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Comments from ACCA
February 2004

Executive Summary

The Association of Chartered Certified Accountants (ACCA) is pleased to have this opportunity to provide comments to the Accounting Standards Board of South Africa on its Framework for the Preparation and Presentation of Financial Statements ("the framework"). These comments have been developed in consultation with a group of experienced accountants who work in the public sector.

ACCA welcomes the framework as a significant contribution to the debate on how public sector entities should account for the management of their financial affairs. We accept, however, that the South African ASB has a difficult task as there are no established and widely recognized standards for the application in the public sector of private sector-style financial statements on an accrual basis. South Africa is the only country whose Government has adopted the International Federation of Accountants (IFAC) Public Sector Committee¿s International Public Sector Accounting Standards (IPSASs) and these are, as yet, far from complete.

ACCA believes that accounting for the probity and regularity with which resources have been used is one of the prime objectives for public sector accounting. Thus we consider that a budget out-turn report is an essential element which ought to be included in the financial statements of public sector organisations.

The production of private sector-style financial statements by public sector organisations may enable a comparison of their relative efficiency. Such financial statements should, however, be part of a broader reporting package, which should include the following aspects:

• a statement of budget out-turn (as noted above)
  and
• a statement of key performance indicators demonstrating efficiency and effectiveness.

Detailed Comments

1. ACCA believes that the South African Accounting Standards Board has a difficult task in identifying Generally Recognised Accounting Practice for the public sector.
   
   
2. In recent years a few countries have changed the format and the basis of their government¿s financial statements, but the traditional approach of the annual accounts being a statement of budget out-turn on the cash basis is still by far the most common approach. This is the approach which is still undertaken by around half of central governments in Organisation for Economic Cooperation and Development (OECD) countries. The Governments of Germany and Italy do not have any plans to change from this approach and late in 2003 the Dutch Government announced that it would not proceed with plans to change the basis of the accounts for its central ministries from the cash to the accrual basis, due to the additional costs involved.
   
   
3. The core set of financial reporting standards to be developed by the Accounting Standards Board of South Africa is to be based on the IPSASs being developed by the IFAC Public Sector Committee. The request to comment from the South African ASB, however, recognizes that these are not comprehensive. Indeed they do not yet cover a number of fundamental areas of public sector accounting, for example, how to account for taxation or the social policy obligations arising, for instance, from healthcare, education or state pensions. IFAC does not expect to be able to finalise standards covering these topics for at least another two years.
   
   
4. South Africa is the only country to have agreed that it will base its standards for government financial reporting on the IPSASs being developed by the IFAC Public Sector Committee. The approach adopted by the US Government, for example, is significantly different from that adopted by the IFAC Public Sector Committee. Other countries which have adopted the private sector-style of accounting for central government finances have also adopted a variety of significantly different approaches. These include, for example, differences over:
   
   
   
   • the basis for the valuation of different classes of assets ¿ historic or current cost ¿ and whether heritage or military assets are capitalised and valued
   • the measurement focus, including the extent of accruals for provisions and intangible assets
     the nature of the balancing items in the operating statement, operating activities, ordinary activities and/or surplus for the period
     and
   • the entity boundary ¿ budget, legal or economic.
     
     
5. The framework appears to recognize the lack of widely accepted international practice in financial reporting by governments, as it only provides details of five documents which were referred to in the development of the framework. Two of these documents were, moreover, developed for the private sector and a third (from the UK¿s own Accounting Standards Board) is still in draft form. ACCA has contested a number of significant assumptions and treatments in this draft document. The absence of documents from the US on this list is rather surprising, for example, Government Accounting Standards Board, ¿Concepts Statement No.1: Objective of Financial Reporting¿ (1987).
   
