QUESTION

Assignment 1: Alternative A
“Best practice financial management is characterised by accrual accounting, budgeting, management and reporting” (Commonwealth Management Advisory Board, 1997, p. 2).

a) What are the differences between ‘full accrual’, ‘modified accrual’ and ‘cash budget’?

b) Explain the issue of transparency.

c) Provide examples of reporting distortions or discrepancies when using specific accounting tools (i.e. accrual versus cash).

Some suggested references
Carlin, T.M. (2005). Debating the impact of accrual accounting and reporting in the public sector. Financial Accountability & Management, 21(3).

Clare, R. (1994). Accrual Accounting: fad or necessity? Directions in Government, 8(4), 30-32.

Commonwealth Department of Finance. (1994). The new financial reports of agencies. Canberra: AGPS.

Corbett, D. (1992). Australian public sector management (Chapter 5). Allen and Unwin. (Dixson 354.9407/C789)

Department of Finance (1992). Supplementary financial statements 1991-92. Canberra.

Levacic, R. (Ed.). (1989). Financial Management in Education, Open University Press, Milton. (Dixson 379.11/L655f)

Lynch, T.D., & Martin, L.L. (1993). Handbook of comparative public budgeting and financial management. New York: Marcel Dekker. (Dixson 336/L987h)

Nicholls, D. (1991). Managing State finance: The NSW experience. Sydney: NSW Treasury. (Dixson 336.944 N613M)

Rabin, J. (Ed.). (1992). Handbook of public budgeting. New York: Marcel Dekker. (Dixson 350.722/236)

Management Advisory Board (1997). Beyond bean counting: Effective financial management in the APS – 1998 and Beyond. Canberra: AGPS.

Wanna, J., O’Faircheallough, C., & Weller, P. (1999). Reform of budgeting and financial management (Chapter 8, pp. 126-144). Public Sector Management in Australia (2nd ed.). South Yarra: Macmillan.

Website: Agency resources and planned performance. In: National Archives of Australia. Retrieved fromhttp://www.dpmc.gov.au/accountability/budget/2009-10/pbs/naa.doc.

 SOLUTION

Differences between ‘Full Accrual’, ‘Modified Accrual’ and ‘Cash Budget’

Full Accrual

Full Accrual accounting is considered to provide accurate information on the current condition of the company. This is a complex and expensive method

As the business transactions are generally complex and need accurate information for running of the business. The events that affect the working of the company like, credits, bad debts, project operations etc. are reflected in the financial statements. This is done during the reporting period such transactions during which occur.

Full Accrual  takes expenses that are measurable and recognizable in the period in which the expenses are incurred. Measurable expenses means when the cost is incurred. (www.msulocalgov.org)

In other words Full Accrual captures the complete essence of the transaction.

The revenue realized and the expenses that have been incurred is put under each year. It provides more accurate and correct financial position of a company as the main concern is on the resources rather than cash. Thus it can be said that Full Accrual is opposite of Cash as it is concerned with transactions

Modified Accrual:

Modified accrual has been established to differentiate business accounting of the firms and the accounting of government. In case of modified accrual terminology itself is difference from that of full accrual. The account of government is different from that of the business. The purpose itself is different. It can be said that modified accrual is more robust as it considers revenue when it is measurable and available with the organization. The modified accrual may be considered as between cash and full accrual accounting. Thus it is hybrid of both full and cash accounting. This is short term focus as the concern is on investments that are convertible into cash and can be utilized by the organizations.

If the principal amount was due in previous fiscal year then adjustment will done under modified accrual. Long term liabilities of an organization are not considered under modified accrual until and unless payment is due for such liabilities (Beechy 2007).

Following example will help in distinguishing between modified and full accrual:

An organization has 1^st April 31^st March fiscal year. The interest has to be paid on loan in the middle of fiscal year. If interest has to be paid for few months of previous fiscal year and few of this fiscal year and is paid in this fiscal year then in case of accrual accounting the expense is taken for current year as for previous year it had been considered.

