5. Government accounting and the use of the accruals basis
5.1 Government accounting
Government accounting is the process of recording, analyzing, classifying, summarizing communicating and interpreting financial information about government in aggregate and in detail reflecting transactions and other economic events involving the receipt, spending, transfer, usability and disposition of assets and liabilities. The purposes of government accounting are:
; To carry out the financial business of government in a timely, efficient and
reliable manner (e.g. to make payments, settle liabilities, collect sums due,
buy and sell assets etc.) subject to necessary financial controls.
; To keep systematic, easily accessible accounting and documentary records as
evidence of past transactions and current financial status, so that detailed
transactions can be identified and traced and all aggregates can be
conveniently broken down into their constituent parts.
; To provide periodic financial statements, containing appropriately classified
financial information, as a basis for (a) stewardship and accountability and (b)
; To maintain financial records suitable for budgetary control, internal control
and the needs of auditors.
; To provide means for effective management of government assets, liabilities,
expenditures and revenues.
In government, the producers of accounting information are rarely qualified accountants. Therefore few have experience of accrual accounting. But they usually belong to a separate cadre allowing for training and the acquisition of specialist accounting skills. In some countries, those who supervise the accounting process are not themselves trained in accounting. Accounts are kept for a wide variety of administrative entities: ministries, departments, taxing authorities and spending units (including for instance hospitals, research centres, colleges, schools, police stations, defence establishments). Accounting entities are spread throughout the country, from the capital city to the remotest corners. Given such a spread, the capacity of accounting entities and of their staff is bound to vary considerably. In order to ensure adequate accounting from such a wide range of entities, a government accounting system has to be:
; Relatively uniform
; Simple to learn and operate
; Easy to consolidate
One of the challenges of accounting reform (for example introduction of accrual 1) is deciding where to stop. Reform cannot be accounting or of a modern treasury system
conveniently brought to all accounting entities in one fell swoop, so a border has to be defined within which the reform is to take place. Usually a small number of entities is responsible for a large number/amount of transactions. The most logical choice for the purposes of reform is to address the needs of these large entities. At the same time the accounting systems of entities not subject to the reform process will require adaptation to allow the reformed system to perform effectively. The characteristics of the accounting system (for instance the basis of accounting; the nature of financial statements) have to suit the needs and capacity of users. An accounting system could be very good when compared with international accounting standards, but might be of limited value to the country concerned, if there were few or no people acquainted with these standards.
A government accounting system normally has eight main components:
; Documents providing evidence of transactions
; Bank accounts through which payments and receipts are handled
; Accounting records (cash book, ledgers etc.)
; Procedures and controls
; A means of aggregation of accounting data
; Internal accounting reports
; External accounting reports (financial statements)
Sub-systems of a government accounting system are as follows:
; General ledger (a system of classified ledger accounts allowing all revenues
and expenditures to be sorted into appropriate categories)
; Cash book
1 See paper four for a fuller discussion)
; Assets and liabilities including cash management
The performance of government accounting systems varies from extremely good, down to utterly inadequate. Many World Bank borrowers have inadequate accounting systems implying a range of difficulties in:
; carrying out day to day transactions at acceptable standards
; providing authentic and accessible records
; pinning responsibility on those alleged to have carried out corrupt activities
; achieving budgetary and internal control
; providing reliable time series data on expenditures, revenues and their
Given such possibilities the need for accounting reform is obvious. It presents a number of issues:
; Basis of accounting cash, accrual or mixed?
; Orientation: control, analysis or strategic choice (or all three)?
; Scope: ministries, major accounting units, comprehensive?
; Human dimension: determinant of success or major constraint?
; Medium of accounting: manual, partially or fully computerized?
; Users: general or specific?
; Financial statements: whole of government, agency , or more specific?
5.2 Bases of accounting
There are four main bases of accounting:
; cash basis
; modified cash basis
; full accruals basis
; modified accruals basis
The cash basis measures cash flows at the time those flows actually take place. The modified cash basis allows a short period of time after the year-end for settling liabilities of the year just ended (and treats this expenditure as occurring in the year just ended). The full accrual basis records expenditures and revenues when they become due (i.e. in many cases before the associated cash flows take place). It records assets and liabilities and is therefore associated with the production of balance sheets. It is also associated with providing depreciation on assets with finite lives. The modified accruals is similar to the full accruals basis, but it is simpler because it does not involve the capitalisation of fixed assets (nor the provision of depreciation of fixed assets).
