The biggest challenge facing public sector accountants is the hit-and-miss quality of government reporting, auditing and financial management. It is time for the profession’s leaders to take a share of responsibility and make change happen
The sovereign debt crisis has grown steadily over the past two or three years with particularly devastating consequences for various European countries such as Ireland, Portugal, Spain and Greece. Not surprisingly, this has had major implications for the eurozone and the common currency – implications and risks that are still hanging over us, not just in Europe but across the world.
The origins of the debt crisis lie in that other crisis – the global financial crisis of 2007 onwards. Indeed, in many ways we should see sovereign debt as simply the latest chapter in the unrelenting global crisis that rolls on like a great financial hurricane threatening everything in its path. And there is increasing speculation that it is about to move on into a further, perhaps even more damaging phase.
The global crisis caused many national economies to fall into recession. While in some cases recession is technically over, lots of countries are struggling to return to strong levels of economic growth, and some – like the UK – have actually slipped back into a double-dip recession.
In difficult periods of this type, government finances come under pressure for two related reasons. First, public expenditure increases as governments spend more to protect jobs; to support people who have lost their livelihoods and sometimes their homes; and to create other programmes to try to stimulate economic recovery.
Secondly, government income falls as tax revenues reduce. Fewer people are working so the proceeds of taxes on earnings are reduced. Citizens begin to act more cautiously; they buy fewer goods. That means sales tax revenues fall. Companies make smaller profits, or even losses, so that the proceeds of corporate taxes reduce as well.
Increasing expenditure and falling revenues is clearly not a formula for success. On the contrary, it is a formula for exactly what we are currently experiencing – uncertainty, turmoil and chaos.
Of course, in this crisis we have also had a third factor hitting government finances – the ‘bail out’ of banks and financial institutions. These extraordinary transactions – often combining astronomically large sums of money and bewildering complexity – have made an already difficult situation seem completely untenable. No wonder that rating agencies start to reflect more cautious views of government debt, and markets become jittery and volatile.
The eurozone is at the heart of this crisis, but it does not end there. The finances of many other countries, such as the UK and the United States, are a matter of acute and very public concern. For a long time we have thought of the economies of emerging countries – particularly Brazil, Russia, India and China (the Brics) – as the potential solution, the new engines of global growth. But now much of the latest economic data from even those economies is far less optimistic. In short, we all face a very uncertain future.
So we should see this as a crisis that threatens us all. We know that financial crises do not respect national boundaries. Many of the worried investors in an ailing government’s sovereign debt will be banks and financial institutions in other parts of the world. This is where we find ourselves dealing with the risk of contagion – the problem rippling around the world like a pandemic, just as the sub-prime problems spread three or four years ago. This is exactly the problem that markets fear in the latest bail-out in Spain.
World leaders have been meeting recently – with a G20 summit this week in Mexico – to try to develop new strategies for resolving the crisis. Most commentators feel that their decisions have been too little, too late. Many of their potential solutions seem to involve the creation of new bail out funds to support casualties of the crisis – countries teetering on the brink of default and financial institutions facing large sovereign write-offs.
But how robust can those solutions be? Crucially we should ask the question: what impact will the creation of new or much larger bail-out funds have on the financial health of sponsoring governments?
The shocking answer to this question is that, in all but a handful of cases, we do not know what the impact will be. Why? Because most governments still account on a cash basis. They do not maintain balance sheets. They do not systematically record and value assets and liabilities including multi-billion dollar obligations to bail out funds.
As we all know, markets hate uncertainty. But what could be more uncertain than the financial position of a government entering into complex bail-out transactions while maintaining its accounting on a cash abacus.
Cash accounting is simply not up to the challenge of reflecting the full financial position of a government. Solutions built on such fragile foundations are bound to fail. We need to own this problem and make sure that we replace fragile foundations with sturdy robust foundations.
So what can we do to accelerate the improvement of better accounting and auditing in governments? How can we make a real impact to drive up standards to provide more resilient public finances and ultimately provide better government in the public interest?
I deliberately mention the public interest because it is so vividly at stake. The way in which governments steward public money affects the quality and availability of public services; economic prosperity, growth and jobs; accountability, trust and confidence in government, and the quality of people’s lives and life chances.
So it seems to me that this is not a situation in which we should be asking ourselves what is best for our profession and us, its members. We talk a great deal about serving the public interest and now really is the moment for us to show by our actions what that means.
