Public Money & Management

ISSN: 0954-0962 (Print) 1467-9302 (Online) Journal homepage: http://www.tandfonline.com/loi/rpmm20

Resource Accounting and Budgeting: Principles,

Concepts and Practice—The MoD Case

Angela Gillibrand & Brian Hilton

To cite this article: Angela Gillibrand & Brian Hilton (1998) Resource Accounting and
Budgeting: Principles, Concepts and Practice—The MoD Case, Public Money
& Management, 18:2, 21-28
To link to this article: http://dx.doi.org/10.1111/1467-9302.00111

Published online: 15 Mar 2010.

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 21

Resource Accounting and

Budgeting: Principles, Concepts
and Practice—The MoD Case
Angela Gillibrand and Brian Hilton
In 1998/99 resource accounting will be trialed in the final group of
departments to which it is to apply. Prominent among these will be the Ministry
of Defence (MoD). The huge size of the MoD’s asset base, and the difficulty of
assessing much of its value, raises problems which will not have to be faced by
July 2016

other government departments.

 Traditional government accounts focused on
cash. Many central government departments
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simply process cash, for example grants or
social security payments. In such cases
resource accounting and budgeting will produce
few changes. The Ministry of Defence (MoD) is
different. It deploys extremely expensive assets,
to produce a result which is tangible in concept,
but mercurial in practice, ‘fighting power’. This
has conceptual, material and moral
components.
Experience suggests that the material is
vital to success in war; the conceptual in the
campaign and the moral in battle. The moral
encapsulates the beliefs that drive one on
despite extreme adversity—victory comes from
convincing the enemy that one has a greater
will to prevail.
The structure-conduct-performance
paradigm leads us to expect that new structures
will engender new behaviour. Resource
Accounting and Budgeting (RAB) has this
intention. In the MoD, military behaviour is
fundamental to value for money (VFM).
MoD’s huge and complex asset base
means that RAB will be significant to it. For the
same reasons, implementing RAB will be more
difficult and problematic than elsewhere. There
will need to be a high degree of congruence
between the accounting principles adopted and
the system of budgetary authority and
accountability constructed. This article
discusses a set of principles that should
underlie RAB. These aid understanding of the
possible impact of alternative budgetary
structures on military performance.
Devolved authority and budgets are not new
to the military. For centuries, the basis of
command in the British Army and the Royal
Navy was budgetary authority. The current
centralized systems did not commence until
after the Exchequer and Audit Act 1866. Before
this, regiments and ships were manned,
equipped and deployed by their commanders.
To run their operation, the War Office and the Angela Gillibrand and
Admiralty issued them with cash budgets. Brian Hilton are in the
Commanders acted as they saw fit. Within School of Defence
broad regulations and directions they were Management, Cranfield
empowered with a high degree of local University, RMCS
autonomy. The 1866 Act ended this. However, Shrivenham.
in 1917 the War Office revived it with an
experiment in what we now call RAB. This ran
on until 1927. Significantly decentralized
empowerment is a fundamental of current
British military doctrine. It is called ‘mission
command’. This expects military commanders
to act locally without specific direction
consistent with their superior commander’s
overall concept of an operation.
Principles Deployed by RAB:
Incentive Structures as a Guiding
Principle
The principles developed in this section provide
a framework to assist structured thinking about
public sector accruals accounting and
budgeting. They provide a means to test the
consistency of a particular system with stated
policy and the base theory underpinning it. The
discussion of each ends with a definition of the
principle involved.
The focus of current public sector reform is
value for money (VFM) generated by local
empowerment. Empowerment does not
necessarily entail devolved power. Power
remains with Parliament, but authority is given
to those locally responsible for delivery.
One way of distinguishing between power
and empowerment is to see them in terms of
the distinction between ‘outcomes’ and
‘outputs’. The political process has ‘power’ to
specify the outcome desired. On the other hand,
the ‘empowered’ public servant determines the
outputs that will deliver those outcomes. A
public servant will be held to account for the
judgement exercised. Resource accounts,
coupled with local budgetary authority, provide
an acceptable and achievable
© CIPFA, 1998 PUBLIC MONEY & MANAGEMENT APRIL–JUNE 1998
 22
means of separating power and empowerment.
The executive has to account to the proprietor’s
representatives for the resources deployed.
This leads to:
Principle 1—Sustained Auditable Propriety (SAP):
RAB should maximize the propriety sustained in
spending public money
