Research In Public Sector Accounting: An Appraisal

By
Irvine Lapsley

This article is an examination of recent research in public sector

accounting, including the financing of public sector institutions, the financial
and management accounting in such organisations, and audit. Its main
objective is to serve as a focus for potential researchers in general and, more
specifically,

to

potential

contributors

to

accounting,

auditing

and

accountability; therefore this paper is restricted to contributions to the

academic literature. The major theme of this short article is that the public
sector of the economy has certain distinctive features which should make it
attractive to potential accounting researchers. The major reason for
undertaking this research rests with the complexity of the public sector: the
heterogeneity of the organisations comprising this sector of the economy
(from

commercial

and

quasi-commercial

organisations

to

non-profit

organisations); the scale of their operations; and the diversity of their

accounting practices. On accounting practices (as discussed in some detail
below), for example, there are differences between the private and public
sectors of the economy and within the public sector of the economy. Such
differences apply to all aspects of the accounting function: the raising of
finance; the decisions to spend (on revenue and capital expenditure); the
basis of recording transactions and related economic event, and the
assessment of the financial performance of such organisations and the
means by which responsible persons are held accountable for the resources
at their disposal (i.e. whether within organisations, by organisations, or
indeed, entire branches of the public sector). Furthermore, their has been
neither systematic academic investigations of many of these specific

accounting issues, nor the construction of theories of how best to account for
public expenditure, form first principles.
The origins of the above-mentioned differences in accounting practices
lie at the heart of the raison detre of the public sector of any economy: the
failure of the marketplace to provide mechanisms by which consumers and
suppliers of services and the financiers of such activities can be assured of
their efficient and equitable provision. This market failure poses difficult
problems for policy-makers, managers and, in turn, accounting researchers.
Also, currently the limits or boundaries to defining what is/is not the public
sector are being challenged by the privatisations programmes of many
central governments. This development, in itself, poses further interesting
problems for accounting researchers.
This article examines recent research activity in public sector
accounting, both in comparison with the methodologies of mainstream
accounting research and also in the light of the modest research effort of
earlier decades in the area. (an earlier article on this subject noted that less
that one percent of articles published in UK academic journals in the 1970s
were concerned with accounting or finance public sector institutions (Perrin,
1981). This articles includes as survey of recent output by academics on
public sector accounting topics, principally in academic journals, although
reference is also made to the limited number of research monographs
published in this field. This literature which this appraisal draws on is limited
to English-Speaking journals, specifically, from Australia, abacus and
accounting and finance; from the UK , accounting and business research,
accounting, organizations and society, the British accounting review,
financial accountability and management and the journal of business finance
and

public

policy,

journal

of

accounting

research

in

governmental

accounting. The period selected for review is that from 1980 onwards.
However, significant impact on subsequent accounting research.

As for the substantive issues which have been tackled by accounting

researchers these can be conveniently grouped as follows:
1.
2.
3.
4.

Finance-related topics
Financial accounting and accountability
Internal accounting and management information systems, and
Audit

1. Finance
The financing of public sector institutions has received little
scrutiny from academic accounting researchers. One strand of this
aspect of public sector accounting which has received a fair degree of
attention from researchers in the US is that of the market for municipal
debt; in particular, the usefulness of accounting risk measures in
predicting changes in bond ratings (see, for example, Wallace (1981),
Ingram and Copeland (1982) and, for an overview, Wilson and Howard
(1985)). In effect, these studies replicate those private sector studies
which assessed the importance of accounting information to capital
markets in the prediction of bankruptcy and the measurement of risk.
An isolated, but related, study is that of pension funding decisions in
US municipalities (Copeland and Wilson, 1986).
These studies are by no means exhaustive, but they have added
to our knowledge of the importance of accounting information in
financing decisions in local government. For example, the Wallace
study (op.cit.) was an investigation of 108 general obligation municipal
bonds an utility revenue bonds in the state of Florida from 1974-76.
This study used multiple regression analysis with the net interest cost
of borrowing as the dependent variable (given the absence of
dependable data on the prices of municipal bonds) which was
regressed against demographic and finance variables. One significant
(but perhaps most predictable) result of this study was the importance
3

