Government Accounting: An Assessment of Theory, Purposes ...

Government Accounting: AnAssessment of Theory, Purposesand StandardsJames L. Chan

Government accounting and financial reporting aims to protect and managepublic money and discharge accountability. These purposes, and the nature ofpublic goods and tax financing, give rise to differences with commercialaccounting. This is not yet reflected either in government accounting standards inEnglish-speaking developed nations or in international public sector accountingstandards. All of these are heavily influenced by private sector practices, whichfavour the accrual basis and consolidated reporting. This article argues for agradual symmetric approach to accruals and a combination of government-wideand fund reporting. The author also proposes some broad accounting principlesto promote political and economic accountability.

At the international level, government accountinghas attracted considerable attention for severalreasons:

•The scale and functions of moderngovernments, in both relative and absoluteterms (World Bank, 1997). More moneyrequires more financial accounting. Managingwith less money necessitates a different kindof accounting—cost accounting—forimproving efficiency and economy.

•Accounting is regarded as a weapon againstfraud and waste in government. Donor nationsand international organizations have realizedthe value of accounting in maintaining soundfinancial systems. Without reliable accountingnumbers, they do not know where the moneywent, let alone how well it was spent.

•The accounting profession has discovered thepotential for extending its skills and services tothe public sector.

•English-speaking developed nations havecoalesced to champion a new kind ofgovernment accounting.

•Two global networks—ComparativeInternational Government AccountingResearch (CIGAR) and the InternationalPublic Management Network (IPMN)—havecreated visible forums for lively exchangeamong academics and practitioners acrossborders and in cyberspace.

From Accountability to AccountingThe global rise of government accounting is

fundamentally due to the greater demand foraccountability in a democracy and marketeconomy. Democratic governance and markettransactions require and foster the norm ofreciprocity—the expectation of exchange ofbenefits of comparable value—upon whichaccountability is based. Accounting informationcan be used to monitor and enforce the termsof economic, social and political contracts. Whena government engages in market transactions—whether buying or selling services, lending orborrowing money—it is subject to economicaccountability. When it levies taxes to financepublic services, it incurs political accountability.

The development of governmentaccounting is related to the constitutional formof government that provides for separation ofpowers, and checks and balances among thelegislative, executive, and judicial branches ofgovernment (Chan and Rubin, 1987). While allgovernments engage in some degree ofplanning and control, only democraticgovernments are mandated to open theirbooks—directly to auditors and indirectly tothe public through financial reports. Fiscaltransparency is therefore an attribute of limitedgovernment, for to give out information is tocede authority. Government officials rationallydo not volunteer more information than isrequired or in their interest. It is therefore notsurprising that, while some accounting is doneon a voluntary basis, financial disclosure isoften made only in response to demand.

The regulatory structure for government

James Chan isProfessor ofAccounting at theUniversity of Illinoiat Chicago andConsulting Professoat ShanghaiUniversity ofFinance andEconomics andXiamen University.He is an activemember of thecomparativeinternationalgovernmentaccounting research(CIGAR) network,and foundedResearch inGovernmental andNonprofitAccounting.

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financial disclosure mirrors the pattern ofaccountability in government and the politicalsystem. In an administrative hierarchy, thesuperior holds subordinates accountable andrequires feedback information on theirperformance. A legislature monitors theconduct of the executive branch, for example,in executing the approved budget.Furthermore, a government has the incentiveto disclose information in order to induce othersto provide resources to it. These includepotential buyers of government securities;vendors of goods and services on credit; andgrantors of financial aid. In these voluntaryexchanges, information is used to predict agovernment's ability to carry out the terms ofcontracts, .\fter the transactions are made,accounting information is used to monitorcontractual performance. Governments are lessinclined to disclose financial information tothose without leverage over it, at least in theshort-term, such as individual taxpayers. It ishere that mandatory standards seek to increasethe information access of those who are leastable to demand it, or to enforce their right toknow.

