A User Guide to the Canadian System of National Accounts

Note to readers

This document is a guide to the various components of the Canadian System of National Economic Accounts, describing frameworks, major concepts, definitions and the purpose of each component. It was published in 1989. Most of the information does not change. However, the Canadian System of National Economic Accounts is constantly making important improvements. For more information see Latest developments in the Canadian economic accounts.

Chapter 4

Income and Expenditure

General

The income and expenditure accounts are the best known and most widely used component of the Canadian System of National Accounts. The accounts were first published on an annual basis in the latter half of the 1940's. In 1952,estimates covering the historical period 1926-50 were published with basic references, and shortly afterwards, quarterly estimates for the years 1947-52 were released. Since that time, annual and quarterly series have been published on a regular and current basis. A detailed recording of the historical background may be found in 'National Income and Expenditure Accounts - Volume 3', Statistics Canada, Catalogue 13-549.

Essentially the accounts start at the point that the input-output tables finish - the measurement of gross domestic product. They record GDP using two methods - by type of purchaser and by type of income generated by production. To the extent that they do only that, they are similar to parts of the input-output system. However, the direction in which they extend the statistical analysis of the economy, the way in which they link economic theory and business accounting practices, and the bridging role they perform between the production and financial systems are the special features which set them apart. Their timeliness, presentational style, and historical continuity have put them in the forefront of all other systems for current analysis.

Many of the main aggregates associated with the production accounts have been defined in describing the input-output system. There are however, some broad aggregates of particular significance to the income and expenditure accounts, such as national income, personal disposal income and final domestic demand, that remain to be defined.

Extending the statistical analysis of the economy

The major contribution made by the income and expenditure accounts is in tracing the impact of production, both direct and indirect, through four broad sectors of the economy: persons and unincorporated business, government, corporate and government business enterprises and non-residents. These institutional type sectors, or transactors, are defined in such a way that the units in each one constitute a grouping of entities expected to behave in broadly similar ways.

The selection of only four sectors is conventional and minimal in terms of behavioural patterns; the number of sectors could be extended, but in balancing comprehensibility and complexity, and for reasons of data availability, the summary presentation has been limited to four sectors. As will be seen later, the financial flows system expands the sectoring: the corporate and government business enterprise sector is divided between financial and non-financial concerns and the financial sector further sub-divided. The choice of sector boundaries and the allocation of units to specific sectors has important ramifications throughout the system of accounts insofar as it delineates the boundaries of production and the valuation placed on its measurement.

The theoretical model underpinning the accounts develops three sets of accounts for each sector - a production account, an income and outlay account, and a capital finance account. The production account records total production expenses and revenue from gross sales of goods and services. Primary production expenses, such as wages and salaries, are carried down from the production to the income and outlay account and distributed as income to the sectors contributing factor services, while revenues from final production are carried down and shown as outlays of the sector making the final purchase. The income and outlay account also records current transfers between sectors, for example, income tax as payments by persons and receipts by government.

The balance in the income and outlay account, in other words the saving or dissaving of the sector, is carried down to the capital finance account where it is offset against capital expenditure of the sector. As the major part of production originates in the business sector, the Canadian System of National Accounts prepares only a single consolidated production account for all sectors. In the process of consolidation, all intermediate products net out and the account records only primary expenses on one side and revenues from sale of final goods and services on the other.

The main difference between the consolidated production account and the summary income and expenditure based estimates of gross domestic production, all of which arrive at the same aggregate, is in the different perspective they give. The consolidated production account views the economy through the eyes of a business accountant, with output being the sum of modified revenue and expense accounts of individual productive units in the economy.

The income and expenditure based aggregates are presented from the viewpoint of an economic accountant with expenditures presented as major demand components and incomes as returns to major factors of production. Items that appear as primary expenses in the consolidated production account, for example, wages, appear as incomes in the income based estimates of gross domestic product, while revenues in the production account from such items as sales appear in the expenditure based estimates as outlays on consumption and investment.

Two sets of accounts are constructed in the Canadian system for individual sectors, one relating to current income and outlay and the other to capital transactions.

The income and outlay account records income accruing to the sector from its productive activity plus income resulting from transfers from other sectors (money flows for which there is no counterpart flow of goods or services). In a similar fashion, the outlay recorded is both expenditure on final production as well as transfer payments to other sectors. In any consolidation of the sector income and outlay accounts, this redistribution of income and purchasing power brought about by transfer payments nets out, one sector's income being another sector's outlay. For an individual sector, however, the inclusion of transfers provides a more accurate picture of the economic role of the sector and of its effective demand over the country's output.

The current income and outlay accounts record main income flows, outlays, and transfer payments, corresponding with type of factor service involved, purpose of outlay, or source of transfer payment. The sector accounts provide a substantial amount of information on a from-whom to-whom basis. For example, wages and salaries received by persons are shown by paying sector, namely, received from business, government, or from persons themselves; they are also recorded as outlays of those sectors respectively.

Outlays by the personal sector are recorded in their accounts according to the sector from which commodities are purchased and as receipts by the selling sector.

The units in each sector are described at length in a later section. In most cases the classification is self evident; however, the treatment of unincorporated business is unique in that it has a split personality, appearing in the business sector in the production account but in the personal sector in the income and expenditure and capital finance accounts.

Although the sector accounts follow the same principles, the individual sectors differ in appearance. For example, the income of the persons and unincorporated business sector is composed mainly of wages and salaries, net income of unincorporated business and transfer payments, while the corporate and government business enterprises sector income is largely profits and investment income. In the government sector nearly all income results from direct and indirect taxes with only a small amount from investment.

Transfer payments figure prominently in the income and outlay accounts and are briefly described before proceeding to the capital finance accounts. They are transactions in which there is no 'quid pro quo'. They are the vehicle by which income accruing to a sector by virtue of its productive activity is redistributed to other sectors.

Such payments have the effect of lowering the consumption or investment of the pay or and raising that of the payee.

In most instances transfer payments are the means by which income is redistributed among units within a sector. Incomes from one group of persons are routed out of the sector to the government and then channelled back to the same sector but to a different group of persons. The major types of transfer payments in the system arise through taxation and government spending. Income is taken out of the hands of the personal, business and nonresident sectors by government, and recycled in the form of social welfare payments, subsidies and interest on the public debt.

The second set of sector accounts contains capital transactions. The source side of the capital finance account shows the sector's gross saving, composed of the balance from the income/outlay account which may be positive or negative, plus allowances for capital consumption, plus any capital transfers from other sectors. (The distinction between current and capital transfers is not always clear in practice, but in theory hinges on the intent or purpose of the transfer.) The disposition side of the account records fixed investment and inventory change. The account is balanced either by an excess or shortfall of saving over capital formation, such a balance representing net lending when positive, or net borrowing when negative.

The schematic presentation shows the income and expenditure accounts. It is less complicated than the input-output component and simply shows the summary production tables for the overall economy and the income and outlay and capital finance accounts for each of the main sectors. Examples of the transactions are also included in each account. The tables within the main block are easily identified with published tables.

Arrows link the corresponding aggregates in the input-output and income and expenditure blocks. Table 3 presents a condensed version of the income and expenditure accounts for the year 1981.

The above description of the income and expenditure set of accounts has focussed on the principal structure of the framework. A great number of derivative tables and much supplementary information have been developed over the years to satisfy analytical needs. Within the framework of the accounts the system provides detailed supplementary data on government transactions and personal expenditure, special tables showing the value of imputed transactions, and further analysis of corporation profits.

Provincial and industrial distributions of selected series are also available.

