Chapter 5. Public Accounting and Fiscal Credibility
- Mario Pessoa, and Carlos Pimenta
- Published Date:
- January 2016
Joseph Cavanagh and Almudena Fernández Benito
Sound public financial management (PFM) requires good practices across all its components. The recent global economic crisis has refocused attention on the potential role of public institutions to catalyze economic growth despite the extreme pressures on public finances. Most countries in Latin America are carrying out important PFM reforms that, among other objectives, aim to build a better regulatory framework to provide legal certainty and ensure confidence in public institutions. These reforms include modernizing institutions such as national treasuries, developing or improving integrated financial management information systems (IFMIS), and creating new tools for a more reliable budget—discussed in other chapters of this book.
The modernization of public accounting takes rightful place among the various reforms. In particular, these reforms include a transition to full accrual-based accounting and the application of international accounting standards, with the objective of improving government transparency and accountability; contributing to better decision making in the formulation of national policies; strengthening fiscal sustainability and credibility; and providing a wider, more accurate and reliable perspective of a nation’s public finances. All these outcomes complement or reinforce the impact of other PFM reforms.
An accounting reform is a significant change in terms of scale and complexity. It brings many benefits, particularly as a consequence of the fresh information that it provides. This chapter—likely to be of interest to treasurers and other senior officials, in addition to public accountants, who are engaged in PFM—describes accrual accounting; provides a summary analysis of the status of the Latin American region; presents various case studies that relate to countries that are committed to accounting reform; and concludes with some thoughts on the execution of accounting reform in Latin America, including the implications for PFM practitioners.
Accrual-Based Accounting As a Tool for Improving Fiscal Credibility
One of the lessons from the 2009 financial crisis was that an incomplete understanding of a country’s underlying fiscal position can have a severe impact on its economy. This is usually a result of a lack of accurate information which, in some cases, is simply due to a government not being able to produce it. For example, a government may not have up-to-date data or reports on the size and maturity of its public sector debt; its hidden or implicit obligations to public corporations and public-private partnerships (PPP); accumulation of employee benefits, such as pensions; potential losses on assets; other liabilities that are not yet recognized; or contingent liabilities.
Since the late 1990s, there has been a concerted effort on the part of governments to improve fiscal transparency, especially since 2010. International institutions have developed international fiscal transparency standards, among which is the International Monetary Fund’s (IMF) Code of Good Practices on Fiscal Transparency and its supporting guides and manuals; specific standards for budget transparency, prepared by the Organisation for Economic Co-operation and Development (OECD); statistical reporting standards in the form of the IMF’s Government Finance Statistics Manual (GFS) and Euro-stat’s European System of Accounts; and accounting standards issued by the International Public Sector Accounting Standards Board (IPSASB).1
According to the IMF, fiscal transparency—defined as the clarity, reliability, frequency, timeliness, and relevance of public fiscal reporting and the openness to the public of a government’s fiscal policymaking process—is a critical element of effective fiscal management. Fiscal transparency helps to ensure that the economic decisions of government are informed by a shared and accurate assessment of the current fiscal position, costs and benefits of policy changes, and potential risks to the fiscal outlook. Fiscal transparency also provides legislatures, markets, and citizens with the information they need to make efficient financial decisions and to hold government to account for its fiscal performance and utilization of public resources. Finally, fiscal transparency facilitates the international surveillance of fiscal developments and assists in mitigating the transmission of fiscal spillovers between countries.
Access to information is key to ensure financial accountability, although the incentives and regulations—particularly with regard to accounting standards and principles, as well as to the audit process—are also critical elements (Schick, 2013). Improving a country’s accounting system by fully adopting accruals and comprehensively disclosing information will most certainly achieve greater transparency and accountability.
The IMF’s new Fiscal Transparency Code gives significant importance to the comprehensive, timely, relevant, and reliable overview of the financial position of the public sector in accordance with international standards.2 There are at least six dimensions that relate to accounting information, which are considered essential to fiscal reporting:
Coverage of institutions. Fiscal reports cover all entities that are engaged in public activity, according to international standards.
Coverage of stocks. Fiscal reports include a balance sheet of public assets, liabilities, and net worth.
Coverage of flows. Fiscal reports cover all public revenues, expenditures, and financing.
Timeliness of annual financial statements. Audited or final annual financial statements are published in a timely manner.
Classification. Fiscal reports classify information in ways that make clear the use of public resources and which facilitate international comparisons.
External audits. Annual financial statements are subject to a published audit by an independent supreme audit institution which validates their reliability.
A country is classified as having achieved an advanced level of fiscal transparency when the above-mentioned dimensions follow international accounting and auditing standards. Such standards include accounting standards issued by IPSASB and auditing standards issued by the International Organization of Supreme Audit Institutions (INTOSAI).
Accrual-based accounting, if properly implemented, should prevent—or at least make more difficult because of increased transparency—some of the fiscal maneuvers or window dressing that governments revert to present their finances in an overly positive light. Such financial and accounting devices can have a significant fiscal impact (Irwin, 2012). Better accounting, reinforced by strong, independent, and professional external audit, can ensure better outcomes. Most significantly, accruals accounting can provide the vehicle to highlight such issues, in ways not possible under cash accounting. Like any vehicle, however, it may not be driven appropriately!
Key Conceptual Differences between Cash and Accruals
The concept behind accruals accounting is very simple. Under cash accounting, payments and receipts are recognized and brought to account when they are paid or received. In contrast, under accruals accounting, transactions and other events are recognized at the time they occur and in the accounting period to which they relate (and not at the time when cash or its equivalent is received or paid).3 So, for example, under accruals an advance payment of rent for five years is brought to account in the five years to which the rent relates, and not when the cash payment is made. Therefore, transactions and events are recorded and recognized in financial statements, based on the period to which they relate.
Behind what appears to be an apparently simple idea, however, there is considerable complexity associated with new concepts for those accountants accustomed to working only on a cash basis.
Perhaps the most significant conceptual difference with cash accounting is that accrual accounting concerns the full range of assets and liabilities of the accounting entity, as well as changes in their value. Cash accounting relates only to one asset: cash,4 including its related movements through cash payments and receipts. This extension of the accounting perspective—from cash to all forms of value—is most clearly visible in the comparison between the principal financial statements that are produced under the two approaches (Figure 5.1):
Under cash accounting,5 it is generally sufficient to produce a statement of cash receipts and payments, including opening and closing cash balances.
Under accruals accounting, it is also necessary to produce a balance sheet6 which shows the assets, liabilities, and net worth or equity (i.e., assets less liabilities) of the entity at the start and end of the accounting period; an operating statement which shows the revenue,7 expenses, and surplus or deficit for the period; and a statement of any other changes in net worth (or equity), which are not reflected in the operating statement. Standards also require a cash flow statement and a full set of disclosure notes.
Figure 5.1Comparison of Cash-Based and Accrual-Based Financial Statements
Source: Authors’ elaboration.
A second major variance between cash and accruals accounting is that the latter tends to break away from the focus on the annual budget and budget performance. Traditional cash-based government accounting is often based on accounting for budget allocations and associated parliamentary appropriations to show whether ministries, as well as government as a whole, have under- or over-spent against their budgetary allocations and the sums voted by the legislature. Similarly, cash accounting is often restricted to accounting for budgetary moneys only—where the accounting entity is usually a budgetary entity (or budget holder). In contrast, accruals accounting covers all the resources used or belonging to an entity, including budgetary funds; and the accounting entity itself is defined in terms of economic concepts of ownership and control rather than in terms of budgetary accountability or boundaries. There is still scope for budgetary accounting within an accruals regime—elaborated on later in this publication—but the main determinants of accrual accounting coverage and presentation are economic rather than budgetary.
This wider perspective is interesting for other areas of PFM as an element that positively contributes to second-generation reform in treasury management which, today, is being pursued in some countries within the Latin American region. The new financial instruments that have come into use, such as treasury bills and treasury bonds, as well as other more complex financial instruments, would not be recognized in financial statements under a traditional pure-cash basis. A switch to accrual accounting will improve the comprehensiveness of financial statements and reporting, as well as the fiscal credibility of a country. Those countries with more fiscal credibility usually have better credit ratings and, hence, have increased access to international financial markets at lower interest rates.
A third significant difference between cash and accruals is the extent to which professional judgment is required concerning the basis of measurement and the boundary for capture. Under the cash basis, it is generally straightforward to decide which transactions should be captured within the accounts and how they will be measured (i.e., any transaction that affects cash balances, measured by its direct cash impact). Under accruals, however, it is not so straightforward: decisions are required about what constitutes the accounting entity or boundary, which assets and liabilities should be included, and how these should be measured and reported in the accounts. In accruals accounting there is far more scope for professional judgment, governed or guided by accounting principles or standards and exercised by professional accountants. This is a sharp contrast to cash accounting, where such matters may be determined by financial administrators who are responsible for the budget and its delivery, probably working with accountants who may be trained only in the specifics of budget accounting. The move to accruals accounting, therefore, will doubtless bring a shift in the balance of influence toward professional accountants (and auditors).
One final conceptual difference that is important between cash and accruals is the degree of certainty and verifiability attached to figures in the accounts. Under cash accounting, it is not unusual for accounting and financial reporting to be in fine detail—to the last cent—and for balances to be directly and fully reconcilable with bank records or physical checks on cash equivalents. Under accrual accounting, accounts are composed of cash-based transactions, which can be directly verified, and accounting estimates and calculations, based on professional judgment and accounting standards. These latter items will include, for example, figures based on algorithms and formulas (e.g., depreciation, work in progress, bad debts provision), or estimates (e.g., actuarial estimates of pension liabilities, external professional valuations of assets). In essence, cash accounting measures and reports on one asset with great accuracy: cash. In contrast, accrual accounting reports on the entire range of assets and liabilities, although with some inherent inaccuracy or fuzziness (i.e., including accounting judgments and calculations that represent a best estimate of the value being reported).
What should be included and how best to value some economic account items are examples of questions that generate most debate. Nevertheless, despite the imperfections, it should be better to have a more complete picture of financial performance and position rather than focusing only on cash. Furthermore, full accruals accounting does not relinquish or reduce cash control and analysis; it actually supplements cash-basis accounting information by providing a cash flow statement, which is one of the financial statements prepared under accrual accounting that reflects all inflows and outflows of funds related to economic activity.
Links between Accruals and International Accounting Standards
The inherent need for professional judgment in accruals accounting leads directly to the question of how such judgment should be exercised. It is, of course, up to the discretion of a government or individual entity to develop and determine its own accounting policies, according to its own logic. However, this does not suggest that a government may set its own rules so as to present a more favorable picture of its finance and financial management.
