PUBLIC SECTOR ACCOUNTING

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Lecture 5

Fundamentals of Accounting System

Fundamentals of Accounting System - Government accounting machinery - Vote accounting and accounting for

receipts and payments - Accounting bases: Fund accounting, Cash

and modified cash basis, Accrual and modified accrual basis, Commitment accounting, Government Financial Management Accounting System (GFMAS)

Overview

Stewardship and accountability

Accounting and reporting entities

Accounting techniques:

Fund accounting

Cash and modified cash

Accrual and modified accrual

Commitment accounting

Budgetary accounting

Stewardship and Accountability Implications on financial accounting and reporting

"the holding of someone else's assets by a steward, [in which] the responsibility of stewardship is to demonstrate that those assets have not been misappropriated (J & P, 2000, p. 131)

Since government operations are significantly financed through taxation, the government has the responsibility as a steward to show the amount of money collected and the form in which the money is held.

Receipts and payments

Budget

the responsibility for your actions to someone else. [It] goes beyond the narrowly defined stewardship of assets to include responsibility for the performance of those assets (J & P, 2000, p. 131).

responsibility of entity/organisation to give account for the use of resources and to accept responsibility for the outcomes / results / performance (3Es) as a result of actions/decisions taken by the entity/organisation.

Financial results

Management accountability

Performance reporting

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Proprietary Theory Sees the organization exclusively in terms of the owners (proprietors).

The reporting unit is therefore the organization as the owners see it.

The accounts are addressed to the shareholders with the B/S showing the shareholders financial position and the income statement showing the change in shareholders financial position.

Corporate accounting ~ Assets Liabilities = Shareholders Equity

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Views organization as distinct from any group of individuals associated with it.

The reporting unit is the entity itself and the report is addressed to all those interested in it.

Value added statement indicate how much value the entity has added thru its operations & how the added value has been distributed to the many resource providers.

No emphasis on shareholders Focus on assets and liabilities

Entity Theory

Commander Theory Organization is seen as a series of responsibility centers,

controlled by a manager (commander), who is responsible for his unit.

Financial report is an aggregation of all the stewardship and performance reports for each responsibility centers.

stewardship

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Fund Theory The reporting unit is defined as a fund Organization is seen as one fund or a series of funds. Financial report would be an aggregation of financial reports of

the constituents funds. Offers the reporting accountant the flexibility to define the

reporting unit where the definition is most useful. Suits public sector organisation Separate purpose, separate funds

Positive Accounting Theory the only accounting theory that will provide a set of predictions that

are consistent with observed phenomena is one based on self-interest [Watts and Zimmerman, 1979:300]

Predicts that accounting choice from the wealth effects the choice has on the agent and important stakeholders [Watts and Zimmerman, 1986], assumes a clear correlation between companies accounting choice and their characteristics.

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Economic Theory of Democracy is reasonable to assume that both agents (politicians) and principals

(voters and other stakeholders) are rational, evaluative individuals trying to maximize his own wealth.

Downs, 1957: 137 In effect, it is an entrepreneur selling policies for votes instead of products for money. Furthermore, it must compete for votes with other parties, just as two or more oligopolists for sales in a market

The information assymetry and conflicting interests are moral hazards, arising from unobservability of the politicians efforts in creating social welfare.

Institutional Theory Focuses on the organization and its problems associated with

uncertainty, legitimacy and mobilization of resources

Assumes that organizations are influenced by pressure from their institutional environment and adopt the structures and/or procedures that are considered legitimate and regarded as the appropriate choice.

Institutional Isomorphism: 1- external pressure from resource provider/or parties it depending on; 2- imitation and modelling successful concepts; and 3- professionalization

Decoupling: separation of the actual practice from the formal practice, can be done more or less consciously by the organization, enables organizations to maintain standardized, legitimating formal structures while their activities vary in response to practical considerations [Meyer and Rowan, 1977:357]

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Accounting and Reporting Entities Accounting

Information system (input process output)

Entities

Defines the boundaries of the system

Determines the particular interest for which information is to be collected and reported.

Accounting entities

Portion of reporting entity covered by separate set of accounting records.

Reporting entities

An area of economic interest reported in financial statements summarizing assets, liabilities, revenue and expenditures.

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Financial Reporting Entity Bases to identify reporting entities:

1. Rules: e.g. Constitution 2. Principles developed by accounting profession, e.g. GASB:

The primary government (Fed, State, Local governments) Organizations for which the government is financially accountable Other organizations

Watt and Zimmerman, 1979:287-88, on accounting standards: Rationales differ (and are inconsistent) across accounting standards because a standard is the result of political action We will observe the nature of accounting theory changing as political issues change. Accounting theory will change contemporaneously with or lag political issues. We will not observe accounting theory generally leading political action

Brorstrom, 2007:150; translation: To a certain point it seems like municipal accounting can be developed in accordance with generally accepted accounting principles, but when it approaches on the space for political action, it stops.

