James H. Potts
ASSOCIATEPROFESSOR OF ACCOUNTING ANDFINANCE THEUNIVERSITY OF WEST FLORIDA

THE EVOLUTION OF BUDGETARY ACCOUNTING THEORY AND PRACTICE IN MUNICIPAL ACCOUNTlNGFROM1870

Introduction

A distinctive characteristic of governmental accounting is the re-quirement to demonstrate compliance with legal restrictions con-cerning control of revenues and expenditures. In fact, control or budgetary accounts must be integrated into a governmental unit’s system of accounts. The National Committee on Governmental Accounting considers the budget and its accompanying control features of such significance that its third principle states:

“An annual budget should be adopted by every governmental unit whether required by law or not, and the accounting system should provide budgetary control over general government revenues and expenditures.”1

The practices of opening budgetary accounts at the beginning of each fiscal year and of closing these accounts at the end of each fiscal year and the integration of the budgetary accounts with the proprietary accounts during the year are almost universally accepted in modern governmental accounting.

This paper briefly discusses the highlights of the evolution of budgetary accounting from approximately 1870. No attempt was made to deal with the evolution of budgetary accounting prior to this period.

Emphasis on the Need for Budgetary Accounts

The first published work describing the double-entry bookkeeping system and providing insight into the reasoning process supporting the accounting records was published in 1494 by Luca Pacioli in Venice. Around 1870 Michele Riva and Guiseppe Cerboni developed a method which incorporated the budgetary accounts in the accounting system.Interestingly, the credit for the development of logismography – a quadruple entry system – is also an Italian contribution.

A distinguishing characteristic of municipal accounting began during this era with the development of separate proprietary and budgetary accounts. Michele Riva, the accountant for the municipality of Ferrara, had set himself the task of proving the inapplicability of double entry to all phases of government finances. Government had two functions, according to Riva : the legislative, concerned with creating the budget and determining the sources of revenue, and the executive, concerned with collecting revenue and authorizing the disbursements voted in the budget. Riva believed the state needed two types of bookkeeping: one for purposes of the budget and all the rights and duties it gives rise to; the other for control of receipts and disbursements.

In 1872 Guiseppe Cerboni published his work on logismography. As administrative director of the war ministry, Cerboni immediately applied his system to its activities. Cerboni convinced the Italian legislature of the efficacy of his system with respect to solving the difficulties of governmental bookkeeping. In 1876 Cerboni was appointed Accountant General of Italy. He immediately extended the system to include all state accounting and thus, the three elements of governmental administration (budgeting, rights and duties entailed by the budget, and receipts and disbursements) were dovetailed into a single system of bookkeeping.

According to peragallo’s interpretation of logismography, only two fundamental accounts with their subdivisions are required: the proprietor’s account and the account which groups together debtors, creditors and employees. Cerboni assumed that the interests of these two groups were unalterably opposed. In applying Iogismography to governmental bookkeeping, Cerboni changed the names of his two fundamental accounts to state and govern, for parliament with its legislative prerogatives and to the executive who executes the laws of the parliament, respectively.

Cerboni maintained that the state has the right to determine the budget and the government has the duty to accept it and carry it out. And when the budget is executed, the government has the right to have this fact acknowledged and the state has the duty to recognize it. Translated into bookkeeping terms, this means that when the budget is approved by the parliament, the state is credited and the government is debited for the sums appropriated in the budget, and that, when sums necessary to meet the budget are raised through taxation and disbursed according to the budget, the state is debited and the government credited.

In Cerboni’s system the general ledger, as it is conceived in dou-ble entry, is eliminated and in its place is substituted an enlarged journal. All transactions are classified into two groups. In the first are placed all transactions which either increase or diminish capital. In the second are placed all transactions which neither increase nor diminish capital. These latter transactions include the exchange of one asset for another or one liability for another, the elimination of a liability by surrender of an asset, or the acquisition of an asset by an increase in liabilities.

