We might hope to see the finances of the Union as clear and intelligible as a merchant's books, so that every member of Congress and every man of any mind in the Union should be able to comprehend them, to investigate abuses, and consequently to control them," said President Thomas Jefferson to Treasury Secretary Albert Gallatin in 1802, which is proudly quoted in the executive summary to the 2006 Financial Report of the US Government.
We are a nation which has produced competent accountants, which gave the world the ancient Bahi-khata (which existed much before the 13th century Italian Pacioli's double-entry system of book-keeping), and which produced the centuries-old Kautilya's Arthashatra, detailing how kings in those days presented the financial statements of the state. Where is our modern government on its financial statements presented to the nation? Does it produce one at all?
For a start, what is sauce for the goose is not sauce for the gander? What is considered acceptable and permissible accounting for the Government of India is no good for tax-paying citizens and companies.
If citizens or corporates were to follow what the government has managed to get away with, namely a peculiar and antiquated accounting and reporting regime, many of them could find themselves behind bars.
Take a look at Section 209 (3) of the Companies Act, which says that "proper books of account shall not be deemed to be kept if there are not kept such books as are necessary to give a true and fair view of the state of affairs of the company and if such books are not kept on accrual basis and according to the double-entry system of accounting." Failure to comply with these requirements is an offence punishable with imprisonment and fine. The same is the case with tax laws where assessees have to pay Income-Tax on income that is determined on the basis of accrual accounting.
What is passed off as financial statements by the government in its budgets is nothing but a simple account of cash receipts and payments that does not even follow the ancient Bahi-khata rules, or the original Arthashatra disclosures. It is an incomprehensible set of numbers, collectively referred to as Financial Statements that produces at the end a figure keenly debated nationwide as the fiscal deficit. What is our real fiscal deficit? No one really knows.
The government does not produce a balance sheet or statement of financial position, as it demands from taxpayers. There is no information at all on the government's financial position and condition, its revenues and costs, assets and liabilities and other obligations and commitments; a system of accounting where there is no accountability for receivables and for liabilities which are at present totally outside the books.
In short, the government accounts for everything on what is called cash basis (where the emphasis is on controls over cash receipts and disbursements) and not on an accrual basis, based on sound accounting methods that have been followed by many countries throughout the globe for the last 10 years and more.
The United States, United Kingdom, New Zealand, Australia, France, Finland and Canada (to name a few) are all on a full-fledged accrual accounting system of book-keeping and reporting that follows prescribed measurement standards.
As the Comptroller and Auditor General of India put it in a remarkable speech, 1 "The cash-based system lacks an adequate framework for accounting for assets and liabilities. Once an asset is acquired it virtually disappears from the accounts." He said in the same speech, "The cash-based system is not the most informative way of presenting accounts in a dynamic democracy like ours. It lacks transparency and it provides a weak basis for informed judgements on the performance of government in terms of economy, efficiency and effectiveness of its programmes."
The cash basis of accounting is dangerous even for individuals, who use credit abundantly these days. It is like someone who has bought a car or a house on installment payments and is not bothered about recognising the existence of the liability for future installments that have to be paid.
In a full accrual system of accounting, expenses are recorded in the period when the goods or services are consumed and revenues are recorded in the period when they are earned. Capital assets are recognised in the books, and an inventory of fixed assets is maintained. Non-cash transactions like depreciation, amortisation, provisions, accruals and receivable are all recorded in the books.
All liabilities are accounted for including recognition of retirement and pension benefits and accumulated leave and tax refunds due to assessees. All these features are conspicuous by their absence in the cash method, which the government has conveniently chosen to perpetuate.
The US government produces two sets of numbers for that country, one called the President's Budget which uses the cash basis and the other, Financial Report of the US Government, that uses the accrual basis. There is so much noise and debate in the US (take a look at the Cooper amendment discussions) about the fiscal deficit and its calculations.
According to the Financial Report using the accrual basis, this is a whopping $449.5 billion for the year ended 30 September 2006 as opposed to a smaller deficit of $247.7 billion according to the President's Budget using the cash basis. This means the real US deficit figure is 80 per cent more than what is reported using the cash basis of accounting.
This gives us an idea of how under-reported could be India's fiscal deficit and the related numbers that emanate from it. We do not have the numbers under accrual basis to make this comparison. Take, for instance, the liability of the government for employee benefits like pension and terminal benefits. The private sector is required to report all these liabilities based on an actuarial valuation in the financial reports. Does the government have an idea of what this figure under actuarial methods will be for, say, the defence sector, the Indian Railways or the organisations registered under the ministry of human resource development?
It will be astronomical and could be many times the fiscal deficit, given that the government employs millions of people. Is there any disclosure about this anywhere? Is not the government palming off this huge liability to an unsuspecting next generation?
There are erratic attempts to move away from the cash basis and some local bodies have plans to move into the double-entry system and on accrual basis, or modified accrual basis. But there is no focused national plan to take this huge project (it took New Zealand some seven years to achieve this) in a systematic manner with definite deadlines, except for statements of intent which are more recommendatory in nature like the Twelfth Financial Commission Report recommending that the government should gradually move towards accrual accounting.
There appears to be fear, uncertainty and doubt in the minds of people in the government about being transparent and accountable for the vast proportion of the resources that they command. Take a look at the Fiscal Responsibility and Budget Management Act of 2003, with only 13 sections. This is an Act to "ensure inter-generational equity in fiscal management and macro-economic stability", but fails to address important matters that are integral to the intent of the Act.
Fear is manifested in Sections 10 and 11 dealing with protection of action taken in good faith and barring the courts from questioning the legality of actions taken under the Act. Compare this with the South African Public Finance Management Act 2. This has 95 sections with far-reaching provisions that even define what "fruitless and wasteful expenditure" is.
The leading BPO and software companies keep the books of large global corporations and have both the IT and accounting capability to help the government. If the government cannot do the full-fledged accrual accounting job on its own, why does it not use these companies' help to sort out its own accounts? Is it because a true accounting picture will not show the government's accounts in a flattering light? But if we don't know the real picture, how will we start thinking of corrective action?