3. Tracking progress and controlling funds
3.1 Distribution of budget authority
Once the budget is authorised and published, budgetary authority has to be distributed to all the units funded by the budget. Without this, these units cannot spend money. There are two basic models for the distribution of budget authority: directly by MOF or indirectly by the major spending agencies. Direct distribution of budget authority has the advantage of speed, but it means that the major spending agencies have only minor budget functions (for instance for their own budgets). In such systems spending agencies are unable to fulfil the management role for which they have nominal responsiblity. The major power relationship is between the MOF and the spending agencies which may number several hundred, including for instance hospitals (e.g. Mongolia).
The indirect method distributes budget authority in a series of waves: first from MOF to the major spending agencies; then from these to their major administrative units; and finally from these units to the smaller units at the bottom of the hierarchy. For instance authority might be passed from MOF to the ministry of education; from that ministry to the directorate of primary education and from the directorate to all the units under the directorate. This hierarchical distribution of budget authority is most commonly found. It provides the major spending agencies with powers over their subordinate offices, enabling the spending agency to assume management responsibility for all its sub-entities. On the other hand it can be cumbersome and time-consuming. A common complaint from the small units at the bottom of the hierarchy is: we always receive our budget authority several weeks after the start of the budget year.
3.2 Release of funds
In most countries budgetary authority is not a sufficient basis for incurring expenditure (India is a notable exception to the rule). MOF must also issue a warrant which gives permission for expenditure to be incurred. So there is a double lock on expenditure: the authorised budget and MOF's authority to incur expenditure. The rationale for the double lock is that MOF needs to match total cash inflows with outflows and therefore must have a means of switching expenditure on or off, depending on the cash flow situation.
A warrant to incur expenditure can be expressed by period (month, quarter) and can refer to specific budget items (capital expenditure, non-wage expenditure). It can even be issued transaction by transaction or for a list of transactions agreed in advance. The following points are relevant to the design of a system of warrants to incur expenditure:
- the more unpredictable are cash inflows, the more MOF will need to control the timing of expenditure via the issue of warrants. The detail and periodicity of a system of warrants reflects the degree of uncertainty of cash flows and is used to achieve necessary remedial actions in terms of modified cash flows.
- the realism of the budget should also be examined. A realistic budget (one which is macroeconomically sound and where actual revenues and expenditures are close to the authorised budget) has less need for continuous within-year management of expenditures than one which is unrealistic in these respects.
- the precise incidence of warrants should be considered. If a strict system of warrants is applied to expenditure for which there is an existing entitlement or which is linked to everyday consumption (e.g. wages, heating, lighting), strong controls may result in expenditure arrears. It is easier to apply warrants to expenditure whose timing can be shifted (e.g. capital expenditure).
- the precise duration of warrants should be considered. The shorter the duration of the warrant the more it will constrain the spending agency. While this may be the basic macroeconomic objective, the spending agency may be prevented from carrying out its basic function (supply of services) and there will be a welfare loss.
- the more precise are warrants (duration, incidence, transaction), the more power lies with MOF and the less with spending agencies. MOF may abuse these powers or may apply them ineffectively (creating feast and famine on a scale not justified by the variability of cash flows).
- spending usually exhibits a seasonal pattern and some expenditures are bulky (e.g. capital expenditures). A good system of warrants reflects the spending patterns of spending agencies.
There are alternatives to the above system. For instance, the published budget may provide a note next to selected line items showing the proportion which is reserved. The unreserved portion can be spent by the spending agency without further MOF approval. The reserved portion is subject to the issue of warrant authority. This system is particularly suitable for large capital works where the precise amount and timing of expenditure is unpredictable, and where implementation reviews may be used to trigger new phases of spending. It can be applied to all line items where expenditure is discretionary.
The above discussion applies to systems in which the release is based on permission to spend, but where the actual money remains in bank accounts controlled by MOF. In some systems a physical release of funds occurs. Money held in centrally controlled bank accounts is transferred to bank accounts held by spending agencies. Money may be transferred annually, in regular monthly amounts or in relation to a profile of spending needs submitted by the spending agency. Normally cash releases are made against receipt of financial statements of the previous period, thus ensuring basic accounting discipline. The characteristics of this system are considered in more detail in the part of the course dealing with cash management (See paper four).
