Conceptual Framework for PBE Reporting: A Meaningful …Conceptual Framework for PBE Reporting: ......

Van Peursem/FRRaG (Financial Reporting, Regulation and Governance) 2009 8:1

Conceptual Framework for PBE Reporting:

A Meaningful Basis for ‘Sector Neutrality’

Karen A Van Peursem Department of Accounting

University of Waikato

Contact Details Karen Van Peursem Department of Accounting University of Waikato PB 3105 Hamilton New Zealand Email: [email protected] Phone: +64 7 838 4466 x8647 Fax: +64 7 838 4332 Abstract Developments are now underway by the International Federation of Accountants (IFAC) to form sector neutral concepts and standards for use in both the public and private sector. Requiring both sectors to use guidance which tends to be grounded in commercial assumptions is, however, of concern. This study stems from a desire to give voice to non-profit sector and accountability concerns, and to offer a way forward for sector neutrality. The aim of this project is to formulate a socially-considerate and resource-conscious conceptual reporting framework for PBEs. The framework is grounded in public sector concepts by drawing on Rutherford’s (1983) framework of resource flows. Sector neutrality is then offered by considering whether and how accounting principles and assumptions may or may not be appropriate to the sector. The development is contextualised in New Zealand practice and standards. The resulting framework is offered as a cost-conscious yet sector-grounded basis for real sector neutrality. Conclusions are drawn as to implications and the potential for further research.

Key words: conceptual framework, accountability, sector neutral, PBEs Standards

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mailto:[email protected]


Conceptual Framework for PBE Reporting: A Meaningful Basis for

‘Sector Neutrality’

1.0 INTRODUCTION

Public Benefit Entity (PBE) is the broad term referring to organisations that “provide

goods or services for community or social benefit” (NZICA, 2007, p.2). PBEs

include non-commercial public sector organisations and charities such as, for

example, government departments, the military, public hospitals and friendly

societies. Some PBEs are formed to compensate for market weaknesses such as a

monopoly energy supplier; others provide a public good to those who might otherwise

be denied access. PBEs create and maintain schools and hospitals, roads and parks.

Unlike corporations, the focus of a PBE is not to create financial returns for equity

holders but to provide some sort of service to society (NZICA, 2007, p. 2).

PBEs may comprise a significant portion of a nation’s GDP and are usually held

accountable to the general public. Their reporting requirements may be established

under law and usually serve accountability. Disclosures may include budgetary plans

and performance indicators as well as financial information (e.g. see Jones and

Pendlebury, 1992, 1-10; NZICA, 2009a). PBEs operate, by definition, outside the

market and are generally seen to be an important part of a healthy and caring society.

Current international and U.S. accounting standards for PBEs tend to be based on

commercial sector concepts. The practice of combining public and private sector

standards is referred to as ‘sector neutrality’ (Kober, Lee and Ng, 2007; Ellwood and

Newberry, 2007). The Australian Accounting Standards Board (AASB) recently

released public sector standards that use sector neutrality and, despite early

development of a separate public sector framework, New Zealand is now doing the

same (Simpkins, 2006; Gilling, 2008; NZSA, 1987a). Sector neutrality is a global

trend led by a number of regulators, business leaders, professions and those conscious

of the cost of funding two separate sets of standards (e.g. see Cohen, 2008; Jones and

Mellett, 2007; Hooks and Tooley, 2007; Connolley and Hyndman, 2006; Goddard,

2002; Jackson and Lapsley, 2003; Lapsley and Pallot, 2000; IPSASB, 2008).

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2.0 THE RESEARCH

Sector neutrality has led to a shift toward commercial practices in the manner that it

draws from private sector models (Davis, 2008, p. 23). Leaders in the sector

neutrality movement – International Federation of Accountants (IFAC) and the U.S.

Financial Accounting Standards Board (FASB) – have adopted a business enterprise

approach in their most recent proposals as has New Zealand (Sawers, 2009, p. 11;

IFAC, 2007 and 2008; Simpkins, 2006, p. 20; NZICA, 2009b, para. 27).

Doing so is not without challenges. Practitioners, standard setters and academics

struggle to force PBE information into business reporting frameworks (Pendleton,

2006; Barton, 2005; Connolly and Hyndman, 2006; Mack and Ryan, 2006; Carlin,

2005). These problems have been acknowledged within the standards themselves:

… If any disclosure requirements contained in the IFRSs are amended or removed in respect of public benefit entities when they are incorporated in the New Zealand equivalent standards, the ability of a public benefit entity applying these standards to assert compliance with IFRSs may be compromised (NZICA, 2006, p. 7)

IFAC’s International Public Sector Accounting Standards Board (IPSASB) (2009), an

independent arm of IFAC (Davis, 2008, p. 23), is currently developing a conceptual

framework for the PBE sector. The New Zealand profession, a member of IFAC, is

seeking feedback on an early adaptation of it (NZICA, 2009b). In this process, the

IPSASB addresses some of the concerns raised about sector neutrality. Developers

hope to issue a core set of standards before 2010 (IPSASB, 2009).

2.1 Purpose

This recent initiative provides a window of opportunity for those who wish to make a

meaningful contribution to the discourse on PBE reporting. This study responds to

that opportunity and is carried out in order to voice an interpretation of PBE

accountability needs, and offer a framework for reporting that could assist in

conceptual formation. Because standard setters may hesitate at the cost of producing

an independent set of PBE standards, the project is formed on the understanding that a

different approach to sector neutrality may, while still cost considerate, better serve

PBE rationales.

