Accrual Accounting & Financial Reporting:Accrual Accounting & Financial Reporting:Benefits and Challenges for the Public SectorBenefits and Challenges for the Public Sector

International Conference on Budgetary Process and Public Expenditure Management

May 25, 2000

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Accrual Accounting and Reporting: Benefits and Challenges for the Public Sector

• Overview of accounting and reporting bases

• Reasons for shift to accrual-based measurement

• Impact on information and incentives

• Extension of accrual measurement into budgeting

• Key challenges

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Measurement Bases Affect Timing of Cost Recognition

• Related to but different from cost allocation

• Changes in basis of measurement may or may not be combined with changes to account structure/ cost allocation

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Cash and Accrual Represent End Points on a Spectrum of Possible Reporting Bases

• Cash-based measurement records receipts and outlays when cash is received or paid, without regard to when the activity generating the revenue, consuming the resources, or increasing the liability occurs

• Accrual-based measurement records transactions in the period when the activity generating the revenue, increasing the liability or consuming the resources occurs--regardless of when the associated cash is actually paid or received

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Cash-based Measurement Traditionally Used in Public Sector

• Advantages:

– Widely used and traditionally accepted measure of government’s short-term impact on the economy

– Tangible (more easily understood and tracked)

– For some government activities, such as grants and salaries, there is not likely to be significant differences between cash and accrual

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Two Reinforcing Issues Have Stimulated Interest in Accrual Reporting and Budgeting

• Concerns about sustainability of government activities

• Development of more performance-focused management systems

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Shortcomings of Cash-based Measurement

• For some programs cash-based reporting and management may provide incomplete or misleading information and perverse incentives

– May fail to recognize future costs associated with current government activities

– May not properly align costs with the provision of goods/services

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Measurement Bases Provide Different Information and Incentives

• Example: Treatment of direct loans and guarantees

– Cash basis (before credit reform in U.S.)• $3 million in direct loans = $3 million in budget outlay• $3 million in loan guarantee = no budget outlay recorded

– Accrual basis (after credit reform in the U.S.)• Cost is recognized for the expected costs of new loans and

guarantees (on a net present value basis) at the time the creditis extended

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Measurement Bases Provide Different Information and Incentives

• Example: U.S. Pension Insurance – Cash-based budget

• Net outlays (cash income) = $1.1 billion

– Accrual-based financial statements• Liability = $9 billion

– Accrual (based on estimate of risk-assumed)• $20 to $40 billion

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Measurement Bases Provide Different Information and Incentives

• Example: Purchase and use of capital asset– Cash-basis: cash payments required in the period

• lack of up-front control over entire purchase price• fails to align costs with consumption of asset• potential for bias against large purchases

– Obligations-basis: budget authority for full price• better up-front control• fails to align costs with the consumption of asset• potential for bias against large purchases

– Accrual-basis: spread cost of asset over its life• lack of up-front control (w/o other compensating controls)• improves alignment of costs with consumption of asset• Asset does not appear as “free good” after initial purchase

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Audited Accrual-based Financial Statements

• Some key benefits– Improved access to reliable financial information– Improved financial, information and internal control

systems– More comprehensive picture of entity’s financial

condition– Consistent and independently verified reporting

practices– Cultural change

• Key Issue - how to integrate with budget and management process

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Accrual Budgeting:U.S. GAO Study Scope

• Countries reviewed:

– Australia– Canada– Iceland– Netherlands– New Zealand– United Kingdom

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Accrual Budgeting Adopted as Part of Broader Reform Efforts

• Impetus and magnitude of reforms varied across countries

• Broader reform context important to understanding the implications of accrual budgeting

– Example: New Zealand’s shift to accrual budgeting coincided with radical change in accountability relationships

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Countries Vary Significantly in Design and Implementation of Accrual Budgeting

• Countries vary with respect to

– extent to which accrual budgeting is part of output budgeting framework

– the scope of budget items measured on an accrual basis

– the organizational level to which accrual budgeting is applied

– the way the budget deficit/surplus is measured

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Accrual Budgeting Used to Support a Number of Reform Objectives

• To varying degrees countries adopted accrual budgeting to address:

– performance challenges

– sustainability of government activities

– accountability concerns

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Accrual Budgeting Used as a Tool in Performance Management Reforms

• By improving alignment of cost to performance, accrual budgeting viewed as:

– better reflecting and supporting more decentralized and performance-focused management systems

– facilitating more competitive, businesslike approaches and fostering cultural change

– encouraging more efficient and effective resource management

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Accrual Budgeting Used to Improve Information and Incentives to Assess

Sustainability Issues

• Sustainability of government activities partially addressed by:

– better budgetary recognition of assets and liabilities

– more complete information to assess a country’s financial health which is considered necessary to support longer-term management and policy perspectives

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Some Sustainability Issues Not Fully Addressed by Accrual-based Budgeting

• Some significant government commitments are not captured by traditional accrual accounting standards

• Meaning of some accrual terms such as “net worth” in government context is unclear

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Accrual Budgeting Used As Tool to Address Accountability Concerns

• Accrual budgeting cited as useful in improving accountability of government by:

– increasing the consistency and credibility of the budget by using generally accepted accounting standards

– improving consistency between ex-ante (budget) and ex-post (financial statement) information

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Accrual Budgeting Raises Some New Accountability Issues

• Some concerns raised included – need for more sophisticated understanding of financial

reporting standards and assumptions

– oversight premised on ability to adequately assess price and quality of outputs

– potential for reduced accountability for capital spending;

– reduce transparency of information on and attention given to the government’s borrowing requirement

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Common Implementation Challenges

• Accounting and reporting standards

• Information Systems

• Asset identification and valuation

• Oversight

• Cultural Change