Abstract

Continued fiscal austerity over the years has diverted the debate from the allocation of resources to the measurement and containment of costs within government. This diversion has led to a more detailed investigation into the approaches to costing in government and the ways in which they could be refined. At the same time, the role of accounting discipline in governments and public bodies needs to be defined, the techniques of cost measurement specified, and appropriate standards set forth for the purpose. Although the emphasis on measuring costs has received an additional impetus during recent years, governments have been concerned with determining costs, even if selectively, for a number of years.1 For example, they have traditionally estimated the costs of irrigation projects, multipurpose river valley projects, and, in industrial countries, major defense projects before making budget decisions. Cost estimation was mostly limited to new investments and new projects and was covered under the broad rubric “investment planning.” But such investments, even at the best of times, represent only a fraction of the total activities of public bodies. Although the rationale for ascertaining costs always existed in government operations, it has received deliberate attention in government circles only for the past three decades.

Continued fiscal austerity over the years has diverted the debate from the allocation of resources to the measurement and containment of costs within government. This diversion has led to a more detailed investigation into the approaches to costing in government and the ways in which they could be refined. At the same time, the role of accounting discipline in governments and public bodies needs to be defined, the techniques of cost measurement specified, and appropriate standards set forth for the purpose. Although the emphasis on measuring costs has received an additional impetus during recent years, governments have been concerned with determining costs, even if selectively, for a number of years.1 For example, they have traditionally estimated the costs of irrigation projects, multipurpose river valley projects, and, in industrial countries, major defense projects before making budget decisions. Cost estimation was mostly limited to new investments and new projects and was covered under the broad rubric “investment planning.” But such investments, even at the best of times, represent only a fraction of the total activities of public bodies. Although the rationale for ascertaining costs always existed in government operations, it has received deliberate attention in government circles only for the past three decades.

Before that, the primary purpose of accounting in government was to provide a detailed record of the transactions that took place. The current debate, which will prevail until a satisfactory methodology for cost measurement is developed, evolved for the following reasons: First, the fiscal austerity experienced during recent years has made governments examine new operations more closely, so that programs that are not viable can either be scaled down, reformulated, or abandoned. (Indeed, this has been the basis for the introduction of the triennial budget system in Sweden.) Ascertaining costs is implicit in this approach, for without such an assessment, policymakers cannot choose between the merits of one program and the claims of others.

Second, costs have become the overarching theme of accountability. The electorate, although aware of the services provided by public bodies, is more interested in knowing the extent of waste, inefficiency, and fraudulent misuse of government resources. Accountability is now interpreted in terms of provision of services at a specified cost and quality in a given period. Third, a major part of government outlays is now devoted to the provision of subsidies (to the manufacturing sector regardless of ownership) and to the reimbursement of expenses incurred by a third party (as in the case of medical care, where a doctor who is not an employee of the government provides a service to a private citizen, who is then reimbursed by the government). These transactions require, at a minimum, some ex ante basis for calculating costs, which thus play a more extensive role in policymaking. It is incumbent on the accounting system to provide the basic data for the calculation of costs.

Because cost measurement has its origins in commercial practices, it is appropriate to review the development of approaches used in the commercial world. Trends in government accounting are then discussed, and, in this context, the relevance for the government of recent developments in the commercial sector is considered.

Commercial Practices

Practices in the commercial world provide ample evidence to support the conventional adage about continuity and change. At each stage of development, there was a systemic response to new challenges and tasks. The history of commercial accounting shows three broad phases after the introduction of double-entry bookkeeping: management accounting, cost accounting, and what is now known as activity accounting. Each phase illustrates the response of the accounting discipline to the changing technologies of manufacturing and the related industrial organization framework. It would appear that each phase held sway for some time, and, when industrial technology changed, the patterns of production changed, and accounting had to change to maintain its relevance.

Before organized entrepreneurship, transactions took place in the market between owner-entrepreneur and individual buyers, and success was measured in the number of daily transactions.2 As transactions grew and manufacturing activity expanded, longer-term arrangements had to be made for hiring workers and procuring raw materials. As a result, prices, which were readily obtained in the earlier era through the market, now had to be calculated by estimating labor and material and the efficiency with which they were used. Managers became overseers of these operations and needed accounting information that was somewhat distinct from the annual balance sheets to assist them in monitoring daily activities. Toward this end, simple analytical measures, such as cost per hour, unit, or worker, were devised. Later, as processing industries came into the picture (such as railways), accounting had to generate data on cost per mile and related indicators. Management accounting measures were thus designed to aid in the day-to-day monitoring of activities but not to measure overall profits, which continued to be a separate activity.

In due course, and with rapid changes in the industrial and processing technology, more detailed and specific measures were needed than were being provided under the management accounting system. In particular, the growing inventories of both raw materials and finished products, as well as the distribution of staffing costs (overheads), created the need for cost accounting, whose purposes were to ascertain internal opportunities for improvement and to identify those activities that generated a higher return. Inventory costing, a procedure that permitted the separation of production expense from the cost of manufactured product inventories, developed from this need. Supplemented by methods aimed at determining and distributing overhead costs, inventory costing has become a dominant part of commercial accounting during the past several decades and continues to occupy an important place in the commercial world.

This overall system of management accounting is now considered obsolete. Johnson and Kaplan (1987, p. 1) argue that the information generated by the system “is too late, too aggregated, and too distorted to be relevant for managers’ planning and control decisions.” They maintain that the reports do not help managers reduce costs because of the time spent on explaining the variations in cost rather than on looking into the technological parameters of their operations. Moreover, the system fails to reflect accurate product costs in that it is based on simplistic and arbitrary methods. Furthermore, because of innovations in production technology with just-in-time inventory of raw material deliveries and with a reduced role for personnel (and thus relegating to the background the issue of overhead costs), the overall relevance of management accounting has become fragile. It is also argued that the existing systems of management accounting force managers to be more short term oriented and to treat all cash outlays as expenses for the period in which they were incurred, ignoring future benefits. In short, accounting design should not be left exclusively to accountants, but should also involve engineers and operating managers.

A result of the continued efforts of accountants and technology-oriented operational managers is the emergence of the cost management system.3 This system explicitly recognizes the transformation that has taken place on the manufacturing floor, which is now dominated not by labor (which hitherto, as noted above, was the main area of attention of cost accounting) but by robotics, computer-aided designs, and flexible manufacturing systems. The changes in technology imply that attention needs to be paid more to growing engineering and data-processing costs than to the decelerating labor and inventory components of costs. It is contended that traditional systems of cost accounting are not only inadequate in the current technological setting, but, if used, they could contribute to distortions in decision making. For example, the allocation of overhead costs on production volume could only encourage excess inventories.

The new technology implies a need for coordinated functioning among the various divisions in the manufacturing unit as well as among the suppliers that provide the inputs. In this context, the role of accounting, it is argued, should not be limited to providing historical data, but should be proactive in managing enterprises and, more significantly, in reducing costs so that enterprises can compete and survive in the marketplace. For this purpose, an integrated cost management system (CMS) has been developed. The CMS has four major elements. The first, which recognizes that resources are often used wastefully, entails estimating costs unrelated to the value added of a product. Because value is added only when a product is being processed, this system attempts to eliminate costs that do not add to the quality of the product, for example, storage costs incurred at the various stages of production. Essentially, the CMS seeks to identify the factors that contribute to the overall costs and to reduce these costs so as to streamline the production process.

