Guide to the
Financial Statements
    of the Commonwealth
   Government of Australia
FOREWORD




In April 1997 the Government agreed to a phased implementation of the
recommendations of the National Commiss...
FOREWORD



I commend the booklet to my fellow members of Parliament, to whom the financial
statements will be of particul...
Contents

1. WHAT CAN THE STATEMENTS TELL US? 1
    Measures provided by each financial statement                      1
 ...
WHAT CAN THE STATEMENTS TELL US?




1. WHAT CAN THE STATEMENTS TELL US?
The Financial Statements of the Commonwealth Gove...
WHAT CAN THE STATEMENTS TELL US?



    ♦   how did cash flows impact on debt?
    ♦   to what extent is working capital (...
WHAT CAN THE STATEMENTS TELL US?



♦   the Commonwealth's unique economic management role; and
♦   the established inter-...
WHAT CAN THE STATEMENTS TELL US?



    .




4
WHY CONSOLIDATE?




2. WHY CONSOLIDATE?
The Commonwealth public sector is made up of around 200 government departments,
p...
WHY CONSOLIDATE?



    ♦   public financial enterprises - Commonwealth authorities and companies, providing
        banki...
WHY CONSOLIDATE?



There are major differences in the composition of revenues and expenses between sectors,
as illustrate...
WHY CONSOLIDATE?




There are also major differences in the composition of assets and liabilities between
sectors, as ill...
THE INTEGRATED ACCRUAL FRAMEWORK




3. THE INTEGRATED ACCRUAL FRAMEWORK
In its Report 338: Accrual Accounting - A Cultura...
THE INTEGRATED ACCRUAL FRAMEWORK



     Recommendation 9.1 - The Commonwealth Government should formally adopt accrual pr...
REVENUES AND EXPENSES




4. REVENUES AND EXPENSES
The statement of revenues and expenses shows:
   ♦   the composition of...
REVENUES AND EXPENSES



The operating result
An operating surplus occurs when revenues exceed expenses in a financial yea...
REVENUES AND EXPENSES




Further analysis is necessary to understand the factors underlying these changes, such as:
   ♦ ...
REVENUES AND EXPENSES




REVENUES AND EXPENSES BY FUNCTION
for the year ended 30 June 199X

                             ...
REVENUES AND EXPENSES




REVENUES AND EXPENSES BY ECONOMIC TYPE
for the year ended 30 June 199X

                        ...
REVENUES AND EXPENSES



Chart 4 shows how the Government allocated resources across the range of policy areas in
1995-96 ...
REVENUES AND EXPENSES



At a broad level Charts 5A, 5B and 5C show changes in the composition of revenues and
expenses an...
REVENUES AND EXPENSES




18
ASSETS AND LIABILITIES




5. ASSETS AND LIABILITIES
The statement of assets and liabilities shows:
   ♦   the composition...
ASSETS AND LIABILITIES



The format of the statement of assets and liabilities can be seen in the proforma statement
on p...
ASSETS AND LIABILITIES




ASSETS AND LIABILITIES
as at 30 June 199X

                                                    ...
ASSETS AND LIABILITIES



Equity can be interpreted as measuring accumulated financial strength (i.e. the impact of
past a...
ASSETS AND LIABILITIES



Measuring inter-temporal effects
The amount of net assets provides an indication of inter-tempor...
ASSETS AND LIABILITIES



There can also be an opportunity cost in holding assets vis-a-vis their alternative use. It is
i...
ASSETS AND LIABILITIES



ACCUMULATED SOURCES AND APPLICATIONS OF FUNDS, 1995-96
                                         ...
ASSETS AND LIABILITIES




26
CASH FLOWS




6. CASH FLOWS
The statement of cash flows shows:
   ♦   the composition of cash inflows and outflows;
   ♦ ...
CASH FLOWS




CASH FLOWS
for the year ended 30 June 199X

                                                               ...
CASH FLOWS



Chart 7 shows cash flows from operating, investing and financing activities for 1995-96.

Chart 7

         ...
CASH FLOWS



Repayment of debt from the proceeds of asset sales will not increase net assets initially.
However, savings ...
CASH FLOWS




NOTE X. RECONCILIATION OF CASH                                   199X   199X
                              ...
CASH FLOWS




32
RATIOS




7. RATIOS
The financial ratios used by investors to assess the results of private sector entities tend to
focus...
RATIOS



INTERGENERATIONAL EFFECT OF OPERATIONS
Operating deficit x 100
Total expenses
   ♦     Indicative of % of curren...
RATIOS



COST OF FUNDING ASSETS
Total cost of funds x class of asset
Total assets + accumulated deficits
   ♦   Indicativ...
RATIOS



REINVESTMENT SUFFICIENCY
Cost of asset replacements
Depreciation
   ♦     Indicative of whether assets are being...
OTHER FACTORS




8. OTHER FACTORS AFFECTING INTERPRETATION

The effect of revaluing assets
The method of valuing assets a...
OTHER FACTORS



An issue which highlights some of the difficulties in determining the appropriate content of
financial re...
OTHER FACTORS



   ♦   have not been recognised as liabilities in the statement of assets and liabilities.
In the financi...
OTHER FACTORS



   ♦   information that has become available,
after the end of the reporting period, but prior to when th...
GLOSSARY




Glossary of Terms




                         41
GLOSSARY




42
GLOSSARY




                                  GLOSSARY OF TERMS
accrual basis         means the accounting basis whereby ...
GLOSSARY




class                  refers to a group of revenues, expenses, assets or liabilities having a similar
      ...
GLOSSARY




equity                 is the residual interest in the assets of a reporting entity after deduction of its
  ...
GLOSSARY




fuel and energy           this term relates to an item in the statement of Revenues and Expenses by
         ...
GLOSSARY




market value             is the amount which could be expected to be received from the disposal of
          ...
Financial Statements of the
Financial Statements of the
Financial Statements of the
Financial Statements of the
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Financial Statements of the

