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Go figure: why public accounting doesn't add up on social value

Accounting in the public sector should be all about serving the public interest, right? But what if the current system overlooks people’s wellbeing to focus only on financials – and what if public sector accounts are ‘materially misstated’? Our columnist gets anxious as he submerges himself in the alphabet soup of global public sector accounting standards – and proposes a simple addition to bring social value back to the surface.

First published by Pioneers Post

Financial reporting provides information for primary users (investors, providers of loan finance and suppliers) so they can make decisions about providing resources to entities (businesses) in the expectation of future financial returns. This is not a good basis for running an economic system, as it ignores any consequences that do not affect financial returns. (Even when they do affect financial returns, current reporting standards mean that many of the consequences are not included or only in a very limited way in financial statements.) It is even less convincing as a basis for public sector accounting, where decisions are made in the wider public interest.

Current interest in sustainability and accounting has focused on the private sector, despite 40% of the world’s economy being in the public sector

The current interest in sustainability and accounting has focused on the private sector, despite 40% of the world’s economy being in the public sector. The public sector has a different audience and purpose when making decisions about providing resources to entities (businesses, charities, semi-public bodies, local authorities, etc). The private sector focuses on private returns to individuals and the public sector focuses on social returns to society.

This has led me to two conclusions. Firstly, that we need to turn our attention to public sector accounting standards. And secondly, that these standards result in accounts that do not meet the information needs as set out in those standards. To do so, they would need to merge with cost benefit analysis, a well-established approach for assessing both social and economic benefits and costs of an investment or activity.

Who defines public interest?

Public sector accounting is guided by the International Public Sector Accounting Standards Board (IPSASB). This has 18 members, 15 from International Federation of Accountants (IFAC) member bodies, plus three members with expertise in public sector financial reporting. Its work is overseen by a public interest committee and members are appointed by IFAC, ensuring that the public interest is served in its standard setting activities.

IFAC’s website tells us that

“Appointments to the International Public Sector Accounting Standards Board are made by the International Federation of Accountants. The Committee does not get involved in decisions on individual appointments”

And that

“The Public Interest Committee is comprised of individuals with expertise in public sector or financial reporting, and professional engagement in organizations that have an interest in promoting high-quality and internationally comparable financial information.”

Hmmm. Where did that reference to financial information come from? And who determines what is in the public interest?

And just on consistency – as we are all so keen on that – the International Reporting Standards Foundation (IFRS) oversees the International Accounting Standards Board (IASB) which produces financial reporting standards, while IFAC looks after the International Auditing and Assurance Board which produces auditing standards for those financial reports. A clear separation of roles. If IFAC looks after the IPSASB which produces public accounting standards, who looks after the assurance of public sector reporting? Perhaps there is yet another body that handles the standard for auditing public sector accounts?

Turns out auditing standards are set by a country’s public auditor and so there are variations, but there is also… wait for it… the International Organisation of Supreme Audit Institutions (INTOSAI).

This may seem complex, but it is important to maintain this separation of roles. And INTOSAI produce the International Standards of Supreme Audit Institutions.

Back to IPSASB. The IPSASB’s standards come in three volumes. The first volume includes the Conceptual Framework for General Purpose Financial Reporting by Public Sector Entities, where Chapter 2 covers the objectives of financial reporting:

“The objectives of financial reporting by public sector entities are to provide information that is useful to users of General Purpose Financial Reports (GPFRs) for accounting purposes and for decision making purposes”

Ok, but who are the users?

“The primary users of GPFRs are service recipients and resource providers and their representatives”

Critically, the framework points out that:

“GPFR are developed to respond to the information needs of service recipients and resource providers who do not possess the authority to require a public sector entity to disclose the information they need for accountability and decision-making purposes”

It also tells us that ‘resource providers’ include taxpayers, donors and lenders.

This is all excellent!

In the next section on “Accountability and Decision Making” the framework goes on to cover what is meant by accountability and the purpose of any decisions. It reminds us that the primary purpose of government is to provide services that enhance or maintain the wellbeing of citizens and other eligible residents.

It keeps getting better! If only this was recognised as the primary purpose of private entities as well.

“The discharge of accountability obligations will also require the provision of information about such matters as the entities’ service delivery achievements during the reporting period.”

Good, but let us see where this goes. Performance in terms of increasing or maintaining wellbeing would be great, but if it is limited to reporting on indicators of activity and outputs, then not so good. And, in fact, later an example of information needs is provided that includes performance in meeting service delivery objectives. Which unfortunately excludes any other consequences arising in pursuit of those objectives…

But despite a framing in terms of wellbeing, and effectiveness in maintaining and enhancing wellbeing, something odd suddenly happens and that all vanishes. Suddenly, the standards leave wellbeing behind and focus on the financial position, the financial performance and cashflows. This, though, is only part of the information that is needed to make the stated purpose and user information needs. It is as if two different groups were involved in drafting: public policy people started and then handed over to financial accountants. Yes, it is important that public bodies account for how they have used resources, but this is only part of the objective. What we also need to know is how effective the use of those resources was in enhancing and maintaining wellbeing.

