Should Developing Countries Adopt Accrual Accounting?

1. Should Developing Countries Adopt Accrual Accounting? Paul Boothe Institute for Public Economics University of Alberta

2. Outline • Motivation • Cash versus accrual accounting • Pros and cons of accrual • Accounting regimes and fiscal rules • Prerequisites for adoption • Checklist for policymakers Institute for Public Economics University of Alberta

3. Motivation • Two perspectives • Public versus private sector • Tale of two finance ministers • The goal: good governance Institute for Public Economics University of Alberta

4. Cash versus Accrual [1] Cash • Traditionally used in public sector • Expenses and revenues recorded when they are paid or received Accrual • Traditionally used in private sector • Expenses and revenues recorded when they are incurred or earned Institute for Public Economics University of Alberta

5. Cash versus Accrual [2] • When transactions are recorded is a key difference • Three examples • Purchase of a capital asset • Public sector pension liabilities • Corporate income tax arrears Institute for Public Economics University of Alberta

6. Cash versus Accrual [3] Institute for Public Economics University of Alberta

7. Accrual Pros and Cons [1] Pros (Athukorala & Reid, 2003) • Matches National Accounts • Recognizes transactions/events when they occur rather than when paid • Separates operating and capital spending • Better information on sustainability • Discloses pension liabilities • Identifies arrears Institute for Public Economics University of Alberta

8. Accrual Pros and Cons [2] Cons (Wynne, 2003) • Ignores different aims of private and public sector • Not designed for legislative accountability • Requires sophisticated analysis and judgments • Exposes public servants to political pressure Institute for Public Economics University of Alberta

9. Fiscal Rules [1] • We know institutions affect fiscal rules (Alesina and Perotti, 1999, Poterba and von Hagen, 1999) • Not much attention yet to incentives flowing from accounting regimes • Boothe (2004)studies influence of accounting regimes on fiscal rules Institute for Public Economics University of Alberta

10. Fiscal Rules [2] Boothe(2004) finds: • Fiscal circumstances may make either cash or accrual regimes more attractive to policymakers • Impacts of common fiscal rules change as regimes change • Regimes may influence the mix and volatility of spending Institute for Public Economics University of Alberta

11. Fiscal Rules [3] Basic cash budgeting model: • Revenue is exogenous • Expenditures include: • transfers • services produced by public capital • gross capital investment • interest payments on public debt Institute for Public Economics University of Alberta

12. Fiscal Rules [4] Basic accrual budgeting model • Revenue is exogenous • Modifies cash expenditures by subtracting gross capital investment and adding depreciation Institute for Public Economics University of Alberta

13. Fiscal Rules [5] • Cash is more attractive than accrual in fiscal consolidations • Balanced budget rules more ‘stringent’ under cash than accrual • Under accrual, capital investment can be financed by borrowing without affecting deficit in short run • Accrual + balance budget rules creates bias for capital spending Institute for Public Economics University of Alberta

14. Fiscal Rules [6] • Critical to recognize that regime changes nature of balanced budget rules • No Canadian gov’t changed fiscal rule after changing to accrual • Bias towards capital spending starting to appear in Canada • Net debt rule is invariant to regime Institute for Public Economics University of Alberta

15. Prerequisites [1] • Developing countries face different public sector environment and challenges (A&R, 2003) • Capacity constraints (HR and technology) • Governance/corruption issues • Many urgent priorities Institute for Public Economics University of Alberta

16. Prerequisites [2] Capacity constraints • Accrual requires sophisticated professional judgments regarding physical assets, long-term social programs • Accrual generally requires more complex IT systems than cash systems Institute for Public Economics University of Alberta

17. Prerequisites [3] Governance/Corruption issues • All accounting systems open to some manipulation • Revenue accruals particularly problematic when tax collection is an issue • Costs of long-term social programs very sensitive to assumptions Institute for Public Economics University of Alberta

18. Prerequisites [4] When resources for public sector reforms are limited, must establish clear priorities • Develop new revenue systems • Reform budget processes • Implement accountability mechanisms • Transform state enterprises Institute for Public Economics University of Alberta

19. Policymakers’ Checklist [1] • Does accrual best meet needs in our public sector? • Is transition to accrual the best use of limited reform resources? • Do we have the HR and IT capacity to successful implement accrual Institute for Public Economics University of Alberta

20. Policymakers’ Checklist [2] “Perfection is the enemy of the good…” Voltaire Institute for Public Economics University of Alberta