Accounting

Private finance initiative has been becoming an increasing area of focus in recent times. It is not a new concept and has already been in extensive use since its inception in Australia and the United Kingdom. However, with the current financial crisis, it has seen increasing prominence as it is being utilizied as the primary vehicle for infrastructure development by the countries that initiated financial stimuli to boost their economies. The link between the public and the private sector that PFI forms to create a partnership has its own share of advantages and drawbacks which has been a topic of debate, not only in the financial circles but also in the British parliament as the country makes extensive use of PFI (Monbiot 2001). Evaluating what it brings to the tables requires understanding the underlying concepts of the Private Finance Initiative.

    It is basically a mechanism whereby the government can obtain finance from the private sector, forming a kind of semi-privatized and de-regulated structure which works jointly on primarily infrastructure development projects. This is done on behalf of the public sector which effectively works to reassign the responsibility for these projects but the accountability still rests on the public sector. The exact details of each PFI deal are specified in the individual contracts signed between the public sector authority and the collection of private investors. These are long term contracts, spanning many years, during which the private sector group has to undertake provision of services and maintenance work (Heald 2003). Payment is made to the consortium on a service provision basis and termination of contracts is a highly complex procedure as it often requires public ownership of the project and repayment of debt to the private entity. The performance by the private partner is also specified in an output specification document whereby the desired quality and specifications are mentioned, which are required to be achieved before the public sector will make payment for the services rendered.

    A Private Finance Initiative accords many advantages to the public sector. First, with this mechanism the costs of major infrastructure development and construction projects do not appear immediately as one big amount on the books of the government. This has a tendency to reduce public expenditure in one term and spread it out over multiple years during which the service is utilized (Heald 2003). This is of importance to the government as the public sector has a finite amount of funds available to pursue multiple goals and this procurement of services and finance through private sector results in an arrangement that allows the public sector to undertake an increasing number of projects. Advantages have also been pointed out in terms of better delivery of services engaged through PFIs. This is because the private sector is deemed more efficient because of its profit motive. The risk of the project undertaken is also transferred from the public to the private sector. As the latter is known to be better at management of risk, the arrangement is believed to result in a better and more risk adjusted outcome where the public sector does not have to bear the brunt of it (Sturmfells 2009).

    PFI projects undertaken in Britains health sector as well as others show that these undertakings reach completion quicker than those pursued solely by the public sector. This represents value for money to the taxpayer. The private consortium also seeks to improve design specifications in a bid to lower costs which may ultimately result in improved provision of services as well as better maintenance of the infrastructure and buildings constructed. This is something that is seen to be lacking in public sector enterprises. Furthermore, the projects are carried out without the costs of them accruing on the national debt of the nation as the contract requires the public sector to make a singular payment.

    There are however significant drawbacks to the Private Finance Initiative as well. The overall costs of PFI projects tend to be higher than those undertaken by the public sector. This is because the private consortium obtains finance via banks which issue the money at rates of interest potentially higher than those of public funded schemes. Cost of capital thus goes up along with the increasing costs of paying for services, rent, maintenance as well as the huge profits that private sector is able to draw from these projects. It thus can be seen as a compromise in terms of higher overall costs to benefit from spread out payments. A lack of incentive for quality maintenance is also pointed out in PFI projects (Sturmfells 2009). Although the private consortium will need to maintain output specifications to get payment, this is restricted by what is written in the contract, and aside from that, there is no incentive to cut costs of construction which may see rising expenses with lower standards.

    In the case of the NHS in the UK, an increasing focus is going towards formulating the PFI contracts and the dealings that have to be subsequently made rather than on patient care and provision of healthcare (Allen 2001). Employment also becomes an issue as many of the public sector workers who are related to the PFI project get their contracts transferred to the private sector which worsens pension arrangements for them and potentially reduces employment as the private sector aims to reduce costs by firing workers. The increasingly complex contracts which are drawn for PFI projects also act as a barrier to effective accountability as assessing the potential tradeoff between benefits and costs becomes difficult and transparency becomes a problem. This is further highlighted in the accounting treatment of PFI projects as they are off-balance sheet for the public sector as it has to make a singular payment for the services obtained from the private sector, resulting in the national debt appearing artificially lower (Monbiot 2001). The assets may not appear on the private consortiums books either as it is an undertaking on behalf of the government and the termination clause means the assets can be taken over by the government at any times with immediate repayment of debt. Thus, revenues and liabilities are recognized but the assets remain off balance sheet. This questions the transparency of the project and is already an issue with the accounting bodies which are contemplating changes in the treatment of PFI projects to bring the assets on the balance sheet.

