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February 22, 2012

Accrual Accounting Essential for Government Transparency and Accountability!

Posted by Ian Ball [1]

In this post Ian Ball, CEO, International Federation of Accountants, argues that it is time for governments to take their accounting responsibilities seriously and to modernise their financial management practices. The eurozone debt crisis has highlighted widespread financial reporting failures and must lead to extensive reform, including adoption of accrual accounting and budgeting practices. Politicians and Ministries of Finance must be pressured to implement these reforms before the next crisis hits.  

The sovereign debt crisis has emphasised the seriousness of the results of poor financial management and financial reporting. Obviously, government actions to limit the impact of the global crisis have exacerbated their financial positions, as many governments acquired significant assets and liabilities, gave guarantees of various kinds, and engaged in massive fiscal stimulus programmes. But the situation now would not be as dire if so many governments had not already made commitments that they did not account for properly, and may not be able to meet.

Governments in general are clearly accounting very poorly for their financial performance and position. This could, and should, lead to significant reform. We saw how financial reporting failure in the private sector a decade or so earlier led to dramatic action, including the passage of the Sarbanes-Oxley Act 2002 in the United States, and the creation of regulatory bodies for private sector audits in most major countries.

But that was the private sector. In this case, it is the public sector where the reporting failure has occurred and, unfortunately, there have been very few calls for action.

There has been a lot of debate about the need for action to reduce deficits and spending, but very little serious consideration of the role that accounting and auditing have played in the crisis. It was refreshing to hear Bill Gates calling for accounting reform at the state government level in the United States. He is quoted as saying that ‘state governments use tricks that would make Enron blush’. Of course, state governments are not alone in this. So perhaps there is some cause for optimism that the crisis will lead to recognition of the need for change.

The chairman of the International Accounting Standards Board (IASB), Hans Hoogervorst, recently suggested that ‘without transparency, there can be no enduring stability’. I believe that without transparency, neither can there be trust or accountability, and a crucial element of transparency in the public sector is accrual accounting.

As a new graduate in accounting, working in the public service in New Zealand 40 years ago, I could not understand why governments did not seem to use solid accounting information. How could you not know what assets you had, what they were worth, and where they were located? How could you not know what it cost to produce your services? How could you not know what your liabilities are?

While I feel I know a lot more now than I did 40 years ago, there is one question in particular which for me remains troubling, especially in the current environment. This question is: ‘What will it take before governments around the world take their own financial responsibilities seriously?’ This is not to suggest that none do, but I do believe that there is a systematic, pervasive, though possibly not deliberate, ignorance of the critical value and importance of good accounting to governments.

The goal is for governments around the world to perform more effectively and efficiently. In order to achieve this, we need high-quality financial management, and as a necessary component of that, high-quality financial reporting, which in turn means much wider adoption of the accrual basis for budgeting, appropriations, and accounting. This is supported by having a set of financial reporting standards that are independently set, of high quality, and with international acceptance and legitimacy.

Reforming Accounting Standards

It has been 15 years since the International Public Sector Accounting Standards (IPSAS) programme was started within the International Federation of Accountants (IFAC), with the aim of developing a single accounting language for the public sector. The IPSASs are based on International Financial Reporting Standards (International Accounting Standards as they were then), which are amended only insofar as it is necessary to reflect the situation in the public sector.

The International Public Sector Accounting Standards Board (IPSASB) encourages public sector entities, including sovereign governments, to adopt the accrual basis of accounting. Our deliberate intent was to change the paradigm for governmental financial reporting, and create an international environment in which cash accounting is accepted as being seriously deficient.

Increasingly, we have pressed for government action in this area, for example, through IFAC’s submissions to the G-20. A lot is at stake. In the past, the failure of governments to manage their finances has had dramatic consequences. Some loss of political control is one of the most immediate consequences when poor financial management in the public sector leads to the need for a bailout – we saw this in Greece and Ireland.

This was exactly what happened in New York in the mid 1970s, when the city was bankrupt, and budget control passed to the financial control board, made up primarily of bankers. If it can happen in New York, it can happen anywhere.

In a more extreme situation, the failure of a government to control its financial position can lead to the loss of democracy. This can occur, and has occurred, when a democratically elected government cannot institute changes as dramatic as are necessitated by the financial situation, and an authoritarian government, which is able to enforce change, steps in.

Certainly, in Europe, the current crisis has led to public debate about the future of the euro. The failure of the euro would be a severe blow for Europe and European integration, and its collapse would, at the very least, be seriously destabilising, and not just for Europe, but for the entire world.

