ACCRUAL ACCOUNTING AND BUDGETING SYSTEMS ISSUES IN AUSTRALIAN GOVERNMENTS
Much confusion has resulted from the adoption of two accrual accounting and budgeting systems by Australian governments – the Government Finance Statistics system and the Australian Accounting Standards system – as each reports vastly different results. Which set of results should be believed and approved by parliament? Further, termination of the former cash accounting system has deprived governments of important information. The systems are examined here, and use of an enhanced GFS system, which incorporates the cash system, is recommended.
The adoption of accrual accounting and budgeting systems (AABS) by Australian governments has been central to the extensive management reform programs adopted over the past 20 years (Department of Finance 1994a, 1994b, Joint Committee of Public Accounts 1995a, 1995b, National Commission of Audit 1996). The reforms were widely praised in official publications and promised significant improvements in efficiency of resource management and in enhanced transparency of information and accountability to parliament and the public. However, they were criticised by many academic accountants (eg, Guthrie 1998). While major improvements have been made in these matters, significant concerns remain about the new accounting information systems and they have created some major problems for government.
The problems reviewed here are those that have arisen from the scrapping of the former cash accounting and budgeting system (CABS) on the introduction of accrual budgeting in 1999, and from the simultaneous introduction of two different accrual accounting and budgeting systems that provide significantly different results. It is contended that:
* the cash accounting and budgeting system provides necessary information for the management of government fiscal policies and cash, and it should be reintroduced, but as an integral subset of an accrual accounting system; and
* the use of two accrual accounting and budgeting systems providing widely different financial measurements has created confusion and questions about which sets of figures should be accepted and used. The nature of each system – the Government Finance Statistics (GFS) system based on International Monetary Fund (IMF) requirements and the Australian Accounting Standards (AAS) system – is examined and related to government financial information requirements. It is concluded that the GFS system is the more appropriate one for government use, being designed specifically for this purpose; whereas the AAS system is not sufficiently relevant for government as it has been designed primarily for business use and, further, it lacks sufficient analytical rigour.
The paper is confined to the activities of the general government (ie, budget) sector of the Australian government and to the information published in regular government financial statements. It does not include the activities of public financial corporations and other government enterprises. While it does not refer to state and territory governments (which are also required to use the same two systems) the same principles apply to them.
NATURE AND ROLES OF GOVERNMENT
The nature and roles of government determine what information is required from the financial management information and reporting system (FMIRS). They establish the environment in which the accounting system is to operate and the purposes for which the information is to be used. In turn, these matters determine how the information is to be measured and reported.
In 1863 the US president Abraham Lincoln pondered on the question of the role of government and concluded: “The legitimate object of government is to do for a community of people whatever they need to have done, but cannot do at all, or cannot do so well, for themselves in their individual capacities.”
Governments typically undertake the following roles (Stiglitz 2000, ch 1-4):
* provision of public goods and services to citizens such as law, order, defence, infrastructure facilities, basic health and education. These are largely collective items characterised by nonrival and non-excludable consumption. All citizens have equal rights to them, and one’s use of them does not normally prevent others from using them;
* provision of social welfare facilities and services to citizens to bring about greater social equity in the nation;
* macro-economic management of the economy to promote steady and sustainable economic growth, high levels of employment and price stability;
* pursuit of intergenerational equity to ensure that each generation pays for the services provided by government to it so as not to bequeath debts to future generations;
* conservation of the nation’s heritage and natural environment so as to avoid their degradation and preserve them for future generations; and
* management of government resources and liabilities to ensure their efficient and effective use. Inefficiency wastes resources and leads to higher costs of service provision.
These activities determine government’s financial management information and reporting needs. Their FMIRS must be designed to provide them with appropriate information to facilitate these tasks and to report to stakeholders. The first five roles are the concern of government fiscal (or budget) policies. They all involve the raising and expenditure of cash, and significant externalities where all the costs and benefits are not confined to the parties involved in the transactions. This occurs because consumption benefits and/or costs are shared (as with all public goods), and/or because of differences between private and social costs and benefits. They fit into Lincoln’s notion that governments are better able to do these things on a collective basis than are citizens operating in their private capacities. Accordingly, the Australian government (Budget Papers 2006-07, p. 8.8) sees the role of its general government sector (GGS) as the provision of “public services that are mainly non-market in nature, and for the collective consumption of the community, or involve the transfer or redistribution of income. The services are largely funded through taxation and other compulsory levies.” Fiscal policies are formulated for the nation and must be approved by parliament prior to implementation. The resource and liability management role is largely a micro-economic responsibility vested in departmental managers implementing government policies as approved by parliament. Their good management is covered by statutes such as the Financial Management and Accountability Act (FMA) 1997, Audit Act 1997 and the Public Service Act 1999.
ACCOUNTING AS A FINANCIAL MANAGEMENT INFORMATION AND REPORTING SYSTEM
In the context of the public sector, accounting should be regarded as a financial management information and reporting system for the use of government and its management, parliament and the public as the key stakeholders. It should report information which is useful for decision-making in the use of resources and for performance measurement, and for accountability purposes (SAC 2 1990, para. 43-45).
