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

Institute for Public Economics Outline Motivation Cash versus accrual accounting Pros and cons of accrual Accounting regimes and fiscal rules Prerequisites for adoption Checklist for policymakers Insert a map of your country. Institute for Public Economics University of Alberta

Institute for Public Economics Motivation Two perspectives Public versus private sector Tale of two finance ministers The goal: good governance Insert a map of your country. Institute for Public Economics University of Alberta

Institute for Public Economics 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 Insert a map of your country. Institute for Public Economics University of Alberta

Institute for Public Economics 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 Insert a map of your country. Institute for Public Economics University of Alberta

Institute for Public Economics Cash versus Accrual [3] Cash Accounting Accrual Accounting Operational requirements Relatively simple Relatively complex Links to traditional budget and revenue systems Relatively strong Relatively weak Coverage Records only transactions that result in cash payments or receipts Records estimated non-cash transactions as well Timing Records only transactions that occur within the accounting period Records the estimated future effects of current transactions and policy changes Audit and control Relatively demanding Insert a map of your country. Institute for Public Economics University of Alberta

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 Insert a map of your country. Institute for Public Economics University of Alberta

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 Insert a map of your country. Institute for Public Economics University of Alberta

Institute for Public Economics 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 Insert a map of your country. Institute for Public Economics University of Alberta

Institute for Public Economics 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 Insert a map of your country. Institute for Public Economics University of Alberta

Institute for Public Economics 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 Insert a map of your country. Institute for Public Economics University of Alberta

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

Institute for Public Economics 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 Insert a map of your country. Institute for Public Economics University of Alberta

Institute for Public Economics 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 Insert a map of your country. Institute for Public Economics University of Alberta

Institute for Public Economics 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 Insert a map of your country. Institute for Public Economics University of Alberta

Institute for Public Economics 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 Insert a map of your country. Institute for Public Economics University of Alberta

Institute for Public Economics 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 Insert a map of your country. Institute for Public Economics University of Alberta

Institute for Public Economics 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 Insert a map of your country. Institute for Public Economics University of Alberta

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 Insert a map of your country. Institute for Public Economics University of Alberta

Policymakers’ Checklist [2] “Perfection is the enemy of the good…” Voltaire Insert a map of your country. Institute for Public Economics University of Alberta