This background paper was prepared by a World Bank team consisting of Jim Brumby (Senior Advisor), Bonnie Ann Sirois (Senior Financial Management Specialist), Juan Carlos Serrano-Machorro (Senior Financial Management Specialist), and Paul Mason (Consultant), to provide background information to Chapter 2 of the Debt Transparency in Developing Countries publication on the role of accrual basis accounting and related financial reporting frameworks as a factor in fostering debt transparency. The team is grateful to Diego Rivetti (Senior Debt Specialist), Edward Olowo- Okere (Global Director, EPSDR), Fily Sissoko (GOV Practice Manager EEAG2), and Ian Ball (Professor of Practice - Public Financial Management, School of Accounting and Commercial Law, Victoria University) for their comments and guidance on the report. The team thanks the peer reviewers Cigdem Aslan (Lead Debt Specialist, EMFMD), Svetlana V. Klimenko (Lead Financial Management Specialist, OPSFM), Sailendra Narayan Pattanayak (Deputy Division Chief, FAD, IMF), Raymond Muhula (Senior Public Sector Specialist, ESAG1), and Parminder P. S. Brar (Lead Governance Specialist, EAWG2) for their review and comments. 1. Introduction .......................................................................................................................................... 1 2. Implications of accrual basis accounting on debt transparency ........................................................... 5 A. Defining debt transparency and how it connects to accrual accounting ............................................. 5 B. Role of general-purpose financial statements in the public sector ...................................................... 7 C. Relevance of financial reporting to debt reporting .............................................................................. 8 E. Additional financial reports on long-term sustainability and/or fiscal risk......................................... 22 F. Influence of accruals on political economy for borrowers and lenders ............................................. 23 G. A way forward for countries to use accountancy to improve debt transparency ............................. 26 3. Summary and Conclusions .................................................................................................................. 34 References .................................................................................................................................................. 37 Annex A - Summary of Foundational Differences between IPSAS and GFS ............................................... 40 Annex B - Systems and Institutional Arrangements ................................................................................... 42 Annex C - Key Factors to Consider when Implementing Accrual Accounting in the Public Sector............. 45 Annex D - Resources ................................................................................................................................... 47 1 Analyzing public debt in low-income developing countries (LIDCs) is like solving a puzzle with many missing pieces. Nearly 40 percent of LIDCs have not published any sovereign debt data in the last two years. Public debt data disclosed in different publications show discrepancies of up to 30 percent of gross domestic product (GDP) across sources and relative to the records of relevant authorities. Over 15 LIDCs have outstanding collateralized debt but no details of the collateralization are provided in official statistics.2 Restructuring of bilateral and commercial debt is often handled privately. All these problems have different origins and implications. Yet, they all amount to a lack of transparency. Greater public debt transparency is essential for macroeconomic stability and sustainable development. To meet the Sustainable Development Goals (SDGs) by 2030, LIDCs will need to invest at least 4.5 percent of national GDP each year on infrastructure alone (Rozenberg and Fay 2019). With growing current account and budget deficits following the global economic slowdown, initial World Bank estimates indicate that external financing needs in LIDCs will reach US$429 billion between 2023 and 2025. Most of these financing needs will have to be met through new borrowing. To ensure that this financing contributes effectively to development outcomes and does not undermine long-term debt sustainability, debt transparency must be improved. This could contribute to mitigating the severity of ‘boom- bust’ cycles and help avoid setbacks in poverty reduction and other development objectives (Reinhart and Pazarbasioglu 2021). The international community has become acutely aware of the importance of debt transparency after recent cases of ‘hidden debt’. The ‘Tuna Bond’ case in Mozambique highlighted the dangers of inadequate debt transparency. In 2016, two large previously unreported loans totaling US$1.15 billion—equal to about 9 percent of the country’s GDP— 1 The introduction draws from elements of the World Bank Publication, Debt Transparency in Developing Countries, to which this background paper contributed (Rivetti 2021). 2 In this report, LIDCs are broadly defined as countries eligible for support from the International Development Association (IDA): http://ida.worldbank.org/about/borrowing-countries. were revealed.3 As a result, donor support was frozen, the economy plunged, and the government was forced to make deep cuts in public spending. The biggest losers were poor Mozambiquans. Nontransparent public debt can quickly alter the lives of millions of ordinary citizens. The COVID-19 pandemic has further highlighted the central role of debt transparency in better assessing debt sustainability, addressing vulnerabilities, and facilitating debt restructuring. The crisis has increased the size of the balance sheet of the public sector and exacerbated the likelihood of contingent liabilities materializing. According to the World Bank/International Monetary Fund (IMF) Low Income Country Debt Sustainability Assessment (LIC-DSA), 44 percent of LIDCs are at high risk of external debt distress and 12 percent of them are already in debt distress. Inadequate transparency could delay debt restructurings and curb the ability of low-income countries to overcome the pandemic and generate a green, resilient, and inclusive recovery. The World Bank Group has responded to the COVID-19 crisis and the need for countercyclical policies by expanding lending, spearheading debt suspension, and promoting greater debt and investment transparency, but client capacity to record and report on complete debt data is still lacking or insufficient. The World Bank and IMF’s call for debt-service suspension to the poorest countries was taken up by the World Bank’s Development Committee and the G-20 Finance Ministers in April 2020, through the Debt Service Suspension Initiative (DSSI), which has subsequently been extended through June 2021. The World Bank has also promoted greater debt transparency through the Sustainable Development Finance Policy (SDFP), an incentive-based approach to leverage reforms for transparent and sustainable development finance in IDA-eligible countries. One of the challenges associated with the implementation of these initiatives, however, is that many clients do not have the capacity or data necessary to comprehensively record and report the entirety of government liabilities, which reduce their chances to meet certain eligibility requirements. In June 2020, the World Bank Group specified five key principles to improve debt transparency and improve investment flows, which apply to borrowing countries as well as creditors. 1. Spell out loan contract terms and payment schedules. 2. Ensure full disclosure of the stock of public and publicly guaranteed debt, SOE liabilities, and debt-like instruments. 3. Enable borrowers to seek relief from excessive confidentiality clauses so they can proceed with more transparent data reporting. 3 The loans were part of a larger financing operation organized by two state-owned enterprises (SOEs) under guarantee of the central government. The revelation led to large upward revisions to Mozambique’s official debt figures. Subsequent investigation showed that the guarantees were not subject to scrutiny by the Ministry of Finance (MoF) before being approved nor were they subject to oversight by the Parliament. 4. Promote effective and prudent use of collateral and liens in sovereign borrowing. 5. Insist that borrowers and lenders avoid violations of legal requirements of other creditors, such as negative pledge clauses. Despite these efforts, the integrity of debt data remains a challenge to debt transparency. A variety of recognition, measurement, and reporting approaches are being employed across jurisdictions, which makes interpretation and cross-country comparisons of debt difficult, and underlying debt data is subject to varying levels of assurance and scrutiny. A prerequisite for enhanced debt and investment transparency is more comprehensive and consistently applied practices for recognition, measurement, reconciliation, reporting, disclosure, and assurance of debt data. The World Bank publication, Debt Transparency in Developing Countries, is the first comprehensive assessment of debt transparency in LIDCs. It presents a complete picture of the current challenges and the pending policy agenda for all stakeholders. It draws upon new databases and surveys to take stock of key gaps in debt reporting, borrowing practices, and legal frameworks, offering a detailed and timely view on the current state of debt transparency in LIDCs. It also synthesizes recent studies and policy discussions on debt transparency and offers practical policy recommendations required to further improve debt transparency in LIDCs. The publication A Sum of Parts: Sovereign Debt Measurement and Reporting explores the role of accrual basis accounting and related financial reporting frameworks as a factor in fostering debt transparency. It was developed as a background paper to inform Chapter 2 of the Debt Transparency in Developing Countries publication, which presents disclosure practices under direct and indirect reporting frameworks and provides evidence on the role of factors that can either foster or deter debt transparency. The objective of this publication is to expound the role of accrual basis accounting and related financial reporting frameworks as a factor in fostering debt transparency. The publication touches on various aspects of accrual accounting, beginning with background information and following with an explanation of the objectives of general-purpose financial statements for governments, the relevance of financial reporting to debt reporting, an overview of fiscal and financial performance indicators based on financial reporting, an explanation of the influence of accruals on political economy for borrowers and lenders and some recommendations with a way forward for client countries to use accountancy to improve debt transparency. The document describes the role of financial reporting as one key avenue to improve the quality of underlying debt data and achieve debt transparency, rather than the only solution to achieve such objectives. Furthermore, there are other key areas in the spectrum of public financial management (PFM) which may be equally relevant to improving the quality of debt data and contributing to debt transparency, such as the implementation of a sound internal control framework, the existence of qualified human resources, well- functioning interconnected financial management information systems, and a strong and well-resourced Supreme Audit Institution (SAI), to name a few. . The World Bank Publication, Debt Transparency in Developing Countries, defined debt transparency as the availability of debt data and borrowing processes that are legitimate, rule based, and traceable. Borrowers and creditors need detailed information on the outstanding stock of public debt, including terms and conditions, to make informed borrowing and lending decisions; citizens also need this information to hold their governments accountable. However, this is only part of debt transparency as reporting needs to be complemented by borrowing processes and practices that ensure that new debt is contracted responsibly and in line with sound legal and operational frameworks to minimize enforcement uncertainty. Debt transparency has two interrelated dimensions: Transparent debt reporting 4 and transparent borrowing operations.5 Accrual accounting is one of the key components of the former. This means that it is one key building block to achieve debt transparency. Taken in isolation, it is a necessary but not sufficient condition in the path to achieving debt transparency. Transparent debt Transparent borrowing reporting operations 4 Transparency in debt reporting means that debt reports should comprise comprehensive, timely, and consistent debt data at public sector level. To facilitate cross-country comparability and comprehensive debt analyses, public sector debt statistics (PSDS) should be compiled and reported based on internationally accepted statistical definitions and concepts (Public Sector Debt Definitions and Reporting in Low-Income Developing Countries; Feb 11, 2020.” https://www.imf.org/en/Publications/Policy-Papers/Issues/2020/02/11/Public-Sector-Debt-Definitions-and-Reporting-in-Low- Income-Developing-Countries-49042). 5 Transparency around borrowing practices is needed to ensure that debt is contracted legitimately, shielded from undue political interference, and grounded on a sound analysis of the legal implications and financial cost and risks of the different borrowing alternatives. An accounting framework comprises criteria for measuring, recognizing, presenting, and disclosing financial information which is presented in an entity's financial statements. Accounting frameworks provide detailed criteria for defining, measuring, recognizing, presenting, and disclosing the liabilities of an entity. Under accrual accounting frameworks, liabilities are generally defined as “present obligations of an entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits or service potential.”6 The definition of liability therefore includes debt as well as non-debt obligations. Although accountancy is fundamental to understanding the general financial health of organizations, it has typically not played a central role in fiscal analysis. In the absence of accrual accounting, fiscal sustainability and economic analysis are often compiled based on statistical data that may not be fully derived from governments’ accounts. Such analysis often relies on manual processes to gather data and crosswalk tables to provide a bridge from the underlying cash basis or obligation basis accounting records. These procedures are generally not subject to audit or other assurance procedures and are often based on estimates rather than actual results. Despite the lack of assurance over the underlying data, the resulting fiscal sustainability and economic analysis outcomes are often published and generally accepted as reliable reflections of countries’ fiscal conditions. Data Definitions: Calculation and comparability of overall debt levels in various jurisdictions are hindered by the fact that the conceptualization, definition and understanding of what constitutes “debt” and, thus, subsequent recording and reporting of government liabilities differ from country to country. That is, there is no consistency regarding the “categories” included in the compilation of general government debt data. Examples of such categories include local governments, extra- budgetary central government, social security funds, central bank, non-financial public entities, and state-owned banks or financial institutions at the subnational level. Data Standards: The lack of consistently and adequately applied public sector accounting or fiscal statistical frameworks and standards hinders data quality, jeopardizes subsequent analysis and decision-making process, and prevents greater alignment in debt reporting across constituencies. Data Recording and Reporting: Similarly, debt reporting and disclosure frameworks are not aligned among jurisdictions, meaning that debt figures and their derivatives are not comparable across countries. For example, many countries fail to report arrears on debt securities/loans, including interest and penalties that accrue on arrears into their accounting and statistical records. Valuation and consolidation practices are likewise unaligned. The international debate and positions taken on the question of debt transparency take on a different flavor when considered through the lens of standardized fiscal reporting drawing on accruals. First, rather than using resources and time to make the argument for transparency and defining the nature of that transparency, fiscal reporting principles guide the determination of appropriate reporting treatment. Second, by using uniform approaches, it is easier to make comparisons between countries and between lenders and borrowers. Third, inconsistencies between reporting for different purposes may be reconciled in a general manner rather than by country. So, for instance, the fact that 6 International Public Sector Accounting Standard (IPSAS) 19, Provisions, Contingent Liabilities and Contingent Assets. countries define ‘official’ lending differently (some with respect to the terms of the loans, others by the nature of interests in the lending entity) can be managed through the lens of a regulated standard. Fourth, it aligns responsibility for the reporting of debt to the general responsibility of reporting the financial condition of the state, separately from the responsibility for engaging in transactions relating to debt. Finally, and most importantly, it supports a discussion on substance rather than form. Analysis and debate about the substantive issue of country debt levels and appropriate policy would be crowded-in rather than debates about how to secure