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Comments from ACCA
August 2003

 

Executive Summary

The Association of Chartered Certified Accountants (ACCA) is pleased to have this opportunity to provide comments to the Accounting Standards Board on its Statement of Principles for Financial Reporting ¿ Proposed Interpretation for Public Benefit Entities (the discussion paper). These comments have been developed with our Public Sector Technical Issues Committee, a group of experienced accountants who work in the public sector.

ACCA welcomes the discussion paper as a significant contribution to the debate over how public sector and not-for-profit entities should account for the management of their financial affairs. We consider, however, that further work is needed before an appropriate set of principles for financial reporting in these sectors can be said to have been developed.

ACCA believes that the ASB should be cautious in asserting that the needs of public sector users can be met merely by re-expressing and expanding the ASB¿s existing principles to make them applicable to public benefit organisations. On balance, we consider that it would be more appropriate to develop a specific set of principles for financial reporting in the public sector.

We consider that the differences between the public and not-for-profit sectors are such that it is unlikely that a suitable set of common principles could be developed for these two sectors. For this reason, our response concentrates on the principles which should be developed for public sector organisations since that is the economically more significant sector.

We also have some concerns regarding ASB¿s identification of the defining class of user for the financial statements of public sector organisations and with the objectives to be achieved by public sector financial statements.

ACCA believes that, if a defining class of user were to be identified for the financial statements of public sector organisations, it should be the electorate rather than the tax payers (as suggested by the discussion paper). There are, however, a range of other stakeholders who should also find financial statements useful. We therefore advocate a multi-stakeholder approach rather than defining any particular primary class of user.

We also believe 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 above)
  
  
• an estimate of planned maintenance postponed or otherwise not undertaken
  
  
• a statement of inter-period resource flows
  
  and
  
  
• a statement of key performance indicators demonstrating efficiency and effectiveness.

 

Detailed Comments

Introduction

1. In this section, we look at the feasibility of developing common financial reporting principles for both the public and not-for-profit sectors from those developed in the private sector. We then consider the users of public sector financial statements, the objectives of these statements and certain problems associated with accounting for public sector assets.

Feasibility of Common Principles

2. The discussion paper recognises that the primary objective of public benefit entities "is to provide goods or services for the general public or social benefit ¿ rather than with a view to a financial return to equity shareholders" (paragraph 10). The paper does not, however, recognise that this difference in objective between public benefit and private sector entities raises the possibility that the users and objectives of the financial statements for the two sectors may also be different.

3. As a result, ACCA believes that the ASB should be cautious in asserting that the needs of public sector users can be met merely by re-expressing and expanding the ASB¿s existing principles to make them applicable to public benefit organisations.

4. Problems will inevitably arise if public sector and not-for-profit entities are treated as one type of entity, public benefit entities, as is the case in the discussion paper. The accountability relationships for these two types of entity are different and the form and content of their financial statements should reflect this.

Users of Financial Statements

5. In the private sector, it has been accepted that the defining class of user of financial statements is "the investor that has supplied risk capital in expectation of a financial return on capital" (paragraph 18 of the preface). This has created something of a problem with conventional financial statements for the private sector, in that the focus has been on the investor and the resultant financial statements have been argued by many to be less useful from the standpoint of the employee, the community, and the general public.

6. This is, in part, why multi-stakeholder approaches such as the Global Reporting Initiative have emerged to fill the gap created by the "defined class of user" approach. For the private sector, we see the Operating and Financial Review statement (OFR) and the "intellectual capital" statement as being partial solutions to the private sector stakeholder information needs gap.

7. In the public sector, the accountability equation is fundamentally different from that found in private sector companies. In place of the financial accountability of the management of a company to its shareholders, we have the political accountability of the government to the electorate and its elected representatives in parliament or the council chamber.

8. If a defining class of user has to be identified for public sector financial statements, theoretically this ought to be the electorate. Elected representatives, however, act on the electorate¿s behalf and use the financial statements to hold the government and the civil service to account for the resources which they were allocated. In addition, there are a range of other stakeholders who should also find financial statements useful. These will include the press, public sector employees, users of public sector services and tax payers.

