed as nominal accounts. These are then included in a ledger (the transfer from the journal is called “posting,” and the accounts are viewed as real to distinguish them from the nominal journal-level accounts). The ledger accounts are more analytical and specify amounts to be received, amounts to be paid, assets acquired, and changes in cash balances, thus showing the assets and liabilities that constitute a part of a balance sheet. The journal is a preparatory stage for the ledger, which takes into account the two aspects of the transactions. Unlike the single-entry system, the double-entry system is complete and fully reflects the financial status of the entity.
In considering whether double-entry bookkeeping can be extended to government accounting three issues need to be addressed. Is this type of bookkeeping necessary? Is it viable? Is it economical? Although these three are not mutually exclusive, they offer different analytical points of departure for the debate.
As noted above, the strongest argument in favor of a single-entry system is the long tradition of spending ministries’ having no source of revenue and of not being expected, at least in the view of those who favor strong centralized financial management, to serve as repositories of financial responsibility. Such approaches are not in accord with the trends that favor endowing the agencies with more financial responsibility. Once the agencies are given the task of self-accounting, they must have adequate accounting standards. This in turn implies a system of recording transactions at two stages, that is, journals and ledgers. The agencies need systems that measure their financial resources and, more important from the point of view of stable management, a record of funded and unfunded liabilities. Thus, the conversion from single- to double-entry bookkeeping is an imperative of the times.
Does the introduction of double-entry bookkeeping contribute to any major dislocation in work and is it viable in the long term? Again, as noted previously, double-entry bookkeeping is already in practice in public organizations, and extending it to the rest of the government is not problematic. Indeed, in some countries, for example, Chile, such an extension has reduced the perceived differences between commercial and government accounting practices. Accounting as taught in the universities equips graduates to move in both worlds and to move from one to the other with ease. Although accounting standards—that is, the treatment of specific items in the balance sheet—in the commercial world and in government may differ, newly trained accountants would be equally familiar with the two approaches. The availability of a pool of human resources with uniform training contributes additional strength to the operation of a system.
The general ledger system described further on may also prove economical because it is operated on the computer and is based on double-entry accounting. It thus requires fewer resources than the traditional system, which was manually operated and tended to be more expensive. Switching from one system to the other will contribute to improved financial management and is also likely to be less expensive over the long term and to offer enhanced, multifaceted capacity.
Cash and Accrual
The bases of budgeting and terms of accounting are primarily considered in terms of cash, accrual, and obligations. Although in some cases the obligational basis is also considered a kind of accrual, it is different. The choice of the basis was governed more by tradition than by rational and calculated review. Basically, budget systems are viewed as either budget funding or budget limiting. The former is intended to provide a greater role for the legislature, which, after due consideration, appropriates or funds a program or project for its entire life. Such appropriations have their own life cycles and are not limited to a fiscal year. As a matter of common practice, these funds, once appropriated, have an average life of more than four to five years and may be extended until, in due course, they become regular components of the annual budget. This system, also known as obligations-based, allows the legislature to look into the continuing relevance of a project or a program and to determine its future.
The budget-limiting system, in contrast, focuses on the amounts to be spent or the limits beyond which spending is not to be undertaken during a fiscal year. The intent is to recognize the paramount role of the legislature in making the annual budget and endowing it with the requisite flexibility. At the time these systems evolved, little weight was attached to the monetary implications of the budget. Within this overall framework, some countries followed an accounting system that bore close resemblance to the commercial accounting system in that they used a double-entry bookkeeping procedure and balance sheets that included, among other items, the liabilities and assets of the entity. These practices, however, were relegated to the background in the early 1970s, when emphasis was laid on the pursuit of macroeconomic policies aimed at economic stabilization. As an integral part of this emphasis, cash-based systems, which are inherently better for reconciling monetary data and for measuring more precisely the impact of budgetary operations on the credit situation specifically and on the economy in general, gained acceptance.
Some Western industrial democracies switched to a cash-based system from an obligations- or accrual-based system. After about two decades of experience with cash-based systems, however, there has been a revival of demand for the restoration of accrual-based systems, and a few countries in the South Pacific have already begun to transform the traditional system into an accrual-based one. These efforts, it should be noted, are being made in those countries that originally followed the budget-limiting approach. Countries using obligations- and funding-based systems may also need to reorient their accounting systems. Because the demand for accrual accounting is likely to increase in the future, it is appropriate to consider the features of these systems, the arguments in favor of cash and accrual systems (and the related issue of whether the choice between the two is real), the relationships between budget and accounts, and the implementation aspects of the switch to an accrual system.
Terms and Definitions
The terminology, such as obligations, commitments, cash-based system, and accrual, both in the literature and in general practice, has not been free from ambiguity. To define the terms, it is necessary to recapitulate briefly the various steps in the budget process. When an entity is authorized to incur an obligation—that is, to enter into a contractual type of transaction in which an order is placed—then the budget system is obligations-based. When the budget is based on the amounts likely to be disbursed, it is considered cash-based. Once the budget is approved, it is implemented through a series of steps: apportionment; internal allotment—a method for dividing the aggregate amounts within an agency to various claimants, such as divisions in the entity or programs; obligation—placement of an order (in some cases a further distinction is made between an obligation and a commitment, the latter being a firm and irrevocable order); disbursement to record the payment; and the expense, where the actual use of the materials acquired is recorded. All accounting systems, regardless of origin and current orientation, are expected, in principle, to record these various stages, although noncompliance is common. While capturing these stages, however, the accounting system may have a primary orientation that is based on cash or on accrual.