transparency. General-purpose financial statements of government, prepared on an accrual basis, are meant to provide a primary source of information for all interested parties to assess if government has met its commitments to its multitude of stakeholders. These statements gain value by meeting needs in addition to those associated with budget execution and international comparability. Drebin, Chan, and Ferguson (1981, 107) maintain that general- purpose financial statements for government should provide financial information to inform economic, political, and social decisions and demonstration of accountability and stewardship and provide information useful for evaluating managerial and organizational performance. The form of general-purpose financial statements for government aims to reflect the needs of the various stakeholders. While some specific aspects of the design and implementation of such can be left to local preferences, the core standards (such as IPSAS) should capture regulated requirements which stipulate the minimum needs to be met. General-purpose financial statements prepared on the accrual basis generally include the following three core statements:  A statement of financial position, recognizing assets and liabilities and disclosing matters of material impact  A statement of operating performance showing how the financial position changed through the year in terms of revenues and expenses and gains and losses  A statement of cash flows, showing inflows and outflows and changes in cash stocks organized by cash flows from operating performance, from investing, and from financing transactions. The notes to these statements generally include a summary of significant accounting policies and other relevant explanatory notes. Financial reporting and statistical reporting frameworks are both based on accrual principles, however each serve a different objective and some methodological differences between the two frameworks exist. The Government Finance Statistics Manual (GFSM), 2014 (p. 342) states that “GFS reports are used to: (i) analyze fiscal policy options, make policy, and evaluate the impact of fiscal policies, (ii) determine the impact on the economy, and (iii) compare outcomes nationally and internationally. The focus is on evaluating the impact of the general government and public sector on the economy, and the influence of government on other sectors of the economy.” Accordingly, financial reporting standards should not be interpreted as a replacement for statistical reporting and analysis. Likewise, statistical reporting is not a replacement for financial reporting. Use of these two frameworks in parallel maximizes understanding and transparency of debt. Because accrual accounting standards and statistical reporting frameworks have some methodological differences for recognizing and valuing transactions and events, the information produced by each reflect these differences. Considering the output of both frameworks can provide a more comprehensive picture of debt than either individual framework taken on its own. The scope and methodological differences of these frameworks should be understood to properly analyze these differences and maximize usefulness of the information produced by each. From the specific analysis of indebtedness to the financial relationships between governments, fiscal debates are strengthened when informed by accrual basis accountancy and financial reporting frameworks. Regardless, the canon of fiscal policy literature often makes little reference to accounting issues.7 Five key distinctions between a financial reporting approach and statistics approach support this argument and are central to the quest of creating an effective framework for managing public debt. (a) Financial reporting is based on the concept of ‘control’ rather than the economic sector, so that the reporting entity is aligned to the responsible entity rather than an analytical artifice. (b) Wherever possible, financial reporting standards mark debt to market values. (c) Financial reporting identifies debt obligations of all controlled entities and then consolidates (after eliminations) across all controlled entities, compared to a net equity concept that may apply statistically. (d) Financial reporting recognizes certain liabilities which are not recognized under statistical frameworks but which affect a government’s ability to service debt. (e) Financial reporting can generate new fiscal and financial performance indicators that can serve the goal of improving resource allocation and use within the public sector. In this paper, ‘accrual reporting standards’ generally refers to those standards captured by IPSAS. IPSAS are increasingly applied by national, subnational, and local governments and related governmental and intergovernmental organizations or institutions that have elected 7 Take, for example, the recent paper by Orszag, Rubin, and Stiglitz (2021) There is no mention of accounting or accrual despite nearly all recommended fiscal policy actions having a ‘through-time’ dimension, such as a focus on public investment, longer debt durations, and estimating liabilities. In his study of the relationship between financial accountability and the rise and fall of nations, Jacob Soll laments society’s recent inability to effectively audit and hold companies and governments accountable as seemingly incomprehensible. “In the wake of fiascos, like Enron, accountants have come to be perceived not only as boring but also as venal and inexpert” (Soll 2014, 205). to adopt them. The standards have come to be recognized globally as part of the normative architecture for financial reporting by government. IPSAS are not mandated by an international regulator. They are issued by the IPSAS Board (IPSASB), an independent standard setting body created under the auspices of the International Federation of Accountants (IFAC), following due process that provides the opportunity for comment by interested parties (including auditors), preparers (including finance ministries), other standard setting bodies, and individuals. IPSAS are based on International Financial Reporting Standards (IFRS) where appropriate and aim to improve the quality of general-purpose financial reporting by public sector entities, leading to better informed assessments of the resource allocation decisions made by governments, thereby increasing transparency and accountability. Like other general-purpose financial reports, IPSAS-based financial statements are typically subject to audit through jurisdictional requirements. IPSAS have a focus on public sector issues, but governments can determine whether IPSAS should apply to government business enterprises. Differences between statistical reporting frameworks and IPSAS have an impact on the amount of debt reported under each of these frameworks. Key differences relate to valuation, scope of consolidation, and criteria for recognition. Most notable among these differences is that IPSAS recognize debt based on fair value while statistical reporting frameworks recognize debt at nominal value.8 The impact of this difference is explored further throughout this paper. Another notable difference is that the scope of consolidation is more subjective in nature under IPSAS than GFS, and scope differences are often unique to each country. IPSAS recognize liabilities, including provisions, when (a) a past economic event has taken place, (b) the amount can be reliably measured, and (c) future outflows are probable. Conversely, statistical frameworks recognize liabilities at the point in time when economic value is created, transformed, exchanged, transferred, or extinguished. Other differences relate to presentation of financial information and terminology. For example, IPSAS financial statements provide information about individual entities; this is not a standard element of statistical reporting. A summary of the key foundational differences between the IPSAS and GFS frameworks which affect debt transparency is presented in Annex B.9 ‘Fair value’ is a central tenet of the financial reporting approach and requires applying the most verifiable methods to determine a reliable estimate of value. By definition, this is the price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants on a certain date. Fair value is especially important in the public sector on both the asset and liability sides. On the asset side, for instance, there are many assets held by governments which may not have a commercial use, and therefore it is difficult to estimate a contemporary value. The fact that the government has the power to alter its own obligations through legal change means that the value of some assets and liabilities can change quite idiosyncratically. 8 Debt is disclosed as a memorandum item at face value, nominal value, and market value (GFSM 2014, p.392). 9 Excerpts from IPSASB Meeting (June 2019) Agenda Item 1.6, IPSAS-GFS Tracking Table. The differences in consolidation methodologies between GFS and IPSAS may result in differences in the scope of consolidation and therefore the amount of debt reported under each framework. Under IPSAS, consolidated financial statements are prepared for ‘whole of government’ based on the concept of control. Control is defined as an entity’s ability to influence the nature and amount of benefits through its power over another entity. Such consolidation criteria may not align with the general government sector which is overwhelmingly used as the basis for GFS consolidation and oftentimes results in a broader scope of consolidation.10 For example, general government GFS consolidation does not include entities engaged in market activities such as SOEs, even though wider public sector reporting does. Conversely, local governments may not be consolidated under IPSAS if they are not controlled by the central government. Control can be a difficult concept to apply to the public sector. In some countries, subnational governments (for example, states or provinces) may be independent rather than being controlled by central government. They may, however, still be dependent on transfers from central government for a significant portion of their budgets. The extent to which this gives a degree of control to central government will depend on the freedom that central government has to determine the level of the transfers, which may be specified in legislation or the Constitution. Similarly, central government may provide bailouts for subnational governments facing debt distress, although this does not happen in all countries. However, as was seen in the 2008 financial crisis, governments may be required to provide bailouts to other sectors of the economy that are clearly not controlled by the government. These factors do not necessarily mean that central government controls the subnational governments, but they do show that determining control in the public sector can be complex. Comparing the entities consolidated under both GFS and IPSAS can provide a useful indication of a government’s potential obligations in the case of institutional failures elsewhere in the public sector. In 2014, the Government of Honduras, through its MoF and the Technical Board of Auditing and Accounting Standards (JUNTEC, by its acronym in Spanish), approved a legal resolution aimed at the adoption of IPSAS commencing in FY2019. The strategy laid out by the government consisted of classifying the IPSAS into three categories: high, medium, and low priority. IPSAS 6 (Consolidated and Separate Financial Statements) was included among the high-priority standards. The country has achieved full consolidation of the central government sector, including the executive, legislative, and judicial branches, according to the Public Expenditure and Financial Accountability (PEFA) conducted in 2016. The financial statements are publicly available and are regularly audited in accordance with the country legal framework. Further, Honduras has continued advancing toward the consolidation of further sectors into the financial statements, including the social security entities, SOEs, universities (with 95 percent advance), and subnational governments (with 77 percent advance). 11 While Honduras has already developed a normative framework for accounting consolidation and a suitable chart of accounts, some challenges remain, including the lack of an automated system. The country is now developing an automated process for the consolidation. In the meantime, spreadsheets are used for consolidation. 10 Under GFS, nonresident and resident market institutional units are included as a single line showing net investment rather than fully consolidated into the general government sector (GFSM 2014, p.344). 11 Source: Memory book from the Forum of Government Accountants of Latin America, supported by the Interamerican Development Bank, 2019. One of the most significant differences between statistical and financial reporting rendering of the State is the way in which the entity of the State is defined. This difference goes to the heart of the different purposes for statistical and financial reports. Statistical reports are chiefly to generate a total picture of the economy. Government Finance Statistics (GFS) is one of the four core standards for measuring the economy; the other three are the balance of payments, national accounts, and money and banking (financial) statistics. GFS estimates are directly comparable with these other statistics as they share the same underlying concepts. For financial reporting, the purpose is to generate a representation of all the financial interests under the control of a single entity. For comparison, here are some examples of the key financial indicators for New Zealand expressed in GFS terms for the general government and central government (Source: Statistics NZ, December 2021) and then the comparator in financial reporting (IPSAS) terms for the New Zealand Crown (Source: Crown Accounts published by NZ Treasury, October 2021).  Under GFS, New Zealand general government net operating deficit improved to NZD 904 million as of June 2021. The GFS measure of central government showed strengthening from NZD 15.4 billion deficit to NZD 2.6 billion deficit. Crown Accounts (which do not include local government) show the operating balance before gains and losses (OBEGAL) was a deficit that improved by NZD 18.5 billion to NZD 4.6 billion.  Under GFS, general government operating expenses increased to NZD 130 billion in the year ended June 2021, while central government increased slightly from NZD 119.6 billion to NZD 120.7 billion. The Core Crown Accounts showed expenses at NZD 107.8 billion.  Under GFS, net worth increased by about NZD 40 billion to NZD 374 billion, while the central government figure increased from NZD 197.1 billion to NZD 231.8 billion. Total net worth in the Crown Accounts increased by NZD 41 billion to NZD 157 billion.  Under GFS, the ratio of general government net debt to nominal GDP reduced slightly to 15.2 percent during the year ended June 2021. The financial accounts showed that net core Crown debt increased from 26.3 percent of GDP to 30.1 percent on June 30, 2021. The level of gross sovereign issued debt reduced slightly from 39.1 percent of GDP to 38.6 percent. As these numbers show, there can be significant differences in these amounts. The situation is also complicated by the fact that at the country level, statistical and finance agencies may exercise some discretion over their interpretation of the GFSM or be constrained in the information available to compile statistics that are consistent with it. This is the case in New Zealand, where Statistics NZ makes some adjustments relative to the GFS numbers produced by the Treasury. In many jurisdictions, including New Zealand, there is no controlling interest over the general government sector—or even the public sector. In most jurisdictions, governments at the central level, state or provincial level, and local level definitionally do not have a relationship based on control. Each is given life in a way which defines its separation from the others; in general, this separation is most clear when it comes to financial and operating decisions. This means that there is no body that is represented by general government accounts or, indeed, public sector accounts. This lack of alignment between interests and reporting means that the financial information so rendered is an artifice for which no body is responsible or accountable for the decisions that are captured by the financial information. The operational implications of this misalignment are significant— as the response to COVID showed, many countries simply do not have effective mechanisms for coordinating government actions across entities and levels of government. Determining the exact effects of the disassociation of accountability and financial information is not a straightforward task. But some aspects are noteworthy. For instance, under financial reporting, consolidation of financial information means that after taking account of interparty holdings within the entity, the liabilities that remain all pertain to the reporting entity. However, statistically, there are holdings that are held by the general government (whether at central, state, or local level) and debts or liabilities held by the various corporations owned by the State which engage in ‘market-based’ transactions. There is typically no entity responsible for the debts across levels of government but rather there are different entities responsible for parts of the debts. This can be a material concern for debt management. Including a broader definition of liabilities in measures of debt may provide a better indication of a government’s ability to service its entire debt. As a result of the differences in valuation and recognition, both borrowings and total liabilities reported under IPSAS may differ significantly from total debt reported under statistical frameworks. Further to the case of New Zealand presented in Box 3, countries present material differences between IPSAS and GFS reports. These differences are often because total liabilities reported under IPSAS include provisions and other liabilities not meeting the GFS definition of debt. Valuation differences play a role as well. Some examples follow:  United Kingdom:12 According to IPSAS, as of 2019 there are GBP 2.5 trillion net liabilities per Whole of Government Accounts (WGA), while according to GFS, public sector net debt amounts to GBP 1.8 trillion.  