Classification Circular Classification of Transfers and Subsidies Vs Goods and Services

Classification of transfers and subsidies and goods and services

CLASSIFICATION CIRCULAR – CLASSIFICATION OF TRANSFERS AND SUBSIDIES VS GOODS AND SERVICES

1Purpose

The purpose of this document is to provide departments with an understanding on how to classify expenditure with a specific focus on the distinction between the goods and services and transfers and subsidies expenditure categories. This document does not deal with other categories of expenditure such ascompensation of employees and payments for financial assets

2Definitions

The Standards Chart of Accounts (SCOA) draws its definitions from the Reference Guide to the Economic Reporting Format (ERF). Some definitions were obtained from the Modified Cash Standard (MCS) which is the departmental financial reporting framework.

The following definitionsare in the ERF:

Transfers and subsidies: Transfers and subsidies include all unrequited payments made by the government unit.

A payment is unrequited provided that the government unit does not receive anything of similar value directly in return for the transfer to the other party.

Goods and services: Goods and services include payments for all goods and services to be used by a government unit, excluding purchases of capital assets.

Goods and services constitute requited payments, as the paying unit receives a good or service in return for the payment made.

The immediate use of fundsprovides for the description of the item being bought and refers to its actual form. The item segment is used to record the immediate use of funds.

Item segment: In this segment, each payment is recorded according to immediate use of funds, without taking into account the ultimate use. The description or form of the item determines how it is classified. A determining question is, “What is being bought?”

The ultimate use of fundsis the eventual purpose for which the item being bought will be used. For the ultimate use, the eventual use of the item is considered, and not the form of the item being bought.

The following definitions are in the MCS:

Inventories are assets:

(a) in the form of materials or supplies to be consumed in the production process;

(b) in the form of materials or supplies to be consumed or distributed in the rendering of services;

(c) held for sale or distribution in the ordinary course of operations; or

(d) in the process of production for sale or distribution

From an economic classification point of view, inventories are current expenditures of government, recorded as part of goods and services.

Exchange transactions are transactions in which one entity receives assets or services, or has liabilities extinguished, and directly gives approximately equal value (primarily in the form of cash, goods, services, or use of assets) to another entity in exchange.

Exchange transaction definition is similar to requited payments which is defined above.

Non-exchange transactions are transactions that are not exchange transactions. In a non-exchange transaction, an entity either receives value from another entity without directly giving approximately equal value in exchange, or gives value to another entity without directly receiving approximately equal value in exchange.

Non-exchange transaction definition is similar to requited payments which is defined above.

3Background

The classification principles are described in theReference Guide to the Economic Reporting Format[1] (ERF) and embedded in the Standard Chart of Accounts (SCOA).

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The Modified Cash Standard (MCS), adopted the classification principles established in the ERF for the classification of expenditure. The alignment between the MCS and the ERF provides decision makers (including oversight structures) with a means to assess the financial performance of a department with reference tothe budget allocations and the actual spending reported at the end of the financial year.

Given the above, when a department receives something directly in return of similar value for the payment made, the transaction is recorded under goods and services. If the department does not receive anything directly in return of similar value for the payment the transaction is recorded under transfers and subsidies.

It is therefore derived that all exchange transactions (or requited payments) are classified as goods and services whilst all non-exchange transactions (or unrequited payments) are classified as transfers and subsidies.

4Expenditure classification

Departmental expenditure encompasses payments arisingout of the operating activities of the department. In determining the correct classificationrelating tovarious expenditure due consideration should be given to the following:

a)Is the payment requited or unrequited?

b)What is the department buying or paying for?

Questions a) and b) above are discussedbelow:

a)Is the payment requited or unrequited?

In determining if the payment is requited or unrequited, the department will assess if it receives something of similar value directly in return for the payment made.

Where payment is made and the department remains in control of the goods bought or services paid for, it indicates that this is a requited payment.

b)What is the department buying or paying for?