Empowerment generally means decentralization,
but of what? Decentralization (see Hilton, 1983)
has three dimensions (the three Is):
•Intents.
•Incentives.
•Information.
These respectively cover the subordination of
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power, authority and responsibility. The first
principle limits the extent of their use.
Current public sector reforms see VFM enhanced
by devolving authority, not the power for directing
expenditure. In the literature on property rights, the
latter entails usus abusus rights, i.e. the right to use,
abuse and alienate an asset (Furubotn and Pejovich,
1979). Asset controllers are then freeholders. They
have a vested interest in sustaining assets with a
view to their later resale value. In addition, others,
who feel they can use the same asset better, can buy
it at a price bettering the financial position of the
current owner. If such a sale is not advantageous,
then the new owner is at financial risk. This is the
basis of ‘high powered’ market incentive (Williamson,
1991). It also provides the moral justification for free
enterprise. One forgoes such incentives with public
ownership. This impedes the transfer of assets from
those using them badly to those using them well.
Decision-makers are not at financial risk.
Current public sector reform intends to
maximize the use of usus abusus rights for assets
deployed for the public good. This justifies
contracting out, outsourcing, market testing and
the Private Finance Initiative (PFI). By such
means society gains from high-powered market
incentives. RAB must therefore maximize the
opportunities evident for public service delivery
using market incentives. This leads to the
second principle: Market-led delivery.
Principle 2—Market-Led Delivery (MLD): The span of
accountability and financial control chosen for distinct
accounting entities should highlight opportunities to
access and use ‘high-powered’ market incentives and
effect control by budgetary not regulatory means
Authority empowers decision-makers to direct the
use of assets to the achievement of pre-specified
ends. It does not give them the power for
unfettered acquisition, disposal or reassignment.
This is what empowerment means. This level of
control yields usus fructus rights, i.e. access to the
fruits of use, the rights of a leaseholder. The
degree to which a leaseholder has an incentive to
sustain an asset depends crucially on the length of
the lease. With a very long lease, for example 99
years, the incentives are close to those of a
freeholder. The short-term holder of usus fructus
rights has an incentive to extract the maximum
possible return from an asset, independent of the
impact of that on value. With a one-year lease,
there is virtually no interest in asset husbandry. To
be consistent with the first principle, and staff
development, civil service tenure is deliberately
brief in any post. When devolving authority it is
then difficult to bring those with it to account. The
new accounts need to counteract any tendency to
extract use value at the expense of opportunities
to support asset values. A financial concept, i.e.
net present value, used as an accountability
criterion, would encourage good asset husbandry.
It treats value as the same as the net benefit
yielded in an asset’s lifetime rather than its utility at
an instant.
Principle 3—Net Present Value (NPV): RAB should
encourage those with delegated authority to
optimally trade-off the values extracted, sustained
and realizable from assets
This principle produces limited ‘closure’. The
values on which it depends, i.e. future costs and
disposal values, are problematic. The principle’s
power to bring decision-makers to account is
thus weak. By limiting the user’s disposal of
assets, the impact of high-powered market
incentives is constrained. On the other hand,
responsibility has been devolved within limits to
ensure delivery of proprietorially specified ends.
In devolving authority, and applying the NPV
principle, decision-makers are empowered to
redirect resources. This is to deliver pre-
specified outcomes, sustain assets and initiate
their replacement. Devolving authority provides
some high-powered market incentives but
constrains ultimate purposes, investment and
disposal. The use of low-powered hierarchical
incentives is then inevitable. Thus
empowerment through the delegation of
authority, does not connote the acquisition of
power. It does provide incentives and
capabilities not accessible with responsibility
alone. With the latter, one is aware of cost; but
does not control it. With delegated authority and
sufficient time in a post, or a peer context, one
can create market-like constructions putting
decision-makers under market-like pressure. To
maximize VFM, a balance is needed between
market and hierarchical incentives. This leads to
the fourth principle: ex ante empowerment.
Principle 4—Ex ante Empowerment (EAE): RAB
should delegate ex ante authority and underpin it
with systems ensuring sustained long term personal
accountability
We define responsibility as restricting decision-
PUBLIC MONEY & MANAGEMENT APRIL–JUNE 1998 © CIPFA, 1998

