Socio-Economic Review

Socio-Economic Review Advance Access originally published online on October 15, 2007
Socio-Economic Review 2007 5(4):725-754; doi:10.1093/ser/mwm017

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Globalization: governmental accounting and International Financial Reporting Standards

Alan Robb¹ and Susan Newberry^2,

¹ St. Mary's University, Halifax, Nova Scotia, Canada
² Faculty of Economics and Business, University of Sydney, New South Wales, Australia

Correspondence: s.newberry{at}econ.usyd.edu.au

From the early 1990s, Australia and New Zealand pioneered the application of business-style accounting practices to all government activities. Today these business-style practices are advocated for governments around the world, either via International Financial Reporting Standards or via the similar International Public Sector Accounting Standards (IPSAS). Although accounting might seem purely technical, accounting practices can carry with them significant constitutional and political (social) implications. Business-style accounting was not devised for governments and is not suited to provide the essential constitutional safeguards or to fulfil governments' public accountability obligations. These points are illustrated using evidence from New Zealand before explaining that today's IPSAS developments were led initially from New Zealand. This article urges those in other countries to consider constitutional and political implications before proceeding with this development.

Key Words: financial institutions • governmental accounting • international financial reporting standards • public sector reforms • New Zealand

JEL classification: H11 structure, scope and performance of government, M41 accounting, P11 planning, coordination and reform

	1. Introduction

TOP 1. Introduction 2. Policy development: the... 3. Governmental accounting and... 4. Disseminating business-style... 5. Concluding comments Funding Notes References

 
New Zealand's world leadership in aspects of its neo-liberal economic reforms is well known, as is the Treasury's leadership as their ‘principal designer and driving force’ (see, for example, Pallot, 1998, p. 158). The country was described as a late starter, but an extreme and rapid mover following a change of government in July 1984 (Ferlie et al., 1996). The Treasury identified the conversion of governmental financial management and reporting to business-style accrual accounting and financial reporting as a core component of those neo-liberal reforms:

It is not entirely clear where economic restructuring ends and public sector management reform begins, or where the latter ends and financial management reform begins. All are related components of a set of reforms designed to improve the performance of the New Zealand economy in delivering social and economic outcomes. (Treasury, 1989, p.1)

Prior to these reforms, the financial management aspects of New Zealand's government operations were derived from a cash-based cycle of expenditure control and reporting. In 1989, New Zealand legislated the adoption of accrual-based budget appropriations and business-sector style accounting throughout the public sector, with full conversion to take effect from the financial year commencing on 1 July 1991. The first accrual-based financial statements for the central government were for the year ended 30 June 1992 (http://www.treasury.govt.nz/financialstatements/year/jun06/27.asp). These were ‘whole of government’ financial statements, using modified business-style consolidation practices to combine the financial reports of the various parts of government.

New Zealand's governmental accounting reformers have since gone on to promote the adoption of similar business-style changes internationally, either directly by applying the International Financial Reporting Standards (IFRS) that are devised for businesses by the International Accounting Standards Board (IASB) or indirectly by applying International Public Sector Accounting Standards (IPSAS) devised by the International Federation of Accountants (IFAC). The IPSAS are based on the IFRS, thus increasing ‘the possibility that, at some point in time, they...may be merged’ (Simpkins, 2000).

Despite the seemingly technical nature of accounting, this adoption and dissemination of business-style accounting for all governments is constitutionally and politically (socially) significant and, therefore, requires wider attention. Although the accounting profession typically presents accounting and financial reporting techniques as neutral, and intended to allow the impartial and representationally faithful presentation of financial reports, such claims have long been refuted (Lehman, 1992, p. 145). Financial statements might purport to represent economic ‘reality’, but they are selective and well known to have a constitutive effect in that what is reported in those statements becomes perceived as reality (Hines, 1989). A potential constitutive effect of adopting business-style practices is to make governments seem like businesses and, eventually, to become thought of and treated as businesses. Indeed, in a revealing comment at the height of New Zealand's reforms, the chairman of the IFAC's public sector committee, Roelof Voormeulen, argued that a government's financial reports should be presented in business form because a government is a business:

Accounting is accounting and auditing is auditing, and ... the techniques, whether they are used in the private or public sector, are the same. I can't see why the accounts of government, which is no more than a huge business, should differ from the accounts of companies. (Anon, 1993, p.37, emphasis added)

Although Voormeulen's comment may have been careless, the idea is consistent with Bobbitt's (2002) comments about globalization and the gradual replacement of the nation state with the market state. Voormeulen's failure to recognize the constitutional underpinnings of a Westminster government is not an isolated one. In the early stages of New Zealand's financial management reforms to the core government, the Auditor-General condemned some proposed financial management changes as constitutionally illiterate (Pallot, 1991). Further, in 2004, a senior staff member of the Auditor-General's office, speaking on his own behalf, commented that those promoting the most recent financial changes either did not understand New Zealand's constitutional conventions or did understand those conventions and were determined to set them aside (see Newberry and Pallot, 2006, for a more detailed explanation of these changes).

A government is significantly different from a business, and the purpose of governmental accounting also differs significantly. In a Westminster system, the ‘underlying principle’ of government accounting is ‘democratic control over the use of funds, made critical by the coercive ability of governments to raise finance through taxation’ (Pallot, 1992, p. 103). Parliamentary scrutiny and control of the government's handling of public finance is a fundamental constitutional convention of the Westminster model, a point emphasized by British Prime Minister and Chancellor of the Exchequer, William Ewart Gladstone, in 1891:

The finance of the country is ultimately associated with the liberties of the country. It is a powerful leverage by which English liberty has been gradually acquired. ... If the House of Commons by any possibility lose the power of the control of the grants of public money, depend upon it, your liberty will be worth very little in comparison. (Gladstone, 1891)

This power of control is crucial because debt incurred by a government is guaranteed in full by the people of the country through the government's coercive power to tax. Business-style accounting practices were never devised to address such serious consequences of financial mismanagement, and this article argues that business-style financial reporting is not suitable for application to governments.

Public policy literature on how particular policy reform ideas take root, develop and spread provides some explanation of how policy developments may occur that are not necessarily appropriate responses to the particular policy issue. That is the focus of the next section which also provides a brief outline of events leading to the world-wide advocacy of business-style accounting for governments. A brief explanation of business-style accrual accounting and its implications follows, and three examples of governmental financial reporting in New Zealand illustrate our concerns about the inappropriateness of business-style accounting. Today's effort to implement business-style accounting for governments worldwide began in New Zealand and Australia, and seemed to be led from there. While the need for change to the previous governmental financial management practices is not disputed, the form of change adopted requires reconsideration if constitutional arrangements regulating the ‘power of control of the grants of public money’ are to be maintained, and to allow for the public purposes of and public interest in governmental activities.

