Accrual Accounting for the Public Sector in need of a re-think?

Andy Wynne - andywynne@lineone.net Introduction For the last decade or so accrual accounting has been presented as the preeminent reform for public sector financial reporting and the basis for the wider New Public Management reforms and the marketisation of the public sector (Barton 2005, Ellwood and Newberry 2007, Ouda 2004 & 2005, Wynne 2007, etc). However, it is becoming increasingly clear that the claimed benefits of introducing accrual accounting are not being realised in practice. In the few countries which have actually adopted this type of reform, the evidence now suggests that, if their governments knew then what they know now, the move to accrual accounting may never have taken place (Dorotinsky, 2008). Several other countries have also reviewed the evidence and have decided that a move to accrual accounting is not appropriate, at least in the short-term (for example, China, Ghana, Malaysia, Mauritius, Namibia, Netherlands, Pakistan). South Africa formally agreed to adopt accrual accounting with section 8 of the Public Finance Management Act, 1999 requiring the National Treasury to, prepare consolidated financial statements in accordance with generally recognised accounting practice. Since 2003, the Accounting Standards Board has produced a suite of accounting standards to define GRAP in the South African context, but relying heavily on International Public Sector Accounting Standards. However, these standards have largely yet to be implemented, so the financial statements for national and provincial departments for the year ending 31 March 2009 are to be prepared on a modified cash basis of accounting. In late 2008, the Finance Minister, Trevor Manuel, approved the implementation date of 17 accrual-based public sector Generally Recognised Accounting Standards, which are planned to be phased in over a period of time. Few national governments have actually adopted this approach, certainly at the national government level. Spain was possibly the first in 1989 followed by the celebrated case of New Zealand by 1993 and Australia in 1994 (Guthrie et al 2005). A few other governments followed over the next decade or so, but by 2006 the total was still only around 10 of the nearly 200 countries in the world (Wynne, 2007). In their summary of the extent of adoption of IPSAS, the IPSAS Board (IPSAS Board, 2008: page 4) list more than 50 countries which have made moves towards adopting IPSAS, but then admit that only five countries have fully adopted accrual accounting in line with their approach: Governments that already apply full accrual accounting standards and apply accounting standards that are broadly consistent with IPSAS requirements: Australia Canada New Zealand United Kingdom United States of America. So what is the evidence of the extent to which the benefits of accrual accounting have actually been delivered? This paper reviews the evidence which is available from on the UK experience. Evidence from the UK The UK has possibly the most extensive experience of adopting this approach for its public sector financial statements. Birmingham City Council, then the sixth biggest economic entity in the UK, moved to a form of accrual accounting in 1850, other local governments slowly followed over the next century. However, the current moves to accrual accounting in the UK

only really started with the health service in 1991. Central government eventually introduced accrual accounting from around 2000 (Wynne, 2007). Despite this long experience of using accrual accounting in the public sector, the use of cash accounting and budgeting, for central government at least, was almost universally accepted until relatively recently. So, for example, Andrew Likierman (the person who was later responsible for the transition to accrual based accounting in UK central government) was able to say, in a book published as late as 1992 that: Those who believe that private sector accounts are superior need to bear two factors in mind. First, that there are no immutable accounting or other financial reporting rules which apply irrespective of the nature and purposes of the organisation whose activities and results are being displayed or the objectives of presentation. Second, that cash accounts, despite their crudeness, have a degree of transparency that accrual accounts cannot give and that many private sector financial reports do not seek to offer. (page 23) Once accrual accounting was adopted by central government the assumed benefits appeared to be slow to arrive. So in a report issued in 2003 on the Governments financial management reforms, the UK National Audit Offices conclusion on the move to accrual accounting (first announced ten years earlier) was that: In most cases it is too soon to identify any discernible benefits from better resource management in terms of contributing to improved public services from for example, enhanced efficiency (Page 31). The National Audit Office published a follow-up report five years later, in February 2008. On the actual benefits of moving to accrual accounting this report concluded that: Departments have made significant progress in using accruals-based accounting and budgeting systems since our previous study. This has allowed departments to better understand how they are using their financial resources, for example by offering more detailed information to manage their assets and liabilities. Departments have used this information to help identify under-utilised assets and to dispose of those no longer required. (paragraph 9, page 7) So the only specific benefit of the move to accrual accounting appeared to be that ministries (called departments in the UK) were able to identify and sell assets (mainly buildings) which were no longer needed. Similar conclusions on the limited nature of the benefits of moving to accrual accounting are provided by academic research undertaken in the UK over the last few years. In 2005, researchers from Queens University, Belfast published the results of their research in to the costs and benefits of adopting accrual accounting in Northern Ireland (NI), a region of the UK (Hyndman and Connolly, 2005). Their research concluded that: Serious deficiencies in the accounting skills available contributed to a rushed, confusing and uneven implementation process (page 6) there was little evidence that [accrual accounting] information was extensively used in decision making within the NI public sector... Many interviewees identified the problems of unnecessary complexity and incomprehensibility of the information as undermining its potential use (page 7)

