Question

In: Accounting

Public Sector accounting is budget driven because most of public entities do not operate on commercial...

Public Sector accounting is budget driven because most of public entities do not operate on commercial basis and as such do not earn income on their own. They are financed from the central pool of government revenue. Local authorities for instance obtain the largest proportion of their funds in the form of grants from the central government. Besides, the local authorities, there are nationalized industries which operate along similar lines like the private sector but regulated by the government and for that matter are limited in what they can do. Accounting information system in the public sector is provided for a host of interested parties with diverse needs and conflicting interest including taxpayers, donor agencies and politicians, etc.

Required:

Describe the characteristics of Public Sector Organisations and clearly show the major divisions of the public sector.                                     [28 marks]     

Identify and explain four main sources of financing the annual budget statement presented to the parliament of Ghana.                                        [20 marks]

Examine the objectives of public sector accounting and financial reporting.     [12 marks]

Solutions

Expert Solution

1. Characteristics of Public Sector Organizations and major divisions of the public sector.                              

                                              A commonly accepted definition of a public enterprise is “Any commercial or industrial undertaking which the government owns and manages with a view to maximize social welfare and uphold the public interest.”

Characteristics of Public Enterprises

The primary characteristics of public enterprises are:

1. They function under the direct control of the government and some are even established under statutes and Companies Act. Therefore, public enterprises are autonomous or Semi-Autonomous in nature.

2. Either the State or the Central government can control a public sector enterprise.

3. Primarily, the objective of establishing a public enterprise is to serve the public. They can supply essential goods/services at reasonable prices and also create employment opportunities.

4. A public enterprise endeavors to serve all section of people in the community.

5. In some sectors, private organizations do not have permission to operate. Therefore, the public sector enterprises enjoy a monopoly in operation. For example, the State enterprises have a monopoly in Energy production, Railways, and Post and Telegraph services.

6. Sometimes, the country receives financial/technological assistance from the international community for the development of industries. These grants are applied through public enterprises.

7. Public sector enterprises are liable to the general public for their actions.

8. These enterprises help in the implementation of the economic plans and policies of the government.

9. The government makes the primary investment in a public sector enterprise. However, they arrange finance for the day-to-day operation making it financially independent.

public sector enterprises have three different forms of organization:

1. Departmental Undertaking – which is primarily used for providing essential services like railways, postal services, etc. to the general public. A Ministry of the Government controls such organizations in the same way as any other department in the government. This form of a public enterprise is apt for activities which require governmental control for the public interest.

       This is the oldest form of public sector enterprises. The departmental undertaking is considered as one of the departments of government. It has no separate existence than the government. It functions under the overall control of one ministry or department of government.

a. They operate under the overall control of one of the ministries of central or state government.

b. They are a part of government only, there is no separate entity.

c. The revenue of departmental undertakings is deposited in the treasury of government.

d. They are financed from the annual budgets of the government.

2. Statutory or Public Corporation – The Parliament or State Legislature can create a corporate body through a Special Act which defines its functions, powers, and pattern of management. This is a Statutory or Public Corporation. In this form, the government provides the entire capital.

       A statutory corporation is a body corporate formed by a special act of parliament or by the central or state legislature. It is fully financed by the government. Its powers, objects, limitations etc. are also decided by the act of the legislature.

a. It is created by an act of parliament or central or state legislature.

b. The powers, objectives & limitations of a public corporation are defined in the act only.

c. Under total control of central or state government operations of public corporations takes place.

d. a public corporation is a separate legal entity. It gets incorporated automatically when the act is passed in the parliament.

3. Government Company – is a company in which the government holds at least 51 percent of the paid-up capital. A Government Company is registered under the Companies Act. Further, all the provisions of the Act are applicable to such a company.

a. It is created by an act of parliament or central or state legislature.

b. The powers, objectives & limitations of a public corporation are defined in the act only.

c. Under total control of central or state government operations of public corporations takes place.

d. a public corporation is a separate legal entity. It gets incorporated automatically when the act is passed in the parliament.