attached to the nature of the audit report (the size of the firm
conducting the audit; whether it is qualified or unqualified) in
determining bond ratings. A later study by Ingram and Copeland
(op.cit.) extended that of Wallace by including a wider sample of bonds
and by examining the impact of state regulated accounting, auditing
and financial management practices on bond rating. This study found
that states with more stringent accounting requirements had lower
yields and systematic (beta) risk measures. Such studies may prove to
be of relevance in the specification of the frequency, format and
substance of local government accounting reports for the use of
creditors (and others)-an issue which is addressed further below.
However, there are other, some fundamental, issues in the
financing of government activities which have received scant attention
from academic accounting researchers. For example, in the UK context,
there have been considerable tensions between central and local
government and the issue of finance is a central factor in this. One
aspect of this is the proposed reform of the UK rating system by which
local government raise a contribution towards the financing of their
activities. This long established system of local taxation is based on
national/hypothetical rents of properties in the case of domestic (nonindustrial) ratepayers. Currently, the UK central government is
proposing to replace the rating system with a community tax charge
(poll tax). Kilgour and Lapsley (1986) analysed the policy options
available for the reform of the rating system and identified the need for
further empirical research on these options. As yet, no academic
accounting researcher has contributed a rigorous study of this nature
to the literature. A further aspect of central-local government financing
which is worthy of research is that of the efficiency of the mechanism
by which central government allocates funds to local government. In
the UK this is a matter of considerable significance as a high proportion
of local government funds (around 70 percent) are allocated from
4

central government. Similarly, the entire issue of the financing of stateowned industries (whether by debt alone, or some mixture of debt and
public sector surrogates for equity or equity itself, i.e. by privatisation)
has received little attention in the accounting literature (but see
Lapsley (1985)). This is of fundamental importance when significant
policy decision are being taken by governments on the privatisation of
state-owned industries. Accounting data is of relevance not only in
decisions relating to the capital structure and from of financing chosen,
but also in measuring the riskiness of product/service markets, the
extent to which monopoly exists, and possible divergences between
private and social costs and benefits. There has been little attempt by
accountants to test the goodness-instead, policy reasons have
dominated the debate.
In sum, academic accounting researchers have contributed to
the study of the financing of public sector institutions largely by
adapting private sector capital market studies and by focusing on the
less contentious issues. However, accounting numbers are important in
many areas of public sector institution finance. The use of such
accounting data in explaining and predicting financial relationships in
these institutions represents an opportunity and, indeed, a need, for
research by academic accountants.
2. Financial accounting and accountability
In terms of the volume of research activity (as measured by
contributions to scholarly journals), the single most important area to
attract the attention of researchers in public sector accounting has
been that of financial accounting and accountability. Reference has
been made above to the importance of the related issues of
accountability and performance assessment in the absence of efficient
markets in the public sector. There are numerous facets to this, many
of which have been tackled by accounting researchers, but most of
which need further investigation. Broadly speaking, this area of public
sector accounting might be subdivided into:
5

a. The form and basis of external reports, and

b. Wider issues of performance assessment
This first of these has attracted the greater degree of attention, but
substantial issues remain unresolved. Those issues are discussed below by
examining the case of nationalised industries and non-profit organisations in
turn.
Nationalised Industries
The paradox of having entire industries which are, on the one hand
regarded as commercial undertakings but, on the other hand, have quite
substantial

obligations

challenging

problems

of
for

non-commercial

regulators

of

such

nature,

has

industries,

presented
accounting

policymakers and researchers. Accounting measures have assumed a

consistent if somewhat contentious role of considerable importance in the
regulation of nationalised industries (Lapsley, 1981a). Perhaps the single
most evident example of this is the role of nationalised industries in the
(unresolved) inflation accounting debate in the UK. An early study of inflation
accounting practices in these industries identified considerable diversity
(Wright, 1979). Indeed, it has been suggested that nationalised industries are
organisations which are distinctive from private sector organisations (in
terms of their origins, their operations and their wider, statutory objectives)
and that this may impinge upon decisions on accounting policies. In this
respect, see McArthurs (1980) analysis of the case for replacement-cost
based accounting in nationalised industries because of the characteristics of
these industries, (i.e. their predictability of demand and continuity of supply).
Nevertheless, a contrary viewpoint is that this variety of accounting practice
is a reflection of the continuing search for consensus on how best to
account for inflation, in which nationalised industries have been selective in
their choice of accounting treatments so as to present their result in the
most favourable light (see Likierman (1983) and also a longitudinal study of
the gas industry (McInnes, 1987).
6

