Budget Issues: Accrual Budgeting Useful in Certain Areas but Does
Not Provide Sufficient Information for Reporting on Our Nation's 
Longer-Term Fiscal Challenge (20-DEC-07, GAO-08-206).		 
                                                                 
The federal government's financial condition and fiscal outlook  
have deteriorated dramatically since 2000. The federal budget has
gone from surplus to deficit and the nation's major reported	 
long-term fiscal exposures--a wide range of programs,		 
responsibilities, and activities that either explicitly or	 
implicitly commit the government to future spending--have more	 
than doubled. Current budget processes and measurements do not	 
fully recognize these fiscal exposures until payments are made.  
Increased information and better incentives to address the	 
long-term consequences of today's policy decisions can help put  
our nation on a more sound fiscal footing. Given its interest in 
accurate and timely information on the U.S. fiscal condition, the
Senate Committee on the Budget asked us to update our study of	 
other nations' experiences with accrual budgeting and look at	 
other ways countries have increased attention to their long-term 
fiscal challenges.						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-08-206 					        
    ACCNO:   A79130						        
  TITLE:     Budget Issues: Accrual Budgeting Useful in Certain Areas 
but Does Not Provide Sufficient Information for Reporting on Our 
Nation's Longer-Term Fiscal Challenge				 
     DATE:   12/20/2007 
  SUBJECT:   Accrual basis accounting				 
	     Budget activities					 
	     Budget allowances					 
	     Budget amendments					 
	     Budget apportionment				 
	     Budget deficit					 
	     Budget obligations 				 
	     Budgets						 
	     Deficit reduction					 
	     Financial management				 
	     Policy evaluation					 
	     Strategic planning 				 

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GAO-08-206

   

     * [1]Results in Brief
     * [2]Background

          * [3]Cash and Accrual Measures of the Government's Annual Fiscal
            Condition

     * [4]Although Certain OECD Countries Continue to Use Accrual Budgeting,
       Objectives and Approaches Vary Significantly

          * [5]Accrual Budgeting Continues to Be Used in the Six Countries
            Studied but Two Did Not Expand Their Use as Previously
            Anticipated
          * [6]Most Countries Use Accruals Primarily to Increase Transparency
            and Improve Government Performance

               * [7]Australia and New Zealand
               * [8]The Netherlands
               * [9]The United Kingdom

          * [10]Some Countries Use Accrual Measures Selectively in Areas
            Where It Enhances Transparency of the Government's Future Cash
            Requirements

               * [11]Iceland
               * [12]Canada

          * [13]Cash Information Remains Important, Particularly for
            Monitoring a Country's Fiscal Position
          * [14]Several Other OECD Countries Have Considered Accrual
            Budgeting since 2000 but Reached Different Decisions

     * [15]Countries Faced a Number of Common Challenges Inherent to Accrual
       Reporting That Led to Some Changes in Their Approach

          * [16]Countries Have Generally Addressed Challenges Related to
            Developing Accounting Standards to Be Used in the Budget,
            Including Asset Identification and Valuation
          * [17]Developing Reliable Financial Data Is Seen as a Prerequisite
            to Accrual Budgeting in Some Countries
          * [18]Volatility in Aggregate Accrual Measures Can Lead to Use of
            More Cash-Like Measures
          * [19]Complexity of Accrual-Based Accounting and Use of Cash-Based
            Fiscal Targets Makes It Difficult for Policymakers to Focus on
            Accrual Measures
          * [20]Concerns about Management and Oversight of Noncash Expenses
            Can Lead to Increased Use of Cash Controls
          * [21]Some Governments Have Had to Address Parliamentary Concerns

     * [22]Accrual Cost Information Helped Inform Some Debates That Led to
       Improvements in Fiscal Condition

          * [23]Accrual Budgeting May Provide Better Cost Information than
            Cash Budgeting for Resource Allocation Decisions
          * [24]Accrual Budgeting Attributed with Helping to Control or
            Manage Certain Long-Term Commitments

     * [25]Countries Use Other Methods to Increase Awareness of Greatest
       Long-Term Fiscal Challenges

          * [26]Aging-Related Expenditures Are Major Drivers of Long-Term
            Fiscal Challenges in Other Countries
          * [27]Long-Term Fiscal Sustainability Reports Used by Many
            Countries to Raise Awareness of Long-Term Fiscal Challenges
          * [28]Several Common Measures Are Used to Assess Fiscal
            Sustainability
          * [29]Reports Stem from Law and Political Commitments
          * [30]Selection of Time Horizon Is Important
          * [31]Countries Use Sensitivity Analysis to Deal with Uncertainty
          * [32]In Some Countries, There Are Indications That the Long-Term
            Report Is Affecting Nearer-Term Decisions

     * [33]Although Accrual Budgeting Can Help in Certain Areas, It Does Not
       Provide Sufficient Information to Understand Longer-Term Fiscal
       Sustainability Issues
     * [34]Conclusions
     * [35]Matter for Congressional Consideration
     * [36]GAO Contact
     * [37]Acknowledgments
     * [38]GAO's Mission
     * [39]Obtaining Copies of GAO Reports and Testimony

          * [40]Order by Mail or Phone

     * [41]To Report Fraud, Waste, and Abuse in Federal Programs
     * [42]Congressional Relations
     * [43]Public Affairs

Report to the Committee on the Budget, U.S. Senate

United States Government Accountability Office

GAO

December 2007

BUDGET ISSUES

Accrual Budgeting Useful in Certain Areas but Does Not Provide Sufficient
Information for Reporting on Our Nation's Longer-Term Fiscal Challenge

GAO-08-206

Contents

Letter 1

[44]Results in Brief 4
[45]Background 6
[46]Although Certain OECD Countries Continue to Use Accrual Budgeting,
Objectives and Approaches Vary Significantly 14
[47]Countries Faced a Number of Common Challenges Inherent to Accrual
Reporting That Led to Some Changes in Their Approach 21
[48]Accrual Cost Information Helped Inform Some Debates That Led to
Improvements in Fiscal Condition 30
[49]Countries Use Other Methods to Increase Awareness of Greatest
Long-Term Fiscal Challenges 33
[50]Although Accrual Budgeting Can Help in Certain Areas, It Does Not
Provide Sufficient Information to Understand Longer-Term Fiscal
Sustainability Issues 41
[51]Conclusions 43
[52]Matter for Congressional Consideration 44
[53]Appendix I Objectives, Scope, and Methodology 45
[54]Appendix II GAO Contact and Staff Acknowledgments 47

Tables

[55]Table 1: Major Reported Fiscal Exposures 12
[56]Table 2: Common Fiscal Indicators Used in Other Countries 37

Figures

[57]Figure 1: Cash and Accrual Measures of Annual Fiscal Position 9
[58]Figure 2: Unified Surpluses and Deficits as a Share of GDP under
Alternative Fiscal Policy Simulations 13
[59]Figure 3: Range of Accrual Budgeting Use 16

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Abbreviations

EU European Union
GAGAS Generally Accepted Government Auditing Standards
GDP gross domestic product
IPSAS International Public Sector Accounting Standards
OBEGAL Operating Balance Excluding Gains and Losses
OBERAC Operating Balance Excluding Revaluations and Accounting Changes
OECD Organisation for Economic Co-operation and Development
PBGC Pension Benefit Guaranty Corporation
SGP Stability and Growth Pact

United States Government Accountability Office
Washington, DC 20548

December 20, 2007

The Honorable Kent Conrad
Chairman
The Honorable Judd Gregg
Ranking Member
Committee on the Budget
United States Senate

The federal government's current financial condition and long-term fiscal
outlook present enormous challenges to the nation's ability to respond to
emerging forces reshaping American society, the United States' place in
the world, and the future role of the federal government. Unfortunately,
the federal government's financial condition and fiscal outlook are worse
than many may understand. In fact, the nation's fiscal condition has
deteriorated dramatically since 2000. The federal budget has gone from
surplus to deficit and the nation's major reported long-term fiscal
exposures--a wide range of programs, responsibilities, and activities that
either explicitly or implicitly commit the government to future
spending--have more than doubled. Current budget processes and
measurements do not fully recognize many of these fiscal exposures until
payments are made. Increased information and better incentives to address
the longer-term budgetary consequences of today's policy decisions can
help put our nation on a more sound fiscal footing.

In 2000, in response to interest in whether accrual budgeting--or the
recording of budgetary costs based on financial accounting concepts--would
improve budget recognition of certain long-term commitments [60]1 and so
encourage action to address them, we looked at the use of accrual
budgeting in Australia, Iceland, New Zealand, and the United Kingdom.
[61]2 We also looked at two other countries--Canada and the
Netherlands--that used accrual budgeting more selectively at that time and
were considering expanding the use of accrual budgeting. We reported that
these countries had adopted accrual budgeting more as part of broader
public management reforms to increase transparency and improve government
performance rather than as a way of increasing awareness of their
longer-term fiscal challenges. None used accrual budgeting for social
insurance programs. [62]3

1In 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 unless noted.

2GAO, Accrual Budgeting: Experiences of Other Nations and Implications for
the United States, [63]GAO/AIMD-00-57 (Washington, D.C.: Feb. 18, 2000).

We concluded that the current cash- and obligation-based budget [76]4 in
the United States provides equal or better control than full accrual
budgeting, but that the United States should consider expanding the use of
accrual measurement in the budget to certain areas where it would enhance
up-front control, namely federal employee pensions and retiree health,
insurance, and environmental liabilities. [77]5 For these programs,
accrual measurement would move budgetary recognition earlier to when
benefits are earned or the insured event occurs. However, for most other
activities there is not a significant difference between cash and accrual
measures. Furthermore, the up-front funding requirement under an
obligation-based budget provides policymakers greater control over capital
investment.

Since our 2000 report, these nations have not only gained additional
experience with accrual budgeting but also have begun using other
measures, analyses, and reporting to improve the understanding of broader
long-term fiscal sustainability issues. Given your interest in the
importance of accurate and timely information on the U.S. fiscal position,
you asked us to update our report on the experiences of these countries
and look at other ways countries have increased attention to their
longer-term fiscal challenges. Reviewing the experience of other countries
with accrual budgeting and fiscal sustainability reporting may identify
some strategies for focusing more attention on the long-term budgetary
implications of the U.S. federal government's current programs and
policies.

3In this report, social insurance programs are generally defined as
government programs intended to protect households or individuals against
certain social risks including loss of income. These programs typically
require payment by the participant (or another party on their behalf) of
contributions through payroll taxes or premiums. Social insurance benefits
are generally viewed as transfer payments and recorded in the budget as
benefits due and payable (accrual basis) or when benefits are paid (cash
basis). Transfer payments are benefits provided without requiring the
recipient to provide current or future goods or services of equivalent
value in return.

4In the United States, federal agencies are required to have authority to
enter into obligations to make outlays of government funds. Obligations
and outlays are usually measured on a cash basis, so we generally refer to
the U.S. federal budget as "cash based." See the background section for
more information.

5For some areas, such as federal credit programs and some federal employee
pension benefits, the U.S. budget already records outlays on an accrual
basis rather than a cash basis in order to recognize the full cost of the
government's commitment up front when the commitment is made.

Specifically, this report examines:

1. Where, how, and why is accrual budgeting used in select Organisation 
for Economic Co-operation and Development (OECD)[Footnote 6] countries 
and how has it changed since 2000? 

2. What challenges and limitations have been discovered in the use of 
accrual budgeting and how have select OECD countries responded to them? 

3. What do select OECD countries perceive the effect of accrual 
budgeting to have been on policy debates, program management, and the 
allocation of resources? 

4. Has accrual budgeting been used to increase awareness of long-term 
fiscal challenges and, if not, what is used instead? 

5. What does this and other GAO work tell us about where and how the 
increased use of accrual concepts in the budget would be useful and 
about ways to increase recognition of the long-term implications of 
today's policy decisions? 

We focused primarily on the six countries in our 2000 report:

* Australia, 

* Canada, 

* Iceland, 

* the Netherlands, 

* New Zealand, and: 

* the United Kingdom.

