Introduction to Public Sector Accounting

CHAPTER I
INTRODUCTION TO PUBLIC SECTOR ACCOUNTING

LEARNING OBJECTIVES

After studying this chapter, readers will be able to:
Understand the objective of public sector accounting
Identifying the various users of Public sector accounting information
Have good grasp of constitutional and regulatory framework as well as the concepts, principles and bases of public sector accounting

What is public sector?

The simplest definition of public sector is all organizations which are not privately owned and operated, but established, run and financed by the government on behalf of the public.
The definition conveys the idea that public sector consists of organizations where control lies in the hands of public, as opposed to private owners.
The objective of public sector is to provide services to the public.
Profit making is not primary to this sector

Definitions:

Accounting: -This refers to a systematic recording and analysis of financial transactions of a business, or public sector.
it is a generally a scientific study in which records of expenditure and income of a company, individuals or government are kept coupled with other useful information for planning, decision making and control.

Finance :A branch of economics which is concerned with resource allocation as well as resource management, acquisition and investment.

Definition of Public Sector Accounting:

Government finance (or, Public Sector Finance as it is commonly known, deals with the allocation of resources in accordance with the budget constraint of a public sector organization, especially government.
It is a composite activities of analysing, summarizing, recording and interpreting the financial transactions of the Government Ministries, Departments and Spending Agencies.
A. Adams (2004) in his book “ Public Sector Accounting and Finance made simple” defines Public sector accounting as a “ process of recording, communicating, summarizing, analysing and interpreting government financial statements and statistics in aggregate and details; it is concerned with receipts, custody and disbursement and rendering of stewardship of public funds entrusted.

OBJECTIVES OF PUBLIC SECTOR ACCOUNTING

The main purposes of public sector accounting are:

Ascertaining the legitimacy of transactions and their compliance with established norms, regulations and statutes. public sector disbursement should accord with the provisions, appropriate acts and financial regulations. There should be due authorizations for all payments so as to avoid an act of fund misappropriation.
providing evidence of stewardship: The act rendering stewardship is being able to account transparently and diligently for the resources entrusted. Government and public sector operators are obliged to display due diligence and sense of probity in the collection and disposal of public funds .
Assisting planning and control: The future faces a lot risks and Therefore, mapping out plans prevents an organization from drifting since plans of actions provides the focus of activities which are being pursued. The unforeseen circumstance is built into plans so as to avoid or prevent organization failure. The public sector establishments should act accordance with the mandate of the government.
Ensuring objective and timely reporting: Users of public sector accounting information are anxious to bridge their knowledge gaps on what government is doing. they definitely treasure prompt and accurate statistics to evaluate government performance.
Evaluating costs incurred and benefits derived: In Public sector, it is difficult to measure the costs and benefits in financial terms in all aspects. The analysis of cost- benefit assesses the economic and social advantages (benefits) and disadvantages (costs) of alternative courses of actions, to ensure that comfort of the citizens is well catered for.

Other objectives are:

Providing basis for decision making
highlighting various sources of revenues receivable and expenditure to be incurred
identifying the source of funds for capital projects
evaluating the economy, efficiency and effectiveness with which the public sector institutions pursue their goals and objectives
ensuring that costs are matched by at least equivalent benefits accruing therefrom.
providing details of outstanding long term commitments and financial obligations.
providing means by which actual performance may be compared with the target
Eliminating corruption
Modernisation of the financial management system of the public sector entities;

USERS OF PUBLIC SECTOR ACCOUNTING INFORMATION:

The users of public sector accounting information can be categorized into two namely; internal and external users
(i) Internal users: this consists of the people such as the president of the country, Ministers, secretary to the treasury, accountant general, auditor general, chief executive officers of parastatals such as CDC, CAMTEL, etc. and heads of government departments
(ii) External users: This group comprises of : the National Assembly, members of the public, foreign countries, international financial institutions such as international Monetary Fund(IMF) , Africa Development Bank (ADB), World Bank; creditors both locally and internationally, political parties, Trade Unions and Researchers. International rating agencies such Fitch, Morgan etc.

THE IMPORTANCE OF PUBLIC SECTOR ACCOUNTING TO THE USERS.