Ecuador:13 As of 2019, IPSAS reflect US$73,258 million total liabilities, while the national debt statistics bulletin shows US$7,317 million of debt.  The Philippines:14 As of 2018, IPSAS reflect PHP 7.975 billion total liabilities while GFS shows PHP 6.758 billion of general government gross debt.  Tanzania: As of 2016, according to IPSAS, there are TZS 61 trillion total liabilities, including TZS 41 trillion of short- and long-term borrowings; however, GFS presents TZS 37.6 trillion of total national debt. Many of the standards under IPSAS are derived from IFRS, which are relied on in private sector financial and securities markets globally. Accordingly, IPSAS include standards designed to capture the most sophisticated debt arrangements and innovative financial instruments that have evolved over time. As a result of these standards, debt creating arrangements such as those arising under guarantees, public-private partnerships (PPPs), SOEs, and pension obligations are recognized on the balance sheet under IPSAS. For example, financial guarantees are recognized on the balance sheet and not as contingent liabilities. PPP15 schemes are recorded on the balance sheet based on the concept of control, bringing both the asset and the liability onto the balance sheet. Relying on control rather than the risk and reward criteria applied by GFS brings more arrangements directly onto the balance sheet for recording and reporting purposes. This is because the concept of control emphasizes substance over form, focusing on an entity’s ability to influence the nature and amount of benefits through its power over another entity, irrespective of its economic role in the community. Box 2 presents many of the arrangements that are captured under IPSAS, including other debt-like arrangements such as central bank swap lines, deposits, and long- term trade credits. 12 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/902427/WGA_2018- 19_Final_signed_21-07-20_for_APS.pdf#page=196. 13 Ecuador is gradually transitioning to IPSAS. 14 The Philippines reports its annual financial statements largely consistent with accrual-based IPSAS. According to its 2018 Annual Financial Report, general government gross debt was 38.9 percent of GDP. 15 PPP arrangement may be captured under IPSAS 32, 34–38, and 41. Specific standards capture information about debt and other liabilities. The financial instruments standards (IPSAS 28, 29, 30, 41, Financial Instruments: Presentation, Recognition and Measurement, and Disclosure) require financial liabilities to be recognized at fair value plus or minus transaction costs and include provisions for differences from the transaction price, derecognition, amortization, impairment, and hedge accounting. These standards apply to all financial liabilities including loans, concessional loans, and derivative financial instruments. They also cover other financial liabilities that are not included in GFS debt measures, including financial guarantees and trade creditors. In addition, guidance is provided in IPSAS 41 on accounting for monetary gold, the issuance of currency, and IMF special drawing rights (SDR) holdings and allocations. Transactions between related parties may not reflect market terms. Terms may be more or less favorable to the reporting entity. IPSAS 20, Related Party Disclosures, defines related party relationships. Under IPSAS 20, information about the transactions between related parties should be disclosed. Other standards capture information about other liabilities. Some of these liabilities have similarities to debt but may not be captured in the GFS debt measures. Examples include liabilities in respect of finance leases ( IPSAS 13/IPSAS 43, Leases) and service concession (or PPP) arrangements (IPSAS 32, Service Concession Arrangements: Grantor). Other liabilities recognized under IPSAS include provisions (IPSAS 19, Provisions, Contingent Liabilities and Contingent Assets ), employee pension liabilities (IPSAS 39, Employee Benefits), and social benefit liabilities (IPSAS 42, Social Benefits). The scope of the reporting entity under IPSAS is based on the principle of control. All assets and liabilities of consolidated entities are recognized, and transactions between members of the same economic entity eliminated ( IPSAS 35, Consolidated Financial Statements). Significant interests in non-controlled entities are typically reported using the equity method and separate financial statements may be prepared for these entities ( IPSAS 34, IPSAS 36–38). Other debt-like arrangements include the following:  Swap lines. The first transaction is the purchase of foreign currency through the issuance of domestic currency. The second transaction is the agreement to repurchase domestic currency for foreign currency at a fixed exchange rate, meeting the definition of a derivative. The derivative would initially be recognized at fair value and subsequently measured at fair value. Changes in the fair value of the derivative would offset any gains and losses in the value of the foreign currency.  Deposits. The fair value of a financial liability with a demand feature, such as demand deposits and some types of time deposits, is recognized at not less than the amount payable on demand, discounted from the first date that the amount could be required to be paid.  Long-term trade credits. Like all financial liabilities including loans, concessional loans, and derivative financial instruments, long-term trade credits are recorded as a financial liability. They are recognized at fair value plus or minus transaction costs.  Debt-like transactions that are structured as payments for goods/services, for example, construction of an airport or highways. Usually, this type of transaction is considered a liability for accounting purposes. Whenever the government or entity has control over the service concession asset (for example, electric power plant, including the decision on what services must be provided with the asset, to whom, and at what price), both the asset and liability should be recognized at fair value (IPSAS 32). Payments made will be in respect of goods and services received, interest expense, and a reduction of the originally reported liability. Rather than defining specific categories of debt, IPSAS provide a principles-based definition of liabilities as well as standards addressing specific transactions or arrangements under which liabilities may arise. In doing so, IPSAS provide a reliable framework for debt and liability reporting by capturing all reliable financial estimates of present and future economic benefits and obligations on a consistent basis in whole- of-government financial reports. This enables generation of information about estimates, uncertainties, and significant assumptions underlying the financial information that would otherwise not necessarily be captured under cash-based systems or statistical reporting frameworks. For example, IPSAS provide valuable information on liabilities such as derivative financial instruments, guarantees of unconsolidated debt, and the fair value of debt obligations (as well as disclosing of the face value). The special nature of central bank transactions is depicted in Box 3. As an issuer of currency… Under GFS, issued currency gives rise to a liability for the central bank. The IPSASB has recently1 amended IPSAS 41, Financial Instruments, to include additional non-authoritative guidance on a number of public sector specific financial instruments. This guidance states that the central bank will have a liability for issued currency where it has an obligation to deliver cash (or other assets) in exchange for the currency and that this liability meets the definition of a financial instrument. The guidance notes that in some countries, legislation may indicate that currency is a charge on government assets. If the central bank does not have an obligation to deliver cash or another asset in exchange for the currency, then no liability is recognized. IPSAS do not have any specific guidance on other transactions through which the central bank issues other central bank money. However, as these transactions meet the definition of a financial instrument and give rise to deposits of commercial banks with the central bank, application of IPSAS 41 would give rise to a liability of the central bank. This is consistent with the treatment in GFS. As a holder of SDR holdings and allocations… Under the guidance issued by the IPSASB, SDR holdings meet the definition of a financial asset. SDR allocations represent the obligation assumed when SDR holdings are distributed to members. IMF members must stand ready to provide currency holdings up to the amount of their SDR allocation. This represents a contractual obligation to deliver cash. Accordingly, SDR allocations are regarded as a financial liability. This is consistent with the treatment in GFS. A special case… The nature of the central bank liabilities described above is different from liabilities arising from loans or bond issues and should therefore be presented separately. In considering a government’s level of debt, the different nature of these central bank liabilities should be taken into account, especially if these liabilities could be settled by issuing further central bank money without any significant inflationary or exchange rate consequences. But principles of consolidation apply… Central bank transactions are only a subset of public sector transactions. Where these transactions take place between the central bank and the national treasury, the effect of the transaction is likely to be eliminated on consolidation. Similarly, where a central bank buys government bonds from the market, the central bank’s asset and the government’s liability will be eliminated (with any price difference recognized as a gain or loss) on consolidation. However, disclosure of the gross amounts may be appropriate if this is needed for a full understanding of the financial statements. In the separate financial statements of the central bank and the national treasury, assets and liabilities would be reported gross, not netted off. Transactions between the central bank and the national treasury may be related party transactions under IPSAS 20, and both entities may need to explain the nature of the transactions between them. Similar considerations will apply to other transactions between the national treasury and central bank, such as the issuing and purchase of treasury bonds. Nonfinancial forms of debt repayment are captured as barter transactions. An entity receiving a nonfinancial asset in settlement of a debt derecognizes the debt (financial asset) and recognizes the nonfinancial asset at fair value. The entity settling the debt with a nonfinancial asset would derecognize the debt (financial liability) and the nonfinancial asset transferred. This could give rise to a gain or loss, as the carrying amount of the nonfinancial asset may not match the value of the debt settled. For example, inventory is normally measured at the lower of cost and net realizable value, which may be lower than its fair value (IPSAS 12). Provisions, defined as liabilities of uncertain timing or amount, may also be recorded for obligations for which there is no counterparty (IPSAS 19). For example, provisions may be recorded for estimated obligations related to restructuring, environmental remediation, or claims such as warranties on the basis that it is probable that the entity will have to meet a proportion of the claims in relation to the overall amount. Under GFS, a liability is not recognized until a claim by the counterparty exists.16 Collateral is reported as a contingent liability in the financial statements. A liability is recognized in the financial statements when the amount can be reasonably estimated and future outflows are probable. Contingent liabilities do not meet this criterion and are disclosed in the notes unless the possibility of an outflow of resources is remote ( IPSAS 19). Entities are required to disclose information about assets pledged as collateral ( IPSAS 17, 30). As the likelihood of payment increases, the government may have to make a provision which is recorded in the financial statements. In cases where collateral turning into payment is certain, this should be recorded in the financial statements. Accounting for such transactions under IPSAS depends on the substance of the agreement. Financial statements capture information on payment arrears beyond debt service. Information on the payments obligated by the government are recorded as accounts payable. And overdue amounts, if significant, are disclosed and may be reclassified as borrowings. This has many implications, including the measurement of the extension of credit to government—for instance, an overdue bill owed by the government to a private sector supplier is in effect an enforced borrowing by the government from that supplier. Similarly, an overdue interest payment is in effect an addition to the capital value of the loan, and an overdue salary is in effect a borrowing by the government from that worker. In this way, the measurement of formal debt may miss important elements of indebtedness. Not all debt is the same. While countries may be able to borrow at market rates of interest, they may also be able to borrow on concessional terms—so-called ‘soft loans’. This is particularly true of IDA countries. Ceteris paribus, borrowing on concessional terms will be more sustainable than borrowing the same amount of principal on market terms, as the repayment costs will be lower. Concessional loans are of specific interest in the current climate. The impact of the COVID- 19 pandemic has resulted in increased government expenditure and reduced government revenues. According to the October 2021 World Economic Outlook, advanced economy 16 GFSM 2014. public debt is forecast to increase by 20 percentage points of GDP by the end of 2021, while emerging and developing country debt will increase 10 percentage points. Many governments are having to borrow additional amounts. The sustainability of such borrowing will be affected by any concessional terms that are available and whether, as has been proposed by some organizations, including under the DSSI, lenders offer moratoriums on repayment. Both concessional rates and moratoriums on repayment could make the cost of servicing the debt more sustainable than if these factors were not available. Differences in valuation methodology can have a significant impact on the level of debt reported. Concessionary loans are recognized at fair value under IPSAS,17 while accounting for the difference between the transaction price and fair value is accounted for as a gain (or a loss for the lender) (IPSAS 23). The loan is subsequently measured at amortized cost using the effective interest method.18 Under GFS, concessionary loans are measured at nominal value, with the difference between the contract value and the present value of the loans, presented as a memorandum item. An example of concessionary lending is presented in Box 4. The failure to recognize (as opposed to disclose) the concessionary component leads to a misstatement of the financial position. The most material differences between GFS and IPSAS in measuring loans are shown in Annex A. Understanding the amounts in the financial statements is important. Initially, concessionary loans are presented at a lower amount than the nominal value in the borrower’s financial statements (this is the fair value / market value of the borrowing). Once the borrowing has been recognized, the amortized cost approach is used. This means that, over time, the (market) rate of interest is recognized as an expense and the amount in the financial statements increases. Immediately before the borrowing is repaid, the amount in the financial statements will match the amount to be repaid. It is also important to note that once the loan has been recognized, the borrower does not adjust the borrowing to reflect changes in fair value. The borrower has an obligation to make its repayments, and this is reflected in the financial statements. The fair value may change to reflect the market’s estimate of the borrower being able to service the loan, but these changes are not reflected in the borrower’s financial statements. Otherwise, the borrower’s financial position would appear to improve as its own credit risk worsened. 17 IPSAS 29 AG84–AG90 and IPSAS 41 AG118–AG127 contain detailed requirements for accounting for concessionary loans. 