A SIGMA/OECD study of four transition economy countries (see PFM blog of 3 February 2025) explored why these countries were undertaking accounting reform and considered whether it was appropriate. It concluded that for countries facing governance and corruption challenges, moving to full accrual accounting should not be considered a short or medium-term priority.
The reasons given by countries for the proposed reform were to:
- Apply international standards of accounting (IPSAS);
- Enable a country to complete its international statistical reports (e.g., to the EU and IMF) more effectively.
Further reasons often advanced include improved financial reporting, improved decision-making, increased accountability, and improved financial management.
However, these benefits do not simply occur by changing a country’s accounting base. Other reforms are necessary, not least to managerial arrangements and those that facilitate effective asset and liability management. The need for such reforms is often not recognised.
Countries contemplating accounting reform should first ask themselves why they need the additional information that accrual accounting would make available. Secondly, does a staffing capacity exist to produce the information that will be required? Thirdly, does the managerial and organisational capacity exist to make use of that information? Accrual accounting enables managers to identify the true cost of alternative models of service delivery and informs decisions about current and future resource allocation. The emphasis is upon ‘management’.
Accrual accounting adds to the traditional cash focussed control a further focus on capital utilisation. This means that each public organisation, including individual ministries, should be concerned not only with budgetary control but also with the utilisation of assets and liability management. Each public sector entity should publish a balance sheet as well as a revenue account. If there is no recognition of these consequences, what is the purpose of introducing a system which is expensive and produces information that management does not use?
Countries should only adopt accrual accounting if management address the following five areas.
- Asset management to make the most effective use of capital involving the identification and valuation of assets, both tangible and intangible, and maximizing asset utilisation and disposing or repurposing surplus or obsolete assets.
- Liability management: to ensure long-term financial sustainability which requires understanding the nature and terms of debt obligations and their prudent management, including loans, credit obligations, leases, and public/private partnerships. Good liability management also requires managing pension liabilities, which may be funded or unfunded, and identifying and managing contingent liabilities which may arise from potential contractual and sometimes international treaty obligations.
- Develop strategic planning: this means much more than conventional 3-year forward inflation-based forecasts. It should include the implications of population changes, climate change and other potential changes, including the impact on forecast balance sheets especially when major investments are involved.
- Strengthen governance and audit: accrual accounting requires larger elements of judgment than cash accounting. This potentially creates greater opportunities for manipulation and fraudulent behaviour. It requires strong and effective governance arrangements and well-designed internal and external audit.
- Strengthen Ministry of Finance controls: these include the size and movement in asset values and liabilities, capital cash flows, the efficiency and effectiveness of capital investments, monitoring asset utilisation and effective strategic planning.
To meet these requirements requires a range of complementary reforms some of which should precede the introduction of accrual accounting. Also, some of these reforms may not be wholly within government control. Such reforms include:
- Ensuring that effective asset value judgements can be made. This depends upon the existence of a market capability and valuation expertise: non-existence encourages the continued inappropriate use of original cost less depreciation to provide an accounting value.
- Remedying weaknesses preventing the valuation of potential liabilities, not least pension liabilities. Such weaknesses include data limitations, inadequate regulatory frameworks, and lack of actuarial capacity.
- Ensuring that a civil service managerial capability exists to make the necessary judgements and to secure consistency of treatment and control throughout the public service. This requires a strong governance capability, consistent standards and probably organisational reform.
- Appointing technically and managerially competent senior-level heads of finance in public organisations. Finance officer responsibilities should include ensuring that a high degree of financial literacy exists, establishing quality governance and risk management arrangements, and that appropriate systems exist to support balance sheet management. This will include internal controls to safeguard assets, to identify and mitigate financial risks and to ensure the accuracy of financial and performance information.
- Ensuring that an effective internal and external audit exists that is fully appreciative of the risks associated with accrual accounting.
All of this requires extensive managerial training as well as technical training for finance staff. Managers are those from whom the benefits of the reform flow. They are the key officials who ought to be advising politicians on judgements about asset utilisation and policies affecting actual and potential liabilities as well as efficient and effective service delivery.
In summary, those promoting the introduction of accrual accounting should recognise that a wide range of other reforms may be required if the reform is to be successful. Some reforms should occur before accrual accounting is introduced and some may not be wholly in the hands of the government to achieve. Not the least of such reforms would be to strengthen the quality of governance within the public sector.