  1. 1. Guide to the Financial Statements of the Commonwealth Government of Australia
  2. 2. FOREWORD In April 1997 the Government agreed to a phased implementation of the recommendations of the National Commission of Audit (NCOA) relating to the Commonwealth's financial framework. These recommendations were seen by the Commission as an essential complement to the structural and cultural change the Government is seeking by way of a more competitive, efficient and effective public sector. The Government's initiative involves a significant change in the way the Commonwealth budgets and manages its finances by moving progressively to a fully integrated accrual financial management framework. Such a framework will entail the Government and its agencies preparing their budgets, managing their operations and preparing their financial reports on a basis similar to that used by business, including specification and costing of relevant outcomes and outputs. The financial statements of the Commonwealth Government of Australia will form a significant component of the integrated accrual financial framework and the greater transparency which they will provide, is intended to complement the Government's Charter of Budget Honesty. The financial statements will bring together the various facets of the Government's financial operations providing greater insight into whether the Government is operating at a sustainable level and whether the financial strength of the Commonwealth has improved or deteriorated. The accrual framework will be introduced according to the following indicative timetable: • Financial Statements of the Commonwealth Government of Australia from 1996- 97; • trial of accrual budgeting arrangements for selected agencies in 1998-99; and • full accrual framework, including an accrual budget and quarterly accrual reports from 1999-2000. This timetable is broadly consistent with the recommendations of the NCOA and the Joint Committee of Public Accounts in its Reports 338 and 341 and recognises the substantial cultural, systems and reskilling implications of the initiative. The success of the Government's initiative will be influenced by the capacity of users of the information to understand basic accrual concepts and interpret the key measures that will be used. This booklet is designed to explain some of these concepts and measures, compare them with those used by commercial entities, and highlight some potential pitfalls in interpreting the information. It is being issued in conjunction with the second trial financial statements of the Commonwealth Government of Australia and the principles and techniques can be applied to those statements. i
  3. 3. FOREWORD I commend the booklet to my fellow members of Parliament, to whom the financial statements will be of particular interest, as well as managers and staff of agencies, training officers, financial analysts, journalists, and other users. JOHN FAHEY Minister for Finance July 1997 ii
  4. 4. Contents 1. WHAT CAN THE STATEMENTS TELL US? 1 Measures provided by each financial statement 1 Making comparisons 2 2. WHY CONSOLIDATE? 5 3. THE INTEGRATED ACCRUAL FRAMEWORK 9 4. REVENUES AND EXPENSES 11 What are revenues and expenses? 11 The operating result 12 Different views of performance 13 5. ASSETS AND LIABILITIES 19 What are assets and liabilities? 19 Alternative classifications of assets and liabilities 20 Equity 20 Measuring inter-temporal effects 23 Sources and applications of funds 23 The accounting equation 23 Attributing the cost of funds between past deficits and assets 24 6. CASH FLOWS 27 Types of cash flows 27 Effects of borrowing for different purposes 29 Using the proceeds from assets sales for different purposes 29 The impact of working capital on cash 30 Macroeconomic analysis 30 7. RATIOS 33 8. OTHER FACTORS AFFECTING INTERPRETATION 37 The effect of revaluing assets 37 Are social welfare entitlements liabilities? 37 Does the right to tax constitute an asset? 38 Commitments 38 Contingencies 39 Events occurring after balance date 39 The need for forward projections 40 GLOSSARY OF TERMS 41 iii
  5. 5. WHAT CAN THE STATEMENTS TELL US? 1. WHAT CAN THE STATEMENTS TELL US? The Financial Statements of the Commonwealth Government of Australia provide information for: ♦ assisting users to assess the performance and financial position of the Commonwealth public sector; and ♦ assisting the Government in its financial planning. They are prepared on the basis of accrual accounting principles (as used by companies and other private sector entities), but are presented differently, in some respects, to reflect the nature of government operations. Measures provided by each financial statement The primary financial statements of the Government focus on three distinct areas: The statement of revenues and expenses is about performance and can assist with questions such as: ♦ is the Commonwealth operating at a sustainable level? (e.g. are the costs of government being met by revenues or being deferred to the future?) ♦ how are costs and revenues made up and how are they changing? ♦ how has the Government allocated resources to various policy areas? (e.g. health, education, social security, transport and communications) ♦ what budgetary measures might be needed to achieve the Government's financial objectives? The statement of assets and liabilities is about financial position and can assist with questions such as: ♦ has the financial strength of the Commonwealth improved or deteriorated? (e.g. have net assets increased, decreased or changed in composition?) ♦ what is the extent of public sector saving or borrowing (and its impact on the economy?) ♦ to what extent could deficits from past years impact on future generations of taxpayers? ♦ how have funds been obtained and used over time? ♦ is there scope to reduce the ongoing cost of funds through changes in the composition of assets and liabilities? The statement of cash flows is about cash management and can assist with questions such as: ♦ are operating activities self sustaining? (or do they require support from borrowing?) ♦ are operating cash flows sufficient to cover ongoing replacements of assets? 1
  6. 6. WHAT CAN THE STATEMENTS TELL US? ♦ how did cash flows impact on debt? ♦ to what extent is working capital (e.g. receivables and inventories) locking-up cash? The above primary statements are supplemented by: ♦ schedules of commitments and contingencies that provide information about obligations, undertakings and uncertainties that could, on the happening of future events, impact on performance, financial position and cash flows; ♦ notes that disaggregate and further explain information in the primary statements and schedules. This Guide will explain: ♦ the accounting concepts underlying the above statements and others (e.g. what do the accrual concepts of revenues, expenses, assets, liabilities and equity mean?); ♦ how the statements are designed (e.g. how they are different, in some respects from those used by commercial entities?); and ♦ how they can be interpreted (e.g. what are key indicators of performance and financial position? what are some of the pitfalls in interpreting the information?). Making comparisons Traditional benchmarks used for judging financial performance are mainly based on commercial criteria and have developed from the environment in which businesses operate. For example: ♦ was there a profit from operations? ♦ what was the rate of return to investors? ♦ is the business financially secure? (e.g. net assets would be a key measure of financial strength, with an excess of liabilities over assets generally indicating insolvency). Differences in the nature and purpose of governments require a wider range of considerations in some areas. For example: ♦ the capacity of governments to raise taxes in the future enables them to sustain their operations where they have an excess of liabilities over assets (a company in similar circumstances would be at risk of being wound up); ♦ continued surpluses or deficits from operations can result in inequitable funding of government operations by different generations of taxpayers (inter-temporal equity); and ♦ governments seek to achieve broader social and economic goals which include demand management, income distribution, market regulation and the provision of services to correct for market failure. There are also differences between governments that need to be taken into account when interpreting their financial statements. Comparability between bottom line measures of the Commonwealth (e.g. the operating result and net assets) with those of the States and Territories is not likely to be meaningful because of: 2
  7. 7. WHAT CAN THE STATEMENTS TELL US? ♦ the Commonwealth's unique economic management role; and ♦ the established inter-governmental financial arrangements whereby the Commonwealth raises taxes for making grants to the States and Territories, which may reflect as an improvement in the financial position of the State or Territory concerned. 3
  8. 8. WHAT CAN THE STATEMENTS TELL US? . 4
  9. 9. WHY CONSOLIDATE? 2. WHY CONSOLIDATE? The Commonwealth public sector is made up of around 200 government departments, public authorities and companies (not including their subsidiaries) which are controlled by the Government. Control of an entity is taken to exist where: ♦ the entity is accountable to the Government; and ♦ the Government has a residual interest in its net assets and liabilities. Consolidation of the financial statements of these entities brings together the various facets of the Government's financial operations (e.g. raising revenues, borrowing, lending, providing goods, services and benefits) and facilitates assessments of: ♦ the overall performance and financial position of the public sector; ♦ what is causing changes in the financial results; and ♦ the impact of government policies on the economy. This assists the Government in: ♦ establishing goals for the future (e.g. budget strategy) ♦ applying financial targets to individual entities (to achieve those goals). Such information also provides accountability to the community for the Government's overall financial management. As well as providing information about the Commonwealth public sector as a whole, the consolidated financial statements provide information about its three component sectors. This: ♦ reflects an interest in the total public sector (both in relation to its impact on the economy and for assessing its overall financial position); ♦ recognises that the public sector comprises commercial, non-commercial and financial entities (which can be analysed according to different criteria); and ♦ highlights any cross-subsidisation between sectors. The sectors are: ♦ general government - departments and Commonwealth authorities, mainly providing goods, services and benefits to the Government and the community from taxes (some goods and services are provided for sale e.g. through the ABC and the CSIRO); ♦ public trading enterprises - Commonwealth authorities and companies, providing goods and services for sale, predominantly to customers outside the Commonwealth public sector (e.g. Telstra, Australia Post, Federal Airports Corporation); and 5
