Public Financial Management: Reporting and Audit

Public Financial Management: Reporting and Audit product: 4242 course code: c210 c310

Public Financial Management: Reporting & Audit Centre for Financial and Management Studies, SOAS, University of London First published 2007, Second Edition, 2010 All rights reserved. No part of this course material may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, including photocopying and recording, or in information storage or retrieval systems, without written permission from the Centre for Financial & Management Studies, SOAS, University of London.

Public Financial Management Reporting and Audit Course Introduction and Overview Contents Introduction Course Authors What this Course is About Learning Outcomes Study Materials Teaching and Learning Strategy 2 4 5 8 8 9 Assessment 9

Public Financial Management Reporting and Audit Introduction Welcome to course Public Financial Management: Reporting and Audit. This course covers the important topic of accounting and accountability. Accounting has traditionally been seen as highly technical and of interest only to accountants, but it is a vital area for all citizens and public sector managers and professionals to understand, at least in broad terms. It is the core part of governance, which has gained such importance in recent years, especially in developing countries. Civil society organisations have also recognised the importance of public finance, with many of them now being active in the area of budget analysis. It is also an area of considerable political controversy. This course aims to enable you to have a broad understanding of the area, to appreciate the major current debates, to allow you to be able to review and understand the accounts and financial statements produced by governments and other public entities, and to understand the role and scope of audit in the public sector. Actual practice varies considerably from country to country, and so this course concentrates on the international standards for public sector financial reporting rather than the practice in any particular country. But we hope that this will provide an introduction to the topic, encourage you to consider the financial statements currently produced by public sector organisations in your country or the country in which you work, and enable you to understand the debates, reasons, costs and benefits for the main reforms which are being proposed in this area. We recommend that you obtain a copy of the latest financial statements for your government or a particular public sector organisation in which you are interested. You can then review these as an example of the different possible approaches which may be applied. Analysing the accounts for a specific organisation should also give you a deeper understanding of the international accounting standards which are being developed for the public sector, the alternative approaches which are being discussed, and the wider political positions which are influencing the choices that are being made in each country. The core part of the annual accounts of most governments has traditionally been a fairly detailed comparison of the government s annual budget agreed by legislature and the actual payments and receipts which were made during the year. The legislature agrees an annual budget which is managed by public officials; the government eventually reports back to the legislature, showing the extent to which the budget was followed, and areas where payments were less than or more than the amounts agreed in the budget. Thus the annual financial statements are a vital aspect of the accountability of the government to the legislature and to the wider society. Reforms of the content and the format of these document should be assessed on the extent to which the proposals will make the accounts more accessible, more easily understood, and whether the statements will provide information which will assist members of the legislature, the media and the general public to hold the government to account for the management of its financial affairs. 2 University of London

Course Introduction and Overview Thus, for example, the annual accounts of the Republic of Mauritius also provide graphs to demonstrate trends in government finances over the previous five years, the contribution provided by different types of taxes, and a broad analysis of where this money was spent. They also provide information on the level of public debt, losses suffered by different ministries, etc., and the levels of foreign aid which were received. These are all areas, which may be considered to be of considerable public interest. However, the international accounting standards which are being developed for the public sector are not necessarily based on such examples of actual good practice. In the course you will see that one of the dominant reforms of public sector financial accounting over the last 25 years has been the introduction of private sector style accounts into the public sector. The objectives of such reforms are modernisation and improving the accountability of government and the public sector. However, they also derive from a particular view of the role of the state and the importance of efficiency, choice and the virtues of the free market. There are fundamental differences between the objectives, roles and purposes of the private and public sectors, and these have led to significant technical challenges when introducing private sector style accounting in the public sector. To take one example, after years of discussion, debate and disagreement, an international accounting standard was issued on taxation only towards the end of 2006. Accounts and financial reports are a vitally important part of modern society; they influence the way organisations operate in the private and public sectors, and have a dramatic effect on our lives. For example, the way in which pensions are accounted for in annual financial statements has had an impact on recent debates in several major European countries over the affordability of both private sector and government pensions. The international accounting standard covering pensions requires estimates of the future costs of pensions to be included in the accounts. This produces large estimated liabilities, and the pension schemes appear to be in deficit. As a result, many companies have closed their pension schemes. Some governments have followed the same policy, despite considerable public protest. Changes in the way companies and governments account for their money have led to decisions which, potentially, will have a detrimental impact on many people s lives for years to come. This course aims to provide you with the knowledge you need to be able to understand such debates, and to critically consider any reforms, which are being suggested for public sector accounting in your own country. The objective of audit is to provide an independent view or opinion on whether or not the financial statements provide a true and fair view of an entity s financial affairs (especially in the private sector) and, in the public sector, to identify cases where the organisation s finances have not been managed in accordance with the laws, regulations and accepted ethical values. An understanding of public sector accountability would not be complete without considering the approach, role and standards which auditors in the public sector are expected to adopt. Centre for Financial and Management Studies 3

Public Financial Management Reporting and Audit To appreciate the importance of the audit process, consider two examples of fraud and corruption, one historical and one recent. In 1720, in return for a loan of 7 million to finance the war against France, the UK s House of Lords passed the South Sea Bill, which gave the South Sea Company a trade monopoly with South America. The scandal which followed the collapse of this company led to the resignation of the Chancellor of the Exchequer (minister of finance) and several members of Parliament. More recently accounting irregularities before the collapse of the Enron company resulted in long prison terms for the director of finance and chief executive. One final example to conclude this introduction demonstrates the importance of financial reporting in the public sector, the process of reform in financial reporting, and the importance of the auditor general. In 2007 the National Audit Office (the auditor general in the UK) reported on a major public sector efficiency program running from 2004 to 2008. According to government figures produced in September 2006, departments had reported considerable progress towards the targets: 62 per cent of the targeted 21.5 billion of annual efficiency gains; 65 per cent of the targeted 70,600 staffing reductions; and 70 per cent of the targeted 13,500 reallocations of posts to the front line of public services. The NAO examined the figures on the reported efficiency gains of 13.3 billion. It concluded that 3.5 billion (26 per cent of the reported efficiency gains) provided a fair representation of actual efficiencies made; 6.7 billion (51 per cent) probably did represent efficiency gains, but it was not possible to be sure due to uncertainty and measurement problems; concerning the remaining 3.1 billion (23 per cent), the measures used either did not actually demonstrate the reported efficiency gains, or the reported gains may be substantially incorrect. (http://www.nao.org.uk/home.htm) Course Authors This course has been written by a group of authors with considerable experience of public sector accounting and audit in various parts of the world. The lead author was Andy Wynne, previously Head of Public Sector Technical Issues with the Association of Chartered Certified Accountants in the United Kingdom - www.accaglobal.com/publicsector. Andy has wide experience of the public sector across the UK and internationally, especially in sub-saharan Africa. He is a regular speaker at international conferences and is editor of the International Journal on Governmental Financial Management theoretical journal, Public Fund Digest: www.icgfm.org/digest.htm The other major contributor to this course was Dr Michael Parry, previously Director and Chairman of International Management Consultants Limited - a well respected UK based consultancy firm with considerable experience in developing countries, especially in Asia and Africa. Mike has a PhD in development accounting, is a chartered accountant, management accountant and tax adviser and economist. He is a specialist in public and private financial management, including information systems and training. Andy and Mike were assisted by Jesse Hughes a public sector financial management consultant based in the United States of America (and past 4 University of London