Use of funds should be taken into consideration. In the SCOA item segment the description or form of the item acquired determines how it is classified andeach payment is recorded according to immediate use of funds, rather than its ultimate use. If a good is bought or service paid for the description should be goods and services. An example is blankets or food parcels acquired for distribution to pensioners in line with the mandate of the department. The immediate use of the goods acquired leads to goods and services classification. On distribution the department relinquishes control of the goods.

On the other hand if funds are paid for which direct benefit will not be obtained, this is atransfer. An example is a department responsible for social welfare paying cash to a pensioner. Immediate use of funds is not to buy a good or to pay for a service. Although it is expected that the pensioner use the cash for sustenance, the department does not have control on what the cash is used for. Cash payments are discussed further in paragraph 5 below.

Another example of a transfer is where a department makes a payment to its public entity in order for the public entity to conduct its operation. In spite of thedepartment’s accounting officer monitoring and expenditure management roles required by section 38(1) of the PFMA, 1999 and paragraph 8.4 of the Treasury Regulations, 2005 respectively, the public entity also has itslegislative mandate.The department makes payment to the public entity, has to play a monitoring and expenditure management roles. However it does not control the operations of the public entity which are overseen by the public entity’s accounting authority.

Should a department make payment to its public entity for the public entity to carry out an activity on behalf of the department, the classification would be goods and services as the department is paying for a service from the public entity. Similarly, a payment made to reimburse another government entity for services delivered on behalf of thedepartment are classified as goods and services.

4.1Cash payment

According to the ERF unrequited cash payments made to the beneficiary are classified as transfers and / or subsidies. Where a department is not buying a good or a service and is transferring cash to a beneficiary, the immediate use of the cash does not result in receipt of goods or services at any stage. Therefore this should be classified as a Transfer.

Payments made to entities for the furtherance of the entities’ operations are also classified as transfer payments. Budget documents allow transfer payments to only be made to the entity that reports to the department. For this reason the SCOA has put restrictions to manage those transfers in the system. For example, Higher Education Institutions are the entities that report to Department of Higher Education. The Department of Higher Education has the responsibility to fund the operational requirements of the Higher Education Institutions.

Transfers of funds in terms of Division of Revenue Act, ENE or EPRE for operations of an entity are classified as transfers.

No additional fee, commission, administration fee, etc., is expected by the transferee from the entity making the transfer. This is because the money is transferred to fund the business of the transferee entity to be able to achieve their objectives.

4.2Acquisition of current or capital goodsor service for distribution

Departments often acquire goods, such as medicine, learning material, blankets, computers etc for which they intend to distribute to beneficiaries, which could be individuals and / or communities. These items are either distributed immediately (i.e. they are delivered directly to the beneficiaries) or are distributed by the department after taking delivery of the items at their own warehouses.

The transaction entered into with the supplier to acquire goods is requited because the department is receiving an item of value in exchange for the payment made (or to be made) to the supplier. A department need not take physical possession of the item(s) for it to be regarded as requited. If the department directs the supplier on where, when and/or to whom the goods should be delivered it has attained control over the goods meaning that there has been an exchange of value between the department and the service provider. Control is lost by the department when the beneficiary takes possession of the item(s), which is viewed as the secondary transaction.

Items (goods or services) acquired for distribution in requited arrangementsmeet the definition of inventories.

4.3Use of intermediaries

The method utilised in acquiring goods or services, should not change the recording of the transaction and the overall classification from goods and services to transfers and subsidies.

Service providers are at times appointed to support departments in achieving its service delivery objectives. The services range from business consultants, researchers, engineers, health care practitioners to audit committee members etc. Service providers take the form of individuals and/or firms. Payment for the services delivered directly to and or consumed directly by the department acquiring such services is regarded as an exchange transaction.

Where the department is the principal in a principal-agent arrangement, an agent acts on behalf of the department. It executes the instructions of the department. Therefore any expenditure incurred by an agent directly or in relation to the agreement is the same as the department incurring such expenditure. In order to disclose the transaction with the third party, a department must consider the principles described in the MCS Chapter on Accounting by Principals and Agents.