The internal users require the accounting information in order to ascertain the various levels of regulatory compliance and whether the actual expenditure is in accordance with the budget.
Further they would like to ascertain whether or not adequate safeguards are available for the protection of public resources
Conversely , the external users would need the information to ascertain the financial viability of a public sector organizations and the efficiency and effective management.

CONSTITUTIONAL AND REGULATORY FRAMEWORK OF PUBLIC SECTOR ACCOUTING

The public sector accounting is regulated by the following:

(i) The Constitution of a country. The constitution of the country is one of the legal frameworks that regulate the receipt and disbursement of public funds.
Auditor general’s office. The office of the auditor general is mandated by the constitution to audit all government ministries and spending agencies. This is to ensure that accountability of government resources is done. The auditor general’s report is submitted to the president and thereafter to parliament.
Accountant general’s office, an office mandated to prepare government financial statements.
Finance (controls and Management) Act. The finance act of various countries provide guidance on management and operation of government funds. The act would regulate on the accounting system, books of accounts of accounts to be kept and the procedures to be followed in preparation of government financial statements.
Financial Regulations: These are manuals of government Ministries/ government departments which deals with financial and accounting matters. The regulations set out the procedures and steps to followed in treating most of government transactions
Finance/Treasury Circular: These are administrative tools which are used to amend the existing provisions of Financial Regulations, Public Service Rules and introduction of new policy guidelines. The circulars are usually issued by Secretary to be Cabinet or the Secretary to the Treasury. In some cases by the Permanent Secretary for Cabinet office or Ministry of Finance of course under the guidance of their superior.
Public Procurement Act: This is a procurement Act of each country which guides on government procurements.

CONCEPTS AND PRINCIPLES APPLICABLE TO PUBLIC SECTOR ACCOUNTING

concepts have been defined as broad basic assumptions which underlie the preparation of financial statement of an Public sector accounting is an integral but separate branch of financial accounting sharing in common many concepts and principles applicable in the private sector. these concepts include: Consistency, Materiality ,Periodicity, Duality, Historical, prudency, Going concern etc.

BASES OF PUBLIC SECTOR ACCOUNTING

There are three bases on which financial statements of Public Sector Institutions are compiled. These are:

The Cash Basis
The Accrual Basis
The Commitment Basis
(i) The Cash Basis: This is a basis of accounting under which revenue is recorded only when cash is received, and expenditure recognized only when cash is paid, irrespective of the fact that the transaction might have occurred in the previous accounting period

Advantages of Cash Basis:

It is simple to understand
Its eliminates the existence of debtors and creditors
It permits easy identification of those who authorize payments and collect revenue
It allows for comparison between the amount provided in the budget and that actually spent.
It saves time and easy to operate
It permits the delegation of work in certain circumstances
The cost of fixed assets is written off in the year of purchase resulting into fewer accounting entries

Disadvantages of Cash Basis

It takes unrealistic view of financial transactions as only the settlement of liabilities recognized.
It does not provide for depreciation since assets are written off in the year of purchase
It does not convey an accurate picture of financial affairs at the end of year.
It can not be used for economic decisions since it tends to hide basic information e.g. missing information relating to fixed assets, debtors and creditors
Its does accord with ‘matching concept’

*Modified Cash Basis: under this basis books of accounts are left open for a maximum of three months after the end of year, so as to capture substantial amount of income or expenses relating to the year just ended

(ii) Accrual Basis

Under this method, revenue is recognized when earned and expenditure acknowledged as liabilities when known or benefits received, notwithstanding the fact that the receipts or payments of cash has taken place wholly or partially in other accounting periods.
It based on the principle of matching income and expenditure to the time a transaction occurs rather than when payments are made or received. This means that an expense is recorded at the point goods or services are received by an organisation rather than thirty days later when the invoice for goods is paid. Similarly, income is recorded at the point the sale is made
The accrual basis is practiced in private sector and all parastatals.
The reason private sector uses this method is because private concern are for profit oriented
Therefore, it is necessary to estimate the profit made in each period with the view to keeping investment assets intact and making periodic distributions to shareholders by way of dividends.

