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MINISTRY OF FINANCE
Introduction to
a Cost-Based
Appropriations System
April 2006
Ministry of Finance
2
Introduction to a Cost-Based
Appropriations System
April 2006
3
Introduction to a Cost-Based Appropriations System
April 2006
Rounding off in tables may result in
figures not adding up to a total.
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This publication may be found at
the Ministry of Finance Home Page
www.fm.dk
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Table of Contents
1. Introduction ...................................................................................................................... 5
Overview of the new appropriations system .................................................................... 5
Background to the reform ................................................................................................ 6
2. Management: Tasks, roles, and responsibilities .............................................................. 9
Agency-level management's tasks and responsibilities ................................................... 9
A more cost-conscious use of resources .................................................................... 9
A better basis for internal economic management and leadership of central
government institutions..............................................................................................10
A greater transparency over what government projects cost to complete .................12
Projects and responsibilities of the Department.........................................................13
3. The new appropriations model.........................................................................................14
Scope of the reform ..........................................................................................................15
Cost-based appropriations ...............................................................................................15
Borrowing limits .............................................................................................................16
Purpose of the borrowing limit ..................................................................................17
What does the borrowing limit include? ....................................................................18
Liquidity and financing ...................................................................................................19
Liquidity distribution .................................................................................................20
Interest rate terms ......................................................................................................21
Special terms of construction and IT credit ..............................................................22
Transparency of minor consumption ...............................................................................23
Rules of presentation........................................................................................................25
4. Conversion from expense-based to cost-based appropriations .......................................29
5. A brief look at the new accounting principles .................................................................32
Purpose of cost-based accounting ....................................................................................32
Cost principles .................................................................................................................32
New government accounting rules ..................................................................................34
6. Review of concepts .........................................................................................................36
Publication went to press on March 27, 2006
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1. Introduction
The central government appropriations system is converting from expense-based budget
and accounting principles to cost-based principles. All central government institutions
converted to cost accounting in 2005, and in 2007 all government institutions will convert
to cost appropriations. This entails fundamental changes in the methods and terms under
which government agencies will operate in the future. The conversion is the culmination
of a long process, in which the Ministry of Finance, Auditor General’s Office, and many
ministries and committees have been involved. The new appropriations rules are
described in “Budget Guidelines 2007,” while the new accounting rules appear in the
Ministry of Finance’s “Economic Administrative Guidelines.”
This publication is designed for users of the new appropriations system--managers,
finance personnel and all others, who as a part of their employment work with the
Appropriations Act and its associated rules. This publication provides an overview of
what the appropriations reform involves, both on the managerial level with regard to
roles, responsibilities and tasks and with respect to the new tools and concepts. A number
of examples are given to illustrate the effects of the new appropriations system.
References are also given for a large number of other publications from the Ministry of
Finance and Finance Committee containing more details about the reform.
Overview of the new appropriations system
The cost-based appropriations system is characterized by the following:
 The cost principle uses a different periodicity for economic events in accounts and
budgets--accounts will in future show the use of resources including depreciation rather
than the period’s income and expenses as before. Similarly, an appropriation will cover
the period’s use of resources. The major difference between now and before is found in
investments and acquisitions.
 Investments and acquisitions are financed within the government’s liquidity scheme
(“loan financed”). Institutions will now keep the generated costs (depreciation and
interest) within the appropriation. This means that operating investments can be started
before the funds have been saved for it--thus creating an increase in an institution’s
margin over the long run. This gives institutions an incentive to optimize their investment
decisions.
 And yet, an institution does not have unlimited entitlement to make loans, because a
borrowing limit for each central government institution is specified in the Appropriations
Act. The borrowing limit is a ceiling on the maximum amount that an individual
institution can obtain.
 Furthermore, the ability of an institution to utilize the maximum amount is limited by
the necessity of paying the costs generated from within the appropriation, a solidity
6
requirement that the total debt may not exceed gross assets, and by rules on presentation
of investments, etc.
 There will be greater transparency of unused appropriations, as funds in the future
will be booked as revenue when the project is completed. If completion is delayed, the
funds will be reserved. If the project is finished using fewer funds than anticipated, the
surplus may be freely applied to any of the agency’s objectives.
 The independent liquidity scheme is renewed and expanded to all central government
institutions. It means, among other things, that there is interest on the institution’s internal
government debt, which gives increased incentive to liquidity management as well as
management of debtors and creditors, etc.
 A new governmental account plan will be introduced starting with the Appropriation
Act for 2007. The new account plan achieves a standardization of the functions of the
most utilized financial systems within and outside the country.
Together the new accounting and appropriations system provide a basis for improved
financial management in government. This requires meanwhile that the institutions are
prepared to tackle the increased responsibility that comes with the new measures of
freedom. Along with increased transparency it will provide fertile soil for continuous
improvement of governmental efficiency. This, however, assumes that the departments
and agencies embrace the reform to ensure that it does not remain a purely technical
exercise. This requires upgrades in competency, as well as management’s active
investigation of the new information and utilization of the new opportunities offered by
the reform.
The cost reform will also bring new roles, tasks, and responsibilities to the departments
with regard to their agencies. The departments must pay more attention to the agencies’
long-term planning, investment decisions, liquidity drain, etc.
Background to the reform
The introduction of cost accounts into central and local government occurred in May of
2002 as a part of the government’s modernization program. The modernization program
led further to an evaluation of the possibility of introducing cost-based budgets into
central and local governments.
On the basis of the work done by a committee appointed by the Ministry of Finance,1 the
Finance Committee expressed its approval in Act 97 of March 2003 for conducting a trial
with cost accounts in 2003 and 2004. It was stated at that time that, based on the
outcome of the trials, a proposal for budget and accounting reform would be made.
The committee’s work resulted in the report “Cost and Efficiency in Government,”
which contained models for how a cost-based accounting and budget system most
appropriately could be applied in government. The report is found at www.fm.dk.
1
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The Finance Committee gave its approval in Act 163 of June 24, 2004 for all central
government institutions to convert beginning in 2005 to cost accounts, and beginning in
2007 to cost appropriations. Furthermore, approval was given to conduct trials with cost
appropriations.2 The trials with cost appropriations that were put into the Appropriations
Act of 2005 and 2006 is treated in “Circulars on Trials with Cost Appropriations” (2004).
The rules for allocation in the new appropriations system were approved by the Finance
Committee in Act 105 of March 15, 2006 and are described in Budget Guidelines 2006.
The Budget Guidelines can be found at www.fm.dk and the Act may be found on the
home page of the Folketing [Parliament].
2
Some of the agencies that participated in the trial with cost appropriations for the
Appropriations Act of 2005 have described their experiences with conversion to cost
appropriations in the collection of articles: Experiences with Cost Appropriations (2005).
8
Figure 1.1.a
COST REFORM PREPARATION AND IMPLEMENTATION
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2. Management: Tasks, roles, and responsibilities
The introduction of cost principles into government budget planning and accounting has
to do with improving government effectiveness through visibility, transparency, and costconscious behavior. The cost reform makes visible the true costs of producing specific
projects. Transparency of costs provides politicians and administrative leadership a better
basis for prioritizing use of resources.
The cost reform thus also has to do with improving behavior, in which government
agencies are urged to think to a higher degree about operating costs through inspiration
from private enterprise. Investment planning, borrowing, interest, liquidity management
and depreciation respective reinvestment are central tools and themes in the new financial
management. The actual consequences and obligations of financial dispositions over a
series of years will be more visible than before. It requires in itself increased
responsibility and will to supervision. Management’s time perspective will thus expand.
As the reform will be implemented in phases, there is time for the reformulated
principles--through adjustments and competency-building--to affect management
behavior. The benefits that administrative leadership in departments, committees and
agencies achieve in the form of increased levels of freedom correspond to greater
management responsibility. Comprehending and mastering this represents one of the
reforms greatest challenges.
Agency-level management’s tasks and responsibilities
On the agency level the goal of the reform is to achieve:

a more cost-conscious use of resources;

a better basis for central agency internal economic management and leadership;