Logismography lasted as long as Cerboni remained in the post of Accountant General, and was dropped in 1893 for a system similar to double entry. While Cerboni’s method was found to be too complicated to be maintained, he made an important contribution by recognizing the need for budgetary accounts in governmental accounting.
Developments to 1910

English accountants also considered the problem of dealing with the budget in the accounting system. Apparently, English thought had not progressed to the point where budgetary information was integrated into the bookkeeping scheme.

In an article published in 1887 S. Cooke recognized the need for control of expenditures and the necessity of keeping the cash outlays within the expected revenues and proposed a worksheet with the following headings to facilitate the preparation of the desired information:

Column 1 Estimated expenditures to end of current year
Column 2 Expenditures to date
Column 3 Amounts expended since date of last report
Column 4 Balance available
Column 5 Expenditures in excess of estimate.”5

Cooke explains the meaning of each column heading in the fol-lowing manner:

“Column 1 would show the estimated expenditures for the whole year.
Column 2 would show the amount expended through the preceding month. This amount would be ex-tracted from the general ledger.
Column 3 would show the amounts expended in the cur-rent month. These amounts would be taken from bills presented for payment.
Column 4 would show the balance available for the re-mainder of the year and would be obtained by subtracting the sum of Columns 2 and 3 from Column 1.
Column 5 would show the excess of expenditures over the estimated revenues and would be obtained by subtracting Column 1 from the sum of Columns 2 and 3.”6

Cooke’s worksheet approach disclosed only a comparison of estimated and actual expenditures. Evidently, encumbrances were not considered in his approach. Since revenues were not explicitly mentioned by Cooke it seems reasonable to assume that estimated revenues and estimated expenditures were equal at the beginning of the fiscal year.

By the 1904-1908 period, there was trans-Atlantic dialogue with articles by accountants from the United States appearing in the British journal, The Accountant, and articles by British accountants appearing in the American publication, The Journal of Accountancy. in one such article, American Ernest Reckitt acknowledged that the legal subordination of the whole system of municipal accounting is detrimental to accounting for assets, liabilities and surplus of revenue over expense. Further, a corresponding laxity of methods existed with respect to the way appropriation accounts were kept.

Reckitt explained at some length that an “appropriation fund” is not a fund at all in the sense of amounting to a segregation of money. Reckitt found it unfortunate that the emphasis in municipal accounting was primarily on fund records and only secondarily on assets and liabilities. Reckitt did not attempt to present in detail a method of appropriation accounting, but recommended the essen-tials of a system by listing the following points:

“1) No appropriation account should be kept in the General Ledger, but a separate account should be kept to record the expenditures of each appropriation. The effect of this plan will be that until the close of the fiscal year the balance of the general fund will represent net revenues; and the ledger balances will in all cases repre-sent either assets or liabilities in a manner similar to any mercantile or commercial concern.

2) An Appropriation Ledger and Journal should be kept and an account with each appropriation opened, each account to be credited with its respective appropriation and charged each month with the total of the ex-penditures applicable to same.

3) The Appropriation Ledger, in order to balance within itself, should carry a “General Appropriation” Account which would be charged with the total appropriations and credited by the total monthly expenses.”

Reckitt’s position was echoed by Ulman in an article published four years later:

“Revenue from taxation, licenses, interest, fines, permits, etc., is appropriated to the credit of the various depart-ments or funds and when disbursed is charged against those departments or funds. Thus the account closes out and nothing remains to tell what the money went for , . . . Thus the appropriation account by affording a gravelike resting place for cash disbursements constitutes a serious evil in public life. It has hidden more official irregularities in the past than any other device known . . . except perhaps burning the books.”

Ulman urged the elimination of the appropriation accounts from the general ledger, thus allowing all revenues to be credited to accounts which show the sources from which they come and requiring expenditures to be charged to asset or expense accounts. Under Ulman’s system posting to appropriation or fund ledgers would be made independently of the transaction postings in the general ledger. Clearly, the discussion centered on the question of the desirability of the integration of the appropriation accounts in the general ledger or on the maintenance of the appropriation accounts separately from the general ledger.

