CHAPTER TWO — OVERVIEW

The climate for improved transparency and accountability often occurs within a broader notion of better ethics in government. Central to improved accountability to Parliament is a greater transparency and adequacy of financial information. This can be achieved by using the most appropriate accounting system available.

A) Historical Perspective

Among most national governments an accrual based accounting system is seen as best meeting the need of greater transparency in reporting public sector financial transactions. As of 2004, a third of the member countries of the Organization for Economic Co-operation and Development (OECD) have adopted accrual accounting in reporting activities and a number of other countries have accepted it for specific transactions⁶. In particular, many countries, including Canada, have introduced, accrual based accounting measure in reporting government financial activities — accrual reporting.

However, there is less consensus regarding the adoption of accrual budgeting — the introduction of accrual accounting in the publication of government budgets and estimates. Among the major industrial countries, there appears to be a wide divergence of views on the desirability of introducing accrual based budgeting systems. Only three OECD member countries in 2004 had adopted accruals for specific transactions in their budget exercises. Nationally, all provinces and territories have introduced some form of accrual accounting in their finances. Two, the Provinces of Ontario and British Columbia have introduced full accrual accounting in their accounts.

In the 1996 Federal Budget Plan, the Canadian government announced its intentions to move to full accrual accounting for budgeting and accounting purposes. Implementation followed such that the 2002-2003 financial statements in Public Accounts and the 2003 Budget were prepared on a base of full accrual accounting.⁷ According to officials of the Treasury Board Secretariat (TBS), accrual accounting was also implemented to support decisions requiring cabinet-level decisions. Estimates, appropriations and most departmental plans and reports remain on a near-cash basis.⁸

Although Canada has committed itself to adopting an accrual budgeting system, it has yet to introduce one. In fact Canada has repeatedly delayed the introduction of accrual budgeting in spite of urgings by the Office of the Auditor General and the House of Commons Standing Committee on Public Accounts to expedite the implementation of an accrual budgeting system⁹.

B) Types of Accrual Bases

While the debate centres on the choice between introducing accrual based budgeting versus retaining cash based budgeting, there are in fact a range of options involving a mix of cash and accrual accounting systems for public sector finances. Cash accounting essentially reports cash transactions when cash is received or paid out by an organization. Therefore, financial statement items such as amounts owed to or by the government or other non-cash items are not recorded. At the other extreme, full accrual accounting recognizes transactions when they have been earned or incurred rather than when cash comes in or out.

In between these two systems are hybrids like modified cash accounting that allows year-end adjustments to recognizing some non-cash items such as accounts receivable and payable. Alternatively, modified accrual follows full accrual principles with one significant departure: it does not recognize capital assets on the statement of financial position. Instead these assets are recognized fully as expenditures when bought.

Currently, the federal government employs different accounting bases for different levels of administration. The table below provides an outline of the different bases of accounting and their use.

Table 1

CURRENT STATUS OF ACCRUAL ACCOUNTING IN GOVERNMENT
	Government-wide	Departmental
BUDGETING PURPOSES
Federal Budget	Accrual	—
Departmental Budget/Estimates	Near-Cash	Near-Cash
Appropriations	Near-Cash	Near-Cash
REPORTING PURPOSES
Summary Financial Statements	Accrual	—
Departmental Financial Statements (unaudited)	—	Accrual
Departmental Performance Reports	—	Near-Cash

SOURCE: Office of the Auditor General, Overview of Accrual-Based Budgeting and Appropriations, Briefing to the House of Commons Standing Committee on Government Operations and Estimates, 26 September 2006.

C) Accounting Standards and Principles in the Public Sector

In the public sector, the basic principles of responsibility and accountability demand that governments provide credible financial information to Parliament and the public. In order for Parliament and the public to perceive this financial information as credible, they must have confidence that it conforms to generally recognized and accepted standards and principles developed by an agency not subject to any political or economic pressure.

Accounting standards specify how transactions and other events are to be recognized, measured, presented and disclosed in government financial statements. In Canada, the authoritative accounting standards for financial accounting and reporting, developed through an organized standard-setting process, are those issued by a recognized standard-setting body: the Public Sector Accounting Board (PSAB).¹⁰

Accounting standards are the primary source of generally accepted accounting principles (GAAP). The CICA Public Sector Accounting (PSA) Handbook contains accounting standards applicable to federal, provincial, territorial and local governments. It also requires that certain public sector organizations follow the CICA Handbook–Accounting unless otherwise directed to specific accounting standards of the PSA Handbook. It should be noted that generally-accepted accounting standards are constantly evolving as they adapt to social and economic conditions. It is important to remember that the senior levels of government in Canada are sovereign and therefore cannot be forced to conform entirely to the CICA’s accounting standards. In practice, however, there is a high degree of conformity to the standards.

