In recent years, there has been a belated recognition that government financial information is insufficient. Indeed, the recent sovereign fiscal crises and the increasing realization that government welfare commitments, if not well managed, can outstrip those governments’ ability to tax, have led to an increased urgency for a richer suite of financial information. To properly report on public finances, all the obligations of governments, and their movements, need to be reported.
Transitioning from cash- to accrual-based financial reporting can help. The existence of a full set of accrual-based public sector accounting standards, developed by the International Public Sector Accounting Standards Board since 1993, and an accrual-based Government Financial Statistics Manual, developed by the International Monetary Fund since 2001, means the public institutions are well-placed to do so.
The OECD reports that 14 countries responding to a recent survey produce full accrual financial statements, 9 produce accrual financial statements with some exceptions, two countries are transitioning to accruals, with 13 remaining on the cash basis, although some of these produce supplementary information.
The move to accrual reporting is, therefore, well underway. Reporting better information is indeed an important step in improving public sector financial management. The next step is to use it.
Beyond Accruals Management
The purpose of public sector financial information is to reduce uncertainty in decision making and to enable governments to be accountable. The key document used to make financial decisions in government is the budget, and it is the budget to which governments are held to account by their legislatures. Therefore, to use the improved financial information from these developments, the accrual information must be integrated into the budget process.
Accrual budgeting explicitly forecasts and shows how resources are raised and used, and how obligations are incurred and settled. Cash budgeting, on the other hand, only focuses on the forecasting and allocation of one economic resource, that is, cash.
Fundamentally, accrual budgeting differs from cash accounting by being transparent about two separate decisions. First, there is a decision on the cost of an item, and secondly, there is a decision on how and when that cost will be settled. Cash budgeting conflates these two separate decisions, and therefore fails at times to fairly forecast their economic impact.
Impacts of Accrual Budgeting
From my experience, moving to an accrual budgeting basis has a number of impacts.
First, the accounting rules should ensure that a government decision to give away value or incur an obligation is captured. There are many methods to give away value that are captured by accrual systems but that aren’t well picked up in cash systems, for example, concessionary loans, transfers of non-cash assets for no or nominal consideration, entering into binding obligations to pay cash outside the budget period, providing insurance with inadequate premiums, etc. The effect, therefore, is to change the mindset of the decision-maker—from, how much cash does this resource allocation decision involve? to what is the cost of this resource allocation decision? The effect is salutary for both politician decision-makers and those holding the politicians to account.
The second impact is the overwhelmingly positive effect on treasury management. With accrual systems in place, policies can be established for working capital management, the use of supplier credit, how to best manage the significant tax debtor balance, etc. All of these are impossible without good accrual information. Under a cash budgeting approach, treasury management also tends to get weighed down with an objective that conflicts with good debt and cash management—that of creating separate cash funds, or “jam jars” that act as accounting mechanisms, or “accounts” of unspent budgetary commitments. The effect of accrual budgeting is to disestablish such wasteful bank accounts, as accrual budgeting processes shoulder the burden of accounting for such allocations.
The third impact comes from the increased credibility and transparency of reporting. Forecasts and financial statements are prepared on a comparative basis, in accordance with standards designed to ensure that the economic substance of transactions and events are fairly reflected, with auditor attestation on the final results. The effect is increased trust in the government of the day as a financial manager.
Opportunities for the Profession
While claims of smoke and mirrors in accounting will never completely disappear, the more that governments can demonstrate that their fiscal information complies with independently set accounting standards, attested to by an independent auditor, the more attention will be directed away from debates on accounting and budgetary practice and toward debates on financial and economic impact. This is where the fiscal policy debates should be.
This represents possibly the most significant opportunity for the international accounting profession today.
It requires professional skill to overcome the usual objections that accrual budgeting is too complex, that it overloads the budgeting process, that it doesn’t fit well with traditional fiscal targets, and that there are more pressing problems to overcome. Unless these excuses for inaction are defeated, financial decision-making in the public sector will continue to be uninformed, cash management will be inhibited, and trust in government held back.
It requires professional skill to change the budgeting processes and systems, to shift the mindsets of the players in these processes, and to present the new information so that it is understandable and useful. Only the accounting profession offers these skills.
Long-Term Benefits
Finally, it represents a noble goal. The benefits of successfully moving to this next step of public sector financial management will be most keenly felt by our children and grandchildren. They are the ones that will feel the pain if governments cannot their financial obligations. They are the ones that will benefit from sustainable public finances. What could be a better objective?
The accounting profession needs to rise to this challenge. I urge it to do so.