Advantages of Accrual Basis:

It takes a realistic view of financial transactions
It gives an accurate picture of the state of financial affairs at the end of the accounting period
It aligns itself with matching concept
It can be used for both economic and investment decision-making as all parameters for performance appraisal are available.
It gives allowance for depreciation of assets used in generation revenue for the enterprise

Disadvantages of Accrual Basis

It is difficult to understand ,especially by non accountants.
It does not permit easy delegation of work in certain circumstances

(iii) Commitment Basis

It is a basis that records anticipated expenditure evidenced by contract or purchase order.
In public sector financing, budgetary and accounting systems are closely related to commitment basis

Advantages of Commitment Basis

It is an aid to financial control since it is regarded as a charge made on budget provision.
It can give a separate payment tabulation when it is required/requested

Advantages of commitment basis contd’

It takes a realistic view of financial transactions
It reveals an accurate picture of state of financial affairs at the end of accounting period.
It aligns itself with matching concept
It can be used for both economic and investment decision-making as all parameters for performance appraisal are available.
It gives allowance for depreciation of assets used in generation revenue for the enterprise

Disadvantages of Commitment Basis

The system involves extra work. Actual figures have to be substituted for commitment provisions to finally determine the running balances under sub-head of expenditure
Over expenditure is more under commitment basis in the expectation that the government may finally release funds to settle the obligations
At the end of the financial year, all commitments that are subject of unfulfilled orders have to be written back to reflect the exact picture of transactions which took place during the year.

COMPARISON BETWEEN GOVERNMENT ACCOUNTING AND PRIVATE SECTOR ACCOUNTING

The main objective of commercial enterprise is to maximize profit while that of government is to provide adequate welfare to people at reasonable costs.
Government revenue is derived from the public in terms of taxation, fines, grants, fees, etc, where as business concerns obtain their income from sale of goods and services
In government financial transactions are recorded on ‘Cash basis’ while in private sector it is on accrual basis.
In Public sector accounting, tangible fixed assets such as land and building, plant and machinery are not shown in the balance sheet where as, in private sector accounting they are reflected, showing Historical Cost, Accumulated Depreciation and Net Book Value (NBV) of each

COMPARISON BETWEEN GOVERNMENT ACCOUNTING AND PRIVATE SECTOR ACCOUNTING

In public sector accounting, current assets such as stocks and debtors are not shown on the balance sheet where as in private sector accounting system both current assets and liabilities are shown.
In government there is no Annual General Meeting (AGM) of stakeholders/shareholders, unlike the private sector which has the AGM. In government what happens is just holding public briefing on specific issues.
In Public sector what operates mostly is the fund accounting, where as in private sector the proprietary approach is adopted.

Government accounting and the use of the accruals basis

5.1 Government accounting

Government accounting is the process of recording, analyzing, classifying, summarizing communicating and interpreting financial information about government in aggregate and in detail reflecting transactions and other economic events involving the receipt, spending, transfer, usability and disposition of assets and liabilities. The purposes of government accounting are:

To carry out the financial business of government in a timely, efficient and reliable manner (e.g. to make payments, settle liabilities, collect sums due, buy and sell assets etc.) subject to necessary financial controls.
To keep systematic, easily accessible accounting and documentary records as evidence of past transactions and current financial status, so that detailed transactions can be identified and traced and all aggregates can be conveniently broken down into their constituent parts.
To provide periodic financial statements, containing appropriately classified financial information, as a basis for (a) stewardship and accountability and (b) decision-making.
To maintain financial records suitable for budgetary control, internal control and the needs of auditors.
To provide means for effective management of government assets, liabilities, expenditures and revenues.

