Public and Private Sector Accounting Free Essay Example

Accounting, known by and large to be a skilled, remunerative, but rather dry profession, has a long and fascinating history. In existence practically from the dawn of civilization, in one form or the other, accounting activity has been integral to some of the most important phases of history.

Responsible for the invention of writing, accountants have over the ages, (because of their organic and fundamental association with the processes of trade, business, industry, governance, and taxation), been involved in monarchy and empire expansion, the process of colonisation, the industrial revolution, the World Wars, scientific progress, globalisation, and the spread of neo liberal economics across the world.

Confucius, as a government official, was responsible for accounting, and much of what we know about the daily lives of ancient peoples comes from accounting records, such as inventories and sales records, found at archaeological sites. Accounting evolution has followed dissimilar routes in different countries and states and has been extensively shaped by the immediate and larger environment.

Japan’s accounting processes, for example, which were significantly shaped by western influences, are very dissimilar from that of neighbouring China and have played an important role in the country’s far more rapid advancement in business, industry and international trade in the 19th and 20th centuries.

Accounting policies and procedures in the modern day have, in somewhat similar fashion, evolved rather differently for private sector businesses and public sector corporations, being shaped and constructed by the unlike needs of the two sectors, the dissimilar nature of their income and expenditure streams, the different control processes under which they operate, and their diverse reporting requirements.

Recent years have however witnessed significant rethinking in and rerouting of the functioning of public enterprises; the steadily increasing application of neo-liberal economic principles and greater accountability for the commercial and financial success of public sector corporations, leading to increasing convergence between the accounting policies and practices of the public with that of the private sector. This essay attempts to investigate the reasons for the differences in their historical evolution, and the current worldwide efforts to bring about greater convergence between the two accounting methods.

Commentary and Discussion Historical Overview of Evolution of Accounting Whilst the extent of involvement of accounting activity in historical life across cultures is becoming clearer with the progress of archaeological work, the accounting profession has historically chosen to adopt a low profile, there being very few pioneers who can be identified with major accounting developments. The most important historical name to arise, in this connection, is that of Luca Pacioli, who in 1494 wrote a book on mathematics, in which he discussed the concept of double entry book keeping. The chapter on practical mathematics addressed mathematics in business. He said that the successful merchant needs three things: sufficient cash or credit, an accounting system that can tell him how he’s doing, and good bookkeeper to operate it. His accounting system consisted of journals and ledgers. It rested on the invention of double-entry bookkeeping. Debits were on the left side because that’s what “debit” meant, “the left”. The numbers on the right were named “credits”. If everything was done right, then the bookkeeper could do a trial balance (“summa summarium”).

Add up all the debits and then add up all the credits, he said. If everything had been done right, the totals should match. If not, “that would indicate a mistake in your Ledger, which mistake you will have to look for diligently with the industry and intelligence God gave you. ” He wrote” It is difficult to overestimate the importance of double entry bookkeeping. Simple and adequate for the needs of business, it caught on immediately with Italian merchants, was central to their success, and contributed towards the impetus that led to the emergence of the Renaissance.

Whilst the conceptualisation and implementation of the double entry system of bookkeeping in the 15th century was the first major watershed in the development of modern day accounting theory, the following centuries were also witness to a number of major developments in Europe and Asia in the area of business recording and accounting, many of which contributed to the development of modern day accounting principles and policies.

Notwithstanding Pacioli’s seminal contribution to accounting methodology, a number of other renaissance forces also helped in giving body and shape to the discipline; key factors among these being the concept of private property, capital, widespread commerce, money, the use of credit, the development of arithmetic, and the growing use of writing for recording transactions.

Although many of these factors did exist in ancient times, they were not found together, until the Middle-Ages, in a form and strength necessary to push for the innovation of double entry. Accounting rules, policies and practices evolved over time in response to the needs of businesses and to a range of developments.

The emergence of the Industrial Revolution in the 18th century led accountants to devise accounting methods for finding the cost of production; large scale production of goods in the United States led to the formulation of cost accounting procedures, the arrival of income tax laws saw substantial modifications in the practice of keeping accounting records, and the great depression of the early decades of the 20th century led to the introduction of standards, the establishment of accounting principles and accounting frameworks.