a greater transparency concerning what it costs to carry out government projects.
A more cost-conscious use of resources
The cost principle means that an appropriation is booked in the years when the
consumption of the resource actually occurs. Its periodicity renders a more accurate
picture of the real draw on resources in the applicable fiscal year. In the new cost-based
budget system investments are financed through borrowing, and the agency budget is not
affected by the total expense in that year. Instead, investments are recorded in the budget
corresponding to annual costs; that is, they are activated as depreciation and interest of
the invested capital.
Thus it will be easier for agencies to undertake profitability considerations on how long it
will pay to maintain old buildings and machinery and when it will pay to reinvest.
Incorrect investments will also be more perceptible. When the value of a large investment
10
does not measure up to the total costs of the project, the accompanying write-offs will
burden the appropriation. Gains as well as losses fall to the agency.
Cost budgeting is therefore a method to economize through the total use of production
factors, including laborsaving investments.
Box 2.1
Example of an IT investment in a cost-based appropriations system
Management wishes to invest in an electronic case management system costing DKR 25 million.
On the basis of a preliminary investigation a savings potential of DKR 6 million annually is
identified under regular operation. The system is assessed as having a lifetime of 5 years. On this
basis, the agency borrows DKR 25 million over the borrowing limit and depreciates the asset
linearly over 5 years—by DKR 5 million annually. In this example, there is an interest rate of
3.25 percent annually. The agency thus receives a DKR 2.6 million margin over 5 years. The
project’s total economy is illustrated below.
Table A
An example of an IT investment
Yr 1
Yr 2
Yr 3
Yr 4
Yr 5
Total
economy
25
0.81
5
6
0.19
20
0.65
5
6
0.35
15
0.49
5
6
0.51
10
0.33
5
6
0.68
5
0.16
5
6
0.84
25
30
2.56
Million DKR
Principal sum
Interest (3.25%)
Depreciation over 5 years
Operating savings
Margin
A similar investment could also be made in the previous expense system. It would, however,
entail that the agency itself had DKR 25 million to finance the expenditure in year 1, or that the
Folketing would grant the agency an additional appropriation of DKR 25 million to cover the
expenditure.
Previously investments such as this were presented to the Finance Committee. With the
cost-based appropriations system the agency itself can decide to initiate the investment
because the presentation requirement to the Finance Committee has been removed.
However, for an agency to initiate an investment on its own, the agency must have a
depreciable appropriation and sufficient borrowing capacity to obtain the initial loan.
A better basis for internal economic management and leadership of central
government institutions
The reform contains a series of new tools to promote efficient and cost-conscious
dispositions. The reform provides, among other things, greater freedom to initiate
investments. It will thus be possible to increase an agency’s economic margin through
profitable investments. Of course, greater responsibility accompanies this freedom. The
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introduction of cost principles brings heightened visibility as to the viability of the
investment decisions that have been made.
It is consequently important that administrators in future acquire a multi-year perspective
on the economic framework. Decisions made today, to a higher degree than before, will
have a detectable impact on the institution’s future economic situation. It will therefore
be necessary in the future to have a multi-year budget horizon—especially in regard to
investment decisions. Appropriations will continue to be annual.
Box 2.2
The Pharmaceutical Board’s long-term perspective
“Undoubtedly the most important element in the reform is its periodicity and thus also it’s longterm perspective in accounting. It is hardly a big secret that many agencies plan one or two years
at a time and that long-term budgeting and future planning are not sufficiently well formulated or
cohesive to be useful in the concrete decision process. Incentives have not been in place, latitude
and inter-dependency is minimal in the appropriations, and specifications in the BO [budget
estimation] years are often almost copies of previous years. If complete control over long-term
budgets and cash flow has not yet been achieved, it needs to be done as soon as possible.
Long-term perspective primarily enters into the process in connection with determining the
investment budget. In order to determine the investment amount for appropriations it is obviously
crucial that one has control over investing in the budget year and the BO years.
In the BO years it is natural that investment plans will be less well formulated. In a typical casemanagement agency, as in the case of the Pharmaceutical Board, the major portion of investment
expenditure is connected to development of IT systems for support in case management. With the
rapid development that exists in IT technology and the need for state-of-the-art IT systems, it is
not possible to predict the need much more than a year in advance.”
Source: “The Experience of the Pharmaceutical Board with Appropriations Reform” in Ministry
of Finance (2005), Experiences with Cost-Based Appropriations.
A part of the goal of the reform is to further concentrate the agency’s focus on core
projects. Production of specific benefits and products must have an impact upon the
individual citizen and the society as a whole. The increased focus on output will be
achieved through various instruments.
The appropriation is booked as income at the same pace as projects are completed. If an
agency has not performed a project, the funds for it must be reserved for this purpose. It
is the agency itself that reserves the funds for unfinished projects. This requires a
heightened focus on documentation of project completion and increased clarity
concerning what it actually costs to accomplish the projects. In this way, actual project
completion and budget appropriation are linked. The model and heightened focus on
project backlog requires management to actively keep informed of how these reserves are
used up.
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The reserve appears in both the annual result and in the upcoming budget, in which it
must be specified when the project will be finished. From now on, the remarks will
contain information on the agency’s projects and goals as well as an overview of the
resources that are allocated to these. This will create a closer connection between finance
and the agency’s managerial documents, such as the performance contract.
The degree to which the agency has finished its projects and correspondingly not used up
its appropriation indicates that the agency has been efficient and created a surplus. The
surplus is basically free, that is, it is not necessary for further project use and can thereby
be held over to next year and used for other agency objectives.
A greater transparency over what government projects cost to complete
Cost budgeting can support future managerial needs by improving the basis for
prioritizing. This is due in part to the greater visibility concerning what individual
projects and activities cost, and in part to greater comparability between central
government agencies, and between government agencies and private enterprise. In a
slightly longer view, it will be possible to see which agencies are particularly efficient
and most capable of carrying out particular projects. Using systematic benchmarking,
agencies can find a basis also for evaluating whether they are competitive compared to
the market.
The introduction of cost principles can provide a better utilization of the existing capital
stock. Cost-based accounting gives agencies a better overview of their assets and creates
the basis for a better utilization of capital stock. The reform promotes a better utilization
of capital stock because the agencies can use the increased insight to undertake a critical
review of their assets and can potentially sell off excess assets. In this way, the individual
agency can create an increasing economic margin.
Box 2.3
The Agency for Government Management’s Experience with Profitability Considerations
“The argument for an investment will in future focus to a higher extent upon the profitability of
the investment. The political factor will naturally continue to exist, but this will be considered to a
higher degree than before in conjunction with profitability.”
Source: “The Agency for Government Management’s Experiences with Appropriation Reform”
in Ministry of Finance (2005) Experiences with cost appropriations.
Projects and responsibilities of the departments
The new appropriations system additionally provides agencies with greater freedom in
their financial planning and project management. Because of this it is necessary that the
departments consider how they will perform their oversight and monitoring of the entire
sphere of ministerial operations in the new appropriations system. There may be a need
for financial administration and the departments’ oversight of economic planning in the
13
agencies within the ministerial sphere to be further developed under cost reform. The new
information on the agencies’ financial situation and planning--for instance, investment
budgets, financing, borrowing limits and capital and reserves--must be integrated into the
administration of the ministerial sphere.
Box 2.4
Cost principles as basis for prioritizing in the Ministry of the Interior and Health
“The opening balance showed that cost-based budget and accounting principles can provide a
much sharper focus on an agency’s tangible and intangible fixed assets as well as lead to a
superior visualization and use of these. It was something of an eye-opener to find that a mediumsized administrative board such as the Pharmaceutical Board possessed intangible fixed assets,
primarily IT systems, of DKR 44 million and that intangible assets formed the major part of the
Board’s total fixed assets. It was also a bit surprising, but very informative, that calculation of
prepaid fee or project revenues--in connection with periodicity of income—could shed new light
over the backlog of open cases and therefore over the progress of cases in an agency.”
Source: “Ministry of the Interior and Health’s Experiences with Appropriations Reform”
in Ministry of Finance (2005), Experiences with cost-based appropriations.
With cost reform, the departments will obtain more relevant information on how and for
what purpose resources are being used in the boards and agencies of the ministerial
sphere. This should enable the departments to focus more upon output instead of input in
their oversight and administration of the entire ministerial sphere of operations. The
conversion to cost principles ensures better than before that goals and profit and loss
management focuses on the agencies’ production and output.
To promote the future administration in the ministerial sphere, it is important to prioritize
resources for developing the competency of existing and new budget and accounting
personnel. Professional upgrading is a prerequisite for the use of the new tools and a
prerequisite, as well, for the personnel to view the reform as an enhancement of their
competency and an opportunity for development. It is of great importance for the reform
that budget and accounting work is integrated.
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3. The new appropriations model
An overview of the new elements in the new appropriations system and their relationship
is given below. The following subjects are reviewed:

