Accrual Accounting And Accrual Budgeting

Accrual Budgeting – Tarun Das

Accrual Accounting and Accrual BudgetingBasic Concepts and Methodology

Prof. Tarun Das1, Ph.D.

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Glocoms Inc. (USA) Strategic Planning Expert, ADB Capacity Building Project on Governance Reforms. For any clarifications contact [email protected]. Glocoms Inc. (USA)

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MOF, Govt. of Mongolia

Accrual Budgeting – Tarun Das

CONTENTS 1 Introduction 1.1 Cash and Accrual Accounting 1.2 Accrual Accounting in Developing Countries 1.3 Accrual Accounting and Economic Statistical Systems 2 Government Accounting Systems 2.1 A simple example of accrual accounting 3 An Operational Cash Plus Accrual Accounting System 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9 3.10 3.11 3.12 3.13 3.14 3.15 3.16 3.17

Accrue wages earned by employees but not yet paid to them. Accrue Pension and Health insurance contributions due Record interest expenses on a mortgage or loan and update the loan balance. Record prepaid insurance. Adjust books for inventory on hand at period end. Accrue interest income earned but not yet received. Record depreciation expense. Adjust for bad debts or contingent liabilities Accrue dividends payable if a corporation. Accrue zero coupon bonds Accrue income taxes payable if a corporation. Account for the sale of fixed assets. Set up accounts receivable balance Set up accounts payable balance Preparing Financial Statements Converting accrual profits to cash flows Projecting cash outflows

4 Status of Accrual Accounting in OECD Countries 5 Pros and Cons of Accrual Accounting 5.1 Benefits of Accrual Accounting 5.2 Critique of Accrual Accounting 5.3 Concluding observations SELECTED REFERENCES

Glocoms Inc. (USA)

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MOF, Govt. of Mongolia

Accrual Budgeting – Tarun Das 1. Cash and Accrual Accounting There are two basic accounting methods- cash and accrual (sometimes called cash basis and accrual basis). The major difference between cash and accrual is that under a cash method, income and expenses are recorded at that point in time when money is actually received or paid. In contrast, under an accrual method, incomes and expenditures are recorded at the time when the economic value is created, transformed, exchanged, transferred, or extinguished irrespective of the time of cash receipts or cash payments. In a nutshell, cash method and accrual method differ only in the timing of when transactions are credited or debited to the financial accounts. Under the accrual method, transactions are counted when the order is made or the item is delivered or the services occur, and it does not matter whether the money is actually received or paid. Under the cash method, income is not counted until cash (or a bank instrument) is actually received, and expenses are not counted until they are actually paid. Cash Method Accounting The cash method of accounting is very simple to use, because it's usually obvious when money comes in or goes out. By contrast, the accrual method requires to recognize transactions when they occur, not necessarily when the cash flows. Besides, for accrual accounting, both the payments and receipts for financial and non-financial assets are required to be recorded at the prevailing market prices and not by the face value. Under both cash and accrual accounting, the purchase price of capital assets must be depreciated or amortized over a number of years. Similarly, if some advance payments are made for an expense that applies beyond the end of the current year, the payments must be prorated and deducted proportionately over the period for which the payments apply. This applies for payments for insurance and repayments of loans. Advance lease payments must be deducted in the year to which they apply, and amounts paid to acquire a lease from another lessee must be deducted evenly over the course of the entire lease. Accrual Method Accounting The accrual method is the more commonly used method of accounting for business enterprises. Under the accrual method, incomes from the sale of goods and services are recorded when the sale occurs; and expenses are recorded when goods or services are received, even though actual payments may take time. To be more precise, under the accrual method, an item of income is recognized when all the events that establish the right to receive the income have happened, and when the amount of income is known with reasonable degree of accuracy. If the estimated and recorded amount differs from the amount eventually received, then an adjustment is made to the income when the payment is actually received. Glocoms Inc. (USA)

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MOF, Govt. of Mongolia

Accrual Budgeting – Tarun Das Similarly, an item of expense is recognized when one becomes liable for it, it does matter whether the amount is actually paid or not in the same year. Becoming liable means that all events have occurred that establish obligation for payments. Thus, the accrual method provides a more accurate picture of the fiscal balance than the cash method, because incomes are recorded on the books when they are truly earned, and expenses are recorded when they are incurred. Basic differences between Cash and Accrual Accounting are indicated in the following table: Table-1: Differences between Cash and Accrual Systems 1. Cash accounting records receipts when 1. Accrual accounting recognizes events and cash is banked and payments when cash is paid.

transactions when they occur, regardless of when cash changes hands.

2. Only a cash flow statement is prepared under cash accounting.

2. Under accrual accounting2—in addition to the cash flow statement— two key financial statements are presented:

2.1 Operating Statement: Shows the financial results of an organization during a period. 2.2 Balance Sheet: Shows all assets and liabilities at a certain point in time, providing insights on the organization’s long-term financial sustainability.

Hybrid method or Cash plus Accrual method Hybrid method means use of accrual accounting to the extent possible and use of cash accounting for the remainder of incomes and expenses. 1.2 Accrual Accounting in Developing Countries Figure-1 illustrates common government levels and sectors. Historically, budgeting and accounting methods generally differ among sectors. For example, central government agencies generally use cash accounting while provincial and local governments, public sector enterprises, and statutory bodies prepare accrual-based reports. 2

International accounting standards require the preparation of four primary key statements: (i) Statement of Financial Position (balance sheet); (ii) Statement of Financial Performance (operating statement, income statement or profit and loss account); (iii) Statement of Changes in Net Assets/ Equity; and (iv) Cash Flow Statement.

Glocoms Inc. (USA)

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MOF, Govt. of Mongolia

Accrual Budgeting – Tarun Das

1.3 Accrual Accounting and Economic Statistical Systems Government accounting systems determine how financial and statistical information is prepared and presented. Presently, governments of most developed countries adopt some forms of accrual accounting for their budgeting and reporting financial statements. All major international statistical systems such as the United Nations National Accounts (NAS), World Bank Global Development Finance (GDF) and the International Monetary Fund (IMF) Government Finance Statistics (GFS), Balance of Payments (BOP), External Debt Statistics (EDS) and Monetary and Financial Statistics (MFS), and the International Accounting Standards (IAS) are now on the accrual basis. These systems are described briefly as follows: (1) The European Union (EU), International Monetary Fund (IMF), OECD, United Nations (UN) and World Bank jointly publish the System of National Accounts (SNA). It compiles aggregate financial statistics for an entire economy; government and private sector activities are combined together. (2) The IMF Government Finance Statistics (GFS) is a specialized system intended to support public sector financial and fiscal analysis. (3) IMF also produces balance of payments statistics and monetary and financial statistics on the basis of accrual accounting.

Glocoms Inc. (USA)

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Accrual Budgeting – Tarun Das (4) The International Federation of Accountants (IFAC) introduced International Public Sector Accounting Standards (IPSAS) in 2000. They are designed for use in the preparation of general purpose financial reports by public sector entities (individual government agencies or the whole government). These international systems have slightly different purposes. Figure-2 illustrates differences in coverage. Many developing countries are also either moving or considering moving from cash accounting to accrual accounting.

