CHAPTER FIVE — OPTIONS

In this chapter the Committee reports on its review on the options considered for introducing accrual accounting in budgeting and appropriations. It also reviews some of the issues that affect Parliament directly.

A) The Price Waterhouse Cooper Study

During its hearings, the Committee was provided with a study, commissioned by the Treasury Board Secretariat, on the issues surrounding the introduction of accrual accounting in government. The study, prepared by Price Waterhouse Cooper and entitled “Increased Use of Accrual Accounting in the Budget and Expenditure Cycle” (PWC Study) was submitted to the Secretariat on 31 March 2006. The Committee was able to discuss the findings of the PWC Study with both the Comptroller General and the Auditor General.

The objective of the Treasury Board Secretariat was, to obtain a study of the concepts of accrual accounting to determine whether, and if so, how, they should apply to the development and execution of the Budget and Expenditure Cycle (BEC) of the Government of Canada. The Secretariat sought to understand if increasing the use of accrual accounting in the BEC would improve for parliamentarians, central agencies, departmental management and the Canadian public, the transparency, accountability and financial management of federal resources.

The mandate given to PWC’s Study was essentially to identify options for introducing accrual accounting in government and to consider the consequences of these options. The report proceeded to identify preferred options that might be of interest to the government and considered the issues that need to be addressed if accrual accounting were introduced into the government over a five-year period.

As part of its work, Price Waterhouse Cooper examined the budgeting and appropriations processes in other jurisdictions. It provided the results of the research into the implementation of accrual accounting in other countries and in the provinces of Alberta, Ontario and British Columbia. The PWC Study also provided a summary and review of the materials obtained from Canadian and international accounting and other organizations.

As a result of this work, the PWC Study was able to outline some key considerations relating specifically to Canadian issues surrounding the introduction of accrual accounting in the federal budgeting and appropriations process. It assessed the readiness and capability of the federal government to implement more accrual accounting in the budget and expenditure cycle and was able to develop some alternative approaches on increasing the use of accrual accounting.

The PWC Study developed six accrual accounting options for consideration, one of which was the Status Quo. Based on consultations with TBS, Senior Financial Officers in government departments and senior management from central agencies it reduced the options to three for testing the readiness of the government to implement change and for use in developing an implementation plan. In the end this number was reduced to one option, which the Study described as the preferred option.

On the basis of its work, the PWC Study assumed that it will take five years for the government to introduce accrual accounting into the public service. Therefore, the PWC Study developed an outline for a five-year implementation program of phased introduction of accrual accounting. The Study also provided a cost estimate based on the consideration of the readiness of the Government of Canada as well as the Canadian issues it has identified. These issues are discussed in greater detail in the next chapter.

B) The Preferred Option for Accrual Accounting

The preferred option, involves the introduction of the 3-way financial statements into the Budget cycle (i.e. a statement of Forecasted Financial Position, a statement of Forecasted Operations and a forecasted statement of Cash Flow). This would entail introducing a statement of Financial Position into the Budget and dividing the current expenses report into a statement of Operations and a statement of Cash Flow. Pro forma financial statements for the whole of government would also be included in Part 1 of the Estimates and departmental pro forma statements included in the Reports on Plans and Priorities. Under the preferred option, the government would also move to an accrual appropriation, although only cash items would be funded (e.g. depreciation would not be funded). Appropriations would have to be so structured as to make the distinction between an item that relates to a future disbursement (“funded”) or an expense related to a past expenditure. The introduction of non-cash items such as depreciation to the appropriations process would improve information available for decision making and acknowledge the importance of these items in managing the affairs of the government.

Under the preferred option, there would be an increased use of accrual accounting and a new focus on the statement of financial position. It represents a moderate change in the financial management of the federal government and moves to address the concerns articulated by the Standing Committee on Public Accounts and the Office of the Auditor General.

C) Parliamentary Control

The Committee discussed the essential features of the preferred option identified by the PWC Study with officials of the Office of the Auditor General, the Office of the Comptroller General and the Treasury Board Secretariat to ascertain the suitability of this approach for Canada and reviewed the potential impact that it might have on Parliament and the public service. It soon became clear that the adoption of accrual accounting could have a significant implication on the Parliament’s control over government spending plans.