While the above studies have focused on the interface between

accounting techniques and the impact of accounting measures selected on
policy decisions, there have been other studies, of a fundamental nature,
which have analysed the basis upon which nationalised industries should
account, from first principles. One novel study was that of Whittington (1985)
in which the author draws upon agency theory to illuminate the problems of
accounting for inflation in nationalised industries. This also serves to
illustrate

that

the

identification

of

principle

and

agent

is

not

so

straightforward in the complex situation of nationalised industries, where

there are several overlapping interests between consumers, employees,
managers, central government and the general public. Also, an important
contribution to the accounting literature on nationalised industries was made
by Wells (1984). Wells study makes a highly original set of recommendations
which incorporate both the basis of accounting and the reporting context of
financial accounts. Wells makers the case for a suite of statements:
operating statements; a statement of external transactions; a statement of
investment; and a statement of solvency. This is recommended on the basis
that there are multiple purposes to be served in the production of the annual
reports and account of nationalised industries: stewardship; to inform on the
costs of services provided and of financial viability; and to provide
responsibility reports. However, the study by Wells has not received the
attention which it deserves.
The issue of the performance assessment of nationalised industries has
received

little attention from academic accounting researchers. One

exception to this is the article by Davies and McInnes(1982) in which the

authors deplore the measurement difficulties of conventional financial
accounting information and stress the (pure) alternative of cash flow
accounting, allied to efficiency audits. This cash flow proposal has little to
recommend it: it is not free from possibilities of manipulation; it sidesteps the
issue of asset valuation and ignores the existence of liabilities in short, it is
7

not as pure as its proponents would assert. (foran alternative view on the
merits of cash flow accounting, see Lee (1972)). More interestingly, the
authors pinpoint the need for (non-financial) efficiency indicators in
measuring the performance of nationalised industries. This aspect of the
accountability of the nationalised industries has received little attention (but
see Lapsley (1984)). Also, wider issues of how accountant might report upon
the divergence of private and social costs and benefits of state industries
have been neglected by academic accountants (but see Lapsley (1981b)).
Not-for-profit organisations
There are four main strands to the accounting literature concerning
financial accounting and the accountability of not-for-profit organisations:
1.
2.
3.
4.

The search for a conceptual framework;

The need for standardisation of accounting practices;
The debate over the appropriate basis of accounting, and
Wider issues of performance assessment.

These issues are considered, in turn, overleaf.

As regards (1) above, the need for a conceptual framework,
contributions to the literature are limited and narrow. Most such studies are
of US origin and are restricted to discussions of local government accounting
issues. The most notable of these studies in Anthony's (1978) exploratory
study for the FASB. This sought to provide a framework for determining
accounting policies and practices. Anthony redefined the not-for-profit
categorizing

of public sector organizations into type A and type B

organizations, in which the former category could raise revenues from the
sale of goods or services and the latter could not. He also sought to provide
an analysis of potential (external) users of accounting information prepared
by these organizations. Further US studies have adopted this deductive
reasoning approach to constructing a theoretical framework for local
government accounting (see Drebin et al., 1981b, for example). Indeed,
there have even been some attempts at empirical verification of potential
8

user needs. However, the evidence obtained to date is not conclusive.

