GTZ Report on Accrual Accounting Status Quo - LGCDP

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Executive Summary 1 01. Executive Summary This report analyses the relative merits of cash based accounting and accrual based accounting systems and their implications for current accounting reform efforts in the municipalities of Nepal. It is meant to inform interested stakeholders about accrual accounting implementation preconditions and implementation scenarios drawing from international as well as past udle (MLD-<strong>GTZ</strong>) experiences. The first part of the report offers an in depth analysis of the system, characteristics, advantages and disadvantages of cash accounting as well as accrual accounting for local governments. It provides information in how accrual accounting can be adjusted for local governments needs, acknowledging the special situation for such attempts in developing countries. The second part of the report describes and analyses past udle activities in accrual accounting implementation and reflects on today’s current situation in the Nepalese municipalities concerning accrual accounting. The third part displays, drawing from international and past udle experiences, recommendations and preconditions when implementing accrual accounting in the municipalities of Nepal. Based on that, a macro as well as micro level implementation strategy is being presented. Drawing from the research and findings, this report recommends at least a modified accrual accounting to be adopted by the municipalities of Nepal. However the author is very much aware of the different situations, experiences and constraints in the municipalities. Therefore an incremental approach which starts first with a focus on accrual accounting booked cash transactions in order to improve revenue management (e.g. for taxes) and expenditure management is being suggested. Only if feasible for the municipality, asset management, meaning the valuation of assets and strategic planning, should be implemented since it requires a higher skill level. All in all municipalities in Nepal are at a critical phase of existence. With the abolishment of the Local Development Fee by 2011 the local governments are under huge pressure to increase their own resources and to allocate them wisely and effective. Accrual Accounting can be important to achieve this and is therefore a part of this broader municipal finance reform. Ones implemented, accrual accounting will also affect current budgeting, reporting and auditing principles since accounting is only one part of a public financial system.
Cash Accounting vs. Accrual Accounting 2 02. Cash Accounting vs. Accrual Accounting 2.1. Definition and comparison of the Cash Accounting System and the Accrual Accounting System Definition of Cash Accounting The cash accounting system primarily focuses on the inflow and outflow of cash transactions within one period. That is why it only knows two accounts in its pure form – the cash inflow account (cash receipts) and the cash outflow account (cash payments) and therefore can only produce cash flow statements that cover cash inflow, cash outflow as well as opening and closing cash balances. Transactions are only recorded when the money for revenues actually is received and on the other side expenditures are only recorded when they are actually paid. This is related to the development of accounting systems in the past. In former times there was no major time difference between the receipt and payment of a certain good, which is why it was not necessary to develop separate accounts in order to reflect this time gap through receivables or payables or whatsoever. This has the effect that cash accounting is blind towards future revenues or expenditures until they are recorded in the cash accounts. Besides that the cash accounting system does not recognize the interlinkage between the source and the application of funds, since the sums normally simply “appear” in the cash inflow or cash outflow account without a connection. Therefore one can not track down the linkage between the money (e.g. taxes or fees) that was used to achieve a certain outcome (e.g. a new bridge). For the same reason one can not connect received cash to the total cash to be received (e.g. in tax management). Furthermore the cash accounting focuses only on cash and therefore doesn’t reflect the status, value or wear and tear of assets and resources and therefore has no incentive for planned, strategic maintenance or reinvestment. Thus it is possible that a municipality lives from their “asset substance” e.g. a street by not acknowledging that assets are devaluing when being used. Therefore maintenance of and reinvestments into assets are not specifically planned in cash accounting or cash budgeting and because of this, necessary “sudden” maintenance or the reinvestment into an asset at risk (e.g. a bridge with cracks) might not be affordable for municipalities in a current fiscal situation. Cash Accounting is the dominant public sector accounting system. Definition of Accrual Accounting On top of the known cash transaction accounts from the cash based accounting system, the accrual accounting system knows multiple accounts, like receivables, payables, asset accounts, depreciations to be made on assets. Therefore it can provide a complete financial overview of e.g. a municipality. It displays full financial information on all cash transactions, assets, resources, resource consumption, true costs, arrears and current as well as future liabilities and revenues. Moreover it recognizes economic events and transactions
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Page 37: References 34 Schiavo-Campo, S. & T

GTZ Report on Accrual Accounting Status Quo - LGCDP

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