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February 08, 2008

Transition to Accrual - A Stepwise Approach

Posted by Bill Dorotinsky

As countries struggle with implementing accrual counting, more and more resources are emerging to assist with their efforts. In an October 15 blog, we posted an IMF FAD Technical Guidance Note on Transitioning to Accrual Accounting. A blog reader kindly brought to our attention another useful reference, "A Stepwise Approach to Transition from a Cash, Modified Cash, or Modified Accrual Basis of Accounting to a Full Accrual Basis for Developing Countries," published in the February 2007 issue of Public Fund Digest (available on-line at the link above). The Public Fund Digest is a publication of the International Consortium of Government Financial Management (ICGFM) -- a recent December 2-4, 2007 conference on which we also blogged about.

The article, written by Jesse Hughes, Professor Emeritus of Accounting at Old Dominion University, provides a succinct series of steps and issues to be addressed in transitioning to an accrual basis:

  1. Identifying and classifying government reporting entities -- not an easy task, as the  article notes, compounded by the wide variety of governmental and quasi-governmental bodies and varying degrees of government control.
  2. Accounting for Cash -  deemed relatively easy in the article, as many governments already have some procedures in place to start with. However, as the note points out, transfers between entities need to be netted out, which is far more challenging than might at first seem the case.
  3. Compiling asset and liability information for reporting entities - a challenge for any country, and an optional disclosure item under the Part 2 of Cash IPSAS.
  4. Other optional IPSAS Cash Basis Part 2 Disclosure Items -- really many elements, including disclosure of administered transactions, transactions of related parties, comparison of actual versus budgeted revenues and expenditures, disclosure of ownership interest in controlled entities, and joint ventures.

Two of the most useful aspects of the article appear as Appendices -- a decision-tree for determining the level of control of another entity for financial reporting purposes (Appendix 1) and a detailed spreadsheet action plan for implementing the transition (Appendix 3).

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Does accrual accounting really provide the benefits which are claimed for it?

In December 2007, Mike Hathorn (chair of the IPSAS Board) said that only six governments had actually issued financial statements on the accrual basis. However, in the UK, in particular, there is extensive experience of the actual practice and so the possible benefits of accrual accounting can be assessed. Birmingham City Council, then the sixth biggest economic entity in the UK, moved to accrual accounting in 1850. The current moves to accrual accounting in the UK started with the health service in 1991, with central government following from around 2000.

In a report, published in December 2003, the UK National Audit Office concluded on the move to accrual accounting (first announced in 1993):

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 (Page 31).

The full report is available from:
http://www.nao.gov.uk/publications/nao_reports/03-04/030461.pdf

The National Audit Office published a follow up report in February 2008 which also considered the actual benefits of moving to accrual accounting concluding that:

Departments have made significant progress in using accruals-based accounting and budgeting systems since our previous study. This has allowed departments to better understand how they are using their financial resources, for example by offering more detailed information to manage their assets and liabilities. Departments have used this information to help identify under-utilised assets and to dispose of those no longer required. The public sector disposed of assets valued at £18.5 billion between 2004-05 and 2006-07 against its objective of realising £30 billion by 2010-11. Central government has contributed £4.7 billion to this total (paragraph 9, page 7).

So the only specific benefit of the move to accrual accounting identified by the UK National Audit office was that ministries (called departments in the UK) were able to use the information to identify and sell assets (mainly buildings) which were no longer needed. The full report is available from:
http://www.nao.org.uk/publications/nao_reports/07-08/0708240.pdf

In 2005, ACCA published research on the costs of benefits of adopting accrual accounting in Northern Ireland, a region of the UK. This research concluded that

the costs of the reforms were seen as substantial, but significant benefits had yet to be realised and there is little evidence that the additional information is, at present at least, being extensively used in decision making, perhaps because it is rarely understood… What RAB information that has been produced is perceived to be rarely understood and used by managers to whom it is directed.

The executive summary and full report on this research are available from:
http://www.accaglobal.com/pubs/research/res_pubs/summaries/rr-087

The UK health service is highly capital intensive and so it may be assumed that the move to accrual accounting in 1991 would have provided significant benefits in terms of the more efficient use of capital assets, for example, buildings. However, a research report by leading UK academics in the field, funded by the Scottish Institute of Chartered Accounting, concluded that:

there was no evidence that the perceived benefits from the introduction of... accruals accounting... were being realised (page ix)

The full research report is available from:
http://www.icas.org.uk/site/cms/contentviewarticle.asp?article=5232

In an article for the ACCA International Public Sector Bulletin (February 2008) the lead researcher, Howard Mellett stated that:

Governments which have undertaken to implement accruals accounting should therefore beware of the fact that… any potential benefits may not be realised.

See: http://www.accaglobal.com/ipsb

Several people are concerned that the claimed benefits of accrual accounting are actually being over-sold especially in developing or transitional countries. The following paper from FEE was originally written by Noel Hepworth, the former leader of CIPFA (the UK’s public sector accounting body), who was concerned about this issue based on his experience in Eastern Europe: http://www.fee.be/publications/default.asp?library_ref=4&content_ref=263

The first issue of Public Fund Digest for 2007 includes an article by Andy Wynne, the Head of Public Sector Technical Issues at ACCA, which tries to provide a balanced view of the arguments for and against a possible move to accrual accounting. His conclusion is that:

The cash basis of accounting has served almost all governments well over at least the last two hundred years. As a result, many countries are now joining Malaysia, Mauritius, the Netherlands, Namibia and others in deciding that despite the potential benefits of accrual accounting, its significant costs mean that it is not a priority reform.

To read the full article see: http://www.icgfm.org/digest.htm

An IMF working paper issued in 2002 (Performance Budgeting – is Accrual Accounting Required?) states that:

Often emerging economies have too eagerly accepted this reorientation [to accrual accounting], and have overlooked a number of important issues… 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 (page 3)

The experience of OECD Countries is that the implementation of accrual accounting is not easy; it takes time and requires sustained political support. Not surprisingly it cannot be considered a top priority for most countries (page 18)

The full working paper is available from:
www.imf.org/external/pubs/cat/longres.cfm?sk=16197.0

HM Treasury (the ministry of finance) in the UK is currently working on a project designed to achieve better alignment between ministries’ budgets, estimates and financial accounts. The aim is to create a single, coherent regime that:

• improves the effectiveness, efficiency and transparency of the process
• enhances accountability to Parliament and the public and underpins the Government fiscal framework
• incentivises good value for money; and
• supports delivery of public services.

The wide ranging nature of these aims suggests that the British Government recognises that the benefits claimed for its move to accrual accounting have not been delivered and that further major change is needed over the next three years (see page 13 of the 2008 National Audit Office report referred to above).

The supporters of the move to accrual accounting argue that a range of benefits are available to governments which move from the cash to the accrual basis of accounting. Such arguments have been widely reported and repeated at many conferences. However, the authoritative independent research which is available suggests that few, if any, of these benefits have actually been achieved in practice. In contrast, the costs of moving to accrual accounting are accepted as being substantial.

The current basis of accounting which is used in almost all countries across the world has been tried, tested and refined over the years. There are many other financial reforms which will provide clear benefits in terms of greater accountability, openness and reliability. The evidence suggests that a move to accrual accounting is costly and will provided only a limited return on the substantial investments which are required.

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