In a cash-based accounting system, revenues and expenditures are recorded only when cash is received or paid out. The system does not take into account the period to which transactions apply. A cash-based system may also include noncash transactions, such as foreign aid received in kind, or the book adjustments made among government agencies when the products of one are delivered to another. A few countries operate what is usually known as a modified cash basis, which includes payments made in a particular period for transactions that were budgeted in a previous year.
Accrual accounting refers to the acquisition of goods and services regardless of payments received or paid out. This conventional definition has been further expanded by the U.S. Federal Accounting Standards Advisory Board5 to include transactions, events, and circumstances that have a financial effect regardless of when cash is paid out or received. This enlarged definition seeks to go beyond the goods and services to policy decisions regarding transfers (pensions and other welfare payments, which have tended to dominate the budgets of several countries) so that all types of liabilities can be captured. Some countries use a modified accrual basis, which involves essentially cash-based accounts adjusted to reflect an accrual basis. Both the modified cash and the accrual basis exemplify systemic responses to policymakers’ periodic demands for additional information; the accounting standards of these systems are not consistent over time, however.
Why Accrual Now?
Cash accounting facilitates the regular assessment of the impact of fiscal activity on the economy and contributes to a reconciliation of the monetary data, which is handled on a cash basis. However, a cash system is ineffective in indicating the immediate, medium-term, and long-term liabilities of a government. For example, the pension liabilities of a government are generally understated, and, more often than not, the budgetary outcome is higher than the estimates included in the budget. Moreover, in cash-based accounting, transactions are recorded as payments are made, and a more detailed inquiry is needed to determine whether the payment is for services rendered during the current or the previous year. Matching payments to income and cost of services in a specific time frame (fiscal year) is rendered difficult. Inasmuch as the information about liabilities is not fully captured, it has been argued that cash-based accounting may unwittingly contribute to distorted fiscal decision making, and legislatures may be called upon to provide a pro forma approval for spending obligations that have already been incurred.
The merits of the accrual system also need to be recognized.6 In contrast to the cash-based system, the accrual-based system seeks to provide a comprehensive picture of all government liabilities, thereby aiding the formulation of realistic fiscal policies. It also facilitates orderly cash management through its explicit portrayal of liabilities. More specifically, it helps fiscal policymakers see beyond the current fiscal year and the next year’s budget. During periods of acute fiscal crisis, the accrual-based system allows policymakers to see beyond the transactions of the week or the month to the medium term and, in particular, to focus on the contingent liabilities and hidden liabilities looming large on the horizon.
At a program management level, accrual-based accounting provides an accurate picture of the full costs by capturing, in addition to cash flows, overhead costs, including the value of the physical assets used in the provision of services. Similarly, estimates of full resource costs, in addition to helping the budgetary allocation of resources, would also facilitate decision making in determining which services the government should provide and which should be contracted out to private suppliers.
The debate during recent years has tended to focus on the relative merits of one form of accounting over another. A more important question is: Why choose between the two systems? In reality, the relationship between the two is a symbiotic one and the two cannot be considered separately. The cash system is less complex and easier to administer, and years of tradition have made it a first choice. It is also true that it has several blind spots and can no longer fully serve the complex demands of public policymakers. It needs to be supplemented by accrual-based accounting so as to provide a fuller picture of the liabilities and costs of operations. When payments are recorded in a cash system, it is assumed that goods and services have been delivered and that the associated liabilities are being liquidated. Conversely, an accrual system assumes that when liabilities are recorded, arrangements are being made to finance them. Together, the two systems provide full information, and the expenditure manager will be better served by drawing on elements of each. Fortunately, modern computer technology permits the recording of each stage of a transaction. Supplementary systems can then be developed for the preparation of the balance sheets and full cost information.
Budget and Accounts
In governments, the coverage, basis, and classification of budgets and accounts are closely linked. Essentially, the accounting system follows the parameters of the budget and provides the needed information at the various stages of budget formulation and implementation. To the extent, however, that the accounting system is accrual-based, the data it reports would differ materially from data used to formulate and implement a budget that is not based on accrual. The significant issue is whether the budget should also be placed on an accrual basis.
The experiences of a few countries, such as Australia, Iceland, and New Zealand, show a diversity of approaches to budgeting and accounting. With the gradual development of accounting standards and extended application of accrual-based accounting systems, it is likely that the debate over the merits of the different accounting systems will lead to convergent approaches. Meanwhile, it is appropriate to consider the various aspects of this issue. As a preliminary step, the following continuum in government financial management comprising the budgeting, accounting, and reporting systems needs to be noted:
| Budget appropriation | → | Accrued expenditures | → | Cash payments | → | Reporting on performance and fiscal developments | ||||||||||
| Budget appropriation | → | Accrued expenditures | → | Cash payments | → | Reporting on performance and fiscal developments | ||||||||||
Any system adopted should reflect the budget concerns, entry into and liquidation of claims, and reporting on performance. It has been argued that the budget system should continue to be primarily a cash-based one for three reasons. First, the budget, as an economic document, should indicate the likely monetary impact of government operations on the economy. From this point of view, the cash-based budget offers an advantage. Second, most of the legislative ceilings and related limits are specified in cash terms and to that extent a cash-based budget would be appropriate. Third, most control operations in government are anchored in a cash basis, and the approaches to cash management, which have a crucial role to play in heavily indebted economies, would be better served by cash systems.
These arguments tend to ignore the foundation of accrual accounting that has been accepted, as discussed earlier, primarily for two reasons. First, legislative authorities as well as policymakers in the executive branch of government should have information on the full cost of programs and projects, and, second, effective planning and financial management in the spending agencies require accrual-based accounting systems.
