AN INVESTIGATION OF THE INFORMATION REQUIREMETNS OF USERS OF AUSTRALIAN PUBLIC SECTOR FINANCIAL REPORTS. Janet Mack

Transcription

1 AN INVESTIGATION OF THE INFORMATION REQUIREMETNS OF USERS OF AUSTRALIAN PUBLIC SECTOR FINANCIAL REPORTS Janet Mack

2 ABSTRACT The emergence of new public management has been implicated in the changes that have occurred in the public sectors of western democracies. One outcome of these changes is that the public sector is expected to operate in a more commercial manner and that it be accountable not only for the money that it spends but also for the effectiveness with which it spends those funds. In response to these expectations, changes have occurred in both the accounting technologies and reporting mechanisms for the public sector. The Treasuries and Departments of Finance for each jurisdiction in Australia set accounting and financial reporting policy for the public sector. However, since the establishment of the Public Sector Accounting Standards Board in 1983, the commonwealth and state governments have shown a willingness to adopt standards issued by the accounting profession. The adoption of three specific public sector accounting standards developed by the accounting profession in accordance with the conceptual framework, mean that a financial reporting model, based on the private sector decisionuseful model, has been adopted in the Australian public sector. The decision-useful model incorporates dependent users who are reliant on general purpose financial reports to make economic decisions. The decision to adopt this model for all public sector reporting entities, did not receive unanimous support. The complexities of the public sector formed the foundation for critics to question the applicability of this model to the public sector. In addition, critics argued that the model lacked empirical substantiation. The purpose of this research is to determine the applicability of the decision-useful model to the public sector by empirically identifying users of public sector general purpose financial reports and their information requirements. Prior empirical research has been piecemeal in terms of both scope and research method. As a result, it has not been cumulative. This research will refine and extend the work of previous studies in two ways. First, in terms of scope, it will encompass all public sector entity types and will address all three elements of the decision-useful model the identity of users, what information they use and their purposes for requiring information. Second, this research will adopt a method i

3 which directly accesses users across public sector entity types. As a consequence, an assessment is able to be made of the applicability of the decision-useful model in general and its application to specific public sector entity types. The findings of this research indicate that the decision-useful model is misspecified in the public sector and that there are significant differences among public sector entity types in terms of users and their information requirements. First, the classification of users as normatively determined is not exhaustive and includes a large representation of nondependant users. Second, all users preferred performance information and narrative information was preferred over general purpose financial reports. Further, users considered that general purpose financial information was more useful for accountability purposes than for decision making. These results should be useful to policymakers and accounting standard setters in the future prescription of the contents of financial reports for public sector entities. KEY WORDS: Public sector, financial reporting ii

4 TABLE OF CONTENTS Abstract Table of Contents List of Tables List of Figures List of Abbreviations Statement of Originality Acknowledgements i iii vi viii ix x xi Chapter 1 Introduction 1.1 Institutional environment 1.2 Annual reporting in the public sector 1.3 The public sector general purpose financial reporting model 1.4 Motivation for the research 1.5 Research questions 1.6 Analytical framework 1.7 Structure of thesis 1.8 Style adopted 1.9 Summary Chapter 2 Literature Review 2.1 The historical development of the models for general purpose financial reporting Underlying concept of decision-usefulness General purpose financial reporting models 2.2 The concept of accountability Public sector accountability relationships Public accountability 2.3 Implications of the choice of reporting model 2.4 Literature on the elements of the decision-useful model Normative user literature Studies that have focused on pre-determined classifications of users Studies that have identified actual users 2.5 Summary iii

5 Chapter 3 - Research Methodology 3.1 Research approach 3.2 Scope of the study 3.3 Data collection and analysis Sample selection of entities Establishing a database Research instrument design Research strategy Preliminary data analysis 3.4 Summary Chapter 4 The Users of General Purpose Financial Reports in the Public Sector 4.1 Classification of respondents 4.2 Analysis of Respondents Analysis of respondents by entity type 4.3 Analysis of results 4.4 Summary Chapter 5 - The Information Requirements of Users of Annual Reports in the Public Sector 5.1 Analysis of responses Factor analysis Analysis based on user categories Analysis based on entity type 5.2 Analysis of results 5.3 Summary Chapter 6 - The Utility of Financial Statement Information 6.1 Analysis of responses Factor analysis Analysis based on user categories Analysis based on entity type 6.2 Analysis of results 6.3 Summary iv

