Accrual_Accounting

Accrual accounting There are two forms of accounting typically used in business which are accrual based and cash based. Until relatively recently Australia government accounted primarily on a cash basis and this was justified on the grounds that the government budgetary and control process is an annual, cash based system. Each year, as part of the budgetary cycle, parliament authorizes expenditures of cash and no distinction is made between capital and operating expenditure. As a result, the accounting system was based on cash. This system was called fund accounting and it was designed to enable departmental managers to control departmental expenditures. It shows Australian public sector entities were required to abandon fund accounting and adopt accrual accounting and the shortcomings of fund accounting. According to Jones R and Pendlebury (2000, pg 143), cash based accounting is a major accounting method that recognizes revenues and expenses at the time physical cash is actually received or paid out and it was justified on the grounds that the government budgetary and control process is an annual. Benefits of cash basis of accounting are government budgets & appropriations are cash based. Monitoring of receipts and spending are easier, cash based financial reports are budget compliant, principles underlying the cash basis are easy to understand and easy to explain, compilation of cash based information is easier, operating costs are lower and no need to exercise any judgment in determining the amount of cash flows for the period. However, there also have limitations and shortcomings, which are impact of consumption of stock of net assets held by government is not known, cash accounting focuses solely on the cash flows of the current period, accountability of government for use of its resources becomes difficult, reporting of receipts and payments in great detail may lead to problems in understanding the information, there is no system of reporting of contingent liabilities which may have significant impact on future revenues, and matching of costs and benefits is not possible (SAKURAUCHI Fumiki, 2002). Moreover information on assets and liabilities is not available. According to SAKURAUCHI Fumiki (2002), Cash, a key measurement in the cash basis accounting, represents just one item of assets and liabilities. Lacking information on other stock such as fixed assets and long-term debts, the cash basis accounting does not provide hints as to the potential impact and burdens that the ongoing fiscal management might bring in the future. When we look at Australia's fiscal conditions today, we can see that roughly 40 percent of the national revenue comes from the issuance of government bonds. Given this circumstance, it has become extremely important to properly manage assets and liabilities on a stock basis and achieve better balance in intergeneration burden sharing. This is why the accrual basis accounting and the disclosure of outstanding assets and liabilities on a balance sheet have become a necessity in the public sector accounting. Now, in Australia, all Commonwealth Government and State government departments are adopted to be reporting on an accrual basis and many other countries also change to an accrual accounting. According to the definition of the accruals by SSAP 2 is as follows: Revenue and costs are accrued, matched with one another so far as their relationship can be established or justifiably assumed and dealt with in the profit and loss account of the period to which they relate; provided that where the accruals concept is inconsistent with the prudence concept, the latter prevails. Funnell W and Cooper K (1998 pg 129), the difference between accrual basis accounting and cash basis accounting is when revenues and expenses are recorded. In cash basis accounting, revenues are recorded when cash is actually received and expenses are recorded when they are actually paid (no matter when they were actually invoiced). Moreover, accrual basis is more detailed which shows how a government financed its activities and met its cash requirements, allows users to evaluate a government’s ongoing ability to finance its activities and to meet its liabilities and commitments and provides a government with the opportunity to demonstrate successful management of its resources. It also useful in evaluating a government’s performance in terms of its service costs, efficiency and accomplishments. On an accrual basis, the information contained in reports prepared is useful both for accountability and decision-making. Financial reports prepared on an accrual basis allow users to assess the accountability for all resources the entity controls and the deployment of those resources and the performance, financial position and cash flows of the entity, and make decisions about providing resources to, or doing business with the entity. It requires organizations to maintain complete records of assets and liabilities. It facilitates better management of assets, including better maintenance, more appropriate replacement policies, identification and disposal of surplus assets, and better management of risks such as loss due to theft or damage. The identification of assets and the recognition of depreciation help managers to understand the impact of using fixed assets in the delivery of services, and encourage managers to consider alternative ways of managing costs and delivering services. In additional, accrual accounting provides a consistent framework for the identification of existing liabilities, and potential or contingent liabilities. The recognition of obligations meeting the definition of a liability and the criteria for recognition which compels governments to acknowledge and plan for the payment of all recognized liabilities, not just borrowings; provides information on the impact of existing liabilities on future resources. Also it means that it is possible to allocate responsibility for the management of all liabilities and provides necessary input for governments to assess whether they can continue to provide current services and the extent to which they can afford new programs and services (Funnell W and Cooper K 1998, pg132). According to Jones R and Pendlebury (2000 pg 148), accrual accounting highlights the impact of financing decisions on net assets/equity and may lead governments to take a longer term view when making financing decisions than is generally possible when relying on cash or modified cash reports. Information on net assets/equity also means that governments may be held accountable for the financial impact of their decisions on both current and future net assets/equity. Changes in an entity's net assets/equity between two reporting dates reflect the increase or decrease in its wealth during the period, under the particular measurement principles adopted and disclosed in the financial statements. Under the accrual basis of accounting, the financial statements will include a Statement of Financial Position which discloses information about assets and liabilities. Where assets and liabilities are not equal, a residual figure for net assets/equity will be reported. Where this figure is positive it can be interpreted as the net resources that may be applied for the provision of goods or services in the future, and therefore the community's investment in the reporting entity. Where the figure is negative, it may be viewed as the amount of future taxation or other revenues which are already committed to paying off debt and other liabilities. Net assets/equity can comprise some or all of the following components that contributed capital, accumulated surpluses and deficits, and reserves (for example revaluation reserve; foreign currency translation reserve) (SAKURAUCHI Fumiki, 2002). Moreover, Governments need information about expenses in order to assess their revenue requirements, the sustainability of existing programs, and the likely cost of proposed activities and services. Accrual accounting provides governments with information on the full costs of their activities so that they can consider the cost consequences of particular policy objectives and the cost of alternative mechanisms for meeting these objectives and decide whether user fees should cover the costs associated with a service; and allocate responsibility for managing particular costs. In conclusion, all Commonwealth Government and State government departments are adopted to be reporting on an accrual basis in Australia and many other countries also change to an accrual accounting. There are actually only a couple of benefits from using the cash based accounting and has more shortcomings. The accrual based accounting provides the government with better perspective of management performance and results. It is how the government measures up against private sector businesses and will hopefully produce better management and efficiency from the public sector of the business. Reference Funnell W and Cooper K (1998) Public sector accounting and accountability in Australia UNSW Press, Sydney, pp. 117-149. Jones R and Pendlebury (2000) Public sector accounting 5th edition, Pearson Education, Essex, chapter 8. SAKURAUCHI Fumiki, (2002), RIETI: Public sector Accounting System and public Governance, viewed 19.12.10, http://www.rieti.go.jp/jp/papers/journal/0207/rr01.html.