Many conference presentations, journal articles and books extol the virtues and benefits of governments adopting accrual accounting, but few provide any real evidence of the actual experience. Independent evidence from the UK on the actual benefits which have been achieved to date suggests that the costs of this type of reform were significant, but that the benefits appeared to be limited. In addition, there may be significant risks involved in adopting this approach to public sector accounting. Two audit reports from the Auditor General of the Cayman Islands provide a brutally frank and honest account of what can go wrong. This is in addition to years of qualified audit reports in France and the US after the adoption of accrual accounting.
In 2005, in a study funded by the Association of Chartered Certified Accountants (ACCA), two respected academics (Connolly and Hyndman) from Northern Ireland (a region of the UK) concluded that: “there was little evidence that [accrual] information was extensively used in decision making … [while] the costs were seen as substantial”. This was around five years after accrual accounting had been implemented in central government departments.
In 2007, in another study funded by an accountancy body (this time the Institute of Chartered Accountants in Scotland – ICAS), another three respected academics (Mellett, Macniven & Marriott) reported the results of their research, saying that: “there was no evidence that the perceived benefits from the introduction of... accruals accounting... were being realised”. This was in the National Health Service in England and Wales which had adopted accrual accounting over 15 years previously.
The arguments for the introduction of accrual accounting in the public sector have only re-arisen in recent years (Birmingham City Council introduced it in 1850) and many key officers have recently changed their minds. So, for example, Sir Andrew Likierman was able to say, in a book published in 1992 that:
Those who believe that private sector accounts are superior need to bear two factors in mind. First, that there are no immutable accounting or other financial reporting rules which apply irrespective of the nature and purposes of the organisation whose activities and results are being displayed or the objectives of presentation. Second, that cash accounts, despite their crudeness, have a degree of transparency that accrual accounts cannot give and that many private sector financial reports do not seek to offer.
(page 23, ‘Financial Reporting in the Public Sector’ in Public Sector Accounting and Financial Control, Edited by Sir Douglas Henley and Clive Holtman, Chapman & Hall).
In July 2008, the Auditor General of the Cayman Islands, Dan Duguay, issued a special report on the State of Financial Accountability Reporting. The Cayman Islands is a British Overseas Territory situated in the Caribbean. In 1997, the Government embarked on a Financial Management Initiative which included the adoption of the accrual basis of accounting for its annual financial statements. Consultants were appointed in 1998 and a Detailed Design and Implementation Strategy was produced in the following year. Accrual based accounts were finally to have been produced for the financial year starting on 1st July 2004, and which should have seen the Cayman Islands being “at the very forefront of financial accountability reporting among governments of the world”.
Unfortunately, it is still not operating as contemplated. The 2008 Auditor General’s report described “a very grim assessment of the state of financial accountability reporting throughout the Cayman Islands Government”. Ten years after the Cayman Islands agreed to adopt accrual accounting, the first accrual based accounts were 2.5 years late and the Auditor General found the “current situation deplorable”. Furthermore he believed that “the legislative assembly has lost control of the public purse”.
In an update report, issued in April 2010, the Auditor General concluded that, “the state of financial accountability reporting has gotten worse in the two years since I last reported on this matter”. The financial statements for 2004/05 (the first year of accrual accounting) had still not been issued, despite the Government having spent an additional $1 million in the current fiscal year to address the problem. The Auditor General assessed the efforts as being “too limited and therefore insufficient to address the situation”. He estimated that at the current rate it would be “several years before the accounting activities of the Government are up to date” and considered that this was “unacceptable”.
In addition to the financial statements being prepared late, the Auditor General considered that they lacked credibility as most of the statements which had been prepared and audited had received a qualified audit opinion. The Auditor General concluded his second special report by saying: “I believe this situation has become a national crisis that could lead to tremendous consequences for the Cayman Islands Government if not addressed immediately”.
The Cayman Islands is not a poor country: the per capita income is one of the highest in the world and, as it is a tax haven and financial services centre, there are many qualified accountants available locally. If the introduction of accrual accounting can go so horribly wrong in the Cayman Islands, imagine what could happen in the many developing countries where accrual accounting is still actively being promoted for the public sector.
The Government of the Cayman Islands is not the first government to suffer qualified audit opinions after the introduction of accrual accounting. In the US, the Government Accountability Office has been unable to provide an opinion on its accrual based consolidated financial statements for the last 13 years (www.fms.treas.gov/fr/backissues.html). This arises from three major impediments; the serious financial management problems at the Department of Defense, the inability to adequately account for and reconcile intragovernmental activity, and the ineffective process for preparing the consolidated financial statements.
Similarly the French Government has suffered seriously qualified audit opinions on its accounts since the accrual basis was adopted in 2006. In there first year there were 13 substantial reservations. This was reduced to nine the following year, but the latest accounts for 2009 still have eight substantial reservations from the Court of Accounts
(http://www.ccomptes.fr/fr/CC/documents/RCE/Rapport-certification-comptes-Etat-exercice2009.pdf).
The next time you hear a speaker listing the many benefits claimed for accrual accounting, ask what the actual evidence is from the few countries which have adopted this approach. The objective and authoritative studies, from the UK for example, suggest that the costs are significant and that the actual benefits are minimal. Now we have reports from the Cayman Islands of the very real risks associated with adopting this approach to public sector accounting. This is in addition to years of qualified audit reports for the governments of the US and France.
REFERENCES:
Duguay, D (2008) Auditor General report on the State of Financial Accountability Reporting (July) Cayman Islands Government:
http://tinyurl.com/accrualcayman1
Duguay, D (2010) Auditor General report on the State of Financial Accountability Reporting (April) Cayman Islands Government:
http://tinyurl.com/accrualcayman2
Hyndman, N. and Connolly, C. (2005) The impact of introducing resource accounting in Northern Ireland, ACCA, London
http://www.accaglobal.com/publicinterest/activities/research/reports/accountability/rr-087
Mellett, H, Macniven, L, Marriott, N, (2007) NHS Resource Accounting in Wales: Problems of Implementation, ICAS
http://www.icas.org.uk/site/cms/contentviewarticle.asp?article=5232
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