Accrual Budgeting and Its Relevance for Developing Countries SNA, GFS and IPSAS have been developed and radically revised in the past decade, and all these systems are now based on accrual accounting. The European System of Accounts (ESA 1995) also mandates accrual-based financial reporting. The following subsections describe the three international systems. System of National Accounts Most recently revised in 1993, SNA comprises an integrated set of macroeconomic accounts, balance sheets and tables based on a set of internationally-agreed concepts, definitions and accounting rules. It provides an accounting framework within which economic data can be compiled and presented in a format that supports economic analysis and policy making. SNA also acts as a reference point for establishing standards for related statistics and harmonizing other statistical systems such as balance of payments, GFS, and financial and monetary statistics (FMS). Furthermore, it introduces a set of new accounts such as environmental accounts.

Glocoms Inc. (USA)

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MOF, Govt. of Mongolia

Accrual Budgeting – Tarun Das Government Finance Statistics The IMF released a revised GFS Manual in 2001, which introduces accrual accounting, balance sheets and complete coverage of government economic and financial activities. Although only a few countries are currently capable of meeting the standards promulgated in this Manual, the number is increasing steadily. International Public Sector Accounting Standards IFAC began issuing accrual-based IPSAS in May 2000. They are based on the private sector International Accounting Standards (IAS). Entities applying the accrual-based IPSAS must also prepare cash flow statements in accordance with IPSAS 2 Cash Flow Statements. Given the development, it is not surprising that, as of December 2002, few countries directly referred to IPSAS for their public sector reporting. 2. Government Accounting Systems The public and private sectors both used cash accounting until the 16th century. While government accounting remained on a cash basis, the private sector developed Generally Accepted Accounting Principles (GAAP)—including accrual accounting—for more transparent information by lenders and better management information for price setting. However, there were no such pressures on the government as it is not guided by commercial motives but by wider objectives of equity, justice and poverty reduction. Besides, government has power to raise resources through creation of money and imposition of more taxes and duties. It is also accountable to a wider group of stakeholders. Furthermore, public sector activities are closely scrutinized by the executives and legislatures through the mechanisms of Budgets and Appropriations. 2.1 A Simple example of Accrual Accounting Using a simple example3 for a small government, Table-2 illustrates differences between cash and accrual accounting for a period of one week. Particularly, the way in which pension obligations are treated is very informative4. Cash accounting ignores the $30 million pension obligation (in present value terms) until the pension payments are actually made usually after many years. But, the accrual accounting immediately recognizes the obligation as an expense. 3

Example is taken from Lakshman Athukorala, S. and Barry Reid (2003) Accrual Budgeting and Accounting in Government and its Relevance for Developing Member Countries, Asian Development Bank, Manila.

4

In keeping with most government pension scheme arrangements, the example assumes that pension obligations are unfunded.

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Accrual Budgeting – Tarun Das The effects of the following five transactions are shown in the financial statements: (1) Corporate taxpayers are required to make tax payments of $100 million, but govt received only $90 million. At the end of the week, $10 million is outstanding. (2) The government sells fixed assets (valued at $100 million) for $100 million. (3) Government paid salary during the week. In addition to paying employees $60 million, the government is obligated to provide for their pensions when they retire. Employees earned $30 million in future pension rights during the week. (4) The government settles an old legal dispute. It agrees to pay $30 million to the plaintiff in 2 months’ time. (5) All the government’s borrowings (amounting to US$500 million) are held in foreign exchange. The exchange rate depreciated by 2% during the week. It may be observed from the table that the Cash accounting shows a surplus of $130 million, while the accrual operating statement shows a deficit of $30 million. The $160 million difference arises from the fact that cash accounting ignores the pension liability ($30 million), the asset already had a value equal to its sale price ($100 million) and therefore no gain in revenues on accrual accounting, the exchange rate change ($10 million), the judgment liability ($30 million), and the taxes to be received ($10 million). Table-2 Accrual Accounting Cash flow statement Receipts: Taxation Asset sales

Payments Salaries

a b

c

Operating statement 90 100

-60

Cash surplus

130

Bank balance Opening Closing

50 180

Glocoms Inc. (USA)

Revenues Taxation

Balance Sheet Opening Changes

a 100

Expenses Personal costs c 90 Foreign exchange Loss e 10 Litigation Expense d 30 Total Accrual deficit

130 -30

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Assets Banks Receivables Fixed assets

50 20 700

a b

Closing

130 10 -100

180 30 600

40

810

30 30 10

30 30 510

Total Liabilities Litigation Pensions Borrowing

770

Total Net assets

500 230

70 -30

570 240

Equity and reserves

270

30

240

0 0 500

d c e

MOF, Govt. of Mongolia

Accrual Budgeting – Tarun Das 3. An Operational Cash Plus Accrual Accounting System It has been mentioned earlier that Hybrid method means use of accrual accounting to the extent possible and use of cash accounting for the remainder of incomes and expenses. In general, all countries first adopt a cash plus accrual accounting system before migrating to a full fledged accrual system. Some of the ways to develop a Cash Plus Accrual Accounting system are described below: Single- or Double-Entry Accounting The double-entry system provides checks and balances to ensure that the books of accounts are always in balance. In double-entry accounting, every transaction has two entries: a debit and a credit. Usually, one of the entries is a balance sheet account. Entries that are not made to a balance sheet account are made to an income account or expense account. Income and expenses affect the net income, which ultimately affects owner's equity or net worth. As debits always equal credits, double-entry accounting prevents some common bookkeeping errors. Many accounting software programs are available, where one has to make only single entry for a transaction, and the software will automatically make the second entry. Adjusting Entries Certain end-of-period adjustments must be made when books are closed. Some adjusting entries are straightforward. Others require judgment and some accounting knowledge. The following are some examples 3.1 Accrue wages earned by employees but not yet paid to them. 3.2 Accrue Pension and Health insurance contributions due 3.3 Record interest expenses on a mortgage or loan and update the loan balance. 3.4 Record prepaid insurance. 3.5 Adjust books for inventory on hand at period end. 3.6 Accrue interest income earned but not yet received. 3.7 Record depreciation expense. 3.8 Adjust for bad debts or contingent liabilities 3.9 Accrue dividends payable if a corporation. 3.10 Accrue zero coupon bonds 3.11Accrue income taxes payable if a corporation. 3.12Account for the sale of fixed assets. 3.13Set up accounts receivable balance if books are maintained on a cash basis. 3.14Set up accounts payable balance if books are maintained on a cash basis. 3.1 Accruing Wages Payable Suppose on 31 December 2006, a department has not paid the employees one week of salary amounting to 100 MNT (Million Tug) that will be paid on 7 January 2007. Make the following general book entry for the accounting year 2006: Glocoms Inc. (USA) 9 MOF, Govt. of Mongolia

Accrual Budgeting – Tarun Das

Debit (MNT) Wages expense

Credit (MNT)