18 IPSAS 29 AG79 and IPSAS 41 AG46 contain requirements for assessing the extent of modifications. In the wake of its sovereign debt crisis, the face value of Greece’s debt was reported at 180 percent of GDP under Public Sector Debt Statistics. However, due to the concessionary terms of the bailout (low interest rates and long-term maturities) the debt was estimated to be 68 percent of GDP under IPSAS.19 On the counterparty’s side, the receivable on the books of Germany was also recorded at nominal value and was not discounted to reflect the concessional arrangements, thereby overstating the asset to German citizens. Because the debt measures in GFS and the System of National Accounts do not show the benefit of concessional terms, it is more difficult to assess sustainability from the statistical reports, requiring considerable additional manipulation for debt sustainability analysis. By contrast, accrual accounting, whether under IPSAS or IFRS, reflects the benefits of the concessional terms in the balance sheet in the financial statements. Governments disclose information about financial instruments to supplement the information included in the financial statements (IPSAS 30). These disclosures include maturity profiles, sensitivity analysis, credit risks, and the like. This information could inform debt management strategies. Similarly, qualitative information, which may have a bearing on the veracity of debt that may not have been incurred at arm’s length, is also disclosed. It also demonstrates to credit rating agencies and creditors that the government understands its debt. Fiscal policy typically covers spending, tax and non-tax receipts, and incurring of debts, providing the means by which governments take meaningful actions. Musgrave and Musgrave (1980) define the objectives of fiscal policy as threefold: to assist economic stabilization, to assist income distribution, and to facilitate budgetary resource allocation. This triptych has remained popular and continues to be applied by the economics profession (Moreno-Dodson 2013). As governments have become more sophisticated and more complex in their operations, there are many ways that they influence economic actors through fiscal instruments that may not result in immediate financial flows. Even when fiscal instruments do relate to an immediate flow, the underlying nature of one flow may differ from another flow. For instance, a receipt raised by the sale of an asset is economically different in its significance than, say, a receipt raised through a tax payment. In the first case, one asset (cash) is replacing another asset that has been sold—it is a ‘within balance sheet’ transaction. In the second case, the taxes are paid without requitedness—the amounts are paid as an operating revenue to the government, perhaps from an entity over which the government has no ownership or financial control. It is generally accepted that it is difficult to manage what is not measured. An adjunct could be that it is difficult to manage well what is not measured appropriately. Over the past 30 years or so, there has been a heightened interest in the role of the fiscal sector as a holder of some forms of residual risk in the economy. Some of this risk can be measured reasonably 19 The Accountant, September 2015, Issue 6142. reliably. For instance, a World Bank team led by Hana Polackova Brixi identified a two-by- two matrix—along with explicit liabilities created through expectations linked to formal direct liabilities and contingent liabilities, there remained a set of implicit liabilities created through expectations and political decision-making that also linked to direct liabilities and contingent liabilities. Subsequent work by the IMF has showed that there were 174 instances when realizations of contingent liabilities affected fiscal sectors, with an average impact of 6.1 percent of GDP (IMF 2016). Much of government management is concerned with getting better performance from the organizations of government; accrual accounting may assist this. Irrespective of the many debates about fiscal policy that focus on the interaction between the fiscal sector and the rest of the economy, organizational performance within government stands as an independent objective, which also may affect the rest of the economy. The production and use of accrual information at the organizational level has proved to be especially helpful in focusing government’s attention on the management of its estate and measuring the financial performance of its constituent entities. The concept of control has been useful in arranging such data and asserting accountability for performance. While the fiscal policy and management analysis may include issues around the quality of spending, it tends to do this unevenly with respect to organizational performance with a poor alignment of statistical measures and organizational activities. The nature and performance of stocks provide an important set of instruments in managing governments’ financial condition. Fiscal literature has overwhelmingly remained focused on flows, the ability to sustain those flows, and the interaction of those flows with the non-fiscal sector. Even when straying into the asset side, the focus is typically on additions to the capital stock (public investment management or infrastructure) rather than management of the asset stock itself. Similarly, much of the focus on debt is on the cashflows associated with servicing the debt (and the relationship between interest rates and growth) rather than the sufficiency of the debt, liabilities, and net worth to fund the necessary assets to support service delivery over time. As countries are moving to apply accrual accounting to their fiscal sectors, they are learning how to make use of balance sheet information to better plan revenues, consider risks, and improve the information base to fiscal policy making. Government balance sheets provide a comprehensive view of all the assets and liabilities that the government controls, including public corporations, natural resource rights, and pension liabilities. They account for the entirety of what the state owns and owes, offering a broader fiscal picture beyond debt and deficits. As brought out in the IMF’s Fiscal Monitor Managing Public Wealth issued in October 2018, the balance sheet can be a reliable source of information for identifying fiscal risks and evaluating and guiding fiscal policies and can raise the tenor of the policy debate. Consideration of the balance sheet over (long) time, linked via the cash flow statement and operating statement, is a disciplined way to do this and can support aggregate fiscal decision- making that aims to keep tax rates constant over time (Bradbury, Brumby, and Skilling 1999).  Austria applied the principles of IPSAS 19 to establish a provision for carbon emissions which may be reduced under a trading scheme, to help monitor its obligation on carbon emissions under the terms agreed with the European Union (EU).  The United States has used accrual information to establish liabilities for deferring scheduled maintenance on capital assets.  The United States and the United Kingdom have used accrual information to designate cash for future cash outlays such as bond redemptions.20 Similar dedicated funds may also be established to provide for post-retirement employee benefit obligations of government.  The Australian government established The Future Fund in 2006, a sovereign wealth fund for meeting unfunded public sector retirement liabilities for futures retirees and various other purposes.21 New Zealand uses departmental accrual information as an important input to its performance management regime and to determine its capital charging flows.  New Zealand uses the balance sheet to act as a government scorecard to hold officials accountable for fiscal and financial decisions made during their tenure. To stay focused on strategic fiscal objectives rather than short-term decision-making, New Zealand tracks the government’s net worth per citizen. The first balance sheet in 1993 established under the country’s Public Finance Act 1989 showed a negative net worth of NZD 14 billion (US$9.2 billion). At the end of FY2019, the net worth had grown to a positive value of NZD 143.3 billion, providing an excellent buffer to support COVID-19 remedial measures, which saw a reduction of net worth to NZD 115.9 billion, or 37.6 percent of GDP.22 The interpretation of government net worth is not straightforward but it can play a useful role in holding government accountable, informing policy decisions, and providing a buffer against fiscal shocks.23 By definition, net worth is a summary number, reflecting the difference between all assets and all liabilities. Given some of the measurement issues on the one hand and the nature of residual claims in the public sector on the other, net worth in the public sector may require further interpretation than in the private sector. Citizens are not shareholders of the government and therefore there is no real ownership of net worth per citizen. Government does not get wound up, so there are no ultimate residual claimants. While ex ante government may appear insolvent and unable to meet its intertemporal budget constraint and therefore be dissolved, ex post it never is as it may use fiat to redefine its obligations. On the other hand, government finances are a form of cooperative, whereby risk in the end falls to the generations of taxpayers as part of a social contract. Over time, net worth directly captures the changing fortunes of the government’s financial position. This is 20 Financial Report of the United States Government, https://fiscal.treasury.gov/reports-statements/financial-report/current- report.html; Annual Report 2019-2020, https://www.gov.uk/government/publications/annual-report-2019-2020 21 https://www.futurefund.gov.au/. 22 (Rajgopal 2020) This was before a rebound to NZD 157.2 billion in 2021, or 46.2 percent of GDP. 23 Academics in many disciplines try to capture this relationship. New monetary theory perhaps provides the most direct repudiation of this concept for sovereigns that issue strong (fiat) currencies. Buiter (2021) explores these issues at length. captured in research that suggests net worth may be a significant driver of bond yields (Peppel-Srebrny 2018). Governments have many distinctive financial features—the power to tax is one; ownership of a central bank may be another. The power to levy taxes remains a contingent asset for government, which, although not recognized in the financial statements, may be disclosed or discussed in a management commentary. This contingent asset, together with government’s power to redefine its obligations, means governments are considered going concerns, even though they may operate for extended periods with negative net assets/equity. The magnitude of unfunded liabilities, for instance, may be an indication that many decisions by voters and their elected representatives have been made without a full understanding of either the government’s current fiscal position or the full costs of the policy decisions (Webb 1991). Different jurisdictions tend to generate their own means to constrain the actual value of the contingent tax asset—examples include civil action to oppose certain taxes such as the case of Macron’s fuel tax and citizen-led referenda such as those in California (Proposition 13) that impose taxation limits on government. 24 A first step in managing unfunded liabilities is to identify them, particularly those which may trigger a fiscal shock upon realization. Unfunded liabilities are those for which insufficient funds are set aside to settle the liabilities when they become due. This may include, for example, unfunded pension liabilities, unfunded commitments under PPP schemes, accident compensation schemes, or any other unfunded provision for which future cash outlays are expected. Fiscal shocks related to these unfunded liabilities may arise if payment is suddenly required. On the other hand, it may be that demographic or other changes may give rise to income flows, which do not as yet meet the recognition criteria that can offset these unfunded liabilities in the future. For this reason, it is important to supplement accrual-based balance sheets with expected flow data into the future. The application of financial reporting frameworks invites the introduction of fiscal health indicators which have traditionally not been applied in the public sector. Some of these can be expected to replicate the indicators used through the more traditional approaches to fiscal management, while some may provide information that hitherto has been hard to collect or not available. Neither an IPSAS-based approach nor a GFS approach is likely to be complete. For instance, IPSASB’s Recommended Practice Guidelines No. 1 provides guidance on reporting on the long-term sustainability of a public sector entity’s finances and on the impact of current policies and decisions made at the reporting date on future inflows and 24 Proposition 13, passed in 1978, restricted property taxation in California. outflows comprising three key dimensions (service, revenue, and debt) as an adjunct to the core reports. A number of indicators are shown in Table 1. Indicator Definition and purpose Accrual-based financial statements’ difference Gross debt, total debt Total gross debt—often referred to as ‘total Marked to market value of debt. Debt may not be an debt’ or ‘total debt liabilities’—consists of all item in balance sheet; probably classified as liabilities that stem from debt instruments25 ‘borrowings’ and separated into current (short-term) and non-current (long-term) amounts. Net debt Net debt is calculated as gross debt minus Borrowings marked to market less financial assets financial assets corresponding to debt (also marked to market); financial assets need to meet instruments. recognition criteria. Net debt/total revenues Net debt as a proportion of total revenues Net debt (borrowings); revenues on accrual basis (broadly, receipts plus change in accounts receivable) Net debt/GDP Net debt as a proportion of GDP Net debt (borrowings) marked to market, GDP Net worth Net worth is the total value of all assets minus Used as a proxy for net value of government financial the total value of its outstanding liabilities. wealth; for many countries, net worth may be Net worth/GDP Net worth as a percentage of GDP negative, meaning that total liabilities exceed total assets. Requires balance sheet. Fiscal gap The fiscal gap is the change in non-interest Cash flow measure, so unaffected. A simplified version spending and/or receipts that would be of intertemporal budget measure (T’-T); see T’-T necessary to maintain public debt at or below a further down in this table. target percentage of GDP. Interest burden ratio Net interest expense divided by total revenues Full interest expense (including concessional add backs) by full accrued revenues, including concessional subsidies Operating cash flow Operational cash income less operational Simple summation from cash flow statement spending Working capital Current assets less current liabilities. A Not part of traditional fiscal analysis; simple measure of short term financial health. summation from operating statement Accounts payable turnover Divide the total primary (that is, non-interest) Not part of traditional fiscal analysis. Declining ratio non-salary operating costs during a period by suggests taking longer to pay bills. Can be presented the average accounts payable for that period. as ‘days to pay’. Indicates, for example, if payment arrears may be occurring. Accounts receivable turnover Divide the total operating revenues during a Not part of traditional fiscal analysis. Declining ratio period by the average revenues collected for suggests taking longer to receive funds. Can be that period. Indicates, for example, if revenue presented as ‘days to receive’. arrears may be occurring. Quick ratio Add cash and equivalents, marketable Not part of traditional fiscal analysis, but similar investments, and accounts receivable and measure is used for cash planning. divide that sum by current liabilities. Ability to meet near term bills. T’-T Tax rate required to meet the intertemporal Tax rate required to meet the intertemporal budget budget constraint minus the current tax rate. A constraint after factoring in realizable net worth higher number suggests more fiscal (including seigniorage where applicable) minus the adjustment is necessary. current tax rate. OBEGAL Removes gains and losses out of assessing Not available in traditional fiscal reporting. Operating accrual based operating balance balance excluding gains and losses. 25A debt instrument is defined as a financial claim that requires payment(s) of interest and/or principal by the debtor to the creditor at a date, or dates, in the future. Traditional financial statements present the financial performance and cash flows for a one-year period and the financial position at the end of the respective year. For the users, it is quite difficult to decipher information about long-term substantiality of government finances or about fiscal risk from such one-year financial statements. Therefore, the IPSASB issued Recommended Practice Guideline (RPG 1), which recommends general purpose financial reports addressing these topics, supplementing the more traditional general purpose financial statements. Like all RPG, this is a non-mandatory guidance issued by the IPSASB. While RPG 1.25 and 1.26 do not prescribe a specific period, they make it clear that sustainability should cover longer periods, possibly of up to 75 years (RPG 1.BC20), depending on the characteristics of the entity and the qualitative characteristics, which are also applicable to long-term reports. The COVID-19 pandemic has affected both the medium-term fiscal framework and the long-term sustainability or fiscal risk reports. The most obvious longer-term effect of the pandemic is the increase in public debt. The increase in debt is a particular concern in the developing countries. During 2021, the World Bank conducted a study focused on the Latin America and the Caribbean region, aimed at understanding the effects of COVID-19 on the governments’ balance sheets with a focus on debt and other key fiscal risk indicators, using a sample of the financial statements of FY2020 of the following nine countries: Brazil, Chile, Colombia, Costa Rica, the Dominican Republic, Ecuador, Mexico, Paraguay, and Peru.26 The main findings of the study are the following:  Only a few countries in the sample prepared reports focused on the long-term sustainability and fiscal risks, and when they did, they were published independently from the financial statements. Also, the responsibility is usually not with the accounting office, but with some other entity, typically within the Ministry of Finance.  On the budgetary side, most countries also used projections, typically between four and six years. They are often referred to as medium-term fiscal frameworks or similar terminology. Given the much shorter time horizon, they can be more detailed and more precise than long-term sustainability and/or fiscal risk reports.  