The scope of the reform

The cost-based appropriation

Borrowing limit

Liquidity and financing model

Transparency in savings

Presentation rules
In general, the reform targets government operating and fixed assets. Basically the reform
builds upon a different periodicity for economic events. It means that the appropriation
will cover the agency’s resource consumption during the finance year, through which a
relationship between the resources distributed and activities performed is created. The
investments in fixed assets must be financed by borrowing, while the appropriation is
charged only for the generated costs in the form of depreciation and interest.
Borrowing occurs within a borrowing limit, which puts a ceiling on the debt that the
individual agencies may have. The ability of an agency to fully utilize the borrowing
limit is restricted by rules that require the presentation of larger investment decisions
before the Finance Committee as well as a “solidity requirement,” in which the total debt
may not exceed the value of the fixed assets. Finally, the agency must always be able to
pay the generated costs in the form of depreciation within the appropriation.
There will be greater transparency of unused appropriations as the funds in the future will
be entered as income when projects are finished. If completion is delayed the funds are
put on reserve. And if the projects are completed at lower cost, the surplus may be freely
applied for use in any of the agency’s objectives. At the same time, the independent
liquidity scheme has been renewed and expanded to all central government institutions,
which reinforces incentives to liquidity management, management of debtors and
creditors, etc.
The overall administration of public finances will remain unchanged as the administrative
framework will not change. Only now, the framework will involve costs rather than
spending. Finally, the appropriation will continue to be the primary control instrument,
even though new control instruments such as borrowing limits and liquidity will be
introduced.
15
Scope of the reform
The reform targets operating and investment assets in government, providing agencies the
opportunity to adjust the mix of their assets in order to facilitate their projects. In this
matter, the introduction of cost-based appropriations affects the operating type and
government enterprise type of appropriation. Furthermore, the reform has significance for
fixed asset appropriations, as these will be abolished due to the fact that investments must
be financed by borrowing. In contrast, the reform does not affect transfers, subsidies, etc.
Exceptions to the appropriation reform are investments in infrastructure (roads, bridges,
railways, etc.) and in national property (palaces, gardens, monuments etc, of special
cultural worth). Finally, there are special circumstances for the Ministry of Defense
sphere. The defense forces and the home security forces are until further notice exempt
from appropriation reform, while the remainder of the Ministry of Defense sphere will
convert to cost appropriations with the Appropriations Act of 2007 along with the other
central government agencies.
The exception to the reform made for infrastructure and national property is due to the
special problems posed by these spheres. Neither infrastructure nor national property can
be characterized as real production factors--they represent instead the output to be
delivered. Thus it would not be possible for the Palace and Property Board administration
to dispose of Frederiksborg palace in order to save depreciation and instead acquire a
cheaper building in Næstved for displaying the chapel and portrait collection. As for
infrastructure, a further consideration is that investments in infrastructure have a political
policy significance, while it is also not meaningful to assess the worth and depreciate
assets that are national property.
Cost-based appropriations
An agency’s cost appropriation must cover the agency’s net costs including capital costs
in the form of depreciation and interest.
Previously, an agency was not charged interest in connection with the use of its assets.
The absence of capital costs has meant that an agency’s cost has not reflected the full cost
of the performance of their activities. From now on, an interest cost will be charged the
agency’s budget and thus the costs of implementing projects. Since the interest profits go
to into the government treasury and appropriations will be corrected for the new interest
costs with conversion to cost appropriations, the arrangement is basically expense-neutral
for both the government treasury and the individual agency. The new cost of interest will
provide an incentive for careful liquidity management and management of accounts
payable and receivable.
Further, a series of bookkeeping measures in future will reflect the real situation and will
come to affect the operating appropriation. Thus a depreciation of a fixed asset--like an
IT system--in the future will burden the appropriation. Likewise, a provision for future
16
obligations--as for instance renewal of a lease--will burden the appropriation in the year
the contract is made.
Conversion to cost appropriations does not change the overall structure--except for the
fact that the overall structure involves costs and not spending. This means that when
agencies finance investments through borrowing, the generated costs in the form of
depreciation and interest could reach into the operating appropriation. If the agency
increases its level of costs through increased investment, other parts of the agency’s costs
could actually be reduced.
Borrowing limits
The borrowing limit is a new concept in the central government appropriations system.
Essentially, agencies can now finance investments in fixed assets by obtaining an internal
government loan. Consequently fixed asset appropriations will be discontinued in those
areas included in the reform.
As investment expenses are no longer included in the actual appropriation, a borrowing
limit has been fixed that sets a ceiling for the debt an individual enterprise may have. The
borrowing limit may not be exceeded without prior approval of the Folketing.
Furthermore, the agencies cannot freely utilize whatever margin exists under the
borrowing limit. In part, the agencies will have an appropriation to cover depreciation of
their investments, and in part, the agencies will continue to lay investments that exceed
presentation limits before the Finance Committee.
In addition, the opportunity for agencies to utilize the borrowing limit is restricted by the
solidity requirement. This stipulates that an agency’s long-term debt obligations-measured by the construction and IT credit and the long-term debt--may not exceed the
value of the intangible and tangible fixed assets. Compliance with the solidity
requirement requires an agency to draw down the debt at the same pace that assets are
depreciated. When the asset is fully depreciated the debt is correspondingly paid,
creating space below the borrowing limit for new acquisition of a comparable asset.
The borrowing limit is fixed in the appropriations act in the finance statement under
remarks, see Box 3.3. If there are additional appropriations of the operating or
government enterprise type for the same enterprise, a so-called enterprise-bearing head
account will be designated, which will be the primary head account of the enterprise. The
borrowing limit may afterwards be divided between all the head accounts in the same
enterprise. This is illustrated in Box 3.1
17
Box 3.1
The Agency for Government Management’s description of an enterprise structure in the
appropriations act.
The Agency for Government Management includes:
07.12.01 Agency for Government Management--central government agency
07.11.12 Welfare Commission—appropriation for current operating costs
HK 07.12.01 is the enterprise-bearing head account. Both operating appropriations are included
under the cost reform. As HK 07.12.01 is the enterprise-bearing head account, the head account
receives the borrowing limit.
Purpose of the borrowing limit
The purpose of the borrowing limit is, first of all, that there continues to be political
control over total investment in the central government. An individual government
agency cannot decide in the course of the fiscal year to make investments if there is no
margin under the borrowing limit. Any increase in the borrowing limit will require a
presentation and will ultimately require an explicit political ruling on it.
Second, the borrowing limit serves a legal function with regard to appropriations. By
approving the borrowing limit for the enterprise-bearing head account in the
appropriations bill, the Folketing at the same time grants authority to the minister to
borrow in order to make investments.
Third, the borrowing limit ensures that sensible investment planning and prioritizing is
undertaken in the ministerial spheres. As excesses over the borrowing limit must be
presented to the Finance Committee, there is a greater incentive to do a thorough and
conscientious budgeting of debt and investments. At the same time, it gives the individual
agency greater freedom in planning its future activities.
Box 3.2
Brief look at the borrowing limit
The borrowing limit is a ceiling on the total debt that central government agencies may carry in
their government interest-bearing accounts. At the same time, the borrowing limit gives the
agencies authority to finance investments by borrowing.
An agency’s potential to utilize the margin below the borrowing limit depends, however, upon
whether the agency has appropriation funds to cover depreciation of the investments.
Furthermore, the total long-term debt must not exceed total assets, which means that an agency
must draw down its debt at the same pace as assets are depreciated. Agencies must from now on
present investments that exceed the presentation limits to the Finance Committee.
18
What does the borrowing limit include?
Just as the case with appropriations, the borrowing limit will be fixed primarily out of
consideration for the amount of investment and the amount of debt that, from the political
side, it is perceived that the agencies should have. This is primarily not dependent upon
the size of investments the individual enterprise has had historically or how large a debt
is anticipated in coming years.
Agencies can have three types of interest-bearing debt in their accounts in the National
Concern Payment System:1

