European Public Sector Accounting Standards

Abstract

One of the defining goals of the European Union (EU) is to provide continental Europe with a single common market in which business transactions and capital investments can move across borders freely and with fiscal confidence. At the center of that confidence, however, is the need for one nation to be able to provide to other nations a clear and reliable accounting of its economic profile. Although a common system for accounting standards has been created for privately traded businesses, the EU and its vast system of economic commissions remain divided on how best to provide similar accounting standards for public sector interests.

Overview

The European Union was in its inception an ambitious attempt to forge a united Europe despite centuries of individual nations' history, culture, religion, and military identity. The vision was simple. Europe was to forge an alliance. It only made sense. Within a global economic market in which traditional borders and nationalities were quickly becoming at best ironic and at worst an impediment to genuine economic growth in the face of emerging digital revolution and the broad use of the Internet, the nations in Europe would simply have to recognize that they shared far more than they disputed. The greater economic health of the Europe, in fact, hinged on these nations working together. If European nations were to remain competitive in what was increasingly emerging as a transnational global economy, cooperation would make the most logical sense. Competition seemed outdated and obsolete.

In November 1993, representatives of twenty-eight European nations gathered in the city chosen to be the Union's de facto capital, Brussels, Belgium, to sign into existence the European Union. The economic potential was stunning—the EU embraced more than 500 million people. If the nations agreed to cooperative economic development, allowing goods and services and capital to flow freely across borders that had for centuries represented significant barriers, the potential economic boon was unlimited. To help create that common market, the economic ministers of these nations recommended adopting a single currency, the euro.

To date, only half of the member nations have agreed to convert their currency, but with the foundations in place for a united Europe, the stage was set for economic expansion. At the center of any economic cooperation, of course, was the need for clear and reliable financial information about the financial health of companies headquartered in one country that might be the target of potential transactions involving companies or lending institutions in other European countries. Unlike in the United States, where a bank in Nebraska interested in financing a project in Nevada could rely on a commonly held set of accounting standards set by the central federal government to obtain a reliable economic profile of the targeted company, the EU had no such provisions. If a banking firm, say, in Spain wanted to pursue a major investment in a windmill farm being built by a contracting company in Norway, the Spanish bank needed accurate and reliable information about that company's economic health, a profile provided by the company's accounting department.

Questions arose as to how a Spanish client, for example, would work with data and figures from Norway that might not conform to the accounting standards of Spain. To help establish a common vocabulary for economic transactions, among the first major reform initiatives undertaken within the first five years of the EU's existence, was directed by the International Accounting Standards Board, which, in turn, drew up a broad conceptual frame for just such financial transactions, termed the International Financial Reporting Standards (IFRS).

However, a significant area, specifically the broad range of services directly controlled and maintained by each nation's central government, called the public sector, was not addressed. Under the umbrella of public sector economy rests a wide variety of essential government services, including the military branches; any infrastructure work (e.g., highway construction or bridge repair); education systems from day care to public colleges; police and public security administration and the larger justice system (including courts and prisons and the associated public records-keeping); public transit systems; taxation agencies; an array of national and regional telecommunications systems and their licensing; and the vast network of clinics, emergency services, physician offices, and hospitals that make up any nation's public health care structure. In short, the public sector represents a significant element of any nation's economic profile.

The economic well-being of a country's public sector would be essential to virtually any decisions by any company or financial institution in any other country interested in pursuing investments in that country. No financial risk, no investment could be made without clear and reliable financial information about the public sector itself and that information, like the financials for private companies already standardized, needed to conform to a single set of accepted standards to help direct the accounting reports upon which any financial decision needed to rest. That would be the only way any EU member could act as guarantor of its national fiscal soundness.

It didn't help that within the first decade of the founding of the EU, one member country after another was rocked by cataclysmic financial crises. The troubled nations—most prominently Italy, Greece, Spain, Switzerland, Denmark, and Ireland— faced crushing levels of debt that threatened essential government services. Teetering near financial emergency, these nations opted to address floundering economies by putting more currency into circulation, resulting in inflationary pricing. Worker strikes closed businesses and day-to-day operations were shut down by angry protests. Numerous banks failed, and populations faced massive unemployment.

Understandably, potential investments between and across borders with countries in crisis need solid financial information, information not clouded by government bias or deliberate obfuscation. Beginning in November 2011, the Council of the European Union began to address the need for public sector agencies to adopt a standard set of accounting principles to guide all financial reporting by all federal agencies in all member nations. The goal was transparency in government operations and, by extension, complete accountability within a nation's government services for accurate, up to date, and carefully detailed financial records. The accounting records and financial benchmarks needed to be uniform from country to country within the EU so that the bank in Spain could competently use the financials from Norway with confidence.

