CHAPTER ONE

OVERVIEW OF FINANCIAL REPORTING FOR GOVERNMENTAL AND NFP

ENTITIES

INTRODUCTION

There are organizations whose object is not to make profit. These not-for-profit organizations
account their resources and financial activities under different accounting system. Every
organization wants to be successful. In order to know if it is successful, “success” must be
defined in terms of goals. And then it needs some means to measure its results against its goals.
Measuring success is often thought of in terms of effectiveness (achieving the goal at the highest
level) and efficiency (achieving the goal through using the least amount of resources. For profit
seeking organizations (FP) or organizations whose objective is to make profit, both efficiency
and effectiveness can easily be measured with financial statement. There are certainly non-
financial criteria to judge success like qualitative or quantitative measures. But regardless of
what other measures are employed, ultimately effectiveness will be measured by the income
statement. Not only income statement measures effectiveness, it also measures efficiency. As
with efficiency, there may be non-financial criteria for evaluating efficiency. But ultimately,
efficiency is evaluated by the expense section of the income statement. If expenses are less than
revenue and the organization has earned an “acceptable” profit, then we can say it is successful
in efficiency. We can therefore say that the objective of the income statement is to demonstrate
both the effectiveness and efficiency of the organization.

For not-for-profit organizations (NFP) however, these objectives are not as useful. Without a
good measure of effectiveness, measurement of efficiency becomes almost meaningless. If NFP
accounting system cannot measure effectiveness (as can profit seeking accounting systems),
what then is their use? They are most often employed to control public resources i.e. each person
given custody of or access to public resources should report back as to how they were used. The
public can then hold the person accountable for the proper use of the resources. This means that
the income statement is only limited to use in judging effectiveness. Both the nature of non-profit
organizations and the objectives of their financial reporting have given rise to a particular
accounting method, i.e. the use of “fund accounting”

1.1. Distinguishing characteristics of Governmental and Not- for Profit entities

A non-profit (not- for profit) organization is a legal accounting entity that is operated for the
benefit of society as a whole rather than for the benefit of an individual proprietor or a group of
partners or shareholders. Thus, the concept of net income is not meaningful for non-profit
organization. A non-profit organization strives only to obtain revenue & support sufficient to
cover its expenses. The major types of government and nonprofit organizations may be
classified as:

 Governmental Units: When thinking of governmental units, one tends to focus upon the
federal government, or on the states within the federal government (state governments) or
those major local governmental units or organizations within those governments.
 Educational Institutions: These could be private, public or community E.g. Colleges &
University, schools.

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  Health Care Providers: These could be private, public or community E.g. hospitals,
clinics, nursing home, Red Cross
 Voluntary Health & Welfare Organizations (VHWO): E.g. NGOS like US AID, save
the children, Care Ethiopia etc.
 Other NFP Organizations E.g. Philanthropic foundation, Political parties, Civic
organizations
A Government &Not for Profit organization exists because a community or society decides to
provide certain goods or services to its group as a whole. Often these goods or services are
provided regardless of whether costs incurred will be recovered through charges for the goods or
services or whether those paying for the goods or services are those benefiting from them.

Governments and other non-profit organizations are unique in the following ways:
 They do not attempt to earn a profit—and most are exempt from income taxes—so
typical business accounting, including income tax accounting, usually is not appropriate.
 They are owned collectively by their constituents; because ownership is not evidenced by
equity shares that can be sold or traded, residents who are dissatisfied with their
government must await a change in its elected governing body or move elsewhere.
 Those contributing financial resources to the organizations do not necessarily receive a
direct or proportionate share of their services. For example, homeowners pay property
taxes to finance public schools even if they do not have children in school.
 Their major policy decisions, and perhaps some operating decisions, typically are made
by majority vote of an elected or appointed governing body (e.g., a state legislature, a
city council, or a hospital board of directors) whose members serve part time, receive
modest or no compensation, and have diverse backgrounds, philosophies, capabilities,
and interests.
 Decisions usually must be made “in the sunshine”—in meetings open to the public,
including the news media—and most have “open records” laws that make their
accounting and other records open to the public.
In generally, there are three distinctions noted by the financial accounting standards board
(FASB) which characterize NFP organizations as
 Receipts of significant amount of resources from resource providers who do not expect
to receive either repayment of economic benefit proportionate to the resources provided
 Operating purposes that are other than provide goods or services at a profit or profit
equivalent
 Absence of defined ownership interests that can be sold, transferred, redeemed, or that
convey entitlement to a share of residual distribution of resources in the event of
liquidation of the organization.
 Putting these points in simple terms we might say that an NFP:
 Gets money from people whom do not necessarily expect anything in return. (eg. Tax
payers, donors to NGOs)
 Is not trying to make money
 Does not have ownership shares that can be sold or bought
The Governmental units and other non-profit organizations would have the following common
characteristics but not with business.