6 Chapter 7 - Findings 7.1 The general purpose financial reporting model 7.2 Findings for the model 7.3 Application of the decision-useful model to individual public sector entity types Local government authorities Government departments Government owned corporations Differences between entity types 7.4 Summary Chapter 8 - Conclusions 8.1 Purpose of the research 8.2 Summary of findings 8.3 Implications of the research 8.4 Limitations of the research 8.5 Future research possibilities Appendix A Legislative requirements to produce annual reports Appendix B Queensland Government Departments Appendix C Queensland Local Government Authorities Appendix D Government Owned Corporations Appendix E Research Instrument Appendix F Emphasis Placed on Disclosure Items by User Category Emphasis Placed on Disclosure Items by Entity Type Appendix G Factor Analysis Question 6 Appendix H Mann-Whitney significance levels for comparing mean factor scores for each user category Appendix I Use made of judgment items by User Category Use made of judgment items by Entity type Appendix J Factor Analysis Question 9 Appendix K Mann-Whitney significance levels for comparing mean factor scores for each user category Bibliography v

7 Table 2.1 Table 3.1 Table 3.2 Table 3.3 Table 3.4 Table 3.5 Table 4.1 Table 4.2 Table 4.3 Table 4.4 Table 4.5 Table 4.6 Table 4.7 Table 5.1 Table 5.2 Table 5.3 Table 5.4 Table 5.5 Table 5.6 Table 5.7 Table 5.8 Table 6.1 Table 6.2 Table 6.3 Table 6.4 Table 6.5 List of Tables Factors investigated by prior user studies Factors investigated by prior user studies Research strategy Response rate by local authority type Survey response rates Modes of access by recipients of annual reports Reclassification of recipient associations to user categories Frequency of responses by user category Frequency of responses by entity type and user category Comparison of user profiles for public sector entity types Comparison of user profiles for government departments and local government authorities Comparison of user profiles for government departments and government owned corporations Comparison of user profiles for local government authorities and government owned corporations Identification of factors and the variables that comprise them Mean factor scores for the emphasis placed on information by user category Comparisons between mean factor scores for the emphasis placed on information by dependent and non-dependent users of public sector general purpose financial reports Mann-Whitney significance levels for comparing mean factor scores for the emphasis placed on information between user categories Mean factor scores for the emphasis placed on information for each entity type Comparison of means of factor scores for the emphasis placed on information between individual entity types Comparison between mean factor scores for the emphasis placed on information by dependent and non-dependent users of local government authority annual reports Comparison between mean factor scores for the emphasis placed on information by dependent and non-dependent users of government department annual reports Identification of factors and the variables that comprise them Mean factor scores for the use made of financial statement information by user category Comparison of the mean factor scores for the use made of financial statement information by dependent and non-dependent users of public sector annual reports Mann- Whitney significance levels for comparing mean factor scores for the use made of financial statement information between user categories Mean factor scores for the use made of financial statement information by entity type vi

8 Table 6.6 Table 6.7 Table 6.8 Table 7.1 Table 7.2 Table 7.3 Table 7.4 Table 7.5 Table 7.6 Table 7.7 Comparison of mean factor scores for the use made of financial statement information between individual entity types Comparison between mean factor scores for the use made of financial statement information by dependent and nondependent users of local government annual reports Comparison between mean factor scores for the use made of financial statement information by dependent and nondependent users of government department annual reports Users of public sector general purpose financial reports and their information needs Users of local government authority general purpose financial reports and their information needs Users of government department general purpose financial reports and their information needs Users of government owned corporation general purpose financial reports and their information needs Comparison of user profiles for government departments, local government authorities and government owned corporations Comparison of information used by users from government departments, local government authorities and government owned corporations Comparison of purposes for which financial statement information is found useful by users from government departments, local government authorities and government owned corporations vii

9 List of Figures Figure 1.1 Figure 1.2 Figure 3.1 Figure 7.1 Institutional and Accountability Frameworks within the Australian Public Sector Public Sector Decision-Useful Model for Financial Reporting Data Collection and Analysis Process Public Sector Decision-Useful Model for Financial Reporting viii

10 List of Abbreviations AARF AICPA FASB GASB JCPA PAEC PSASB SAC SFAC Australian Accounting Research Foundation Americain Institute of Certified Public Accountants Financial Accounting Standards Board Governmental Accounting Standards Board Joint Committee of Public Accounts Public Accounts and Estimates Committee Public Sector Accounting Standards Board Statement of Accounting Concept Statement of Financial Accounting Concept ix

11 STATEMENT OF ORIGINALITY This is to certify that the work contained in this thesis has never previously been submitted for a degree or diploma in any university and that, to the best of my knowledge and belief, the thesis contains no material previously published or written by another person except where due reference is made in the thesis itself. Janet Mack Date x