	2. Policy development: the garbage can model

TOP 1. Introduction 2. Policy development: the... 3. Governmental accounting and... 4. Disseminating business-style... 5. Concluding comments Funding Notes References

 
Kingdon (2003), in his development of Cohen et al.'s (1972) garbage can model of the policy-making process, identified three processes that function separately: problem recognition, formation and refining of policy proposals and politics. Policy reform is most likely when these processes come together. According to Kingdon (2003), a policy community of specialists who share ideas ‘develop their proposals and then wait for problems to come along to which they can attach their solutions, or for a development in the political stream like a change of administration that makes their solutions more likely to be adopted’ (Kingdon, 2003, p. 88). Such an opportunity may be provided through either problem recognition or politics. For example, a crisis may prompt recognition of a problem, or implementation elsewhere of a similar solution may bring the matter to political attention. The opportunity provides a ‘policy window’ through which the pre-developed ‘solution’ may be sold, even though that solution might not be entirely appropriate for the particular problem.

A more determined application of this garbage can model occurs if policy entrepreneurs conduct a policy mission, as has been claimed occurred in New Zealand's reforms (Wallis and Dollery, 1997). Some neo-liberal reformers advocate forcing open the policy window by, for example, deliberately prompting a crisis. Williamson and Kaufman (1994, p. 565) observe that such crises have ‘often played a critical role in stimulating reform ... These worst of times give rise to the best of opportunities for those who understand the need for fundamental economic reform’.

This garbage can model of the policy-making process may be applied to governmental financial reporting developments. In the United States, in the mid-1970s, a financial crisis in New York City aroused widespread concern about financial management practices, thus prompting problem recognition. That the application of business-style accounting as a solution was already available in the policy community was apparent from earlier largely unsuccessful efforts to reform budgeting and accounting at the federal level and to introduce business-style processes, including in the Department of Defence (see, for example, Mosher, 1954; Staats, 1968). Major accounting firms, such as Arthur Andersen and Peat Marwick, were involved in these federal efforts in the mid-1960s (Anthony, 2002) and, subsequently, in New York City. Despite the limited success of these efforts, Arthur Andersen and other major accounting firms promoted business-style governmental accounting reforms in Australia in the early 1980s, claiming success in New York (Christenson, 2003). From the mid-1980s, some Australian states adopted business-style accounting for governmental financial management, and from 1989, New Zealand's central government adopted it. This garbage can model of policy-making suggests that business-style financial reporting came to be seen as appropriate for governments because it was promoted by influential and well-connected players in the policy-making process.

An Australian report to the OECD's Public Management service (PUMA) in 1992 commented on the ‘high standard’ of financial reporting achieved by ‘commercially oriented areas of the public sector and Government Business Enterprises’. It advised that ‘work underway to apply similar accrual standards to departmental reporting practices will further enhance resource management and accountability for these elements of the public sector’ (PUMA, 1993, p. 26). Soon after this, in 1993, the accounting standard setters in both New Zealand and Australia claimed that their financial reporting standards apply to both the business and government sectors, and called their approach to standard-setting ‘sector neutral’. It was during these developments that Voormeulen (1993, quoted above) visited New Zealand arguing that business-style accounting should be applied. In both jurisdictions, senior accountants from the respective Treasuries (Ministries of Finance) became increasingly active in financial reporting standard setting, and the standard setters adopted a ‘closed’ approach to standard setting on matters that particularly affected the public sector (Ryan et al., 1999). Today, the precedent in New Zealand and Australia bolsters efforts to ‘sell’ business-style accounting and financial reporting practices to solve the ‘problem’ of appropriate governmental accounting practices for governments around the world. This solution is promoted by key reformers from both countries, and through various global bodies, including IFAC, the World Bank and the International Monetary Fund (IMF).

	3. Governmental accounting and the application of business-style accounting

TOP 1. Introduction 2. Policy development: the... 3. Governmental accounting and... 4. Disseminating business-style... 5. Concluding comments Funding Notes References

 
The development of any accounting system requires consideration of the underlying purpose of that system. Under the Westminster government convention, the purpose of governmental accounting is democratic (i.e. parliamentary) scrutiny and control over the executive government's use of funds. The power to scrutinize and control was achieved only after many years of struggle against the ruling power (see Pallot, 1992). A Westminster parliamentary system relies on some separation and balancing of power between parliament (the legislature), the executive government (the ruling power) and the judiciary.

The cash accounting previously used for government accounting purposes in New Zealand involved an annualized focus on cash appropriations which allowed parliamentary scrutiny and control over expenditure in the current year. Its shortcomings had become problematic as government activities expanded and became increasingly complex. It did not assist the planning of longer term programmes, or track goods held for longer than a year such as inventories of armaments and larger equipment such as vehicles and buildings, nor did it contribute to monitoring performance in respect of longer term concerns.

Accrual accounting extends the focus of cash accounting by including in financial reports, transactions and events which occurred in the current year even though they have not necessarily involved the receipt or payment of cash. This extended focus supports the reporting in financial terms of changes in inventories and larger equipment. However, accrual accounting shifts the focus away from cash control and has other shortcomings, just one notorious example being the problem of off-balance sheet financing techniques which are potentially dangerous in a governmental environment of unlimited liability. Careful consideration is therefore required to develop a governmental accounting system that maintains constitutional controls and addresses adequately matters of particular concern to governments.

Business-style accrual accounting addresses some longer term concerns, but it was devised for the circumstances and conditions of businesses. In this form, accrual accounting leads to two key reports, one representing stocks and the other representing flows. The report showing stocks is a balance sheet which purportedly represents, in financial terms, all assets and liabilities of an organization, the difference between those two amounts being regarded as the amount financed by the owners of the organization and called equity. The report showing flows is an income statement which focuses attention on the resulting balance of the flows for the year, which is known as profit or loss. The point of articulation between the two statements is the reported profit or loss. In the 1980s, for several reasons, including the collapse of seemingly profitable and successful companies and the focus on financial performance for capital markets, concerns about the shortcomings of accrual accounting prompted the introduction of a third statement, the statement of cash flows. This statement, however, is created by working backwards from accrual-based statements to approximate cash flows.

Evidently, the structure of these reports suits business activities, given the understood business objectives of profitable performance and increasing equity because those items are the focus of attention in financial reporting. The manner in which those items are changed during the year receives variable attention, considerable attention usually being paid to the components of the income statement through which profit is determined, but relatively little attention being paid to the changes in the balance sheet. Management of the balance sheet tends to be seen as the responsibility of those operating the company, and a corporate financial controller is typically granted considerable discretion to manage investments and liabilities. Financial control is, therefore, centred at the management level of a business, albeit within broader policies set by the board of directors.

It does not follow that the same structure, focus and approach to control is suitable for governments, and the argument of this article is that business-style accrual accounting is constitutionally inappropriate for application to governments. We illustrate this point by observing first that business-style accrual accounting carries with it a centralized financial control function that undermines the fundamental constitutional principle of democratic control. Secondly, we argue that the business-style accrual accounting practices used to produce the financial reports for a group of companies (i.e. a consolidated financial report), when applied to combine the reports of various parts of a government to produce a ‘whole of government’ financial report, override the constitutional separation of powers. Thirdly, we demonstrate how the use of business-style accounting practices, including the use of ‘fair value’ policies to revalue assets and liabilities, has facilitated the disposal of public assets without parliamentary or public knowledge.

