STITUTIONS | INSTITUTIONS | INSTITUTIONS | INSTITUTIONS | INSTITUTIONS | INSTITUTIONS | INSTITUTIONS | INSTITUTIONS | INSTITUTIONS | INSTITUTIONS | INSTITUTIONS | I STITUTIONS | INSTITUTIONS | INSTITUTIONS | INSTITUTIONS | INSTITUTIONS | INSTITUTIONS INSTITUTIONS | INSTITUTIONS | INSTITUTIONS | INSTITUTIONS | INSTITUTIONS | INSTITUTIONS | I MANAGEMENT Institutions Global Department Prosperity Insight Series A product of Government Balance Sheet Lab ACCRUAL ACCOUNTING FOR FISCAL 2024 GLOBAL REPORT ON THE USE OF © 2024 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. 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Because The World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202- 522-2625; e-mail: pubrights@worldbank.org. >>> Acknowledgments The report, Use of Accrual Accounting for Fiscal Management, is a Global Report prepared under the Governance Global Practice’s Balance Sheet Lab. The report was prepared by a team led by Bonnie Ann Sirois (Senior Financial Management Specialist) and Srinivas Gurazada (Global Lead, Public Financial Management). The team includes Christopher Robert Fabling (Consultant), Erna Swart (Consultant), Aisha Lanette DeGuzman (Senior Financial Management Specialist), Noemi Dailola (Consultant), Nouf Sh M M Alazmi (Financial Management Specialist), Patrick Kabuya (Senior Financial Management Specialist), Khuram Farooq (Senior Financial Management Specialist), Tim Williamson (Senior Governance and Public Sector Specialist), Debasish Kumar Das (Consultant), Hubert Nii-Aponsah (Consultant), and Rhea Almocera-Santiago (Consultant). James M. Brumby (Senior Advisor) provided technical guidance and advice to the team. Arturo Herrera Gutierrez (Global Director), Adenike Sherifat Oyeyiola (Practice Manager), and Serdar Yilmaz (Practice Manager) provided overall guidance and valuable advice for the preparation of the report. Authors are grateful to the following for sharing the case studies presented in Appendix E and elsewhere in the report. Vietnam – Ha Thuy Tran, in consultation with Vu Duc Chinh, General Director, Accounting and Auditing Supervisory Department, Ministry of Finance of Vietnam, and Nguyen Thi Hien, Deputy General Director, State Accounting Department, State Treasury of Vietnam Chile – Juan Carlos Serrano-Machorro, in consultation with Yolanda Bascuñan, Deputy Chief of the Accounting Division of the Ministry of Finance >>> Acknowledgments Rwanda – Josephine Kabura Kamau, in consultation with Marcel Mukeshimana, Accountant-General, Ministry of Finance and Economic Planning, Rwanda The team is grateful to Ian Carruthers (Chair, IPSAS Board), Kesavan Srinivasan (Chairperson, Government Accounting Standards Advisory Board, India), Ian Ball (Professor, Victoria University, and Advisor, New Zealand Government Accounting), Laura Leka (Principal, IFAC), Francesco Grigoli (Senior Economist, IMF), Alexander Metcalfe (Global Head of Public Sector, ACCA), Chiara Bronchi (Practice Manager), Saeeda Sabah Rashid (Lead Financial Management Specialist), Suraiya Zannath (Lead Financial Management Specialist), Daniel Rogger (Senior Economist, World Bank), Diego Rivetti (Senior Debt Specialist, World Bank) and João Carlos Fonseca (Principal, IPSASB) who provided useful contributions as peer reviewers at concept stage or reviewers at final report stage. The team was supported by Bertin Lopez (Senior Program Assistant), Nene Mane (Senior Operations Assistant), Liudmila Uvarova (Senior Knowledge Management Officer), and Lara Saade (Senior External Affairs Officer). >>> Contents Executive Summary 7 Introduction 9 1. Adoption and Use of Accrual Accounting in the Public 12 Sector a. Profiling and Comparative Analysis of Countries 15 by Basis of Accounting b. Challenges Associated with Partial Accrual 19 Accounting c. Debt Management and Fiscal Analysis 20 d. Use of Information Systems to Facilitate the Use 26 of Accrual-Based Financial Information e. Costs Versus Benefits of Adopting and 28 Implementing Accrual Accounting f. Case Studies 29 2. Theory of Change 33 3. Conclusions and Policy Recommendations 43 References 46 Additional References 48 Appendix A – Theory of Change 49 Appendix B – Profile of Countries by Basis of Accounting 55 >>> Contents Appendix C – Summary of Foundational Differences Between International Public Sector Accounting 62 Standards and Government Finance Statements Appendix D – Selected Case Studies 66 a. Vietnam 67 b. Chile 68 c. Rwanda 70 >>> Executive Summary There has been a growing global trend toward the adoption of accrual accounting in the public sector. However, relatively few countries prepare annual consolidated financial statements for the whole of government that fully comply with accrual-based accounting principles. Even fewer countries have a fully integrated planning, budgeting, financial reporting, and fiscal management process. This raises the question of whether governments recognize the benefits of public sector accounting reforms beyond publication of annual whole-of-government consolidated financial statements. This report investigates whether the use of accrual information, particularly information on the government balance sheet, is associated with improved fiscal management. It explores the vari- ous uses of accrual-based financial information and available evidence, both empirical and an- ecdotal, of countries that have fully implemented accrual accounting. It looks at the benefits and outcomes associated with accrual accounting in terms of improved fiscal management and bet- ter management of fiscal risks. It also highlights the valuable lessons that can be learned from these countries to assist developing nations in implementing public sector accounting reforms and achieving better fiscal management. Drawing on the analysis, the report presents a theory of change for the adoption and implementation of accrual accounting. The analysis further highlights several challenges that adversely impact the overall quality and reliability of accrual-based financial information. These challenges include lack of transparency over partial accrual information, inconsistent basis of preparation wherein variations in national accounting frameworks and definitions of the Government Reporting Entity (GRE) lead to a lack of comparability across jurisdictions, the need to integrate past and future focused information, and the complexity faced by governments in managing accrual-based financial information. To address these challenges, the report offers the following policy recommendations: 1. Strengthen the public sector accounting reform process by defining clear objectives for accrual accounting reforms, extending beyond financial reporting to include improved bud- get management, financial analysis, and policy outcomes; integrating accrual accounting reforms into broader public financial management reforms; establishing criteria for assess- ing reform readiness at each stage of the transition to ensure smooth implementation; and recognizing that full implementation requires several stages, allowing for gradual progress and capacity building. PROSPERITY INSIGHT <<< 7 2. Address the lack of transparency in partial accrual accounting through disclosure of accrual-based information or full compliance with the International Public Sector Account- ing Standards (IPSAS) cash basis standard. Jurisdictions using partial accrual account- ing are recommended to disclose the extent of accrual-based information in their financial statements annually. Disclosure guidelines should be developed to promote consistency of disclosure across jurisdictions reporting financial information on a partial accrual basis. Jurisdictions in the preparatory or transition phase to full IPSAS adoption are recommended to disclose this information, monitor compliance with transition requirements, and prepare whole-of-government consolidated financial statements in full compliance with the IPSAS cash basis standard, including encouraged accrual-based disclosures. 3. Ensure assurance over financial data through an auditable system and by expanding reconciliation and assurance procedures. It is recommended the jurisdictions generate fi- nancial information from a single, auditable accrual-based system, replacing manual proce- dures and estimates that lack independent assurance. They should also expand reconcili- ation and assurance procedures for manually compiled or estimated accrual information to increase the reliability of analysis. While implementation of these policy recommendations would be a significant advancement toward increasing the transparency of partial accrual information, greater progress would require a consensus to be reached on the mandatory requirements for countries to adopt and implement International Public Sector Accounting Standards. PROSPERITY INSIGHT <<< 8 >>> Introduction Many countries have transitioned or are in the process of transitioning to the accrual basis of accounting to prepare their general-purpose financial statements. This has primarily been driven by recognition of the limitations of cash basis accounting, particularly in terms of the complete- ness of information. Accrual accounting provides a comprehensive view of financial position, performance, and cash flows by recognizing revenues and expenses when they are earned or incurred. The use of accrual information has long been recognized as a basis for fiscal and economic analysis in es- tablished frameworks for finance and economic statistics.1 However, in the absence of accrual- based accounting as the foundation of an integrated planning, budgeting, and financial reporting framework, accrual information often depends on data not directly sourced from the government accounts. Such financial data that is not subject to the independent assurance applied to ac- counting information underlying audited whole-of-government annual financial statements can result in misinformation and, ultimately, ineffective fiscal management. This raises further ques- tions about whether governments understand the full range of information and management needs informed by accrual data and the need to ensure integrity over that data. Starting in 1996, the International Public Sector Accounting Standards (IPSAS) have progres- sively been developed to offer principles-based guidance for countries adopting accrual-based financial reporting. Despite this advance, accrual accounting reforms are underrepresented in public financial management reform programs (World Bank 2020). Little analysis exists to mea- sure the outcomes associated with accrual accounting reforms in the public sector, which limits the availability of information for governments to make well-informed decisions about whether to undertake such reforms. The lack of extensive evidence on the benefits associated with accrual accounting reforms, combined with the absence of a requirement for independent assurance over data supporting fiscal and economic analyses, means that accrual accounting is often not prioritized as a reform measure. This report examines the various uses of accrual-based financial information, many of which have been adapted from private sector practices to the public sector context. It aims to answer two key questions: • Is accrual accounting associated with improved fiscal management? • Are there lessons or findings on the relationship between accrual accounting and fiscal management explicitly related to developing economies? 1. The System of National Accounts (SNA), which measures the economic activities of a nation, and the Government Finance Statistics (GFS) framework, developed to support fiscal analysis, follow the principles of accrual accounting, supplemented by cash basis information. PROSPERITY INSIGHT <<< 9 The report presents analysis of the adoption and implementation of accrual accounting in the public sector to explore its role in providing information on fiscal sustainability, informing econom- ic analysis, and supporting policy decision-making. The analysis examines the benefits and dis- advantages of accrual accounting using various methods, including profiling the socioeconomic characteristics of countries and the results of Public Expenditure and Financial Accountability assessments by their accounting basis in 2020; analyzing completeness and comparability is- sues with partial accrual accounting; reviewing research on accrual-based financial information as an indicator of fiscal risks; and assessing the use of accrual-based financial information for debt management and transparency. The analysis also reviewed the role of technology in facili- tating access to accrual data and the costs versus benefits of accrual adoption. It also included three case studies of developing countries preparing for the transition to full accrual accounting. Drawing on the lessons learned by countries that have successfully adopted accrual accounting, this report outlines a “theory of change” that identifies two distinct phases of accrual accounting reforms. The first phase involves the initial adoption of accrual accounting and the preparation of an opening balance sheet, as well as the production of accrual-based financial statements for individual public sector entities and consolidated financial statements for the whole of govern- ment. This phase primarily focuses on improving transparency. However, it does not necessarily lead to better decision-making as it only provides information about past financial position and performance. The second phase, which is crucial for achieving high-level outcomes, involves implementing accrual-based planning and budgeting, as well as a performance measurement system. This phase establishes a clear link between accrual-based financial information and fi- nancial and nonfinancial performance information, enabling a fully integrated strategic planning, budgeting, financial reporting, and fiscal management approach. Association with improved fiscal management The analysis indicates that integrating accrual information into planning, budgeting, and financial reporting allows for comprehensive analysis of public resource use, asset and liability man- agement, and public service efficiency. This integration helps governments manage fiscal risks by leveraging their balance sheet on a whole-of-government basis. It enables informed invest- ment and borrowing decisions, considering long-term sustainability and intergenerational equity. Policy options can be assessed for their impact on the government’s financial position, aiding strategic planning and budgeting by prioritizing investments, determining borrowing levels, fore- casting surpluses or deficits, and considering intergenerational wealth. This is crucial given the current high deficits and rising debt distress in many countries. Recent empirical research in 24 OECD countries supports the adoption of accrual accounting, showing its effectiveness in assessing fiscal risks. The study indicates that accrual-based finan- cial data is positively recognized by international capital markets, leading to improved sovereign credit ratings and lower borrowing costs. Strong credit ratings, in turn, enable governments to respond to fiscal risks more efficiently by establishing reserves and promoting policy flexibility (Jung, Kim, and Chang 2020). PROSPERITY INSIGHT <<< 10 Lessons on the relationship between accrual accounting and fiscal management Although there is evidence that adopting and implementing accrual accounting in the public sector can have positive impacts, there are concerns about whether the benefits of adoption outweigh the costs, and it is challenging to quantify the costs and benefits accurately. The tran- sition often entails significant expenses, such as the introduction of new information systems and the need for capacity building. However, the advantages tend to accumulate over time. For instance, a study estimated that full adoption of accrual-based European Public Sector Account- ing Standards (EPSAS) by the EU could incrementally raise its GDP by €19 billion per year once peak accounting maturity is achieved. This is against an anticipated cost of €6.9 billion over a five-year period. These figures, though approximate, highlight the potential benefits that accrual accounting could bring. The analysis further highlights several challenges that adversely impact the overall quality and reliability of accrual-based financial information. These challenges include the following: Lack of transparency over partial accrual information. The partial accrual basis of accounting is associated with a lack of transparency about which elements of the financial statements are recognized on an accrual basis. As a result, the comparability, completeness and reliability of the financial information produced by these countries is compromised. Additionally, management and fiscal analysis derived from manually compiled or estimated accrual data lacks the reliability of data sourced from an audited accrual-based system. Inconsistent basis of preparation. Variations in national accounting frameworks and definitions of the Government Reporting Entity (GRE) lead to a lack of comparability across jurisdictions. Integration of past and future focused information. Financial statement preparation should be seen as one aspect of a fully integrated planning, budgeting, financial reporting, and fiscal man- agement process. However, this is infrequently applied in practice. Managing information complexity. Simplification to make accrual-based financial information more user-friendly is receiving much attention. However, a government is responsible for a very broad range of activities, and accounting for them is necessarily complex. The aim should there- fore be to provide additional analyses with an appropriate level of detail to serve the differing needs of stakeholders. PROSPERITY INSIGHT <<< 11 1. >>> Adoption and Use of Accrual Accounting in the Public Sector Interest in accrual accounting increased in the 1990s due to its potential to enhance public finan- cial management and performance. Early debates focused on the differences between public and private sector activities and whether accrual accounting was suitable for evaluating the public sector’s financial position and performance. The anticipated benefits included improved transparency and accountability, a comprehensive view of public finances, and stronger incen- tives for efficient resource management (OECD 1993). As support for accrual accounting in the public sector grew, focus shifted to implementation, particularly the need for specific public sector accounting standards. Extensive stakeholder dis- cussions, including those at the annual OECD Accruals Symposiums, led to the development of International Public Sector Accounting Standards (IPSAS) by the International Federation of Ac- countants (IFAC) Public Sector Committee, which became the IPSAS Board (IPSASB) in 2004. Starting in 1996, this effort has produced 39 IPSAS accrual standards and a cash-basis IPSAS. The importance of government balance sheets is increasingly recognized. An IMF study in 2018 highlighted that public sector balance sheets offer a complete picture of public wealth, encom- passing all assets and liabilities controlled by the government, including public corporations, nat- ural resources, and pension liabilities. This comprehensive view goes beyond debt and deficits, providing better fiscal transparency and enabling improved revenue generation, risk reduction, and fiscal policy making (IMF 2018). While many countries have adopted accrual accounting for financial reporting, the planning and budgeting cycle is still based on cash-basis accounting in many countries. Only a small number of countries, primarily higher-income countries, have implemented accrual-based budgeting. PROSPERITY INSIGHT <<< 12 > > > B OX 1 - What is Meant By the Term “Accrual”? How does Accrual-based Accounting differ from Accounting on a Cash Basis? The term “accrual” encompasses two key concepts: Recognition of economic events. Accrual accounting records economic events when they occur, not when cash trans- actions happen. This includes accruing tax revenue when a taxable service is delivered, recording salary and pension expenses when public services are performed, and recognizing asset losses as expenses. Unlike cash accounting, ac- crual accounting also includes noncash charges like depreciation, revaluations, and provisions for liabilities. Recognition of assets and liabilities. Accrual accounting requires governments to recognize all assets and liabilities on the balance sheet, including financial assets (e.g., investments, loans), nonfinancial assets (e.g., property, infrastruc- ture), and liabilities (e.g., debt, pension obligations). These are regularly revalued to reflect the true financial position. In contrast, cash-basis accounting typically only accounts for cash and cash equivalents, with limited disclosures on other assets and liabilities at book value. Source: Adapted from Moretti and Youngberry (2018). The “Balance Sheet” – One component of a set The presentation of financial statements is important because of financial statements it affects the comprehensiveness and understandability of a government’s financial position at the end of the financial This report frequently refers to the “balance sheet,” which year; its past financial performance for the financial year; and is one of the components of a government’s consolidated the cash flows it generated from operating, investing, and financial statements and is prepared on an accrual basis. financing activities during the financial year. PROSPERITY INSIGHT <<< 13 > > > B OX 2 - Components of a Set of Government Financial Statements Statement of financial position or balance sheet presents a government’s net financial position at a point in time (that is, its assets less its liabilities, as of the end of financial reporting period). A statement of changes in net assets/equity presents the movements in net assets that consist of the net operating surplus or deficit from the statement of financial performance, and other movements that were not recognized in the net operating surplus or deficit. For example, this could be corrections (prior period adjustments) for assets and liabilities not previously recognized in the statement of financial position. This statement can either be included on the face of the statement of financial position or be presented as part of the supporting note disclosures. Statement of financial performance presents a government’s net operating surplus or deficit for the financial reporting period (that is, its revenues less expenditures for the financial year). This will often include a comparison of budget ver- sus actual outturns achieved, with further detailed explanations of major variances being included in the supporting note disclosures. Statement of cash flows presents the movements in a government’s net cash position for the financial reporting period (that is, the cash inflows less its cash outflows for operating, investing, and financing activities for the