Wellbeing first

Wellbeing is so important though, that the public sector does also create this information. Not with the same regularity or granularity. But it is there. It is just that is called cost benefit analysis, which is a well-recognised approach for assessing the wider social and wellbeing benefits and costs, as well as economic benefits and costs, of an investment, a project or an activity. If we are serious about the audience and purpose of public sector accounting – enhancing and maintaining wellbeing – then we need to combine cost benefit analysis with financial accounting.

If we are serious about the purpose of public sector accounting, then we need to combine cost benefit analysis with financial accounting

In the UK, this is set out in the Green Book which is central government’s guidance on appraisal and evaluation. Here are the relevant sections:

2.2 Appraisal is the process of assessing the costs, benefits and risks of alternative ways to meet government objectives. It helps decision makers to understand the potential effects, trade-offs and overall impact of options by providing an objective evidence base for decision making.

2.3 The appraisal of social value, also known as public value, is based on the principles and ideas of welfare economics and concerns overall social welfare efficiency, not simply economic market efficiency. Social or public value therefore includes all significant costs and benefits that affect the welfare and wellbeing of the population, not just market effects. For example, environmental, cultural, health, social care, justice and security effects are included. This welfare and wellbeing consideration applies to the entire population that is served by the government, not simply taxpayers.

2.30 Evaluation is the systematic assessment of an intervention’s design, implementation and outcomes. It tests: if or how far an intervention is working or has worked as expected; if the costs and benefits were as anticipated and whether there were significant unexpected consequences.

It is as if two different groups were involved in drafting: public policy people started and then handed over to financial accountants

It is all about wellbeing! And evaluation here is the equivalent of an income and expenditure statement, if wellbeing replaced income. And seems exactly what would be needed to meet the stated objectives of the public accounting standards and information needs of the users.

As the standard says, the user of government accounts is the public, taxpayers, eligible residents and service recipients. Not that every member of the public will be spending Sunday afternoons poring over the accounts, any more than you might look at the accounts of any of the companies in your pension pot. But the way in which they are prepared should be based on providing information to those with an interest.

The public has two interests: first, how was my money spent, and second, what happened to wellbeing as a result.

Separating the answer to these questions has led to a difference between public sector accounting (how my money was spent) and cost benefit analysis (what happened as a result of that expenditure). However, the IPSASB Conceptual Framework requires the information to be material, to include the issues that matter to the user. As they put it:

“Information is material if its misstatement or omission could influence the discharge of accountability by the entity or the decisions that user make on the basis of GPFRs [General Purpose Financial Reports] prepared for that reporting period.”

Unless we have the benefits included, in terms of wellbeing, as set out in the cost benefit analysis and the Green Book, surely public sector accounts are materially misstated?

Back to basics

Material misstatement seems a strong conclusion, so I look forward to finding out what I’ve missed.

But, on the off chance that there is an issue here, we can resolve it. Cost benefit analysis already provides for valuation so that we can report on those benefits and there are even specific approaches to valuing wellbeing. Of course, using a common unit for wellbeing risks hiding distribution effects – an additional £1,000 for one group does not have the same effect on wellbeing as it would for another group. Actually, this is no different to financial reporting. The value of a £1,000 dividend to one group is not the same as the value of £1,000 expenditure to a multinational supplier to that business.

This problem has been recognised in the public sector but, just as with financial reporting, the solution is so often to add things on to the current system rather than go back to basics to see if a more fundamental change would make things less complicated. In the UK, the Social Value Act requires commissioners to consider the social value being created and destroyed when commissioning public services. Sounds familiar. In June this year the UK government’s National Procurement Policy Statement required public entities to consider social value in their procurement decisions. The thinking processes to do this exist in accounting and cost benefit analysis. If these were merged, we would not need these additional initiatives.

Now that I come to think about it, if we are merging public accounting with cost benefit analysis and focusing on wellbeing, we should also merge all this with financial reporting. Financial reporting focuses on expected financial returns but, apart from that small subset of investors who are misers, no one is thinking about expected financial returns as an end in themselves. Those financial returns are spent to increase, or, as a minimum, maintain wellbeing. There is no point increasing returns by 10% if the spending power of those returns has gone down by 50% as the cost of water, energy and food goes through the roof. Money is a poor proxy for wellbeing, and it is time to replace it with more direct valuations of wellbeing. They won’t be perfect either, but they will be more useful.

Then we can have an approach to accounting, focusing on the needs of users’ needs to maintain or increase wellbeing, used by public, private and non-profit sectors. Sounds good to me!


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