12 ACKNOWLEDGEMENTS The writing of a thesis is necessarily an individual journey, however, there have been many people who have helped and supported me on the way. Without a doubt I could not have achieved this milestone without the support of my supervisors. To my principal supervisor Assoc. Professor Chris Ryan there are not words to express the thanks and gratitude that I owe you. There were many times when I know that it must have been very frustrating working on this project but your support never wavered. As well I do not think there is anybody who could have been more generous both with their time and knowledge. I have grown as a researcher as a result of your input. I would also like to thank my associate supervisor Professor Keitha Dunstan who has also been a source of great support. The statistical elements of this thesis in particular would have suffered without your input. To my mother I say thank you for not only the enormous amount of practical support that you gave me with my other responsibilities which allowed me to complete this project, but also the emotional support to continue when I didn t think that I could. To my friends, Kate, Sue, Pauline, Paula, Elizabeth, Helen, Sue, Jeannie, Sally and Ann thank you - you kept me in touch with the rest of the world. Lastly I would like to thank those who participated in this research, the entity officers who were happy to provide the necessary information for surveys to be distributed and the survey respondents. Without the assistance of both of these groups this research would not have been possible. xi

13 CHAPTER ONE INTRODUCTION The last twenty years has seen enormous changes in the public sector in Australia. Changes have occurred to human resource management systems, accounting systems and industrial relations systems. These changes have also occurred in other western democracies and are due to a combination of several factors (Broadbent and Guthrie, 1992; Ryan, 1995). One of the factors proposed as being a catalyst for the changes is the emergence of the new right and its promotion of market solutions to public sector resourcing problems (Hood, 1991). Others have argued that the role of government has been challenged in the late twentieth century (Pollitt, 1990). In addition, the fiscal problems suffered by many western democracies in conjunction with the oil crisis have contributed to the changing character of the public sector (Wanna, O Faircheallaigh and Weller, 1992). In an Australian context, it has been argued that the resource constraints of the 1970 s that resulted from a decline in the level of taxation revenue and the restructuring of the national economy are factors that have also contributed to the changes in the public sector (Emy and Hughes, 1991). One consequence of these changes has been that the public sector has had to adapt to new expectations that it operate in a more commercial manner, including the adoption of private sector style organisational practices. As a result, there have been changes in the expectations of managers of public sector enterprises (Pollitt, 1990; Wanna, O Faircheallaigh and Weller, 1992). While once public sector entities were able to discharge their accountability responsibilities by reporting on the manner in which appropriated funds were dispersed, managers are now also held accountable for the efficiency and effectiveness with which they use those 1

14 funds. The public sector rhetoric is now concerned with terms such as outputs, efficiency, value for money and full cost (Guthrie, 1998). The promotion of these new accountabilities created a general dissatisfaction with the existing public sector accounting system with its emphasis on cash and fund accounting (Parker and Guthrie, 1990). This led to the endorsement of accrual accounting for use within the new public sector as the vehicle by which agencies would improve their accountability and manage their finances more efficiently (Chua and Sinclair, 1994; Ryan, 1998; Guthrie, 1998). The move towards an accrual model as used in the private sector provided the accounting profession with an opportunity to become active in public sector accounting through its Public Sector Accounting Standards Board (PSASB). One of the first tasks undertaken by the PSASB was to commission the development of a conceptual framework within which to develop public sector accounting standards (Sutcliffe, 1985). The 1985 monograph Financial Reporting in the Public Sector A Framework for Analysis and Identification of Issues (Sutcliffe, 1985) laid down the fundamental principles which were to guide the production of accounting standards in the Australian public sector. This monograph, which advocated the adoption of a common conceptual framework for both the private and public sectors, was embraced by the PSASB. As a result of the deliberate decision of the PSASB to adopt a common conceptual framework for both the public and private sectors, the public sector model is effectively the same as the private sector model. Consequently, there is no difference between the two sectors in terms of the classifications of dependent users or their information needs (McGregor, 1999). The public sector financial reporting model that has emerged assumes that dependent users have needs for information for the purposes of economic decision making and accountability that can be satisfied by the provision of general purpose financial reports. The public sector financial reporting model has been criticised as lacking empirical substantiation and ignoring the diversity and complexity of public sector institutions (Walker, 1989; Jones, 1992; Jones and Puglisi, 1997; Barton, 1999). It Chapter One: Introduction 2