Harmonization seemed to many economists to be common sense. "A unified set of global standards is essential to improved financial management and to ensure that government accounting is transparent and robust" (Aggestam-Pontoppidan, 2013). Over the next six years, different agencies and commissions sponsored by the EU each called for some movement toward standardizing the accounting principles governing public sector agencies in each of the member nations. However, these recommendations, created in broad consultation with a variety of government and private sector economic forecasters and economic planners, representing all of the EU member-states, were largely resisted as nation-states voiced concerns over handing over the fiscal oversight of their own national agencies to this new body. The move was seen by some nations as nothing less than a surrender, at least in part, of their nation's economic autonomy.

Applications

At the center of the emerging controversy over developing a set of European public sector accounting standards was the traditional perception of the vitality and relevance of a nation's budget. The budget, traditionally a projection set at the beginning of a fiscal year and used to determine the financial health of that organization, governs the fiscal viability of any public sector agency. These budgets, drawn up in anticipation of the actual providing of these public sector services, should be the key to measuring the financial health of these public sector agencies. Accountants or accounting divisions within the agencies would be responsible for creating the operating budget, itself based on data that measured how much actual cash would be available for the upcoming fiscal year to cover the services the government projected to provide. The battle over drawing up the annual budget was often a pitched showdown between different entrenched political parties and often involved complicated political maneuvering and diplomacy to create a simple working budget, which in turn became the economic charter of the public sector for that year.

The creation of a budget for a private sector business or industry is fairly straightforward. A company's accountants take a measure of the incoming revenue and factors into that emerging budget the actual expenses that will have to be spent to continue providing the services that company provides. This type of budget, known as an accrual budget, creates the emerging picture of that company's fiscal health by simply squaring income against outgo, that is, revenue against expenses, to produce a reliable picture of that company's health. It is a concept of bookkeeping as simple as any basic household budget. A family can only be judged financially secure if whatever income that family has is balanced against monies going out.

Indeed, if a budget only indicated monies coming in, the picture of financial health for a family, business, or agency would be considerably skewed. Cash flow in has to be balanced against cash flow out, a principle firmly established in the accounting practices of businesses. "[T]he accrual-based accounting system is the only generally accepted accounting framework that provides a complete, true and fair view of the financial and economic status of individual governments, as well as the assets and liabilities, revenues and expenditures of companies" (Harsanyi et al., 2016).

However, the budgets created for public sector agencies is far simpler and, critics argue, far less reliable. The budget for public sector agencies in Europe are routinely recorded as monies received—called cash-based accounting—in which the total is not balanced against monies allocated. The accounting practice is quite simple to create as it does not factor in the overlay of expenses. Thus, an agency (and nation-state, for that matter) can be perceived to be in far better financial shape than it actually is. Cash-based accounting helps public agencies maintain an aura of financial stability and sometimes helps prevent public outcry or deflect investigative scrutiny.

The appearance of robust financial health creates stability in a government as its agencies do not appear to be in financial straits. By not calculating cash flow out, these agencies can maintain, year to year, a fairly stable workforce, often creating huge bureaucratic redundancies and posting unnecessary positions staffed by a workforce that could be considerably consolidated should the actual working budget become an element of the public record. Because these public sector agencies never need address the realities of expenditures in their yearly budget, there is no compelling need to review operations, to look for ways to minimize costs and to maximize services, to evaluate positions for their viability. In short, cash-based accounting creates no incentive to impose a cost-efficient operating service.

Not surprisingly, with the advent of the EU and the growing call for establishing a viable set of continent-wide accounting standards to monitor public sector financials as well as private sector companies, governments have resisted because these budget creations have become a critical element in how individual agencies maintain their independence and operating integrity. The numerous financial crises faced by member nations, however, served notice that a more transparent system for public sector finances was in order (Ugwumadu, 2015).

The status quo becomes evidence and justification for institutional inertia. The problem faced by the EU, demonstrated in the aftermath of the global financial crisis, is that, given the reluctance of government agencies to follow an accrual budget, the financial profiles filed by many national agencies' accounting departments is necessarily suspect and unreliable. Fortunately, a gradual trend toward accrual accounting is being followed among EU members (Dabbicco & D'Amore, 2016). Nevertheless, it may be that only by compelling countries to follow a standard set of accounting standards can the EU establish a common market in which all participants share a common set of financial records expectations.

Issues

The goal of the European Union's financial ambition for the continent is three-fold: transparency of all public sector agencies' operations; uniformity in recording practices from country to country; and complete accountability within public sector agencies to ensure fiscal responsibility. These three principles create the foundation for private sector accounting standards but not public sector agencies. The development of European public sector accounting standards is itself an attempt to forge a common market for the EU. Accrual-based accounting standards are believed by many economics to be essential for transparency, benchmarking across other member states, and accountability of public decision makers. Further, governmental fiscal policy that is better informed has the potential for long-term wealth building (Scott, 2015).

That governments and government agencies within the EU seldom operate within parameters similar to those of the private sector, is a problem perceived by both the commissions charged with the task of creating public sector accounting standards. Companies interested in investing in the vast economic market created by the EU also express concerns about the financial viability of the critical agencies within the public sector while they cannot be accurately measured. Vitor Caldera, a member of the European Union's influential Court of Accountants, argues for a more useful budget that can be used "as an instrument, and not an end, to solve problems and make an impact" (qtd. in Russell, 2016).