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  Organization to serve the society (citizens): governmental units exist to serve the citizens
subject to their jurisdictions
 General absence of profit motive: With few exceptions, governmental units render
services to the citizenry without the objective of profiting from those services
 Society as a principal source of revenue: depend on the general population for a
substantial portion of their support
 Importance of budget: The government can then hold the person accountable for the
resources. This means that budget become highly important in governmental entities
 Stewardship for resources: governmental units in financial reporting demonstrate
adequate stewardship for resources provided by its citizenry.
1.2. Sources of financial reporting standards for Governmental and NFP entities
in Ethiopia
Proclamation no, 847/2014 is a proclamation to provide for financial reporting which was issued
in 2014 to establish a sound, transparent and understandable financial reporting system
applicable to entities in both private and public sectors. It give rise the accounting and auditing
board of Ethiopia (AABE) with responsibility of direct financial reporting issues in Ethiopia.
In Article 4, sub article 1; The Accounting and Auditing Board of Ethiopia (AABE) shall be
established by regulation to be issued by the Council of Ministers. Sources of financial reporting
standards for Governmental and NFP entities in Ethiopia is stated here article 4, sub article 2;
The Board(AABE) shall have the powers and duties to: (a) issue standards and directives
relating to financial reporting and auditing and ensure compliance therewith.
Article 5 sub article 1 states the financial reporting standards to be used when preparing financial
statements shall be:
a) international financial reporting standards
b) international financial reporting standards for small and medium enterprises;
c) International Public Sector Accounting standards (IPSAS) applicable to charities and
societies.
Which is issued by the International Accounting Standards Board or its successor or issued by
the International Public Sector Accounting Standards Board or its successor as adopted, adapted
or amended by the Board.
1.3. Objectives of financial reporting in NFP entities

The objectives of financial reporting by public sector are to provide information about the entity
that is useful to users of general purpose financial reports (GPFRs) for accountability purpose
and for decision making purpose. The financial reporting is not an end of itself. Its purpose is to
provide information to users of GPFRs. The objective of financial reporting is therefore
determined by reference to the users of reports and their information need.
General purpose financial report of public sector entities are primarily develop to respond the
information needs of service recipients and resource providers who don’t possess the authority to
require a public sector entities to disclose the information they need. Government’s and other
public sector A entities raise the resource from taxpayers, donors, lenders and others resource
providers.

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Users of Financial Reports can both internal external users;
 Internal (governing bodies of state and local governmental units)
 External citizens, regulatory bodies, rating agencies, lending institutions, academics and
supernational organizations such as world bank

The information need of these users varies considerably as their interest of information. In
generally, financial statements of public sector entities should meet:
 For accountability and decision making purpose the users will need information that
supports the assessment of
1. The performance of the entity during the reporting periods in,
 Meeting its service delivery and other operating and financial objectives;
 Managing the resources it is responsible for;
 Complying with the relevant budgetary, legislative and other authorities
regulating the raise and the use of resource.
2. The liquidity such as ability to meet current obligation, solvency that is ability to
meet obligation in long term.
 Financial reporting should assist in fulfilling governmental duty to be publicly
accountable & should enable users to assess that accountability by:

 Providing information’s to determine whether current year revenues were

sufficient to pay for current year services.
 Demonstrating whether resources were obtained & used in accordance with the
entities legally adopted budget & demonstrating compliance with other finance
related or contractual requirements.
 Providing information to assist users in assessing the service efforts, costs &
accomplishment of the governmental entity.

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  Finical reporting should assist users in evaluating the operating results of the
governmental entity the year by:

 Providing information about sources and uses of financial resources.

 Providing information how it financed its activities and met its cash
requirements.
 Providing information necessary to determine whether its financial position
improved or deteriorated as a result of the year’s operations.
 Financial reporting should assist users in assessing the level of services that can be
provided by the governmental entity and its ability to meet its obligations as it become
due by.

