accrual accounting in the nepalese municipal public sector (udle)

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    Urban Development through Local EffortsProgramme

    A joint programme of the Ministry of Local Development (MLD) andthe German Technical Cooperation (GTZ)

    December 2008

    Accrual Accounting

    in the Nepalese Municipal Publ ic Sector

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    Abbreviations and Acronyms

    ADB Asian Development Bank

    GTZ German Technical Cooperation

    IAS International Accounting Standards

    ICAN Institute of Chartered Accountants of Nepal

    IFAC International Federation of Accountants

    IPSAS International Public Sector Accounting Standard (of IFAC)

    IPSASB International Public Sector Accounting Standard Board

    IPT Integrated Property Tax

    KMC Kathmandu Metropolitan City

    LBFC Local Bodies Fiscal Commission

    LGCDP Local Governance and Community Development Program

    MC/PM Minimum Conditions and Performance Measures

    MLD Ministry of Local Development

    MuAN Municipality Association of Nepal

    OECD Organisation for Economic Co-operation and Development

    RLC Regional Learning Centre

    udle urban development through local efforts program

    UDTC Urban Development Training Centre

    WTO World Trade Organization

    Acknowledgments

    Urban Development through Local Effort Programme (udle) would like to thank all organizations and institutions which

    provided valuable information and inputs.

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    Contents

    01. Executive Summary (p.1)

    02. Cash Accounting vs. Accrual Accounting (p.2)

    2.1. Definition and comparison of the Cash Accounting System and the Accrual Accounting System (p.2)

    2.2. Advantages and Disadvantages of Cash Accounting and Accrual Accounting (p.4)

    2.3. The dimensions of Accrual Accounting Financial Statements (p.7)

    2.4. In-Betweenism: Mixed Approaches of Cash and Accrual Accounting (p.8)

    2.5. Which accounting approach for which level of government? (p.9)

    2.6. International Public Sector Accounting Standards IPSAS (p.11)

    2.7. International Experiences on the Local Level (p.11)

    03. Findings and observations in the Nepalese municipalities (p.14)

    3.1. Accrual accounting history and past udle experiences (p.14)

    3.2. Status Quo in the Nepalese municipalities regarding Accrual Accounting (p.18)

    04. How to implement Accrual Accounting? (p.21)

    4.1. Recommendations and preconditions for the implementation of Accrual Accounting (p.21)

    4.1.1. Technical accrual accounting recommendations and preconditions (p.21)

    4.1.2. General accrual accounting recommendations and preconditions (p.25)

    4.2. Development of a macro and micro implementation plan (p.28)

    05. Annex (p.30)

    06. References (p.32)

    Tables and Figures

    Overview 1: Cash Accounting vs. Accrual Accounting (p.3)

    Overview 2: The three most important dimensions of Accrual Accounting Financial Statements (p.8)

    Overview 3: Worldwide efforts by local governments to implement accrual accounting (p.13)

    Table 1: Municipality Types (p.18)

    Table 2: Technical accrual accounting recommendations and preconditions (p.21)

    Table 3: General accrual accounting recommendations and preconditions (p.25)

    Table 4: Macro and Micro Level Strategy (p.29)

    Annex 1: IPSAS List (p.30)

    Annex 2: Macro level implementation plan (p.31)

    Annex 3: Udle monitoring (p.31)

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    Executive Summary 1

    01. Executive Summary

    This report analyses the relative merits of cash based accounting and accrual based accounting systems and their

    implications for current accounting reform efforts in the municipalities of Nepal. It is meant to inform interested

    stakeholders about accrual accounting implementation preconditions and implementation scenarios drawing from

    international as well as past udle (MLD-GTZ) experiences.

    The first part of the report offers an in depth analysis of the system, characteristics, advantages and disadvantages of

    cash accounting as well as accrual accounting for local governments. It provides information in how accrual accounting

    can be adjusted for local governments needs, acknowledging the special situation for such attempts in developing

    countries.

    The second part of the report describes and analyses past udle activities in accrual accounting implementation and

    reflects on todays current situation in the Nepalese municipalities concerning accrual accounting.

    The third part displays, drawing from international and past udle experiences, recommendations and preconditions

    when implementing accrual accounting in the municipalities of Nepal. Based on that, a macro as well as micro level

    implementation strategy is being presented.

    Drawing from the research and findings, this report recommends at least a modified accrual accounting to be adopted

    by the municipalities of Nepal. However the author is very much aware of the different situations, experiences and

    constraints in the municipalities. Therefore an incremental approach which starts first with a focus on accrual

    accounting booked cash transactions in order to improve revenue management (e.g. for taxes) and expenditure

    management is being suggested. Only if feasible for the municipality, asset management, meaning the valuation of

    assets and strategic planning, should be implemented since it requires a higher skill level.

    All in all municipalities in Nepal are at a critical phase of existence. With the abolishment of the Local Development Fee

    by 2011 the local governments are under huge pressure to increase their own resources and to allocate them wisely

    and effective. Accrual Accounting can be important to achieve this and is therefore a part of this broader municipal

    finance reform. Ones implemented, accrual accounting will also affect current budgeting, reporting and auditing

    principles since accounting is only one part of a public financial system.

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    Cash Accounting vs. Accrual Accounting 2

    02. Cash Accounting vs. Accrual Accounting

    2.1. Definition and comparison of the Cash Accounting System and the

    Accrual Accounting System

    Definition of Cash Accounting

    The cash accounting system primarily focuses on the inflow and outflow of cash transactions within one period. That is

    why it only knows two accounts in its pure form the cash inflow account (cash receipts) and the cash outflow account

    (cash payments) and therefore can only produce cash flow statements that cover cash inflow, cash outflow as well as

    opening and closing cash balances. Transactions are only recorded when the money for revenues actually is received

    and on the other side expenditures are only recorded when they are actually paid. This is related to the development of

    accounting systems in the past. In former times there was no major time difference between the receipt and payment

    of a certain good, which is why it was not necessary to develop separate accounts in order to reflect this time gap

    through receivables or payables or whatsoever. This has the effect that cash accounting is blind towards future

    revenues or expenditures until they are recorded in the cash accounts. Besides that the cash accounting system does

    not recognize the interlinkage between the source and the application of funds, since the sums normally simply

    appear in the cash inflow or cash outflow account without a connection. Therefore one can not track down the linkage

    between the money (e.g. taxes or fees) that was used to achieve a certain outcome (e.g. a new bridge). For the same

    reason one can not connect received cash to the total cash to be received (e.g. in tax management). Furthermore the

    cash accounting focuses only on cash and therefore doesnt reflect the status, value or wear and tear of assets and

    resources and therefore has no incentive for planned, strategic maintenance or reinvestment. Thus it is possible that a

    municipality lives from their asset substance e.g. a street by not acknowledging that assets are devaluing when being

    used. Therefore maintenance of and reinvestments into assets are not specifically planned in cash accounting or cash

    budgeting and because of this, necessary sudden maintenance or the reinvestment into an asset at risk (e.g. a bridge

    with cracks) might not be affordable for municipalities in a current fiscal situation. Cash Accounting is the dominant

    public sector accounting system.

    Definition of Accrual Accounting

    On top of the known cash transaction accounts from the cash based accounting system, the accrual accounting

    system knows multiple accounts, like receivables, payables, asset accounts, depreciations to be made on assets.

    Therefore it can provide a complete financial overview of e.g. a municipality.

    It displays full financial information on all cash transactions, assets, resources, resource consumption, true costs,

    arrears and current as well as future liabilities and revenues. Moreover it recognizes economic events and transactions

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    Cash Accounting vs. Accrual Accounting 3

    when they occur rather when money is actually exchanged. This effectively addresses the time difference between the

    receipt and payment of goods and also makes future strategic planning and multiple years planning possible. For

    example an accountant knows that in the fiscal year of 2008/2009 a certain total amount of tax is to be received even

    though it is not yet paid by the tax payer. As a result the accountant would be able to track down the reason for arrears.

    Transactions always affect two accounts in the accrual based accounting, the credits and debits side, which always

    have to be matched and balanced. Therefore it is possible to show the source and application of funds which makes an

    allocation of resources according to specific cost centres possible. For example a cost centre can be created for a bus

    park by showing the revenues but also the matched expenses (e.g. operational and maintenance cost) of the bus park.

