Chapter 3 · Fundamentals of accounting

Budgets are requests for, and subsequently authorisations to spend, public

money and, at bottom, they are financed by taxation. The form of the requests
is a plan for future spending, against which actual spending can be compared
for internal control purposes and external control. Governments are publicly
accountable during all stages in this control cycle, to varying degrees. In their
definitive form, budgets are requests by the executive of a sovereign government
for the authority from the legislature to collect taxes. In the context of local
governments, they may be seen as requests by officers for the authority from the
council of politicians; or the requests may be directly from the local government
to the electorate, in the form of budget hearings.
Budgets may not be produced by accountants at all, but, once they have been
approved, it is the role of accounting to monitor actual spending against the
budget in order to provide a crucial form of control. As the form and content of the
budget can significantly influence the extent of the control that is possible, account-
ing would always want a central role in forming the budget request. In the UK, at
central and local levels, accounting has played just such a central role; in the USA
and continental Europe, it is common for budgeting to be divorced from accounting.
Budgets developed as requests for money to spend, but in modern govern-
ments they are better described as requests to spend. This widens the nature of
budgets from being only concerned with money as a medium of exchange to
allowing other forms of spending (the definition of which depends on the basis
of accounting) against the budget. Thus, spending can be defined as passing
invoices for payment rather than the actual payment of cash.
These two definitions of spending have fundamental effects on budgetary con-
trol, which has particular emphasis on ensuring that budgets are not overspent.
A system defined by cash payments provides natural limits to the amount spent
(the cash available).
Another definition of spending that leads to a very different kind of budget is
one that identifies the commitments (at the US federal level these are generally
known as obligations; at the US state and local level, they are encumbrances) to
spend as spending. Those commitments might be of different kinds (depending
on the issue of orders to suppliers or the signing of contracts, including employ-
ment contracts), but they occur earlier, sometimes years earlier, than the pro-
cessing of invoices for payment or their actual payment.
Control in a government is a means to an end, not the end itself. Governments
exist to provide services; their recurring objective is to provide them better. The
traditional role of accounting in modern government was limited to matters of
financial probity, spending within budgets and the minimisation of spending.
Matters relating to the quantity and quality of services provided were largely
implicit and, anyway, were left to service professionals and politicians. During
and since the second half of the twentieth century, however, there was a stream
of initiatives, including budgeting initiatives, which shared the same fundamental
premise: that, given scarce resources, explicit measurement of the quantity, if not
the quality, of services provided, linked to measurement of resources consumed,
produces better services.
The implementation of systems based on this premise requires the measure-
ment of inputs and outputs, but it also requires the establishment of causal

