ABSTRACT
This paper propose a depth understanding and critical evaluation of the benefits and challanges of accrual accounting versus cash accounting aplication for budgeting and reporting in Municipal Council of Kota Kinabalu, a local government in Malaysia. Motivation of this paper is drawn on the potential benefits of accrual accounting in budgeting and financial reporting of a local government as empirically established in other countries. However, despite the success stories of accrual accounting aplication in other countries, it has yet to be fully replicated in Malaysia. The expected contribution of this paper are; (i) Critical evaluation of financial management and reporting practices of local government in Malaysia; (ii) Empirically analysing the benefits and limitations of cash versus accrual accounting application in budgeting and accounting transaction of a local government, the case of DBKK; and (iii) Contributing to enrich the literature and body of knowledge of local government accounting practices in Malaysia.
Keywords: Budgeting, Financial Reporting, Accrual Accounting, Local Government, Malaysia
INTRODUCTION
Motivation for Research
The government manages its financial economic activities through public accounting. Public accounting systems aim at authorizing and recording cash receipts and expenditures in respect of an agreed budget. In most countries, it is not consistently regulated. There are two types of approach in public sector’s financial reporting which are cash accounting and accrual accounting. In Malaysia, cash and modified cash is the current basis adopted by the Malaysian government. Malaysian government has also made a move in implementing the accrual accounting for public sectors (Abdul Samad, 2001). This is because accrual basis of accounting generates better quality of financial information and this information is necessary for the discharge of accountability and better decision making by internal management (Sutcliffe, 2001). Moreover, the traditional cash accounting system adopted in many countries is perceived as no longer satisfactory (Abdul Samad, 2001).

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Many countries like Australia, New Zealand and Canada have fully implemented this accounting reform in their government accounting. As for Malaysian context, according to Abdul Samad (2001), by looking at the experiences of the countries that had undergone reformation in the public sector, it could be concluded that the major demand for the push to accrual accounting is the growing demand for a greater transparency and better performances of the government sector and the companies controlled by the government.
The objective of this study is to investigate and critically evaluate the benefits and challanges of accrual accounting versus cash accounting aplication in Municipal Council of Kota Kinabalu (DBKK), a local government in Malaysia.
Arrangement of research proposal is as follows; the next section will discuss about the philosophical background related to Public Sector (PS) as well as accounting standards employed by them. This is follow by empirical analysis of cash vs. accrual budgeting and accounting application in PS. This expected to sheeds a light on identifying the potential research gaps. Following this is the research questions and contributions which are designed based on the identified research gaps. The final part of this paper summarises the research methodology and structure as well as research planning.
PHILOSOPHICAL BACKGROUND
Defining Public Sector in Malaysia
Public sector is part of the economy concerned with providing basic government services whether federal, state or local/municipal council. Components of Public Sector in Malaysia is categorised into three tiers of government namely; federal government, state government and local government (Fatimah et. al., 2008). Public sector organisations exhibit a variety of social, economic, political and legal characteristics (xxxxx).
Figure 1: Components of Public Sector in Malaysia
The federal government s the highest tier of the government, which comprises of the minsitries, departments and public enterprises. Ministris are the highest boy in the federal administratives followed by government department/agencies which responsibles for implementing government policies. While, a public enterprises can be classified eiher as a statutory or non-statutory bodies.
State government is the second tier of the government, which comprises of ministries (for Sabah and Sarawak only), department and public enterprises. The administrative mechniery of the State is headed by the State Secretary.
The local government is in the third tier of the government hierarchy in Malaysia. The local government is governed by the Local Governmen Act 1976. By virtue of Section 2 of this Act, local authority mean any City Council, Municipal Council or District Council. In Malaysia, the power of the decision making is transferred to the local authorities administer their respective areas. In respect to the accounting management, Section 9(2) states that the local authority shall furnish the State Authority with such returns, accounts and other information with respect to the property and activities of the local authority.
