Why Governments Should Use the Government Finance Statistics Accounting System

ALLAN BARTON

Why Governments Should Usethe Government Finance Statistics

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In May 2008, the Australian government presented its budget to parliamentsolely in terms of the IMF Government Finance Statistics (GFS) account-ing system; and in December 2008 it announced that all outcome financialstatements were also to be GFS based.

These two decisions brought to an end a long and arduous controversyover the use of accrual accounting by governments in Australia since theiradoption the early 1990s. Initially, the Australian Accounting Standards(AAS) business-based system was adopted, with a few modest extensionscovering the public sector. However, there was much controversy over thedisplacement of cash accounting and budgeting systems by accrualaccounting; and secondly whether the AAS system was appropriate for thepublic sector.

In May 1999, the Australian government introduced accrual budgeting inplace of cash budgets. However two sets of accrual budgets were presentedto parliament—an AAS-based one and a GFS-based one. The two budgetspresented substantially different results, causing endless confusion in par-liament. Furthermore, departments and the whole of government contin-ued to present only AAS outcome financial statements.

In this paper, the above history is traced out together with the reasonsfor the decisions.The final decision to adopt the GFS system, covering bothcash and accrual accounting systems, is explained in terms of the roles andoperating environments of governments. These determine the financialinformation needs of government, and they are shown to be fundamentallydifferent from those of business. Finally, the structure and concepts used inthe GFS system are explained.

Key words: Cash and accrual accounting systems; Government FinanceStatistics accounting system; Roles of governments.

The adoption of accrual accounting by Australian governments during the 1990s wasone of the most important reforms made under the extensive new public manage-ment reform programs here and in many advanced nations (Hood, 1995). But muchcontroversy has accompanied its adoption. While accounting professional bodiesand firms supported its adoption, many academics challenged its adoption, both as amatter of principle or on account of particular requirements of the system adopted.

Allan Barton is an Emeritus Professor in the College of Business and Economics at the AustralianNational University in Canberra and an Honorary Professor of Accounting at the University of Sydney.

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Invariably the accounting standard bodies prescribed adoption of the existing stan-dards by the public sector, with some minor modifications, as occurred in Australia.

The Commonwealth Government of Australia decided to adopt accrual account-ing (AA) in 1992, and all departments had installed it by 1994 and the first draftconsolidated financial statements were prepared in 1995. During this period, theonly standards available were the Australian Accounting Standards Board (AASB)standards.1 In 1996, three new standards designed for the public sector werepromulgated—AAS 27, 29 and 31, covering local governments, government depart-ments and the whole of government. However, the standards were adopted only foroutcome financial reporting; all budgets were still based on cash accounting. In May1999, the Commonwealth Government presented its budget on an accrual basis inorder that the outcome results could be readily compared with their respectivebudgets, and discontinued its cash budgeting system. However, two sets of budgetpapers were presented to parliament—an accrual budget based on AAS, andanother one based on a newly upgraded Government Finance Statistics (GFS)system incorporating accrual accounting. The government’s Charter of BudgetHonesty Act (1998) prescribed that only official external accounting standardsshould be used and there were now two such sets of standards.The GFS system is anInternational Monetary Fund (IMF) system used extensively around the world fornational income measurement and for fiscal policy purposes. Prior to its upgradeincorporating accrual measurements in the late 1990s, it was a cash-based system.

However, each set of budgets reported substantially different figures for mostitems, leading to much confusion in parliament.Which set of budget figures were thecorrect ones, and which budget did the cash appropriation bills relate to? As well,both sets of accrual budgets were presented with their cash counterparts, adding tothe confusion. This state of confusion persisted until a new Labor government, withlittle warning, scrapped the AAS budgets in May 2008 and presented only the GFSaccrual budgets together with their cash counterparts.

Furthermore, another cause of confusion existed in the budget and accountingsystems—departments only used the AAS system for their budget and financialreporting to parliament. In December 2008, the government made the decision todiscontinue use of the AAS system for their outcome financial statements, and to useonly the GFS cash and accrual system. The changeover is still underway. Australia isthe first nation in the world to use the GFS cash and accrual accounting system forboth its budgeting and outcome financial reporting.

The above history sets the background to this paper. The explanations and analy-sis are confined to the Commonwealth Government of Australia, and within it, to thegeneral government sector (GGS). Thus it is confined to the budget sector of thegovernment which is directly controlled by parliament. The GGS excludes publicfinancial corporations such as the Reserve Bank of Australia and public non-financial corporations such as Australia Post.All the other government corporationsare fairly small and their results are scarcely material in the whole of governmentfinancial statements. Furthermore, all state governments are now required to use the

1 AAS became equivalent to IFRS on 1 January 2005.

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GFS system and the analysis here can also be applied to them with appropriatemodification for the different activities they undertake.

Before examining why governments should use the GFS accounting system, somefurther background information is covered to assist readers to understand the manyissues involved in the final adoption of the GFS system. These topics comprise:

1. the nature and purpose of accounting as a financial management information andreporting system (FMIRS) which reports required information to stakeholderusers;

2. the nature, purpose and functions of governments as compared with those ofbusiness; and

3. fundamental differences between the two sectors.

The GFS system is then outlined and its relevance for public sector use demon-strated. Some concluding comments complete the paper.

ACCOUNTING AS A FINANCIAL MANAGEMENT INFORMATION ANDREPORTING SYSTEM (FMIRS)

The purpose of an accounting system is to provide financial information on anentity’s activities, resources and performance as required by stakeholder users. Itshould be a useful FMIRS. To achieve this objective, accounting concepts, standardsand processes must be designed to report the financial information needed by usersto enable them to perform their functions. To be useful, the information must berelevant, reliable, comparable and understandable by users (AASB Framework, July2005). Only when these conditions are satisfied can the FMIRS provide financialstatements to stakeholders which faithfully represent what they purport to representand hence provide a ‘true and fair view’ of the entity’s financial performance andposition. The AAS and GFS systems are appraised on the basis of these criteria.

THE NATURE, PURPOSE AND FUNCTIONS OF GOVERNMENT

Governments are elected by citizens to manage the affairs of the nation as a whole toprovide those goods and services which cannot readily be provided by private firms.They act as the agents of citizens and are accountable to them for their actions andperformance. U.S. President Abraham Lincoln (1863, p. 282) recognized the impor-tant roles of governments many years ago when he observed:‘The legitimate object ofgovernment is to do for a community of people whatever they need to have done, butcannot do at all, or cannot do so well, for themselves in their individual capacities’.

Nowadays a widely accepted prescription for the roles of government in a moderndemocratic nation is ‘the provision of public services that are mainly non-market innature, and for the collective consumption of the community, or involve the transferor redistribution of income. The services are largely funded through taxation andother compulsory levies’ (Commonwealth of Australia, Budget Paper No. 1, 2009–10,p. 9.13, adapted from IMF, 2001, para. 1.2).

W H Y G OV E R N M E N T S S H O U L D U S E T H E G F S AC C O U N T I N G S YS T E M



Functions of GovernmentsUndertaking these responsibilities requires:

1. provision of public goods and services to the community,2. provision of social welfare services to the community, and3. raising taxation revenues to fund the above services.

In undertaking these duties, governments aim to formulate their policies in such away as to achieve:

4. stable economic growth to ensure high levels of employment, productivity growthand rising real incomes, and low inflation rates, referred to as macroeconomicmanagement policies;

5. an acceptable distribution of income and wealth across the nation’s citizens andthe avoidance of poverty;

6. maintenance of intergenerational equity by ensuring that each generation fundsthe public and social welfare services that it receives and does not bequeath debtsto future generations;

7. protection, conservation and enhancement of the nation’s natural environment;and

8. protection, conservation and promotion of the nation’s cultural facilities.

The implementation and funding for these policies is undertaken in governmentbudgets, and are referred to as fiscal policies.

9. Efficient management of government resources.

The nature of these functions is explained below:

1. Provision of public goods and services to the community Typical examples ofthese goods and services include the nation’s systems of law, order and regulation,foreign affairs policies, defence services, public roads, recreational facilities such asparklands and sports grounds, cultural facilities such as art galleries and museums,environmental protection, and so on. They also include public schools and hospitals,preschool and aged-care facilities.With a few partial exceptions, private firms cannotprovide these services to the community as they do not have the legal powers to doso or they are cost prohibitive. As explained below, most public goods and servicesrequire substantial investment in their facilities which causes fixed costs to be high,whereas the direct marginal costs of providing additional services to users are oftennegligible or zero.As well, for some of the services, such as use of public roads, thereis a ‘free-rider’ problem. Unless the government reclassifies the road as a toll road(which is only practical for major highways), the owner cannot enforce payment andusers can therefore easily avoid it.