 Providing information about its financial position and condition

 Providing information about its and other non-financial resources.
 Disclosing legal or contractual restrictions on resources and the risk of potential
loss of resources.
In generally IPSASB assumes the following as the main information needs of users of GPFRs in
the public sector:
 Performance (accomplishment of operational and financial objectives; resource
management; compliance with regulation and laws);
 Liquidity and solvency of the entity;
 The sustainability of the entity’s service delivery and other operations over the long term;
 Whether resources are used economically, efficiently, effectively and as intended;
 Whether the volume and cost of services provided during the reporting period are
appropriate;
 Whether levels of taxes or other resources raised are enough to maintain the volume and
quality of services;
 How current operations are being funded (taxes, borrowing, other sources…); and
 Future funding needs and sources.

1.4. IPSAS versus IFRS

There are main accounting principles constituting important postulates or assumptions in PSA,
the interpretation of which might be different from that in business accounting.
Like in business accounting, in PSA under IPSAS the accrual regime prevails in financial
accounting – transactions are recognized when they occur (and not when cash or equivalent is
received or paid); transactions and events are recorded and recognized in the financial statements
of the periods to which they relate. Elements to be recognized are assets/liabilities,
expenses/revenue and net assets/equity. Still, the application of the matching concept required
under this principle is problematic in public sector organizations, questioning the meaning of the
deficit/surplus in the financial performance statement and raising a need to consider non-
financial performance reporting as a complement.
Unlike IFRS-based business accounting, under IPSAS, a cash regime might also be used in
financial accounting. in budgetary accounting, recognizing transactions only when cash or
equivalent is received or paid; statements provide information on sources of cash raised during

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the period, the purposes for which cash was used, and the balance at the reporting date. Elements
to be recognized are cash expenditure – payments, and cash revenue – receipts
Table 1.1. shows comparison between IPSAS & IFRS

1.5. The Conceptual Framework for Public Sector Accounting [The IPSASB]

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First accrual basis International Public Sector Accounting Standards (IPSAS) were developed in
1997.The IPSASB issues IPSASs dealing with financial reporting under the cash basis of
accounting and the accrual basis of accounting. They were developed by referencing the
International Accounting Standards (IAS), issued by the International Accounting Standards
Board (IASB), which have now been subsumed within International Financial Reporting
Standards (IFRS).

The accrual IP'SAS is based on the IFRS, where the requirements of those Standards are
applicable to the public sector. They also deal with public sector specific financial reporting
issues that are not dealt with in IFRSs.

The adoption of IPSASs by governments will improve both the quality and comparability of
financial information. The IPSASB recognizes the right of governments and national standard-
setters to establish accounting standards and guidelines for financial reporting in their
jurisdictions. The IPSASB encourages the adoption of IPSASs and the harmonization of
national requirements with IPSASs.

Financial statements should be described as complying with IPSASs only if they comply with all
the requirements of each applicable IPSAS.
Principles-based accrual accounting standards, such as IPSAS, are underpinned by a conceptual
framework that provides the broad principles on which the accounting standards are built. In
addition, the conceptual framework underpins the Recommended Practice Guidelines issued by
the IPSASB.

The Conceptual Framework of the IPSASB was published in full on 31 October 2014 with the
title ‘The Conceptual Framework for General Purpose Financial Reporting by Public Sector
Entities’. The Conceptual Framework for General Purpose Financial Reporting by Public Sector
Entities (the Conceptual Framework) provides the International Public Sector Accounting
Standards Board (IPSASB) with the concepts that will underpin the development of International
Public Sector Accounting Standards (IPSASs) and Recommended Practice Guidelines (RPGs) in
the coming years. It enables the IPSASB to further improve the consistency of its standard-
setting by strengthening the linkage between IPSASs. Additionally, the transparency of the
concepts underpinning the development of IPSASs and RPGs enhances the IPSASB’s
accountability.

The Conceptual Framework also responds to key public sector characteristics in its approach to
elements (the building blocks of financial statements), the measurement of assets and liabilities,
and the presentation of financial reports, while focusing on service recipients’ and resource
providers’ needs for high-quality financial reporting information for both accountability and
decision-making purposes.

1.5.1. Objectives of financial reporting

Financial statements are a structured representation of the financial position and financial
performance of an entity. The objectives of general purpose financial statements are to provide

