[Warning: this is a technical blogpiece for public financial management specialists]
Is moving to a accrual budgeting a good idea? This is a question I am asked from time to time. It is a controversial matter which needs to be carefully considered by any country contemplating making this move. Accrual budgeting has benefits, but also brings added complexity – and the two need to be weighed against one another. It is certainly not the case that the adoption of accrual accounting necessarily means that a country should also adopt accrual budgeting. Combining accrual accounting with some form of cash budgeting remains a perfectly acceptable option. It is also not the case that, as is sometimes suggested, accrual budgeting is required if a country is to have an effective performance budgeting system.
Moving to an accrual budgeting system requires a number of key technical design decisions. There is no one unique form of accrual budgeting which constitutes “best practice” which may be simply adopted wholesale. Amongst these design decisions are the following:
- How will capital budgeting work?
The defining feature of accrual budgeting is that ministries and agencies are given budgets for their accrual expenses, as opposed to their cash payments. But whatever the budgeting system, it is crucial to maintain control over capital expenditure, and capital expenditure is not an expense. So it is essential to combine budget allocations for expenses with some form of budget allocations covering capital expenditure – broadly in the same manner that ministries are given capital expenditure allocations under cash budgeting systems. The crucial question then is what concept of capital expenditure is used for this purpose, including whether it is modified in accord with accrual concepts. An associated question is whether or not to give the depreciation component of expenses allocations a role in the budgeting system.
- How will the accrual budgeting system be integrated with access to cash for payments?
Under an accrual budgeting system, ministries and agencies will receive expenses allocations which in part cover expenses incurred this year which are not paid until next year or subsequent years (e.g. some bills payable or employee leave entitlements). The question then is how to regulate their access to the cash required to make such payments, in such a manner that they do not spend – in cash terms – significantly more than their past expenses budgets entitle them to spend. The appropriate answer to this question will not necessarily be the same for all countries.
Closely associated with this is a major transitional issue which arises when moving from a cash budgeting system to an accrual budgeting system. In the year this transition is made, ministries will find that they need to make many payments arising from past expenses which are not part of the transitional year’s expenses budget. Arrangements need to be made for them to receive an appropriate transitional cash allocation.
- How will commitment control work?
Commitments control is an essential part of any budgeting system. This is just as true in accrual budgeting system as in a cash budgeting system, because there are many types of spending commitment which only result in expenses in future years. The signature of a multi-year contract for an infrastructure project is an example. This point is not always understood – there are some who seem to think that the problem of commitment control disappears if one moves to an accrual budgeting system.
These are merely a sample of the range of major technical questions which arise if it is decided to move to an accrual budgeting system. It points to the need not only to reflect carefully before deciding to make the move but also – once having decided to move to accrual budgeting – to put appropriate effort into the design and sequencing of what is a highly demanding reform.
Some of these issues are discussed further in past writings of mine on this topic, which may be found on my website.
2 thoughts on “Accrual Budgeting: Think Carefully Before Jumping”
Good points across the board. In Canada we distinguish between budgeting (on an accrual basis) and expenditure management/appropriations which are on a cash basis. I’d like to think that we get the best of both worlds in this way, but there are certain challenges in cross-walks and reconciliation. I am doing a paper on our model for the Korean Institute of Public Finance. Are you, or have you worked worked with them
Thanks Brian. We’re on the same wavelength here. When I talk about “accrual budgeting” I mean the specification of budget appropriations in accrual terms (i.e. based primarily on appropriations for accrual expenses). Using this terminology, Canada is an essentially cash budgeting system. (The issue of the accounting basis of aggregate fiscal targets is a separate matter, and the relationship between these and the appropriation basis is something I’ve written about at length.)
Yes, I know the KPI well, and have had links with them over the years. A fine institution.