We also did a limited review of two other nations--Denmark and
Switzerland--that recently expanded the use of accrual budgeting and two
countries--Norway and Sweden--that considered accrual budgeting but
decided against it.

6The OECD currently consists of 30 member states that share a commitment
to democratic government and the market economy.

Any analysis of budget processes, measurements, and concepts in other
nations must recognize that the role played by legislative bodies in a
parliamentary system of government is quite different than the role played
by the Congress of the United States, especially in the process of
resource allocation. All countries in our study that have adopted accruals
have parliamentary systems in which the government is formed by the
political party, or coalition of parties, that have the support of a
majority of Parliament. Many important decisions that are debated during
the annual budget and appropriations process in the Congress of the United
States occur in case study countries before the budget is presented to
Parliament for approval. The Parliaments in the countries we studied
regularly enact the government's budget without amendment; failure to do
so may be viewed as a lack of confidence in the government. This
difference is likely to influence perspectives on the trade-offs
associated with the use of accrual budgeting, particularly in terms of
accountability and legislative control.

The work on this report was done from June 2007 through December 2007 in
accordance with Generally Accepted Government Auditing Standards (GAGAS).
Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe that
the evidence obtained provides a reasonable basis for our findings and
conclusions based on our audit objectives.

Results in Brief

Accrual budgeting continues to be used to some extent in all six countries
reviewed in 2000. The six countries have taken different approaches in the
design of their accrual-based budgets, and all continue to use cash
information particularly for evaluating the overall fiscal condition.
Since 2000, more OECD countries have expanded the use of accrual
measurement in the budget, including Denmark and Switzerland. However, two
countries in our study--Canada and the Netherlands--which had considered
broader expansions of accrual budgeting, have thus far made only limited
changes. Two other countries--Norway and Sweden--also considered adopting
accrual budgeting in recent years but decided against it, primarily
because they believed the cash budget provides for better control,
particularly over capital investment.

When significantly expanding the use of accrual budgeting, there are
several common transitional challenges countries initially faced including
developing accounting standards for the budget and deciding what assets to
value and how to value them. Countries tended to work through these issues
over time. However, a number of implementation challenges cited in our
2000 report still exist. These challenges illustrate the inherent
complexity of using accrual-based measures for managing a nation's
resources. For example, accrual-based measures experience volatility due
to changes in the value of assets and liabilities or changes in
assumptions (e.g., interest rates, inflation, and productivity) used to
estimate future payments whether or not there has been a change in the
underlying fiscal stance. Management and oversight of noncash expenses
[78]7 were also cited as challenges. These challenges have led some
countries to modify their approaches to accrual budgeting and to continue
a reliance on cash-based measures for broad fiscal policy making.

Despite these challenges, officials in many of the countries in our 2000
report believe that accrual-based cost information provides better
information on the cost of performance than cash-based measures. Accrual
budgeting, which recognizes resources as they are used to produce goods
and services, provides the full cost of all programs and may allow for
better comparisons between different methods of delivering government
services. Therefore, accrual budgeting is expected to help program
managers achieve efficiencies and better allocate resources. Several
countries cited examples of where the provision of accrual-based cost
information helped highlight the full cost of programs, such as government
employee pensions and insurance, that were ultimately reformed. Although
officials said that reform might have occurred eventually, they believe
the accrual-based cost information helped spur action.

Accrual budgeting is not used by the countries in our study for
recognizing nations' longer-term fiscal challenges that are driven
primarily by public pension and health care programs (social insurance)
because, like the United States, the countries in our study do not
consider future social insurance benefit payments to be explicit
liabilities. Instead, many of these other countries have prepared or are
preparing reports assessing fiscal sustainability of their nation's
finances. The goal of these reports is to increase public awareness and
understanding of the long-term fiscal outlook in light of escalating
health care cost growth and population aging; to stimulate public and
policy debates; and to help policymakers make informed decisions. The
countries used several common measures, such as cash-flow measures of
future revenue and spending and summary measures of fiscal imbalance and
fiscal gaps, to assess fiscal sustainability. Each measure provides a
different perspective on the nation's long-term financing and each measure
has its limitations. Therefore, most countries use more than one measure
to assess fiscal sustainability.

7Noncash expenses are expenses related to services provided but not paid
during the year, such as depreciation.

Our study of these countries and our own work confirms the need for better
information to make trade-offs between individual programs and to increase
attention on longer-term fiscal challenges. Despite the challenges that
exist in estimating accrual-based cost information, it may be preferable
to be approximately right than exactly wrong. The selective use of accrual
budgeting in areas where it would enhance up-front control of future cash
resources would put programs on a more level playing field and be
beneficial. However, to improve the understanding of the broader long-term
fiscal challenges, additional measures, analyses, and reporting, including
fiscal sustainability reporting, are needed.

As the Comptroller General has said before, our nation is on an imprudent
and unsustainable path. Continuing on our current fiscal path would
gradually erode, if not suddenly damage, our economy, our standard of
living, and ultimately even our domestic tranquility and our national
security. Although no change in measurement or reporting can replace
substantive action to meet our longer-term fiscal challenge, we believe
that increasing the use of accrual-based cost information for budget
decisions involving both existing and proposed programs that require
significant future cash resources could facilitate consideration of
competing demands. At the same time a fiscal sustainability report would
provide both the nation's citizens and policymakers with a comprehensive
picture of the long-term fiscal condition of the government as a whole.

Background

The U.S. federal budget [79]8 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. The budget process helps
highlight for policymakers and the public the overall "cost" of
government. Since the budget process also 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 term "cost" has different meanings in the
budget and financial statements. In the budget, the term "cost" generally
refers to the amount of cash needed during the period. In the financial
statements, the term "cost" means the amount of resources used to produce
goods or deliver services during the period regardless of when cash is
used. Therefore, one goal of accrual budgeting is to report the "full
cost" of government services provided during the year. [80]9 The different
methods of reporting (e.g., cash, obligations, or accrual) represent much
more than technical means of cost measurement. They reflect fundamental
choices about the information and incentives provided by the budget.

8For this report, the "federal budget" is used broadly to refer to the
planning and debate during the federal budget process by both the
executive and legislative branches. For an overview of the federal budget
process, see GAO, A Glossary of Terms Used in the Federal Budget Process,
[64]GAO-05-734SP (Washington, D.C.: September 2005).

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 being
increased. In comparison, obligation-based budgeting--which is used in the
U.S. federal government--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.
Obligation-based budgeting provides an additional level of control over
pure cash budgeting by requiring that federal agencies have statutory
authority to enter into obligations to make outlays of government funds.
With limited exceptions, the amounts to be obligated are measured on a
cash or cash-equivalent basis. Therefore, we generally refer to the U.S.
federal budget as "cash based." [81]10

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 concepts in financial accounting standards. Thus,
accrual-based budgeting generally provides information similar to that
found in a private sector operating statement.

9In this report, the term "full cost" is used in the financial reporting
sense unless otherwise noted.

10For a discussion of the methods for tracking funds in the federal
government, see [65]GAO-05-734SP at app. III, 120-3.

Choices about the appropriate method of budget reporting are complicated
by the multiplicity of the budget's uses and users, including policymakers
and managers. The federal budget is simultaneously asked to provide full
information and appropriate incentives for resource allocation, control
over cash, recognition of future commitments, and the monitoring of
performance. Given these 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
full cash cost at the time the decision is made but assessing performance
and its cost is generally best supported by accrual-based cost
information, which recognizes resources as they are used to produce goods
and services. The up-front funding requirement under an obligation-based
budget helps ensure policymakers' 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 the necessary trade-offs, the method of budget
reporting should be selected to meet the primary decision-making and
accountability needs of a governmental system while balancing the needs of
multiple users.

Cash and Accrual Measures of the Government's Annual Fiscal Condition

The federal government reports both cash and accrual measures of its
current finances. The key focus of the policy debate is the unified budget
deficit/surplus. With limited exceptions, [82]11 the unified budget
deficit/surplus is the difference between cash receipts and cash othe
government as a whole including any Social Security surplus. [83]12 The
second measure, the government's net operating cost, is the amount bywhich
costs--as reported on an accrual basis--exceed revenue and is reported in
the federal government's financial statements. [84]1313 Figure 1 showthe
cash and accrual measures for fiscal years 2000 mount bywhich costs--as
reported on an accrual basis--exceed revenue and is reported in the
federal government's financial statements. Figure 1 showthe cash and
accrual measures for fiscal years 2000 to 2007.

11The budget surplus/deficit includes the outlays for credit programs and
certain interest payments measured on an accrual basis. Federal agencies
record outlays on an accrual basis for several other items, including some
federal employee pensions; however, these outlays do not affect the
unified budget deficit because the outlays are intragovernmental--paid by
one agency to another.

12The unified budget is a comprehensive measure of all federal activities
both on-budget and off-budget. The on-budget deficit includes all
budgetary accounts other than those designated by law as off-budget. The
off-budget accounts are the Postal Service and Social Security trust
funds. Because the unified deficit is compatible with the accrual deficit
that also includes both on- and off-budget accounts, we focus on the
unified budget number.

Figure 1: Cash and Accrual Measures of Annual Fiscal Position Figure 1:
Cash and Accrual Measures of Annual Fiscal Position

Note: Data from the Financial Reports of the United States Government. The
fiscal year 2005 accrual results included a significant negative actuarial
adjustment, and 2006 included a significant positive adjustment, primarily
due to changes in interest rate assumptions used to estimate the veterans
compensation liability.

The cash and accrual results are based on the same underlying
activities--the differences arise due to the timing of when the costs of
certain activities are recognized. As explained earlier, for the
cash-based budget deficit, costs are recorded when cash payments are made
for goods received or services performed. For the accrual deficit, costs
are recognized when goods are used or services are performed regardless of
when cash payments are made. For many program areas, the timing difference
is small but for others the timing differences can amount to billions of
dollars each year. Differences arise when a cost is accrued (and affects
the accrual deficit) in one fiscal year but paid (and affects the cash
deficit) in another fiscal year. The following six areas account for the
largest differences between cash and accrual deficits: [85]14

* civilian employee benefits, 

* military employee benefits, 

* veterans compensation, 

* environmental liabilities (e.g., cleanup and disposal), 

* insurance programs, and: 

* capital assets. 

13The consolidated financial statements of the U.S. government are largely
on an accrual basis. See Department of the Treasury, Financial Report of
the United States Government, 2006. GAO is responsible for auditing the
financial statements included in the Financial Report, but we have been
unable to express an opinion on them because the federal government could
not demonstrate the reliability of significant portions of the financial
statements. Accordingly, amounts taken from the Financial Report may not
be reliable.

For example, the accrual deficit includes an expense for current
employees' pension and other retirement benefits, which are earned during
the employee's working years and are part of the annual cost of providing
government services but not paid until sometime in the future when the
employee retires. The cash budget deficit does not include retirement
benefits earned today, but it does reflect payments made to current
retirees. (These cash payments reflect past accrued expenses.) The
difference between the accrued retirement benefits recognized and cash
payments made during the year is the difference between the accrual and
cash measures due to employee benefits.

In the year that capital assets such as structures and equipment are
purchased, the budget recognizes the full cash cost to provide decision
makers with the information and incentives to make efficient decisions at
the only time that they can control the cost. Specifically, budget
authority for the asset's full cash cost must generally be provided up
front before the asset can be purchased. The full cash cost of a capital
asset is recorded as an outlay and included in the cash budget deficit
when the asset is paid for. However, under the accrual basis of accounting
used in the financial statements, the cash cost of the asset is initially
recorded on the balance sheet. The cash cost of the asset is then spread
over its expected useful life to match the asset's cost with its use.
Therefore, each year the accrual deficit only reflects one year's worth of
the cash cost, called depreciation expense.

14For a discussion of how the accrual and cash deficits relate to each
other, see GAO, Understanding Similarities and Differences between Accrual
and Cash Deficits, [66]GAO-07-117SP (Washington, D.C.: December 2006).