3.1 Business-style accrual accounting undermines the fundamental constitutional principle of democratic control
A Westminster parliamentary model of democracy relies on a separation and balancing of power between the parliament (the legislature), the executive government and the judiciary. Parliamentary scrutiny and control of public finance is so fundamental to this that Gladstone (1891) linked ‘the finance of the country ... with the liberties of the country’. A basic constitutional safeguard for citizens and taxpayers is that no money shall be collected or spent except in ways and means approved by Parliament. This principle is enshrined in New Zealand's Constitution Act 1986, which states that it is unlawful for the government, except by or under an act of Parliament, to levy a tax, to raise a loan or to receive any money as a loan from any person or to spend any public money. The business model underlying New Zealand's financial management reforms undermines this legislated principle.

Integral to the separation and balancing of powers are the roles of the Auditor-General and the Treasury. In New Zealand, the Auditor-General is an officer of Parliament whose role is to advise and assist the whole Parliament in its scrutiny and control role. The Treasury is an agent of the executive government, which forms just one part of the whole parliament. Traditionally, the Auditor-General's role has included a constitutional safeguarding function of ensuring that before any public money is made available to the executive government of the day (via the Treasury), lawful authority exists, in the form of parliamentary appropriations. This is known as the controller function; but while it shares the ‘controller’ title, it is a constitutional role and differs significantly from that of the corporate financial controller mentioned earlier.

The business model on which New Zealand's financial management and accounting reforms are based conceptualizes the Treasury as a multi-national corporate-style financial controller. This implies that financial control is perceived as a management function to be conducted by the executive government, through its agent, the Treasury. Under this business model, the Auditor-General's constitutional controller function is considered redundant, thus, conceptually at least, setting aside a fundamental constitutional control.

The Public Finance Act of 1989 and subsequent amendments have gradually disabled and removed the Auditor-General's controller function. This disabling and removal was achieved by legislating for a budgeting process which focuses attention on accrual appropriations for outputs (i.e. expenses affecting the income statement), while delegating authority to the Minister of Finance (via the Treasury) to engage in all borrowing and investing activities without prior parliamentary scrutiny. The requirement that all departments of government operate their own bank accounts confined the Auditor-General's controller function by not extending the controller powers to those departmental bank accounts. Most recently, the remnants of the controller function that operated prior to money being passed to the Treasury's control were replaced, by allowing the Treasury full access and requiring the Auditor-General to rely on after-the-fact assurances from the Treasury that expenditure of public money was in accordance with parliamentary appropriations. The Auditor-General retains the power to prevent payments if there is cause to suspect they are being made without lawful authority. How the Auditor-General can hope to obtain the information required to ascertain that cause exists is not clear (see Newberry and Pallot, 2006, for further explanation). These changes undermine Parliament's crucial constitutional powers.

The accrual-based output budgeting and appropriations structure adopted in New Zealand is a procurement (contracting out) model which might make sense if all government services were purchased (procured) from non-government suppliers. Arguably, this is an intended outcome of the reformed financial management system, Savas (2000, p. 65) even insists that just such a distinction is at ‘the heart of the entire concept of privatization’. New Zealand's former Secretary to the Treasury and key reformer Graham Scott (2001, p. 177) also suggested as much in his explanation of instructions to government departments when the reformed system was implemented: ‘Departments were encouraged by central agencies to imagine that their department did not exist, and they were assigned a budget to acquire the same services through contracts’. While services are still provided by government departments, however, this procurement model form of budgeting and appropriations misrepresents the financial activities of the government and further undermines parliamentary scrutiny processes.

The model is based on the idea that the focus of attention at budget time should be on the procurement of outputs (such as provision of custodial services for prison inmates) rather than inputs (such as the salaries of prison officers, cleaning and maintenance of prisons, etc.). Budgets are presented as if the government were a client procuring services in the form of the outputs generated by various government departments, and they therefore facilitate contracting out. The accrual-based budgets are stated at the full cost of outputs, determined by allocating all expenses, some of which are not cash expenses, over the outputs. The accrual-based budgets thus bring into the appropriation process items that do not require the expenditure of taxpayer funds, depreciation being just one example of a fictional amount. Other accrual items have been introduced simply to pretend that costs are similar to those incurred by businesses and to include proxy amounts for interest charges, cost of capital and taxes. This introduction of accrual-based appropriations has, therefore, weakened constitutional controls because parliamentary approval of these budgets means parliamentary approval for the executive government to spend up to the full-cost amount of outputs which include fictitious amounts. Not only does this increase the discretion available to the executive government because the full amount of money made available is greater than the amount required for cash expenditure on the outputs, the inclusion of arbitrary, imaginary accrual items is more likely to confuse readers of the financial reports rather than to improve transparency and accountability (Pallot, 1991; Guthrie, 1998). An additional delegated power granted to the Minister of Finance (and the Treasury) to manage balance sheet items provides the potential for diversion of public money to purposes not approved or contemplated by Parliament (Pallot, 1991).

While output-based budgeting means Parliament has largely relinquished its cash controls over the executive government, a paradox arises because the Treasury imposes strict cash controls. Although the budgets must be presented to Parliament in this accrual-based output form, this veneer conceals a cash-based budget baseline regime which limits the amount of funding (cash) provided to departments (Newberry, 2002). Government departments are not permitted to borrow. In some cases the cash funding provided has been so limited that departments have been unable to function (Newberry, 2002). These cash controls produce effects to which parliament has not necessarily assented. For example, in 1998 the State Services Commission observed that resource erosion in government departments meant departments were losing their capability to perform even core functions effectively, and that morale was low (State Services Commission, 1998). Similarly, the Auditor-General (1999, p. 74) observed that:

Capabilities can be built up or run down without such changes necessarily being evident in the organisation's financial statements. ... To the extent that the Executive is able to convert capability resources into current consumption without a transparent appropriation for the purpose, it may be escaping Parliament's control of supply.

The manner in which this financial resource erosion occurs has since been documented (Newberry, 2002). At the detailed level, largely escaping parliamentary scrutiny, financial resource erosion processes are designed into the system (Newberry, 2002). Occasionally, for example, when public sector disasters involving unnecessary deaths have prompted some form of inquiry, findings have included revelations of lack of financial resources, and concerns about ‘systemic failure’, a suggestion contested by the system's designers (see Newberry, 2003, p. 100 for examples).

In summary, the accrual-based budgeting and financial reporting practices adopted have shifted the balance of power to favour centralized controls exercised by the executive government and the Treasury. This shift has reduced parliament's opportunity and ability to scrutinize the executive government's activities and impose its constitutional controls. This shift has, therefore, undermined constitutional conventions.