Each EU member nation theoretically acts as guarantor of its own financial well-being. Until budgetary reporting can be entirely severed from management control and local and national political deal-making, a union-wide set of accounting standards for the public sector remains out of reach. However, calls for such standards, to be implemented across the EU, increased as waves of economic crises swept Europe during the global financial crisis (Aggestam-Pontoppidan & Brusca, 2016).

Without collective agreement to adopt a common convention for accounting standards, the ability of EU members to respond to crises, let alone prevent them, is hampered. When a public sector agency in any of the EU members faces the potential for economic crisis, the easiest solution (because the budget registers cash only) will remain the government printing and circulating more money, thereby escalating rather than addressing the underlying financial problems and nearly guaranteeing runaway inflation. Countries that so respond spark negative perceptions among fellow members, including that of a cumbersome bureaucracy and a treasury that is fiscally unstable.

Adoption of accrual-based accounting can, in the long term, actually create a new perception of public sector spending. "By conceptualizing public sector accrual accounting as part of a chain of linked reforms, it is possible to extend debates about public sector accrual accounting such that they yield insights not just into the nature of accounting, but also into the consequences for subsequent decision making and resource allocation of the employment of accounting tools in particular ways" (Carlin, 2005). Efficiency, and the stability that results, is perhaps the best argument for establishing sooner rather than later European public sector accounting standards.

Terms & Concepts

Accrual Budget: Budget based on income when received against expenses as they are incurred.

Bureaucracy: System of agencies designed to maintain and direct government services and offices.

Cash-Based Budget: Budget based on income received and anticipated.

European Union: Confederacy created among nearly thirty European nations in the last decade of the twentieth century as a way to create a common economic market as well as a common political and military entity.

Institutional Inertia: Premise that institutional operations as they exist currently are sufficient to provide services needed, thereby eliminating the need for review and/or change.

Public Sector: Part of the economy that consists of agencies run by non-elected officials and funded by local, state, or federal governments that provide what services are deemed as essential to the maintenance of that political unit.

Transparency: In accounting, the need for agency operations to be completely open to public scrutiny.

Bibliography

Aggestam-Pontoppidan, C. (2013). The European Union is moving toward implementation of European Public Sector Accounting Standards. Journal of Government Financial Management 62(3), 50–53. Retrieved on November 15, 2017 at EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=100446445&site=ehost-live

Aggestam-Pontoppidan, C., & Brusca, I. (2016) The first steps towards harmonizing public sector accounting for European Union member states: Strategies and perspectives. Public Money & Management 36(3), 181–188. Retrieved November 15, 2017 at EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=112732509&site=ehost-live

Carlin, T. (2005). Debating the impact of accrual accounting and reporting in the public sector. Financial Accountability & Management 21(3), 309–336. Retrieved January 1, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=17519310&site=ehost-live

Dabbicco, G., & D'Amore, M. (2016). Debate: Accounting for microeconomic surveillance in Europe. Public Money & Management 36(3), 162–164. Retrieved on November 15, 2017 from EBSCO Online Database Business Source Ulitmate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=112732506&site=ehost-live

Harsányi, G., Lukács, L. I., Ormos, M., Sisa, K., Szedlák, K., & Veress, A. (2016). EPSAS: Investment into the future: European Public Sector Accounting: Present and future. Public Finance Quarterly (0031–496X), 61(4), 480–499. Retrieved November 15, 2017 at EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=123353701&site=ehost-live

Russell, V. (2016). EU under scrutiny. Public Finance (3), 38–40. Retrieved from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=114463663&site=ehost-live

Scott, A. (2015). A standards odyssey. Public Finance, 5, 42. Retrieved on November 15, 2017 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=103038077&site=ehost-live

Ugumadu, J. (September 2015). Slow train through Europe. Public Finance, 9, 40–41. Retrieved on November 15, 2017 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=110378444&site=ehost-live

Suggested Reading

Crişan, A., & Nistor, C. (2016). Are the European Public Sector Accounting Standards (EPSAS) based on IPSAS a real necessity for the European Union? Review of Economic Studies & Research Virgil Madgearu, 9(1), 1–2. Retrieved January 1, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=116258507&site=ehost-live

De Grauwe, P. (2016). Economics of monetary union. New York: Oxford University Press.

Jones, R. H., & Caruana, J. (2015). EPSAS—Worrying the Wrong End of the Stick?. International Journal Of Public Administration, 38(4), 240–252. Retrieved January 1, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=101141403&site=ehost-live

Pindar, J., & Usherwood, S. (2013). European Union: A very short introduction. New York: Oxford University Press.

Pontoppidan, C. A., & Brusca, I. (2016). The first steps towards harmonizing public sector accounting for European Union member states: strategies and perspectives. Public Money & Management, 36(3), 181–188. Retrieved January 1, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=112732509&site=ehost-live