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June 25, 2010

IFAC Recommends Adoption of Accrual-based Accounting for the Public Sector

Posted by Sanjay Vani 

The International Federation of Accountants (IFAC) has recently issued a  letter to G-20 participants, who are meeting on June 26‐27, 2010 in Toronto, Canada. This letter is a follow-up to their previous submissions to the G‐20 in 2009 addressing the global financial crisis. In this letter, IFAC is recommending adoption of accrual-based accounting for governments and public sector entities. The full text of the recommendation is as follows:

"The G-20 should strongly encourage all governments to provide greater transparency and accountability in public sector finances.

As a result of the financial crisis, establishing greater trust between governments and their constituents should be one of the highest priorities for national leaders and public officials. Investors in government securities, taxpayers, and citizens in all nations should be provided with accurate and appropriate financial information regarding the balance sheets, public expenditures, and transactions for all governments and government-controlled entities. By providing accurate and complete information on such expenditures and transactions, governments demonstrate accountability and stewardship, reinforcing their own credibility and safeguarding their democratic legitimacy. We urge governments and public sector entities throughout the world to provide clear and comprehensive information regarding the financial consequences of economic, political, and social decisions. Such information should disclose the full, long-term economic impact of decisions, not just the immediate cash flows. Such information should also provide a clear understanding of the relationship between the market and non-market activities of the government, and between financial statements and statistical bases of financial reporting. In addition, such information should be broad enough in scope to provide insights about the past, present, and future, and should include prospective financial information about future expenditures.

Acknowledging that many governments adhere to the cash basis of accounting, IFAC and the International Public Sector Accounting Standards Board (IPSASB) encourage the adoption of accrual-based accounting as it reinforces the principles of transparency and accountability. Under the accrual basis of accounting, transactions and other events are recognized when they occur (and not only when cash or its equivalent is received or paid). Therefore, transactions and events are recognized and reported in the financial statements of the periods to which they relate. This is consistent with what is required of private sector, publically listed companies to ensure that investors receive fully transparent financial information. Under accrual accounting there is reporting of assets, liabilities, net assets/equity, revenue, and expenses, and not just cash flows and cash balances.

Most significantly, the accrual basis for accounting records and reports assets and liabilities that are relevant to fiscal policy and long-term fiscal sustainability, but which are not necessarily reported under cash accounting. When items are not recorded, it is likely that they are also not well managed or are more susceptible to being manipulated. The accrual basis offers a more complete picture of a government’s financial performance and position since it provides information not just on debt but also on governments’ other liabilities, contingent liabilities, and guarantees. Accrual accounting practices improve not only the quality of financial information for all stakeholders (investors, taxpayers, ratepayers, public officials, suppliers, creditors, employees, the media, etc.), but also improve the quality of financial management, and they reduce the risk of financial reporting fraud."

This is a significant recommendation to a very influential group coming from an important body. Although many of us in the PFM field hold very strong and differing views on the applicability of accrual-based accounting for government, especially in developing countries, most of us would agree that governments must first at least have the capacity to prepare reliable and timely cash-based financial reports before attempting highly complex reforms such as implementation of accrual-based accounting.

Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.


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Sanjay is clearly correct to indicate that the first priority of any government is to prepare reliable and timely cash-based financial reports, before even considering a possible move to the accrual basis of accounting. But governments also have to consider the balance of costs and benefits of such a move, especially at a time when so many governments feel constrained to reduce their general levels of expenditure.

IFAC may be more successful in persuading more governments to move to accrual accounting if they were able to provide authoritative and independent evidence that such a move provides the benefits claimed for it. It is not enough to assert, yet again, that accrual accounting provides greater openness, accountability and enhances asset management. At least five G20 countries have some experience of accrual accounting at central government level. Where is the actual evidence from Australia, Canada, France, United Kingdom and United States to support IFAC’s claims?

In the UK at least there has been some research, but unfortunately the results do not support the view that the benefits of a move to accrual accounting are greater than the costs.

In 2005, two respected academics (Connolly and Hyndman) from Northern Ireland (a region of the UK) concluded that: “there was little evidence that [accrual] information was extensively used in decision making … the costs were seen as substantial”. This was around five years after accrual accounting had been implemented in central government departments.

In 2008, three other respected academics (Mellett, Macniven & Marriott) reported the results of their research, which had been funded by a member of IFAC, saying that: “there was no evidence that the perceived benefits from the introduction of... accruals accounting... were being realised”. This was in the National Health Service in England and Wales which had adopted accrual accounting over 15 years previously.

In addition there are significant risks associated with such a move. For example, in July 2008, the Auditor General of the Cayman Islands, Dan Duguay, issued a special report, “describing a very grim assessment of the state of financial accountability reporting throughout the Cayman Islands Government”. Ten years after the Cayman Islands agreed to adopt accrual accounting, the first accrual accounts were 2.5 years late and the Auditor General found the “current situation deplorable” and he believed that “the legislative assembly has lost control of the public purse.

