What is accounting for public debt in the public sector? In this public sector accounting guide, we are going to consider accounting for public debt, which will give us explanations for questions like:
- What is public debt?
- “Public debt management”
- The importance of public debt
- Classification of public debt
- What is public debt pdf
- Public debt management” pdf
- Sources of public debt
- Public debt management strategies
Legislations that guide the practice of lending and borrowing in public financial administration include:
- The loans Act, 1970 (Act 335)
- Financial Administration Act, 2003 (Act 654) section 23-24)
- Financial Administration Regulations 200L, L.I. 1802, Section 90-93
Besides, the controller and accountant general is expected by law to report on the following in the annual accounts:
- The public debt
- Deposits and other trust money’s
- The securities of government
- Public loans
- Equity investments of the consolidated fund, and
- Revolving funds for government stores.
PUBLIC DEBT- AN OVERVIEW
Let’s go on to explain more terms in the accounting for public debt.
What is public debt?
Public debt is the money owed by the government to organizations both within and outside the country. Money owed to lenders within the country is known as domestic debt, while that owed to other lenders is known as foreign debt.
Public debt is the money owed by the government to organizations both within and outside Ghana, Kenya, Nigeria, South Africa, Malaysia, Zimbabwe, Malawi, India, the United States, the United Kingdom, and any other country. Money owed to the aforementioned countries’ lenders is known as domestic debt, while that owed to other lenders is known as foreign debt.
Debts have to be repaid, or redeemed, during and/or at the end of their term. The term is agreed upon when the debt is granted by the lender and could be anytime from a few months to many years. In addition, the lender charges interest on the amount outstanding.
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The government raises revenue to cover its expenditure through taxes, duties, fees, fines and so on. It is very difficult to control the level and timing of revenue receipts and the timing of payments is also often either outside the government’s control or fixed (monthly salaries, for example).
Therefore, there are occasions when the expenditure has to be met, but the general revenue balance of the consolidated fund (the balance of receipts over expenditure) is insufficient. This situation can arise even if the budget is balanced over the year as a whole (that is, the total amount of revenue is sufficient to cover all the governments expenditure).
The government therefore has to borrow money on a short-term basis (possibly only for a few months for one or two years) to meet the shortfall until the anticipated revenue is received.
If the government is unable to raise sufficient revenue in the longer term, it will have to borrow money in order to be able to continue to provide services or finance permanent assets (such as roads and buildings).
Debts incurred under these circumstance will usually be on a medium to long term basis (often five to ten years).
CLASSIFICATION OF PUBLIC DEBT
For us to have better understanding about classification of public debt let us first look at the types of Public debt.
TYPES OF PUBLIC DEBT
Let us now explain the types of public debt into detail
1. DOMESTIC SHORT-TERM DEBT
This is money raised by the government from within Ghana, which is to be repaid within a short period.
These are short term securities (meaning that the government is committed to repurchasing them at the end of their term, that is at their maturity date) sold to the public and institutions.
They are available with terms of three months, six months one year or two years, but may be held for several terms before being redeemed.
They are very flexible and enables the government to meet shortfalls in funds due to difference in the timing of revenue and expenditure.
They also offer investors a good rate of interest on the opportunity to redeem their investment at any time.
Ways and means advances
These are moneys advanced to the government by the Bank of Ghana from their reserves, to be repaid when there is sufficient revenue. These advances usually occur at the beginning of the year, before the annual estimates have been approved, when the balance on the consolidated fund is traditionally low.
2. DOMESTIC MEDIUM AND LONG TERM DEBT.
This is money raised by the government from with Ghana, which is to be repaid after several years.
Government stocks and bonds
These are securities with a term that will normally be for at least five years. As well as the commitment to repurchase, the government is also committed to paying a specified amount of interest periodically throughout the term (say, every three months).
The government may obtain loans from institutions with Ghana such as Cocobod.
