Government accounting: awash on a sea of money

EXPERIENCE of public sector accounting has left me with the view that governments show a systematic, pervasive, though possibly not deliberate, ignorance of the critical value and importance of good accounting to their own management. What will it take for governments to take their financial responsibilities seriously?

The world economy is emerging from a global financial crisis, which tested the international financial system to its limits. Many governments intervened dramatically in their economies by acquiring assets and liabilities or through other significant economic interventions. The majority of those actions will not be accounted for properly. This is not a new phenomenon; Governments have always been reluctant to embrace the highest accounting standards for their own reporting.

Some of this may have arisen from negligence – but in many cases, it was deliberate. For example, many public and private arrangements for the construction of public infrastructure were designed in significant part to limit public sector borrowing requirements, even though these arrangements resulted in substantial liabilities and obligations, conveniently not reported under cash accounting.

We are in the middle of a crisis associated with Greek, and other countries’, sovereign debt. Part of the problem, at least in the Greek case, was what in the private sector would be labelled financial reporting fraud. Astonishingly, financial crises involving either financial reporting fraud, unauditable and unreliable financial information, or reporting against low quality standards do not seem to lead to calls for better accounting by governments. They certainly do in the private sector, and rightly so. Indeed, in the middle of the sovereign debt crisis, major European governments rebuffed the nine smaller countries who wanted the EU to address one of the most egregious areas of government accounting – pensions.

Could poor standards of accounting have been deliberately selected so some governments would not have to face – and answer for – the financial hole in which they find themselves?

There is expertise out there for governments to draw on. Bodies such as CIPFA promote good public financial management and trains accountants in the highest standards of public sector accounting.

Yet, the relationship between governments and accountancy is not primarily about good financial reporting. An even more important failure lies in the field of service delivery. When governments mismanage, citizens lose by getting fewer services, of a lower quality, than otherwise.
So, what are the consequences of governments mismanaging their finances to the point where they cannot meet their obligations? They include policy adjustments, tax increases and spending reductions, through to the loss of democratic control.

Imposing the level of discipline required to make the necessary adjustments has, in some circumstances, led to external parties taking control of the government’s finances or to an authoritarian government taking power. These outcomes constitute a high price for weak governmental institutions.

An appropriately designed financial framework could significantly assist governments in managing their finances. Good accounting and financial management is not the only explanatory factor, but it is worth considering the New Zealand experience during the past two decades.

The New Zealand Government strengthened its balance sheet to a position in which it had a net worth equivalent to nearly 60 per cent of GDP from just over 10 per cent at the beginning of the last decade and from a negative net worth position a decade earlier. As a result the capacity to absorb the shock of the financial crisis was significantly greater and therefore the risk of social disruption reduced.

During this period the New Zealand Government reported its financial position on a full accrual accounting basis – the same as is used for the private sector – and did so on a monthly basis. This made the complete fiscal position available each month when the latest results and associated full year projections were released. This reporting basis greatly increased the information in its financial statements and enabled New Zealand’s public sector managers to make financial decisions on their true position, rather than on short-term cash flows.

These developments in financial management are regrettably atypical, which is hard to understand when the accounting policy issues are entirely manageable and we know how to apply accrual accounting and budgeting in large organisations.

If the issue is resources, imagine a large corporate explaining to its regulator and shareholders it cannot meet its reporting obligations because it cannot afford a decent accounting system.

The reality is that politicians, public servants and voters do not always act entirely in the public interest, and are better seen in the same manner as economics regards others – rational and self-interested. These characteristics go some way to explaining why we do not have high standards of transparency and accounting in governments, particularly as governments choose their own accounting rules.

This is, of course, not saying public servants never act in the public interest, rather that they are people just like those in the corporate sector.

For this reason, as in the corporate sector, their decisions and behaviour need to be constrained by reporting obligations that fully disclose the government’s financial performance and position.

In the absence of high quality financial management and reporting, governments will continue to expose the international financial system to risk and themselves to the accusation of double standards, which, in the eyes of the public, diminishes both politicians and the political system.

Ian Ball is CEO of the International Federation of Accountants

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Fiona Westwood of Smith and Williamson.