    This would make the calculation of product costs possible. For example one could calculate an appropriate bus ticket

    fee in order to cover all the expenses of the bus park. However, cost centres can also be established for individuals

    (e.g. in tax management), projects, departments and so on.

    The connection of the source and application of funds also makes performance based budgeting, reporting, auditing

    and in general outcome orientation possible since one knows the crucial linkage between what was invested by whom

    to achieve a certain outcome. For this reason accrual accounting has the potential to change the steering tools on

    which cash accounting is based on towards performance and outcome orientation. For example accrual accounting

    provides a mayor or executive officer with much more financial information which enables him to optimize the

    budgeting process.

    Another major characteristic of accrual accounting is the usage of depreciations and/or reserve allocation in order to

    reflect the wear and tear of assets and future resource consumption. Depreciations are bookings, used to artificially

    display the real happening devaluation of e.g. a street through usage. Reserve allocation is a connected tool to reserve

    money for maintenance or reinvestment in order to address this devaluation. Through the income statement, where

    total revenues are matched to expenses, the net resource consumption of e.g. a municipality is being displayed. The

    income statement together with the balance statement of financial position displays the profit or deficit of a financial

    period.

    Accrual based accounting is the dominant private sector accounting system.

    Overview 1: Cash Accounting vs. Accrual Accounting (Broader Overview available under

    Athukorala & Reid, 2003, p.26-27)

    Cash Accounting Accrual Accounting

    Full knowledge of all payment flows Only cash transactions Complete financial overview possible

    Time of booking Recognizes transactions and economic

    events only when cash is received or paid

    Recognizes transactions and economic

    events when they occur

    Management of Assets and

    Resources

    No single accounts for assets and

    resources

    Full knowledge on the value of

    resources and assets

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    Cash Accounting vs. Accrual Accounting 4

    Depreciations, reserves, revenue,

    expenses

    Not possible Resource consumption and the wear

    and tear of resources is displayed

    Cost and results accounting No knowledge of costs by specific cost

    centres or service products since the

    linkage between source and application

    of funds is missing; no matching of

    revenues and expenses

    Full knowledge of true costs by specific

    cost centres and products

    2.2. Advantages and Disadvantages of Cash Accounting and Accrual

    Accounting

    Advantages of Cash Accounting

    Most of all cash based accounting is simple, cheap and objective in its operationand is therefore less knowledge

    intensive (SAFA, 2006, p.3). It provides basic financial information about liquidi ty and solvencyby producing cash

    statements. In addition, this system fits easily to most government budget, reporting and auditing principles since these

    are usually cash based until now.

    Disadvantages of Cash Accounting

    However, cash accounting does not provide sufficient information about non monetary resources like assets,

    receivables, payables, true costs, l iability or revenue arrears and future liabili ties(e.g. pensions) (World Bank,

    2007, p. IX; SAFA, 2006, p.3). Another point is that even though it provides cash statements one cannot interpret the

    source and application of funds on these statements (Athukorala & Reid, 2003, p.18). Therefore a municipal

    government might recognize that a total amount of money was spend according to the budget plan but it can not

    evaluate exactly for what purpose that money was used. During auditing the municipal government can therefore not

    evaluate if the provided total amount of money was really necessary to achieve a certain planned outcome since the

    direct booked linkage is missing. For these reasons it lacks outcome orientation.Moreover it cannot provide

    information on resource consumption, meaning the wear and tear of assets, and therefore does not acknowledge

    financially the devaluation and necessary maintenance when using a street, a car or a bridge. For this reason it has no

    possibil ity to plan ahead strategicallysince maintenance, total amounts to be received from e.g. taxes or total

    amounts to be paid (loan payments for instance) can not be displayed. Therefore no systematic asset management,

    debt managementand resource allocation according to cost centres is possible. As an aftermath it is possible that

    municipalities with cash accounting live from their asset substance and suddenly need large unplanned

    reinvestments into old infrastructure. Furthermore, other weaknesses are the lack of accountabilityand the lack of

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    Cash Accounting vs. Accrual Accounting 5

    transparencyby not being able to tell relevant stakeholders like tax payers the source and application of specific

    resources e.g. taxes. In the context of Nepalese Municipalities, most of the public properties are not accounted in the

    books of accounts and inventories of such valuable public assets (land, public parks and other important historical

    monuments) are ignored due to the application of cash accounting. A comprehensive strategic financial

    management plan of municipal bodies is impossible to be developed and implemented on base of cash

    accounting systems.

    Advantages of Accrual Accounting

    Most of all accrual accounting allows displaying information on non-monetary resources, assets, true costs, future

    liabili ties, receivables, payablesand therefore provides important knowledge for the development of a financial

    strategy, a transparent, effective and efficient revenue and expenditure managementas well as decision making

    processes of a municipality.

    Moreover, the financial statements and information produced according to accrual accounting provide local and central

    government agencies, creditors, donors, foreign investors, rating agencies, tax payers and other stakeholders with

    reliable information about the financial and economic situation of a municipality(SAFA, 2006, p.2).

    Furthermore, it enhances transparency by disclosing current and future liabilities (e.g. outstanding

    reinvestments into assets), resource consumption, true costs and the source and applications of funds

    according to cost centres(IMF, 2007, p.6, p.17; Champoux, 2006, p.14-15).

    Therefore it also provides the necessary information to hold the administration and different cost centres

    accountable and responsive for their actions. This is especially important in Nepal since a well developed tax

    culture does not exist. With accrual accounting it is possible to show the tax payers what was achieved with theirmoney.

    Additionally, it also empowers cost centres, a slaughter house for instance, by giving them the freedom to self

    manage their resources in an efficient way because they can see their expenses that are matched to their revenues.

    For the reason that accrual accounting always affects the debtors and the credits side and that it recognizes economic

    events when they occur, an accountant can draw a linkage between the taxes already received and the total amount of

    taxes to be paid. On the other hand depreciations and the allocation of reserves for crucial assets and future liabilities

    provide a sustainable accounting approach for debt management, strategic planning as well as asset

    managementincluding the maintenance of and reinvestment into assets. Accrual information also allows a proper

    evaluation to be made on quality, feasibility, efficiency and effectiveness of investments(Athukorala & Reid,2003, p.17, p.28). This is possible because accrual accounting can connect the source with the application of funds.

    Therefore it allows a better allocation of scare resources in the long run. Furthermore that evaluation also provides

    a municipality with important implications for budgeting, reporting and auditing.

    Additionally, accrual accounting is also able to compare services and costs across organizations.

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    Cash Accounting vs. Accrual Accounting 6

    Disadvantages of Accrual Accounting

    Most of the criticism related to accrual accounting arises from the relative complexity of the system, compared to

    cash accounting as well as high implementation costs (e.g. regarding the valuation of assets, training and

    information technology) (Athukorala & Reid, 2003, p.24). As a result of that, the implementation of accrual accounting

    is challenging especially for smaller municipalities. Without external support most of those municipalities are not able to

    adopt accrual accounting caused by a limited number of human resources and adequately trained personnel as well as

    low financial capabilities.

    In addition criticism arises about the so called vague estimations about the values of the assets of a municipality, which

    are used for depreciations and maintenance later on. However, wrong valuation will be recognized in accrual

    accounting after some time, since an engineer will see if depreciation and connected reserve allocation for

    maintenance and reinvestment are picturing the reality.

    Moreover the operation of such a system is supposed to be more difficult, skill-intensiveand expensive since it

    requires additional education of human resources (HR) and, at some stage, the use of Information Technology (IT)

    (Boothe, 2007, p.196; Athukorala & Reid, 2003, p.25; Wynne, 2003; Wynne, 2004, p.9-11). This certainly is correct but

    one has also to take into account the long term benefits accrual accounting can provide in revenue mobilization

    through tax management, asset management and debt management for instance. However, in some cases the

    acknowledgement of receivables creates big expectations regarding the upcoming revenues, which are being rarely

    achieved by the local governments in the short term. Some of the criticism holds especially true for developing

    countries (IMF, 2007, p.17). Not only because of the mentioned difficulties which all countries experience, but also

    because of problems like corruption, unclear property rights, capacity and resource constraints, informal economies,

    informality etc. (Schick, 2006). These problems however will affect both cash accounting but also accrual accounting.