financial year reconciled to the net increase or decrease in its cash position). This is in essence the equivalent financial information provided by cash-based accounting. Accounting policies presents the basis for preparation of the financial statements, including the key overall assumptions used (for example, the going concern basis) and specific policies applied for major categories of assets, liabilities, rev- enue, and expenditures. Supporting note disclosures present additional, more detailed information and analysis of significant line items presented on the face of the statements outlined above. Audit opinion provides the external auditor’s opinion on the truth and fairness of the overall financial statements. Accrual Accounting Adoption by Govern- Box 4). There are a variety of reasons for these decisions, ments is not Universal including a lack of political support, a belief that the costs of such a transition would exceed the expected benefits, While many countries have transitioned or are in the and insufficient technical capability to implement. However, process of transitioning to accrual-based accounting in the overriding concern is a misperception about loss of their public sectors, some have chosen not to do so (see budgetary control by legislatures. PROSPERITY INSIGHT <<< 14 > > > B OX 3 - Why not Accruals? The Cases of the Netherlands, Norway, and Germany While the great majority of OECD countries have embraced accrual-based accounting, some have chosen not to. Ger- many, the Netherlands, and Norway are three examples. Germany In 2006, Germany’s Federal Ministry of Finance aimed to modernize the budgeting and accounting system by comple- menting the cash-based system with an accrual-based one. Despite some states adopting accrual accounting, the fed- eral project was halted in 2010 due to high costs and concerns from parliamentarians about losing budgetary influence. Currently, four states (Hessen, Hamburg, Bremen, and North Rhine-Westphalia) use accrual accounting, with North Rhine-Westphalia applying it internally but not issuing external financial statements. Netherlands A 2017 government inquiry in the Netherlands found that while a comprehensive accrual system would be clearer for forecasting and accounting, the existing cash-based system was functioning well. Concerns about the transition’s impact on already pressured ministries led to the recommendation against immediate adoption. An interim evaluation was sug- gested for 2020, but the High-Level Working Group on the Budgetary Stance remained hesitant to recommend accrual accounting. Norway A 2015 government inquiry in Norway concluded that there were no substantial reasons to shift from the cash-based system. The inquiry argued that cash-based budgeting supports countercyclical fiscal policy and aligns better with par- liamentary scrutiny. Therefore, it recommended maintaining the cash-based system for both budgeting and accounting. Sources: “Revenues and expenses revaluated – Report of the Advisory Committee on the Central Government Accounting System”; Bedre beslut- ningsgrunnlag, bedre styring (NOU: 2015:14); OECD (2015); OECD (1993). a. Profiling and Comparative Analysis of Countries by Basis of Accounting A profiling exercise was completed to identify the socioeconomic gathered for 165 countries by IFAC Chartered Institute of characteristics of countries associated with each of the three Public Finance and Accountancy (CIPFA) in completing the bases of accounting (cash, accrual, and partial accrual) applied International Public Sector Financial Accountability Index, in 2020. The analysis utilized publicly available datasets and 2020. compared the information against IPSAS by country data PROSPERITY INSIGHT <<< 15 > > > T A B L E 1 - Basis of Accounting, by Income Group Parcial Accrual Cash Accrual 40% 30% 30% INCOME GROUP 66 Countries 50 Countries 49 Countries No. % No. % No. % Low-income 14 21% 8 16% 1 2% Lower-middle-income 13 20% 16 32% 8 16% Upper-middle-income 22 33% 10 20% 10 21% High-income 15 23% 13 26% 27 55% No tag 2 3% 3 6% 3 6% Total 66 100% 50 100% 49 100% Source: Based on IPSAS by Country Data (IFAC-CIPFA), 2020; and World Bank Classification of Countries by Income Group, 2020. Note: The Chartered Institute of Public Finance and Accountancy (CIPFA) is a professional accountancy organization based in the United Kingdom. Of the 165 jurisdictions surveyed by IFAC-CIPFA in 2020, countries at about one quarter. Countries using partial only 49 countries (30 percent) reported using accrual accrual accounting fall in between, with upper-middle-income accounting. Most countries used partial accrual accounting, countries representing one third. while 30 percent used cash basis accounting. The survey did not distinguish between countries using partial accrual as a Additional profiling across geographic regions, democratic transition to full accrual and those using it permanently. categorization, fragility, financial management information system (FMIS) maturity, Open Budget Data (OBD) index, High-income countries make up the majority (55 percent) of and Country Policy and Institutional Assessment (CPIA) those using accrual accounting, followed by upper-middle- scores is detailed in Appendix C. The profiling revealed that income countries (about 20 percent). Lower-middle-income countries adopting accrual accounting share similarities in and low-income countries together represent less than 20 income group, democratic categorization, and fragility. Trends percent of those using accrual accounting. Conversely, lower- were also noted in FMIS maturity, Open Budget Data, CPIAs, middle-income and low-income countries account for almost and selected Global Development and World Development half (48 percent) of those using cash basis accounting, with Indicators. The common characteristics for each accounting upper-middle-income countries at one fifth and high-income category are summarized table 2. PROSPERITY INSIGHT <<< 16 > > > T A B L E 2 - Profile of Countries by Basis of Accounting Cash Basis Partial Accrual Accrual • More prominent among low- and • Many are upper-middle-income • Many are high-income countries lower-middle-income countries countries • A substantial share of countries • More prominent in Sub-Saharan • More prominent in Latin America are from East Asia and the Africa and the Caribbean, and Sub- Pacific, and Europe and Central • Higher percentage of hybrid Saharan Africa Asia regime countries • Most prominent among mid-range • Many are high-range performing • More prominent among fragile performing democracies, weak democracies states democracies, and hybrid and • More prominent among APEC • Less organized and informative in authoritarian-regime countries countries and 43 percent are FMIS and OBD publications, and • Average FMIS, OBD, and CPIA OECD countries have lower FMIS and OBD scores scores are generally higher than • On average, more organized • Many are assessed as having cash-basis countries and lower and informative in their FMIS partially acceptable to below- than countries applying the accrual and OBD publications and have desired level of public finance data basis higher FMIS and OBD scores presentation • Demonstrate a moderate level of • Many were assessed as having • Characterized by lower average FMIS maturity good quality and more informative CPIA scores public finance data presentation • Demonstrate a low level of FMIS • Performance is more favorable maturity on many development and growth indicators, most notably those related to transparency, accountability, and corruption • Demonstrate a higher level of FMIS maturity Note: APEC = Asia-Pacific Economic Cooperation, CPIA = Country Policy and Institutional Assessment, FMIS = financial management information system, OBD = Open Budget Data, OECD = Organisation for Economic Co-operation and Development. The profiling exercise includes a comparative analysis of budget execution control, accounting and reporting, and countries’ public expenditure and financial accountability external audit. It evaluates how well these systems support (PEFA) scores by accounting basis (cash, partial accrual, and sound public financial management, which is essential for accrual) using 2016 framework data. The PEFA framework effective policy implementation and resource allocation. PEFA assesses the strength of a country’s public financial scores by accounting basis for 56 low, lower-middle, and management, covering budget reliability, transparency, asset upper-middle-income countries are presented in figure 1, with and liability management, fiscal strategy and budgeting, the full dataset in Table C.7, Appendix C. PROSPERITY INSIGHT <<< 17 > > > F I G U R E 1 - PEFA Scores by Accounting Basis, 2016 Framework Accrual Cash Partial Accrual 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00 Budget Reliability Transparency of Management of Policy-based Fiscal Predictabiliy & Accounting & External Security Public Finances Assets & Liabilities Strategy & Budgeting Control in Budget Reporting & Audit Execution Source: PEFA 2016 Framework; IPSAS by Country Data (IFAC-CIPFA) 2020; PEFA scores are available at https://www.pefa.org/index.php/assessments/ batch-downloads. The comparative analysis indicates that countries applying assets and liabilities, supports policy-based fiscal strategies, accrual accounting reflect higher PEFA scores across PEFA and contributes to more predictable and controlled budget pillars except for credibility of the budget. To date, very few execution. Accrual accounting’s recognition of revenues and countries apply accrual budgeting. Credibility of the budget expenses when they occur, rather than on a cash basis, is influenced by many factors, including macroeconomic allows for regular, timely financial reporting, which is reflected forecasting, fiscal strategy, and the extent to which the budget in PEFA scores. is comprehensive and policy based. Accrual budgeting can likewise influence the credibility of the budget by providing The comparative analysis did not establish causal relationships a more accurate and complete financial picture. The overall between the basis of accounting applied and the indicators of impact on PEFA scores depends on how well the accrual fiscal performance demonstrated by each category. In other accounting system is implemented and integrated with other words, the analysis did not determine whether outcomes are public financial management practices. caused by the accounting practices being applied or whether the choice of accounting practices reflect the income levels, Factors contributing to better performance on indicators resources available, and quality of the bureaucracies within of public expenditure and financial accountability include the state institutions of each respective category, which in effectiveness of public financial management systems, turn enable improved performance on indicators of fiscal strong governance and institutions, comprehensive legal and performance. As noted in the profiling exercise, countries with regulatory frameworks, and strong technical competency. good public sector financial management outcomes are more Accrual accounting likewise contributes to this objective by likely to apply the more complex and sophisticated option of providing a complete picture of financial transactions, including accrual accounting. Because accrual accounting involves more future payables and receivables, which cash accounting does complex accounting processes than cash basis accounting, not capture. This approach presents a comprehensive view of the application of accrual accounting is often accompanied by a government’s financial position on which to base financial a more mature internal control framework which may further decision-making. It also aids in the effective management of contribute to these results. PROSPERITY INSIGHT <<< 18 b. Challenges Associated With Partial Accrual Accounting Based on the 2020 IFAC-CIPFA data, many countries (66, In the period before accrual accounting is fully implemented, or 40 percent of the 165 countries surveyed) were applying these countries only recognize certain classes of assets and accounting on a partial accrual basis. However, it is generally liabilities on their balance sheets. There are adverse impacts accepted within the accountancy profession that there are when the transition from partial accrual accounting to full only two bases of accounting—the cash basis and the accrual accrual accounting takes too long, as the financial information basis. produced is neither complete nor readily comparable with other jurisdictions. For this reason, IPSAS 33 requires that The term partial accrual basis has arisen to describe the transition must be completed within a three-year period. accounting methodologies where some transactions are Many countries do not comply with this requirement. The three recognized on an accrual basis while other transactions are developing countries’ case studies provided in Appendix E recognized on a cash basis. This may be because a country illustrate that many countries spend a significant amount of has chosen to transition to full accrual accounting using a time in the preparatory phase of their public sector accounting phased approach or because a country’s national accounting reforms prior to transitioning to full accrual accounting. framework includes some accrual elements, but no further changes toward full accrual accounting are planned. In either Regardless of whether countries are deemed partial accrual case, there is no universally defined framework for partial adopters or not, they should transparently disclose in their accrual accounting that specifies which elements should be whole-of-government consolidated financial statements recognized on a cash or accrual basis. the extent to which they include accrual-based information. Unfortunately, this is typically not done. It is often unclear The purported definition of what constitutes partial accrual what information is accrual-based, and more importantly, what accounting is very wide. For example, some countries may only assets, liabilities, revenues, and expenditures have not been recognize receivables and payables, while others recognize a properly recognized. broader range of assets and liabilities on their balance sheets. Countries transitioning to accrual accounting can take various A further complicating factor is that not all countries prepare pathways. Cavanagh, Flynn, and Moretti (2016) lay out an whole-of-government consolidated financial statements. indicative pathway for the transition to accrual accounting, In some cases, certain public sector entities are excluded identifying the main elements added at each phase. Application because of technical difficulties with the consolidation of such an indicative pathway during the transition period, process, or because they are not under government control along with the inclusion of informative disclosures in annual (this is explained in more detail in Appendix D, where the financial statements, would be a significant step forward in definition of the government reporting entity is discussed). reducing the lack of transparency associated with accounting This has an impact on the comparability across jurisdictions. and reporting on a partial accrual basis.2 To reduce this inconsistency, jurisdictions could commit to full consolidation at the whole-of-government level, including all Transition by countries to accrual accounting is usually paced state-owned enterprises. to match the resources available at the time of adoption. For example, the recognition of infrastructural assets and property, Polzer, Grossi, and Reichard (2021) discuss the challenges plant, and equipment often requires valuation techniques to of completeness and comparability in the European Union’s determine the cost, particularly where cost records are not development of compulsory European Public Sector available or are incomplete, like in many countries where Accounting Standards (EPSAS), which are based on IPSAS. capital expenditure has been expensed under cash-basis They note that while harmonizing public sector accounting accounting. They also require assessments of their remaining systems through IPSAS offers advantages, particularly for useful lives and residual values. Similarly, the valuation of comparable financial information among EU member states, noncurrent liabilities such as pension entitlements requires there are also arguments for deviations from these standards. actuarial assessments. As a result, preparation for recognition of noncurrent assets and liabilities often takes place in later phases of the implementation process. 2. See table 1 of Implementing Accrual Accounting in the Public Sector by Cavanagh, Flynn, and Moretti (2016). PROSPERITY INSIGHT <<< 19 The article highlights that different degrees of IPSAS The need for international incentives or compulsion for adopting implementation and compatibility between countries result accrual accounting standards is also emphasized in a World in only broad-level comparability of financial reports. Bank report on sovereign debt and reporting. Brumby, Sirois, Practical implementation and interpretation, influenced by Serrano-Machorro, and Mason (2022) argue that adopting permitted options and required judgment, do not achieve true internationally recognized accrual accounting standards and comparability. This raises questions about the extent to which disclosing compliance can significantly improve public sector government reporting should be comparable and whether financial reporting quality. However, they note that countries voluntary standardization can achieve this goal. are unlikely to adopt these standards voluntarily due to sovereignty rights and competency shortages, suggesting that international mandates may be necessary. c. Debt Management and Fiscal Analysis Apart from the recognition of current and non-current assets, included low interest rates and extended repayment periods, governments have a comprehensive picture of whole-of- the debt’s value was recalculated to be around 68 percent of government debt, assets, and the related liabilities arising GDP under IPSAS. On the other hand, the corresponding credit from public–private partnerships (PPPs), assets and liabilities recorded in Germany’s accounts was not adjusted to reflect arising from social benefits provided by government, and the these favorable terms, leading to an inflated representation of impact of guarantees issued, among others. Accrual basis the asset for German citizens (Brumby and others 2022). financial reports can thereby strengthen transparency over both debt and non-debt obligations. Governments can use Public Sector Debt Statistics (PSDS) require marketable this information to assess intergenerational wealth and the debt to be evaluated at fair value along with nominal value. sustainability of government programs and policy decisions. However, non-marketable debt, such as a loan, is evaluated at nominal value since it is not intended for trading and therefore Accrual principles applicable to various financial reporting estimating a fair value would be challenging and necessarily and statistical frameworks are, for the most part, similar. subjective as it would imply making assumptions on probability However, there are no universal principles applicable to all of default and possible recoveries that do not result from accrual-based frameworks that define (i) sectoral coverage; objective market price. In Debt Sustainability Analysis (DSA)3, (ii) instrument coverage, (iii) valuation methodology, and nominal value remains key, as the baseline assumption is that (iv) the criteria for recognition of liabilities. Therefore, some the borrowing country would service its debt, and the DSA methodological differences between frameworks exist. assesses the probability of this baseline. While DSA relies The differences between IPSAS and Government Finance on a wide set of indicators that factor in concessionality and Statistics can result in significant differences between the market conditions, a DSA based on market value may have amount of liabilities captured and reported in accrual basis perverse effects—that is, if macro-fiscal conditions improve, financial reports vs. the amount of debt reported under debt then borrowing cost decreases and bond prices increases, statistical principles. These differences are illustrated in thereby triggering a rise in the stock of debt evaluated at fair figure 2. A detailed description of differences between the two value. In the above example, fair value may underestimate frameworks is presented in Appendix D. Greece’s debt challenges, as 68 percent is the result of a present value of future cash flows that are not only reflecting The difference in debt reported under the two frameworks is better post-restructuring terms but are also discounted at particularly pronounced in instances where debt is undertaken market yields which are higher than risk-free benchmarks. on concessional terms. This is because debt is measured based on fair value in accordance with IPSAS and at nominal The example provided demonstrates the notable disparities value in accordance with statistical frameworks. For instance, that can arise in the reporting of liabilities between different Greece’s debt was officially recorded at 180 percent of GDP frameworks. These differences may also be influenced by according to Public Sector Debt Statistics. However, after the application of fair value or discounted value for reporting accounting for the favorable conditions of the debt, which liabilities under IPSAS, as well as the recognition of other 3. Refers to DSA completed using IMF-World Bank Debt Sustainability Framework for Low-Income Countries (LIC DSF), 2017 and IMF-World Bank Debt Sustainability Analysis for Market-Access Countries (MAC DSA), 2017. PROSPERITY INSIGHT <<< 20 liabilities such as accounts payable and provisions, which basis used for standard debt management activities, (e.g., are not considered as debt under GFS. The scope of design of a strategy, borrowing plan, issuance calendar, debt consolidation can lead to significant variations in the extent of payments), based on the assumption that the country would liabilities captured by the two frameworks. While the liabilities service its debt under normal circumstances, fair value of reported under IPSAS generally offer a more comprehensive marketable debt is considered primarily to gauge the market’s representation, the lack of consistency hampers data quality appetite for new issuances or to plan liability management and subsequent analysis and decision-making processes operations (e.g., buyback, exchanges). Considering the (Brumby and others 2022.) economic substance of debt further allows countries to make more informed decisions regarding borrowing and lending Regardless of these differences, the existing practices of practices. This enables borrowing to be done responsibly and considering fair value in the assessment of debt sustainability