All the countries analyzed in the sample have medium-term expenditure frameworks. Usually, they are updated in the context of budget preparation. The budget proposal 26The study is accessible at the following link: https://documents.worldbank.org/en/publication/documents- reports/documentdetail/955661644425911704/impact-of-covid-19-on-financial-reporting-in-latin-america-and-the- caribbean?deliveryName=DM143163 . The study-specific stated objectives were the following: (i) Analyze whether the financial impact of COVID-19 is reflected in the financial reports of the selected countries in accordance with the relevant normative accounting framework for each country, using IPSAS as reference; (ii) Assess whether the balance sheet of the countries included in the sample can convey the long-term fiscal sustainability of the government, reflecting the fiscal risks associated with the financial performance and financial position of the government in the context of the COVID-19 pandemic; (iii) Determine whether the notes to the financial statements were being used to present the financial information in a transparent manner by explaining materially large figures and significant changes caused by the COVID-19 pandemic. for 2021, presented in late 2020, was the first one that reflected the effects of the pandemic. The expenditure frameworks also considered the effects of increased debt. However, considering that, it will not be possible to fully amortize the increased debt to pre-pandemic levels within the medium-term time horizon of four to six years. Hence, the focus of the medium-term fiscal framework published in 2020 is more on the ongoing pandemic and the subsequent economic reactivation than on longer- term economic effects.  Some countries have additionally published a fiscal risk report, also in the context of the 2021 budget proposal. The focus of such reports is often on debt, and they cover slightly longer periods than the medium-term framework, for example, 10 to 12 years. However, the period covered is not as long as proposed by IPSAS RPG 1, which is 30 to 75 years. Nevertheless, since the additional debt incurred during the pandemic will likely not be fully amortized within 10 to 12 years; an extension of the period still might become necessary. It is also important to know whether debt financing has been used for investments with longer-term service potential or for short-term consumption expenditures. In light of the above factors and, in particular, the increase in debt which all jurisdictions have experienced, the study recommended, as a good practice, to publish a report that covers the period over which it is necessary to pay back the debt. In most cases, this period will be longer than the typical period covered by the medium-term fiscal framework. Similar to the long-term sustainability reports recommended by IPSAS RPG 1, that report will analyze different scenarios, reflecting different patterns of economic recovery. It is a good practice to publish a separate report from the financial statements, and information from that report should be cross-referenced to the information on debt contained in the financial statements. Public debt can be incurred for good, not-so-good, and quite poor purposes. A shortage of financing capital may mean that there are many positive projects that cannot be funded. Evidence suggests that this can be very costly in developing countries where marginal capital improvements can be expected to be especially beneficial.27 In other words, borrowings may assist in meeting some of the funding gaps for good projects. However, knowledge, capacity, and political economy constraints may compromise project selection and implementation, while tax policy and related administration may compromise tax buoyancy, detracting from the fiscal resources available. A recent World Bank report noted that during the (now) fourth wave of debt, it became apparent that borrowed funds had been diverted toward purposes that did not raise export proceeds or productivity or potential output, suggesting that some debt increases were not associated with monetized economic development (Kose et al. 2021, 27There is a large body of literature on diminishing returns to scale and related issues, including Izquierdo et al. 2019, 24, who note “we consistently find that public investment multipliers in low initial public capital countries are significantly higher than in high initial public capital countries”. 18). In other words, some borrowings were used for some not-so-good or even poor purposes. Policy effectiveness, including over such measures as the amount of sovereign borrowing and its recording and reporting, need not be understood solely from a technical perspective. Adopting a political economy perspective as outlined in the World Development Report (WDR) 2017 (page 30) and elsewhere allows consideration of the process that actors use to bargain about the design and implementation of policies in a specific institutional setting. For analytical purposes, the WDR 2017 grouped participants in the policy process as elites and citizens according to the relative degree of influence over the policy-making process. Consideration may be given to the institutions, incentives, and interests that may influence the way that elites and citizens may commit to a course of action, cooperate, and coordinate around public policy issues. In states characterized by monopolistic power (elite dominance) rather than consensual action, fiscal policy and public debt can become a process by which politically dominant groups gain advantage by transferring liabilities to other people in the polity (Eusepi and Wagner 2017, 146). Debt build-ups are not new. There has been something of a recurring pattern to countries’ excessive borrowing, with three completed waves of debt build-up and the fourth wave under way. The first three waves ended in financial crises, and there is a clear concern going forward: “Debt in low-income countries has started to rise after a prolonged period of decline following debt-relief measures in the late 1990s and 2000s.” (Kose et al. 2021, 6). This recurring trend around debt accumulation does suggest that there may be institutional and political economy factors at play. If the borrower is especially capital constrained, it may be tempted to access a lender with less regard to the cost of such action.28 As long as new financing can be accessed, there are strong incentives to delay the reckoning if it appears likely that the reckoning will result in dislocation and costs. This may lead to the borrower being tempted to limit or distort its disclosures, as seen in the quite recent cases of Greece and Mozambique. The borrower incentive may reflect a view that in the end the commitment to repay will turn out to be non- enforceable and a rescheduling or deferment will become necessary, with costs borne by both the lender and borrower. The lender may have an incentive to cooperate in this, especially if some of the value of the loan is associated with access to collateralized assets, contracts for service, or other geopolitical objectives. That way, the international actor role of the lender may exacerbate a natural tendency in the borrower country to borrow excessively. Difficulties in appropriately measuring and reporting debts in a cash-based accounting system can exacerbate mismatches. This may occur especially between those who enter into a sovereign borrowing (today’s politically exposed decision-makers) and those actors who must pay (the future population). For instance, through this lens, a grace period that may be advantageous in cash flow management may result in fiscal illusion, as even the servicing costs are hidden until the end of the grace period. By that time the beneficiaries of 28By way of example, Deborah Brautigam and Meg Rithmire in the Atlantic (February 26, 2021) detail how Sri Lanka accessed Chinese financing for a proposed port at Hambantota after being turned down by India and the US. the borrowing may well have prospered, leaving the bill for others. If a default occurs, the costs of the adjustment will be met by the second group and not the first. Conversely, in an accrual system, marking the new borrowing to market creates an impost on the balance sheet and results in an interest expense during the grace period, perhaps lessening the likelihood of creation of a fiscal illusion associated with the terms of the loan and increasing the likelihood that costs and benefits will be considered together. Decision-makers may have limited time horizons. Typically, those exposed to contestable political cycles may be sensitive to making decisions influenced by the timing of those cycles; these contestable cycles are often shorter than terms provided by creditors and shorter than the financial interests of the body of citizens or the economic life of an asset created. This can reinforce a mismatch between the politically driven payoff period and the longer-term payoff cycle associated with long-term borrowing, encouraging more rather than less borrowing and allowing more immediate enjoyment of benefits coupled with deferment of costs. Unless the debt is consciously counterbalanced, say by a sinking fund or other run-up in liquefiable assets as a commitment device, this can exacerbate a tendency to take on debts. Eusepi and Wagner (2017, 138) refer to “systemic lying” that may underpin the taking- on of unfunded liabilities as a component of public debt as a systemic form of collective lying.” This may be an extreme form of the behavior identified by Oates (1988, 76) that taxpaying citizens likely see lower costs associated with current programs if they pay for them through (direct) taxation, and “reliance on debt rather than tax finance will result in a larger public budget.” Greater transparency could be expected to lower the risk premia that markets charge sovereign borrowers. Ceteris paribus, more transparency would allow markets to provide sovereigns with more access to capital and at better terms. Efforts to depict and measure these risk premia have not always been successful (Alesina et al. 1992). Yet it is understood that greater fiscal transparency is associated with lower borrowing costs, improvements in government effectiveness, and lower government debt, with a view that transparent balance sheets can be considered a prerequisite for sound debt management (Kose et al. 2021, 186). Notwithstanding these benefits, the implementation of accrual accounting reforms, necessary for a fully transparent balance sheet, can turn into a daunting task, with poorly understood benefits. Fritz, Verhoeven, and Avenia (2017) suggest that the highly specialized nature of implementing an accounting reform may obscure some of the nontechnical and incentive issues involved. Such are the political economy incentives, that the absence of a regulated international standard for fiscal reporting most likely contributes to welfare losses. Opportunistic behavior on both the lenders’ and borrowers’ sides could lead to higher than optimal levels of debt on the one hand, yet the failure to undertake superior quality projects on the other. Additionally, any confusion concerning amounts owed or owned can mean that private actors in both borrower and lender countries are not fully versed in the implications of their financial interests and the state. One study in Sweden showed that taxpayers may underestimate fiscal costs due to deliberate fiscal obfuscation exercised by the authorities. (Sanandaji and Wallace 2011, 237–246.) This illusion could work in both directions. Box 4 dealt with the case of Greece whereby the concessionary terms meant that the real value of the liability (to Greece) and the actual value of the asset (to Germany) were considerably less than carried in the accounts of both. Regulated international accounting standards applying across government would place the financial reporting of both the liabilities and the assets into a transparent straitjacket. This could increase disclosure about the amounts borrowed, the costs associated, and the value of the assets created.29 Such standards and policies would have government accountants draw lines that define assets and liabilities and “instruct them how to calculate asset and liability amounts at year’s end and changes in them during the year’s course” (Chan and Qi Zhang 2013). Incentives could be reduced to move fiscal operations to entities outside the government’s accounts, and make more difficult the use of accounting stratagems, as detailed by the IMF in April 2011 (IMF, Fiscal Monitor, April 2011, 73 –78). Kose et al. (2021, 192) suggest that future research could aim to identify institutional arrangements that prevent, or build resilience against, politically driven unproductive debt buildups. To that end, the World Bank is undertaking a study on the relationship between adoption of accrual accounting and aspects of fiscal management, such as debt accumulation. The adoption of internationally recognized accrual accounting standards, together with disclosure of compliance with them, should lead in time to a significant improvement in the quality of general-purpose financial reporting by public sector entities. Given that it is now more than 30 years since the first country in the modern era adopted fully adopted accrual reporting, it appears unlikely that countries will move to follow this adoption of their own volition. Whether because of the stated rights of sovereignty or the claims of competency shortages, adoption of IPSAS (without local amendment) appears unlikely unless mandated internationally.30 Two core challenges may remain for the adoption of debt reporting consistent with international accounting standards: the challenge of sovereignty and the challenge of technical capacity:  Sovereignty. Due to national preferences of both creditor and debtor nations, many countries do not fully adopt IPSAS and prefer to adopt national standards based to varying degrees on IPSAS. This necessarily leads to dilution of the IPSAS applied and a degree of inconsistency between countries. The International Public Sector Accountability Index31 completed in 2019 indicates that 23 percent (31) of 29 The issues here are very similar to those addressed by George Akerloff 50 years ago in his article on the market for lemons, where he specifically considered the case of lending in ‘underdeveloped countries’. 30 This is not making the argument that such standards are a global public good (consistent with the critique of Rodrik 2019). It is making the argument based on such standards providing an effective commitment device that may be in the public interest, more akin to the arguments in favor of two-level games in diplomacy (Putnam 1988). 31 The index is a joint project of IFAC and the Chartered Institute of Public Finance and Accountancy and provides information on the adoption of accrual-based accounting and IPSAS across 150 jurisdictions. For more information, see jurisdictions have adopted modified IPSAS, while others have adopted IPSAS only for central government entities or are currently using cash-based IPSAS. The specific deviations and their effects are not typically disclosed in public sector financial statements, which decreases transparency and may result in misinterpretation. Regulation of the international standards may enhance usefulness and comparability overall by reducing inter-jurisdictional variations in application and leading to standards that would be less subject to the discretion of individual countries.  Technical capacity. The technical capacity to implement IPSAS, both expertise and the enabling environment, is often not in place. Responsible agencies often do not have qualified accountants on staff to lead the reform, and the underlying systems and institutional arrangements may be underdeveloped and fragmented. Despite the foundational role of accrual accounting reforms in PFM systems, such reforms are often not prioritized within broader PFM reform initiatives. For this prioritization to take place, the role of accrual accounting in public sector management and decision-making could be better communicated, recognized, and understood within the community of decision-makers. The degree of countries’ compliance with IPSAS could be clear and transparent. If a country wished to exercise sovereign choice by deviating from international standards, this would provide for that flexibility but within the confines of documenting the deviation. Only by providing transparency as to the degree of compliance with IPSAS can the information gap be addressed and the degree of IPSAS application by individual countries be understood by users of financial statements. Information gaps can be addressed by the following measures:  Enhancement of regulatory framework and methodologies. Existing frameworks and methodologies are often incomplete, inconsistent, or outdated. They often vary between different jurisdictions, levels of government, and agencies. Addressing this involves support for the adoption and application of clear definition and scope of debt as well as articulation of the state-wide requirements for debt consolidation and disclosure, which will be consistent with international best practices and applies across all government levels.  