CHAPTER I

The context of Managing Public MoneyLearning objectives:1. What is meant by the term public money?2. Concept of public value and how it relates to financial management.

3. Financial aspects of the new public management (NPM) regime that has been adopted in many developed and developing countries.

4. Outline of key concepts in public sector accounting.

What is public money?

Probably what comes first to our minds is that public money is the money that government gets from taxes and spends on the provisions of public services.Nuances:

Government does not only get money from taxes. There are income that comes from fees and charges, from properties and investments, from grants, donations and legacies and from borrowing.

Public services are not only provided by the government. There are services provided by charities, voluntary organizations, faith-based groups and philanthropists (known as the third sector) as well as the wide range of services provided by private sector organizations either under contract or in some regulated way.

In a sense, public money is the money that might be referred to in popular newspapers as ours. It might not legally be the case but citizens see money that they have paid overto government in a different way to money paid to a for-profit organization. This is where accountability comes in because people is more watchful on the money that they paid the government than the money paid for-profit organizations.Public moneymight mean all the money received and managed by a government but if that was thecase how should we regard the money donated to charities and used to provide public services?

It is from this that we get to the essence of the difference between the private sectorand the public sector. For the private sector the goal is to make money but for thepublic sector money is the means to the end. As Mark Moore put it:[Non-profit organizations] have to be able to sustain themselves financially and todo that they may have to compete to some degree with other non-profit firms.But their ultimate goal is not to capture and seize value for themselves, but togive away their capabilities to achieve the largest impact on social conditions thatthey can.

(Moore, 2003)

There are different terms used to describe the organizations that are the focus ofthis book, including public sector organizations and non-profit organizations. A termthat is becoming more common in academic literature and in accounting standards ispublic benefit entities (PBEs). Laughlin (2008: 251) cites Simpkinss summary of the features of PBEs:

their objective is to provide goods and services to various recipients or todevelop or implement policy on behalf of governments and not to make aprofit; they are always characterized by the absence of defined ownership interests thatcan be sold, transferred or redeemed; they typically have a wide group of stakeholders to consider (including thepublic at large); their revenues are generally derived from taxes or other similar contributionsobtained through the exercise of coercive powers; and

their capital assets are typically acquired and held to deliver serviceswithout the intention of earning a return to them.

This term PBE refers to the generic organizations thatpublic managers work in or with. This is because it captures organizations such asnationalized industries that are managed on a commercial basis but differ from otherprivate sector, for-profit organizations because they are owned by a government andvoluntary and charitable organizations, as well as government ministries, hospitals,schools, police forces, local governments, etc. that are commonly thought of as thepublic sector.The term public manager refers to those who are involved inthe executive management of PBEs. As well as the chief executive and line managersthe term includes the members of the governing body, whether they are electedpoliticians, appointees or volunteers and private sector managers, if they produceprimarily for government. The term is not used quite as broadly as Moore (1995: 23)uses it: supervising agents, judges, lobbyists and interest group leaders (Rhodes andWanna, 2007: 408) are excluded here because they are not in a position to manage a PBEs finances although they may have considerable influence on the public managerswho can.

Public services

The classical economic view is that the public sector provides goods and services thatare desirable but which, for one reason or another, a market economy cannot supplyeffectively. There are two types of goods that the public sector provides: public goodsand merit goods.Public goods

Public goods (and services) are commodities that are non-rivalrous and non-excludable.

Non-rivalrous means that the consumption of the commodity does not reduce itsavailability to others and non-excludable means that no one can be effectively excludedfrom enjoying the benefits of the commodity. If the market were to provide such goodsand services the providers would have the potential problem of free-riders, peopleconsuming the goods without purchasing them, because of the non-excludability (i.e.the free-riders could not be excluded). The provision of such goods by the government is feasible because of the enforcement of taxes. Examples of public goods include streetlighting, national defence, free-to-air broadcasting(although modern technology has made encryption of broadcast signals possible so television and radio is not a publicgood now).