    Still, the mentioned problems and difficulties are the reason why accrual accounting implementation in developing

    countries requires a carefully planned, comprehensive and long term approach, including the necessary technical,

    financial and political support and commitment by the relevant stakeholders. This is needed to overcome obstacles like

    capacity constraints, corruption, manipulation, lack of resources, the lack of formal accounting regulations, policies,

    fiscal rules, standards and manuals etc. (Athukorala & Reid, 2003, p.53-61; Boothe, 2007, p.195-199).

    All in all just a few minor steps, starting with the booking of cash transactions based on an accrual accounting system

    (this would include taxes, fees etc.), can improve the financial management of resource constraint local governments inNepal.

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    Cash Accounting vs. Accrual Accounting 7

    2.3. The dimensions of Accrual Accounting Financial Statements

    The dimensions of accrual accounting which are recommended by international standards consist of balance, income,

    capital change and cash flow statements (IPSASB, 2008b; Grossi, 2006).

    Balance Statement of Financial Position

    The balance statement of financial position consists of the different values on the debits and credits side. The debit

    side consists of floating assets and capital assets. The credits side consists of reserves and liabilities. On both sides

    one can distinguish between current and non current values. Through the calculation of the difference between debits

    and credits side, the equity capital can be displayed. Therefore one can see if the municipality has accumulated a

    deficit or a surplus.

    Income Statement (Operating Statement)

    The income statement is a sub account of the equity capital account, showing on each side of the account the

    revenues and expenses of a fiscal period separated according to operational and non operational activities as well as

    ordinary activities and extraordinary items. On the one hand revenues are recorded according to their source and on

    the other hand expenses are recorded according to their function, nature or use. The matching principle directly

    connects expenses to specific items of revenue on the basis of cause and effect relationships. The result of a fiscal

    year, the net income or net resource consumption, is calculated through the difference between revenues and

    expenses. As a result, the profit or loss of a fiscal year can be displayed.

    Statement of changes in net assets/equity

    This statement records all adjustments in net assets which are for example due to necessary revaluation of assets,

    past valuation errors or changing accounting policies.

    Cash Flow Statement

    The cash flow statement is being used for the documentation; supervision and steering of the cash flow and therefore

    ensures the liquidity and solvency of a municipality. These information are prerequisites for the access to loans on the

    capital market, e.g. if municipalities needed to cover expensive infrastructure investments partly by loan. Moreover this

    knowledge about solvency is also a signal on the credit market that reduces the risk and uncertainty for lenders when

    giving loans to municipalities.

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    Cash Accounting vs. Accrual Accounting 8

    A Cash flow statement is essential because even a surplus in the balance statement is no guarantee that sufficient

    resources for operational activities are available. Cash flows are inflows and outflows of cash and cash equivalents.

    Receipts of cash (cash inflow) are booked according to the source of funds. Disbursements (cash outflow) are booked

    according to the application of funds. On each side the values are separated according to operating, investing and

    financing activities. These information allow to ensure operating activities of a municipality and also allow to decide on

    future investment activities and liquidity needs.

    Overview 2: The three most important dimensions of Accrual Accounting Financial Statements

    2.4. In-Betweenism: Mixed Approaches of Cash and Accrual Accounting

    When looking at accounting systems in the public sector usually mixed approaches rather than pure forms of cash

    based accounting or accrual based accounting are in place. These mixed forms of accounting systems are in practise

    at different government levels and countries.

    In both systems differences arise on the one hand about the time of booking and on the other hand on the

    preconditions for booking.

    Themodified cash basis of accountingrecognizes transactions and events which belong to the previous fiscal yearand normally would be reflected in a cash inflow or outflow within the current fiscal year (Schiavo-Campo & Tommasi,

    1999, p.3). The difference compared to the pure cash accounting system lies in the fact of leaving the books open for

    cash transactions (mostly expenditures, sometimes also revenues) that are related to the previous fiscal year

    throughout a complementary period during the next fiscal year. Therefore it recognizes cash transactions that belong

    together and ensures a greater conformity within one fiscal year (Schiavo-Campo & Tommasi, 1999, p.3).

    Cash Receipts

    Disbursements

    Cash FlowStatement

    BalanceStatement

    IncomeStatement

    Liquidity

    Debits Credits

    Floatingassets

    capitalassets

    Equitycapital

    Reserves

    Liabilities

    Debits Credits

    Revenues

    Ex enses

    Fiscal YearOutcome

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    Cash Accounting vs. Accrual Accounting 9

    All in all modified cash accounting would be a first step to match cash transactions related to an economic event to the

    same fiscal year. For this reason the planning and operation of next years budget is not that much affected by the past

    fiscal year arrears.

    The modified accrual basis of accounting uses the same accounting framework as full accrual accounting.

    However, it is bound to a single fiscal period and therefore short term focused by merely recognizing economic

    transactions as revenues if they are available or measurable to liquidate liabilities in the current fiscal period or soon

    thereafter. Similarly, expenditures are only recognized if they are expected to draw on the currently spendable

    revenues in the fiscal period rather than long term resources. Although modified accrual accounting recognizes the

    total amounts in the different accounts on the debits and credits side, e.g. through receivables or payables, it only

    operates with the measurable or spendable funds and values. This has the advantage that there are no big

    expectations regarding the upcoming revenues since only the available funds matter. For example even though an

    accountant knows receivables in tax he does not book them as revenue until they are actually received and spendable.

    For this reason, long term revenues or long term expenses are excluded in modified accrual accounting. The same

    holds true for assets that are of long term use. Under modified accrual accounting they are written off immediately

    when acquired. Therefore no systematic asset management exists in modified accrual accounting. This is also the

    reason why modified accrual accounting does not use the term expenses and uses merely expenditure instead.

    Compared to the two mentioned forms of cash accounting, the modified accrual accounting has the advantage of being

    able to link the source and the application of available or spendable funds as explained before. Therefore it recognizes

    if payments have been used according to their purpose. Moreover it ensures fund availability and fund flows for

    expenditure purposes. All in all modified accrual accounting is a good first step for incremental accrual accounting

    implementation since it uses the same principles like full accrual accounting.

    2.5. Which accounting approach for which level of government?

    Regarding accounting systems for the public sector one has to take into consideration that there is a functional

    difference between the national and sub-national level of government. This difference is mainly due to the different

    scope of their actions towards the citizens as well as their public goods and services they provide. That is why it is not

    necessarily compulsory to use one accounting system throughout all administrative levels of government even though

    an integrated approach of accounting would be very useful and easier to handle in terms of budgeting, reporting and

    auditing.

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    Cash Accounting vs. Accrual Accounting 10

    In order to reflect at least outstanding receivables (e.g. in tax management) and payables, the crucial linkage between

    the source and application of funds, to create more transparency, accountability and responsiveness according to cost

    centres (e.g. a bus park), some degree of accrual accounting seems necessary (Chu, 2008, p.9). The question is how

    extensive this accrual accounting approach has to be in order to be appropriate and efficient for the national or sub-

    national government level.

    At the national levelit is not a priority to implement a full fledged accrual accounting system since central government

    normally does not own many assets or at least does not have to rely on them as much as the sub national level.

    Moreover national government usually redistributes monetary values and funds only. Therefore the first step of reform

    would be to improve the existing cash accounting system according to international cash accounting standards for the

    public sector (e.g. the IPSASB Cash Standards) (IPSASB, 2008b; World Bank, 2007, p. 5). As a second step of reform

    one can focus on the implementation of a modified accrual accounting system that dominantly focuses on revenues

    that are available to liquidate expenditures. In other words monetary values and central government funds but with the

    important difference, compared to cash accounting, of knowing the connection between the source and the application

    of these funds. Besides that, one would also know receivables and payables.1

    1In this regard, Nepal has already conducted a study on the improvements of the existing government accounting system under the technicalsupport of ADB the outcomes and suggestions are under discussion.

    As a result the central government

    would be able to evaluate the outcome of their funding as well as revenue and expenditure arrears. Of course that

    would also affect national budgeting, reporting and auditing in the long run.

