public finance

Chapter 1

WHAT PUBLIC FINANCE •

ADMINISTRATION IS

What is public finance administration? The need for carefully considering

public finance administration as a topic area arises because it lacks any

clear-cut technical or commonsense definition. Rather than present readers

with a bland and overqualified topic definition that is a relief to forget, we

want to make public finance administration a topic of some meaning beyond

a mere book title by approaching the topic through common conceptions

about the area. The most common conceptions of public finance administra-

tion include the notions that public finance administration is dull and ob-

scure, that it deals with numbers and calculations that are sometimes esoteric,

that it is about money, and that it is technical in character. Some of these

conceptions are correct, whereas others are partially or totally false. The listing

of news stories in Table 1.1 provides a starting point for assessing what public

finance administration is about.

The news stories display the excitement of major political, personal, and

organizational drama when large amounts of money are being handled in

interesting ways. The regular flow of such stories, and general public interest,

do not allow public finance administration to be obscure. The interesting ways

that public monies are handled or mishandled have significant impacts on

every citizen in the form of taxes, public services, and public policies. Such a

topic—and, we hope, this book—is neither obscure nor uninteresting.

Clearly, numbers, calculations, and money play an important role in public

finance administration. Numbers represent measurements of money or mone-

tary value in real situations. The 2.5 million residents, and their government

officials, in Orange County, California, saw 1.7 billion dollars of real invest-

ment losses in 1994, approximately $680 per resident. Residents' concern with

garbage collection fees and other public revenues is no mere fascination with

numbers but instead reflects a very real concern for meeting their living costs.

The calculations here, as is overwhelmingly the case in public finance admini-

stration, are simple, straightforward arithmetic. The reason for precise meas-

urement of monetary values is the importance attached to money as a medium

for measuring the value of resources available for exchange. People pay

attention to money, precise measurements of monetary value, and calcula-

tions concerning monetary values because money is a marker for all things of

material value.

Numerical representations of money and related calculations represent

more that just material values. Other real issues and ideas are very much

involved in the realm of public finance administration. Examples from the

listing of news stories include an international organization eyeing possible

revenue sources, a federal agency experimenting with purchasing regulations,

a state economic development project, a city collecting debts, and a church

losing more than two million dollars to embezzlement. Often, questions arise

in public finance administration regarding what is fair, what is appropriate,

and what is good public policy.

The conception of public finance administration as technical is wholly

correct. Technical despite connotations to the contrary, means the way things

are done. Public finance administration concerns how things are done with

money, and is, therefore, at the heart of the administration of public organi-

zations. Each item in the list of news stories represents a problem or situation

TABLE 1.1 Public Finance Administration News Stories

Orange County loses $1.7 billion because of risky investments, and treasurer pleads guilty to six counts of fraud, consulted astrologer Mercedes Benz economic incentives package ruled unconstitutional and renegotiated

U.S. Federal Emergency Management Agency works to ensure timely payments to disaster

Victims County weighs sports stadium investment with cost-benefit analysis

A former treasurer of Episcopal Church embezzles 2.2 million dollars, says actions cry for

help, church against prosecution

Alabama state legislators try to find way to get state pension despite constitutional ban

1RS refuses to return man's check when he grossly overpaid because of two year statute of

limitations

U.S. Representative promotes taxpayer bill of rights

City sets sights on collecting loans originally made for economic development

City police radio system contract award stopped by court

New York City bond rating lowered

UN auditor cannot find $40 million of physical assets when concluding Cambodian peace

mission, no guidelines for financial liquidation of mission

U.S. Department of Defense experimential purchasing program cuts regulations and costs for

buying weapons

Spy agency hoards money to build building

Spy agency lost track of $2 billion

Bill for garbage collection goes up

Florida spaceport fails to take off in state-sponsored commercial space program

United Nations seeks tax

4 • P U B L I C F I N A N C E A D M I N I S T R A T I O N

that public officials responsible for public finance administration have to deal

with in some fashion. Officials' concerns in these and countless other situ-

ations involving public monies are what to do and how to do it.

Public finance administration is based on very diverse concepts linked by

the common idea of handling public monies. In other words, public finance

administration is concerned with the handling of public assets and liabilities,

and making relevant information and insights available to public officials so

they can make informed decisions. (These two sentences represent our closest

approach to a formal, concise definition of public finance administration.)

Public entities, such as governments and nonprofit organizations, are re-

sponsible for the flow of tremendously large amounts of money every year.

Federal receipts and payments are calculated in the hundreds of billions of

dollars. Often, states handle billions of dollars. Local governments and non-

profit organizations collectively deal with hundreds of billions of dollars. Few

public administrators deal directly with the overall financial operations of

their public organization; many do have firsthand dealings with public monies

in their own responsibility areas. Nonprofit housing officials, local public

works directors, state development specialists, and federal park rangers are all

involved in some aspects of public finance administration. All public admin-

istrators, generalists as well as those specializing in public finance functions,

deal with public finances on a daily basis.

Public finance administration is concerned with how monies are handled

as they flow into, within, and out of various public sector organizations.

Interest in this area has grown increasingly in recent years among the general

public, policymakers, public administrators, and concerned academics. Few

areas intersect so many aspects of public organizations as does public finance

administration. The "how" of public finance administration, which incorpo-

rates a wide variety of topics, is the central focus of this book.

WHAT PUBLIC FINANCE •

ADMINISTRATION IS N O T

Although public finance administration has been generally described, it can

also be distinguished from what it is not. Public finance administration is not

private finance administration, public finance, macroeconomics, or public

budgeting. Although each of these areas has relevance for public finance

administration, each can be distinguished from the major focus of this text.

Private finance administration is concerned with handling the assets and

liabilities of individuals and businesses to gain income and profits through

the sale of goods and services. Private-sector finance administration deals

differently with products, taxes, and constraints than does public finance

administration. In the private sector, income comes from the voluntary ex-

change of money for goods and services, and taxes are paid to governments.

The products of the private sector are provided on the basis of market demand

and profitability, and taxes are involuntary payments. The constraints on

private organizations are the factors of production (e.g., capital, labor, and land) that are available, legal restrictions on economic activity, taxes, and

market conditions. Though many analytical concepts are useful for both

private and public finance administration, the two use quite distinct practices.

Macroeconomics and public finance are theoretical fields in economics.

Public finance as discussed by economists is concerned with economic prin-

ciples as they relate to public sector impacts on the private economy, specifi-

cally the allocative, distributive, and regulatory impacts of public budgets.

Macroeconomics deals with the behavior of national economies and is the

basis for fiscal and monetary policy recommendations. Neither focuses on the

administrative activities of public organizations.

Public budgeting is concerned with the planned acquisition and use of

resources by public entities. It involves the decisions of what revenues to

collect and what expenditures to make. Public budgeting and public finance

administration are closely linked, but they are separate functions. Public

budgeting is concerned with policy decisions related to obtaining and using

resources, and public finance administration is concerned with providing

relevant information on which to make budgetary decisions, implementing

such decisions, and other aspects of handling public monies. How they relate

is discussed in Chapter 2.

• THE KEY ELEMENTS OF

PUBLIC FINANCE ADMINISTRATION

The key elements necessary to understand and practice public finance

administration include a basic comprehension of public organizations and

how they function, an understanding of major finance concepts, and a de-

tailed knowledge of particular techniques.

Public Organizations

Throughout this book, certain characteristics of public organizations are

emphasized for their relation to public finance administration. These charac-

teristics include legal constraints, political circumstances, and the peculiar

character of most public services.

Legal Constraints

Various laws require, authorize, and prohibit public finance administration

activities. For example, Article I of the U.S. Constitution authorizes Congress

to lay and collect taxes (Section 8) while restricting that power (Section 9).

State constitutions restrict both state and local governments in raising and

spending public funds. Thousands of federal, state, and local laws affect

financial actions of public organizations. Examples of requirements laws

include requiring checks to be signed by three different officials, public

referenda for school bonds, and certain procedures to be followed in obligat-

ing a government to make a purchase. Authorizing laws allow governments to hoose to do certain things, for example, use particular revenue sources, offer

economic development incentives, or borrow money to build roads. Likewise,

laws prohibit certain activities. Prohibited activities include spending more

money than is collected and investing public monies in certain securities.

Nonprofit organizations are subject to relevant laws as well as their own

bylaws and regulations.

Political Circumstances

Because their activities depend on long-term popular support of the citi-

zens they represent and because elected representatives are concerned with

getting votes in the next election, public organizations are politically sensitive.

In the United States, citizens elect representatives to exercise control of

governments. Within the constraints of law, elected officials determine the

actions of governments. Because of the support needed from the public,

elected officials may make decisions based on political pressures as well as

other factors. Public administrators must consider political circumstances

because their activities are overseen by elected officials. Nonprofit organiza-

tions are no less sensitive to political pressure from their supporters, including

governments that charter and regulate nonprofit organizations and in some

cases provide them with grants and contracts.

Public Goods

Public organizations primarily produce public goods. Public goods display

the characteristics of indivisibility, nonsubtractability, or both. Indivisibility

means that a good cannot practically be divided up into pieces and, therefore,

is generally available to all within a given area. (National defense is a public

good from which all members of a nation benefit or suffer.) Nonsubtractabil-

ity means that one person benefiting from a good does not subtract from or

deny others benefit of that same good. (National defense and lighthouses are

clear-cut examples.) Private organizations do not provide public goods be-

cause doing so is not profitable.

Financial Concepts

Financial concepts are discussed throughout the book within the context

of particular topic areas. Some concepts appear in many places, others appear

only once. Within the various topic areas, financial concepts are explained and

illustrated in relation to the practical application of particular techniques.

Abstract concepts are introduced for the purpose of developing an under-

standing of the practice of public finance administration.

Particular Techniques

Particular techniques are discussed with their meanings and purposes,

major elements and concepts, and steps in carrying out the technique. Each

Introduction • 3 hapter starts out at a general level showing what a technique is about and

how it fits into the operations of public organizations. More detailed discus-

sions ensue, illuminating the specific details and actions involved in using

particular techniques and providing specific, concrete examples. Also, some

of the following chapters provide lists of "Suggested Readings" at the end for

readers desiring to pursue a topic in greater detail.

• THE BASES OF PUBLIC

FINANCE ADMINISTRATION

Bases refer to situational factors determining what can be done. The bases

of public finance administration include relevant laws, political circum-

stances, techniques, and organizational arrangements. Laws provide require-

ments, authorizations, and prohibitions. Political circumstances provide gen-

eral (and on occasion very specific) guidance, often through the budgetary

process. Techniques, though they are basic and available to all public officials,

may or may not be used in a given situation. For example, the most basic of

all public finance administration techniques is public accounting. Yet, ac-

counting is not fully used by public organizations despite its critical impor-

tance. (A sad and amusing case of such non-use is the actual statement of a

public administrator, upon having a check bounce, that "someone ought to

keep track of these things") Various techniques are used to a greater or lesser

extent in given situations. Organizational arrangements established by con-

stitutions, laws, and other policies vary considerably. The division of respon-

sibilities among public officials generally includes (1) overall financial guid-

ance from policymakers who are elected legislators and elected or appointed

executives, (2) one or more specialized finance offices or agencies, and (3)

responsibilities allocated to operating agencies. Responsibility for financial

activities is divided in various ways between and among political and admin-

istrative officials. Among the political officials, responsibilities are divided

depending on the relative powers of legislators and executives and the number

of elected executives who have financial responsibilities. For administrative

officials, the responsibilities are divided among one or more specialized

finance offices and the operating units. For the specialized finance office or

offices, the possibilities range from one person handling an organization's

finances to a host of specialized offices. Common specialized organizational

responsibilities include revenue collection, accounting, expenditure disburse-

ment, treasury, purchasing, debt management, pension administration, and

risk management. Operating units can have more or fewer finance activities

delegated to them in different situations. Such diversity in the organization of

public finance administration results from tradition and circumstances,

though recent years have seen a trend toward greater centralization.

Politics, laws, knowledge of particular techniques, and organizational ar-

rangements all constrain or determine what occurs in a particular situation.

On occasion, a particular practice more favorable on technical grounds is

made impossible by one of these factors. The most common difficulty is

political circumstances. ublic organizations display three orientations: control, management, and

planning.1

Although public organizations reflect all three orientations in

varying degrees, particular organizations tend toward a greater emphasis on

one of the three. A control orientation is reflected in a concentration of effort

to ensure that the organization completes specific tasks and that organization

members do not deviate from official policies. A management orientation is

reflected in a concentration of efforts to achieve efficiency and effectiveness

in day-to-day operations and, hence, pronounced attention to operational

details. A planning orientation is reflected in a concentration of efforts on

determining organizational goals and the choice of means to achieve goals.

Each of the different orientations is also reflected in the relevance of different

kinds of information. The control orientation requires information about

whether certain actions are taken or not. The management orientation re-

quires measures of input-output relationships and accomplishments. The

planning orientation requires projections of future events, visions of possible

futures, and means of achieving possible futures.