Josiah Wedgwood, the famous potter, contributed significantly to cost accounting by studying his books, manufacturing cost structure, overhead, and market structure to avoid bankruptcy during the recession. He became an accounting pioneer and his firm survives even today. Accountancy practices in recent years have been repeatedly scrutinised, modified and clarified through the setting up of accounting standards, the establishment of auditor responsibilities and the enactment of laws for appropriate disclosure.

The reputation of the accounting profession has been severely tarnished by corporate scams and frauds like Enron, which has led to the questioning of accounting methods and principles, as well the integrity of the accounting profession. Accounting systems and practices, whilst developing side by side all over the world have followed distinctly different routes, being influenced by institutional and cultural factors.

Institutional factors like legal systems, taxation laws, financing norms and methods, credit availability and stock exchange requirements, which have been markedly different for Anglo-Saxon, European, Central Asian, and East Asian environments have shaped the development of accounting systems accordingly. Researchers like Hofstede and Gray have theorised that cultural differences have also played a significant role in the establishment of different accounting systems in different countries.

Gray took up Hofstede’s cultural hypotheses and linked them to the development of accounting systems in a meaningful way, stating that cultural or societal values permeated through organisational and occupational subcultures, and vice versa, though obviously the degree of integration differed from place to place. “Accounting systems and practices can influence and reinforce societal values” Development of Accounting Methods in the Public and Private Sectors

The power of various influences to shape the development of accounting systems and methodologies is also evident in the shaping of accounting norms for the public sector and their significant differences from those adopted by or enforced upon the private sector; the public sector, basically implying corporations whose ownership vested with governments, and whose control was accordingly decided by government diktat.

Whilst governments had until the 1930s focussed mainly on the controlling of law and order, defence, foreign policy, and similar other areas, the end of the Second World War saw them taking a far greater interest in business and commercial affairs, as well as in infrastructural sectors. Whilst some of these developments were due to the influence of socialist thought and the example set by socialist states, (where all businesses were controlled by the government), they were also influenced by the widespread disenchantment with the capitalist way of governance after the great depression of the 1930s.

The huge task of nation building after the devastation caused by World War II made it necessary for governments to actually contribute to infrastructure building, nursing of revived industries, and setting up of new businesses. In the UK, activities like mining and railways were controlled by the government. In Italy the state owned IRI (Institute for Industrial Reconstruction) owned companies engaged in mining, steel, airlines, banking, telephones, and automobile manufacture, and in India the government, apart from controlling all infrastructural activity also controlled the majority of heavy business investment and activity.

Substantial governmental control over infrastructural and commercial activity, in addition to its existing control over governmental departments, led to the evolution of a significantly different form of accounting than what was followed by the private sector. The most important of these differences concerned the mode of booking expenditures and incomes, which in the private sector worked on the accrual basis, even whilst the public sector chose to stay with the older method of recording them only after they had been realised in cash or kind.

The cash basis of accounting, which records income or expenditure transactions only after such transactions have resulted in the physical receipt or payment of cash, constituted the commonly followed way of accounting for all enterprises, until the adoption of the accrual way of accounting by businesses, changed commonly held accounting perspectives. The cash system records accounting events when they become tangible, e. g. , when a customer’s check arrives, when a shipped product reaches the customer, or when money for a business-related expense is removed from the bank.

Cash accounting registers income when money arrives and registers expenses when money goes out of the business. Even today the cash accounting method is a more familiar accounting method because of its use by most individuals in tracking of personal finances. Under this method, one’s income is taxable when it is received, and expenses are deductible when they are paid. Cash accounting remains a straightforward and easily understood method of record-keeping for tax purposes.

The accrual method on the other hand approaches accounting events in real time. A sale is registered as soon as a customer receives a consignment even though the actual payment could come much later. Similarly an expense is recorded as soon as the event occurs and a liability recorded as soon as an event occur, whether it is purchase of material, use of services like water or electricity and use of employed or contracted labor, even though such transactions do not involve the simultaneous exchange of money.