sustainably, and the management of risks associated with and debt management brings multiple benefits. It considers debt accumulation and debt distress. the economic reality of debt obligations, in sync with market dynamics, such as changes in interest rates and credit spreads. As a result of significant methodological differences, total This approach enhances risk management, particularly liabilities reported under IPSAS are not directly comparable in cases where debt is traded, as it allows governments to with GFS or other statistical debt figures. The discrepancy, evaluate and consequently reduce their vulnerability to driven by accounts payable, provisions, and other liabilities interest rate, credit, and market risks in their debt holdings. not recognized as debt under GFS, is sizeable as shown in While nominal value, including any change determined by figure 2. interest and foreign exchange volatility, is generally the > > > F I G U R E 2 - Total Debt Reported by Statistical Frameworks as a Percent of Total IPSAS Liabilities Tanzania 2019 Philippines 2018 Ecuador 2019 United Kingdom 2019 0% 20% 40% 60% 80% 100% 120% Statistical Reporting Frameworks IPSAS Source: Adapted from Brumby et al. (2022). Note: Statistical reporting frameworks refer to GFS and PSDS, as applicable PROSPERITY INSIGHT <<< 21 Impact of fiscal risks on sovereign bond yields and fiscal balances had been measured on an accrual basis or a cash basis. This research utilized accrual-based A country’s fiscal risks are reflected in its sovereign credit government financial information to analyze the association rating or sovereign bond yield, and much of the prior literature with sovereign credit ratings or sovereign bond yields. on these indicators focused on identifying the factors that affect them.4 The determinants of sovereign credit ratings There is broad consensus that the level of government debt is include gross national income (GNI) per capita, economic a major factor influencing a country’s fiscal risks. The higher growth rate, inflation rate, level of foreign debt, level of the level of government debt, the more pressure there is to economic development, amount of fiscal income, and the anti- repay the principal because of the rising cost of financing the corruption index (Bissoondoyal-Bheenick 2005; Cantor and repayment. Increases in government debt therefore increase Packer 1996).5 the fiscal risks facing a country, lowering its sovereign credit rating. The increased fiscal risks from increased government Research suggests that sovereign bond yields are relative to debt compel countries to guarantee higher returns for the macroeconomic factors of individual countries.6 Global investors in their sovereign bonds, which leads to increases in factors also affect the sovereign credit ratings of those countries sovereign bond yields. and the yields of their sovereign bonds. These risk factors affect sovereign credit ratings adversely and the sovereign Government liabilities measured on an accrual basis not only bond yields positively.7 However, much of the literature treats reflect current debt levels but also recognize a broader range national debt (or liabilities) and fiscal balances—two of the of other liabilities that a country has incurred and therefore main macroeconomic factors—as simple control variables. must repay. It follows that accrual-based liability recognition provides a more comprehensive picture of a country’s fiscal Until a study by Jung, Kim, and Chang in 2020, there was no risks rather than basing the analysis solely on the level of attempt to distinguish whether the national debt (or liabilities) government debt. > > > B OX 4 - Accrual accounting and credit ratings While budget transparency is generally linked to better credit ratings (Arbatli and Escolano 2012; Hameed 2005), there is little academic research directly connecting accrual accounting to improved credit ratings. Government perceptions on the impact of accrual reforms on credit ratings vary. Australia, Canada, and Switzerland report that rating agencies use accrual-based financial statements to assess their financial position and balance sheet strength. In contrast, Spain and France do not observe particular interest from rating agencies in their accrual-based statements. The challenge in linking accrual accounting to better credit ratings may stem from the fact that credit ratings, like long- term sustainability assessments, focus on a government’s ability to generate sufficient cash flows for debt payments. Consequently, rating agencies typically rely on government statistics for current cash flow information. Source: Based on case studies and interviews and presentation of Fergus McCormick, Chief Economist, Co-Head of Sovereign Ratings, Global Sov- ereign Ratings, DBRS Inc. See IMF Conference website. 4. The IMF defines fiscal risks as “the possibility of deviations of fiscal outcomes from what was expected at the time of the budget [preparation] or [during] other fore- cast”(Cebotari and others 2009). 5. For example, Afonso, Furceri, and Gomes (2011) report that GNI per capita, economic growth rate, and the level of government debt are short-term factors affecting sovereign credit ratings, while long-term factors include the level of foreign debt, the level of foreign reserves, and experience with bankruptcy. Ismailescu and Kazemi (2010), analyzing how sovereign credit ratings influence the credit default swap (CDS) spreads of 22 emerging economies, found that CDS spreads are more sensitive to an increase in sovereign credit ratings than to a fall. 6. Sovereign bond yields are subject to macroeconomic or idiosyncratic factors of countries, including their inflation rates, the level of net foreign assets held, actual cur- rency exchange rate, level of government debt, and their fiscal balance (Jaramillo and Weber 2013; Jung, Kim, and Chang 2020; Min 1999). 7. Global factors, such as the global financial crisis and the COVID-19 pandemic, also affect the sovereign bond yields. McGuire and Schrijvers (2003) argued that 80 percent of the national debt spreads of emerging economies could be explained by global factors. Weigel and Gemmill (2006) compared the influences of global factors and idiosyncratic national factors on four emerging economies in South America and concluded that global factors exert a greater effect on sovereign bond yields than national idiosyncratic ones. Li et al. (2009) analyzed the relationship between liquidity and sovereign bond yields using a liquidity model and argued that the liquidity risk of the bond market, as measured from the perspective of overall systematic risk, was reflected in the prices of sovereign bonds. PROSPERITY INSIGHT <<< 22 The research paper analyzed the accrual-based financial Management of fiscal risks using consolidated information of 24 OECD member states using accrual balance sheet capacity accounting and found it beneficial for public financial management (PFM). Key findings are as follows: Recent attention has focused on using the capacity of a country’s “whole-of-government” consolidated balance 1. The greater a government’s liabilities, the lower its sheet to manage fiscal risks and to assess and evaluate sovereign credit rating and the higher its sovereign bond the impacts of different policy options on a country’s overall yields. More specifically, a 1 percent increase in the level financial position. This approach, outlined in the “Theory of of government liabilities corresponded to a drop of 0.032 Change” (Section 2), involves a fully integrated approach to percent in sovereign credit rating and a 0.026 percent strategic planning, budgeting, financial reporting, and fiscal increase in sovereign bond yields with 10-year maturities. management. It involves use of the “whole-of government” consolidated balance sheet to manage fiscal risks (including 2. The sounder the fiscal balance, the higher the sovereign responding to fiscal shocks) and to consider intergenerational credit rating and the lower the sovereign bond yields. A equity issues. All policy decisions are evaluated based on their 1 percent increase in fiscal balance raised the sovereign expected impact on the “whole-of-government” consolidated credit rating by 0.15 percent and lowered the sovereign financial position. bond yields (with 10-year maturities) by between 0.06 to 0.08 percent. While balance sheet analysis has long been utilized in the private sector to inform decision-making and management, These results indicate that strong sovereign credit ratings it has been more limited in the public sector, often focusing give a government the fiscal space to effectively respond to a on liquid resources held by the general government country’s fiscal risks by creating buffers and allowing for flexible sector. However, by applying consolidated balance sheet policy responses. Furthermore, the paper provided evidence management and incorporating fiscal forecasting tools and that the international capital market recognizes the positive modeling to assess sustainability of fiscal policy options, this effects of the OECD members’ accrual-based accounting on approach is an effective means of managing a country’s fiscal PFM. This research provides empirical evidence of the value risks. This comprehensive perspective offers valuable insights of accrual-based government financial information, particularly for policy management, decision-making, and stewardship in the usefulness of accrual-based government liabilities and the public sector. fiscal balance as trustworthy indicators of fiscal risks. A paper issued by the OECD in 2021 “provides guidance on the further steps governments can take to improve transparency and risk analysis on balance-sheet-based policies and, more generally, advance thinking on better balance sheet management” (Moretti, Braendle, and Leroy 2021). The authors of the paper developed figure 3 below to illustrate the way governments could systematically use this approach. PROSPERITY INSIGHT <<< 23 > > > F I G U R E 3 - Transparency and Risk Analysis Requirements for Balance-Sheet-Based Policies • Principal of fiscal • Estimates for the lifetime responsability of the policy • Other principles (e.g. cost • Clarity on key recovery) assumptions Design Costing Reporting Budgeting • Tailored interim reporting • Neutrality • Performance information • Credibility Balance Sheet Management Framework Source: Moretti, Braendle, and Leroy (2021). Leveraging private sector practices in public The public service and social objectives of the public sector sector fiscal management differ markedly from the “for profit” commercial objectives of the private sector. In the private sector, accrual accounting The application of financial reporting frameworks also invites the has for many years been used as a tool to support better introduction of fiscal health indicators that have traditionally not management and decision-making, and as a mechanism been applied in the public sector. Some of these can replicate for accountability to shareholders. Market participants use the indicators used through more traditional approaches to accrual-based financial information to measure companies’ fiscal management, or to provide information that previously values and make better informed investment/divestment has been hard to collect or not available. However, neither decisions. an IPSAS-based approach nor a GFS approach is likely to be sufficient on its own. For instance, IPSASB’s Recommended To assist private sector managers in making informed Practice Guidelines No. 1 provides guidance on reporting on operational decisions, management accounting has emerged the long-term sustainability of a public sector entity’s finances to analyze and interpret accounting information, often in and on the impact of current policies and decisions made at conjunction with nonfinancial information. Techniques such as the reporting date on future inflows and outflows comprising cost accounting, activity-based costing, marginal costing, lean three key dimensions (service, revenue, and debt) as an accounting, throughput accounting, and break-even analysis adjunct to the core reports. Ensuring the accuracy of fiscal have evolved to capture fixed, variable, and total costs analysis, irrespective of the framework employed, demands of production; determine project profit and loss at various thorough verification of the accrual information supporting levels of sales and production; reduce waste; and maximize the indicators. This verification, ideally through independent productivity, quality, and profit. Cost centers are used to hold audits or other assurance measures, becomes especially managers accountable at an operational level. crucial when the data originates from manual processes or estimations rather than directly from government accounts. Many countries’ PFM reform agendas have been shaped by a view that their public sectors were operating inefficiently and lacked accountability for their performance. A key mechanism PROSPERITY INSIGHT <<< 24 to address this shortcoming was adopted from the private 5. Techniques to simplify accrual-based financial information sector with the introduction of competition. This was designed to make it more understandable for “lay” stakeholders. to manage the provision of public goods and services on a more “commercial” basis, and in some cases, directly to Other innovations have been directed toward making accrual- market-based forces. The adoption of accrual accounting based information more user-friendly and useful for planning was necessary to support this change, as it provides the and budgetary decision-making. The following are some of the financial information on the full costs of public sector goods noteworthy initiatives: and services and has been used as the basis for measuring improvements in efficiency, effectiveness, and accountability. 1. Condensing the financial reporting timeframes to make the information available at an earlier stage of planning Over time, other uses of accrual-based information in the and budgeting processes. private sector have been adapted to the public sector context. Examples include: 2. Using management commentaries, simplification, and summarization of the planning and budgeting forecast 1. Investment and divestment policy decisions that focus on information and the financial statements to make them return on investment. more accessible to a broader range of stakeholders. 2. Long-term sustainable asset management with 3. Using accrual-based information to inform citizens and replacement and maintenance decisions based on decision-makers about the efficiency and effectiveness objective technical engineering data. (improved service delivery) of public management. 3. Borrowing and liquidity management with a focus on 4. Using technology, including the internet and business data the maturity profile of net debt to minimize the costs of warehousing, to make information more easily available borrowing. to citizens, the legislature, and other stakeholders. 4. Measuring performance with a focus on results and full 5. Including key ratios in the notes to the financial statements, costs (performance versus consumption of resources). to help improve understanding of financial and budgetary management. > > > B OX 5 : United Kingdom’s Balance Sheet Review A balance sheet review was undertaken in line with the government’s balance sheet management principles, which are to • secure maximum value for taxpayers from the government’s assets and liabilities, • enhance transparency over the government’s balance sheet management decisions, • optimize the management and mitigation of balance sheet risks, • safeguard overall public sector net worth, and • strengthen fiscal sustainability. The review concluded that the UK government would release resources for further investment in public services and improve the sustainability of public finances. It identified significant opportunities to increase the efficiency of the balance sheet, which fit into three broad categories: • Transparency – increasing transparency over the long-term impacts of policies on the public sector balance sheet. • Asset management – delivering better value for money from assets. • Risk management – strengthening control of long-term risks and costs of liabilities. Source: HM Treasury (2020). PROSPERITY INSIGHT <<< 25 d. Use of Information Systems to Facilitate the Use of Accrual- Based Financial Information Modernization of information systems is a key component be completed based on data that are not derived from of many PFM reform programs. Implementation or updates governments’ accounting system. Such analysis often relies to the financial management information system (FMIS) are on manual processes and bridging tables that are generally undertaken as part of a country’s information technology not subject to audit or other assurance procedures and are strategy, and it is extremely important that the public sector often based on estimates rather than actual results. Despite accounting reforms are properly aligned and sequenced with the lack of assurance over the underlying data, the resulting the implementation. fiscal sustainability and economic analysis outcomes are often published and generally accepted as reliable representations In the absence of functionality for accrual accounting within of countries’ fiscal conditions (Brumby and others 2022). the FMIS, fiscal sustainability and economic analysis must > > > B OX 6 : Single Source of Truth The Republic of the Marshall Islands carries out accounting and reporting in conformity with accounting standards issued by the United States Governmental Accounting Standards Board, which require full accrual with dual perspective (both cash and ac­ crual) capabilities, in addition to Government Finance Statistics. Before introducing a new FMIS in 2022, accounts were maintained on a cash basis, and full accrual accounting was achieved using spreadsheets and templates with external support. The Marshall Islands’ Ministry of Finance Banking and Postal Services (MoFBPS) adopted the slogan “Jimwe Tiljok im Mool” (single source of truth) for the FMIS project, because of its functionality as a single data source to meet the needs of the country’s various reporting requirements. The slogan appears on MoFBPS uniform shirts and has be­come widely recognized throughout the government. Source: Based on consultation with Patrick Langrine, Former Secretary of Finance, Ministry of Finance, Banking and Postal Services, The Republic of the Marshall Islands (2023.) The role of the FMIS is to provide essential and informational multiple sources and reporting under multiple frameworks. Key foundation for PFM, and achieving this objective has data sources include the general ledger of the government increased the importance of ensuring the FMIS functionality in an integrated financial management information system is comprehensive. This includes flexible modular architecture (IFMIS) and other data sources external to the IFMIS: debt and technologies, rapid adaptability to new conditions, and information, contingent liabilities of SOEs, asset management efficiency and effectiveness (Pimenta and Seco 2021). systems, and financial reports from subnational governments, among others. In some countries, these technologies include The FMIS can help overcome difficulties that can arise from dual general ledgers that support both cash-based and implementation of accrual accounting reforms and address accrual-based accounting, financial consolidation modules challenges stemming from the inconsistencies between that can consolidate information from multiple data sources, IPSAS and GFS reporting frameworks. During the reform and analytical tools to inform fiscal and economic analyses. process, issues often arise because of the need for integration of new sources of information and creation of temporary work An FMIS further allows interoperability with other key systems practices and processes. Proper functional specification and of government, such as the banking system and debt planning for the FMIS implementation can greatly reduce the management system. Enabling the integration of information time and additional costs associated with resolving these technology systems that manage debt and investment data problems. with countries’ FMIS enables the exchange of information, ensuring that relevant data is accessible for debt transparency An important aspect of the transition is capturing accrual- and evidence-based decision-making across the entire public based information in the general ledger and using a unified finance process. chart of accounts (UCOA) to enable consolidation of data from PROSPERITY INSIGHT <<< 26 > > > B OX 7 : Unified Chart of Accounts A Unified Chart of Accounts (UCOA) facilitates the full range of government reporting requirements, as illustrated in Figure B7.1. > > > FIGURE B7.1: Government Reporting Requirements Financial Planning • Source of funds: Revenue, Statistical Reporting Loans • Sectors of Economy: Health, • Type of funds: Statutory Education, Housing, Law and Funds, Trust Funds, Donor Order Funds Fund Functional Classification Classification Program Economic Classification Classification Budgetary Planning and Financial Reporting Monitoring • Assets, Liabilities, • Policy objectives of the Expenditures, Revenue, government Equity Segments of the Budget Classification/Chart of Accounts and how they support government reporting needs The UCOA enables data to be classified as follows: • Functional classification. This is used for reporting on socioeconomic objectives that the government intends to achieve through its expenditures. These reports can be used for analytical, statistical, comparative and deci- sion-making/policy formulation, and monitoring purposes. For example, reports on expenditures incurred on health, education, social protection, and environment can provide useful information on the priorities and effectiveness of government policies on these socioeconomic objectives. • Program classification. A program is a set of activities that meet the specific policy objectives of the government (for example, preprimary education or the development of crop production). In contrast to functional classification, a classification by program considers the government’s policy objectives and how these policies will be implemented. Programs may be subdivided into homogeneous categories called activities (for example, the vaccination activity within a disease prevention program), which in turn may encompass a series of related initiatives and projects. Classifying expenditures by program can serve two purposes: (1) identifying and clarifying the goals and objectives of government spending; and (2) monitoring operational performance through performance indicators, which may relate to the inputs, outputs, or outcomes of a program. A classification by program can contribute to improved trans- parency and accountability, and can help link inputs to objectives or outcomes. • Administrative or entity segment/classification. This