  10. 10. WHY CONSOLIDATE? ♦ public financial enterprises - Commonwealth authorities and companies, providing banking and other financial services (e.g. the Reserve Bank, Export Finance and Insurance Corporation, Comcare). Commonwealth Government of Australia Public Trading Public Financial General Government Enterprises Enterprises Commonwealth Budget Commercial Statutory departments/ dependent Statutory Corporations and agencies. Statutory Corporations and Companies. For example: Corporation Companies. For example: • Department of s. For example: • Reserve Bank of Treasury For example: • Telstra Corporation Australia • Department of • CSIRO Limited • Housing Loans Social Security • ABC • Australian Postal Insurance • Australian Taxation • National Corporation Corporation Office Gallery of • Ferderal Airports • Export Finance • Australian Bureau Australia Corporations and Insurance of Statistics Corporation The principles of consolidation and financial reporting require: ♦ aggregation of each class of revenues, expenses, assets, liabilities and cash flows in the financial statements of controlled entities; ♦ elimination of transactions and balances between related entities (i.e. those subject to the same controlling body) in each sector to avoid double counting; and ♦ presentation in consolidated financial statements in a format relevant to government planning and assessments by users. 6
  11. 11. WHY CONSOLIDATE? There are major differences in the composition of revenues and expenses between sectors, as illustrated in Charts 1A and 1B (based on 1995-96 figures). This highlights the different forces driving the overall operating result and the need for different management strategies for each sector. Chart 1A 1995-96 Composition of Revenues by Sector Public Financial Enterprises Public Trading Enterprises General Government 0% 20% 40% 60% 80% 100% Tax Goods and services Interest and other Chart 1B 1995-96 Composition of Expenses by Sector Public Financial Enterprises Public Trading Enterprises General Government 0% 20% 40% 60% 80% 100% Goods and services Subsidies, benefits and grants Interest and other 7
  12. 12. WHY CONSOLIDATE? There are also major differences in the composition of assets and liabilities between sectors, as illustrated in Charts 2A and 2B (based on 1995-96 figures). This highlights differences in the way the sectors obtain and use their funds and assists in identifying areas that may need restructuring. Chart 2A 1995-96 Composition of Assets by Sector Financial assets Non-financial assets 100% 80% 60% 40% 20% 0% General Public Trading Public Financial Government Enterprises Enterprises Chart 2B 1995-96 Composition of Liabilities by Sector Provisions and payables Debt 100% 80% 60% 40% 20% 0% General Public Trading Public Financial Government Enterprises Enterprises 8
  13. 13. THE INTEGRATED ACCRUAL FRAMEWORK 3. THE INTEGRATED ACCRUAL FRAMEWORK In its Report 338: Accrual Accounting - A Cultural Change, (August 1995) the Joint Committee of Public Accounts quoted from an exhibit which addressed the need for the different elements of a government's financial management system to interact in an integrated and consistent manner: An obvious, but in a government financial management context frequently ignored, example is the need to measure performance ex post in a manner consistent with ex ante agreements, whether those agreements are specified in budgets or some other contractual or quasi-contractual arrangement. The problems created by ex post and ex ante marching to a different beat are plain enough. Decision makers face conflicting signals and incentives and their performance will normally reflect this. The sort of inconsistency I am identifying also reflects a lack of clarity over objectives. In June 1996, the National Commission of Audit expressed agreement with these sentiments with respect to the need to adopt an accrual based financial management framework. A key finding of the Commission was that: A full accrual accounting framework is an essential complement to the structural and cultural change the Government is seeking by way of a more competitive, efficient public sector. It is also essential if the accountability requirements of the Parliament and the taxpayer, and the Government's commitment to a Charter of Budget Honesty, are to be met. The Commission said that such an accrual framework: ♦ separates the current and capital sides of the budget as a fundamental element of its conceptual framework; ♦ sets the economic costs incurred in a reporting period (including provision for the consumption of capital assets) against the economic benefits accrued in that period - whether or not cash is exchanged - giving a more reliable measure of the current surplus or deficit; ♦ shows the impact of the surplus or deficit on the resources controlled and on the level of obligations, including the contingent liabilities, outstanding at the end of the accounting period; ♦ incorporates cash flow reporting which is essential in evaluating the short term impact of the Government's budget and for cash management purposes; ♦ provides a consistent, full cost, budgeting and accounting framework that facilitates the determination of performance targets in the budget, their monitoring by managers during the year and their evaluation at the end of the year; ♦ being consistent with private sector accounting standards, also facilitates market testing of public sector service delivery and/or benchmarking against similar activities elsewhere. The Commission's recommendations included the following: 9
  14. 14. THE INTEGRATED ACCRUAL FRAMEWORK Recommendation 9.1 - The Commonwealth Government should formally adopt accrual principles as the basis for an integrated budgeting, resource management and financial reporting framework both at the agency level and at the aggregate budget sector level. Recommendation 9.3 - The Commonwealth Budget should be presented in the budget papers on an accrual basis as from the 1998-99 Budget. Recommendation 10.1 - Whole of government financial statements reporting on the financial performance and position of the Commonwealth Government for the year ended 30 June should continue to be prepared annually on a basis similar to that adopted for the 1994-95 trial. The Government has agreed to the phased implementation of an integrated accrual budgeting, managing and financial reporting framework by the year 1999-2000. The first phase will involve the tabling in Parliament of audited consolidated financial statements of the Commonwealth public sector for 1996-97 based on the two trials. 10
  15. 15. REVENUES AND EXPENSES 4. REVENUES AND EXPENSES The statement of revenues and expenses shows: ♦ the composition of revenues and expenses; and ♦ the amount of the operating surplus or deficit. The statement is used to assess the financial performance of the Commonwealth for the last financial year, compared with the previous financial year. Analysis is likely to focus on whether the Commonwealth is operating at a sustainable level; what factors are influencing the results; and what budgetary measures might be needed. A supplementary statement shows the revenues and expenses of the general government, public trading enterprises and public financial enterprises sectors. What are revenues and expenses? Under accrual accounting, revenues and expenses are recognised at the time economic value is created, transformed, exchanged, transferred or extinguished (irrespective of whether there have been cash receipts or payments). For example, under accrual accounting, services received but not yet paid for would be recorded immediately as an expense and a liability for the amount contracted for; whereas, under cash accounting no transaction would be recorded. The main aim of accrual reporting is to compare economic costs incurred during a particular reporting period with the economic benefits earned in that period and to show the value of resources controlled and obligations outstanding at the end of that period. Revenues are inflows of resources (e.g. from taxation and sales of goods and services) that increase net assets. They: ♦ include non-cash income such as tax receivable or accrued (as these increase net assets); ♦ include cash income received directly from cash sales (as these increase net assets); and ♦ exclude cash inflows from asset sales or repayments of loans made (as these simply exchange cash with another form of asset). Expenses are outflows of resources (e.g. for providing goods, services and benefits) that decrease net assets. They: ♦ include some non-cash costs such as depreciation of assets and accrued employee costs (as these decrease net assets); ♦ include operating costs paid directly through cash purchases (as these decrease net assets); and ♦ exclude cash outflows on capital items (e.g. property, plant and equipment) and loans made (as these simply exchange cash with another asset). 11
  16. 16. REVENUES AND EXPENSES The operating result An operating surplus occurs when revenues exceed expenses in a financial year. This will: ♦ increase net assets (and financial strength); ♦ increase capacity to reduce debt (and interest), invest in new infrastructure and provide services and benefits; ♦ affect inter-generational equity (i.e. current taxpayers could be absorbing past deficits or paying in advance for future expenses); and ♦ decrease pressure on financial markets over time (through reduced borrowing). An operating deficit occurs when expenses exceed revenues in a financial year. Continued operating deficits are not sustainable because they: ♦ decrease net assets (and financial strength); ♦ decrease capacity to reduce debt (and interest), invest in new infrastructure and provide services and benefits; ♦ affect inter-generational equity (i.e. the cost of services and benefits enjoyed by current taxpayers may be passed on to future taxpayers); and ♦ increase pressure on financial markets over time (through increased borrowing). The operating result is the main factor contributing to changes in net assets and financial position from one period to the next (revaluation of assets can also be a significant factor). Analysis of changes in the composition of revenues and expenses can show how various items influenced a change in the operating result. At a broad level, charts 3A and 3B show the factors that caused a reduction of $4.7 billion in the operating result for 1995-96 compared with the previous year. Chart 3A Chart 3B Increase in Revenues from 1994-95 to 1995-96 Increase in Expenses 20,000 from 1994-95 to 1995-96 20,000 15,000 15,000 10,000 10,000 $ millions $ millions 5,000 5,000 0 0 Interest and other Total interest and other Sales of Goods and Services Subsidies, benefits and grants Goods and services Taxes 12