There is much to be gained, therefore, from the development of standards that have some external validity. There is now a considerable body of international accounting standards and established practices, on which governments can draw. Much of this work has its roots in the efforts to standardize accounting practices in the private sector, now reflected in the International Financial Reporting Standards (IFRS), produced by the International Accounting Standards Board. For the public sector, and since the late 1990s, IPSASB—which is a part of the International Federation of Accountants (IFAC)—has been producing the International Public Sector Accounting Standards (IPSAS). The latter are largely based on IFRS, although they are adapted to or developed for the public sector. The only internationally recognized set of standards for the public sector are IPSAS (European Commission, 2013).8 The choice of international standards, therefore, will largely come down to IFRS for government business enterprises and IPSAS for the rest of the public sector (see Figure 5.2).9 Commercial entities within the public sector should apply IFRS or the national equivalent.
Figure 5.2International Accounting Standards for Various Public Sector Units
Source: Authors’ elaboration.
The advantage of basing national standards on international ones is that the latter have been developed after an arduous work on behalf of international experts, and based on national accounting best practices. In addition, private sector—and more recently public sector—standards are based on a conceptual framework that defines the purposes of financial reporting, outlining the main concepts that underlie accounting and the standards-setting process. As such, international standards increasingly provide a sound and integrated framework of guidance. As a result, it should be easy, when viewing a set of accounts that follow international standards, to find the relevant information and understand it. Accounts that comply with international standards will almost certainly be more credible to the public and the legislature, as well as the international development community, lenders, and the rating agencies that monitor the financial health and performance of countries. While the work on these standards is already substantial, it is not yet complete. The process of developing and amending them, as well as identifying new requirements, continues.
International standards are framed in terms of financial reporting requirements; that is, they specify what should be reported or disclosed in annual financial statements. They do not specify the manner in which this information should be obtained or how accrual accounting should be implemented. They are, however, the key driver that informs the transition to accrual accounting.
With one exception, all standards apply to accruals accounting. There is, so far, only one (unnumbered) IPSAS for cash accounts and, as of end-2014, 32 accrual-based IPSAS (Table 5.1), of which one (IPSAS 15) has been superseded by later standards.10
|Standard||Title of the standard|
|IPSAS 1||Presentation of Financial Statements|
|IPSAS 2||Cash Flow Statements|
|IPSAS 3||Accounting Policies, Changes in Accounting Estimates, and Errors|
|IPSAS 4||The Effects of Changes in Foreign Exchange Rates|
|IPSAS 5||Borrowing Costs|
|IPSAS 6||Consolidated and Separate Financial Statements|
|IPSAS 7||Investments in Associates|
|IPSAS 8||Interests in Joint Ventures|
|IPSAS 9||Revenue from Exchange Transaction|
|IPSAS 10||Financial Reporting in Hyperinflationary Economies|
|IPSAS 11||Construction Contracts|
|IPSAS 14||Events after the Reporting Date|
|IPSAS 15||Financial Instruments: Disclosure and Presentation|
|IPSAS 16||Investment Property|
|IPSAS 17||Property, Plant, and Equipment|
|IPSAS 18||Segment Reporting|
|IPSAS 19||Provisions, Contingent Liabilities, Contingent Assets|
|IPSAS 20||Related Party Disclosures|
|IPSAS 21||Impairment of Noncash-Generating Assets|
|IPSAS 22||Disclosure of Financial Information about the General Government Sector|
|IPSAS 23||Revenue from Non-Exchange Transactions (Taxes and Transfers)|
|IPSAS 24||Presentation of Budget Information in Financial Statements|
|IPSAS 25||Employee Benefits|
|IPSAS 26||Impairment of Cash-Generating Assets|
|IPSAS 28||Financial Instruments: Presentation|
|IPSAS 29||Financial Instruments: Recognition and Measurement|
|IPSAS 30||Financial Instruments: Disclosures|
|IPSAS 31||Intangible Assets|
|IPSAS 32||Service Concession Arrangements: Grantor|
At least in theory, it is possible to remain on a cash basis and claim compliance with international standards. It is evident, however, that IPSASB never intended for cash basis to be a permanent solution. The cash IPSAS even includes sections on accrual-type disclosures and the transition to accrual accounting. Furthermore, IPSASB has published a separate study paper that provides guidance on the transition from cash to accruals (IPSAS, 2011). It is therefore fair to say that the adoption of international standards will often go hand in hand with a switch to accruals. Transition to accrual accounting will usually involve the gradual adoption of relevant standards, as discussed later in this chapter.
International accounting standards are not mandatory; there is no international law that requires their adoption. Instead, each country should adopt or adapt the relevant standards into its own national law or regulations.11 Nevertheless, countries that fully transition to accruals usually take the standards into consideration to some extent, which is certainly the case in Latin America.
The adoption of standards can take place directly or indirectly (Bergmann, 2009). Directly, the legislation of the country refers specifically to the adoption of the original IPSAS text (e.g., Dominican Republic). Indirectly, as in the case of Brazil and Chile, the country approves standards in its legislation, based on IPSAS to a greater or lesser extent. These are followed by secondary regulations that put them into force. In both approaches, an accounting manual is the vehicle to promulgate national standards, while technical consultations with regard to their implementation are carried out through administrative resolutions.
Similarly, “adoption of IPSAS” can be distinguished from “adaptation to IPSAS.” In the former case, standards that are applicable to a country are transposed into national legislation without significant change. In the latter case, a country that adapts its government accounting to IPSAS usually does not entirely change its national legislation; rather, it includes some changes to bring it closer to international standards, such as in the case of Brazil. In addition, some countries may opt not to apply certain standards, as is the case of most of Latin America in terms of the IPSAS relating to financial reporting in hyperinflationary economies.
Advantages and Disadvantages of Switching to Accrual-Based Accounting
There is considerable debate about the advantages and disadvantages of switching to full accruals accounting. The growing weight of opinion, however, is in favor of accruals accounting, demonstrated by the increasing number of countries, worldwide, that have adopted or intend to adopt accrual accounting and international standards.12
Those who make the case against accrual accounting argue that cash accounting has served governments well for a very long time13—that it is well suited to the needs of the public sector, especially to budgetary accounting; and that accruals can undermine cash and expenditure control. Opponents also state that much of the additional information that accruals accounting requires and produces (e.g., fixed assets, investments, or public debt) already exists and can be reported separately or as an adjunct to the cash accounts. They also contend that the cost of moving to accruals accounting is significant, and that the required systems and technical expertise may be beyond the capacity of governments in many developing countries. Finally, they contest that accrual accounting results in financial statements are difficult to understand and interpret; that they rely too much on judgment rather than on certainty; and that they include numbers that are less accurate than cash numbers. These arguments are worth considering, for at the very least they highlight some of the key risks to avoid or which should be minimized when transitioning to accrual-based accounting.
In contrast, advocates of accrual accounting argue that it represents a significant change in the coverage and the transparency of governments’ financial information. They claim that it provides public financial managers, parliamentarians, analysts, commentators, and members of the public with a more complete view of government financial performance and position, prepared within a coherent framework of international standards. Users of the accounts will be able to focus beyond cash and budgetary numbers, with the availability of structured information on material assets and liabilities. Users also will be privy to information that may never have been published before or that was only available in separate or highly technical publications. Supporters argue that accrual accounting is entirely compatible with cash control and management, stating that some of the weaknesses in public finance—exposed by the recent global economic crisis—such as high government indebtedness, would have been apparent sooner had accruals accounting been in place. On the issues of cost and transition challenges, these should not be avoided; rather, they should be appropriately managed, with a transition that is well planned and compatible with a country’s capacity. Proponents of accruals accounting also believe that its adoption will strengthen or revive the various systems and controls that are required to achieve sound financial management (e.g., monitoring of asset holdings, public debts, and other liabilities). Furthermore, they point out that accruals accounting has been the norm in the private sector since the nineteenth century or earlier.
The intelligibility and reliability of accruals information presents challenges to government accountants. These can be overcome by the application of international standards to ensure that financial statements are comprehensible, comprehensive, useful, and reliable (i.e., fit for purpose). Their reliability is reinforced by the scrutiny of independent and professional public audit institutions. A final benefit is that accruals accounting, when well implemented, may improve a government’s standing with rating agencies, which influences the cost of borrowing. A half a percentage point less in interest rates can make a very significant difference in borrowing costs.
Overall, therefore, the balance of argument is more in favor of accruals. Implementation should be tailored to the needs and capacities of each country: transition should be at a pace that allows the costs to be managed and which is compatible with the capacity to undertake such reform.
Public Accounting in Latin America
In comparison with other regions of the world, public accounting in Latin America is well established. These countries prepare comprehensive financial statements on a yearly basis, following a modified cash or modified accruals basis.
The accounting systems in Latin America are all based on Spanish (or Portuguese) tradition in terms of legislation. In general, they are similar in the following ways:
Legal framework. Countries have a solid and hierarchical legal framework. The government accounting system, as well as each segment of the PFM system, is defined by law. At the peak of the legal pyramid is the Constitution, which includes the consolidated data relating to the financial statements. Most countries include the supreme court of auditors and/or the comptroller general’s office (Contraloría), as well as their obligations with regard to the audit of the consolidated statement and the deadlines for submission to parliament. At the second level of the pyramid, a financial-administration act or the organic budget law identifies the entity in charge of government accounting and the general principles on which government accounting will be based. These principles are developed by a secondary legislation (e.g., regulations, decrees), usually approved by the minister of finance and prepared by the government accounting director or Contraloría. Secondary legislation also includes the government accounting manual, guidelines that incorporate the methodologies, and accounting consultation.
Double-entry accounting. Countries apply a double-entry accounting method that recognizes credit and debit records; this is equally applied by the private sector. The institutions responsible for recording data are established within the various line ministries, decentralized entities, regions, and municipalities. Data is recorded in an information and communications technology (ICT) system that is integrated with other systems, to a greater or lesser extent, depending on the country.
Transparency. Countries prepare financial statements for publication (Table 5.2) and submission to parliament. The timing of submission varies among countries. According to the IMF’s Fiscal Transparency Code, the “advanced” standard on the timeliness of annual financial statements is met when the audited or final annual financial statements are published within six months beyond the end of the financial year. Not many countries in the region meet this standard; they usually present their statements between 12 and 18 months beyond the end of the financial year.
Legislature oversight. Countries involve their respective parliament in the final approval of consolidated financial statements, although the approval’s impact and the discussions on public accounts vary significantly from country to country. In general, however, due to presentation delays, the parliamentary discussion has insignificant outcome or impact.