9. The ASB, however, argues that "the defining class of user for the financial statements of public benefit entities is the funders and financial supporters" (paragraph 1.13) and goes on to indicate that, for the public sector, "this will be the taxpayer" (paragraph 1.15). This conclusion flows from the attempt to interpret ASB¿s principles of financial reporting to public benefit entities with the minimum of translation or change.

10. The identification of taxpayers as the defining class of user of public sector financial reports leads the ASB to assume that private sector style financial statements will provide the essential information which the users need. In contrast, we believe that a range of other information is required by the users of public sector financial statements. This will include some statements, for example, budget out-turn reports which are rarely, if ever, provided in the private sector.

The Importance of Budget Out-turn Reports

11. ACCA believes that one of the prime objectives of the financial statements for any public sector organisation should be to fulfil the stewardship function by providing an audited comparison of the actual use of resources with that agreed in the budget. A government¿s financial accountability arises from the budget setting process during which it gains agreement to the levels of taxation which are to be levied and to 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.

12. The discussion paper recognises that this stewardship function "plays an important role in the preparation of financial statements by public benefit entities" (paragraph 1.5), but the implications of this insight are not adequately explored and the discussion paper suggests that the provision of information on the "reporting entity¿s financial performance and financial position" (page 24) is significantly more important.

13. As a result of similar arguments to those in the discussion paper, many public sector organisations in the UK now produce financial statements which are comparable to those in the private sector. In some cases, however, a consequence of this change has been that the stewardship function of financial accounting has been overlooked. Local authorities, for example, are not required to publish audited comparisons of actual income and expenditure with that authorised in their annual budgets.

Interperiod resource flows

14. A secondary objective of financial statements in public sector organisations should be to report on inter-period resource flows. Financial reports should help users to assess:

• whether current-year revenues are sufficient to pay for the services provided that year
  
  
• the extent to which resources provided in past years have been utilised
  
  and
  
  
• whether future taxpayers will be required to assume burdens for services provided during the year in question.
  

15. This objective will not necessarily be fully achieved by the private sector style financial statements advocated by the discussion paper, but could be fulfilled by a modified balance sheet or suitable narrative and/or financially quantified notes to the financial statements.

Achieving Efficient and Effective Public Services

16. Another objective of the financial statements of a public sector organisation is to demonstrate the efficiency or value for money with which it has provided goods and services and its effectiveness in meeting its strategic objectives. The 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, nor the relative efficiency/effectiveness of the provider organisation over time.

17. We believe 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.

18. As suggested by the discussion paper, the production of private sector style financial statements by public sector organisations may enable a comparison of their relative efficiency as compared with possible private sector providers of the goods and services which are produced. We believe that such financial statements should, however, be part of a broader reporting package, in which a budget out-turn report and a statement of inter-period resource flows should play an equally prominent role reporting the value of assets or their maintenance?

19. 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 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.

20. The importance attached to maintaining capital assets has increased in recent years in the UK 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. There are also current or developing problems with funding the necessary investment in the infrastructure for rail travel, water services and waste disposal. This backlog maintenance was not identified with the introduction of private sector style financial statements in local government or in the NHS. 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 organisation.

Measurement bases for assets

21. The discussion paper suggests that a mix of historic cost and current value should be adopted (paragraph 6.3) despite the admission that differences between the valuation method used may be material, even between alternative measures of current value (paragraph 6.4). We believe that it would be preferable if one, consistent approach to asset valuation were to be adopted, although, as indicated above, this aspect is less important in the public sector than in the private sector.

22. The limited utility of capital values to the users of public sector financial statements is shown by the policy adopted for accounting for capital assets in central government. HM Treasury has adopted a cost benefit trade-off in determining which assets are to be valued in its resource accounts. Non-operating heritage assets such as the crown jewels, Stonehenge and paintings in the National Portrait Gallery are all given a nominal value, while new additions to the latter collection will be included in the balance sheet at their purchase price or value when acquired.

23. We consider that the discussion of the value in use basis (paragraph 6.5) does not recognise the full range of alternatives. In addition to the scenarios described, public sector entities may also be responsible for transfer payments (for example, unemployment benefits) and services may be provided at a rate above the market rate (for example the delivery of letters within London) as a result of the public sector¿s monopoly position.

Taxation

24. ACCA agrees with the conclusion in the discussion paper (paragraph 5.29) that taxation should be accounted for on a receipts basis. We consider that the costs of introducing any alternative basis could not be justified by any possible benefits.