The exercise of accountability requiresinstitutions in both senses of the term: namely,organizations; and rules of the game (WorldBank, 2002, p. 4). In government accounting,these refer to standard-setting bodies and thestandards they promulgate. These institutionsof government accounting in individualcountries are extensively documented in theCIGAR literature and will not be covered inthis article. It is, how ever, important to describethe general purposes of governmentaccounting, in order to contrast it withcommercial accounting.

Purposes of Government AccountingGovernment accounting has three purposes.Its basic purpose is to safeguard the publictreasury by preventing and detectingcorruption and graft. Corruption ingovernment exists in various forms, and isnurtured by incentives (Rose-Ackerman, 1978).This is an acute problem in poor, developingcountries, but corruption is not limited to them(Rose-Ackerman. 1999). Giting a recent reportby the International Monetary Fund (IMF)and the International Development Association,Thomas (2001, p. 38) observed that heavilyindebted, poor countries 'lack the practicesand procedures necessary for budgeting,monitoring, and reporting on the use of publicresources'. While it is tempting to linkcorruption with dictatorship, corruption can

also occur in a democracy, despite the checksand balances built into the machinery ofgovernment to thwart and expose fiscalmisconduct. For example, more than a centuryafter its Declaration of Independence, theUnited States still needed a municipal reformmovement to emphasize basic financial record-keeping to fight corruption in localgovernments (Ghan, 2001).

The intermediate purpose of governmentaccounting is to facilitate sound financialmanagement. Financial management includesactivities such as collecting taxes and otherrevenues, paying bills, borrow ing and repayingdebts. In a well-run government, these activitiesare budgeted or otherwise planned. Theirexecution through duly authorized transactionsis recorded in the financial accounting system.Reformers want governments to operate in aneconomical, efficient and effective manner. Inthat case, governments will also need amanagement or cost accounting system to findout the cost—or better still, the least cost—ofproviding government services. Almost 50) earsago, Herbert Simon and his associatescounselled corporate controllers to go beyondtheir score-keeping function to directmanagement's attention to problem areas andhelp solve problems (Simon et al., 1954). 1 haiadvice may well apply to governmentaccountants, who face competition from otherprofessionals eager to provide information andfinancial services to government.

The advanced purpose of governmentaccounting is to help government discharge itspublic accountability. Public accotuitabilityexists in three levels of principal-agentrelationship: accountability of the btireaucrac}to the chief executive, of the exectitive to thelegislature, and of the government to the people.This purpose can be better achieved 1)\increasing the agent's incentive to disclose andby lowering the principal's information costs.Downs (1957) has cautioned that it is rationalfor voters to be ignorant because of the highcost of becoming informed.

The purposes of government accountingare labelled as 'basic', 'intermediate' and'advanced' to convey the order of priorities inbuilding the full capacity of a governmentaccounting system. Such a system is differentfrom commercial accounting in somefundamental respects.

Government versus Commercial AccountingBusiness accounting has often been used as abenchmark for evaluating governmentaccounting. Two hundred years ago, Thomas

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Jefferson (quoted by Arthur Andersen, 1986)wished to see *the finance of the Union as clearand intelligible as a merchant's books, so thatevery member of Congress, and every man ofany mind in the Union, should be able tocomprehend them to investigate abuses, andconsequently to control them'. Is it possiblethat government and business accounting arefundamentally alike in unimportant respects—as public and private management are (Allison,1980)? What are the important respects that setgovernment accounting apart from its businesscounterpart?

In order to serve the three identifiedpurposes, financial accounting andmanagement accounting cannot be so neatlycompartmentalized in the public sector, wheremanagement accounting refers to budgetingand control, rather than accounting solely inthe service of managers. The budget is anexpression of public policy and politicalpreferences. It is an instrument of fiscal policyon revenue and spending to achievemacroeconomic objectives. It providesbenchmarks for performance measured partlyby the accounting system. Given their closerelationship, it is often difficult to tell wherebudgeting ends and accounting begins. Theyreinforce each other in demonstrating anddischarging fiscal accountability to thegovernment's stakeholders, who are morenumerous and diverse than the owners of afirm. Indeed, governments do not have owners.