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information about the financial position, financial performance, and cash flows of an entity that
is useful to a wide range of users in making and evaluating decisions about the allocation of
resources. Specifically, the objectives of general purpose financial reporting in the public sector
should be to provide information useful for decision making, and to demonstrate the
accountability of the entity for the resources entrusted to it, by:
 Providing information about the sources, allocation, and uses of financial resources;
 Providing information about how the entity financed its activities and met its cash
requirements;
 Providing information that is useful in evaluating the entity’s ability to finance its
activities and to meet its liabilities and commitments;
 Providing information about the financial condition of the entity and changes in it; and
 Providing aggregate information useful in evaluating the entity’s performance in terms
of service costs, efficiency, and accomplishments.
General purpose financial statements can also have a predictive or prospective role, providing
information useful in predicting the level of resources required for continued operations, the
resources that may be generated by continued operations, and the associated risks and
uncertainties. Financial reporting may also provide users with information:
 Indicating whether resources were obtained and used in accordance with the legally
adopted budget; and
 Indicating whether resources were obtained and used in accordance with legal and
contractual requirements, including financial limits established by appropriate legislative
authorities.
The objective IPSAS is to prescribe the manner in which general purpose financial statements
should be presented to ensure comparability both with the entity’s financial statements of
previous periods and with the financial statements of other entities.

General purpose financial statements are those intended to meet the needs of users who are not in
a position to demand reports tailored to meet their particular information needs. Users of general
purpose financial statements include taxpayers and ratepayers, members of the legislature,
creditors, suppliers, the media, and employees. General purpose financial statements include
those that are presented separately or within another public document such as an annual report.
This Standard does not apply to condensed interim financial information

The IPSAS applies to all public sector entities other than Government Business Enterprises
(GBEs). GBEs include both trading enterprises, such as utilities, and financial enterprises, such
as financial institutions. GBEs are, in substance, no different from entities conducting similar
activities in the private sector. GBEs generally operate to make a profit, although some may have
limited community service obligations under which they are required to provide some
individuals and organizations in the community with goods and services at either no charge or a
significantly reduced charge.
A complete set of financial statements comprises:
 A statement of financial position;
 A statement of financial performance;
 A statement of changes in net assets/equity;

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  A cash flow statement;
 When the entity makes publicly available its approved budget, a comparison
of budget and actual amounts either as a separate additional financial
statement or as a budget column in the financial statements; and
 Notes, comprising a summary of significant accounting policies and other
explanatory notes
The financial statements provide users with information about an entity’s resources and
obligations at the reporting date and the flow of resources between reporting dates. This
information is useful for users making assessments of an entity’s ability to continue to provide
goods and services at a given level, and the level of resources that may need to be provided to
the entity in the future so that it can continue to meet its service delivery obligations.

Public sector entities are typically subject to budgetary limits in the form of appropriations or
budget authorizations (or equivalent), which may be given effect through authorizing legislation.
General purpose financial reporting by public sector entities may provide information on whether
resources were obtained and used in accordance with the legally adopted budget. Entities which
make publicly available their approved budget(s) are required to comply with the requirements
of IPSAS 24, “Presentation of Budget Information in Financial Statements.” For other entities,
where the financial statements and the budget are on the same basis of accounting, this Standard
encourages the inclusion in the financial statements of a comparison with the budgeted amounts
for the reporting period.

1.5.2. Fundamental concepts Recognition, measurement, and disclosure concepts

Basic concepts
There are main accounting principles constituting important postulates or assumptions in PSA,
the interpretation of which might be different from that in business accounting. Some of these
principles are; accrual, going concern and substance over form – are addressed here, within the
IPSAS perspective.
 Accrual concern
Accrual basis means a basis of accounting under which transactions and other events are
recognized when they occur (and not only when cash or its equivalent is received or paid).
Therefore, the transactions and events are recorded in the accounting records and recognized in
the financial statements of the periods to which they relate. The elements recognized under
accrual accounting are assets, liabilities, net assets/equity, revenue, and expenses. However
under IPSAS, a cash regime might also be used in financial accounting.
 Going concern
Another important principle is the going concern, by which financial statements must be
prepared on a going concern basis, unless there is an intention to liquidate the entity or to cease
operating, or if there is no realistic alternative but to do so.
When preparing financial statements, an assessment of an entity’s ability to continue as a going
concern shall be made. This assessment shall be made by those responsible for the preparation of
financial statements. Financial statements shall be prepared on a going concern basis unless there
is an intention to liquidate the entity or to cease operating, or if there is no realistic alternative