Each system has certain strengths and, as argued earlier, attempts to choose between the two and to consider each one to the exclusion of the other contribute to an avoidable controversy. In Australia, accrual budgeting has been introduced as an adjunct to cash budgeting. In Iceland, the decision has been to present the budget to the legislature on both an accrual and a cash basis. Data presented for each department distinguish between cash receipts and expenditures and accrued receipts and expenditures. In New Zealand, government activities have been divided into three categories: purchasing outputs (Mode A), functioning primarily as an owner (Mode B), and providing benefits (Mode C). For Mode A, which focuses only on inputs, appropriations are made on a cash basis. In Mode B, attention shifts to the consumption of resources and may operate on a “net” or a “gross” basis. Capital injections and related budgetary provisions are made on a cash basis but are expected to be fully supported by adequate documentation on the full cost of producing output.
For those activities that revolve around the administration of transfer payments, appropriations are made on a cash basis. In all these cases, however, the budget documents have been strengthened to include operating statements and statements of projected performance. From 1994, appropriations are made in both cash and accrual terms, and, in addition, ample financial information is provided on an accrual basis. In the United States, the legislature will continue to approve the annual budget on a cash basis (within the overall framework of program obligations) although accounting statements would be on accrual basis. These different approaches should not add materially to the work burden and, in any event, any costs would be offset by the benefits that are expected to accrue.
Dimensions of the Issue
How does the introduction of accrual accounting in government affect the presentation of the budget? While the answer is dependent on the legislative tradition and the basis of appropriation, from a technical point of view, it depends on the items included in the budget and the way they are treated in cash- and accrual-based budgets and accounts. For this purpose, the treatment of the main components of object-wise classification, which is common to all the agencies in the government, is illustrated in Table 7.
Substantive differences exist in payments for goods and services and for capital expenditures. In these cases, the cash basis offers an inadequate picture of the actual extent to which liabilities have been incurred and could thus contribute to misleading conclusions about the real state of finances. The accrual-based system has an advantage in that it illustrates the full extent of the resources needed to finance decisions already made by the government. The establishment of accrual-based budgets, where cash-based accounting is in use, should start from the bottom: each agency’s estimates should be expressed in both cash and accrual terms, with an explanation of the differences. Such a presentation would serve the informational needs of legislators, policymakers, effective internal financial management, and cash management for the whole government. The application of computer technology makes this task somewhat simpler than might appear at first sight.
General Ledger System
At the core of government financial management (which is now considered under various names, such as Integrated Financial Management Systems (IFMS) and Integrated Functional Budget and Accounting Systems (IFBAS)) is the general ledger, in which all inflows and outflows are finally recorded. The role of the ledger in the budget system is to track the status of appropriations, indicating amounts committed and the linkages between commitments and payments (Diagram 1). The ledger also plays a role in treasury operations, serving as the channel through which most transactions are carried out.
This core (general ledger) is then linked to the subsidiary systems that must be maintained by either the central or spending agencies. An illustration of this is provided in Diagram 2. In a more simplified form, when the budget is organized in the traditional line-item format, the agencies may be required, in pursuance of the traditional orientation and methods of control, to maintain commitment control entries, funds distribution among various entities, and applications for virements or reappropriation from one accounting head to another. In addition, each agency, depending on its main activity, may be required to maintain special computer files for travel, utility payments, pensions, inventory management, foreign aid, revenue refunds, and assets disposed of in the context of privatization. The range of files that could be opened is fairly large and is limited only by the capacity of hardware and software and by the technological status of the communications system.
Notwithstanding the obvious appeal of the computer-operated general ledger system (whether based on customized software or off-the-shelf software—of which several packages are available and more are likely to become available with the increasing acceptance of this approach and consequent expansion of the market), several issues have been raised about the way in which the system should be implemented and the preparatory steps that need to be taken. At this stage, it is premature to discuss various points: whether the introduction should be through a mainframe or through a linkage among available personal computers; whether separate arrangements should be made to hire space in the satellite so that information could be collected from the regions; and whether an earth station is needed and, if so, the financial implications of such arrangements. Technology is changing rapidly. It is also becoming fiercely competitive, so that estimates of financial implications, which differ from country to country in any case, change rapidly as well. The only assertion that can be made about the future is that a financial manager will have more technological choices and less expensive arrangements than in the past.
