Why is more attention not paid to government financial statements?
Why is more attention not paid to government financial statements?
Notes for a speech by Michael Ferguson, Chartered Professional AccountantCPA, Chartered AccountantCA, Fellow Chartered Professional AccountantFCPA, Fellow Chartered AccountantFCA (New Brunswick), Auditor General of Canada, 23 November 2017
Most of you are familiar with what we do at the Office of the Auditor General of Canada, but I should, nevertheless, start with giving you an overview of the Office.
We have approximately 560 employees located mostly in Ottawa, but also in our regional offices in Halifax, Montréal, Edmonton and Vancouver. We work on performance audits of government programs and we audit of the financial statements of the Government and of its Crown corporations. We also carry out special examinations of the systems and practices in place in each of those Crown corporations once every 10 years. Performance audits are executed under my direction or under that of the Commissioner of the Environment and Sustainable Development.
Our work targets not only the federal government, but also each of Canada’s three territories since they do not have their own Auditor General. We recently released a report that is relevant to my discussion today. The report in question was a summary commentary on our 2015–16 financial audits. You can find this commentary on our website.
Personally, I have been Auditor General of Canada for six years now, and I have – I hate to mention it – worked for about 30 years in government financial management. Over the course of my career, it has been my responsibility both to prepare government financial statements and to audit government financial statements. I am therefore very familiar with the care and attention that goes into the preparation and public release of those statements.
Today, I would like to discuss one thing that bothers me about the government financial environment as it exists now: it seems that hardly anyone pays attention to a government’s financial statements. Now, of course, governments may see that as a feature of the system rather than a bug. But for me, my concern was again illustrated when, a few weeks ago, the federal government released its public accounts, which include its audited financial statements. I searched for the government’s news release about the publication of the public accounts. You can see a copy of what I found on the screen behind me.
You might work in a jurisdiction where the audited statements generate a lot of attention and discussion, and are seen as a valuable source of information by members of your legislatures; however, I believe that may be the exception rather than the rule. I contend that many people pay attention to a government’s budget, but almost no one pays attention to the actuals. Do not get me wrong: the budget is very important, as is the opportunity for Parliament to debate the estimates that authorize governments to spend. However, it reminds me of what Norm Betts, a former Minister of Finance in New Brunswick, used to say: “Anyone can balance a budget; balancing the actuals is what is hard!”
Maybe the lack of interest in the government financial statements could mean that they are not important. That worries me because it takes a lot of time and effort to prepare and audit government financial statements and other financial information. This makes us wonder why the Public Sector Accounting Board spends so much time fretting the details of government accounting standards. If, then, government financial statements are important, why do they not get more attention, especially from a key stakeholder: parliamentarians themselves?
This has gnawed at me for some time now, and today I will explore what I believe are the reasons that government financial statements do not get the attention that I think they deserve. According to the Public Sector Accounting Handbook, government financial statements should communicate information to users of those statements. To accomplish that, the Handbook tells us that the information must be relevant, reliable, and communicated in a useful manner. It also explains that relevant information is information that is predictive, retrospective, and accountable, and that it is timely. It states that the characteristics of reliable information are representational faithfulness, completeness, neutrality, conservatism and verifiability. It also states that to be useful, the information should be communicated so that it is comparable, understandable and clearly presented.
Relevant, reliable and useful.
Let us keep these three qualities in mind and explore the following questions:
- Is government financial information relevant? Does it matter?
- Are government financial statements reliable?
- Are they useful?
Does a government’s financial information matter?
We will start with relevance: Is government financial information important? Do government financial statements matter?
To explore relevance, I will start by presenting a reference from a book titled The Reckoning – Financial Accountability and the Rise and Fall of Nations by Jacob Soll. The name of the book alone gives some indication of the historical importance of accounting. Soll describes the role of accounting in the history of the Roman Empire, for example. He says that at many points, Cicero publicly complained that Vice Consul Mark Antony kept bad account books, forged accounts and signatures, and “squandered a countless sum of moneys” stolen from Caesar. Unfortunately for Cicero, just after he publicly denounced Mark Antony and his shady financial dealings, Mark Antony came to power as part of a triumvirate. Mark Antony hunted down Cicero and had his head and hands chopped off and displayed in the Forum. An act that Soll says grimly illustrates that the powerful do not respond well to those who call for their books to be opened.
