Accrual Budgeting: Experiences of Other Nations and Implications for the
United States (Chapter Report, 02/18/2000, GAO/AIMD-00-57).

Pursuant to a congressional request, GAO reviewed other countries'
experiences in accrual budgeting, focusing on: (1) countries' reasons
for shifting to accrual budgeting; (2) the ways other countries are
using accrual-based information in the budget; (3) the implications of
accrual budgeting for decision-making; (4) the key implementation
challenges (technical and political) associated with the use of accrual
budgeting; and (5) issues raised by these countries' experiences that
may be informative to the United States.

GAO noted that: (1) several countries have adopted accrual budgeting as
a tool to address concerns about public sector performance,
sustainability of government activities, and accountability; (2) much
more than an isolated technical exercise, the shift to accrual budgeting
has generally reflected much wider and more fundamental reform efforts;
(3) although these countries are still in the early stages of developing
and implementing accrual budgeting, proponents believe that it provides
more complete information and better incentives to address these
concerns; (4) accrual budgeting has been used as a tool to support
performance-focused management because, in some cases, it more clearly
links the total cost of resources used to the performance achieved; (5)
proponents believe that accrual budgeting improves incentives to address
the longer-term implications of current decisions by better reflecting
year-to-year changes in assets and liabilities; (6) proponents also
believe that accrual budgeting improves accountability and control by
enhancing the consistency of budget information, even though it raises
some new oversight issues; (7) others have expressed skepticism and
concerns about the use of accrual budgeting; (8) some experts have
expressed concern about reduction in the transparency of information on
the government's cash borrowing requirement and about the ability to
clearly track and control government spending; (9) countries faced a
number of implementation challenges, such as identification and
valuation of assets; (10) despite obvious significant political,
cultural, budget, and economic differences, these countries' early
experiences with accrual budgeting provide some valuable insights for
the United States; (11) however, the challenge is how to translate
useful ideas developed in a parliamentary political system to the U.S.'
system in ways that could improve the U.S.' decision-making process
while protecting its unique institutional needs; (12) GAO believes that
the selective application of accrual budgeting to certain long-term
commitments can strengthen the information and accountability for these
costs; (13) decision-making could benefit from incorporating accrual
measurement into the budget in ways that better match the cost of
resources consumed with the performance achieved without forfeiting
budgetary control; and (14) even without changing the measurement basis
of budgeting to accrual, congressional oversight and managerial
decision-making could be enhanced by better integration of supplemental
accrual-based information into the decision-making process.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  AIMD-00-57
     TITLE:  Accrual Budgeting: Experiences of Other Nations and
	     Implications for the United States
      DATE:  02/18/2000
   SUBJECT:  Budgeting
	     Accrual basis accounting
	     Cash basis accounting
	     Budget authority
	     Budget obligations
	     Performance measures
	     Foreign governments
	     Cost-based budgeting
	     Budget controllability
IDENTIFIER:  Australia
	     Canada
	     Iceland
	     Netherlands
	     New Zealand
	     United Kingdom
	     Social Security Program
	     Federal Employees Retirement System

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Report to the Honorable
Benjamin L. Cardin,
House of Representatives

February 2000

ACCRUAL BUDGETING

Experiences of Other Nations and Implications for the United
States
*****************

*****************

GAO/AIMD-00-57

Letter                                                                     5

Executive Summary

                                                                          6

Chapter 1               Introduction

                                                                         30

Chapter 2               An Overview of Nations' Accrual Budgeting
Initiatives

                                                                         46

Chapter 3               Perspectives on Accrual Budgeting for Decision-
making

                                                                         61

Chapter 4               Challenges in Implementing Accrual Budgeting

                                                                         86

Chapter 5               Adapting Accrual Budgeting for the United States
Context

                                                                         96

Appendixes

Appendix I:  Commonwealth of Australia

                                                                        114

Appendix II:  Canada

                                                                        137

Appendix III:  Iceland

                                                                        151

Appendix IV:  The Netherlands

                                                                        165

Appendix V:  New Zealand

                                                                        174

Appendix VI:  United Kingdom

                                                                        201

Appendix VII:  GAO Contacts and Staff Acknowledgements

                                                                        217

Table 1:  Comparison of Methods of Budget Reporting34

Table 2:  Use of Accrual Reporting and Budgeting by Country
Reviewed                                        37

Table 3:  Statutory Framework for Performance-Based Management
and Accountability Reform Efforts in the United States38

Table 4:  Design Features of Case Study Countries' Accrual Budgeting
Approaches58

Figure 1:  Improvements in Budget Information Attributed to Accrual
Budgeting50

Figure 2:  Conceptual Concerns Raised About Accrual Budgeting54

Figure 3:  Reconciliation of the Accrual Operating Result to the Fiscal
Balance122

Figure 4:  Financial Statements Used to Represent the Government's
Budget                                         124

Figure 5:  Measures of Fiscal Position         128

Figure 6:  Reconciliation Between Operating and Cash Balances129

Figure 7:  Estimated Cash Balance Compared to Estimated
Accrual-Based Operating Result, Fiscal Years 1998-99 Through
2002-03                                        130

Figure 8:  Alternative Measures of the Fiscal Balance--Budgetary
Balance Versus Financial Requirements/Surplus  147

Figure 9:  The Three Modes of Appropriations   179

Figure 10:  The Three Primary Statements Used to Present the Budget184

Figure 11:  The Seven Types of Appropriations  185

Figure 12:  Reconciliation Between Operating Balance and Adjusted
Financial Balance (Cash)190

Figure 13:  Accrual Operating and Adjusted Cash Balances, Fiscal
Years 1994-95 Through 1997-98                  191

Figure 14:  Reconciliation of Resources to Financing Requirement208

AAS     Australian Accounting Standards

ACC     Accident Compensation Corporation

AME     annually-managed expenditures

ANAO    Australian National Audit Office

CAF     capital acquisition funds

CFO     Chief Financial Officers

CICA    Canadian Institute of Chartered Accountants

DCA     Deficit Control Act 

DoFA    Department of Finance and Administration

DOE     Department of Education

ERC     Expenditure Review Committee

FASAB   Federal Accounting Standards Advisory Board

FIS     Financial Information Strategy

FMI     Financial Management Initiative

FRA     Fiscal Responsibility Act

FRAB    Financial Reporting Advisory Board

GAAP    generally accepted accounting principles

GDP     gross domestic product

IP      Independency Party

JCPA    Joint Committee on Public Accounts

NAO     National Audit Office

NCOA    National Commission of Audit

OAG     Office of the Auditor General

OECD    Organization of Economic Cooperation and Development

OMB     Office of Management and Budget

PP      Progressive Party

PRA     Public Roads Administration

PSAB    Public Sector Accounting Board

PSASB   Public Sector Accounting Standards Board

PSNB    public sector net borrowing

PSNCR   public sector net cash requirement

PUMA    Public Management Service

RAB     resource accounting and budgeting

RAM     Resource Accounting Manual

RSSI    required supplementary stewardship information

SOE     State-Owned Enterprise

TBS     Treasury Board Secretariat

                                                 Accounting and Information
                                                        Management Division

B-280850

February 18, 2000

The Honorable Benjamin L. Cardin
House of Representatives

Dear Mr. Cardin:

This report responds to your request that we look at the other nations
that have moved toward the fuller use of accrual concepts in budget
reporting with an eye to what help their early experiences might offer the
United States. There are obvious and significant political, cultural and
economic differences between the United States and these countries-
Australia, Canada, Iceland, the Netherlands, New Zealand, and the United
Kingdom. Nevertheless, their early experiences offer some insights as the
United States considers ways to improve budget recognition of long-term
commitments and continues to strive for improvements in government
performance and accountability. 

Accrual-based and cash-based costs are similar for many government
activities. However, accrual measurement would move budget recognition
forward for the costs of some programs such as insurance and pensions,
which involve future cash flows. The opposite would be true for the
purchase of capital assets: accrual measurement would provide a later
recognition of the cost. 

The U.S. federal budget is expected to provide information on the
government's impact on the macro-economy as well as full information and
appropriate incentives for resource allocation, for control over cash, for
the recognition of future commitments, and for monitoring performance. As
a result choices about the method of budget reporting require trade-offs
among these multiple and potentially competing objectives. 

We hope you find this report useful in your efforts to improve the federal
budget process. We are sending copies to interested congressional
committees and the Director of Office of Management and Budget. Copies
will be made available to others upon request. If you or your staff have
any questions about this report, please contact me on (202) 512-9573.

Sincerely yours,

*****************

*****************

Paul L. Posner
Director, Budget Issues

EXECUTIVE SUMMARY
=================

Purpose
-------

Budgeting is the process by which we as a nation resolve the large number
of often conflicting objectives that citizens and their representatives
seek to achieve through government action. In that sense, nothing could be
more important than debates about the budget. It is in the context of the
budget debate that decisions are made about 

o   the federal government's fiscal policy, i.e., the relationship
  between spending and revenues;

o   where the federal government will be involved and the allocation of
  resources across various program areas; and

o   the tools the government will use to carry out these policies. 

Given this, the nature and quality of the information used in the budget
debate matters a great deal. Information permitting decisionmakers to look
broadly across a range of ways to provide federal support--both spending
and tax incentives--can improve the ability to make decisions about
allocating resources and the best tools to use. Information on the long-
term implications of different decisions is also important because they
are not always obvious and may have major consequences. For these reasons,
questions about changing the method of budget reporting/Footnote1/ arise.

The method of budget reporting represents much more than a technical
decision about how to measure costs; rather it reflects fundamental
choices about the types of controls and incentives that are important in
the decision-making process. Countries traditionally have relied on cash-
based budgeting--recording amounts in the budget based on when cash is
received or paid, regardless of when revenues are earned, resources are
consumed, or liabilities are increased. These cash-based systems reflect
the traditional focus of public sector budgeting on control, ensuring
compliance with spending limits and assessing the short-term economic
impact of fiscal policy. The United States, however, uses a system of both
a cash- and obligation-based budget that permits greater control than
solely a cash-based system. Recognizing that even this provided inadequate
recognition and control for credit programs, in 1990 the United States
embraced a form of accrual budgeting in that area./Footnote2/

In recent years, the United States and several other countries have
undertaken reforms--some more sweeping than others--aimed at improving
public sector financial and performance management. At the same time, in
the United States, there has been increasing concern about the need to
recognize the long-term cost implications of current commitments and
decisions. Despite recent budget surpluses, the United States continues to
face long-term budget pressures that stem in large part from the
burgeoning costs of health and retirement programs prompted by the aging
population. Simulations by GAO's and the Congressional Budget Office's
(CBO) long-term budget models illustrate these budget pressures; even if
projected budget surpluses are "saved" and used to pay down debt, growth
in Social Security, Medicare and Medicaid threaten to crowd out
discretionary spending. Both this concern and recent management reform
efforts have challenged traditional thinking about cash-based and
obligation-based budgeting systems and stimulated interest in the
potential for accrual-based measurement--which records transactions in the
period revenues are earned, resources are consumed, or liabilities are
increased--to contribute to improved public sector management. 

In the United States, two key concerns have increased interest in the
potential for using accrual budgeting for programs other than credit
programs: (1) a desire to improve the recognition of long-term commitments
in the budget and (2) an interest in more directly linking improved cost
and performance information to the federal budget process. As a result,
there has been interest in the experiences of countries that have adopted
accrual budgeting and what lessons might be learned from these
experiences. Representative Benjamin Cardin asked us to examine

o   countries' reasons for shifting to accrual budgeting,

o   the ways other countries are using accrual-based information in the
  budget,

o   the implications of accrual budgeting for decision-making,

o   the key implementation challenges (technical and political)
  associated with the use of accrual budgeting, and

o   issues raised by these countries' experiences that may be informative
  to the United States.

GAO's review included six countries--Australia, Canada, Iceland, the
Netherlands, New Zealand and the United Kingdom.

Background
----------

The federal budget serves as the primary financial plan of the federal
government. Although budget decisions are inherently based on political
choice, the method of budget reporting plays an important role by
determining the information available and incentives provided to
policymakers. Further, because the budget process serves as a key point of
accountability, the way costs are measured in the budget can have
significant consequences for managerial incentives. Therefore, choices
about the method of budget reporting represent much more than technical
decisions about how to measure cost; rather they reflect fundamental
choices about the controls and incentives to be provided by the decision-
making process. 

The measurement bases discussed in this report--cash, accrual, and
obligations--primarily affect the timing at which the budget recognizes
costs. The structure or scope of budget accounts--i.e., whether budget
costs are arranged based on organization, program, spending item, etc.--
also helps determine the focus of decision-making, and the level of
oversight and control placed on public spending, but it is a separate
issue. The adoption of accrual-based measurement for budgeting may or may
not be combined with changes to the account structure. 

The recognition of costs in the budget (timing) is different for cash-,
accrual-, and obligation-based reporting./Footnote3/ 

o   Cash-based budgeting records receipts and outlays at the same time
  cash is received or paid, without regard to when the activity
  generating the revenue, consuming the resources, or increasing the
  liability occurs. 

o   Accrual-based budgeting records transactions in the period when the
  activity generating the revenue, increasing the liability or consuming
  the resources occurs--regardless of when the associated cash is
  actually paid or received. Although the costs recorded for accrual-
  based budgeting need not be identical to those used for accrual-based
  accounting, the term accrual budgeting usually has been used to refer
  to the recording of budget costs based on financial accounting
  standards. As a result, accrual-based appropriations, by reflecting the
  costs incurred during a fiscal year, generally are similar to the
  expenses reported in a private sector operating statement.

o   Obligation-based budgeting focuses upon controlling the legal
  obligations or commitments entered during a period. Obligation-based
  budgeting records financial transactions, primarily when orders are
  placed, contracts are awarded and other similar transactions are made
  that will require payment during the same or a future period. 

The U.S. budget is neither accrual nor pure cash; it is obligation-based
because it focuses upon controlling the legal obligations or commitments
entered into during a period. Obligation-based budgeting involves three
stages: (1) the Congress must enact budget authority up front before
government officials can obligate the government to make outlays, 
(2) government officials commit the government to make outlays by entering
into legally binding agreements, and (3) outlays (cash disbursements) are
made to liquidate obligations. However, with limited
exceptions,/Footnote4/ the amounts to be obligated are measured on a cash
or cash equivalent basis and the unified budget deficit/surplus/Footnote5/-
-the key focus of the policy debate--represents the difference between
cash receipts and cash outlays in a given year. 

The use of cash-based measurement in public sector budgeting has several
advantages. Perhaps most notably, cash has been a widely used and
traditionally accepted measure of the government's impact on the
economy./Footnote6/ Further, because it can be tracked, cash fits well
with the traditional public sector budgeting focus on control and on
ensuring compliance with spending limits. In addition, for most government
activities the time between the occurrence of the underlying transaction
resulting in a government liability and the cash outlays necessary to
liquidate the liability is relatively short. Therefore, cash-based
measurement generally provides both adequate information and control.

Despite these advantages, two reinforcing issues have stimulated interest
in the use of accrual measurement for public sector management. At the
governmentwide level, costly incidents, such as the deposit insurance
crisis in the United States and the issuance of guarantees in New Zealand,
served to highlight shortcomings of cash reporting for signaling the long-
term implications associated with some policy decisions and the need for a
more complete picture of a government's financial condition. At the
organizational level, the desire to improve the efficiency and
effectiveness of government operations through more performance-focused
management has placed an emphasis on understanding and managing costs.
Faced with concerns about the sustainability of government activities and
with demands for more result-oriented management systems, other countries
moved towards accrual-based measurement for financial reporting and a few
moved from cash-based budgeting to accrual budgeting. Similar concerns
have raised questions about whether the current U.S. cash- and obligation-
based budget adequately (1) presents information on the long-term
sustainability of government activities or
(2) matches cost to government performance in a way which effectively
supports management reform efforts. 

For some activities, such as credit and pension programs, cash-based
measurement is incomplete and potentially misleading. As a result, the
true cost to the government as a whole, and/or the cost of particular
goods or services, may be misstated. For example, GAO has argued that the
cash-based measure understates the costs of commitments already entered
into for federal insurance programs./Footnote7/ Further, the cash flows
for some items, such as asset purchases, may not adequately match annual
resources consumed with the provision of goods and services. As a result,
it may be difficult to fully assess the costs associated with a given
level of performance. 

In recent years, the United States and other countries have undertaken
reforms aimed at improving public sector financial management and
performance while enhancing transparency and accountability. These reforms
have served to highlight the need for more complete and comparable cost
and performance information. For example, it has been recognized that
adequately assessing performance under more result-oriented management
systems requires information beyond the cash flows in a given period and
more consistent and credible cost data across programs and accounts. As a
result, the United States government began to produce audited agency and
governmentwide financial statements to provide accrual-based information
on the cost of government activities. The challenge, however, remains of
how to integrate this information into the budget process so that it
effectively supports policy decision-making and management reform
objectives. 

Results in Brief
----------------

Within broader reform efforts, several countries have adopted accrual
budgeting as a tool to address concerns about public sector performance,
sustainability of government activities, and accountability. Much more
than an isolated technical exercise, the shift to accrual budgeting has
generally reflected much wider and more fundamental reform efforts.
Although these countries are still in the early stages of developing and
implementing accrual budgeting, proponents believe that it provides more
complete information and better incentives to address these concerns. 

Accrual budgeting has been used as a tool to support performance-focused
management because, in some cases, it more clearly links the total cost of
resources used to the performance achieved. For example, New Zealand and
Australia/Footnote8/ combined accrual budgeting with output budgeting to
support more decentralized management systems that hold managers
responsible for results while reducing controls over inputs (specific
spending items). Under these systems, appropriations are made not for
specific items, such as salaries or supplies, but for funds to provide
specific outputs (goods and services delivered on behalf of the
government). Managers are then held accountable for delivering the
specified outputs within the appropriated amount. This makes understanding
the total costs (including items such as accrued employee pensions to be
paid in the future) associated with a given result important both for
deciding on appropriation amounts and for ensuring accountability. Other
countries, such as the United Kingdom, which chose to incorporate accrual
measurement into the budget to reflect more completely and systematically
the cost of resources consumed, have stopped short of adopting output-
based appropriations.

Proponents also believe that accrual budgeting improves incentives to
address the longer-term implications of current decisions by better
reflecting year-to-year changes in assets and liabilities. For example,
New Zealand officials attributed reforms in both its employee pension
program and an accident insurance program to the fact that costs became
more apparent in the budget. Proponents also believed accrual budgeting
improves accountability and control by enhancing the consistency of budget
information, even though it raises some new oversight issues. For example,
proponents saw improving the consistency between the budget and the
financial statements as important to enhancing oversight. 

Although some officials and experts cited benefits, others expressed
skepticism and concerns about the use of accrual budgeting. While
proponents noted that information on cash flows is available under accrual
budgeting, other experts expressed concern about a reduction in the
transparency of information on the government's cash borrowing
requirement. Another potential reduction to transparency stemmed from the
fact that accrual budgeting requires more sophisticated understanding of
financial reporting standards and underlying assumptions. Along these
lines, concerns were raised about the ability to clearly track and control
government spending. In addition, some thought that some benefits, such as
improved asset registers, could be achieved through accrual accounting and
reporting alone without using accrual-based measurement for budgeting.
Finally, countries faced a number of implementation challenges, such as
the identification and valuation of assets.

Despite obvious and significant political, cultural, budget, and economic
differences, these countries' early experiences with accrual budgeting
provide some valuable insights for the United States. Their experiences,
however, must be seen in the context of their particular situations. The
challenge is how to translate useful ideas developed in a parliamentary
political system to the U.S. system in ways that could improve its
decision-making process while protecting its unique institutional needs.
In analyzing the benefits cited by other countries and the potential for
similar benefits in the United States, it is important to consider that
the legislative bodies in a parliamentary system of government and the
Congress of the United States differ, especially in the role each plays in
the budget process. The U.S. Congress is an independent and separate
branch of government that takes a more active role in resource allocation
decisions than the parliaments in GAO's case study countries. Many
important decisions that, in the United States, are debated during the
annual appropriations process occur in case study countries before the
budget is presented for parliamentary approval. Also, most case study
countries generally deal with the approval of obligations through
executive branch controls whereas in the United States congressional
approval (budget authority) is required before executive branch
departments can obligate funds. Further, most case study countries used
purely cash reporting for budgeting before adopting accrual budgeting. In
contrast, the United States' obligation-based budgeting already captures
many obligations not apparent in a purely cash system. These differences
are likely to influence perspectives on the trade-offs associated with the
use of accrual budgeting, particularly in terms of accountability and
legislative control issues.

Any reform effort should begin with consideration of the overarching
managerial and control objectives embodied within the United States'
institutional system. While concerns have been raised that the U.S.
obligation-based system may not adequately reflect all long-term
commitments or properly align budget cost recognition with the consumption
of resources, it offers other benefits in terms of up-front control of
obligations. Thus, the challenge for the U.S. system is to see if accrual
concepts can be adapted to address the unique budgetary needs of the
Congress as well as the executive branch. 

The up-front funding requirement under an obligation-based budget helps
ensure control but does not necessarily align budget cost recognition with
the consumption of resources. Conversely, accrual measurement can be used
to better match costs with the consumption of resources, but in its
simplest form does not necessarily provide up-front control over entering
into legally binding commitments. Thus, choices about the basis of
budgeting depend in part on the relative importance one places on
recognizing and controlling the full costs at the time decisions are made
versus matching budget recognition to the period resources are actually
consumed. 

GAO believes that the selective application of accrual budgeting to
certain long-term commitments can strengthen the information and
accountability for these costs. In addition, decision-making could benefit
from incorporating accrual measurement into the budget in ways that better
match the cost of resources consumed with the performance achieved without
forfeiting budgetary control. Finally, even without changing the
measurement basis of budgeting to accrual, congressional oversight and
managerial decision-making could be enhanced by better integration of
supplemental accrual-based information (e.g., net present value for long-
term commitments and unit cost for goods and services) into the decision-
making process.

Earlier recognition can promote timelier action to address some long-term
commitments before they become too unwieldy or burdensome. For many
government activities, such as salaries or grant payments, there generally
would not be significant differences in the timing of budget recognition
between cash and the annual accrued costs. Accrual measurement, however,
would advance the recognition of costs for commitments such as pensions
and insurance that involve cash flows over many years. Such an approach
might also be helpful for selected tax expenditures where current cash
flow numbers fail to capture their longer-term effects on government
revenues (e.g., the timing differences associated with certain pension and
savings incentives). Conversely, for capital assets, accrual measurement
would delay cost recognition by spreading costs over the lives of the
assets. Thus, while accrual budgeting matches budget costs with the
provision of goods and services, it raises issues about up-front cost
recognition and control for capital assets./Footnote9/ 

For these reasons, adopting accrual budgeting selectively within an
obligation-based control system may improve information while preserving
up-front control within the United States' unique separation of powers
system. Specifically, accrual measurement within the obligation-based
budget might result in better budget information and incentives for
decision-making for programs like government employee pensions or
insurance in which cash-based measurement may fail to capture the
magnitude of the government's commitment. The approach developed for
credit programs in the Federal Credit Reform Act of 1990 is an example of
the selective application of accrual budgeting. On the other hand, the
obligation-based approach could be retained for items like capital, for
which the use of accrual budgeting without additional compensating
controls would reduce the up-front control provided by the United States'
current system.

In terms of providing a more complete picture of the long-term
sustainability of a government's activities, it is important to note that
accrual budgeting as implemented by the case study countries does not
cover social insurance commitments. The extent to which accrual budgeting
based on financial accounting standards can be used to improve the
recognition of long-term issues is limited. Although social insurance is
generally viewed as a government commitment likely to result in a future
cash outlay,/Footnote10/ it is not judged to be a liability according to
accounting standards in these countries. Thus, none of them have budgeted
for such commitments on an accrual basis. This would also be the case if
the United States adopted accrual budgeting based on its federal
accounting standards./Footnote11/ 

As a result, accrual budgeting as implemented by case study countries is
not the answer to questions of how to improve the budget recognition of
long-term social insurance commitments. If formal recognition of social
insurance commitments in the budget is desired, other methods of
incorporating accrual concepts into the budget could be developed. Some
possible approaches for Social Security, for example, might include
recasting the Social Security surplus by recording outlays in the same
amount as social insurance receipts to reflect the government's commitment
to spend those amounts on benefits in the future. Alternatively, revenue
recognition of the surplus receipts might be deferred until they are used
to make payments in the future. Another possibility would be to track the
expected cost of the government's long-term commitments in the budget for
each budget account or program alongside its cash-based budget authority
and outlays. These ideas and others would need to be explored in detail by
experts in the field of budgeting to determine their workability and
potential benefits. Suggestions have been made that a budget concepts
commission is needed to address a number of issues, including Social
Security; it could be the proper forum to fully develop new budgeting ideas.

Congressional oversight could also be enhanced by better matching of the
cost of resources consumed with the performance achieved in a manner that
does not forfeit budgetary controls. For instance, GAO's previous review
of agencies' performance plans shows that some agencies have been able to
develop approaches that make basic and useful connections between proposed
spending and performance goals within the current budget
framework./Footnote12/ While full accrual budgeting is not necessary to
continue improving such connections or to enhance the quality of cost
information, efforts will be necessary to mitigate the danger that such
cost information may be treated as a supplemental exercise rather than
considered integral to the budget debate. Also, accrual budgeting could be
used to better reflect resources consumed without moving to output-based
appropriations. For example, mechanisms to charge programs for the use of
capital assets over time, such as capital acquisition funds,/Footnote13/
could better align the cost of capital with its use while preserving the
up-front control. This type of mechanism is one way that accrual-based
cost could be incorporated in the budget at the agency level while
preserving the cash and obligations basis for the government as a whole.

GAO Analysis 
-------------

Accrual Budgeting Adopted as Part of Broader Reform Efforts
-----------------------------------------------------------

In case study countries, the use of accrual budgeting has been linked
intrinsically with broader reform efforts driven by concerns about the
size, role, and effectiveness of the public sector. These reforms have
generally sought to improve government activities through improved
transparency and/or more performance-oriented management. However, while
accrual budgeting has generally been much more than an isolated technical
exercise and reflective of wider and more fundamental reform efforts, the
impetus for and the magnitude of change varied significantly across the
countries reviewed. Some countries, such as New Zealand and Iceland, were
motivated by large deficits or concerns over the sustainability of
government activities. Others, such as the United Kingdom and Australia,
undertook changes to make general improvements in public sector management. 

The implications of a shift to accrual budgeting need to be seen in the
context of these broader reform efforts. For example, in New Zealand, the
adoption of accrual accounting and budgeting was only one component of
sweeping reforms undertaken to restore its economy after several years of
serious economic difficulties. As part of these reforms, New Zealand not
only changed its reporting from cash to accrual but also comprehensively
and fundamentally restructured the role of the national government in the
economy and radically changed the accountability relationship between the
government and departmental executives. To varying degrees, the other case
study countries also undertook accrual budgeting as part of broader
financial and performance management reforms. 

Countries Vary Significantly in the Design and Implementation of Accrual-
based Budgeting Systems
---------------------------------------------------------------------------

Not surprisingly, each country's reform objectives and budget control
needs influenced the approach taken to designing and implementing its
accrual budgeting framework. Approaches varied with respect to

o   the extent to which accrual budgeting is used as part of an output
  budgeting framework in which the budget is intrinsically linked to
  performance,

o   the scope of budget items measured on an accrual basis, and

o   the organizational level to which accrual budgeting is applied.

Four countries--New Zealand, Australia, Iceland, and the United Kingdom--
have chosen, or are expecting, to implement accrual budgeting for most
budget items at both the departmental and central government levels. Their
approaches (1) use the same accounting standards/Footnote14/ for both
financial reporting and budgeting and (2) incorporate primary financial
statements/Footnote15/ roughly similar to those found in private sector
financial reporting into the budget process. With two notable exceptions--
the exclusion of capital and centralization of pension costs in Iceland
and the United Kingdom's exclusion of revenues--these countries apply
accrual-based measurement using financial accounting standards to
virtually all budget items at both the departmental and the governmentwide
levels./Footnote16/ 

Two of these four countries--New Zealand and Australia--placed significant
emphasis on directly linking the budget (including the basis of
appropriation) with their overall performance and accountability
structures. In these two countries, the shift to accrual measurement
occurred concurrently with a shift to output-based appropriations. In
general terms, output-based appropriations provide funding for the total
resources required to produce an "output" (a good or service produced by
departments) including costs that do not require a cash outlay, such as
depreciation. The United Kingdom has also proposed an accrual budgeting
framework that aligns resources to performance, but has stopped short of
adopting output-based appropriations. Iceland's approach reflects a
greater emphasis on recognizing the cost of the long-term commitment for
employee pensions at the governmentwide level rather than allocating costs
to particular goods and services.

The other two case study countries, Canada and the Netherlands, have
applied accrual budgeting on a more limited basis to specific budget items
or departments. Canada currently applies accrual budgeting to public
sector employee pensions and accounts payable at both the department and
the governmentwide levels. However, Canada is considering shifting capital
to an accrual basis with the intent of better integrating its financial
management system. The Netherlands has applied accrual budgeting, using an
approach similar to the New Zealand and Australia output-based models, for
a select number of agencies (subunits within ministries) but is still
undecided about its application governmentwide. 

Countries Measure Budget Deficit/Surplus Differently
----------------------------------------------------

Another key difference among countries' approaches is the basis used to
measure the governmentwide deficit/surplus. New Zealand reports its
deficit/surplus using the accrual-based net operating result. Under
Iceland's approach, the main focus of the budget debate is the Operating
Statement which includes estimates of revenues and expenses on both an
accrual and a cash basis. However, the aggregate operating result is
reported only on an accrual basis. Australia has chosen to use a "fiscal
balance" measure which is derived by adjusting the accrual-based operating
balance to better approximate cash and the national investment/saving gap.
Under the current Canadian system, two measures of fiscal position
(deficit/surplus) are used: (1) the financial balance, or cash requirement
which approximates the country's financing needs and (2) the budgetary
balance--its primary fiscal measure--that includes pensions, accounts
payable, and other accrual-measured items/Footnote17/ even though cash is
not needed immediately. In the Netherlands, the governmentwide
deficit/surplus is reported on a cash basis. 

Accrual Budgeting Used as a Tool in Addressing Performance Management
Challenges
---------------------------------------------------------------------------

Proponents described accrual budgeting as a useful, if not critical, tool
in addressing performance management challenges. Accrual-based measurement
is viewed as eliminating distortions that are inherent in cash-based
reporting, such as reporting pensions as they are paid rather than as they
are earned, and thus better matching the budget recognition of cost with
the expected performance results. As a result, accrual budgeting is
credited with supporting broader performance management reform efforts in
several ways, such as

o   reflecting and supporting more decentralized and performance-focused
  accountability systems; 

o   facilitating more competitive, businesslike approaches to providing
  government goods and services; and

o   encouraging more efficient and effective resource management,
  particularly with respect to capital assets.

For example, New Zealand and Australia/Footnote18/ combined accrual
budgeting with output budgeting to support more decentralized management
systems that hold managers responsible for results while reducing controls
over inputs (specific spending items). Under these systems, appropriations
are made for outputs (goods and services delivered on behalf of the
government), rather than for specific items, such as salaries or supplies.
These systems aim to create a more businesslike environment in which an
appropriation can be thought of as the "price" received by the department
and paid by the government for a given output. Managers are then held
accountable for delivering the specified outputs within the appropriated
amount. This makes understanding the total costs associated with a given
output, not just the immediate cash outlays, important to ensuring
accountability. From the department's perspective, outputs must be
"priced" so that appropriations will be sufficient to cover costs over
time. From the perspective of policymakers as the purchasers of goods and
services, only by understanding the complete costs, including those that
do not result in immediate cash flows, can an organization's performance
be fully assessed and compared to other organizations, both public and
private. In this way, accrual measurement in the budget is used to hold
managers accountable in these more decentralized systems. As a result,
some proponents view accrual budgeting as critical to establishing more
performance-focused management systems. Other countries, such as the
United Kingdom, have chosen accrual budgeting in an attempt to reflect
more completely and systematically the cost of resources consumed, but
have stopped short of adopting output-based appropriations.

Accrual budgeting also was viewed as beneficial in the area of capital
asset management. In addition to one-time benefits such as the
identification and valuation of assets, accrual budgeting was credited
with creating better incentives for ongoing asset management by matching
the costs of an asset with its use and better recognizing the cost of
holding capital. However, some doubts and concerns about the advantages of
accrual budgeting for assets were also expressed, some similar to concerns
that would apply in the United States. For example, asset valuation was
difficult and often subjective. Thus, using the asset values as the basis
for budgeting for depreciation was questioned. Concerns also were
expressed over whether managers would actually "save" the amounts
appropriated for depreciation to use for asset replacement and whether
they might choose to operate using obsolete assets to avoid cost-of-
capital charges. Proponents, however, argue that compensating controls can
serve to alleviate these concerns. Since accrual budgeting has been in
place for only a relatively short period in any of the case study
countries, it is too soon to determine if these concerns are valid. 

In addition, experts in the United States expressed concern about a
reduction of up-front control over asset purchases relative to that
currently provided under the United States' obligation-based budget.
Whereas case study countries generally deal with the approval of
obligations, such as asset purchases, through executive controls, in the
United States congressional approval (budget authority) is required for
departments to make such obligations. 

Accrual Budgeting Used to Improve Information and Incentives With Respect
to the Sustainability of Government Activities
---------------------------------------------------------------------------

Many of the countries that have adopted accrual budgeting have done so, in
part, with the expectation that it will help decisionmakers better
understand the long-term sustainability of government policies. Proponents
saw accrual budgeting as useful for assessing the sustainability of
government policies by providing

o   better budgetary recognition of liabilities and

o   a more complete set of information to assess a country's financial
  health. 

For example, New Zealand and Iceland credited accrual budgeting with
highlighting the longer-term consequences associated with public sector
employee pension programs. In Iceland, accrual budgeting showed the
consequences of wage negotiations on future public sector employee pension
costs. The full costs of these agreements were not fully realized by the
public until the adoption of accrual budgeting led to the recognition of
the liability in the budget estimates. Icelandic officials informed us
that there is no longer public support for decisions that are so costly in
the long term. Similarly, New Zealand officials decided to discontinue the
defined benefit public employee pension program after pension liabilities
were recognized on the balance sheet and the expense incurred was included
in the budget. More recently, as a result of recognizing the liability
from providing accident coverage, the New Zealand government initiated
efforts to reform the Accident Compensation Corporation program. 

Furthermore, proponents suggested that accrual budgeting provided
decisionmakers with a more comprehensive picture of a government's
financial condition by better integrating financial statement information--
including the balance sheet, operating statement, and cash flow statement--
into the decision-making process. However, none of the case study
countries budget for long-term commitments, such as social insurance, on
an accrual basis. This is because, in their accrual budgets, countries
have generally mirrored their financial accounting standards that do not
consider such commitments to be liabilities. 

Accrual Budgeting Helps Address Some Accountability and Control Issues but
Raises Others
---------------------------------------------------------------------------

Proponents also believe accrual budgeting improves transparency and
accountability. For example, officials in New Zealand informed us that
cash-based budgeting followed inconsistent and complex practices
understood by only a few practitioners. In contrast, proponents believe
that the decision to use accrual-based financial accounting standards as
the basis for budgeting improved the credibility of the budget because
these standards are developed by an independent body, are well documented,
and are generally accepted and understood. In addition, they viewed using
the same measurement basis for budgeting and financial reporting as
enhancing oversight. Others disagreed with this view, believing that the
increased complexities associated with the use of accrual budgeting may
reduce transparency and control. Because accrual measurement focuses on
recognizing the financial effects of economic events, it is necessarily
dependent on interpretations and judgments about both when those economic
effects occur and what their ultimate costs will be. Some of the concerns
focus on features that, depending on the approach used, could be part of
accrual budgeting, such as (1) cash may be appropriated for noncash
expenses such as depreciation which do not require immediate cash outlays,
(2) some of the assumptions and judgments necessary to develop accrual
estimates are complex and may have no clear resolution, and (3) when
combined with output-based budgeting, wide discretion is provided to
departments over the use of resources. Under these conditions, effective
oversight depends on the use of sophisticated financial and performance
management principles such as asset/liability management and benchmarking. 

Some Express Skepticism About Use of Accrual-Based Budgeting
------------------------------------------------------------

Despite perceived benefits, some officials and other budget experts
expressed skepticism about the value or feasibility of accrual budgeting.
A key concern expressed by some government officials and other experts was
that accrual budgeting does not focus sufficient attention on the
government's borrowing requirement and thus fails to adequately address
the central government's stewardship role for the current and future
economy. As noted earlier, there was also some concern because
decisionmakers have encountered difficulties understanding the
complexities involved in the use of accrual budgeting because of the
technical issues and assumptions on which accrual measurement is based.
For example, the National Audit Office in the United Kingdom noted that
while accrual measurement may provide a more comprehensive basis to assess
costs, it is likely to be less precise than cash. Officials from several
countries commented on the difficulties encountered in valuing some
assets, including the subjective nature of valuations in some cases. For
example, several country officials acknowledge the difficulties associated
with valuing unique assets such as military equipment or national
monuments which do not have alternative uses or readily available
comparisons in the private market./Footnote19/ Nevertheless, asset values
are particularly important because they serve as the basis for the annual
depreciation charge included in an accrual budget. 

Implications

Despite obvious and significant political, cultural, and economic
differences, the early experiences of other countries with accrual
budgeting provide insights that may be helpful as the United States
considers ways to improve budget recognition of long-term commitments and
continues to strive for increased government performance and
accountability. In analyzing the benefits cited by other countries and the
potential for similar benefits in the United States, it is important to
consider key differences between (1) the legislative bodies in a
parliamentary system of government and the Congress of the United States,
especially in terms of the role each plays in the budget process, (2) the
methods of budget reporting already in place in each country, and (3) the
relative stages of development of financial reporting and budgeting
processes. In addition, the implications of other reforms undertaken at
the same time as accrual budgeting need to be considered. Given the
differences between the United States and the other countries in all of
these factors, it is unlikely that the United States would achieve all of
the benefits claimed by case study countries. However, some benefits could
result from expanding the selective use of accrual budgeting, as has
already been demonstrated for credit programs. 

The implications of various accrual budgeting approaches must be evaluated
against the objectives sought in the U.S. budgeting system. Choices about
the appropriate method of budget reporting are complicated by the
multiplicity of the budget's uses and users. The federal budget is
simultaneously asked to provide full information and appropriate
incentives for resource allocation, control over cash, recognition of
future commitments, and monitoring of performance. Given the multiple and
potentially competing objectives, choices about the method of budget
reporting involve trade-offs. For example, control over spending is
greatest if the budget recognizes the complete costs at the time the
spending decision is made while assessing performance and its costs is
generally best supported by recognizing resources as they are used to
produce goods and services.

Thus, changing the basis of budgeting is much more than a technical
change; it represents choices among the uses and functions of the budget.
An accrual budget can be used to better match recognition of budget costs
with the use of resources and to capture changes in assets and
liabilities. However, despite some acknowledged limitations in these
areas, the obligations basis of budgeting used by the United States
provides its own benefits, particularly for up-front budgetary control.
Since the United States operates under the principle of the separation of
powers the constitutional provision "no money shall be drawn from the
Treasury but in the consequence of appropriations made by law" is
particularly important./Footnote20/ 

Whether accrual budgeting as implemented by the case study countries would
provide earlier budget recognition of costs depends on the item. For many
government activities, such as salaries or grant payments, there generally
would not be significant differences between cash and the annual accrual-
based costs. However, for programs which involve future cash flows such as
insurance and pensions, accrual measurement would move cost recognition
earlier to when the insured event occurs or benefits are earned, even if
cash flows do not occur in the budget year. In contrast, for capital
assets, accrual measurement would delay recognition relative to obligation-
based budgeting by matching its costs not with the purchase but with the
consumption of the asset. For example, while an obligation-based budget
recognizes the full cost of an asset and permits congressional control by
requiring up-front authority for the asset's full cash purchase price
before the purchase is made, generally an accrual budget would not show a
cost for an asset until it begins to be depreciated--after it has been
purchased and put into service./Footnote21/ 

The fact that a shift to accrual budgeting would reduce control over
capital purchases relative to the obligation-based budget and would not
make a significant difference for most budget items raises serious
questions about whether full accrual budgeting would provide sufficient
benefits to warrant its full adoption in the United States. However,
adopting accrual budgeting selectively within an obligation-based control
system could be beneficial. It would provide a means for improving budget
information and incentives for decision-making in cases where cash-based
measurement does not capture the full cost of the government's commitment
while preserving the up-front control of the obligation-based budget. The
approach developed for credit programs in the Federal Credit Reform Act of
1990 is an example./Footnote22/ Similar treatment might be extended to
other areas in the budget for which cash basis reporting does not
adequately represent the extent of the government's commitment, such as
employee pensions and retiree health benefits or federal insurance
programs./Footnote23/ 

However, there are limits to which an accrual measurement based on
financial accounting standards improves recognition of long-term issues.
For example, accrual budgeting as implemented by the case study countries
does not fully deal with social insurance commitments. In general, the
countries have chosen to mirror their financial accounting standards in
their accrual budgets. Although social insurance programs may be widely
viewed as government commitments likely to result in future cash outlays,
they are not currently judged to be liabilities under accounting standards
in these countries. Thus, none of them have budgeted for such commitments
on an accrual basis. This would also be the case if the United States
adopted accrual budgeting based on its federal accounting standards. 

As a result, accrual budgeting based on current financial accounting
standards is not the answer to questions about improving the budget
recognition of long-term social insurance commitments. If formal
recognition of social insurance commitments in the budget is desired,
other methods of incorporating accrual concepts into the budget could be
developed. For programs with current surpluses that are dedicated for long-
term cost commitments like Social Security, the budget might record
outlays in the same amount as social insurance receipts to reflect the
government's commitment to spend those amounts on benefits in the future.
Alternatively, it might defer revenue recognition until the receipts are
used to make payments in the future. Finally, if the decision is made not
to formally recognize and control the future costs of social insurance
commitments directly in the budget, decision-making could still be
enhanced by better integrating supplemental reporting of these costs into
the budget process. For instance, the present value of the expected cost
of the government's long-term commitments could be tracked in the budget
for each budget account or program alongside its cash-based budget
authority and outlays. These ideas and others would need to be explored in
detail by experts in the field of budgeting to determine their workability
and potential benefits. Suggestions have been made that a budget concepts
commission is needed to address a number of issues including Social
Security; it could be the proper forum to fully develop new budgeting ideas.

Some countries' reform efforts--in particular Australia and New Zealand--
emphasized the importance of matching the budget (including the basis of
appropriations) with a government's overall performance management and
accountability structure./Footnote24/ The United States faces similar
issues as it strives to satisfy the objectives of recent reforms such as
the Government Performance and Results Act (the Results Act). 

However, in the U.S. context, the combination of a shift to accrual
measurement with a loosening of controls over agency spending decisions
raises questions about both decreasing the up-front control and changing
the nature of congressional oversight. Nevertheless, some better matching
of the cost of resources consumed with the performance achieved might be
accomplished without forfeiting budgetary controls. For example, GAO's
performance budgeting report suggests that agency budget structures can be
brought into closer alignment with their performance goals. This shift
would help facilitate greater congressional coordination of performance
issues in budget deliberations. 

Ultimately, in certain areas the development of accrual budgeting
mechanisms could be used to embrace, not weaken, congressional oversight.
In the U.S. system, congressional budgeting could be enhanced if
systematic cost data were presented across programs and accounts. To move
toward this goal, intermediate steps to provide accrual data while
preserving the control benefits of obligation-based budgeting could be
taken. For example, mechanisms to charge programs for the use of capital
assets over time, such as capital acquisition funds, could better align
the cost of capital with its use while preserving up-front control. This
type of mechanism is one way that accrual-based costs could be
incorporated in the budget at the agency level while preserving the cash
and obligations basis for the government as a whole.

In conclusion, the United States can benefit from the experiences of
countries that have adopted accrual budgeting. However, for several
reasons, the wholesale adoption of accrual budgeting in the United States
may not garner the benefits cited by other countries and may in fact
undermine other important budgetary goals in the U.S. system.
Nevertheless, the United States' obligation- and cash-based budget might
be improved by selectively incorporating some accrual concepts when doing
so would improve the up-front recognition of the government's commitments.
In addition, an exploration of accrual concepts different from those
embodied in accounting standards could very well lead to new ways of
budgeting for long-term commitments like social insurance. For example, as
mentioned above, steps such as deferring revenue recognition could be used
as a means to better match Social Security revenues with benefit payments.
Finally, some case study countries' experiences point to the importance
and challenges associated with improving cost information to support more
performance-focused management. As the United States pursues the
objectives of the Results Act, continued efforts will be necessary to
integrate improved financial and performance information into the budget
process. 

However, in considering potential reforms, it is important to recognize
that the timing of cost recognition--i.e., cash versus accrual measurement-
-is but one of several factors that shape the budgetary information and
incentives provided to decisionmakers. For example, as noted above, the
structure or scope of budget accounts--i.e., whether budget costs are
arranged based on organization, program, or spending item--also helps
determine the level of oversight and control placed on public spending.
Both the early experiences of some case study countries and GAO's past
work on the Results Act draw attention to the importance of better
integrating planning and budgeting. Significant challenges remain in
improving the information provided in the federal budget so that
decisionmakers have a more comprehensive and cohesive picture of the
government's activities. For example, in the past, GAO has emphasized the
need to better integrate information on the various federal strategies and
tools--such as spending, tax expenditures, and regulation--being used to
address particular national needs. The development of a broader and more
integrated budgetary framework is particularly important for crosscutting
areas, such as health care or the antiterrorism effort, which may involve
tax incentives and/or an array of programs carried out by numerous
different agencies. More fully integrating longer-term analyses, such as
the use of net present value calculations, into the budget process may
also be useful in helping decisionmakers understand the future
implications of current policy decisions. Along these lines, case study
countries' experiences suggest that there may be value in using multiple
measures to assess fiscal and managerial performance. Thus, as in the case
study countries, accrual budgeting represents one tool which can be used
to improve the role of the budget in addressing concerns about public
sector performance, sustainability of government activities, and
accountability for results. Further, since the U.S. government continues
to have responsibility for the national fiscal policy and management of
the national debt, whatever the merits of accrual measurement, budget
measures which are easily reconciled with the public sector borrowing
requirement will continue to be important. 

Matters for Congressional Consideration

As the Congress considers changes in the budget structure and/or process,
it would be well served to explore ways to improve information on two
dimensions: breadth and time horizon. This report dealt with one way to
lengthen the time horizon for information. The Congress should consider
the selective use of accrual measurement in the budget in areas where it
would enhance obligation-based control. In addition, the Congress and the
Office of Management and Budget should consider whether and when to use
mechanisms, such as capital acquisition funds, to better match budget
recognition with the consumption of resources while preserving up-front
control.