Course Introduction and Overview editor of Public Fund Digest) and Fred Mear, Principal Lecturer at de Montfort University in the United Kingdom and CeFiMS tutor on public financial management courses. The project editor on this course is Jonathan Simms. Dr Simms has extensive experience editing books and learning materials in economics, private and public finance, and quantitative methods. He is a CeFiMS tutor in macroeconomics and financial markets, and a visiting lecturer at Manchester Business School. What this Course is About The first six units of the course cover public sector accounting; Units 7 and 8 consider public sector audit. Unit 1 provides a broad introduction to accounting and accountability, contrasting the differences between the private and public sectors and emphasising the importance of the budget in the public sector context. The differences between these two sectors need to be clearly understood, although there has been some convergence in recent years. The main aspects of public sector financial reporting and the contents of public sector financial statements are explored. You may already be familiar with the methods of cash and accrual accounting from your other studies or your work. This unit includes a brief introduction of the main concepts, sufficient to enable those less familiar with accounts to understand how private sector accounting might be applied in the public sector. Unit 2 considers further the nature of public sector organisations and considers the relevance of the recent promotion of the adoption of private sector style financial statements for public sector organisations. The unit explains the development of accounting bases in the public sector, and the current trend of moving to accrual accounting in the public sector. It considers the cash basis and why it has traditionally been used in the public sector, exploring the relationship between the workflow of government financial transactions and the accounting base. The unit then considers the potential benefits of using accruals accounting in the public sector, and examines the existing evidence on whether these benefits have been achieved. Unit 3 outlines the development of the International Public Sector Accounting Standards Board, and the main aspects of its cash basis IPSAS, the guidance developed by the IPSASB for the cash basis of accounting. Unit 4 introduces the main set of standards being developed and promoted by the IPSAS Board for the accrual basis of accounting. This unit also provides an introduction to the analysis of public sector financial statements and provides some practice in analysing accrual-based general-purpose financial statements. Unit 5 introduces those areas of public sector accounting where an international consensus on the accruals basis has not been reached. This concerns transactions or balances that exist in the public sector, but do not exist in the private sector. Therefore it is not possible to adapt private sector accounting standards. It considers the main arguments that are being used to develop Centre for Financial and Management Studies 5

Public Financial Management Reporting and Audit standards in these areas. The unit illustrates the complexity in accounting, and examines some of the political implications of accounting. Unit 6 considers the wider benchmarks for public financial management, the role of international organisations in developing alternative international standards, and the variety of approaches to accounting standards for the public sector. It provides an introduction to international standards related to financial reporting including the IMF s Government Finance Statistics System of statistical reporting and the PEFA benchmarks for public financial management. Unit 7 turns to public sector audit, and considers the scope, roles and processes of public audit and the main international standards which are relevant for the auditor general and others working in this area. Unit 8 considers how the desirable properties of audit and the Supreme Audit Institution described in Unit 7 can be achieved in practice. It looks at the key concept of independence of the Auditor General and how this is achieved in the public sector. The unit also provides an introduction to the areas of audit sampling and reporting. In addition, specialist areas such as performance audit, the audit of computer systems, and environmental audit are introduced. Some of the readings in the course are the actual accounting standards and the guidance on how the standards should be applied. These documents are included as course readings so that you can understand how to apply the standards, how to interpret financial statements produced in accordance with the standards, and how to assess the debate concerning the standards. The standards and guidance are written in a way that is clear and unambiguous, but, for obvious reasons, the documents present the standards and guidance without discussion or debate. Therefore the questions in the units are intended to help you appreciate the main points of the readings, and to consider the implications of applying the standards, and to assist you in developing your understanding of these materials. As you read these documents (and the other course materials), you may also find it useful to think of different public services with which you are familiar, as a manager in an organisation providing the service, as a consumer or user of the service, or as a citizen and a taxpayer, and imagine how the provision of the services might change if the accounting reforms were introduced: Would the provision of the service be improved or worsened?; Is it actually possible, with current resources, to introduce these accounting and reporting reforms in these sectors in your country? The Structure of the Course Unit 1 Introduction to Public Sector Accounting 1.1 Introduction 1.2 Accounting in the Private Sector 1.3 Differences Between the Private Sector and the Public Sector 1.4 Structure of the Public Sector 1.5 Public Sector Accounting 1.6 Conclusion and Summary 6 University of London

Course Introduction and Overview Unit 2 Accounting Bases and Standards 2.1 The Nature of Public Sector Entities 2.2 What is Public Financial Management? 2.3 The Accounting Bases for Public Sector Financial Reporting 2.4 Workflow and the Accounting Base 2.5 The Accrual Basis of Accounting in the Public Sector 2.6 The Arguments for Accrual Accounting for National Government Financial Statements 2.7 Conclusions and Summary Unit 3 International Public Sector Accounting Standards Board (IPSASB) and the Cash Basis Standard 3.1 The Origins and Role of the International Public Sector Accounting Standards Board 3.2 Origins of IFAC's Public Sector Committee 3.3 Establishment of the International Public Sector Accounting Standards Board 3.4 Status of the International Public Sector Accounting Standards 3.5 Financial Reporting under the Cash Basis of Accounting 3.6 The Cash Basis IPSAS and the Relevance of Consolidated Accounts for the Public Sector 3.7 Accounting for International Aid 3.8 Budget Reporting Standards 3.9 Summary and Conclusions Unit 4 International Accrual-Based Accounting Standards for the Public Sector 4.1 Application of IFRS to the Public Sector 4.2 IPSAS 1 to 21 - Definitions and Broad Principles 4.3 Interpretation of Financial Statements Based on the IPSAS 4.4 Summary and Conclusions Unit 5 Developing Public Sector Accounting Standards 5.1 Introduction 5.2 Taxation 5.3 Pensions - Employees 5.4 Social Policy Obligations - State Pensions 5.5 PFI and PPP 5.6 Heritage Assets 5.7 Summary and Conclusions Unit 6 Public Financial Management Benchmarks and Review 6.1 Wider Public Financial Management Benchmarks 6.2 Statistical Reporting Systems 6.3 IMF Government Finance Statistics and Code of Transparency 6.4 PEFA Benchmark for Public Financial Management 6.5 National Accounting Standards 6.6 Summary and Conclusions Unit 7 Public Sector Audit - Standards and Guidance 7.1 The Roles and Scope of Public Sector Audit 7.2 The Process of Public Sector Audit 7.3 Standards and Guidance for Audit in the Public sector 7.4 Public Expenditure and Financial Accountability (PEFA) - Performance Measurement Framework 7.5 Summary and Conclusions Centre for Financial and Management Studies 7