3.2 Group accounting practices used for whole of government reporting override the constitutional separation of powers
An important issue arising from the application of business sector accounting practices is how to decide what is, and what is not, part of the government for whole of government financial reports. New Zealand's financial management reforms fragmented governmental activities, and required each fragment to report separately. Broadly, three types of governmental bodies were established. State-owned enterprises (SOEs) were created as limited liability companies, with their shares owned by two ministers on behalf of the government. SOEs conduct commercial activities, funding their operations through user charges, and they are required to function as if they are private companies and to observe normal commercial accounting requirements. Many SOEs were privatized, but some remain in government hands, including some that generate electricity. One SOE, Transpower, has sole responsibility for the country's high-voltage electricity transmission. The second type of government body is the Crown Entity. These were created for activities that require government funding for their operations, but they may impose some user charges. Crown entities include hospitals, universities and schools. Early intentions were that these be privatized, but the idea is so unpopular politically that direct privatization has not occurred, although reductions by forcing mergers and through financial constraints are occurring. The third type is government departments, including the central agencies of the government, the Treasury and the State Services Commission and the Department of the Prime Minister and the Cabinet, as well as departments that provide advice and deliver services such as the Corrections Department, which is responsible for the incarceration of prisoners and the Department of Statistics. Most of the service-providing departments have been restructured several times in recent years. Offices of Parliament, such as the Auditor-General and Clerk of the House of Representatives, are treated similarly to departments, but in keeping with the idea of separation of powers, as parliamentary services they report to Parliament, rather than to a minister. All of these bodies must prepare individual financial reports for submission to Parliament.

Accompanying this fragmentation of government activities was the idea that the financial reports of the numerous parts of government should be combined to produce a single financial report for the whole of government. In keeping with the idea that business-style accounting practices provide an appropriate model for governmental reporting, the business-style practice of producing a financial report for a group of companies (consolidation, group accounting) has been applied. The central idea of this practice, however, is the dominance of the other members of the group by a single body. This dominance idea conflicts with the constitutional conventions which require the separation and balancing of power among parliament, the executive government and the judiciary, rather than the concentration of power in the hands of one party. This section shall discuss the consequences of applying business-style group accounting as to (a) which party is dominant (referred to as control) and (b) the accounting techniques used to combine financial statements and their effect on the overall level of reported public borrowing.

Whole of government financial reports prepared using business sector financial reporting standards require identification of a single controlling body. Group accounting developed to capture the effects when a company owns the majority of shares of another company and can, therefore, control its activities by dominating shareholder voting and by dominating the board. This is called an ‘ownership’ form of control. Control of other bodies may be achieved by other means; for example, a monopoly purchaser can control the activities of its suppliers, but group accounting ignores this form of control.

Application in a governmental accounting environment of group accounting requirements based on identification of a single controlling body and what it controls raises questions about which body, if any, should be regarded as the single controlling body for whole of government financial reporting purposes. This issue has constitutional implications, especially because of accounting's constitutive nature. If one body is deemed to control for financial reporting purposes, it obtains power useful for other purposes. That body can, for example, demand more detailed information than might otherwise be available to it, and impose detailed financial and operating rules that can affect the functional abilities of those subjected to the information demands and financial rules.

Consistent with the concept of the Treasury as a multi-national style corporate controller, the Public Finance Act, by its interpretation of ‘the Crown’, casts the executive government as the overall controlling power. By requiring the inclusion in whole of government financial reports of the courts and offices of parliament, as well as SOEs, Crown Entities and other departments, the implication is that the executive government owns and controls them all. This suggests that the courts and offices of parliament should no longer be regarded as counter-balancing powers to the executive government. Instead, they might be regarded as subsidiaries of the executive government that may be weakened or even wound up by the will of the executive government.

This idea of a single controlling power has significant constitutional implications. With the courts and offices of parliament subject to similar financial resource-eroding processes affecting departments, there is the potential to undermine their balancing powers and their effectiveness. Recently, questions have arisen about the level of competence within the Auditor-General's office, for example, in relation to Transpower, as explained in a later section. In 2004, when legislation extending the financial reforms was under consideration, the Treasury was both the sponsoring department of the proposed legislation and advisor to the parliamentary select committee considering the legislation. The nature of that complex legislation as proposed and later enacted is explained in Newberry and Pallot (2005, 2006). It has strengthened the powers of the executive government and the Treasury, weakened the powers of parliament and removed the Auditor-General's controller function.

Business-style whole of government financial reports also challenge efforts to monitor the level of public debt. The unlimited taxpayer guarantee of all public debt makes the ability to monitor this especially important. New Zealand adopted principles of fiscal responsibility in 1994, three years after converting to accrual accounting. Possibly because of the closed method used to legislate these principles, they make little sense in an accrual accounting environment (Newberry and Pallot, 2003). The principles specify the application of any operating surplus to repay debt until debt is reduced to an unspecified ‘prudent’ level, and balanced budgets after that. A reported operating surplus determined using accrual accounting is not necessarily a measure of a net cash inflow and cannot, therefore, be expected to reduce debt. For example, the determination of operating surplus includes unrealized changes in the assessed value of commercial forests (Government of New Zealand, 2006).

The reported level of public debt is affected by the accounting policies adopted. Group accounting practices have long been criticized as misleading (Clarke et al., 2003) and, as exemplified recently by Enron and Parmalat may facilitate concealment, rather than reporting, of the level of debt. Just one of several examples of how whole of government financial reports mislead as to the level of public debt is the application, between 1992 and 2002, of a ‘modified equity method’ to include the financial reports of the SOEs in the whole of government financial reports.

The shareholding ministers of the SOEs can require the SOEs to pay dividends. When the dividend required exceeds the funds held by the SOEs, they must raise debt to pay the dividend. Application of the modified equity method to include the SOEs in the whole of government reports meant that the debt raised by the SOEs was excluded from the whole of government reports, while the dividends received from the SOEs were reported, in the whole of government reports, as investment income and cash inflows.¹ The combined effect is absurd: while the principles of fiscal responsibility misleadingly suggest that a reported operating surplus will reduce public debt, the accounting policy adopted to include the SOE financial reports in the whole of government financial report meant these increases in debt were not reported as such and, instead, directly boosted the reported operating surplus.

Whole of government reports prepared using business sector-derived accounting techniques are not helpful. Shareholders of companies might be unconcerned about debt levels given their limited liability status. In the case of governments, taxpayer liability is unlimited. Clarity about the levels of public debt and the amount and application of public money is thus constitutionally important.

While not denying the potential usefulness of accrual accounting to produce government financial reports, the appropriateness of applying business sector-derived accounting techniques to prepare them requires debate. Whereas a Westminster democracy is based on the separation and balancing of powers, the business-style accounting technique for group accounting depends on the identification of a single controlling body. In New Zealand, the approach adopted to prepare whole of government financial reports suggests that the controlling body is the executive government, an ironic conclusion when the history of the Westminster parliament's long struggle to wrest control from the Crown is remembered.

