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October 15, 2007

Transition to Accrual Accounting -- IMF Technical Guidance Note

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Accrual accounting is a hot topic these days, with many countries expressing interest in adopting accruals. A July 2006 IMF FAD Technical Guidance Note by FAD staff members Abdul Khan and Stephen Mayes provides advice on the design, planning, and implementation of an accrual-based accounting regime. The guidelines address a number of issues associated with the implementation of accrual-based accounting, and are intended to provide broad guidance on the preconditions necessary for the successful transition to accrual accounting, the appropriate sequencing of the reform steps, and the milestones which could serve as yardsticks of progress.

The guidelines are intended to apply primarily to general government departments and agencies within national, provincial/state, and local jurisdictions. It is assumed that state-owned enterprises engaged in commercial activities are already budgeting, accounting, and reporting on full accrual basis.

[Click here to download the full Note Download fad_guidance_note_transition_to_accrual.pdf]

What is Accrual Accounting?

Accrual accounting is an accounting methodology under which transactions are recognized as the underlying economic events occur, regardless of the timing of the related cash receipts and payments. Following this methodology, revenues are recognized when income is earned, and expenses are recognized when liabilities are incurred or resources consumed. This contrasts with the cash accounting basis under which revenues and expenditures are recognized when cash is received and paid respectively.

Rationale for Moving to Accrual Accounting?

At the macrofiscal level, the importance of accrual accounting for macroeconomic policy arises from the fact that it measures assets and liabilities that are relevant to the overall stance of fiscal policy and fiscal sustainability, but which are not measured by cash accounting. In particular, whereas cash accounting measures only conventional debt, accrual accounting measures other quasi-debt liabilities such as amounts payable for the receipt of goods and services, and employee liabilities

An accrual accounting framework is essential to systematically determine the full costs of a government’s activities. Full cost information (including non-cash costs such as depreciation, and accrued civil service pensions) is essential for assessing the efficiency of government services and thus is a key element of any public sector performance management framework. More specifically, information about the full costs of government services can be crucial when considering alternative service delivery options including outsourcing and cost recovery, as well as for the purposes of international benchmarking (e.g., comparing the costs of health or education services).

More systematic asset and liability management required. Since accrual accounting requires the preparation of government balance sheets, and this involves the identification, measurement, and periodic reporting of government assets and liabilities, it requires governments to adopt a more systematic approach for identifying, keeping track of, and valuing all assets and liabilities. These activities can encourage the development of systems (such as asset registers) and procedures for planning and management of assets and liabilities. Thus the introduction of accrual accounting, particularly when accompanied by related reform initiatives to improve public sector performance, can promote a general improvement in the management of assets, as well as a heightened awareness of the cost of holding and deploying assets. In a similar fashion, the requirement to identify, measure and report government liabilities, and the resulting enhanced transparency can foster better financial planning to ensure that the government is able to meet its liabilities as they fall due.

What is accrual budgeting?

It is sometimes argued that the benefits outlined above are unlikely to be fully achieved unless the accrual reforms encompass not just accounting, but also budgeting. While accrual accounting is concerned with ex post reporting, accrual budgeting involves ex ante planning on an accrual basis. Accrual budgets incorporate, in addition to cash flows, all noncash budgeted transactions such as depreciation and civil service pensions, and projected stocks of assets and liabilities. The parliamentary appropriations may also be determined on an accrual basis to pay for the full costs of government operations regardless of the timing of the cash payments, although this is not an essential element of accrual budgets and would depend on the legal and other requirements and conventions of particular jurisdictions.

What are the key implementation issues?

The Note addresses numerous topics associated with the move to accruals, such as formulating accounting policies, gaps in current international accounting standards, cash information in an accrual framework, aligning accrual accounting with budgeting, budget classification and the chart of accounts, the opening balance sheet, centralized verse decentralized financial processes, consolidation issues, and 'controlled' versus 'administered' items.

The paper also discusses some preconditions for a successful transition to accruals. These are identified as:

  • An acceptable cash accounting based system -- A sound accounting system that can generate reliable cash based data is an essential basis from which to start the move to an accrual framework.
  • Political ownership -- It is critical that the planned introduction of accrual accounting is supported at the highest levels of the executive.
  • Technical capacity -- International experience suggests that a lack of adequate technical resources can be a major impediment to successful implementation of accrual accounting. It is essential that a government considering a move to accrual accounting has either a core of officials with required technical (accounting, IT, etc.) skills, or the capacity to recruit such people for its key positions.
  • Automated Information Systems -- Although, in theory, cash or accrual accounting can be implemented with either a manual or an electronic system, in practice, it would be inadvisable for a government to attempt to implement full accrual accounting without the aid of a modern government financial management information system (GFMIS) with proven functionality in areas such as general ledger, accounts payable, purchases, assets management, etc.

The Guidelines also include some useful discussion of reform sequencing, noting that "The sequencing of implementation should take into account the context of the overall reform agenda of the government. International experience suggests that a move to accrual accounting is usually a supportive rather than a leading component of a set of broader public sector reforms." The note includes the implementation timeframe, and suggests some approaches to phased introduction of accruals, such as (1) staging by business areas and (2) staging by sector or size, and pilot studies

Posted by Abdul Khan

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Comments

Hi Kylie,

Your question on payroll is intriguing. In the payroll systems that I've seen, statutory obligations (such as taxes or pension contributions) are reflected in earnings and deductions. These can be mandated for either the entire civil service or selected groups. The audit function, software supported or internal audit, verifies if these are being met appropriately.

Do you have a specific scenario or circumstance in mind?

Thanks,
Hal

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