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1 J. OF PUBLIC BUDGETING, ACCOUNTING & FINANCIAL MANAGEMENT, 19 (4), WINTER 2007 GOVERNMENTAL ACCOUNTING IN PORTUGAL: WHY ACCRUAL BASIS IS A PROBLEM 1 Susana Margarida Jorge, João Baptista da Costa Carvalho, and Maria José Fernandes* ABSTRACT Until the end of 1997, governmental accounting in Portugal was characterised as essentially cash-based budgetary accounting, using singleentry as the bookkeeping method. The only compulsory accounting system was Budgetary Accounting. As many countries all over the world, nowadays Portugal is implementing a reform of the whole governmental accounting, which has as most important innovations the use of double-entry within a system compulsorily integrating accrual-based Financial and Cost Accounting along with Budgetary Accounting (still essentially cash-based). The main purpose of this paper is to describe and analyse the reform and current situation of governmental accounting in Portugal, especially discussing the accrual basis implementation. In particular, it shows that not only governmental accounting reform in Portugal has been going towards international harmonization, but also problems that have arisen are common to others faced by several countries. Perspectives of future evolution are also presented. INTRODUCTION Generally, accounting in Portugal is influenced by the Continental European perspective and is characterized by the existence of explicit * Susana Margarida Jorge, Ph.D., is an Assistant Professor, Faculty of Economics, University of Coimbra, Portugal. Her research interests are in governmental accounting, with special focus on local government. João Baptista da Costa Carvalho, Ph.D., is an Associate Professor, School of Economics and Management, University of Minho, Braga, Portugal. His research interests are in public sector accounting. Maria José Fernandes, Ph.D., is Coordinator Professor, School of Management, Instituto Politécnico do Cávado e do Ave, Barcelos, Portugal. Her research interests are in public sector accounting. Copyright 2007 by PrAcademics Press

2 412 JORGE, CARVALHO & FERNANDES standards concerning the elaboration and presentation of the accounting information. Until the end of 1997, governmental accounting was essentially cash-based budgeting, using single-entry as bookkeeping method. The only compulsory accounting system was budgetary accounting. At the present time, Portugal is passing through a reform process of the whole governmental accounting, which has as most important innovations the use of double-entry in an integrated system embracing three compulsory sub-systems: accrual-based financial and cost accounting and modified cash-based budgetary accounting. The approval in 1997 of the first Official Plan for Governmental Accounting 2 (OPGA Law-decree 232/97) and the subsequent approval of specific plans for some public administration sub-sectors, namely the Official Accounting Plan for Local Government (OAP-LG Law-decree 54A/99) in 1999, in 2000 the Official Accounting Plan for Education (OAP-Ed Instruction 794/2000) and the Official Accounting Plan for Health (OAP-H Instruction 898/2000) and finally the Official Accounting Plan for Social Security (OAP-SS Lawdecree 12/2002) in 2002, indicate the passage from a traditional to a modern governmental accounting. While in the former the main goal was account for the budget legal compliance, the latter is expected to be a supporting tool in the management and evaluation of governmental entities, contributing to the implementation of the New Public Management (NPM). This paper describes and analyses the situation in Portugal concerning the reform of governmental accounting. Recent studies carried out by national oversight and standardization bodies as well as by researchers, have emphasised that the implementation of the accrual basis is one of the major problems. Subsequently, the major contribution in this study relates to discussing the implementation of accrual-based accounting in governmental entities in Portugal, particularly addressing reasons why some have been finding problems in putting it into practice as well as in reading the information reported in accrual-based financial statements. In particular, the study aims at showing that: on the one hand, the governmental accounting reform in Portugal has been going towards international harmonization and, on the other hand, problems that have arose, namely related to accrual basis implementation, are common to others faced by several countries.

3 GOVERNMENTAL ACCOUNTING IN PORTUGAL: WHY ACCRUAL BASIS IS A PROBLEM 413 This subject has not been approached in Portuguese literature, which addresses essentially technical issues, since it is based in laws and accounting and budgeting manuals. In what concerns international literature, Portugal has been included in comparative studies essentially about the topic of governmental accounting international harmonization (e.g. Fernandes & Carvalho, 2001; Ballaguer Coll et al., 2001; Jorge, 2003; Brusca Alijarde & Bénito Lopez, 2002). Nevertheless, none of these has analysed the accrual basis implementation. Henceforth, the paper is organised in four main sections. Section 2 situates the Portuguese Public Administration and governmental accounting reform within the international context, introducing the subject of governmental accounting harmonization. Section 3 offers an overview of the recent changes and current state of governmental financial management and accounting in Portugal. Section 4 presents studies recently developed in Portugal concerning the implementation of the new accounting system, particularly highlighting issues related to the application of the accrual basis. Section 5 discusses reasons why accrual basis might be a problem, considering the Portuguese situation in face of international studies addressing this matter for other countries. To conclude, some perspectives of future evolution and final comments are presented. PUBLIC ADMINISTRATION AND GOVERNMENTAL ACCOUNTING REFORM: PORTUGAL IN FACE OF THE INTERNATIONAL CONTEXT In the last fifteen years, within the New Public Management (NPM) trend, Portugal has been reforming the public administration, not only in what concerns administrative issues, but also especially regarding governmental accounting and financial management. In this respect, after a revision of the Constitution in 1989 changing the basic rules for the State s Budget structure and the budgetary management principles and methods, the Governmental Accounting Basis Law (Law 8/90) was passed, launching the foundations for the state financial management new regime, which started in 1992 (Lawdecree 155/92). New rules for the State s general budget framework were meanwhile issued in 1991 (Law 6/91, already revoked in 2001 by Law 91/2001). The main objectives established by the State financial management new regime reflect an evident concern with

