IPSAS 22: A New Standard for WGA? Johan Christiaens, Ghent University, Department of Accountancy and Corporate Finance, Kuiperskaai 55/E, 9000 Ghent, Belgium, [email protected] Jan Rommel, Catholic University Leuven, Belgium, [email protected] Philippe Van Cauwenberge, Ghent University, Department of Accountancy and Corporate Finance, Ghent, Belgium, [email protected] Abstract This paper gives insight into the implications of the IPSAS framework on implementing WGA. We argue that it reflects a business-like perspective, resulting in certain improvements e.g. reporting a fair view. However, it creates difficulties in capturing specific governmental characteristics, particularly when looking at the statistical bases of financial reporting. Key words: whole of government accounting, consolidation, public sector accounting standards

1. Introduction During the last decades, New Public Management in general and accounting reforms in particular have transformed the public sector landscape. The striving for a business-like point of view in governments brought about the change of a traditional cash accounting system to an accrual-based accounting system. Accrual accounting, which has been transferred from the private for-profit sector, was expected to increase the financial transparency and accountability of governments. Previous literature has already debated the strengths and weaknesses of accrual accounting in governments (Christiaens and Rommel, 2008). Being part of business-like accounting, it was likely that also the concept of consolidation would be taken over. In order to achieve comparable macro-economic data, the United Nations developed the System of National Accounts (United Nations, 1993) and COFOG (Classification of Functions of Governments). The latest version of the European System of Accounts dates from 1995 (ESA 95, Eurostat). In addition, the IMF created the GFSM (= Governmental Financial Statistics Manual, 2001). Finally, in the beginning of the nineties, New Zealand (1992) became the first country to produce whole of government accounts on a full accrual basis (Pallot 2001, p. 383). Without denying the improvements of Whole of Government Accounting (or WGA) in New Zealand, Pallot discussed a number of accounting difficulties to be overcome. Chow et al. (2007, p. 28) revealed that, despite the encouragement of WGA as a tool to improve both the management of the economy and processes of public accountability, there is still little detailed analysis of WGA and its implications for public sector management. Meanwhile, the International Public Sector Accounting Standards Board (IPSASB), being the unique public sector accounting standard setter worldwide, has recently established accounting standards and guidelines for the preparation and presentation of WGA financial statements (IPSAS 22, 2006). Because National Accounting of the Government Sector is an underdeveloped area in the domain of accounting research (Chow et al. 2007, p. 28; Sierra et al. 2004, p. 2) and given the importance of IPSAS, the current study attempts to shed some light on the implications of IPSAS 22 as a framework for WGA. What will be the consequences of applying IPSAS as a framework for WGA? What kind of accounting information will result from applying the IPSAS concept? Apart from the use of previous research, the current contribution is a documentary study, based on a critical examination of legislation, standards and interpretations. After the introduction, this contribution proceeds with a discussion of the IPSAS WGA framework focusing on its framework and objectives. Next, the paper analyses the consequences of the IPSAS framework on public sector accounting. The remainder offers an overview and conclusions. 2. Discussion of the IPSAS WGA framework Although standard setters have paid attention to financial accounting in the profit sector for a very long time, elaborating accounting standards for the public sector took place rather recently by establishing the IPSASB in 1987. The objectives of the IPSASB are to serve the public interest by developing high quality public sector financial reporting standards. Its underlying philosophy is that, while most of the basic principles of accounting seem to be the same across both public and private sectors, the application of these principles raises a number of specific issues in the public sector context. The IPSASB develops accounting standards that set out the requirements for financial reporting by governments and other

public sector entities. They apply to general purpose financial statements prepared under the accrual basis of accounting and the cash basis of accounting, as specified. The IPSASs are the authoritative requirements for financial reporting of public sector entities established by the IPSASB. Because IPSASs are essentially based on the accounting standards issued for the private sector by IASB, they could be developed rather easily, particularly for issues that are more or less similar to the profit sector. IPSASs are high quality global financial reporting standards for application by public sector entities other than Government Business Enterprises (GBEs). However, the IPSASB copes with relevant questions and difficulties on items where governments have specific characteristics (e.g. nonexchange transactions; WGA). In addition, IPSASB issues non-authoritative documents, which provide guidance on the migration from the cash to the accrual basis. Its objectives are to enhance the quality and uniformity of financial reporting by facilitating the convergence of international and national standards. IPSAS 22 (“Disclosure of Financial Information About the General Government Sector” issued December 2006) regulates and determines the whole of government accounting approach. It prescribes1 disclosure requirements for governments that elect to present information about the general government sector (GGS) in their consolidated financial statements. According to IPSAS 22 WGA reporting is not obligatory, but if a government decides to disclose WGA information, it should follow the prescriptions of IPSAS 22. Furthermore, WGA should only be prepared for governmental economic entities (= groups) that develop consolidated financial statements. Thus, a government that is not disclosing consolidated statements for whatever reason is not supposed to disclose GGS information. An important interpretation is that even for governments that should consolidate but are not in compliance, GGS should not be disclosed. As shown in Table 1 the General Government Sector (GGS) is defined in general terms in IPSAS 22 § 5. According to IPSAS 22 § 15 this definition is supposed to correspond with the government or sectors thereof subject to Statistical Bases of Financial Reporting. GGS encompasses the central operations of government and typically includes all those nonmarket non-profit entities that have their operations funded primarily by the government and government entities. The GGS does not include Public Financial (PFC), or Non-Financial Corporations (PNFCs) (IPSAS 22 § 18).