The relationship of economic to business accounting

The conceptualisation of the economic accounts lay in the domain of the economic theorists, who pointed the way towards the significant components, balances and relationships which govern the structure and behaviour of an economy. In the case of the income and expenditure accounts there was a happy coincidence between the basic constructs around which macroeconomic analysis centred and the principles governing business accounting.

Some rearrangement and modification of basic business accounts gave operational definition to the theorists' concepts.

Both the economic accounts and business accounts are based on a double-entry system. Each account is a balancing statement with debits (outlays or uses) offsetting credits (income or sources). The objectives of both are to present a fair picture of the state of an entity that both enlightens and assists in the decision making process.

The pattern of business accounting is most easily recognized in the context of the business sector of the income and expenditure accounts, but the personal, government and non-resident sectors follow the same principles even though the approach is a more pragmatic one. The three basic economic accounts -production, income and outlay and capital finance - are derived from the income, retained earnings and changes in financial position statements of the business accounting world.

The business income statement records operating and non-operating revenues of the firm on one side of the account and its charges against revenue such as purchased materials, wages and salaries, depreciation, inventory change, interest and indirect taxes on the other.

By a rearrangement of some of the items, the income statement can be transformed into the production account more familiar to economic accountants.

The total revenue of the firm is converted to an output value by adjusting sales revenue by the change in inventories of finished goods and goods-in-process and by deducting non-operating revenues such as interest and dividend receipts. The resulting gross output measure is converted to a net measure by subtracting the cost of current purchases of goods and services, including changes in raw material inventories. The balance in the account is maintained by appropriate adjustment of the expense side of the account to remove all entries other than wages, capital consumption allowances, net interest payments, indirect taxes and profits.

The income and outlay economic account is derived from the business income and retained earnings statement.

The business retained earnings statement records net income before tax on one side, and the distribution of that income through dividends paid and corporate profits tax on the other - retained earnings balance the statement.

The conversion to an economic account requires that net income before tax be adjusted to an operating profit concept by removing dividends received and capital gains on sales of fixed capital and securities and adding depletion charges. This add-back of depletion charges is necessary because natural resource discoveries are not treated as capital formation in the national accounts and therefore depletion allowances cannot be charged against profits. Counterpart adjustments are made to the distribution of profits side of the account - the retained earnings figure is redefined by these adjustments to include depletion allowances and exclude capital gains.

The business balance sheet or change in financial position statement provide the material for the derivation of the capital finance account in the income and expenditure accounts. It also provides the data for changes in financial assets, liabilities and net worth in the financial flows and balance sheet accounts.

The use side of the capital finance account records changes in fixed assets before depreciation (purchases of plant and machinery less any sales) and inventory change taken from the balance sheet. The source side of the account records retained earnings, as adjusted in the income account (excluding capital gains but including depletion allowances), plus depreciation allowances. The balancing item is the equivalent of the net change in financial assets which appears in the changes in financial position statement in business accounting. In national accounting terminology this balance represents net lending or borrowing, or surplus or deficit in the case of government.

This summary of the relationship between business and economic accounts grossly simplifies the translations that take place between business records and income and expenditure accounts. It ignores such adjustments as those made to inventory valuation and depreciation allowances, the problems associated with fitting data from the non-business sector of the economy into the accounting framework, and the distinction between transfers and other transactions. However, as over threequarters of production originates within the business sector, the linkage provides a realistic perspective on both the logic and the rationale for the direction of development followed by the income and expenditure accounts.

Aggregates associated with the income and expenditure accounts

Some important concepts and definitions relating to gross domestic product and the three methods of measuring production have already been discussed. The overview chapter outlined the boundaries of production, net and gross measures, the distinction between national and domestic production and market price and factor cost, while the input-output chapter explained the various methods employed to measure production. As these concepts and definitions apply equally to the income and expenditure accounts the reader may wish to review them before proceeding.

One distinction between the input-output tables and the income and expenditure accounts that should be noted is the different treatment of the statistical discrepancy between the conceptually identical expenditure and income based production estimate. In the input-output system any imbalance that remains after all steps have been taken to balance the sales and purchases of each commodity group is attributed to the change in inventory category - in effect, the discrepancy item is assumed to be an unmeasured inventory change. In the income and expenditure accounts any difference between the expenditure and income based estimates is not attributed to a specific component but is shown as a discrepancy item, the higher aggregate is reduced and the lower one raised by one half of the discrepancy.

A number of important measures closely associated with the income and expenditure accounts have not yet been defined. These include net national and domestic income at factor cost, personal income, personal disposable income and final domestic demand.

a) Net National and Domestic Income

National income is defined as the sum of all incomes of residents of a country arising as a result of the current production of goods and services; some of that income is generated abroad. Domestic income is the sum of all incomes derived from economic activity taking place within the geographical boundaries of the country; some of that income is generated by non-residents. The income aggregates comprising employment income, rent, profits and other investment income are generally known as factor incomes as they broadly correspond to the economic factors of production, labour and capital. Income received as transfers, such as pensions or family allowances, is not included as they are redistributions of factor incomes and to include them would be to double count incomes. The classification of income types is not always clear cut: net income of unincorporated business represents in part a return to labour and in part a return to capital.

Although national income does not differ significantly from domestic income it is lower in Canada to the extent that factor payments to abroad exceed those received from abroad. Since the recent comprehensive revision of the Canadian income and expenditure accounts more prominence is given to net domestic income at factor cost. Either national or domestic income at factor cost is normally used in resource allocation analysis.

b) Personal income

An important and commonly used aggregate in the accounts is personal income. It consists of the sum of all income of resident persons from productive services rendered, plus all transfer incomes from government, business and the non-resident sector.

The main component is labour income but also included are net income of unincorporated business, interest, dividends and other investment income of persons, including that accrued on behalf of persons by life insurance companies, trusteed pension funds and other similar institutions. Personal income is measured before tax deductions and contributions to social security schemes paid by employees.

In the Canadian System of National Accounts 'persons' and 'personal sector' are defined to include trusteed pension plans, and private non-commercial institutions such as universities, labour unions, professional organizations, fraternal societies and charitable institutions. The income of these groups is therefore included in the coverage of personal income. Because of this broad definition of the personal sector it is important not to interpret the aggregates and their derivatives, such as saving, as relating solely to households.

c) Personal disposable income

Another frequently used aggregate is personal disposable income. This is the income available to persons after having met certain specific commitments. It is derived by deducting from total personal income, direct taxes, and other fees, licences and permit costs paid to government, including hospital and medical insurance premiums paid under publicly operated plans. Personal disposable income is equal to personal expenditure on goods and services and transfers to business and non-residents plus personal saving.

d) Final domestic demand

Final domestic demand, which appears in the income and expenditure accounts as a supplementary aggregate, measures personal expenditure on goods and services, government current expenditure on goods and services and business and government investment in fixed capital. It differs from the more widely used gross domestic product at market prices by omitting investment in inventories and exports of goods and services; it includes the import content of the measured components.

e) Gross national product

The most commonly used aggregate until the recent comprehensive revision was gross national product, usually referred to as GNP. Although greater emphasis is now given to the domestic concept, the national measure is still available. In the case of the expenditure based estimate, the net factor income adjustment can either be made explicitly at the aggregate level, or can be made to the export and import component of the account. The income based estimate of domestic product can either be adjusted explicitly at the total level or in the investment income component.