The absence of ownership in governmentmakes it problematic to apply the accountingequation (assets = liabilities + owners' equity)and its corollary (profit = revenues-expenses)to the public sector. An exception may be localgovernments. These are municipalcorporations chartered by the state to performcertain public services, which in many cases areprivate goods (for example water) or only quasi-public goods (for example elementaryeducation). These entities have clear origins,and own identifiable assets and liabilities.

Unfortunately, the assets and liabilities ofthe national government of a sovereign stateare difficult to identify and harder still tomeasure in financial terms. With regard toassets, except in rare instances (such as theUnited States' purchase of Louisiana fromFrance, or Alaska from Russia), few nationsacquire new territories through buy-and-selltransactions. Most occupy their ancestral landsand some acquired their territories throughmilitary conquests or colonization. Historicalcosts, even if data are available, are notmeaningful, yet market prices, even ifjustifiable.

are hard to come by. The same problems arisein the case of natural resources and heritageassets. On the liability side, it is not easy to drawthe line between a national government'scontractual or legal obligations and its politicalcommitments and social responsibilities for thegeneral welfare. In contrast to corporations'limited liabilities, governments in a democracyare prone to expand their responsibilities,resulting in larger budgets and frequent deficits(Buchanan and Wagner, 1977).

Accounting principles allow a business,whether private or state-owned, to recognizerevenues only to the extent of goods or servicesprovided. Governments uniquely providepublic goods and finance them throughtaxation. Public goods are consumedcollectively, and non-payers cannot beexcluded—hence requiring tax financing.These characteristics sever the link betweenservice delivery and revenue recognition,making it impossible to match revenues andexpenses (Sunder, 1997). This accountingproblem is also exacerbated by the involuntarynature of many transactions betweengovernment and people. The government'soperating statement tracks resource flows, andonly incidentally measures the government'sservice efforts and accomplishments.

These unique characteristics of governmentare the primary source of the differencesbetween government and commercialaccounting. These differences, argues Sunder(1997, p. 198), 'do not constitute prima facieevidence that the former are defective andshould be altered to conform to the latter'.More specifically, Nobes (1988, p. 198)challenged the assertion that 'Anglo-Saxoncommercial accounting involving accruals-based annual financial statements is necessaryfor accountability, control and decision-makingrelating to government'.

From the research perspective, theoriesunderlying government accounting standardsare mostly normative, in contrast to thedevelopment of positive theory in (business)financial accounting. The latter (Watts, 1977;Watts and Zimmerman, 1978, 1990) draws itsinspiration from the contract-cost theory of thefirm originating from Coase (1937). A similarincipient conceptual revolution startedtentatively with Zimmerman's (1977) paperlinking government financial reporting topolitical incentives. It is time to resume thesearch for a positive theory of governmentaccounting standards. One way would be tobuild on the work of Chester Barnard andHerbert Simon.

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At about the same time Goase wrote hisfamous paper explaining the existence of thefirm in terms of transaction costs, Barnard(1938) identified the functions of the executiveas securing the co-operation of the stakeholdersof an organization. Barnard's work is currentlyenjoying a revival, primarily through the effortsof Oliver Williamson (1990). Much earlier,Simon (1945) applied Barnard's insight togovernment in his hook Administrative Behavior.In Simon's view, an organization is inequilibrium if Barnard's executive succeeds insecuring the contributions of stakeholders byoffering them adequate inducements to stay inthe organizational coalition. A business can beviewed in the same way (Gohen and Gyert,1965). In both types of organization, thechallenge for managers is to negotiatesatisfactory terms of contracts to keep thecoalition intact. In such a theory, owners areimportant as contributors of equity capital, butthey are not the only group managers try toplease. In other words, the owner-centredtheory of the firm and the single-principalagency theory are a special case of the Barnard-Simon organization theory.