1

“A government that prepares and presents consolidated financial statements under the accrual basis of accounting and elects to disclose financial information about the general governmental sector shall do so in accordance with the requirements of this Standard.” (IPSAS 22 §2)

Table 1: Definition of the different players and their accounting/reporting regulations Sector Economic group)

entity

Definition

(= Group of entities comprising a controlling entity and one or more controlled entities General Government §5 All non-profit Sector (GGS) entities that undertake non-market activities and rely primarily on appropriations or allocations from the government to fund their service delivery activities §15 All entities of general government as defined in Statistical Bases of Financial Reporting (SBFR) Sector Statistical Bases = GGS + PFC + PNFC of Financial Reporting (SBFR)

Accounting standards IPSAS 6

All IPSASs IPSAS 6

SNA 1993

Financial reporting Consolidated Financial Statements

except GGS Statements

Statistical Reporting

Financial

Financial

The Statistical Bases of Financial Reporting (SBFR) will provide information about the corporations sector of government that primarily engages in market activities. According to IPSAS 22 § 9 the objective of GGS is to provide information useful for decision-making and to demonstrate the accountability for the entity for the resources entrusted to it. The objective of SBFR is different because it aims to provide information suitable for analyzing and evaluating fiscal policy, especially the performance of the GGS and the broader public sector of any country. IPSAS 22 (§32) acknowledges that differences in valuation and disclosure between GGS reporting and SBFR reporting can occur and accordingly suggests to disclose the reconciliation. However, these two kinds of reporting serve different frameworks that need not to be compared mathematically in order to avoid misunderstanding of different users. Currently, many governments and other public sector entities follow very diverse accounting prescriptions. In addition, many countries lack authoritative (homogeneous, wellspecified) standards, developed by professional bodies for the public sector. When standards do exist, they may be either at an early stage of development or may be limited to specific types of entities in the public sector. In most continental West-European countries, accounting requirements are not developed by professional bodies but are issued by their legislator, leading to a variety of accounting regulations. Previous research revealed increasing disparities of accounting regulations and practices that currently coexist in public sector accounting systems (Christiaens 2001, Pina and Torres 1996). Governmental accounting appears to be an uncoordinated and extremely complicated “chimera”, creating the need to be consolidated into coherent accounts (Jones, 1995). In this respect the IPSASs have played a positive role by providing unique authoritative accounting regulations that are known worldwide. Organizations such as NATO, the UN and the European Commission have all decided to adopt IPSAS. Adopting IPSASs and preparing WGA will require convergence of

