Public Sector Accounting Systems
The public sector accounting has received much debate over the years because of the quality of information disclosed in accounts statements. In the last few years, there have been some improvements on the public sector accounting owing to the demand by the government to disclose information in a more transparent and accountable manner. There have been requirements by the government to provide a flow of information and disclose stock information presented in accounts statements or budget statements. The government prepares and discloses cost information along with the financial statements including income statements and balance sheets for various government agencies. The main intention of disclosing financial statements by the government is to fulfil the states accountability to its citizens and the market participants, as well (Khan & Stephen, 2009, p.109.
There are two different accounting systems that can be used by the government in order to enhance transparency and accountability when reporting income and expenses by various public sectors. Traditionally, the government used the cash accounting method but it has recently been replaced by the modern accrual accounting method to report the financial position of an entity. The cash accounting method (the traditional model) in public sectors was seen as the most appropriate method because of its compliance to rules and regulations for instance, in the budget out-run report. The accrual accounting method (the modern model) in public sectors is seen as the most appropriate because of its efficiency (Khan & Stephen, 2009, p.110).
Differences between Cash Accounting and Accrual Accounting
Cash accounting and accrual accounting methods have been utilized by various governments although they differ in many aspects including the timing when transactions such as sales are accounted to accounts. The cash accounting method has been traditionally used although recently it has been replaced by the accrual accounting method because of the many advantages linked with the accrual accounting method (Pallot, 2010, p.11). Cash accounting differs from accrual accounting in that income and expenses are only counted the moment cash has been received. This implies that revenues and expenses can only be recognized after payment has been received. Cash method has been preferred due to a number of advantages such as the fact that it is easy to use, and it is also objective with only few choices made (Barrett, 2004, p.45). However, the cash accounting method has its own disadvantages such as the inability to match expenses with revenues generated by the entity. This is because income and expense are only counted after payment implying that the income statement and balance sheet prepared by the accounting managers does not provide a clear picture of the activities in the entity. That said, the true operations of the entity are distorted because it incorrectly reflects the income and expenses of the entity from the recent and present activities (International Federation of Accountants, 2003, p.17).
The cash accounting method is different from accrual accounting method because transactions are counted after an order has been made and delivered to the customers regardless of when it will be paid. In this case, income is only counted the moment cash has been received, and expenses are counted when goods and services have been received (CIPFA, 2010, p.28). The accrual accounting method has more advantages over the cash method, and this is the reason why it is more preferred by public sectors. One of these advantages is that the current income is more accurate in accrual method than the cash method. This implies that the statement of account and the balance sheet are more accurate estimates of the true financial position of the company. The current position of a company is very vital because it helps in predicting the future income and financial position of the entity, as well (Beechy, 2007, p.125). However, the accrual accounting method is composite to predict and understand for a number of reasons for instance, in many cases income does not match the previous cash (Janc, 2011, p. 11).
Why Accrual Accounting is the Most Preferred Accounting System by the Government
That said, the accrual accounting method is the most preferred accounting system in the public sector because it tends to maximize competition and efficiency in public management to be achieved with minimal operation costs for competitive advantage. It is a process of moving from the traditional model (characterized as a more rigid model of cashed income and paid expenses) to a more forecasted cash and income that would eventually result into the increase of the public management efficiency and transparency. Financial statements in any institution ought to give an idea about the true value of equity (it should reflect the true financial position of the entity in the market). There are a number of factors that have forced the government to adopt the accrual accounting method both at local and central levels. These factors include the strong engagement of IFAC-PSC, increased diversification of accounting systems, interest by international finance institutions, and quality of government reports (Perrin, 2008, p.39).
The 2007 global financial crisis left so many unanswered questions on government accounting and public financial management. Most of the advanced economies including US and EU had to cope with substantial pressures because of a number of factors such as restricted budgets, stagnant economies, and huge debts. This is a challenge experienced by most of the economies across the globe thus the need to improve the public sector management of resources by reporting high quality information on the accrued income and expenses in order to be able to forecast the financial position of the entity in the future. A sound and transparent public accounting is one of the most critical components in providing better decisions which eventually result into proper utilization of public resources (International Federation of Accountants, 2003, p.22).
Accrual accounting is a method whereby transactions are recognized when an order has been made and delivery made irrespective of cash receipts and payment timing. That said, income is only counted when cash has been made while expenses are recognized when resources have been consumed. The public sector, therefore, needs to use accrual accounting method to record transactions on an accrual basis (Perrin, 2008, p.41). Citizens, government, financial markets, donors, and investors need true and fair information on how public resources are utilized, and this information can only be achieved through the accrual accounting method. The cash accounting method lacks sufficient information on public sector assets and liabilities but rather provides a short-term view on the financial position of the entity (McKendrick, 2003, p.109).