Answers to ¿Questions for Respondents¿

Comments on the particular questions raised in the discussion paper

(a) Do you agree that the ASB should develop of an Interpretation of the Statement of Principles for Financial Reporting to provide guidance on the application and, where necessary, re-interpretation of the principles for public benefit entities?

ACCA has reservations with the idea that it is possible to adapt the ASB¿s Statement of Principles for Financial Reporting to make it applicable for public benefit entities. While this may be possible for not-for-profit organisations, the prime users of public sector financial statements - the electorate - require fundamentally different information from that provided to shareholders of private sector companies.

(b) Do you have any comments on the form of the Proposed Interpretation? For example, do you think that it should contain more, or less, information from the Statement of Principles for Financial Reporting? Or do you think that a different format should be adopted? If you do, what format would you propose and why?

A statement of principles for financial reporting in the public sector should start from the particular information needs of the users of the accounts. The format of the discussion paper of adapting the principles developed for the private sector may increase the comparability of financial statements between public and private sector bodies , but this approach may reduce relevance and understandability individual public sector financial statements.

(c) Do you agree that the needs of public benefit entities from both public and private sectors can be dealt with in the same Interpretation? If not, why not?

Financial statements for the public and private sectors have different defined class of users and different objectives. Thus it may not be possible to develop a common set of principles for financial reporting of public benefit entities from both public and private sectors.

(d) Do you agree with the introduction of the term 'public benefit entities' to describe those entities to which the Proposed Interpretation is intended to apply? If not, what term would you use to describe such entities, and why?

We do not consider that it would be particularly easy to develop a common set of principles for financial reporting to cover both the not-for-profit and the public sectors. Thus we do not believe that it is particularly helpful to develop a term that encompasses both of these sectors.

(e) Do you agree with the definition of 'public benefit entities' as set out in paragraph 10 of the Introduction? If not, why not, and what alternative definition would you propose?

We accept this as a reasonable definition, but see the response above to the previous question. We also note that the definition included at paragraph 10 of the introduction to the discussion paper is slightly different to that at paragraph 15 of the preface.

(f) Do you agree that 'funders and financial supporters' are the defining class of user? If not, what do you consider to be the defining class of user and why?

We believe that it is inappropriate to try to identify a defining class of user for the annual reports of public sector and not-for-profit organisations. As argued above, we believe that an approach which recognises the multi-stakeholder nature of such organisations would be more appropriate. If a defining class of user has to be identified for public sector financial statements, however, then theoretically it ought to be the electorate.

(g) Do you agree with the definition of 'funders and financial supporters' as set out in paragraph 1.13? If not, why not, and what alternative definition would you propose?

We do not find this definition particularly helpful (see our answer to question (f) above).

(h) Do you agree with the analysis of the role of intermediaries in relation to the defining class of user? If not, why not?

We agree with the analysis of the role of intermediaries in relation to the defining class of user.

(i) Do you agree that the boundary of the reporting entity should be determined by reference to control? If not, why not and how would you suggest determining the boundary of the reporting entity?

We agree that the boundary of the reporting entity should be determined by reference to control. We recognise, however, that influence and control form a continuum and that the control of many public sector organisations may be constrained by, for example, central government or a regulator acting on its behalf.

(j) Do you agree that the definitions of the elements of the financial statements do not require re-expression in order to be applicable to public benefit entities? If not, why not, and what alternative definition(s) would you propose?

We believe that the definitions of the elements of the financial statements for public sector organisations need to be developed to reflect the particular information needs of their users.

(k) Do you agree with the proposed application of the definition of assets? If not, why not?

We believe that the explanation of the definition of assets in the discussion paper is particularly tortuous and demonstrates the problems of applying to the public sector principles for financial reporting which have been developed for the private sector.

That said, however, we believe that if public sector bodies are going to produce income statements and balance sheets (among their other reports), then these statements should be produced on broadly similar recognition and measurement principles to the private sector.

(l) Do you agree that a reduction in demand for the goods/ services provided by an asset can lead to an impairment? If not, why not?

We agree that a reduction in demand for the goods/ services provided by an asset can lead to an impairment.