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Accounting Entities in Malaysia

Based on structure

federal, state, local authorities, statutory bodies, public enterprises, agencies

Based on funds (programs, initiatives etc)

consolidated revenue, loan and trust

under each of these funds, individual accounts-funds is created based on objective/purpose.

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Fund Accounting Accounting method that reports in terms of funds rather than in terms of

organizations The system segregates resources according to specific purposes, and the

resulting reports would be able to show whether resources have been used for the purpose intended.

A fund may be established as a result of legal requirements, instructions from Parliament or the government itself

Monies that are paid in a particular fund cannot be used indiscriminately designations relates with the policy of organizations Bequest relates with the terms of the bequest Specific government grant

Explicitly recognises the political, economic and legal differences that exist between the services provided, and the activities carried on, within public sector organisations.

The operations of funds may be terminated by the establisher or other relevant parties with higher authority

Critiques against fund accounting:

Higher costs involved in producing the accounts (physical costs)

Associated costs relates to the investment of time and skill needed to understand fund accounting

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What is a FUND? A fiscal or accounting entity with a self-balancing set of accounts recording cash and other financial resources together with all related liabilities and residual equities or balances and changes therein which are segregated for the purpose of carrying on specific activities or attaining objectives in accordance with special regulations, restrictions or limitations. GASB, 1998. Section 1300

Fiscal entity assets set aside for specific purposes Accounting entity double entry transactions created to account for the fiscal entity

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Types of Funds General Fund

General purposes

Special Revenue Fund For specific

purposes or to finance specific activities

Capital Projects Fund Capital

expenditure that requires specific source of finance

Debt Service Fund To service the

governments borrowings

Entrepreneur Fund

To finance business activities

Trust Fund

For the purpose of trusts

Other Funds

Cash Accounting Accounting technique that recognizes transactions and other events when cash is

received and paid. It measures financial results for a period as the difference between cash received and cash paid.

Issues with Cash Accounting i. Fails to show the proper picture of the financial position and performance of

the organization Eg 1 Sale of capital assets (land and buildings)

Implications? Eg 2 Postponement of cash payment

Implications? ii. Fails to estimate whether governments can continue to afford the services they

currently deliver, or new services on the basis of full-cost information iii. Fails to provide information about total costs of government programmes/

activities

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Accrual Accounting Accounting technique that recognizes transactions and other events when revenue and

costs are accrued (recognised as they are earned or incurred), and matched with one another so far as their relationship can be established or justifiably assumed, and

dealt with in the profit and loss account of the period to which they relate

record financial effects in the periods in which those transactions, events and circumstances occur (FASB, SFAC No 1)

Issues with Accrual Accounting Subjectivity and this could distort accounting information

Depreciation method, rate of provision for debts Relevance of AA is rather limited during inflationary period Involve more administrative and accounting costs

More accounts need to be maintained Lead to a certain manipulations, particularly at the end of a financial year

Unnecessary spending for an approved budget

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Recognition of Transactions

Sale/Purchase

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Order

received/issued

Goods

dispatched/received

with invoice

Cash

received/paid

ACCRUAL

CASH

COMMITMENT

Modified Basis of Accounting

Cash and modified cash

Accrual and modified accrual

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CASH ACCRUAL MODIFIED

CASH

MODIFIED

ACCRUAL IPSAS

ACCRUAL

Modified Cash Accounting Accounting technique that recognizes transactions and other

events when cash is received or paid. The books are kept open for a specified period (about a month) after the year end

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Extension

31.12.x0 31.1.x1

Receipts and payments that occur during the specified period but originate in the previous accounting period are recognized as receipts and payments of the previous reporting period

Payments during the extended period (31.1.x1) are charged to the prior years budget (31.12.x0) provided that:

Works are performed, goods are received and services are rendered before or at the end of the financial year (31.12.x0)

Payments for the respective commitments have not been disbursed before or at the end of the financial year (31.12.x0)

Payments for the respective commitments are disbursed before or at 31.1.x1

Benefits of Modified Cash i. Provides a better picture of the payments and commitments

ii. Expenditure can be related to the annual budget of the organization

iii. Provides a better relationship between expenditure and performance for a governmental departments and agencies

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Modified Accrual Accounting

Accounting technique that recognizes transactions and other events when they occur rather than when cash is paid or received.

Physical assets are expensed at the time of purchased

Only disclose future commitments requirements by recognizing financial assets and liabilities, net financial assets (or net financial liabilities), modified revenue and expenditures.

