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All you need to know about accrual accounting

Satya Sontanam | Updated on January 28, 2019 Published on January 28, 2019

With Budget 2019 around the corner, all the eyes are on the fiscal deficit (total revenue – total expenditure) number that the Finance Minister will present for the current fiscal year. But, did you know that there is a lot of room for the government to ‘adjust’ this number, by advancing revenues and postponing expenditure to the next year? The Comptroller and Auditor General of India (CAG) had recently flagged such practices. But they arise because the government accounts have always been prepared on a cash basis and not on an accrual basis, as companies do.

What is it?

In accrual-based accounting, the revenue and expenditure of an entity is recorded in the books when it is earned or incurred, irrespective of when cash is actually paid or received. Whereas, in cash-based accounting, books are prepared wholly on the basis of cash flows.

Take a small business that made a sale on March 28, 2018 but received payment for it on April 5, 2018. Under accrual-based accounting, the sale amount is recognised as revenue on the date of sale (March 28, 2018).

The sale will thus figure in its accounts for 2017-18. But in the cash system of accounting, the sale would be accounted on the day when the firm receives cash (April 5, 2018). It would thus not figure in the books for 2017-18.

Commercial entities the world over follow only accrual accounting and present a cash flow statement separately. The GoI is mandated only to present a receipts and expenditure (cash flows) statement each year.

Why is it important?

As cash accounting records expenditure only when it is paid, a government looking to present a low deficit number can delay payments to suppliers of goods or services and carry over the liability to the next fiscal.

For example, the CAG has flagged that the Food Corporation of India (FCI), which procures foodgrains from farmers, has seen mounting dues from the government over the years resulting in large ‘carry over’ liabilities. To meet its financial requirements arising out of these arrears, FCI resorts to off-Budget loans with interest payments. This increases the final subsidy bill for the government.

The Twelfth Finance Commission had noted that the cash-based system of accounting creates room for ‘fiscal opportunism’, as tax revenues can be collected in excess during a period and payments easily be deferred to future periods.

Under the accrual system of accounting, though the payment could be delayed, the expenditure will need to be accounted for, making it harder to window-dress deficit numbers through such means.

Why should I care?

Accrual accounting could make government financial transactions more transparent. It could also reduce delays and interest costs for arms of the government. With off-Budget items reduced, the Budget itself would offer a more reliable picture of the government’s finances.

It can help better assess revenue requirements of the Centre and States vis-à vis the available resources.

If you closely track India’s fiscal policy and public finance, do get equipped with the knowledge of accrual accounting.

Taking note of the importance of accrual accounting, actions have already been initiated by the Centre to shift its current accounting practice over time.

Indian Railways is already set to prepare its financial statements for this fiscal under the accrual-based accounting system.

Bottomline

Governments can get away with pretty much anything. So it is good when they volunteer to reform.

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Published on January 28, 2019
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