GTZ Report on Accrual Accounting Status Quo - LGCDP
GTZ Report on Accrual Accounting Status Quo - LGCDP GTZ Report on Accrual Accounting Status Quo - LGCDP
Cash Accounting vs. Accrual Accounting 3 when they occur rather when money is actually exchanged. This effectively addresses the time difference between the receipt and payment of goods and also makes future strategic planning and multiple years planning possible. For example an accountant knows that in the fiscal year of 2008/2009 a certain total amount of tax is to be received even though it is not yet paid by the tax payer. As a result the accountant would be able to track down the reason for arrears. Transactions always affect two accounts in the accrual based accounting, the credits and debits side, which always have to be matched and balanced. Therefore it is possible to show the source and application of funds which makes an allocation of resources according to specific cost centres possible. For example a cost centre can be created for a bus park by showing the revenues but also the matched expenses (e.g. operational and maintenance cost) of the bus park. This would make the calculation of product costs possible. For example one could calculate an appropriate bus ticket fee in order to cover all the expenses of the bus park. However, cost centres can also be established for individuals (e.g. in tax management), projects, departments and so on. The connection of the source and application of funds also makes performance based budgeting, reporting, auditing and in general outcome orientation possible since one knows the crucial linkage between what was invested by whom to achieve a certain outcome. For this reason accrual accounting has the potential to change the steering tools on which cash accounting is based on towards performance and outcome orientation. For example accrual accounting provides a mayor or executive officer with much more financial information which enables him to optimize the budgeting process. Another major characteristic of accrual accounting is the usage of depreciations and/or reserve allocation in order to reflect the wear and tear of assets and future resource consumption. Depreciations are bookings, used to artificially display the real happening devaluation of e.g. a street through usage. Reserve allocation is a connected tool to reserve money for maintenance or reinvestment in order to address this devaluation. Through the income statement, where total revenues are matched to expenses, the net resource consumption of e.g. a municipality is being displayed. The income statement together with the balance statement of financial position displays the profit or deficit of a financial period. Accrual based accounting is the dominant private sector accounting system. Overview 1: Cash Accounting vs. Accrual Accounting (Broader Overview available under Athukorala & Reid, 2003, p.26-27) Cash Accounting Accrual Accounting Full knowledge of all payment flows Only cash transactions Complete financial overview possible Time of booking Recognizes transactions and economic Recognizes transactions and economic events only when cash is received or paid events when they occur Management of Assets and Resources No single accounts for assets and resources Full knowledge on the value of resources and assets
Cash Accounting vs. Accrual Accounting 4 Depreciations, reserves, revenue, expenses Cost and results accounting Not possible No knowledge of costs by specific cost centres or service products since the linkage between source and application of funds is missing; no matching of revenues and expenses Resource consumption and the wear and tear of resources is displayed Full knowledge of true costs by specific cost centres and products 2.2. Advantages and Disadvantages of Cash Accounting and Accrual Accounting Advantages of Cash Accounting Most of all cash based accounting is simple, cheap and objective in its operation and is therefore less knowledge intensive (SAFA, 2006, p.3). It provides basic financial information about liquidity and solvency by producing cash statements. In addition, this system fits easily to most government budget, reporting and auditing principles since these are usually cash based until now. Disadvantages of Cash Accounting However, cash accounting does not provide sufficient information about non monetary resources like assets, receivables, payables, true costs, liability or revenue arrears and future liabilities (e.g. pensions) (World Bank, 2007, p. IX; SAFA, 2006, p.3). Another point is that even though it provides cash statements one cannot interpret the source and application of funds on these statements (Athukorala & Reid, 2003, p.18). Therefore a municipal government might recognize that a total amount of money was spend according to the budget plan but it can not evaluate exactly for what purpose that