  17. 17. REVENUES AND EXPENSES Further analysis is necessary to understand the factors underlying these changes, such as: ♦ the level of economic activity (e.g. affecting prices, levels of tax revenues and levels of social welfare payments); ♦ demographic or other parameter changes (e.g. affecting entitlements to subsidies, benefits and grants); ♦ government policies (e.g. tax measures and priorities for spending on health, welfare, education, defence etc); ♦ management efficiency (e.g. maximising outputs for a given quantity of inputs); ♦ changes in values of assets and liabilities (e.g. reflecting market values, replacement costs or the value of currencies held); ♦ financing arrangements (e.g. the mix of equity, debt and non-interest bearing sources of funds). Analysis of the factors mentioned above can lead to an understanding of what is driving ex post financial results and where to direct any remedial measures in the future (e.g. by setting budgetary targets). Different views of performance In the Commonwealth's financial statements, two views of expenses are given to assist in understanding and controlling costs: one view classifies expenses by function (also known as the Government Purpose Classification), the other classifies expenses by economic type (also known as the Economic Transactions Framework). These can be seen in the proforma statements on pages 14 and 15. Expenses by function (and sub-function) show how the Government allocates resources to various policy areas under such headings as social security, health, education, transport and communication and defence. The social security function would, for example, include such sub-functions as 'assistance to the aged', 'assistance to veterans and dependants', 'assistance to people with disabilities', 'assistance to families with children'). The classifications used are those required by the International Monetary Fund for Government Finance Statistics. 13
  18. 18. REVENUES AND EXPENSES REVENUES AND EXPENSES BY FUNCTION for the year ended 30 June 199X 199X 199X $m $m Revenues by source Taxation Non-taxation Total revenues Expenses by purpose 1 General Public Services Legislative and executive affairs Financial and fiscal affairs Foreign economic aid General research General services Government Superannuation Benefit Defence Public order and safety Education Health Social Security and welfare Housing and community amenities Recreation and culture Fuel and energy Agriculture, forestry and fishing Mining, manufacturing and construction Transport and communications Other economic affairs Central banking Other financial services Other purposes Public debt interest General purpose inter government transactions Asset Sales Elimination of inter-purpose transactions Total expenses Operating result 1 Refer to the glossary for an explanation of terms 14
  19. 19. REVENUES AND EXPENSES REVENUES AND EXPENSES BY ECONOMIC TYPE for the year ended 30 June 199X 199X 199X Note $m $m Revenues TAXATION Income tax Sales tax Excise duty Customs duty Other taxes, fees and fines Total taxation revenues NON-TAXATION Sales of goods and services (incl user charges / fees) Interest and dividends Net foreign exchange gains Other sources of non-taxation revenue Total non-taxation revenues Total revenues Expenses GOODS AND SERVICES Employees Suppliers Depreciation and amortisation Net write-down of assets Other goods and services expenses Total cost of goods and services SUBSIDIES, BENEFITS AND GRANTS Subsidies Personal benefits Grants to private sector to State and Territory governments to overseas Total subsidies, benefits and grants INTEREST AND OTHER Interest and other financing costs Net losses from asset sales program Total interest and other Total expenses Operating result 15
  20. 20. REVENUES AND EXPENSES Chart 4 shows how the Government allocated resources across the range of policy areas in 1995-96 compared with the previous year. Chart 4 Expenses by Function 1995-96 1994-95 Social security & welfare Transport & communication Health Gen purpose inter-govt transactions General public service Education Defence Public debt interest Other economic affairs Agriculture, forestry & fisheries Recreation & culture Public order & safety Housing & community amenities Mining, manufacturing and construction Central banking Fuel & energy Asset sales Other financial services 0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000 $ Millions Expenses by economic type have been divided into three basic areas that require distinct management strategies: ♦ the cost of providing goods and services (this is driven by levels of efficiency and decisions about what goods and services are to be provided - management strategies required are similar to those in the private sector); ♦ the cost of subsidies, benefits and grants (this is driven mainly by social, economic, industry, government and other policies as well as economic conditions); and ♦ the cost of interest and other financing costs (this is driven by the level of debt - management strategies include maintaining operations at a sustainable level and realising under-performing assets). 16
  21. 21. REVENUES AND EXPENSES At a broad level Charts 5A, 5B and 5C show changes in the composition of revenues and expenses and the operating result by economic type in 1995-96. Chart 5A Chart 5B Composition of Revenues Composition of Expenses 200,000 200,000 150,000 150,000 100,000 100,000 $ millions $ millions 50,000 50,000 0 0 1994-95 1995-96 1994-95 1995-96 Interest, dividends and other Interest and financing costs Sales of goods and services Subsidies, benefits and grants Taxation Providing goods and services Chart 5C Operating Result 200,000 Total expenses 150,000 Total revenues 100,000 $ millions 50,000 0 1994-95 1995-96 Deficit Total revenues The size and composition of items under subsidies, benefits and grants is unique to the Commonwealth and is the main reason why Commonwealth Government performance cannot be compared with private sector or State governments. Such items involve the transfer of financial benefits to other governments, individuals and other parties for national or public interest purposes, without receiving any tangible consideration in return (often referred to as unrequited or non-reciprocal transfers). 17
  22. 22. REVENUES AND EXPENSES 18
  23. 23. ASSETS AND LIABILITIES 5. ASSETS AND LIABILITIES The statement of assets and liabilities shows: ♦ the composition of assets and liabilities; and ♦ the amount of change in net assets (equity). The statement is used to assess the financial position of the Commonwealth at the end of the last financial year compared with the previous financial year and how funds have been obtained and used. As previously mentioned, changes in financial position mainly arise from the operating result (i.e. the statement is linked to the statement of revenues and expenses), but can also be affected by the revaluation of assets. Analysis is likely to focus on changes in financial strength; intergenerational effects of operations over time; how funds have been obtained and used; and the cost of funds required to maintain asset holdings (e.g. as a step towards identifying assets that may not justify incurring such costs and which could be realised to reduce debt and interest costs). A supplementary statement shows the assets and liabilities of the general government, public trading enterprises and public financial enterprises sectors. What are assets and liabilities? Assets are future economic benefits controlled by Commonwealth entities as a result of past transactions or events. When combined with resources provided by employees and other service providers, assets enable the Government to provide goods, services and benefits. In the statement of assets and liabilities, individual classes of assets are shown under two headings to assist in analysing their purpose and cost effectiveness in achieving objectives: ♦ 'financial assets' (which, except for financial institutions, are often incidental to core functions such as providing goods, services and benefits); and ♦ 'non-financial assets' (which are used in the delivery of goods, services and benefits). Financial assets are mainly cash, investments and receivables; whereas, non-financial assets are mainly property, plant and equipment. Liabilities are, in essence, amounts owed to other persons or bodies. Technically, they are described as 'future sacrifices of future economic benefits that Commonwealth entities are presently obliged to make to other entities as a result of past transactions or events'. In the statement of assets and liabilities, individual classes of liabilities are shown under two headings to assist in analysing the sources and costs of funds: ♦ 'debt' (which is interest bearing); and ♦ 'provisions and payables' (which are non-interest bearing). Debt is mainly government securities, loans and deposits; whereas provisions and payables are mainly amounts owed to employees, suppliers, other governments and recipients of benefits. 19
  24. 24. ASSETS AND LIABILITIES The format of the statement of assets and liabilities can be seen in the proforma statement on page 21. Where the exchange of economic value and cash do not occur simultaneously the effect of the timing difference is reflected as an asset or a liability in the financial statements (e.g. income tax due to the Commonwealth, but not yet received would be recorded as an asset 'receivables' and a revenue). Where the exchange of economic value and cash occur simultaneously, there may be a replacement of one asset with another (e.g. cash with a physical asset) or a simultaneous increase or decrease in an asset and a liability (e.g. debt and cash). Alternative classifications of assets and liabilities While the headings mentioned above are considered most relevant for showing the Commonwealth's financial position, assets and liabilities can also be shown under the headings of 'current' and 'non-current' to distinguish those receivable or payable within the next 12 months from those expected to be held for more than 12 months. Classifications of current and non-current are used extensively in the private sector and are intended to indicate liquidity (capacity to meet current liabilities as they fall due). However, in practice, such classifications have tended to be subjective and unreliable indicators. Long term positive cash flows from operations are more important in assessing capacity to meet liabilities and sustain operations. In the Commonwealth's case, these are supported by the unique powers of a government to impose taxation. Equity The difference between assets and liabilities is most commonly referred to as 'equity' (other terms used are net assets and net worth). Equity represents the extent to which the Government has incurred obligations or accrued economic benefits which will either involve a call on resources in the future or will be available for use in the future. Equity is made up of three components: ♦ capital; ♦ accumulated operating results (surpluses or deficits); and ♦ reserves. Changes in the components of equity explain why net assets have increased or decreased (e.g. whether from an operating surplus or revaluation of assets ). 20
  25. 25. ASSETS AND LIABILITIES ASSETS AND LIABILITIES as at 30 June 199X 199X 199X Note $m $m Liabilities DEBT Government securities Loans Leases Deposits Overdrafts Other debt Total debt PROVISIONS AND PAYABLES Employees Suppliers Personal benefits Subsidies Grants Australian currency on issue Provision for taxation refunds Other provisions and payables Total provisions and payables Total liabilities EQUITY 1 Accumulated results Reserves Private shareholders of Commonwealth entities Total equity Total liabilities and equity Assets FINANCIAL ASSETS Cash Receivables Investments Accrued revenues Other financial assets Total financial assets NON-FINANCIAL ASSETS Land and buildings Infrastructure, plant and equipment Inventories Intangibles Other non-financial assets Total non-financial assets Total assets 1 This is the residual interest in assets after deduction of liabilities. 21