Multilayer government structure. Finally, countries have—to a greater or lesser extent—a complex territorial structure that includes the central government, regions, many municipalities, and public business entities. It is important to highlight that subnational governments have significant autonomy in managing their expenditures, and their revenue system is based on a mix of transfers from the central government, as well as revenue. In some countries, subnational governments are able to approve their own accounting regulations and use their own ICT systems, although they are not always adequately integrated within the central government system. This profusion of systems tends to create greater complexity to the scope of accounting, making such reforms even more challenging. Moreover, the resources—in terms of technical capacities and methods—are often inadequate in comparison with central government, constituting significant obstacles to the full adoption of accruals.
|Legal basis for reporting requirements|
|Constitution||Law approved by the legislature||Organizational or internal rules||Publication of consolidated central government reports|
|Argentina||X||X||Central Budget Authority website|
|Brazil||X||X||Central government information portal|
|Chile||X||X||General Controller Office information portal|
|Colombia||X||Line ministries or individual agencies|
|Costa Rica||X||X||Central Budget Authority website|
|Dominican Republic||X||X||Line ministries or individual agencies|
|Ecuador||X||Central Budget Authority website|
|El Salvador||X||X||X||Central government information portal|
|Guatemala||X||X||Central Budget Authority website and line ministries or individual agencies|
|Honduras||X||Central Budget Authority website|
|Mexico||X||X||Central government information portal|
|Panama||X||Line ministries or individual agencies|
|Paraguay||X||X||Central Budget Authority website|
|Peru||X||Central Budget Authority website|
Accounting Reforms in Latin America
Latin America has experienced a growing interest in international accounting standards during recent years. Several countries have moved toward adoption, reflecting the advantages of fully applied accruals—as explained in the previous section of this chapter. None of the countries, however, has yet completed the transition. The concept behind accounting reform is to improve the reliability of data, transparency, and fiscal credibility of financial statements and to enhance the quality of decision making and the formulation of national policies.
This section broadly presents the status of accounting reform in various Latin American countries. The relevant data has been collected from various sources, including country websites, public documents, and the exchange of information that took place during the first seminar of the Latin American Government Accounting Forum (Foro de Contadores Gubernamentales de América Latina (FOCAL)) (Box 5.1).
To date, no country in the region has fully applied IPSAS or accrual-based accounting practices. However, none are applying simple cash accounting. Most countries are implementing a mixed system that combines accruals accounting for various elements and cash accounting for others.
Accounting reform is a custom-made process. Several conditions can affect the pace and rhythm of such reform, such as the degree of support from the highest authorities, level of capacity, and appetite for reform within the ministry of finance, as well as the specific functionalities within financial systems. A further key underpinning is the need to update accounting policies to fully complete the implementation process. These factors make it very difficult to categorize countries. Nevertheless, to present a view of the status of Latin America, four groups have been distinguished and are represented in Figure 5.3.
Figure 5.3Accruals Implementation in Latin America
Source: Authors’ elaboration.
Box 5.1.A Permanent Forum on Government Accounting: Latin American Government Accounting Forum
In November 2014, the first seminar of the Latin American Government Accounting Forum (Foro de Contadores Gubernamentales de América Latina (FOCAL)) was held in Chile. The seminar was organized by Chile’s Contraloría General with the support of the Inter-American Development Bank, International Monetary Fund, and World Bank. FOCAL is a new initiative, sponsored by 14 Latin American countries, in parallel to the successful Latin American Treasury Forum (Foro de Tesorerías Gubernamentales de América Latina (FOTEGAL)), established in 2010.
FOCALa aims to provide a permanent forum for technical discussions and exchanges of experience in the transition process to accrual accounting and the adoption of IPSAS. During the first seminar, the discussions focused on several topics, such as the importance of appropriate accounting standards to improve fiscal transparency and accountability; managing the transition from cash to accruals; and the accounting of financial instruments, concessions, and public-private partnerships.aFurther information can be found athttp://www.contraloria.cl/NewPortal2/portal2/ShowProperty/BEA%20Repository/Sitios/FOCAL/index.html.
Excluding those countries (white) that fall outside of the national legislation sample, the first group of countries (light pink) (i.e., Argentina, Bolivia, Paraguay, Uruguay) includes those that have not formally initiated the transition process nor have adopted IPSAS. They account within their own legislation, usually with a mix of cash and accrual methods. It is very common, for example, that revenues are identified when cash flow takes place, in contrast to expenses that are identified on an accrual basis (e.g., ensuring budgetary payments are made in the thirteenth month or similar extended period). In some cases, the national legislation is already broadly consistent with IPSAS, placing these countries in a better position at the start to enable them to complete the reform.
The case of Argentina reflects this particular stage—a country that has not changed its national regulation since 1996 and which, to date, has not yet published a strategy encompassing the adoption of IPSAS. The current system was approved by a resolution, submitted by the Secretary of Finance in 1996 to modify a previous resolution that was passed in 1993. The Secretary of Finance, through this resolution, delegates to the General Accountant the power to approve secondary legislation, referred to as Disposiciones. The resolution approves the Manual of Government Accounting, comprising a glossary, chart of accounts (CoA), operating instructions, and examples of financial statements.
Paraguay and Uruguay are in the process of analyzing the benefits of reform. So far, no strategy has been officially adopted.
The second category of countries (medium pink) includes those (i.e., El Salvador, Guatemala, Nicaragua, Panama) that are in the process of IPSAS accounting reform, having already implemented a strategy. In Guatemala, for example, accrual-based accounting began subsequent to the enactment of the Organic Budget Law in 1997, and the IPSAS implementation process commenced in 2005 as part of a financial systems project.
The transition to IPSAS in Panama also relates to a new IFMIS, now a priority of the Ministry of Economy and Finance. While IPSAS adoption is intended, the strategy has yet to be approved, (i.e., supported by the government’s Director of General Accounting and the Contraloría, who are responsible for approving the new regulation).
The third group of countries (dark pink) (i.e., Colombia, Dominican Republic, Ecuador, Honduras) have prepared a transition strategy or are at the stage where an official pronouncement to transition to IPSAS has been made, although the transition has not yet officially begun. For instance, in Colombia, the Public Accounting Regime (Régimen Contable Público) approved a resolution in 2007 that comprises the General Public Accounting Plan, Operating Procedures Manual (Manual de Procedimientos), and Public Accounting Principles. In June 2013, the National Comptroller General (Contraloría General de la Nación) published a strategy to incorporate IFRS and IPSAS (Colombian Government, 2013). The strategy presents the background to the public accounting regulation, as well as the conceptual framework for IPSAS, and it demonstrates the intention of the General Accountant to adopt IPSAS in the near future. The next step will include the approval of accounting policies in line with IPSAS, followed by the gradual introduction of the new framework. On its end, Ecuador enacted a law in 2010 that defines accruals as the accounting principle to be observed by entities in the nonfinancial public sector. The government plans to implement IPSAS by 2019.
Lastly, the fourth group of countries (red) shows those (i.e., Brazil, Chile, Costa Rica, Mexico, Peru) that have approved a plan to include legal authority to implement IPSAS or full accrual accounting. In Peru, for instance, IPSAS have been officially adopted and the authorities are working on applying the standards. In Brazil, however, there has been an official adaptation, or convergence, toward IPSAS.
In the case of Mexico, the General Law of Government Accounting (Ley General de Contabilidad Gubernamental) was approved on December 31, 2008. The law is applicable to the entire government. The initial date for implementation of the new accounting procedures was January 1, 2009, but the deadline has been extended successively to January 2013 and January 2014. In April 2015, the financial statements of the executive, legislative, and judiciary branches; autonomous entities; and the parastatal sector of the federal government were finally presented for the first time, following the harmonization of the framework.14 The law requires that revenues and expenditures be calculated according to accrual-based accounting procedures. In August 2009, the National Council of Accounting Harmonization (Consejo Nacional de Armonización Contable (CONAC)) published a conceptual framework relating to government accounting, which defined the accounting standards to be issued by CONAC, along with IPSAS standards, as well as supplementary IFRS ones.
Alternative Methods to Assess Progress
The survey that was presented at the FOCAL seminar represents those countries that are considering government accounting reform. Each anticipates issuing financial statements according to IPSAS standards over the medium to long term, despite the variation in their strategies, which will become apparent in the survey.
The application process will differ between countries, although most have established 2019—or later—as the expected first year to issue IPSAS financial statements for their respective central government. The later date, for example, applies to Brazil (2020), Chile (2019), Costa Rica (2021), and Panama (2021). Countries that are in the initial stage of transition should expect a longer implementation period.
Most countries prefer to fully adopt IPSAS rather than assume specific amendments for their current frameworks. Countries, essentially, are not required to adopt the IPSAS standards in their entirety since some of the standards do not apply to them (e.g., IPSAS 10 regarding hyperinflation). Furthermore, various areas are missing from the current version of the IPSAS framework (e.g., mineral rights and reserves), for which other principles are more relevant. Some countries are adopting the standards in stages, such as in Honduras where the standards will be divided for the short, medium and long term. Chile categorized the standards in four groups, as shown in Figure 5.4, but issued all the standards at the same time in the Resolution of the General Controller Office number 16, approved in March 2015.
Figure 5.4Phased Study of Accounting Standards: Chile
Source: Contraloría General de la República de Chile.
All the countries in the sample, with the exception of Uruguay, prepare financial position and financial performance statements (Uruguay prepares a Treasury Position statement, as well as a comparative statement of budget-to-actual amounts). Most countries also prepare a cash flow statement and one that compares budget to actual amounts; others (e.g., Costa Rica, El Salvador, Panama) add a statement of changes to net assets.
The coverage of financial statements varies significantly among Latin American countries. Some include information that only covers the central government, while others include the public sector. For example, Mexico prepares financial statements that cover only a limited number of entities within central government; Honduras includes only the central government, although it intends to eventually expand the framework to embody its municipalities. Chile and El Salvador incorporate general government, although they do not consolidate the accounts by layer of government which, instead, are presented in separate tables that make up the same document; and Peru’s financial statements include the entire public sector. In nearly all countries, these statements are published, most of which are accompanied by an external audit review.
The timeline for financial statements varies. It takes up to 18 months in some countries, which is somewhat longer than the ideal under-six-month period, previously mentioned.
Finally, the comprehensiveness of disclosure notes varies significantly among countries. Most will present information on accounting policies, cash and cash equivalents, and public debt. In contrast, data relating to salaries and benefits of public officials and the details of uncleared, suspended accounts may also be reported.
The survey of Latin American countries has revealed that countries that seek to upgrade their government accounting system to full accruals usually face two kinds of challenges:
Transition process—how to prepare a strategy to adopt (or adapt) IPSAS: Four case studies on accounting reforms are presented to assist in the identification of the most important obstacles that countries face during transition.
Standards—how to technically implement some of them: Based on the survey previously mentioned, some countries face accounting elements that are challenging. These include fixed and intangible assets (IPSAS 17, 31), accounting for contingent liabilities and provisions (IPSAS 19), tax revenue recognition (IPSAS 23), and financial instruments (IPSAS 28, 29, 30). Box 5.2 summarizes the implications of these specific standards.
Other issues that relate to accounting reform, which are considered key to its success, include the integration of government accounting with budget and treasury processes. These aspects highlight the significance of developing a standardized CoA and clear budget execution process; having a modernized IFMIS in place; and ensuring the relevant technical capacities. These issues are covered in the following section of this chapter.
Case Studies: Accounting Reforms in Chile, Brazil, Costa Rica, and Peru
Sequential Model of IPSAS Adoption: The Case of Chile
Experience has shown that the preferred way to implement IPSAS in the region is by doing it gradually and in phases. While there is no unique path to follow, Figure 5.5 presents a general approach, based on the experience of Chile—a simplified process of preparation and implementation of IPSAS and one that can be applied in other Latin American countries.