We have previously noted that while both cash and accrual measures of the
government's overall finances are informative, neither measure alone
provides a full picture. [86]15 For example, the unified budget deficit
provides information on borrowing needs and current cash flow, but does
not measure the amount of resources used to provide goods or services in
the current year. While the accrual deficit provides information on
resources used in the current year, it does not provide information on how
much the government has to borrow in the current year to finance
government activities. Nor does it provide information about the timing of
payments and receipts, which can be very important. Therefore, just as
investors need income statements, statements of cash flow, and balance
sheets to understand a business's financial condition, both cash and
accrual measures are important for understanding the government's
financial condition.

Although a more complete picture of the government's fiscal stance today
and over time comes from looking at both the cash and accrual measures
than from looking at either alone, even the two together do not provide
sufficient information on our future fiscal challenges. In addition to
considering the federal government's current financial condition, it is
critical to look at other measures of the long-term fiscal outlook of the
federal government. While there are various ways to consider and assess
the long-term fiscal outlook, any analysis should include more than just
the obligations and costs recognized in the budget and financial
statements. It should take account of the implicit promises embedded in
current policy and the timing of these longer-term obligations and
commitments in relation to the resources available under various
assumptions. For example, while the cash and accrual measures showed
improvement between fiscal year 2005 and fiscal year 2007, our long-term
fiscal outlook did not change. In fact, the U.S. government's total
reported liabilities, net social insurance commitments, and other fiscal
exposures continue to grow and total more than $52 trillion, representing
approximately four times the nation's total output, or gross domestic
product (GDP), in fiscal year 2007, up from about $20 trillion, or two
times GDP in fiscal year 2000 (see table 1).

15 [67]GAO-07-117SP .

Table 1: Major Reported Fiscal Exposures

Dollars in trillions                                                       
                                                   2000 2007 Percent increase 
Explicit liabilities                             6.9 10.8               57 
Publicly held debt Military and civilian             
pensions and retiree health Other                    
Commitments and contingencies                    0.5  1.1               97 
For example, PBGC,a undelivered orders                                     
Implicit exposures                              13.0 40.8              213 
Future Social Security benefits                  3.8  6.8                  
Future Medicare Part A benefits                  2.7 12.3                  
Future Medicare Part B benefits                  6.5 13.4                  
Future Medicare Part D benefits                       8.4                  
Total                                           20.4 52.7              158 

Source: Department of the Treasury.

Note: Data from 2000 and 2007 Financial Reports of the United States
Government. Estimates for Social Security and Medicare are at present
value as of January 1 of each year and all other data are as of September
30. Totals and percent increases may not add due to rounding.

aPension Benefit Guaranty Corporation.

Another way to assess the U.S. government's long-term fiscal outlook and
the sustainability of federal programs is to run simulations of future
revenues and spending for all federal programs, based on a continuation of
current or proposed policy. Long-term simulations by GAO, the
Congressional Budget Office, and others show that we face large and
growing structural deficits driven primarily by rising health care costs
and known demographic trends. As shown in figure 2, GAO's long-term
simulations--which are neither forecasts nor predictions--continue to show
ever-increasing long-term deficits resulting in a federal debt level that
ultimately spirals out of control. The timing of deficits and the
resulting debt buildup varies depending on the assumptions used, but under
either optimistic ("Baseline Extended") or more realistic assumptions
("Alternative simulation"), the federal government's current fiscal policy
is unsustainable. [87]16

16For more information on the assumptions underlying our simulations, see
GAO, The Nation's Long-Term Fiscal Outlook: August 2007 Update,
[68]GAO-07-1261R (Washington, D.C.: Sept. 28, 2007).

Figure 2: Unified Surpluses and Deficits as a Share of GDP under
Alternative Fiscal Policy Simulations

Note: The data are from GAO's August 2007 analysis in [88]GAO-07-1261R .

One summary measure of the long-term fiscal challenge is called "the
fiscal gap." The fiscal gap is the amount of spending reduction or tax
increases that would be needed today to meet some future debt target. To
keep debt as a share of GDP at or below today's ratio under our
Alternative simulation would require spending cuts or tax increases equal
to 7.5 percent of the entire economy each year over the next 75 years, or
a total of about $54 trillion in present value terms. To put this in
perspective, closing the gap would require an immediate and permanent
increase in federal tax revenues of more than 40 percent or an equivalent
reduction in federal program spending (i.e., in all spending except for
interest on the debt held by the public, which cannot be directly
controlled).

As demonstrated by these various measures, our nation is on an
unsustainable fiscal path. This path increasingly will constrain our
ability to address emerging and unexpected budgetary needs and will
increase the burdens that will be faced by future generations. Since at
its heart the budget debate is about the allocation of limited resources,
the budget process can and should play a key role in helping to address
our long-term fiscal challenge.

Although Certain OECD Countries Continue to Use Accrual Budgeting, Objectives
and Approaches Vary Significantly

The six countries reviewed in 2000 continue to use accrual budgeting.
However, two countries that were considering broader expansions of accrual
budgeting have thus far made only limited changes. Although each country's
budgeting framework has unique features, the six countries have taken one
of two broad approaches toward accrual budgeting:

* One approach uses accruals for most or all items in the budget 
primarily to support broader efforts to improve government performance. 

* A second approach more selectively uses accrual information in areas 
where it increases recognition of future cash requirements related to 
services provided during the year that are not fully recognized in a 
cash-based budget. 

Regardless of which approach is used, cash information remains important
in all the countries to evaluate overall fiscal position. None of the
countries reviewed include anticipated future payments for social
insurance programs (namely public pensions and health services) in the
current year's budget measure. Social insurance programs are generally
viewed as transfer payments rather than liabilities. Transfer payments are
benefits provided without requiring the recipient to provide current or
future goods or services of equivalent value in return.

Accrual Budgeting Continues to Be Used in the Six Countries Studied but Two Did
Not Expand Their Use as Previously Anticipated

Since 2000, three countries--Australia, New Zealand, and Iceland--have
continued to use the accrual budgeting frameworks in place in 2000. In
2000, we reported that the United Kingdom was planning to implement an
accrual-based budgeting framework, called Resource Accounting and
Budgeting. After Parliament passed the necessary legislation in 2000, the
United Kingdom implemented resource accounting and budgeting in 2001. The
United Kingdom has continued to make some modifications to its framework,
including introduction of controls over cash.

Although two countries--the Netherlands and Canada--have considered
broader expansions of accrual budgeting since 2000, thus far they have
made only limited changes. In the Netherlands only budgets for some
government agencies are on an accrual basis and the governmentwide budget
remains on a modified cash basis. The Dutch government decided against
moving the governmentwide budget to an accrual basis in 2001. Although the
Dutch cabinet thought that the accrual-based system added value at the
agencies where it had been implemented, it thought the cost of
implementing accrual budgeting governmentwide, including changing
information systems, developing accounting standards, and changing
regulations would outweigh any advantages.

In 2003 Canada significantly expanded the use of accruals in the
governmentwide budget, but the information used to support appropriations
(called the Main Estimates) and the appropriations themselves remain
largely on a cash basis. [89]17 Since the 1990s, there has been debate
within the Canadian government concerning the appropriate application of
accruals. The Canadian Office of the Auditor General and a key committee
in Parliament, the House of Commons Committee on Public Accounts, have
advocated preparing the Main Estimates on a full accrual basis. The
current government agrees in principle that accrual measurement can be
useful but considers this to be a complex issue that requires study and
consultation with parliamentarians. After consultation with
parliamentarians, the current government plans to present a model for a
new accrual-based appropriations process in 2008.

Although the use of accrual budgeting in other major industrialized
countries has grown, it is not currently the norm. Since 2000, the number
of OECD countries that report using accruals at least in part has
increased. [90]18 For example, as noted previously, Denmark and
Switzerland recently expanded the use of accruals in the budget. Some
countries also report using both cash- and accrual-based accounting in the
budget. However, the majority of OECD countries reported using either
cash- or obligation-based budgeting or both.

The extent to which countries in our study used accrual budgeting
varied--from full accrual at all levels of government to more limited use
at either the agency or program level. Figure 3 illustrates the broad
range of use.

17Canada does provide departments with appropriations for the accrued cost
of employee pensions.

18Based on our analysis of OECD surveys conducted in 2000, 2003, and 2006.
The most recent survey results can be found at
[69]http://webnet4.oecd.org/budgeting/Budgeting.aspx (as of Oct. 3, 2007).
We were unable to validate some of the responses to the surveys and there
were changes in the response categories over time; therefore our use of
the survey results is limited.

Figure 3: Range of Accrual Budgeting Use

The extent to which countries use accrual budgeting generally reflects the
objectives to be satisfied. Countries that switched to accrual budgeting
primarily as a way of providing better cost and performance information
for decision making generally used accruals to a greater extent in the
budget, as illustrated by the first two approaches--full accrual at all
levels of government. In general, these countries also sought to put
financial reporting and budgeting on a consistent basis. Countries that
switched to accrual budgeting primarily as a way of increasing recognition
of future cash requirements related to services provided during the year
generally use it only for selected programs where accruals enhance
up-front control and provide better information for decision making (e.g.,
loans and government employee pensions); this approach is similar to the
United States' current use of accruals. Regardless of the approach, cash
information remains important. Most countries in our study continue to use
cash-based measures for broad fiscal policy decisions. The following
section describes each country's objective and approach in more detail.

Most Countries Use Accruals Primarily to Increase Transparency and Improve
Government Performance

Four countries--Australia, New Zealand, the Netherlands, and the United
Kingdom--primarily use accrual budgeting to support broader efforts to
improve the efficiency and performance of the public sector. Compared to
cash-based budgeting, accruals are thought to provide better cost
information and to encourage better management of government assets and
liabilities. Among this group of countries, however, there is significant
variation in the scope of accrual budgeting as well as the linkage between
performance goals and appropriations.

  Australia and New Zealand

Since the 1990s, Australia and New Zealand have extensively used accruals
in conjunction with output-based budgeting. [91]19 The introduction of
accrual budgeting in both countries was a key element of broader reforms
meant to improve the efficiency and performance of the public sector.
Reformers in both countries thought that accruals would provide better
cost information and better management incentives than the previous
cash-based budgeting framework. Reformers also thought it was important to
have a consistent framework for budgeting and financial reporting to allow
actual performance to be compared with expectations.

Accrual budgeting in both countries is also intended to provide funding
for the full cost of departments' activities. Australia and New Zealand
departments receive funding for noncash expenses, such as depreciation of
existing assets, accrued employee pension benefits, [92]20 and the
estimated future costs of environmental cleanup resulting from government
activities. Reformers in both countries thought that appropriating on a
full-cost basis created compelling incentives for department managers to
focus on the full cost of their department's activities as well as manage
noncash expenses.

One important feature of Australia's and New Zealand's budgeting
frameworks is that departmental appropriations are closely linked to
outcomes and outputs, and department executives are given considerable
flexibility in managing their department's finances, provided that the
department meets its performance goals. It is thought that giving
department executives more flexibility generally contributes to better
performance. In comparison to the United States, the appropriations acts
in Australia and New Zealand place less emphasis on how departments
allocate their funding among different types of expenses. Nevertheless,
two key departments, the Treasury in New Zealand and the Department of
Finance and Administration in Australia, do centrally review and must
approve departmental plans for major capital purchases.

19Australia transitioned to accrual budgeting in financial year 1999-2000;
New Zealand transitioned to accrual budgeting on the departmental level in
1992 and 1994 for the governmentwide budget.

20Australia and New Zealand government departments are generally not
responsible for funding health benefits for current or retired government
employees. Australia's and New Zealand's governments provide health care
for all citizens, although some citizens purchase supplementary private
health insurance.

  The Netherlands

The Netherlands has used accrual budgeting in select government agencies
primarily as a tool for improving performance. In the early 1990s, the
government allowed a limited number of government entities (called
agencies) to operate as if they were private sector contractors by
adopting a results-oriented performance-management model, including
accrual accounting and budgeting. Under the Dutch approach, the agencies
are effectively service providers for the central government's ministries.
These agencies receive funding for the accrual-based cost from the
ministries that they service. For example, although the Ministry of
Justice is appropriated funds on a cash basis to buy services from the
Prison Service, the Prison Service charges the ministry the full cost of
the services it provides. The number of government entities participating
in this program has increased from 22 in 2000 to approximately 40 in mid
2007. However, while the agencies budgeting on an accrual basis represent
about 60 percent of the government in terms of employees, they are a small
part of the government's overall budget since the majority of the Dutch
government's expenditures are spent on transfer payments, which continue
to be budgeted on a cash basis.