100

Accrued wages

100 To accrue wages owed but unpaid on 31/12/2006

3.2 Accruing Pension and Health insurance contributions Suppose on 3 January 2007, government deposited Pension and benefit contribution and Health insurance contributions amounting to 1000 MNT due as of 31 December 2006. One-half of that (500 MNT) is the government’s share that has not yet been recorded on the books of accounts. We have to make general journal entry as follows: Debit(MNT ) Pension and benefit contribution and Health insurance contributions expense

Credit (MNT)

500

Pension and benefit contribution and Health insurance contributions payable

500

To accrue employer share of taxes owed but unpaid on 31/12/2006 3.3 Adjusting Interest and Loan Balances Assume that government makes a monthly mortgage payment of 50 MNT for a building taken on mortgage. Each monthly payment is part interest (20 MNT) and part principal (30 MNT). If the correct amounts of interest and principal are recorded in the cash disbursements journal every month, no adjusting entry would be necessary. An example of such a cash disbursements journal entry is given below: Debit Interest expense

240

Mortgage payable

360

Cash

Credit

600 3.4 Prepaid Insurance

Suppose a department paid an annual staff car insurance premium of 12 MNT on September 1, 2006 for a fleet of staff cars, and charged the 12 MNT to insurance expense in the cash disbursements journal. As of December 31, 2006, department has used up just four months (4 MNT) of this coverage, and have eight months of coverage for 2007. The Glocoms Inc. (USA)

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MOF, Govt. of Mongolia

Accrual Budgeting – Tarun Das eight months of prepaid coverage (8 MNT) represents an asset to the department. We need to make the following general journal entry: Debit Prepaid staff car insurance

Credit

8

Staff car insurance expense

8

To set up eight months of prepaid insurance on 31/12/2006 3.5 Adjusting Entry for Inventory On December 31, 2006, a department physically counts the inventory items it has on hand, and determines that the total cost of the departmental inventory as on December 31, 2006 is 180 MNT. Looking back at the general ledger, it is observed that the year started with a December 31, 2005, inventory cost of 150 MNT. We need to make the following general journal entries to update inventory: Debit Purchases

Credit

150

Inventory

150

To clear out beginning (1/1/2006) inventory Debit Inventory

Credit

180

Purchases

180

To book ending inventory at 31/12/2006 3.6 Accruing Interest Income Receivable An Agency has a one-year, 1000 MNT certificate of deposit that it purchased on May 1, 2006 from a financial company. The company pays simple interest, at 6 percent, at the end of its term on April 30, 2007. As of December 31, 2006, the agency has earned 40 MNT which is eight months of interest (1000 x 6% x 8/12). Agency should make the following adjusting entry: Debit Interest receivable

Credit

40

Interest income

40

To record eight months' accrued interest on 31/12/2006 Glocoms Inc. (USA)

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MOF, Govt. of Mongolia

Accrual Budgeting – Tarun Das 3.7 Recording Depreciation Expense An Agency has equipment and a building for carrying out its business. Using a depreciation schedule, the accountant determines that the current period depreciation is 35 MNT on the equipment, and 25 MNT on the building. The Agency needs to make the following adjusting entry to record depreciation expense and update the accumulated depreciation accounts: Debit Credit Depreciation expense

60

Accumulated depreciation equipment

35

Accumulated Depreciation building

25

To record depreciation for the period ended 12/31/04 3.8 Adjusting for Bad Debts or Contingent Liabilities Suppose a Department has lent money to a public sector enterprise which has become sick and is unable to repay the loan. Since the Department had rarely any trouble in getting the repayment of loan, it did not set up a reserve for bad debts. However, as the Department reviews accounts receivable at year end, it notices that a particular Agency, now insolvent, still owes 750 MNT. The Department is certain that this money will never be paid. It is necessary to write off this account by making the following adjusting entry: Debit Bad debt expense

Credit

750

Accounts receivable

750

To record bad debts for the year ended 31/12/2006 3.9 Accruing Dividends Payable An Agency declares a dividend of 100 Tug a share on December 31, 2006. There are one million shares of common stock outstanding. The dividend will be paid on January 15, 2007. It is necessary to make the following adjusting entry: Debit (MNT) Retained earnings

Credit (MNT)

100

Dividends payable

10,000

To record dividends payable as of 31/12/2006.

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MOF, Govt. of Mongolia

Accrual Budgeting – Tarun Das 3.10 Accruing Zero Coupon Bonds

3.11 Accruing Income Taxes Payable Suppose, an agency has made four estimated income tax payments of 5 MNT each for its calendar-year 2006 tax liability. These payments were each recorded during the year in the cash disbursements journal as follows: Debit (MNT) Reserve for income. tax

Credit (MNT)

5

Cash

5

Since the four payments were made during the year, there is a debit balance of 20 MNT (3 MNT x 4) in the reserve for income tax account on December 31, 2006. The Agency’s corporate income tax return for the year ended December 31, 2006, has been completed, and it shows a tax liability for the year of 25 MNT. Since the agency has already paid in 20 MNT, Agency has to pay additional amount of 5 MNT to the Revenue Department. It is necessary to make the following adjusting entry to reflect the income tax expense for the year and the amount of tax owed to the Revenue Department at year end:

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Accrual Budgeting – Tarun Das

Debit Income tax expense

Credit

25

Reserve for income tax

20

Income taxes payable

5

To record income taxes for the year ended 31/12/2006 3.12 Adjusting for Sales of Fixed Assets On March 4, 2006, a department sold a government building for 50 MNT. At the time of the sale, the department made the following entry in the expenditure and receipts accounts: Debit Cash

Credit

50

Gain on sale of asset

50

The building had a cost of 40 MNT. As of December 31, 2005, department had taken 25 MNT of accumulated depreciation on the building. The adjusted basis cost of the building is 15 MNT (40 MNT cost minus 25 MNT depreciated). Therefore, the Department has a gain of 12 MNT on the sale (50 MNT received minus 38 MNT basis). It is necessary to make the following adjusting entry to take the building off the books and reflect the correct amount of gain (or loss) on the sale: Debit Gain on sale of asset

15

Accumulated depreciation building

25

Credit

Building

40

To adjust for sale of truck on 31/12/2006 3.13 Adjusting Year-End Receivables Assume that an Agency keeps its books on the cash basis, but its financial reporting and tax returns are done on the accrual basis. The Agency adds up its accounts receivable ledgers and finds that its total receivables are 16500 MNT on December 31, 2006. The Department’s accounts receivable balance on December 31, 2005, which is currently shown in the general ledger, was 13950 MNT. The Department needs to make the following adjusting entries to update the year-end accounts receivable balance: Debit Glocoms Inc. (USA)

