Integration of Accrual-Based Accounting, Budgetary Accounting, Cost Accounting and Performance Measurement

Ronald Young, Consultant and former Executive Director, Federal Accounting Standards Advisory Board What is Integration?

"Integration" has become one of the most overused words in federal financial management. Many use the word in reference to financial accounting and budgeting functions. "Integration" is also used in the context of multiple financial management systems operated by an agency. However, I have seen no uniform definition of the word in accounting literature. Indeed Integration" means different things to different people.

Regarding the financial accounting and budgetary accounting processes, some think of Integration" as a reconciliation process that explains differences between different bases of accounting (e.g., cash basis and accrual basis). Others think of it as using one basis of accounting (accountants favor full accrual) for all decisions and for budgeting purposes. New Zealand has adopted such an approach, and Great Britain is experimenting with a full accrual budget.

From what I have learned about the way governments operate, especially large ones such as the U.S. federal government, a more practical concept of "Integration" is the notion of striving for the development of a robust data base where differences between financial accounting and budget accounting are narrowed to conform to accrual-based principles where appropriate, while allowing differences where they are needed to distinguish between the unique nature of certain federal government activities and those in the private sector.

I see "Integration" of accrual-based financial accounting and the budgeting processes as adding dimensions to the way policy makers analyze and understand a program. "Integration" should improve the decision-making process by offering program managers, administrators, and elected officials a multidimensional view of a program.

Unless financial accounting information based on accrual concepts finds its way into the "management information system" of program managers, administrators and elected officials, the power of the information cannot be internalized into the decision-making process. The goal should be to assist these potential users by providing sound economic information using accrual-based accounting where appropriate. This information can then be "integrated" or "linked," with the Budget, and with financial and cost reporting, which in turn should be "linked" to performance measurement.

The U.S. Federal Government Works Toward "Integration" of Financial Information

The U.S. federal government has been working toward achieving the "Integration" objective in a very serious and dedicated manner for about six years now. In 1990 the federal government enacted the Chief Financial Officers Act (CFO Act). The purpose of this act, in a nutshell, was to vastly improve financial management in the federal government. The Act established an infrastructure of chief financial officers and deputy chief financial officers whose sole responsibility is to carry out the necessary steps to achieve the expectations of the CFO Act. The Act also established the goal of modernizing and integrating all financial management systems. The CFO Act called for a data base of financial information and performance measures that managers and elected officials could rely upon to assess the cost and performance of programs. Our hope is that this data base of information would provide added dimensions to the cash-based information. Decision-makers should be able to rely upon this database for assistance in allocating resources in the Budget.

In addition to the CFO Act, Congress enacted the "Government Performance and Results Act." This law required the establishment of pilot programs to identify performance measures and track them to see if they have a useful impact in managing programs. The General Accounting Office, the Office of Management and Budget, and the Department of the Treasury also established the Federal Accounting Standards Advisory Board (FASAB). The Board's goal was to develop a body of "generally accepted accounting standards" (including cost accounting standards) for federal agencies. The agencies would incorporate these standards into their financial accounting and, in some respects, their budgetary accounting systems. They would be able to rely upon these accounting systems when preparing general purpose financial statements and cost reports that would be subject to the scrutiny of an audit. The FASAB completed a body of "generally accepted accounting standards" and cost accounting standards for the federal government in 1996. These standards are now being "integrated" into the accounting system of all federal agencies. It is expected that many of these standards will also, in time, be incorporated into the budget or at least used in making budget decisions.

The Budget

Before going further I must explain a little about the Budget and the preeminent role it plays in the allocation of resources in the federal government. The current federal budget is, in most respects, a cash-based budget. Although the expectation is that this will change over time to recognize costs and losses as they occur (recognized and measured using accrual principles). Currently, costs or losses that would normally be recognized when incurred under private sector accounting standards are not recognized in the Budget until the year the President and\or the Congress decides there will be a cash outflow. And much of the debate in Congress is over the magnitude of the cash expenditures in the Budget. Because the Budget is mostly cash based, program managers have, in the past, only been held accountable for meeting the cash expenditures in the Budget (spending all the money allocated). Until recently very little interest has been expressed in knowing the true cost of programs (i.e., those costs and losses that would be recognized on an accrual basis) and managing to minimize those costs. Furthermore, there has been no requirement to apply any cost accounting standards to assess the full cost of delivering government goods and services. Cash outlays for programs are currently fragmented among several other programs and costs are not accounted for on a unified program basis. This has made it difficult to establish and track meaningful performance measures for programs. Until recently very little interest in obtaining such information existed. The Office of Management and Budget is exploring ways to reorganize the budget structure to be compatible with financial reporting on economic units rather than on budget accounts.