The Malaysian’s Public Sector Accounting Theory and Practices
Accounting has been generally defined as the system of identifying, classifying, recording, summarising, analysing and reporting of financial data and information of an organisation in accordance with the accepted principles, concepts, conventions, standards, and regulation (Fatimah et. al., 2008). Public sector accounting is different from private sector accounting. Accounting and financial reporting for public sector are based on distinctive concepts, standards and procedures designed to accomondate their environment and needs of their accounting information users (Fatimah et. al., 2008). In Malaysia, the public sector accounting system is designed to comply with the Federal Constitution, statutory and other legal requirements.
In general, the public sector uses fund accounting where seperate accounts are maintained for each fund so that limitations and resrictions placed on use of the resources allocated can be properly monitored. The government financial system and procedures can be devided into two categories namely financial procedures and non-financial procedures. The financial procedures related to the finance and accounting of public funds. While, the non-financial procedures on the aspects including finance and accounting.
The government financial system and procesures are based on; (i) Federal Constitution, (ii) Financial Procedure Act 1957, (iii) Treasury instructions, (iv) Treasury circulars, (v) Government Accounting Standards, and (vi) International Public Sector Accounting Standards (IPSASs).
The Government Accounting Standards (PPK) has been set p by the Accountant General Department since 2002. Its objective is to prescribe the standards and the basis for preparation of government financial statements in accordabce with the requirements of the Federal Constitution and the Financial Procedures Act 1957 (Revised 1972). According to the Public Accounts 2006, the Accountant General Department has issued the following PPK;
Table 1:
PPK
Particulars
Issued On
Effective for Financial Year
1
Government Accounting Policies
November 2002
2003
2
Presentation of Financial Statements
May 2004
2005
3
Consolidated Revenue Account
May 2004
2005
4
Consolidated Trust Account
December 2004
2006
5
Consolidated Loan Account
December 2004
2006
6
Investment
December 2004
2006
7
Cash
December 2005
2007
8
Statement of Memorandum Account
December 2005
2007
9
Foreign Exchange
June 2007
2008
10
Government Grant
June 2007
2008
Source: Public Account 2006, as cited in Fatimah et. al., 2008
Basis of Accounting
The Federal and State Government have been adopting modified cash basis of accounting in the preparation of the annual financial statements where expenditures incurred in the old financial year but not yet paid will be paid in January of the new financial year and are reported as expenses for the old financial year. As for the Local Government, Statutory Bodies and Government Linked Companies, they have been adopting accrual basis of accounting in the preparation of the general purpose financial statements.
Types of accounting systems
The bases of accounting systems are generally classified into four broad categories: cash, modified cash, modified accrual, and full accrual. This classification refers to the accounting principles that determine when the transactions or events should be recognized for financial reporting purposes.
Problem Statements
Traditionally, governments used to deploy input-based budgeting systems and cash-based accounting systems. However, these systems do not provide information that is necessary for a government to operate efficiently and effectively (Hoek, 2005). Despite the potential benefits of the accrual system in promoting financial efficiency and accountability (Wynne, 2004; xxxx; xxxx; xxxx), still not all government agencies have implemented this system and empirical research have established evidence on why some countries have not done so (Wynne, 2004; xxxx; xxxx; xxxx). Additionally, no cost benefit study has been undertaken on the move to accrual based accounting (Wynne, 2004).
In Malaysia, in line with the financial budgeting and reporting reforms in public sector, government has also made a move in implementing the accrual accounting for public sectors (Abdul Samad, 2001). This is because accrual basis of accounting generates better quality of financial information and this information is necessary for the discharge of accountability and better decision making by internal management (Sutcliffe, 2001). Moreover, the traditional cash accounting system adopted in many countries is perceived as no longer satisfactory (Abdul Samad, 2001).
Empirically, many research on accrual accounting have been carried out in western countries such as New Zealand, Australia, Finland, Greece, Denmark, Sweden and United States (Hoek, 2005; xxxx; xxxx; xxxx), but few researches have been done covering public sector in Malaysia.
Based on the identified problems and motivated to carry out this research to determine whether local authorities have fully adopt the accrual accounting in recording the income and expenditures. This research is expected to contribute to the enrichment of body of knowledge in the area of Local Government Accounting Practices specifically in Malaysia.
Research Questions
The main research questions of this study are as follows:-
RQ_1:
Understanding of accounting prnciples and practices of DBKK
RQ_2:
Investigation of current accounting systems used by DBKK
RQ_3:
Adoption of cash vs. accrual budgeting and accounting in DBKK. What are the problems?
