Accounting rules for public duty and private failure

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What are the similarities, and the differences, between the uses and needs of accounting in the public and private sectors?

For centuries the British exchequer was a cash box rather than a system of budgeting and resource planning. The job of the accounting system was to measure what went in and out, to ensure propriety but not value for money. Productive investment and profligate spending, capital and current receipts, were all one.

The past 10 years have seen the introduction of resource accounting, which charges for the use of capital assets, and better recognition of accruals. These are steps forward, but the analogy of Her Majesty’s Treasury plc should not be pushed too far. Fundamental differences between governments and commercial organisations translate into fundamental differences in their accounting needs.

Government is necessarily a going concern by virtue of the nature of government activity, and its financial strength derives from its ability to raise future taxes. Governments default not because they cannot pay but because they will not pay. They make a choice that the consequences of repudiating commitments are less damaging than the domestic political consequences of raising the money. Creditors cannot take possession of public assets. The public sector balance sheet is therefore not analogous to a private sector one.

The differences are equally great for liabilities. Determining liabilities is a duty of directors. But government is the body that determines what are and are not liabilities. Government does so both for itself and for every other economic agent. Pension liabilities, for example, are defined by regulations that have not yet been made in the context of legislation that is the subject of frequent amendment. The obligations of government are the product of future political expectations and compromises, not current legal duties. Generational equity, the balance between our needs and those of our children, and the implications of current pension expectations for future tax levels are vital elements in planning economic policy. But calculations that show the unfunded liabilities of governments in trillions of dollars are as futile as calculations that show the expected value of future tax receipts in trillions of dollars.

The question of whether one entity is controlled by another is critical to private sector accounting. In the past decade both private businesses and governments have used the rules that govern these relationships to present misleading accounts. New international financial reporting standards have rightly sought to check such abuses.

But here also government differs from a company. Government ultimately controls all economic entities. When Northern Rock ran into difficulties the key decisions on its future were made by state agencies. When the problems failed to resolve themselves, a bill to make government the legal owner of the business passed parliament within 24 hours.

The legal basis of these public powers over private sector entities varies and may not formally exist: but in a crisis, government can take the legal authority it needs. The list of activities that government in this sense controls includes big financial institutions, utilities and many other businesses of national and strategic importance. What are the proper responsibilities of government when institutions such as Northern Rock and Bear Stearns, or Railtrack, British Energy and perhaps General Motors, struggle to meet their liabilities? What will such contingencies cost the taxpayer? These are important questions, but no accounting rules can answer them.

Governments, like private sector companies, are anxious to promote flattering reports of their affairs. The job of resisting their attempts lies with statistical agencies such as Eurostat and the UK Office for National Statistics. The Financial Reporting Advisory Board applies private sector accounting principles to UK public sector activities. None of these organisations has the remit or competence to determine the information needed to formulate policy and the degree to which policy goals have been achieved. In a subsequent column, I will describe how that gap should be filled. A true and fair view is even more important to the operation of democracy than the functioning of markets.

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