From the Office of the Auditor General of British Columbia
Public sector organizations generally exist to provide services to the public rather than to generate profits. Business enterprises focus on generating profits and wealth for shareholders. So how do these two sectors differ in their preparation of financial statements?
Public sector financial statements differ from those of business enterprises. Individuals reviewing public sector financial statements for the first time often wonder how to interpret the unfamiliar presentation, and many ask: “Why are the organization’s assets separated on the statement of financial position?”; “What is ‘net debt’?”; and “Why is the budget reported in the financial statements?” The answers to these questions rest with the fact that public sector organizations differ fundamentally in terms of their objectives, and, therefore, in terms of performance measurement. While a comprehensive description of public sector financial statements is beyond the scope of this article, the most unique features are discussed below.
When the Public Sector Accounting Board (PSAB) sets accounting standards for the public sector, it must factor in the sector’s unique characteristics; these unique characteristics drive many of the standards contained within the CPA Canada Public Sector Handbook. The principle characteristic unique to the public sector is that it generally exists to provide services to the public rather than to generate profits; this has a number of financial reporting implications, including the following:
- Public sector entities provide services and redistribute wealth – A significant portion of a public sector entity’s operations are funded by non-exchange transactions, such as taxation revenues and grants. In order for financial statements to provide a full understanding of the nature and extent of these transactions for accountability purposes, accounting standards that address the recognition, measurement, presentation, and disclosure of these transactions are needed.
- Budgets are used to communicate priorities – The financial statements include the approved budget compared with the actual results. This enables readers to see how actual resource allocation and revenue generation differed from those originally planned.
- Tangible capital assets are held to provide services – In the public sector, tangible capital assets and other assets are not used to generate cash flow. In the financial statements, these assets are presented as non-financial assets, separate from the assets that generate cash flow or that can be used to repay liabilities (financial assets). The separation of financial and non-financial assets in the statement of financial position is the basis for the presentation of “net debt,” a performance measure unique to public sector financial statements.
Measuring Performance in Public Sector Financial Statements
While the primary focus is often on the annual operating surplus or deficit, this measure only tells part of the story. Performance measurement is much broader in the public sector than it is for a business enterprise focused primarily on delivering profits.
The statement of financial position
This financial statement presents net debt or net financial assets, as well as accumulated surplus or deficit. Both measures help readers see the cumulative impact of past transactions and events on future revenue requirements and service capacity.
Net debt or net financial assets
Net debt, a term unique to public sector financial reporting, refers to the difference between an entity’s financial assets and its liabilities at a specific point in time. Because this performance measure is presented directly within the statement of financial position, readers do not see total assets presented in public sector financial statements (again, non-financial assets are reported separately).
Being in a net debt position means financial assets are insufficient to repay existing liabilities, and future revenues will be required to fund costs incurred in prior years for the delivery of services, investments in tangible capital assets, and other transactions. By contrast, a net financial asset position may provide opportunities for future services to be financed from existing resources. Given the importance of this performance measure, public sector financial statements also include the statement of change in net debt (or net financial assets).
Accumulated surplus or deficit
An accumulated surplus position means net resources (both financial and non-financial) are available that may be used to provide future services. An accumulated deficit position means that annual operating deficits (which reflect the amortization of tangible capital assets) have been financed through borrowing. Being in an accumulated deficit position means that an entity will require future revenues to finance its historic operations.
It is important to assess the strength or weakness of the position presented, as well as how the position is trending over time. For example, an entity in a strong financial position may incur operating deficits over several years, yet continue to maintain a relatively strong financial position.
The statement of operations
This financial statement presents annual operating surplus or deficit, which is the measure most readers focus on when reviewing public sector financial statements. This statement also provides information on revenue generation and resource allocation.
Reporting budget information within financial statements is unique to the public sector. This information primarily appears on the statement of operations, but it also appears in other statements where budget authorizations are normally required, such as tangible capital asset acquisitions or the issuance of new debt.
Annual budgets approved by elected officials and boards provide financial accountability information that explains how an entity intends to finance operations and spend available resources to achieve its objectives. Including the budget in the financial statements enables readers to compare actual results to the original plan.
Revenues are classified by source, providing readers with useful information on an entity’s use of taxation or fees to finance operations, and on its potential dependency on transfers from other governments to provide services. Expenses are presented by program or functional classification rather than by type; this presentation by program informs readers of resource allocation decisions related to the entity’s objectives, and explains how actual resource allocation compared to the allocation communicated in the original budget.
As is the case with the financial position performance measures discussed earlier, it is important to assess trends when evaluating financial performance.
Reporting the full financial performance story
Financial statements alone cannot tell the full story of financial performance. This is particularly true in the public sector, where performance objectives extend beyond profitability. For example, financial statements do not demonstrate how efficiently an entity has used its available economic resources when delivering services, or why the actual financial results differ from original plans. Recognizing these limitations, PSAB has developed four statements of recommended practice (SORPs) to help entities prepare accountability information not present in basic financial statements:
- SORP-1, Financial statement discussion & analysis;
- SORP-2, Public performance reporting;
- SORP-3, Assessment of tangible capital assets; and
- SORP-4, Indicators of financial condition.
The additional reporting recommended in the SORPs is meant to supplement basic financial statements and provide a more complete picture of performance in the public sector.
To increase awareness and understanding of public sector financial reporting, the Office of the Auditor General of BC has published several online resources, available at www.bcauditor.com:
- Understanding Canadian Public Sector Financial Statements
- Public Sector Accounting Standards - Model Financial Statements for Government Organizations
- Summary of Canadian Public Sector Accounting Standards for Government Organizations
In addition, the PSAB website (www.frascanada.ca) includes information on the financial reporting framework and current standard-setting activities.
- Section 1100 Financial statement objectives – Appendix A of the CPA Canada Public Sector Handbook includes a full list of unique characteristics and the resulting financial reporting implications.