Information can be useful only if it satisfies certain criteria for usefulness and is appropriate for the environment and roles of the accounting entity. These criteria are relevance, reliability, comparability and understandability, and are explained in SAC 3 (1990, para. 5). Relevant information must relate to the purposes for which it is to be used; ie, the decisions made, measurement and assessment of financial position and performance, and the fulfilment of accountability obligations. To be relevant and timely, it must be tailored to suit the operating environment of the entity and the concepts being measured and be promptly reported. Reliable information requires that it can be depended on to represent faithfully the transactions, concepts and results of operations that it purports to represent and do so without bias or undue error. There must be a correspondence between the message that the information conveys and the reality of the entity’s operations. Comparable information requires the use of consistent accounting concepts and practices so that like information can be validly compared within and between statements, over time and between entities. Understandability means that users are readily able to comprehend what the information purports to mean. This requires that the presentation of information must not be obfuscated by irrelevant detail, non-disclosure of key items, and inappropriate terminology, classification of items or accounting practices. The first three criteria for useful information are interrelated and they all affect understandability.
FMIRS can take a variety of forms according to the information required from them. They may encompass cash transactions only (cash-based accounting) or all cash and accrual transactions (partial accrual accounting); they may include nontransactions which affect income and wealth such as asset consumption charges (full accrual accounting); they may adopt initial transaction prices of assets and liabilities (historic cost accounting) or their current market values, either entry or exit prices (current value accounting systems) as the basis of income and wealth measurement; and they may use the dollar measuring rod as a unit of exchange or as a unit of general purchasing power. Finally, the systems can relate to the past and record actual transactions and events (ex post or outcome financial statements), or to expected future transactions and events (ex ante or budgeted financial statements).
The only financial report which can be prepared in the cash-based accounting system is the cashflow statement, and the only asset reported is the cash balance. Two financial statements can be prepared under partial accrual accounting: a cashflow statement and a summary of external transactions (covering both cash and credit items). Full accrual accounting systems are required to measure income and financial position in addition to the cashflow and all external transactions reports. These involve the measurements of all items of revenue and expense, and all assets and liabilities. As well, detailed management reports on segments of operations (products, departments, etc.) can be prepared in the system.
The broad framework of these systems is outlined in Appendix 1. The information produced in each system differs, and the choice between them depends upon the type of information required. No one system can provide all the financial information possibly required.
THE MAJOR ISSUES AND THEIR SOLUTION
Cessation of cash accounting and budgeting systems
CABS have been used by all Australian governments since birth. They have been viewed as an integral component of a democratic system since the seventeenth century in the United Kingdom and subsequently in other democratic nations. The Department of Finance (1994a, p. 9) succinctly describes the role of cash accounting in the Westminster system of government: “Historically, governments have operated on an annual cash basis because this is fundamental to the democratic constitutional safeguards which have been evolving since the days of King Charles I of England. The basic safeguard is that no monies shall be collected or spent except in ways and amounts approved by Parliament through budget appropriations.”
These requirements are included in the Australian Constitution 1901 (Section 83) and in the FMA Act 1997. All policies involving cash transactions, both receipts and payments, must be approved by parliament before implementation. They must also pass through the Consolidated Revenue Fund (CRF) (Section 81). Information on budget compliance must be submitted to parliament and be audited (Audit Act 1997) to certify that parliament’s wishes have been adhered to. Evidence of budget compliance is an integral part of the accountability process.
Notwithstanding the above requirements, as well as its essential role in fiscal policy determination and cash management, CABS was terminated without public warning on the introduction of the AAS system of accrual accounting and budgeting in the May 1999 budget. Yet most of the literature supporting the adoption of accrual accounting by government stressed that CABS should be retained as part of the more comprehensive accrual accounting system. For example, the National Commission of Audit (NCA 1996, p. 223) states: “Thus, the short to medium term cash impact of the budget will continue to be important for macro-economic management purposes . . . accrual budgets would continue to provide this cash information.”
As the preceding explanation of FMIRS and Appendix 1 indicate, there is no technical reason why cashflow reports prepared directly from cash transactions cannot be prepared daily in an accrual accounting system. Many corporations do so, as the information is needed for efficient cash management. In government, it is needed for this purpose and also for fiscal policy and accountability purposes.
Cash is central to all government fiscal policies because it funds the resources required to provide all the goods and services to the community. Guthrie and Parker (1998, p. 14) note that “cash is the resource appropriated from the community by parliament, and cash is the resource used by governments in delivering services to the community”. Cash budgets provide parliament with information on the new resources required for allocation to departments and programs, and thence to citizens in the form of the types of goods and services discussed above; and secondly, on how they are to be funded through taxation and other measures. Provision of new resources involves government policy decisions and parliamentary approval.
