Learner Guide Fundamentals of Municipal Accounting Unit Standard Title Apply accounting principles and procedures in the preparation of reports and decision-making Unit Standard ID 119350 1
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, Notice This material has been developed by National Treasury as part of a broader skills development initiative to support the implementation of the Municipal Minimum Competency Regulations, Gazette 29967, June 2007. The material should be used as part of the broader context of curricular content and was designed to achieve the recognised municipal financial management qualifications Only those service providers that appear on the National Treasury website list of Service Providers and Modules are authorised to use this product, which must be used for the express purpose of providing approved learning programme(s) towards municipal competency regulations. Service providers will appear on this list only after formal accreditation in full or in part have been reviewed and approved in respect of related training by the National Treasury. Service Providers wishing to confirm if they have been listed as preferred service providers for use by municipalities should visit the National Treasury website at www.treasury.gov.za/legislation/mfma under Training and Validation which will be updated from time to time. Service Providers are not permitted to substantially amend or change this material without the express authorisation in writing of the National Treasury MFMA Implementation Unit. Any requests to amend or alter this publication must be submitted to mfma@treasury.gov.za, prior to the commencement of any training or activity that the material may relate to. Notwithstanding the above limitations, National Treasury encourages those Authorised Service Providers using this product to further develop the material with the inclusion of case studies and practical examples where appropriate, to enhance practical relevance for learners where possible. We remind you that this material has been provided as a resource to assist practitioners in local government to become qualified municipal finance management professionals, it is not intended to provide legal or other advice on which a municipality should rely on in fulfilling their statutory or social responsibilities. Other parties not referred to above, may use this material for training purposes only, provided that such purposes will be not for profit only, and prior approval is granted by National Treasury. MFMA Implementation Unit 3rd Floor, 40 Church Square, Pretoria September 2008 1
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, Table of Content 1.MODULE TITLE 4 2.UNIT STANDARD TITLE 4 3.MODULE STRUCTURE 4 4.UNIT STANDARD OUTCOMES 5 5.UNIT STANDARD PURPOSE 5 6.LEARNING ASSUMED TO BE IN PLACE 5 7.UNIT STANDARD CONTENT 6 8.UNIT STANDARD ASSESSMENT 6 9.MODERATION 8 10.REFERENCES 8 Unit One: Demonstrate an understanding of accounting principles and reporting requirements and nature of accounting functions in the public sector: 10 1.LEARNING OUTCOMES 10 2.KEY CONCEPTS 11 3.INTRODUCTION/OVERVIEW 15 4.LEARNING ASSUMED TO BE IN PLACE 17 5.UNIT CONTENT 17 6.SOURCES / REFERENCES 45 7.LEARNING TASKS/ACTIVITIES 45 Unit Two: Use accounting techniques and approaches to process financial information. 47 1.LEARNING OUTCOMES 47 2.KEY CONCEPTS 47 3.INTRODUCTION/OVERVIEW 48 4.LEARNING ASSUMED TO BE IN PLACE 49 5.UNIT CONTENT 49 6.SOURCES / REFERENCES 70 7.LEARNING TASKS/ACTIVITIES 70 Unit Three: Apply end of period accounting procedures in the preparation of financial statements. 72 1.LEARNING OUTCOMES 72 2.KEY CONCEPTS 72 3.INTRODUCTION/OVERVIEW 73 2
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, 4.LEARNING ASSUMED TO BE IN PLACE 74 5.UNIT CONTENT 74 6.SOURCES / REFERENCES 75 7.LEARNING TASKS/ACTIVITIES 76 Unit Four: Apply procedures necessary for control over cash transactions and balances. 77 1.LEARNING OUTCOMES 77 2.KEY CONCEPTS 77 3.INTRODUCTION/OVERVIEW 78 4.LEARNING ASSUMED TO BE IN PLACE 79 5.UNIT CONTENT 79 6.SOURCES / REFERENCES 103 7.LEARNING TASKS/ACTIVITIES 103 Unit Five: Utilise procedures for reporting and recording accounts receivables. 104 1.LEARNING OUTCOMES 104 2.KEY CONCEPTS 104 3.INTRODUCTION/OVERVIEW 107 4.LEARNING ASSUMED TO BE IN PLACE 108 5.UNIT CONTENT 108 6.SOURCES / REFERENCES 118 7.LEARNING TASKS/ACTIVITIES 118 Unit Six: Utilise procedures for recording and reporting on liabilities in the public sector. 120 1.LEARNING OUTCOMES 120 2.KEY CONCEPTS 120 3.INTRODUCTION/OVERVIEW 121 4.LEARNING ASSUMED TO BE IN PLACE 123 5.UNIT CONTENT 123 6.SOURCES / REFERENCES 132 7.LEARNING TASKS/ACTIVITIES 132 3
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, 1. MODULE TITLE 1.1. Municipal Finance Reporting and Performance Management 2. UNIT STANDARD TITLE 2.1. Apply accounting principles and procedures in the preparation of reports and decision making (SAQA Unit Standard Number 119350) 3. MODULE STRUCTURE 3.1. Qualification: Certificate in Municipal Finance Management (Core) 3.2. National Diploma: Public Finance Management and Administration (core) 3.3. National Certificate: Public Administration (elective) 3.4. Credits 15 3.5. NQF level 5 3.6. Type Core / elective 3.7. Duration 150 Notional hours (50 training hours and 100 workplace hours) 4
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, 4. UNIT STANDARD OUTCOMES 4.1. ON COMPLETION OF THIS UNIT STANDARD, YOU SHOULD BE ABLE TO: 4.1.1. Demonstrate an understanding of accounting principles and reporting requirements and nature of accounting functions in the public sector; 4.1.2. Use accounting techniques and approaches to process financial information; 4.1.3. Apply end of period accounting procedures in the preparation of financial statements; 4.1.4. Apply procedures necessary for control over cash transactions and balances; 4.1.5. Utilise procedures for reporting and recording accounts receivables; and 4.1.6. Utilise procedures for recording and reporting on liabilities in the public sector. 5. UNIT STANDARD PURPOSE 5.1. Learners working towards this standard will be working within a Public Sector environment, specializing in Public Finance Management and Administration, where the acquisition of competence against this standard will add value to the participant s job. This standard will also add value to public officials who are seeking to develop a career pathway towards becoming an accomplished public finance management and administration specialist. 6. LEARNING ASSUMED TO BE IN PLACE 6.1. Further education and training certificate or equivalent qualification at NQF level 4. 5
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, 7. UNIT STANDARD CONTENT 7.1. UNIT 1: Demonstrate an understanding of accounting principles and reporting requirements and nature of accounting functions in the public sector. 7.2. UNIT 2: Use accounting techniques and approaches to process financial information. 7.3. UNIT 3: Apply end of period accounting procedures in the preparation of financial statements. 7.4. UNIT 4: Apply procedures necessary for control over cash transactions and balances. 7.5. UNIT 5: Utilise procedures for reporting and recording accounts receivables. 7.6. UNIT 6: Utilise procedures for recording and reporting on liabilities in the public sector. 8. UNIT STANDARD ASSESSMENT 8.1. THE STRUCTURE OF THE ASSESSMENT IS AS FOLLOWS: 8.1.1. Formative assessment 8.1.1.1. The formative assessment will be done by the participant by way of self assessment by completing the learning tasks / activities as set out at the end of each unit contained in the remainder of this module. 6
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, 8.1.2. Summative assessment 8.1.2.1. One comprehensive individual assignment that can be prepared by the participant on a progressive basis as the module takes place. 8.2. ASSESSMENT CRITERIA 8.2.1. In assessing the individual assignment that is submitted by the participant, the demonstration by the participant of the following will be taken into account: 8.2.1.1. Originality. 8.2.1.2. Knowledge of the theory covered in the module. 8.2.1.3. Insight into the theory covered in the module. 8.2.1.4. Application of the theory and methodologies covered in the module. 8.2.1.5. Ability to analyse information and situations faced by the participant in the workplace. 8.2.1.6. Acknowledgement of sources utilised in the preparation of the assignment. 8.3. ASSESSMENT METHODS/STRATEGIES 8.3.1. Assessment for this module will be formative and summative. The formative assessment will be self - assessment and will be done by the participant by completing each of the learning tasks / activities as set out at the end of each of the units in the remainder of this module. The summative assessment at the end of this module is going to be in the form of a comprehensive individual assignment that will test your competence in the following sections as set out below. Questions will be based on the whole module and you should therefore have sufficient knowledge of all the information contained in the module. 7