--------------------------------------
/Footnote1/-^In this report, the method of budget reporting refers to when
  and how transactions are recognized and measured in the budget.
/Footnote2/-^A long-standing exception to the reporting of outlays and
  receipts on a cash or cash equivalent basis is interest on public issues
  of public debt, which is recorded as it accrues.
/Footnote3/-^For additional explanation of the difference in these
  measurement bases, see chapter 1.
/Footnote4/-^The U.S. budget uses accrual measures to recognize the
  government's costs for certain programs. For more information see
  chapter 1.
/Footnote5/-^Under budget concepts set forth in the Report of the
  President's Commission on Budget Concepts, the unified budget is a
  comprehensive budget in which receipts and outlays from federal and
  trust funds are consolidated. When these fund groups are consolidated to
  display budget totals, transactions that are outlays of one fund group
  for payment to another fund group (that is, interfund transactions) are
  deducted to avoid double counting. 
/Footnote6/-^A cash-based budget is not the only measure available to
  assess the impact of government activities on the economy. In the United
  States, for example, the official national income and product accounts
  (NIPAs) provide a picture of government activities in terms of
  production, distribution, and use of output. There are a number of major
  differences in the treatment of federal receipts and expenditures in the
  NIPAs and their treatment in the unified budget, including adjustments
  for timing of payments. For example, the unified budget counts receipts
  for corporate taxes when they are paid, whereas NIPA counts them when
  the liability is accrued. NIPA and the unified budget also differ in
  their treatment of investment and capital consumption. The unified
  budget reflects all expenditures of the federal government including
  investment while the NIPA budget shows current expenditures and thus
  excludes investments and includes the consumption of fixed capital
  (depreciation). 
/Footnote7/-^See Budget Issues: Budgeting for Federal Insurance Programs
  (GAO/AIMD-97-16, September 30, 1997).
/Footnote8/-^The Netherlands has applied a similar approach on a limited
  basis to select departments.
/Footnote9/-^While the full cost of an asset may not be appropriated up
  front, case study countries established a number of compensating
  controls in an attempt to alleviate control concerns. In most cases,
  case study countries require appropriations for the annual cash required
  to purchase assets. A number of case study countries also established
  supplemental approval processes for capital projects. In New Zealand,
  managers are not allowed to change the structure of their balance sheets
  without legislative approval; this is aimed at preventing managers from
  running down their asset bases to artificially lower the price of
  outputs. However, legislative approval is not required for asset
  purchases below a certain amount if the department can fund them from
  depreciation reserves. See chapter 3 and country appendixes for
  additional information. 
/Footnote10/-^Under current law, U.S. Social Security benefits can only be
  paid from the trust fund balance. 
/Footnote11/-^Accounting standards in case study countries do not
  recognize future social insurance payments as a liability because they
  are uncertain. For example, the government can change these programs.
  Similarly, accounting standards developed for the U.S. federal
  government do not view social insurance as a liability because the level
  of future benefits is considered to be uncertain. Proponents of these
  standards point out that the underlying laws establishing a claim to
  payments can be (and have been) changed over time. Also, they cite that
  estimates change greatly depending on economic assumptions and have
  changed overtime. For example, the 1983 legislative changes to the
  Social Security program were expected to maintain a positive fund
  balance until 2063; however, by current intermediate cost assumptions
  the fund will run out three decades sooner. However, many others believe
  that a liability should be recognized for the net benefits expected to
  be paid in future periods to current participants. Agreement on the
  final standards calling for disclosures but not recognizing a liability
  for such payments was a compromise between the two positions. While not
  included as a liability, information on social insurance is to be
  included as "required supplementary stewardship information" (RSSI). The
  requirement for RSSI was established in recognition of the federal
  government's unique stewardship role over certain resources entrusted to
  it. The standards require that an entity responsible for a social
  insurance program include in its financial report, as RSSI, a
  description of the social insurance program, how it is financed, how
  benefits are calculated, and its financial and actuarial status. 
/Footnote12/-^Performance Budgeting: Initial Agency Experiences Provide a
  Foundation to Assess Future Directions (GAO/T-AIMD/GGD-99-216, July 1,
  1999). 
/Footnote13/-^Capital acquisition funds would finance the purchase of
  capital assets with up-front funding using funds borrowed from the
  Treasury. They would then rent the assets to one or more program
  accounts, charging a rate sufficient to cover repayments of principal
  and interest on the Treasury loan.
/Footnote14/-^Some countries' accounting standards are not fully accrual-
  based. For example, Iceland reports physical assets on a cash basis and
  the United Kingdom accounts for revenues on a cash basis.
/Footnote15/-^Traditionally, primary financial statements include (1) a
  balance sheet which presents the total balances of assets, liabilities,
  and net position of an organization as of a specific time, (2) a
  statement of operations which provides accrual-based information on an
  organization's flows of revenues and expenses and other changes in the
  organization's net resources during a period of time, and (3) a
  statement of cash flows which presents the cash flows of an organization
  during a period of time. 
/Footnote16/-^For the most part, social insurance is not recognized as a
  liability under financial accounting standards used in the case study
  countries and the United States. See footnote 8. 
/Footnote17/-^For additional details see appendix II on Canada.
/Footnote18/-^The Netherlands has applied a similar approach on a limited
  basis to select departments.
/Footnote19/-^In the United States, there has been debate surrounding the
  treatment and valuation of unique governmental assets such as weapon
  systems and heritage assets. In considering this issue, the Federal
  Accounting Standards Advisory Board (FASAB) suggested that (1) the value
  of some federal assets, such as museums and national parks, may be
  indeterminable and (2) allocating the costs of assets such as military
  weapons systems to accounting periods may be meaningless. In response to
  these difficulties, FASAB required a new category of financial
  reporting, "required supplementary stewardship information," which is to
  accompany financial statements, but not be included directly on the
  balance sheet. 
/Footnote20/-^U.S. Constitution, Article I, Section 9, Clause 7.
/Footnote21/-^Case study country officials, however, pointed out that
  their accrual budgeting frameworks have compensating controls. Although
  treatment varies among case study countries, appropriations are
  generally required for the annual cash required to purchase assets.
  However, these annual cash amounts may not represent the full cost of
  the assets. In some cases, legislative approval is not required for
  asset purchases below a certain amount if the department can fund them
  from depreciation reserves.
/Footnote22/-^For credit programs, obligations measured on a cash basis
  sent the wrong signals about the cost of the government's commitment,
  while obligations measured on an accrual basis--as required by credit
  reform--showed the expected cost to the government over the life of the
  credit instrument.
/Footnote23/-^See Budget Issues: Budgeting for Federal Insurance Programs
  (GAO/AIMD-97-16, September 30, 1997).
/Footnote24/-^Improved alignment in these countries involved both a change
  in (1) how costs were measured from cash to accrual and (2) what was
  measured to focus on the results of government spending.

INTRODUCTION
============

In recent years, the United States and several other countries have made
changes--some more sweeping than others--aimed at improving public sector
financial and performance management. Although differences exist, the
reforms have converged around the common objective of establishing more
business-like practices with the aim of improving the performance,
sustainability, and transparency of government activities and ensuring
accountability for results. In a number of countries, these reform efforts
have challenged traditional thinking about cash-based accounting and
budgeting systems and stimulated interest in the potential for accrual-
based information to contribute to improved public sector management.
Accrual measurement is generally viewed as a better means of matching cost
recognition with the consumption of resources.

At least 11 of 29 Organization for Economic Cooperation and Development
(OECD) member countries, including the United States, have incorporated
accrual-based measures to some degree into their financial management
systems, and four--Australia, New Zealand, Iceland, and the United
Kingdom/Footnote1/--have extended or plan to extend the use of accruals
directly into the budget for most items. Others, such as the United
States, Canada, and the Netherlands, have adopted more limited accrual
budgeting approaches, applying accrual budgeting to a limited number of
budget items or specific departments. Other countries' early experiences
with accrual budgeting may be useful to the United States as it continues
down the path toward improving the way the government budgets for and
manages its operations and programs and considers whether to extend its
use of accrual budgeting.

Background

Method of Budget Reporting Reflects Choices About the Uses and Functions
of the Budget
---------------------------------------------------------------------------

The U.S. federal budget serves as the primary financial plan of the
federal government and thus plays a critical role in the decision-making
process. Policymakers, managers, and the American people rely on it to
frame their understanding of significant choices about the role of the
government and to provide them with information to make decisions about
individual programs and overall fiscal policy. While budgetary decisions
are inherently based on political choice, the method of budget
reporting/Footnote2/ plays an important role by shaping difficult choices
and highlighting what trade-offs are brought to the forefront. Further,
because the budget process serves as a key point of accountability between
policymakers and managers, the way costs are measured and reported in the
budget can have significant consequences for managerial incentives. The
three bases of measurement discussed in this report--cash, obligations,
and accrual--represent much more than technical means of cost measurement;
they reflect fundamental choices about the uses and functions of the budget.

Cash and accrual represent two different bases for measuring budgetary
costs. Cash-based measurement records receipts and outlays when cash is
received or paid, without regard to when the activity occurs that results
in revenue being earned, resources being consumed, or liabilities
increased. Accrual-based measurement, on the other hand, records revenues
and expenses in the period the activity generating revenues, increasing
liabilities or consuming resources occurs, regardless of when associated
cash is actually received or paid. Accrual measurement is useful in
accommodating situations where transactions are not completed in one
period. In the financial accounting context, accrual measurement places an
emphasis on contractual duties. For example, revenues are recognized to
the extent that goods or services have been delivered and expenses are
recognized for assets used and liabilities incurred in generating the
revenue. In an accrual accounting system, a corollary of revenue and
expense recognition is the simultaneous recognition of changes in assets
and liabilities. 

In comparison, obligation-based budgeting focuses on the legal obligations
entered into during a period regardless of when cash is paid or received
and regardless of when resources acquired are to be received or consumed.
The obligations basis is used in the United States for controlling federal
government obligations and outlays. Obligation-based budgeting involves
three stages: (1) the Congress must enact budget authority/Footnote3/
before government officials may obligate the government to make
outlays,/Footnote4/
(2) government officials commit--obligate--the government to make outlays
by entering into legally binding agreements, and (3) outlays are made to
liquidate obligations. Obligation-based budgeting, as currently used in
the United States, provides an additional level of control over pure cash
budgeting by requiring that entities have authority to enter into
obligations to make outlays of government funds. Budget authority,
obligations, outlays, and receipts are generally measured in cash or cash-
equivalent terms./Footnote5/ Further, with limited exceptions, the unified
budget deficit/surplus--the key focus of the policy debate--is the
difference between cash receipts and cash outlays. As a result, the U.S.
budget is often referred to as cash-based as well as obligation-based.

In contrast to cash- and obligation-based budgeting, accrual budgeting
generally involves aligning budget recognition with the period in which
resources are consumed or liabilities increased, rather than when
obligations are made or cash flows occur. Although accruals can be
measured in a variety of ways, the term accrual budgeting typically has
been used in case study countries to refer to the recording of budgetary
costs based on financial accounting standards. Thus, accrual-based
appropriations, by reflecting costs incurred during a fiscal year,
generally provide information similar to that found in a private sector
operating statement. Table 1 provides an overview of the three methods of
budget reporting--cash-based, obligation-based, and accrual-based--and
uses two hypothetical transactions to illustrate how the budgetary
information provided to decisionmakers may differ based on the method used. 

Choices about the appropriate method of budget reporting are complicated
by the multiplicity of the budget's uses and users. The federal budget is
simultaneously asked to provide full information and appropriate
incentives for resource allocation, control over cash, recognition of
future commitments,/Footnote6/ and the monitoring of performance. Given
the multiple and potentially competing objectives, choices about the
method of budget reporting involve trade-offs. For example, control over
spending is greatest if the budget recognizes the complete cost at the
time the decision is made while assessing performance and its cost is
generally best supported by recognizing resources as they are used to
produce goods and services. As demonstrated in table 1, the up-front
funding requirement under an obligation-based budget helps ensure control
over the acquisition of a new building but does not align its cost with
its use. Conversely, accrual budgeting better aligns the cost of the
building with the periods that benefit from its use, but in its simplest
form it does not provide for up-front control over entering a legally
binding commitment to purchase the building. Given these trade-offs, a
budget reporting approach should be selected based on the primary decision-
making and accountability needs of a governmental system while balancing
the needs of multiple users.

Table****Helvetica:x11****1:    Comparison of Methods of Budget Reporting

 from Previous Page
-------------------------------------------------------------------------
| Metho : General description :  Budgetary treatment of hypothetical    |
| d     :                     :  transactions relating to capital and   |
|       :                     :              inventories                |
|-----------------------------------------------------------------------|
|       :                     : Purchase and 1st    : Purchase and      |
|       :                     : year's use of       : use of supplies   |
|       :                     : building            :                   |
|       :                     :                     : Total supplies    |
|       :                     : Total equipment     : ordered and       |
|       :                     : cost  = $10m        : received = $3m    |
|       :                     : Cash payments       : Total payments    |
|       :                     : during fiscal year  : for supplies =    |
|       :                     : = $5m               : $2m               |
|       :                     : Depreciation        : Total supplies    |
|       :                     : expense for fiscal  : used = $1m        |
|       :                     : year = $1m          :                   |
|-----------------------------------------------------------------------|
| Cash  : Budget authoritya   : $5m included in     : $2m included in   |
|       : would equal         : budget authority    : budget authority  |
|       : estimated cash      :                     :                   |
|       : payments for the    : $5m included in     : $2m included in   |
|       : fiscal year. No     : outlays and in      : outlays and in    |
|       : appropriation       : deficit/surplus     : deficit/surplus   |
|       : required            : calculation         : calculation       |
|       : for outstanding     :                     :                   |
|       : contract costs or   :                     :                   |
|       : depreciation        :                     :                   |
|       : expense. Prior      :                     :                   |
|       : legislative budget  :                     :                   |
|       : approval may not    :                     :                   |
|       : be required before  :                     :                   |
|       : entering into       :                     :                   |
|       : legally binding     :                     :                   |
|       : contracts whose     :                     :                   |
|       : cash consequences   :                     :                   |
|       : do not occur        :                     :                   |
|       : during the fiscal   :                     :                   |
|       : year.               :                     :                   |
|       :                     :                     :                   |
|       : Outlaysb and        :                     :                   |
|       : receipts are        :                     :                   |
|       : recognized          :                     :                   |
|       : in the budget only  :                     :                   |
|       : in year cash flows  :                     :                   |
|       : take place.         :                     :                   |
|-----------------------------------------------------------------------|
| Accru : Budget authority    : $1m included in     : $1m included in   |
| alc   : is the estimated    : budget authority    : budget authority  |
|       : amount of           :                     :                   |
|       : resources           : $1m included in     : $1m included in   |
|       : consumed,           : outlays in the      : outlays and in    |
|       : irrespective of     : deficit/surplus     : deficit/surplus   |
|       : when commitment is  : calculation         : calculation to    |
|       : made or cash flows  : (assuming net       : cover supplies    |
|       : take place.         : operating amount    : consumed during   |
|       :                     : used as measure of  : the period        |
|       : Outlays/receipts    : deficit/surplus)    :                   |
|       : are recognized in   :                     : $2m included in   |
|       : budget in the       : $5m included in     : financing         |
|       : period resources    : financing           : requirement       |
|       : are consumed,       : requirement (cash   : (cash flows),     |
|       : liabilities         : flows), which may   : which may or      |
|       : increased, or       : or may not          : may not require   |
|       : receipts earned.    : require approval    : approval          |
|       :                     : depending on        : depending on      |
|       :                     : approach used       : approach used     |
|-----------------------------------------------------------------------|
| Curre : Budget authority    : $10m included in    : $3m included in   |
| nt    : is the authority    : budget authority    : budget            |
| Unite : provided by law to  : and obligations     : authority and     |
| d     : enter into          :                     : obligations       |
| State : financial           :                     :                   |
| s     : obligations that    :                     :                   |
| oblig : will result in      :                     :                   |
| ation : immediate           :                     :                   |
| -     : or future outlays   :                     :                   |
| based : involving federal   :                     :                   |
|       : government funds.   : $5m included in     :                   |
| budge : This authority is   : outlays and in      : $2m included in   |
| t     : required before     : deficit/surplus     : outlays and in    |
|       : officials can       : calculation         : deficit/surplus   |
|       : enter into legal    :                     : calculation       |
|       : commitments on      :                     :                   |
|       : behalf of the       :                     :                   |
|       : government.         :                     :                   |
|       :                     :                     :                   |
|       : Obligations are     :                     :                   |
|       : recorded primarily  :                     :                   |
|       : when goods and      :                     :                   |
|       : services are        :                     :                   |
|       : ordered,            :                     :                   |
|       : regardless of when  :                     :                   |
|       : resources acquired  :                     :                   |
|       : are to be received  :                     :                   |
|       : or consumed.        :                     :                   |
-------------------------------------------------------------------------

Notes:

aIn this table, the term "budget authority" is used as a proxy for
whatever term a government uses to imply legislative approval of amounts
in its budget. In case study countries, authority to enter obligations is
generally dealt with through executive controls. In the United States,
congressional approval is required to enter into financial obligations.

bIn this table, the term "outlay" is used as a proxy for whatever term a
government uses to signify the use of resources.

cAs will be discussed in detail in the report, accrual budgeting
approaches vary significantly across countries. These examples are to
provide general understanding of the accrual budgeting concept in its
simplest form.

Cash-Based Measurement Traditionally Used for Public Sector Budgeting 
----------------------------------------------------------------------

Historically, countries have maintained central government budgets on a
cash basis. The use of cash-based measurement in public sector budgeting
has several advantages. Perhaps most notably, cash is a widely used and
traditionally accepted measure of the government's impact on the economy
since the cash-based deficit closely approximates the government's
borrowing needs./Footnote7/ Further, because it can be easily tracked,
cash fits well with the traditional focus of public sector budgeting on
control and on ensuring compliance with spending limits. In addition, for
most government activities, such as salaries or grant payments, the time
between the occurrence of the underlying transaction and the cash flows is
relatively short. Therefore, cash-based measurement generally provides
both adequate information and control.

There are some activities, however, for which cash measurement is
misleading. For programs such as credit, pensions, other postemployment
benefits, and insurance, the current-year government obligations can
involve cash flows to and from the government for many years. Other
programs involve implied commitments or claims on future budgetary
resources for social insurance programs such as Social Security and
Medicare. Cash-based reporting also does not adequately reflect the cost
of other decisions that can have a long-term impact, such as the cost of
some tax expenditures, regulations, or government liabilities for
environmental cleanup. As a result, cash-based measurement may not
recognize the government's ultimate costs at the time the commitment is
made. In other cases, such as for capital assets and inventories, the
actual use or consumption of the asset may be spread over a period of
time. As a result, cash-based measurement may not properly align costs
with the provision of government goods or services. Thus, the true cost to
the government as a whole and the specific cost of particular goods or
services may be overstated in some periods and understated in others.
These issues have led analysts and researchers in the United States and
other countries to raise concerns over the past several decades that cash-
based budgeting does not provide adequate information or appropriate
incentives for some government activities. While the United States
budgeted on an obligations basis and garnered its control benefits, most
other case study countries were budgeting solely on a cash basis prior to
their shift to accrual budgeting. 

Public Management Reforms Have Renewed Interest in Accrual Reporting and
Budgeting
---------------------------------------------------------------------------

In recent years, public sector reforms emphasizing improving transparency,
cost effectiveness, and managerial flexibility have served to further
highlight the limitations of cash-based reporting and budgeting. For
example, it has been recognized that adequately assessing performance
under more result-oriented management systems requires information beyond
the cash flows in a given period and more consistent and credible cost
data across programs and accounts. At the same time, there has been a
growing recognition that information on the long-term cost consequences of
today's commitments is important for policymakers as they consider making
those commitments. 

Faced with concerns about the sustainability of government activities and
the demands of more result-oriented management systems, some countries
have begun moving towards accrual-based measurement for financial
reporting and, in some cases, budgeting. To date, at least 11 OECD
countries, including the United States, had incorporated accrual measures
to some degree for financial accounting purposes, and four--New Zealand,
Australia, Iceland, and the United Kingdom--had extended or plan to extend
accruals directly into their budgets for most budget items. Other
countries, such as the United States, Canada, and the Netherlands, have
adopted accrual budgeting approaches only for specific budget items or
departments. Table 2 provides a snapshot of the use of accrual reporting
and budgeting by the United States and the other countries included in our
review.

Table****Helvetica:x11****2:    Use of Accrual Reporting and Budgeting by
                                Country Reviewed

-------------------------------------------------------------------------
|           :   Accrual financial statements    :  :    Budgets on      |
|           :                                   :  :   accrual basis    |
|-----------------------------------------------------------------------|
|           : Department-   : National (core)   :  :                    |
|           : level         : government        :  :                    |
|-----------------------------------------------------------------------|
| United    : Yes           : Yes, subject to   :  : No, with limited   |
| States    :               : audit since FY    :  : exceptionsa        |
|           :               : 1997              :  :                    |
|-----------------------------------------------------------------------|
| New       : Yes, since    : Yes, since        :  : Yes, since FY      |
| Zealand   : FY 1991-92    : FY1991-92         :  : 1994-95            |
|-----------------------------------------------------------------------|
| Australia : Yes, since    : Yes, since FY     :  : Yes, since FY      |
|           : FY 1995-96    : 1997-98           :  : 1999-2000          |
|-----------------------------------------------------------------------|
| United    : Yes, started  : Yes, estimated    :  : Proposed. First    |
| Kingdom   : in 1993; all  : for FY 1999-2000b :  : accrual budget     |
|           : by            :                   :  : to be presented    |
|           : FY 1999-2000  :                   :  : for FY 2001-02     |
|-----------------------------------------------------------------------|
| Iceland   : Yes, since    : Yes, since FY 1992:  : Yes, since FY      |
|           : FY 1992       :                   :  : 1998. Also         |
|           :               :                   :  : presented on       |
|           :               :                   :  : cash basis         |
|-----------------------------------------------------------------------|
| Canada    : Noc           : Yes, modified     :  : No, modified       |
|           :               : accrual; full     :  : accrual            |
|           :               : accrual for       :  : including          |
|           :               : FY 2001-02        :  : pensions and       |
|           :               :                   :  : accounts payable   |
|-----------------------------------------------------------------------|
| Netherlan : No, except    : No                :  : No, except for     |
| ds        : for select    :                   :  : select agencies    |
|           : agenciesd     :                   :  :                    |
-------------------------------------------------------------------------

Notes:

aAccrual measurement used for credit programs and some interest.

bThis involves the whole-of-government, including local authorities
proposed for FY 2005-06.

cDepartmental financial statements will be produced on a full accrual
basis in FY 2001-02.

dTwenty-two agencies produce accrual-based financial statements and
receive appropriations for the "price" of outputs based on accrued costs.
For more information on these agencies and the Dutch approach to accrual
budgeting, see appendix IV.

Recent U.S. Reform Has Taken Significant Steps to Improve Financial and
Performance Management
---------------------------------------------------------------------------

Like many of its OECD counterparts, the United States has taken
significant steps in recent years to improve public sector financial and
performance management. Recognizing the need to improve effectiveness
while at the same time limiting costs, the Congress established a
statutory framework, outlined in table 3, which provides a powerful
framework for instilling a more performance-driven approach to management
and accountability./Footnote8/ These reforms have served to highlight the
need for more complete and reliable cost and performance information. In
doing so, questions have been raised about whether the current U.S. cash-
and obligation-based budget provides (1) a complete picture of the
government's financial condition to assess the long-term sustainability of
government activities such as Social Security and (2) matches cost to
government performance in ways which effectively support management reform
efforts. 

Table****Helvetica:x11****3:    Statutory Frameworka for Performance-Based
                                Management and Accountability Reform
                                Efforts in the United States

------------------------------------------------------------------------
| Title of act        : Purpose                                        |
|----------------------------------------------------------------------|
| Government          : The purposes of the Results Act include        |
| Performance and     : holding federal agencies accountable for       |
| Results Act of      : achieving program results and requiring        |
| 1993, P.L. 103-62   : federal agencies to clarify their missions,    |
|                     : set program goals,                             |
|                     : and measure performance toward achieving       |
|                     : those goals.                                   |
|----------------------------------------------------------------------|
| Chief Financial     : The objective of the Chief Financial           |
| Officers Act of     : Officers (CFO) Act is to greatly improve and   |
| 1990, P.L. 101-     : strengthen financial management and            |
| 576, and            : accountability in the federal government.      |
| Government          :                                                |
| Management Reform   : The Government Management Reform Act           |
| Act of 1994,        : expanded the CFO Act by, among other things,   |
| P.L. 103-356        : establishing requirements for the              |
|                     : preparation and audit of 24 agencywide         |
|                     : financial statements beginning with fiscal     |
|                     : year 1996 and for the preparation and audit    |
|                     : of consolidated financial statements for the   |
|                     : federal government beginning with fiscal       |
|                     : year 1997.                                     |
|----------------------------------------------------------------------|
| Federal Financial   : The purpose of the Federal Financial           |
| Management          : Management Improvement Act is to ensure that   |
| Improvement Act of  : agency financial management systems comply     |
| 1996,               : with federal financial management system       |
| P.L. 104-208, Div.  : requirements, applicable federal accounting    |
| A,                  : standards, and the U.S. Government Standard    |
| Title I, sec.       : General Ledger b in order to provide           |
| 101(f) [Title       : uniform, reliable, and more useful financial   |
| VIII],              : information.                                   |
| 110 Stat. 3009-389  :                                                |
|----------------------------------------------------------------------|
| Clinger-Cohen Act   : The purpose of the Clinger-Cohen Actc is to    |
| of 1996,            : improve the productivity, efficiency, and      |
| P.L. 104-208        : effectiveness of federal programs through      |
|                     : the improved acquisition, use, and disposal    |
|                     : of information technology resources.           |
|----------------------------------------------------------------------|
| Federal Managers'   : The purpose of the Federal Managers'           |
| Financial           : Financial Integrity Act is to establish a      |
| Integrity Act of    : framework for ongoing evaluations of agency    |
| 1982, P.L. 97-255,  : systems for internal accounting and            |
| 31 U.S.C. secs.     : administrative control.                        |
| 1105, 1113, and 3512:                                                |
|----------------------------------------------------------------------|
| Federal Credit      : The purpose of the Federal Credit Reform Act   |
| Reform Act of 1990, : is to accurately measure the costs of          |
| as amended, P.L.    : federal credit programs by placing the cost    |
| 101-508, 104 Stat.  : of credit programs on a budgetary basis        |
| 1388-609 (1990),    : equivalent to other federal spending and to    |
| and as amended      : improve the allocation of resources among      |
| by P.L. 105-33,     : credit programs and between credit and other   |
| 111 Stat. 692 (1997): spending programs.                             |
------------------------------------------------------------------------

Notes: 

aThe framework also includes: Paperwork Reduction Act of 1995, P.L. 104-
13; Debt Collection Act of 1982, as amended, P.L. 97-365; Debt Collection
Improvement Act of 1996, P.L. 104-134, sec. 31001; Prompt Payment Act P.L.
97-177, 96 Stat. 85 (1982), Codified at 31 U.S.C. secs. 3901-3906;
Inspector General Act, as amended P.L. 95-452; and Computer Security Act
of 1987, as amended, P.L. 100-235, 101 Stat. 1724 (1988), as amended by
P.L. 104-106, 110 Stat. 701 (1996).

bThe U.S. Government Standard General Ledger provides a standard chart of
accounts and standardized transactions that agencies are to use in all
their financial systems.

cThe Omnibus Consolidated Appropriations Act of 1997 (P.L. 104-208)
renamed both the Federal Acquisition Reform Act of 1996 (P.L. 104-106,
Div. D) and the Information Technology Management Reform Act of 1996 (P.L.
104-106, Div. E) as the "Clinger-Cohen Act of 1996."

At the heart of this framework are two significant reforms of the 1990s:
the Chief Financial Officers (CFO) Act of 1990 and the Government
Performance and Results Act of 1993 (the Results Act). The CFO Act--as
expanded by the Government Management Reform Act of 1994 and amended by
the Federal Financial Management Improvement Act of 1996--was designed to
remedy decades of serious neglect in federal financial management by
establishing chief financial officers across the government and requiring
the preparation of audited annual financial statements. It requires the
preparation and audit of agencywide financial statements for 24 specified
agencies beginning with fiscal year 1996 and for the preparation and audit
of consolidated financial statements for the federal government beginning
with fiscal year 1997. While the CFO Act established the foundation for
improving management and financial accountability among agencies, the
Results Act aims more directly at improving program performance. Under the
Results Act, agencies are required to set multiyear strategic goals and
corresponding annual goals, measure performance toward achievement of
those goals, and report on their progress. 

These reform objectives have been supported by the development of
financial and cost accounting standards suitable for the federal
environment./Footnote9/ Under these federal financial accounting
standards, the financial statements required by the CFO Act are prepared
on an accrual basis unless otherwise noted. In contrast, the federal
budget is based on budgetary concepts and policies adopted by the Congress
and the executive branch, generally on an annual cash and obligation basis.

The United States has, however, also recognized the contribution accrual-
based measurement can make to budgeting. In a series of reports in the
1980s on managing the cost of government, we advocated the use of some
accrual cost measures in the budget. Specifically, we reported that the
budget's exclusive focus on cash transactions meant that the costs of some
programs, including retirement, insurance, and credit, were not accurately
reflected in the budget. Since then, the budget has been modified
gradually with the use of accrual measures to recognize the government's
costs for certain programs. For example, in 1985, budgeting for military
retirement costs was moved to an accrual basis at the program level by
reflecting the government's expected costs for retirement benefits as they
are earned. Similarly, since 1987, accruing retirement costs not covered
by employee contributions have been charged to employing agencies for
civilian employees covered by the Federal Employees Retirement System. In
both cases, these program costs are offset within the budget because each
agency's outlays for the accrued cost are paid to and recorded as receipts
by the military and civilian retirement systems, respectively. As a
result, the allocation of costs across agencies is improved. However,
because the retirement systems themselves are within the budget, total
outlays, and thus the deficit/surplus, include only cash outlays to
current retirees.

More recently, the Federal Credit Reform Act of 1990 changed the method of
controlling and accounting for credit programs to an accrual basis and
uses these accrued costs in the deficit and surplus. Prior to credit
reform, outlays for credit programs were reflected in the budget only when
cash was disbursed. Thus, the full amount of direct loans was reported as
an outlay, ignoring that many would in fact be repaid. For loan
guarantees, no outlays were reported when guarantees were made, thus
ignoring the fact that some of the guaranteed loans would eventually
default and require governmental cash outlays. Cash-based measurement thus
overstated the cost of direct loans and understated the cost of loan
guarantees in the year they were made. This not only skewed the cost
comparisons between these two similar programs but also misrepresented
their relative costs in comparison with other federal spending and led to
disadvantageous patterns of funding loan guarantees rather than direct
loan programs. Credit reform addressed the shortfalls of cash-based budget
measurement for credit programs by requiring the budget to include before
the credit is extended the estimated net present value/Footnote10/ of the
cost/Footnote11/ to the federal government over the entire lives of loans
or loan guarantees. 

There has been continued interest in the potential for accrual-based
measurement to overcome the limitations of cash-based measurement for
specific programs. Several years ago, the Chairman of the House Committee
on the Budget asked us to review the budget treatment of federal insurance
programs to assess whether cash-based budgeting provides complete
information and whether accrual-based information could be used to improve
budgeting for these programs. In 1997, we concluded that for federal
insurance programs cash-based measurement may provide incomplete or
misleading information because the annual net cash flows currently
reported in the budget may not adequately match premium collections with
the expected costs of insurance commitments. We recommended that the
Director of the Office of Management and Budget (OMB) develop accrual-
based cost estimation models for federal insurance programs and encourage
similar efforts at agencies with insurance programs. Further, we
recommended that, as estimates become available, they should be reported
annually in a standardized format as supplemental information along with
the cash-based estimates./Footnote12/ Building on these recommendations,
legislation was introduced in the 106th Congress calling for the
development of accrual-based cost estimates for federal insurance
programs, with the eventual aim of incorporating these estimates into the
budget. In addition, there has been increasing attention paid to the
solvency of the Social Security program, which has generated interest in
whether accrual-based information could serve to highlight long-term
issues in the annual budget process.

Two concerns in particular have prompted interest in the use of accrual
budgeting: (1) a desire to improve the budget treatment of commitments
which extend over many years and (2) a growing recognition that to be most
useful the improved cost and performance information provided by recent
reforms must be closely linked to the federal government's budget and
appropriations process. As a result, there has been interest in what
lessons may be learned from other countries that have chosen to adopt
accrual-based budgeting. These countries' early experiences with the
benefits, problems, and feasibility of incorporating accrual-based
measurement into the budget may provide insights as the United States
continues its own financial and performance management reform efforts.

Countries Face Common Reform Objectives But Different Institutional
Frameworks
---------------------------------------------------------------------------

Although commonalties in recent public sector reform agendas pursued by
the United States and other countries provide a valuable opportunity for
shared learning, consideration must be given to significant differences
that exist among countries. Specifically, key differences exist between
the role legislative bodies in a parliamentary system of government and
the Congress of the United States play in the budget process. In the
United States, the legislature and executive are independently elected and
have different constituencies and roles. In a parliamentary system,
governments are formed by the political party, or coalition of parties,
that have the support of a majority of Parliament. As a result, the line
between the executive and the legislative functions is not as clear as it
is in the United States. Many important budget decisions that are debated
during the annual appropriations process in the United States occur before
the budget is presented for parliamentary approval in the parliamentary
system. Parliament's duty is to satisfy itself on behalf of its
constituency that the current government has the Parliament's full
confidence to continue governing. In fulfilling this duty, case study
countries' parliaments regularly enact the government's budget without
amendment. In Westminster systems a failure to do so may be viewed as a
lack of confidence in the government and signal a need for new elections,
including for a new Parliament.

Another difference between the United States and other countries is the
method of budget reporting to which accrual is compared. While most of the
countries in our study previously had budgeted on a cash basis, the United
States has an obligation-based budget that permits greater legislative
control than a cash-based budget. This difference is significant for
evaluating the implications of a shift to accrual budgeting. As discussed
later in this report, the use of an obligation-based budget provides
additional recognition and control beyond that in either a pure cash
budget or an accrual budget and thus has additional implications for
assessing what would be gained and/or lost were the United States to move
to accrual budgeting.

Objectives, Scope, and Methodology

Representative Benjamin L. Cardin asked us to review other countries'
experiences with accrual budgeting. Specifically, Representative Cardin
was interested in accrual budgeting since such a shift in measurement is
one way to improve the recognition of the costs of some government
commitments. We were asked to review (1) how accrual budgeting fits into
these countries' other reform efforts and (2) the implications the shift
in budget reporting has had, or may have, on fiscal policy decision-making
and on managerial decision-making. Finally, Representative Cardin asked us
to summarize, based on the experiences of these countries, any issues for
the United States to consider.

To select countries for our review we consulted with OECD's Public
Management Service (PUMA). PUMA analyzes and assesses information and
reports on public management developments in OECD member countries,
including detailed studies on budget reforms. Based on this preliminary
research, we identified countries that have adopted or plan to adopt
accrual budgeting for most government activities. These were the United
Kingdom, Iceland, Australia, and New Zealand. Two other countries--Canada
and the Netherlands--have adopted accrual budgeting selectively and may
expand into other areas but do not have set plans and time frames for
doing so. In addition, we interviewed PUMA officials, as well as other
international experts on accrual budgeting reforms with the International
Monetary Fund (IMF) and the Brookings Institution to obtain more
information on the nature and scope of these countries' reforms. We also
researched these countries' budget processes and reforms from other
publicly available information sources, including their own government
Internet web sites.

We focused most of our attention on the four countries that have
implemented, or plan to implement, accrual budgeting most fully. To obtain
information on the genesis of these countries' reforms, the role accrual
budgeting plays in broader reform efforts, the perceived benefits of
accrual budgeting, and the implementation challenges posed by the shift to
accrual budgeting, we interviewed various government officials and other
analysts involved in influencing decisions about accrual budgeting.
Specifically, we spoke with senior officials responsible for designing and
implementing the reforms. In general, these same officials were also able
to describe the key details of the new budget format and the implications
this shift had or is expected to have for decision-making.

We also spoke with proponents and skeptics of accrual budgeting in Canada
and the Netherlands, both of which are considering accrual budgeting
issues. In these countries we focused our resources on understanding the
issues in their debate over how accrual budgeting might be implemented and
how it might influence decision-making.

To determine the interaction between the new accrual-based budgets and
fiscal policy, we interviewed senior government officials responsible for
the development of fiscal policy. We also reviewed these countries'
published strategies for debt management and fiscal policy to gain an
understanding of how accrual budgeting will affect these strategies.

To determine the impact the shift to accrual budgeting will have on
resource allocation decisions we met with Members of Parliament when
possible and with key parliamentary staff. They were able to describe
Parliament's role in the resource allocation process, which differs from
the role the Congress plays in resource allocation in the United States.
In most of these countries, we also interviewed senior staff to Cabinet
officials to gain information on how the accrual information is used in
the development and implementation of fiscal policy.

To gain an understanding of (1) how accrual budgeting will influence
managerial decision-making at the departmental level and (2) what
challenges are faced in implementing the shift to an accrual budget, we
interviewed the budget development officers in various ministries. For
example, in Australia we met with the budget development officers at the
Ministry of Defence and Ministry of Family and Community Services. In the
United Kingdom, we met with officials from the Ministry of Defence,
Customs and Excise, and the Home Office. 

To identify potential audit and financial control issues, we interviewed
senior staff in the national audit offices.

We sent copies of the appendixes for review and comment to officials in
each of the countries we visited to ensure the accuracy of our portrayal
of their reform efforts and the details of the treatment of specific
budget items.

To help us identify and assess the implications that the experiences of
these countries may have for the U.S. budget process, we convened a panel
of experts including staff from OMB and the Congressional Budget Office.
We provided the panelists with information gathered during our visits and
held a wide-ranging discussion of the implications for the United States.
In addition, our panelists and other experts reviewed a draft of this
report to ensure completeness and accuracy of the issues discussed in
relation to the implications of accrual budgeting in the U.S. context.

Our work was conducted in the six case study countries and Washington,
D.C., from July 1998 through January 2000 in accordance with generally
accepted government auditing standards.

--------------------------------------
/Footnote1/-^As discussed in more detail in the report, Iceland has
  adopted accrual budgeting with the notable exception of capital
  spending. The United Kingdom does not accrue revenues.
/Footnote2/-^In this report, the method of budget reporting refers to the
  criteria used to determine how and when transactions are recognized and
  measured in the budget.
/Footnote3/-^In the U.S. federal budget system, budget authority refers to
  authority provided by law to enter into financial obligations that will
  result in immediate or future outlays of government funds.
/Footnote4/-^In the U.S. federal budget system, outlays refer to the
  disbursement of government funds in order to liquidate an obligation.
/Footnote5/-^Theoretically, transactions within an obligation-based budget
  could be measured on either a cash/cash-equivalent basis or an accrual
  basis. With limited exceptions, the U.S. obligation-based budget
  measures transactions on a cash or cash-equivalent basis. One exception
  is the treatment of credit programs for which budget authority,
  obligations, and outlays are measured on an accrual basis. Certain
  interest payments are also measured on an accrual basis. For more
  details, see the discussion of credit reform in the following section on
  recent reform efforts in the United States.
/Footnote6/-^In this report, the term "commitment" is used to mean a
  promise to provide a good or service. It does not necessarily mean a
  legally binding obligation, although it may be, in the case of a
  contract to purchase an asset, for example.
/Footnote7/-^A cash-based budget is not the only measure available to
  assess the impact of government activities on the economy. In the United
  States, for example, the official national income and product accounts
  (NIPAs) provide a picture of government activities in terms of
  production, distribution, and use of output. There are a number of major
  differences in the treatment of federal receipts and expenditures in the
  NIPAs from their treatment in the unified budget, including adjustments
  for timing of payments. For example, the unified budget counts receipts
  for corporate taxes when they are received, whereas NIPA counts them
  when the liability is accrued. NIPA and the unified budget also differ
  in their treatment of investment and capital consumption. The unified
  budget reflects all expenditures of the federal government including
  investment while the NIPA budget shows current expenditures and thus
  excludes investments and includes the consumption of fixed capital
  (depreciation). 
/Footnote8/-^See Managing for Results: The Statutory Framework for
  Performance-Based Management and Accountability (GAO/GGD/AIMD-98-52,
  January 28, 1998).
/Footnote9/-^The Federal Accounting Standards Advisory Board (FASAB) was
  established in October 1990 to consider and recommend accounting
  standards to address the financial and budgetary information needs of
  the Congress, executive agencies, and other users of federal financial
  information. When the Board has developed a proposed concept or
  standard, it is submitted to the Secretary of the Treasury, the Director
  of OMB, and the Comptroller General for their review. If, within 90 days
  after its submission, any one of these officials objects to the proposed
  concept or standard, then it is returned to the Board for further
  consideration. If, within 90 days after its submission, none of these
  officials objects to the proposed concept or standard, it becomes final.
  Cost accounting standards developed by FASAB require agencies to develop
  and implement cost accounting systems that can be used to relate the
  full costs of various programs and activities to performance outputs.
/Footnote10/-^Present value is the worth of a future stream of returns or
  costs in terms of money paid today. A dollar today is worth more than a
  dollar at some date in the future because today's dollar could be
  invested and earn interest in the interim.
/Footnote11/-^Under the Federal Credit Reform Act, the estimated cost of a
  direct loan or loan guarantee is now the sum of all expected costs--
  including interest rate subsidies and estimated default losses--and all
  expected payments received by the government over the life of the
  commitment, discounted by the interest rate on Treasury securities of
  similar maturity to the loan or guarantee. Reestimation of the cost of
  loans disbursed or guaranteed in a given year is required over the life
  of the commitment.
/Footnote12/-^See Budget Issues: Budgeting for Federal Insurance Programs
  (GAO-AIMD-97-16, September 30, 1997).
Budget Issues: Budgeting for Federal Insurance Programs (GAO/AIMD-97-16, 

AN OVERVIEW OF NATIONS' ACCRUAL BUDGETING INITIATIVES
=====================================================

In the countries we reviewed, the use of accrual budgeting has been linked
intrinsically with broader public management reforms driven by concerns
about the size, role, and effectiveness of the public sector. While
proponents attributed improvements in fiscal policy and managerial
decision-making to the adoption of accrual budgeting, others have
expressed skepticism about the usefulness and feasibility of accrual
measurement for public sector budgeting. Further, because accrual
budgeting was just one part of broader reform efforts, it is difficult to
isolate the direct benefits and limitations of accrual budgeting from
those resulting from other aspects of the comprehensive changes. 

Although countries that have chosen to adopt accrual budgeting tend to use
a common language in articulating their objectives, they have taken
significantly different approaches in designing and implementing their
accrual budgeting frameworks. These approaches generally reflect each
individual country's reform environment and objectives. Thus, while
"accrual budgeting" is often used as a generic term, it has been applied
in different forms to address a variety of budgeting challenges.

Accrual Budgeting Adopted as Part of Broader Reform Efforts

Case study countries generally adopted accrual budgeting and reporting as
part of broader reform efforts./Footnote1/ In general, these efforts
sought to improve the effectiveness and efficiency of public sector
operations through improved transparency and more decentralized
performance-oriented management. However, the impetus for and the
magnitude of change varied. Some countries, such as New Zealand and
Iceland, were motivated by large deficits and/or concerns over the
sustainability of a large public sector. Others, such as the United
Kingdom and Australia, undertook change as part of more general
improvements in public sector management. Further, the situation is
dynamic as some countries continue to refine and expand their reforms,
including the role of accrual budgeting. 

As countries pursued these broader reform agendas, officials increasingly
realized the limitations of purely cash-based budgeting systems. For
example, by focusing budget decisions on cash flows within a particular
year, cash-based budgeting did not include crucial information on assets,
liabilities, and other commitments necessary to assess the sustainability
of government activities or to provide incentives for a longer-range
policy and management focus. Further, because cash-based budgeting did not
always capture the full costs incurred in a period, it was viewed as
hampering full understanding of and accountability for the relationship
between performance and cost, a cornerstone of the performance-oriented
management paradigm. According to officials in several countries, these
concerns were heightened by the general belief that cash-based budgeting
allowed manipulation of spending across years simply by delaying or
accelerating cash payments. In addition, they expressed concerns that cash-
based budgeting misstated the annual cost of using capital by failing to
spread the purchase costs of capital projects over their useful lives and
by ignoring the opportunity cost of tying up capital in the form of
physical assets.

Proponents described accrual budgeting as an integral tool within broader
reform efforts. In New Zealand, accrual budgeting was adopted as a part of
a systematic program of sweeping changes that, beginning in 1984, sought
to transform the country's economy and public management system in
response to several years of serious economic difficulties. These reforms
comprehensively and fundamentally restructured the role of the national
government in the economy by corporatizing and privatizing government
entities and enhancing efficiency and accountability in the remaining
public sector./Footnote2/ In addition, the reforms radically changed the
accountability relationship between the government and departmental
executives by establishing 5-year contracts with departmental executives
and holding them accountable for achieving discrete and measurable
performance outputs included in the terms of purchase
agreements/Footnote3/ signed with their respective ministers. Accrual
budgeting was described as an essential tool in supporting this new model
of devolution of responsibility by reflecting the full costs of resources
used in achieving those outputs. 

Australia's adoption of an integrated accrual budgeting and reporting
framework built on numerous reforms previously undertaken to improve the
effectiveness and efficiency of government operations and increase the
transparency of budget and fiscal policy decisions. Following a
comprehensive review of the government's operations in 1996, a reform
agenda was developed which, according to the National Commission on
Audits, was intended to (1) put the public sector on a more business-like
footing, (2) foster a more competitive environment, and (3) build a
culture that values high performance. Along these lines, the Financial
Management and Accountability Act of 1997 devolved responsibility for
financial management to agencies and established mechanisms to help hold
chief executives accountable for the results of exercising their
management prerogatives. As in New Zealand, some Australian officials
described the adoption of an integrated accrual budgeting and reporting
framework as key to advancing these efforts. It was generally believed
that improving the consistency and comparability of financial, budget, and
performance information would increase its use in the decision-making
process.

Similarly, the United Kingdom's proposed adoption of accrual budgeting
emerged from long-standing efforts aimed at improving public sector
performance. Throughout the 1980s the United Kingdom embarked on a series
of reforms aimed at improving public sector performance, including the
Financial Management Initiative (FMI), which emphasized the devolution of
responsibility for budget and financial management. At the beginning of
these performance reforms, it became clear that a cash-based system would
fail to account completely for all costs necessary to deliver a specific
result, thus making it difficult to adequately assess and compare
performance within the public sector, and between the public and private
sectors. As a result, attention turned to developing an accrual-based
integrated system that would better support reform efforts by improving
the quality and consistency of the cost information and incentives
provided to decisionmakers. Given this, the United Kingdom's accrual-based
system was described by one Treasury official as an extension of earlier
reform efforts rather than a "new" direction. 

Canada also is considering expanding its use of accrual measurement in
budgeting as part of an ongoing effort to improve government financial
management and establish more business-like practices. The Financial
Information Strategy (FIS) first announced in 1989 sought to decentralize
many financial reporting responsibilities to departments and to use
accrual accounting and new reporting structures to provide departmental
managers with better tools for financial management. Through FIS, Canadian
officials hope both to achieve improvements in the government's
accountability framework and to increase efficiencies in program and
service delivery. The Canadian Auditor General opined that efforts to
integrate improved financial management into day-to-day decision-making
may be impeded if this information is not used for appropriations and
budgeting, traditionally the means by which managers are held accountable.
Because of these concerns, in December 1998, the government was asked by
Parliament to study how best to incorporate accrual concepts more fully in
the budget and appropriations.

Although Iceland's adoption of accrual budgeting also was only one small
part of broader reforms, the driving factor in Iceland's decision to adopt
accrual-based budgeting and reporting was concern over the sustainability
of the government financial commitments. According to senior officials
with the Ministry of Finance, the overarching theme behind the reforms was
to recognize the full costs of central government obligations when they
are made rather than when they are paid. In particular, there were
concerns over the large accumulated pension liability for public sector
employees. Under the prior cash system, these costs were reflected in the
budget when paid, not when earned. As a result, there were concerns that
the costs of the government's underlying commitments were understated. 

The Netherlands' efforts in this area have focused on rebalancing the role
of the public sector through privatization, deregulation, and
decentralization. Since 1992, the Netherlands increasingly has adopted
performance management initiatives to achieve these objectives and to
improve the efficiency of the public sector. The government viewed accrual
budgeting and financial statement reporting as providing the framework
necessary to manage for results. To date, an accrual framework is being
applied only in agencies where it was deemed useful in promoting results-
oriented management, such as those engaged in providing specific,
definable services like correctional facilities. In 1992, the Netherlands
amended its Government Accounts Act to create agencies--a new subunit of
government--and allow them to operate on a private sector management model
which included accrual budgeting and financial reporting. 

Accrual-Based Budgeting Credited with Improving Completeness and
Usefulness of Budget Information for Decision-making

The difficulties in isolating the benefits of accrual budgeting from those
resulting from other elements in broader reform efforts have not stopped
proponents of accrual budgeting from claiming benefits from accrual
budgeting. This chapter provides a brief introduction to some of the
general benefits and concerns these countries associated with the use of
accrual budgeting. The next chapter more fully discusses the role of
accrual budgeting in addressing issues of performance, sustainability, and
accountability within the public sector. 

As outlined in figure 1, proponents credited accrual budgeting with
improving the completeness and usefulness of the budget for decision-
making by:

o   better aligning cost with performance,

o   providing information on all costs to encourage a longer-term
  management and policy focus, and 

o   improving the consistency and credibility of budget reporting. 