A public organization invariably expresses its orientation in its public

finance administration activities. Certain finance techniques are emphasized

or used in particular ways in association with particular orientations. Also,

because the orientations typically require information congruent with their

purposes, the techniques are used on different information or used to develop

different kinds of information. A control orientation is associated with greater

attention to accounting, auditing, and expenditure administration; a manage-

ment orientation with cost analysis, purchasing, cash management, and risk

management; and a planning orientation with financial predictions and

capital budgeting. Despite the affinity between certain techniques and orien-

tations, any of the techniques can be used to serve any orientation. Through-

out this text, the themes of control, management, and planning will be used

to put the techniques and practices in perspective. Knowing what a technique

or practice is oriented toward accomplishing can help us understand how an

accomplishment is obtained.

These varying orientations are examples of Miles' Law: "Where you stand

depends on where you sit."2

Frequently, understanding different perspectives

helps in understanding the specifics of public finance administration.

SYSTEMS IN PUBLIC •

FINANCE ADMINISTRATION

Public finance administration techniques are applied in differing degrees,

though not always in a predictable pattern. For example, although the federal

government might be thought to be more systematic, local governments are

actually more systematic in their use of capital budgeting and cash management.

Technique applications range from complete systems to principles appli-

cations to single practice applications. Complete systems provide regular procedures, generally represented by written policies, for all relevant areas

covered by a technique. Also, complete systems are generally reviewed peri-

odically to make appropriate changes. Complete systems show a high degree

of effort. Principles applications use one or more technique principles as

practical rules of thumb to govern certain aspects of a technique area. For

example, in the area of cash management, federal officials generally follow the

principle that collections and payments should be made in a timely fashion.

Finally, some public organizations use one or more particular practices or

actions in a technique area. For example, many local governments make

regular checking account deposits, a practice found in the cash management

technique area.

Applications of public finance administration techniques vary because of

public official interest, the utility of particular applications, or both. Public

officials, both policymakers and administrators, have varying knowledge of

and interest in various technique areas. Knowledge and interest can produce

systems applications by themselves. The utility of technique applications can

be estimated in political and monetary terms. Politically, because of problems,

perceptions, or opportunities, a technique can be presented as having high

utility, particularly where a problem is perceived. For example, Orange County,

and many other public organizations, reviewed their investment policies be-

cause of the highly and widely publicized losses. Monetarily, applications can be

valued by estimating monetarily valued costs and benefits, as in the case of the

county looking at the investment in a sports stadium. In many cases, complete

systems are not justified by reasonable estimates of advantages to a public

organization, and principles or practice applications are more useful.

Computer systems are one example of complete system applications. The

use of computers in various areas of public finance administration continues

to grow and to become routine. Although computer usage affects various

technique areas, however, computer applications are not discussed extensively

in this text because the material on technique areas is more fundamental.

Computers make more and faster computations possible but do not make

them more easily understood or more appropriate. Basic understanding of

the techniques makes understanding the usage of computers in the various

areas intelligible.

• THE ORDER OF THIS BOOK

The chapters in this book are arranged by logical precedence—earlier

chapters provide a basis for understanding one or more later chapters. For

example, the next chapter describes relationships between public budgeting

and public finance administration, which provides a comprehensive overview

of the handling of public monies. The chapter on public sector accounting

provides an understanding of financial information storage and retrieval and

explanations of various important terms. Understanding information systems

and key terms makes later chapters more intelligible. This arrangement does

not lend itself to a set of multichapter book sections that stand alone. All

public finance administration is intertwined, both conceptually and practi- cally. The book, though, can be thought as having four parts. First, the initial

four chapters provide a broad introduction to public finance administration,

including its relationship with public budgeting, the crucial area of public

sector accounting that provides many concepts used in tracking the flow of

resources in and out of public organizations, and a discussion of the economic

concepts of money and value. Second, the nextfivechapters focus on revenues

and expenditures, how they are administered, and the importance of forecast-

ing and cost analysis in dealing with revenue and expenditure flows. Third,

the following seven chapters deal with various less visible, but not less impor-

tant, technical areas that focus on managing cashflow, investments, debt, risk,

purchasing, capital budgets, and financial components of human resource

management, especially pensions. Fourth, the last three chapters take a

broader and more evaluative perspective while looking at the techniques in

auditing, assessing financial conditions, and the emerging use of development

finance.

CHAPTER 2

Budgeting and

Finance Administration

C H A P T E R

How public finance administration relates to public budgeting puzzles

many people. Both areas are public and involve money. To many people,

the terms overlap. This impression is reinforced by texts used in the general

area. Public budgeting, public finance, and mixed topic texts cover the same

and divergent topics without any apparent order, rhyme, or reason. This

chapter clarifies what public budgeting is and how it relates to public finance

administration. The two areas are highly interrelated and not completely

separable. Public budgeting is the process of making decisions about public

revenues and expenditures; public finance administration concerns the tech-

niques used in dealing with public monies. The two are only clearly distinct

in concept.

PUBLIC BUDGETING •

Public budgeting can be defined as the planned acquisition and use of

resources by public entities, similar to what individuals and households do

when making and spending money. This simple definition obscures the

numerous highly complicated and interrelated phenomena that constitute

public budgeting, such as the following:

• The large number o f people involved

• The fact that budgets deal with public or communal concerns about which people

have different viewpoints

• The extended time periods, typically a year

• The fact that budgets are binding

• The technical difficulties o f the subject matters (e.g., nuclear waste disposal,

health research, and economic relationships)

• The sheer size o f the resources involved

11 Budgeting proposals and results are recorded in documents that are plans

for gathering and spending money over some time period. One distinctive

feature of public budgeting is the number of different documents that are used

by a variety of persons, at different times, and for different purposes. The

number of documents reflects the fact that public budgeting is a formal

process used to coordinate the activities of large numbers of people. Individu-

als and households budget only for themselves; public organizations budget

for themselves and their constituents.

Personal and household budgets can be for any point in time to any other

point in time, from formal to very informal, and from rigid to flexible to the

changing at any point in time. Because public budgets involve numerous

people and are binding for fixed time periods, they proceed through a formal-

ized process with distinctive beginnings and endings and definite intermedi-

ate steps.

The public budgeting process is described as having four general stages,

which are given various names:

1. Preparation or formulation

2. Submission and approval, policy making, legal enactment, or formal approval

3. Implementation or execution

4. Audit and review, audit, audit and evaluation, or review

The first stage involves preparing estimates of revenues and expenditures

for a specific, future time period. The beginning is found in the call or call

letter that directs various officials to fulfill budgeting responsibilities. The

timing of the call can be fixed by law or can be a matter of administrative or

executive convenience. Estimating revenues and expenditures is undertaken

in various places. Usually, and especially with taxes, estimates of revenues are

made by central administrative officials. Estimates of expenditures are made

by operating units under the general direction of instructions found in the

call letter. Estimating expenditures generally involves considering what activi-

ties or policies to propose, what things should be purchased to carry out

organizational activities or policies, and what the prices are likely to be. The

operating agencies are proponents of spending, and the central officials are

proponents of economizing and of care in the selection of spending choices.

The second stage of the budgeting process begins when the chief executive

or administrative officer submits a proposed budget to the policy-making or

legislative body. Policymakers look at the information in the proposed budget

along with other information available to them. A proposed budget is treated

as another proposed policy or law. The process is one of gathering informa-

tion, looking at alternatives, and voting on preferred policies. This stage

concludes when the proposed budget with any changes is approved as a policy

or policies, or as a law or laws that provide authorizations to operating officials

to collect and spend money.

The third stage of the budgetary process is the period when money is spent

and collected: The approved budget plan is carried into action. This stage is

4 • P U B L I C F I N A N C E A D M I N I S T R A T I O N

the primary reason that budgets exist: to fund the provision of public-sector

goods and services.

The fourth stage of the process involves auditing and reviewing the ap-

proved budget's implementation. Both reviews and audits involve looking at

things to ascertain that an organization is performing well. People within

public organizations conduct reviews, usually informally, although annual

reports are formal yearly reviews. Reviews answer questions concerning how

well or appropriate the budget and the organization meet their obligations

and opportunities. Audits are technical reviews culminating in a formal

report, usually conducted by persons outside of the organization, that speak

to specific questions. Examples of such questions include whether the organi-

zation followed standard accounting rules, complied with budget decisions,

had procedures to guard resources and the accuracy of financial data, and

performed in an economical, efficient, and effective manner. Audits are fre-

quently required by laws or by persons outside of the specific organizational

units being audited.

Public budgeting is highly political; it determines whose policy preferences

prevail. Decisions on whether to raise or lower taxes or expenditures, to build

bombers or provide health care for the poor, and to hire police or social

workers are all public budget decisions, as is any other public sector decision

about the collecting or spending of money. Politics are especially evident in

the first two stages of the process. Federal officials debate issues of taxes,

defense, and social spending. State officials predominantly choose among

taxes, education, highways, prisons, and welfare. Local government spending

choices abound whereas easy revenues elude officials. Expenditure opportu-

nities for nonprofit organizations exceed their revenues as well.

Public budgeting can be viewed from a wide variety of perspectives. Already,

it has been discussed as being a plan, a process, and a matter of politics.

Likewise, budgets can be seen as control, management, and planning devices.

Various other identifiable participants provide perspectives useful for under-

standing the process. For politicians or policymakers, decisions on revenues

and expenditures fulfill their responsibility to act for public organizations and

to meet constituent concerns. From a constituent's perspective, the budget

may or may not reflect public service and revenue preferences. For econo-

mists, budgets allocate resources, distribute costs and benefits, and stabilize

economies, as well as represent choices under conditions of scarcity. For

operating officials, budgets represent constraints that restrict their activities

by controlling the provision of resources to operate (i.e., the budget within

which they have to stay).

Expenditure budgets are prepared using a variety of different approaches.

A budget approach refers to a general way of doing a budget that includes

particular ideas and reflects different concerns. Approaches use different

information and organize information differently to answer different ques-

tions. Lump sum budgeting, the simplest approach to public budgeting, was

used widely until this century. This approach presents expenditure decisions

as lump sums to fund public organizations or organizational units. It answers

the question, "How much for each organizational unit?" The line item ap-

proach is currently the most common one in the United States. All the things

to be purchased, the objects of expenditure, are listed, one to a line, for

example:

Paperclips . . . 10 cases ( 1 0 , 0 0 0 to the case).. . $ 5 0 . 0 0 .

The line item approach answers the questions of how much a public organi-

zation will be buying at what price. This is the most familiar approach and the

one most people describe when asked to describe a budget. Three later

approaches emphasize other concerns: Performance budgeting focuses atten-

tion on what activities are performed and the relative efficiency with which

they are performed (i.e., "bang for the buck"). Program budgeting focuses

attention on effectiveness by looking at the predicted results from budgets.

Zero-base budgeting focuses attention on choices by providing budget alter-

natives.

A variety of techniques is used in public budgeting, some used in different

fields and some mostly or exclusively in budgeting. Cost-benefit and cost-

effectiveness analysis, trend analysis, operations research, and regression analysis

are widely applied analytical techniques that are sometimes used in budgeting.

Multiyear financial projections, crosswalks of budget information from one

form of organization to another, and financial capacity evaluation are analyti-

cal techniques generally used in connection with public budgeting concerns.

These examples show a few of the many techniques used in public budgeting.

This text deals with public finance administration techniques, all of which

bear some relationship to public budgeting.

• RELATIONSHIP BETWEEN PUBLIC BUDGETING

A N D PUBLIC FINANCE ADMINISTRATION

How public budgeting and public finance administration relate can be

viewed from a conceptual and a practical viewpoint. Public budgeting focuses

on the issues of alternative choices, typically at a broad level of detail. From a

conceptual viewpoint, public budgeting relates to all areas of public finance

administration, but it does so in a general sense. Public budgeting provides

the arena for the large decisions, the what. Public finance administration deals

with the smaller decisions, the how. Public budgeting encompasses and brack-

ets public finance administration. Public budgeting is the activity carried out

by political actors and upper-level administrators to determine the outcome

of public revenue and expenditure decisions; public finance administration

activities are carried out, principally, at and by lower levels of public organi-

zations. This distinction between making budget decisions and carrying them

out may not provide a perfectly unambiguous dividing line, but it shows the

different thrusts of the areas. When a government decides that a dam across

a raging river is the appropriate response to a perceived need for flood control,

that decision is a budgetary one and is recorded in budgeting documents. All

the handling of monies after the budgetary decision is made falls into the realm of public finance administration, which is concerned with carrying out

organizational functions by applying particular techniques. In a sense, public

finance administration can be seen as involving the detail work underlying

and following budget decision making.

Much like the distinction between politics and administration, public budget-

ing and finance administration may not be irrevocably separable. The distinc-

tion may be only conceptual and, practically, a question of focus. Public

budgeting decisions set the agenda for public finance administration activi-

ties. Public finance administration processing techniques are used to gather

information for conducting and analyzing budgetary debates and issues. Like

the politics-administration dichotomy, the public budgeting and public fi-

nance administration distinction may break down ultimately where public

budgeting at the higher levels and its associated politics come into contact

with the work of the public organization and public finance administration

at the lower levels.

