Spinning out of control?

23 Mar 12
Deficient accounting by governments has been one of the causes of the sovereign debt crisis. So what can be done? Finance experts recently converged on Vienna to find a solution to this long-standing problem. Mike Thatcher reports

By Mike Thatcher | 23 March 2012

Deficient accounting by governments has been one of the causes of the sovereign debt crisis. So what can be done? Finance experts recently converged on Vienna to find a solution to this long-standing problem

George Osborne’s recent Budget ­highlighted the parlous state of the UK public finances. Borrowing in 2011/12 was expected to be £126bn, with public sector net debt set to peak at 76.3% in 2014/15.

These are frightening figures, but they could have been a lot worse. If the chancellor had chosen to highlight calculations based on Whole of Government Accounts rather than the UK’s National Accounts he would have caused a stir. For example, the deficit of £107bn in 2009/10 would have translated to £165bn under WGA.

Decisions such as these provide a dilemma for politicians across the globe. Modern accounting techniques – such as WGA – are based on accepted international standards and use accrual rather than cash accounting. They allow for proper comparisons and are more transparent – it’s harder to hide tricky items like pension liabilities or Private Finance Initiative commitments.

But inevitably, this makes the figures look worse. Perhaps, as a result, governments are hardly rushing to introduce accrual-based International Public Sector Accounting Standards. Fewer than 60 countries have introduced accrual-based accounting and only a handful currently use accrual-based budgeting.

To the public this may all seem to be an arcane argument carried out by bean counters with nothing better to do. But it does matter.

Inadequate accounting and auditing have clearly been factors in the sovereign debt crisis affecting Europe, the US and beyond. This was most obvious in Greece, where successive governments misreported official economic data. But the Greeks are not alone in adopting poor or dubious financial practices.

Germany, Italy, the Netherlands and Japan all still use cash accounting, as do India, Brazil and China. The German government recently ‘found’ an extra €55bn following an ‘accounting error’. This worked in its favour but several German cities are facing huge liabilities arising from interest rate swaps.

Meanwhile, in the US, the Government Accountability Office has been unable to express an opinion on the federal ­government’s consolidated financial statements for the past 15 years. The ­billionaire philanthropist Bill Gates has described the accounting methods used by some US states as ‘so blatant and extreme’ that ‘Enron would blush’.

We’ve now had bailouts in Ireland, Greece and Portugal and the introduction of technocratic governments in Athens and Rome. The US has lost its coveted triple-A credit rating and seen its debt levels pass $15.5 trillion.

With the crisis showing little sign of abating, the International Federation of Accountants recently convened a conference in Vienna to find a way forward. In his opening address, chief executive Ian Ball explained the frustration felt by those leading the profession globally.

‘It has been a matter of amazement that the crisis and instability that we have been going through for the past four years has resulted in so little examination of the role of the woefully deficient accounting, auditing and financial management provided by many governments.’

Ball has been a vocal critic of the slow progress made by governments with their accounting. He has described what went on in Greece as ‘financial reporting fraud’ and called for urgent reform.

IFAC used the conference to issue a policy paper calling for greater public sector financial management transparency and accountability. ‘While the problems highlighted by the sovereign debt crisis cannot be solved by better reporting alone, they cannot be solved in the long term without it,’ said Ball.

The federation wants governments to commit to several accounting reforms including: publishing audited financial statements within six months of year end; producing budgeting, appropriations and reporting on an accrual basis; and providing full transparency in fiscal positions ahead of general elections.

This will take some doing given where we currently are. Andreas Bergmann, the chair of the International Public Sector Accounting Standards Board, told the conference that progress had been made on accrual-based accounting but currently only four countries, one being the UK, makes use of accrual-based budgeting.

‘Budgeting is more difficult to tackle, as it is essentially a much more political business than accounting. The politicians need to be completely confident that the new system is living up to their expectations,’ Bergmann told Cooking Recipes.

There is a strong consensus among accountancy bodies – including CIPFA, which has its own ‘Fixing the Foundations’ campaign – that accruals rather than cash is the right way to go. But buy-in from the politicians is much harder to achieve.

There was hope last year when the European Parliament’s Monetary and Economic Affairs Committee proposed mandating all 27 member states to adopt International Public Sector Accounting Standards within three years. But this has now morphed into a European Commission consultation into the advantages and disadvantages of applying the standards EU-wide. It will report back before the end of the year and, if the go-ahead is given, implementation will take another three to five years.

