Citizens, taxpayers and investors must not sit back as governments continue to mismanage their fiscal positions. Neither a soundly-based recovery nor long-term sustainability can be attained without accounting reforms

I was quoted in a short article on government accounting practices that ran in The Economist in April (Book-cooking guide). The article highlighted a new International Monetary Fund Staff Discussion Note —Accounting Devices and Fiscal Illusions, by Timothy C. Irwin that discussed some of the devices governments use to misrepresent their financial performance and position.

While the IMF note certainly describes many legitimate concerns, the need for reform in government accounting practices and management is not a new issue.  The sovereign debt and global financial crises have undoubtedly made even more urgent the need for reform, but it was already long overdue pre-crisis.

The International Federation of Accountants has been speaking out on the need for reform for over a decade, and will remain committed to this cause.  And as early as 2007, we publically stated our concern that the standards and regulations governing sovereign issuers were not of sufficient quality to protect investors and ensure the stability of capital markets.

The Economist also published, on May 5, a letter in which I pointed out that the article understated the consequences of governments using these obsolete (cash-based) accounting practices and the fiscal illusions they enable.

First, governments that operate on a cash basis do not fully understand their financial position and performance and consequently cannot adequately manage them.  The cash-based systems that most governments currently use for budgeting, appropriations, and reporting attempt to manage highly complex financial transactions and positions with outdated accounting and budgeting technology.

Second, the use of cash-based numbers means politicians are confronted with incentives to manage in terms of those inadequate numbers.  This has the effect of, for example, encouraging them to substitute long-term liabilities (like pension obligations) for current cash outlays (like salary payments).

This has created huge public service pension obligations relative to debt in many countries. It creates the illusion of current solvency at the price of future crisis. The debt to GDP ratio is obviously not a good measure of fiscal position if, for example, non-debt liabilities are larger than the debt itself (as is the case in the United Kingdom).

Especially in the context of the sovereign debt crisis, the incentives faced by politicians in many countries encourage them to avoid the transparency that comes with robust accounting.  Consider how much worse the situation would look if the commonly used measure were total liabilities to GDP instead of debt to GDP.

For the United Kingdom, as an example, the ratio of total liabilities to GDP is approximately 170%, compared with a gross debt to GDP number of just 68% according to the Whole of Government Accounts for the 2009/10 fiscal year. Not to be obvious, the difference between the two measures represents an amount greater than the total output of the UK economy for a year.

IFAC has long recognised that one way to protect the public interest is to develop, promote, and enforce a common set of high-quality international financial reporting standards for the public sector.  Consistent with this, our view is that governments should adopt the accrual-based International Public Sector Accounting Standards set by the International Public Sector Accounting Standards Board.

But what is hard to understand is why there is no public outcry, no global pressure for reform?  Why has there not been the same reaction to revealed deficiencies in public sector accounting as was the case in the private sector, post-Enron?  How can governments not see that financial stability and confidence in financial markets relies as much on trust in the numbers coming from government as it does from the public sector?

In my letter to The Economist, I observed that the pessimistic note on which their article concludes (‘Don’t hold your breath’) suggests that we — as citizens, taxpayers and investors —will sit by watching our governments continue to mismanage their fiscal positions.  This is not acceptable.  Neither a soundly-based recovery nor long-term fiscal sustainability can be attained without reform.  The global economy and the welfare of future generations depend on it.

Ian Ball is the chief executive of the International Federation of Accountants