Accrual accounting in the public sector

Accrual accounting in the public sector is a method to present financial information on government operations. Under accrual accounting, income and expenditure transactions are recognized when they occur, regardless of when the associated cash payments are made. The difference between public sector accrual accounting and cash accounting is most apparent in the treatment of capital assets (i.e. equipment, buildings, and public infrastructure that lasts many years). Under accrual accounting, expenditure on capital is added as an asset in the government's balance sheet in the year the capital is purchased, but the cost is not included in the year's budget as an operating expense. Instead, payment for capital used (i.e., the estimated depreciation or amortization) is included in that year's budget as an operating expense.

The usefulness of accrual accounting in the public sector remains in dispute. Advocates say a government that employs accrual accounting is less likely to underinvest in public infrastructure since large up-front capital costs are not recorded as a current period expenditure — rather, the expense is recorded over the years the capital is used (depreciates). Detractors counter that, following this reasoning, since the capital purchase does not generate a current period expense, accrual accounting may encourage excessive spending on capital and borrowing.

A central argument in favour of public sector accrual accounting over cash-based accounting is that it can provide more comprehensive information on government finances, including balance sheet data on assets, liabilities, and depreciation. However, accrual accounting income statements and balance sheets are based on technically complex and often arbitrary estimates of the value of public assets (market values are usually not available), so the information may not be reliable. This may impede citizen comprehension and the transparency of government finances. Other concerns with accrual accounting in the public sector are that it is more easily manipulated because it tends to be less transparent and is less understood by the public; a deficit/surplus under accrual accounting provides a less accurate measure of the government's borrowing and fiscal stimulus to the economy compared to a cash-accounting deficit/surplus; and accrual accounting is more costly because of the technical demands (often requiring new IT systems and more qualified accountants).

While accrual accounting has been used in the private sector for over a century, it has become common in the public sector only since around 2000. In 2020, 30% of 165 jurisdictions surveyed worldwide used accrual accounting.

How accrual accounting differs from cash accounting in the public sector

Accrual accounting differs from cash-based accounting in two main dimensions:

(1) Recording government transactions: Under cash accounting, income and expenditure transactions are recorded when the associated cash is received or paid. By contrast, under accrual accounting, income and expenditure transactions are recognized when they occur, regardless of when payments are made.

While some transactions generate a simultaneous cash payment, with transactions like the generation of a pension obligation and purchase of capital, they do not. (However, in many instances the cash accounting system can be modified to incorporate future costs — for example, future pension obligations associated with employment of a public sector worker can be recognized by allocating funds to a public sector employee pension plan. )

(2) Assets and liabilities in the government balance sheet: The second key aspect of public sector accrual accounting is that all government assets and liabilities are recognized in the government's balance sheet. These include financial assets (such as equities), non-financial assets (such as land and buildings), and liabilities such as civil service (government employee) pension obligations. Assets may be recorded at their historic cost, current market value, or some approximation; and are regularly revalued to indicate their financial value. By contrast, governments that follow pure cash accounting typically include only cash holdings on the assets side and, possibly, debt on the liability side of their balance sheets.