RQ_4:
Will accrual accounting improves the financial performance of DBKK?
RQ_5:
Cost-Benefits analysis and program implementation design of accrual accounting implementation in DBKK.
Research Contributions
Critical evaluation of financial management and reporting practices of local government in Malaysia.
Empirically analysing the benefits and limitations of cash versus accrual accounting application in budgeting and accounting reporting of a local government.
Comprehensive program implementation design for implementation of accrual-based accounting in local government.
Contributing to enrich the literature and body of knowledge of local government accounting practices in Malaysia.
LITERATURE REVIEW
This section will discussed the empirical findings of previous papers related to the application of Accrual Budgeting and Accounting in Government Sector all over the world. Specific attention will be focused on financial reporting in local government of Malaysia.
The Move to Accrual Budgeting and Accounting in Government Sector
Identifying Strategic Research Issues
Budgeting & Accounting Reporting in Government Sectors
Public Sector Accounting Principles & Practices
Figure 2: Mapping the Literature Review
The Public Sector Accounting Principles and Practices: The World Views
Budgeting and Accounting Reporting in Government Sector
.
Innovation – Cronological Events
The Move to Accrual Accounting : Identifying The Research Gaps
The move from the cash basis to the accrual basis of accounting in the Australian Public Sector (APS) was a key element of the New Public Management (NPM) reform program and an event of historical significance (Davis, 2010).
One of the most crucial aspects of New Public Management (NPM) was the wave of reforms in financial information systems. These changes are an essential element in improving the management and decision-making of government institutions, which is also called New Public Financial Management (NPFM) (Guthrie et al., 1999).
The cornerstone of reforming financial information systems is the introduction of accrual accounting in the public sector, at the expense of traditional cash accounting systems (Lapsley, 1999). Several governments have been adopting and implementing accrual accounting systems
Over the last 20 years, there have been increasing calls for the government and public sector organization to move to accrual based accounting and adopt private-sector style financial statements (Wynne, 2004).
Traditionally, cash accounting in public sector focused on the control of expenditure. The reform of the public sector has changed the traditional role of accounting to one that is focused on accountability and the efficient allocation of resources. This implies that accounting should concentrate upon outputs, performance measurement, efficiency, cost
saving, productivity and performance measurement (Hoque and Moll, 2001; Broadbent and Guthrie, 1992). This in turn requires that new accounting technologies be employed such as planning program budgeting, accrual accounting, performance indicators and annual reporting mechanism (Hoque and Moll, 2001). Accrual accounting if being adopted in public sector, provides a better quality of information and a better way of discharging accountability among the public sector managers.
Many countries like Australia, New Zealand and Canada have fully implemented? this accounting reform in their government accounting. As for Malaysian context, according
to Abdul Samad (2001), by looking at the experiences of the countries that had undergone reformation in the public sector, it could be concluded that the major demand for the push to accrual accounting is the growing demand for a greater transparency and better performances of the government sector and the companies controlled by the government.
Public Sector Accounting : Some International Evidence
Governments and Public Sector Entities (PSEs) of the developed part of the world which were once using Cash-Basis of Accounting are now rapidly moving towards Accrual-Based Accounting System. Some of these countries have not only implemented the full Accrual-Based Accounting but have also adopted International Public Sector Accounting Standards (IPSASs) for compilation of government accounts and financial reporting. Status of implementation of Accrual-Based Accounting and adoption of IPSASs by the Governments is as under:
• Australia (State, Federal and Local Governments)
• Canada (State, Federal and Local Governments)
• Finland (Government agencies and whole of Government)
• France (Local Governments)
• Germany (Some Government Organizations)
• Ireland (Pilot Project For Selected Government Departments)
• Italy (Local Governments)
• Malaysia (Local Governments)
• Netherlands (Government agencies and Local Governments)
• New Zealand (National and Local Governments)
• Sweden (Central Government agencies and Local Governments)
• Switzerland (Local Governments)
• Tanzania (Local Governments)
• United Kingdom (Local Governments)
• USA (Federal Government)
Source: South Asian Federation Of Accountants, 2006
Comparative analysis of the governmental financial information systems: International Evidence
Source: Christiaens et. al., (2010)
Accrual vs Cash
Cash accounting requires the record of inflows and outflows of cash. Accrual accounting
as defined by Federal Accounting Standards Advisory Board, the recognition of the financial effects of transactions, events and circumstances in the period(s) when (they) occur, regardless of when cash is received or paid. It also requires revenue to be recognized in the period in which economic benefits can be measured reliably. Like wise, expenses are recognized when the consumption of goods is capable of reliable measurement (Hoque and Moll, 2001).