  The United Kingdom

The United Kingdom implemented what it calls resource budgeting for
financial year 2001-2002. The United Kingdom's approach makes less use of
the Australia-New Zealand form of performance-based budgeting and imposes
tighter controls on cash than the Australia and New Zealand approaches.
The United Kingdom's Parliament votes both cash and "resources" (i.e., the
full accrual-based cost of a department's services). The resource budget
recognizes such noncash expenses as accrued employee pension benefits as
well as depreciation of existing assets but limits the ability of
departments to use funds appropriated for noncash items to fund current
spending. Treasury officials from the United Kingdom told us that in
practice this near-cash limit on departmental spending is the focus of
budgetary planning. Treasury officials also noted that although
departments have public service agreements that include performance
targets, the United Kingdom has not really used outcome-based budgeting.

Some Countries Use Accrual Measures Selectively in Areas Where It Enhances
Transparency of the Government's Future Cash Requirements

A second approach has been to use accrual information more selectively for
programs or areas where it highlights annual costs that are not fully
recognized in the cash-based budget. Iceland and Canada generally have
taken this approach.

  Iceland

Since 1998, Iceland has budgeted on an accrual basis except for capital
expenditures, which remain on a cash basis. Iceland's approach was
designed primarily to improve transparency and accountability in its
budget. The only areas with significant differences between cash- and
accrual-based estimates are government employee pensions, interest, and
tax revenue. Iceland also uses accrual budgeting for loan programs.
Accrual budgeting in Iceland has had only a limited effect on
department-level budgets for two reasons. First, capital budgeting remains
on a cash basis. Second, the oversight and administration of employee
pensions, tax revenue, and the subsidy costs for loans are located in the
Finance Ministry, not individual departments. Consequently, for most
Icelandic departments, there are only minor differences between cash- and
accrual-based estimates for the department's operating budgets.

  Canada

The federal government of Canada currently uses both accrual and cash for
budgeting purposes. The governmentwide budget is largely on an accrual
basis; the information used to support appropriations (called the Main
Estimates) and the appropriations themselves remain largely on a cash
basis; certain areas such as the future pensions for current employees are
measured on an accrual basis. [93]21 Canada's current government has been
considering moving the Main Estimates and appropriations to a full accrual
basis. Since the 1990s, the Canadian Office of the Auditor General and a
key parliamentary committee, the House of Commons Committee on Public
Accounts, have recommended moving appropriations to an accrual basis so
that managers would make more informed decisions about the use of
resources. The Office of the Auditor General and the committee think it is
important to use the same accounting standards in the budget and the
Estimates. The current government agrees that moving to accrual-based
budget and appropriations may have benefits. Officials from Canada's
Finance Department and Treasury Board Secretariat told us that it was
important to study the experience of other governments with accruals
before designing a new, accrual-based appropriations process. The
officials also said the current government was consulting with members of
Parliament and plans to present a model for Parliament's consideration in
2008.

21The budget provides the government's overall fiscal plan for revenues
and expenses and details spending proposals for the government's new
initiatives. The Main Estimates are detailed plans for all government
expenditures by department and agency. Appropriations are the legislation
necessary to implement the Main Estimates.

Cash Information Remains Important, Particularly for Monitoring a Country's
Fiscal Position

Regardless of the approach taken in use of accrual budgeting, all of the
countries consider cash information to be important, particularly for
monitoring the country's fiscal position even where fiscal indicators are
accrual based. Three of the countries--Australia, the Netherlands, and the
United Kingdom--calculate the governmentwide surplus/deficit on either a
cash or near-cash basis. In the other three countries--Iceland, New
Zealand, and Canada--aggregate fiscal indicators are largely accrual
based, but officials we spoke with said that cash information continues to
be important in evaluating fiscal policy.

Although Australia extensively uses accruals for departmental
appropriations, Australian officials said that a key measure for
policymakers is the country's surplus measured on a cash basis. [94]22
This is due in part to a goal of running cash-based surpluses over the
business cycle to contribute to national savings. Both the Netherlands and
the United Kingdom, as members of the European Union (EU), are required to
report the net lending or borrowing requirement, which officials described
as a near-cash number. [95]23 Officials from the United Kingdom also said
that cash information is important because the current government has
pledged to avoid borrowing to finance current expenditures and to keep net
debt at prudent levels. New Zealand makes several adjustments to the
accrual-based operating balance to remove items that do not affect the
underlying financing of government and must pay attention to its cash
position to ensure it meets its debt-to-GDP target.

Several Other OECD Countries Have Considered Accrual Budgeting since 2000 but
Reached Different Decisions

Since 2000, at least two additional OECD countries--Denmark and
Switzerland--have expanded the use of accruals in the budget without
moving to full accrual budgeting. Switzerland has recently expanded
accrual measurement as part of broader reforms to improve government
financial reporting. However, Switzerland's governmentwide surplus/deficit
continues to be calculated on a cash basis and some government assets,
such as defense assets, are not capitalized. Beginning in 2007, Denmark
moved departmental operating budgets and associated capital spending to an
accrual basis, primarily to support efforts to improve the performance of
government departments. However, Denmark does not accrue capital spending
on infrastructure, and both grants and transfer payments are measured on a
cash basis.

22Unusual transactions such as large receipts from asset sales are
excluded from the cash surplus in Australia.

23Net borrowing (or lending) is a national accounting concept and is
similar to the unified budget surplus or deficit. Unlike accruals, the
national accounts in the United Kingdom recognize pensions paid in the
current year and do not recognize costs associated with "provisions,"
which are cases where there is uncertainty about whether a liability
exists, the amount to settle it, or the timing of the payments. The United
Kingdom's national accounts also record the cost of single-use military
equipment in the year purchased rather than depreciating them.

Sweden and Norway considered moving toward accrual budgeting but decided
against it. Between 1999 and 2003 Sweden developed a plan to move from
cash to accrual budgeting but in 2004 chose not to implement these plans.
Swedish officials said that the government was concerned that accrual
budgeting would diminish control of cash spending, potentially undermine
fiscal discipline and lead to bigger investments, principally for
infrastructure and war equipment. Norway went through a similar decision
process. In 2003, a government-appointed committee recommended Norway move
to full accrual budgeting, but the government at that time argued that the
fiscal policy role of the budget is better served by cash-based
appropriations and that the cash system enables better control of
investments. Parliament agreed. However, Norway is testing accrual
accounting at 10 agencies to achieve purposes similar to those cited by
other countries--namely to provide better cost information; to establish a
baseline for benchmarking costs, both between government agencies and in
relation to private organizations; and to generate more complete
information on the assets and liabilities of the government.

Countries Faced a Number of Common Challenges Inherent to Accrual Reporting That
Led to Some Changes in Their Approach

Any significant expansion in the use of accruals creates a number of
transitional challenges, including how to develop accounting standards for
the budget and deciding what assets to value and how to value them. Beyond
transitional issues however, there are several challenges inherent to
accrual budgeting, as we noted in 2000. These challenges illustrate the
inherent complexity of using accrual-based numbers for managing a nation's
resources and led to some modifications in countries' use of accrual
reporting in the budget, such as reliance on more cash-based measures of
the overall budget.

Countries Have Generally Addressed Challenges Related to Developing Accounting
Standards to Be Used in the Budget, Including Asset Identification and Valuation

Developing accounting standards to use in the budget and deciding what
public assets to value and how to value them were initial challenges for
countries moving to accrual budgeting. These took time to work out and
refinements continue. Some countries in our study sought to put the
government's financial reporting and budgeting on the same basis and to
make them comparable to the private sector. In all, three of the six
countries in our 2000 report and Denmark said that the technical standards
used in the budget were substantially based on private-sector accounting
standards. Only Canada and Switzerland said the technical standards were
based on public sector accounting standards. Three countries--Australia,
the Netherlands, and the United Kingdom--reported that the standards used
for aggregate measures were based on national accounting standards
(similar to the national income and product accounts in the United States)
set by an international organization (e.g., the International Monetary
Fund's Government Finance Statistics or the European System of Accounts).

Some countries in our study thought that adopting standards and concepts
developed by independent bodies was important. While both cash and accrual
accounting can be subject to gaming, some believe that accrual accounting
in particular opens up the opportunity for manipulation. Three countries
responded that a commission of experts outside of government developed the
standards. Other countries, however, said that although their standards
were based on independent standards, the finance ministry or bureau of
statistics has the ultimate responsibility for developing standards. In
these countries, accounting standards were generally not adopted intact
from an independent entity. For example, Switzerland's accrual budgeting
system is designed to be closely aligned with the international public
sector accounting standards (IPSAS), but there were some deviations from
IPSAS for constitutional reasons such as compliance with the cash-based
balanced budget requirement. Also, for practical reasons, Switzerland does
not capitalize defense investments, which is required under IPSAS.

Besides developing the accounting standards to be used in the budget, a
key challenge when switching to accrual budgeting, particularly for
countries that choose to treat capital on an accrual basis (i.e., to
capitalize assets and record them on the balance sheet) and provide
funding for noncash depreciation costs, is to ensure that the recorded
value of the capital asset is as accurate as possible. The value of the
capital asset is used to calculate annual depreciation costs and in turn
fund future capital acquisitions (replacements). If an agency overvalued
its assets, it could be difficult to reduce the level of assets once
accrual budgeting is implemented because the excess value represents a
source of funding for the agency in the form of depreciation. On the
flipside, if assets were undervalued, they may not provide good
information on the cost of maintaining or replacing the asset. In 2004,
for example, the New Zealand government purchased the nation's rail
network for only NZ$1. Officials with whom we spoke said the NZ$1 value
did not yield good information about annual depreciation (maintenance)
costs. Therefore the New Zealand government revalued the network at
NZ$10.3 billion in 2006; this revaluation led to an increase in the New
Zealand government's net worth. More importantly, the annual operating
balance used in the budget now reflects the associated depreciation costs.

In Australia, the government thought that capitalizing assets would lead
to a better understanding of what is owned and what would be needed in the
future. However, an Australian official said departments still request
supplementary funding to replace old assets. An Australian official said
that this may be because some departments were not fully funded for all
capitalized assets in their opening balance sheets during the move to
accrual budgets. It could also be because new asset purchases are not
identical to the assets they replace or because agencies did not have
sufficient assets to carry out their goals in the first place.

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 identifying and agreeing on the asset
values. Valuing assets poses special problems in the public sector since
it owns unique assets such as heritage assets (e.g., museums and national
parks) and defense assets (e.g., weapons and tanks). By nature, heritage
assets are generally not marketable. Their cost is often not determinable
or relevant to their significance and they may have very long life cycles
(e.g., hundreds of years). Although the recognition issues associated with
heritage assets are challenging, these assets are generally not very
significant in terms of the overall effect on fiscal finances. As a
result, valuing heritage assets may be seen as not worth the effort.
Indeed, of all the countries we reviewed, only Australia and New Zealand
capitalize all assets. The other countries exclude unique government
assets such as highways, bridges, national parks, historical buildings,
and military assets.

The most common approaches for valuing assets are historical cost and fair
value. (Fair value is usually the same as market value; in the absence of
reliable market values, replacement cost is often used.) Five of seven
countries in our study that measure capital assets on an accrual basis use
fair or market value. Only two--Canada and Denmark--use historical cost.
Use of market value relies on professional judgments to assess values and
the values can fluctuate sharply between reporting periods. Although
historical cost is based on a verifiable acquisition price and does not
fluctuate, the reported amounts may not reflect the current value of the
asset. Furthermore, it is often very difficult to estimate the original
costs of government assets that are hundreds of years old or for which
cost records have not been maintained.

