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Should Developing Countries Adopt Accrual Accounting?

Should Developing Countries Adopt Accrual Accounting?. Paul Boothe Institute for Public Economics University of Alberta. Outline. Motivation Cash versus accrual accounting Pros and cons of accrual Accounting regimes and fiscal rules Prerequisites for adoption Checklist for policymakers.

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Should Developing Countries Adopt Accrual Accounting?

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

  2. Outline • Motivation • Cash versus accrual accounting • Pros and cons of accrual • Accounting regimes and fiscal rules • Prerequisites for adoption • Checklist for policymakers Institute for Public Economics University of Alberta

  3. Motivation • Two perspectives • Public versus private sector • Tale of two finance ministers • The goal: good governance Institute for Public Economics University of Alberta

  4. Cash versus Accrual [1] Cash • Traditionally used in public sector • Expenses and revenues recorded when they are paid or received Accrual • Traditionally used in private sector • Expenses and revenues recorded when they are incurred or earned Institute for Public Economics University of Alberta

  5. Cash versus Accrual [2] • When transactions are recorded is a key difference • Three examples • Purchase of a capital asset • Public sector pension liabilities • Corporate income tax arrears Institute for Public Economics University of Alberta

  6. Cash versus Accrual [3] Institute for Public Economics University of Alberta

  7. Accrual Pros and Cons [1] Pros (Athukorala & Reid, 2003) • Matches National Accounts • Recognizes transactions/events when they occur rather than when paid • Separates operating and capital spending • Better information on sustainability • Discloses pension liabilities • Identifies arrears Institute for Public Economics University of Alberta

  8. Accrual Pros and Cons [2] Cons (Wynne, 2003) • Ignores different aims of private and public sector • Not designed for legislative accountability • Requires sophisticated analysis and judgments • Exposes public servants to political pressure Institute for Public Economics University of Alberta

  9. Fiscal Rules [1] • We know institutions affect fiscal rules (Alesina and Perotti, 1999, Poterba and von Hagen, 1999) • Not much attention yet to incentives flowing from accounting regimes • Boothe (2004)studies influence of accounting regimes on fiscal rules Institute for Public Economics University of Alberta

  10. Fiscal Rules [2] Boothe(2004) finds: • Fiscal circumstances may make either cash or accrual regimes more attractive to policymakers • Impacts of common fiscal rules change as regimes change • Regimes may influence the mix and volatility of spending Institute for Public Economics University of Alberta

  11. Fiscal Rules [3] Basic cash budgeting model: • Revenue is exogenous • Expenditures include: • transfers • services produced by public capital • gross capital investment • interest payments on public debt Institute for Public Economics University of Alberta

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

  13. Fiscal Rules [5] • Cash is more attractive than accrual in fiscal consolidations • Balanced budget rules more ‘stringent’ under cash than accrual • Under accrual, capital investment can be financed by borrowing without affecting deficit in short run • Accrual + balance budget rules creates bias for capital spending Institute for Public Economics University of Alberta

  14. Fiscal Rules [6] • Critical to recognize that regime changes nature of balanced budget rules • No Canadian gov’t changed fiscal rule after changing to accrual • Bias towards capital spending starting to appear in Canada • Net debt rule is invariant to regime Institute for Public Economics University of Alberta

  15. Prerequisites [1] • Developing countries face different public sector environment and challenges (A&R, 2003) • Capacity constraints (HR and technology) • Governance/corruption issues • Many urgent priorities Institute for Public Economics University of Alberta

  16. Prerequisites [2] Capacity constraints • Accrual requires sophisticated professional judgments regarding physical assets, long-term social programs • Accrual generally requires more complex IT systems than cash systems Institute for Public Economics University of Alberta

  17. Prerequisites [3] Governance/Corruption issues • All accounting systems open to some manipulation • Revenue accruals particularly problematic when tax collection is an issue • Costs of long-term social programs very sensitive to assumptions Institute for Public Economics University of Alberta

  18. Prerequisites [4] When resources for public sector reforms are limited, must establish clear priorities • Develop new revenue systems • Reform budget processes • Implement accountability mechanisms • Transform state enterprises Institute for Public Economics University of Alberta

  19. Policymakers’ Checklist [1] • Does accrual best meet needs in our public sector? • Is transition to accrual the best use of limited reform resources? • Do we have the HR and IT capacity to successful implement accrual Institute for Public Economics University of Alberta

  20. Policymakers’ Checklist [2] “Perfection is the enemy of the good…” Voltaire Institute for Public Economics University of Alberta

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