the various different sets of accounting rules and guidance covering different public sector bodies (Chow et al, 2007, p. 35). 3. Analysis of the consequences to public sector accounting from different perspectives: In general, the objectives of WGA can be described as improving the organizational management, the accountability and macro-economic policy-making (Chow et al. 2007, p. 34). The IPSAS framework approaches these objectives by emphasizing the need for: (1) transparency; (2) a better understanding of the governmental market and non-market activities; (3) understanding of the relationship between financial statements vs. statistical bases of financial reporting. Transparency In recent years, international financial crises have highlighted the need for better governance through more transparent financial reporting. The IMF stated that there is ‘a clear consensus that good governance is of central importance to achieving macro-economic stability and high-quality growth and that fiscal transparency is a key aspect of good governance’ (International Monetary Fund, 2001). Holding governments and their agencies accountable is a key element to good governance in the public sector and transparency is a necessary condition for the discharge of accountability. As a framework for WGA, IPSAS 22 encourages a centralized overview of all assets, liabilities and profit/loss for the whole of government. Hence, this financial reporting assists in improving public sector solvency, sustainability and intergenerational equity (Chow et al., 2007, p. 34). However, one could argue that, for determining intergenerational equity, WGA is not necessary and potentially misleading because financial accounting behind WGA does not take into account the actualized future savings that are important to consider in examining the intergenerational equilibrium (Feenstra and Van Helden, 2003). Difficulties in determining the group (perimeter) Defining and determining the group (economic entity) has given rise to critical analyses. Referring to HM Treasury, Chow et al. (2007, p. 35) focus on the necessity of extending governmental consolidation beyond the level of the central government. This is vital if WGA is to become a usable and meaningful measure of net worth for the entire public sector. An important issue in IPSAS 22 is that WGA is only possible in governments that prepare and present consolidated financial statements. Moreover, financial statements consolidate only controlled entities (§6). Control is defined in IPSAS 6 by § 8: ’The power to govern the financial and operating policies of another entity so as to benefit from its activities’. IPSAS 6 (§ 28-30) further defines control in terms of the power element and the benefit element. Control stems from the entity’s power to govern the financial and operating policies of another entity. IPSAS 6 (§ 36) states that the power of an entity to govern decision-making in relation to the financial and operating policies of another entity is insufficient to ensure the existence of control. The controlling entity needs to be able to govern decision-making so as to be able to benefit from its activities. According to IPSAS 6 (§ 39-40) the benefits are only in an economic perspective (‘obtain economic benefits’, ‘holding title to the net assets/ equity of the other entity’).

Apparently, the IPSAS framework regarding WGA is strongly based on business-like concepts: GGS financial reporting is only applicable if the government prepares consolidated statements and the consolidation of governments is only based on business-like conditions. Thus, a government that lacks ’control’ over certain entities should not prepare consolidated statements and, accordingly, should not disclose GGS information. However, in many instances, the entities do not meet the definition of control, but still have an important financial relationship with government, often of another kind than business-like. Two concrete examples are hospitals or schools (Broadbent, 2007, p. 195). These are often established as autonomous non-profit entities and are not controlled (see IPSAS 6 §41) by the government, but are relatively autonomous instead. Nevertheless, they obtain important resources from the government to accomplish their objectives. Often such non-profit entities are often scrutinized by means of Oversight Bodies (e.g. Supreme Audit Institutions) but still without the business-like kind of control as defined by IPSAS 6. As such, an important consequence is that the IPSAS WGA framework looses a relevant part of the WGA picture. This difficulty is reinforced by the occurring off-balance sheet ‘manoeuvring’, which was discussed by Chow et al. (2007, p. 41). For the UK, they found that a large portion of public debt is kept “off-balance sheet” by restructuring public service providers such that they become private companies (e.g. National Rail Road Companies). Apparently, on the one hand WGA undergoes a certain way of convergence with consolidation -at least in standards and concepts, while on the other hand the accounting practices behind consolidation and WGA appear to diverge (Christiaens, 2001). From a conceptual point of view, IPSAS 6 (regulating consolidation) obliges governments to consolidate companies that are controlled by the government. However, IPSAS 22, regulating WGA, remains unclear as to defining the entities that should be included in GGS financial reporting. Even the boundaries of those entities are not made clear enough. According to Chow et al. (2007, p. 43) this is caused by the need to report on the basis of political accountability in addition to the existence of a differently organized economic dimension. More generally, the definition of a governmental entity is not as easy as often assumed. CICA (1985) analyzed four kinds of definitions: the legal entity concept, the ownership and control concept, the economic entity concept and finally the political accountability concept. Hence, the selection of entities and activities to be included in the perimeter remains subjective and political. IPSAS 22 seems to avoid this difficulty by merely concentrating on the economic dimension. As such, IPSAS 22 does not lead to a complete picture despite the fact that IPSAS strives for complete WGA reporting. General government sector accounting data in the perspective of macro-economic theory of fiscal policy One of the supposed attractions of WGA next to improving organizational management and public accountability lies in the provision of better quality and more transparent information to assist with the development of fiscal policy (Cheng et al., 2007). Indeed, the setting and monitoring of fiscal policy was one of the main explicit objectives of the introduction of WGA in the UK (NAO, 2002, p.5; Heald and Georgiou, 2000). In its crudest form, fiscal policy attempts to influence the direction and level of the economy through the determination of the combination of government revenue (T) and government spending on goods and services (G). Accordingly, the stance of fiscal policy can either be expansionary (TG) or neutral (T=G) (Blanchard, 1997). For the evaluation of the effects of fiscal policy, T and G should be considered as ‘real’ flows in the sense that they purport to actual transfers of resources between the government and the

