MUNICIPAL ACCOUNTING

By David C. Jones, CPFA, FCCA (UK).

Growing concern about democracy is often linked to greater emphasis on market

economics. This attempts to emphasize the efficiency of commerce, and related activity,
through freedom of exchange and information. One important concern, however, is the
re-thinking of the roles of government – national, regional and local. Sometimes, these
are conflicting and are also connected with political beliefs. A major assertion by some is
that government should not be in the business of business, however defined, but should
confine itself to a more constrained role, as a provider of good governance, order and
discipline. Government should, some argue, mainly confine itself to facilitation of the
delivery of goods and services, wholly or mainly by the private sector.

Emanating from this is a concern that governmental regulation has become too intrusive,
invasive and costly, as well as increasingly constraining of business efficiency and
profitability. However, free-market economics, claimed by some as the principal efficient
allocator of economic resources, is known to be inherently flawed. For example, markets,
for land, capital, goods, services and labour, cannot function efficiently unless there is
order and discipline in society. It is essential that there be a rule of law, under which
business activity may be conducted without fear of disruption, from crime or civil
wrongdoing. The civil law must facilitate, defend and uphold the validity of contracts.

Economists and politicians will continue to argue about necessary degrees of government
intervention, especially those seen as essential to correct and control perceived market
failures. This is not the place to expand these arguments. Instead, attention will be
focussed on a topic on which there can be little scope for disagreement, at least in
principle. This topic is accountability and transparency.

In recent times, all have observed the lack of transparency and other grave shortcomings
in the activities of private sector economic and commercial activity. Newly evolving
economies, such as those of the former Soviet Union and Eastern Europe (fSUEE), have
been seeking from their new Western friends and more capitalistic neighbours, principles,
models and examples to guide them in their search for more efficient and transparent
commerce. That they have been badly let down, and sadly disappointed in their search, is
now obvious. Moreover, in capitalist as well as in former socialist economies, the public
sector has been no better than its private sector counterparts. Accountability, there, has
often been simplistic, politically manipulative and opportunistic. There is, indeed, a crisis
of accountability, virtually world wide.

Accountability and Transparency

It is essential and urgent that there be a restoration of transparency and accountability,

in business and in governance. Only the introduction and continuous practice of efficient
accounting practices can adequately deal with issues of accountability. These are
fundamental to full and fair reporting. This, in turn, depends on the efficient and effective
operation of markets and regulatory practices, as well as of governance and taxation.

1
A necessary – though by no means sufficient – stipulation for this activity can be
summed up in a few words from the Christian Bible. These could, however, just as easily
emanate from other fine religious texts, of various faiths, or from great works of
literature, for which is especially famous:

“Forgetting all dishonesty, let us speak the truth to our neighbor, for we
are all members of one another.”

A current concern is that of ensuring a good balance between central control and local
autonomy. Democracy demands robust and effective local public management. However,
it also requires significant central control and guidance. There is, almost daily, increasing
emphasis on concern about accountability, cost definition and control, as well as on
transparency of financial reporting. This cannot, however, be imposed wholly or mainly
by the central government. Nonetheless, decentralization does not mean complete
autonomy or independence. It implies the building of strong and effective partnerships
among central, state and local governments, to deliver public services and to otherwise
serve a free people. Moreover, it will be state and local governments, rather than central
governments, that will deliver many of these public services. In a nation as big and
diverse as (say) Russia, it cannot be otherwise. There are vast needs, as well as vast
resources. This requires management with fairness, trust, accountability and discipline.

Countries of the fSUEE currently look forward to new opportunities, to supply, to partner
and to befriend, as well as to compete with, an expanded European Union. Thus, the
following words, from a well-known writer on public administration, Mr. Charles Handy,
might be apposite. He wrote, in 1997, as follows:

“I think that Europe, for instance, is going to be organized around cities

rather than nations. Cities are something we can relate to much more easily.
Increasingly, national governments in Europe will become less powerful.
You'll have super-national governments like the European Union, and you
will have more powerful local, regional, city governments. And nothing
much in between -- which is why, of course, there's such a fuss going on in
Europe at the moment. This is, in essence, what is going to happen in
America. Some of the states will have to delegate more power to cities.
Federal government will still be important for international affairs and broad
national policies, but city government will become key. As countries get
richer, they become more participatory.

“Central government has done many things. And I'm not arguing that this
should change, I'm just arguing that it will change. It seems to me that
people want more control over their lives and what goes on around them.
And all the evidence is that as you get richer, you demand these things. So
one of the strange things is that there are no rich dictatorships. When
dictatorships are successful, economically, the pressures for democracy
become too great. I'm arguing that as countries get richer, even under
democracy, they become more participatory. [Emphasis added]

2
For example, one of the World’s most democratic countries, as well as one of the most
prosperous, is the USA. It also has by far the greatest local participation in governance.
To date, perhaps because of the emphasis on markets, there has been much more concern
about the development and implementation of accounting practices within the private
sector than in the public sector. There is a whole range of International Accounting
Standards for the private sector, promulgated by the International Accounting Standards
Board. Discussions are currently in progress to widen their applicability to certain nations
that, until now, have not fully recognized them. These include the USA, UK and Canada.

The Public Sector Committee of the International Federation of Accountants has only
recently (within about the last three years or so) begun to issue standards and exposure
drafts for the public sector. The standards are referred to as International Public Sector
Accounting Standards. These standards, although based on sound principles, may be even
more difficult to gain acceptance than those for the private sector.

There are several reasons for this. Firstly, central governments, themselves, are involved.
They are notoriously difficult to persuade to yield any degree of sovereignty to
international bodies, even in matters so mundane – albeit essential – as accounting.
Secondly, the size and complexity of government activities have tended to engender a
simplicity of approach to accounting, rather than leading to serious attempts to address
these complexities with better standards and more efficient practices. Thirdly, central
governments, because of their relatively large sizes, tend to rely upon the statistical “law
of inertia of large numbers”, whereby mistakes or adjustments in one part of the
accounting system can be assumed to be offset by compensating mistakes and
adjustments elsewhere in the system. However, local governments, being much smaller,
cannot so easily do this. Finally, governments have traditionally engendered a “we have
always done it this way, why change?” approach to many administrative and managerial
techniques. Accounting has been no exception.

The economics profession has not always helped, largely by its ambivalence to
accounting concerns. At the micro-economic level, it has, with considerable justification,
criticized the accounting profession for being less than fully accurate and discerning,
when accounting for costs of activities and valuations of assets. Indeed, it was, initially,
as much at the initiative of economists, as that of accountants, that investigations were
engendered into “current value accounting” during the seventies, especially in the UK
and the USA. The fact that quite sensible recommendations, at that time, were scuttled by
business interests (because of effects on profit reporting) and the accounting profession
(because of claimed complexity) does little credit to either group. However, at the macro-
economic levels, economists have fostered an approach of simplicity, often bordering on
crudity, when examining and presenting accounts of governments, especially those of
national governments. Thus, crude decisions have sometimes emanated from crude
packaging of accounting information. There is still another ambivalence. Economists
insist that real costs be represented by resource consumption. Yet, the economists
themselves have tended to rely, for their own activities, on the simplest forms of cash
accounting. The latter often have little to say about resource consumption and
management. What they do say, moreover, tends to be erroneous and even manipulative.

3
Municipal Accountability for Costs (Results) and Resources

Most large or medium-sized private businesses are legally required to keep their financial
accounts in compliance with national or international accounting standards. Thus,
although neither financial nor economic costs of activities can be directly derived from
these, they usually provide sound bases for the development of cost accounting
computations and of the cost accounting systems necessary to generate these.

As discussed in many places elsewhere, financial accounting systems used in the public
sector, and particularly in local government units, may be of two main forms. Firstly, for
activities that are revenue-seeking and possibly intended to earn profits, the financial
accounting systems are often quite similar to those used in private sector enterprises. This
is especially so if the public sector revenue-seeking activities are performed by an entity
with some degree of legal separation from core local government activities, funded
mainly from taxes and other general revenues.

Secondly, financial accounting systems for activities to be funded from general revenues
have often been much simpler in form from those used in the private commercial sector.
However, although the form may be relatively simple, the substance of the accounts may
be very complex, covering a huge variety of activities, possibly ranging from “archive
management” to “zoos”! Some of these services, moreover, are very large. Many are very
capital-intensive. For example, outside of national defense services, education is one of
the world’s largest public sector or private sector activities, with school buildings as
major assets and teachers’ salaries probably by far the largest current cost element.

Unfortunately, however, even more than within the private sector, public financial
accounting systems typically fall short of what is necessary to achieve cost measurement,
either for pricing or for other policy decisions. Moreover, the huge quantities of capital
resources, held as “fixed assets” are often treated, for accounting purposes, with disdain.
Yet, in the public sector, the concepts of “costs” and “resources” are almost constantly
used in the policy discourse. They are also frequently misunderstood, misused and abused
concepts. Decisions that should be based on costs or resources are based on almost
anything but these.

In all sectors of business and public activity, therefore, cost accounting systems are
needed, in addition to financial accounting systems. Ideally, cost accounting systems
should be capable of providing accurate information about the consumption of economic
resources for specified activities. These should either be the economic resources actually
consumed or at least those attributed, allocated or ascertained, in some mathematically
acceptable way. Cost accounts, almost always, produce financial and other information
about more activities, in much more detail and sometimes in different ways, than
financial accounts. Thus, although soundly-based financial accounts are necessary, they
are usually not sufficient for the purposes of costing1.

1
Also, more often than not, “costing” often does not refer to “cost accounting” at all – but to engineering estimates!

4
Comprehensive cost accounting systems can be perceived of as being firmly “bolted on”
to the related financial accounting systems. They should derive much of their necessary
information from the financial accounting and be capable of being wholly reconcilable
with them. Accounting systems, complete or incomplete, are expected (system-wise) to
balance debits against credits or (more conceptually) to match resources against results.
This is as true of cost accounting systems as of financial accounting systems.

There are at least two approaches to the need to set up cost accounting systems. The first
is to derive from the financial accounting system whatever information is available in it,
in whatever form it exists. Then, an attempt is made to arrange the information in forms
that will be useful in calculating costs. This may well require the addition of
supplementary information that is not currently available in the financial accounting
system, at least in usable form. Indeed, where financial accounting systems are crude or
incomplete, the balancing of cost accounting systems against these may prove to be
difficult, sometimes impossible, and often futile to attempt. In other words, the costs of
deriving costs may exceed the benefits of having them available.

With many accounting systems currently in use in local governments, in many different
countries, this is typically the case. Therefore, costs derived from these accounts will only
be partial. They may, indeed, be relatively useless as a basis for many policy decisions.

However, “the perfect is the enemy of the good,” it is sometimes said2. Therefore, as a
second alternative, one does what one reasonably can with the information and systems
available, producing figures that, while not closely approximating costs, are at least more
useful than mere cash payments or expenditures. They are, however, likely to be more
useful if taken from the accounting system than if derived, more or less informally, from
a variety of other documents, of varying and dubious credibility.

In recent years, the “magic of the market-place” has been held out to all as an unbridled
paragon of virtue in financial and economic management. Thus, deregulation,
privatization, contracting out, public-private partnerships and (as in UK) the “Private
Finance Initiative,” have all been used as adjuncts to more traditional methods. These
largely relied on the financing of fixed assets by long-term public debt and operating
them by public employees.

The newer approaches have often been a mixed blessing. Without doubt, they have
provided useful alternatives in financing and operating public services. They have also
opened the public sector more widely to many innovations and efficiencies, hitherto
seeming to be largely exclusive to the private sector. One particular domain where this
has been so, is to increase the pressure for more accurate accounting, within the public
sector, to facilitate more rational comparisons of cost and resource use with those offered
by the private sector.

2
In cost accounting, this may be a necessary postulate only because of the inadequate quality of input data. However,
for cost outputs, the emphasis should be the converse. Thus, the “merely good” is the enemy of “as near perfect as one
can get.”

5
However, the world is now littered with financial disasters relating to privatization and
deregulation. The “California Energy Crisis,” the “British Rail” debacle and the financial
failure of the “Channel Tunnel” are just a few of the more obvious that come to mind.
Moreover, many major frauds and financial failures have been in sectors highlighted as
good candidates for privatization: electricity3, telecommunications, water and solid waste
management. So far as accounting is concerned, after Enron, Worldcom and Waste
Management Inc., to mention just a few, is it necessary to say any more? Well, yes, it is:
Arthur Andersen!