14

Credit

MOF, Govt. of Mongolia

Accrual Budgeting – Tarun Das

Sales

13,950

Accounts receivable

13,950

To clear out 1/1/2005 accounts receivable balance Debit Accounts receivable

Credit

16,500

Reserve for income tax

16,500

To set up 12/31/2004 accounts receivable balance 3.14 Adjusting Year-End Accounts Payable Assume that an Agency keeps its books on the cash basis, but its financial reporting and tax returns are done on an accrual basis. The Agency adds up its accounts payable ledgers and finds that its total payables on December 31, 2006, are 2650 MNT, consisting of merchandise purchases of 2100 MNT, equipment repairs of 330 MNT, and an electricity bill for 220 MNT. The Agency’s accounts payable balance on December 31, 2005, which is currently shown in the general ledger, was 1500 MNT. It looks at the adjusting entries for last year and finds that at the end of 2005 it owed 1000 MNT for merchandise purchases, 180 MNT for advertising, and 320 MNT for a utility bill. The Agency needs to make the following adjusting entries to update the year-end accounts payable balance: I

Debit

Accounts payable

Credit

1,500

Purchases

1,000

Advertising

180

Utilities

320

To clear out 1/1/2006 accounts payable balance Debit Purchases

Credit

2,100

Repairs and maintenance

330

Utilities

220

Accounts payable

2,650

To set up 12/31/2006 accounts payable

3.15 Preparing Financial Statements The standard financial statements include the following: Glocoms Inc. (USA) 15

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Accrual Budgeting – Tarun Das • •

a balance sheet an income statement (a) Balance Sheet

Also called a statement of financial position, a balance sheet is a financial "snapshot" of a business at a given date in time. It lists all assets, liabilities, and the difference between the two, which is the owner's equity, or net worth. The accounting equation (assets = liabilities + net worth) is the basis for the balance sheet. The following is an example of a balance sheet for a small company:

Assets Current Assets Cash Accounts receivable Inventory Prepaid Insurance Total Current Assets Fixed Assets Equipment Less: Accum. Deprec. Total Fixed Assets Total Assets

Glocoms Inc. (USA)

ABC Company Balance Sheet December 31, 200X Liabilities and Capital Current Liabilities $12,300 Accounts payable $ 8,900 22,900 Wages payable 11,525 32,090 Total Current Liabilities 2,500 Long-Term Liabilities $69,790 Bank Loan Payable 17,500 Total Long-Term Liability 100,200 Total Liabilities (78,321) Capital 21,879 Tom Beta, Capital $91,669 Total Liabilities/Capital

16

$20,425

17,500 37,925 53,744 $91,669

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Accrual Budgeting – Tarun Das

Suggested General Ledger Accounts

A list of common general ledger accounts is shown below. Depending on the type of an Agency, it will use many, but probably not all, of these account names. On financial statements, they should generally be placed in the order shown.

(A) Balance Sheet Accounts: Assets: • • • • • • • • • • • • • • • • • • • • • •

petty cash (if you maintain a petty cash fund) cash in checking (a separate ledger account for each bank account) cash in savings accounts receivable reserve for bad debts inventory prepaid expenses office supplies (if you maintain a significant amount of office supply inventory) utility deposits notes receivable investments organization expenses vehicles accumulated depreciation — vehicles furniture and fixtures accumulated depreciation — furniture and fixtures equipment accumulated depreciation — equipment buildings accumulated depreciation — buildings land goodwill

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Accrual Budgeting – Tarun Das

Liabilities • • • • • • • • • •

accounts payable sales tax payable federal withholding taxes payable FICA taxes payable state withholding taxes payable unemployment taxes payable accrued wages unearned revenue accrued income taxes note payable

Capital Accounts: • • • • • •

owner's equity owner's drawing account common stock additional paid-in capital preferred stock retained earnings

(B) Income Statement Accounts:

Income: • • • • • •

sales revenues sales returns and allowances sales discounts investment income gain (loss) on sale of assets

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Accrual Budgeting – Tarun Das

Expenses: • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • •

purchases (if you purchase inventory for resale) freight (if you purchase inventory for resale) purchases returns and allowances (if you purchase inventory for resale) cost of goods sold: materials cost of goods sold: labor cost of goods sold: direct expenses cost of goods sold: indirect expenses advertising amortization bad debt expense bank charges charitable contributions commissions expense contract labor credit card fees expense delivery expense depreciation expense dues and subscriptions entertainment income taxes insurance interest expense maintenance miscellaneous office expense operating supplies payroll taxes permits and licenses postage professional fees property taxes rent repairs telephone travel utilities vehicle expenses wages

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Accrual Budgeting – Tarun Das

(b) Income Statement or Profit & Loss Account Also called a profit and loss statement, or a "P&L," an income statement lists all income, expenses, and net income (or loss). The net income (or loss) is equal to income minus expenses. The following is an example of an income statement: Profit & Loss Account Sales

$462,452

Cost of Goods Sold Beginning Inventory

$ 27,335

Add: Purchases

235,689

Total:

263,024

Less: Ending inventory

32,090

Cost of Goods Sold

230,934

Gross Profit

231,518

Expenses Advertising

1,850

Depreciation

13,250

Insurance

5,400

Payroll taxes

8,200

Rent

9,600

Repairs and maintenance

13,984

Utilities

17,801

Wages

98,852

Total Expenses

168,937

Net Income

$ 62,581

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Accrual Budgeting – Tarun Das (c) Closing Entries Assume that the general ledger has been finalized and a balance sheet and income statement have been prepared for the year ended December 31, 2006. We need to prepare the four closing entries as follows: Debit Sales

Credit

462,452

Income summary

462,452

To close the revenue account on 31/12/2006 Debit Income summary

Credit

399,871

Purchases

230,934

Advertising

1,850

Depreciation

13,250

Insurance

5,400

Payroll taxes

8,200

Rent

9,600

Repairs and maintenance

13,984

Utilities

17,801

Wages

98,852

To close the expense accounts on 31/12/2006 Debit Credit Income summary

62,581

Tom Beta, capital

62,581

To transfer 12/31/2004 net income to the capital account Debit Owner's equity or capital.

Credit

12,000

Owner's capital, drawing

12,000

To close drawing account for year ended 12/31/2006

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Accrual Budgeting – Tarun Das 3.16 Converting Accrual Profit to Cash Flow If the books are maintained on the accrual method of accounting, then some adjustments need to be made for the actual cash flow. These adjustments are necessary because certain expenses are taken into account to determine the accrual net profit, even though these expenses do not currently require a cash outlay. To convert the accrual profit to cash flow profit, a balance sheet needs to be prepared both for the beginning and end of the period under examination. As a general rule, following formula:

accrual net profit can be converted into cash profits by using the

Net Profit + Depreciation - Increases (or + Decreases) in Accounts Receivable - Increases (or + Decreases) in Inventories + Increases (or - Decreases) in Accounts Payable - Decreases (or + Increases) in Notes Payable (Bank Loans) = Net Cash Flow ABC Company Comparative Balance Sheets 31/12/2005

31/12/2006

$17,845

$4,375

12,185

27,371

6,034

9,133

83,239

83,239

Less: Accumulated Depreciation

(44,826)

(48,989)

Total Assets

$74,477

$75,129

Accounts Payable

$6,977

$7,630

Notes Payable (Bank Loans)

27,500

12,000

Total Liabilities

$34,477

$19,630

Stockholder's Equity

$40,000

$55,499

Total Liabilities and Equity

$74,477

$75,129

Cash Accounts Receivable Inventory Property and Equipment

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Accrual Budgeting – Tarun Das 3.17 Projected Cash Outflows

The following items are generally included in the projection of cash outflows: Anticipated Cash Outflows •

•

• •

•

Cost of goods sold o inventory purchases o shipping and handling o manufacturing costs Operating expenses o payroll o payroll taxes o advertising o subscriptions and dues o professional fees o office and postage o rent o utilities o insurance o taxes and licenses o supplies o repairs and maintenance o credit card fees o bank service charges o other operating expenses One-time purchases o new property or equipment Debt payments o interest o principal Other cash outflows

In accrual accounting, in addition to these items we need to forecast provisions for liabilities, charges and contingencies. Major provisions include those for pensions, provident funds, health and other social insurance funds, depreciation funds, capital charges, national calamity funds, contingent liability funds, market price stabilization funds etc.