Public Financial Management Reporting and Audit Unit 8 Public Sector Audit - Practice 8.1 Independence and the Auditor-General 8.2 Organisation of a Supreme Audit Institution 8.3 Audit Sampling 8.4 Audit Reporting 8.5 Value for Money (Performance) Audit 8.6 Audit of IT and Information Systems 8.7 Environmental Audit 8.8 Summary and Conclusions Learning Outcomes When you have completed your study of this course, you will be able to Understand the purposes and methods of accounting for public sector entities and governments Assess the appropriate accounting base for different types of transaction Describe the relationship between types of management controls and types of accounting Describe how accounting standards are derived and propounded Describe the main accounting standards and understand the differences among them Understand the particular accounting problems of transactions that are exclusive to the public sector Analyse the various financial management benchmarks and standards that are in operation in the public sector in different jurisdictions Understand the principles and practices of audit in the public sector. Study Materials In this course you will receive two important resource manuals: IMF (2001) Government Financial Statistics Manual, Washington, DC: IMF, ISBN ISBN 1-58906-061-X HM Treasury (2004) Managing Resources Case Studies (the Orange Guide) and three Volumes of readings taken particularly from the major regulatory bodies in this field. You will also be asked to read from the course text supplied with the course Public Financial Management: Planning and Performance, S. Schiavo- Campo and D. Tommasi, Managing Government Expenditure, 1999, Asian Development Bank. If you have not taken this course then the text will be supplied as part of this course. 8 University of London

Course Introduction and Overview Teaching and Learning Strategy The materials for this course necessarily include detailed manuals and guidance for public sector accounting and audit. They also include academic articles that set out the arguments for and against particular approaches and techniques, as well as examples of accounts and audit reports from national, ministry-level and international bodies. You will need to be able to move from one to another of these sorts of materials in order to develop your mastery of the subject. How you do this will depend to some extent on your learning style. Some people prefer to start from the concrete, especially examples, and then turn to more abstract ideas. Others prefer to work out the principles first and then look at examples. We suggest in the Introduction that you obtain a copy of the national accounts of the country you are based in, or of an organisation with which you are familiar, in order to apply the ideas, techniques and rules discussed in the course. This is especially important if your preferred style of learning is to move from the concrete to the abstract. If you are not familiar with accounting terms, there will be a lot of new language for you. If this is the case, we suggest that you create your own list of new words and their definitions. There is a glossary of terms, especially those used in accruals accounting at Appendix Two. You will not have to learn all these words, but they will be a useful source for definitions as you build up your vocabulary. You will also, of course, have access to your tutor and fellow students through the Online Study Centre. Please feel free to discuss issues with your fellow students and to ask questions of your tutor. At certain points during the course you will be prompted to go online and discuss. Assessment Your performance on each course is assessed through two written assignments and one examination. The assignments are written after week four and eight of the course session and the examination is written at a local examination centre in October. The assignment questions contain fairly detailed guidance about what is required. All assignment answers are limited to 2,500 words and are marked using marking guidelines. When you receive your grade it is accompanied by comments on your paper, including advice about how you might improve, and any clarifications about matters you may not have understood. These comments are designed to help you master the subject and to improve your skills as you progress through your programme. The written examinations are unseen (you will only see the paper in the exam centre) and written by hand, over a three hour period. We advise that you practice writing exams in these conditions as part of you examination preparation, as it is not something you would normally do. Centre for Financial and Management Studies 9

Public Financial Management Reporting and Audit You are not allowed to take in books or notes to the exam room. This means that you need to revise thoroughly in preparation for each exam. This is especially important if you have completed the course in the early part of the year, or in a previous year. Preparing for Assignments and Exams There is good advice on preparing for assignments and exams and writing them in Sections 8.2 and 8.3 of Studying at a Distance by Talbot. We recommend that you follow this advice. The examinations you will sit are designed to evaluate your knowledge and skills in the subjects you have studied: they are not designed to trick you. If you have studied the course thoroughly, you will pass the exam. Understanding assessment questions Examination and assignment questions are set to test different knowledge and skills. Sometimes a question will contain more than one part, each part testing a different aspect of your skills and knowledge. You need to spot the key words to know what is being asked of you. Here we categorise the types of things that are asked for in assignments and exams, and the words used. All the examples are from CeFiMS examination papers and assignment questions. Definitions Some questions mainly require you to show that you have learned some concepts, by setting out their precise meaning. Such questions are likely to be preliminary and be supplemented by more analytical questions. Generally Pass marks are awarded if the answer only contains definitions. They will contain words such as: Describe Define Examine Distinguish between Compare Contrast Write notes on Outline What is meant by List Reasoning Other questions are designed to test your reasoning, by explaining cause and effect. Convincing explanations generally carry additional marks to basic definitions. They will include words such as: Interpret Explain What conditions influence What are the consequences of What are the implications of Judgment Others ask you to make a judgment, perhaps of a policy or of a course of action. They will include words like: 10 University of London

Course Introduction and Overview Evaluate Critically examine Assess Do you agree that To what extent does Calculation Sometimes, you are asked to make a calculation, using a specified technique, where the question begins: Use indifference curve analysis to Using any economic model you know Calculate the standard deviation Test whether It is most likely that questions that ask you to make a calculation will also ask for an application of the result, or an interpretation. Advice Other questions ask you to provide advice in a particular situation. This applies to law questions and to policy papers where advice is asked in relation to a policy problem. Your advice should be based on relevant law, principles, evidence of what actions are likely to be effective. Advise Provide advice on Explain how you would advise Critique In many cases the question will include the word critically. This means that you are expected to look at the question from at least two points of view, offering a critique of each view and your judgment. You are expected to be critical of what you have read. The questions may begin Critically analyse Critically consider Critically assess Critically discuss the argument that Examine by argument Questions that begin with discuss are similar they ask you to examine by argument, to debate and give reasons for and against a variety of options, for example Discuss the advantages and disadvantages of Discuss this statement Discuss the view that Discuss the arguments and debates concerning The grading scheme Details of the general definitions of what is expected in order to obtain a particular grade are shown below. Remember: examiners will take account of the fact that examination conditions are less conducive to polished work than the conditions in which you write your assignments. These criteria are used in grading all assignments and examinations. Note that as the criteria of each grade rises, it accumulates the elements of the grade below. Centre for Financial and Management Studies 11

