RAPPORT

NR 155

Accounting Innovations in the Public Sector

A comparative analysis of the accrual accounting reform
process in the Swedish and Finnish local governments

Paper to be presented at the 27th Annual Congress of the European

Accounting Association, 1-3 April 2004 in Prague, the Czech Republic.

Mars 2004
Ola Mattisson
Salme Näsi
Torbjörn Tagesson

Ett samarbetsprojekt mellan

RENHÅLLNINGSVERKSFÖRENINGEN SVENSKA KOMMUNFÖRBUNDET VA-
FORSK OCH INSTITUTET FÖR EKONOMISK FORSKNING VID LUNDS UNIVERSITET
 Accounting Innovations in the Public Sector
- A comparative analysis of the accrual accounting reform process in
the Swedish and Finnish local governments

Ola Mattisson1, Salme Näsi2 and Torbjörn Tagesson 3

Abstract

The transition from cash accounting to accrual accounting has been a trend in the public sector in many countries
during the last two decades. In Sweden this movement started in the mid 1980s and it is a process still at work.
In Finland both the local and central government adopted accrual accounting during the latter half of the 1990s.

The research done in the field so far has to a large extent focused on pros and cons of accrual accounting in
public sector settings. Even though accrual accounting implies certain basic principles, it is obvious that both the
design and implementation might differ. The aim of this paper is to explore the differences and similarities of the
accrual accounting reform processes in local governments in Sweden and in Finland. The study is based upon the
results of other studies, as well as on empirical work that has been carried out by the authors in different research
projects during the last years.

The comparison between the two countries includes, for example, the triggers behind the introduction of accrual
accounting, and interpretation of the main functions and users of accounting information. One overall result is
that financial reporting in the Swedish local governments is used more for the claim of accountability, than it is
in the Finnish local governments, at least concerning accountability to external stakeholders. One explanation for
this is that in Sweden the central government is one of the most important stakeholders of the local government.
Central government uses financial reporting as a tool for controlling that local government meets the legal
requirements for a budgetary balance and other demands that are connected to central government funding.
Local governments in Finland and more independent accounting entities form the central government. Accrual
accounting information is produced for budgetary and financial control purposes in the municipal council and at
different levels of the organisations of the municipality in question.

Paper to be presented at the 27th Annual Congress of the European Accounting Association, 1-3 April
2004 in Prague, the Czech Republic.

First draft, please do not quote.

1
Lund University, School of Economics and Management, P.O. Box 7080, SE-220 07 Lund, Sweden.
E-mail: ola.mattisson@fek.lu.se
2
University of Tampere, School of Business Administration, P.O. Box 33014 University of Tampere, Finland.
E-mail: salme.nasi@uta.fi
3
Kristianstad University, Department of Business Studies, SE-291 88 Kristianstad, Sweden.
E-mail: torbjorn.tagesson@e.hkr.se

2
1. Introduction

During the last decades local government accounting as well as central government
accounting in Sweden and Finland has changed from cash based accounting towards accrual
accounting. The same is true for public sector organisations in several other countries (see
e.g., OECD, 2000). Even though there obviously are some similarities in the public sector
accrual accounting reforms in different countries, there are also many differences, which may
explain divergence in design and implementation aspects of the accounting systems as well as
the use of accounting information by different stakeholders. Crucial factors where the local
governments in different countries differ are the structure of the government and the influence
and need for information from external stakeholders. “Accounting is a social system much
like language and law. As such, it tends to evolve by adapting to its environment…”(AICPA,
1973, p 3).
In this paper we will describe the transition process from cash accounting to accrual
accounting in the local governments in Sweden and Finland. The transition processes in these
two countries will then be compared and analysed. As a basis for our analysis we will use the
model for innovation process in financial accounting standards setting developed by Hussein
(1981).
The paper is organised as follows: Part 2 describes the theoretical framework and the basis of
analysis. Part 3 describes the transition process from cash accounting to accrual accounting in
the local governments in Sweden, and part 4 the corresponding process in the local
governments in Finland. Part 5 presents the analysis, and part 6 presents concluding remarks.