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Accrual Budgeting – Tarun Das 4. Status of Accrual Accounting and Budgeting in OECD Countries Table-2 reviews the status of accrual accounting and budgeting in OECD member countries. It reveals that most OECD members have introduced aspects of accrual accounting and more intend to do so in future. Table-2 Status of Accrual Accounting and Budgeting in OECD Countries

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4.1 Status of Accrual Accounting in Five pioneer countries viz. New Zealand, Australia, the United Kingdom, the United States, and Sweden Five countries viz. New Zealand, Australia, the United Kingdom, the United States, and Sweden have been pioneers in accrual accounting and accrual budgeting. They provide good examples for other countries who desire to introduce accrual accounting and budgeting, although their systems, techniques and methodology differ significantly. Among the countries which are moving from cash accounting and budgeting to accrual accounting and budgeting, only Australia and New Zealand have adopted the technique of output costing and output budgeting, and the other countries are adopting the technique of input costing and input budgeting (Martin Dees and Paul Neelissen 2004). Five Pioneering Countries Compared With respect to the general design of the accrual system, the following observations can be made about the five countries whose practices were compared by Martin Dees and Paul Neelissen (2004). •

Most introduced an accrual system that was both comprehensive (for all central government entities) and full (including complete statements of financial position and financial performance and a link between these two main documents).

•

Most adopted an accrual basis for both budgeting and accounting.

•

The budgets and, in particular, the accounts of most include the three main accrual-based financial statements (statement of financial position, statement of financial performance, and cash flow statement).

•

The financial statements of the various parts of central government are generally consolidated into central government financial statements; the public sector as a whole is generally not consolidated.

•

The legislature authorizes various items: costs, cash expenditures, obligations, or both; in most cases it principally authorizes costs.

•

Accounting standards in most pioneering countries are based on private sector standards, with certain departures to allow for the unique characteristics of their government.

•

National and government accounting are separate; national accounting standards played virtually no role in the development of government accounting standards in most pioneering countries.

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Accrual Budgeting – Tarun Das The details of these observations are presented in Table-1 in the Box below. With respect to the main accounting principles applicable in each country, the following observations can be made: •

There are considerable differences in valuation policies from primarily historical cost (Sweden, United States) to primarily modified historical cost (New Zealand, United Kingdom) to primarily current value (Australia).

•

The main statement of financial position classification agrees with the generally accepted classification of fixed and current assets, liabilities, and equity as a balancing item.

•

Provisions for liabilities, charges and contingencies are permitted in all five countries.

•

All five countries calculate equity (under a variety of names) in accordance with generally accepted principles as the balance of assets and liabilities.

•

In all five countries, tax revenue allocated by the central tax collecting agency is accounted for by the other parts of central government receiving the revenue.

•

All five countries calculate an operating result (in a variety of ways) as the balance between income and expenses.

•

Three of the five countries apply a capital charge.

Table 2 presents the main accounting principles applicable in each country. Anther study on “Accrual Accounting and Budgeting- Key Issues and Recent Developments” prepared by the OECD Public Management Committee, Public Management Service for the Twenty-third Annual Meeting of OECD Senior Budget Officials at Washington D.C., 3-4 June 2002, concluded the following: “About half of all Member countries have adopted accruals to one degree or another. There are great variations, however, to what extent Member countries have adopted accruals, from doing so for agency and ministry-level financial reporting exclusively to whole-of-government financial reporting to budgeting (see Appendices I to IV). The migration to accruals has been remarkably quick if one considers that it is only about ten years since the first Member country adopted full accruals.”

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“Although accruals have been used in the private sector for a very long time, it is not possible to simply adopt private sector accruals to the public sector in bulk. There are a number of unique issues that arise when governments move to accruals. The government has certain types of assets and liabilities that do not exist in the private sector, including heritage assets, military assets, infrastructure assets and the treatment of social insurance programs. What valuation methods are used is very important, especially from an economic analysis point of view. What institutional structures are in place for setting accounting standards are very important, especially the need to maintain their independence while respecting the constitutional responsibilities of the finance minister. Finally, a great number of implementation issues arise when accruals is being adopted in the public sector.” “Finally, it must be emphasised that accruals is not a “magic bullet” for improving the performance of the public sector. It is simply a tool for getting better information about the true cost of government. It needs to be used effectively and in tandem with a number of other management reforms in order to achieve the desired improvement in decisionmaking in government.” The purpose of this rather long quotation is to convey the message that even developed countries with highly trained and skilled manpower and sufficient financial resources and Glocoms Inc. (USA)

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Accrual Budgeting – Tarun Das technology have not fully implemented accrual budgeting system, and they are still in the process of experimentation and development. General lessons from these experiences indicate that a shift to a full fledged accrual system of accounting and budgeting will take longer period and cannot be done at one stroke. However, a beginning needs to be done “for getting better information about the true cost of government”. Initially, we need a mixture of cash and accrual budgeting i.e. cash plus accrual accounting and budgeting. 5 Pros and Cons of Accrual Accounting 5.1 Benefits of Accrual Accounting Proponents of accrual accounting argue that there are immense benefits of the accrual accounting for the government, departments, the economy and Parliament such as: (i) (ii) (iii) (iv)

For the government, it is a beneficial tool for planning and control of public expenditure and it serves as a better indicator for the fiscal sustainability and government accountability. At the organization level, accrual-based financial statements reduce the scope for fraud and corruption. It also helps to judge the effectiveness of the organization over a period. For departments, accrual accounting system offers improved management information, particularly on costs and assets, including working capital, thus facilitating more informed management decisions on allocation of resources. As the system provides a stronger basis for executive accountability, Parliament has better control over fiscal management.

