In this article, we share a high-level overview of the financial reporting for public sector entities in Malaysia. We had previously shared with you the Overview of the Malaysian Public Sector Accounting Standards (“MPSAS”). If you haven’t read, you may want to go through it first as it will provide a brief understanding of the development of public sector accounting standards in Malaysia.
Many people are not fully understand why there is a need for another specific framework for the public sector entities. Why can’t the public sector entities adopt the same framework as the private sector entities? In this article, we share our insights on why there is a need for public sector accounting standards.
The characteristic of public sector entities
The fundamental thinking why the public sector entities need a separate framework is mainly due to the special characteristics of the public sector entities. There are three fundamental characteristics of public sector entities, consistent with its definition in the 2020 Handbook of the International Public Sector Accounting Pronouncements.
The three fundamental characteristics are as follows:
1. Delivery goods and providing services to the public
Public sector entities are established to deliver goods and provide services to the public at large. Although the structure and level of authority between the government in one country to another may not be the same, at the end of the day, all public sector entities have this objective.
In addition to this objective, some public sector entities serve to redistribute income and wealth. For example, in the Malaysian context, public sector entities such as Pusat Zakat, Baitulmal and others, established and monitored under the state government, play the function to redistribute income and wealth in the society.
2. Non-profit making objective
Unlike private sector entities in which the main objective of making profits, public sector entities do not have similar objective. Public sector entities are there to deliver goods and to provide services regardless of whether they make profits or not. Most of the time, public sector entities operate at loss. This is because the goods or services provided to the public are free of charge.
Having said this, some of the public sector entities may also charge a nominal or a subsidised amount for the goods and services. But this does not necessarily mean they are operating with the primary objective to make profits. The price charged is to minimally cover the cost of purchasing and producing the goods and services or other administrative costs.
In recent time, some public sector entities need to secure ways to generate some income for sustainability purposes. This fact generally does not violate the non-profit oriented objective. At the end of the day, public sector entities deliver and provide goods and services to the public at a minimal amount, if not at no charge.
3. The funding sources
Private sector entities which obtain their finances from investors. However, public sector entities fund their activities and operations through taxes, government transfers and grants, social contributions and debt or fees. Public sector entities do not have investors from the public to fund their operations and activities. Hence, they are largely depend on government budget appropriation or grants.
Because public sector entities do not have investors, they do not have the obligation to make profits. As we know that in the private sector, the main objective of any investors is to get a high return. The higher the profits a company makes, the higher the return to the investors. The high return comes mainly from the company’s ability to charge for the goods and services produced in the market. Public sector entities, however, do not not adopt the same model.
The core principles developed in public sector accounting standards
The following are the fundamental principles in public sector accounting standards that are not available for private sector entities. These principles acknowledge the characteristics of public sector entities as explained above.
1. Service potential
The service potential concept relates to the primary reason for public sector entities to hold assets. Unlike private sector entities which invest and hold assets to generate future economic benefits (i.e. ability to generate cash flows), public sector entities hold assets for their service potential, regardless of whether such assets do not generate cash flows.
Some public sector entities may also hold specialised assets. For example, military assets, infrastructure and roads with limited market available for such assets. In addition to that, public sector entities may also hold assets as part of their historical and cultural characters. For example, Tugu Negara, Bangunan Sultan Abdul Samad and others. Other examples of assets held by public sector entities for their service potential are national parks, beaches and others.
All these assets will need different consideration for their accounting recognition and measurement. This can be particularly important when it comes to the impairment assessment of these assets. As they do not generate cash flows, a different impairment principle is required.
2. Non-exchange transactions
As explained earlier, the goods and services provided by public sector entities are generally free of charge or at a minimal amount. The act of providing goods and services with no or nominal fee is a non-exchange transactions in public sector accounting standards.
The nature of non-exchange transactions will have an impact on how they are recognised, recorded, measured, presented and disclosed in the financial statements. The accounting for non-exchange transactions is different from normal exchange transactions, where entities received an equal amount of consideration based on the goods or services provided.
We hope you now have a brief understanding of why there is a need for public sector accounting standards. In our upcoming articles in MPSAS Series, we will share with you the accounting requirements for specific public sector accounting standards as well as the comparison between MPSAS and private sector accounting standards.
In the meantime, do enjoy various other related accounting articles in the Financial Accounting section.