The review of the literature of the period shows that by 1908, municipal accounting thought had evolved to the point of requiring a system or systems utilizing both proprietary and budgetary ac-counts. Frederick Cleveland pointed this out when he said that, to obtain any degree of control, “it will be necessary to institute both a system of asset and liability accounts, and a general classification of income and expense accounts, in addition to the appropriation or fund accounts.”’10
Impact of New York City’s Accounting System Revision

Probably the most significant single event lending impetus to the development of budgetary accounting in the United States was the

The Accounting Historians Journal, Spring,1977

revision which began about 1906, in New York City’s accounting system. At the time of the reorganization no records were main-tained of open market orders or contract claims and no central accounting records of vouchers payable were kept. Warrants were charged to the various boroughs of the city, while control over expenditures could be exercised only on a departmental level.

A series of articles in 1909 by Harold D. Force, of the New York City Finance Department, provided an in-depth discussion of some of the accounting revisions made up to that time. The new system required the issuance of some original document, in advance of expenditure, for all classes of transactions except payrolls. Transactions were classified into four main divisions:

1) Open Market Orders
2) Contracts
3) Miscellaneous Claims
4) Payrolls.11

Very likely, the most significant achievement of the revised sys-tem was the inclusion of a scheme of entries which afforded a major element of control against spending beyond the amounts appropriated. The New York reorganization incorporated basic elements of a comprehensive system into municipal accounting records. The inclusion of the proprietary and fund accounts and the recognition of encumbrances upon appropriations, constituted a milestone. While much improvement and refinement remained to be accomplished, future progress was made much more rapidly than in the past.

Exposition of the “Dual-System”

Within a year after Force’s rather incomplete schematic of the New York City system, Frederick Cleveland published an outstanding demonstration and explanation of the importance of the budgetary accounts. Cleveland recognized that a municipal corporation has unique conditions not shared by private corporations. Because the citizenry has enfranchised it to acquire its resources through eminent domain and granted other powers of sovereignty, its agents are permitted to proceed only upon specific authorization.
To this end Cleveland suggested that the general ledger incor-porate the following budgetary accounts:

“Budgetary Debit Accounts Budgetary Credit Accounts

a) Estimated requirements a) Authorizations to incur li-
b) Available balance
(other abilities(unencumbered than cash) balance) Unapplied balance (net cash) b) Reserve for contracts
c) Reserve for open market orders

d) Other reserves

e) Free and appropriable surplus”

Definitions of the above terms were as follows:

“Estimated requirements—A Debit fund account for the purpose of showing the amounts of estimated revenue to meet obligations previously authorized.The account bal-ance would be the difference between the estimates and the amounts actually accrued or collected. Available balance (other than cash)—A debit account showing the amount of taxes levied accruing to the benefit of each fund or class of funds and which reduces the estimated requirements.

Unapplied balance (net cash)—a debit accounting show-ing the amount of cash available after deducting all obli-gations against the fund.

Authorizations to incur liabilities—a credit account which shows the balance unencumbered of all authorizations to incur liabilities. The administrative value of this account cannot be overestimated. If a fund cannot be overencum-bered, it cannot be overspent.

Reserve for contacts, reserve for open market orders, other fund reserves—credit accounts which show basically the amount of encumberances outstanding. The balance in these accounts would be the total amounts entered into less vouchers or warrants drawn for payment.”

While Cleveland’s original examples were considerably more detailed and complex, the essence of the proposed system was evident. Basically, his “dual-system required a complete general ledger for the budgetary accounts as well as a complete general ledger for the proprietary accounts. With few exceptions, each time a journal entry was made in the proprietary accounts a corresponding entry would be made in the budgetary accounts. Perhaps the unique feature of his presentation was the statement of the budgetary accounts at the end of the fiscal period. From the context of his presentation it appears that the budgetary accounts would be carried over from period to period.

Cleveland’s “dual-system” was perpetrated further in 1913 by the Handbood of Municipal Accounting published by the New York Bureau of Municipal Research. The accounting system promul-gated in the Handbook was the generally accepted authority for the next fifteen years.