Merit goods and externalities

An externality is a cost or benefit arising from production or consumption of acommodity that falls upon someone who did not agree to be part of the transaction.This means that the cost or benefit is not taken into account in the market price of thetransaction. Costs that spill over to third parties are called negative externalities andbenefits are called positive externalities.Perhaps the classic example of an externality is pollution emanating from a factoryproducing some goods. If there was a completely free market the factory ownerswould not have an incentive to spend money on technology to eliminate the pollution,nor would they bear the cost of the pollution damage. In practice governments haveimplemented systems of regulation that require factories, etc. to reduce their pollution.Sometimes, there is a direct tax or levy, which aimsto reduce the amount of pollution produced.In terms of economics the problem with externalities is that negative externalitiescause the market to over-provide the goods or services because all of the costs are nottaken into account in the price of the goods; whereas positive externalities undersupplythe goods or services because all the benefits are not taken into account.Merit goods (and services), in contrast with public goods, are commodities that areexcludable but which, for reasons of equity, governments decide to provide them. Ingeneral, this means that governments will provide the commodities (services) on thebasis of need rather than ability (or willingness) to pay. The theory goes that in a freemarket merit goods would be under-produced because: they produce positive externalities meaning that there are benefits to society thatare not taken into account by the individual who consumes them; and individuals seek to maximise their short-term benefits, failing to take intoaccount the longer-term benefits that often accrue from the goods.

Healthcare is an example of a merit good. A visit to a doctor is not a public good.It is rivalrous because the individual has used an amount of the doctors time therebyreducing the amount of the doctors time that others can use and excludable becausethe doctor can decide not to see an individual. Healthcare also has positive externalities.If an individual is treated for a contagious disease then other individuals benefit. All ofthis means that governments provide healthcare even though there may be an effectivemarket for private healthcare running in parallel with the public provision. Given that governments provide (or commission and pay for) a wide range of publicand merit goods because, in part at least, the market would fail, it would not be possiblefor the government to use a market mechanism to pay for the services. Instead, theseservices are financed from taxes except, perhaps, for minor aspects where fees arecharged to service users. The cost of all these services therefore falls within the publicsector.

MonopoliesAnother way that governments intervene in the market is for the management ofmonopolies, especially so-called natural monopolies such as utility services where thereis a very high capital investment in infrastructure required. In previous generationssuch monopolies were owned and managed directly by the government but underNPM the preference is for such services to be provided by profit-seeking private sectororganizations that are regulated by the government. The regulation protects consumersfrom unwarranted price rises and also sets terms for allowing competitors to accessthe private companys infrastructure. For these services public money is spent on the regulation and, in some cases, in a subsidy tothe private sector operators.

How big is the public sector?

The public sector is huge. It spends almost 30 per cent of the worlds gross domesticproduct (GDP). The World Bank (2010) shows the figure was 26.9 per cent in 2005rising to 28.3 per cent in 2008. The picture differs from country to country. Indeveloped countries it can be as much as half of the economy but for other countriesit can be as low as 11 per cent. The public sector in different countries isnot directly comparable because the calculations depend on definitions about what isand is not public expenditure. In the UK, utilities such as water, electricity and gasare provided by regulated private sector companies and this puts the services outsidethe definition of the public sector although they would be within the public sector inother jurisdictions. The UKs railways have also been privatized but the train operatingcompanies and the infrastructure company receive public subsidies, so the subsidy iswithin the definition of the public sector (and is equivalent to the net trading loss thatother countries national rail businesses incur). Broadbent and Laughlin (2003: 3334) discuss the view taken by Broadbent and Guthrie in a 1992 paper that if organizations aresubject to claims by the public that what they produce is in the public interest and haveinputs controlled in some way by government, then they are within the public sector.

Thus the provision of say utilities (gas, electricity, water) are public services,whether the organizations providing these services are now owned by privateshareholders (as in the UK), having originally been part of the public sector, or areand always have been, owned by private shareholders (as in the USA).(Broadbent and Laughlin, 2003: 334)The other type of privatization, where government bodies award contracts to suppliers of services such as cleaning, catering, refuse collection, payroll andinformation and communications technology (ICT) is within the definition of thepublic sector because the expenditure on the service contracts is incurred by thegovernment body (not by the consumer as in the case of utilities).

Where does public money come from?