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, 8.3.1.1. Section 1: This section will require you to provide answers to a number of questions that are based on your knowledge of the theory that has been covered in the learning outcomes as set out in the module. These questions will be similar to the ones that are included in the learning tasks / activities that are set out at the end of each unit of the module. 8.3.1.2. Section 2: This section will be based on a case study that will be based on a real life scenario to test your insight into the theory that has been covered in the module and also to test you ability to apply of the theory and methodologies covered in the module. 8.3.1.3. Section 3: This section will require you to apply the knowledge that you have gained to situations faced by you in the workplace. For example it may be required of you to analyse the Cash Flow Statement of the organization you work for and to recommend strategies to improve the cash flow position of your own entity. 9. MODERATION 9.1. Two examiners will be appointed for this module by the service provider. Once one examiner has assessed the individual assignment, the other one will undertake a similar exercise to finalise the results. 10. REFERENCES 10.1. Correia, C., Flynn, D., Uliana, E., Wormald, M. 2000. Financial Management. 4th ed. Cape Town: Juta. 10.2. 2006. Framework for the preparation and presentation of financial statements.lynwood Ridge: Accounting Standards Board. 10.3. Issued standards of GRAP. Lynwood Ridge: Accounting Standards Board. 8
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, 10.4. National treasury website, www.treasury.gov.za. 10.5. South-Africa. National Treasury. March 2005. Treasury Regulations for departments, trading entities, constitutional institutions and public entities - issued in terms of the Public Finance Management Act, 1999. 10.6. South-Africa. National Treasury. 1999. Public Finance Management Act, Act 1 of 1999. 10.7. South-Africa. National Treasury. 2003. Municipal Finance Management Act, Act 56 of 2003. 10.8. South-Africa. National Treasury. 2000. Municipal Systems Act, Act 32 of 2000. 10.9. South-Africa. National Treasury. 1998. Municipal Structures Act, Act 117 of 1998. 10.10. South-Africa. National Treasury. Various MFMA accounting circulars issued by National Treasury. 9
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, Unit One: Demonstrate an understanding of accounting principles and reporting requirements and nature of accounting functions in the public sector: 1. LEARNING OUTCOMES 1.1. ON COMPLETION OF THIS STUDY UNIT, YOU SHOULD BE ABLE TO: 1.1.1. Explain the public sector accounting environment in the context of the public sector. 1.1.2. Explain the nature of accounting principles, concepts and organizations influencing the development of accounting practice for the public sector. 1.1.3. Implement appropriate accounting systems and procedures in the public sector environment. 1.1.4. Explain treasury guidelines related to accounting. 1.1.5. Understand the importance of maintaining accounting records that are updated in a timely manner. 1.1.6. Understand the different financial reports that support management and decision making in the public sector. 1.1.7. Understand the difference between the cash and accrual basis of accounting. 10
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, 2. KEY CONCEPTS AFS: IAS: IFRS: GAAP: GAMAP: Annual Financial Statements is an acronym for international accounting standards. These standards are the guidelines that are followed by private sector entities for the preparation of AFS. The IAS are internationally accepted accounting best practice. is an acronym for international financial reporting standards. In future the International Accounting Standards Board will no longer issue IAS, as the name of these standards has now been changed to IFRS. is an acronym for generally accepted accounting practice. SA GAAP is the set of accounting standards that is followed by private sector entities in SA for the preparation of AFS. In most cases the SA GAAP has been aligned with and very closely resembles the IAS and IFRS. is an acronym for generally accepted municipal accounting practice. These standards were developed in 1998 and were based on GAAP at that point in time. It was initially envisaged that these standards would be the guidelines followed by municipalities for the preparation of AFS. Since 1997, however, GAAP and the IAS have changed substantially, resulting in GAMAP being outdated. GAMAP is therefore in a process of being replaced with GRAP. 11
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, IPSAS: GRAP: is an acronym for international public sector accounting standards. The IPSAS are the public sector equivalent of the IAS and are regarded as being internationally accepted accounting best practice for public sector entities. is an acronym for generally recognised accounting practice. GRAP is being developed in SA and is based on the IPSAS. GRAP is the acceptance and implementation by SA of the IPSAS. A GRAP standard is based on an IAS/ IFRS where no IPSAS exists for the accounting treatment in question. Once the GRAP standard relating to a specific topic has been developed the GAMAP equivalent will be withdrawn and be replaced by the newly developed GRAP standard. The outcome of this exercise is that eventually all the GAMAP standards will be withdrawn and we will have one set of GRAP standards that will be utilised by all Public Sector entities in all three spheres of government in SA. 12
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, ASB: Annual Financial statements (AFS): is an acronym for the Accounting Standards Board. This is a South African Body. In terms of section 89(1) of the PFMA, the primary functions of the ASB are to: Set standards of generally recognised accounting practice for the financial statements of departments; public entities; constitutional institutions; municipalities and boards, commissions, companies, corporations, funds or other entities under the ownership control of a municipality; and Parliament and provincial legislatures, Prepare and publish directives and guidelines concerning the standards set above, Recommend to the Minister of Finance effective dates of implementation of these standards for the different categories of institutions to which the standards apply and Perform any other function incidental to advancing financial reporting in the public sector. Financial statements must fairly present the state of affairs of the Public Sector Entity, its performance against the budget, its management of revenue, expenditure, assets and liabilities, its business activities, its financial results and its financial position as at the end of the financial year. A complete set of financial statements as determined in GRAP 1 includes the following minimum components: Statement of financial position Statement of financial performance Statement of changes in net assets Cash flow statement A summary of significant accounting policies Notes to the financial statements. 13
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, Going concern: Accrual basis: Prudence: Substance form: over Financial statements should be prepared on the assumption that a Public Sector entity is a going concern, and will continue in operation for the foreseeable future. Financial problems of an entity are normally resolved by either the ability to raise taxes or by some other intervention (for example recovery plan funded by other organs of state) in order to ensure that services are maintained. Under this basis, the effects of transactions and other events are recognized when they occur (and not as cash or its equivalent is received or paid), and they are recorded in the accounting records and reported in the financial statements of the period to which they relate. It is the inclusion of a degree of caution in the exercise of the judgments needed to make the estimates required under the conditions of uncertainty, such that assets or revenues are not overstated and liabilities or expenses are not understated. If information is to represent faithfully the transactions and other events that it purports to represent, it is necessary that these transactions are accounted for and presented in accordance with their substance and economic reality and not merely their legal form. The substance of transactions or other events is not always consistent with that which is apparent form their legal or contrived form. (Example: The public sector may dispose of an asset to another party, but agreements may exist that ensure that the public sector continues to enjoy the future economic benefits for instance a public private partnership to manage a road). 14
