Chapter 11: Second Administrative Reforms Commission Part V
Public Finance Management - Public finance management includes resource mobilization, prioritization of programmes, the
budgetary process, efficient management of resources and exercising controls.
Evolution of Budgeting
The line item Budget
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.
In the late nineteenth century, line-item budgeting was introduced in some countries
The line item budget is defined as the budget in which the individual financial statement items
are grouped by cost centers or departments.
In a line-item system, expenditures for the budgeted period are listed according to objects of
expenditure, or line-items.
The line item budget approach is easy to understand and implement
Its major disadvantage is that it does not provide enough information to the top levels
a performance budget reflects the goal/ objectives of the organization and spells out performance
A Performance Budget gives an indication of how the funds spent are expected to give outputs
and ultimately the outcomes.
it is not easy to arrive at standard unit costs especially in social programmes which require a
Zero-based Budgeting (ZBB)
under zero-based budgeting every activity is evaluated each time a budget is made and only if it
is established that the activity is necessary, are funds allocated to it.
The basic purpose of ZBB is phasing out of programmes/ activities which do not have relevance
No government ever implemented a full zero-based budget, but in modified forms the basic
principles of ZBB are often used.
Decision units in ZBB
A Decision unit is a distinct segment of an organization for which budget is prepared.
It can also be a programme, scheme, project, or an operation.
A decision package is a budget request which should contain the following :
A description of the function or activity of the decision unit
The goals and objectives of the various functions / activities of the unit
Benefits to be derived from financing the activity / programme in the present context.
The projected / estimated cost of the package
The yearly phasing of the proposed expenditure / project cost
Alternative ways of performing the same activity or achieving the same objectives.
Programme Budgeting and Performance Budgeting
Introduced in the US Federal Government in the mid-1960s
The basic building block of the system was classification of expenditure into programmes, which
meant objective-oriented classification
It aimed at an integrated expenditure management system, in which systematic policy and expenditure
planning would be developed and closely integrated with the budget.
Many governments today use the programme budgeting label for their performance budgeting
Weaknesses in the Budgetary Process :
Government budgets generally have the following shortcoming
Poor planning, Poor expenditure control;
No links between policy making, planning and budgeting;
Inadequate funding of operations and maintenance;
Inadequate accounting systems, Poor cash management;
Inadequate reporting of financial performance;
Almost exclusive focus on inputs, with performance judged largely in terms of spending no
more, or less, than appropriated in the budget
Core Principles of Reforms
Reforms in Financial Management System are part of overall governance reforms
Sound financial management is the responsibility of all government departments/ agencies
Medium-term plan/budget frameworks and aligning plan budgets and accounts
Prudent economic assumptions:
- Top-down budgeting techniques: Instead of bottoms up (offices telling departments how much
Transparency and simplicity:
- Relaxing central input controls:
Focus on results:
- Adopting modern financial management practices
accrual accounting, information technology, financial information systems
Budgeting to be realistic
Existing Financial System Management in India
Financial Statements and Accounts
Budget is also known as the, Annual financial statement of the concerned Government (Articles
112 & 202)
The appropriations are required to be made in the manner provided in the constitution.
Constitution of India necessitate the maintenance of government accounts in three parts with
regard to receipts
Consolidated Fund of India /States
Public account of India/States
Contingency Fund of India/States.
Annual Financial Statement
prepared according to General Financial Rules (GFR), General Accounting Rules (GAR), Budget
Manual (in the States).
It is a statement of estimated annual receipts and expenditure is prepared by each Government
and presented to its legislature.
The part of the estimates pertaining to expenditure charged upon the consolidated Fund is not
submitted to the vote of 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
A separate demand is presented for each Department or the major services under the control of
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.
After the Demands have been passed by the legislature, an Appropriation Bill is introduced to
provide for the appropriation out of the consolidated Fund of India
Fiscal Responsibility and Budget Management Act, 2003
Three Statements are to be presented to the Parliament, which form a part of the budget documents
Macro-economic Framework Statement - contains an assessment of the growth prospects of
Medium term Fiscal Policy Statement
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
Fiscal Policy Strategy Statement
- seeks to outline the strategic priorities of the Government in the fiscal area for the
Division of Budget
Within each of the divisions and Sections of the consolidated Fund as referred to above, the
transactions are grouped into Sectors such as,
General Services, Social Services, Economic Services, under which specific functions
or services are placed
These Sectors are further sub-divided into `Major Heads of Account'
In some specific cases, the Sectors are sub-divided into sub-sectors before their division into
Major Heads of Account.
The Sectors, Major heads, Sub-heads and Detailed heads together constitute a five-tier arrangement
of the classification structure of Government Accounts.
The Major Heads of Account falling within the consolidated Fund generally correspond to `Functions'
Flow of Funds Related to Union Government Programmes
The first 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 is through the Planning commission.
the States receive Plan funds from the Planning commission in the form of `central Assistance'
under the `Scheme of Financing of States' Annual Plan.
`Centrally Sponsored Schemes' (CSS)
The centrally Sponsored Schemes do not fall within the subjects allocated to union Government
in list I of the Seventh Schedule of the constitution.