Further, cash is central to macro-economic management of the economy. Governments aim for sustainable and steady economic growth which maintains high levels of employment with low inflation. They can influence these matters both through the massive size of their budgets (currently some $250 billion of receipts and of expenditures, or about 23% of GDP for the Australian government), and the directions of their expenditures and sources of taxation – these affect the allocation of resources in the economy. All transactions affect the level of economic activity – production, sales and employment. All cash transactions involve a flow of resources into or out from the government to the community. Expenditures add to aggregate demand in the private sector, while taxation reduces it. The cash budget balance shows the net effect of taxation and expenditure policies on aggregate demand. Budget surpluses reduce it and are contractionary, while budget deficits do the opposite. In turn, this affects inflation, economic growth, employment and stability of the economy. The cash budget also influences financial markets and interest rates. Deficits must be funded through government borrowing, while surpluses add to the savings of the nation and are available to fund investment expenditure elsewhere.
As well, long-term cash budgets extending over the economic cycle are needed to determine whether current policies are compatible with the objective of intergenerational equity. A long-term cash deficit indicates that, on current expectations, taxation receipts are inadequate to fund the budgeted provision of services.
CABS is also necessary for efficient cash management by government to ensure adequate liquidity throughout the year and to minimise borrowing costs. With annual cash operating budget inflows and outflows of about $250 billion each, the flow of cash through the government is enormous by business standards. In addition there are significant capital transactions and loan repayments. There can be substantial fluctuations between daily cash inflows and outflows, resulting in daily deficits or surpluses. The government must ensure it has sufficient cash on hand each day to meet its expenditures, and if a deficit is expected, it must arrange to borrow the money in advance through the sale of treasury notes. Conversely it can invest temporary cash surpluses or redeem outstanding treasury notes. Rolling cash budgets must be prepared each day for efficient cash management.
Hence, for fiscal policy purposes, efficient cash management and budget legal compliance and accountability purposes, CABS is necessary and the information must be available on a timely basis, such as daily for cash management. This can be done where the information is compiled directly from cash transactions undertaken each day. The only outcome cashflow statements (CFS) currently published are annual ones which can only satisfy accountability purposes. Unfortunately the statements are prepared from each set of end-of-year accrual financial statements (GFS and AAS) by eliminating all the non-cash transactions and events from them (as can be seen in Appendix 1). This is an inefficient process which takes about three months to accomplish.
Further, the cashflow information derived from two different accrual accounting systems using the add-back method can be very different, even though they purport to cover the same transactions. Table 1 summarises the cashflows for each major category in the 2006/07 budgets.
Which sets of figures are to be believed? Does the government expect to receive $268,582 million or $232,048 million in taxes and other receipts, to generate an operating cash surplus of $15,959 million or $21,045 million, etc? Clearly this is an unsatisfactory situation which confuses parliament and other users and casts doubt on the reliability of the data. The measures selected affect assessment of the macro-economic impact of the budget and financial markets. The differences are caused by the use of different classification criteria in each system. Fortunately, the different systems do not affect the final cash balance. The system which reports the more relevant and reliable information for the purpose in hand should be chosen.
Hence, a major reform to the present FMIR systems must be the re-introduction of CABS to enable the regular preparation of cashflow statements directly from cash transactions. second, it must form a component of the FMIR system judged to be the more appropriate one for the use of government.
Adoption of two accrual accounting and budgeting systems (AABS)
The case for the adoption of accrual accounting and budgeting systems is based on the government’s need to have comprehensive records of its vast holdings of non-cash assets and portfolio of liabilities in order to manage them officially (Department of Finance 1994b, JCPA 1995a, 1995b, National Commission of Audit 1996). As at 30 June 2005, the general government sector of the Australian government had financial assets of $83,710 million and nonfinancial assets of $75,095 million (Consolidated Financial Statements, pp. 78-80, based on AAS). Conversely, it had liabilities for borrowings, staff superannuation and other obligations of $195,258 million. The gross deficit in its net worth was $74,900 million, offset by reserves of $38,447 million (mainly asset revaluation), to yield a negative net equity of $36,453 million. Its assets and liabilities are much larger than those of any Australian business corporation; further, corporations cannot remain operating with negative equity.
There can be no effective management of such a vast portfolio of assets and liabilities without appropriate accounting records of them. Further, management attention was concentrated on fiscal policy issues, cash budget compliance and cash management, and a refocusing of management attention to encompass all the non-financial assets and liabilities of the government required a “cultural change” (JCPA 1995a). As a result, many assets were surplus to requirements, under-used or poorly maintained (ANAO 1995-96, 1997-98 and 1999-2000). Likewise, burgeoning liabilities from budget deficits and unfunded superannuation commitments were largely ignored. As well, accrual accounting is needed for cost control of departmental operations and of programs for delivery of services to the public. This information is necessary for determining priorities in expenditure programs, and for facilitating better management of government resources and hence efficiency of operations. In brief, accrual accounting is required for the final resource management role of government. But as well, by facilitating greater efficiency in use of the government’s own vast stock of resources, it helps to promote improved macro-economic management of the economy.
Given the potential for accrual accounting to yield substantial efficiency benefits, the major issue concerning its adoption is not whether it should be adopted, but which system of AABS should be adopted. The government has in fact adopted two very different systems of accrual accounting – the Government Finance Statistics (GFS) standard of the IMF and the system formulated by the Australian Accounting Standards Board (AASB). AAS are the professional accounting standards developed for and used by business. Almost the whole package of AAS and the Statements of Accounting Concepts (SACs) have been adopted by the public sector. However, those of major relevance are AAS 29 Financial Reporting by Government Departments (1996), AAS 31 Financial Reporting by Government (1996) and the SACs (1990). Table 2 illustrates the figures produced under each system for the 2006/07 Australian budget.