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 3.1 Elements of accounting

relationships between the measures of input, the low-level measures of outputs,

the high-level measures of output and the unmeasured qualitative outcomes.
This is of particular importance to accounting as, whatever else performance
measurement systems achieve, they must relate outputs and outcomes to costs
for them to have economic meaning. Moreover, any such systems must be
judged not only in the terms set by those systems but also by the lived experi-
ence of government services, which we must at least allow could be very different
from what the systems portray.
Knowing the causal relationships between measures of inputs and outputs is
the foundation of for-profit accounting, significantly helped by the natural use
of the same scale of measurement: money. Projected turnover drives the budgets,
which then identifies the necessary production, which in turn identifies the costs
that vary with output (sometimes called the engineered costs – the balance being
termed discretionary costs). Cost–volume–profit analysis, with its attendant tech-
niques of standard costing and variance analysis, is the underlying technique. It
identifies that part of the cost structure in which costs do not vary with output
– termed fixed costs; those that do vary but not continuously – the semi-fixed
costs; and those that vary continuously – variable costs.
The proportion of engineered costs to discretionary costs varies by business
and industry, the higher proportions being found in manufacturing, but, even in
service industries in which causal relationships can be difficult to establish, the
benefits of naturally occurring money measurement are available. The definitive
cases in government, in which outputs can easily be measured but not in money
terms, are also those in which most costs are discretionary.
There is an associated contrast between for-profit businesses and govern-
ments that identifies another fundamental difference in budgeting. The turnover
that drives a business budget, in a profitable business, maintains the existing
levels of equity and debt and can increase it in the form of retained earnings. In
this sense, the profitable business can be said to be self-financing, in that the
turnover finances the business. In a government, in this sense, it is the budget
that finances, typically annually. Government budgets are recurring requests
for finance, which, if not authorised, would result in the government ceasing
to exist.
The form that budgets physically take varies across organisations, countries
and over time, as does the form of all financial statements. Although budgets
have not been subject to the attentions of standard-setting bodies in the way that
financial reporting has, there are common features of budgets. Since the 1940s,
these features have been challenged, particularly by the techniques of programme
budgeting and zero-base budgeting, which were at the height of their popularity
in the USA in the 1960s and 1970s. As comprehensive alternatives they failed to
be accepted, but there are elements of each that continue to have relevance.
The traditional starting point of a budget is the organisational structure – or,
more specifically, identification of those officers within the government who are
held accountable for spending money against budgets. In the private sector, this
would be known as responsibility accounting but, in fact, governments as a
whole commonly structure everything – not just their finances – in terms of
holding specific officials accountable for their actions, culminating in holding

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Chapter 3 · Fundamentals of accounting

the government itself accountable. This feature of budgets applies whether

budgets are held at a high level of aggregation or there is significant devolution
of budgets: the organisational structure locates the budgets.
Within each of the budgets thus identified, there are other common elements.
Budgets are usually listings of what is to be bought with the money being
requested: they are lists of inputs. They may be very broadly specified and may,
in extremis, be a single amount. They may also, and were more typically,
specified in much detail. There might be one amount for the whole of the
costs of employees, but this might also be broken down into very detailed items,
such as overtime pay for wage-earners. Again, though, whatever the level of
specification, budgets are usually lists of inputs. In the USA, accountants often
label these as lists of ‘line items’, the same term being used in the financial
statements.
The definitive budgets are for one year – the coming fiscal year. The form of
this annual request embodies another common feature of budgets: the request
for the coming year is justified in terms of the marginal changes made to the
previous year’s budget. When political scientist Aaron Wildavsky observed this
part of government budgeting in the early 1960s, at the beginning of his
celebrated work on budgetary processes, he called it ‘incrementalism’. There was
nothing new about the practice but his nomenclature has stuck, even though the
word misleadingly implies that the practice must always lead to budgets increas-
ing year on year. The essence of this feature of budgeting is not that budgets must
always increase, but that they are justified by marginal changes from previous
years, which may, in principle, be decrements.
Summing up these common features, their traditional form is of line item,
incremental budgets that reflect the organisational structure. As they are
expressed in money terms, they are natural ways to request money. They are also
very good at providing a crucial sort of financial control that financial officers
demand, in that the budgets specifically identify who is spending money and
what they are buying with it. This demand is not only in the interests of the
financial officers themselves but also that of the public, whose money is being
spent. It is common in many countries for budgets to be enacted as law, in part
to emphasise the importance of this kind of control.
In Europe in particular, in modern governments, the budget was used to
impose central control on all aspects of governments. Rules were developed,
many of which are still in use, to provide central control. Budgets that provide
money for only a year, after which time they lapse, is one such (known as
‘annuality’); another is the rule that budgets are provided gross, so that any
income earned by a budgetholder must be surrendered to the central coffers (the
‘gross budget principle’); the requirement that budgets balance (that budgeted
spending is financed by taxation) was also common. This emphasis on central
control was also associated – notwithstanding the fact that the size of govern-
ment budgets since the late nineteenth century grew at unprecedented rates –
with the idea that public money had to be spent on the cheapest that money
could buy, especially for routine, recurrent spending.
It is important, in modern governments, to understand that annual budgets –
as plans to spend money (however that spending is defined) – are not wholly

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