Comparison of Public & Private Sector Budgeting - Coursework Example

Comparison of Public & Private Sector Budgeting Introduction This paper will examine the similarities and differences between budgeting in private and public sector enterprises, and proceeds from the assumption that the distinction between the two forms of enterprise is growing narrower. In order to explore the subject fully, the discussion is organised in four parts: First, public enterprises will be defined. Second, the purposes of accounting and budgeting for private and public enterprises will be examined, and then the different methods applied by public enterprises will be described in greater detail. Finally, the reasons why the differences between public and private enterprises are growing less distinct will be discussed in the context of budgeting. Defining Public Enterprise A public enterprise differs from a private enterprise mainly in terms of who receives the value from its activities. Private enterprises ultimately create value for their stakeholders, the owners and shareholders of the company. They do, of course, create value for their customers and the recipients of their services, but providing that value for customers is a means to the end of providing stakeholder value. In other words, without a profit, the private enterprise would have no reason to exist. Public enterprises, by contrast, have the primary goal of providing value for their customers. Public services are “those activities which are enshrined within the notion of public good or service based on universality of access for the citizenry rather than the private provision through a market.” (Broadbent & Guthrie, 2008: 135) The difference is in the perspective towards the measurement of value; private enterprises fundamentally measure value to themselves, while public enterprises must measure value from the point of view of the people who receive its services. This also means that public enterprises are much more restricted in how much and in what manner they address the outcomes for their stakeholders – the public, who funds their operations through taxes and fees and receives no return apart from the services provided – than private enterprises. (Lapalombara, 2003) In other words, there is a much stronger and more complex accountability for public enterprises in that it cannot be measured in simple terms like earnings per share or profits. Public enterprises also contribute to wider economies. Because of this, and because efficiency and prudence in managing resources contributes to better services, public enterprises are increasingly borrowing ideas of management from the private sector, even to the point of becoming increasingly privatised themselves in some places. (Broadbent & Guthrie, 2008: 130) Differences in Accounting & Budgeting in the Private and Public Sectors Accounting for any enterprise is done for the purpose of ensuring accountability, making certain that the movement of money can be tracked. For public enterprises, accountability is required for both economic and political reasons: Economic, for the simple reason of a fair exchange of value that applies to any enterprise; and political, because of the social contract between the enterprise and those who fund it – the taxpayers or other donors. (Chan, 2003: 13) Accounting and budgeting in the private sector is concerned mainly with the efficient allocation of financial resources. In the public sector, however, while that is still an important objective, accounting and budgeting have the added goal of controlling behaviour; compelling or preventing specific activities among organisations or individuals. (Ellwood & Newberry, 2007: 550-551) Sometimes that goal of ensuring certain predictable behaviours conflicts with the need to efficiently manage costs and provide the best level of service possible. Cash budgeting has traditionally worked adequately for public enterprises because they are more like consumers or households in nature compared to private enterprises; private enterprises measure efficiency by a comparison of costs and revenue, whereas public enterprises measure efficiency by how closely the pre-determined outcomes for which a budget is set match what was anticipated once the budgeting period has ended. (Van der Hoek, 2005: 34) But because higher levels of efficiency are required – particularly in recent years, when public enterprise budgets have been handicapped by a world-wide financial downturn – many public enterprises are moving towards methods used in private enterprise. Methods of Accounting & Budgeting in the Public Sector The traditional methodology for public enterprises, particularly those supported by governments, involves input-based budgeting and cash accounting. An important consideration for public enterprises is that, unlike private enterprises, they must usually publish their budgets. (Van der Hoek, 2005: 33) Therefore the financial reporting at the end of the year becomes a matter of verifying the expenditure according to the budget that was allocated at the beginning of the year, rather than, as in a private enterprise, providing an assessment of the enterprise’s performance. There are some variations in the manner of budgeting and appropriations for public enterprises. The most common method is the cash-based appropriation, which is done when the government is only allowed by its laws to spend money for a limited time; once the budget is approved (usually by a Legislature), the entire amount for the enterprise is appropriated at once. A second method is commitment-based appropriation, where the budget and the