The financial and sovereign debt crisis have brought to light, as never before, the need for better financial reporting by governments worldwide, and the need for improvements in the management of public resources. Citizens are affected by a government’s financial management decisions. Strong and transparent financial reporting has the potential to improve public sector decision making and make governments more accountable to their constituents. The failure of governments to manage their finances has in the past, and could again in the future have, dramatic consequences such as loss of democratic control, social unrest and the failure of governments to meet their commitments today and in the future
International Public Sector Accounting Standards Board
This week the Institute of Chartered Accountants of Guyana (ICAG) will be having its annual ‘Accountants’ Week‘ at the Pegasus Hotel. The topics to be discussed include developments in financial reporting; the need for international public sector accounting standards for Guyana; and an update on audit and ethics issues. The ICAG has asked me to make a presentation on the second topic.
I thought it would be a good idea to kill two birds with one stone, except that at the ICAG forum the audience will comprise mainly accountants and businessmen, in contrast to the thrust of this article that is written with the general public in mind.
What are accounting standards and why are they necessary?
Accounting standards are fundamental principles that organizations follow in recognizing, measuring and recording financial transactions as well as in periodically presenting and disclosing them in a set of financial statements comprising income, expenditure, assets and liabilities. They are in effect codes of practice developed by professional accounting bodies to facilitate uniformity of practice and consistency in the accounting treatment of transactions, and in presenting the results of operations and financial position of organisations. They also aid comparability among businesses of a similar nature as well as across a wide variety of businesses.
An organisation can become bankrupt in the belief that it is making profits and distributing them to the owners, whereas in fact it has been making losses when applying accounting standards. The Enron and WorldCom scandals highlight the importance of strictly following accounting rules. These two scandals have caused the United States to tighten its rules, especially with the passing of the Sarbanes-Oxley Act of 2002. The Oil-For-Food scandal at the United Nations also resulted in a series of reform initiatives, the most important being the adoption of the International Public Sector Accounting Standards (IPSAS).
Accounting standards are not meant to be a set of rigid rules. There may be situations where adherence to a specific standard may not give a fair presentation of the financial statements, or where a particular event or transaction is not covered by an accounting standard. In such circumstances, the exercise of sound professional judgment and/or consultation with professional bodies/individuals will be necessary.
Types of accounting standards
There are three main types of accounting standards that are recognized internationally:
International Financial Reporting Standards (IFRS) that are applicable mainly to private sector organizations. IFRS is the successor to the International Accounting Standards developed during the period 1973-2001;
International Public Sector Accounting Standards (IPSAS) that are used by governments, intergovernmental organizations, and international organizations. Developed since 1997, they are essentially IFRSs but adjusted as appropriate to meet the specific requirements of government; and
National standards that are promulgated either by the recognised professional accounting bodies in the country or by legislation.
The United States, India, South Africa and several other countries have developed their own standards. Many countries, however, find it more convenient to adopt the first two types of standards, rather than re-inventing the wheel. In Guyana, the ICAG has adopted IFRS for private sector organizations.
Cash basis of accounting versus accrual basis
Traditionally, countries have used the cash basis of accounting for recording and reporting financial transactions. Transactions are recognised as expenditure only when payments are made for the supply of goods and services, and for works undertaken, irrespective of when value is received. Similarly, revenue is recognized and recorded only when cash is received and not when the amounts are due to be collected on the presentation of invoices.
The cash basis of accounting is simple to operate and is relatively inexpensive. It also helps legislators in monitoring and controlling expenditure. However, it suffers from a number of shortcomings. With the emphasis on cash, proper accountability for assets, particularly fixed assets and inventories is largely ignored. There is also a tendency of understating liabilities, particularly those relating to pensions. In addition, there is often the practice of accelerating expenditure in the closing months of the year to utilize budgetary allocations, or to postpone expenditure to avoid allocations being overrun, thereby facilitating a significant degree of manipulation of the accounts. Further, comparative analysis from one year to the next is difficult, and information about cost is restricted to a mere comparison of expenditure with budgetary allocations.
The other form of accounting is the accrual basis of accounting.