Developing Reliable Financial Data Is Seen as a Prerequisite to Accrual
Budgeting in Some Countries

We have reported that enhancing the use of performance and "full-cost"
information in budgeting is a multifaceted challenge that must build on
reliable cost and performance data, among other things. [96]24 Reliable
financial information was also viewed as important to have before moving
to accrual budgeting in some countries we reviewed. For example, in the
Netherlands, an agency must receive a "clean audit" or an unqualified
audit opinion for the year prior to moving to accrual budgeting and at
least 6 months must have been spent in a trial run of the accrual
accounting system. Other criteria must also be met before moving to
accrual-based budgeting and receiving the associated flexibilities
including being able to describe and measure the agency's products and
services. Before moving to accrual budgeting in New Zealand, a department
had to define its broad classes of outputs, develop an accrual-based
system capable of monthly and annual reporting, and develop a
cost-allocation system to allocate all input costs including depreciation
and overhead to outputs and provide assurance it had an adequate level of
internal controls. There was not, however, a requirement for an
unqualified opinion for the agency.

Accrual budgeting can also lead to improvements in financial information.
Auditable financial accounts were not a prerequisite for moving to accrual
budgeting in the United Kingdom. When the United Kingdom moved to accrual
budgeting in 2001-2002, the government had 16 accounts for central
government departments with "qualified" opinions. [97]25 However, since
the introduction of accrual budgeting, the United Kingdom reported that
the number of qualified accounts had declined and the timeliness of
financial reporting, which maximizes the usefulness of the information to
managers, Parliament, and other stakeholders, has improved.

24GAO, Performance Budgeting: Efforts to Restructure Budgets to Better
Align Resources with Performance, [70]GAO-05-117SP (Washington, D.C.:
February 2005).

25A "qualified" opinion means that the auditor disagreed with the
treatment or presentation of financial information.

Volatility in Aggregate Accrual Measures Can Lead to Use of More Cash-Like
Measures

Both cash and accrual measures are subject to volatility. Cash accounting
may not be useful for measuring cost because spikes in receipts or
payments can cause swings in the apparent "cost" of a program or activity.
For example, if a program purchases a large amount of equipment in one
year, it will appear costly under cash accounting, but under accrual
accounting, only a proportion of the equipment's cost in the form of
depreciation would be shown in that year. Accrual measures experience
volatility for other reasons such as changes in the value of assets and
liabilities or changes in assumptions (e.g., interest rates, inflation,
and productivity) used to estimate future payments.

Because the accrual-based operating results can be volatile due to events
outside the government's control, New Zealand generally does not use it as
a measure of the government's short-term fiscal stewardship. For example,
under New Zealand's accrual-based accounting standards, most assets are
revalued at least every 3 years. New Zealand uses fair value, which is
usually the same as market value when there is an active market. As noted
above, market values tend to fluctuate between reporting periods. The
changing market values can cause swings in the reported accrual-based
operating results because such changes are reflected as revenue or cost in
the year revalued. Therefore, changes in operating results may reflect not
a fundamental change to the government's finances but rather changes in
the value of assets or liabilities that do not affect the government's
financing in the current period. Fluctuations can also result from annual
changes in the value of liabilities when there are deviations between
actual experience and the actuarial assumptions used or changes in
actuarial assumptions. The liabilities for New Zealand's government
pension and insurance programs, for example, fluctuate from year to year
partly due to changes in the underlying assumptions such as interest rates
and inflation. [98]26 To deal with this, the New Zealand Treasury removes
revaluations and other movements that do not reflect the underlying
financing of government from its operating balance. It is this
measure--the Operating Balance Excluding Revaluations and Accounting
Changes (OBERAC)--that has been the focus of policy debates in New Zealand
since about 2001.

26Such fluctuations also occur in the U.S. government's financial
statements. For example, in the United States, changes in the interest
rate assumptions used to estimate the value of future benefits led to wide
fluctuations in the veterans compensation liability. The liability
increased by $105.6 billion in 2003, decreased by $30 billion in 2004, and
then increased by $197.8 billion in 2005.

More recently the New Zealand Treasury shifted its focus to a new
measure--Operating Balance Excluding Gains and Losses (OBEGAL). Gains and
losses can result when the value of an asset or liability differs from the
value booked on the balance sheet. If the government sells an asset and
the sales price equals book value, there is no gain or loss, because a
cash inflow equal to book value is the exchange of one asset for another
of equal recorded value. However, if the sales price is more or less than
the book value of the property, the difference is reflected as a gain or
loss. New Zealand set up a fund to partially prefund future superannuation
expenses. [99]27 This fund reports gains and losses on its investments.
Because the current government wishes to retain the investment returns in
the fund, beginning with the 2007 budget the government has shifted its
focus to the OBEGAL to ensure the government is meeting its fiscal
objectives. New Zealand said that by excluding net gains and losses the
OBEGAL gives a more direct indication of the underlying stewardship of the
government.

Complexity of Accrual-Based Accounting and Use of Cash-Based Fiscal Targets
Makes It Difficult for Policymakers to Focus on Accrual Measures

Accrual accounting is inherently more complex than cash-based accounting,
which is like managing a checkbook. One Australian official noted that
using accrual measures can be challenging because many cabinet ministers
and members of Parliament are trained in professional fields other than
finance and accounting and may be more familiar with cash budgeting.

Focusing on accrual-based numbers can be difficult given the existence of
cash-based fiscal policy targets. For example, several countries--Canada,
New Zealand, and the United Kingdom--have fiscal policy targets that
target the amount the country can borrow; borrowing (or debt) is based on
cash measures. Also, while accrual numbers are used at the agency level in
Australia, Australia has had a goal of running cash-based surpluses over
the business cycle. This is due in part to a long-standing goal in
Australia to improve national savings. At the time of our study, [100]28
Australia's Treasurer primarily focused on the cash-based fiscal position
to show the government's effect on national savings. [101]29 Agency
managers therefore have an obligation to manage both the cash and accrual
implications of their resource use.

27New Zealand Superannuation is financial assistance for people 65 years
of age or older who have lived in New Zealand for a certain amount of
time. It is not based on income. This entitlement is recognized in the
budget when due and payable.

New Zealand also pays attention to its cash position. New Zealand's
current fiscal policy goal is to maintain gross debt at around 20 percent
of GDP. This means that New Zealand's cash position must be such that cash
receipts equal cash outlays excluding interest expense. [102]30 It also
means the accrual-based operating surplus must be sufficient to cover
investments--cash needed today but not expensed until the future.

Cash information is still used at both the overall fiscal policy level and
department level in the United Kingdom. The current United Kingdom
government has pledged to avoid borrowing to finance current expenditures
and maintain public debt at a prudent level. Both of the government's
fiscal targets are measured on a near-cash basis. Consequently, United
Kingdom Treasury officials said that Treasury has imposed limits on
departmental cash spending because spending directly affects the country's
cash-based fiscal position.

Concerns about Management and Oversight of Noncash Expenses Can Lead to
Increased Use of Cash Controls

Different countries have taken different approaches to managing noncash
expenses, particularly in regard to capital assets. In Australia and New
Zealand, cash is appropriated for the full accrual amounts, including
noncash items such as depreciation for existing assets. Agencies are
expected to replenish their current assets from funding provided for
depreciation and they have the funding to do so (subject to the oversight
discussed below). The full cost of government is the focus of the
operating budget rather than the immediate cash requirement. The downside
of this approach is that control of cash and capital acquisitions to
replace assets can become challenging. If an agency is given cash to fund
depreciation expense, there is a risk that agencies may use the funds to
cover other expenses. Similarly, Parliament may lose control over the
acquisition of capital assets since it will have funded them through
depreciation provided in previous years.

28A new government was sworn in on December 3, 2007, just before issuance
of this report. This statement refers to the government in power prior to
December 3.

29Australia's underlying cash balance is the difference between revenues
and expenditures measured on a cash basis and excludes unusual
transactions such as large receipts from asset sales.

30This rule of thumb holds precisely if the interest rate on debt equals
the rate of GDP growth. If, however, the interest rate exceeds GDP growth,
cash receipts must exceed cash outlays excluding interest in order to keep
the debt-GDP ratio constant. Conversely, New Zealand can run cash deficits
if GDP growth exceeds the interest rate on debt.

To address these concerns, countries have implemented cash management
policies and specific controls over capital acquisitions. For example,
like Australia and New Zealand, the United Kingdom initially provided
funding for the full cost of programs, outputs, or outcomes with the
thought that it would generate efficiencies. Over time, however, United
Kingdom Treasury officials said they became concerned that some
departments were shifting noncash expenses to cash expenses, which
adversely affected the government's borrowing requirement. As a result,
the United Kingdom has imposed controls on cash. Departments' budgets now
include both the amount of the full accrual costs and the cash required.
The Parliament approves both numbers. This not only helps ensure that
department spending is in-line with the government's fiscal policy goals
but also reinforces Parliament's control over capital acquisitions.

Australia also reported that it is considering a model that would give the
Parliament both cash and accrual information in a form that better meets
its needs and preferences. On the basis of reports by the Australian
National Audit Office and others that departments could potentially use
funds provided for depreciation of existing assets to fund noncapital
acquisitions or that agencies are not appropriately using the funds to
repair or replace existing assets, the Australian Senate expressed concern
about the transparency of funding for depreciation and the potential loss
of control over new capital purchases. [103]31 The Senate recommended that
the government consider reporting and budgeting for capital expenditures
separately, including a subdivision of expenditures between asset
replacement (i.e., the depreciation component) and asset expansion.

All countries we reviewed that accrue capital investments have a process
in place to facilitate oversight over capital. While most of these
countries include depreciation of existing assets in operating budgets,
most also preserve up-front control of capital by approving capital
purchases above a certain threshold. For example, in New Zealand, all
capital purchases above NZ$15 million must be approved by the cabinet. In
Australia, any capital purchase above A$10 million in any one year must
have a business case prepared and must be included in the budget proposal
to be submitted for government approval. The United Kingdom Treasury
reviews departmental capital plans. In the Netherlands, capital purchases
by agencies are made through loans provided by the Ministry of Finance.
The Ministry of Finance has to approve the level of loans per agency.

31In Australia, both houses of Parliament approve all appropriations, but
the Senate has more authority to review and amend appropriations for new
government activities.

Some Governments Have Had to Address Parliamentary Concerns

As previously noted, all of the countries in our study are parliamentary
systems in which the political party that controls the current government
has primary control over budgetary matters. However, as noted above, in
some countries Parliaments have expressed general concerns that the budget
presentations are confusing under accrual budgeting. Several countries in
our study use more than one method of budget accounting, which can be
confusing for Parliament and other users. In Australia, for example, where
two accounting standards are currently used in the budget, the Senate has
recommended the adoption of a single agreed-upon accounting standard. In
Canada, the government reports the budget surplus/deficit on an accrual
basis but department-level appropriations remain on a cash basis. Canadian
audit officials we spoke with said the Parliament wants the
department-level appropriations prepared on an accrual basis in part
because the two different measures and crosswalks are confusing. Canada is
considering moving department-level budgets to an accrual basis in order
to provide consistent financial information for all levels of government
and a better linkage between the budget and appropriations.

In the United Kingdom, some members of Parliament said it was unclear how
the accrual-based appropriations related to the nation's fiscal goals,
which are largely cash based. As a result, the government is undertaking
an "alignment project" to better align budget accounts with the
government's two fiscal rules to (1) avoid borrowing to finance current
expenditures and (2) keep net debt at prudent levels.

Australia's Senate expressed concern about reduced transparency of some
information and said that the budget could be improved if data were
presented at the program level (in addition to outcomes). The Australian
government official we spoke with said that the government already
provides the Parliament and public with extensive information on both the
full costs of government activities and the performance of agencies. It
was not clear to the official, however, that providing more detailed
information would improve the quality and usefulness of information
considering the administrative workload involved and the potential for
creating more "red tape" for managers. The Australian official thought
more concise and relevant reports might be more useful than more
information.

Accrual Cost Information Helped Inform Some Debates That Led to Improvements in
Fiscal Condition

Despite the inherent challenges, our six case study countries have
continued to use accrual budgeting and additional countries have adopted
accrual budgeting since 2000. These countries view having accrual-based
cost information available to program managers for resource allocation
decisions as outweighing the associated difficulties. In several
countries, officials we spoke with said they believe accrual budgeting
provides better information on the cost of annual operations and
performance than cash-based budgeting particularly in regard to the use of
capital assets and programs that incur costs that are not paid in cash
today.