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With these interests in mind, the aim of this project is to formulate a socially

considerate and resource-conscious conceptual reporting framework for PBEs.

Driving the conceptual framework is an adherence to fundamental public good

principles while giving space to practical needs of sector neutrality. It is hoped that

the framework can form one of the ‘many mutually shaping factors’ of conceptual

development to which Lye, Perera and Rahman (2005) refer.

2.2 Prior Research and Method

Conceptual frameworks for reporting have long been offered for the public, PBE or

charitable sector (e.g. O’Neill, 2009; Laughlin, 2008; Benito, Montesinos, Bastida,

2008; Pallot, 1992 and 1991; Mellett, 2001; Van Peursem, 1999; Lye, Perera and

Rahman, 2005; Carnegie and West, 2005; Guthrie, 1998). Unfortunately however,

there has not been much demand for them (Hooks and Tooley, 2007). Laughlin’s

(2008) effort is one of the more recent and, like this project, is also developed in time

to comment on recent IFAC/FASB initiatives. Laughlin (2008) also exhibits concern

with the sector neutrality approach stating that “some of the [private sector]

underlying concepts and standards need reshaping to allow them to fit the context of

PBEs” (p. 252). Laughlin (2008) relies on Stewart’s (1984) levels of accountability

and entity-based accountability; I take as inspiration the work of Rutherford (1983)

and his analysis of resource flows.

By initiating the project with a PBE rationale, such as that which Rutherford (1983)

provides, the outcome is grounded in a PBE-relevant context and avoids the problem

of starting with commercial assumptions. In the model to come there is sympathy for

adapting commercial standards and practices so as long as they are consistent with

PBE rationales. The resulting framework is thus incremental where an incremental

approach conforms to PBE understandings, but radically different where it does not.

The conceptual reporting framework for PBEs can be understood to be a mid-range

level of conceptualisation. That is, it draws from a larger picture of PBE motivations

and resourcing practices, and points to an outcome which can be applied reasonably

directly to reporting standardisation and practice. This conceptual development pays

attention to how events or transactions should be classified for reporting, a focus that

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is revealed in the form the framework takes, pictured in Figure III. Non-

classificationist PBE reporting problems, such as to do with valuation or interperiod

equity, are left to other conceptualisations in the interest of retaining a reasonable

scope around this effort. Informal discussions with the NZICA PBE committee

inform understandings, and the conceptual development is formed and exampled

within the context of New Zealand practices and standards.

3.0 A RESOURCE FLOW PERSPECTIVE

As was noted, anchoring PBE standards on commercial assumptions can create

problems (e.g. see Anessi-Pessina, Nasi and Steccolini, 2008; IPSASB, 2008; Barton,

2005, p. 138; Mellett and Williams, 1996). Jones (1998) summarises the concern in

his observations of 1990 UK changes: “whatever the reasons were for requiring

resource accounting to be based on company accounting, they have necessitated

theoretical and practical contortions” (p. 15). Such contortions would not seem to

serve accountability. Rutherford (1983) provides a way forward.

For-profit organisations exist in an environment of competition, equity return and

decision-usefulness, and their reporting requirements reflect this (e.g. Mack and Ryan,

2006; Benito Mentesinos and Bastida, 2008; Barton, 2005, pp. 141-142; Mellett and

Williams, 1996). The profit motive also explains user interest in statements of

‘income’ and in the accumulated earnings that can be returned to owners. In contrast,

… Governments … are elected by citizens to make collective decisions on their behalf to provide those goods and services which cannot readily be provided by private firms, and those for social welfare purposes (Barton, 2005, p. 141-142) [emphasis added].

This collective nature and social service is reflected in, for example, the New Zealand

Ministry of Social Development Annual Report:

… [our purpose is that] we lead social development to achieve better futures for all New Zealanders … (Ministry of Social Development, Annual Report, 2003, p ii).

And in standards:

Public benefit entities are reporting entities whose primary objective is to provide goods or services for community or a social benefit (NZICA, 2007c, para. 8.2)

Lobbying efforts play a significant role in determining revenue inflows for PBEs as

most rely on public largesse. This is not unique to New Zealand; it is a characteristic

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of the sector generally (Carnegie and West, 2005; Lye, Perera and Rahman, 2005, p.

794; Barton, 2005; Jones, 2000).

Rutherford’s (1983) framework and explanation of public sector resource flows neatly

illustrate these fundamental differences. Rutherford pictures the two sectors – public

and private – in terms of resource flows. The first shows self-sustaining organizations

(private sector entities) whose flows operate in a closed system, or a ‘circle’.

Contributed capital is converted to payments for raw materials, goods and wages;

these in turn are converted into outputs, products or services produced. Products, in

turn, generate sales. Sales revenue (less related expenses) contribute to capital or

dividends and are thus returned to contributors in proportion to their contribution.

Figure I: Resource flows in Profit (Self sustaining) Organisations

Capital, dividends

Goods delivered, wages, labour

Sales, outputs, sales revenue

Derived from Rutherford, 1983

Payments, Raw materials,

Implicit in Rutherford’s (1983) explanation are the incentives that would follow.