The second element of the CMS involves activity costing, which also provides the conceptual underpinning to the design of the system. This concept recognizes that determining the activity level of a business links investment management, cost accounting, and performance measurement. As in government operations, the basic goal is to classify the activities of a firm by function, activity, task, and information elements that broadly represent how work is divided into meaningful blocks. (This classification is comparable to the classification of government transactions into functions, programs, activities, and cost elements.) Activity accounting seeks to associate cost and performance with an activity. Here again, as is traditional, costs comprise direct labor, material, technology, and other identifiable costs (these are comparable to the traditional categories of direct and indirect costs). Unlike in traditional systems, in the activity accounting approach overhead costs are calculated with reference to the consumption method, that is, actual materials or resources consumed.

Thus, the volume-based overhead absorption is replaced by a series of cost-driver rates for the activities that comprise the overheads of the enterprise. A cost driver is defined as anything that has a direct influence on the costs and performance of an enterprise. For example, with reference to materials management, material handling is viewed as an activity and each identified stage of material handling as a cost driver. From this, a cost rate per material movement can be derived and applied to individual product lines. The costs so identified can be used for investment management so that alternative activities that have potential for a higher rate of return can be identified. This accounting approach also assists in cost analysis and containment in that it illustrates how resources have actually been used.4 In contrast to traditional methods that focused on describing and controlling inputs as a way of reducing cost pressures, this method seeks a more direct relationship between costs of resources and their purpose. It also establishes links between costs and performance. From the point of view of the enterprise, however, the usefulness of this application lies in its emphasis on identifying and measuring the contribution or impact of each cost driver.5

The third element of the CMS refers to target costs, which are used to calculate the price that will enable a product to capture or retain a market share. Such targets represent the goals to be achieved through selective reductions in the various activity costs, and detailed activity costs and related strategies are essential.

The fourth element of the CMS entails improving the traceability of costs to management reporting objectives. The CMS recognizes that, in the context of advanced technology, when cost estimations are far off the mark, the consequences for the operations can be serious. It is important that the costs determine the cause and effect relationship and facilitate product costing. This function exemplifies the limitations of the traditional direct and indirect costs. The CMS seeks instead a more precise relationship between cost-driver aspects, operational targets, and management objectives.

The CMS represents the cutting edge of thinking in commercial accounting and, as a response to changing production and managerial styles induced by advanced technology, it shows a greater degree of adaptability and anticipates a future dominated by computer-driven technologies. The system has not, however, been adopted universally. The limited application can be ascribed not to any major conceptual drawback, but mostly to the detailed operational studies that need to be undertaken before the system can be introduced.

Government Approaches

Government accounting, until the early 1950s, was concerned with compiling appropriation accounts so as to provide the legislature and the public with an account of funds collected and spent and the administrative agencies on which they were expended. There was little concern for costs except to estimate them before approving new policies or projects. These estimated costs served as benchmarks of the amounts likely to be appropriated and were more in the nature of back-of-the envelope calculations. They had little value for either monitoring or control purposes, and once policies and projects were approved and included in the budget, the appropriated amounts became the anchors to which the traditional framework of process-related payment control was attached. Into this languid process wafted a fresh breeze in the form of performance budgeting.

Although performance budgeting had been in operation since the early 1920s at the local government level, it came into greater prominence in the 1950s when it was applied to the federal government in the United States. This approach to budgeting was influenced not by the tradition of public administration, but by management theories and cost accounting. It required (1) an advance program of work, (2) a classification of government activities into functions (“a major division of the total organized effort of government, the purpose of which is to provide a distinct and public service”), programs (a segment of a function that has a measurable major “end” objective), activities (a division of programs into homogeneous types of work), and cost elements or the objects on which expenditures were incurred, and (3) efficiency indicators, including, where possible, measurement of activities.6 While performance budgeting consists of several elements, those described hereafter are most relevant to the discussion on accounting.

Following the classification of government transactions, the new system basically envisaged two types of accounting orientation—responsibility accounting and cost funding and analysis. Under the former approach, all outlays were charged to a responsible organization as applied costs for its uses. The responsibility costs thus sought to indicate the outlays and results of operations by organizational unit by linking costs of inputs and outputs, or accomplishments. Cost funding and related analysis provided the means by which the underlying responsibilities and, more significantly, costs were arranged, allocated, and summarized. They provided the requisite activity identifications in that the costs of each activity, however measured, were shown separately, in turn providing a continuing linkage for budget allocations, payment and accounting, performance monitoring, and, at a later date, evaluation. Within this broad framework, a distinction was made between operating costs and cost accounting that would apply primarily to construction projects and works. Since performance budgeting did not distinguish between current and capital budgets, the distinction between operating costs and cost accounting was not real but a convenient means of denoting the area of primary applicability. Thus, cost accounting was applied to medical services even when there was no capital outlay. The data showed both operating costs and net service cost. The operating costs mostly referred to outlays on personnel and related administrative expenses. Cost accounting practices in turn distinguished between direct and indirect costs. The former referred to those that could be uniquely applied to a program or a service center and typically included costs of labor and material. The latter included, in principle, costs that could not be identified with any single project or service but were utilized by more than one cost center and covered costs of selected supplies, equipment, and service facility shops. Costs of service facility shops were calculated on the basis of use of the common facilities or equipment for the project.

Cost funding, in the event, is largely a process of allocating indirect costs to specific programs and projects. Supplementing these approaches, the system envisaged the calculation of standard and average costs. The standard costs represent the best estimate of what each component of the service, or the cost center, should cost on a per unit basis if the organization operates efficiently. Similarly, average costs are also estimated with reference to unit costs of each activity over a period of time and thus provide an indication of movements in the costs. The standard costs set a target for the organizations and were used in conjunction with average costs to monitor the actual costs, variations from the standards, and reasons for variations and to set in motion the forces aimed at rectifying excessive variations.

The implementation of performance budgeting, however, was not successful. Apart from the difficulty of implementing radical reforms in government organizations, the argument that the government was more concerned with providing a service than with recovering costs fully also resurfaced. But as fiscal crises continued, and as other avenues for mobilization of resources were being exhausted, attention turned to measuring and containing costs—the elements that constituted the core components of performance budgeting. Although performance budgeting itself is no longer advocated but is being introduced in different forms in governments, it nonetheless opened new doors on awareness of costs in public organizations.

Despite this awareness, experience shows a sharp divide between developing and industrial countries in their approaches to ascertaining costs. It is instructive to consider briefly the experiences of the United Kingdom, the United States, and developing countries as a group. Before considering these experiences, however, it is useful to recall the distinction between cost containment and cost measurement. The former refers to the recent reductions in expenditure allocations. Governments confronted with resource shortages traditionally maintain pay scales even when they are due to be revised to reflect inflation levels (wage freeze); freeze or even reduce staffing levels through attrition or employee buyouts (early retirement with suitable augmentation in severance benefits); deferral or reduction of capital projects; limitations on running costs or operational costs of programs; or “caps” or ceilings on expenditure levels. These measures represent efforts to contain expenditure growth. In some cases, some of these measures, such as freezes in pay and staffing, can even contribute to selective reductions in costs without affecting the quantity and quality of goods and services provided. Cost measurement reflects the relationships between inputs and outputs, and cost containment refers to maintaining outputs while reducing inputs.