15 has been argued that the simplicity of the private sector general purpose financial reporting model is inappropriate for the public sector and its complex mix of operating structures, sources of financing, operating motives and accountability obligations (see for example, English, 1999, 2003; Carnegie and Wolnizer, 1995; Guthrie 1998; Walker 1989). The objective of this research is to provide empirical evidence on the applicability of the general purpose financial reporting model to the public sector. The research was conducted within the Australian public sector and incorporated the different types of organisations within the public sector and the diversity of their accountability relationships. 1 The remainder of the chapter will outline the institutional environment within which public sector general purpose financial reporting occurs, examine the role of annual reporting in the public sector, and describe the public sector general purpose financial reporting model. The final four sections of this chapter will explain the motivation for the research, identify the research issues to be addressed, describe the analytical framework used in the research, describe the structure and style of the thesis and provide a brief summary of the chapter. 1.1 INSTITUTIONAL ENVIRONMENT It is generally agreed that the institutional environment within which public sector accounting is regulated is the product of three significant influences. The first is the Westminster system of accountable government; the second is the federal system of government, which operates in Australia; the third is the involvement of the accounting profession in the regulation of public sector accounting. Each of these will be discussed in turn. The first influence is that the Australian political system is based on the Westminster system of responsible government that originated and was operating in the UK at the time Australia became an independent nation (Stewart 1 The Australian public sector comprises departments, statutory authorities, government owned corporations and local government authorities. Chapter One: Introduction 3

16 and Ward, 1996). This doctrine of responsible government has, as one of its key assumptions, that Parliament is the central body in a chain of accountability that allows the electorate to hold those who govern accountable for their actions. Thus, as the central player in the chain of accountability, Parliament is accountable to the public (Davis et al., 1993). 2 This doctrine of responsible government embodies the notion of accountability. Ministerial responsibility is a convention that allows Parliament to exercise its constitutional responsibility to monitor the performance of executive government, including its financial performance and to report on that performance (Milazzo, 1992). One of the functions of Parliament is that of controlling government expenditure by evaluating financial proposals and subsequently ensuring that government funds have been expended appropriately. In practice, the task of scrutiny of the appropriate dispersion of funds most often falls to the Auditor General who then reports to Parliament. While the responsible government system operates for the Commonwealth and State governments, it is not applicable to local government authorities. Local government authorities do not operate under the Westminster system so the concept of ministerial responsibility is not applicable. The governing body for local government authorities is the council. The council, which is comprised of the elected representatives from the community, is not formally divided between a government and an opposition (and independent members) as state and federal parliaments are. Consequently, there is no equivalent in local government authorities to cabinet. Instead, the council meets in its entirety to determine matters of policy for the local government authority. In local government authorities therefore, the council is directly responsible to ratepayers and electors for its actions (Emy and Hughes, 1991). The result of this is that there are different accountability regimes in local government authorities than those that operate in state and Commonwealth governments. There are fewer layers in the 2 Other accountability relationships exist between government and Parliament (and thereby indirectly, to the public); Ministers who are accountable to cabinet and as well to Parliament for the activities of their departments; and heads of departments who are accountable to government through the appropriate minister. Chapter One: Introduction 4

17 governance system for local government authorities than there are for state and federal governments and consequently the accountability relationships are different. The second influence on the institutional environment within which the public sector is regulated is the federal system. Australia is a federation with a central government and seven states together with one territory. Each state encompasses many local government authorities. The outcome of this federal system is that Australia has three levels of government, the Commonwealth, the states and local government (Davis et al., 1993). The Commonwealth government and each of the state and territory governments have acts of parliament that govern the accounting and reporting requirements for entities encompassed by that particular government. The Departments of Finance and Treasury 3 in each jurisdiction have the responsibility for setting accounting requirements for each of the entities within their jurisdictions. Requirements for accounting and reporting for local government authorities are regulated by the state governments via legislation and administrative oversight through Departments of Local Government. 4 Figure 1.1 details the institutions and accountability frameworks within the Australian public sector. It can be seen that the Commonwealth and State governments are comprised of budget-funded authorities and non-budget authorities. These non-budget authorities include both statutory authorities and government owned corporations. 5 Local governments are shown as a subset of state governments as, although not controlled by them, their accounting and financial reporting requirements are set by the state government department responsible for the administration of local government authority matters. 3 Depending on the jurisdiction the titles of Department of Finance, Treasury and Department of Finance and Treasury are used to describe the department responsible for financial and accounting functions of the jurisdiction. In this thesis the term used to describe such entities will be Treasury. 4 In Queensland, The Financial Administration and Audit Act, 1977 regulates the accounting functions of state government public sector entities and the Local Government Act 1993 regulates those functions for local government authorities. 5 Statutory authorities has been described as any body performing a public function and established by or appointed pursuant to any rule, regulation, by-law, order in council, proclamation or other instrument of a legislative character (NSW PAC, 1983). Statutory authorities can be either fully funded by the government or self-funding. Government owned corporations are either corporations in which the government is a shareholder covered by the corporations law or statutory corporations which are covered by individual government legislation (Funnell and Cooper, 1998). Chapter One: Introduction 5