Cash- and Accrual-Based Budgets
Cash- and Accrual-Based Budgets
| Category | Cash-Based Budget | Accrual-Based Budget | Remarks | |
|---|---|---|---|---|
| Current expenditures | ||||
| Personal emoluments and related benefits | Budget estimates would be based on the cash amounts likely to be paid during the year. | Estimates would reflect the complete liability. | Differences between the two would be minimal in most cases. In some cases, actual cash payments may be lower than the accrual-based estimates when, for example, a new pay revision is approved but payments may not be made in full and may be spread over more than one fiscal year. | |
| Purchases of goods and services | As above, estimates reflect the likely actual disbursement during the year. | Estimates would be based on orders placed regardless of delivery or their payment or the actual use of the goods and services received. | Differences arise in the following cases: (1) When substantial lags exist in the delivery of goods and services, cash estimates would be different. (2) When payments are likely to be carried over as a part of a policy of “liability management,” cash estimates would be lower. (3) Cash outlays could be higher when substantial arrears carried over from previous years are proposed to be fully paid. | |
| Debt service | In principle, cash estimates are based on accrual method, in that repayments due and the interest payable on outstanding debt are taken into account. | Estimates are based on the levels of outstanding debt and related repayments and interest costs. Future debt estimates are based on forecasts. | Actual cash outlays could be less when a part of the debt is capitalized and carried forward. But, in general, the differences between the two would be minimal. | |
| Pensions and entitlements | Estimates would be based on the likely magnitudes of payments. | Estimates would be based on the liabilities specified in the relevant legislation. Although the liabilities could be open ended, the annual estimates would be limited to the liabilities estimated to be liquidated during the year. | Differences arise in the following cases: (1) When pensions are organized on a separate basis outside the regular budget, the transfers made from the budget may be less than actually indicated. (2) In cases of acute stringency, some payments may be held over and carried forward to the next year. | |
| Subsidies and grants to public enterprises | Estimates would be based on the relevant legislation and price forecasts. | Basis is the same as in cash estimates. | Differences may arise only insofar as it is determined that the actual payments should be less than the liabilities indicated by legislation and price forecasts. | |
| Grants to other levels of government and nongovernmental organizations | Based on relevant legislation. | Based on relevant legislation. | As above. | |
| Capital expenditures | ||||
| Material assets | Based on the estimated payments regardless of actual liabilities. | Based on estimated contractual liabilities and actual progress of physical work. | Differences could be considerable, and much would depend on the cash payment schedules that may be formulated independent of the physical aspects. The differences could be substantial in regard to donor- financed equipment. Further, year-end balance sheets could reflect the market rather than the acquisition value. | |
| Financial investments | Based on policy decisions to acquire financial assets and to make other investments. | As in the case of cash-based estimates. | Differences arise in balance sheet presentation in that the investments would be shown at market value rather than at acquired value. | |
| Lending | As above. | As above | Differences arise annually when the loan portfolio is assessed and nonperforming loans are written off. | |
Cash- and Accrual-Based Budgets
| Category | Cash-Based Budget | Accrual-Based Budget | Remarks | |
|---|---|---|---|---|
| Current expenditures | ||||
| Personal emoluments and related benefits | Budget estimates would be based on the cash amounts likely to be paid during the year. | Estimates would reflect the complete liability. | Differences between the two would be minimal in most cases. In some cases, actual cash payments may be lower than the accrual-based estimates when, for example, a new pay revision is approved but payments may not be made in full and may be spread over more than one fiscal year. | |
| Purchases of goods and services | As above, estimates reflect the likely actual disbursement during the year. | Estimates would be based on orders placed regardless of delivery or their payment or the actual use of the goods and services received. | Differences arise in the following cases: (1) When substantial lags exist in the delivery of goods and services, cash estimates would be different. (2) When payments are likely to be carried over as a part of a policy of “liability management,” cash estimates would be lower. (3) Cash outlays could be higher when substantial arrears carried over from previous years are proposed to be fully paid. | |
| Debt service | In principle, cash estimates are based on accrual method, in that repayments due and the interest payable on outstanding debt are taken into account. | Estimates are based on the levels of outstanding debt and related repayments and interest costs. Future debt estimates are based on forecasts. | Actual cash outlays could be less when a part of the debt is capitalized and carried forward. But, in general, the differences between the two would be minimal. | |
| Pensions and entitlements | Estimates would be based on the likely magnitudes of payments. | Estimates would be based on the liabilities specified in the relevant legislation. Although the liabilities could be open ended, the annual estimates would be limited to the liabilities estimated to be liquidated during the year. | Differences arise in the following cases: (1) When pensions are organized on a separate basis outside the regular budget, the transfers made from the budget may be less than actually indicated. (2) In cases of acute stringency, some payments may be held over and carried forward to the next year. | |
| Subsidies and grants to public enterprises | Estimates would be based on the relevant legislation and price forecasts. | Basis is the same as in cash estimates. | Differences may arise only insofar as it is determined that the actual payments should be less than the liabilities indicated by legislation and price forecasts. | |
| Grants to other levels of government and nongovernmental organizations | Based on relevant legislation. | Based on relevant legislation. | As above. | |
| Capital expenditures | ||||
| Material assets | Based on the estimated payments regardless of actual liabilities. | Based on estimated contractual liabilities and actual progress of physical work. | Differences could be considerable, and much would depend on the cash payment schedules that may be formulated independent of the physical aspects. The differences could be substantial in regard to donor- financed equipment. Further, year-end balance sheets could reflect the market rather than the acquisition value. | |
| Financial investments | Based on policy decisions to acquire financial assets and to make other investments. | As in the case of cash-based estimates. | Differences arise in balance sheet presentation in that the investments would be shown at market value rather than at acquired value. | |
| Lending | As above. | As above | Differences arise annually when the loan portfolio is assessed and nonperforming loans are written off. | |
Overall Financial Management System
Illustrates the interaction between core and specialized information systems. The specialized systems shown here are illustrative and not exhaustive.Overall Financial Management System
Illustrates the interaction between core and specialized information systems. The specialized systems shown here are illustrative and not exhaustive.Overall Financial Management System
Illustrates the interaction between core and specialized information systems. The specialized systems shown here are illustrative and not exhaustive.Two issues arise in the preparation of the existing systems to facilitate the application of the general ledger system. They are the fund structure and the traditional budget classification. Fund systems in government are generally categorized as limited, intermediate, or extensive. When channeled through five or fewer funds, the system is considered limited. Systems with 5–20 funds are regarded as intermediate, and those with more funds are viewed as extensive. These limits are drawn for purely analytical purposes, and the conventional belief is that as the number of funds grows, transactions among them grow exponentially and may contribute to a loss of control. In addition, more personnel may be required to manage the funds. In the context of a computer-operated general ledger, the number of funds does not pose a major problem. Each fund will be recognized as a subsidiary or as a special system with regular, specific linkages to the general ledger (Diagram 2). Similarly, the nomenclature of the budget does not pose a problem, as the entries in the ledger will reflect the categories of the budget. However, it would be incongruous to apply advanced technology to a conventional approach to control. Rather, the potential of the technology should be used to effect a substantive change in the approaches to budgetary control. Experience has shown conclusively that when essential changes are not made in the budget categories and related controls, computer processing ends up as a quick mechanical adjunct to the conventional process.