The underlying difficulty with private provision of public goods and services is thatthey are characterized by non-rival and non-excludable use characteristics (Stiglitz,2000).These conditions require that they be provided on a collective basis to citizens,and funded likewise from taxation. The concept of public goods is a technical eco-nomics term which also includes services. They are also referred to as community

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goods. The use of public goods is non-rival, as one citizen’s use of them does notprevent other citizens from using or benefiting from them.Their use by any one citizenis non-excludable, as no one can prevent others from using them. Public goods areprovided to the community generally—they are open to all citizens to use or benefitfrom them, and they share in their use. Citizens have no property rights to them.

Public goods are referred to as pure ones when the above conditions fully apply.However, for a few public goods where exclusion is possible, such as for publicschools and hospitals, all citizens may not have access to them when capacity con-straints occur. In such cases, a rationing mechanism such as waiting lists isrequired. Alternatively, residents can access private schools and hospitals if theycan afford the price, or the government may subsidize their use by citizens, eitherdirectly (as in a Medicare health insurance payment) or through payment of asubsidy to the school or hospital. In these cases, the item is referred to as a mixedpublic/private good.

Hence, where goods and services required by citizens have the characteristics ofnon-rival and non-excludable use, it is more efficient and effective for governmentsto provide them on a collective, shared-use basis, and likewise for citizens to fundthem on this basis through taxation. This is in accordance with Abraham Lincoln’sobservation of 1863. Such goods cannot be provided by business firms because oftheir non-market nature. They can only be provided by the GGS, as indicated in theIMF’s prescription of core government roles.

The nature of public goods and services can also be explained in terms of theeconomic concept of externalities. Externalities occur wherever private costs do notequal social costs (i.e., the total cost incurred by the nation) or conversely whereprivate benefits do not coincide with the total social benefit. Social costs exceedprivate costs for example where private production or use of the good causespollution of the environment. Where this occurs, environmental degradation results.The global warming crisis can be explained in terms of such negative externalities.Alternatively, with respect to differences between the two sets of benefits, anincrease in educational and health standards accruing from private (or mixedpublic–private) provision may enhance the productivity and general welfare of thecommunity. While externalities at the level of individual firms and consumers maynot always be significant, they can have substantial flow-on effects at the nationallevel. Two current examples of major negative externalities causing severe nationaland international problems are the global financial crisis and global warming.

2. Provision of social welfare services to citizens Governments provide a range ofsocial welfare services to disadvantaged citizens for social equity purposes. Commu-nities generally desire to provide assistance to elderly folk in the form of agepensions and health care, unemployed citizens, those needing substantial carebecause of injury or medical reasons, as well as to children in day care centres andpublic schools. There is always a substantial overlap in the provision of educationand health support between the public goods and social welfare reasons. Privatefirms have no obligation to provide social welfare benefits to their staff or the public.This obligation is also covered in the IMF specification of the key roles of the GGS.




3. Taxation policies Governments invariably use a range of taxation methods tofund their activities. These include income taxes on persons, company profits taxes,expenditure taxes, capital gains taxes, and so on. With respect to personal incometaxes, governments generally use progressive income tax policies and capital gainstaxes to restrict the accumulation of excessive wealth by some citizens. This helps toavoid a gross maldistribution of income and wealth in the community as well asproviding taxation revenues used by governments to provide welfare services torelieve poverty.

4. Macroeconomic management policies Free market economies through historyhave undergone cycles of unstable economic growth resulting in booms and reces-sions, and their accompanying substantial unemployment, business bankruptcy andgovernment budget deficits (Garnaut, 2009; Stiglitz, 2010). The current world finan-cial crisis is an example of this. Fiscal policies can play an important role in ensuringstable economic growth with high employment and low inflation, though they mustbe supported by complementary policies concerning monetary supply and interestrates (Reserve Bank responsibilities), exchange rates, tariffs, wages, business com-petition and other economic policies. The great macroeconomist, John MaynardKeynes (1936), analysed the problems of the trade cycle and explained how fiscalpolicies could be developed to minimize the extent of such cycles. In particular theyrequire governments to allocate their budget expenditures to promote stablegrowth, productive employment and business profitability, and use budgets tomanage aggregate demand in the economy and generate surpluses in good economicperiods which can assist in funding budget deficits incurred in recessionary periods.This policy also assists in achieving intergenerational equity.

5. An equitable distribution of income and wealth across the nation’s citizens Whilemeasures of national income per head indicate the level of average income in anation, they are not good measures of overall economic and social welfare wherethere are both some extremely wealthy citizens and large numbers of citizens livingin poverty. Government policies normally aim to improve the overall well-being oftheir communities. Taxation and social welfare policies, together with full employ-ment policies, endeavour to bring about a socially acceptable distribution of incomeand wealth.

Neoclassical economic theory does not examine the distribution of wealth andincome across the nation because it is confined to production theory of goods andservices.

6. Maintenance of intergenerational equity The ageing of the population, slowerrates of economic growth in recent years and mounting government debt levels(though less so in Australia compared with the United States, United Kingdom andthe European Economic Union) have focused long-term budget policy attention onthe need to ensure that budgets over the medium term do not incur deficits. Other-wise government debt accumulates which must in due course be repaid by futuregenerations for services provided to previous generations.The National Commissionof Audit Report (1996) drew the government’s attention to the likely impact of an

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ageing population on future government debt levels unless corrective action wastaken. The government accepted the recommendations and included the need toachieve intergenerational equity in the Charter of Budget Honesty Act (1998). AnIntergenerational Report is currently produced every three years. In Australia, theage dependency ratio of the population, that is, the number of 65 plus year olds to18–64 year olds, is forecast to double from 19% to 39% by the year 2047; that is, thenumber of people in the working age group who can support the elderly will declinefrom 4:1 to 1.5:1 (Intergenerational Report, April 2007). Can the future work forcesupport such a high number of elderly citizens? Policies to reduce this enormousburden on future taxpayers include governments reducing their existing debt levelsthrough generation of net budget surpluses over the longer term, encouragingcitizens to increase their superannuation benefits through higher contributions andtax incentives, and postponing retirement dates.

As well as an ageing population, the non-funding of public servants’ superannua-tion by governments until recently (resulting in substantial government debt),increasing inadequacies in public infrastructure, environmental degradation, andinadequate preservation of the nation’s cultural facilities, impact on future citizens.

7. Environmental protection policies Governments have a major responsibility toprotect the natural environment to avoid its degradation (Barton, 1999b, Stern,2009). Life depends on the whole ecosystem, that is, the natural environment, and itrequires government protection because it can be treated as a ‘free good’ by firmsand people when they incur no charges for its use. While the threat of globalwarming is of the utmost concern at the moment, the problem is a much wider one.Pollution of land, rivers, seas and water catchment areas by industry and people hascaused substantial damage, poor farming practices cause reductions in soil fertilityand erosion, excessive destruction of native forests (particularly tropical rain forests)and so on, together with global warming, have damaging environmental impacts.These include significant reductions in ecological biodiversity and loss of manyspecies of plants, animals and birds; melting of glaciers and icecaps, destruction ofbarrier reefs, and so on. The World Commission on Environment and Development(1987) expressed grave concerns about the damage being caused to the naturalenvironment of planet Earth and recommended adoption of policies to achieveecological sustainability. Recent concerns about increasing greenhouse gases in theatmosphere which are a major cause of global warming and climate volatility havereceived major attention from governments world-wide. Since around 1850, green-house gas concentrations in the atmosphere have grown from 285 parts per million(ppm) to 430 ppm and average global temperatures by around 2 degrees; and climatevolatility (storms and droughts) has increased (Stern, 2009). Many solutions havebeen proposed for carbon pollution reduction schemes to reduce the volume ofcarbon dioxide and other greenhouse gases being dumped into the atmosphere.However, international agreement is still to be achieved.

Environmental degradation is a major negative externality which governmentsshould endeavour to reduce for the benefit of both current and future generations ofcitizens, and for the world at large as many of the issues are global ones. Without




government intervention, firms and people can treat the natural environment as a‘free good’ and recklessly exploit it. Current Australian government policy is toreduce greenhouse gas emissions by 60% by 2050. Environmental managementpolicies can include ‘green’ taxes on carbon pollution and other areas of pollution toraise private costs to their total social cost and use the revenues for remediation;placing caps on emissions and subsidizing development and installation of new cleanfuel technologies such as solar and wind electricity generation in place of coal-firedplants; regulations to stop pollution; restrictions on forest clearing; restrictions onwater consumption; requirements for increased efficiency in building design toreduce power consumption; upgrading public transport facilities in cities to reduceuse of cars and trucks, and so on.