short-term debt;

long-term debt;
 balance for construction and IT credit (development loan for current IT and
construction projects).
Only one total borrowing limit is fixed, which includes the debt from all three interestbearing government accounts. The short-term debt account and the line-of-credit can both
go into debit and credit, but only when the line-of-credit is negative does it affect the
borrowing limit. The contents of a line-of-credit cannot be offset to settle charges against
the borrowing limit.
Apart from the debt on the three interest-bearing government accounts, agencies can also
have other short-term debt obligations, for instance, debt to suppliers. These short-term
debt obligations, however, are not factored into the borrowing limit. The borrowing limit
is fixed in the financial statement under remarks concerning the enterprise-bearing head
account. Box 3.5 shows a financial statement for the National Library, which participated
in a pilot study of cost-based appropriations in ÆF 2005. In addition to the borrowing
limit, the overview also contains a description of the capital and reserves and the
agency’s debt to the National Concern Payment System.
1
The government accounts are administrated by the SKB system [Government Concern
Payment System] and is the government funding system. SKB handles deposit and
withdrawals to and from the agency. All deposits and withdrawals handled through SKB
from outside are automatically cleared through a special account set up by the Agency for
Government Management in the Central Bank.
19
Box 3.3
Financial Overview for the National Library
Table A
Capital and reserves, debt entries, and borrowing limits
Presentation
Final
year
Total
expense
R
2002
R
2003
B
2004
F
2005
BO1
2006
BO3
2007
BO3
2008
138.1
146.6
204.9
199.7
20.0
9.4
10.5
8.2
-
62.6
-
-
-11.5
146.6
-13.7
204.9
-15.7
199.7
-15.6
192.3
0.8
34.0
-
-
33.2
28.6
-
-
-
62.6
-
-
34.0
-
-
-
Million DKR
Total capital and
reserves
- subtract adjusted
capital
- subtract reserves
- subtract provisions
- subtract retained
surplus
Long-term debt, start
of year
+ acquisitions
+ accessed
construction and IT
credit
- Installment
Long-term debt, end
of year
Construction and IT
credit, start of year
+ current projects
- projects transferred
to long-term debt
Construction and IT
credit, end of year
Short-term debt
Total debt
Borrowing limit
Degree of utilization
xx.x
xx.x
xx.x
xx.x
-
1.0
2.4
5.0
180.6
226.4
79.8
205.9
226.4
90.9
202.1
226.4
89.3
197.3
226.4
87.1

The borrowing limit imposes a restriction on the total debt of the agency as seen in the agency’s financial
statement. At the top of the financing statement the capital and reserves appears. After this comes the long-term debt at
the beginning of the year, which largely corresponds to the agency’s assets.

The long-term debt at year’s end represents loans obtained for acquisitions and transfers from the construction and
IT credit. From this, the year’s installment is subtracted. The total debt is obtained by combining the balance of the
construction and IT credit and the short-term debt--in this case DKR 180.6 million in 2007.