Table 2: An Overview of Cash Accounting vs. Accrual Accounting systems
Basis of comparison
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
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
Source: Adapted from Athukorala, S. & Reid, B. (2003)
The main advantage of the cash system is simplicity, objectivity and the need to assess the compliance with cash budgets. However there are limitations like the system does not disclosed a true financial and economic position of the entity, no performance indicator and information on cost of services provided available for performance evaluation and control purpose (Montesinos and Bargues, 1996). In addition, the cashbased system also does not provide sufficient information to assess the government financial requirements like cash and revenue requirement to pay for past debts as well as future services, besides fail to provide the government complete information on all that they owe (Hillier, 1996).
Advantages of accrual accounting in government
A number of researchers argue that cash based financial system and accrual accounting is both useful, however financial reports based on accrual accounting has its own advantages and significance to the modern government. Accrual accounting in government provides better quality financial information, more comprehensive and increase efficiency. This allows a better way of discharging accountability (Abdul Samad, 2001; Sutcliffe, 2001; Hoque and Moll, 2001; Wynne, 2004) by extending the assessment of financial performance beyond the application of cash (OECD, 1993) and supports a better decision making by internal management (OECD, 1993; Sutcliffe, 2001) by providing information on the full cost of operations and the resources used to deliver services to the public (Hoque and Moll, 2001).
Reasons for not adopting accrual accountinga
Panel A:
Local governments
Panel B:
Central governments
Balance sheets and profit/loss calculations are
of less importance in the public sector
Cash accounting systems are better complement
to budgetary accounting systems
Accounting reform would lead to considerable costs
The current cash accounting system meets all
requirements
A cash based system fits the characteristics of a
public sector organization
The accounting system has only just been changed to
a modified cash accounting system
Local governments resist accounting reform
Some public sector efforts cannot be accounted for
Former accounting reforms have shown significant
implementation problems
Accrual accounting has limited potential to
support political decision-making
aMultiple reasons simultaneously possible.
Source: Adapted from Wynne, 2004.
Comprehensive Analysis of Accrual Based Accounting in Government Sector
Advantages
Disadvantages
Risk
Essential Pre-Conditions
Accrual based financial accounts have more information than cash based accounts and have a greater focus on outputs rather than just inputs
The information available from accrula based accounts facilitates a better quality of management and decision making, including in the case of allocation of resources.
It enables comparisons of full cost of services with the costs of the provision of those services by the private and voluntary sector.
It provides greater comparability of management performance results which are not affected by the timing of cash payments and receipts and which information about fixed and current assets and liabilities.
It designed to measures profit, a concept which is meaningless in the public sector, where surpluses can arise from the failure to provide agreed services.
Maintenance of public asets is mopre important than providing information on their value.
It takes budgetary control away from finance staff, as they decide when cash is paid, but non-financial managers and suppliers decide when invoices are issued.
It does not appear to have ensured adequate costing system.
It has not been wiodely used by other countries.
Cash-based accounting is comparatively simple and abjective.
Its complexity may mean that there is less surveillance by Parliment and so the government is less accountable.
It requires greater professional judgement by both the preparers and auditors of government accounts.
Loss of financial control with the introduction of a more complex system.
Diversion of resources from more productive reforms.
The possibility of government accounting being bought into dispute if accrual accounting fails.
The possibility that international accounting standards could be applied with no real understanding of issues involved.
The gaps in the standards not being properly addressed.
Decision on accounting treatements being made on political grounds.
The external auditor being unable to prevent politically-based amendments to the accounts.
An adequate timescale and budget not being allowed for the change.