Predominantly public money comes from taxes and duties but governments have othersources. There are services that are provided in return for a fee and there will be incomefrom investments in the form of rents, dividends and interest. There can be incomefrom the sale of assets, such as the sale of franchises to mobile phone operators orwhen nationally owned organizations are privatized. A government might also receiveincome in the form of grants and donations, possibly from overseas governments, aidagencies, charities or faith-based organizations.

Even with all these sources of income, governments often have spending plans fora given year that exceed the total amount of money they will receive from taxes andcharges, sales and investments and will have to borrow money. To the extent that theborrowed money is used to pay for the investment in new capital projects there is anargument that the repayments of the debt will be paid over the following twenty, thirty,fifty years by the taxpayers who will benefit from the capital project. Even so, just asa private citizen has to maintain their debt to a level they can afford to repay, so dogovernments.

What is public money spent on?

PBEs cover such myriad functions and responsibilities that almost anything might be purchased by some organization somewhere. As a generalization, the public sector provides services to or on behalf of citizens much more than it provides goods. Services are intangible, existing only at the point the service is delivered. Historically such service-based organizations would spend the majority of their expenditure onstaffing, perhaps 75 or 80 per cent of the total spending. The move towards commissioning of partnerships meansthat an increasing proportion of expenditure by public organizations will be on service contracts and/or grants to third parties rather than on direct employee costs (althoughthe chances are that the contractors and third parties will use the majority of the moneythey receive to pay for their staff to deliver the services). Public expectations about the management of public money

There is something else different about the public sector, too: the public expect much more from public servants than they do from the private sector managers. Therelationship is different. If one purchases goods or services from a profit-seekingorganization then it is a discrete transaction between the two parties. As a customer oneis concerned with the quality of the goods, the after sales service and so on but one doesnot expect the organization to sell you the goods or services at a discount because one isa part-owner as well as a customer. Customers are unlikely to have an opinion about thelevel of the chief executives salary or whether or not they should travel in a private jet.

Citizens expectations about PBEs, however, are not like that. Witness the publicreaction to the recent pork barrel scam. People are expecting that their money will be spent efficiently and that officials will be accountable with every action that they will do involving peoples money. What is public value?

Public managers have different specific goals and objectives from each other but theyshare the need to spend public money to achieve them. Managers of many (but not all)companies are spending other peoples money but they are required to do so in a waythat creates more money for the owners and rather than simply maximizing profitsin the short term, they are expected to do something that is strategically important inthe longer term, increase shareholder value. Public managers spending public moneyare expected to do something similar: to create what Mark Moore called public value(1995).

Moore conceptualized the challenge facing public mangers as a strategic triangle:the three key questions managers must answer in testing the adequacy of theirvision of organizational purpose: whether the purpose is publicly valuable, whetherit will be politically and legally supported and whether it is administratively andoperationally feasible.(Moore, 1995: 22)

The answer to Moores three key questions will inevitably feed into the budgetingprocess because a budget links an organizations governance (whether the authoritycomes from political or other sources) with its capacity, and values everything byexpressing the plans in money terms. It only goes so far because Moores notion ofcreating public value extends beyond the boundaries of the organization to includeco-producers (1995), but to the extent that there is a financial relationship betweenthe organization and the co-producers it should be included within the budget (and thestatement of accounts). This idea is picked up in Chapter 2 on budgeting.Moore sees financial management and the achievement of financial performancetargets as the means to the end of creating public value. A PBE needs to do this if it isto survive, but it needs to do more than this if it is to create public value (Moore, 2000:195; 2003: 7). This is a key difference between PBEs and private sector, profit-seekingorganizations where the ultimate goal is definable and measurable in financial terms. Itfollows that it is important for a public manager to exercise control over the financialresources at their disposal and to use financial performance measures to assess whetherthey are on course to achieve the organizations goals. Issues relating to this will bediscussed in Chapter 9.

