Jim Brooks looks at how new international accounting standards are having an impact on public sector accounting in the UK.
International accounting standards increasingly affect the way the public sector reports its annual revenue and capital activities. And this has had a profound but also unseen effect on the philosophy of governance and stewardship. Local authorities traditionally report for the twin accountability – first, to local taxpayers, and second, to the Government.
It has always been notoriously difficult to compare different local authorities through the annual reporting mechanisms, and there have been many attempts, particularly over the last 30 years, to enable meaningful comparisons to be made. Of all the possible ways to make these comparisons, the annual accounts and balance sheet has probably been the least well-used.
So why the sudden emphasis on international accounting standards?
Part of this drive is to ensure that the strength and performance of public sector companies and other organisations, as described by the annual accounts and balance sheet, can be compared across the world.
The accounts are intended to be compiled on the basis of accepted criteria and audited to exacting standards.
The recent scandals of international companies deliberately misrepresenting their financial strength, or rather weakness, has added emotion and a sense of outrage to the rather cold, technical debate that previously characterised the discussions. The heat in the argument reflects the international nature of financial markets.
Many individuals have savings and pension-based investments in both foreign and domestic markets, and have a direct stake in their financial performance. So, we need to be able to compare these organisations, particularly in terms of their profitability and financial strength. Such investment decisions depend on it.
One by-product of international accounting standards is that local authority balance sheets are now much more usable, in terms of explaining the financial strength of an authority.
Comparisons over time and with other authorities are now valid in new and interesting ways. Previously, they were arcane and labyrinthine documents which few people understood. Even fewer could compile them and positively nobody read them. I am confident that comparisons between councils will begin to have much greater validity and balance sheets will be much more in evidence in future. CIPFA produces an annual Statement of recommended practice (SORP) which explains how the new accounting standards are to be introduced into the public sector and the impact in the coming year. Ironically, the extent of these annual changes sometimes makes it harder to compare accounts and balance sheets over time. The CIPFA SORP for 2007 is particularly challenging for directors of finance. Even though it is unlikely that the rules will be fully in place by 1 April 2007, it is imperative that a number of the accounting practices are reviewed prior to 31 March, particularly in relation to commercial debt such as LOBOs, premia and discounts and investments. There are grey areas where judgements will need to be taken, and some of these carry financial risk. The Audit Commission also produces an annual guidance to external auditors which explains where audit effort is to be concentrated each year. Two other big changes loom on the accounting horizon. The first is whole-life costing, and the second is depreciation accounting. Both of these are likely to have important effects on local authority capital spending decisions. Both these charges may well exacerbate the cautious approach we have in the UK toward investing in our infrastructure.
Experts in the financial regulatory framework which governs the public sector, pull their hair out at the way the accounting standards sometimes impact on public organisations. We regularly deal with the unforeseen implications for financing decisions, investments and the proactive management of outstanding debt.
There is a real danger that viable commercial, financial opportunities currently available within the public sector could almost accidentally be outlawed by the interaction of accounting standards and complicated financial regulations designed to control and regulate local authorities and public organisations.
This runs counter to the Government's stated wish to free-up local constraints from red tape and to rely on the Prudential code for overall control and finances.
This is yet another way in which the role of a director of finance is complicated. Already carrying overall responsibility for the finances of the authority, and with statutory responsibilities as a tax collector and a fiduciary duty to taxpayers, the requirement to be expert in the complexion of local government finance, commercial financing mechanisms and international accounting standards reveals a facet of the director of finance's work, rarely seen outside its own, cloistered boundaries. w
Jim Brooks is executive director of Sector Treasury Services.