In government, the producers of accounting information are rarely qualified accountants. Therefore few have experience of accrual accounting. But they usually belong to a separate cadre allowing for training and the acquisition of specialist accounting skills. In some countries, those who supervise the accounting process are not themselves trained in accounting. Accounts are kept for a wide variety of administrative entities: ministries, departments, taxing authorities and spending units (including for instance hospitals, research centres, colleges, schools, police stations, defence establishments). Accounting entities are spread throughout the country, from the capital city to the remotest corners. Given such a spread, the capacity of accounting entities and of their staff is bound to vary considerably. In order to ensure adequate accounting from such a wide range of entities, a government accounting system has to be:

Relatively uniform
Well-documented
Simple to learn and operate
Easy to consolidate

One of the challenges of accounting reform (for example introduction of accrual accounting or of a modern treasury system is deciding where to stop. Reform cannot be conveniently brought to all accounting entities in one fell swoop, so a border has to be defined within which the reform is to take place. Usually a small number of entities is responsible for a large number/amount of transactions. The most logical choice for the purposes of reform is to address the needs of these large entities. At the same time the accounting systems of entities not subject to the reform process will require adaptation to allow the reformed system to perform effectively. The characteristics of the accounting system (for instance the basis of accounting; the nature of financial statements) have to suit the needs and capacity of users. An accounting system could be very good when compared with international accounting standards, but might be of limited value to the country concerned, if there were few or no people acquainted with these standards.

A government accounting system normally has eight main components:

Documents providing evidence of transactions
Bank accounts through which payments and receipts are handled
Accounting records (cash book, ledgers etc.)
Procedures and controls
A means of aggregation of accounting data
Internal accounting reports
External accounting reports (financial statements)
Staff

Sub-systems of a government accounting system are as follows:

General ledger (a system of classified ledger accounts allowing all revenues and expenditures to be sorted into appropriate categories)
Cash book
Payroll
Payables
Receivables
Assets and liabilities including cash management

The performance of government accounting systems varies from extremely good, down to utterly inadequate. Many World Bank borrowers have inadequate accounting systems implying a range of difficulties in:

carrying out day to day transactions at acceptable standards
providing authentic and accessible records
pinning responsibility on those alleged to have carried out corrupt activities
achieving budgetary and internal control
providing reliable time series data on expenditures, revenues and their components

Given such possibilities the need for accounting reform is obvious. It presents a number of issues:

Basis of accounting cash, accrual or mixed?
Orientation: control, analysis or strategic choice (or all three)?
Scope: ministries, major accounting units, comprehensive?
Human dimension: determinant of success or major constraint?
Medium of accounting: manual, partially or fully computerized?
Users: general or specific?
Financial statements: whole of government, agency , or more specific?

5.2 Bases of accounting

There are four main bases of accounting:

cash basis
modified cash basis
full accruals basis
modified accruals basis

The cash basis measures cash flows at the time those flows actually take place. The modified cash basis allows a short period of time after the year-end for settling liabilities of the year just ended (and treats this expenditure as occurring in the year just ended). The full accrual basis records expenditures and revenues when they become due (i.e. in many cases before the associated cash flows take place). It records assets and liabilities and is therefore associated with the production of balance sheets. It is also associated with providing depreciation on assets with finite lives. The modified accruals is similar to the full accruals basis, but it is simpler because it does not involve the capitalisation of fixed assets (nor the provision of depreciation of fixed assets).

The basis of accounting determines the extent of information that an accounting system can collect and therefore report. A pure, cash-based system can only report on cash balances and cash flows (inward and outward). But cash payment or receipt is usually only a small element in the history of a transaction. For instance a purchase transaction might go through the following stages, each of which could generate accounting information:

Commitment of funds
Issue of purchase order for the supply of goods
Receipt of the goods and of the invoice claiming payment
Payment of invoice
De-commitment of excess funds committed

Pure cash accounting does not provide useful information for managing payables and receivables. In the above example, an accrual system would show the amount owing to the supplier. Then when full payment occurred, the amount owing would be extinguished. Of more practical importance is the lack of an accounting sub-system for receivables in a pure cash-based system. Without this, managing revenues is far less efficient. For instance if sums due are noted only in files, and not entered into a double-entry accounting system, they can easily escape attention. Moreover the files may be displaced or lost. An accrual accounting system provides a systematic method of recording and managing sums due, something which many governments badly lack.

5.3 Arguments for the cash basis

Why then is the cash basis the predominant basis of accounting for governments? The answer is that the cash basis is:

Easy to learn and carry out. It requires care, but no special accounting skills.
Well-adapted to the needs of budgetary control. Payment is definite. Strict budget control can be exercised by comparing sums authorized with those actually spent.
Easy to understand and verify.
A statutory requirement in many countries.

