Accrual accounting and fiscal discipline in Government

By Don Wehby, Financial Gleaner Guest Columnist

In view of the global financial crisis and recent debt crises in several countries, there has been growing recognition worldwide of the need to strengthen public-sector financial systems and procedures.

This has been accompanied by increased demand for accountability and transparency.

Many countries, initially using cash-based accounting, have moved to more sophisticated modified cash or accrual-based accounting.

When one considers how cash accounting actually distorts the true picture, then the case for accrual becomes even more evident.

In Jamaica, there is the non-recording of pension liabilities, arrears to suppliers, tax on interest refund arrears and deferred financing, to name a few disadvantages. All of these are significant liabilities which are not recorded when incurred.

The accrual accounting method recognises expenses when they are incurred and revenue when it is earned, rather than when payment is made or received - for example, sales are recorded as revenue when goods are shipped even though payment is not expected for days, weeks, or months.

Most firms use the accrual basis of accounting in recording transactions.

A recent report from the International Public Sector Accounting Standards Board stated that over 80 countries have either adopted, or have processes in place to adopt these international accounting standards for public-sector financial management reporting. They include New Zealand, Australia, Italy, Germany, the Cayman Islands and Barbados.

Our country's own macroeconomic performance in the last 20 years indicates that there is dire need to strengthen the system of public-sector financial management. In this period, economic growth has averaged in the region of one per cent.

The fiscal balance over the same period has averaged -4.9 per cent annually, and the debt-to-GDP ratio has moved from 87.3 per cent in 2000 to 129.3 per cent in 2010.

Adopting accrual accounting across Government, as opposed to cash management, should be, at the very least, a medium-term objective for Jamaica.

This is all very relevant to the day-to-day work of public-sector accountants, as the introduction of such a system would mean that their roles would change.

For the transition to accrual accounting to be effective, it cannot be undertaken by itself. It should form part of a larger programme of economic reform - for example, three possible reform options are:

1) implementation of a 'Central Treasury Management Unit';

2) improvement of the existing budget process; and

3) improved accuracy and availability of fiscal data - to be able to set proper macroeconomic targets.

The Central Treasury Management Unit would be given the specific mandate, in the first instance, to focus on cash management.

It is very inefficient for the Government to simultaneously have cash-rich entities earning minimal interest rates and cash-strapped entities incurring huge overdraft interest rates.

There needs to be a concerted effort to minimise such inefficiencies throughout Government, especially in light of our current financial situation and the reported poor state of fiscal accounts.

The cash basis of preparing budgets allows for incomplete recording of transactions, which renders it difficult to estimate the full cost of government operations.

This, of course, has implications for the quality of decisions made by the Ministry of Finance and the Public Service.

I am an advocate of accrual accounting because:

a) At the aggregate level, accrual-based fiscal indicators provide better information about the sustainability of fiscal policies; provide a stronger basis for government accountability and provide a better measure of the effects of government policies on aggregate demand; and

b) At the organisational level, accrual-based financial statements provide better measures of organisational efficiency and effectiveness and reduce opportunities for fraud and corruption.

benefits of making the switch

The case of New Zealand is an example of the benefits to be gained from making the switch. The government of New Zealand first produced fully accrual-based combined financial statements in 1992. By 1994, New Zealand had started to see marked improvements in its debt-to-GDP ratio - a significant change from the prior 20-year slide in the fiscal accounts.

Gross financial liabilities were 65 per cent of GDP in 1993; by 2005 they were 23 per cent of GDP. As such, a fiscal surplus was recorded, and that started a trend which continues today.

What is even more noteworthy is that all commentators agree that the reforms engendered a much greater sense of fiscal discipline throughout the public service. This is what is needed in Jamaica.

Introduction of accrual accounting is, however, not without its challenges.

The most challenging aspect is the training of accounting staff, as this method is not currently used in central Government.

With any introduction of accrual accounting in the public sector a timeline should be worked out with a specific project unit, along with methodology to implement it. If it is done right, the benefits to the fiscal accounts would be significant.

Don Wehby is group chief executive officer of GraceKennedy Limited. don.wehby@gkco.com