Ingram and Copelands study (1981) of municipal accounting information and
the voting behaviour of constitutents suggested that voters are rational and
can make the link between accounting information and voting decisions.
However, surveys of users perceptions of the distinctive structure of local
government accounting information, with separate fund accounts for
different services, have produced conflicting result. For example, Smith et
al.s study (1985) of potential users for such information found a distinct
preference for fund-type accounting statements rather than consolidated
accounting statement for local governments. On the other hand, Gaffneys
study (1986) found that the former type of statement created difficulties for
certain potential users, such as civic associations.
In any event, there are many unresolved issues of accounting principle
and practice in public sector organization which stem from the absence of a
satisfactory conceptual framework. Thus, item (2) above, addresses such a
matter (discussion of which has been largely confined to local government):
variability in accounting practice (see Pendlebury and Jones, 1982; Chandler
and Cook, 1986). This raises the issue of central government prescription of
local government accounting practices versus the determination of such
practices by professional accounting bodies. This matter is not so-clear-cut
as may be thought. For example, Kilgour and Lapsleys study (1987) of the
regulation of local authority accounting practice in Scotland disclosed an
apparent preference by practicing accountant in local government for central
government prescription. This aspect of local government accounting has
also attracted the attention of researchers in the US. In particular, US studies
have pursued the question of reasons other than generally accepted best
accounting practice for making choices of the accounting treatment by local
government accountant (see, for example, Ingram, 1984; Baker and Sen,
1984).

This

issue

is

worthy

of

serious

investigation

by

accounting

researchers. Indeed, it is fair to say that the entire issue of standardization of

9

local government accounting practice is some way from a solution, given the
absence of an overriding purpose of their annual accounts and the
accounting measurement problems which they face, as discussed below.
Much of the above literature on local government accounting might be
characterized as empirical deductive, which essentially consists of a
rationalization of existing accounting practices. However, more fundamental
issues have also been addressed in the public sector accounting literature.
Perhaps the single most important issue is that of (3) above, i.e. the basis of
accounting measurement. This is most evident in the discussion of the
appropriate treatment of capital expenditure. The matter of whether local
authorities and health care organizations should record capital assets and
depreciate these has been fiercely debated and is still a matter of
controversy. Lapsley (1981c) presented a case for depreciation accounting to
be adopted by health authorities in the UK, but this is a matter which has
only recently been addressed seriously by accounting policymakers (AHST,
1985). However, the questions of how best to account for capital expenditure
in local government is even more complex than in health care. This is also
partly because of their funds system of accounting, which is more conducive
to the finance-capital approach to capital accounting adopted by local
authorities, in which the form of finance is the key determinant in decisions
over whether to capitalize expenditure or not, and for how long. These
difficulties are accentuated by the characteristics of local authorities: the
wide variety of activities undertaken with a consequent variety of assets
held, ranging from relatively rapidly-consumed operational assets, such as
vehicles and computer equipment, to infrastructure assets with high initial
capital costs, exceptionally long lives and little or no alternative use, such as
roads. For many years the adoption of capital asset accounting by local
government has had its proponents and opponents and it is still the subject
of active debate (see, for example, Anthony, 1978; Jones 1982; and
Woodham; 1984).
10

While the debate continues over the nature, use and regulation of the
accounting numbers in the financial reports of not-for-profit organizations,
these organizations have also been affected by the drive to provide
performance indicators, specifically incorporating non-financial information,
as part of the process of improving their accountability. Thus, Bevan and
Brazier (1985) demonstrate the usefulness of three such measures: hospital
efficiency, district equity and hospital equity, as means by which the
responsibilities of different tiers of the UKs nationalized health service might
be clarified. However, the dangers and limitations of such developments
improving accountability are immense. Thus, Pollitt (1986) demonstrates the
intrinsic political dimension to many policy decisions, which measures of
efficiency fail to capture and, indeed, may distort. Similarly, Mayston (1985)
has argued that the development of performance indicators cannot take
place in isolation
characteristic
theoretical

from decision relevance and reliability. These

might be seen as fundamental attributes of a (partial)

model of public sector accounting, which, is noted above,

remains to be developed. Indeed, the entire issue of how to construct

performance indicators and the context in which they should be used are
also matters which are still in their infancy.