The borrowing limit is fixed here to the highest budgeted loan volume in the F [fiscal] and BO [budget estimate]
years plus a buffer of 10 percent.
Liquidity and financing
Liquidity will be to a greater extent an independent managerial parameter, which is due
to the changed periodicity that creates a bigger shift in time between appropriation and
the need for liquidity.
20
Liquidity distribution
In the new appropriations system the principles for liquidity distribution and financing
are changed. The set-up for independent liquidity is expanded to include all payments,
that is, payments arising from operations as well as investments. Agencies are introduced
to liquidity on account corresponding to the appropriation, also even if portions of the
appropriation do not drive liquidity. On the other hand, the agency does not receive
liquidity corresponding to its acquisitions--acquisition shall in future be financed by
borrowing.
To support the changed appropriation distribution four new government accounts have
been set up for each enterprise in the National Concern Payment System [SKB accounts]:
1.
A financing account (FF7) (also called a line-of-credit) for clearing ordinary
payments. The agency’s appropriation is deposited each month into the agency’s
financing account in 12 increments. There is an overdraft limit on the financing
account.
2.
A non-interest-bearing account (FF5) is used in connection with net working
capital (ratio between current assets and short-term debt obligations), provisions,
reserved appropriation, and carryover obligations. There are special rules for
using liquidity from this account; in particular, liquidity can only be moved in and
out of this account one time a year.
3.
An account (FF6) (also called construction and IT credit) for clearing payments
on current construction and IT development activities. When investments are
finished and activated, the debt is transferred to the long-term debt. The account
must not be used to finance daily liquidity needs.
4.
A long-term debt account (FF4) for investment expenses not financed through the
construction and IT credit. The agency must regularly pay installments on the
long-term debt. The account may not be used to finance daily liquidity.
Relationship between the various accounts is illustrated in Figure 1.
21
Figure 1
The new liquidity model
Remarks
 Illustrated above is the relationship between the various accounts. The arrows in the figure
illustrate transfer of liquidity.
 The appropriation is paid out in 12 increments to the agency’s line-of-credit. From the lineof-credit comes all of the payments either as an installment on the debt, as deposits to the
non-interest-account (for changes in the net working capital--among other things, the reserve)
or as payment to suppliers and personnel, etc.
 If the agency currently has a construction or IT project, the liquidity is taken from here and
put into the line-of-credit, from which the suppliers, etc., are paid. When the projects are
finished, the project is activated on the balance, and the debt is transferred to the long-term
debt account. In other words, the liquidity is transferred from the long-term debt account to
the construction and IT credit, where it is neutralized. After this, the debt created by the
investment is paid down at the same pace that the asset is depreciated. When the asset is fully
depreciated and will likely be replaced, the events repeat.
Interest rate terms
Interest rates on the financing account are fixed asymmetrically, such that the interest rate
on deposits is generally lower than the lending rate. Likewise, the interest rates are fixed
such that the construction and IT credit has a higher lending rate than the lending rate on
the financing account, which again has a higher lending rate than the long-term debt. The
interest structure is set to create incentives to delay withdrawals and hasten deposits.
Likewise the interest structure creates incentives to finish construction and IT projects
and incentives to use the contents of the short-term financing account to bring down the
long-term debt.
22
Thus the agency can through effective liquidation management ensure that it achieves the
least possible interest expense or the largest possible interest income.
Table 3.1
Interest rate terms (for March 2006)
FF7 Financing account (line of credit)
FF4 Long-term debt
FF6 Construction and IT credit
Deposit rate
2.25 pct.
-
Lending rate
4.25 pct
3.25 pct.
5.75 pct.
The Ministry of Finance announces the interest rates once a year immediately before the
beginning of the fiscal year, but the Ministry of Finance can change the interest rates. The
rates are applied to the interest-bearing SKB accounts a quarter later.
Special terms for construction and IT credit
For agencies that begin construction and IT projects, these will be financed by the
construction and IT credit during the development phase. With the goal of ensuring the
fastest possible conclusion to the project the interest on construction and IT credit is
higher than for the other accounts. The interest on the construction and IT credit is
booked as expenditure the same as the interest expense on the other accounts. When the
asset is put in use, the debt is transferred to the long-term debt account. At the same time,
the asset is entered into the balance and the agency’s operating appropriation is charged
with the annual depreciation of the asset. The asset can only be entered into the balanced
at its real value. As soon as some of the investment costs are spent, the asset is
depreciated and the operating appropriation is charged with the depreciation. Agencies
thus bear the risk in investment, but also receive the benefit from a strict capital
management.
The accrued interest costs on the construction and IT credit are booked as expenditure,
just as the interest costs on the other SKB accounts.
23
Box 3.4
Example of investment using the Construction and IT Credit
The “X“ Board invests in a new IT-based resource management system. A development period of
4 years and a subsequent depreciation period of 5 years are budgeted. The project’s total expense
amounts to DKR 116.5 million with a net operating savings of DKR 23.5 million (A return on
investment of 20 percent.)
Table A
Example of investment using the Construction and IT Credit
Total
expense
Million DKR
Resource management
system
Liquidity withdrawal
Accumulated liquidity
withdrawal (borrowing
limit)
Construction and IT
interest*)
Long term debt
Interest**)
Depreciation
Operating savings
Effect of operating
appropriation
2007
2008
2009
2010
2011
2012
2013
2014
2015
Total
10.0
10.0
20.0
30.0
20.0
50.0
50.0
100.0
0.0
80.0
0.0
60.0
0.0
40.0
0.0
20.0
0.0
0.0
100.0
100.0
0.6
1.7
2.8
5.5
0.0
0.0
0.0
0.0
0.0
10.5
0.0
0.0
0.0
0.0
2.4
1.8
1.2
0.6
0.0
6.0
0.0
0.0
0.6
0.0
0.0
1.7
0.0
0.0
2.8
0.0
0.0
5.5
20.0
-28.0
-5.6
20.0
-28.0
-6.2
20.0
-28.0
-6.8
20.0
-28.0
-7.4
20.0
-28.0
-8.0
100.0
140.0
-23.5
116.5
Comment: Distribution of liquidity to investments and appropriations occurs at the
beginning of the year. Interest earnings resulting from efficiency are not included in the
example.
Transparency of minor consumption
Agencies will also have the opportunity in the future to further allocate unused
appropriation money, though with certain adjustments. Until now, no notice has been
taken of the extent to which minor consumption can be an expression of the agency’s
effectiveness and the completion of planned projects or the failure to achieve the
anticipated projects. Henceforth the minor consumption of the central government
agencies must be divided between reserves and retained surplus.
The reserve is that part of the minor consumption that is earmarked to specific objectives
or projects. If at the end of the year there are projects that are still unfinished, an amount
is reserved in the agency’s balance. At the same time, the agency must enter liquidity for
the non-interest account. This amount can first be used--and the appropriation first
booked--in the year the project is undertaken. The appropriation reserve must be
described in the annual report and will also appear in the appropriations act, see Box 6.
24
Box 3.5
Reserve statement for the National Library in the Appropriations Act of 2006
2. Reserve statement
Million DKR (year’s beginning)
Accumulated reserve appropriation
B year
11.4
Remarks:
Appropriations are reserved for four purposes: to finance purchase of materials in the form of
electronic periodical archives, DKR 4.5 million is reserved in the years 2005-2009; to completion
of the digital project financed by UMTS funds, DKR 2.0 million is reserved in the years 20052006; to clearing the library book depository of stacks of uncatalogued material, DKR 2.5 million
is reserved in the years 2005-2007; and to the streamlining of the processes of completion of the
IT project (E-kat), DKR 2.4 million is reserved in the years 2005-2007. Any discrepancy between
the sum of the specified amounts and the reserve amount is due to rounding off.
The surplus is that part of the minor consumption that is not tied to specific goals and
projects. The surplus is transferred and accrues as capital on the agency’s capital and
reserves and corresponds to interest-bearing liquidity on the agency’s line-of-credit. The
surplus may freely be used by the agency for its objectives. At the same time, the surplus
is included in the valuation of the agency’s finances and appropriation needs. The surplus
appears in the financing statement under remarks.
The distribution of the year’s outcome between reserves and surplus occurs at the end of
the year. It is basically the agency itself that determines which funds shall be reserved
and which are surplus.
Here another decision must be made as to how large a part of the retained surplus should
be eliminated from the appropriation settlement. A part of the agency’s surplus can be
due to the fact that projects for various reasons that the agency had no control over were
cheaper than anticipated. This part of the surplus should consequently be eliminated. The
reserves are controlled by the agency’s relevant department and the Government Auditor
General.
25
Box 3.6
Specification of the National Library’s carryover holding.
The National Library converted to cost appropriations with the Appropriations Act of 2005. With
the conversion to cost appropriations, the National Library had a total carryover holding of DKR
27.5 million. From this, DKR 13.0 million was eliminated, as these funds were dedicated to the
financing of acquisitions. The amount of the National Library’s carryover holding that was
divided between reserves and retained surplus was therefore DKR 14.5 million.
Of this, 9.7 million was categorized as reserved appropriation, that is, for projects that were
postponed. These projects were as yet to be purchased magazines (DKR 2.5 million), a
digitalization project (DKR 1.2 million), development of a system of electronic cataloging (DKR
3.0 million), and clearing of the Library Book Depository (DKR 3.0 million). Discrepancies with
Box 5 are due to the fact the figures in Box 5 are from the Appropriations Act of 2006, while the
figures in this box are from 2005.
The remaining DKR 4.8 million was categorized as free savings, that is, funds the National
Library has achieved through earlier streamlining, etc.
The reserves and profit disposition will in future be part of the appropriations settlement.
The reserve and profit disposition is done just before the appropriations settlement. The
information will appear in both the annual report and the government account. In the
appropriation bill the current carryover statement will be replaced by a reserves statement
that shows the amount of the appropriations reserved to unfinished projects.
Rules of presentation
With transition to cost appropriations the rules for presentation to the Finance Committee
have been altered.
The altered presentation parameters must be seen in the context that investments that
occur within a borrowing limit are already approved by the Folketing. This reduces the
need to present each and every minor investment disposition. A natural consequence of
this is that the borrowing limit should always be exceeded in the presentation. Further,
the presentation parameters also apply to investments that today are financed by the
operating appropriation and which therefore will not appear under the current rules. Box
7 contains the basic new presentation rules.
26
Box 3.7
Presentation rules
Event
Exceed borrowing limit
Investment in capital assets
Housing contracts, other rent and leasing
Sale of sites, acreage, and buildings
Changes in investments in assets financed
through the construction and IT credit
Presentation
Always
> DKR 50 million or > DKR 25 million when
lifetime is > 10 years
> DKR 20 million
> DKR 5 million
> 10 percent of total amount, but at least DKR
5 million
Source: “Budget Guidelines 2006,” www.fm.dk
The requirements for information that must appear in the presentation have also been
enlarged and formalized, so that the Finance Committee has a better opportunity to
evaluate the total economy of the projects. What is new is that presentations must contain
information on the underlying multi-year budgeting, liquidity structure, profitability
considerations as well as a statement of special risk factors. This information might
appear as in the box below.
27
Box 3.8
Example of investment financed through making a loan
The “Y” Board desires to renovate its laboratories. The project’s total cost amounts to DKR 116.5
million (including financing) with a net savings of DKR 28.5 million as a result (corresponding to
a turnover of investment of 25 percent).