3. FOREIGN MEDIUM AND LONG TERM DEBT
The government may raise funds from outside Ghana, using four possible sources:
Bilateral loans: these are loans that the government will obtain from the government or government affiliated agencies of another county.
Multilateral Loans: these are loans obtained from international financial institutions like the international Monetary fund and the world bank.
Loan from other institutions: the government may obtain loans from other international financial institutions such as commercial banks.
Export credits: Ghanaian companies wishing to purchase large items of machinery from other countries may grant loans in the form of export credits so that they can pay them over a period of time.
The government has to guarantee that it will repay the loans if the companies are unable to.
In reality, the government takes over the loans and the company repays the government when it is able to.
CONSEQUENCES OF INCURRING PUBLIC DEBT
Public debts allow the government to raise funds to cover expenditures, but it also commits the government to make interest payments and repay all the amounts borrowed. Thus there is more money available, but also greater demands on it.
The original problem of lack of funds may therefore be made worse over time. More debt will be required unless the government can identify a new source of income or increase the amounts raised from existing sources.
If such as increase cannot be achieved and the government wishes to avoid incurring further debts, then its program will have to be cut back so that expenditure is reduced and payments to lenders may be made.
In addition, some medium and long-term lenders may attach conditions to their loans.
For example, they may insist that the government adopt certain economic policies before the funds are advanced.
Thus, the government may not be able to follow those policies that it considers to be the most appropriate.
Investors may be discouraged from setting up business in a country that is highly indebted, for instance, if the government is trying to raise funds by increasing the level of tax charged on profits.
The government, therefore, has to introduce measures to try and encourage investors in order to boost the economy, even though these policies may actually reduce its ability to lighten the debt burden.
PUBLIC DEBT MANAGEMENT
The public debt must be properly managed. This is to ensure that its cost is as low as possible and that the government does not make any unnecessary commitments.
One element of debt management is that of obtaining the most appropriate type of debt with regard to its term.
For example, if funds are required to cover expenditure at the beginning of a month that will be covered by tax receipts two weeks later, then only short-term debt should be incurred. This will then be redeemed using the receipts.
On the other hand, if the government wishes to build a new road to the upper west, long-term debt should be obtained.
This is because the government is going to have to increase revenue, whether from existing or new sources in order to repay the loan. It is unlikely that this could be done over a short period of time.
It is also important that the government ensures that any debt agreements entered into are the most appropriate with respect to interest rates, repayments, and so on.
The government has a duty to minimize the impact of public debt on the economy as far as it is able.
Another element of debt management involves having the information necessary to properly plan cash requirements.
The government needs to know when receipts are expected and payments must be made.
It can then make an informed decision on the amount and timing of any further debt to be incurred.
The type of debt to be incurred may also be decided and negotiations entered into to achieve the best possible.
Early repayments, which reduce interest charges, may also be planned if it is apparent that there will be surplus revenue.
In order to repay debts without incurring more, the government may choose to obtain funds by selling (divesting) its detribalize industries and its shares in various commercial and quasi-government institutions.
However, this decision must be carefully considered, as it may be that the future earning of the industry or institution could be greater than the cost of incurring further debt.
WHY SHOULD THE GOVERNMENT MAKE INVESTMENTS?
The government will invest in a company in order to make funds available to it. Such an investment is often uses to encourage innovation, for example, the development of new products and mothed of working.
Under the company’s cod, the government will have a say in how the company is run if it owns sufficient share.
Therefore, owning shares is preferable to granting a loan if the government wishes to maintain some control over the company.
The government will also be entitled to receive income in the form of dividends when the company makes profit.
Investing in an organization is also a way of the government providing employment.
INCIDENCE OF PUBLIC DEBT IN GHANA
These could be summarized as follows:
- Ghana faces perennial foreign exchange constraints due to low export receipts. This means that finding enough foreign currency to pay for her imports especially crude oil is an annual challenge.
- There is high domestic borrowing from commercial banks to finance oil imports, apart from oil there are also other imports on credit from bilateral sources compounding its foreign exchange challenges.
