Public Sector Organizations - Assignment Example

To what extent should the financial reporting practices of public sector organizations differ from those used by companies in the private sector? The public sector differs from the private sector in several fronts which is due to the basic difference in the structure and functions of both the sectors. It is believed that the private sector has major objective of profit making where as the public sector’s main motto is to look after the public welfare with equity in distribution of resources. There is a possibility of higher corruption in the public enterprises and hence needs separate accounting and monitoring system accordingly. One more important factor to be kept in mind is that the performance of public sector unit will directly contribute to country’s economy and the efficiency is to be accountable to the general public. Hence the financial accounting system is to be very strict to ensure the uniform justice. Making them profit driven is crucial for the whole nation as will add further to the gross domestic product of the country and for generating higher employment. In addition the reforms in public sector are needed for following factors which also decide the style of financial reporting in public enterprises. (a) to restructure and rationalise the public sector in order to lessen the dominance of unproductive investments in the sector; (b) to re-orientate the enterprises for privatisation and commercialisation towards a new horizon of performance improvement, viability and over all efficiency; (c) to raise funds for financing socio-economic developments in such areas as health, education and infrastructure; (d) to ensure positive returns on public sector investments in commercialised enterprises, through more efficient management. The financial reporting analysis studies indicated that majority private firms get involved in cost reduction activities and hence their efficiency is higher and hence public sector can follow this by implementing cost reduction measures with out affecting the social objectives. Matsumari and Matsushima (2004) conducted an investigation on mixed duopoly, in which a public enterprise with social objectives competes with a profit-maximizing private firm. The use of a Hotelling-type spatial model helped them in product differentiation. Similarly the production costs were reduced by following cost-reducing activities. It was also noticed that the private firms engage in excessive strategic cost-reducing activities and hence their production cost becomes lower than the public firm. It was also felt that privatization of the loss making public firms will result in reducing the operational losses and converting them in to profit making enterprises. The second factor that is to be kept in mind is that the source of funds for the public sector is from the public mainly where as the source of funding in private sector is from private individuals. Hence the public sector enterprises should be held highly responsible for the financial performance. It does not mean that the private sector should be neglected but it suggests that the private sector needs a separate style of financial reporting system. The users and stakeholders are another crucial component based on which the financial reporting should be analyzed. In case of public sector the end users and stake holders are comparatively of diverse in nature. In case of private sector, the end users are nothing but the customers. The financial reporting of public sector includes the total assets and total liabilities and their sub break up and net assets which is the difference between the assets and liabilities. The expenditure will also even the investment management, administration and operation charges 1. Similarly the liabilities of the government agencies must be reviewed properly for efficient cash and capital management 2. The public sector should be mainly held accountable for any financial discrepancy as the income for the developmental activities is contributed by the public and it has to reveal all the financial transactions with highest level of transparency. In case of private sector the accountability is judged in completely different manner. ---------------------------------------------------------------------- 1:http://www.kernfoundation.org/images/Annual%20Reports/2005/2005-Audit-Report.pdf. 2 : IFAC. Public sector accounting. Study 6 : Accounting for and reporting liabilities. http://www.ifac.org/Store/Details.tmpl?SID=95600191723319&Cart=11679600725138198. The main objective of such analysis is that any act of any employee which degrades the efficiency of the enterprise will be made accountable or responsible for such act. The main aim of this standard of maintaining transparency is to define the standards for disclosure requirements for public sector enterprises in their annual financial statements. The disclosure of appropriate information about the financial parameters of public sector units will enhance the transparency of financial reports, and provide for an improved coordination between the market and non-market activities of the government. This will also result in better understanding of financial statements and statistical bases of financial reporting of public sector units (IPSAS a, 2006). This much extent of transparency is not common in private sector as far as the financial reporting practices are concerned. The study of two types