The cash basis of accounting has been traditionally used across the public sector. In the last five years in particular there have been discussions over the benefits of a change to the accrual basis.
The move to accrual accounting is part of the process of adopting private-sector-style financial statements for use in the public sector. This includes the production of the equivalent of a profit and loss account, a balance sheet and a cash-flow statement. In the process all major capital assets are valued (in some cases each year) and the costs of these assets are charged to the expenditure account over their useful lives through the use of some form of depreciation.
Private-sector-style financial statements may provide additional information, especially on the value of capital assets, and may allow increased comparability of relative efficiency between organisations. They may not, however, provide useful and relevant information on, for example, the extent to which public sector buildings are being adequately maintained. In addition, the costs of producing such financial statements may be significant. The decision on whether to publish such accounts should, however, be taken after undertaking a comprehensive cost-benefit analysis.
The benefits of accruals accounting have been summarised by Evans (Resource accounting and budgeting, 1995):
- better measurement of costs and revenues, including comparisons between years
- greater focus on outputs rather than inputs
- more efficient and effective use of resources, eg, through charges for fixed assets
- full cost of providing a service can be compared with outside suppliers
- a better indication of the sustainability of government policy
- improved accountability
- better financial management
- greater comparability of management performance results.
Accrual accounting should not be considered in isolation, but as part of a package of reforms which have come to be known as New Public Management. Accrual accounting is not an end in itself, but rather, a means of shifting the emphasis of the budgetary process away from cash inputs, towards outputs and outcomes, in the hope that this will result in greater management efficiencies, and hence, better outcomes for governments and the communities they serve. The move to accrual accounting is primarily aimed at facilitating contestability in the provision of public-sector services. Thus, it aims to allow comparisons of the current cost of providing the service with potential alternative providers of these services from the public, not-for-profit, or private sectors.
International Federation of Accountants (IFAC) International Public Sector Accounting Standards Board (IPSASB) argues strongly that all governments should adopt the accrual basis. Even in the introduction to its cash-basis accounting standard (2003) it states that the 'Committee encourages governments to progress to the accrual basis of accounting'. In many of its other publications it puts the case for transferring from the cash to the accrual basis, but it only provides the presumed benefits of this transfer.
This is because no cost-benefit study has ever been undertaken of this move, despite the significant costs involved. These include, for example, the increasing number of qualified accountants employed by the UK central Government from nearly 600 in 1989 to 2200 in 2003. Whether accrual-based accounting will deliver its promises remains an open question. As Sir Andrew Likierman FCCA puts it (Changes to Managerial Decision-Taking in UK Central Government, Management Accounting Research, 2000,11(2) pp 253–261), 'A full analysis will only be possible once the new systems have been working for a number of years'. By 2004 however, Likierman accepted that he never had any figure on how much, as a discrete figure, the introduction of accrual accounting in the UK central Government cost (Minutes of evidence of the Public Accounts Committee (PAC), 7 January 2004).
The move to the accrual basis for public-sector financial reporting has not gained universal acceptance. In Europe, for example, the governments of Germany and Italy have yet to make any definite plans to make the transition and the Dutch Government has decided that it will not proceed with its plans for the financial statements of its ministries to be produced on the accrual basis. Whilst in Asia, China, Japan, Malaysia and Singapore have all considered the options and have decided not to move to accrual accounting. Many organisations which work in transitional and developing countries, for example SIGMA and the Department for International Development (DFID) (UK), question the priority, for these countries at least, of moving from the cash to the accrual basis of accounting.
Any move to the introduction of private-style financial statements and changing the basis of these accounts to the accrual basis should only be introduced as part of an overall reform strategy for public-sector financial management. In many cases such changes, even if considered necessary, will not have a particularly high relative importance.
There are increasing doubts over whether the move to accrual accounting is worth the costs and the additional risks involved. ACCA, for example, has called for a different set of principles for public-sector financial reporting from those developed for the private sector.
A National Audit Office (NAO) (UK) report issued in December 2003 said that:
'In most cases it is too soon to identify any discernible benefits from better resource management in terms of contributing to improved public services from, for example, enhanced efficiency.'
Thus, many ACCA members believe that where the introduction of private-sector-style accrual-based financial statements is being considered, this reform should be informed by a rigorous comparison of the likely costs and benefits. We appreciate that accurate figures may not always be available, but in all cases, the specific benefits to the entities concerned should be compared with a reasonable estimate of the likely costs. This will allow a review to be undertaken at a future date, comparing estimates of the actual costs and benefits with those which were expected.
