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February 08, 2012

Does the “Accrual” Emperor have any Clothes?

Posted by Holger van Eden

In late 2010, the Dutch Ministry of Finance (MoF) sent a letter [Download Netherlands] to parliament refuting the idea to move central government accounting and budgeting to an accrual basis. Due to language issues the argumentation of the Ministry received perhaps less attention internationally then it deserved. The letter emphasizes that international experience with accrual accounting, and especially with accrual budgeting, has been mixed at best, and that the push for accruals is being led by a misunderstanding of the applicability of private sector accounting standards and practices to the government sector. The main concerns of the Dutch Finance Ministry pertain to the increase of complexity of accrual documents, the decrease of accessibility for parliament, the limited added value of accrual information in government decision making (especially for policy ministries), the tendency of accrual information to shift allocative authority from the political to the administrative level, and last but not least the high costs of introduction and maintenance.

The letter to the Dutch parliament is supported by a number of underlying studies. At first glance the most striking information is perhaps a cost analysis of what the introduction and operation of accrual accounting would cost the Dutch tax payer. The table below indicates that implementation costs would likely range between 129 and 261 million Euro and additional operational costs would be anywhere between 13 and 28 million Euro per year.

Table 1: Overview of the Cost of Government-Wide Implementation of Accrual Basis Accounting

Incidental (one-off) costs

Lower Threshold

Upper Threshold

IT systems

€ 30 million

€ 71 million


€ 16 million

€ 25 million

Valuation of assets

€ 11 million

€ 22 million

Change process

€ 72 million

€ 143 million

Total implementation

€ 129 million

€ 261 million

Structural costs




€ 6 million

€ 14 million

Maintenance of IT systems

€ 2 million

€ 4 million

Valuation of assets

€ 5 million

€ 11 million

Total structural costs per year

€ 13 million

€ 28 million

Clearly these are sizeable numbers, but still one could argue the cost argument is perhaps not that strong. On a state budget of 250 billion Euro in 2011, introduction costs would come down to say 0.1 percent of annual expenditures. Spread out over 5 years this does not seem an insurmountable amount if it were for a useful reform. Having seen cost estimates for the UK, where the introduction of accrual accounting and budgeting has taken over ten years, the Dutch estimates seem, if anything, to be on the low side.

The reviews of international experience and academic literature accompanying the letter to parliament discuss in more depth a number of important drawbacks to accrual based accounting and budgeting. First, the improved quality of information that accruals is supposed to deliver is questioned. Accruals is complex and subject to many choices, assumptions and potential mistakes (and manipulation – the Greece deficit misreporting was noticed due to the much higher cash deficit, not by the partial accruals measure of ESA95). Cash accounting, moreover, can be amended with accrual information on an as needed basis, and government balance sheets can be compiled without the introduction of accrual accounting. “Modified” cash accounting can thus provide a satisfactory view on government finances is the argument.

Secondly, parliaments and ministries of finance have been hesitant to discuss the budget in accrual terms due to the increased complexity of the accrual presentation and the parallel decrease in transparency and year to year comparability. Countries like France, the U.S., Sweden, and Romania have introduced accrual accounting to supplement cash information on budget execution, but they have quite deliberately chosen not to introduce accruals for the budget itself. Even early adopter Australia has de facto gone back to budgetary decision-making on a cash basis. Only three OECD countries, New Zealand, Denmark and the U.K. presently operate their budgets fully on an accrual basis. The use of accruals, according to some of the reviewed literature favors technocratic rather than political allocation of resources (which to some might not be a bad thing of course!).

Thirdly, accrual accounting information in countries that have made the switch seems to be hardly used by public sector managers. This has been noted, for example, by the New Zealand Auditor General. Given the prevalence of current expenditure, the difference between cash and accruals for many categories of expenditure is also quite minimal, while for large investment projects cost benefit analysis can be done outside the accounting framework. This is particularly true in federal countries like Australia, where the federal budget consist mainly of transfers (except for the Defense department).