3.3 ‘Fair value’ accounting practices conceal the disposal of public assets
Traditionally, accrual accounting has recorded actual transactions, with all transactions recorded at the transaction amount. One perceived shortfall of this historical cost method of accrual accounting is that, over time, the balance sheet becomes meaningless because the value of assets can increase or decrease significantly. The idea of depreciation emerged as an additional accrual to allocate the cost of assets purchased over the period used, but this does not necessarily capture the changes in value of the assets. In some countries, especially the UK, Australia and New Zealand, financial reporting standards have allowed an option for companies to make accrual adjustments that record changes in some asset values. Other countries, such as the United States, reject such valuation adjustments. This asset revaluation practice is controversial and, therefore, remains an option rather than a requirement. Under the IFRS, this option of recording changes in some asset values is called ‘fair value’ accounting.

The creation of SOEs occurred at an early stage (1985–1986) in New Zealand's public sector reforms. An extensive programme of privatization followed, against mounting public opposition that culminated in a changed electoral system. This change took effect from 1996, and all governments since then have been coalitions. This has reduced the pace, if not the general direction, of New Zealand's reforms (Newberry and Pallot, 2005).

One election pledge of the coalition Labour government elected in 1999, and still in power, was that there would be no further privatization. All SOEs of that time have remained state owned, but the transactions engaged in by some of those SOEs, particularly those responsible for crucial infrastructure assets, have come into question. Because the nature of these transactions is not apparent from the audited financial reports, the acceptability of business-style accounting and auditing practices, including the use of fair value accounting, requires thought.

During the 1990s, the country's electricity generation and transmission activities were separated and re-regulated to favour market activities, including the development of an electricity generation and transmission market. These changes were unpopular with the voting public which, having been assured of benefits, experienced spiralling domestic electricity prices and increased instability of electricity supply. Most of the country's electricity is hydro-generated in remote areas of the South Island and transmitted north via a high-voltage transmission grid to the more populous areas of the South Island as well as via undersea cable to the North Island where most of the country's population lives. Without that grid, much of the country would be without electricity. It is, therefore, a key strategic asset in New Zealand.

Among the SOEs, not privatized is Transpower New Zealand Ltd, which has sole responsibility for owning and operating this high-voltage transmission grid. Despite its responsibility, the election pledge of no further privatization and the known public opposition to further privatization, Transpower engaged in a transaction that effectively sold the South Island portion of the grid.

In 2003, in a cross-border lease with the Wachovia Bank of North Carolina (USA), Transpower sold the whole of the South Island high-voltage transmission grid to the Wachovia Bank for $701 million. It then leased the operation of the grid back from the Wachovia Bank via the Cayman Islands, a tax haven (Gorman, 2005a; Newberry and Robb, 2005a). This lease back from Wachovia is for 100 years, but the lease contains an option for Transpower to repurchase the transmission grid after approximately 25 years. The repurchase price and conditions have not been revealed. This arrangement is a lease-to-service (LTS) contract, a recent variant of abusive tax-driven arrangements that had been banned in the United States. Tax-driven arrangements are engaged in for the purpose of obtaining tax deductions or tax benefits rather than for any commercial or industrial reason. For the Wachovia Bank, the arrangement most likely would allow it to claim large tax deductions in the United States, in a manner similar to those claimed following the Wachovia Bank's tax-driven and controversial transaction in Germany with Bochum's underground sewerage system (PBS, 2006). The negative effect of transactions such as these on the United States tax base is significant.

At the time of the Transpower transaction, LTS arrangements were under investigation in the United States, and they have since been banned as tax abusive. That the nature of the arrangement was known to Transpower is apparent because reporting of the transaction in Transpower's financial reports was delayed during the investigation. The date of the Transpower transaction preceded by days the date from which the LTS arrangements were banned. The tax-abusive nature of such transactions was politically sensitive in both New Zealand and the United States.

In New Zealand, the political sensitivities related partly to the government's announced policy that the publicly unpopular privatization initiatives had ceased. The sensitivities also related to New Zealand's international reputation if a SOE, with its shares wholly owned and its financial reports consolidated in the whole of government reports, and therefore shown as part of the government, was seen to be attacking another country's tax base (i.e. the US) (Cabinet Economic Development Committee, 2003; Gorman 2005d; Newberry and Robb, 2005b). The issue went to the Cabinet, which was advised to adopt a set of general principles for SOEs contemplating such arrangements. Their boards were exhorted to have regard to the sensitivities, and required to manage any ‘communication risks’ arising (Cabinet Economic Development Committee, 2003).

Transpower's NZ$701 million cross-border lease over the South Island high-voltage transmission grid was New Zealand's largest US lease (Anon, 2004). The transaction occurred in December 2003, but reporting was delayed for a year because of the US tax investigation. It was a massive and highly significant arrangement for Transpower, but almost no information about it was provided in Transpower's financial reports. The most obvious information was a reported gain of $34.6 million, which represented almost half of Transpower's reported profit for the half-year ending 31 December 2005. A newspaper reporter (Gorman) printed Transpower's response to his inquiry about this gain, that it was a one-off gain earned by helping Transpower's counter-party to ‘manage their tax liabilities’ (Newberry and Robb, 2005a).

A note to Transpower's financial reports provided a little more information, including the fact that this was not Transpower's first such arrangement:

Transpower has entered into three cross-border leases in respect of certain HVDC converter stations, the submarine cables and the majority of the AC transmission assets in the South Island. Transpower has given guarantees and certain undertakings in accordance with the cross-border lease agreements signed in May 1996 (Submarine cables), October 1996 (HVDC converter stations) and December 2003 (South Island AC assets). The likelihood of losses in respect of these guarantees is considered to be remote. (Transpower New Zealand Limited and Subsidiaries, 2005)

Not disclosed was that the arrangement involved the sale of the transmission grid, the amount of money involved (NZ$701 million) or that the grid was leased back from its new owners for 100 years, but contained a repurchase option after approximately 25 years. Materiality considerations inherent in business-style financial reporting suggest that this information should be provided. The other cross-border leases mentioned in the note related to other parts of the country's high-voltage transmission grid. They had been dealt with similarly in Transpower's financial reports, and had generated no public discussion.

When the nature of this arrangement was explained to the general public, it made headline news. Transpower argued that its accountability obligations had been discharged through the provision of audited financial reports and claimed commercial confidentiality for its unwillingness to provide further information (Gorman, 2005a, c). The financiers for this deal, however, had won a prize for it and an industry publication (Asset Finance International, 2004), had already published some of the information that Transpower declined to divulge (Gorman, 2005e). Thus, Transpower seemed to be managing its ‘communication risks’ through obscure business-style financial reporting.

Scrutiny of Transpower's financial reports reveals that the application of fair value accounting policies contributed to the lack of information about this deal in the financial reports. In the financial year immediately preceding this transaction, Transpower revalued its transmission assets to the latest ‘fair value’, and then changed its accounting policy back to historical cost, announcing that the carrying amounts of all assets would forthwith be regarded as their cost.