Greater accountability has also been demanded by the voting and taxpaying public. As
the private sector’s superiority has been emphasized, less financial resources have been
available to the public sector. Clearly, in improving public sector accounting, we are at
the early stages in most countries. Relatively few are currently setting the pace, such as
New Zealand, Australia and the United Kingdom. There is still much to be done and this
work is continuing. The International Federation of Accountants is also involved.
Unfortunately, the private sector has hardly covered itself with glory, either in the private
delivery of public services or in credible and effective accounting.

It used to be thought that the private sector was clever and innovative, in contrast to a dull
and cumbersome public sector. Indeed, the relatively perceived “rough and ready”
attitude of the public sector engendered the expression: "Close enough for government
work!" Unfortunately, this is, now, not nearly close enough! The Economist, some time
ago, stated as follows:

"The government has gone wrong, however, on the first point – the mix of
its spending between investment and consumption. To see this, the idea of
a public-sector balance-sheet is helpful. It would be a short-sighted
company that minimized its liabilities and ignored its assets. So, too, for
governments. Like companies, they should aim, at least, to maintain their
net worth – the value of assets less liabilities. This highlights the
distinction between borrowing to finance spending on (say) salaries
(which reduces net worth), and borrowing for investment (which generates
future income, so should leave net worth unchanged)…The balance-sheet
approach also exposes tricks such as selling public assets, which most
governments wrongly treat as cutting their deficits".

The issue of greater accountability – within both public and private sectors – was also
addressed by a well-known economist, Kenneth Boulding, as follows:

"Although I…with all modern economists, owe an enormous debt to

Keynes' brilliance of insight and imaginative sweep, his system shows a
number of weaknesses that have not been corrected by his followers.

3
A former senior trader at the Enron Corporation pleaded guilty yesterday to engaging in a conspiracy that illegally
manipulated the California power market during the state's energy crisis, driving up prices and generating millions of
dollars in excess profits for his employer. [New York Times, 18 October, 2002]

6
 “One of these weaknesses is a general failure to distinguish between two
very different processes in economic life, the exchange or payments
process, on the one hand, by which existing assets, including money, are
circulated among various owners, and the processes of production,
consumption, income and outgo on the other, by which assets are created,
destroyed and accumulated”4.

Elsewhere, Professor Boulding writes:

"The usual marginal analysis treats the firm as if it had nothing but an
income account; it has no balance sheet, no capital problems and no
dynamics;...Consequently, the economist has been able to give only
fragmentary accounts of inventory changes, investment structures,
liquidity positions and like problems5."

Over a century ago, a judicial ruling in the United Kingdom stated the following:

‘A full and fair balance sheet must be such a balance sheet as to convey a
truthful statement as to the company’s position. It must not conceal any
known cause of weakness in the financial position, or suggest anything
which cannot be supported as fairly correct....6’

Finally, in my own writing7, I emphasize the points made by the Economist and Professor
Boulding, by the following:

“An accountant records and interprets variations in financial position. He

or she records, in money values, the results of variations during any period
of time, at the end of which he or she can balance net results (of past
operations) against net resources (available for future operations)”.

The results of past operations – the use, consumption, transformation, degradation and
destruction of economic resources – are costs. The resources available for future
operations are the assets and liabilities that remain, after the costs incurred during the
preceding accounting period have been fully accounted for. Integrating these, for useful
and effective purposes, is “A full and fair balance sheet [that] must be such a balance
sheet as to convey a truthful statement.”

The following slide takes a broad view of the use of a community’s capital resources. It
begins by addressing resource mobilization, bringing together various sources of funding
with the use of natural resources and of the common wealth. From this, it derives the
concept of resource allocation - among various asset forms, of fixed and working capital.

4
A (1950) text "A Reconstruction of Economics," by Kenneth Boulding (1910-1993)]
5
Boulding (Op. Cit.)
6
Re London and General Bank (No2) [1895] 2 Ch 673, 692
7
Municipal Accounting for Developing Countries, by David C. Jones [© The Chartered Institute of Public Finance and
Accountancy and the World Bank (1984)]

7
In addition, it deals with resource conservation - keeping such assets in good working
order. Thereafter, it demonstrates resource utilization - the various ways in which the
assets may be put to use - or may deteriorate or be distributed, in the process of
production. Finally, it shows resource activation and influence, by the use of:
information, raw materials, services and energy; as well as by human activity, such as the
effort and skill of various workers and the demands and expectations of customers and
clients.

USE OF ECONOMIC RESOURCES

RESOURCE ALLOCATION RESOURCE MOBILIZATION
(& RESOURCE CONSERVATION)
LAND CAPITAL CONTRIBUTIONS
PERMANENT WORKS ASSET SALES
BUILDINGS LONG-TERM DEBT
EQUIPMENT & MACHINERY TEMPORARY DEBT
SUPPLIERS (CREDIT)
MONETARY INVESTMENT
INVENTORIES THE COMMON WEALTH
WORK IN PROGRESS
CUSTOMERS (CREDIT) NATURAL RESOURCES
CASH

RESOURCE UTILIZATION
RESOURCE ACTIVATION
PRODUCTION
DISTRIBUTION INFORMATION
OPERATION RAW MATERIALS
MAINTENANCE SERVICES
ENERGY
ADMINISTRATION STIMULATION
TAXES LABOR
DEPRECIATION CUSTOMERS & CLIENTS
INTEREST HUMAN CAPITAL*
DIVIDEND MANAGEMENT
RETAINED EARNINGS (ENTERPRISE)*
PROPERTY DISPOSAL * CREATIVE, INNOVATIVE
(RIGHT-BRAIN) TALENT
RESULTS

WASTE, DAMAGE CONSUMPTION RETURN &

& DESTRUCTION (SATISFACTION) REINVESTMENT
COMMERCIAL, COMMERCIAL, COMMERCIAL,
SOCIAL & SOCIAL & SOCIAL &
ECOLOGICAL ECOLOGICAL ECOLOGICAL

The next slide shows the various results which should be expected from the mobilization,
allocation, conservation, utilization and activation of resources. Almost inevitably, there
will be three main categories of results: consumption from which satisfaction is
derived; waste and destruction; and, return and reinvestment. From these main results
will derive a number of others, not all of them necessarily in the financial interest of the
entity. Thus, although profitability may be an important goal and success measure, there
are many other legitimate concerns to which attention must be given. These will include:
reliability and safety of operations; financial obligations to creditors and to government;
service to customers; satisfaction of workers and the general public; and, responsibility
for the environment. Many of these matters are specifically defined.

8
 OUTCOMES AND SATISFACTIONS
RESULTS OF ACTIVITY

WASTE, DAMAGE CONSUMPTION RETURN &

& DESTRUCTION (SATISFACTION) REINVESTMENT
COMMERCIAL, COMMERCIAL, COMMERCIAL,
SOCIAL & SOCIAL & SOCIAL &
ECOLOGICAL ECOLOGICAL ECOLOGICAL

IMPORTANT SUCCESS CRITERIA AND PRINCIPAL FOCUS OF ATTENTION

PERFORMING USEFUL & HIGH-QUALITY

PROFITABILITY
ACTIVITIES AT APPROPRIATE PLACES AND TIMES

LONG-TERM OPTIMIZATION OF RESOURCE USE

DEBT SERVICE
(PRODUCTIVITY & WASTE CONTROL)

QUALITY OF ENVIRONMENT

WASTE INNOVATION - CONSUMER SATISFACTION ,

DISPOSAL REINVESTMENT & PRODUCT DEVELOPMENT

DAMAGE PRODUCT & PAYMENT

RECTIFICATION SERVICE QUALITY OF TAXES

OPERATIONAL QUALITY OF QUALITY OF

RELIABILITY LABOR LIFE SOCIAL LIFE

The next slide shows that outcomes and satisfactions can be translated into resource
consumption, resource transformation and conservation and operational results for the
entity. Normally, a complete and accurate financial accounting system will still not,
typically, record information about economic costs and benefits external to the entity.
However, it will, at least bound these within the internal system, so that the externalities
can be separately and specifically identified for particular purposes. The internal
accounting system, therefore, can be derived as follows.

WASTE, DAMAGE CONSUMPTION RETURN &

& DESTRUCTION (SATISFACTION) REINVESTMENT
COMMERCIAL, COMMERCIAL, COMMERCIAL,
SOCIAL & SOCIAL & SOCIAL &
ECOLOGICAL ECOLOGICAL ECOLOGICAL

BOOK-KEEPING, ACCOUNTING AND FINANCIAL REPORTING PROCEDURES FOR RESOU RCES & RESULTS
(ECONOMIC EXTERNALITIES ARE NOT USUALLY CAPTURED BY STANDARD ACCOUNTING PRACTICES)

[AN EXAMPLE]

TRAN.No.
RESOURCES RESULTS
ITEMS VALUE CHANGE ITEMS VALUE CHANGE

$m $m $m $m

1/8 Fixed Assets 1,250+ Capital 400+

Inventories 15+ Revenues 556+
Receivables 9+ Expenses 243-
Cash 222+ 97- Interest 97- 97-
------ ------
1,496+ 97-
Long Term Debt 880-
------ ------ ------ ------
616+ 9 97- 616+ 97-
====== ====== ====== ======
Fortunately, current trends are away from crudity and towards better accountability. New
Zealand has set a sensible path, as many years ago it introduced, for its national and
local government accounts, a system of “full accrual accounting at current value.”
This, in principle, is virtually the same as resource accounting. More recently, local
governments in the United Kingdom introduced similar practices 8 and the UK national
government is introducing, for its own transactions, a system that is actually referred to as
“resource accounting.” In the USA, the system of accounting recommended for state and
local governments is currently under revision, headed in the same direction.

Resource accounting, if that is what it might be called, is completely consistent with the
concept of recording and reporting resources within a balance sheet and recording and
reporting results within an income and expenditure account9. The following slide shows
how this would be done.

Financial Statements of Resources &

Results

R
E TRAMBUS TRAN
S
O
U BALANCE SHEE
R
C
E
S $m $m
Fixed Assets
Property, Plant and
R
E
Equipment 1,250
S
U
L
T Current Assets
S
Inventories 15
Receivables 9
Cash 222 246
----- -----
1,496
=====
8
Prior to this innovation, UK local governments used accounting practices that, while quite sophisticated and striving
to be closely related to costs, fell somewhat short of the practices now currently followed.
9
This is a generic term. It includes those of “profit and loss” and “income” statements.

10
TRAMBUS TRAN
INCOME AND EXPEN
Many countries of the former Soviet Union and Eastern Europe (fSUEE) already
subscribe to the local government principles of the Council of Europe. Some will shortly
join the European Union. Thus, attention to local government accounting in these areas is
not only important for good governance. It is also needed to contribute towards greater
expected uniformity of practice, for management, reporting and gathering of statistics on
an EU-wide basis. Indeed, commonality of commercial accounting standards for the
European Union is virtually imminent.

Local Government Accounting in the Former Soviet Union and Eastern Europe

In the fSUEE, emphasis on sound accountability for local government is very apposite.
An essential key to transformation of governance systems in these countries is, without
doubt, much greater decentralization. What this means, virtually by definition, is that the
overall system of governance be increasingly vested in much smaller units of government
than hitherto. Each of these, moreover, must operate a wide range of public services
within the limits of its own local, delegated or designated financial resources.

Because they are individual (corporate) units, there is much less scope for transfer of
financial resources than when they were under huge centralized governmental systems.
Also, much more emphasis is now placed on decisions relating to involvement of private
sector entities in the delivery of services10. Decisions about this can only be valid and
efficient if they are based on a valid and efficient recognition of the costs of doing so.

Daily, one is regaled in various media, by rhetoric – much of it political – regarding the
"costs" of public services and the need to cut, curtail or control them. Clearly, this is a
concern that is unlikely to go away. It is also prey to much misunderstanding and error.

This has relevance to the establishment of quasi-autonomous entities delivering a single

service or a range of related services. Sometimes these entities are potentially revenue
earning (or revenue-seeking) from direct user charges, intended to cover some or all of
the costs. Sometimes, such entities are financed wholly or mainly from public revenues
or are provided with subsidies to cover that part of the costs not recovered from users.

As already explained, only the accounting for internal costs of public (and private)
enterprises is dealt with in standard accounting systems. Thus, economic externalities are
set aside. This is not because they are unimportant or irrelevant. They just do not
normally appear in the accounts of enterprises, except perhaps as "Pigovian" taxes11 or
subsidies, to compensate for external costs or benefits. However, external costs are
extremely important. Thus, especially as they relate to the environment, they must be
taken into account in prices. This cannot be done, however, unless internal costs are first
accurately identified.

