The long road to accrual accounting
For two decades, government finance professionals have been shifting from cash-based to accrual accounting. Dawn Cowie scours a new set of interviews for lessons on how governments can realise the accrual system’s benefits
Accrual accounting is viewed by many as the gold standard in public sector accounting and an important driver of better financial management around the world. Since the 1990s, national governments have been making the shift from cash-based to accrual accounting – and last month the International Public Sector Accounting Standards Board (IPSAB) published a series of video interviews exploring the method’s strengths and the challenges around implementing it.
In traditional cash-based accounting, revenues and expenditures are recorded when cash moves in and out of the organisation – so expenses appear in the accounts when invoices are paid, for example, whilst additional working days are logged when the employee receives their salary. But under accrual accounting, income and outgoings enter the system as the money is earned or costs are incurred – for example, when an invoice is generated or an employee works a day of overtime.
The IPSAB interviews reveal the challenges involved in making the transition to accrual accounting and International Public Sector Accounting Standards (IPSASs): these include the difficulty of overhauling financial systems and processes to log income and expenditure on a daily basis, retraining staff, and educating politicians about how to use the new information.
However, they also make clear that accrual accounting brings many benefits – such as more reliable, transparent and timely financial reporting; better decision-making by politicians and public officials; and greater transparency and clarity, resulting in better use of taxpayers’ money.
Motives for change
The main motive for public bodies to move to accrual accounting is the prospect of producing a clearer and more accurate picture of their financial position. Arguably, accrual accounting gives management a better understanding of the real cost of transactions in the public sector because it provides day-to-day information on how and where income and expenditure are generated.
In Australia – one of the first countries to adopt the system, in 1993 – this put an end to the “year-end spend-up”, says Mike Black, IPSASB member and former Auditor-General of Tasmania. This was where agencies would go on a spending spree in the last two months of the financial year after discovering they were going to underspend their budgets. “You didn’t need to do that if you managed your business on a proper accrual basis,” says Black.
With accrual accounting, managers are forced to grasp the true scope and cost of their assets and liabilities – and the implications of this data. As Black explains: “Some costs were not being captured under a cash-based framework. What was the real debt of the organisation, and what were the real assets we were managing?”
It also wasn’t clear that politicians were being held accountable in terms of their stewardship and management of the country’s resources. Black says: “How well were we managing those assets? Did we pay attention to those assets once the money was spent? What was the true cost of the taxes we needed to fund them?”
Accrual accounting has helped Australian decision-makers to plan for the long term, says Black. For example, there’s a better understanding of the country’s infrastructure assets: their lifespans, how they are valued, and how to ensure there are enough resources to maintain them for the longer term.
It’s also highlighted some of the country’s obligations, such as defined benefit liabilities in its public sector pension schemes. “What are the real costs of those arrangements?” says Black. “How long is it going to take to fully fund those arrangements, even though in Australia we’ve closed most of them down? They’ve got a run-out period going through to 2065-67. That is now much better understood.”
Making the system work
In the US, the shift to accrual accounting started in 1996 as part of a drive to improve the reliability of the financial statements produced by federal agencies, upgrade antiquated systems, and capture better information on assets, liabilities and net costs incurred throughout the year.
As Bob Dacey, chief accountant for the US Government Accountability Office, explains, the reliability of financial reporting has since improved dramatically. Of the 24 largest federal agencies, 21 received unmodified ‘clean’ opinions on their most recent financial statements, compared with six out of 24 at the start of the transition. The only agency that has never had a clean opinion is the department of defence.
One of the biggest US challenges has been overhauling organisations’ systems and processes to produce accurate and timely information, says Dacey. One of the problems was that financial statements and their audits were only due from federal agencies five months after the end of the fiscal year. “What we found was that people were spending that full five months coming up with estimates and numbers, but not improving the underlying systems and data that they really need day-to-day to make good financial management decisions,” says Dacey. The solution was to bring forward the deadline for audited financial statements to 45 days after the end of the accounting year, forcing agencies to come up with better systems and processes.
Building support
One of the common themes from the IPSAB interviews is the difficulty of convincing people who are comfortable with cash-based accounting of the need for change. In South Africa there was a lot of resistance to change, says Jeanine Poggiolini, technical director at South Africa’s Accounting Standards Board. “We were criticised, given the level of maturity of our public sector, for wanting to move to what is seen as the gold standard in public reporting rather than moving to something simpler first,” she says.
An ongoing challenge in South Africa is finding skilled accrual accounting practitioners who want to work in remote and rural areas. “Some of the rural areas have really embraced the change and developed their people appropriately. The problem is that they often can’t retain them,” says Poggiolini.
In Australia, Black says, the shift to accrual accounting initially led to many people leaving public sector agencies. But the system is now embedded across the public sector; and because many private companies have used accrual accounting for many years, these days it’s much easier for finance professionals to move between the public and private sectors.
Educating politicians
Rod Monette, Public Sector Accounting Board Chair and former Comptroller General of Canada, notes that when you’re putting in place a new financial system you need political support – not least because building the systems and capabilities required is expensive.
Looking back, Monette says he regrets not spending more time educating users about what his team were doing and why it was a good thing. “A lot of the financial statements are not easily understood by the average person or politician. We need people who can use the information,” he comments.
Talking about the Australian experience, Black says that politicians were left behind. “I look at the debates on the parliamentary floor and it’s all about inputs and cash. It’s not about the drivers of costs and transparency and managing our asset base and our debt,” he says.
The road ahead
In the USA, officials are still working to improve the way accrual accounting operates in some fields. These include intergovernmental transactions, where linking the work of different government agencies together can provide a much clearer and more up to date picture. Dacey notes that “one of the areas we’re looking at heavily is shared systems, where we can have common areas for processing systems and transactions rather than having each area develop their own and maintain it which can be very expensive.”
In Australia too, says Black, accrual management is still a work in progress – but it has already produced major benefits in public sector finance management. The next step is to roll out the system to remaining corners of government, ensuring that every national public body is making decisions on the basis of really accurate, clear and up to date information. “We couldn’t get agencies to run their businesses on the basis of accrual information,” he says. “We still find agencies that cash report monthly and only accrual report annually. That is still a gap, because they’re not making decisions based on the important information that’s needed month to month to run the business.”
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See also:
From counting figures to reconfiguring: the changing role of the government finance chief
About Dawn Cowie
Dawn Cowie is a journalist and editor based in London specialising in financial services and financial management. She has worked on news and analysis aimed at senior managers across the UK financial services sector for the past nine years and also has experience covering public policy and investor relations. She has edited magazines for the ICAEW and the CBI, and contributed to Financial News, The Wall Street Journal and Euromoney.
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