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Financial Administration, Thesis of Microeconomics

University of Zambia Microeconomics

Financial administration means the management of finances of a state or of a public authority endowed with taxing and spending powers

Typology: Thesis

2016/2017

Uploaded on 04/26/2017

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Financial Administration

•Collection of suﬃcient resources from the economy in an appropriate manner

along with allocating and use of these resources eﬃciently and eﬀectively

constitute good ﬁnancial management. Resource generation, resource

allocation and expenditure management (resource utilization) are the essential

components of a public ﬁnancial management system.

•Eﬃcient and eﬀective expenditure management calls for expenditure planning,

allocation of resources according to policy priorities and good ﬁnancial

operational management and control. Good ﬁnancial operational management

focuses on minimizing cost per unit of output, achieving outcome for which

these outputs are intended and enhancing the value for money spent.

•The ﬁnancial management system is quite wide and encompasses resource

mobilization, prioritization of governmental eﬀorts, resource allocation,

formulation of detailed plans, setting up information systems that assist

decision making, having meticulous accounting systems and creation of robust

internal and external accountability mechanisms.

•The commission has focused primarily on expenditure management.

•Public ﬁnance management includes resource mobilization, prioritization of

programmes, the budgetary process, eﬃcient management of resources and

exercising controls.

•It was earlier conﬁned to budgeting, accounting, monitoring and evaluation.

But, it is now widely accepted that it includes taxation and other resource

mobilization, debt and cash management, budgetary process, accounting

systems, information systems and internal and external audit. Reforms therefore

include:

•Improving the collection of revenue is critical.

•Sound principles for deﬁcit funding should be established, eﬃciencies

sought and proper risk management procedures introduced.

•Eﬀective planning and allocation of resources is key

•Eﬀective oversight and monitoring are crucial to sound governance

and PFM reform.

1

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Financial Administration

Collection of sufficient resources from the economy in an appropriate manner along with allocating and use of these resources efficiently and effectively constitute good financial management. Resource generation, resource allocation and expenditure management (resource utilization) are the essential components of a public financial management system.
Efficient and effective expenditure management calls for expenditure planning, allocation of resources according to policy priorities and good financial operational management and control. Good financial operational management focuses on minimizing cost per unit of output, achieving outcome for which these outputs are intended and enhancing the value for money spent.
The financial management system is quite wide and encompasses resource mobilization, prioritization of governmental efforts, resource allocation, formulation of detailed plans, setting up information systems that assist decision making, having meticulous accounting systems and creation of robust internal and external accountability mechanisms.
The commission has focused primarily on expenditure management.
Public finance management includes resource mobilization, prioritization of programmes, the budgetary process, efficient management of resources and exercising controls.
It was earlier confined to budgeting, accounting, monitoring and evaluation. But, it is now widely accepted that it includes taxation and other resource mobilization, debt and cash management, budgetary process, accounting systems, information systems and internal and external audit. Reforms therefore include: - Improving the collection of revenue is critical. - Sound principles for deficit funding should be established, efficiencies sought and proper risk management procedures introduced. - Effective planning and allocation of resources is key - Effective oversight and monitoring are crucial to sound governance and PFM reform.

Evolution of Budgeting

Budgeting is the process of estimating the availability of resources and then allocating them to various activities of an organization according to a pre- determined priority.
The line item Budget
- the budget in which the individual financial statement items are grouped by cost centers or departments. It shows the comparison between the financial data for the past accounting or budgeting periods and estimated figures for the current or a future period
- The focus is on ensuring that the agencies or units do not exceed the ceilings prescribed
- It also facilitates centralized control and fixing of authority and responsibility of the spending units. Its major disadvantage is that it does not provide enough information to the top levels about the activities and achievements of individual units.
Performance Budgeting
- Performance budget reflects the goal/objectives of the organization and spells out performance targets. These targets are sought to be achieved through a strategy(s). Unit costs are associated with the strategy and allocations are accordingly made for achievement of the objectives.
- performance budgeting has a limitation - it is not easy to arrive at standard unit costs especially in social programmes which require a multi- pronged approach.
Zero-based Budgeting (ZBB)
- every budgeting cycle starts from scratch.
- The basic purpose of ZBB is phasing out of programmes/activities which do not have relevance anymore.
- because of the efforts involved in preparing a zero-based budget and institutional resistance related to personnel issues, no government ever implemented a full zero-based budget, but in modified forms the basic principles of ZBB are often used.