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, Matching: Consistency: Conservatism: This concept requires revenues earned and expenses incurred to be matched with one another, and with the services to which they relate in the same reporting period. This means that, where applicable, any revenues or expenses relating to a particular service have to be accounted for when earned or incurred and not when money is received or paid. The importance of comparability requires consistency in the treatment of similar accounting transactions and the presentation of financial information within each reporting period and from one period to the next. This means that the same form of presentation should be used and that the same items should be included in the financial statements for succeeding periods. This concept relates particularly to the areas of asset valuation and revenue determination. Fundamentally it means that an accountant, in considering approximately equally acceptable alternatives, will use the one that tends to portray the least optimistic picture of the estimated or actual financial position and/or operating results of a reporting entity. 3. INTRODUCTION/OVERVIEW 3.1. Financial reporting is the means of communicating financial information to users. Currently a large portion of entities within the public sector utilise the cash basis of accounting to prepare their financial reports, which, simply put, requires an entity to account for transactions whenever cash is received or paid by the entity. In accordance with this methodology most assets are expensed when purchased and very few liabilities and provisions are recognised leading to a Statement of Financial Positions which is not a fair presentation of the affairs of the Public Sector Entity. 15
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, 3.2. The goal of Public Sector accounting standards, and specifically of GRAP and IFRS/ IAS in South Africa, is to provide a set of generally recognized accounting concepts and principles which will bring about the consistent treatment of accounting transactions and presentation of financial results by all Public sector entities in South Africa. It is important to note that Government business enterprises and other entities with listed debt or equity have to comply with the full set of IFRS and IAS. 3.3. Furthermore these standards will be based on accrual accounting principles, which will address the shortcomings of the currently employed cash basis of accounting. In the light of the abovementioned move from cash to accrual accounting and the required implementation of GRAP, there is a huge demand that will be placed on public sector entities to change their accounting systems, procedures, accounting records and internal controls to ensure that these are aligned to accrual accounting requirements and also to the requirements of the GRAP standards. Furthermore a need exists for capacity building of finance staff to ensure that they understand the demands and implementation requirements of the GRAP standards. 16
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, 4. LEARNING ASSUMED TO BE IN PLACE 4.1. Further Education and Training Certificate or equivalent qualification at NQF level 4. 5. UNIT CONTENT 5.1. ASSESSMENT CRITERION 1: 5.1.1. The public sector accounting environment is explained in the context of the public sector 5.1.1.1. Accounting frameworks that need to be adhered to by different Public Sector Entities in South Africa is illustrated in the following diagram which illustrates the existence and context of Generally Recognised Accounting Practice (GRAP) in the public sector environment: CONSTITUTION OF THE REPUBLIC OF SOUTH AFRICA NO. 108 OF 1996 In terms of the Constitution, all spheres of government need to ensure proper financial management and accountability of their financial affairs. The need for legislation governing the financial management and financial accountability at national and provincial level gave rise to the existence to the Public Finance Management Act (PFMA) (The diagram is completed on the next page) 17
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, PUBLIC FINANCE MANAGEMENT ACT (PFMA) NO. 1 OF 1999 The objective of the PFMA is to secure transparency, accountability, and sound management of the revenue, expenditure, assets and liabilities of the institutions to which the Act applies. In terms of section 5 of the PFMA, a National Treasury (NT) is established with delegated functions and powers as per section 6 of the PFMA. In context of all spheres of government, the NT must co-ordinate intergovernmental financial and fiscal relations. (for more detail on NT s responsibilities and powers, refer to the section below headed History of the development of GRAP standards in SA ). In terms of section 87 of the PFMA, an Accounting Standards Board (ASB) is established, with delegated functions and powers as per section 89 and 90 of the PFMA. The ASB must, amongst other responsibilities, set standards of generally recognized accounting practice as required by section 216 (1) (a) of the Constitution for the annual financial statements of all spheres of government. The PFMA does not make specific provision for local government financial affairs. Thus a need for a similar act, governing local government financial management and financial accountability gave rise to the existence of the Municipal Finance Management Act. MUNICIPAL FINANCE MANAGEMENT ACT (MFMA) NO. 56 OF 2003 The objective of the MFMA is to secure sound and sustainable management of the fiscal and financial affairs of municipalities and municipal entities by establishing norms and standards and other requirements in terms of section 2 of the MFMA. In terms of section 122 (3) of the MFMA, both the annual financial statements and consolidated annual financial statements of municipalities and municipal entities must be prepared in accordance with generally recognised accounting practice (GRAP) as prescribed in terms of section 91(1)(b) of the PFMA. 18
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, 5.1.2. Meaning and purpose of a financial reporting framework 5.1.2.1. A comprehensive basis of accounting comprises a set of criteria used in preparing financial statements which applies to all material items and which has substantial support. A financial reporting framework constitutes a comprehensive basis of accounting for an entity s financial statements 5.1.2.2. The section below explains the current accounting frameworks that are utilised by the various public sector entities in South Africa, and gives an indication of how these frameworks will change in the future. Type of Public Sector Entity National and provincial departments Parliament and provincial legislatures Municipalities Existing Accounting Framework Modified cash basis of accounting. Assets are expensed when purchased. Very few liabilities and provisions are recorded on the AFS. Only revenue and expenditure paid and received in cash is recorded. Same as above Currently municipalities are classified as high medium or low capacity municipalities depending on their financial management capability. High capacity municipalities are New proposed Accounting Framework Eventual implementation of accrual accounting by way of implementing GRAP standards Same as above It is estimated that a comprehensive set of GRAP standards will be issued and be effective by 30 June 2009, and will cover all relevant public sector accounting issues, with the need for 19
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, Type of Public Sector Entity Municipal entities Public entities national and provincial (3A, 3C) and constitutional institutions Existing Accounting Framework already implementing all issued and effective GRAP standards and certain GAAP standards where GRAP is not yet developed. Municipal entities take on various legal forms such as private companies or service utilities. Depending on their current legal status, these entities will have adopted accounting frameworks accordingly (e.g. GAAP). SA GAAP standards, with the issued and effective GRAP standards (GRAP 1,2 and 3) replacing the equivalent GAAP standard. New proposed Accounting Framework dependency on GAAP standards therefore disappearing. It is envisaged that all municipalities and other relevant entities will then have to comply with this set of GRAP standards. It is estimated that a comprehensive set of GRAP standards will be issued and be effective by 30 June 2009, and will cover all relevant public sector accounting issues, with the need for dependency on GAAP standards therefore disappearing. In terms of MFMA circular no. 44, municipal entities will have to comply with this set of GRAP standards by 2010. Same as above 20
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, Type of Public Sector Entity Public Entities (Schedule 2, 3B, 3D) and trading entities Unlisted entities Government business enterprises and other entities with listed debt or equity Existing Accounting Framework SA GAAP SA GAAP or entity specific basis of accounting IFRS/ IAS IFRS/ IAS basis of accounting New proposed Accounting Framework SA GAAP SA GAAP or entity specific basis of accounting IFRS/ IAS IFRS/ IAS basis of accounting 5.1.2.3. The financial reporting framework for the majority of private sector entities, such as companies, is the International Accounting Standards. However, the financial reporting framework for public sector entities is currently in the development process. Public sector accounting is undergoing a transition from the cash basis/ modified cash basis of accounting to accrual accounting. The financial reporting frameworks currently applicable to public sector entities and the future financial reporting frameworks are explained later on in this section. 5.1.3. The need for accounting standards in the public sector of SA. 5.1.3.1. The need for accounting standards and the adherence thereto by all spheres of government is explained by the Conceptual Framework underlying GRAP This Framework states that comparability between financial statements must be achieved, thus users must be able to compare the financial statements of an entity over time in order to identify trends in its financial position and financial performance. Users must also be able to compare the financial statements of different entities in order to evaluate their relative financial position, financial performance and changes in net assets. The adherence to uniform accounting standards ensures this. 5.1.3.2. In terms of the above-mentioned Framework, Generally Recognised Accounting Practice normally results in financial statements that convey what is generally 21
