Public Sector Reform: Need for a Modern System of Public Accounting

We have the most crude accounting tools. It’s tragic because our accounts and our national arithmetic doesn’t tell us the things that we need to know.

Susan George, American Activist.

The present system of Government accounting has long been seen as no longer fit for purpose.

This is recognised in the Comprehensive Expenditure Report 2012-2014 (December 2011) which introduces what it calls “incentives for responsible expenditure management”. It states (page 95)

Under the existing processes for current expenditure, managers have little or no incentive to be prudent and to make savings with their allocation in a given year. Indeed, if a saving appears to be in prospect at the end of a year, the incentive for a manager is to spend all of that money, rather than see it ‘lost.’

The failure to introduce a modern, accrual accounting based, system of financial management and controls in the public service has been serious failure in the management of the public service.

What’s Wrong with the Present System?

First, it is cash based and thus takes no account of liabilities. Secondly, it ignores depreciation or amortisation in on-going costs; once an office is built it’s free. Thirdly, we do not track assets. When there is no balance sheet, then efficient use of capital – including realisation of assets when appropriate – gets no management focus.

Accounting systems give managers signals in relation to the costs of the resources that they are using. The present cash based system, which largely ignores future liabilities, does not meet modern standards and give misleading signals in the following areas.

• Employment: the failure to account for pension costs means that the cost of employing additional people is understated

• Once capital has been allocated, the failure to account for its use effectively means that capital is treated as free and there is little or no incentive to use assets efficiently.

• The cash based (“use it or lose it” system) leads to a rush to spend money before the end of the year.

The Government Proposals

To address some of these issues, the Government has proposed a new range of measures to help managers make the right decisions in the public interest.

These are

• A Department may carry over 80% of its saving, with the balance of 20% going to the Exchequer.

• Carried over funds may be spent on once-off projects or structural measures, but may not be used to create an on-going liability for the Exchequer.

In addition, Departments may retain up to 50% of the proceeds of certain property sales for once-off projects.

As a quid pro quo for the carryover entitlements, Departments which fail to manage within their expenditure ceiling in any year will be subject to an offsetting adjustment in the envelope for the following year and will need to devise policy measures to live within the reduced allocation.

Accrual Accounting

Under accrual accounting, transactions are recognised as the underlying economic events occur. Revenue is recognised when income is earned and expenses are recognised when liabilities are incurred.

An accrual accounting system is essential to see the full cost of government’s activities and to assess the efficiency of public services. It is a key element of any effective public sector performance management framework.(See Transition to Accrual Accounting, Abdul Khan and Stephen Mayes, IMF Fiscal Affairs Department, Technical Notes and Manuals 09/02, September 2009. http://www.imf.org/external/pubs/ft/tnm/2009/tnm0902.pdf)
Comment

A modern system of public accounting is an essential part of the infrastructure to deliver efficient public sector management. It is no longer sufficient to rely on a system largely developed in the Gladstonian era.

The changes proposed in the Comprehensive Expenditure Report are an attempt to counteract the perverse incentives in the current system. It will be interesting to see their effect.

While the changes are broadly positive, care will need to be taken to avoid other perverse incentives. Being able to keep 80% of savings is a powerful incentive to budget costs too high and could potentially lead to inefficient allocation of the resources carried forward. Similarly retaining 50% of property sales could lead to inappropriate disposals of property and similar less than optimal expenditure of the proceeds.

Further change is necessary. A modern accruals based system of accounting should be adopted which would take account of the costs of accrued pension liabiities and depreciation of fixed assets.

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