3. Internal accounting and management information systems

In recent years, there have been pressures for radical changes in
management accounting in the private sector (Kaplan, 1983). There
have also been calls for changes in the methodology employed by
management accounting researchers: this includes the move away
from esoteric model-building to a stress on real world situations; the
use of the case study approach to enrich data collection and the use of
longitudinal investigations, where possible, for similar reasons; also the
need to experiment with novel (to accountants) research methods such
as participant observation and decision tracing. All of these changes
11

have the purpose of obtaining more informed views of what actually

happens in organizations, instead of what outsiders assume to be the
norm within organizations (see Kaplan, 1986). Such studies as have
been carried out in the management accounting of public sector
organizations have not ignored these developments. Nevertheless,
there still remains a strong view of studies based on well-established
methodologies and on deductive reasoning, rather than observational
studies.
A categorization
conventional

of

actual

classifications

research

into

published

subsets

of

(according

what

to

constitutes

management accounting) reveals a concentration on two aspects:

1) Investment appraisal, and
2) Management control
A surprising omission is that of pricing/charging by public service
organizations,

given

the

fundamental

importance

of

these

organizations in most economies and, consequently, the sensitivity of

their pricing decisions. One exception to this was the discussion of
price-setting in nationalized industries by Lapsley (1981a), but this was
in the wider context of the regulation of such industries. A further
study which touched upon this aspect of internal accounting by public
sector organizations was that by Barnes and Webb (1986). This was a
small-scale study of the effects of changes in cost accounting
treatment on decision-makers in setting prices, in a public service
organizations. The results of these study were inconclusive, but it is of
interest because of the research approach adopted: an examination of
functional fixation by simulating pricing decisions.
On investment appraisal, existing studies have used survey
techniques (Lapsley, 1986); critically evaluated central government
pronouncements and directives (Mooney and Henderson, 1986); and
used case studies in analyzing investment decisions (Sharp, 1985).
These studies provide evidence of differences in the degree of
12

sophistication in the application of investment appraisal techniques.

They also point up the implication of government (and/or funding
agencies) influencing the methods of investment appraisal adopted in
the public sector. However, these studies have not exhausted the
possibilities for research in this area. Indeed, there is a clear case for
more novel approaches to the study of the investment decisions in
public sector organizations, where the context of the decision may be
complicated/blurred by political and non-commercial considerations
and, indeed, by technical measurement problems (particularly the
value of services provided, where there are no prices) which are absent
in the private sector. In this regard, the case study/observational
approach adopted by King (1975) might yield interesting results, if
replicated and extended to non-profit organizations.
Within the area of management control there have been studies
which have addressed the problems of specific parts of the public
sector, notably local government health care and public enterprise. In
local government, Jonsson (1982) conducted a case study of budgeting
within a local authority in Sweden. This drew upon financial documents
and publications (the official view), interviews with officers (the
insider view) and coverage of the budget in the media (the
outsider view).
This study was conducted over three years in which the local
authority concerned, experienced a cutback in its level of funding. This
circumstance proved to be the dominant factor in explaining budgetary
relationship in this local authority-a factor which undermined the
importance of technique/variations in accounting to maintain financial
control. However, contrasting results were found in Reeds simulation
(1986)

of

budget

officers

decision-making

in

programmes

of

expenditure on crime prevention. In this study, existing budgetary

information

was

varied

by

the

introduction

of

non-financial
13

performance measures. Reed found that this significantly influenced

decision makers behavior, although background variables (subjects
gender, work experience, education and personal perceptions of the
severity of local crime) also influenced funding decisions. While these
rather thin findings points to the need for a greater understanding of
the behavioral aspects of budgetary control in local government, other
evidence

(see

Pendlebury,

1985)

also

points

to

need

for

improvements in the technical aspects of financial control in local

authorities (less emphasis on a single year for forward planning,
greater sophistication of costing studies). In health care, the most
significant and comprehensive study of the UKs health service was
that by Perrin et al. (1978). This reported the results of an investigation
of all aspects of financial planning and control in the National Health
Service. It identified problems with inadequate budgetary control and
potential conflicts between clinicians and providers of financial
information. These issues have been pursued in later studies (see
Bourn and Ezzamel, 1985, 1986) but the NHS, with its distinctive
culture and complex set of goals, remains