  26. 26. ASSETS AND LIABILITIES Equity can be interpreted as measuring accumulated financial strength (i.e. the impact of past actions in accumulating net resources). However, given that equity does not recognise the capacity of the Government to raise taxes in the future or its obligation to meet future pension payments, it will only provide a partial measure of financial strength. This has implications for inter-government comparisons. For example, the Commonwealth Government may have a greater capacity to raise taxation revenue than State and Territory governments (providing greater inherent financial strength); but, this may be offset by its obligation to meet pension payments. At a broad level Charts 6A, 6B and 6C show changes in the composition of assets, liabilities and equity over 1995-96. Chart 6A Chart 6B Composition of Assets Composition of 300,000 Liabilities 300,000 250,000 250,000 200,000 200,000 150,000 150,000 $ millions 100,000 $ millions 100,000 50,000 50,000 0 0 1994-95 1995-96 1994-95 1995-96 Non-financial assets Provisions and payables Financial assets Debt Chart 6C Equity 150,000 100,000 50,000 0 $ millions -50,000 -100,000 1994-95 1995-96 Reserves Accumulated results 22
  27. 27. ASSETS AND LIABILITIES Measuring inter-temporal effects The amount of net assets provides an indication of inter-temporal or inter-generational equity. Inter-temporal effects are neutral when the financing of government activities matches the stream of services provided. Hence: ♦ positive net assets (from cumulative revenues exceeding cumulative expenses) indicates that taxpayers to date have funded a net accumulation of government resources which have the potential to benefit future taxpayers; ♦ negative net assets (from cumulative revenues falling short of cumulative expenses) indicates that commitments have been incurred that may require higher revenues or lower expenses in future. Sources and applications of funds Changes in the amounts of assets and liabilities show how funds were obtained and how they were applied. e.g. if a computer were purchased on credit, the supplier would provide the source of funds (recorded as an increase in liabilities) and the application of funds would be an increase in assets. Sources of funds in a particular accounting period are not necessarily cash, although a cash flow would normally occur in due course (e.g. for the repayment of a liability). The Commonwealth's statement of assets and liabilities has been structured so as to show the combined sources of funds and how they were applied over time. Funds are provided by: ♦ increases in liabilities; ♦ decreases in assets; ♦ operating surpluses; and ♦ capital contributions. Funds are used by: ♦ increases in assets; ♦ decreases in liabilities; and ♦ operating deficits. The accounting equation The 'accounting equation' is derived from the relationship between assets and liabilities [assets - liabilities = equity]. Hence, the statement of assets and liabilities can be expressed in different ways to emphasise certain features. In the Commonwealth's financial statements, the statement has been expressed as [liabilities + equity = assets] to show how the combined sources of funds from liabilities and equity have been invested in assets. As assets must be funded by an equal sum of liabilities and equity (sources of funds), they indirectly generate holding costs through interest and dividends payable on those funds. 23
  28. 28. ASSETS AND LIABILITIES There can also be an opportunity cost in holding assets vis-a-vis their alternative use. It is important therefore to identify surplus or under-performing assets which may not justify incurring these costs. For example: ♦ except in public financial enterprises, financial assets such as cash and receivables would normally be expected to be kept to the minimum level needed to support core functions; and ♦ there should be no obsolete, under-utilised or inefficient non-financial assets. Disposing of non-essential assets can provide ongoing savings through reductions in debt and associated interest costs. This will reduce an underlying deficit or increase an underlying surplus. Attributing the cost of funds between past deficits and assets Funds are required to compensate for past deficits as well as to support existing assets. Hence the ongoing cost of these funds has an impact on future performance. Using the accounting equation, the statement of assets and liabilities can be re-expressed to highlight the proportion of available funds needed to support past deficits compared to existing assets [liabilities + reserves = accumulated deficits + assets]. This facilitates analysis of the annual cost of funds generated by past deficits compared to existing assets and provides a lead as to how those costs might be addressed. The costs can be derived as follows: COST OF FUNDING ASSETS * Total cost of funds x class of asset Total assets + accumulated deficits Indicative of the cost of funds needed to support each class of asset COST OF FUNDING PAST DEFICITS * Total cost of funds x accumulated deficits Total assets + accumulated deficits Indicative of the cost of funds needed to support accumulated deficits * Further ratios are given in a later section on 'Ratios' Measures to reduce the cost of funds employed could therefore involve a combination of: ♦ recouping past deficits (through future surpluses); ♦ realising surplus and under-performing assets; and ♦ applying the proceeds to reducing debt. The following table shows how the 1995-96 statement of assets and liabilities would appear when re-expressed in the manner suggested above. 24
  29. 29. ASSETS AND LIABILITIES ACCUMULATED SOURCES AND APPLICATIONS OF FUNDS, 1995-96 Consol* Gen govt PTEs PFEs $m $m $m $m Accumulated sources of funds Debt 125,901 117,952 11,418 13,507 Non-interest bearing liabilities 131,117 101,202 8,440 26,820 Total liabilities 257,018 219,154 19,858 40,327 Capital 908 8,947 70 Accumulated surpluses 5,945 Reserves 18,879 43,130 5,189 8,357 Total accumulated sources of funds 275,897 263,192 39,939 48,754 Accumulated applications of funds Financial assets 93,822 123,634 8,237 44,832 Non-financial assets 82,368 51,261 31,702 428 Total assets 176,190 174,895 39, 939 45,260 Accumulated deficits 99,707 88,297 3,494 Total accumulated applications of funds 275,897 263,192 39,939 48,754 The statement of revenues and expenses shows that the total cost of funds for the year (i.e. interest on debt) was $11.7 billion. If, for the purposes of analysis, the cost of funds is proportionately allocated to the areas that used those funds (in accordance with the above formulae), the cost of funding financial assets (mainly receivables and investments) would be $4 billion, non-financial assets (mainly property, plant and equipment) $3.5 billion and deficits from past years $4.3 billion. At a more detailed level, the annual cost of funding receivables and accrued tax revenue (included in financial assets) was $2.4 billion and investments $1.4 billion. Similarly, if the cost of interest on funds applied to investments is deducted from the interest or dividends received on those investments, the income is reduced from $3.5 billion to a net $2.1 billion. (or from 10.5% to 6.3%). 25
  30. 30. ASSETS AND LIABILITIES 26
  31. 31. CASH FLOWS 6. CASH FLOWS The statement of cash flows shows: ♦ the composition of cash inflows and outflows; ♦ the amount of the cash surplus or deficit; and ♦ the change in cash held (from the beginning to the end of the period). The statement of cash flows is used to assess how cash was managed by the Commonwealth for the last financial year, compared with the previous financial year. Analysis is likely to focus on how operating and investing activities were financed; whether cash flow levels from these activities are sustainable; how they impact on financial position; and how working capital could be locking up cash. A supplementary statement shows the cash flows of the general government, public trading enterprises and public financial enterprises sectors. Types of cash flows In the statement of cash flows, the different classes of cash inflows and outflows are shown under the headings - 'operating', 'investing' and 'financing': ♦ operating activities are those activities which relate to the provision of goods, services and benefits (e.g. payments to employees and suppliers); ♦ investing activities are those activities which relate to the acquisition and disposal of property, plant and equipment and other productive assets and investments such as securities; and ♦ financing activities are those activities which relate to changing the size and composition of the financial structure, including capital and borrowings. The format of the Statement of Cash Flows can be seen in the proforma statement on page 28. Some aspects of terminology and approach in the statement of cash flows are different from those used in the Commonwealth's traditional cash based budget (which is presented in accordance with standards for Government Finance Statistics laid down by the International Monetary Fund): ♦ in the statement of cash flows, gross inflows and outflows are shown for each class of activities; whereas, in the budget certain receipts generated by outlays are offset against those outlays (or vice versa); ♦ 'operating' and 'investing' activities in the statement of cash flows cover transactions similar to those described as 'current' and 'capital' in the budget; and ♦ 'financing' has similar meanings under both approaches. 27
  32. 32. CASH FLOWS CASH FLOWS for the year ended 30 June 199X 199X 199X Note $m $m OPERATING ACTIVITIES Cash received Taxes, fees and fines Sales of goods and services Interest and dividends Other Total cash received Cash used Payments re employees Payments re suppliers Subsidies paid Personal benefits Grant payments Interest and other financing costs Other Total cash used Net cash from operating activities INVESTING ACTIVITIES Cash received Proceeds from asset sales program Proceeds from sales of property, plant and equipment Repayments of advances Other Total cash received Cash used Purchase of property,plant and equipment Other Total cash used Net cash from investing activities FINANCING ACTIVITIES Cash received Proceeds from issues of currency Proceeds from borrowings Other Total cash received Cash used Other Total cash used Net cash from financing activities Net increase in cash held add Cash at beginning of year Cash at end of year 28