This theory can be used to identify potentialusers of government's financial information bypostulating that they use the information topredict their inducements from government(Ghan, 1981). Recently, Sunder (1997) appliedcontract-cost theory to explain and justify thedifferences betw-een accounting for governmentand nonprofit organizations and businessaccounting. Much more research is neededbefore the multiple-stakeholder perspectivecan have an impact on standards. In themeantime, government accounting has shiftedcloser to the business (financial) accountingmodel.

Changes for the Better?Among the numerous changes in governmentaccounting in recent years, the emergence ofInternational Public Sector AccountingStandards (IPSASs) stands out as the mostsignificant development (see Sutcliffe, 2003).The initial set of IPSASs, unfortunately, hasrather uncritically emulated the businessaccounting standards set by the InternationalAccounting Standards Board's predecessor(Ghan, 2002). They are detailed technicalprovisions designed by accountants foraccountants, not for public policy-makers whosesupport is critical for their successfulimplementation. Fven so, IPSASs have somesymbolic value. By basing the initial IPSASs onIASG standards, the IPSASs might benefit from

the popular notion that business accounting (atleast before the 2002 Enron/Arthur Andersenscandal) stood for financial discipline andintegrity. Furthermore, the New PublicManagement literature has raised expectationsabout the ability of accounting to makegovernment more efficient (see Olsen et aL,1998, for a review). IPSASs could raise theprestige of government accountants, who areoften regarded more as bureaucrats thancredentialled professionals like certified/chartered accountants. IPSASs might facilitatethe entry of private sector accountants andauditors into the public sector. Perhaps IPSASsmight serve as a catalyst for includinggovernment accounting in the common bodyof knowledge expected of all accountants.Finally, the financial support of internationalorganizations, such as the World Bank and theIMF, constitutes a favourable assessment of theexpected contribution of IPSASs to governmentfinancial accountability.

How ever, it would be naive to exaggerategovernments' propensity to reform theiraccounting systems on the basis of IPSASs. Asovereign nation is likely to zealously guard itsauthority to determine its own governmentaccounting standards. This resistance might beovercome if the introduction of IPSASs weremade a condition for receiving internationalgrants and loans. The enforceability of IPSASswould be higher if it were invoked ininternational agreements or treaties (similar tothe Maastricht Treaty) specifying convergencecriteria for fiscal policy, .\nother way to promoteIPSASs is to link it to membership obligationsto international organizations, such as theUnited Nations, the World Bank, the IMF, theOrganization for Economic Go-operation andDevelopment (OFGD), and the EuropeanUnion. Better still, is for these internationalorganizations to set an example by adoptingthe IPSASs themselves, as the OEGD has done.

Each country's own way of adoptinggovernment accounting standards will affecttheir likelihood of using IPSASs. (Countriesusing independent boards may find it easier toimport IPSASs than those that legislategovernment accounting standards. Unless thereare scandals or financial crises linked to badaccounting or reporting practices, changeswould be slow and infrequent. As Machiavelli(1513, quoted by Rogers, 1983) counselled hisPrince: 'There is nothing more difficult to plan,more doubtful of success, nor more dangerousto manage than the creation of a new order ofthings'. Liider (1992) emphasized the uncertainprospect of adopting government accounting

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innovations and the necessity of overcomingnumerous barriers. As in corporate accountingand financial reporting (Ball, 2001), IPSASsneed infrastructural support in the form of arobust legal system and a culture ofaccountability. Rigorous accounting standardsmay run counter to the interests of agovernment. The support of the institutionsthat hold resources of value to governments—the international lenders, donors, bond-ratingagencies—may prove to be indispensable.