10
In the fSUEE, there was, of course, for all practical purposes, no private sector.
11
“Pigovian taxes (named after the famous British economist, Pigou) are levied, for example, upon outputs (often
indirectly, by taxing inputs) which cause environmental pollution. Because direct pricing is often not possible, this
serves as a rough and ready way to both limit the output by indirect price rationing or to raise the revenue to help pay
for the costs imposed by its impact, such as costs of industrial treatment or curative medicine.

11
In principle, local government accounting systems must address:

(a) identification, comparison, verification and control of costs;

(b) the manner in which prices, taxes or inter-governmental transfers are

determined;

(c) adequacy and appropriateness, or otherwise, of prices or taxes;

(d) measurement of efficiency and effectiveness of public services;

(e) comparison and contrast of costs and prices: among entities, over time,
and against budgets and other expectations;

(f) costs and benefits of providing services in different ways, especially by

comparison between in-house provision and contracting-out;

(g) costs and benefits of projects, to determine and then to achieve the least-
economic-cost technically feasible solutions to the concerns they address;

(h) the manner of funding capital expenditure and its impact on current
accounting and financial management; and,

(i) providing necessary – albeit not always sufficient – cost data, to facilitate
efficient and credible financial and economic analysis of activities.

All such matters, when promulgated in a general way, are intellectually fascinating and
politically appealing. Everyone surely agrees that prices for public services should be
"adequate," "appropriate" and “as low as possible.” Moreover, "costs" should be properly
identified and controlled, while public services should be tested for efficiency and
effectiveness against internal and external standards. Unfortunately, when these matters
are addressed more systematically, a number of important and difficult issues intrude.
These have potential for significant discomfort, to both those who perform the studies
and those requested to provide basic data. Some of the principal concerns are definitional.
Thus, for example, while the concept of a "price" has clear legal and practical
implications, concepts such as "cost," "profit" and "subsidy" are dependent upon the
manner in which these are computed. Recent scandals in private sector corporate
reporting have made this concern only too obvious!

12
Cost Definition, Recognition and Distinction

Often, in consideration of cost issues, reference is made, among other things, to the
distinction between accounting concepts (e.g. average costs) and economic concepts,
(e.g. marginal costs and opportunity costs). In principle, these observations are pertinent.
In practice, they are likely to be a source of frustration. This is because accounting
systems do not provide much information about such matters as marginal (or opportunity)
costs12. They are not designed, primarily, to do this. They will, instead, following
whatever rules are in place, initially provide information on a historical basis, however
subsequently adjusted. This will more readily lend itself (when used with appropriate
technical indicators) to the determination of average, job or activity costs.

In a way, this situation is unfortunate, because many management and public policy
decisions are more appropriately based on economic principles than on purely financial
ones. However, many such decisions concern the analysis of projects or other significant
changes in operations. Thus, a priori, estimates can often be built into decision-making,
even though ex post, the corresponding actual figures may be more difficult to trace.

Unless long-term (marginal) costs are eventually covered from prices, or other revenues,
any private or public entity will fail, financially and operationally. Indeed, so-called
natural monopolies, usually network systems, sometimes have falling marginal costs.
Thus, to keep these entities financially viable may require prices to be in excess of
marginal costs, or else the differences must be subsidized. The extent of the subsidies, as
compared to an allowable price increase, should be influenced by the extent to which
customers, attracted by the lower prices, enhance general external economic welfare by
additional use of the service. Public transport, waste disposal and toll roads are examples
where this might be appropriate, depending upon the circumstances of each case.

Cost definition cannot be meaningful unless based on economic principles. Therefore, it

should relate as closely as possible to the concept of resource consumption, rather than
to the mere receipt and payment of cash. This concept deals with the oft-avoided (or
ignored) issues of how to account for fixed assets at current value. Emphasis on resource
consumption does not imply that cash-flow is unimportant, for a variety of other reasons.
Nonetheless, "cash-flow," other than by blind coincidence, is unlikely to be synonymous
with "cost."

12
Nonetheless, cost accounting systems can provide more detailed analysis than is usually available from financial
accounts. This analysis can, moreover, be crafted to suit the , nature of the activities, the needs of various users and
observers of accounting data.

13
Thus, to set some basic principles, the following assertion is made:

Costs – in terms of resource use – of any business or public activity – must include the
properly recognized and recorded expenditures, for each service or activity individually,
on the following:

(a) operation of the activity – in the production of goods and services or the
generation of activities;

(b) maintenance of all premises, plant and equipment in a satisfactory

condition to perform its operations in a safe and efficient manner for its
entire working life;

(c) administration and management of the activities, together with the

payment of taxes, necessary to ensure that operations are efficiently
effected; and,

(d) the rental cost (capital cost recovery factors) of all fixed and working
capital, specifically comprising, either (for property not owned) the
market rent, or (for property owned):

(i) consumption of capital, typically recognized as depreciation of

premises, plant and equipment, together with final disposal costs;

(ii) adjustment of value, either in terms of changes in real values

(opportunity costs) of property or in recognition of the effects of
changes in monetary values (inflation and deflation); and,

(iii) return on investment, including interest on debt and an expected

and reasonable return (opportunity costs) on contributed (equity)
capital, either by dividends to owners or by retained earnings.

Allowing for all of the above as resource costs, it would be prudent to expect that activity
costs would also allow for an additional (albeit small) "surplus," over and above the
expected and reasonable costs of capital, to allow for periodical fluctuations in financial
fortunes, more specifically: risk; uncertainty; new activity; and, longer-term stability.

These principles should be regarded as fundamental. The use and transfer of monetary
and other resources, for a variety of purposes, is often referred to as expenditure .
However, only expenditures that conform to the principles of cost accounting should be
referred to, specifically, as “costs.” For example, there is frequent reference in financial
practice to "capital expenditure." While this is certainly the result of a use and transfer of
resources, it is not usually a cost. Instead, it represents a transformation of resources into
a form in which they can be used, abused, consumed and (sometimes) destroyed, in the
delivery of final goods and services.

14
The following slide shows these concepts in diagrammatic form. It is accompanied by a
second slide, showing how accounting for costs is integrally related to accounting for
assets and liabilities.

COST RECOGNITION & COVERAGE

OPERATION RISK
UNCERTAINTY
NEW ACTIVITY &
STABILITY
Potential Financial
Trade-off
MAINTENANCE

INTERNAL
FIXED ASSET FINANCING
ADMINISTRATION
DEPRECIATION

SURPLUS
FIXED ASSET CAPITAL (SAVING)
REVALUATION RECOVERY

LOSS
RETURN ON SURPLUS
(SUBSIDY)
INVESTMENT (LOSS)

SERVICE
INTEREST CHARGES
DIVIDEND &
RETAINED
EARNINGS
POLITICAL TAX
DECISIONS REVENUES

15
 ASSET AND LIABILITY MANAGEMENT
INFRASTRUCTURE,
PROPERTY, PLANT
AND EQUIPMENT CAPITAL - SURPLUS

MONETARY LONG-TERM LOANS

INVESTMENTS OUTSTANDING

RECEIVABLES AND PAYABLES:AND

CASH TEMPORARY LOANS

INVENTORIES

OPERATIONS RETURN ON
INVESTMENT
MAINTENANCE
ADJUSTMENT
OF VALUE
ADMINISTRATION

RENT OF PROPERTY DEPRECIATION

It is the subsequent recognition of periodic depreciation (or obsolescence) of fixed assets,

initially resulting from such capital expenditure, that is a cost, as defined. This is the
consumption of capital.

An example, in the public sector, might be the construction of a road or the improvement
(as distinct from the maintenance or repair) of an existing road. This construction
represents a transformation of economic resources into an asset – in this case a road – the
use, operation and maintenance of which would be the actual incurrence of cost. To the
construction contractor, the expenditures might well qualify as "cost." However, from the
contractor's perspective, the construction would not be capital expenditure. It would be
the cost of earning revenues by delivering a product to a customer – the road authority.

Currently evolving “public-private partnership” schemes may cause these concepts to

become increasingly complex. Where, for example, contractors provide infrastructure on
a "Build, Operate and Own" (BOO) basis, the contractor – or another private entity – will
own the asset. In this case, the road authority, in effect, will "lease" the asset from the
contractor, not unlike a leased vehicle. This will still conform to the concept of “rent.”

16
The Return on Investment

What is included as part of the "return on investment" is the provision for dividend and
retained earnings, typically accruing to the owners (shareholders) of an entity. These are
items that, according to "generally accepted accounting principles" are not treated as
costs but as allocations of "profit." The distinction arises because private sector financial
accounts reflect “property rights” rather than economic principles. Thus, the interests of
owners (shareholders) are reported as the earnings only after all claims have been met
from those outside of the entity, including lenders.

There is, however, common agreement among economists that what are considered as
"normal" profits are, indeed, no more than a part of the "opportunity cost of capital."
Only extra-ordinary earnings are typically regarded as true "profits," somewhat analogous
to what is described as a "surplus" in the above set of distinctions 13. Standard practices of
financial analysis deal explicitly with “costs of capital”, the return on total net assets, as
the weighted consolidation of the separate and specific returns to debt and equity
financing14.

This has a parallel in the public sector. In some countries, notably in the USA and UK, it
had, in the past, typically become standard practice for state and local governments to
finance up to and including 100% of certain items of capital expenditure by the
incurrence of long-term debt. Amortization periods would be closely related to the
working lives of the fixed assets acquired. Thus, there was an approximate link between
the accounting practice dealing with debt service and that required for life-cycle costing.

However, even where all or part of these assets may be financed from sources other than
debt, the funds used still have an opportunity cost. The financing of capital expenditure
from general revenues will either add to the overall "deficit," which will have to be
borrowed, with interest, or eliminate part of the overall "surplus." This creates a loss of
interest on the related monetary investment. Even if covered by taxes, the taxpayers
(effectively the "shareholders" of the government) will (collectively) lose the equivalent
in interest on what would otherwise have been the investment of their own money15.

Cost definition is the fundamental basis against which all other related aspects will need
to be assessed. For example, it affects, or is affected by: cost accounting systems; prices;
allocations of overheads; budgetary management; fiscal deficits; maintenance of assets;
fixed asset valuation; and, inter-governmental transfers. Effective decisions on public
policy depend upon whether, and in what form, the costs of these are recognized.
Furthermore, cost recognition, to be consistent, should relate to the maintenance, use and
consumption of resources and not to the manner in which these resources are financed.

13
In contrast to the terminology used in the text, the surplus, in the jargon of economics, is the only item that may be
perceived of as the “economic rent.” This closely reflects the teachings of the classical economist, David Ricardo.
14
Equity includes "retained earnings." These are somewhat analogous to situations where compound interest is retained
by borrowers, in that these earnings are reinvested and are therefore expected to earn returns.
15
This is not an argument against the financing of fixed assets from taxes - only an explanation of its consequences.

17
Accounting System Implications

Although the cost components are clearly distinguished, it is unlikely that they will, for
the time being at least, be fully recognized as part of any standard accounting system. It
has already been illustrated how certain differences in presentation may arise for private
businesses, with respect to profit. In public sector accounts, there may well be other
concerns, which will confuse and distort the presentation of costs. The public sector will
normally use one of four types of accounting systems. There may, however, be overlap
between one type and another, so that they become hybrid systems. For this reason, they
are often difficult to classify definitively16.

First, there is the simplest form of cash accounts. This merely records the flows of
receipts and payments to and from the governmental unit. This system may or may not
separate the cash flows between "capital" and "recurrent" transactions. Moreover, it may
or may not distinguish between those receipts and payments that deal with income and
expenditure – gains and losses of resources – and those dealing with the acquisition,
disposal and destruction of assets or the incurrence and repayment of liabilities.

Cash accounting typically makes no provision for transactions and adjustments that do
not emanate from direct receipts and payments. Important omissions are adjustments
relating to changes in fixed asset values and changes in the values of long term debt.
Indeed, cash accounts do not normally allow for the preparation of comprehensive
balance sheets. The most likely summary will be that pertaining only to short-term
monetary assets and liabilities. Cash transactions are many and varied. However, as the
following slides demonstrate, the competition for cash, from various sources, is a very
corrupting influence on the stability of an accounting system based merely on cash.

Even such short-term assets and liabilities as inventories, receivables and payables will
not, typically, appear in balance sheets, because they are not accrued 17. Cash accounting
systems have, until now, normally been used for central (federal) governments (including
that of the USA) and (less commonly) for state and local governments. They are still
used, in modified forms, in many state and local governments.

