March 19, 2009Doug Hadden
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