More comprehensive: IMF considers accrual accounting to be superior to cash accounting “because accrual accounting records all resource flows, including internal transactions, in-kind transactions and other economic flows. This comprehensive recording permits the integration of flows with changes in the balance sheet.” Accrual reports also provide a cash flow statement and record acquisitions of non-financial assets separately. Conversely, cash-based accounts normally do not differentiate between expenses and acquisitions of nonfinancial assets (such as lands and buildings). Simpler and easier to understand: Cash accounts generally comprise a single income and expenditure statement—in contrast to the multiple statements and accounting notes provided by accrual information. In practice, cash-based government financial statements tend to be difficult for understanding and interpretation. Conversely, accrual financial statements are familiar to businesspeople, financial journalists and credit rating agencies). Lower borrowing costs: There is evidence from the US that “states that use accrual information borrow at better terms than those states that use solely cash information.” Glocoms Inc. (USA)

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Accrual Budgeting – Tarun Das Harder to manipulate: Both cash and accrual information can be manipulated, but many technical people believe that cash accounts can be easily manipulated than accrual accounts. Cash accounting can be manipulated by (i) selecting favorable accounting policies; (ii) changing payment and receipt dates; (iii) changing the reporting entity; and (iv) classifying current items as capital items or vice versa (for instance, privatization proceeds might be shown as revenue). Accrual accounting can also be manipulated by (i) selecting favorable accounting policies; (ii) making favorable assumptions, for instance on discount rates; and (iii) managing accruals. However, under standard accounting norms and guidelines and international best practices, it is more difficult to manipulate accrual accounting than the cash accounting. More comparable and consistent: The IMF considers that accrual accounting provides better information about the underlying fiscal trends by removing year-to-year variability caused by the timing of cash receipts and payments (particularly capital payments). The revised IMF GFS and the major macroeconomic statistical systems such as UN Standard National Accounts (SNA), IMF balance of payments (BOP), and IMF monetary and financial statistics (MFS) use the accrual basis. Therefore, preparing government financial statements on the accrual basis improves the accuracy and consistency of national accounts and IMF BOP and MFS. Includes liability disclosures: Governments generally have significant liabilities other than public debt. An important example is the future obligation to pay civil service pensions and other terminal benefits to the employees. Other liabilities include amounts payable, accrued interest, accrued salaries and wages, transfer payments payable, and environmental liabilities. These obligations are typically under-funded in the cash account. But, accrual accounting shows the unfunded liability on the balance sheet as a liability, and provides additional disclosures and supplementary notes on contingent liabilities and other commitments. Information is provided for considering intergenerational fairness. Intergenerational fairness is important in fiscal policy—it reflects the degree to which the government today is paying for the costs of scarce resources. Basis for identifying payment arrears. Payment arrears arise when an obligatory payment is not made by its due-for-payment date. All arrears are automatically included in accrual-based statistics. Information for managing liquidity. Managing liquidity is an important task of the government with the help of the monetary authority. It is difficult to assess solvency and future cash flows with the cash basis because of missing information on arrears. Better information for decision making. Fiscal strategy deals with the management of revenue and expenditure flows, assets and liabilities. Under the cash basis, fiscal strategy focuses on short-term revenues and expenditures (i.e., 1–3years). Under the accrual basis, assets and liabilities are given the same attention as debt in terms of targets, risk analysis and contribution to economic policy objectives. Glocoms Inc. (USA) 31 MOF, Govt. of Mongolia

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Better accountability basis. Accrual accounting is intended to provide information to owners and lenders for better accountability and decision making. Financial reports prepared on an accrual basis allow users to assess accountability for all resources the entity controls and how those resources are used. Provides information for managing resources. Cash accounts exclude most assets and liabilities, but accrual accounting maintain complete records of assets and liabilities leading to better asset management and maintenance, more appropriate replacement policies, identification and disposal of surplus assets, and better management of risks (such as loss due to theft or damage). Identifies payment arrears. In contrast to cash information, accrual information provides a basis for identifying payment arrears. Supports better liquidity management. Rich information provided under the accrual basis, including cash information, represents a sound foundation for managing liquidity. Provides a basis for pricing products and services. Although non-financial measures are necessary to measure quality, accrual accounting provides information on which to compare price. By contrast, cash accounting is inadequate for pricing because some elements of resource usage (e.g., depreciation) are not fully allocated to costs. Reduces opportunities for fraud and corruption. The integrated asset management nature of accrual accounting provides greatly enhanced asset stewardship. For instance, it improves control over donor-provided assets. Furthermore, cash-based systems are more easily manipulated than accrual-based systems. 5.2 Critique of Accrual Accounting On the other hand, opponents argue that: (i) (ii) (iii) (iv)

(v)

Accrual accounts are very complex and more difficult to understand and are not easily comprehensible to non-technical persons. Implementation and operations of accrual accounting are expensive. Measurement of assets and liabilities on the basis of accrual accounting involves more subjectivity than that for cash accounting, and therefore may be susceptible to manipulation. The technical complications and time-consuming nature of the movement to accrual accounting can be judged from the fact that only a few countries have implemented full accrual accounting. Even among the OECD countries, the emphasis has been to modify the pure cash-based accounting system to the socalled hybrid accounting/ modified accrual system/ cash-plus accrual system. Therefore, at the initial stage the emphasis of the developing countries should be on getting the basics right.

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Accrual Budgeting – Tarun Das Implementation is difficult and expensive Some aspects of accrual accounting are more difficult than cash implementations. For example, it is difficult for a government organization to know the full amount of tax revenue that it is likely to receive at a given time. Moreover, implementing and operating an accrual accounting system can be expensive. However, millions of organizations use accrual accounting, and few use cash accounting. Variations in cash accounting methods between countries further limit the availability of computerized accounting information systems. Indeed, many countries develop their own computer systems to support cash accounting, rather than rely on proven commercial accounting systems (with accrual accounting capability). In any case, whether a government uses cash or accrual accounting, qualified accounting personnel must manage the system. Arguments are made that non-accountant staff can operate cash-based accounting systems with minimal input from qualified accountants, whereas accrual-based systems require trained accountants, particularly during implementation. Given that the private sector uses accrual accounting, recruitment and training of accounting staff is easier under accrual accounting. Moreover, accrual systems (generally) require fewer personnel to operate them. 5.3 Concluding Observations Reality lies somewhere in between these two extreme views. Experiences of developed countries provide valuable lessons for the importance of communications, quality assurance, and the use of commercially-available accounting software. A study by ADB5 observes that the successful implementation of accrual accounting in a developing country depends on (a) strong political commitment; (ii) careful planning of the phase-out and timing; (iii) clear communications of intentions and objectives; (iv) qualified accounting and auditing personnel; (v) appropriate financial management information systems; and (vi) the recognition of accrual accounting as a part of wider public sector reforms. The study concludes that developing countries adopting accrual accounting and budgeting should do so in a realistic and practical manner, as given by the constraints of resources and capacity. It recommends a gradual, cautious and step-by-step approach, starting with implementation of the best practices of cash accounting systems, and strengthening their general accounting and auditing systems consistent with the eventual adoption of accrual accounting.

