Implementing Full Accrual Accounting
In this budget the Government has moved to full accrual accounting as its accounting standard. Full accrual accounting replaces the previous accounting standard, modified accrual. The Auditor General recommended the shift to full accrual accounting as soon as the outstanding issues causing delays were resolved. Following extensive consultations with the Office of the Auditor General, the Government believes that there is now sufficient quality assurance as to the reliability of the accrual accounting numbers. The Government noted that it intended to take this step in last October’s Economic and Fiscal Update .
What Is Full Accrual Accounting?
The Government’s previous accounting standard—modified accrual—used a mix of accrual and cash accounting, depending on the type of transaction. With this budget the Government is extending the use of accrual accounting to all items that were previously recorded on a cash basis. Accordingly, the new accounting standard is called full accrual accounting.
Under modified accrual accounting, the value of the Government’s stock of capital assets, such as buildings, vehicles and equipment, was not shown on the Government’s balance sheet. Under full accrual, the cost of these non-financial assets will now be recorded. Under modified accrual accounting, the full purchase price of a capital asset was shown as an expenditure item in the year of purchase and therefore had an immediate impact on the annual budgetary balance. Under full accrual, the annual cost of owning a capital asset will be the estimated depreciation (or amortization) in the value of the asset according to Generally Accepted Accounting Principles. Full accrual accounting therefore spreads the cost over the useful life of the asset. Similarly, under modified accrual, the cost of an item held in inventory is recognized in the year in which the item is purchased while, under full accrual, it is recognized as an expense in the year in which the item is used.
Example: The Canadian Coast Guard Buys a New Icebreaker
Under modified accrual accounting:
- The ship is not included as part of the Government’s assets. Other things being equal, the federal debt (accumulated deficit) increases by the amount of cash used to pay for the ship, in the year in which the Canadian Coast Guard takes ownership, without any recognition that this cash has purchased a long-lived asset.
- The only part of the annual cost of owning the ship that is recorded is the annual cash outlay for operations and maintenance.
- The ship is included as part of the Government’s assets, offsetting the reduction in cash needed to pay for the ship.
- The annual cost of owning the ship is reported as the depreciation in the value of the ship plus the cash outlays for operations and maintenance.
Under modified accrual accounting, tax revenues were recorded on a cash basis in the year they were received. Refunds were charged against revenues in the year in which the refunds were paid. Under full accrual accounting, tax receipts and refunds will generally be recorded in the year in which the taxable activity took place, not when cash payments occurred. Accordingly, a receivable will be established for taxes still owing to the Government and a payable will be established for tax refunds owing to taxpayers.
Example: Taxes and Refunds
There are significant collection lags between the time that a taxpayer earns taxable income and when the associated taxes are actually received by the Government. For example, individuals are required to file their final tax returns by the end of April for the previous taxation year. This results in a significant amount of taxes received in April and May on income earned in the previous taxation year. It also results in tax refunds being paid in the period April to June for overpayment of taxes made in the previous taxation year.
Under modified accrual accounting:
- Taxes paid when income tax returns were filed after March 31, 2001, were recorded as revenue in fiscal year 2001–02, which began April 1, 2001, even though those payments arose from income earned in 2000. Refunds to taxpayers paid after March 31, 2001, were charged against revenues in fiscal year 2001–02, even though these payments returned overpayments made in 2000.
- There is no recognition of taxes due to the Government or refunds due to taxpayers. They are only recorded when they are received or paid.
Under full accrual:
- Taxes paid in fiscal year 2001–02 that relate to the year 2000 are recorded in fiscal year 2000–01, to the extent that reliable estimates can be made. Refunds to taxpayers paid in fiscal year 2001–02 are charged against revenues in fiscal year 2000–01, as those refunds reflect overpayments made in 2000.
- A receivable is established for taxes owed to the federal government on March 31, 2001, for taxation year 2000. Similarly, a liability, or payable, is established for taxes still to be refunded to taxpayers as of March 31, 2001.
Under full accrual accounting, a more comprehensive list of liabilities will be recorded on the balance sheet. As a result of the shift to full accrual accounting, the Government will now include the estimated cost of environmental clean-ups in areas of federal jurisdiction; the value of liabilities related to Aboriginal claims to the extent payment is likely and estimable; and increased liabilities for post-employment benefits for federal employees, including workers’ compensation, veterans’ disability costs, and federal employee retirement benefits such as health and dental care.