- Unsteady export prices for Ghana exports reflect on price fluctuations in the domestic market leading to local currency depreciation and therefore difficulties in raising enough local currency to finance imports.
- Because there is no synchronization between revenue and expdenture in the budget cycle, there is the tendency to experience large budgetary imbalances and therefore the need for domestic borrowing;
- Low growth of the economy makes it also difficult to close the deficit gap in the national budget, through taxation. This is because transfer payments (for existing debts, principal / interests) are indexed to currency fluctuations and inflation. Besides, there are other national liabilities. For example, commitments due to wage negotiables and variations in public works (even when the budget does not capture new programmes) wound lead to budget deficits.
- High unemployment is another factor leading to deficits. When there is high unemployment in the economy the government is often unwilling to squeeze the two principal categories of discretionary expenditure, namely, public consumption and investment.
- In an economy where there is high inflation such as Ghana, both revenue and expenditure are highly sensitive to inflationary swings, hence the deficit;
- Cutting expenditures means trimming service expenditure, taking away benefits, curtailing rights to payments and allocation losses. The government is often unwilling to touch these expenditures and therefore would have to borrow money.
- Mandatory transfer payments, and non-discretionary payments such as charged expenditure on pensions, health care, and entitlements are very difficult to cut when there is economic slowdown and expenditure is outstripping revenue.
- In Ghana, in response to economic crises or when national election is near, governments often tend to abandon fixed targets in the budget in favor of political expediency, often resulting in deficits.
ACCOUNTING FOR PUBLIC DEBET
Debt consists of all liabilities that require payment or payments of interest and / or principal by the debtor to the creditor at a date or dates in the futures. Thus, all liabilities are debts except for shares and other equity and financial derivatives.
In some cases, the current market value of a debt may differ significantly from its nominal value. For some analytic purposes, nominal values of debt may be preferable to current market values, and, in general, it is useful to be able to compare nominal values with current market values.
It is recommended, therefore, that estimated of total debt and the most important categories of debt be presented in both values.
A debt is in arrears when it has not been liquidated by its due for payment data. Information on debt in arrears can be useful for various types of policy analysis and solvency assessments.
The total amount of debt in arrears should be indicated as a memorandum item and the classification of liabilities should be expanded to show how much of each category is in arrears whenever the amounts are significant.
For example, a government unit’s liability for securities other than shares owed to domestic units should be divided into the amount not in arrears and the amount in arrears.
If the debtor does not make a payment on or before its scheduled date, including any grace period, some payment arrears is created. Depending on the contractual conditions, the existence of arrears may change the terms of the entire liability or only the portion in arrears.
For example, failure to make a scheduled payment may convert the entire principal of a long term loan into a loan callable on demand.
If the terms and conditions have changed with respect to any part of the liability, that part should be treated as a separate instrument, possibly in a different category of liabilities.
Thus, it is recorded as if payment were made on the scheduled date equal to the amount being reclassified, and then amount of financing obtained by not making scheduled payments becomes clear.
When arrears exist, either each relevant category of liabilities should be sub-classified to indicate the amounts in arrears, or the amounts in arrear should all be classified as accounts payable.
Government often guarantees debts incurred by MDAs. Frequently the creditor is willing to lend funds to the debtor only if government guarantees that debt. Debt assumption takes place when the creditors invokes the contract conditions permitting the guarantee to be called, and the government assumes responsibility for the debt as the primary obligor, or debtor. Thus, debt assumptions involve three units that is the government, the creditor, and original debtor. The government incurs a new liability to the creditor and the liability of the original debtor is extinguished. The new debt may carry the same terms as the original debts, or new terms may come into force because the guarantee was invoked
In addition to normal interest payment and principal repayment transactions regarding own debt government may undertake a range of often complex debt and debt related transactions, including assuming debt guaranteed, rescheduling debt. And canceling debt.
Interest, principal, and Arrears
The most common debt transactions of government are interest expends and the repayment of principal.