2. Theoretical framework

In research and literature, accounting changes are often treated as innovations (see e.g.
Tritschler, 1970; Comiskey and Groves, 1972; Hicks 1978; Hussein, 1981, Lüder 1992 and
1994, and Chan, Jones and Lüder 1996). There are at least two alternative models for choice
to study accounting innovations, the one developed by Hussein (1981) and the other one
developed by Lüder (1992 and 1994). Both models are later used by several other researchers.
Lüder's so-called 'Contingency model' is well-known and often used, developed and revised in
several versions by the Comparative International Governmental Accounting Research
(CIGAR) scholars (see e.g. Chan 1994, Jaruga, Nowak, and Dixon 1995, Monsen and Näsi
1998).

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Hussein (1981) has based his analysis of accounting standard setting on a model by Zaltman,
Duncan and Holbeck (1973), a model which originally was used to explain adaptation of
technical and other innovations in organizations. Hussein’s modified model is in turn used by
different researchers who have discussed or studied accounting change (e.g. Jönsson, 1985;
Artsberg, 1992, Paulsson and Tagesson, 2003). Hussein (1981, p. 28) writes: "There are two
approaches to the study of innovations, the result approach and the process approach. The
result approach looks at the final outcome, letting the process remain hidden in a "black box".
The process approach focuses on the process itself from the initiation stage to the final
outcome."
Both the Lüder's Contingency Model and the Hussein's Model are transition process
oriented and include the same or equivalent elements. In the former the innovation process
is sparked by a stimuli, such as a financial scandal or governmental financial crisis; in the
latter, an innovation process starts as a consequence of a performance gap existing in the
current system as to how it works and how it should work. In the Lüder's model structural
variables and the users and producers of accounting information and their attitudes,
expectations and behaviour play an important role. Hussein divides the innovation process
into two sub-processes, initiation and implementation. The initiation sub-process extends
from the outset to the decision sub-stage, and the implementation sub-process describes the
actual beginning of activity. The initiation sub-process of the model consists of four sub-
stages; knowledge and awareness, formation of attitudes, implicit bargaining (legitimation)
and outcome (see Figure 1). Hussein's model is therefore even more clearly process-
oriented than the Lüder's Contingency Model.

In this paper we are going to use the Hussein's model (or modified Zaltman et al model) as
our framework for describing, analysing and comparing the transition processes of
accounting systems from cash based to accrual based in the local governments in two Nordic
countries, Sweden and Finland.

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 Mass Inter-personal Inter-personal and
communication Communication mass
communication

Adapt

Performance Knowledge Formation of Implicit bargaining

gap and Attitudes (legitimation) Outcome Reject
awareness
Pre-
empt
Perceived Relative power of
characteristics of each group,
the innovation sub-group or
coalition

Social structure
Change agents and Other parties in
norms of groups the environment
and sub-groups

Results of
Innovators and experimentation Presence of
opinion leaders by coalitions
some
organisations

Interpersonal
Experience with relationships
similar methods between group
leaders

Figure 1. Hussein’s model of the innovation process with respect to accounting change

A “performance gap” exists if there is a difference between how the present method works
and how it actually is supposed to work (e.g. Zaltman et al., 1973; Jönsson, 1985). According

5
to Jönsson (1985) this can arise when there is knowledge about a better solution or if the
present method does not solve the problem (ibid.). Before the innovation can be adopted there
must be an awareness that the innovation exists (Hussein, 1981). Change agents play an active
role in making knowledge and awareness of innovations. These change agents can be
external as well as internal (ibid.). In an accounting context internal change agents ought to be
found among the accountors (the management liable for account) and employees working
with accounting, while the external change agents ought to be found among the accountees
and other users of the accounting information.
When the attitude of the innovation is formed, the perceived characteristics of the
innovation are important (Hussein, 1981). Hussein reminds that “Since it is the perceived
characteristics and not the objective characteristics that are important in influencing the
process, the same innovation may be perceived to have different characteristics by different
persons.” (p 29) He also points out that the characteristics of the innovation do not necessarily
have the same degree of importance to all groups.