Cost measurement in the United Kingdom received little attention (except for capital projects) until the mid-1960s. Influenced in part by the newly ushered in planning, programming, and budgeting (PPB) systems in the United States, the Fulton Commission in the United Kingdom (1968) that reviewed the working of the government recommended that financial management be improved by taking into account the skills of modern management accounting. But, neither this recommendation nor the 1976 Melville-Burney report,7 which recommended the establishment of an accounting service in government, sought to define management accounting and its role in the government. As a result, confusion between the new managerialism that was introduced in government during the 1980s and traditional management accounting exists today.8

Cost measurement in the United Kingdom occurred in three stages: First, in the wake of the application of variants of PPB systems, efforts were made to develop what were then known as functional costs, broadly comparable to the total outlays for a given function. The purpose was to gather together all the outlays that were scattered throughout the budget and to estimate the costs of selected programs, particularly in the defense sector. This process yielded place to the second stage, familiarly known as “running costs”—which reflected the operational costs of a program and thus included, in addition to the wage component, related expenses on the goods and services that formed the necessary complement of a program. This category was introduced more as an instrument to provide flexibility to managers (as part of the financial management initiative) and less as a device for measuring costs, much less for containing them. These costs merely reflected the financial flows for a program during one year and did not include either the capital component or the accrued overheads.

The third stage refers to the introduction of performance measures, and, as an integral part of this effort, costs were computed for selective operations and used extensively as a basis for budgeting and budget implementation. Most of the performance measures continue to be oriented to the physical aspects of the work load, while, in some sectors, such as health and defense, more vigorous efforts have been or are being made to formulate costs. The need to develop cost measures in the health sector was viewed as particularly acute in view of the preponderant role of reimbursement techniques for compensating doctors and clinics outside the government for services provided. It should also be noted that cost accountancy efforts remain separate from the regular financial accounting operations.9

In the United States, too, application of cost accounting has gone through various stages of development, beginning with the development of guidelines in the area of major construction and river valley projects. These efforts received additional impetus, over the years, through the introduction of performance budgeting and PPB systems, which also emphasized the measurement of costs. As a result of these efforts, most agencies in the government have developed cost measurement techniques for purposes of budget formulation and implementation. A survey of existing practices by the U.S. General Accounting Office (GAO) shows that cost information is used primarily for program or activity management, selectively for purposes of performance measurement, and infrequently for allocation of overhead costs.10 Moreover, no uniform standards currently exist although they are being developed by the U.S. Federal Accounting Standards Advisory Board.11 In addition, it also appears that, in some cases, there is a schism between external reporting of costs and internal management requirements and that some agencies find the external reporting requirements to be contrary to their internal requirements. In such cases, managers may be merely paying lip service to the system. Moreover, the GAO review also shows that, in several cases, cost accounting was undertaken as a separate effort and was not always linked to the general ledger system.

In developing countries, as noted earlier, accounting systems have not been geared to measuring costs or, therefore, to providing information on costs either to the legislature or to the public. Their primary purpose continues to be the provision of an account of funds received and spent. The rationale for such spending and the costs incurred have not been included in their purview. Even in countries that have introduced double-entry bookkeeping and where extensive computerization has taken place, such as Chile, little progress has been made in the measurement of costs.

The preceding discussion shows that in both industrial and developing countries, cost measurement has yet to secure a foothold in the overall accounting system. Organizationally, cost accounting and financial accounting remain two separate streams of activity. In some cases, the former is undertaken as an ad hoc exercise and may not be materially dependent on the general ledger system. When systems are centrally designed, they may not reflect the interests of the user and, conceptually, may leave much to be desired. What are described as costs represent, in fact, the financial flows during a year and do not take into account the considerable overhead costs. They may also not include the cost of services provided by other government departments. Finally, the classifications used in most accounting systems today may be so broad that they do not shed light on the factors contributing to expenditure growth or on the impact of the relative price effect. Therefore, information compiled on costs has several limitations, which are further accentuated during inflationary periods. These limitations explain why cost control played a minor role in expenditure management in governments. However, without cost control, the effectiveness of the accounting system is limited.

Relevance of Commercial Practices

Every organization, whether or not it sells its services, has an obligation to ascertain its costs so as to minimize the burden on the taxpaying public. Although there are fundamental differences between governments and the commercial world in terms of motives for providing goods and services and in recovering costs, there is little difference in the estimation or measurement of costs. Cost estimation as practiced commercially may need adjustment in its application to government. The major difference between a government and a commercial organization, a manufacturing one in particular, is that in the latter, production reflects an engineering design, is easily identifiable, and lends itself to precise measurement of costs. In governments, the administrative process is more ambiguous, and there may not always be a match between tasks, power, and responsibility. The three most important factors contributing to higher costs in government are time, overstaffing, and acquisition of more materials than may be indicated by the tasks to be performed. The time factor in governments is illustrated in Diagram 3.

Diagram 3.
Diagram 3.

Time and Costs in Government Operations

Evaluations undertaken by governments and international organizations show that projects and programs tend to take longer than initially estimated and that final costs bear no resemblance to the estimates made at the time the project was considered. The extended time may be due to a lack of finances or key materials, extended interdepartmental consultations, and associated process costs. Second, experience shows that government is a major employer, hiring people not because they are needed to provide the services, but because they have to be found employment.12 Third, materials are often acquired and then lost or not accounted for. In some countries, the loss of acquired materials far exceeds the quantities that are eventually put to use. Costs do not appear to be any lower when services being financed by the government budget are contracted out to be performed by others.

Governments are not unaware of the waste and spiraling costs, which have become endemic in public organizations, that are unrelated to the value added. Indeed, any budget speech, randomly chosen, would contain a passage about the need to avoid waste and to be economical, efficient, and effective in the use of resources. Although these themes have long dominated the financial management scene, their continued persistence suggests that exhortations do not necessarily contribute to tangible results. Identifiable actions are linked to the introduction of necessary systems, techniques, and improved operating methods. Moreover, what is needed is a strategy aimed at securing an understanding of the dynamic factors that affect cost behavior so that substantive, as opposed to symbolic, factors can be addressed.

The need for improvement in the methods employed in government is clear. In this context, the cost management system appears to be particularly relevant. But, like all applications of commercial approaches to government operations, this system, too, could be objected to on conceptual and practical considerations, as has happened in the past.

A more detailed analysis of the components of the CMS shows that governments and commercial organizations are more similar than they appear to be at first sight (see Table 9). The primary differences are found in manufacturing and in the delivery of services. But government and commercial financial management have other elements in common. For example, unit costs were specified for several years as norms to be achieved by agencies in all former centrally planned economies. Those norms, however, were more abused than used primarily because they were often arbitrary and had questionable empirical underpinning. Furthermore, because the norms were imposed from the outside, agencies complied with them only nominally. In contrast, under the CMS, the role of each cost driver can be identified and measured, and ways to address deviational behavior are outlined. Cost drivers would transform the way in which financial managers work in governments.

Financial managers traditionally viewed budgetary allocations as a handout and considered it their role to spend it in an orderly way. The CMS, however, makes managers responsible for delivering services within specific cost estimates. The applicability of the CMS to government is more wide ranging than is normally perceived; for example, it has been applied to the Internal Revenue Service in the United States. In hospitals, the CMS has had a more extended application, and the cost-driver analysis has been used advantageously to analyze patient movement (appointment, X rays and other radiological tests, film processing, reporting, and review) and to estimate the costs of hospitalization, nursing care, ambulatory services, and a host of related activities. The results of these analyses have contributed to new treatment design, customer profitability, and overall improved care. Thus, the CMS is a significant innovation with considerable potential for government use and is likely to play a dominant role in government accounting for the foreseeable future.

Table 9.

