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By Martha Jones Denning
 PSAB WANTS FINANCIAL STATEMENT READERS TO LOOK AT MORE THAN JUST A GOVERNMENT'S ANNUAL SURPLUS/DEFICIT
It was an historic moment. On October 22, 2002, PSAB approved a new reporting model for the federal, provincial and territorial governments. The model includes four statements that provide a comprehensive look at a government financial position and results. While it retains many key features of the model it replaced — it still requires that net debt and the change in net debt be reported — it also provides new information about the annual costs and nonfinancial assets of a government.
 Because the new model gives a more complete picture of the state of a government's finances, October 2002 will be considered a turning point in the annals of government reporting in Canada. But the approval of the model was marked by solemnity rather than exuberance — a reflection of the considerable change in mindset that is needed if this model is to ultimately be a success.
The new model represents a mindset change on at least two levels:
• Governments now must focus on costs rather than spending, and there can be enormous operational implications of this change in focus.
• Even more important, readers of financial statements, legislators and government managers have to move beyond the narrow, one-dimensional focus on the "almighty" annual surplus/deficit and recognize that government is too complex for its annual success or failure to be assessed on the basis of just one number.
Background
A rocky road led to the approval of the three sections that comprise the new senior government reporting model. The project was started in 1999 because few governments were using the PSAB approved 1997 reporting model, a compromise model that was six years in the making. Some governments had stayed with the old pure net debt model and some adopted a commercial model, and most that were planning to change their reporting were not expecting to adopt the 1997 model. Comparability between jurisdictions was impaired and there was no consensus on what model might be more acceptable than the 1997 compromise. PSAB was not satisfied with this situation and agreed to take a second look at how senior governments should report their financial position and results.
Three years later, with the agreement of a majority of the preparers and legislative auditors of the senior governments, PSAB approved a conceptual framework and a new reporting model that is detailed in "Financial Statement Concepts — Federal, Provincial and Territorial Governments," Section PS 1000, "Financial Statement objectives — Federal, Provincial and Territorial Governments," Section PS 1100, and "Financial Statement Presentation — Federal, Provincial and Territorial Governments," Section PS 1200.
The sections were issued in January 2003, and the new standards are effective for all fiscal years beginning on or after April 1, 2005.
Some in the government community agreed to this new model because it represents the greatest consensus ever reached on what the government's summary financial statements should look like. Others agreed because they were more satisfied with how this model incorporates tangible capital assets than how the 1997 model did. Still others agreed because net debt and the change in net debt are still given prominence — indicators that were felt to be at risk of being lost because some governments had moved to a commercial model of reporting.
However, some strongly disagreed with moving away from an expenditure-based measure of annual results because of the potential for runaway spending facilitated by a move to an expense-based annual surplus/deficit. For some governments, the depreciation charge on their capital assets would be considerably less than their normal capital spending. And with an expense-based operating statement, governments could spend on new capital and the effect of the spending on the annual surplus/ deficit would be spread over the lives of the new assets. The debt incurred to pay for this spending would, however, show up as a liability right away and the affordability of future services could be impaired.
A new paradigm
Government budgets focus on annual results and are considered to be key fiscal accountability documents. Most financial statement users, including the legislature and the media, focus primarily on government annual results as the sole determinant of whether the government has done a good job. On the other hand, a government's net debt and gross debt are clearly liens on its ability to provide services. An increase in gross or net debt is not necessarily bad, but it might indicate the government's flexibility and spending room to provide future services have been impaired. And what about cash position and sources of cash? If issuing debt is a primary source of cash, and taxes and user fees are secondary, and this situation persists over more than one year, then the sustainability of government programs might be called into question. The annual surplus/ deficit alone will not provide this important information.
 In a 1998 speech, known as "The numbers Game," then SEC chairman Arthur Levitt focused on earnings management in the private sector. Levitt stated: "Increasingly, I have become concerned that the motivation to meet Wall Street earnings expectations may be overriding common- sense business practices. Too many corporate managers, auditors, and analysts are participants in a game of nods and winks. In the zeal to satisfy consensus earnings estimates and project a smooth earnings path, wishful thinking may be winning the day over faithful representation. As a result, I fear that we are witnessing an erosion in the quality of earnings, and therefore, the quality of financial reporting. Managing may be giving way to manipulation; integrity may be losing out to illusion."
Like private sector companies that feel pressure from the markets to meet or exceed earnings targets, many senior governments face balanced budget legislation and pressure to avoid actual deficits. A number of provinces currently have stabilization funds; other jurisdictions are actively considering their use.
The genesis for these stabilization funds is the need to align the budgetary pressures associated with a balanced budget, and actual financial results. Transferring to and from these stabilization funds (or reserves) has been a fund accounting feature that continues to be prevalent in local government accounting. On consolidation, however, these transfers should be eliminated. Nevertheless, these transfers, potentially, could be shown as sources or uses of funds. This could result in a different bottom line for budget and actual results than that required by the CICA public Sector Accounting Handbook.
So, if focusing exclusively on one number encourages the management of results and facilitates overspending on capital, the obvious move for a standard setter is to develop a robust, informative reporting model and encourage those concerned with government finances to look beyond the one number when evaluating them. That is PSAB's game plan.