In the second report, issued in April of this year, the Auditor General concluded that, “the state of financial accountability reporting has gotten worse in the two years since I last reported on this matter”. Despite the Government spending an additional $1 million in the last fiscal year to address the problem, the Auditor General assessed these efforts as being, “too limited and therefore; insufficient to address the situation”. He concluded his second report by saying, “I believe this situation has become a national crisis that could lead to tremendous consequences for the Cayman Islands Government if not addressed immediately”.

The Cayman Islands is not a poor country, the per capita income is one of the highest in the world and, as it is a tax haven and financial services centre, there are many qualified accountants available locally.

The first report of the Auditor General on the State of Financial Accountability Reporting (July 2008) in the Cayman Islands Government is available from:

The second report of the Auditor General of the Cayman Islands is available from:

Accrual Accounting - the Public Financial Management Fist Fight?

No subject, with the possible exception of Public Private Partnerships, can get PFM experts' blood to boil like accrual accounting. There seems to be a problem of diminishing returns against increased complexity as governments transition to accrual accounting. Examples include the high cost to value real property and maintain valuations. (Case in point was the very interesting reaction by PFM experts from African countries to the Government of Canada presentation about valuation at the 2007 ICGFM Conference - http://www.icgfm.org/2006Presentations.htm )

There is a political ramification to accrual accounting. (This has been pointed out during very lively discussions at FreeBalance International Steering Committee meetings.) Politicians tend to govern for relatively short periods of time yet government policy can have long-term implications such a social security. For example, David Walker, the former US Comptroller General believes that the reported US deficit is much higher when considering accrual accounting: http://icgfm.blogspot.com/2009/05/us-stimulus-mismanagement-fraud-and.html . One only has to look at the U.S. National Debt Clock to see the delta between what the government reports and what accrual accounting might report: http://www.brillig.com/debt_clock/

And, it is difficult to measure many contingent liabilities with any sense of accuracy in the government context.

Perhaps IFAC should provide a roadmap to accrual describing the stages between cash and full accrual with guidance for the public sector: linking capacity with each stage, benefits & good practices, costs & benefits etc. Many governments have moved to modified cash (good definition at: http://icgfm.blogspot.com/2010/06/proposed-definition-of-modified-cash.html) or modified accrual. Perhaps IFAC could provide guidance on the soft skills of selling this to politicians given the political nature of reporting on a accrual basis!

I agree with Sanjay and hope that Doug's wishes will be fulfilled by the new and substantially improved edition of IFAC's Study 14 on the Transition to the Accrual Basis of Accounting. It should be published towards the end of this year (2010). Amongst other things, it will provide more emphasize on the "soft factors", but also on the interaction between budgeting, accounting and financial statistics.

As regards Andy's scepticism, I think looking at some of the jurisdictions in Continental Europe which have adopted accrual accounting a few decades ago, might be helpful. There, we are far from the boiling point, and the effects are generally very positive. However, accruals have become so much common sense that nobody actually gets excited about it. Let's take the state and local levels in Switzerland, which adopted accrual accounting (and budgeting!) in the 1980s. The fiscal debate in these jurisdictions is strongly focused on investments, how to finance them and how to make sure they keep their value. For instance in the largest state in Switzerland, the State of Zurich (which has an economy that would globally rank about number 50 if it was an independent country) explicitly mentions maintenance of capital as the core objective of its fiscal policy. And yes, all the states and local governments had a very sound fiscal performance over the last 20 years - despite inheriting a lot of additional tasks from federal level. The federal level, in contrast, was piling up debt until very recently - despite successfully unloading many tasks to lower levels ... and yes: The federal government only introduced accrual accounting in 2007, capital maintenance was not even alluded to in its fiscal policy and investments were treated like out of the pocket expenditure. Similar stories could be told about Sweden, Denmark and other European countries.

Andreas Bergmann

But where is the authoritative and independent evidence that a move to accrual accounting provides the benefits claimed for it that I am asking for?

For example, did governments which have adopted accrual accounting really run up smaller deficits and so debts in recent years than those which still use 'cash' accounting (but usually report on government debt). And was this really a causal relationship?

I agree with Andy. The recommendations to move towards accrual are many but few explain what the evidence of benefits is, especially when compared to the costs. In addition, there is this great danger that countries with less developed systems are attracted to the idea of “cutting edge” reforms in this area and emulate the more advanced ones- with little capacity to actually reap any rewards. As a result, already scarce resources are diverted from the fundamental improvements that are immediate and important, to such reforms. In this context Dough Hadden’s point about a road map from cash to full accrual, linking it to capacity is important. Let us be careful here, developing countries really can’t afford to do what OECD countries can without first improving their fundamentals. In that sense this discussion is a bit restricted in its practical application in the developing world.

From a long time, accounting for public entities has been on a cash basis, with no change until the '80s when it was considered appropriate that these should move closer to commercial accounting principles practiced in the private sector. Demands for better accountability by governments and by public sector managers are being heard around the world as the public realizes that living on credit is not sustainable for individuals and the same principle applies to governments.

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