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, understood as a fair presentation of such information, if compiled in accordance with these accounting standards. 5.1.3.3. Furthermore, the adherence to accounting standards ensures consistency through the application of these accounting standards and changes thereto being applied consistently over all periods of financial information presented. 5.1.3.4. From an international perspective, the adherence to international accounting standards by SA spheres of government ensures accountability and comparability on an international level. Therefore, accounting standards are a necessity for the public sector of SA s participation in the global economy and aids in matters such as taking up of foreign loans. 5.1.4. History of the development of the GRAP standards in SA. 5.1.4.1. The National Treasury (NT) in association with other key stakeholders has led the process of the development of accounting reforms in the South African Public Sector since 1998. 5.1.4.2. The existence of GRAP/ GAMAP derives from accounting standards that have been issued at an international level this can be illustrated as follows: 22
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, 5.1.4.3. The key aspects of the above-mentioned process can be summarised as follows, with more detailed descriptions of the acronyms used set out under section 1.2.1 above entitled: Key Concepts. New accounting standards called GAMAP, to be utilised by municipalities for the preparation of their AFS, were developed and based on SA GAAP as at 30 November 1997. The envisaged application of these standards would result in the AFS of municipalities more closely resembling those of entities in the private sector. GAMAP has since become outdated as substantial changes have taken place to GAAP since 1997. GAAP has changed dramatically since 1997 as the international accounting standards, on which SA GAAP is based, have changed since 1997. A process was started by the ASB in August of 2002 to review and amend the existing outdated standards of GAMAP, and also to develop the new standards of GRAP, which will eventually replace the GAMAP standards. These standards of GRAP are based on the IPSAS, which did not exist in 23
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, 1997, when the GAMAP standards were developed. IPSAS are in turn based on the relevant IAS or IFRS. 5.1.4.4. The roles of responsibilities for the ASB, the National Treasury and the Auditor- General, can be summarised as follows: The ASB sets the accounting standards, National Treasury assists in the implementation of the standards by, for example, developing the appropriate formats, making recommendations and regulating the approach to implementation, providing guidance and rendering support for implementation, including training, The Auditor-General audits annual financial statements in line with the standards and the formats. 5.2. ASSESSMENT CRITERION 2: 5.2.1. The nature of accounting principles, concepts and organizations influencing the development of accounting practice for the public sector are explained. 5.2.1.1. The rules and conventions of accounting are commonly referred to as principles. It is therefore important that sound accounting principles should exist. The pocket Oxford dictionary defines a principle as a fundamental truth or law as the basis of reasoning or action. 5.2.1.2. Accounting principles may therefore be regarded as specific fundamental tenets which, on the basis of reason, demonstrated performance and general acceptance, are generally essential to effective management control and financial reporting. 5.2.1.3. The accounting principles, concepts and disclosure requirements are included in the standards of Generally Recognised Accounting Practice (GRAP), also referred to as the accounting standards. The accounting standards give the following guidance to the preparers of AFS when dealing with specific topics: 24
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, They explain the accounting treatment of transactions, in other words the debit and credit entries. They explain the accounting measurement of transactions. They explain the disclosure requirements of transactions in the entity s Annual Financial Statements 5.2.1.4. As stated earlier, paragraph 63 of the framework for the preparation and presentation of AFS the application of Generally Recognised Accounting Practice normally results in financial statements that convey what is generally understood as a fair presentation of such information. 5.2.1.5. Prior to the approval and publication of the Government Gazette 30013 (which is discussed in detail below), dated 30 June 2007, municipalities that were required to comply with section 122(3) of the Municipal Finance Management Act (MFMA), 56 of 2003 had to utilize the following accounting standards for financial reporting purposes: The effective Standards of Generally Recognised Accounting Practices (GRAP); The effective Standards of Generally Accepted Municipal Accounting Practices (GAMAP); and The effective Standards of South African Generally Accepted Accounting Practice (SA GAAP) including any interpretations and circulars issued by the Accounting Practices Board and SAICA respectively. 5.2.1.6. The effective GRAP, GAMAP and GAAP standards as at 29 June 2007 are as follows: GRAP 1 Presentation of financial statements GRAP 2 Cash Flow Statements GRAP 3 Accounting policies, changes in accounting estimates GAMAP 4 Foreign exchange GAMAP 6 Consolidations 25
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, GAMAP 7 Associates GAMAP 8 Joint Ventures GAMAP 9 Revenue GAMAP 12 Inventories GAMAP 17 PPE GAMAP 19 Provisions 5.2.1.7. GAAP standards - List of standards as set out on page 43 to 47 of the NT APPLICATION OF ACCOUNTING STANDARDS GUIDE (updated by NT and issued on 17 August 2007) 5.2.1.8. Although the MFMA requires the use of generally recognised accounting practice (GRAP) for the preparation and presentation of financial statements, not all transactions at a municipal level were addressed by the effective GRAP/GAMAP standards and therefore before 29 June 2007 municipalities were expected to comply with GAAP, where transactions were not addressed by the GRAP or GAMAP standards. 5.2.1.9. The purpose of Government Gazette 30013 and the resulting NT APPLICATION OF ACCOUNTING STANDARDS GUIDE was to ease the burden resting on municipalities to comply with all relevant GAAP standards by allowing a phased in approach by exempting municipalities for a specific time period from complying with either the full GAAP standard or with specific portions thereof. 5.2.1.10. It is important to note here that the GAMAP and GAAP standards, which are relevant to municipalities, will eventually be replaced by GRAP standards once these standards are developed and become effective. Government business enterprises and other entities with listed debt or equity will continue applying the full set of IFRS and IAS. 5.2.1.11. The following organizations influence the development of accounting practice in the public sector. National Treasury (NT) 26
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, Accounting Standards Board (ASB) Auditor-General of South Africa (AGSA) International Accounting Standards Board (IASB) International Federation of Accountants (IFAC) 5.3. ASSESSMENT CRITERION 3: 5.3.1. Appropriate accounting systems and procedures are derived and implemented in the public sector environment. 5.3.1.1. Accounting systems An accounting system is made up by the personnel, procedures, devices and records used by an entity to develop accounting information and to communicate this accounting information to decision makers, internally and externally. The design and capabilities of these systems vary greatly from one entity to the next. Many factors affect the structure of an accounting system within an entity. Among the most important are the entity s needs for accounting information and the resources available for running its operations. 5.3.1.2. Purpose of an accounting system In developing information about the financial position of an entity and the results of its operations, most accounting systems perform the following basic functions: Record and interpret the effects of entity transactions; Classify the effects of similar transactions in a manner that permits determination of the various totals and sub-totals useful to management and used in accounting reports; and Summarize and communicate the information contained in the system to decision makers. 27
