by Robert L. Bland

To the casual observer, the budget cycle may appear as a mere extension of the accounting function. Accountants track the flow of money into and out of the organization and periodically prepare reports on the financial condition of the government or nonprofit organization. But appearances are deceptive. In government, the budget and accounting systems function independently of one another, although each supports the other. Much like a Venn diagram, functionally they represent two independent circles. Yet these circles intersect, and information produced by one is used as input by the other.

The accounting system provides the record-keeping framework in which transactions authorized by the budget are logged. Some characterize these tasks as the “3 Rs” of accounting: recording, reconciling, and reporting. The recording function uses an ingenious device – double-entry bookkeeping, developed during the Middle Ages – to enter every transaction into a journal. Each transaction has at least one debit entry and one credit entry in the journal (ergo, “double entry”). For any given transaction, the sum of the debits always equals the sum of the credits. The really fun thing about this ingenious device is that those who have slogged through an accounting problem know that human error has a way of working its way into the process. Invariably at the end of a long string of transactions, debits and credits do not balance, and the remainder of the night is spent trying to find the mistake.

Reconciling involves a separate set of tasks that posts the journal entries to a ledger, a spreadsheet that reorganizes the journal information by accounts. For example, all the journal entries that involve the receipt or disbursement of cash are posted to the cash account. All journal entries that involve creating or paying liabilities to vendors for their services are posted to accounts payable. Accounts, in turn, are grouped in the ledger by type: assets, liabilities, fund balance, revenues, and expenditures/expenses.

One important wrinkle in governmental accounting is that activities and their accounts are grouped into funds. The accounts associated with police and fire protection are in the general fund, at least most of them. The accounts associated with a street widening project are in a capital projects fund. While local governments may have dozens of funds (states even have hundreds), they all can be categorized into one of 11 types. Each fund has its own set of accounts in each of the basic categories: assets, liabilities, and fund balance. Most also have accounts for revenues and expenditures (or expenses for the business-type of funds).

The culmination of the accounting cycle is the reporting of the results of all these transactions. Financial reports are of two types. Interim reports provide real-time information for users within government on the balance in each account for each fund. Information technology has made online interim reporting feasible and affordable for most governments and nonprofits. The second type of report, the comprehensive annual financial report (CAFR), provides external constituencies (citizens, bond raters, investors, grantors) with critical information on the financial condition of each fund and of the government or nonprofit overall. This report, at least the basic most aggregated information, is subject to an examination by an external auditor, who reports in a written statement on the report’s accuracy (the audit opinion).

At about this point, the astute observer asks, “How do accountants keep all of this straight?” While budgeting remains individualized (each government and nonprofit develops its own processes and rules and compiles them into a budget policy statement and budget manual), accounting relies on a common set of rules – generally accepted accounting principles (GAAP) – to govern its procedures. These principles are developed by the Governmental Accounting Standards Board (GASB) through a highly consultative and deliberative process. This board’s proclamations, once finalized, are designated as statements. For example, GASB Statement 34, issued in 1999, brought sweeping changes in the way state and local governments record, reconcile, and report their financial information.

At the outset, the accounting-budgeting interface was characterized as a Venn diagram. The more interesting dynamics occur where these two circles intersect. For example, the accounting system provides input into the budgeting cycle in such areas as year-end fund balance, under- or overage in revenues and expenditures, and historical information for each account used by department heads in preparing their budget requests. The accounting system provides the budget with a reality check as the fiscal year progresses. Once the fiscal year ends, the actual balances from the accounting system are compared with the approved amounts in the budget to assess the effectiveness of the management team to maintain compliance with the approved budget.

On the other side, the budget system produces information used as input by the accounting system. For example, at the outset of the fiscal year after the budget has been approved, the accounting system enters the approved amount for each account as its beginning balance. The approved budget instructs the accounting system on how much to set aside in the fund balance for reserves or what interfund transfers to make. And the budget provides the accounting system with information on the amount and type of revenue to accrue.

While the budget is the preeminent financial planning document in government, the accounting system provides the framework for maintaining the financial integrity of that government or nonprofit organization. And the check on the integrity of the accounting system is the external auditor’s verification of the accuracy of the CAFR and the internal controls that govern how financial data are collected, processed, and documented.

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Originally published in Academic Matters in May 2008.

Bob Bland is professor and chair of the Department of Public Administration at the University of North Texas and is the author of A Budgeting Guide for Local Government, 2nd edition (ICMA, 2007).