Application of Cost Management System

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Capital Charge

In the case of private sector operations, investors receive dividends, and lenders receive interest on loans made. Regardless of ownership, the state gets the proceeds of income or corporate taxes (unless otherwise specifically exempted). The shareholders invest in an activity with the twin anticipation of receiving a dividend as well as a prospective increase in the share value, which tends to rise along with the growth in the rate of dividends.

When government is the sole investor, there is no feature analogous to capital gains. There is, however, an opportunity cost to the capital. Given its alternative uses, capital is expected to be used or employed where its yield is highest, over a period, relative to the opportunities available. While depreciation, to the extent practiced, provides a recovery of the assets, no systematic recovery of the overall cost of capital has been taken up by the departments in government. Government investment in the operations of its agencies (which is not calculated in the conventional accounting system) is an important element of the total cost of goods and services provided by government. These aspects of sunk capital are also not reflected fully at the time of investment appraisal—that is, when the investment is made—because the techniques of cost-benefit analysis tend to emphasize incremental capital.

Given the substantial government investment (even if depleted over the years by natural causes and neglect of operations and maintenance during periods of fiscal austerity), the question is: What can the accounting system do to promote a full awareness of all costs governments incur in the provision of services? Specifically, how can the cost of capital be recognized and recovered? It is in this context that the practice of the Government of New Zealand and the proposal of the Government of the United Kingdom are relevant.13 These envisage a depreciation (principally a measure of the use of an asset, its wearing-out use, passage of time, or technological obsolescence) and a capital charge for the unremunerated capital employed. Thus, the operating cost statement, recommended for use in the Government of the United Kingdom, includes provision for cost of capital:

Department Operating Cost Statement

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Source: United Kingdom (1994a).

In New Zealand, this cost is known as the capital charge rate, and the total capital charge is explicitly shown as an expenditure item in the budget of departments. The capital charge is calculated as the department’s charge rate multiplied by its capital base. This process recognizes that the charge rate has two components: (1) operating returns from using the investment in the current year, and (2) expected gains or increases in returns in future years from continued holding of the investment. The former is realized on the assumption that a policy of full cost recovery will be followed each year, while the capital charge is a cash payment that is to be taken into account in computing the costs to be recovered. The capital charge rate is determined, annually, as the difference between the nominal cost of capital minus the expected gains in government holdings. This net rate is expected to ensure that the costs of a department correspond with its revenues during each accounting period. The capital charge is assessed twice a year on the basis of the reported value of assets included in the half-yearly and yearly balance sheets.

The capital charge system, which may still be considered to be in its infancy, is not without intrinsic problems. First, it may have some unintended distortionary effects in that, because human resources are excluded from the computation of the capital base, the allocation of resources between physical and human resource may be affected. Second, private sector practices are not fully applicable to government. In private sector practice, the risk factor in capital asset pricing is taken into account but is extremely difficult to compute for public operations. Third, the mere fact that a capital charge is included does not necessarily oblige a department to undertake full cost recovery. The department may often be engaged in providing many services, some of which may aim to recover full costs while others may seek to recover more or less depending on the market situation. The aggregate indicators in such a situation do not fully indicate the extent of cross-subsidization.

The capital charge should be seen as one of the many elements that need to be taken into account in establishing and operating a cost management system. It is important for the government to ascertain what factors are contributing to cost increases and how those factors may be brought under its control. In this context, it is essential that systems be established to facilitate the assignment of costs to outputs. These mechanisms should make it easier to trace costs directly, assign costs on a cause-and-effect basis, and allocate costs consistently. These include assigning indirect costs, of which the capital charge is an important (and hitherto neglected) one that merits explicit consideration. Cost consciousness or cost recovery cannot occur in the absence of a cost management system. The introduction of such a system should be the primary task of those engaged in formulating policies to improve government accounting.

Foreign Aid Accounts

Before moving to a consideration of the accounting standards, it is essential to consider some important areas that need to be addressed. The accounting of foreign aid is one such area that has gained considerable importance in recent years for both donors and recipients. While the amount of aid extended by donors may not constitute a significant share of their respective budgets, total aid received from various countries and international financial institutions forms a significant portion of the recipients’ budgets. In some cases, the share exceeds 30 percent and has a crucial role in fiscal policy formulation and implementation and, as a consequence, in the budget and accounting systems of the country. This increasing role, while reflecting the sphere of shared decision making and responsibilities among donors and recipients, also illustrates the growing demand for accountability and an improved basis for internal management.

Foreign aid covers a wide variety of transactions, including capital assistance, technical cooperation,14 balance of payments or budgetary support, and emergency aid for relief from natural disasters. Aid may be given for projects or activities not related to projects, in the form of food, services, consumable items, cash, or equipment, or in the form of loans or grants. It may be given directly to the central government or through that government to other levels of government or to statutory organizations, public enterprises, or private organizations on the basis of guarantees provided by government. In some cases, aid (such as for relief from natural disaster) may be administered by an international organization, subcontracted out to a consulting firm (in the case of technical cooperation arrangements), or undertaken by the recipient government within the overall framework of conditions that form part of an agreement.

Accounting issues, which in some ways are derived from the approaches and practices of budgeting, differ for donors and recipients. At the donors’ end, aid may be provided through the budget directly, through one of the agencies specifically organized for the purpose, or through an extrabudgetary fund and may take the form of a loan, a grant (when equipment or money is given), or services for personnel paid by the donor but used by the recipient country under a technical assistance program. In addition, the budget includes subscriptions to regional and international financial organizations that have been set up specifically to provide aid to developing countries. More recently, as part of debt-relief packages, donor governments have provided relief by forgoing interest, writing off debt, or deferring repayment. Where funds are provided through the budget, the transactions go through the usual process of review and, in most cases, are subject to legislative approval. Where, however, such aid is given from an extrabudgetary fund, or by an organization owned and controlled by government but outside the ambit of the budget, it may not require legislative approval.

For the donor, accounting is a straightforward exercise in that the value of equipment and services is expressed in current terms of the national currency and is so indicated in the budget. The accounts show both actual outlays and the estimates. Reflecting the growing complexity of foreign aid, three issues that are fairly common to most donor countries have arisen.15 These are the risk assessment of loans, costs of debt relief, and accounting treatment of loans provided to national governments or regional and international organizations for onward assistance to other countries. It is normally assumed that all loans extended to governments, unless repudiated, are collected. However, sovereign governments have, in some cases, unilaterally repudiated repayment responsibility, and, in other cases, external pressures have been exerted to forgo the claims. Thus, the loan portfolio as shown in the government accounts may not reflect the real picture. Donor governments must therefore periodically assess their portfolios and make such adjustments as are warranted. It is also suggested that frequently debt relief that is provided in any of the forms described earlier should be reported to the legislature.

The accounting treatment of loans given as part of aid package raises two issues. First, these loans, which usually carry a low rate of interest and have long periods of amortization, are more like grants. It is therefore argued that they should be considered grants from the outset. In the United States, the national income accounts show these loans as grants. But then, these accounts are distinct from budgets and related appropriation accounts and, unlike the budgets, are not operational or legal. Second, the capital provided by donor governments to regional and international financial institutions does not have any return either in the present or in the future and, as such, is distinct from a government’s other capital assets. It is suggested that this distinction should also be properly reflected in the accounts.