Over time most private sector businesses, apart from those controlled by small individuals or which were small in size, chose to switch over to the accrual system, forced as much by pressure from regulatory bodies and lending institutions, as by their desire to reflect more logical and realistic business and accounting outcomes. Most tax systems stipulate the compulsory use of accrual systems for private businesses after they achieve a certain size or adopt specified legal structures like those of privately owned or joint stock companies.

Most public sector organisations, across the world, however chose to remain with the cash based system of accounting. Such decisions grew out of certain specific circumstances. Governments are essentially different in their nature from businesses, the information required for better understanding and assessment of the financial operations of government organisations extending beyond the reporting of surpluses and deficits.

Governments, unlike the private sector, whilst required to run their operations efficiently, are required to provide goods and services to the public, which in some cases becomes more important than making profits. The measurement of surpluses or deficits is in many cases not the primary indicator of the performance of government working. In many countries the public sector continues to retain a separate and different approach from the private sector.

Their services are often provided free at the point of use and there is little or no direct link between the cost of these and government income, which is mainly in the form of taxation. The government, in many cases, decides upon the amount of grants required for specific public sector organisations through the formulation of budgets and provides the same on a periodic basis; many such organisations preferring to call their financial statements “receipt and expenditure” rather than profit and loss statements. The accounting policies of public sector organisations are also shaped by their different reporting requirements.

Private sector organisations, especially those that are legally structured as joint stock companies need to provide a true and fair description of their financial performance for the benefit of their shareholders, the tax authorities, and other stakeholders. Even smaller organisations need to necessarily satisfy the requirements of tax departments and their owners, and their accountants routinely adopt the accrual system for recording transactions and preparing statements. Reporting requirements for government controlled organizations is significantly different.

Comparison of actual disbursals and expenses with those budgeted is a routine requirement, a need that is more conveniently filled through the use of cash accounting records. The managements of such organisations also have to report on specific information needs of various bodies, including supervisory government departments, parliamentary bodies, and the governmental auditors. Conclusion Recent years have seen extensive debate in public sector accounting and the changes made in many countries for shifting from the cash to the accrual basis of accounting.

Public sector working has been influenced during the last three decades by the concepts of New Public Management, (NPM), which expressly calls for enhancement of the efficiency, effectiveness, and accountability of public service delivery through the implementation of a wide range of changes that include deregulation, decentralisation, outsourcing, substitution of input control by output control, result orientation, responsibility assignment and introduction and implementation of private sector management techniques.

Whilst the adoption of the accrual system of accounting will lead to the production of more logical and more accurate financial statements, the convergence process will need extensive retraining and education not just of public sector accountants but also of public sector auditors and the users of these financial statements. Such lack of familiarity may lead to inaccuracies in the preparation of financial statements and will need to be addressed through appropriate training and skills upgradation of the concerned people.

With the aim of public sector reforms being the dismantling of bureaucracy and more efficient use of resources, increased managerial autonomy and discretion is being accompanied by an emphasis on more extensive accounting practices. Again with accounting playing a key role in NPM implementation and in public sector reforms, the need for greater convergence between public and private sector accounting is being increasingly evidenced.

Significant accounting reforms are taking place in many countries, more specifically in the United States, the UK, and West and Nordic Europe. Many public sector companies are changing their accounting policies to institutionalise accrual accounting for budgetary and external financial reporting purposes in order to provide useful information about liabilities, debt, usage of assets, and the cost of public services Whilst change is coming about slowly in public sector accounting, the issue is still being debated vigorously in many countries.

The International Federation of Accountants (IFAC) formulated the “Guideline for Governmental Financial Reporting” in 1998 to help public sector units at all levels to prepare their financial reports on the basis of accruals. The IFAC Guideline, along with the International Accounting Standards (IAS) followed by the private sector, make the basis for the International Public sector Accounting Standards (IPSAS) developed by the Public sector Committee (PSC) of IFAC.