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, 5.3.1.3. Design and installation of accounting systems The design and installation of large accounting systems is a specialized field. It involves not just accounting, but expertise in management, information systems, marketing and in many cases computer programming. Thus accounting systems generally are designed and installed by a team of people with many specialized capabilities. Large entities have a staff of systems analysts, internal auditors and other professionals who work full time in designing and improving the accounting system. Medium sized entities often hire a professional accounting firm to design or update their systems. Small entities with limited resources often purchase one of the many packages of accounting systems designed for small entities. These packages are available through office supply stores, computer stores and software manufacturers. 5.4. ASSESSMENT CRITERION 4: 5.4.1. Treasury guidelines relating to accounting are explained. The National Treasury (NT) has issued various circulars, application guidelines and municipal specimen sets of annual financial statements to assist municipalities and municipal entities in compiling GRAP compliant annual financial statements. However, as explained in section 1.4.1 above, these documents serve as transitional support material until the public sector accounting conversion to GRAP is complete. Certain of these documents serve as good reference material, but are no longer applicable (they have been indicated below as such). These documents are discussed briefly in the remainder of this section. 5.4.1.1. NT MFMA Circular No. 18 Implementation of new accounting standards and Format of annual financial statements (Issued 23 June 2005 not applicable anymore) 28
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, The objective of NT MFMA circular no. 18 is to give municipalities and municipal entities a background on National Treasury s mandate to introduce Generally Recognised Accounting Practice (GRAP) in terms of section 216(1)(a) of the Constitution. This circular specifically addressed the following issues: The role of the Accounting Standards Board (ASB) in setting the accounting standards which municipalities and municipal entities have to comply with; Introduction of the 3 GRAP and 8 GAMAP standards that are the minimum standards to be complied with by high capacity municipalities and all municipal entities for the year ended 30 June 2005. As mentioned earlier, the 3 GRAP and 8 GAMAP standards, referred to in the document are as follows: GRAP 1 Presentation of financial statements GRAP 2 Cash Flow Statements GRAP 3 Accounting policies, changes in accounting estimates GAMAP 4 Foreign exchange GAMAP 6 Consolidations GAMAP 7 Associates GAMAP 8 Joint Ventures GAMAP 9 Revenue GAMAP 12 Inventories GAMAP 17 PPE GAMAP 19 Provisions The concept of mandatory and encouraged accounting standards, meaning that municipalities and municipal entities should apply their mind to transactions and events that are not covered by the existing GRAP and GAMAP standards, as set out above (implying application of the International Public Sector Accounting Standards (IPSAS) and the International Financial Reporting Standards (IFRS) for areas of accounting not covered by GRAP or GAMAP); 29
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, Implementation of GRAP by capacity, i.e. the effective dates for producing new GRAP compliant annual financial statements in line with the MFMA phased implementation strategy; Format of annual financial statements and audit, depending on the capacity level of municipalities (being GRAP format); Consistency in application of accounting standards by municipalities and municipal entities; Key steps to compliance with GRAP and capacity building by municipalities and municipal entities of their officials and early implementation of GRAP compliant accounting and information systems; and Submission of 2004/05 annual financial statements of municipalities and municipal entities to NT. 5.4.1.2. NT MFMA Circular no. 18 is issued with the inclusion of: A specimen set of annual financial statements for application as guideline by municipalities for compiling its annual financial statements in 2005/06, depending on its capacity level; and An accounting standards application guide for the implementation of approved standards of GRAP. The accounting standards application guide addressed the accounting treatment of property, plant and equipment (PPE), the unbundling of loans redeemed and other capital receipts, the process to establish the Capitalization Reserve (CR), the Capital Replacement Reserve (CRR) and the External Financing Fund (EFF) and certain other accounting issues. 5.4.1.3. NT MFMA Circular No. 36 Annual financial statements for 2005/06 for municipalities and municipal entities (Issued 11 July 2006 not applicable anymore) The objective of NT MFMA circular no. 36 is to provide guidance to municipalities on the preparation and timely submission of the annual 30
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, financial statements for municipalities and entities for the 2005/06 financial year. The following issues relating to the annual financial statements are clarified in this circular: Applicable accounting standards and formats; Specimen municipal annual financial statements; Consolidated specimen financial statements; Timing and implementation by capacity; Withdrawal and resubmission of financial statements; The municipal audit file; Additional disclosures; and Non compliance with Chapter 12 of the MFMA. NT MFMA Circular no. 36 is issued with the inclusion of: A specimen set of annual financial statements for application as guideline by municipalities for compiling its annual financial statements in 2005/06 for small, medium and large municipalities; A consolidated specimen set of annual financial statements for application as guideline by municipalities for compiling its consolidated annual financial statements in 2005/06; and Basis of preparation for municipal entities. 5.4.1.4. NT MFMA Circular No. 44 Preparation of annual financial statements based on the Exemption Gazette 30013 (Issued 25 July 2007 to expire after the public sector accounting conversion to GRAP) The objective of NT MFMA circular no. 44 is to provide guidance on the implementation and interpretation of the above-mentioned Gazette (this Gazette is discussed below) and the preparation and submission of annual financial statements as required by the MFMA. This circular specifically addressed the following issues and was relevant for municipalities preparing AFS for the year ended 30 June 2007: 31
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, The exemptions granted in terms of the Government Gazette No. 30013, dated 29 June 2007; New GRAP compliance dates for municipalities and municipal entities due to the extension granted in the above-mentioned Gazette; Impact of these exemptions on the preparation and submission of annual financial statements on municipalities municipal entities as per its capacity level; Application process to be followed by municipalities and municipal entities for deviation from the exemptions granted in the abovementioned Gazette; and The submission of implementation plans by municipalities and municipal entities to NT and Provincial Treasury (PT). NT MFMA Circular no. 44 is issued with the inclusion of: A template implementation plan for accounting standard reforms for high capacity municipalities for completion and submission to PT and NT; and A template implementation plan for accounting standard reforms for medium and low capacity municipalities for completion and submission to PT and NT. 5.4.1.5. GOVERNMENT GAZETTE 30013 (issued 29 June 2007 to expire after the public sector accounting conversion to GRAP) The purpose of this Gazette is to grant exemption to municipalities and municipal entities from certain GRAP accounting standards and the requirement to compile consolidated annual financial statements. These exemptions are granted for a specific period, subject to conditions contained in the Gazette and the Annexure thereto municipalities are required in terms of the Gazette to submit implementation plans for accounting standard reforms to NT and PT before 30 October 2007 and an updated plan, showing progress made in implementation, before 31 March 2008. 32
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, NT issued the below-mentioned two application of accounting standards guides to assist municipalities and municipal entities in applying the exemptions as per the Gazette. APPLICATION OF ACCOUNTING STANDARDS GUIDE (issued by NT on 30 July 2007 to expire after the public sector accounting conversion to GRAP) The purpose of this document is to provide guidance to municipalities and municipal entities on the accounting implications of the Exemption Gazette 30013, dated 29 June 2007. This document should be read in conjunction with NT MFMA Circular 44, discussed above. APPLICATION OF ACCOUNTING STANDARDS GUIDE (updated by NT and issued on 17 August 2007 to expire after the public sector accounting conversion to GRAP) The purpose of this document is to provide updated guidance to municipalities and municipal entities on the accounting implications of the Exemption Gazette 30013, dated 29 June 2007. This document should be read in conjunction with NT MFMA Circular 44, discussed above. 5.5. ASSESSMENT CRITERION 5: 5.5.1. Understand the importance of maintaining accounting records that are updated in a timely manner. 5.5.1.1. Accounting standards describe generally recognized accounting concepts and principles, aimed to ensure consistent treatment of accounting transactions and presentation of financial results. To ensure compliance with these accounting standards, it is necessary that accounting controls, accounting processes and ultimately accounting records are maintained and updated in a timely manner. 33