Public Financial Management Reporting and Audit Assignments awarded better marks will therefore have become comprehensive in both their depth of core skills and advanced skills. 70% and above: Distinction As for the (60-69%) below plus: shows clear evidence of wide and relevant reading and an engagement with the conceptual issues develops a sophisticated and intelligent argument shows a rigorous use and a sophisticated understanding of relevant source materials, balancing appropriately between factual detail and key theoretical issues. Materials are evaluated directly and their assumptions and arguments challenged and/or appraised shows original thinking and a willingness to take risks 60-69%: Merit As for the (50-59%) below plus: shows strong evidence of critical insight and critical thinking shows a detailed understanding of the major factual and/or theoretical issues and directly engages with the relevant literature on the topic develops a focussed and clear argument and articulates clearly and convincingly a sustained train of logical thought shows clear evidence of planning and appropriate choice of sources and methodology 50-59%: Pass below Merit (50% = pass mark) shows a reasonable understanding of the major factual and/or theoretical issues involved shows evidence of planning and selection from appropriate sources, demonstrates some knowledge of the literature the text shows, in places, examples of a clear train of thought or argument the text is introduced and concludes appropriately 45-49%: Marginal Failure shows some awareness and understanding of the factual or theoretical issues, but with little development misunderstandings are evident shows some evidence of planning, although irrelevant/unrelated material or arguments are included 0-44%: Clear Failure fails to answer the question or to develop an argument that relates to the question set does not engage with the relevant literature or demonstrate a knowledge of the key issues contains clear conceptual or factual errors or misunderstandings Specimen exam papers [approved by Faculty Learning and Teaching Committee November 2006] Your final examination will be very similar to the Specimen Exam Paper that you received in your course materials. It will have the same structure and style and the range of question will be comparable. 12 University of London

Course Introduction and Overview CeFiMS does not provide past papers or model answers to papers. Our courses are continuously updated and past papers will not be a reliable guide to current and future examinations. The specimen exam paper is designed to be relevant to reflect the exam that will be set on the current edition of the course Further information The OSC will have documentation and information on each year s examination registration and administration process. If you still have questions, both academics and administrators are available to answer queries. Centre for Financial and Management Studies 13

Public Financial Management Reporting and Audit UNIVERSITY OF LONDON Centre for Financial and Management Studies MSc Examination Postgraduate Diploma Examination for External Students 91DFMC210 91DFMC310 PUBLIC POLICY AND MANAGEMENT PUBLIC FINANCIAL MANAGEMENT Public Financial Management: Reporting and Audit Specimen Exam This is a specimen examination paper designed to show you the type of examination you will have at the end of the year for Public Financial Management: Reporting and Audit. The number of questions and the structure of the examination will be the same but the wording and the requirements of each question will be different. Best wishes for success on your final examination. The examination must be completed in THREE hours. Answer Question 1, plus ONE question from Section A and ONE question from Section B. You must answer THREE questions in total. The examiners give equal weight to each question; therefore, you are advised to distribute your time approximately equally between three questions. You should support your answers with relevant examples, where appropriate. Do not remove this Paper from the Examination Room. It must be attached to your answer book at the end of the examination. University of London, 2007 PLEASE TURN OVER 14 University of London

Course Introduction and Overview Answer Question 1, plus ONE question from Section A and ONE question from Section B. You must answer THREE questions in total. Question 1 This question relates to the OECD Statements of Financial Position, Statements of Financial Performance, and Budget (Statement of Financial Performance by Segment) for the years ending 31 December 2005 and 31 December 2004. Answer all parts of this question. a. The notes on accounts payable and deferred income reveal the following information. 31 December 2005 1000s 31 December 2004 1000s Suppliers and accrued charges 26,121 20,482 of which accrued charges 13,300 14,400 Using the creditor days measure, has the OECD improved or worsened between 2005 and 2006 in the time it takes to pay suppliers and to pay invoices? b. Explain the main reasons for the difference between the net surplus shown in the 2005 budget and the net deficit shown in the 2005 Statement of Financial Performance. c. Analyse and compare the Statement of Financial Performance between 2005 and 2004. d. Analyse and compare the Statement of Financial Position between 2005 and 2004. [25% of marks] [25% of marks] [25% of marks] [25% of marks] Centre for Financial and Management Studies 15

Public Financial Management Reporting and Audit 16 University of London

Course Introduction and Overview Centre for Financial and Management Studies 17

Public Financial Management Reporting and Audit OECD Statement of Financial performance by Segment 18 University of London

Course Introduction and Overview Section A (Answer ONE question from this section) 2. Examine the objectives and principles of government financial reporting. 3. What are the arguments for moving to the accrual basis in government reporting, and to what extent are the expected benefits likely to be delivered? 4. Compare and contrast the UN Classification of Functions of Government and the IMF GFS Economic Classification, in the context of classifying government expenses and receipts. 5. Outline and discuss the most significant areas of general financial reporting covered in the International Public Sector Accounting Standards (IPSAS) on the accrual basis. Section B (Answer ONE question from this section) 6. You work for a credit rating agency, and you are assessing the ability of a government to finance future operations, pay interest on its debt, and repay debt principal. In the government s reported Statement of Financial Position (produced according to guidelines from the IPSAS Board) there is a very significant asset entry, Taxes Receivable. Explain what this entry represents, and how you would interpret it. 7. Comment on the relationship between the IMF system of Government Financial Statistics (GFS) and the accruals IPSAS. 8. To what extent is the INTOSAI (1977) Declaration of Guidelines on Auditing Precepts (the Lima Declaration) timeless and essential? 9. In the context of public audit, explain what is meant by all of the following an unqualified audit opinion a qualified audit opinion an adverse audit opinion a disclaimer of opinion In each case, explain what the opinion indicates about the financial statements being audited, providing appropriate examples. [END OF EXAMINATION] Centre for Financial and Management Studies 19

Public Financial Management Reporting and Audit 20 University of London

Public Financial Management Reporting and Audit Unit 1 Introduction to Public Sector Accounting Contents 1.1 Introduction 3 1.2 Accounting in the Private Sector 4 1.3 Differences Between the Private Sector and the Public Sector 8 1.4 Structure of the Public Sector 12 1.5 Public Sector Accounting 14 1.6 Conclusion and Summary 18 References and Websites 18

Public Financial Management Reporting and Audit Unit Content The purpose of this unit is to provide an overview of financial reporting in both the private and public sectors. The differences between these two sectors need to be clearly understood, although there has been some convergence in recent years. The main aspects of public sector financial reporting and the contents of public sector financial statements are explored. The course as a whole is intended to help you think critically about public sector financial reporting and audit, and to enable you to develop confidence in evaluating different approaches and the reforms which have been suggested in recent years. Learning Outcomes When you have completed this unit, you will be able to define and explain the uses of the main financial statements outline and discuss the broad accounting issues relating to public sector accounting policy define accountability in the public sector explain how changes in management affect financial accounting use and discuss the importance of basic public sector financial statements. Readings for Unit 1 Course Reader Government Accounting Standards Board (GASB, US) (2006) Why Governmental Accounting and Financial Reporting Is and Should Be Different. Brian Rutherford (1983) Financial Reporting in the Public Sector, Chapter 2 and an excerpt from Chapter 4 To help your understanding of terms that are new to you, there is a glossary of terms, taken from the IFAC Handbook of International Public Sector Accounting Pronouncements (2009 Edition) provided as an Appendix to Unit 8, within this Course Binder. 2 University of London