The Handbook treated estimated revenue as an asset. In discussing the budgetary account used to record the estimated requirements to meet budget authorizations the authors noted that a credit balance in the account at the end of year would indicate that expectations had been more than realized. A debit balance would indicate the converse and, assuming the full amount of appropriations had been expended or obligated, “must herefore be considered a prospective asset inasmuch as it must be provided for in the tax levy of the following year.13 This use supported the contention that budgetary accounts were not closed at the end of the fiscal period, but were carried forward from period to period.

First Movement Away from the “Dual-System”

Francis Oakey recognized the need for the inclusion of the bud-getary accounts in the accounting system, but, unlike Cleveland and the Bureau, Oakey included the budgetary accounts in a for-mat he called Statement of Resources and Obligations. The com-bination of the budgetary and proprietary accounts in one statement was a significant departure from generally accepted practice which materially affected later developments in municipal accounting.

Oakey justified the inclusion of the budgetary accounts in the statement on the basis that the administration of a fund must be based on a financial plan or program covering the fiscal period. Therefore, the accounts and reports relating to the financial condi-tion of the fund must include all resources that are, or will be, available within the fiscal period as well as all obligations that are, or will be, incurred during the fiscal period. Given this position, the accounts and statements must include balances that are not yet assets reduced to possession or realization and obligations which do not as yet represent realized liabilities. Oakey’s Statement of Resources and Obligations significantly increased an administrator’s potential for efficient management. The statement enabled financial executives to quickly determine liquidity at any given point in time and facilitated future planning. After making the case for the inclusion of the budgetary accounts, Oakey stated:

“Consequently, a consolidated statement of all fund re-sources and obligations does not represent the assets and liabilities of a government as a whole, and, except for budgetary purposes, is of no value as a basis of information because it is composed of elements that have either a very limited, or no, relation to each other.”14
While Oakey agreed that a Statement of the Resources and Obligations of a fund should include the budgetary accounts, his concept of a municipal balance sheet was strikingly different. The balance sheet of a government should not include the budgetary accounts, nor should it include any assets and liabilities represent-ing the government’s responsibility as custodian, agent or admin-istrator.

The Advent of Current Treatment of Budgetary Accounts

Between 1926 and 1933 Lloyd Morey wrote two books on municipal accounting and published numerous articles. His writings covered the full range of municipal accounting, including the necessity for both budgetary and proprietary accounts in the municipal accounting scheme.

Morey held that the use of the dual system, requiring a complete double entry in the proprietary accounts and a corresponding double entry in the budgetary accounts, accomplished no real purpose. Such a system, according to Morey, resulted in an unnecessary duplication of accounting entries and a false showing of financial condition. Resources of a fund consist of its assets in hand and the resources expected to be realized during the fiscal period; the obligations of a fund consist of the actual liabilities and the obligations in the forms of orders and contracts outstanding. The excess of resources over obligations represent the sum available for further appropriations. No other figure of fund surplus, according to Morey, can be of significance for any purpose.

In municipal accounting literature, Morey’s contained the first definitive statement with respect to the disposition of the budgetary accounts at the end of the period:

“At the end of a fiscal period, budget accounts are as-sumed to be closed and the balance sheet is, therefore, automatically reduced to accounts of real assets and li-abilities.”15
In 1926, Morey demonstrated his system for unifying the budgetary and proprietary accounts of each fund. The terminology suggested by Morey in this article bears a marked similarity to the terms used in current municipal accounting literature. For example, Morey’s simplified scheme of journalizing employs such account titles as Estimated Revenues, Appropriations, Reserve for Encumbrances, and Unappropriated Estimated Surplus.16 In the interest of simplicity, Morey suggested that the accounts of Available, Balance, Unapplied Cash, Reserve for Temporary Loans, and others be dropped and the above accounts substituted in their places.

Under Morey’s system all budgetary accounts except Unappro-priated Surplus and Reserve for Encumbrances would be closed at the end of the fiscal period. Unappropriated surplus would be carried forward as “an obligation of the succeeding period.”17 Nor did Morey’s system include the Reserve for Encumbrances as part of the unappropriated surplus. With the exception of the “net revenue” approach-the inclusion of actual revenues and estimated revenues in one account and the charging of appropriations with expenditures-Morey’s presentation was strikingly modern.