4 414 JORGE, CARVALHO & FERNANDES modernising the public administration. 4 Accordingly, the new regime aimed at: Better rationalization of the public expenses; The accomplishment of legality; More efficient control of public expenses; An increased and more timely financial information; and Enhancing the responsibility of public managers. As necessary measures to achieve the proposed objectives, we highlight: The decentralization at administrative and financial levels; A progressive reduction of the number of services and funds with administrative autonomy only, changing to a management regime more demanding in financial terms; The modification of the structure of the State s Budget in terms of economic classification codes of revenues and expenses and the revision of the Budget preparation process; The decreasing of the ex-ante budgetary control system and consequent increase of the ex-post control; The revision of the stages of expenses execution and of the consequent accounting records; The obligation of producing not only financial information, but also information concerning the economic situation. The origins and philosophy of the reforms that have happened in Portugal are shared by different OECD countries. Nevertheless, the reform strategies undertaken have been divergent regarding their main objectives, scope and intensity (OECD, 1980, 1990, 1993 and 1995), leading to the existence of different models of public management, depending on the characteristics of each country or group of countries (Suleimen, 2000). Several authors, such as Torres and Pina (2004), Olsen and Peters (1996), Pollitt and Summa (1997), Clark and Newman (1997) and Green-Pederson (2002) have identified three types of factors

5 GOVERNMENTAL ACCOUNTING IN PORTUGAL: WHY ACCRUAL BASIS IS A PROBLEM 415 normally proposed as explanations for the extent to which different countries have implemented NPM reforms: a) Macroeconomics problems in the OECD countries in the 1970s that encouraged countries with biggest difficulties to implement NPM reforms to the largest extent; b) The introduction of NPM reforms as part of a neo-liberal political view in the 1980s; c) Different receptivity from the European Continental tradition to market-type reforms of the Anglo-American culture. However, to Bislev and Salskov-Iverson (2001), the NPM is a variable concept. Therefore, it is not a) Analytically consistent in the sense that it can be ascribed to a certain theoretical perspective in the Public Sector; b) Ideologically coherent, although the first waves of NPM reforms were carried by neo-liberal energies; c) Homogenous across nations and institutional boundaries. Table 1 presents the classification of the different OECD countries in function of the characteristics of their public management system, proposed by the OECD service of Public Management (PUMA). It can be observed that Portugal presents the characteristics of a country of normative public management. According to Pina and Torres (2002), the South European countries (namely Spain, Portugal, Italy, France and Greece) have more difficulties in adopting NPM postulates. These countries belong to a public administration culture that is grounded in administrative law and influenced by structures imported from the French legal model. Subsequently, based on the OECD reports, they have proposed a classification of the degree of implementation of the NPM in Continental European countries as function of four criteria: a) degree of decentralization of the Public Sector, b) degree of development of the budget and of governmental accounting, c) role of the State and its relationship with the citizens, and d) application of measures regarding the increase of productivity in labour. According to this classification, those authors consider Portugal as presenting a degree of decentralization that can be classified as

6 416 JORGE, CARVALHO & FERNANDES TABLE 1 OECD Countries according to their Model of Public Management Countries Model of Management Management based on performance Mix management Normative management Anglo-Saxon Scandinavian Continental Latin New Zeeland Australia United Kingdom Canada USA Ireland Source: Suleiman (2000, p.6) Sweden Finland Denmark Norway Netherlands Austria Switzerland Germany Belgium France Portugal Italy Spain Greece medium and a level of development of the budget and of governmental accounting considered as medium to low. Araújo (2001) explains that this happens because the power of tradition and the persistence of rules, beliefs, norms and practices which are embedded in the culture hampered the introduction of new management models. Even so, two historic facts definitely mark the path followed in the implementation of the principles of the NPM in Portugal: 1) the revolution of April 1974, a military coup that put an end to the dictatorial regimen, allowing the possibility of modernising the Public Sector up to then characterised by models of State intervention specific of those regimens; and 2) the entrance of Portugal to the then European Economic Community, in 1986, which defined the effective start of public management reforms. On the subject of governmental accounting, the different countries integrating the EU were required to compulsorily produce accounting and financial information not only to national users but also to European bodies as well. The restrictions imposed at the level

