Many governments have invested large sums of money in the development of accrual accounting. Unfortunately, for most of these governments this has to date been a poor investment. Why? Because many are making little or no use of all the information that has been produced. This is a regrettable situation, to say the least.
This gives urgency to the question: how can greater use be made of accrual information to deliver a better return on the investment?
One potential use is to reframe aggregate fiscal policy using accrual measures of the overall fiscal stance. There are good arguments for doing so (see box). However, the main benefits that are typically claimed for accrual accounting do not lie in the realm of aggregate fiscal policy. Rather, accrual accounting is usually proposed as an instrument for promoting improved government performance.
Accruals and Aggregate Fiscal Policy
The role of accrual accounting in aggregate fiscal policy has been discussed extensively in previous blogs1. Three points stand out. First, with respect to fiscal sustainability, it makes complete sense to move from narrow cash measures of debt to broader accrual debt measures – e.g. net financial worth. Second — again with respect to fiscal sustainability — it would be a major mistake to shift from a focus on debt to the use of the accrual net worth measure as the key fiscal sustainability measure. Third, there are persuasive arguments for using the accrual operating balance as a measure of the intergenerational equity stance of fiscal policy.
The most obvious performance application for accrual accounting is as an instrument for promoting increased operational efficiency. Operational efficiency means producing outputs – in government, mainly services delivered to citizens, such as education and medical treatments– at the lowest possible cost without sacrificing quality. Accrual accounting is the only conceptually sound way of measuring output costs because it measures the costs of the resources used in the production of those outputs. It is because they need to accurately measure their cost of production, as well as revenues and profits, that businesses use accrual accounting.
If governments are to make more use of accrual accounting to promote operational efficiency, the two obvious applications are:
- Accrual output unit cost measures: these are the best indicators of operational efficiency because measuring the unit costs of outputs based on accrual accounting is inherently more accurate than measuring cash expenditure per output.
- Output budgeting (a.k.a. unit cost budgeting): this means financing the providers of specific categories of public sector service based on output unit costs and the planned volume of outputs. An example is the system used in Scandinavia and elsewhere of funding government schools primarily on enrolment numbers multiplied by the average annual cost of students at various levels. This makes use of accrual unit cost measures as a budgeting tool rather than “merely” for information purposes.
Any government with sufficient resources and technical capacity should be using accrual accounting for these two purposes. A few governments already do this. Unfortunately, however, they are the exceptions. Even the majority of developed countries are making far too little use of accrual accounting for either output costing or output budgeting.
This “thumbs up” to the expanded use of accrual accounting for output costing and budgeting needs, however, to be heavily qualified by noting that these are applications that only make sense for selected government services. They can work well for appropriate categories of education, health and certain other services, but are either unsuitable or of limited value in many other areas (e.g. defense, policing and emergency services)2.
Quite demanding accounting is also required. To measure output unit costs, accrual accounting must be combined with complex managerial accounting (in particular, to allocate costs between different categories of outputs). Not all governments have the capacity to do this, and it is not cheap.
The conclusion to which this points is clear. The development of accrual output unit cost measures, and the use of these measures as the basis for output budgeting, should be done on a strictly selective basis. Output unit cost should only be measured for those government services for which unit costs are a sufficiently useful measure of operational efficiency to justify the cost of undertaking the complex accounting needed. As for output budgeting, experience demonstrates that it cannot and should not be the basis for the entire government budget. Governments in a few countries (Australia and New Zealand) tried this thirty years ago, and it didn’t work.
Mention of the government-wide budgeting system raises the other big issue: accrual budgeting. Does it make sense to shift the entire government budget onto an accrual basis? We turn to this topic in the next blog piece.
- See “A Net Worth Rule?” (May 2023) and “Debt, Not Net Worth, Is What Matters” (May 2022). ↩︎
- See my series of four blogs on this topic, starting with “Unit Cost Budgeting?” (January 2022). ↩︎