However, for all of its alleged complexity, full accrual accounting is NOT Rocket
Science. There are Only 14 Types of Cash Flows and 28 Types of Other Entries. It
should, however, be observed that there are TWICE as Many Other Types of Entries as
there are Cash Flows! consequently, results derived only from Cash Flows are
inherently unreliable. Also, they may easily be misleading, or even fraudulent18.

16
In July 1998, IFAC promulgated four choices of accounting systems for the public sector. These were: “accrual,”
“modified accrual,” “cash” and “modified cash.” It ultimately decided to be more definitive, giving precedence only to
the “accrual” system. This is the system represented in “Municipal Accounting.” Thus, it is fully consistent with IFAC
principles.
17
In accounting jargon, "accrued" means "appropriately accounted for as assets and liabilities." For example, in cash
accounting, if there is an unpaid invoice at the end of an accounting period in which a credit transaction occurred, and
no accrual is made, the transaction is not recognized, for accounting purposes, until the invoiced amount is paid, in a
subsequent accounting period to that when the transaction event occurred.
18 For example, in its August 5, 2003 edition, The Economist observed: “The American government's accounts look
about as reliable as Enron's…. The government's accounts are drawn up on a cash basis.”

18
 THE COMPETITION FOR CASH MONEY
SALES OF
CREATION
ASSETS (INCL. MAJOR POLICY ISSUES
(NATIONAL
PRIVATIZATION)
GOVERNMENT)
CHARGES, GRANTS &
TAXATION
FINES & TRANSFERS
INTEREST

LONG-TERM LONG-TERM
BORROWING LENDING
(PRIMARY) SOURCES

TEMPORARY
INVENTORY
BORROWING
(INTERMEDIATE) POOL (INTERMEDIATE)
ENHANCEMENTS OF CASH DEPLETIONS
(DIS-SAVINGS) (UNSTABLE) (SAVINGS)
WITHHOLDING DEBTORS
SUPPLIERS (GRANTING
PAYMENTS OF CREDIT)
(FINAL) USES & ABUSES
MONETARY MONETARY
INVESTMENT MAJOR POLICY OUTCOMES INVESTMENT
(WITHDRAWAL) (& UNINTENDED CONSEQUENCES) (DEPOSIT)

CAPITAL GRANTS & INTEREST

"F.C.W.A!" INVESTMENT ACTIVITY TRANSFERS ON DEBT

The second form of accounts is the fund accounting system. This builds on the basic
cash accounting system to provide for a separation of groups of transactions into funds.
These funds are designated to fulfill legal requirements and/or useful purposes. They
attempt to ensure that resources (especially, but not exclusively, cash) designated for one
purpose are not appropriated for another, except under the system rules. Careful design
and implementation of fund accounts can sometimes facilitate more efficient distinctions
of costs or expenditures than is possible with simple cash accounting. Alternatively, the
funds may be used to create surrogates for elements of cost (resource use) distinctions.
For example, the allocation of debt service expenditures to individual services, or the
creation of "renewals funds," may sometimes serve as approximations of depreciation
charges19. This procedure, however, is less valid if large proportions of capital
expenditure are financed otherwise than from debt.

19
This is analogous to house mortgages. Covering the mortgage payments is not really “cost recovery.” More precisely,
cost also includes: depreciation on the current value, plus interest on the owners’ equity. However, it correspondingly
excludes: repayments (amortization) of principal. These are only cash-flows (not costs) and are – therefore – savings.

19
Fund accounting systems may well use accrual of current assets and liabilities, although
this may sometimes be only partial. For example, what is sometimes referred to as
"modified accrual" systems record payables, receivables from user charges, and
inventories as accruals, but treat most general tax receipts on a cash basis.

Fund accounting systems are typically used for those activities of state and local
governments that are funded wholly or mainly from taxes and other general revenues.
Central (federal) governments may also use some aspects of fund accounting, especially
when required to "earmark" specific revenues for specific expenditures. This is typically
where the revenues are collected and the related expenditures are disbursed in different
financial periods, such as in the case of pension or social security funds.

The third form of accounts is based on that which is most familiar to the private sector.
This is the system of enterprise accrual accounting at historical cost. It is the system
most commonly used in all low-inflation countries for their commercial activities. This
accounting system seeks to ensure that most of the fundamental principles of accounting
are reflected in the financial accounts and reports.

It falls short of this goal, however, in two principal ways. Firstly, as already explained, all
of the profits accruing to owners are treated as “surpluses” rather than (at least partially)
as “costs of capital.”

Secondly, no provision is made for the adjustment of the value of fixed (non-monetary)
assets to allow for inflation (or deflation). Depreciation charges, therefore, do not capture
"current costs" of use and deterioration of fixed assets.

This form of accounts is typically used by state and local governments, as well as by
government-owned enterprises, for activities providing public utility services. Their
operations are usually financed wholly or substantially from user charges, paid directly
by customers. However, there may sometimes be either subsidies from general public
revenues or even transfers to general revenues from earned income.

Finally, there is a slowly increasing use, in both the public and private sectors, of the
system of accounting known as "full accrual accounting at current value (or cost)." It is
operated in mainly the same way as the “historical cost” version and, like this version,
does not treat (any proportion of) profits as costs of capital.

However, it provides for regular or periodic revaluation of non-monetary assets, mainly

premises, plant, equipment and infrastructure, to values closely related to current market
values. It thus allows for inflation. For each asset, both the gross values, based on original
cost, and the accumulated depreciation, reflecting use and deterioration to date, are
updated. Thus, the net values closely resemble the cost of replacement, in the market, by
a comparable asset in the same state of maintenance and deterioration20.

20
The purpose of revaluation is not to establish replacement cost per se. It is to facilitate recognition of the full costs
relating to depreciation, as adjusted by changing money values (and, if appropriate, opportunity costs).

20
Periodic depreciation is then charged in the accounts, on the basis of the current values of
the assets. Furthermore, the measurement of the cost of capital, either on total assets in
use or on equity (financial interests of owners), as a percentage, is based on the
contributed capital, retained earnings and reserves as updated and adjusted for the
revaluations.

This system of accounting is increasingly used where inflation is high, rendering fixed
asset values (and, therefore, all costs and other information relating to the use of these)
quickly obsolete. Indeed, without such adjustments, inter-period comparisons are
relatively meaningless, the more so with higher inflation. There is, however, still a
reluctance to use such a system in the mainstream private sector of relatively low-
inflation countries21, a matter over which the accounting professions, internationally, have
already been mired in controversy for several decades22.

Central governments sometimes promulgate the use of “half-baked” systems of

adjustment. They may require revaluation of fixed assets “only to the extent that,” or
“if,” inflation exceeds certain percentages. For political reasons, this percentage is,
typically, on the low side of actual inflation, because it is determined by the government
itself. Thus, the adjustments to fixed assets are typically: incorrect to begin with; apply
only partially; never fully catch up with the actual inflation; and, accordingly, produce
increasingly meaningless – and therefore useless – information. This, indeed, can no
longer be related to either the original transactions nor to subsequent economic changes.

Effect of Accounting Systems on Cost Definitions

From the above explanations it can be observed that cost recognition, as definitively
presented, may be significantly compromised by the type of accounting system in use and
the way in which it is operated. Some of the more important concerns that affect
satisfactory cost recognition and computation are the failed or inadequate use (or
recognition) of:

(a) accrual systems, for inventories, receivables and payables: this will
engender a (false) recognition of expenditures (and income) from financial
periods other than those in which the costs were incurred;

(b) overhead expenditures: this will engender the under-recognition of costs

in those activities to which these overheads should have been properly charged,
with compensating over-recognition at their point of original expenditure;

(c) depreciation: this will avoid recognition of the costs of consumption, use
and deterioration of fixed assets, often a significant cost component of capital-
intensive public sector activities;

21
This is a topic that is only very recently being addressed, by either national or international institutions. Moreover,
the private sector (notably in USA) still shuns it!
22
It might be thought that low inflation rates make it unnecessary to allow for related changes in accounting systems.
However, even at (say) 3.5% annual inflation, after 10 years, asset values will have increased by over 40%.

21
 (d) assessment of normal profits as "costs of capital": this will under-
recognize the return on investment implicit in the use of the funding of fixed and
working capital by owners or by other funding sources except for lenders; and,

(e) revaluation of fixed assets to allow for inflation: this will result in
under-recognition of current fixed asset values and the related current costs of
depreciation, as well as an over-recognition of return on investment, when
expressed as a percentage of the real (opportunity) costs of capital.

Many public services are capital-intensive. Thus, concerns that relate to the accounting
treatment of fixed assets are particularly important. Also, failure to recognize the costs of
funding of capital investment, other than from debt, as a cost of capital, is also
distortionary. A high proportion of this capital investment is often financed (effectively
subsidized) by grants from higher levels of government. These are typically by capital
grants from the federal (central) or state governments to local governments or public
utilities. Sometimes, it is by local governments directly financing capital investment of
their owned revenue-seeking enterprises23.

A Contribution to Greater Accountability

One substantial contribution towards a solution of current concerns in municipal

accounting is the availability of a comprehensive text, that of “Municipal Accounting
for Developing Countries.” It was published by the Chartered Institute of Public Finance
and Accountancy of the United Kingdom and the World Bank, Washington D.C.,
originally in 1982. Its sole author is David C. Jones, a United Kingdom citizen, currently
resident in the USA. A former Senior Financial Analyst at the World Bank, Mr. Jones
retired from that Institution in 1987, as its Financial Adviser for Water Supply and Urban
Development. As a Chartered Public Finance Accountant, for forty years, he is thus a
member of – and holds credentials to practice accountancy from – The Chartered Institute
of Public Finance and Accountancy. He is also a UK Chartered Certified Accountant.

At present, Mr. Jones is a part-time Research Fellow of the Center for Urban
Development Studies, of the Harvard University Graduate School of Design, where he
teaches and consults on Urban Financial Management. As a staff member of the World
Bank and of Harvard University, and as an independent consultant, he has provided
technical assistance and training in over fifty countries, world wide. In recent years, these
have been mainly the newly emerging democracies of fSUEE – and also South Africa.
Mr. Jones is also President of Farsight Inc.

23
For example, this practice has been especially prevalent in the urban transport systems of municipalities of the
fSUEE. Tramway tracks, trolley lines and vehicles have typically been financed from general taxes, with passengers
being required to pay from fares, only the operation and maintenance costs. Although there may well be justifications
for transport subsidies, these should not be arbitrarily applied as an outcome of mediocre accounting. They should be
related to properly computed costs. It is the obligation of an accounting system to produce these. [Lest it appear that
criticism is directed only at fSUEE countries, this is the system of funding that is also practiced in USA. For example,
the Washington D.C. “underground railway” (METRO) was funded in this way.]

22
 Municipal Accounting for Developing Countries
by
David C. Jones, CPFA, FCCA (UK)

[900 pages; © Chartered Institute of Public Finance and Accountancy

and The World Bank]

Recently, Farsight Inc., has associated with ZAO Marketing, Consulting, Design
(ZAO/MCD) St. Petersburg, in the development and delivery of workshops in “Local
Government Performance Measurement – UK Experience” in various locations in Russia.
These were, most particularly: Vologda Oblast, Chelyabinsk Oblast and Chuvashia
Republic. Earlier, he had participated, also with ZAO/MCD, on a project for the
improvement of municipal accounting in the City of St. Petersburg. He has also worked
on other projects in St. Petersburg, as well as on workshops in Moscow, Nizhniy
Novgorod and Khabarovsk. As well as working in Russia, Mr. Jones has worked in
Romania, Georgia, Azerbaijan, Ukraine, Belarus, Latvia, Lithuania, Poland, Albania,
Macedonia and Bosnia. Before the dissolution of Yugoslavia, he also worked in Croatia,
Serbia, Montenegro and Kosovo. All these activities have been connected with municipal
finance and/or accounting. In some cases, this has involved transforming accounting or
auditing systems.

23
“Municipal Accounting” came about because of an urgent need for guidance for staff and
clients of the World Bank. They were engaged in projects that involved reform of local
government or public utility accounting practices. It is, therefore, compiled as an
international text and not, necessarily, directed towards the practices of any particular
country. Thus, its contents have virtually universal applicability. However, any precise
applicability of accounting principles to a particular country will depend upon the laws
and practices of that country. Although these vary in detail, they aim to address very
similar concerns.

The necessity for both principle and uniformity, internationally, engenders a need for
many common standards and practices. The book addresses these. It is also, as indicated
in Annex 5, fully consistent with the International Public Sector Accounting Standards
of the International Federation of Accountants.