Again, as for the cashflow budget figures, the sets of budget figures for each FMIRS are substantially different and the same questions can be asked about which system portrays the ‘”true” budget. Again, the answer must depend on which of the systems is more appropriate for the uses of government and provides the more relevant and reliable information. Parliament is dissatisfied with the situation; the Joint Committee of Public Accounts and Audit (2002) held an inquiry into it but was unable to resolve the problem. Subsequently the Financial Reporting Council (FRC) issued a directive to the AASB to “harmonise” the two systems into a single set of government reports (18 December 2002). The FRC is a government-appointed body which supervises the activities of the board. A Heads of Treasury Committee has since provided many submissions to facilitate harmonisation for the board’s consideration (Challen and Jeffery 2003, 2005).
The major differences in the treatment of items are listed in Budget Paper No. 12006-07 (Statement 8) and a reconciliation statement is provided. They relate to treatment of the goods and services tax, commonwealth tax transfers to the states, expenditure on military equipment, valuation bases of assets and liabilities, and holding gains and losses. Their treatment is currently under review for the systems harmonisation project.
The GFS system was introduced in 1993 for the general government sector for both budget and outcome purposes. However, the statements were not published and GFS was not applied at the departmental level. It was used by Treasury in conjunction with CABS until 1999, when CABS was discontinued upon the introduction of the AAS accrual budgets. At the same time, the separate recording of cash transactions was abolished with the scrapping of the cash transactions recording system. Also in 1999, the GFS budgets were published for the first time, and in 2000 the outcome statements for GGS.
Accrual accounting based on AAS was introduced progressively by departments from about 1990, and the first departmental outcome statements were produced in 1993. Draft consolidated financial statements for the whole-of-government comprising the GGS and public enterprises were completed in 1995. However CABS budgets and outcome statements were continued till 1999, when AAS budget statements were introduced for both departments and the GGS. Thus since 1999, both AABS budget and outcome statements have been published, though the budgets are for the GGS only and the audited outcome statements are consolidated ones for the whole-of-government only. This in itself is a major anomaly (Challen and Jeffery 2005), as AAS31 does not recognise the GGS as an accounting entity while the budget does, and there is no budget for the whole-of-government while there are outcome statements for it. The board recently proposed to rectify this anomaly through the issue of AASB 1049 (September 2006) in which the GGS is to be recognised as an accounting entity. Both sets of AABS are explained and examined below to isolate the causes of the differences between them.
Government Finance Statistics – Accrual Accounting and Budgeting System (GFS AABS)
The purpose of the GFS system (IMF 2001, para. 1.2-1.4) “is to provide a comprehensive conceptual and accounting framework suitable for analysing and evaluating fiscal policy, especially the performance of the general government sector and the broader public sector of any country”. The system was developed specifically for the public sector to accommodate the special nature and roles of governments and for assessing their economic impact on the nation. It was adopted by Treasury for these fiscal policy purposes because the existing AAS accrual accounting systems did not provide the information.
The system is based on IMF economic measurement standards used for the measurement of the GDP of nations and its components, and is integrated with the UN System of National Accounts (SNA). The system enables relevant and reliable measurements of GDP to be made which are internationally comparable. It is an economic measurement system based on economic concepts throughout and uses a rigorous, analytical approach. It is based on doubleentry recording, a sharp distinction between stocks and flows of resources, and current market prices of all assets and liabilities (primarily current buying prices of non-financial assets and realisable prices of financial assets and liabilities). The function of the system is to provide governments with information for fiscal policy purposes, as CABS had previously done, rather than for micro-management of government activities and resources.
A sharp distinction is made between stocks and flows of resources in the system because of their differing economic effects. Resource flows directly affect production, sales and employment and enter into the GDP; as well, they affect the stocks of resources (assets, liabilities and net assets or wealth). Changes in resources can also arise from some non-transaction events such as changes in market prices, discovery of new mineral deposits and the growth of forests.
Two types of resource flows are distinguished: transactions and other economic flows.
Transactions represent resource flows that come about as a result of mutually agreed interactions between the government and external parties. Under accrual accounting, these flows are recognised as and when they occur. Transactions are classified into exchange transactions which involve the purchase and sale of items; and transfers which provide goods, services or cash to or from the government without recognising something in return. Taxes and social welfare benefits are examples of transfer payments. Internal asset consumption, such as depreciation of non-financial assets and inventory consumption, is recognised along with transaction resource flows as it reduces resources even though it does not involve a market transaction. These resource flows are summarised in a Statement of Government Operations, and they all impact on the stock of assets and liabilities shown in the balance sheet, (see Appendix 2, Appendix 3). This statement is similar to the Statement of External Transactions portrayed in Appendix 1 but with the inclusion of asset consumption charges. As well, because the system is based on recording transaction resource flows, it is easy to segregate cash transactions and report on them directly in cashflow statements.