Definitions of the sectors

Transactions in the economy are organised and presented according to four broadly defined groups of transactors. In principle, the four sectors are defined so that the economic units assigned to each one exhibit similar patterns of behaviour, and the transactions between units in different sectors are analytically significant. Because the income and expenditure accounts are largely structured around the sectoring principle the definitions that follow are quite detailed.

The persons and unincorporated business sector displays the transactions of members of the community as final consumers. The government sector records the transactions reflecting the role of the non-commercial government operations as they relate to taxation and public expenditure. The corporate and government business enterprise sector, shows the transactions of those economic units organised to produce goods and services at a price calculated to cover costs and yield a profit. The non-resident sector displays the transactions of Canadian residents with the rest of the world and is different in character from the others. It is not organised on the principle of grouping homogeneous economic units but rather on residency and it includes transactions of persons, businesses and governments.

a) Persons and unincorporated business sector

Generally referred to as the personal sector, the full title 'persons and unincorporated business' indicates that the sector does not simply consist of individuals or households but extends much beyond.

First, the sector includes the entire net income of self-employed or unincorporated businesses because of data limitations. Ideally, this income should be split between income retained in the business and that withdrawn for purely personal use; for example, part of the income of self-employed farmers, retailers and professional practitioners is withdrawn for personal living expenses and part is retained in the business for, say, reinvestment. This latter portion should more correctly remain in the business sector.

So far it has not been statistically feasible to make this separation. A consequence of this is that personal saving contains a small element of saving by unincorporated businesses that would more appropriately be classified as undistributed business profits.

The capital finance account includes the major part of unincorporated business investment in fixed capital and capital consumption allowances. The inclusion of these major components of the operations of unincorporated business in the capital finance account is an unfortunate compromise forced on the system by data deficiencies. Because of statistical difficulties, inventory investment in non-farm goods by self-employed business proprietors is not included but remains in the business sector. Such blurring of the boundaries of the sector complicates the interpretation of the numbers.

Second, the sector includes private non-commercial institutions serving persons, such as labour unions, universities, religious institutions, charities, professional associations and social clubs. These institutions and groupings are included on the grounds that they are 'associations of individuals' acting collectively for the mutual benefit of individuals. The operating expenses of these groups (including the pay of their employees) are included in consumer expenditure. Their investment income and transfers from other sectors are included in personal sector income. Gifts and donations from other individuals are transfers within the sector and are excluded. The capital finance account includes capital spending by this group on such buildings as universities and churches.

Third, the sector includes certain transactions relating to life insurance and pension plans. The treatment of life insurance and trusteed pension plans is based on the consideration that funds held under these schemes are the collective property of individual policy holders and members of the pension plans; they are funds held on behalf of persons. This treatment affects several components of the personal sector.

Since income of the funds is considered to belong collectively to persons, the funds' income, other than premiums paid directly by persons, is added to personal income. This includes investment income and the premiums and contributions paid on behalf of persons by their employers.

As life insurance premium payments and contributions to pension plans add to the funds of the schemes, the payments by persons are not shown in full as personal expenditure. Only that part of the premium or contribution which covers the operating or administrative costs of the scheme is included as consumer expenditure, including an element of profit when the schemes are run by private companies.

Operating costs are equated with the value of the service provided by life insurers or pension fund managers. In the case of life insurance the service charge for providing insurance is estimated to be the excess of premiums received over claims paid and net additions to the funds held. The income and outlay treatment outlined above has the effect of consolidating the saving of the life insurance and trusteed pension plans with individuals' saving. As previously noted, the saving is regarded as having been undertaken collectively by the schemes on behalf of persons.

Some interesting implications result from the above consolidations. In ignoring both premium and contribution outlays in excess of the cost of providing a service and benefits received by persons, important cash flows disappear from view. In the case of the premiums and contributions, the rationale is that part of the outlay is not consumer spending but saving; in the latter case, the benefits paid are considered a return of saving analogous to funds received from the sale of financial assets and are not income flows.

By contrast, the transactions of social insurance funds such as the Canada Pension Plan and non-trusteed government pension plans for its own employees are treated quite differently - they are regarded as being in the government sector. Contributions to and benefits from these schemes are shown as transfer payments flowing between the personal and government sectors. Investment income of the funds is credited to government saving. The conceptual reasons for the differing treatment are related to the contractual differences between government and trusteed schemes and the fact that one is unfunded and the other largely funded. The government treatment follows events in the real world more closely in the sense that it tracks the cash flows and recognizes that the saving is locked into the sector providing the service until certain rather rigid conditions are met. The argument advanced for the treatment accorded to private schemes is that pension and life insurance schemes are viewed as personal saving by individuals and that this perception is reflected in their behaviour and current consumption patterns.

b) The government sector

This sector covers a broad range of activities carried out directly by the various levels of government or their agencies. The essential characteristic of these activities is that they are non-commercial in nature.

They are undertaken by society on a collective basis and financed for the most part out of taxation or government borrowing. Activities of government business enterprises operating for a profit are not included here; their methods of operation and motivation are considered more closely related to those of private business enterprises.

The government sector defined within the Canadian System of National Accounts covers three main groups of activities:

1. the departments of the three levels of government - federal, provincial and local - ordinarily engaged in such activities as administration, defence, the regulation of public order, the promotion of economic development and the provision of health, education, cultural, recreational and other social and community services that are normally included in the budgetary statements of government;
2. schemes administered by public authorities for purposes of providing social security services, such as the Canada and Quebec Pension Plans, workers' compensation and various pension plans and normally financed out of extrabudgetary funds; and,
3. agencies, commissions, and boards financed from public funds and receiving most of their funds in the form of government grants, including for example, such bodies as the National Research Council, the National Film Board and the National Capital Commission at the federal level, health service commissions at the provincial level and school boards at the local level. The above include such major activities as the operation of all public hospitals and government administered medical health care plans.

In the process of preparing the overall sector account, transactions between the different levels of government are in general netted out according to the principle of omitting intra-sector transactions. A major exception to the consolidation principle is the treatment of interest payments on the public debt, which are shown on a combined basis for all three levels of government. Inter-governmental payments of interest appear as part of government expenditure and as part of investment income. Certain taxes on final expenditure levied by one level of government and paid by another are also shown as both payments and receipts by the sector. The treatment in the latter case puts the government sector on the same basis as the private sector in the sense that its expenditure at market prices includes indirect taxes.

It also means that the sum of all sectors' final expenditure equals the total for the economy.

c) The corporate and government business enterprise sector

This sector covers privately controlled corporate enterprises together with government business enterprises. The enterprises included are responsible for the greater part of the country's production. It is important to recognize the distinction between the business sector as defined in the production accounts and the corporate and government business enterprise sector referred to in the income and outlay and capital finance accounts.

In the case of the production account both corporate and unincorporated businesses are included but in the income and outlay and capital finance accounts, because of statistical difficulties, the net income, saving and capital outlays of unincorporated businesses are included in the personal sector. The net income of an unincorporated business cannot be allocated accurately between the proprietor and the business; hence the entire amount is attributed to the personal sector.

The sector is defined in terms of the type of institution rather than activity. Corporations in the private sector are legal entities distinct from the persons who are their members; they are essentially organised to yield a profit and are owned and controlled by members of the private sector of the economy. In general, corporate entities have limited liability. The sector includes some private non-profit organisations serving corporations such as trade associations.

Government business enterprises share similar behavioural characteristics with private sector corporations, the main distinction being that of ownership and control. Although government business enterprises are owned and controlled by public authorities, they operate with a substantial degree of independence in the day-to-day conduct of their business and normally are organised to run as self-sustaining enterprises, in many cases yielding a profit. Government business units may be used to promote government policy objectives and in this event the yielding of gain by the enterprise may become of secondary importance. The enterprises are found in a wide range of activities through the industrial field.