Shareholders, looking to the potential rewards in dividends or capital appreciation,

would naturally be interested in whether and how those resources had been ‘managed’

to that end. It is a reasonably closed system of contribution and reward.

In contrast, and for PBEs, a distinction lies in the fact that, unlike the commercial

sector, beneficiaries of PBE efforts may not contribute in proportion to the degree to

which they receive benefits. So, for example, a welfare recipient will not, in all

likelihood, be paying as much in taxes as they receive in benefits; while the wealthy

taxpayer will not be receiving benefits in proportion to their larger contribution. In

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brief, there is no direct relationship between resources contributed and those to whom

outputs are distributed or for whom outputs are created (Figure II).

Figure II: Resource Flows in the Public Benefit Entity

Taxes, donations Outputs,

outcomes

Outputs

Goods delivered, wages, labour

Derived from Rutherford, 1989

Externalities add a further disturbance to the smooth flow of resources. PBE inflows

are acquired from taxes or donations, while outflows occur as a result of internal,

managerial actions. Also while managers are charged with providing public services,

reducing costs or redistributing revenues, their overall direction may be driven by

externally approved budgets or mandates.

These are generally recognised as points of distinction between the two sectors; yet,

the difference is not fundamentally addressed in commercially-grounded standards

(Jackson and Lapsley, 2003; Simpkins, 2006; Mellett and Williams, 1996 for related

discussions). The commercial sector holds management accountable for income

(inflows), expense (outflows) and, significantly, the relationship between them (net

income). Doing so, in effect, uses net income as a proxy for managerial efficiency.

Such a practice seems sensible in the private sector, but holds PBEs to account as if

they were also engaged in a closed system of resource inflows and outflows.

Understanding these distinctions would seem to be crucial to the development of a

sensible reporting framework. Implicitly, and through his analysis, Rutherford (1983)

points to that for which a manager or political player can be reasonably held to

account; use of budgetary finance for the former and funding policy for the latter. It is

this that forms the conceptual basis for the analysis to follow.

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4.0 CHALLENGING ACCOUNTING ASSUMPTIONS

Accounting assumptions and principles are the foundations of accounting practice,

establishing the basis for accounting and reporting. They include such established

ideas as revenue recognition and matching, going concern and entity, and ‘assets’,

‘liabilities’ and ‘net worth’ concepts. For this project, each principle or assumption to

do with classification and disclosure is considered in light of Rutherford’s (1983)

framework to suggest which, if any, may be adaptable to PBEs. The general purpose

reporting statements – statements of income and financial position primarily – are also

subject to review in light of this analysis. The conceptual framework for PBE

reporting, a classification framework, ultimately takes shape as each assumption or

principle is considered in turn.

The principles are familiar to accounting practitioners and academics. Among the

most challenging for PBEs are the matching principle for net income, heritage assets,

and certain liabilities and categories of revenue. These fundamental differences are

first considered in forming the conceptual framework for PBE reporting.

4.1 The Matching Principle and Revenue

The ‘matching’ principle holds that revenue should be reported in the period in which

it is ‘earned’, and matched to the costs taken to derive them. This is a commercial

concept and, as was discussed, is less relevant for PBEs because it assumes that the

two processes – resource inflows and outflows -- are part of a closed system. Trying

to apply this principle to PBEs without adjusting for the distinction has led to

problems. This is illustrated by a pattern of standards developed in New Zealand over

time. Initially, ‘matching’ was accepted practice when such standards only applied to

the commercial sector:

Matching of expenses and revenues… Under accrual accounting, expenses and revenues are recognised as they are incurred or earned (rather than as money is paid or received) and recorded in the financial statements of the period to which they relate. Results for the period are determined by matching expenses with the related revenues (NZSA, 1987b, para. 4.2(a)

In commercial situations, this makes sense: ‘Net income’ proxies for managerial

efficiency and, assuming a capital appreciation goal, effectiveness. Combining it with

revenue yields a measure of managed capital appreciation. This does not correspond

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with events in the PBE sector however where ‘revenue’ (taxes, grants, contributions)

is politically acquired, where costs are internally managed and where outputs may be

nonfinancial. The 1991 NZSA Statement of Concepts, using phrasing still applied

today, attempted to modify this section so that it would also apply to the public sector.

Their language has changed, the tone is distant, and a hesitation is revealed:

It has been common practice when recognising expenses in the statement of financial performance to make a direct association between costs incurred and specific items of revenue. (NZSA, 1991, para. 7.25) [emphasis added]. … using the matching principle, the various components of expense which make up the cost of goods sold are recognised in the statement of financial performance at the same time as the revenue derived from the sale of the goods. This approach may result in recognition and/or classification decisions that are inconsistent with the definitions of elements adopted in this Statement. If the application of the matching principle would result in the recognition of items which do not meet the definition of assets or liabilities, it is inappropriate and not permitted (NZSA, 1993, para. 7.24)

These days, perhaps as a result of forcing it into sector neutral standards, ‘matching’

is no longer distinguished as an overriding ‘principle’:

Expenses are recognised … on the basis of a direct association between the costs incurred and the earning of specific items of income. This process, [is] commonly referred to as the matching of costs with revenues… the application of the matching concept … does not allow the recognition of items in the balance sheet which do not meet the definition of assets or liabilities… (NZICA, 2009c, January, p. 31, para. 95)

Such qualification as to its use would seem justified as sector neutrality would

otherwise force it onto matching political-inflows with managed-outflows (also see

Anessi-Pessina, Nasi and Steccolini, 2008; Christensen, 2003; Robinson, 1998). In

‘matching’ costs to revenues is found a fundamental difference between the two

sectors.