Expenditure/liquidity withdrawal for purchase of laboratory in 2007 is DKR 100 million.
The laboratory is depreciated over 10 years by DKR 10 million annually.
Interest is computed on the remaining capital sum, that is, acquisition sum minus
subsequent depreciation. The interest rate in this sample is set at 3 percent.
An annual operations savings of DKR 14.5 million is assumed.
Table A
Example of investment financing through making a loan
2008
2009
2010
2011
2012
2013
2014
2015
2016
100.5
90.0
80.0
70.0
60.0
50.0
40.0
30.0
20.0
10.0
10.0
10.0
10.0
10.0
10.0
10.0
10.0
10.0
10.0
10.0
3.0
14.5
-1.5
2.7
14.5
-1.8
2.4
14.5
-2.1
2.1
14.5
-2.4
1.8
14.5
-2.7
1.5
14.5
-3.0
1.2
14.5
-3.3
0.9
14.5
-3.6
0.6
14.5
-3.9
0.3
14.5
-4.2
Total 2007
expense
Million DKR
Purchase of
laboratory equipment
Depreciation
Interest (3 percent)
Operations savings
Total impact of
operating
appropriation
116.5
Total
100.0
16.5
145.5
-28.5
Remarks: Division of liquidity between investments and appropriations occurs at the
beginning of the year of the year. Interest earnings resulting from streamlining do not
appear in the example.
Presentation parameters for transactions under the rent regulation are unchanged so that
the special latitude given to real estate can be preserved. There will also be permission to
sell assets under the presentation rules. However, properties outside the rent regulation
must be given over to the government real estate company Freja A/S for sale. The selling
agency will upon sale of the property increase its financial margin, as in this case the
property will not be depreciated. The agency’s debt will be reduced corresponding to the
book value of the property, while any profits from the sale will fall to Freja A/S.
28
4. Conversion from expense-based to cost-based appropriation
The budget reform will be fully implemented in the Appropriations Act of 2007—and
therefore also for the central government accounts for 2007. This chapter will briefly
discuss the conversion from expense-based to cost-based appropriations. For more
detailed information about this, refer to the guidelines on conversion that can be found at
the Agency for Government Management’s home page www.oes.kd.
Costs will be equal to expenses over an agency’s entire lifetime. The difference between
costs and expenses in a single year is due to different periodicity, that is, the point in time
in which a transaction burdens the appropriation.
As it is only the periodicity of the appropriation that is changed in the conversion to cost
appropriations, the cost-based operating appropriation can be set to correspond to the
expense-based appropriation. Situations can arise, however, in which the altered
periodicity of the appropriation could mean that the cost and expense appropriation
would differ.
It is in connection with investments that periodicity diverges most from an expense
system to a cost system. If an agency has previously made large investments--that it does
not expect to make in the future--the costs will be greater than the expenses until the
investments are fully depreciated. This is due to the investments of earlier years
burdening the agency’s future costs in the form of depreciation while there are no new
investments planned for the future.
Conversely, an agency that is anticipating large future investments will have expenses
that in a certain period are greater than their costs. The reason for this is that investments
fully impact expenses, while depreciation on these investments is distributed periodically
over the entire lifetime of the future investment.
Beside investments the primary difference in periodicity occurs in the cost of wages, in
which vacation pay is periodized. In the expense system the agency bears the cost of
vacation pay in the year when the vacation is taken, while in the cost system the agency
bears the cost of the vacation pay in the year that the vacation is earned. In other words,
the vacation pay obligation is brought forward one year.
Conversion to cost-based appropriations is a matter of ‘translating’ the expense-based
appropriation to the cost-based one. The altered periodicity involves, as noted, shifts in
appropriations across the financing years, but “the current value” of the margin will be
unchanged. In fact, a series of steps occur. First, the agency adjusts the opening balance.
That is, on the basis of its capital assets, the agency’s long-term debt and the construction
and IT credit are set as well. Then, the carryover sum is divided between the reserve
appropriation (the postponed projects) and retained surplus--free funds.
Next comes the budgeting of the balance and operations for FY2007 and the upcoming
BO [budget estimation] years 2008-2010. The purpose of this is to produce a budget that
29
will afterwards serve as the basis for determining the initial appropriation and borrowing
limit.
The primary consideration in budgeting is that the transition should not affect the
agency’s activity. This means that the budget is prepared from the existing framework
and on that basis is adjusted for the technical changes that result from cost principles.
When the technical transition is completed, the ordinary changes resulting from the
appropriations process will be budgeted in.
Afterwards, the appropriation and borrowing limit will be fixed on the basis of the
budgeting. At this stage, it will be determined which changes resulting from the
conversion to cost-based appropriations will cause changes in the level of appropriation.
The essential for fixing the appropriation is, as stated, that the transition to cost
appropriations should not change the agency’s resources in relation to its original
expectations. In most cases this means that the appropriation will be more or less
unchanged, as a number of technical corrections can be made in order to ensure a neutral
conversion with regard to resources.
The initial cost-based operating appropriation is determined largely by the framework of
FFL2006. After this, adjustments are made for the technical changes that result from cost
principles. In order to ensure that the conversion is resource-neutral, it will be necessary
in the course of the process to recalculate the cost appropriation back into an expense
appropriation with the object of comparing it with the original expense-based
expectations. The box below contains a short description of calculating the cost-based
appropriations.
Box 4.1
Calculating the cost-based appropriation
An outline of the main features of the cost-based appropriation is calculated in the following
way:
- acquisitions
+ depreciations
+ cost of interest
+/- periodicity entries
= outline of cost-based appropriation
Next, the borrowing limit is determined based on the agency’s SKB debt in the F or the
BO year, whichever is highest. Then a buffer is added. The borrowing limit will lie at this
level. Factored into the SKB debt are the anticipated year-end balances on the short-term
financing account (line-of-credit), the long-term debt and the construction and IT credit.
30
Box 4.2
Example of conversion from expense to cost appropriations
Presented below is a hypothetical example for “X” Board’s conversion to cost appropriations.
First, a multi-year budgeting on the basis of cost principles is done. The top line below shows the
outcome of a cost-based budget. In order to ensure that the resources of the new budget are
comparable to the old, a recalculation is made.
Table A
Conversion table between costs and expenses
DKR 1,000
Cost-based result
Depreciation
Investments on capital
budget
Credited interest on SKBdebt due to cost reform
Provision for vacation pay
Reserved provisions
Consumption of inventory
Total corrections
Expense appropriation
2007
259,538
-9,363
20,000
2008
198,750
-11,292
16,100
2009
210,456
-10,146
1,500
2010
213,282
-8,585
1,500
2011
208,210
-6,285
7,000
Total
1,090,236
-45,671
46,100
-147
-2,997
-3,060
-1,759
-1,472
-9435
-479
0
0
10,011
269,549
-656
0
0
-1,155
199,905
-181
0
0
-11.887
198,569
584
0
0
-8,260
205,022
610
0
0
-147
208,063
-122
0
0
- 9,128
1,081,108
To go from the cost-based result to the expense-based, the following must be done:
 First, the budgeted depreciations on the agency’s assets are subtracted, as these are fully
financed by acquisitions in the expense-based system.
 Correspondingly the budgeted investments are added. It may be seen that investments
naturally fluctuate somewhat more than depreciations, but viewed over the entire period they are
largely the same resource consumption--the difference is thus periodicity.
 Cost of interest is then subtracted, as these financing costs are also entered with the cost
appropriations. The agency is compensated for these costs, which go into the government‘s
general fund.
 There is also a small correction for vacation pay, since the costs of vacation pay falls in the
earning period, while the expense is in the payment period. As the number of personnel from
2006-2009 is rising, there are more costs than expense. From 2010-2011 the cost will be reversed
to become less than expense.
If the whole period of 2007-2011 is taken together, it may be seen that the cost appropriations
figure is approximately DKR 9.1 million higher than expense appropriations. This corresponds
largely to the new interest costs, which is why the agency’s financial margin is unchanged.
For more information on recalculating from costs to expenses, refer to guidelines ‘Budgeting
balance and operation’ that can be found at www.oes.dk.
31
After the appropriation and borrowing limit are fixed, these will be incorporated into the
budget proposal. New guidelines have been developed for compiling the cost-based
budget proposal. The major points in the new remarks are the following:

Budget specifications are adjusted and simplified and, among others, must now
contain information on the use of reserve appropriations and a budgeting of the year’s
expected result. Standard accounts will no longer be found in the budget
specification, rather the income accounts will appear in an independent statement.

The carryover account statement is replaced by the “Reserve Statement,” which
shows the portion of appropriations reserved to projects not yet begun, see Box 3.5.

The remarks will contain an overview of the trial agency’s projects and goals that link
the Appropriations Act to the outcomes contract. Division of expenses among the
main objectives is connected with the project definition in the overview of projects
and goals.