I PSASs and the latest accounting standardsin English-speaking developed nations havetwo things in common: they all favour theaccrual basis of accounting and government-wide financial presentation. Are these changesfor the better?

Accrual Basis of AccountingThe case for the accrual basis in business(including state-owned enterprise) accountingis strong: no revenue (and therefore no profit)can be recognized in the accounts and reportedin the income statement until the firm hasprovided goods and services. Since what setsgovernment apart from business is the taxfinancing for the production of public goods,this 'operating statement' rationale for accrualsin the public sector is not particularly persuasive.The principal argument for accruals lies in thebalance sheet.

Covernments hold cash or its equivalents,short-term and long-term financial assets (forexample taxes receivable), and a variety ofcapital assets (for example office buildings andequipment, military equipment, culturalartifacts, infrastructure and natural resources).They also owe short-term debts (for examplewages payable) and long-term obligations (forexample bonds payable, employee pensionspayable), and possibly payments under socialinsurance and welfare programs. Given thesearrays of potential assets and liabilities, agovernment has choices to make. It could optfor:

•'Mild' accruals to show only short-termfinancial assets and short-term liabilities.

• 'Moderate' accruals to additionally show long-term financial assets and long-term liabilities.

•'Strong' accruals to further bring variouscategories of capital assets onto the balancesheet.

• 'Radical' accruals, which would show legislatedentitlement benefits as liabilities.

From this perspective, the real issue is,therefore, not whether to accrue, but how far

down the above list to admit items onto thebalance sheet (Chan, 1999). A gradualsymmetric approach to accruals is preferable.Accrual accounting should proceed graduallybecause stronger forms of accrual are morerisky. They create more measurementproblems, have less theoretical support, andare more subjective. Few accountants wouldargue against mild and moderate forms ofaccrual. But consensus begins to break downwith capital assets, and radical accrual hardlyhas any support. Symmetrical accruals meansaligning assets and liabilities of similar natureand maturity. This would avoid distortion andmanipulation (for example recognize moreassets and less liabilities).

When a government's budget is expressedon the cash basis, the accrual bases of accountingadd value to a government's financialdisclosures. They provide more reliablemeasures of a government's solvency positionover a longer time horizon, and force thedisclosure ofthe amounts of unfunded liabilities,such as public employee retirement pensionand other benefits. Accrual accounting couldtherefore trigger debates on intergenerationalequity, the idea that each generation shouldshoulder its own financial burden for theservices it receives.

Government-Wide ReportingThe main attraction of government-widefinancial reporting is that it might reduce theinformation analysis and evaluation costs ofusers. Over 40 years ago. Downs (1957) warnedthat high information costs would discouragevoters from obtaining more and complexinformation about government. Voters arerationally ignorant after weighing the marginalbenefits and marginal costs of informationsearch, in a manner similar to consumers'behaviour (Stigler, 1961). By reducing thevolume of information, government-widereports could become more accessible to thegeneral public. There are a few other benefits:

•Properly constructed government-widefinancial statements show the span ofaccountability in government. For example,no matter how large or complex the USFederal Government is, ultimately theCongress and the President are responsible.No matter what and how many special entitiesare created—some in order to circumventconstitutional or statutory debt limitations—the line of authority is traceable to the highestauthority in the government structure.Government-wide financial statements could

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therefore deter the evasion of accountability.•The data collection, analysis and

summarization necessary to produce thosereports has the salutary effect of forcing thegovernment to improve the quality of data.For example, it took the United StatesGovernment at least 15 years to develop theoperational mechanism for consolidatinghundreds of accounts and scores ofdepartments. Only after departmentslearned to produce their own consolidatedfinancial statements could the US Treasuryconstruct the first audited government-widefinancial statements (U S General AccountingOffice, 1998).

•(x)nsolidated financial statements match agovernment's unified budget, givinggovernment a more effective feedbackmechanism.