   
6. There is increasing recognition internationally that whilst significant costs are clearly involved in moving to the accrual basis for central government financial reporting, the benefits have yet to be clearly demonstrated and may take many years to materialise. This is demonstrated, for example, by the UK experience of moving its Government accounts to the accrual basis. The UK National Audit Office (NAO) commented on this move (first announced in 1993) in a report published in December 2003, stating:
   
   "In most cases it is too soon to identify any discernible benefits from better resource management in terms of contributing to improved public services from for example, enhanced efficiency."
   (Page 31, full report available from: http://www.nao.gov.uk/publications/nao_reports/03-04/030461.pdf)
   
   
7. ACCA is currently funding some research on this issue. Early indications from this research in one region of the UK (Northern Ireland), are that while the costs of the reforms are clear and significant, the benefits are far less tangible.
   
   
8. The framework recognises that there are significant differences between financial reporting by a government department and that which is appropriate for the private sector. ACCA considers, however, that the framework does not go far enough in identifying the particular information needs of users of public sector financial statements. At paragraph 15, the framework appears to be saying that private sector-style financial statements provide the information which users of public sector financial statements require, without first considering what these requirements actually are. In addition, paragraph 26 of the framework does not appear to recognize the fundamental difference between the economic decisions which private sector financial statements inform and political decisions which are taken on the basis of information provided in public sector financial statements. ACCA believes that the primary function of public sector financial statements is to fulfil the requirement for the democratic accountability of government rather than that of providing information which will inform the economic decisions of the users of such financial statements.
   
   
   

   The importance of budget out-turn reports

9. ACCA believes that one of the prime objectives of the financial statements of governments and their departments should be to fulfil the stewardship function by providing an audited comparison of the actual use of resources with that which was agreed in the budget. A government¿s financial accountability arises from the budget setting process, during which it gains agreement on the levels of taxation which are to be levied and on the funding which will be allocated to the various services which it intends to provide. Thus the budget out-turn report is one of the prime documents by which governments should be held to account for the regularity and probity of their financial management.
   
   
10. The framework does not appear to recognize the fundamental importance of such an audited budget out-turn report. Thus at paragraph 14, it merely suggests that "a comparison of actual results to the budget" might be an example of "other forms of presentation" which "may or may not be provided with the financial statements". The implications of this appear to be that this budget out-turn report may not be included within the scope of external audit.
    
    
    

    Achieving efficient and effective public services
    

11. The framework recognizes that "a key objective of financial statements is the provision of information to enhance a user¿s assessment of the efficient and effective use of funds and other resources" (paragraph 10). Financial statements can, however, only provide a partial answer, as they do not indicate the level or the quality of the goods and services which have been provided. As a result the financial statements can only indicate the costs of providing goods and services and not the efficiency nor the effectiveness with which they have been provided.
    
    
12. We believe, for this reason, that a further important element of public sector reporting should be a statement of outcomes on service delivery. This would consist of appropriate non-financial performance indicators covering the key efficiency and effectiveness aspects of the reporting organisation¿s activities.
    
    
    

    The implication of a true and fair view
    

13. We believe that paragraph 51 of the framework should be made clearer. The ASB appears to be stating that financial statements which adopt its standard and guidance, and thus "Generally Recognized Accounting Practice (GRAP)", can be described as "presenting fairly the financial position, financial performance and changes in financial position" of the entity concerned. This is in contrast to private sector entities and those government business enterprises which adopt "Generally Accepted Accounting Practice (GAAP)". In these cases the financial statements may be described as presenting a true and fair view of the financial affairs of the entity.
    
    
    

    Definition of public sector assets

14. The South African ASB has adopted the definition of a public sector asset which has been developed by the IFAC Public Sector Committee:
    
    An asset is a resource controlled by the entity as a result of past events and from which future economic benefits or service potential is expected to flow to the entity.
    
    The main conceptual problem with this definition is that it extends the private sector definition to include "service potential" whilst this may only be of benefit to the entity through the achievement of its objectives. It does not necessarily, as paragraph 58 of the framework claims, "contribute directly or indirectly, to the flow of cash and cash equivalents to the entity". In fact, public sector assets may often have a negative impact on an entity¿s cash flow due to the obligation for the entity to maintain the assets it holds.

     

    Reporting the value of assets or their maintenance?

