Hanging in the balance

Good financial management is key at a national level as well as at an organisational level, as shown by the crisis in the Eurozone that has sent shock waves across the developed world. Never before has the level of sovereign debt been under such scrutiny. Ian Ball, head of the International Federation of Accountants, stated that the crisis is a result of the "woefully deficit accounting, auditing, and financial management practices by governments.”

“The problem is that governments do not have enough capital. But it is worse than that – most governments do not even know what their capital is, because their archaic budgetary and accounting practices do not actually know what their balance sheets look like.”

In the UK we do have a general government balance sheet, which puts us significantly in advance of not only our European neighbours but the world too. The recent publication of the first ever Whole of Government Account marks a significant achievement for the UK and the beginning of the step change required in the development of policy based on long term fiscal sustainability. HM Treasury are to be congratulated on the publication and thoroughly deserved the recent award for the best contribution to the profession presented to them at the Government Finance Professionalism annual conference.

The UK Whole of Government Accounts is the widest consolidation in scope in the world, having the broadest definition of general government, including local as well as central government. Only Australia and New Zealand have attempted something similar but they do not include local government. For the first time we have a complete picture of public sector assets and liabilities (including contingent liabilities), and a consolidated set of accounts that has been subject to audit review. The WGA does have a qualified audit opinion, so the data does have limitations, but we are world leaders in preparing and publishing the information.

One qualification covers the boundary of what is considered ‘general government’ Almost 1500 bodies from central government, local government, health and public corporations are included as part of the consolidation. However, the Bank of England is not included in the WGA boundary. Plans are in place to consolidate this fully in 2010-11. Also the support government has given to high street banks including Northern Rock, Lloyds Banking Group, Royal Bank of Scotland Group and Bradford and Bingley is shown as an investment (even though in the case of Northern Rock we, the state, owned 88% of the shares). The 'temporary' nature of the support was cited as the reason for this treatment. Given the sale of Northern Rock to the Virgin Group, this appears to be the correct assumption.

WGA goes some way to addressing the concern that governments do not know what their balance sheet look like. Although WGA may at first look like uncomfortable reading, as it shows the public sector has net liabilities that will need to be funded in the future, we need to remember that governments can guarantee future revenue flows through the right to levy taxation – an option not available to the private sector.

The highlights?
Broadly, these remain the same as the unaudited version of WGA that was published earlier this year to accompany the first Office for Budget Responsibility’s report on long term fiscal sustainability. Government holds significant value of assets, but surprisingly the value of property plant and equipment held by local government is almost 50% of the total. Given that the highest value assets are held by the Ministry of Defence, the traditional view was that central government held the majority of general government assets. But this is not the case.

This will change again when local government begin using the same basis of measuring highways infrastructure assets (the road network) as that which is used by central government. Under International Financial Reporting Standards, both measurement options are allowed. So it is not 'wrong' that different sectors have different approaches in their own accounts. However in a consolidated set of accounts the basis for measurement should the same. The current estimate is that measuring the local highways assets on a depreciated replacement cost basis would result in an increase in the assets values of over £200 billion. CIPFA are working with various stakeholders to achieve this consistent approach. But to do this properly will take time.

The pension data highlights a liability of £1,133 billion. Indeed this has been subject to significant media attention and that was even before the publication of the Hutton Report and subsequent government plans for pension reform. MThe OBR report acknowledges the figure is significantly (over £331bn) higher than a year earlier. Although £260bn “has nothing to with the changes in the size of prospective pension payments; instead it “reflects a fall in the discount rate”.

It is worth noting that in 2010-11 the figure will decrease by approx £300bn due to the move from using RPI to using CPI to calculate pension uprating. Capital liabilities arising from Private Finance Initiative (PFI) contracts were around £40 billion. The value for money that PFI provides has been under scrutiny by the Public Accounts Committee. In their recent report they challenged the value for money assessment for PFI schemes. In the calculations the taxation income from the private sector has been overestimated as many of the companies were based overseas.

There are over £100 billion in provisions for future costs that are expected (but not certain) to arise, the bulk of these are potential nuclear decommissioning costs.

There are over £200 billion of quantifiable contingent liabilities. These are costs that could arise in the future but the probability of this happening is assessed as less than 50%.

None of this should be of any surprise to informed readers. This information has always been publicly available in individual public sector organisations’ own audited accounts, accessible from their respective websites. That is not to say that previously we did not have a balance sheet – we also have National Accounts that are prepared by the independent Office for National Statistics (ONS). These are based on the European System of National Accounts (ESA95), which is designed to aid consistency and comparability across EU nations.

However, there are significant differences between ESA95 and IFRS. Public Sector Net Debt (PSND) – the difference between public sector’s liabilities and liquid financial assets – was £906 billion at March 2011. This figure is not as complete as the WGA equivalent (which for example also includes debt from PFI arrangements): at March 2010 PSND under WGA was £1.2 trillion whereas under National Accounts this was £760 billion.

So how will the publication of the WGA help? The data will help in making medium term forecasts on whether the UK public finances are sustainable over the long term. Long term fiscal sustainability has been defined as “the ability of an entity to meet service delivery and financial commitments now and in the future”

The OBR’s March report highlighted the difficulties in achieving this, pointing out that in the absence of offsetting tax increases or spending cuts, the analysis points to the PSND being on an 'unsustainable upward trajectory'. This is primarily due to pressures of an ageing population. Spending cuts and tax increases were included in the Budget, but we cannot be complacent; in its Economic and Fiscal Outlook report in November 2011, the OBR noted that without the additional measures included in the Autumn Statement, the government would have missed its target in respect of PSND.

To manage our way out of this 'wicked issue' (an issue that is so difficult that it cannot be resolved by traditional means), the challenge to governments to demonstrate leadership has been made. In our prospectus 'Fixing the Foundations', CIPFA has called upon the leaders to work collaboratively with us, as the leading accountancy institute specialising in public sector financial management, to achieve a global step change in financial management in governments.

The UK Government recognises that it needs to further strengthen financial management in government and is working on embedding the Managing Taxpayers Money Wisely:  A Commitment to Action agenda. This was launched by HMT and endorsed by the Economic Secretary to the Treasury and is part of the wider Finance Transformation Programme.

Managing taxpayers Money Wisely identifies four areas of development where the public sector can improve financial management. These are: Leadership – driving better performance from the top; Cost Conscious Culture – so every decision is based on informal financial assessment; Professionalism – so that all public servants have financial awareness; and Expert Central Functions – providing the strategy to work towards common goals.

HMT with the Head of Government Finance Profession are working on making this a reality. As we see from the OBR report doing nothing is not an option. The level of cuts that have to be implemented whilst managing the ever increasing demands on public services will require strong leadership and good financial management skills. This is an opportunity for accountants from across the public sector to step up to the challenge and support the business of government to make the difficult choices that lie ahead. For all our futures, and the future of the generations to come, failure is not an option.

About CIPFA
CIPFA, the Chartered Institute of Public Finance and Accountancy, is the professional body for people in public finance. Our 14,000 members work throughout the public services, in national audit agencies, in major accountancy firms, and in other bodies where public money needs to be effectively and efficiently managed.

Further information
www.cipfa.org.uk