Much new financial information on borrowing limit, debt, etc. will be introduced, see
Box 3.3.
32
5. A brief look at the new accounting principles
Beginning 2005, all central government agencies must prepare cost-based accounting. In
cost accounting the focus is on the costs associated with the activities of a single fiscal
year.
Implementation of cost accounts means that all central government agencies must prepare
a balance sheet that shows the agency’s assets and liabilities and also adjust the daily
operation. The year’s financial transactions are reported in the annual report’s income
statement, balance sheet and notes. Cost-based accounting consists of:
 A balance sheet, showing what an agency owns or holds (assets) and will pay out
(obligations) by year’s end, and
 An income statement, showing the year’s income and consumption related to received
benefits or completed activities during the course of the year.
There is an inner relationship between the balance sheet and the income statement. For
instance, the acquisition of a new machine is recorded on the balance sheet as something
the agency owns (an asset). The subsequent use of the machine is registered as
depreciation (wear and tear) on the income statement and as a corresponding write-off of
value of the machine on the balance sheet. The relationship between the income
statement and the balance sheet can also be shown in a cash flow statement in the
account. Refer to the concept overview in Chapter 6 for a more detailed discussion of the
individual concepts.
Purpose of cost-based accounting
The purpose in introducing cost-based accounting principles into the government is to
make resource consumption of projects more visible. The reform means that the cost of
producing government benefits will become more transparent. It will be easier to
compare the price of the benefits the agency sells or makes available to the society with
the resources required to deliver these benefits.
Further, the government accounts will be more comprehensive because the development
of the state’s value and obligations will be computed systematically. In addition,
principles are used that are more easily compared with accounting principles in the
private sector. In those spheres where it is relevant to compare resource consumption
within government or in relation to private suppliers, the state will obtain a better basis
for prioritizing the various uses of appropriations.
Cost principles
All accounting principles start with the entry of various economic events. Events
typically recorded in the bookkeeping are:
33

Ordering/incurring of obligation;

Delivery;

Receipt of invoice;

Payment;

Consumption.
The various accounting principles differ as to which of these events appear in the
agency’s account. The various economic events are normally not isolated, rather a link in
a chain of transactions that can extend over more than one accounting period. Because of
this, there may be a distribution over these periods (periodicity). Take, for example, a
board that acquires new PCs. Payment will normally occur in the first year, while
consumption extends over a number of years corresponding to the economic lifetime of
the PCs. Of these economic events, the ones that receive the focus will be decisive for
what appears in the account in the individual years.
In general, different accounting principles vary as to which economic events appear in the
agency’s accounting and which events have the greatest significance for the agency’s
financial management. Several accounting principles are summarized below.
Table 5.1
Accounting principles
Accounting principle
Cash principle
Periodicity
Payment
Right of acquisition
Delivery
Cost principle
Consumption
Source:
What appears in the account
The account shows deposits and
withdrawals during a period regardless
of consumption or earnings.
Account shows period’s principle
revenues and expenses.
Account shows period's actual
consumption, regardless of payment date
Cost Principles in Government, Ministry of Finance (2003).
The cash principle is the traditional principle used for government finances and the most
used internationally. The principle is simple because it focuses exclusively on when the
money goes in or out of the cash fund or bank account.
The cash principle meanwhile is less useful for money management as it lacks
information on receivables and debt, and because even modest fluctuations in payment
dates can have great significance for computed expenses and revenues. The principle is
also not useful for calculating resource consumption in various activities.
34
The principle is, on the other hand, comparatively useful for monitoring purposes, as it is
easy to compare the budgeted expenses with those actually made.
The cost principle is used in private enterprise, non-profit institutions, etc. The principle
is based on a number of internationally agreed standards that have continuously
developed in recent years.
The cost principle focuses on calculating resource consumption in different activities.
The principle is thus useful in assessing development in, for example, productivity and
effectiveness.
Basically cost principles are just another way of showing the economic events that are the
basis for the accounting. Therefore government agencies will largely continue to do the
bookkeeping entries they do today. There will however be some entries that can be
omitted while other new entries will need to be made.
In Denmark, the government has long used the right to acquisition principle that lies in
between the cash principle and the cost principle. The right to acquisition principle
calculates expenses and income at the time of delivery. The use of the right to acquisition
principle means that government accounting principles already today require significantly
more periodicity than in cash accounting. Periodicity already functions in connection
with the purchase of goods and payment of advanced wages.
New governmental accounting rules
The new accounting rules introduced in the Statutory Order of December 2004
correspond to a great extent to the Annual Accounts Act. The new government
accounting rules diverge, however, from the Annual Accounts Act in certain areas. That
is because the goal of a cost-based accounting report in government is not entirely the
same as in the private sector. For private enterprise the goal of the accounts report is
primarily to create a realistic picture of the enterprise’s basis for economic existence in
relation to its owners and other interests. Consequently, the annual accounts focus on the
statement of the enterprise’s value and future earnings potential.
In government the primary objective with a cost-based accounting report is to aid
financial management through calculation of resource consumption in executing
government projects. At the same time, attention must be paid to the potential for
maintaining strict management over appropriations. In consequence, the accounting rules
allow less freedom of interpretation than the Annual Accounts Act does and thus diverges
from the Annual Accounts Act in the following points:
 There will be only limited opportunity to take a write-off on capital assets. If an asset
is written off, the loss will burden the appropriation.
 Appreciation of operations and transport funds, inventory, etc., will not be allowed
unless approval has been obtained from the Ministry of Finance.
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 Specific depreciation principles and periods are fixed for intangible and tangible
capital assets.
 Specific limits on amounts and lifetimes are set as to when internally prepared
intangible capital assets can be activated, see above.

