IPSAS vs IFRS - what is the most suitable accounting framework for the public sector?

The adoption of accrual accounting by governments is gathering momentum. Many jurisdictions that are already applying accrual accounting have based their accounting framework on either International Financial Reporting Standards (IFRS) or International Public Sector Accounting Standards (IPSAS) and adapting them to suit their specific needs. If a government were to adopt accrual accounting now, is the adoption of IPSAS the most sensible option?

Whilst government accounting requirements are not too dissimilar to those of the private sector, some differences exist. Some jurisdictions have been applying accrual accounting for a long time and IFRS were viewed as the only credible international accounting standards (see Appendix 1 for UK’s journey to IFRS adoption). Indeed, the 2013 EU Commission report into the suitability of IPSAS for the member states stated that IPSAS were unsuitable for adoption, citing gaps in the literature, lack of a conceptual framework and unsuitable governance arrangements as reasons why. 

At the time, it was hard to argue against the EU findings, but great progress has been made by the IPSAS Board (IPSASB) to address the issues raised. There is a feeling that IPSAS are on the cusp of becoming much more widely accepted and it is against this background that we review, at a high level, some of the key differences between IFRS and IPSAS. This series of articles will help shape the debate about what framework jurisdictions, applying accrual accounting, should consider. 

We will review four key financial reporting standards, adding to this list over time, starting with the following:

1. Accounting for grants
2. Concept of fair value and measurement more generally
3. Government amalgamations – also known as machinery of government changes
4. Impairment 

Users of IFRS and IPSAS

IFRS are internationally recognised, widely adopted and are designed for large profit-orientated companies. The wide adoption brings about consistency in financial statements which in turn facilitates cross border comparability and understandability. This makes them particularly suitable for globally listed companies on public stock exchanges.

On the other hand, IPSAS are designed for public sector entities whose main objectives are to provide goods and services to benefit society and to redistribute wealth. They are entities primarily financed by taxation, not profit. It is fair to say that IPSAS are not currently widely adopted and finding a definitive number of jurisdictions that have adopted IPSAS is not easy since IPSAS are often only used as a reference point.

Users of government accounts

The objective of financial reporting by public sector entities is to provide information about the entity that is useful to users of financial statements for accountability purposes and for decision-making purposes (IPSASB Conceptual Framework 2.1).

Accountability of government is hugely important and having good processes in place is vital to hold to account those charged with governance. Financial statements are key for oversight committees and national audit institutions to obtain the information required in order to evaluate performance and ascertain value for money. Furthermore, having an official, audited statement of accounts sets the tone for a more rigorous governance environment as part of a wider public finance management infrastructure. Accrual accounting in general is a key component of ensuring sustainable public finances. 

The annual report, including the financial statements, is likely to be a useful tool for the entity producing it. It acts as a reference point and helps the entity explain how it performs, especially if the annual reports link the objectives and key performance indicators to the financial statements. The audited output is trusted and is often used for promotional activities.

However, there are a number of additional, external interested users including citizens, regulatory bodies, rating agencies, lending institutions, academics and supranational organisations such as the World Bank. These wide-ranging stakeholders will have different information needs, ranging from how effectively services are being delivered to what are the financial risks to which the entity is exposed.

By contrast, private sector annual reports are primarily produced for the shareholders, the owners of the company. 

Key definition differences between IFRS and IPSAS 

Outlined below are some key definition differences between the private and public sector financial reporting frameworks. 

The differences in financial reporting requirements between the public and private sectors are due largely to the environment in which the entities operate. Private sector entities will tend to seek profit maximisation and operate at arm’s length, whereas public sector entities tend to focus on service delivery, often at below market terms.

The public sector tends to have many intra-governmental transactions, which are not always rooted in contracts. They can also have different trigger points as to what may constitute a past event, such as ministerial directions. These and other factors often mean that definition and scope need to be tweaked for IFRS standards to work for public sector financial reporting. 

Accounting item	IFRS	IPSAS
Asset	A resource presently controlled by the entity as a result of a past event.	A resource presently controlled by the entity as a result of a past event.
Resource	Right that has the potential to produce economic benefits.	An item with service potential or the ability to generate economic benefits.
Service potential	N/A	Service potential is the capacity to provide services that contribute to achieving the entity’s objectives.
Non-exchange transactions	N/A	Transactions where an entity receives resources and provides no or nominal consideration directly in return.

Measurement	Fair value is a key measurement basis in IFRS yet can cause some issues when applied in a public sector context. A fair value measurement of a non-financial asset takes into account a market participant’s ability to generate economic benefits by using the asset to its highest and best use or by selling it to another market participant that would use the asset to its highest and best use. This is not always possible in the public sector.
Scope/definitions	IPSAS often need to change the scope and definitions of their IFRS equivalent to make them work as intended for the public sector. For example, “contracts” are replaced with “binding arrangements” in the IFRS 15 revenue standard to widen the scope so as to include transactions that are not necessarily underpinned by a contract.
Business combinations	Accounting for combinations under common control is outside the scope of IFRS. IPSAS recognise that this is a common transaction in the public sector and have adopted the pooling of interest method (merger accounting). IPSAS differentiate between acquisition and amalgamations; IFRS only considers acquisitions.

Whilst it is important to understand and acknowledge the differences, alignment between IPSAS and IFRS should be encouraged wherever possible. The principles applied must be consistent so that the accounting outcome is the same for comparable transactions. This is important for mixed private sector and public sector group consolidations and for maximising the transferability of accountancy skills between the private and public sectors. Indeed, many IPSAS standards are aligned with IFRS and will continue to be aligned going forwards. 

 

Appendix 1: Background of UK Government path to IFRS adoption

In 1994 the UK Government decided to move away from cash accounting and to adopt accrual accounting. Whilst this paper is not about the virtues of accrual accounting, the benefits cited at the time were as follows: 

• Better management information – departments would be able to cost resources used and to match them to outputs they deliver; 
• More informed decision making by taking into account the opportunity cost of capital; 
• Improvements to public expenditure planning and promoting better use of resources; 
• Better information for formulating economic policy and preparing national accounts. 

It took until 2001-02 for central government departments to publish the first set of accrual-based resource accounts which were based on UK GAAP. Almost ten years later, in 2009-10 International Financial Reporting Standards (IFRS) were adopted. The reasons for this change are not well documented but it is said that the Government wanted to remain aligned with the private sector and use internationally recognised standards. All EU listed companies were required to prepare financial statements following IFRS from 2005.