Issues for the recipient governments are somewhat more complex, reflecting in part the institutional arrangements. Typically, the central agencies in governments are responsible for coordinating all incoming aid and arranging for its inclusion in the government budget. There are also several spending agencies, each one having many project authorities that are responsible for implementing aided projects. There is considerable divergence in the approaches of the spending and central agencies. The former are more concerned with optimizing foreign aid resources, which they consider to be more easily available than domestic resources. Spending agencies see a convergence between their approaches and those of the donors in that they have a collective interest in furthering the development objectives of the country. Also, the donors may be seeking projects or programs that will give them more visibility, ultimately supplanting domestic agencies by advocating causes that are closer to the donors’ own agenda and unstated political ends. Although the central agencies are equally interested in furthering the development objectives of the country, their interest is tempered by the need to maintain a vigilant eye on the absorptive capacity of the economy, its repaying capacity, and the collective impact of aid on the stabilization objectives being pursued.

This divergence in the spending and central agencies’ approaches, as illustrated further on, could also induce the spending agencies to seek channels of foreign aid outside the regular budget. In preparing the annual budget, the spending agencies may be inclined to show a higher rate of utilization of foreign aid so as to buttress their demands for the allocation of domestic financial resources. The central agencies, in contrast, may follow more conservative approaches, and the eventual size of annual allocations may be determined jointly by the central agencies, the spending agencies, and the donor. Transactions included in the budget may not necessarily be reflected in the regular accounts and, if they are, they may be maintained as an integral part of satellite accounts that are not within the jurisdiction of the accountant general.

In some countries, separate offices are established either in the finance or in the planning ministry to maintain aid accounts. Further aid given in kind (except food or commodity aid that would generate counterpart funds when sold to the public) may not enter the accounts for the simple reason that no credit or cash transactions pass through either the treasury or the banking system. Discrepancies between the data furnished by donors and those prepared by the central agencies and the accounting authority of the government are therefore likely. Similarly, technical assistance (as distinct from technical cooperation) may be included in the budget although practices across countries are by no means uniform. In India, Kenya, Zimbabwe, and, more recently, Tanzania, for example, the purposes as well as the magnitude of technical assistance are specifically included in the annual budget. But these may not find their counterparts in the annual accounts of the government because the transactions do not pass through the accounts.

The budget may also show the amounts on-lent to regions or public enterprises. Under this approach, the amounts repaid and interest paid may also be shown in the budget. Frequently, the amortization periods and other on-lending terms may be different and, indeed, more stringent than those specified by the donor, to cover the risks involved in such on-lending. Guarantees provided by the government may not always be shown either in the budget or in accounts except when formal procedures of scrutiny are a prerequisite for the provision of such guarantees and related contingent liabilities are shown in the annual accounts of the government.

The amounts included in the budget may be made available to the recipient governments in three ways. Cash grants (in foreign or domestic currency—the latter accrue when the donor retains some of the counterpart funds) may be directly transferred to the credit of the recipient government. In regard to project loans, where adherence to the international competitive bidding procedures is deemed obligatory, either a letter of credit or a reimbursement procedure may be adopted. Under the former, the supplies of equipment may be directly paid by the donor, and no transaction may appear in the account books of the recipient country. The project authority would initiate the requisite administrative actions with the donor, and the transaction would appear only when the donor reports the disbursements made. In some cases, however, the amounts at issue may first be paid out of the consolidated funds of the government and then claimed from the donor. In this case, the transaction would be included in the government accounts from the initial stages as an outflow that is subsequently reimbursed by the donors. This procedure, which is still prevalent, although on a reduced scale, implies greater pressure on domestic finances and may strain cash management. To avoid this stress, some international and regional financial organizations have set up revolving funds through which selective advances can be made and pressures on domestic resources reduced.

The process described above has developed several problems related to the management of foreign aid and accounting. First, numerous problems of coordination among projects and between donors and recipients exist, and decisions about the selection of projects are diffuse and extensively fragmented, hampering the negotiation and utilization of aid. In addition, there is the more philosophical issue of whether aid has been fully transparent and effective. These points form part of a separate discussion and are therefore not covered here.

As for accounting, aid given in kind, including commodity assistance, is generally not included in either the budget or the accounts. Even when it is included, there are substantial differences between the quantity of aid indicated by the donors and that recorded by the recipients. Although some related procedural matters have already been considered, it is essential that they be examined in depth. When formally negotiated with the central agencies, aid given in the form of equipment or other consumables and extended as a grant is usually recorded in the budget. When it is extended directly to the spending agencies or to governmental organizations, it is unlikely to be included in the budget, particularly if the amounts are small. More or less the same could be said about technical assistance. Recipient governments are less than eager to show the full amount of technical assistance in the form of salaries for expatriate personnel, even if paid by the donors, because they appear enormous when converted into local currency. Although the tenets of transparency and accountability demand that aid received be included in the budget, such budgetary presentation may create controversies. These are tempered by recognition of the spillover effects and by expediency. When commodity aid is sold in the market, it generates counterpart funds that become a short-term resource for the government.

The discrepancies in the valuation of aid occur basically for three reasons. First, the coverage of aid may be different between the donor and the recipient. The former may include aid given to public enterprises and nongovernmental organizations that do not form part of the budgetary transactions of the recipient. Second, the goods may be declared at a value lower than that indicated by the donor when they are cleared through customs in the recipient country. Since, in most cases, the aided imports may be duty free, the spending agencies in the recipient governments may not declare the correct market value (in some cases, the scarcity of information contributes to this phenomenon). As the central agencies in the host countries proceed on the basis of customs declaration, the amount of aid may be shown as less than that indicated by the donor. Third, the exchange rates used by donors and recipient countries may be different and may contribute to avoidable discrepancies between the two sources. These tend to be magnified when the aid received is substantial. This very factor of substantiality also makes it imperative that accounting be improved.

While several countries have made a good deal of progress, aid accounting remains a murky area. Two types of improvements are needed. First, a comprehensive aid accounting system needs to be established regardless of political views about including all types of aid in the budget. Such an accounting system, which is best maintained as a satellite account, should indicate total resources received, the pattern of their use, and their contribution to the local economic development effort. Second, there should be a periodic reconciliation of data with each individual donor so that discrepancies can be identified and their origins traced and resolved. This regular dialogue, whose importance cannot be overemphasized, should also address the issues arising from direct purchases funded by donors.

A second problem area in managing foreign aid relates to funds on-lent to regional governments and public enterprises. It is argued that neither the budget nor the accounts provide an accurate record of those transactions. This problem stems from the relationship between regional governments and public enterprises on the one hand, and with the donors on the other. During the early years of aid administration, funds were routinely channeled through the central government. Pressure to increase direct contact between these sublevels of government and the donors has since grown although experience has shown that direct contact could weaken the traditional role played by the central agencies in the central government. Often, the terms of on-lending are not specified at the outset, and claims are neither registered properly nor tracked effectively for follow-up action. Furthermore, interest payable may be deferred, written off, or capitalized, and similar treatment may be extended to the principal as well. In the process, both transparency and accountability may be jeopardized, leaving an enduring gap in financial management. It is therefore essential that separate records be maintained as part of the satellite account referred to above.

Finally, the accounting systems at the project level are weak. Frequently, the documentation needed to claim reimbursement from the donor is not maintained properly and, even when it is maintained, documents may not be submitted on time. Inevitably, this has an adverse impact on a country’s cash management, which is already, in most cases, under severe stress. In some cases, projects are set up on the basis of partial funding by user charges, but slowness or a lack of eagerness in collecting those charges may also have an adverse impact on the overall financial status of the governments. These problems, in turn, require the installation of adequate accounting systems in the projects. The general ledger system described in earlier sections is a good framework for a satellite accounting system that would address these shortcomings. The satellite accounting system can be maintained either manually or electronically with considerable advantage to all concerned.