Because of the author’s background and training, the book has some degree of natural
bias towards practices of the United Kingdom. This has turned out to be fortuitous. The
UK is a leading proponent of good accounting practices (public and private) within the
European Union and the throughout the world. It has also introduced, for its own local
governments, the most advanced systems of accounting currently in use, incorporating
the principles of “full accrual at current value.” This system, incidentally, is not yet
used in private commercial entities. [A Britisher, Sir David Tweedie, who is a Scottish
Chartered Accountant, is chairman of the International Accounting Standards Board.]

The nine-hundred page manual: “Municipal Accounting for Developing Countries,” was
given this title because of the principal focus of the World Bank, at the time of its
publication. This was on what were almost always referred to as “developing countries,”
a phrase more concerned with “political correctness” than with discerning accuracy.
Since the admission to the Bank of the countries of the FSUEE, this expression is, of
course, even less apposite than it originally was.

This would also be consistent with the comments of several professional colleagues of
the author, including the book’s official independent reviewer. They took the view that
the expression did not do adequate justice to the high standards of accounting practice
that it explained and promulgated, some of which were in advance of the, then, current
practices – even in the United Kingdom24.

The text of “Municipal Accounting” is very comprehensive. Indeed, it is probably the

most complete, detailed and integrated text on accounting ever published, in any
language, for either private or public sector activity. Moreover, as indicated by its
reviewer, “it is written entirely by one author, and so does not suffer from the diversity of
styles of 11 contributors25.” Details of the content of the book are provided in Annex 1.

24
This was fortuitous. Principles are explained in the book for capturing full costs of activities and assets. These were
prescient, in that they are very similar to those that were, much more recently, adopted by the Chartered Institute of
Public Finance and Accountancy. These are incorporated into UK law and currently practiced throughout the country.
25
The reference to “11 contributors” relates to a much earlier standard British text, with which it was contrasted
(Municipal Book-keeping and Accounts, by Henry Brown).

24
This continuity is further enhanced by another factor, virtually unique in the teaching of
accounting. After the book has dealt with the main principles of accounting for public
sector entities, it establishes a capital program and an operating budget. From this point,
it uses the same, or related, numbers throughout the remainder of the text, for the various
accounting activities and the associated administrative procedures. Then, in a later
chapter, the actual numbers recorded for these activities are compiled into a set of
annual financial statements. These include presentations in forms familiar to both public
sector and private sector accountants. They are also accompanied by relevant supporting
statements, together with authentic working papers.

Thus, the entire book, apart from its introductory chapters, is a giant case study. This
fully accords with the traditions and practices of the Harvard Business School, another
part of the famous university where Mr. Jones is on the staff and where he has received
training in the application of the case method.

The principal teaching concepts of the book,26 those of matching “resources” and
“results” were invented by the author. These were used, for example, as a basis for the
instruction on public and private sector accounting principles for transport enterprises,
carried out by Mr. Jones for the World Bank Institute, in 1995, in Washington, in Minsk,
Belarus and in Kiev, Ukraine. In principle and in detail, therefore, it can form the core of
what is required for sound accounting practices that are applicable to virtually every
country’s local government and public service delivery systems. This applies not just
within the fSUEE but to virtually anywhere in the world.

Discussions are in progress for the book to be re-published in its entirety. Virtually all of
its present content has general relevance for current practice. Indeed, for republication, it
requires only minor updating of style, revision of sample dates and correction of very
minor errors of content. Publication in this fashion will serve the following concerns:

• It will be recognizable as the text that it supercedes, with the

improvements inherent mainly in minor revisions;
• It will be able to become quickly available as a useful working document
for practitioners, trainers and academics;
• It will be readily associated with the publication of its first edition by the
Chartered Institute of Public Finance and Accountancy and the World Bank,
two very important and well-recognized institutions in the domain of
competent financial management, internationally;
• It will be readily associated with its author, a qualified accountant, who is
still an eminent and recognized practitioner in public sector accounting;
• It will provide a sound basis for the derivation of additional work needed
in the fSUEE on accounting practices and on related municipal financial
management practices;

26
These were indirectly derived, however, from teachings given to the author, during his own studies, by Mr. J.B.
Woodham. He was an eminent Chartered Public Finance Accountant and a former President of the Chartered Institute
of Public Finance and Accountancy, of which the author has also been a member for over forty years.

25
 • It will help to engender the author’s participation in the other activities
that will emanate from this publication.

The book is oriented towards accounting practices currently used by the more advanced
local government systems, world-wide. Beyond mere cash accounting, it describes and
promulgates the use of accrual accounting. It also promotes the charging of the costs of
financing fixed assets in the annual operating accounts of the services to which these
assets relate. By the demonstration of sinking funds, loans pooling and consolidated loans
funds, it provides a surrogate for the recognition of the annual costs of using fixed assets.

The book, in its main explanatory text, does not demonstrate the use of depreciation for
largely tax-borne (i.e. non-revenue-seeking) services. This is not because it is incorrect. It
is because it has not yet become standard practice, outside of the precedent-setting New
Zealand and UK, the two situations already referred to above. These alone, for the time
being, practice “full accrual accounting” either at historical cost or at current value.

Nonetheless, the concept of depreciation is fully explained and demonstrated in the

text. An example is given for its use with the waste collection (liquid waste) service. This
is appropriate, because, together with solid waste management, it is an example of a
service that has been most contracted out by local government units, to private sector
companies27. Therefore, the demonstration of private sector accounting practices, in this
case, helps to encourage full cost comparison of alternative methods of service delivery.

The present anomalous situation, relating to fixed asset accounting, is clearly beyond the
control of any individual author. One person can only report on and interpret – but not
determine – the accounting systems currently in use. However, the book clearly
explains, in its final chapter, the main shortcomings of present systems. It also indicates a
method, close to the best practices currently used (as in the UK and, shortly, in USA) to
overcome these difficulties28. Thus, the book seeks to recognize current operational
practice as well as providing “a reach that is somewhat beyond the immediate grasp29.”

Too much need not be made of these matters, however. They relate, mainly, to the form
of presentation of accounts. As the book is extremely technical, detailed and thorough,
much of its content deals with matters that will be dealt with in largely the same manner,
whatever the presentation within the final accounts and financial statements.

27
And, incidentally, a service that includes at least one company, “Waste Management Inc.” which, in collusion with
Arthur Andersen and Company (now virtually defunct), was heavily fined by the SEC. of the U.S.A. for publishing
false financial statements. (Arthur Andersen was also sanctioned and fined).
28
A recent study by the US General Accounting Office, on “Accrual Budgeting” was presented, in December 2001, to
a meeting of the International Consortium on Governmental Financial Management, in Washington D.C. Interestingly,
the reaction of the U.S. Treasury Department was that the system that it would favor for capital accounting for the US
Federal Government was very similar to the one promulgated (as long ago as 1984) in Municipal Accounting. This
(US) opinion had been arrived at completely independently from any review of the text of Municipal Accounting.
29
This is a teaching philosophy that is also used by the Harvard Business School.

26
In another interesting concept, the book avoids the often implicitly “apologetic” nature of
texts that perceive “non-profit-seeking” entities as impaired or tarnished versions of
“good business practice.”

Instead, it introduces the concepts (invented by the author) of “resources” and “results.”
These emphasize the neutrality of public sector accounting with respect to profitability.
This is, moreover, a concept that is theoretically neutral as to whether the activities
accounted for are revenue-seeking or not. It also, correctly, undermines the concept that
public sector accounts cannot match the effectiveness of those of the private sector,
because they do not deal with “profit.”

Finally, it seeks to disparage the claims, by the well-meaning but ill-informed, that
“governments should be run like businesses.” As has now been only too obvious,
governments do not have a monopoly on unsatisfactory accounting. Nor do private
businesses, especially monopolies, have a monopoly on good accounting practices.
Indeed, in other writings, the author contends that sometimes, “businesses must be run
like governments.”

It is not education that is needed, as much as knowledge. In the far-off days of World
War II, Winston Churchill once said, of Britain: “Give us the tools and we shall finish the
job!” For example, in Russia – as then – tools are available, at least to do a better job than
currently. Some of these tools, in the form of the book “Municipal Accounting” have
already been sharpened. Following the tradition of Peter the Great, who significantly
contributed to Russia’s modernization, work on this has already begun in St. Petersburg.
Acting on its own initiative, ZAO/MCD saw the importance of the benefit of the book,
firstly to the City Government of St. Petersburg itself and secondly to state and local
governments throughout the Russian Federation. Consequently, eight key chapters,
together with the preface, have already been translated into the Russian language by
ZAO/MCD.

The original copyright is held jointly by the Chartered Institute of Public Finance and
Accountancy (UK) (Cipfa) and the World Bank. Clearly, the topic is one that both
institutions have a major interest in supporting. Moreover, it is the policy of the World
Bank to permit wider circulation of its materials, subject to proper attribution. This matter
is being further explored as part of the republication process.

In the meantime, reliance is placed upon the reproduction and circulation of a limited
number of its chapters, for the purposes only of education and publicity. These chapters
deal with basic principles of accountancy and introduce the application of these to local
government accounting requirements. They are necessary – but far from sufficient –
requirements for the development of effective accountability. Also indispensable will be
knowledge of the transformation of basic accounting data into recognized reporting
formats. This will require three additional achievements. The first will be the translation
of those chapters of the book that relate to this. The second will be a settlement of the
most useful form in which the financial reports will be presented. Finally, the overall
presentation should be integrated with the full republication of the book, on a wider basis.

27
28
In offering circulation of this partial text within Russia, and in the Russian language, it is
obviously hoped to provide some degree of accounting knowledge that can be built upon.
However, it is also hoped that this small pilot project can elicit comment, criticism and
suggestions from recipients. These can then be used and translated by ZAO/MCD as a
basis for further work and also passed on to the author. From this can be developed
further chapters in the Russian language, as well as a more comprehensive and credible
basis for its forthcoming full re-publication in English.

In addition to showing, in Annex 1, the detailed contents of the book, other annexes have
been added, to exemplify its potential use and potential. Annex 2 shows a unique chart,
invented by the author. This demonstrates, upon a single page, all of the accounting
activities necessary, within either a private or public sector entity. There is a small key to
the diagram and a single-page explanation. Thus, the profound and complex nature of
underlying accounting theory is belied by the diagram’s simplicity and brevity. However,
with very minor exceptions, what one sees is what one gets. That is all that there is!

The book embodies all of this, in one form or another. In Annex 3, there is a small set of
diagrams that have been derived directly from two within the book. Taken together, they
show all of the major cash flows and information flows that are likely to comprise an
accounting system of a local government unit. They also show how a local government
unit relates to the financial environment within which it customarily operates.

Annex 4 provides a brief theoretical narrative, together with two major references – one
British and one American – from which basic principles in the book have been derived.
These first came to the author’s attention in the mid-fifties, as a student of local
government accounting. He was required to study: “The Form of Published Accounts of
Local Authorities.” This was an official document, promulgated for U.K. practice, by the
“Institute of Municipal Treasurers and Accountants.”

This Institute, now the Chartered Institute of Public Finance and Accountancy, is one of
which the author has been a member, for forty years. It is a primary national public sector
accountancy body in the U.K. and in the world. It has taken the lead, in the U.K., in
shepherding local government and public sector accounting to some of the most advanced
levels currently practiced. Together with the World Bank, it is a joint publisher of
“Municipal Accounting.”

As already indicated, Annex 5 lists the entire set of International Public Sector
Accounting Standards30. It then shows, against each separate standard, how the material
in the book relates to these. The outcome is that every one of the international standards
is addressed, in one form or another, within the book. So far as is known, no other text
is available that does this.

30
© International Federation of Accountants, 545 Fifth Avenue, 14th Floor, New York, New York 10017 USA.

29
Despite the claims made here for the authenticity of “Municipal Accounting” one must be
careful not to disparage nor disdain the important work being done by many others.
Consequently, the book cannot claim to be the last word on these matters. However, to
quote Winston Churchill, one more time, from World War II: “This is not the end. It is
not even the beginning of the end. But at least in may be the end of the beginning.”

In writing this introduction, the author is mindful of the kindness, graciousness and
professional cooperation that he has received from his Russian friends and colleagues and
from public officials, as well as from staff of railways, airlines, hotels and other service
entities, during several enjoyable visits to Russia. If his participation in this activity can
be perceived as modest and partial thanks for these courtesies, he will be most grateful.