Table 1. Principles to guide RAB.
Principle number and name
1 Sustained auditable propriety
2 Market-led delivery
3 Net present value
Diego] at 11:55 25 July 2016
4 Ex ante empowerment
5 Ex post accountability
23
Short name Definition
(SAP) The accounts should maximize the
propriety sustained in spending
public money.
(MLD) The span of accountability and financial
control chosen for distinct accounting
entities should highlight opportunities to
access and use the high-powered
incentives provided by markets.
(NPV) Accounting and financial systems should
encourage those with delegated authority
to optimally trade-off the values
extracted, sustained and realized from
their assets.
(EAE) Ex ante authority should be delegated
and underpinned by accounting and
financial systems supporting accountable
personal control.
(EPA) With hierarchical responsibility the
accounting, not planning, system should
drive structure and incentive to ensure
auditable ex post personal performance.
 makers to using information to direct assets in a
pre-specified way to pre-specified ends. In the
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literature, this is a usus right. The decision-
maker is merely an asset’s tenant. There is no
power to specify intent and none of the built-in
incentives of authority. Direct monitoring of such
‘tenant’/management responsibilities is the only
way to ensure that a proprietor’s assets are
used as intended. Limiting actors to
responsibility is to accept low powered
hierarchical incentives. The relationship
between cause and effect, and consequently
reward and punishment, is uncertain. Without a
clear link between these it is difficult to contract
for market delivery.
The commercial response to this is to
empower managers within a tight time frame.
They have to contract ex ante for an agreed level
of commercial performance and are held tightly
to account for delivery ex post. The bureaucracy
emphasizes ex ante commitment coupled with
tough ex post audit of probity but not value
delivered. This has made it seem inefficient.
This has led to current interest in ‘re-inventing
government as a business’ (Hilton, 1994).
Decentralizing responsibility with no evident
personal authority or power, nor ex post VFM
accountability, provides valuable disinterested
objectivity in public servants. They then cope
well with the regular changes in political
direction inevitable in democracy. Citizens
demand decision-making attitudes consistent
with SAP and so despite current reforms, the
delivery of some services will remain by
bureaucratic hierarchy. For these we need an
accounting system supporting a
well-directed use of available incentives.
Principle 5—Ex post Personal Accountability
(EPA): With hierarchical responsibility the
accounting, not planning, system should drive
structure and incentive to ensure personal
performance is auditable ex post (see table 1)
We thus have five principles guiding RAB:
•Sustained auditable propriety (SAP.
•Market led delivery (MLD).
•Net present value (NPV).
•Ex ante empowerment (EAE).
•Ex post accountability (EPA).
The MoD Asset Base: Size and
Complexity
The MoD asset base is such that capital charges
and depreciation are likely to be at least as much
as the current cash procurement budget. The
assessment of these values is problematic (Hilton
and Gillibrand, 1996). The private sector only
sustains assets delivering returns as good as
those obtainable elsewhere. Cash flow must cover
the costs of acquiring, maintaining and disposing.
An office building let at £20,000 p.a., when the
yield required is 7%, reflects a value of £285,714
(cash flow/required yield).
Valuations are then adjusted to reflect
factors such as tenant quality. In the public
sector this method can be used directly. A city-
centre building may have a value computable
by such means. The MLD principle then
suggests that it be accounted for as a business
© CIPFA, 1998 PUBLIC MONEY & MANAGEMENT APRIL–JUNE 1998
 24
or even run as one under the PFI. However,
MoD buildings are often specific in use. Offices
may have a nuclear shelter attached or be
dispersed to the countryside.
In local authority accounting, the first kind of
asset, i.e. a sellable one, is treated as a capital
outlay and the second as an other long-term outlay.
In defence things are even more difficult.
Consider valuing a tank. One could envisage
military assets as protecting an income stream
and so are analogous to a security system or
insurance policy. In theory, one could then value
them using the NPV principle. But even
commercial estimates of future income streams
are so uncertain that accountants despair and
use adjusted historic cost.
This, too, has problems for MoD. The
procurement market is not free. Historically based
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attributions of cost are unreliable. An estimate
could use the total cost of resources invested in an