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, 5.5.1.2. The advantages of compiling financial statements from accounting records that are maintained and updated in a timely manner include the following: Assessing the municipality s ability to meet its long- and short-term obligations. Assessing the municipality s ability to maintain the level and quality of its services and to finance new programmes. Gaining an understanding of future rates and other revenue requirements. Understanding spending priorities. Determining the municipality s impact on the economy. Measuring performance in the management of financial resources. Assessing compliance with legislative requirements and the needs of regulatory authorities. 5.5.1.3. The importance of timely updated accounting records can best be illustrated by way of some practical examples: Statement of financial position Asset registers for PPE and Investment Properties in order to have an accurate updated theoretical record of assets on which the financial statement figures are based at year-end, the asset registers need to be updated continuously as transactions occur during the year. Finance leased assets information regarding every leased asset need to be updated and monitored regularly to ensure accurate calculation of interest and capital repayment portions of lease instalments. Investments register the register should be updated continuously with changes occurring during the year (e.g. changes in interest rates, reinvestment of funds, new investments made and redemption of investments) Bank reconciliation monthly reconciliation for each bank account between the bank control general ledger account and the bank statement received from the banking institution. Long outstanding reconciling items 34
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, need to be cleared on a timely basis to ensure accuracy of recorded amounts, cash control, and the prevention of fraud/theft. Debtors to prevent incorrect invoicing and loss of revenue, details regarding new accounts, accounts closed, non-payment or payments in arrears by debtors, charges for the month on sales or services provided should be updated in a timely manner, but at least on a monthly basis. Debtors reconciliation monthly reconciliations should be performed to ensure accuracy of accounting records and of amounts payable. Differences between the debtors ledger and the debtors control account in the general ledger, including large or unusual reconciling amounts should be followed up regularly. Debtors age analysis regular reconciliation should be performed between the debtors ledger and the debtors age analysis. The follow-up of differences on a monthly basis would prevent circumstances where large differences still occur and need to be investigated at year-end. Loans register - the register should be updated continuously with changes occurring during the year (eg. changes in interest rates, repayments and finance charges, unusual transactions, new loans). Finance lease liabilities information regarding every leased asset, as well as changes in interest rates and installments need to be updated and monitored regularly to ensure accurate calculation of interest and capital repayment portions of lease installments. Creditors to prevent legal claims and non-compliance with laws and regulations, details regarding new suppliers, accounts closed, discounts received, payments made, etc. should be updated in a timely manner, but at least on a monthly basis. Creditors reconciliation - monthly reconciliations should be performed to ensure accuracy of accounting records and payments made. Differences between the creditors ledger and the creditors control account in the general ledger, including large or unusual reconciling amounts should be followed up regularly. Leave pay register updating the register with employees details, and continuously as leave days are earned and utilised would ensure accurate calculation of leave pay when these payments are due. 35
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, Statement of financial performance Budgeted v Actual Revenue and Expenditure to continuously measure revenue and expenditure against the budget, and prevent unauthorized expenditure, accounting records need to be updated as transactions occur. Revenue correct classification of the type of revenue and the accuracy and completeness of totals. Interest received updating the investments register continuously for changes in interest rates, re-investment of funds, new investments made and redemption of investments will ensure the accurate recording and presentation of interest received. Expenditure correct classification of the type of expenditure and the accuracy and completeness of totals. Interest paid, including on finance lease liabilities updating the loans register continuously for changes in interest rates, repayments and finance charges, unusual transactions and new loans will ensure the accurate recording and presentation of interest paid. 5.6. ASSESSMENT CRITERION 6: 5.6.1. Understand the different financial reports to support management and decision-making in the public sector. The overall goal of financial reporting is accountability. All financial reporting objectives are derived from the accountability concept. Financial reporting can be divided in two areas, namely internal reporting and external reporting. 5.6.1.1. Internal reporting Most internal reporting is non-statutory and is executed for the purpose of control. It embraces a wide range of reporting techniques, such as the completion of routine forms on daily operations to monthly / quarterly 36
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, financial reports (for example age analysis of debtors) to management. It requires a constant stream of accounting information to monitor and control the efficient and economical use of financial and other resources within the entity. In general internal reports must always comply with the criteria of relevance, usefulness, timeliness and accuracy and must facilitate management control, planning and performance. MFMA sections, 71 to 75 is clear on the need for reports The following internal reports can be utilized to support management and decision-making in the public sector: Monthly / quarterly and ad hoc reports: These financial reports will include, inter alia, the following information: Monthly cash and bank reconciliations, including the name, type and account number of the primary bank account, change of primary bank account, bank details of all the accounts held by the entity, notifications of investments including opening and closing balances, serious financial problems, drafting of annual performance agreements, net overdrawn position including steps taken to rectify, submission of information as may be prescribed, placing of documents on web site, quarterly report on implementation of supply chain management policy, payments due by organ of state in respect of service charges, report on all expenditure relating to salaries, investment portfolio, information regarding long-term debts, etc. Cash flow forecast: Information system and related reports should indicate cash forecasts on an annual, six-monthly, quarterly, monthly and daily basis. The cash flow forecast should be updated at least each month in terms of daily actual cash received and expenditure incurred. Management can use this information to assess borrowings needed, increases in rates and tariffs and expenditure. Information must also enable managers to determine timing of expenditures, investments, etc. The information and related reports should also interface with a variety of other systems long-term financial plan, capital expenditure system, the budgetary system, purchases, stores, debtors, creditors, the billing system, payroll system and virtually every financial system which is likely to have a cash-related impact on the financial activities. 37