Three aspects of the enterprise sector should be noted. First, all business enterprises resident in Canada organised as corporations are included in the sector, irrespective of whether they are owned or controlled by Canadians or by non-residents.

Secondly, statistical deficiencies force the routing of large amounts of investment income related to interest on the public debt through the income and outlay account; the amounts routed in and out of the sector are the same and hence do not disturb the derived saving balance of the account but they do distort the aggregate income and outlay shown.

Thirdly, a significant segment of the sector, covering banks and other financial institutions, require special treatment in the accounts.

Because users sometimes find the treatment of banks and other financial intermediaries confusing it is worth reiterating the description given in the input-output chapter. The conventional national accounting methodology yields a negative or unreasonably small positive estimate of income originating in the industry. Income originating in, or the value added by, an industry is normally estimated by summing payments to factors of production; interest payments which constitute one of the factor returns is included net of interest receipts.

The reason this procedure results in unreasonable estimates for the banks and financial intermediaries is that these institutions rely heavily on the interest they receive from the investment of clients' funds to finance the services they provide to clients. Thus, they do not charge specifically for all services rendered to clients. By netting out interest receipts when deriving net income originating, and by not having a specific charge for services rendered when measuring net output from the product side of the account renders the traditional national accounting methodology unsatisfactory for this segment of the sector.

In order to overcome this problem an amount is imputed for the short-circuited transactions, that is, for the services rendered by financial intermediaries to their clients without charge. The amount of the imputation is taken to be equivalent to interest received less interest paid to lenders of funds to the institution.

d) The non-resident sector

The non-resident sector constitutes an important and integral part of the Canadian System of National Accounts. It differs in composition from the three sectors so far described. The personal, government and business sectors were groupings of units with some uniformity in behaviour and motivation, whereas the only binding link in the non-resident sector is the residency of the unit included. The sector includes all transactions of non-residents with Canadian residents.

The boundaries of the sector hinge on the determination of residency of individuals, government units, enterprises and international organisations. A general discussion of the question of residency appeared in the overview chapter in the section dealing with the national and domestic concept and will not be repeated. Further discussion of the residency concept appears in the chapter on balance of payments.

The non-resident sector does not fit happily into the conceptual framework developed for the domestic sectors. The income and outlay and capital finance accounts for domestic sectors record the distribution of types of income arising from production and any redistribution resulting from transfers, and the disposition of income on final goods and services both of a current and capital nature. In the case of the non-resident sector, the structure is that of an embryonic balance of payments statement. The income of non-residents is stated in terms of the value of Canadian imports of goods and services plus transfer payments by Canadians to non-residents and their outlay records Canadian exports of goods and services plus transfers to Canadians. For obvious reasons the account is not structured in terms of factor income receipts of non-residents, nor is there any offset to saving in terms of capital formation. The sector's accounts are, to a large extent, an expedient way of balancing the system.

Definitions of the main transaction categories Income flows and other charges against production, as well as the major demand components of gross domestic product are defined in this section. In addition some important flows appearing in the sector tables will be described. As with transactors, the transactions are groupings which are both analytically significant and correspond as far as possible to important economic constructs.

A number of possibilities present themselves regarding the stage at which transactions are recorded. In practice the choice is usually between the cash payment and receipt basis, or the accrual (payable/receivable) basis. In the former the transaction is recorded when money passes, and in the latter, when an expenditure is made.

In principle the Canadian accounts adopt the accrual basis for recording transactions, and to the extent possible, the principle is applied consistently.

The adoption of one method poses some difficulties insofar as data sources may use different methods; for example, most commercial accounting reflects the accrual basis, whilst government accounting is largely on a cash basis. Where known problems create serious data inconsistencies attempts are made to adjust data to the chosen basis. Since the different methods relate to the time at which transactions are recorded, the longer the period of account, the less likely the choice of method will produce greatly different results; the problems are likely to be more severe in quarterly than annual compilations.

In the sector accounts where the emphasis is on income and expenditure distribution, as opposed to production measures, it is sometimes regarded as analytically more useful to examine the cash flows.

Income flows and other charges against production in the income based estimates of gross domestic product:-

a) Wages, salaries and supplementary labour income

Wages and salaries cover all earnings from employment of Canadian residents, including payments in kind such as free board and lodging.

Also included are such payments as commissions, directors' fees, tips and bonuses, and taxable allowances such as cost-of-living allowances and payment in respect of vacation and sick leave. The estimates do not include earnings from selfemployment or partnership, income from independent professional practice, or income of farmers from farming operations. Military pay and allowances are a component of wages, salaries and supplementary labour income.

Wages and salaries are estimated before tax deductions and before contributions of employees to unemployment insurance, pensions and other social insurance schemes. Bonuses, commissions and retroactive wage increases are included in the period in which they are paid because of the statistical difficulty of allocating them to the period in which they were earned.

Supplementary labour income consists of other expenditures by employers on labour account that can be regarded as payment for employees' services. Included here are employers' contributions to pension funds, employee welfare funds, unemployment insurance and workers' compensation.

b) Corporation profits before taxes

This component represents the net earnings from economic activity of privately-held corporations and is generally regarded as the share of these corporations in the gross domestic product, in other words, their factor income. Based on business accounting, profits require a number of adjustments to convert them to the needs of the economic accounts.

Corporation profits before taxes are measured after deducting an allowance for the consumption of fixed capital in the current period. Conceptually, the allowance would best be based on the replacement cost of capital but, being derived from business accounts, it is normally based on the original cost.

The original cost allowance is accepted partly because of statistical difficulties in estimating replacement cost valuations and partly from a desire not to depart too far from the business accounting concept of profits.

Depletion allowances are not charged against profits in the national accounts. In business accounting, discoveries of new natural resources are capitalized and their exhaustion is regarded as a production cost.

In the national accounts they are not included as part of the stock of wealth and no cost of depleting them is made against profits; hence economic profits are higher. In the case of geological and geophysical survey costs, capitalized by business but considered current expenses in the national accounts, economic profits are lower than recorded business profits.

Mining and exploration costs involving the acquisition of tangible durable equipment and construction or drilling, which may be treated as current charges against profits by business, are considered capital formation in the economic accounts; in this case economic profits are higher than business accounting records.

Corporation profits include gains and losses arising from the effect of price changes on inventory values. National accounting concepts rule that these gains and losses do not arise as a result of current economic production and should not be permitted to influence profits. In the Canadian accounts the adjustment is not made directly to profits but a separate inventory valuation adjustment series is published. Users may then analyse the economic construct of profits by making the adjustment themselves, or they may use the alternative business accounting concept. Corporation profits before taxes also exclude other forms of capital gains and losses as these do not represent factor incomes arising from current production.

The payment of dividends is considered to be a distribution of profits in the economic accounts and so the published series of profits is before dividend payments. It is important therefore to exclude from profits those dividends received by Canadian corporations from other Canadian corporations when summing business accounting records of profits.

Other adjustments required to fit business profits into the mold of the economic accounts include the adding back of some items considered as expenses by business but as distribution of profits by economists. These include certain taxes, bad debts owed by persons and written off, and charitable contributions.

c) Interest and miscellaneous investment income

This component measures interest income of persons and government investment income before deduction of direct taxes. Being on a domestic basis the total includes interest earned in Canada payable to nonresidents, but excludes that due to Canadian residents from their activities outside the country.