Figure****Helvetica:x11****1:    Improvements in Budget Information
                                 Attributed to Accrual Budgeting

*****************

*****************

Proponents from several countries suggested that accrual-based information
was an important tool in understanding the full costs of government
programs and activities. Because accrual measurement matches costs with
the period resources are used in the provision of goods and services, it
generally has been viewed as providing a more accurate and complete
picture of the cost of government activities than the cash flows in a
given period. For example, accrual budgeting recognizes costs which
contribute to the provision of goods and services but do not require
immediate cash distributions such as employees' deferred compensation
(pensions to be paid in the future). It also spreads the costs of some
cash spending over the periods that benefit from it. For example, in an
accrual budget, the purchase cost of a capital asset would be spread over
the life of the asset as it is used rather than having the full cash
amount appearing as a cost in the period the asset is purchased as in a
cash-based budget. Thus, accrual-based information is a better indicator
of the actual resources consumed in performing government activities.
However, whether it is also appropriate for resource allocation depends in
part on whether it represents the full cost of government's commitment at
the time decisions are made. In some instances, such as pensions, accrual
measurement recognizes the government's commitment earlier than
obligations measured on a cash-basis; in other instances, particularly
capital assets, accrual measurement does not reflect the government's full
resource commitment at the time the decision is made./Footnote4/ 

In addition, accrual budgeting was viewed as enhancing understanding of
the cost of performance by making budget information more comparable to
other financial and performance indicators. For example, proponents
suggested that if both the budget and the financial statement are accrual-
based, it is easier to compare the amount requested and appropriated in
the budget to actual results reported in the financial statements and
other performance reports. Thus, accrual budgeting was viewed as helping
to improve understanding of the link between budgeted amounts and results
achieved. 

Further, proponents argue that by incorporating a balance sheet
perspective,/Footnote5/ accrual budgeting improves the information and
incentives to support a government's stewardship role. While countries
that have enacted an accrual budget/Footnote6/ generally vote on items
similar to expenses found in a projected operating statement, in doing so
they incorporate balance sheet information into the budget debate. They do
this by:
(1) including expenses associated with changes in an entity's assets and
liabilities in appropriation amounts and (2) requiring primary financial
statements to be included as part of the budget presentation./Footnote7/ 

Accrual-based appropriations generally reflect costs incurred during a
fiscal year and thus provide information similar to that found in an
operating statement. An operating statement recognizes revenue and
expenses of a period and reflects changes in the balance sheet. For
example, an asset's value is reduced by depreciation on the balance sheet
and a depreciation expense is recorded in the operating statement. Since
they reflect information similar to that included in a projected operating
statement, appropriations under accrual budgeting generally capture
expenses for a period including those that reflect changes in the balance
sheet such as depreciation or changes in the liability for pension
benefits. 

As a result, proponents generally view an accrual-based framework as
encouraging a fuller assessment of the government's management of its
assets and liabilities, and thus its longer-term financial health.
However, it is important to note that none of the countries currently use,
or plan to use, accrual budgeting to focus attention on the long-term
fiscal pressures of social insurance and health programs that experts
predict may have serious implications for many of the world's
industrialized countries./Footnote8/ 

In these countries, aligning the basis of budgetary measurement with
financial reporting standards, in particular, standards that mirror
generally accepted practices in the private sector, was seen as increasing
the credibility and consistency of budget information for public sector
decisionmakers, the financial markets, and the public. Some argued that
the public has some familiarity with private sector accounting and so
would find a budget based on it more understandable. Using the same
measurement basis throughout the financial management cycle was viewed as
increasing the credibility and consistency of information provided to
decisionmakers and thus enhancing the relevance and usefulness of
financial statements and other cost information for budgetary and
managerial decision-making. 

Proponents acknowledged that accrual-based information could be provided
without changing the budget basis, but they suggested it might have little
effect on management decisions and behavior unless it was the basis of
accountability, i.e., budgeting. Proponents asserted that budgeting on one
basis, i.e., cash, and reporting on another basis, i.e., accrual, would
send conflicting signals and incentives. In the words of a former New
Zealand official who championed the adoption of accrual budgeting,
"accrual accounting will not amount to much more than an interesting
accounting exercise unless the information is used for the purposes of
economic management." 

Some Express Skepticism About Use of Accrual-Based Budgeting
------------------------------------------------------------

Despite these perceived benefits, some officials and other experts
expressed skepticism about the value or feasibility of accrual budgeting.
Figure 2 lists some concerns raised about accrual budgeting with respect
to a central government's role in the economy and control over spending.
In addition, a number of implementation challenges raised by accrual
budgeting are discussed in chapter 4. 

Figure****Helvetica:x11****2:    Conceptual Concerns Raised About Accrual
                                 Budgeting

*****************

*****************

A concern expressed by some experts was that accrual budgeting does not
focus sufficient attention on the government's borrowing requirement and
thus fails to address adequately the central government's role as partial
custodian of the economy. For example, some economists in New Zealand told
us that even though the cash flow statement provides information on the
government's borrowing requirements, it does not provide adequate
information for analyses of the effects of government policies. There was
also some concern because decisionmakers have encountered difficulties
understanding the complexities involved in the use of accruals for
budgeting because of the technical issues and assumptions on which accrual
measurement is based. As a result, in Australia and New Zealand, observers
suggested that the opportunity may exist for manipulation in the
inherently political budget environment. Because accrual measurement
focuses on recognizing the financial effects of economic events, it is
necessarily dependent on interpretations and judgments about both when
those economic effects occur and what their ultimate cost will be. While
cash-based budget estimates also require judgment and interpretation, the
impact of a budget decision is known with more certainty at the end of the
reporting period. In contrast, the impact of accrual-measured budget
decisions may remain a matter of judgment. In our previous work on accrual
budgeting we have explored the budgetary implications of uncertainty in
estimates of risk assumed by federal insurance programs./Footnote9/ 

Finally, as discussed in chapter 5, using the accrual basis to measure
costs in the budget may, in some cases, provide less up-front budget
control than does obligation-based budgeting, such as used in the United
States. For example, obligation-based budgeting requires budget authority
for the full cost of a building before the purchase obligation is made
while accrual budgeting generally spreads cost recognition over the life
of the building. Thus, for capital assets, obligation-based budgeting
provides greater control over committing the government to future payments
than does a pure cash or accrual basis. Thus, choices about the basis of
budgeting depend in large part on the relative importance one places on
recognizing and controlling the full costs at the time decisions are made
versus the matching of recognition to the period resources are consumed.
As discussed in chapter 5, methods could be developed to capture accrued
costs, such as capital acquisition funds, so that costs can be matched
with performance while still preserving up-front control. 

For these reasons, some view accrual budgeting as potentially undermining
the central government's traditional roles in overseeing the economy and
ensuring accountability for taxpayer funds. In addition, some U.S.
officials and budget experts have suggested that these potential risks of
full accrual budgeting may not be warranted given that for most parts of
the budget, the differences between cash (for obligations) and accrual
measurement are not likely to be significant. Skepticism about the
benefits of a change to accrual budgeting is increased by the fact that if
accrual budgeting were implemented based on financial accounting standards
as done by the case study countries, it would not fully address social
insurance commitments. 

Countries Vary Significantly in the Design and Implementation of Accrual-
Based Budgeting Systems

Despite the use of common language in articulating their objectives,
countries that have chosen to adopt accrual budgeting have taken
significantly different approaches in designing and implementing accrual
budgeting frameworks. Four countries--New Zealand, Australia, Iceland and
the United Kingdom/Footnote10/--have chosen fairly inclusive approaches to
implementing accrual budgeting. These approaches (1) use the same accrual-
based/Footnote11/ accounting standards accepted by the government both for
financial reporting and to measure budget items and (2) incorporate
primary financial statements/Footnote12/ roughly similar to those found in
private sector financial reporting as part of the budget process. With two
notable exceptions--Iceland's exclusion of capital and centralization of
pension costs and the United Kingdom's exclusion of revenues--these
countries apply accrual-based measurement to virtually all budget items at
both the departmental level and the central government. The other two case
study countries, Canada and the Netherlands, have applied accrual
budgeting on a more limited basis to specific budget items or departments. 

Not surprisingly, these varied approaches are reflective of each
individual country's reform objectives and budgetary needs. As shown in
table 4, approaches varied with respect to:

o   the extent to which accrual budgeting is used as part of an output
  budgeting framework in which the budget is intrinsically linked to
  performance;

o   the scope of budget items measured on an accrual basis; and

o   the organizational level to which accrual budgeting is applied.

Table****Helvetica:x11****4:    Design Features of Case Study Countries'
                                Accrual Budgeting Approaches

-------------------------------------------------------------------------
| Design feature      : New   : Austr : Unite : Icela : Canada: Nether  |
|                     : Zeala : alia  : d     : nd    : (curr : lands   |
|                     : nd    :       : Kingd :       : ent   : (for    |
|                     :       :       : om    :       : syste : select  |
|                     :       :       :       :       : m)    :         |
|                     :       :       :       :       :       : agenci  |
|                     :       :       :       :       :       : es      |
|                     :       :       :       :       :       : only)   |
|-----------------------------------------------------------------------|
| Same accrual-based  : X     : X     : X     : X     : X     : X       |
| standards for       :       :       :       :       :       :         |
| financial           :       :       :       :       :       :         |
| reporting and       :       :       :       :       :       :         |
| budgeting           :       :       :       :       :       :         |
|-----------------------------------------------------------------------|
| Budget              : X     : X     : X     : X     :       :         |
| presentation        :       :       :       :       :       :         |
| includes primary    :       :       :       :       :       :         |
| financial statements:       :       :       :       :       :         |
|-----------------------------------------------------------------------|
| Physical assets on  : X     : X     : X     :       :       : X       |
| an accrual basis    :       :       :       :       :       :         |
| in departmental     :       :       :       :       :       :         |
| budgets             :       :       :       :       :       :         |
|-----------------------------------------------------------------------|
| Accrued pension     : X     : X     : X     :       : X     : X       |
| expense for current :       :       :       :       :       :         |
| employees included  :       :       :       :       :       :         |
| in departmental     :       :       :       :       :       :         |
| budgets             :       :       :       :       :       :         |
|-----------------------------------------------------------------------|
| Output-based        : X     : X     :       :       :       : X       |
| appropriations      :       :       :       :       :       :         |
|-----------------------------------------------------------------------|
| Departments         : X     : X     :       :       :       : X       |
| receive authority   :       :       :       :       :       :         |
| to draw             :       :       :       :       :       :         |
| cash for non-cash   :       :       :       :       :       :         |
| accruals, such as   :       :       :       :       :       :         |
| depreciation, as    :       :       :       :       :       :         |
| means of            :       :       :       :       :       :         |
| supporting          :       :       :       :       :       :         |
| decentralized       :       :       :       :       :       :         |
| management framework:       :       :       :       :       :         |
|-----------------------------------------------------------------------|
| Recognition of      : X     :       :       : X     : X     :         |
| change in accrued   :       :       :       :       :       :         |
| pension             :       :       :       :       :       :         |
| liabilities in      :       :       :       :       :       :         |
| governmentwide      :       :       :       :       :       :         |
| deficit/surplus     :       :       :       :       :       :         |
|-----------------------------------------------------------------------|
| Accrual-based net   : X     :       :       : X     :       :         |
| operating balance   :       :       :       :       :       :         |
| used                :       :       :       :       :       :         |
| as governmentwide   :       :       :       :       :       :         |
| deficit/surplus     :       :       :       :       :       :         |
| measure             :       :       :       :       :       :         |
-------------------------------------------------------------------------

New Zealand and Australia placed significant emphasis on directly linking
the budget (including the basis of appropriation) with their overall
performance and accountability structure. In these two countries, the
shift to accrual measurement occurred concurrently with a shift to output-
based appropriations./Footnote13/ In general terms, output-based
appropriations provide funding for the total resources required to produce
an "output" (a good or service produced by departments on behalf of the
government) including costs that do not require a cash outlay, such as
depreciation and pension expenses. Reflecting the desire for a business-
like environment, the intent is that, where possible, appropriations will
come to represent the "fair market price" the government intends to pay
for the department's outputs. However, Australian officials we spoke with
acknowledge that for the first few years, at least, appropriations will be
based on the total accrued costs (inputs) used to produce an output. They
suggested that the objective over time is to benchmark the prices of these
services to the private sector or other government prices for similar
services. 

The United Kingdom has also proposed an accrual budgeting framework that
aligns resources to performance, but it stops short of adopting output-
based appropriations. Under its proposed approach, accrual-based "resource
accounts" will replace appropriation accounts and become the main form of
accountability to Parliament. Parliamentary approval for departmental
funding is to operate on a dual cash and "resource" basis. Each budget
estimate will be represented by both an accrual request for resources--
which includes noncash amounts such as depreciation--and a cash
requirement for proposed cash withdrawals. However, in comparison to the
New Zealand and Australia models, which provide cash to cover noncash
amounts such as depreciation, the United Kingdom's resource budget would
treat noncash items as "notional" entries, i.e., departments will not
receive cash to cover these amounts. While stressing that a number of
issues, such as the precise treatment of capital, were still unresolved,
officials noted that a key objective in designing the system was to
concentrate attention on resources without relinquishing control over cash. 

Iceland's approach to accrual budgeting reflects a greater emphasis on
recognizing certain long-term commitments, such as employee pensions, as
opposed to allocating costs to particular goods and services. Although
significant realignment of the budget occurred as a result of the reforms,
its goal was to bring more activities into the fiscal budget--creating
links to the decision-making process--rather than aligning resources to
programs and activities. For example, Iceland's approach to budget reform
differs in two key ways from the approaches adopted in other case study
countries: (1) capital is reported on a cash basis as work is completed
and paid for, rather than on an accrual basis with depreciation to align
its cost with its use in the production of goods and services and (2)
public sector pensions are controlled and recognized centrally in the
Ministry of Finance's budget rather than allocated to budgets of the
various ministries that manage the associated programs and activities.
Under Iceland's approach, the main focus of budget debate is on the
Operating Statement that includes estimates of revenues and expenses on
both an accrual and a cash basis. However, the operating result
(deficit/surplus) is reported only on an accrual basis.

Canada and the Netherlands have taken more limited approaches to accrual
budgeting, applying accruals only to specific departments or specific
budget items. Canada currently uses accrual for public sector employee
pensions and accounts payable at both the department level and the
governmentwide level. However, it is considering a change which would
shift capital and other items to an accrual basis with the intent of
better integrating the financial management system. Under the current
system, Canada has two measures of fiscal position (deficit/surplus):
(1) the financial balance, or cash requirement, which approximates the
country's financing need and (2) the budgetary balance--its primary fiscal
measure--that includes pensions, accounts payable, and other accrual-
measured items even though cash is not needed immediately.

The Netherlands has applied accrual budgeting, using an approach similar
to the New Zealand and Australia models, for a select number of agencies
(subunits within ministries) but is still undecided about its application
governmentwide. Under the Dutch approach, a ministry receives an
appropriation to cover the price--including costs for which no cash outlay
is required--of goods and services purchased from an agency under its
control. For example, the Ministry of Justice would receive a cash
appropriation to cover the price of goods and services it intends to
purchase from the Prison Service. The Ministry of Justice would in turn
give the Prison Service a cash amount that is intended to represent the
"price" for the goods and services provided by that agency to the
Ministry. Under this regime, Parliament must approve an agency's accrued
costs--including noncash costs such as depreciation--and agencies can
"save" funds in an account with the Ministry of Finance to fund future
capital expenses. In addition, effective January 1, 2000, agencies are
able to "borrow" funds from the Ministry of Finance as well. Both the use
of "savings" and the "borrowing" of funds require approval by the Ministry
of Finance and ultimately must be enacted into law by the Parliament. The
governmentwide deficit/surplus is reported on a cash basis. 

Each of the case study countries turned to some form of accrual budgeting
as part of a broader reform effort. Chapter 3 discusses how they use
accrual budgeting to address some key issues.

--------------------------------------
/Footnote1/-^See appendixes for more detailed descriptions of the accrual
  budgeting reforms in each country.
/Footnote2/-^Budget Issues: Privatization/Divestiture Practices in Other
  Nations (GAO/AIMD-96-23, December 15, 1995).
/Footnote3/-^The purchase agreements between ministers and departments
  specify individual outputs in terms and conditions similar to private
  sector contracts.
/Footnote4/-^Proponents note that case study countries have established
  compensating control for capital asset projects. Although treatment
  varies among case study countries, appropriations are generally required
  for annual cash requirements for asset purchases that exceed
  departmental reserves or are above a certain dollar amount. See chapter
  3 and country appendixes for additional information. 
/Footnote5/-^A balance sheet perspective refers to providing information
  on assets and liabilities of an entity.
/Footnote6/-^New Zealand, Australia, and Iceland.
/Footnote7/-^Primary financial statements include a Balance Sheet, an
  Operating Statement, and a Cash Flow Statement. Iceland does not require
  a Balance Sheet in its budget presentation.
/Footnote8/-^Most countries use financial accounting standards as the
  basis of measurement for accrual budgeting. In order for a future cost
  to be recognized as a liability under most accounting standards, it must
  be considered both probable and reasonably estimable. Generally,
  government commitments such as social insurance have not been judged as
  meeting these criteria for recognition. Although not considered a
  liability, U.S. federal accounting standards do call for supplemental
  disclosures for social insurance programs. For further discussion, see
  chapter 5.
/Footnote9/-^September 30, 1997).
/Footnote10/-^Adoption of the United Kingdom's approach remains subject to
  parliamentary approval.
/Footnote11/-^Some accounting standards are not fully accrual-based. For
  example, Iceland's accounting standards require that physical assets be
  reported on a cash basis and the United Kingdom accounts for revenues on
  a cash basis.
/Footnote12/-^Traditionally primary financial statements include (1) a
  balance sheet which presents the total balances of assets, liabilities
  and net position of an organization as of a specific time, (2) a
  statement of operations which provides information on an organization's
  flows of revenues and expenses and other changes in the organization's
  net resources, during a period of time and (3) a statement of cash flows
  which presents the cash flows of an organization during a period of time. 
/Footnote13/-^Both New Zealand and Australia distinguish between items
  controlled by departments and items administered by departments on the
  government's behalf such as social insurance. New Zealand has several
  types of appropriations. For more information, see appendix I and
  appendix V.

PERSPECTIVES ON ACCRUAL BUDGETING FOR DECISION-MAKING
=====================================================

As suggested in the previous chapter, the case study countries, to varying
degrees, have turned to accrual budgeting to address concerns about public
sector performance, sustainability, and accountability. Similar concerns
have also been the focus of recent reform efforts within the United
States. In several countries, accrual budgeting has been used as a tool to
support wider performance management reforms including, in some cases,
more decentralized, performance-driven accountability systems. Accrual
budgeting is also viewed as improving the recognition of the future costs
of current decisions and so increasing the attention paid to the
sustainability of government activities. Further, accrual budgeting was
viewed as improving accountability by enhancing consistency and
transparency of budget information, even though it raises some new control
issues. However, the extent to which accrual budgeting has, or is expected
to, influence decision-making varies with the approach chosen by each
country. This chapter discusses more fully the various perspectives on
implications of accrual budgeting for decision-making.

Performance, Sustainability, and Accountability Issues Central to Reform
Efforts
---------------------------------------------------------------------------

The case study countries and the United States share the common objective
of improving public sector financial management and performance while
enhancing transparency and accountability. As described in the previous
chapter, these issues came to the forefront as the countries undertook
broader reform efforts to address significant fiscal stress and/or to
improve government operations. In the United States, there has been a
similar move to improve government performance and financial management,
leading to the enactment of a series of reforms./Footnote1/ At the same
time, changing demographics and other factors have brought to the
forefront questions about the sustainability of the government's long-term
commitments such as Social Security and Medicare.

To varying degrees countries in our review have used, or plan to use,
accrual budgeting to help address similar concerns about public sector
performance, sustainability, and accountability. Proponents of accrual
budgeting argue that the only way to really affect decision-making is to
move beyond financial statement and performance reporting to using accrual
information as the basis of resource allocation. However, most countries
have limited experience with their accrual-based frameworks and provided
only a few specific examples of decisions attributable to its use.
Further, since in general case study countries moved from a system of cash-
based accounting and cash-based budgeting to accrual accounting and
accrual budgeting, it is often difficult to distinguish the benefits of
accrual budgeting from those that would have been achieved with accrual
accounting alone. This is particularly true for such one-time benefits as
the development of financial systems or the identification of assets.
Finally, as noted earlier, the comprehensive nature of some of the reform
efforts makes it difficult to isolate the benefits of accrual budgeting
from those stemming from other changes. For example, New Zealand--the
country with the most experience with accrual budgeting--implemented
accrual budgeting as only one part of sweeping and radical reforms that
restructured the role of government and its financial and performance
management system.

Accrual Budgeting as a Tool in Addressing Performance Management Challenges
---------------------------------------------------------------------------

Country officials and other proponents saw accrual budgeting as a useful,
if not critical, tool in addressing performance management challenges. In
particular, accrual budgeting has been used to provide more timely
recognition of the complete costs of government activities, an important
factor in assessing performance. However, the design of each country's
accrual budgeting system, which tends to reflect the country's overall
management approach, shapes its role in addressing performance challenges.

In our case study countries, accrual budgeting is credited with supporting
broader management reform efforts in several ways, such as 

o   reflecting and supporting more decentralized and performance-focused
  accountability systems, 

o   facilitating more competitive, businesslike approaches to providing
  government goods and services, and 

o   encouraging more efficient and effective resource management,
  particularly with respect to capital assets.

Accrual Budgeting Viewed as Supporting More Decentralized, Performance-
Focused Accountability Systems
---------------------------------------------------------------------------

In some countries, accrual budgeting has been used to support more
decentralized, performance-focused management. Most notably, in New
Zealand and Australia, the adoption of accrual budgeting complemented a
shift to systems that allow managers considerable autonomy, including
increased freedom over the use of resources (inputs), while holding them
accountable for delivering specified results within budgeted
costs./Footnote2/ Officials and other reformers from both countries
stressed that accrual measurement, by providing a tool to match costs with
the provision of goods and services, was key to supporting these more
decentralized management systems that emphasize managerial flexibility as
a means of improving efficiency and effectiveness.

In both Australia and New Zealand performance management benefits were
attributed to the union of output budgeting/Footnote3/ and accrual
budgeting, not a shift to accrual measurement alone. In general, output-
based appropriations provide funding for the total resources used to
produce an "output" (a good or service produced on behalf of the
government), including costs that do not require an immediate cash outlay.
Managers are then given significant discretion over the mix of inputs
(spending on salaries, supplies, capital, etc.) used to produce agreed
upon outputs. This type of approach reflects and supports the philosophy
that the public sector should operate as close to a private sector model
as possible.

By structuring appropriations around outputs, these systems are intended
to reduce the traditional budget focus on controlling inputs while
increasing accountability for performance. Under New Zealand's approach,
output-based appropriations are the result of purchase agreements between
department executives and their ministers, with the ministers specifying
the output to be provided in a given quantity and at a given quality. In
Australia, appropriations for each department are for the full financial
resources, measured on an accrual basis, required to produce outputs that
contribute to the outcomes the government is trying to achieve. This
output-outcome structure is determined during a strategic planning process
in which departments and their ministers define desired outcomes, then
define the outputs that, if delivered, would lead to these outcomes.
Reflecting the desire for a more businesslike environment, the ultimate
goal in both countries was for departments to be appropriated the fair
market price of outputs./Footnote4/ Further, to provide additional
incentives to continually seek efficiencies, the Australian system permits
departments to retain a share of any operating surpluses.

Accrual budgeting was described as useful, if not critical, to developing
accountability within these more decentralized, output-focused systems. In
the view of one former official from New Zealand "a decentralized public
management structure that focuses on output and performance could not be
managed without accrual budgeting." Because an output-based system gives
departments significant discretion over how funding is used to produce
outputs, oversight is premised on the ability of policymakers, as the
purchasers of goods and services, to adequately assess the price and
quality of outputs. As a result, reliable information on the full costs of
producing goods and services, rather than just the immediate cash outlays,
becomes increasingly important to ensuring accountability.

By better aligning budget recognition with the consumption of resources,
proponents view accrual measurement as providing a better analytical base
to assess the full costs associated with a given level of performance. For
example, accrual measurement recognizes costs as they are incurred, such
as employee pensions, which may not result in cash outlays for many years
but nevertheless were earned within a budget year. Proponents also point
out that accrual measurement helps mitigate some cost distortions inherent
in cash-based budgeting. For example, the National Commission of Audit in
Australia noted that, under its accrual budgeting framework, a department
would no longer appear efficient in budgetary terms just because it used
less cash in a year if, at the same time, it accumulated more liabilities.
Conversely, it noted that a department would not automatically appear as a
poor performer because it spent a large amount of cash in 1 year on
capital assets that may in fact enable it to operate more efficiently over
time. As a result, accrual budgeting is seen as enhancing accountability
by, for example, facilitating comparisons of cost and performance among
alternative suppliers, both public and private.

Proponents from both New Zealand and Australia stressed the importance of
integrating accrual-based information directly into the budget. In their
view, better cost information alone would be insufficient to influence
managerial behavior; holding decisionmakers and managers accountable
through the budget process for all the costs associated with a given level
of performance would be more effective in creating incentives to ensure
efficiency and effectiveness in the absence of input controls. Along these
lines, a former New Zealand official involved with the reforms stressed
that if performance is what drives reform, and accrual concepts are deemed
most appropriate to assess the costs associated with performance, then it
follows that one would budget on this basis.

Accrual Budgeting Viewed as Useful in Facilitating More Competitive
Approaches and Fostering Cultural Change 
---------------------------------------------------------------------------

Whether combined with output budgeting or not, accrual budgeting was
described as improving performance by fostering more competitive and
businesslike approaches within the public sector. For example, accrual
budgeting was described as making it easier to compare performance among
alternative suppliers, both public and private. In addition, accrual
budgeting was described as important to fostering cultural change that
heightens awareness of financial and performance management issues.

Accrual Budgeting Viewed as Supporting Performance Reforms by Facilitating
Comparisons

Some proponents view accrual budgeting as supporting performance reforms
by facilitating more valid comparisons among alternative sources of goods
and services. As we have reported in the past, consistent and complete
cost information is important to fostering better management by making it
easier to more fully understand the implications of different decisions.
Similarly, officials and proponents suggested that accrual measurement
allows for more valid comparisons of performance and thus can help the
government identify inefficient areas or determine the most efficient
method of delivering government goods and services. Further, accrual
budgeting was seen as fostering more performance-focused management and
oversight by increasing the comparability of prospective budget
information with actual financial and performance information.

A senior budget official from the Netherlands used prison services to
illustrate the discord between cash-based budgeting and performance
assessment, including comparisons among alternative suppliers. He noted
that, on a cash basis, a prison making capital improvements would appear
more costly in the budget than another prison that is not making such
improvements, regardless of the year-to-year relative efficiency of the
prisons' operations. In his opinion, accrual budgeting, by spreading the
budget recognition of the cost of capital improvements over the life of
the asset, would help to improve the information and facilitate more valid
comparisons between the relative cost of operations. While this was an
improvement over a cash-based budgeting system, it does not provide for
the up-front control over capital purchase obligations that exists in an
obligation-based system. One possible approach combining the benefits of
both would be to compare accrual-based financial reports while retaining
control over government commitments under an obligation-based budgeting
system. 

Proponents of accrual budgeting saw enhanced comparability with the
private sector as beneficial. Full consideration of how a good or service
can be provided most efficiently requires understanding its full costs
including noncash items such as employee benefits earned but paid later.
Under cash budgeting or obligation-based budgeting measured on a cash
basis, these items tend to be excluded from a government's current budget
decisions. However, they are incorporated into the price of private sector
suppliers. Proponents envision that accrual budgeting, by providing more
complete and comparable costs, could result in better choices about
whether a good or service should be provided by a government department or
by a private sector entity. New Zealand intended for departments to pay
interest, taxes, and dividends so that their costs could be more readily
compared to other suppliers (including private sector entities) providing
similar goods and services. 

With more complete cost information, accrual budgeting is seen by its
proponents as a potential tool to encourage competition and facilitate
mechanisms such as contracting-out, price benchmarking, and intra-agency
charging. For example, New Zealand used accrual reports to determine the
full cost of providing policy advice in various departments. It was also
credited with helping to identify high and low cost areas, providing a
clearer understanding of intradepartmental cost differentials and raising
the possibility of achieving greater efficiencies and cost savings. As
discussed above, some proponents see the ability to more readily make
comparisons based on complete cost information as an essential component
to ensuring accountability within decentralized management systems.

Accrual Budgeting Seen as Important Tool in Supporting "Cultural Change"

Proponents see accrual budgeting as an important tool in changing the
public sector "culture" towards a more competitive, businesslike
environment. As a general point, proponents argued that providing accrual-
based information in financial statements or other supplemental reports
was not likely to change behavior significantly if the accountability
process, i.e., budgeting, remained on a cash basis. For example, the
Australian National Commission of Audit (NCOA) expressed the view that a
full accrual framework, including accrual budgeting, was an essential
component of the structural and cultural change the government was seeking
for a more competitive, efficient, and effective public sector. Observers
in the United Kingdom also suggested that, although as a general rule
generating interest in financial management issues is difficult, the use
of accrual measurement in the budget appears to have increased the
attention paid to implementing the recent accrual reforms. Similarly,
Canada's Auditor General emphasized the importance of changing the basis
of appropriations to accrual to encourage the use of this information in
day-to-day management.

Proponents generally held the view that accrual budgeting serves to
enhance the prominence of performance management and oversight. Country
officials and department managers we spoke with noted a greater focus on
financial management as a result of the shift to an integrated accrual-
based framework, including accrual budgeting. They suggested that, since
the budget really matters to departmental managers, including accrual-
based information in the budget greatly increases the stakes associated
with its preparation and use. For example, officials from the Office of
the Controller and Auditor General in New Zealand said that financial data
under the accrual-based framework are more robust, consistent in quality,
and timely. Departments now produce monthly accrual reports within 7 days
of the end of the month. They attributed this in part to the departments
more closely monitoring their accounts on an accrual basis to avoid
breaching appropriations. The view that accrual-based frameworks had
improved, or were expected to improve, financial and cost data was held in
most case study countries.

Accrual Budgeting Viewed as Encouraging More Efficient and Effective
Resource Management
---------------------------------------------------------------------------

Advocates of accrual budgeting view it as a useful tool to encourage more
efficient and effective resource management, particularly with respect to
capital assets./Footnote5/ However, because most case study countries used
predominately cash-based budgeting systems prior to changing to the
accrual basis, their views of the trade-offs associated with a shift to
accrual budgeting based on financial accounting standards are likely to
differ from that of the United States. Shifting to accrual budgeting might
not yield the same benefits in the United States, which already has
accrual-based financial reporting. Moreover, compared to obligation-based
budgeting in the United States accrual budgeting without compensating
controls would delay the budget recognition of the government's commitment
for asset purchases.

Proponents and officials in most of the case study countries view accrual
budgeting as encouraging the more efficient and effective use of resources
by

o   providing better information and incentives with respect to total
  resources consumed in the provision of goods and services, and 

o   better reflecting the cost of capital, thus encouraging better
  capital asset management.

Proponents see accrual budgeting as improving resource management by
providing a better analytical base and incentives for assessing
performance and managing costs. Managers from the United Kingdom and New
Zealand expected that by providing more and better quality information,
accrual-based frameworks would improve resource management by increasing
the number and quality of questions asked about an organization and its
performance. Although some other government officials view the increased
agency discretion provided in systems that combined output budgeting with
accrual budgeting with concern, proponents credited these systems with
helping achieve fiscal constraint by better targeting spending cuts and,
as discussed in the previous section, by encouraging efficiency gains. For
example, according to a former New Zealand government official, under the
old cash and input focused system, the government could arbitrarily impose
an across-the-board budget squeeze but would not necessarily know the
direct implications of this squeeze on performance. In contrast, improved
availability and quality of performance and cost information under their
accrual-based frameworks would enable officials to better understand the
implication of budget decisions on performance. Specifically, under
accrual-based output budgeting, the ability to translate a change in
funding to a change in output was viewed by some proponents as improving
the decision-making process. Some we spoke with, however, credited these
benefits, at least in part, to the better linking of spending to specific
results than to the shift from cash to accrual measurement.

In some countries accrual budgeting was used as a tool to support
increased flexibility in asset management. In New Zealand, Australia, and
the Netherlands, for example, department appropriations include funding
for noncash items such as depreciation expense. Managers are expected to
manage their asset base, which includes purchasing replacement assets with
funds accumulated from this depreciation expense, although skeptics might
worry that such funds would not be saved. Proponents say that this
increased flexibility allows managers to make and implement more efficient
decisions with respect to their asset mix. In New Zealand, for example,
managers could replace nonperforming telephone equipment more quickly
rather than submitting to the previous lengthy approval process. In this
approach, however, more than budgetary accounting has been changed.
Agencies in some countries have been given a level of discretion with
respect to asset purchases that is significantly different from the U. S.
system./Footnote6/

Up-front control over contractual obligations is the focus of the U.S.
obligation-based budget and including the cost of an asset in the budget
before the government's commitment is made provides the Congress an
opportunity to control spending. Recording the full cost for an asset
purchase up front, as in the United States' obligation-based budget, also
promotes fiscal control, an important objective in U.S. budgeting. By
recording the costs up front, agencies and the Congress are encouraged to
compare that cost with expected benefits when deciding whether to purchase
the asset. Conversely, for capital assets, accrual measurement would delay
cost recognition so as to spread the costs over the life of the
asset./Footnote7/ In this sense, choices about the basis of budgeting
depend in part on the relative importance placed on recognizing and
controlling the full costs at the time decisions are made versus the
matching of budget recognition to the period resources are consumed.

Officials in several case study countries pointed to some compensating
controls within their accrual frameworks. For example, if the cost of an
asset exceeds accumulated depreciation, "capital injections"/Footnote8/
are required and these are subject to parliamentary approval in Australia
and New Zealand and parliamentary notification in the Netherlands. In
these cases, budget approval would be for the cash required in the budget
year. In addition, in New Zealand, even if an agency had accumulated
sufficient funds to replace an asset without a capital injection, capital
purchases above a specified amount require approval./Footnote9/ Further,
Australia, New Zealand, and the United Kingdom require additional
information on capital purchases under their accrual-based frameworks. For
example, information such as (1) depreciation and capital charges
resulting from the new asset and (2) the available cash reserves and
capital injection needs may be required. This richer suite of information
is perceived to help decisionmakers to make the proper trade-off between
alternatives, e.g., whether to buy or lease a new asset, or simply to
renovate an existing asset. Finally, some proponents pointed out that
because depreciation and the capital charge would be included in future
budgets, an asset no longer appeared as a "free good" after the initial
purchase.

Improved alignment between budget recognition and the use of capital is
another cited benefit of accrual budgeting. In Australia, New Zealand, the
United Kingdom, and the Netherlands, the appropriation for a department's
operating budget or for specified outputs includes the annual cost of
using capital, i.e., depreciation and the cost of capital
charge./Footnote10/ This treatment was viewed as useful in (1) enabling
comparisons among the relative costs of different operations and (2)
distinguishing between current and capital spending.

Proponents believe that this approach improves decision-making by
spreading the budget recognition of capital costs over the life of the
asset. Specifically, it was viewed as improving both the information and
the incentives to make more valid comparisons between the relative cost of
operations. Further, some proponents suggested that by better aligning the
budget recognition of capital with its use, accrual budgeting can be used
to provide a better distinction between current spending and capital
investment. For example, in New Zealand, the United Kingdom, and
Australia, cash requirements for capital acquisitions are treated
separately from the cost of using capital in departmental budgets. Some
proponents stated the view that this reduces a perceived bias against
investment which may be created when the purchase cost of a capital asset
must be recognized in the budget in the year of the purchase. The trade-
off here is between aligning budget recognition of capital with its use
and the greater fiscal control realized from up-front budgeting. In the
United States, the purchase cost is recorded up front so that commitments
for asset purchases can be controlled by the Congress before they are
made. In the U.S. setting, information on the use of capital in providing
services is available to the Congress in accrual-based financial reports
for use in conjunction with obligation-based budgeting.

To further encourage the efficient use of assets, some countries also
incorporated capital charges into their accrual budgeting frameworks. A
capital charge, similar to an interest charge, generally is used to
reflect the opportunity cost of capital invested. Several countries in our
review--Australia, New Zealand, and the United Kingdom--have established a
policy of levying a capital charge based on a percentage of a department's
net assets in order to recognize the cost of capital held by
departments./Footnote11/ In New Zealand, this works as follows:
departments are appropriated as part of the output price a capital charge
based on their asset base at the beginning of the year; at the end of the
year they must pay the government a capital charge based on their year-end
asset base. If a department has a smaller asset base at the end of the
year than the asset base for which the appropriation was made, the
department is permitted to keep part of the appropriation made for the
capital charge. New Zealand officials see this as providing an incentive
to identify and dispose of underperforming assets; Department of Education
officials stated that the capital charge spurred the department to sell a
number of vacant sites that it had acquired in the 1960s and held although
they were no longer needed.

Further, proponents credit accrual budgeting with improving the
identification and valuation of assets. Although acknowledging that this
benefit might have been achieved through a shift to accrual accounting
alone without changing the basis of budgeting, proponents suggested that
the link to budget improved incentives to take the reforms seriously and
not simply treat accrual-based information as a paperwork exercise. Some
officials and managers cited cases of finding assets that were poorly
managed and even assets that they were unaware of owning. In New Zealand,
the asset identification exercise led to the discovery that unpaid fines
due to the Department of Justice were a significant asset on the
department's balance sheet. Subsequent attention prompted the department
to actively manage its accounts receivable by replacing traditional
collection methods with direct payment systems at courthouses and using
computerized call centers for tracking slow payers.

Some Skepticism and Concerns Raised About Implications of Accrual
Budgeting on Resource Management 

Some skepticism has been raised about the claims for accrual budgeting's
beneficial impact on resource management. Some expressed concerns about
the implications of the assumptions and judgments necessary for accrual
measurement on transparency and thus on users' understanding. In addition,
some we spoke with were uncertain about the extent to which the new
information had influenced managerial decision-making. Several issues were
noted with respect to asset management. For example, officials in New
Zealand's Office of Controller and Auditor General were uncertain about
the effectiveness of having a charge for capital in changing behavior
significantly. Further, some officials noted that, while changes resulting
from the shift to accrual were greatest for capital intensive departments,
in New Zealand only a limited number of departments hold enough assets to
make the change significant in the annual budget process. Along a
different line, some analysts expressed the concern that capital charging
could drive department executives to decisions that are rational in the
short term but damaging in the long term. For example, an audit official
suggested that a department might have an incentive to try to operate with
obsolete and fully depreciated assets in order to avoid a higher capital
charge. In addition, while proponents thought that the increased
discretion over asset purchases was key to supporting managerial
efficiency and effectiveness, the increased discretion combined with cash
funding for depreciation could result in the potential for departments to
divert this funding for other purposes.

Additional concerns were raised that some forms of accrual budgeting could
impede efficient asset management./Footnote12/ For example, some officials
in New Zealand noted that in a technology-intensive environment, such as
defense, asset prices tend to increase commensurate with improving
technology. In such an environment, accumulated depreciation would be
inadequate to fund asset replacement, thus requiring capital injections.
Because capital injections are given heightened scrutiny during the budget
process, some hypothesized that it could be harder to replace assets.
Another concern about the New Zealand model of accrual budgeting was the
possibility that requiring departments to maintain their asset
bases/Footnote13/ could serve to lock in the asset levels that existed
when accrual budgeting was first implemented whether or not this reflects
the optimal allocation of assets among departments. Further, the use of
initial asset base levels to calculate future budgetary amounts, including
the depreciation charge generally based on current value, could give
departments that were asset rich an advantage over those that were asset
poor. This latter group either must request a capital injection or operate
with minimal assets. Although New Zealand officials told us that there had
been no significant attempt to optimize asset levels prior to the shift to
accrual budgeting, proponents suggested that accrual budgeting has
increased the attention given to these issues. 

In addition, the need to incorporate accrual measurement directly into the
budget may be questioned. Some of the benefits credited to accrual
budgeting--improved asset identification and valuation, better information
on the organization and its activities, or improved capital investment
planning--might have been achieved without a shift in budgetary
measurement by, for example, implementing accrual-based accounting and
reporting alone. Some experts also noted that the cost of capital charges
could be implemented within obligation- or cash-based budgeting systems.
Proponents, however, expressed the strong belief that the link to the
budget increased the incentives to take the reforms seriously and to
ensure numbers were reasonable.

Asset identification and valuation were cumbersome and time-consuming
efforts and the integration of accrual concepts such as depreciation
created new budgetary control issues. These and other implementation
challenges are more fully discussed in chapter 4.

Sustainability of Government Activity Partially Addressed by Accrual
Budgeting
---------------------------------------------------------------------------

Some countries that have incorporated accrual information in their
financial management systems have done so, in part, with the expectation
that it will help decisionmakers better understand long-term
sustainability of government policies. This can be thought of as going
beyond the longer-term management perspective for capital or more
effectively targeting budget reductions to support fiscal constraints, as
discussed in the preceding section, to the question of assessing the
sustainability of government policies by providing

o   better budget recognition of liabilities, and

o   a more complete set of information to assess a country's financial
  health.

However, there are limits to using an accrual budget based on financial
accounting standards in addressing long-term sustainability issues. A key
limitation is that accrual budgeting as implemented by the case study
countries does not capture social insurance commitments. The case study
countries chose to largely mirror their financial accounting standards in
their accrual budgets, but social insurance is not judged to be a
liability under their accounting standards. Thus, none of them have
budgeted for such commitments on an accrual basis. This would also be the
case if the United States adopted accrual budgeting strictly based on its
federal accounting standards.

Accrual Budgeting's Better Recognition of Liabilities Credited With
Leading to Program Changes
---------------------------------------------------------------------------

Although accrual budgeting does not deal with social insurance programs,
proponents said it provides a fuller picture of other liabilities arising
from past and current policy actions. For programs with long-term
commitments, including public employee pensions, insurance, and credit,
cash-based budgeting may not recognize a government's ultimate costs at
the time the commitments are made. In these cases, accrual-based
information on the government's liabilities could improve budgetary
decision-making. Indeed, proponents from New Zealand and Iceland pointed
to accrual budgeting as leading to changes to such programs.

In both countries the adoption of accrual budgeting highlighted issues
with respect to public employee pension programs. In Iceland, accrual
budgeting showed the consequences of wage negotiations on future public
employee pension costs. Since a retiree receives a pension tied to the
base salary of the person currently in the retiree's former job, wage
renegotiations directly affect Iceland's pension liabilities. The full
costs of these agreements were not fully realized by the public until the
adoption of accrual budgeting led to the recognition of the liability in
the budget estimates. Officials informed us that there is no longer public
support for decisions that are so costly in the long term. Similarly, in
New Zealand, recognizing pension liabilities on the balance sheet and
accruing the annual change in that liability as an expense in the budget
prompted greater fiscal caution about these long-term commitments. Under
cash budgeting, the magnitude of future public sector pension costs was
recalculated and reported to Parliament every 5 years, but this
information generally did not play a significant role in the budget
debate. According to a former minister, once the full liability for public
sector pensions was brought onto the balance sheet and the annual change
in the liability was included in the budget as an expense, New Zealand
made the difficult decision to close its defined benefit pension plan to
new government employees.

As a result of recognizing the liability from providing accident coverage,
the New Zealand government initiated efforts to reform the Accident
Compensation Corporation (ACC) program. ACC is an insurance program
comprising six accounts covering accidents ranging from motor vehicle to
those occurring on the job. In the past, the value of future payments due
to claimants was recorded only in the financial statement footnotes and
had no impact on either the operating statement or balance sheet of either
the ACC or the government. The accounting treatment recently changed, and
the government recorded a liability for these programs for the first time
in fiscal year 1999-2000. Consequently, the government booked on its
balance sheet a liability of nearly NZ$7 billion for previous
accidents./Footnote14/ With accrual budgeting, this also reduced the
estimated budget surpluses by 
NZ$500 million since the estimated future cost of current accidents was
booked as an operating expense. Officials attributed New Zealand's
decision to raise premiums and add surcharges largely to this inclusion of
program costs in the budget. The intention was to fully fund portions of
ACC by 2014, thus helping to ensure that those programs are sustainable
into the future.

Accrual budgeting was also credited with spurring changes in insurance
claims management. Under the new accrual environment, ACC staff is
dedicating more time to managing long-term disability cases with the
highest projected costs. Through active management, ACC aims to reduce the
severity of disability cases and thus program costs in the long run.

Some proponents also believe accrual budgeting helps improve decision-
making by providing more complete information for understanding how
budgetary decisions will affect a country's financial health. Accrual
budgeting frameworks were viewed as providing more complete information in
at least two ways. The first way is by including actual and projected
accrual-based financial statements in the budget presentation. For
example, the accrual budget presentations in Australia,
Iceland,/Footnote15/ New Zealand, and the United Kingdom include the
primary financial statements./Footnote16/ The second way is by reflecting
annual balance sheet changes in the operating statement which is, in
effect, the accrual budget. For example, an accrual-based appropriation
would include the cost of pension benefits earned but not paid in the
budget year, which represents the annual increase in the liability on the
balance sheet. As a result, accrual-based appropriations capture changes
to a government's net worth,/Footnote17/ which flow through the operating
statement. Some view trends in net worth, if measured on a consistent
basis, as one indication of whether a country's fiscal condition is
improving or declining.

Some Experts Question Usefulness of Accrual Budgeting for Addressing
Sustainability Issues
---------------------------------------------------------------------------

While proponents expressed the view that accrual budgeting was valuable in
heightening awareness of sustainability issues, other experts were more
cautious on this point. Two key concerns were:

o   some significant government commitments are not captured in an
  accrual budget, and

o   the meaning of "net worth" in the government context is unclear.

First, as noted above, accrual budgeting based on financial accounting
standards does not capture some key fiscal pressures, such as future costs
associated with social insurance programs. While some case study countries
used modeling to estimate the future costs of these programs, none include
them--or plan to include them--in the accrual-based budget. 

Specifically, none of the case study countries recognize social insurance
commitments as liabilities in their financial statements or record the
expense in their accrual budgets. This is because these commitments do not
meet financial accounting standards' criteria for recognition as a
liability. Generally, the financial accounting standards adopted by most
of the case study countries define liability recognition with three
criteria:
(1) an event has occurred, (2) a future payment is probable, and (3) the
amount of the future payment is reasonably estimable. Using these
standards, a differentiation generally is made between pension and
insurance programs, which meet the recognition criteria as liabilities,
and social insurance programs, which do not. For example, premium payments
for insurance programs bring with them an expectation that claims will be
paid--a probable and reasonably estimable future payment will be made once
an insured event has occurred. On the other hand, the future payments for
social insurance programs, which in the case study countries are funded on
a pay-as-you-go basis, could be adjusted to fit within the fiscal policy
objectives of the government at the time the payments need to be
made./Footnote18/ However, many of the case study countries use long-term
cash forecasts, as does the United States, to recognize and present
information on the imbalance between revenues and expected payment streams
for social insurance programs.

Another argument made against recognizing social insurance as a liability
is that a key factor in the government's ability to meet these social
obligations, i.e., the power to tax, is not recognized as an asset. For
example, according to officials in several case study countries,
estimating future tax revenue is complicated and it may not be able to be
reliably estimated. Since the power to tax is an asset that the government
could call upon to meet the demand for social insurance, some experts
suggested that accruing a liability for social insurance but not
recognizing the power to tax as an asset would give an inaccurate picture
of fiscal position.

This is one major reason why some accrual-based concepts such as net worth
are difficult to fit into the government context. As mentioned above, some
important long-term commitments are not recognized as liabilities and do
not appear on the balance sheet. Further, a government's "power to tax"--
the means by which any government can pay its long-term commitments--is
not recognized in government financial statements. In addition, there are
numerous valuation issues created by the unique nature of many government
assets and liabilities. Nevertheless, proponents maintain that the new
framework provides more and better information than the previous cash-
based framework. Further, New Zealand officials suggested that, although
there are difficulties in measuring and interpreting some balance sheet
items, this information may still provide useful trend information if
measured using consistent standards from year to year. That is, while the
measure may not necessarily be precise, changes from one year to the next
may provide insights to decisionmakers on the implications of their
decisions for the overall health of the nation.