Commitment Accounting Recognize transactions when the organisation is committed to them.

Often a sub-system of the main accounting system, e.g. with cash

accounting.

The transaction is recognized when invoice/order is issued or received.

Related to budgetary control, that is, at any one point of time, the

person responsible for controlling the resources would know the

amount already committed from the budgets

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Budgetary Accounting The practice of keeping and presenting the operating accounts in the

same format as and alongside the budgets.

Users of the reports could assess performance of the government against the budget.

Enhances accountability

Financial Reporting Framework

Conceptual framework - objectives

Accounting concepts

Users and uses of financial reporting

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Financial Reporting Framework Conceptual

The objectives of financial reporting by public sector entities are to provide information about the reporting entity useful to users for accountability purposes, and for making resource allocation, political and social decisions (IFAC Consultation Paper, 2008)

Objectives: to comply with the law and to provide information on financial position, financial performance and changes in financial position of the government. The information is useful for various users. (Government Accounting Standard 1, 2002)

Objektif penyediaan penyata kewangan kerajaan adalah untuk memenuhi kehendak undang-undang. Di samping itu, ia juga memberi maklumat mengenai kedudukan kewangan, prestasi kewangan dan perubahan kedudukan kewangan kerajaan. Maklumat ini berguna kepada pelbagai golongan pengguna.

(Piawaian Perakaunan Kerajaan 1, 2002).

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Financial Reporting Framework Accounting Concepts

Entity concept Separate fund entities

Periodicity concept Flow of funds according to the budgetary period

Matching concept Match allocation received with expenditure (surplus or

deficit)

Going concern

concept

Government will continue to exist for the foreseeable future

Basis of Accounting Cash basis

Modified cash basis

Assets & Liabilities No full disclosure of assets and liabilities in the balance sheet

; Depreciation are not provided

Equity Equity interest with the public is not shown in the Balance

sheet

Financial

Statements

Statement of receipts & payments/Cash statement; Fund

statement; Operating statements (revenue and expenditures)

Users / User groups Reporting is determined by users and uses

public sector is not homogeneous, huge number of potential users Practical approach: differential and integral

Differential emphasizes complexity of financial accounting (many user groups taxpayers, investors, employees, vendors, legislative bodies, voters, management etc)

Integral emphasizes commonalities (relatively fewer user groups legislative and governing bodies, the public, economic and financial analyst, etc)

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US study (Drebin, Chan and Fergusan, 1981) produced 10 user groups: Provision of financial resources (1) Taxpayers, (2) grantors, (3)

investors, (4) fee-paying service recipients Provision of material resources (5) Employees, (6) vendors Resource allocation decisions (7) Legislative bodies, (8)

management Constraints set by (9) voters, (10) oversight bodies

User needs Financial viability test of solvency and liquidity; relationship between

inflows and outflows; and degree of resource transferability

Fiscal compliance extent to which the organization has complied with conditions attached to its authority to spend

Management performance value for money

Cost of services provided comparison among providers and over time

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According to GASB, user needs are :

Comparing actual financial results with legally adopted budgets

Assessing financial condition and results of operations

Assisting in determining compliance with finance related laws, rules and regulations

Assisting in evaluating efficiency and effectiveness

Features of Financial Reports Designed to comply with the constitution & other legal requirements.

Accounting system is related to the budget classification (supply expenditures, emoluments etc)

Source of fund, spending, responsible authority.

Designed to facilitate audit

Availability of evidence, documentation, classification etc.

Developed for effective administration control of fund & operations, programme management, audit & appraisal.

Reporting - Fund accounting

Recording - Modified cash basis

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Issues in Financial Reporting How far any user groups actually do use the accounts

Electors and voters are generally ill-informed as individuals and rely on their representatives to interpret the info.

Despite the requirement to produce financial reports, there is no direct incentive to make them better.

Creative accounting

Rules of financial reporting

Whether there should be greater standardization of financial reports.

Cost of producing the annual financial reports

How far public sector bodies should follow private sector practice in reporting

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Tutorial Questions 1. There is a spectrum of accounting bases that ranges from: the cash

basis of accounting, at one extreme; to the full accrual basis, at the other end of the spectrum. In between, there are many variations that are, in effect, modifications of either the cash or the full accrual bases. (IFAC PSC Study No 1, 1991 look up this paper).

Required:

Based on the above statement, describe the measurement focus and elements of financial statements for each of the four bases of accounting in the spectrum.

2. The government of Malaysia has decided to adopt accrual accounting, shifting from the previously used modified cash accounting. Identify two principal financial statement items affected by this change and describe how accounting for these items has changed.

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