The main items in the category are Canadian bond and mortgage interest; paid and imputed interest on deposits with chartered banks and similar financial institutions; and investment income received on behalf of persons by insurance companies, trusteed pension funds, fraternal and mutual benefit societies, arising from a diverse range of financial instruments.

Items of less significance are royalties received by persons, interest credited to persons from federal government annuities accounts, and the profits and interest of mutual non-life insurance companies.

Government investment income includes the profits of government business enterprises, royalties, interest on government loans and advances, interest on publicly held funds such as government pension and social insurance funds and imputed interest.

A major adjustment is made to the interest and miscellaneous investment income component on account of interest on the public debt and on consumer debt.

Interest on the public debt is excluded from the interest component of domestic income since it is regarded as a transfer, or distribution of income, rather than a factor income arising from a productive service. For statistical reasons, the full amount of interest on the public debt is deducted from total interest income received by persons. To the extent that business and government are holders of public debt, part of the deduction should apply to these sectors and corporation profits and government investment income should be lower and investment income of persons higher.

Part of interest on consumer debt is also treated as a transfer payment and is excluded from national income by an explicit deduction in the interest and miscellaneous investment income component. The reason for this exclusion is that consumer outlays are considered to be current expenditures with the exception of housing. Since consumer goods cannot give rise to investment income, it is necessary to exclude interest on the debt which finances such goods. Administrative expenses which are incurred in rendering services to borrowers are, however, included in personal expenditure and gross domestic product.

d) Accrued net income of farm operators from farm production

This component includes the sales of farm products, plus the imputed value of farm output consumed by the farm family, plus the value of the physical change in farm inventories, less farm operating expenses and capital consumption allowances on farm buildings and equipment. Income not derived from farming activities is excluded, as are transfer payments.

e) Net income of non-farm unincorporated business including rent

This item consists of the earnings of working proprietors from their own businesses and also includes the net income of independent professional practitioners such as doctors, lawyers, dentists and engineers.

Net rental income of persons covers net rents (either paid or imputed) received from ownership of residential property and net paid rents from the ownership of non-residential property. Net rent is equivalent to gross rent less landlord expenses such as heating, property taxes, capital consumption allowances, mortgage interest, insurance and repairs.

f) Inventory valuation adjustment

Because business accounting records generally incorporate inventories in the production process on the basis of their historical cost, the change in the book value of inventories and the profits reflected in business books may include an element due to price changes. If prices have risen or fallen between the time that inventories were acquired and the current period when they are used up and replaced, both inventory change and profits will contain an element of capital gain or loss which is not related to the measurement of current production.

In the economic accounts, this element is removed and the change in inventories is valued at current prices of the period. The adjustment to inventory investment carried out on the expenditure side of the accounts requires a counterpart entry on the income side, so that a profit figure maybe derived using the same method of inventory valuation.

g) Indirect taxes and subsidies

Indirect taxes represent a part of the market price of goods and services and must be added to domestic income at factor cost to arrive at a market price valuation. Indirect taxes are normally distinguished from direct taxes on the basis that the former are imposed on expenditures as opposed to incomes.

Among the major taxes included in the Canadian accounts as indirect are sales and excise taxes, import duties and property taxes. Taxes on income, or direct taxes, are already included in market prices by virtue of the fact that factor incomes are gross of direct tax payments.

Subsidies represent amounts contributed by governments toward current costs of production. In this sense they may be regarded as negative taxes which reduce market prices below factor costs. For this reason subsidies are deducted from the total of factor costs to arrive at gross domestic product at market prices.

h) Capital consumption allowances

The gross aggregates in the Canadian System of National Accounts measure production and income before allowances for the using up of capital in the production process. However, as such a charge against production is embodied in the market price of commodities in the expenditure based estimates, a specific allowance must be included on the income side of the accounts to maintain the conceptual balance. In business accounting the provision for the depreciation of capital is usually based on the historical cost of the asset and on an assumed length of life.

Conceptually, in economic accounting, the valuation of capital consumed is more appropriately based on its replacement cost in accordance with the current price valuation principle. For example, in periods of rising prices, business accounting methods will understate the cost of capital consumed in current prices but overstate profits which is a residual after deducting other expenses from revenues. The effect of the overstatement may be offset to some extent by the fact that business may, for tax purposes, depreciate an asset over a shorter length of life than its actual life-span.

In the Canadian accounts, the estimates of capital consumption allowances area mixture of historical and replacement cost bases. In areas where business records are generally not available, capital cost allowances are estimated at replacement cost - for example, on housing, fishing fleets and equipment, agricultural plant and equipment, and government fixed investment. In all other areas historical cost estimates from business accounting records are used. No matter which method is employed in the business sector the gross measure of production does not vary, but the choice of method is reflected in the net measure of production as different capital consumption allowances affect the level of profits.

For many analytical purposes, business accounting records of depreciation have become less relevant given the rapid price changes experienced in the past decade, a fact recognized by both business and national accountants. There has been much study and many new recommendations in this area over the same period. Two difficulties are prominent in switching to replacement valuation. One relates to the impact of quality and technological change and how to take these into account in the context of the replacement cost of existing assets, and the other to determining the service lives of assets and the manner in which costs should be allocated over these lives. These are not problems new to estimating capital consumption, but they are important issues that have to be addressed when considering any changes in this area.

Two miscellaneous balancing adjustments required to close off the income based estimate of gross domestic product are included in this component.

The first relates to items not considered as capital in the national accounts but charged to capital by business. Because this treatment leads to higher business net income, a negative adjustment is required to keep the income and expenditure based gross domestic product estimates in balance. Items charged to capital by business but not considered as capital in the national accounts do not appear on the expenditure side of the accounts, thus the income based estimate would be too high without this adjustment.

The second adjustment relates to business and residential insurance claims paid to compensate for fire and other type of losses. These claims, a form of capital consumption, together with the factor incomes generated by the insurance service, constitute the income based counterpart to the premiums paid by business which enter into the market prices of the expenditure based estimate.

Demand components of the expenditure based estimates of gross domestic product:-

a) Personal expenditure on consumer goods and services

Personal expenditure on consumer goods and services includes outlays on all new durable, semidurable, and non-durable goods and services except purchases of dwelling units. Intra-sectoral purchases of used goods are excluded and only an estimate of dealers' margins and commissions on used goods are included as representing expenditure on current production. However, purchases of used imports and capital items from the business sector, for example automobiles, are included.

The inclusion of imputations for free board and lodging and other income-in-kind in the estimates is as if persons had received income and had specifically purchased goods and services of equivalent value. Purchases of dwelling units are not included as current expenditures but appear under fixed investment as if the purchasers were businesses. This capitalisation of dwellings requires that personal expenditure include an imputed rent estimate paid by owner-occupiers to themselves for the service yielded by the dwelling.

The estimate also includes outlays by those, other than individuals and households, who are part of the personal sector, such as the operating costs of noncommercial institutions serving persons, and the operating costs plus profits of life insurance companies.

Spending by Canadian residents temporarily abroad, either as tourists or as members of the armed forces, is included as part of personal expenditure, while expenditure by foreign residents temporarily in Canada is excluded. All expenditures that are regarded as business costs are excluded.

b) Government current expenditure on goods and services

This component consists of current outlays for goods and services of the federal, provincial and local governments, including locally administered elementary and secondary school systems and government administered hospital care services. It does not include government purchases on capital account (investment in fixed capital and inventory change), nor the activities of government business enterprises. The outlays cover all general operating expenses of government departments and agencies, including wages and salaries, office supplies and repair and maintenance costs, plus an imputed allowance for the consumption of government fixed capital.