Figure 5.5Approach to the Adoption of IPSAS in Gradual Steps
Source: Authors’ elaboration.
Box 5.2.Challenges Regarding Accounting for Economic Activities in Latin America
Infrastructure assets (e.g., road networks, sewer systems, power and telecommunications networks) represent a major class of asset that is relevant to the public sector. Currently, no Latin American country has a complete inventory of its fixed assets. Such information can provide multiple benefits. In particular, it will make policymakers aware of the country’s asset holdings and help to identify unproductive assets. By actively managing public commercial assets, a country can generate more income, thus lowering public debt and contributing savings on debt interest. Compiling an inventory, however, and obtaining valuations of the many types of public asset, can represent a major challenge, especially where asset management systems are obsolete or nonexistent.
From an accounting perspective, these elements (with the exception of heritage assets) are covered by IPSAS 17 and must follow the standard’s requirements for recognition, valuation, and disclosure. The same applies to specialized military equipment. Physical assets covered by IPSAS 17 would normally be recognized at cost, including those costs associated with acquisition and preparation for use. Where there is no exchange transaction, the asset must be recognized at fair value. Thereafter, the asset is depreciated over its useful life, applying either the cost or revaluation method. The same method (cost or revaluation) must be applied to all assets within the same class:
Cost method: The asset is carried at cost, less accumulated depreciation and impairment losses. Depreciation is charged as an expense over the asset’s useful life, using a systematic basis (e.g., straight line, unit of use/production, diminishing balance).
Revaluation method: The asset is carried at revalued amount, which is fair value at revaluation date, less accumulated depreciation and impairment losses. Fair value would normally be based on market values, although the absence of a market may require other approaches, such as the market value of analogous assets, depreciated replacement cost, or restoration cost. Valuations and revaluations would normally be carried out by professional valuers on a frequency determined by the nature of the asset and the volatility in value: the more volatile the value, the more frequent the valuation. Some assets may require annual valuation, while other classes may justify a three- or five-year revaluation cycle.
Upon disposal or retirement of an asset, there may well be a gain or loss that also needs to be recognized.
Heritage assets (e.g., historical buildings and monuments, archaeological sites, conservation areas and nature reserves, and works of art) are not required to be recognized; however, if recognized, they can be valued by using an appropriate method or methods, depending on their type.
An intangible asset is an identifiable nonmonetary asset without physical substance. While it is tempting to consider that these are relatively rare, they are more common than might be imagined. They include copyrights, patents, and other intellectual property rights; software; websites; advertising, startup, research and development activities; airport landing rights; and broadcasting and telecommunication licenses. The recognition of these kinds of assets could facilitate better management of administrative concessions and the improved delivery of public services.
IPSAS 31 provides guidance on the accounting treatment of such assets. Under the standard, recognition of heritage intangible assets is optional, and the standard excludes concession or mineral extraction rights. Intangible assets should be measured initially at cost, unless they are acquired through a nonexchange transaction, when they should be measured at their fair value on acquisition. Subsequent valuation should use the cost or revaluation method, with all assets in the same class adopting the same method. Intangible assets with a definite lifespan are amortized, using a systematic method over their useful lives, while those with an indefinite life are not depreciated. An asset is derecognized when disposed of or it no longer brings economic benefit.
Provisions and contingent liabilities
The recognition of provisions in the balance sheet and the disclosure of information on contingent liabilities are important elements that can improve financial reporting for a country. IPSAS 19 concerns the reporting of probable or possible events which will have an effect on the entity’s finances.
A provision is a present probable liability of an entity, of uncertain timing or amount. The recording of the liability in the entity’s balance sheet is matched to an appropriate expense account in the entity’s operating statement.
Contingent assets and liabilities, on the other hand, are possible and outside the control of the entity (e.g., liabilities that depend on judicial disputes), or (less commonly) are present obligations whose value cannot be estimated reliably. Contingent assets and liabilities are disclosed in the notes to the accounts.
Since the last global economic crisis, countries are paying more attention to fiscal risks and contingent liabilities. Several countries in the region are interested in preparing a report that reflects both components and, in some cases, are in the process of doing so.
This is probably one of the most challenging changes that a country in transition may face. So far, no Latin American country has recognized revenues under an accrual basis. The revenue recognition principle is a key component of accrual accounting, together with matching principle. They both determine the accounting period in which revenues should be recognized. According to the principle, revenues are recognized when they are earned (usually when goods are transferred or services rendered, or when a taxable event occurs), no matter when cash is received. In cash accounting, in contrast, revenues are recognized when cash is received, regardless of when it was earned. The implications are significant; think, for example, about income taxes; these are accrued during a fiscal year, but often collected during the following year.
Regarding taxes, IPSAS 23 suggests the recognition point or event for typical tax streams (i.e., when the legal right to receive has been established). IPSAS 23 poses special challenges in administrations where tax assessments are subject to regular legal challenge and other factors which may delay or impede eventual collection. Countries may, therefore, hesitate to apply the standard as recommended. If applied, however, the accounts would then show taxes assessed, as well as taxes “lost,” though legal challenge and other reasons—which are items of legitimate management and taxpayer interest, reflecting on the efficiency of tax administration.
The use of financial instruments is becoming very popular and sophisticated in Latin America. Under a cash basis, some are not recognized in the budget, since they do not have any impact from a budgetary perspective. That is why the accounting recognition becomes a cornerstone for providing this kind of information to policymakers and third parties interested in the financial situation of a country.
The term “financial instrument” is defined as “any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity.” The asset or liability will be settled in cash or a contractual right to receive cash, or an equity instrument (e.g., shares). In practice, the term covers a range of assets and liabilities, such as cash, loans made and received, bonds held and issued, and equity investments. In addition to these “primary” financial instruments, it also covers derivatives, financial guarantee contracts, and other more complex arrangements. There are IPSAS standards that deal with the presentation (IPSAS 28) and the recognition and measurement (IPSAS 29) of financial instruments. A further standard (IPSAS 30) deals with additional disclosures in relation to financial instruments and risk.
|Type of tax||Recognition point|
|Income tax||The earning of assessable income during the taxation period by the taxpayer|
|Value-added tax||The undertaking of taxable activity during the taxation period by the taxpayer|
|Goods and services tax||The purchase or sale of taxable goods and services during the taxation period|
|Customs duty||The movement of dutiable goods or services across the customs boundary|
|Death duty||The death of a person owning taxable property|
|Property tax||The passing of the date on which the tax is levied, or the period for which the tax is levied, if the tax is levied on a periodic basis|
IPSAS 28 sets out the principles for classifying financial instruments as assets, liabilities, or net assets, as well as principles for offsetting financial assets and liabilities. It discusses the various types of financial instruments and establishes some basic principles as to their accounting treatment:
Classification is based on substance, not the form, of the instrument and is made at the time of issue of the instrument.
An equity instrument gives the holder a residual interest in the net assets of another entity.
Other financial assets or liabilities oblige the issuer, or confer on the holder, the right to receive cash or another financial instrument.
Interest, dividends or similar distributions, and losses and gains relating to a financial instrument are reported as revenue or expense.
Offsetting of financial assets and liabilities is permitted only when an entity has a legally enforceable right to set off the amounts and has the intention to settle on a net basis or realize the asset and settle the liability simultaneously.
IPSAS 29 requires that all financial assets and financial liabilities, including all derivatives and certain embedded derivatives, are recognized in the statement of financial position. On initial recognition, the asset or liability is measured at its fair value where possible. Where the financial asset or financial liability is not recognized at fair value through surplus or deficit (in effect, assets and liabilities not held for trading), these are measured at fair value plus those transaction costs directly attributable to the acquisition or issue of the financial asset or financial liability. Interest, dividends or similar distributions, losses, and gains relating to financial instruments should be recognized as revenue or expense in surplus or deficit. The standard requires the distinction to be drawn between financial assets and liabilities, as distinct from equity instruments (where the holder has a residual interest in the net assets of another entity).
These steps are taken in turn:
Legal framework. Due to the legal tradition of public administration in Latin America, the starting point would be the preparation or modification of national legislation. Practice varies from country to country on what types of legislation or norms govern public accounting and which part of government is responsible for them. These legal provisions need to be reviewed to support the transition and adoption to accruals.
Strategy. The second stage is the development of a strategy and timeframe for the reform. In Chile, the Comptroller General of the Republic (Contraloría General de la República (CGR)) took the lead in the process, and aligned its strategy with other bodies involved with or affected by the reform. Once the support of these other organizations was obtained, the CGR established a timetable that aims to fully apply IPSAS by 2019. The process formally started in 2010, with the intention to start in 2016 with the implementation of IPSAS in the central government.15 The statements will cover all entities included in the budget, those that are centralized and decentralized, and some autonomous bodies, such as the CGR. The coverage will be expanded gradually, including the municipalities at the final stage. The strategy revolves around three main components: legislation, ICT systems, and capacity building.
Gap analysis. The third step involves the official adoption of IPSAS and the undertaking of a gap analysis, which compares existing practices with IPSAS requirements. This facilitates the preparation of a timetable and set of tasks that can be agreed and shared with all the actors in the process. In Chile, the IPSAS gap analysis has allowed the authorities to identify four groups of standards, varying in their degree of difficulty. The analysis also identified some standards that were not applicable in the country.
Guidelines. The fourth step is to develop guidelines and timetables for implementing the new standards in the different layers of government. In this phase, it is essential to invest in capacity building and to adjust the IFMIS to the requirements of the new accounting system.
Implementation. The fifth and last step relates to the actual implementation of the standards and the preparation of financial statements. This phase is expected to be achieved gradually, and will not end with the first release of government financial statements. The full implementation of accrual accounting requires continuing improvement, to be managed in subsequent years, and the assurance that accrual practices are embedded as part of the normal business of the organization. The accounting reform is more than a mere accounting enhancement—it is a transformation of the government PFM system and will be of benefit to the entire country.
Figure 5.6Prioritize Conversion to Ipsas: Chile
Source: Comptroller General of the Republic of Chile.
Convergence to IPSAS: The Case of Brazil
Brazilian accounting reform is based on national standards that converge toward IPSAS. The seed of the accounting reform dates back to 2000, when the Fiscal Responsibility Law was approved. This Law included some directions regarding accrual-based accounting it and required the preparation and presentation of cost accounting information. The approval of the IMF GFS Manual 2001 contributed to government interest in reforming public sector accounting.
During the 2000s, there was some work toward government accounting modernization, including the creation of a Convergence Committee in 2007. This worked under the Federal Accounting Council and involved accountants from several states and municipalities. The National Treasury of the Ministry of Finance has been one of the leading institutions. In 2008, the Ministry of Finance decided to converge the Brazilian public sector accounting standards toward IPSAS, and it placed the National Treasury in charge of the convergence process to include all levels of government: central, states, and municipalities. Later, in 2009, a decree formally delegated the role to consolidate public sector accounting regulation to the National Treasury. So far, the Treasury has created the Brazilian accounting manual, including the guidelines on the practical implementation of the standards.
