Sustainable Public Financial Management

Doug Hadden, VP Products

Why should governments move to accrual accounting? To international standards? These were some of the themes at the first annual international CIPFA (The Chartered Institute of Public Finance & Accountancy) conference on trust and accountability in London last week.

[My presentation audio from the video on lessons learned in GRP in developing countries has some problems, but the full slideshow with script is available.]

David Walker, the former comptroller general of the United States spoke about misleading public accounts and the lack of financial transparency.  An upcoming study with Standford University and Walker’s Comeback America Initiative will show that New Zealand, the first country to adopt accrual accounting, leads in fiscal transparency.

Ian Ball of the International Federation of Accountants (IFAC) spoke about the move to accrual accounting in New Zealand. Although accrual accounting exposes political expediency, it leads to much better decisions according to Mr. Ball who showed how the value of the Government of New Zealand has increased over time until the financial crisis.

Dr. Ionnis Sarmas described the public debt crisis in Greece. Dr. Sarmas showed how subsequent audits increased the debt estimate. Financial controls were not observed. Professor John Fitzgerald described the public debt crisis in Ireland and the lack of effective oversight in the financial sector. He pointed out that Germany has decided not to adopt even modified cash accounting.

Here are some takeaways:

• The lack of accrual accounting enables governments to “cook the books”. In particular, governments often show pension investments as assets but do not count the present value of pension obligations or entitlements.
• The use of different standards makes it difficult to compare governments around the world and can hide systemic weaknesses.
• The lack of multiple year planning in many countries provides too short a window for substantial change.
• Many vehicles used for managing public finances are dubious from an accounting perspective. As David Walker says, Trust Funds in the US Federal Government are not funded and no one trusts them. There is also concern about the magic bullet of Public Private Partnerships (PPPs). Governments often absorb the liability should the private sector partner fail.
• Perhaps developing countries, like Timor-Leste, will leapfrog more developed countries, on this road to international public sector accounting standards.
• Trust and accountability means that the population needs to see the books. Politicians and public servants need to understand the long-term implications of public policy.

 Doug Hadden, VP Products

Another busy conference at the International Consortium on Governmental Financial Management in Washington this week. Lots of content uploaded to the ICGFM Blog – as my “second job” as VP Communications for the organization. International accounting standards in the public sector might not be top of mind for everyone. Yet, I wonder whether using the International Public Sector Accounting Standards (IPSAS) could provide the context we need to understand the debt crisis in Greece, Ireland or the United States. For one thing, government transparency is opaque if everyone is using different standards.

IPSAS was a major focus on the conference and the International Journal on Governmental Financial Management Volume 2 issue:

Many of the attendees at the conference came from developing countries. Many are adopting the cash-based IPSAS. Those from aid-dependent countries were vocal about the need for aid transparency and aid harmonization. There was some very interesting discussion from the presentation on the International Aid Transparency Initiative with takeaways from Malawi and Rwanda. Aid remains inefficient because of the lack of harmonization to country needs, high transaction costs and duplication. Panelists agreed that getting timely data was more important than full accuracy in data. Otherwise, budget planning and budget execution are interrupted.

The ability to provide transparent data via the web was selected in the ICGFM poll as having the greatest impact. This is reflective of the appetite for transparency in developing countries.

Developing country governments are seeing economic and stability benefits to transparency. And, many are leaping ahead of developed countries through the use of E-Government technology, budget/procurement/human resources transparency and adoption of international standards. (This is the crux of my argument from my article in the November Cutter IT Journal, E-Government Development and Public Sector Transparency Trends in Emerging and Developing Countries ) 

As one participant pointed out, many governments in developed countries do not want to change national standards for sovereignty reasons or because they feel their standards are superior. This makes it difficult to compare national debt across multiple countries. We may see a leap forward as countries like Georgia and Honduras move ahead of the G7 in support of standards – then move ahead in accural accounting and performance management.

We’re seeing this trend with many of our customers. The sophistication of the Chart of Accounts in Sierra Leone remains a wonder – in my opinion, much better than the COA used by most donors. Timor-Leste continues to advance transparency with a portal from FreeBalance and is forging ahead with performance management functionality for managers and ministers. Kosovo has rapidly adopted International and European standards.

Recent financial shocks have led to accelerated adoption of Government Resource Planning (GRP) and Public Financial Management (PFM) reform in emerging countries. What about more developed countries? There has been some examples of fiscal reforms in countries like Korea, and changes in regulations for the financial sector in OECD countries. Yet, governments in Iceland, Greece and Ireland are experiencing significant fiscal shortfalls.

How can GRP help governments to adapt more effectively to unexpected financial crisis? Freezing spending and public sector wages is a typical approach. How can emerging country governments expect to better manage budget shortfalls if the budget management software in use in developing countries appears so ineffective?

Financial Stress and the  ’Budget Problem‘

Government financial management is budget driven, unlike the private sector. Government budgets are complex. And, constrained:

• Capital expenditures often span multiple years and generate multi-year commitments. Slowing in-progress capital expenditures can result in half completed bridges, buildings, internet infrastructures.
• Recurrent expenditures often have minimum costs that provide little room for reduced spending. Hospitals need electricity and medical supplies.
• Public Private Partnerships (PPP) bring expenses off the government balance sheet. However, governments are often liable to pick up on these projects when the private sector partner encounters financial difficulty.
• Legal constraints often mandate expenditures, such as the results of  ’propositions’ in the the American State of California. These expenditures cannot be reduced. Many governments are unable to reduce the size of the public service even when jobs are identified as redundant, as in the case of India.
• Donor projects executed by the government or outside organizations often require a legal commitment for the government. Governments may need to contribute funds to projects or provide specific deliverables. Cutting back on the government expenditure can cancel donor funded programs.
• Wages often represent a significant portion of government expenditures. Governments are often the largest employer in countries.  This is why salaries are often reduced or frozen when governments encounter budget deficits. Yet, this method often demoralizes public servants and reduces the quality of government services.
• Government objectives and priorities are difficult to manage during financial crisis. New priorities such as stimulus packages are introduced. Medium and long-term objectives often take a “back seat”.

Effective Budget Management for Governments Under Financial Stress

Many budget preparation software applications used by governments are ineffective in handling financial crisis.  Applications developed for the private sector do not have necessary features for modeling multi-year budgets. Custom applications typically manage the ceremony of budget proposals. Spreadsheet applications are not able to handle whole-of-government budget analysis.  These solutions are often unable to forecast budget surpluses or deficits during the fiscal year.

Governments can use effective budget preparation and budget execution software components of GRP to more effectively deal with financial crisis. These applications, like the FreeBalance Accountability Suite, can support the following:

• Scenario planning and what-if analysis during budget preparation and execution. Financial crisis can be modeled in budget preparation software. Governments can leverage these models should a crisis occur. Governments can also update these scenarios with actual figures to enable more effective reaction to problems.
• Forecasting provides early warning on revenue shortfalls. Governments can react quicker and more effectively.
• Wage forecasting is particularly important when managing deficit situations. Wages include salaries, benefits, training, travel, bonuses and other civil services expenses. So, wages can vary significantly from plans. Human Resources applications rarely have budget visibility. Wage forecasting and variance is critical. Elements of salary costs other than wages could be reduced.
• Multiple year visibility to budgets, budget types and budget constraints to enable decision-makers to find more effective methods of expenditure management.
• Objectives management for budgets enable governments to link expenditures with objectives and priorities.  Every expenditure is linked with one or more objectives. Priorities change during a financial crisis. Objectives management enables governments to recast budget plans during the fiscal year to focus on priorities.