Parliament votes on the overall fiscal plan as embodied in the Budget and Appropriations. Parliamentary control of supply is a critical element that drives the design of the Canadian model for departmental budgeting and appropriations. In considering a change in the accounting base, the federal government needs to ascertain what changes might be necessary in the way that Parliament votes appropriations. Mr. Moloney of the Treasury Board Secretariat outlined for the Committee some of the key questions that Member’s of Parliament need to answer:

• What control does Parliament want to exercise over specific expenditures, or revenues, within the fiscal plan set by the Budget?
• What information is needed to support the controls? Where and when is the information needed?

He reminded the Committee that the answers to these questions would influence not only the form and coverage of appropriations but also the information in the Estimates documents against which departments will be held to account. This in turn has an effect on the way that departments conduct their financial management activities. To understand some of the implications on Parliamentary control of introducing accrual accounting, Mr. Moloney presented the Committee with a simple tangible capital asset example which is reproduced below.

We assume that equipment is to be constructed over a 2-year period. Construction costs involve expenditures of $25 million in the first year and $75 million in the second. The equipment is put in use in year 3 and will last 10 years. The information is presented in the table below. This investment decision immediately affects the Balance Sheet but does not affect the Statement of Operations (annual surplus/deficit) until years 3 through 12.

There are four appropriation models offered by the Treasury Board Secretariat for consideration in dealing with this information in the Estimates. Each option is considered in turn.

TABLE 4

Simple Tangible Asset Acquisition Example
Year	Acquisition costs Millions of dollars	Accrual Millions of dollars
		Asset	Expense
1	25	25
2	75	75
3		(10)	10
…		(10)	10
12		(10)	10
Total	100	0	100

Source: Treasury Board Secretariat, Accrual Accounting for Budgeting and Appropriations, Presentation to the Standing Committee on Government Operations and Estimates, 7 November 2006.

Option 1, is the current practice whereby Parliament votes appropriations for acquisition costs only (a vote of $25 million in year one and a vote of $75 million in year 2). There are no votes on the annual amortization expenses of $10 million for years 3 through 12. In this model, Parliament continues to vote only on the traditional cash outlays but not on the accrued expenses of amortization. Under this model, Parliament has a Vote that provides approval for a level of expenditures to acquire or improve tangible capital assets. The Estimates provide information on capital expenditures for the appropriate year, and there is accountability for expenditure decisions made by managers.

There are certain issues identified with using Option 1:

• There is difficulty in obtaining capital funding, which can contribute to the deterioration of assets;
• There is distortion in the departmental lease-buy decisions;
• Multi-year projects can create commitments on the part of government beyond the annual appropriation cycle;
• The information provided is skewed in favour of the ongoing cost of service delivery; and
• It fosters a short-term focus on the part of managers.(See Chapter 3, for more discussion on this issue.)

Under Option 2, Parliament might choose not to vote on the cash acquisition costs but instead choose to have ten annual votes of $10 million under the amortization expenses in years 3 through 12. In this approach there is a vote that provides “approval” for the consumption of tangible capital assets in service delivery. The option’s benefits are that it:

• Removes short-term cash constraint from departmental lease-buy decisions;
• May make capital asset replacement easier;
• Provides better information on cost of ongoing service delivery — it matches costs with consumption of resources; and
• Should promote longer-term view of resource management.

There remain issues surrounding Option 2:

• There is no parliamentary control over asset purchases or construction;
• It could weaken government-wide cash management;
• While it seems to provide control of amortization, generally, amortization is governed by accounting standards which might limit managerial or parliamentary discretion on amortization;
• It does not spell out the consequences of Parliament not approving amortization expenses in any given year;
• It does not deal with the consequences for exceeding a vote due to unexpected non-cash expenses; and
• There is weaken accountability because the current government and managers are being held accountable for past decisions and future governments and managers will be accountable for effects of current decisions.

