Accounting in the Public Sector

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Accounting in the Public Sector

• Noel Hepworth
• Chartered Institute of Public Finance and
  Accountancy
• University of Malta, February 2003

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Accounting in the Public Sector

• The objectives of government
• Differences between private and public sectors
• Forms of accounting
• Why cash accounting is so common
• The problems with the use of cash accounting
• The pressure for change to accruals
• The dangers with the change to accruals
• Performance, what is it and how can it be
  measured?
• Audit

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Objectives of accounting

• In the private sector
• To inform the stakeholders about the performance
  of the business
• To provide possible investors with information
• To aid management decision making
• Increasingly to inform regulators.

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Objectives of accounting

• In the public sector (traditional)
• To provide a financial summary
• To enable detailed comparisons of spending to be
  made with the budget
• To allow the identification of spending to ensure
  it complies with the law and other legal
  authorities (Parliamentary approvals)
• To provide the basis for the next budget.

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Objectives of accounting

• In the public sector (modern)
• To inform the stakeholders about the financial
  situation of the government
• To provide possible investors with information
  about creditworthiness
• To aid management decision making
• To identify assets and liabilities
• To facilitate democratic transparency.

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Critical differences between private and public
sectors

• In the public sector
• No test of performance such as profit or rate of
  return
• Non financial measures needed
• Problem of linking inputs to outputs
• Decisions made for political reasons, not
  financial
• Test of management competence is political, not
  financial.
• All this affects the management approach.

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Critical differences between private and public
sectors

• Overall aim of financial control in the
  government is to ensure
• That the Government obtains Parliamentary
  authority for what it wishes to spend (no
  taxation without representation), and
• That the Government only spends money on
  objectives approved by the Parliament.

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Critical differences between private and public
sectors

• Overall aim of a political party is to gain power
  and to stay in power.
• Civil service should be independent of the
  Government. Therefore it can serve any political
  party. Its role is to advise and to carry out the
  instructions of government within the law and
  within the authorised budget. Civil service
  should be the protector of the constitution.

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Critical differences between private and public
sectors

• In the public sector there is no market.
  Therefore a critical difference between the
  private and public sectors is that
• In the private sector you have a choice about
  whether to spend and on what to spend
• In the public sector through taxation, you have
  no choice you are forced to spend, usually
  depending upon your level of income.

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Forms of accounting in the public sector

• Most common is the cash basis
• Some governments still account using single
  entry
• Modern trend is to adopt accrual accounting
• However, this trend can be both dangerous and
  flawed.

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Why is cash accounting so common?

• Parliamentary approvals are granted on a cash
  basis
• Tax revenue and Parliamentary approval to raise
  taxes are essentially about cash revenues
• Therefore, the budget is drawn up on a cash
  basis
• The budget deficit is funded by tax revenue or by
  borrowing again a cash transaction
• Reporting to Parliament about what has happened
  has to be on the same basis cash.

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The problems with the use of cash accounting (1)

• Is of little help in developing value for money
• Does not facilitate delegation to management with
  performance responsibility
• Says nothing about assets and liabilities, nor
  charge for the cost of capital
• Says nothing about depreciation and the
  maintenance of assets

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The problems with the use of cash accounting (2)

• Does not facilitate comparison with the private
  sector
• Does not separately identify revenue and capital
  expenditure, so borrowing can be used to finance
  revenue spending
• Does not allow an audit of the financial
  statements and therefore encourages law and
  transaction based audit.

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Cash accounting

• Advantages are
• Simplicity
• Cash can be tightly controlled
• Easy comparison of spending with tax revenues
• Easily understood by Parliamentarians
• Easy for Parliament to grant cash appropriations.

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The pressures for change to accruals

• New management style, with delegated power
• Privatisation and contracting out
• Need to improve value for money
• No cash accounting standards and real concern
  about the quality of public sector accounting
• Pressure for increased transparency to aid
  democracy and reduce corruption
• Accrual definitions now adopted by IMF and
  Eurostat for statistical returns
• The current fashion i.e. peer pressure.

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The dangers with a change to accruals

• Great flexibility in interpretation of standards
• Pressure from politicians to state results in a
  manner that suits them
• Unwillingness to accept the management
  implications of the information produced
• No real understanding by management or Ministry
  of Finance of the meaning of accrual accounting
  or accounting standards
• No link between accrual accounts and a cash based
  budget.

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Results of these dangers

• Increase in corruption
• Higher costs of accounting with no real benefit
• Loss of financial control
• Disillusion by politicians with the system.

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What can be done to minimise these risks?

• Prepare carefully and ensure a culture of
  obedience to and enforcement of rules applies
• Invest in training of management
• Employ more accountants in more senior roles
• Establish an independent standard setter
  reporting directly to Parliament key roles for
  the profession
• Change the budget to an accruals basis
• Invest in IT
• Ensure that the auditor is fully prepared.

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Measuring performance in government (1)

• Accrual accounting provides a more accurate
  measure of cost. But that does not tell a manager
  or politician about performance
• Non financial measures need to be developed
• Auditor should audit financial and non financial
  information
• Management should be held to account for failure
  to perform against measures as well as finance

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Measuring performance in government (2)

• Management accounting systems need to be
  developed
• Performance information should be based on
  outcomes not on outputs or inputs
• Qualitative performance measures essential
• Performance measures should be independent of
  management.
• Guard against managing to the measure what can
  be measured gets managed.

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Audit

• Traditional public sector audit approach
• Audit focus is on compliance and regularity
• Audit often transaction, not systems based
• Basis of audit can be the law rather than finance
  and accounting
• Audit certificate does not relate to the
  financial statements
• Materiality has a political meaning
• Auditor reports to Government.

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Audit

• Modern audit approach
• Still has regard to compliance however,
• Financial statements audit
• Certificate accounts present fairly
• Audit approach focussed on systems
• Materiality definition similar to private
  sector
• Independence of auditor from Government
• Basis of audit is ISAs.

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Summary

• Important operational differences between the
  private and public sectors
• Lack of a marked has a material effect upon
  operational management
• Cash basis of accounting is widely used
• Gradual shift to accruals
• Increased role for accountants especially with
  reforms to management processes
• Audit is changing from a law based approach to
  financial audit.

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Contacts

• E.mail Noel.hepworth_at_ipf.co.uk
• Phone [phone], or for IPF
• 00 44 20 8667 1144
• Web site www.cipfa.org or www.ipf.co.uk