7 GOVERNMENTAL ACCOUNTING IN PORTUGAL: WHY ACCRUAL BASIS IS A PROBLEM 417 of the public deficit control and of the observance of the established by the European System of Accounts (ESA) are conspicuous (Ribeiro, 2004). As a consequence, this internationalization of accounting gave origin, on the one hand, to more users of accounting information and, on the other hand, to a process of international harmonization of governmental accounting to which Portugal could not stay indifferent. In fact, the accounting information will only achieve its objectives if it is able to answer to the informational needs of its different users. In order to reach this purpose, accounting information included within budgetary and financial reporting, must show several characteristics, such as: utility, reliability, comparability, be understandable, and reflect a true and fair view of the budgetary, economic and financial situation of each reporting entity. Recent literature (e.g. Lüder and Jones, 2003, Lapsley and Pallot, 2000; Lüder, 1989 and 2001; Brusca and Condor, 2002; Montesinos and Vela, 2000; Pina and Torres, 1996) has focused on issues related with this harmonization process, which has started in the private sector (Nobes and Parker, 1995) but that, at present times, within a trend of bringing governmental accounting closer to business accounting, as well as of increasing accountability to supra-national entities, has also achieved major relevance within the Public Sector context. Bac (2005) addresses the importance of international harmonization in governmental accounting highlighting three points: Comparability, particularly considering the fact that currently many countries enter into quasi-supra-national federations, like the EU. In such a context where common economic policy is intensified (e.g. Euro-zone), interest in comparability may rise. Procurement of a basis for a minimum of quality of financial reporting all over the world, especially useful for developing countries and countries in transition, supporting the development of their own governmental accounting legislation. Contribution to the use and dissemination of knowledge and experience with respect to governmental accounting. According to Lüder (1989), the international harmonization will also work as stimulus to the modernization of governmental

8 418 JORGE, CARVALHO & FERNANDES accounting across countries, particularly important triggering reforms in nations members of international bodies in which the accountability process benefits from harmonised statements. The ongoing harmonization process of governmental accounting relies mainly on the support and work developed by different international bodies, from which the International Federation of Accountants (IFAC) is outstanding. Indeed, in 1986 it was created the Public Sector Committee (PSC), currently designated International Public Sector Accounting Standards Board (IPSASB) 3, which main function is producing International Public Sector Accounting Standards (IPSASs). While acknowledging problems of making them of compulsory application, since IPSASs cannot surpass the regulations issued nationally by each country, the IPSASB strongly recommends their worldwide adoption. Subsequently, the process of governmental accounting international harmonization is still very far from IPSASB aspirations and certainly very far from the one in the business accounting context. Ribeiro (2004) explains that three main factors seem to be responsible for this delay: Financial markets have not the same influence in Public Administration as in companies; The accounting culture amongst Public Administrations follows very different traditions; and Governments are averse in adopting their national regulations to others external and supranational, since that might question national sovereignty without an evident compensation. However, Brusca and Condor (2002) explain that governmental accounting harmonization is getting underway and some international organizations, such as the EU, have started a process which gives evidence of this and aims at reducing the differences between the countries. Ribeiro (2004) stresses that governmental accounting harmonization within the EU is expected to become a reality before long, since: European bodies (e.g. the European Commission) accounting systems have been reforming according to IPSASs;

9 GOVERNMENTAL ACCOUNTING IN PORTUGAL: WHY ACCRUAL BASIS IS A PROBLEM 419 Some EU member-states (e.g. UK, France, Spain and Sweden) have already been adapting their governmental accounting systems to IPSASs; Accounting and auditing professionals across Europe have been interested in technical comparability; and The political cost in terms of sovereignty and legitimacy might turn into positive results for politicians (e.g. improvements in European Public Administrations). In any case, the process is delayed compared to the one in business accounting, for which EU regulations were passed in 2002 giving the member-states a transition period up to 2005 from which IFRSs from the IASB would become compulsory at least for listed corporations. 5 Regarding governmental accounting, the EU main procedures have resumed to adopting IPSASs to the European institutions accounting system. According to Ribeiro (2004), this is justified by the fact that currently the EU main concern is controlling member-states public debt and deficit, within the Stabilization Pact, safeguarding the value of the common currency. As expected, this delay is reflected in the initiatives carried out by the national regulatory bodies. Therefore, in Portugal, as in the majority of the EU member-states, the process of adopting IPSASs has not started yet (although they have already been translated to Portuguese), as it additionally requires further intervention of the Public Administration Accounting Standardization Commission (PAASC) as the standardization body for governmental accounting. Nevertheless, it can be considered that governmental accounting in Portugal has followed the same track as other countries, as we will analyse in this study, i.e., Portugal has going towards the international harmonization of governmental accounting, even though through a legislative accounting with a strong political influence. Caperchione (1999) explains that there is some growing uniformity of policies among the countries that are making an effort to modernise governmental accounting, namely concerning: Introduction of accrual-based accounting systems; Modification of the policies and tools to disclose economic and financial performance;