Fees paid to intermediaries for execution of tasks required by the department are classified as goods and services.

5Enquiries

Please contact the SCOA Technical Committee via the SCOA call center at (012) 315 5311 or by sending a concise email to if further clarity or discussion is required regarding the classification guidance highlighted above.

SCOA Technical Committee

Date:

Classification of transfers and subsidies and goods and services

Annexure A: Classification Examples

Example 1: Requited or unrequited

Example / Value received approximate value exchanged / Requited or Unrequited / Buying a good, paying for services or paying cash / Classification
A department purchases and distributes learning and teaching support materials / Yes / Requited / Buying a good / Goods and Services
A department appoints an advisor to assist an entity with its financial management practices and the advisor reports directly to the entity. / Yes / Requited / Paying for services / Goods and Services
A department purchases blankets for distribution to households that were destroyed in a fire. / Yes / Requited / Buying a good / Goods and Services
A department provides funds to an NGO to deliver food to schools. The NGO is free to decide how the funds will be utilised in order to fulfil the requirements set by the department. / No / Unrequited / Paying cash / Transfers and subsidies
Social Grants paid to the beneficiaries: The department makes a payment to an entity, for an entity to make social grants payments to the beneficiaries identified by the department. / No / Unrequited / Paying cash / Transfers and subsidies
Fee paid to the distributing entity: The department makes a payment to an entity, for an entity to make social grants payments to the beneficiaries identified by the department. / Yes / Requited / Paying for services / Goods and Services

Example 2.1: Purchase of computers for a school

A department acquires 10 desktop computers intended for a computer centre at a school. The department follows its own procurement process determining the most suitable computers (and installed software) for the environment in which they will operate. The desktop computers are delivered directly to and installed in the computer centre of the primary school. Once installed the department transfers ownership to the school.

The department pays the supplier a market related price discounted by 15 %. This discount is within the usual discount rates given by suppliers to most favoured customers.

The transaction is arequited for the Department because:

the discount provided does not change the classification of the transaction;

the department decided on what should be bought, and where it should be delivered and is responsible for the installation / set up of the computer centre;

it has control over the value or the computers acquired until transfer of ownership to the school;

The Department will classify the transactions as goods and services: inventory and would recognise the balance of goods acquired as Inventory at year-end, if the computers had been acquired but not yet installed and ownership transferred to the school.

Example 2.2: Funding of computers for a school

A department approves funding for 10 desktop computers intended for a computer centre at a primary school. The primary school must follow a competitive procurement process but is free to decide on what computers they require and is responsible for arranging and taking delivery of the computers and the setting up of the computer centre.

The school pays the supplier a market related price (no discount). The total cost of the computers, the delivery and the installation is recovered from the Department.

Even though the department fully reimburses the school, the transaction is anunrequited for the Department because:

the department has no say on what is being procured and whether the items will be suitable for the type of computer centre required for the primary school;

there is no control over the items acquired by the school;

The transaction must be classified as transfers to departmental agencies and accounts.

Examples 3: Acquisition of items for distribution

• Department of health purchases medicine for the patients. In some instances the medicine is delivered directly to the hospitals. This medicine is classified as goods and services (inventory). The immediate use of funds is to purchase medicine and is classified as goods and services (inventory).
• Department of education purchases Learner Teacher Support Material (LTSM) through the implementing agent for schools. The LTSM is classified as goods and services (inventory). When the materials are delivered directly to the school, this is still classified as goods and services (inventory).
• Department of Agriculture purchases agricultural inputs or make use of the 3rd party to purchase the agricultural inputs for delivery to the beneficiaries (farmers). The immediate use of the funds is purchasing the agricultural inputs and consequently this will be classified as goods and services and accounted for as inventory.

[1]First issued in November 2003, updated in September 2009 and is subject to a further update.