Practically, public finance administration involves techniques. Many tech-

niques can be grouped together in various ways. Techniques can be grouped

under the themes of control, management, and planning; into management

and analysis groups; into asset and liability management groups reflecting an

accounting viewpoint; and into groups for the budgetary process stages. For

the sake of clarifying the relationship between public budgeting and public

finance administration, particular techniques are listed in Table 2.1 under the

stage of the budgetary process with which each is most closely associated.

The preparation stage of budgeting involves predicting future events and

analyzing budget choices. Therefore, relevant techniques and related topics

are discussed here. Still, techniques generally more relevant to other budget

stages can be used or considered during this stage. The preparation stage is a

time to forecast revenues and expenditures. How much will be collected and

how much will be spent provides the basis for budgetary discussions. The

amount of money collected in revenues is the typical limiting factor on

expenditures. How much a particular policy, program, or other budget entity

is expected to cost affects its consideration. Preliminary estimates of revenue

and expenditures are the starting points for serious budget decision making.

This is a technical area of great political consequence, as estimates form the

political terrain for budgetary politics, with some of the various forecasts

being technically plausible but also politically convenient.

Cost analysis is used to weigh alternatives so choices can be made. These

analytical techniques are used to choose and support expenditure choices.

Simple cost analysis is similar to expenditure estimation. In cost-effectiveness

analysis, the benefits of options are assumed and the cost per unit produced

is estimated to choose among alternatives. In cost-benefit analysis, costs and

benefits of policies, projects, or operating methods are compared to facilitate

making an informed choice. Arguments and information from these analyti-

cal techniques often find their way into budget approval sessions. These kinds

of analyses also are commissioned in the budget implementation stage for

later decision on issues in the approval stage of the next budget cycle.

Capital budgeting, which has various manifestations, is done both in con-

nection with and separately from the regular budget process. Capital items are

TABLE 2.1 Public Budgeting Stages and Public Finance Administration

Techniques

Stages Techniques/Areas

1. Preparation: Forecasting revenues and expenditures, Cost analysis,

Capital budgeting, Debt administration, Risk

management, Pension administration and other

personnel issues, Assessing financial conditions,

Economic development and development finance

2. Approval: Policymakers look at information developed in preparation

stage and revenues

3. Implementation: Accounting, Revenue administration, Expenditure

administration, Purchasing, Cash management, and

Investment

4. Audit and Review: Auditing

investments in physical assets with extended utility (e.g., buildings, roads,

vehicles, and other equipment), which are treated differently from regular,

recurrent items of expenditure (e.g., personnel, transfer payments, and ex-

pendable supplies). Where budgets are divided into an operating budget and

a capital budget, the capital budget represents a multiyear plan for expendi-

tures on capital items. Usually, expenditures are authorized simultaneously

for both budgets for a one-year period. Where there is not a separate capital

budget, capital items are often given extraordinary treatment in criteria for

selection of capital items, purchasing processes, approval for inclusion in a

proposed budget, and analysis. Often, cost analysis is applied to capital items.

Debt administration involves acquiring and paying back borrowed money.

Debt is usually incurred as a result of capital projects that are funded sepa-

rately from regular budgets. Debt is paid for in each regular budget, however.

The federal government, of course, is exceptional in debt (perhaps phenome-

nal resonates better), because debt has been used more for economic policy

and political reasons than as a means of funding capital projects.

Debt administration is characterized by multiyear expenditures, a charac-

teristic shared by two areas—risk management and pension administration—

that are sufficiently closely related for all three to be called liability admini-

stration. All three areas also involve multiyear obligations, that is, future

monetary obligations.

Risk management, minimizing the adverse consequences of "the slings and

arrows of outrageous fortune," affects regular operating budgets in two

general ways: decision about what to do and not to do and paying for or

financing risks. First, certain programs, policies, procedures, facilities, and

expenditures may not be chosen or may be handled differently as a result of

risk management analysis. Risks and their potential costs can be too great to

justify doing something or can justify additional expenditures to make things

safer. Second, operating budgets show funding for risks. Risks are potential

losses that may or may not occur. Funding can take the form of insurance

payments, the transfer of monies to contingency accounts to pay for risk

losses, or expenditures to pay for actual losses (e.g., replacement of items or

damage claims).

Pension administration, which involves making arrangements for pay-

ments to be made to employees or their dependents when they are no longer

employed by an organization, should show up in regular budgets as a cost of

operating. Unfortunately, this is often not the case. Despite the fact that

pensions are financed out of the same revenue sources as other expenditures,

pensions are paid out over an extended time period. Currently employed

personnel will be paid pension benefits in the future, and these payments are

often left out of budgets. This is a serious omission, as pensions are a signifi-

cant portion of expenditures for personnel, which is most frequently the

largest public organizational expenditure. At the state and local level, person-

nel expenditures are frequently more than half of the expenditures made. To

predict future budgetary costs accurately, one has to predict the cost of

pensions as well as other personnel costs, such as direct wage payments, fringe

benefits, collateral expenditures, and raises.

An assessment of the financial condition of a public organization contrib-

utes to budget preparation by determining areas of financial strengths and

weaknesses. For example, an organization with insufficient revenue flows

might avoid debt, or a government with excessive cash balances might lower

taxes. Such assessments can be used to guide operating and capital budgeting

decisions.

Development finance is concerned with using the financial tools available

to public organizations, principally governments, to increase favorable eco-

nomic activity. It is a part of the general area of economic development that

is generally concerned with increasing economic activity. Public organizations

participate in development finance by providing financial incentives to en-

courage persons to engage in favored economic activities. These financial

incentives provide means by which projects can occur that otherwise would

not be possible. The key here is that incentives change the situation. Incentives

include tax incentives, public organization financial participation in projects,

and a variety of innovative financing techniques to assist entrepreneurs in

accumulating capital for a project.

The approval stage of the budget process involves the policymakers looking

at all of the relevant information presented in budget proposals, along with

any gathered during budget hearings. At this stage, policymakers often con-

sider policy issues having to do with revenues for the sake of making adjust-

ments. Revenues are interesting in the budget process principally as a funding

mechanism and as a matter of political controversy. Revenue measures define

an art form concerned with separating people and money. Also, revenue

characteristics are relevant to revenue administration. Policymakers figure

out what to do to acquire revenues, and administrators have the pleasure of

finding out how to make revenue policies work in practice. This reminds some

revenue administrators of the mice's proposal to bell the cat.

The budget implementation stage includes the technique areas of account-

ing, revenue administration, expenditure administration, purchasing, cash

management, and investment. Public-sector accounting involves making re-

cords of financial activities that occur during the implementation stage. The

records developed in this stage—measurements of actual revenues and actual

expenditures—form the basis for estimates of expenditures and revenues

during the next budget preparation stages, audits and reviews of the implemen-

tation of the budget, and financial decisions during budget implementation.

Revenue administration deals with finding the revenue base, assessing its

value, and collecting money from individuals and organizations. It requires

providing information to people to persuade them to send money to public

organizations.

Expenditure administration handles making payments for spending com-

mitments. Unlike a personal situation, where an individual or family spends

money by making choices and paying by cash, check, or through some credit

arrangement, public organizations extend the process of spending money.

Typically, certain people decide what money to spend (budgeteers); someone

buys something or makes transfer decisions, usually under the supervision of

some superior (operating officials); someone else pays the bill (treasury

officials); and someone else will later review the expenditure (auditors). An

emphasis on controlling behavior to ensure that public monies are not mis-

used, which necessitates voluminous accounting records, characterizes expen-

diture administration.

Although expenditure administration focuses on actually spending money

and how it changes hands, purchasing deals with the actions associated with

buying goods and services other than hiring personnel. Purchasing involves

figuring out what, when, and how to buy, with particular attention to deciding

what to buy and what costs to incur.

Cash management relates to implementing both sides of a budget. In cash

management, one attempts to predict and adjust the flows of cash to benefit

a public organization. This involves bringing revenue into the treasury in a

timely fashion, paying bills on time, and investing money.

Public organizations make investments from money on hand (e.g., money

from cash management or borrowing), and from money put aside for future

purposes (e.g., pensions and risk management). Money on hand that is not

otherwise used serves a public organization best by being invested because

investments provide revenues. Of course, the situation in which money is

being invested determines the choice of investments. Basically, money is

invested in either an obligation (debt) or an equity (ownership) situation. An

obligation or debt situation occurs when money is loaned or entrusted to

another party, which creates a debt obligation with some interest payment

being the investment benefit; an equity or ownership situation occurs when

money is used to purchase some valuable thing that is expected to produce

income, an increase in value, or both.

The fourth and final stage of the budget process, the audit and review stage,

appears to be relatively simple but is actually one of the most complex areas.

The complexity stems from the wide variety of audit purposes and techniques

because those techniques require collateral actions during the preparation and

the implementation stages, because some auditing can take place in the

implementation stage or at any point or period of time following the comple-

tion of budget implementation, and because audits take place while other

budget stage activities are taking place. Performance auditing is one kind of

audit. In performance auditing, certain activities are defined as performances

before budget implementation, recorded during budget implementation, and analyzed during the audit stage. Other kinds of audits include ones concern-

ing accounting systems and reports, management procedures, and effective-

ness. Audits guide the other budget stages. Likewise, reviews of and reports

on an agency's or organization's budget year using various methods of analysis

can be quite complex.

C O N C L U S I O N •

Although public budgeting and public finance administration are concep-

tually distinguishable, in the world of practice one can always be said to be

dealing with a public budget when one is engaged in public finance admini-

stration activities. The reader has been shown the conceptual and practical

distinctions between the technical focus of public finance administration and

the political focus of public budgeting. Budgeting activities can be thought of

as the tip of the iceberg that is most visible; finance activities are less visible

and a larger portion of the whole set of connected activities. As with icebergs,

one is well advised to pay attention to the submerged as well as exposed

portions of public organizations' finances.

CHAPTER 3

Accounting, despite a great deal of mystique, can be understood as the

recording and reporting of financial information. Part of accounting's

mystique stems from the professional accounting jargon. One example of such

jargon is the commonly used definition of "fund":

A fiscal and accounting entity with a self-balancing set of accounts recording cash

and other financial resources, together with all related liabilities and residual

equities or balances, and changes therein, which are segregated for the purpose

of carrying on specific activities or attaining certain objectives in accordance with

special regulations, restrictions, or limitations.1

A fund can be described less technically and more intelligibly as a separate set

of accounts established to keep track of particular things. Separateness fun-

damentally defines a fund. Here, accounting terms and concepts are presented

and explained with a minimum of technical jargon.

Another part of accounting's mystique has to do with numbers, a math

phobia if you will. Fortunately, the mathematics actually involved are adding

and subtracting. One does not have to penetrate the mysteries of secret

accounting rituals nor enter the higher realms of mathematics to understand

public-sector accounting (henceforth referred to as public accounting).

Knowledge of the purposes, concepts, and practices of public accounting and

basic arithmetic is sufficient to understand public accounting thoroughly.

Accounting is important in public finance administration because account-

ing systems primarily provide financial information for public organizations

when decisions concerning money are made. The accounting system provides

answers to such questions as

• How much money is on hand?

• What can be spent on personnel?

• Has money been collected and spent as it was budgeted?

• How much does it cost to . . . ?

Accounting systems can be said to serve the control, management, and

planning purposes of public finance administration. Public accounting em-

phasizes control. Budgeted expenditure information, that is, how much

money can be spent by what organizational units for what, is introduced into

accounting systems to control expenditures. For example, a particular office

budget may allow $1000 for office supplies. Not only is that information in

the accounting system but also how much has been spent and how much

remains available to be spent (the balance). The person authorized to expend

the $1000 for office supplies, the accounting office, and higher-level officials

have the same information available to them. This use of accounting prevents

improper spending. The same sort of information for the entire budget is

available to oversight authorities and the public of the various governmental

jurisdictions. The availability of budgetary information in the accounting

system makes it possible to track actual expenditures in relation to budgeted

expenditures, which is a prerequisite for control.

Accounting systems provide information to make managerial decisions of

an operational and financial character. If money available for office supplies

is running out, that information could lead to decisions aimed at conserving

such supplies. Likewise, accounting information showing a surplus in another

account and a dwindling office supplies account might lead to shifting money

into the office supplies account. Management decisions concerned with money

are based on accounting system information.

Accounting systems provide information that allow people to make finan-

cial plans. Plans are usually based on predictions that the future will be much

like the past. Budgets, for example, are plans based primarily on the experi-

ences of previous years as recorded in the accounting system. Cash manage-

ment provides another example of using accounting information for plan-

ning, where one uses past years' revenue and expenditure patterns to

anticipate the current-year pattern. How public accounting supports these

three purposes will become more clear as particular examples are discussed

in later chapters.