In Option 3, Parliament could choose to vote on both the acquisition costs and on the amortization expenses. This means that there is a vote on acquisition costs in the Estimates for year 1 of $25 million, a vote on the acquisition costs in the Estimates for year 2 of $75 million, and one vote on amortization expenses in each of the Estimates for years 3 through 12 of $10 million. Altogether, Parliament would vote twelve times in the Estimates on this project. The double-voting approach of Option 3 provides approval for the level of expenditures on tangible capital assets and “approval” for the consumption of tangible capital assets in the form of amortization expenses. The potential benefits are that it:

• Assists in levelling playing field for departmental lease-buy decisions;
• Provides information on both cost of program (expense) and major capital acquisitions (expenditures) so there is no decrease in current level of information for cash management;
• Helps to explain why there could be cash requirements in a period of annual accrual-based surpluses; and
• Gives consideration to both short-term and longer-term impacts of decisions.

The possible issues that might arise if Parliament were to adopt Option 3 are that it:

• May be confusing to vote on and to manage both the acquisition costs and amortization expenses;
• While it seems to provide control of amortization, generally, amortization is governed by accounting standards which might limit managerial or parliamentary discretion on amortization;
• It does not spell out the consequences of Parliament not approving amortization expenses in any given year;
• It does not deal with the consequences for exceeding a vote due to unexpected non-cash expenses; and
• Only partially resolves the issues of weakened accountability and government-wide cash management.

Option 4 proposes a Parliamentary vote on the acquisition costs and a statutory appropriation on the amortization expenses. In this model Parliament would consider a vote on acquisition costs in the Estimates for year 1 of $25 million, a vote on the acquisition costs in the Estimates for year 2 of $75 million, and one statutory appropriation on amortization expenses in each of the Estimates for years 3 through 12 of $10 million. Under this option, the Estimates provide approval for both the level of expenditures on tangible capital assets and information on the consumption of tangible capital assets (amortization). However, the statutory appropriation would require changes to the Financial Administration Act to permit their use in this situation. The potential benefits of Option 4 are that it:

• Assists in levelling the playing field for lease-buy decisions;
• Provides information on both the cost of a program (expense) and on major capital acquisitions (disbursements) so there is no decrease in cash management;
• Helps to explain why there could be a cash requirement in a period of annual accrual-based surpluses;
• Gives consideration to short-term and longer-term impacts of decisions; and
• Avoids issues associated with the control of amortization.

The potential issues associated with Option 4 are:

• Possible confusion over two separate amounts for one project in the Estimates; and
• Parliamentary and managerial emphasis may remain focussed on acquisition costs.

In reviewing the characteristics of the four options the Committee became aware that adopting an accrual accounting base for the government budget and expenditure cycle introduces new items in the government Estimates that might require Parliament’s attention. Although many of the possible changes arising out of the introduction of accrual accounting in budgeting and appropriations might be handled in a straightforward manner, the addition of information on capital assets and liabilities requires that Parliament provide some direction. Mr. Moloney reminded the Committee of the different approaches used in the last two reforms of the Estimates.

a)     The reform of the structure and contents of the Estimates in the early 1980s followed a recommendation by the House of Commons Standing Committee on Public Accounts that the Office of the Auditor General and the Treasury Board Secretariat surveyed individual members of Parliament for their input (25 members were selected from list of 51 interested MPs. The names were provided by caucus chairs).

b)     In the mid 1990s, the House of Commons Standing Committee on Procedure and House Affairs observed in its 110th Report, 1995: “…the primary focus of any revisions to the Estimates and other related material must be on the needs of Parliament.” In that reform, the Treasury Board Secretariat worked with a Parliamentary Working Group on a detailed model of revised Estimates. The result was that a motion was introduced in the House of Commons to split the Part III of the Estimates into a Spring Report on Plans and Priorities and a Fall Departmental Performance Report.

After considering the benefits and issues surrounding each of the four options put forth by the Treasury Board Secretariat, the Committee feels that the preferred route in the introduction of accrual accounting in the budget and appropriations is for Parliament to adopt Option 4, which allows a vote for appropriations on capital acquisitions and a statutory appropriation for the related amortization expenses. The Committee therefore recommends:

RECOMMENDATION 7

That the Government of Canada provide in the Estimates for voted appropriations on the acquisition costs of capital assets and statutory appropriations on the related amortization expenses.