D) The Benefits of Accrual Budgeting

The change from cash accounting to accrual accounting in the budget process is expected to yield several benefits including improved efficiency, greater transparency, improved financial management, and better accountability. However, accrual budgeting is not universally accepted. The adoption of accrual budgeting is controversial and has been subject to a long standing debate in the public sector accounting literature.¹¹ The many actors interested in governmental accounting have different points of view on the desirability of implementing accrual budgeting in public sector finances. International organizations have been active in promoting the adoption of the accrual basis for governmental accounting. Also supporting a move to accrual accounting have been management consultants, and key public sector reformers. However, all of the witnesses appearing before the Committee acknowledged that the benefits of introducing accrual accounting in the budgeting and appropriations activities of the government is likely to yield benefits that exceed the costs associated with such an action. In her briefing material presented to the Committee, the Auditor General identified the following advantages of introducing full accrual accounting in government finances.¹²

1. Reflects full scope and size of government’s:

·        resources (all financial and non-financial assets)

·        obligations (all liabilities)

·        costs (resources consumed)

2. Greater focus on consumption of resources

3. Better link of the results to the resources used to achieve them

4. Fuller information available to government for improved decision   making

·        more focus on assets (maintenance requirements, replacement policies, buy vs. lease)

·        more attention to managing liabilities

·        more focus on full cost of programs and services

The Auditor General clearly stated her view of the benefits of introducing accrual accounting when she noted that:

While we recognized in our financial information chapter that a department's cash requirements and cash flow management will continue to be important information for Parliament, we concluded that Parliament would be better served if it also received information in the estimates and appropriations based on accrual accounting. Such an approach would make the process more consistent with the one used in the government's financial reporting of results.

Mr. Ronald Salole (Vice-President, Standards, Canadian Institute of Chartered Accountants) also preferred that the government introduce accrual accounting into all of its financial records. He reminded the Committee that accrual accounting is:

reporting and it is historical. It is not looking forward necessarily. It's telling it the way it is — not the way people want it to be or the way people like it to be, but the way it is.

            He preferred the use of an accrual based system of accounting because:

The accrual basis of accounting is the best way we've developed, internationally, globally, to be able to do that. It portrays a picture and says here are the transactions and events that occurred in this particular period. Here's the balance sheet, the statement of the financial position. It tells you what its assets and its liabilities are, and it tells you what the changes in those assets and liabilities are. We focus on setting standards for that, because we can come up with some rigid, well-based, well-grounded principles, and we reason from them.

He also noted that:

… research shows that financial reports prepared on the accrual basis of accounting, historically, also happen to be the best predictors of what is likely to happen in the future.

Mr. Bruce Bennett, Acting Controller for the Government of Ontario appeared before the Committee to relay Ontario’s experience in implementing accrual accounting in appropriations. While he pointed out numerous hurdles that they had to overcome he believes that it was a positive experience. Among a number of benefits arising out of the experience he pointed out that accrual accounting offers:

A better measurement of program expenditure is the most fundamental one, and there is an improved basis for year-over-year comparisons of program expenditures. In other words, the timing of when actual cash payments went out is not as relevant as when the actual expense was incurred or consumed.

It provides a more comprehensive base for legislative and management control of the provincial expenditures … it really eliminates the confusion from maintaining a different basis of accounting for estimates than was used for the province's summary financial statements and budget.

Mr. Arn van Iersel, the Acting Auditor General of British Columbia also presented a long list of costs and challenges that the Province of British Columbia experienced when the government introduced accrual accounting practices. However, he explained that the decision to go forward was not taken without anticipation of realizing some benefits. On the basis of his experience he believes that accrual accounting enhances transparency and accountability with the estimates and the public accounts on the same basis.” He also believes that accrual accounting improves the management of government resources.

We also believe it improves the management or stewardship of resources, capital assets being one of them. In the previous system, where capital assets were expensed, this led to a desire in some cases to buy those assets strictly subject to appropriation room at the end of the year — and then you sort of bought them and forgot about them.