is used for reporting on accountabilities for budget man- agement—both expenditures and revenues—at the administration level, including ministries, agencies, and their departments. PROSPERITY INSIGHT <<< 27 • Economic classification. This is used for financial reporting. It provides information on types of expenditures— such as on salaries, goods and services, interests, grants, subsidies, and transfers—or revenues—for example, taxes, social contributions, or grants. • Fund classification. This is used for reporting on sources of funds, such as revenue, donor funds, loans, and grants. Additional segments like geographical or beneficiary segment provide information on geographical location of govern- ment expenditures and key beneficiaries. e. Costs Versus Benefits of Adopting and Implementing Accrual Accounting Before embarking on an accrual accounting reform, it is crucial facilitates a more efficient and effective resource planning, (3) to establish clear reform objectives. Only with clear objectives improves accountability, and (4) allows longer-term focus on can an analysis be completed to assess the costs and benefits the effects of government or management decisions (long- associated with the proposed reform and inform decisions term sustainability). These benefits have also been the basis about resource allocation and prioritization. The analysis for overall PFM reform agendas in many countries. provides a framework for identifying the underlying economic principles and theories that can guide the reform process and There is extensive experience with the adoption and enables the development of strategies that are more likely to implementation of accrual accounting, particularly in higher- achieve the desired objectives. income countries; however, research has shown that it can be difficult to quantify the full associated costs. While it is By providing a clear reform objective and an understanding relatively easy to measure costs such as the implementation of of the potential impacts and benefits of the reform, policy new IT systems, other significant costs incurred as part of the makers can additionally engage with various stakeholders, implementation of accrual accounting in relation to capacity including businesses, civil society organizations, and the building and change management are often more difficult to public. This engagement helps build support for the reform measure accurately because they may have been allocated and ensures that diverse perspectives are considered. It helps across a range of different reforms. In developing countries, a in understanding the potential impact of the reform on various high proportion of these costs is often financed by development stakeholders and designing reform strategies that minimize partners, which can further complicate measurement. negative impacts and maximize positive outcomes. Cavanagh, Flynn, and Moretti (2016) stated that data on the An independent evaluation completed by the World Bank costs of the full transition were not readily available; however, found that support to improve public sector accounting has their study quoted estimated costs of transitions in advanced been associated with positive results; however, less than one- economies such as in Austria (€30 million) and Switzerland third of IDA-eligible countries received such support during the (€40 million), the bulk of which were spent on IT systems. PwC evaluation period (Independent Evaluation Group 2020). The (2014) estimated the average implementation costs ranged evaluation further found that, due to the crosscutting nature from 0.009 to 0.053 percent of a country’s GDP. The paper of accrual accounting reforms and the long-term commitment emphasized that reliable estimates of costs would require an involved, they should be closely integrated with other areas in-depth assessment that takes account of the situation and of PFM reform. These findings indicate that the objectives of characteristics for each member state. Clearly, estimates accrual accounting reform are not clearly defined, and the would be much higher for lower-capacity countries that are scope and interconnectivity of accounting reform is not clearly starting from a lower base and require more investment in understood. information systems and staff capacity. OECD (1993) outlines the incremental benefits of accrual Eurostat (2020) further projected that, if the EU had fully accounting to the public sector: (1) supports efforts toward adopted accrual-based European Public Sector Accounting a more competitive approach to public sector provision, (2) Standards (EPSAS), its aggregate GDP level could have PROSPERITY INSIGHT <<< 28 gradually increased by €19 billion once maximum public sector performance indicators. It enables the assessment of policy accounting maturity is reached, compared with the estimated costs and outcomes. A number of governments have also implementation costs of €6.9 billion over five years. While the implemented accrual-based budgeting systems, which have paper emphasizes that this information should only be treated been positively received and have supported decision-making. as indicative, it does illustrate the potential magnitude of the Governments have provided positive feedback on the benefits benefits. they have derived from the wider finance reforms. According to PwC (2014), while the benefits of public sector Similarly, the benefits achieved tend to be incremental in accounting reform are difficult to quantify, they can be significant nature and are often realized over an extended timeframe. if governments go beyond mere compliance with accounting As explained in the Theory of Change section, higher order standards. Implementing accrual accounting practices is benefits can usually only be fully realized in the second phase necessary to build management information systems that of accounting reforms where the accrual basis is applied to the support informed decision-making. Accrual accounting data planning and budgeting processes and where a performance can be used to develop results-based management practices, measurement system is implemented. cost accounting, asset management programs, and other key f. Case Studies Case studies for three developing countries that are in process All three countries in the case studies are still in the of transitioning to the accrual basis of accounting are presented preparation phase. Only when they are ready to prepare in Appendix E. The case studies identify some of the benefits their first full accrual-based opening balance sheet will they that the countries have realized or are expecting to realize enter the transition phase. They will then need to comply from the eventual transition to full accrual accounting by their with the IPSAS 33 three-year transition requirement if they public sectors. All the three country case studies illustrate wish to assert full compliance with IPSAS. In practice, very the critical importance of understanding the stage they are at few countries have complied with this IPSAS 33 requirement. with their accounting reforms. As discussed in Chapter 2.b, The case studies demonstrate the level of effort required to the IPSAS suite makes a clear distinction between those prepare for a transition to accrual accounting. countries that are in the preparation phase and those that are in the transition phase. PROSPERITY INSIGHT <<< 29 > > > B OX 8 Benefits Realized During Transition to Accrual In Vietnam, all government revenue and expenditure previously reported outside the central government financial reports are included in the consolidated financial statements. Better balance sheet management has helped increase revenue through improved management of receivables and follow-up of arrears and other liabilities and has effectively contributed to managing fiscal risks and improving fiscal policymaking through consolidation of revenue and expenditure in the financial statements since 2019. In Chile, the IPSAS implementation process has resulted in the following tangible benefits to date: • Providing better information to higher levels of government and constituents. • Facilitating the fiscal and financial monitoring function of public finances. • Enhanced government performance through access to better financial information. • Facilitating the oversight function of the Supreme Audit Institution. In Rwanda, a number of benefits have been realized to date from the implementation of accrual accounting. • Increased completeness and improved the management of receivables. • Sub-consolidations for separate clusters of SOEs are produced and used to monitor the financial performance and position of those clusters, facilitating analysis of the fiscal risks and allowing for prompt remedial action where necessary. • Accrual for outstanding invoices is used by decision-makers to assess compliance with the previous budget spending limits and determine the fiscal space for plans and budgets. • A statement of public debt with commercial borrowing is included in the consolidated financial statements and has resulted in improved monitoring and planning for repayments and the liabilities incurred to finance assets. Transparency is further enhanced by the inclusion of government guarantees, contingent liabilities, and pension and other employee entitlement liabilities as note disclosures in the consolidated financial statements and the inclusion of SOE information. Despite the ongoing nature of their transition to accrual Experiences from OECD countries accounting, all three countries have realized some of the benefits outlined in phase one of the Theory of Change Many OECD countries have completed their public sector (chapter 3). However, the current stage of their public sector accounting reform programs and have completed self- accounting reforms has not yet enabled them to realize the assessments on the extent to which their initial goals for high-level outcomes associated with the second phase of accrual reforms were achieved. They have also provided reforms. The lessons and findings on the relationship between recommendations on how finance ministries can optimize the accrual accounting and improved fiscal management will likely outcomes of transitioning to accrual accounting. become increasingly relevant as their public sector accounting reforms progress. Some uses of accrual information in OECD countries are set out in box 9. PROSPERITY INSIGHT <<< 30 > > > B OX 9 : Added Value of Accrual Reforms in OECD Countries In 2018, the OECD conducted a study of the experience of 11 countries (Australia, Austria, Canada, Estonia, France, Japan, the Republic of Korea, New Zealand, Spain, Switzerland, and the United Kingdom) that have introduced accrual accounting and/or accrual budgeting into their public sector. The study summarizes the countries’ initial objectives of accrual reforms and their own assessment of how well these objectives have been achieved and proposes recom- mendations on how finance ministries should go about achieving maximum outcomes from their transition to accrual accounting. Fully Achieved Ongoing Partially Achieved 52% 48% 40% 40% 40% 40% 36% 32% 32% 32% 32% 32% 32% 32% 28% 28% 28% 24% 24% 20% 20% Efficiency of Better Decision on Better Financial Information on Full Increasing Enhanced Business Processes Asset and Liabilities Analysis Cost of Governments Awareness on Public Accountability Greater Operations Finances Transparency The study identified the following uses of accrual information in specific countries: Long-term fiscal sustainability assessments. The UK Office for Budget Responsibility estimates the economic value of the government’s contingent liabilities in cases where there is a non-zero but less than 50 percent probability that the government will face some cost in the future. Macro-fiscal analysis. In Canada and France, accrual-based information is regularly used for macro-fiscal analysis. Identification of fiscal risks. Austria, Estonia, and France noted that accrual accounting has helped in identifying and monitoring risks that were previously not acknowledged or reliably measured. In many cases, the risks identified relate to contingent liabilities (for example, guarantees), provisions (for example, tax litigations), and long-term debt obligations (for example, pensions). Among those OECD countries that have started publishing comprehensive and regular assess- ments of fiscal risks, a majority had previously introduced accrual reforms (Australia, New Zealand, Finland, and the UK). Improved management of assets and liabilities. Accrual accounting reforms in several OECD countries have led to improvements in cash management, tax receivable collections, inventory management, management of PPP arrange- ments, management of surplus assets, and resource management. PROSPERITY INSIGHT <<< 31 Active balance sheet management. Spain has developed a set of ratios for analyzing the government balance sheet and operating statement. The UK uses various financial ratios during a stress test of the public sector balance sheet in its Fiscal Risks Report. France, Japan, and the UK are developing and maintaining accounting data sets that cover at least five years to get a sense of trends in government expenses, revenues, assets, and liabilities over time. Using accrual data as a building block for richer, more reliable fiscal Information. Because their budgetary, ac- counting, and statistical frameworks are all accrual-based and integrated, New Zealand and the UK indicate that fiscal reporting as a whole is built on a “block” of audited departmental annual reports and accounts. Consequently, external stakeholders have greater confidence in the reliability of data; can better navigate budget documents, accounts, and statistics; have a better sense of how these documents relate to each other; and have greater confidence in the overall reliability of fiscal data. Generating a richer suite of information for other fiscal reports and increasing fiscal transparency. All countries agree that publishing financial statements increases transparency in itself, but many consider that better outcomes are achieved when this information is put into use for preparing or improving other fiscal reports such as improving fiscal forecasts, as mentioned by the UK, and allowing better long-term fiscal sustainability assessments, as mentioned by Canada and New Zealand. One lesson from this study for finance ministries that wish to convince stakeholders of the usefulness of accrual reforms is that outcomes should not be assessed only in terms of direct impacts from the publi- cation of accrual-basis financial statements, which may be limited, but also in terms of indirect benefits on quality and completeness of fiscal reports and overall improvements in fiscal transparency, which is likely to be more significant. Creating a feedback loop within the budget cycle. Case studies clearly show that policy makers have paid greater attention to the acquisition, disposal, and management of government assets, liabilities, and contingent liabilities fol- lowing accrual reforms. Examples cover areas as varied as defense inventories, public sector pensions, infrastructure decommissioning costs, and medical litigations. Countries mentioned that more than pushing policy makers to make bet- ter decisions, accrual accounting creates safeguards preventing them from making bad decisions, such as the creation of liabilities and contingent liabilities as a means of implementing public policies, for example, in the form of deferred benefits or guarantees. Use at the operational level. Accrual accounting has been proven a useful tool for strengthening the assessment of the performance of departments or operational units. Practices include benchmarking of operational costs and greater accountability from managers on financial and operational performance. Decisions about the pricing of government ser- vices are also, in some cases, transparently set, based on full costs rather than simply cash outlaid. Source: Moretti and Youngberry (2018). Many countries have expressed satisfaction that their In particular, the use of full accrual costs for evaluating the reforms’ objectives have been fully achieved—transparency management and performance of government entities (20 (52 percent) and accountability (48 percent). However, other percent) is not widespread (OECD and IFAC 2017). objectives have not yet been fully met by many respondents. PROSPERITY INSIGHT <<< 32 2. >>> Theory of Change To develop a theory of change, this section takes the lessons learned by countries that have successfully adopted accrual accounting and are starting to achieve high-level outcomes. This theory of change highlights the issues that countries adopting accrual accounting will need to ad- dress to ensure that the full benefits of that adoption are realized, focusing on the second phase of accounting reforms. A similar project management approach as adopted during the first phase will likely be necessary. Sustainable public finances require an appropriate information base for policy makers to take informed decisions and for legislatures and citizens to be able to hold governments accountable for their performance. Accrual accounting does not replace cash records. Across the PFM spec- trum, cash and accrual basis accounting coexist, each serving different purposes and providing different insights into the financial health and management of public funds. Strong principles- based accounting standards that enable credible financial statements to be prepared and inde- pendently audited provide the appropriate information base for transparent decision-making and accountability. It is often stated that the adoption of accrual accounting primarily aims to improve transparency and accountability, as well as decision-making. A key challenge is to ensure that these reforms fully deliver the desired benefits. To achieve the full benefits from accrual accounting, two distinct phases of the reform process are needed (figure 4). The first phase is effectively completed once the first accrual-based whole-of-government con- solidated financial statements, which are fully compliant with IPSAS, have been produced (Ap- pendix A). This greatly improves transparency and accountability but does not necessarily lead to better decision-making because it only provides information about past financial position and performance. Decision-makers also require information about the government’s goals and ob- jectives and its expected future financial position and performance to enable them to make well- informed decisions. A second phase in the reform process is therefore required (Appendix B). During this phase, a clear link between the accrual-based financial information and financial and nonfinancial per- formance information (developed using forecasts of future financial position and financial per- formance) used in the planning and budgeting processes need to be established. This inte- gration can be best achieved through adoption of accrual budgeting and implementation of a performance measurement system that uses financial and nonfinancial performance indicators PROSPERITY INSIGHT <<< 33 to measure achievement of progress toward the government’s objectives and then make informed decisions about which op- overall goals and objectives, as established during the strate- tions to choose. gic planning process. It is these decisions that will deliver the higher-order benefits Information about the government’s current financial position to countries in terms of improved management of fiscal risks and past financial and nonfinancial performance, combined (including fiscal shocks), sustainable long-term asset man- with information about its expected future financial position agement, and better investment and borrowing decisions that and financial and nonfinancial performance, provides a sound consider intergenerational equity issues. basis for assessing the financial resources the government will have available. The government can then determine what Without this second phase, there is a risk that countries will its net operating surplus or deficit will be, what investments it view their accrual accounting reforms as complete, but without wishes to make, and what level of borrowing will be required delivering all the potential benefits. These negative percep- to finance its future operations. This enables the government tions may deter further reforms. to identify the feasible options it has for achieving its goals and > > > F I G U R E 4 - Phases of Accrual Accounting Reform Phase 1 Phase 2 • Individual entities prepare financial Individual entities implement accrual-based statements that fully comply with IPSAS or budgeting national equivalent accounting standards. • Consolidated whole-of-government balance • Consolidated whole-of-government financial sheet capacity used to statements are prepared • manage fiscal risks including fiscal shocks, • support sustainable long-term asset management, and • consider intergenerational equiity. Realizing the Benefits Associated With Public they are still on a learning curve to getting full value out of Sector Accounting Reform their accrual-based financial information. Overall, accrual accounting reforms themselves seem to take five to ten years As countries progress through the different steps of accrual to implement, depending on the starting position, resources accounting reform, they are progressively able to realize high- allocated, and other factors. While transparency benefits level outcomes. Most countries that have adopted accrual appear to come relatively quickly once the first phase of the accounting considered their options to maximize outcomes of reforms are complete, the policy and management outcomes their reform once they felt more confident with the quality of often take more time to achieve. their accrual-based financial information and had built up the capacity to undertake more advanced reforms. The focus of the discussion below is primarily at the whole-of- government level, but the reform process and the benefits that Experience shows that countries that moved to accrual can be realized during each step are equally applicable at the accounting and budgeting decades ago acknowledge that individual government agency level. PROSPERITY INSIGHT <<< 34 > > > B OX 1 0 : Steps to Accrual Accounting Adoption and Implementation Step 1. Initial Adoption When preparing the accrual-based financial statements, two key decisions need to be made: 1. What accounting standards will be applied? 