Question

The main purpose of the public sector financial reporting in the early days was to demonstrate compliance with legal and contractual provisions. These provisions did not require the determination and reporting of profit. Thus, accrual accounting was less practised or known in the public sector. However, due to the growing establishment of ‘business-type’ government agencies, the need for improvement in the accounting and reporting practices of those entities is essential. With a view to disclosing more meaningful information of the financial statement prepared by the government entities, many countries have begun to change their accounting techniques from cash basis to accrual accounting. The shift towards a comprehensive accrual-oriented public sector accounting and financial reporting structure began to take place in the late 1980s, most notably in New Zealand and Australia.  In Malaysia, a Treasury Circular No.4 on the implementation of accrual accounting in the federal government was issued on 28 March 2013. This circular has stipulated that all reporting entities in the Malaysian public sector are expected to produce financial statements prepared using the Accruals basis, for the first time in the financial year beginning on or after 1st January 2015. However, key challenges surrounding issues such as awareness, infrastructure, training and political will must be addressed before the benefits will become fully apparent. The continuous improvements in the public sector financial management of the Malaysian government were partly attributed to the extensive use of ICT in various government agencies. The integrated government accounting system anchored by the Government Financial Management Accounting System (GFMAS) as well as the Standard Accounting System for Government Agencies (SAGA) was the main impetus for the successful transformation and implementation of Accruals Accounting in the Malaysian public sector.

Elaborate on the implementation of Accruals Accounting by Malaysian Local Authorities and discuss issues inherent in the accounting treatment of heritage assets, military equipment and infrastructure assets.

Answer 1

Over the past two decades, a growing number of governments have begun moving away from pure cash accounting toward accrual accounting. While accrual accounting has been the norm among private corporations for over a century, the vast majority of governments prepared their budgets and accounts on a cash basis up until the end of the last century. The recent spread of accrual accounting to the public sector can be attributed to a number of related factors, including:

(i) a growing recognition of the limits of pure cash accounting

(ii) the development of accrualbased international standards for government fiscal and financial reporting including Government Finance Statistics Manual (GFSM) and International Public Sector Accounting Standards (IPSAS);

(iii) the professionalization of the government accounting cadre and resulting introduction of private sector techniques into the public sector; and

(iv) the advent of computerized financial management information systems (FMISs) which greatly reduce the transaction costs of collecting and consolidating .

Pure cash accounting has a number of weaknesses from the point of view of government financial transparency, integrity, and accountability. Under cash accounting, transactions are recognized only when the associated cash is received or paid and economic events are not reported if there is no immediate exchange of cash. Governments have been tempted to exploit this weakness by deferring cash disbursements or bringing forward cash receipts as a means of artificially inflating their financial balance. Moreover, governments that follow cash accounting tend to not maintain comprehensive and up-to-date records of the value of their assets and liabilities. This enables them to transfer assets (such as land or mineral rights) or incur liabilities (such as pensions or public-private partnership contracts) to third-parties without disclosing their financial implications for the government and taxpayer.The term accrual accounting has come to be associated with four related innovations in government accounting over the last several decades. These innovations are:

• The recognition of economic events in flow reports at the time at which they occur, as well as when the related cash receipts and payments change hands. For this purposes an “economic event” is an event which results in the creation, transfer, or destruction of economic value. Economic events can include the delivery of a taxable service by a private company (for whichthe government accrues tax revenue), performance of a public service by a government employee (for which the government accrues a salary and perhaps a pension expense), or the loss or theft of a government asset such as a vehicle or equipment (for which a reduction in the asset stock will be recognized). These economic events may directly generate a corresponding or simultaneous cash flow, but in many cases—such as depreciation, revaluations, or impairment—they do not. This is an important difference between cash and accrual bases. Note however these other economic events are real, and can be connected to previous or subsequent cash impacts: for example, depreciation usually represents the allocation of the cost of an asset over its useful life; and revaluation or impairment may reflect a changed view of the (cash) amount that can be recovered from the asset when sold.

• The recording of all stocks of assets and liabilities, in balance sheets. Governments that follow pure cash accounting typically account only for their cash holdings on the assets side and, possibly, debt on the liability side of their balance sheets. These are often valued at “book value” or the value at which they were initially acquired or issued. Under accrual accounting, governments recognize all assets and liabilities including financial assets (such as equities), non-financial assets (such as land and buildings), and liabilities other than debt securities and bonds (such as payment arrears and pension obligations). These stocks are usually recorded at their current market value, their value inuse, or some approximation, and regularly revalued to ensure the balance sheet reflects the government’s true financial position at a given point in time.

• Enhanced monitoring of liabilities and contingent liabilities. Liabilities such as employee entitlements, environmental obligations, insurance claim obligations, expected losses under guarantee schemes which are not typically recognized in a cash accounting environment receive much more attention once recognized under accruals.