That isn't happening in B.C. now. You purchase assets, but you have to know that whatever the amortization period is, this is a cost that will carry on into your future budgets. If you have significant asset acquisitions, of course, this infringes on other operating costs. So we think it makes people more responsive and more accountable for capital in other resources.

E) Some Concerns

While the witnesses appearing during the Committee’s study were generally supportive of introducing accrual accounting in government, the Committee is aware that there are concerns about the process. Having the entire government adopt full accrual accounting is complex and costly. The witnesses from the governments of Ontario and British Columbia were very clear in relaying to the Committee the numerous hurdles and challenges that need to be overcome in order to successfully introduce accrual accounting into government. In addition the Committee reviewed a study commissioned by the Treasury Board Secretariat that considered in detail the issues and problems that the federal government would face in implementing accrual accounting. Undoubtedly the preparation of additional financial statements and the inclusion of new items in the budget and appropriations documents will necessitate additional operating expenses in their preparation that are not incurred in the current system. However, these additional costs will be offset by the elimination of the significant costs that are currently incurred when the government attempts to reconcile its cash accounting items with its accrual accounting statements at the end of each fiscal period. Furthermore the ongoing benefits of greater transparency in government financial documents will lead to additional savings through more accurate effective decision-making by departments.

The Committee found that most of the issues and problems that are cited against the introduction of accrual accounting involve technical accounting matters that on the whole have been solved by accountants in one jurisdiction or another. In particular there are problems involved in valuating heritage and military assets and in valuating environmental and social liabilities. Clearly, these technical accounting problems are not common to the private sector where accrual accounting has long been practiced. The essential problem is that there are unique assets and liabilities in the public sector for which there exist no set rules to guide officials tasked with preparing government financial documents and statements. This lack of guidance could result in inappropriate treatment of assets and liabilities which in turn could have an impact on fiscal policy. Where programs yield future cash flow, accrual budgeting would move cost recognition forward, and so contribute to the evaluation of the sustainability of fiscal policy. On the other hand, where activity involves capital assets, accrual budgeting delays the recording of costs by spreading them over the useful life of the assets, and this could undermine fiscal policy.

The fact that certain assets and liabilities may accrue in one period but be expensed or amortized in another also creates concerns. Accrual based accounting recognizes those events which raise the prospect of granting multi-year appropriations or of acquiring assets with an amortization period that goes well beyond a parliamentary mandate. Such a prospect worries many people concerned about budget discipline.

Finally, if the federal government were to adopt full accrual accounting, it would require a complete reworking of the content of the budget reports presented to Parliament. The budget documents would be remodeled to take account of the government’s financial performance and the state of its finances and cash flow.

The Committee discussed all of these concerns with the various witnesses and its views are expressed in subsequent chapters.

After examining the evidence it received on the benefits and concerns about introducing accrual accounting in government finances, the Committee concluded that the benefits and advantages of operating under a full accrual accounting system outweigh the concerns expressed by the critics. The Committee therefore recommends:

RECOMMENDATION 1

That the Government of Canada adopt full accrual accounting for budgeting and appropriations.

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6	Jon Blondal, 2004, Issues in Accrual Budgeting, OECD Journal on Budgeting, vol. 4, no. 1, p. 103-119.

7	Treasury Board Secretariat, Accrual Accounting for Budgeting and Appropriations, Brief presented to the House of Commons Standing Committee on Government Operations and Estimates, September 2006.

8	As of 1 April 2001, all departments and agencies had successfully implemented new financial systems capable of handling accrual financial information for the preparation of summary and reporting financial statements. Report of the Auditor General, December 2002, Chapter 5, p. 1.

9

See: Reports of the Auditor General for the years 2002 (Chapter 5), 2004 (Chapter 6), and 2005 (Chapter 8). The HCSC on Public Accounts has made numerous recommendations to the Government urging it to implement an accrual budgeting system. For a partial list of the Public Accounts Committee’s recommendations see the Report of the Auditor General, February 2005, Appendix C.

10	The PSAB consists of one Chair and a maximum of 11 members recruited by the Board to serve in an individual capacity, and not as a representative of a government or organization.

11	Jon Blondal, 2004, Issues in Accrual Budgeting, OECD Journal on Budgeting, vol. 4, no. 1, p. 105-107.

12	Office of the Auditor General, Overview of Accrual-Based Budgeting and Appropriations, Briefing to the House of Commons Standing Committee on Government Operations and Estimates, 26 September 2006.