Accounting Aspects of Privatization

Since the mid-1980s, privatization has gained acceptance as a major plank of the fiscal policy of governments in most industrial and developing countries. The term privatization is not necessarily restricted to the divestiture, in one form or another, of state-owned enterprises. It also covers the sale of government assets, including property. In both categories, government accounting suffers several shortcomings in the following areas: (1) costs associated with privatization of public enterprises, (2) losses incurred in the sale or divestiture of enterprises, and (3) losses incurred in the sale of government-owned assets other than public enterprises.

The sale of public enterprises is often preceded by the injection of additional capital and debt funding aimed at making the condition of the enterprises more attractive. In addition, certain costs are associated with the use of underwriters, with the provision of sales incentives, with the guarantee of a net return on income after privatization for an indefinite or extended period, and with sales. Generally, these costs are not explicitly estimated and, if they are estimated, they are not given due publicity. In most cases, they are shown in neither the budget nor the accounts. More often than not, sales proceeds are shown in the budget net of these expenditures, adversely affecting both transparency and accountability. An appropriate way to overcome these problems is to show the amounts for each of these transaction groups in the budget and the accounts. While such a presentation may be seen as a self-fulfilling prophecy, these estimates are not about the sale value of either the shares or the enterprise itself but reflect the transaction costs associated with privatization.16 The public needs to be assured that the transaction costs are reasonable.

A second problem arises when the seller does not realize the full market value of the shares or the enterprise. Experience shows that any of the following practices will result in a gross undervaluation of the enterprise:17 giving it to workers and managers, selling it to workers and managers, arranging a spontaneous privatization (in which workers and managers find a buyer at a negotiated price that primarily enriches the manager rather than enhancing the value received by the government), or offering vouchers to citizens entitling them to claim shares in an enterprise. This is primarily because the existing accounting systems do not maintain the value of the assets in current market prices but rather at the acquisition or purchase value. This practice illustrates how little weight is attached to accountability in government administration. The appropriate procedure (indeed, it is a normal and logical expectation of the accounting system) would be to maintain a record of the asset in terms of the current market value, which requires an annual updating of the values of all assets.

In addition to enterprises, governments are also selling other types of property that they own, including land, releases from commodity inventories, surplus equipment, and releases from strategic stockpiles of selected nonferrous metals. These sales were a normal part of government activity long before privatization became the cornerstone of government fiscal policies and may also represent a serious undervaluation whose magnitude cannot always be ascertained. Furthermore, because storage costs are not computed, it is difficult to assess the sales option. If government agencies maintained regular balance sheets of assets and liabilities, assessment would be simplified.

Accounting and Performance Indicators

Although performance budgeting as a system did not have a long life in the early 1950s when it was first introduced, many of its elements are now accepted in modern budgetary management. The system recognizes that different agencies perform different tasks and should therefore be delegated adequate power and responsibility to discharge their tasks. This includes the power to use the resources allotted for specific tasks on the assurance that specific outcomes would be generated. The agencies, in turn, must be accountable for delivering services for a set cost and within an agreed time frame. In sum, the system involves the specification of performance indicators in four broad areas: productivity, cost per unit or task, time frame, and budgetary outcome and effectiveness.

These areas are generally considered to be part of a management information system, which tends to be counterproductive when designed as a stream of activity separate from, or parallel to, traditional accounting. Because most of the basic data needed for a management information system are drawn from the accounting system, it is appropriate that the latter be strengthened to serve management interests. Accordingly, each organization would need to develop subsystems of accounting. Productivity measurement would involve assessing the relationship between the existing capacity and the services scheduled to be delivered. These services would inevitably differ from one agency to another. Essentially, however, on the assumption that existing technology continues without any major change, productivity measures seek to indicate the average output units per person. Weights are also used to express comparable types of work done in each area on a comparable basis. In addition, the quality of work, such as permissible error rates, is also specified.18

Similarly, costs need to be measured and specified in ranges so as to explain the difference between estimated cost and realized actual cost after the contracts have been finalized and implementation completed. These cost estimates, as has been noted previously, have become quite sophisticated. In addition to the traditional area of construction, they are prominent in health, education, and entitlement administration. For example, the costs for health care programs are now calculated in detail in the industrial countries for various types of hospital treatment, visits to the physician and dentist, and so on. In the United Kingdom, budget documents for many agencies routinely show the unit costs for various programs for the budget year as well as the forecast years. The reasons for variations are also explained in detail. These provide an organized basis for more purposeful expenditure control.

The budgets also show the time frame for the completion of projects and programs, as well as what may be expected in terms of the achievement of original objectives. The following points must be recognized in devising performance indicators. (1) Each agency has its own unique features of work, objectives, and performance orientation. (2) Most of these features have their origins in the accounting data generated, although a few are bound to be outside the purview of the accounting system. In devising indicators, each agency should involve both the users and the accounting unit at every step of the process. (3) It is essential that these indicators be closely linked with the accounting system so that relevant standards can be developed for government-wide application. Linking the two will create a central point for disseminating information and for using it during the budget process.

Other Issues

Many observers have commented with almost monotonous regularity that accounting information is considerably delayed or received long after it is due or needed. These delays have hindered effective policymaking and the restructuring of the public sector. While a number of factors have contributed to the ineffective operation of the accounting system as a whole, three of them merit consideration. These are (1) systemic issues (other than those discussed earlier), (2) process factors, and (3) the quality and quantity of human resources.

The systemic issues stem primarily from the existence of too many accounts and avoidable suspense accounts.19 As discussed earlier, the existence of extrabudgetary accounts will not be a major problem as long as specific accounting procedures govern their initial compilation and consolidation at a later stage of operations and as long as channels of communication exist between the compiling agency and the central accounting agency. In addition, if these accounts are computerized, then the central agencies have automatic access to these operations on an up-to-date basis. In practice, however, these conditions are not always found, with the consequence that the flow of information is substantially hindered. Indeed, some of these off-budget accounts, which in several cases are operated by the security arm of the government, claim to be outside the purview of the normal accounting system. While some of these claims may be tenable in part, they do not apply to the broad spectrum of funds. The funds may be organized to provide some degree of operational autonomy (and hence flexibility) rather than to avoid the application of government-wide accounting standards. Indeed, such a posture could compromise accountability. It is therefore essential that the continued relevance of these funds be reviewed and efforts made to rationalize them. A balance has to be achieved between accounting convenience and the operational autonomy of the fund managers.

Suspense accounts represent a separate problem. They refer, with some regional variation, to the provisional booking of receipts and expenditures pending final transfer to their intended destination and broadly comprise two types: (1) payment delays (or float) awaiting final transfer to the bank accounts of the government, and (2) accounts maintained in the budget awaiting final transfer to the consumer or original budget allottee. These transactions occur mostly where centralized arrangements exist for the procurement of stores used throughout the government and the operations of the public works department. In these cases, transactions are undertaken by these agencies on behalf of the indenting departments, and suspense accounts arise when the initial payment is either received or made by the central agency and then adjusted against the agency when the orders for stores or works are placed. These adjustments tend to be time consuming and involve large-scale carryovers from one year to the next.

