Cash to accrual: What does the global public sector shift mean?

By Gary Anders

At the most fundamental level, the difference between cash and accrual accounting is when revenue and expenses are recognised in the financial accounts.

Cash accounting books revenue at the time it is received and as an expense when money is paid out. As such, revenue earned in one financial year may end up being reported in the next financial year’s accounts. The same goes for expenses.

Accrual accounting books revenue when it is actually earned and as an expense when it is incurred. In other words, revenue and expenses are booked in real time rather than deferred.

As such, accrual accounting effectively produces a clearer and more accurate picture of an organisation’s financial position at any point in time. This increased transparency is particularly important for the public sector.

In a status report released last year, the International Federation of Accountants (IFAC) and the Chartered Institute of Public Finance and Accountancy (CIPFA) have forecast that 50 per cent of governments will have transitioned to reporting on an accrual basis by 2025.

The joint report is based on the International Public Sector Financial Accountability Index, which captures the current and future use of public financial reporting bases and frameworks from 165 government jurisdictions around the world.

Momentum for accrual is building

As at the end of 2020, about 30 per cent of governments globally were reporting on an accrual basis.

Australia, New Zealand, the US, the UK, France and Canada are among the early adopters of accrual accounting and have been reporting purely on an accrual basis since the 1990s.

Other countries have been slower off the mark, but the list has been growing steadily since then.

Many European countries have moved to accrual basis accounting by now, although Germany, the Netherlands and Norway remain notable exceptions and currently appear to have no immediate intention of switching from the cash accounting method. Other countries in the region have indicated they intend to move from partial accrual accounting to full accrual by 2025.

Elsewhere, momentum for accrual adoption over the next few years is building. There are currently 17 jurisdictions in Asia, 15 in Latin America and the Caribbean, and nine in Africa in line for accrual accounting adoption by 2025.

However, while Japan, Hong Kong, South Korea and Indonesia have already made the shift to accrual accounting, other significant Asian economies, including India and Singapore, appear to be wedded to cash basis accounting at this stage. Thailand is intending to continue using a partial accrual accounting model, while Vietnam has indicated it intends to move from partial to full accrual in the near future.

Greater government transparency around budgeting and spending, and hence greater accountability, are core elements in the global push for governments to adopt accrual accounting.

Using accrual basis accounting will also give a government direct oversight over its balance sheet liabilities, such as the amounts being spent on long-term infrastructure projects.

Then there are the large amounts of capital governments are required to hold in order to cover public servants’ annual leave, superannuation and pension liabilities.

“By providing a comprehensive view of government finances, accrual reporting helps ensure that expenditure of public funds is transparent, public officials are held accountable, and future liabilities are recognised officially and planned for properly,” IFAC and CIPFA state.

“With governments under more financial strain than ever following the huge levels of pandemic-related expenditure, understanding the overall picture and making the best use of the remaining resources is crucial to long-term recovery.

 

"Accrual-based accounting is essential in helping governments mitigate corruption, improve trust and transparency, and deliver desired outcomes that communities deserve and need in the post-pandemic world."

 

“Accrual-based accounting is essential in helping governments mitigate corruption, improve trust and transparency, and deliver desired outcomes that their communities deserve and need in the post-pandemic world.”

Kevin Dancey, CEO at IFAC, adds that the continued shift from cash to accrual reporting in the public sector “will be crucial to governments globally in making the tough choices they face following the pandemic”.

This will necessarily include increased usage of international accrual-based accounting standards developed by the International Public Sector Accounting Standards Board (IPSASB).

Almost 60 per cent of governments that reported on an accrual basis in 2020 used International Public Sector Accounting Standards (IPSAS) either directly, indirectly or as a reference point.

It is expected that, by the end of 2025, nearly three-quarters (73 per cent) of governments that report on accrual will use IPSAS in one of these three ways.

“Professional accountants have a critical role to play in delivering the full potential benefits for citizens worldwide in terms of decision-making, transparency and accountability,” Dancey says.

He notes that, in addition to the support of regional and international organisations, effective implementation of accrual accounting relies on the skills of public sector accountants to interpret the richer, more comprehensive data.

“As more governments move to accrual, the need for public sector accountants will increase correspondingly.”

Malaysia's accrual accounting transition gathers pace

The Malaysian Government began accounting for transactions on an accrual basis in 2018, but so far the country has not officially implemented accrual accounting.

The reason for that is fairly simple. Transitioning from cash to accrual accounting on a national public sector level is a mammoth task.

“Malaysia has made great progress in its efforts and actions in transitioning towards financial reporting based on the accrual principle,” says Datuk Dr Yacob Mustafa FCPA, accountant general of Malaysia.