This is resolved in the conceptual reporting framework by separating (non-

commercial) inflows from expenses. This is accomplished by recommending two

new places in which to disclose the two types of ‘revenue’: The Statement of Net

Expenses (for commercial revenues) and the Statement of Net Inflows (for non-

commercial revenues) (Figure III). The value is in ensuring that resource flows which

derive from earned and non-earned (political) sources are reported distinctly.

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Figure III: Conceptual PBE Reporting Framework

Revenue: Non-Commercial Enhancements

Revenue: Commercial Enhancements (Accrual)

Less: Operating Expenses (Accrual)

Net Expenses

Net Inflows (or Outflows)

Beginning Equity Balance: Equals: Ending Equity Balance

Revenue: Non-Financial (Social) Enhancements

Net Service Efficiency

Liabilities: Controllable

Assets: Non-heritage

Liabilities: Imposed

Liabilities: PV of future heritage asset costs

Statement of Financial Position

Statement of Service Efficiency

Statement of Net Inflows

Divided by

Added to

Assets: Heritage

Net Expenses

Statement of Net Expenses

Operating Expenses (Accrual)

Equals

Less:

Equals Equals

Further elements to each of these new reports will be introduced as the model forms.

4.2 Heritage Assets

Another fundamental difference is to do with the meaning and value associated with

heritage assets (e.g. IPSASB, 2009, current IPSAS1). A heritage asset is defined by

its public good characteristics:

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[Public good] types of goods and services are characterised by non-rival and non-excludable consumptions characteristics… non-rival in the sense that one citizen’s use of them does not deprive other citizens’ benefiting from them. … non-excludable in that one citizen cannot prevent other citizens from accessing their benefits… (Barton, 2005, p. 142).

A heritage asset may be the museum, the rights to foreshore and seabed, or the public

school grounds (Deneulin and Townsend, 2007, p. 20; Brodie, 2008; Pallot, 1992).

They do not contribute to future revenue inflows; to the contrary, they will more

likely impose a drain on future assets due to their age or fragile nature.

Social and environmental assets held in trust … are resources, both economic and non-economic, over which the entity has management responsibility to provide future social benefits to the public and which are normally to be conserved and maintained … (Barton, 2005, p. 150).

Nor are heritage assets a ‘property’ in the sense that they can be sold or contribute to

future capital. Unlike commercial assets therefore, they are not a ‘cost’ of producing

revenue, but rather a politically-determined obligation. In terms of Rutherford’s

(1983) framework, heritage assets comprise future resource outflows.

It is not surprising therefore that practitioners struggle with how to report them in the

financial statements. In the 2005-2006 annual report of the Dunedin City Council

(Appendix I), Parks and Reserves, a heritage asset, is recognised but not in the body

of the financial statements or in terms of its future drain on resources. The

commercial concept of ‘asset’ simply is not appropriate for heritage properties.

To preserve some element of economic substance, it would seem that the heritage

asset could be disclosed, but not in a way that would indicate resource recovery, and

that the present value of future costs needed to maintain it should also be disclosed.

The former could be shown in a separate account therefore, and the latter could be

shown as a ‘liability’. While ‘valuation’ is not specifically addressed in this

framework, it could be disclosed at the present value of its future anticipated costs so

as to recognise the actual anticipated amount of the liability. Doing so would reveal

both the financial and obligatory nature of heritage assets. The recommended

disclosure is pictured in the PBE Conceptual Reporting Framework (Figure III) in the

(PBE) Statement of Financial Position.

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The heritage asset represents a fundamental departure from a commercial framework.

The PBE conceptual reporting framework makes therefore a separate accommodation

for accountability purposes.

4.3 Liabilities

Commercially-inspired interpretations of ‘liabilities’ also fail to embrace PBE

situations. A definition incorporating traditional business assumptions follows:

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 or service potential (IFAC, 2002, p. 591).

‘Past events’ that lie outside the commercial mould, such as political decisions to

distribute funds, are not part of Rutherford’s (1983) managed inner ‘circle’.

Accountability is not served therefore if there is an attempt to attribute externally-

determined flows to internally managed funds, or to associate them with economic

benefits. A New Zealand standard (scheduled for replacement) is revealing in its

somewhat awkward attempt to attach such a PBE situation to a commercial standard.

Liabilities are the future sacrifices of service potential or of future economic benefits that the entity is presently obliged to make to other entities as a result of past transactions or other past events (NZICA, 2004, p. 11 para. 7.10).

While adopting PBE language of ‘service potential’, the standard seems to imply that

‘future sacrifices’ can be made to correspond with ‘past events’. The obligation of an

electrical company to serve rural customers or of a public hospital to minister to the

poor is a politically-mandated drain on future resources and may bear no relationship

to past managerial decisions. This is again part of the open-loop to which Rutherford

(1983) refers in which the consequent event (the liability) neither derives from nor

feeds into the provision of resource inflows. It makes little sense therefore to treat

them as part of a closed system. Legal obligations to serve the ‘public’ may be

imposed by government and represent a political will, but not a commercial incentive.

