Assessing Accrual based accounting systems

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It has been argued that the "rhetoric of government about accruals accounting can be very different from the reality of accruals based accounting systems in actual use" (Connolly & Hyndman, 2006); implying that many of the benefits of RAB are exaggerated and that the advantages are much more difficult to realise in practice. Connolly and Hyndman regard it as a possible deliberate overstatement of Resource accounting's benefits, and an understatement of the costs involved. This view is supported by Rubin (2000) when remarking on budget reforms. Rubin claims that sometimes it is the case that reformers, such as the Government, make amplifying claims about the benefit of a particular reform so as to get the proposal accepted. In her work on the politics of public budgeting, Rubin evokes the idea that in order to obtain acceptance of reforms, the government commonly use an assortment of approaches such as the exaggeration of benefits.

Another example of an approach/strategy government use is the creating of difficult-to-substantiate arguments that there is a need for reform that will enable future economic benefits (Rubin, 2000). This, Rubin argues, can give rise to the "presentation of figures of dubious accuracy and the construction of arguments that obscure rather than elucidate key decisions" (Rubin, 2000). This section will examine the disadvantages of using full accrual accounting in the context of the UK Governments Resource Accounting and Budgeting.

4.1 Complexity and Implementation costs

Through extensive research methods such as interviews, Connolly & Hyndman (2006) conducted a study of Resource accounting within Northern Ireland. Their study found that the RAB system is complex, expensive and has few benefits to date. Connolly and Hyndman established that whilst the HM Treasury held the opinion that the implementation of Resource Accounting would be "cost neutral" (Connolly & Hyndman, 2006), the interviewees whom participated in their study, emphasised that this was not true. It was revealed through the participants that even though none of the departments had prepared an individual budget for the introduction of resource accounting, or maintained a record of actual expenses occurred as a result of the introduction, the costs incurred were viewed as being sizeable; especially those in relation to payroll. There was always the likelihood that the introduction of resource accounting would create a path for increased costs, yet it was continuously refuted by officials. Interviewees went on to say that the production of truthful and fair cost information as part of an ex-post evaluation would not be accepted by those in favour of and promoting resource accounting (Connolly & Hyndman, 2006). Connolly and Hyndman claim that this "implies a process of understatement, official denial and obfuscation of cost had developed (perhaps deliberately), and this has possibly served to reduce both transparency and informed debate regarding the appropriateness of RA". This is similar to the theory of Rubin (2000).

In terms of complexity, parliamentary employees and National Audit Office officials are apprehensive due to the increasing complexity of resource accounting as it may have "negative implications for Parliamentary accountability and control" (Jones, 1996). Support of this comes from Wynne (2007) whom argues a possible relationship between the convolution of accrual accounting and decreasing surveillance by Parliament. This, Wynne claims makes government less accountable. These concerns are strengthened as a result of the severe dependence on professional judgement associated with accrual accounting. In Connolly and Hyndman's 2006 study, many participants noted that the complexity only acts as a dissolver of any potential that resource accounting has to meet its main aim of improving decision making in, and accountability by the UK public sector.

4.2 Increased costs of producing financial statements

The use of RAB has also led to increased costs relating to the production of financial statements. Wynne (2007) argues that these cost increases are the effect of the need to indentify and value existing assets, establish accounting systems and develop accounting policies and the required skills as well as provide training and guidance for both the users and preparers of the financial information. These are continuous expenses, connoting that accrual accounting creates incessant costs for its maintenance. This includes the cost of having to employ a large number of additional professionally qualified accountants as the government have customarily used few qualified accountants as the need had not arose for more due to the simplicity of the cash-based accounting system previously implemented (Wynne, 2007). This can be illustrated by the number of professionally qualified accountants in the UK central government which "increased nearly fourfold from almost 600 in 1989 to 2200 in 2003" (Wynne, 2007) in the period that accrual accounting was introduced in the UK public sector.

Participants in Connolly and Hyndman's study of RAB in Northern Ireland also commented on the number of supplementary positions created as a consequence of resource accounting. The median was approximately six or seven professional qualified accountants. One department in the study even alleged that resource accounting had created thirty additional posts in that department alone (Connolly & Hyndman, 2006). Although it is fair to say that most of the Northern Ireland departments are small in comparison to those in the UK, it still encountered a three-fold increase in accounting employees in many departments as a direct result of resource accounting. Such increases show the "magnitude of this enlargement", whereby an extra cost such as this reduces the funds available for the government to distribute to or to spend on, important sectors within the central government such as education and healthcare.

