International Journal of Government Auditing – October 2014
A growing number of countries around the world apply the cash-basis IPSAS (International Public Sector Accounting Standards) when preparing government financial statements. For supreme audit institutions (SAIs) the adoption of the cash- basis IPSAS is a welcome development, as the International Standards of Supreme Audit Institutions (ISSAI 1210, § A8) list IPSAS as an acceptable general purpose financial reporting framework. This article deals with some of the challenges faced by SAIs when auditing cash-basis IPSAS financial statements.
Compliance with the requirements as well as the encouragement of the cash-basis IPSAS (IPSAS – Financial Reporting under the Cash Basis of Accounting, http://www.ifac.org/sites/default/files/publications/files/financial-reporting-under-t.pdf ) enhances comprehensive and transparent financial reporting of the cash receipts, cash payments, and cash balances of the government. Compliance will also enhance comparability of the government's financial statements with the financial statements of other governments applying the cash-basis IPSAS.
Governments in developing countries usually adopt the cash-basis IPSAS as a stepping-stone towards the adoption of the accrual-basis IPSAS standards. The primary statement under the cash-basis IPSAS is the statement of cash receipts and payments. Many governments prepare financial statements on an accounting basis somewhere in between cash accounting and accrual accounting. Information regarding a modified cash basis or a modified accrual basis can be maintained under the cash-basis IPSAS, if relegated to the notes of the financial statements. By adopting the cash-basis IPSAS, and following the International Public Sector Accounting Standards Board's (IPSASB) encouragement to prepare the statement of cash receipts and payments in the format of a cash flow statement, the government effectively complies with IPSAS 2 Cash Flow Statements, a standard from the accrual suite of IPSAS standards (http://www.ifac.org/sites/default/files/publications/files/ipsas-2-cash-flow-stateme.pdf ).
The cash-basis IPSAS is equally suitable for central governments and local governments. Examples of central governments applying the cash-basis IPSAS are Burkina Faso, Fiji, Liberia, Mauritius, Nigeria, Seychelles, Sierra Leone, Solomon Islands, and Timor- Leste. An example of a local government applying the cash-basis IPSAS is the provincial government of Punjab in Pakistan. Not all of these governments fully comply with the cash-basis IPSAS, as yet. A list of governments adopting IPSAS is available on the website of the IPSASB, at http://www.ifac.org/public-sector.
IPSASs are promulgated by the IPSASB under the auspices of the International Federation of Accountants (IFAC). IPSASB prepares accounting standards for both accrual-basis and cash-basis accounting. Cash-basis accounting means a basis of accounting that recognizes transactions and other events only when cash is received or paid. The cash-basis IPSAS prescribes the manner in which the general purpose financial statements are to be presented under the cash-basis of accounting. IPSAS has dealt with the cash-basis through the development of a single standard.
The cash-basis IPSAS comprises two parts. The first part, which is mandatory, sets out the requirements that must be complied with by entities which claim to be reporting in accordance with the cash-basis IPSAS. The optional second part of the standard identifies additional accounting policies and disclosures that an entity is encouraged to adopt in order to enhance its financial accountability and the transparency of its financial statements. This second part also includes explanations of alternative methods of presenting certain information.
According to the cash-basis IPSAS, an entity should prepare and present general purpose financial statements which include the following components:
The cash-basis IPSAS requires all accrual accounting information to be moved to the disclosures—the statement of assets and liabilities prepared by many governments in developing countries should not be presented as one of the primary financial statements, but as a note disclosure. Because of the hybrid nature (partly cash, partly accrual) of this statement, it is not in accordance with the cash-basis, a basis of accounting that recognizes transactions and other events only when cash is received or paid.
If an entity intends to migrate to the accrual basis of accounting, IPSAS encourages presenting a statement of cash receipts and payments in the same format as that required by IPSAS 2 Cash Flow Statements (see https://www.ifac.org/sites/default/files/publications/files/ipsas-2-cash-flow-stateme.pdf ). The cash-basis IPSAS encourages entities to present a cash flow statement that reports cash flows classified by operating activities, investing activities, and financing activities.
The main challenges faced by supreme audit institutions when auditing cash-basis IPSAS financial statements are threefold. First, there is the requirement for the government to consolidate all government-controlled entities; this significantly widens the scope of the audit. Second, there is the IPSAS-requirement to report third party- payments (payments from a donor directly to a supplier), making supreme audit institutions express an opinion on cash flows outside the audited reporting entity. Finally, since the cash-basis IPSAS is a fair presentation framework, the SAI needs to assess whether the government provides all additional information necessary for a fair presentation of the entity's cash receipts, cash payments, and cash balances. We will deal with each of these challenges in the following sections.
IPSAS requires recognition of all cash receipts, cash payments, and cash balances controlled by the government. Control of another entity for financial reporting purposes is defined as the power to govern the financial and operating policies of another entity so as to benefit from its activities. In order to comply with the reporting entity definition in IPSAS, governments need to extend the reporting entity beyond the budget sector.
