Sustainable Public Financial Management

We’ve started to distinguish FreeBalance software as Government Resource Planning. GRP is much more than a variation of generic software: it’s a unique tool for financial and information management.

We’ve talked about some of these unique characteristics in the past. It’s now time to provide a comprehensive definition of GRP.

GRP is software designed for the unique requirements of public financial management. GRP software is budget-driven through the use of Commitment Accounting, where the budget is the legal embodiment of government objectives. Commitment Accounting is used only in government and other forms of public financial management.

Budget Cycle

GRP is designed to cover the entire government budget cycle, including Budget Preparation and Budget Execution. Budget Preparation is the key mechanism for governments to determine how objectives will be met and how to improve government performance. Government revenue and expenditures are managed during Budget Execution using Commitment Accounting. Funds are set aside during procurement and hiring cycles to ensure that the budget is not exceeded. Changes in the government financial situation result in budget transfers to ensure fiscal discipline.

Government Performance Management, Government Services and Accountability

Governments carry complex mandates. Improving results requires mechanisms in GRP software for planning and analysis throughout the Budget Cycle with an emphasis on improving government services.

Governments don’t have shareholders. They report to citizens, and citizens demand transparent and open government. Citizen reports focus on planned budgets versus actual expenditures. Governments use governance mechanisms to describe how objectives will be met, and then assess whether objectives were or were not met. Many governments follow international public sector accounting standards for these reports. Releasing this information to citizens makes governments more accountable.

Reform and Modernization

Managing and reporting on government performance requires a complex Chart of Accounts (COA) design. COAs change as governments find new ways to improve services and performance. These changes need to be integrated into the fundamental building blocks of Commitment Accounting to ensure that budgets are executed properly.

There’s more to on-going government reform. The state-of-the-art in Enterprise Resource Planning (ERP) for the private sector focuses on Business Process Re-engineering (BPR). Businesses develop the most efficient processes and leverage best practices. Software is customized to achieve industry best practices, improved efficiency and unique business models. Once implemented, the software undergoes minor modifications.

There’s really no such thing as industry “best practices” in government, although there are numerous good practices. (Practices must be related to the government context – what is important to the government and the human capacity of the government.) And, governments cannot adopt better practices without legal changes. Digital signatures on cheques, for example, or accrual accounting procedures and de-centralized decision making, are all considered good practices. But these practices require legal reform and are adopted over time.

Government Resource Planning software must adapt to government reform and change. Unlike enterprise software, GRP is not predicated on the notion that the implementation requires business re-engineering in order to achieve a pre-determined “end-state”. Nor is the quest for reform confined to emerging government – G8 governments constantly look for ways to modernize their processes. Since there’s no such thing as an “end state” in government, there is never an “end state” in GRP.

This is section 2.3 of a series of blog entries creating a Government IFMIS Technology Evaluation Guide. This includes information to assist in evaluating IFMIS options and the technology requirements for FreeBalance IFMIS implementations. These series will be combined with feedback to produce a comprehensive Technology Evaluation Guide to be published on our web site.

Government financial management is different from the private sector, particularly for budgets and commitments. This is often called ‘Commitment’ or ‘Encumbrance’ accounting. Financial Accounting relates to transactions that affect the General Ledger such as revenue, payroll and purchasing.

Private sector accounting focuses on the ability of companies to manage for the “bottom line”: profit. Governments do not manage for profit. The government “bottom line” is budget. The budget represents the legal embodiment of government policy. Commitment Accounting precedes the traditional accounting cycle and typically contains the following elements:

• Draft budget plan – consists of budget estimates that have yet to be approved.
• Budget – consists of budget at the line item level.
• Appropriations, allotments or warrants – consist of budgetary information that authorizes spending. These can be combinations of short and long term allotments. 
• Commitments – represent the start of a spending process through the generation of a Purchase Requisition. A commitment sets aside an estimate amount from the budget. This prevents other commitments that could exceed the budget.
• Obligations – represents a legal obligation with a supplier through the generation of a Purchase Order. The obligation can be at a different amount that the estimate. The original commitment is de-committed. The commitment is replaced by the obligation. (The government may elect not to enter into a contract. The entire amount is de-committed and made available in the budget.)
• Payments – actual payments made. The payment de-obligates and replaces the obligated amount with the actual amount that could be different.
• Budget transfers and virements that change the budget amounts to reflect changes in need or government financial position. For example, the government may recognize that there will be revenue shortfalls and adjusts the expenditure budget. Or new priorities require transferring budget to different programs.

Commitment accounting requires many steps prior to affecting the General Ledger. Government financial management systems must track the status of all of these steps to ensure that the budget will not be overspent. The available budget for spending is often referred to as the “free balance” where:

free balance = budget – (commitments + obligations + actuals)

The status of budgets, commitments and obligations provide government decision-makers with trend information that can predict budget variances. 

There are variations in Commitment accounting among governments including:

• Terminology: commitments are often termed “soft commitments” or “pre-encumbrances”. Obligations are often termed “hard commitments” or “encumbrances”
• 1 or 2 Commitment stages: some governments do not track the “soft” commitment as affecting the budget. This is often the case when the government is modernizing and has lower human capacity so processes should be streamlined. It is also the case when the government organization is of a modest size where there is limited value to having soft commitments.
• 1 or more allotments: some governments leverage more than one appropriation. For example, governments often have an annual appropriation that is used for predicting budget variance for the year, and a monthly warrant or authority to spend.
• Cash or Accrual Accounting: some governments use modified or full accrual accounting that hits the General Ledger when the goods or services, and invoice, have been received.
• Multi-year Commitments: governments often have different rules for commitments that can span more than one year. Some types of goods or services may need to be delivered in the fiscal year otherwise the contract is cancelled.

There are many benefits to the use of Commitment Accounting in government including:

• Ensuring sufficient funds are available to meet contractual needs
• Guaranteeing that budgets will not be overspent
• Helping in planning for future costs
• Assisting in determining flexibility in adjusting budget transfers
• Predicting budget variances to speed up or slow down spending to meet government objectives
• Balancing the budget cycle with the General Ledger to ensure information integrity