of financial accounting is crucial in public sector i.e. cash based financial accounting and accrual based financial accounting. However the selection has to be made based on the suitable identification of financial parameters (IFAC, 2000). The estimation of the tax will also vary from public enterprise to private enterprise. The main logic behind this is due to the mandatory implementation of social objectives by the public enterprises which is not the case with the private organizations. Therefore the taxation should be liberal for its applicability to public sector is concerned. It will certainly ensure the equal distribution of justice and resources to the common people who are part of the public sector. In case of private enterprises, the sole motto is to earn profit for the few selected individuals and to encourage employees to achieve this target, they will be provided with some financial incentives. Several times it is noticed that the salary shown on the pay slip of employee will have significant number of non taxable sub heads benefiting the employee. In general, some private companies even try to manipulate their financial accounts to minimize the tax and their financial reporting practices also reflect the same. However this is not to be encouraged and to be controlled immediately by implementing prudent financial accountancy measures. This will not be seen in the public sector where the record of financial transactions will be highly transparent. Due to these reasons the financial reporting practices vary from public sector to private enterprises in terms of taxation. Income statement and balance sheet also vary from a public sector company to a private enterprise. The private enterprise mainly concentrates on net returns, Profit before tax, operating profits and gross expenditure in the income statement. In case of public enterprise, the expenditure will be mainly reflected in the form of meeting the basic requirement of the public and hence it may not result in the significant profits in income statement, however it results in the society development and there are some measures which estimate the extent of benefit accrued by the public enterprises in the due course. There are parameters like benefit cost ratio, pay back period and internal rate of returns which are commonly used in schemes implemented by the public sector units involving the end users. The benefit cost ratio reflects the benefit in terms of unit currency generated due to the expenditure of one unit of currency. Internal rate of returns gives us an idea that the fastness or rate at which the money gets enhanced due to the implementation of technology under any public scheme. Similarly the pay back period exactly decides the total period that is required to get back the total amount of expenditure involved in the project. This is applied in both private and public enterprises. This helps in selection of a private enterprise as the ability of person varies once the money is invested. Some people may not tolerate for a long time to block their capital. For them the project with shorter pay back period is needed. In case of public sector, there will be some occasions where the end users or common people should derive the benefit with in a stipulated period for which the project with less pay back period will be selected. However in some of the cases, the public will get tremendous benefit in long run if project is implemented successfully. In those cases, the project with long pay back period will be justified. One cannot undermine the role of politics on the over all performance in general and financial reporting practices of the organizations in particular. The private entrepreneurs have been giving the donations for the political parties in the name of the party fund at the time of election to almost all the parties and once they come to power the companies expect them to do some favor which certainly affects the performance of the enterprise. In terms of financial reporting the private companies hide the information relating to the donations given to the political parties. In case of public enterprises this practice of donations to political parties is not common, however the employees get influenced by the political parties to some extent while delivering their duties. In general the budgeting procedures vary from government enterprise to the private sector. Majority governments in several countries have been following the cash based financial accounting procedures which is slowly getting transformed to an accrual based financial accounting practice due to the advantages of the latter (Peter Vander Hoek, 2001). It was noticed that governments mainly used deploy input-based budgeting systems and cash-based accounting systems initially. However, these systems do not provide the information that is necessary for a government to operate efficiently and effectively. Therefore, several countries have already shifted to shift from cash-based to some form of accrual accounting in the public sector. However the successful implementation of accrual-based system strongly requires wider financial management reforms including performance management. The changeover from cash-based accounting and budgeting systems to an accrual-based system has become phenomenal in some countries like Netherlands. This financial accounting in public sector requires a comparison of budget amounts and the actual amounts arising from execution