Disclosure of externally-imposed liabilities is accommodated by separate disclosure in

the proposed framework (Figure III), with payments debited to the Statement of Net

Expenses as they are incurred. The question of when to recognise such an obligation

is another challenge, and this is left to discussions of ‘commitments’ accounting (e.g.

Anessi-Pessina, Nasi and Steccolini, 2008) as timing has no direct impact on the

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model being proposed here. In closing, it can be said that combining enterprise-

driven liabilities and externally imposed liabilities should and can be avoided through

alternative disclosure practices (Figure III).

4.4 Revenue: Non-Financial Enhancements

‘Revenues’ are enhancements that organisations contribute from enterprise and that

PBEs contribute from a variety of sources:

Income [encompassing both revenue and gains] is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities … other than those relating to contributions from equity participants (NZICA, 2009c, p. 27, para. 70)

Enhancements need not be ‘financial’. The use of the ‘enhancement’ terminology,

used to accommodate the PBE sector, glosses over a fundamental difference in the

nature of that which an organisation produces. Creating better public roads is a

product of a roads department, reducing illegal goods into the country is a benefit of

having a customs department, providing for social welfare recipients or public

hospital patients are intended outcomes. Such non-financial enhancements are, even

as interpreted by this sector neutral standard, a form of revenue. This point is widely

recognised (e.g. Carnegie and West, 2005; Pallot, 1991; Walker, 2002) and has, in the

past, been realised in practice. In 1987 the New Zealand Society of Accountants

encouraged the development of ‘service performance’ statements including non

financial enhancements1. Treasury requirements and the Public Finance Act 1989

reinforced these positions. They are still reported by some PBEs (see Table I for an

example from a New Zealand tertiary institution).

Table I: Performance Indicator Proxies Reporting Educational Benefit per Cost

Student

EffectiveFulltimeStudent

Completed

Qualification

Research Output

Net Expense per… $1.91 $5.97 $15.20 $98.47 Government subsidy per… $2.08 $6.48 $16.54 $107.18

Derived from the New Zealand Eastern Institute of Technology 2007 Annual Report

1 The same terminology ‘service performance’ is adopted later here as well.

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In conceptual terms, it would seem to be appropriate and important to ensure that a

measure of such achievement is fully incorporated into the reports. Social outputs are,

effectively, an equivalent to ‘financial revenue’ for the commercial sector.

Unfortunately, today’s sector neutral standards shy away from including non-financial

enhancements. There is neither facility nor requirement to incorporate them into the

body of the financial statements, only the expectation that they should be ‘measured

reliably’ (NZICA, 2009c, p. 31, para. 93). This is unfortunate because the ‘matching’

principle, applied to non-financial enhancements, could usefully serve here. Matching

costs to non-financial enhancements relays, in principle at least, how resources used

are applied to social outcomes achieved; a PBE-equivalent to the commercial concept

of ‘net income’. That is, matching costs to evidence of outputs comprise a reasonably

straightforward way to calibrate managerial efficiency.

It is acknowledged that it will be difficult to reach agreement as to selecting and

measuring social ‘enhancements’. While the performance indicator literature is well-

developed, it is also controversial. Selecting or calibrating outputs is known to be

challenging at least, political at worst (e.g. Cohen, 2008; Van Peursem et al. 1995).

Yet while measurement problems may inhibit such reporting, disclosing performance

indicators is surely no more subjective than, for example, valuing assets with no fixed

market value, determining foreign exchange or accrued tax values or a host of other

issues which find their way into accounting standards.

It is concluded therefore that matching costs to non-financial enhancements is

reasonable and conceptually equivalent to matching commercial revenues and costs.

This is incorporated into the conceptual reporting framework for PBEs as a new

report: The Statement of Service Efficiency (Figure III). In keeping with Rutherford’s

(1983) vision therefore, and in an effort to report proxies of efficiency in both sectors,

using performance indicators against costs is a way forward.

4.5. Revenue: Non Commercial Enhancements

‘Revenue’ takes on yet another form for this unique sector: non-commercial

enhancements. This is the resource inflows from taxation, donations and the like.

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Economic benefits from this source will usually comprise a major portion of revenue

for a PBE comprising, for example, 99.5% of the total revenue for the New Zealand

Ministry of Social Welfare. It is common, indeed integral, to PBEs that most inflows

will be derived from such non-commercial sources:

In a non-exchange transaction, an entity either receives value from another entity without directly giving approximately equal value in exchange, or gives value to another entity without directly receiving approximately equal value in exchange (IFAC, 2006, para. 7).

Disclosing such inflows as ‘revenue’ imposes, in effect, a quasi-market on PBE

reporting. Unlike the commercial sector where inflows are part of a closed system,

PBE non-commercial enhancements are external to managed processes. In principle

therefore, non-commercial revenues should be reported independently of commercial-

type revenues, and not netted against ‘costs’ except, perhaps, for the purpose of

disclosing a flow of funds (e.g. as in The Statement of Net Inflows, Figure III). Non-

commercial inflows are closer in concept to contributions from ‘equity’ than they are

to ‘revenue’. Reports should reflect this.

The new Statement of Net Inflows (showing the net amount being closed to equity on

the Statement of Financial Position) is how this idea is represented in the conceptual

framework for PBE reporting (Figure III). Together with Non-financial and

Commercial revenues therefore, Non-Commercial Enhancements forms the third of

three conceptually distinct sources of revenue.