4.3 It is not in alignment with UK GAAP

It can be assertively said that accrual accounting is designed to measure profit, hence used by the private sector where the main aim is to produce surpluses. This notion is "largely meaningless in the public sector, where surpluses can arise from the failure to provide agreed services" (Wynne, 2007). Moreover, it is not the primary intention of the public sector to make a profit. With RAB in accordance to UK GAAP, it can be contended that this system is not designed to correspond to the objectives of governmental financial reporting; Barton et al (2005) even proposes that the framework of GAAP is at "odds with public service provision such as a national health service". This is illustrated in the work of Ellwood (2008), whom found that "the constructed reality of NHS accounting is accounting statements that are neither reflective of GAAP nor appropriate as a mechanism for controlling and monitoring NHS organisations", argueing that information produced through the implementation of resource accounting, is misleading to users accustomed to GAAP. Ellwood additionally argued that "the volatility and harshness of the regime causes, encourages and permits further distortions". This highlights a fundamental drawback of using accrual accounting as by producing a distorted view, the GAAP framework does not adhere to commercial reality, or public service values.

This concept of distortion has been supported by the work of Gainsbury (2006), claiming that it has been created through the exaggeration and disguising of deficits generated by the RAB's 'carry-forward' procedure. This procedure entails the carrying forward of under spending and overspending to the following year's revenue allocation. Gainsbury found that RAB inflated the NHS's net overspend in 2005 by £117 million through the disguising of "similar amounts of overspending over the past five years, as resources were inflated in each of those years through the previous year's under-spending". She states that the Department of Health's approximation of the 2005/2006 over-spend was £512 million of which only £395 million was the deficit for that particular year due to the £117 million over-spend from the 2004/2005 period being deducted from the revenue allocation at the beginning of the year. In effect, this £117 million was not allocated as revenue but used to settle the previous year's debt. Gainsbury notes that it is a vital concern that many trusts cannot supply sufficient services and care in the present year as their allocated revenue has diminished through covering the deficits accumulated in the previous year.

4.4 Inability to include future unearned income

A predicament for government is formed through not being able to include future unearned income on a GAAP-based balance sheet (Chow et al, 2007). The UK government currently uses forecasts of future tax revenues (a form of future unearned income) to construct decisions on a macro-economic level and the Treasury "undertakes a comprehensive spending review biennially, which looks ahead three years" (Ellwood & Newbury, 2007). Under the regulations of the UK GAAP, it will not be allowed to continue to forecast such unearned income; accrual accounting specifically prohibits this. This connotes that due to the fact not all financial information will be presented in the government published financial statements, information may be misconstrued.

The proposal of the inclusion of future unearned income such as tax revenues, and future liabilities would not be approved under the private sector's understanding of GAAP rules on provisions, contingent liabilities and contingent assets (Chow et al, 2007). Chow et al highlight that this can be seen in FRS 12, which forbids including unearned future income in order to "avoid giving misleading indications of the likelihood of a profit arising'. In response to this, Chow et al argue that in terms of the public as appose to the private sector there is a much higher level of certainty ascribed to future revenues and liabilities due to "government's sovereign 'right to tax' future taxpayers and its ongoing commitment to provide services such as healthcare and education". However, this certainty does not allow it to adhere to the conditions to be included in a GAAP-based balance sheet. Consequently the exclusion of these future cash flows, as a result of accrual accounting explicitly forbidding it, restricts the use of accrual balance sheets in evaluating the long-term fiscal stability of the government.

To place this situation in context, the need to include future unearned income and liabilities in the balance sheet is not a recent issue. Buiter (1985) had put forward the proposition of a more complete balance sheet nearly a quarter of a century ago. The model Buiter constructed was future orientated and through the use of actuarial based measures he aimed to take into view the present value of future income. Buiter's (1985) justification of the rationality of such an act was the Government's sovereign entitlement to set taxes. His model also took into account the present value of the spending commitments held in the future. Buiter ( 1985) argued that this model he had designed was "capable of assisting government in improving its management of public sector solvency, sustainability, and inter-generational fairness". This proposal was dismissed by the HM treasury soon after the concept was put forward alleging its execution would be far too complex owing to the substantial amount of estimating necessary to enumerate the future-considerate information (Odling-Smee & Riley, 1985). It was the result of fundamental economic changes such as the proposal and implementation of Resource Based Accounting that rekindled the interest in the orientation of the balance sheet from the late 1990's.