By 1934 Morey’s system of budgetary accounting was supported by H. A. Finney and Carl Chatters. In his Advanced Accounting Finney followed Morey’s “simplified” system, “which is recommended in preference to the somewhat older, and more involved, dual account system.”18 Chatters’ Accounting Manual for Small Cities also generally follows Morey’s recommendations regarding the treatment of budgetary accounts.
Conclusion

This study shows that the evolution of budgetary accounting since 1870 has progressed through several well defined stages. Contrary to popular impression this evolution did not, like Topsy, “just grow.” Rather, it was consciously and effectively directed by persons who articulated accounting systems which reflected their particular beliefs. At any given time existing systems were no more than the definitive statements of procedure by those who held a specific theory of municipal accounting systems.

Perhaps an important lesson for the future can be learned from Eldon Hendricksen:

“. . . In all disciplines, theories and concepts are developed in historical continuity. One thought leads to another. Where we are today depends in large part on where we were yesterday. In fact, many of the things we do are based on reasons no longer relevant; we have even lost sight of many of the reasons . . ,”19

FOOTNOTES

1National Committee on Governmental Accounting, p. 5.
2Peragallo, pp. 112-13.
3Ibid., p. 113.
4Ibid.
5Cooke, p. 166.
6lbid.
7Reckitt, p. 411.
8lbid., p. 413.
9Ulman, p. 270.
10Cleveland, “Municipal Credit and Accounting Reform,” p. 176.
11Force, pp. 107-21.
12Cleveland, “Uses and Purpose of a Municipal General Ledger,” p. 402.
13Handbook of Municipal Accounting, p. 40.
14Oakey, p. 229.
15Morey, “Finding Correct Principles of Public Accounts,” pp. 151-59.
16Morey, “Fund and Proprietary Accounts in Governmental Accounting,” pp. 77.
17lbid., p. 38.
18Finney, p. 519.
19Hendricksen, p. 15.

BIBLIOGRAPHY

1. Frederick A. Cleveland, “Municipal Credit and Accounting Reform,” The Jour
nal of Accountancy, June, 1906.
2. Frederick A. Cleveland, “Uses and Purposes of a Municipal General Ledger,”
The Journal of Accountancy, October, 1910.
3. S. Cooke, “Municipal Accounts,” The Accountant, March 10, 1887.
4. H. A. Finney, Principles of Accounting-Advanced, New York,Prentice Hall,
1934.
5. Harold D. Force, “New York City’s Revision of Accounts and Methods,” Part II,
The Journal of Accountancy, June, 1909.
6. Handbook of Municipal Accounting,New York,D. Appleton and Company,
1913.
7. Eldon S.Hendricksen, Accounting Theory,Homewood,Illinois,Richard D.
Irwin, Inc., 1965.
8. Lloyd Morey, “Finding Correct Principles of Public Accounts,” (a speech pre
sented to ,the American Association of University Instructors in Accounting,
December, 1926) in Lloyd Morey, Manual of Municipal Accounting, New York,
John Wiley and Sons, 1927.

100 The Accounting Historians Journal, Spring,1977
9.Lloyd Morey, “Fund and Proprietary Accounts in Governmental Accounting,” The Accounting Review, June, 1926.
10. National Committee on Governmental Accounting, Governmental Accounting,
Auditing and Financial Reporting, Chicago, Municipal Finance Officers Associ
ation, 1968.
11. Francis Oakey, Principles of Government Accounting and Reporting, New York,
D. Appleton and Co., 1920.
12. Edward Peragallo, Origin and Evolution of Double Entry Bookkeeping, New
York, American Institute Publishing Company, 1938.

13. Ernest Reckitt,”Appropriations inRespect toMunicipal Accounting,”The
Accountant, October 15, 1904.
14. Stephen,Ulman, “UniformMunicipal Accounting,”The Journal of Accoun
tancy, August, 1908.