10 420 JORGE, CARVALHO & FERNANDES Introduction of tools to assess actual performance, i.e., the impact on consumer needs, and to adequately disclose it to the various stakeholders (performance evaluation and measures of service and effort accomplishment ); Setting up of a corpus of national accounting standards. In the recent reform of Portuguese governmental accounting, these features can also be noticed, confirming the convergence towards the harmonization process. Indeed, the current governmental accounting framework generally: Comprises accrual-based financial and cost accounting together with essentially cash-based budgeting; Requires the calculation of the costs of services provided; Produces financial statements that are reported together with budgetary statements; Aims at providing information to account for each entity budgetary, financial and economic situation, as well as to support decision-making (management); Is based on a legal framework produced by a national (governmental accounting) standardization body. Nevertheless, as Araújo (1999) explains, the emphasis on the rule of law, the tradition of bureaucracy and resistance to change, the centralised nature, the control through hierarchy, and the focus on the process of inputs, have hampered the success of such reforms. THE REFORM AND CURRENT STATE OF GOVERNMENTAL ACCOUNTING IN PORTUGAL As explained, the actual reform of the State s financial management and of governmental accounting in Portugal, was started with the approval and publication of a set of regulations. Since legality is one of the most important principles overriding in Public Sector accounting, this shows the comprehensive and normative character of the process (Carvalho, 2000). The reform started more effectively from 1992, with the State Financial Management New System, comprising separate accounting regimes

11 GOVERNMENTAL ACCOUNTING IN PORTUGAL: WHY ACCRUAL BASIS IS A PROBLEM 421 for the different governmental entities under the Central Administration. By appending as subjects of analysis the economic perspective and the public assets ownership aspects, measures of efficiency, effectiveness and economy in the management of the public expenses, and the preparation of information to be used as support to decision making of different users (including National Accounting), the new system of governmental accounting was targeting the objectives required by the NPM and making possible the information to become of increased utility and comparably. These new objectives are mentioned in the OPGA approved in 1997, when it refers that the governmental accounting system has as main objective the creation of conditions to the integration of different aspects budgetary, financial and cost accounting in a modern public accounting, that constitutes a fundamental instrument to support the management of public entities and to their evaluation (Law-decree 232/97). Table 2 synthesises the differences between the models in use before and after the introduction of the new system. As referred to by Jorge (2001), the approval of the OPGA has an historical meaning in the reform of governmental accounting in Portugal, providing an adequate accounting system capable of answering to the needs of a modern Public Administration. Nevertheless, it represents only the first of several necessary steps to the total implementation and consecution of the objectives of the Public Administration reform in Portugal. The process of implementing the new accounting system has represented a cultural shock, because it requires a change of mentality where economic rationality, management by objectives, achievement of an increased value for money, innovation and rigour, and accountability are central. The main sources for this new system were: The Official Plan for Business Accounting (Law-decree 410/89) particularly for financial accounting, namely in what concerns the valuation criteria and accounting principles and also the models for the reporting statements (except the budgetary maps);

12 422 JORGE, CARVALHO & FERNANDES Budgetary Accounting structured under the Cash Basis. TABLE 2 Portuguese Governmental Accounting System Evolution Until 1990 From 1990 until 1997 Since 1997 By rule, the entities had a budgetary accounting system. Entities with financial autonomy (exceptional regime) had a system based on business accounting (accrual basis). The users of information were almost exclusively the Government, Parliament and The Court of Accounts (Supreme Audit Office). There were no Official Accounting Plans. The entities obliged to follow an accounting system business alike used the business accounting plan or approved specific plans based on that. The legislation concerning reporting statements was sparse and approved by the State. The Court of Accounts defined reporting statements. There was only obligation of listing fixed operational assets. The registration of fixed assets and vehicles was centralised in the State s Property General Department. Legislation was approved to the inventory and actualization of the State s assets. Depreciation rates were those defined for business accounting. By rule, governmental entities have three accounting systems: budgetary, financial and cost accounting. The entities with much reduced budget (exceptional regime) need to have budgetary accounting only. The new accounting system supposes the existence of other users of accounting information, namely the citizens. An Official Governmental Accounting Plan was approved, with compulsory utilization to the whole of Public Administration. The legislation concerning reporting statements is broad and approved by the State. All governmental sub-sectors accounting plans have to be authorised by the Public Administration Accounting Standardization Commission. The Court of Accounts defines the reporting statements amongst which financial statements are similar to those defined in the business accounting plan (Resolutions 04/2001 and 01/2004). Legislation was approved for the Assessment and Inventory of Public Property, including depreciation rates, since 2000 (Instruction 671/2000).