A C C O U N T I N G : •

PUBLIC VERSUS PRIVATE

Public accounting differs from private accounting in many respects. The

key distinction involves the uses to which accounting information can be put.

Private accounting information is oriented toward showing net worth and

profits. Public organizations are never sold nor do they make a profit; there-

fore, net worth and profit are pointless for public organizations. Public

accounting is oriented toward showing flows of money—generally revenues

and expenditures—particularly in relationship to budgeted amounts. The

control orientation reflects the fact that public organizations are bound by

budgetary authorizations to collect revenues and to make expenditures. Also,

because both have the same information categories, public accounting sys-

tems are said to "mirror" budgets. To overspend a budget is a violation of

budget law or policy as well as a demonstration of political insensitivity. Public organizations prevent that by tracking their budgets in their accounting

systems, which is one reason for public accounting systems primarily show-

ing concern with the control of public funds. Many specific differences in

concepts and practices reflect these fundamental differences between public

and private accounting.

Two noteworthy differences in the public sector are the diverse kinds and

sources of accounting rules (more formally "the authoritative sources of

accounting standards"). Businesses have one basic set of accounting rules

from one source. In contrast, the six categories of areas covered by differing

accounting rules are colleges and universities, hospitals, voluntary health and

welfare organizations, nonprofit organizations, state and local governments,

and the federal government. Each of the different categories has two or more

sources of accounting rules.2

Also, over the last several years, various sources

keep developing new accounting and reporting rules, which have caused some

consternation in public organizations as they became required to do new and

different things. Some of the new rules require recording and reporting the

value of employees' accumulated leave, nonprofit organization pledges, and

performance measures.

• FINANCIAL REPORTS-

THE END RESULT OF A C C O U N T I N G

The purpose of accounting is to make financial information available.

Information comes out of accounting systems in financial reports. Here, by

starting with the end results, financial reports, the reader can see what all of

the hoopla along the way is about.

Accounting systems use a wide variety of standard accounting reports and

countless other optional reports. Reports vary by time period, scope, and level

of detail. Differences in reports are determined by the people for whom they

are prepared. An administrator concerned with $1,000 appropriated for office

supplies wants to know how much money has been spent and how much can

still be spent (the balance), whereas governing officials do not care about those

office supplies and use much less detailed reports. For the most part, those

using accounting reports find them tailored to their needs, however imperfect

that tailoring may be.

The time periods involved for various reports are a year or series of years;

a quarter, which is the first, second, third, or fourth set of three-month periods

in a year (e.g., January 1 to March 31 is the first quarter); a month; and any

specifically requested period or point in time. Yearly reports are almost

universal, and quarterly or monthly reports are common in all but the smallest

organizations. The particular period or point in time reports are used to reach

specific decisions; for example, whether we have money to buy more office

supplies.

The scope and detail of reports vary. Generally, the broader the scope, the

less detail there is; conversely the narrower the scope, the more details there

are. The administrator of an office uses a detailed accounting report for that

office, whereas a governing official uses a more general report covering all the various organizational units. The scope of reports ranges from a particular

transaction, through a particular account or set of accounts to an organiza-

tional unit, to a comprehensive report of all financial information for a public

organization. Likewise, the level of detail varies. Some degree of summariza-

tion of detail is necessary to make the reports useful. The greatest detail

possible includes all information in all the accounts in the accounting system.

Generally, the most detailed reports are for the expenditure accounts for the

lowest level of organizational subdivisions; those reports show the appropria-

tion, the amount expended in some fashion, and the balance (the amount still

available to spend for expenditure accounts). Revenue reports are as detailed,

but only the central finance offices have many of those accounts. Also, there

are many more expenditure accounts than revenue accounts. In revenue

accounts, one finds estimated revenues, revenues collected in some fashion,

and the balance (revenues remaining to be collected). Normally, reports for

officials at higher organizational levels are less detailed and summarized by

different categories such as organizational unit, objects of expenditure, and

the like. The following discussion of the different report users shows the

variety in accounting reports.

The users of financial reports are administrators, governing officials, the

public, and the financial community. Each of these groups has fundamentally

different information needs because they have different purposes and do

different things. Administrators need the most specific reports to make op-

erational decisions and detailed plans. Governing officials, unless they are

probing or reviewing a very specific question, are concerned with the overall

financial position of the whole organization. The public takes a perspective

similar to governing officials except that the public is not usually as interested.

The financial community's interest focuses on the creditworthiness of gov-

ernments to make decisions about lending money to public organizations.

Other groups, such as special interest groups, researchers, and employee

unions, generally use the reports intended for the public.

Managers need the most specific information to make day-to-day decisions.

The lower the level of the organizational subdivision, the greater the detail

that is needed. For example, an office manager is likely to get a monthly report

detailing the balances in all the accounts for that office, including the office

supplies account. Part of that report would include the following:

Account Budgeted Spent Available to Spend

Office Supplies $1,000 $ 5 0 0 $ 5 0 0 (balance)

The office manager can see the situation for all of the office accounts in a

straightforward fashion. If the report comes early in the fiscalyear, the manager

may have a problem in the office supplies account because half of the appropria-

tion has been spent. If the report is late in the fiscal year, the manager has some

flexibility. Occasionally, lower-level managers need more specific information

and keep their own records or request specific information.

Higher-level managers receive less detailed reports but also have access to

the more detailed reports distributed to lower-level managers. For example, a manager responsible for three organizational subdivisions is likely to receive

less detailed reports than the managers of those three subdivisions.

Such reports might include the following:

Organizational

Unit Budgeted Spent Available for Expenditure

UnitX $30,000 $15,000 $15,000

UnitY $43,000 $26,000 $17,000

Unit Ζ $37,000 $17,000 $20,000

This report shows the financial situation of the three organizational subdivi-

sions. The manager receiving this report is likely to look further into the

situation of Unit Y, unless already known, because that unit is spending money

much more rapidly than the other two units, which marks it as having an

unusual situation, if not some problem. The two options for the higher-level

manager are talking to the Unit Y manager or looking at the more detailed

Unit Y report, which this manager may or may not receive on a regular basis.

In addition, higher-level managers frequently receive exception reports. An

exception report is made when certain specific exceptions to what is expected

occur. For example, for Unit Y, an exception report might be a copy of Unit

Y's detailed report going to one or more upper-level managers because its

spending exceeded one half of its budget before the fiscal year midpoint.

Another kind of exception report might be a listing by organizational unit of

every account that shows expenditures in excess of one half of the budgeted

amount during the same time period. The result is the same. Upper-level

managers are apprised of exceptions as they occur. Exception reports are one

way of tracking compliance with administrative directives. The regular reports

distributed to managers in public organizations become less specific at the

higher levels of organizations, except in small organizations, because too many

details are not very useful. The less detailed, broader reports along with

exception reports make it possible to track the organizations' finances without

requiring managers to wade through page after page of detailed reports. The

higher managerial levels are not concerned about the $1000 office supplies

situation unless it poses a particular problem.

Governing officials receive regular reports that are comprehensive in breadth

and not particularly detailed. Elected officials look to accounting reports that

show budget plans in broad outline to see that they are being implemented as

planned. An example for a governing official might appear as follows:

Second Quarter, 1997

Estimated Actual

Revenues $ 4 , 0 0 0 , 0 0 0

Expenditures $ 3 , 8 4 0 , 0 0 0

$ 4 , 0 1 2 , 3 8 3

$ 3 , 7 8 5 , 0 0 0

rganizational

Unit Budgeted Spent Available for Expenditure

Agency A $ 1 0 0 , 0 0 0 $ 5 0 , 0 0 0 $ 5 0 , 0 0 0

Agency Β $ 1 4 9 , 0 0 0 $ 7 2 , 8 3 8 $ 7 6 , 1 6 2

Agency C $ 2 1 1 , 0 0 0 $ 1 1 0 , 0 5 0 $ 1 0 0 , 9 5 0

Deviations from the budget signal a need to gather more detailed informa-

tion and perhaps a need to alter the budget plan. When budgetary changes are

contemplated, more detailed information is used by governing officials to

make policy decisions. One prime example is found in budget proposals

submitted to elected officials, which usually contain at least one previous year

and the current year's information for most categories in a budget. An

example might look something like this:

Budget Proposal: UnitX

Budgeted

Year-to-Date

Requested This Year Last Year Expenditures

Office Supplies

$ 1 3 0 0 $ 1 0 0 0 $ 9 0 0 $ 1 0 0 0

The public uses very general annual reports to form an overall impression

of a government's or nonprofit organization's operations. Constituents re-

ceive information on public organizations through the medium of news

reports, more often broadcast than print ones. The information received by

the public typically includes revenues by source, expenditure by function or

organizational subdivisions, the financial results of operations (surplus or

deficit), and debt. Sometimes, such reports represent figures in bar graphs and

pie charts. Such information shows in a general way what an organization is

doing and where it stands financially. An example of information for the

general public from accounting reports might look like this:

Mudville Finances, 1997

Revenues by Source

Sales Tax $ 2 , 0 0 0 , 0 0 0

Property Tax $ 7 , 0 0 0 , 0 0 0

Miscellaneous $ 1,500,000

Total $ 1 0 , 5 0 0 , 0 0 0

Expenditures by Function

Administration $ 500,000

Public Safety $ 4,500,000

Public Works $ 3,000,000

Recreation $ 1,500,000

Total $ 9,500,000

Surplus $ 1,000,000

Outstanding Debt $ 3,000,000

The financial community reviews financial reports o f public organizations,

primarily state and local governments, as a way to evaluate organizations'

ability to repay loans. State and local governments "sell" bonds, which are

nothing more than legally binding promises to repay the price o f the bond

(the principal) plus interest at some future time. As with other credit situ-

ations, the people lending money have an intense interest in being certain that

they are lending money to someone who has the ability to meet the payments.

Annual financial reports are an important component o f the information

used by financial institutions and ratings services to evaluate creditworthi-

ness. Some of the measures used are overall indebtedness, revenue capacity,

and operating results (surpluses or deficits). Financial community members

concerned with lending money to Mudville would look at the same informa-

tion provided to the public but also at other indicators of financial condition,

including multiple years of annual financial reports. In that manner, the

financial community can observe whether Mudville's financial position is

improving or declining and, more important, judge whether Mudville can pay

back its loans. Though the financial community starts with accounting system

information, it looks at many other things.

The whole range of possible reports and suggested reporting requirements

staggers the imagination. In addition to internal reports for differing time

periods, organizational units and levels, and degrees of detail, external reports

show the same information arrayed in different ways along with even more

information not in accounts. An illustrative example of such an external

report, a Comprehensive Annual Financial Report, in Governmental Account-

ing, Auditing, and Financial Reporting, has a table of contents of approximately

four and one-half pages and more than 129 pages o f reported data and text.3

• A C C O U N T I N G CYCLE A N D

A C C O U N T I N G DOCUMENTS

So far, public accounting has been discussed in general terms and for the

final product of accounting, financial reports. Let us now focus on the

practices of accounting, that is, how accounting is done.

All accounting operates on a general cycle of events that begins with the

recording of a financial transaction and ends with reports. The cycle consists

of four steps:

Financial transaction and evidence of that transaction

2. Entering the transaction into a journal

3. Posting journal entries to a ledger

4. Obtaining information in a ledger for reports

These terms will become familiar as each stage of the accounting cycle is

described; most have to do with the written documents produced at each stage

of the cycle. Because computerized accounting systems use a slightly different

cycle and are harder to understand, we will use the traditional cycle and

documents and afterward briefly discuss how computerized accounting sys-

tems differ. The typical documents include

1. Evidence of a transaction (receipt, voucher, budget)

2. Journal (general and special journals)

3. Ledger (general and special ledgers)

4. Reports

For the sake of illustration, a single transaction can be followed through the

cycle. A transaction means an event about which information is gathered.

Suppose that a transaction involves a supplier of paper selling 10 cartons of

paper to a government agency. When that occurs, the variety of documents

produced can include a purchase order, a shipping or delivery voucher, and a

receipt. Among all these documents produced, the public organization uses

one or more to record the transaction. This occurs according to specific rules,

often using forms designed for a specific type of transaction for a particular

public organization. The rules cover what constitutes a financial transaction,

when to record it, and what information to record. Everything a public

organization wants to know about any transaction has to be recorded; hence

special forms are used. At a minimum, the government records the date, the

amount, what was purchased, and who was paid. Many more items could also

be recorded; most commonly included are an account number signifying the

organizational unit and the source or category of budget authority. An exam-

ple of a voucher (a payment authorization) for this transaction would be that

for Mudville, as shown below.

Payment Voucher 3 4 7 Date: January 3 0 , 1 9 9 7

Account Number: 0 3 - 2 3 1 - 0 0 3

Item(s) Purchased: 10 Cartons o f Paper Price: $ 3 0 0

Supplier: Ajax Paper Company

Payment: Warrant 7 3 0 0 5 Signed:

By looking at this document closely, we can find what is being recorded in

the accounting system. Mudville refers to the public organization, in this case

the City of Mudville. From left to right, one first finds the term Payment

Voucher 347. Voucher is a term meaning a supporting document, usually for

expenditures. In this case, the voucher was designed to collect accounting system information and indicate that the items purchased have been received.