The expense of providing goods and services sold to the public are excluded from government expenditure as outlays for these commodities show up in the expenditure of other sectors. Expenditures for military equipment and defence installations are not capitalised but appear as current outlays.

This final demand component covers only government current purchases of final goods and services and should not be confused with total government outlays. A larger part of government spending takes the form of transfer payments and is recorded in the sector accounts under such items as social security payments, interest on the public debt, subsidies to producers and other transfers.

c) Investment in fixed capital

Business and government investment in fixed capital is defined in broad terms to include the production of physical productive assets that yield a service in the future, examples of which include factories, dwelling units and machinery. It is the major component of production which adds to the nation's wealth. Looked at another way, it is that part of final expenditure not consumed, exported or added to inventories during the accounting period.

Operationally, investment in fixed capital covers outlays on new durable tangible assets with a lifetime use of one year or more. Outlays on used buildings and machinery, except for related fees and commissions, are excluded since such goods are not part of the nation's production in the period of account. Imports of used capital machinery and equipment are included in the estimate as adding to the stock of capital of the nation, but do not affect the overall measure of production as they are also a part of the negative import adjustment.

The estimates include capital costs associated with the development of natural resources but not outlays for land, mineral deposits and timber tracts themselves; the former expenses are attributable to productive activity but not the latter. Alterations and improvements to existing stock which extend the life of the asset beyond that originally anticipated are treated as fixed capital, but regular repair and maintenance expenses are not. Costs associated with the purchase of fixed assets such as architectural, engineering, legal and landscaping fees and expenses are included in the estimate. The estimates are gross in the sense that no deduction is made for the consumption of the existing stock of capital in the production process during the period of account - the gross concept is useful to the extent that replacement of worn-out or obsolete capital assets can, within limits, be postponed.

Three sub-components of fixed capital are provided - residential construction, non-residential construction and machinery and equipment and these estimates are further subdivided between government and business. The government estimates exclude capital outlays by government-owned enterprises, which are included in the business sector, and military installation and equipment which are considered current outlays.

Business residential construction estimates cover both commercial and owner-occupied type housing, ranging from single dwelling units through to major apartment complexes, including ancillary structures such as garages, sunrooms and other major additions and alterations. Business investment in nonresidential construction and machinery and equipment covers investment in all forms of productive assets by business - corporations, unincorporated business and government business enterprises - and by non-commercial institutions - churches, universities and charitable and welfare agencies.

The Canadian income and expenditure accounts do not include consumer durable goods as investment even though many meet the criteria of durability, tangibility and reproducibility. This decision is of importance in the Canadian context because the balance sheet accounts do consider certain consumer goods as fixed assets; the matter is discussed more fully in the final chapter.

d) Inventories

The change in holdings of business and government inventories represents that portion of current production which has not yet been sold, or that portion of previous years' production which is included in sales of the current year. In the former case there is inventory investment and in the latter disinvestment. The value embodied in the accounts should represent the physical quantity of the change times relevant average prices during the period of account. Inventories fall into three categories: stocks of raw materials and fuels waiting to be fed into the productive process, stocks of work-in-progress or partly finished goods already in the production stream, and stocks of finished goods waiting to be sold.

Many business accounting methods yield book values of inventory deemed unsuitable for the income and expenditure accounts. In times of rising prices changes in recorded business inventory book values will frequently include an element of capital gain which simply reflects the fact that beginning-of-period inventories and withdrawals have been recorded at original cost, while purchases and end-of-period inventories are recorded at a higher price. A valuation adjustment is thus made to lower the book value change in inventories - the same adjustment is explicitly shown in the income based estimates to maintain the balance between the two sides of the account. When prices are falling the reverse situation holds true. The calculation to derive the inventory valuation adjustment is complex and involves knowledge or assumptions about the commodity content of the stocks, the business accounting methods used in arriving at book value of stocks and the availability of price indices which match inventory content.

There are certain types of inventory specifically excluded from the measurement of the change in inventories in the production account. Changes in stocks that are due to natural process rather than economic activity are excluded, such as the discovery of mineral reserves and growing forests.

Inventories held by consumers for future consumption are excluded because these have already been included in the estimate of personal expenditure.

In general, construction projects and certain machinery and equipment, the manufacture of which extends over a long period and for which progress payments are made, are recorded as fixed investment in capital at the time progress payments are made rather than as stocks of goods-in-process.

e) Exports and imports of goods and services

Exports of goods and services are final sales by the domestic economy and must be included in an accounting of final production. Conversely, because final domestic demand generated by persons, government and business includes goods and services not produced in Canada, the value of imports of such goods and services must be subtracted in estimating domestic production. Trade in goods takes place when the ownership of merchandise passes between residents and non-residents and in services when the service is rendered.

Exports and imports of goods and services constitute the only international transactions embodied in the measure of gross domestic production but other international transactions also have an impact on parts of the income and expenditure accounts.

Investment income and transfers between residents and non-residents are important flows affecting individual sector incomes and outlays and in differentiating domestic and national aggregates.

The total of all international transactions recorded in the income and expenditure accounts is directly linked to the major flows shown in the Canadian balance of international payments estimates. The detailed statements appearing in the balance of payments are condensed into transactions in goods, services, investment income flows, and transfer payments and receipts for use in the income and expenditure accounts.

Net exports of goods and services (exports less imports), plus net investment income and net transfers is equal to the current account balance in the balance of payments statement; when positive this balance is an element in increasing the net wealth of the nation.

Transactions specific to individual sector accounts

Transactions in the sector accounts are composed of three principal elements: the initial distribution of earnings attributable to productive activity, there distribution of that income in the form of transfers, and the allocation of final spending on goods and services produced. Two balancing items fall out of the sector income and outlay and capital finance accounts respectively. The first residual is the difference between current income and expenditure, a saving or dissaving figure, and the second the difference between saving and capital accumulation, a lending or borrowing estimate.

The income and expenditure transactions correspond with those explained in the context of the gross domestic product measure and need no further description. Of the other transactions, transfer payments were discussed in the section on 'Extending the statistical analysis of the economy' and it remains only to discuss the saving and lending aggregates appearing in each of the sector accounts. Saving is that part of the sector's income, both earned and received as transfers, not spent on current consumption or paid out in the form of transfers. The net saving total recorded in the income/outlay account for each sector is carried forward to the capital finance account. It is possible for sectors to spend more than their current income, in which case net saving becomes negative.

The capital finance account shows, in addition to net saving, the total of capital consumption allowances and capital transfers received. It sets off against this estimate of gross saving, spending on fixed assets, inventory change and any outlays of a capital transfer nature. A positive balance signifies lending and a negative one indicates borrowing by a sector. Lending and borrowing are translated into financial claims in the financial flows branch of the System of National Accounts.

Conceptually, the sum of lending less borrowing of the domestic sectors of the Canadian economy equals the net acquisition of financial claims on non-residents. The same total may be arrived at by subtracting the value of the domestic sectors' capital formation, including inventory change, from gross saving by the domestic sectors.

The size of a sector's saving and financial surplus or deficit is not only the result of income and expenditure patterns but also the conventions defining the sector. For example, in the personal sector, because of statistical difficulties, certain flows attributable to unincorporated business are included, thus raising the level of saving.