The common elements of the budgetary reforms in OECD member countries are: - Medium-term budget frameworks - form the basis for achieving fiscal consolidation. Budgets are however enacted for a time period of one year, and are notorious for their short-term focus. This short-term time horizon is often criticised for impeding effective expenditure management; decisions on resource allocation are said to be made on an ad hoc or piecemeal basis. - Prudent economic assumptions - There is no single factor more responsible for “de-railing” fiscal consolidation programmes than the use of incorrect economic assumptions. - top-down budgeting techniques – ■ Budgeting has traditionally operated on a bottom-up principle. This means that all agencies and all ministries send requests for funding to the finance ministry. These requests greatly exceed what they realistically believe they will get. This bottom-up system has several disadvantages to it. ■ First, it is very time consuming and it is essentially a game; all participants know that the initial requests are not realistic. ■ Second, this process has an inherent bias for increasing expenditures; all new programmes, or expansion of existing programs, are financed by new requests; there was no system for reallocation within spending ministries and there were no pre-set spending limits. ■ Third, it was difficult to reflect political priorities in this system as it was a bottom-up exercise with the budget “emerging” at the end of this process. ■ The starting point for the new system is for the government to make a binding political decision as to the total level of expenditures and to divide them among individual spending ministries. This decision is made possible by the medium-term expenditure frameworks which contain baseline expenditure information,

■ The Finance Ministry concerns itself only with the level of aggregate expenditure for each ministry; not the internal allocations. ■ Each ministry has a total amount and it can freely reallocate that money among its various agencies and programmes. This has several advantages to it. It serves to hamper creeping increases in expenditures as new policies are funded by reallocations from other areas within the ministry. It creates ownership in the respective ministries for the actions that are taken. Decisions are also better informed as spending ministries are in the best position to judge the relative merits of their programmes

Relaxing central input controls - This is based on the simple premise that the heads of individual agencies are in the best position to choose the most efficient mix of inputs to carry out the agency’s activities. Relaxing central input controls operates at three levels. First, the consolidation of various budget lines into a single appropriation for all operating costs (salaries, travel, supplies, etc.). Second, the decentralisation of the personnel management function. Third, the decentralisation of other common service provisions, notably accommodations (buildings). The can be seen as the public sector’s version of “deregulation.” focus on results;
An increased focus on results –

■ public sector has traditionally been based on compliance with rules and procedures. It didn’t matter what you did as long as you observed the rules. Now, when the public sector is deregulated, a new results-based system is needed to hold managers accountable. This is a fundamental change: holding managers accountable for what they do, not how they do it. ■ some government activities simply lend themselves to results measurement much more readily than others. a few homogenous products or services. On the other hand, agencies that produce heterogeneous and individualised services can be very difficult to measure. ■ choice of defining results either in terms of outputs or outcomes. Outputs are the goods and services that government

priced areas to lower-priced areas and use the amount of the capital charge they save for other purposes. ■ Carry-overs - Only in cases where an agency continuously, year-on- year, builds up carry-overs does the Ministry of Finance intervene. The advent of medium-term expenditure frameworks also gives a benchmark for agencies to see that their appropriations are in fact being carried-over. ■ Interest-bearing accounts - the appropriation of an agency is divided into twelfths (representing each month) and deposited into an agency’s account (either within the finance ministry or with a commercial bank.) If an agency spends at less than this rate, they will receive interest on the difference. If they spend at a faster rate, they will pay interest on the difference.

Although they are identified as seven separate features, they do in fact build on each other and must be seen as a package.

The Budgetary Process

Based on the constitutional provisions and provisions contained in the General Financial Rules (GFR), General Accounting Rules (GAR), Budget Manual (in the States) etc, a statement of its estimated annual receipts and expenditure is prepared by each Government and presented to its legislature. This “Annual Financial Statement” is commonly known as the Budget. In this statement, the sums required to meet the expenditure charged15 upon the consolidated Fund of India or the consolidated Fund of the State or the consolidated Fund of the union Territory and the sums required to meet other expenditure proposed to be met from the Fund are shown separately.
The part of the estimates pertaining to expenditure charged upon the consolidated Fund is not submitted to the vote of the legislature (although it is open to discussion in the legislature). The part of the estimate which is concerned with other expenditures is submitted to the legislature concerned in the form of Demands for Grants on the recommendation of the President or the Governor of the State or the Administrator of the union Territory with legislature, as the case may be.