The IT systems not being adequate.
The process of financial management and expenditure control being made more difficult.
Accounting issued to be agreed before accrual absed accounting can be introduced;
Taxation revenues
Depreciations
Approaches to the recorgnition of assets
Military assets
Infrastructure assers
Natural resources
Acceptance for change
Participation of the accountancy and other profeessions
Joint development of accounting standards
Support of the government auditors
Comprenensive management trainning;
Understanding of concepts underlying accrual accounting in budgeting and financial reporting.
An appropriate culture approach
A robust audit process
No corruption
A recognition of the time needed for change.
An IT capacity.
A willingness to use incentives and penalties.
That the accrual based approach is part of a process of reform.
Source: Summarised from Wynne, 2004
The Research Focus : Local Government Accounting in Malaysia
Local Government (LG) accounting has attracted the attention of some members of the academic and professional community since the end of the 19th, early 20th century (e.g. Cooke, 1887; Cleveland, 1909; Metz, 1909; Walker, 1923; Morey, 1933, 1934; Welcker, 1934) as cited in Sargiacomo and Gomes (2010). A LG can be defined as “the government of a town, city, county, or region at a local level by locally elected politicians”. Consequently, “a local government will typically only have control over their specific geographical region, and can not pass or enforce laws that will affect a wider area. Local governments can elect officials, enact taxes, and do many other things that a national government would do, just on a smaller scale”.
This research will be focusing on a local government accounting issues in Malaysia and taking Municipal Council of Kota Kinabalu City as the sole local government body that is to be investigated.
Development of Theoritical Framework
The following theoritical framework elaborates the process flows for consideration in decision making for choice of accounting systems in local government. Empirical evidence shows that there are internal and external factors that will influence the choice of cash-based or accrual-based budgeting and accounting. The choice is strategically important for local government efficiency and accountability.
Cash-Based System
Efficiency? & Accountability?in LG
Choice of Accounting Systems in LG
Internal & External Factors
&
Policies
Accrual-Based System
The choice to move from cash-based to accrual-based accounting systems is not an easy tasks. It will involve a total change of the entire organixation accounting systems and facility supports. Thus, this ideas involve a costs. (explain further)
RESEARCH METHODOLOGY
This research will need to employ a combination of qualitative and quantitative research techniques to investigates and clarifies the identified research questions. Summary of the research investigations and methodologies are as tabulated below:
No.
Research Questions
Methodology
Instruments
RQ_1
Understanding of accounting prnciples and practices of DBKK
Qualitative Technique
Structured interview and inspections of records/policies/circulars
RQ_2
Investigation of current accounting systems used by DBKK
Qualitative Technique
Structured interview and inspections of records/policies/circulars
RQ_3
Application of cash vs. accrual budgeting and accounting in DBKK
Qualitative Technique
Structured interview and inspections of records/policies/circulars
RQ_4
Will accrual accounting improves the financial performance of DBKK?
Quantitative Technique
Accounting Experiments – comparing the effects of cash versus accrual accounting on 10 years historical financial performance. Is there any different?
RQ_5
Cost-Benefits analysis and program implementation design of accrual accounting implementation in DBKK.
Quantitative Technique
Determinantion of costs and benefits associated with implementation of accrual-based accounting in DBKK. This research also will provide a comprehensive program implementation design for adoption of accrual-based accounting in DBKK.
RESEARCH STRUCTURE
[2] State the research objectives
[3] Determine relevant questions
[1] Define and refine the research problems
[6] Interpret the results and write report
[5] Collect data and perform analysis
[4] Formulate relevant research hypotheses
RESEARCH PLANNING
Gantt Chart and Milestones
GANTT CHART
YEAR 1
YEAR 2
YEAR 3
2011
2012
2013
2014
 
 ACTIVITIES/MONTHS
6
7
8
9
10
11
12
1
2
3
4
5
6
7
8
9
10
11
12
1
2
3
4
5
6
7
8
9
10
11
12
1
2
3
4
5
6
1
Initial Preparation
2
Literature Review
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
3
Research Design
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
4
Proposal Defence
5
Proposal Refinement
6
Fieldwork
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
7
Data Analysis
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
8
Documentation of Report