The Canadian sector accounts have had to deviate from the ideal conceptual treatment in certain instances because of statistical deficiencies. The major departure occurs in the income and outlay account of the corporate and government business enterprise sector. Instead of simply showing profits and current transfers from other sectors as income, net interest originating in the business sector and interest on the public debt are routed into the sector income and outlay account as income flows. In turn these amounts appear as outlays in the account along with dividend payments and tax transfers. This routing of flows through the account that do not properly belong there does not affect the sector's saving estimate as both sides of the account are inflated. However, it distorts the absolute levels of income and outlay for the sector.

A less significant deviation is the inclusion of intergovernmental payments of interest on the public debt which appear in the income and outlay account of the government sector. These payments and receipts would normally be netted out in the consolidation procedure but it has been deemed useful to show the gross level of interest payments in the case of the public debt. This treatment has no impact on the surplus or deficit figure for the government sector as the same entry appears on both sides of the account.

Other features of the income and expenditure accounts

a) Constant price estimates

The income and expenditure accounts and the input-output tables both include constant price estimates of expenditure on gross domestic production. The reasons for producing constant price series and the problems posed in the deflation process were discussed in the input-output chapter. It noted the importance of being able to analyse 'real' changes in production, the significance of selecting the most appropriate index and base year and the difficulty of distinguishing between price and quality change.

Two are as presenting unique problems were also noted, those services having no market price and non-standard products for which there are no price indices.

The constant price estimates in the income and expenditure accounts provide a second and independent estimate of expenditure based GDP, arrived at by deflating at a different level of detail and stage of pricing. About 300series valued at final market or purchaser prices are deflated. The deflation is undertaken at a more detailed level than appears in the published tables because this improves the accuracy of the estimates. The more detail, the greater the possibility of more precise price index matching and the less likelihood of price dispersion within a single component.

The major difference between the deflation undertaken in the income and expenditure accounts and the input-output tables is the point of pricing.

The income and expenditure accounts components are deflated at the final point of sale, or purchase price, in contrast to deflation in the input-output system at the producer price stage with subsequent margins covering transportation, trading and taxes being separately deflated. Theoretically the estimates should be identical but because of different methodologies the major aggregates differ slightly - their closeness, however, reinforces confidence in both sets of estimates.

The input-output and income and expenditure systems both include constant price estimates of the exports and imports of goods and services. Such estimates do not appear in the balance of payments system of accounts because in practical terms the balancing nature of the system's current and capital account cannot be reproduced in constant prices. The linkage of production and financial data in constant prices remains an elusive concept.

b) Income and product by industry

The main orientation of the income and expenditure accounts is towards institutional sectoring. However, since their development preceded that of most of the other branches of the system, pressures developed for some disaggregation of the overall gross domestic product estimates along industrial lines. Selected components for fifteen main industries are prepared and published, including wages, salaries and supplementary labour income, profits and other investment income, and net income of unincorporated business. In addition, industrial distributions of two of the principal components of the expenditure based estimates, investment in fixed capital and the value of physical change in inventories, are prepared.

The preferred unit of classification for industrial statistics is usually the establishment. In the case of the income and expenditure accounts there is some deviation from this principle due to data availability.

Both profits and capital consumption allowances are examples of important series available only on a company basis, and it is on this basis that they are allocated industrially. The use of the company as opposed to the establishment as the unit of classification provides a less pure form of industrial distribution. Because multi-establishment companies may be engaged in a wide range of activities, the attribution of, say, profits to the industry in which the company has its single most important activity may well distort the true industrial origin of profits.

Interest payments are considered to constitute part of the value added by, or income originating in, the industry using the capital rather than the lending industry. In order to avoid double counting, interest received from other industries is deducted from interest paid, so that only net interest paid is included in any industrial distribution of income originating.

c) Income and product by region

The accounts have long provided provincial and territorial estimates of personal income, personal disposable income and their principal components.

Generally, the allocation of personal income on a geographic basis has not presented major conceptual problems. By adopting the domestic concept for the income measure, incomes earned within provincial or territorial boundaries are ascribed to that region regardless of the residence of the owner of the factor of production.

In more recent years the scope of regional data within the income and expenditure framework has been extended. Since the late seventies, income and expenditure based estimates of provincial gross domestic product have been prepared as an integral part of the accounts, with the provincial estimates adding to the national total. As with the Canadian totals, the provincial product income-based estimates sum the incomes received by the factors of production - labour income, corporation profits, farm income, capital consumption allowances, and so on.

The expenditure estimates sum all sales to final consumers - persons, governments, businesses on capital account and net exports. The full range of sector tables has not been developed but government revenue and expenditure accounts showing current and capital transactions by different levels of government are available.

The preparation of regional accounts poses problems of concept and data availability that do not exist at the Canada level. These problems are aired more fully in reports on the provincial economic accounts, but briefly, they include:-

1. the distribution of corporation profits among provinces where they are earned in multiestablishment, multi-province corporations - the solution in the Canadian system is to allocate profit on the basis of operating surplus, sales or labour income to the area where activities are taking place rather than head office;
2. the regional allocation of indirect taxes levied and subsidies paid by the federal government - the problem is resolved in the Canadian accounts by assigning them to the province according to the location of production;
3. the most appropriate regional allocation of mobile capital investment such as aircraft and railway rolling stock - in the Canadian accounts the allocations are based rather arbitrarily on such data as transport industry employment and freight loading statistics;
4. the residency of the federal government is an issue of some consequence in the allocation of government expenditure by province -whether it should be regarded as expenditure on provincial production by a resident of the province or by an external sector. The Canadian system regards it as expenditure by a resident of the province, a treatment consistent with multi-provincial corporations in which the income is attributed to the province in which the activity takes place rather than the province of the head office.

A problem of major significance in the provincial accounts is the accurate measurement of transactions in goods and services between a province and the rest of the world, including other provinces. This estimate is the weakest link in the accounts. With no direct estimate of provincial imports and exports available, net exports are derived as the balancing item in the identity income-based equals expenditurebased provincial gross domestic product. This residual estimate not only covers net external flows but also non-offsetting errors which exist on both sides of the account.

d) Government supplementary information

The income and expenditure accounts provide much supplementary data on the operations of government that are consistent with the concepts and definitions employed in the sector account. A comprehensive picture of the types of revenue, expenditure, saving and financial investment by the various levels of government, hospitals and Canada and Quebec Pension Plans is given. Further detail is provided on the direct and indirect taxes levied on persons and corporations by different levels of government, the source of government investment income and the programmes under which transfer payments are made to persons, to business and to other levels of government.

e) Quarterly seasonally adjusted estimates of GDP

The availability of quarterly seasonally adjusted GDP estimates has added significantly to the analytical usefulness of the accounts. Although the full range of tables are not prepared quarterly, the core current price tables and the constant price expenditure estimates, along with tables concerning the four institutional sectors are available. The quarterly accounts are conceptually and definitionally consistent with the annual accounts. In order to achieve the vastly improved timeliness of the quarterly estimates, different data sources and methodology are frequently employed, resulting in some trade-off in accuracy for timeliness. Quarterly estimates are revised as firmer data become available.

The purpose of the seasonal adjustment process is to uncover the underlying changes occurring in the main components of the accounts by smoothing out repetitive intra-annual fluctuations. Examples of such movements include the peaking of agricultural production in the summer months and of consumer expenditure prior to Christmas. In the latter case the technique does not eliminate any consumer expenditure, but simply redistributes the normal fourth quarter peak between other quarters, so that it becomes possible to observe the underlying trend through the third and fourth quarter without it being obscured by the normal Christmas uplift.

The analysis of economic events is nowadays predominately undertaken in terms of seasonally adjusted series, so much so that the Canadian system of income and expenditure accounts published quarterly report no longer contains unadjusted estimates, although they are available upon request.