A related issue is the impact of technology on the control exercised by the central agencies. Hitherto, the centralized system of control was based on two premises: (1) the finance ministry should exercise the control, and (2) most control should be exercised through the traditional verification methods, at the payment stage. Although valid in an earlier time, these premises are open to criticism in a context where modern technology has made instant information possible, thereby leveling the playing field. The role of the finance ministry is now to monitor developments once a budget is approved and to provide guidance to the spending agencies on cost-effective methods of resource utilization. The general ledger system thus serves as a clearinghouse for recent developments and makes it easier for participants to anticipate likely trends. Decision makers who once relied on their proverbial sixth sense to anticipate situations can now rely on the general ledger for the identification of vulnerable areas. Under this system, control is more meaningful and therefore more effective.
The implementation of the general ledger system offers, in theory, a choice—a massive overnight shift or the more evolutionary approach of spreading through pilot projects and learning from experience at each stage. In practice, however, the choice has been limited to the evolutionary approach. Experience shows that limiting initial projects to headquarters and the major spending agencies is appropriate. Later, the projects can be extended to the regions and field operations.
Government Accounts and National Income Accounts
In the commercial world, the annual balance sheet and related statements on income and expenditure and sources and uses of funds make the accumulation accounts and the flows during the year for which these statements relate more transparent. A counterpart of this in the government sector is the national income accounts (NIA), which are primarily based on accounting data and seek to compare and aggregate heterogeneous information from the government accounts to compile comparable data in this subsector over time. These accounts thus provide data on current revenue, current expenditure or consumption, net saving, and gross capital formation and how it has been financed. The accounts answer questions that arise in the formulation of the annual budget about the optimum level of public accumulation and annual capital investment. Although decisions continue to be more political than economic in their orientation (and in developing countries, this responsibility is often shared with donor governments and international and regional financial institutions), the NIA provide an empirical basis for such decisions. The NIA, as policy accounts, are different from the government’s closed accounts, which, in most cases, must be audited, submitted to the legislature, or published.
The NIA have several subaccounts that relate to the general government (central government plus local governments); public sector (general government plus state-owned enterprises); state enterprise operations; tax statistics; transfer expenditures including interest, subsidies, and other transfers; outlays on the environment; expenditure on social welfare; and outlays of the main departments, such as defense. These subaccounts are detailed to facilitate the netting of transactions to arrive at analytically meaningful subaggregates. For policy purposes, the NIA may also be supplemented by generational accounts (see discussion below). Both NIA and generational accounts represent separate analytical constructions, based mostly on government accounts but partly on separate supplementary investigations to enable policymakers to ascertain the current status of government finances and to make decisions thereon.
Government accounts also shed light on the status of government finances but in a more technical and somewhat narrower way. They represent the first stage from which the NIA are drawn. Until recently, government accounts did not provide accumulation accounts (that is, an accumulation of assets and liabilities); nor did they separate, as in the commercial world, operational budgets from investment budgets. If, however, the complete commercial formats of accounting are applied to public entities, the compilation of such accounts would be rendered easy. Meanwhile, the NIA seek to provide this information. In their present form and as applied across industrial and developing countries, the NIA are based on the methodology developed by the United Nations over two decades ago. This methodology has recently been refined further, and the NIA will, in the future, be based on the refined methodology.7
The NIA provide for both a current and a capital account to classify government transactions. While definitional approaches and related practices are, for the most part, congruent insofar as current consumption is concerned, they differ from prevailing practices with respect to the capital account. This is primarily because the capital budgets (and hence accounts) in governments reflect a wide variety of practices, indeed a veritable salmagundi, that are often different from the approaches indicated in the NIA. For example, expenditures on software and leasing of equipment are recorded in most budgets as current, while they would be shown in the NIA under the capital account. Similarly, outlays on the maintenance of a capital asset during the first year of its operation are conventionally recorded under capital expenditures in government budgets and accounts. There are several other details where the respective treatments differ, and these are illustrated in Table 8. A major issue relates to depreciation or estimates of consumption of fixed capital. These estimates require that regular data about the life of an asset as well as average prices for the period be maintained. Governments do not generally maintain depreciation accounts, and even when they do, the budgetary provisions tend to be arbitrary, more for the sake of form, and their utility for financial management is rendered moot. In this area, accounting standards that lend themselves to consistent and uniform application throughout the government need to be developed.
Budgets, Accounts, and National Income Accounts
Amounts forgone, formally written off, or postponed may not be fully reflected either in the budget or in associated accounts.