The number "347" is a unique, usually preprinted, number that identifies this

particular payment voucher. All the payment vouchers are filed in numerical

order, and if someone decides to review this financial transaction, 347 can be

found after 346 and before 348. Documents in an accounting system are

designed for cross-referencing for the sake of double-checking. By using

document numbers, any and all transactions can be traced through the

accounting cycle. When documents have no numbers, they are filed by date.

The date "January 30,1997," provides information for the time dimension of

financial reports as well as uniquely identifying the transaction as occurring

on this particular day and no other, which distinguishes it from all similar

transactions.

The account number "03-231-003" represents one of the most unnecessar-

ily mystifying aspects of accounting. All that an account number signifies is a

name; any account number is simply a shorthand way of naming something.

Your name identifies you just as numbers on team members identify them

(e.g., number 34, Shaquille O'Neal). An account is an information category.

The numbers identify in which account (information category) to record

gathered information. The numbers here indicate the expenditure (03), Ad-

ministrative Services Office (231), and Office Supplies (003) account.

The "items purchased" is self-explanatory. The "price" indicates the

amount of money involved. The signature on this document might be either

the person processing the transaction or the person who is authorized to

spend money. The requirement of signatures on accounting documents is

used to locate responsibility for an action. With a signature, it is practically

impossible for a person to deny doing or knowing about something. The

"Payment: Warrant 73005" is an entry made by the finance office when the

payment was made to the vendor. The term warrant refers to a government

check. The number, again, is used for cross-referencing. All of this information

indicates that the paper transaction has occurred and that the vendor has been

paid.

The next event in the accounting cycle is entering the evidence of a financial

transaction into a journal. Entering simply means writing, and journal refers

to a document created by entering evidence in a particular, systematic way.

The key feature that organizes journals is that evidence is entered in chrono-

logical order, that is, by date. For transactions that occur frequently, often

special journals are used to record one particular kind of transaction (e.g.,

payroll, warrants, and property tax payments). Periodically, special journal

information is summarized and entered into the general journal. The general

journal is a record of all transactions for an organization. The idea behind

special journals is that detailed information of a particular kind should be kept

together and that the general journal should not become crowded with minute

detail. Journal entries include pieces of information similar to the original

evidence documents; however, the information is systematically organized

and augmented in the journal. One version of a general journal entry for the

illustrative paper transaction might be as follows.

Public-Sector Accounting General Journal Transaction Document Date Number Number Accounts Debit Credit M a y l 4711 Voucher 3 4 7 0 3 - 2 3 1 - 0 0 3 $ 3 0 0 W a r r a n t 7 3 0 0 5 0 1 - 2 3 1 - 0 0 3 $ 3 0 0 The heading indicates that this is the General Journal. The date is self- explanatory. The transaction number 4711 is a unique number for this journal entry, which identifies it. Later in the accounting cycle, this number can be used to trace this particular transaction. The document numbers are the same as those on the payment voucher discussed earlier. The account numbers show our old friend 03-231-003 and a closely related number, 01-231-003. The only difference in the account names is in the first two digits, 01 instead of 03. As you remember, 231 stands for Administrative Services Office, and 003 stands for Office Supplies. The first, 01, stands for Cash, and 03 stands for Expendi- ture. The accounts shown are "Cash-Administrative Services Office-Office Supplies" and "Expenditure-Administrative Services Office-Office Supplies." This practice is more precise, less time-consuming, and less confusing com- pared with using full account names. The two accounts are listed here because the financial transaction being accounted for affects them. The cash account, 01, is listed because a warrant was written against that account and sent to the vendor. Just as for a personal checking account, the warrant amount is recorded to keep track of the balance available in the cash account. Likewise, the expenditure account, 03-231-003, is listed to keep track of this expendi- ture. It should be noted that the documents—the voucher and the warrant— are listed on the same line as the accounts that they affect; the warrant affects the cash account and the payment voucher affects the expenditure account. This brings us to the point that the dreaded debits and credits can be introduced. Take a deep breath and listen closely. As unbelievable as it may sound, debits and credits are no big deal. Exhale. To the uninitiated, this may come as a wild surprise. If you understand the following four words, you can understand the meaning of debit and credit: left, right, add, and subtract Let's start with left and right. Debit means left, and credit means right. As you can see in the journal example, the debit entry is on the left and the credit on the right. Debit and credit entries are on separate lines and on the left and right to ensure that they are entered correctly. Debits always are entered in the left-hand column and credits in the right-hand column. Debits and credits also indicate whether the amount listed is to be added to or subtracted from something. In the example here, $300 is added to an expenditure account, 03, and $300 is subtracted from the cash account, 01. In this example, why the particular addition and subtraction are made is easily understood: $300 paid to Ajax Paper Company means $300 less cash, so subtract from the cash account; $300 spent on paper means $300 more expenditure, so add to the expenditure account. Deciding what to debit and what to credit, that myste- rious accounting rite, goes by the name of analysis. In any accounting system,

set rules determine what accounts to debit and credit in particular circum-

stances (add to or subtract from). The difficulties associated with learning

about debits and credits primarily arise from learning the rules for what

accounts to debit and to credit in different circumstances. Because each entry

involves at least one debit and one credit entry concerning the same transac-

tion, confusion can easily occur. How the adding and subtracting aspects of

debits and credits work will be developed later. Whenever a transaction is

entered, at least one debit and one credit entry are always made.

Finally, it should be noted that the journal entry omits some information

on the payment voucher, namely the 10 cartons of paper and Ajax Paper

Company. If anyone ever wants to find out what was purchased or who the

supplier was, they can track back to it using the payment voucher number

347.

Taking a broad look at the journal entry, we can see that no truly new

information has been added to the accounting system by anything other than

manipulation or processing evidence of the original transaction. The trans-

action number is an arbitrary name given to the journal entry. The debit and

credit record the adding and subtracting of the amount on the payment

voucher and warrant. A journal is principally a means of organizing all the

original evidence in a systematic order for the purpose of having it recorded

and available in one place as a record and as a basis for posting the information

to a ledger.

Accounts are found in ledgers, which is where the information from the

general journal is placed, which is called posting. In some cases special ledgers

are kept for the same purposes as special journals, and in the same fashion

information summarized from special ledgers is posted to the general ledger.

The organizing concept for journals is date, and the organizing concept for

ledgers is account. An account is any defined set or category of financial

information. Most accounts are fairly standard. The most common varieties

of accounts are discussed below. The ledger entries for the paper transaction

are shown in two versions, the first using "T" accounts, used in the teaching

of accounting, and the second representing the appearance of actual ledger

accounts, which use typical abbreviations for debit, credit, and balance.

"T" Accounts

Expenditures- -03-231-003 Cash—01-231-003

Debit Credit Debit Credit

Balance 1000 Balance 1000

4711 3 0 0 4711 3 0 0

New Balance 1300 New Balance 7 0 0

Ledger Accounts

Transaction Other 03-231-003 01-231-003 Other

Number Accounts Dr Cr Bal Dr Cr Bal Accounts

1000 1 0 0 0

4 7 1 1 3 0 0 3 0 0

1300 7 0 0

The ledger accounts are used to record the financial impact of transactions

and to accumulate that information to show their results over time. Put

another way, ledgers are used to prepare reports showing the effects of

financial transactions over time (e.g., monthly, quarterly, and annual reports).

In the two versions of this example, information brought forward from the

general journal entry includes the transaction number from the general

journal, the account numbers, and the debit or credit status of the entries. In

both examples, the accounts show a balance reflecting information previously

posted to the accounts. In both cases, the $300 is posted to an account as a

debit or a credit, and the $300 is added to or subtracted from the previous

balance. The $300 is added to the expenditure balance and subtracted from

the cash balance. Although this may seem mysterious, it makes sense in two

ways, common sense and accounting sense. In commonsense terms, an addi-

tional expenditure of $300 is added to the balance showing the amount of

expenditures and subtracted from the balance showing cash on hand. In

accounting-sense terms, there are two rules:

1. Debit an expenditure account to show an expenditure

2. Credit a cash account to show a cash outlay

The visual impression in a "T" account makes it very easy to decide whether

to add or subtract when debiting and crediting. If an entry is on the same side

of the line dividing debits and credits for an account, it is added; if it is on a

different side, it is subtracted. Although this can appear confusing, debits and

credits will become clearer as they are discussed and illustrated in more detail.

The two versions of ledger accounts are visually rather than conceptually

different. The "T" accounts example merely shows the accounts as physically

isolated. In actual practice, as illustrated in the ledger accounts example, that

is not the case. Paper-based systems and printouts of computer-based systems

show several accounts across each sheet of paper, which is visually more

detailed and much more practical because it takes up less space and is easier

to use.

The next and last step in the accounting cycle is extracting information

from the accounts to create reports. Of all the information in all the accounts,

information appropriate to particular reports is selected. The only informa-

tion from accounts used for reports are balances, except in those rare instances

where specific transaction information is desired. Balances are used either to

report a total result to the current point in time for a fiscal year or to report

the financial impact of operations for a specific period, which is reflected in

the changes in balances between one point in time and another. An example

of this can be seen by using the paper transaction example and assuming (1)

that the balance of $1000 in both accounts existed after three months of the

fiscal year, (2) that the $300 transaction occurred in the fourth month, and

(3) that the new balances were unchanged through the fourth month. After

four months, the balances are $ 1300 and $700, showing more expenditure and

less cash than the previous month's balances. To show what occurred during

any particular period, take the beginning balances and compute the difference

between those balances and concluding ones. A visual example of such a

report may make this more clear.

Report: Fourth Month

Expenditure Account Cash Account

Third-Month Balances $ 1 0 0 0 $ 1 0 0 0

Fourth-Month Balances $ 1 3 0 0 $ 7 0 0

Change in Balances + $ 3 0 0 - $ 3 0 0

So, account balances are used to prepare reports, but how can one tell which

accounts to choose? The accounts chosen are those appropriate for the report

users. Reports are selected by using the account numbers. For example,

upper-level administrators and elected officials find expenditure and cash

accounts information in their reports, and the administrator of the Adminis-

trative Services Office finds all accounts for that office in accounting reports.

The various accounts are identified and selected by using the account num-

bers: (01), Cash; (03), Expenditures; and (231), Administrative Services Of-

fice. Cash account balances show available cash; expenditure account balances

display what was spent; and Administrative Services Office account balances

indicate remaining expenditure authority. Any categorization of information

that is part of the account codes can be used. For example, if someone wanted

to know how much had been spent on office supplies by the whole organiza-

tion, that could be computed by adding all of the Office Supplies accounts,

those with the account codes 03-###-003. Information, however, can only be

extracted from an accounting system or any other information system after it

has been entered into the system in some fashion. For our example, account

codes, the first two digits are the most noticeable and are used to identify cash

and expenditures, often the most important accounts in public accounting

systems. The administrative unit code comes next, and the object of expendi-

ture code, Office Supplies, comes last because it is the most detailed and the

least important aspect of the transactions that are coded.

Computerized accounting systems differ from the traditional cycle by

sometimes capturing (gathering) transaction information when the first evi-

dence of a transaction is recorded (when the transaction is done on-line) and

sometimes having the information input from original evidence documents.

Once information is input, usually it can be shown organized as a journal, ledger, or report by particular commands based on conceptions of traditional

accounting systems. Computerized accounting systems are basically database

programs with built-in routines.

Although this description of events in the accounting cycle answers the

question, "What happens in the accounting cycle?" and shows examples of

accounting documents, the illustrations of the different information catego-

ries have been left incomplete for the sake of laying out the cycle. This brings

us to the accounting jargon necessary to understand public accounting, the

jargon that identifies the information categories. Accounting involves processing

information; the key is understanding the information categories used.

I N F O R M A T I O N CATEGORIES •

Categories used to organize information are central to any information

system. Words are used to categorize reality, and the concepts underlying

words are used to organize physical things (e.g., socks are found in the sock

drawer or spices in the spice rack). In information systems, abstract state-

ments are used to maintain records, for example, the record in a checkbook.

Information systems rely on abstract definitions and defined operations that

are implied by the definitions or are carried out according to some set of rules.

For example, a checkbook record uses the categories of balance, deposit,

checks, and service charges (checks and service charges are subtracted from

the balance and deposits added). Information systems are based on conven-

tions or customary practices. Accounting information systems are more com-

plicated and harder to grasp because of the large number of categories and

rules and because they are not based on familiar, everyday experiences.

Nonetheless, in public accounting most information categories and their rules

are simple derivatives from six central concepts: fund, the accounting equa-

tion, account types, debits and credits, bases, and account classifications.

Here, a brief preview might help introduce concepts and make the extended

discussion more intelligible.

• A fund is the initial division o f public accounting systems; funds are used to keep

particular information separate. An example is a highway fund used to record

transactions for revenues and expenditures for highways.

