OGGO Committee Report

CHAPTER THREE — BETTER COST INFORMATION FOR BETTER RESOURCE MANAGEMENT: REGARDING TANGIBLE CAPITAL ASSETS

… the failure to use accrual information was a factor when departments chose the less cost-effective option for office accommodation.

Sheila Fraser, Auditor General of Canada, Tuesday, September 26, 2006

The main advantage of full accrual accounting is that it makes it possible to measure an organization's performance by focusing primarily on assets, on the management of liabilities and on the full cost of programs and services. In short, accrual accounting encompasses all resources management, not only the availability of funds or the short-term cash flow balance. In a modified cash accounting method as the federal government uses, attention is focused almost exclusively on expenses. Amounts spent on capital assets are more or less written off and are no longer shown anywhere. With an accrual-based budgeting method they continue to appear in the accounts as a cash acquisition creates an asset that has value. It is this concept of value that is the very basis of the philosophy underlying accrual accounting.

The accrual accounting method has many other advantages, the most important being that it gives managers a more comprehensive picture of their program's financial performance. Thus, it offers a better tool for deciding how best to manage available resources. Full accrual accounting should make it easier for Parliament to hold the government responsible for managing its assets, for the total cost of its programs and for its capacity to respect its short- and long-term financial obligations.

A) Capital assets: The example of the acquisition of leased office space

The May 2006 report from the Office of the Auditor General, whose Chapter 7 on the acquisition of rented offices occasioned a meeting of the Committee, provided a telling example of the potential advantages of full accrual accounting when the federal government is deciding whether to lease or buy office space. According to the Office of the Auditor General, under the present accounting method, the government does not always choose the most economical solution for the accommodation needs of its departments and therefore the taxpayers’ money is not always used in the best possible way. This is because decisions concerning the funding of capital assets are dependent on the availability of funds (parliamentary appropriations), which can be a major obstacle to the effective management of resources.

B) A typical example

Under a cash accounting method, the entire amount spent to acquire a real asset is listed as an expenditure during the fiscal year in which the transaction takes place. Besides not providing any information on the value of the government's capital assets or on the costs associated with using them in the delivery of services during subsequent years, the cash method introduces a negative bias with respect to capital expenditures and the government's acquisition of assets in the context of expenditure controls. Under this scenario the government will prefer to lease office space on a long-term basis rather than purchase it, so as to minimize its expenditures in the short term. This is often not the best solution.

On the other hand, under full accrual accounting, the government would no longer assign the entire cost of acquiring an asset to a single fiscal year if the asset's use extended over a number of years. Instead, the government would include this new acquisition in its portfolio of assets and spread out the costs of using and maintaining this asset (including amortization) as expenditures over subsequent fiscal years. Asset management would thus make greater use of concepts such as useful life or life cycle.

Consider the following fictitious case, presented to the Committee by the Office of the Auditor General on September 26, 2006, illustrates this situation:

On April 1, 2004, the government purchases a piece of equipment costing $100,000. The equipment is expected to last for 10 years and to contribute to operations evenly over that period.

• Under the accrual accounting method, the government would record the $100,000 cost as an asset in the 2004-2005 fiscal year in which it was purchased and then record $10,000 of amortization expense for each year of its useful life, that is 10 years.
• Under the cash method of accounting, the government would have recorded, in the 2004-2005 fiscal year, the entire cost ($100,000) as an expenditure for that year.

In addition, the accrual method continues to track the outstanding annual balance of the asset until it is sold or removed from service. The cash accounting method, however, would not have reported that any balance was remaining.

Table 2

PURCHASE OF EQUIPMENT COSTING $100,000
	March 31
	2004-2005	2005-2006
Impact on operations	—	—
Cash accounting	(100 000 $)	0
Accrual accounting	(10 000 $)	(10 000 $)
Impact on balance sheet (tangible capital assets)	—	—
Cash accounting	0	0
Accrual accounting	(90 000 $)	(80 000 $)

Source : Office of the Auditor General.

C) Better management of government assets

Given the evidence it heard, the Committee is of the opinion that accrual-based budgeting and appropriations at the departmental level may be a catalyst for wide-ranging reforms in government management. Adopting full accrual accounting could thus open new perspectives on investment decisions, accountability and the stewardship of government assets by:

• providing a context conducive to debates on maintaining, renewing, replacing and funding assets;
• establishing a common basis of measurement to assess the value of assets;
• providing a point of departure to evaluate the physical condition of infrastructures and other assets on a regular basis over the years;
• providing a better idea of the costs related to the delivery of services to the public that require the use of real property or other assets.

In addition, the Committee thinks that better information on real property and assets in general will allow the government to make better decisions in order to:

• dispose of surplus assets more quickly and at a better price in order to use the product to reduce public debt or invest in other government operations;
• better anticipate the normal deterioration process of real property and infrastructures in order to take the necessary measures to limit the future costs of maintaining, renewing or replacing them.