The convergence plan includes dissemination to all public sector accountants of the IPSAS in the form of a Portuguese-language version. While the implementation of accruals in Brazil is based on IPSAS, it is not a full adoption; instead, it is based on a convergence toward these standards. Having a convergence plan in lieu of a full adoption plan has introduced some flexibility in the accounting reform.
Brazil has adopted some key steps in the implementation process to smooth out the path toward accounting reform:
There is only one national CoA that is used by the central and subnational governments.
The National Treasury has developed a template for financial statements that permits all layers of government to share the same financial information through their ICT systems.
The regulations are established by law, which means that the adoption of the accounting manual for the public sector is mandatory.
The legislation is very comprehensive and aims to consolidate the public sector accounts under the same national standards. The consolidation of financial statements, including all layers of government, is a good source of information for policymakers.
The reform, however, has suffered from several delays; the most recent plan is to have the accounting manual in effect as of 2015 for all levels of government; there is doubt, however, that this will be achieved comprehensively. It is likely that the central government and some states will be able to implement it in 2015, with others starting its execution in 2016 or later. Delays in the implementation can be attributed to the following issues:
At inception, the reform was supposed to include all layers of government (26 states, the Federal District of Brasilia, and more than 5,500 municipalities). The lack of technical capacity in some states and most of the municipalities, as well as the lack of an appropriate financial management information system, has resulted in a delay in reform plans, particularly at the subnational government level. Obviously, some states are more likely to be ready for the implementation of national standards than others. The State of Santa Catarina, for example, has made a lot of progress in comparison with other states. States in Brazil face financing difficulties in strengthening their accounting departments and updating systems to meet the growing complexity of the new standards. Some states are resorting to external consultancy to support the accounting transition, a change that requires consolidation of accounts and elimination of duplication of accounting for budgetary and accruals purposes. The cost of these changes is likely to be offset by efficiency gains in the medium term.
Difficulty in applying complex standards (e.g., those on financial instruments, social benefits, or infrastructures). Some of these standards incorporate valuation methods previously unknown to officials, as well as other challenges (e.g., creation of a database of physical assets).
In the case of some of the states, the new methodology will probably reveal information not currently available, such as a sizable pensions deficit or the value of tax incentives granted to companies, as well as the corresponding impact of these incentives on the fiscal performance of states. Only a few states currently report the amount of fiscal incentives and the claimed benefits associated with them—in each case, outside of the financial statements. States will also need to calculate their provisions for doubtful debts and disclose those risks, based on their probability of failure to receive monies.
The accounting reform requires change in public sector culture. Since the reform has involved several players—the Federal Accounting Council, National Treasury, consultative bodies, academia, federation representatives, among others—the discussion of standards has sometimes been complex. An initial optimistic timeline had to be adapted to the available capacity and, in some cases, to circumvent resistance.
Accounting policies that are beyond the capacity of the current ICT systems for central and local governments have also led to delays. The National Treasury has used this delay as an opportunity to select which IPSAS requirements to implement first, taking into account political agendas (e.g., avoiding the recognition of large, long-term deficits and liabilities). For these and other reasons, some state Courts of Accounts have not required compliance with some of the standards issued by the National Treasury, even though this will impair full comparability of accounting information.
Accounting reform: The Case of Costa Rica
Costa Rica16 has been implementing IPSAS since 2001, when the National Accounting Office (responsible for elaborating the general accounting standards) signed an agreement to formally adopt IPSAS with the Inter-American Accounting Association (member of IFAC) and the Inter-American Development Bank under the framework of the Public Accounts Accountability Program. The first step taken after this pronouncement was to build a legal framework to support its adoption. In 2001, the Financial Administration and Public Budget Law was approved, and it included “government accounting” as a subsystem of the new Financial Administration System. The Regulation under that Law declared that the National Accounting Office is the body responsible for the elaboration of the specific rules and technical guidelines on government accounting.
Several decrees have been approved since 2008, including a National Accounting General Plan for the public sector entities of Costa Rica. Initially, a decree established that the adoption and implementation of IPSAS should commence in January 2009 and be completed by January 2012 by the central government. Due to the difficulties in achieving that deadline, in 2011 the deadline was extended to 2016. Among the difficulties are the complexities of applying the new standards, lack of a well-structured plan to complete the reform, and lack of the necessary resources (i.e., legal support, consultants, systems, and investment in capacity building). The implementation plan of IPSAS adoption by the central government is gradual, and Costa Rica has distinguished two phases: the first includes standards that can be applied in 2016 and the second includes the “transition regulations,” which is supposed to be completed by 2021. Government business enterprises, however, are required to present their first financial statements under IFRS by 2016.
In 2011, together with the review of the deadline for IPSAS execution, other significant steps were undertaken: (i) elaboration of an action plan; (ii) update of the General Accounting Plan with the new standards issued (at inception in 2008, it included 18 IPSAS, and it was extended in December 2011); (iii) update of the Accounting Action Plan for the nonfinancial and nonbusiness public sector; (iv) elaboration of the IPSASs Implementation Methodology, using the IFAC guidelines of Study 14 on the Transition to the Accounting on the Basis of Accruals; and (v) investment in capacity building.
As a result, Costa Rica currently is working on the implementation process with the challenge of issuing the first IPSAS financial statements for the central public sector by January 2016 (excluding transitional regulations). The action plan includes the milestones that are shown in Figure 5.7.
Figure 5.7Application of Milestones for Implementation: Costa Rica
Source: IBSASB/IFAC (2014).
Adoption of IPSAS: The Case of Peru
Public sector accounting reform in Peru is based on a comprehensive legal framework, from the point of formal law and drilling down specific aspects by way of lower-level legislation. The main driver of the reform is the General Directorate of Public Accounting of Peru (Dirección General de Contabilidad Pública (DGCP)), although a higher body at the executive or legislative level has not formally approved a formal action plan.
Since 2010, DGCP has been directly responsible for the regulation of public sector accounting standards for all levels of government (central, regional, and local), and is making substantial effort to implement IPSAS within the entire public sector. All 32 IPSAS were adopted through a resolution approved in September 2013. The implementation of the 32 IPSAS is guided by resolutions (e.g., in 2014, it approved a resolution on PPP), directives (e.g., in 2014, on derivative financial instruments), as well as instructions (the latest dates back to 2005 and contains formulas and depreciation rates). Although all IPSAS have been formally adopted, some of these secondary regulations have delayed the effective adoption of some of the standards (e.g., IPSAS 18, 24), restricted options on certain IPSAS (e.g., valuation of property, plant and equipment), or departed from IPSAS—at least in the immediate future (e.g., post-employment benefits).
Peru’s DGCP has also elaborated a new CoA. There is a unified single CoA, issued in 2009, which is based on the requirements of IPSAS and GFSM2001 (Peru’s GFS reporting is still based on GFS86), and it applies to all levels of government. It was last updated in 2013.
It is particularly remarkable that the consolidated financial statements (Cuenta General de la República), presented by Peru’s DGCP, include the entire public sector. This coverage is very comprehensive by international standards; very few governments consolidate the entire public sector. This consolidation aims to be in full compliance with IPSAS and it is based on IPSAS (for the government sector) or IFRS (for state-owned enterprises). The accounting policies, however, are not harmonized, but the differences are relatively limited since IPSAS and IFRS are similar standards, essentially based on the same principles.
Best Use of Public Accounting: Full Accruals and Its Implications for Treasurers and Senior Finance Staff
Reliable and complete accounting information can bring multiple benefits to a country, as previously discussed; however, it takes time to adapt the system to new standards. Strong political commitment is needed from inception. There is much to be planned during the transition to full accruals.
This section provides an overview and discusses some of the main aspects that will be of interest to treasurers and other senior finance staff in the public sector. For accountants and others interested in more technical matters, there is also other useful guidance material on the transition to accruals (Khan and Mayes, 2009; IPSAS, 2011; Flynn, Moretti, and Cavanagh, 2015).
Why should treasurers and other senior finance staff be concerned with an accounting reform full of technicalities and arcane questions that are of interest only to accountants? This section argues the fact that they will want—and need—to be involved with the reform, since it will affect many matters within the domains of other finance staff. These include:
Organizational structures established to oversee the accounting reform;
Timescale and phasing of reform;
Design and delivery of strategies for a transition to accruals;
Rollout to different parts of the public sector;
Oversight of assets and liabilities, other than cash;
Changes to accounting and other systems;
Impacts on budgetary, treasury, and other financial control systems; and
Changes to coding systems and charts of accounts.
Organizing for Reform: Key Actors and Participants
It will come as no great surprise that the principal participants in the reform will be public sector accountants. These will be involved at the central level to develop strategies, establish accounting standards, and monitor implementation. In Latin America, this role usually falls to the responsibility of an Accountant General, Comptroller General, or equivalent official (see Box 5.3). Accountants will also play a role at the entity level—that is, in each accountable organization such as a Ministry or agency—to oversee implementation and continued operation of accounting systems.
The central cadre will need to work with teams or networks of accountants in each subsector or individual entity. Much of the transition work will fall to these people at the operational level. It is also quite possible, however, that the training and experience of these public accountants—at the central and operational levels—will have been acquired in the existing system. If that is so, there will need to be a major educational program to expand their acquaintance and expertise in accruals accounting.
Box 5.3.Accounting Reforms in Latin America: Responsibility
Most Latin American countries have a General Directorate of Government Accounting Unit in the Ministry of Finance, whose General Director (Contador General) will usually take the lead on reform. This is the case in Colombia and Peru, among others.
Other countries, such as Chile, have a different model, where the Comptroller General’s Office, (Contraloria General)—a body independent from the Ministry of Finance—is the entity in charge of government accounting, from the development of rules to the preparation of the financial statements. In Chile, for example, the transition model and the strategy are led by the Contralor General and his team. Nevertheless, the success of the reform is due to significant collaboration and interaction with the General Directorate of the Budget and the ministries.
Other countries have a more complex structure, such as Panama, in which the General Director of Government Accounting, under the Ministry of Finance, takes the lead on reform, although the Comptroller General’s Office is in charge of the legislative development, as recognized in the Constitution. In these cases, the successful implementation requires even a stronger engagement of all the competent institutions.
In Brazil, there have been several players involved in accounting reform: the federal accounting council, which sets the Brazilian public sector accounting standards and which has defined the convergence process; and the National Treasury, in charge of the approval of the public sector accounting manual and the issuance of guidelines. In addition, during the reform process, other bodies have also been consulted, such as the Court of Accounts, responsible for public audit and the compliance with the accounting rules; consultative bodies of accounting practices; public accountants operating in states and municipalities; federal representatives; and academia. All of them played a role in the discussion of the standards before they were approved and became mandatory.