  33. 33. CASH FLOWS Chart 7 shows cash flows from operating, investing and financing activities for 1995-96. Chart 7 Cash Flows $ millions -10,000 -5,000 0 5,000 10,000 15,000 Net inflow from financing activities Net outflow from operating activities Net outflow from investing activities 1994/95 1995/96 Effects of borrowing for different purposes Ideally, net cash flows from operating activities (e.g. receipts from taxation less payments to employees, suppliers and persons receiving benefits) should be sufficient to cover replacements of existing assets (shown under investing activities) over time. A continued shortfall of net cash from operating activities must therefore be made up from borrowing (shown under financing activities). This increases costs to the Commonwealth through debt servicing and puts pressure on the amount of funds available in the financial markets for other purposes. Borrowing to finance operating activities will reduce net assets and potentially weaken financial strength; whereas, borrowing to finance investment in new capital is matched by an equivalent asset and does not in itself weaken financial position. While borrowing to finance new capital may be intrinsically sound, financial position can still be weakened if future revenues are not sufficient to cover interest payments and repayments of principal by the end of the useful life of the asset (necessitating roll-over of borrowings). Revenues equivalent to depreciation and interest plus expected proceeds from the residual value of the asset could be budgeted for. Where depreciation is based on replacement cost, this formula would allow for changing prices. Using the proceeds from asset sales for different purposes Funding a shortfall of cash from operating activities from the proceeds of asset sales can avoid or reduce the need for borrowing but this form of financing will reduce net assets and weaken financial position (i.e. is not sustainable in the long term). 29
  34. 34. CASH FLOWS Repayment of debt from the proceeds of asset sales will not increase net assets initially. However, savings in future interest payments will, other things being equal, improve future operating results and enable progressive strengthening of financial position. The impact of working capital on cash The table reconciling the operating and cash results (see page 31) highlights the importance of efficient management of working capital to reduce the need for borrowing. For example increases in receivables and inventories lock-up cash; whereas, decreases in these items can make can make cash available. Cash used by working capital items in 1995-96 was $8.6 billion and total cash provided by these items was $2.3 billion (for 1994-95 the figures were $11.7 billion used and $6.6 billion provided). An increase in cash on hand would not normally be desirable where there are net cash outflows from operating activities. This is because the increase in cash may need to be financed by borrowings which will generate ongoing interest costs. Macroeconomic analysis From a demand management perspective, the focus of attention is frequently on the impact of fiscal policy on economic activity in a particular year or quarter, or in a succession of such time periods. For such short to medium term purposes, cash flow information would normally be used. This is because a fiscal stimulus or consolidation may not be reflected in accrual measures such as the operating result or changes in net assets because of the different timing of the economic events (which determine accrual measures) and the cash flows they generate. Changes in net assets, for example, will not always reflect instances where a fiscal stimulus is provided through increased expenditure on capital works. In the accrual statements, an increase in liabilities to fund capital works would be matched by the increase in assets created by the investment. Thus, the net assets of the Government would not change despite the contribution to economic activity that the increase in capital expenditure provides. On the other hand, accrual information, by providing a better measure of the underlying fiscal balance, is a better guide to longer term impacts on economic activity and sustainability of fiscal policies. The accrual framework, by including the operating result, change in net assets as well as cash impacts, provides more comprehensive information for macroeconomic analysis than a simple cash based framework. 30
  35. 35. CASH FLOWS NOTE X. RECONCILIATION OF CASH 199X 199X $m $m (a) Reconciliation of operating result to net increase in cash Operating result (revenues less expenses) less REVENUES NOT PROVIDING CASH Foreign exchange gains Total revenues not providing cash plus EXPENSES NOT REQUIRING CASH Increase in employee entitlements Depreciation Provision for bad and doubtful debts Provision for diminution in value Foreign exchange losses Losses on disposal of financial assets Losses on disposal of non-financial assets Other Total expenses not requiring cash plus CASH PROVIDED BY WORKING CAPITAL ITEMS Decrease in receivables Decrease in inventories Decrease in other financial assets Decrease in other non-financial assets Total cash provided by working capital items less CASH USED BY WORKING CAPITAL ITEMS Increase in receivables Increase in other financial assets Increase in inventories Increase in other line items Decrease in suppliers Decrease in other provisions and payables Total cash used by working capital items equals Net cash from operating activities 1 less Net cash from investing activities equals Cash deficit 1 plus Net cash from financing activities equals Net increase in cash 1 Details given in the Statement of Cash Flows 31
  36. 36. CASH FLOWS 32
  37. 37. RATIOS 7. RATIOS The financial ratios used by investors to assess the results of private sector entities tend to focus on matters such as profits, dividend yields and solvency. In contrast, ♦ governments do not seek profits as a primary aim; ♦ taxpayers do not receive dividends from the Government; ♦ the risk of insolvency is remote because of the Government's power to tax. Taxpayers are likely to assess the Government by factors such as the effectiveness of its policies, the efficiency of their delivery, the levels of taxes and charges it imposes to fund its operations and the distribution of benefits and costs to the community. Hence, analysis of the Government's financial statements can usefully focus on such matters as: ♦ what is driving the costs of government operations and, as a consequence, the level of taxation; and ♦ whether the funding of government activities is equitable between generations of taxpayers. While financial statements can provide some information on the distributional effects of spending and revenue raising, such questions are largely beyond the scope of financial reporting. In analysing the financial statements, it is useful to: ♦ compare performance indicators, cost drivers and revenue sources over time (e.g. % change) to assess trends; ♦ examine the composition of items in each statement (e.g. % items to totals) to find what is influencing key performance indicators such as the operating result; ♦ examine relationships between various items or groups of items (e.g. ratios) that highlight performance, financial position and cash flows; and ♦ summarise information in charts and tables. The financial ratios which follow aim to highlight factors that affect costs through efficiency of resource management or cause costs to be transferred to other generations. This information enables adverse trends to be addressed in the budget. CHANGE IN NET ASSETS FROM OPERATIONS Operating result x 100 Opening net assets (or opening net liabilities) ♦ Shows of % change in net assets/liabilities arising from operations ♦ Shows whether costs have been met by revenues or deferred to the future 33
  38. 38. RATIOS INTERGENERATIONAL EFFECT OF OPERATIONS Operating deficit x 100 Total expenses ♦ Indicative of % of current expenses deferred to future taxpayers Operating surplus x 100 Total revenues ♦ Indicative of % of current revenues which will benefit future taxpayers (where there are accumulated surpluses) ♦ Indicative of % of current revenues applied to expenses of past taxpayers (where there are accumulated deficits) REVENUES % taxation to total revenues % non-taxation to total revenues % variation on previous year % variation from budget EXPENSES % cost of goods and services to total revenues % subsidies, benefits and grants to total revenues % interest and other costs to total revenues % total expenses to total revenues % variation on previous year % variation from budget ASSETS USED IN PRODUCTION Non-financial assets x 100 Total assets ♦ Shows % of total assets used in producing goods and services FINANCIAL ASSETS Financial assets x 100 Total assets ♦ Shows % of total assets not used in producing goods and services. ♦ For public financial enterprises, these are the main assets used to generated income; whereas, for service providing agencies they should normally be kept at minimum levels necessary to support core functions (hence analysis may be most effective at sector level). 34
  39. 39. RATIOS COST OF FUNDING ASSETS Total cost of funds x class of asset Total assets + accumulated deficits ♦ Indicative of the cost of funds needed to support each class of asset COST OF FUNDING PAST DEFICITS Total cost of funds x accumulated deficits Total assets + accumulated deficits ♦ Indicative of the cost of funds needed to support accumulated deficits NET RETURN/COST OF INVESTMENTS Interest and dividends received - cost of funds invested x 100 Average investments ♦ Indicative of the net return/cost of investments after allowing for the cost of funds invested TURNOVER OF RECEIVABLES Average receivables by class x 365 Total of receivables raised/accrued by class ♦ Shows average number of days to collect each class of receivables TURNOVER OF INVENTORIES Average inventories by class x 365 Inventories sold/used by class ♦ Shows average number of days each class of inventory held before sale or consumption. INTEREST BEARING SOURCES OF FUNDS Debt x 100 Total sources of funds (i.e. total liabilities + positive equity) ♦ Shows % interest bearing sources of funds ASSET REPLACEMENT CAPACITY Net cash from operations Depreciation ♦ Indicative of capacity to fund ongoing asset replacements without recourse to borrowing ♦ Generally a ratio in excess of 1:1 over time would be desirable 35
  40. 40. RATIOS REINVESTMENT SUFFICIENCY Cost of asset replacements Depreciation ♦ Indicative of whether assets are being maintained or run-down. ♦ Generally a ratio in excess of 1:1 over time would be desirable CHANGES IN WORKING CAPITAL Cash used/provided by receivables Cash used/provided by creditors Cash used/provided by inventories Cash used/provided by investments Cash used/provided by changes in bank balance RATE OF CHANGE Change in item or total x 100 Previous year item or total ♦ Highlights material changes in items that may warrant further inquiry CHANGE IN COMPOSITION Change in % item to total ♦ Highlights material changes in the composition of revenues, expenses, assets, liabilities, equity and cash flows 36