2. Main sources of financing

                                    Sources of finance for business are equity, debt, debentures, retained earnings, term loans, working capital loans, letter of credit, euro issue, venture funding etc. These sources of funds are used in different situations. They are classified based on time period, ownership and control, and their source of generation. It is ideal to evaluate each source of capital before opting for it.

                  On the basis of a time period, sources are classified as long-term, medium term, and short term. Ownership and control classify sources of finance into owned and borrowed capital.

Internal Sources

The internal source of capital is the one which is generated internally by the business. These are as follows:

Retained profits

Reduction or controlling of working capital

Sale of assets etc.

The internal source of funds has the same characteristics of owned capital. The best part of the internal sourcing of capital is that the business grows by itself and does not depend on outside parties. Disadvantages of both equity and debt are not present in this form of financing. Neither ownership dilutes nor fixed obligation/bankruptcy risk arises.

External Sources

An external source of finance is the capital generated from outside the business. Apart from the internal sources of funds, all the sources are external sources.

Deciding the right source of funds is a crucial business decision taken by top-level finance managers. The usage of the wrong source increases the cost of funds which in turn would have a direct impact on the feasibility of the project under concern. Improper match of the type of capital with business requirements may go against the smooth functioning of the business. For instance, if fixed assets, which derive benefits after 2 years, are financed through short-term finances will create cash flow mismatch after one year and the manager will again have to look for finances and pay the fee for raising capital again.

According to Time Period

1. Long-Term Sources of Finance

Long-term financing means capital requirements for a period of more than 5 years to 10, 15, 20 years or maybe more depending on other factors. Capital expenditures in fixed assets like plant and machinery, land and building, etc of business are funded using long-term sources of finance. Part of working capital which permanently stays with the business is also financed with long-term sources of funds. Long-term financing sources can be in the form of any of them:

a. Share Capital or Equity Shares

b. Preference Capital or Preference Shares

c. Retained Earnings or Internal Accruals

d. Debenture / Bonds

e. Term Loans from Financial Institutes, Government, and Commercial Banks

f. Venture Funding

g. Asset Securitization

h. International Financing by way of Euro Issue, Foreign Currency Loans, ADR, GDR, etc.

Medium Term Sources of Finance

Medium term financing means financing for a period of 3 to 5 years and is used generally for two reasons. One, when long-term capital is not available for the time being and second when deferred revenue expenditures like advertisements are made which are to be written off over a period of 3 to 5 years. Medium term financing sources can in the form of one of them:

a. Preference Capital or Preference Shares

b. Debenture / Bonds

c. Medium Term Loans from

d. Financial Institutes

e. Government, and

f. Commercial Banks

g. Lease Finance

h. Hire Purchase Finance

Short Term Sources of Finance

Short term financing means financing for a period of less than 1 year. The need for short-term finance arises to finance the current assets of a business like an inventory of raw material and finished goods, debtors, minimum cash and bank balance etc. Short-term financing is also named as working capital financing. Short term finances are available in the form of:

a. Trade Credit

b. Short Term Loans like Working Capital Loans from Commercial Banks

c. Fixed Deposits for a period of 1 year or less

d. Advances received from customers

e. Creditors

f. Payables

g. Factoring Services

h. Bill Discounting etc.

According to Ownership and Control:

Sources of finances are classified based on ownership and control over the business. These two parameters are an important consideration while selecting a source of funds for the business. Whenever we bring in capital, there are two types of costs – one is the interest and another is sharing ownership and control. Some entrepreneurs may not like to dilute their ownership rights in the business and others may believe in sharing the risk.