Unit 1 Introduction to Public Sector Accounting 1.1 Introduction Accounting is the recording of the financial transactions of a company and the reporting of its financial results at the end of the year. Thus, in the private sector at least, financial reporting provides an account of the financial affairs of the company and the extent to which it has achieved its main objective, to earn a profit. The objective of audit is to provide an independent opinion on the accuracy of the company s accounts and thus to provide assurance that the profit figure is a reasonable, or true and fair view of the company s financial success. In contrast, in the public sector, the financial statements can, at best, only provide half the story. They essentially provide an account of what the government has spent its money on. They do not indicate how successful the government has been at achieving its objectives. These objectives are to provide essential services to the citizens and broadly to improve their well being. Thus these objectives are beyond the scope of the government s financial statements. However, these statements do provide an essential role in facilitating the accountability of government to parliament and to the country at large. The following section includes a brief explanation of the elements of financial statements. This material will be very familiar to some of you, either from your work or your previous studies. Even if this is the case, it will be good for you to check that you have a clear understanding of these ideas: this knowledge will be useful when you study later sections and units which concentrate on the differences between accounting approaches in the private and public sectors, and on the application of private sector accounting methods in the public sector. 1.1.1 What is accounting? Accounting is something that we all have heard of and discussed throughout our lives and careers. However this familiarity often causes more confusion than help because we have encountered the idea of accounting in different contexts and with different meanings. Review Question Write down your understanding of the role and objectives of accounting and financial reporting in general terms. You will probably have suggested a broad spectrum of different roles and objectives for accounting. It may include areas that are internal to the management of the organisation and also external aspects including reporting to shareholders and regulatory bodies. Managerial Accounting deals with the internal accounting information needs of an organisation. In contrast, Financial Accounting deals with the reporting of an organisation to its external stakeholders (owners or shareholders of a company, and citizens of a government). Centre for Financial and Management Studies 3

Public Financial Management Reporting and Audit The managers or owners of a business have two main questions. First, is the business operating at a profit? Second, will the business be able to meet its commitments as they fall due, to pay wages to staff and to pay the suppliers when required? To be successful, businesses need to be profitable, but they also need to be solvent; they need to have the cash available to pay the bills when they are due for payment. 1.2 Accounting in the Private Sector The basic stewardship requirement of accounting is to inform owners of an organisation how the managers have spent their money and what income and assets they have generated from that spending. The basic capitalist model is that owners invest capital into a business with the intention of seeing their capital grow, and to gain a return from their investment and the risks taken. Accounting has developed over thousands of years and taken a range of forms depending on the way in which society was organised and the form of the individual entities. Accounting, as we understand it today, developed in the 19th Century to account for individual companies. Originally these were mainly managed directly by their owners. Accounting enabled the owner to see where the resources for the business had come from, to record what assets these had been used to obtain and how much profit had been earned. Thus accounting played a stewardship role, allowing the owner-manager to record the transactions of the business and to gain an overview of its financial health. Over the course of the 20th Century the basic unit of the economy changed from owner managed businesses to large international companies with shares quoted on stock exchanges. Financial reporting adapted to reflect these changes. Formal accounting standards were developed to regulate an increasingly complex business environment. The role of accounting changed as the owners of businesses (shareholders) became more and more distant from the managers of these businesses. Accounting moved from meeting the needs of an owner-manager to providing information to actual or potential shareholders and company creditors (those lending money to a business) to help them to decide whether to continue to invest in the particular business or to move their capital and to invest in alternative opportunities. In the later part of the 20th Century internationally accepted accounting standards began to develop reflecting the globalisation of business. In addition, the perspective of accounting changed from providing an essentially historical account of how the resources of a company had been used, to providing forward looking information on the likely prospects for a business. One indication of this is the move from recording assets in the balance sheet at their historic cost (the price originally paid to obtain them) to the use of estimates of their current or fair value. 1.2.1 Financial statements The annual accounts or financial statements of a company consist of the following: 4 University of London

Unit 1 Introduction to Public Sector Accounting the profit and loss account the balance sheet the cash flow statement the notes to the accounts. The profit and loss account provides information on the amount of profit (or loss) which has been earned in the last year (and the previous year, as figures for that year are also provided). The balance sheet and cash flow statement provide information on liquidity and the extent to which the company is solvent and able to pay its bills on time. The notes to the accounts provide details on the specific accounting policies that have been adopted and provide further detailed figures related to the accounts. 1.2.2 The Balance Sheet This is often considered to be the primary accounting document. It lists the assets, liabilities and capital of an organisation at a particular point in time, usually the end of the last financial year. Assets are defined, in international accounting standards, as resources controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity. Thus assets may include cash, machinery, cars, buildings, but also intangible assets, such as the right to use a certain technique or, for example, the right to drill for oil in a certain area. Debts owed to the business are also considered to be assets as they are controlled (are legally enforceable), result from past events (for example, the sale of a commodity) and will result in a cash in-flow for the business. A distinction is made between fixed and current assets: Fixed assets permanent, not purchased for resale in the normal course of business. Acquired to be used over several years, for example, a building or machinery. Current assets may be bought and sold in a short time period (less than 1 year). May also be circulating assets, constantly changing, for example, money in the bank and items held in stock (spare parts for a machine). The distinction is one of time, how quickly the asset will be used or sold. In a car sales business, the vehicles held for sale would be considered current assets (stock). In contrast, an identical vehicle that is to remain and be used by the business for several years (e.g. a courtesy car) would be a fixed asset. People or staff are not considered to be assets as they are not controlled by the organisation. This is a major problem in organisations that rely on human assets. Consider how effective your department would be if there were no people to carry out the work! The value at which assets, especially fixed assets, are included in the balance sheet may be problematic, as a variety of different approaches can be used. Thus the following bases may be used in appropriate cases to value an asset: historic cost the original cost of the asset Centre for Financial and Management Studies 5

Public Financial Management Reporting and Audit net realisable value the price which would be received if the asset were to be sold replacement cost the cost of replacing the asset net present value the value of the future revenue stream associated with the asset. Liabilities are present obligations of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. Examples of liabilities are unpaid invoices for goods or services that have been received or loans from a bank. The first would usually be current liabilities (those expected to be paid within the next year), the second would usually be long-term liabilities. Again there may be problems in identifying and valuing a liability. Liabilities are only recognised in the balance sheet if it is probable that they will eventually be paid for and if a reliable estimate can be made of their value. Thus the commitments or obligations associated with a company pension scheme may be difficult to estimate reliably so it is not clear whether or not there is a liability to be recognised in the balance sheet. The difference between the assets and liabilities of a company is its capital. The capital of a business consists of the original investment, loans (and other liabilities) and profits which have been retained by the business (and not paid out as dividends, etc., to the owner). Thus the company s capital is an estimate of the value of the business to its owners or shareholders. But the value of shares in the company may provide another estimate of its capital (especially for those companies whose shares are quoted on a stock exchange). The value of the capital of an entity provided by its balance sheet may be very different to that provided by the current price of its shares quoted on a stock exchange. Activity For each of the following items, determine whether they are they assets, capital or liabilities. 1 $10,000 owed to your uncle who gave you the money to start a corner shop. 2 $3,000 piece of land purchased by an organisation in 1990. 3 $10,000 profit made by the organisation during the last accounting year. 4 $12,000 worth of stock held in the store room, but not yet paid for. 5 $14,000 cash deposited in a business account by Dhillon to set up Dhillon Consultants. Your answers should have been the following: 1 Liability: The $10,000 owed to your uncle is a liability. Your uncle may not want immediate payment, but he is not an owner or partner of the business. 2 Asset: The $3,000 piece of land purchased by the organisation is an asset. 3 Capital: The $10,000 profit made by the organisation during the last accounting year will be added to the capital figure, as an amount owed 6 University of London