Accrual Budgeting May Provide Better Cost Information than Cash Budgeting for
Resource Allocation Decisions

In general, countries said that accrual-based cost information contributes
to improved resource allocation and program management decisions. Under
cash budgeting, a program's budget shows only the immediate cash outlay
and not the cash that will have to be paid in the future for the service
provided today. Accrual budgeting, which recognizes resources as they are
used to produce goods and services, provides the full cost of all programs
and may allow for better comparisons between different methods of
delivering government services.

New Zealand officials, in particular, believe the cost information
provided by accrual-based budgeting has led to efficiencies and better
resource allocation decisions. New Zealand attributed the cost information
provided by accrual budgeting as helping them identify where and how to
cut spending to put the country on a more sound fiscal footing in the
early 1990s. Several of the countries have attributed specific
improvements on the departmental level to accrual budgeting. For example,
under accrual accounting, the cost of a loan includes the subsidy
cost--the cost of lending below market rates and provisions for bad debt.
When New Zealand recently made student loans interest free, the cost of
the subsidy was taken into consideration during the policy debate. The
United Kingdom also reported the more complete information on student
loans directly affects lending decisions at the Department of Education
and Employment. [104]32

32Credit programs are already recorded on an accrual basis in the U.S.
budget.

In several of the countries, one perceived advantage of accruals was to
facilitate comparisons between the public sector and private sector.
Accrual-based cost estimates could be used to "benchmark," or compare the
cost of existing public service providers to alternative providers in
either the public or private sectors. The OECD reported in 2005 that both
agencies and core ministries in the Netherlands were content with the
results from accrual budgeting at the agencies. [105]33 Agencies, which
now receive a budget for the full cost of their activities, like the
flexibilities under accrual budgeting, while core ministries value the
output and price information they receive from the agencies. The
ministries also reported that agencies' use of accrual budgeting enables
them to consider the performance of the agencies relative to alternatives
(i.e., decentralization to subnational government or contracting out). At
the same time, the availability of the alternatives enabled ministries to
put more pressure on agencies to improve cost efficiency and to reduce
prices. New Zealand, however, reported that there is little evidence
available that similar types of outputs are compared or benchmarked in a
way that was thought desirable at the time the reforms were initiated.
Concerns about the usefulness and robustness of cost accounting systems
continue and there remains a concern that the specification of outputs is
not at a sufficient standard to ensure high-quality government
performance.

Accrual Budgeting Attributed with Helping to Control or Manage Certain Long-Term
Commitments

In several case study countries, accrual budgeting helped policymakers
recognize the full cost of certain programs at an earlier point and make
decisions that limited future cash requirements. For example, as reported
in 2000, both New Zealand and Iceland credited accrual budgeting with
highlighting the longer-term budgetary consequences associated with public
sector employee pension programs. In Iceland, accrual budgeting showed the
consequences of wage negotiations on future public sector employee pension
outlays. The full costs of these agreements were not fully realized by the
public until the adoption of accrual budgeting. At that time, Icelandic
officials told us that there was no longer public support for decisions
that were 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.

33Dirk-Jan Kraan, "Typically Dutch," OECD Journal on Budgeting, vol. 4,
no. 4 (2005).

Since 2000, reforms aimed at putting government employee pensions on a
more sustainable footing were enacted in Australia and the United Kingdom.
In Australia, unfunded pension liabilities for government employees are
currently the largest liability on Australia's balance sheet (which is
part of its budget documents). To cover this liability, the Australian
government recently established an investment fund called the "Future
Fund" to help pay future pension payments. [106]34 Government employee
pensions in the United Kingdom were also reformed. In 2007, the United
Kingdom government raised the pension age to 65 for employees hired
beginning in July 2007 and limited the government's contribution to
pensions to 20 percent. United Kingdom officials acknowledged that there
was already recognition that the program needed significant reform before
the introduction of accrual measures, but said accrual budgeting helped
highlight the full cost of pension liabilities and forced the debate on
pension reform to happen sooner.

Accrual budgeting has also changed the information available for insurance
programs, veterans benefits, and environmental liabilities. As reported in
2000, New Zealand officials attributed reforms of the Accident
Compensation Corporation program to recognizing the liability and expenses
from providing accident coverage in the budget. Recognizing the estimated
future outlays associated with current accidents reduced budget surpluses
by NZ$500 million. At that time, officials attributed New Zealand's
decision to raise premiums and add surcharges largely to this inclusion of
program costs in the budget. Also, in 2002 New Zealand ratified the Kyoto
Protocols committing to reduce net emissions of greenhouse gases over the
2008-2012 period. Consistent with financial accounting standards, New
Zealand recognized a liability for the obligation created by this
commitment. New Zealand officials attributed accrual accounting with
helping them focus on ways to manage environmental liabilities.

Canadian officials attributed accrual information with leading to recent
changes in veterans benefits. The use of accrual accounting requires
Veterans Affairs Canada to record the full cost of veteran benefits in the
year they are earned rather than paid. Therefore when considering changes
to veterans benefits, Veterans Affairs Canada considered the effect of
future cash flows in discounted terms. Initial results indicated that the
planned changes to veteran benefits represented a substantial expense for
the year. As a result, Veterans Affairs Canada modified the admissibility
requirements limiting the financial effect of the changes.

34For background information on the Future Fund, see
[71]http://www.futurefund.gov.au/about_the_future_fund/outline.html .

Countries Use Other Methods to Increase Awareness of Greatest Long-Term Fiscal
Challenges

Accrual budgeting was not used to increase awareness of long-term fiscal
challenges that are primarily driven by old-age public pensions and
healthcare programs. None of the countries in our study include future
social insurance payments in the budget. Like the United States, the other
countries do not consider future social insurance payments to be
liabilities. Instead, in recent years, several countries have begun
reporting on the sustainability of the government's overall finances over
longer-term horizons, given demographic and fiscal trends.

Aging-Related Expenditures Are Major Drivers of Long-Term Fiscal Challenges in
Other Countries

Aging is a worldwide phenomenon. One of the key challenges that all
developed economies are facing over the coming decades is demographic
change. This demographic shift--driven by increased life expectancies,
falling fertility rates, and the retirement of the baby boom
generation--will place increased pressure on government budgets (i.e.,
public pensions and health care). For example, by 2047, a quarter of
Australia's population is projected to be aged 65 and over--nearly double
the current proportion. Similarly, by 2050, New Zealand projects that the
number of people over 65 is expected to grow almost threefold, while those
85 and over will grow sixfold. Similar trends hold for the other countries
we studied.

Although public pension benefits are a major driver, the most challenging
aspect of the long-term fiscal outlook in many of the countries we
studied--as in the United States--is health care spending. Health spending
is expected to increase significantly over the next 40 years due to
population aging, new medical technologies, new drugs, and other factors.
For example, Australia projects that health care spending as a share of
GDP will nearly double by 2046-2047. Similarly, the United Kingdom
projects that its health spending will increase faster than other types of
spending--from around 7 1/2 percent of GDP in 2005-2006 to around 10
percent of GDP by 2055-2056. New Zealand projects a rise in the ratio of
health spending to GDP of 6.6 percentage points between 2005 and 2050
resulting in health spending of about 12 percent of GDP. Similar trends
are projected in the other countries we reviewed.

Long-Term Fiscal Sustainability Reports Used by Many Countries to Raise
Awareness of Long-Term Fiscal Challenges

In recent years, many countries in our study have started preparing
long-term fiscal sustainability reports. Frequently cited reasons for this
are

* to improve fiscal transparency and provide supplemental information 
to the budget; 

* to increase public awareness and understanding of the long-term 
fiscal outlook; 

* to stimulate public and policy debates; and: 

* to help policymakers make informed decisions. 

These reports go beyond the effects of individual pension and health care
programs to show the effect of these programs on the government budget as
a whole. Unlike accrual or cash budgeting, which are intended to provide
annual cost information, fiscal sustainability reporting provides a
framework for understanding the government's long-term fiscal condition,
including the interaction of federal programs, and whether the
government's current programs and policies are sustainable. In fiscal
sustainability reports, countries measure both the effect of current
policy on the government's fiscal condition and the extent of policy
changes necessary to achieve a desired level of sustainability. These
countries hope that a greater understanding of the profound changes they
will experience in the decades ahead will help stimulate policy debates
and public discussions that will assist them in making fiscally sound
decisions for current and future generations and in achieving high and
stable rates of long-term economic growth.

Fiscal sustainability is generally described by countries as the
government's ability to manage its finances so it can meet its spending
commitments now and in the future. A sustainable fiscal policy would
encourage investment and allow for stable economic growth so that future
generations would not bear a tax or debt burden for services provided to
the current generation. An unsustainable condition exists when demographic
and other factors are projected to place significant pressures on future
generations and government finances over the long term and result in a
growing imbalance between revenues and expenditures.

Four of six case study countries produce reports on long-term (i.e., more
than 10 years) fiscal sustainability. The Netherlands first issued a
report on the long term in 2000. Both the United Kingdom and Australia
followed, issuing their first reports in 2002. New Zealand issued its
first report in 2006. Of our case study countries, only Canada and Iceland
currently do not issue long-term fiscal sustainability reports. [107]35
However, Canada is planning to issue a comprehensive fiscal sustainability
and intergenerational report in the near future. Of our limited review
countries, Norway reported that it has traditionally provided Parliament
reports on long-term budget projections as well as fiscal sustainability
analyses. Further, Switzerland is planning to issue a long-term fiscal
sustainability report in early 2008. [108]36

The European Commission is also increasing its focus on the fiscal
sustainability of the EU member states, including the Netherlands, United
Kingdom, Denmark, and Sweden, as part of the Stability and Growth Pact
(SGP). The SGP, an agreement by EU member states on how to conduct,
facilitate, and maintain their Economic and Monetary Union requirements,
requires member states to submit Stability or Convergence Reports, which
are used by the European Council to survey and assess the member's public
finances. [109]37 The guidelines for the content of these reports were
changed in 2005 to include a chapter with long-term projections of public
finances and information on the country's strategies to ensure the
sustainability of public finances. The European Commission uses this
information to annually assess and report on the long-term sustainability
of all EU members, including consideration of quantitative measures (e.g.,
primary balance, debt-to-GDP) and qualitative considerations of other
factors, such as structural reforms undertaken and reliability of the
projections. Such reporting includes an assessment of the sustainability
of member countries' finances, policy guidance to EU members to improve
sustainability, and discussion of the effect of significant policy changes
on the sustainability of member countries' finances. The Commission
released its first comprehensive assessment on the long-term
sustainability of public finances in October 2006. [110]38

35Canada issued a report called The Sustainable Development Strategy
2007-2009, which discusses strategies and progress relating to broad
fiscal, social, and environmental goals. This report is required by the
1995 amendment to the Auditor General Act. The report has been prepared
every 3 years since 1997 and is available at
[72]http://www.fin.gc.ca/toce/2006/sds2007e.html .

36Both Canada and Switzerland are federal systems and are planning to
report on fiscal sustainability for all levels of government--not just the
central government.

37The European Commission requires member states that have adopted the
euro (e.g., the Netherlands) to submit stability program updates annually
that cover at least the preceding year, the current year, and the next 3
years. Member states that have not adopted the EU currency (e.g., Denmark
and Sweden) prepare a "Convergence Report" annually that is similar to the
Stability Report but includes more information on monetary policy
objectives.