Cash Budget

It can be called the forecast of cash flows i.e. receipts during the budget period. This is also referred to as ways and means budget. The advantage of anticipating cash position well in advance are to obvious to require discussion. Employees must be paid. Taxation liability must be settled promptly. Failure to meet any of these obligations will lead to irreparable loss to company’s reputation. In most cases monthly cash forecasts for the budget period are made, but the company can make weekly or even daily forecasts according to its business operations. It is necessary to have proper coordination between cash budget and other functional budgets. Preparation of cash budget is based primarily on following information

a)     Detailed estimates of cash receipts

b)     Detailed estimates of cash disbursement

c)     Time lag induced by credit transactions

d)     Time lag in items of revenue and expenditure

Following are the objectives of cash budget

1. It ensures whether sufficient cash is available for revenue and capital expenditure
2. Shows when additional finance is needed and how much additional finance is needed.
3. Shows when surplus fund are available in business.
4. Preparation of cash budget helps the company to plan its cash position in such a way so as to get maximum seasonal discounts.

Cash budgets are not made for performance evaluation. It is done in order to keep company’s liquid position sound enough to meet its daily obligation; this is the main objective of preparing and keeping the cash budget. According to various analysts it is good for a company if it uses continuous budget to prepare cash budget.

Under this the forecasts for a period is made in such a way that the forecast for the complete month is available. Thus if the forecast for a period is dropped it can be adjusted in another period. Period in this case can be month or a period as discussed earlier.

Below examples provide the difference in more detail:

In case of full accrual the budget operation account will be debited by 1000 and the liability will be credited by 1000 while in case of payment liability will be debited by 800 and the cash bank will be credited. In the year 1997 the budget operations will be credited by 1000 whereas the expenses account will be debited by 700. The depreciation on the assets will be credited whereas expenses account will be debited by 137. These all details will be provided by the full accrual accounting system.

Under Modified accrual the details that will be provided are that the budget operation account will be debited by 1000 and the liability will be credited by 1000 while in case of payment liability will be debited by 800 and the cash bank will be credited.(Clare,1994)

The accrual accounting must be favored in developing countries as these countries cannot afford ambiguity and thus clarity of information related to financials will assist them in recognizing the key area where in improvements may be made. In case of developed economies also this play an important role as a lot of complexity is there in the economy and unless the accounts are managed properly there will be issues in h\estimating the investments being made and the key areas of concerns may be identified.

Thus the accounting reporting is beneficial for both the developing and developed world playing an important role in each case.

The issue of transparency

The reforms brought by the senate over last few years have been very effective and have benefited all including government firms.

However there are certain issues in transparency (Commonwealth Department of Finance. 1994). These are as under:

• Issues with improved efficiency
• Difficulty with outcomes and lack of specificity
• Instability in outcomes
• Performance Information
• Other Issues

Issues with improved transparency

Improved transparency means that the relationship of the outcomes to that of costing. This means that the costing should be fully utilized for the outcomes and also to note that how well the costing were utilized if not fully. However it is very difficult to give the exact relation of the outcomes to the costs but also it makes it more difficult to ascertain that the values provided are giving the exact relation. This is because the outcome or costing or both may depend on a range of variables which may be difficult to quantify.

Difficulties with outcomes & lack of specificity

The outcome must be specific. Unless it is the case so it will be difficult to assess the outcomes. There is a certain process defined to assess the outcomes. The outcomes must comply ith the process so that the accurate and efficient accounting of outcomes is done.

Instability in outcomes

Another issue with bringing in more transparency is that the instable outcomes set by the firms. Since the firms keep changing their outcomes and costing it becomes a tedious and never ending job to compare the data and deriving appropriate analysis.

Performance information

The firms give the information on the parameters which would be used in the assessment of the performance of the firms. If this information is not provided in particular format this will result in ambiguity in analysis of the performance estimation and predicted and thus the relationship might lead to incorrect decision making. Thus the very purpose of the gathering of performance information and report making is no solved.

Thus the purpose of the annual reports is not only to give the activities or tasks that were performed but also the performance analysis. This will be based on standard framework that will be set aside

Other Issues

The other issues include Appropriations and sources of money. This may result in inappropriate funding of outputs that will be mentioned in the report and thus the analysis might not be correct.