    At the municipal levela totally different picture appears since a municipality usually owns more capital assets (e.g.

    roads, bridges but also transport service providers and other infrastructure) and floating assets. In addition it has to

    deal with resource consumption, reserve allocation, critical debt levels etc. and the allocation of usually scare

    resources in general. Therefore a sustainable asset and debt management is very crucial at a municipal level. In order

    to achieve these aims, a full accrual accounting system for the municipality including its public companies (e.g.

    transport providers and facilities) would be of major concern in the long run.

    However, in order to consolidate accrual accounting implementation a modified accrual accounting should be the first

    major step for municipalities towards full accrual accounting implementation since it uses the same accounting

    framework and usually the same software. In developing countries it should be an option of choice if the municipalities

    start with a modified or full accrual accounting according to their current status and capacity. Both accrual accounting

    systems can enhance transparency by displaying what public goods have been produced with tax money, e.g.

    Integrated Property Tax (IPT) in Nepal, or other taxes and fees.

    However, a full financial overview including asset management is only possible with a full fledged accrual accounting.

    The financial statements an accrual accounting can provide are an important basis to achieve credibility towards

    stakeholders like donors, banks, foreign investors, tax payers or the general public. Moreover, these information are

    useful for the management level of the municipality in order to improve the efficiency, effectiveness, feasibility,

    sustainability and quality of their investments and their financial management in more general terms.

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    Cash Accounting vs. Accrual Accounting 11

    2.6. International Public Sector Accounting Standards IPSAS

    Compared to the private sector there were only relatively few international recognized public sector accountingstandards. By introducing IPSAS, this scenario has changed over recent years and more and more countries are at

    least orientating their reform efforts along the lines of these standards.

    The International Public Sector Accounting Standards (IPSAS) were developed by the International Public Sector

    Accounting Standards Board (IPSASB) which belongs to the International Federation of Accountants (IFAC).

    The IPSAS are based on the International Accounting Standards (IAS) which IFAC developed for the standardization

    of the international private sector accounting. The IPSASB exists since 1986 and [] focuses on the accounting and

    financial reporting needs of national, regional and local governments, related governmental agencies, and the

    constituencies they serve. It addresses these needs by issuing and promoting benchmark guidance and facilitating theexchange of information among accountants and those who work in the public sector or rely on its work . (IPSASB,

    2008).

    The IPSASB works on the standardization, harmonization, comparabili ty and transparency enhancement of

    international public sector accounting. The standards reduce the risk produced by lacking accounting knowledge

    and misstatements, foster guidance on accounting treatment and define minimum accounting requirements (IMF,

    2007, p.7). Furthermore the usage of such a standard reduces financial risks and transaction costs for possible

    lenders. As long as these standards are not part of the national regulation, they are only recommendations.

    All in all the IPSASB produced 26 IPSAS for accrual accounting in the public sector addressing different accounting

    topics e.g. financial statements, inventories etc. (IPSASB, 2008b; see also Annex 1 for all IPSAS, p.30). For instance

    an accrual based financial statement along the lines of IPSAS requests a balance statement of financial position, an

    income statement, a cash-flow statement and a statement on the changes in net assets/equity (IPSASB, 2008b).

    In addition IPSASB published a guidance manual for the transition towards accrual accounting practise, which

    can be of major technical help for ongoing accrual accounting activities in Nepal (IFAC, 2003). It also produced a

    handbook of standards for cash based accounting practise, which can be of direct usage for the national

    government level in Nepal (IPSASB, 2008b). On their homepage IFAC provides a list showing which countries

    applied IPSAS as of July 2008, however this list is confusing because it is not clearly indicated if the

    international standard for cash or accrual accounting is meant (IPSASB, 2008c). Very helpful is also the

    publ ished glossary on accounting terms as of 2006 (IFAC, 2006).

    2.7. International Experiences on the Local Level

    Worldwide it seems that the most progressive accrual accounting implementers are regional or local governments,

    which are usually ahead of central government in terms of accrual accounting reform (FEE, 2007, p.6, p.23-24; FEE,

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    Cash Accounting vs. Accrual Accounting 12

    2003, p.1). This applies to more developed as well as developing countries. Mostly the national level of government

    benefits from the experiences made by the local governments (FEE, 2007, p.6).

    OECD Countries

    Within the OECD the majority of local governments use some sort of an accrual based accounting system. This is valid

    for most local governments in Switzerland, the Netherlands, Sweden, Spain, Portugal, Finland, France, Great Britain,

    Germany, Italy, USA, New Zealand, Australia, Canada and Iceland. Also relatively new OECD members like Poland

    and Slovakia are in the process of accrual accounting implementations.

    In Germany for example a comprehensive municipal reform to change to accrual accounting has started in 2003 on a

    regional basis. During this reform process some of the sixteen federal regions made the change to accrual accounting

    mandatory for their municipalities. Others approved the change to accrual accounting on a voluntary basis. The fastest

    and broadest approach undertaken by a bigger federal region is being done by the state of North-Rhine Westphalia,

    which made it mandatory for all municipalities to change to accrual accounting until the end of 2009. Besides that the

    federal regions of Hamburg and Bremen already introduced accrual accounting around 2006.

    All in all 11 out 16 federal regions made it mandatory for their municipalities to introduce accrual accounting until 2013

    at the very latest. Five federal regions left the decision up to their municipalities whether they want to introduce accrual

    accounting or go for the traditional cash accounting system or a modified accounting system (KPMG, 2008, p.1-3).

    Besides these regulatory approaches there are a lot of towns and municipalities who introduced accrual accounting on

    a voluntary basis.

    For further information on the mentioned countries see Athukorala & Reid, 2003, p.79-81; IPSASB, 2008c; FEE, 2007,p.23-24; Grossi, 2006, p.4-5; IFAC, 2000, p.65; CESifo, 2007.

    Accrual accounting is part of a broad financial management reformin the public sector in the above mentioned

    countries. However, they differ on the implementation of some sort of performance budgeting, reporting and auditing

    but the change in accounting usually had implications for these other components.

    Non-OECD Countries

    In the case of South Asia, a couple of countries implemented some sort of accrual accounting at local level or are in

    the process of doing so.

    In India for instance, some federal states including Tamil Nadu, Maharashtra, UP and Karnataka are using accrual

    based accounting. The urban local bodies however are more speedily towards the implementation of accrual

    accounting because of a decision by the Supreme Court of India in 2001 that forces all urban governments to

    implement accrual accounting, e.g. Municipal Corporation of Delhi since 2003 (SAFA, 2006, p.7-8).

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    Cash Accounting vs. Accrual Accounting 13

    Malaysia introduced accrual accounting only on the local level (IFAC, 2000, p.65).

    Similarly, Bangkok Metropolitan City of the Thailand, introduced an accrual accounting system in 2006.

    The Fiji Islands recently purchased accrual accounting software and plan to move to accrual accounting in the medium

    term (Athukorala & Reid, 2003, p.30; ADB, 2002, p. 33-34). The same holds for Sri Lanka, Indonesia, The Philippines,

    China (ADB, 2002, p.33-34). However in these cases it is not sure if this also holds true for the local government level.

    Singapore currently uses both types of accounting; cash based accounting and accrual based accounting (CPA

    Australia, 2004).

    According to a SAFA study from 2006 Bangladesh is on the way to move to an accrual based accounting system.

    Other countries like Chile, UAE, Tanzania, Romania, Estonia, and Latvia implemented accrual accounting at least at

    local level.

    Russia, Azerbaijan, Barbados, Cayman Islands, Mongolia, South Africa, Israel, Jamaica and Slovenia etc. appear to be

    in the process of accrual accounting implementation, but its not possible to assess on which level of government or

    how far this process is on the way (IPSASB, 2008c; IFAC, 2006, p.65).

    Furthermore The European Union pushes for accrual accounting implementation in new member states or prospective

    member states.

    Although this might look very promising, one has to be very careful when implementing accrual accounting systems in

    developing countries since these usually face even greater problems when introducing this system compared to more

    developed countries (see p.6).