Soll also tells us that bad accounting has a way of coming back to haunt those who practice it. After the triumvirate had broken apart, another of its members, Octavian, defeated Mark Antony in battle, which led to his suicide. Octavian took power, became Emperor Augustus, and brought order to the chaotic empire. Unlike Mark Antony, Augustus kept good account books, and made the accounts public, which meant he was able to live a long life. He died either of natural causes, or because his wife poisoned him – which probably would have had nothing to do with accounting infidelities.
History tells us that government financial reporting was important to the extent where bad financial accounting and reporting resulted in bloodshed. But is government financial reporting important today?
One of the few organizations that has done some research into the state of senior government financial reporting in Canada is the C.D. Howe Institute. Each year, it produces a scorecard of senior governments’ financial reporting. The most recent is its report titled Numbers You Can Trust? The Fiscal Accountability of Canada’s Senior Governments, 2017. That report explains that government financial information plays an important role in Canadian democracy. It says – and I am paraphrasing – that Canadian, governments provide a wide range of services, such as national defence, policing, health, education and income support. And in 2016, all the levels of government combined incurred expenses that equaled about 40 % of gross domestic product or GDP. Furthermore, it states that the federal and provincial governments have unlimited legal authority to borrow if they spend more than they raise through taxes and fees. For these reasons, the report explains that “ensuring that taxpayers and citizens can monitor, influence and react to the resources their elected representatives and officials manage is central to democratic government.”
Finally, the C.D. Howe Institute’s report states that audited financial statements provide critical information that can be compared to the spending intentions that governments presented in their budgets at the beginning of the fiscal year. That means that how faithfully a governments’ financial statements reflect its actions, and how readily readers of those financial statements can find and interpret the information is vitally important.
I think that I have made both the historical and the contemporary case that government financial information is relevant and important.
Are government financial statements reliable?
I am now going to turn to the second quality of financial information and look at whether government financial statements are reliable. Here, I will draw on my own experience:
The financial statements of governments in the 1980s and 1990s were often the subject of political fights. Much like Cicero in ancient Rome, opposition parties in the 80s and 90s regularly accused governments of funny accounting, and disputed the published results. Many of their complaints had merit, although no blood was shed because of it.
We must remember that in the very early 80s, accounting standards did not exist for government financial statements, and even after the then Public Sector Accounting and Auditing Board was established, it took years to establish a set of standards that covered the most problematic topics. Topics included the following: What should be included in the reporting entity? How should we account for tangible capital assets? Are loans that a government essentially repays to itself really considered assets? How do we account for government business enterprises – that being entities that make money?
The accusations of smoke and mirror accounting that were so common 20 to 30 years ago not only affected the reputation of governments; it also affected the reputation of the auditors of those government financial statements. On the campaign trail, opposition parties would promise that, if elected, they would have an independent auditor go through the government’s books. A direct, although not necessarily intentional, questioning of the competence of auditors general of the time. It was not until years later that governments generally got to the point where, in the words of one Nova Scotia politician – we can stop arguing over what the numbers are, and start arguing over what they mean.
We now live in a world where, for example, the recently released (without fanfare) financial statements of the Government of Canada were the 19th in a row without a modified auditor’s opinion. Because there is now a very robust set of accounting standards for governments in Canada, all senior governments should be able to produce a set of statements without a modification to the auditor’s report. I will make the possible exception of when a government implements a new complex accounting standard that might take some time to put in place. But even for those, Public Sector Accounting BoardPSAB now usually gives generous transition periods, so that a modified audit opinion be extremely rare. For the most part, we now operate in a world where government financial statements receive clean audit opinions.
But there are exceptions.
In fact, it is very disturbing that three large provinces choose not to comply with generally accepted accounting principles for some transactions, and receive modified audit opinions on their summary financial statements. Those three provinces are of course British Columbia, Ontario and Quebec, although in Quebec’s case I am referring to their 2016 financial statements because they have not yet issued their 2017 statements. But, in jurisdictions where all the accounting rules are followed and there are no modifications to the audit opinion, there is little argument about what the numbers are. Unfortunately, that may also mean that fewer people look at the numbers to figure out what they mean.
I think that for many senior Canadian jurisdictions (with notable exceptions, the most worrisome of which is Ontario right now) I can say that government financial statements are reliable. This is something I could not have said at the start of my career in government. Perhaps the lack of interest in reliable government financial statements means that they are now a victim of their own success.
Are government financial statements useful?
If, then, government financial information matters, and many government financial statements are reliable, we should expect not to like the answer to the last question: Are they useful?