Other economic flows represent changes to stocks that do not result from transactions or from internal asset consumption. They arise from price movements and abnormal events. They often arise fortuitously without any active decision-making being involved. Valuation changes in stocks of resources arise from price changes in individual assets and liabilities. They are holding gains and losses which do not alter the physical stock of resources. All assets and liabilities are revalued at current market prices prevailing at the end of each year, and holding gains and losses are then recognised. Abnormal items include damage caused by natural disasters (earthquakes, bushfires, floods, etc.), discovery of new mineral resources, and growth of forests, etc. However, they are excluded from normal operating resource flows because (for most items) they are irregular and largely unpredictable. The valuation changes and abnormal items are summarised in a Statement of Other Economic Flows (see Appendix 3). They are recorded directly as balance-sheet changes and do not enter into the Statement of Government Operations.
Structure of the GFS Analytic Framework
The framework is illustrated in Appendix 3. It shows that the beginning-of-period stocks in the opening balance sheet, plus transaction resource flows (summarised in the Statement of Government Operations), plus other economic flows (shown in the Statement of Other Economic Flows) yields the end-of-period balance sheet. This parallels business accounting.
The Statement of Government Operations (Appendixes 2 and 3) provides the government with some important economic magnitudes – net operating balance, gross and net capital formation by government, and net lending/borrowing which in turn is represented by the increase in financial assets/liabilities. The net operating balance indicates the extent to which current revenues fund the operating costs of government service provision. It thereby reports on the change in net worth from transactions activity and the ongoing sustainability of government operations. It should be noted that it excludes holding gains and losses on assets/liabilities and other (abnormal) changes in the volume of assets. These items are treated as pure balance sheet items and flow through directly to Net Worth. Government capital formation indicates the extent to which the budget has added to the nation’s capital stock and its capacity to provide additional public services. Net lending/borrowing measures the extent to which the government is either placing resources for disposal by other sectors of the economy or utilising savings. It indicates the financial impact of the government on the rest of the economy.
The Statement of Other Economic Flows (Appendix 3) presents the influences on government Net Worth that are not the result of government transactions and asset consumption. Rather, they result from price changes in assets and liabilities (resulting in holding gains and losses) and from special events (natural disasters, new mineral discoveries and so on). These items are recorded directly in Net Worth and do not pass through the Statement of Government Operations.
The closing Balance Sheet presents the stock of assets and liabilities and shows the government’s Net Worth. Change in Net Worth helps assess the sustainability of government operations. Declining net worth (consequent upon a running down of asset stocks or increasing liabilities as a result of net operating deficits) can indicate the non-sustainability of present fiscal policies.
All the above information is required for fiscal policy purposes to facilitate good macroeconomic management of the nation’s activities. While the financial statements have some resemblance to their business counterparts, their uses and interpretation differ markedly from those of business statements of financial performance and position.
In addition, a Cashflow Statement is prepared and presented in the usual format of operating, investing and financing transactions.
The GFS system based on accrual accounting is a superior information system to CABS. It is a comprehensive FMIRS tailored to provide governments with appropriate information required for the good fiscal management of their economies (as does CABS), and as well provides information on all the assets and liabilities of the government which is needed for resource management purposes. Hence its net worth, and the total operating costs of departments and programs, can also be calculated. It can satisfy all the requirements for quality information specified in SAC 3 of relevance, reliability with representational faithfulness, comparability and understandability. The information provided is relevant for the five major areas of fiscal policy management. All the reasons for the use of CABS for fiscal policy purposes apply equally to the GFS system, as both are based on reporting transaction resource flows. However, in principle GFS is preferable because the recording of transactions as they occur matches the timing of the resource flows. But it should be noted that for most government operating transactions, the time difference between the two is not significant. More than 80% of Australian government expenditure is cash transfers and the regular payroll is a further 10%. By designing the GFS system to report simultaneously on cash and accrual transactions, the benefits of both systems can be obtained – GFS information for fiscal policy management and CABS for cash management and parliamentary cash appropriations. The current value basis used in the system underlies the economic theory of efficient resource allocation, a major function of accounting information systems. As well, regular revaluations of physical assets at their current costs and use of the physical capital maintenance concept provides information on the asset consumption changes required to sustain the operating capability to provide services into the future. Sustainability of public services is an important need of citizens. Finally, the information produced from the GFS system is closely linked to the other macro-economic statistical systems including the national accounts, balance of payments and all the monetary and financial statistics produced by the government. All these important economic statistical systems are thereby integrated and mutually consistent.
It should be noted that the GFS system could be readily extended to the departmental level to provide the information required for resource management purposes – that is, the final role of government. To date it has been confined to the GGS for fiscal policy management purposes, while the departmental resource management role has been confined to the AAS system. In my opinion, the GFS system would provide better-quality information for departmental management purposes and avoid many of the limitations of the AAS system as applied to government. It readily satisfies the SAC 3 requirements for quality information. The GFS system applied at the micro level is essentially the current cost accounting system based on physical capital maintenance. This system is explained in Barton (1984, ch. 24, 26) and in SAP 1 (1983). Thus the GFS system could be used as a comprehensive FMIRS for the GGS for both macroeconomic and microeconomic management.