Consistent application of IPSAS and fiscal statistics standards. While the GFSM has traditionally been followed for debt and investment reporting in the public sector, it is not being consistently applied, making it difficult to compare debt profiles across countries and even within countries. This similarly applies to accounting and reporting standards. This lack of consistency complicates compilation (and compromises quality) of debt data by accounting and reporting units and its subsequent reconciliation with data prepared by debt management units. Consistent application of IPSAS can boost the quality and integrity of reported data; however, its adoption, as well as the transition from cash to accrual basis accounting, requires adequate planning and substantial technical assistance https://www.ifac.org/knowledge-gateway/supporting-international-standards/discussion/international-public-sector-financial- accountability-index. support. Overall, capturing a larger share of public sector financial commitments within these frameworks is crucial for countries’ capacity to enhance their debt and investment transparency. The past 40 years have seen a shift toward accrual basis accounting standards for governments. In 1984, the United States began its transition by initiating a user needs study that resulted in the publication of the Government Accounting Standards Board (GASB) Research Report, The Needs of Users of Governmental Financial Reports, by David B. Jones and others in 1985. In 1986, IFAC established the Public Sector Committee (PSC) as one of its standing committees. The PSC had a broad mandate to develop programs for the improvement of public sector financial management and accountability. The IPSAS, which use accrual concepts, were initiated about 25 years ago. In 2001, the GFS followed suit and the GFSM was overhauled with an accrual framework, in growing acceptance that many aspects of public sector fiscal management required a more complete balance sheet approach. In 2020, a survey conducted jointly by IFAC and the Chartered Institute of Public Finance and Accountancy (CIPFA) revealed that approximately 30 percent of jurisdictions reported on accrual basis, compared to 24 percent in 2018, and 50 percent of all countries plan to use accrual accounting by 2025.. 32 Figure 1. Forecast/Projection of Accrual Accounting Adoption by Countries Globally 33 There are no internationally enforced accounting standards for governments to generate financial, statistical, or other fiscal reports. Governments can, and do, report as they wish in accordance with their own local laws. This means that different reporting approaches are used internationally, often making interpretation and cross-country comparisons difficult. Governments variously account according to advanced accrual concepts, rudimentary cash concepts, on obligations or commitments, according to statistical norms (on cash and accrual basis), and on a fund accounting basis. There is, for instance, no requirement or assumption that the two sides of a debt transaction—the creditor and the debtor—will treat the one transaction in symmetrical terms. This set of arrangements is anomalous compared to the private sector—reporting entities typically need to comply with standards laid down and enforced by an arm’s length party. The historical legacy of government fiscal reporting is different and distinct from that of the private sector. Historically, the primary purpose of government reporting was to present the results of budget execution. This would show inflows, outflows, and the difference between the two resulting in either a surplus or a deficit; it was by its nature, a fund accounting treatment of the financial flows of government. The budget represented the request to spend in accordance with taxing the people for a specific amount with the gap between receipts and expenditures (payments) addressed through financing; the report at the end of the year showed compliance against the request agreed. Accordingly, every jurisdiction looked different, given the nature of what was captured by its ‘fund’. These differences made it especially difficult to compare across countries and even within countries across jurisdictions, such as across the states of Australia or the United States. Statistical reporting serves to make fiscal analysis and reporting internationally (and interjurisdictionally) comparable but does so in a manner that may be disconnected from the way in which accountability is exercised. By having a classification system that neatly fits with broader economic concepts and national accounting, statistical reporting can be a useful basis on which to look at the interactions between the fiscal sector and the broader economy but may be less effective as a mechanism for holding the government accountable.  Disclosure of all material deviations from IPSAS and the estimation of the impact of the deviations in the financial statements. This information should necessarily 32 International Public Sector Financial Accountability Index: 2020, International Federation of Accountants, https://www.ifac.org/knowledge-gateway/supporting-international-standards/discussion/international-public-sector-financial- accountability-index-2020. 33 Ibid. be attested to by external auditors to provide assurance as to whether the deviations are properly disclosed in all material respects. Such an approach would be feasible only if the reporting entity has the technical capacity to complete the assessment and the SAI has the capacity to audit the assessment.  Consideration of an internationally recognized and governed formal assessment on a periodic basis. Due to limited capacity in many countries, this may be a more workable alternative than leaving countries to disclose deviations from IPSAS themselves. An IPSAS gap analysis34 is typically completed as an initial step in the IPSAS adoption process; however, such an assessment, including the impacts of the reported deviations, is rarely completed after the initial assessment and no standardized and internationally governed framework for completing the analysis currently exists. To measure the degree of IPSAS compliance over time, such an assessment could be completed on a cyclical basis. Establishing strong governance arrangements over the assessment framework, through an international steering committee, and engaging international stakeholders such as the IPSASB and other development partners would contribute to the robustness of the framework, increase legitimacy, and promote consistency of application. To reap the benefits of accrual accounting in debt reporting, certain enabling systems and institutional arrangements should be in place. The quality, accuracy, and timeliness of accounting data under an accrual framework are highly dependent on the design and consistent application and implementation of detailed accounting policies that guide the recognition, measurement, and recording of specific balance sheet items. These are discussed in more detail in Annex B and include the following:  An adequate legal framework over accounting and financial reporting  Clear procedures for developing accounting policies, including, but not limited to, defined authorities for their approval, defined timelines for their development, consultation and approval, identification of key stakeholders for holding policy consultations, procedures to ensure adherence to legal framework, and determination of procedures  Unified Chart of Accounts (UCOA) to allow for seamless preparation of both statistical reports and whole-of-government financial statements  Adequate technological capacity and information systems to electronically capture, record, categorize, consolidate, and report transactional-level financial data and provide access, processing, and administrative controls  Adequate human resources and technical knowledge to lead the reform process and oversee implementation  Clearly defined accounting policies, instructions, and competencies to promote consistency of application among individual reporting units  Inventory and control of financial instruments to capture all related commitments, contingencies, and other relevant information IPSAS Gap Analyses have been completed for countries adopting IPSAS by a variety of development partners, including the 34 World Bank, and consulting firms. Each of these maintain their own toolkits or frameworks for conducting the analysis.  Internal controls and procedures to assist identification and management of ‘other contingent liabilities’ which are not automatically captured by government accounting systems  Internal controls to match spending with resources available  Adequate external audit capacity to complete an audit of the financial statements, including the underlying systems, procedures, and controls governing the accounting process  Reciprocal information flow between the Debt Management Office (DMO) and the accrual accounting system to ensure coordination of information. The congruence and coordination of accounting and debt management in Estonia is depicted in Box 6. Improving debt transparency requires building the capacity of government officials in debt and investment management, accounting, and reporting units. Besides the enhancement of regulatory frameworks and adoption of standards and methodologies, there is a need to build personnel skills to apply such frameworks and methodologies properly and consistently, including through the development of guidance and procedures for specific operations. Strengthening coordination (including through systems interfacing) enables access to relevant data for debt transparency. Improving debt transparency requires boosting coordination and collaboration between fiscal risk/debt management, public investment management (PIM), and debt recording and reporting units, as well as interfacing of their respective IT systems. This involves reinforcing the interfaces between such units by incentivizing collaboration and, thus, closing the feedback loop and ensuring that disclosed information is available and comprehensive enough to be used for evidence-based decision- making throughout the public finance chain. It is critical to allow for the interfacing of IT systems managing debt and investment data with countries’ Financial Management Information Systems. Improving debt transparency requires the parallel improvement of public investment data management and alignment and reconciliation with debt data to obtain a comprehensive picture of debt profiles. To effectively support decision-making processes and attract capital inflows, including from the private sector, disclosure of debt-creating arrangements should be complemented with the disclosure of public investments, incurred by the governments in the corresponding period, to allow for matching of debts incurred with the assets created. This should cover such areas as infrastructure, utilities, publicly funded research and development, and green investments, among others. Disclosure of investments should be inclusive of the ones owned by the central and local governments, PPPs, and SOEs. Better transparency around public investment data is important to gauge PIM efficiency, in determining whether investments can achieve the economic benefits necessary to justify their (often significant) costs or they are just contributing to overall debt levels. There is an important connection between PFM and debt management frameworks, which should be considered when assessing the level of technical capacity for debt transparency in a particular country.35 Successful management of public finance is a necessary condition for fiscal sustainability, a stable macroeconomic environment, public sector accountability, and the provision of basic public goods and services. It includes (a) public financial management—and its subcomponents of public expenditure management, PIM, and integrated financial management information systems (IFMIS)—and (b) public sector debt management. These two are referred to as public financial and debt management (PFDM). A wide range of diagnostics are relevant to PFDM, including, but not limited to, PEFA, Public Investment Management Assessment (PIMA), Debt Management and Performance Assessment (DEMPA), IMF Article IV Staff reports, Debt Sustainability Analysis (DSA), and Medium-Term Debt Management Strategy (MTDS). This information could be considered when assessing country PFDM capacity. An independent evaluation completed by the World Bank found that support to improve public sector accounting has been associated with positive results, as evidenced through improved PEFA scoring; however, such support is limited with less than one-third of IDA- eligible countries having received such support during the evaluation period.36 Implementation of IPSAS is a long-term commitment which typically progresses through a phased approach over several years, with the need to keep abreast of new standards and pronouncements. Due to the cross-cutting nature of accounting, it should be closely integrated with other areas of PFM reform. In adopting an incremental approach to accrual accounting reform, jurisdictions should consider those accounting standards that offer the greatest improvements to debt transparency, considering the existing environment over debt management and reporting. Key IPSAS that relate to debt concepts and definitions are presented in Box 24. Reforms should be fit-for-purpose and jurisdictions initiate accrual reforms with enabling systems and institutional arrangements that are unique to each jurisdiction. Accordingly, the objectives of the reform must be clearly defined and each reform must begin with an assessment of the existing environment in comparison to the stated objectives. Annexes C and D present resources that are available to countries considering accrual accounting reforms. 35 World Bank Support for Public Financial and Debt Management in IDA-Eligible Countries, Independent Evaluation Group, March 17, 2021. 36 World Bank Support for Public Financial and Debt Management in IDA-Eligible Countries, An Independent Evaluation, December 10, 2020. Estonia provides a useful example of the relationship between the functions carried out by the State Treasury Department (DMO) and the accounting function of government, which applies IPSAS-based accounting standards. The Estonian Treasury is divided into four specialized teams: front office, middle office, back office, and payments team, as shown in Figure 2. Figure 2 As shown here, the Treasury Department of the MoF is responsible for the following core functions: cash management; debt management; investment of the Stabilization Reserve Fund (‘rainy day’ fund); management of the Treasury Single Account (TSA) system, including management of the centralized payment system for government entities (both on-budget and off-budget entities included in the TSA); and management of on-lending and state guarantees. The general ledger of the State is held in the common financial accounting platform (SAP), which is divided by budget units (ministry, agency, department). The DMO is a separate budget unit within the MoF. The SAP Treasury module is used for the DMO’s transactions. Information on transactions is entered into SAP by the DMO and this is automatically reflected in the general ledger. The State Shared Service Center (SSSC) central accounting department accesses all the necessary data for financial reporting from SAP. In addition to the data in the SAP general ledger, the DMO provides information to the central accounting department of the SSSC for preparation of notes to the annual financial statement—for example, information on contingent liabilities such as state guarantees and callable capital in international financial institutions (for example, the World Bank, European Investment Bank, Nordic Investment Bank, Council of Europe Development Bank , European Stability Mechanism) as well as information on debt repayments over the next five years. The SSSC is responsible for payroll accounting and human resources services for all ministries and agencies in addition to its other tasks (for example, management of EU grants, procurement services). The SSSC prepares a consolidated annual financial report of the State which is audited by the National Audit Office. Statistics Estonia, an independent agency of the MoF, extracts data on government sector entities from the public sector financial statements database and uses bridge tables to prepare government statistical reports. The public sector financial statements database includes financial reports of all public sector entities and this database is managed by the SSSC. The differences between debt recorded in government financial statements and statistical reports may remain because different standards and methodology are used to compile financial and statistical reports. Statistical reports for the general government sector follow the European System of Accounts (ESA) 2010 framework, while the government financial statements are IPSAS based. Government contingent liabilities and other fiscal risks are not captured in the accounting system but are managed and monitored by various operational departments of the MoF, such as the Fiscal Policy Department (medium-term macroeconomic risks, including scenario analysis; government debt and deficit plans; implications for expenditure and revenue; and forecasts for the long-term sustainability of government finances); the State Assets Department (adherence to SOE governance and transparency guidelines and sector and individual SOE financial performance); the Local Governments Financial Management Department (monitors local government developments aimed at early detection of risk of financial difficulties); the Insurance Policy Department and Fiscal Policy Department (sustainability of the current pensions system under various demographic, macroeconomic, and policy scenarios); and the State Treasury Department that monitors the ownership interest in international financial institutions (including callable capital) and guarantees given (for example, loan guarantees, export credit guarantees, deposit insurance guarantee, outstanding stock of student loans with government guarantee). In addition, the Ministry of Interior carries out an assessment of various threats that could affect Estonia, including environmental and other threats (nuclear or cyber attacks). The Bank of Estonia (central bank) monitors financial sector resilience and overall macro-fiscal risks from the financial sector. The SSSC consolidates information on the ongoing court cases (legal claims) from all ministries and agencies. All ministries, agencies, and departments assess their off-balance sheet liabilities