Failure by governments to control their finances can lead to significant and painful economic adjustments, with the potential for social unrest. Such measures as increasing the retirement age or renegotiating public service conditions of employment can have serious repercussions. For example, in the United States, Congress has been considering whether to allow states to file for bankruptcy. The idea behind this is, of course, to allow states to renegotiate contracts into which they had previously entered. This would certainly provoke a serious situation with the public sector unions.

David M. Walker, former Comptroller General of the United States, has worked for years to alert Americans to the seriousness of the situation in the United States. To cover rising federal commitments, every man, woman, and child in America are already more than a $250,000 in debt. David Walker has referred to this as every US citizen having a full mortgage but no house.

A key step in the journey to better financial management and reporting was taken in New Zealand and in Australia twenty years ago. Until the initiatives by these governments in the early 1990s, government accounting at the national level was cash accounting. The first steps were bold ones; there was not a lot of precedent for what was being done, and none at all at the national government level.

The next key milestone was the development by IFAC in 1996 of the programme to establish IPSASs, with the support of the World Bank and the Asian Development Bank to name a few. IFAC members provided the technical expertise, while the World Bank and others provided both financial support and a degree of legitimacy. The International Monetary Fund’s move to put the government finance statistics on an accrual basis served to reinforce this trend.

These developments made significant contributions to the accrual basis of accounting becoming the benchmark for governmental financial reporting, which is where I believe we now are.

As far as financial management (including budgeting and appropriations) is concerned, the situation is still bleak. To illustrate the problems, I would use two examples – the Securities and Exchange Commission in the US and Her Majesty’s Revenue & Customs in the UK – which have both faced heavy criticism for their poor financial management.

It seems that even government agencies, which have every reason to understand the importance of good financial information and which enforce that requirement in respect to the private sector, do not themselves demonstrate adequate financial management performance. We clearly have a long way to go before we can be comfortable about the quality of financial management, even in developed countries.

There is, however, a growing group on the reform journey, as jurisdictions and international institutions move to adopt the accrual basis of accounting and/or IPSASs. Currently included in the IPSAS adoption group are: the United Nations system, the European Commission, the Organisation for Economic and Co-operation and Development (OECD), and the North Atlantic Treaty Organisation (NATO). National governments include Austria, Brazil, Cambodia, Costa Rica, Kenya, Peru, South Africa, Spain, Switzerland, and Vietnam. The accrual (rather than IPSASs) adopters are a much larger group including: the US, the UK, Canada, Australia, New Zealand, and many others. While many are on the journey, challenges of implementation remain significant.

What is Holding us Back?

So, who is not on the journey with us? In general, politicians are not. While some politicians see the value of transparency, the general situation appears to be that politicians do not welcome transparency from the public sector as they do from the corporate sector.

Also, in general, ministries of finance are not on this journey. This may be partly because they reflect the preferences of the ministers, but is also because in many cases they are working within highly idiosyncratic cash-based budget and accounting systems. A move to accrual based accounting and budgeting would force them outside their area of expertise and would, effectively, require them to write-off a significant component of their own human capital. This is not something people are generally keen to do.

Obstacles that are often identified include financial reporting policy issues, constitutional and legal restrictions, and accounting resources, which include people and systems. Let’s look for a moment on the subject of resources. In developing countries this obstacle is real, and hence there are cash-based IPSASs for those jurisdictions that wish to be transparent, but do not have the necessary resources for an accrual-based accounting system.

But, in developed countries, this is no excuse. Imagine a listed entity going to its regulator and explaining that while they were keen to meet the financial reporting requirements, they did not have the resources to operate such a sophisticated accounting system.

However, the most serious obstacle in my view, at least for middle income and developed countries, is the absence of a political will for transparency on the part of too many governments. Why is it that even in the middle of a sovereign debt crisis, triggered in part by financial reporting fraud by the Greek government, there is no strong will by governments for better financial reporting?

I believe the answer to be that the structure of incentives faced by politicians makes them keen to avoid transparency, and institutional arrangements that would be effective in forcing this transparency do not exist in most countries. There are two elements to this:

• The incentives, which, for an individual politician as well as a political party, are generally short term and often less strongly related to serving the public interest than we might wish.

• The current institutional arrangements, such as the budgeting and appropriations rules, requirements for fiscal responsibility and transparency, and accounting methodologies, provide weak incentives for high-quality reporting and financial management.