while no department had prepared a budget for the introduction of [accrual accounting], or kept records of actual costs, the costs were perceived as being substantial (page 7). Many of the costs of introducing accrual accounting will be ongoing rather than being one off. This will include, for example, the increased costs of employing significantly more professionally qualified accountants (Hyndman and Connolly, 2005). Governments have traditionally had few qualified accountants in their civil service because of the simplicity of their cash accounting systems; for example, in 2002 Norway had only one professionally qualified accountant on the staff of its Ministry of Finance. The UK public sector, especially local government, has a tradition of employing qualified accountants (perhaps because of its early adoption of accrual accounting) and they have their own professional body, CIPFA. Despite this, the number of professionally qualified accountants working across the UK central government increased nearly fourfold from almost 600 in 1989 to 2200 in 2003 (the period over which accrual based accounting was introduced) (Wynne, 2007). In addition, for example, the auditors fees for the UK National Audit Office increased by 67% with the introduction of accrual accounting in 2001/02 (NAO, 2002). The UK health service is highly capital intensive and so it may be assumed that the move to accrual accounting from 1991 would have provided significant benefits in terms of the more efficient use of these capital assets, for example, hospitals and medical equipment. However, a research report by leading UK academics in the field (Mellet, Macniven & Marriott, 2007), funded by the Scottish Institute of Chartered Accounting, concluded that: there was no evidence that the perceived benefits from the introduction of... accruals accounting... were being realised (page ix) In an article for the International Public Sector Bulletin (February, 2008) outlining the results of this study, the lead researcher, Howard Mellett provided further details, indicating that: No positive impact on decision making was found. Accounting measures did not influence rent or buy or retain or dispose decisions, although the desire not to take an adverse hit to the bottom line could impede disposal decisions. Similarly, no evidence was found of the opportunity cost of capital expenditure being recognised, as reflected through measures based on resource accounting, this being a matter for active consideration when acquiring or constructing fixed assets. (page 7) In this article, Mellett concluded by saying: Governments which have undertaken to implement accruals accounting should therefore beware of the fact that any potential benefits may not be realised. (page 8) The final stage of the move to accrual accounting in the UK was to have been the production of Whole of Government Accounts (WGA). However, recently published research suggests that this is facing significant problems: The longer the delays in publication of WGA financial statements, the more it is likely to be argued that the problems encountered are fundamental ones, rather than initial teething troubles or resource issues. (Chow et al, 2008, page 27) Several other people from the UK are concerned that the claimed benefits of accrual accounting are being over-sold especially to the governments of developing or transitional countries, for example, Noel Hepworth, the former leader of CIPFA (the UKs public sector accounting body) and formerly Chair of the Federation of European Accountants Public Sector Committee. Based on his experience of moves towards the introduction of accrual accounting in Eastern Europe, Hepworth (2003) concluded that:

To introduce accrual accounting is costly, time consuming and requires a diversion of resources from other activities. It requires a great deal of cooperation from key actors and will need significant changes of substance to the organisation, procedures and responsibilities of managers. As Parliament is also affected because of the changes that will be needed to the cash allocation and budgetary control processes it too will need to be consulted. What is more, accrual accounting provides wide scope for the exercise of judgement and this requires technical knowledge, a disciplined approach and an audit system capable of monitoring how judgement is exercised For these reasons the introduction of accrual accounting also carries considerable risk. (page 42) Members of the UK parliament have recently complained about the complexity of the Governments financial reporting. They claimed that even Members with financial or business experience struggle to understand the financial information provided and that had such a system been deliberately designed, it could fairly be assumed that it had been set up with the specific purpose of making it impossible to hold the Government and Departments to account (House of Commons, 2008). It is also recognised by HM Treasury (the ministry of finance in the UK) that current arrangements:

can cause confusion and inefficiency and make effective Parliamentary scrutiny of public spending more difficult. This is, moreover, a reform that many in Parliament have themselves called for. (Financial Reporting Advisory Board, 2007, page 2)
As a result, HM Treasury is currently working on a project designed to achieve better alignment between ministries budgets, estimates and financial accounts. The aim is to create a single, coherent regime that (NAO, 2008, page 13): improves the effectiveness, efficiency and transparency of the process enhances accountability to Parliament and the public and underpins the Government fiscal framework incentivises good value for money; and supports delivery of public services.

The wide ranging nature of these aims suggests that the British Government has been forced to recognise that the benefits claimed for its move to accrual accounting have not actually been delivered and that further major reforms to financial reporting are needed over the next few years. Conclusions Supporters of the move to accrual accounting argue that a range of significant benefits are available to governments which move from the cash to the accrual basis of accounting. Such arguments have been widely reported and repeated at many conferences. However, the authoritative independent research which is now available suggests that few, if any, of these benefits have been actually achieved in practice. In contrast, the costs of moving to accrual accounting are accepted as being substantial. In addition it should be noted that several leading OECD countries are still not convinced of the overall benefits of moving to full accrual accounting and budgeting. A recent multi-country overview by the US General Accountability Office concluded Accrual Budgeting useful in certain areas but does not provide sufficient information for reporting on our nations longerterm fiscal challenge. This reinforces growing recent scepticism on the value of a full transition to accrual accounting and budgeting.

The South African Government has spent several years preparing for a possible move to accrual accounting. However, the major costs of introducing this change have yet to been incurred. Over the last decade South African public sector accounting has been subject to major and far reaching reform. Given the turmoil, uncertainty and financial pressures resulting from the global economic recession, perhaps now is not the time to introduce a further wave of major reforms, especially where the evidence for their actual benefits is yet to be clearly shown. The financial statements of South African government departments already provide a wide range of information and, importantly, are produced and audited within three months of the year end a world class standard. Especially in a period of financial austerity, further reforms should concentrate on refining and consolidating these reforms. The question should not be when are we to adopt accrual accounting; but what specific additional refinements and information will actually be used by the users of the governments financial statements.

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