• An accounting equation is used for each fund to organize all o f the accounts and

to guide the mathematical operations.

• The account types refer to the fundamental categories or kinds o f accounts that

are used to record information.

• Debits and credits involve adding and subtracting entries to the accounts accord-

ing to set rules.

• A basis refers to different conceptions o f when to record entries, that is, when a

transaction has occurred.

• Account classifications are numbering systems that define all o f the accounts, such

as 0 3 - 2 3 1 - 0 0 3 .

Briefly, a public accounting system is divided into funds, each of which uses

its own accounting equation to organize the various types of accounts, which

are given numerical names in the account classification. All the operations—

debits and credits—are determined by rules depending on the basis and the

account type. Accounting concepts fit together very tightly, but they have to

be taken apart to show the information categories.

Funds and Account Groups4

Public accounting is often called fund accounting. In the private sector, an

organization's accounting is done as part of a unitary whole. In contrast,

public organizations' accounting systems are divided into distinct parts: funds

and account groups. All the information found in a public accounting system

is found in its funds and account groups. Basically, a fund is a separate group

of accounts. The cash and other financial resources accounts show the assets,

what the organization owns; the liability accounts show what the organization

owes; and the residual balance or fund balance accounts show what the

organization "owes" to itself, which is the difference between total assets and

total liabilities.

Public organizations have funds primarily because of legal restrictions on

the use of revenues and to collect different types of information. Preferably,

entities use as few funds as possible to avoid unnecessary work and confusion.

There are various reasons for legally restricting the use of certain revenues.

Revenues can be earmarked for particular expenditures, such as highways or

social security; money from grants can be restricted to a particular fund;

revenues from bequests can be restricted to ensure compliance with the terms

of the bequest; or revenues from the sale of bonds can be restricted to ensure

that the money is used for legally allowable purposes. Likewise, other revenues

can be restricted to particular funds to collect information useful for running

a public organization. Funds used for this reason include funds used to record

debt payments and charges for services provided by one organizational subunit

to other subunits.

The types of funds used in public accounting fall into three categories:

governmental, proprietary, andfiduciary. Governmental funds segregate par-

ticular resources and show how they are used. Proprietary funds measure the

income position of services where fees are collected by relating expenses to

revenues. Fiduciary funds, also called trust and agency funds, show that respon-

sibilities to others are being carried out. The fund types used by state and local

governments are

• Governmental: General, special revenue, capital projects, and debt service funds

• Proprietary: Enterprise and internal service funds

• Fiduciary: Expendable trust, nonexpendable trust, pension trust, and agency

funds

In addition, some local governments u s e funds t o account for special assess-

ment projects, even though those kind o f funds are no longer recognized. The

federal government a n d the various kinds o f nonprofit organizations u s e

similar types of funds, even though some have different names. The number

of funds used by public organizations varies from one to many funds. A

general fund is always used.

One general fund is used by all public organizations to account for a large

portion of their transactions. Any financial transactions not restricted to

another fund are found in the general fund, including the many transactions

for ordinary operations.

Special revenue funds are used where revenues from a specific source or

sources are restricted to expenditures for particular purposes. Federal taxes

on gasoline, for example, go into a federal fund from which expenditures are

made to provide for transportation systems. Likewise, because many grants

can only be used for certain purposes, many recipients establish grant project

funds. Often unpopular revenue sources are sold politically by restricting the

revenue to "good" purposes, for example, state lottery revenues for education.

Capital projects funds are used to account for construction of physical

facilities because of legal restrictions or a desire to focus attention on one or

more capital projects.

Debt service funds can be used to account for the accumulation of resources

for and payment of general obligation long-term debt (i.e., an overall public

organization debt to be paid off in future fiscal years). Other kinds of debt can

be accounted for in a debt service fund also. Short-term debt and revenue

bond debt are accounted for in the fund to which the debt is attributed,

however.

Enterprise funds are used in accounting for businesslike activities or in other

situations where payments are made for services that benefit identifiable

consumers. Publicly owned utilities, zoos, universities, parking lots, hospitals,

and airports are typical enterprise services. Enterprise funds are used to track

the degree to which such services are self-supporting or subsidized. Enterprise

funds are particularly useful in ensuring that services requiring expensive

capital investments are being priced at an appropriate level to pay for the

capital investment.

Internal service funds are used when a public organization subunit provides

measurable services to another subunit. Copying centers and motor pools are

typical examples. The use of internal service funds makes it possible to

attribute service expenses to particular organizational units or programs.

Fiduciary funds or trust and agency funds are used when a public organiza-

tion is handling someone else's monies in the capacity of a trustee or an agent.

Trust funds involve managing resources by making decisions as public organi-

zations execute a trust placed in them by someone else; agency funds involve

holding resources for others as an agent when the others are expected to

reclaim their resources. The financial transactions are segregated to a separate

fund to ensure proper handling of the monies. Expendable trust fund means

that the resources in the fund can be spent on particular purposes, for

example, cemetery expendable trust fund. A nonexpendable trust fund means

that the original principal placed in the fund cannot be spent; some such funds

can allow expenditure of the investment return, for example, an endowed

scholarship fund, but others might require that no part of the fund be spent,

for example, a fund that has revolving loans. Pension trust funds are used to account for the accumulation, investment, calculation, and payment of pen-

sion benefits. Agency funds are used to hold monies owned by other entities;

generally, this type of fund is used to account for the temporary custody of

the monies and not their ownership or use, for example, utility customer

deposits or property taxes held by a county for a school district.

In addition, two sets of account groups contribute to showing a public

organization's financial situation. Unlike funds that are used to record sepa-

rate or restricted revenues and particularly the expenditure of such revenues,

the two account groups maintain a record of fixed assets and long-term debt

not associated with particular funds. In some cases, fixed assets and long-term

debt are attributed to and recorded in particular funds, for example, enterprise

funds and internal service funds. Although this can seem confusing in theory,

the practice is relatively simple because what is accounted for in the account

groups is limited and governed by clear-cut rules. The two account groups are

General Fixed Assets and General Long-Term Debt.

The General Fixed Assets Account Group includes a listing of all general fixed

assets and their monetary cost. Fixed assets include property of a lasting

character—land, buildings, equipment, and the like. It does not include assets

that are "liquid," money or things easily convertible to money, such as stocks,

bonds, and the like. In accounting for general fixed assets, their purchase is

recorded as an expenditure in the relevant fund whereas the ownership of such

assets is recorded in the General Fixed Asset Account Group.

The General Long-Term Debt Account Group is used to record outstanding

debts owed by the public organization that are not attributable to any particular

fund. This account group lists the amounts and types of debt. Often, the

purpose and due dates for debts are recorded also. In accounting for general

long-term debt, the monies received to create the debt are treated as revenue

in one or more funds while the debt itself is recorded in the account group.

The funds and the account groups are the broad areas within which public

accounting takes place. Within the funds, accounting is done in the context of

accounting equations.

The Accounting Equation

An equation is a statement of a mathematical relationship (e.g., 1 + 1 = 2 ) .

The most familiar form of equation expresses the concept of mathematical

equality: One side of an equation equals the other. As long as the same thing

is done to both sides of an equation expressing equality, the equation always

has equal mathematical values on both sides of the equation. Modern, double-

entry accounting is characterized by always having at least two entries for

every accounting transaction and by the rules of accounting operating in such

a way that the accounting equation, which expresses equality, is always in

balance (i.e., one side of the equation always equals the other). All additions

to and subtractions from accounts are such that no entry is allowed by the

rules to disturb the relationship of equality. Additions and subtractions have

an equal effect on the total value of both sides of the equation. The various

accounts and the rules of adding and subtracting (the dreaded debits and

credits) are organized to maintain "balance." Also, this approach highlights

mathematical errors because errors throw an equation out of balance.

All accounting equations, accounts, and rules (debits and credits) are

logical developments from the basic accounting equation: Assets = Equity.

Assets refer to resources owned, and equity refers to resources owed. In the

practice of accounting, assets and equity are two aspects of the same concrete

phenomenon. For instance, if you were to account for bananas and you had

two of these yellow fruit, your basic accounting equation would be 2 bananas

= 2 bananas. Your assets and equity would be the same. If you gave one away

or traded a banana for an apple, your accounting equation would show 1

banana = 1 banana or = 1 banana + 1 apple = 1 banana + 1 apple.

All possible transactions are recorded in a way that keeps an accounting

equation in balance.

All accounts are theoretically derived from assets and equity and can be

found either on the asset side of the accounting equation, which is the left

side, or on the equity side of the accounting equation, which is the right side.

Using the accounting equation concept, you add to both sides of the

equation:

2 = 2

Add: 1 2 + 1 = 2 + 1

3 = 3

subtract from both sides of the equation:

2 = 2

Subtract: 1 2 - 1 = 2 - 1

1 = 1

or add and subtract on one or both sides of the equation in such a fashion

that the equality relation is maintained:

2 + 1 = 1 + 2

Transfer: 1 from one asset account to another

( 2 - l ) + ( 2 + l ) = 2 + 2

1 + 3 = 2 + 2

The rationale behind all the rules is "Keep the equation in balance."

Debits and credits are used because they represent left and right and provide

a means of adding and subtracting. The simplest way of expressing this is

through working with a basic accounting equation: Assets = Equity. If you

start with two bananas, the basic equation is

Assets = Equity

2 bananas = 2 bananas

By using "Τ" accounts, we get

Assets = Equity

Debit Credit Debit Credit

2 bananas 2 bananas

For accounts on the left side of an accounting equation, a positive balance

or an addition is debit, and debit means left. For accounts on the right side of

an accounting equation, a positive balance or addition is a credit, and credit

means right. Debit and credit are abbreviated as Dr and Cr respectively.

The "T" accounts show adding and subtracting relationships visually. We

add to or subtract from an account on one side of an accounting equation

differently than we add to and subtract from an account on the other side of

an equation.

The left side of the accounting equation is sometimes referred to as the asset

or debit balance side, and the right side is referred to as the equity or credit

balance side. The asset and equity labels derive from the fundamental charac-

ter of the accounts on each side of the accounting equation, and the debit and

credit balance labels are because those are the normal balances on the respec-

tive sides of an accounting equation.

Add: one banana

Assets = Equity

Dr Cr Dr Cr

2 bananas 2 bananas

1 banana 1 banana

3 bananas 3 bananas

Subtract: one banana

Assets = Equity

Dr Cr Dr Cr

2 bananas 2 bananas

1 banana 1 banana

1 banana I banana

The rules for adding and subtracting are as follows:

Addition: debit on the left side o f an equation

credit on the right side o f an equation

Subtraction: credit on the left side o f an equation

debit on the right side o f an equation

We know whether to debit or credit depending on whether we are adding

to or subtracting from an account and whether the account is on the left or

on the right. The act of deciding what to debit and what to credit is called

analysis. To do analysis is to determine which accounts are affected and in

what way. In other words, we are determining from where and to where

resources are going. One way of knowing whether to debit or credit accounts

is to know the account types. The various account types are invariably on one

side or the other of an accounting equation.

The account types come in three groups: real, nominal, and budgetary

accounts. The real accounts are the only ones found on the balance sheet and

can be said to reflect "real" impacts on the financial condition of an organi-

zation. Nominal accounts show the flow of monies during a fiscal period.

Budgetary accounts are used to record budgetary decisions.

Real account types include assets and two types of equity accounts: liabili-

ties and fund balance. Typical asset accounts include cash, short-term and

long-term investments, and payments due from others. Equity accounts

include liability accounts, which show what an organization owes to others,

and fund balance accounts, which show what an organization "owes" itself.

For the most part, one fund balance account is used in an artificial manner to

keep an equation in balance. Hence, the numbers in a fund balance account

are not particularly meaningful and merely reflect the difference between the

total assets and total liabilities. Liability accounts include payments due to

others, short-term debt, and in enterprise funds, long-term debt. These ac-

count types form the basic accounting equation reflected on the balance sheet,

which is a report. When a fiscal period accounting system is put into service,

the previously blank pages of the journal and ledgers are said to be opened

when the balances of these account types are taken from the balance statement

for the end of the last fiscal reporting period and entered into the journal and

posted to the ledger. Conversely, one closes the books when all the other account

types are closed and the balances in these accounts are recorded on the balance

statement. These account types provide a slightly expanded accounting equation:

Assets = Liabilities + Fund Balance

The nominal account types—revenue and expenditure—are used to record

the impact of operations during a fiscal period, that is, to show the flow of

monies. Although accounting theory explains the location of these accounts

in an accounting equation, it suffices here merely to show the locations:

Assets + Expenditures = Liabilities + Fund Balance + Revenues

Typical revenue accounts include revenues by various sources (e.g., income

taxes, sales taxes, property taxes, import duties, and parking meter collec-

tions). Expenditure accounts reflect the budgetary categories, such as the

organization unit (Administrative Services) and object of expenditure (Office

Supplies).