Lakshman Athukorala, S. and Barry Reid (2003) Accrual Budgeting and Accounting in Government and its Relevance for Developing Member Countries, Asian Development Bank, Manila Glocoms Inc. (USA) 33 MOF, Govt. of Mongolia 5

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Selected References Dees, Martin and Paul Neelissen (2004) Five Countries Pioneering Accrual Budgeting and Accounting in Central Government, International Journal of Auditing, January 2004 Diamond, Jack (2002) Performance Budgeting: Is Accrual Accounting Required? Working Paper WP/02/240. Washington, DC: IMF. International Federation of Accountants IFAC (1996) Perspectives on Accrual Accounting. Occasional Paper 3. New York: Public Sector Committee. International Monetary Fund (IMF) (2002) Government Finance Statistics 2001 Companion Material. Washington, DC. _______ (2005) Balance of Payments Manual, Washington, DC. _______ (2007a) Monetary and Financial Statistics Manual (MFSM), Washington, DC. _______ (2007b) Monetary and Financial Statistics (MFS): Compilation Guide, Washington, DC. Lakshman Athukorala, S. and Barry Reid (2003) Accrual Budgeting and Accounting in Government and its Relevance for Developing Member Countries, Asian Development Bank, Manila OECD Public Management Committee (2002) Accrual Accounting and Budgeting: Key Issues and Recent Developments, prepared for the Twenty-third Annual Meeting of OECD Senior Budget Officials at Washington D.C., 3-4 June 2002, published by the PUMA/SBO (2002)10, Paris. United States of America, Government Audit Office (2000) Accrual Budgeting – Experiences of Other Nations and Applications for the United States, Report to the Honourable Benjamin L. Cardin, House of Representatives. World Bank (1998) Public Expenditure Management Handbook, Washington, D.C.

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Glossary Accounting equation: Assets = liabilities + owner's equity. The financial statement called the balance sheet is based on the "accounting equation." In general, assets are recorded on the left-hand side of the equation, and liabilities and equities are recorded on the right-hand side of the equation. Similarly, some balance sheets are presented so that assets are on the left, liabilities and owner's equity is on the right. Accounts payable: Also called A/P, accounts payable are the bills that the business enterprise owes to the suppliers. Accounts receivable: Also called A/R, accounts receivable are the amounts owed to the enterprise by the clients or customers. Accrual method of accounting: With the accrual method, income is recorded when the sale occurs, not necessarily when payments are received. Similarly, an expense is recorded when goods or services are received, even though payments for them may be made later. Adjusting entries: Special accounting entries that must be made when the books of accounts are closed at the end of an accounting period. Adjusting entries are necessary to update the accounts for items that are not recorded in the daily transactions. Aging report: An aging report is a list of customers' accounts receivable amounts and their due dates. It alerts an enterprise to any slow-paying customers. An aging report can also be prepared for the accounts payable, which will help an enterprise manage its outstanding bills. Allowance for bad debts: Also called reserve for bad debts, it is an estimate of uncollectable customer accounts. It is known as a "contra" account because it is listed with the assets, but it will have a credit balance instead of a debit balance. For balance sheet purposes, it is a reduction of accounts receivable. Amortization. (1) The decrease in the value of an intangible nonproduced asset resulting from a decrease in the remaining period of its service life. (2) The repayment of a portion of the principal of a loan, bond, or other debt instrument. (3) The decrease in the discount or premium recorded with respect to the maturity value of a debt instrument resulting from the passage of time. Arrear. An obligatory payment by a debtor to a creditor that is not made by its due-forpayment date, including any grace period. See due-for-payment basis of recording. Assets: Things of value held by the business. Assets are balance sheet accounts. Examples of assets are cash, accounts receivable, and furniture and fixtures. Glocoms Inc. (USA)

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Accrual Budgeting – Tarun Das Autonomous pension fund. An employer social insurance scheme providing retirement benefits that is a separate institutional unit. Autonomous pension funds that are organized and managed by government units are classified as public financial corporations. See employer social insurance scheme and retirement benefit.

Balance sheet: Also called a statement of financial position, a balance sheet is a financial "snapshot" of your business at a given date in time. It lists assets, liabilities, and the difference between the two, which is equity, or net worth. The balance sheet is a real-life example of the accounting equation as it shows that assets = liabilities + owner's equity. Cash method. Under the cash method of accounting, incomes are recorded only when the cash is received from the customers. Similarly, an expense is recorded only when a bank check is written or cash is paid to the vendor. Most individuals use the cash method for their personal finances because it's simpler and less time-consuming. However, this method can distort the income and expenses of an enterprise, if it extends credits to its customers, if it buys on credit from the suppliers, or it keeps an inventory of the products it sells. Capital grant. A noncompulsory transfer from one government unit or international organization to a second government unit or international organization in the form of cash that the recipient is expected or required to use to acquire an asset or assets other than inventories, an asset other than inventories and cash, the cancellation of a liability by mutual agreement between the creditor and debtor, or the assumption by one unit of a debt of the other unit. Capital tax. A tax levied once or at irregular and very infrequent intervals on the values of the assets or net worth of institutional units or on the values of assets transferred between institutional units as a result of legacies, gifts inter vivos, or other transfers. Capital transfer. A transfer of a non-cash asset, the cancellation of a liability by mutual agreement between the creditor and debtor, the transfer of cash that was raised by disposing of an asset, the transfer of cash that the recipient is expected to use for the acquisition of an asset, or the assumption by the one unit of a debt of the other unit. In each case inventories are excluded. Chart of accounts: The list of account titles used to keep accounting records. Closing: Closing the books refers to procedures that take place at the end of an accounting period. Adjusting entries are made, and then the income and expense accounts are "closed." The net profit that results from the closing of the income and expense accounts is transferred to an equity account such as retained earnings. Corporation: A legal entity, formed by the issuance of a charter from the state. A corporation is owned by one or more stockholders.

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Accrual Budgeting – Tarun Das Cost of goods sold: Cost of inventory items sold to customers. It may consist of several cost components, such as merchandise purchase costs, freight, and manufacturing costs. Credit memo: Writing off all or part of a customer's account balance. A credit memo is required, for example, when a customer who bought merchandise on account returned some merchandise, or overpaid on their account. Credits: At least one component of every accounting transaction (journal entry) is a credit amount. Credits increase liabilities and equity and decrease assets. For this reason, credits are generally entered on the right-hand side (the liability and equity side of the accounting equation) of a two-column journal or ledger. Current assets: Assets that are in the form of cash or will generally be converted to cash or used up within one year. Examples are accounts receivable and inventory. Current liabilities: Liabilities payable within one year. Examples are accounts payable and payroll taxes payable. Debit memo: Billing a customer again. A debit memo would be required, for example, when a customer has made a payment on their account by check, but the check bounced. Debits: At least one component of every accounting transaction (journal entry) is a debit amount. Debits increase assets and decrease liabilities and equity. For this reason, debits are generally entered on the left-hand side (the asset side of the accounting equation) of a two-column journal or ledger. Depreciation: An annual write-off of a portion of the cost of fixed assets, such as vehicles and equipment. Depreciation is listed among the expenses on the income statement. Double-entry accounting: In double-entry accounting, every transaction has two journal entries: a debit and a credit. Debits must always equal credits. Because debits equal credits, double-entry accounting prevents some common bookkeeping errors. Errors that do occur are easier to find. Double-entry accounting is the basis of a true accounting system. Drawing account: A general ledger account used by some sole proprietorships and partnerships to keep track of amounts drawn out of the business by an owner. Equity: The net worth of a company. Also called owner's equity or capital. Equity comes from investment in the business by the owners, plus accumulated net profits of the business that have not been paid out to the owners. It essentially represents amounts owed to the owners. Equity accounts are balance sheet accounts.

