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Accounting & Budgeting1

The requirement to maintain an accounting of the governments finances is not

only embedded in the laws and regulations of the government, but hallmarks of public

service are compliance with those and other laws, the transparency of government

operations, and accountability for taxpayer funds. Defense managers should assume the

responsibility to meet all three objectives and doing so requires a consistent flow of

reliable financial information. Financial management processes seek to perform all three

functions compliance, transparency, and accountability while supporting management

decision-making. This brief essay examines the role of accounting in government and the

DoD, especially. It considers the various bases for accounting stressing the information

content of each base, the types of decisions they support, and the stakeholders that need

such information.

Ask a recent MBA graduate how many different types of accounting he or she

studied and the likely response will be "two," financial accounting and managerial (or

cost) accounting. Within the DOD, accounting is performed three ways: financial,

managerial, and budgetary.

Financial accounting is what one sees in a publicly-traded, for-profit

corporation's annual report: balance sheets, income statements, and statements of cash

flow and owner's equity. Terms associated with financial accounting include profit,

earnings before interest and taxes, depreciation, and revenue recognition. Financial

accounting is performed on an accrual basis in accordance with generally accepted

accounting principles. That is, transactions are recorded when revenues are earned and

costs incurred, which may not coincide with the actual receipt or payment. The rules are

rigid and strict; there is governmental oversight. The focus is on the accurate and reliable

capturing, recording, categorizing, and presenting of historical events. The intended

audience is outsiders. For a corporation, the outsiders are those in the capital markets

(potential lenders and investors); for a government agency, the outsiders are those with a

financial interest (legislators, taxpayers, and institutional investors in government debt).

1 This borrows from, and revises, material from Jones, Candreva & Devore, Financing National Defense,

IAP Press, 2012.

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Managerial accounting is what one does not see in a corporation's annual report.

It is the internal analysis conducted by the corporation to weigh one decision against the

next: Should we expand this plant? Should we drop that product line? Should we buy or

lease a specific capability? What does it cost to provide this service versus an alternative?

Terms associated with managerial accounting include weighted average cost of capital,

allocation, cost driver, internal rate of return, profit center, analysis of variances, and

cost-volume-profit analysis. Managerial accounting is performed on a cost basis, rather

than an accrual basis. There are common tools and practices for managerial accounting,

but no generally accepted management accounting principles; there is no government

oversight. The focus is on internal management decisions about the organization's

mission and scope of operations; the goal is to increase the value of the firm through an

understanding of costs and profits. The audience is internal; in fact, the data is so

proprietary that corporations typically wouldn't dream of sharing it within their

industries, with the government, or the public. Within the DOD, this type of accounting

enables working capital fund activities to set their rates based on unit cost; it is also

important information for determining cost estimates for investment decisions.

Budgetary accounting is what government employees are most familiar with. It is

the process of budgeting, justifying, and accounting for appropriations. Terms associated

with budgetary accounting include commitment, expenditure, apportionment, obligation,

authority, and disbursement. Budgetary accounting is performed on a cash basis in which

events are recorded as cash (or budget authority) is received, budget authority is

obligated, and payments are made (obligations are liquidated). There are strict rules

embedded in federal appropriation law and principles articulated by the Comptroller

General; there is significant oversight. The focus is on compliance with the law that

funds have been spent in accordance with the purpose, time, and amount that restrictions

attached to the appropriation. The audience is both internal and external. There is no

corporate analogy, though try discussing the concept of "obligation" with a

commercially focused certified public accountant Certified Public Accountant (CPA) or a

college accounting professor and gauge his or her reaction. Table 1 summarizes the three

bases of accounting.

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Table 1 Three bases for accounting

Consider the process of buying and using a piece of capital equipment. The same

sequence of events can be described in three different ways depending on the basis of

accounting. In financial, or accrual-based, accounting transactions are recorded when

economic events occur. When the item is shipped (or received) the organization has an

asset and a corresponding accounts payable. When the item is paid for, liquid assets are

reduced and the accounts payable is satisfied. When the item is used in the process of

generating products or services for sale, the asset is depreciated and the depreciation

expense matched to the revenue generated. Managerial accounting analysis may have

supported a make-buy-lease decision or a financing decision when the item was procured.

Managerial accounting is also concerned with recording the cost of the item in relation to

the lines of businesses or cost centers it supports. Budgetary accounting would have

recorded a commitment at the time a contracting approach was identified, an obligation

when the contract was signed, and an expenditure when the equipment was paid for. All

three systems describe the same series of events, but consider only certain portions of that

series worth capturing and reporting.