30

MUNICIPAL ACCOUNTING
Details of Contents
CHAPTERS CONTENTS
NUMBERED
1–5 Basic accountancy
principles, Ledger accounts,
Cash transactions, Journals
and subsidiary records,
Errors and adjustments.
6 Simple non-profit accounts.
7 Municipal accounts –
introduction.
8 Fixed assets – introduction.
9 Municipal Budgets.
10 – 13 Income accounting,
Expenditure accounting,
Income and expenditure
analysis, Stores and costing.
31
Annex 1
COMMENTS
Introduction to accounting principles and
practices necessary for use within
municipal and other local government
units, omitting reference to partnerships
and corporate accounting in business.
Explanation of simple, general principles
and practices used for non-profit entities,
as a precursor to more specialized
accounts for local government entities.
Explanation of how basic principles of
accounting for simple non-profit entities
may be applied more specifically to more
complex local government entities.
Explanation of standard practices for
accounting for fixed assets and how these
might apply, for example, to a refuse
collection (solid waste) activity.
Explanation of how to prepare and
present capital investment programs and
recurrent budgets in cost-based and
programmatic formats, including working
papers and supporting information.
Explanation of detailed administrative
procedures and related accounting
activity for (a) assessment and collection
of property taxes, housing rents, sundry
debtors, periodic and other revenues; (b)
procurement of goods and services for
operations; (c) analysis of income and
expenditure; (d) storage, issue and returns
of materials and parts; (e) cost
management of vehicles and plant; and,
(f) detailed cost accounting of jobs,
processes and activities.
CHAPTERS CONTENTS COMMENTS
NUMBERED

14 – 15 Capital expenditure, Capital Explanation of detailed administrative

expenditure (continued). procedures and related accounting
activity for capital expenditure, together
with its financing by relatively simple
means, such as by simple (earmarked)
loans and current revenues.
16 Final accounts. Explanation of the preparation and
presentation of final accounts and
published financial statements, together
with supporting documents, explanations
and working papers, all based on the
various transactions demonstrated in
earlier chapters.
17 – 19 Internal borrowing, Explanation of the extension of capital
Temporary borrowing, expenditure financing from simpler
Replacement borrowing and methods to those more advanced and
sinking funds. complex, to facilitate the use of more
sophisticated instruments and debt
management activity.
20 Loans pooling. Use of loans pools or consolidated loans
funds to facilitate the deliberate mis-
matching of fixed asset life-cycles with
availability of market funding, while still
enabling correct accounting for asset use.
21 Depreciation and capital Examining a way forward, towards the
funds31. application of full commercial accounting
principles and practices to all of local
government operations and activities,
even those financed wholly from taxes.

31
This represents state-of-the-art accounting. Typically, it is not currently used by many local government systems.
However, this is where practices are inevitably headed, to comply with expanding complexity and rigorousness of
standard practices and principles, including and especially, those of the IFAC and the European Union. These expected
practices are becoming increasingly necessary, as the distinctions continue to blur and to harmonize, between the public
and private sectors. Indeed, in some of the more advanced uses of accounting, the public sector, hitherto seen as a “poor
relation” to the private sector, is now taking a number of important leads.

32
 Annex 2

Accounting Flow Chart (Accrual)

TRADING
STOCK MANUFACTURE SALES
OF OR
1 2 --------------------------
GOODS AND OPERATING REVENUE
MATERIALS ACCOUNT INCOME

1 4
2
6 8
5
CREDITORS PROFIT
6 (PAYABLES) AND LOSS 7 4
3
-------------------------
INCOME AND
9 EXPENDITURE DEBTORS
3 (RECEIVABLES)
10
12
23
11

SHAREHOLDERS
(STOCK NET
HOLDERS) EARNINGS
13 -------------------------
GENERAL FUND
5 SURPLUS
21

14
16
6

15
17 23 CAPITAL &
RESERVES
(INCLUDING 20
FIXED ASSET
REVALUATION) 27 28
18
19
22

SPECIAL 8
FUNDS
-------------------------- 24 EXPENSES
PROVISION 25
FOR EXPENSES
MONETARY
7 INVESTMENT
9

10
26
DEPRECIATION OR
LOANS CAPITAL
CASH FINANCING RESERVE
AND 13 28
12 --------------------------
11 BANK FIXED
ASSETS 14

27

33
 Accounting Flow Chart

1. The attached chart illustrates the working of the entire accounting system of any
financially autonomous entity, keeping its accounts on an accrual basis. It can be
applied to private sector, public utility, enterprise or municipal accounting systems.

2. It is probable that well over ninety-five percent of accounting entries, for any kind of
business, are represented by the fourteen cash-flows and twenty-eight other book
entries represented on the chart. Thus, forty-two entries cover all transaction types.

3. Each class of account has been given a separate symbol. In the “Keys to Symbols”
box, those on the left represent “personal” accounts (debtors and creditors). Those on
the right represent “real” accounts (cash, stocks of goods / materials and fixed assets)
and “nominal” accounts (gains and losses - income and expenditures). Furthermore,
the symbols with straight sides (squares and triangles) represent resources (assets and
liabilities), whilst the circles represent the analysis of results (gains and losses).

4. Each line represents a class of business transaction or a generally recognized

accounting adjustment. Where a line touches the left-hand side of an accounting
symbol, it represents a debit entry to that class of account. Conversely, a line touching
the right-hand side represents a credit. Solid lines represent cash flows and broken
lines represent accounting entries not directly related to cash transactions.

5. The arrows on the lines are somewhat arbitrary. However, they attempt to show the
direction in which each transaction is normally understood to flow. The entries are
conceptual, not legal. For example, the transfer of extra-ordinary losses (and fixed
asset revaluations) direct to “Capital and Reserves” is regarded as bad accounting
practice in many systems but is acceptable in others. In this chart, they have been
shown as direct transfers to “Capital and Reserves,” merely for simplicity.

6. The chart indicates that an accounting system, whilst complex, is bounded and closed.
For accountants, it may assist in systems and computer work. For non-accountants, it
may be useful in understanding what accountants are doing (or supposed to be doing)
and may also help to develop an appreciation of what can and should be expected
from an accounting system. For students of accounting, the chart may represent a
useful learning tool, to be used in conjunction with other teaching materials.

7. The chart covers most accounting procedures likely to be encountered. It includes,

moreover, the two main entries concerned with the conversion of historical cost
accounts to current values. This is still a matter of uncertainty and contention among
accountants and is not practiced in all systems. However, unless recognized, especially
where high rates of inflation exist, fixed asset (and other non-monetary asset) values,
based only on historical costs, become increasingly meaningless. Furthermore,
depreciation (and other capital charges) based of these historic values will cause the
under-statement of costs and a corresponding over-statement of profits.

34
 Accounting Flow Chart

KEY TO SYMBOLS
___________ Cash Flows ------------- Accounting Flows

∆ Legal Claims
Debit
Amounts
Claimed Tangible
Debit Increases in
Assets
by the Entity Amounts Assets
Credit Credit Decreases in
Settled
Assets
Amounts Gains and
∇ Legal Claims
Debit
Settled Ο Losses
Debit Losses or
Expenses
against the Amounts (Income and Gains or
Credit Credit
Entity Claimed Expenditure) Income

Cash Flows

1. Cash Purchases - Stock (Inventories) 8. Investment Withdrawal

2. Cash Sales or Revenue Income 9. Cash Expenses
3. Cash Settlement - Creditors (Payables) 10. Investment of Cash in Monetary Instruments
4. Cash Settlement - Debtors (Receivables) 11. Loan Repayments
5. Dividends or Share (Stock) Repayment 12. Loans Raised
6. New Share Capital 13. Capital Expenditure
7. Payment from Funds 14. Sales - Fixed Assets

Accounting Flows

1. Use of Stocks (Inventories) 22. Transfer of Expenses32

2. Sales Income 23. Accrued Expenses
3. Expenses (Trading, Operations, 24. Transfers to Special Funds/Provision for
Manufacturing) Expenses
4. Revenue (Recurrent) Income 25. Investment Losses
5. Credit Purchases 26. Depreciation (Commercial or Enterprise
6. Cash Discount Received Accounts) & Capital Discharged - by Loans
7. Gross Profit (Trading, Operations, Repaid, Revenue Contributions to Capital or
Manufacturing) Special Funds Applied (Municipal - Public
8. (Sales & Operational) Income Recoverable Sector - Accounts)
9. Taxes Now Payable 27. Revaluation of Fixed Assets
10. Expenses (Profit and Loss or Income and 28. Revaluation of Accumulated Depreciation
Expenditure)
11. Net Loss or Net Expenditure
12. Net Earnings or Net Income
13. Allocated or Declared Dividends
14. Transfers to Reserves
15. Capital Repayable
16. Surplus on Investments (Credited as
Income)
17. Future Income or Corporation Tax
(Provision)
18. Extra-ordinary Losses 32
There are a great variety of expenses but all are
19. Expenses Paid in Advance accounted for in the same way: an appropriate
20. Surplus on Investments (Credited as Capital) “expense” account is debited and either “cash” or
21. Bad Debts or Discounts Allowed “payables” is credited. Transfers, for final accounts,
will depend upon the types of expenditure.

35
 Annex 3
1

Charts Extracted and Adapted from:

Municipal Accounting for Developing Countries
David C. Jones CPFA, FCCA (U.K.)
© “Chartered Institute of Public Finance and
Accountancy” and “The World Bank”

CASH FLOWS
INFORMATION & INSTRUCTIONS

PAYERS CENTRAL GOVERNMENT SUPPLIERS

OF TAXES, FEES PUBLIC AUTHORITIES CONTRACTORS
& CHARGES THE GENERAL PUBLIC & EMPLOYEES
& CAPITAL MARKETS

BRANCH BRANCH
CASHIERS CASHIERS
(DISTRICT (IMPREST
OFFICES) LENDERS BORROWERS HOLDERS)
(BANKS & & INVESTMENT
BONDHOLDERS) RECIP IENTS

MAIL & MAIL &

BRANCH ELECRONIC ELECRONIC BRANCH
BANKS TRANSFERS TRANSFERS BANKS

MAIN CASHIER LOCAL MAIN CASHIER

FOR COLLECTIONS GOVERNMENT FOR PAYMENTS
(CHIEF CASHIER) UNIT’S BANK (CHIEF PAYMASTER)
SWEEPS
CASH FLOWS
INFORMATION & INSTRUCTIONS

36
 3
TAXES
FEES & HOUSE HOLDS , BUSINESSES, INVESTORS, LENDERS CAPITAL
CHARGES AND GOVERNMENTS (DOMESTIC AND FOREIGN) MARKETS

GRANTS LOANS & SHARED TAXES LOANS

LOANS
(GOVERNMENT & FOREIGN INSTITUTIONS) RAISED
REPAID

LOCAL CAPITAL CAPITAL

BUDGETARY
GOVERNMENT GRANTS CONTRI- SINKING
SUPPORT
ENTITIES & LOANS BUTIONS FUNDS (**)

OPERATING BUDGETARY CONTRIBUTION

"CAPITAL"
(RECURRENT) FOREIGN
FUNDING
FINANCE DEFICIT FINANCING (*) CURRENCY
RESERVES
WORKING CAPITAL WORK IN “PRINTING
PROGRESS MONEY”
(CENTRAL NET
CAPITAL INVES TMENT & USAGE BANK) FOREIGN
EXPENDITURE EARNINGS
ON (COMMERCE
CONTRIBUTIONS (**) SPECIAL FUNDS
(COSTS OF) (INCLUDING PENSION, &
SERVICES SOCIAL SECURITY & INDUSTRY)
DEBT SERVICE LOANS FUNDS)
(*) = IMPRUDENT (& OFTEN ILLEGAL) PRACTICE
(**) = INCLUDING FOREIGN EXCHANGE HOLDINGS FOR FUTURE FOREIGN DE
BT REPAYMENTS

CASH INCOME CENTRAL GOVERNMENT

PUBLIC AUTHORITIES EMPLOYEES
SOURCES
THE GENERAL PUBLIC
& CAP ITAL MARKETS

TICKETS & DEBTORS CREDITORS PAYROLLS

RECEIPTS
INVOICE BILLING OF RECORDS OF INVOICES
PAYMENTS BORROWERS ORDERS
DEBTORS
AND LENDERS
COPY EXP ENDITURE
CASHIERS BILLING OF SECTION
DEBTORS OPERATING ORDERS
DEP ARTMENTS
COPY COPY PURCHASE
RECEIPTS INVOICES STORES &
PLANT USAGE PRICES &
QUANTITIES PAID
COPY INCOME INVOICES &
RECEIPTS SECTION PAYROLLS
STORES &
P LANT RCORDS STORES NOTES
CONTROL & PLANT LOGS
SUMMARY SUMMARY
TOTALS
CONTROL
TOTALS
ACCOUNTANCY ACCOUNTANCY ACCOUNTANCY
SECTION SECTION SECTION
(INCOME SUMMARY (FINANCIAL SUMMARY (EXPENDITURE
ANALYSIS) STATEMENTS) ANALYSIS