2. What definition of the Government Reporting Entity (GRE) will be used? Step 2. Preparation of an Opening Balance Sheet Obtain a full understanding of what assets, liabilities, commitments, and contingent liabilities the GRE has. This requires a concerted effort and can take a long time to complete. This is because often, base accounting records for assets and liabilities need to be created to support preparation of an opening balance sheet (refer to Annex 1 for further detail). Step 3. Preparation of Accrual-Based Financial Statements The preparation of annual accrual-based financial statements requires the use of new systems, processes, and informa- tion sources. The first few years are often characterized by intensive hands-on learning and capacity building. External expertise is needed to assist with the preparation of the financial statements and the conduct of an independent financial audit process. The quality of the financial statements is generally improved incrementally over time. Step 5. Integration of Accrual-Based Financial and Nonfinancial Performance Information The integration of financial and nonfinancial performance information is often accompanied by the introduction of accru- al-based budgeting and a performance measurement system. This phase includes a more in-depth focus on the way public resources are used and maintained (including procurement processes), the way financial assets and liabilities (including contingencies) are managed, and the effectiveness and efficiency of service delivery. Step 6. Fully Integrated Strategic Planning, Budgeting, Financial Reporting, and Fiscal Risk Management. This final stage is characterized by the utilization of the capacity of the “whole-of-government” balance sheet to manage fiscal risks (including responding to fiscal shocks) and consider intergenerational issues. All investment, borrowing, and operating expense decisions are made in the context of a “whole-of-government” strategic plan. Note: The IPSASB makes a clear distinction between the “adoption” and “implementation” of accrual accounting though some literature in the field uses these terms interchangeably. The appropriate approach to the transition to accrual accounting will vary in each jurisdiction. Box 15 summarizes the key elements that will apply where a jurisdiction’s intention is to be able to assert full compliance with the IPSAS accrual standards. One of the aims of IFAC’s Pathways to Accrual platform is to build up case study examples of the various approaches to accrual implementation. PROSPERITY INSIGHT <<< 35 Phases of accrual accounting reforms Preparation of Accrual-Based Financial Statements PHASE 1 The preparation of accrual-based financial statements Initial Adoption of Accrual Accounting provides a comprehensive picture of a country’s current financial position and past financial performance. The preparation of individual entity financial statements and WOGFS on a cash basis that are fully compliant with A country’s decision-makers and other users are provided the cash-basis IPSAS mandatory requirements are major with comprehensive financial information about their current achievements. Individual entity financial statement preparation financial position and past financial performance.8 Where an is usually a key building block for preparation of WOGFS. This independent external audit has been conducted, users can enables individual entities and a country to achieve benefits take further assurance on the accuracy and reliability of the from international recognition that it has been able to prepare information. This additional assurance is also important for reliable and transparent cash-based financial information. external users such as lenders, creditors, and credit rating Incremental improvements can be made by compliance with agencies. This may affect a country’s sovereign risk credit the encouraged IPSAS cash-basis standard disclosures which rating, which could result in a reduction in a country’s overall will also assist the transition to accrual accounting. costs of borrowing. Key decisions that must be considered during the initial For internal users, preparation of annual financial statements adoption of accrual accounting include (1) the accounting will usually result in the identification of many opportunities standards that should be applied and (2) the definition of the for improvement. Some may be obvious from the financial GRE that will be used. statements. Others may only become clear after further analysis of trend information (for example, increases in classes Preparation of the Opening Balance Sheet of contingent liabilities or provisions that may warrant further investigation). Still others may be identified by the internal The preparation of an opening balance sheet provides audit or independent external audit processes. the government with a clear picture of its assets, liabilities, commitments, and contingencies. These opportunities for improvement usually prompt actions to This provides the government with a comprehensive 1. strengthen the overall internal control environment and understanding of its overall financial position (that is, the ensure completeness of revenue and expenditure; assets it owns, their value and their condition, the extent and 2. improve the management of physical assets (including value of the liabilities and commitments it has entered, and infrastructural assets, weapons systems, property, plant the contingent liabilities that exist along with their potential risk and equipment, and inventories); and exposures). 3. lead to better management of financial assets and liabilities (cash, investments, receivables, payables, employee Many developing countries are still at the preparation stage in entitlements, pension liabilities) and their associated risks the reform process. Many have not yet achieved an IPSAS- (including contingencies). compliant, whole-of-government opening balance sheet. This highlights the dilemma some countries face in taking a phased Different skills sets are required to investigate the issues, approach by adopting groups of accrual-based accounting identify their causes, and develop appropriate solutions. standards over an extended period. They are unable to Improvements are often required in the more subjective areas prepare a full opening balance sheet, and their partial accrual- (those that require professional judgment) where various based information is not comparable with other jurisdictions. estimates and assumptions are used (e.g., asset and liability valuations, asset impairment, provisions for obsolescence, provisions for doubtful debts, and actuarial assessments for liabilities). 8. The key benefits outlined here may offer a partial explanation for the improved PEFA scores cited on page 11 (e.g., completeness of revenue and expenditure [PI-6]). PROSPERITY INSIGHT <<< 36 > > > B OX 1 1 : United Kingdom – Better Management of Clinical Negligence Claims The first UK Whole of Government Accounts (WGA) covered the financial year ending March 31, 2010. In the following years, it became apparent that the full benefits of accrual accounting would only be achieved through further investment. In 2017, a dedicated balance sheet management team was created at the Treasury. A balance sheet review highlighted a trend of increasing provisions in respect of clinical negligence claims (£85.3 billion on March 31, 2019, with a further £51 billion of contingent liabilities). Further analysis identified that obstetric claims make up 50 percent of the value of clinical negligence claims (HM Treasury 2020). The response to the balance sheet review has focused on reducing the increasing cost of clinical negligence, taking a cross-government approach. The primary focus has been on improving patient safety, preventing negligent harm in the first instance. The Treasury noted that as well as being the right thing to do, this focus has the potential to reduce the costs of clinical negligence. A cross-government task force considered a program of work to identify new or existing interventions that draw on the latest research on approaches to prevent infant brain injuries. The balance sheet review was a catalyst for funding and piloting new interventions targeting infant brain injury. > > > B OX 1 2 : Nonfinancial Information Used to Determine Appropriate Valuations of Assets and Liabilities Infrastructure Assets Infrastructure asset management plans are developed using technical engineering data to determine component re- placement and maintenance schedules. This information supports the sustainability of the infrastructural asset itself as the costs of the associated investment and maintenance requirements are made on a more objective and transparent basis. Where insufficient resources are available to meet these costs, the accrual-based information makes the impacts (in terms of deferred maintenance) or the level of asset performance more visible. Civil Service and Military Pensions Pension liabilities are usually determined by actuarial assessments and valuations that need to be completed by quali- fied actuaries. The actuarial valuations are based on years of service of members and historical claims that are used to estimate future claim levels based on life expectancy. The valuations can be heavily affected by macroeconomic factors such as the level of inflation and the level of interest rates (as these determine the discount factors applied to the future cash flows). Where pension liabilities are underfunded, the accrual-based financial information clearly highlights this as an issue. PROSPERITY INSIGHT <<< 37 > > > B OX 1 3 : Managing Unfunded Liabilities A first step in managing unfunded liabilities is to identify them, particularly those that may trigger a fiscal shock upon realization. Unfunded liabilities are those for which insufficient funds are set aside to settle the liabilities when they be- come 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 have not yet met 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 the expected flow data in the future (Brumby and others 2022). PROSPERITY INSIGHT <<< 38 PHASE 2 information in the financial statements and including it within the scope of the audit process adds little value to users of the Integration of financial information with planning financial statements. and budgeting information Accrual budgeting can be introduced at this stage, which has A clear link between the government’s strategic plan (which the major advantages of (1) ensuring there is a single version sets out its medium- to long-term objectives or its desired of the financial truth that can be monitored and managed in outcomes), the annual budget process (which establishes the a year, (2) having direct accountability for the overall budget government’s shorter-term goals for the year), and the accrual- versus actual variances at the end of the financial year, and (3) based financial information should be established to integrate enabling direct comparability with the accrual-based financial financial information with planning and budgeting information. information. Often, this is facilitated by implementing a performance Today, relatively few countries have implemented accrual measurement system (Gimbert, Bisbe, and Mendoza 2020) budgeting—primarily because of a perception that using that incorporates the performance indicators that will be used to accrual budgeting will lead to a loss of control over the measure progress toward achieving the government’s desired budget. Failing to implement accrual budgeting has adverse outcomes. Financial and nonfinancial performance indicators consequences, as the lack of direct comparability between are used to measure progress toward the achievement of budget information and financial statements can cause the medium- to long-term objectives or desired outcomes confusion. It can also mean that significant extra work is set during the planning process. The budget process then required to provide reconciliations between the two sets of provides estimates of the expected level of inputs/outputs information. required to deliver the shorter-term goals or intermediate outcomes. Performance indicators normally include quantity, The integration of accrual-based financial information with the quality (efficiency, effectiveness, and timeliness), and cost planning and budgeting information provides the opportunity dimensions. to focus in more depth on the effectiveness and efficiency of the use of public resources, the management of assets and To date, relatively few countries have implemented performance liabilities, and the delivery of public services. measurement systems. This is primarily because of the view that preparation of the financial statements is a standalone Performance indicators that are designed to specifically process rather than a part of an integrated financial reporting measure progress toward the government’s objectives and cycle (as explained earlier, the cycle begins with the planning goals can assist with holding the government accountable process, then moves to the budgeting process, and ends with for its performance. Where the indicators show that the the financial reporting process). This often leads to adverse government’s targets have not been achieved, they highlight consequences particularly associated with lengthy delays in areas that may need further internal investigation. both the preparation and audit of the financial statements. This means that the financial information on past performance The implementation of accrual budgeting eliminates the need cannot be fully used to inform the future-looking planning and for reconciliations between the budget information prepared budgeting processes. on a cash basis and the financial information prepared on an accrual basis. It also offers the opportunity to integrate There may also be concerns about cost versus benefit the budgeting and appropriation (spending authorization) of implementing a performance measurement system. processes and provides incentives for better financial Some would argue that including nonfinancial performance management. PROSPERITY INSIGHT <<< 39 > > > B OX 1 4 : United Kingdom - Property Management A UK balance sheet review found that there was no central register of government property (HM Treasury 2020). Such a register could uncover opportunities to maximize the value or utilization of government property. The Treasury worked with the Office of Government Property (OGP) to support the development of the Digital National Asset Register (DNAR) and the creation of a marketplace for property (Government Property Finder). Better management and commercialization of government property assets will be supported by a geospatial DNAR. The DNAR will create a single record of land and property assets of public sector entities (including central and local govern- ment), thereby unifying the estate information. Unifying the data in this manner will identify opportunities for property disposal, relocation, and colocation by providing information on vacant, surplus, and available estate within the public sector. It will also identify opportunities for release of land for public benefit—such as on housing, hospitals, or schools—under one umbrella. This work builds on previous work, after the publication of the first UK Whole of Government Accounts. From 2010 through 2019, the central estate (covering core functions of central government) was reduced in size by 30 percent (Cabinet Office 2019). The balance sheet review also drew attention to spending, operational, and wider benefits of increased investment in maintenance. This work has shown that under-investment in maintenance has an impact on the useful life and value of public sector assets, affecting public sector net worth over the long run. There is a strong case of value for money when increasing the investment in asset maintenance. The OGP found that deferring backlog maintenance can multiply costs by more than 1.5 times over a period of two to four years. Integration of strategic planning, budgeting, Countries that reach this stage in the reform process can financial reporting, and fiscal management use the capacity of the government’s balance sheet to manage fiscal risks (including responding to fiscal shocks) Once a country reaches this stage of the reform process, on a whole-of-government basis.9 Investment and borrowing it can then begin to operate under a fully integrated decisions are made after consideration of their impact on the strategic planning, budgeting, financial reporting, and fiscal government’s financial position and its net operating surplus management framework on a whole-of-government basis. or deficit. Proper consideration can be given to longer-term sustainability and intergenerational equity issues. It follows from the discussion above, that relatively few countries have reached this stage. For those countries that The strength of the government’s balance sheet can be have not or do not plan to pursue more advanced second successfully used to mitigate the impacts of fiscal risks phase reforms, it means that they will struggle to achieve the such as economic downturns; natural disasters such as full benefits of the overall accrual accounting reform process. floods, droughts, and earthquakes; and public-health-related It also explains why many countries think that their accrual pandemics. The government can implement policies to provide accounting reforms end with completion of implementation relief to those sections of society that are adversely affected accrual accounting for their financial statements. (for example, tax relief, incentives, employment subsidies, support for small and medium-sized enterprises, and direct This is the stage where the full benefits of the overall reform transfer payments). This enables businesses to remain process can be realized. economically viable until the country’s economy recovers 9. ACCA published a report on Sustainable public finances through Covid-19, which included 24 recommendations that are aligned with this report. The Sustainable public finances report observed that governments adopted innovative and sizable fiscal policy interventions to support their economies during the COVID-19 pandemic. How- ever, most of these interventions were not captured by traditional economic metrics, such as debt-to-GDP ratios. To address this problem, the central recommendation of the report was for governments to use accrual accounting data and take a “balance-sheet approach” to effectively manage public finances amid the COVID-19 crisis. PROSPERITY INSIGHT <<< 40 and allows individual citizens to sustain themselves until they social contract. Over time, net worth trends do directly capture can find employment. These policies are usually financed by the changing fortunes of the government’s financial position. increased government borrowing and net operating deficits. Peppel-Srebrny (2018) suggests that the net worth may be a significant driver of bond yields. A common concern in many countries is the short timeframe (three to five years) of the election cycle and the impact this A government can have a negative net worth yet remain can have on key decision-making. Often, politicians and other fiscally sustainable because it has the power to tax. The key government officials find it difficult to make decisions that could question is whether using the fiscal sustainability projections, affect their chances of being reelected or reappointed. This based on the model in the IPSASB RPG1,11 can allow the can mean that longer-term sustainability and intergenerational government financial situation to remain within tolerable levels equity are not fully considered or costed, and any repercussions in terms of net deficit, net debt, and overall financial position are left for the future generation to contend with. over the longer term. Standards-based financial statements may not always Prioritization and decision-making contain good news. Implementing accounting standards may reveal positions and practices that have negative The government is unlikely to have sufficient resources to act on connotations, particularly for politicians, and may reveal achieving its goals and objectives in all areas simultaneously. errors and omissions in the accounting system that need to be A key aspect of strategic planning is prioritization of the areas addressed. This ought not be viewed as a negative feature of it wishes to focus on given its available resources. Macro- the reforms, but rather as a positive step forward. Improving and micro-economic factors are used to forecast future net transparency and accountability because of the need to fully operating surpluses or deficits, the levels of future planned comply with international standards makes it more difficult for investments, and the level of any increases or decreases in the such practices to continue unnoticed. borrowing required to finance government operations. Often, governments set maximum limits for net operating deficits and Some examples often cited are the debates about the extent of borrowing as part of the strategic planning process to help underfunded pension liabilities, excessive levels of borrowing, manage fiscal risks. and the magnitude of net operating deficits some countries run, which call into question longer-term sustainability of public The information on government priorities and the maximum finances. In the future, these debates are likely to be extended limits imposed on the net operating deficit and borrowing to cover the implications of climate change, natural resource are the key parameters for the annual budget process. The depletion, and environmental degradation/rectification costs. budget process is where the goals and objectives set out in the strategic plan are actioned. Estimates of the level of The interpretation of government net worth is not expected revenues (for example, taxation) and expenditures straightforward, but it can play a useful role in holding (for example, operating costs) are made, and these determine governments accountable, informing policy decisions, and the expected net operating surplus or deficit. The level of providing a buffer against fiscal shocks.10 By definition, net investments to be made in priority areas are usually determined worth is a summary number, reflecting the difference between using an iterative process, with the deficit and borrowing limits all assets and all liabilities. Given some of the measurement being the key constraints. issues on the one hand and the nature of residual claims in the public sector on the other, net worth in the public sector When resources are insufficient for the planned investments, may require further interpretation than in the private sector. a government has two options: Citizens are not shareholders of the government and therefore 1. Take actions to increase its revenues (for example, raise there is no real ownership of net worth per citizen. The tax rates or introduce new taxes) or reduce operating government does not get wound up, so there are no ultimate costs (which could adversely affect the quality-of-service residual claimants. While ex ante government may appear delivery), or to be insolvent and unable to meet its intertemporal budget 2. Reduce the level of planned investments. constraint and therefore may be dissolved, ex post it never is, as it may use fiat to redefine its obligations. On the other hand, Both these options require decisions on prioritization and an government finances are a form of cooperative, whereby risk analysis of the fiscal impacts. in the end falls to the generations of taxpayers as part of a 10. Academics in many disciplines try to capture this relationship. New monetary theory provides perhaps the most direct repudiation of this concept for sovereigns that issue strong currencies. Buiter (2021) explores these issues at length. 