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, Service delivery and budget implementation plan (SDBIP): Information regarding the revenue and expenditure projections for each month and service delivery targets and performance indicators for each quarter should be indicated in the SDBIP. Debtor collection and credit control: Financial reports on debtors should include the following information: Debtor age analysis indicating the debtor, type of service, amount outstanding as per current, 30 days, 60 days, 90 days and 90+ days. Payments received in terms of current and outstanding debtors. Interest on arrears. Realistic targets consistent with GRAP and collection ratios, as well as the estimates of income set out in the budget, less an acceptable provision for bad debts. Other information such as debt collection procedures, extension of time for payment of accounts, termination of services when payments are in arrears, matters related to unauthorized consumption of services, theft, damages and any other matters that may be prescribed. Exception reports: Exception reports should be created to indicate for instance, exceptional high or low usage of services. The cases listed should be followed-up and corrected. After corrections have been made, an exception report should again be created that is reviewed by a senior official in the Billing Section and signed as evidence of the review. The report should be filed for audit purposes. 5.6.1.2. External reporting External reporting is done mainly in compliance with statutory requirements and is aimed at satisfying the accountability objective. Such reports must enable managers, councilors and ministers to faithfully discharge their accounting responsibilities to both internal and external stakeholders. These reports are also subject to the criteria published in the internal reports. The 38
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, following external reports can be utilised to support management and decision-making in the public sector: Annual financial statements: The objective of financial statements is to provide information about the financial position, financial performance and cash flows in a manner that is useful to a range of users. Annual report: The annual report of the entity consisting of the following components, must be tabled during each financial year: Annual financial statements Auditor-General s report on the financial statements Annual performance report Assessment of arrears on taxes, service charges, etc. Assessment of the entity s performance with regard to revenue collection from each revenue source and for each vote in the budget. Particulars of any corrective actions taken or to be taken in response to issues raised in audit reports. Any further information as prescribed Budget: A sound budget is one which sensibly allocates realistically expected resources to the achievement of defined performance objectives identified as per priorities in the strategic planning of the entity. The budget consists of two components namely operating (revenue and expenses) and capital. The purpose of dividing a budget into capital and operating is, firstly to ensure that each of the principal activities and projects of the entity is assigned a fair portion of the resources available. Secondly, to hold the relevant head of department or senior official accountable for managing the resources allocated to such vote in an efficient manner. Other reports that add value in the management of expenditure 5.6.1.3. General characteristics of financial reporting Internal and external financial reporting should provide information that is useful to a wide range of users in making economic decisions. Financial reporting 39
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, should therefore include the following basic information to ensure that it provides useful information: Financial reporting should provide clearly presented, understandable, timely and consistent information that is useful to present and potential resource providers and other users in making rational decisions about the allocation or resources, assessing the services provided and the ability to continue to provide them and assessing how councilors and officials have discharged their stewardship and accountability responsibilities. Financial reporting should provide all information required for the fair presentation of an entity s financial position and financial performance i.e. it should be in accordance with GRAP. Financial reporting should also provide the following information: Economic resources, obligations, net assets and the effects of transactions, events and circumstances that change resources and interests in those resources. The performance of an entity during a given period, for example the achievement of goals and objectives as well as the number and kind of resources used in the process. How cash and other liquid resources were obtained and spent. Financial reporting should provide information useful in assessing whether financial resources were administered in accordance with the limits established by legislative and regulatory authorities. Financial reporting should include, where applicable, a comparison of current period amounts with those of prior periods and a comparison of actual results with budgeted or planned results. Financial reporting should also include explanations and interpretations to help users understand financial information provided. 40
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, 5.7. ASSESSMENT CRITERION 7: 5.7.1. Understand the difference between cash and accrual basis of accounting. The objective of financial statements is to provide information about the financial position, financial performance, cash flows, and changes in community wealth of an entity in a manner that is useful to a range of users. 5.7.1.1. In order to meet these objectives, financial statements should be prepared on the accrual basis of accounting. Under this basis, the effects of transactions and other events are recognized when they occur (and not as cash or its equivalent is received or paid cash basis), and they are recorded in the accounting records and reported in the financial statements of the period to which they relate. 5.7.1.2. Financial statements prepared on the accrual basis inform users not only of past transactions involving the payment and receipt of cash, but also of obligations to pay cash and/or potential to deliver services in the future. Thus they provide the type of information about past events and other transactions that is most useful to users to assess the responsibility for accountability of government. EXAMPLE: An entity bills its consumers for services rendered before 30 June (end of financial year), the billing is recorded in the accounting records as revenues even though the payment of accounts may only take place in the new financial year (after 1 July). Similarly, if a entity prepares its June payroll on 25 June, all the expenses associated with this payroll will be recorded as employee-related costs during June even though the portion of those costs which relates to PAYE or pension and medical aid contributions is only paid over during July. 41
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, The full accrual basis of accounting is the generally recognized basis of accounting for entities. It places emphasis on earnings as a measure of efforts rather than on the inflows and outflows of any type of resources. When revenues and expenses cannot be exactly measured at the end of the accounting period, for example services rendered by resources acquired through property rates, electricity meters read at a date other than the end of the period, or goods received but not yet invoiced or paid, the accrual basis is applied in the sense that revenue must be measurable and available within the accounting period or soon enough thereafter to pay for liabilities incurred during that period. Likewise, expenses for operations and PPE are recognized when such liabilities are incurred, if measurable. The following table serves as a summary of the major differences between the cash and accrual basis of accounting: Accounting item Short and long term liabilities Leases Non-current and current provisions Cash basis of accounting Majority of liabilities not accounted for All transactions in terms of leasing arrangements are expensed Provisions are not accounted for Accrual basis of accounting All liabilities accounted for where present obligation exists due to past event for which settlement requires outflow of economic benefits Leasing arrangements are categorized as finance or operating leases and assets held under finance leases as capitalized All provisions accounted for where liabilities exist of uncertain timing or amount. 42
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, Accounting item Debtors and creditors PPE Investment property Inventories Financial instruments Service revenue Cash basis of accounting Debtors and creditors are not always raised, as revenue and expenses (capital and operating) are recorded when cash is received or paid PPE are expensed when acquired No distinction is made between investment property and PPE Inventories are expensed when acquired, e.g. government departments expense all inventories acquired Financial assets and financial liabilities are not accounted for in accordance with the accounting standards on financial instruments. Examples of financial instruments are cash, debtors and creditor Service revenue is recognized when cash is received for services rendered or to be rendered in the future Accrual basis of accounting Debtors and creditors are raised in order to account for revenue and expenditure (capital and operating) when it accrues to the entity PPE are capitalized as assets when acquired Distinction is made between investment property and PPE Inventories are capitalized as assets when acquire Financial assets and financial liabilities are accounted for in accordance with the accounting standards on financial instruments, e.g. debtors are tested for impairment annually and provision for bad debt is made accordingly Service revenue is recognized in the financial year when services have been rendered 43