asset’s design, production and support. But these
costs are not always clear. If they are, they may be
non-attributable or simply not recorded. Even then,
a weapon will have a value above or below this,
derived from its ability to perform against a
prospective enemy. Two approaches then exist.
One could take a subjective view of a weapon’s
military potential as a percentage above or below
that achievable by the prospective opposing
weapon, i.e. apply the EAE principle. The
determination of this should be by the individual
accountable for delivery in battle. However he is
partial. Applying the SAP principle, such a
judgement would need to be checked by someone
else qualified by experience to do so. A second
method would attempt to find some measurable
characteristics of the asset correlated with value—
for instance, age. This could be used to depreciate
or appreciate value proportionately.
In the case of weapons systems, the cost of
the MoD’s original investment is the only
practicable baseline for value. The handling of
subsequent value changes due to wear and
tear, refurbishment, retrofits, etc. remains
debatable, as will the impact of counters to the
threat it imposes (see Hildebrandt, 1992).
Valuation also depends on a view of when the
asset will be displaced or replaced. If we wish to
generate the ‘right’ incentives, the EAE principle
suggests those accountable for service delivery
should be those held to account for an asset’s
value and cost. This implies delegation to those
making operational decisions.
MoD must also take account of the changes
that occur in the nature of some assets when
moving from peace to war. Then some items
change from assets to consumables, for example
ammunition and missiles. A carelessly
implemented system of budgetary allocation could
have a perverse impact on military effectiveness
and by the EAE principle the ‘use value’ of military
assets. Being incentivized in peace to sustain a
weapon’s value as an asset for deterrence may
undermine an individual’s capacity to treat it as
expendable in war. Military training can
counteract such effects. It does so for military
manpower. However the requirement to do so
needs to be recognized.
Thus MoD has to be very careful to whom it
gives budgetary accountability for equipment. This
is fundamental to defence VFM. It is far beyond
the experience of traditional accounting and
budgetary practice. MoD has to develop its own
distinct criteria beyond Accounting Standards
Board (ASB) rules and commercial practice. These
criteria apply to categorizing, valuing and
allocating budgetary responsibility for assets.
The RAB Budgetary Structure, the MoD
and Incentives—An Example
The policy behind the introduction of RAB is to
provide better public sector incentives. It is the
budgetary regime that creates incentives, not the
accounting one, MoD already runs a decentralized
cash budgetary regime. It has approximately 13
Top Level Budgets (TLBs), each with an annual
cash budget. Under RAB these will become
resource budgets. Assets supplied free may be
badly used or abused. If managers have to
account for full cost they might use fewer assets
more carefully. The NPV principle supports good
husbandry. In central government no incentive
exists for asset users to preserve or sustain them.
Although RAB should change this, accounting
alone will not.
Under RAB those responsible for deciding on
required military capability will have to meet its full
cost. They might then reconsider their actions.
Mechanisms already exist ensuring economy.
However, the regulatory bureaucracy used is not
consistent with the Army’s system of empowerment,
‘mission command’. In action, this empowers
commanders to use their discretion within clear limits.
The EAE principle also does so. However, ‘mission
command’ also brings commanders to account ex post
for their consistency with the aim of their superior
command. This is in line with the EPA principle. The
RAB budgetary regime should ensure consistency
with this.
Table 2 attempts to show how the difference
between cash accounts and resource accounts
would affect various budget holders and their view
of a replacement decision for a tank. In addition
the table emphasizes the importance of the
visibility of the total output cost in making such a
decision. This is summarized in the right-hand
column beneath its subdivided components. Row
1 reflects the current system of cash budgeting.
Spares support, for example for transmissions,
requires £290,000 in cash. The Quarter Master
General’s (QMG’s) budget pays for this. The tank
costs £10,000 per year for fuel and spares and the
operator, Land Command, carries the budget for
this. The Procurement Executive paid £2,000,000
for this tank historically. This is already written off
(indicated by [square brackets]). Land Command
may, or may not, choose to pass its cash cost on
to the
PUBLIC MONEY & MANAGEMENT APRIL–JUNE 1998 © CIPFA, 1998
 25