8. Management of the nation’s cultural facilities Preservation and promotion of thenation’s important cultural facilities is another important responsibility of govern-ment (Pallot, 1990; Carnegie and Wolnizer, 1995; Barton, 1999b, 2000). They includepublic art galleries, museums, libraries, symphony orchestras, war memorials, park-lands and gardens, sporting and other recreational facilities which store much of thenation’s heritage. They all produce significant positive externalities through educa-tion, scientific research and improvements in human health. Citizens desire to learnabout the nation’s history and culture and they reap enjoyment from them. Becausethey cannot readily be provided by private firms on account of the high costs incurredand the inability to charge cost-recovery admission charges,they become public goodswhich depend largely on the government for their provision. Free admission stimu-lates public use of the facilities and thereby enhances the nation’s culture.

9. Efficient management of government resources A final responsibility of govern-ments which only came to be emphasized during the extensive public sector reformprograms of the 1980s and 1990s, was recognition of the need to manage all theirown resources (comprising total revenues, total costs, total assets and total liabili-ties), used to provide services to citizens as efficiently and effectively as possible, andnot confine their attention to only cash receipts and expenditures and cash balances.Improved efficiency minimizes government operating costs and releases funds forthe provision of additional services, enhanced budget savings or tax reductions. Italso enhances government accountability to citizens for its performance in under-taking its tasks.

Government Accountability to Parliament and CitizensA final important requirement for governments concerns their accountability toparliament and electors (Funnell and Cooper, 1998; Mulgan, 2000, 2007). Govern-ments are elected by citizens to undertake the above tasks on their behalf. They areagents of citizens. A fundamental legal and political requirement is that governmentpolicies and their implementation must be transparent so that citizens know whattheir governments are doing on their behalf and their financial implications, andsecondly that governments are accountable to citizens for their policies, actions andperformance. Governments must accept responsibility for these matters and areanswerable to citizens in elections. Transparency and accountability are largely

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achieved through all policies and their financial requirements having to be presentedto parliament and approved by it before they can be implemented.Thus with respectto budget matters, the Australian Constitution (1901, ss 81 and 83) require that alltaxation and expenditure policies must be approved by parliament before they canbe implemented. Secondly, all financial outcome statements must be audited andpresented to parliament. Hence all budget statements must be presented to parlia-ment for debate and approval and all cash allocations to departments and agenciesmust first be approved in Appropriation Bills by parliament. Regular ex post budgetreports are presented to parliament throughout the year so that it is kept advised ofprogress to date.

Differences Between Government and Business OperationsAs can be seen from the above explanation of the nature, purpose and functions ofgovernment as compared with those of business, there are many fundamental dif-ferences between the two sectors. While governments are established to act onbehalf of citizens in the provision of public and social welfare goods and servicesfunded from taxation, and in so doing maintain a stable economy with high employ-ment levels and so on, businesses are established to sell private goods and servicesto users who wish to purchase them in the expectation of earning profit. Buyers ownthe goods they purchase and can use and dispose of them as they wish. Firms’operations are funded from owners’ investment, borrowings, and revenues receivedfrom sale of their outputs, and they must earn adequate profits and maintain a soundfinancial position to survive. Thus performance information on revenues, operatingcosts and profits, and on all assets, liabilities and equity is essential for their goodmanagement and for reporting to investors and the capital market. This informationis reported in general purpose income statements, balance sheets and cash flowstatements as per the AAS standards.

While there are parallels in the types of information required for public sectorentities, there are also differences because of basic differences in the purposes servedby each sector and the nature of their operations. Sales revenue and taxationrevenues are fundamentally different in nature; profit differs from the government’soperating budget balance which is not distributable as dividends; the government’sbalance sheet is not a full statement of its financial position as its most valuable asset,namely the power to tax, is not included. These matters are discussed later in thepaper (pp. 423–6).

Furthermore, there are major differences in the accountability requirements ofeach sector. Business operations need to be undertaken on a confidential basisbecause they cannot let competitors know any details about them, and their budgetsand departmental activities and results are confidential, while the accountabilityinformation provided to investors is restricted to the provision of general purposefinancial statements once a year, supplemented by abbreviated quarterly reports.These accountability requirements are only minor when compared with those ofgovernments, as explained above.

Hence, it can be seen from the above explanation of the respective nature androles of government as contrasted with those of business operations that there are




many important differences between them. For a government accounting system tobe a useful FMIRS, it must be designed to take account of these special attributes ofgovernment. Otherwise it cannot provide relevant and reliable information to man-agement, parliament and citizens in the financial statements which faithfully repre-sent what they purport to represent and hence provide a ‘true and fair view’ tostakeholders. If these fundamental differences did not exist, the functions of gov-ernments could be reduced largely to law making and regulation, and most servicescould be provided by business. But most citizens prefer that they be provided bygovernment and pay taxes to fund them.

THE PATHWAY TO ADOPTION OF THE GFS ACCOUNTING SYSTEM

Some HistoryNotwithstanding the above fundamental differences between governments and busi-ness in their objectives, roles and operating environments, the AASB refused torecognize their implications for standard setting for the public sector for many years.Rather, they stayed with their policy of sector-neutral accounting standards underwhich business accounting standards should be used by all sectors of the economy,with only some minor variations to allow for ‘industry differences’. This policy wasapplied to the development of the first three industry standards for the public sector:AAS 27 (1996) covering accounting for local governments, AAS 29 (1996) coveringgovernment departments, and AAS 31 (1996) covering the whole of government.Allthe standards required adoption of accrual accounting based on existing businessaccounting standards. At that time, they were the only ones available. Most govern-ments in Australia had installed accrual accounting systems prior to 1996.The policyof sector-neutral standards was subsequently justified by McGregor (1999) whostated that:

An important feature of the concepts statements developed by the Board is that they areapplicable to financial reporting by all types of reporting entities. That is, no distinction ismade between entities on the basis of . . . sector location (public or private).

The concepts referred to are in the Conceptual Framework comprising SAC 1(1990), SAC 2 (1990), SAC 3 (1990) and SAC 4 (1992). SAC 3 and SAC 4 weresubsequently absorbed into an updated Conceptual Framework (2005) upon theadoption of the International Financial Reporting Standards (IFRS) by Australia in2005.

When accrual budgeting was introduced in 1999 to enable comparability of budgetstatements with their accounting financial statements counterparts, the governmentpresented two set of budget papers to parliament—one based on AAS and the otheron Government Finance Statistics accounting standards. Treasury required the GFSbudgets for fiscal policy uses as they found the AAS budgets did not provide theinformation they required. However, the GFS system was unknown outside Trea-sury, and in particular to the accounting profession. The GFS accounting system,which is explained later in the paper, is an International Monetary Fund (IMF)system designed specifically to provide governments with the financial information

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they require for fiscal policy purposes, as well as for the measurement of nations’gross domestic products (GDPs) and its components.

The presentation of two sets of budgets to parliament led to major confusion, asboth reported significantly different results (Commonwealth of Australia, BudgetPaper No. 1, 1997–2007; Barton, 2007). Questions arose concerning which budgetpresented the ‘true and fair’ results to parliament and should be believed; whichbudget was to be approved by parliament; and so on.These issues caused substantialcontroversy over the ensuing years and the path to their resolution was a long andcontroversial one.

Some academics challenged the application of the business accounting standardsto governments. Walker (1989) began the debate but to no avail. Barton (1999a,2003) and Newberry (2002) resumed it after the publication of McGregor’s (1999)justification for the sector-neutral principle, as did the senior Heads of TreasuryAccounting and Reporting Advisory Committee (HOTARAC) which representedall governments in Australia (Challen and Jeffery, 2003, 2004, 2005).2 The JointCommittee on Public Accounts and Audit (JCPAA) reviewed the matter (ReportNo. 388, June 2002) but was unable to resolve it.3 In December 2002, the FinancialReporting Council (FRC) issued a directive to the Board that it ‘pursue as an urgentpriority the harmonization of . . . GFS and GAAP reporting. The objective shouldbe to achieve an Australian Accounting Standard for a single set of governmentreports’ (Bulletin, December 2002).4 Later, the FRC commissioned Mr K. Simpkinsto examine the case for applying sector-neutral standards to the public sector, and hedid not find a strong case to support it (Report, 2006).5 Next, the Senate Committeeon Finance and Public Administration (SCFPA) examined the provision of two setsof budget papers and recommended that a single system was required (Report,March 2007). While it did not recommend adoption per se of the GFS system, itsrecommendations all favoured it. The AASB had established a Convergence Com-mittee to examine FRB’s ‘urgent’ harmonization directive, and in October 2007 itfinally issued AASB 1049, Whole of Government and General Government SectorFinancial Reporting. While the new standard incorporated many improvements tothe former AAS 29 and 31 standards (which were then withdrawn), it still remainedbased on the AAS Conceptual Framework standards (SAC 1, SAC 2 and the Frame-work, 2005) and retained many limitations for a useful public sector accounting andbudgeting information system. In return, the GFS system was modified to includeAAS treatment of some items.

