CHAPTER ONE

OVERVIEW OF FINANCIAL REPORTING FOR GOVERNMENT AND

NFP ENTITIES

1.1. Distinguishing characteristics of Governmental and Not- for- Profit entities

Governmental and not-for-profit organizations differ in important ways from business

organizations. Not surprisingly then, accounting and financial reporting for governmental and
not-for-profit organizations is markedly different from accounting and financial reporting for
businesses. An understanding of how these organizations differ from business organizations is
essential to understanding the unique accounting and financial reporting principles that have
evolved for governmental and not-for-profit organizations.
Government and other not-for profit entities are unique in that:
a. Receipts of significant amounts of resources from resource providers who do not expect
to receive either repayment or economic benefits proportionate to the resources provided.
b. Operating purposes that are other than to provide goods or services at a profit or profit
equivalent.
c. Absence of defined ownership interests that can be sold, transferred, or redeemed, or that
convey entitlement to a share of a residual distribution of resources in the event of
liquidation of the organization

A not-for-profit organization exists because a community or society considers it necessary or

desirable to provide certain goods or services to its groups as a whole, often without reference to
whether costs incurred will be recovered through charges for the goods or services or whether
those paying for the goods or services are those benefiting from them. In most instances NFP
organizations provide goods and services which are not commercially feasible to produce
through private enterprise and/or which are deemed so vital to the public well-being that it is felt
that their provision should be supervised by elected or appointed representatives of the public.
1.2 Objectives of financial reporting in NFP entities
IPSAS 1 Presentation of financial statements “Objectives of Financial Reporting,” states that
“Accountability is the cornerstone of all financial reporting in government. . . . Accountability
requires governments to answer to the citizenry—to justify the raising of public resources and
the purposes for which they are used.” The board elaborated:
Governmental accountability is based on the belief that the citizenry has a “right to know,” a
right to receive openly declared facts that may lead to public debate by the citizens and their
elected representatives. Financial reporting plays a major role in fulfilling government’s duty to
be publicly accountable in a democratic society.

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Closely related to the concept of accountability as the cornerstone of governmental financial
reporting is the concept the IPSAS refers to as inter period equity. The concept and its
importance are explained as follows: The Board believes that inter period equity is a significant
part of accountability and is fundamental to public administration. It therefore needs to be
considered when establishing financial reporting objectives. In short, financial reporting should
help users assess whether current-year revenues are sufficient to pay for services provided that
year and whether future taxpayers will be required to assume burdens for services previously
provided.
Comparison of Financial Reporting Objectives—State and Local Governments, Federal
Government, and Not-for-Profit Organization
State and Local Governments Federal Government Not-for-Profit Organizations
Financial reporting is used in making Financial reporting Financial reporting should
economic, social, and political decisions should help to achieve provide information useful in:
and in assessing accountability primarily accountability and is • Making resource allocation
by: intended to assist report decisions
users in evaluating:
• Comparing actual financial results • Assessing services and
with the legally adopted budget. • Budgetary integrity ability to provide services
• Assessing financial condition and • Operating performance • Assessing management
results of operations. stewardship and performance
• Stewardship
• Assisting in determining compliance • Assessing economic
• Adequacy of systems
with finance-related laws, rules, and resources, obligations, net
and control
regulations. resources, and changes in
them
• Assisting in evaluating efficiency and
effectiveness.

Note that the objectives of financial reporting for governments and not-for-profit entities stress
the need for the public to understand and evaluate the financial activities and management of
these organizations. Readers will recognize the impact on their lives, and on their bank accounts,
of the activities of the layers of government they are obligated to support and of the not-for-profit
organizations they voluntarily support. Since each of us is significantly affected, it is important
that we be able to read intelligently the financial reports of governmental and not-for-profit
entities. In order to make informed decisions as citizens, taxpayers, creditors, and donors, readers
should make the effort to learn the accounting and financial reporting standards developed by the
authoritative bodies.
1.3 IPSAS versus IFRS

Key definition differences between IFRS and IPSAS

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Users of IFRS and IPSAS

IFRS are internationally recognized, widely adopted and are designed for large profit-orientated
companies. The wide adoption brings about consistency in financial statements which in turn
facilitates cross border comparability and understandability. This makes them particularly
suitable for globally listed companies on public stock exchanges.