The budgetary account types—estimated revenue and appropriation—are

used to record the budgetary decisions of an organization. The estimated

revenues are those predicted in the organizations budget and that the organi-

zation is authorized to collect, and the appropriations are authorizations to

spend money. They a r e used to relate actual revenues and expenditures to their

corresponding budgetary estimates and limits. Because expenditures are lim-

ited by budgetary law or policy, the appropriation accounts are used to control

expenditures. The specific estimated revenue and appropriation accounts use

exactly the same titles as the revenue and expenditure accounts except that

budgetary accounts show the budgeted amounts and the nominal accounts

show the effects of actual operations. The expanded accounting equation,

without theoretical justifications, is

Virtually all transactions affect only the Asset, Expenditure, Revenue, and

Liability accounts. The budgetary and the fund balance accounts are used in

opening and closing the books, and in between those events, the budgetary

accounts are used as benchmarks or guides against which the revenue and

expenditure accounts are measured. The only other time you have budgetary

account transactions during a year is when a budget is changed.

Finally, accounts are subdivided into control accounts and subsidiary ac-

counts. This is surely an unwelcome but necessary complication because most

accounting information is in subsidiary accounts. The control accounts are

the accounts in the general accounting equation discussed earlier (e.g., Assets,

Expenditures, Revenues, and Liabilities). The subsidiary accounts usually

include information from two or more control accounts. Also, the control

accounts are broad in character, and the subsidiary accounts are very specific.

The control accounts are few in number, whereas subsidiary accounts are

numerous.

Subsidiary accounts contain detailed and partial information from one or

more control accounts. An example of a subsidiary account is a Personnel

Expenditure Subsidiary Account, which has the Expenditure Account as its

control account. The subsidiary account in this example is only used to record

transactions having to do with personnel expenditures whereas the control

account is used to record all expenditures. There are three purposes served by

having separate accounts for partial information. First, subsidiary accounts

provide detail. Second, they bring together specific budgetary and nominal

account information in one place. Third, they leave the general accounting

equation free of excessive detail, which makes it easier to determine if the

equation is in balance.

The use of both control and subsidiary accounts is done by entering control

and subsidiary account information into the journal and posting that infor-

mation to both ledger accounts. It works in such a way that the same infor-

mation posted to a subsidiary account is also posted to a control account. How

this works and how subsidiary accounts serve the purposes listed can be seen

by way of examples. An example of journal entries for a control and a

subsidiary account can show how this is accomplished.

Assets =

+ Expenditures

+ Estimated Revenues

Liabilities

+ Revenues

+ Appropriations

+ Fund Balance

Journal Example

First Version: Debit Credit

Expenditure

Administrative Services-Office Supplies

Cash

$ 1 0 0

$ 1 0 0

or

Second Version:

0 3 - 2 3 1 - 0 0 3

0 1 - 2 3 1 - 0 0 3

$ 1 0 0

$ 1 0 0

Both versions of the journal example have Expenditure, 03, as the control

account. In the first version, the subsidiary account, Administrative Services-

Office Supplies, is listed below the control account. In the second version, both

the control account and subsidiary account are indicated by the numerical

code. The Cash Account in this example, as in general practice, is not a control

account. A number of subsidiary accounts can be listed under the control

account. This is appropriate when, for example, an organization made a

payment to an office supplies firm for supplies being delivered to different

organizational subunits with their own subsidiary accounts. The journal entry

in such a case shows the control account entry and then various amounts for

the different subsidiary accounts. In turn, the journal entries are posted to the

ledger accounts as shown here.

Ledger Accounts

Control Account:

Expenditures (03)

Dr Cr

Balance $ 1 0 0 0

$ 100

New Balance $ 1 1 0 0

Subsidiary Account

Administrative Services-Office Supplies (231-003)

Dr Cr

Balance $ 2 0 0

$ 100

New Balance $ 3 0 0

It is easy to see how subsidiary accounts provide detailed information.

Expanding the example of the Personnel Expenditure Subsidiary Account, we

can look at subsidiary expenditure accounts for personnel, supplies, and

contracts for three organizational units. The control account is the Expendi-

ture Account.

Expenditure Account

Dr Cr

Balance $ 1 0 0 , 0 0 0

Subsidiary Expenditure Accounts (Debit Balances)

Unit A Unit Β UnitC Row Totals

Personnel $ 2 2 , 0 0 0 $ 2 5 , 0 0 0 $ 2 3 , 0 0 0 $ 7 0 , 0 0 0

Supplies $ 6,000 $ 2 , 0 0 0 $ 1 2 , 0 0 0 $ 2 0 , 0 0 0

Contracts - 0 - $ 2 , 0 0 0 $ 8,000 $ 10,000

Column

Totals $ 2 8 , 0 0 0 $ 2 9 , 0 0 0 $ 4 3 , 0 0 0 $ 1 0 0 , 0 0 0

The sum of the balances in the subsidiary accounts is equal to the balance of

the control account. The subsidiary accounts show details relevant to the

organization using the accounting system. As in the earlier Office Supplies

example, the people using the accounting system can see how their organizational

subunit stands in respect to particular categories of financial information.

Subsidiary accounts also bring specific information from two or more

control accounts together in one place. For the most part, this results in

showing the relationship between the budgeted and actual amounts in specific

categories and the remaining balances. In this way the subsidiary accounts

show how the details of operations relate to the budget. The subsidiary

accounts record transactions for the different types of control accounts and a

subsidiary account balance. An example most simply shows how this works.

Control Accounts

Expenditures

Dr Cr

Appropriations

Dr Cr

Balance $ 1 0 0 , 0 0 0

100

$ 2 0 0 , 0 0 0

$ 1 0 0 , 1 0 0

Subsidiary Accounts

Administrative Services-Office Supplies

Expenditure Appropriation

Available for Expenditure

Balance

Dr Cr (Cr)

$1000 $1000

$ 900$100

In this example, $100 is posted to both the expenditure control account and

the subsidiary administrative services-office supplies account. The subsidiary

account shows an initial credit balance of $1000, which occurred when the

budgetary appropriation of $ 1000 was posted to the account. The posting of the

expenditure of $100 as a debit results in a new balance of $900 when the debit

amount is subtracted from the credit balance. This subsidiary account shows the

amount of the remaining budget authority, which is the difference between the

amount appropriated—the budgetary account category—and the amount

expended—the nominal account category. The balance remaining is what can

still be spent on office supplies by the Administrative Services Office.

The previous examples show how the purpose of keeping the number of

accounts in the general accounting equation to a minimum is served. By using

the control accounts to determine that the equation is in balance, bookkeepers

and accountants save a lot of time. If all the entries and postings are done

correctly, the sum of the balances of the control accounts is equal to the sum

of the balances of the subsidiary accounts because exactly the same informa-

tion is posted to the control and subsidiary accounts.

Bases of accounting are concerned with when to record financial transac-

tions and, hence, what really constitutes a transaction. The bases use different

rules to record transactions. For example, only an encumbrance-basis ac-

counting system uses "encumbrance" accounts that reflect the recognition of

an accounting transaction at a particular point in time. The bases determine

which of a large number of sequential events are recorded by when a transac-

tion is recognized. There are four bases and one modified version: cash,

accrual, modified accrual, encumbrance, and cost. Two or three bases can be

used at the same time.

Cash basis accounting is the easiest to understand and use. In using the cash

basis of accounting, you record a financial transaction when money or its

equivalent changes hands. Individuals account for their personal checking

accounts using this basis. The cash basis is intuitively appealing and easy to

use. The cash basis has two major faults: First, by manipulating the flow or

recording of cash transactions, the financial picture of an organization can

easily be distorted. The classic example is an organization not paying bills for

goods or services and carrying them from one year to another to hide the

implicit debt such bills represent. Second, the cash basis provides the latest

possible recording of financial transactions for collecting information. Events

are irreversible by the time they are recorded. Accounting is taught using

another basis, the accrual basis.

Bases of Accounting

Accrual basis accounting uses the notion of legal obligation to record

financial transactions. Under this basis of accounting, financial transactions

are recorded when a legally binding financial obligation has occurred. Ten

cartons of paper arriving with a bill and someone billed for a tax payment are

two different examples of events recorded in accrual-based accounts. Accrual

basis accounts are those with the words payable, due, and receivable in their

account names. Cash transactions are also recorded in an accrual-based

accounting system. Enterprise and internal service funds ordinarily use the

accrual basis.

Modified accrual basis accounting is like accrual accounting in its central

notion of legal obligation. It differs from accrual accounting primarily with

respect to the accrual of revenues. Because public revenues are unpredictable

and not easily measured, modified accrual basis accounting requires that

revenues be both measurable and available during the current fiscal period

before they can be recorded as obligations due to a public organization.

According to authoritative accounting standards, most funds should use the

modified accrual basis. Both accrual and its modified version provide infor-

mation on financial transactions, particularly expenditures, earlier than a cash

basis system.

Encumbrance basis accounting relies on the notion of commitment. Finan-

cial transactions are recorded when a commitment is made. This basis is used

only for expenditure accounts. Rather than wait until an order of goods or

services is received, the encumbrance basis can be used to record commit-

ments when orders are placed or even when spending decisions are made. By

accounting for decisions to spend, you can set aside monies already commit-

ted and thereby have the earliest possible information about expenditures,

some of which may be reversed. Like accrual accounting, encumbrance-based

systems also record financial transactions concerning the actual transfer of

money. An accrual or a modified accrual basis and an encumbrance basis can

be used concurrently.

Finally, and least important for public organizations, cost basis accounting

relies on the notion of use or consumption of resources to recognize a

financial transaction. The purpose of cost accounting is to record the costs of

providing goods and services. Cost accounting is almost always an addition

to an accounting system rather than a primary basis for gathering informa-

tion. An example of a cost being incurred is the use of a carton of paper to

produce tax bills. When the carton is used, it would be recorded as a cost.

Public organizations seldom engage in cost accounting, though cost account-

ing can be very useful in some situations, particularly in connection with the

pricing of goods and services sold by public organizations. For example,

nonprofit hospitals may need to determine the actual expenditures for differ-

ent treatments to accurately price them. The key aspects of the bases are

summarized in Table 3.1.

Differences among the commonly used bases are the timing of recording,

the accuracy of reports, and the work involved. The encumbrance basis

provides the earliest record of expenditures, followed in order by the accrual

basis, the cash basis, and the cost basis. Encumbrance information includes

intentions, whereas accrual information is firm legal obligations. Accrual-

ABLE 3.1 Accounting Bases

Time Dimension (Key Idea)

Basis Earlier to Later Example

Encumbrance Commitment Order placed for paper

Accrual & Obligation Paper and bill received

Modified Accrual

Cash Money moves Paper paid for

Cost Use Paper consumed

based accounting frequently includes accounts showing obligations and cur-

rent assets not normally found in accounting systems using other bases,

including depreciation, receivables, payables, and inventory. These accounts

provide a greater breadth of information and make it possible to obtain a more

precise understanding of an organization's current financial position. For the

amount of work involved, the cash basis requires the fewest entries and takes

the least work to train people to keep the books and to understand reports.

No basis of accounting neglects recording of cash transactions; they only

differ in what else is recorded. Accrual-based accounting probably involves

the most work because it is harder to understand, which makes training people

more difficult. Any accrual transaction requires two sets of entries, one for the

obligation and one for the cash transaction that eliminates the obligation.

Encumbrance accounting appears to be slightly less difficult than accrual

accounting because it is easier to understand and to train people. It uses three

sets of entries for every transaction: one for the commitment and two when

the record of the commitment is eliminated and the cash payment sent.

Larger public organizations, those more reliant on debt financing, and

those with more professionalized staff use the modified accrual and accrual

bases. In many cases, states require that certain local government activities be

accounted for using an accrual basis, for example, enterprise fund activities.

Some financially conservative public organizations, particularly municipali-

ties, use the encumbrance basis, sometimes in conjunction with an accrual

basis.

Smaller public organizations, those with less professionalized staff, and

those less reliant on debt financing use the cash basis, except where required

to use an accrual basis. Although professional accounting groups rail against

this practice and insist upon the superiority of the accrual bases, the use of

the cash basis makes sense in organizations relying heavily on part-time and

volunteer labor or in geographically isolated places. In such organizations, the

costs of training for and using an accrual basis are high, and the staffs have

plenty of other things to claim their attention.

Account Classification

All accounting systems use a variety of accounts for their reporting needs.

Because of the length of many account titles and for greater accuracy, accounts

are assigned a numerical code. The listing of all accounts and their assigned

codes is called the chart of accounts. The chart of accounts is functionally

equivalent to the program at a sporting event, just as keeping score is a

different kind of accounting. Charts of accounts vary essentially in the degree

of detail based on how detailed the accounts are themselves. To have a

sufficient coding system, we have to have a designated set of codes for every

aspect of the account that is recorded. A very simple accounting system with

only nine accounts is easy to code with a single digit for each account, 1-9.

