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Blog Article

Accrual accounting as a foundation for developing Public Financial Management

Monday 8 August 2022

Public financial management (PFM) has increasingly adopted accrual accounting in recent decades, which has improved financial information and management, and increased transparency and accountability. This has been a huge change in the public sector, much of which historically assigned (“votes”) tax revenues to be spent on objectives for one year only, in the context of longer/term spending plans. Money had to be spent in year and only amounts received or paid were accounted for in year (“cash accounting”). A full transition to accrual accounting is a long-term process and there are models for it such as the International Federation of Accountants (IFAC) Pathway to Accruals[1] and the Chartered Institute of Public Finance and Accountancy (CIPFA) Stepping Stones to Accrual Accounting[2].

Around 75% of nations have adopted accrual accounting for year-end report and some 25% prepare accrual budgets[3]. The scale of the public sector in many nations means that different parts have different legacy systems. Some parts may have long since adopted forms or accrual accounting while others have cash accounting systems. These need to be brought together if the aim is to provide state-level financial information, such as with the UK’s Whole of Government Accounts (WGA).

Valuing public sector

The public sector has many intriguing types of assets, such as nuclear power stations, palaces and castles, motorways and other roads, defence assets, and lots more. It is not always easy to value these using established valuation and accounting methodologies as, for example, there is often no real market for the assets and many have long life spans and some, such as historic assets, face significant impairment as they age. The valuation of employee pension benefits – in a sector that often employs many people and pension systems are of the “defined benefit” sort to be funded at least in part by tax revenues – often highlighted substantial liabilities that had not historically had to be valued, and so the position on them has become more transparent and plans could be made to help ensure their full funding.

While International Financial Reporting Standards (IFRS) have been applied in many parts of the public sector, including by the UK WGA, the sector now increasingly adopts International Public Sector Accounting Standards (IPSAS) to prepare financial statements on an accruals basis, reflecting the specific accounting and reporting requirements for the sector. The IPSAS Board has guidance for governments and government entities on the transition to accrual accounting (“Study 14”)[4]. IFAC has produced an introduction to IPSAS[5] and other guidance.

Greater information from accrual accounting has allowed for both targeted financial management, and greater transparency and accountability. For example, the New Zealand government has gone from negative to positive net worth since the introduction of accrual accounting [6]. The UK’s WGA to 31 March 2020 shows £2138.5 bn assets, of which 61% is plant property and equipment including roads and rail networks and £4,972.7 liabilities, of which £2,189.5 relates to public sector pension liabilities[7]. However, accrual accounting in government does not typically include substantial financial sums like future tax revenues and state pension liabilities.

The impact on career paths in PFM

The transition to accrual accounting and greater financial information has been an important factor in the professionalisation of financial management in many public sector settings. Many public sector institutions historically often appointed according to grade, rather than a professional specialisation. Governments often have a shortage of finance professionals generally because of factors like competition and economic migration and also a shortage of PFM expertise because further and higher education focuses on the commercial sector. The move to accrual accounting was often accompanied by an increasing professionalisation of PFM resources, such as requiring some level of certification, right through to professional qualification, or accreditation. Non-financial staff across the public sector also have to appreciate accrual accounting principles, such as to fulfil year end completion and disclosure processes.

Research by CIPFA[8] indicates planning and resource management is also a key financial skill for future PFM leaders and budgeting and financial experience will remain important, while strategic thinking is a key future non-financial skill in government finance. Accrual accounting expertise supports all of these.

Examples of projects to build government finance capacity include the African Professionalisation Initiative which has the goal to grow the capacity of professional accountants and auditors who are equipped to support accountability, transparency and good governance in the public sector.  It aims to address a severe shortage of professional accountants and auditors that have also typically only been exposed to private sector theory and often lack an understanding of public sector challenges and expectations[9].

Where next for financial information and reporting in the public sector?

The adoption of accrual accounting highlights how wider information on the use of resources benefits the public sector and so has naturally led to consideration of further development. The IPSAS Board is now seeking consultation on advancing public sector sustainability reporting[10] to evaluate the demand from stakeholders for sustainability reporting guidance and priority areas for guidance. It is also consulting on developing guidance on the recognition, measurement, presentation, and disclosure of natural resources in the public sector[11].

Individual nations are also taking other initiatives forward to improve information. New Zealand, for example, recently established a wellbeing budget[12], to measure progress on a broader range of measures than traditional fiscal and economic considerations.

The establishing of accrual accounting in the public sector has been an important step in improving the reporting and transparency of resources used in the public sector, but it will not be the last.

[1] Pathways to Accrual – International Federation of Accountants (IFAC)

[2] Stepping stones to accrual accounting – Chartered Institute of Public Finance and Accountancy (CIPFA)

[3] Accrual Practices and Reform Experiences in OECD Countries – International Federation of Accountants (IFAC)

[4] Study 14 - Transition to the Accrual Basis of Accounting: Guidance for Governments and Government Entities (Third Edition) – International Federation of Accountants (IFAC)

[5] Introduction to IPSAS – International Federation of Accountants (IFAC)

[6] New Zealand - the public finance pioneer – Public Finance Focus

[7] Whole of Government Accounts: year ended 31 March 2020 – HM Treasury, United Kingdom

[8] Talent Management in Government Finance – Chartered Institute of Public Finance and Accountancy (CIPFA)

[9] African Professionalisation Initiative

[10] Consultation Paper, Advancing Public Sector Sustainability Reporting – International Federation of Accountants (IFAC)

[11] Consultation Paper, Natural Resources – International Federation of Accountants (IFAC)

[12] Budget 2022: The Wellbeing Outlook and Approach – The Treasury, New Zealand Government

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