11. The United Kingdom OBR long-term fiscal projections and fiscal risk report uses a more developed version of this model. PROSPERITY INSIGHT <<< 41 Capacity building other users. This simplification aspect is the key to increased accessibility for a broad range of stakeholders.12 Centers of There is a common misperception that accounting is a rules- excellence can assist with specialist skills development and based system that produces precise financial results, whereas train managers on how accrual-based information can be in fact the opposite is true. Accrual-based financial statements used to make better decisions and drive improvements. are prepared by applying principles-based accounting standards that require a high degree of professional Auditors need to understand the principles-based accounting judgment. Many of the asset and liability valuations, accruals, standards and be able to form an opinion on whether and provisions are based on estimates and assumptions to the professional judgments, estimates, and assumptions varying degrees. It is largely up to the preparers to use their used by the preparers were appropriate. Where they have professional judgment to determine the most appropriate any concerns, they need to understand how to apply the basis for their calculation. materiality concept to determine the potential impact on users of the financial statements. In cases where they consider that Having sufficient technical capacity in place is a core the concerns may have an impact on users, they need to requirement, as it can affect the quality of government financial understand the appropriate type of audit opinion to issue. reporting. Sufficient technical capacity includes having enabling systems and institutional arrangements to support Key decision-makers should have a high-level understanding implementation, such as a supportive legal framework, UCOA, of the planning, budgeting, and financial reporting cycle, adequate technological capacity and information systems, including the external audit process, the implications of the adequate human resources and technical knowledge, audit opinion, and any key audit matters raised by external inventory and control of financial instruments, internal auditors. They should also understand the basis on which the controls for identifying and managing contingent liabilities and budget and the financial statements (including both financial commitments to spend, and adequate external audit capacity. and nonfinancial aspects) have been prepared and whether the An independent external audit provides assurance over the key limitations (such as the net operating deficit and borrowing appropriateness or faults in the professional judgments made limits set at the planning stage) have been complied with. by preparers. The legislature is often provided with separate resources and Preparers must understand how to apply their professional specialist expertise to assist them in assessing the options judgment in making decisions about the basis for valuations, available for the important decisions that require their approval, estimates, and provisions. They also need to be trained in how and to hold the government accountable for its performance. to present the accrual-based information in a way that can However, in many countries, these resources are inadequate. be understood by non-accountant “lay” decision-makers and 12. The UK Whole of Government Accounts have made excellent progress in providing a simplified presentation at the beginning of the financial statements, which is more accessible to “lay” readers (see Year at a Glance, p. 9). PROSPERITY INSIGHT <<< 42 3. >>> Conclusions and Policy Recommendations This report has examined the various uses of accrual accounting information. It explores how it is being used to support better-informed decision-making, and how the capacity provided by whole-of-government balance sheet can be used to manage fiscal risks including fiscal shocks, support sustainable long-term asset management, and ensure proper consideration of inter- generational equity issues. The report also highlights the lessons that can be learned to assist developing nations in implementing public sector accounting reforms and in achieving better fiscal management. Based on the analysis, it can be concluded that accrual accounting is associated with improved fiscal management. The use of accrual information, particularly information on the government balance sheet which provides a comprehensive picture of what the government owns and owes, has been shown to lead to improved fiscal outcomes and better management of fiscal risks. Countries that have fully implemented accrual accounting have achieved better fiscal manage- ment. Furthermore, there are lessons and findings on the relationship between accrual accounting and fiscal management that are explicitly related to developing economies. These lessons can be used to assist developing nations in implementing public sector accounting reforms and in achieving better fiscal management. Overall, the adoption and implementation of accrual accounting in the public sector can provide benefits such as improved transparency, accountability, decision-making, and management of assets and liabilities. However, the transition to accrual accounting requires careful planning, capacity building, and integration with other areas of public financial management reform. It is a gradual process that takes time to fully realize the benefits. PROSPERITY INSIGHT <<< 43 Public Sector Accounting Reform informed decisions also increases significantly. The adoption of accrual accounting in the public sector is a In developing environments, the available capacity is often growing global trend. However, there are several challenges limited. There is often a low number of accounting and that impact the quality and reliability of the financial information auditing professionals, especially in the public sector, and the being produced. institutional capacity necessary to support the development of the profession is weak. In such a context, it may be preferable Firstly, there is a lack of transparency associated with the to remain with the cash basis of accounting and consider the partial basis of accrual accounting, which is meant to be implementation of accrual accounting once sufficient capacity applied as a transitional measure toward adoption of accrual has been built. The case studies provided in Appendix E offer accounting. Many countries apply partial accrual accounting, examples of the reform journeys of three countries that are at which means that some transactions are recognized on an the initial stages of reform. accrual basis while others are recognized on a cash basis. This lack of transparency about what is included and what is not To increase reform readiness, it is important to first focus included compromises the completeness and comparability of on improving cash basis accounting and building technical the financial information. Additionally, management and fiscal capacity. For countries considering accrual accounting analysis derived from manually compiled or estimated accrual reforms, the main objectives should be to work toward data lacks the reliability of data sourced from an audited achieving full compliance with the IPSAS cash basis standard accrual-based accounting system. and to build the institutional capacity necessary to support the development of the accounting and auditing profession. Secondly, there is inconsistency in the basis of preparation. Once the necessary capacity is developed, countries can Many countries do not prepare consolidated whole-of- consider adopting and implementing accrual accounting more government financial statements, and where they do, there effectively. are variations in the definition of the Government Reporting Entity. This lack of consistency hinders the comparability of Policy Recommendations financial information across jurisdictions. Based on the analysis and findings of the report, the following Lastly, there is a need for the integration of past and future- policy recommendations are drawn: focused information. Financial statement preparation should be part of an integrated planning, budgeting, financial 1. Strengthen the public sector accounting reform process reporting, and fiscal management process. However, this by (a) ensuring clarity about the reform objectives; (b) integration is often lacking, which limits the usefulness of the integrating public sector accounting reforms into broader financial information for decision-making. PFM reforms; (c) establishing minimum reform readiness parameters, and; (d) understand that there will be several Overall, these challenges highlight the importance of stages of reform required. addressing the issues related to the adoption of accrual accounting in the public sector to ensure the quality and To provide a clear direction and purpose for reform, it is essential comparability of financial information. for countries embarking on accrual accounting reforms to set clear objectives. This includes understanding the broad Stage of development and available capacity range of benefits that can be achieved beyond the production of consolidated financial reports. These benefits include Accounting reforms are a medium- to long-term process, and it improving budget management, enhancing financial analysis, is crucial for country authorities to have a clear understanding and achieving better policy results. Accrual accounting should of their objectives and to set realistic and achievable targets. not be seen as a standalone process; it should be integrated Accrual accounting standards are principles-based and require with broader PFM reforms. This integration ensures that a a high level of professional judgment for proper application; unified accrual-based system becomes the foundation of an therefore, as countries transition from the cash basis to integrated planning, budgeting, and financial reporting cycle. partial accrual and eventually to full accrual accounting, the This ensures the accuracy and integrity of financial data, level of professional judgment required to prepare financial financial information should be generated from this single, statements increases significantly. This also means that the auditable accrual-based system. This unified system should capacity required to prepare, audit, interpret results, and make replace manual procedures, parallel processes, and any PROSPERITY INSIGHT <<< 44 estimates that lack independent assurance, thereby providing adoption are recommended to annually declare and integrity over all the financial data underpinning management publicly disclose this information. They should also decisions and analysis. actively monitor compliance with the IPSAS 33 transition period requirement. Further it is recommended that these To enhance the readiness for the transition to accrual prepare whole of government consolidated financial accounting and increase the likelihood of achieving objectives, statements in full compliance with the IPSAS cash jurisdictions are advised to establish a set of criteria for basis standard, including encouraged accrual-based assessing reform readiness at each stage of the transition. disclosures. These criteria may vary depending on the scope and ambition of the reform, as well as the country’s context and level b. Jurisdictions applying partial accrual accounting on a of PFM maturity. It is important to define clear transition non-transitional basis are recommended to disclose pathways towards full accrual compliance and determine the the extent of accrual-based information in their financial Government Reporting Entity for the preparation of whole- statements. The international accountancy profession of-government consolidated financial statements. Before and development partners can support this effort by progressing to the next stage, transitioning jurisdictions should developing recommended disclosure guidelines for evaluate whether the minimum readiness parameters have jurisdictions which report financial information on a partial been met at each stage of the public sector accounting reform accrual basis. process. Jurisdictions should anticipate undergoing several stages of reform to fully realize the benefits of public sector 3. Recognize the need for assurance over financial data accrual accounting. The transition to accrual accounting is underpinning fiscal management and analysis. a journey that takes time and requires careful planning and implementation. By recognizing the multiple stages of reform, To ensure reliability in jurisdictions where a single, audited countries can minimize the transition period and increase the accrual-based system is not used for planning, budgeting, likelihood of achieving their objectives. and financial reporting, it is recommended to implement reconciliation and assurance procedures for manually 2. Recognize and mitigate the lack of transparency of the compiled or estimated accrual information. This will enhance partial accrual basis of accounting. the reliability of the analysis derived from such data, which is not directly sourced from government accounts. To promote consistency across jurisdictions and address the lack of transparency associated with the partial accrual basis While implementation of these policy recommendations of accounting, the following actions are recommended: would increase transparency of partial accrual information, greater progress would require reaching a consensus on a. Jurisdictions applying a partial accrual basis of accounting mandatory requirements for countries to adopt and implement during the preparatory or transition phases to full IPSAS International Public Sector Accounting Standards. PROSPERITY INSIGHT <<< 45 >>> References Afonso, António, Davide Furceri, and Pedro Gomes. 2011. Short- and long-run determinants of sovereign debt credit ratings.” International Journal of Finance and Economics 16 (1). Arbatli, E. and J. Escolano. 2015. “Fiscal Transparency, Fiscal Performance and Credit Ratings.” Fiscal Studies, Vol. 36, Institute of Fiscal Studies, London. Brumby, Jim, Bonnie Ann Sirois, Juan Carlos Serrano-Machorro, and Paul Mason. 2022. A Sum of Parts – Sovereign Debt Measurement and Reporting. World Bank. Buiter, Willem. 2021. Central Banks as Fiscal Players. Cambridge University Press. Cabinet Office. 2019. State of the Estate (In 2018–19). Presented to Parliament pursuant to sec- tion 86 of the Climate Change Act 2008, HM Government. Cantor, Richard, and Frank Packer. 1996. “Determinants and Impact of Sovereign Credit Rat- ings.” FRBNY Economic Policy Review. Cavanagh, Joe, Suzanne Flynn, and Delphine Moretti. 2016. Implementing Accrual Accounting in the Public Sector. Interational Monetary Fund. Cebotari, Aliona et al. 2009. Fiscal Risks: Sources, Disclosure, and Management. Washington, DC: IMF. Eurostat. 2020. Updated Accounting Maturities of EU Governments and EPSAS Implementation Costs. Paper by PwC on behalf of Eurostat, June. Gimbert, Xavier, Josep Bisbe, and Xavier Mendoza. 2010. “The Role of Performance Measure- ment Systems in Strategy Formulation Processes.” Long Range Planning 43 (4): 477–497. Hameed, F. 2005. “Fiscal Transparency and Economic Outcomes.” IMF Working Paper WP/05/225, Washington, DC. HM Treasury. 2020. The Balance Sheet Review Report: Improving Public Sector Balance Sheet Management. IMF (International Monetary Fund). 2018. Fiscal Monitor, Managing Public Wealth. Washington, DC: IMF. IMF. 2018. Fiscal Monitor, Managing Public Wealth. Washington, DC: IMF. PROSPERITY INSIGHT <<< 46 IFAC (International Federation of Accountants) – CIPFA (Chartered Institute of Public Finance and Accounting). 2021. International Public Sector Accountability Index 2021 Status Report. Independent Evaluation Group. 2021. World Bank Support for Public Financial and Debt Man- agement in IDA-Eligible Countries, An Independent Evaluation. Washington, DC: World Bank. Ismailescu, Iuliana, and Hossein Kazemi. 2010. “The reaction of emerging market credit de- fault swap spreads to sovereign credit rating changes.” Journal of Banking & Finance 34 (12): 2861–2873. Jaramillo, Laura, and Anke Weber. 2013. “Bond Yields in Emerging Economies: It Matters What State You Are In.” Working Paper 13/264, International Monetary Fund, Washington, DC. Jung, Do-Jin, Jong-Hyun Kim, and Seok-Jin Chang. 2020. “Does Accrual-based Government Financial Information Serve as an Indicator of Fiscal Risks?” Public Money & Management 41 (8): 594–603. Li, J., P. McGuire, and M. Schrijvers. 2009. “A Dynamic Framework for Sovereign Risk Pricing.” Journal of International Financial Markets, Institutions and Money 19 (3): 451–470. McGuire, Patrick, and Martijn Schrivers. 2003. “Common Factors in Emerging Market Spreads.” BIS Quarterly Review. Bank for International Settlements (BIS). Min, Hong-Ghi. 1999. “Determinants of Emerging Market Bond Spread: Do Economic Funda- mentals Matter?” Policy Research Working Paper 1899, World Bank, Washington, DC. Moretti, Delphine, and Tim Youngberry. 2018. “Getting Added Value out of Accruals Reforms.” OECD Journal on Budgeting 18 (1): 144–166. Moretti, Delphine, Thomas Braendle, and Alexandre Leroy. 2021. “Balance Sheet-based Poli- cies in COVID‑19 Fiscal Packages: How to Improve Transparency and Risk Analysis?” OECD Journal on Budgeting 21 (2). OECD. 1993. “Accounting for What? The Value of Accrual Accounting to the Public Sector.” OECD Occasional Paper OCED/GD (93) 178. OECD. 2015. “Budget Review: Germany.” OECD Journal on Budgeting 2014 (2). Paris: OECD Publishing. OECD and IFAC. 2017. Accrual Practices and Reform Experiences in OECD Countries. Paris: OECD; New York City: IFAC. Peppel-Srebrny, J. 2018. “Government Borrowing Cost and Balance Sheets: Do Assets Mat- ter?” University of Oxford. Pimenta, Carlos, and Antonio Seco. 2021. Financial Management Information Systems (FMIS) – Project Guide: Strategic, Functional, Technological, and Governance Issues in the Design and Implementation of New Platforms for Public Financial Management Systems. New York: Inter-American Development Bank. PROSPERITY INSIGHT <<< 47 Polzer, Tobias, Giuseppe Grossi, and Christoph Reichard. 2021. “Implementation of the Inter- national Public Sector Accounting Standards in Europe: Variations on a Global Theme.” Ac- counting Forum 46 (1): 57–82. PwC. 2014. Collection of information related to the potential impact, including costs, of imple- menting accrual accounting in the public sector and technical analysis of the suitability of indi- vidual IPSAS standards. Weigel, C., and G. Gemmill. 2006. “Sovereign Risk Premiums and Contagion: Evidence from Emerging Market Debt.” Journal of International Money and Finance 25 (6): 888–912. World Bank. 2020. World Bank Support for Public Financial and Debt Management in IDA- Eligible Countries: An Independent Evaluation. Washington DC: World Bank, July 28. Additional References IMF (International Monetary Fund). 2011. Guide for Compilers and Users. Public Sector Debt Statistics (PSDS). IMF-World Bank. 2018. Debt Sustainability Framework (includes both IMF-World Bank Debt Sustainability Framework for Low-Income Countries [LIC DSF] and IMF Debt Sustainability Analysis for Market-Access Countries [MAC DSA], 2017). Sneller, Joost, and Bart Snels. 