This requires transactions to be recorded as expenditure when value is received as opposed to when payment is made. Similarly, recordings of revenue are made when goods and services are supplied to customers, as opposed to when payments are received. Detailed accounting rules have to be followed, and all income and expenditure as well as assets and liabilities are fully accounted for. Indeed, many of the shortcomings of the traditional cash accounting system are obviated using this framework of accounting.
The accrual basis of accounting is superior to cash basis of accounting since it gives a complete picture and provides a fairer presentation of the financial statements in terms of results of operation and financial position. It also facilitates greater transparency and enhanced accountability. The IFRSs are accrual-based standards while 31 of the 32 IPSAS standards are accrual-based.
Many countries have recognized the limitations of the cash basis of accounting. Some of them have signalled their intention to gravitate towards accrual accounting consistent with international accounting standards. Others have adopted or are in the process of adopting such a framework. For example, New Zealand, Australia, USA, UK, Canada, Colombia and France as well as eight intergovernmental organizations, including the Commonwealth Secretariat, the European Communities, INTERPOL, NATO and OECD, have all adopted full accrual accounting. In addition, of the 24 entities that make up the United Nations system-wide operations, 21 will be implementing IPSAS fully by the end of the year. The World Food Programme, a UN agency, has implemented IPSAS in its entirety since 2008. It has so far received a clean bill of health from its external auditors. The UN Secretariat proposes to be fully IPSAS-compliant by 2014.
Accounting standards and the Government of Guyana
The Government of Guyana uses the cash basis of accounting that it inherited from colonial times. Section 56 of the Fiscal Management and Accountability Act 2003 requires the Minister of Finance to promulgate appropriate accounting standards to be employed by officials responsible for the maintenance of the accounts and records. However, after nine years of the passing of the Act, this is yet to be done.
Using the cash basis of accounting, every year the government produces 13 sets of financial statements comprising the public accounts of Guyana. These statements, or combination thereof, however, do not give a complete picture of the results of operations and the financial position of the country. In addition, a review of the latest Auditor General’s report on these statements indicates that none of the statements received a clean bill of health because of the significant discrepancies and shortcomings contained in them. In fact, the Auditor General qualified his opinion on seven statements, ie he had reservations of a material nature about them. The remaining six statements were so deficient that he was obliged to disclaim his opinion on them, ie the uncertainties and reservations were of such a fundamental nature that the Auditor General was unable to express an opinion on these statements.
In very simple terms, the Public Accounts are really in a bad shape. Yet we seem happy, indeed content, to announce that we have audited accounts for the country! In the private sector, this is unprecedented, and the slightest qualification from the external auditors is likely to bring about a change in the management of the organization. Imagine what will happen to the share price of a publicly traded company if its external auditors issue a qualified opinion on the company’s accounts. It is also doubtful if other countries will tolerate such a state of affairs as exists in Guyana.
The deficiencies highlighted by the Auditor General are not new. They existed since 1992, following the restoration of public accountability after a ten-year lapse. It was not a perfect restart of the process. However, one would have expected progressive improvements in financial reporting over the years. Unfortunately, little or nothing was done, hence the successive negative reports of the Auditor General on the Public Accounts. We tend to focus on the ‘juicy‘ parts of the Auditor General’s reports almost to the exclusion of the overall view given on the financial statements as a whole.
The quality of financial reporting on the Public Accounts of Guyana leaves much to be desired. The time has therefore come for some serious reform initiatives to be undertaken in respect of our public financial management system. Any such initiative should incorporate new rules and standards consistent with international best practice.
There appears to be little or no appetite to develop our own accounting standards for the operations of government. In any event, there is hardly any uniqueness in our system to justify doing so. This leaves us with the choice of adopting either IFRS or IPSAS. Since the latter is public sector oriented, it would be preferable to adopt the accrual-based IPSAS for the accounting and financial reporting of the government. This would be consistent with what many other countries are doing. IPSAS is likely to improve the quality of financial reporting, aid comparability and provide greater assurance of credibility and transparency as a whole.
The adoption of the cash-based IPSAS is not recommended since it will result in a mere tinkering with the existing system with all its attendant deficiencies.