Notwithstanding the overall rigour of the GFS system, there are questionable treatments of some items in it. The principal matter concerns the expensing of expenditure on the purchase of military weapons equipment, since it does not generate future cash inflows. However, this is inconsistent with expenditure on most other categories of physical assets.
Australian Accounting Standards Accrual Accounting and Budgeting System (AAS AABS)
AAS were originally formulated by the AASB for business entities and subsequently applied, with some minor modifications, to the public sector. The standards developed specifically for the public sector (AAS 29 and AAS 31, 1996) adopt the same principles as the business standards and make allowances only for some different administrative arrangements in government. They are used throughout all government departments (as required by AAS 29) and a consolidated set of financial statements is prepared for whole-of-government (as per AAS 31) including financial and business enterprises. They are all subject to audit by the ANAO. AAS are heavily influenced by US and IASB standards because of the need to harmonise accounting standards in a world of global business. The IASB standards replaced the Australian standards on 1 January 2005 under the Corporate Law Economic Reform Program.
AAS were applied to the public sector because they already existed at the time of the decision to adopt accrual accounting. It was contended by the profession that there was no need to “reinvent the wheel” (Christensen 2003). It was also considered that a “sector neutral” approach would enable cost savings in standards formulation and enhanced comparability of financial information across the business and government sectors (McGregor 1999, pp. 3, 19). Only minor variations are allowed for specific industry characteristics and the public sector is treated as being just another industry. The most important variation allowed is for departments to distinguish between “administered items” (for example, transfer payments made according to legislation) and items controlled by departmental management.
Because AAS are well known throughout the profession, their details need not be repeated here. Rather, only some of their key components and attributes which are relevant for their application to the public sector are covered.
It is contended here that the “sector neutral” approach underlying application of the same accounting standards to the business and public sectors is unsound because of some fundamental differences in the nature and roles of each sector. These matters determine the financial information requirements of management and stakeholders in each sector. Governments exist to provide collective goods and social welfare benefits to citizens, funded from taxation, whereas businesses exist to sell goods and services to customers at a price yielding a profit. Consequently, some of the accounting standards designed for business use lack relevance for the public sector. This topic is further examined in Barton (2005). However the AASB does not accept that fundamental differences exist.
Many implications for the design of an FMIRS for the public sector follow from these different roles and they indicate where business standards need modifying to suit the public sector. They include:
* The objectives of financial statements. The focus of AAS is on the preparation of information on accounting transactions and events to be included in general purpose financial reports (GPFRs) for those stakeholders who have limited access to information about the entity. GPFRs comprise statements of financial performance and position, and a cashflow statement. Their objectives are stated (SAC 2 1990, paras 43-5) as the provision of information useful to users for resource-use decisionmaking, evaluation and accountability purposes, and for assessing financial performance and position, and financing and investing activities. Corporate financial reporting is primarily concerned with providing information in GPFRs to investors and the capital market on profitability and financial position of companies. This has little relevance to the public sector, whose major stakeholder groups are parliament, citizens and businesses generally, and whose interests are more focused on accountability of governments for their policies and actions. The requirements for accountability of governments are more widespread and fundamental than those for business (Mulgan 2000). The major purpose of outcome financial statements is to fulfil accountability obligations to parliament and the public rather than to serve resource-use decision-making purposes. Democratic governments are accountable to citizens for all their activities. This requires that parliament and the public are kept fully informed of government policies and activities. Parliament can demand full access to specific information (subject to security and commercial-in-confidence considerations). Hence the distinction between general purpose financial reporting and management reporting in the public sector is not a sharp one.
* Related to the above, the requirements for government financial reporting differ from those for business. Governments must publish budgets and they must be approved by parliament in open session before implementation. They cannot remain confidential as do business budgets. Further, budgets and outcome financial statements (as per AAS 29) of government departments must also be published, unlike in business, where they are for internal use only. Departments are merely the administrative arms of government which deliver services to the public as determined by government, and are funded to do so from tax revenue. They are cost centres rather than revenue-generating profit centres and they have no assets or liabilities of their own.
* The concept of control which forms the basis of the entity concept is not appropriate for the public sector and, for example, until this year it was used to exclude the general government sector as an accounting entity. The control concept used to define a business entity relates to the capacity of the entity to dominate the decision-making of another (SAC 1 1990, para. 6). However, while statutory agencies and public corporations are owned by government, and their charters are determined by government (through legislation), their governing boards are given statutory independence which constrains ministers’ abilities to influence their dayto-day operations. This is the reason why such bodies are not included in the budget sector.
* The business concept of assets is not wholly appropriate to the public sector. Assets are defined as “future economic benefits controlled by the entity as a result of past transactions or other events”, and control is defined as ” the capacity of the entity to benefit from the asset” (SAC 4,1990, para. 14). While this definition is appropriate for government financial assets, it does not suit most government non-financial assets acquired to provide non-cash services to citizens – defence, health, education, roads, and so on – rather than to generate revenue for the government. Alternative asset definitions are given in Barton (2005, pp. 149-50).
* Definitions of the concepts of revenue, liabilities and equity are not specifically related to the public sector as they are based on the inappropriate definition of assets. For example, governments raise most of their revenue from taxes rather than from user charges for goods and services provided to citizens, many liabilities arise from social welfare obligations to citizens rather than from credit purchases or borrowing, and governments do not need contributed equity.