Overall, a number of significant and conceptual distinctions arise between the

commercial and PBE sectors, revealed through an assessment of accounting principles

and through the lens of Rutherford’s (1983) framework of resource flows. These

fundamental differences are set out in Table II, and incorporated into the conceptual

framework for reporting in Figure III.

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Table II: PBE Conceptual Differences

Accounting

Principle

PBE Meanings

Application

Example

Report and Conceptual Implications

Matching

Fundamentally different: Where ‘Revenue’ acquired not from enterprise generated from booked expenses, it may be generated through ‘political’ efforts not recorded in the books of the entity. Hence, ‘matching’ would not compare similar types of enterprise.

Public hospital ‘revenue’ may be budgeted from central government funds, and costs forced to be constrained to meet that budget, or over-expenditures may be resolved through political action.

Modify reports so as to match only those inflows and outflows that make sense ‘conceptually’

Heritage Assets

Fundamentally different: particularly with respect to valuation of assets which do not contribute to either revenue or outputs.

Parks and historical buildings which may go ‘up’ in value but have no marketable value. Public goods.

Difficult area to equate to private sector principles; may require separate disclosure or measure as ‘outcome’. Also depreciation and amortization implications

Imposed Liabilities

Fundamentally different: Liabilities may be imposed on an organisation ‘politically’ and result in no equivalent ‘asset’ and an extraordinary ‘expense’.

An Act requires a public hospital to serve all patients who present: Is this a measurable liability?

Separate standardisation to consider non-controllable aspect.

Revenue: Non financial from Social Enhancements

Outputs or outcomes as a direct result of organizational effort and expenditure

Number of welfare clients served

Non-financial performance indicators to measure, ‘match’ where reasonable to costs taken to incur

Revenue: Non-commercial

Politically not economically driven; not directly derived from incurring costs

Government grants; tax transfers; private donations, legacies.

Disclose separately, consider periodicity and valuation

4.6 Adaptable Principles and Assumptions

Other commercial accounting principles are better equipped to accommodate the PBE

situation. Where it is possible to modify guidance without creating conceptual

dissonance, meaningful sector neutrality is possible. Rutherford’s (1983)

understanding of closed versus open resource flow systems again provides a

benchmark for determining appropriate PBE reporting (Table III).

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Table III: Accounting Principles Which Allow Standard/Report Integration

Principle

PBE Meanings

Example Reporting

Implications Adaptable

Revenue: Commercial Inflows

Decouple from other types non-commercial inflows

User pays fees from public sector providers

Other than decoupling, treat as commercial revenue

Accrual concepts

Applicable, except where budget-driven cash reporting needed

Capital or debt service or imposed cash budgets

May require special report on cash basis; otherwise assume accrual for expenses and commercial revenue inflows

Expenses (Accrued)

To accomplish PBE goals (financial or nonfinancial) expenses must be incurred.

School or road department running costs.

Special applications of existing practice.

Equity Challengeable if unrelated to distribution rights; but may indicate over- or under-spending.

Social welfare agency CR to Equity may reflect distribution failure, not taxpayer equity

Use of dedicated ‘Reserves’ accounts; decouple as needed to express concepts

Entity Principle

Political, legal or managerially-controlled entities may be relevant.

‘Departments’, ‘Divisions’, ‘Friendly Societies’ accountability differences

Special applications of existing principles to define PBE ‘entity’

Equivalent Periodicity Similar to private

sector challenges PBE may have to meet long-term contracts

Modify terminology

Consistency Similar to private sector challenges.

Challenge when entity changes

Modify terminology

Objectivity Similar to private sector challenges, non-monetary assets and liabilities create challenges.

Valuation of intangibles, revenue attributable to policy.

Modify terminology.

Disclosure The user interests and compliance requirements should be kept in mind.

User interests include: public health patient, taxpayer, manager, elected officials.

Evaluate user needs and legal disclosure requirements.

Going Concern

May be determined politically; mitigating circumstances may be common.

Public hospitals and schools may not be ‘allowed’ to fail.

Footnote disclosure, consider mitigating circumstances if rescue package probable

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4.6.1 Accrued Expenses

Accrual accounting is an established principle for commercial accounting. Even

though its relevance for the PBE sector is sometimes challenged and the cash-basis is

sometimes advocated (see IFAC, 2007; Hooks and Tooley, 2007) IFAC, FASB and

NZICA have essentially adopted accrual accounting for the PBE sector (IPSASB,

2009). Accrual accounting includes the practice of ‘matching’ revenues and

expenses, and this presents the problems discussed previously, so it may be of value

to understand the specific circumstances in which ‘matching’ is more or less

appropriate for the PBE sector.

Reporting expenses when they occur is an accrual practice which may be appropriate

for PBEs as well. Doing so conforms to a periodicity principle relevant to both

sectors: recording expenses incurred over the period of time in which related

enhancements occurred. As in the private sector, PBE expenses represent the costs

incurred to generate enhancements, though such ‘enhancements’ are social

achievements in PBEs. Conceptually, and at least with respect to expenses therefore,

accrual accounting serves the interests in both sectors by enforcing an accountability

for those costs that are related to enhancements achieved. Accrual accounting for

expenses is thus not modified in the conceptual framework for PBEs, though it is

reflected in a new statement -- the Statement of Net Expenses -- so as to group them

with social enhancements (Figure III).