2 Mr D. Challen was the Head of HOTARAC and Treasury Secretary in Tasmania, and Mr C. J. Jefferywas Director of Finance and Accounting in the Tasmanian government. In addition, HOTARAC madea large number of submissions recommending many changes to the standards to AASB, again withlittle success.

3 The JCPAA is a senior parliamentary committee comprising members of the government and theopposition from both Houses.

4 The FRC is a government-appointed body which determines the broad strategic directions for thesetting of accounting standards by the AASB.

5 Mr Simpkins was a former Deputy Auditor-General of New Zealand.




However, a newly elected government chose to present its first budget for 2008–09in May 2008 based solely according to the GFS system, as slightly modified to includesome AAS treatment of items where they were considered to be preferable. Thisbrought the complex and controversial matter of dual budget reporting to a suddenend and the government has continued to present only GFS budgets since then.

At the same time in early 2008, the new Minister for Finance, Mr L. Tanner,commissioned experienced Senator A. Murray, who was about to retire, to examineand respond to a series of issues listed in his Operation Sunlight paper designed toimprove transparency and accountability in budget reporting. Many of the issuesarose from government departments continuing to use the AAS systems for theiraccounting whereas throughout the government focused attention only on the GFSbudget, and comparability between the budget and outcome statements was lacking.This further accentuated the confusion occurring in parliament. In his response,Senator Murray recommended that all departmental and agency expendituresshould use the same accounting system as used in the budget to enable their align-ment (Operation Sunlight Report, June 2008). The government accepted these rec-ommendations in its December 2008 Response.

Before examining the issues concerning applicability of particular AAS conceptsand objectives to the public sector, a brief summary of the case provided for adop-tion of the sector-neutral standards, as contained in the Simpkins Review (2006), isgiven.

Sector-Neutrality of Accounting StandardsThe major justifications provided by the standards setting authorities in severalcountries for the adoption of sector-neutral accounting standards for the SimpkinsReview (2006) were as follows:

1. Economies in standard setting Only one rather than two sets of standards arerequired, leading to cost savings in standard setting. Likewise only one rather thantwo standard setting boards is required. Early in the adoption of accrual accountingby the public sector, the question was raised by some professional accountants of‘why reinvent the wheel?’ (Christensen. 2003).

While there can be initial cost savings, they will only be maintained in the longterm if the standards are appropriate for their areas of application. Use of inappro-priate standards will result in the presentation of misleading information in theadopting industry and thereby cause inefficiencies to occur. The accounting systemswill not satisfy the framework requirements of relevance, reliability, comparabilityand understandability for a quality information system for the use of managementand stakeholders.

2. Governments use much the same types of assets as in the private sector While thisis true for normal administrative assets and financial assets, many types of physicalassets used in the public sector are not used to any extent in the business sector.These assets include many infrastructure facilities (public roads, water storages, etc.),defence equipment, war memorials, museums, art galleries, community parks andgardens, and so on. Moreover, even where there is similarity in the physical form of

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the assets, the markets where they are employed differ, that is, public versus privatemarkets, and this affects their financial valuations. Consider, for example, how landvalues differ according to zoning regulations even though the land itself is the same.

3. Enhanced comparability in financial reports of the two sectors Comparability canonly occur where like things are compared.Apples must be compared with apples andnot with oranges.The present system is akin to rolling all the fruit into one basket andcalling them apples. But given some fundamental differences between the public andprivate sectors which are ignored by the standards setters, presentation of financialinformation in the same format results in false comparisons being made, and leads toincorrect decision making and performance accountability. Again the accountingsystem will not be providing the useful information required of them.

4. Facilitate transfer of private sector accountants into the public sector to help easestaff shortages A modest amount of retraining is the appropriate solution here,rather than the adoption of sham comparability.

Simpkins (2006, pp. 88, 102) concluded that: ‘the current documents do notprovide a sufficient, nor, in some respects, appropriate basis to underpin sector-neutral accounting standards for the future’, and ‘in my view the needs of users ofpublic sector . . . entities in Australia are not being met to the extent that theyought’. Finally, he stated that ‘the primary test should be which approach is likely tobest meet user needs’.

PROBLEMS WITH THE APPLICATION OF AAS TOTHE PUBLIC SECTOR

The main concern with the application of AAS to the public sector is that they do notsufficiently acknowledge the fundamental differences in the nature, purpose andfunctions of government from those of the business sector, as explained earlier in thepaper. These matters are the primary determinants of the relevance of financialinformation for stakeholder needs. Many of the issues examined below are coveredin the extensive literature in the topic. This includes Barton (1999a, 1999b, 2000,2004, 2005, 2006, 2007, 2009), Carnegie and Wolnizer (1995), Christiansen (2003),Conn (1996), Ellwood and Newberry (2007), Guthrie (1998), Guthrie et al. (2003),Lapsley (1999, 2009), Mulgan (2000, 2007), Newberry (2003), Newberry and Pallot(2005), Walker (1989), Walker et al. (2000), and Wanna (2008).

The major limitations in the AAS Conceptual Framework with respect to thepublic sector all concern matters of relevance. They comprise:

1. Objectives statement The Framework (paras 12–14) states ‘the objectives offinancial reports is to provide information about the financial position, financialperformance and cash flows of an entity that is useful . . . to users in making eco-nomic decisions . . . and to show the accountability of management for the resourcesentrusted to it’. This is appropriate for business because profit generation is theirfundamental objective and they must earn sufficient profit and maintain a solventfinancial position to remain in business. Investors, capital markets and other




external stakeholders require this information primarily for their decision making.However, these are not the objectives of governments because of their serviceprovision roles. Government outcome financial statements should focus on theiraccountability responsibilities to parliament and citizens rather than on providingdecision-useful information for investors (Mulgan, 2000, 2007). The decision makinginformation role is largely fulfilled by the publication and prominence given to theirbudgets, unlike in business where budgets are confidential to the entity. In demo-cratic nations governments must remain accountable to their citizens for their poli-cies and actions. Published financial statements are one of the key mechanisms forinforming citizens of the government’s stewardship of their taxation payments andprovision of services. Accountability is a much more onerous responsibility forgovernments than it is for business entities because of the different nature of theirenvironments and roles. Hence it requires greater emphasis in the objectivesstatement.

2. Operating statements In AAS, operating statements under their varying names(financial performance, profit and loss, and now comprehensive income) summarizethe revenues and expenses/losses of the business and its profit/loss. This informationis required for assessing its financial performance and for dividend distributionpurposes. While government operating statements also report on operating activi-ties, these are significantly different from those of business. Taxes provide mostgovernment revenues rather than sales to customers, and government expensescontain a large share of cash transfer payments to citizens and other governmentsectors (some 66% for the Australian government). The budget balance is not ameasure of profit or loss, but the extent to which government revenues have fundedthe expenses of the period.

3. Balance sheets AAS balance sheets show all the assets, liabilities and equity ofthe business as a means of assessing its financial position and its rate of return oninvestment. Liquidity and solvency are important components of financial position.However, while government balance sheets show their assets and liabilities, and networth in place of equity, they are not necessarily comprehensive statements offinancial position for several reasons. Governments do not have contributed capitalto provide funds for investment in assets; rather, they have a more valuableright—the power to tax—which is not reported on the balance sheet. Secondly,governments only report those assets that can be reliably valued, and this therebyexcludes many resources such as many cultural and environmental items, roads, andcomplex defence equipment for which there are no active markets. Hence a negativenet worth (as currently exists for the Australian government) does not imply bank-ruptcy as it would for a business. Finally, most of the non-financial assets are used toprovide services to the public and not for government revenue generation.

4. Assets AAS defines assets as ‘resources controlled by the entity . . . from whichfuture economic benefits are expected to flow to the entity’ (Framework, para. 49).While this definition is appropriate for business and for the financial assets and somephysical assets of governments, it is not appropriate for most of their non-financial

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assets for three reasons. First, these assets do not generate cash revenues for gov-ernment. Future economic benefits represent future cash inflows; cash is the mediumin which they are received (with a few negotiated exceptions). Rather, they providepublic services to the community such as defence, health, education, public roads andso on. Secondly, the benefits are not received by the government; rather they flow tothe public.While the Framework extends the description of future economic benefitsto include ‘service potential’ (para. 49.1), this attaches an incorrect meaning toeconomic benefits.Thirdly, for reasons about the control concept covered below, it isappropriate to replace ‘control’ by ‘ownership’ for government assets.

5. Equity AAS defines equity as ‘the residual interest in the assets of the entityafter deducting all liabilities’ (para. 49). While this is appropriate for business, it isnot an appropriate concept for governments and is liable to misinterpretation in agovernment balance sheet. Unlike business entities, governments do not need inves-tor owners to fund their assets as they do this from taxation revenues and borrow-ings.The item is better called net worth or net assets, and is useful information in thiscontext. For the GGS, it summarizes the financial consequences over time of fiscalpolicies, and hence is an indication of their sustainability and intergenerationaleffects. Furthermore, at the departmental level, departments have no equity in theassets over which they have day-to-day management responsibilities. Again, netassets or net worth are preferable titles.