13 GOVERNMENTAL ACCOUNTING IN PORTUGAL: WHY ACCRUAL BASIS IS A PROBLEM The Spanish Plan General de Contabilidad Pública (Public Accounting General Plan) especially for the model of Budgetary Accounting. There are, however, several differences between the approved model and these sources. In what concerns the differences between the accounting of the business sector and of the Public Administration, it must be emphasised the fact that in the latter the ownership ( patrimonial perspective ) and legal aspects prevail over the financial and economic perspective. Additionally, governmental accounting requires three compulsory sub-systems budgetary, financial and cost accounting the first one still playing a central role. In relation to the differences between Portugal and Spain, it is important to highlight the fact that in Portugal the ownership focus prevails over the financial and economic focus. Furthermore, the accrual basis is integrally accomplished (full accruals) in what concerns the preparation of the balance sheet and the calculation of the economic annual net result. 6 The three mandatory accounting sub-systems currently existing in Public Administration have different features and objectives. Their main technical characteristics are presented in Table 3. TABLE 3 Governmental Accounting Integrated System Budgetary Accounting Financial Accounting Cost Accounting - Revenues and expenditures economic classification - Expenditures functional classification - Budgetary Statements - Book value for fixed assets - Economic result - Debts value - Stocks value - Costs and revenues by nature - Balance sheets - Expenses (revenues and results are optional) by functions, activities, services, products, departments Modified Cash Basis Accruals Basis Accruals Basis Double-entry Double-entry Not defined free Source: Fernandes and Carvalho (1999)

14 424 JORGE, CARVALHO & FERNANDES Concerning their objectives, while Budgetary Accounting aims at controlling the budget execution, Financial Accounting has the purpose of reporting on the entities economic and financial situation and Cost Accounting operates in calculating cost of services. In addition, the system: 1) Lays upon general accepted accounting principles (GAAP) and budgetary rules; 2) Establishes valuation and recognition criteria; 3) Uses complementary legislation for fixed assets actualization and for the economic (budgetary) classification of expenses and revenues; 4) Follows the historical cost prevailing as valuation criteria for fixed assets; 5) Requires public domain assets (infrastructure, cultural and heritage assets) to be listed in the Balance Sheet and compulsory depreciated if appropriate; 6) Requires assets acquired under financial leasing system to be immediately registered as fixed assets; 7) Has as main standardization bodies the PAASC and the Ministry of Finance; 8) Has The Court of Accounts as the external supervisor (Supreme Auditor) body. 7 Motivated by the specificities associated to the Public Administration several sub-sectors, from the publication of the OPGA, four accounting plans have been approved, as mentioned in the Introduction. In fact, the OPGA (Law-decree 232/97, Article 5, No. 1) states that ( ) the timings for the adaptation of the sub-sector accounting plans that are indispensable are approved by instruction of the Minister of Finances and, when is the case, of the other ministers involved, after hearing the Public Administration Accounting Standardization Commission. There are, however, integrated funds and services, such as the Ministries Cabinets, for which there was no need for a specific plan, so they use the general one. Notwithstanding the particularities of each framework, there are many commonalities assuring both the uniformity sought in the topdown approach that has been followed in the reform process as a

15 GOVERNMENTAL ACCOUNTING IN PORTUGAL: WHY ACCRUAL BASIS IS A PROBLEM 425 whole, and that conditions remain to comparability and consolidation of information. We believe it can be said that the legal framework for the ongoing reform is now completed. Indeed, with the recent issuance by The Court of Accounts of instructions defining the organization of reporting statements for all governmental entities, all the legislative conditions are met to make possible the effective introduction of the new governmental accounting system. Therefore, the moment has come to analyse its implementation at the level of several entities and whether the information that has been published represents the true and fair view of their budgetary, economic and financial situation, that is, whether the ongoing reform is driving towards the achievement of the initially stated objectives. In particular, since it has been asserted that the adoption of accrual accounting would result in improved accountability to oversight bodies and better management of the public services based in enhanced information to support decision-making, it is now important to analyse whether those aims were no more than a rhetoric exercise. IMPLEMENTING ACCRUAL BASIS IN PORTUGUESE GOVERNMENTAL ACCOUNTING In the last couple of years, national oversight and standardization bodies have produced several reports and some researchers have also developed studies regarding the accomplishment of the governmental accounting reform objectives, namely whether, with the introduction of accrual basis, the system is now more informative. From these, which were the first on the subject, we highlight four. Public Administration Accounting Standardization Commission (CNCAP, 2003) In the activities report for 2003, the PAASC presented conclusions from the analysis performed to the financial statements of 50 pilot entities of the central administration firstly experimenting the new accounting system. 8 The most important were: - Recognising that the implementation of new governmental accounting system has progressively grown;

