Author Topic: Accrual accounting – who cares?  (Read 468 times)

marybetley

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Accrual accounting – who cares?
« on: December 14, 2010, 21:51:06 GMT »
Ministries of Finance in a number of countries practicing cash-based or modified-cash-based accounting are contemplating or actively planning a move to accrual accounting.  Indeed, the International Federation of Accountants (IFAC) explicitly recommended the widespread adoption of accrual accounting in a letter to G-20 participants in June 2010.  The questions that this move raise are: (i) why; and (ii) is it a good thing?

In many countries, the commitment to moving towards accrual accounting coincides with the planned introduction of new Financial Management Information Systems (FMIS or IFMIS), as these countries upgrade their Chart of Accounts to incorporate the GFS 2001 standard for expenditure classification, which provides for the option of (but does not require) accrual accounting.

The immediate attraction of accrual accounting to a government with a capital-constrained budget (e.g. in terms of a government-stipulated upper limit on the share of the overall budget or of GDP) is fairly obvious.  Under accrual accounting, the cost of a capital asset is spread over the asset’s life; under cash-accounting, by contrast, the cost is recorded in full when the purchase is incurred.  Thus, accrual accounting allows for the smoothing of capital expenditure. 

Other potential benefits include : (i) improved accountability for in-year expenditures (since financial statements show expenditures in the financial periods when they were made, regardless of when the cash was paid), thereby providing a more comprehensive picture of arrears; (ii) clearer basis for such accountability with the reporting of the full resource implications of government expenditures (including non-cash costs); and (iii) better management of assets and liabilities.

Thus, in the short term, the superficial benefit of accrual accounting is clear, but what about in the longer-term?  Firstly, the move to an accrual basis involves significant costs, not least of which is the cost of training staff.  In practice, the shortage of accounting and IT skills is likely to be a major impediment to introducing accrual accounting.  Secondly, the ability to generate the potential benefits requires a reliable basis for existing accounting information; where cash-based accounting information is poor (e.g. due to weak accounting skills), this will adversely affect their ability to  reap the benefits from accrual accounting.  Thirdly, it will be important for the intended recipients of the accrual-based financial statements (e.g. Parliamentarians) to understand them; the complexity of the new financial statements means that training users will add significantly to the costs.  Finally, in order to have a consistent comparison between actuals against planned, governments would need to move to an accrual basis for budgeting as well – this adds an additional level of complexity which is arguably beyond most governments (OECD or otherwise).

Overall, there is limited experience by governments around the world of implementing full accrual accounting.  In fact, many governments, including a fair proportion in the OECD, use a modified version, incorporating some accrual aspects (in a manner similar to many  governments who operate a modified cash-based accounting system).  According to ACCA, the benefits in practice of moving to accrual accounting have not been sufficiently demonstrated, and, in those countries which have implemented it, the process has involved a minimum of 8-10 years.  For most countries, the potential risks appear high.

STONE

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Re: Accrual accounting – who cares?
« Reply #1 on: January 10, 2011, 10:23:59 GMT »
I think you may have mis-titled your piece - should it not be accrual accounting - who understands?

Even if there is accrual accounting and it is understood, the cash accounts (modified or not) are still important.  There are parallels with the private sector where cash is king - the accounts can look good but if you run out of cash you run out of cash.  The markets and hence Ministers of Finance will always worry about the cash deficit, regardless of whether they understand accrual accounting.

petagny

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Re: Accrual accounting – who cares?
« Reply #2 on: January 10, 2011, 11:07:01 GMT »
Useful post about the differences between solvency and liquidity:

http://seekingalpha.com/article/205069-liquidity-solvency-and-the-difference-between-u-s-and-greece

Technically speaking a country with control over its own money supply cannot run out of cash -  but risks doing a Zimbabwe!

Countries in the eurozone are not in control of their currencies and can rapidly find themselves in a liquidity crisis. Greece was evidently insolvent (and as a consequence couldn't borrow and faced a liquidity crisis) but what about Spain? When Spain can borrow at around 5% (as now) it is probably solvent (and still has adequate liquidity), however, if the markets get the jitters (after Portugal tumbles, for example) and rates rise to 6.5% the country is probably no longer solvent and liquidity dries up. The markets' fears become self-fulfilling!


 

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