On the other hand, IPSAS are designed for public sector entities whose main objectives are to
provide goods and services to benefit society and to redistribute wealth. They are entities
primarily financed by taxation, not profit. It is fair to say that IPSAS are not currently widely
adopted and finding a definitive number of jurisdictions that have adopted IPSAS is not easy
since IPSAS are often only used as a reference point.

Users of government accounts

The objective of financial reporting by public sector entities is to provide information about the
entity that is useful to users of financial statements for accountability purposes and for decision-
making purposes (IPSASB Conceptual Framework 2.1).

Accountability of government is hugely important and having good processes in place is vital to
hold to account those charged with governance. Financial statements are key for oversight
committees and national audit institutions to obtain the information required in order to evaluate
performance and ascertain value for money. Furthermore, having an official, audited statement
of accounts sets the tone for a more rigorous governance environment as part of a wider public
finance management infrastructure. Accrual accounting in general is a key component of
ensuring sustainable public finances.

The annual report, including the financial statements, is likely to be a useful tool for the entity
producing it. It acts as a reference point and helps the entity explain how it performs, especially
if the annual reports link the objectives and key performance indicators to the financial
statements. The audited output is trusted and is often used for promotional activities.

However, there are a number of additional, external interested users including citizens,
regulatory bodies, rating agencies, lending institutions, academics and supranational
organizations such as the World Bank. These wide-ranging stakeholders will have different
information needs, ranging from how effectively services are being delivered to what are the
financial risks to which the entity is exposed.

By contrast, private sector annual reports are primarily produced for the shareholders, the owners
of the company.

Outlined below are some key definition differences between the private and public sector
financial reporting frameworks.

The differences in financial reporting requirements between the public and private sectors are
due largely to the environment in which the entities operate. Private sector entities will tend to

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seek profit maximization and operate at arm’s length, whereas public sector entities tend to focus
on service delivery, often at below market terms.

The public sector tends to have many intra-governmental transactions, which are not always
rooted in contracts. They can also have different trigger points as to what may constitute a past
event, such as ministerial directions. These and other factors often mean that definition and scope
need to be tweaked for IFRS standards to work for public sector financial reporting.

Accounting item IFRS IPSAS

Asset A resource presently controlled by the A resource presently controlled by
entity as a result of a past event. the entity as a result of a past
event.
Resource Right that has the potential to produce An item with service potential or
economic benefits. the ability to generate economic
benefits.
Service potential N/A Service potential is the capacity to
provide services that contribute to
achieving the entity’s objectives.
Non-exchange N/A Transactions where an entity
transactions receives resources and provides no
or nominal consideration directly
Measurement Fair value is a key measurement basis in IFRS yet can cause some issues when
applied in a public sector context.

A fair value measurement of a non-financial asset takes into account a market

participant’s ability to generate economic benefits by using the asset to its
highest and best use or by selling it to another market participant that would use
the asset to its highest and best use. This is not always possible in the public
sector.
Scope/definitions IPSAS often need to change the scope and definitions of their IFRS equivalent
to make them work as intended for the public sector. For example, “contracts”
are replaced with “binding arrangements” in the IFRS 15 revenue standard to
widen the scope so as to include transactions that are not necessarily
underpinned by a contract
Business Accounting for combinations under common control is outside the scope of
combinations IFRS. IPSAS recognize that this is a common transaction in the public sector
and have adopted the pooling of interest method (merger accounting). IPSAS
differentiate between acquisition and amalgamations; IFRS only considers
acquisitions.