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but to do so. When those responsible for the preparation of the financial statements are aware, in
making their assessment, of material uncertainties related to events or conditions that may cast
significant doubt upon the entity’s ability to continue as a going concern, those uncertainties
shall be disclosed. When financial statements are not prepared on a going concern basis, that fact
shall be disclosed, together with the basis on which the financial statements are prepared and the
reason why the entity is not regarded as a going concern.
While this appears to be similar to business accounting, a different interpretation is required in
the public sector context: instead of considering financial viability issues (essentially reflected in
the net financial position), a long-term perspective of financial sustainability must be considered,
pointing to continuity in public service provision. As in businesses, material uncertainty might
raise doubts about an entity’s ability to continue. Yet, in the public sector, not only tests of
liquidity and solvency are important, but other (non-financial) issues (e.g., power to levy taxes,
multi-year funding agreements, merging, restructuring, etc.) are, too, so the going concern relates
to the ability of maintaining public service provision as expected.
 Economic Entity
The term economic entity is used in this Standard to define, for financial reporting purposes, a
group of entities comprising the controlling entity and any controlled entities. Other terms
sometimes used to refer to an economic entity include administrative entity, financial entity,
consolidated entity, and group. An economic entity may include entities with both social policy
and commercial objectives. For example, a government housing department may be an economic
entity that includes entities that provide housing for a nominal charge, as well as entities that
provide accommodation on a commercial basis.
 Materiality
Assessing whether an omission or misstatement could influence decisions of users, and so be
material, requires consideration of the characteristics of those users. Users are assumed to have a
reasonable knowledge of the public sector and economic activities and accounting, and a
willingness to study the information with reasonable diligence. Therefore, the assessment needs
to take into account how users with such attributes could reasonably be expected to be influenced
in making and evaluating decisions.
 Qualitative characteristics of the financial information
In order to be useful, information included in GPFRs of public sector entities must contain
certain attributes. The IPSAS conceptual framework (CF) explains that these qualitative
characteristics are: relevance, faithful representation, understandability, timeliness,
comparability, and verifiability, with no particular hierarchy of importance.
 Measurements
The term “measurement basis” refers to the concept that is used in determining the amount at
which an asset or liability is stated in the financial statements. Examples of measurement bases
are historical cost, market value and replacement cost. It is envisaged that the IPSASB
Framework will identify factors that should be considered in choosing the measurement basis to
be required for particular assets and liabilities in specific circumstances, rather than identify a
single measurement basis that is appropriate in all circumstances.
Measurement bases may be classified according to whether they:

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 • Reflect historical or current attributes of an asset or liability;
• Represent an entry or an exit perspective; and
• Reflect either a market or an entity-specific perspective
 Historical cost represents an historical, entry perspective, entity-specific value.
Compared to other measurement bases, it is generally simple to apply and has a high
degree of verifiability, although, as with other measurement bases, there are important
limitations on the extent to which it has these qualities. It may, however, not be as
relevant as other measurement bases, particularly where price changes are significant.
 Market value represents a current, market perspective, which may be either an entry or
an exit value. Market values have many virtues for assets and liabilities that are traded on
deep and liquid markets. In some cases a market price may not be directly observable, but
market information may be used to estimate market values. However, the relevance of
market values is challenged for highly specialized assets, which are frequently
encountered in the public sector.
 Replacement cost represents a current, entry perspective, and is entity-specific. Where
available, it is likely to provide relevant information, particularly for assets that are held
in order to provide services. In some cases, however, it may be complex and costly to
apply and rely on subjective judgments that limit the verifiability and comparability of
the financial statements.
The deprival value model provides a means of selecting the most relevant measurement basis,
which is that which would just compensate the entity for the loss of the asset.
The measurement bases may be the following
 Measurement bases are either historical or current. When a historical measurement
basis is used, assets and liabilities are stated at the amount of an attribute at a past date: in
contrast under a current measurement basis, the measurement reflects the economic and
financial environment prevailing at the reporting date.
 Measurement bases may use either entry or exit values. An entry basis reflects the
consideration payable (or receivable) for the acquisition (or assumption) of an asset (or
liability). An exit basis reflects the amount that will be derived from the asset, often from
its sale. In a diversified economy entry and exit prices differ as entities typically acquire
assets from specialized suppliers, and cannot sell the asset at the same price as the party
from which the asset is acquired. (A familiar example is an individual’s inability to sell a
car at the price that s/he has recently paid the dealer.) If selling prices are used in such a
case a difference will arise—sometimes described as a “day one” profit or loss—on the
initial recognition of an asset. Related to the choice between entry and exit values is
whether the measurement basis requires transaction costs to be treated as part of the entry
or exit value of assets and liabilities.
A measurement basis that reflects the value that will be derived through the use of the asset by
the entity, such as value in use may also be thought of as an exit value, because, like selling
price, it looks forward to what will be derived from the asset. Measurement bases may adopt
either a market or an entity-specific perspective. A market perspective may be argued to promote
comparability in that the same asset (or liability) can be expected to be reported at the same
amount by different entities whereas measurement bases that take an entity-specific perspective
will differ between different entities, although arguably they may be more relevant.

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Accounting for public sector and civil society chapter 1