In the following year, when this $701 million arrangement occurred, Transpower ‘sold’ the transmission assets and then leased them back. Accrual accounting practices meant this large transaction was barely perceptible in Transpower's financial reports. When assets are sold, they are removed from the balance sheet and the gain or loss on sale is reported in the income statement. The restatement to fair value meant Trasnpower reported no loss or gain because the ‘cost’ was approximately equal to the selling price. Neither was there any noticeable change in the total assets reported in Transpower's balance sheet because the lease back part of this arrangement resulted in a similar but smaller amount showing up as leased assets. The full amount of the sale is not shown unless there is particular reason for doing so. The $34.6 million reported as income from the transaction was less than 5% of the whole transaction, and the information provided about this gave no indication that it was related to the effective sale of the South Island transmission grid. Transpower attempted to deny that the arrangement amounted to the sale of the grid, arguing it held an option to repurchase the transmission grid in about 25 years. Had the grid not already been sold, Transpower would not need the option to repurchase it.

The size, nature and potential public interest in this transaction was such that it should have been explained in the financial reports. Parliament's Commerce Select Committee had reviewed Transpower's audited financial reports, receiving advice from the Auditor-General to assist in that review process. That advice did not alert the Select Committee to the nature of this $701 million transmission grid transaction and the select committee's report to Parliament suggested nothing was amiss. When the nature of this deal was drawn to public attention, it became apparent that neither the Parliament nor the Select Committee was aware of it (Gorman, 2005a, b). Transpower, however, claimed that it had been fully transparent and accountable, and that its financial reports were audited by a Big Four accounting firm acting on behalf of the Auditor-General.

This, in turn, raised questions about the Auditor-General's ability to perform adequately his parliamentary advisory function when aspects of his auditing function are contracted out. The Auditor-General's knowledge of Transpower's activities must have been considerably reduced, thus impairing his ability to advise the Select Committee, which, in turn, did not have the knowledge to advise Parliament.

Questions also arose about the independence of Transpower's auditor, PriceWaterhouseCoopers, when it was revealed that only 20% of its fees from Transpower related to auditing. The remaining 80% related to other services, including ‘audit opinions of regulatory reporting and debt prospectuses, assistance to internal audit function, other assurance-oriented assignments, and tax advice and other engagements’ (Gorman, 2005c, p. A5; Transpower, 2004, p. S2). This contravened the Auditor-General's own-stated policies (Gorman, 2005c). Subsequently, the Auditor-General assigned Transpower's audit to another Big Four firm, Ernst & Young.

In summary of these three examples, the use of business-style accrual accounting practices should not be accepted as automatically appropriate for application to governments. They have been developed for business conditions which differ significantly from the conditions of governmental activities. Although the examples provided above relate to New Zealand, they raise significant constitutional issues, and are relevant for those in other countries because, as is shown in the next section, the wider dissemination of business-style accrual accounting to governments around the world has been led from New Zealand. Indeed, in the early stages, this initiative was based on developments in New Zealand.

	4. Disseminating business-style accrual accounting for governments around the world

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Section 2 explained that, following a report to the OECD's Public Management service (PUMA) in 1992, the accounting standard-setters in both New Zealand and Australia claimed their financial reporting standards are ‘sector neutral’, and then adopted a closed approach to standard-setting on matters that particularly affected the public sector (Ryan et al., 1999). This development was, and remains, controversial. Over the last few years, however, and still today, various global bodies, including IFAC, the World Bank and the IMF, have promoted the application of business-style accounting to governments worldwide. Those involved in the application of business-style accounting to governments in New Zealand and Australia have been key players in this international development. This section provides a historical outline of this development in New Zealand, noting the efforts now being directed at international level.

In early 1993, following a restructuring of New Zealand's professional accounting body, the New Zealand Society of Accountants (NZSA, subsequently renamed the New Zealand Institute of Chartered Accountants-NZICA), senior accountants from the Treasury became increasingly active in financial reporting standard-setting activities. Ian Ball, the leader of the Treasury's Financial Management Support Service responsible for introducing and implementing New Zealand's financial management reforms, developed a close working relationship with April McKenzie, the newly appointed director of accounting and professional standards at NZICA.

The NZICA rejected its earlier efforts to develop accrual accounting especially for the public sector in favour of the ‘sector-neutral’ approach, i.e. the application of business-style accrual accounting. Legislation proposing that businesses be required to comply with financial reporting standards had been delayed for two years, but was revived and read in Parliament for the second time in May 1993. With this reading, all processes allowing public input ended. Debate at the time raised sovereignty concerns because the legislation proposed delegating ‘to an outside body, ... the power to make binding rules. In many respects we are being asked to delegate the power to legislate—our own principal power’ (Caygill, 1993). After this second reading debate, the proposed requirement that businesses comply with financial reporting standards was extended to encompass the public sector, and then passed into law without public comment. With this change, Parliament delegated to a newly established Crown Entity, the Accounting Standards Review Board (ASRB), its power to set rules for both business and governmental financial reporting.

Ball was appointed to the ASRB and also to the NZICA's financial reporting standard-setting committee. The NZICA submits its financial reporting standards to the ASRB for approval. New Zealand's development of sector-neutral accounting then proceeded alongside Australia's.

In 1996, Ball became chair of the IFAC's Public Sector Committee (PSC), thus significantly increasing the influence of the PSC ‘both inside and outside IFAC’ according to the IFAC President Juan Herrera (NZICA, 1996; Pryde, 1996). April McKenzie became the PSC's technical adviser while also continuing her role as the NZICA's director of accounting and professional standards.

The PSC's ‘most exciting’ initiative was its standards project—a ‘multi-year project which would look at the various types of accounting used by governments (from cash to full accrual and in between), provide recommendations on how these bases should be implemented and then make an in-depth study of how IAS [International Accounting Standards] could be integrated into public sector systems’ (NZICA, 1996). The project would be done in two phases with completion expected by 2000. Ball chaired the PSC's sub-committee dealing with the project, and McKenzie oversaw the general management of the project. Much of the project work was conducted in New Zealand through NZICA and with the involvement of NZICA technical staff, some of whom moved to the New York office of IFAC (NZICA, 1997b). The PSC obtained funding support of about US$1 000 000 from the World Bank and other agencies including the IMF and the United Nations Development Programme (NZICA, 1996; Walker, 1997).

By 1997, this project was represented as a means of improving governmental financial reporting by standardizing the rules within each basis of accounting and encouraging ‘increased use by governments’ of IAS, the name then given to IFRS. The idea of developing specific standards to govern accounting for the public sector was dismissed as being ‘extremely expensive and would duplicate much of the work which has already been done in the private sector’ (NZICA, 1997a). This level of international involvement was a source of pride in New Zealand, prompting comment by both the President of NZICA, Warren Allen, himself a member of IFAC's Education Committee and the CEO, Diana Pryde:

The Institute has taken active roles in two international forums where its expertise is recognised as ‘best practice.’ Public sector accounting and accounting education are two areas where we make a major contribution to the international profession. It is appropriate that we play our part, particularly in areas where we are seen as having the ability to make a difference. (Allen, 1997, p. 7)

... an increased level of involvement in international standard setting forums such as the International Federation of Accountants Public Sector Committee and the G4 + 1 group of standard setters is a key role for the Institute. Our international involvement has helped raise the profile of financial reporting standards set by the profession in New Zealand. This enables the Institute to position itself so it has more influence on standards set internationally, which makes standard-setting in our country more efficient and effective. (Pryde, 1997, p. 7)

In 2000, following the issue of the first eight IPSAS, their release in New Zealand was greeted with pride by those involved (Mackenzie, 2000, p. 1; Simpkins, 2000; Walker, 2000). During the project's process, ‘many issues [had been] debated, such as the appropriate treatment of military or heritage assets’ but the project committee ‘proved able to resolve most issues with unanimity, or near that’ (NZICA, 2000a, p. 13). While the project committee members might have agreed, however, other views were ignored.