Example: The Cost of Cleaning Up Federal Contaminated Sites
Under modified accrual accounting:
- The Government’s estimated liability for cleaning up its existing contaminated sites is included on its balance sheet.
- Expenditures for cleaning up these contaminated sites are not included as expenses in the years in which payments are made because they reduce, dollar-for-dollar, a liability that has already been recognized on the Government’s books.
- New liabilities will be included in the year in which they become known.
Example: Disability Benefits for Veterans
Under modified accrual accounting:
- The Government’s liability for veterans’ disability benefits is not recognized on its balance sheet.
- Expenditures for veterans’ disability benefits are recognized in the fiscal years in which the payments are made.
Under full accrual:
- The Government’s liability for veterans’ disability benefits is recorded on its balance sheet. This is the present value of all expected future payments for these veterans’ future benefits as a result of past services provided by veterans.
- Payments for veterans’ disability benefits are no longer reported as expenditures in the years in which payments are made, but instead reduce the liability that has already been recognized on the Government’s books.
- For currently serving members, the annual expense cost reflects the net present value of all future payments expected as a result of new disabilities arising during the year.
- Each year, as the liability is adjusted to reflect its current actuarial value, an interest component is added and charged to public debt charges, similar to the recording of the liability for federal employees’ pensions.
- Thus one result of moving to accrual accounting is an increase in recorded public debt charges. However, the increase will have no impact on cash outflows.
What Are the Benefits of Full Accrual Accounting?
Full accrual accounting improves transparency and accountability by providing more comprehensive and up-to-date financial statements and greater accountability by the Government to Parliament and the Canadian public.
- The Government’s balance sheet will provide a more comprehensive picture of the Government’s assets and liabilities. For example, the cost of the buildings that the Government owns will appear on its balance sheet for the first time, as will its liabilities for cleaning up contamination on its properties.
- The annual
budgetary balance will better reflect the impact of economic events during the fiscal year. In particular, year-to-year changes in recorded tax revenues will more accurately reflect the year-to-year changes in the tax base and tax rates, as these changes will not be affected by lags in tax collections and the payment of refunds.
- The annual budgetary balance will better reflect the impact of government decisions during the fiscal year. In particular, government decisions that cause an increase (or decrease) in the Government’s liabilities for post-employment or retirement benefits will be recorded in the year in which the decision was made. Under modified accrual accounting, the full costs of some of these decisions would not be shown in the Government’s financial statements until all of the resulting cash payments were made many years later.
Full accrual accounting enables more effective decision making about government operations, spending and longer-term risks and obligations.
- As full accrual accounting recognizes the value of the Government’s physical assets in its financial statements, it requires the Government to recognize the amortization of those assets as a cost. This will lead to better recording of assets, and encourage better stewardship of those assets and better decisions about whether to buy, lease or sell buildings and equipment.
- Full accrual accounting will show more accurately the cost of owning and operating capital equipment, providing a better picture of the cost of providing programs and services, and better relate decisions about whether to buy, lease or sell buildings and equipment.
- More complete recording of the Government’s liabilities (i.e. environmental liabilities, liabilities to Aboriginal peoples and liabilities for retirement and post-employment benefits) will encourage departments to develop better plans for managing those liabilities.
The Public Sector Accounting Board of the Canadian Institute of Chartered Accountants (CICA) recommends that senior levels of government adopt full accrual accounting in the presentation of their financial statements. [1 ] In their "Observations" on the Government’s financial statements, Auditors General have strongly encouraged the Government to adopt full accrual accounting. It is the accounting practice already used by six provinces—including Quebec, Ontario and Alberta—and by foreign governments such as Australia and New Zealand. Among G7 countries, the United Kingdom has announced its intention to move to accrual accounting.
The Treasury Board Secretariat has established a working group on accrual budgeting to examine the potential application of accrual information to the budgetary process. The working group is examining how accrual concepts bear on many types of decisions, drawing on the experience of other governments that have implemented accrual accounting. For the present, appropriations by Parliament will remain unchanged.