4.6.2 Equity

Although a PBE may not have ‘owners’ in the sense that commercial organisations

have ‘investors’, a public in a democratic society is still owed an accounting for the

use of public resources. The public (or at least ‘a’ public) are effectively ‘owners’ of

public assets. ‘Equity’ is a relevant concept therefore, even if applied to different

owner populations. This is reflected in the Statement of Financial Position which

includes the same general categories of assets, liabilities and equity (Figure III).

One difference however is that ‘equity’ for a PBE is not usually ‘distributable’ in the

same way that dividends are distributable in a closed system. While a PBE can

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accumulate a surplus, it would comprise a measure of distributional potential; rather

like not giving a dividend at all. A positive (credit) balance could indicate that

funding is available for future expenditures, that there was underutilised capacity, or

that the need was not as great as budgeted (with likely implications for the following

year’s budget). A ‘debit’ balance could indicate the need for future cash inflows or an

over-utilisation of existing inflows. New footnote disclosures may be required to

explain this, but as in the commercial sector, equity is a residual of resource flows

after operations and attributable to ‘owners’. Modifications to commercial concepts

would seem to call for only minor adaptations therefore (Figure III).

4.6.3 Entity Principle

Horngren and Harrisons’ (1989) definition of ‘entity’, while dated, allows space for

organisations in both sectors and is a conceptually sound basis for sector neutrality:

An accounting entity is an organization or a section of an organization that stands apart from other organizations and individuals as a separate economic unit (Horngren and Harrison, 1989, p. 9).

The ‘economic unit’ for a PBE could be a government department, authority, trust, or

charity as divided along budgetary or managerial lines. In these respects, the

difference between its use in the two sectors is more a matter of application than

substance. NZICA reveals a (perhaps less sector neutral) definition:

A reporting entity is an entity for which there are users who rely on the financial statements as their major source of financial information about the entity (NZICA, 2009c, p. 10-11, para. 8).

A problem is in the use of the term ‘financial’ to describe the information worthy of

disclosure. Were that absent, such as occurs in Horngren and Harrisons’ (1989)

definition, one can then find common ground between the two sectors. The 2005-

2006 Dunedin City Council, for example, divides its ‘entities’ along functional lines --

forestry, bus transport, treasury, energy, utility and rail (Appendix I) – similar to what

a corporate may do. Further discussion can be found in the 2008 IFAC consultation

paper, where they come to a similar view (IFAC, 2008, para. 5.12-5.34).

The PBE conceptual framework for reporting the ‘entity’ is represented by the

external ‘box’ (Figure III). Consolidated statements are not precluded by the

framework as combining government departments and functions into a central set of

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reports seems possible. This also has precedent such as occurred in New Zealand

prior to the 1989 legislation.

4.6.4 Equivalent Principles and Assumptions

Other reporting assumptions apply similarly to both sectors (also see Mack and Ryan,

2006). The periodicity principle is one of these (Table III). The accountant

somewhat artificially divides the reporting period into (usually) 12 month segments.

The greatest challenge seems to lie in deciding whether to allocate a revenue (or

expense) to one period or another, a problem that accrual accounting and matching

generally address. It would seem that this need not be significantly changed for

application to the PBE sector because recognising revenue when it is earned (or

achieved in the case of Non-Financial or Non-Commercial Enhancements) seems

appropriate. These do not appear to be conceptual differences for which framework

modification is required.

Consistency, objectivity and disclosure also adopt different forms in PBEs, but again

do not appear to be of a different nature. Consistency in accounting treatment would

seem to be important to both the public and private user to enable comparisons to be

made. Problems with objectivity are shared by both sectors (see for example

Stalebrink and Sacco, 2003). Even as PBE accountants may struggle to measure Non-

Financial Enhancements, private sector accountants and standard setters struggle with

valuing intellectual assets, brand names, non-market investments, and futures and

forward contracts. While measurement is thus difficult, both sectors face similar

problems; hence neither consistency nor objectivity poses a conceptual distinction.

Disclosures needed for the PBE sector may be more extensive and compliance-based,

but disclosure is not unique in concept. Disclosure may be different due to the legal

structures which fund PBEs and which may require revealing compliance with, for

example, budgets, statutory acts or regulations. Also there may be a need for

additional disclosure where the public good is involved. Disclosure as a ‘concept’

therefore does not merit separate conceptualisation.

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Finally, the commercial accounting assumptions associated with reporting as a ‘going

concern’ looms as large, but not uniquely, for PBE organisations. The distinction for

PBEs may be in the perhaps greater potential for government bailout. This is not, of

course, precluded in the private sector either: Air New Zealand and the Bank of New

Zealand (BNZ) have both been rescued through government intervention, and most

would be familiar with recent events overseas with billions being invested in the

rescue of AIG and General Motors. Irrespective of the nature of the organisation,

when it becomes apparent that they are about to fail, accounting principles inform that

impaired assets should be written down and losses for damaged stock should be

recognised. Such going concern practices and assumptions would seem to be

appropriate in both sectors therefore, although clearly attention should be given to the

potential for government bailout. This is another application of an existing

assumption, and therefore no special provision is made for going concern in the

conceptual framework.

5.0 PBE CONCEPTUAL FRAMEWORK

This now establishes the basis on which a sector neutral conceptual framework for

PBE reporting can be formed (Figure III). The framework is illustrated in the style of

general purpose statements and major categories of accounts, all of which conform to

the principles set out in the preceding sections and as discussed in combination below.