Unit 1 Introduction to Public Sector Accounting to the owner or owners of the business. All profits belong to the owners of the organisation. 4 Asset: The $12,000 worth of stock not yet paid for is an asset. The amount owed would be classified as a liability as it is owed to a supplier. 5 Asset: The bank account with $14,000 cash deposited in it by Dhillon to set up Dhillon Consultants is an asset. The $14,000 owed to Dhillon is capital, assuming that he owns the business. These three elements (assets, capital and liabilities) are combined to produce what is known as the accounting equation: Assets = Capital + Liabilities The two sides of the equation have the same totals as they represent the same thing from two different points of view: Resources: what are they (assets) = Resources: who supplied them (capital and liabilities) The balance sheet has many different layouts of the accounting equation but all consist of those three elements. A typical example is shown below. Balance Sheet of XYZ Ltd as at 30th June 20XX $ $ $ Fixed Assets Freehold Premises 100,000 Machinery 50,000 Vehicles 25,000 175,000 Current Assets Stock 30,000 Debtors 40,000 Cash 5,000 75,000 Current Liabilities Trade Creditors 25,000 Bank Overdraft 3,000 28,000 Net Current Assets (working capital) 47,000 Total Assets less Current Liabilities 222,000 Long-term Liabilities Mortgage Loan 150,000 150,000 Capital 72,000 1.2.3 The Profit and Loss Account The profit and loss account is a statement of the revenue (income) received from operating activities less the expenses incurred to generate that income. The detailed headings used will depend on the type of organisation, whether manufacturing, retail or service activities, but an example of a typical layout is shown on the next page. Centre for Financial and Management Studies 7

Public Financial Management Reporting and Audit XYZ Business Profit and Loss Account for the year ended 31st December 20XX $ $ $ Sales 220,000 Less Cost of Sales 25,000 Gross Profit 195,000 Less Overhead expenses Wages & Salaries 70,000 Telephone 3,000 Rent 10,000 Depreciation 30,000 Loan interest 12,000 125,000 Profit on ordinary activities before tax 70,000 Tax on ordinary activities 25,000 Profit on ordinary activities after tax 45,000 Extraordinary income 12,000 Profit for the financial year 57,000 To calculate the annual profit, the matching concept is very important. The revenue earned from sales has to be matched with the cost of producing those goods or services sold. The most significant aspect of this is matching the cost of fixed assets with the goods and services which are produced over the lives of the fixed assets (which may be many years). Thus the cost of a factory building has to be matched with the revenue earned from the materials that are produced in this building throughout the life of the building. Depreciation is the usual method of achieving this matching. The cost of the building is usually spread over its useful life by charging depreciation to the profit and loss account each year. Thus a building that cost $400,000 with an expected life of 50 years will result in an annual depreciation charge of $8,000. If the building was opened for use at the beginning of 2003, then the depreciated historic cost of the building to be included in the balance sheet for the year ending 31 December 2007 would be $360,000; calculated as $400,000 (5 $8,000). 1.3 Differences Between the Private Sector and the Public Sector Governments are fundamentally different from for-profit business enterprises in several important ways. They have different purposes, processes of generating revenues, stakeholders, budgetary obligations, and propensity for longevity. These differences require separate accounting and financial reporting standards in order to provide information to meet the needs of stakeholders to assess government accountability and to make political, social, and economic decisions Source: (Government Accounting Standards Board (US) White Paper 2006: 1). 8 University of London

Unit 1 Introduction to Public Sector Accounting Reading Please read the first nine pages (including the Executive Summary) of the GASB US document Why Governmental Accounting and Financial Is and Should Be Different. As you read these pages, please consider the following questions. Who are the primary users of governmental financial reports? How is the information that creditors need different between private sector and public sector organisations? Why does tax revenue require different accounting treatment compared to the revenues of business enterprises? How is government accountability to its stakeholders different to the accountability of a firm to its shareholders? Government Accounting Standards Board (2006) Why Governmental Accounting and Financial Reporting Is and Should Be Different, reproduced in the Course Reader. Most public sector organisations do not have the objective of making a profit. They generally provide goods and services to the public which are free or at least at a price which is less than the cost of providing the services. Thus the concept of profit which private sector financial statements are designed to measure is not relevant. Public sector organisations generally raise their income directly or indirectly from taxation. Thus the matching concept is not relevant because the services provided by the public sector to an individual are not related to the taxes which they have paid. Indeed, most people accept that the richer members of society should pay higher taxes, whilst government services are more extensive for the poorer members of society. Thus the public sector involves at least some degree of redistribution of resources. Private sector financial statements are provided, primarily at least, for the shareholders of the entity. The stakeholders of public sector organisations are a less discrete group of people and may include all citizens of a country. The budget (which in democracies is usually agreed annually by parliament or other legislature) is central to accountability in the public sector. Thus the primary financial statement is usually a comparison between the agreed budget and the actual payments and receipts made by the government over the year. Governments, on average, last longer than private sector entities. Their closure or continued existence is usually based on a political decision rather than their financial performance. Thus the solvency of a public sector entity may not be a directly relevant concept. For these reasons, most governments produce financial statements that have a very different format to those produced by the private sector. The differences between the private and the public sectors are summarised here. Accountability to Accountability mechanism Accountability for Leadership Private Shareholder AGM Global Director leadership Public Parliament/legislature Anytime Single/global Political leadership Source: Bogdanor (2001) Centre for Financial and Management Studies 9

Public Financial Management Reporting and Audit The differences are fundamental in that the accounting system must support the governance process. Shareholders can hold company directors to account for their actions at the company s Annual General Meeting when the accounts are proposed for approval. The individual decisions and policies of the company s managers are not to be questioned. If shareholders do not like the performance they can either withdraw from the company, or change the directors (a very rare occurrence). The legislature or parliament is not like a shareholder, it can question public sector officials at anytime, it can demand particular action be taken and demand for a specific account to be provided of this action. The leadership is political and not by individual directors. For commercial entities the accounting system provides a universal inputoutput model, as described in Figure 1.1. Figure 1.1 Commercial accounting model Source: Parry (2005) This explains why the accrual accounting model is dominant in the commercial sector - it provides a universal input-output model in the same units for any type of business, and a common indicator of performance - profit. This model and this simple performance measure simply do not exist for the public sector. You will consider accruals accounting, and in particular the potential for using accruals in the public sector, in greater detail in later units of the course. For the moment, and if you are unfamiliar with this term, here is a definition from IFAC, quoted in ADB p. 227: [Full accrual accounting is a system that] recognizes transactions and events when they occur irrespective of when cash is paid or received. Revenues reflect the amounts that came due during the year, whether collected or not. Expenses reflect the amount of goods and services consumed during the year, whether or not they are paid for in that 10 University of London

