This is our very first article published in a series of articles under MPSAS Series, aimed at sharing with you the accounting 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, please go through it first as this will give you a brief understanding of the development of public sector accounting standards in Malaysia.
Many people are not fully aware of or 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 are happy to share with you 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 from the private sector entities is mainly due to the special characteristics of the public sector entities. There are three fundamental characteristics of the public sector entities, consistent with how public sector entities are defined 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 as part of the bigger objective of any government – 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 are established with one aim – to deliver the goods and provide services to the public at large. In addition to the objective of delivering goods and providing services to the public, some public sector entities are also established 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 which are incorporated with the main objective of making profits, public sector entities do not have a similar primary 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 are operating at loss and these losses are absorbed by the government. 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, it is also observed that some public sector entities are expected to be more creative to find ways to generate some income for sustainability purposes. This fact generally does not violate the non-profit oriented objective because, at the end of the day, goods and services are delivered and provided to the public at a minimal amount, if not at no charge.
3. The funding sources
Unlike private sector entities which obtain their finances from investors, the activities and operations of public sector entities are funded 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 and hence, largely depend on government budget appropriation or grants. Because public sector entities do not have investors to finance their operations and activities, they are not required or obligated to make profits from the goods and services provided to the public. 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. And the high return is partly driven by the ability of the company to charge for the goods and services produced by them in the market. This, however, is not the model adopted in the public sector.
The core principles developed in public sector accounting standards
The following are the core principles developed in public sector accounting standards that are not available for private sector entities. These principles are introduced to acknowledge the characteristics of public sector entities as explained above.
1. Service potential
The service potential concept in public sector standards relates to the primary reason for 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 of the assets of the public sector entities are also specialised such as 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 such as Tugu Negara, Bangunan Sultan Abdul Samad and others. Other examples of assets held by public sector entities for their service potential purposes are national parks, beaches and others. All these assets are held for service potential – part of the responsibility of the government. 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 categorised as 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 of public sector entities. 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.