    Overview 3: Worldwide efforts by local governments to implement accrual accounting

    OECD implemented Switzerland, the Netherlands, Sweden, Spain, Portugal, Finland, France, Great Britain,

    Germany, Italy, USA, New Zealand, Australia, Canada and Iceland, Poland and Slovakia

    Non OECD implemented Chile, UAE, Tanzania, Romania, Estonia, and Latvia, Malaysia, Singapore (both systems)

    Non OECD in the process India, Fiji Islands, Sri Lanka, Indonesia, The Philippines, Russia, China, Azerbaijan,

    Barbados, Cayman Islands, Mongolia, Bangladesh, South Africa, Israel, Jamaica and

    Slovenia, Nepal

    EU pushes for accrual accounting

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    Findings and observations in the Nepalese municipalities 14

    03. Findings and observations in the Nepalese municipalities

    3.1. Accrual accounting history and past udle experiences

    Since 1960/1961 municipalities are using the current government accounting system which was developed with

    the technical assistance of UNDP and USAID at that time2

    Accrual accounting activities in Nepal did not begin until the restoration of democracy in 1990. However, efforts

    did not start until the Asian Development Bank (ADB) first made the implementation of accrual accounting a

    condition for Kathmandu Metropolitan City (KMC) for receiving loans. As a result KMC formed a taskforce for the

    implementation of accrual accounting, developed a new chart of accounts and started further preparations for

    accrual accounting implementation. These efforts were financed by the then existing Kathmandu Town

    Development Project.

    (see also World Bank, 2007, p.2; World Bank, 2003,

    p.46).

    Ever since the starting point of this discourse in Nepal, accrual accounting was usually referred to as corporate

    accounting system or CAS.

    Beginning in 1992 the technical assistance to Nepalese municipalities in finance and management became one of

    the areas of support, provided by the udle programme. Since then efforts focussed mainly on mobilizing municipal

    resources, improving municipal financial management, supporting computer skills training, computerization, DOS

    based cash accounting and tax software and the reforming of the accounting system (udle, 2006).

    Starting in 1996 udle supported the introduction of accrual accounting with a sensitization workshop at the UDTC

    in a joint effort with MuAN.

    In August 1997 udle assisted in the preparation of an accrual accounting manual which was supported in a joint

    effort with the Nepali Chartered Accountants.

    In March 1998 another workshop, focussing on the merits of accrual accounting as well as the above mentioned

    manual was conducted for municipal accountants.

    In November 1998 a six days accrual accounting training at UDTC was conducted for the accounting staff of the

    municipalities of Kathmandu, Lalitpur, Bhaktapur, Butwal, Dharan, Hetauda, Pokhara, Siddharthenagar,

    Dhangadhi and Biratnagar. It was sponsored by the Kathmandu Town Development Project. After that a computer

    accrual accounting training was conducted for the same municipal accountants.

    In June 1999 Kathmandu itself organized a two weeks training in accrual accounting for its own accounting staff.

    In October 1999 the MuAN presented an agenda stressing the implementation of accrual accounting. On that

    meeting KMC also announced that it would implement accrual accounting in 2001. Therefore, accrual accounting

    was well established on the municipal reform agenda in Nepal around 1999.

    2This was reported by different municipalities during the research.

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    Findings and observations in the Nepalese municipalities 15

    In December 1999 the government of Nepal passed the Local Self Governance Act. The separately annexed

    financial administration specification of this act3

    After that regulation was conceded, udle concentrated its following efforts firstly on the development of an

    accrual accounting system combined with appropriate software and secondly on an accrual accounting

    implementation project plan:

    leaves the municipalities the choice between the usage of cash

    accounting and accrual accounting (Nepal Legislation, 1999c, p.16). However, in the same paragraph of this act

    an added statement, called 1a, rejects this option of choice by stressing that all municipalities have to

    introduce accrual based accountingwithin five years time and thereby making accrual accounting obligatory for

    all municipal governments. Hence, it provides the necessary legal base for further udle activities.

    1) The proposed accrual accounting system recognized accounting heads for cash, bank, receivables

    (including taxes, fees etc.), payables, fixed assets (vehicles, fire engines, furniture, electric equipment, office

    apparatus etc.), floating assets (consumers goods, logistics, fuel etc.), revenues, expenses, loans, funds and

    reserves. However, it did not include depreciations at that time. The valuation of land usually was based on

    reports, prepared by the Land Revenue Office as well as suitable market price schemes. The valuation of

    buildings was undertaken by engineers of the municipality or their wards4

    2) The proposedimplementation project planstretched over six months and was implemented parallel with

    the existing cash accounting system. It included:

    . Movable assets were valued

    according to available documents provided by the municipalities or their wards. Problems appeared in the

    valuation of receivables since usually no systematic records of taxes and fees existed back then. The same

    holds true for assets. All in all the system was beyond modified accrual accounting but not a full fledged

    accrual accounting system.

    o a system study on the existing accounting system,

    o a system conversion phase with experimental balances (focusing mainly on cash) and the identification

    and valuation of assets as well as the identification of unrecorded liabilities and revenues,

    o a system running phase,

    o a system reporting phase that included the creation of financial statements like a balance statement and

    cash flow statement by udle,

    o a full implementation phase supervised by udle for manual accrual accounting practice and reporting

    handled by the municipal staff, and finally

    o

    the computerization of the accrual accounting system with the udle self developed DOS based accrualaccounting software.

    In the first fiscal year after implementation accrual accounting was to be done both manually and computerized. If the

    computerized booking was correct only computer based accrual accounting was to be continued.

    3The second edition as of 2005 was used for this report.4A ward in Nepal is a local political division. Nine wards make up a Village Development Committee (VDC).

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    Findings and observations in the Nepalese municipalities 16

    Udle then started to assist eight municipalities in the implementation of the described accrual based accounting

    system (Dharan, Butwal, Dhangadhi, Nepalgunj, Pokhara, Hetauda, Banepa and Kathmandu) (Chhetri, 2002;

    udle, 2006).

    The first attempts of implementation on a piloting basis were made from January 1st of 2000 onwards in Dharan

    and after this in Butwal starting the implementation on February 12th of 2000 onwards.

    The accrual accounting system combined with the then newly developed software, supported by udle, was fully

    introduced in the fiscal year of 2001 in Dharan, Butwal, Dhangadhi, Nepalgunj and Kathmandu. In the following

    year Pokhara, Hetauda and Banepa followed.However, in the post implementation phase different problems

    and obstacles led to the fact that only Dharan, Butwal and Kathmandu managed to continue accrual

    accounting.

    Although udle assisted in the long term implementation of accrual accounting in three municipalities and

    achieved a general sensitization towards accrual accounting at municipal level, the first attempts to introduce

    accrual accounting in selected municipalit ies had only limited success.

    After this, udle reduced its efforts and support in accrual accounting until 2007. However since one year udle restarted

    major efforts in accrual accounting implementation and is preparing a comprehensive implementation scenario. This

    report is part of this process.

    Analysis and lessons learnt

    It is obvious that only those municipalities which received either strong technical support from udle (Dharan and

    Butwal) or had accrual accounting on the agenda since a relatively long time (Kathmandu Metropolitan City)succeeded to continue accrual accounting practice. Only KMC had enough resources to organize and finance extra

    accrual accounting training for their staff when udle support was not sufficient anymore, especially in the post

    implementation phase.

    Major reported obstacles for the successful implementation in the municipalities were:

    Lack of suff icient training on manual as well as computerized accrual accounting practise. A proper

    general training before the implementation which would have made sure that the accounting staff both knows and

    understands the concept of manual and computerized accrual accounting was missing. The same holds true forthe post implementation phase, where a long term, individual needs based refresher training as well as general

    technical back up and support on demand for all municipalities was missing.

    Lack of conceptual clarity by the municipalities and other important stakeholders what accrual accounting

    actually is. This again indicates insufficient theoretical and practical information.

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    Findings and observations in the Nepalese municipalities 17

    Lack of adequate human resources in the municipalit ies.Accrual accounting training will hardly be successful

    if a general capacity constraint in terms of human resources exists. This indicates an insufficient education system

    for public servants.

    Problems in the valuation process of assets:the identification, documentation as well as valuation of capital

    and floating assets were major obstacles in the process. Due to that the valuation was incomplete or even

    completely failed.

    Lack of suf ficient integrated databases:the identification and documentation of tax and fee receivables mostly

    failed, caused by weak tax revenue databases.