18 FIGURE 1.1 Institutional and accountability frameworks within the Australian public sector 6 AUSTRALIAN PUBLIC SECTOR Commonwealth Parliament (Whole of Government) State and Territory Parliaments (Whole of Government) Local Government Authorities Budget Authorities (Departments) Non-Budget Authorities (GOCs, SAs) Budget Authorities (Departments) Non-Budget Authorities (GOCs, SAs) Key: GOCs Government Owned Corporations SAs Statutory Authorities The third influence on the institutional environment within which the public service is regulated is the involvement of the accounting profession. Until twenty years ago, the Westminster system of government and the federal system of government were the predominant institutional influences on the public sector reporting model. However, the changes in the public sector that have included changes in the method of accounting have seen the emergence of a third influence on the regulation of accounting policy in the public sector. The accounting profession has become involved in the formulation of public sector accounting policy (Walker, 1989; Ryan, 1999). Even though it is the Treasuries and Departments of Finance in each jurisdiction that have the responsibility for setting accounting policy for the public sector, the Commonwealth and State 6 Adapted from Emy and Hughes (1991) Australian Politics: Realities in Conflict, Figure 10.1, p.379. Chapter One: Introduction 6

19 governments have shown a willingness to adopt the professional standards issued by the accounting profession through its PSASB (Ryan, 1999). 7 Indeed the State and Federal governments partially funded the PSASB in order to advance the development of public sector accounting standards. Ryan (1999) argues that accounting policy officers in the Treasuries and Departments of Finance actively promoted a co-operative standard setting arrangement between themselves and the accounting profession. They saw the benefits of using an organisation that already had an infrastructure in place to develop accounting standards. Further, using the PSASB, allowed them to distance themselves from policy formation when trying to regulate standards in their respective jurisdictions. To date, three specific public sector accounting standards have been issued AAS 27 Financial Reporting by Local Governments in 1991, AAS 29 Financial Reporting by Government Departments in 1993 and AAS 31 Financial Reporting by Governments in Taken together these three standards impose a general purpose reporting model based on accrual accounting on all three levels of government. These standards have been adopted by all jurisdictions in Australia. 8 The legislative adoption of these three accounting standards, grounded as they are in the conceptual framework as defined by the Statements of Accounting Concepts developed by the accounting profession, means that a new public sector financial reporting model has been adopted in the Australian public sector to replace the traditional cash-focused model. Having established the public sector institutional environment, the role of annual reporting in the public sector will be discussed in the next section. The annual report is the primary vehicle for disseminating public sector general purpose financial reports to stakeholders. This will be followed by a description of the general purpose financial reporting model adopted in the Australian public sector and its primary elements. 7 The PSASB is an arm of the Australian Accounting Research Foundation which is the body set up by the Institute of Chartered Accountants and the Australian Society of Certified Practicing Accountants to deal with technical accounting issues and formulate accounting standards (Sutcliffe, 1985). 8 Appendix A contains a table detailing for each state the relevant legislation and regulations. Chapter One: Introduction 7

20 1.2 ANNUAL REPORTING IN THE PUBLIC SECTOR The increased emphasis on performance and accountability that has occurred in the public sector has led to a greater awareness of mechanisms that are available to discharge accountability. In this respect, the role of the annual report in the accountability chain and as a means of discharging public accountability has received increased prominence. It has been argued that annual reports should be considered in their context as only one of several methods of discharging accountability (Coy and Pratt, 1998; Sinclair, 1995; Kloot and Martin, 2001). In a parliamentary system, the presentation of annual reports is one stage in a cycle of accountability that begins with the budget process and ends with the tabling of reports to parliament (English, 2003). While it is acknowledged that the annual report is not the only accountability mechanism available to public sector agencies, it is statutorily required as the primary medium of accountability (JCPA, 1989; PAEC, 1999). Even though they are not the sole accountability mechanism for state and commonwealth public sector entities annual reports are regarded as the cornerstone of public and parliamentary scrutiny (SSCFPA, 1989; Milazzo, 1992; PAC, 2001). Further, they enable governments to discharge their accountability obligations to a diverse group of stakeholders (JCPA, 1989: PAEC, 1999; Banks and Nelson, 1994; Coy et al., 2001). Boyne and Law (1991: 179) argue that the annual report is the only comprehensive statement of stewardship available to the public, a view echoed by Coy et al., (2001: 14 ) who state: The value of the [public sector] annual report rests in the provision of a wide range of summarised, relevant information in a single document, which enable all stakeholders to obtain a comprehensive understanding of [an entity s] objectives and performance in financial and non-financial terms. No other single source of such information is available to all stakeholders on a routine basis. A public sector annual report commonly comprises both descriptive information about the entity and its activities and the audited financial statements which Chapter One: Introduction 8