Another variation on control of cash flows involves commitment control, or controlling the authority to incur commitments, the rate of commitment, and thereby the rate of cash outflows. Under a commitment control system, authority to commit funds is issued, instead of or in addition to warrants. The Treasury or the budget office may issue these ‘apportionments’ of commitment authority, usually by quarter. Under this variant, spending units prepare financial plans that present planned commitments and cash requirements --- tied to original budget authority --- on a monthly or quarterly basis. The treasury then controls to these plans.
Financial plans are a critical element of good cash management, addressed in the session on treasury.
3.3 Disbursement rules
These are established by law, in financial regulations and in the working procedures of MOF and spending agencies. They ensure that those who take or share in expenditure decisions do so within a system of appropriate controls. Those authorised to give prior approval of proposed expenditures are identified and their powers defined. Ex ante (sometimes called pre-expenditure) is designed to prevent various types of abuse such as fraud or over-commitment.
In some countries (for instance in those whose public finance systems have been influenced in the past by France[1]) ex ante control is exercised by MOF. MOF carries out pre-expenditure checks, and if satisfied, issues a visa permitting a proposed expenditure to be passed to an accountant for payment. The accountant is also employed by MOF. In other countries (for instance in those whose public finance systems have been influenced in the past by Britain) ex ante control is carried out by the spending agency itself. In the first system ex ante control is centralised; in the second it is distributed.
Irrespective of the location of ex ante control, it asks similar questions. It seeks to establish whether:
a)the expense is within the authority of the proposer;
b)the expense conforms to a category of the budget in which there are available resources;
c)the documents associated with the proposed expenditure are complete;
d)the proposal is free from material error;
e)the expense complies with the provisions of relevant laws, regulations and decisions; and
f)the identity of the beneficiary (the person to whom payment will be made) is clearly stated.[2]
3.4 Budgetary control
Annual totals
The most basic form of budgetary control compares budget authorisations for the year with what was spent during the year. Using cash expenditure as the definition of spending, the comparison can be made using either the original annual budget authorizations or these authorizations as amended by supplementary budgets and budget transfers.
The first comparison gives an idea of the realism of the original budget. The second gives a more complete definition of what has been authorised and therefore provides a better legal basis for deciding whether over or under-spending has occurred.[3] It may be of less importance in an economic sense, depending on the factors which have given rise to amendments and transfers. If such changes are relatively small and not designed as a cloak for distorting the budget, the second comparison may be the more useful. In some countries, large supplementary budgets and transfers occur without adequate legislative scrutiny or subsequent tracking.
Comparisons may be made for total expenditures and revenues. Sometimes, expenditures are over-estimated (in particular capital expenditures) and revenues are under-estimated . Such systematic sources of bias should be investigated and if possible corrected. They indicate undue caution and unwillingness to learn from experience. A welcome by-product is that the actual budget deficit is less than was forecast.
Individual appropriations
Comparisons can also be made by appropriation category (See paper one). The sums appropriated in the budget should correspond quite closely to the budgets of the major spending agencies. Sometimes they do not. A budget which partly funds specific institutions (e.g. the ministry of justice) and partly funds functions (e.g. education) is difficult to understand and a poor vehicle for control. A budget which identifies clearly the appropriations of major spending agencies is the most likely to provide a vehicle for holding these agencies accountable (e.g. via parliamentary control).
Spending units
Budgetary control also operates at lower levels and over shorter time periods. A spending agency has a number of budgetary control objectives:
- avoid over-expenditure by continuous comparison of sums authorised with cumulative expenditures to date
- ensure that spending authority is sufficient to cover expected expenditures month by month by ensuring that future expenditures are well-anticipated
- avoid under-expenditure by watching budget heads and ensuring that sums are committed well in advance (i.e. that the ex ante control process is geared to the use of the available funds)
- provide budgetary authority to sub-units and ensure that their monthly and cumulative expenditure is less than the amount of budgetary authority given
Government budgeting and accounting systems are mostly cash-based.[4] This means that expenditure is defined as equivalent to the cash actually spent during the period. In some cases this may include instructions to make payment which have not yet been acted upon (in terms of actual cash payment) at the year-end. In other systems cash paid in the first month of the new fiscal year which relates to expenditure of the previous year, is treated as cash expenditure of the period to which it relates.
Stages of Financial Commitment or Transactions
Individual financial transactions proceed through a standard set of stages before a financial liability is paid. It is important to understand these stages both for understanding the budget numbers supplied by government and understanding how to better manage the budget and cash flow. Not all stages are present in any given system, and certainly not all stages are monitored by governments.
