This article first appeared in The Edge Malaysia Weekly on May 17, 2021 - May 23, 2021

THE Covid-19 pandemic could be an opportune time for Malaysia to adopt accrual accounting for its public sector, as it could be the building block needed to enhance the public’s trust in government finances.

In the Mid Term Review of the 11th Malaysia Plan in 2018, former finance minister Lim Guan Eng had said that the then Pakatan Harapan government was committed to the shift from cash-based accounting standards to accrual accounting standards by 2021. He also said then that accrual accounting would provide comprehensive financial reporting, which includes government guarantees, contingent and future liabilities, as well as other commitments of the government.

At present, however, the Accountant General’s Department of Malaysia still adopts Cash Basis International Public Sector Accounting Standards (IPSAS), though policymakers have been talking about a move to an Accruals Basis IPSAS for some time now.

In layman’s terms, accrual accounting is a method whereby revenue or expenses are recorded when a transaction occurs rather than when payment is received or made. This is opposed to cash accounting, where payment receipts are recorded during the period in which they are received, and expenses are recorded in the period in which they are actually paid.

In a cash accounting balance sheet, assets, liabilities and equity are recorded, but line items such as payables and receivables are excluded — in line with the principle that only transactions done on cash terms are recorded.

Institute of Chartered Accountants in England and Wales (ICAEW) director of public sector Alison Ring says there are many benefits to adopting accrual accounting, with the key vital benefit being that it helps policymakers make better decisions about the future.

“Accrual accounting tells you about what assets and resources you have, and also about your liabilities, how you are going to pay for those items on your balance sheet. Therefore, you can then forecast the income that you would need to raise to pay off those liabilities — just like in accounting for corporates.

“In this way, finances are more transparent, and you will have that honest dialogue with citizens on what assets the government actually holds, and it also allows you to assess whether you have created value for money for a particular policy that was implemented. For example, Malaysia’s National Employment Council says it plans to create 160,000 jobs this year, which will involve an outlay of government expenditure. Thus, accrual accounting [through the notes to accounts] will describe the outcome of that policy — in terms of how many jobs were created and are those jobs sustainable,” she tells The Edge in a recent interview.

Martin Wheatcroft, an external adviser to ICAEW on public finances who was also present at the interview, concurs. He says accrual accounting is a building block that comes with “a whole package of things”.

“To implement it, you need to have trained accountants, solid financial systems in place and strong financial management for managing projects to ensure that costs are kept within the budget,” he says.

It is also because of those added requirements that the transition from cash-based to accruals-based accounting is an uphill task for governments, and why it is taking some time for them, including Malaysia, to make the change.

Ring says: “Arguably, it takes a lot of work. Accrual accounting is just one element of it and having it on its own is just not enough. You are going to need a skilled workforce, a good data system, a good financial reporting system but, most importantly, you are going to need the political will to push that transition forward.

“Also, once the reporting is in place, you need to have the independent scrutiny [or a good audit system for checks and balances] and the legal and institutional frameworks in place, for example, which accounting standards are you going to adopt — International Financial Reporting Standards or International Public Sector Accounting Standards? So, there is a lot that needs to be put in place, and that is why it is quite a challenge to do.”

The 2018 Index Status Report by the Chartered Institute of Public Finance and Accountancy and the International Federation of Accountants, which captures information from 150 countries, found that while 25% of governments currently report on an accrual basis, 65% of governments will report on an accrual basis by end-2023. Asia, Africa and Latin America and the Caribbean will lead the projected increase by end-2023. It should be noted, however, that an updated version of the study, which should take into account the impact of the Covid-19 pandemic, has yet to be released.

On which country has set the “gold standard” for accrual accounting, both Ring and Wheatcroft agree it is New Zealand.

“New Zealand is probably the flagship country that everyone highlights when it comes to accruals accounting, and that’s probably because they use it not just for day-to-day accounting but also for their budgeting process. They have reaped the best benefits from that, as, pre-pandemic, they had one of the strongest balance sheets for a developed country and, obviously, they had a more resilient balance sheet going into the pandemic,” says Wheatcroft.

Assets that a country holds today may not just be limited to traditional tangible fixed assets, but would also include intangibles such as data, says Ring.

“In Malaysia, with the Digital Economy blueprint being rolled out, a lot of public sector information is going to be on the cloud — which is great, but the question is what do you do with the asset and how do you best use it to benefit your citizens?

“For example, if you have an ageing population, how do you use that information, together with financial information, to make the right policy decisions regarding social security and healthcare?” she says.

The benefits of implementing accruals accounting outweigh the challenges posed in implementing it, especially in the long run.

Wheatcroft says: “It might seem like a lot of money to properly implement accruals accounting for the first time and going from zero to 100, but in the overall scheme of things, it’s a relatively small investment and the benefits are huge in terms of better information, which will help in longer-term decision making that can be worth huge amounts of money. In other words, the better decisions that you make can cover the costs of initial implementation.

“Cash accounting allows you to manage today, whereas accruals accounting allows you to manage tomorrow.”

The transparency of accrual accounting also creates that bond of trust between citizens and government, says Ring.

“If the citizen can see what the government’s money, or the taxes that they pay, are being channelled to, it strengthens that bond of trust between the government and its citizens.

“Overall, you will get a better sense of the financial position of the country, particularly now, if you are thinking about things such as climate change and how the country is going to demonstrate its ambition to have a sustainable economy,” says Ring.

Having an accruals accounting system in place would also help reduce the likelihood of financial scandals, such as that of 1Malaysia Development Bhd.

Ring says: “You are never going to have certainty that there won’t be any financial scandals but, because you have that financial transparency with accruals accounting and everything is independently scrutinised, that gives you that reduced likelihood of that happening

“In the public sector in the UK, for example, you have non-executive directors who sit on the boards of public sector departments, so they give that independent scrutiny, and they have the skills and competency to do this job, which is important for good governance.

“In the private sector, there is an emphasis on good corporate governance, which is good for the financial growth of the company. So, why wouldn’t you want to have the same for the public sector? And, in fact, we should be strengthening that.”

With governments including Malaysia spending billions to roll out stimulus packages as a result of the Covid-19 pandemic, it is therefore imperative that good financial management — be it on accruals or cash basis — is in place to ensure that the government’s funds are rightly allocated to the most deserving groups.

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