The Malaysian Government currently prepares accounts using both cash and accrual reporting.

“The accrual-based financial reporting is presented at the ministries level as a management report to support the official federal government financial statements prepared on a cash basis,” Mustafa says.

“However, from the legal aspect, amendments to the acts related to financial reporting have been implemented and are in the process of being tabled in parliament for approval.”

Mustafa says Malaysia’s journey towards implementing accrual accounting started 10 years ago, when it was placed as one of the agenda items in the Public Sector Transformation Policy measures under the New Economic Model 2011-2020.

To get to where it is now, and to ensure a smooth implementation, Malaysia has taken four main steps – developing standards and policies, reviewing and drafting amendments to laws and regulations, upgrading process and technological capabilities, and developing and empowering human resources through change management initiatives.

Mustafa says various stakeholder engagement activities have been put in place, including getting buy-in and support from relevant authorities and driving change through government departments by emphasising the importance and benefits of switching to accrual accounting.

“Ultimately, the support from relevant authorities and the cooperation from personnel have contributed as success factors in maintaining the momentum during the transition and materialising the implementation of accrual accounting.

“In order to equip personnel with relevant knowledge and skills in accounting systems and accrual accounting, ongoing training sessions are conducted for the people involved.”

Until now, a total of 32 Malaysian Public Sector Accounting Standards (MPSAS) have been developed – primarily from IPSAS – and transformed into accounting policies.

Mustafa says the Malaysian system is being developed as centralised, harmonised, integrated, upgradable and supportive of continuous improvement.

The biggest challenge in implementing accrual accounting in Malaysia to date has been the amendment of legislation and rules pertaining to the financial reporting and accounting system, such as the Financial Procedures Act 1957 and other relevant acts.

“This step is important and necessary, as the current Financial Procedures Act 1957 requires a cash-based financial statement to be presented to parliament,” he says.

“Therefore, relevant amendments to these laws and regulations are made to enable a set of accrual-based financial statements to be tabled in parliament.

 

"The benefits and advantages resulting from the pre-enacted implementation of accrual accounting have been seen significantly at the level of departments, ministries and the Malaysian Government as a whole, especially in the aspects of asset and liability management."

 

“The challenges of developing an accounting system that implements accrual-based transaction processing and reporting, while meeting cash-based reporting requirements based on the current legal framework, are inevitable.”

One such challenge concerns the development and enhancement of both accountants’ and administrative skill sets.

About 1000 government employees from across different ministries have undertaken training sessions on the new Malaysian accounting policies and on how to use the government’s accrual accounting system.

They have then been tasked with training about 73,000 other users throughout Malaysia.

A clearer financial picture in Malaysia

Until amendments to all relevant acts are approved by the Malaysian Parliament, accrual-based financial statements are being categorised as “management reports”.

“These compulsory accrual-based financial statements, which have been prepared at the ministries and federal government levels, have been used as a reference by the government’s top management to obtain an overview of Malaysia’s performance and financial position,” Mustafa says.

“The benefits and advantages resulting from the pre-enacted implementation of accrual accounting have been seen significantly at the level of departments, ministries and the Malaysian Government as a whole, especially in the aspects of asset and liability management.”

Mustafa says additional information available from the accrual accounting system has provided a broader picture of public financial sustainability in Malaysia.

“Fiscal aggregate analysis can be performed from various angles based on the true depiction of government operations, taking into account the liquidity of assets, commitments for current and non-current liabilities as well as the real snapshot of financial performance and position, measured under fair value convention.

“The comprehensiveness of financial reporting under the accrual concept contributes towards better transparency, which produces improved decision-making on public policy planning and resource utilisation, thus supporting the establishment of good governance and excellent public service delivery.”

Bridging the accounting gap

The implementation of accrual accounting by the federal government of Malaysia has bridged the gap between accounting practices in the private sector and the public sector, which, according to Mustafa, has had a positive impact on the marketability of public sector accountants.

Furthermore, the accounting and financial reporting approach under MPSAS, which is similar to the practices under the Malaysia Financial Reporting Standards (MFRS), offers additional value to public sector accountants in providing their services as facilitators to the private sector.

“In fact, public sector accountants have an advantage in terms of a large-scale implementation framework with a variety of forms of transactions that may not be available in the private sector,” Mustafa says.

“Thus, there is no doubt that the implementation of accrual accounting is a very good and strategic step to elevate the accounting profession in the public sector.

“The implementation of accrual accounting has also paved the way for increasing the number of public sector accountants with professional qualifications.”