6. Revenue The AAS definitions are convoluted and confusing. Revenue as such isnot defined in the Framework, and is referred to as income. However, income (orprofit) is traditionally defined in terms of the gain in net assets, whereas the termrevenue in the context of para. 74 relates to the inflow of assets that arise in thecourse of the ordinary activities of the entity, and it is stated that revenue includesboth revenue and gains. It is desirable for definitions to have a contextual content toindicate the nature of the item, rather than just be an arithmetical rule. Thus in thecase of governments, revenue is obtained from taxes and other compulsory levies onthe public as well as from user charges and investment returns, and which increasesgovernment assets.

7. Expenses are defined in para. 70 as ‘decreases in economic benefits . . . in theform of outflows or depletions of assets . . . that result in decreases in equity’. Thisdefinition is the reverse of the (gross) income definition and it suffers from the sameinadequacies. It does not indicate that the entity receives resources or service ben-efits from incurring the expenses to produce its services for sale to customers. Aswell, it lacks contextual relevance for governments as the bulk of expenditurescomprise social welfare benefits paid to citizens and transfer payments to othergovernments. For governments, expenses are the costs incurred to provide servicesto itself or to the public.

8. Net profit This important concept is not defined in the AAS Framework, not-withstanding that the pursuit of profit is the motivating objective of business and isof tremendous importance to investors and the capital market and is the basis fordividend payments. Its public sector counterpart is the budget balance, which is the




difference between the operating revenues and costs of service provision, as mea-sured in accordance with the other government standards. The measure is a keyvariable in fiscal policy formulation and management. It affects the government’sliabilities (for a deficit) or financial assets (for a surplus), capital markets and interestrates (both being important externalities).

9. Measurement basis for the elements of financial statements The financial mea-surement basis is critical to the meaning and uses of the statements of financialperformance and financial position. It affects the reported values of all assets andliabilities, and hence net worth, and also the asset consumption charges which affectprofit or income. The options allowed comprise historical cost, current cost, currentrealizable values, fair values, present values, and varying combinations thereof (para.100). Historical cost is the most commonly adopted basis, but is rarely used alone.Normally a range of bases are used together. Furthermore, no capital maintenancebasis is specified in the Framework (para. 81). This item determines the treatment ofasset and liability revaluations as revenue or as equity/net worth adjustments, as wellas asset consumption charges and hence income/budget balance, and it underpinsthe concept of income or budget balance being measured.

Because no asset measurement and capital maintenance bases are prescribed inthe Standards, published corporate financial statements can fail to satisfy the criteriarequired for information to be useful, particularly those of relevance, reliability andrepresentational faithfulness, comparability and understandability. (Framework,paras 24–41). As a result, the financial statements may not report the ‘true and fair’information on financial performance and position required for resource use deci-sion making and accountability purposes.

10. Control The AAS concept of control concerns the capacity of the entity todominate the decision making of another and is used to define boundaries of theentity (SAC 1, para. 6). Control over assets rather than their ownership is appropri-ate for complex business structures as occurs in many corporate groups. But thisapproach is not suitable for the public sector, and for example it was the reason forthe GGS not being recognized as an accounting entity prior to the release of AASB1049 in October 2007 (Challen and Jeffery, 2003, 2004, 2005). Hence the GGS iscontrolled by governments through parliament and not by some parent entity, andfor citizens it is the most important accounting entity in the nation.

Furthermore, the business control concept is not appropriate for judicial institu-tions and for most statutory bodies. Courts of law are given complete autonomy foradjudicating on cases before them under the Westminster system of democracy. Thegoverning boards of public corporations are given operational independence so as torestrict ministers’ powers to intervene in their operations, even though they areowned by governments.

Because of the above limitations of the AAS Conceptual Framework for publicsector accounting and financial reporting, it is not an appropriate one. Accountingstandards for the public sector must be designed for the specific nature and roles ofgovernment. While the number of standards that require changing is relatively few,they are the most fundamental ones mainly concerning the conceptual framework of

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the FMIRS. Most of the AAS concern the recording of transactions and these aresimilar in both sectors apart from taxes and transfer payments.

THE GOVERNMENT FINANCE STATISTICS (GFS)ACCOUNTING SYSTEM

As outlined earlier, the government initially adopted the GFS system for its 1998–99budget along with the AAS budget; and following years of controversy and therelease of AASB 1049 in 2007, modified the GFS system as part of the harmoniza-tion process. The GFS adopted some preferred AAS item treatments, the mostimportant one being the capitalization of defence weapons platform expenditures asassets and subjecting them to depreciation charges. On the other hand, the AASadopted the GFS operating statement in place of its business income statement andpermitted the use of GFS treatment of items if they did not conflict with AAStreatments where options were allowed. Some AASB 1049 requirements were notaccepted by the government. Budget Paper No. 1, 2008–09, Statement 9, Notes 1 and2, and Appendix A set out details of the new policies and the reasons for the changesaccepted or rejected. Subsequently in December 2008, the government accepted therecommendations of Senator Murray’s Operation Sunlight Report that all govern-ment financial reports (of programs, departments and the GGS) should use theenhanced GFS system.

Thus, with these few amendments, the government was able to produce a singleand meaningful set of budget statements based on one set of harmonized accountingstandards which complied with the requirements of the Charter for financial report-ing. Furthermore, the GFS system provides for reporting both accrual and cashbudgets, together with their outcome financial statements, on the transactions basis.

Nature and Purpose of the GFS SystemThe purpose of the GFS system (IMF, 2001, paras 1.2–1.4) ‘is to provide a compre-hensive conceptual and accounting framework suitable for analysing and evaluatingfiscal policy, especially the performance of the general government sector and thebroader public sector of any country’. Similar statements are included in the Aus-tralian System of Government Finance Statistics (Australian Bureau of Statistics,2005, paras 1.7, 1.14), a local adaptation of the IMF System. The system was devel-oped specifically for the public sector to provide the financial information requiredto accommodate the special nature and roles of governments and for assessing theireconomic impact on the nation, as outlined earlier in the paper (pp. 413–19). It wasadopted by Treasury for these fiscal policy purposes because the existing AASaccrual accounting systems did not provide the information. However, the statementof purpose needs updating to include the provision of financial information requiredto facilitate efficient management of all government resources

The system is based on IMF economic measurement standards used for themeasurement of the GDP of nations and its components, and is integrated with theUN System of National Accounts (SNA). The system enables relevant and reliablemeasurements of GDP to be made which are internationally comparable. It is an




economic measurement system based on economic concepts throughout and uses arigorous, analytical approach. It is based on double entry recording, a sharp distinc-tion between stocks and flows of resources, and use of current market prices of allassets and liabilities (primarily current buying prices of non-financial assets andrealizable prices of financial assets and liabilities).

Outline and Structure of the GFS SystemIn order to provide the financial information required by governments to developfiscal policies and to measure their impact on the economy, and to measure allgovernment resource uses and stocks, the GFS incorporates the following features.

1. Distinction between stocks and flows of resources A sharp distinction is madebetween stocks and flows of resources in the system because of their differingeconomic effects. Resource flows directly affect production, sales and employmentand enter into the GDP, and they are reported in the operating statement. As well,they affect the stocks of assets and liabilities as shown in the balance sheet. Changesin resources can also arise from some non-transaction events such as changes inmarket prices, discovery of new mineral deposits and the growth of forests.

Two types of resource flows are distinguished: transactions and other economicflows. Transactions represent resource flows that come about as a result of interac-tions between the government and external parties. Under accrual accounting, theseflows are recognized as and when they occur. Transactions are classified intoexchange transactions which involve the purchase and sale of items; while transfersinvolve provision of goods, services or cash to or from the government withoutrecognizing something in return such as taxes and social welfare benefits.

Other economic flows represent changes to stocks that do not result from trans-actions or from internal asset consumption. They arise from price movements andabnormal events. They often arise fortuitously without any active decision makingbeing involved. Valuation changes in stocks of resources arise from price changes inindividual assets and liabilities. They are holding gains and losses which do not alterthe physical stock of resources. All assets and liabilities are revalued at currentmarket prices prevailing at the end of each year, and holding gains and losses arethen recognized.Abnormal items include damage caused by natural disasters (earth-quakes, bushfires, floods, etc.), discovery of new mineral resources, and growth offorests, etc. However, they are excluded from normal operating resource flowsbecause (for most items) they are irregular and largely unpredictable.