    Lack of an appropriate software solution:The DOS based accrual accounting software that was provided with

    the assistance of udle, appeared to be too complicated and not very user friendly. As an aftermath municipal staff

    with already low IT skill levels had difficulties applying the software. Only those municipalities succeeded to

    continue with the software which had at least one well trained IT expert within their accounting section that was

    capable of updating the software himself (Butwal, Dharan and Kathmandu). In addition, the provided accounting

    software could not be integrated with other existing software systems. The fact that the udle supported software

    was mostly designed only by a single person had the disadvantage that every municipality heavily depended on

    this one programmer since the existing municipal software education was not sufficient. Also due to that udle just

    did not have the capacity to support all municipalities in accounting software practice and updates in the same

    way.

    Lack of a clear and strong udle commitment. Udle support was neither comprehensive enough, nor long term

    focused. It did not focus sufficiently on the crucial post implementation period due to own capacity constraints and

    a changed working focus. In addition, the technical, political and financial support udle gave was not equal

    towards all municipalities which tried implementation.

    Lack of political commitmentby the government, some mayors and accounting staff.

    Missing links between local and national accounting practise. At the end of the fiscal year the few

    municipalities that actually are using accrual accounting can not send their accrual based accounting financial

    statements to the central government. The Comptroller General Office of the Nepalese Government only accepts

    cash accounting financial statements for auditing and is reluctant to adjust to current accrual accounting reforms.

    This creates a lot of double work for the municipalities, which was also a reason why some municipalities did not

    implement accrual accounting in the first place.

    Major reported facilitators of the process were:

    Strong udle support(in the case of Dharan and Butwal).

    Availability of well trained accountants and IT experts(Dharan, Butwal, KMC).

    Availability of own resourcesfor extra training. This holds especially true for KMC.

    General administrative capacityin public finance.

    Political commitment and enthusiasmexisting in the municipalities by all relevant stakeholders.

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    Findings and observations in the Nepalese municipalities 18

    Existing experience in accounting software.

    Availability of informationabout capital and floating assets as well as databases on revenues and expenses.

    3.2. Status Quo in the Nepalese municipalities regarding Accrual Accounting

    Regarding the accounting systems of local governments in Nepal there are currently very different experience levels

    throughout the country. The following type assessment is based on the current status of the accounting system as well

    as the accounting software in the municipalities.The type assessment can be of major help during the preparation

    of a nationwide, flexible accrual accounting implementation strategy that wants to take into account individual

    municipal needs and starting points.These capacity differences will affect the type of accrual accounting that will be

    implemented, the type of manual and computerized training that is necessary, the extent of the accrual accounting

    software that will be provided and the amount of financial support that is needed. Possibly even a pre education and

    computerization will be necessary.

    Table 1: Municipality Types

    Municipality

    Type

    Characteristics

    Type I These municipalities successfully implemented and use the accrual accounting system including

    an accrual accounting software (Dharan, Butwal and Kathmandu Metropolitan City).

    They differ on their accrual accounting software and current accrual accounting practise.

    Dharan and Butwal are using self updated and self managed versions of the old udle supported

    DOS based accrual accounting software. However this old software is not network based and can

    not integrate the databases from existing tax revenue software and house numbering information

    systems.

    Both Butwal and Dharan are producing financial statements including a balance statement, an

    income statement and a cash-flow statement. They are used to asset management including

    depreciations and debt management.

    Since the implementation of accrual accounting, Butwal was even able to reduce its debt level, to

    avoid deficit spending, to ease accounting in general, to report more efficiently and to improve interms of transparency.

    KMC uses an Oracle-network based accrual accounting software, recently provided by a private

    software company. This software manages to integrate different software modules (including tax,

    fee and citizenship software modules) and databases, functioning as an effective data interface.

    The software system is very well established, user friendly and is now effectively in practise in

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    Findings and observations in the Nepalese municipalities 19

    KMC. KMC is also in the process of decentralizing this software to its wards, making it easier for

    citizens to access public services. The wards function as local accounting centres and only have

    a limited budget. Through the network connection the wards and the central KMC administration

    will be interlinked, making it easy for the central management to supervise the activities in the

    wards. The software is also able to limit access to different accounting heads and vouchers

    according to the job position of the public officer. The creation of cost centres according to

    projects, taxes, fees, wards, specific individuals and so on is also possible. All in all this

    integrated and modular software is easy adjustable to the needs and administrative status of any

    municipality and would be a sound solution for all municipalities in Nepal.

    KMC is well ahead of modified accrual accounting but is not practising asset management,

    meaning depreciations, and reserve allocation etc. at the moment.

    Type II These municipalities have some experiences in accrual accounting implementation but failed in

    the previous attempt for explained reasons (Dhangadhi, Nepalgunj, Pokhara, Hetauda and

    Banepa).

    Some of these municipalities also tried to implement accrual accounting manually but

    discontinued after some time and returned to cash based accounting.

    These municipalities all have at least partly computerized accounting and/or tax systems and

    usually are eager to restart there accrual accounting implementations efforts.

    Type III These municipalities did not try to implement accrual accounting systems but have at least partly

    computerized accounting systems and some information about what accrual accounting is (e.g.

    Lalitpur, Bhaktapur).

    Some of these municipalities now feel prepared to join the accrual accounting reform process.

    Type IV These municipalities are not computerized, have never tried to implement accrual accounting and

    also do not have sufficient information about what accrual accounting actually is (many small

    and remote municipalities etc.).

    All in all the municipalities of Nepal are currently under a strong pressure for reform. They are still very much

    dependent on the Local Development Fee (LDF), which is a national import tax, collected by the central government

    and distributed to the municipalities. The LDF accounts for over 70 percent of the municipal tax revenues (udle, 2008).

    However due to the upcoming membership of Nepal in the WTO the LDF will be abolished soon. This will leave the

    municipalities with a huge revenue gap. The government has not yet decided how much money on which scheme willbe distributed to the municipalities in order to partly cover this gap in the future.

    Whatsoever, the municipalities are very much under pressure to increase their own revenues through local taxes and

    fees but also to find ways to efficiently allocate scare resources. The implementation of accrual accounting can be

    of major help in achieving these aims(see again advantages on p.5).

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    Findings and observations in the Nepalese municipalities 20

    Another current incentive to implement accrual accounting is its role in the new Minimum Conditions and Performance

    Measures (MC/PM) system, which was developed by MLD/LBFC with technical support of udle. Within this system the

    implementation of accrual accounting is supported through monetary incentives. The MC/PM system is a performance

    based tool for the distribution of grants and funds honouring outstanding institutional capacity and service delivery

    function. The municipalities must fulfil an increasing number of minimum conditions (MCs) in key institutional

    improvement areas. The individual performance measures (PMs) allow the distribution of funds according to

    outstanding performance. The use of accrual accounting systems is one of these performance indicators (PM). Future

    LGCDP expanded block grant distribution to municipalities will be based on municipal MC/PM performance.

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    How to implement Accrual Accounting? 21

    04. How to implement Accrual Accounting?

    4.1. Recommendations and p reconditions for the implementation of Accrual Accounting

    The different starting points and needs of the municipalitiesin the process have to be adequately addressed in all stages of future implementation and post implementation

    phases (see Table 1, p.18).

    Drawing on the findings of the study as well as international recommendations (Athukorala & Reid, 2003, p.56-62; Wynne, 2004, p.16-20; FEE, 2003, p.10-12; IMF, 2007, p.13-14;

    IPSASB, 2003) this part of the report displays a possible way of implementing accrual accounting at the municipal level.

    It will start with technical recommendations and preconditions for accrual accounting as well as general recommendations and preconditions for the implementation of accrual

    accounting and will be concluded with a micro and macro level implementation strategy.

    4.1.1. Technical accrual accounting recommendations and preconditions

    Table 2: Technical accrual accounting recommendations and preconditions

    Accrual Accounting Laws and Regulations Who is supporting?

    In order to guarantee an effective implementation the current legal framework has to be revised. Accrual accounting activities need to have an in

    tune and interconnected legal framework, including an adapted municipal and national budgeting, reporting and auditing (internal and external)

    system.5

    Concerning that issue one has to review possible linkages to performance or outcome based budgeting as well as reporting and auditing

    (Diamond, 2002; IMF, 2007, p.9).