The Finance Bill containing the annual taxation proposals is considered and passed by the legislature only after the Demands for Grants have been voted and the total expenditure is known. Then it enters the statute as the Finance Act.
Vote on Account – for making any grant in advance in respect of the estimated expenditure for a part of any financial year pending the completion of the parliamentary procedure;
Vote of Credit – for making a grant for meeting an unexpected demand upon the resources of India when on account of the magnitude or the indefinite character of the service the demand cannot be stated with the details ordinarily given in an annual financial statement; and
Exceptional Grant – for making provision for an exceptional grant that does not form part of the current service of any financial year.
As per the requirements of the Fiscal Responsibility and Budget Management Act, 2003 three Statements are to be presented to the Parliament, which form a part of the budget documents: - the Macro-economic Framework Statement - contains an assessment of the growth prospects of the economy. - the Medium term Fiscal Policy Statement- indicates the three-year rolling targets for four specific fiscal indicators in relation to GDP at market prices, namely, (i)Revenue Deficit, (ii) Fiscal Deficit, (iii)Tax to GDP Ratio, and (iv) Total Out-Standing Debt at the end of the year (Effective revenue Deficit added this year) - The Fiscal Policy Strategy Statement - seeks to outline the strategic priorities of the Government in the fiscal area for the ensuing year.
Appropriation Bill
- The Grants made by the legislature and
- The expenditure charged on the consolidated Fund, but not exceeding in any case the amount shown in the statement previously laid before the legislature.

legislative Assembly may also request the cAG to undertake the audit of accounts of any authority / body which has not been entrusted to him under law.
The Reports submitted by the cAG and laid before each House of Parliament is examined by the committee on Public Accounts (Pac)

Internal Audit

internal audit is conducted through the Internal Audit Wings in the Principal Accounts Offices of various Ministries/Departments.
The appraisal, monitoring and evaluation of individual schemes;
Assessment of adequacy and effectiveness of internal controls in general,
Identification and monitoring of risk factors (including those contained in the Outcome Budget); critical assessment of economy, efficiency and effectiveness of service delivery mechanism to ensure value for money; and
Providing an effective monitoring system to facilitate mid-course corrections.

Integrated Financial Adviser (IFA)

A scheme of Integrated Financial Advisers was put in place in 1975.
In general, the IFAs were made responsible for:
- Preparation of the budget of the Department/Ministry,
- Arranging payments directly to the bodies, corporations and authorities of grant-in-aid, loans, etc., as may be sanctioned by the Department;
- Arranging payments through Pay and Accounts Offices
- compilation and consolidation of the accounts of the Department/ Ministry
- Introduction of a system of management accounting suited to the functions and requirements of the Department/Ministry;
- Installation of a sound system of internal inspection within the department

Flow of Funds Related to Union Government Programmes

Transfer of funds from the union to the States due to the inadequacy of sources of generation of revenue takes place through various means. The first and foremost is by way of devolution as per the recommendations made by the

Finance commission (in terms of Articles 280 and 281 of the constitution). The second channel is through the Planning commission. In this case, the States receive Plan funds from the Planning commission in the form of ‘central Assistance’ under the ‘Scheme of Financing of States’ Annual Plan. They also receive Plan Funds through various union Government Ministries/Departments in respect of certain schemes implemented by State Governments. These schemes are known as ‘centrally Sponsored Schemes’ (cSS).

due to lack of a proper information system, the tracking of fund flow and correlation between the amount released and expenditure made could not be determined without a degree of uncertainty. Further, when funds are transferred directly to the implementing agencies in the States, it has to be done in advance which results in a substantial accumulation of funds in the pipe line.

ANALYSIS OF THE BUDGETARY PROCESS

In the conventional line-item budgeting, the major focus is on ensuring that agencies do not exceed the specified allocation.27 Financial compliance is sought to be achieved in this system through a detailed budgetary specification of inputs and to achieve this, detailed procedures are designed for expenditure control.
When a Demand is taken up for discussion, any Member may seek reduction in the amount of the Demand by moving any of the following types of cut Motions: - Disapproval of Policy Cut (by moving “that the amount of the Demand be reduced to Re. 1”, thereby representing a disapproval of the policy underlying the demand); - Economy Cut (by moving “that the amount of the demand be reduced by a specified amount”, thereby representing the economy that can be effected); and - Token Cut (by moving “that the amount of the demand be reduced by Rs. 100”, in order to ventilate a specific grievance).
At the end of the period allotted for discussion on the Demands for Grants, the Speaker puts all the outstanding Demands for Grants to the vote of the House. This process is known as ‘Guillotine’ which acts as a device for bringing the debate on financial proposals to an end within a specified time

■ Reducing tendency of parking of funds. ■ Effectively monitoring the expenditure pattern. a Monthly Expenditure Plan (MEP) has to be worked out for each Demand for Grant. MEP for the month of March may not exceed 15 per cent of the budgeted provision [Budget Estimate]; and MEP for the months of January-March may be so fixed that the QEA for the last quarter may not exceed 33 per cent of the budgeted provision;