Unit 1 Introduction to Public Sector Accounting period. The costs of assets are deferred and recognized when the assets are used to provide service. For the public sector it is not so easy to construct a universal input-output model. The fundamental problem is that output is generally service delivery and not expressed in monetary units. An attempt to develop a similar model for the public sector is shown in Figure 1.2. Figure 1.2 A public sector accounting model Source: Parry (2005) It is considered that this model, whilst less elegant than the commercial entity model, does provide a working framework for the public sector. Whilst financial inflows and outflows are not directly linked, they are nevertheless under the control of government, and therefore the borrowing requirement is a real and important measure. Review question Do you think that the conceptual models presented in these Figures are sufficiently close to allow a common set of accounting standards for commercial and public sector entities, or should the standards be completely different? Activity Consider the following items, in terms of possible depreciation, and write down what you think is relevant and reliable in accounting terms. What annual charge would be relevant to make in a profit and loss account for the government? And how reliable do you think such a charge would be? 1 Replacement of a nuclear submarine 2 The value of heritage assets 3 A valuable painting donated to your national museum Centre for Financial and Management Studies 11

Public Financial Management Reporting and Audit 4 The state highway between your capital city and your country s major industrial port or border. 5 Your country s defence equipment. Post your answers on the OSC to debate the different results from different perspectives. Your answers will indicate how you think the information will be used, and how decisions about the spending on those activities are made. If you feel that the calculation of depreciation information on the above items is not relevant to any decisions that are being made in these areas then we must question whether it is worth the cost of implementing private sector style financial statements in the public sector. Reading Now please read Rutherford s Chapter 2 in the Reader. As you read this chapter, please consider the following points. Consider how recent public sector reforms may have made private sector style financial statements more relevant to the public sector. Do users of financial information in the public sector have different requirements to users of financial information in the private sector? Brian Rutherford (1983) Chapter 2, reprinted in the Course Reader from Financial Reporting in the Public Sector. 1.4 Structure of the Public Sector Public sector financial accounting is concerned with how governments record and report on the outcome of the financial management of their affairs. Financial reports are provided by the whole range of government entities from large central government ministries down to small local authorities; in addition there may be quite significant state-owned enterprises. The various levels and aspects of management of state resources require quite different technical approaches to accounting as the user requirements can vary quite significantly. The discussion of appropriate techniques requires an understanding of where the organisation lies within the policy making, and accountability hierarchy. To understand why it is important to consider where the organisation lies within government, consider Figure 1.3, which shows the relationships between the legislature, the executive and citizens. Looking at the Figure, can you imagine how organisations located in different levels of government might need to use different accounting systems? Operational organisations may also include agencies responsible for specific tasks, advisory and regulatory authorities. These and other institutions, such as schools, or universities, may have their own financial accounting processes and issue their own financial reports. As a professional or a politician working in government, the task and the degree of discretion you will have 12 University of London

Unit 1 Introduction to Public Sector Accounting depends on where you are located in the system and what sort of system you work in. Each level is accountable to the level above and has control, to a greater or lesser extent, over the level below. In addition, there is also accountability to the users of the services. Thus accountability can take many forms. In recent years some have argued that competition with private sector providers, contestability between public sector entities and increased user choice will lead to the more efficient management of resources. This is misleading, as all governments have always wished to be efficient. There are however, different models as to how this can best be achieved. The currently dominant model is that the public sector should copy the private sector and the adoption of private sector style financial statements may be part of this trend. Others argue that cooperation, team work and the public sector ethos are far more important in ensuring that high quality services are provided efficiently to those that need them. Figure 1.3 Accountability in Public Finance, the relationships between legislature, executive and citizens 1.4.1 Recent reforms In many countries public sector financial reporting has changed significantly over the last 25 years to reflect wider reforms known as New Public Management. New Public Management reforms typically include: privatisation and outsourcing deregulation commodification of public services creation of purchaser/provider splits or creation of agencies. Centre for Financial and Management Studies 13

Public Financial Management Reporting and Audit However, accounting can still be defined fundamentally as the process of identifying, measuring and communicating economic information to permit informed judgements by the users of that information (American Accounting Association, 1966). Therefore, it is important that it meets the needs of the users. It can be seen as a support activity, to support the decision making process. How different governments make decisions and how they are held accountable for those decisions will impact heavily on the design and use of accounting and financial management systems. As systems of public management change, then the systems of financial management and accounting should also change to ensure that relevant and appropriate information is provided internally to managers and externally to the full range of stakeholders. Under a bureaucratic system the accountability lies with the legislature and executive. A bureaucratic system is dependent on rules and processes, so the basic assumption that can be identified is that if the processes are correctly applied and efficiently administered, then the outputs from the service will be produced. What needs to be managed therefore are the inputs and the process. From a financial management viewpoint, this will require a simple system to meet the needs of priority setting and input management. Whilst the pre-eminence of market mechanisms is the current dominant consensus there is a danger that all private sector techniques are seen as being appropriate for the public sector. It is much more complex than this. In some cases the private sector methodology may be appropriate, in other cases it is not. We must at all times consider what we are trying to achieve from the system, and use the most appropriate tools for that purpose. 1.5 Public Sector Accounting Government financial accounting has traditionally consisted of providing an out-turn report, comparing the actual payments and receipts with those which were authorised in the budget by parliament. This approach still forms the basis for the practice of almost all governments across the world. It is a simple and robust approach, which provides assurance through the audit of such accounts that government spending has been in line with the agreed budget and that fraud and other irregularities have been minimised. 1.5.1 Budget reporting The preface of the IPSAS Board Research Report, Budget Reporting (2004) states that: Most governments prepare and issue as public documents, or otherwise make publicly available, their annual financial budgets. The budget documents are widely distributed and promoted. They reflect the financial characteristics of the government s plans for the forthcoming period. Monitoring and reporting on budget execution is essential for measuring compliance with Parliamentary (or similar) authorization. Making budget data publicly available is necessary to enable transparent reporting of the government s financial intentions and of its use of taxes. Government budgets are generally approved by the legislature. While administrative arrangements can differ from jurisdiction to jurisdiction, 14 University of London