Some Accountability and Control Issues Are Addressed by Accrual Budgeting
but Others Are Raised
---------------------------------------------------------------------------

Proponents in all of the case study countries expected greater
accountability from the adoption of accrual budgeting. Specifically,
officials and other proponents credit the use of accounting standards for
budgeting with increasing the transparency and credibility of budget
estimates. Against the backdrop of their own budget history, they viewed
the adoption of accounting standards as promoting greater accountability
and transparency. Markets in particular were viewed as one audience for
these reforms; for example, enhancing the credibility of budget
information for financial market participants was viewed as a critical
part of New Zealand's initiatives to enhance its market standing. In some
cases, the adoption of accrual budgeting corresponded with the
establishment of other new budget planning and reporting procedures
designed to institute forward looking budgetary frameworks and
reports./Footnote19/

Accrual Budgeting Adopted for Greater Transparency and Accountability
---------------------------------------------------------------------

In general, the case study countries adopted accrual budgeting in reform
environments which stressed the need to improve the "transparency" of the
budget process and invite increased scrutiny of fiscal policy and specific
spending initiatives. For example, Australia's Charter of Budget Honesty
and New Zealand's Fiscal Responsibility Act each mandate the release, at
the start of the budget process, of fiscal strategy statements setting the
broad strategic goals of the government. Subsequently, the budget
represents how the government intends to implement its strategy. These two
countries viewed an accrual framework as important in supporting efforts
to improve transparency. In particular, proponents in New Zealand informed
us that cash-based budgeting followed inconsistent and complex practices
understood by only a few practitioners. In contrast, private sector
standards were viewed as generally accepted and understood. Consequently,
proponents view applying these standards to the budget as helping to
ensure that the budget is understood and subject to greater public
scrutiny than was possible when the budget was cash-based.

Proponents stated the opinion that budgeting based on accounting standards
increased the consistency and credibility of budget information because
the accounting standards are independently developed, well documented, and
may be more readily understood. For example, in New Zealand, applying
private sector or other established accrual accounting standards was
viewed as improving the credibility of government financial management in
the credit markets. New Zealand had experienced loss of market confidence--
partly attributable to government's poor fiscal management--and faced the
prospect of credit downgrades. Reform efforts including accrual budgeting
were begun, at least in part, to regain the trust of the credit markets.
Officials in the United Kingdom and New Zealand told us that they believe
the adoption of standards for budget development and presentation that
mirror private sector accounting standards will enhance the credibility of
budget estimates in the public debate. Officials told us that in their
opinion, budgeting based on these standards provides consistency and
reliability which can help instill confidence in the estimates and in the
ability of the government to achieve its fiscal targets.

Improving the consistency between the budget estimates and the financial
statements was also seen as important to enhancing parliamentary scrutiny.
Proponents expressed the belief that lack of comparability between the
information in the budget and the information decisionmakers receive on
the actual results of their budget initiatives in accrual-based financial
reports was problematic. For example, officials from New Zealand,
Australia, and the United Kingdom all noted that differing budgeting and
reporting standards generally provided conflicting signals to
decisionmakers and could lead to the failure to adequately focus on
results and performance. They viewed the alignment of the basis of
budgetary measurement with that used in financial accounting standards,
i.e., accrual, as providing a consistent basis with which to make
comparisons.

Accrual Budgeting Raised New Accountability and Transparency Concerns 
----------------------------------------------------------------------

Just as different budget structures highlight different issues, they can
bring to the forefront different trade-offs. Budgetary accounting may hide
or make transparent the implications of given choices and so confer an
advantage or disadvantage. In some cases the trade-offs highlighted in an
accrual budget are different than those that would have been presented for
the same budget proposal under a cash budget. Although decisionmakers were
expected to benefit from any new information that would be available as a
result of accrual budgeting, its use--especially in support of more
decentralized, performance-focused management philosophies--also raised
some new accountability and control concerns.

Some forms of accrual budgeting may provide less control by top-level
decisionmakers over some budget items. This is especially true for capital
assets where, on an accrual basis, parliamentary decisionmakers may have
less ability to control asset purchasing decisions than with a cash-based
or obligation-based budget. As previously noted, in New Zealand,
Australia, and the Netherlands cash is appropriated for noncash items,
such as depreciation expense, and agencies will be allowed to save for
asset renovation or replacement. Proponents in these countries argue that
this discretion is key to encouraging effective management and that
compensating controls can be established to alleviate these concerns.
However, critics have raised concerns that delegating asset purchase
authority to departments entails surrendering control over decisions that
should be made in a governmentwide arena. This delegation could limit the
government's ability to make trade-offs across agencies in the use of
scarce resources. It also ties funding for new assets to existing assets
through depreciation which fails to recognize changes in needs. For
example, this process could provide too much for agencies with declining
demands for assets and too little for agencies with expanding asset needs.
It is unclear whether the compensating controls that were instituted to
provide for parliamentary review of most asset purchases offset these
problems.

Monitoring budget execution on an accrual basis presents new challenges.
Under cash- and obligation-based budgeting, oversight of budget execution
is relatively straightforward because managers usually do not have access
to more cash than they are expected to use in a given period and
obligations are closely monitored to avoid breaching the amount permitted
by law. Under these types of budgeting systems, oversight of budget
execution generally involves reviews of obligations incurred and cash
disbursements to ensure that payments are made in accordance with
authorized purposes.

Some we spoke with expressed concerns that the increased complexities
associated with the use of accruals may lead to reduced transparency and
control. These challenges arise because, depending on the accrual approach
used: (1) cash may be appropriated for noncash expenses,
(2) some accrual-based amounts are based on assumptions and judgments
which must be understood to reduce the potential for error or
manipulation, and (3) when combined with output-based budgeting, wide
discretion is provided over the use of resources. For example,
parliamentary staff in the United Kingdom expressed concern about the
ability to understand the reconciliation between cash requirements and
accrued costs. Further, observers in New Zealand expressed concern that in
the absence of truly competitive environments, the lack of detailed input
information makes it difficult to judge departmental performance,
especially the reasonableness of the output "prices" on which the system
is premised. Under an accrual budgeting model, oversight may be grounded
in financial management principles such as asset/liability management and
the sustainability of projected cash flows. For example, in Australia,
departmental performance will be monitored based on assessment of
departmental operating statements. This is important in these systems
because, as departments are given significant discretion over how funding
is used to produce outputs, oversight is premised on the ability of
policymakers, as the purchasers of goods and services, to adequately
assess the price and quality of outputs. As a result, understanding the
full costs of producing goods and services, rather than just the immediate
cash outlays, becomes increasingly important to ensuring accountability.

These issues and other oversight challenges will be discussed more fully
in chapter 4.

Countries Developed Mechanisms to Cope With Budget Control Issues 
------------------------------------------------------------------

Proponents noted various mechanisms which can help address control issues.
For example, officials from several countries, including New Zealand,
Australia, and the United Kingdom, pointed to corresponding enhancements
such as alternative measures of fiscal performance, increased requirements
for strategic and investment planning, and increased accountability for
performance. For these reasons, proponents argued that it was important to
consider a country's entire accrual-based management framework when
considering issues of control and accountability. For example, limits may
be placed on managerial discretion by fiscal targets that govern key
budgetary decisions and continue to be measured primarily on a cash basis.
Officials argued that if total borrowing is constrained through fiscal
policy objectives, such as debt-to-GDP targets, it may be more difficult
for departments to justify capital injections (cash advances) for an asset
purchase price even if only one year's depreciation expense would be
recognized in the accrual-based budget.

All case study countries that adopted accrual budgeting continued to use
some cash-based measures to monitor fiscal policy. For example, New
Zealand uses an accrual-based operating balance as its primary deficit or
surplus measure, but continues to monitor its debt-to-GDP ratio--a cash-
based measure. Officials explained that the debt-to-GDP ratio is a key
fiscal target which, used in conjunction with an accrual-based surplus or
deficit, provides additional information for decisionmakers to undertake
fiscally cautious decisions that contribute to improving the fiscal health
of the country./Footnote20/ In fact, New Zealand officials and experts we
interviewed explained that setting debt targets guides the determination
of the accrual-based surplus or deficit target.

In the United Kingdom, the adoption of a fiscal framework which more
clearly distinguishes between current and capital spending was intended in
part to encourage capital investment. Nevertheless, the Parliament has
asked that the new appropriations bills include a reconciliation at the
departmental level between resources consumed (accrual amounts) and cash.
Furthermore, they asked to vote on the departmental cash reconciliation as
well as on the resources allocated at the activity level. These votes are
intended to draw attention to the cash needs of the budget and demonstrate
an interest in continuing parliamentary review of these cash resources.

In Australia, debate continues over whether the dominant measure of fiscal
position should be accrual- or cash-based. Some who advocated that the
primary measure of fiscal position be accrual-based stated that in order
to most fully influence behavior, the government should use as its primary
measure the same measure to which departments are held accountable. Others
expressed the view that that cash-based measures are a better indication
of the government's role as steward of the economy and, additionally, are
more familiar to the public. While Australia's budget is presented on an
accrual basis, the budget balance--or bottom line--is adjusted to
represent the cash financing requirements.

Aside from constraints imposed through cash-adjusted and cash-based fiscal
targets, some case study countries imposed other controls at different
levels in the budget process. For example, successive reforms in New
Zealand--the State Sector Act of 1988 and the Public Finance Act of 1989--
changed the locus of accountability in the public service by holding
executives responsible for their performance through public service
contracts. The new public service system is characterized by executive
discretion over the hiring and firing of managers and other employees
should performance not measure up to the expectations set forth in their
contracts. 

In addition, in some countries Cabinet scrutiny ensures that cash controls
are still in place at an overall governmental and fiscal level. In
Australia, for example, the Expenditure Review Committee, which is
responsible for making budget decisions, retained its focus on incremental
changes and cash requirements. Further, the Department of Finance and
Administration (DoFA) will continue to review the monthly expenditure
reports to ensure that departmental spending is in line with what has been
budgeted and appropriated. Although ultimate accountability for any breach
in budgeted appropriations lies at the department level, DoFA expects to
review spending trends and advise senior decisionmakers if financial
management is suspect. Similarly, in New Zealand, the timely availability
of monthly financial statements was viewed as allowing analysts in the
Department of Treasury to determine whether departments are on track to
deliver outputs within the agreed upon price, or on the verge of breaching
their appropriations.

Conclusion
----------

Case study countries expressed the view that accrual budgeting is a useful
tool in addressing concerns about public performance, sustainability, and
accountability. Some proponents view it as necessary to support more
decentralized, performance-focused management by improving links between
cost and performance. Accrual budgeting was viewed as providing
decisionmakers with more complete information on sustainability of some
government policies with long-term budgetary implications. Finally,
proponents expressed the belief that accrual budgeting would improve
accountability and control by enhancing the consistency and transparency
of budget information. This last point was challenged by other observers
who expressed concerns and skepticism that the increased complexities of
accrual measurement and the decentralization of responsibility that
accompanied most of the case study countries' budget reforms present
difficult trade-offs that might offset the benefits proponents expect to
achieve. Finally, some question the usefulness of accrual budgeting in
addressing sustainability issues because it does not capture some key
fiscal pressures--those associated with social insurance and health care
programs.

The design of an accrual budgeting system shapes its role in addressing
these challenges and tends to reflect a country's overall management
approach and desired level of control. For example, the extent to which
the adoption of accrual budgeting reflected fundamental changes to core
management philosophies and systems varied significantly. Some countries,
such as New Zealand and Australia, integrated accrual budgeting with
output-based appropriations to support decentralized, performance-focused
management systems. The United Kingdom plans to use accrual budgeting to
better recognize costs but to date has not chosen to shift to output-based
appropriations. Conversely, Iceland's accrual budgeting system, which
excludes capital and accrues pension costs only at the central level,
better reflects aggregate costs to the government but places less emphasis
on allocating full costs to particular goods and services. In general, the
design of a country's accrual budgeting system tended to reflect its key
concerns and reform objectives.

--------------------------------------
/Footnote1/-^For further discussion of reform efforts see chapter 1 and
  chapter 5.
/Footnote2/-^The Netherlands has applied a similar approach on a more
  limited basis to specific department activities.
/Footnote3/-^Output generally refers to goods and services produced by
  departments. For example, in New Zealand the quantity and price of
  outputs are agreed upon by the ministers and their departments' chief
  executives. 
/Footnote4/-^New Zealand has used a staged approach to implementing
  accrual-based output appropriations. The final stage, to which no
  department has transitioned, assumes competition among suppliers of
  outputs. For more detailed discussion of the New Zealand system, see
  appendix V. Australia's system is designed so that appropriations
  ultimately are to represent the "price" the government intends to pay
  for each agency's contribution to the achievement of planned outcomes.
  Australian officials noted however that at least in the first few years,
  appropriations would be based on the total accrued costs (inputs) used
  to produce an output. See more information on the Australian system, see
  appendix I. 
/Footnote5/-^Not all case study countries use accrual budgeting for
  capital assets. As discussed in appendix III, Iceland expenses assets as
  payments are made. Canada plans to report all assets on an accrual basis
  in its whole-of-government financial statements beginning in fiscal year
  2001-2002. As discussed in appendix II, Canada has not decided yet
  whether to budget on a full accrual basis. In the United Kingdom, the
  current proposal is for depreciation and capital charges to be "notional
  entries" which require a parliamentary vote but will not result in the
  departments receiving cash.
/Footnote6/-^Proponents point out that case study countries established a
  number of compensating controls in an attempt to alleviate control
  concerns. For example, in New Zealand, managers are not allowed to
  change the structure of their balance sheets without legislative
  approval; this is aimed at preventing managers from running down their
  asset bases to artificially lower the price of outputs. A number of case
  study countries also established supplemental approval processes for
  capital projects. See country appendixes for additional information.
/Footnote7/-^Although treatment varies among case study countries,
  appropriations are generally required for the annual cash required to
  purchase assets. However, these annual cash amounts may not represent
  the full cost of the assets. In some cases, legislative approval is not
  required for asset purchases below a certain amount if the department
  can fund them from depreciation reserves.
/Footnote8/-^In general terms, a capital injection refers to the amount of
  additional funds required for a capital purchase beyond a department's
  available reserves. It represents an increased investment in a
  department's asset base.
/Footnote9/-^Asset purchases over NZ$10 million require cabinet approval,
  whether or not departments need a cash injection.
/Footnote10/-^Specifically, in New Zealand, Australia, and the
  Netherlands, departments receive cash funding to cover these noncash
  amounts. In the United Kingdom, the current proposal is for these
  amounts to be "notional entries" which require a parliamentary vote but
  will not result in the departments receiving cash.
/Footnote11/-^In the Netherlands, agencies will pay for the capital costs
  associated with loans used to finance asset purchases beginning in 2000.
/Footnote12/-^As noted earlier, some forms of accrual budgeting provide
  appropriations for noncash expenses such as depreciation with the
  expectation that departments will use these funds to maintain their
  asset base.
/Footnote13/-^In an accrual budgeting framework, maintaining the asset
  base generally refers to managing the value of assets on the balance
  sheet so that it does not decline from year to year except through the
  sale of excess assets.
/Footnote14/-^The recognition was to be based on the estimated probable
  cost of claims existing at the end of the year, with minor adjustment
  for claims incurred but not reported based on historical experience.
/Footnote15/-^Iceland does not include a projected balance sheet in its
  budget presentation.
/Footnote16/-^Primary financial statements include an operating statement,
  a balance sheet, and a statement of cash flows.
/Footnote17/-^Net worth is the difference between balance sheet assets and
  liabilities. Case study countries that have capitalized assets included
  values for heritage assets and defense weapon systems as assets on their
  balance sheets. However, some exceptions are made due to valuation
  difficulties.
/Footnote18/-^The Canadian Pension Plan, broadly similar to the U.S.
  Social Security system, is a joint federal-provincial program. It is
  separate from both federal and provincial budgets and its revenues and
  expenses are not included in Canada's budget. 
/Footnote19/-^In the United States, the Congressional Budget Office
  produces 10-year outlay-based projections for use in the budget process.
/Footnote20/-^For more detailed discussion of this topic see Budget
  Surpluses: Experiences of Other Nations and Implications for the United
  States (GAO/AIMD-00-23, November 2, 1999).

CHALLENGES IN IMPLEMENTING ACCRUAL BUDGETING
============================================

Case study countries faced a number of challenges in implementing their
accrual budgeting systems. First, they had to determine what standards to
use to measure accrual amounts in the budget. To varying degrees,
countries also had to develop new systems to collect and analyze accrual-
based data. In addition, countries faced challenges with respect to asset
identification and valuation, oversight of budget execution, and cultural
change. Most countries felt that strong leadership and extensive education
efforts were key to addressing these implementation challenges. 

Countries Faced Some Common Implementation Challenges
-----------------------------------------------------

In our case study countries, a key rationale for moving to an accrual
budget was the desire to use a consistent set of standards for financial
statements and for the budget. Although the process for developing public
sector accounting standards differed in each country, they all adopted
accounting standards similar to those used by the private sector in their
countries. The adoption of standards developed by an independent body was
viewed as increasing the consistency and credibility of budget
information. With some modifications, the accounting standards were
adopted for budgeting as well. Most of the countries found they needed new
information management systems to collect accrual-based data and in some
cases to facilitate reporting under new output/outcome-based account
structures. In the transition from a cash-based reporting environment to
accrual-based frameworks countries faced further challenges with respect to

o   asset identification and valuation,

o   oversight, and

o   cultural change.

Identification and Valuation of Assets Presented Difficulties in Move to
Accrual Framework
---------------------------------------------------------------------------

Asset identification and valuation were cumbersome and time-consuming
efforts for the countries that chose to capitalize assets. Indeed, one of
the reasons that Iceland decided against capitalizing assets was the
difficulty it would have faced in identifying and agreeing on the asset
values. Even in countries that have accounting standards in place to
provide guidance on asset valuation, the valuation of individual assets
can be subjective. For example, unique assets such as national parks,
military weapons systems, and infrastructure proved very difficult to
value./Footnote1/ Further, some suggested that funding of depreciation
creates an incentive for departments to overvalue their initial asset base
to ensure higher funding levels to replace assets in the future.

Different approaches were used for asset valuation and identification. In
New Zealand, the use of different approaches across departments was cited
by some as raising concerns about the reliability of the estimates and the
"fairness" of the funding levels across government. For example, the
Department of Education (DOE) hired an independent contractor to assist
with asset valuations. Other agencies assessed the value of their assets
themselves. Officials noted that departments as diverse as the Department
of Defense, DOE, and the police department have had problems identifying
assets and/or determining their ownership. Officials from the other
countries which chose to capitalize assets expressed similar views that
much time was spent on trying to get asset registers right. 

The allocation of assets among departments at the time of the change to
accrual budgeting also may affect future operations. Under accrual
budgeting approaches in which depreciation funding is to be used to
maintain the existing asset base, the issue of whether the initial asset
mix is optimal may have unintended consequences. For example, in New
Zealand there was an implicit assumption that departments began accrual
budgeting with the capital necessary to ensure the sustainability of their
activities. Under accrual budgeting, depreciation funding permitted
renovation or replacement of the existing asset base. As a result, some
equity problems have arisen between departments that were asset-rich and
those that were asset-poor at the time of the change to accrual budgeting.
Departments that were asset-rich when the new system was implemented were
able to maintain their asset bases regardless of shifts in relative
spending priorities and demand for services. Officials found that some
asset-rich departments have been able to install up-to-date computer
systems because the price of their outputs was based on operating expenses
that included depreciation costs for a large asset base and they had
accumulated their depreciation funding. In contrast, asset-poor
departments were not able to accumulate much depreciation funding and were
unable to fund new, more expensive, replacement assets. Officials warned
that these departments had been forced to run down their asset bases and
may need capital injections in the near future. Some believed that such
capital injections will be difficult to get in the future.

Management and Oversight Roles Will Be Affected by Use of Accrual Budgeting
---------------------------------------------------------------------------

Accrual budgeting presents new challenges for the management and oversight
of public funds. Accrual measurement requires the use of judgment
regarding, for example, the estimated useful life of an asset, the
recognition of a contingent liability, and revenue forecasting.
Decisionmakers will need to understand how such judgments can affect a
department's budget request. The change in management and oversight of
public funds will, perhaps, be most dramatic in those countries that have
adopted an output-based model because such models inherently focus less on
control over inputs. Rather, output-based models are premised on the
ability of decisionmakers to assess the appropriateness of the "price" of
outputs. Some countries made various attempts, such as crosswalks between
cash and accrual reports, to assist decisionmakers in performing their
oversight roles.

Decisionmakers Sought Crosswalks and Reconciliation to Cash

Many users of budget documents, notably members of Parliament and their
staffs as well as observers outside of government, expressed an interest
in having a crosswalk between the last fiscal year in which a cash budget
was presented and the first fiscal year in which an accrual budget is
presented. They thought this would help the users understand the
implications of the shift in budget measurement. Some countries have
accommodated this desire for crosswalks while others, for various reasons,
have not. For example, in Iceland as the reforms were being debated in the
Althingi, the Ministry of Finance presented budgets for the two previous
fiscal years on both a cash and an accrual basis providing decisionmakers
a clear idea of what information might be lost and what was gained in the
change. Members of the Althingi and other senior government officials
indicated that this approach was helpful in gaining widespread support for
the reforms. Iceland requires the budget to be presented on both a cash
and an accrual basis, although the detailed spending estimates are
presented only on an accrual basis.

In the United Kingdom, the Parliament has requested that the proposed
period of dual running of the old cash system and the new accrual-based
resource system be extended to allow time for increased understanding of
the implications for parliamentary control and oversight. The Treasury
opposes the extension and has testified that doing so would be too costly
and could undermine incentives to move to the new system. In contrast, in
New Zealand, officials found no need for cash information after the first
transitional budget was produced. Treasury officials said that after
consulting with various users of budget information, including
parliamentarians, experts, and the press, a consensus was reached to forgo
future presentation of cash-based supplementary budget information.

Crosswalks to cash could not be implemented in Australia primarily because
the adoption of accrual measures also coincided with the adoption of a new
budget framework. Resources will no longer be appropriated by object
classes to specific departments and agencies; rather, appropriations
structures have been "remapped" to show the allocation of resources to
outcomes and outputs to more effectively account for the full costs of
those programs and activities. Budget officials in Australia said that a
crosswalk between the last fiscal year's cash-based budget and the new
accrual-based budget would not be practical, largely due to the fact that
a new information management system was developed to allocate resources to
outputs and the cash-based information would not be collected in
accordance with this new framework. Instead, the previous fiscal year's
budget was reestimated on an accrual basis to highlight the differences
between cash and accrual estimates.

New Analytical Skills Are Required for Oversight

In addition to understanding how accrual-based budget requests compare to
the previous cash-based requests, parliamentarians must be able to
understand basic accounting concepts, such as depreciation and
revaluation, and the implication of their use in order to perform their
oversight responsibilities. For some items, financial statement and budget
reporting on an accrual basis requires more assumptions and judgment than
cash-based reporting. However, independent auditors provide assurances as
to the reliability and reasonableness of these judgments in their review
of the financial statements. On the other hand, when budget estimates are
presented for parliamentary approval no such independent review has been
undertaken. A department's request for depreciation expense, for example,
may have increased from the previous year due to a revaluation of assets
that has not yet been subjected to independent audit. Consequently, absent
further scrutiny, these estimates could be enacted into law and cash
appropriated to the departments for expenses that may be overstated. This
concern has been addressed in different ways. For example in Australia,
departmental budget requests are reviewed by analysts in the Department of
Finance and Administration (DoFA) and compared to the department's most
recent audited financial statements and to requests made during recent
budget cycles. In New Zealand, because output prices are rarely changed,
any higher depreciation expenses resulting from asset revaluations would
have to be absorbed by the agency. If an agency were to insist that as a
result of the higher depreciation costs it needed additional
appropriations, the request would require considerable justification and
review of its assumptions in order for the minister to agree to a "price"
increase for that department.

Some observers expected that the shift in the focus of parliamentary
scrutiny of budget estimates would pose challenges. Some experts in New
Zealand felt that the focus on output funding instead of input funding
could provide opportunities for departments to mask data because the new
reporting framework/Footnote2/ does not provide information on the mix of
inputs used to produce each specific output. For example, social work
services to children and young persons is one output requiring an
appropriation of almost NZ$190 million. Although the output is defined by
various performance standards, such as the number of notifications
investigated or the number of orders in force, the appropriation documents
provide no detail as to the mix of personnel, overhead, or technology used
to provide the output. Consequently, it can be difficult to determine
whether an output was achieved by extracting efficiencies or by running
down and not replacing needed assets.

Furthermore, as departments redefine outputs over time, the lack of input
information may make it difficult to compare performance on a consistent
basis. Moreover, output classes are defined inconsistently--some in more
detail than others--which makes meaningful comparisons within and across
departments challenging. Some observers noted these factors have the
potential to complicate oversight now that the departments have been given
a great degree of managerial discretion.

In Australia, some parliamentary staff said that trying to change the
focus of parliamentary oversight from its current focus on inputs--the
cash budgeted for personnel, supplies, and overhead--to departmental
performance and output prices may present challenges because the issues
are complex and the committees tend to be understaffed. Australia's new
budget framework, which encompasses much more than accrual budgeting,
seeks to link appropriations for outputs purchased to outcomes such as
"Stronger Families." These broad outcomes represent the current
government's policy initiatives; outputs represent what the government
purchases in order to achieve the desired policy outcomes. Moving the
focus of oversight from detailed inputs to broad outcomes presents an
additional level of complexity because in many cases an outcome requires
contributions from many agencies and is affected by numerous public and
private factors. Also, in many cases direct causal links have not been
established between outputs and outcomes. 

Assessing Prices Is Critical to an Output-based Approach to Accrual
Budgeting

Under output budgeting frameworks, the government agrees to purchase
outputs from the departments at agreed-upon accrual-based prices.
Conceptually, the government and the Parliament should be able to
ascertain whether the output price is fair based on comparisons with
similar services offered in the private sector or by other government
agencies. However, many argue that because private markets do not exist
for numerous government services, benchmarking will be difficult. New
Zealand, with more experience in output budgeting than any other country,
is still grappling with this issue. Officials said that the benchmarking
exercise is difficult for a number of reasons. First, analyzing the price
of a publicly funded activity can be complicated. For example, a few years
ago the Customs and Treasury departments analyzed the processing of in-
bound passengers. Even this simple process had to be broken into
surveillance, baggage checking, paper processing, etc. As a result, it
took 6 months to fully understand the process and assign a price to each
component. Once such a process analysis is complete, finding an exact
private sector equivalent against which to benchmark prices is not
straightforward, partly because there is often no private sector
counterpart that performs the same function as a sovereign government
entity. New Zealand appropriates to more than 750 outputs, but as of
fiscal year 1999-2000 only a few output prices had been successfully
benchmarked. Many officials said that this exercise was only just
beginning and most appropriations continued to be closely tied to
departmental operating costs. 

Similarly, in the Netherlands, the goal of the accrual budgeting
framework/Footnote3/ is to encourage agencies to benchmark their prices
against other providers--public or private--of similar services, but even
after 6 years this has been done infrequently. Instead, the price usually
reflects the costs of production. The lack of widespread benchmarking to
determine prices was attributed to inexperience with accrual measures, the
recent accession of many new agencies in the program, and the fact that
for some of the services these agencies provide there is no private sector
equivalent that can be used for benchmarking.

Cultural Change Was Necessary to Achieve Benefits of Accrual Budgeting 
-----------------------------------------------------------------------

As with any major reform effort, significant cultural change was viewed as
important to ensuring successful implementation of accrual budgeting. The
shift to an accrual budget, especially in Australia and New Zealand, was
part of a major change in how departments requested and would be held
accountable for resources. Shifting accountability from central oversight
agencies to individual departments changed the way financial resources
were controlled. Many officials described these changes in control and the
focus of information as "cultural changes," signaling the magnitude of the
challenges and the possible resistance to the implementation of the
reforms. These concerns were largely addressed through extensive training
efforts on accrual techniques specifically and, more generally, on the
benefits expected from the broader reform efforts.

Implementation time frames varied significantly across case study
countries. There is little consensus, however, regarding the appropriate
length of time needed for implementation. The United Kingdom's
implementation approach provides for a long phase-in period for the
reforms: over 6 years will have passed between 1994, when the government
issued a "white paper" signaling its intention to proceed with budget
reforms, and 2001 when the first accrual-based budget is to be presented
in Parliament. Treasury officials said that they were able to take
advantage of the long time frame to thoroughly vet the reporting
standards, train personnel, and perform "dry runs" of the new budget
presentations. Some believe that even 6 years is not long enough to fully
prepare for the reforms. Others in the Treasury argue that the long lead
time allowed departments to "put off" the inevitable. In contrast,
Australia introduced its first accrual budget within 18 months after laws
requiring a shift to accrual budgeting had been enacted. However, problems
with quick implementation were noted in Australia where officials
expressed frustration at trying to provide training on policy changes
while the policies were still being developed. 

Leadership Commitment and Extensive Training Are Keys to Addressing
Implementation Challenges
---------------------------------------------------------------------------

In all countries, commitment to financial reporting and budgeting reforms
from the top levels of government was considered crucial to successful
implementation. In addition to management commitment, extensive training
helped increase general understanding of the benefits to be achieved and
reduced the resistance to change.

Demonstration of Leadership Commitment Essential for Successful
Implementation of Reforms
---------------------------------------------------------------------------

A key factor in successfully moving to accrual budgeting was the strong
support from both the political leadership and within the bureaucracy. In
New Zealand, politicians' needs for better financial and managerial
information provided the impetus behind the passage of the Public Finance
Act. The act significantly changed the managerial accountability and
incentive structure. Under the new system, all managers are required to
sign limited-term contracts and are subject to annual reviews based on
quantifiable performance criteria. If not met, contracts were not renewed
for another term. According to many observers, once departmental managers
recognized the degree of change necessary to implement these reforms and
the implications for not meeting their contractual obligations, their own
commitment to making the changes increased significantly.

In Iceland, financial reporting reform legislation was debated for nearly
3 years in the Althingi before it was enacted. The bill passed by
unanimous vote, an outcome sought by the government to ensure the widest
possible support for these reforms. While punitive incentives were not
imposed in Iceland as they were in New Zealand, the extent of the debate
and the support of the political leadership from all parties sent a strong
signal. In addition, to ensure the consistency of the new measurement
basis and to ease its implementation and use in the budget process, most
of the more complex accrual analyses were done by the Ministry of Finance,
consolidated in its budget, and not allocated to individual departmental
budgets.

In the United Kingdom, the impetus to move to accrual budgeting has
continued despite changes in the parties controlling the government. A
senior Treasury official noted that a key factor in the successful
implementation of accrual budgeting has been the strong ministerial
backing from the start, under both Conservative and Labour governments.
These officials said that politicians viewed the reforms as grounded in
the goal of providing managerial improvements and better information to
Parliament. Equally important, the reforms had support from the senior
level within Treasury which ensured a consistency of staff responsible for
designing and implementing the reforms.

In Australia, support for the reforms at the ministerial level was ensured
through direct dialogue between the Minister of Finance and Administration
and his colleagues in the Cabinet. The expectation followed that Cabinet
ministers would reinforce the importance of the reforms throughout the
departments in the ministers' portfolios. These reinforcements
complemented training strategies that were geared towards further
emphasizing the government's commitment to the reforms.

Multifaceted Training Methods Used to Support Cultural Change
-------------------------------------------------------------

Training played a key role in most countries to ensure that accrual
concepts were well understood. But more important, training opportunities
were also used to ensure the dissemination of information on and a clear
understanding of the government's commitment to these reforms and to
instill an equal commitment to and understanding of the reforms at every
level of the bureaucracy. In Australia the outreach effort to inform and
educate departmental personnel was undertaken by DoFA. The training
curriculum was designed to reach multiple levels of management through the
use of different communication tools and techniques such as seminars,
speeches, focus groups, newsletters, and Internet web sites. Most
importantly, the training curriculum could be redesigned for different
levels of management depending on the needs of the users. DoFA officials
believe that the use of a multifaceted, multimedia approach facilitated
communication about the reforms, allowing them to address departmental
concerns as quickly as possible. 

Officials at the United Kingdom's National Audit Office also believe that
training will be essential to successful implementation of accrual-based
resource accounting and budgeting and that a huge education effort is
necessary to ensure that staff at all levels are technically equipped to
understand and implement basic accrual requirements. Individual
departments prepare and implement their own training programs by taking
pieces of the curriculum developed by the Treasury. Treasury has taken the
role of facilitating the exchange of ideas through a "training network,"
which they believe also supports a key objective in delegating more
authority and responsibility to the departments. 

Furthermore, as accounting issues typically garner little management
interest, the link to the budget has worked to increase interest in the
overall reforms. Many departmental personnel are realizing that their
budget will soon be measured differently and this will affect their
funding levels. Officials in the various departments that are in charge of
training suggested that as a result of these linkages, staff are paying
more attention to the reforms than might have otherwise been expected.

Observations
------------

Case study countries faced some common challenges in implementing their
accrual-based frameworks. Most countries found that they needed new
information management systems to support the collection of accrual-based
data and, in some cases, to facilitate reporting under new output/outcome-
based frameworks. In addition, country officials reported significant
challenges in asset identification and valuation. Further, the shift to
accrual-based financial and budget reporting required a significant
cultural change with implications for managerial and oversight roles.
Cultural change and the concomitant managerial and oversight role changes
were most pronounced in countries which combined a shift to accrual
budgeting with output-based budgeting. Leadership commitment and extensive
training were identified as crucial in addressing these implementation
challenges.

--------------------------------------
/Footnote1/-^In the United States, there has been debate surrounding the
  treatment and valuation of unique governmental assets such as weapons
  systems and heritage assets. In considering this issue, FASAB suggested
  that (1) the value of some federal assets, such as museums and national
  parks, may be indeterminable and (2) allocating the costs of assets such
  as military weapons systems to accounting periods may be meaningless. In
  response to these difficulties, FASAB required a new category of
  financial reporting, "required supplementary stewardship information,"
  which is to accompany financial statements but is not included directly
  on the balance sheet. 
/Footnote2/-^For more information on New Zealand's output pricing model of
  accrual budgeting see appendix V.
/Footnote3/-^See appendix IV for more information on the Netherlands'
  accrual budgeting framework.
Financial Audit: 1998 Financial Report of the United States Government (GAO/
Obligation-based budgeting involves three stages: (1) the Congress must
enact budget authority before government officials can obligate the
government to make outlays;
Budget Issues: Budgeting For Federal Insurance Programs (GAO/AIMD-97-16,
September 30, 1997) and Budget Issues: Budgeting For Federal Insurance
Programs (GAO/

ADAPTING ACCRUAL BUDGETING FOR THE UNITED STATES CONTEXT
========================================================

The United States and the countries in our review share common objectives
of improving the efficiency, effectiveness, and sustainability of
government activities while enhancing transparency and accountability. To
varying degrees, case study countries have turned to accrual budgeting as
a tool in addressing these issues. Despite obvious and significant
political, cultural, and economic differences, these countries' early
experiences with accrual budgeting provide some valuable insights for the
United States. Their experiences, however, must be seen in context of
their particular situations and any translation to the United States
should be done within context of its situation and political structure. 

Accrual budgeting in some case study countries was coupled with
initiatives to devolve authority and accountability to executive agencies.
The United States, unlike the case study countries, has a separation of
powers between the executive and legislative branches of government with
the Congress taking an active role in resource allocation decisions and
oversight. The challenge becomes how to translate useful ideas developed
in a parliamentary political system to the U.S. system. Any reform efforts
need to be adapted to meet the unique budgeting needs of both the Congress
and the executive branch in the U.S. system. This chapter explores the
implications accrual budgeting could have within the United States' unique
constitutional framework and focuses on ways to adapt accrual concepts to
enhance the information available to the Congress and the President in
considering budget decisions. Accrual concepts can effectively serve to
enhance accountability by the Congress as well as the executive branch for
certain types of budgeting decisions, particularly those involving
commitments of future budgetary resources. 

To understand the implications of accrual budgeting it is necessary to
consider the goals of the federal budget process. Although the U.S. cash-
and obligation-based budget may not fully recognize long-term commitments
or directly match full costs with the provision of goods and services, it
nevertheless offers other benefits, particularly for up-front budgetary
control of the purchase of capital assets. Accrual budgeting based on
financial accounting standards can be used to better match costs with the
provision of goods and services, but whether it would result in earlier
budget recognition than the current cash- and obligation-based budget
depends on the budget item. Accrual budgeting would advance the
recognition of costs for items, such as pensions and insurance, that
involve cash flows over many years, but would delay it for capital assets
so as to spread costs over the periods that benefit from their use. In
this sense, the decision about whether to apply accrual budgeting based on
financial accounting standards for the entire budget depends on the
relative importance one places on recognizing and controlling costs at the
time decisions are made versus the matching of costs to the period
resources are consumed in the provision of goods and services. In the
United States, specific concerns about the implications for budgetary
control would be raised if some accrual budgeting approaches were applied
to capital assets; this concern is especially great with regard to control
over asset purchases. Further, accrual budgeting, as implemented by the
case study countries, ameliorates but does not "solve" the problem of
inadequate recognition of long-term commitments since social insurance
commitments are not included. 

The differences between the United States and the case study countries in
the budgetary role of the legislative branch make it unlikely that any
case study country's accrual budgeting approach would be fully applicable
for the United States. Nevertheless, several useful ideas still can be
drawn from their experiences. For example, the experiences of Iceland and
New Zealand suggest that using accrual budgeting for some programs, such
as pensions and insurance could result in better information and
incentives for budgetary decision-making. Further, while accrual budgeting
as implemented by case study countries would not address long-term
commitments associated with social insurance, it would be possible to
develop budgeting approaches drawing on accrual concepts but not
specifically wedded to financial accounting standards. Finally, while
accrual-based output budgeting models adopted by New Zealand and Australia
are not likely to be adopted fully in the United States, their experiences
with clearly aligning budget and performance information within an
integrated accountability framework in order to support performance
management reforms could prompt some further exploration of ways to better
match costs and performance without sacrificing up-front control.

Performance, Sustainability, and Accountability Central to U.S. Reform
Efforts
---------------------------------------------------------------------------

The United States and the countries in our review share common objectives
of improving public sector financial and performance management while
enhancing transparency and accountability. As in these other countries,
decisionmakers in the United States recognize that the federal government
could benefit from greater integration of financial accounting and
performance reporting in the budget decision-making process. At the same
time, changing demographics and other factors have raised questions about
the sustainability of the government's long-term commitments, such as
Social Security, Medicare, and Medicaid. 

In response to the desire to improve effectiveness and accountability
while limiting costs, the Congress established a statutory framework to
address key management issues. Two major laws are at the heart of this
framework: the Chief Financial Officers Act of 1990 (CFO Act) and the
Government Performance and Results Act of 1993 (the Results Act). 

The CFO Act--as expanded by the Government Management Reform Act of 1994--
was designed to remedy decades of serious neglect in federal financial
management. For example, the act, among other things, established chief
financial officers across the government, called for improved financial
management systems and controls, including cost accounting, and required
the preparation of audited annual financial statements for the 24 largest
agencies and for the government as a whole. To improve the usefulness of
federal financial reports and ensure public accountability, the Federal
Accounting Standards Advisory Board (FASAB) was established to develop
accounting standards suitable for the federal government./Footnote1/ FASAB
completed work on the basic set of Federal Financial Accounting Standards
(FFAS) in 1996, but some standards did not become effective until 1998 and
1999. 

These efforts are prompting steady improvements in federal financial
accountability, but more work remains. Major agencies covered by the act
are issuing agencywide financial statements and the U.S. government has
prepared and subjected to audit consolidated financial statements for the
government as a whole. However, our audits of the 1997 and 1998
consolidated statements revealed serious deficiencies--including systems
weaknesses, problems with fundamental recordkeeping, and weak internal
controls--which prevent the government from accurately reporting a
significant portion of its assets, liabilities, and costs. Because of
these deficiencies, we were unable and did not express an opinion on these
financial statements./Footnote2/ As these findings indicate, there are
major obstacles, both at the agency and consolidated levels, in preparing
reliable financial statements for the U.S. government. 

While the CFO Act established the foundation for improving financial
management and accountability among agencies, the Results Act aimed more
directly at program performance. Under the Results Act, agencies are
required to set multiyear strategic goals and corresponding annual goals,
measure performance toward achievement of those goals, and report on their
progress. Among its several purposes, the act is designed to improve
congressional decision-making by providing information on the
effectiveness and efficiency of federal programs and spending. That is,
with regard to spending decisions, the act aims for a closer and clearer
link between the process of allocating resources and the expected results
to be achieved with those resources. This is viewed as important to
shifting the budget debate from a focus on inputs to a focus on performance.

There also has been a growing recognition that policymakers need
information on the long-term cost consequences of today's commitments. The
long-term costs implied by the government's current commitments can
encumber major shares of future budget resources, thereby constraining the
government's fiscal policy. Our long-term budget model illustrates that
the growth in Social Security and health commitments threatens to crowd
out discretionary spending in the long run, assuming a constant tax
burden. This is particularly important for programs such as Social
Security and Medicare that require long time horizons to understand the
implications of the government's commitment and its impact on fiscal
policy. The congressional budget process has made progress in considering
the longer term in budgeting by requiring a multiyear focus, including the
use of a 10-year budget window. Further, the Federal Credit Reform Act of
1990 changed the method of budgeting for credit programs to an accrual
basis to provide more timely recognition of their costs to the
government./Footnote3/ 

These reforms represent significant steps towards improving budgeting,
financial information, and performance management and have begun to
provide the tools for better management. At the same time, additional
challenges remain to ensure that high performance principles become an
integral part of the government's operating culture rather than just
paperwork exercises. For example, agencies face significant challenges in
improving linkages between performance plans and budget requests. As we
have reported earlier, tensions exist between the needs of planning and
budgeting structures. While budget structures have evolved over time to
help the Congress control and monitor agency activities and spending,
planning structures tend to be broader and wide-ranging in order to
articulate the mission and outcomes agencies seek to influence. Despite
these tensions, better integration of planning and budgeting is important
to meeting key expectations of the Results Act./Footnote4/ Similarly,
while the audited financial statements required by the CFO Act provide
important information on the government's assets, liabilities, and overall
financial position, integrating this information to better inform budget
decisions remains a challenge. Further, although the multiyear focus of
the Deficit Control Act (DCA)/Footnote5/ represented progress in
considering longer-term budgeting, it did not fully address sustainability
issues. This is particularly important for programs such as Social
Security, Medicare, and Medicaid, whose rising costs are key drivers
threatening the sustainability of the government's fiscal policy. Although
considerable long-term actuarial analyses of Social Security and Medicare
costs have been done, the cash-based budget is not currently structured to
focus on the long-term outlook for these commitments. 

Countries in our review turned to accrual budgeting, at least in part, to
help address similar concerns about public sector performance,
sustainability, and accountability. Overall, proponents stressed the value
of moving beyond accrual-based financial statement reporting to using
accrual-based information in the budget--the key accountability and
decision-making mechanism--in heightening the awareness of and
responsibility for addressing these concerns.

Transferability of Other Nations' Experiences
---------------------------------------------

Despite obvious and significant political, cultural, and economic
differences, these countries' early experiences with accrual budgeting
provide some insights that may be helpful to the United States. Their
experiences, however, must be seen in the context of their particular
situations and any translation to the United States should be done in the
context of its situation and political structure. It is important to
consider key differences between (1) the legislative bodies in a
parliamentary system of government and the Congress of the United States,
especially in terms of the role each plays in the budget process, and (2)
the methods of budget reporting already in place in each country. In
addition, the implications of other reforms undertaken at the same time as
accrual budgeting need to be considered. Given the differences between the
United States and the other countries in all of these factors, it is
unlikely that the United States would achieve all of the benefits claimed
by case study countries. However, some benefits could result from the
selective use of accrual budgeting, as has already been demonstrated for
credit programs.

Parliamentary bodies in our case study countries exercise their influence
differently than the U.S. Congress. Governments are formed by the
political party, or coalition of parties, that hold the support of a
majority of Parliament. As such, the line between the executive and the
legislative functions is not as clear as it is in the United States where
the separation of powers serves as a check on each branch's power. Many
important budget decisions that, in the United States, are debated and
settled during the annual appropriations process, occur in the case study
countries before the budget is presented for parliamentary approval.
Parliament's duty is to satisfy itself that the current government has the
Parliament's full confidence to continue governing. If it is satisfied on
that front, case study countries' parliaments regularly enact the
government's budget without amendment. In Westminster systems, the failure
to do so would be viewed as a statement of "no confidence" in the
government and would signal a need for new elections, including for a new
Parliament. The separation of powers also has implications for budget
accountability as the Congress generally exerts a greater degree of
control over agency spending. Most case study countries generally deal
with the approval of obligations through executive branch controls whereas
in the United States congressional approval (budget authority) is required
before executive branch departments can obligate funds.

Further, while most of the countries in our study had previously budgeted
on a pure cash basis, the United States has both a cash- and obligation-
based budget. A pure cash budget focuses on the cash flows to and from the
government in a given period. The United States' obligations basis of
budgeting focuses upon controlling the legal obligations entered into
during a period./Footnote6/ The U.S. budget is also referred to as cash-
based because, with limited exceptions,/Footnote7/ the amounts to be
obligated are measured on a cash basis, and the unified budget
deficit/surplus--the key focus of the policy debate--represents the
difference in cash receipts and cash outlays in a given year. These
differences between pure cash-based budgeting and the United States' cash-
and obligation-based budget have implications for assessing the potential
benefits to be achieved from the adoption of accrual budgeting. 

The information and incentives provided by the budget are shaped by both
the measurement basis used to record costs in the budget and the structure
of budget accounts (appropriations). The measurement bases discussed in
this report--cash, accrual, and obligations--primarily affect the timing
at which the budget recognizes costs. In general, controlling the ability
to enter into obligations--as is done by the U. S. Congress--provides the
most control, especially when obligations are measured in a way that is
truly representative of the government's commitment to make future
payments. In some cases, such as insurance and employee pensions,
obligations measured on an accrual basis would advance the timing of
budget recognition and thus enhance the Congress' ability to control.
However, for capital purchases, accrual measurement would delay the budget
recognition of costs and thus may impair the Congress' ability to exercise
control./Footnote8/ The structure or scope of budget accounts--i.e.,
whether budget costs are arranged based on organization, program, or
spending item--also help determine the type and amount of oversight and
control over public spending. 

The case study countries varied in the extent to which they made changes
to the budget account structure when adopting accrual budgeting. In two
countries, New Zealand and Australia, performance management benefits were
attributed to a marriage of output budgeting/Footnote9/ and accrual
budgeting, not a shift to accrual measurement alone. Some observers
expressed skepticism that performance improvements would have been
achieved solely by a shift to accrual budgeting in the absence of the much
greater managerial flexibility provided by output budgeting. This
managerial discretion over how an appropriation is spent is significantly
different from the detailed nature of U.S. congressional control over
spending. While these and other factors, such as differences in size and
culture, make it unlikely that any of the other countries' accrual
budgeting approaches would be adopted in full, their experiences
nevertheless provide ideas for the United States to draw upon in
addressing its concerns about performance, sustainability, and
accountability. 

Selective Application of Accrual Budgeting Offers Some Benefits
---------------------------------------------------------------

The challenge is to adapt accrual budgeting concepts used in other
countries to address the unique features of the United States' budget
process. In particular, the control role played by the Congress in that
process means that any adaptations must meet the information needs of that
body as well as the President in developing an overall fiscal policy for
the nation and in formulating detailed appropriation bills and budget
proposals. Thus, while accrual in some other countries was coupled with
devolution of authority and accountability to executive agencies, in the
United States' setting accrual concepts must address the Congress' needs
for better information on the cost implications of its budget decisions. 

From this perspective, accrual concepts can help the Congress in those
selective cases where using accruals would result in more timely
information and recognition of costs. Obligation-based budgeting generally
helps ensure that the Congress approves obligations to be entered into by
agencies before they are made. Accrual measurement within an obligation-
based budget enhances control for programs that involve cash flows over
many years, such as insurance and pensions, by recognizing costs earlier
when the commitment is made. Doing so would provide a more complete
picture of the cost of current decisions and thus may encourage timely
changes in these programs to control costs. In contrast, for capital
assets, accrual budgeting, by recording depreciation rather than the
purchase cost, would delay budget recognition in order to match the cost
of an asset with its use in providing services. From a congressional
perspective, obligation-based budgeting promotes accountability by
recognizing the purchase cost up front and thus permits congressional
control over an asset's purchase before the contractual obligation is
made. However, for many government activities, such as salaries or grant
payments, there generally would not be significant differences in the
recognition of costs measured on a cash or accrual basis. The fact that a
shift to accrual measurement without compensating controls would erode
control over capital purchases and may not result in significant
differences for many government activities raises serious questions about
whether full accrual would provide sufficient benefits to warrant its
adoption in the United States. However, adopting accrual measurement
selectively within an obligation-based control system may prove
beneficial. It would provide a means to improve budget information and
incentives for decision-making in cases where cash-based measurement is
clearly misleading while preserving the up-front control of the obligation-
based budget. However, as discussed later, there are limits to which
accrual budgeting based on financial accounting standards can be used to
address long-term sustainability issues. 