Attention is first drawn to the two statements formed to replace the traditional

Statement of Income: the Statements of Net Expenses and of Service Efficiency. The

former is created to distinguish internal, managed net expenses, and the latter is

formed to reveal a meaningful input-output relationship. In the commercial sector,

one statement accomplishes both; but for PBEs, they must be separated to reflect

these concepts.

Attention is also drawn to how all three concepts of ‘revenue’ are independently

recognised in the framework, each allocated to a statement relevant to its nature as a

resource flow. Having three revenue concepts avoids the awkward and conceptually

troubling practice of combining earned and non-earned revenue. It also ensures that

21


non-economic enhancements are recognised within the body of, and not just as an

addendum to, the statements.

The Statement of Net Inflows is similar in substance to a commercial statement of

funds flow, or a cash flow statement. In using this title, there is a desire to convey

that Net Inflows are not equivalent to Net Income.

It is Net Services (found in the Statement of Service Efficiency) where an equivalent

for managerial efficiency is found. The Statement of Service Efficiency compares

non-financial enhancements (outputs) to managed costs (inputs), and holds PBEs to

account for their productivity in proportion to the resource outflows employed in

reaching them. While the ending balance from the Statement of Service Efficiency,

being in ratio form, cannot be carried forward as would Net Income, it need not be as

equity does not represent accumulated earnings in the PBE sector. The Statement of

Service Efficiency’s contribution is in disclosing a PBE proxy for managerial

efficiency, which is of value to the reader presumably no less than its equivalent (Net

Income) is of value to commercial report users.

Account balances are carried forward into the Statement of Financial Position. The

Statement of Financial Position differs from its commercial equivalent only in terms

of adding some accounts (heritage assets and liabilities, imposed liabilities). Net

Inflows (or Outflows if negative) are closed to the equity account, as occurs for

business reports though, in PBEs, representing accumulated public, not private,

equity. Sector neutrality is thus accommodated, and further disclosures can clarify the

nature of ownership.

Some scope limitations to the framework are acknowledged. The framework does not

try to address valuation issues. So while, for example, heritage assets are separately

disclosed to reveal their special nature, the present value of future maintenance costs

is only suggested as a value. Also the issue of how to value amortization is not

addressed except to suggest that it should occur. So for example, the question of

interperiod equity sometimes finds its way into public sector or PBE conversations, in

particular as to how to allocate the expenses associated with major non-commercial

resource inflows over time. By including them on the Statement of Net Inflows, the

22


standard setter is free to offer methods for their diminution as they deem appropriate.

The PBE Conceptual Framework sets up a situation that allows PBE-appropriate

separate recognition, valuation and allocation.

As one goal of the development is to accommodate sector neutrality where

reasonable, this point deserves comment as well. Despite new statements and a few

new accounts, most terms and categorisations will be familiar to the financial report

reader. The ending equity balance continues to represent accumulated net

contributions. The Statement of Financial Position remains recognisable to the

commercial report reader as does the Statement of Net (Funds) Flows. A proxy for

managerial efficiency (Net Income) remains, albeit in a more PBE-relevant form. The

final product is thus suggested to be conceptually sound in terms of PBE rationales

while granting space to commercial accounting practices.

6.0 CONCLUSIONS AND FURTHER RESEARCH

With a nod to incrementalism, the conceptual framework offered here is one that

demonstrates how commercial accounting principles – and standards – can be adapted

for PBE readers. While ‘revenues’, heritage assets, some liabilities and the matching

principle require reconfiguration for the PBE sector, other accounts and practices can

be drawn from the commercial field. The PBE conceptual framework for reporting

makes its contribution by virtue of its foundation in PBE principles, a characteristic so

far lacking in sector neutral standards.

The benefits of applying the conceptual model for PBE reporting to practice are also

in terms of costs. The public benefit entity sector must have its non-profit rationales

recognised in order to produce a meaningful report, and the framework allows this to

occur by considering social as well as financial activities. At the same time, the

conceptual framework retains commercial practices where it is appropriate to do so.

The framework is thus sector neutral insofar as the cost of forming standards are not

likely to be as great as they would be for a framework which starts afresh. The

implication is that it provides both the foundation in PBE principles needed for

reasoned reporting and takes into account cost considerations.

23


Future research could usefully develop the model. Interviewing PBE key personnel

could support its refinement, as further field research would build onto this conceptual

foundation. Engaging with the PBE community may also inspire the sort of debate

that is needed to form PBE sector standards that truly represent PBE rationales.

Further research could also look to specific applications and accounting standards to

determine how they could be revised in accordance with the PBE conceptual reporting

framework. By intent, the framework does not operate from standards, as do the

bolted-on practices now used, but to standards from concepts. This could be applied

perhaps through a process of action research or focus groups.

Accounting standardisation operates in the shadow of powerful commercial and

regulatory influence. The PBE Conceptual Reporting Framework provides an

opportunity to formulate sector neutral standards without the significant risk of

commercial standard default. It is a time for fruitful discussion that takes into account

and fundamentally integrates public sector rationales into reporting practices. The

PBE sector accountee deserves more than add-on standards. This framework is one

instrument to assist in such a quest.

24


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Appendix I: Dunedin City Council Annual Report 2005-2006

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