Accrual-basis Budgeting: International Experience. Edition №1

Last year, EU4PFM held a series of workshops on Public Sector Accounting for the Ministry of Finance. In a Q&A format, we are launching a new rubric to spotlight pivotal insights from these sessions that could be valuable for PSA experts.

Q1: What is the role of accrual-basis budgeting in public finance management?

A1: Accrual-basis budgeting supports better decision making and accountability in line with the objectives of general purpose international financial reporting. It also promotes an output-focused orientation, where the measurement of value for money (effectiveness, efficiency, and economy) is important.

Q2: What is the significance of accrual-basis budget execution reports according to the PEFA 2019 report?

A2: The PEFA 2019 report highlights the CoM’s Strategy for the Modernization of the Public Sector Accounting and Financial Reporting System until 2025, aiming to reflect the accruals method in budget execution statements. It also notes that the Treasury reflects treasury operations on a cash basis while accounting for government debt and the liabilities of spending units. This is possible because the spending units account for their liabilities in their systems.

Q3: What do the PEFA reports reveal about the implementation of accrual-basis budgeting in various countries?

A3: The PEFA 2019 report highlights the following key points regarding the implementation of accrual-basis budgeting in various countries:

• Ukraine: Partial accrual basis with a PEFA score of A in 2019. Budget execution reports are based on IMF’s GFS classifications.
• Serbia: Cash basis with a PEFA score of D in 2019, reflecting the lack of accrued elements in the budget.
• Moldova: Partial accrual basis with a PEFA score of B in 2022, closely mirroring the arrangements in Ukraine.
• Georgia: Cash basis with a surprising A score in 2017, although reviewers praised clear classification.
• Albania: Modified cash basis with an A score in 2016, where expenses are recognized on an accrual basis and revenue on a cash basis.

Q4: What are the different models for combining budgetary management and financial reporting?

A4: Three models to consider are:

Cash Basis

• Allocating cash budgets and outcomes to economic classification codes
  • Advantages: Good for tight control of cash, easy to implement
  • Disadvantages: Assets and liabilities are not part of the accounting system.

Accrual Basis

• Accounting for all elements of financial statements controlled by the government, including financial and non-financial assets and liabilities
  • Advantages: Assets and liabilities are a key part of the accounting system, improving the management of state resources and obligations
  • Disadvantages: Increased complexity requiring greater knowledge, little interest shown in accruals by politicians and economists, resistance to change.

Hybrid

• “Modified accruals” or “modified cash,” combines elements of cash and accrual budgeting. It offers potential benefits from both sides but requires maintaining two accounting systems, one for cash appropriations and another for resource use measured by accruals.
  • Advantages: Potentially combines the benefits of cash and accruals
  • Disadvantages: Requires a dual accounting and reporting approach, one for budget appropriations in cash and another for the real use of resources measured by accruals.

Q5: What are the findings from the IFAC data on countries around the world regarding the adoption of accrual-basis financial statements?

A5: According to the IFAC data, in the 2021 survey, 30% of countries published accrual-basis financial statements, with 40% adopting a partial accruals basis and 30% adopting a cash basis for financial reporting. The 2021 survey did not mention the basis of budgeting in these countries, but the 2018 survey stated that only 15 governments (about 10% of all jurisdictions responding to the survey) prepared fully accruals-basis budgets.

Q6: What are the benefits of accrual-basis budgeting according to international research?

A6: From international research, the benefits of accrual-basis budgeting include:

• Accountability: In supporting better decision-making, accruals budgeting also promotes stronger accountability.
• Fiscal Credibility: Accruals basis accounting focuses on assets and liabilities, such as debt, making debt liabilities and credit risks visible.
• Capital Maintenance: Accrual-basis budgeting highlights the need for provisions for future expenditure to replace capital assets, ensuring capital maintenance.
• Medium-term forecasting: Allows for more realistic financial projections based on assets and liabilities.
• Managing Large Projects: Improves transparency in Public-Private Partnerships (PPPs).

Q7: What are the arguments for Cash basis budgeting?

A7:

• Simplicity: Easier to understand and implement.
• Control: Enables stricter control over cash flow, preventing exceeding approved budgets.
• Tax Revenue: Cash basis simplifies recognizing tax revenue when collected.

Q8: What are the risks associated with accrual-basis budgeting?

A8:

• Complexity: Requires more technical expertise and can be less transparent to the public.
• Manipulation: Offers opportunities to manipulate budget figures through estimates and valuations.
• Need for Capacity: May necessitate investment in training public sector accountants.

Q9:  Is there a successful example of aligning budgeting and financial reporting?

A9: The UK’s “Clear Line of Sight” project successfully merged budgeting and financial reporting systems, fostering greater trust in public sector accounting.

The project was envisaged as a way of providing a single set of data for budgeting and financial reporting. Initially, there were misalignments, including the following:

• National budget expenditure allocations to support some entities were treated as grants payable to those bodies in the financial statements;
• the expenditure of devolved national administrations was not included in the budget but was included in the financial statements of the government as grants paid;
• Provisions for future expenditure reported under IFRS are recognized differently from provisions in the budget.

As a result of the alignment project, the majority of transactions are recorded in budgets and financial statements at the same value and in the same period (with some exceptions).

Having a single system of accounting for government’s management of the economy engenders greater trust in public sector accounting generally. The UK government appears to have successfully brought budgeting and accounting into the same chart of account codes such that very few anomalies remain.