Discrepancies when using specific accounting tools (Accrual & Cash).

Cash Accounting

It has been argued that the cash accounting is not the ideal method. This is because it does not provide the full information. There may be a case that according to cash method the company might be receiving cash but in actual it might end up in bad debt.

Including all accrual transactions in the accounting reports gives the holistic picture of the business. The business person has he clear picture of how the business is performing, what can be done and how it should be performed in order that it is reflected on to the reports. In cash method cannot provide such information in the books. There might be cases wherein cash method shows less assets and liabilities. Thus cash accounting is only helpful in giving information on the liquidity of an organization.(Day,1992)

Financial accounting standard board also supports accrual accounting over cash accounting.

 Accrual Accounting

The issues with Accrual Accounting include the following:

Calculations associated:

There may be the case that the revenues are occurring in one period but the expenses are incurred in another period, in such cases the documentation and calculation will have to be kept and the calculations will have to be done so that the appropriate adjustments are made.(Corbett,1992)

Efforts requirements

A lot of manual efforts will be required to properly keep the data related to accounting. Thereby a proper system has to be placed with a responsible person to ensure that all the items are put under proper head and at the same time it is ensured that unknowingly an item is not counted wice resulting in erroneous figures and thus accounting.

Cash Flows:

Sometimes it becomes difficult to determine the cash flow for an organization as there is a lot of complexity associated with the calculations as there might be issues in considering the items and how and where to consider in doing the reporting

There may also be the cases wherein the company making the mistake shows that the organization is making huge profits whereas in actual the organization might not have enough cash for that.
Costs Associated:

As discussed earlier there is cost associated with calculations and the efforts. This might lead to extra burden on the company.(Blondal,1994) There might be the need for creating a separate department if the number of transactions is more. In such case there might be a need to hire experts which also add to the costs of the company.

Conclusion & Discussion

As discussed above the three accounting systems, full, modified and cash have their advantages and limitations. All the methods are utilized as per the purpose and requirements. Thus it can not be stated that which is better. Accounting and reporting system being the important aspect for building the budget and decision making of a firm plays important part in the stability and working of the company. From being used as purpose of assuring compliance and tracking efficient utilization of money to providing important tool for management and decision making and at the same time assisting governments across the world in preparing national accounts the role of accounting reports has been changing and thus is central to the working of all the businesses.

Another aspect as discussed in full accrual and modified accrual is that it not only provide information on how efficiently the finances have been made but also provide assistance in assessing operational efficiency.

References

• Carlin, T.M. (2005). Debating the impact of accrual accounting and reporting in the public sector. Financial Accountability & Management, 21(3).

  CICA Handbook 4430.16. The Allocation Problem in Financial Accounting Theory (1969), and The Allocation Problem: Part Two (1974).

• Clare, R. (1994). Accrual Accounting: fad or necessity? Directions in Government, 8(4), 30-32.

  Commonwealth Department of Finance. (1994). The new financial reports of agencies. Canberra: AGPS.

  Corbett, D. (1992). Australian public sector management (Chapter 5). Allen and Unwin. (Dixson 354.9407/C789)

• Day J.W. http://www.reallifeaccounting.com/pubs/Article_Theme_Accrual_vs_Cash.pdf
• Terminology for Accountants, Fourth Edition. Toronto: Canadian Institute of Chartered Accountants, 1992.
• Beechy .H. (2007). The Innovation Journal: The Public Sector Innovation Journal, Volume 12(3), 2007, article 4.
• John R Blondal 1994,Issues in Accural Budgeting, viewed on 7^th april 2012, http://www.oecd.org/dataoecd/21/11/42187939.pdf
• Modified V/s Full Accural Accounting, viewed on 7^th april 2012,

http://www.msulocalgov.org/resources/Data%2FTraining%20Resources%2FMMCTFOA%2FMMCTFOA%202010%20Archive%2FB2B%20103%20Modified%20vs%20Full%20Accrual%20Accounting.pdf

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