private sector. In other words, G and T are to be considered as effective resource flows, unadjusted for any form of accrual accounting. Accordingly, the evaluation of the direction and intensity of fiscal policy can be made on a pure cash accounting base. Likewise, the calculation of the government deficit, which determines the need for borrowing and serves as an important macro-economic target number, also involves only cash in and outflows. With Bt − 1 indicating previous period debt and r equal to the interest rate, the deficit equation is: deficit t = Bt − Bt − 1 = r.Bt − 1 + Gt − Tt The determination of the need for future period government financing is strictly a matter of cash flow arithmetic, the rigor of which would be undermined by the intrusion of accrual accounting adjustments. It is however more sensible to express the dynamics of government debt vis-à-vis the level of national output or national income (Y). The reason is that Y is the tax base and indicates the potential to service future government debt. If g is the growth rate of national output, the dynamic of the debt ratio (B/Y) can be written as: Bt Bt − 1 B G − Tt − = (r − g ) t − 1 + t Yt Yt − 1 Yt − 1 Yt At first sight, the same cash in and outflow variables seem to appear in this equation, to wit interest payments, government spending and taxation. The demand for government accounting inputs seems to be unaffected, which seems logical since this equation is only a rescaling of the original deficit equation. However, for purposes of macro-economic planning, forecasts of the debt-to-GDP ratio also require forecasts of the economic growth rate g and this is where government capital assets come in. In 1990, Barro presented a growth model where macro-economic growth was endogenous with respect to public investment. Since then, several authors have distinguished between government consumption and investment and investigated - analytically or empirically, the effects of public capital on the performance of the economy (Futagami et al., 1993; Greiner, 2007; Yakita, 2008). Public infrastructures such as highways, airports, electrical facilities etc. are considered to increase the efficiency of private production factors. This form of externality is often referred to as ‘service potential‘. Accordingly, macro-economic production functions are augmented with a public capital variable, which is, an explicit justification, from a macro-economic policy point of view, for the need for an accrual-based accounting mechanism with delivers government capital as an output. It is important to notice at this stage that these macro-economic models make no distinction in the level (central, state, local of even government enterprise) at which public capital assets are situated, which provides natural support for the case of reporting public capital assets on a consolidated base. In other words, this point of view is in contrast with the contention that consolidation would be of little value given the differences between the various government departments and levels of government (Chow et al., 2007). Although there may be different types of government capital assets, they have service potential, no matter under what level of government budget it has been approved. A related point is that the IPSAS notion of ‘control’ to determine the scope of consolidation seems irrelevant in this context. What matters is the availability of public capital to society regardless of the fact that a public asset is under the control of the central government. In other words, for the determination of the scope of consolidation, the macro-economic theory-based demand for a notion of public capital assets seems to correspond more with a ‘sector approach’ like it is used in the systems of national accounts such as ESA95.

It should be clear that, up to now, no mention was made of the need for any notion of government equity or net worth. The only inputs required up to now for fiscal policy are government spending on goods and services (G), revenue (T), interest payments on government borrowing and the stock of government capital. The information requirements become slightly more involved when considerations of intergenerational redistribution and fairness are introduced as an additional goal of fiscal policy. For instance, under the so-called golden rule (Chow et al. 2007), which was adopted in the UK in 1998, borrowing is only allowed to finance government investment, exactly to assure that future generations should not be made ‘worse off‘ by the fiscal conduct of present generations. In a similar vein, calls to take into account future pension obligations are motivated by the concern not to leave future generations ‘worse off’ (Buiter, 1985). In this context, it is interesting to point out that the term ‘worse off’ is the exact same wording that was used in Hicks (1946), which is broadly considered as the seminal work with regard to the economic definition of income and equity. In fact, as pointed out by Van Cauwenberge and De Beelde (2007), Hicks (1946) provides the theoretical motivation for a balance sheet based approach to accounting, which underlies IPSAS GAAP. The main contribution by Hicks has been to point out the inter-temporal nature of the income concept: income emerges only after the value of net worth or capital has been maintained such that the entity is not ‘worse off’ after the period. Accordingly, it is not surprisingly that the concept of net worth of government turns up, once intertemporal or intergenerational considerations are added as an additional goal of fiscal policy. Intuitively, there is a strong link between the notion of intertemporal status quo and the maintenance of net worth. In practice however, as is forcefully argued in Chow et al. (2007), the calculation of net worth could run into serious conceptual and practical problems related to recognition and measurement of government assets and liabilities. Some of these difficulties pertain to the choice of a correct measurement base for infrastructural assets, others to the accounting treatment of heritage assets, potential inclusion of future projected (tax) revenues and (pension) liabilities and the conceptual and actuarial estimation problems that this brings along. Acknowledging the demand for purposes of fiscal policy for information of (subsets of) government assets and liabilities that were outlined above, it seems therefore questionable that there is any informational benefit for the conduct of fiscal policy in adding all these components to calculate an aggregate that is called net worth or equity. Business-like characteristics of WGA The alleged benefits of WGA are similar to the claims that are made about transferring businesslike techniques into the public sector in general. WGA is said to provide better information for decision-makers, which will ultimately lead to enhanced efficiency and performance. In addition, citizens acquire more information on the government’s financial position, so that transparency and public accountability will ultimately be improved (see Chow et al., 2007). However, these claims are problematic in various ways. First, it is questionable whether information on efficiency in general, and on the financial position in particular, is useful in a politically organized context. Accrual accounting starts from the assertion that everything is measurable in economic terms. However, this rationality is rather narrow, since ‘quantity tends to become a surrogate for quality’ (Lapsley, 1999) and ‘accounting is not a neutral reflector of ‘reality’ 2’ (Broadbent 2007 p. 193). Moreover, rationality in the sense of financial or economic value is biased since it is only a part of the picture. Measuring 2