    Udle (MLD-GTZ),,

    Comptroller General

    Office, Institute of

    Chartered Accountants,

    LBFC, MuAN,

    5For further information on national level budgeting, accounting and auditing as well as international literature please refer to World Bank, 2007; World Bank 2003 and Shah, 2007.

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    How to implement Accrual Accounting? 22

    Currently the Comptroller General Office does not accept accrual based financial statements for external auditing purposes. This indicates that

    existing procedures between the local and central level of government are not matched and have to be revised.

    A Nepal Public Accrual Accounting Standard should be developed according to IPSAS and the Nepal Accounting Standard (NAS).

    Regulations must acknowledge the different starting points and experiences of the municipalities in accrual accounting (see p.18-19).

    An efficient auditing and monitoring of the implementation process combined with selected support is essential for the success of the accrual

    accounting implementation.

    The term Corporate Accounting System or CAS should be revised since it implies that public and private accounting are identical, which

    however is not the case.

    consultants

    Accrual Accounting Guidelines and Manuals Who is supporting?

    Accrual accounting guidelines and manuals are supposed to close the gap between the developed public accrual accounting

    regulations/standards and the practical implementation, transition period and operation (see also IPSASB, 2003 and IMF, 2007).

    Specific technical accrual accounting guidelines and manuals which address not only accrual accounting in general but also the transition or

    implementation are necessary. This is an important lesson learnt since there needs to be more clarity on how to proceed during the

    implementation process. Information must be provided on difficult issues like the valuation methods of specific asset types, inventory,

    depreciations, debt management, revenue management, opening balance sheet, closing balance sheet, and other financial statements.

    The guidelines should use standardized methods for each accrual accounting component, e.g. in the valuation of certain asset types, since many

    different methods will be misleading and would be an obstacle to achieve a certain quality standard of accrual accounting across Nepal.

    Udle (MLD-GTZ),

    Comptroller General

    Office, the Institute of

    Chartered Accountants,

    LBFC, MuAN, ,

    consultants

    Conceptual Clarity Who is supporting?

    During past reforms municipal staff was not sufficiently trained and informed about the characteristics, the meaning, the scope and the

    environment of accrual accounting.

    One has to ensure that the accounting staff is capable of using and understanding the manual accrual accounting practise. Only after that

    software training and following project phases should be started

    Also in this case it is important to acknowledge the different starting points and needs of the municipalities before a possible accrual accounting

    implementation

    Udle (MLD-GTZ),

    Comptroller General

    Office, MuAN

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    How to implement Accrual Accounting? 23

    Accrual Accounting Implementation Plan Who is supporting?

    A detailed implementation plan with major project milestones from a macro (national) as well as micro (municipal) perspective is needed to clarify

    the different assignments of the relevant stakeholders.

    The micro level implementation plan needs to be flexible enough to be adjusted to the different situations and needs in the municipalities

    (especially with regard to the components of the accrual accounting).

    The macro level accrual accounting implementation plan displays the overall national perspective of accrual accounting implementation.

    Both types need to include specified inputs, activities, milestones, project phases, timelines, objectives and outcomes.

    These plans must be available for interested stakeholders in written and digital version to enhance the transparency of the process.

    Udle (MLD-GTZ), the

    Institute of Chartered

    Accountants, MuAN,

    LBFC, private software

    company, consultants

    Obtaining information (databases, past records and documentation) Who is supporting?

    Central government agencies (e.g. Land revenue office) and the municipalities have to integrate their information on assets, receivables (e.g.

    tax), payables etc. into one database. This has to be done before accrual accounting software implementation. Otherwise a comprehensive

    asset, debt and tax management will not be possible.

    If these information are not available, the municipalities should start the valuation of capital and floating assets according to the guidelines well in

    advance.

    In the end the obtained information and databases should be integrated into a ready available accrual accounting software.

    MLD, Central

    Government Agencies

    (e.g. Land Revenue

    Office), MuAN, a private

    software company, all

    municipalities

    Chart of Accounts Who is supporting?

    Before accrual accounting implementation, a new standardized chart of accounts for public accrual accounting needs to be developed.

    A chart of accounts organizes the different accounting heads based on specific number digits. That makes the classification and coding of

    transactions and events possible, so that they can be tracked down to specific cost centres (e.g. a bus park or individuals).

    The digits should be similar to the private sector chart of accounts. That would facilitate the knowledge and staff exchange between the public

    and private sector.

    The chart of accounts should allow the integration of current tax reform programs in Nepal (i.e. adding PAN to four to six digit account numbers

    to track tax payments).

    Udle (MLD-GTZ), LBFC,

    Comptroller General

    Office and the Institute of

    Chartered Accountants, a

    private software company

    Inventory Who is supporting?

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    How to implement Accrual Accounting? 24

    The inventory is a major component when preparing the first opening balance sheet since it identifies the movable and immovable assets which

    will later on be valuated, maintained and perhaps are subject to reinvestments.

    The first inventory should not be too extensive and be more focused on very valuable, crucial assets or assets at risk (e.g. transport facilities,

    health care, emergency facilities and other infrastructure)

    Udle (MLD-GTZ), all

    municipalities,

    consultants

    Valuation of assets Who is supporting?

    The valuation of assets is a major component of accrual accounting that should be treated carefully.

    There are various valuation methods according to the type of asset. Land should be valuated according to an average standard price per square

    meter. The valuation of municipal buildings, streets etc. should be carried out in a very conservative way, focussing mainly on replacement

    values since the municipality usually does not want to sell their office buildings or streets. Movable assets like cars and trucks can be valued

    according to their purchase price or to their current market value.

    In the past the Land Revenue Office was responsible for land inventory and valuation. However, municipalities should take over these functions

    in the future since it is their property.

    All in all valuation of assets should be conservative and not to high since it is very crucial to set appropriate depreciations, reserve allocations

    and reinvestment amounts.

    In addition, it should not be allowed to revaluate assets every year and thereby manipulating the equity capital. Revaluation should only happen

    in defined timeframes according to an accrual accounting regulation.

    Udle (MLD-GTZ), all

    municipalities,

    consultants

    Depreciations Who is supporting

    Depreciations are essential for asset management and are displaying the wear and tear of assets or net resource consumption.

    The reason for the devaluation of an asset can be the simple usage or a change in current market prices.

    In order to depreciate, one needs to estimate how long an asset can be used. In order to keep it simple, one should then depreciate on a linear

    basis per fiscal period. This should be done very realistically. It is of no use to set the usage time unrealistically high in order to be able to book a

    lower depreciation per fiscal period. This will only lead to the fact that e.g. a street will be already completely devalued before the planned usage

    time is achieved. Therefore the street will be in a very bad condition and the municipality has no available reserves to cover these unplanned

    cots. However the usage time of an asset can be reviewed after some time to adjust the estimation, if required.

    Udle (MLD-GTZ), all

    municipalities,

    consultants

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    How to implement Accrual Accounting? 25

    As a proposal for sustainable asset management, maintenance costs and reserve allocation for reinvestment into the asset should be connected

    to the depreciation. This could be done by using a certain percentage of the booked depreciation as an estimated lump sum for maintenance

    costs and reserve allocation. That way, investments might get more costly on the first glimpse but with proper planned maintenance one can

    extent the usage time of an asset and, when devalued, even replace it through available reserves.

    Depreciations and reserve allocation should be compulsory for crucial assets according to the individual capacity of the municipality.

    4.1.2. General accrual accounting recommendations and preconditions

    Table 3: General accrual accounting recommendations and preconditions

    Project Management Who is supporting?

    It is a major and difficult task to coordinate and steer a nationwide municipal accrual accounting implementation.

    A possible approach could be to decentralize the coordination process by empowering regionally based coordinators in the five development

    regions (according to the Regional Learning Centres) to facilitate the implementation process. This coordinator needs to have sufficient

    knowledge in manual as well as computerized accrual accounting. The coordinator would be the contact person for the municipalities in the

    development region, udle and the government.

    The Regional Learning Centres (RLCs in Dhanagadhi, Nepalgunj, Butwal, Hetauda, Dharan) could play a more active role in the facilitation of a

    decentralized knowledge transfer among the municipalities in the development regions. One needs to revise if the RLCs can accomplish these

    aims at the moment.