The first point requires us to recognise and accept that politicians, like public servants and like people working in the private sector, are not angels working tirelessly and exclusively in the public interest. Politicians want to get re-elected, and in general they like the benefits they receive from being in office.

In itself, there is nothing wrong in this. But if transparency puts those benefits at risk, we should not be surprised that politicians resist it. Put bluntly, a well-argued case demonstrating how the global public interest is served by having uniform and high-quality public sector accounting standards will not cut much ice. This should not surprise us.

This view of political behaviour is consistent with the economics of public choice, or public choice theory. This is not saying politicians and public servants never act in the public interest, it is simply saying that they are people, just like those who work in the corporate sector. As Nobel Prize winner James Buchanan put it, public choice theory is ‘politics without romance’.

Viewed in this way, the differences between the public and private sectors do not lie primarily in what motivates individuals; they lie in the institutions within which they operate – facing, as they do, radically different incentives and constraints.

When we observe rational, self-interested behaviour in the private sector leading to undesirable social outcomes, such as pollution or the extraction of monopoly profits, we expect governments to act to constrain that self-interested behaviour. In other words, we change the rules of the game to try to get better alignment between the actions of individuals and our social objectives.

Changing Incentive Structures

So if public choice explains, at least in part, why governments make poor use of accounting and accounting information because they do not want to be constrained in the way they almost universally constrain companies in the private sector what can we do?

The trick lies in the second point: the institutional arrangements. Politicians need to work within a framework where the incentives do a better job of making the interests of those in government align to the public interest. The institutions – the organisations, laws, processes, and roles – that governments design to administer their financial affairs have considerable power in shaping outcomes.

Presently, the use of the cash basis for budgeting, appropriations, and reporting means governments are attempting to manage highly complex financial positions with outdated accounting and budgeting technology.

The results have the potential to be dire. The European sovereign debt crisis is unresolved after a series of successively more powerful actions at the European and international levels, and in the US serious risks to the financial system are emerging from the financial positions of state and municipal governments, as well as from the federal government.

Sheila Bair, chairman of the Federal Deposit Insurance Corporation (FDIC) and one of the most senior regulators in the US, has raised the possibility that the next financial crisis will originate in Washington, rather than Wall Street.

Whether through deficient accounting standards, off-balance sheet transactions, or fraudulent misreporting – the real financial position of the government is hidden. This enables governments to sustain, for a period, levels of cash outlays and debt that their real financial position cannot support.

And what can the accountancy profession do? We must recognise that any reform will require well-informed pressure from outside governments. This is not a set of changes we can generally expect governments to undertake of their own volition; it will require action by the profession, both internationally and nationally. While the changes required need to occur at the national level, pressure at an international level can certainly help. Peer pressure has a role, as we have seen through the development of the IPSASs and their becoming an international benchmark.

At the national level, professional accounting institutes speaking out on the need for governance reform, including financial management reform, is critical. They must call for institutional arrangements that change the incentives faced by politicians and effectively constrain their behaviour. There are few other organisations in society with the authority and expertise to take such a position.

If the sovereign debt crisis does not stir us as an international profession to speak out on this issue, we will have missed an opportunity, we will have failed to live up to our public interest obligations, and we will have let down the future generations who will have to pick up the tab. Without such action, the international financial system is exposed to significant risk and the global economy to unnecessary waste.

At IFAC, through the International Public Sector Accounting Standards Board we have, for over a decade, set financial reporting standards for the public sector. Increasingly, we have pressed for government action in this area. The momentum toward adopting IPSASs is building globally, but needs a lot more impetus. That impetus could, given the difficulties facing those wishing to invest in sovereign debt, come from investors and financial institutions who must in many cases make investment decisions on the basis of seriously deficient information. Support could also come from securities regulators, who have to date given surprisingly little attention to this area.

Another reform we have been actively promoting is for the international Public Interest Oversight Board, which has oversight of the International Auditing and Assurance Standards Board, the International Accounting Education Standards Board, and the International Ethics Standards Board for Accountants, to have oversight of the IPSASB. We believe this will further enhance the legitimacy of the IPSASB, and make it easier for governments to make the decision to adopt IPSASs.

IFAC and CIPFA are partnering on a project in the area of public sector governance. This project, in seeking to establish a governance framework for public sector organisations, has the potential to be both a catalyst for action by the profession, and a basis on which governance arrangements in specific organisations or jurisdictions can be evaluated.