Ball has expressed concern at the delay, but he hopes that sense will eventually prevail. ‘One of the things that politicians don’t like is surprises,’ he explained to PF at the conference. ‘Well, if you’ve got a good financial system in place, you’ll still get surprises but you won’t get them as often and they won’t be as nasty as if you don’t.’

Ruth Richardson, New Zealand’s former finance minister, explained to delegates in Vienna how politicians can be persuaded of the need for change and the benefits that this brings to the economy, to public services and to democracy. It often takes a crisis before governments will do the right thing, she suggested.

‘Politicians have been complicit in the delusion that economic and social liabilities can be incurred without regard for the fiscal consequences. The only way to break that cycle is to arm politicians and public alike with nothing but the fiscal truth and the whole truth, and trust that this will prove to be the game changer.’

New Zealand introduced accrual accounting in the 1990s, along with output-based budgeting and performance management regimes for all state entities. The boost to accountability and transparency, said Richardson, completely redefined the political debate. While politicians did not turn into saints overnight, she suggested that they all eventually became converts to the new approach.

‘The road to fiscal rehabilitation is a grinding one with electorates seeing their expectations shattered and governments having to live in straitened circumstances. But this is the time to learn the lessons of fiscal destruction, and embrace creative public policy solutions.’

Once the politicians are convinced, the next challenge is to build the skills and capacity of the accountants. More and better technical accountancy will require more and better technical accountants.

This point was made in Vienna by James Turley, chair and chief executive officer of Ernst & Young. He discussed a recent report from the auditor general of New South Wales in Australia. The AG found 1,256 mistakes in the state’s financial records submitted last year, 540 of which needed to be corrected before an audit opinion could be issued.

‘The auditor general noted that there were not enough qualified finance personnel to correctly interpret accounting standards and to produce high-quality financial statements,’ said Turley. ‘But Australia is by no means alone, they are just more honest.’

In fact, when it comes to fiscal responsibility Australia is regarded as the front runner. An index of ‘fiscal fitness’ ­compiled by David M Walker, the founder of the Comeback America Initiative and former US comptroller general, places Australia first and New Zealand second. The UK comes a creditable ninth, the US languishes in 28th position and Greece comes 34th and last.

Walker discussed the index at the conference and told delegates that we were at a ‘critical crossroads’. America’s position towards the bottom of the table was ‘embarrassing’ but reflected the fact that ‘the past ten years have clearly been the most fiscally irresponsible in the ­history of the US’.

He said the country had a growing structural deficit caused by demographic trends, rising health care costs and outdated tax systems. Politicians from both main parties were refusing to accept the reality of the situation creating a ­‘dysfunctional democracy’.

Walker claimed that the US was in a worse position than Spain and the UK in terms of total government public debt as a percentage of GDP. And this ignored the trillions of dollars that the US owes to its social insurance and other ‘trust funds’. ‘You can’t trust them, they’re not funded,’ he added.

He suggested that the US and other developed economies were ‘headed for an iceberg that could sink the ship of state’. Finance professionals had to stand up for what was right.

‘I believe we have a unique ­opportunity and obligation to lead and to improve reporting and accounting. If we do that, we can make sure that our combined future is better than our past.’

Warm praise for Chile

Chile is a somewhat unexpected star in the fiscal responsibility firmament. It comes seventh in the index compiled by David M Walker, and found itself receiving warm praise from a number of speakers at the conference.

The country has a small economy, is in a major earthquake zone and is susceptible to commodity price shocks because of its dependence on the copper industry.

‘Putting all this together,’ said Vincenzo La Via, chief financial officer of the World Bank Group, ‘it’s a recipe for fiscal shock, but Chile is tackling these risks head on and is becoming a model of transparency.’

Under Chile’s Fiscal Responsibility Law, a report must be published annually showing the size and characteristics of its contingent liabilities.

Chile has also adopted counter-cyclical fiscal policies, so that surpluses accumulate during economic booms. As a result, it has low debt levels, consistent growth and is considered one of South America’s most stable and prosperous nations.

‘We need to be careful about inferring causation, but I think that lessons can be drawn from Chile’s experience for the benefit of other countries,’ said La Via. Two out of three of the major ratings agencies have upgraded their assessments of the economy since 2010, but Chile’s assessment still compares unfavourably with some European countries.

This does not impress Andreas Bergmann, the chair of the International Public Sector Accounting Standards Board. ‘Chile gets a rating that is worse than that of many European countries that are not doing well fiscally, that have huge debt levels and a relatively poor record on public sector financial management. But they benefit from being European and that’s why I question the analytical skills of ratings agencies to some degree,’ he told PF.

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