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, Accounting item Cash basis of accounting Accrual basis of accounting Sale of goods Revenue is recognized for the sale of goods when cash is received for the sale thereof Revenue is recognized for the sale of goods when the entity has transferred to the buyer the risks and rewards of ownership and when the entity no longer controls the g Government grant and subsidy revenue conditional grants Revenue is recognized when government grants and subsidies are received, even if the grants are conditional Revenue is recognized for government grants and subsidies received when the conditions of the grants and subsidies are met Accrual of interest Interest received or paid in cash is recognized Interest which accrues to the entity is recognized once it accrues Accrual of expenses and revenue for incomplete billing periods Revenue for services rendered or sale of goods and expenditure for purchases or services received are recognized when the related cash is received or paid Revenue is recognized when services are rendered and goods are sold and expenses are recognized when goods or services are received, taking into account the accruals for revenue and expenditure for the last few days of the financial year for which billing takes place after year end Accrual of Revenue for services Revenue is recognized 44
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, Accounting item expenses and revenue for incomplete billing periods Cash basis of accounting rendered or sale of goods and expenditure for purchases or services received are recognized when the related cash is received or paid Accrual basis of accounting when services are rendered and goods are sold and expenses are recognized when goods or services are received, taking into account the accruals for revenue and expenditure for the last few days of the financial year for which billing takes place after year end 6. SOURCES / REFERENCES 6.1. Fourie, M., Opperman, L. 2007. Municipal Finance and Accounting. 1st ed. Pretoria: Van Schaik. 6.2. South-Africa. National Treasury. 2003. Municipal Finance Management Act, Act 56 of 2003. 7. LEARNING TASKS/ACTIVITIES 7.1. List five organizations that influence the development of accounting practice in the public sector. (2.5) 7.2. What is the primary issue in accounting for revenue? Also list the two major recognition criterions for the recognition of revenue. (3) 7.3. Briefly explain three challenges which may be encountered by an entity in preparing a GRAP compliant Fixed Asset Register. (3) 45
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, 7.4. Are the following statements true or false? Briefly explain. 7.4.1. When a provision involves a present obligation and satisfies the rest of the definition, it is not recognized as a liability unless the exact amount of the obligation is known. (1) 7.4.2. Budgeting and accounting systems operate independently from each other, thus the budgeting process need not be in line with the GRAP requirements. (1) 7.5. Name four advantages of compiling financial statements from accounting records that are maintained and updated in a timely manner. (4) 7.6. Information updated in a timely manner in the asset records for PPE and Investment Properties will produce information which is vital for financial statement reporting. List and briefly explain 5 types of asset related information which these asset records should be able to provide annually. (5) 7.7. Name four types of basic information which should be included in financial reporting to ensure that it provides useful information for both internal and external financial reporting. (4) 7.8. What is the difference between the cash and the accrual basis of accounting? (2) 46
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, Unit Two: Use accounting techniques and approaches to process financial information. 1. LEARNING OUTCOMES 1.1. ON COMPLETION OF THIS STUDY UNIT, YOU SHOULD BE ABLE TO: 1.1.1. Prepare the different accounting records that are necessary to process financial information. These include the general ledger, cash books, Fixed Asset Registers and stores ledgers. 1.1.2. Prepare and analyse regular reports on the financial position, financial performance and cash-flows. 1.1.3. Present information to decision-makers on the performance against the budget. 1.1.4. Explain the use and role of the standard chart of accounts in the public sector. 2. KEY CONCEPTS Statement of Fin. Position (Balance sheet) Statement of financial Performance(Income statement) Public sector s financial position and changes in the financial position at end of a financial year is principally contained in the statement of financial position. The statement consist of two parts, namely liabilities which is the capital or funds the public sector has at its disposal, and assets which is the items for which the capital or funds were utilized. Information about the performance of the public sector is necessary to determine, inter alia, whether an institution is able to generate sufficient revenues to sustain its current level of operation and whether it will 47
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, be able to employ additional resources in the future. Cash flow statement the cash flow statement provides information regarding the cash effects of the public sector s operations, its investing transactions and its financing transactions. Net realisable value the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. National Treasury Body established as per the requirements of Section 5 of the PFMA. Provincial Treasury Body established as per the requirements of Section 17 of the PFMA 3. INTRODUCTION/OVERVIEW 3.1. Although a modern and comprehensive management information system comprises the collection, storing and processing of, as well as reporting on, all data and information, its structure must obviously provide for the relevant accounting systems and subsystems. These will consist of the following: 3.1.1. The budgetary system, including a long-term capital programme and the annual and projected capital and operating budgets. 3.1.2. A central control system, which will comprise property and asset registers, budgetary control, income and expenditure accounts, capital accounts, and general ledger accounts (including funds, reserves and provisions) 3.1.3. Accounting subsystems, such as debtors and creditors systems, purchases and store management systems, and the payroll system. 3.1.4. Cost and management accounting subsystems, such as costing for capital projects and works, costing for maintenance, costing for workshops, and costing for the management of vehicles and equipment. 48
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, 3.1.5. A reporting system, to comply with the statutory requirements. 4. LEARNING ASSUMED TO BE IN PLACE 4.1. Further Education and Training Certificate or equivalent qualification at NQF level 5. 5. UNIT CONTENT 5.1. ASSESSMENT CRITERION1: Preparation of the different accounting records necessary to process financial information. These include the general ledger, cash books, Fixed Asset Registers and store ledgers. 5.1.1. Cash book, general ledger and trial balance 5.1.1.1. An entity s cash book is a detailed record of all payments and receipts that has been or will be paid or received in the entity s bank account for a specific period. 5.1.1.2. To ensure that all transactions are processed in the accounting system, it is very important that the entity s cashbook is reconciled with its bank statements on a monthly basis. 5.1.1.3. The general ledger is a detailed record of all accounting transactions (including all cash book and journal entries), during a specific period, summarised per the following elements of financial statements: assets; liabilities; net asset income; and 49
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, expenses; 5.1.1.4. The first three elements i.e. assets, liabilities and equity relate to the financial position of an entity as set out in the Statement of Financial Position (Balance Sheet). The last two elements, i.e. income and expenses, relate to the performance of an entity as set out in the Statement of Financial Performance (Income Statement). 5.1.1.5. The trial balance is a summary of balances of general ledger accounts as at a certain date. 5.1.1.6. The cash book, general ledger and trial balance are key accounting records that are used for the compilation of annual financial statements. The following general diagram illustrates the typical flow of documentation/ books of first entry in an accounting cycle: 50
Learner Guide: Apply accounting principles and procedures in the preparation of reports and decisionmaking. LP 2, 5.1.2. Preparation of a Fixed Asset Register (FAR) for both PPE and Investment Properties 51