2022. “Debate: Parliament’s Quest to Improve Accounting Infor- mation in the Netherlands.” Public Money & Management 42 (3): 142–143. PROSPERITY INSIGHT <<< 48 >>> Appendix A –Theory of Change PROSPERITY INSIGHT <<< 49 > > > T H EO RY O F C H A N G E : P H AS E 1 Account Classification Outputs Use of information / Activities Results Outcomes Cash and cash Ensures all cash receipts and Optimal net cash Bank statements Regular bank reconciliations equivalents payments have been recorded position Receivables sub-ledgers – Monitoring of collectability of Ensures receivables exist these record tax and other receivables through aging analysis and are correctly valued after Accounts receivable Higher revenues revenues earned but not yet and the level of subsequent allowance for any bad and received receipts doubtful debts CURRENT Ensures inventories exist Inventory registers – these Monitoring of condition/availability ASSETS and are correctly valued after Inventories record the quantities and value through regular physical stock- Optimal inventory levels Assets that are allowance for any stock losses of items on hand takes able to be realized and obsolescence within 12 months Investment portfolio sub-ledgers Ensures investments exist Monitoring of investments through Improved investment – these record the quantities and are correctly valued after Short-term investments regular confirmations of existence management and and values of the different allowance for any realized or and values returns investments held unrealized gains or losses Current portion of policy- Loan registers – these record Ensures loan receivables are driven lending (student loan details (recipients, Monitoring of collectability of loan identified, exist, are collected Loan losses minimized loans and business principal, interest rates, maturity receivables and correctly valued after support loans) date) allowance for any bad debts Ensures all cash receipts and Optimal net cash Bank overdraft Bank statements Regular bank reconciliations payments have been recorded position Ensures compliance with Payables sub-ledgers – these Monitoring of extent and aging of terms of payment agreed with Payables arrears Accounts payable record all expenditures incurred payables owed suppliers, contractors, and minimized CURRENT but not yet paid employees LIABILITIES Borrowing records – these Liabilities that are Monitoring of borrowing maturity Ensures compliance with the Current portion of record the details of loans Level and maturity of due to be repaid profile which highlights the amount terms and conditions in the borrowing owing (principal, maturity date, net debt optimized within 12 months due within 12 months loan agreements interest rate) Debt management and sustainability Current portion of other Monitoring of the extent of these Ensures compliance with the analysis informed by long-term pension and Other long-term liability records liabilities that are due within 12 terms and conditions in the economic (fair) value of liabilities (see below) months agreements debt reflecting current market conditions Measures whether all Improved liquidity Net working capital Net working capital ratio Key measure of liquidity obligations can be met as management they fall due CONTINUED Activities Outputs Use of information Results Outcomes • Ensures assets exist and Fixed asset registers – these • Monitoring of existence and are correctly valued after record all details of the fixed asset condition through Property, plant, and allowance for depreciation assets (description, location, regular physical stock-takes Sustainable asset equipment and impairment provisions quantity, expected useful life, • Asset maintenance, management • Ensures fixed assets are cost or valuation, accumulated replacement, and disposal managed on a sustainable depreciation, book value) decision-making basis Ensures infrastructural assets Investment decisions Asset management plans – these are managed on a sustainable consider the impacts record technical data for each Component replacement and Infrastructural assets basis and that deferred on level of borrowing component including maintenance maintenance decision-making maintenance issues are and the net operating and replacement requirements avoided surplus or deficit NON- Ensures weapons systems Asset registers and management CURRENT • Monitoring of condition and is managed on a sustainable plans – these record technical obsolescence basis and correctly Sustainable asset ASSETS Weapons systems data for each component including • Depreciation and valued after allowance for management Long-term asset maintenance and replacement impairment costs depreciation, impairment, and requirements holdings obsolescence Ensures policy-driven lending Policy-driven lending Loan registers –- these record Monitoring of collectability of assets are correctly valued (student loans or loan details (recipients, principal, Loan losses minimized principal and interest after allowance for bad or business support loans) interest rates, maturity date) doubtful loans Ensures investments exist Investments (equity, joint Monitoring of investment Better investment and Investment registers and and are correctly valued after venture, and public– performance and any associated divestment decisions contingent liability registers allowance for realized and private partnerships) contingent liabilities based on performance unrealized gains or losses Ensures wealth fund Wealth fund records – these investments/assets exist and Sovereign wealth fund Monitoring of wealth fund Sovereign wealth fund record the wealth fund are correctly valued after assets performance growth investments/assets allowance for realized and unrealized gains or losses CONTINUED Activities Outputs Use of information Results Outcomes Borrowing records – these Ensures compliance with the Borrowing record the details of loans owing Monitoring of borrowing levels Financing costs terms and conditions of the (principal, maturity date, interest and the costs of borrowing minimized NON- loan agreements rate) CURRENT Pension records – these record Actuarial assessments LIABILITIES Civil service and military the details of the members of the Monitoring of the extent to which completed to ensure the full Long-term employee benefits and pension plans (dates of service, the pension plans liabilities are Full costs recognized extent of pension liabilities are superannuations entitlements, expected retirement funded liabilities recognized date) Other long-term liabilities Provisions made to recognize (environmental damage Monitoring the full costs/ the liabilities that have been Relevant assessments Full costs recognized rectification, climate obligations incurred because of past change mitigation) actions Measures whether Net taxpayers’ equity (or net Key measure of an entity’s financial assets/equity) financial position position has improved or deteriorated STATEMENT OF FINANCIAL PERFORMANCE All revenues due recorded – tax • Monitoring of receivables and other fees/levies received in aging Strengthened collection Completeness of REVENUES Operating income • Provisions for bad/doubtful Recorded when cash plus accounts receivable processes revenues owed but not yet received debts earned rather than when cash is • Active monitoring of returns received All investment income due on investments recorded – interest dividends and Completeness of Investment income • Provisions for unrealized Better investment returns realized gains received in cash investment income gains (see below for plus unrealized gains unrealized losses) CONTINUED Activities Outputs Use of information Results Outcomes • Provisions for cash and non-cash employee • Strengthened controls • Completeness of All operating costs recorded entitlements and pensions over commitments and expenditure (administration, inventory Operating costs • Monitoring of inventory employee entitlements • Full costs of management, and salary and levels and condition • Strengthened inventory operations pension entitlements) • Provisions for inventory controls recognized losses/obsolescence • Monitoring of existence, • All fixed asset costs recorded condition, and valuations of (maintenance, depreciation, long-term asset holdings impairment, losses on • Provisions for depreciation disposal) and asset impairment • Sustainable • All infrastructural asset costs • Recognition of gains and long-term asset recorded (maintenance, losses on disposal or EXPENDITURES management depreciation) destruction of long-term • Strengthened controls Recorded when • Full costs of • All weapons systems costs assets over long-term assets incurred rather than holding of long- recorded (maintenance, • Provisions for deferred • Strengthened loan Investment costs term assets when cash payment depreciation, losses on maintenance collection processes recognized is made destruction, obsolescence • Monitoring of collectability • Informed investment and • Full costs of policy • All policy-driven lending costs • Provisions for bad/doubtful divestment decisions lending recognized recorded loans • Improved • All costs on other investments • Active monitoring of returns investment returns recorded (realized and on investments unrealized losses on equity • Gains or losses on disposal interests in SOEs, PPPs, joint recognized ventures) • Provisions for unrealized losses • Proactive management of financing costs • Terms and conditions of • Financing costs • All financing costs recorded • Provision for interest owing borrowing agreements minimized Financing costs (interest, foreign exchange but not paid complied with • Full costs gains and losses) • Provisions for unrealized • Management on a net of financing foreign exchange gains or debt basis recognized losses Measures whether the Key measure of financial targeted net operating Net operating defi- Net operating surplus or deficit performance surplus or deficit was cit minimized achieved > > > T H EO RY O F C H A N G E : P H AS E 2 Activities Outputs Use of information Results Outcomes Financial and nonfinancial Fully integrated approach Progress toward the desired Performance measurement performance indicators used to strategic planning, outcomes used to hold the system implemented – to measure progress toward budgeting, and financial Key performance indicators government and individual provides a link to the achievement of the objectives and reporting (including entities to account for their strategic planning process goals established in the strategic nonfinancial performance performance plan information) Budget information directly Budgets for all revenues, comparable with financial Accrual budgeting introduced expenditures, assets, and liabilities Budget versus actual analysis statements and other financial on an accrual basis reporting Identification of fiscal risks and Impacts of the different policy options Results of the chosen policy Optimal use of balance Management of fiscal risks policy options available assessed actions evaluated sheet capacity • Assessments of available options • Assessment of balance sheet • Borrowing capacity within limits set capacity in the strategic plan • Additional borrowing • Net operating deficit within Government financial Management of pandemic Best combination of options • Increase in planned net limits set in the strategic plan position maintained at fiscal shock chosen operating deficit (increase revenues or decrease acceptable level • Reduction in planned expenditures) investment level • Planned investments reprioritization process Long-term asset management Sustainable long-term asset plans establish the service level Technical data for maintenance, Actual service levels achieved Desired services levels management requirements that should be replacement, and new investments compared to targets set maintained or improved maintained or improved. Engineering data used to determine Actual performance measured Asset management plan with Maintained or improved Roading network maintenance and replacement costs and achievements reported detailed service level requirements service levels and service level targets against service level targets Results of the chosen policy Identification of intergenerational actions evaluated in terms Government financial Impacts of different policy options Intergeneration issues equity issues and the policy options of the overall impact on the position maintained at assessed available government’s current and future acceptable level financial position Reduction in entitlements, increase Actuarial assessment data to determine in retirement age eligibility, or the magnitude of the funding gap Actual results of the policy option Level of unfunded pension Unfunded pension liabilities establishment of a dedicated and assess the impact of the options chosen reported liabilities reduced investment fund available >>> Appendix B –Profile of Countries by Basis of Accounting PROSPERITY INSIGHT <<< 55 > > > T A B L E B 1 - Basis of Accounting, by Region Parcial Accrual Cash Accrual 40% 30% 30% REGION 66 Countries 50 Countries 49 Countries No. % No. % No. % East Asia and Pacific (EAP) 6 9% 7 14% 14 29% Europe and Central Asia (ECA) 21 31% 9 18% 18 37% Latin America and the Caribbean (LAC) 16 24% 8 16% 9 18% Middle East and North Africa (MENA) 1 2% 5 10% 1 2% North America (US and Canada) 2 4% South Asia (SAR) 1 2% 6 12% Sub-Saharan Africa (AFR) 19 29% 12 24% 2 4% No tag 2 3% 3 6% 3 6% Total 66 100% 50 100% 49 100% Source: Based on IPSAS by Country Data (IFAC-CIPFA), 2020, and World Bank Classification of Countries by Region, 2020. > > > F I G U R E B 1 - Basis of Accounting, by Democratic Categorization Number of Countries Authoritarian Regime (25) 0 16 9 High performing democracy (17) 12 1 4 Mid-range performing democracy (53) 19 23 11 Weak democracy (20) 3 11 6 Hybrid Regime (15) 3 6 6 Accrual Partial accrual Cash Source: Based on IPSAS by Country Data (IFAC-CIPFA), 2020, and The Global State of Democracy Indices, 2020. PROSPERITY INSIGHT <<< 56 > > > F I G U R E B 2 - Financial Reporting Basis, by Fragile State, APEC, and OECD Membership APEC Countries (19) 12 5 2 OECD Countries (34) 21 8 5 Fragile States (25) 2 11 12 > > > F I G U R E 2 - Financial reporting basis – By fragile state and APEC and OECD Membership Accrual Partial accrual Cash Source: Based on IPSAS by Country Data (IFAC-CIPFA), 2020; Financial Management Information System (FMIS); and Open Budget Data Global Dataset on 198 Countries, Latest Update – 2017. Note: APEC = Asia-Pacific Economic Cooperation, OECD = Organisation for Economic Co-operation and Development. > > > T A B L E B 2 - Answers on Select Financial Management Information Systems and Open Budget Data Assessment Questions 2020 Financial Reporting Basis Parcial Accrual Cash Accrual TOTAL 66 50 49 Is there a dedicated PF publication web site? NO % NO % NO % Yes (but, not clearly visible from home page) 12 18% 8 16% 3 6% Yes (easy access to PF data from the home page) 46 70% 35 70% 37 76% No 5 8% 3 6% 2 4% No data 3 5% 4 8% 7 14% 66 100% 50 100% 49 100% Is there a web site / doc on FMIS solution? NO % NO % NO % Yes (reference doc only) 30 45% 27 54% 14 29% Yes (FMIS related web site) 33 50% 19 38% 28 57% No data 3 5% 4 8% 7 14% 66 100% 50 100% 49 100% Presence of Open Data (online, editable, free) NO % NO % NO % Yes 21 32% 10 20% 25 51% No 42 64% 36 72% 17 35% No data 3 5% 4 8% 7 14% 66 100% 50 100% 49 100% Source: Based on IPSAS by Country Data (IFAC-CIPFA), 2020; Financial Management Information Systems; and Open Budget Data Global Dataset on 198 Countries, 2020. PROSPERITY INSIGHT <<< 57 > > > T A B L E B 3 - Quality of Public Finance Data Presentation 2020 Financial Reporting Basis Parcial Accrual Cash Accrual 66 50 49 NO % NO % NO % Good quality (informative and easy to read) 20 30% 17 34% 26 53% Partial acceptable (some of the tables are useful) 36 55% 26 53% 14 29% Below desired level (not informative) 7 11% 3 6% 2 4% No data 3 5% 4 8% 7 14% Total 66 100% 50 100% 49 100% Source: Based on IPSAS by Country Data (IFAC-CIPFA), 2020; Financial Management Information Systems; and Open Budget Data Global Dataset on 198 Countries, 2020. > > > T A B L E B 4 - Country Policy and Institutional Assessments 2020 Financial Reporting Basis Parcial Accrual Cash Accrual 24 25 5 Average Rating CPIA building human resources rating 3.75 3.58 3.3 CPIA business regulatory environment rating 3.08 3 2.8 CPIA debt policy rating 3.31 3.06 3.3 CPIA economic management cluster average 3.35 3.14 3.3 CPIA efficiency of revenue mobilization rating 3.42 3.4 2.9 CPIA equity of public resource use rating 3.56 3.38 3 CPIA financial sector rating 2.9 2.9 2.6 CPIA fiscal policy rating 3.1 3.04 3.1 10 PEFA CPIA gender equalitySelected Indicators rating For Comparsion with the FMIS&BT scores 3.48 3.26 3.1 CPIA macroeconomic management rating 3.36 3.32 3.5 CPIA policies for social inclusion/equity cluster av 3.45 3.29 3.1 CPIA policy and institutions for environmental susta 3.4 3.22 3.2 CPIA property rights and rule-based governance rating 2.96 2.88 3.1 CPIA public sector management and institutions clust 3.04 3.04 2.92 CPIA quality of budgetary and financial management r 3.04 3.12 2.8 CPIA quality of public administration rating 2.94 2.9 2.6 CPIA social protection rating 3.08 3 2.9 CPIA structural policies cluster average 3.29 3.17 3 CPIA trade rating 3.9 3.6 3.6 CPIA transparency, accountability, and corruption in 2.85 2.9 3.2 IDA resource allocation index 3.29 3.16 3.08 Source:Based on IPSAS by Country Data (IFAC-CIPFA), 2020; and Country Policy and Institutional Assessment 2020. PROSPERITY INSIGHT <<< 58 > > > T A B L E B 5 - Average Values/Estimates of Select World Governance Indicators and World Development Indicators, 2020 2020 Financial Reporting Basis Parcial Accrual Cash Accrual Average No. of Average No. of Average No. of Countries Countries Countries Government Effectiveness: Estimate -0.113 65 -0.062 46 0.648 46 Voice and Accountability: Estimate -0.056 65 -0.004 45 0.700 47 Political Stability and Absence of Violence/ -0.025 64 0.023 46 0.264 47 Terrorism: Estimate Corruption Index 41.623 61 45.375 40 55.825 40 Exchange Rate 1,073.151 58 624.407 36 739.433 32 Market capitalization of listed domestic com- 51.542 22 88.102 13 145.792 22 panies (% of GDP) Stocks traded, turnover ratio of domestic 39.078 22 23.837 11 57.094 20 10 PEFA shares Indicators Selected For Comparsion with the FMIS&BT scores (%) Terms of trade 121.516 62 104.162 44 116.871 43 Central government debt, total (% of GDP) 72.761 20 84.287 10 76.160 26 Gross fixed capital formation (% of GDP) 22.730 54 22.084 33 23.591 39 Source: Based on IPSAS by Country Data (IFAC-CIPFA), 2020; World Bank Open Data on Global Development Indicators 2020; and World Development Indicators 2020. > > > T A B L E B 6 - Combined FMIS Maturity Index 2020 Financial Reporting Basis Parcial Accrual Cash Accrual TOTAL 63 46 42 % % % T operational 8 9 2 F (B+T) operational OR T+TSA operational 38 54 29 F+TSA operational 54 37 69 Source: Based on IPSAS by Country Data (IFAC-CIPFA), 2020; FMIS and Open Budget Data Global Dataset on 198 Countries, 2020. Note: A significantly higher share of countries that apply accrual accounting have financial systems (F) comprising operational Budget, Treasury, and Treasury Single Account (TSA) components, indicating a higher level of FMIS maturity. Countries using cash-basis accounting systems primarily have (1) an operational treasury management system (T) and TSA, or (2) operational budget and treasury management systems F (B + T). PROSPERITY INSIGHT <<< 59 > > > T A B L E B 7 - PEFA Scores by Accounting Basis, 2016 Framework Country Name Basis of Accounting Country Group BR TPF MAL PFSB PCBE A&R ES&A Albania Partial Accrual EME 3.3 2.5 2.7 2.3 2.8 4.0 2.7 Argentina Accrual EME 2.6 4.0 3.2 1.8 2.5 2.8 3.2 Bangladesh Cash LIC 2.1 2.5 1.5 2.0 2.0 2.8 2.7 Bhutan Cash LIC 2.6 2.5 3.2 1.8 3.3 1.8 2.2 Bosnia and Herzegovina Partial Accrual LIC 3.0 3.0 1.5 1.8 2.8 1.5 1.3 Botswana Partial Accrual LIC 2.6 3.0 1.8 2.3 2.3 2.0 2.2 Burkina Faso Partial Accrual LIC 2.0 2.3 1.8 1.5 1.8 2.0 3.0 Burundi Partial Accrual LIC 2.4 1.8 1.0 1.0 1.3 1.0 1.7 Chad Partial Accrual LIC 1.4 1.0 1.2 1.3 1.8 1.5 1.5 Colombia Accrual EME 2.5 4.0 2.8 2.8 3.5 3.8 3.0 Congo, Dem. Rep. of Partial Accrual EME 1.4 1.5 1.2 1.3 1.3 1.8 1.3 Costa Rica Partial Accrual LIC 3.1 4.0 3.7 2.3 3.5 3.0 3.0 Cote D'Ivoire Cash LIC 3.0 2.0 1.7 1.8 2.8 2.8 2.2 Dominican Republic Accrual EME 2.4 3.5 3.2 2.3 2.3 2.8 2.2 El Salvador Partial Accrual LIC 3.0 3.5 2.3 2.0 2.8 2.3 1.8 Ethiopia Cash LIC 2.5 2.5 2.8 1.3 2.8 2.0 2.7 Georgia Partial Accrual LIC 3.0 4.0 3.8 3.5 3.5 3.5 3.8 Ghana Partial Accrual LIC 1.5 1.5 3.0 1.3 1.8 1.8 2.8 Guatemala Accrual LIC 2.9 2.5 2.5 2.0 2.0 1.8 2.5 Indonesia Accrual EME 2.4 3.5 3.2 1.8 3.3 3.5 3.5 Jamaica Cash LIC 3.5 3.3 1.5 1.5 2.5 3.0 2.2 Jordan Cash EME 3.4 2.8 2.8 1.3 2.8 3.0 3.0 Kazakhstan Partial Accrual EME 2.1 2.3 1.8 2.5 2.5 3.0 3.3 Kenya Partial Accrual LIC 2.4 2.8 2.8 2.5 3.0 3.0 3.7 Kosovo Cash LIC 3.0 2.5 2.8 2.5 3.3 3.0 2.8 Kyrgyz Republic Partial Accrual LIC 2.6 3.5 2.3 2.3 3.5 2.3 3.2 Lao PDR Cash LIC 2.4 1.3 1.3 1.0 1.5 1.5 1.8 Lesotho Cash LIC 1.8 1.5 1.2 2.0 1.5 1.5 2.7 Liberia Cash LIC 2.0 2.3 1.2 1.3 2.8 2.8 1.8 Madagascar Partial Accrual LIC 1.4 2.0 2.2 1.0 2.5 1.5 1.7 CONTINUED Malawi Partial Accrual LIC 3.0 2.0 1.7 1.3 2.0 1.5 2.8 Mali Partial Accrual LIC 1.6 2.0 1.7 2.0 2.3 2.8 3.2 Maldives Cash LIC 2.9 2.0 2.7 1.8 2.8 2.5 2.5 Moldova Accrual LIC 2.9 3.3 3.5 2.3 3.8 3.3 3.3 Mongolia Partial Accrual LIC 2.6 3.5 3.0 3.0 3.0 2.8 3.5 Montenegro Cash LIC 3.5 3.3 2.2 1.8 2.8 3.3 2.8 Mozambique Cash LIC 2.1 1.0 1.3 1.5 1.8 1.5 2.7 Nigeria Accrual LIC 1.5 2.0 1.7 1.3 2.5 1.8 1.3 Palau (Agile) Accrual LIC 2.1 3.0 1.7 1.8 2.8 2.0 2.5 Paraguay Partial Accrual EME 2.6 2.5 2.3 2.0 2.8 3.0 2.3 Philippines Accrual EME 1.9 3.8 3.8 3.5 2.8 3.5 3.8 Rwanda Partial Accrual LIC 3.1 3.3 2.3 3.3 3.0 3.5 3.3 Sao Tome and Principe Cash LIC 1.5 1.0 1.3 1.0 1.5 1.3 1.2 Senegal Partial Accrual LIC 2.6 2.0 1.2 1.5 1.3 2.3 2.3 Seychelles Partial Accrual LIC 2.6 3.5 2.3 1.5 2.5 3.0 2.3 Sierra Leone Cash LIC 2.1 2.0 2.0 1.5 3.0 2.3 2.0 Tajikistan Partial Accrual LIC 2.8 4.0 2.2 2.0 2.8 3.0 2.8 Tanzania Accrual LIC 1.3 2.5 1.8 2.3 3.3 2.8 3.0 Togo Partial Accrual LIC 1.6 1.5 1.0 1.3 1.5 1.3 1.7 Tonga Cash LIC 1.4 3.0 2.3 2.8 2.0 2.0 2.3 Tunisia (Agile) Cash LIC 3.1 2.0 2.5 1.5 2.0 2.5 2.2 Ukraine Accrual EME 3.8 3.0 3.7 2.3 3.5 2.8 2.0 Uganda Partial Accrual LIC 3.3 3.3 3.2 1.8 3.0 3.0 2.3 Uzbekistan Partial Accrual LIC 3.5 2.5 1.5 2.5 2.5 2.0 2.8 Zambia Cash LIC 2.5 2.8 2.2 1.3 1.8 3.5 3.3 Zimbabwe Cash LIC 1.9 1.8 1.3 1.5 2.0 2.3 2.3 Note: BR = Budget Reliability, TPF = Transparency of Public Finances, MAL = Management of Assets and Liabilities, PFSB = Policy-based Fiscal Strategy and Budgeting, PCBE = Predictability and Control in Budget Execution, A&R = Accounting and Reporting, ES&A = External Scrutiny and Audit, EME= Emerging Market Economies, LIC= Low-Income Economies. Source: PEFA 2016 Framework; IPSAS by Country Data (IFAC-CIPFA) 2020; PEFA scores are available at https://www.pefa.org/index.php/assessments/batch-downloads. >>> Appendix C –Summary of Foundational Differences Between International Public Sector Accounting Standards and Government Finance Statements PROSPERITY INSIGHT <<< 62 IPSAS GFS Evaluate financial performance and Analyze and evaluate fiscal policy, position (including at individual entity especially the performance of the Objective level), hold management accountable, general government and the broader and inform decision making. public sector of any economy. Economic entity, defined as a group Public sector, which includes the Scope of consolidation of entities that includes one or more general government sector and the controlled entities resident public corporations. Assets, liabilities, revenue, expense, Assets, liabilities, revenue, expense, Accounts net assets/equity equity Statements of financial position, Statement of Operations, Statement financial performance, changes in net of Other Economic Flows, Balance Reports/Financial Statements assets/equity and cash flows, notes to Sheet, and Statement of Sources and financial statements Uses of Cash Fair value plus or minus, in the case of financial liability not at fair value Valuation/measurement of debt/ through surplus or deficit, transaction Nominal value liabilities costs that are directly attributable to its acquisition or issue Distinguishes between realized and Distinguishes between value and Revaluations and other value changes unrealized gains/losses volume changes Past events with probable outflows recognized: recognize liabilities, inclu- ding provisions, when: • A past economic event has taken place; Economic events when economic Recognition criteria • The amount can be reliably mea- value is created, transformed, ex- sured; and changed, transferred, or extinguished • Future outflows are probable. If items cannot be measured reliably, they could be disclosed as contingent liabilities or contingent assets. While recognition should occur, a The use of the projected unit credit specific actuarial method to measure Employee benefit obligations method to measure the defined benefit the net present value of future bene- obligation (IPSAS 39) fits is not explicitly recommended. Reported (by both the borrower and Reported (by both the borrower and the lender) at the fair value of the loan the lender) at the principal received (which for a market loan will be the Market loan by the government/transferred by the principal amount) plus interest ac- lender, plus any arrears of interest, crued less repayments of principal and less any repayments of principal interest CONTINUED PROSPERITY INSIGHT <<< 63 Concessional interest rates to a foreign government are seen as pro- viding a transfer equal to the differen- Concessional loans are measured at ce between the actual interest and fair value by discounting the expected the market equivalent interest. If such cash flows using a market-related rate a transfer is recognized, it is usually of interest for a similar instrument. recorded as current international coo- Low interest and interest free loans The difference between this fair value peration. The interest recorded would and the transaction price represents be adjusted by the same amount. But the concessional element of the loan the means of incorporating the impact and is recognized as revenue by the into the SNA has not been developed recipient. (IPSAS 23, 41) and, until this is done, information on concessional debt is shown in supple- mentary tables. (SNA 22.123–124) To be disclosed as memorandum items rather than recognized (SNA 2008, 11.130) with elaboration (SNA Nonperforming loans are impaired; the 13.66). In practice, no provision will loss is assessed using an expected exist until both counterparties agree loss model (IPSAS 41 or an incurred Nonperforming loans to debt relief (a mutually agreed loss model under IPSAS 29, the pre- write-off). vious standard) and recognized as an Thus, loans remain on balance sheet expense. 