In most governments the cash basis is used in conjunction with the commitment basis for budgetary control purposes. Under the commitment basis, expected expenditures are first entered into the accounting system as commitments (sometimes called obligations). Authorized expenditure (the available budget) is reduced by commitments which have not been liquidated (i.e. not been followed by a cash payment). However, when the cash payment occurs, the sum committed is extinguished.

5.4 Arguments for the accruals basis

The arguments for accrual accounting are as follows:

Cash accounting does not generate enough useful information e.g. about payables and receivables.
Only accrual accounting, provides adequate information on the full costs of operation, thus supporting decision-making e.g. decisions either to place sub-contracts with private sector contractors or to carry out the work in-house.
Only accrual accounting generates reliable information on the full range of assets and liabilities.
Only accrual accounting can generate comprehensive financial information about government e.g. a loan which is written off has no impact on a cash-based statement, but under accrual accounting it diminishes net worth.

These are strong and valid arguments. However, the possibility remains that accrual features could be added to a cash-based accounting system. The Bank funds several treasury modernization projects. They aim to improve budgeting, accounting and cash management. They all use the cash basis and in all cases accrual-based sub-systems are added to cover payables and receivables and sometimes asset management (inventory and fixed assets). Moreover, liabilities arising from government borrowing are tracked and accounted for outside the treasury system. Is this a satisfactory halfway house?

5.5 Special needs of developing and transitional countries

What is a satisfactory halfway house depends on circumstances. It would not be satisfactory for those countries that have adopted, or are aiming to adopt full accrual accounting. These are without exception rich countries. The following considerations are relevant to a decision by a developing or transitional country to adopt full accrual accounting:

Accrual accounting information is more difficult and more costly to produce and to use, than cash-based accounting information.
Part of the cost of using accrual-based data is the cost of understanding it. Accrual-based data cannot be easily understood by non-accountants.
The adoption of full accrual accounting is more complex and more costly than the simple cash basis. Asset valuation is an example of complexity and cost.
Modifying cash-based systems to produce some accrual-type data may make sense.
Poor countries usually lack accounting skills, and therefore have few trained people who can either produce complex accounting information or use it.
The accounting systems of many developing countries suffer from a range of serious defects even though they employ the simplest accounting basis (cash). There may be higher priorities for the use scarce accounting resources.
Technical assistance could be used to supplement national accounting skills. This might permit the introduction of accrual accounting, but how far would such assistance go in producing a working, accrual accounting system for the nation as a whole?

5.6 International Public Sector Accounting Standards (IPSAS)

The Public Sector Committee (PSC) of the International Federation of Accountants formulates IPSAS. The preface to IPSAS explains:

IPSAS are intended for national, regional and local governments and related government entities such as agencies, boards and commissions.
At present such entities have diverse reporting practices and there are no authoritative international standards.
IPSAS are authoritative requirements established by PSC to improve the quality of financial reporting in the public sector around the world.
PSC addresses governmental needs by issuing and promoting benchmark guidance supported by education, research and dissemination.
PSC’s primary focus is ensuring that its pronouncements are consistent with those of the International Accounting Standards Committee.
PSC is concerned with “general purpose financial statements”.
IPSAS apply to the published financial statements of public sector entities except for government business entities which are to follow International Accounting Standards (IASs).
IPSAS do not over-ride statutory or other official national requirements, but PSC encourages governments and national standard-setters to adopt IPSAS.

PSC started work on the basis of four alternative accounting bases: cash basis; modified cash basis; modified accrual basis; and accruals basis. The cash and modified cash bases were defined as being practically the same (the only difference being that under the modified basis the books were left open for a period of months after the year end for the settlement of bills). The modified accrual and accrual basis differ principally in that the latter requires the capitalization of fixed assets and their depreciation. PSC assumed that countries would evolve along a continuum between cash and full accruals.