Measuring public value

Some PBEs (including the British Broadcasting Corporation (BBC) and the ScottishGovernment) have adopted the concept of public value as the basis of their performancemanagement system (Talbot, 2008: 3). If a public managers job is to create publicvalue then it feels like we should be able to express the public value created in financial terms or at least in numerical terms. We can do this for the value created by a manager in a private sector organization in a number of ways. We can put to the profit earned in a period, the return on investment and the like. Furthermore, the revenue from sales is a measure of the value that customers place on the goods or services that they purchase so it is possible to calculate a proxy measure for the aggregate value created for customers.Things are not so clear-cut in public sector. Without sales revenue, the control of expenditure is how the public manager governs the creation of public value. A public manager cannot claim that the value of what they create is equal to the amount spent on the delivery of the service. If that was the case it would mean that spending more creates more value. Sometimes it may be the case that the extra spending improves the quality and/or the quantity of services produced but it clearly is not the case of the extra spending is on waste or extravagance.It is important that the public value that is created is at least as great as the value of the resources that were expended in its creation. We have to take account of the efficiency of the organization in converting inputs into outputs.

Financial management under New Public Management

A public sector manager faced with an option to spend some money should ask themselves three questions:

is the spending within the rules?

Can we afford it?

Is it value for money?

Three yeses are required before proceeding. There are seven doctrines that typify NPM according to Hood (1991):

Hands-on professional management

Explicit performance standards and measures

Focus on output and results

Disaggregation and decentralization

Increased competition

Private sector management practices

Greater discipline and parsimony in the use of resources

CHAPTER II

Budgets and Budgeting

Learning Objectives:

1. To understand the objectives of budgeting

2. To be able to explain the strengths and weaknesses of the common, alternative approaches to preparing a budget

3. To be aware of the differences between public and private sector budgeting practices

4. To understand the significance of assumptions in budget preparation

What is a budget?

The etymology of budget is from the old French word bougette meaning a small leather bag or purse. It is a plan written in financial terms. The budget says in numbers what the organizations plans say in words. The Oxford Dictionary of English defined it as an estimate of income and expenditure for a set period of time whilst Smith and Lynch (2003: 5) have a public budget as a request of funds to run the government.A budget is a plan for the accomplishment of programs related to objectives and goals within a definite time period, including an estimate of resources required, together with an estimate of resources available, usually compared with one or more past periods and showing future requirements.

-Smith and Lynch, 2003: 6

Process of public budgeting the acquisition and use of resources by public organizations (Swain and Reed 2010 : 3). According to them, budgeting has four stages: preparation, submission and approval, implementation and review and reporting. Budgeting and creating public value

Three points of the budget triangle: The level of income and borrowing, which is what determines the capacity of the public managers organization (which by definition will be less than the operational capacity);

The planned expenditure and investment, which will be the resources that are to be converted into the goods and services that are valued by the public; and

Approval by the organizations highest level of governance (which may or may not include publicly elected officials)

The objectives of budgeting

There are six objectives of budgeting:

To plan

To authorize managers to incur expenditure

To measure performance

To control

To communicate

To motivate managers

Form and content of a budget

Objective view is where income and expenditure is analysed in terms of the outputs and services or capital projects.Subjective view the analysis is in terms of inputs such as employee costs.

Table 1 Objective and subjective analysis of a university

Objective analysisSubjective analysis

Academic departments

Administration and support services

Student services

Residences

Catering and conferencesExpenditure

Employees

Premises-related expenses

Supplies and services

Transport-related expenses

Capital financing charges

Income

Grant income

Income from fees and charges

Sales

Income from investments

Internal recharges

Alternative approaches to budgeting

Incremental budgeting is probably the most basic approach to budget preparation. It is finding a solution by assuming that the solution that worked last time must be nearly right for this time and adjusting it here and there until it fits. Incremental budgeting taps into the way one often thinks about the future: by looking at the past and identifying what is different now.

AdvantagesDisadvantages

Simplicity, both to undertake and also to explain to stakeholders

Produces relatively a stable budgetThere is no challenge to the base budget the assumptions within it

Have a high degree of inertia and it can be difficult to respond to radical changes

Focused on inputs

Strong focus on departments

Gives the participant an incentive to overestimate costs

Zero-based budgeting in terms of problem-solving analogy it is the equivalent of starting with a blank sheet of paper. Under this approach the organization will build up its budget for every activity and project from scratch every year, effectively justifying every item in the budget by reference to the organizations mission, objectives and policies.AdvantagesDisadvantages