Public Sector Governance and Accountability Series: Budgeting and ...

Accrual Accounting in the Public Sector 181
Differences between Cash and Accrual Accounting in the
Public Sector
What are the key differences between cash and accrual systems of accounting
as applied to the public sector? 1 The cash system of accounting is one in which
expenses and revenues are recorded in the period that payments are made or
received. The accrual system of accounting is one in which revenues are
recorded in the period in which they are earned (whether received or not)
and expenses in the period in which they are incurred (whether paid or not).
The cash system of accounting has traditionally been used in the public
sector. It matches well with the annual budgeting and revenue collection
systems used by governments and legislatures in industrial countries. More
recently, led primarily by the international agencies, such as the OECD, the
IMF, and the World Bank, and by some international accounting bodies, such
as IFAC, countries have been strongly encouraged to adopt the accounting
system generally used by the private sector: accrual accounting.
The most profound difference between the two accounting systems
relates to the time transactions are recorded. For example, under a cash
accounting system, revenue is not recorded until it is actually received,
whereas under an accrual system, revenue is recorded when it is earned, even
if it is not received until far into the future. Likewise, under a cash system,
expenses are not recorded until they are actually paid. In contrast, under the
accrual system, expenses are recorded when they are incurred, even if they
are not actually paid until far into the future.
The difference between the two systems can be made clear by considering
a couple of examples. Consider first the accounting treatment of the purchase
of a capital asset. Suppose a government purchases an office building. Under a
cash system of accounting, the full cost of the building is recorded as an expense
in the year it is purchased. Under an accrual system, the depreciation of the
building is recorded as an expense in each year of the useful life of the building.
A second example relates to public sector pensions. Under a cash system,
recorded pension expenses are measured by the payments made to beneficiaries
during the relevant accounting period (usually a year). However, under
an accrual system, recorded pension expenses are measured by the change in
estimated pension liabilities. Thus, all other things equal, if the government
changes a pension policy that will result in higher pension payments in the
future, the estimated discounted sum of those additional payments is
recorded as a pension expense in the period the policy change occurred.
Of course, both accounting systems have strengths and weaknesses
when applied to the public sector. Table 6.1 highlights the key strengths and