15. The reporting of information on capital assets is another area where private sector-style financial statements do not necessarily provide all the information which is needed by the users of public sector financial statements. In the private sector, for example, the recognition and valuation of the company¿s assets will have a significant impact on the profit which is reported. In the public sector, however, reporting the extent to which capital assets are maintained is far more important than reporting their total value. As long as a school or hospital is, for example, being kept for its current use, its capital value is of limited interest, but the extent to which such assets are being adequately maintained is of much greater interest to the user.
    
    
16. The importance attached to maintaining capital assets has increased in recent years in the UK, for example, as it has become apparent that there had been a failure to maintain adequately the public infrastructure. This has resulted in a significant backlog of maintenance expenditure. This backlog maintenance was not identified despite the use of private sector style financial statements in local government and the health service. This suggests that governments need to be clearly held to account for this aspect of the management of public services, and that public sector financial statements should clearly show the value of any work not undertaken, or which has been postponed, which may be considered necessary to maintain adequately the asset base of the entity.
    
    
    
    

    Revenue

17. The section of the framework on revenue, paragraphs 88 ¿ 91, does not deal with the revenue which public sector entities receive in the form of appropriations from the Treasury. This is the major source of income for many public sector entities.
    
    

    Comment on Specific Matters Requested

18. 1. Financial statements are prepared on the assumption that an entity is a going concern. The factors that would be considered in the public sector differ from those that would be considered in the private sector. Paragraph .27 lists some of these factors, but there may be more. Are there any other factors that should be considered?

    There is a fundamental difference between the going concern concept in the private and public sectors. In the public sector, the extent to which a government department or other public entity is a going concern will be dependent on government policy and this policy may or may not be based on the financial performance or position of the entity.
    

    ACCA believes that a government entity should be considered to be a going concern unless the government has made a specific decision to the contrary and agreed a specific timetable for the merger, winding up or other action to terminate the status of the entity. The going concern assumption may also be relaxed if a government has an established policy of winding up an entity if it does not achieve certain targets and the entity has not in fact achieved the specific targets which were set for it.
    

     

19. 2. A political commitment and a government commitment that gives rise to a present obligation cannot easily be determined. Paragraph .69 attempts to determine the distinction. Is this distinction appropriate or are there any other factors that should be considered?

    At paragraph 113, the framework recognizes that within the public sector matching involves not only the matching of expenditure with associated revenue (which is usually impossible for governments), but also matching on the basis of time. Time "matching involves the recognition of receipts (and payments) directly associated with the passage of time". This insight is not used however, to help to distinguish between a government commitment and a present obligation which should be recognized in the financial statements as a liability. IFAC Public Sector Committee appears to be moving towards the position that commitments which depend on the passage of time, for example, future state pension or other social benefits, are not present obligations. The Committee¿s position is still however, far from clear and the framework does not state how this issue is to be addressed in South Africa.
    

    Paragraph 69 of the framework recognizes that a "distinction needs to be drawn between a present obligation and a future commitment". The framework provides some guidance in the following paragraph that general promises by government do not give rise to a present obligation. This principle will have to be extended and further guidance developed for government entities to be able to account for social policy obligations, for example, education and health care.

     

20. 3. A wide range of measurement bases is included under the section

    "Measurement of the elements of financial statements" in paragraphs .120 ¿ .128. The Board is of the view that it is inappropriate to be too restrictive during a period of transition from cash to accrual. Do you have any views on the appropriateness of these measurement bases in the public sector?

    One of the most significant costs of the introduction of accrual accounting by governments is the move from use of historic costs to the use of some variety (or varieties) of current cost. We agree that the "balance between benefit and cost is a pervasive constraint". ACCA also believes that historic costs have a number of advantages with regard to the qualitative characteristics of financial statements, namely of understandability, relevance, reliability and comparability. For these reasons, we believe that in the public sector the historic costs of assets should be the basis for their valuation unless a persuasive argument can be made for the adoption of an alternative basis. Government entities should be encouraged to adopt this approach unless they firmly believe that the advantages of an alternative approach are significantly greater than the associated costs.

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