All the above matters limit the relevance of AAS to the public sector, and hence the usefulness of the financial information provided. But further, the standards suffer from some defects in their conceptual and analytical rigour. In particular, they are not based on a consistent financial measurement system because the basis of asset and liability valuation is not prescribed and the key concepts of profit and capital maintenance are not adequately defined. Hence assets and liabilities may be valued on any of historical cost, current replacement cost or realisable values, or even present values in some cases. The valuation basis affects not only the measurement of total assets and liabilities, and therefore financial position, but also the asset consumption charges and recognition of holding gains and losses, and hence profit measurements. The notion of profit measured is an all-inclusive one (“comprehensive income”) of the change in equity resulting from all transactions and events of the period, except for changes in direct ownership investment. It includes recognised unrealised holding gains and losses, even though they may not represent increases in recorded wealth which add to the entity’s spending ability (such as an increase in the current replacement cost of public roads and drains which do not generate revenue and cannot be sold). The measure of “comprehensive income” in such circumstances can lack validity, and it is difficult to make valid interpretations of financial performance and position. These limitations of the standards apply to business accounting as well as to government accounting. Their limitations for the business sector are examined in Wells et al (2003) and they are graphically illustrated in each wave of corporate collapses, which tend to occur about every decade (Sykes 1994, Clarke et al 2003).
As a consequence of the above limitations of the AAS system and the different operating environments of governments, AAS financial statements of governments suffer from serious shortcomings in their information usefulness. These include:
* The statements are of no use for fiscal policy purposes. They are based on a balance sheet approach for the analysis of transactions and events, whereas fiscal policy management requires the use of a resource flows and stocks approach.
* The absence of a rigorous financial measurement system and some key definitions limits the relevance and reliability of information and its comparability across different jurisdictions within Australia and internationally. The AAS statements could not be used, for example, for the preparation of the national accounts and the measurement of key economic concepts such as GDP.
* The statement of financial performance lacks representational faithfulness if it is interpreted similarly to its business counterpart and would be misleading. Taxation revenues cannot be interpreted similarly to sales revenues, and the budget balance is not comparable to a profit or loss. Departmental budget surpluses are the difference between the cost of service provision and the appropriations made to fund them, and are not a source of funds to pay dividends. They can be readily altered through changing appropriations or the services provided. The statement is more accurately termed an “operating statement”, as it summarises department and GGS operations over the period.
* Likewise, a government statement of financial position lacks representational faithfulness as it does not aim to show this in a business sense. Most of its non-financial assets are not revenuegenerating, they cannot be used to repay liabilities and the statement does not include the most valuable of all government resources – the sovereign power to tax. Rather, it is a list of government assets and liabilities and is better termed a “balance sheet”. Moreover, if the negative equity of the government as at the end of each year (for example, -$36,453 million at 30 June 2005), were judged by business criteria, then it is seriously bankrupt. But governments do not require contributed capital to fund their assets because of their taxing powers. Finally, although departments publish statements of financial position showing “their” assets and liabilities, in fact they have none. Rather, they are government resources for which they have some management responsibility.
Hence, in its present form the AAS system is unsuitable for the use of government because of its restricted relevance and analytical rigour. These deficiencies largely result from departures from the rigorous conceptual framework approach for the development of the standards as espoused in Policy Statement 5 (1995), and the ideological belief that business standards should be applied to the public sector so that the standards can be sector-neutral. As a consequence of these serious limitations of the AAS system of financial measurement for the public sector, the financial statements lack representational faithfulness and the information provided fails to satisfy adequately the criteria for useful information of relevance, reliability, comparability and understandability.
But notwithstanding the above limitations of the AAS system, many of the standards are sound and can be used in the public sector. The GFS system uses them wherever they are not in conflict. Most of the AAS concerning the recording of the transactions and expense recognition (which comprise the majority of the standards) apply equally to both public and private sectors. The major differences are largely confined to where public sector transactions differ from business ones (such as for taxation and transfer payments) and in the transformation of transactions data into the operating statement and balance sheet (see Figure 1). Here the objectives for the financial statements differ somewhat between the two sectors because the functions of business and government differ, and consequently the information requirements. But overall, there is a substantial overlap between the two systems.
The present system of accounting in the Australian government is untenable, with the presentation of two sets of accrual budget statements and outcome financial statements which show very different results for all components, and the absence of CABS which is needed for fiscal policy purposes, appropriation bills and good cash management. In principle, the solutions are obvious:
* the reintroduction of CABS as a subset of AABS for the direct recording and timely reporting of cash transactions as occurred prior to 1999; and
* harmonisation of the sound features of AAS and GFS into one combined, robust accrual accounting FMIRS system which is based on the GFS model and is relevant for the public sector.