A More Business-like Approach

However, the environment is rapidly changing. The change began in earnest when the CFO Act was enacted. The mandate became even more urgent under the leadership of Vice President Gore and his National Performance Review (NPR). The NPR focused on downsizing personnel and upgrading technology, establishing enterprise funds for federal activities that could operate in a business-like manner, outsourcing activities, modernizing and "integrating" federal financial management systems, and improving financial reporting, cost accounting and performance measurement. Our citizens are demanding a smaller and more efficiently run government, as evidenced by the election of new members of Congress who actively promote these goals. These new members of Congress, both Democratic and Republican, have shown an enormous interest in taking more business-like approaches to running the government. Many old guard politicians whose main interest was in spending money to make their constituents happyÑregardless of the cost-benefit of the spendingÑhave either retired or were defeated in the elections.

Our Strategy

We devised a strategy to develop a body of accrual-based accounting standards that could be "integrated" into the financial accounting systems of the agencies and also supplement the Budget. When this "Integration" is complete it will significantly enhance the database of information available to managers, budget experts and others. This enhanced database will help budget specialists, administrators and elected officials with management, budget, and policy decisions. It will also help to monitor performance measures.

Only when financial accounting standards are substantially incorporated into the Budget, and managers become accountable for controlling the costs of their programs and managing to meet expectations established by performance measures, will the power of economic based accounting standards become "integrated" into the financial management process. When this occurs the behavior of managers will begin to become economically driven.

Of course, developing financial accounting and cost accounting standards for "Integration" into the budget requires financial management systems that are also "integrated" or "linked." This is an effort that is taking place in earnest in our government. In fact, each year the Office of Management and Budget and the CFOs present to Congress an updated five year plan spelling out the progress made in streamlining financial management systems. The reports that accompany these plans give the impression that progress is being made, albeit slowly.

The FASAB was created as a deliberative body and as a forum where the accountants, the budget experts and the program managers could work together to develop meaningful accounting standards to help improve the financial management of the federal government and to help the citizenry understand the condition of the government's finances. The FASAB members focused on an accrual-based accounting system, generally, for the financial reporting. However, they did not do this by simply attempting to follow private sector standards blindly. The FASAB and its staff worked closely with our Office of Management and Budget and our Congressional Budget Office to identify areas where accrual accounting might be useful for assessing the cost of programs and for incorporation into the budget.

Where Financial Accounting and Budgetary Accounting Meet

For example, many members of the budget community saw merit in adjusting the budget estimates of future cash outflows using an accrual-based accounting system that recognizes losses for programs such as:

Prior to the new federal accounting standards, losses associated with these major programs were only budgeted for the years when cash outflows were expected, not when the losses were actually incurred. Now, with the new standards, assuming these estimated losses are incorporated into the budget, there will be significant areas where financial reports and budget statements will be the same or very similar. Also, the costs recognized in the budget and financial statements will become a part of the costs in measuring the performance of these programs. As you can see, I hope, bringing together financial and budgetary accounting in these major areas will achieve an "Integration" of financial accounting, cost accounting, budgetary accounting and performance measurement that should be of significant value to all who use financial data.

Financial accounting and budgetary accounting for many of our social programs will continue to be done on a cash basis. These are programs where the government is, in effect, giving money to citizens who meet certain means tests. Examples of these are food stamps, aid for dependent children, and other similar programs.

Social Security and Medicare, our two largest social programs, are also accounted for on a cash basis for now. However, many knowledgeable people believe that a full accrual liability using actuarial projection should be reported in both the financial statements and the Budget. There are also persuasive arguments to the effect that these programs are not actually different from entitlement or social programs, because they are financed mostly out of payments by workers into a "trust fund." The argument goes that these are in essence payments into a pension plan. However, our Social Security Administration, its actuaries, and many budget experts argue that these payments are really a separate tax levied to finance these programs. While this issue is being debated, the FASAB standards will require that financial accounting substantially follow the Budget accounting.

Accounting for Capital Assets

Until the new body of "generally accepted accounting standards" was established, the federal government, as a general rule, did not capitalize assets and record depreciation on them, with the exception of revolving funds that are run like a business. (I should point out that the U.S. Comptroller General did publish a body of accounting standards known as "Title 2." These standards were viewed as a "rubber stamping" of private sector standards for the federal government. However, these standards were never generally accepted by the Executive Branch of the federal government, principally because they did not take into account the unique aspects of a national government). The federal government holds vast resources and assets. Most private sector accountants believed that these assets should be capitalized and depreciated. In fact they often cite the government of New Zealand, which does capitalize and depreciate all assets, as a model for other countries to follow. However, New Zealand has made other reforms in managing its government, which are based on a unicameral system, that are not practical for countries such as the United States. The FASAB did study the New Zealand initiative and was influenced by it in some respects. However, after a series of user needs assessments, intensive discussion by FASAB members, exposure drafts, and several public hearings, FASAB decided that the information about assets that was needed varied depending on the asset and the use. If the information is to be useful and "integrated" into the budget decisions, the accounting standards must provide for this information.