2. A transactions-based recording and financial reporting system A transactions-based system is used in contrast to the AAS system based on the balance sheetapproach. With the transactions-based system, cash transactions are summarizedand reported directly into a cash flow statement, and likewise all transactions (cashand credit) are summarized and reported in a statement of external transactions(formerly known as a funds statement), see Appendix A. In a central data-basedfinancial information system, these transaction reports can be prepared daily ifrequired with little effort. In contrast to this approach, professional accountingstandards systems no longer provide for presentation of the (former) funds state-

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ment, and the cash flow statement is normally prepared from the accrual financialstatements by eliminating all non-cash components from each item. This is a time-consuming and needlessly complex process when a simple, speedy and low-costalternative is available. It is also of note that the amounts disclosed in the cash flowstatement under the GFS and AAS systems differed markedly when both systemswere in use (Barton, 2007). Parliament expects statements of cash receipts andexpenditures of the government to be identical other than for classificationdifferences.

3. Financial statements reporting In Australia three statements are prepared—theoperating statement, balance sheet and cash flow statement—whereas four are usedunder the IMF presentation. Other economic flows are included as a separatecomponent in the Australian operating statement but shown as a separate statementin the IMF version. The IMF structure of the financial statements is shown inAppendixes B and C, while the Australian version is shown in the Appendix Dfinancial statements.

While the three statements are broadly similar to those of business, their presen-tation and classification of items differ significantly to suit the information needs ofgovernment. The statements show important economic measures required for fiscalpolicy purposes known as analytical balances, which are italicized in the followingparagraphs.

The operating statement summarizes on an accruals basis total transaction rev-enues and operating expenses of the government, and asset consumption expenses(inventory usage and depreciation) to derive the net operating balance for thebudget and its outcomes report. The net operating balance measures the extent towhich current revenues fund the operating costs of government service provision. Itthereby reports on the change in net worth of the government from recurrenttransactions activity and the ongoing sustainability of government operations. Thegross operating balance (not shown) can also be calculated by excluding the assetconsumption charges from the expenses to show the net redistribution of resourcesfrom the private to public sector use. (This parallels the distinction between GDPand the national income measurements in national accounting.)

Other economic flows comprising holding gains and losses on assets and liabilitiesare reported in the lower tier of the operating statement. They are not included asincome as can occur under AAS, and they flow directly to net worth. Adjusting the‘other economic flows’ provides the comprehensive result for the government’srecurrent activities and resource revaluations over the period, and it shows the totalchange in net worth. This information is important for assessing the government’sperformance over time and for its intergenerational consequences.

Next, as a note to the operating statement, the net operating balance is adjustedfor non-financial asset sales and purchases to determine the government’s capitalformation over the period and the fiscal balance. Government capital formationindicates the extent to which the budget has added to the nation’s capital stock andits capacity to provide additional public services. The fiscal balance measures thegovernment’s net lending or borrowing over the period, that is, the extent to which




the government is either placing resources for disposal by other sectors of theeconomy or utilizing savings. It indicates the financial impact of the government onfinancial markets and on the rest of the economy.

The balance sheet presents the stock of government assets and liabilities andshows its net worth. This information is necessary for their efficient management bydepartments, rather than for fiscal policies. Assets are classified into financial andnon-financial items, and liabilities into interest-bearing liabilities, and provisions andpayables, unlike the current/non-current classification in the AAS. Net worth mea-sures the extent of government ownership of the measured wealth of the nation.

However, unlike a business balance sheet, a government balance sheet is not acomprehensive statement of its financial position and long-term solvency for thereasons indicated earlier in the paper (see pp. 424) However, footnotes show parts ofthe solvency information. Net financial worth of the government (total financialassets less all liabilities), net financial liabilities (total liabilities less financial assets)and net debt (borrowings and deposits held less all financial assets excluding equityinvestments in other government entities) measures are shown in Appendix D.Furthermore, a negative net worth does not imply government bankruptcy becausegovernments do not need contributed capital for funding their assets; rather, theyhave taxation powers. Changes in net worth help assess the sustainability of existingpolicies in government operations and their impact on future generations. Decliningnet worth (consequent upon a running down of asset stocks or increasing liabilitiesas a result of net operating deficits) can indicate the non-sustainability of presentfiscal policies and future budgetary problems, whereas increasing net worth does theopposite.

The cash flow statement. While the statement records all cash flows arising fromoperating, investing and financing activities, it is presented in a somewhat differentformat to business ones to relate cash flows to their accrual counterparts for fiscalpolicy purposes and for cash management. The statement reports cash receipts andpayments on operating activities to derive the operating cash surplus/deficit (whichis comparable to the gross operating balance in the operating statement). Cashtransactions on non-financial assets (capital formation), on financial assets for long-term investment purposes, and on financial assets for short-term liquidity purposes,are each shown separately for budget decision purposes. However, three importantanalytical balances—the GFS underlying cash balances (the cash operating balanceplus capital formation expenditure and which is the counterpart to the accrual fiscalbalance measure), the underlying cash balance (the above plus income from long-term financial investments), and the headline cash balance (the above plus incomefrom short-term investments), are reported in the main budget papers to highlighttheir role in fiscal policy strategy (Budget Paper No. 1, 2010–11, Statement 3,Table 5,pp. 3–12) rather than in the cash flow statement.

Specification of Key ItemsRevenues are all transactions that increase the net worth of the GGS (IMF, 2001,para. 4.20). They exclude all proceeds from sales of non-financial assets other thaninventories and all asset and liability holding gains and losses.

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Expenses are operating transactions that reduce the net worth of the GGS.However, in the operating statement, depreciation (which is a non-transactionevent) is included as a deduction from gross operating balance to derive the netoperating balance (which flows through to net worth). The purchase of a non-financial asset is not an expense because it has no effect on net worth (para. 4.25).

Assets are resources owned by the GGS and provide future benefits to the gov-ernment or the community at large from holding or using them over a period of time(para. 7.4). Non-financial assets may be general-purpose assets such as office build-ings, equipment and schools; infrastructure assets which are immovable and gener-ally do not possess alternative uses and whose benefits accrue to the community atlarge such as roads and lighting systems; and heritage assets which the governmentintends to preserve indefinitely because of their unique cultural and historical sig-nificance (paras 7.7–7.10).

Liabilities are obligations to provide economic benefits for owners of the corre-sponding financial claim (para. 7.14).

Net worth is the difference between the total value of all assets and total value ofall liabilities (para. 7.140).

All the descriptions of items are thus simple and appropriate for governmentoperations. Descriptions are also provided for sub-categories of each item.

Valuation of assets and liabilities. They are to be valued at their current marketvalues, that is, the amount to be paid to acquire the asset on the valuation date or todischarge the liability (p. 114). If there are no observable market prices, assets can bevalued at their current new price less an allowance for consumption of fixed capital(i.e., accumulated depreciation). Most fixed assets are recorded at their written downreplacement cost. However, those assets for which acceptably reliable valuationscannot be obtained need not be included in the balance sheet. Many cultural andenvironmental assets fall into this category.

Evaluation of the SystemThe GFS system which provides both cash and accrual information is superior to thealternative systems. The system is designed specifically for government use and ittakes into account all the special features of governments which distinguish themfrom the private sector, and hence the information provided is relevant to the needsof government and parliament. It is a comprehensive FMIRS which provides gov-ernments both with the financial information they require to undertake their desiredfiscal policies and to manage their resources efficiently and to fulfil their account-ability obligations to parliament and citizens. A complete cash accounting andbudgeting system (CABS) can be an integral part of it to provide the informationrequired for fiscal policy and cash management purposes, along with the full accrualinformation required to manage all the governments resources efficiently and toassist in longer term fiscal policy management.

Cash budgets and outcome reports are required for annual fiscal policy purposesand for assessing the liquidity of the GGS. Cash funds all the resources required bygovernments to provide their services to the public. The Constitution requires thatall tax revenues to be raised and all expenditures to be made must first be approved




by parliament. Fiscal policies cannot be managed without this information. Fiscalpolicies substantially transfer the distribution of resources in the economy awayfrom the private sector to the public sector for the reasons contained in the budgetpolicies, and the extent of wealth and income redistribution from taxation and socialwelfare policies. These amount to about 25% of the GDP in Australia. They alsohave significant impacts on the performance of the macro economy apart from thedistribution of resources across it. A cash budget deficit shows the extent to whichthe budget has stimulated the level of aggregate demand in the economy, whichincreases employment and GDP, but can also promote inflation. Conversely, abudget surplus withdraws money from the economy and reduces the level of aggre-gate demand and employment, and lowers inflationary pressures.

Several important fiscal analytical balances and cash management balances arereported in the cash flow statement and in the Budget Papers.All this information isrequired for the good management of the macro economy to achieve stable eco-nomic growth with full employment and low inflation. It is vital for budget policydecision making and approval and for accountability purposes that this informationis provided to parliament.