16 426 JORGE, CARVALHO & FERNANDES - Presenting reservations about the reliability, relevance and comparability of the information disclosed in the reporting statements, namely pointing out the need for specialised verification of the accounts, in order to assure that the information is fairly presented (i.e. whether the new system requirements are satisfied); - Admitting that the implementation of the new system is still in a phase with complex problems to solve and difficulties to overcome, most of them related to the suitability of software applications and the insufficiency of human resources qualified in these subjects; - Acknowledging that changing from cash to accrual basis, although had intended to improve the quality and quantity of the information reported (namely adding the economic to the monetary perspective), has brought serious problems concerning: the valuation of public domain assets; the clear understanding of the difference between cost and expenditure; and the recognition as receivables or accrued revenues of the grants transferred from the Central Government. The Court of Accounts (TC, 2003) In 2002, The Court of Accounts has applied a questionnaire to the reporting entities of the public tertiary education sector subject to the new accounting system, totalising 201 entities, with the purpose of identifying the degree of implementation and difficulties in the application of the new framework. The main results achieved, published in 2003, were as follows: The most important limitations or constraints in the implementation of the new accounting system are: 1) difficulties with integrated software programs; 2) lack of human and financial resources; 3) difficulties in the preparation of some required financial statements, such as the Balance Sheet and the Operational Statement; 4) need of reformulating the internal control system; 5) lack of a technical supporting group; The main difficulties in the elaboration of the initial inventory of assets are the attribution of an actual value to the library books and art objects;

17 GOVERNMENTAL ACCOUNTING IN PORTUGAL: WHY ACCRUAL BASIS IS A PROBLEM 427 It is recognised the utility of consolidated accounts, but the main difficulties of its preparation concern the lack of harmonization of the information amongst the different entities of the group, specifically the software programs, the internal control system and the valuation criteria; Recognising the need to have a conceptual structure instructing how to understand the business accounting notions within the Public Administration context, especially those concerning total assets that must include specific items, the interpretation of the Net Result as a performance measure, and the meaning of equity as indicator of financial position. Fernandes (2004) This was a study on the degree of implementation of the new accounting system in the Local Government, developed by using a questionnaire delivered to all Portuguese municipalities. From a response rate of just over 30% of the population (since 101 out of 308 municipalities answered), it was verified that: 87.2% have started the implementation in 2002, 6.4% in 2001 and only 3.2% in 2000, what is not to be found strange as the compulsory implementation firstly expected for 2000 was later postponed for 2001 and after for The Cost Accounting system is the one that presents a more reduced degree of implementation (only 17% of the entities enquired said to have started implementing), while all entities have the Budgetary Accounting system already considerably implemented. Reasons for this relate to difficulties faced by entities considering items that are budgeted as expenditures and must be allocated to activities and services as expenses/costs. The perspective of resources consumed (accruals), implying the recognition of internal economic flows, is difficult to put in practice, since it demands an accurate identification of the timing when costs are incurred and revenues obtained, regardless their payment or receipt; this is not easy, given the still very strong cash culture as well as the way grants and taxes collected by the Central Government are transferred to the Local Government. 33% have not valuated and inventoried any of the public domain assets yet, so the Balance Sheets reported do not reflect the total

18 428 JORGE, CARVALHO & FERNANDES patrimony (property owned and controlled) of each entity; accordingly, they are financial balance sheets and not patrimonial balance sheets, as intended by the new governmental accounting. Only 17% of the entities answered to have the inventorying process already concluded. Concerning the organizational alterations that were derived in order to implementing the new accounting system, 40% answered changes at the level of: - Creation of new department related with the systems of accounting, audit and management control; - Recruiting personnel with specific training in the accounting field. This has been necessary since the background of many civil servants responsible for the accounting services, was in law, public administration or public finances, therefore not so familiar with certain accounting practices, in particular those closer to business accounting (e.g. double-entry bookkeeping method and the accrual concept). Before the reform, their main responsibilities concerned merely budgeting the budget (legal) execution in a cash basis. - Reorganization of procedures and of communication channels. Carvalho et al. (2006) This was an empirical preliminary study evidencing how the rules and some failures of the Local Government accounting new system framework might cause distortions when analysing the entities economic and financial situation. The specific topics analysed were: The effect of recognising public domain assets on the assets structure, on the entities equity, and on the annual net economic result, namely considering those assets depreciation; The weight of the deferred revenues within the liabilities structure; The weight of the receivables over the total assets; The structure of cash on hand and deposits in banks; The annual economic net result compared with the budgetary result and the cash balance.