By adopting the accrual accounting method, the government shows a strong desire to achieve greater efficiency, transparency, and accountability by providing quality financial information to various investors across the globe. The application of the International Public Sector Accounting Standards (IPSAS) helps to enhance information quality reported by various entities in the public sector because it facilitates the comparison across entities and governments (Hepworth, 2003, p.39). An accrual accounting method is the best option for the government regarding the position of IPSAS because it provides a number of standards to be followed by the public sector when reporting the financial position using the accrual accounting method. The main objective by IPSAS are the improvements on quality (transparency and accountability) when reporting the financial position of an entity and comparability of financial information (Accounting Standards Board, 2003, p.26).
In the case of local public sector accounting, there have been some harmonization processes adopted by various governments for instance, in EU, the accrual systems for receivables and inventories (interest, social contribution and taxes), and payables are required when accounting for expenditures and receipts during the financial periods. Another key important issue to note is that during the harmonization process the full depreciation of fixed assets is recognized in order to ensure that all costs including use and depreciation of fixed assets are taken into account. This is very important in the local public sector because it is a significant cost element in the public sectors that are capital intensive (Brusca & Vincente, 2002, p.139).
At the micro-fiscal level, accrual accounting is important in the sense that it measures all assets and liabilities pertinent to the fiscal policies in place. Accrual accounting goes further to measure quasi-debt liabilities including employee liabilities and all accounts payable for the receipt of either goods or services received (Christianens, Windels & Vanslembrouck, 2004, p.101). However, there are gaps in the current international accounting standards including IPSAS. There are 20 IPSAS currently available to accrual accounting concerning subjects such as presentation of financial statements, segment reporting, contingent liabilities, financial instruments, and the effects of foreign exchange rates changes. IPSAS standards facilitates the generation of high quality financial reporting by the government but there are gaps on how the standards are governed such as non-exchange revenues recognition including transfers and taxes, heritage assets, and accounting for social policies of the government (Christiaens & Brecht, 2009, p.67).
Evidence of Adoption of Accrual Accounting Method
Most of the governments across the globe have adopted accrual accounting method to prepare financial statements. A good example is the United States government that produces audited financial statements for only budget entities. However, some of the government entities are excluded including the Army Force Exchange Service and the United States Education Inc. The UK government, on the other hand, produces consolidated financial statements of the central government (Larby, 2003, p.89). The New Zealand implementation of the accrual accounting method was successful because at the beginning of its adoption in 1996, there was general dissatisfaction with the status of quo. New Zealand and Australia produces audited financial statements for the federal government. New Zealand, Australia, and the United Kingdom are currently using the accrual accounting methods in both local and central governments in financial reporting and budgeting, as well (Carlin & Guthrie, 2000, p.97).
In the context of the European integration, Romania was forced to change its accounting system from cash accounting to accrual accounting with some harmonization processes such as revaluation of fixed assets in order to allow for inflation. On this note, the current fixed assets values and current costs of depreciation are recognized when preparing the financial statements. The other harmonization process is the evaluation of normal profits recognized as costs of capital and the return on other investments. In the case of Canada the governments the accrual accounting method was adopted in the early 1980s following the contributions of the Public Sector Accounting and Auditing Board (PSASB). The implementation of accrual accounting method has been achieved by previous governments and legislative auditors who have convinced the governments on the advantages of accrual accounting over the cash accounting method. All governments in Canada have changed from cash method to accrual accounting method (Hepworth, 2013, p.39). However, there are governments that still use the cash accounting method such as Slovenia that has modified its cash flow principle. Most of the public entities in Slovenia use the cash accounting method to prepare financial reports but there are considerations to transit from cash accounting to accrual accounting method in order to enhance efficiency, transparency, and accountability when preparing financial reports (Christiaens & Jan, 2008, p.61).
In conclusion, the public accounting trend is in the transition from the traditional model of accounting (cash accounting) to accrual accounting principle. The cash accounting method produce income and expenditure statements that are based on cash flow principle in a yearly budget, and this can result into financial instability. The cash accounting method is only applicable in situations where minority of liabilities are long-term something which is not common in modern economies as they are currently facing increasing long-term liabilities including pensions, unemployment, and social security. When budget revenues are recorded using the cash flow principle government deficits are conceived. This is the reason why modern government are in transition from cash flow principle (cash accounting) to the accrual accounting method because it enables transparent business monitoring including claims and liabilities which do not apply in the cash accounting method. The 2007 global financial crisis revealed that besides the private sector, the public sectors too require quality financial information which helps investors, government, citizens, donors, and financial markets to make the most appropriate decisions on their investments. The financial statements prepared by the public sectors should disclose full information such as long-term impact of decisions taken. In the public sector, financial statements must provide clear distinction between market and non-market activities. The financial statements must provide information on the past, present, and future because this information helps in establishing enhanced trust between the various stakeholders including the government, citizens, donors, and investors. This is important for the government because it helps in building a foundation for their recovery and also protects the credibility of democratic legitimacy.
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