Whether a government will be able to meet its commitments when they arise
in the future may depend on how well it reduces its debt today so the
burden does not fall entirely to future generations. Countries may have
different assumptions about what is sustainable but one aim is to keep
debt at "prudent levels." Several of our case study countries have set
debt-to-GDP targets in their efforts to address fiscal sustainability
issues. For example, Canada wants to reduce its net debt (i.e., financial
liabilities less financial assets) for all levels of government to zero by
2021. Similarly, New Zealand's current objective is to reduce debt to
around 20 percent of GDP over the next decade. The United Kingdom, under
its sustainable investment rule, requires that public sector net debt is
to be maintained below 40 percent of GDP over the economic cycle.
Australia and the Netherlands have no explicit debt level targets,
although the Netherlands is subject to EU limits on general government
debt. [111]39

Several Common Measures Are Used to Assess Fiscal Sustainability

The countries studied used a number of measures to assess the fiscal
sustainability of their policies. Common approaches to assessing fiscal
sustainability include cash-flow measures of revenue and spending and
public debt as a percent of GDP as well as summary measures of fiscal
imbalance and fiscal gap (see table 2). Each measure provides a different
perspective on the nation's long-term financing. Cash-flow measures are
useful for showing the timing of the problem and the key drivers, while
measures such as the fiscal imbalance or fiscal gap are useful for showing
the size of action needed to achieve fiscal sustainability. Each measure
has limitations by itself and presents an incomplete picture. Therefore,
most countries use more than one measure to assess fiscal sustainability.

38Economic Policy Committee and European Commission, "The impact of ageing
on public expenditure: projections for the EU25 Member States on pensions,
health-care, long-term care, education and unemployment transfers
(2004-2050)," European Economy, Special Reports, no. 1 (Luxembourg, 2006).

39An important condition for successfully moving to a single European
currency is that economies of the participating countries should converge
toward each other and remain healthy. Therefore, members of the EU are
expected to avoid excessive budgetary deficits (i.e., above 3 percent) and
to ensure their debt-to-GDP ratio stays within the reference value limit
of 60 percent.

Table 2: Common Fiscal Indicators Used in Other Countries

Measure                  Used by        Description                        
Indicators that show the timing of long-term problem but not overall size
Future annual cash flows Australia      Illustrates the timing of and      
(as a percent of GDP)                   future trends in spending          
                            Netherlands    components, total spending, and    
                                           revenue and their relationship     
                            New Zealand    over time.                         
                                                                              
                            United Kingdom                                    
Future primary balance   Australia      The primary balance excludes net   
(as a percent of GDP)                   interest payments from underlying  
                            Netherlands    cash balances. Primary balances    
                                           offer useful parameters for the    
                            United Kingdom part of the budget that is         
                                           controllable.                      
Future annual            Australia      Illustrates the relationship       
projections of public                   between public debt and GDP over   
debt (as a percent of    Netherlands    time. The debt-to-GDP ratio        
GDP)                                    provides an indication of a        
                            New Zealand    nation's ability to repay its      
                                           public debt by comparing the size  
                            United Kingdom of its debt to the size of its     
                                           economy.                           
Future primary operating New Zealand    Illustrates the relationship       
balance                                 between future revenues and        
                                           expenses excluding financing costs 
                                           (measured on an accrual basis)     
                                           over time.                         
Indicators that show the size of long-term problem but not timing
Fiscal gap (as a percent Australia      Illustrates the change in fiscal   
of GDP)a                                policy needed to achieve a         
                            Norway         particular debt target at some     
                                           point in the future. This change   
                            United Kingdom can be calculated in terms of the  
                                           adjustment needed today or at some 
                                           point in the future.               
Fiscal imbalance or      Netherlands    The fiscal imbalance is similar to 
intertemporal budget                    the fiscal gap except that it is   
constraint (as a percent United Kingdom more stringent; it assumes that    
of GDP)a                                all government debt must be repaid 
                                           by the end of the period. It       
                                           illustrates whether and to what    
                                           extent the government's future     
                                           revenues cover future expenditures 
                                           and public debt.                   

Source: GAO.

aThese measures can be presented as either percents of GDP or in present
value dollars, however, case study countries focused on the percents of
GDP.

Two measures--the fiscal gap and fiscal imbalance--show the size of the
problem in terms of action needed to meet a particular budget constraint.
Changes in these measures over time are useful for showing improvement or
deterioration in the overall fiscal condition. The fiscal gap shows the
change in revenue or noninterest spending needed immediately and
maintained every year to achieve a particular debt target at some point in
the future. The fiscal imbalance (or intertemporal budget constraint) is
similar to the fiscal gap but the calculation assumes all current debt is
paid off by the end of the period. These summary measures can also be
calculated in terms of the adjustment needed in the future if adjustment
is delayed (which would increase its size). The change in policy can be in
the form of adjustments to taxes, spending, or both. A positive fiscal gap
or imbalance implies that fiscal policy should be tightened (i.e.,
spending cut or taxes raised) while a negative fiscal gap or imbalance
implies that fiscal policy could be loosened (i.e., spending increased or
taxes reduced). A fiscal gap or imbalance implies potential harm to future
generations if action to make public finances sustainable is deferred thus
requiring more budgetary actions (or higher interest costs) in the future
than today. It should be noted that a fiscal gap or imbalance of zero over
a finite period does not mean that current fiscal policy is sustainable
forever. For example, debt could still be rising faster than GDP at the
end of the period. Another limitation to these summary measures is that by
definition they do not provide information on timing of receipts and
outlays, which is important.

Most of the countries we studied used share of GDP measures rather than
present value dollar measures. In part this is to avoid the situation in
which a small change in the discount rate assumption leads to large swings
in the dollar-based sustainability measures. Present value dollar measures
are highly sensitive to assumptions about the discount rate. An increase
of 0.5 percentage points in the discount rate used to calculate the U.S.
fiscal gap reduces the present value of the fiscal gap from $54.3 trillion
to $47.7 trillion; in contrast such a change results in a smaller
proportional change to the gap as a share of GDP from 7.5 to 7.3 percent.
[112]40 Also, since the numbers can be so large, it may be difficult for
policymakers and the general public to understand without placing the
numbers in context of the resources available in the economy to finance
the fiscal gap.

Reports Stem from Law and Political Commitments

Fiscal sustainability reports are required by law in two
countries--Australia and New Zealand. [113]41 The legislation underpinning
both countries' fiscal sustainability reports does not dictate in detail
what measures should be included in the report. Rather, the law specifies
only the frequency of reporting (i.e., every 4 years for New Zealand and
every 5 years for Australia), the years to be covered, and the overall
goal. Both Australia and New Zealand are required to assess the long-term
sustainability of government finances over a 40-year horizon. Switzerland
is required by law and an accompanying regulation to issue a
sustainability report periodically, but at least every 4 years.

40Under GAO's Alternative simulation that is based on recent trends and
policy preferences. For more information on this simulation, see
[73]GAO-07-1261R .

41In Australia the legislation requiring the report is the Charter of
Budget Honesty Act of 1998 and in New Zealand the Public Finance Act, as
amended in 2004.

Neither the Netherlands' nor the United Kingdom's reports are required by
law. Instead, the reports stem from political commitments of the current
government. The Netherlands prepared its first report in 2000 and reported
again in 2006. In the United Kingdom the current government made a
political commitment to annually report on the long-term fiscal challenges
as part of the current government's fiscal framework and has prepared
reports annually since 2002. Canada's upcoming report also stems from a
commitment made by the current government. [114]42 A drawback of not
having any legal or legislative requirement for the report is that future
governments may or may not continue what the current government started.

Selection of Time Horizon Is Important

The size of a nation's fiscal gap or fiscal imbalance will depend on the
time period chosen. Even if a particular sustainability condition is
satisfied over the chosen period, there may still be fiscal challenges
further out. Extending the time period can partially address this
limitation, but it increases uncertainty. Most of the case study countries
that prepare fiscal sustainability reports cover the next 40 to 50 years.
However, the Netherlands report goes out through 2100. The United Kingdom
calculates the intertemporal budget constraint over an infinite time
horizon, which poses a high degree of uncertainty. Choosing the horizon
for the fiscal gap or imbalance calculations therefore involves a
trade-off in that it should be long enough to capture all the major future
budgetary developments but also short enough to minimize uncertainty. It
may be best to present these measures over a range of horizons.

Countries Use Sensitivity Analysis to Deal with Uncertainty

As with any long-term projection, uncertainty is an issue. To deal with
the uncertainty of projections, countries have done sensitivity analysis.
For example, the United Kingdom performed a sensitivity analysis using
different assumptions for productivity growth and interest rates. The
United Kingdom found that the fiscal gap was robust to changes in
productivity growth, meaning that the required policy action changed
little. However, the fiscal gap was more sensitive to changes in the
interest rate assumption. For example, in the United Kingdom, an increase
in the interest rate assumption from 2.5 percent to 3.0 percent increases
the fiscal gap for the 50-year period by 50 percent from 0.5 percent to
0.75 percent of GDP.

42See Department of Finance Canada, Budget 2007 (Mar. 19, 2007), p. 155,
which can be downloaded from [74]http://www.fin.gc.ca/access/budinfoe.html
.

In Some Countries, There Are Indications That the Long-Term Report Is Affecting
Nearer-Term Decisions

Sustainability requirements are important when setting short- and
medium-term policy targets. The sooner countries act to put their
governments on a more sustainable footing, the better. Acting sooner
rather than later permits changes to be phased in more gradually and gives
those affected time to adjust to the changes. Citizens can adjust their
savings now to prepare for retirement. In the Netherlands, a medium-term
fiscal target has been set based on the information presented in the
sustainability report. The current government has explicitly linked
expenditure ceilings and revenue targets to attaining a structural fiscal
surplus of 1 percent of GDP at the end of 2011, which the Netherlands
Bureau of Economic Policy Analysis has estimated is needed for public
finances to be sustainable given the impending population aging. [115]43
In addition a study group recommended that the adjustments should be
introduced gradually so that they are bearable for all generations.
[116]44

According to New Zealand officials, its fiscal sustainability report shows
that long-term demographic pressures will make it increasingly hard to
meet fiscal objectives and therefore policy adjustments will be required.
Recognizing that small changes made now will help to prevent making big
changes later on, officials said the report has encouraged and enabled
greater consideration of long-term implications of new policy initiatives
in the budget process. New Zealand intends to link departments' annual
Statements of Intent to long-term projections. Under this approach,
departmental objectives will have to be modified or justified to meet the
long-term objectives.

43See Netherlands Bureau of Economic Policy Analysis, Ageing and the
Sustainability of Dutch Public Finances (2006).

44See Government of Netherlands, Ageing and Sustainability, Twelfth Report
by the Study Group on the Budget Margin (Jun. 22, 2006).

Although Accrual Budgeting Can Help in Certain Areas, It Does Not Provide
Sufficient Information to Understand Longer-Term Fiscal Sustainability Issues

Before implementing accrual budgeting some countries were experiencing
moderate to large deficits. Some countries' dependence on trade and
foreign borrowing led to concerns that increased deficits could lead to
rising interest rates and devaluation of the currency, and ultimately a
financial crisis. As a result, fiscal discipline was necessary. Accrual
budgeting was adopted as part of larger reforms to improve transparency,
accountability, and government performance. The United States faces
long-term fiscal challenges that, absent reforms, could have adverse
effects in the form of higher interest rates, reduced investment, and more
expensive imports ultimately threatening our nation's well-being.

The range of approaches used by countries in our study illustrate that
accrual budgeting need not be viewed as a "one size fits all" choice. The
experiences of countries in our study show that the switch to accrual
budgeting was most beneficial for programs where cash- or
obligations-based accounting did not recognize the full program cost up
front. As we stated in 2000 and in other GAO reports, increased accrual
information in certain areas of the budget--insurance, environmental
liabilities, and federal employee pensions and retiree health [117]45
--can help the Congress and the President better recognize the long-term
budgetary consequencesof today's operations and help prevent these areas
from becoming long-term issues. However, accrual budgeting raises
significant challenges forthe management and oversight of capital
purchases and noncash expenses, especially depreciation. Many of our case
study countries implemented additional controls to maintain up-front
control over resources within their accrual budget frameworks. Indeed, in
the U.S. system of government where the Congress has the "power of the
purse," maintaining control over

While cost and performance information provided under accrual budgeting
can be useful, this information must be reliable if budget decisions are
to be based on it. We have reported that the financial management systems
at the majority of federal agencies are still unable routinely to produce
reliable, useful, and timely financial information. [118]46 Until there is
better financial information, a switch to full accrual budgeting may be
premature. As we reported in a previous report on U.S. agencies' efforts
to restructure their budgets to better capture the full cost of
performance, the use of full-cost information in budget decisions may
reflect rather than drive the development of good cost information in
government. [119]47

45For civilian employees hired since 1984 and personnel in 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. Also,
since 2001 the full cost of retiree health benefits for military retirees
eligible for Medicare is also recognized in the budget. However, the
remainder of federal pension and health benefits needs to be addressed.
The federal budget currently recognizes only about 40 percent of the cost
of pensions for civilians hired before 1984.