In January 2006, research funded by ACCA on the costs of benefits of introducing accrual accounting in Northern Ireland (a region of the UK) was published. This research found that whilst “the costs were perceived as being substantial”, “there was little evidence that [the accrual accounting] information was extensively used in decision making”. A summary of this research and the full report are available from the research section:
Study 11 - Government financial reporting
IFAC, May 2000. The IFAC Public Sector Committee has issued a major study exploring the accounting issues and practices of government financial reporting. This document explores in some detail the relative approaches of the cash and the accrual basis for reporting by public-sector organisations.
Should the move to accrual accounting be a priority for the public sector? [PDF, 43k]
A brief summary of the main arguments to be considered, especially for developing and middle income countries, when considering a possible move from cash to accrual accounting for their public sector.
Complexity with bells on
Accounting & Business, March 2006. Andy Wynne reports on new research published by ACCA on the costs and benefits of moving from cash to accrual accounting in Northern Ireland (a region of the UK). This research was undertaken by Noel Hyndman of Queen’s University, Belfast and Ciaran Connolly of the University of Ulster.
The Adoption of Accrual Accounting and Budgeting by Governments (Central, Federal, Regional and Local) (2003)
FEE, July 2003. Fédération des Experts Comptables Européens – European Federation of Accountants (FEE) has issued a paper outlining the risks to European governments of moving to the accrual basis for their accounts.
Performance budgeting – is accrual accounting required?
IMF, December 2002. In this working paper the International Monetary Fund (IMF) says that often 'emerging economies have too eagerly accepted this reorientation [to accrual-based accounting], and have overlooked a number of important issues' and that 'while agreeing that accrual accounting systems are more comprehensive and provide a wealth of financial information, it is important at the same time not to overstate the case'.
Is the move to accrual-based accounting a real priority for public-sector accounting? [PDF, 311k]
Andy Wynne, 2003. This paper, while acknowledging the arguments provided by the IFAC Public Sector Committee and others in favour of a move to accrual accounting, provides some of the counter-arguments and the risks which may be involved with such a move.
Do Private Sector Financial Statements Provide a Suitable Model for Pubic Sector Accounts? [PDF, 128k]
Andy Wynne, 2003. This paper provides some of the background to the move to accrual accounting by the public sectors of some countries in recent years. It also provides a review of the case for and against such a move.
Study 14 - Transition to the Accrual Basis of Accounting: Guidance for Governments and Government Entities (Second Edition)
IFAC, December 2003. This Study is intended to assist governments and government entities wishing to migrate to the accrual basis of accounting in accordance with International Public Sector Accounting Standards (IPSASs).
Are financial statements enough?
ACCA article, Andy Wynne, Jan 2002. In recent years, there has been almost universal acceptance that public bodies should adopt private-sector accounting practices when preparing their financial statements. The IFAC Public Sector Committee has set itself the task of producing a set of accounting standards to be used by public-sector bodies that have adopted the accruals basis of accounting. In the UK, public- sector organisations adopted accruals accounting in the early 1990s and central Government is following suit this year. However, little work has been undertaken to consider the benefits gained from moving from the cash basis of accounting and little consideration has been given to the costs of making this change.
Cash or accrual accounting [PDF, 282k]
2003. This presentation examines the relative merits for the public sector of the cash and accrual bases of accounting
Public sector accounting needs its own set of principles says ACCA
ACCA press release, Aug 2003. Public sector and not-for-profit entities have wholly different objectives from private companies, and so need a distinctive set of accounting principles, says ACCA. In its response to the Accounting Standards Board (ASB)'s Discussion Paper, 'Principles for financial reporting - proposed interpretation for public sector entities', ACCA warns the ASB not to assume that its existing private-sector principles can be merely expanded and re-expressed to suit public-benefit entities.
Proposed interpretation for public-benefit entities
ACCA's response to the [UK] Accounting Standard Board (ASB)'s conceptual frameworks for the public sector: August 2003.
Framework for the Preparation and Presentation of Financial Statements
ACCA's comments to the Accounting Standards Board of South Africa on its Framework for the preparation and presentation of financial statements. February 2004
For an application of private-sector principles in the public sector see the IFAC Public Sector Committee website, their Standards and other publications