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Mid Year Economic Review 2014-15 carried out by the Government had listed the following fiscal challenges, besides two others:

o Budget was unduly over burdened by a legacy of carried over expenditure

o Revenue projections were over optimistic

There is no doubt such carried over expenditure from one fiscal year to another and incorrect estimation of revenue clouds the true financial status for the fiscal and significantly affects fiscal management of the country. Such aberrations provide an incorrect picture of the cost of government activities from year to year, distort budgeting from one budget cycle to another and therefore can lead to incorrect fiscal management decisions. No doubt, this has far reaching consequences for financial health of the country and must not be allowed to pass on as a legacy any further. 

The genesis of the problem lies in the fact that Government accounts for its expenditure & revenue on “cash basis” and carries out its budgeting accordingly. The Government neither prepares a Balance Sheet of its Assets & Liabilities.

In the “cash basis” of accounting, expenditure & income get recorded at the time when the cash outflow or inflow takes place. It can be within the same current year or the next year or even the future years. In other words, expenditure is only recognized when it is paid for and revenue is only recognized when money is actually received rather than the year in which the expenditure or revenue actually “became due” or was actually “incurred” but not paid for. Clearly the trigger for recognition under this method is outflow or inflow of money. This method of accounting suffers from severe limitations. For example, advance tax received in the current fiscal, which actually pertains to the next year, will get accounted as current year’s revenue whereas it clearly is a revenue receipt for the next year. While the revenue of current fiscal will be inflated, the revenue for next year would be understated. Similarly, “off budget” subsidies approved for current fiscal but not actually paid will be treated in the same way. We know that such subsides for food, oil, fertiliser etc can be very large.

The remedy lies in a shift to "accrual basis" of accounting of government expenditure & income as well as budgeting. Accrual methodology ensures that expenditure & revenue get recorded as & when the underlying economic event takes place. It’s immaterial whether the expenditure has been paid for or not or whether the money has been received or not. The emphasis is on expenditure & income becoming due. Thus, the financial results of economic activities get recorded & accounted for fully in the year in in which they take place and they are not allowed to “overflow” or get “carried over” to the next fiscal. There can be no concept of “off budget” items or their impact on the fiscal management. The government, by following this method, will be able to form a much better & truer assessment of the financial state of affairs and undertake fiscal management measures accordingly. The method would also provide a better assessment of the efficiency in government expenditure and appropriate measures can be taken to effect savings in such expenditure. Government would also be in a better position to take right fiscal decisions by knowing its financial commitments correctly and utilize public resources in a much better manner.

Another important aspect is treating investment expenditure to generate revenue differently than the usual revenue expenditure. Such investment expenditure is of “capital” nature, benefit from which will accrue in future economic periods. A Balance Sheet of Government’s assets & liabilities will then be possible reflecting the true state of affairs of country’s financial affairs. Simply put, Government must examine resorting to “capital budgeting” also. The Government would thus be presenting two separate budgets outlining the income-expenditure aspect and assets-liabilities aspect separately.

It may sound a bit complicated & difficult to implement considering the easy approach of cash basis of accounting and the cover of lack of accountability associated with it. But Budget 2015 is the right time to make a beginning for the new Government.

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