Taxation: Everybody does it, but the world has yet to agree on how to account for it.But that may soon change.

The International Public Sector Accounting Standards Board of the International Federation of Accountants recently issued the first proposal for a worldwide standard on "non-exchange revenue" that governments receive.

Now all the world has to do is agree on a few things. The proposal covers a broad scope of issues, including some big ones, such as the very basis on which taxes should be recognized and how they should be measured.

The IPSASB's technical director, Paul Sutcliffe, called the proposed standard "very important."

"For the first time, this document proposes international accounting standards for the recognition and measurement of the main sources of revenue for most governments and their entities - that is, taxes and transfers, including a wide range of non-exchange revenues," Sutcliffe explained. "The exposure draft will provide guidance to those countries searching for accounting policies to deal with this complex area."

Under the proposal, non-exchange revenues include not only taxes, but also transfers from other governments and international organizations, gifts and donations.

The exposure draft also provides guidance on how conditions and restrictions on the user of transferred resources are to be reflected in financial statements.

The exposure draft elicits comments on whether the scope of the proposed standard should exclude entity combinations that are non-exchange transactions, and whether it should include compulsory contributions to Social Security schemes, such as health insurance and pensions, that are in the nature of non-exchange transactions.

Other issues of controversy include recognition of assets when resources are transferred, measurement of acquired assets at fair value on initial recognition, whether to recognize at transfer or when the receiver has enforceable claim, and whether to distinguish exchange and non-exchange components of non-exchange transactions.

Accountability, transparency, analysis

Sutcliffe said that the proposed standard makes sense not only for financial reporting purposes - accountability and transparency - but also for purposes of economic analyses.

"We should be reporting the results of economic phenomena, like the imposition of taxes, in the period in which the taxing event occurs and the government gains the right to resources," Sutcliffe said. "This will often be the same period in which the cash flows, but need not be."

IFAC chief executive Ian Ball said that the proposal would be difficult to adopt for reasons more political than technical, because it would be useful only for governments that shift from cash-basis accounting to accrual-basis accounting.

"If a government chooses to implement public sector accounting standards, in almost all cases it will imply a significant increase in accounting effort, and the reason for that is quite simple: because most governments account extremely badly for all of their financial transactions," Ball said. "Implementing the set of standards generally, and this one in particular, would mean that governments would have to improve their accounting systems."

Countries that adopt the eventual standard could see a significant shift in their surplus or deficit, especially if they are at the same time moving from cash-basis to accrual-basis accounting across the board.

"It makes sense to report revenue in the period in which the economic activity which creates the revenue and gives the government control of additional resources actually occurs," Sutcliffe said. "This is when the government is better off. This may not be the same as the period in which, for example, the cash is collected. For purely administrative reasons, in many jurisdictions cash may be collected before or after the economic event [the taxing event] occurs."

Even among countries that have already adopted accrual accounting, as the U.S. has at state and local levels, the proposed standard would in most cases require changes from national standards. In fact, Ball said, few countries - and the U.S. is not among them - have comprehensive, principles-based standards on all forms of non-exchange revenues.

Sutcliffe noted that while few countries would be able to implement the proposed standard immediately, many could use it as they move toward accrual accounting.

"We are advised that, increasingly, countries are indicating their intention to move to accrual," Sutcliffe said. "That movement will take time and should include the development of sound policies for this critical element of financial reporting."

Though any change in standards will mean more work for governmental accountants, at least during the adoption process, the result would be more stable and efficient capital markets. The increase in consistent, accurate information, Ball said, would yield a decrease in the risk premium associated with numbers that are less than ideally accurate.

"The benefits are to people who are trying to use information about the fiscal position and fiscal performance of governments," Ball said. "The primary purpose of this standard is to get better consistency in the way taxes are reported and better quality of reporting, in the sense that they would be reporting more accurately to reflect the real economic resource flows associated with taxes."

The IPSASB standards are designed to apply to not only national governments, but state, provincial and local governments, as well as entities under them that issue financial statements.

Sutcliffe said that one of the most challenging parts of the proposal was its approach.

"Rather than starting from an approach which focused on particular/specific types of transactions and provides views on whether revenue arises from that transaction, and when and how much revenue, the exposure draft establishes broad principles and then explains how those principles are applied to particular transactions," Sutcliffe said. "This means that the principles are in place to provide broad guidance. They can be applied to transactions that may be of particular importance to some jurisdictions, but not in other jurisdictions. The problem with adopting an approach which focuses on specific transactions, is that some types of transactions may be missed. This is particularly significant for international standards intended to encompass many different jurisdictions, with different resource flows and administrative arrangements."

Sutcliffe also explained that the ED requires an entity to determine whether it gains control of an asset as a result of the taxable event or transfer of resources occurring, whether that taxable event or transfer also carries with it a liability that must be discharged, and provides that any increase in net assets is treated as revenue. The ED also explains that revenue does not arise as a result of a direct contribution of equity by owners.

The IPSASB requests comments by June 30, 2006.

Copies may be downloaded at www.ifac.org.

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