Inadequate adherence to the multi-year perspective and missing ‘line of sight’ between plan and budget. Multi-year budgeting addresses the basic problem faced in budgeting, - how to integrate planning and budgeting. The preparation of rolling multi-year expenditure planning leads to improvement in budget preparation by providing advance expenditure ceilings to the departments, increasing predictability of resource availability, and by improving efficiency of public spending. It is considered as the cornerstone of performance oriented budgeting, linking resources to policy objectives that defines performance. In India, the Five year Plans provide the basis for a medium-term multi-year perspective for resource allocation. On the basis of this, each year the Planning commission, in consultation with the Ministry of Finance, allocates annual limits for plan expenditures to each Ministry/Department. It has been noticed, however, that often, major projects and schemes are launched by government which are not provided for in the plan. This results in change in allocation for other projects and schemes thereby diluting plan objectives. Another weakness of the current budget exercise is the absence of a clear link between the plan and the budget.
No correlation between expenditure and actual implementation: funds lie in the pipeline with various project authorities and there is considerable lag before they are actually utilized. Thus the accounts do not reflect the correct position as regards the implementation of government schemes and programmes.
Mis-stating of financial position: The present system of release of funds to project authorities outside the government often leads to parking of funds which is often resorted to in order to prevent lapsing of funds. This

leads to idle funds being maintained outside government accounts and thus portrays an incorrect picture of government funds besides causing loss of interest to government.

Ad hoc project announcements: Indiscriminate announcement of projects/schemes not included in the plan/budget is regularly made, often without proper consideration and detailing.
Emphasis on compliance with procedures rather than on outcomes: At present, government departments often measure their performance in relation to the expenditure targets laid down in the budget without adequate regard to outputs and even less to outcomes. Furthermore, little emphasis is placed on efficient utilization of resources. Check PB, ZBB and OB.
Irrational plan / non-plan distinction leads to inefficiency in resource utilization: The distinction has led to ever increasing tendency to start new schemes/projects to the utter neglect of maintenance of existing capacity and service levels. The distinction also often leads to the misperception that non-plan expenditure is inherently wasteful and should be avoided. This dichotomy has resulted in fragmented view of resource allocation to various sectors. The plan versus non-plan distinction in expenditures needs to be abolished keeping in view its impact on budget development and public service delivery. The Departments should have the flexibility in formulating their budgets with prior indication of resource availability.
Performance Budget
a technique of presenting Government operations in terms of functions, programmes, activities and projects’.
emphasis should get shifted from the means of accomplishment to the accomplishments themselves.
the precise definition of the work to be done or services to be rendered and a correct estimate of what that work or service would cost.
three basic steps were required in the introduction of the system of performance budgeting:

The key words used here are ‘Outlays’, ‘Outputs’ and ‘Outcomes’. It has been recognised in the guidelines that converting ‘outlays’ into ‘outcomes’ is a complex process addressing “value for money” concerns;
Defining intermediate and final outcomes specifically in measurable and monitorable terms;
Standardizing unit cost of delivery;
Benchmarking the standards/quality of outcomes and services;
capacity building for requisite efficiency at all levels, in terms of equipment, technology, knowledge and skills;
Ensuring adequate flow of funds at the appropriate time to the appropriate level, avoiding both delay and ‘parking’ of funds;
Setting up effective monitoring and evaluation systems, to indicate the directions for further calibration and honing the processes, to deliver the intended outcomes; and
Involving the community/target groups/recipients of the service, with easy access and feedback systems.
‘outlays’ imply total financial resources deployed for achieving certain outcomes.
‘Outputs’ have been defined as the ‘measure of the physical quantity of the goods or services produced through an activity under a scheme or programme’. They are identified as an intermediate stage between ‘outlays’ and ‘outcomes’.
The purpose is to capture intermediate ‘outputs’ before identifying and measuring the ‘final outcome’.
‘Outcomes’ are the end product/results of various Government initiatives and interventions, including those involving partnership with the State Governments, Public Sector undertakings, Autonomous Bodies, private sector and the community. They involve much more than mere ‘outputs’, since they cover the quality and effectiveness of the goods or services produced as a consequence of an activity under a scheme or programme.