However, support for the two modified bases was judged to be inadequate (despite vociferous opposition from Canada) and the focus was shifted to two bases: cash and full accruals. Thus to comply with IPSAS a government must either use the cash or the full accruals basis for its principal general-purpose financial statements. Using the full accruals basis implies financial statements similar to those produced by large corporations.

PSC has produced one standard for the cash basis and is in course of producing a series of standards similar to those of IAS for the accruals basis. For a government entity to be in compliance with IPSAS its general-purpose financial statements must not mix bases of accounting (i.e. must be produced either on the cash or on the full accruals basis), and they must consolidate all the entities controlled by that entity. In other words a national government must produce fully consolidated financial statements for all the entities which it controls. This is an elegant solution to the shenanigans following the coming into force of the Maastricht Treaty. Governments changed the definition of the reporting entity at will in order to fall inside the Maastricht criteria (general government budget deficit no more than 3%, and government borrowing no more than 60% of Gross Domestic Product). However elegant the solution, very few governments of developing countries consolidate accounting information to this level, very few are able to do so and even fewer are likely to wish to do so.

Other issues facing the IPSAS program are as follows:

The virtually endless process of producing IAS look-alike standards.
Lack of authority on the part of IFAC in securing adoption of IPSAS and a possible vested interest in recommending accrual-based accounts (as IFAC membership is made up of professional institutes of accounting primarily concerned with private sector issues).
Catering to the needs of a small number of developed countries while ignoring the needs of a large number of developing countries.
Excessive enthusiasm for an accounting model suitable for a sophisticated economy without clear indications of its limitations in less developed environments.
Under-estimation of the likely difficulties which governments will face in adopting IPSAS, especially the requirement for fully consolidated financial statements on a single accounting basis.

Despite such issues there is strong support for IPSAS including virtual IMF endorsement in its new approach to Government Finance Statistics.

CHAPTER TWO

SOURCES AND USES OF GOVERNMENT REVENUE

SOURCES:

The following points highlight the nine main sources of government revenue. The sources are: 1. Tax 2. Rates 3. Fees 4. Licence Fee 5. Surplus of the public sector units 6. Fine and penalties 7. Gifts and grants 8. Printing of paper money 9. Borrowings.

1. Tax:

A tax is a compulsory levy imposed by a public authority against which tax payers cannot claim anything. It is not imposed as a penalty for only legal offence. The essence of a tax, as distinguished from other charges by the government, is the absence of a direct quid pro quo (i.e., exchange of favour) between the tax payer and the public authority.

Tax has three important features:

(i) It is a compulsory contribution, to the state from the citizen. Anyone refusing to pay tax is punished under law. Nobody can object to taxation on the ground that he is not getting the benefit of certain state services,

(ii) It is the personal obligation of the individual to pay taxes under all circumstances,

(iii) There is no direct relationship between benefit and tax payment.

2. Rates:

Rates refer to local taxation, i.e., taxation levied by (or for) local rather than central government. Normally rates are proportional to the estimated rentable value of business and domestic properties. Rates are often criticised as being unrelated to income.

3. Fees:

Fee is a payment to defray the cost of each recurring service undertaken by the government, primarily in the public interest.

4. Licence fee:

A licence fee is paid in those instances in which the government authority is invoked simply to confer a permission or a privilege.

5. Surplus of the public sector units:

The government acts like a business- person and the public acts like its customers. The government may either sell goods or render services like train, city bus, electricity, transport, posts and telegraphs, water supply, etc. The government also earns revenue from the production of commodities like steel, oil, life-saving drugs, etc.

6. Fine and penalties:

They are the charges imposed on persons as a punishment for contravention of a law. The main purpose of these is not to raise revenue from the public but to force them to follow law and order of the country.

7. Gifts and grants:

Gifts are voluntary contribution from private individuals or non-government donors to the government fund for specific purposes such as relief fund, defence fund during war or an emergency. However, this source provides a small portion of government revenue.

8. Printing of paper money:

It is another source of revenue of the government. It is a method of creating extra resources. This method is normally avoided because if once this method of financing is started, it becomes difficult to stop it.

9. Borrowings:

Borrowings from the public is another source of government revenue. It includes loans from the public in the form of deposits, bonds, etc. and also from the foreign agencies and organisations.