The basis of accounting determines the extent of information that an accounting system can collect and therefore report. A pure, cash-based system can only report on cash balances and cash flows (inward and outward). But cash payment or receipt is usually only a small element in the history of a transaction. For instance a purchase transaction might go through the following stages, each of which could generate accounting information:
; Commitment of funds
; Issue of purchase order for the supply of goods
; Receipt of the goods and of the invoice claiming payment
; Payment of invoice
; De-commitment of excess funds committed
Pure cash accounting does not provide useful information for managing payables and receivables. In the above example, an accrual system would show the amount owing to the supplier. Then when full payment occurred, the amount owing would be extinguished. Of more practical importance is the lack of an accounting sub-system for receivables in a pure cash-based system. Without this, managing revenues is far less efficient. For instance if sums due are noted only in files, and not entered into a double-entry accounting system, they can easily escape attention. Moreover the files may be displaced
or lost. An accrual accounting system provides a systematic method of recording and managing sums due, something which many governments badly lack.
5.3 Arguments for the cash basis
Why then is the cash basis the predominant basis of accounting for governments? The answer is that the cash basis is:
; Easy to learn and carry out. It requires care, but no special accounting skills.
; Well-adapted to the needs of budgetary control. Payment is definite. Strict
budget control can be exercised by comparing sums authorized with those
; Easy to understand and verify.
; A statutory requirement in many countries.
In most governments the cash basis is used in conjunction with the commitment basis for budgetary control purposes. Under the commitment basis, expected expenditures are first entered into the accounting system as commitments (sometimes called obligations). Authorized expenditure (the available budget) is reduced by commitments which have not been liquidated (i.e. not been followed by a cash payment). However, when the cash payment occurs, the sum committed is extinguished.
5.4 Arguments for the accruals basis
The arguments for accrual accounting are as follows:
; Cash accounting does not generate enough useful information e.g. about
payables and receivables.
; Only accrual accounting, provides adequate information on the full costs of
operation, thus supporting decision-making e.g. decisions either to place sub-
contracts with private sector contractors or to carry out the work in-house.
; Only accrual accounting generates reliable information on the full range of
assets and liabilities.
; Only accrual accounting can generate comprehensive financial information
about government e.g. a loan which is written off has no impact on a cash-
based statement, but under accrual accounting it diminishes net worth.
These are strong and valid arguments. However, the possibility remains that accrual features could be added to a cash-based accounting system. The Bank funds several treasury modernization projects. They aim to improve budgeting, accounting and cash
management. They all use the cash basis and in all cases accrual-based sub-systems are added to cover payables and receivables and sometimes asset management (inventory and fixed assets). Moreover, liabilities arising from government borrowing are tracked and accounted for outside the treasury system. Is this a satisfactory halfway house?
5.5 Special needs of developing and transitional countries
What is a satisfactory halfway house depends on circumstances. It would not be satisfactory for those countries that have adopted, or are aiming to adopt full accrual 2 The following considerations accounting. These are without exception rich countries.
are relevant to a decision by a developing or transitional country to adopt full accrual accounting:
; Accrual accounting information is more difficult and more costly to produce
and to use, than cash-based accounting information.
; Part of the cost of using accrual-based data is the cost of understanding it.
Accrual-based data cannot be easily understood by non-accountants.
; The adoption of full accrual accounting is more complex and more costly than
the simple cash basis. Asset valuation is an example of complexity and cost.
; Modifying cash-based systems to produce some accrual-type data may make
; Poor countries usually lack accounting skills, and therefore have few trained
people who can either produce complex accounting information or use it.
; The accounting systems of many developing countries suffer from a range of
serious defects even though they employ the simplest accounting basis (cash).
There may be higher priorities for the use scarce accounting resources.
; Technical assistance could be used to supplement national accounting skills.
This might permit the introduction of accrual accounting, but how far would
such assistance go in producing a working, accrual accounting system for the
nation as a whole?
5.6 International Public Sector Accounting Standards (IPSAS)
The Public Sector Committee (PSC) of the International Federation of Accountants formulates IPSAS. The preface to IPSAS explains:
2 The case of Mongolia seems to be an exception. It has been attempting to adopt full accrual accounting. No assessment has yet been made of the degree of success.
; IPSAS are intended for national, regional and local governments and related
government entities such as agencies, boards and commissions.
; At present such entities have diverse reporting practices and there are no
authoritative international standards.
; IPSAS are authoritative requirements established by PSC to improve the
quality of financial reporting in the public sector around the world.