Weak financial management foundations are not inevitable. They occur because people take or fail to take decisions. Governments account largely on a cash basis because governments choose to do so. They take decisions without proper regard to financial consequences because they choose to do so. They run up large debts and deficits because they choose to do so. They make lots of other poor choices too.
But governments are susceptible to pressure and influence. If it is presented clearly and determinedly and persuasively, governments can be encouraged to listen to and to act on good advice.
If we really want to we can create pressure for a step change in public financial management, reporting and auditing. And we can make it happen. It will not be easy. I know that. But it is possible.
What it calls for is concerted, co-ordinated action. Every professional institute like CIPFA, every accountant general, every auditor general, every finance ministry – each of us and all of us together reinforcing the same compelling arguments for a step-change in all aspects of public financial management.
We have raw materials to work with. The International Public Sector Accounting Standards Board has now delivered a comprehensive set of standards, IPSASs, tailored for the public sector. INTOSAI, the Supreme Audit Institutions, has produced an excellent suite of audit standards specifically for the sector. We also have the Public Expenditure and Financial Accountability framework.
And this catalogue is constantly expanding. In 2010, for example, CIPFA published its Whole System Approach to public financial management. Only a couple of weeks ago, I attended the annual meeting of the African Development Bank in Tanzania where African finance ministers were discussing a new draft Declaration on Improving public financial Governance.
However, before we can use these tools we have to win some arguments. In Europe, for example, we must convey the message that the biggest issue concerning the accounting profession is not the independence of company auditors, important though that is. On the contrary, the elephant in the Commission room is the quality and reliability of the financial statements of its own member states.
If we are to send that message to politicians in Europe and elsewhere, we also have to take that message to heart ourselves, and we have to reflect it in our priorities and our actions.
The biggest challenges facing the accountancy profession right now are the quality of government reporting, auditing and financial management. This is a key issue in the current crisis and it is a massive issue in creating conditions for stability and the avoidance of future crises.
Government finances are not a separate self-contained thing. We can absolutely see in the current crisis how they are wired into the financial sector, the wider economy and the lives of us all. They have profound implications for society and the communities in which we live and work. They affect the quality of vital public services on which we all depend, such as schools, roads, healthcare and public transport. They impact on jobs, growth and development. They affect the quality of our lives and, in many cases, life chances.
When government finances go seriously wrong, lots of significant consequences follow. Markets become anxious and jittery; public spending and public services have to be cut back; economies begin to nose dive; unemployment starts to rise; austerity comes to call.
No wonder ordinary people react so emotionally in demonstrations and sometimes even riots as these events occur in rapid, chaotic sequence. We may not approve of their actions but we should at least understand them.
In short, government financial management matters. And it is time for our profession, and us as its leaders, to bring all of our collective influence to bear and to take our share of responsibility to make change happen.
CIPFA has a special interest in these matters. Governments and public sector finance is our exclusive focus. We are committed to try to bring about a step-change in financial management performance, and we are convinced that now is the moment. There will never be a better opportunity.
We have some strong ideas and plans for affecting change: we advocate a global programme to make the change from cash to accruals and to implement modern standards; a global portal to join up government finance practitioners around the world, supporting both the sharing of good practice and continuous learning and development; and a determined programme for making that step-change across the world and building the public financial management professional capacity to sustain it.
Capacity that will help to deliver better reporting, better auditing, better controls, better management accounting and forecasting. And, of course, capacity that will help to deliver better decisions, greater transparency, stronger accountability and, most valuable in the current crisis, greater confidence.
Of course, CIPFA can’t do this alone. We can’t even scratch the surface of the problem if we work alone. We acknowledge that in our prospectus – Fixing the Foundations – which we launched in at the IFAC Council meeting in Berlin in November last year. We need the help of accountants and auditors general and a range of other organisations, to partner with us, to be part of a movement to bring about change, to transform government accounting, auditing and financial management in the public interest.
Working apart we will fail; working together I really believe that we can succeed and make a huge difference.
We all know that these are historic times by any measure or definition. In 20, 30, 40 years’ time people will talk about the great global crisis at the beginning of the 21st century. And when we say that we were there, in important leadership roles, at the very moment of crisis they will ask a question. What did you do?
I want us to be able to say that we exercised real leadership, that we stepped up to the plate, that as a profession we set any self interest to one side and put the public interest first.
I want to say that we stood together, we acted boldly and courageously, and we did the right thing.
Steve Freer is the chief executive of CIPFA. This blog is an edited version of his speech today to the Commonwealth Secretariat Conference in London