Table 2. Illustration of RAB applied to military hardware (tank).

Budget or Old tank New tank
Account
type PE costs QMG Land PE costs QMG Land costs
costs cost costs

1 Cash [2,000,000] 290,000 10,000 3,050,000 45,000 5,000

2 Cash 300,000 3,100,000

Capital Depreciation Capital Depreciation

charge* charge*

3 Local
resource 120,000 200,000 290,000 10,000 183,000 305,000 45,000 5,000
accounts
of California, San Diego] at 11:55 25 July 2016

4 Outputs
resource 620,000 538,000
account

5 Local
resource 120,000 200,000 250,000 8,000 180,000 300,000 40,000 4,500
budget

6 Output
resource 578,000 524,500
budget

PE = the Procurement Executive who buy the MoD’s material and equipment. QMG = Quarter Master General: the
Army’s manager of the material of war. Land = UK Land Forces: the supplier of military output. Each of these is what
MoD calls a Top Level Budget.
*Capital charges are at 6% on capital employed.
 Divisional Commander, a Higher Level Budget
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(HLB).
A new tank would be cheaper to operate,
costing QMG £45,000 and Land Command
£5,000. However the purchase would require
the Procurement Executive (PE) to spend
£3,050,000 in cash. So, under the current
system of cash budgeting, obvious savings from
replacement are foregone.
Immediately below (row 2) all costs are
included in the TLB of Land Command. This
provides the final output cost of military capability.
Incentives stay the same. The front line is merely
made aware of the costs it imposes on QMG and
the MoD for spares. A decision by Land Command
to train tank drivers to save on transmissions
would have a real cash cost, in travel and
subsistence and an opportunity cost in the loss of
a driver for a time. Transmissions are ‘free’ from
stock in a cash-based system.
In row 3, we have moved over to resource
accounting. It is now very clear to the MoD that
it is cheaper to buy new tanks. However, if they
cannot find the cash or fund the new tank, they
might not be able to buy them despite the
apparent clarity of the case for replacement.
If all costs are accounted for at one place (row
4), it is now clear to those accountable for delivering
military capability that that capability is being
dissipated by retaining the old weapon system.
One would expect them to push hard for
replacement. They have a clear accounting
case, although an economic case based on the
net present value of future cash outflows may
not exist.
Resource budgeting (row 5) needs to mirror
the resource accounts so as to facilitate planning
and sensible comparison with the actual spend.
Not only is it clear that replacement is worthwhile,
it is also fundable. The budget provided the full
resources to fund output and indicates when
assets should be replaced.
In row 6, maintenance and asset use cost
lie with the operational commander who is
accountable for final output from supplied fully-
costed inputs. It is worth noting that this process
narrows the gap between the VFM from
replacement and retention.
Questions Raised by the Above
Example
We now consider a number of questions that arise
from trying to implement RAB in the MoD. The first
is how attritional assets should be expensed: in
the year of acquisition or when charged out to the
end user? This issue is vital to MoD’s VFM
© CIPFA, 1998 PUBLIC MONEY & MANAGEMENT APRIL–JUNE 1998
 26
interests. Consider ammunition: in war, it is clearly
consumable and an expense; however, in peace it
is equally clearly a stock deterring an enemy from
attack. In peace, there is thus a case for placing all
ammunition on the balance sheet as a fixed asset
representing war reserve. One would then only
expense it when issued to combat units.
Ammunition kept in the central stock will have a
sell-by date varying by type. The sell-by date could
be a basis for depreciation. The cost of
maintaining that stock would be this depreciation
plus storage, overhead and management costs.
Fully depreciated ammunition issued prior to
disposal would then have little ‘use cost’, but
significant accumulated holding costs and very
high disposal costs, given its toxicity. A strong
incentive then exists to fire it off.
The second question addresses the MoD’s
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incentive problems at the strategic level. How
should asset losses, real or potential, and/or
decisions on write-offs be handled to ensure
‘proper’ incentives? Large write-offs need
financing. Real adjustments in the expenditure
