Basic principles of financial reporting in the public sector

Fiscal Indicators Available in Accrual Statistics, Russian Federation, 2010

In some countries, such as Australia and New Zealand, the adoption of accrual accounting was associated with a broader set of economic reforms aimed at improving efficiency by embracing market-based competition in a range of sectors traditionally closely regulated or owned by government (see %Chapter 1). These two countries embarked on a drive toward closer engagement of the private sector in what were previously traditional areas of government (by contracting out, privatization, or public-private partnerships) and toward an explicitly performance-based approach to managing government resources that provided greater financial flexibility to public sector managers (see %Chapter 7). Accrual accounting was seen as supportive of these endeavors.

Accountants and auditors in the public sector also had a natural interest in the improvements being made in private sector accounting standards. And the adoption of accrual accounting was facilitated by the formulation and implementation of accrual accounting standards for government that were based on private sector standards but modified to reflect the specific circumstances of government. 5 The development of computerized accounting systems that enabled the more complex accrual approach also aided the application of accrual accounting to government. With the development of various accrual-based international standards for both statistics and accounting—including the United Nations’ System of National Accounts 1993 (SNA 1993) and the European Commission’s European System of Accounts 1995 (ESA 95), and later International Public Sector Accounting Standards (IPSAS) and the IMF’s GFSM 2001—accrual accounting became an international benchmark to which many countries aspired.

Practical impediments to adoption of full accrual accounting can be encountered, including the absence of trained accounting professionals within government, the absence of technical and political leadership, the lack of change agents (to overcome barriers to reform embedded in organizational culture), the cost of capacity building, and the cost of implementing new systems. A particular challenge in moving to full accrual accounting is the need to develop a full database of physical assets and to value those assets as required by accrual accounting standards. Some of the valuation methods—such as the market-based valuations required by GFSM 2001—require, in the absence of an active market for the assets, technical accounting capacity and difficult judgments. In developing countries, achieving robust cash accounting—supplemented by information on financial liabilities—is usually the priority and is typically sequenced before adoption of full accrual accounting.

The cost of overcoming these impediments to implementation of accrual reporting is not insignificant. For example, in 2010 the Dutch Minister of Finance informed parliament that the costs of implementing an accrual reporting regime in central government would be at least €129 million initially and at least €13 million a year thereafter. 6 By comparison, total spending of central government was €269 billion in 2010 (IMF, 2012b, p. 349). No complete cost-benefit analysis of accrual reporting has been done, probably because of the difficulty of placing a financial value on the hoped-for benefits, such as transparency and accountability.

Despite the costs, growing fiscal problems in advanced economies may well encourage more governments to adopt accrual reporting or, when accrual reporting is already used, to recognize a more comprehensive range of assets and liabilities. Many of the interventions made by governments in response to the global financial crisis, including the purchase of nonperforming assets and issuance of guarantees, are better reflected in accrual than in cash accounts. But even under most accrual reporting standards, guarantees are frequently not recognized on government balance sheets, and under some standards contractual pensions and obligations related to public-private partnerships are not recognized. These omissions create the same kinds of problems that led many governments to move from cash to accrual accounting in the first place and may create further pressure, both within governments and from external stakeholders, to enhance the comprehensiveness of fiscal reporting.

8.2. Coverage Of Reporting

Traditionally, central governments’ financial reports were closely tied to the budget, and thus showed the spending and revenue of government departments—an approach that was simple and allowed governments, the legislature, and the public to see how most taxes were spent and to check whether the budget was executed as planned. Transfers made in the budget to the central bank, state-owned enterprises (SOEs), and other extrabudgetary entities were reported, but not the total spending or total revenue of these entities. If the government reported debt, it probably recorded only its direct debt, and not the debt of other public entities.

Despite their appeal, budget reports have widely recognized limitations. Extrabudgetary funds can perform ordinary public functions, so budget reports can underestimate the impact of government on the economy. Similarly, the debts of SOEs may be implicitly or explicitly government guaranteed, so a measure of debt that includes only direct debt may underestimate the government’s debt-related problems. And, if spending is being devolved from the central government to sub-national governments (see %Chapter 12), budget reports can give a misleading picture of changes in total public spending.

Over time, these limitations have grown. The importance of public bodies other than government departments expanded after World War II, as public welfare systems developed, private businesses were nationalized, and independent regulatory agencies were created. Later, many governments sought to move the market-based activities of their ministries and departments into public corporations, only some of which were eventually privatized. Governments under pressure to reduce their reported deficit or debts also found it convenient to transfer responsibilities for spending and borrowing to these entities because they were outside the scope of the budget report. In the developing world especially, governments set up government-controlled and government-guaranteed development banks that could be used to channel resources to favored projects. Almost everywhere, governments encouraged their SOEs to pursue social as well as commercial goals. The problem was that the costs to the central government’s budget were often not avoided, just deferred: at some point the development banks and SOEs needed government bailouts. As the limitations of reports with narrow coverage became more obvious, the coverage of reports was often extended beyond the budget—though in divergent directions in accounts and statistics.

Government finance statistics are part of a broader system of national accounts in which the national economy is divided into five sectors: households, nonprofits, financial corporations, nonfinancial corporations, and governments (ISGWNA, 1993). Statisticians have therefore produced reports for government as a sector (general government), as well as for subsectors of general government such as local government and central government (which is broader than budgetary central government). State-owned banks and other enterprises are typically classified as financial or nonfinancial corporations and therefore excluded from statistics on government finances, though they can be included in reports on the public sector, a category that combines general government with government-controlled financial and nonfinancial corporations.

The extension in the coverage of statistics has been clearest in the European Union, where fiscal statistics are used as the basis of fiscal rules in a set of countries that differ greatly in the allocation of public responsibilities among the tiers of government—central, provincial, and local. Because of these differences, European rule makers and statisticians have emphasized the importance of data on general government, not just central government. As early as 1990, all members of the European Union, except Italy and Portugal, reported fiscal data to the IMF for general government (IMF, 1990, pp. 44, 96). Now all do. In the face of governments’ efforts to keep spending out of the accounts by having it undertaken by SOEs, European statisticians have also tried hard to include in general government all public entities that carry out noncommercial government functions, irrespective of their legal form.

Extensions of coverage have not been confined to Europe. Table 8.4, which has the same structure as Table 8.2, shows changes in the coverage of fiscal statistics reported to the IMF and published in its yearbooks of fiscal data. It reveals that from 2004 to 2011, the coverage of fiscal statistics increased in 59 countries, remained constant in 106, and declined in 19. Four countries that previously reported only for budgetary central government and ten that reported only for central government now report for general government.

Broadest Coverage of Fiscal Statistics Reported to IMF

Sources: IMF (2004, 2012b). Note: For concreteness, reporting is proxied by reporting of revenue. See also note to Table 8.2.