21 comprise the general purpose financial report. As a result, the annual report has become the primary method of disseminating general purpose financial reports to external stakeholders. The next section will examine a specific subset of the annual report, the general purpose financial report. 1.3 THE PUBLIC SECTOR GENERAL PURPOSE FINANCIAL REPORTING MODEL The PSASB was established as an arm of the Australian Accounting Research Foundation (AARF) in late Its purpose was to promote the development of general purpose financial reporting in the public sector at the commonwealth, state and local government levels. The PSASB was primarily concerned with developing standards of reporting that would provide public sector users of financial statements with useful financial information (Sutcliffe, 1985). The PSASB determined that accounting standards in the public sector should be developed within the context of a conceptual framework (Miller, 1988). As a result of this decision it commissioned Paul Sutcliffe, an AARF researcher, to develop such a framework. Accounting Theory Monograph 5, Financial Reporting in the Public Sector A Framework for Analysis and Identification of Issues was produced and endorsed by the PSASB. In this monograph, it was argued that the public and private sectors should share a common structure for a conceptual framework and the framework being developed by AARF for the private sector was also appropriate for the public sector. This decision was important because the conceptual framework provides a structure from which accounting standards are developed as part of an overall strategy rather than as an ad hoc response to specific issues (McGregor, 1999). It provides a blueprint that defines the border of the discipline of financial reporting, 9 The PSASB was disbanded on the 1/1/2000 as a result of the establishment of the Financial Reporting Council and the Australian Accounting Standards Board that took over responsibility for developing accounting standards for both the public and private sectors (Financial Reporting Council Annual Report, 2000). Chapter One: Introduction 9

22 and as well, defines the subject, objectives, elements and characteristics of the discipline. The conceptual framework is effectively operationalised by the development of Statements of Accounting Concepts (SACs). To date, four Statements of Accounting Concepts have been issued. The first two of these set out the circumstances in which general purpose financial reports should be prepared and presented. They define the nature, subject, purpose and broad content of general-purpose financial reports (AARF, 1990). Statement of Accounting Concept 1 Definition of the Reporting Entity (SAC 1) addresses the issue of determining which entities are reporting entities and will, as a consequence, be subject to the reporting requirements of the conceptual framework. A reporting entity is defined as an entity in which it is reasonable to expect that users exist who will be dependent on general purpose financial reports for the provision of information to enable them to make economic decisions (para 40). Several guidelines are provided for determining whether or not a particular entity is a reporting entity. SAC 1 identifies public sector entities including departments, local government authorities, whole of government, statutory authorities and government owned corporations as reporting entities. As a result of this determination, these entities are required to prepare general purpose financial reports. Statement of Accounting Concept 2 Objective of General Purpose Financial Reporting (SAC 2) is, as the name suggests, concerned with the objectives of general purpose financial reports. SAC 2 identifies the three crucial elements of the general purpose financial reporting model. First, it identifies the users of general purpose financial reports (who requires information). It then identifies the purposes for which users may require information (why information is required) before prescribing the types of information that users will require (what information is required). The identification of users is therefore crucial to the model prescribed by SAC 2. In relation to users, SAC 2 establishes two broad categories of users of general purpose financial reports those users who are dependent on the information Chapter One: Introduction 10

23 provided by general purpose financial reports for their information needs, and those who are able to command special purpose financial reports - non-dependent users. Included in the non-dependent category are taxation authorities, central banks and management and governing bodies. All of these users are deemed by SAC 2 to have access to, or the power to command, special purpose financial reports. The information needs of these non-dependent users are deemed to be outside the scope of SAC 2 (paras 8 and 20). Having established that there are two broad categories of users and that general purpose financial reporting is concerned only with the needs of dependent users, SAC 2 identifies three classes of dependent users and their respective information needs. The classes that it identifies are: resource providers (eg. ratepayers, lenders and investors), resource recipients (eg. residents, consumers and taxpayers), and review and oversight bodies (eg. media, analysts and special interest groups). In relation to what information is required, SAC 2 determines that in order to meet the information needs of users, general purpose financial reports should provide information about the performance of the entity, the financial position of the entity, the financing and investing activity of the entity and compliance matters. With regard to the purposes for which information is required SAC 2 takes the position that, in view of the information needs of the users identified in the statement, the objective of general purpose financial reporting is to provide information to users that is useful for making and evaluating decisions about the allocation of scarce resources (para 26). Further, it is asserted that when general purpose financial reports meet this objective they will also enable entities to discharge accountability. The stated objective clearly indicates that SAC 2 is prescribing a decision-useful model for general purpose financial reporting within an overall framework of user needs. In short, SAC 2 prescribes a financial reporting model that has three elements, dependent users requiring general purpose financial information for the purposes of making economic decisions. Chapter One: Introduction 11