accounts, balance sheet or borrowing are needed.
How this is set up to attain the right operational
incentives will be of vital importance to the MoD.
Equipment values can be lost through
cancellation, warfare or the appearance of an
effective enemy counter. Acquisitions can be
cancelled. The UK has the new Upholder Class
submarines surplus to requirements. These cost
£800M to procure. It is important to remember
that defence production is generally one-off.
Replacement is usually not possible from an
existing production line or stock.
Under the proposed system of accounts, a
cancelled programme such as this would be on
the balance sheet as work in progress valued at
cost. This could be a significant part of MoD’s
annual budget. A private sector company could
choose its accounting treatment. Limits to
power and authority constrain the MoD. It could
not choose what actions to take, for example a
charge to the expenditure accounts, financing
the write-off, allow the assets to pass into the
hands of others to use better, i.e. the equivalent
of bankruptcy. The Secretary of Defence would
have to place his preferred option before
Parliament. This could be politically difficult.
Cancelling a defence programme under RAB
will require a new kind of planning. Bankruptcy is
hardly an option, an election could be. Politicians
are therefore likely to approach this problem with
circumspection. The view might be taken that the
political costs of a write-off were so high that
cancellation was not a realistic option.
Programmes or facilities could then be
sustained for political, democratic reasons, despite
being militarily indefensible. Depreciation and
capital charges would not then reflect real value to
a budget-holder. This could be a disincentive
adverse to morale. This compounds the initial loss
in military value. The asset should perhaps be
written-off centrally not at the operational level.
In war, the full cost of replacing destroyed
equipment is generally expensed. What was an
asset is now a consumable. RAB needs to support
this transition from peace to war. Accounting can
help. However, the right incentives require budgets
matching the decision-making hierarchy.
Finally, if the change in value was due to an
increase in the military effectiveness of a
prospective enemy then the value of the asset
needs writing down. If charged to the budget
holder’s revenue the resulting disincentive
would amplify any decline in fighting power. In
such circumstances, by the EAE principle, the
charge should stay on the balance sheet. The
charge is outwith the commander’s control and
so it is inappropriate to hold him to account. His
balance sheet then signals the decline in his
military capability. His superiors then have to
act. They could either lower their expectations
of him or take corrective action themselves.
Generally, the decisions to acquire or dispose
of equipment are central ones if the incentives
generated are to be correct. The write-off should
be taken as a charge on the MoD’s consolidated
accounts. This would require financing. It could
also lead to early replacement. Provided
depreciation is a real resource charge, and not
notional, accumulated depreciation allowances
could help finance the write-off. RAB would then
provide both the need and means to replace
technically redundant military assets. However, if a
change in the military effectiveness of an asset
was due to bad treatment then the charge, and the
finance, should theoretically fall on the budget
holder. Both the EAE and NPV principle require
this. This communicates a strong message on
asset abuse. However, it would not be acceptable
to sustain such a decline in military effectiveness.
It would then make sense to follow the Royal
Navy’s tradition. Court martial the man in
command, replace him and take the charge to the
central accounts. This neatly restores the
symmetry of accountability and incentives.
There could be a similar problem in the
opposite direction. This could create the need
for revaluation. This would produce a
‘revaluation surplus’. If the result was that only
the value of the asset changed, with no impact
on revenue, then our accounting principles
would suggest that the change be recorded as a
balance sheet transaction only.
If some of the surplus was sellable, then a
realizable gain would occur. This would need to be
shown in the consolidated trading account. Under
the terms of the MLD principle, the accounts of the