For financial statements to be useful, they have to communicate quality information that a user can understand in sufficient, but not excessive, quantity. And the information has to be available when the user needs it. Let us start with that last point and look at the timeliness of government financial statements.
The provincial, territorial and federal governments in Canada have a 31 March year-end. Using the dates of when governments tabled their 2016 financial statements – and I used 2016 because not all jurisdictions have tabled their 2017 financial statements yet – we see that Alberta tabled its audited 2016 financial statements at the end of June 2016, three months after its year-end. Both Saskatchewan and British Columbia tabled theirs in July. The three largest jurisdictions, the federal government, Ontario and Quebec tabled their financial statements in October, more than six months after their year-ends. PEI was the last province to table their 2016 financial statements, in December.
We all know how much work it takes to prepare and audit a set of financial statements for a senior government, so to us, most of those dates sound reasonable. But I looked at the financial statements of Exxon Mobile Corporation for the year ended 31 December 2016. Over the years 2012 to 2016, Exxon had revenue of between $451 billion and $219 billion, which is in the same range as the Government of Canada’s revenue totaling about $293 billion for the year ended 31 March 2017. In Exxon’s management discussion and analysis, about seven pages explain critical estimates and uncertainties they have to deal with in their accounting. They have to make estimates in complex areas, such as oil and natural gas reserves, impairments, asset retirement obligations, suspended exploratory well costs, and tax contingencies. Let us also not forget that their financial information will be relied on by users to make investment decisions. Despite all that, Exxon’s audit report for its 31 December 2016 financial statements is dated 22 February 2017, less than two months after its year end. They, like all other publicly traded companies, have had to balance precision and timeliness, with timeliness being the priority.
Perhaps one reason that government financial statements do not receive the attention they should is that in most cases, they are not timely even though we may think they are. At the federal level, if the audited financial statements could be tabled in mid-June, they would be available before Parliament breaks for the summer and while the previous fiscal year still matters.
I have probably caused everyone in this room who works for the federal government to go into spasms, including those who work at the Office of the Auditor General. Do not worry; I do not expect it to happen. But, in my opinion, historical financial information reaches its best-before date very quickly, and most governments release their financial statements too late. By the time they are released, the fiscal year that they cover is quickly forgotten.
If government financial statements are not timely, it is not something you hear about, except in the most egregious cases. That is probably because parliamentarians do not know when financial statements should be released. Most of them have nothing to compare it to, so few – if any – complain that the financial statements are not timely. That does not mean they are timely. If they are not timely, that would be a reason why the financial statements might be ignored. Information that is not timely is not useful.
What about the financial information itself? Are all the numbers and the words in a set of financial statements useful? The report by the C.D. Howe Institute that I referred to earlier states that there is useful information in government financial statements.
That is good news.
The report specifically mentions the statement of operations and the statement of financial position. Therefore, there is useful information in government financial statements, even if it is not timely. That means that we are left with the real reason that the statements do not get much attention.
They scare readers.
I am not referring to readers like bond rating agencies. Detailed and dense financial information does not scare off the few sophisticated users out there, but on the other hand, those users do not really rely very much on the financial statements because they can get the information they need through other means. It is the less sophisticated reader who is scared off, and that probably includes most parliamentarians. They see a wall of numbers and words, densely packed together, written in technical language, and usually presented in the passive tense. They do not know how to interpret it or what questions to ask. They are probably afraid to ask questions about it in case those questions reveal that they do not understand the information they read. For example, who can really make sense out of a government’s statement of cash flows?
What does it really tell anyone?
Certainly, an indirect method statement of cash flow with a bottom line that is the amount of cash and cash equivalents that a government has on hand at the end of the year is – not to pull any punches – pretty useless. The federal government, for example, has over $714 billion in net debt. Therefore, what is relevant about a statement that shows how its cash position changed over the fiscal year? I do not think that they are even any government decision makers who would say that they use that statement. I had hoped that the direct method approach to cash flow would solve that problem, but the few of them I have seen have left me just as confused. Maybe the cash flow statement could be salvaged if it was rearranged to put the emphasis on changes in the government’s debt position; that is if the emphasis was on what the government borrowed and what it borrowed for. Even that might not be easy to understand and if that is the case, in my opinion, the flow statement should no longer be a required financial statement.