(m) Do you agree with the proposed application of the definition of liabilities? If not, why not?

We largely agree with the proposed application of the definition of liabilities. We note, however, that there are some complex issues for public sector accounting such as accounting for social policy benefits, where further consideration is required.

(n) Do you agree that general political promises do not give rise to liabilities? If not, why not?

We agree that general political promises should not give rise to liabilities to be included in the financial statements of public sector organisations.

(o) Do you agree that the residual interest in a public benefit entity should not be attributed to any group of individuals or entities? If not, why not?

We agree that the residual interest in a public benefit entity should not be attributed to any group of individuals or entities.

(p) Do you agree that where transactions that might be commonly referred to as 'notional' are in fact a contribution from controlling parties, they should be accounted for as such? Otherwise 'notional transactions' should not be reported. If you do not agree, why not?

We find the section of the ASB's paper dealing with notional transactions difficult to understand. There is no adequate definition of what is meant by a notional transaction, and we are uneasy about a system where "notional" transactions from controlling parties get recognised, but similar transactions with other parties would not.

(q) Do you agree that, where a public benefit entity is controlled by another entity, contributions from controlling parties in their capacity as controlling parties (which, for example, may include certain grants from a controlling party) should not be reported as gains? If not, why not?

On this issue we believe that the ASB paper is not clear enough. We are not sure why funding from a controlling party should not be treated as revenue by the recipient. We are thinking, for example, of one charity controlled by another. A donation from one to the other is still just that, and the economic substance for the recipient is that it has received funds to be spent in accordance with its objects irrespective of the source of those funds. The donation or grant will not have increased the controlling party's residual interest as they are unlikely to have any. More helpful for the range of users of the financial statements in such cases would be the clear disclosure of the name of the controlling party and the extent and nature of the transactions with that party.

A significant amount of resources flow between public sector entities and other public sector (or quasi-public sector) organisations. These can include, for example, capital or revenue grants or other subventions to public sector organisations from central government, the European Union or the National Lottery. These are dealt with relatively briefly by the discussion paper in paragraphs 4.52 to 4.57, but the principles have yet to be adequately or clearly developed.

(r) Do you agree with the proposed recognition point for grants and donations receivable? If not, why not and at what point would you consider it appropriate to recognise them?

We believe it may be preferable to adopt a "probable" rather than "virtually certain" test for recognition of grants and donations. In the college example, if a minimum drop out rate is a condition for a grant, then should the grant only be recognised when the course is completed?

We do not agree with the implication in paragraph 5.45 of the discussion paper that a liability should be recognised even if "the reporting entity does not anticipate disposing of the asset in the foreseeable future". We would expect that, as the sale of the asset would be under the control of the organisation, the asset would be recognised as such on receipt of the resources. The sale of such an asset, if it occurred, would, however, lead to the creation of a corresponding liability.

(s) Do you agree with the proposed treatment of capital grants? If not, why not and how would you propose they should be treated?

We disagree with the proposed treatment of capital grants. The explanations provided are inconsistent with how liabilities should be measured. A capital grant should be recognised as income and the asset at its full value. The liability to repay in the event of disposal of the asset should not be shown in full, but only to the extent that it was probable (in most cases at or near zero).

(t) Do you agree that, other than combinations involving entities under common control, the majority of business combinations between public benefit entities are acquisitions? If not, why not?

All public sector organisations may be considered to be in the nature of wholly owned subsidiaries and this will become clearer with the development of Whole of Government Accounts. Thus, combinations of public sector organisations should be treated as mergers rather than acquisitions. The discussion paper lacks a clear positive statement that combinations involving entities under common control should be treated as mergers.

(u) Do you agree with the proposals for the accounting for the fair value of the net assets acquired in an acquisition? If not, why not and what alternative would you propose?

See response to question (t) above.

(v) Do you believe that any other guidance or re-expression of the principles is needed? If so, please provide details.

We believe that a separate set of principles should be developed for financial reporting of public sector organisations. This would start by identifying the users of the financial statements of such organisations which we suggest are, for example, the electorate, their political representatives, the press, public sector employees, users of public sector services and tax payers.

The principles would then identify the requirements of these users, some of which we have outlined in this response and so consider the form of financial statements which should be provided. One of the most important of these we believe would be a budget out-turn report.

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