The approach developed for credit programs in the Federal Credit Reform
Act of 1990 is an example of a selective application of accrual
measurement within the obligation-based system. Unlike other programs for
which obligations represent cash payments to be made, obligations measured
on a cash basis for credit programs sent the wrong signals about the cost
of the government's commitment. The initial cost of loans in the budget
ignored repayments while loan guarantees initially appeared to be free.
The Credit Reform Act required that outlays for credit programs be
reported on an accrual basis as the expected cost to the government over
the life of the credit instrument./Footnote10/ Thus, the obligations that
result in those outlays are also accrual-based. 

Targets of Opportunity
----------------------

There are several areas in the budget in which obligations measured on a
cash basis do not adequately represent the extent of the government's
commitment. In these cases, the annual cash flows recognized in the United
States' current budget fail to capture and control the long-term
commitment entered into by the government. These areas include 

o   employee pension programs,

o   retiree health programs,

o   federal insurance programs, such as deposit and crop insurance, and 

o   environmental cleanup.

Although the future cost of a portion of civilian and military retirement
has been recognized in the budget, the future costs for some of these
pensions and for all retiree health benefits and veterans benefits are
not. For civilian employees hired since 1984 and personnel in the military
service after October 1, 1984, the full cost of pension benefits is
recognized in the budget at the department level as they are earned.
However, none of the accruing costs of civilian or military retiree health
benefits or the full cost of retirement benefits for civilian employees
hired before 1985 are recognized in the budget. Similarly, the
government's cost for veterans' pensions and benefits are not reflected in
the budget as they are earned. For these costs, recognizing in the budget
the annual benefits earned would provide a truer representation of the
commitments that the government has made than reporting cash payments in
the year.

Federal insurance is provided to individuals and businesses against a wide
variety of risks, ranging from natural disasters under the flood and crop
insurance programs to bank and employer bankruptcies under the deposit and
pension insurance programs. In the past, we reported that the use of
accrual concepts in the budget has the potential to overcome the time lag
between the extension of an insurance commitment, collection of premiums,
and payment of claims that currently distorts the government's cost for
these programs on an annual cash flow basis. Accrual concepts could be
used to recognize the government's cost at the time the insurance
commitment is made regardless of the timing of cash flows. The
government's accrued costs could be measured as the difference between a
full risk premium, based on the expected costs of losses inherent in the
insurance commitment, and the premium charged to the insured. /Footnote11/ 

Future environmental cleanup costs are another long-term cost resulting
from federal operations that are not reflected in the budget. These costs
have only been recognized in the budget to the extent that appropriations
have been provided for specific cleanup work. Under federal accounting
standards, environmental cleanup costs are reported as a liability on the
financial statements. Recognizing in the budget the new environmental
cleanup costs resulting from the government's activities during the year
would provide a truer representation of the commitments that the
government has made.

Some Long-term Commitments May Need to Be Addressed in an Innovative Way
------------------------------------------------------------------------

Some in the United States are interested in improving the budget
recognition of long-term commitments, such as those associated with large
social insurance programs, and may think that accrual budgeting would
help. However, as implemented by the case study countries, accrual
budgeting does not address these commitments. In general, the countries
chose to mirror their financial accounting standards in their accrual
budgets. Even though social insurance is largely viewed as a government
commitment that may result in future cash outlays, it is not judged to be
a liability based on accounting standards in these countries or in the
United States. The standards in these countries generally establish
criteria for determining a liability based on whether (1) an event has
occurred, (2) a future payment is probable, and (3) the amount of the
future payment is reasonably estimable. Since social insurance is not
judged by accountants as meeting these criteria, none of the case study
countries have budgeted for such commitments on an accrual basis. This
would also be the case if the United States adopted accrual budgeting
based on current federal accounting standards./Footnote12/ The appropriate
treatment of these types of long-term commitments in financial and
budgetary reporting remains a challenge. 

For these commitments, it may be useful to consider alternative approaches
that deviate from financial accounting standards but still recognize costs
sooner than would be the case under the current cash- and obligation-based
budget. For example, annual outlays could be recorded for the Social
Security program in the same amount as the annual receipts. This would
eliminate any annual surplus and recognize that at least the amount paid
into the trust funds will be spent on Social Security. Alternatively,
budget recognition of receipts might be deferred until the receipts are
used to make payments in the future. Under these two options, the current
cash surplus in Social Security projected to last until 2014 would not be
recorded as income available for spending. Another possibility would be to
present as supplemental information the net present value of the expected
cost of the government's long-term commitments in the budget for each
budget account or program alongside its cash-based budget authority and
outlays. These and other ideas could be explored with the goal of
developing a workable concept. Suggestions have been made that a budget
concepts commission is needed to address Social Security and other
budgeting issues; it could be the proper forum to fully develop new
budgeting ideas such as those mentioned here.

Some Country Reforms Emphasize the Need to Better Align Budget and
Performance Information to Enhance Accountability for Results
---------------------------------------------------------------------------

Some countries' reform efforts--particularly those in Australia and New
Zealand--emphasize the importance of improving the congruency between the
budget and the government's overall performance management and
accountability structure. In these countries, the adoption of accrual-
based measurement in the budget was combined with a shift to output
budgeting./Footnote13/ Under output budgeting all the costs associated
with producing an output--salaries, depreciation, etc.--are appropriated
in a lump sum for the specified outputs. Appropriations are in effect
structured around the "price" of various outputs rather than specific
budget items such as salaries or equipment. For example, the Ministry of
Defence in Australia has one outcome/Footnote14/ (appropriation) linked to
22 different outputs rather than specific appropriations for personnel,
procurement, operations and maintenance, and research and development.
Thus, managers have discretion over how to use the appropriation to
deliver agreed-upon outputs. Some observers suggested that accrual
budgeting alone, while providing a valuable tool to more completely
recognize the cost of providing outputs, would not have achieved the same
improvements in performance in the absence of this increased managerial
discretion. This type of managerial discretion, however, may not be
compatible with the U.S. Congress' more detailed control and oversight of
spending. 

In the U.S. context, any potential advantages achieved by changing the
budget account structure in this way to appropriate funds for a specific
output would need to be considered against the benefits provided by the
U.S. Congress' traditional focus on specific spending decisions. For
example, appropriation decisions, reinforced by specific accounts, program
activity items, and committee report language, allow the Congress more
control over specific spending choices. However, in many cases, existing
accounts and program by activity schedules do not always provide direct
linkages between all of the costs of a specific output and the achievement
of that output. Conversely, more performance-based accounts may provide
better linkages between spending and results but could result in less
detailed information on specific spending decisions. Our previous work
further highlights the tension between the objectives of more performance-
focused management reforms, such as those required by the Results Act and
budget structures that have evolved to help the Congress control and
monitor agency activities and spending./Footnote15/ 

Despite this tension, steps could be taken to further improve links
between costs and related performance. Our review of agencies' performance
plans shows that some agencies have been able to develop approaches that
make basic and useful connections between proposed spending and expected
performance. Further, it may be possible to develop mechanisms that
achieve better matching of budget costs and performance without forfeiting
up-front budgeting controls. For example, capital acquisition funds (CAF)
could better match an asset's cost with its use in the provision of goods
and services while preserving up-front funding control. Under this type of
mechanism, a CAF could be created for each department to purchase all of
the department's assets. It would have authority to borrow/Footnote16/
from the Treasury/Footnote17/ to purchase federally owned assets needed by
sub-components of the department. These sub-components would then "rent"
the assets from the CAF, paying sufficient rent so that the CAF could
repay both the principal and interest on the Treasury loan. Because the
interest on the Treasury loan is included in the rent, the cost of using
resources to purchase the asset would be reflected in the agency's budget.
Thus, the cost appearing in the sub-components' budgets--the rent paid--
represents both the asset cost and the cost of the capital used in the
provision of goods and services. This type of mechanism is one way that
accrual-based cost could be incorporated in the budget at the agency level
while preserving the cash and obligations basis for the government as a
whole. 

Both the experiences of the case study countries and our previous work
highlight the need for continued efforts to improve the role of the
federal budget in addressing the performance and sustainability of
government activities as well as accountability for decisions made. To
varying degrees, the case study countries have used accrual concepts
within the budget as a tool in addressing these issues. As in these
countries, the degree to which accrual concepts are integrated into the
U.S. federal budget should reflect the government's fiscal control and
managerial objectives. 

Thus, to be most useful, the ideas drawn from other countries' experiences
with accrual budgeting must be considered in the context of the U.S.
government's institutional structure. For example, the selective use of
accrual measurement in the budget may be used to recognize the cost of
decisions whose cash consequences may not occur for years while preserving
the up-front control of obligation-based budgeting. The development of
mechanisms such as CAFs as well as continued work to better align the
program and activities structures, which form the basis for agencies'
budget requests, with performance goals could support the emphasis on
performance-driven management envisioned under the Results Act while
recognizing that the current budget account structure evolved at least in
part from the Congress' desire to ensure detailed accountability over
spending decisions.

Conclusions
-----------

The United States can benefit from the experiences of countries that have
adopted accrual budgeting. However, for several reasons, the wholesale
adoption of accrual budgeting in the United States may not garner the
benefits cited by other countries. First, some countries combined accrual
budgeting with broader management reforms, including substantial shifts in
authority and accountability to executive agencies; thus, the benefits
they cite cannot be solely attributed to accrual budgeting. Second, the up-
front control of the U.S. obligation-based budget provides important
accountability within our institutional framework of government to meet
the needs of both the Congress and the President in addressing their
unique accountability for fiscal policy and budgetary outcomes. In
addition, many of the one-time benefits, such as the identification of
assets and liabilities, already have begun to be addressed by the CFO Act
and other reforms. Finally, the size and complexity of the U.S.
government's activities suggest that it would face implementation
challenges similar to, if not greater than, those faced by case study
countries.

The challenge is how to translate useful ideas developed in one political
system to the United States' system in ways that improve its decision-
making process while protecting its unique institutional needs.
Recognizing the unique role of the Congress in the budget process, accrual
concepts can be selectively applied to strengthen the capacity of the
Congress and the President by prompting greater information and
accountability for the costs of commitments extending into the future.
While the United States' obligation- and cash-based budget serves well in
most areas, it could be improved by selectively incorporating some accrual
concepts to better recognize costs of certain commitments. In addition,
explorations of accrual concepts different from those embodied in
accounting standards could very well lead to new ways of budgeting for
long-term commitments. While accrual budgeting, in its purest form,
applied to capital would serve to weaken accountability for the costs of
commitments, other approaches can be explored.

In considering potential reforms it is also important to recognize that
the timing of cost recognition, that is, cash versus accrual measurement,
is but one of several factors that shape the budgetary information and
incentives provided to decisionmakers. Although accrual measurement may
result in more timely budget recognition for some items, this change alone
will not be sufficient to improve budget information. Decisionmakers also
need information with sufficient breadth to adequately assess the relative
contribution of multiple programs and various tools--such as spending and
tax expenditures--to carry out common federal missions. The development of
a broader and more integrated budgetary framework is particularly
important for crosscutting areas, such as health care or the antiterrorism
effort, which may involve both tax incentives and an array of programs
carried out by numerous agencies. More fully integrating longer term
analyses, such as the use of net present value calculations, into the
budget process may also be useful in helping decisionmakers understand the
future implications of current policy decisions. Some case study
countries' experiences suggest that there may be value in using multiple
measures to assess fiscal and managerial performance. Thus, accrual
budgeting is just one of a number of tools and approaches that the United
States should consider as it works to improve the role of the budget in
addressing concerns about public sector performance, the sustainability of
government activities, and accountability for results. 

Matters for Congressional Consideration
---------------------------------------

As the Congress considers changes in the budget structure and/or process,
it would be well served to explore ways to improve information on two
dimensions: breadth and time horizon. This report dealt with one way to
lengthen the time horizon for information. The Congress should consider
the selective use of accrual measurement in the budget in areas where it
would enhance obligation-based control. In addition, the Congress and the
Office of Management and Budget should consider whether and when to use
mechanisms, such as capital acquisition funds, to better match budget
recognition with the consumption of resources while preserving up-front
control.

--------------------------------------
/Footnote1/-^The Federal Accounting Standards Advisory Board (FASAB) was
  established in October 1990. See chapter 1 for more detail.
/Footnote2/-^AIMD-99-130, March 31, 1999) and Financial Audit: 1997
  Consolidated Financial Statements of the Untied States Government
  (GAO/AIMD-98-127, March 31, 1998).
/Footnote3/-^See chapter 1 for more detailed discussion of the Federal
  Credit Reform Act.
/Footnote4/-^Performance Budgeting: Initial Agency Experiences Provide a
  Foundation to Assess Future Directions (GAO/T-AIMD/GGD-99-216, July 1,
  1999).
/Footnote5/-^The Balanced Budget and Emergency Deficit Control Act of 1985
  as amended by the Budget Enforcement Act of 1990, the Omnibus Budget
  Reconciliation Act of 1993, and the Budget Enforcement Act of 1997. The
  DCA as amended established statutory limits on federal government
  spending for fiscal years 1991 through 2002.
/Footnote6/-^(2) government officials commit the government to make
  outlays by entering into legally binding agreements; and (3) outlays are
  made in payment to liquidate obligations.
/Footnote7/-^The U.S. budget uses accrual measures to recognize the
  government's costs for certain programs. For more information see
  chapter 1.
/Footnote8/-^Proponents of accrual budgeting suggest that compensating
  controls can be used to address control issues. In most cases, case
  study countries require appropriations for the annual cash required to
  purchase assets. However, cash requirements may not cover the full cost
  of the asset. Legislative approval may not be required for asset
  purchases below a certain amount if the department can fund them from
  depreciation reserves. Case study countries also established a number of
  other compensating controls in an attempt to alleviate control concerns.
  For example, in New Zealand, managers are not allowed to change the
  structure of their balance sheets without legislative approval; this is
  aimed at preventing managers from running down their asset bases to
  artificially lower the price of outputs. A number of case study
  countries also established supplemental approval processes for capital
  projects. See chapter 3 and country appendixes for additional information.
/Footnote9/-^In these countries the shift to accrual measurement in the
  budget occurred concurrently with a shift to output-based
  appropriations. In general terms, output-based appropriations provide
  funding for the total resources required to produce an "output" (a good
  or service produced by departments on behalf of the government)
  including costs that do not require an immediate cash outlay, such as
  depreciation and pension expenses. 
/Footnote10/-^See chapter 1 for additional details.
/Footnote11/-^T-AIMD-98-147, April 23, 1998).
/Footnote12/-^Accounting standards developed for the U.S. federal
  government do not view social insurance as a liability because the level
  of future benefits is considered to be uncertain. Proponents of these
  standards point out that the underlying laws establishing a claim to
  payments can be (and have been) changed over time. Also, they cite that
  estimates change greatly depending on economic assumptions and have
  changed over time. For example, the 1983 legislative changes were
  expected to maintain a positive fund balance until 2063; however, by
  current intermediate cost assumptions the fund will run out three
  decades sooner. However, many others believe that a liability should be
  recognized for the net benefits expected to be paid in future periods to
  current participants. The final standard calling for disclosures but not
  recognizing a liability for such payments was a compromise between the
  two positions. 
/Footnote13/-^In general terms, output-based appropriations provide
  funding for the total resources required to produce an "output" (a good
  or service produced by departments on behalf of the government)
  including costs that do not require an immediate cash outlay, such as
  depreciation and pension expenses. 
/Footnote14/-^The Australian Department of Defence outcome is "The
  prevention or defeat of armed force against Australia and its interest."
  Examples of the associated outputs are "capability for afloat support"
  and "military geographic information." 
/Footnote15/-^Performance Budgeting: Initial Agency Experiences Provide a
  Foundation to Assess Future Directions (GAO/T-AIMD/GGD-99-216, July 1,
  1999).
/Footnote16/-^Authority to borrow refers to the statutory authority that
  permits a federal agency to incur obligations and make payments to
  liquidate obligations out of borrowed monies. This does not include the
  Treasury's authority to borrow from the public or other sources under 31
  U.S.C. 31. 
/Footnote17/-^Authority to borrow is a type of budget authority and thus
  is subject to congressional control.

COMMONWEALTH OF AUSTRALIA
=========================

Australia's shift to accrual reporting and budgeting has progressed over
several years, along with a series of broader reform efforts aimed at
improving service delivery, fiscal position, and public sector
performance. The shift to accrual budgeting was undertaken to ensure a
better link between budgeted information and actual performance. A unique
aspect of Australia's accrual budgeting, reporting, and accounting
framework is that it seeks to both link outputs and outcomes through a
strategic planning process and to hold managers accountable for outputs.
The shift is also intended to increase transparency and accountability of
public policies through greater consistency of information and,
ultimately, through benchmarking of public activities against similar
activities in the private sector.

Background

The Commonwealth of Australia is a federation composed of a national
government, 6 state governments, territories, and hundreds of local
government bodies. The legislative power at the national level is vested
in the Commonwealth Parliament, made up of the House of Representatives
(148 members) and the Senate (76 members--12 from each of the 6 states and
2 from each of the two most populous territories). The party or coalition
of parties with a majority in the House of Representatives forms the
government and provides the Prime Minister. The Prime Minister and Cabinet
form the Executive Government of the Commonwealth. Cabinet members are
selected from both the House and the Senate.

The two largest political parties in the Commonwealth Parliament are the
Australian Labor Party and the Liberal Party of Australia. The other
parties are the Australian Democrats, the National Party of Australia, and
independents. The Labor Party was in office from 1983 through 1996, after
which it was replaced by the Liberal-National Coalition.

The Commonwealth government collects more than 70 percent of the public
sector revenue but is responsible for just over half of public sector
expenditures--the remainder is transferred to lower levels of government.
Commonwealth budget responsibilities include national defense,
immigration, outpatient services and pharmaceuticals, social security and
welfare,/Footnote1/ and others. State responsibilities include most public
sector spending on education, hospitals, public safety, and
infrastructure. Local responsibilities include local roads and parks,
libraries, and land-use planning. Commonwealth revenue comes primarily
from income taxes, sales taxes, and custom and excise duties. State
revenue comes mainly from payroll, business franchise, and stamp taxes, as
well as Commonwealth transfers in the form of general and specific purpose
grants, and a national goods and services tax which will go into effect 
July 1, 2000. Local government revenue comes from property taxes, charges,
fines, and a portion of the Commonwealth grants to the states.

The Budget Process
------------------

The governing party or coalition of parties in power has control over the
entire budget process. The government, through the Department of the
Treasury and the Department of Finance and Administration (DoFA), prepares
the budget for presentation to Parliament. The budget contains estimates
for the current budget year, which runs from July 1 to June 30, and
projections for the 3 forward years. The process starts with senior
ministers setting overall fiscal strategy and policy and defining
government priorities for the Budget. A subgroup of the Cabinet called the
Expenditure Review Committee (ERC--which is chaired by the Prime Minister,
or in the Prime Minister's absence by the Treasurer) sets outlay
targets/Footnote2/ and examines all expenditure proposals in the light of
the government's strategic fiscal policy framework. Cabinet ministers
advocate for new programs (new outputs in the new framework) or increased
funding (increased prices for outputs in the new framework) before ERC,
which reviews and recommends to the Cabinet those programs that promise to
fulfill Cabinet priorities. There is a separate Revenue Committee of the
Cabinet to consider revenue measures.

Budgets are passed largely intact by the House, as the majority of members
are from the same party, or coalition of parties, as the Executive
Government that developed the budget. The Australian Constitution prevents
the Senate from amending appropriation legislation relating to "ordinary
annual services" of the government, as opposed to its other activities. In
1965, the Executive Government and the Senate entered into a compact to
distinguish between "ordinary annual services" and other funding requests.
Appropriations for "ordinary annual services," which under the new
framework includes replacement capital, are presented in Bill 1, which the
Senate must pass or reject in total./Footnote3/ Bill 2, which contains
requests for spending on new outcomes or capital projects, can be changed
by the Senate. 

The Economy and the Budget
--------------------------

Australia's economy grew quickly in the late 1980s, spurred by strong
growth in exports, consumption, and high business investment. However, in
1991 Australia entered a recession. The economy began to recover in 1992,
and since then Australia has experienced a period of sustained growth in
gross domestic product (GDP) averaging about 4 percent per year, compared
to an annual average of over 3 percent in the 1970s and 1980s. Australia's
GDP growth in the 1990s has come with lower inflation than in the previous
two decades. Despite a drop in the unemployment rate from a peak of almost
11 percent in 1993 to just below 7 percent by the end of 1999, inflation
has averaged around 2 percent annually since 1993. In the 12 months ending
September 1999, GDP growth remained strong at
3.9 percent, despite an economic crisis in much of Asia. 

The Commonwealth has experienced two periods of budget surpluses since the
mid-1980s, both preceded by periods of deficits and deficit reduction. The
first surplus period started in fiscal year 1987-88 and lasted through 4
fiscal years. Deficits reemerged in 1991 primarily as a result of the
recession. In 1996, a newly elected government embarked on a renewed
deficit reduction effort that culminated in underlying budget surpluses
since fiscal year 1997-98, measured on a new definition of fiscal
balance./Footnote4/ 

Recent Reforms 
---------------

Over the past two decades, the government instituted numerous management
and budgetary process changes aimed at making delivery of government
services more efficient. These reforms sought to highlight budgetary
decisions, thus making them more transparent./Footnote5/ Reforms continued
in the latter half of the 1990s when the government introduced the Charter
of Budget Honesty to further improve fiscal performance through increasing
transparency and accountability of fiscal policy. Following a
comprehensive review of government operations conducted in 1996 by the
National Commission of Audit (NCOA),/Footnote6/ the new public sector
reform agenda emphasized (1) putting the public sector on a more
businesslike footing, (2) fostering a more competitive environment, and
(3) building a performance culture. The Financial Management and
Accountability Act 1997 introduced devolution of greater responsibility
for Commonwealth financial administration to departments and agencies,
along with the means with which to hold chief executives accountable for
exercising their management prerogatives. An accrual-based, resource
management framework that integrated budgeting, reporting, and accounting
on the same basis was seen as the tool that would allow the government to
move closer to its goals of efficiency, transparency, and performance
management.

Use of Accruals in Financial Management

Australia has progressively extended the use of accrual accounting across
government, first requiring audited financial statements at the
departmental level, then recommending audited whole-of-government reports,
and finally budgeting on an accrual basis. The progressive application of
accrual in government came about as decisionmakers in both the executive
and legislative branches became increasingly convinced of the need for
better alignment between budgeted amounts and financial information on
actual performance. 

Implementation Timeline
-----------------------

Australia extended the use of accrual accounting progressively across
government by making continual modifications to cash reporting and
improving the reporting of assets and liabilities. In the early 1990s, as
the government increased the use of contracting out for services,
managers' needs for new information to better price goods and services,
manage assets and liabilities, and administer contracts, spurred the
search for new ways to measure the costs of performance. By fiscal year
1994-95, departments had fully transitioned to reporting their operations
on a full accrual basis and publishing financial statements, which are
audited by the Australian National Audit Office (ANAO)./Footnote7/ For the
year ending June 30, 1998, the Commonwealth government as a whole received
an unqualified audit opinion on its financial statements. 

In April 1997, the government agreed to the implementation of accrual-
based outcome and output budgeting for the fiscal year 1999-2000 budget.
By November 1998, all departments and agencies had agreed with their
ministers on the desired outcomes and the contributing outputs to achieve
those outcomes. In the first part of 1999, departments and agencies
assigned accrual-based prices to those outcomes. The fiscal year 1999-2000
budget, tabled in May 1999, was the first budget to implement the full
accrual-based outcomes and outputs framework including accrual budgets and
accrual reporting. Though this budget expresses funding in accrual terms,
it is still considered transitional because it allocates funding to
departments based on the full accrual expenses of department inputs
necessary to provide the outputs that the government plans to contribute
to the achievement of outcomes that the government has decided to fund.
The Australian model seeks to move departments and agencies to a system
where they will justify the price of their outputs as far as possible by
comparison with other suppliers. Officials informed us, however, that it
would take a few years before they could successfully determine proper
benchmarked prices.

Factors Driving Adoption of Accrual Budgeting
---------------------------------------------

The adoption of accrual budgeting was spurred by recommendations from both
a parliamentary committee and a government commission. In 1995, the Joint
Committee on Public Accounts (JCPA) endorsed the preparation of audited
consolidated financial statements for the government beginning with the
1997-98 financial year./Footnote8/ The committee further suggested that
the Commonwealth adopt accrual budgeting once the first audited whole-of-
government financial statements were tabled in Parliament.

In 1996, the NCOA recommended an integrated resource management and
accountability framework that would focus explicitly on outputs and
outcomes, identify the full cost of resources consumed by a program, and
facilitate the competitive tendering and benchmarking processes. In an
assessment of government operations and fiscal position, NCOA noted that
the existing financial management information systems maintained for
budget formulation purposes were predicated on the need to provide the
government with forward estimates through a sophisticated but still cash-
based system. While all Commonwealth entities were required annually to
table audited financial statements prepared on an accrual basis, NCOA
found that few had implemented accrual standards in such a way as to
enable them to budget, track, and manage their programs based on a
knowledge of their full costs. Proponents of NCOA's framework believed
that by putting the onus on departments and agencies to manage on a
businesslike footing, the new accrual-based, resource management framework
would force greater attention on cost data. 

NCOA also determined that an accrual framework would support the
accountability needs of the public and Parliament by increasing
transparency and comparability in the government's financial activities at
the departmental, aggregate budget, and whole-of-government levels.
According to finance officials we interviewed, accrual budgeting was
grounded in the belief that in order to be useful, the costs of expected
and actual performance should be budgeted and reported on the same basis.
Applying consistent standards to the accounting of various items, such as
purchases and sales of physical assets, enables better comparisons between
(1) the costs of expected and actual performance, (2) the total costs
accruing to different departments delivering similar outputs, and
(3) the costs of public versus private sector provision of services.
Consistent information is also crucial to the appraisal of performance in
an environment of devolved responsibility where executives and managers
are given discretion to determine how and by whom services are delivered
and how operations are financed and organized. 

NCOA's findings and recommendations found resonance among some members of
Parliament who had voiced concerns that the disconnect between budgeting
and financial statement reporting discouraged the use of financial
statement information for decision-making. Additionally, these
parliamentarians believed that continued existence of a cash-based
budgeting system would impede the acceptance of accrual accounting and
reporting in government departments and create confusion for those trying
to monitor the financial position of government. Finally, cash budgeting
was perceived as failing to effect the behavioral changes necessary to
achieve better and more efficient government. 

Once the government decided to adopt accrual standards for budgeting, it
also determined that the budget should follow all applicable accounting
standards developed by official standard-setting bodies./Footnote9/ The
1999-2000 budget was reported against two accrual standards. The first,
the Australian Accounting Standard No. 31 `Financial Reporting by
Government' (AAS31) is the relevant accounting standard for financial
reporting by governments. The second, the Australian Bureau of Statistics'
accrual-based Government Finance Statistics (GFS) standard is consistent
with international standards used by the International Monetary Fund and
the United Nations. In areas where departures from applicable standards
were necessary--for example, the budget covers the general government
sector instead of the whole-of-government sector covered by financial
reporting--the budget documents identify these exceptions. 

Summary of Accrual Budgeting System

Australia's accrual-based model of budgeting sought to change
appropriations from a cash to an outcome-output framework, with outputs
priced on an accrual basis and tied to the achievement of outcomes. While
the old cash-based budgeting framework focused on measuring inputs and
monitoring outcomes, the links between inputs and outcomes have often been
unclear. The new accrual framework seeks to address this problem by
switching the focus from measuring inputs to measuring outputs, thereby
achieving a more direct link to outcomes. 

Under the new accrual budgeting framework, departments work with their
ministers to specify both outputs and outcomes. Specification of output
requires the identification of the price of output and other key
attributes, such as quantity and quality, whereas specifying outcomes
involves providing performance information on the achievement of planned
outcomes and the contribution of outputs to those outcomes. Under this new
model, departmental executives are held accountable for the delivery of
both outputs and the contribution their agencies' outputs make to the
achievement of outcomes. This approach differs from the New Zealand model.
While under the Australian model, ministers are responsible for defining
outcomes and for ensuring that outputs to be supplied by departments
produce those outcomes, the New Zealand model holds departmental
executives responsible only for the delivery of outputs, and not outcomes. 

The new accrual framework also changes the primary measure of the fiscal
position from an underlying cash balance--net of advances--to what is
referred to as a fiscal balance. The fiscal balance, like the underlying
cash balance, measures the government's contribution to net lending (the
national investment/saving imbalance) and hence to the external current
account balance. Fiscal balance is a measure in the GFS operating
statement. Since the measure is consistent with GFS standards and concepts
it is also consistent with international standards. However, it can also
be derived by making adjustments to the standard operating result. Figure
3 illustrates the translation from the accrual-based net operating result
to the fiscal balance.

Figure****Helvetica:x11****3:    Reconciliation of the Accrual Operating
                                 Result to the Fiscal Balance

*****************

*****************

These adjustments bring the operating result to a measurement closer to
net lending. For example, purchases of property, plant, and equipment are
subtracted from the operating result while proceeds from sales of
property, plant, and equipment are added to the operating result.
Officials in Australia argued that a measure that approximates net lending
(rather than the operating result) ensures consistency with the National
Accounts concepts, thus allowing a more ready assessment of the budget's
impact on the economy. As we reported in our previous work, Australia's
fiscal policies have been developed largely in response to concerns over
low national saving and high net foreign debt and their impact on
Australia's international competitiveness./Footnote10/ This is consistent
with the United Nations' System of National Accounts 1993. In the same
manner, the fiscal balance measures the government's net lending and hence
its contribution to, or detraction from, the private saving pool. In this
area as well as in its focus on outcomes, the Australian accrual model
differs from New Zealand's in that Australia puts more emphasis on
retaining a net lending measure of fiscal position whereas New Zealand
uses the accrual operating result as a primary measure of the impact of
its fiscal policies. 

At a broader level, officials we spoke to considered the main advantage of
accrual measures (as opposed to cash) to be a more comprehensive
indication of the total activity of government and the long-term effects
of current policy. They also suggested that cash measures do, however,
have some advantages for tracking expenditures in a fiscal year and
helping to identify the short-term effect of fiscal policy on the economy.
Consequently, cash indicators for the headline and the underlying balance
will continue to be produced.

Structure of Appropriations 
----------------------------

Figure 4 shows the financial statements used in presenting the
Commonwealth's fiscal year 1999-2000 budget. The first three financial
statements are similar to the primary financial statements used in the
private sector and are based on Australian accounting
standards./Footnote11/ The government also submitted a fourth statement,
the capital budget statement, to present information on capital
transactions./Footnote12/ 

Figure****Helvetica:x11****4:    Financial Statements Used to Represent
                                 the Government's Budget

*****************

*****************

Appropriations for each department or agency are for the financial
resources, measured on an accrual basis, required to produce outputs that
contribute to government outcomes. The output-outcome structure is
determined through the strategic planning process, in which departments
and their ministers first define desired outcomes, then define the outputs
that, if delivered, would lead to the achievement of those outcomes.
Appropriations make a differentiation between departmental items
(controlled by departments) and administered items (where departments have
no discretion and where expenses arise when recipients meet eligibility
criteria, e.g., loans and social security payments). Appropriation Bill 1
includes recurring departmental and administered items. Appropriation Bill
2 includes requests for capital injections and funding for new outcomes. 

Treatment of Specific Budget Items
----------------------------------

Budgeting and reporting in Australia follow accrual accounting standards.
This means that assets are capitalized and depreciation expense recorded
over the life of the asset. Liabilities are recorded when they are
incurred, as follows: 

o   Public sector employee pension: Under accrual budgeting, departments
  pay into a centralized pension fund an amount equal to the public
  pension accruing to current employees, as well as the interest on or
  any changes in the outstanding liability due to past services rendered.
  Generally, changes in the value of the outstanding liability occur as a
  result of revaluation in the number of salary earners and assumptions
  relating to wage growth, inflation, and the expected rate of return on
  investment. The public pension expense is booked as a departmental
  expense on the department's operating statement, incorporated into the
  prices of outputs, and thus included in the department's request for
  funding. The centralized pension fund records these contributions as
  revenues and uses cash received to make payments to current retirees.
  At the end of the year, the central pension fund books an actuarial
  liability in the whole-of-government financial statements.

o   Capital: Under accrual budgeting, the annual cost of using capital
  assets, namely depreciation and a cost-of-capital charge, is recorded
  in the operating statement and thus incorporated into the cost of the
  departments' outputs. The departments receive appropriations for these
  noncash expenditures. The cost-of-capital charge is funded based on the
  beginning asset balance and repaid to the government based on the
  ending asset balance. Managers have the freedom to optimize their asset
  base, which includes purchasing replacement assets by using funds
  accumulated from this depreciation expense. Departments with adequate
  reserves can purchase assets subject to ministerial approval, which is
  required even if the proposed purchase is to be financed through a
  finance lease or other financing arrangement that would not require an
  immediate cash outlay. Departments with inadequate funds to replace
  assets have to request a capital injection--an appropriation--for the
  difference between funds required and available reserves. The cash flow
  statement will outline most cash outlays for the purchase of property,
  plant, equipment, and intangibles while the capital budget statement
  will record total capital expenditures.

o   Inventories: Departments and agencies can use one of several
  generally accepted methods for valuing inventory. Expenses are recorded
  when inventories are used, not when purchased or when the cash outlays
  occur. Inventory standards apply to only a few departments as most are
  not accumulating inventories and have no incentive to carry large
  stockpiles of supplies.

o   Insurance, loans, and guarantees: Loans are treated as an
  administered expense and shown on the department's budget as cash
  outlays when loans are disbursed and cash receipts when payments are
  collected. 

o   Social insurance: The social security and old-age pension programs
  are financed from general government revenue. Social security is means-
  tested and is a supplement to occupational-based pension arrangements.
  It will continue to operate on a "pay-as-you-go" basis with the budget
  reflecting the total accrued expense for the current year, even if cash
  has not been disbursed. Neither the budget nor the financial statements
  of the government recognize the future commitments of the government.
  In addition, the government treats the Superannuation
  Guarantee/Footnote13/ as general revenue, and does not accumulate it to
  offset future benefits. 

o   Revenues: Revenue in the budget is recognized when the taxpayer makes
  a self-assessment or when the Australian Taxation Office or Australian
  Customs Service issues an assessment. This recognition basis
  acknowledges that the government cannot reliably forecast or properly
  value revenues at the time that the economic activity that gives rise
  to the tax liability occurs. Under the new accrual framework, the
  government makes an adjustment to receivables to account for
  uncollectible taxes. 

Aggregate Budget Measure
------------------------

As shown in figure 5, the government provided several fiscal measures in
the 1999-2000 budget: (1) a cash balance (called headline cash balance),
(2) an underlying balance (called underlying cash balance), (3) an
operating balance (called the operating result), and (4) a fiscal balance.
Officials from the Treasurer's Office informed us that while the two
objectives of the budget--positively affecting the economy in the short
term and focusing attention on managerial issues--are not at odds with
each other, they necessitate the use of different measures. They argued
that the short-term focus of the former objective is best served when
described on a cash basis while the medium- to long-term focus of the
latter purpose is best described on an accrual basis. Thus, while the
accrual-based operating balance provides information that can be used to
address medium- to long-term issues, Australian officials we spoke with
felt that a measure that better approximates cash--the fiscal balance--
would better assist the government in the conduct of fiscal policies.
These officials believed that the fiscal balance, which is derived by
making adjustments to the operating balance, is a better indication of the
government's contribution to net lending (the national investment/saving
imbalance)./Footnote14/

Figure****Helvetica:x11****5:    Measures of Fiscal Position

*****************

*****************

Key Differences Between Cash and Accrual 
-----------------------------------------

Key differences between accrual and cash amounts occur because of timing.
Timing differences mean that the bottom line--the surplus or deficit--is
affected in either direction by accrual or cash recognition depending on
the activities undertaken by the government in a particular year. This
timing difference is most apparent for revenues, asset purchases, public
employee pensions, and interest expense. (See figure 6.) For example, cash
outlays for the purchase of assets decrease the cash balance in the year
the cash is paid under a cash system, but have no effect on the
deficit/surplus under an accrual system, as replacement assets will
eventually be purchased from depreciation expenses accumulated over the
life of the asset. In succeeding years, as the asset is put into service,
depreciation expense decreases the accrual-based operating balance, but
has no effect on the cash balance. In most instances, because the cash
basis tends to recognize large capital items all at once while the accrual
basis spreads the cost of purchase over the useful life of the asset,
accrual measurements generally smooth out expenses. 

Figure****Helvetica:x11****6:    Reconciliation Between Operating and Cash
                                 Balances

*****************

*****************

Figure 7 shows the differences between the cash and accrual balances as
measures of the fiscal position. In the fiscal year 1999-2000 budget, the
estimated cash surplus is A$23 billion, compared to an operating surplus
of A$5.7 billion, or a difference of 2.8 percent of GDP. The difference is
attributed mostly to planned asset sales totaling about A$16 billion.
Similarly, in the fiscal years 2001-02 and 2002-03 budgets, planned asset
sales are projected to cause the cash balance to be substantially larger
than the operating result. By contrast, in the fiscal year 2000-01 budget,
the cash surplus is expected to be smaller than the operating surplus due
to planned asset purchases.

Figure****Helvetica:x11****7:    Estimated Cash Balance Compared to
                                 Estimated Accrual-Based Operating Result,
                                 Fiscal Years 1998-99 Through 2002-03

*****************

*****************

Source: Budget Strategy and Outlook, 1999-2000.

Views on Implications for Decision-making

The fiscal year 1999-2000 budget is the first accrual-based budget.
Consequently, Australia does not yet have any actual experience on which
to fully assess its implications for decision-making. Nevertheless,
officials and managers we spoke with anticipated that accrual budgeting
would bring about better fiscal and managerial decision-making. Officials
expect that

o   the greater focus on maintaining ongoing budgetary health will result
  in better decisions that are sustainable in the long run;

o   the output and outcome focus will result in greater scrutiny of
  government objectives and services and lead to improved budget
  decisions; 

o   the ability to make comparisons, and ultimately, to benchmark price
  and performance against private sector entities will spur the public
  sector towards achieving better results with fewer resources;

o   the accrual framework will improve transparency and accountability;
  and 

o   the accrual budgeting and reporting framework will bring about better
  asset management. 

Further, NCOA reported that on an aggregate budget level, accrual-based
budget projections would provide a more appropriate measure of the ongoing
budget balance. By highlighting instances where revenues may not be
sufficient to cover all expenses over the forward estimate--even though
cash receipts may be available to meet all cash obligations--accrual
budgeting helps focus legislative attention earlier if the asset base is
being run down or increasing levels of liabilities are being accumulated.
With accrual-based projections it also would be possible to see that a
projected cash shortfall and a resulting increase in borrowing may be more
than offset by an increase in assets and future productive capacity. While
the JCPA acknowledged that reporting on a cash basis is simple and that a
cash deficit or surplus best captures the net short-term economic impact
of the budget, it also argued that accrual budgeting makes possible the
assessment of the government's management of its asset base, its
liabilities, and its long-term fiscal strength. Further, NCOA noted that
accrual budgeting and reporting would not detract attention from cash
because the cash flow statement, one of the principal financial statements
required by the accrual framework, will provide the cash information. 

Accrual-based budgeting is expected to improve effectiveness and
efficiency of government programs by centering the budget discussion on
what departments and agencies are expected to deliver, i.e., the quantity
and quality of outputs rather than inputs. According to government
officials, discussions that revolve around outcomes and outputs would
necessitate examination of all the costs necessary to deliver those
outcomes and outputs. Officials contrasted the new accrual framework to
the former cash-based system where departments were guaranteed a budget
based on the previous year's costs and the budget debate concentrated only
on new spending proposals and saving options--only 3 to 5 percent of the
budget. They thought that budget data presented as line-by-line input
costs provided a lot of detail without giving decisionmakers adequate
information to focus on what the government was doing and whether it was
effective. In contrast, officials believed that the outcome and output
focus of the new accrual system would shift the budget debate toward
deliberating on the bigger picture, i.e., the objectives of the government
and the "totality" of how a department manages its operations and assets. 

On the managerial front, officials believed that the new accrual framework
would improve incentives to manage better with fewer resources by making
it possible to compare performance between government entities and between
public and private sector performance. By using a consistent basis to
measure the cost of output and eliminating the distortions inherent in a
cash system, accrual standards provide an analytical base from which to
compare the costs of one department with another. For example, a
department would no longer appear more efficient just because it used less
cash in a year if, at the same time, it had accumulated more liabilities
and consumed more of its asset base. Conversely, a department would not
automatically be judged a poor performer because it spent a large amount
of cash in one year to purchase an asset, even though the asset would
enable it to operate more efficiently in the future. Finally, by
accounting on a similar basis as private sector entities, accrual
budgeting allows for greater comparability with the private sector.
Ultimately, it is hoped that the new accrual system will deliver
information so that decisions can be made as to whether a service or good
should be purchased from a government department or a private sector
entity. Benchmarking, both between departments and against private
entities, is an important objective of the Australian accrual budgeting,
reporting, and accounting model.

Officials further expected that the ability to retain at least a share of
their operating surpluses would lead to better performance by improving
management incentives to seek efficiencies continually and improve output
delivery, ultimately leading to better outcomes. The government reasoned
that withdrawing operating surpluses as they occur or reducing the
departmental budget concurrent with the expected efficiency would reduce
the incentive to achieve an operating surplus, and, ultimately, the
incentive-driven efficiency gains.

Officials believed that standardized and consistent financial information
would improve external reporting and facilitate review of government
performance, thereby advancing the Commonwealth's agenda of greater
accountability and transparency. They pointed at many research findings
indicating that reporting information on planned performance on a cash
basis and actual performance on an accrual basis through financial
statements provided conflicting signals and incentives. Studies also found
that managers held accountable for the budget on a cash basis failed to
use financial data in the decision-making process. The government hoped
that information consistency would provide for better assessment of
planned and actual performance, and, consequently, lead to better results. 

Some officials expressed skepticism that financial reporting on an accrual
basis necessitates budgeting on that basis. These officials pointed out
that the basic budget of the Commonwealth involves handing out cash.
Consequently, it makes very little difference whether these transactions
are measured on an accrual or a cash basis. However, even these officials
conceded that there might be greater potential for managerial
improvements. For example, finance officials have repeatedly pointed out
serious degradation of physical property at the Federal Airport Authority.
However, because of a minor recession in the early 1990s, and because
under cash-based budgeting any large cash outlay to address the physical
degradation would have a significant impact on one year's fiscal balance,
successive governments ignored the need to take actions to improve and
maintain the asset base. As it now prepares for privatization of the
entity, Parliament finds that the degradation is so serious that it needs
to spend A$100 million just to be able to sell the property. NAO officials
speculated that, had accrual accounting standards been in place that
allowed for the capital spending to be spread over the life of the asset,
instead of a cash budgeting system where the entire amount of the spending
needed to be recognized at the time the cash was disbursed, decisionmakers
might have taken earlier and more timely actions. Ultimately, accrual
budgeting may help address the tendency under accrual financial reporting
to maintain and manage to a cash-based system and then use adjustments at
the end of the accounting period to construct general-purpose financial
reports.

Proponents expect that clearer distinction between capital and operating
costs will yield important benefits in the area of capital. In the past,
capital was not treated consistently. For example, an asset that cost less
than A$250,000 might have been treated as an operating cost and included
in Appropriation Bill 1--therefore not subject to changes in Parliament--
whereas another asset costing the same amount might have been viewed as a
new project and submitted as part of Appropriation Bill 2--and so
subjected to a higher level of scrutiny. In the new model, all
transactions requiring an appropriation in the form of equity injections
or loans will appear in Appropriation Bill 2. In addition, the capital
budget statement--one of the four primary budget statements--will also
include details on every capital project, whether it is to be funded
through capital injections or loans, or from departments' accumulated
depreciation. Officials informed us that although under the new framework
departments will have flexibility to replace assets through accumulated
depreciation, in the beginning departments will not have accumulated
adequate funds to replace old assets, much less purchase new assets.
Consequently, officials expect that for some period of time, most capital
asset transactions will appear in Appropriations Bill 2, which is subject
to Senate amendments, and that this will help focus the debate on whether
there is a need for new capital spending. In the long run, after these
debates have occurred, departments can replace assets out of accumulated
depreciation, though they will continue to provide information on their
actions through the capital budget statement. 

Like other countries that have switched, or are considering a shift, to
accrual, Australia also expects better asset management as a benefit from
accrual budgeting. For example, the Department of Defence never had an
inventory system for consumables such as bullets and ration packs. Accrual
accounting requirements resulted in the unearthing of over 
A$2 billion in inventory. Now, incorporating the inventory costs in the
budget will help focus attention on the oversight of these stocks. 

As an example of how accrual budgeting provides improved information and
incentives that lead to better decisions, Treasury officials pointed to
the resolution of what, until recently, was the difficult issue of
retiring debt on which premiums must be paid or discounts taken. Under
accrual standards, any premium or discount on a particular debt issue is
recognized annually, over the life of the issuance. In contrast, the cash
system records the full value of the repurchase premium or discount for
the year in which the repurchased debt was cancelled or matured. Thus,
under cash, retiring debt on which a premium is due--a good thing--could
necessitate a cash outlay with a negative impact on that year's bottom
line, and was politically difficult to undertake. Under the accrual basis,
discounts and premiums are amortized over the life of the debt.
Consequently, early debt retirement would have no budgetary impact and
could be made based on economic analysis alone.

Parliamentary Accountability and Control
----------------------------------------

While most parliamentary staff we spoke with were generally supportive of
the new accrual framework, questions related to the balance of power and
control over spending have arisen within the context of accrual budgeting.
They acknowledged that accrual budgets may weaken senatorial power. Under
the cash basis, Parliament had to pass appropriation legislation to
approve departmental expenditures. The Senate in particular had the
authority to make changes to expenditures proposed in Bill 2--principally
capital and new initiatives--and thus could make large amendments to
government budget proposals. Under the new accrual framework, once a
department receives the authority to purchase an asset, it could
continually replace the asset using funds accumulated from depreciation
expense, and thus would no longer need Senate appropriation. Similarly, if
the department does not intend to purchase new assets from its reserves,
it may choose to divert the cash into funding other operating areas.
Consequently, the Senate's constitutional authority to express disapproval
of the government's budget may diminish because departments can maintain
operations while they wait for Senate action on appropriations. 

Another concern has been raised over the potential loss of important data
that may result in a relaxing of fiscal discipline. Officials informed us
that under the cash system, all new capital submissions showed the fiscal
impact of these commitments for 10 years or more. While agencies are to
continue to submit these estimates, the new capital budget statement
provides details only for the budget year and 3 forward years like the
rest of the budget. Since the new capital budget statement will be the
focus of the budgeting process, ANAO officials we interviewed were
concerned that decisionmakers would shift attention towards the shorter-
term horizon, which could result in decisions that negatively affect the
government's fiscal position. Furthermore, concerns were expressed that
there may be an incentive under the new reporting requirement to forgo
fiscal discipline. Because the government under the new framework has to
recognize only depreciation expense on new capital in the year a new asset
is acquired, officials are concerned that the benefits from "announcing"
new capital projects would outweigh the costs and result in the
acquisition of many new capital projects. 

DoFA officials dismissed concerns that appropriating cash for noncash
expenses may result in departments diverting available cash into expenses.
They were confident that ex-post controls were adequate to monitor the
behavior of departments and agencies. While they conceded that no
mechanism exists to prevent departments from spending cash that is to be
accumulating for depreciation for some other operating expense, such as
increasing salaries, such an expenditure would result in an unapproved
expense, and therefore a loss on the department's financial statements.
Because the DoFA plans to require monthly reporting, it expects that
deviations would show up promptly through the routine process of examining
departmental financial statements. A loss would be apparent in the
analytical process, and would have to be justified to the Minister for
Finance and Administration.

