Noel Hepworth

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Migration from Cash to Accruals Challenges,
pre-requisites and critical success factors

• Noel Hepworth
• Chairman, CIPFA International

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• ISSUES

What is the aim of the reform?
Reflecting on Enron!
Benefits and risks of cash accounting
Benefits and risks of accrual accounting
The costs of changing to accruals
Comparison of risks cash v accrual
Pre conditions for success
A conclusion for developing countries
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The aim of the reform -some questions!
Are financial reports the whole truth
What are the accounting system
financial reports for
?
Does the system of accounting make any
difference
Is there an Enron type risk in the public sector
If there is a risk, what can be done
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Purpose of the accounting system- to provide
information for

• External stakeholders both general and specific
  reports key element in accountability.
• Management for internal financial control,
  decision making performance
• assessment.
• Are these objectives achieved? If not,
• is the accounting base a factor?
• The Accountant General is responsible
• for quality and integrity of the financial
• information system

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Do public sector financial reports tell the
whole truth?

• Are the accounts complete? Possible omissions
• Off-balance sheet transactions
• Some public sector entities, control is the
  issue?
• Some transfers, guarantees, other obligations?
• Pension liabilities for civil servants?
• Some assets and liabilities
• Uncollected tax revenues?
• Anything else?

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Is an Enron type situation possible in your
country? (1)

• The accounts are incomplete
• Accounting is on a cash basis
• Budget is the focus of interest, not accounts
• The overall concern is with inputs,
• not outputs
• Distinction between capital and revenue lacks
  clarity

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Is an Enron type situation possible in your
country? (2)

• Audit and scrutiny process in inadequate
• Published accounts are not understandable with no
  clear user of financial statements
• Political aim is to present best position
• Is it the form of the accounting system that
  creates the risk in government accounting?
• Would a change from cash to accruals make the
  difference?

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Can there be an Enron type situation possible in
your country?

• Yes! there are serious risks in many countries,
• but politics hides them the cash basis is
• convenient.
• Examples borrow to finance revenue California
• Not providing adequately for pensions Germany
• Not accounting properly for assets Greece
• But Enron accounted on an accruals basis!
• Other factors more important than accounting base
• Governments claim sovereignty can they be
• trusted to be objective?

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Factors to prevent or reduce risk of an Enron in
the public sector (1)
Clear separation of capital from revenue
expenditure income
Strong audit/ accountability arrangements
Devices like leasing private finance of
public assets carefully assessed for impact
Risk to be genuinely transferred to private
sector before exclusion from public sector b.s.
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Factors to prevent or reduce risk of an Enron in
the public sector (1)
Independence of Government standard setting
Political willingness to challenge and cause
change in accounts if necessary
A constitutional requirement that
future commitments fully accounted for,
including leases/guarantees. pension/
social obligations
Independent accountability of civil service
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Benefits of cash accounting

• Simple
• Links with cash budget and taxation systems
• Easy to understand
• Easy to audit and control

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Risks of cash accounting

• Ability to manipulate cash flows
• Assets and liabilities ignored
• Cash statement does not provide a full picture of
  the financial position
• Does not facilitate efficient use of resources
• No link with economic analyses.
• Hides intergenerational transfers of cost.

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The purpose of accrual accounting- is to improve
the quality of

• Financial reporting.
• Financial management of government
• as a whole?
• Financial management of individual
• services and cost centres?
• And so tell at least more of the truth.
• But, will it do any of these, who is interested
  and
• what actions will result?

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Benefits and risks of accrualaccounting
benefits in theory
Facilities better quality management
Accrual accounts more complete than cash
Scope for manipulation of cash removed
Requires a record of assets and liabilities
Opportunity to change organisation behaviour
Provides better assessment of financial health
can link with economic data
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Benefits and risks of accrualaccounting risks
in practice
Standards capable of manipulation
Seen as technocratic exercise, not management
Lack of independent accounting standards
No linkage with budget (unless reformed)
therefore risk of loss of financial control
Politicians will not impose discipline
Management unwilling or unable to use accrual
information to improve services
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Benefits and risks
Who considers the accounts just who is
interested?
Isnt the focus of political and NGO interest on
the budget?
What can the auditor do that is effective?
There is great scope for judgement in accrual
accounting more so than with cash who will
monitor the exercise of judgement will
Parliament?
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Changes to accruals the costs

• Opportunity cost of change can you afford it?
• Training of financial managers.
• Training of managers and culture change.
• Changing software and hardware.
• Appointing/retaining skilled accountants.
• Diversion from other activity e.g. PRS
• Commitment to long run investment not a 1 year
  reform
• Higher costs have to be offset by benefits
• from management gain!

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Comparison of risks- cash v accrual

• Accruals creates illusion of quality system,
• but reality is that quality depends upon
• Independence of the standard setting process.
• The skills of government accountants.
• Management capacity to use the information.
• Political willingness to address issues.
• Quality of audit and reporting process.
• Use of reports by politicians and stakeholders.

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An accruals system pre-conditions for success
(1)

• Politicians/management understand the change and
  can use information to improve efficiency.
• Existing cash accounting system works well.
• MoF authority respected with a culture that also
  respects MoF regulations.
• No parallel accounting systems exist because MoF
  system is so deficient.
• No systemic corruption.

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An accruals system pre-conditions for success
(2)

• An annual, comprehensive ext. audit exists.
• Accounting standards can be set independently of
  Government, or jointly with third parties.
• Acceptance that accounting standards are dynamic
  and need to be regularly updated.
• The accountancy profession is willing/able to
  cooperate with civil service, train accountants
  in Government and to educate staff about
  standards.

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An accruals system pre-conditions for success
(3)

• Govt auditor supports/participates in reform.
• Management training programme to focus on
  resources used rather than cash paid.
• The budget prepared on same accruals basis.
• An IT capacity exists to manage the information
  promptly and efficiently.
• Managers can and will improve efficiency shift
  emphasis from inputs to outputs.
• Politicians will make decisions.

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An accruals system
Overall judgement only worthwhile if
Political willingness to act on new
information ie to require management improvement

• Cash system works well
• change will not solve
• problems, only
• make them worse

Political willingness to recognise long term
nature of the process
Can be clear independence in standard setting
Willingness to accept the opportunity cost
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Moving to accrual accounting

• Some Governments are/have adopted full/partial
• accrual accounting e.g.
• Finland, Iceland, Sweden, United Kingdom,
• New Zealand, Australia, Iceland, European
• Commission ( and accrual budgeting)
• Others are considering it
• South Africa, Canada, Norway,
• France, Croatia, Israel.

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Moving to accrual accounting

• As developing countries, should you move
• to accruals?
• Some consultants are pressing for change.
• Some aid agencies, like DFID, do not feel this
  appropriate.
• For some countries (not all) the opportunity
  costs will be considerable.
• Is it such a priority over other priorities?

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Conclusion
Unless accruals system is used effectively and
right conditions exist, the greater risk of loss
of financial control lies with an accruals system
than with a cash based system
To change, takes time with high opportunity cost
unless management reforms made to work
Do not make the change unless prepared to carry
through the political / management consequences
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Concluding Advice

• Change will not solve current problems
• only worsen them
• solve problems before making a change
• and then
• ensure the right conditions exist before
• changing!

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Contacts

• Noel.Hepworth_at_IPF.co.uk
• Phone - CIPFA 00 44 20 7543 5600
• - IPF 00 44 20 8667 1144
• Fax - IPF 00 44 20 8681 8058
• Web site CIPFA www.cipfa.org.uk
• IPF www.ipf.com

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