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 market loan and revenue (a grant) for the benefit of the concessio- nal terms and debt moratorium. These are recognized and measured in the same manner as a concessional loan (above). Reported (by both the borrower and Interest is accrued and recognized the lender) at the principal received as an expense throughout the loan by the government/transferred by the period, including those periods where Concessional loan followed by debt lender, plus any arrears of interest, a moratorium is in effect. moratorium less any repayments of principal. Compared to the GFS treatment, the The effects of the concessional terms operating position will be positive for and debt moratorium are not reflected the borrower (negative for the lender) in the GFS reporting. when the loan is entered.. Subse- quently, the increased levels of interest recognized mean that the operating position in future periods will be nega- tive for the borrower (and positive for the lender), particularly in the periods where a moratorium is in effect. CONTINUED PROSPERITY INSIGHT <<< 64 In debt rescheduling, the applicable existing debt is recorded as being repaid and a new debt instrument (or instruments) created with new terms Where debt rescheduling occurs, the and conditions. This treatment does debt to be treated as repaid and a not apply to interest arrears that are new loan recognized if the changes rescheduled when the conditions in are significant or the carrying amount the existing debt contract remain un- adjusted to reflect the new terms if the changed. In such a case, the existing changes are not significant. Where the debt contract is not considered as Debt rescheduling new terms are more favorable, whe- rescheduled, only the interest arrears. ther due to payment holidays, lower A new debt instrument is recorded interest rates, or partial cancellation of for the rescheduled interest arrears. the principal, the borrower will recogni- (GFSM 2014 para A3.12) ze revenue reflecting the benefit it will If the outstanding principal amount of receive from the amended terms. the claim (generally loans), recorded at its nominal value, is diminished, a capital transfer must be recorded in favor of the defaulting debtor for the claim which is cancelled. Source: Adapted from Brumby et al. (2022). Note: GFS = Government Finance Statistics, IPSAS = International Public Sector Accounting Standards, SNA = System of National Accounts. PROSPERITY INSIGHT <<< 65 >>> Appendix D –Selected Case Studies PROSPERITY INSIGHT <<< 66 a. Vietnam In September 2021, Vietnam became the latest country management of receivables and follow-up of arrears and other in Asia to issue IPSAS-based public sector accounting liabilities and has effectively contributed to managing fiscal standards, following the footsteps of Indonesia, Malaysia, risks and improving fiscal policymaking through consolidation the Philippines, and Singapore. The Government of Vietnam of revenue and expenditure in the WOGFS since 2019. approved the roadmap to issue VPSAS, based on IPSAS, in However, the consolidated financial statements are not July 2019. Following this roadmap, VPSAS will be issued in audited or made available to the public. phases from 2021 to 2024. The first five VPSAS were issued in 2021 and included standards on assets, inventories, and More effective monitoring of nonfinancial assets is presentation of financial statements and cash flow statements. incorporated in the planned adoption of VPSAS. Vietnam Six additional VPSAS were issued in July 2022, including maintains a national asset register that captures six categories standards on revenues, construction contracts, borrowing of nonfinancial tangible assets: costs, events after the balance sheet date, and presentation of budget information. In June 2024, the next five standards • Land for public office buildings and public service facilities. on provision, contingent liabilities/assets, accounting estimate • Public office buildings and public service facilities. and errors, the effect of changes in foreign exchange rates, • Cars of all types. leases and service concession arrangement have been • Other assets with original values of D500 million or higher. finally issued, making total number of VPSAS standards had • Concentrated rural water supply structures. been issued in Vietnam so far is 16 standards. Before that, • Road infrastructure assets. in April 2024, the MOF also issued revised guidance circular providing all detailed public accounting guidance and policy Intangible nonfinancial assets, including land use rights, in line with already issued VPSAS standards, especially on copyrights, software, and brand values are also captured in infrastructure asset accounting and reporting and once all the national asset register. government infrastructure assets are properly accounted for in consolidated Whole of Government Financial Statements The Ministry of Finance (MOF) compiles a nationwide report (WOGFS), the quality of annual prepared WOGFS will be on public asset management and uses it to report to the significantly improved at both national and subnational levels. national government. Accounting for nonfinancial assets is on an accrual basis using historical cost. The revaluation of The existing accounting framework applied in Vietnam, assets in the public sector is not allowed. Road infrastructure before the issuance of VPSAS, incorporated some accrual assets are included in the WOGFS, but other infrastructural principles, such as recognition and measurement of public assets are not (aviation, in-land water, national railways, assets (excluding asset revaluations), recognition and and irrigation structures). The MOF is currently developing measurement of account receivables and payables, and the accounting guidance to be fully aligned with the 2021-issued recording of public expenditure. The new accounting guidance nonfinancial assets standards, based on IPSAS, and it is allows the use of a provision mechanism for public service expected that this aligned guidance will be fully applied when delivery units. The introduction of VPSAS is assisting with the preparing the FY2023 financial statements. harmonization of various accounting regimes and guidance. This will help promote the consistent application of a sound The Government of Vietnam has made progress toward public sector accounting framework and provide support for adoption and implementation of accrual accounting, which the consolidation process. it believes will contribute to achieving sustainable public finances and good governance. However, it recognizes that The WOGFS consolidates financial reports from all ministries, some significant challenges remain to fully maximize the extra-budgetary funds, tax, customs, and other government benefits of accrual accounting. These include (1) issuing the management funds such as reserves, as well as financial remaining standards in compliance with IPSAS to the extent reports from all subnational governments in 63 provinces. The possible, (2) revising all detailed accounting guidance to WOGFS is prepared on a partial accrual basis and includes a fully align with the issued standards, (3) developing training balance sheet, an income statement, a cash flow statement, modules and conducting extensive training to build the and disclosures including government guarantees and capacity of public sector accountants and WOGFS users, (4) contingent liabilities. All government revenue and expenditure making the WOGFS available to the public, (5) revising the previously reported outside the central government financial relevant legislation to ensure the WOGFS is audited regularly, reports are included in the WOGFS. Better balance sheet and (6) increasing the use of accrual information for fiscal management has helped increase revenue through improved management and reporting. PROSPERITY INSIGHT <<< 67 Observations on the Vietnam Case Study 1. Full compliance with IPSAS will not be asserted because of the extent of local contextualization of VPSAS. This Vietnam has chosen to adopt IPSAS indirectly through the means that the financial statements produced will not be VPSAS endorsement process. It is aiming to achieve full fully comparable with other jurisdictions. WOGFS for all national and subnational levels, including 2. Much time and resources are spent on preparing the its substantial portfolio of state-owned enterprises. This VPSAS, adapting the IPSAS to the Vietnam context. More country case therefore provides a good example of a very time and resources will be required in the future to keep comprehensive public sector accounting reform program. VPSAS up to date. It also illustrates why it is very important that each country 3. VPSAS is being adopted on a batch basis, which means carefully consider the objectives it wishes to achieve from a that the full transition will necessarily be over an extended transition to accrual accounting. period. The WOGFS prepared during the extended transition period will not provide a complete picture of Vietnam can be considered as a partial accrual adopter that Vietnam’s financial position and financial performance is at the preparation stage and will likely remain such for and potentially could provide misleading information if not an extended period. Vietnam’s approach to the transition to carefully interpreted. accrual accounting will likely have the following impacts: 4. Vietnam may struggle to fully realize the high-level outcomes of sustainable public finances and improved fiscal management unless a second phase of reforms is implemented. Source: Ha Thuy Tran, in consultation with Vu Duc Chinh, General Director, Accounting and Auditing Supervisory Department, Ministry of Finance of Vietnam, and Nguyen Thi Hien, Deputy General Director, State Accounting Department, State Treasury of Vietnam. b. Chile Chile started the indirect adoption of IPSAS in 2016 by accrual accounting strengthened information on assets and enacting a new legal framework in 2015. Chile is leading liabilities and improved the recording of property incomes and the implementation of IPSAS in the region at the central expenses. government level and is now focusing its efforts on improving financial information at the subnational level. The accounting The path to IPSAS adoption has not been easy. A phased framework in place before the 2015 reforms had already approach was used to achieve indirect adoption of IPSAS in a incorporated some accrual principles. Thus, the gap covered series of incremental steps. This started in 2015 and focused through the 2015 reforms was not a radical change to the on the following aspects: way things were already accounted for. The 2015 reforms to First Phase Second Phase Third Phase Fourth Phase Fifth Phase Date: August Date: October Date: May 2018 Date: July 2019 Date: August 2021 2015 2016 Development of Development of use of Diagnostic of best practic- Support in Continuation of training IPSAS business intelligence es for the implementation IPSAS imple- support in the materials, and and big data analytics of IPSAS at subnational mentation at implementation delivery of work- tools and a diagnostic level and improvement of the central of IPSAS and the shops. Also, the of the feasibillity for the platform fo accessing government development of TA focused on the the implementation of the normative accounting an online learning implementation of IPSAS at subnational framework using artificial platform for IPSAS financial audits level intelligence PROSPERITY INSIGHT <<< 68 To date, the IPSAS implementation process has resulted in The Government of Chile recognizes that there are still the following tangible benefits: challenges ahead to maximize the benefits of applying accrual accounting. The intention is to gradually continue • Providing better information to higher levels of toward closing the existing gaps for the full adoption of the government and constituents. The country’s Supreme IPSAS. Some of the most critical pending issues are the full Audit Institution prepares the annual consolidated recognition of taxes and pension liabilities and improving the financial management report for the Republic, as use of accrual information for fiscal risk management and mandated by the Constitution. This report is presented to reporting. the President of the Republic and to the presidents of both houses of Congress. The report includes the whole-of- Observations on the Chile Case Study government budgetary, financial, and fiscal performance at a consolidated level and for each sector of government. While Chile’s approach to the transition to accrual accounting The report is also available to citizens through the internet. follows an indirect approach to the adoption of IPSAS, it has These reports are prepared in a user-friendly format, not adopted IPSAS to the same extent as Vietnam. It has also which facilitates understanding. taken a different approach to the preparation of its consolidated • Facilitating the fiscal and financial monitoring financial statements by focusing first on the central government function of public finances. The MOF has been a direct level and defining its Government Reporting Entity (GRE) to beneficiary of the improvement in financial information, include only central government entities. It is now focusing which is also closely integrated with the budgetary on extending the definition of its GRE to include subnational records. Such information is extensively used by the MOF entities. for the oversight of public finances. Significant progress has been made with the recognition of service concession In Chile’s case, the country is classified as a partial adopter in assets and their associated liabilities and infrastructure the preparation stage and will likely remain so for some time. assets (previously recorded as expenses). Chile’s approach to the transition to accrual accounting will • Enhanced government performance through access likely have the following impacts: to better financial information. The financial accounting reform required the preparation of individual financial 1. Chile may eventually be able to assert full compliance statements for public sector entities. Using this information with IPSAS once it is able to prepare an opening balance has allowed public sector officials to have a better and sheet for the WOGFS including the subnational level more comprehensive picture of the performance of the entities (assuming there have not been any significant individual entities under their responsibility and has departures from IPSAS). enabled closer monitoring of key performance indicators 2. It will need to carefully consider when to officially enter used for improving the efficiency of government the transition phase, as it must comply with the IPSAS 33 expenditures. three-year transition requirement if it wishes to assert full • Facilitating the oversight function of the Supreme compliance with IPSAS. Audit Institution. The accrual basis information also 3. The transition phase should only commence once Chile ensures that critical information is readily available for is ready to prepare its first full IPSAS-compliant opening audit purposes, allowing auditors to monitor the economic balance sheet for the WOGFS. events on a continuous basis. Furthermore, since most 4. While it has realized some lower-order benefits, a second public entities publish individual financial statements, phase of reforms will be required to realize the high-level the SAI conducts financial audits on a sample basis, outcomes (as described above in the Theory of Change thereby ensuring the quality and transparency of financial chapter). information. Source: Juan Carlos Serrano-Machorro, in consultation with Yolanda Bascuñan, Deputy Chief of the Accounting Division of the Ministry of Finance, Chile. PROSPERITY INSIGHT <<< 69 c. Rwanda In 2008, the Government of Rwanda established under law that when assessing the macroeconomic fiscal risks, when or accounting standards for public institutions shall be consistent where to invest, and whether to diversify the portfolio. The with IPSAS. The implementation period was planned for six government’s ownership interest in public corporations years, from FY2018–2019 to FY2023–2024. It has not been is closely monitored particularly to ensure longer-term decided whether the budget will be migrated to the accrual sustainability. basis or not. The SOE information is disclosed in the government’s To date, the following benefits have been realized from the consolidated financial statements while sub-consolidations implementation of accrual accounting for separate clusters of SOEs are produced. This information is used to monitor the financial performance and position Trade and Other Receivables of those clusters, facilitating analysis of the fiscal risks and allowing for prompt remedial action where necessary. The shift to accruing for delivery notes has increased the completeness and improved the management of receivables. Non-Current Assets Previously, advances were expensed at the time of issuance while other receivables were among memorandum records The government executes its budget by payment of salaries, and hence were provided as off-balance sheet information. acquisition of goods and services, acquisition of infrastructure, and other non-current assets. Previously, infrastructure and Receivables from exchange transactions (such as sales other non-current assets were expensed and not recognized of assets or from rendering of services, advances, and in the balance sheet, and as a result these assets difficult to prepayments) are recognized in statement of financial monitor and manage. position, while receivables from non-exchange transactions are currently disclosed within financial statements. For Acquired and built assets are registered in the government example, the taxes filed but not yet paid are being disclosed in asset register at their purchase cost. Currently, information is the financial statements, and users can refer to this information included as note disclosures in the individual entity’s financial when planning and budgeting for the next fiscal year. In the statements as well as in the government’s consolidated future, it is expected that these transaction types will also be financial statements. It is expected that in the future, these fully recognized in the statement of financial position. assets will be recognized in the statement of financial position. The identification and disclosure of non-current assets revealed Government revenues are well-documented and tracked to many weaknesses, and this prompted management decisions ensure recoverability. Off-balance sheet information is easily to improve the efficient and effective management of assets. forgotten, increasing the risk of fraud. The performance in tax Actions have been taken to reduce the level of idle assets and collection is also easily monitored because the arrears and improve asset management planning and maintenance. corresponding recoverability are reported. Accruing Outstanding Invoices Investments in SOEs Accrual for outstanding invoices is used by decision-makers to State-owned enterprises (SOEs) hold a large volume of assess compliance with the previous budget spending limits government assets and liabilities. Fiscal reports, including and determine the fiscal space for plans and budgets. All the SOEs, reflect the net worth of the government as a commitments for deliveries are recognized as liabilities. This whole and fiscal risks that the government is exposed to. has resulted in better allocation of available resources for the As a shareholder the government invests in SOEs to pursue next budget cycle. different objectives, including social, economic, political, and geographical objectives. The complete information on these liabilities has resulted in a reduction in the level of payments in arrears, timely payment Improved operational performance by SOEs will help the of suppliers, improved cash planning, better service delivery, economy. Information on SOEs is used by decision-makers and an improved government contribution to doing business. PROSPERITY INSIGHT <<< 70 Non-Current Liabilities Observations on the Rwanda Case Study Development activities are largely financed by external Rwanda is classified as a partial adopter in the preparation resources, through borrowing repayable over a longer term. stage and will likely remain so for some time. While, at the The government needs to monitor the level of borrowing, time of publication, IPSAS standards have yet to be adopted repayments, and associated risks. A complete picture is in full, work is progressing towards their adoption. crucial to ensure accountability, long-term debt sustainability, and service performance, and to determine the capacity for Rwanda’s approach to the reform process for full further borrowing. implementation of accrual accounting will likely have the following impacts: The consolidated financial statements include a statement of public debt with commercial borrowing, in-year borrowing, 1. The country will need to carefully consider when to and repayments reflected on the face of the balance sheet, officially enter the transition phase as it will need to ensure and additional information on stocks is included in the note it is able to comply with the IPSAS 33 three-year transition disclosures. This more complete information means that the requirement. net position is easily visible from the balance sheet and that 2. The transition phase should only commence once the fiscal risks can be better assessed. This has also resulted country is ready to prepare its first full IPSAS- compliant in improved monitoring and planning for repayments and the opening balance sheet for the WOGFS. liabilities incurred to finance assets. 3. While the country has realized some lower-order benefits, a second phase of reforms will be required to realize the Government guarantees, contingent liabilities, and pension high-level outcomes (as described above in the Theory of and other employee entitlement liabilities are currently included Change chapter). as note disclosures in the consolidated financial statements. It is expected that these liabilities will be fully recognized in the financial statements in the future. Source: Josephine Kabura Kamau, in consultation with Marcel Mukeshimana, Accountant-General, Ministry of Finance and Economic Planning, Rwanda. PROSPERITY INSIGHT <<< 71