CABS is also necessary for efficient cash management by the government toensure it has the liquidity to fund its daily operations and to minimize the borrow-ings required to fund cash deficits when they occur. Large differences between cashinflows from taxation and expenditures occur throughout the course of the year,resulting in temporary cash surpluses and deficits.Where a deficit is expected, it mustarrange to borrow the money in advance through the sale of treasury notes by theReserve Bank, while conversely it can use temporary cash surpluses to redeem themor invest them on the money market to reduce annual interest costs. Rolling cashbudgets must be prepared daily to facilitate efficient management. This can bereadily done in the GFS transactions-based system, but not from the traditionalmethod of adding back non-cash components used in the AAS system.

Finally, CABS information is required at the departmental level for budget legalcompliance and accountability purposes in addition to managing operations. Depart-ments must operate within their budgets.

Hence, ongoing CABS information is required throughout the year for fiscalpolicy management, cash management and budget compliance management. Thedirect reporting of CABS data in the GFS system enables the provision of thisinformation.

Furthermore, the cash transactions of governments have significant flow-oneffects (externalities) on the macro economy. Budget deficits have to be financedfrom government borrowing or asset sales and these impact on financial markets,interest rates and the level of overseas debt, while budget surpluses have reverseeffects.

Accrual budgets and outcome financial statements are required primarily for thegood management of total government resources. These are largely departmentalmanagement responsibilities. Information on total revenues and costs of serviceprovision, and on all assets and liabilities, must be known to enable their goodmanagement and thereby enhance efficiency of operations (a major criticism of

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earlier reviews of government operations) and departmental accountability to par-liament for their performance. Regular revaluations of physical assets at marketreplacement cost (as new less accumulated depreciation) and charging depreciationthereon and use of the physical capital maintenance concept provides information tomanagement about maintenance of the government’s operating capability to sustainprovision of infrastructure services into the future. Citizens expect their govern-ments to do this.

The operating statement serves similar fiscal purposes as the cash budget but isfocused on whether the government’s revenues cover the full cost of service provi-sion and not just the cash costs. It is also useful for showing the net impacts of currentfiscal policies on all the assets and liabilities in the balance sheet and on governmentnet worth. Changes in net worth, that is, the government’s share of the nationalwealth, is a useful indicator of the sustainability of current fiscal policies. Increasingdebt incurred to fund services to current residents incurs future interest charges andrepayment obligations to be borne by future residents. If taken to an excess, thiscan cause the acute political and economic problems currently occurring in manynations.

The two tasks remaining to be completed for full use of the revised GFS systemare to complete its implementation in departments as their only FMIRS, and tointegrate the departmental cash reporting systems into a central data base for dailycash management purposes.These tasks have arisen because departments previouslyused the AAS systems as their primary system. Use of the GFS system throughoutthe GGS facilitates comparability of departmental and whole-of-GGS activities atbudget and outcome levels, and cash management

CONCLUDING COMMENTS

The adoption of an accounting system by the Australian government appropriate forits information needs has been a long and arduous task involving many conflicts anddifferences of opinion over almost 30 years. If accounting is to be an FMIRS whichmeasures and reports useful information, it must be designed to suit users’ informa-tion needs and report information which is understandable, relevant and reliable sothat the financial reports faithfully represent what they purport to represent andthereby provide a true and fair view of the entity’s financial operations.

The paper examines the experience of the government in the development of newaccrual budgeting systems following the adoption of accrual budgeting in 1999 andthe scrapping of its former cash budgeting system. Along with the AAS budgets,which complemented its accrual systems, the government introduced the largelyunknown GFS budget system. Doing so resulted in much confusion in parliament asthe two sets of budgets produced very different results and a major controversyensued concerning the merits of each system.

To resolve this issue, the paper explains the nature, purpose and functions ofgovernments to establish their financial information requirements for their budgetand accounting outcome reports, and how they differ from those of business. It thentraverses the long and controversial path to the ultimate adoption in 2008 of an




enhanced GFS system which incorporated AAS treatment of some items. Thisincludes an examination of the limitations of AAS concepts in their application tothe public sector and the validity of the sector-neutral accounting standards prin-ciple adopted by the AASB. Pressure on the AASB to include the unique features ofgovernment operations resulted in the development of the new standard, AASB1049, for government use. This standard made some significant compromises andsome of its proposals which were desirable improvements were incorporated intothe GFS system. However AASB 1049 largely retained the conceptual frameworkbasis underlying all AAS which were formulated for business operations, and mostof its requirements were not accepted by the government.

In 2008, the government made the courageous decision to go it alone with theadoption of the enhanced GFS system as its sole FMIRS. In doing so, it could reporton all cash transactions and all accrual transactions directly, which is important forfiscal policy purposes. The GFS system is explained to show how it is designed toprovide the information needed by governments for fiscal policy, resource manage-ment and accountability purposes. By being transactions based, cash and accrualaccounting and budgeting systems can be integrated into one comprehensiveFMIRS which reports the information needed by governments and parliaments toperform the functions that citizens require of them. The information can satisfy thestandards for quality information.

Australia has now become the world’s leader in use of the GFS system forgovernment accounting purposes. Hopefully the benefits from using it will be rec-ognized by other nations and its use becomes widespread.

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A BAC U S


APPENDIX A

FRAMEWORK FOR FINANCIAL MANAGEMENT ANDREPORTING SYSTEMS

Transaction

data

Data processing Events Financial

performance and

position reports

Financialperformanceand positionbased on

historical costs

Recording,classifying andsummarizingtransactions inthe accounts

All externaltransactions ofentity(transactionprices)

Internal

allocations for

asset

consumption

Operatingstatementssummarize all

external

transactions for

cash and credit

Detailedmanagementsegment reports

Financialperformanceand positionbased on current

market values of

assets and

liabilities

Cash flowstatementssummarize all

external cash

receipt and

paymenttransactions

Changes in

market prices of

assets and

liabilities

Transaction

reports

Source: Barton (1982, p. 46).




APPENDIX B

STRUCTURE OF THE GFS ANALYTICAL FRAMEWORK FLOWS

Source: Government Finance Statistics Manual, 2001, Figure 401, p. 37.

A BAC U S


APPENDIX C

STATEMENT OF GOVERNMENT OPERATIONS

Transactions affecting net worth

REVENUE

Taxes

Social contributions

Grants

Other revenue

EXPENSE

Compensation of employees

Use of goods and services

Consumption of fixed capital

Interest

Subsidies

Grants

Social benefits

Other expenses

NET/GROSS OPERATING BALANCE1

Transactions in non-financial assets

NET ACQUISITION OF NON-FINANCIALASSETS2

Fixed assets

Changes in inventories

Valuables

Nonproduced assets

NET LENDING/BORROWINGS3

Transactions in financial assets and liabilities(financing)

NET ACQUISITION OF FINANCIALASSETS

Domestic

Foreign

NET INCURRENCE OF LIABILITIES

Domestic

Foreign

1 The net operating balance equals revenue minusexpense. The gross operating balance equalsrevenue minus expense other than consumptionof fixed capital.

2 Acquisitions minus disposals and consumptionof fixed capital.

3 Net lending/borrowing equals the net operatingbalance minus the net acquisition of non-financial assets. It is also equal to the netacquisition of financial assets minus the netincurrence of liabilities.

Source: Government Financial Statistics Manual,2001, Table 4.1, p. 38.




APPENDIX D

STATEMENT 9: BUDGET FINANCIAL STATEMENTS

Table 1

AUSTRALIAN GOVERNMENT GENERAL GOVERNMENT SECTOR OPERATINGSTATEMENT

Note Estimates Projections

2008–09 $m 2009–10 $m 2010–11 $m 2011–12 $m 2012–13 $m

Revenue

Taxation revenue 3 275,751 267,727 275,981 301,876 331,002

Sales of goods andservices

4 6,373 7,483 7,746 7,918 7,706

Interest income 5 5,454 4,697 4,586 4,512 4,484

Dividend income 5 3,194 6,413 2,562 2,566 2,406

Other 6 5,166 4,292 3,967 3,905 4,085

Total revenue 295,939 290,612 294,841 320,776 349,684

Expenses

Gross operating expenses

Wages and salaries (a) 7 15,691 17,069 16,993 17,023 17,085

Superannuation 7 2,945 3,384 3,490 3,556 3,631

Depreciation andamortisation

8 5,520 5,634 5,570 5,343 5,430

Payment for supply ofgoods and services

9 57,925 63,229 63,155 65,855 67,177

Other operating expenses(a)

