In which circumstances the benefits of accruals accounting for government are likely to be fully realized?

Author: Emilio Valli. 

The recent academic literature on public financial management defines two broad systems of government accounting: cash accounting and resource-based or accruals accounting. 

In its basic form cash accounting is an “accounting method that records cash receipts, payments, and balances” on a yearly basis and “the cash basis of accounting recognizes transactions and events only when cash has been received or paid” (Schiavo-Campo and Tommasi. 1999: 496).  

This approach to accounting matches the needs of government for expenditure control in countries where political decisions are made on an annual basis (Mear and Flynn.2007); a short-term time horizon in which the incidence of capital expenditures (i.e. depreciation) on the total cost of a government activity is fractional and the effect of adjustments in the stock of capital assets can be omitted. Nevertheless, this approach is appropriate to the needs of government “provided that it is complemented by an adequate system for registering commitments and reporting on arrears” (Schiavo-Campo and Tommasi.1999: 21, 22) 

Modified cash accounting is a variant of the pure cash accounting form and aims to address the issue of recording end-of-year payments in the cash flows basis of the relevant fiscal year (Schiavo-Campo and Tommasi.1999). This is achieved by acknowledging payments or receipts occurred in the reporting period for which information on a cash flows basis cannot be obtained during the period, provided that documentary proof of the transaction is issued no later than a specified time limit within the next reporting period. Conversely, cash flows occurred in the initial reporting period but which relate to the previous, are deducted from the cash flows basis (Schiavo-Campo and Tommasi.1999).

Because modified cash accounting provides opportunities for the manipulation of national accounts, it has the potential to negatively affect government’s ability to exercise effective control on the level of aggregate expenditure. In simple words “this system normally adds trouble and risk, and is generally to be avoided” (Schiavo-Campo and Tommasi.1999: 22). 

Accruals or resource-based accounting derives from the commercial sector and, unlike cash accounting, this method records revenues and expenditures when they are due rather than when the cash transaction takes place. It is also important to observe that accruals accounting differs from cash accounting in that it aims at measuring the full actual cost of an activity or output by recording capital expenditures and adjustments in the stock of assets and liabilities of government (Mear and Flynn.2007).           

Two variations of the accruals accounting method can be identified:  modified accruals accounting, which in addition to cash transactions covers financial assets and liabilities, and full accruals accounting (or Whole of Government Accounts) which, in addition, covers the non-financial assets (Schiavo-Campo and Tommasi. 1999). Under both methods, a balance sheet is produced annually, which summarizes the overall financial position of the state (modified accruals accounting) or the position of the full asset base (WGA approach).  

Accruals accounting is believed to enhance the accountability of spending authorities in relation to their legal compliance in the management of public resources (in one word, for their stewardship) by improving the transparency of published accounts relative to the real costs of government activities.  Evans makes use of the term ‘true costs’ by which he means “all of the economic costs of a particular activity or of providing a particular service, including the cost of holding and using fixed assets in providing that activity or service” (Evans.1995: 4).    

By linking directly financial inputs with service outputs, accruals accounting is also likely to improve the accountability of government bodies for the use of public resources through accounts information that enables to assess government performance in achieving the set policy objectives and by disclosing the real costs of government activities (Evans.1995).   

Moreover, by adopting uniform accounting standards across the public sector comparable with those in the private sector, the accruals accounting system has the advantage of facilitating comparisons of costs between different government departments and between public and private sector, which in turn, if used by public managers, is conducive to enhanced efficiency savings (Evans.1995).  

Finally, by relating financial inputs with activities and services provision, accruals accounting is believed to provide decision-makers with a multi-annual perspective on the effect of their decisions (Evans.1995).           

A 1993 review of accruals accounting by the OECD, concludes that the application of some forms of accruals accounting in the public sector is necessary in order to provide public managers with the data needed to take informed decisions in a policy environment characterized by the application of the set of principles which form the New Public Management approach, including notably the principle of holding managers accountable for outputs, results and efficiency (Evans.1995). 

Nevertheless, the OECD study also makes explicit the conditions under which the accruals accounting information can realize the expected benefits. Notably: the information needs to be reinforced with data on the quality of outputs and services, to be fed in appropriate performance indicators; an implementation strategy should be developed based on an assessment of the needs of all accruals based information users; the framework for accountability needs to be clearly spelled out and incentives for public managers devised; the introduction of accruals accounting should be accompanied by significant investment in management information systems and in changing the organizational culture; a cost and benefit analysis of the investment should be undertaken; accruals accounting principles drawn from the private sector should be adapted to the specific nature of public sector activities (Evans.1995). 

The point to be retained is that accruals accounting is a tool which will not deliver the anticipated benefits unless put to use. Full implementation requires a sizeable, long-term investment in changing the culture of management in public sector organizations and in developing the management and technical skills of public servants to enable them to assume the complex tasks that this approach entails. A major investment in IT systems is also required to support the more complex management information systems that need to be established (Evans.1995). 

Crucially, incentives need to be devised for public managers with focus on allowing them to retain for their institution the additional savings generated through a more efficient financial management (Evans.1995). For this to happen, however, the role of the Ministry of Finance or of equivalent central statutory authority which has leading responsibility for the whole government economic management, should be considered. The scope and share of responsibilities of the ministries of finance is different from country to country, depending on their political and administrative needs (Mear and Flynn.2007), and any institutional reforms to enable a degree of financial decentralization should be tailored to a country ‘specificity’.   

As pointed out in the OECD review, in the most advanced countries the implementation of full accruals accounting remains largely at the conception or design stage. “In the one country that had fully implemented such arrangements (New Zealand) experience was limited to only approximately two years” (Evans.1995: 11).  This leads Evans to conclude that “clearly, the extent to which accruals accounting has or will actually benefit accountability and financial management will need to be assessed over a much longer term”(Evans.1995: 11). 

List of bibliographic references

Evans, M (1995) ‘Resource Accounting and Budgeting in Government: the Policy Framework’ in  Public Financial Management: Planning and Performance, Reader Volume One,London, Centre for Financial Management, SOAS, University of London, pp.67-99

Mear, F and Flynn, N (2007) ‘Unit 4: Accounting and Budgeting-National Level’ in Public Financial Management: Planning and Performance, Course Binder, London, Centre for Financial Management, SOAS, University of London, pp.2-13

Mear, F and Flynn, N (2007) ‘Unit 6: The Management and Control of Budgets’ in Public Financial Management: Planning and Performance, Course Binder, London, Centre for Financial Management, SOAS, University of London, pp.2-11

Schiavo-Campo, S and Tommasi, D (1999) ‘Managing Government Expenditure’, Chapter 6, Manila, Asian Development Bank, pp 1-26

Schiavo-Campo, S and Tommasi, D (1999) ‘Managing Government Expenditure’, Chapter 7, Manila, Asian Development Bank, pp 1-21