What’s happening with net debt?

As part of a project to revise the conceptual framework and reporting model for public sector entities, the Public Sector Accounting Board (PSAB) is proposing amendments to the calculation and presentation of net debt.

When it comes to providing accountability to the public in regard to government finances, the importance of net debt as an indicator cannot be ignored.

A google search on net debt of Canadian governments delivers hundreds of thousands of results. A recent editorial in The Globe and Mail stated “Here’s the only number the next finance minister has to focus on: the net debt-to-GDP ratio”.

What is net debt?

According to the CPA Canada Public Sector Accounting (PSA) Handbook:

“Net debt is measured as the difference between a government's liabilities and financial assets. This difference bears directly on the government's future revenue requirements and on its ability to finance its activities and meet its liabilities and contractual obligations. Net debt provides a measure of the future revenues required to pay for past transactions and events.”

This indicator is currently presented on the statement of financial position.

The net debt debate

There are concerns with the net debt indicator. Stakeholders have said:

  • it’s confusing
  • it’s not applicable to all public sector entities
  • the calculation includes items that should be excluded, muddying up the meaning of the indicator
  • the net debt indicator does not provide good accountability information for their users

Others hold very strongly to this indicator and its value for the following reasons:

  • The net debt to GDP ratio is a critical sustainability indicator for governments. They reference it in explaining their finances to the public and public understanding of this ratio has grown.
  • Net debt provides information about future revenues required to meet past spending. The extent of an entity’s net debt and its financial ability to service residual liabilities is an important factor in assessing its sustainability.
  • Being in a net debt position will have an impact on the setting of future tax rates and other funding decisions. Such future revenue requirements need not be fulfilled through taxation or government transfers. Future revenues might also come from donors. The net debt indicator doesn’t specify the source of the future required revenues; it merely indicates the need for future revenues. The nature and extent of future revenue raising is a policy decision.
  • Net debt is a number that results from spending. It arises when a public sector entity spends more than the amount of revenues it raises in the year, or over the years. Government spending (including spending by the public sector entities that make up the government) represents almost half of Canada’s gross domestic product. So, net debt has a direct relationship to the economy when it is reported by governments.
  • Net debt is an indicator that reflects accountability for spending decisions in the period they are made. It provides important information about the financial affairs of an entity and is one indicator of the entity’s ability to finance future operations.

The proposals

PSAB feels that all feedback it has received on this topic has validity.

So, in its Statement of Principles, A Revised Reporting Model for the Canadian Public Sector, PSAB is proposing to:

  • relocate the net debt indicator to its own statement, the statement of net debt
  • revise the calculation of net debt

Relocating the net debt indicator

The relocation of net debt to its own statement creates the opportunity to make the net debt indicator more understandable and meaningful to users. Trying to improve the calculation of net debt on the statement of financial position made the statement of financial position difficult to understand and reduced its accountability value.

The relocation of net debt to its own statement is not meant to lessen the importance of the indicator. In fact, the Statement of Concepts, A Revised Conceptual Framework for the Canadian Public Sector (the accompanying document to the Statement of Principles) states that “no one financial statement is more important than any other.” That is, all statements in the financial statement package are important, each statement has its own purpose and all statements would need to be looked at together when evaluating an entity’s finances.

Revising the net debt calculation

PSAB is proposing the following formula:

 
 
 
 
 
 
 
 

PSAB is proposing to refine the calculation of net debt to exclude items such as the following:

  • Endowments: If they’re restricted in perpetuity, they’ll never be available to settle liabilities, and so should not be netted against the liabilities.
  • Performance obligations: These obligations would not be settled through the use of financial assets.

The intent of the proposal is to refine the net debt calculation, not change the meaning of the indicator. In fact, these proposed exclusions take the indicator back to its original meaning – future revenue requirements. The goal: to make the indicator more meaningful and to provide information that helps users make good decisions.
If the net debt indicator includes things that it shouldn’t, bad decisions may be made…and that is not in the public interest.

What do you think?

PSAB wants to know if you agree with:

  • the removal of the net debt indicator from the statement of financial position and presenting it in its own statement, the statement of net debt
  • the revised calculation of net debt in order to retain the meaning of this indicator

Let us know what you think by responding to PSAB’s Statement of Principles, “A Revised Reporting Model for the Canadian Public Sector,” by November 28, 2018.

To learn more about these and other proposals, register for the October 17, 2018 , webinar “Explore PSAB’s Statement of Principles for a Revised Reporting Model.”

Contact

Antonella Risi, CPA, CA
Principal, Public Sector Accounting
Tel: (416) 204-3484
Email: arisi@psabcanada.ca

Martha Jones Denning, CPA, CA
Principal, Public Sector Accounting
Tel: (416) 204-3288
Email: mjonesdenning@psabcanada.ca