Governance arrangements should align the interests of politicians and public servants with those of the public at large – the public interest. The project is drawing on previous initiatives, for example IFAC’s report Governance in the Public Sector: A Governing Body Perspective and CIPFA’s Whole System Approach to Public Financial Management (PFM), which proposes an integrated approach to the design and improvement of public financial management.

Accounting is an important component of public sector management. Its neglect by governments around the world has contributed significantly to the situation that we now face, as governments have been able to commit resources without having to account properly for those commitments. We are too late to avoid the consequences of past neglect, but a serious undertaking by governments to adopt and implement appropriate financial reporting standards would at least signal an intention not to repeat the mistake.

[1] Ian Ball is chief executive officer of the International Federation of Accountants. This is an edited version of an article published in the latest issue of Public Money & Management.

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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In the public systems, it is important (and always better)that accrual budgeting and accrual accounting move in tandem.Moving both in accrual formats help appreciate it better in legal and legislative angles too. In many cases, the countries constitutionally prohibit the executive authorities from 'committing' beyond the expenses authorized by the legislature. There are examples and success stories of available middle-paths; yet accrual budgeting will help accrual accounting!

Ian Ball argues that politicians are against accrual accounting because it is not in their interests. But surely he and IFAC, as the ‘trade union’ for the accountancy profession, are similarly influenced by their own economic interests? For example, accrual accounting certainly increases the number of jobs for accountants. The number of professionally qualified accountants working across the UK central government increased nearly fourfold from almost 600 in 1989 to 2200 in 2003 (the period over which accrual based accounting was introduced) according to HM Treasury (the UK’s Ministry of Finance).

In these circumstances I do not think it is enough for Ball just to make assertions such as:

Governments in general are clearly accounting very poorly for their financial performance and position.

a crucial element of transparency in the public sector is accrual accounting.


cash accounting is accepted as being seriously deficient.

Ball’s main claim is that the eurozone debt crisis has highlighted widespread financial reporting failures and that these could be overcome by the adoption of accrual accounting. But several European governments which had already adopted the accrual basis of accounting for their annual financial statements have also seen a significant increase in the level of their government debt in the recent past, for example, UK, France and especially Spain. In addition, the debt and deficit position of European governments is monitored through specific statistical reports and not their annual financial statements and so changes to the later would make little difference to the information available on the deficit or debt position of their governments.

Ball provides no evidence that a move to accrual accounting would improve transparency. Certainly this has not been the case in Britain. The former cash basis of accounting provided simple financial statements which were relatively easy to understand. The current financial statements are almost unintelligible, even by experienced public sector financial accountants, as was confirmed to me recently by a senior official of the public sector accounting body, CIPFA.

If cash accounting is ‘seriously deficient’ as Ball claims, why has it been retained for so long and by so many governments? Accrual accounting was adopted by Birmingham City Council as earlier as 1850 (then the sixth largest economic entity in Britain) but its adoption by the British central government was delayed by another 150 years. Similarly the Government of the Republic of Ireland still has no plans to change from the cash basis of accounting despite sharing the same language and being a neighbouring country to Britain.

In addition, over 90% of the governments across the world retain the cash basis of accounting (although none have actually adopted the Cash Basis IPSAS) including three quarters of the G20 countries responsible for the largest economies of the world. Another consideration for developing and transitional countries is that none of the industrialised countries adopted accrual accounting before they industrialised. Clearly public sector accrual accounting is not a perquisite to economic development.

All the independent and authoritative research on the actual experience of a move to accrual accounting has found that the costs are significant and the benefits are limited. This is summarised in my paper which can be viewed at: http://tinyurl.com/ceuj72

These conclusions were confirmed recently by the French Audit Office in a report on the implementation of their financial reforms, ten years after the law was changed and five years after its implementation from January 1, 2006. This report concluded that:

managers have not accepted accrual accounting as a tool for decision-making, owing to the lack of support and training needed to more closely link management and accounting.

Finally, in an article in which Ball is unnecessarily critical of his fellow public sector professionals and makes apparently libellous statements about “financial reporting fraud by the Greek government” (without any supporting evidence), you might expect him to take greater care with the accuracy of his own statements. However, he erroneously lists Kenya and South Africa as the two African members of the IPSAS adoption group. In neither case are the financial statements of the governments of these countries actually produced on the accrual basis, much less being based on the accrual based IPSAS.

My impression is that many politicians are swayed by the ill informed and biased arguments provided by the likes of Ian Ball. As a result, it is left to public sector accountants to try and reduce and postpone the introduction of accrual accounting as they know the costs and appreciate that every extra accountant means one less nurse or teacher for their nation’s children.

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