1.4 The Conceptual Framework for Public Sector Accounting [The IPSASB]

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The Conceptual Framework for General Purpose Financial Reporting by Public Sector Entities
(the Conceptual Framework) establishes the concepts that are to be applied in developing
International Public Sector Accounting Standards (IPSASs) and Recommended Practice
Guidelines (RPGs) applicable to the preparation and presentation of general purpose financial
reports (GPFRs) of public sector entities.
GPFRs are a central component of, and support and enhance, transparent financial reporting by
governments and other public sector entities. GPFRs are financial reports intended to meet the
information needs of users who are unable to require the preparation of financial reports tailored
to meet their specific information needs.
The primary objective of most public sector entities is to deliver services to the public, rather
than to make profits and generate a return on equity to investors. Consequently the performance
of such entities can be only partially evaluated by examination of financial position, financial
performance and cash flows. GPFRs provide information to users for accountability and
decision-making purposes. Therefore, users of the GPFRs of public sector entities need
information to support assessments of such matters as:
 Whether the entity provided its services to constituents in an efficient and effective
manner;
 The resources currently available for future expenditures, and to what extent there are
restrictions or conditions attached to their use;
 To what extent the burden on future-year taxpayers of paying for current services has
changed; and
 Whether the entity’s ability to provide services has improved or deteriorated compared
with the previous year

The Conceptual Framework applies to financial reporting by public sector entities that apply
IPSASs. Therefore, it applies to GPFRs of national, regional, state/provincial and local
governments. It also applies to a wide range of other public sector entities including:
 Government ministries, departments, programs, boards, commissions, agencies;
 Public sector social security funds, trusts, and statutory authorities; and
 International governmental organizations

Objectives of Financial Reporting

The objectives of financial reporting by public sector entities are to provide information about
the entity that is useful to users of GPFRs for accountability purposes and for decision-making
purposes (hereafter referred to as “useful for accountability and decision-making purposes”).
Financial reporting is not an end in itself. Its purpose is to provide information useful to users of
GPFRs. The objectives of financial reporting are therefore determined by reference to the users
of GPFRs, and their information needs.

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Users of General Purpose Financial Reports
Governments and other public sector entities raise resources from taxpayers, donors, lenders and
other resource providers for use in the provision of services to citizens and other service
recipients. These entities are accountable for their management and use of resources to those that
provide them with resources, and to those that depend on them to use those resources to deliver
necessary services. Those that provide the resources and receive, or expect to receive, the
services also require information as input for decision-making purposes.
QUALITATIVE CHARACTERISTICS
1. Relevance
2. Faithful Representation
3. Understandability
4. Timeliness
5. Comparability
6. Verifiability

Constraints on Information Included in General Purpose Financial Reports

1. Materiality
2. Cost-Benefit

QUALITATIVE CHARACTERISTICS
Relevance
Financial and non-financial information is relevant if it is capable of making a difference in
achieving the objectives of financial reporting. Financial and non-financial information is
capable of making a difference when it has confirmatory value, predictive value, or both. It may
be capable of making a difference, and thus be relevant, even if some users choose not to take
advantage of it or are already aware of it.
 Financial and non-financial information has confirmatory value if it confirms or changes
past (or present) expectations.
 GPFRs may present information about an entity’s anticipated future service delivery
activities, objectives and costs, and the amount and sources of the resources that are
intended to be allocated to providing services in the future. Such future oriented
information will have predictive value and be relevant for accountability and decision-
making purposes

Faithful Representation
To be useful in financial reporting, information must be a faithful representation of the economic
and other phenomena that it purports to represent. Faithful representation is attained when the