In the case of heritage assets, for example, considerable concern was aroused, especially in Australia, over the role and limits of accounting and what is achieved by valuing and reporting such assets in financial reports. Carnegie and Wolnizer (1995, 1997, 1999) challenged the application of conventional business-style accounting practices to these items, citing the ‘International Accord’ adopted in 1995 at the International Conference on the Value and Valuation of Natural Science Collections:

Governments should...recognise that the value of natural science collections lies in their scientific and cultural importance, and that, although in certain circumstances it may be possible to place a verifiable financial valuation on such material for accounting purposes, there appears to be no demonstrable benefit in doing so. (International Accord on the Value of Natural Science Collections, 1995, emphasis in original, cited in Carnegie and Wolnizer, 1999, p. 24)

Carnegie and Wolnizer (1999, p. 19) questioned the usefulness of this accounting development for heritage assets, seeking answers to several questions about the reported financial value resulting from application of business-style accounting (Carnegie and Wolnizer 1995, p. 44; 1999, p. 16):

What is the commercial meaning of any such financial quantum?

By recourse to what reliable commercial evidence may an auditor authenticate that financial sum?

In what demonstrable way or ways is such a financial quantum useful for enhancing and judging the accountability of those who manage not-for-profit public arts institutions having non-commercial objectives?

In what demonstrable way or ways is that financial quantum useful for gauging the financial efficiency with which a public (grant-dependent) arts institution is managed?

Those questions have not yet been answered (Carnegie and Wolnizer, 1999; Newberry, 2001). Hooper and Kearins (2005), reporting on research conducted with museums in New Zealand, noted resistance and even refusal to comply, clearly posing problems for Simpkins who, as Deputy Auditor-General was perceived as taking ‘a hard line’ (p. 425). Museum staff, including accountants, commented on the ‘absurdities of measuring museum holdings by shelving at so much per metre as if measuring curtain fabric, or of depreciating assets with lives of millions of years’ (p. 428).

Despite challenges such as those outlined above and other concerns, Ball believed the IPSAS would produce significant benefits: ‘The role of quality financial reporting in contributing to the performance of economies is well recognized by the international financial institutions; those that have good systems of governance tend to have well-performing economies. Good accounting is part of good governance’ (NZICA, 2000a). How these accounting requirements would contribute to the benefits Ball claimed is not clear. His suggestion that accounting provides ‘the key’ to social and economic development was challenged as ‘an article of faith’, lacking evidence (Colquhoun, 2000), but the closed processes adopted in both New Zealand and Australia have meant that reservations, concerns and requests for explanation about this development have received little, if any, response.

By 2000, implementation of findings from the second stage of the PSC project, ‘an in-depth study of how IAS could be integrated into public sector systems’ (NZICA, 1996), was also under way. Simpkins, who was also a PSC member with long-standing involvement in this project as ‘technical adviser to the Committee Chair, fellow New Zealander, Ian Ball’, explained the situation and expectations:

Of course, we now have two sets of International Standards in the accounting arena – we would prefer just one. Nevertheless, basing the Public Sector Standards on the International Accounting Standards significantly increases the possibility that, at some point, they too may be merged. Just as we needed time to reach this point, so too we need to allow time for that to occur in the international environment. (Simpkins, 2000, p. 93)

Since the establishment of the IASB, this convergence of IPSAS and IFRS has been contentious. In 2006, the IASB proposed that its standard-setting focus should be confined to financial reporting for financial market participants, thus weakening still further arguments that business-style financial reporting is applicable to governments. However, the IASB is clearly under pressure from those seeking a single set of IFRS for businesses and governments alike (Simpkins, 2000; ICAA, 2006b; NZICA, 2006). For example, the NZICA urged the IASB to ‘consider using sector-neutral language whenever possible, to minimise the changes that will be required later in the project’ and recommended regular liaison between the IASB and IFAC's Public Sector Accounting Standards Board (NZICA, 2006, p. 5). The Institute of Chartered Accountants in Australia (ICAA) also seeks changes from the IASB (ICAA, 2006b, p. 1).

These efforts to sustain and extend the sector-neutral approach continue despite the growing evidence of shortcomings in both New Zealand and Australia. In 2005, Australia's Financial Reporting Council commissioned an independent study on this matter. New Zealand's Simpkins, who, in 1993 while employed at Ernst & Young, was named as one of the ‘limited range of consultants...involved in the project’ by those developing Australia's approach, performed that study (Thompson, 1993). His close involvement throughout the sector-neutral development and previously declared preference for a single set of standards raise doubts about his suitability to conduct an independent study, although Simpkins did acknowledge problems with the sector-neutral effort (Simpkins, 2006). The ‘frank discussions’ noted at an experts' round-table discussion in Australia in August 2006, following publication of Simpkins's report, highlighted serious concerns (ICAA, 2006a). Despite all this, ‘board chairs and senior staff members of the standard-setting bodies of Australia, Canada, New Zealand and the UK’ have established a ‘monitoring group’, which seeks to ‘encourage’ the IASB to consider the implications of its proposed conceptual framework and standards for not-for-profit entities in both the public and private sectors. To date, the IASB has declined to consider the implications for these entities either throughout its current conceptual framework project or at the end of each phase. The monitoring group's rationale for its activities is that these standard-setters are responsible for developing ‘standards for not-for-profit entities and are committed to using the pronouncements of the IASB in their work’ (Monitoring Group, 2007, p. 4).²

Confirming the pressure on the IASB as well as on the FASB, McGregor and Street (2007, p. 42) identify the question of applicability of the IASB's framework to not-for-profit entities as a currently contentious issue ‘between the IASB and some of its national standard setting partners’, observing that ‘the Australians and New Zealanders developed sector neutral frameworks and have for many years produced sector neutral accounting standards based on those frameworks’. In contrast, the GASB (2006) has restated its views about the inappropriateness of applying business-style accounting practices to governments.