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Accrual Budgeting – Tarun Das Expense accounts: These are the accounts used to keep track of the costs of doing business: where money goes. Examples are advertising, payroll taxes, and wages. Expenses are income statement accounts. Fixed assets: Assets that are generally not converted to cash within one year. Examples are equipment and vehicles. Foot: To total the amounts in a column, such as a column in a journal or a ledger. General ledger: A general ledger is the collection of all balance sheet, income, and expense accounts used to keep the accounting records of a business. Income accounts: These are the accounts used to keep track of sources of income. Examples are merchandise sales, consulting revenue, and interest income. Income statement: Also called a profit and loss statement or a "P&L." It lists income, expenses, and net profit (or loss). The net profit (or loss) equals income minus expenses. Inventory: Goods held for sales to customers. Inventory can be merchandise bought for resale, or it can be merchandise manufactured or processed for selling the end product to the customer. Journal: The chronological, day-to-day transactions of a business are recorded in sales, cash receipts, and cash disbursements journals. A general journal is used to enter period end adjusting and closing entries and other special transactions not entered in the other journals. In a traditional, manual accounting system, each of these journals is a collection of multi-column spreadsheets usually contained in a hardcover binder. Liabilities: What your business owes creditors. Liabilities are balance sheet accounts. Examples are accounts payable, payroll taxes payable, and loans payable. Long-term liabilities: Liabilities that are not due within one year. An example would be a mortgage payable. Merchandise inventory: Goods held for sale to customers. Net income: Also called profit or net profit, it is equal to income minus expenses. Net income is the bottom line of the income statement (also called the profit and loss statement). Partnership: An unincorporated business with two or more owners. Post: To summarize all journal entries and transfer them to the general ledger accounts. This is done at the end of an accounting period. Glocoms Inc. (USA)

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Accrual Budgeting – Tarun Das Prepaid expenses: Amounts paid in advance to a vendor or creditor for goods or services. A prepaid expense is actually an asset of an enterprise because the vendor or supplier owes the goods or services to the enterprise. An example is the unexpired portion of an annual insurance premium. Prepaid income: Also called unearned revenue, it represents money received in advance for providing a service to the customer. Prepaid income is actually a liability of the enterprise because it still owes the service to the customer. An example is an advance payment to a Consultant for some consulting services to be performed in the future. Profit and loss statement: Also called an income statement or "P&L." It lists all income, expenses, and net profit (or loss). The net profit (or loss) equals income minus expenses. Proprietorship: An unincorporated business with only one owner. Reserve for bad debts: Also called allowance for bad debts, it is an estimate of uncollectable customer accounts. It is known as a "contra" account because it is listed with the assets, but it will have a credit balance instead of a debit balance. For balance sheet purposes, it is a reduction of accounts receivable. Retained earnings: Profits of the business that have not been paid to the owners; profits that have been "retained" in the business. Retained earnings are an "equity" account that is presented on the balance sheet and on the statement of changes in owners' equity. Sole proprietorship: An unincorporated business with only one owner. Trial balance: A trial balance is prepared at the end of an accounting period by adding up all the account balances in the general ledger. The debit balances should equal the credit balances. Unearned revenue: Also called prepaid income, it represents money received in advance of providing a service to the customer. It is actually a liability of an enterprise as it still owes the service to the customer. An example is an advance payment to a Consultant for some consulting services to be performed in the future. Work-in-progress inventories. Goods and services that have been partially processed, fabricated, or assembled by the producer but that are not usually sold, shipped, or turned over to others without further processing and whose production will be continued in a subsequent period. Written-down replacement cost. The initial acquisition cost of an asset plus an appropriate revaluation for subsequent price changes, minus an allowance for consumption of fixed capital, amortization, or depletion.

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Accrual Budgeting – Tarun Das APPENDIX I Accounting Basis Applied for Budget Approved by Legislature Country Australia Austria Belgium Canada Czech Rep Denmark Finland France Germany Greece Hungary Iceland Ireland Japan Korea Luxembourg Mexico Netherlands Norway New Zealand Poland Portugal Spain Sweden Switzerland Turkey United Kingdom United States

Full Accrual Basis

Accrual Basis, except no Capitalization or Depreciation of Assets

Cash Basis, except certain transactions on Accrual Basis

Full Cash Basis

X X X X X X(1) X(2) X X X X X X X X X X X X X X X X X X X X(3)

i.

X(4) Denmark – Interest Expenses and Employee Pensions Treated on

Accrual Basis. ii. iii.

Finland – Transfer Payments Not on Accrual Basis. United Kingdom – Budget on Full Accrual Basis Effective Fiscal Year 2001-02.

iv.

United States – Interest Expenses, Certain Employee Pension Plans, and Loan and Guarantee Programmes Treated on Accrual Basis.

Source: OECD Budgeting Database

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APPENDIX II Plans to Move Budget to Accrual Basis Country Canada Denmark Germany Korea Netherlands Portugal Sweden Switzerland

Full Accrual Basis Budgeting to be introduced X(1)

Additional Accrual Basis information to be presented X X

X(1) X X X(1) X(1)

i. under Active Consideration. Source: OECD Budgeting Database

APPENDIX III Additional Use of Accruals in Departmental / Agency Level Financial Statements Country

Departmental/ Agency Level Financial Statements on Full Accrual Basis

Belgium Germany Hungary Ireland Japan Netherlands Portugal Switzerland United Kingdom

i.

Financial Statements on Full Cash Basis but Supplementary Accrual Information is presented X X X X

X X X X X

This refers to departments/agencies that prepare separate financial statements for their own operations and where such financial statements contain more accrual information than the consolidated (whole-ofgovernment) financial statements. In cases where the consolidated (whole-ofgovernment) financial statements are on full accrual basis (Appendix 3), departmental/agency level financial statements would also be on full accrual basis.

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Accrual Budgeting – Tarun Das Source: OECD Budgeting Database

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Accrual Budgeting – Tarun Das APPENDIX IV Accounting Basis Applied for Consolidated (Whole-of-Government) Financial Statements

Australia Austria Belgium Canada Czech Republic Denmark Finland France Germany Hungary Iceland Ireland Japan Korea Luxembourg Mexico Netherlands Norway New Zealand Poland Portugal Spain Sweden Switzerland Turkey United Kingdom United States

Full Accrual

Accrual Basis, except no Capitalization or

Basis X

Depreciation of Assets

Cash Basis, except certain Transactions on Accrual Basis

Full Cash Basis

X X X X X(1) X X(2) X X X X X X X X X X X X(3) X X X X X X(4) X

i. Denmark – Interest Expense and Employee Pensions Treated on Accrual Basis. ii. France – Interest Expense and Certain Other Transactions Treated on Accrual Basis. Full Accrual Basis to be introduced. iii. Poland – Employee Pensions Treated on Accrual Basis. iv. United Kingdom – Statements on Full Accrual Basis Effective Fiscal Year 2005-06. Source: OECD Budgeting Database.

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