19 GOVERNMENTAL ACCOUNTING IN PORTUGAL: WHY ACCRUAL BASIS IS A PROBLEM 429 From a universe of 308 they have analysed the financial reporting statements of 147 municipalities. Out of these, 59 were selected as sample to this study, considering the following exclusion criteria: Did not have public domain assets in the balance sheet or, in spite of having, more than 80% were in-process, indicating that, in fact, those public domain assets existing before the implementation of the new system were not yet totally or in great part valuated and recognised; Did not have deferred revenues within the liabilities, indicating that they were not using the accrual basis correctly. In fact, every municipality develops investment projects generally financed by earmarked capital grants and transfers, either from the State Budget or the EU that, according to the new system rules, must be recognised as deferred revenues; Although fulfilling the two above criteria, did not have depreciation in the Operational Statement neither accumulated depreciation in the Balance Sheet, revealing that they were not accomplishing with one of the main rules of the new system. In their point of view, not listing public domain assets, not accomplishing with the accrual basis and not considering assets depreciation are the crucial issues that have a substantial influence on the financial statements analysis, according to the new accounting system. This led to a first conclusion that only 40% of the entities analysed have presented a Balance Sheet fairly meeting the new system requirements, i.e., appropriate information about each entity financial and economic situation. Additionally, their main findings were: Since public domain assets cannot be sold and mortgaged, when analysing the Balance Sheet from the financial perspective, they cannot be considered neither as part of the assets nor within equity. Given that those assets were representing 51% of the total fixed assets and their depreciation 74% of the annual depreciation, the requirement for them to be listed according to the new accounting system was changing considerably the assets composition and the costs structure within the Operational Statement. Indeed, listing public domain assets in the Balance Sheet was increasing the equity over total assets from 48.3% to 73%, which did not represent an effective increasing, given the

20 430 JORGE, CARVALHO & FERNANDES legal features of those assets. Consequently, an economic and financial analysis of the financial statements prepared according to the new system ( patrimonial perspective ) offers a distorted version of the financial perspective. According to the new system, deferred revenues are considered liabilities; however, they are not claimable. Therefore, when analysing debt ratios, they should not be considered. The interpretation of the annual economic net result might be misleading, since following the business accounting model, full accruals are considered as well as the matching concept. But the profit or loss is not a meaningful measure to assess the performance of governmental entities. Since it is difficult to establish a direct relationship between costs incurred and taxes (the main revenues), the interpretation of the annual economic net result must be done carefully and necessarily complemented with other economic and budgetary indicators/measures. The study showed an economic surplus of 5.6% at the same time as a budgetary deficit of -6.7% (undertaken commitments higher than rights) and a cash balance of -1.9% (payments are higher than receipts only possible considering a surplus from previous years), evidencing different balances obtained when analysing the same reality in different perspectives. The economic result might, however, be seen as more subjective, inasmuch as it is a consequence of some conventions (e.g. considering nonearmarked capital transfers as revenues of the year they are received) as well as of not using the accruals basis completely (e.g. recognising every fiscal revenues within the year they are received). The researchers finally concluded that, since the information disclosed by the Balance Sheet and the Operational Statement tends to be more subjective, users still give preference to the information included within the budgetary statements. There is still the need to establish a conceptual framework for governmental accounting in Portugal, which might help to reduce the subjectivity still existing within the financial statements, in particular the Balance Sheet and the Operational Statement, eventually increasing usefulness perceived by their users.

21 GOVERNMENTAL ACCOUNTING IN PORTUGAL: WHY ACCRUAL BASIS IS A PROBLEM 431 One common issue from the above studies is that all of them have emphasised that the implementation of accrual-based accounting somehow has been one of the major problems or has created difficulties. Consequently, they show that it is not yet possible to conclude that the introduction of accrual basis has caused, as intended, the accounting system to become more informative, i.e., many issues concerning the claimed benefits of accrual accounting are still unresolved. WHY ACCRUAL BASIS IS A PROBLEM Within the private sector, the accrual-based accounting is the most commonly used accounting method, implying the recognition of revenues and expenses in the accounting period in which they are earned or incurred respectively rather than when cash is paid or received. On the other hand, governments traditionally use cash basis, allowing managers to control and monitor receipts and payments against appropriations and to account to Parliament for the appropriated monies. Nevertheless, it is currently believed that the information reported in accrual basis brings many potentialities to governmental financial statements users, thus becoming more useful than cash basis information. Many have been discussing the advantages and drawbacks of accrual accounting within Public Administration. Two important frameworks that address governmental financial statements to be prepared using full accrual-based accounting are GASB (1999) Statement 34: Basic Financial Statements Management s Discussion and Analysis for State and Local Governments, and IPSASs (IFAC, 2001a; 2001b; 2001c; 2001d; 2001e; 2001f; 2002a; 2002b; 2002c; 2004). The former changed the way State and Local governments in US present financial information to the public, proposing a disclosure format of financial statements similar to those of business companies, i.e., accrual-based, along with traditional funds statements. Together these allow to: Reporting on the overall state of the entities financial health, not just funds ; Including information on infrastructure assets;