“National accounts valued stocks of arms and missiles, but not the cost of malaria.” (Broadbent 2007, p. 194).

efficiency is only easy in monetary terms. However, as Hooper et al. (2004) contend, the price is not the same as the value. Whereas enterprises are established with the aim of making economic profits, with inputs and outputs that are measurable in economic terms, the objectives of governments are much wider. Governments mainly aim at providing services that lead to societal benefits (e.g. education, defense) and that are not readily measurable in economic terms. Adopting an accounting system that only captures the economic profits provides only a part of the picture. Furthermore, it can be said that, in a political context, ensuring responsibility and responsiveness may be a more important concern than efficiency (Curristine, 1999). This may explain why cameralistic accounting per government or per government department still prevails (see Christiaens and Rommel, 2008). The latter is not intended to provide an overview of the financial position nor of the financial performance (Christiaens, 2000). Instead, it is concerned with the registration and use of authorized budgets, driven by budgetary principles. This system expects to control the execution of the budget approved by the governmental decision makers. Secondly, the claim that businesslike mechanisms would lead to better information for decision-makers (i.e. the full cost of service) is doubtful. Robinson (1998) argues that knowing the ‘full cost’ is not useful for decision-making. Contrary to expenditures, costs are very difficult to agree on, especially in a political context. Costs consist of arbitrary estimates and allocations of depreciations, writing-off’s, overhead and other indirect items, making them very difficult to monitor (Guthrie, 1998). These accrued amounts cannot easily be controlled because of the absence of related measurable outputs. This is also confirmed in previous research (Mol and de Kruif, 2004) indicating that, in many governments, traditional budgetary control mechanisms, concentrating on cash receipts and payments, remain necessary. 4. Conclusions The central aim of this article was to examine the whole of government accounting framework as developed by the IPSAS. Apart from most IPSASs that are applicable per governmental accounting entity, the IPSASB issued an accounting standard for consolidation (IPSAS 6) in order to report on the group of governmental entities on which the controlling entity has the power to govern the financial and operating policies. Because in governments the perimeter of related parties is larger than only the economic controlled entities, IPSAS gave rise to the standard 22 regulating the financial reporting on the general government sector. This GGS reporting approaches the existing statistical based financial reporting (SNA 1993), which is used in public policy analysis and decision-making. Undoubtedly, the IPSAS framework for WGA has the merit to open the eyes by providing transparent whole of government financial statements. This new way of looking at governmental financial characteristics enables the discussion about accountability in terms of public debt, intergenerational equity and other issues that have been underestimated in traditional governmental areas. On the other hand the analysis of the IPSAS WGA framework suggests several conceptual problems. Firstly, IPSASs are strongly inspired by business accounting standards and favor the assumption that governmental reporting should be driven by business accounting methods and point of views. It emphasizes general government sector reporting starting from governments that consolidate using businesslike criteria. Secondly, there is the confrontation with the well-known statistical based financial reporting systems (SNA 1993), which actually serve other user needs. The way in which IPSAS regulates these two kinds of reporting remains rather complex, particularly for decision-makers. Finally, the IPSAS appear to underestimate the political and organizational characteristics of governments, which even play a more important

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