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Next generation and accrual accounting: the challenges of public accounting systems

In the wake of the initial outbreak of the pandemic, European Union member states drew up investment and reform plans to access vast EU resources (2,346.3 billion euro). These funds were unlocked in the Next Generation Plan, and tapped from the long-term budget for the 2021-2027 period and from reserves that were already earmarked for workers, companies, and member states.

Italy will by the biggest beneficiary of European resources in terms of overall funding. Specifically, our country will be administering a total of 222.1 billion euro in investments, of which, 191.5 billion to be allocated to specifically investments and reforms presented in the National Recovery and Resilience Plan (PNRR), which runs from 2021 to 2026. This project entails an investment package allocated to six missions (digitalization, innovation, competitiveness, culture and tourism; the green revolution and ecological transition; infrastructure for sustainable mobility; education and research; social inclusion and cohesion; and health). Supporting these missions, in turn, are a series of horizontal or “contextual” reforms (which encompass the PA), as well as sector and cross-sector reforms. Particularly interesting is the reform that calls for “providing Public Administrations with a harmonized accrual accounting system” to take effect by 2026. This provision reignites a debate, one that has never reached a consensus, surrounding the issues of the bases of accounting, accounting systems and accounting maturity in the public sector. These questions also tie into the capacity of financial information technology systems of Italy’s institutions to fulfill information and reporting requirements regarding the use of incoming resources, to satisfy not only the demands of the EU but of citizens as well. In this sense, the PNRR represents a fresh opportunity to revive - and even dial up - the debate on the need to harmonize PA accounting practices across Europe (among and within member states), a process which was set in motion in 2011 with the adoption of the directive addressing national budgetary frameworks (Council Directive 2011/85/UE), but which has yet to be fully implemented.

While it is true that monitoring cash flows and spending is a fundamental aspect of reporting, the widely held opinion today is that financial accounting alone does not reflect overall performance or the financial position of PAs. (Note that financial accounting, or consolidated financial accounting, is still in force or at least common practice in various sectors, as is the case for local administrations, since the enactment Legislative Decree 118/2011.) For example, there are certain components of assets and revenue streams that are not properly reported in the framework of financial accounting, even though they impact the administration’s budget surplus/ deficit. Consider, for instance, non-interest-bearing liabilities, non-financial investments, or other non-monetary income items. Moreover, by introducing accrual accounting, PAs can more clearly underscore the rights and responsibilities relative to various investment and financing transactions. At the same time, the accounting practices and tools that are typically found in the private sector cannot be transposed – as is - to public administrations, even if this transposition is strongly advocated with the advent of New Public Financial Management. What’s more, the process of harmonizing accounting rules is hindered first by the absence of standards that can adapt to extremely heterogeneous accounting practices we find among EU member, and second by the difficulty of implementing International Public Sector Accounting Standards (IPSAS) and/or European Public Sector Accounting Standards (EPSAS).

Establishing a harmonized accounting system for the public sector based on the accrual principle appears to be a necessary step toward achieving the social, environmental, technological and cultural goals that constitute the core of the PNRR. In fact, despite a tendency to rigidly follow pre-set standards, and existing national barriers, the development of EPSAS has won broad consensus. European accounting principles for the public sector are thought to be an effective response to the need to control the deficit and national debt, and to promote a standardized approach that takes into account the distinct characteristics of each member state. Also key is the fact that accrual accounting in the public sector can help paint a complete picture of what the PA owns (although admittedly there is still some skepticism on this score, for example as regards assets and liabilities), what it owes, and the value that is created or destroyed. The much-touted economic competence in the public sector also represents a fundamental principle in terms of accountability and transparency in financial communication, intergenerational fairness, and efficiency – all indispensable for achieving the goals of the PNRR, and essential at a European level as well.

Let’s consider the example of local governments. After investments plummeted from 2008 to 2017, municipal administrations now find themselves shouldering the responsibility for PNRR implementation, and having to manage around 35% of the total financing. So after an initial response to the crisis based on cash advances and short-term subsidies, today local entities are (finally) being asked to re-envision their services and infrastructure from a long-term perspective.

To do so, in accounting this means local authorities will be expected to: assign an identification code for each project to monitor progress; draw on/refer to the relevant budget items the PNRR to reconstruct income and expenses for each project; and utilize a rolling budget to constantly adjust expected results. All this requires special effort in selecting the right projects to implement, and perhaps even greater effort in carefully monitoring and communicating how public funds are used, with the help of effective information and accounting systems. For this reason, accessing investments and actioning the reforms in the PNRR must be supported by financial information that accurately depicts the complexities of the PA, while avoiding loss of information.

But with regard to reporting that respects the rules and commitments envisaged in the NPRR, how far will the urgency to do so translate into concrete efforts by PAs to revisit their accounting systems by going beyond compliance alone and adopting a performance monitoring approach? How far will the new accounting principles, rules and procedures go to effectively support the revision of practices, competencies, and the use of accounting information for decision making and accountability? A possible response may come from the national standard setter which has already instituted working groups in the Ministry of Economy and finance – General Accounting Office (MEF-RGS) to discuss technical questions and governance issues regarding accounting rules and the new information opportunities for the PAs that will be implementing the accrual reform. These working groups represent opportunities for engagement between standard setters (MEF-RGS) and the PAs impacted by the reform. Absolutely crucial is ensuring the effectiveness of this engagement, and mitigating the risk of low participation, which has come up on the same issues during attempts to harmonize accounting rules in compliance with Legislative Decree 118/2011. In fact, in that case, with the exception of the regions, few of the local authorities who were addressed by the reform actually participated in the testing phase for implementation of the Decree.

No doubt, the change on the table is a major one, in terms of both the skills required and the actions to be carried out. Aside from the need to respect the relative timeline, along with this change there must come a shift in perspective with regard to what purpose financial statements serve - not only as an authorization documentation, but also as a tool for making forecasts and comparisons. Moreover, accounting principles and standards must also come into play that can respond both to the need for harmonization and the true and fair representation of the financial situation of each PA. To this end, we suggest proceeding with a gradual implementation at several administrative levels or by homogeneous groups of bodies. This would reveal the specificities of each entity as well as the general aspects common to them all (including application problems). Based on this, the standard setter could propose the most appropriate methods for adopting the new accounting framework.

Secondly, PAs must immediately invest in accounting competencies and technical/specialist skills so that accounting managers can guide their organizations in gradually adopting the new accrual-based system. Further, investments are also needed in transversal managerial competencies. The idea here is to enable even those who are not experts in accounting or financial reporting (managers from other departments, administrators, and decision-makers more generally) to understand the information and accountability potential deriving from the informed use of economic, financial and equity data produced by the entity. Finally, we must remember not to underestimate universities and research centers during this transition phase. In this scenario, these institutions would be excellent interlocutors to reflect on the system as a whole, and to find the right approach to onboard the stakeholders in this reform, and to delineate and transfer the technicalities and information potential of the accounting systems to the PAs.