Interest is an expense incurred by a debtor for the use of funds. An interest bearing financial instrument can be classified as deposits, securities other than shares, loans, or accounts receivables/payable.
Interest accrues continuously and its treated as if the debtor continuously borrows an additional quantity of the same financial instrument, thereby increasing the debtor’s total liability.
When the debtor makes a payment, the liability is reduced. Traditionally the shares of a periodic payment equal to the amount of interest that has accrued and is due for payment is referred to as an interest payment. The remainder is referred to as principal payment.
Contingent contracts are contracts that create a conditional financial claim on a unit. In this context, conditional means that the claim only becomes effective if a stipulated condition or conditions arise.
By conferring rights or obligations that may affect futures decisions, contingent arrangements are involved. Collectively, such contingencies may be important for financial policy and analysis.
Accordingly, important contingent contract should be recorded as a memorandum item.
Contingent contracts can represent either potential assets or liabilities. A common type of contingent liability of a government unit is guarantee of payment by a third party, such as when the government unit guarantees the repayments are contingent because the guarantor is required to repay the loan only if the borrower defaults.
Debt write-offs and write-downs
Government units that are creditors may write off financial assets without an agreement with the debtor in cases such as bankruptcy of the debtor. For example, a public corporation that has borrowed from the government unit may be insolvent and have its assets liquidated.
As a result, the government unit’s claims have no value and is eliminated from the balance sheet by recording another economic flow.
A unilateral write down of a partial value of a debt is treated similarly, reduced amount of the debt remains on the balance sheet. A unilateral write-off by a debtor, or debt repudiation, is not recognized.
In general, a loan is valued on the balance sheets of both creditors and debtors at nominal value.
Loans that have become marketable in secondary markets should be reclassified as securities other than shares and valued at market prices.
In addition, on the evidence of similar debt that has been traded in the market (for example, under loans for equity swaps). In such circumstances, a memorandum item should be recorded, noting the apparently lower value of the loans.
Debt for equity swaps
A government unit acting as a creditor might exchange a debt instrument for shares and other equity issued by the same unit that issued the debt instrument.
The recording of this event depends on the value of the shares and other equity received by the government unit and whether there has been an agreement to forgive debt.
Debt forgiveness is the cancellation of a debt by mutual agreement between a creditor and a debtor. It is always recorded as the creditor providing a capital grant or transfer to the debtor. Government units may be involved in debt forgiveness as creditors or debtors.
Debt forgiveness results in a decrease in financial assets and usually a decrease in net worth for the creditor equal to the value of the debt forgiven, as well as a decrease in liabilities and an increase in net worth for the debtor.
If the second party to the transaction is a foreign government or a unit at another government unit, then the transaction is any other type of unit, and the transaction is a capital grant for both the creditor and debtor.
If the second party to the transaction is any other type of unit, then the transaction is classified as miscellaneous other expense or capital transfers when the government unit is the creditor and as other revenue or capital voluntary transfers other than grants when it is the debtor.
Debt restructuring and rescheduling
Government units may agree on a bilateral arrangement to alter the terms for servicing and existing debt.
Accounting for public debt will give us explanations for questions like What is public debt? Public debt is the money owed by the government to organizations both within and outside the country.
The term is agreed upon when the debt is granted by the lender and could be anytime from a few months to many years. The general revenue balance of the consolidated fund (the balance of receipts over expenditure) is the sum of receipts and outlays.
The government may borrow money on a short-term basis (possibly only for a few months or one or two years) to meet the shortfall. Public debts allow the government to raise funds to cover expenditures but commit it to make interest payments and repaying all the amounts borrowed.
Ghanaian companies wishing to purchase large items of machinery from other countries may be granted loans in the form of export credits so that they can pay them back over time.
More debt will be required unless the government can identify a new source of income or increase the amounts raised from existing sources.
Lenders may attach conditions to their loans—for example, that the government adopts certain economic policies before the funds are advanced. The government may have to introduce measures to try and encourage investors in order to boost the economy.