Governmental Accounting: Part 3 (#276)
/In this podcast episode, we discuss the budgeting aspects of governmental accounting. Key points made are noted below.
The Need for Detailed Budgeting
It’s absolutely critical for a government to have a detailed budget for each of its funds, because the supply of cash is strictly limited. Once you use up the cash, there isn’t going to be any more.
Durations of Budgets
Government budgets usually have a duration of one year. Once a budget is prepared, it’s forwarded to the legislature for further discussion, and then it’s converted into an appropriation bill. That appropriation lays out the maximum amount that can be spent over the budget period.
There’s also the long-range budget, which usually goes for a period of four to six years. This is more of a planning document, so that everyone has a better idea of how much cash is needed in the future, so that they can start figuring out how to finance it.
Flexible Budgets
When I talk about having a fixed pool of cash available, that’s generally true, and most government budgets are considered to be fixed. But – in a few cases a flexible budget can be used. A flexible budget contains formulas that alter the amount of a budget line item, depending on the activity level. The most likely candidate for a flexible budget is a proprietary fund, which as you might recall from two episodes ago, covers the business activities of a government, like a state park or an airport. Proprietary funds tend to have a more variable revenue level, so expenditures need to change in conjunction with the sales level.
Budgetary Control
The main point about government budgets is budgetary control. There are several types of control. One is the appropriated budget, which is created when an appropriation bill has been signed into law. This appropriation begins with the original budget that was submitted to the legislature, and which has then been adjusted for all kinds of things, like supplemental appropriations, transfers between funds, and reserves for various contingencies. This is the strictest level of control.
The Non-Appropriated Budget
A different level of control is associated with the non-appropriated budget. This one is not subject to appropriation, because it’s been authorized by statute. This is a lower level of control, because it can’t be touched. For example, a portion of your state-level sales tax might be automatically set aside for school funding. Or, a chunk of your gasoline tax might be set aside for road maintenance. Those are examples of a non-appropriated budget.
Budgetary Execution and Management
There’s one other type of budgetary control, which is called budgetary execution and management. This is basically everything else, and it involves adjusting the budget to make it fit reality. It might involve setting up contingency reserves, funding transfers between funds, deferring funds, and basically whatever is needed to put money where it’s actually needed. In short, the appropriated budget represents the big picture level of funding, while budgetary execution and management is at the most detailed level of deciding where to place the cash.
The Budgetary Account
A unique feature of budgeting for governments is the budgetary account. This is an actual entry into each fund, showing the amount of the budget assigned to that fund. These accounts are reversed at the end of the year, so they don’t have an effect on ending balances – but they’re quite useful for monitoring the amount of available funding for each fund.
Encumbrances
And then we have encumbrances. An encumbrance is a commitment related to an unperformed contract for goods or services to a government. It’s used to ensure that there’ll be enough cash available to pay for the supplier invoices associated with those contracts. An encumbrance is usually recorded for larger contracts, just to make sure that the government has set aside enough cash to pay for it. So for example, if a city government enters into a contract to pay out $100,000 for tree trimming services, then it also sets aside, or encumbers, $100,000 to make sure that the supplier’s bill can be paid.
It’s quite possible that a contract will run past the end of the year, so the associated encumbrance can still be outstanding at year-end. If so, it basically indicates the amount of cash set aside to pay for the rest of the contract. And once the associated contract has been completed and paid for, the encumbrance linked to it is removed from the accounting records.
Summary
In short, budgeting is a very big deal for governments. I’ve talked in some of my books and articles about how budgeting might even be harmful for businesses in general, since they tend not to be overly accurate once you go a few months into the future, and they tend to make decision-making too rigid. But that doesn’t really apply to governments. They simply cannot run out of cash, so they have to watch every penny. Hence, the need for appropriations, and budgetary accounts, and encumbrances.