money was used. During auditing the municipal government can therefore not evaluate if the provided total amount of money was really necessary to achieve a certain planned outcome since the direct booked linkage is missing. For these reasons it lacks outcome orientation. Moreover it cannot provide information on resource consumption, meaning the wear and tear of assets, and therefore does not acknowledge financially the devaluation and necessary maintenance when using a street, a car or a bridge. For this reason it has no possibility to plan ahead strategically since maintenance, total amounts to be received from e.g. taxes or total amounts to be paid (loan payments for instance) can not be displayed. Therefore no systematic asset management, debt management and resource allocation according to cost centres is possible. As an aftermath it is possible that municipalities with cash accounting live from their asset substance and suddenly need large unplanned reinvestments into old infrastructure. Furthermore, other weaknesses are the lack of accountability and the lack of
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- Page 3 and 4: Contents 01. Executive Summary (p.1
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- Page 33 and 34: Annex 30 05. Annex Annex 1 IPSAS Li
- Page 35 and 36: References 32 06. References ADB (2
- Page 37: References 34 Schiavo-Campo, S. & T
Cash <strong>Accounting</strong> vs. <strong>Accrual</strong> <strong>Accounting</strong> 4<br />
Depreciati<strong>on</strong>s, reserves, revenue,<br />
expenses<br />
Cost and results accounting<br />
Not possible<br />
No knowledge of costs by specific cost<br />
centres or service products since the<br />
linkage between source and applicati<strong>on</strong><br />
of funds is missing; no matching of<br />
revenues and expenses<br />
Resource c<strong>on</strong>sumpti<strong>on</strong> and the wear<br />
and tear of resources is displayed<br />
Full knowledge of true costs by specific<br />
cost centres and products<br />
2.2. Advantages and Disadvantages of Cash <strong>Accounting</strong> and <strong>Accrual</strong><br />
<strong>Accounting</strong><br />
Advantages of Cash <strong>Accounting</strong><br />
Most of all cash based accounting is simple, cheap and objective in its operati<strong>on</strong> and is therefore less knowledge<br />
intensive (SAFA, 2006, p.3). It provides basic financial informati<strong>on</strong> about liquidity and solvency by producing cash<br />
statements. In additi<strong>on</strong>, this system fits easily to most government budget, reporting and auditing principles since these<br />
are usually cash based until now.<br />
Disadvantages of Cash <strong>Accounting</strong><br />
However, cash accounting does not provide sufficient informati<strong>on</strong> about n<strong>on</strong> m<strong>on</strong>etary resources like assets,<br />
receivables, payables, true costs, liability or revenue arrears and future liabilities (e.g. pensi<strong>on</strong>s) (World Bank,<br />
2007, p. IX; SAFA, 2006, p.3). Another point is that even though it provides cash statements <strong>on</strong>e cannot interpret the<br />
source and applicati<strong>on</strong> of funds <strong>on</strong> these statements (Athukorala & Reid, 2003, p.18). Therefore a municipal<br />
government might recognize that a total amount of m<strong>on</strong>ey was spend according to the budget plan but it can not<br />
evaluate exactly for what purpose that m<strong>on</strong>ey was used. During auditing the municipal government can therefore not<br />
evaluate if the provided total amount of m<strong>on</strong>ey was really necessary to achieve a certain planned outcome since the<br />
direct booked linkage is missing. For these reas<strong>on</strong>s it lacks outcome orientati<strong>on</strong>. Moreover it cannot provide<br />
informati<strong>on</strong> <strong>on</strong> resource c<strong>on</strong>sumpti<strong>on</strong>, meaning the wear and tear of assets, and therefore does not acknowledge<br />
financially the devaluati<strong>on</strong> and necessary maintenance when using a street, a car or a bridge. For this reas<strong>on</strong> it has no<br />
possibility to plan ahead strategically since maintenance, total amounts to be received from e.g. taxes or total<br />
amounts to be paid (loan payments for instance) can not be displayed. Therefore no systematic asset management,<br />
debt management and resource allocati<strong>on</strong> according to cost centres is possible. As an aftermath it is possible that<br />
municipalities with cash accounting live from their asset substance and suddenly need large unplanned<br />
reinvestments into old infrastructure. Furthermore, other weaknesses are the lack of accountability and the lack of
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