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depiction of the phenomenon is complete, neutral, and free from material error. Information that
faithfully represents an economic or other phenomenon depicts the substance of the underlying
transaction, other event, activity or circumstance―which is not necessarily always the same as
its legal form.
Complete related to an omission of some information can cause the representation of an
economic or other phenomenon to be false or misleading, and thus not useful to users of GPFRs.
Neutrality in financial reporting is the absence of bias. It means that the selection and
presentation of financial and non-financial information is not made with the intention of attaining
a particular predetermined result.
Free from material error does not mean complete accuracy in all respects. Free from material
error means there are no errors or omissions that are individually or collectively material in the
description of the phenomenon, and the process used to produce the reported information has
been applied as described
Understandability
Understandability is the quality of information that enables users to comprehend its meaning.
GPFRs of public sector entities should present information in a manner that responds to the
needs and knowledge base of users, and to the nature of the information presented.
Understandability is enhanced when information is classified, characterized, and presented
clearly and concisely. Users of GPFRs are assumed to have a reasonable knowledge of the
entity’s activities and the environment in which it operates, to be able and prepared to read
GPFRs, and to review and analyze the information presented with reasonable diligence. Some
economic and other phenomena are particularly complex and difficult to represent in GPFRs, and
some users may need to seek the aid of an advisor to assist in their understanding of them. All
efforts should be undertaken to represent economic and other phenomena included in GPFRs in a
manner that is understandable to a wide range of users. However, information should not be
excluded from GPFRs solely because it may be too complex or difficult for some users to
understand without assistance.
Timeliness
Timeliness means having information available for users before it loses its capacity to be useful
for accountability and decision-making purposes. Having relevant information available sooner
can enhance its usefulness as input to assessments of accountability and its capacity to inform
and influence decisions that need to be made. A lack of timeliness can render information less
useful.
Comparability
Comparability is the quality of information that enables users to identify similarities in, and
differences between, two sets of phenomena. Comparability is not a quality of an individual item
of information, but rather a quality of the relationship between two or more items of information.

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Comparability differs from consistency. Consistency refers to the use of the same accounting
principles or policies and basis of preparation, either from period to period within an entity or in
a single period across more than one entity. Comparability is the goal, and consistency helps in
achieving that goal.
Verifiability
Verifiability is the quality of information that helps assure users that information in GPFRs
faithfully represents the economic and other phenomena that it purports to represent.
Supportability is sometimes used to describe this quality when applied in respect of explanatory
information and prospective financial and non-financial quantitative information disclosed in
GPFRs―that is, the quality of information that helps assure users that explanatory or prospective
financial and non- financial quantitative information faithfully represents the economic and other
phenomena that it purports to represent. Whether referred to as verifiability or supportability, the
characteristic implies that different knowledgeable and independent observers could reach
general consensus, although not necessarily complete agreement, that either:
 The information represents the economic and other phenomena that it purports to
represent without material error or bias; or
 An appropriate recognition, measurement, or representation method has been applied
without material error or bias.

To be verifiable, information need not be a single point estimate. A range of possible amounts
and the related probabilities also can be verified.
Verification may be direct or indirect. With direct verification, an amount or other representation
is itself verified, such as by (a) counting cash, (b) observing marketable securities and their
quoted prices, or (c) confirming that the factors identified as influencing past service delivery
performance were present and operated with the effect identified. With indirect verification, the
amount or other representation is verified by checking the inputs and recalculating the outputs
using the same accounting convention or methodology. An example is verifying the carrying
amount of inventory by checking the inputs (quantities and costs) and recalculating the ending
inventory using the same cost flow assumption (for example, average cost or first-in-first-out)

Constraints on Information Included in General Purpose Financial Reports Materiality

Information is material if its omission or misstatement could influence the discharge of
accountability by the entity, or the decisions that users make on the basis of the entity’s GPFRs
prepared for that reporting period. Materiality depends on both the nature and amount of the item
judged in the particular circumstances of each entity. GPFRs may encompass qualitative and
quantitative information about service delivery achievements during the reporting period, and
expectations about service delivery and financial outcomes in the future. Consequently, it is not
possible to specify a uniform quantitative threshold at which a particular type of information
becomes material.

