Budget Issues: Accrual Budgeting Useful in Certain Areas but Does Not Provide Sufficient Information for Reporting on Our Nation's Longer-Term Fiscal Challenge
Published: 2007-12-20T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: 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.
section_title: What GAO Found
paragraphs: 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. 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. 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.

section_title: Letter
paragraphs: 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 and  so encourage action to address them, we looked at the use of accrual  budgeting in Australia, Iceland, New Zealand, and the United Kingdom.  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.
We concluded that the current cash- and obligation-based budget 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. 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.
Specifically, this report examines:  1.  Where, how, and why is accrual budgeting used in select Organisation  for Economic Co-operation and Development (OECD) 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 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.
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.
subsections: section_title: Background
paragraphs: The U.S. federal budget serves as the primary financial plan of the federal  government and thus plays a critical role in the decision-making process.  Policymakers, managers, and the American people rely on it to frame their  understanding of significant choices about the role of the government and  to provide them with information to make decisions about individual  programs and overall fiscal policy. 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. 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.
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.”
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.
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.
subsections: section_title: Cash and Accrual Measures of the Government’s Annual Fiscal Condition
paragraphs: 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, the unified budget  deficit/surplus is the difference between cash receipts and cash o the government as a whole including any Social Security surplus. utlays for   The  second measure, the government’s net operating cost, is the amount by mount by which costs—as reported on an accrual basis—exceed revenue and is  which costs—as reported on an accrual basis—exceed revenue and is  reported in the federal government’s financial statements.  Figure 1 show reported in the federal government’s financial statements.
The 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. 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:    civilian employee benefits,    military employee benefits,    veterans compensation,    environmental liabilities (e.g., cleanup and disposal),   insurance programs, and    capital assets.
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.
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. 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).
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.
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.
section_title: Although Certain OECD Countries Continue to Use Accrual Budgeting, Objectives and Approaches Vary Significantly
paragraphs: 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.
subsections: section_title: Accrual Budgeting Continues to Be Used in the Six Countries Studied but Two Did Not Expand Their Use as Previously Anticipated
paragraphs: 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. 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. 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.
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.
section_title: Most Countries Use Accruals Primarily to Increase Transparency and Improve Government Performance
paragraphs: 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.
subsections: section_title: Australia and New Zealand
paragraphs: Since the 1990s, Australia and New Zealand have extensively used accruals  in conjunction with output-based budgeting. 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, 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.
section_title: The Netherlands
paragraphs: 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.
section_title: The United Kingdom
paragraphs: 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.
section_title: Some Countries Use Accrual Measures Selectively in Areas Where It Enhances Transparency of the Government’s Future Cash Requirements
paragraphs: 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.
subsections: section_title: Iceland
paragraphs: 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.
section_title: Canada
paragraphs: 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. 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.
section_title: Cash Information Remains Important, Particularly for Monitoring a Country’s Fiscal Position
paragraphs: 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. 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. 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.
section_title: Several Other OECD Countries Have Considered Accrual Budgeting since 2000 but Reached Different Decisions
paragraphs: 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.
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.
section_title: Countries Faced a Number of Common Challenges Inherent to Accrual Reporting That Led to Some Changes in Their Approach
paragraphs: 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.
subsections: section_title: Countries Have Generally Addressed Challenges Related to Developing Accounting Standards to Be Used in the Budget, Including Asset Identification and Valuation
paragraphs: 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.
section_title: Developing Reliable Financial Data Is Seen as a Prerequisite to Accrual Budgeting in Some Countries
paragraphs: 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. 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. 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.
section_title: Volatility in Aggregate Accrual Measures Can Lead to Use of More Cash- Like Measures
paragraphs: 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. 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.
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. 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.
section_title: Complexity of Accrual- Based Accounting and Use of Cash-Based Fiscal Targets Makes It Difficult for Policymakers to Focus on Accrual Measures
paragraphs: 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, Australia’s  Treasurer primarily focused on the cash-based fiscal position to show the  government’s effect on national savings. Agency managers therefore have  an obligation to manage both the cash and accrual implications of their  resource use.
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. 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.
section_title: Concerns about Management and Oversight of Noncash Expenses Can Lead to Increased Use of Cash Controls
paragraphs: 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.
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. 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.
section_title: Some Governments Have Had to Address Parliamentary Concerns
paragraphs: 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.
section_title: Accrual Cost Information Helped Inform Some Debates That Led to Improvements in Fiscal Condition
paragraphs: 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.
subsections: section_title: Accrual Budgeting May Provide Better Cost Information than Cash Budgeting for Resource Allocation Decisions
paragraphs: 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.
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. 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.
section_title: Accrual Budgeting Attributed with Helping to Control or Manage Certain Long-Term Commitments
paragraphs: 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.
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. 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.
section_title: Countries Use Other Methods to Increase Awareness of Greatest Long-Term Fiscal Challenges
paragraphs: 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.
subsections: section_title: Aging-Related Expenditures Are Major Drivers of Long-Term Fiscal Challenges in Other Countries
paragraphs: 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 7½ 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.
section_title: Long-Term Fiscal Sustainability Reports Used by Many Countries to Raise Awareness of Long- Term Fiscal Challenges
paragraphs: 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. 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.
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. 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.
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.
section_title: Several Common Measures Are Used to Assess Fiscal Sustainability
paragraphs: 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.
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. 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.
section_title: Reports Stem from Law and Political Commitments
paragraphs: Fiscal sustainability reports are required by law in two countries— Australia and New Zealand. 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.
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. 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.
section_title: Selection of Time Horizon Is Important
paragraphs: 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.
section_title: Countries Use Sensitivity Analysis to Deal with Uncertainty
paragraphs: 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.
section_title: In Some Countries, There Are Indications That the Long-Term Report Is Affecting Nearer-Term Decisions
paragraphs: 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. In  addition a study group recommended that the adjustments should be  introduced gradually so that they are bearable for all generations.
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.
section_title: Although Accrual Budgeting Can Help in Certain Areas, It Does Not Provide Sufficient Information to Understand Longer- Term Fiscal Sustainability Issues
paragraphs: 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—can help the Congress  and the President better recognize the long-term budgetary consequences of today’s operations and help prevent these areas from becoming long- term issues. However, accrual budgeting raises significant challenges for  the 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  resources is important.
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.
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.
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.
section_title: Conclusions
paragraphs: 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.
section_title: Matter for Congressional Consideration
paragraphs: 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 http://www.gao.gov. Please contact  Susan Irving at (202) 512-9142 or irvings@gao.gov if you have any  questions about this report. Key contributors are listed in appendix II.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: 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 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.
section_title: Appendix II: GAO Contact and Staff Acknowledgments
subsections: section_title: Acknowledgments
paragraphs: Key contributors to this assignment were Jay McTigue, Assistant Director;  Melissa Wolf, Analyst-in-Charge; Michael O’Neill; and Margit Willems  Whitaker.