Very complicated systems can use more than 10 digits to code an account. As

a rule, public organizations have more complicated systems because of control

and details. Table 3.2 provides a relatively complicated example of an account

code that can be understood through the following discussion of account

classifications.

The best way to illustrate charts of accounts is to construct one to show

what goes into such an enterprise. North Snowshoe lost its accounting system

and bookkeeper in an avalanche, so we can construct one for them. First of

all, codes can be established for funds. It makes sense to assign a two-digit

code for funds because of the number of different kinds of funds. Though all

types of funds are not used everywhere, frequently there are several of one

fund type. If we used a one-digit code, 1 to 9, and then found we needed a

tenth fund, we would have to revise the whole system. The fund codes:

10—General Fund

20—Special Revenue Funds

21—Disaster Relief Grant

2 2 — T a x on Avalanche Insurance

30—Capital Projects Funds

31—Avalanche Retaining Wall

4 0 — D e b t Service Fund

50—Special Assessment Funds

51—Paving District #3 (Blizzard Hills Subdivision)

60—Enterprise Funds

61—Icehouse

62—Sewer

TABLE 3.2 Anatomy o f an Account Code

10-01-415.121-300

70—Internal Service Funds

71—Snowmobile Motor Pool

80—Trust and Agency Funds

81—Frostbite Cemetery Expendable Trust

90—Account Groups

91—General Fixed Assets

92—General Long-Term Debt

The first two digits of all of the account codes for North Snowshoe show the

fund, for example, 10 for the general fund or 90 the account groups.

Next, organizational subdivisions are used to ensure compliance with

appropriate legislation. In most instances appropriations are granted to or-

ganizational units. This budgetary information is recorded in accounting

systems by organizational unit codes: 01—Avalanche Alert Department. Such

designations are necessary to ensure control of expenditures. Taking the

previous example one step further, all general fund accounts for the Avalanche

Alert Department start with the account code 10-01.

Next, in descending level of detail, are codes for account types. Although

different systems are theoretically possible, the standard recommended in

Governmental Accounting, Auditing, and Financial Reporting (listed in chapter

notes) and used by most public organizations is a four-type system.

1. Assets

2. Equities (Liabilities and Fund Balance)

3. Revenue

4. Expenditure

The budgetary account types are not coded because they are mirrored by the

revenue and expenditure accounts and are accounted for in revenue and

expenditure subsidiary accounts. Also, the account types can be further sub-

divided to include specific account categories. Asset accounts show the kind

of asset, 101-Cash. Equity accounts show different kinds of liabilities and fund

balance accounts, 201-Accounts Payable and 253-Fund Balance. Revenue

accounts are categorized by the source of revenue: 310-General Property Tax.

The expenditure accounts are generally classified by function or program and

activity: 415-Financial Administration. More detailed codes can be used to

designate function or program; for example, the account code for accounting

for the Avalanche Alert Department is 10-01-415.121.

Another aspect is the character of expenditures that focuses on time period:

current operating expenditures, capital outlays, debt service, and intergovern-

mental transfers. Often in practice, this recommendation is ignored because

the effort required to gather and record this information is thought to exceed

its value.

Finally, accounts are coded to show objects of expenditure, that is, goods

and services for which money is spent. For example, depending on how

detailed the chart of accounts is, the object code for the cost of our consulting

service in setting up their chart of accounts could be 30 or 300. Following the

previous example, the whole code for accounting consulting services for the

Avalanche Alert Department is 10-01 -415.121 -300. As with organization subunit

codes, object of expenditure codes are used to designate accounts for the

purpose of budgetary control. Generally, account codes for every kind of

expenditure in a public organization's budget occur at the same level of detail.

If the budget uses Personnel as an appropriations category, the account codes

show a personnel appropriation and expenditure code. If the budget shows

further detail for personnel expenses by type of employee or type of expense,

the code of accounts shows those same details as account codes because there

are subsidiary accounts for every budget category.

To review and extend our view of charts of accounts, account codes repre-

sent account titles; they supply short, precise names for accounts. The account

codes are arranged in groups to facilitate recording information that the

designers of an accounting system decide is useful. The account codes illus-

trated here are those most commonly used.

As you may have noticed already, the expenditure account codes are the

most detailed because of the preoccupation of public organizations with

control and, hence, accounting for expenditure as appropriated. Likewise, for

management or planning purposes, the expenditure accounts are the most

often used accounts. The other account types are relatively few in number,

primarily because of the use of organizational subunit and object codes.

Except for expenditure codes, accounts are coded only by fund and account

types. For example, 10-310, which signifies general fund-general property tax,

is sufficient to identify that account.

Nonetheless, account codes used in conjunction with expenditure trans-

actions are parallel, or echoes of expenditure codes, despite the fact that

the other account in the transaction can be identified by a single code. For

example, the expenditure code of 10-01-415-30 (general fund-avalanche

alert department-financial administration-accounting services) appears in

accounting documents along with 10-01-101-30 (general fund-avalanche

alert department-cash-accounting services). In the case of 10-01-101-30, only

two of the four sets of numbers designate the actual account, which is general

fund-cash (10-00-201-00). Likewise, a revenue code could appear as 10-00-

310-00 (general fund-general property tax). The use of essentially dummy or

meaningless account codes serves two purposes—maintaining consistency in

code patterns and length of code and providing a second account code to

check against the first. In other words, this practice fosters precision and

accuracy.

Also, it should be noted that the account codes discussed here are merely

the common and recommended ones. Any other characteristic or aspect of a

financial transaction that can be conceptualized can be the basis for a set of

account codes. The most common one not previously discussed is that of cost

center. Cost centers refer to any set of expenditures that can be identified and

grouped (e.g., activities, projects, or programs). Using such a code, you can

develop and use figures on different cost centers, primarily for managerial

purposes. In some cases, cost center codes are not part of the formal account-

ing system but are developed and used within organization subunits. In such

cases, letters of the alphabet are used to avoid confusing the central accounting

personnel (e.g., 10-01-415-30a). Account codes are only limited by one's

imagination.

Information categories discussed here, whether funds or expenditures,

reflect information used in the practice of public finance administration. Even

though a few concepts are limited to accounting practices alone (e.g., the

accounting equation and debits and credits), most information categories

discussed here reflect very real information necessary to administer public

finances.

SPECIALIZED USES OF A C C O U N T I N G •

Virtually all public organizations engage in the generic accounting practices

discussed so far. In addition, many use specialized accounting for other aspects

or purposes of financial administration. Generic accounting is oriented to-

ward tracking revenues and expenditures in relationship to budgets and

recording the resulting balances, assets, and liabilities. Most needs for financial

information are sufficiently served by generic accounting. Specialized ac-

counting serves other information needs. Specialized uses of accounting

include internal control, cost accounting, personnel accounting, financial

disclosure, and inventory accounting.

Internal Control

Internal control, which results in internal control systems or internal con-

trols, refers to procedures that control how accounting and related financial

matters are handled in an organization. Internal control procedures are

designed first of all to safeguard an organization's assets from mishandling,

whether by accident or on purpose. Although internal control serves this

central purpose, it also ensures compliance with legal requirements (budget-

ary and others), supports the accuracy of accounting systems records, gener-

ally follows good management practices, and helps employees avoid tempta-

tions to misuse organizational resources. Internal control is discussed under

the heading of accounting because it is usually a part of accounting system

and procedures design, even though most areas of financial management are

concerned to some degree with safeguarding resources. Principles of internal

control are built into the design of accounting systems.

The practice of internal control relies on the central ideas of fixing respon-

sibilities and reviewing the exercise of responsibilities. Responsibilities are

"fixed" in two senses. First, responsibilities in the sense of everything required

and prohibited is specified in written policies and procedures. These include

such things as when to record what information and physical safeguards for

assets. Second, responsibilities for particular individuals are specified by

linking particular individuals to particular actions by signature, by job assign-

ment, or both. Associated with individual responsibilities is the notion that

personnel should be competent and trustworthy and adequately trained for

their responsibilities. Reviews are built into an accounting system by proce-

dures that divide transactions responsibilities between two or more persons often with a routine of comparing totals between or among those persons),

accounting reports, management reviews of transactions, and internal and

outside audits of the accounting system. The same kind of internal control

procedures, sometimes referred to as administrative controls, can specify

routines, responsibilities, and reviews for any area of an organization. Most

frequently internal control is applied to public finance areas with high values,

especially purchasing, investment, cash management, pensions, expenditure

administration, and revenue administration.

Not only is it necessary to have internal control procedures, it is also

necessary to follow them. Not having and not following are functionally

equivalent. Orange County, California, was a case of both in different respects;

the county lacked internal control procedures on borrowing for investment

and specific investments, and the treasurer violated accounting system rules

by committing fraud. Another example of an organization that did not

practice internal control is an Iowa village that lost hundreds of thousands of

dollars when the village clerk wrote and cashed 40 or 50 checks to herself over

a two-year period while forging another official's signature. The loss was

discovered when the clerk moved to Arizona. Apparently, no one bothered to

check the balance in the village's bank account against accounting reports.

Cost Accounting

Cost accounting, a separate basis, can be used where attributing costs to a

particular category is necessary or helpful. Categories used in cost accounting

include particular services, functions, programs, projects, or organizational

subunits. Through the use of cost accounting, one can determine what some-

thing costs totally and by components. Knowledge of costs, both total and

component costs, supports managerial and policy decisions as to allocation

of resources in budgets, prices of services, and choice of operating methods.

Personnel Accounting

In addition to personnel records dealing with the personnel process itself,

personnel accounting involves accounting for financial transactions concern-

ing personnel. Personnel accounting deals with all manner of payments

involving personnel, primarily in relation to payments to or on behalf of

employees or because of employees.

Personnel accounting is specialized because of the need for more detailed

information than is easily accommodated in a general accounting system.

Summary entries from personnel accounting systems are entered into general

accounting systems based on the personnel journal entries.

The amount of detail in personnel accounting stems from the primary

information category and the variety of information recorded. The primary

information category is the individual employee payment record, for which

all manner of payments are recorded whether the payment is to the employee,

on behalf of the employee, or on account of the employee. Employees are paid

regular wages and salaries as well as other special payments. Taxes and other payments are made on behalf of employees and based on payroll deductions.

Public organizations make payments to other organizations on account of

particular employees (e.g., payroll taxes on employers, worker's compensation

insurance, and pension and health plan payments). Because personnel ac-

counting records are organized by individual employees and show payments

made for each employee, these records show the fulfillment of legal obliga-

tions with respect to each employee.

Financial Disclosure

Many public organizations desiring to issue bonds have found themselves

required by state laws or the practical requirements of investor concern to

make financial disclosure. Financial disclosure statements commonly include

the following:

1. Standard accounting report information, such as total revenues and total expen-

ditures

2. Information based on accounting reports, for example, available debt capacity

(debt limit-current debt)

3. General economic conditions, such as unemployment rate

4. Specifics of bond issue, for example, revenue source for repayment

Because financial disclosure statements rely partially on accounting systems,

the persons responsible for the accounting are also given the responsibility for

maintaining specialized financial disclosure records and preparing financial

disclosure statements.

Inventory Accounting

Inventory accounting deals with keeping track of materials and capital

equipment. The reasons for inventory accounting are reduction of waste and

loss, maintenance of necessary inventories to operate, and minimization of

purchasing costs. Inventory accounting supplies useful information for

budget preparation.

A C C O U N T I N G A N D MANAGERS •

Accounting information is a key ingredient in managerial decision making.

Although managers in public organizations deal with finances, people, pro-

grams, operations, and organizational relations, the management of finances

is frequently overlooked in discussions of management. Organization fi-

nances concern some of the most important realities that managers face,

particularly for the use and availability of resources. In dealing with finances,

most managers' exposure is to accounting information.

When managers are in a control relationship, whether being controlled or

controlling others, their attention is on subsidiary expenditure accounts.

Financial control through an accounting system is one of the most effective means of organizational control: no money, no action. Management decisions

about how to operate are based on reviews of accounting information on

costs, expenditures, and the balances available for expenditure. A good exam-

ple of this is found in cases where managers look at their accounts to deter-

mine where to focus their attention. In public organizations, usually personnel

is the overwhelming user of resources. If an organization's resources are

primarily personnel, the focus of management attention should be on the

efficient and effective use of personnel rather than on other more minor

resources. Cost and expenditure information is particularly useful in choosing

between alternative operational practices. Financial management decisions,

particularly those having to do with cash, debt, and investment management,

rely heavily on past accounting data. Planning relies on information from the

near past for projections into the future for budgets, capital budgets, and

service plans. When managers have decisions to make, they frequently draw

on financial information provided by an accounting system.

• C O N C L U S I O N

As promised in the introduction, you have not been turned into an accountant.

This chapter, however, provides a basic understanding of public accounting and

penetrates into and illuminates some of the mysteries of accounting. The key

facets covered here encompass accounting reports, the accounting process, the

kinds of information recorded, various specialized uses of accounting, and an

appreciation of how accounting relates to management. Later chapters pro-

vide examples of how accounting supports other financial administration

techniques.