Public auditors will also have a key role, since their expertise will need to grow in parallel with the accountants. A switch to accruals will throw up new challenges for audit offices, and they too may need significant additional training to equip them for this new environment. Auditors will require as much skill and acquaintance with the new accounting standards as do the accountants who compile the accounts. Furthermore, the audit office or offices should be involved in the transition strategy to ensure that audit opinions are taken into account and to minimize subsequent avoidable disagreements over accounting policies and presentation.
Accountants and auditors are not the only ones interested in this new type of accounting. In any public administration, there will be a wide range of people who have to work with accounting systems and data. These include staff in the treasury and in economic planning and budgetary departments, who develop the annual or multiyear budgets and monitor budget implementation. A change to accruals may well affect the basis on which the budget is drawn up, or it may affect other expenditure control mechanisms. There are also senior managers, financial managers, and budget holders who need to understand how the new accruals will be executed. Finally, the national statistics department will have an interest since they also have to produce data according to international standards, established by the IMF and others and, often, they need to rely on government accounting systems for much of their information.
Transition will almost certainly require changes to ICT systems and manual procedures. This, in turn, will involve ICT departments and business analysts throughout the public administration. The scale of such changes should not be underestimated, and poor systems implementation is one of the greatest risks to a successful transition. Equally, these system changes should neither be seen as the central driver or focal point of reform, nor the reform be viewed as ICT-led. There are many dimensions to reform, of which ICT is an important one; it should be the servant of reform and not the master.
One final and important body with an interest in the transition will be the legislature. It will almost certainly be called upon to sanction or authorize the legislation required to introduce accruals accounting. Those in the legislature will also be interested in the progress made with transition. Most importantly, they will need support to be able to interpret and use the new information that accruals accounting will provide. As mentioned earlier, it is important to approve the legal framework that supports accounting reform within the different layers of the legal framework.
Strategists should not lose sight of the essential need for action at the central, subnational, and decentralized entity levels. In theory, the transition to accruals accounting could be left entirely to the individual entities working within international standards. Such a libertarian approach, however, is unlikely to be successful and would certainly not support proper consolidation, since each entity will probably interpret standards differently and on different timescales.
Instead, the transition to accruals may offer an opportunity to rethink the architecture of public accounting. The demands of consolidation will swing the balance of advantage toward central solutions, since full and successful consolidation requires the coordination of accounting policies across a wide range of bodies. Furthermore, if all or many types of organizations need to develop new ICT systems, there may be an advantage to central, rather than distributed solutions. Solutions may range from “central light,” in which the minimum is centralized (e.g., a consolidation system only)—for example, in the case of Brazil—to “central heavy” (in which all systems are provided centrally)—for example, in the case of Peru.
At the very least, successful transition requires strong central coordinating forces, even if implementation is left to the lower levels or individual entities. It is very likely, though, that these central mechanisms will need to be accompanied by subsectoral mechanisms, since each subsector may face particular challenges (e.g., legacy systems and procedures, different legal requirements, special classes of transaction) which need to be worked on within a central framework of standards and other requirements. Such sub-sectoral mechanisms will also be important in achieving buy-in and support from those most closely involved in implementation.
Implementation Process and Timeframe
A full switch to accrual accounting is unlikely to be quick. Advanced economies have taken five or more years to make the transition. In emerging countries, a full transition could last 10 or more years. The timescale and degree of effort will very much depend on the starting point.
In the particular case of Latin America, countries begin from a position where some parts of the public sector may have already adopted or have always been using accrual-based accounting, thus providing the advantage of a cadre of public accountants already versed in accrual accounting. The reform can be more challenging in subnational governments, since implementation at this level will have to start from a position of little expertise in this area. For these levels of government, the trajectory toward transition could be a very long one.
In considering implementation, it is useful to think of transition as a number of different dimensions in which public accounting will need to change. For each part of the public sector, planners will have to think about:
Growth in the range of transactions (revenues, expenses, assets and liabilities) to be captured within the accounts, so that all material items are included.
Development of the financial statements to include these additional classes of transactions and associated disclosures.
Development and application of more advanced techniques for valuing account items, so that the financial statements give the most accurate and useful view of public finances.
Design and Delivery of Strategies for a Transition to Accruals
As is the case for any major reform, a vital first step is to research, develop, and put in place an overarching strategy. As we saw in the case studies, some countries have suffered from delays in the reform process due to the lack of a clear action plan and strategy to guide the reform. It is recommended that the strategy first be informed by a gap analysis and that the strategy itself cover all the key areas (Box 5.4).
Box 5.4.Initial Planning and Strategy
Matters to be covered in an initial gap analysis
Data and analyses on the territory to be covered; types of public sector bodies; classification (commercial or noncommercial); and current state of readiness, among others.
Information on existing accounting standards and reporting practices for public bodies of all types (i.e., commercial and traditional government).
Data and analyses on the types and materiality of revenues, expenses, assets, and liabilities, which may need to be integrated into the new accounts. At this stage, in the absence of decent records on assets and liabilities, it may be necessary to make informed guesses as to materiality.
Information on existing accounting and related financial systems and their suitability to support accruals accounting.
Data and analyses on the availability of accounting expertise and experience in the public sector, and each sub-sector.
Coverage of a transition strategy
Which accounting standards will be used and where, and how they will be developed, modified, or maintained in the future.
Legislative changes needed to legitimize the switch from cash or modified cash to accruals.
Sequencing of implementation for each subsector or type of body.
For each subsector, what system developments and improvements, as well as what growth in accounting capacity, will be required to sustain the transition and eventual adoption of accruals.
For each subsector, how accounting systems and related financial reports will gradually encompass or include all relevant transactions (revenues, expenses, assets, liabilities).
For most governments, implementation will almost certainly entail a gradual expansion of accounting systems and financial reporting to include more accrual accounting features until full accruals status is achieved. This means expanding the classes of assets and liabilities, applying more international standards, and developing financial statements and related disclosures, year on year, until the required degree of compliance is achieved.
International accounting standards allow for this gradual adoption, with many including provisions (“waivers”) that give entities more time to meet all the requirements during the transition period. The maximum waiver period is five years, although most standards provide for three years. In many cases, however, it is likely that the practical challenges will be of a scale such that the implementation period will extend beyond five years, in which case it is inevitable that interim or intermediate financial statements will not be fully compliant with international standards, despite the transition waivers. This, however, does not imply that there is no value in striving toward adopting these standards; rather, it is better to be fully aware of this fact and to manage expectations accordingly.
Note that during the interim period, countries in transition are unable to claim that they are in compliance with international standards until the final few years prior to this achievement, based on the waivers. During the trajectory, transparency is essential, and an indication of what is or is not compliant with international standards must be included in the notes to the financial statements, as well as what the next steps are in terms of the transition.
A question often asked is whether it is advisable or necessary to achieve compliance with cash-based IPSAS prior to embarking on the road toward accrual accounting. This, however, may not be the best way forward for countries that have already moved beyond pure cash-based accounting, as is the case in Latin America. The cash-based IPSAS is, undoubtedly, a useful benchmark for countries within a pure cash environment. Many countries will, nevertheless, start their transition from a point where they already operate on a modified cash basis (especially where accounting is based on budgetary rules). In such cases, they will already be in an early stage of transition, thus making it senseless to return to pure cash accounting.
Rollout across the Public Sector
At the outset of implementation, it is useful to consider a planned and gradual rollout across the various parts of the public sector. International accounting standards require “consolidated” accounts that include all the transactions and balances of those entities and resources that are controlled by the reporting entity. In the case of government, therefore, there is an expectation that the accounts consolidate many, if not all, public bodies. Likewise, international statistical standards apply to public sector data and other aggregates. From reform inception, implementation should be coordinated for each group or type of public entity, with each group being consolidated during the transition period. Table 5.3 shows how the public sector is divided into subsectors.
A typical sequencing for consolidation purposes, which gradually encompasses the entire public sector, is exemplified by the following:
Start with central government (i.e., ministries, departments, and associated decentralized entities).
Rollout to subnational government levels, including noncommercial satellite entities. At this point, the national and subnational governments can be consolidated to produce accounts for general government.17
Lastly, include public corporations to provide a public sector or whole of government account.18
The sequence above may need to be adjusted, especially where different sectors are more or less advanced, or have started from different positions in the trajectory toward accruals accounting. Execution in each subsector should proceed as resources and existing capacities dictate. There is little point in delaying or stalling execution in one sector while other sectors catch up or overtake. In some instances, for example, entities that are at arm’s length may already be applying accrual-based accounting, and will need to continue toward IPSAS compliance, in parallel to introducing accruals from inception into central government. Figure 5.8 provides such an example, demonstrating how the various parts of a general government may proceed toward accruals and eventual consolidation.
Figure 5.8Sequence of Implementation in General Government: An Example
Source: Authors’ elaboration.
Capturing Additional Classes of Assets and Liabilities
As previously explained, the transition period will entail a steady growth in assets and liabilities (and associated transactions) for capture and disclosure; the gradual development of the financial statements and other disclosures; and eventual adoption of international standards in parallel with these two other developments. It is essential to have a transition strategy in place; while there may be a single objective (full accruals across all public bodies), there are many alternative paths toward its achievement. The essence of a transition strategy is to ensure that the path selected is custom-made for local capacity and existing arrangements, and that it takes into consideration the legal and institutional traditions.
In an ideal situation, this expansion of the accounts to include additional categories of assets and liabilities will follow a sequence that is dictated by cost (assembling the data) and benefit (materiality of the data to be disclosed), prioritizing those that are most cost beneficial. In practice, however, the sequencing may well be dictated by the capacity of existing systems, as well as the cost of adding or developing new ones for additional information.
There are several approaches to the sequencing of accounting reform. One was prepared by Flynn, Moretti and Cavanagh (2015), according to which the sequence is as follows:
Cash and cash movements (i.e., the starting point, a cash basis);
Then add payables and receivables;
Then add other financial assets (debt, investments, others);
Then add physical assets, including inventories; and
Lastly, add intangible assets and liabilities.
There is nothing sacrosanct about this particular sequence; for example, if reliable data on physical assets is available, there will be no need to delay or defer its inclusion to a later stage. Likewise, the government may also have sufficient data to include public service pension liabilities, based on actuarial valuations. For some data classes (e.g., fixed assets), however, it may be a challenge to develop and verify opening balances, since the data may be incomplete and a major stocktake will be needed to bring the data and systems up to date.
This gradual expansion also implies that the various IPSAS will come into play at different stages of the transition. Those relating to the fundamentals of accounts presentation and accounting policies (e.g., IPSAS 1-4, 6, 14, 18, 19, 20, 24) will be applicable from the outset, although their provisions may only be achievable in stages. Thereafter, as each type of asset and liability is added to the mix, the related standards will come into the picture. For instance, standards relating to operating revenues, borrowing costs, various investments, and other financial instruments, as well as leases (IPSAS 5, 7, 8, 9, 13, 28-30) may come earlier within the transition. Subsequently, inventories and physical assets may be added (IPSAS 11, 12, 16, 17, 21, 26), with intangible assets (IPSAS 31) following on. Public-private partnerships represent a special class of asset (and liability) that can be included in these later stages (IPSAS 32—see Box 5.5). The timing of employee benefits (IPSAS 25) and the accrual of tax revenues (IPSAS 23) have traditionally posed challenges, and these may occur sooner or later during transition, depending on the degree of preparedness.