Program managers and budget analysts are very interested in knowing the full cost of delivering government services, including the capital cost (depreciation) of the assets used and consumed in delivering the service. For example, they agree that buildings, computers, furniture, rolling stock, communications equipment, government roads and timber grown for harvest, should be capitalized and depreciated. And the depreciation should be part of the total cost of the goods or services. These costs should eventually be incorporated into budget decisions and into the Budget. However, regarding our military weapon systems (e.g., ships, missiles, tanks, aircraft) cost information is considered important, but the depreciation component is not. More important to users is information about the magnitude of deferred maintenance associated with these assets. A reliable assessment of the dollar value of deferred maintenance can be used for budget purposes to provide for future cash outlays that will be needed to keep these assets operational. Regarding nuclear submarines, the cost of decontaminating these vessels (measured in the billions of dollars) at the end of their useful life is important information to consider in the Budget. Estimates of decontamination costs can be accrued over the life of the vessel and included in the total cost of operations; a liability for the future cost of decontamination can also be established. The past practice has been to ignore these costs until the time when the actual decontamination was scheduled. These are some additional examples of'ÔIntegration" of financial accounting and budgetary accounting.

The federal government owns vast amounts of land. Those who manage these lands and many members of Congress are not interested in placing a monetary value on them in order to capitalize them on a balance sheet. The value of these lands in total is not a meaningful figure because the government is not in the business of selling land. The government is the custodian of the public lands. However, from a management and budgetary perspective there is great interest in the quantities of land, locations, uses, maintenance costs, and cost to preserve (prevent erosion), or clean up hazardous waste. Users believe this type of information is useful from the management and budget perspective. By designing accounting standards to accommodate these needs the information could be "integrated" into the decision process and into the Budget.

A Need For Cost Accounting

When the FASAB set out to accomplish its tasks, members of Congress, program managers and budget experts expressed an overriding interest in good cost information. They were extremely interested in knowing the full cost of delivering government goods and services. They did not see a lot of value in the balance sheet (except for business type activities). Therefore a major focus in designing the accounting standards was to ensure the development of adequate expense and cost information that would help determine the full cost of providing goods and services on a program basis. The balance sheet was a secondary concern, though still important. Both program managers and budget analysts believed that unless the accounting standards provided for consistent and reliable cost and expense information about the full cost of delivering services and for use in performance measurement, there could be no meaningful Integration" into the management information system.

The FASAB developed a body of cost accounting standards that all federal agencies are required to implement soon. The FASAB endorsed Activity Based Costing (ABC) as superior to traditional costing approaches but they did not require it. Whether traditional costing or ABC is implemented by an agency, it is likely to be a major effort because very few people in the federal government have the knowledge and skills to design even a rudimentary cost accounting system. Furthermore, many agencies do not have accounting and other systems that are integrated to the extent that they provide consistent and reliable information. This will change, but it will take time. There are several organizations in our government where efforts to install cost accounting systems are in progress. Most seem to be favoring ABC systems. In many instances these agencies are also attempting to install basic core accounting systems (accounting, payroll, travel, inventory). In these particular instances consultants, such as myself, work with agency staff to help them integrate their financial accounting and cost accounting. We help them analyze their business processes and develop links between work activities and products or services so that the cost of only the activities used are part of the cost of production. To accommodate the cost accounting process in most instances some revisions to the general ledger accounts are needed. Then, depending on the type of cost accounting system to be used (i.e., activity based or traditional), appropriate cost accounting software will be needed. This software must easily interface with the accounting system. The software draws off needed expense data and activity data from the accounting system and other systems, and performs cost analysis based on the user-defined parameters. A number of commercial off-the-shelf software packages are available to suit these user needs. This is much more cost-effective than attempting to develop one's own cost accounting software. Where management prefers the traditional cost accounting method, accounting and financial management packages exist that contain tables permitting the allocation of cost to departments and products. Most entities who are developing cost accounting systems today are revolving funds and enterprise funds where the cost of producing goods or services is expected to be recovered by user fees. However, the new cost accounting standards must be implemented by all federal agencies. This effort to develop cost accounting systems for all agencies will take time, but I believe with the high quality cadre of CFOs the federal government has recruited, and with their persistent effort, the practice of cost accounting will become routine in the not too distant future.

A Government-Wide Standard General Ledger

In the federal government we have what is known as the Standard General Ledger. This is a uniform chart of accounts that must be maintained at the government-wide level. Each department and agency is permitted to maintain more detailed accounts for their own financial management purposes. All agencies are required to be in compliance with the Standard General Ledger. However, only about 60% are in full complianceÑthe others use conversion tables to produce data for the Standard General Ledger, while working toward compliance. The quality and reliability of these converted data are in question. As the FASAB developed the new accounting standards for the federal government, the FASAB staff worked with the agencies to make the needed changes (e.g., add, modify and delete accounts) in the Standard General Ledger. This helped to facilitate the integration of the accounting standards into each agency's financial management system. This is because each agency's financial statements are expected to be based on the information drawn from their own general ledger which should be mapped to the Standard General Ledger.

Conclusion

I would like to conclude by emphasizing that the "Integration" of accrual-based accounting standards into systems is more than a mechanical feat. It is a systematic approach to developing standards that meet the needs of users. If these needs are satisfied, the "Integration" is achieved when the users (i.e., program managers, budget analysts, elected officials, and public citizens) use the information to manage programs, control costs, and influence the allocation of resources in the Budget.