The cost-reduction argument, in my view,is outweighed by the inability of government-wide reports to serve the financial integrity andfinancial management purposes mentionedearlier. Therefore I favour the more discerningapproach of the Governmental AccountingStandards Board (GASB) in the United States(Chan, 2001). In the GASB's reporting modelfor state and local governments, thegovernment-wide financial statements areaugmented by those of funds—entities createdfor resource allocation and stewardshippurposes. The government-wide financialstatements include not only the governmentitself, but also, in a separate column, legalentities for which it is accountable. Furthermore,governmental (that is, unique to government)and business-type activities are shownseparately. The GASB approach is superiorbecause users can choose the level of detail tomatch their needs and information-processingcapability.

As this analysis of accruals and reportingformat shows, accounting standard-settingrequires the evaluation of options in terms ofcosts and benefits. Further research is neededto gauge the amounts and pinpoint theincidence of costs and benefits—preferably inquantitative terms—to the government and itsstakeholders.

Summary and ProposalsOver the past 25 years, there have been somenotable institutional and conceptual innovationsin government accounting, contributing to itsgreater visibility and influence. Its emphasishas shifted from bureaucratic control toaccountability reporting to the public. In some

countries, government accounting standardsare no longer set by government officials, butby relatively independent boards. Whileacknowledging the importance of cash—thelifeblood in government as in business—contemporary accounting standards aim attracking the long-term consequences ofdecisions and actions. Government officials areheld accountable for their stewardship of bothfinancial and capital assets. Finally, it is notenough to keep the books accurately; the bookshave to be open to the public. When the publicdoes not have the time or ability to inspect theaccounts, governments have to make the taskeasier by preparing comprehensible—as wellas comprehensive—financial statements.

Many challenges remain, especially at theglobal and international level. A major issue isthe proper balance between internationalnorms and domestic practices arising fromnational political ideology, economic systemand culture. As a mechanism of governance,government accounting is subject to politicalforces that distribute power, and economicforces that determine the supply of and demandfor resources. Therefore, unless accountingstandards boards ally themselves with theinstitutions that can withhold something ofvalue to a government—a grant, a loan, anunqualified audit opinion, a favourable bondrating—their pronouncements would remainineffectual. Unfortunately, at the internationallevel, there are relatively few levers available toa body such as the IFAC Public SectorCommittee to enforce its standards. However,accountants could make the case that fiscalaccountability is an international normapplicable to all governments regardless oftheir political and economic system.

Once this transcendent value of fiscalaccountability is embraced, it is a technicalmatter to work out the means ofimplementation. These include not only year-end financial statements—the current focus ofIPSASs—but also budgets, internal controlsand external audits. 1 urge the IFAC PublicSector Committee to rectify its neglect of thebudget and to include 'actual versus budget'comparisons in financial statements.Furthermore, putting aside differences ofopinions on accounting choices, the entire bodyof detailed standards should be framed by a setof broader principles aimed at promotinggovernment fiscal accountability, such as:

•The objectives of government accounting areto safeguard the public treasury andpr()pert\, to accurately measure and

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communicate the government's fmancialcondition so as to demonstrate financialaccountability, and to facilitate decision-making.

•Agovernment should prepare and publish itsbudgets, maintain complete financialrecords, provide full financial disclosure,and subject itself to independent audits.

•The form and content of financial reportsshould be guided by the rights and need toknow of intended users.

•The accounting system should measure thecash and other financial consequences ofpast transactions and events, including, butnot limited to, budget execution.

•The accounting system should be capable ofkeeping track of the levels and changes inassets, liabilities, revenues and expendituresor expenses, relative to budgeted amounts.

These principles do not prescribe accountingchoices. Rather, they provide a foundation fordeliberating and setting governmentaccounting standards. •

AcknowledgementsI thank this issue's guest editor, David Heald,and a referee for their comments, and JessamineGhan for making the article more clear andreadable.

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PMPA Publications

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