Box 5.5.Public-Private Partnerships
These types of arrangements are becoming an increasingly popular way for a government or public body to acquire an asset—or the use of an asset—without having to provide the capital outlay at outset. A private enterprise will provide the asset, and may well maintain it through its lifecycle in return for annual or other periodic payments. Such arrangements throw up issues as to who “owns” the asset and whether or not it should appear on the public sector balance sheet.
IPSAS 32 deals with such “Service concession agreements” (note that it does not deal with all types of relationship with the private sector, which fall under other standards relating to investments, leases, and financial instruments). Under IPSAS 32, the general rule is that the asset is recognized on the public balance sheet, alongside the liability for future payments to the service provider. The idea is that the accounts present the true picture of these arrangements and the extent to which the public body enjoys the use of an asset, even though it nominally “belongs” to a private sector partner.
Box 5.6.Valuation Methods
The principal alternative to historic cost is referred to as “fair value,” which is meant to represent the amount for which an asset could be exchanged, or a liability settled, between parties. Fair value is often based on market values for the same or analogous assets or liabilities. Where no market data or analogue exists, a fair value may be calculated, based on reasonable assumptions that a buyer might be expected to use. Fair value methods are used principally for marketable assets and liabilities, while other methods are used for some types of assets (e.g., stocks) and liabilities.
Note that although each standard may apply at a given stage during transition, each may need to be implemented gradually (e.g., if a recommended valuation method is not possible from the outset).
Once each class of asset or liability is added to the balance sheet, the associated revenues and expenses—as well as other changes in value—are added to the operating statement. In this way, the financial statements extend to include all relevant stocks and flows. Moreover, the integrity of the accounts is maintained; all changes in balance sheet values are captured in the operating statement (or, as in a few cases, in the statement of changes in net assets).
Another dimension of this gradual growth in coverage is the potential to move valuation methods gradually for some classes of assets or liabilities from the most simple (typically, historic cost) to the more sophisticated methods that are recommended or required for full compliance with the relevant accounting standard (see Box 5.6).
This sequencing of transaction classes above can be applied to one type of entity as a group (e.g., all central ministries), but the timing and sequencing may be different for each type of entity (e.g., central and local government), depending on the systems and data that are available at the outset. The availability of accounting data for each type of entity would also need to be coordinated with the strategy and sequencing for consolidation.
During this gradual transition and adoption of standards, the accounts will provide a progressively more complete and accurate picture of a country’s financial performance and position. At the outset, these will be seen solely in terms of cash balances and changes in them; by the end, however, the accounts should capture all material assets and liabilities and how these change over the year. Interim accounts will lay somewhere in between. The degree of completeness at any stage in the trajectory will depend on the materiality of assets and liabilities yet to be included. Accuracy will also increase as accounting policies approach those required by the standards.19 It is essential, however, that the notes to the accounts explain this transition strategy and identify such exclusions and departures from standards, so that the user of the account is fully aware of these gaps. The initial gap analysis—which is an integral part of the transition strategy—would be expected to help ensure that the more material exceptions are tackled sooner rather than later.
Implications for Budgetary, Treasury, and Financial Control Systems
A significant challenge in any transition to accrual-based accounting—and one of particular interest to treasurers—is how the new accounting methods will integrate with the budgeting system and associated financial controls. The centrality of budgets and legislative approvals, together with subsequent accountability for budget execution, are the key differences between public sector and private sector accounting modalities. Traditionally, budget regimes have focused on cash or modified cash control.
Governments that are considering a move toward accrual accounting face three issues that relate to budgetary and other financial control systems:
Whether or not to move budgeting to an accruals basis;
How to report on budget outturns in an accruals accounting environment; and
How to reconcile accruals accounting with traditional controls over cash and other stages of the spending process.
On the first of these questions, one simple option is that accruals accounting is introduced without any change to cash-based budgetary systems and rules. This, however, would mean that new accruals financial reporting is completely divorced from budgetary accounting; not only because budgeting remains on the basis of cash or modified cash, but also because the coverage of the budget is likely to vary from that of financial statements. As previously stated, the boundaries and presentations of accrual accounting are governed by economic concepts and not by administrative or budgetary rules.
A complete separation of systems for accounting and budgeting has other drawbacks. First, there would be the burden of running two separate and parallel systems. Second, there is the risk that financial reporting may be seen as a tiresome and irrelevant afterthought, since administrative and parliamentary oversights focus on budget approval and performance. Third, it would be very complicated to link or make connections between the two presentations of the public finances, and there would be confusion over which presents the more useful or correct picture and for which purposes.
There may be advantages, therefore, in better integration between accounting and budget. Experience to date, however, shows that accrual accounting is not automatically accompanied by accrual-based budgeting; many countries have retained cash-based budgeting or some hybrid alongside accrual-based financial reporting (Blöndal, 2004; Schick, 2007). There are several reasons for this:
Finance ministries and legislatures may be reluctant to let go of cash as the basis for their control over the public purse, either because of tradition or the “concreteness” of cash.
Accrual budgeting requires greater financial literacy, as well as a strong framework of rules and accompanying policing, to ensure that budget numbers are realistic to begin with and that budget outturn numbers are reliable. Without strong discipline, spending departments may be tempted to use the flexibility inherent in accrual accounting to circumvent budget rules.
An accrual budget regime may be difficult to reconcile with the idea that the budget is an absolute limit which cannot be exceeded, and this problem is likely to be exacerbated where budgets and budget limits are very detailed. This issue arises because some account or budget items are noncash or may be outside the full control of the spending body (say, for example, that debtors are worse than anticipated, or an actuarial cost is revised upwards, or assets revalued downwards—all leading to an excess over budget). An accruals budget regime, therefore, is better suited to a more flexible regime where budget variations (negative and positive) are allowed but must, nonetheless, be accounted for.
In practice, most countries have opted to retain cash or modified cash-based budgeting, or to place budget limits only on those budget components which are more directly controllable. In other cases, they may have adopted dual budgeting, whereby departments have budgets for accruals alongside an overall cash control, which is also subject to budget approval.
On the second question—the reporting of budget performance within accrual accounts—international standards (IPSAS 24) require an entity to show outturn against original and final approved budgets, either as an additional financial statement or as additional columns to one of the other main financial statements. IPSAS 24 only applies where the budget is published, as is the case in the majority of Latin American countries. The standard also requires, in the notes to the account, an explanation of material differences between outturn and budget, unless such information is already published elsewhere and a suitable cross-reference is provided in the notes. In those cases where the final budget is always the same as the outturn—because the budget is revised and approved on a continuous or near-continuous basis—the explanations should focus on variations between outturn and the original budget.20
This requirement may seem straightforward enough, although in practice there may well be complications in meeting it. The degree of difficulty will depend on three things: the coverage, classification, and accounting basis for the budget:
If the coverage of the budget is less than that of the financial statements, then budget comparisons may only be possible within segmental reporting and not in the principal statements.21 This would almost certainly be the case for consolidated accounts of general government or the public sector, since not all expenditures will be covered by the budget. In this context, for example, one segment could be “budgetary central government,” with another for “other central government,” with similar distinctions between budgetary and nonbudgetary expenses being included for other subsectors or levels of government. Another complication of coverage would be the use of multiyear budgets—the standard provides guidance on how these might be matched to annual financial reporting.
If the principal classification of the budget differs from that used in the main financial statements, a separate statement of budgetary performance will be needed, with reconciliation to the totals shown in the main financial statements. This could well be the case, for example, where the principal budget classification is organic (by ministry or sector), while the classification in the main financial statements is economic (e.g., staff costs, goods and services, grants).
If the budget is accruals-based, reconciliation would be to the numbers in the operating statement or the segment operating statement. If the budget is cash-based, then the reconciliation would be to the cash flow statement or segment cash flow statement. If the budget is based on modified cash, however, reconciliation would be more complicated—there would need to be a reconciliation between account and budget totals before a breakdown of budget performance could be provided.
Budget reporting practices vary from country to country. In many economies, the tradition will be to have a sizeable set of public accounts that show consolidated information for budgetary central government, together with detailed outturn and budget information for each ministry or sector. In other traditions, the consolidated account is the main accounting output, with departmental accounts and other analyses published separately (or unpublished). In this latter situation, the new consolidated accrual accounts could include only high-level budget comparisons with a cross-reference to the detailed budget analyses available elsewhere.
The third question relates to the natural concern of treasurers that accruals accounting may undermine a government’s ability to control cash or other aspects of the spending regime. The short answer is “no.” Budgeting and spending control systems usually comprise controls which are based on Parliamentary approvals and on other controls (usually more detailed ones), exercised by the Ministry of Finance under its delegated authority. Cash controls can either be embedded within the Parliamentary appropriation or budget approval system—subject directly to legal limits—or, instead, they can be implemented as one of a set of administrative controls under the jurisdiction of the ministry of finance. For example, a ministry of finance could, alongside accrual budgets, also impose controls on cash releases, as it might do for staff expenditures or numbers, administrative expenditures, capital expenditures, or any other control items in a year. Spending departments would need ministry of finance authority to vary these limits. Furthermore, of course, a ministry of finance would still wish to keep a close eye on cash flow and liquidity as part of its treasury management or financial programming function. Such cash-based controls will still be possible, since an accrual accounting system also facilitates control over cash flows—in the same way that the millions of businesses worldwide, which use accrual accounting systems, continue to exercise control over their cash flows.
One particular issue of interest to treasurers will be that the traditional control and monitoring over commitments may not be executed directly through the accounting system. The link between the budget execution process, financial statements, and treasury management is shown in Figure 5.9.
Figure 5.9Links Between Budget Execution, Financial Statements, and Treasury Management
Source: Authors’ elaboration.
From this illustration, it can be seen that the traditional and broad concept of a commitment—the earmarking or release of funds for specific expenditures before an order is placed or an invoice is raised—has no direct equivalent in the accounting sphere (being neither an accrual nor a payment). Instead, commitment control would need to operate at an earlier stage in the expense cycle, or through financial programming which limits the cash releases available in any given period. Alternatively, if a government is building its own accounting system, it may wish to incorporate this additional functionality within its system design.
In Latin America, budget execution is reported on a mix of cash and modified cash basis: budget execution reports present revenue on a cash basis and expenditures on a modified cash basis, which means that expenditures are registered when the obligation for payment is recognized (devengado or liquidado, depending on the country). In general, this obligation crystalizes on the invoice date. In some countries, however—mainly due to weak internal controls—the date included in the system is a different one, which undermines the credibility of data.
