Unpaid bills distort budget and government accounts

By R.M.B Senanayake

This budget was introduced at a time of a crisis in the balance of payments when the funding constraint has to be tight to restore macro-economic balance. Budget figures and measures seem to indicate that this need is being borne in mind. Yet, the oil and petroleum subsidies which are a heavy drain on the government have not been touched.  

The Budget Speech says the budget deficit will be reduced to 5.8% of GDP. It is Rs 507 billion and the nominal GDP next year would then be Rs 8,742 billion. This seems to be too optimistic unless the GDP deflator (a measure of inflation which was 7.8 in 2011) is much higher than the 7.0% inflation referred to for 2013 in the budget. But there are more serious drawbacks in the whole process of execution of a budget in our country.

The reality of the budget figures

Making a budget and announcing various relief measures is only part of the job. It must be implemented with the necessary financial discipline. The harder part is to implement the budget and ensure that the spending plans are adhered to and the budget deficit kept to what was announced, not by creative accounting but by accepted methods of accounting.

Government accounting is based on cash basis and not accrual basis like in businesses. The flow of tax revenue is uneven and the spending is subject to the cash flow constraint. All revenue goes into the consolidated fund and its banking counterpart is the DST Account in the Bank of Ceylon. (There are departmental bank accounts as well). The Treasury is rationing cash to the departments to whom allocations have already been made in the budget and they cannot pay out despite the budget appropriations unless they have the money which it is released by the Treasury. So it is necessary for the Treasury to draw up a cash flow statement to accompany the Budget or include in the Fiscal Management Report.

Under the Financial Regulations, departments are not allowed to incur liabilities for supplies and services unless there is provision in the budget. But even with the provision, the departments are unable to settle bills in time since the Treasury is unable to ensure a smooth cash flow to the departments. Those who have made supplies or services to the government know the payments procedure. They submit the bills or invoices along with the delivery of the goods or services. The storekeeper checks and accepts the goods if they conform to the specifications in the tender. He then sends the invoice to the payments section where a voucher is prepared. Then the cheque or pay order is issued by the department to the supplier.

But the department cannot release such cheque to the supplier unless it has funds in its bank account. But they have to depend on the Treasury for the money which is released in installments according to the imprest permitted to the department. If the Treasury has not provided the money, the department accumulates arrears in payments. The Treasury may also, if it so wishes, spread out the release of moneys and allow carryover of payments for this year’s expenditure to the next financial year. This will help the Treasury to keep down expenditure to the budgeted figure and show a realized budget deficit closer to the budgeted figure.

Mr. Indrajit Coomaraswamy, formerly of the Commonwealth Secretariat, told me that such arrears payments were resorted to even in the 1980s. But now such payment arrears have reached a high level. I understand that such payment arrears are at present over Rs 100 billion. How much of the payment arrears relate to the budgeted expenditure in 2011? Since the running of payment arrears seems to be a common practice, it is necessary to know the amount of such arrears at the end of each financial year so that the increase in such arrears can be accounted for under the previous financial year. Accumulating payment arrears has serious repercussion on the cash flows of firms which provide supplies and services to the government.

But more seriously, the practice calls into question the validity and usefulness of the budget figures for any macro-economic analysis unless an adjustment is made for the change in payment arrears from one financial year to the next.  The accepted delay in payment is only for the normal time required to process the payment after the goods have already been received and accepted. The fiscal economist should ascertain whether information conveyed about spending from the budget during the year or at the end of  the  budget year refers to commitments for the purchase of goods and services or the payment orders issued in respect of them or payments encashed. It is not proper cash accounting for the Department or the Treasury to postpone payments because the latter cannot provide the necessary funds in time to pay for the supplies and services ordered and delivered by the private sector or inter government agencies. There are huge arrears in payments due to the CPC by the Railway whose funding is provided in the budget.

What then does the Budget data relate to? Are they relating to commitments or only to cash payments? If it is the latter then the fiscal economists in the Central Bank must take them into account in their macro-economic analysis, allowing for the change in payment arrears over the previous year.  The public also should know the magnitude of such payment arrears and the fiscal economist must make allowance for it in determining the budget deficit/GDP ratio and other quantitative measures of fiscal soundness. Does the Treasury collect data on outstanding payment vouchers? The Treasury collects data about the encashment of payments through cheques or pay orders. For fiscal monitoring purposes, it concentrates on the final encashment stage of payment, when cheques from government accounts are cleared through the banking system—the cash accounting stage. This is usually the only reliable and timely information available on a centralized basis. But in the absence of data on payments in arrears in the departments and a published cash flow statement it is not possible for the fiscal economist to monitor the performance of the budget.

In accrual accounting terms, once goods or services are verified as delivered, the government has incurred a liability; but in cash accounting terms the expenditure is not counted until payment is made. Although the government is said to follow the cash accounting system, it forces suppliers to give credit. But these should then be included in the expenditure of the budgeted year they relate to. The Treasury may direct departments to delay payments and build up payment arrears which may be carried over to the next financial year. This can be used as a method to keep the realized figures down to the budgeted figures. If such practices are relied on for a prolonged period, the departmental or ministries’ liabilities (and hence expenditure levels) are not correctly reflected in the accounts, owing to the existence of unpaid overdue bills, which represent expenditure arrears. They also distort expenditure figures of the government provided in the budget.

How can the accumulation of arrears be measured?

Payment arrears can arise on any expenditure item, including wages, transfers, and debt servicing. Thus, while they are most commonly found on payments due to the private sector for the supply of goods and services, that is by no means the only item affected. For such goods and services, except in those cases legally disputed, an arrear exists when a bill has been received for services verified as successfully delivered but not paid after what is considered the "acceptable grace period." So if payments are not paid during the fiscal year that the commitments are made and payments are normally due, the payment figures would seriously under-state the financial performance. In short by following a policy of accumulating payments in arrears a false budget is created.  

A typical problem encountered in measuring arrears is that accounting systems are unable to determine which bills are already beyond their acceptable grace period - for example, when bills received are not carefully noted in either a general ledger or separate book- keeping record. Often, the amount of arrears can only be defined through a proxy, which is the difference between the amount of bills received (if known) and the amount of bills paid. In any case the accumulation of payments in arrears is a serious distortion of the budget and does not present the true picture of government spending and the budget deficit.

The budget should include a Cash Flow Plan if the fiscal economists are to monitor correctly the government spending.

Fiscal economists need to keep in mind the difference between an accrued and a cash liability for public expenditures. Once goods are delivered and the bill is received and verified, an accrued liability has arisen. In economic terms expenditure should be recorded then as having taken place. But all too often the Treasury, aware of the paramount importance of the monetary variables in macroeconomic adjustment programs, may seek to avoid recording a cash liability. Limiting the amount of cash liability allows the government to hold down (below target, for example) borrowing in cash terms. So the credibility of the budget deficit and the financing estimates are open to serious doubt.

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