• Chris Thorne

The Wealth of Nations - does anyone have a clue?

Adam Smith first postulated the concept of Gross Domestic Product as a measure of national wealth 240 years ago, but the means of production are assets, both created and naturally occuring. In many economies the government owns a significant percentage of the total assets, but there is absolutely no global consistency about how these assets are recorded and measured. This gives politicians greater freedom to spin the numbers to suit their agendas, but given the increasing interdependence between economies, is this smoke and mirrors approach to a nation's assets really sustainable? What can be done about it?

In 2013 the IMF published a working paper[1] that examined the role of non-financial assets in government accounting and debt management across more than thirty large and small economies. This found that, on average, the reported value of government owned non-financial assets amounted to 67% of GDP. Given that the GDPs of the nations in the sample ranged from $4.3bn up to $17.4tn, the total value of non-financial assets implied by that average is not a trivial amount!

However, while the IMF paper contained some interesting case studies, it was also clear that comparisons between countries in the sample could not be reliably made given wide variations in the type and detail of data recorded by each one and in the valuation methodologies used. For example, while Australia stood out as having non-financial assets of approximately 120% of GDP, over half of this was attributable to the fact that Australia was one of the few countries in the sample that included a value for subsoil assets (ie minerals) in the value of government owned lands. Others, eg Canada, included land but excluded subsoil assets or, as in the case of Germany and the USA, disregarded “non-created assets”, such as land, in their entirety.

Not surprisingly the IMF paper concluded that expanding and improving the consistency of data on nonfinancial assets is required as a first step for more transparency and eventually more effective asset management. It also follows that greater transparency about the extent and value of assets should improve economic management.

As with private individuals or firms, understanding the value of a government’s assets is fundamental to understanding its overall financial position. However, the IMF’s findings suggest that there is no sound mechanism making consistent evaluations of the assets owned by different countries. With growing concerns over potential sovereign default it is surprising that there has not been greater pressure from not only the global financial institutions but also creditors, many of whom are also governmentsor sovereign funds, for consistency on what is to be recognised as an asset and how that should be measured.

Governments, or government appointed financial regulators, increasingly realise the benefits of common standards for financial reporting by organisations in the private sector. For example, over 130 countries now require or permit listed companies within their jurisdiction to report using International Financial Reporting Standards (IFRS). However, governments seem unwilling to accept such discipline when it comes to their own financial reporting. Although International Public Sector Accounting Standards (IPSAS) exist, very few countries actually adopt them. While many set their own standards to include elements of the IPSAS, there are many variations, not least around asset recognition and measurement.

The question of what should be recognised as an asset and how it should be measured financially is more contentious in the public sector because many assets are held for purposes other than the direct generation of economic benefits. The question of how investment in such assets is recorded is therefore affected by political as well as economic considerations. Also, there are more assets in the public sector which are unique by virtue of their design or location or which are not cash generative, which creates a challenge in determining the most appropriate measurement approach. It is therefore not surprising that different countries have reached different conclusions on the most appropriate solution.

A few years ago the International Valuation Standards Council (IVSC) looked at updating and revising its standards on the valuation of public sector assets but, not surprisingly given the findings in the IMF report, it concluded that there was no basis on which it could issue internationally applicable valuation standards or guidance. While some common valuation challenges were identified across different economies, the solutions were almost always dictated by national regulations. The IVSC could see no role for international valuation standards in this area until there was greater consensus among the major economies as to what government assets should be recognised and then measured using valuation techniques.

The IPSAS Board has recognised the challenges peculiar to the measurement of public sector assets and has addressed this its new Conceptual Framework[2] . This identifies historical cost, market value, replacement cost, net selling price and value in use as possible alternative measurement bases but goes on to confirm that it is not possible to identify a single measurement basis that best meets the measurement objective at the Conceptual Framework level. However, it does provide guidance on the criteria to be considered in selecting the most appropriate basis for both assets and liabilities.

While a cynic might say that the range of options recognised by the Conceptual Framework will do nothing to reduce diversity, I think it is to be welcomed. One of the problems we saw when the IVSC tackled this issue was a polarisation between supporters of value and supporters of cost. It is not difficult to find examples where either would give unhelpful or irrelevant information, and there is a tendency for proponents of each to use these to justify their opposition to the other option, ignoring the cases where their own favoured approach produces a meaningless number. The Conceptual Framework makes it clear that such fundamentalism is inappropriate and a more nuanced approach to the question of measurement is required.

It is unrealistic to expect there to ever be a single approach for measuring, let alone valuing, public sector assets, around the world. Indeed, such a thing would be as wrong as it is impractical. No measurement should disregard the factual matrix of the asset in question if it is to be useful. However, that does not mean that nothing can be or should be done to bring greater consistency and transparency to the way in which decisions on what government assets should be recognised and how the benefits accruing from those assets are then measured. Clearly the apparently random decisions of what each nation discloses about the value of its government owned assets highlighted by the IMF cannot continue if those same governments wish to have a more stable and sustainable global financial system.

While prescriptive directions on how to value have their place for specific situations in specific markets, at a global level framework documents such as that produced by the IPSAS Board are far more useful. They provide the necessary flexibility to be used within different legal, regulatory, and cultural systems while setting common objectives and desired outcomes which are understandable and achievable. Is this a template for bringing disparate practices together across not only public sector accounting but other disciplines within the global financial system to better understand and manage risks?

[1] Another Look at Governments’ Balance Sheets: The Role of Nonfinancial Assets. WP/13/95

[2] The Conceptual Framework for General Purpose Financial Reporting by Public Sector Entities - Chapter 7: Measurement of Assets and Liabilities in Financial Statements - IPSASB® 2014