Question 2
A continuing trend in the financial circles for a substantial number of years has been declaration of the need for a harmonization of the financial reporting mechanism followed around the world. This is stressed on because the advantages of such an undertaking would be enormous. There would be a rapid reduction in the cost of compliance with accounting regulations of global firms that operate in different regions around the world. As the regulations become easier to implement, it will encourage companies to list on stock exchanges around the world without the additional costs of compliance, allowing easy flow of capital world wide (Buchanan 2003). This carries obvious benefits for development of commercial activity and growth in the world economy. Finally, the investor class would benefit tremendously as well as a single harmonized way of financial reporting will make company comparisons around the world a lot easier as well as encourage more trust in a globally accepted set of accounting standards which will be a result of the combination of accounting skills from every part of the world. This idea however carries many obstacles as has been shown by opposition from different corners. The SEC and IOSCO publicly stated that there is no acceptable global standard to follow as yet. However, the IASB has been making rapid strides towards this goal (Murphy 2000).

    Historically, countries devised their own accounting standards or established regulations and the USs GAAP under the FASB was regarded as the leader in this effort for quite a while. Then IASB stepped in and started developing accounting standards for countries that did not have them and took a principles based approach to setting basic mechanisms for financial reporting as well as reporting them. It eventually gained increasing acceptance from the European Union and countries around the world, being adopted by most. The IAS, as they were developed, however did have their critics who questioned their application as a globally applicable set of standards.

    IOSCO raised questions regarding some of the standards that were produced by the IASB and even preferred the application GAAP in certain cases. At the time, there were around 255 stated differences between the IAS and GAAP in application. In addition, vehement opposition stemmed from the US and the SEC as it viewed the GAAP to be superior in terms of quality to the other set of standards being proposed. This was built on a history of development of accounting standards as well as a strict rules based approach which specified compliance for every case, as opposed to the leniency of judgment accorded by the principles based IAS. In addition to claims of deficiency in quality, SEC also questioned the infrastructure of the IASB which varied in its operations and methodology from FASB, potentially leaving less control with the US if the global standards were adopted. Apart from these openly stated differences, harmonization faces other implicit difficulties as well. Culture and the historic development of mechanisms in certain parts of the world mean that there is a rigid loyalty to the things of old and opposition to anything that seeks to replace it. Nationalism also comes in at certain points such as in the US and EU countries as harmonization means giving up control which raises questions of sovereignty (Nobes 2006).

    These differences however have been slowly disappearing which is an encouraging sign for harmonization of financial reporting at some time in the future. IOSCO has agreed to endorse use of IFRS as they are now known for cross border reporting, provided a core set of standards of significant quality is going to be developed. This was accomplished in 1999 leading to eventual support of IOSCO. The strong claim of SEC about superiority of GAAP took a hit in the wake of the accounting scandals such as Enron, WorldCom and Sunbeam which questioned the rules based approach of GAAP and presented a favorable picture of the principles based IFRS. Thus the FASB and the IASB agreed to sign a memorandum of understanding aimed at greater convergence of standards. In pursuance of this objective, both decided to work together towards harmonization and a revised standard on Earnings per share was prepared by the FASB (Nobes 2006). Obstacles in the EU disappeared to a great deal with the adoption of the single currency and monetary policy by the European Central Bank which paved the way for acceptance of the IFRS by EU and requirement for the companies to be in accordance with the standards. This additionally prompted countries that trade with the EU countries to endorse the IFRS and initiate policies aimed towards adopting them. Even in the US, companies with a big scale of operations present accounts in accordance with both IFRS and GAAP or publish a reconciliation from one to the other which makes comparisons easier. In essence, the only element that now needs to be satisfied for effective harmonization is convergence between the GAAP and the IFRS which is already underway. When these differences are bridged by the ongoing process, the US and EU will have common mechanisms for financial reporting which will prompt the remaining countries to follow. Thus it can be said that international harmonization of accounting standards is a reality that will be accomplished in the not too distant future.