Fourth, the knowledge on accrual accounting in the government sector is limited, while accountancy professionals can be expensive to hire on a permanent basis. This leads to accrual accounting being outsourced, implemented by consultants and thus not used very much to support regular government operations.

Finally, the international comparability that accrual accounting has promised through international standards as IPSAS and IFRS has proven to be a mirage. All countries that have adopted accrual accounting, even those claiming to use international standards, have chosen national interpretations of these standards; thus international comparability remains problematic.

Many of these criticisms of accrual accounting and budgeting are not new. The studies performed are a bit short on recommendations: what are the desirable features of a good system of modified cash budgeting?; is moving to accrual accounting while keeping cash appropriations more attractive (keeping the best of the two systems) or less (similar costs, with less benefits) than going to full acruual accounting and budgeting? Perhaps, the most important comment from the Dutch Ministry of Finance is that more evaluation of the impact of accrual accounting and budgeting is necessary. With the exception of Australia, non of the early adopters have seriously reviewed the impact of their reforms. This would seem necessary before, as the Ministry puts it, the implicit assumption is made that private sector accounting practices are superior to those used in the government sector and easily transferable.    


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I think an important point made in the report is that "the application of these standards to the public sector is driven by a naive conviction of the superiority of the financial tools used by the private sector."
This sense of inferiority in the public sector (despite the contrary evidence of a certain lack of professional standards in the private sector) has motivated many to move towards accrual without a full appreciation of either the costs or the benefits of this measure.
Also the importance of knowledge of accrual in the public sector is a bit overstated. Most work in the public sector consists of routine accounting and rather clerical posting of accounts. What is required is not a large team of professional accountants well versed in IPSAS etc. but a few excellent ones at the top who can then guide, by developing manuals and providing training to the army of clerks that actually do government accounting.

I think that this is an important post and draws attention to probably the most comprehensive and objective study of the costs and limited benefits of accrual accounting in the public sector.

One of the major problems of moving to accrual accounting is the increased complexity of the accrual-based accounts. As the letter from the Dutch Ministry of Finance says:

Most countries concur in the view that an accrual basis accounting system is more complex than a cash basis system. They report that the financial information provided by an accrual basis system is more complex.

It seems to me that the major challenge of public sector financial reporting is to develop an approach and a format which enables the reports to be accessible to their main uses, the citizens and their elected representatives. It is interesting that after the adoption of the accrual basis for government reporting, projects were initiated in both Australia (Operation Sunlight) and the UK (Clear Line of Sight) to try to rationalise and simplify financial reporting to parliament.

The actual costs of moving to accrual accounting may not be huge, certainly in relation to the overall level of a government’s budget. But if the result is financial statements which are less easy for non-accountants to understand then it is understandable that the Dutch Ministry of Finance could say:

The foregoing means that caution is warranted in the implementation of accrual accounting by central governments – caution not only because the existing international standards are directly based on the experience of the private sector, but also because the application of these standards to the public sector is driven by a naive conviction of the superiority of the financial tools used by the private sector.

We do, of course, want to try and continually improve the quality of the financial information produced by governments. The debate over accrual accounting has unfortunately created a smoke screen which probably reduced research into existing good practice. Last year I led a study by the African Capacity Building Foundation looking at existing good practice in this area by governments of sub-Saharan Africa. The draft report is now available from: http://tinyurl.com/esaag2012

We are now in the process of developing guidance on annual financial reporting for African governments based on this research. I will be making a presentation on the research and developing guidance at the annual conference of the regional body for Accountants General, ESAAG, towards the end of this month.

Thank you, Brian, for this contribution to more realism.

In private discussions, many PFM experts concur with these views, whereas in collegial workshops or in their reports, they carry on promoting IPSAS and accruals for developing countries...

Will there be a time when everyone will recognize that the Emperor is naked?

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