China moves ahead on accrual accounting

8 Dec 15

China has made good progress in implementing accrual accounting, but big challenges remain.

With over 15,000 budget entities in central government, and hundreds of thousands in local government, good government accounting is obviously very important in China. From a fiscal risk point of view, local government is perhaps the most important, as they have borrowed extensively through informal mechanisms in the past decade, and have started doing so formally (on a non-pilot basis) through bond issuance at the start of this year. For this reason, China’s State Council approved the Accrual Government Comprehensive Financial Reporting Reform Plan in 2014. As part of the plan’s implementation, the Ministry of Finance (MOF) recently published a package of accounting and financial reporting guidelines, including the Government Accounting Basic Standard, Government Financial Reporting Regulations, and the General Budget Accounting Regulation. The issuance of these critical documents marks the start of a substantial transformation China is making towards adopting accrual accounting.

Long time in development

MOF started its orientation on accrual government accounting at the beginning of the century. After a few international comparative studies and the review of the current accounting system, MOF established a government accounting reform committee to promote the reform process. The committee carried out dozens of studies on the feasibility of transitioning from cash to accrual accounting, the relationship between budget and financial reporting, the classification of reporting entities, the definition of liabilities and assets in the Chinese context, etc. However, because preventing fraud and abuse of public funds was initially the MOF’s top priority, PFM reforms focused on budget management and reporting, and expenditure control issues. Most resources were directed towards basic reforms in the PFM system such as the Departmental Budget Reform, Treasury Single Account Reform, and Government Procurement Reform. Accrual accounting did not make much progress in practice until 2010.

In 2011, MOF started with an initiative on accruals at the subnational level. Eleven provincial governments and eleven municipalities participated successfully in a pilot to produce accrual-based government financial reports by transforming and reorganizing data from current final accounts and other relevant documents. While the methodology was crude, it was the easiest way to start and did not require much resource input. From then on, more and more subnational governments joined this experiment. Based on this pilot’s relative success, it was concluded that accrual accounting reform, designed for the Chinese context, would be feasible for all levels of governments.

Speeding up the move to accruals

With basic PFM functionality established, China started a few years ago to look at more advanced PFM reforms. In 2014, China published its new budget law and the Fiscal and Tax System Reform Plan, which vowed to implement systemic PFM reforms, such as strengthened government debt management, a new medium-term fiscal framework, performance budgeting, etc. However, without the support of state-of-the-art government financial information, most of which should be based on accrual accounting, these advanced reforms have little chance to succeed. Good government accounting is the infrastructure of a modern PFM system.

Three examples highlight the role accrual accounting can play. First, high quality balance sheet information is a prerequisite for effective government debt management. During the past few years, subnational governments of China have accumulated huge amounts of debts. Since subnational governments have no reliable balance sheets, it is hard to know how much debt they have, and even harder to control its expansion. To address this the central government requires the National Audit Office (NAO) to collect and verify the fragmented subnational debt data from time to time. Accrual accounting can fill this information gap by producing consolidated financial statements which cover all government entities. High quality balance sheets will provide more timely and structured information on local government finances for both administrative and market oversight.

Second, accrual accounting can play an important role in government asset management. In order to satisfy the growing needs for modern infrastructure, China has invested a lot of public funds in roads, bridges, sewer lines, waste disposal plants, etc. However, some of these assets are not maintained well and some are even forgotten by government entities which supported their funding. Accrual accounting requires careful identification, reliable measurement, and periodic reporting on all kinds of assets, including not only those used by governments themselves, but also of the public bodies and state-owned enterprises they control. With the help of accrual accounting, governments can adopt a more systematic approach to keeping track of all government assets and strengthening their management.

Third, accrual accounting lays the foundation for better government performance measurement. A few years ago, the government started a campaign to decrease operational costs in budget entities. However, the achievements were vague because lack of relevant cost information. For example, depreciation of fixed assets, accrued civil service pensions etc, are all government costs, which cannot be captured by cash accounting. Only after fully adopting accrual accounting, can governments clearly present the cost of every programme or cost centre.

Challenges ahead

Although recently published accrual accounting standards and regulations have laid a good foundation for progress, there are still some big challenges ahead. The obvious one is how to develop uniform accounting application guidance for all government entities. Given the huge number and diversified nature of government entities in China, there are a vast number of practical issues that need to be resolved, such as defining the scope of the reporting entity, reconciling mismatches in related party information, assessing useful lives for different types of assets, etc. Since accounting standards are principal based, detailed and uniform application guidance is necessary to ensure consistency in practice.

Limited institutional capacity is also a significant obstacle. There are about one million accounting staff working at all levels of government in China. Most have very limited knowledge of accrual accounting, which is quite complex relative to cash accounting. Extensive and cost-effective capacity building programmes should be set in place as soon as possible. Asset valuation and auditing are related activities that will need to complement the accounting for revenues and expenses.  A training strategy for these professions should be developed as well.

The modernization of IT systems is another big issue in the public sector (which lags behind the private sector in this area considerably). Implementation of an integrated financial management information system (IFMIS) is usually one of the most significant structural components of an accrual accounting project. While a fully integrated IT system may be out of reach for a large country like China, automated interlinkages should be developed. Within MOF itself, fragmented IT systems will need to be fully integrated and better linked with other departments to reduce work load, and improve accuracy, dependability and timeliness of data.

This article was first published on the IMF PFM Blog, the International Monetary Fund's forum on public financial management innovation, capacity building and technical assistance. The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.

  • Guohua Huang

    technical assistance advisor with the PFM2 division of the IMF’s Fiscal Affairs Department (FAD). He worked at the Ministry of Finance of China for nine years and was a member of the International Public Sector Accounting Standards Board (IPSASB).

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