of the budget to be included in the financial statements. In addition these financial statements have to be made available to public which reflects its accountability to the general public. (IPSAS b, 2006) . In case the difference exists between the budget and actual amounts, the reasons have to be explained. This reflects the accountability nature of the public sector units while reporting their financial results which is not the case with the private sector. The transparency is also found to be higher with public enterprises in comparison with the private firms. The government may raise the capital needed for the infrastructure through various means i.e. medium term and long term revenue bonds etc. (George W. Mitchell,1955) where as in case of private entrepreneurs the capital raising will be done through stock market. While examining the financial efficacy of the public sector one should not forget the fact that the estimation varies from one primary sector to other. For example, if one analyzes the health sector which is one of the basic sectors, the financial efficiency of National Health Service (NHS) in England can be measured in terms of cost per unit of care and productivity of capital estate (Pollock and Gaffney, 1998 and NHS executive, 1998). Last but not the least the balance sheet in terms of assets, liabilities and capital also varies remarkably between the public sector and private sector. In public sector units the contingent assets and contingent liabilities will be mainly analyzed (IPSAS c, 2006) which is not the case with the private firms. The format used by the private sector units in several regions has been found to be FASB (Financial Accounting Standard Board) where as the public sector follows the GASB (Governmental Accounting Standard Board)3 format. Similarly the IASB (International Accounting Standards Board) and PSC (Public Sector Committee) of IFAC (International Federation of Accountants)4 formulate the accounting standards for ------------------------------------------------------------------------ 3 : IPEDS Finance Data FASB and GASB - What's the Difference?http://nces.ed.gov/ipeds/web2000/gasbfasb.asp. 4 : Ian Mackintosh. PUBLIC SECTOR FINANCIAL REPORTING. A Dynamic InternationalSituation.http://www1.worldbank.org/publicsector/pe/JanSeminar/Course%20Readings/10.%20Transparency/PUBLIC%20SECTOR%20FINANCIAL%20REPORTING.doc. private firms and public sector units respectively at international level Assets will be mainly analyzed in both public and private firms in terms of fair value and historical cost accounting. Fair value is the amount at which an asset could be bought or sold in a current transaction between willing parties, other than in liquidation. Similarly historical cost accounting can be described as an accounting principle that requires all financial statement items to be based on original cost. It is generally an amount assumed to reflect the fair market value of an item at the transaction date. Liabilities will be also be analyzed in terms of fair value. The fair value of a liability can be described as the amount at which that liability could be incurred or settled in a current transaction between willing parties, other than in liquidation. Profitability ratios are mainly used in private firms which are nothing but measures of performance showing how much the firm is earning compared to its sales, assets or equity. Similarly surplus has to be analyzed which generally means any excess assets left after liabilities and debt, including capital stock, have been subtracted. The main difference is that the financial ratios like profitability ratios are used in private sector mainly in comparison with the other competitors where as in public sector the profitability in term of social justice will be the main objective. Overall, the private sector will follow the financial reporting practices which reflect its performance in comparison with the industry and the financial reporting practices of public sector should differ from that of private sector as it has different objectives in general and social objectives in particular. References : George W. Mitchell. 1955. Economic Aspects of Revenue Bond Financing. The Journal of Finance, Vol. 10, No. 2 (May, 1955), pp. 223-229. IFAC. 2000. Study 11 - Government Financial Reporting: Accounting Issues and Practices. Public sector accounting.http://www.ifac.org/Store/Details.tmpl?SID=960181971346&Cart=11679600725138198 IPSAS a. 2006. IPSAS 22: Disclosure of Financial Information About the General Government Sector dated December 2006 P:30.ISBN#: 1-931949-61-1. IPSAS b. 2006 IPSAS 24: Presentation of Budget Information in Financial Statements. Dated December 2006. P:32.ISBN#: 1-931949-65-4. IPSAS c. 2006 IPSAS 19: Provisions, contingent liabilities and contingent assets. Dated February 2006. P:45. Matsumura, Toshihiro and Matsushima, Noriaki, "Endogenous Cost Differentials between Public and Private Enterprises: A Mixed Duopoly Approach" . Economica, Vol. 71, No. 284, pp. 671-688. NHS Executive. The new NHS: a national framework for assessing performance. Leeds: NHSE; 1998. (EL(98)4.) . Peter Vander Hoek, M. 2001. From Cash to Accrual Budgeting and Accounting in the Public Sector: The Dutch Experience. Public Budgeting & Finance. Volume 25. Issue 1. P:32. Pollock,A.M. and Gaffney,D. 1998. Capital charges: a tax on the NHS Worse may follow as NHS assets are privatized. BMJ. 18; 317(7152): 157–158. Read More