Implementation Issues

At the time of our visit, the departments were in the process of putting
together the first accrual budgets. Officials were able to identify
several key challenges to implementing accrual, including (1) expanding
the skill level, (2) achieving cultural change, and (3) developing
adequate accounting and cost systems. 

A senior DoFA official said that improving the accounting skill of budget
staff accustomed to operating within a cash environment is crucial to
ensuring the smooth transition and implementation of accrual budgeting.
The department took a survey to assess the accounting skills that already
existed at the other departments and highlighted those skills that needed
developing. Although individual departments had to assume the
responsibility for ensuring that budget and other personnel were properly
trained, DoFA worked with various consultants to develop a training
strategy to build up the skills necessary to adopt to the accrual reforms. 

Cultural change was and continues to be a key challenge. DoFA officials
spearheading the switch to accrual budgeting informed us that ensuring
cultural change was a necessary ingredient to a successful transition.
Eighteen months ago, DoFA started to address this need by convening
representatives from every department so that they could better
disseminate information related to the new accrual framework. The group
served to raise awareness within departments that a change was going to
take place and helped develop an openness and receptiveness to change.
DoFA officials believed that this approach helped to inform managers and
executives of the new budgeting and accounting approach and to generate
support and buy-in for the reform.

Finally, a DoFA official identified cost accounting as an area needing
extensive attention before the full benefits of an accrual system could be
achieved. The shift towards appropriations based on price had created an
increased need for cost accounting information, but there was significant
variation in the quality of cost information systems across departments
and agencies, indicating that this was one area in the public sector that
needed greater attention. Improving cost information was viewed as a
necessary next step to further financial management and to improve the
effectiveness of accrual budgeting and reporting information for
performance assessment.

--------------------------------------
/Footnote1/-^The term social security and welfare refers to old-age
  pensions, unemployment benefits, and welfare. Old-age pension payments
  are funded out of the general fund, with neither employers nor employees
  making contributory payments. Unemployment benefits are also funded out
  of the general fund, and there is no separate unemployment insurance fund.
/Footnote2/-^Outlay targets are set using a system of forward estimates,
  which are outlay estimates based on decisions made in the previous
  budget year with no future policy changes--similar to the "baseline" in
  the United States.
/Footnote3/-^If the Senate does not pass the government's budget, a new
  general election may be called. In 1975, a "double dissolution" of the
  Labor government under Prime Minister Whitlam and the sitting Parliament
  occurred after the Senate twice refused to pass the appropriation bills
  for government's "ordinary annual services." 
/Footnote4/-^The term surplus/deficit can refer to three measures of
  budget balance. Prior to fiscal year 1996-97, it referred to the
  headline cash balance, measured as the difference between revenue and
  cash outlays. Beginning in fiscal year 1996-97, the measurement of the
  surplus/deficit changed from a headline cash basis to an `underlying
  cash' basis, which excludes the net effects of advances, loans, and
  equity transactions such as sales and purchases of capital assets. If a
  headline cash measurement is used, Australia achieved a small surplus of
  about one-half percent of GDP in fiscal year 1996-97. Beginning in
  fiscal year 1999-2000, with the implementation of the new accrual
  budgeting framework, the fiscal balance has been adopted as the new
  measure of fiscal position. 
/Footnote5/-^The reforms can be sorted into two broad initiatives--the
  Financial Management Improvement Program and Program Management and
  Budgeting. Reforms restructured departments into portfolios, introduced
  budgeting using forward estimates over a 3-year period, and required
  that departments provide an "efficiency dividend," i.e., budget savings,
  through increased efficiency.
/Footnote6/-^NCOA was established by the government in March 1996 to
  review and report on the state of fiscal position and to advise the
  government on the management of its finances in order to improve
  Australia's medium- and long-term fiscal position.
/Footnote7/-^The Auditor General Act 1997 grants to ANAO the ability to
  conduct financial statement and performance audits of Commonwealth
  agencies, authorities, and owned and controlled companies. ANAO also
  provides professional advice and assistance in relation to auditing and
  accounting matters generally with the emphasis on practical guidance.
/Footnote8/-^Financial Reporting for the Commonwealth: Towards Greater
  Transparency and Accountability, Parliament of the Commonwealth of
  Australia, Joint Committee of Public Accounts, Report 341, November 1995.
/Footnote9/-^In Australia, there are two important accounting standard-
  setting bodies. The Public Sector Accounting Standards Board (PSASB) was
  established in 1983 to formulate, develop, and maintain reporting
  standards of relevance to public sector entities. PSASB works closely
  with the Australian Accounting Standards Board, which is responsible for
  developing standards for private companies, to jointly develop and
  promulgate Statements of Accounting Concepts and Australian Accounting
  Standards that are applicable to both the public and private sectors. It
  is planned to merge the two boards during the year 2000.
/Footnote10/-^Budget Surpluses: Experiences of Other Nations and
  Implications for the United States (GAO/AIMD-00-23, November 2, 1999).
/Footnote11/-^The fiscal year 1999-2000 budget was prepared in accordance
  with applicable Australian Accounting Standards (AAS) with several
  exceptions. First, the budget covers the general government sector
  instead of the whole-of-government sector covered by AAS. Second,
  dividends are recorded in the year declared instead of in the year
  earned. Third, taxes collected on behalf of others are not recognized in
  the budget. Fourth, revenue is recorded on a different basis as
  explained in a later section.
/Footnote12/-^The Capital Budget Statement includes information on all
  capital expenditures, which may be funded by the internal funds of each
  department--i.e., cash from operations, cash appropriations made by the
  government in previous years, and sales of agency assets--and/or from
  capital injections and loans. This statement is different from
  Appropriations Bill 2, which covers only projects requiring capital
  injections or loans.
/Footnote13/-^The government requires that employers pay a set percentage
  of each employee's wage into a superannuation fund, generally private,
  of the employee's choosing. Consequently, these payments do not affect
  the government's budget. Employers who do not pay superannuation will
  pay to the government a fee--the Superannuation Guarantee Charge--
  equivalent to the contributions (plus interest) that they should have
  paid directly to a superannuation fund on behalf of their employees. 
/Footnote14/-^The Australian government has repeatedly expressed concern
  over the low rate of national saving and the country's dependence on
  foreign sources to make up the difference between the saving rate and
  the investment demand. Deficit and surplus policies of the Australian
  government have been articulated within the framework of reducing the
  government's call on national saving and increasing the government's
  contribution to net lending.

CANADA
======

Over the last 30 years, a series of national commissions have produced
studies arguing that the financial management information available to
Canadian decisionmakers needed improvement. These studies placed
particular focus on the need to collect information on the complete costs
of government activities. During the 1990s, the government proceeded with
plans to improve the quality and quantity of financial information. In
1995, a decision was made to produce audited financial statements, on a
full accrual basis, for the whole-of-government by fiscal year 2001-02.
The decision regarding how to maintain the alignment between the financial
statements and the departmental appropriation requests was deferred at
that time. Recently, parliamentary committees and the Auditor General's
office have recommended changing the appropriations request to a full
accrual basis to be consistent with the financial statements.

Background

Canada is a federal system composed of a central government,
10 provincial governments, and three territories./Footnote1/ All of these
governments are parliamentary systems. The federal government is composed
of a Senate and a House of Commons. Members of the House of Commons are
elected by popular vote, at least every 5 years, while senators are
appointed by the Governor General on the recommendation of the Prime
Minister. While the House of Commons is the main law-making body, no bill
can become law unless it has been passed by the Senate. In general, the
political party with the majority of seats in the House of Commons usually
forms the government and the leader of this party becomes the Prime
Minister.

Governmental Structure
----------------------

The current Prime Minister, Jean Chr****ITCCentury Book:x8e****tien,
became Prime Minister in 1993 when the Liberal Party regained a majority
in the House after 9 years of Progressive Conservative Party rule. In June
1997, the Liberal government was reelected, winning 155 of 301 seats in
the House. Throughout most of this century, the Liberal Party and the
Progressive Conservative Party have dominated Canadian federal politics.
Currently, however, the Reform Party has the second largest number of
seats in the House at 59. The remaining seats are divided among the Bloc
Qu****ITCCentury Book:x8e****becois (44), the New Democratic Party (21),
the Progressive Conservatives (19), and independent members (2).

Executive authority at the federal level resides in the Prime Minister's
Cabinet. The Prime Minister chooses Cabinet ministers from members of
Parliament in the governing party. The Cabinet is responsible for most
legislation; it develops government policy and is responsible to the House
of Commons. The federal government has explicit responsibility over
national defense, interprovincial and international trade and commerce,
immigration, the banking and monetary system, and criminal laws.
Provincial governments are responsible for education, property and civil
rights, the administration of justice, the hospital system, natural
resources within their borders, social security, health, and municipal
institutions. All powers not specifically conferred upon the provinces are
assigned to the federal government.

The Budget Process
------------------

In recent years, reforms have been undertaken to make the Canadian federal
budget process more open. In response to criticism of the closed nature of
the budget process, the government began to move towards greater openness
in 1994. In the fall of 1994, the government began releasing annual
midyear fiscal updates that contain deficit/surplus targets and an
economic update. In addition, after release of the midyear updates, a
series of consultations about the next year's budget have been held with
members of Parliament and the public. Several officials we interviewed
said that the prebudget consultations allow the government to put forward
some of its ideas for new spending and tax initiatives and receive
feedback prior to release of the Budget. 

The Cabinet has the sole power to prepare and introduce budget-related
bills. In general, neither the House nor the Senate may increase taxes or
expenditures./Footnote2/ The government, led by the Ministry of Finance,
prepares its budget, which is tabled in, or presented to, Parliament. The
government's budget is tabled in the House of Commons by the Finance
Minister, usually in mid-February, giving the government's overall fiscal
plan for revenues and expenditures and their relationships to the
aggregate measures used to set fiscal targets. In addition, the Budget
sets forth detailed spending proposals for the government's new
initiatives. The Main Estimates, on the other hand, are the detailed plans
for all government expenditures, by department and agency, and are tabled
by the President of the Treasury Board Secretariat (TBS) several days
after the Budget./Footnote3/ The legislation necessary to implement the
Main Estimates and Budget are also tabled and are referred to as "money
bills." The Estimates are required to be tabled by March 1 and are usually
passed before Parliament adjourns in late June. As the fiscal year begins
on April 1, Parliament approves an "interim supply," allowing the
government to spend the funds necessary for ongoing operations during this
period.

The Budget and Main Estimates are neither changed nor debated to any
significant degree in Parliament. Failure to pass any of the associated
money bills would signal a lack of confidence in the government and almost
always lead to new elections. Observers note that this does not mean the
government has a free hand. It must consult extensively with Parliament--
at least with members of the governing party--prior to introducing any of
these bills to ensure passage. Similarly, the government would likely
withdraw certain aspects of the budget framework if majority support were
not certain.

The Economy and the Budget 
---------------------------

During the 1980s and 1990s, Canada experienced two short but severe
recessions and two lengthy periods of growth. As a result of the first
recession in fiscal year 1981-82, unemployment soared from less than
8 percent in 1981 to nearly 12 percent in 1983. The economy rebounded
strongly from the recession, with real economic growth above 5 percent in
both 1984 and 1985. The strong recovery, however, eventually led to
inflationary pressures, and the Bank of Canada responded by tightening
monetary policy in late 1987. When economic activity slowed in late 1990,
the bank began to gradually lower interest rates. However, by 1991, the
Canadian economy was again in recession. The unemployment rate rose from
about 8 percent in 1990 to over 10 percent in 1991, and remained above 10
percent until 1995. Growth finally began to pick up in mid-1993, was even
stronger in 1994, but began to slow again in 1995. In 1997 and 1998,
growth picked up again. 

After struggling with large deficits for over two decades,/Footnote4/
Canada achieved a federal budget surplus in fiscal year 1997-98 and
expects another one for fiscal year 1998-99. These results reflect several
years of significant fiscal restraint, particularly on the spending side
of the budget. Such restraint was prompted by concerns that a high and
rising debt burden--at both the federal and provincial level--was a major
obstacle to the nation's economic future. In response, the federal
government's strategy since the mid-1990s has been to reduce the deficit
and achieve a balanced budget in accordance with a specific set of fiscal
targets. The government has consistently bettered these targets, in part
due to its deliberately cautious approach to budget planning. Given this
track record, the government's official target of a balanced budget
implies a policy of at least modest surpluses. The government recognizes
that its cautious planning could result in surpluses by describing its
fiscal goal as "balance or better."

Recent Budgetary Reforms
------------------------

For more than 30 years, various national commissions have reported on the
need to improve the financial information available to key decisionmakers
in Canada. The Financial Information Strategy (FIS) was first announced in
1989, and through FIS Canada hopes to achieve improvements in the
government's accountability framework as well as efficiencies in program
and service delivery. To accomplish FIS' objectives, Canada plans to
decentralize many of the financial reporting responsibilities to the
departments and to use accrual accounting concepts and new reporting
structures to provide departmental managers with better tools for
financial management. Under the current financial management regime,
financial information is collected, and departmental spending controlled,
at the central level by TBS and the Receiver General./Footnote5/ In 1995,
the Minister of Finance announced the government's decision to adopt full
accrual accounting, but set no timetables for implementation. Later that
year, TBS adopted a plan to prepare audited financial statements, on a
full accrual basis, by 2001. Departmental financial statements must be
capable of withstanding the test of audit. At that time, however, a
decision on whether to change the departmental appropriation to a full
accrual basis was deferred.

In 1996, a parallel reform effort to improve reporting to Parliament was
begun. A number of agencies participated in a pilot program to produce
Performance Reports in the fall--during prebudget consultations--that
present the results achieved by the agencies in accomplishing the plans
set forth in the spring in the Reports on Plans and Priorities./Footnote6/
Members of Parliament have indicated that having these reports during the
prebudget consultative process has proven useful, and the pilot has been
extended to all departments. In order to improve the link between the
costs of resources consumed and the results achieved in providing a public
service, the government has announced its intention to include proposed
(budgeted) and actual departmental financial statements on a full accrual
basis within the Part III Reports on Plans and Priorities and the annual
Performance Reports, but did not establish a time frame for doing so.

In 1997, the government announced the Modernization of Comptrollership
initiative, a broad reform initiative to improve management in the public
sector. The new initiative has incorporated the FIS initiative, which
continues to play an integral role in meeting the broader objectives of
better financial management. Modernizing Comptrollership takes the theme
of decentralization of accountability a step further than FIS by
incorporating a human resource component to ensure that managers have the
training and skills they need to make decisions in the new environment, a
risk management component to provide guidance to managers on how to manage
their programs and departments in an environment of scarce resources, and
a performance reporting and results initiative to link resources to
results. Because these efforts depend heavily on the information provided
through accrual accounting, they complement FIS.

In 1998, the House of Commons Standing Committee on Public Accounts argued
that to help ensure the success of the FIS Initiative, the government and
the Parliament should also appropriate funds on a full accrual basis. It
recommended that TBS determine the best possible options to move the
appropriations process to a full accrual basis and to report to Parliament
regularly on the progress made in developing these options. This
recommendation was based largely on the recognition that departmental
managers have long been held accountable only through the appropriations
process. If funds were appropriated on the same basis as they were
reported, the committee believed decisionmakers would make better use of
accrual-based information. TBS plans to develop a number of models for
consultation with a variety of stakeholders, officials in the Secretariat,
staff from the budget and accounting offices in the various departments
and program managers.

Use of Accruals in Financial Management

Timeline: Progression of Use of Accruals
----------------------------------------

Canada was one of the first countries in the world to start moving away
from a cash-based reporting system to an accrual basis in its financial
statements. A number of significant expenditure items are reported on an
accrual basis in the financial statements. For example, public sector
employee pension costs are recorded on an actuarial basis and fully
accrued and gains and losses in the pension fund are fully amortized.
Furthermore, loans, investments, and advances are subject to an annual
revaluation to reflect estimates of changes from carrying value. This
allowance for valuation for loans, investments, and advances represents
the estimated losses/gains on these assets at year-end. The move to full
accrual reporting in the whole-of-government financial statements for
fiscal year 2001-02 will most notably include the full capitalization of
all assets and related depreciation accounts.

Canada also budgets for some items on an accrual basis. For example, as in
the financial statements, the future pension costs for current employees
are accrued and included in the departmental budget estimates. Adjustments
for the amortization of the net gains and losses are made once the budget
is consolidated and not allocated to the individual departments. The
budget also includes in the agencies' appropriations request--the
Estimates--the expected payment needs for accounts payable./Footnote7/
However, financial assets such as loans, investments, and advances are
treated as nonbudgetary items/Footnote8/ and tangible capital is expensed,
not accrued. Tax revenues are budgeted on a cash basis but nontax revenues
are accrued./Footnote9/

Factors Driving Adoption of Full Accrual Budgeting
--------------------------------------------------

Canada appears to have rejected a sweeping approach to public management
reforms favoring, instead, more gradual reform. The call for the Estimates
to be presented on an accrual basis should be viewed as yet another
incremental step in furthering efforts to improve financial information
available to Canadian decisionmakers. Officials at the TBS and the Office
of the Auditor General (OAG) said that once there was a decision to change
the accounting treatment for capital, they thought it important to
consider changing the budgetary treatment to ensure alignment. Since
pensions and accounts payable were already accrued in the budget, tangible
capital and tax revenues were the only budgetary items remaining for which
cash and accrual treatment significantly differed. 

As part of a recent performance audit on the government's FIS
initiative,/Footnote10/ OAG said that by appropriating funds on an accrual
basis, the government and the Parliament would strengthen FIS by putting
budgetary accountability and reporting on the same basis. The audit found
that in implementing FIS, the government had focused its attention on
ensuring that departments were implementing their new financial systems
and on ensuring that those systems could produce the information necessary
to produce the government's annual financial statements. Missing, OAG
found, was a plan to make the full accrual financial information available
to all managers within departments and agencies, not just those with
financial reporting responsibilities. The Standing Committee on Public
Accounts concurred with the OAG report and recommended that TBS determine
the best possible options for moving the appropriation process to a full
accrual basis. Although the process of developing these options is only in
its earliest stages, TBS' consultative process has begun in the hopes that
it will give stakeholders a better idea of what they are gaining and what
might be lost in terms of financial information presented. 

OAG also believes that FIS would support the parallel initiative on
performance management and accounting for results since it could provide
improvements in the government's ability to link costs and results.
Similarly, in its 1997 report entitled Accounting for Results, TBS said
that FIS aims to enhance government decision-making and accountability and
to improve organizational performance by providing more complete
information on the costs of programs and activities. A senior TBS official
told us that the adoption of full accrual accounting for budgeting and
reporting is considered a milestone in gaining the ability to fully cost
the resources consumed relative to the services provided and results
achieved by government programs and activities.

Summary of Accrual Budgeting System

Structure of Appropriations
---------------------------

Key issues regarding the structure of accrual appropriations have yet to
be resolved. TBS expects that eventually the accrual appropriation model
will be represented by the three primary statements found in public and
private sector financial statements (1) a Statement of Operations, (2) a
Statement of Financial Position (Balance Sheet), and (3) a Cash Flows
Statement. If such a format is adopted, votes could be assigned to each
department's Statement of Operations and represent approval of the
department's projected expenses during the year. Likewise, a vote on a
department's Statement of Financial Position would signal approval the
department's plans for disposal and acquisition of new capital. Both the
Statement of Financial Position and the Statement of Operations would
reconcile to the Cash Flows Statement and thus approval of the first two
implies approval of the department's cash requirements.

Description of Aggregate Budget Measure
---------------------------------------

Canada's main measure of the federal surplus/deficit--called the budgetary
balance--is calculated on a modified accrual basis which includes the
accrued costs of public sector pensions and certain accounts-payable
transactions. Canada also reports a cash-based measure or financial
requirements/surplus--roughly equivalent to the government's borrowing
requirements. In recent years, the financial requirements/surplus has
recorded significantly lower deficits or higher surpluses than the
budgetary balance (see figure 8). This is largely because public sector
pensions and other adjustments are accrued in the budgetary balance while
the financial balance is a cash-based amount. The nature of the items
accrued in the budgetary balance requires that an expense is recognized in
the budget before the cash is needed to pay the expense. Thus, under the
government's cautious fiscal policy framework,/Footnote11/ accrual
treatment of these items reduces the resources available for other
spending. If accrual budgeting for capital is implemented the opposite
would be true. If no adjustments were made to the Estimates for the
accrual treatment of capital, the budgetary balance would capture only the
annual depreciation charge instead of the cash needed to acquire the
asset. The financial balance would, of course, recognize the cash needed
to acquire an asset.

Figure****Helvetica:x11****8:    Alternative Measures of the Fiscal
                                 Balance--Budgetary Balance Versus
                                 Financial Requirements/Surplus

*****************

*****************

Note: Aggregate balances for fiscal year 1998-99 are estimates and for
fiscal years 1999-00 and 2000-01 are projected.

Source: The Budget Plan 1999.

Cash Flows Versus Accrual Operating Balance: Key Differences Between Cash
and Accruals
---------------------------------------------------------------------------

In fiscal year 1997-98, the budgetary surplus was nearly C$3.5 billion--
about 0.4 percent of gross domestic product (GDP)--while the financial
surplus was about C$12.7 billion. As previously noted, this is largely the
result of accruing spending items that require more resources under
accrual measurement than would be required if budgeted on a cash basis.
Given this pattern, Canada achieved a financial surplus in fiscal year
1996-97--1 year earlier than it reached a budgetary surplus, its primary
measure of fiscal position. 

Views on Implications for Decision-making 

Canada has only started to consider how to develop and present its
Estimates on an accrual basis and thus has only begun to address issues
relating to the impact this information will have on the budget--the main
tool used to develop and implement the government's fiscal policy.
Proponents of accrual budgeting in OAG and TBS believe that the greatest
benefits will come as a result of improved managerial decision-making.
They base their expectations on the experiences of other countries, such
as New Zealand, and certain Canadian provinces, such as Alberta, which
already adopted full accrual budgeting. TBS plans to consult with
departmental managers as well as with Parliament over the course of the
coming months.

Concerns have been raised that the accrual treatment of capital could
dilute the meaning of budgetary balance, which has been very important in
gaining the public's understanding and support of the current government's
fiscal policy agenda. For example, if the budget includes only the
annualized depreciation costs, the concept of budgetary balance
essentially ignores the means of financing asset acquisition. Critics
argue, for example, that if only a fraction of the cost of acquiring an
asset is recognized in the budget it could lead to an erosion of the
fiscal discipline and adversely affect the debt to GDP ratio--an equally
important fiscal target given Canada's high debt levels and debt-service
costs. A TBS official believes that the budget presentation formats under
consideration will afford sufficient transparency to clearly present
planned and actual cash requirements through the Statement of Cash Flows.

Similar unresolved concerns have been raised with respect to capitalizing
assets in the financial statements. With the decision to fully accrue
tangible capital assets in Canadian governments' financial statements, the
Public Sector Accounting Board (PSAB)/Footnote12/ issued a standard
calling for governments to adjust their operating results (revenues less
expenses) to reflect the net change in capital assets. This adjustment
effectively nets out the depreciation expense charged and adds/subtracts
the total value of assets sold/purchased in that reporting period.
However, some provincial governments are arguing for a change that would
free them from the asset reporting standard. 

Proponents of accrual budgeting at TBS and OAG believe that most of the
benefits of the shift to an accrual-based budget will come as a result of
improved managerial decisions. OAG officials, while instrumental in
promoting the shift to accrual appropriations, were unable to provide
specific examples of how certain decisions would be made differently if
managers were held to account for appropriations measured by accrual as
opposed to those measured by cash. They most frequently point to
improvements made in asset management to make their case, arguing, for
example, that lease/purchase decisions would not be skewed in favor of the
lease under accrual budgeting. However, skeptics argue that if the fiscal
framework is still set to a cash-based debt to GDP ratio, managers will
still be constrained in their lease/buy decision. In fact, they argue that
managers have always had the information to make "better" lease/buy
decisions. Instead, the decisions that were made were done so under strict
borrowing constraints. If fiscal policy is to continue to focus on debt
levels, borrowing constraints will still limit the ability of the manager
to obtain the cash needed to buy an asset even though the "budget" would
only record the annualized depreciation expense.

Implementation Issues
---------------------

Most of the other countries in our study have approached accrual budgeting
and its implementation differently than has Canada. Canada followed a more
incremental path in choosing to accrue pensions and accounts payable and
is still making decisions about other items, such as capital. Canada has
only recently taken the first steps towards the adoption of a full accrual
budget by approving the decision to go forward with plans on how best to
present their Estimates on an accrual basis for capital. Critical issues,
such as reconciliation of the Estimates with fiscal policy, have yet to be
worked out. 

Two critical implementation issues have been identified--the need for
training in accrual concepts and in new management strategies, and the
importance of a significant cultural change. Because this effort is in the
early stages, these have yet to be resolved. According to officials in OAG
and TBS, while most of those who will work in the departments on the new
decentralized accounting systems have some experience with accruals, most
of those who work on budgeting do not. Training for budget development
staff is expected to be extensive over many years. In addition, new skills
will be needed in TBS. As the central agency for financial information,
TBS will no longer control spending the same way it did in the past.
Instead, it plans to offer guidance to the departments and review the
departments' financial statements and budgets from a financial analysis
perspective.

OAG also recognized in its recent report that to ensure the success of
FIS, central agencies still need to secure departmental "buy-in" and the
departments must put in place the necessary systems and training needed to
achieve success. We found in New Zealand and Australia that top-level
support and commitment to reforms were viewed as key elements to
successfully implementing accrual budgeting. 

--------------------------------------
/Footnote1/-^Each provincial legislature is composed of a single house
  that is elected by popular vote. Provincial premiers are the leaders of
  the parties that hold majorities in the provincial legislatures. In
  addition, provincial legislatures may set up municipal governments,
  giving them powers as they see fit.
/Footnote2/-^Members are allowed to propose a decrease in a tax or
  expenditure, but such actions are rare. 
/Footnote3/-^TBS is an administrative arm of the Treasury Board--a
  committee of ministers--and provides advice to the board on the
  preparation of the government's expenditure budget, the monitoring of
  program spending, and other responsibilities.
/Footnote4/-^For a detailed discussion, see Deficit Reduction: Experiences
  of Other Nations (GAO/AIMD-95-30, December 13, 1994) and Budget
  Surpluses: Experiences of Other Nations and Implications for the United
  States (GAO/AIMD-00-23, November 2, 1999).
/Footnote5/-^The Receiver General of Canada manages the finances of the
  Canadian government. It provides banking and cash management services
  and maintains accounting records.
/Footnote6/-^The government request to Parliament for authority to spend
  public monies consists of three parts. The Government Expenditure Plan
  (Part I) and the Main Estimates (Part II) contain financial information.
  Part III is divided into two parts. The Reports on Plans and Priorities,
  published at budget time, focus on departmental plans and priorities for
  the coming year. The Performance Reports in the fall present the results
  achieved by the agencies.
/Footnote7/-^Accounts payable that are due and payable at year-end are
  accrued by the government of Canada and charged to its appropriations. A
  number of liabilities are accrued centrally at year-end that are only
  reflected in appropriations in the year that payment is made. For
  example, new spending proposals included in the Federal Budget and
  meeting the criteria for recognition at year-end would be included in
  this adjustment. Other liabilities, such as contractual obligations and
  contingent liabilities, are disclosed in the notes to the government's
  financial statements and not charged to the deficit/surplus.
/Footnote8/-^Departments are voted authority or have enabling authority to
  make loans not to exceed an approved book value. In effect, authority is
  granted to lend but this does not have budgetary impact. While
  revaluation adjustments at year-end affect annual financial reports, it
  is only when loans in default are written off that parliamentary
  appropriations are required and the deficit/surplus is affected.
  Concessionary loans are made infrequently but require parliamentary
  appropriations and affect the budget aggregate (deficit/surplus).
/Footnote9/-^Nontax revenues include return on investments such as
  interest on loans and advances, dividends from investments, and transfer
  of profits and surpluses and other nontax revenues such as proceeds from
  the sale of assets, service fees, licenses, permits, etc. Nontax
  revenues totaled about 6.5 percent of total revenues in fiscal year 1997-
  98.
/Footnote10/-^Under the 1977 Auditor General Act, OAG responsibilities
  were clarified and expanded to include a broad mandate to examine how
  well the government managed its affairs. The act also gives OAG
  authority to conduct value-for-money or performance audits. These
  performance audits help inform legislators on how well the government is
  implementing its policies and programs. While OAG does not question the
  merit of a particular government policy, it does help legislators judge
  how well those policies were implemented and does make recommendations
  on ways in which implementation can be improved.
/Footnote11/-^The budget seeks to match expected revenues to budgeted
  expenditures, thus seeking a balanced budget. However, budgeted
  expenditures include a C$3 billion Contingency Fund that can be used for
  emergencies while permitting the budget to stay in balance. If no
  emergency arises, the Contingency Fund will be used to pay down debt.
/Footnote12/-^In 1981, the Canadian Institute of Chartered Accountants
  (CICA) established the Public Sector Accounting and Auditing Board, now
  referred to as PSAB. PSAB has the authority to issue recommendations and
  guidance with respect to matters of accounting in the public sector.
  Recommendations are developed in accordance with an extensive process of
  consultation and debate ("due process") with a national network of
  associates of CICA who represent the preparers, auditors, and users of
  government financial statements. Under PSAB's Terms of Reference, the
  board consists of 12 members, 8 of whom represent government entities
  responsible for financial reporting and auditing.

ICELAND
=======

Iceland began to consider reforms of its public sector in the early 1990s
partly in reaction to internal pressures brought on by years of deficit
spending and high inflation rates. Iceland's accession to the European
Economic Area in 1994 and the requirements for membership also encouraged
an atmosphere conducive to public sector reforms. While the goals of
Iceland's reform efforts are broad, as in many of the other countries in
our study, Iceland has approached this effort incrementally. Many specific
reforms have already been enacted and implemented, such as the Financial
Reporting Reforms which address the issue of accrual budgeting; however,
at the time of our visit initiatives to adopt performance goals and manage
for results were only in their infancy.

Background

Iceland is a parliamentary democracy with a President, Prime Minister and
Cabinet, and a judiciary. The Parliament, or Althingi, has 63 members.
Each minister in the Cabinet is a member of the Althingi. The President
has limited powers, with the Prime Minister and Cabinet ministers
exercising most executive functions. Iceland considers itself a "modern
welfare state." The Ministry of Health and Social Security comprises
nearly 40 percent of the central government budget. It finances hospitals,
health care services, and old-age and disability pensions. The Education
Ministry is the second largest ministry and is responsible for higher
education. Primary and secondary schools are run by local governments.
Together these two ministries account for more than half of the government
budget. Iceland does not have a military force.

Government Structure
--------------------

The present government, a coalition of the conservative Independency Party
(IP) and the centrist Progressive Party (PP), came into office following
parliamentary elections in 1995, succeeding a coalition of the
Independency Party and the Social Democratic Party which had been in
office since 1991. The IP-PP coalition continues in office following the
parliamentary elections in 1999. Iceland's Prime Minister is Mr. David
Oddsson who has led both coalitions since 1991.

There are two levels of government in Iceland--local and central. Local
governments are elected and have the authority to levy taxes and enter
into contracts for public works projects that require central government
cost sharing. Primary schools are run and financed locally whereas
secondary schools--roughly from age 16 and on--are run and financed by the
central government. The central government and local governments share
costs for certain investment projects, such as local hospitals, community
health centers, and nursing homes. In most cases the central government paid
85 percent of the costs and the local governments were responsible for the
remainder. In the past these cost-sharing obligations led to
intergovernmental pressures as local governments went forward with
investment projects despite central government budget constraints.
According to Ministry of Finance officials, in several cases local
governments financed projects and then demanded that the central
government reimburse them for its share, frustrating the central
government's efforts to set budget priorities. This issue has been
ameliorated, however, since certain reforms were enacted in 1996. Now no
ministry can obligate central government resources without obtaining
authorization from the Ministry of Finance. Likewise, local governments
must obtain agreement from the appropriate Ministry before signing a
contract that would also require central government financial
participation. 

Budget Process
--------------

The government introduces its budget for the next fiscal year on October 1
and it is normally passed a few weeks before the start of the new fiscal
year on January 1. The annual budget is developed using the previous
year's budget levels as a baseline, with adjustments for inflation, new
salary agreements, extraordinary charges, and new policy initiatives. The
process itself is continuous as the development of the next year's budget
begins almost as soon as the current year's budget is passed. 

A new budget process--"frame budgeting"--was introduced in 1991. Early in
the budget development process, ministries are allocated a share of
resources for continuation of existing programs based on projected
revenues and overall fiscal policy objectives. New spending initiatives
are given closer scrutiny by a special cabinet committee and in most cases
ministries are expected to find funding for new initiatives through
savings from current spending levels. 

The Ministry of Finance prepares the budget. During the final stages of
the budget development process there are frequent meetings that include
the Chairman and Vice Chairman of the Budget Committee, the various
ministers, and officials with the Ministry of Finance. A summary version
of the budget is put to the majority members of Parliament for approval
before it is finalized. The rest of Parliament sees the budget when it is
introduced by the Minister of Finance on October 1. Normally the budget is
introduced with a speech by the Minister of Finance at the beginning of
the first reading. An extensive debate ensues that can last up to 2 days.
The full Parliament then passes the budget to the Budget Committee where
it will be reviewed in detail for up to 3 months./Footnote1/ 

During this process the Budget Committee typically delegates oversight and
review of a particular ministry's budget to the standing committees that
have general oversight responsibilities over those ministries. Standing
committees have some authority to direct funding within a ministry's
allocation and toward the end of their review they generally hold hearings
to communicate to the Ministry of Finance and the Budget Committee what
they think should occur in their ministry's budget. A report on the
standing committee's recommendations is then transmitted to the Budget
Committee for further guidance.

It is generally agreed that while the Althingi must approve the budget and
thus must approve all spending, there are few parliamentary controls over
spending. In practice, the Althingi makes no major changes in the final
budget from what is proposed by the Ministry of Finance. The last time
there was a major difference was in 1987 when the total budget package was
reduced by about 5 percent. There was also a slight adjustment of about
****ITCCentury Book:xba**** percent in the 1997 budget.

The Economy and the Budget
--------------------------

Iceland's economy historically has been susceptible to inflation and is
highly dependent on foreign trade. Inflation rose to 43 percent in 1974
and 59 percent in 1980, falling to 15 percent in 1987 but rising again to
30 percent in 1988. Since then, the inflation rate has dramatically
fallen. Although monetary policy is driven largely through exchange rate
targets, officials with the Central Bank said that fiscal policy does
influence their strategies. The current government is committed to tight
fiscal measures.

In 1995, the new government declared its intentions to reduce the deficit
and reach a balanced budget by 1997. The government also recognized the
need not only for a balanced budget but also for sufficiently large
surpluses in the next few years to cover outstanding Treasury debt and
future pension commitments. In addition, it recognized the need to
generate surpluses to reduce the outstanding government debt. Although the
government's fiscal policy is described as "tight," the Ministry of
Finance also notes that the recent surpluses have resulted not necessarily
from expenditure constraints alone, but are also the result of the
stronger than expected economy and the impact this has had on revenues. 

The Icelandic economy has gone through a period of rapid growth since
1994. Growth was particularly strong for the last four years. Inflation
has been kept in check. The unemployment rate has been kept at nearly the
full employment level as many large investment projects are underway. All
of these events have resulted in an unusually large increase in real
disposable incomes and in private consumption that contribute to above
average revenue collections from income taxes and the value added tax. 

Iceland's economic policy has focused, of late, on promoting and
maintaining economic stability by shifting away from market intervention
and towards liberalization of the markets and increased competition. The
overriding economic policy concern of the government has been to maintain
and strengthen the stability of the Icelandic economy to ensure continued
economic growth and increased employment. A credible fiscal and monetary
policy was seen as a prerequisite for this, since this would lead to lower
interest rates and encourage private investment. In both fiscal years 1998
and 1999 cash budget surpluses were achieved. The fiscal year 2000 budget
is also projected to run a large cash surplus reversing the trend of
continuous deficits since the mid-1980s. 

Recent Reforms
--------------

Accrual budgeting is only a small part of the greater effort undertaken in
Iceland over the last 8 years to promote improvements in public sector
financial management. Senior officials with the Ministry of Finance
indicated that the overarching theme behind all these reforms has been to
promote transparency and accountability, specifically to recognize the
full costs of commitments when they are made rather than when they need to
be paid. In addition to the Financial Reporting Act, several important
laws have been enacted to contribute to the overall goals of reforming the
public sector; these include pension reforms, limitations on the extent to
which government guarantees are granted, and civil service restructuring.

Notably, in enacting financial reporting reforms, decisionmakers
restructured the revenue side of the budget. Previously, earmarked
revenues were often subtracted from budgeted expenditures of the
beneficiary agencies thus masking the full economic impact of government
finances. Now all revenues are presented together in the Operating
Statement. These reforms also created a direct link between spending
authority and the means of financing. In the past a separate credit budget
was enacted that authorized the borrowing necessary to finance the
spending approved in the fiscal budget. Now the borrowing requirements are
directly linked to the budget through the Statement of Cash Flows. In
addition, in order to make direct links between the budget and the
financial statements, financial reporting reforms also require that the
budget be presented both on an accrual and cash basis. To the extent that
the accrual treatment of select budgetary items captures the future
financial liabilities of the government, this aspect of the reform serves
to enhance the transparency of the financial impact of government
decisions. 

As will be explained later and in more detail, capital assets are not
budgeted or accounted for on an accrual basis. In order to highlight the
budgetary impact of capital decisions on future years' budgets, the
reforms require longer term financial plans for major capital projects.
Even though these plans are not binding, they do provide more information
on the likely budgetary impact of capital decisions than was previously
presented.

Use of Accruals in Financial Management

In 1994, the government submitted the Financial Reporting Act to the
Althingi. The act was based on work conducted over the previous 5 years by
the Financial Reporting Commission./Footnote2/ The Commission recommended
significant changes in the format of the budget and the financial
statements; specifically the budget and the financial statements should be
reported on an accrual basis, the two should be presented in a uniform
format, and their presentation should be based on private sector reporting
standards as far as practicable. The Commission reasoned that given that
the financial statements are the final report on the government's finances
for each fiscal year, they are the basic source of information on the
government's finances as a whole and for individual agencies. In addition,
the audited financial statements should enable the government's finances
to be judged by their impact on the economy largely by analyzing changes--
measured on a consistent basis and using generally accepted accounting
standards--from one reporting period to another. They also noted that the
statements are the framework for the Althingi to monitor whether its
decisions in the budget have been implemented. 

Overview of Use of Accrual for Financial Reporting and Budgeting
----------------------------------------------------------------

In reviewing the applicability of private sector accrual accounting
standards for public sector reporting and budgeting the Commission
recommended one significant deviation. Namely, property, plant, and
equipment (physical capital) are not reported as assets and will continue
to be reported as expenditures when purchased. In deciding against
adopting private sector reporting standards for capital, the Commission
recognized that the private sector standards would make it easier to
compare the performance of one agency with that of another and with
private sector alternatives. However, there were also problems with
implementation; for example, reporting depreciation requires assets to be
valued and their useful lives estimated. The Commission found that this
was in many cases not practicable for many government assets. It noted, in
particular, difficulties in establishing values for large infrastructure
projects, museums, national parks, etc. It also questioned the purpose
served by depreciating these assets. The Commission concluded that
reporting the annual depreciation of assets, instead of the purchase of
assets, goes against the objective of showing how all tax revenue is
allocated in a given year.

A second deviation from private sector reporting standards deals with the
treatment of interest expense. The Commission noted that the private
sector standards were currently under review and were likely to change in
the next few years to conform to international standards. While a goal of
financial reporting reforms was to align the public sector accounting
standards with those in the private sector, the fact that changes in
private sector standards were imminent led to a decision to defer changes
to the public sector standard. The central government records all interest
expense, even that portion of the expense that is the result of currency
fluctuations on non-kr****ITCCentury Book:x97****nur denominated loans.

The Commission also recommended a presentation format for budget reporting
that sought to align the budget and the financial statements to ensure
that decisionmakers, in particular the Althingi, could track the financial
results of its budgetary decisions during the previous year. The budget is
comprised of two key statements: an Operating Statement that shows accrued
revenue and expenses budgeted for a given fiscal year and a Statement of
Cash Flows from operations, investments, and financing activities. In
addition, supplementary information includes a statement of accounting
principles and more detailed statements of loans and guarantees; holdings
in noncentral government activities; property, plant, and equipment; and
changes in capital. The Statement of Cash Flows is generally in line with
private sector practice and represents the net borrowing requirement. This
measure is believed to give the best picture of the government's impact on
the economy.

Factors Driving Adoption of Accrual Budgeting
---------------------------------------------

The primary intent of the broad financial reporting reforms is to improve
the transparency of financial information through uniform reporting
standards and through the recognition of the full cost of central
government obligations when they are made. Financial reporting reforms
have taken shape in response to new information technologies, new
requirements of international organizations for uniform data from their
member countries, new methodologies to illuminate the impact that
government finances have on the economy, and increased oversight by the
Althingi in economic and budgetary matters. As previously noted, Ministry
of Finance officials consider accrual budgeting to be only one part of a
broader effort to reform the public sector in Iceland. Accruing the costs
of certain government obligations is considered to be one part of
improving the recognition of the full costs of these various obligations.

Summary of Accrual Budgeting System

In two key aspects, Iceland's approach to accrual budgeting differs
significantly from the approaches adopted in the other countries in our
study. First, in an attempt to satisfy all the key users of financial
information, the Operating Statement section of the budget is presented
both on an accrual and a cash basis. Second, as noted previously, capital
is expensed rather than capitalized and depreciated. Although a
significant realignment of the budget occurred as a result of the reforms,
this effort was designed to bring more activities into the fiscal budget--
creating linkages in the decision-making process--rather than to realign
resources to programs and activities as in other countries in our study.

Structure of Appropriations
---------------------------

The main focus of the budget debate is on the Operating Statement, which
is presented on both a cash and an accrual basis. The Operating Statement
shows revenues by major classes, e.g., individual income tax, corporate
income tax, and value-added tax. Revenues are followed by expenses
organized by ministry or other major administrative categories such as
interest expense. The difference between revenues and expenses--the
operating balance--is only presented on an accrual basis. Passage of the
budget provides authority to spend. 

The Operating Statement is followed by the Statement of Cash Flow, which
reconciles any accrued gains/losses and noncash expenses to cash to
provide information on the government's Net Borrowing Requirement.
Detailed departmental spending by subadministrative unit and program is
measured on an accrual basis only and follows the Statement of Cash Flows. 

Treatment of Specific Budget Items
----------------------------------

o   Revenues are accrued. The Revenue Department in the Ministry of
  Finance calculates and estimates all revenues levied based on current
  laws using projections of income and sales. The total amount of all
  taxes levied in that year is presented as accrued revenues in the
  budget. The total revenues in the cash budget represent the sum of all
  cash projected to be received in the budget year. Uncollectible taxes
  and forfeited taxes are expensed in the accrual budget under the
  Ministry of Finance's budget.

o   Operating costs, such as salaries and supplies, are accrued but in
  practice the differences between the accrual-based costs and the cash-
  based operating costs are immaterial.

o   Capital is expensed as acquired. Major infrastructure projects--for
  example roads, bridges, and tunnels--are expensed as work is completed
  and paid for. If a major project extends over multiple fiscal years,
  only the amount actually paid in that year is recognized in the annual
  financial statements and only the amount of cash expected to be paid
  out each year is recognized in the annual budget.

o   Accounts payable are accrued but the only department with material
  accounts payable is the Public Roads Administration (PRA). PRA
  officials admitted that they have substantial flexibility to reprogram
  funds. For example, when budget estimates differed from actual work
  completed, PRA could shift funds from projects where pay-outs were less
  than anticipated or borrow from contractors until the next budget year.
  Such borrowing in essence would defer payment until new budgetary
  resources were available. In the 1999 budget, resources were approved
  to liquidate the accrued accounts payable liability and fully fund new
  projects. The practice of deferring payments is discouraged and some
  officials hope that the longer term focus of the new road building
  plans will prevent the need for these practices to continue.

o   Non-capital inventory costs are accrued, but do not differ materially
  from cash treatment. Since capital is expensed in the year it is
  purchased the budgetary impact of the accrual of any capital inventory
  expense will be the same as if treated as a cash expense.

o   Public sector pensions are accrued. Pensions are centralized and
  these liabilities and their related expenses are shown in the Ministry
  of Finance's budget--not in the budgets of the various ministries. One
  of the major goals of the reform efforts in Iceland was to improve the
  way that public sector pensions were recognized in the financial
  statements and the budget. The initial accrual of unfunded pension
  liabilities in the 1989 financial statements and the resulting
  realization by the government and the Althingi of their large size was
  one of the issues that precipitated the complete review of Iceland's
  financial reporting practices, according to Ministry of Finance
  officials. The realization also prompted changes to the public sector
  pension scheme. The previous scheme has been closed to all new
  employees since 1997 and in its place a new fully funded pension scheme
  was adopted. Those in the previous system were offered a choice of
  shifting to the new system with some benefits transferred. The
  accumulated liabilities of the old scheme are recognized in the
  financial statements but only the annual changes in those liabilities
  are shown in the current budget. All future liabilities in the new
  scheme are expensed on an accrual basis. 

o   Iceland recognizes and has made some effort to prepare for
  significant demographic changes as a result of the aging of the
  population. For example, Iceland recently enacted pension reforms aimed
  at increasing national saving and strengthening pension plans for
  private workers./Footnote3/ While Iceland mandates universal pension
  coverage for private sector employees, there are also two levels to
  Iceland's social insurance for the aged--a small old-age pension
  program for people who have never entered the workforce and general
  welfare programs. The total expenditure budgeted for the former in 1999
  was only Kr. 225 million (.1 percent of total expenditures)--Kr. 200
  million in cash and Kr. 25 million accrued for future payments.
  Ministry of Finance officials said that this small program was being
  terminated and those that would have been eligible in the future will
  be taken care of through the general welfare programs. In contrast, the
  general welfare programs are very large and are not accrued. In 1999,
  the total general welfare budget for the aged and disabled was funded
  through the Ministry of Health and Social Security at Kr. 17.7 billion
  (about 9 percent of total expenditures). The largest share of this
  program, about Kr. 14.96 billion (84 percent of program expenditures
  and 8 percent of government expenditures) provides funds for old-age
  and disabled benefits. Basic old-age benefits are paid to all persons
  67 years old and older and are means-tested. A Ministry of Finance
  official said that since there is no guarantee on the level of the
  benefits, there is no reason to accrue a liability for the costs of
  these benefits.

o   Iceland makes loans to state-owned enterprises and funds, continues
  to offer below market rate student loans, and has a housing loan fund.
  New loans are booked at their net present value, incorporating any
  subsidy costs and default risks. The value of existing loans is
  reestimated by the National Audit Office. Subsidy costs are included in
  the Ministry of Finance's budget. Operating costs of the loan programs
  are included in the individual agency's budget. The operating balance
  is adjusted by cash flows for investing to get to the cash-based net
  borrowing requirements. The State Guarantee Act considerably narrowed
  the authority of the government to issue state guarantees, but it calls
  for an assessment of risk before a guarantee is issued and the
  establishment of a loan loss account to provide for losses on state
  guarantees. A risk premium is called for on all issues of state
  guarantees. 

o   Ministry of Finance officials said that Iceland offers a natural
  disaster insurance program that provides funds to those who suffer from
  the effects of earthquakes, volcanic eruptions, and floods that occur
  regularly in Iceland as a result of its situation on a geographical
  fault line. The budget treatment for this insurance is cash-based.
  Premiums are not based on a formal risk assessment but the balance in
  the fund is normally enough to cover the needs that arise in a year.
  The costs associated with such disasters are normally paid for either
  through the premium balances or through a special appropriation. 

Description of Aggregate Budget Measure
---------------------------------------

The main focus of the budget debate is on the Operating Statement, which
shows estimates of revenue and expenses on both an accrual and a cash
basis. However, as recommended by the Financial Reporting Commission, the
Operating Statement section of the budget shows the operating result
(deficit/surplus) only on an accrual basis even though the detailed
presentation of both cash and accrual estimates is maintained in the rest
of the Operating Statement. Although the cash-based deficit/surplus figure
is not presented in the Operating Statement, the cash flow statement
reconciles the accrual budget to the government's borrowing requirement,
which the Commission believes is the best picture of the government's
impact on the economy.