The first type of suspense account can be minimized or, at any rate, the discrepancies between government and monetary accounts can be resolved through improvements in the payments system and through regular reconciliation. The second type of suspense account has been limited in some countries by not allowing separate budgets for the central agencies engaged in the provision of services. In these cases, the client agencies’ budgets for stores purchase and public works are transferred at the outset of the year to the central agencies to administer directly. Elsewhere, payments systems have been improved so that the client agencies can pay for and carry the goods. In some countries, however, these suspense accounts persist and are used to circumvent budgetary discipline. For example, in India, the client agencies routinely spend their budget allotments and seek additional funds when demands are received from the central agencies.20 This can have a substantial, adverse impact on the eventual budget outcome. These problems illustrate that suspense accounts have become cumbersome and have created difficulties in the compilation of accounts. An obvious solution is to minimize the number of suspense accounts while improving the payments system. Such improvements have become imperative because, under the new managerialism, the central departments are obliged to compete with the private sector in providing services to the client departments in government.

Process factors refer to the proximity between policymakers and the individuals responsible for providing accounting information. Accountants are not decision makers on matters of expenditure control but do play an important role in providing consistent and credible information to both the policymaker and the general public. In this respect, fulfillment of the promise has been substantially less than expected, largely because, as illustrated in the previous discussion, of the organizational and process factors involved in the compilation of accounts. The processes adopted are ancient. Responsibilities are extensively fragmented. Operations are governed by outdated regulations. There are competing bureaucracies and a muddle of unenforceable regulations. Even where a computerized system is in place, it remains an information retrieval system and has not brought about major changes in the orientation and the values of the system. The organizational culture remains narrow, in most cases, and accounting is viewed as distant and limited to being a link with audit, and, when operational, legislative committees. A continuation of this role is unlikely to equip government accounting agencies to serve the numerous purposes inherent in the national fiscal management scene in current and future settings. Values and orientation do not, however, change through central command or hope. Change must be effected from within and happens when improvement is made in implementation. Improvement can be brought about through fine-tuning rather than through the imposition of an overall design.

Far too often, the shortcomings of the accounting systems are ascribed to shortages of skilled personnel. Cursory evidence shows that most accounting organizations are adequately staffed but that most of the staff are engaged in repetitive and elementary tasks that can be performed with greater effectiveness by a personal computer. It is quite likely that if the cost of processing accounting documents were estimated, it would show a persistent increase in overheads, reflecting unused capacity. Furthermore, deploying more personnel without addressing the underlying processes and techniques is unlikely to improve performance. Shortage of skilled personnel is, however, a separate matter. In most governments, staff become accountants by virtue of being employed as such, and very few are trained and qualified. Although when governments switch over to double-entry bookkeeping and maintenance of commercial-type accounts, staff mobility is likely to improve, there will still be a need for intensive staff training at all levels. Moreover, efforts should be made to improve the working relationship of program and finance managers. In the government of the United States, for example, these issues are being addressed through improved communication and intensive training.21

Accounting Standards

The preceding discussion shows that elements of government accounting are open to interpretation and that the potential exists for widely differing practices and, ultimately, a lack of coherence between different governments or within a particular country. Standards are needed to secure uniform compliance from government agencies. Standards would also highlight the differences between government and commercial accounting systems and the reasons for the differences. This section is devoted to a discussion of accounting principles and standards, followed by a consideration of the elements that need standardization and a review of other financial management areas in need of improvement. The concluding part deals with the organizational aspects of the specification of standards.

Standards are different from principles. The latter deal, in this context, with the general features and goals of accounting, while the former are more specific and provide the operational basis for agencies to apply in their day-to-day activities. Principles may indicate that each organization should have an acceptable accounting system that facilitates public disclosure of the financial status of the agency. The system should publish data periodically (annually) that should be simple, verifiable, and comprehensive. The system should be sustainable and should facilitate the matching of sources and uses of funds. The organization expected to give a more material form and sustainable action to these principles should be well structured and cost effective. Although not specifically recognized, cost is an important element. The conversion of these principles into action does not justify unlimited costs. Rather, the costs of compliance should be explicitly recognized and should be taken into account in designing the organization that is to be made responsible for the regular practice of these principles.22

The principles need to be accompanied by the specification of standards guiding all aspects of accounting. Without standards, accounting practices would diverge, and it would be difficult to ascertain the status of government finances. Standards are needed to make available information that is “understandable, relevant and reliable about the financial position, activities and results of operations”23 of the government and its units. Formulation of standards involves identifying issues in each area and determining how to address them. In considering the issues and in evolving the standards, due attention must be paid to user needs. These needs are not homogeneous given the wide diversity among users.

The needs of central agencies tend to be different from those of the spending agencies or the legislature. Essentially, these differences reflect basic distinctions between macro- and micromanagement. Accounting is the common instrument of both. Standards may thus not always be uniform and may, in certain cases, take into account the unique features of an agency. The standards must represent a balance between what is needed and what is practicable. If the latter is substantially different from the former, a phased implementation program may be appropriate. In some cases, the existing standards may need to be replaced or modified, and the need as well as the utility of the proposed standard should be clearly demonstrable. The standards should be clear and viable. Above all, there should be a balance between the costs incurred in developing the standards and the expected benefits. The standards are not substitutes for operations, nor do they consist of forms designed for the purpose of recording data. They provide the rationale, the philosophy, and the objective as well as the meaning for the regular accounting activity in a public entity.

The type of standards needed and their components are illustrated in Table 10. The description should not be considered exhaustive. The applicability of the standards to government and its entities raises two issues. These standards may not necessarily apply to all levels of government. The increasing decentralization of responsibilities implies that most of the tasks that were hitherto performed by the central government would be performed at the provincial, regional, state, and local levels. But a major part of the funding for these tasks may continue to flow from the central government in the form of either shared revenues or block grants. In either event, the lack of congruence between resources and responsibilities makes it imperative to establish standards for operational control and accounting systems at all levels. In a number of industrial countries, separate standards have been set up for various levels of government. In the United Kingdom, local authorities have developed distinct standards that run parallel to those of the private sector. In the United States, many of the standards that are now found at the state and local government levels were developed over a half century by the National Council of Government Accounting (NCGA). Its activities were later absorbed by the Governmental Accounting Standards Board.

Another issue is the applicability of government standards to the state enterprise sector. These enterprises represent a wide variety of organizational forms and include departmental enterprises, companies, and corporations. While the companies are expected to follow commercial accounting standards (as may be specified in the legislation relating to the establishment of companies), the path of departmental enterprises and corporations is less clear. Accounting arrangements for departmental enterprises are usually laid out in the government accounts, while accounting arrangements for corporations are expected to be specified in the relevant legislation. Regardless of their organizational form and the environment in which they function, these entities are primarily engaged in commercial activities, that is, in selling goods and services to the public. It is therefore necessary to envisage standards that are applicable to these entities. They may be the same as those that apply to commercial organizations or may, in some cases, require modification.

Table 10.

Government Accounting Standards

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Establishing standards for government accounting will involve a departure from the orientation of the accounting systems now in operation in most countries. From maintaining accounting records of appropriations to explaining archaic regulations and conventions, the standards should pave the way for forward-looking systems that will subserve the needs of internal management. The standards represent only one of the pillars of overall financial management. Effective provision of government services requires an overall improvement in the financial management of the public sector. The components of financial management that are in need of strengthening would differ from country to country, and officials in each must articulate a comprehensive government policy about the future direction of financial management.