Unit 1 Introduction to Public Sector Accounting in most cases spending units have no authority to commit or spend government funds until the legislation imparting spending authority has been passed by the legislature. In many respects, and for many external users, the budget documents are the most important financial statements issued by governments. The budget also serves as a key tool for financial management and control, and is the central component of the process that provides for government and parliamentary (or similar) oversight of the financial dimensions of operations. The objectives of public sector financial reporting outlined below also show the importance of the budget for the public sector. In the private sector shareholders may be interested in the financial statements of a company in which they invest as it indicates how profitable the entity has been. In the public sector there is not so much interest in the financial statements, but in contrast it is the government s budget which gains much media coverage. This is because it is the budget which informs citizens about the financial consequences of the government s actions in terms of, for example, increased taxation. 1.5.2 Objectives of reporting The analysis here is taken from Allen and Tommasi (2001: 317 18). The essential purpose of a financial reporting system is to demonstrate how the government has managed its financial resources revenues and expenditures, assets and liabilities. Ideally, therefore, it should answer the following questions. Budgetary integrity. Have resources been used in conformity with legal authorisations and mandatory requirements? What is the portion/part of appropriations not committed (i.e. not used)? What are the expenditures committed but not yet paid? Operating performance. How much do programmes cost? How were they financed? What was achieved? What are the liabilities arising from their execution? How has the government managed its assets? Stewardship. Did the government s financial position improve or deteriorate? What provision has been made for the future? Systems and control. Are there systems to ensure effective compliance with budgetary and financial regulations, proper management of assets and adequate performance? Reports are an important instrument for planning and policy formulation. For this purpose, they should provide information on ongoing programmes and the main objectives of government ministries and agencies. Reports can also be used as a source of information for parliament and the general public. They give an organisation the opportunity to present a statement of its achievements, and to provide information for a wide variety of purposes. Reporting must take into account the needs of different groups of users including: i) the council of ministers, ministries, agencies, and programme managers ii) the legislature Centre for Financial and Management Studies 15

Public Financial Management Reporting and Audit iii) outside the government, individual citizens, the media, corporations, universities, NGOs and other interest groups, investors and creditors, international financial institutions (IFIs) and the financial markets. Many groups of users need comprehensive and timely information on the budget. The executive branch of government needs periodic information about the status of budgetary resources to ensure efficient budget implementation and to assess the comparative costs of different programmes. Citizens and the legislature need information on the costs and performance of programmes that affect them and their constituents. The financial markets use information on the government s finances in order to assess the credit worthiness of a country and to make judgements about the value of its debt and the appropriate level of interest rates and exchange rates. 1.5.3 Principles of reporting The following points are taken from Schiavo-Campo and Tommasi (1999: 254). Reports prepared by the government for internal and external use are governed by the following principles. Completeness. The information, in the aggregate, should cover all aspects of the government s financial relationships. Legitimacy. The form and contents of financial reports should be appropriate for the intended users and comply with accepted standards. User friendliness. Reports should be easy to understand by wellinformed and interested users, and should permit information to be captured quickly and communicated easily. They should include explanations and interpretations for legislators and citizens who are not familiar with budgetary concepts and methodological issues. Financial statements can be difficult for non-accountants; where possible, charts and illustrations should be used to improve readability. Reliability. The information presented in the reports should be verifiable and free of bias. Reliability does not imply precision or certainty. For some items, a properly explained estimate provides more meaningful information than no estimate at all; for example, tax expenditures, fiscal risks or superannuation (pension) liabilities. Relevance. Information is provided in response to an explicitly recognised need. The traditional function of year-end reports is to allow the legislature to verify budget execution. The broader objectives of financial reporting require that reports take into account the different needs of the various users. A frequent criticism of government financial reports is that they are both overloaded with information and difficult to interpret. Consistency. Consistency in the methodology, scope and coverage of financial reports is required not only internally, but also over time. Once an accounting or reporting method is adopted, it should be used for all similar transactions unless there is good cause to change it. If methods or the coverage of reports have altered, or if the financial reporting entity has changed, the effect of the change should be shown in the reports. Timeliness. The passage of time usually diminishes the usefulness of information. A timely estimate (an estimate that is available when a decision needs to be made) may then be more useful than precise 16 University of London

Unit 1 Introduction to Public Sector Accounting information that takes longer to produce. However, although the timely production of information is valued, it is still necessary to undertake statistical compilation and data checking even after the preliminary reports have been published. Comparability. Financial reporting should help users make relevant comparisons among similar reporting units, such as comparisons of the costs of specific functions or activities. Usefulness. Reports on the operations of specific ministries or agencies, to be useful both inside and outside the organisation, should contribute to an understanding of the current and future activities of the agency, its sources and uses of funds, the financial management of these funds, and its assets and liabilities. Government Debt In addition to comparisons of actual payments and receipts with the budget, many governments also provide details of levels of government debt and interest payments with their financial statements. The significance of the level of government debt has grown in recent years with the debt crisis in many developing countries and a growing emphasis on the need for a balanced budget. However, the governments of developing countries still need to borrow to invest in the basic infrastructure of their countries. Fund accounting Fund accounting is often used in the public sector as part of budgetary control. Funds may be established for specific purposes. The accounts then need to be prepared and audited to ensure that the monies provide have been used for the agreed purposes. Many countries, especially those whose government financial management procedures are based on the Westminster tradition, have a consolidated fund into which all government income is paid. Funds are then transferred from the consolidated fund to funds for individual ministries and other entities. In addition, other funds may be established for specific purposes. Thus a development fund may be established to administer and report on the financing of development projects. A consolidated loans fund may also be used to administer, control and report upon the management of the government s debt and interest payments. Reading Now please read pages 46 52 of Rutherford s Chapter 4 in the Course Reader. As you read, please consider the following questions. Why is fund accounting particularly useful in the public sector? What are the two essential features of a fund? In the Opalthorpe University example, which common room (the JCR or the SCR) has made a surplus and which has made a deficit over the year? The cash at the bank is a positive balance of 7,000, but the SCR fund has a negative balance of 40,000. How is this possible? Brian Rutherford (1983) Chapter 4 (excerpt), reprinted in the Course Reader from Financial Reporting in the Public Sector. Centre for Financial and Management Studies 17

Public Financial Management Reporting and Audit 1.6 Conclusion and Summary This unit has provided an introduction to financial reporting in the private sector and provided an introduction to the contents and format of the main two financial statements, the balance sheet and the profit and loss account. The differences between the objectives of the private sector and the public sector were then considered; the implications of these differences for financial reporting in the public sector were explained. The structure of the public sector was then outlined and its implications for accountability considered. An overview of the objectives of financial reporting in the public sector was then provided along with a description of some unique aspects of public sector financial reporting including the importance of the budget, government debt and funding accounting. References and Websites Allen, R. and D. Tommasi (eds) (2001) Managing Public Expenditure: A Reference Book for Transition Countries, Paris: OECD. Bogdanor, V. (2001) Civil Service Reform: A PPMA report, London: Public Policy and Management Association. Government Accounting Standards Board (GASB, US) (2006) Why Governmental Accounting and Financial Reporting Is and Should Be Different, Norwalk CT: GASB, available at http://www.gasb.org/white_paper_full.pdf IFAC (2009) Glossary of Defined Terms, Handbook of International Public Sector Accounting Pronouncements, 2009 Edition, IFAC: 1056 89. IPSASB (2004) Budget Reporting, IPSAS Board Research Report, May 2004, Washington DC: International Federation of Accountants. Parry, M. (2005) Accrual Accounting for National Governments, ICGFM Public Fund Digest, Vol. V, No. 2. These are available for free download on the ICGFM web site http://www.icgfm.org Rutherford, B.A. (1983) Financial Reporting in the Public Sector, London: Butterworths. Schiavo-Campo, S. and D. Tommasi (1999) Managing Government Expenditure, Manila: Asian Development Bank. 18 University of London