The government recognises the problem and work is under way towards its resolution. Serious consideration is being given to the reintroduction of CABS using the direct method as a component of AABS. The Heads of Treasury Committee is currently analysing the two AAB systems and making recommendations to the AASB for changes in each in order to harmonise them wherever possible. The major deficiencies in AAS arising from their restricted relevance to the public sector and their inadequate analytical rigour can be overcome. Similarly there are some deficiencies in the GFS system which need to be remedied, such as the expensing of all expenditures on new military equipment. Making appropriate changes to each system would enable harmonisation of the systems and the use of one comprehensive accrual and cash FMIRS in government which provides relevant, reliable, comparable and understandable information on government activities for decision-making, management control and accountability purposes. The prospective benefits from harmonisation and reintroduction of CABS as a component of AABS are substantial.
AASB, 1983, SAP 1 Current Cost Accounting.
AASB, 1990, SAC 1 Definition of the Reporting Entity.
AASB, 1990, SAC 2 Objective of General Purpose Financial Reporting.
AASB, 1990, SAC 3 Qualitative Characteristics of Useful Information.
AASB, 1990, SAC 4 Definition and Recognition of the Elements of Financial Statements.
AASB, 1995, Policy Statement 5 The Nature and Purpose of Statements of Accounting Concepts.
AASB, 1996, AAS 29 Financial Reporting by Government Departments.
AASB, 1996, AAS 31 Financial Reporting by Governments.
AASB, 2006, 1049 Financial Reporting of General Government Sectors by Governments.
Australian National Audit Office (ANAO), 1995-96, “Asset Management”, Audit Report No. 27, Canberra.
Australian National Audit Office, 1997-98, “Asset Management”, Audit Report No. 41, Canberra.
Australian National Audit Office, 1999-2000, “Commonwealth Debt Management”, Audit Report No. 14, Canberra.
Barton, A.D., 1984, The Anatomy of Accounting, 3rd edn, UQP, Brisbane.
Barton, A.D., 2005, “Professional Accounting Standards and the Public Sector – A Mismatch”, Abacus 41, 7, June.
Challen, D., and C. Jeffery, 2003, “Harmonisation of Government Finance Statistics and Generally Accepted Accounting Principles”, Australian Accounting Review 13, 2, July.
Challen, D., and C. Jeffery, 2005, “Definition of the Reporting Entity”, Australian Accounting Review 15,1, March.
Christensen, M., 2003, “Without Reinventing the Wheel: Business Accounting Applied to the Public sector”, Australian Accounting Review 13,2, July.
Clarke, F., G. Dean and K. Oliver, 2003, Corporate Collapse, Accounting Regulatory and Ethical Failure, 2nd edn, CUP, Cambridge.
Commonwealth of Australia, 2006-07, “Budget Paper No. 1”, Statements 8,9 and 10, Canberra.
Commonwealth of Australia, 2005, “Consolidated Financial Statements”, Canberra.
Department of Finance, 1994a, “The New Financial Reports of Agencies”, Canberra, July.
Department of Finance, 1994b, “Resource Management in the Australian Public Sector”, Canberra, November.
Financial Reporting Council, 2002, Bulletin, 18 December, Canberra.
Guthrie, J., 1998, “Application of Accrual Accounting in the Australian Public Sector Rhetoric or Reality?”, Financial Accountability and Management 14,1, February.
Guthrie, J., and L. Parker, 1998, “Managerialism and Marketisation in Financial Management Change in Australia”, in O. Olson, J. Guthrie and C. Humphrey (eds), Global Warning! Debating International Developments in New Public Management, Cappelen Akademisk, Forag, Bergen, Norway.
International Monetary Fund, 2001, Government Finance Statistics Manual, Washington.
Joint Committee of Public Accounts and Audit (JCPAA), 1995a, “Accrual Accounting, A Cultural Change”, Report 338, August, Canberra.
Joint Committee of Public Accounts and Audit (JCPAA), 1995b, “Financial Reporting for the Commonwealth: Towards Greater Transparency and Accountability”, Report 341, AGPS, Canberra, November.
Joint Committee of Public Accounts and Audit (JCPAA), 2002, “Review of Accrual Budget Documentation”, Report No. 388, June.
Lincoln, A., 1863, World Book Encyclopaedia, 1978, World Book International, Chicago.
McGregor, W., 1999, “The Pivotal Role of Accounting Concepts in the Development of Public Sector Accounting Standards”, Australian Accounting Review 9,1, March.
Mulgan, R., 2000, “Comparing Accountability in the Public and Private Sectors”, Australian Journal of Public Administration 5,1, March.
National Commission of Audit, 1996, “Report to the Commonwealth Government”, AGPS, Canberra.
Stiglitz, J., 2000, Economics of the Public Sector, 3rd edn, Norton, New York.
Sykes, T, 1994, The Bold Riders, Behind Australia’s Corporate Collapses, Alien & Unwin, Sydney.
Wells, M. 2003, “Forum: The Accounting Conceptual Framework”, Abacus 39,1, October.
Allan Barton is an emeritus professor and a visiting fellow in Accounting at The Australian National University, and an honorary professor of Sydney University. Another version of this paper, initially presented at the AFAANZ Conference in Melbourne, July, 2005, is published in Agenda, Vol. 12, No. 3,2005. The author thanks the editor, Professor G. Wells, for permission to publish this version here.
Copyright Australian Society of Certified Practising Accountants Mar 2007
Provided by ProQuest Information and Learning Company. All rights Reserved