In its discussions with the Auditor General and the Treasury Board Secretariat, the Committee became aware that Parliament might be asked to consider the acquisition of a capital asset that requires cash outlays in more than one year. Currently, such a capital investment would require that Parliament vote each year’s cash requirement until the projected investment is complete. No further votes would be required. Under accrual accounting the entire investment is recognized when the decision is made to invest in the capital project. Parliament could approve the investment, recognizing that funds will be disbursed in later years as they are required to complete the investment. Alternatively, Parliament might want to continue to vote on each disbursement of funds. The issue of multi-year appropriation is considered further in the following section.

D) Multi-Year Appropriations¹⁵

A multi-year appropriation is an appropriation with a specific purpose and monetary limit granted by Parliament that can be utilized over more than one fiscal year. Generally, Parliament votes an appropriation for a specific purpose for a given fiscal year. However, such an approach has been known to create difficulties. Annual appropriations can often fall short of the sum required to meet the longer term needs of government policies. A focus on annual appropriations can lead to a variety of distortions such as over-consumption or under-investments. While the use of accrual accounting might identify such potential distortion in the management of government resources, their elimination may require the introduction of multi-year appropriations.

The advantage of using multi-year appropriations is that they provide a number of benefits that may enhance the value for money of public expenditure by:

• improving linkages between budget decisions in the current year and expenditure requirements in subsequent years;
• reducing administrative costs associated with annual appropriations;
• providing greater flexibility in conducting government activities;
• reducing the likelihood of wasteful year-end spending practices;
• shortening debates over the same issues year after year and allowing more time to be spent on oversight; and
• encouraging a longer-term budgeting focus.

The perceived disadvantages of multi-year appropriations are that:

• the process would be more lengthy and contentious the first year because the fiscal stakes would be higher;
• Parliament is supposed to approve spending plans annually. The use of multi-year spending appropriations does not allow a Parliament to review government planned expenditures annually. This is not to be confused with statutory expenditures, over which Parliament has no annual control, but at least the expenditure plan is reported and voted upon annually.
• without annual appropriation, Parliament begins to lose a degree of oversight on government spending. Any problems that Parliamentarians might capture under the current system could go unnoticed for a longer period.

In order to ensure that multi-year appropriations are well managed and evaluated, responsible departments should have sound financial management systems and practices. In addition, a multi-year plan of expenditure should include key milestones, termination points and progress report requirements.

Currently, New Zealand and the United Kingdom both employ some form of multi-year appropriations.¹⁶ In New Zealand, multi-year appropriations are permitted for a maximum period of five years. They are used in situations that are well-defined and self-contained, where the costs fall across two or more financial years. Usually, the use of multi-year appropriation is desired because there is considerable uncertainty about the distribution of costs across financial years.

In the United Kingdom, multi-years appropriations apply only to select spending items. They exclude expenditures which cannot reasonably be subject to firm, multi-year limits, such as: social security benefits, agricultural policy payments, transfers to local authorities, debt interest, payments to EU institutions, etc. Multi-year appropriations can extend for up to three years and limits to departmental expenditures are established. This gives greater financial stability to departments and helps them control their own costs over the medium term.

In Canada, the Estimates provide for bi-annual appropriations for the Canada Border Security Agency, the Canada Revenue Agency and Parks Canada. The Committee believes that there are other instances where the acquisition of capital assets might be conducted in a more efficient and effective manner if departments were able to avail themselves of multi-year appropriations. The Committee therefore recommends:

RECOMMENDATION 8

That the Government of Canada introduce multi-year appropriations, of up to 5 years, into its budgeting and expenditure cycle.

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For a broad discussion of multi-year appropriation consult: Anderson, Barrett B., Statement on Biennial Budgeting, Subcommittee on Legislation and Budget Process Committee on Rules, U.S. House of Representatives, 27 July 2005. OECD, "Models of Public Budgeting and Accounting Reform", OECD Journal of Budgeting, Volume 2, Supplement 1, 2002. The Treasury, A Guide to the Public Finance Act, Government of New Zealand, August 2005. The Treasury, Multi-Year Appropriations, Treasury Circular 2000/17, Government of New Zealand, 21 December 2000.

16	In Canada, the provinces of Québec, Nova Scotia and Saskatchewan are known to make some use of multi-year appropriations.