principal responsible trading agency within the
MoD, would indicate the surplus. The problem
would then be to stop such funds being used to
finance extra spending over that appropriated.
Carrying the MLD principle to the limit would
obviate the problem. The agency should be an
independent trading company. Market realizable
gains and losses would then have occurred in a
private sector
PUBLIC MONEY & MANAGEMENT APRIL–JUNE 1998 © CIPFA, 1998
27
 organization. If they had occurred within the
MoD, then the Treasury might adopt the local
authorities’ approach. The windfalls would stay
on the balance sheet. They would not be
transferable to the revenue account without
explicit stakeholder, Treasury or Parliamentary
permission. In such circumstances, asset
revaluation could have no obvious impact on
behaviour. This compounds the argument for
MLD.
Depreciation and capital charges would,
however, vary with the associated revaluation/
devaluation, reflecting the nature and tenor of
the business, and replacement policy. By the
EAE principle, the intention is to indicate the
cost in use of assets. Without this no standard
of comparison would exist as a basis for
deciding on the benefit derivable from using one
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asset as compared to another. Under the local
authority model, the depreciation would appear
as a loan redemption payment in the revenue
account. However, the equivalence between
depreciation and principal repayments is not
one-to-one. The asset may be more valuable
than the loan, or the loan period may not reflect
the life of the asset. The financing of the capital
expenditure could differ from revenue.
A market-based alternative would be to take
the asset off the balance sheet. One could use the
PFI and/or lease. This leaves windfall gains and
losses with the lessor. Given the MoD’s risks, it is
unlikely that the MLD principle could lead to all
risks being absorbed by the private sector.
However many of the risks, if inappropriate for the
MoD itself or the PFI, could by the converse of the
EAE principle be taken on as leases. The Public
Works Loan Board could provide the necessary
finance supervised by the Treasury. The supplier
or the financier would then have retained
ownership. The MoD would merely pay rent. But
this carries its own problems. Without attributing
the full cost of ownership to the MoD the
incentives to avoid damage decrease. This would
require higher rental charges as the lessor would
need to incorporate incentives to good
housekeeping. Alternatively, a higher attrition rate
could have the effect of encouraging perceived
obsolescence, allowing more frequent
renegotiation of leasing terms. This happens in
commercial leasing.
From this, the question arises: ‘Is it in the
Government’s interest to take MoD funding off the
balance sheet?’ In the short term, there could be a
one-off benefit to the PSBR from the MoD’s budget.
We have to consider two points. First, whether one
wants to fund an item on or off the balance sheet.
Second, once acquired, how should one account for
its use and replacement. As we have seen, the new
resource budgets eliminate the distortions to
decision-making endemic in a cash system. From the
taxpayer’s perspective the two worst of these are:
The retention versus replacement decision for MoD
equipment; the capacity of MoD to use material
stocks to
circumvent annuality in the sort term by putting
its military capability at risk by running down
stocks.
Retention versus Replacement
The current system creates incentives for the
Government to defer the replacement of military
equipment and stock. The tank example
illustrated how this is contrary to the outcome
desired by a post-holder under EAE or NPV.
Stock and Annuality
In the face of short-term budgetary pressure, it has
been easy for the MoD to maintain activity levels
and procurement. It did this by consuming stock.
The cost of this can be high in the long term. The
whole tank fleet in Germany had to be
cannibalized to provide sufficient spares to support
the Gulf War. This was a direct result of stock
consumption in the 1970s and 1980s.
The current cash budgeting system is thus
financially inefficient for the military,
departmental finances, the taxpayer, MoD
suppliers and even the security of the nation.
For MoD VFM, RAB needs to charge assets
out in a manner that balances the rationality of
replacement and the incentives for annual