24 Figure 1.2 is a diagrammatic representation of the public sector reporting model that results from the operationalisation of the conceptual framework through the SAC s. FIGURE 1.2 Public sector decision-useful model for financial reporting Reporting Entities Whole of Government Government Departments Government Owned Corporations Statutory Bodies Local Government Author ities General purpose Financial reports (what) Classes of Dependent Users (who) * Resource providers (eg taxpayers) * Resource recpients (eg pensioners) * Review & oversight bodies (eg auditors) Purposes for Requiring Information *Economic dec ision making *Accountability The remaining two Statements of Accounting Concept build on the concepts developed in the first two statements. SAC 3 addresses the qualitative characteristics of financial information. It identifies the attributes, such as relevance, materiality and reliability, that financial information should possess so that it can meet the objectives specified in SAC 2. SAC 4 provides more detailed information about the specific elements of financial statements, including criteria for their recognition in financial statements. In summary, the PSASB endorsed the conceptual framework as relevant to the public sector. The public sector reporting model that exists as a result of the Chapter One: Introduction 12

25 conceptual framework defines the users of general purpose financial reports and their purposes for requiring information to be identical to those for private sector entities. In addition there has been no differentiation between the different types of public sector entities. However these assumptions are not empirically derived but are normative assessments made without reference to the complexity and diversity of the myriad of accountability relationships that exist within the public sector. It is the objective of this research to empirically test the veracity of these assessments. 1.4 MOTIVATION FOR THE RESEARCH The adoption of a general purpose financial reporting model for the public sector grounded in a decision-useful framework (as described in section 1.3) was not without criticism (McGregor, 1999) and it is these criticisms that were the initial stimulus for this research. The complexity of the public sector in terms of its operating structure, sources of financing, operating motives and accountability obligations resulted in concerns being raised regarding the appropriateness and simplicity of this framework for the public sector (see for example, Walker, 1989; Aiken, 1994; English, 2003). The most fundamental of these concerns was whether a financial reporting model primarily concerned with reporting performance in terms of profit and loss (financial bottom line) had the capacity to adequately and fairly reflect the performance of organizations for which the generation of profit was not the operating motive. In other words, could a financial reporting model based on reporting profit adequately explain the performance of public sector entities with diverse operating motives and discharge their accountability obligations (Walker, 1989; Guthrie, 1998; Ma and Mathews, 1993; Stanton and Stanton, 1998; Conn, 1996)? This research will tease out this issue. An issue that is closely related to the decision-useful model is the existence and identity of users. The private sector decision-useful model for financial reporting Chapter One: Introduction 13

26 was adopted for the public sector based primarily on normative assessments of the users of public sector general purpose financial reports and their information requirements (Rutherford, 1992). Concern was expressed, when the adoption of the private sector model for the public sector was suggested, that users and their information needs in the public sector were not the same as those in the private sector. Walker (1989) was critical of AARF publications, arguing that the questions of identifying users, what information is relevant to those users, and the manner in which the information is used were not based on analytical or empirical evidence. He argued that the classifications of users and their information needs identified in the private sector did not transpose to the public sector. There are no shareholders in the public sector and creditors in the public sector are unlikely to have the same information needs as those in the private sector. Similarly, Mayston (1992) has also challenged these categories of users, arguing that the accountability relationships in the public sector are more complex and less well defined than those in the private sector and this has contributed to difficulties in identifying users for public sector reports. While these authors have argued their point from a theoretical perspective, despite the importance of the identity of users to the model there has been very little empirical research into the identification of users and what little has been done lacks a strong conceptual framework (Cheng, 1992; Rutherford, 1992; Ma and Matthews, 1993). Jones (1992) indicates that the lack of any empirical investigation is a common feature of many conceptual framework projects in the public sector internationally. Ma and Matthews (1993) contend that it is this lack of empirical data on users that has raised the possibility that the existing accounting standards which are premised on the existence of users as identified in the private sector are inappropriate for public sector agencies. This research will provide empirical evidence on the users of public sector financial reports and their information needs. An expansion of the concerns noted above relates to whether or not it is appropriate to apply the same general purpose financial reporting model to each of the entities ( government departments, statutory authorities, government owned corporations and local government authorities) in the public sector (Barton, 1999). Chapter One: Introduction 14