4.5 Potential to undermine fiscal control

Another issue that arises through the use of accrual accounting in government is the effect, or in fact, influence, it has on fiscal policy. With accrual accounting, in terms of tax revenues, there is a tendency to "overestimate the amounts of revenues that represent a real receivable for the government" (Marti, 2006). This is a result of the differing recording of expense; accruals budgeting records capital expenditure less depreciation, whereas cash budgeting records the actual capital expenditure. Therefore, under the accruals concept, there would be a lesser expense figure.

This treatment has the potential to undermine fiscal control. It could lead to the UK government making decisions on undertaking capital projects which are costly, knowing that the cost of the project would appear in the budget over a number of years following the period in which the decision was made, as oppose to appearing fully in the period of decision. This does not show the government's true financial position as attempts to support and increase fiscal discipline are weakened by evasive approaches (Hepworth, 2002). Hepworth regards this matter parallel to Marti (2006) arguing that "although [accrual budgeting] inhibits certain scams, the accrual basis introduces new complexity into financial management. For one thing, most governments still maintain some cash controls; for another, the accrual basis relies on assumptions about income, assets and liabilities". However, he does not imply that the cash-basis of budgeting is free from "scams," in fact; Hepworth (2002) argues that with cash budgeting "governments can satisfy fiscal norms by deferring payments or accelerating tax collections, by deferring maintenance and selling assets, and by a variety of bookkeeping tricks". Hepworth notes that the shift to accrual may have been an act to counter this, nevertheless he argues despite cash based accounting's shortcomings, its prevailing desirability is that it is based on actual transactions and not assumed transactions which accrual budgeting is centred around.

4.6 Limitation of the role of Government

Moreover, another dilemma caused by accrual accounting is the possibility of the role limitation of government and hence, the loss of control. Ellwood and Newbury (2007) argue that although there are benefits associated with accrual accounting, the mode in which this form of accounting has been pioneered in the UK government supports the progression of neo-liberal policies of privatisation and trade liberalisation by imparting misleading and biased data. This is due to the information produced having the purpose of being an influential factor on decisions and policy outcomes.

To put this into context: three features make up the neo-liberal reforms; firstly, anti-inflationary monetary policy; second, macro-level fiscal disciplines which are obligatory for the government in order to attain balanced budgets; and finally, micro-economic reforms which encourage trade liberalisation and inflate the business sector. Together, they form an "iron tripod" (Ellwood & Newbury, 2007) which "constrains and reduces the size and power of governments while at the same time supporting and encouraging the expansion of business activity" (Ellwood and Newbury, 2007). The effect this has is that it reduces the role of the government or increases the role of other institutions in providing goods and services (Savas, 2000). Consequently, the role of government is "re-cast as merely a procurer, rather than a provider of services, purchasing in a competitive, or at least, contestable, market" (Ellwood & Newbury, 2007).

Therefore, it can be argued that through accrual accounting, government has lost part of its role as well as its control whilst inadvertently becoming similar to a private sector business as the role shifted from provider to purchaser. Accrual accounting has, in this sense, undermined the authority of the government.

4.7 Subjectivity

Another problem with accrual-based accounting is it subjectivity. Athukorala & Reid (2003) argue it is "less objective than cash accounting" (Athukorala and Reid, 2003), allowing scope for manipulation as the financial information is vulnerable to biased opinions. Even Likierman, the person who was responsible for the introduction of RAB in the central government of the UK, had in 1992, years before supporting accrual-based accounting, held the opinion that cash-based accounts "despite their crudeness, have a degree of transparency that accrual accounts cannot give and that many private sector financial reports do not seek to offer" (Likierman, 1992).

Furthermore, it has been regarded that the extent of the potential for manipulation and misinterpretation of resource accounting information has made committees of the parliament concerned that the comprehensibility of the financial information may be forgone and the control of the parliament diluted (Connolly & Hyndman, 2006). This lack of objectivity, restricts the understanding of accrual accounting information for both the public and Parliament, hence affecting the judgements of these crucial stakeholders.