Specific principles are fixed for activating minor assets in batches.
It is possible to read more on this at ØAV.
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6. Review of concepts
Loan installments
An agency’s long-term debt and construction and IT credit must never exceed the value
of its tangible and intangible capital assets. This requires that the agency draw down its
long-term debt at the same pace that the asset is depreciated (consumed).
Depreciation
When a capital investment is recorded on the balance sheet, the cost price is reduced by
depreciation and write-offs as an expression of wear-and-tear of the asset. Depreciation
of a capital asset begins when the asset is put into use.
All capital assets, when the historic cost price exceeds the bagatelle limit of DKR 50,000,
are depreciated using the linear method. Linear depreciation means that the cost price in
the form of resource consumption (for instance, wear-and-tear, technological
obsolescence, etc.) is divided into equal parts over the lifetime of the asset.
The lifetime is defined as its economic life. Economic life expresses the number of years
the asset is expected to have an economic value for the institution. If the asset is replaced
before its economic life has run out, the time of use becomes the period of depreciation.
The Agency of Government Management has fixed the lifetime for all capital assets.
Assets
The assets on the balance sheet consist of the agency’s fixed holdings and receivables.
The holdings are the value of the agency’s productive assets as well as the physical and
non-physical assets acquired for the purpose of extended use, including developed IT
systems, buildings, machines, and IT equipment and more, as well as any inventory.
Receivables include cash receivables from sale of goods and beneficial services, current
work on a foreign account and deferred entries in the form of prepaid costs. Further, the
balance sheet includes financial assets. See Balance sheet for more.
Activation
An asset is ‘activated’ and entered on the balance sheet when the asset is acquired for
extended use or ownership and becomes a productive asset in the agency, and the asset’s
cost price can be calculated reliably. Inclusion requires that the asset contribute to
fulfillment of the agency’s goals.
Balance sheet (Status)
A balance sheet is a statement of the agency’s assets and liabilities. The asset side shows
the enterprise’s capital assets and liquid assets, which is a calculation of the operating
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funds that the enterprise has for executing its projects. The liability side shows the
agency’s capital and reserves, carryover obligations and debt obligations.
Box 6.1
Balance sheet
Assets
Capital assets
Intangible capital assets
Tangible capital assets
Financial capital assets
Liquid Assets
Inventory
Receivables
Securities and stocks
Liquid funds
Liabilities
Capital and reserves
Carryover obligations
Long-term debt
Short-term debt
Carryover obligations
A carryover obligation is an obligation that arose in the current or earlier fiscal years
which is probable but uncertain with regard to its precise amount or date of discharge. A
carryover obligation is recorded on the balance sheet when it becomes certain that it will
be redeemed and the value can be determined reliably.
A carryover obligation can be, for instance, agreements or contracts, expenses owed for
achievement rewards, bonuses, obligations associated with severance arrangements,
limited tenure appointments, etc.
Cost price
The cost price of an asset is the amount given as compensation for the asset regardless of
whether it is acquired from an external party or internally manufactured. The cost price of
an obligation is that amount received in compensation for that obligation.
Assets and obligations will be valued using the cost price principle, which means that
assets and obligations are valued at the acquisition price.
Borrowing limit
An agency has the authority to make internal government loans within a borrowing limit
that is stipulated in the Appropriations Act. The borrowing limit is comprised of the
agency’s long-term debt balance, construction and IT credit and if negative, also the lineof-credit.
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Write-offs
Capital assets and liquid assets that unexpectedly decrease in value must be written off, if
the fall in value is not temporary. A substantial fall in value must be present before a
write-off can be taken. Write-offs must be taken cautiously. Capital assets may not be
written off on the basis of subjective valuations or as a consequence of general price
developments. Large and substantial write-offs must be submitted and approved by the
Finance Committee, see the current presentation rules. All write-offs must be
documented in the annual report with the reason for taking it.
Cost distribution
Cost distribution is a calculation model that takes the recorded costs and divides them to
create an overview of what “something” costs. This “something” can be specific
products, assets, projects, or budget objectives. This yields cost information that can
support management’s decisions and/or outside demands for transparency in resource
utilization.
Cost distribution does not affect the agency’s result or balance and is therefore not a
requirement for implementing the accounting reform. There are no formal requirements
for designing a cost distribution model other than that the choice of distribution principles
should be well-considered and well-documented.
Write-up
A write-up of an asset will—contrary to a write-off—mean that the value of an asset will
be increased on the balance sheet. Government agencies are not permitted to take writeups for assets.
Retained surplus
The retained surplus is part of the agency’s capital and reserves. The retained surplus is
an expression of the agency’s completion of projects cheaper or more efficiently than
anticipated. The retained surplus can be directly used by the agency for any of its goals.
The size of the retained surplus will however be a factor in the discussions relating to the
regular budget process.
Liabilities
Liabilities are the sum of capital and reserves and incurred obligations. Capital and
reserves is a residual entry representing the difference between assets and obligations.
Incurred obligations can be debt obligations or carryover obligations (provisions). Debt
obligations can be short-term or long-term. Short-term debt obligations include debt to
suppliers for goods and services as well as owed wages, vacation pay, and over-time
work, etc. In addition, prepaid income is included as deferred entry under debt
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obligations. Long-term debt obligations include governmental debt, priority debt and
loans for the financing of assets, which only a few agencies have.
Periodicity
Cost principles use a different periodicity for accounting than used earlier. Revenue is not
first entered when it is received or when costs are paid. Revenue and costs shall in the
future be entered at the same time as the activities with which they are connected are
performed. This means that revenues will be entered at the point in time they are earned
or created, regardless of the time they are paid in. Likewise, costs are entered at the point
in time they are consumed regardless of the time they are paid.
An example might be a capital asset—that it has been decided to junk or replace within a
few years—which would not be fully written off in the year the decision was made, but
would be spread over a period until the asset is taken out of operation. This means that
the period of depreciation would be shortened. The write-off is carried forward through
larger depreciations over a shorter period than originally anticipated.
Account
The starting point for all accounting is the registering of various economic events.
An account based on the cost principle consists of:
 a balance sheet that shows what the agency owns or has to its credit (assets) and owes
(obligations) at year’s end, and
 an income statement that shows the year’s revenues and consumption related to the
benefits delivered or activities performed during the course of the year.
There is an inner relationship between the balance sheet and the income statement.
Interest
An agency’s interest costs and interest revenues express respectively the capital costs and
the capital revenues connected with the agency’s liquidity in assets and the liquid outlay
in connection with obligations.
In the liquidity and financing model the agency is equipped with three forms of accounts
that charge interest:

a short-term financing account (line-of-credit);

a long-term debt for financing the purchase of capital assets;

a construction and IT credit to financing of current construction and IT projects.
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Reserved appropriation
If the agency has received an appropriation for projects that are not in progress or are
delayed, the agency must reserve a part of its appropriation. The size of this reserved
appropriation depends upon the project’s state of completion.
A reserved appropriation is entered as a short-term debt entry in the agency’s accounting
and expresses the agency’s obligation to deliver the project for which the appropriation
was designated.
Profit distribution
A distribution of profits is made in connection with the clearing of an appropriation. The
profit distribution is a disposition of the agency’s profit from the income statement. The
profit distribution determines how large a portion of the profit should be dropped,
reserved, or transferred to the agency’s retained surplus of capital and reserves.
Income statement
The income statement is a report of the agency’s annual operating profit and is published
in the annual report. The cost-based income statement shows the agency’s appropriation,
revenues, and resource consumption organized in periods according to cost principles.
The income statement determines the result that can be transferred to the agency’s
balance sheet.
Box 6.2
Entries in the income statement
Ordinary operating revenues
Ordinary operating costs
I. Profit from ordinary operation
Other operating entries
II. Profit before financial entries
Financial entries
III. Profit before extraordinary entries
Extraordinary entries
IV. Year’s profit according to cost principles
 By ordinary activities is meant activities that constitute a part of the agency’s main
activity and that are constant and regularly recurrent.
 By other operating entries is meant activities that lie outside the agency’s main
activities but normally are regularly recurrent. The financial entries include the agency’s
financial revenues and costs.
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 Finally the extraordinary entries include activities that seldom occur and are outside
the enterprise’s control. For a revenue/cost to be defined as extraordinary, it must be
completely unpredictable and clearly distinct from activities connected with the agency’s
objectives.
Right of acquisition principle
The right of acquisition principle entails calculating expenses and revenues at the time of
delivery. The right of acquisition principle is terminated in connection with the cost
reform to cost principle.
Solidity requirement
A disposition rule states that an agency’s long-term debt obligation, measured by the
long-term debt and the construction and IT credit, may not exceed the value of the
intangible and tangible capital assets. This rule has been made to ensure that agencies
continually draw down their long-term debt at the same pace as they use their capital
assets.
Government bond
With conversion to cost-based appropriations an illiquid asset has been inserted into the
agency’s balance sheet similar to a government bond. A government bond is a document
in which the government assumes an obligation of a specified fixed amount and in
content is like a guarantee. The government bond is placed like a financial capital asset
and is set off against capital and reserves under the entry “start capital.”
Fluctuation limit
The set-off for the agency’s government bond (see above) is the entry “start capital”
under capital and reserves. Start capital also expresses the agency’s permitted fluctuation
limits so that the retained surplus does not go into the negative with an amount that
exceeds the start capital. The balance for the retained surplus must, in addition, not be
negative four years in a row.
Materiality principle
The rules of accounting provide the general framework for government accounting. In
areas where the rules do not provide an exact guideline and where issues must therefore
be based to a greater or lesser degree upon arbitrary decisions, it is the individual agency
that must make these decisions, in part inferred from the materiality principle.
Whether the effect of the decision is material or not depends upon the decision’s
consequences for the agency, both in relation to finance and in relation to other matters
material to the agency’s operations. Particularly in compiling cost-based appropriations,
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more or less arbitrary decisions will have to be made in a number of areas, to which the
materiality principle may be applied. Some examples of this, for instance, could be
questions about setting aside funds for carryover obligations; a decision whether an
expense should be regarded as maintenance or as an improvement; as well as about the
need of taking depreciation on the agency’s capital assets.
Annual report
The annual report (including any annex) is the central government agency’s report of
financial and technical outcomes. It contains a brief summary, a statement of goals, and a
report on the financial accounts (income and balance). Since the fiscal year 2003 it has
been obligatory for all agencies to prepare an annual report. This dos not apply to
departments, however, unless they have external and operational projects of considerable
size.