The new five-message model
Just as earnings per share does not provide enough information about the financial health of a business, one annual results number is also insufficient to explain whether a government has had a good year. Government financial statements prepared using the new reporting model give readers five messages about the state of a government's finances:
1. The government's net debt position is often called its future revenue requirements because the indicator provides a measure of future revenue required to pay for past transactions and events. Net debt is calculated as the difference between financial assets and liabilities. It provides an indication of the affordability of additional spending. See Figure 1 above.
2. The government's accumulated surplus/deficit position represents the net recognized economic resources (net assets) of the government. Nonfinancial assets, such as capital assets, are used primarily to provide future services. These assets are added to net debt to calculate the net assets indicator. The extent of a government's net assets is an indication of its ability to provide future services. See Figure 1 above.
3. The government's annual surplus/deficit measures, in monetary terms, whether a government has maintained its net assets in the year. It also shows whether revenue raised in the year was sufficient to cover the costs of that period. See Figure 2 above.
4. The government's change in net debt in the year is a measure of whether revenue raised was sufficient to cover the spending of the government in the year. An increase in net debt means that more future revenue will be needed to pay for the effects of past transactions and events. And, if a government is spending on capital, the statement of change in net debt will highlight this activity in comparison to planned spending. See Figure 3 above.
5. The government's cash flow in the year is reported on the cash flow statement, which shows the change in cash in the year as well as highlights the sources and uses of cash in the period. Capital activities, including the use of cash to acquire capital assets, are highlighted on this statement. See Figure 4 below.
The standards have been issued and now PSAB's task is to communicate and educate in order to encourage the change in mindset to a five-message model.
 The communications and education task will be an uphill battle. People don't want to know the bad news (like debt increases) and taxpayers want their government to provide for them. Some politicians will see the new model as an opportunity to make political capital by increasing their spending to do just that — take care of the constituents who elected them. Unless legislators, media and taxpayers look beyond the annual results of government, all they will see is that under the new model they are able to get more stuff and still show a surplus. After all, as a former chairman of the US House of Representatives finance committee said, "You get gold stars for giving it away, black marks for taking it away, and nobody gives a damn if you mortgage the future." But legislators, media and taxpayers should care and PSAB is promoting this broader perspective.
Education is needed so users understand that an annual surplus on an expense basis does not mean that the government has profits or cash it can spend. A change in how a government measures its annual results does not generate cash or open up spending room. The landscape has remained the same, but the picture is taken from a different perspective. To get the full picture, users must look at a government's gross and net debt positions and the sources and uses of its cash in addition to its annual results. Only then will they truly understand whether the government is doing a good job in managing the resources entrusted to it or whether their future is being mortgaged to support the present.
New information about costs
The new reporting model is just the beginning of a change in focus from spending to costs. Audited financial statement information provides overall accountability for costs, but is at too high a level to be meaningful for management purposes. It is just a starting point.
Over and above its accountability value, information on an expense basis for the whole government reporting entity has real value. A government receives the full benefit of this cost information if it is developed, recorded and used at the departmental and/or activity level for:
• understanding the cost of using and maintaining assets in the period;
• managing costs in the period through service delivery choices, cost reduction initiatives and other tools;
• setting fees for services to be provided in the period;
• benchmarking activities and assessing performance;
• improving accountability for the allocation and use of government resources;
• and planning for asset maintenance and replacement.
Government managers will have to change the way they manage and think about their operations and about capital in particular. Education across government will be necessary because of this change in focus from spending to costs to ensure the new mindset is communicated and applied. The information will have great value to governments, but generating and using it requires nothing less than a revolution in government accounting.
The road ahead
Governments that do not already prepare their books or report their financial position and results on an expense basis are working to meet the deadline for adoption of the new model. They are educating people across government to make sure the frontline staff that manage government resources are up to speed on the new requirements.
PSAB started the communications process for the new model with a press release when the new standards were issued in january 2003. Brochures explaining the new model and new mindset will be distributed to key individuals who are responsible for evaluating, analysing and communicating government financial results. PSAB will speak to Canadian accounting educators about the new reporting model later this spring.
The key message in all of these communications is: government is too complex for its annual success or failure to be assessed on the basis of just one number. Look beyond annual results and question the government's debt position and its cash flow. Ask if government spending is affordable and its services sustainable.
PSAB's current project, Financial Statement Discussion and Analysis, is developing guidance that will help governments better explain their financial statements to users. A subsequent project will look at indicators of government financial condition that will explain government finances in an economic context. Still other work of PSAB will develop guidance for financial and nonfinancial performance reporting.
But the change starts here — with the new reporting model and looking beyond annual results. When taxpayers look at one number and allow governments to tout their success based only on this one number, they are doing themselves and their descendants a disservice — because spending must be affordable, services must be sustainable and debt levels must be manageable in the eyes of Canadians and the international community. Just like chickens always come home to roost, debt always eventually comes due.
Martha Jones Denning is a principal in the Public Sector Accounting department, responsible for PSAB's Senior Government Reporting Model project.
Technical Editor: Robert T. Rutherford, FCA, Vice-president, Standards, CICA. | 