37
 5

CASH INCOME CENTRAL GOVERNMENT

PUBLIC AUTHORITIES EMPLOYEES
SOURCES
THE GENERAL PUBLIC
& CAPITAL MARKETS

TICKETS & DEBTORS CREDITORS PAYROLLS

RECEIPTS
INVOICE BORROWERS
BILLING OF
PAYMENTS DEBTORS AND LENDERS ORDERS INVOICES

EXPENDITURE
CASHIERS BILLING OF
DEBTORS SECTION
OPERATING COPY
COPY COPY DEPARTMENTS ORDERS
RECEIPTS INVOICES

INCOME
SECTION

“INTERNAL” ACCOUNTING

“EXTERNAL” ACCOUNTING

OPERATING COPY EXPENDITURE

CASHIERS
DEP ARTMENTS ORDERS SECTION

COPY
COPY STORES &
RECEIPTS PURCHASE
INVOICES
PLANT USAGE PRICES &
QUANTITIES PAID
COPY INCOME INVOICES &
RECEIPTS SECTION PAYROLLS
STORES &
P LANT RCORDS STORES NOTES
CONTROL SUMMARY & PLANT LOGS
TOTALS
SUMMARY CONTROL
TOTALS
ACCOUNTANCY ACCOUNTANCY ACCOUNTANCY
SECTION SECTION SECTION
(INCOME SUMMARY (FINANCIAL SUMMARY (EXPENDITURE
ANALYSIS) STATEMENTS) ANALYSIS)

38
 7

CASH INCOME CENTRAL GOVERNMENT

SOURCES PUBLIC AUTHORITIES
THE GENERAL PUBLIC
& CAPITAL MARKETS

TICKETS & DEBTORS

RECEIPTS
INVOICE BILLING OF RECORDS OF
PAYMENTS DEBTORS BORROWERS
AND LENDERS

CASHIERS BILLING OF
DEBTORS OPERATING
DEPARTMENTS
COPY COPY DATA &
CONTROL
RECEIPTS INVOICES

MANAGEMENT &
COPY INCOME
BUDGET SECTION
RECEIPTS SECTION
OR DEPARTMENT

CONTROL SUMMARY DATA &

TOTALS
CONTROL

ACCOUNTANCY ACCOUNTANCY
SECTION SUMMARY SECTION
(INCOME (FINANCIAL
ANALYSIS) STATEMENTS)
DATA & CONTROL

CENTRAL GOVERNMENT
PUBLIC AUTHORITIES EMP LOYEES
THE GENERAL PUBLIC
& CAPITAL MARKETS

CREDITORS PAYROLLS

RECORDS OF
INVOICES
BORROWERS ORDERS
AND LENDERS
EXP ENDITURE
COPY SECTION
OPERATING ORDERS
DEPARTMENTS

DATA & STORES & PURCHASE

PRICES &
CONTROL PLANT USAGE PAID
QUANTITIES
INVOICES &
PAYROLLS DATA &
STORES &
PLANT RCORDS CONTROL
STORES NOTES
MANAGEMENT & & PLANT LOGS
BUDGET SECTION SUMMARY
OR DEPARTMENT CONTROL
ACCOUNTANCY TOTALS ACCOUNTANCY
SECTION SECTION
(FINANCIAL SUMMARY (EXP ENDITURE
STATEMENTS) ANALYSIS
DATA & CONTROL

39
 Annex 4
PUBLIC SECTOR ACCOUNTING PRINCIPLES

The concept of “standard practices” with respect to governmental accounting, is, at

present, a very generalized concept. It might, perhaps, be referred to as “best practices.”
There really are NO international or universally applicable standard practices specifically
for local governmental accounting. Recent publications of accounting standards and
“exposure drafts” by the International Federation of Accountants (IFAC) initially claimed
that governmental accounting follows practices ranging from simple “cash-based,”
through “modified cash,” then “modified accrual,” to “full accrual.” After international
discussion, this was modified. The IFAC has now concentrated on accrual accounting
standards, with only limited (supplementary) reference to cash-based accounting. Some
countries (e.g. UK, for local government; New Zealand for central AND local
government) use “full accrual at current value.” The US Governmental Accounting
Standards Board has recently recommended that US local governments produce dual
financial reports, combining “commercially-based” practices with those emanating from
the truly unique US “fund accounting” system.

The concepts of “resources” and “results,” when applied to overall accounting principles,
were originally devised, for teaching and illustrative purposes, by David C. Jones. For
example, in his definitive textbook “Municipal Accounting for Developing Countries,”
the following appears (p2):

“An accountant records and interprets variations in financial position. He

records, in money values, the results of variations during any period of
time, at the end of which he can balance net results (of past operations)
against net resources (available for future operations)”.

These theories, developed by the author, are grounded in principles enunciated by (inter
alia) eminent British writer and district auditor, Carson Roberts and from a US book,
'Accounting principles and practice', by Hatfield, Sanders and Burton. They have also
been interpreted by a former president of the Chartered Institute of Public Finance and
Accountancy, Mr. J.B.Woodham, Borough Treasurer, and later Chief Executive, of
Middlesborough and of Cleveland County, England. He refers to “resources” as “what”
accounts (what one owns and what one owes) and results as “how” accounts (how the
changes in resources came about). The concepts fit very neatly with those relating to (on
the one hand) balance sheets and (on the other hand) income and expenditure accounts.
International Accounting Standards are fully consistent with these theories.

40
"The Primary Classification of Balances33
• The only useful classification - the only useful and illuminating classification of
balance sheet entries (apart from subsidiary classifications which are dealt with
elsewhere) is that which groups them into liabilities and assets (which come from
personal accounts) and fund balances (which come from the impersonal
accounts). This is an intelligible classification and it is one which covers the
whole ground. All the asset and liability items which appear upon any balance
sheet come from personal accounts
• The balances which come from the impersonal accounts to the asset side all
represent fund deficiencies or deferred charges, and are very distinct in nature
from the balances which personal accounts bring to the asset side. The balances
on the other side which come from impersonal accounts are equally distinct from
liabilities, being all of the nature of fund surpluses, when that expression includes
capital provisions made, unallocated revenues, and unspent capital receipts.
• These surplus or deficiency balances, which the impersonal accounts produce, are
the proper balancing factors, between lists of assets and liabilities; they are
necessary complements which bring the two sides to equal totals."
Double-entry Book-keeping34
"....double-entry book-keeping attempts, through two parallel records, to present two
distinct but closely related sets of facts. These are:

(i) a record, in detail, of what one owns and what one owes.

(ii) a record of how much one was originally worth, and subsequent changes,
whether additions to or subtractions from, that original sum.

The first set of records deals with items of wealth, both positive and negative. The
positive items - that is, what one owns - are called assets. The negative items - that is,
what one owes - are called liabilities.....

The second set of records, constituting the other aspect of double-entry book-keeping,
does not deal with items of actual wealth. It has nothing to say as to the kinds of things
owned. It does not record the form nor the amount of the debts owed. It deals solely with
changes in the amount which the proprietor is worth."

33
A. Carson Roberts 'Local Administration (Finance and Accounts)’. [Carson Roberts was a famous, probably the first
famous, British District (local government) Auditor. His influence was particularly felt in the 1920s and he produced
what can properly be called the first major local government accounting textbook in the UK, in 1919.]
34
'Accounting Principles and Practice', by Hatfield, Sanders and Burton (an American text).

41
 International Public Sector Accounting Standards Reflected in MUDCi.
STANDARD
IPSAS 1 - Presentation of Financial
Statements
The objective of this Standard is to
prescribe the overall
considerations for the presentation
of financial statements, guidance
for the structure and minimum
requirements for the content of
financial statements prepared
under the accrual basis of
accounting.
IPSAS 2 - Cash Flow Statements
The cash flow statement requires
the provision of information about
the historical changes in cash and
cash equivalents of an entity by
means of a cash flow statement
which classifies cash flows during
the period from operating, investing
and financing activities. Cash flow
information allows users to
ascertain how a public sector entity
raised the cash it required to fund
its activities and the manner in
which that cash was used.
Annex 5
APPLICATION IN
“Municipal Accounting"
In Chapter 16, there is a complete set of final
accounts. This incorporates all activities shown,
as examples, of budgets, basic records and ledger
accounts in Chapters 9 – 15, using the accrual
method of accounting. The same numbers used
in the examples are incorporated into these
final accountsii, with hypothetical numbers
introduced (for balancing and completeness)
where using these in the examples would be
redundant.
There is a complete trial balance – not in “brief
textbook” format – but just as one would appear,
in full, for the accounts of an actual local
government. Then come all the ledger accounts
needed for the final accounts. These are shown
in detail and also (until this becomes redundant)
in a form most suitable for analysis and transfer
among accounts. All journal entries are shown,
exemplifying the transfers among various
accounts, as part of the “closing of accounts”
process. Annual financial statements are shown
in “standard” (debit and credit) formats as well
as in “narrative” formats. Two different balance
sheet formats are shown. One is consolidated.
The other divides the balances between the
capital and revenue (recurrent) items.
Supporting statements, relating to funding of
capital expenditure, are shown – following the
main financial statements. Finally, all necessary
working papers, to support the calculations and
adjustments for closing entries, are appended.
Chapter 3 is devoted to “Cash Transactions.”
Chapter 7, titled “Municipal accounts –
introduction” starts with a simple set of cash
accounts and then shows how these can be
converted to (i) modified cash statements and (ii)
modified accrual statements. Finally, a simple set
of “Complete final accounts” in accrual format is
produced. [Note, in the Annual Financial
Statements, a “Statement of Cash Flows” is not
included – but will be in the revised version.
(When the text was published, these were not
required). In any case, this statement is a
(derived) reporting statement and not a basic
accounting document. All actual cash accounting
transactions have been fully recorded
documented and explained.]
42
 STANDARD
IPSAS 3 - Net Surplus or Deficit for
the Period, Fundamental Errors
and Changes in Accounting
Policies
The objective of this Standard is to
prescribe the classification and
disclosure of extraordinary items
and the separate disclosure of
certain items in the financial
statements. It also specifies the
accounting treatment for changes
in accounting estimates, changes
in accounting policies and the
correction of fundamental errors.
IPSAS 4 - The Effects of Changes
in Foreign Exchange Rates
This publication deals with
accounting for foreign currency
transactions and foreign
operations. IPSAS 4 sets out the
requirements for deciding which
exchange rate to use and how to
recognize in the financial
statements the financial effect of
changes in exchange rates.
IPSAS 5 - Borrowing Costs
This Standard prescribes the
accounting treatment for borrowing
costs and generally requires the
immediate expensing of borrowing
costs. However, the Standard
permits, as an allowed alternative
treatment, the capitalization of
borrowing costs that are directly
attributable to the acquisition,
construction or production of a
qualifying asset.
IPSAS 6 - Consolidated Financial
APPLICATION IN
“Municipal Accounting"
In Chapter 16, all items are properly and
appropriately classified in the “Final Accounts.”
Moreover, where they were not correctly
classified in the routine basic accounting, the
journal entries for the “accounts closing” activity
make and demonstrate necessary adjustments.
The final output is consistent with IPSAS.
Chapter 11 deals with Expenditure accounting.
An Appendix to this chapter deals with foreign
purchases. However, foreign exchange
adjustments are not specifically explained in
detail. This is because (i) they apply much more
to central governments (ii) they represent a very
minor (probably miniscule) part of the
transactions of most local governments and (iii)
gains and losses on foreign exchange
transactions are not, essentially, different from
other types of expenditure. Accounting for them
will easily be accommodated within the structure
of the text.
Chapters 14 and 15 deal extensively with capital
expenditure and its funding. Chapters 17
(internal borrowing), 18 (temporary borrowing),
19 (replacement borrowing and sinking funds),
and 20 (loans pooling) deal with a variety of
advanced and complex techniques for local
borrowing. All interest and other borrowing
costs are allocated in accordance with IPSAS.
These are correctly shown and allocated within
the final accounts, in Chapter 16.
The final accounts shown in chapter 16 are in the
43
 STANDARD APPLICATION IN
“Municipal Accounting"
formats of consolidated accounts. Using the
This Standard requires all
same formats, with necessary adjustments, they
controlling entities to prepare
can easily be converted into de-consolidated or
consolidated financial statements
disaggregated statements. Alternatively, they can
which consolidate all controlled
be further consolidated with the accounts of
entities on a line by line basis. The
additional activities. [Note. Control is not
Standard also contains a detailed
referred to. Very important though this is, it is
discussion of the concept of control
outside the scope of this text, which deal with
as it applies in the public sector
accounting methodology. Reference should be
and guidance on determining
made to other publications of the author (e.g.
whether control exists for financial
Public Accountability for Stewardship,
reporting purposes.
Performance and Security by David C. Jones)]

This is a more advanced topic. It is not

IPSAS 7 - Accounting for
specifically shown in the text in detail. However,
Investments in Associates
Chapter 16 formats can easily incorporate this
This Standard requires all activity, following the IPSAS requirements.
investments in associate to be
accounted for in the consolidated
financial statements using the
equity method of accounting,
except when the investment is
acquired and held exclusively with
a view to its disposal in the near
future in which case the cost
method is required.
This is a more advanced topic. It is not
IPSAS 8 - Financial Reporting of
specifically shown in the text in detail. However,
Interests in Joint Ventures
Chapter 16 formats can easily incorporate this
This Standard specifies activity, following the IPSAS requirements.
proportionate consolidation as the
benchmark treatment for
accounting for such joint venturers
entered into by public sector
entities. IPSAS 8 also permits – as
an allowed alternative – joint
ventures to be accounted for using
the equity method of accounting.

