Financial Reporting Developing Accrual Accounting in South Africa

1
Financial Reporting Developing Accrual
Accounting in South Africa

• Noel Hepworth
• Chartered Institute of Public Finance and
  Accountancy
• IPFA Conference, South Africa, 2002

2
Issues

• International developments
• Benefits of accrual accounting
• A culture change
• Risks
• Control and supervision
• Accounting standards
• Preconditions for success

3
International developments

• Encouragement by World Bank IMF
• Few countries already changed to accruals. (Only
  UK of G7 countries has fully switched to
  accruals.)
• Some countries considering the switch
• Some claim to be accounting on accruals but not
  clear if they are
• Majority remain on cash
• An ability to complete GFS does not mean that a
  country accounts on accruals basis

4
Benefits

• Improved resource allocation
• Better quality policy making
• Better control of capital
• Better identification of liabilities
• Opportunity for private/public comparison
• Financial management becomes a central concern
• Better quality management of cash flow and
  current assets/liabilities

5
A culture change

• Accrual accounting is about much more than
  financial reporting it is about the whole
  process of financial management
• Provides a better understanding of the nature of
  costs, and
• A better understanding of what the costs mean for
  financial management and outcomes
• However only if accrual accounts are properly
  used.

6
A culture change

• Main criticism of cash accounts is that they can
  be manipulated, but then
• Accrual accounts can be manipulated to an even
  greater degree, both
• In the keeping of the accounts and in the way
  standards are set

7
A culture change

• Financial reporting is about what has happened.
• Politicians and stakeholders are interested in
  what will happen.
• Therefore, there is an immediate question about a
  need for accrual budgeting and the more advanced
  countries have all adopted accrual budgeting, but
  only UK of G7.

8
A culture change

• Creates difficult issues for managers political
  and official (1)
• Defines costs in a new way
• Requires assets to be listed and valued
• Raises questions about efficiency in the use of
  assets and whether or not to be kept
• Raises questions about the cost of capital it
  is not a free good

9
A culture change

• Creates difficult issues for managers political
  and official (2)
• Requires liabilities to be identified and valued
• Raises questions about the comparability of
  public/private costs
• Asks whether capital costs should be substituted
  for revenue costs
• Asks questions about the transfer of risk

10
A culture change

• Treatment of capital - a contentious issue
• Mixed range of decisions
• Some countries use historic costs
• Some use current/fair values
• Which is correct?
• Assets should be valued on current basis (as are
  all other costs) and depreciated! Under
  maintenance high depreciation

11
A culture change

• Introduction of accrual accounting should
  therefore force the issue of generational costs
  of activities i.e. who is to pay, this
  generation or future generations?

12
A cultural change

• Conclusion introduction of accrual accounting
  should be part of the process of public sector
  reform.
• If the country does not have a parallel policy of
  responding to the accrual information or have the
  managerial capacity, including political willwhy
  bother?
• To switch is time consuming, expensive and risky.

13
Risks (1)

• Introduction of accruals is not risk free main
  areas of risk are
• Inadequate technical capacity within the public
  sector
• Inadequate computer systems
• Inadequate preparation
• Failure to recognise long run costs and
  investment needed

14
Risks (2)

• A failure to technically manage and maintain the
  process not once for all
• Failure to link with other reforms financial
  reporting is not an end in itself
• Inadequate monitoring of change process and of
  subsequent management
• Corruption of standard setting process

15
Risks (3)

• Loss of control because
• Budget and accounts not on same basis
• Emphasis of control is shifted from cash
• Interpretation of information is difficult
  without skilled financial managers
• Different scope for manipulation from cash

16
Control and supervision

• Parliamentary supervision
• External audit supervision
• Supervisors need to be part of the change
  process. Therefore they need to understand
• How their interests will be safeguarded
• That there is no scope for them to be manipulated
  through the operational process

17
Accounting standards

• Critical area International standards not
  comprehensive and difficult areas not yet
  defined
• employee obligations (pensions)
• social policy obligations (state pensions,
  universal education health care, transfer
  payments)
• taxation
• heritage assets and infrastructure
• costs of environmental protection

18
Accounting standards

• Wide scope for interpretation, e.g.
• Entity boundary
• Who carries risk (public/private partnerships)
• Valuation principles (assets, stock, plant and
  equipment)
• Impairment
• (IAS 36 difficult to translate for public sector)
• How to define the public sector
• .

19
Accounting standards

• To what does the financial report apply?
• To central government , or
• To general government
• If latter consistent with GFS, but consolidation
  of whole of government accounts extremely
  difficult.
• These problems of definition, interpretation and
  coverage make international comparison (and debt
  rating) difficult

20
Accounting standards

• Who is to set them?
• The Ministry of Finance?
• An independent board?
• Some joint arrangement?
• Essential condition that the Ministry of Finance
  does not have unfettered discretion and has to
  account to Parliament for decisions.
• Remember process is dynamic, not static.

21
Preconditions for success (1)

• A cultural willingness to accept reform
• A recognition that accrual accounting is not an
  end in itself
• Consultation and acceptance
• Accountancy profession has capacity to assist and
  is willing to do so
• An acceptance of the changed role and position of
  the financial manager

22
Preconditions for success (2)

• Support and involvement of Govt. external auditor
• An appreciation by ext. auditor of the changed
  role and new skills required
• Adequately trained departmental managers
• A public sector cultural ethic that accepts
  authority of MoF
• No systemic corruption and no informal parallel
  budget processes

23
Preconditions for success (3)

• Recognition that time to introduce will be
  substantial no rush and widespread political
  support
• An IT capacity capable on handling new
  requirements
• System of incentives and penalties to encourage
  efficiency in use of resources

24
UK Experience

• Changeover to accrual accounting and budgeting in
  c.g. took 8 years
• Parliament needed to be convinced and requires
  cash and accrual information
• 3 years on about 20 of accounts still qualified
• PAC criticises late publication of accounts
• Whole of government accounts not yet available
• UK is committed and sophisticated technically

25
Is the exercise worthwhile?

• Yes, for the benefits are considerable
• However, our experience is that
• The change is not simple
• It cannot be rushed
• Training, training, training
• Ensure the cash system works well first
• Link with management reform, because not an end
  in itself.