at the end of the financial year. The SSSC has developed a special reporting form to collect such information, which is audited by the National Audit Office and published in the annual financial report of the State. The State Treasury Department works with all the above-mentioned stakeholders and is provided with early warnings regarding a potential crystallization of government contingent liabilities, which is then considered in cash and debt management activities. Not all the risks listed above will be reported in the financial statements; instead they may be reported in other financial reports, for example, a management commentary on the financial statements or a fiscal sustainability report. Data constraints to debt transparency will be most satisfactorily addressed by dealing with the root cause of the issue, which is the general poor quality of general-purpose fiscal reporting. Without a shift to standardized accrual-basis government reporting, ad hoc issues in reporting will continue to arise as creditor and debtor nations respond to the incentives before them. In such circumstances, it will always be a case of chasing emerging practice with ad hoc fixes rather than placing the emerging practices within a reporting environment that rests on strongly established concepts and principles. The absence of international regulations applying to debt reporting has resulted in a variety of reporting approaches being employed at the national level, which makes interpretation and cross-country comparisons of debt difficult. GFS and IPSAS have generally come to be recognized as normative architecture for statistical reporting and financial reporting, yet compliance is poor. Governments variously account according to advanced accrual concepts, rudimentary cash concepts, or statistical norms (on cash and accrual basis) or on a fund accounting basis. There is likewise no requirement or assumption that the two sides of a debt transaction—the creditor and the debtor—are reported symmetrically. Nonuniform institutional arrangements across countries mean that even when there may be data for the same years, interpretation is difficult. The application of consistently applied rigorous standards, whether on a statistical or financial reporting basis, may take many years. Financial reporting and statistical frameworks each serve different purposes and have notable methodological dissimilarities around consolidation, valuation, recognition criteria, and disclosure principles. Although both apply the accrual basis of accounting, the differences between the frameworks can result in significantly different amounts reported as debt under the two frameworks, particularly if debt is undertaken on concessional terms. In the current environment, countries are undertaking concessional debt on an unprecedented scale to fund COVID-19 response and relief measures and the impact of these valuation and reporting differences can have a significant impact on countries’ balance sheets. Despite the broad fiscal perspective that it offers to inform decision-making, policy management, and stewardship, consolidated balance sheet management is quite new to the public sector. Although balance sheet analysis has long been used to inform management analysis and decisions in the private sector, this is not the case in the public sector where the analysis has been more partial, tending to focus on liquid resources held by or as liabilities against the general government sector. The insights in applying consolidated balance sheet management, coupled with the tools of fiscal forecasting to generate the intertemporal budget constraint, suggest that this may well be an appropriate way to manage the fiscal envelope going forward.37 The coherence of the IPSAS concept framework can provide a strong foundation for underpinning sovereign debt analysis and reducing the likelihood of a fifth wave of debt to follow the current fourth wave. A core challenge to effective debt reporting through international accounting standards remains choices exercised in the name of sovereignty. Due to the lack of international regulation, countries adopt IPSAS to varying degrees based on national preferences. Political economy factors may also affect these decisions. The resulting variations in reporting lead to the noted lack of comparability among issuers of financial statements and asymmetry in reporting transactions between debtors and creditors. These variations are not apparent on the face of the individual financial statements and would therefore only be understood through further background and analysis of the financial reporting framework of the issuer. Having sufficient technical capacity in place is another core challenge that can affect the reporting choices available to government. Despite the billions spent on improving PFM systems, technical capacity is deficient in many countries. Sufficient technical capacity includes having enabling systems and institutional arrangements to support implementation, (a) a supportive legal framework, (b) UCOA, (c) adequate technological capacity and information systems, (d) adequate human resources and technical knowledge, (e) inventory and control of financial instruments; (f) internal controls for identifying managing contingent liabilities and commitments to spend, and (g) adequate external audit capacity. Institutional arrangements should also allow for reciprocal information flow between the DMO and accrual accounting system. The debt recording and management systems should ideally be integrated with the government’s Integrated Financial Management Information System (IFMIS) to support the seamless and consistent information flow and reduce the chances of error and misstatement. To improve the overall consistency and quality of debt reporting in view of the above circumstances and challenges, several conclusions may be drawn. First, some manner of international monitoring would help ensure consistency of application of IPSAS as the normative accrual accounting framework, identify variations, and disclose the impacts of these variations. Internationally recognized and adopted standards would most effectively address these issues. Encouraging a reference to IPSAS in countries’ legal frameworks would 37Willem Buiter takes this further in his recent Central Banks as Fiscal Players, which adapts this methodology to take account of the actions of central banks. “Since the central bank has the ability to issue this unquestionably liquid liability at will and at effectively zero marginal cost, the consolidated general government and central bank should never face a potential domestic currency illiquidity problem, nor a domestic currency debt default problem. Default is a matter of choice, never of necessity. This is one of the tenets of Modern Monetary Theory that is correct. If (sic) course, if the alternative to sovereign default (on domestic-currency-denominated debt) is highly inflationary monetization, a government may choose to default rather than risk the inflationary alternative.” (Buiter 2021, 55) at least commit the country to report in a manner broadly consistent with this framework, even if adopted indirectly or as a reference point. International support could be provided, where necessary, to assist countries to report on variations from IPSAS and their impact on the financial statements. The second conclusion is that greater focus should be placed on accrual accounting reforms as a fundamental aspect of broader PFM reform. Transparent and accurate debt reporting is only as good as the underlying data. Despite the role of accounting information as the underlying source of financial data informing debt reporting under both statistical and financial reporting frameworks, accrual accounting reforms are underrepresented in PFM reform support programs. This paper has highlighted approaches to recognition, measurement and reporting of government financial information drawing from international accounting standards. Application of such standards, and/or other ameliorative actions that are suggested here, may support the preparation of more comparable and higher quality debt data, as well as providing better information for many other aspects of decision making. Akerloff, G. 1970. “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism.” The Quarterly Journal of Economics 84 (3): 488–500. Alesina, A., M. De Broeck, A. Prati, G. Tabellini, M. Obstfeld, and S. Rebelo. 1992. “Default Risk on Government Debt in OECD Countries.” Economic Policy 7 (15): 427–463. Bova, E., M. Ruiz-Arranz, F. G. Toscani, H. E. Ture, 2016. The Fiscal Costs of Contingent Liabilities: A New Dataset. WP 16/14. IMF. Bradbury, S., J. Brumby, and D. Skilling. 1999. “Sovereign Net Worth; An Analytical Framework.” Working Paper 99/3, NZ Treasury. Buiter, Willem. 2021. Central Banks as Fiscal Players. Cambridge UP. Chan, James L., and Qi Zhang., 2013. “Government Accounting Standards and Policies.” In The International Handbook of Public Financial Management, edited by R. Allen, R. Hemming, and B. Potter, 742-766. Palgrave Macmillan, USA. Drebin, A. R., J. L. Chan, and L. C. Ferguson. 1981. Objectives of Accounting and Financial Reporting for - Governmental Units; A Research Study. National Council on Governmental Accounting research report. Easterly, Bill. 2002. “How Did Highly Indebted Poor Countries Become Highly Indebted; Two Decades of Debt Relief.” World Development 30 (10): 1677–1696. Eusepi, Giuseppe, and Richard E. Wagner. 2017. Public Debt: An Illusion of Democratic Political Economy. Edward Elgar Books. Flynn, Suzanne, Delphine Moretti, and Joe Cavanagh. 2016. “Implementing Accrual Accounting in the Public Sector.” Technical Notes and Manuals. Fiscal Affairs Department, International Monetary Fund. Fritz, V., M. Verhoeven, and A. Avenia. 2017. Political Economy of Public Financial Management Reforms: Experiences and Implications for Dialogue and Operational Engagement. World Bank, Washington, DC. https://openknowledge.worldbank.org/handle/10986/28887. IMF, Fiscal Monitor, April 2011, 73–78 Izquierdo, A., R. Lama, J. P. Medina, J. Puig, D. Riera-Crichton, C. Vegh, and G. Vuletin.. 2019. Is the Public Investment Multiplier Higher in Developing Countries? An Empirical Exploration. IMF, WP19/289. Kose, Ayhan M., P. Nagle, F. Ohnsorge, and N. Sugawara. 2021. Global Waves of Debt. Causes and Consequences. World Bank. Moreno-Dodson, Blanca (ed). 2013. Is Fiscal Policy the Answer? A Developing Country Perspective. World Bank, Washington DC. Musgrave, Richard A., and P. B. Musgrave. 1980. Public Finance in Theory and Practice. New York, McGraw-Hill. Oates, W. E. 1988. “On the Nature and Measurement of Fiscal Illusion: A Survey.” In Taxation and Fiscal Federalism: Essays in Honour of Russell Mathews, edited by G. Brennan, B. S. Grewal, and P. Groenewegan. ANU Press, Sydney. Orszag, Peter, Robert Rubin, and Joe Stiglitz. 2021. “Fiscal Resiliency in an Uncertain World: The Role of Semiautonomous Discretion.” Peterson Institute Policy Brief, 21-2, January 2021. Peppel-Srebrny, J. 2018. “Government Borrowing Cost and Balance Sheets: Do Assets Matter?” University of Oxford. Putnam, Robert D. 1988. “Diplomacy and Domestic Politics. The Logic of Two-level Games.” International organization 42 (3): 427–460). Rajgopal, Shivaram. 2020. The Secret Behind New Zealand’s Victory oOver Covid-19: Its Balance Sheet. This was before a rebound to NZD 157.2 billion in 2021, or 46.2 percent of GDP. 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IPSAS GFS Evaluate financial performance and position Analyze and evaluate outcomes of fiscal policy (including at individual entity level), hold decisions, determine impact on the economy, Objective management accountable, and inform decision and compare national and international making. outcomes. Economic entity, defined as a group of entities Focuses on general government sector, thereby Scope of consolidation that includes one or more controlled entities excluding institutional units primarily engaged in market activities Assets, liabilities, revenue, expense, net Assets, liabilities, revenue, expense, equity Accounts assets/equity Statements of financial position, financial Various statistical reports Reports/Financial performance, changes in equity and cash flows, Statements notes to financial statements Fair value plus or minus, in the case of financial Nominal value Valuation/measurement liability not at fair value through surplus or of debt/liabilities deficit, transaction costs that are directly attributable to its acquisition or issue Revaluations and other Distinguishes between realized and unrealized Distinguishes between value and volume value changes gains/losses changes Past events with probable outflows recognized: Economic events when economic value is recognize liabilities, including provisions, when created, transformed, exchanged, transferred, • A past economic event has taken place; or extinguished • The amount can be reliably measured; and Recognition criteria • Future outflows are probable. If items cannot be measured reliably, they could be disclosed as contingent liabilities or contingent assets. The use of the projected unit credit method to While recognition should occur, a specific Employee benefit measure the defined benefit obligation (IPSAS actuarial method to measure the net present obligations 39) value of future benefits is not explicitly recommended. Reported (by both the borrower and the lender) Reported (by both the borrower and the lender) at the fair value of the loan (which for a market at the principal received by the Market loan loan will be the principal amount) plus interest government/transferred by the lender, plus any accrued less repayments of principal and arrears of interest, less any repayments of interest principal Concessional loans are measured at fair value by Concessional interest rates to a foreign discounting the expected cash flows using a government are seen as providing a transfer market-related rate of interest for a similar equal to the difference between the actual instrument. The difference between this fair interest and the market equivalent interest. If value and the transaction price represents the such a transfer is recognized, it is usually Low interest and interest concessional element of the loan and is recorded as current international cooperation. free loans recognized as revenue by the recipient. (IPSAS The interest recorded would be adjusted by the 23, 41) same amount. But the means of incorporating the impact into the SNA has not been developed and, until this is done, information on concessional debt is shown in supplementary tables. (SNA 22.123–124) IPSAS GFS Nonperforming loans are impaired; the loss is To be disclosed as memorandum items rather assessed using an expected loss model (IPSAS 41 than recognized (SNA 2008, 11.130) with or an incurred loss model under IPSAS 29, the elaboration (SNA 13.66). In practice, no previous standard) and recognized as an provision will exist until both counterparties Nonperforming loans expense. agree to debt relief (a mutually agreed write- off). Thus, loans remain on balance sheet until a debt cancellation, write-off, or write-down has taken place. (GFSM 2014, para 7.262–7.263) IPSAS recognizes two components to the loan: a Reported (by both the borrower and the lender) market loan and revenue (a grant) for the at the principal received by the benefit of the concessional terms and debt government/transferred by the lender, plus any moratorium. These are recognized and arrears of interest, less any repayments of measured in the same manner as a concessional principal. loan (above). The effects of the concessional terms and debt Interest is accrued and recognized as an moratorium are not reflected in the GFS expense throughout the loan period, including reporting. Concessional loan those periods where a moratorium is in effect. followed by debt moratorium Compared to the GFS treatment, the operating position will be positive for the borrower (negative for the lender) when the loan is entered into. Subsequently, the increased levels of interest recognized mean that the operating position in future periods will be negative for the borrower (and positive for the lender), particularly in the periods where a moratorium is in effect. Where debt rescheduling occurs, the debt to be In debt rescheduling, the applicable existing treated as repaid and a new loan recognized if debt is recorded as being repaid and a new debt the changes are significant or the carrying instrument (or instruments) created with new amount adjusted to reflect the new terms if the terms and conditions. This treatment does not changes are not significant. Where the new apply to interest arrears that are rescheduled terms are more favorable, whether due to when the conditions in the existing debt payment holidays, lower interest rates, or contract remain unchanged. In such a case, the partial cancellation of the principal, the existing debt contract is not considered as Debt rescheduling borrower will recognize revenue reflecting the rescheduled, only the interest arrears. A new benefit it will receive from the amended terms. debt instrument is recorded for the rescheduled interest arrears. (GFSM 2014 para A3.12) If the outstanding principal amount of the claim (generally loans), recorded at its nominal value, is diminished, a capital transfer has to be recorded in favor of the defaulting debtor for the amount of the claim which is cancelled. Certain enabling systems and institutional arrangements should be in place to reap the benefits of accrual accounting in debt reporting.  Legal framework: In the absence of internationally mandated standards, the legal framework should clearly identify whether IPSAS are adopted as a basis for national standards, whether directly, indirectly, or otherwise, to promote transparency, accountability, and comparability of financial information. Any national standard setting arrangements should support objectivity, independence, and integrity in government financial reporting. Involving an interested party in standard setting may induce conflicts of interest.  