an interesting area of

potential research for accountants. On the other hand, interesting

problems may also be found in other health care systems. See, for
example, Blanchard et als study (1986) of the distortion of budgetary
information reported by hospital to a regulatory commission. Finally,
the Berry et al. study (1985) of the management control process within
one part of a major public enterprise is of particular interest. This study
discovered that the physical production planning of this organization
dominated all consideration of financial aspects of planning. Indeed,
accounting information (such as profit and also accounts) was not used
at all, it was often used in a somewhat ambiguous manner.
While the above studies have added valuable contributions to our
limited knowledge of the detailed operation of specific parts of the
14

public sector, there has been no attempt to map out the key elements
of a conceptual framework for the totality of management accounting
in the public sector, comparable to that attempted by researchers in
financial accounting. Perhaps the nearest to this is Hofstedes (1981)
painstaking analysis of the nature of the management control in notfor-profit activities. He characterizes not-for-profit activities as typically
having ambiguous objectives, non-measurable outputs, non-repetitive
activities and unknown effects of management intervention. These
factors inhibit the development of effective management control
systems: Hofstede argues that the answer to this problem has been
the adoption of control methods (management-by-objectives; planning;
programming budgetary systems; zero-based budgets) which, he
demonstrates, have their origins in the private sector and which do not
transfer well to not-for-profit activities. In sum, this evidence points to
the need for further research, of a fundamental nature, on internal
accounting and management information systems.
4. Audit
The audit of public sector institutions is of significance because of
the sheer scale of public funds devoted to such activities but, more
particularly, because of the mechanisms and means by which the audit
of public sector institutions differ from those of the private sector.
However, there have been few academic studies of public sector audit.
One aspect of such audits which has attracted the attention of
accounting researchers is that of the regulation of the external auditor.
Beck and Barefield (1986) constructed a model which has used to
predict the amount which firms would bid for public sector audit
assignments. The predictions of this model (based on an ordinary least
squares regression analysis) were then compared with the actual bids
made. In practice. This model had limited usefulness as it consistently
overestimated the lowest (winning) bid. Another aspect of the
regulation of public sector audit was undertaken by Tomkins (1986).
15

This latter article is a statement of the experiences of one firm of

professional accountants in the conduct of its audits of local authorities
in the UK. This article is largely descriptive, but it identifies areas of
potential research, including, for example, the future role of the
traditional regularity audit and the role of the accountant in conducting
audits with distinct policy implications.
However, the single most important aspect of public sector audit,
which distinguishes it from that of private sector audit engagements, is
that of the concept of value-for-money, often expressed as the three
Es: economy, efficiency and effectiveness. Glynn (1985) has
documented the institutional background to the development of this
concept in six countries. Grimwood and Tomkins (1986) conducted an
investigation to determine the extent to which the third, and most
controversial, of the three Es (effectiveness) was included in to
public sector audit engagements. The limited nature of the above
study means that its conclusion (that little effectiveness audit is
undertaken) cannot readily be generalized, although prima facie, the
difficulties of identifying and measuring the attainment of policy
objectives

would

support

this

finding

(see

Tomkins,

1987).

Nevertheless, this study represents a distinctive contribution to the

admittedly thin literature of public sector audit, much of which is
professional rather than academic and rigorous.
Conclusion
This article has sought to explore the extent to which accounting
researchers have investigated public sector accounting. It draws upon
contribution to the most important academic journals in English-speaking
countries. The types of studies undertaken have reflected research activity
elsewhere

in

accounting:

methodologies

employed

include

deductive

reasoning, simulations, surveys, case studies and observational studies.

16

Numerous opportunities for further research have been identified throughout

this paper and so will not be repeated here.
A major finding of this study is that the most significant effort of
accounting researchers has been directed towards financial accounting and
accountability. While there has been some research into management
accounting in public sector institutions, the financing and audit of such
organizations have been seriously neglected. Perhaps the single most
distinctive aspect of this research activity is the absence of a theoretical
background which provides a framework for the development of accounting
principles and practices in the public sector; all of which underlines the need
for research which does not merely replicate earlier studies, but which makes
contributions of a fundamental nature to the literature on public sector
accounting.

17