Neo-liberal reformers in both New Zealand and Australia have been labelled more ‘fanatical’ than reformers in other countries (Pusey, 1991, p. 209). New Zealand's economic restructuring involved a small community of policy entrepreneurs conducting a policy mission (Wallis and Dollery, 1997). The application to government of business-style accrual accounting that was such a fundamental part of those reforms similarly involved a small group located in strategic positions. In New Zealand, Ian Ball (the Treasury), April McKenzie (NZICA) and Kevin Simpkins (Ernst & Young, then Office of the Auditor-General) with involvement through cross-linking standard-setting committees of NZICA and, later, IFAC seemed particularly influential in this aspect of, initially, New Zealand's reforms but later the development and international dissemination of IPSAS, and efforts to converge them with IFRS. Ball, for example, is now the chief executive of IFAC and a member of the IASB's Standards Advisory Council. Although this section has focused most on those pursuing these developments in New Zealand, comment in Australia about the closed approach adopted there and those involved suggests a similarly narrow community of policy entrepreneurs (see, for example, Ryan et al., 1999) who are now active at the international level. For example, the policy entrepreneurs in Australia included Ian Mackintosh, who is now chair of the United Kingdom's Accounting Standards Board, and therefore part of the monitoring group (Financial Reporting Council, 2004).

While those pursuing these governmental accounting developments have asserted that the business-style changes to governmental accounting will contribute to good governance, such claims should not be accepted at face value. The implications of governments adopting business-style practices require careful consideration. With the IPSAS accounting standards now increasingly being adopted worldwide, their initial development and the eventual intention of merging the IPSAS with IFRS should be understood. Their appropriateness for the purpose should not be assumed.

	5. Concluding comments

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Kingdon's garbage can model of policy development provides a possible explanation of how an inappropriate solution (application of business-style accounting) for a policy problem (appropriate accounting practices for government) may emerge. Kingdon's model also contemplates policy entrepreneurs creating the conditions to which the pre-decided solution may be applied (Wallis and Dollery, 1997). Policy entrepreneurs from both New Zealand and Australia have subsequently been involved in efforts to apply business-style accounting to governments worldwide.

The idea that ‘good governance’ in all governments may be achieved by adopting business-style financial reporting standards begs the question of exactly what will be achieved by observing these standards. The need to look closely at the standards and what they achieve, rather than accepting rhetorical claims at face value has been acknowledged both by economists promoting neo-liberal reforms (for example, Buchanan et al., 1987) and by accountants (for example, Hopwood, 1984). When the financial reports of governments are presented as if the governments were businesses, the constitutive nature of accounting suggests that eventually governments will be regarded as businesses.

Despite assertions that adopting business-style accounting based upon IFRS will improve governance, those standards were devised for limited liability companies which limit shareholders' risk and encourage management to take risks with shareholders' funds to earn superior financial returns. Those standards were not designed in contemplation of the unlimited liability for government debt borne by taxpayers and citizens. This unlimited liability makes essential the maintenance of constitutional controls over the executive government and over its access to public money. Cash expenditure controls are not a feature of business-style accounting (Biondi, 2006). Further, this unlimited liability makes probity-related accountability requirements especially important. As evidenced by the examples from New Zealand, business-style financial reports involve the application of a business logic that is inconsistent with the public purpose and context of government financial activities, and are not suitable for this purpose.

In New Zealand, where this business-style accounting initiative has been proceeding for some years, the adverse constitutional implications are becoming increasingly apparent. The shift to business-style financial management and reporting has meant the disabling and removal of key Westminster-style parliamentary safeguards and conventions, and thus reducing Parliament's power to scrutinize and exert financial control over the government of the day. Evidently, these changes transfer power to the executive government.

Even Parliament's power to regulate governmental financial reporting has been delegated, thereby limiting its own ability to demand reporting improvements. Following the decision to adopt IFRS, Parliament's power to regulate governmental financial reporting has been transferred to a power outside the country, thereby raising further sovereignty concerns. The IASB clearly states that its focus is on the financial reporting practices of businesses for financial market participants, a statement that troubles standard-setters of New Zealand and Australia who have led the initiative to apply business-style practices to government.

Superficially, movement to IPSAS, as is now being widely advocated, may seem to provide a better option for governmental accounting than adoption of IFRS. While IPSAS are stated as specifically developed for governments, it should be understood that they are based on the business-style accounting trialled in New Zealand and Australia, with the intention of merging them eventually with IFRS (Simpkins, 2000).

It is becoming increasingly apparent as globalization proceeds that this business-style governmental accounting development involves broadening what is perceived as appropriate ‘business’ activities and narrowing what is perceived as appropriate ‘government’ activities. This has implications for any country with a democratically elected government because, according to Bobbitt, globalization seems to be leading us towards the replacement of nation states with market states (Bobbitt, 2002).

With the early stages of this business-style governmental accounting development driven from New Zealand, and driven, it seems, by only a few people, it is possible that the constitutional implications were not fully thought through. Before governments in other countries adopt business-style accounting and financial reporting practices as standardized either through IFRS or through IPSAS, simply because adherence to these is now espoused as the epitome of good governance, we urge the need for public debate. New Zealand has been well recognized for its world leadership of these accounting and financial reporting reforms, but that does not mean other countries should follow without question. Rather, there is a need to scrutinize carefully and learn from New Zealand's efforts to lead the world, and to avoid those developments that undermine democratic principles. While we do not object to the use of accrual accounting per se, the form of accrual accounting adopted and the uses to which it is put should support democratic principles through the scrutiny and control of public finance.

	Funding

TOP 1. Introduction 2. Policy development: the... 3. Governmental accounting and... 4. Disseminating business-style... 5. Concluding comments Funding Notes References

 
Alan Robb would like to acknowledge a research grant from the College of Economics and Business, University of Canterbury.

	Notes

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¹ The government's financial statements for 1997 demonstrate how increases in SOEs' debt could be reported as revenue to the government. These are available at http://www.treasury.govt.nz/pubs/fmb/CFS97/contents.htm. Note 9 explains the modified equity method of consolidation under which dividends received from SOEs are reported as revenue, and then the total net surplus/deficit of SOEs, net of the dividends already reported as revenue is shown before achieving the reported operating balance. A change in company law in 1993 removed the earlier earned income limitations on dividend payments, and this meant dividends paid could exceed reported profits, and in the case of some SOEs did exceed reported profits (see Note 9, there).

One SOE, Contact Energy Ltd, an electricity generator, was separated from another SOE in November 1995, with the government holding 100% of its shares. It was required to borrow to help finance the assets with which it was established. For its financial year ended on 30 September 1996, it reported a deficit of NZ$32 million. Following a decision in 1996 to increase Contact Energy Ltd's gearing, the SOE paid to the government a dividend of $150 million. The state of the Contact Energy Ltd's balance sheet at the time makes clear that it would have been forced to borrow to pay the $150 million dividend (see www.contactenergy.co.nz/web/pdf/financial/1996_annualreport_financials.pdf).

The modified equity method adopted to incorporate SOEs into the whole of government financial reports meant that the SOE borrowings, forced to finance the dividend, were reported in the whole of government financial report for the 1997 financial year as investment revenue, and in the statement of cash flows as operating cash inflows (http://www.treasury.govt.nz/pubs/fmb/CFS97/contents.htm, pp. 40, 43, and Note 3). A small adjustment to the government's operating statement picks up the difference between the total of dividends received and the reported results of the equity accounted entities, but conceals the fact that the dividends came from only a few SOEs, some of which had to borrow. Some of the reported investment revenue is, in fact, increases of borrowing.

² Simpkins is also the independent report writer for this group.

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