What is the difference between public and private accounting?

JEREMY NICHOLLS, 28 FEBRUARY 2013 

We need to rethink the way in which public bodies prepare financial accounts in order that we; the public, can better understand how and why money is being spent on our behalf. Going back to basic accounting principles suggests that we could combine financial accounting and social cost benefit analysis (SCBA) into a single more meaningful account.

Currently accounts for public bodies are prepared along very similar lines as accounts for private organisations; income and expenditure, debtors and creditors, accruals and prepayments – job done. But these are not the only relevant issues for a set of public accounts. What is currently being included provides information from a very limited perspective of government accountability – has tax payers money been spent on the purpose.  But nothing about what value has been created or destroyed for everyone for whom the government is accountable (not only taxpayers).

The real user of government accounts is the public, not that every member of the public will be spending Sunday afternoons poring over the accounts but the way in which they are prepared should be based on providing information to those with an interest. The public has two interests, one how was my money spent and secondly what happened as a result.

Separating the answer to these questions has led to a difference between public sector accounting: how was my money spent, and SCBA: what happened as a result of that expenditure. However there is an accounting principle is that accounts should include the issues that are of interest to the user. Whilst this user is defined as the investor in private sector accounting, the investor for an account of a public body is the public and their interest will be much wider.

I would argue that most of the costs and benefits arising from government expenditure should be included in government accounts. Most but not all for two reasons; firstly since SCBA does not generally consider materiality in deciding what should be included or excluded some things may be missed out and some may be included which are not material, secondly since a focus on what is of interest from the perspective of the public is likely to identify other issues that have not been included in cost benefit analyses. But SCBA, prepared as part of an assessment of government expenditure, is the type of information that should be included.

One reason why these costs and benefits have not been included is that public accounting developed from private accounting with its focus on identifying the profits that can be distributed. In private accounting this has been comparatively easy. Most issues that are included are transactions between people who are parties to a contract and the contract sets out the value. There are some issues that may need to be included to allow for breach of contract (bad debts) or where there was no contract but someone’s rights were affected by the business (contingent liability) but these have been a small proportion of the overall issues.

In the public sector, expenditure sets out to have effects on people with whom government does not have a contract. Consequently contract based issues are probably the minority of the issues that should be included.

There is another reason why these are not included. There are two requirements for an issue to get into the accounts. The second one is that it should be valued. Easy enough if there are contracts, easy enough to estimate breaches of contract. Much harder to do in situations where there is no contract. But this is what cost benefit analyses sets out to do; to value these costs and benefits even though too often the benefits are valued from the perspective of the government department and not from the perspective of the public, affected by the policy, where the value will be the change in their wellbeing.

But it is possible to value changes in wellbeing.  If public accounting had to start including values of costs and benefits experienced by the public as a result of government policy and had to this on an annual basis, it would be possible to improve how this is done very quickly.  In comparison to the amount spent by government, in the UK over £500 billion per annum and compared to what is being spend on SCBA and accounting at the moment, it need not be expensive.

It is not that public and private accounting are different, it is that the user and therefore the interests are different. Thinking about the public as those with an interest would mean that financial accounting and SCBA could merge and we would get the information we are interested in.

how do we trust claims made around achieving social impact?

KARL LEATHAM, 13 SEPTEMBER 2012

Why would we want to? Well, don’t we care about unverifiable claims made in the world of Impact Measurement? Perhaps we should. The whole business runs to the heart of how we survive as organisations with a social mission. If you don’t feel this then you may contribute to the view that we really don’t need to be so fussy. The line of argument goes something like this... why do we need to prove our claims? What’s this trust business about…. Isn’t a description of what we aim to achieve, for whom and the activity we undertake in pursuit of this enough?