Budgets, Accounts, and National Income Accounts
| Description | Budget Systems | Accounting Systems | National Accounts | |
|---|---|---|---|---|
| Coverage of the system | The coverage of the budget is, in principle, expected to be coterminous with that of the government. In practice, however, several transactions may be outside the budget. | Generally follow the purview of the budget. In some cases, extra-budgetary accounts may also be available on a consolidated basis. | Coverage is complete and includes all transactions, whether organized as a part of the budget or outside, of the central and general governments. | |
| Current and capital distinctions | Very few governments have current and capital budgets. Several practices represent variations of this theme. | Broadly follow the budget systems. In some cases, governments are now required to prepare annual balance sheets showing both stocks and flows. | Require both accumulation accounts and balance sheets. These accounts are drawn from the regular accounts of a government. If these data are not adequate, subsidiary systems are established to collect the needed data. | |
| Scope of capital account | In general, those items that have prospective benefits, a life span of more than one year, are above a specified monetary ceiling, and usually financed by debt are included in the capital budget. | Follow the budgetary practice. | Cover assets that are owned (and therefore can be disposed of) by governments and those that have prospective economic benefits. | |
| Acquisition of existing assets | ||||
| Flows during the year | Recorded at the purchase value of the asset. If they are acquired over a period of years, each year’s budget shows only a part of the total outlay. | Broadly follow the budgetary practice. For purposes of balance sheets, the concept of constructive delivery may be used, and parts of assets would be deemed to have been acquired. But few governments are currently preparing consolidated annual balance sheets. | Recorded in the system, and, where progress payments are made, the concept of constructive delivery is invoked. | |
| Stocks | Stocks of assets are not recorded in the budget or its associated documents. | Stocks of assets must be shown where the governments maintain balance sheets on commercial lines. Mostly, however, this information is not available. | Information on the accumulated levels is systematically included. | |
| Assets built during the year | Outlays incurred during the year are shown. Total outlay on an asset is generally not shown. Also, the concept of constructive delivery is not applied. | Reflects the situation as in the budget. Concept of constructive delivery is generally not applied. | Fully recorded and imputations are made for work in progress with reference to the concept of constructive delivery. | |
| Financial assets | ||||
| Loans1 | Only the flows (and not the stocks) are shown in the budget. | Accounts show mostly flows. | Now required to be compiled on a comprehensive basis for the accumulation accounts and balance sheets. | |
| Shares and investment | As above. | As above. | ||
| Monetary gold, SDR allocations, and related investments | Generally not included in the budget of the government. | These and the stocks in regard to the above items are mostly shown in the balance sheets of the central bank. | ||
| Capital transfers | Shown in the budget; data are limited to flows. However, the end use of these transfers could be and often is different from the intent. | Required to be recorded on a comprehensive basis. For end use, the approaches indicated in the Frascati Manual may be utilized. In addition, debt cancellation by mutual agreement is recorded as a capital transfer (this information is generally not available in the budget). | ||
| Capital assets | Only amounts spent during the year on the acquisition or life renewal of these assets are shown in the budget. | Data mostly restricted to flows. | ||
| Cultivated assets | Most government accounts show only those transactions recorded in the budget. Where, however, supplementary balance sheets are prepared, value of commercial forests, national parks, etc. is shown. Plantations and orchards may be shown only when they are extensive or are on a commercial scale. | Required to be included in the national accounts. | ||
| Intangible assets | Outlays on computer software and others are usually considered as consumption expenditures. | These are generally recorded only where balance sheet approach is used. Even then, they would be recognized only when a foreseeable future benefit is perceived. | Explicitly recognized in the national accounts. | |
| Assets acquired through barter and foreign aid | Barter transactions are not usually recorded in the budget. Assets acquired through foreign aid are generally shown, although there are enormous data gaps. | Barter transactions may not be recognized. Assets acquired through foreign aid are recorded. | All assets, including those acquired through barter, are required to be included in the national accounts. | |
| Treatment of selected items | ||||
| valuation | Outlays reflect the acquisition value. Stocks, as noted above, are not shown. | Stocks are mostly shown at acquired value; when commercial accounts are compiled, stocks are shown at the net | All assets are required to be shown at their current market value. | |
| Changes in inventories | Not normally recorded. | Included in systems that produce annual balance sheets. | Required to be included. | |
| Depreciation | Included in few countries. | Included in few countries. Different classes of assets have specific lives. | Included in the national accounts. | |
| Small tools | Mostly shown in the current or operational budget. | As in the budget system. | Treated as fixed assets when they form a significant part of the value of the total stock. | |
| Military equipment | Outlays, except those on structures and dwellings, are considered as consumption expenditures. | As in the budget system. | Only structures and dwellings are considered as fixed assets. | |
Amounts forgone, formally written off, or postponed may not be fully reflected either in the budget or in associated accounts.
Budgets, Accounts, and National Income Accounts
| Description | Budget Systems | Accounting Systems | National Accounts | |
|---|---|---|---|---|
| Coverage of the system | The coverage of the budget is, in principle, expected to be coterminous with that of the government. In practice, however, several transactions may be outside the budget. | Generally follow the purview of the budget. In some cases, extra-budgetary accounts may also be available on a consolidated basis. | Coverage is complete and includes all transactions, whether organized as a part of the budget or outside, of the central and general governments. | |
| Current and capital distinctions | Very few governments have current and capital budgets. Several practices represent variations of this theme. | Broadly follow the budget systems. In some cases, governments are now required to prepare annual balance sheets showing both stocks and flows. | Require both accumulation accounts and balance sheets. These accounts are drawn from the regular accounts of a government. If these data are not adequate, subsidiary systems are established to collect the needed data. | |
| Scope of capital account | In general, those items that have prospective benefits, a life span of more than one year, are above a specified monetary ceiling, and usually financed by debt are included in the capital budget. | Follow the budgetary practice. | Cover assets that are owned (and therefore can be disposed of) by governments and those that have prospective economic benefits. | |
| Acquisition of existing assets | ||||
| Flows during the year | Recorded at the purchase value of the asset. If they are acquired over a period of years, each year’s budget shows only a part of the total outlay. | Broadly follow the budgetary practice. For purposes of balance sheets, the concept of constructive delivery may be used, and parts of assets would be deemed to have been acquired. But few governments are currently preparing consolidated annual balance sheets. | Recorded in the system, and, where progress payments are made, the concept of constructive delivery is invoked. | |
