Recognising government expenses using performance obligations – is this the right approach?

No universal guidance on accounting for expenses

All entities – whether public or private sector – incur expenses. Unlike revenue, there is no universal standard dealing with accounting for expenses. Guidance on expenses focuses on dealing with specific transactions, and usually the key accounting issue is when to recognise a liability for expenses (e.g. employee benefits and provisions), or whether an asset should be recognised instead of an expense (e.g. inventory).

In the public sector there is a higher prevalence of “non-exchange” expenses, i.e. those expenses that arise when governments provide goods, services, cash or other support and do not receive approximately equal value directly in return. This is contrasted with the private sector where most entities will incur “exchange” expenses and receive value directly in return, e.g. compensation paid to employees, and consideration paid to acquire goods, services and assets. Where public sector entities incur “exchange” expenses, accounting Standards similar to those in the private sector are applied. There is no guidance for non-exchange expenses.

The lack of guidance on non-exchange expenses has led the International Public Sector Accounting Standards Board (IPSASB) to issue several International Public Sector Accounting Standards (IPSAS), or proposed IPSAS, over the last few years to address this issue. Most recently, the IPSASB issued ED 72 on Transfer Expenses for comment. Transfer expenses are transfers of goods and services between an entity and an individual, household or entity, without the entity directly receiving any consideration in return. The transactions often involve a third-party transaction where one entity provides resources to another entity and that entity is required to use those resources to provide goods or services to beneficiaries. Examples include transfers of goods, services or cash between government entities and others.

As the ASB primarily uses IPSAS in developing Standards of GRAP, it is exploring and discussing the proposals in ED 72 and how feasible it is to apply locally. Issues identified locally on ED 72 will be shared with the IPSASB.

What is the IPSASB’s proposed approach for recognising transfer expenses?

The accounting for transfer expenses varies depending on whether the transaction:

 Arises from a binding arrangement and has performance obligations.

 Arises from a binding arrangement and has present obligations.

 Does not arise from a binding arrangement.

The most complex approach is where transactions arise from a binding arrangement and haveperformance obligations. The approach for these transactions is discussed below, while the approach for the other transactions will be discussed on the 22nd of June.

Under this approach, called the “public sector performance obligation approach” or PSPOA, an entity
needs to apply the five steps discussed below:

Step 1: Identify whether a binding arrangement exists 

In the PSPOA, the nature of the arrangement is such that one entity provides resources to another entity, and the entity receiving the resources is required to provide goods or services to a third-party beneficiary. This requirement to provide goods or services in the arrangement gives rise to the “performance obligation”. For transactions to be accounted for using the PSPOA, a “binding arrangement” must exist between the entity providing the resources and the entity receiving the resources. The third-party beneficiary is not a party to the binding arrangement.

A binding arrangement could arise from a contract, or another mechanism such as a law, as long as the arrangement gives rise to both rights and obligations for both parties to the transaction. A key criterion for applying the PSPOA to expense transactions is that the entity providing the resources both identifies the performance obligations to be fulfilled and monitors their fulfilment throughout the contract. Where arrangements are modified, entities need to consider whether the modification is such that it amends the existing rights and obligations in an arrangement or creates new rights and obligations. Where existing rights and obligations are modified, adjustments are needed to reflect a modification for past transactions recognised as well as the combined effect of the changes for future transactions. This can be complex.

Step 2: Identify the performance obligations in the transaction

Performance obligations relate to the provision of distinct goods or services, or a series of distinct goods or services, to a third-party beneficiary. Entities would need to assess whether these goods or services result in different performance obligations, as well as whether they are either satisfied over time or at a point in time.

Step 3: Determine the consideration to be exchanged in the transaction

The consideration is the amount that the entity expects to transfer to the other entity, in exchange for the goods and services provided to the third-party beneficiary. This could include variable consideration such as discounts, rebates, refunds, credits, price concessions, incentives, penalties, etc. The consideration could also vary depending on the occurrence (or not) of a future event.

Subject to certain criteria, variable consideration is included in the transaction price using estimates of the amount the entity will be required to pay.

Step 4: Allocate the transaction consideration

The transaction consideration is allocated to the distinct goods and services (performance obligations) so that this reflects the cost that the entity expects to pay for the promised goods and services. This allocation is also necessary to enable the recognition of expenses either over time or at a point in time. The consideration is allocated based on the relative stand-alone, observable purchase prices of the goods and services. In allocating the consideration, entities also need to consider how to allocate discounts and variable consideration, and whether this applies to all goods and services or only some.

Step 5: Recognise expenses when performance obligations are satisfied

Performance obligations are satisfied when the third-party beneficiary controls the goods or services. Expenses are either recognised over time, or at a point in time. It may be difficult to determine when performance obligations are satisfied for transactions that have multiple components.

So why this approach?

Rationale

The IPSASB is proposing to use the PSPOA for the recognition of revenue transactions with performance obligations. It wanted to propose a consistent approach for recognising revenue and expenses, particularly where public sector entities will potentially be counterparties to the same transaction.

It is important to note that the PSPOA only applies to a limited number of expense transactions, i.e. those transactions that involve three parties where one entity provides resources to another entity and that entity is required to use those resources to provide goods or services to beneficiaries. As a result, this approach is not applied universally to all “non-exchange” expense transactions, nor is it applied to “exchange” expense transactions.

Applying the approach

The 5-step approach outlined above is onerous to apply. While it can be argued that this approach is only onerous if the transactions are complex, making the accounting for simple expense transactions more onerous may be a step too far for many governments.

The private sector locally has highlighted challenges with the implementation of the PSPOA to revenue transactions when adopting IFRS 15 on Revenue from Contracts with Customers. Therefore, a key question to discuss during the deliberations on ED 72 is whether this approach is appropriate for such a small sub-section of government’s expense transactions. It is also notable that an equivalent of the PSPOA is not applied in the private sector for any of its expenses.

Where can the EDs be accessed and how can you provide comment?

ED 72 was issued for comment along with proposed IPSAS on changes to revenue recognition. ED 72, along with the Exposure Drafts on revenue have been published on the ASB’s website and can be accessed here: https://www.asb.co.za/comment-on-proposals/.

The EDs are as follows:

 ED 181 on IPSASB Exposure Draft on Revenue with Performance Obligations (ED 70)

 ED 182 on IPSASB Exposure Draft on Revenue without Performance Obligations (ED 71)

 ED 183 on IPSASB Exposure Draft on Transfer Expenses (ED 72)

Comment can be submitted to the Secretariat of the ASB at info@asb.co.za. The comment deadline is 1 October 2020.

The views expressed in this article are those of Secretariat and not the ASB Board.