Controlled entities may operate different accounting bases than those used by the central government. For example, government business enterprises are likely to apply accrual accounting principles, perhaps in compliance with International Financial Reporting Standards (IFRS). Included within most accrual accounting frameworks, including IFRS, is the requirement to produce a cash flow statement—this statement can be used to compile consolidated cash-basis IPSAS financial statements.
The preparation of consolidated financial statements requires the elimination of all inter-entity transactions. The cash-basis IPSAS requires that when accounts are prepared at the government level, the transactions within departments of the government included in the consolidation are eliminated. Any inter-entity balances need to be reconciled and any unexplained differences need to be straightened out. Auditing the eliminations, if material, poses a challenge to the auditor since controlling entities and controlled entities do not usually keep track of these inter- entity transactions and balances.
Consolidated financial statements will expand the scope of work of the SAI considerably. This is because the audit opinion will cover the consolidated financial statements of the government, including all entities controlled by the government such as agencies and state-owned enterprises (referred to by IPSAS as government business enterprises). The auditor will effectively conduct a group audit, for which guidance is provided by the ISSAI 1600 Special Considerations – Audits of Group Financial Statements (http://www.issai.org/media/13124/issai_1600_e_.pdf ). ISSAI 1600 deals with special considerations that apply to group audits, in particular those that involve component auditors. In this case the SAI serves as the group auditor and the component auditors are the auditors of the public enterprises and other controlled entities. In accordance with ISSAI 1220 Quality Control for an Audit of Financial Statements, the SAI (the 'group engagement partner') is required to be satisfied that those performing the group audit engagement, including component auditors, collectively have the appropriate competence and capabilities. The group engagement partner is also responsible for the direction, supervision, and performance of the group audit engagement.
IPSAS requires separate disclosure of total external assistance paid by third parties to directly settle obligations of the government, or purchase goods and services on behalf of the government. An example is a development bank that pays directly to a building firm for an infrastructure project, and then advises the government's debt unit about the drawdown of the loan. In accordance with the standard, the statement of cash receipts and payments provides a separate column showing payments by third parties. Auditing these third-party payments may be a challenge for SAIs, because transactions made by third parties on behalf of the government are frequently not systematically identified. For example, projects directly paid for by the donor may not be captured through the accounting and reporting system. Also, information received from donors may be incomplete. However, the standard states that these disclosures should only be made when, during the reporting period, the entity has been formally advised by the third party or the recipient that such payment has been made, or has otherwise verified the payment. This means that if these third party payments have been made, but the entity has not been formally advised and has not otherwise been able to verify these payments, the financial statements are nevertheless compliant with the cash-basis IPSAS.
When expressing an unmodified opinion on financial statements in accordance with the ISSAI 1700 Forming an opinion and reporting on financial statements the auditor may use one of the following phrases:
Which one of these phrases the auditor should use depends on whether the accounting framework applied is a fair presentation framework or a compliance framework. An accounting framework is a fair presentation framework if it acknowledges explicitly that, to achieve fair presentation of the financial statements, it may be necessary for management to provide disclosures beyond those specifically required by the requirements in a standard (IPSAS 1, paragraph 27, 29) or to depart from a requirement in a standard (IPSAS 1, paragraph 31). Either one of these suffice for the framework to be a fair presentation framework.
The cash-basis IPSAS does not state that in the extremely rare circumstances in which management concludes that compliance with a requirement in an IPSAS standard would be so misleading that it would conflict with the objectives of financial statements, the entity shall depart from that requirement if the relevant regulatory framework requires, or otherwise does not prohibit, such a departure. However, the cash-basis IPSAS acknowledges explicitly that the notes to the financial statements of an entity should provide additional information which is not presented on the face of the financial statements but is necessary for a fair presentation of the entity's cash receipts, cash payments, and cash balances (Cash-basis IPSAS, paragraph 1.3.30, b).
The cash-basis IPSAS therefore qualifies as a fair presentation framework rather than as a compliance framework in accordance with ISSAI 1700 Forming an opinion and reporting on financial statements (http://www.issai.org/media/13148/issai_1700_e_.pdf ). When the audit is conducted in accordance with the ISSAIs, and the financial statements are prepared in accordance with the cash-basis IPSAS, the auditor may state that these financial statements 'present fairly' in accordance with the cash-basis IPSAS.
As part of his/her audit, the auditor should therefore establish that the financial statements provide disclosures beyond those specifically required by the cash-basis IPSAS, considered necessary for a fair presentation of the entity's cash receipts, cash payments, and cash balances. An example may be the building up of arrears to suppliers, because deferred spending reduces spending now but increases it later.
The adoption of IPSAS by a government will improve both the quality and comparability of the financial reporting of the cash receipts, cash payments, and cash balances of the entity. By applying the cash-basis IPSAS, the government also broadly complies with two important standards from the accrual suite of IPSAS standards: IPSAS 2 Cash Flow Statements and IPSAS 24 Budget Information in the Financial Statements. Because the cash-basis IPSAS constitutes a fair presentation framework, the SAI may issue an audit opinion stating that these financial statements give a true and fair view of the cash receipts, cash payments, and cash balances of the government in accordance with the cash-basis IPSAS.