Uses of the income and expenditure accounts

If the extent to which it is used measures the value of a set of statistics, the income and expenditure accounts are almost certainly the most treasured series in the Canadian System of National Accounts. The uses fall into three main categories: analysis, projection and forecasting, and policy formulation.

In analytical uses the purpose is usually to discover key variables and relationships suggested by theory, or suggestive of theory - the time series in the various tables of the income and expenditure accounts provide the data base for an unusual amount of exploratory activity in this field. The aggregates or components of the income and expenditure accounts are also used extensively in the field of forecasting, or as background to assist in projecting other series; the forecasts are based on patterns of past behaviour and assumptions about current and future developments.

Policy formulation and decision making in the context of the income and expenditure accounts usually follows the analysis and forecasting stage and assesses the implications of policy changes in the light of national accounts estimates. In the business field the estimates are likely to impact on policy decisions (marketing strategies based on consumer spending), whereas in government the policy decisions are likely to impact on the estimates (agricultural subsidies impact on farm income).

Examples of uses of the accounts abound in the business, union, academic and government fields. The most widespread use is simply as background information, indicating the general business climate; in this context the data appear in speeches, company reports and as supporting material in relation to company or government programmes.

Analyses of the structure and growth of the economy within the framework of the accounts appear in economic textbooks, studies by agencies such as the Economic Council of Canada, private research institutes, consultants, and Royal Commissions concerned with the economic prospects of Canada. Structural analyses focus upon such aspects of the economy as the composition of major demand categories, the industrial or regional distribution of production, the income shares of major factors of production, the role of government, and the financing of capital formation.

The economy has been explored and modelled in terms of the accounts by both private and public institutions in attempts to gain a better understanding of economic relationships and the impact of changing economic conditions. In labour negotiations the accounts are frequently employed to contribute toward an understanding of productivity and the relative share of factor incomes.

Short and long range projections of the growth of the Canadian economy, cast in terms of the income and expenditure accounts, figure prominently in business journals and reports dealing with predictions of conditions of employment, stock market fluctuations, prices, interest rate changes, sales targets and capital spending plans.

A projection or forecast of the trend in the overall economic climate is frequently used as the starting point for specific industry and company predictions and targets.

Forecasts of Canadian economic performance are also used by international agencies where the prospects of the major industrial countries are appraised and evaluated regularly with the aim of promoting the co-ordination of national economic policies. Forecasts are regularly prepared by governments as a preliminary step in the preparation of their budgets; it is customary for most governments to estimate their revenues and assess their spending programmes against the background of the income and expenditure accounts.

Economic policy formulation and business decision making frequently evolve from analysis and forecasting done within the framework of the accounts. Examples of this are the development of tax policies that are determined by the predicted growth and distribution of corporate profits and personal incomes and by estimated tax yields, and the development of production goals and sales strategies of major enterprises that are based on predictions of personal disposable income and consumer demand.

In addition to the above, the income and expenditure measures may be used as an administrative tool as in the case of tax sharing arrangements between the federal government and the provinces, and in the determination of Canada's contribution to international agencies.

Extensive use is made of the accounts in the educational system at the higher levels, particularly in economic and related business courses, where they are used to promote an understanding of the Canadian economy and to illustrate macroeconomic theory.

A more limited technical use of the accounts, but nevertheless a highly important one, is their role in evaluating and planning the programmes of statistical agencies. Because of their comprehensive nature and the balancing characteristics built into the framework, the accounts provide an ideal vehicle for revealing gaps and weaknesses in the statistical data base and for forcing a more rigorous approach to the development of classification systems. This particular use is not limited to the income and expenditure accounts but applies to all components of the system.

Links and reconciliation with financial flows

A description of the link between the income and expenditure accounts and the input-output tables has already been given in the final section of Chapter 3. This section deals with the relationship between the income and expenditure accounts and the financial flows branch of the system. How the income and expenditure accounts are related to the current account of the balance of payments will be described in the chapter on balance of payments.

The overlap between the income and expenditure and financial flows systems occurs with the measurement of saving and investment. The income and expenditure system contains capital finance accounts which record gross saving, capital formation and net financial investment, representing the final distribution of the proceeds derived from current productive activity after taking account of current consumption. The financial flow system also contains estimates broadly similar to saving and investment in non-financial and financial assets, but moves beyond these flows to record the financial transactions that underlie the net financial investment figure common to both systems.

As noted above, the single point of overlap is the net financial investment of each sector. In the income and expenditure accounts it represents lending by a sector with saving in excess of its capital formation, or borrowing by a sector with saving insufficient to finance its capital spending. In the financial flow accounts it represents the net result of transactions in financial assets and liabilities by any sector.

Estimates of net financial investment derived from either the income and expenditure accounts or the financial accounts is theoretically identical. If a sector's saving exceeds its investment in non-financial capital, the balance must be reflected in a net increase in financial assets. The reverse is true for sectors spending more than they save; in this case there must be a net decrease in their financial assets, usually as a result of an increase in financial liabilities.

In both sets of accounts, lending and borrowing or net financial investment summed across all sectors equals zero. The lending of one sector is offset by the borrowing of another, or put differently, the net acquisition of financial assets is offset by the net issuance of liabilities.

The income and expenditure system closes at the point where the amount of lending and borrowing necessary to balance the supply and disposition of production is shown. The financial flows pick up at this point and show the form of financial instrument used to accomplish this transfer of funds from lenders to borrowers.

Net financial investment can be determined independently from either system of accounts and as might be suspected is determined itself by the interaction of variables from both the production and financial markets.

The integration of the two branches of the Canadian System of National Accounts has been accomplished in the sense that the definitions of transactions are, to the extent possible, compatible; sector boundaries are the same at the level of aggregation used in the income and expenditure accounts; and the aggregates from the capital finance accounts are used as benchmark data in the financial flows system for saving and investment.

The extent to which the two systems are truly integrated and reconcilable requires some further exploration and examination. The fact that the independently derived estimates of net financial investment at the sector level show significant differences raises the question of to what extent they reflect discrepancies attributable to statistical shortcomings or uncovered conceptual and definitional problems.

At the conceptual level it is not clear that all the adjustments necessary to fully integrate the non-financial and the financial sets of statistics are in place. Although both sets stem from business accounting type records, a number of adjustments are made to both the non-financial and the financial series. The income and expenditure transactions are conceptually on an accrual basis, while the financial flows are recorded at the time payments are made. Although some timing adjustments are made to the financial data to make it consistent with the accrual-based production data, for example, in the case of government and chartered banks interest flows, more timing adjustments of this type may still be required.

The financial flow accounts also include estimates for the net purchase of existing assets on a sector by sector basis, whereas such transfers are not recorded separately in the income and expenditure capital finance accounts with the exception of net inheritances and migrants funds'. This difference in treatment creates statistical differences at the sector level in the estimates of lending/borrowing. Part of the reconciliation problem is the result of statistical short comings in the different source data used in the two sets of accounts. In the income and expenditure accounts, for example, lending of persons and unincorporated business is derived residually as the difference between their income and spending and hence contains the errors of these aggregates. In the financial flow accounts, lending, or its equivalent net financial investment, contains the errors embodied in the asset and liability estimates. The fact that the statistical discrepancy item in the income and expenditure accounts is carried into the financial flow accounts with no attempt to allocate it by sector ensures that, if all else were correct, there would be sector discrepancies that would only net out at the aggregate level.

Despite the progress made, the above indicates the complexity of there conciliation process and the fact that there are still areas where further work may yield improvements.