; PSC addresses governmental needs by issuing and promoting benchmark
guidance supported by education, research and dissemination.
; PSC’s primary focus is ensuring that its pronouncements are consistent with
those of the International Accounting Standards Committee.
; PSC is concerned with “general purpose financial statements”.
; IPSAS apply to the published financial statements of public sector entities
except for government business entities which are to follow International
Accounting Standards (IASs).
; IPSAS do not over-ride statutory or other official national requirements, but
PSC encourages governments and national standard-setters to adopt IPSAS.
PSC started work on the basis of four alternative accounting bases: cash basis; modified cash basis; modified accrual basis; and accruals basis. The cash and modified cash bases were defined as being practically the same (the only difference being that under the modified basis the books were left open for a period of months after the year end for the settlement of bills). The modified accrual and accrual basis differ principally in that the latter requires the capitalization of fixed assets and their depreciation. PSC assumed that countries would evolve along a continuum between cash and full accruals.
However, support for the two modified bases was judged to be inadequate (despite vociferous opposition from Canada) and the focus was shifted to two bases: cash and full accruals. Thus to comply with IPSAS a government must either use the cash or the full accruals basis for its principal general-purpose financial statements. Using the full accruals basis implies financial statements similar to those produced by large corporations.
PSC has produced one standard for the cash basis and is in course of producing a series of standards similar to those of IAS for the accruals basis. For a government entity to be in compliance with IPSAS its general-purpose financial statements must not mix bases of accounting (i.e. must be produced either on the cash or on the full accruals basis), and they must consolidate all the entities controlled by that entity. In other words a national government must produce fully consolidated financial statements for all the entities which it controls. This is an elegant solution to the shenanigans following the coming
into force of the Maastricht Treaty. Governments changed the definition of the reporting entity at will in order to fall inside the Maastricht criteria (general government budget deficit no more than 3%, and government borrowing no more than 60% of Gross Domestic Product). However elegant the solution, very few governments of developing countries consolidate accounting information to this level, very few are able to do so and even fewer are likely to wish to do so.
Other issues facing the IPSAS program are as follows:
; The virtually endless process of producing IAS look-alike standards.
; Lack of authority on the part of IFAC in securing adoption of IPSAS and a
possible vested interest in recommending accrual-based accounts (as IFAC
membership is made up of professional institutes of accounting primarily
concerned with private sector issues).
; Catering to the needs of a small number of developed countries while ignoring
the needs of a large number of developing countries.
; Excessive enthusiasm for an accounting model suitable for a sophisticated
economy without clear indications of its limitations in less developed
; Under-estimation of the likely difficulties which governments will face in
adopting IPSAS, especially the requirement for fully consolidated financial
statements on a single accounting basis.
Despite such issues there is strong support for IPSAS including virtual IMF endorsement in its new approach to Government Finance Statistics.
5.7 Discussion topics
Are there differences between the accountability models which should be applied to governments and to companies? Should government’s financial statements reflect
concepts which apply to commercial entities (profitability, keeping capital intact)?
Can governments be managed properly without the full range of accounting information that only an accrual-based system can supply?
What advantages and disadvantages are there in governments valuing their fixed assets and depreciating them?
What are the implications of PSC/IFAC requirements that in order to claim compliance with IPSAS all government controlled entities should be consolidated for the purpose of producing financial statements and (b) that only one accounting basis should be used in those statements?
Why, given its obvious defects, has the cash basis survived so long in government accounting?
Why do the Bank’s treasury modernization projects use the cash basis supplemented by systems for payables, receivables and commitments?
Is there a continuum between cash and accruals along which countries are likely to progress and if so how important is the modified accruals basis as a convenient staging post?
British Government (1994) Better accounting for taxpayers’ money: resource accounting and budgeting in government, Her Majesty’s Stationery Office, London.
International Federation of Accountants (2000), Financial reporting under the cash basis of accounting, Exposure draft9, Public Sector Committee, New York.
International Federation of Accountants (various dates), International Public Sector
Accounting Standards, Public Sector Committee, New York.
International Federation of Accountants (2002), Transition to the Accrual Basis of
Accounting, Public Sector Committee, New York.
Organisation for Economic Cooperation and Development (1993), Accounting for what?
The value of accrual accounting to the public sector, PUMA, Paris.
Organisation for economic Cooperation and Development (1997), Accrual accounting in
the Netherlands and the United Kingdom, PUMA, Paris.