Financial

Accounting

Managerial

Accounting

Budgetary

Accounting

Associated

Terms

Income Statement,

Balance Sheet, Cash Flows, Revenue Recognition, EBITDA,

EPS, P/E ratio, Quick ratio

Allocation, cost and profit

centers, product line, ABC, NPV, IRR, ROI, WACC, non-financial indicators

Commitment, obligation,

outlay, appropriation, apportionment, budget, phasing plan, color of money

Time

Horizon

History a record of whats already happened

Future decisions about alternative courses of action

Past, present, and future

Audience Capital Markets shareholders and potential lenders

Internal Management* Stakeholders: managers,

taxpayer, congress, everyone

Rules GAAP Tools, no rules* Law

Oversight SEC, AICPA, FASB None* Congress, tax payers, OMB, chain of command

Objective Transparency, accountability, and comparability (over time & across entities)

Maximizing profitability,

adding economic value, decision-making by managers

Compliance

* Companies under contract with the federal government are required to follow certain cost accounting standards.

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As an analogy, consider three witnesses to an automobile accident. Witness A is

a police officer who describes the maneuvers of vehicles 1 and 2, their rate of speed in

relation to road conditions, the drivers compliance with traffic rules such as the right of

way or obeying signage. Witness B is a physicist who describes moments of inertia,

angular momentum, coefficients of friction, and compressive strength of materials.

Witness C is a foley artist who describes the sounds of the scene: squealing tires,

crunching metal, shattering glass, gasps and screams, cries for help, and sirens. All three

witnesses describe the exact same event, but choose those aspects that are most relevant

to them, the story they tell, and the users of their information.

Notice that budgetary accounting merely records the promise to pay (obligation)

and the payment, but does not capture the ownership of the asset nor the impact of that

asset on any line of business. Budgetary accounting does not tell a manager what is

owned nor how it is used, thus it is of limited utility for management decision-making.

As the former DOD comptroller, Tina Jonas, once commented before the House of

Representatives Government Oversight Committee, It is important to note that our

financial systems and processes were developed to support the budget and appropriations

process. Therefore, they unfortunately do not generate the type of financial information

that meets the needs of the Department's decision makers" (Jonas, 2002). Financial and

managerial accounting practices have long been viewed as important adjuncts to

budgetary accounting.

Financial management practices should ensure that all three forms of accounting

occur in an integrated fashion. The Budget and Accounting Procedures Act of 1950

required heads of agencies to establish and maintain systems of accounting designed to

provide reliable accounting results to serve as the basis for agency budget requests and

budget control and execution (Hoge & Martin, 2006). The example above buying and

using a capital asset is a single series of actions that can be described as consisting of

certain financial, economic, and legal transactions that would be captured in the various

accounting systems. Since all three forms of accounting are describing the same series of

actions, one should be able to cross-walk the information in the various accounting

reports to get a comprehensive view of the organization. Hoge and Martin (2006, p. 123)

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graphically represent the different purposes for which accounting systems exist in Figure

1.

Figure 1 Functions of Accounting Systems

Budgeting is distinct from accounting, and one should note that [b]udgets are

undeniably more important than financial statements in local as well as national

governments (Smith & Chen, 2006, p. 16). The process of budgeting is where policy

disputes are waged, priorities are established, resources are allocated, and winners and

losers determined. Budgets are also used as control devices during execution to keep

public managers focused on the policy priorities. Accounting is often regarded by line

managers as a housekeeping task that does not influence decision-making. Most

comptrollers offices within DOD are separated into two groups and [a]t times, the

communications between budget offices and accounting offices resemble a visit to a

foreign country where the language spoken is different from the visitors (Hoge &

Martin, 2006, p. 137). Line managers rarely communicate with the accountants yet

frequently interact with the budget side.

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References

Hoge, J., and E. Martin. 2006. Linking Accounting and Budgeting Data: A Discourse.

Public Budgeting and Finance , 26/2: 121-142.

Jonas, Tina. 2002. Statement before the House Government Reform Committee,

Subcommittee on Government Efficiency, Financial Management and

Intergovernmental Relations, 20 March. Washington, DC: GPO.

Smith, K. A., and Chen, R. H. 2006. Assessing Reforms of Government Accounting and

Budgeting. Public Performance and Management Review, 30/1:14-34.