22 432 JORGE, CARVALHO & FERNANDES Showing charges for services separately from general government revenues so one can determine whether a program is paying for itself or being paid for by general tax revenues. IFAC (2003) pronounces that the financial statements prepared under the accrual basis allow: - Assessing the accountability for all resources the entity controls and the deployment of those resources; - Assessing the entity s performance, financial position and cash flows; - Making decisions about providing resources to, or doing business with, the entity; - Getting information on how a government financed its activities and met cash requirements; - Evaluating a government s ongoing ability to finance its activities and to meet its liabilities and commitments; - Getting information on the financial position of a government and changes in financial position; - Providing a government with the opportunity to demonstrate successful management of its resources; and - Be useful in evaluating a government s performance in terms of its service costs, efficiency and accomplishments. As to academic research, the issue has been largely debated (Guthrie, 1998; Christiaens, 2002). Within the context of countries more advanced in introducing accrual basis accounting in the Public Administration, we highlight Guthrie (1998) who addresses some advantages of accrual accounting and financial reporting for Australia: accrual-based financial statements contain a range of accounting-based information more comprehensive than the subset of information captured by traditional cash accounting systems; accounting systems record information about revenues, expenses, assets and liabilities. Moreover he explains that accrual information has been considered as: Providing an accurate assessment of the full cost of service provision since non-cash expenses (e.g. depreciation) are included in governmental accounts;

23 GOVERNMENTAL ACCOUNTING IN PORTUGAL: WHY ACCRUAL BASIS IS A PROBLEM 433 An indicator of efficiency of program performance since it offers more comprehensive indication of the cost of government programs, allowing greater emphasis on cost control and efficiency measurement; Offering numbers that would have a significant impact on the determination of pricing policy for user charging; Improving accountability by governments to their constituents, better financial management by public service managers and greater comparability of management performance between jurisdictions. Although in Portugal, as referred to in Sections 2 e 3, these advantages have also been acknowledged and promoted, some drawbacks have been recognised as well. From Section 4, the most important problems can be summarised as relating to: 1) listing and valuating public domain assets; 2) understanding the accruals concept and subsequent application of the economic perspective in the recognition of costs and revenues; 3) conventions assumed for the new system that increase the subjectivity of the Net Result meaning, already per se very problematic to understand within the governmental entities; 4) the need to have a conceptual framework that would clarify how to adapt the business accounting statements and concepts to some specificities of the Public Administration context; and 5) the need for more intervention of the PAASC in providing guidance. Moreover, it might be said that these and other difficulties have also been identified in the literature as have been faced by several countries. Again taking the Australian example, Guthrie (1998) stresses the problem of interpreting ratios calculated on the basis of business style financial statements, which are meaningless or non-relevant in the Public Sector. Questioning the adoption of accrual-based business-type financial statements to governmental entities, he explains that much of the information produced ( ), such as assets valuation and owners equity cannot be used for decision about performance, accountability or funding decisions in the government sector. ( ) It is difficult to reconcile the rhetoric underlying the adoption of these private sector performance measures with the reality of their unsuitability for the adoption in public sector settings (Guthrie, 1998, p. 9). As to the argument of accruals allowing the

24 434 JORGE, CARVALHO & FERNANDES assessment of full cost of service provision, Guthrie (1998, p. 3) explains that it ignores the fact that the difference between cash and accrual numbers is ultimately one of timing for recognition of transactions in the long run, one cannot expect cumulatively significant differences in cost measure between the numbers of both bases. In what concerns public domain assets, Guthrie (1998, p. 15) addresses their valuation methodology, explaining that the definition of assets ground in notions of economic benefit may not be appropriate for many of the assets controlled by the Public Administration. Despite being commonly argued that it is important to know the total value of public assets in order to have the capacity to effectively manage them (particularly in connection to decisions related to the running down of assets or the utilization of public assets), there is little to suggest that adding together monetary valuations (sometimes rather subjective) of infrastructure, cultural and historical assets, is important to achieve that purpose. Indeed, public domain assets have not commercial values (Byrne, 2002), so listing them within the total assets in the Balance Sheet implies somehow arbitrary economic valuations. On the other hand, since they cannot have a financial value, the exercise of listing them is hardly useful. In Europe, also Christiaens (2004) explains that, with the introduction of accrual accounting in Public Administration, some relevant questions regarding the recognition and valuation of certain assets remain unanswered. These fundamentally relate with the difficulties to fit such assets in a business-oriented accrual accounting system where there is room only for assets creating economic output. Similar issues are also addressed by Barton (1999). Guthrie (1998) also emphasises the problem that the definition of assets itself in the Public Administration context might be, indicating the need for a conceptual framework about these subjects. Näsi et al. (2001) explain that, considering the current purpose of governmental accounting of providing the general public with a reliable picture of the overall financial situation of governments, it is important to have a comprehensive Balance Sheet, i.e., listing all public assets. Nonetheless, they raise the question on the usefulness and relevance of information on certain type of public assets to the