46See GAO's Auditor's Report in the 2006 Financial Report of the United
States Government (Washington, D.C.: Dec. 15, 2006).

47 [75]GAO-05-117SP .

Further, challenges exist in estimating accrual-based cost information for
some areas, including veterans compensation, federal employee pensions and
retiree health, insurance, and environmental liabilities, that require a
significant amount of the government's future cash resources. For example,
estimates of future outlays for pensions or veterans compensation depend
on assumptions of future wages, inflation, and interest rates that are
inherently uncertain and subject to volatility. Trends in health care
costs and utilization underlying estimates of federal employee
postretirement health benefits have also been volatile. The estimated
cleanup costs of the government's hazardous waste are another area where
the accrued expenses may not be based on reliable estimates. Not all
environmental liabilities have been identified and cleanup and disposal
technologies are not currently available for all sites. However, in areas
such as these, it may be preferable to be approximately right than exactly
wrong. Failure to pay attention to programs that require future cash
resources can further mortgage our children's future.

Although accrual budgeting can provide more information about annual
operations that require future cash resources, it does not provide
sufficient information to understand broader long-term fiscal
sustainability. An accrual budget does not include costs associated with
future government operations and thus would not help recognize some of our
greatest long-term fiscal challenges--related to Social Security,
Medicare, and Medicaid. A growing trend in other countries is to develop
reports on fiscal sustainability that evaluate the fiscal condition of not
only the key drivers of the nation's long-term fiscal outlook but
government as a whole. Fiscal sustainability reports that show future
revenue and outlays for social insurance programs and the
interrelationship of these programs with all federal government programs
would provide a comprehensive analysis of the nation's fiscal path and the
extent to which future budgetary resources would be sufficient to sustain
public services and meet obligations as they come due. By highlighting the
trade-offs between all federal programs competing for federal resources,
such a report would improve policymakers' understanding of the tough
choices that will have to be made to ensure future generations do not bear
an unfair tax or debt burden for services provided to current generations.

Most countries recognize the need for various measures of fiscal position,
including the projected debt-to-GDP ratios and fiscal gap measures. Since
no single measure or concept can provide policymakers with all the
information necessary to make prudent fiscal policy decisions, it is
necessary to use a range of measures or concepts that show both the size
of the problem and the timing of when action is needed.

Conclusions

This study and the deterioration of the nation's financial condition and
fiscal outlook since 2000 confirm our view that the Congress should
consider requiring increased information on the long-term budget
implications of current and proposed policies on both the spending and tax
sides of the budget. In addition, the selective use of accrual budgeting
for programs that require future cash resources related to services
provided during the year would provide increased information and
incentives to manage these long-term commitments. While the countries in
our study have found accrual-based information useful for improving
managerial decision making, many continue to use cash-based information
for broad fiscal policy decisions. This suggests that accrual measures may
be useful supplements rather than substitutes of our current cash- and
obligations-based budget. Presenting accrual information alongside
cash-based budget numbers, particularly in areas where it would enhance
up-front control of budgetary resources would put programs on a more level
playing field and be useful to policymakers both when debating current
programs and when considering new legislation.

Since accrual-based budgeting would not provide policymakers with
information about our nation's largest fiscal challenges--Social Security,
Medicare, and Medicaid--fiscal sustainability reporting could help fill
this void. The reports could include both long-term cash-flow projections
and summary fiscal gap measures for the whole of government that would
show both the timing and overall size of the nation's fiscal challenges.

Accrual budgeting and fiscal sustainability reporting are only means to an
end; neither can change decisions in and of itself. The change in
measurement used in the budget provides policymakers and program managers
with different information, but the political values and instincts of
policymakers may not change. While recognizing fuller costs could help
inform policymakers of the need to reform, it will require action on their
part to address them. Any expansion of accrual-based concepts in the
budget or increased reporting requirements would need to be accompanied by
a commitment to fiscal discipline and political will.

Matter for Congressional Consideration

To increase awareness and understanding of the long-term budgetary
implications of current and proposed policies for the budget, the Congress
should require increased information on major tax and spending proposals.
In addition, the Congress should consider requiring increased reporting of
accrual-based cost information alongside cash-based budget numbers for
both existing and proposed programs where accrual-based cost information
includes significant future cash resource requirements that are not yet
reflected in the cash-based budget. Such programs include veterans
compensation, federal employee pensions and retiree health, insurance, and
environmental liabilities. To ensure that the information affects
incentives and budgetary decisions, the Congress could explore further use
of accrual-based budgeting for these programs.

Regardless of what is decided about the information and incentives for
individual programs, the Congress should require periodic reports on
fiscal sustainability for the government as a whole. Such reports would
help increase awareness of the longer-term fiscal challenges facing the
nation in light of our aging population and rising health care costs as
well as the range of federal responsibilities, programs, and activities
that may explicitly or implicitly commit the government to future
spending.

We are sending copies of this report to interested parties. Copies will
also be sent to others upon request. In addition, the report will be
available at no charge on the GAO Web site at [120]http://www.gao.gov .
Please contact Susan Irving at (202) 512-9142 or [email protected] if you
have any questions about this report. Key contributors are listed in
appendix II.

Susan J. Irving
Director, Federal Budget Analysis Strategic Issues

Appendix I: Objectives, Scope, and Methodology

To update the findings of our 2000 report, we examined (1) where, how, and
why accrual budgeting is used in select Organisation for Economic
Co-operation and Development (OECD) countries and how it has changed since
2000; (2) what challenges and limitations were discovered and how select
OECD countries responded to them; (3) what select OECD countries perceived
the effect to have been on policy debates, program management, and the
allocation of resources; (4) whether accrual budgeting has been used to
increase awareness of long-term fiscal challenges and, if not, what is
used instead; and (5) what the experience of select OECD countries and
other GAO work tell us about where and how the increased use of accrual
concepts in the budget would be useful and ways to increase the
recognition of long-term budgetary implications of policy decisions.

To address these objectives, we primarily focused on the six countries in
the 2000 GAO report:

* Australia, 

* Canada, 

* Iceland, 

* the Netherlands, 

* New Zealand, and: 

* the United Kingdom. 

We also did a limited review of two other nations--Denmark and
Switzerland--that have recently expanded the use of accrual measures in
the budget. Since these countries may not provide a complete picture of
the potential limitations or the use of alternative ways to increase the
focus on long-term fiscal challenges, we also looked at two
countries--Norway and Sweden--that considered expanding the use of accrual
measurement in the budget but decided against it, to understand why.

We reviewed budget publications and used a set of questions to gather
information on how and why accrual concepts are used in the budget in the
selected countries and how this has changed since 2000. For context, we
also reviewed the results of a recent survey done by the OECD on budgeting
practices in all OECD countries and compared to older survey results to
understand general trends in the use of accrual budgeting over time. To
identify factors that facilitated accrual budgeting; strategies for
addressing commonly cited implementation challenges; and how and where
accrual has or has not changed the budget debate, we primarily focused on
the six countries studied in 2000. We interviewed (by e-mail, telephone,
and videoconferencing) officials from the budget and national audit
offices in select countries and reviewed official budget documents and
related literature to gather information on the challenges and limitations
of accrual budgeting; how the use of accruals in the budget has affected
policy debates, resource allocation decisions, and program management; and
other approaches used to address long-term fiscal challenges. We did not
interview parliamentary officials or staff or program managers. The
information on foreign laws in this report does not reflect our
independent legal analysis, but is based on interviews and secondary
sources. We identified key themes from the experience of other nations,
reviewed past GAO work, and considered the differences between other
nations and the United States to identify useful insights about how to use
more accrual-based or other information to inform budget debates.

The experience of any one OECD country is not generalizable to other
countries. In analyzing other countries' experiences and identifying
useful insights for the United States, it is important to consider the
constitutional differences between Parliament in parliamentary systems of
government and the Congress of the United States, especially in the role
each legislature plays in the national budget process. The U.S. Congress
is an independent and separate, but coequal, branch of the national
government with the constitutional prerogative to control federal spending
and resource allocation. Many important decisions that are debated during
the annual budget and appropriations process in the United States occur in
case study countries before the budget is presented to Parliament for
approval. Also, most case study countries generally deal with the approval
of obligations through agency or bureaucratic controls whereas in the
United States congressional approval (i.e., "budget authority") is
required before federal agencies 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.

Appendix II: GAO Contact and Staff Acknowledgments

GAO Contact

Susan J. Irving, (202) 512-9142 or [email protected]

Acknowledgments

Key contributors to this assignment were Jay McTigue, Assistant Director;
Melissa Wolf, Analyst-in-Charge; Michael O'Neill; and Margit Willems
Whitaker.

(450572)

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Highlights of [129]GAO-08-206 , a report to the Committee on the Budget,
U.S. Senate

December 2007

BUDGET ISSUES

Accrual Budgeting Useful in Certain Areas but Does Not Provide Sufficient
Information for Reporting on Our Nation's Longer-Term Fiscal Challenge

The federal government's financial condition and fiscal outlook have
deteriorated dramatically since 2000. The federal budget has gone from
surplus to deficit and the nation's major reported long-term fiscal
exposures--a wide range of programs, responsibilities, and activities that
either explicitly or implicitly commit the government to future
spending--have more than doubled. Current budget processes and
measurements do not fully recognize these fiscal exposures until payments
are made. Increased information and better incentives to address the
long-term consequences of today's policy decisions can help put our nation
on a more sound fiscal footing.

Given its interest in accurate and timely information on the U.S. fiscal
condition, the Senate Committee on the Budget asked us to update our study
of other nations' experiences with accrual budgeting and look at other
ways countries have increased attention to their long-term fiscal
challenges.

[130]What GAO Recommends

The Congress should require increased reporting on the long-term budgetary
implications of major tax and spending programs. In addition, Congress
should explore using accrual budgeting for certain programs to ensure the
information affects incentives and budget decision making. Congress should
also require periodic reports on fiscal sustainability for the government
as a whole.

In 2000, GAO reviewed the use of accrual budgeting--or the recording of
budgetary costs based on financial accounting concepts--in Australia,
Canada, Iceland, the Netherlands, New Zealand, and the United Kingdom.
These countries had adopted accrual budgeting more to increase
transparency and improve government performance than to increase awareness
of long-term fiscal challenges. Accrual budgeting continues to be used in
all six countries; Canada and the Netherlands, which use accrual
information selectively, considered expanding the use of accruals but thus
far have made only limited changes. Since 2000, other countries have
considered using accrual budgeting. For example, Denmark and Switzerland
began using accrual budgeting on a selective basis. Norway and Sweden,
however, rejected accrual budgeting primarily because they believed cash
budgeting enables better control over resources.

Countries have taken different approaches in the design of their accrual
budgets. The figure below shows the range of approaches used. Regardless
of the approach taken, cash information remains important in all the
countries for evaluating the government's finances. Other countries'
experiences show that accrual budgeting can be useful for recognizing the
full costs of certain programs, such as public employee pensions and
retiree health, insurance, veterans benefits, and environmental
liabilities, that will require future cash resources. However, these other
countries do not use accrual budgeting to recognize their long-term fiscal
challenges that are primarily driven by public health care and pension
programs. Instead, many countries in GAO's study have begun preparing
fiscal sustainability reports to help assess these programs in the context
of overall sustainability of government finances. European Union members
also annually report on longer-term fiscal sustainability.

Range of Accrual Budgeting Use

Although no change in measurement or reporting can replace substantive
action to meet our longer-term fiscal challenge, GAO believes that better
and more complete information on both the full-cost implications of
individual decisions and on fiscal sustainability of the government's
finances can help.

References

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