The performance budget, now part of the outcome budget,
Outcome Budget cannot be prepared for all Ministries/Departments simply by way of declaration. It’s a complex process and a number of steps are involved. a beginning may be made with proper preparation and training in case of the Flagship Schemes and certain national priorities.
Traditionally, government schemes are evaluated in terms of expenditure incurred and adherence to process requirement. It is necessary to shift the focus from vertical input controls to horizontal coordination and monitoring of outcomes. The need for horizontal coordination is evident from the fact that interventions in one are, say, rural drinking water nad sanitation, affect outcomes in health, which affect outcomes in education.

FLOW OF FUNDS FROM ThE UNION TO ThE STATES - CENTRALLy SPONSORED SChEMES

CSS is incurred only when payment is made either to a beneficiary of the scheme or to the supplier of goods and services. However, due to the lack of a proper information system, the tracking of fund flow and correlation between the amount released and expenditure made could not be determined without a degree of uncertainty. Further, when funds are transferred directly to the implementing agencies in the States, it has to be done in advance which results in a substantial accumulation of funds in the pipeline.
The basic issues here are:
- whether the simple release of funds by union Government Ministries/ Departments to State Governments/other implementing agencies, NGOs, societies etc in the States for implementing various centrally sponsored schemes could be termed as expenditure in their accounts,
- whether real time information about the use of funds so transferred is available,
- whether such use of funds gets adequately reflected in government accounts, and how to minimize the costs of raising the financial resources which are lying unutilized.

A lot would require to be done for improving the estimating and forecasting capabilities within Ministries/Departments and implementing agencies. major reforms in financial management can only be undertaken if capacity of both - individuals and institutions – is improved.

ACCRUAL SYSTEM OF ACCOUNTING

Double Entry System, which is based on the fact that in every transaction or financial change two parties or accounts are involved, one giving and other receiving. Under that system, every transaction, therefore, requires two entries in the books, one against the party or account giving and the other against the party or account receiving.
In its Budget for a year, Government is interested to forecast with the greatest possible accuracy what is expected to be received or paid during the year, and whether the former together with the balance of the past year is sufficient to cover the latter.
The mass of the Government accounts being on cash basis is kept on Single Entry.
The cash-based system of accounting lays emphasis on transactions vis- à-vis the budget. It does not record and report complete financial information required for management of resources. The system fails to reflect government’s liabilities such as accrued liabilities arising due to unfunded pensions and superannuation benefits and current liabilities arising from a disconnect between commitments and payments. Similarly, the present system is unable to track current assets as well as non-financial assets. It does not provide information on the assets held by the government, much less the cost of holding and operating these assets and the impact of current consumption on the stock of assets. Another major limitation is its inability to record the full cost of providing services by the government’s departments or the commitments made by the government regarding payment in future years. The cash-based accounting provides room for fiscal opportunism, as tax revenues can be collected in excess during a period followed by high incidence of refunds, payments can easily be deferred and passed on to future periods, revenues due in the future could be compromised by providing for one-time payments, etc.

the system of accrual accounting recognizes financial flows at the time economic value is created, transformed, exchanged, transferred or extinguished, whether or not cash is exchanged at that time. It is different from cash-based system in that it records flow of resources. Expenses are recorded when the resources (labour, goods and services and capital) are consumed, and income when it is earned, i.e. when the goods are sold or the services rendered. Thus, in addition to cash flow, unpaid consumptions (payables) and unrealized income (receivables) are also recorded. Resources acquired but not fully consumed during an accounting period are treated as assets (inventory and fixed assets). The system of accrual accounting, thus, inter alia, allows better cost – price calculations, records capital use properly, distinguishes between current and capital expenditures, presents a complete picture of debt and other liabilities and focuses policy attention on financial position, as shown in the whole balance sheet not just cash flows or debts. It gives a complete measure of cost of various services, takes care of disinvestment receipts and provides adequate information of both fiscal balance and net worth and their changes over time. Information, as would be available under accrual accounts - There is a high cost of transition from cash-based to accrual-based accounting system as it requires higher level of trained and skilled personnel, and higher costs are involved in identification and evaluation of assets and setting up the technological infrastructure. - The transition period takes a fairly long time to settle, sometimes even more than a decade.
Full accrual accounting requires a comprehensive registration of assets and a sound cost measurement system. Implementing such systems government-wide needs time and its cost-effectiveness needs to be carefully examined. Full accrual accounting would not contribute to the development of a performance- oriented approach to budgeting at the agency level if depreciation is roughly estimated. If accounting standards are not clearly specified and reported, accrual accounting leaves room for “creative accounting”, through manipulating estimates of depreciation, provisions, recognition of losses, etc.”
It might start with those areas of of government activity that require information on the value of physical assets, their uses and full costs (e.g. agencies that

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ACCRUAL SYSTEM OF ACCOUNTING