Throughout the text, all exchange transactions

IPSAS 9 - Revenue from Exchange
are recorded following IPSAS. As with the
Transactions
stated standard, some degree of leeway may be

44
 STANDARD APPLICATION IN
“Municipal Accounting"
used where transactions are not material.
The standards, which have been
However, the final accounts conform to IPSAS.
set in bold italic type, should be
In addition, transactions that are not exchange
read in the context of the
transactions are also fully accounted for, as befits
commentary paragraphs in this
a system of accounting which is accrual-based
Standard, which are in plain type,
and fully consistent with IPSAS.
and in the context of the "Preface
to International Public Sector
Accounting Standards".
International Public Sector
Accounting Standards are not
intended to apply to immaterial
items
No specific examples are given relating to
IPSAS 10 - Financial Reporting in
hyperinflation, as this is a special case, outside
Hyperinflationary Economies
the scope of the text. However, Chapter 21 deals
The International Federation of extensively with the valuation of non-monetary
Accountants — Public Sector assets, including revaluation relating to
Committee (the Committee) is inflation. This topic is only very recently being
developing a set of recommended addressed by IPSAS. [Note: the text – published
accounting standards for public in 1984 – already included recommendations
sector entities, referred to as for the application of “deprecation accounting”
International Public Sector and “current value accounting” for the non-
Accounting Standards (IPSASs). revenue-seeking (tax-borne) public sector. This
The Committee recognizes the was done about fifteen years before these
significant benefits of achieving matters were addressed by either national or
consistent and comparable international bodies of accountantsiii.
financial information across
jurisdictions and it believes that the
IPSASs will play a key role in
enabling these benefits to be
realized.

Chapters 14 and 15 deal extensively with all

IPSAS 11 - Construction Contracts
aspects of capital expenditure including
The objective of this Standard is to construction contracts. There are special
examples given, to show how multi-year

45
 STANDARD APPLICATION IN
“Municipal Accounting"
construction contracts will be accounted for –
prescribe the accounting treatment
both within the accounting system and by extra,
of costs and revenue associated
supplementary, records. Moreover, examples are
with construction contracts. The
given to show how such contracts will be
Standard:
funded, especially by long-term borrowing.
As a very detailed example, a step-by-step
• identifies the arrangements that
analysis is shown of a construction contract for
are to be classified as construction
a sewage disposal works. This links the technical
contracts;
(engineering) progress of construction with the
related financial activity. Moreover, the entire
• provides guidance on the types of
accounting information is carried forward into
construction contracts that can
the final accounts on an accrual basis, consistent
arise in the public sector; and
with IPSAS.
• specifies the basis for recognition
and disclosure of contract
expenses and, if relevant, contract
revenues.

Because of the nature of the

activity undertaken in construction
contracts, the date at which the
contract activity is entered into and
the date when the activity is
completed usually fall into different
reporting periods.
IPSAS 12 - Inventories
The standards, which have been
set in bold italic type, should be
read in the context of the
commentary paragraphs in this
Standard, which are in plain type,
and in the context of the "Preface
to International Public Sector
Accounting Standards".
International Public Sector
Accounting Standards are not
intended to apply to immaterial
items.
Chapter 12 deals with “Income and expenditure
analysis.” It includes a section showing how
stores (inventories) are incorporated into the
accounting records of expenditure. Chapter 13
then deals more thoroughly with “Stores and
Costing.” This chapter addresses the physical
management and financial valuation of stores
(inventories) including stock-taking. Chapter 13
also deals with more detailed aspects of cost
definition, computation and management. The
latter also extends to labor, transport, plant,
contracting, and the use of small tools and
equipment.

Leases are not specifically dealt with in the text.

IPSAS 13 - Leases
However, operating leases are accounted for as
The objective of this Standard is to normal operating expenses and financial leases
are accounted for in a manner that is closely

46
 STANDARD
prescribe, for lessees and lessors,
the appropriate accounting policies
and disclosures to apply in relation
to finance and operating leases.
IPSAS 14 - Events After the
Reporting Date
The objective of this Standard is to
prescribe:
(a)when an entity should adjust its
financial statements for events
after the reporting date; and
(b)the disclosures that an entity
should give about the date when
the financial statements were
authorized for issue and about
events after the reporting date.
APPLICATION IN
“Municipal Accounting"
based on capital expenditure accounting. Both of
these matters are covered extensively and in
detail in the text, in conformity with IPSAS.
These matters are concerned with reporting
and publication of information within annual
financial statements. The items will be dealt with
on an ad hoc basis, depending on their nature and
circumstances. These adjustments raise no
material issues relating to accounting practice.
In any case, Chapter 16 provides, through
examples in ledgers, journal entries and working
papers, abundant examples of how year-end
adjustments are made. These are in accordance
with IPSAS.

The Standard also requires that an

entity should not prepare its
financial statements on a going
concern basis if events after the
reporting date indicate that the
going concern assumption is not
appropriate.

In Chapter 7, starting with simple cash accounts

IPSAS 15 - Financial Instruments:
and finally producing full accounts on a
Disclosure and Presentation
(modified) accrual basis the text shows how
various assets and liabilities, including financial

47
 STANDARD
The objective of this Standard is to
enhance financial statement users’
understanding of the significance
of on-balance-sheet and off-
balance-sheet financial instruments
to a government’s or other public
sector entity’s financial position,
performance and cash flows. In
this Standard, references to
"balance sheet" in the context of
"on-balance-sheet" and "off-
balance-sheet" have the same
meaning as "statement of financial
position".
IPSAS 16 - Investment Property
The objective of this International
Public Sector Accounting Standard
is to prescribe the accounting
treatment for investment property
and related disclosure
requirements.
IPSAS 17 - Property, Plant and
Equipment
The objective of this Standard is to
prescribe the accounting treatment
for property, plant and equipment.
The principal issues in accounting
for property, plant and equipment
are the timing of recognition of the
assets, the determination of their
carrying amounts and the
depreciation charges to be
recognized in relation to them.
IPSAS 17 - Property, Plant and
Equipment
APPLICATION IN
“Municipal Accounting"
instruments, are omitted from simple (or non-
existent) balance sheets but gradually recognized
as more complex balance sheets are constructed.
Much of this standard is, in any case,
concerned with reporting rather than
accounting. The various accounting methods
used in the text are consistent with (or can be
readily made consistent with) the requirements
of this standard. Where monetary instruments are
shown in the text, they are (except where
specifically indicated – to illustrate a point) in
compliance with IPSAS.
The text follows IPSAS for all matters relating
to investment property. This property is not
emphasized in the text, as it is peripheral to the
normal operations. Indeed, it is (in general –
and without specific justification) probably
unsound financial management practice for
local government units to hold investment
property that is not related to its primary
activities.
The appropriate treatment of “Property, Plant
and Equipment” is probably the most detailed
and contentious concern within the context of
International Accounting Standards for The
Public Sector. Indeed, it is only during the last
five years or so that the concern has been fully
addressed by IPSAS. Fortunately, for those
seeking guidance, as well as stepping-stones to
a full application of this standard, the text –
published in 1984 – was a pre-emptive strike!
Chapter 8 – “Fixed Assets – Introduction” shows
a complete worked example of the use of
depreciation, as followed in the private sector
(under IASB rules) for a vacuum tanker vehicle.
This, together with solid waste management
deals with a service most likely to be contracted
out from by the public sector, Chapters 14 and
15, dealing with capital expenditure, show
examples where annual capital charges are based
on debt service, following a modified accrual
system.
In various other places in the text, details are
shown of advanced methods. These include
loans pooling and the use of sinking funds.
Chapter 21 deals extensively with the concern
48
 STANDARD
The objective of this Standard is to
prescribe the accounting treatment
for property, plant and equipment.
The principal issues in accounting
for property, plant and equipment
are the timing of recognition of the
assets, the determination of their
carrying amounts and the
depreciation charges to be
recognized in relation to them.
[Continued]
IPSAS 18 - Segment Reporting
establishes principles for reporting
financial information about
distinguishable activities of a
government or other public sector
entity appropriate for evaluating the
entity’s past performance in
achieving its objectives and for
making decisions about the future
allocation of resources
IPSAS 19 - Provisions, Contingent
Liabilities and Contingent Assets
APPLICATION IN
“Municipal Accounting"
of depreciation of fixed assets, fully in
accordance with IPSAS. It also addresses
valuation of non-monetary assets, including
revaluation relating to inflation. This is a topic
that is only very recently being addressed, by
either national or international institutions.
Moreover, the private sector (notably in USA)
still shuns it! Thus, it is unlikely to become
standard practice, in many public sector systems,
any time in the near future. However much one
may support and recommend adherence to full
IPSAS, it is necessary to provide a satisfactory
alternative – for showing fixed assets in
balance sheets and also for charging an
appropriate portion of their funding costs
against annual current revenuesiv. Detailed
examples of this can be found within the main
text of the book, especially in Chapters 14 – 16.
Chapter 21 shows, also with detailed examples,
how to convert these methods to full IPSAS and
beyond, including fixed asset valuation!
The entire text is concerned with the allocation
and analysis of activities among services, units,
divisions and/or programs. It includes a variety
of worked examples, showing how the various
segments of overall activities are differentiated
or combined. Moreover, within the context of the
matrix of analysis, there are two sets of results
that can be derived. One is the inputs (e.g. labor,
materials, contracts, transport, plant, stores and
capital charges). The other is outputs (e.g. health,
education, roads, street-lighting, solid waste
removal etc.). Statements can be prepared using
either aspect, for management or external
purposes. These would be in accordance with the
IPSAS.
Various aspects of provisions and reserves are
explained and illustrated by examples in Chapter
8. References are made, where appropriate, and
throughout the text, to contingent assets and
49
 STANDARD APPLICATION IN
“Municipal Accounting"
liabilities. This concern, however, is to an extent
The objective of this Standard is to
one that addresses reporting, rather than basic
define provisions, contingent
accounting. The basic accounting within the text
liabilities and contingent assets,
can readily be adapted or adopted to deal with
identify the circumstances in which
these matters.
provisions should be recognized,
how they should be measured and
the disclosures that should be
made about them. The Standard
also requires that certain
information be disclosed about
contingent liabilities and contingent
assets in the notes to the financial
statements to enable users to
understand their nature, timing and
amount.
This IPSAS deals with the presentational
IPSAS 20 - Related Party
aspects of financial reporting, rather than with
Disclosures
the accounting aspects. The final accounts
The objective of this Standard is to shown in Chapter 16 provide abundant examples
require disclosure of the existence that can be adapted or adopted for the purposes
of related party relationships where of disclosing related party transactions.
control exists and the disclosure of
information about transactions
between the entity and its related
parties in certain circumstances.
This information is required for
accountability purposes and to
facilitate a better understanding of
the financial position and
performance of the reporting entity.
The principal issues in disclosing
information about related parties
are identifying which parties control
or significantly influence the
reporting entity and determining
what information should be
disclosed about transactions with
those parties.

50
i
“Municipal Accounting for Developing Countries” by David C. Jones
ii
Used for purposes of instruction, this is a unique technique developed by the author.
iii
Clearly, the methodology was speculative. As it transpired, however, this is suitable for application (or adaptation) to the most advanced systems
currently in use or being developed.
iv
This is essential, for both cash-flow and cost purposes. The UK, for example, requires a statutory “Minimum Revenue Provision.”