• The consolidation of all entities under government control. Cash accounts typically only cover budgetary central government (central government ministries and agencies). Accrualbased international accounting standards call for financial statements which consolidate all entities under government control4 (such as extra-budgetary funds, arms-length agencies, and public corporations)

Accrual accounting therefore offers a number of benefits over traditional cash accounting from the point of view of government transparency, accountability, and financial management. First, by capturing both cash transactions and non-cash flows in financial statements, accrual-based fiscal reports provide a more comprehensive view of the government’s financial performance and the cost of government activities. Second, accrual accounting can help focus greater attention on the part of policymakers and the public on the acquisition, disposal, and management of government assets, liabilities, and contingent liabilities. Third, by consolidating not onlycentral government ministries and agencies but all institutional units under government control, accrual accounts provide a more complete picture of the financial position of the public sector as a whole. Fourth, by reporting stocks and flows within an integrated accounting framework based on internationally-accepted standards such as GFSM2014 and IPSAS, accrual accounting can improve the reliability and integrity of government financial data. At the same time, as discussed later this note, governments need to establish a well-functioning cash accounting system before contemplating a move to accrual accounting. Comprehensive and timely monitoring of cash reserves and flows is vital to evaluating a government financing needs at any point in time. Accounting for uses of cash is also important to ensuring the integrity of the government finances and ensuring that all cash receipts and payments are authorized by law. Finally, most government budgets are on a cash or modified cash basis, therefore effective monitoring of cash receipts and outlays is needed to report on the execution of the budget even after moving to full accrual accounting. This note provides those governments contemplating a move toward accrual accounting with guidance on the preparation, sequencing, and implementation of the reforms. The note builds on the conceptual guidance provided by Khan and Mayes’ Transition to Accrual Accounting by providing practical advice on preparing for the transition to accrual accounting, as well as the necessary changes to the format of financial statements, content of accounting policies, and design of accounting systems at each phase of the transition.6 It also identifies which IPSAS standards and elements of the GFSM2014 framework to adopt at each phase of the transition with the aim of achieving full compliance with both by the end of the transition.

• Clarify the objectives of the reform: Having a common understanding of what the move to accrual accounting is expected to achieve is essential in order to shape the transition and gain the necessary commitment and ownership. Objectives may include: greater external transparency, more reliable internal management information, stricter controls over expenditure arrears and other liabilities, improved working capital management, more efficient management of government assets, stricter financial oversight of extra-budgetary entities, or a better understanding and management of fiscal risks. The relative importance attached to each of these objectives will, in turn, inform the sequencing of the different reforms involved in the transition.

• Establish a representative reform team: This should comprise all key stakeholders, including the: Ministry of Finance (MoF), government accountants, line ministries, local government, public enterprises, statistics compilers, Parliament, Supreme Audit Institution and accounting standard setters, and may need to be split into a steering committee and task forces to deal with specific technical issues. A core of full-time staff in the MoF with a strong understanding of accounting will be essential to drive the reform, deliver training, ensure preparations are made for each phase, and address technical problems as they arise.

• Survey existing accounting policies, systems, skills and practices: This survey should cover the entire public sector including central government ministries, extra-budgetary funds and agencies, local governments, and public corporations and assess each sector’s current degree of compliance with the requirements of accrual accounting based on international standards. The results should inform both the costing of thereform and phasing of the transition. For example, it may be the case that some classes of public entities (such as local governments or public corporations) already apply accrual accounting in part or in full, and can therefore be brought into the reform effort sooner rather than later.

• Estimate the costs of reform: Once the above gap analysis has been completed, the government should estimate the costs of the reform to determine whether the prospective benefits outweigh the costs, and secure budgetary resources to implement the reform—which may be phased or involve partial adoption. Recent experience indicates that financial and other costs of reforms can vary significantly depending on the state of accounting practices, degree of ambition, and links with other financial management reforms.

• Establish a mechanism for setting accounting standards:

Historically in many jurisdictions, accounting standards in the public sector have been set by the MoF. This is at odds with the need for objectivity, independence, and integrity in government financial reporting. Many countries introducing accrual accounting based on international accounting standards have taken the opportunity to externalize the setting of accounting standards for the public sector by:

– Establishing independent boards designed to advise the government on the adoption or adaptation of international accounting standards (France, UK);

– Vesting responsibility for determination of public sector accounting standards in an independent national body (New Zealand, Australia, Canada, South Africa);

– Adopting standards developed by an international standard setter (Chile); and – Consulting the supreme audit institutions before enacting new accounting standards in the public sector .

Training and change management:

The introduction of accrual elements into government accounts will require significant training of preparers of the financial statements in new concepts, systems, and accounting methods. This training also needs to extend to the users of financial statements including ministers and senior officials in the MoF, parliamentarians, civil society, and the supreme audit institution (SAI).To reach this diverse range of stakeholders, training needs to make use of a variety of modalities including lectures, hands-on or online tutorials, guidance notes, and a dedicated helpdesk facility.

• Develop an action plan for the transition: The transition to accrual accounting is seldom, if ever, made in a single step. In most cases a transition plan needs to be defined, which sets out the key stages of the reform, including the responsibilities and timing for the preparatory tasks, reforms to the relevant systems and processes, and format and content of financial statements at each stage. The plan should also consider whether pilot exercises or parallel running of cash and accrual systems are required. IPSAS 33 provides further guidance for when an entity first adopts accrual basis IPSASs., including voluntary exemptions (or “reliefs”) during the transition period. The following section discusses a stylized phasing for the transition and the policy and operational reforms involved at each stage.