27 As the application of the model currently stands, SAC 1 determines that all public sector entities are reporting entities. This means that every public sector entity from the smallest local government authority to the federal government of Australia has the same reporting requirements. The model as it is currently applied does not take into account the vast diversity in size, structure, objectives, and accountability relationships that exist amongst public sector entities. Indeed the PSASB argued that the fact that no distinction is made between entities of any type, either public or private, on these grounds is an important and positive feature of the framework. 10 Others, however, have argued that these differences in the characteristics of public sector entity types indicate the necessity of the public sector having its own unique set of accounting standards and reporting framework (Walker, 1989; Guthrie, 1998; Ma and Mathews, 1993; Stanton and Stanton, 1998; Conn, 1996; Rutherford, 1992; Van Peursem and Pratt, 1992). Such a framework would accommodate the differing characteristics of public sector entity types. These normative arguments have been supported by recent empirical research that has identified cross-sectional variation among public sector entity types in the distribution of their financial statements, their accountability relationships and the way they satisfy those relationships. Ryan, Dunstan and Brown (2002) illustrate that there are different accountability relationships amongst public sector entities because of their differing institutional structures. Kloot and Martin (2000) have identified differing accountability relationships amongst local government authorities resulting in variations amongst the different entities in the value of the annual report in discharging accountability obligations. As well there is evidence that there are differences in the profiles of recipients of annual reports distributed by public sector entities (Kloot and Martin, 2001; Mack, Ryan and Dunstan, 2001; Clark, 2002) and differences among users both in respect of the information that they require and the purposes to which they put the information (Priest, Ng and Dolley, 1999; Collins, Keenan and Lapsley, 1991; Daniels and Daniels, 1991). 10 There is in the private sector the capacity for some entities to operate under a differential reporting regime under certain circumstances. Chapter One: Introduction 15

28 This research will address these normative concerns and empirical findings by encompassing different types of public sector entities. In summary, this study is motivated by the ongoing debate about the public sector financial reporting model, the lack of empirical justification for its underlying features including the identification of users, what information they require and the purposes for which they find general purpose financial reporting useful (Rutherford, 1992; Ma and Matthews, 1993) and its application across the entire public sector. It is also motivated by the continuing calls for empirical research about users and their information needs in the public sector which have to date been unanswered (Jones, 1992: Rutherford, 1992; Ma and Matthews, 1993). The choice of model for the production of financial reports accounting paradigm is not neutral (Hopwood, 1984). As a consequence of the introduction of private sector based accounting technologies, aspects of the operations of the public sector that were not previously reduced to financial presentation are now being reported in that manner. This in turn has the potential to affect not only the way the public sector is viewed and assessed but also the way in which it carries out its functions (Hopwood, 1985; Revsine, 1991; Gray and Jenkins, 1993; McCrae and Aiken, 1994; Aiken, 1994; and Aiken and Capitano, 1995). This thesis will contribute to the debate about the appropriateness of the model not by further theorising or normative assessment but will instead employ an empirical methodology to examine both the appropriateness of the public sector general purpose financial reporting model and its application to various public sector entity types. 1.5 RESEARCH QUESTIONS The adoption of the general purpose financial reporting model in the Australian public sector, despite the reservations expressed about its applicability, provides the central research issue for this thesis. Chapter One: Introduction 16

29 Is the general purpose financial reporting model as described by SAC 2 and adopted in the Australian public sector applicable to the public sector and its constituent entity types? In order to address this issue this research will empirically examine each of the elements of the general purpose financial reporting model - the identification of users, the information they require and the purposes for which they require information. The first element in the model, users, gives the first specific research question. Research Question 1 (a) Who are the users of general purpose financial reports in the Australian public sector? (b) Are there cross-sectional variations in the user profiles of different public sector entity types? The second research question seeks information about the information requirements of users of public sector annual reports. Research Question 2 (a) What emphasis do individual categories of user place on information contained in general purpose financial statements? (b) What emphasis do individual categories of user place on non-financial information contained in the annual reports of public sector entities? (c) Are there cross-sectional variations in the emphasis placed on the information contained in annual reports by users from different public sector entity types? The third research question seeks information about the purposes to which users put information contained in general purpose financial statements. Chapter One: Introduction 17

30 Research Question 3 (a) For what purposes do individual categories of user consider the information contained in general purpose financial statements to be useful? (b) Are there cross-sectional variations in the purposes for which users from different public sector entity types find financial statement information to be useful? Synthesising the answers to these individual research questions will enable a determination of the applicability of the model to the public sector and to each of its different entity types. The empirical evidence provided by this research will provide policy makers with information about accounting policy and its effectiveness in discharging accountability. It will therefore have the capacity to impact on future policy prescriptions. 1.6 ANALYTICAL FRAMEWORK The analytical framework used in this thesis is principal/agent theory. The formal accountability relationship in both the public and private sectors is one of principal and agent (or superior and subordinate), where agents are held accountable to, and receive direction from, their principals Mulgan (2000a). Mayston (1993) has argued that principal/agent theory is a lens through which accountability can be viewed. The general agency model consists of a principal(s), an agent(s), an agreed task(s) or function, and the rendering of an account by the agent to the principal for the performance of that task or function. The provision of an account by the agent to the principal is to address the issue of information asymmetries and to enable the principal to assess the performance of the agent. The reporting obligation placed on an agent is one way in which the principal can observe the results of the actions of the agent (Greiling, 1999). In each specific agency situation, the composition of three of these elements (principal, agent, task) will vary, however Chapter One: Introduction 18