Depending on the country and on the ICT system applied, accounting entities may generate two entries into the system, one for accounting purposes and the other for reporting budget execution—which can jeopardize the uniformity of data. Modern financial systems promote the integration of such information and the simplification of data entry to avoid this kind of problem.
Accounting and Other Financial Information Systems
Transition often involves major changes to government financial systems, and it requires much more systems integration than modified cash accounting does. Although accruals accounting will still obtain much of the required data from transactions passing through the payment or receipts cycles, it will also need data that may come from satellite or separate systems (e.g., debt management systems, human resource systems for staff benefits). Furthermore, accruals accounting will also use accounts figures that are based on algorithms, formulas, or estimates. Accrual accounts also require additional disclosures (e.g., contingent liabilities, related party transactions) that may require new data not previously assembled or analyzed. Transition is thus not simply a matter of modifying an accounting system; it involves integrating or using data from a number of sources.
Indeed, integration is so central that accrual accounting may be one of the key drivers behind implementation of an IFMIS, since it is best served by close integration of various financial systems (e.g., General Ledger, Accounts Payable and Receivable, Revenue Management, Procurement, Fixed Assets, Personnel, among others) that were previously operated on a standalone basis or were loosely integrated. Many countries in Latin America use an IFMIS project as a driver and enabler of their new government accounting system (see Box 5.7). Chapter 7 of this book discusses, in more detail, the reforms of the IFMIS systems in Latin America.
Box 5.7.IFMIS Reform: A Component of Accounting Reform
Panama, for example, is changing its current integrated financial management information system, known as SIAF Panama, to a new one, referred to as Integration and Technical Solutions of the Operational Management Model (Integración y Soluciones Tecnológicas del Modelo de Gestión Operativa), which will facilitate the adoption of the new accounting standards. The new system will become operational in 2015, whereas the adoption of IPSAS will be a longer process, expected to be completed in 2021.
In Peru, there has already been a pronouncement on IPSAS adoption and a Law has been enacted to adopt IPSAS. Currently, the government is modernizing the IFMIS, known as the Integrated Administrative and Financial System (Sistema Integrado de Administración Financiera (SIAF)), which will be replaced by a new version, SIAF II. The new system will help to improve the application of the new standards by accounting entities.
Classification of Accounting Transactions
One area of transition which could have consequences for non-accountants is that of the classification of transactions. This may appear to be a rather dry and technical matter, strictly for bookkeepers; however, in modern financial systems, classification is central to many financial management activities and to the production of useful management information. Transition should take into account the need to align, as far as possible, accounting and budgetary classifications—preferably from reform inception.
A CoA is a set of codes that are used to classify accounting transactions. While a principal use of a CoA is to provide the classifications required for financial reporting, in modern integrated systems the CoA also provides the classifications for other purposes such as budgetary control and reporting, management information, and statistical reporting. A CoA, therefore, will often have several dimensions or segments, each containing a different classification system (Cooper and Pattanayak, 2011). The CoA needs to reflect the interests of many parties and, most especially, the budget, control, and accounting officials.
In many countries, government use of cash or modified cash accounting will already have a standard CoA to be used by all entities within central government, with possibly another for local government and yet another for satellite bodies. These charts of accounts will cover receipts and payments, and the internal structure of the CoA will probably reflect the classifications used in the budget. For public enterprises, these are more likely to maintain their own CoAs, capable of supporting IFRS-style accrual reporting. In the transition to accruals, one of the first developments should be the production of a new CoA, to be used by all public noncommercial entities, extending the CoA to cover assets and liabilities, as well as other changes in net worth (i.e., other than receipts and payments).
One tension which this new standard CoA may introduce is the inability of each institution or type of institution to include elements that cater to their own specific characteristics or operational needs. Ideally, therefore, the standard CoA should leave room for such user-defined classifications of expense and revenue, among others. The degree of standardization, in part, will depend on the degree of detail to be provided in the consolidated accounts. In some countries, the tradition is for the government consolidated account to be the only place where such detail is provided (with individual entities not producing their own accounts). In other countries, this detail is disclosed in individual entity accounts, while the consolidated accounts (and, thus, the standard CoA) are more summarized. Nevertheless, where a country elects to present highly summarized consolidated accounts, the standardization at lower levels may be justified by the needs of financial control or detailed analyses of government finances.
Potential confusion may arise between the CoA needed for financial reporting, based on IPSAS, and the coding systems needed to support statistical (often referred to as “fiscal”) reporting under the IMF’s GFS. In contrast to IPSAS, GFS does come with a standard reporting template and a standard classification system. At first glance, there is a great deal of commonality between GFS and the way in which a government may present its financial statements. There are, however, important differences between IPSAS and GFS, reflecting their different objectives and perspectives, and it would be wrong to use a GFS-based reporting template and coding system for financial reporting without modification.22 A better solution is to adopt one of the classification systems (IPSAS or GFS) as the principal coding to be used in everyday operations and data entry, with the ICT system automatically mapping this coding system to the other classification system. In this way, a single coding entry and set of coded transactions can be used to produce IPSAS accounts, as well as GFS statistical reports. The principal coding structure may be IPSAS or it might be GFS—the choice will mostly depend on whether the budget is intended to mirror the eventual accounts, or whether it is based on GFS classifications.
Finally, this standard government CoA is very unlikely to be suited or applicable to government business enterprises that should be following IFRS reporting requirements. If the eventual intention, however, is to produce whole-of-government accounts that cover all commercial and noncommercial parts of government, there will be a need for a further mapping system, allowing IFRS-based accounts to be translated into IPSAS-based accounts and then merged with the IPSAS-based data. This conversion may not be wholly straightforward, however, since one difference between IFRS and IPSAS will be in the valuation methods used for certain types of assets or liabilities. The original IFRS data, therefore, may need to be reworked first before mapping. Clearly, such mapping and reworking will be easier if the consolidated accounts are in summarized form—it will be much more onerous if the financial activities and position of government enterprises have to be reclassified to three or four levels of detail.
An analysis of practices in the region demonstrates that like other complex PFM reforms, accounting reforms take a long time to implement. They should be founded on a detailed action plan and strong political commitment from inception.
Accounting reforms usually take a long time because it is necessary to change legislation, develop complex standards and norms, change ICT systems, and improve the capacity of thousands of accountants spread across the central and subnational governments. These demands put considerable pressure on the leaders of accounting reform. Support from the legislature is essential, since legal reform is usually the first step—as seen in the cases of Brazil, Costa Rica, and Peru. The approval of new legislation also shows the commitment of the executive and legislative levels to the reforms, and it provides the visibility necessary for leaders of the reform to move ahead. Good communication is essential to keep stakeholders and society informed, especially considering that the reform’s impact will take a while to become apparent.
An accounting reform has more chance of succeeding if it is part of a broader PFM reform; in most of the case studies, it was advantageous to be connected with the development of a new IFMIS or to the improvement or updating of the existing one. In addition, some interested parties, such as treasurers and budget officials, can play an important role, as they are the most direct beneficiaries of better financial information.
The territorial structure of many Latin American countries—with large numbers of municipalities, several regions and/or states, and a considerable degree of autonomy within the public sector—adds to the complexity of the reforms. Capacities vary among governments and, usually, a big investment in capacity building is required, particularly in relation to the municipalities. This is the reason why reform should be a gradual process and why it should adopt flexible timeframes for implementation. For example, it can begin at the level of central government, and gradually move to states or provinces, and then to municipalities.
The benefits of accounting reform are evident in the substantive increase in financial information on noncash assets and liabilities. This impact, however, is not immediate and needs an educated audience, as the information is more complex to understand and interpret. In practice, evidence shows that better accounting provides more credibility and can eventually lead to improved credit ratings. Moreover, the disclosure of information that was previously not available or not consolidated (e.g., deficits of public corporations; contingent liabilities of PPPs; accumulated cost of employee benefits, such as pension; loss of assets; and contingent and unrecognized liabilities) will expose fiscal risks that will need to be taken into consideration by policymakers. This is precisely where the benefits of accrual accounting are most evident.
Bergmann, A.2009. Public Sector Financial Management.London: FT Prentice Hall.
Blöndal, Jón R.2004. “Issues in Accrual Budgeting.” OECD Journal on Budgeting4:1: 103–19.
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Cooper, J. and S.Pattanayak.2011. “Chart of Accounts: A Critical Element of the Public Financial Management Framework.” IMF Technical Notes and Manuals. Washington DC: International Monetary Fund. Available at https://www.imf.org/external/pubs/ft/tnm/2011/tnm1103.pdf.
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Note that all references to IPSAS refer to the standards promulgated at the end of 2014 and which are published by IPSASB in its official annual handbook.
The Fiscal Transparency Code is available at http://www.imf.org/external/np/fad/trans/.
See, for example, the Cash IPSAS for such definitions.
“Cash” includes cash on hand, demand deposits, and cash equivalents—the latter of which are short term and highly liquid investments that are readily convertible to known amounts of cash. These are subject to an insignificant risk of change in value (Cash-Basis IPSAS, paragraph 1.2.1).
Often under a modified cash basis, as in the many countries that account for budgetary expenditures on an accrual basis and revenues on a cash basis.
Statement of Financial Position is the terminology preferred by IPSAS.
Statement of Financial Performance is the terminology preferred by IPSAS.
For a discussion of IPSAS’s advantages and drawbacks, see European Commission (2013).
Some early adopters also used IFRS or similar commercial standards for this noncommercial segment of the public sector, due in part to the fact that at the time, the IPSAS standards had not yet been developed.
IPSASB publishes an annual handbook containing all the standards (see http://www.ifac.org/public-sector).
See IPSASB (2006) for guidance on when national standard setters can legitimately claim compliance with international standards.
See for example, the annual surveys of government accounting practice, published by Ernst & Young (http://www.ey.com/GL/en/Industries/Government—Public-Sec-tor/Transparency-in-public-sector-accounting_Survey-results—accounting-system-trends) and PwC (2013).
See the published financial statements at http://www.cuentapublica.hacienda.gob.mx/es/CP/2014.
This deadline originally was 2015, but it was postponed one year to improve capacities and allow the institutions to reflect accounting adjustments prior to the application of the new standards.
Further information can be found at http://nicspcr.com/.
General government is a statistical concept, defined as the public sector less public corporations. In effect, it aims to capture traditional government functions exercised at all levels of government (central, regional, local).
Commercial organizations, such as public corporations, should report using IFRS or national-equivalent accounting standards, and they will need to convert their accounts to be compatible with IPSAS or their national equivalent, so that they can be consolidated.
“Accuracy” in this context means that the figures provide a true and fair view of the value of the asset or liability, or the changes in its value over the year; where the figures are based on estimates or other valuation methods, there is no such thing as a 100 percent “true” or accurate figure against which the accounting estimate can be judged.
Some countries have disclosure of the original budget proposed by government, budget approved by legislature, modified budget, and outturn.
Segmental reporting, covered by IPSAS 18, encourages more detailed analysis of financial results by operating “segment” or other component parts in the disclosure notes to the accounts.