Perhaps PSAB should relax its standards to allow governments and government organizations to experiment with how they report flow information. While the statement of cash flow presents a wall of nearly impenetrable numbers to the reader, many notes to the financial statements present a wall of nearly impenetrable words. For example, if a reader wanted to understand a government’s contingent liabilities, I think the information contained in many government financial statements would leave them frustrated. I think that all governments could still make many of the notes to their financial statements more reader-friendly. And, generally, I think that the financial statement discussion and analysis that goes with a set of government financial statements usually only provides marginal help to the reader. For example, one accepted measure of a government’s financial situation that is reported in many government financial statement discussions and analyses, is the ratio of debt to GDP. However, there are many different ways to define debt in that calculation. And no one has ever been able to say what an ideal debt to GDP ratio is for a government.
Without a real target, and an explanation of why that target was chosen, the ratios do not help the reader understand a government’s financial position very much. In fact, the ratio of debt to GDP can confuse readers because the ratio can improve even in years that a government runs a deficit. That sends mixed messages to a reader of the financial statements who assumes a deficit is bad, but an improved debt to GDP ratio is good.
From the federal government’s financial statement discussion and analysis, I can come up with at least five different ways to calculate a debt to GDP ratio, depending on the definition of debt that I use. That means that different analysts might use different ratios, all of which are right, but all that result in a different number.
That confuses people.
The federal government could use its financial statement discussion and analysis to help people understand what each of those ratios represent and how they relate to each other. After all, debt to GDP is a key financial ratio that comes directly from information contained in the financial statements. The federal government’s financial statement discussion and analysis explicitly gives four measures of debt to GDP, and we can calculate the fifth.
The four measures, in ascending order, are the following:
First, a ratio calculated by the International Monetary Fund, or IMF, that says that Canada’s total government net debt to GDP – not just federal government but all levels of government – was about 28%. Those of you who work in the area know that that number sounds much too low. In its calculation, the IMF uses a debt number that includes – and stay with me on this – the net debt of all levels of government, but then removes government employee pension plan liabilities and deducts the value of the assets in the Canada Pension Plan and the Quebec Pension Plan. They do this to make the result comparable to other G7 countries. But that also means that the absolute percentage of 28% does not actually reflect government debt in Canada.
The second measure of debt to GDP is the federal government’s accumulated deficit to GDP, which was about 31%. The third measure is the federal government’s net debt to GDP, which was about 35%. And the fourth measure is the federal government’s interest bearing debt to GDP, which was about 48%.
The financial statement discussion and analysis does not give the fifth ratio (the ratio of total liabilities to GDP), but we can calculate it to be about 54%.
There are therefore five measures of debt to GDP, depending on your definition of debt; a nuance that most readers will not understand. They will just hear different analysts talking about some measure of debt to GDP using anything from 28% to almost double that – 54%. And they will not know what to believe. That is only one example of how even the analysis of financial information does not render it more accessible to the non-expert reader. I have used the federal government as an example because it is the one that I know the best. However, I am sure that there are similar problems with the financial statement discussions and analyses issued by other Canadian governments.
There is much more behind the numbers in the financial statements than a reader can understand. If we want them to understand, we need to better explain what the numbers mean. In my opinion, this is the number one reason why financial statements are not used: it takes too much work to understand their messages other than the very simple message of whether the government had a surplus or a deficit.
To summarize the answers to the three questions I asked at the beginning, I can say that government financial statements are important and that they matter. They are also, in many cases, reliable. While they are inherently useful, they are not really useable.
Now that I have answered the three questions, here is a summary of what I learned as I put this presentation together.
First of all, we should be proud of the Canadian governments that have made their financial statements robust and reliable. As an opposition member on the federal public accounts committee recently said, we should be celebrating 19 years in a row of unqualified audit opinions for the federal government. But governments should not choose which public sector accounting standards to apply or not to apply. It is unacceptable that three provinces choose to have qualified audit opinions. Also, PSAB is the reason that Canada has robust accounting standards for governments. Thanks to all the good work done since it was formed; work led by John Kelly, Ron Salole, Tim Beauchamp and now Michael, not to mention the work done by all the staff at PSAB. PSAB took on the task to put in place a set of Canadian government specific accounting standards – and that work took many years of effort.
Governments also need to make their financial information more accessible.
They should look at the notes to their financial statements to see whether they are written just to comply with standards or whether they truly convey information that is understandable.
They also need to look at their financial statement discussion and analysis to see if it is an insightful document that truly helps the reader get behind the numbers.
To conclude, I would like to leave you with two parting thoughts: If I had my way, governments and auditors would work toward financial statements that are tabled by mid-June each year; and PSAB would seriously reconsider the worth of the cash-flow statement.
Thank you for your attention.