A cursory review of a sample of countries shows that most developing countries do not have a rational and sustained government policy on financial management in general or on accounting in particular. Meanwhile, new forces have emerged that influence the way governments work. Not grasping these changes and not engaging in the constructive effort of strengthening the government could have an adverse impact that may take even more time to rectify. It is imperative that governments envisage these changes as part of an overall framework for strengthening government financial management. The United States Government, for example, has initiated a five-year plan to revitalize financial management at the federal level.24 Its plan envisages development in seven key areas: (1) accountability standards, (2) financial management organization (internal relationships between program and financial managers), (3) financial management personnel (strengthening training programs), (4) financial systems (updating software and other electronic data processing (EDP) technology), (5) management controls (internal controls in the agencies), (6) asset management (property management, recovery of loans, etc.), and (7) audit financial reporting (improving the content and timeliness of audited accounting statements). Benchmarks are specified in the plan and are expected to be implemented according to the schedule. In a similar way, New Zealand overhauled its financial management through such legislation as the State Sector Act of 1988 (which marked a new era in the relationships between ministers—the political level of decision making—and heads of departments—the administrative level) and the Public Finance Act of 1989 (which revamped the budget and accounting system). Many industrial countries have also initiated organizational and legislative measures to strengthen their systems.25 Similar efforts are indicated in other countries, where an initiative in this regard is long overdue.

The formulation of accounting standards should be a collective effort. To permit maximum objectivity, it is best undertaken outside the normal functioning of the government by the users of the spending agencies, accounting professionals in the government and the commercial world, economists, and administrators. This group must focus on the requirements of the public and its desire to comprehend governmental activities. The changes are substantial, the tasks are large, and the results are likely to come slowly. The consequences of inactivity could be even more substantial.

1

Economists have been more concerned with costs and gains associated with the substitution ratios if voluntary exchanges were to occur. In such an exchange, there is little concern for the third party, and each one will make himself better off without making someone else worse off. This postulate, also known as Pareto optimality, and its relevance for policymaking in regard to the allocation of resources has been the primary focus of economists. It is recognized that this postulate does not offer unambiguous guidance for policymaking and that personal preferences and judgments continue to play a major role. It is also recognized that each resource has alternate uses and is best employed where its yield is the highest relative to the opportunities available. This approach of opportunity costs has paved the way for the application of cost-benefit and other related quantitative techniques of analysis that explore the available alternatives.

2

The developments discussed here are based on the detailed description provided in Johnson and Kaplan (1987), pp. 6–14.

3

The discussion is based on Berliner and Brimson (1988) and Brimson (1991).

4

For a more detailed discussion, see King, Lapsley, Mitchell, and Moyes (1994), pp. 143–59.

5

The specific application of this approach to a processing company like American Express offers an illustration. For years, to meet its income target, the company depended upon reducing its operational costs by reducing personnel. But such reductions have limits, and the company had to look for areas that were not related to human resources. It therefore embarked on re-engineering its operations through three approaches—cost re-engineering (using more efficient processing or reducing some operational stages), structural re-engineering (using fewer plants than before), and strategic re-engineering (which required fundamental changes in how the work was performed). Together they contributed to substantial savings. (These measures are comparable to cutting staff, shedding activities, and restructuring the public sector.) See United States, Joint Financial Management Improvement Program (1994a).

6

For a more detailed discussion of this and related systems and their features, see Premchand (1969 and 1983) and United Nations (1965).

7

For a review of these developments, see Likierman (1994).

8

The new managerialism refers to hands-on professional management, explicit standards and measures of performance, emphasis on output control, greater competition in the public sector, stress on private sector styles of management practices, and emphasis on greater discipline and parsimony in resource use. For a detailed discussion of the conceptual and practical aspects, see Hood (1991) and Premchand (1994).

9

The picture will change significantly once accrual accounting is introduced fully as is proposed to be done by the end of the century.

11

According to the U.S. Office of Management and Budget (1993), p. 57, these standards are expected to be issued and applied during 1995–97.

12

One of the major factors contributing to higher costs in government is the excess unused capacity. This leads to higher overheads. Cost accounting should help the identification of this element.

13

See United Kingdom (1994a), and, for New Zealand, McCulloch (1992).

14

Technical cooperation is conceptually broader than technical assistance. The latter generally refers to the provision of personnel, usually engaged in an institution-building activity (and therefore perceived to be additive in nature rather than substitutive for the local personnel), by a donor to a recipient country. The former refers to a broader set of development activities, including training, information exchanges, and the supply of equipment and materials. See Berg and United Nations Development Program (1993).

15

For a typical illustration of some of these issues, see Canada, Office of the Auditor General (1993). Of particular interest are chapters 10, 11, and 12.

16

This section is not concerned with the problems of the accounting approaches followed by public enterprises. The general assumption is that they follow commercial accounting approaches. But this is not always correct. In many cases, accounts are organizationally structured (e.g., postal and telecommunications), and it is not always easy to separate the accounts of a commercial entity. Some enterprises may follow only cash-based systems that vary substantially in their content and coverage. These problems are particularly acute in the economies in transition. In these cases, decisions regarding the classification of transactions, the recording of production cost flows, the allocation of costs, depreciation, and amortization were centrally determined, reflecting the needs of the planners rather than of management. Accounts must be extensively restructured if they are to meet the criteria of commercial formats. Further, they involved the concentration of bookkeeping and fiscal regulations in the same standard-setting body. Thus, the budget was largely dependent on revenues generated by the enterprises because accounting rules had a bias that would provide for more tax collections Lack of external accountability also affected the values assigned in the accounting process, such as those relating to receivables, stocks, fixed assets, and contingent liabilities. For a discussion of these issues, see United Nations Conference on Trade and Development (1993). pp. 25–27.

17

For discussion with reference to the United Kingdom, see Beauchamp (1990b).

18

For an illustration of these aspects with reference to the United Kingdom and the annual reports submitted by each ministry as part of the annual budget, see Durham (1987).

19

The World Bank, in its report (1994a) observed “public spending is difficult to track because of numerous off-budget accounts, the opacity of military budgets, and the financial operations of public enterprises and the banking system (p. 125).”

20

See, for example, Gupta (1993). pp- 85–87 and pp. 117–30.

21

The Joint Financial Management Program in the United States emphasized that the pursuit of wise spending is common to both program and financial managers and that the perception of conflict should yield place to a commitment to collaboration. Toward this end, it was suggested that financial management should be viewed as a career rather man as just a job and that financial management concepts should be incorporated into new employee orientation programs. It also added that the financial managers’ performance should include a critical “program response,” while the program managers’ plans should include a “financial management” element. See United States, Joint Financial Management Improvement Program (1992b).

22

These principles, which are an expression of general intent, are different from the more specific principles enunciated as part of the Generally Accepted Accounting Principles. These principles include full disclosure, compliance of legal and contractual provisions, operations of funds, distinctions among the various types of assets, enumeration and specification of long-term liabilities, basis of accounting, the capacity of the accounting system to serve the government budgets, classification of revenues and expenditure, and contents of financial reports. They also include accountability, intergenerational equity, reliability, relevance, timeliness, consistency, and comparability. The principles thus combine a statement of general principles and specification of minimum standards.

23

Mission Statement for the U.S. Federal Accounting Standards Advisory Board. See United States, Federal Accounting Standards Advisory Board (1991). It may be noted in this context that in regard to companies in the private sector (which include public enterprises registered under the Trade or Companies Act), the International Accounting Standards Committee (IASC) has been endeavoring since 1973 to improve financial reports through the development and publication of accounting standards (see International Accounting Standards Committee (1992), and Ernst & Young (1993)). The standards suggested by the IASC are viewed as a benchmark for countries that develop their own requirements and are used by companies and government authorities regulating domestic and foreign companies. Over the years, several standards have been issued, and these are regularly updated to reflect the changing realities.

25

See Organization for Economic Cooperation and Development (various issues) for a summary of these developments.

Author: A. Premchand
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