However, they are funded by the union Government to achieve certain national objectives
Actual expenditure under the CSS is incurred only when payment is made either to a beneficiary
of the scheme or to the supplier of goods and services.
Preparation of the Budget
Preparation of the Annual Budget in the Government of India follows both the top-down and
While guidelines and instructions are issued by the Ministry of Finance and Planning commission,
the spending Ministries/Departments make requests for budgetary allocations based on their own
The provisions which govern the preparatory process are contained in the General Financial
Weaknesses in the Budgetary System and Implementation
Unrealistic budget estimates:
Delay in implementation of projects:
Skewed expenditure pattern:
a major portion getting spent in the last quarter of the financial year, especially in the last
Inadequate adherence to the multi-year perspective and missing `line of sight' between plan and
No correlation between expenditure and actual implementation:
Parking of funds by implementing agencies, outside the government accounts portrays an incorrect
picture of the financial position of government.
Mis-stating of financial position:
Ad hoc project announcements:
Irrational plan / non-plan distinction leads to inefficiency in resource utilization.
The assumptions made while formulating estimates must be realistic.
The gap between the `estimates' and `actuals' must be ascertained and efforts made to minimize
The method of formulation of the annual budget by getting details from different organizations/units/agencies
and fitting them into a pre- determined aggregate amount leads to unrealistic
This method should be given up along with the method of budgeting on the basis of `analysis
This should be replaced by a `top-down' method by indicating aggregate limits to expenditure
to each organization/agency.
Internal capacity for making realistic estimates needs to be developed.
The practice of announcing projects and schemes on an ad-hoc basis in budgets and on important
National Days, and during visits of dignitaries functionaries to States needs to be stopped.
Outcome Budget :
Announced in Budget speech of the Finance Minister (Budget 2005-06)
The first outcome budget was passed in the Parliament on August 25, 2005
The guidelines have prescribed the following steps
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
Ensuring adequate flow of funds at the appropriate time to the appropriate level
effective monitoring and evaluation systems
Involving the community/target groups/recipients of the service, with easy access and feedback
`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'.
`Outcomes' are the end product/results of various Government initiatives and interventions
They cover the quality and effectiveness of the goods or services produced as a consequence
of an activity under a scheme or programme.
For the year 2007-08, the Outcome Budget and Performance Budget were merged and placed in
one combined document.
Outcome budgeting is a complex process and a number of steps are involved before it can
be attempted with any degree of usefulness.
A beginning may be made with proper preparation and training in case of the Flagship
Schemes and certain national priorities.
Distinction between Plan and Non-Plan
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.
leads to the misperception that non-plan expenditure is inherently wasteful and should be
Non-Plan expenditure covers expenditure on security, interest payments and subsidies etc
ARC' view: The Plan versus non-Plan distinction needs to be done away with.
Development of Financial Information System
Providing timely and reliable information to the decision makers
Providing inputs to control systems
Monitoring financial and physical progress
Ensuring proper utilization of resources
Presently, all Federal Government units (Executive, legislation and Judiciary) in Brazil including
all State/owned company units are required to use SIAFI.
ARC: A robust financial information system, on the lines of SIAFI of Brazil, needs to be created
in the government in a time bound manner.
Accrual System of Accounting
Principles of Government Accounting
The accounting methods adopted for commercial concerns, and the preparation of Manufacturing,
Trading and Profit and Loss Accounts and a Balance Sheet, in the commercial sense, are,
therefore, unsuitable and unnecessary.
On the basis of the budget and the accounts, Government determines
(a) whether it will be justified in curtailing or expanding its activities
(b) whether it can and should increase or decrease taxation accordingly.
Methods of Government Accounting -
The mass of the Government accounts being on cash basis is kept on Single Entry. A portion of the accounts which is kept on the Double Entry System for profitable activities,etc.
In a loan given, the World Bank included the introduction of accrual accounting as a part of its
Issues with Cash based system
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
It does not provide a full picture of the government's financial position at any given point and
the changes that take place over time as a result of government policy.
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.
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
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.
Twelfth Finance commission
The change over to the accrual based system of accounting will place considerable demands on
the accounting personnel in various government organizations
A Task Force should be set up to examine the costs and benefits of introducing the accrual system
Internal Control and Audit
Weaknesses of the Present System of Internal Audit -
comptroller and Auditor General of India had constituted a task force at the request of the
Ministry of Finance in July 2006 for benchmarking the status of internal audit in the union
Task Force observed the following:
Serious deficiencies in the existing internal audit system making it inadequate and ineffective
The internal audit guidelines are outdated and there are no manuals in many cases.
There are also no prescribed internal auditing standards.
Under-resourcing of the internal audit service and shortage of manpower
The limited staff of the internal audit is also sometimes diverted for accounting and budgeting
There was no segregation of duties especially at supervisory levels between those who are responsible
for internal audit and those responsible for pre-audit, disbursement and accounting
Independence is hampered in two ways.
Internal audit vested with the chief controllers of Accounts, who were also responsible for
accounting and payment functions
Financial Advisers are enjoined to `review the progress of internal audit'.