| Stocks | Stocks of assets are not recorded in the budget or its associated documents. | Stocks of assets must be shown where the governments maintain balance sheets on commercial lines. Mostly, however, this information is not available. | Information on the accumulated levels is systematically included. | |
| Assets built during the year | Outlays incurred during the year are shown. Total outlay on an asset is generally not shown. Also, the concept of constructive delivery is not applied. | Reflects the situation as in the budget. Concept of constructive delivery is generally not applied. | Fully recorded and imputations are made for work in progress with reference to the concept of constructive delivery. | |
| Financial assets | ||||
| Loans1 | Only the flows (and not the stocks) are shown in the budget. | Accounts show mostly flows. | Now required to be compiled on a comprehensive basis for the accumulation accounts and balance sheets. | |
| Shares and investment | As above. | As above. | ||
| Monetary gold, SDR allocations, and related investments | Generally not included in the budget of the government. | These and the stocks in regard to the above items are mostly shown in the balance sheets of the central bank. | ||
| Capital transfers | Shown in the budget; data are limited to flows. However, the end use of these transfers could be and often is different from the intent. | Required to be recorded on a comprehensive basis. For end use, the approaches indicated in the Frascati Manual may be utilized. In addition, debt cancellation by mutual agreement is recorded as a capital transfer (this information is generally not available in the budget). | ||
| Capital assets | Only amounts spent during the year on the acquisition or life renewal of these assets are shown in the budget. | Data mostly restricted to flows. | ||
| Cultivated assets | Most government accounts show only those transactions recorded in the budget. Where, however, supplementary balance sheets are prepared, value of commercial forests, national parks, etc. is shown. Plantations and orchards may be shown only when they are extensive or are on a commercial scale. | Required to be included in the national accounts. | ||
| Intangible assets | Outlays on computer software and others are usually considered as consumption expenditures. | These are generally recorded only where balance sheet approach is used. Even then, they would be recognized only when a foreseeable future benefit is perceived. | Explicitly recognized in the national accounts. | |
| Assets acquired through barter and foreign aid | Barter transactions are not usually recorded in the budget. Assets acquired through foreign aid are generally shown, although there are enormous data gaps. | Barter transactions may not be recognized. Assets acquired through foreign aid are recorded. | All assets, including those acquired through barter, are required to be included in the national accounts. | |
| Treatment of selected items | ||||
| valuation | Outlays reflect the acquisition value. Stocks, as noted above, are not shown. | Stocks are mostly shown at acquired value; when commercial accounts are compiled, stocks are shown at the net | All assets are required to be shown at their current market value. | |
| Changes in inventories | Not normally recorded. | Included in systems that produce annual balance sheets. | Required to be included. | |
| Depreciation | Included in few countries. | Included in few countries. Different classes of assets have specific lives. | Included in the national accounts. | |
| Small tools | Mostly shown in the current or operational budget. | As in the budget system. | Treated as fixed assets when they form a significant part of the value of the total stock. | |
| Military equipment | Outlays, except those on structures and dwellings, are considered as consumption expenditures. | As in the budget system. | Only structures and dwellings are considered as fixed assets. | |
Amounts forgone, formally written off, or postponed may not be fully reflected either in the budget or in associated accounts.
Several industrial countries have set up computerized, integrated data bases for all public accounts. Such data bases have become essential in view of the variety of demands made by economists, political authorities, and international institutions for fundamental statistical documentation at a detailed level. This, in turn, involves the compilation and maintenance of detailed building blocks on government transactions that can then be arranged and rearranged according to the user’s requirements. These blocks are entirely menu-driven but in each case require the maintenance of a detailed data base. The introduction of commercial accounts, with a specific distinction between operational and investment budgets, and the related maintenance of detailed data bases would also facilitate the compilation of national income accounts.
Generational Accounts
It is now generally accepted that fiscal issues cannot be solved during one fiscal year and require concerted and consistent efforts over time to address them. This approach recognizes that most fiscal policymaking addresses the short-term concerns that may leave a lot, at any rate more than intended, to future generations—a long legacy of problems and fewer resources. Although policymakers do not resort to the philosophical predictions of religious leaders about the arrival of a savior, they tend to be optimistic about the future. This has several practical implications. Two cardinal principles of modern accounting are that there should be a match between resources and uses of funds in a time frame and that there should be intergenerational equity. The former principle requires that resources raised in a period should be adequate for the services provided and, as a corollary, that the citizens of the current period should not be shifting a part of the burden for payment to the next generation. However, the bulk of the expenditures incurred now on retirement, health care, and life insurance tend to understate current expenditures by shifting them to the future. Similarly, experience shows conclusively that during periods of fiscal stress, expenditures on routine repairs, maintenance, and replacement of assets are deferred to the point that their real value is substantially eroded by the time they are available to future generations. How should the accounting system reflect these realities and are its methods adequate?
Policymakers, including accountants and economists, recognize that measurement of economic performance over time is not merely important but essential. While economists tend to emphasize intergenerational equity, accountants have been trying to evolve methods, such as accrual, that illumine the assets and liabilities of public entities at any given time. But economists have developed another method to measure fiscal performance properly in the belief that existing methods are inadequate and that the deficit, as calculated, is “a number in search of a concept.”8 In the United States, economists have proposed that the Government replace the existing annual budget with a system of “generational accounts.” Although such a major change is unlikely—largely because the system is now being reoriented after a long period of contemplation, analysis, and inaction—generational accounts are being used as an analytical device to illustrate the underlying trends in government finances.9 Similar efforts are under way in Italy, Japan, and Norway, although in Italy the effort is restricted to an analytical study undertaken by the central bank and has not made any forays into the actual budgetary process. What then is the method of generational accounting? What are its strengths and vulnerabilities? Can it replace the existing budget system? Does it represent a major advance over the accrual accounting approach? These questions are considered below.
