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Accrual accounting in government
May, 24th 2007
The Railways is probably one department of the Government where transition to accrual accounting can be smooth and fairly fast.

Accounting on track. - N. Sridharan

In recent times there has been an increasing shift towards accrual accounting as distinct from cash in accounting in governments. While developed countries have gone in for some aspects of accrual accounting as basis for budgeting and reporting, the international systems for compiling government finance statistics and national accounts are wholly on accrual basis. The Government of India is also considering such a move.

Virtues of switchover

The proponents of accrual accounting argue that there are immense benefits for the department, the government, the economy and Parliament if there is a switchover to accrual accounting. For departments, this accounting system will offer improved management information, particularly on costs and assets, including working capital, thus facilitating more informed management decisions on allocation of resources.

It will also be possible to judge the effectiveness and efficiency of the organisation over a period and across the sectors. For the government as a whole it is a beneficial tool for planning and control of public expenditure and serves as a better indicator of the sustainability of fiscal policies. With more quality data of National Accounts, evaluation of economic performance is greatly enhanced. As the system provides a stronger basis for Executive accountability, Parliament has better control over fiscal management. Thus improved resource allocation, enhanced accountability of the managers, greater fiscal transparency and a comprehensive view of the impact of government activities on the economy are all claimed as major virtues of accrual accounting.

Arguments against

Opponents, however, argue that implementation and operation of accrual accounting are difficult and expensive. Further, the element of subjectivity involved in recognition and measurement of assets and liabilities, rather than cash, may be susceptible to manipulation. The accounts are more difficult to understand and are not easily comprehendible to laypersons. The daunting and time-consuming nature of the changeover process can be judged from the fact that very few countries have implemented accrual accounting and even among the OECD countries the emphasis has been to modify the pure cash-based accounting system to a modified accrual system.

With the changing requirements of government policies, where improved mechanisms to ensure macroeconomic stabilisation objectives are called for, there seems to be a necessity to go in for some refinements in the existing cash-based accounting system. It must be admitted that the speed of implementation will vary from country to country and between the departments within the country. The Indian Railways, for instance, is well placed to migrate to a modified cash-based system, thanks to historical facts, frequent internal reviews and nature of operations .

New Zealand's experience

The only country which has gone in for a full-fledged accrual system, and that too at one shot, is New Zealand. The main piece of financial legislation introducing a major reform in Government from a system based on compliance, with detailed and restrictive rules and budget cash limits, to a performance- and accountability-based regime, was the Public Finance Act 1989.

The budget documents of New Zealand indicate the commitment and objectives. For instance, the government's fiscal strategy, as presented in the budget for 2007, is to strengthen its fiscal position so that it is well placed to respond to future challenges such as those associated with population ageing.

The Government is implementing this strategy primarily by building up financial assets in the New Zealand Superannuation (NZS) Fund and maintaining gross debt at around 20 per cent of GDP. To keep debt stable, the Government has said it intends to run its cash position so that borrowing is in line with GDP over time. In practice, this means running operating surpluses sufficient to cover the contributions to the NZS Fund and some other capital spending needs

The strategy is illustrated in the Chart.

New Zealand's experience has been commended by the World Bank and other international organisations as a successful demonstration of a change in government accounting and budgeting that is possible. But not all countries are geared for such a leapfrogging approach. There has been a cautious and incremental approach even in countries such as the UK, the Netherlands, Canada, etc.

The UK has implemented what is known as Resource Accounting and Budgeting (RAB). The system is an accrual-based approach focusing on resources consumed over an accounting period rather than just cash spent. Accounting principles, policies and treatments are set out in the Resource Accounting Manual, taking into account the not-for-profit environment and the requirements of budgeting and Parliamentary control.

The Netherlands is another country where accrual accounting and budgeting have been introduced in all government services where it is deemed useful; but at the aggregate level the cash-based system of budgeting and reporting are maintained. The Canadian Government's policy on classification and coding of financial transaction provides information for multiple users both within and outside departments. The four-way classification, as it is nomenclatured, entails departments to furnish financial information by authority, purpose, responsibility and object.

Expert Group's recommendations

The Government of India constituted an Expert Group to review the classification system for government transactions. The Group had as terms of reference the following:

Review the existing norms for classification of expenditure between capital and revenue and suggest improvements with a view to reflecting a true and fair view of Government Accounts;

Examine the feasibility of and suggest the general approach to gender budgeting and economic classification; and

Suggest improvements in the current system for harmonising budgetary, accounting and economic classification.

The recommendations of the Group on the issue of harmonisation of different classification systems is adoption of a multidimensional classification structure with linkages between the accounting classification and standard international classification systems such as Government Finance Statistics (GFS) and System of National Accounts (SNA) with pilot-cum-parallel run in the Ministries of Education and Health.

The proposed structure will be multidimensional with four segments representing Fund, Economic Categories, Functions and Programmes.

The need for a sound classification system is well established. Especially in a Federal set-up like ours where funds devolution from Centre to State Governments takes place and programmes are implemented by State Governments, mapping of complex linkages at different levels is essential. The transition from cash to modified accrual accounting necessitates adoption of a classification structure that facilitates the recording of revenues, expenses, assets, liabilities and cash flows so as to conform to Government Finance Statistics Manual 2001(GFSM 2001).

Once this is established, the transition has to follow a strategy. First, the system of cash accounting should work well. This may necessitate adjustments to improve fiscal reporting. An essential element of this adjustment will be to include payables and receivables. The next stage is to introduce additional elements of accrual accounting to identify and assess the provisions for employee entitlements such as pensions, which have generally been shown to be a significant hidden cost.

Recognition and provisioning of these liabilities will ensure that budget managers are not taken by surprise in future. Similar treatment is warranted in the accounting of payments received by Government, especially deposits and instalment payment. Interest payable on debt also should be realistically assessed.

The Railway Ministry is probably one department of the Government where transition to accrual accounting can be smooth and fairly fast. As companies built and operated the Railways, the accounting systems had commercial links and orientation. The Railways does maintain a double entry book-keeping format, linking accounts to record unrealised dues and un-discharged liabilities.

`Traffic suspense' is a suspense head which shows the outstanding dues of train operations. Billing for other transactions such as licensing of railway land, advertisement hoardings, stalls, etc., are routed through `Demands Recoverable'. Expenditure pertaining to the previous fiscal is brought to account through `Demands Payable'.

The Railways compiled its asset register in 2000-01 and announced that depreciation provision will be linked to the actual requirements of replacements and renewals. Actuarial evaluation of pension liability is under process. The Ministry has been compiling Performance budget since 1994-95, arising out of the recommendations of the Standing Committee. The budget gives an appraisal of the Railways' performance, including shortfalls, if any, in respect of revenue earnings, expenditure and plan-head wise performance. Keeping in view the Government's guidelines to convert financial outlays into physical outcomes, the `Outcome budget' has been introduced from this year.

As has been stated in the document, there is a mechanism to measure the development outcomes of all major programmes in the Ministry with quarterly measurable, monitorable targets. The accounting classification of the Railways identifies the authority responsible for activities under each demand. A study commissioned by the Comptroller and Auditor General of India had concluded that the Ministry of Railways can easily migrate to accrual accounting with minimal adjustments. Now that the Railways is the cynosure of all eyes, with improved finances, the next step forward can be to modify its accounting system to facilitate evaluation of its efficiency, effectiveness and service delivery.

Vijayalakshmi Viswanathan
(The author is former Financial Commissioner of the Railways.)

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