I’m thinking about these basic questions just after the Olympic games and just as the opening ceremony of the Paralympics attracted 11 million viewers. I thought about the standards that give rise to rules and regulations that, for the best athletes in the world, define who can take part, in which sport, at what level, with which aids and at which of these two Olympic world events. What definitions of standards regulate whether Oscar Pistorius takes part in the Olympics and/ or the Paralympics. Which rule or standard allows participation in both? How are standards judged and administered to create the level playing field for all comers? How is a ‘rating’ applied to the sports aids a potential world-class disabled athlete is able to employ in the world of highly competitive Olympic sport?

I’m sure we will hear more about this as the latest exhibition of human endeavour hits our screens. The rules, the regulation, who decides, how administered and how can the rule be challenged are all part of a democratic process.

However, perhaps we don’t need to understand how it all works and yet we couldn’t vicariously engage in the excitement of sheer high end personal achievement for sporting heroes without having some feel that standards are explicitly applied. In the end we have to be assured that a standard exits, is transparent and equally applied to all. Unless we want to be completely involved in the regulation process ourselves we will have to engage in trust.

It’s the same trust that we need to have in any regulatory system. So it is with proving social value.

The assurance of social value requires a provenance and trust. Trust is an important word – when we want to be assured that in any given process, a standard is being applied. It gets breached and we lose faith very quickly. It seems we don’t do trust so easily these days and probably with good reason.

I’m reminded of a presentation Richard Spencer gave recently at The SROI Network’s International conference in Berlin. He demonstrated that apart from a few notable exceptions, we simply do not trust governments and large state institutions – generally, in the western world – less than 40% of national populations trust their governance. That’s scary if not surprising!

But then - who would have thought that banking institutions were not being properly regulated on our behalf and that we would end up losing substantial trust (at very least) in them?

In fact, we know that’s exactly what happened, and yet on the other side of the coin, financial audit is regulated, has a standard, follows a set format and what is more, that standard and format of verification is agreed all over the world.

So, when it comes to auditing accounts we have a very clear standard. Its exactly what we need for accounting for and verifying the social value our activities create.

Back to where I started. Impact measurement, proof of social value creation – do we need it and if we do - how do we trust in it?

Lets start with needing a system of agreed standards and definitions for proving Impact measurements. When we get to know the measure we get to have some power of differentiation. That allows a conversation about what is notable impact, perhaps what is good enough impact (at the early stages of an activity), what is not a good level of impact (what are we going to do about it?) and perhaps even more importantly; where are we creating negative impact and how can we stop doing that. Without the standard, we don’t get to know the things we are doing that don’t add up to verifiable impact. We can no longer get away with just saying we do it. We have to demonstrate we do it and the demonstration is believable.

In the world of Social Return on Investment this is why we feel that creating a standard of verification is so important. It creates a common language to work with, providing a qualification level for what constitutes demonstrable social value. It provides a framework within which those who have a need to assure others about the claims they are making can work. Maybe more importantly than this, it begins to provide a basis upon which we can build up trust in the importance of tracking and establishing social value when trust in conventional institutions that play important roles in our daily lives is crumbling.

The seven principles used to define an acceptable level of SROI analysis and reporting is a clear beginning. The SROI Network’s assurance process for members is an important offer in defining standards. Amid the debate about Impact measurement practice, The Network is the only organisation that is pushing ahead with a social impact verification process. Its not perfect, we would recognise perfection takes some time (to paraphrase the well known expression) …..

….but nothing stands still - SROI methodology evolves, other systems of Impact measurement emerge – healthy debate on all these developments ensues and yet at some point agreement will need to be reached on what sets the reporting standard for assuring social value.

Is this different from how it was over the course of history of the financial audit world? Perhaps there is a strong common theme lying dormant between the financial and social value worlds. How do we create audit and assurance processes for organisations that capture a more comprehensive story beyond the purely financial?

Audit Futures recently got together some interested people for a day to think about contributing to the shape of how audit works in future. It was a pleasure to join the group and hear so many perspectives. There were a number of themes but one that stood out for me was how we should be thinking in future about auditing important non-financial aspects of what goes on in organisations.

We think we have made a start on this in the SROI world and much more will be achieved through continuing these conversations in movements like Audit Futures.