7 4,694 4,571 4,806 4,995 5,177

Total gross operatingexpenses

86,774 93,887 94,013 96,772 98,500

Superannuation interestexpense

7 6,432 6,792 7,016 7,245 7,489

Interest expenses 10 5,358 7,556 9,664 12,036 13,864

Current transfers

Current grants 11 94,804 102,185 105,371 110,451 113,529

Subsidy expenses 8,088 8,121 8,569 10,072 13,727

Personal benefits 12 111,556 99,579 106,406 111,960 120,085

Total current transfers 214,448 209,885 220,345 232,483 247,342

Capital transfers 11

Mutually agreedwrite-downs

1,717 1,657 1,738 1,846 1,932

Other capital grants 9,712 18,434 11,752 6,006 5,865

Total capital transfers 11,430 20,091 13,490 7,852 7,796

Total expenses 324,443 338,213 344,528 356,388 374,990

Net operating balance -28,504 -47,601 -49,687 -35,612 -25,306

A BAC U S


Table 1

CONTINUED


2008–09 $m 2009–10 $m 2010–11 $m 2011–12 $m 2012–13 $m

Other economic flows

Revaluation of equity (b) -8,490 2,044 2,012 2,481 2,887

Net write-downs of assets(including bad anddoubtful debts)

-4,089 -3,903 -4,069 -4,268 -4,608

Assets recognised for thefirst time

316 293 272 228 218

Actuarial revaluations -1,866 -1 0 0 0

Net foreign exchangegains

-143 -5 0 0 0

Net swap interest received -25 187 93 48 39

Market valuation of debt -3,245 147 -56 -372 -447

Other economicrevaluations (c)

-112 -595 110 -98 -173

Total other economic flows -17,653 -1,832 -1,638 -1,981 -2,084

Comprehensive result—

Total change in net worth 13 -46,157 -49,432 -51,325 -37,593 -27,391

Net operating balance -28,504 -47,601 -49,687 -35,612 -25,306

Net acquisition ofnon-financial assets

Purchases of non-financialassets

9,910 11,305 11,639 11,300 10,163

less sales of non-financialassets

516 619 258 154 161

less depreciation 5,520 5,634 5,570 5,343 5,430

plus Change in inventories 417 425 216 171 468

plus Other movements innon-financial assets

56 68 241 165 -24

Total net acquisition ofnon-financial assets

4,347 5,545 6,269 6,139 5,016

Fiscal balance (Net lending/borrowing) (d)

-32,851 -53,145 -55,956 -41,751 -30,323

(a) Consistent with ABS GFS classification, other employee related expenses are reported under otheroperating expenses.Total employee expenses equal wages and salaries plus other operating expenses.

(b) Revaluation of equity reflects changes in the market valuation of investments. This line also reflectsany equity revaluations at the point of disposal or sale.

(c) Largely reflects other revaluation of assets and liabilities.(d) The term fiscal balance is not used by the ABS.




Table 2

AUSTRALIAN GOVERNMENT GENERAL GOVERNMENT SECTOR BALANCE SHEET


2008–09 $m 2009–10 $m 2011–12 $m 2011–12 $m 2012–12 $m

Assets

Financial assets

Cash and deposits 20 (a) 1,538 1,282 1,769 2,353 2,679

Advances paid 14 21,948 23,873 25,538 25,818 25,148

Investments, loansand placements

15 102,506 100,415 92,308 92,496 93,927

Other receivables 14 32,708 36,626 38,975 45,944 56,747

Equity investments

Investments in otherpublic sector entities

18,870 20,177 23,848 30,073 30,098

Equity accountedinvestments

224 224 224 224 224

Investments—shares 22,856 24,976 26,753 28,206 29,138

Total financial assets 200,650 207,572 209,414 225,113 237,961

Non-financial assets 16

Land 7,994 7,568 7,579 7,624 7,570

Buildings 18,967 20,227 21,139 22,375 22,791

Plant, equipment andinfrastructure

44,465 47,856 52,175 56,475 60,084

Inventories 6,523 6,921 7,108 7,213 7,614

Intangibles 3,101 3,752 4,179 4,561 4,885

Investment property 168 143 125 109 422

Biological assets 29 30 31 32 32

Heritage and culturalassets

8,286 8,376 8,419 8,460 8,500

Assets held for sale 552 545 530 522 513

Other non-financial assets 3,003 1,874 1,804 1,485 1,304

Total non-financial assets 93,088 97,292 103,090 108,857 113,716

Total assets 293,738 304,864 312,504 333,970 351,677

Liabilities

Interest bearing liabilities

Deposits held 339 339 339 339 339

Advances received 0 0 0 0 0

Government securities 111,867 169,907 222,487 273,318 300,814

Loans 17 8,170 8,173 8,243 7,956 8,071

Other borrowing 919 851 791 754 706

Total interest bearingliabilities

121,296 179,270 231,860 282,366 309,929

A BAC U S


Table 2

CONTINUED


2008–09 $m 2009–10 $m 2011–12 $m 2011–12 $m 2012–12 $m

Provisions and payables

Superannuation liability 18 118,401 122,423 126,499 130,575 134,672

Other employee liabilities 18 9,419 9,725 10,127 10,580 11,085

Suppliers payable 19 3,658 3,639 3,736 3,819 3,861

Personal benefits payable 19 14,222 12,490 12,995 13,900 14,977

Subsidies payable 19 1,586 1,659 1,937 1,991 2,076

Grants payable 19 6,746 6,511 6,481 6,377 6,384

Other provisions andpayables

19 7,653 7,824 8,870 11,955 23,679

Total provision and payables 161,686 164,271 170,646 179,198 196,733

Total liabilities 282,981 343,541 402,505 461,564 506,662

Net worth (a) 10,756 -38,676 -90,001 -127,594 -154,985

Net financial worth (b) -82,331 -135,968 -193,091 -236,451 -268,701

Net financial liabilities (c) 101,201 156,145 216,939 266,524 298,799

Net debt (d) -4,697 53,700 112,245 161,699 188,175

(a) Net worth is calculated as total assets minus total liabilities.(b) Net financial worth equals total financial assets minus total liabilities.That is, it excludes non-financial

assets.(c) Net financial liabilities equals total liabilities less financial assets other than investments in other

public sector entities.(d) Net debt equals the sum of deposits held, advances received, government securities, loans and other

borrowing, minus the sum of cash and deposits, advances paid, loans and placements.




Table 3

AUSTRALIAN GOVERNMENT GENERAL GOVERNMENT SECTOR CASH FLOWSTATEMENT(a)

Estimates Projections

2008–09 $m 2009–10 $m 2010–11 $m 2011–12 $m 2012–13 $m

Cash receipts fromoperating activities

Taxes received 269,377 259,436 268,600 291,329 321,374

Receipts from sales ofgoods and services

6,356 7,480 7,723 7,898 7,668

Interest receipts 5,014 4,426 4,345 4,291 4,341

Dividends and income taxequivalents

3,152 5,663 3,362 2,616 2,456

Other receipts 5,328 4,360 3,979 3,937 4,094

Total operating receipts 289,228 281,364 288,008 310,071 339,932

Cash payments foroperating activities

Payments for employees -21,412 -23,127 -23,457 -23,778 -24,140

Payments for goods andservices

-56,813 -62,201 -61,828 -64,487 -66,303

Grants and subsidies paid -111,812 -127,722 -125,240 -125,660 -128,485

Interest paid -4,078 -5,890 -9,061 -10,257 -11,975

Personal benefit payments -110,393 -102,368 -107,059 -112,216 -120,230

Other payments -3,810 -4,305 -4,268 -4,416 -4,469

Total operating payments -308,319 -325,613 -330,914 -340,813 -355,601

Net cash flows fromoperating activities

-19,090 -44,249 -42,906 -30,743 -15,668

Cash flows frominvestments innon-financial assets

Sales of non-financialassets

555 619 258 154 161

Purchases of non-financialassets

-9,469 -11,030 -11,503 -11,138 -9,860

Net cash flows frominvestments innon-financial assets

-8,914 -10,411 -11,245 -10,984 -9,699

Net cash flows frominvestments in financialassets for policy purposes

-7,428 -5,089 -4,761 -6,762 300

A BAC U S


Table 3

CONTINUED

Estimates Projections

2008–09 $m 2009–10 $m 2010–11 $m 2011–12 $m 2012–13 $m

Cash flows frominvestments in financialassets for liquiditypurposes

Increase in investments -12,483 1,761 6,645 -442 -604

Net cash flows frominvestments in financialassets for liquiditypurposes

-12,483 1,761 6,645 -442 -604

Cash receipts fromfinancing activities

Borrowing 48,124 58,424 54,199 51,601 28,341

Other financing 1,127 411 203 104 82

Total cash payments forfinancing activities

49,250 58,835 54,402 51,705 28,423

Cash payments forfinancing activities

Borrowing 0 0 0 0 0

Other financing -1,836 -1,104 -1,648 -2,190 -2,426

Total cash payments forfinancing activities

-1,836 -1,104 -1,648 -2,190 -2,426

Net cash flows fromfinancing activities

47,414 57,731 52,754 49,515 25,997

Net increase (decrease) incash held

-501 -257 487 584 326

Source: Commonwealth of Australia, Budget Strategy and Outlook, Budget Paper 1, 2009–10, pp. 9.3–9.5.




Documents

Why Governments Should Use the Government Finance Statistics Accounting System