appropriations to meet it are done on a ‘rolling’ basis, with no time limit; the money is provided as needed, although those needs have to be pre-determined. The third method is the accrual-based appropriation, which is based on the full cost of government operations and takes into account changes in assets and liabilities. (Van der Hoek, 2005: 37) However, it is easy to see two potential problems with accrual-based appropriations. First and most obvious, in many countries it requires a change in law regarding who can approve spending; if this is ordinarily the responsibility of the Legislature, it can be imagined that the lawmakers would never accomplish anything else but to constantly authorise small appropriations. Second, the accrual method assumes an income; spending is based on the amount of revenue being received. Most public enterprises do not generate revenue, or at least do not generate a surplus of revenue, and so the accrual method might be difficult to use. Why Public Enterprises are becoming more like Private Enterprises Public enterprises not only have the goal of adequately providing services, but also being a productive component of larger political objectives. (Matheson & Kwon, 2003: 9) Thus, they have the same goal of economic efficiency as private enterprises, but for different reasons. For example, a government enterprise funded by taxpayer money would have an interest in spending efficiently, so that more services could be provided at the same cost or the same services could be provided at less cost, thereby preventing the need for the government to raise taxes. The reason many public enterprises are adopting more private-enterprise methods in budgeting and accounting is that the traditional methods of input-based budgeting and cash accounting do not provide enough information to manage efficiency. (Van der Hoek, 2005: 33) Efficiency in the context of the traditional methods can only be judged in terms of whether or not the public enterprise achieves its expectations, and there is no particular incentive for the enterprise to try to exceed them. Another problem is that public enterprises are usually thought of as having ambiguous and difficult to quantify goals. Unlike private enterprises driven by profit, the measures of success in a public enterprise cannot be expressed by simple, objective factors like profit margin or earnings per share. But there is a human factor that helps to overcome this problem; many managers in public enterprises have experience and education in private-sector management concepts, and can apply those to public-sector management. (Hainey & Bozeman, 2000: 452) Public-sector enterprises are also becoming more sensitive to consumer demand, partly as a result of the orientation of public-sector managers as described above, and partly as a direct response to citizens themselves making less of a distinction between the nature of services they pay for by choice, and those they pay for with their taxes. (Johnson, et al., 2003: 59) While a flexible method such as accrual-based budgeting may be the best way for a private-sector enterprise to meet its primary goals of maximising profits and productivity, from a consumer point of view those goals are irrelevant; the consumer has a choice not to buy the private enterprise’s product or service if he is not satisfied with it. He does not have that choice with a public-sector enterprise, and therefore his expectations demand a much higher level of accountability from the public-sector enterprise, and will have much more serious negative consequences – usually when the next election is held – if they are not met. Therefore, more public-sector enterprises are required to meet traditionally private-sector objectives of cost efficiency, performance management (which is largely linked to cost management), and improved financial reporting. (Van der Hoek, 2005: 38) One of the most obvious ways this can be achieved is by shifting the traditional methods of managing public-enterprise budgeting and accounting from the somewhat static input- and cash-based methods to more flexible systems such as commitment-based budgeting and accrual-based budgeting and accounting. References Broadbent, J., and Guthrie, J. (2008) “Public sector to public services: 20 years of ‘contextual’ accounting research”. Accounting, Auditing & Accountability Journal, 21(2): 129-169. Chan, J.L. (2003) “Government Accounting: An Assessment of Theory, Purposes and Standards”. Public Money & Management, 23(1): 13-19. Ellwood, S., and Newberry, S. (2007) “Public sector accrual accounting: institutionalising neo-liberal principles?” Accounting, Auditing & Accountability Journal, 20(4): 549-573. LaPalombara, J. (2003) “Power and Politics in Organizations: Public and Private Sector Comparisons”. In: M. Dierkes, A. Berthoin Antal, J. Child, and I. Nonaka (Eds.), Handbook of Organizational Learning. Oxford: Oxford University Press. Johnson, P.F., Leenders, M.R., and McCue, C. (2003) “A Comparison of Purchasing’s Organizational Roles and Responsibilities in the Public and Private Sector”. Journal of Public Procurement, 3(1): 57-74. Matheson, A., and Kwon, H-S. (2003) “Public Sector Modernisation: a New Agenda”. OECD Journal on Budgeting, 3(1): 7-23. Rainey, H.G., and Bozeman, B. (2000) “Comparing Public and Private Organizations: Empirical Research and the Power of the A Priori”. Journal of Public Administration Research and Theory, 10(2): 447-469. Van der Hoek, P. (2005) “From Cash to Accrual Budgeting and Accounting in the Public Sector: The Dutch Experience”. Public Budgeting & Finance, Spring 2005: 32-45. Read More