Pre-commitment/encumbrance/reservation – before actually incurring a financial liability of government, a spending unit can ‘reserve’ some of its available funding or set it aside in its own financial information system. This is done to prevent the money from being committed more than once, and to assure the unit stays within budget. For example, when the fiscal year starts, a spending unit may ‘reserve’ its expected salary costs, to assure these are available when needed. This is frequently not found in developing countries.
Commitment – contracting for an expense, or committing the government to an expenditure (e.g. hiring a new employee, signing a supply contract). In some cases, government may be able to avoid the actual expenditure or cancel the commitment without incurring expenses. In other cases, contract clauses may specify penalties for cancellation. In some systems, these commitment must be verified by a central authority to assure they are for legal purposes, within budget, etc.
Receipt of good or service – an exchange of value has occurred, such as the government receiving supplies, or an employee or contractor having provided services. Generally, this is a legally binding phase --- the government formally owes a financial payment, generally enforceable in court. (Exceptions are of course possible where the goods where not in order, etc.)
Invoice – The government receives a bill for payment. This may be simultaneous with receipt of goods or services, but not always.
Verification/payment order – the spending unit must verify that it has received the goods or services, they were in good order, the proper amount, of sufficient quality, etc. If the invoice is verified, a payment order is issued requesting the treasury to pay the invoice. This stage also invoices checking by the spending unit or treasury that the agency has the funds in its budget and the expense was legitimate. In some countries, this is improperly used to mange cash flow, such that invoices are held in suspense until sufficient cash is available to make the payment, allowing scope for corruption. This is also done to avoid having to report arrears --- overdue payments --- as technically, since the invoice is not verified as ready to pay, no payment order is issued, and not financial obligation exists.
Payment – simply, the treasury has issued a check or made a payment transfer.
Clearance – the check is cashed or cash disbursed. This is the stage at which funds actually leave the government treasury account and are transferred to the recipient as payment. When this is done, the financial obligation of government for this transaction has been ‘liquidated.’
Rudimentary financial management systems routinely track the payment stage. This is rather late in the stages of budget execution, and generally does not allow adequate management of cash flow and prevention of arrears.
All countries should attempt to meet financial obligations as they fall due, otherwise they become a form of non-transparent financing. In a cash rationed system, the monitoring of arrears and management of commitments tend to require constant vigilance. Management information should be available at the Ministry of Finance concerning the stock of arrears, the monthly movements in arrears and the level of commitments.
If cash rationing is a feature of the control system, the decisions made about which activities should receive cash and which should not become a very important part of the resource allocation system. Assessors should reflect on whether there is a means to protect higher priority spending, such as poverty-reducing expenditures. Certain types of spending, such as health services, can experience severe deteriorations in service delivery from late or no payment of invoices.
Arrears are expenditures that have been incurred by government, but not paid within 30 days[5] of receipt of the good or service or invoice (whichever is later). They represent government liabilities that have not been honored at the appropriate time.
Arrears are not the same as outstanding commitments, obligations or encumbrances. Encumbrances represent a reservation of spending authority by operating units, prior to actually incurring any expense, and as such provide a tool for program managers to avoid over-spending. Commitments or obligations generally represent the contracting for an expense (e.g. signing a contract to purchase), but the goods or services may or may not have been received. An actual government financial liability is incurred after the goods or services have been received --- economic value has been transferred to the government. It is from this point that one begins to measure liabilities. Where invoices are delivered to government at the same time of receipt of the good or service, the calculation of arrears as liabilities older than 30 days is straightforward. In some cases, vendors may invoice after providing the good or service, and this date should be the starting point for calculating arrears.
Governments (typically the Treasury) should regularly produce tables showing the aging of payables. Typically these will show government payments 30, 60, 90, and greater than 90 days overdue. This can be the basis for assessing the amount of arrears, as long as there is reasonable confidence that the information is relatively complete. Some caution is required in the definitions used to produce the table. In countries using ex ante visa controls, it is not uncommon for governments not to recognize an arrear or liability until after the invoice has been independently verified by the controller. This added visa requirement can be used to under-report arrears --- if cash flow is short, the controller may simply stop verifying invoices. Accordingly, tables based on length of time expiring from receipt of invoice are generally preferable.