An Office of the Chief Internal Auditor (CIA) should be established in select Ministries/departments
to carry out the functions related to internal audit.
CIAs should be directly responsible to the Secretary of the Department.
Standards for internal audit should be prescribed by the Office of the C&AG
The Accounting functions should be completely separated from Internal Audit.
Integrated Financial Adviser
The role of the chief Accounting Authority -
be responsible and accountable for financial management of his Ministry or department;
be responsible for the effective, efficient, economical and transparent use of resources of the
Ministry or Department
be responsible for preparation of expenditures and other statements
shall ensure that his Ministry of Department maintains full and proper records of financial transactions
Relationship between Auditor and Auditee
There is need for better understanding and synergy between the audit and auditees for enhanced
public accountability and consequently better audit impact.
There should be balanced reporting by the audit.
There is need for increasing interaction as well as coordination between the executive and the
audit, including at senior levels.
Timeliness of Audit and concurrent Audit
concurrent performance audit of long-term on-going schemes should be undertaken at appropriate
External audit needs to be more timely in inspecting and reporting so that their reports can be
used for timely corrective action.
All audits for the year under review should be completed by 30th of September of the following
IT should be used increasingly and effectively for data collection and analysis.
The pending audit paras should be monitored by having a database on them in each Ministry/Department.
External Audit and Parliamentary Control
External audit has a very important role to play in financial management
provides assurance to Parliament/legislature that public money has been spent for the purpose
for which it was sanctioned by the Parliament/legislature
is a crucial element of public accountability as it is an independent external scrutiny.
is a deterrent against careless decision-making and irresponsible attitude towards public
expenditure and project management
is expected to establish public confidence that public money is being properly spent.
External audit includes examination of the economy, efficiency and effectiveness
is expected to help in achieving full value for money
The Comptroller and Auditor General of India
- To promote excellence in public sector audit and accounting services towards improving the
quality of governance.
Types of Audit
Performance Audit, slowly developed as an attempt to measure the economy, efficiency and
effectiveness of the Government expenditure.
Performance Audit, Regularity (Financial) Audit, Regularity (compliance) Audit, IT Audit
Strengths of External Audit in India
The CAG has a high status enshrined in the constitution, upheld by long traditions of public
audit in India.
The institution of audit under the CAG is often regarded as the fourth pillar in the democratic
setup and an essential instrument of financial control and accountability.
The constitution of India ensures independence and autonomy of the public audit.
The expression `Audit' or scope of the audit has not been defined either in the constitution or
the CAG's DPC Act, 1971
The scope of external audit is, therefore, wide.
Audit can respond to changes, reforms, new initiatives, changing patterns of Government activities,
international developments in the profession and rising expectations of the stakeholders
regarding public accountability.
The CAG has the power to determine the nature and extent of audit and related access to records
and to relevant information.
The CAG has the inherent right to determine what should be included in the Audit Reports.
There is a requirement that Audit Reports should be tabled in the Parliament/ legislature and
thereafter these become public documents.
There are well documented Audit Manuals and audit guidelines for the Auditors to follow.
Auditing Standards framed on lines of INTOSAI (International Organization of Supreme Audit
Institutions) guidelines are available
Challenges before the External Audit
There is hardly any accountability for not taking timely action on audit observations.
There is a feeling that the CAG's reports are sometimes not timely because there is substantial
time gap between occurrence of an irregularity and its reporting by Audit.
CAG's audit itself is post facto - its findings and recommendations may be too late for
Audit findings are based exclusively on documents and files
There is a feeling that external audit reports tend to be unduly negative and their focus is on
irregularities and fault finding.
Audit does not always recognize the practical constraints under which the Government/Government
Audit often does not discriminate between errors arising out of bonafide intentions/malafide
Audit Reports are not always presented in a sufficiently constructive manner
Audit must therefore identify systemic problems.
Audit does not give due credit for good performance.
The relationship between the auditor and auditee is not always harmonious.
Audit is viewed as a system for policing Government Organisations.
There is inadequate synergy/coordination between external audit and internal audit.
There is rarely any audit of grants and loans to NGOs.
Accountability to Parliament
In scrutinizing the Appropriation Accounts and the Report of the C&AG thereon, the committee
that the moneys shown in the accounts as having been disbursed were legally available for,
and applicable to, the service or purpose to which they have been applied or charged;
that the expenditure conforms to the authority which governs it;
that every re-appropriation has been made in accordance with the provisions made in this
behalf under rules framed by competent authorit
to examine the statement of accounts showing the income and expenditure of autonomous
and semi-autonomous bodies,
to consider the report of the comptroller and Auditor-General in cases where the President
may have required him to conduct an audit
Departmentally related Standing committees
The general procedure relating to Demands for Grants
after the general discussion on the Budget in the two Houses is over, the Houses shall be
adjourned for a fixed period
the committees shall consider the Demands for Grants of the concerned Ministries during
the aforesaid period;
the committees shall make their report within the period and shall not ask for more time;
the Demands for Grants shall be considered by the House in the light of the reports of the
there shall be a separate report on the Demands for Grants of each Ministry.