Key Differences Between Cash and Accruals
-----------------------------------------

The only areas of the budget where there are significant differences in
the cash and accrual treatment are in revenues, pensions, and interest.
The oversight and administration of these activities are localized in the
Ministry of Finance.

Cash Flows Versus Accrual Operating Balance
-------------------------------------------

The accrual-based operating balance is adjusted for cash flows from
operating and investing activities to get to the net borrowing
requirements or, as in the case of Iceland since 1998, the net debt
repayment potential. It is then further adjusted for changes resulting
from financing activities, which detail the government's plans to repay or
restructure its debt. Key budget documents show a clear link between the
net movement in cash balances and the debt reduction goals for the fiscal
year. Since fiscal year 1998, as a result of the cash flows from operating
and investing activities, the government reduced its gross debt to GDP
ratio to 34 percent from a high of 51****ITCCentury Book:xba**** percent
in 1995. The fiscal year 2000 budget also projects continued cash
surpluses and further debt reduction to about 30 percent of GDP.

Views on Implications for Decision-making

Iceland's current fiscal policy has been described as tight with a goal of
debt reduction. Iceland's selective approach to accrual budgeting has lent
itself well to this policy. Accrual treatment of capital in a budget
usually means that the purchase price of the capital is not recorded when
the actual cash outlays are made but instead is spread over the asset's
useful life. On the other hand, accrual treatment of many other budget
items, such as pensions, insurance, and credit programs often result in
recording a greater amount of budgetary resources up front in comparison
to cash budgeting. In choosing to accrue only those items that would
require more up front funding on an accrual basis and against accruing
those items that would require less, Iceland effectively reserves more
cash resources that can be used to repay debt than if the budget was only
measured on cash or full accrual. Specifically, the budgeted surplus
measured on a cash basis for 1999 was higher than the budgeted surplus
measured on an accrual basis./Footnote4/ By focusing on the accrual-based
surplus (which in effect reserved some cash for future payments), Iceland
was able to use the "extra" cash to pay down more debt.

The impact on the rest of the budget of the use of accrual measurement for
only select budgetary items has been to constrain spending in other areas
in order to meet or exceed fiscal targets. The budget shows the
deficit/surplus only on an accrual basis. At the time of our visit
Ministry of Finance officials expressed concern that if they showed a
large cash surplus there would be increased pressures to spend, reducing
the amount available to buy back debt. The cash-based surplus number could
be easily arrived at by summing the cash column, but Ministry of Finance
officials acknowledged that they hoped to focus the debate on the accrual
measure of fiscal position. 

Unlike in many of the other countries in our study, the approach taken for
accrual budgeting in Iceland is not anticipated to affect managerial
decision-making at the ministry level. In most of the other countries, the
capitalization of assets will result in the most significant changes to
individual department or agency budgets. In Iceland, however, assets are
not capitalized and pension expense--the only other budget item that is
significantly different under accrual budgeting--has been consolidated in
a central agency and will not influence managerial decision-making at the
agency level. 

Senior officials with the Ministry of Health and Social Security disagreed
with the Financial Reporting Commission's decision against the
capitalization of assets. The Ministry of Health and Social Security is
the largest in terms of budgetary resources and is capital-intensive with
state-owned hospitals and very expensive medical equipment. As new medical
technologies are developed, the ministry must perform cost analyses to
determine whether it should make the investment to develop expertise in a
new technique--or purchase new equipment--or whether it is more cost
effective to send its citizens abroad for treatment./Footnote5/ This
information has been collected on an accrual basis and analyzed for many
years in the ministry because it needs the information and analysis to
perform its functions. In essence it must maintain two sets of books
because the accrual information is not requested by the Ministry of
Finance, the Cabinet, or the Althingi. From a managerial perspective,
therefore, the ministry sees great value in capitalizing assets.

In a broad managerial sense, however, the package of public sector
employee pension benefits may be scrutinized more heavily by various
decisionmakers and the public than in the past as a result of the adoption
of accrual treatment of those benefits in the budget. In 1998 the Ministry
of Finance negotiated a new wage agreement with public sector
employees./Footnote6/ Pensioners receive a pension tied to the base salary
of the person who is currently in the job; therefore, wage renegotiations
have a direct impact on the pension liability. According to the editor of
one of the leading newspapers, there is the perception that public sector
employees receive better salaries, pensions, and other benefits than
workers in the private sector receive. When the new wage agreement was
announced concern was raised regarding its costs, but it was not until the
June reestimates of the budget--on an accrual basis--were announced in
August that the full costs were known. There was a great deal of public
outcry in the press and among parliamentarians regarding the cost of this
agreement; specifically, there were concerns that the full cost should
have been known before the agreement was reached. Ministry of Finance
officials said that it was very difficult to estimate these costs as the
agreement was being negotiated, but added that in the future the full
costs of new policy decisions will likely be more fully debated before any
agreements are reached. There is no longer support to give something in
the short term that is costly in the long term.

Efforts are underway to implement performance management strategies, such
as developing ministerial goals and objectives, increasing accountability
for results through performance contracts, and outsourcing some government
functions. These efforts are only in their very early stages of
implementation and ministry officials have not tied budgetary resources to
results. 

Implementation Issues

Unlike many of the other countries in our study, Iceland mitigated the
costs and time required to train ministry staff in accrual concepts by
consolidating the development, analysis, and presentation of the
methodologically complex accrual estimates within the Ministry of Finance.
Officials from the Ministry of Finance said that ministry and State
Accounting Office staff were trained accountants and did not have
difficulty adjusting to the new measurement techniques.

--------------------------------------
/Footnote1/-^There are 12 standing committees in the Althingi but the two
  with the most prominent role in the budget process are the Budget
  Committee and the Economics and Trade Committee. The Economics and Trade
  Committee has jurisdiction over all revenues, while the Budget Committee
  oversees the expenditure side of the budget. Each committee is chaired
  by a member of Parliament with ties to the political party(ies) in the
  government.
/Footnote2/-^The Financial Reporting Commission is a statutory board
  established by the Financial Reporting Act of 1966 with six ex-officio
  members representing the Ministry of Finance, the State Accounting
  Office, the National Audit Office, the Bureau of Statistics, the Central
  Bank, and the National Economic Institute.
/Footnote3/-^Private sector pension reforms were recently enacted that aim
  to increase national saving by providing favorable tax treatment on a
  larger share of personal income if it is invested in long-term pension
  schemes. Reforms also require the consolidation of private sector
  pension plans to ensure greater diversification of investment risk as
  any liability accruing to them would not be a government liability.
/Footnote4/-^In fiscal year 2000 the cash-based surplus is projected to be
  33 percent higher than the accrual-based surplus.
/Footnote5/-^In Iceland health care is provided to all citizens. In
  addition, citizens of other countries are offered health care if they
  are visiting or working in Iceland. If a health care provider in Iceland
  treats a citizen of another country, Iceland must provide cost
  information, prepared under generally accepted standards, in order to
  collect payment from the health plan in the other country.
/Footnote6/-^The Ministry of Finance is responsible for negotiating the
  wage agreements with public sector employees; no parliamentary agreement
  is required.
An important condition for successfully moving to a single European
currency on 

THE NETHERLANDS
===============

In the 1980s, the Netherlands found itself in circumstances similar to
those of many other industrialized countries with burgeoning deficits,
high unemployment, and declining public confidence in the public sector's
ability to deliver promised services and programs. In response the
government sought not only to reduce the deficit but also ways to reduce
the public sector's role in the economy--largely through privatization,
deregulation, and decentralization. Since 1992, the Netherlands
increasingly has adopted performance management initiatives to achieve
these objectives and to improve the efficiency of the public sector. The
government viewed accrual budgeting and financial statement reporting as
providing the framework necessary to manage for results. An accrual
framework is being applied only in those specific agencies where it was
deemed useful in promoting results-oriented management. When the first
agencies began employing accrual measurement in 1994 it was seen as a
pilot effort, but there is no plan for these agencies to revert back to a
cash basis of accounting and budgeting. Cash-based budgeting continues at
the aggregate level to record total expenditures and receipts and remains
the focus for fiscal policy decision-making.

Background

The Netherlands is a parliamentary democracy under a constitutional
monarch. Its government is based on the principles of ministerial
responsibility and parliamentary governance. The national government
comprises three main institutions: the Monarch, the Council of Ministers,
and the Parliament. The Council of Ministers plans and implements
government policy. Most ministers also head government ministries. The
ministers are responsible to the Parliament, but unlike the British
westministerial system, Dutch ministers cannot simultaneously be members
of Parliament. There are 12 provinces, each governed by a locally elected
provincial council and a provincial executive appointed by members of the
provincial council.

Government Structure
--------------------

The Dutch Parliament consists of two houses--the First and Second
Chambers. The First Chamber has 75 members elected by the 12 provincial
councils. As a general rule they meet for only about 1 day per week and
usually consider broad policy issues, focusing little attention on budget
issues. The Second Chamber consists of 150 members elected for 4-year
terms on the basis of a nationwide system of proportional representation.
Members represent the whole country rather than individual districts and
are normally elected on a party slate, not individually.

Only the Second Chamber may initiate legislation and amend bills submitted
by the Council of Ministers. All legislation passed by the Second Chamber
must be approved by the First Chamber before it can become law. Both
Chambers may question ministers and other government officials about
proposed or existing programs.

The Monarch appoints the formateur who forms the Council of Ministers
after the elections. Historically, Dutch governments have been based on
the support of a majority in both houses of parliament. The current
government is a three-way coalition formed in August 1998 and led by Prime
Minister Wim Kok of the Labor Party. The three-way coalition government
holds 97 of the 150 seats in the Second Chamber. Prime Minister Kok also
led the coalition that governed from 1994 to August 1998.

Economy and the Budget
----------------------

The Dutch economy, like most other Organization of Economic Cooperation
and Development (OECD) economies, experienced sluggish growth and rising
unemployment in the late 1970s and early 1980s. In 1982, the Netherlands
found itself in its most severe post-war recession with negative growth in
its gross domestic product (GDP), measured at -1.2 percent in both 1981
and 1982. A new government was formed in late 1982 and faced what many
considered an unsustainable situation. Government debt had doubled since
the early 1970s and total government outlays exceeded 60 percent of GDP.
The deficit (9.5 percent of GDP in 1983) was putting an upward pressure on
interest rates, hindering growth in the private sector. Although the
budget deficits were exacerbated by a slumping economy, much of the budget
stress was structural, reflecting the predominance of transfer payments in
the budget. The government estimated that only half of the increase in the
deficit could be attributed to the business cycle. There were widespread
concerns about the implications of the structural deficit for financial
markets and business investment. 

Reducing the deficit was the principal objective of the governing
coalition that formed in 1982. Actual government spending fell 2.5 percent
by 1986 and, while the deficit also fell, it was still about .75
percentage points above the goal set by the government. A new coalition
government formed in 1986 called for renewed fiscal restraint and set
goals for further deficit reduction. Most of the real cuts in spending
were in public investment; its share of GDP had been declining steadily
since the 1970s but reached historic lows in the late 1980s. Real cuts in
public sector wages and transfer payments were achieved, however the
number of recipients did not decline. Instead, wages and benefits did not
grow as rapidly as inflation. 

The economy improved in the late 1980s and reforms to the country's
disability benefit system and lower subsidies for housing, public
transportation, and education ameliorated some of the budget's structural
imbalance. Given the size of the public sector, greater productivity was
viewed as an important step in meeting new spending pressures under tight
fiscal constraints. In the early 1990s, the government sought further
improvements in management of the public sector through the introduction
of market discipline and market processes. The government hoped that small
improvements in productivity combined with modest wage increases would
lead to savings of about a quarter percent in public sector wage bills. 

Government finances have improved substantially since 1994. The coalition
government in power from 1994-1998 took actions that resulted in a
reduction in the deficit from 3.8 percent of GDP in 1994 to about 1
percent of GDP in 1999. Similarly, since 1994 the debt-to-GDP ratio has
been reduced from about 78 percent to 64 percent. The Netherlands is
firmly committed to the European Economic and Monetary Union and was able
to comply with the convergence criteria established in the Maastricht
Treaty./Footnote1/

The economy peaked in 1998 with strong 4 percent growth in GDP, sharply
falling unemployment, and moderate inflation. GDP growth for 1999 and 2000
is expected to slow to about 2.75 and 2.5 percent, respectively, but
unemployment is expected to remain low at about 5 percent of the labor
force. The fiscal and budgetary policies of the current coalition
government seek to maintain the momentum achieved by previous governments
in shrinking the deficit, reducing the debt-to-GDP ratio, and rebalancing
the public sector's role in the economy largely through deregulation. In
addition, this government has stated its commitment to enhancing the
infrastructure base. When the government put together its fiscal year
1999/Footnote2/ budget it estimated economic growth at about 2.25 percent.
Based on trends for the first half of the year, the growth rate is
expected to reach 2.75 percent. As a result of the better-than-expected
economic performance in 1999, the government's fiscal year 2000 budget
plans to reduce the deficit to about one-half percent of GDP while
providing for tax cuts/Footnote3/ and investment in environmentally
conscious improvements in public sector infrastructure.

Budget Reforms
--------------

Faced with daunting deficits in the early 1980s, the government developed
plans to improve financial accountability and the efficiency and
effectiveness of the public sector. Government officials also began to
explore ways to shrink the public sector's role in the economy. Many
different approaches were taken to streamline government; privatization,
deregulation, and decentralization were chief among them. A 1998 study
reported that the fact that few entities were actually privatized was
attributed, in part, to the fact that the cash-based accounting systems
then in use did not provide enough insight into costs to permit fair
prices to be estimated by either potential buyers or the
government./Footnote4/

The Netherlands made significant progress improving the quality and
timeliness of its financial accounting system during the late 1980s.
However, instead of again attempting privatization of some public
entities, in 1992 the government sought to improve the effectiveness of
public sector activities by focusing on a more results-oriented
performance management model. Taking an incremental approach to change,
the government and Parliament decided to allow a few government entities
to operate as if they were in the private sector. Parliament further
insisted that before an entity could shift to this new framework it needed
to define clearly the products it intended to provide and describe how it
intended to achieve any promised efficiencies. Accrual accounting and
budgeting was thought to be useful in achieving such efficiencies. The
Ministry of Finance noted that some activities could be better supported
through the use of accrual measures to spur a more results-based
management focus. Specifically, a government report found that accrual
measurement would facilitate a better costing of some government
activity./Footnote5/ The Ministry of Finance reasoned that efficiency
gains could be achieved through this more results-oriented environment if
expected outputs were more clearly articulated and the associated costs of
producing those outputs were better aligned. 

Adoption of an accrual framework, even for a limited number of public
entities, required an amendment to the Government Accounts Act which
required cash treatment for both budgeting and financial reporting on
budget execution. The selected entities were deemed "agencies"--a new
subdivision of government. According to parliamentary staff, once the
Government Accounts Act was amended, entities could volunteer to become
agencies. The first four new agencies were created in 1994. Over the
years, many more entities have elected to participate. Currently there are
22 agencies and 10 more entities are considering becoming agencies. The
share of public sector expenditures currently made by agencies is small--
only about 5 percent. However, they are labor intensive, employing about
25 percent of all public sector employees. The Dutch Tax Department
recently applied for agency status and, if its application were approved,
the share of public sector employees in agencies would rise to
50 percent. However, because most of the Netherlands' budget is transfer
payments, the share of total public expenditures budgeted on an accrual
basis will remain small. The rest of government still budgets on a cash
basis and, when all department and agency budgets are consolidated, the
fiscal balance is reported on a cash basis. 

Capital investment suffered in the 1980s even as the Netherlands tried to
rein in spending on social programs. Parliament's Public Expenditure
Committee promoted the adoption of a separate capital budget, which
successive governments also supported. However, there were also many who
opposed this separation, arguing that a capital budget would highlight the
lack of capital investment and that, by accruing only the depreciation
costs, a capital budget would provide greater incentives to spend the
scarce cash available in the Treasury. In the end, the overriding fiscal
policy goal at the time was to bring the deficit to within the European
Union's (EU) requirements. The EU deficit targets are cash-based and the
government at the time felt that a shift to a full accrual-based capital
budget could be deferred.

Structure of Agencies' Accrual Appropriations

The government's budget is developed and presented to the Parliament by
government ministries. Agencies are sub-units of ministries; their budgets
are approved and appropriated through the various ministries as prices
paid by the ministries for outputs. At the ministerial level,
appropriations are cash-based even though the amounts appropriated are
based on the agencies' accrual-based costs. For example, the Prison
Service is a line item in the budget of the Ministry of
Justice./Footnote6/ In this output budgeting framework, the Ministry of
Justice buys the services, for example, the number of prison beds it needs
that year (a proxy for the number of prisoners), from Prison Services. The
Ministry of Justice is appropriated funds on a cash basis to buy services
from the Prison Service, which are priced on an accrual basis.

While the goal of this framework is to encourage agencies to benchmark
their prices against other providers--public or private--of similar
services, this has been done infrequently. Instead, the price usually
reflects the costs of production. Thus, in the above example, the price
the Ministry of Justice agrees to pay the Prison Service is based on the
accrual-based costs the agency will incur in providing the service. This
price will include many noncash expenses, such as depreciation, which are
part of the costs. The lack of widespread benchmarking to determine prices
was attributed to inexperience with accrual measures, the recent accession
of many new agencies in the program, and the fact that for some of the
services these agencies provide there is no private sector equivalent that
can be used for benchmarking. Ultimately, as more agencies become
accustomed to accrual measurement, there is an expectation that they
should be able to benchmark their prices. In theory, this will lead to the
identification of efficiencies as agencies seek to compete with providers
of similar services.

Agencies must produce a set of accrual-based financial statements at year-
end. These statements are audited by the Netherlands Court of Audit and
presented by mid-May for the fiscal year that ended the previous December.
Budget development begins in the ministries about this same time and, as
input to budget development, the agencies' previous year's statements are
reviewed by the cognizant ministry, the Ministry of Finance, and
ultimately the Parliament. An agency's operating result is scrutinized to
ensure that the appropriated price was sufficient to cover all costs and
that the agency is not operating at a loss. 

A change was recently made to the way agencies finance future capital
investments. Prior to the change, agencies accumulated depreciation
funding until they could finance a capital investment. Agencies can now
borrow money for such investments from the Treasury. Agencies will use
their accumulated depreciation and other savings/Footnote7/ to repay the
loan. 

Since the agencies are still part of the public sector, significant
controls are placed on their ability to freely manage all their assets
including "savings" and capital assets. For example, any proposed capital
acquisition is reviewed by an agency's ministry to evaluate its relevance
and need. Capital acquisition plans are presented through the agency's
budgeted cash flow statement. Any new loans are noted and plans for such
financing are presented by the agency for approval to its ministry and
then to the Council of Ministers. All capital acquisition requests must
fit within the government's financing constraints and thus the Ministry of
Finance must also evaluate the effect the individual plans will have on
the deficit before they can be approved./Footnote8/ Parliament reviews
both the most recent audited financial statements and the budgeted
financial statements that are used to develop the price paid to the
agencies for their services. However, no specific vote is taken on an
agency's capital acquisition plan.

Starting this fiscal year--January 1, 2000--new agencies will have to pay
for all assets on their balance sheets when they become agencies. In
essence they are purchasing their assets from their ministries. These new
agencies will be able to borrow from the Treasury to finance the initial
asset purchase. The interest paid on the loans will approximate the cost
of capital, i.e., the opportunity cost of holding the assets. The agency's
price--and thus its appropriation--will include this cost of capital.
Highlighting the cost of holding these assets provides incentives for the
agency to better manage its capital base.

As in other countries, significant differences exist in the Netherlands
between the cash needed for pension payments to retirees and the accrued
costs of current employee pension liabilities. The Dutch public sector
employee pension plan is separate from the rest of the government budget.
For agency employees, the employer's share of pension costs is transferred
directly to this fund and invested. So, while accrued pension costs are
included in the agencies' appropriations, they are immediately transferred
out of the agencies' control to the general pension fund. 

Agencies are permitted to sell their services to entities other than the
central government and earn additional revenues, but this has not yet
occurred. For example, if the Prison Service finds itself with excess
capacity it could take in prisoners from other countries and supplement
its Dutch appropriation. However, the cognizant Ministry, the Council of
Ministers, and the Parliament all have considerable influence over these
transactions due to their oversight of the agency's financial statements.
Essentially, they must agree on the agency's income statement and approve
of its plans to take in more income. There are also rules that apply to
ensure that these public sector agencies do not unfairly compete against
the private sector, as agencies are not subject to taxation on this income
as the private sector would be. Currently, the greatest concern is that
any decision to offer services outside the Netherlands be weighed against
the agency's capacity to serve the Dutch people. For example, overcrowded
prison conditions could result if the Prison Service management was driven
by price competition alone.

Views on Implications for Decision-making

Although accrual budgeting is used for internal cost allocation, it has
little impact on fiscal policy since the surplus/deficit is essentially a
cash-based number. Accrual budgeting coupled with management reforms was
primarily undertaken to achieve management efficiencies. The government
believes that clearly specifying the outputs agencies are expected to
produce and aligning resources to the outputs provides greater
transparency in agency operations. Senior budget officials point to the
Prison Service for examples of how such benefits could manifest
themselves. When providing services--i.e., the number of prison beds per
year--the outputs are spread throughout various facilities. According to
these officials, the costs of housing, feeding, and guarding a prisoner
should be similar for all facilities. But under the traditional cash-based
framework, the costs differ primarily because of capital acquisitions or
renovations. Accrual budgeting as implemented in the Netherlands seeks to
even out those spikes. Once those costs are evenly allocated, if
differences continue to exist, price benchmarking between prisons and
other cost analyses can be performed that should encourage price
competition. According to officials, this could lead to lower government
expenditures. The selective approach to accrual budgeting taken in the
Netherlands permits the benefits of accrual accounting to be realized for
cost accounting purposes and for agency decision-making, while preserving
the cash figure for comparative purposes within the European Monetary Union.

--------------------------------------
/Footnote1/-^January 1, 1999, was that the economies of the participating
  countries should converge towards each other and, at the same time,
  remain healthy.
/Footnote2/-^The fiscal year corresponds to the calendar year.
/Footnote3/-^The governing coalition agreed to set aside half of any
  revenue "windfalls" for tax reduction and the other half for deficit
  reduction.
/Footnote4/-^Haffner, Robert C. G. and Koen G. Berden, "Reforming Public
  Enterprises - Case Studies: The Netherlands,(c) Public Management
  Service, OECD, 1998.
/Footnote5/-^Public sector accounting standards largely mirror those used
  in the Dutch private sector. Municipal governments in the Netherlands
  use accrual-based standards for financial statement reporting and
  budgeting. Discussions are ongoing in the Ministry of Finance on whether
  these standards need to be reviewed for applicability to the public
  sector.
/Footnote6/-^In most cases an agency is one line item within its
  Ministry's budget. However, there are some very small agencies that may
  be included with other program expenses within a line item in their
  ministries' budgets.
/Footnote7/-^Also effective in fiscal year 2000, a 5 percent cap was
  placed on the amount an agency can carry forward from one year to the
  next, exclusive of depreciation. Reserves greater than 5 percent of its
  total appropriation signal the need for the agency to lower its price
  (essentially its budget request).
/Footnote8/-^The deficit/surplus is still largely a cash-based number.
  Loans for new capital injections are considered outlays and are netted
  against payments made on existing loans to determine the net effect on
  the deficit/surplus.

NEW ZEALAND
===========

New Zealand adopted accrual budgeting as part of a systematic program of
sweeping reforms in both the private and the public sectors that started
in 1984. In the public sector, the government aimed (1) to reduce its role
in the economy through corporatizing and privatizing government entities and
(2) to extract efficiencies and increased accountability from the
remaining public sector. Accrual-based reporting was adopted as a tool in
these wider management reform efforts. It was seen as providing a coherent
framework for systematically determining the output of government, then
evaluating performance and accountability in the new decentralized
management system. Budgeting was transitioned to a full accrual basis to
provide a direct link between the budget, the financial statements, and
the results of government activities. 

Background

New Zealand has a unicameral parliamentary system with 120 members elected
for 3-year terms, with the most recent election occurring in November
1999. It has a mixed-member-proportional electoral system, in which half
of Parliament is elected directly as district representatives, while the
other half is appointed by each party from its own candidates in
proportion to the percentage of the popular vote it receives. The
government is headed by the Prime Minister who, along with other Cabinet
members, can often make administrative or regulatory changes without
public input or legislative approval. Prior to the change to proportional
representation, the New Zealand government traditionally was controlled by
either one of the two major parties--the Labour Party or the National
Party. In 1996, as a result of the introduction of proportional
representation that enabled minor parties to have greater representation
in Parliament, the National Party entered into an agreement with the New
Zealand First Party to form a coalition government. In 1999, another
coalition government was formed comprising the Labour and Alliance parties.

The Budget Process
------------------

The governing party or Coalition party in power has control over the
entire budget process. The government, through the Department of the
Treasury, prepares the budget for presentation to Parliament. Before the
budget is released, the government releases the Budget Policy Statement
(BPS) setting forth the strategic objectives for the upcoming fiscal year
(which runs from July 1 to June 30) and the following 3 years. These
objectives help define the framework within which new initiatives and
programs proposed by departments are to be evaluated. New programs
constitute a small part of the overall budget, as most of the budget goes
to fund core services. New programs are proposed, considered, and approved
prior to the public presentation of the Budget Economic and Fiscal Update
(the budget). The budget sets forth the government's overall plan for
revenues and expenditures that fulfills the strategic objectives announced
in the Budget Policy Statement. The Minister of Finance also presents the
Estimates of Appropriations, which provide detailed information by
department and agency, to accompany the budget.

Concurrent with the presentation of the budget, the government is required
to release the Fiscal Strategy Report (FSR) to report on whether the
actual budget decisions contained in the budget are consistent with the
government's short-term fiscal intentions set out in the most recent BPS.
Where those intentions have changed, the government is required to state
the reasons for the departure. The FSR is to contain projections of fiscal
trends over a ten-year period, as well as an assessment of the consistency
of these outlooks with the objectives for medium- to long-term fiscal
policy stated in the most recent BPS. Again, any inconsistency with the
BPS has to be explained.

While the New Zealand Parliament has power to control government finances
and appropriate expenses, in reality the budget is usually passed without
much change. The failure to pass a budget would signal a lack of
confidence and would likely result in the dissolution of the government
and new elections. Standing committees in Parliament examine the budget,
question ministers and departments about their requests, and report back
to Parliament. Parliament may offer modifications to the government's
budget through procedures called "Standing Orders." However, these orders
also give the government a financial veto if Parliament's changes would
result in a significant impact on the "fiscal aggregates," or overall
financial position. During the parliamentary deliberation process, the
government continues to operate through supply bills./Footnote1/

The Economy and the Budget
--------------------------

From the mid-1980s to the early 1990s, the New Zealand economy experienced
a prolonged period of very slow growth. In 1991, real gross domestic
product (GDP) was less than 3 percent higher than in 1984, compared to an
average increase of more than 20 percent for other Organization of
Economic Cooperation and Development countries during the same period.
Unemployment soared from less than 5 percent in the early 1980s to almost
11 percent in 1991. The economy rebounded starting in late 1991, led by
strong export growth. Economic expansion continued until 1996, when the
economy started to slow. More recently, the Asian economic crisis has
negatively affected New Zealand's growth. 

Budget deficits had characterized New Zealand's fiscal position for almost
two decades. However, deficit reduction efforts and a strengthening
economy have led to the achievement of surpluses from fiscal year 1993-94
through fiscal year 1998-99. These surpluses are measured on an accrual
basis--as required by new legislation--as opposed to the cash basis used
to measure fiscal position before fiscal year 1993-94. The surpluses,
along with proceeds from privatization, have allowed the government to
undertake substantial debt reduction. By 1998, net debt had declined to
less than 25 percent of GDP from a level of more than 50 percent in 1992.
Current projections estimate that the budget will be roughly in balance in
fiscal year 1999-2000 before achieving surpluses again starting in fiscal
year 2000-01.

Recent Reforms 
---------------

Between the mid-1980s and mid-1990s, New Zealand implemented systematic
and sweeping reforms in the private and public sector that transformed the
country from one of the world's most controlled economies outside the
communist world to one marked by openness. Reforms affected every sector
and reflected several elected governments' views that economic openness
and competition were the engines of economic growth. Financial reporting
and budget process reforms were the least controversial of all of New
Zealand's efforts during this period.

Prior to 1984, the New Zealand government played a substantial role in
providing goods and services. In addition to providing extensive subsidies
to various businesses, the government owned coal mines, banks, airlines,
telecommunications, and other industries that together produced more than
12 percent of GDP. Government policies also focused on maintaining the
standard of living of New Zealanders through generous provisions for
social programs financed by borrowing heavily from abroad.

The 1984 election brought a new government to power, along with an agenda
that focused on introducing competition to a heavily regulated economy and
dismantling the state's involvement in the economic sector. To effect
this, the government devalued and then floated the currency, opened
financial markets to international capital flows and investment, and
deregulated major sectors of the economy. It also removed wage and price
controls and reduced or eliminated subsidies from many industries. 

After introducing competition in the private sector, the government turned
to reforming the public sector. The government's goals were to reduce its
size and to adopt modern management practices. The first major step taken
to improving performance of the public sector was the State-Owned
Enterprises Act of 1986, which organized departments with commercial
activities into separate commercial entities and required them to adopt
business practices, implement new accounting systems, and compete with
private sector entities where applicable. Subsequently, the State Sector
Act of 1988 sought to improve accountability and performance in the core
public service by reforming it and replacing the permanent tenure system
for heads of government departments with a contract system. The act
specified that executives would be evaluated on the basis of their
performance, and transferred the power to hire, fire, and determine pay
levels to each chief executive. Thus, each chief executive is now the
employer for his/her department. 

The Public Finance Act of 1989 furthered the move towards a new financial
management system and enhanced the link between budget and performance at
the departmental level by shifting to output-based appropriations for the
delivery of services over which departments had control. /Footnote2/ As a
result, at the department level, the measurement basis for budgeting,
reporting, and performance assessment was shifted from a cash to an
accrual basis.

In 1994, the Fiscal Responsibility Act (FRA) expanded the accrual-based
framework to cover all government accounts so that programs such as
transfers and loans (which were still being budgeted on a cash basis
although they had been reported in financial statements on an accrual
basis since 1992) were to be budgeted on an accrual basis. By establishing
a set of guiding principles for fiscal decision-making and requiring
extensive reporting of fiscal performance, FRA added a new dimension to
reforms that were until then primarily oriented towards increasing
accountability of departmental executives so as to extract better
departmental management. FRA extended this accountability framework to the
rest of the government by requiring that the government first articulate
its fiscal strategy before budget submission, and then report subsequently
on its performance. Whereas in the past, performance and accountability
applied to the micromanagement level, they now became characteristics of
the fiscal framework as well. 

Use of Accruals in Financial Management 

Unlike most other countries that have chosen to take an incremental
approach to implementing accrual-based reporting, New Zealand viewed
accrual accounting and budgeting as a part of a coherent framework.
According to New Zealand officials, the adoption of accrual budgeting was
the least controversial element of the reform program. There was already a
body of knowledge about the shortcomings of the cash system, as well as
proven benefits from accruals provided by the experience of state-owned
enterprises. Once a new direction was chosen, the government moved quickly
towards implementation.

Implementation Timeline
-----------------------

The transition from cash to a full accrual-based system of reporting and
budgeting began in 1989./Footnote3/ Departments transitioned all key
elements, including both accrual budgeting and accrual reporting, at the
same time. Before moving onto the new system, departments individually had
to receive approval from the Treasury, with the approval hinging on
whether departments fulfilled specific requirements. Specifically, each
department had to (1) define its broad classes of outputs (the basis for
accrual-based appropriations), (2) develop an accrual-based system capable
of monthly and annual reporting, (3) develop a cost allocation system to
allocate all input costs, including depreciation and overhead, to outputs,
and
(4) develop a system of cash management. At the end of 2 years, and before
the start of the fiscal year 1991-92 budget process, all departments had
completed the transition process. In the 1991-92 budget, departments were
required to present accrual budgets for their core services using almost
800 output classes instead of the 50-plus departmental appropriations that
existed prior to the transition to accrual budgeting. By the end of 1991,
all but six departments had received unqualified audit reports. Once
individual departments had transitioned into the new financial management
system, the government as a whole focused on the aggregated financial
reporting of the government. In October 1992, the government presented to
Parliament the first comprehensive set of accrual-based annual financial
statements for the fiscal year ending June 30, 1992. In 1994, following an
amendment to the Public Finance Act, the government prepared and presented
the entire budget, including loans and transfers, on an accrual basis,
thereby completing the transition to the accrual-based framework.

The Public Finance Act distinguishes between three types of
appropriations, known as Modes A, B, and C (see figure 9). The three modes
range along a continuum, from appropriating for input costs to
appropriating for output prices. The three modes recognize that
departments are in different stages of adopting reforms and that some
departments provide goods and services that are more commercial and
subject to competition than others. By 1991, all departments had
transitioned out of Mode A into Mode B, which is still the usual mode of
appropriation. Departments have not yet transitioned to Mode C, although a
number of features that were originally envisaged for Mode C (such as a
cost of capital), now apply to Mode B.

Figure****Helvetica:x11****9:    The Three Modes of Appropriations

*****************

*****************

The Public Finance Act requires that the financial statements for the New
Zealand government and for each government department be prepared in
accordance with generally accepted accounting practices. Generally
accepted accounting practices are financial reporting standards approved
by New Zealand's Accounting Standards Review Board from submissions by the
Institute of Chartered Accountants of New Zealand or any other person or
body. Rather than developing its own separate standards, the government
adopted generally accepted accounting practices used by entities in the
private sector for reporting. If necessary, Treasury officials would
develop specific accounting policies within the public accounting
framework through the New Zealand standards-setting process. Using the
generally accepted accounting practices framework, Treasury officials
developed accounting policies that (1) define the reporting entity, (2)
specify a system for consolidating information, and (3) develop a format
for presenting and publishing the government accounts. The Comptroller and
Auditor General's Office, the Finance and Expenditure Select Committee,
and experts in the public and private sectors reviewed these policies as
they were developed. 

Factors Driving Adoption of Accrual Budgeting
---------------------------------------------

New Zealand's approach to accrual budgeting is one of the most
comprehensive of the countries that have implemented it to date. In part,
it reflected the rejection of a cash system that was not providing proper
information for the management of assets and liabilities. The fiscal
system in New Zealand's central government had traditionally focused on
the annual cash cost of inputs such as personnel, travel, maintenance, and
materials. As in most other countries, the government and Parliament
exerted control over inputs by mandating the use of specific suppliers and
regulated compliance through extensive instructions. Budgeting took the
form of a set of appropriations of cash payments to recipients, to a
government activity, or to a type of payment such as a grant or a capital
payment. Managers focused on budget and legal compliance rather than on
managing resources efficiently and effectively. The accounting system for
the whole of government, including state-owned enterprises, was entirely
cash-based. 

The previous cash-based system had several deficiencies, some of which
were highlighted by the country's reform agenda. According to officials
and experts, the cash-based system was not providing crucial financial
data on assets and liabilities to support the government's "ownership"
role and created incentives for poor resource management. Further, the
government did not know the full cost of producing a good or service,
which was fundamental to the government role as "purchaser" under a more
decentralized management regime. 

According to New Zealand officials, under its previous cash-based system
the government did not know what assets it owned, the value of these
assets, and whether these assets were being put to the best use. For
example, when officials in the 1970s wanted to sell spare land holdings,
they could not identify what land the government owned. The New Zealand
cash system did not account for future liabilities arising from present
commitments. The New Zealand government in the late 1970s provided
guarantees to industries engaged in activities such as oil production
aimed at reducing the country's reliance on foreign sources. The
guarantees cost the government of the day nothing; however, as oil prices
fell, industries withdrew from those sectors and redeemed the guarantees.
Subsequent governments had to pay the high costs of those commitments made
by earlier governments. Similarly, the cash accounting system was
arbitrary in its application of specific principles. For example, under
the cash system, the calculation of the deficit included the effect of
interest rate changes on the cost of servicing government debt, but did
not incorporate the effects of exchange rate changes on the value of the
debt. Accordingly, when the currency declined in value, the value of the
debt in New Zealand dollars increased, making the debt more expensive.
Because the cash basis failed to account for this effect, the government
continued borrowing in low-interest rate, strong-currency markets, without
appropriate consideration and accounting for the risk involved in currency
changes. 

Another rationale for moving the entire public sector to accrual
accounting and budgeting came from the improvement in the performance of
state-owned enterprises (SOE) when they adopted accruals. These entities
had in the past produced no return to the government. After
corporatization and the implementation of accrual accounting and
budgeting, these entities started producing profits./Footnote4/ By 1992,
SOEs were paying more than 
NZ$500 million in dividends, which were used to improve the fiscal
position of the government. According to government officials,
improvements in this sector were seen as an indication that management
efficiencies could be achieved by moving departments to accrual accounting
and budgeting as well. 

The final impetus, however, lay in the desire to tie budgeting to
performance and accountability in a coherent framework. In this regard, a
New Zealand government official stated that "there is much more to
recommend the development of accrual accounting in government when it is
implemented in the context of a regime which encourages management
performance." In the new environment, the government defines strategies,
which ministers translate into performance requirements (outputs) of the
chief executives of departments. Under the reformed system, the government
purchases these departmental outputs at an agreed upon price. Thus, output
pricing is crucial. To properly determine the output price, the government
needed to account for all output costs, not simply the cash flows in any
given year. According to an architect of the New Zealand system, the
accrual framework was chosen not "because it was better accounting, but
because it was an integral part of the management framework" that the
government was trying to install. 

According to officials we interviewed, once the decision was made that
accrual information would form the basis of reporting, they viewed it as
crucial that it also become a key budgetary tool. A former official who
was a key champion of the adoption of accrual budgeting stated that
"accrual accounting for the whole of government will not amount to much
more than an interesting accounting exercise unless the information is
used for the purposes of economic management." Officials in New Zealand
did not believe that accrual-based financial reporting alone would create
incentives to manage programs more effectively. Further, they noted that
even departments that were able to prepare financial statements had no
incentive to do so unless they formed the basis of accountability, by
tying actual performance to what was expected as represented by the budget. 

Officials we spoke with also stressed the importance of following
existing, widely accepted private sector standards. They pointed to
relatively few exceptions where private sector standards failed to meet
public sector needs. Such standards are preferable because they increase
accountability by ensuring that more people would be informed and able to
scrutinize the financial position and performance of the government.

The Audit Office provides its opinion on the financial statements through
audit reports./Footnote5/ In addition, the Audit Office is heavily
involved with the Treasury in the development of the accounting policies
of the Crown. Financial statements of SOEs and Crown entities are audited
separately, and their results of operations are reported in the Financial
Statements of the Government of New Zealand. 

Summary of Accrual Budgeting System

The New Zealand system makes a distinction between two roles of
government: as purchaser of goods and services and as owner of assets used
to provide those goods and services. Given its dual role as owner and
purchaser, the government is not only interested in the services that are
being rendered, but also the maintenance of an asset base to ensure the
sustainability of these services. New Zealand's accrual-based framework
encompassing output-based budgeting and accrual-based measurement in both
financial reporting and budgeting is viewed as crucial in providing the
information and incentives needed to make this dual role work.

Structure of Appropriations 
----------------------------

Appropriations are generally limited to 1 year, consistent with the annual
budget cycle, and cover proposed expenses./Footnote6/ Multiyear
appropriations are rare and arise when Parliament wishes to signal a
commitment that requires appropriations for more than 1 year. As shown in
figure 10, the government's budget is presented by three primary
statements similar to those found in private sector reporting: the
Forecast Statement of Financial Performance, the Forecast Statement of
Financial Position, and the Forecast Statement of Cash Flows.

Figure****Helvetica:x11****10:    The Three Primary Statements Used to
                                  Present the Budget

*****************

*****************

In addition, the government also submits the Forecast Statement of
Borrowings, the Statement of Commitments, and the Statement of Actual
Specific Fiscal Risks. The Statement of Borrowings reports on the net debt
of the government. The Statement of Commitments reports on the commitments
of the government for future years, broken down into capital commitments,
such as military equipment, and operating commitments, such as
noncancelable leases./Footnote7/ These statements provide aggregate data
at a high level, while the Estimates of Appropriations that accompany the
above statements break down the budget request to detailed objectives and
outcomes of the government and provide details on departments' and
agencies' outputs. As shown in figure 11, there are seven types of
appropriations. The funding request for each appropriation reflects the
results of the purchase agreement between department executives and
ministers, whereby the latter define the output to be provided and specify
the quantity and quality. While department managers and ministers have
authority to shift resources within each type of appropriation as long as
they deliver the agreed upon outputs, ministers do not have the authority
to transfer resources between types of appropriations without the consent
of Parliament. 

Figure****Helvetica:x11****11:    The Seven Types of Appropriations

*****************

*****************

Appropriations are provided for the total cost of outputs, including
salaries and wages, as well as other costs not requiring cash outlays,
such as depreciation. The cost of output also includes a cost of capital
charge--akin to an interest charge for using capital--levied on
departmental net assets to reflect the full cost of government services
and to create an incentive to (1) more efficiently use assets and (2)
dispose of surplus assets by making it more expensive to own assets of low
utility. 

Treatment of Specific Budget Items
----------------------------------

As mentioned above, the treatment of budget items follows generally
accepted accounting practices. This means that assets are capitalized and
depreciation expense recorded over the life of the asset. Liabilities are
recorded when they become probable and measurable. Our review, including
interviews with New Zealand officials, showed that specific budget items
are treated as follows.

o   Public sector employee pension: Under accrual budgeting, each
  department transfers an actuarially derived amount equal to future
  pension benefits earned during the year to the Government
  Superannuation Fund, i.e., the Public Employee Pension Fund. This
  amount is recorded as an expense on each department's financial
  statements and budget. The accumulated total of each department's
  expense is recognized as an expense (a debit) on the government's
  Statement of Financial Performance. A corresponding liability (a
  credit) is added to the existing pension liability from past services
  already recorded on the Statement of Financial Position, while cash
  outlays to current pensioners are recognized as reduction to pension
  liability. The movement in pension liability thus reflects the combined
  effects of cash outlays and current expense.

o   Capital: New Zealand's appropriation for capital is divided into two
  categories: (1) appropriation for any increase in departments' net
  asset holdings, and (2) appropriation to fund activities related to
  assets undertaken by the Crown, such as construction of state highways,
  national parks, or Parliament buildings. New Zealand's cash
  appropriation to departments includes funding for noncash items such as
  depreciation expense. Managers have the freedom to optimize their asset
  base, which includes purchasing replacement assets by using funds
  accumulated from this depreciation expense. Managers with adequate
  reserves have the discretion to purchase assets up to a 
  NZ$7 million limit, while those seeking to purchase assets between
  NZ$7 million to NZ$10 million must seek ministerial approval, even
  if they have enough reserves. Departments with inadequate funds to
  replace assets must request a capital injection--an appropriation
  for the difference between funds required and available reserves.
  Asset purchases over NZ$10 million must receive Cabinet approval,
  whether or not departments need a cash injection. To further
  encourage better management of assets, the government implemented a
  cost of capital charge on the net assets of the department. The
  capital charge is used to derive the cost of the output, thus the
  cash appropriated to departments includes the capital cost. Assets
  undertaken by the Crown are managed by departments on behalf of the
  Crown. In these instances, departments receive cash appropriation
  for the administrative costs of managing these assets, and not the
  depreciation expense, as decisions to replace these assets are made
  by the Crown and not by individual departments.

o   Inventories: Inventories are recorded as assets in accordance with
  generally accepted accounting practices at the lower of cost or net
  current value, with appropriate allowances for obsolescence.

o   Insurance, loans, and guarantees:/Footnote8/ The Accident
  Compensation Corporation, New Zealand's major insurance program, covers
  all types of insurance including motor vehicle, on-the-job injury, and
  others. Starting with the fiscal year 1999-2000 budget, accident
  insurance is recorded on an accrual basis in the budget. An expense is
  recorded at the net present value of the estimated cash outflows of
  claims filed during the year, plus a small estimate based on historical
  data on the value of accidents that had occurred but had not been filed
  in the year. For fiscal year 1999-2000, the government also booked, in
  its Statement of Financial Position, a change in the Crown balance due
  to the recognition by the Accident Compensation Corporation of the
  estimated liability from past accidents. Loan programs are appropriated
  to departments as a capital contribution. Loans are recorded on the
  Statement of Financial Position at the recoverable value that includes
  an estimate for uncollectibles. Bad debt expense is recorded the year
  the loan is issued.

o   Social insurance: The old-age pension program operates on a pay-as-
  you-go basis out of general revenue. New Zealand does not report a
  liability for commitments for this program. 

o   Revenues: Revenues are measured on an accrual basis and recognized at
  the point the debt to the Crown arises, for example, when an individual
  or company earns income that would be subject to tax. This means that
  taxes on income or goods and services that are deducted directly at the
  source are recognized when the transaction is forecast to occur. Other
  taxes are not recognized until an assessment is made by the revenue
  department or filed by the individual or company. The power to tax is
  not recognized as an asset because the criteria for recognizing an
  asset is not properly satisfied since the transaction that gives rise
  to the revenue has not occurred, nor could its value be measured
  reliably. 

Aggregate Budget Measure
------------------------

Multiple measures are used to evaluate New Zealand's fiscal position. The
primary measures are the operating balance,/Footnote9/ the debt to GDP
ratio, and net worth. The operating balance became one principal measure
of the fiscal position when FRA made mandatory the use of accrual
accounting standards for fiscal forecasting purposes. Under FRA, the
government is required to present, in every budget, 3-year projections of
government finances using the three principal financial statements
described earlier. By requiring accrual-based budgets for the current year
as well as the forecast budgets, FRA's intent was to increase both the
transparency and credibility of the public accounts. The main differences
between the accrual operating balance and the traditional cash balance are
depreciation, changes in the pension liabilities of public employees,
changes in working capital such as receivables and payables, and changes
in the valuation of forests owned by the Crown. In addition, except for
gains or losses, the accrual operating balance excludes the cash effects
from the purchases or sales of assets. 

In addition to the operating balance, New Zealand also emphasizes the debt
to GDP ratio--a cash measure--as a key indicator to track the government's
impact on the economy. According to government officials, the reason for
focusing on debt was because a small and open economy like New Zealand
needs to attempt to maintain a low debt to GDP ratio to be able to respond
to future economic shocks. Officials and experts we interviewed explained
that setting a debt to GDP ratio guided the subsequent determination of
the operating balance. It also helped keep the government focused on
maintaining surpluses and in articulating the need for running sustained
operating surpluses. 

Net worth, i.e., the difference between assets and liabilities, was also
used at times to gauge fiscal performance. According to government
officials, the changes in net worth allow government officials and other
experts to analyze the government's fiscal performance over time. An
increasing net worth can indicate improved financial position, while a
decreasing net worth may signal the need for government to take actions to
address shortfalls in assets or increases in liabilities. Furthermore,
changes in net worth may be used to assess the fiscal sustainability of
government programs because liabilities used to calculate net worth
reflect the estimated commitment that the government had made in the
past./Footnote10/ 

Key Differences Between Accrual and Cash
----------------------------------------

Figure 12 shows the reconciliation between the operating balance and the
adjusted financial (cash) balance. Key differences between accrual and
cash relate to the timing of the recognition of revenues and expenses. The
greatest timing difference between accrual and cash occurs in the
recognition of pension expense, depreciation expense, and the purchase of
assets. Timing differences mean that the bottom line--the surplus or
deficit--is affected in either direction by accrual or cash depending on
the activities undertaken by the government in a particular year. For
example, cash outlays for the purchase of assets decrease the surplus (or
increase the deficit) in the year the cash is paid under a cash system,
but have no effect under an accrual system. In succeeding years, as the
asset is put into service, depreciation expense decreases the accrual-
based surplus (or increases the accrual-based deficit), but has no effect
on the cash balance. In most instances, because the cash basis tends to
recognize large capital items all at once while the accrual basis spreads
the cost of purchases over the useful lives of the assets, accrual
measurements generally smooth out expenses if capital purchases are not
made at a constant level year after year. 