Owned Capital

Owned capital also refers to equity. It is sourced from promoters of the company or from the general public by issuing new equity shares. Promoters start the business by bringing in the required money for a startup. Following are the sources of Owned Capital:

a. Equity

b. Preference

c. Retained Earnings

d. Convertible Debentures

e. Venture Fund or Private Equity

Further, when the business grows and internal accruals like profits of the company are not enough to satisfy financing requirements, the promoters have a choice of selecting ownership capital or non-ownership capital. This decision is up to the promoters. Still, to discuss, certain advantages of equity capital are as follows:

It is a long-term capital which means it stays permanently with the business.

There is no burden of paying interest or installments like borrowed capital. So, the risk of bankruptcy also reduces. Businesses in infancy stages prefer equity for this reason.

Borrowed Capital

Borrowed or debt capital is the finance arranged from outside sources. These sources of debt financing include the following:

a. Financial institutions,

b. Commercial banks or

c. The general public in case of debentures

In this type of capital, the borrower has a charge on the assets of the business which means the company will pay the borrower by selling the assets in case of liquidation. Another feature of the borrowed fund is a regular payment of fixed interest and repayment of capital.

3. objectives of public sector accounting and financial reporting

Public Sector Accounting (ACC 310), introduced the simplest definition of ‘Public Sector’ is “all organizations which are not privately owned and operated, but which are established, run and financed by Government on behalf of the public.”

PURPOSE OF PUBLIC SECTOR ACCOUNTING

1. Demonstrating the proprietary of transactions and their conformity with the law, established rules and regulations.

2. Measuring current performance.

3. Providing useful information for the efficient control and effective management of government operations.

4. Facilitating audit exercise to be carried out.

5. Planning future operations.

6. Appraising those in the authority, in efficiency and effectiveness

OBJECTIVES OF PUBLIC SECTOR ACCOUNTING

(a) Ascertaining the legitimacy of transactions and their compliance with the established norms, regulations and statutes.

(b) Providing evidence of stewardship.

(c) Assisting planning and control.

(d) Assisting objective and timely reporting.

(e) Providing the basis for decision-making.

(f) Enhancing the appraisal of the efficiency of management.

(g) Highlighting the various sources of revenue receivable and the expenditure to be incurred.

(h) Identifying the sources of funding capital projects.

(i) Evaluating the economy, efficiency and effectiveness with which Public Sector Organizations pursue their goals and objectives.

(j) Ensuring that costs are matched by at least equivalent benefits accruing therefrom.

(k) Providing the details of outstanding long-term commitments and financial obligations.

(I) Providing the means by which actual performance may be compared with the target set.

(l) Proffering solutions to the various bottlenecks and/or problems identified.

Financial reporting is the financial results of an organization that are released its stakeholders and the public. This reporting is a key function of the controller, who may be assisted by the investor relations officer if an organization is publicly held. Financial reporting typically encompasses the following documents and postings:

a. Financial statements, which include the income statement, balance sheet, and statement of cash flows

b. Accompanying footnote disclosures, which include more detail on certain topics, as prescribed by the relevant accounting framework

c. Any financial information that the company chooses to post about itself on its website

d. Annual reports issued to shareholders

e. Any prospectus issued to potential investors concerning the issuance of securities by the organization

Objectives of financial reporting

1. Providing information to the management of an organization which is used for the purpose of planning, analysis, benchmarking and decision making.

2. Providing information to investors, promoters, debt provider and creditors which is used to enable them to male rational and prudent decisions regarding investment, credit etc.

3. Providing information to shareholders & public at large in case of listed companies about various aspects of an organization.

4. Providing information about the economic resources of an organization, claims to those resources (liabilities & owner’s equity) and how these resources and claims have undergone change over a period of time.

5. Providing information as to how an organization is procuring & using various resources.

6. Providing information to various stakeholders regarding performance management of an organization as to how diligently & ethically they are discharging their fiduciary duties & responsibilities.

7. Providing information to the statutory auditors which in turn facilitates audit.

8. Enhancing social welfare by looking into the interest of employees, trade union & Government.


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