    The efforts of the regional based coordinator and the RLC would provide a knowledge transfer platform within a development region.

    The UDTC could be a knowledge transfer platform at the national level. One needs to revise if the UDTC currently can accomplish such a task.

    Udle would primarily monitor, evaluate and control the implementation process from a macro perspective according to the implementation plan.

    Secondly udle would provide technical back up on demand. Activities would be reported by the regional coordinators, the RLCs and UDTC to

    udle.

    Please have a look at Annex 3 and Annex 4 (p.31) to get a better impression of this implementation approach.

    Udle (MLD-GTZ),

    Regional Coordinators,

    Regional Learning

    Centres, UDTC

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    How to implement Accrual Accounting? 26

    Training and Education Who is supporting?

    A comprehensive training and general education has to ensure that adequate human resources are available for an accrual accounting

    implementation. These efforts also have to take the different starting points in the municipalities into account (see Table 1, p.18). This report

    proposes four training and education categories:

    1) Firstly, there should be a general training. The aim of the general training is that everybody understands the concept of manualaccrual

    accounting and related topics. Each course lasts 5 days and ends with final examination. For the successful participation of a course a

    certificate should be provided in cooperation with or by the Chartered Accountants of Nepal. That would be a sufficient incentive for course

    participants since they have an official document that enhances their careers. The structure of the general education is as follows:

    a) Manual Basis of Accrual Accounting

    b) Expenditure Administration

    c) Debt Management

    d) Asset Management (with special focus on inventory, valuation and management of municipal assets)

    e) Revenue Administration (with special focus on municipal revenue titles like taxes)

    2) Secondly, only after successfully finishing the general training, an accrual accounting software trainingshould be conducted. This software

    training lasts 14 days and should be facilitated by the same private software company that also provides the accrual accounting software.

    The concept is as follows:

    a) First week the functions and possibilities of the software and its modules are presented.

    b) Second week is aimed to use the knowledge gained in exercises, ideally based on case studies from municipalities.3) Thirdly, there should be further needs based trainingon demand and refresher trainings. Knowledge transfer between municipalities

    should also be enhanced in this training category.

    4) Fourthly, amid-career degreeto improve the general municipal finance capacity should be established. This degree has the aim to ensure

    long term, sustainable public sector education and should not only focus on accrual accounting but also on all other important municipal

    public finance and management issues (e.g. revenue and tax management). The degree could be financed to a certain level by the central

    government, the municipalities and through a donor basket fund.

    Udle (MLD-GTZ),

    Institute of Chartered

    Accountants or any other

    reliable, high-level

    training institution,

    universities, public sector

    education facilities, a

    private software company

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    How to implement Accrual Accounting? 27

    User Friendly Accrual Accounting Information Technology Who is supporting

    The is a need for a user friendly, network based, integrated and modular accrual accounting software that integrates other existing software and

    databases for accounting, tax management, fees etc. As a result receivables or payables would be much better documented and transactions

    could be tracked down to specific cost centres.

    The software needs to be easily adjustable according to the status of the municipality (a basic, standard and sophisticated versions must be

    available). Please see again Table 1, p.18 for the different municipality types.

    However it is in the interest of all to prevent the chaos of many different software types and software languages. Therefore the property rights of

    such software should be in public hands. This would also allow the cheap distribution to small and remote municipalities. The private software

    company would earn its revenue through the software training, on demand services and technical back up.

    Joint software

    development

    programmed by a private

    software company

    Available Technical and Financial Resources Who supports?

    As explained before on p. 6 accrual accounting implementation involves high fixed costs at the beginning and during the implementation phase

    (training costs, consultant costs, software costs etc.). The financial resources should be provided by donors, central government funds and

    municipalities together.

    Another way to give monetary incentives for accrual accounting implementation is the mentioned MC/PM system (see p.19). Besides simply

    supporting accrual accounting implementation with this tool, one could that way also promote specific aspects of accrual accounting. An example

    would be the usage of performance targets for a proper asset management or a low debt level.

    One also has to revise funding possibilities directly through LGCDP.

    Udle (MLD-GTZ), Donor

    community, MC/PM,

    LGCDP, municipalities

    Political Commitment Who is supporting

    Accrual accounting implementation needs the acceptance and support of all relevant stakeholders since this will ease the process significantly.

    Therefore it is crucial to communicate the benefits of accrual accounting to local and central political parties, local and central government,

    political associations, civil servants, mayors and other relevant stakeholders (for advantages see p.5).

    Udle (MLD-GTZ),

    Municipalities and

    Mayors

    Communication Who is supporting?

    A significant emphasis should be placed in communicating necessary information about the purpose and objectives of the reform process. A

    wider group should be addressed by these information, including the general public (e.g. tax payers), journalists, the scientific public finance

    Udle (MLD-GTZ), MuAN,

    LBFC, Institute of

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    How to implement Accrual Accounting? 28

    community, donor organizations etc. Chartered Accountants,

    the municipalities and

    mayors

    Part of broad reform Who is supporting?

    Accrual accounting implementation should be understood as part of a broad based public finance reform since it will affect municipal and national

    budgeting, reporting and auditing procedures in the long term as well. Moreover accrual accounting implementation should be interlinked to other

    municipal finance reforms (own resource mobilization, revenue management, expenditure management etc.). In this context one has to revise

    feasible ways to integrate reform efforts e.g. in training.

    Udle (MLD-GTZ), all

    municipalities

    4.2. Development of a macro and micro implementation pl an

    An accrual accounting implementation strategy for Nepalese municipalities has to fit all municipalities by taking into account their needs, different starting points. (please see Table

    1, p. 18). The approach should neither slow down the, in terms of accrual accounting, advanced municipalities, nor should it overburden those municipalities which are at the very

    beginning of accrual accounting implementation. However, all municipalities should be provided with the same user friendly, integrated, modular, network based accrual

    accounting software which is easily adjustable to the needs and status of the municipalities. Of major strategically importance is the post implementation support since this is a

    very crucial phase as drawn as a lesson learnt from past udle experiences. The following overview is a proposal for a macro as well as micro level implementation plan including

    important milestones. The different components have been explained in the previous chapters.

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    How to implement Accrual Accounting? 29

    Table 4: Macro and Micro Level Strategy

    Macro level strategy Micro Level Strategy

    Milestones:

    1) Form a project planning steering group

    2) Develop a national implementation plan

    3) Establish a legal framework for accrual accounting

    4) Develop a new chart of accounts

    5) Develop detailed accrual accounting guidelines and manuals (also focussing on

    implementation phase)

    6) Software Development

    7) Prepare nationwide training in manual and computerized accrual accounting

    8) Prepare long term education

    9) Establish post implementation back up facility

    Milestones

    1) Create a project management steering group

    2) Accounting system and needs assessment

    3) Decide on modified or full accrual accounting

    4) General and specific training

    5) Inventory; Obtaining information

    6) Valuation of Assets (only if a full accrual accounting system is wanted)

    7) Budgeting

    8) Opening balance sheet

    9) First fiscal year should be done both manually and computerized

    10) First financial statements at the end of the fiscal year

    11) Thereafter, computerized Accrual Accounting only

    12) Financial statements

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    Annex 30

    05. Annex

    Annex 1

    IPSAS List

    IPSAS 1 - Presentation of Financial Statements

    IPSAS 2 - Cash Flow Statements

    IPSAS 3 - Accounting Policies, Changes in Accounting Estimates and Errors

    IPSAS 4 - The Effects of Changes in Foreign Exchange Rates

    IPSAS 5 - Borrowing Costs

    IPSAS 6 - Consolidated Financial Statements and Accounting for Controlled Entities

    IPSAS 7 - Accounting for Investments in Associates

    IPSAS 8 - Interests in Joint Ventures

    IPSAS 9 - Revenue from Exchange Transactions

    IPSAS 10 - Financial Reporting in Hyperinflationary Economies

    IPSAS 11 - Construction Contracts

    IPSAS 12 - Inventories

    IPSAS 13 - Leases

    IPSAS 14 - Events after the Reporting Date

    IPSAS 15 - Financial Instruments: Disclosure and Presentation

    IPSAS 16 - Investment Property

    IPSAS 17 - Property, Plant and Equipment

    IPSAS 18 - Seg