Figure****Helvetica:x11****12:    Reconciliation Between Operating Balance
                                  and Adjusted Financial Balance (Cash)

*****************

*****************

During the period from fiscal year 1994-95 through fiscal year 1997-98,
the accrual operating balance differed from the cash balance, but the
differences varied in magnitude and direction. In fiscal year 1995-96, the
accrual operating surplus exceeded the cash surplus by about 3 percent of
GDP, with the difference attributable in part to the purchase and sale of
investments. In fiscal year 1996-97, the government achieved a cash
surplus that exceeded the accrual operating surplus by almost 2.7 percent
of GDP, due primarily to the sale of physical assets. In fiscal year 1997-
98, the government actually achieved an accrual operating surplus but was
in cash deficit, primarily because of purchases of investments and
physical assets (see figure 13). 

Figure****Helvetica:x11****13:    Accrual Operating and Adjusted Cash
                                  Balances, Fiscal Years 1994-95 Through
                                  1997-98

*****************

*****************

Note: In 1994, the New Zealand government changed its definition of
surpluses/deficits from a cash basis to an accrual operating balance
basis. The adjusted cash balances from fiscal years 1994-95 through 1997-
98 are our calculations and reflect the cash flows from operating and
investing activities, which approximate the adjusted financial balance
used to measure surpluses/deficits prior to 1994. However, some additional
adjustments are necessary to arrive at an exact measure of the adjusted
financial balance.

Source: New Zealand Treasury.

Views on Implications for Decision-making

It is difficult to isolate the effects of the adoption of accrual
budgeting from those of the extensive public sector reform that occurred
in New Zealand. It is also difficult to determine whether benefits
attributed to accrual budgeting would have occurred with accrual
accounting alone (i.e., without accrual budgeting). Since the New Zealand
government never considered budgeting and accounting on different bases,
when officials spoke of the benefits of accruals, they usually were
referring to the benefits from both accrual accounting and budgeting. Some
of the benefits for fiscal and managerial decision-making attributed to
the accrual framework included

o   encouraging more fiscally responsible decisions through better
  recognition of assets and liabilities; 

o   providing better information and incentives for asset management by
  recognizing the cost of capital asset use through the depreciation and
  capital charging regime;

o   enabling departments to make efficient decisions when faced with a
  budget squeeze by improving cost recognition, thus helping to pinpoint
  inefficiencies; and

o   encouraging better financial reporting discipline and the development
  of modern financial practices and systems.

As discussed later in this section, some critics have voiced concerns that
managers have too much flexibility to make decisions that properly belong
in the legislative arena. Others felt that the change in the basis of
reporting and the emphasis on accrual rather than cash made it more
difficult to assess the government's impact on the economy. Further, some
disagreed that accrual budgeting improved transparency, noting that the
use of accruals requires a more sophisticated understanding of financial
issues because accrual measurement is based on technical standards and
underlying professional judgments and assumptions.

According to a former minister, the greatest impact on fiscal policy from
the introduction of the accrual framework has been to emphasize issues of
sustainability by bringing greater attention to liabilities. In his view,
recognizing and recording a long-term liability on the balance sheet
causes greater fiscal caution and budget discipline. Under the cash
budgeting system, parliamentarians were generally aware of the
consequences of actions that have a future impact on the budget, but
without the reporting requirement for liabilities embodied in accrual
accounting standards, politicians were able to discount the magnitude of
future liabilities in favor of funding current popular programs. For
example, under the previous system the magnitude of government commitments
to public sector pensions was recalculated and reported to Parliament
every 5 years. However, since the liability was not a current estimate, it
did not play a significant role in the budget debate. Consequently,
politicians did not use it to argue convincingly for fiscal prudence when
pushed by employee representatives to expand program benefits. Reporting
the liability on the balance sheet annually as required by accounting
standards made the long-term commitment more visible, and gave the
government support, grounded in analytical data, for making difficult
decisions. This former high-ranking official also told us that recognizing
more than NZ$7 billion of public sector pension liability raised concerns
in the government about the sustainability of the program. Subsequently,
the government first refused to increase benefits and later closed the
centrally operated, defined-benefit plan to new employees./Footnote11/
Similarly, the government ceased offering earthquake insurance to
businesses once the liabilities of the program were reported on the
balance sheet. 

On the managerial side, current officials credited accrual-based budgeting
with generating better information and creating the proper incentive for
better asset management. To create the beginning balance sheet, an
extensive exercise was conducted to find and value government assets. The
exercise confirmed that where records of assets existed, they were
woefully inadequate. Some organizations, such as the Department of
Education, found assets that they were unaware of owning. While the most
valuable assets were land and buildings, departments also found they had
significant other assets. For example, the asset identification exercise
found that unpaid fines due to the Department for Courts were a
significant asset to that department's balance sheet. Subsequent attention
prompted the department to actively manage this asset by replacing the
traditional collection methods with direct payment systems at courthouses
and computerized call centers for tracking slow payers. 

In addition, officials viewed the introduction of the capital charge as a
significant incentive for better asset management. As mentioned
previously, while the department is appropriated the capital charge as
part of the price of its output, it must pay the cost of capital back to
the government. If a department has a smaller asset base at the end of the
year than the asset base for which the appropriation was made, the
department is permitted to keep part of the capital charge. The consensus
among officials we interviewed was that the capital charge had
substantially reduced the amount of idle assets held by departments.
However, other analysts argued that the capital charge might have driven
department executives into making rational short-term decisions that could
be damaging to the long-term sustainability of departmental operations.
For example, an audit official informed us that partly to avoid a higher
capital charge, one department has not replaced its assets, but instead
has continued to operate with obsolete and fully depreciated assets, a
move that enabled it to service more clients in the short run, but
compromised its ability to deliver the best service in the long run. 

Recognizing depreciation as an expense in the budget also was cited by
some supporters of accrual budgeting as changing decision-making to result
in more efficient asset use. Because departments are paid to produce
outputs, the government has taken a hands-off approach on how departments
manage inputs to produce those outputs. Since output prices are revised
only periodically, departments may receive appropriations covering
depreciation on assets that have been totally depreciated or assets that
have been disposed. If a department is able to reduce an input cost such
as depreciation expense while its price level stays the same, it can save
that money to fund future replacement of an assets, or alternatively, it
may use that money to fund other expenses such as additional personnel or
salaries.

Others, however, expressed skepticism about the desirability of a
depreciation regime. Some felt that giving managers the discretion to
apply reserves built from depreciation expenses toward asset replacement
amounted to giving executives too much freedom to make allocation
decisions./Footnote12/ Others felt that the depreciation regime might
impede efficient replacement of assets./Footnote13/ For example, officials
in the New Zealand Defence Force informed us that in a technology-
intensive environment, asset prices tend to increase commensurate with
improving technology. In this environment, accumulated depreciation would
never be adequate to fund asset replacement, thus requiring capital
injections in almost all circumstances.

Some officials noted that adopting accrual-based budgeting was also
valuable in ensuring fiscal discipline and improving the ability to
maintain surpluses. Since 1991, New Zealand has maintained the core budget
of each department at a constant nominal level, allowing almost no room
for increases. Departments desiring additional funding had to deliver
additional output or present convincing arguments as to why they could not
extract additional efficiency from their organizations. According to a
former Finance Minister, under a cash system the government could
arbitrarily impose a budget squeeze on departments, but that could also
cause arbitrary cuts to otherwise crucial programs. In contrast, because
of the availability of cost information in the accrual budgeting
framework, officials were able to identify and either cut or improve the
efficiency of less efficient areas instead of sacrificing an area that was
fundamental to its ability to deliver agreed upon outputs. While this is
the generally accepted theory, some New Zealand experts have raised
concerns that departments may have reached the limits of their abilities
to "squeeze out" efficiencies and have begun to run down their capacity--
by failing to replace or maintain both physical and human capital--in
their drive towards efficiency.

In general, economists we interviewed felt that the new framework provided
useful information to analyze the government's effectiveness in managing
the country's finances. However, some said that the accrual accounting and
budgeting framework, particularly the focus on the net operating balance
and output appropriations, fails to provide adequate information with
which to make informed analysis about the effect of government policies on
specific sectors of the economy. Although the cash flows statement
provides data on cash inflows and outflows, these data are available only
on an aggregate level. Consequently, analysts informed us that they were
unable to determine how much cash was spent, for example, on the
transportation sector, and thus they were unable to determine the effect
that such spending had on economic growth. These analysts believed that
sector-specific details on cash inflows and outflows, as were provided
under the cash basis, would greatly assist them in analyzing the effects
of government spending./Footnote14/ Others told us that using net worth to
measure sustainability was flawed because (1) the objective of the
government is not to operate at a profit, (2) some government assets are
difficult to value, therefore net worth may be misstated, and (3) a focus
on net worth tends to direct the government towards implementing financial
rather than fiscal policies. A former Secretary of the Treasury responded
that the debate on whether cash or the accrual-based operating balance
should be used to measure fiscal position is based on the "misplaced
desire to look at accrual accounting information as if it were the be-all
and end-all to fiscal management, instead of looking at accrual as another
set of data that facilitates exercises on comparability." Officials
acknowledged that an accrual-based net worth number is necessarily based
on some underlying assumptions and professional judgments. However, they
emphasized that what is most important is not the absolute level of net
worth, but the ability to track trends in net worth as an indicator of the
government's fiscal condition using consistent standards. Further,
officials stressed that the government continues to monitor its cash needs
through the cash flow statement. 

Parliamentarians we interviewed were generally supportive of the new
accrual framework and welcomed the additional information it provided.
While most admitted to not fully understanding the intricacies of accrual,
they generally felt comfortable with accrual principles and the quality of
information provided. However, some expressed concerns about
accountability under an output-based appropriation framework because
defining output is complex, and departments have incentives to revise
those definitions, so that tracking accountability can be difficult.

Treasury officials believed that reporting under the accrual budgeting
framework enhanced accountability. According to these officials, financial
systems were no longer designed in house; instead, departments acquired
modern, off-the-shelf financial systems to enable them to provide
sophisticated financial information to the Treasury in a timely manner.
Such information, which is now available each month, allows analysts to
conduct financial analysis and provide early notice of departments at risk
of not meeting their output agreements. In contrast, under the previous
system, financial data were not available until the end of the fiscal year
and indications that a department may be at risk of breaching its cash
appropriation were not available on a timely basis. 

Implementation Issues

Implementation issues in New Zealand can be organized into three groups:
(1) transitional issues, which relate to timing, skills, and resources
necessary to implement accrual, as well as issues related to asset
identification and valuation, (2) issues that relate to accountability and
parliamentary control, and (3) ongoing challenges, including output
pricing, asset management, and the capital base. 

Transitional Issues
-------------------

Officials told us that although timing, skills, and resources to implement
accrual budgeting were initially considered problematic, they were
generally resolved without too much difficulty. According to a former
Treasury official, though the targeted transition period was considered
optimistic, all departments made the transition to accrual within the time
frame specified. In addition, though departments were not given additional
resources to fund the development of new accounting systems but instead
were expected to recoup the cost from efficiency gains, freeing
departments from the cumbersome regulations of the old cash process was
one such source of efficiency gain. In addition, the new integrated
accounting system substantially reduced processing and reconciliation
problems, thereby freeing resources for other purposes.

A major challenge throughout implementation was to ensure that the opening
balance sheet was as accurate as possible. The accuracy of the balance
sheet was particularly important given that it provided the foundation for
amounts, such as depreciation and capital charges, that under the new
regime were to be included in the budget. Since government entities were
previously less concerned with managing assets, the existing information
on both the ownership and valuation aspects of assets was inadequate.
Departments and auditors found it particularly difficult to ensure that
all properties were reported. Officials explained that there was a lot of
fine-tuning of the reported asset values in the early years of
implementation, but that the problem was substantially resolved after
several years of experience.

A key factor in the successful move to accrual budgeting was the strong
support both from the political leadership and within the bureaucracy.
Politicians' needs for better financial and managerial information
provided the impetus behind the passage of the Public Finance Act of 1989,
with decisionmakers committed to ensuring that the implementation was
successful. Once departments realized that performance management, and the
accompanying accrual framework, was not going away, momentum for its
implementation was established. Peer pressure was brought to bear, as
chief executives operating under 5-year contracts had an incentive to
ensure that they quickly and effectively transitioned to the new
environment. 

Officials also attributed implementation success to the adoption of
private sector accounting standards. Whereas in the past, budget officials
received special training in cash budgeting, now a larger pool of
potential employees exist who have already been educated in the common
accounting standards used in both the public and the private sectors. In
addition, managers were given more freedom to hire from this larger
available human resources pool. 

Parliamentary Accountability and Control 
-----------------------------------------

Ten years after implementing accrual budgeting, tension continues to exist
between accountability and control. At its core, the accrual-based
framework was designed to give more flexibility to managers in exchange
for more information to Parliament and the public. However, discussions
continued as to how much decision-making freedom to give managers. One
issue that illustrates the tension between managerial autonomy and
parliamentary control is the proposal that departments be able to retain
surpluses achieved through efficiencies and cost reductions. From a
managerial standpoint, being able to retain surpluses increases the
incentive to be more efficient, more innovative, and more results-
oriented. From the point of view of Parliament, retention of surpluses
undercuts one of the fundamental principles of public expenditure, i.e.,
that money is appropriated for specific purposes. While using its
efficiency gains to provide more of its own output may be desirable from a
department's point of view, it may not be in the collective interest for
the government to devote the department's efficiency gains to that output
because priorities may lie elsewhere. For example, there is no
governmentwide policy to reinvest savings in the same area where the
savings were made. Government reserves the right to invest departmental
savings in other high priority areas. Experts we interviewed admitted that
this continues to be a difficult area to resolve. 

Another area that illustrates the tension between parliamentary and
managerial control is capital, specifically the question of who should
decide the proper mix of capital. From a managerial standpoint,
depreciation measures the cost of resource consumption. However, providing
depreciation expense to departments in the form of cash is tantamount to
giving free rein to managers, who may elect to use the funding to finance
other activities in the short term. Under the cash system,
parliamentarians through their legislative authority to appropriate funds
could determine whether and when asset purchases could be made. Under the
new environment, they no longer play this role. 

Output pricing is another area that not only presents practical
implementation difficulties, but also has implications for parliamentary
control. Some officials in the legislative branch felt that the focus on
output instead of input controls might provide opportunities for
departments to mask data. This is because the new reporting framework does
not routinely provide information on the mix of input used to produce each
specific output. For example, social work services to children and young
persons is one output requiring an appropriation of almost NZ$190 million.
Although the output is defined by various performance standards, such as
the number of notifications investigated or the number of orders in force,
the appropriation documents provide no detail as to the mix of personnel,
overhead, or technology used to provide the output. Consequently, it can
be difficult to determine whether an output was achieved by extracting
efficiencies, or by running down and not replacing needed assets.
Furthermore, as departments redefine outputs over time, the lack of input
information makes it even more difficult to compare performance on a
consistent basis. In addition, output classes are inconsistent--some are
broad, whereas others are detailed--making meaningful comparisons within
and across departments challenging. While Parliament has tried to better
monitor performance and sometimes relied on auditors' reports, officials
cited difficulties in achieving optimal oversight over departments that
have been given a great degree of managerial discretion. 

Ongoing Implementation Challenges
---------------------------------

Issues related to output pricing, asset management, and the capital base
represent ongoing challenges to government officials. New Zealand's
accrual-based budgeting framework is premised on the ability of government
in its purchaser role to adequately assess the price and quality of
outputs. However, while pricing outputs for state-owned enterprises is
possible because private sector comparisons can be made, pricing outputs
for unique government services that have no comparable alternative in the
private sector continues to present a tremendous challenge. In instances
where prices could be derived, judging the quality of the output produced
presented additional challenges. For example, although it is possible to
accumulate the cost of policy advice across government for comparison
purposes, the quality and relevance of such advice is harder to evaluate.
It is thus difficult to judge when a price is right, when the price is too
high, or when the price is too low. 

Asset management was also cited as a difficult area. According to several
Treasury officials, the difficulty arose from the decision not to optimize
the asset base at the time of the switch to accrual budgeting. Because the
new framework assumed that departments started out with the capital
necessary to ensure sustainability of their activities, departments found
it difficult to argue for capital injections to purchase additional
assets, thus discouraging departments with legitimate capital needs from
seeking additional appropriations. Over the last several years, we were
told, major equity problems have arisen. Departments that were asset-rich
when the new system was implemented were able to maintain and even expand
their asset bases, thus delivering quality service. Asset-poor departments
have continued to run down their asset bases. Officials found that some
asset-rich departments have been able to install up-to-date computer
systems because they accumulated depreciation funding. In contrast, an
asset-poor department that could not accumulate much depreciation funding
did not have an adequate computer system and therefore no longer
maintained information on its caseload on-line. Officials also warned that
several departments were not able to accumulate adequate depreciation
expense to fund new assets, and therefore had continually run down their
assets and would require capital injections in the near future.

--------------------------------------
/Footnote1/-^Supply bills allow government agencies to continue operations
  until permanent appropriations have been made by Parliament. 
/Footnote2/-^The New Zealand framework differentiates between items
  controlled by departments and items administered by departments on
  behalf of the government. (See figure 11.)
/Footnote3/-^Starting with the fiscal year 1989-90 budget, New Zealand's
  fiscal year runs from July 1 to June 30. 
/Footnote4/-^As extensive reforms occurred to SOEs at about the same time,
  it is difficult to draw a clear distinction between the benefits of
  corporatizing--putting SOEs on a commercial basis and forcing them to
  compete with private sector entities--and switching to accrual budgeting
  and accounting.
/Footnote5/-^The Public Finance Act of 1977 established the Audit Office
  to provide independent information, assurance, and advice to Parliament.
  The office's current functions include performing and reporting on
  results of audits of financial statements and service performance
  information, and reporting on matters arising from audits generally. In
  addition, the Audit Office undertakes special audits regarding matters
  of concern identified by select committees, the public, or the Audit
  Office itself. 
/Footnote6/-^However, since appropriations cover noncash expenses such as
  depreciation, departments may carry cash balances.
/Footnote7/-^This statement does not provide estimates of commitments for
  social insurance, which operates on a pay-as-you-go basis out of general
  revenue.
/Footnote8/-^Better disclosure of contingent liabilities helped point out
  the risk involved with the provision of government guarantees.
  Currently, guarantees are not a material item on the government's
  balance sheet.
/Footnote9/-^The operating balance is an accrual measure of the results of
  the operations of the New Zealand government for a fiscal year. It is
  the difference between revenue, calculated on an accrual basis, and
  expenses, also calculated on an accrual basis. The accrual operating
  balance is derived through inclusion of transactions such as
  depreciation and revenue receivable. Although these transactions did not
  result in cash outlays or receipts, they were the results of current
  year's operations. 
/Footnote10/-^As noted previously, this does not include social insurance
  commitments.
/Footnote11/-^The government allowed departments flexibility to offer
  pension plans in wage negotiations, as long as they were defined-
  contribution plans.
/Footnote12/-^In New Zealand, decisions about individual asset purchases
  are made by the executive government and approved at an aggregate level
  by the legislature.
/Footnote13/-^According to Treasury officials, departments that did not
  efficiently and effectively replace assets could face operational
  difficulties, which could result in sanctions for their chief executives
  for poor performance. 
/Footnote14/-^New Zealand officials countered that information on the cash
  flows of each entity is published annually and can be extracted and
  collated by private sector analysts. 

UNITED KINGDOM
==============

The United Kingdom's shift to accrual reporting and budgeting has
progressed over several years, coinciding with a series of broader reform
efforts aimed at improving the nation's economic health and public
management regime. The United Kingdom's accrual framework, known as
Resource Accounting and Budgeting, applies commercial style accounting
practices to central government financial reporting and to budgeting.
Subject to Parliament's approval, resource budgeting is to be in effect
from financial year 2001-02. As currently proposed, resource accounts
consisting of five financial schedules prepared on an accrual basis are to
replace the traditional cash-based appropriation accounts and become the
main form of accountability to Parliament. Parliamentary approval for
departmental funding is expected to operate on a dual cash and accrual
basis.

Background

The United Kingdom is a unitary state composed of England, Scotland,
Wales, and Northern Ireland./Footnote1/ There are two main levels of
government--the central government and local authorities. The central
government has direct or indirect control over most government revenues
and spending, while local authorities are primarily responsible for
service delivery in education, housing, and social services. 

Governmental Structure
----------------------

The government is a parliamentary system, with a Parliament composed of
two chambers--the House of Lords and the House of Commons. The focus of
parliamentary control lies with the House of Commons, which is comprised
of approximately 659 elected members. It is responsible for the passage of
legislation and scrutiny of public administration, with sole legislative
responsibility for budget matters. The House of Lords has relatively
limited powers in the legislative process and virtually no power with
respect to budget matters. The government is headed by a Prime Minister,
who is the leader of the majority party in the House of Commons, and an
appointed cabinet of about 20 members, who are also members of Parliament.
A general election is held at least once every 5 years. 

Two political parties--the Labour Party and the Conservative Party--have
dominated British politics. The current Labour government, headed by Prime
Minister Tony Blair, was elected in 1997. Prior to Labour's taking power
in 1997, the Conservative Party had held power since 1979. 

The Budget Process
------------------

The governing political party effectively controls the entire budget
process. The Treasury serves as the primary control point for spending and
tax decisions with the Parliament playing only a limited role in the
budget process. The Parliament cannot increase the government's spending
proposals and, in practice, has limited ability to do anything other than
accept them.

The current Labour government recently modified the budget planning
process. Total spending is split into two categories that have separate
control mechanisms. The first category is subject to Departmental
Expenditure Limits, which are set for 3 years and, unlike the old process,
will generally not be reviewed annually. The second category, Annually-
Managed Expenditures (AME), consists of spending that is more difficult to
control. Its largest components include social security benefits,
interest, and local government expenditure. Spending covered by AME will
be subject to annual reviews and considered part of total spending for
purposes of achieving the government's fiscal goals. The budget also
includes an annual reserve that is intended more for emergency spending
than as a source of supplemental funds for departments. The new budget
framework also places a greater emphasis on distinguishing between current
and capital spending. 

The Economy and the Budget 
---------------------------

Over the past two decades, the United Kingdom has experienced periods of
deep recession and robust growth. After recovering from a deep recession
lasting from 1979 to 1981, the economy experienced sustained growth with
an annual average growth rate of more than 3 percent in real terms for
nearly a decade before dipping into a recession again between 1990 and
1992. The economy began to recover during the second half of 1992 and has
continued to expand since then. 

During the past two decades, changes in the United Kingdom's fiscal
position have closely followed the economic cycle./Footnote2/ From the mid-
1970s to the mid-1980s, the United Kingdom had large budget deficits.
Deficits gave way to surpluses during the 1980s expansion. Then, with the
onset of the recession in the early 1990s, deficits reemerged before
steadily declining in tandem with the sustained economic growth of the mid-
 to late 1990s. 

The United Kingdom's net public debt, as a percentage of GDP, has
fluctuated during the past two decades. The net debt to GDP ratio declined
from approximately 70 percent in 1970 to about 45 percent in 1979 before
increasing again in 1980. The net debt to GDP ratio declined again during
the 1980s before increasing again until the late 1990s. The trend of
increasing debt to GDP reversed itself, with net debt as a percentage of
GDP falling to about 42 percent in 1998 and projected to decrease further
to about 36 percent by 2003-04. 

Recent Reform Efforts
---------------------

Improving the efficiency and effectiveness of public sector performance
has been a high priority in the United Kingdom for over a decade. The
United Kingdom's early efforts to improve public sector financial
management were launched in 1982 with the Financial Management Initiative
that emphasized the devolution of responsibility for budget and financial
controls. The country continued to embark on a series of reforms
throughout the 1980s emphasizing improved performance management within
the public sector. 

Most recently, the Labour government has undertaken a series of reforms
aimed at improving the health of the economy and the effectiveness,
efficiency, and transparency of government activities. In June 1997, the
government launched a comprehensive assessment of all government spending
programs--both current and capital--with the aim of better aligning
programs with government priorities and generating ways of improving
efficiency and service quality. Additionally, as discussed below, the
government plans to adopt a form of accrual accounting and budgeting,
known as Resource Accounting and Budgeting (RAB), which was originally
proposed by the previous government. 

The Labour government also established a statutory basis for developing
fiscal policy with a new law requiring the government to issue a "Code for
Fiscal Stability." The purpose of the law is to increase the transparency
of fiscal policy decision-making and to enhance accountability by
requiring the government to present a fiscal strategy and meet certain
reporting requirements. Although the Code for Fiscal Stability provides a
general framework requiring that fiscal and debt management policy be
guided by five key principles--transparency, stability, responsibility,
fairness, and efficiency--it nevertheless allows the incumbent government
wide discretion in developing its specific strategy. 

The current Labour government's fiscal code establishes two rules: (1) the
"golden rule" which prohibits borrowing to finance current spending and
(2) the "sustainable investment rule" which requires that net public debt
as share of GDP be kept at a "stable and prudent" level. Both rules are to
be applied over the economic cycle, allowing for fiscal fluctuations based
on economic conditions. These fiscal rules are meant to work together. The
"golden rule" is intended to recognize explicitly the different economic
nature of current and capital spending and is designed to ensure control
of public finances while allowing deficit financing of capital investment,
net of depreciation and asset sales./Footnote3/ At the same time, the
"sustainable investment rule" recognizes that borrowing for public
investment must be constrained by the need to ensure a "prudent level" of
debt. 

Use of Accruals in Financial Management

Timeline: Progression of Use of Accruals
----------------------------------------

The United Kingdom has progressively extended the use of accrual
accounting (known as resource accounting) across government and is
currently aiming to have accrual budgeting fully implemented for fiscal
year 2001-02. Resource accounting applies commercial-style accrual
accounting to central government departments. Additionally, it includes a
framework for analyzing expenditures by departmental aims and objectives,
relating them to outputs where possible. Resource budgeting refers to the
planning, managing, and controlling of public expenditures, at both the
departmental and aggregate levels, based on resource accounting techniques
and information.

The then-Chancellor of the Exchequer launched the United Kingdom's move
toward resource accounting and budgeting in 1993 as part of his budget
proposals. In 1994, the Green Paper, Better Accounting for the Taxpayer's
Money, set out the potential benefits of implementing resource accounting
in departments and considered the case for adopting accruals for
budgeting. A 1995 White paper confirmed the government's commitment to use
resource accounting as the basis of public expenditure planning and
control (budgeting). However, changing the basis of Parliament's voting of
funds will require new legislation. A draft bill has been introduced for
consultation with the hope of having final legislation by summer 2000. 

Initial implementation efforts focused on developing the standards and
information systems necessary for financial statement reporting. One of
the first steps was determining appropriate reporting standards and
requirements. After consultation with other government departments and
other interested bodies, the Treasury produced a Resource Accounting
Manual (RAM) that sets out the standards and policies to be used to guide
the preparation of departmental resource accounts. The Financial Reporting
Advisory Board (FRAB)/Footnote4/ conducted a comprehensive review of and
eventually endorsed the RAM. The Board is expected to continue to review
the RAM and consider proposals for change based on experience, the
evolution of generally accepted accounting practices, and development of
policy aims with respect to RAB.

Over the past several years, departments have made progress in
implementing resource accounting. For purposes of testing the new systems,
the first resource accounts were to be produced for fiscal year 1998-99.
Although not to be published, the National Audit Office (NAO)/Footnote5/
was to audit these "dry run" accounts. Subject to departmental progress in
preparing their accounts, audits were to be concluded in October 1999. NAO
will advise the departments and through them the Treasury of their
findings. The first full set of published resource accounts is scheduled
for financial year 1999-2000. With a foundation in resource accounting,
Treasury turned its efforts toward implementing resource (accrual)
budgeting.

Factors Surrounding the Adoption of Accrual Budgeting
-----------------------------------------------------

Reform efforts--within the United Kingdom and across the international
community--set the stage for the United Kingdom's move to accrual
budgeting. From the start of the United Kingdom's performance reforms, it
became clear that it would be difficult to adequately assess "value for
money"/Footnote6/ under a cash-based system and attention turned to
developing an integrated financial system that would more effectively
support reform efforts by improving the quality and consistency of the
information provided to decisionmakers. The recognition that the cash-
based budget system was not fully reflecting the needs of performance
management was bolstered by the increasing use of accruals elsewhere in
the United Kingdom public sector and a general skepticism about the cash
system, which was viewed as allowing manipulation of spending across years
and creating disincentives for capital spending. Further, the movement of
other countries to accrual budgeting was described as helping to provide
United Kingdom officials "the courage" to undertake RAB. 

As an outgrowth of the United Kingdom's long-standing public sector reform
efforts aimed at achieving more efficient performance and better value for
money, RAB's design reflects the central government's concern about
improving performance measurement and the links between inputs and
outputs. As described by one Treasury official, RAB is about more than
changing the basis of calculating cost. It is as much about identifying
the costs of aims and objectives and a more systematic use of output and
performance measures which carries forward the Financial Management
Initiative of 1982./Footnote7/ The government's new fiscal framework,
especially its emphasis on distinguishing current and capital spending,
was also viewed as further paving the way for RAB and providing a conduit
to advance it not only as a "micromanagement" tool but as useful for
fiscal policy. 

The United Kingdom's Proposed Accrual Budgeting System 

The RAB framework involves both a shift to accrual-based measurement and
the linking of inputs to outputs (performance measurement). Both
components--the change to an accrual measurement basis and the move to
output-based reporting--are viewed as important to the design of RAB.

Structure of Appropriations
---------------------------

Under resource budgeting, resource accounts will replace appropriation
accounts/Footnote8/ and become the main form of accountability to
Parliament. As proposed, parliamentary approval for departmental funding
is to operate on a dual cash and "resource" basis. Each budget estimate
will include

o   several "requests for resources" which represent expenses on an
  accrual basis, including noncash amounts such as depreciation and a 6
  percent charge on net assets employed, and 

o   a single cash requirement, built up from the resource requests and
  representing an absolute limit on the withdrawals from the Consolidated
  Fund./Footnote9/ 

Thus, instead of cash alone being the budgetary measure, departments will
have a resource budget in accrual terms and an associated cash
requirement, known as the financing requirement. In comparison to the New
Zealand and Australia models, which provide cash to cover noncash amounts
such as depreciation, the United Kingdom's resource budget would treat
noncash items as "notional" entries, i.e., departments will not receive
cash to cover these amounts. Figure 14 shows, in general terms, the
reconciliation between the resource budget and the financing (cash)
requirement./Footnote10/ Similarly, overall planning totals will be the
government's Resource Control Total and an associated Total Financing
Requirement. While stressing that a number of issues, such as the precise
treatment of capital, were still unresolved at the time of our visit,
officials noted that a key objective in designing the resource budgeting
system was to concentrate attention on resources while continuing to
control cash.

Figure****Helvetica:x11****14:    Reconciliation of Resources to Financing
                                  Requirement

*****************

*****************

The resource accounts for departments will consist of five schedules,
including three that are similar to private sector statements, namely a
Balance Sheet, an Operating Cost Statement, and a Statement of Cash Flows.
The other two statements, which do not have direct private sector
equivalents, include (1) a Summary of Resource Outturn/Footnote11/ and (2)
a Statement of Resources by Departmental Aims and Objectives. The Summary
of Resource Outturn will serve as the statement for parliamentary control,
highlighting the request for resources and the net cash requirement that
are voted on by Parliament. It will provide reconciliation between
requests for resources and the consequential cash requirement. The
Statement of Resources by Departmental Aims and Objectives links resource
inputs to department aims and objectives. In addition, but outside the
accounts, a sixth statement--an Output and Performance Analysis--will show
achievement against departmental objectives, major outputs, and overall
efficiency of operations.

The use of resource accounts for budgeting is to be phased in over the
next several years. The first resource accounts will be published for the
fiscal year 1999-2000, and will be produced in parallel with the present
cash-based Supply Estimates and Appropriation Accounts. The Treasury,
subject to the approval of Parliament, then plans to implement resource-
based budgeting for 2001-02, replacing cash-based appropriation accounts. 

Treatment of Specific Budget Items
----------------------------------

At the time of our visit the Treasury was in the process of developing a
resource budgeting manual to serve as an operational guide for departments
in preparing their resource budgets. Because this manual was in the
development stage, officials and staff we spoke with stressed that some of
the implementation and control issues surrounding the treatment of certain
items were not fully resolved. However, officials stressed that
compatibility of accounting standards for use in the budget was and
continues to be given considerable attention. According to Treasury
officials, during the development phase, attempts were made to anticipate
the accounting standards' capacity to support resource budgeting. In cases
where the requirements of generally accepted accounting practices and the
parliamentary control process are in conflict, the manual states that
generally accepted accounting practices should be adapted accordingly. For
example, officials noted that in order to coincide with the budget process
the timing of asset valuations was adjusted. 

The following summarizes the proposed treatment of key budget items.

o   Public sector employee pensions: Under resource budgeting, each
  department will pay an actuarially derived contribution for annual
  employee pension costs to relevant pension schemes, resulting in an
  intragovernmental transfer. These pension contributions will be
  included in a department's request for resources and cash requirement.
  The centralized pension schemes receive these contributions from the
  departments and use them to make payments to current retirees. Thus, at
  the governmentwide level, the total financing requirement represents
  the total cash required for payments to current retirees in that year.
  If cash payments to current retirees exceed the departmental
  contributions, drawings are made from the Consolidation Fund to makeup
  the difference. 

For each pension scheme there will be a separate actuarial statement that
shows total pension liability and the level of annual contributions
(expressed as a percentage of pay) that departments need to make to meet
the liability. However, this actuarial amount is not recorded in the
pension funds' resource request or financing requirement. 

o   Capital: The purchase of new capital assets would require a cash
  appropriation for payments made in the fiscal year; this amount would
  be included in a department's financing requirement but would not be
  included in the resource budget. The annual cost of using capital,
  namely depreciation and a cost of capital charge,/Footnote12/ would be
  included in the request for resources as "notional" entries and would
  require a parliamentary vote but would not result in departments
  receiving cash. Thus, in comparison with the New Zealand model that
  provides cash to cover noncash amounts, such as depreciation and
  capital charges, with the expectation that departments will manage and
  use these funds to maintain their asset base, RAB was designed to help
  focus attention on the cost of capital use without significantly
  decentralizing cash and asset management. As shown in figure 14, under
  resource budgeting, the noncash amounts, such as depreciation, are
  backed out in order to get to the cash requirement. 

o   Inventories: Under resource budgeting, the cash requirement would
  include the payments estimated to be made during the fiscal year. The
  request for resources would include the amount of inventories estimated
  to be consumed during the fiscal year. 

o   Insurance, loans, and guarantees: These types of programs are limited
  in the United Kingdom and generally are outside the coverage of RAB.
  Loans made by departments to bodies not consolidated in their accounts
  will nonetheless be recognized as assets in resource accounts. The
  making or recovery of loans will be included in the cash requirement.
  Significant contingent liabilities are noted in the budget estimates
  and presented to Parliament and reported in notes to the accounts. 

o   Social Insurance: The National Insurance Fund, which covers
  unemployment, state retirement pensions, and part of the National
  Health Service, will not be covered by RAB. This fund is operated on a
  "pay-as-you-go" basis with the budget reflecting cash flows for the
  fiscal year. Any shortfall between collections and payments is paid out
  of Consolidated Fund revenues. 

o   Revenues: Under RAB, tax revenues will continue to be measured for
  the time being on a cash basis, primarily due to measurement
  difficulties and prohibitive implementation costs.

Aggregate Budget Measure
------------------------

At the time of our visit, there was still uncertainty about the link
between the RAB initiative and the measures focused on for fiscal policy.
Corresponding to the introduction of its new fiscal policy framework, the
Labour government introduced a new format for presenting fiscal policy
measures. The new format is intended to more readily allow the monitoring
and assessment of progress against the two fiscal rules described above--
the "golden rule" and the "sustainable investment rule." 

The main changes under the new format are to better distinguish current
and capital spending and to focus on a measure of budget balance that
excludes financial transactions. Under the new format the three principle
measures of public finances are as follows.

o   Surplus/deficit on current budget: Under the new format, current
  receipts less current spending will be used to judge whether the
  "golden rule" will be met over the economic cycle.

o   Public Sector Net Borrowing (PSNB): Under the new format, the
  Treasury has switched to PSNB as the main overall budget measure. Prior
  to 1998, the main surplus/deficit measure was the public sector net
  cash requirement (PSNCR), referred to at the time as the public sector
  borrowing requirement./Footnote13/ PSNB differs from PSNCR by excluding
  privatization proceeds and other financial transactions./Footnote14/ 

o   Public Sector Net Debt Ratio: Under the new format, total debt of the
  public sector (net of certain liquid assets) as a proportion of GDP is
  used to judge whether the government's "sustainable investment rule" is
  met. 

Although the interaction between the information provided under RAB and
these measures has not been fully resolved, some Treasury officials
speculated that the current budget surplus/deficit may be measured on an
accrual basis once resource budgeting is implemented. However, they noted
that a number of issues, such as the interaction of the RAB measure with
national income account reporting, were still under discussion.

Key Differences Between Cash Versus Resource Budgeting
------------------------------------------------------

As noted above, the first resource budget is expected to replace
appropriation accounts in fiscal year 2000-01. However, based on
experience to date with resource accounting, the implications of resource
budgeting are expected to be greatest for capital intensive departments,
such as the Ministry of Defense, while other less capital-intensive
departments, such as the Home Office, were not anticipating significant
changes resulting from the budgetary change to accrual-based measurement.

Views on Implications for Decision-making

In introducing RAB, the Treasury asserted significant benefits for fiscal
policy and managerial decision-making including

o   making decisionmakers focus more on resources consumed and not just
  the cash spent,

o   treating capital and current expenditure in a way that better
  reflects their different economic significance, and 

o   encouraging a greater emphasis on outputs and the achievement of aims
  and objectives.

According to the Treasury, RAB is expected to improve decision-making at
both the governmentwide and the departmental level by ensuring that the
"full economic costs of government activities are measured properly"
through the inclusion of costs such as capital consumption and by matching
costs to the right time period. /Footnote15/ Another significant benefit
credited to RAB is the improved integration of the full cycle of planning,
budgeting, monitoring, and reporting./Footnote16/ Along these lines, a key
official we spoke with stressed RAB's alignment of the basis of budgetary
measurement with financial reporting standards that mirror private sector
generally accepted accounting practices as critical to improving the
transparency, consistency, and credibility of information and incentives
for decision-making. Officials we spoke with stressed that they viewed
having the ex-post financial reporting system and the ex-ante budgeting
system on the same measurement basis as valuable for facilitating decision-
making.

From a departmental management perspective, resource budgeting is
anticipated to provide managers with better management information as well
as improve the incentives to manage resources more effectively. Resource
budgeting was viewed as particularly beneficial in two areas: improved
asset management and better linkages between resources and outputs.
Overall, the information and incentives under resource budgeting were
described as having the potential to enable both department managers and
policymakers to make better decisions about how best to use resources. For
example, officials from the Ministry of Defence credited RAB with
improving understanding of asset base and inventory levels, noting that
these issues are being taken more seriously now that they will be directly
linked to the budget. However, some we spoke with pointed out that
resource budgeting would have the greatest implications for capital-
intensive departments and would likely have significantly less impact on
other departments. In addition, some of the benefits of RAB may result
from improved financial accounting and linkages of resources to outputs
rather than the change of budgetary measurement basis from cash to accrual. 

Proponents also argue that resource budgeting will help ensure that the
planning framework delivers the government's fiscal policy objectives.
First, using departmental resource accounts to underpin resource
allocation decisions at the aggregate levels is viewed as helping to
ensure that allocations among the government's competing priorities are
made in consideration of full cost information. Further, some officials
suggested that resource budgeting will encourage a wider breadth of
questions with respect to sustainability and efficiency than previously
considered under the cash system. The Treasury noted that the government
collectively will benefit because, what is good for departmental
management is also good for the government as a whole. Finally, resource
budgeting is viewed by some as supporting the government's investment
objectives by spreading the cost of capital over its useful life and by
clarifying the opportunity costs associated with holding capital through
capital charging. 

The direct implications of resource budgeting on parliamentary decision-
making, however, are hard to discern. Parliamentary Committee Reports,
while expressing some caution, articulated support for RAB noting the
anticipated benefit of increased information for parliamentary decision-
making. As expressed by the Clerk of the House, "the House, in general,
and departmental select committees in particular, will welcome the greater
range of information which will be provided in resource-based documents."
However, despite these perceived benefits of improved information, both
parliamentary staff and academics cautioned that the extent to which
resource budgeting will influence parliamentary decision-making must be
considered in the context of the Parliament's limited role in the budget
process. As previously noted, Parliament has historically had a limited
role in the budget decision-making process. Nevertheless, parliamentary
staff generally agreed with others that Parliament may benefit from RAB
indirectly through improved management of departments and increased
information for oversight. 

Implementation Issues

At the time of our visit, Treasury and Parliament were beginning to
address numerous implementation and control issues raised by the
introduction of resource budgeting. Officials we spoke with acknowledged
that because the RAB initiative was still in the early stages, some
implementation and control issues remained unresolved. Some of the key
issues surrounding the introduction of resource budgeting included the
following.

Parliamentary Accountability and Control
----------------------------------------

The introduction of resource budgeting has raised concerns about the
implications for parliamentary accountability and control. In particular,
parliamentary committees have expressed concerns that the replacement of
appropriation accounts may result in reduced understanding and weaken
parliamentary oversight. In July 1998, the Committee of Public Accounts
noted that a "main concern is that the current bases for voting
Supply/Footnote17/ and holding departments accountable should not be
discontinued until it is clear that there are equally effective or better
arrangements to replace them."

Parliamentary control concerns about resource budgeting have been
intensified, at least in part, by the heavy reliance on professional
judgment involved with the use of accrual-based measurement and other
unresolved issues dealing with implementation specifics. A general concern
was expressed that the movement towards accrual-based measurement will
introduce a greater degree of professional judgment, and thus uncertainty,
into the budgetary process than is presently the case with the cash-based
system. Both parliamentary staff and NAO officials expressed concerns
about the added level of complexity associated with accrual-based
reporting. Some suggested that this added complexity could lead to the
potential for manipulation. For example, whether a transaction is recorded
in the budget will not simply be based on the timing of cash payment, but
rather will depend on professional judgments about the timing of the
consumption of resources and other underlying assumptions. Further, some
issues surrounding how new assumptions will be integrated into the budget
process have not been fully resolved. For example, since budget amounts
for departments are to be fixed for a 3-year period under the new fiscal
framework, how will changes in assumptions surrounding depreciation and
capital charges be handled in order to prevent departmental windfalls
(excess funding)? Also parliamentary staff and NAO officials expressed
concern about the ability to adequately track the linkages between the
request for resources and the underlying cash requirement. 

Transitional Issues
-------------------

The government is taking a number of steps to smooth the transition to
resource budgeting and to help mitigate concerns. Officials and program
managers stressed that ensuring cultural change and training is critical
to the success of resource budgeting. Treasury officials told us that
numerous training efforts are being undertaken to support the
implementation of RAB. Much of this training has been decentralized, with
Treasury taking on a facilitating role while departments have
responsibility for designing and implementing their own training programs.
Additional implementation issues have focused on how to structure account
presentations and voting procedures to provide sufficient assurance about
cash control while focusing decision-making on resources. At the time of
our visit, there were continuing efforts to clarify the treatment of more
technical accounting issues in the budget context. Some Treasury
officials, however, noted that a number of issues might not come to light
until resource budgeting is underway.

In part because of these implementation challenges, the appropriate
implementation timetable continues to be a source of debate. One Treasury
official stressed that the goal has been to make the timetable long enough
to allow for sufficient groundwork but short enough so that the initiative
is taken seriously and the momentum is maintained. Some suggested that
extending the dual running of the old cash system and the new resource-
based system would allow time for increased understanding of the
implications for parliamentary control and oversight. The Treasury,
however, opposed additional dual running of the two systems, testifying
that doing so would be extremely costly and would undermine incentives to
move to the new system. To help allay fears the Treasury has developed a
series of "trigger points" to assess department progress./Footnote18/
Departmental implementation concerns to date have focused on system and
staff capacity.

NAO has been, and will continue to be, involved with monitoring department
progress. In 1997 and 1998, NAO conducted surveys of departments'
preparedness that reviewed, among other things, departments' accounting
systems and policies and the extent of progress made on preparing opening
balance sheets. NAO then found that while the majority of departments had
made considerable progress some still had significant work to do. 

During the first half of 1999, as part of trigger point 2, NAO conducted
an audit of departments' opening balance sheets as of April 1, 1998, and a
further assessment of departments' systems. They found that, in the main,
balance sheets were reasonably complete, although they also found errors
and omissions of varying size and significance. On systems, further
progress had been made but some departments still have to develop fully
certain elements necessary to meet all requirements. In NAO's view, the
first full indication of departments' preparedness will be the audit
findings on the 1998-1999 dry run accounts.

--------------------------------------
/Footnote1/-^The government has devolved powers to Scotland, Wales, and
  Northern Ireland. 
/Footnote2/-^Budget Surplus: Experiences of Other Nations and Implications
  for the United States (GAO/AIMD-00-23, November 2, 1999) and Deficit
  Reduction: Experiences of Other Nations (GAO/AIMD-95-30, December 13,
  1994).
/Footnote3/-^The government defines investment as "physical investment and
  grants in support of capital spending by private sector." See Fiscal
  Policy: current and capital spending, HM Treasury (United Kingdom),
  1998, p. 7 fn. 2.
/Footnote4/-^Although the legislative authority to set public sector
  accounting standards lies with the Treasury, FRAB was established, on
  the advice of Parliament, to provide the Treasury with independent
  advice on developing and applying financial reporting principles and
  standards to the central government.
/Footnote5/-^NAO was established in 1983 to provide independent
  information, assurance, and advice to Parliament. NAO, which employs
  about 750 staff, is headed by the Comptroller and Auditor General. NAO
  carries out two main types of work: (1) financial audits that certify
  the accounts and include examining the regularity and propriety of
  government expenditure and addressing the risks to financial control and
  accountability and (2) value for money audits that review the economy,
  efficiency, and effectiveness of publicly funded programs, projects, and
  activities. 
/Footnote6/-^"Value for Money" refers to the economy, efficiency, and
  effectiveness of publicly funded programs, projects, and activities. 
/Footnote7/-^The Financial Management Initiative of 1982 emphasized the
  need for managers at all levels to have clearly defined objectives,
  responsibility for the best use of resources, and information
  particularly about costs and the achievement of objectives.
/Footnote8/-^In the United Kingdom system, an appropriation account is an
  end of the year account that compares amounts authorized by Parliament
  with actual cash payments made and receipts collected and explains any
  substantial differences. One account is prepared for each vote. A vote
  is taken to provide funds for each individual "supply estimate"--a
  statement presented to the House of Commons of the estimated expenditure
  of a department. 
/Footnote9/-^The Consolidated Fund is the account to which tax revenues
  and other current receipts not specifically directed elsewhere are held
  and from which payments for the largest part of central government
  expenditure are made. 
/Footnote10/-^The financing requirement refers to the net cash
  implications of a department's resource budget. It is the cash limit
  that will apply to departmental spending. 
/Footnote11/-^The term "outturn" refers to actual expenditure and income. 
/Footnote12/-^The cost of capital charge is a charge on an entity's total
  net assets.
/Footnote13/-^PSNCR includes receipts and expenditures at all levels of
  government, including privatization proceeds, and is similar to the
  United States' unified budget. 
/Footnote14/-^Other financial transactions include loans made by the
  public sector and some other adjustments which reflect the precise
  timing of payments.
/Footnote15/-^Resource Accounting and Budgeting: A Short Guide to the
  Financial Reforms, Her Majesty's Treasury, January 1998.
/Footnote16/-^The Green Paper notes that "the consistency of departments'
  internal budgeting systems with the overall system of budgetary
  allocation and control within the government is a key objective." 
/Footnote17/-^Voting supply refers to voting the budget.
/Footnote18/-^The three "trigger points" identified by the government are
  as follows: (1) stage one approval--survey of departments' progress
  towards developing and implementing systems and policies to support
  resource accounting, (2) assessment of departments' opening balance
  sheets for 1999-2000, and (3) NAO's audit of departments' dry-run 1998-
  99 resource accounts. 

GAO CONTACTS AND STAFF ACKNOWLEDGEMENTS
=======================================

GAO Contacts

Christine E. Bonham, Assistant Director (202) 512-9576
Elizabeth A. McClarin, Evaluator-in-Charge (202) 512-5059

Acknowledgements

In addition to those named above, Tuyet Quan Thai and Bill J. Keller made
significant contributions to this report.

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