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Assessments of materiality will be made in the context of the legislative, institutional and
operating environment within which the entity operates and, in respect of prospective financial
and non-financial information, the preparer’s knowledge and expectations about the future.
Disclosure of information about compliance or non-compliance with legislation, regulation or
other authority may be material because of its nature―irrespective of the magnitude of any
amounts involved. In determining whether an item is material in these circumstances,
consideration will be given to such matters as the nature, legality, sensitivity and consequences
of past or anticipated transactions and events, the parties involved in any such transactions and
the circumstances giving rise to them
Cost-Benefit
Financial reporting imposes costs. The benefits of financial reporting should justify those costs.
Assessing whether the benefits of providing information justify the related costs is often a matter
of judgment, because it is often not possible to identify and/or quantify all the costs and all the
benefits of information included in GPFRs.
The costs of providing information include the costs of collecting and processing the
information, the costs of verifying it and/or presenting the assumptions and methodologies that
support it, and the costs of disseminating it. Users incur the costs of analysis and interpretation.
Omission of useful information also imposes costs, including the costs that users incur to obtain
needed information from other sources and the costs that result from making decisions using
incomplete data provided by GPFRs
Application of the cost-benefit constraint involves assessing whether the benefits of reporting
information are likely to justify the costs incurred to provide and use the information. When
making this assessment, it is necessary to consider whether one or more qualitative characteristic
might be sacrificed to some degree to reduce cost.
In developing IPSASs, the IPSASB considers information from preparers, users, academics, and
others about the expected nature and quantity of the benefits and costs of the proposed
requirements. Disclosure and other requirements which result in the presentation of information
useful to users of GPFRs for accountability and decision-making purposes and satisfy the
qualitative characteristics are prescribed by IPSASs when the benefits of compliance with those
disclosures and other requirements are assessed by the IPSASB to justify their costs.
Balance between the Qualitative Characteristics
The qualitative characteristics work together to contribute to the usefulness of information. For
example, to be relevant, information must be timely and understandable. In some cases, a
balancing or trade-off between qualitative characteristics may be necessary to achieve the
objectives of financial reporting. The relative importance of the qualitative characteristics in each
situation is a matter of professional judgment. The aim is to achieve an appropriate balance
among the characteristics in order to meet the objectives of financial reporting
The Objective of Measurement

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The objective of measurement is:
To select those measurement bases that most fairly reflect the cost of services, operational
capacity and financial capacity of the entity in a manner that is useful in holding the entity to
account, and for decision-making purposes.
The selection of a measurement basis for assets and liabilities contributes to meeting the
objectives of financial reporting in the public sector by providing information that enables users
to assess:
 The cost of services provided in the period in historical or current terms;
 Operational capacity—the capacity of the entity to support the provision of
services in future periods through physical and other resources; and
 Financial capacity—the capacity of the entity to fund its activities

Measurement Bases and their Selection

It is not possible to identify a single measurement basis that best meets the measurement
objective at a Conceptual Framework level. Therefore, the Conceptual Framework does not
propose a single measurement basis (or combination of bases) for all transactions, events and
conditions. It provides guidance on the selection of a measurement basis for assets and liabilities
in order to meet the measurement objective
The following measurement bases for assets are identified in terms of the information they
provide about the cost of services delivered by an entity, the operating capacity of an entity and
the financial capacity of an entity, and the extent to which they provide information that meets
the qualitative characteristics:
 Historical cost;
 Market value;
 Replacement cost;
 Net selling price; and
 Value in use

The following measurement bases for liabilities are identified in terms of (a) the information
they provide about the cost of services delivered by an entity, the operating capacity of an
entity and the financial capacity of an entity; and (b) the extent to which they provide
information that meets the qualitative characteristics:
 Historical cost;
 Cost of fulfillment;
 Market value;
 Cost of release; and
 Assumption price

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Recognition
Recognition is the process of incorporating and including in amounts displayed on the face of
the appropriate financial statement an item that meets the definition of an element and can be
measured in a way that achieves the qualitative characteristics and takes account of the
constraints on information included in GPFRs.
The recognition criteria are that:
 An item satisfies the definition of an element; and
 Can be measured in a way that achieves the qualitative characteristics and takes account
of constraints on information in GPFRs.

All items that satisfy the recognition criteria are recognized in the financial statements. In some
circumstances, an IPSAS may also specify that, to achieve the objectives of financial reporting, a
resource or obligation that does not meet the definition of an element is to be recognized in the
financial statements provided it can be measured in a way that meets the qualitative
characteristics and constraints.

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