  41. 41. OTHER FACTORS 8. OTHER FACTORS AFFECTING INTERPRETATION The effect of revaluing assets The method of valuing assets affects the cost of providing goods, services and benefits (through depreciation charges) as well as the amount of net assets. A range of valuation methods are currently used by Commonwealth entities. However, the financial statement guidelines of the Minister for Finance will require all departments and authorities to progressively revalue their property, plant and equipment on a 'deprival' basis by 1 July 1999. Under the deprival model: ♦ assets that would be replaced are valued by reference to their current replacement cost; ♦ assets surplus to requirements are valued by reference to their market value. An advantage of the deprival approach is that it shows the current values of assets and, through depreciation, the current costs of consuming the service potential in those assets. This, in turn, flows into the total cost of providing goods and services (outputs) and will affect future parliamentary appropriations based on the cost of those outputs. Initially, upwards revaluations of assets will increase equity; whereas, downwards revaluations will reduce equity. However, the increase or decrease is then included in the base used for calculating depreciation over the remaining lives of assets (where they have finite lives), reversing the change in equity over time. Depreciation is the reduction in the net value of an asset as the flow of services from that asset is consumed. The purpose of measuring depreciation in accrual reports is to record the economic cost of using assets over time. By incorporating this cost in the operating statement, the Government can ensure that these costs are taken into account as they accrue. If revenue is set to match depreciation, then assets will accrue to match the consumption of capital, so that the assets can be replaced when they wear out without recourse to borrowing or reducing services. Accounting standards require different treatment of upward revaluations compared with downward revaluations: ♦ upward revaluations of assets must be taken to the asset revaluation reserve (in the balance sheet); whereas ♦ downward revaluations must be treated as expenses (in the operating statement). An exception to this rule is that reversals of previous valuations are reported in the same manner as the original valuation. Are social welfare entitlements liabilities? Liabilities are recognised when it is probable that a future sacrifice of economic benefits will be required and the amount of the liability can be measured reliably. 37
  42. 42. OTHER FACTORS An issue which highlights some of the difficulties in determining the appropriate content of financial reports of governments is whether pension and other welfare entitlements should be treated as liabilities in the same way as employee superannuation entitlements. Both require the government to make payments in the future and so are relevant to assessing financial position. Moreover, the future payment of pensions is a far more significant commitment of resources than employee superannuation and is influenced by government policy as it applies from time to time, economic factors and demographic factors. Statement of Accounting Concepts 4 and Discussion Paper 21 (issued by the Australian Accounting Research Foundation) cast doubt on whether pensions and other welfare entitlements should be included in the statement of assets and liabilities. SAC 4 states that the 'mere intention to sacrifice future economic benefits in the future is not sufficient to give rise to a liability.' It also notes that 'the formal adoption of a budget, the passing of legislation, the establishment of a grant program do not, of themselves, create present obligations for the Government. DP 21 concludes that a 'present obligation does not exist in respect of items such as unemployment benefits, family allowances and age and invalid pensions'. The trial financial reports have treated pension and other social welfare entitlements as constituting an expense at the time of payment as it is only at this time that the government is committed to fulfilling the entitlement enacted by parliament. The financial statements of the Government of New Zealand adopt a similar approach. Forward estimates of outlays (and their equivalent compiled on an accruals basis) provide estimates of the future cost of existing government policies, having regard to assumptions about key economic and demographic factors. Does the right to tax constitute an asset? A conceptual issue is whether the Government's ability to raise taxation revenue in the future constitutes an asset (which could, for instance, be seen to offset liabilities arising from the commitment to pay pensions). Assets are defined in SAC 4 as future economic benefits controlled by an entity as a result of past transactions or other past events. They are to be recognised in financial reports when the inflow of economic benefits is probable and can be measured reliably. While the conferring of taxation powers on the Commonwealth by The Constitution could be regarded as the necessary past event giving rise to future economic benefits, it is doubtful whether the amount of future taxes could be measured reliably. On the other hand, if the earning of income by taxpayers were regarded as the necessary past event, there would not be an asset because there is no past event giving rise to future economic benefits. Consistent with these principles, the trial financial reports do not include as an asset the Commonwealth's right to tax. Forward estimates of revenue reflect forecasts of future tax revenue and rely on forecasts of future economic variables. Commitments 'Commitments' are obligations or undertakings to make future payments that: ♦ exist at the end of the reporting period; and 38
  43. 43. OTHER FACTORS ♦ have not been recognised as liabilities in the statement of assets and liabilities. In the financial statements of the Commonwealth, commitments are disclosed in a separate schedule of commitments. Obligations include those arising under agreements equally proportionately unperformed (e.g. for capital expenditure contracted for). Undertakings are unconditional promises that are expected to create future liabilities (e.g. on the happening of a future event). Commitments of other entities to Commonwealth entities are disclosed as commitments receivable. Contingencies 'Contingencies' are conditions, situations, or circumstances that: ♦ exist at the end of the reporting period; ♦ create uncertainty as to possible gain or loss to an entity; and ♦ will be confirmed only on the occurrence or non-occurrence of one or more uncertain future events. In the financial statements of the Commonwealth, contingencies are disclosed in a separate statement of contingencies. Disclosures of contingencies should enable assessment of both the nature of, and the uncertainties which affect those contingencies. A material contingent loss should be recognised as an expense (in the operating statement) where it is probable that a future event will confirm a loss which can be estimated with reasonable accuracy at the date on which the financial statements are certified. A material contingent gain should be recognised as revenues only if it is probable that the gain will be realised. A material contingency which is not recognised in the operating statement must be disclosed in the statement of contingencies unless the possible loss or gain is remote. Estimates of the outcome and financial effects of contingencies should be based on consideration of information available up to the date on which the financial statements are certified and should include a review of events occurring after the end of the reporting period. Events occurring after balance date Financial statements record economic events that occur during fixed reporting periods and must therefore be prepared, audited and published after the end of each reporting period. This process sometimes takes several months, during which time events may occur that would materially affect assessments of the results for the reporting period e.g. a major after balance date fall in the value of investments held by a financial institution. Accounting standards describe an event occurring after balance date as: ♦ a circumstance that has arisen; or 39
  44. 44. OTHER FACTORS ♦ information that has become available, after the end of the reporting period, but prior to when the financial statements are certified. There are two types of after balance date events: ♦ the first type are those events which provide evidence of, or further elucidate, conditions which existed at balance date - the financial effect of such events should be reflected in the financial results for the reporting period; and ♦ the second type are those events which create new conditions as distinct from any that may have existed at balance date - the financial effect of such events should be explained in a note to the current financial statements and reflected in the financial results for the next reporting period. An after balance date event of the second type could be a major factor in evaluating the entity's financial strength or future prospects. In these circumstances, the event must be disclosed, otherwise reliance on the financial statements could become misleading. The need for forward projections Equity and changes in equity are point-in-time estimates. They incorporate some information on future expenditure, in the form of current commitments but only provide a snapshot of the fiscal situation at a given point in time. They do not provide information on whether the equity of government may improve or deteriorate over time without discretionary policy adjustments, for example, as a consequence of changing employee superannuation entitlement arising from demographic factors. Nor do they take account of the impact that external influences, such as economic conditions, may have on the fiscal outlook. Forward projections of accrual measures would be required to fully assess fiscal sustainability. 40
  45. 45. GLOSSARY Glossary of Terms 41
  46. 46. GLOSSARY 42
  47. 47. GLOSSARY GLOSSARY OF TERMS accrual basis means the accounting basis whereby items are brought to account as they are earned or incurred (and not as cash is received or paid) and included in the financial statements for the accounting periods to which they relate (AAS 6) accumulated means the aggregate, at a given point of time, of the depreciation expenses in depreciation respect of a particular depreciable asset or class of depreciable assets (AAS 4) accumulated results is a component of equity and is the accumulation of operating results over the life of a reporting entity plus other adjustments and transfers required in accordance with accounting standards agriculture, forestry, and this term relates to an item in the statement of Revenues and Expenses by fishing Function and includes agricultural land management, agricultural water resources management, agricultural support schemes, agricultural research and extension services, forestry, and fishing amortisation The term ‘amortisation’ is often used interchangeably with the term ‘depreciation’. The terms have the same meaning, however, depreciation is generally used in relation to assets with a useful life of greater than one year that have physical substance, while amortisation is generally used in relation to intangible assets (AAS4) assets future economic benefits controlled by an entity as a result of past transactions or other past events (SAC4) associated entity means an entity in which the reporting entity holds an interest in the net assets and over which the reporting entity is able to exercise significant influence, but does not have control. Investments in associated entities are measured at values which reflect the Commonwealth Government’s share of these entities net assets. cash means cash on hand and cash equivalents (AAS 28) cash equivalents means highly liquid investments that are readily convertible to cash on hand at the investors option and which a company or economic entity uses in its cash management function on a day-to-day basis; and borrowings which are integral to the cash management function and which are not subject to a term facility (AASB 1026) cash accounting is an accounting method which records cash receipts, payments and balances and provides reports which show the sources of cash and how cash was used Charter of Budget relates to legislation establishing a new fiscal framework that aims to produce Honesty better fiscal outcomes by putting in place institutional arrangements to improve the discipline, transparency and accountability applying to the conduct of fiscal policy . 43