The Benefits of Full Accrual Accounting
As the Auditor General indicated in her comments on the Government’s 2001–02 financial statements:
"I remain convinced that accrual accounting is superior to the Government’s current accounting policies. It provides a more complete measure of the overall size of the Government, which should enhance accountability to Parliament; it eliminates the distortion of reported financial results caused by altering the timing of cash receipts and disbursements; and it is an essential component of management reform initiatives underway in the Government."
Auditor General of Canada
Why Implement Full Accrual Accounting in This Budget?
The Government has been working towards full accrual accounting since the 1995 budget. The Treasury Board Secretariat has developed accrual accounting policies. The Receiver General for Canada and departments have put in place new financial information systems and acquired the accounting expertise needed to report on the greater range of financial activity that this approach requires. The phase-in by departments started in April 1999 and was completed in April 2001.
In the 2001 budget the Government announced that it had decided to delay the move to full accrual by at least one year given the timing of the budget and the fact that important components of the information required to implement accrual accounting had yet to be audited and verified. In her "Observations" on the 2002 Public Accounts last fall, the Auditor General encouraged the Government to resolve the issues which had caused delays in the introduction of full accrual accounting and to implement it for the 2002–03 financial statements. Given the progress that has been made since that time in finalizing the estimates, and working closely with the Office of the Auditor General, the Government is now confident it can introduce accrual accounting.
How Does Full Accrual Accounting Affect Fiscal Planning?
The Government’s fiscal anchor remains the annual budgetary balance. With the implementation of full accrual accounting, there will be changes to how the annual budgetary balance is calculated. Details on these changes and how they affect the reported results are provided below.
Federal Debt (Accumulated Deficit)
The Government will continue to use the accumulation of all annual surpluses and deficits in the past, or the accumulated deficit as it is labelled in the Public Accounts of Canada. to measure the debt and the debt-to-GDP (gross domestic product) ratio. For communications purposes, the accumulated deficit will also be referred to as the "federal debt."
Prior to the shift to full accrual accounting there was no distinction between net debt and the accumulated deficit, so these terms were used interchangeably. With the implementation of full accrual accounting that is no longer the case. Net debt is the Government’s liabilities excluding the value of its non-financial assets. The accumulated deficit, however, takes into account the value of the non-financial assets. With the shift to full accrual accounting and the resulting inclusion of non-financial assets, the two indicators will represent different measures of the Government’s financial position.
What Is the Impact of Implementing Full Accrual Accounting on the Government’s Financial Statements?
The implementation of full accrual accounting affects the financial position (the statement of assets and liabilities) of the Government of Canada and therefore the annual change in assets and liabilities, or the budgetary balance.
The most comprehensive measure of the Government’s overall financial position is the accumulated deficit or the federal debt. This is the difference between the Government’s total liabilities and its total assets. Accordingly, it is also equal to the accumulation of annual deficits and surpluses since Confederation.
- Under full accrual accounting, the Government’s liabilities will include a number of liabilities not previously recognized. These include liabilities for: environmental clean-ups on federally owed lands; Aboriginal claims; post-employment benefits such as veterans’ disability costs, workers’ compensation and retirement benefits for dental and health costs of federal public servants; and tax refunds payable by the federal government. As shown in Table A6.1, the net impact of these accrual adjustments is to increase total liabilities by $71.0 billion at March 31, 2002.
- Under full accrual accounting, the Government’s assets also include financial assets that were not taken into account before, namely tax receivables (taxes owed by taxpayers) and the value of the Government’s holdings in its enterprise Crown corporations. The value of these assets amount to $45.9 billion at March 31, 2002. The Government’s assets also include non-financial assets, such as tangible capital assets, inventories and prepayments. The value of these non-financial assets is estimated at $53.8 billion at March 31, 2002. Thus total recorded assets increase by $99.7 billion at March 31, 2002.
- As the increase in the value of the assets more than offsets the additional liabilities, the federal debt (i.e. total liabilities net of all financial and non-financial assets) is $507.7 billion at March 31, 2002, under full accrual accounting, $28.7 billion lower than the corresponding figure calculated using modified accrual accounting.
- Net debt, which excludes non-financial assets, is now estimated at $563 billion at March 31, 2002, compared to $536 billion under modified accrual. This occurs because the value of the financial liabilities that are added to the balance sheet in shifting to full accrual is greater than the value of the additional financial assets (as shown in Table A6.1).
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