budgetary economy.
Models do exist incorporating the NPV
principle for equipment disposal and the
maintenance of stock. They weight the cost of
maintaining an asset and its cost of replacement. If
the full cost of ownership were borne by military
end-user, then the benefits of better housekeeping
could be quickly realized. RAB provides incentives
to ensure assets are kept in better condition for
longer. On the other hand, if a military asset had a
use value at the end of its predicted life, then
keeping it might make sense.
What should depreciation be in such
circumstances? What is the correct use value of a
fully written down asset? MLD would suggest, and
EAE would encourage, the straight line
depreciation rate to continue. This would provide
accumulated savings for the user. In effect this
‘use’ appreciation should legitimately be credited
to a revaluation reserve reflecting the earlier error
in underestimating the asset’s lifetime. A credit
could then accumulate under MoD control. This
would provide an incentive to good asset care.
However, unless such balances could be held to
MoD’s account within the operating provisions of
the Consolidated Fund, this would be in breach of
the extant Exchequer and Audit Act 1866. If
Parliament accepts the budgeting provisions of
RAB it needs to make a clear decision. Should
these provisions be retained or not? Cash flow of
this type would create a stock of finance that could
erode annuality.
This, of course, assumes that, under the
budgetary dimension of RAB, the Treasury
transfers full costs in cash to departments’
budgets. It is not clear that this is intended. If not,
one would have the silly anomaly that MoD’s cash
© CIPFA, 1998 PUBLIC MONEY & MANAGEMENT APRIL–JUNE 1998
 28
budget could increase significantly if it transferred
delivery to an external lower cost supplier.
However, if such discretion were possible, it would
be necessary by the SAP principle for an annual
review of MoD continued maintenance versus
replacement costs. This would need to be reported
to the Treasury and the Public Accounts
Committee. It would be necessary to stop units
keeping ineffective items going simply to build up
discretionary reserves. This would be at the
expense of VFM. Exhausted military capability or
non-battle worthy assets would be retained.
Finessing of annuality by such means has been
implicit practice until now, through the judicious
management of stock. RAB would make such
actions explicit.
A highly pertinent question here is would any
treasury, private or public, allow such a result? Is
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the Treasury the country’s banker or central
treasury? Which one of these two models is
appropriate is one of the most important questions
RAB has to answer in the new few years.
Conclusion
This article has raised issues on capitalizing and
expensing public expenditure. The Treasury’s
Green Paper (Cmnd 2626, 1994) and subsequent
White Paper (Cmnd 2929, 1995) on Resource
Accounting and Budgeting have set out the
framework for the work that is now going on in
departments. Public discussion to date has not
raised all the issues needed to inform this work.
We have worked at them from a MoD perspective.
There they differ significantly in magnitude, scale,
motivational consequences, distribution of
authority and asset type from elsewhere.
We have explained what we believe are the
principles that should apply to RAB. These were
submitted in a slightly different form in evidence
to the Treasury, in response to the Green Paper
(Cmnd 2626).
Some novel ideas emerge from using these
principles, particularly for generating appropriate
incentives out of a RAB budgetary regime. The
key issues are how to finance activity and produce
the incentives that RAB intends to support. It is
clear that having more of MoD’s activities in the
market and making MoD employees more
personally accountable for the results of their
decisions could enhance defence VFM. For this to
be effective reward and punishment has to be
consistent with best private sector practice. Until
recently, this has never been contemplated for civil
servants. Interestingly, it is already standard
practice for the military. The process of mission
command ensures this.
It is also clear that the congruence of
accounts, financing, organizational design and
managerial control are fundamental to the
success of the changes contemplated. ■
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