  48. 48. GLOSSARY class refers to a group of revenues, expenses, assets or liabilities having a similar nature or function in the operations of the entity, e.g. taxation revenue commitments relate to obligations or undertakings to make future payments to other entities that exist at the end of the reporting period, and have not been recognised as liabilities in the statement of assets and liabilities. Obligations include those arising under agreements equally proportionately unperformed. Undertakings are unconditional promises that are expected to create future liabilities. . contingencies relate to conditions, situations or circumstances that: • exist at the end of the reporting period • create uncertainty as to possible gain or loss to an entity; and • will be confirmed only on the occurrence or non-occurrence of one or more uncertain future events. control of an asset relates to the capacity of a reporting entity to benefit from the asset in the pursuit of the reporting entity's objective and to deny or regulate the access of others to that benefit (SAC 4, AAS 29) control of an entity for the purposes of these financial statements, the control of another entity by the Commonwealth Government is taken to exist where: • the other entity is accountable to the Commonwealth Government; and • the Commonwealth Government has a residual financial interest in the net assets of that entity defence in the statement of Revenues and Expenses by Function this item includes military and civil defence affairs, foreign military aid and defence research depreciation expense depreciation expense means an expense recognised systematically for the purpose of allocating the depreciable amount of a depreciable asset over its useful life. (AAS4) education in the statement of Revenues and Expenses by Function this item includes primary and secondary education, university and other higher education, technical and further education, preschool and special education, and transportation of students effectiveness means the extent to which the entity achieved the objectives established for its operations, activities and/or programs, whether those objectives were expressed in terms of outputs or outcomes (AAS 29) efficiency means the extent to which the entity maximised the outputs produced from a given set of inputs or minimised the input cost of producing a given level and quality of outputs (AAS 29) entity means any legal, administrative or fiduciary arrangement, organisational structure or other party (including a person) having the capacity to deploy scarce resources in order to achieve objectives (SAC 1, AAS 1, 4, 10, 24, 28, 29) 44
  49. 49. GLOSSARY equity is the residual interest in the assets of a reporting entity after deduction of its liabilities expenses are consumptions or losses of future economic benefits in the form of reductions in assets or increases in liabilities of the entity expenses by purpose means the disaggregation of expenses by the purpose of Commonwealth Government policy, e.g. defence, housing, education. Purposes are determined by applying Government Financial Statistics Reporting Principles used by the Australian Bureau of Statistics financial asset means any asset that is: cash; a contractual right to receive cash or another financial asset from another entity; a contractual right to exchange financial instruments with another entity under conditions that are potentially favorable; or an equity instrument of another entity (AAS 33) financial position means the economic condition of a reporting entity, having regard to its control over resources, financial structure, capacity for adaptation and solvency (SAC 2) financial reporting involves summarising information in the accounting records in accordance with accounting standards and other requirements and presenting it in financial statements designed to suit the needs of management or external users financial statements • Revenues and Expenses by Function; • Revenues and Expenses by Economic Type; • Assets and Liabilities; • Cash Flows; • Commitments; • Contingencies; • Revenues and Expenses by Economic Type by Sector; • Assets and Liabilities by Sector; • Cash Flows by sector; • Commitments by Sector; • Contingencies by Sector; • Notes financing activities means those activities which relate to changing the size and composition of the financial structure of an entity, including equity, and borrowings not falling within the definition of cash (AAS 28) 45
  50. 50. GLOSSARY fuel and energy this term relates to an item in the statement of Revenues and Expenses by Function and includes coal, petroleum, gas, nuclear affairs, and electricity general government the primary function of this sector is to provide public services which are sector mainly non-market in nature, are mainly for the collective consumption of the community, involve the transfer or redistribution of income and are financed mainly through taxes and other compulsory levies general public services this term relates to an item in the statement of Revenues and Expenses by Function and includes legislative and executive affairs, financial and fiscal affairs, foreign economic aid, general research, general services, and government superannuation benefits general purpose are financial reports intended to meet the information needs common to financial reports users who are unable to command the preparation of reports tailored so as to satisfy, specifically, all of their information needs (SAC1) health this term relates to an item in the statement of Revenues and Expenses by Function and includes general hospitals, repatriation hospitals, mental health institutions, nursing homes, special hospitals, hospital benefits, medical clinics and practitioners, dental clinics and practitioners, maternal and infant health, ambulance services, medical benefits, school and other public health services, pharmaceuticals, medical aids and appliances, and health research housing and community this term relates to an item in the statement of Revenues and Expenses by amenities Function and includes housing and community development, water supply, household garbage and other sanitation, sewerage, urban stormwater drainage, protection of the environment, and street lighting intangibles assets that embody future economic benefit but do not have physical substance, for example patents, trademarks and goodwill inventories means: (a) goods, other property and services: held for sale in the ordinary course of operations; in the process of production for such sale; or to be used up in the production of goods, other property or services for sale including consumable stores and supplies, but does not include depreciable assets as defined in Australian Accounting Standard AAS4 Depreciation for Non- Current Assets (AAS 2, 10); (b) stocks of goods and other property to be used in the production of goods, other property and services (which are not held for sale) investing activities means those activities which relate to the acquisition and disposal of assets, including property, plant and equipment and other productive assets and investments such as securities, not falling within the definition of cash (AAS 28) liabilities are future sacrifices of future economic benefits that the entity is presently obliged to make to other entities as a result of past transactions or other past events (SAC 4) 46
  51. 51. GLOSSARY market value is the amount which could be expected to be received from the disposal of an asset in an orderly market after deducting costs expected to be incurred in realising the proceeds of such a disposal (AAS 25) mining, manufacturing this term relates to an item in the statement of Revenues and Expenses by and construction Function and includes activities relating to prospecting, mining and mineral resources development; manufacturing activities and research into manufacturing methods, materials and industrial management; and activities associated with the building and construction industry this term excludes all activities relating to mineral fuels, and manufacturing relating to production of fuel and energy classified under fuel and energy National Commission the Government established the National Commission of Audit in March of Audit 1996 to provide an independent report on the financial position of the Commonwealth. The commission presented its report in June 1996. The Commission’s report included a broad range of recommendations and findings relating to the appropriateness, effectiveness, efficiency of government programs and public sector administration as well as government accountability non-financial assets are all assets which are not 'financial assets' notes to the financial form part of the financial statements and their function is to disaggregate and statements further explain the information contained in the primary financial statements, thereby freeing those statements from details that could otherwise obscure the key financial indicators operating activities means those activities which relate to the provision of goods, services and benefits operating result the difference between revenues and expenses and is either a surplus or a deficit other economic affairs this term relates to an item in the statement of Revenues and Expenses by Function and includes storage, sale yards, markets, tourism and area promotion, and labour and employment affairs other purposes in the statement of Revenues and Expenses by Function this item includes public debt transactions, general purpose inter-government transactions, and natural disaster relief performance means the proficiency of a reporting entity in acquiring resources economically and using those resources efficiently and effectively in achieving specified objectives (SAC 2) provisions and payables are liabilities that have arisen or accrued as a result of goods and services received (e.g. from employees) and normally do not normally generate an ongoing interest expense 47

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