Generational accounting represents an attempt to throw light on the present value budget constraint of the government. This restraint means that the government would have to finance its expenditures from the income from current assets (net of debt) and from the resources contributed by current and future generations. To the extent that the current generation pays less (net of transfers) to finance the transactions of the government, the burden will be shifted forward and will have to be borne by future generations. If this burden is regularly shifted forward, then the debt will grow and, over a period of years, if no discretionary unilateral action is taken by the debt holder to forgive the debt, it could reach a stage of default and constitute a major financial crisis. Some city governments in Europe and the United States, as well as some heavily indebted countries, have experienced such a crisis.
Essentially, the system of generational accounts consists of the following elements: (1) value of the future purchases of goods and services by the government, (2) value of future taxes to be paid by existing generations, (3) value of the taxes to be paid by future generations, (4) value of the transfers received by existing generations in the future, (5) value of the transfers received by future generations, (6) government debt, (7) value of government assets that yield income in the future, and (8) a discount rate so as to reduce all the values indicated in the preceding steps to the present (that is, at the time of calculation). The present value budget constraint, according to this approach, is that the present value of the government’s future purchase of goods and services cannot exceed the sum total of the future taxes paid by current and future generations (net of transfers in each case) and income from the assets net of debt.
To facilitate calculation, the present value of goods and services is computed on the assumption that present policies will continue without any change. This estimate minus the resources paid by the existing generation (net of transfers) and the present value of assets (net of debt—this could be a negative figure in some countries where debt levels are very high) indicates the burden to be borne by future generations. Calculations made for the United States suggest that the generations born after 1993 are likely to make payments 126 percent higher than those born in 1992, while for Norway the comparable figure would be about 69 percent and for Italy (on the basis of data computed for 1990), it could be two or three times larger than the U.S. figure. Basically, however, generational accounts show the aggregate amount (the difference between the present value of government purchases of goods and services minus the future tax payments by existing generations (net of transfers) and income from current assets (net of debt)). This aggregate amount is a single number and cannot be divided among the various taxes or the wide variety of transfers.
The concept of generational accounts, while attractive in some ways, has several obvious limitations.10 Even family budgets are done on an annual, if not on a much shorter-term basis. Although the conclusions to be drawn into the next generation may be self-evident and compelling, the present generation may tend to think and concentrate (without necessarily contributing to the hedonistic philosophy of Omar Khayyam) on the present rather than on the unborn tomorrow.11 This may very well be the approach of governments that are in a state of continuous fiscal crisis. Another flaw of the methodology is that it ignores the beneficial impact of public expenditures, and the calculation of the present value of the net assets of the government may not do full justice to the long-term benefits that derive from government expenditures on, among other services, education and health. Furthermore, the methodology neglects to take into account the dynamics of the population, the economy, and the future policies of the government. The choice of the discount rate, as in the cost-benefit analysis, is crucial because of its effect on the calculations. In effect, this methodology seeks to place the policymakers’ faith in the analysts’ arbitrary choice of rate. It could well lead to a revival of allegations about the tyranny of assumptions over the intuitive approaches of the less quantitative genre of the policymakers.
Even as a foundation on which to base policy decisions, the value of generational accounting is dubious. It can indicate only the broad contours of a problem and may not offer any advantages over the vast array of analytical devices available to a policymaker. The most myopic of fiscal policymakers realize that future generations may have to bear larger burdens once the difference between the rates of growth of revenues and expenditures becomes significant. Also, in contrast to the accrual method of accounting, which relies more on facts and details and is management oriented, generational accounts can serve, at best, only as analytical inputs primarily because of the aggregate nature of the analysis and the imputations involved. These accounts may, however, motivate a policymaker to pay more attention to, among other issues, intergenerational equity. No single aggregate can replace the complexity and subtlety of the details of budgets and accounts. Haveman (1994, p. 96) concludes that, “although certain of the tabulations provided by generational accounting have proved interesting, provocative, and worthwhile, the notion that generational accounts should replace the annual public budget is quite unjustified.” It is a reasonable assessment.
See Kautilya (1992). The detailed enumeration of various steps to be taken in the maintenance and inspection of accounts suggests that the age of calculators had arrived a long time before the lamentation by Edmund Burke, Reflections on the Revolution in France, that “the age of chivalry is gone. That of Sophisters, Calculators and Economists has succeeded.”
In the United States, the legislation relating to the Chief Financial Officers’ Act of 1990 (Section 102 (a)) states that the accounts “do not accurately disclose the current and probable future costs of operating and investment decisions, including the future needs of cash or other resources, do not permit adequate comparison of actual costs among executive agencies, and do not provide the timely information required for efficient management of programs” (Joint Financial Management Improvement Program, 1992a).
The term “government” is used here rather generally. As will be noted from the discussion in this section, there may be areas where double-entry bookkeeping may be in practice in some parts of the government. The reference here is to the predominant practice.
This discussion is largely relevant to the British Commonwealth countries. Countries that follow the French, Latin American, or American-type systems usually have a double-entry bookkeeping approach.
See its Exposure Draft (1991).
For a more recent statement, see Organization for Economic Cooperation and Development (1993).
See Kotlikoff (1992), p. 12.
See United States, Office of Management and Budget (1994), pp. 29–31.
Haveman (1994) offers a well-reasoned critique of the Generational Accounts Proposals.
Goode and Steuerle (1994) point out that rational people will take some (emphasis in the original) account of what they expect to do in the future but how far ahead and how accurately they will look are problematical, Goode and Steuerle add that “life time planning is limited by myopia, uncertainty, and lack of access to credit during periods of low income. Economists differ on the validity of the life cycle theory of behaviors, and the evidence is mixed” (p. 1031).