Unified Chart of Accounts: A UCOA allows for seamless preparation of both statistical reports and whole-of-government financial statements. Since both frameworks are based on accrual accounting principles, many of these accounts are the same in these frameworks. Differences arise, however, in response to the reporting differences between these two frameworks described in Section C and Annex A. These differences should be properly captured in the UCOA and countries should be pragmatic about how differences between the frameworks are met. Different economic segments may not necessarily be required for each of the dissimilarities.38  Adequate technological capacity and information systems: An IFMIS supports the execution and management of public sector financial operations by enabling the electronic capture, recording, categorization, consolidation, and reporting of transactional-level financial data based on the UCOA and predefined standardized reporting formats. Access, processing, and administrative controls are typically programmed into the IFMIS to provide a level of security, data integrity, and processing uniformity, enhancing credibility of government financial information, preventing data redundancy, and thereby providing reliable accrual basis accounting data from which both financial and statistical reporting are derived. Figure A.1 denotes typical IFMIS architecture.  Adequate human resources and technical knowledge: Expertise is required at the central level to lead the reform process and oversee implementation; however, broad IPSAS expertise among all finance staff is not required. This core expertise should include strong technical knowledge of IPSAS, an understanding of the interrelationship between accounting and financial reporting with other PFM processes, and knowledge of the IFMIS or other information technology systems supporting the accounting processes. Capacity for establishing the market value of financial instruments may also need to be developed, as well as capacity for developing actuarial estimates of the expected cost of providing post- employment and other long-term benefits. If this expertise is outsourced due to capacity constraints, it should be developed internally over time.  Clearly defined accounting policies, instructions and competencies: Policies should be clearly defined at the central level to promote consistency of application among individual reporting units included in the consolidated financial statements. Likewise, clear and detailed accounting instructions for both statistical and accounting frameworks can provide step-by- 38Optimizing the Unified Chart of Accounts Design, PEMPAL Treasury COP Public Sector Accounting Working Group, October 2020. step guidance to enable operational-level finance and accounting staff throughout government to process transactions in a consistent manner based on the accounting standards and policies in effect. Operational training and knowledge should focus on these instructions.  Inventory and control of financial instruments: A complete and reliable inventory and valuation of all financial instruments, as well as details of these arrangements, should be maintained to ensure that all related commitments, contingencies, and other relevant information are properly recorded in the financial statements and qualitative information is properly disclosed. In many countries, central coordination of this inventory is led by the DMO.  Internal controls and procedures to assist identification and management of ‘other contingent liabilities’: Processes for identifying and reporting ‘other contingent liabilities’ should be in place. ‘Other contingent liabilities’ may include potential legal claims against government, guarantees provided, or any other form of implicit or explicit potential claims which are not automatically captured by government accounting systems. The information should be aggregated by nature and include information on estimated amount, probability, and any possible reimbursement.  Internal controls to match spending with resources available: A standard form of internal control is a commitment control system, which limits spending commitments to budget authority either through computerized or, in some countries, through manual systems. (It is assumed that within-year budget authority is consistent with available resources.) Use of such a system can mitigate some of the pressures that may otherwise lead to payment arrears. In an IFMIS, commitment controls are typically imbedded as a core management module and play an important role in preventing the build-up of payment arrears.  Adequate external audit capacity: Government financial statements are typically subject to external audit in accordance with national laws. External auditors, generally the SAI of the country, should possess the requisite expertise to complete an audit of IPSAS-based financial statements, including the underlying systems, procedures, and controls governing the accounting process.  Reciprocal information flow between the DMO and the accrual accounting system: Processes should exist for sharing information captured through the accrual accounting system and information captured outside the accrual accounting system, by the DMO or elsewhere, that is needed to inform financial reporting of debt. For example, the debt recording and management system which maintains information on debt incurred and payments made for debt service should be integrated within the broader IFMIS. Additionally, the DMO maintains critical information on the inventory of all financial instruments, as well as details of these arrangements, which is needed to inform accrual accounting frameworks and related financial statement disclosures. Conversely, the accounting system captures information on payment arrears, lease arrangements, cash overdrafts, and other debt-like instruments which may not be captured through the debt recording and management system. Ultimately, there should be correlation of debt reporting under the different frameworks, accounting for differences such as instrument coverage, debt definition applied, and valuation method. Source: World Bank. Transitioning to accrual accounting, and in particular IPSAS adoption, is a complex process, which requires ensuring that the right pieces are in place. The IPSAS implementation: current status and challenges paper, prepared by the Association of Chartered Certified Accountants (ACCA), identified the following key issues to consider in the transition to full IPSAS adoption: (a) Stakeholder engagement, defined as the level of awareness and understanding of the IPSAS reform by key actors such as the Ministry of Finance and other key line ministries, auditor generals, accountant generals, congress, and others (b) Structural and legal transformation, which implies that the legal and regulation framework should be in place to accommodate the implementation of IPSAS (c) Transformation and change management, to ensure that there is a cultural transformative process accompanying the accounting reform (d) Skills capacity, which is critical to ensure that the government staff have the right skills and competences required to undertake their responsibilities (e) Costs, as countries should allocate sufficient multiannual budget to ensure that the implementation elements needed for accrual accounting will be adequately funded (f) Technology and infrastructure, as the existing IT infrastructure may not be typically sufficient to support the implementation of IPSAS, likely implying the need to undertake significant upgrades to the IFMIS (g) Implementation approach, as the country will typically require well-defined implementation plans at all levels of government (h) External support, which could be provided by public accounting organizations, academia, donors and other key actors. To support governments in the implementation of accrual accounting, IFAC developed the ‘Pathways to Accrual’ tool, which is primarily intended to assist public sector entities transitioning from cash to accrual basis of accounting and may also be useful for entities already reporting on an accrual basis and are considering transitioning to IPSAS. The tool includes, among others, an overview of the wider context in which the transition to the accrual basis of accounting may occur; a discussion of various transition pathways that entities choosing an incremental implementation process may adopt; identification of the main tasks associated with recognition of assets, liabilities, revenues, and expenses, including issues and challenges associated with the identification of, as well as measurement of, those elements in financial statements; some implications of adopting accrual basis IPSAS; practical suggestions based on the experience of other entities and jurisdictions; and links to other useful guidance and resources. As noted also by the Pathways to Accrual document, the length of the reform period may differ across jurisdictions. In determining the reform period, decisions will be needed on the balance between the time taken for preparatory work and the time required for the actual transition in line with the requirements of IPSAS 33.39 While in a country where there is strong political support, a limited number of entities, and good professional and institutional capacity, a short reform period of up to three years could be achieved, 39The IPSASB issued IPSAS 33 First-time Adoption of Accrual Basis IPSAS in January 2015. The objective of this standard is to provide guidance to a first-time adopter that prepares and presents financial statements following the adoption of accrual basis IPSASs, to present-high quality information. reforms could also extend for periods longer than five or six years in countries with low capacity or poor political support, exposing to significant risks of reform fatigue. The World Bank Technical Note on First Time Adoption of Accrual Basis IPSAS laid out two possible approaches for an implementation strategy: a ‘big bang’ approach or a phased approach. A big bang approach entails a switch from the pre-IPSAS accounting system to full IPSAS compliance commencing from a particular date. By contrast, a phased approach involves the progressive implementation of improvements in a planned sequence, with the aim of meeting IPSAS requirements to the fullest extent practicable by the end of the final phase.40 Big Bang Phased Implementation All or most of the requirements of IPSAS would A phased approach enables the jurisdictions to be implemented by all government entities adopt some IPSAS requirements in the short term, from a specific date. with progressive implementation of IPSAS over the It involves risks such as a high dependence on medium term. It also allows time to build IPSAS- external consultants and a crowding-out of related skills and expertise in keeping with the pace internal organizational skills. A big bang of implementation. However, it should be noticed approach could lead to a significant delay in that a phased approach also has risks, mainly (a) startup while all the preparations necessary to longer implementation periods, (b) reform fatigue, be ready for a full implementation are and (c) loss of momentum and political support. completed. 40IPSAS 33 is designed for a phased approach, that is, it includes some exemptions over a period not exceeding three years. In some jurisdictions, the big bang approach is the only option due to administrative law requiring entities to follow formal legislation for financial reporting, which may not permit entities to phase the implementation, while the parallel dry run of both systems usually is costly and requires additional operational capacity. The IMF’s Fiscal Transparency Code contains a set of principles that are relevant for transparency in reporting of sovereign debt and liabilities. These include the following Fiscal Transparency Principles:41  Principle 1.1.1. Coverage of Institutions. Fiscal reports cover all entities engaged in public activity according to international standards.  Principle 1.1.2. Coverage of Stocks. Fiscal reports include a balance sheet of public assets, liabilities, and net worth.  Principle 1.1.3. Coverage of Flows. Fiscal reports cover all public revenues, expenditures, and financing.  Principle 1.3.2. Internal Consistency. Fiscal reports are internally consistent and include reconciliations between alternative measures of summary fiscal aggregates.  Principle 1.4.2. External Audit. Annual financial statements are subject to a published audit by an independent SAI which validates their reliability.  Principle 3.1.3. Long-Term Fiscal Sustainability Analysis. The government regularly publishes projections of the evolution of public finances over the long term.  Principle 3.2.2. Asset and Liability Management. Risks relating to major assets and liabilities are disclosed and managed.  Principle 3.2.3. Guarantees. The government’s guarantee exposure is regularly disclosed and authorized by law.  Principle 3.2.4. on Public-Private Partnerships. Obligations under public-private partnerships are regularly disclosed and actively managed. A tool is available to measure the effects of fiscal policy decisions on liabilities and net worth. The recourse to fiscal policy measures has increased as a result of the COVID-19 pandemic. Policy makers need reliable financial information to analyze the impact of fiscal and related programs and be able to determine their effect in terms of the increase of fiscal risks and their potential impact in the economy. While accrual accounting is not the only tool at their disposal, it represents a reliable instrument to provide such information. Notably, IPSASB and IFAC released a COVID-19 Intervention Assessment Tool, to help governments assess, evaluate, and inform various types of interventions. The tool provides an immediate means of evaluating the economic impacts of current and planned policy initiatives, which can be used independent of any given jurisdiction’s public sector accounting basis. The set of fiscal indicators that are commonly used in cash accounting environments may not be most appropriate when the richer set of data from accruals are available. 41Here are the links to the Fiscal Transparency Code and Fiscal Transparency Handbook (https://www.imf.org/external/np/fad/trans/Code2019.pdf and http://www.elibrary.imf.org/fth) The World Bank’s paper on the role of Government Financial Reporting in Times of the COVID-19 Pandemic provides guidance to accountants and auditors on how governments can use existing systems to identify opportunities to improve future reporting in light of the policy actions implemented during 2020 and beyond. The paper highlights the impact of the pandemic on government financial performance, position, and cash flows, presenting a consolidated view of the financial statements highlighting the possible effects of fiscal measures taken as a result of COVID. The items where most countries could experience increases are borrowings, long-term provisions, and employee benefits. This paper may be useful in assessing the impact of the pandemic on the key fiscal indicators. Various resources are available for countries that are adopting accrual accounting. An indicative approach to transitioning to accrual accounting is presented by Flynn, Moretti, and Cavanaugh (2016).42 The approach guides countries through a transition from cash basis accounting to full accrual accounting through a series of sequenced steps focused on three parallel dimensions of financial reporting: the balance sheet, operating statement, and scope of consolidation. The following list is not exhaustive but includes a number of publications and articles with useful information.  Study 14, Transition to the Accrual Basis of Accounting (IPSASB)  Stepping Stones to Accrual Accounting (CIPFA)  Implementing Accrual Accounting in the Public Sector (IMF)  Transition to Accrual Accounting (IMF)  Getting Added Value out of Accruals Reforms (OECD)  Is Cash Still King? (Association of Chartered Certified Accountants [ACCA]/IFAC)  Accrual Accounting is for the Public Sector (Deloitte)  Implementing Accrual Accounting in the Public Sector–Understanding Your Technology Is Vital! (IFAC)  Accruals in the Public Sector Are Here to Stay! Pursuing a Productive Debate (IFAC) Recent guidance that shows how accrual accounting, and IPSAS in particular, can provide useful information in respect of topical issues includes the following:  COVID-19: Relevant IPSASB Accounting Guidance (IPSASB)  COVID-19 Intervention Assessment Tool (IFAC and the Zurich University of Applied Science [ZHAW])  Climate Change: Relevant IPSASB Guidance (IPSASB) Adoption of cash basis IPSAS is seen as a first step toward the adoption of accrual basis IPSAS rather than as an end in itself. By its very definition, cash basis accounting does not capture accrual elements. However, the cash basis standard within the IPSAS framework includes mandatory requirements (Part I) as well as encouraged (Part II) disclosures. The Part II supplemental disclosures capture elements of 42Flynn, Suzanne, Delphine Moretti, and Joe Cavanagh. 2016. “Implementing Accrual Accounting in the Public Sector.” Technical Notes and Manuals. Fiscal Affairs Department, International Monetary Fund. debt by disclosing liabilities, joint arrangements, and external assistance received including loans. In Bangladesh, for example, the World Bank is providing technical assistance to adopt cash basis IPSAS with disclosures including a ‘Statement of Proceeds of Borrowings’ (domestic and foreign) and ‘Schedule of Liabilities’ that show outstanding domestic and foreign loans. Upon producing its first cash basis IPSAS compliant financial statements for FY19/20, a road map will be prepared by government to transition to accrual basis IPSAS. The World Bank currently supports several countries in cash basis IPSAS reforms as a first step in preparing for accrual basis IPSAS reforms.