Table 1 Characteristics of accounting innovations

Relative advantage: The degree to which a proposed standard is perceived to be
superior to the present practice.
Relevance: The degree to which financial statements based on the proposed
standard provide information pertinent to decisions concerning
(a) valuing the firm; (b) evaluating management; and
(c) evaluating management performance.
Reliability: The degree to which information provided by financial
statements based on the proposed standard is free
from bias and verifiable.
Comparability: The degree to which the proposed standard is consistent with
existing values and past experiences.
Communicability: The degree to which a proposed standard is easy to understand
and describe to others.
Radicalness: Material departure from existing practice

Source: Hussein 1981 p 30.

Hussein's lists of the characteristics of accounting innovations are illustrated in table 1. Apart
from the perceived characteristics, other factors that impact the formation of attitudes are

6
social structure and norms (Hussein, 1981). According to Hussein the degree of change
receptiveness is different from one social system to another.
In the final phase the innovation gain legitimacy through negotiation and agreement between
the different groups and sub-groups (e.g. Watts and Zimmerman, 1978; Hussein, 1981;
Jönsson, 1985). Information, communicative qualifications and power are important factors
that affect the possibility to receive respect for one’s position (Hussein, 1981; Jönsson, 1985).
Depending on situation and stakeholder structure, the relative distribution of power can vary
between internal and external interests. But of course, the relative distribution of power can
also vary between different sub-groups in the external circle as well as between different sub-
groups in the internal circle. (e.g. Hussein, 1981; Jönsson, 1985) The power controlling tools
are accessibility to different sanctions, legal as well as financial (e.g. Jönsson 1985; Östman,
1997). The more relative power a group has, the more influence this group will have on the
selection and implementation of the change (e.g. Zaltman and Wallendorf, 1983).

3. Accrual Accounting Reform Process in the Local governments in Sweden

3.1. Local governments in Sweden

The local level of the public sector in Sweden consists of two different administrative
systems. Firstly there are 290 municipalities responsible for local issues as schools, care of
various kinds and technical infrastructure. Secondly there are 21 county councils responsible
health care and some other across-the-board tasks too costly for a single municipality. Even
though geographical area and compulsory tasks differ, same basic legislative framework in
applies to both municipalities and county councils. Both parts have large powers of self-
determination and are, by law and tradition, relatively autonomous from the central
government. The autonomy is based upon sections 1 and 7 in the Instrument of Government
Act4. The autonomy of the local government is further specified in the Municipality Act
(1991:900) (Kommunallagen) that, among other things, deals with issues concerning
competence, organization structure, budgeting, and accounting in the county councils and
municipalities. It is noteworthy that the Municipality Act only regulates procedures and
obligations for the elected representatives and the rights and obligations of the local

4
Section 1 states that local government autonomy is an important principle in the constitution, and section 7
states that the decision-making power at the local level rests with the elected assemblies in the municipalities and
county councils. In section 7 it is also stated that local government has the right to levy taxes.

7
government institutions. The role of the civil servant employed in local government is not
even mentioned in this context.
Both county councils and municipalities are run by elected bodies with politicians, elected
directly by citizens every fourth year. According to the Municipality Act, the elected bodies
have to appoint a board to be responsible for carrying out decisions. In relation to central
government, these bodies are relatively free to organise their activities and depending on the
local needs, it can appoint a number of local government committees. Aside from a
compulsory elections committee, the number and names of these committees show great
variation, depending on the municipality in question.
In spite of this formal independence, central government still has a significant influence in
two ways. Firstly, local governments receive a lump sum transfer (approximately 15% of the
municipal revenues) from the central government. Secondly, a large proportion of the
activities in local government actually have to do with implementation of policies that are
decided upon by the national parliament. To make sure that those policies can be carried out
with the same standard to inhabitants, no matter where in the country people live, the central
government has introduced a system of transfer payments. Local governments with high
revenues from taxation and good conditions of social, geographical, and age structure have to
pay a part of their income to central government. This money is then redistributed to other
local governments with less fortunate conditions.

3.2 The innovation and transition process of the accrual accounting in the local
governments in Sweden

The concept of accountability was first mentioned explicitly in the Municipal Act of 1901.
General rules about auditing, however, had already been introduced in 1862. During the first
half of the 20th century, it was to a great extent the elected representatives that prepared,
carried out, and controlled or audited local government accounting. But since the middle of
the 1950s there have been many changes in local government business and activities. The
accounting has also gone through some changes, especially in recent years, while the form of
auditing has only had minor changes.
In the Municipal Act of 1953, rules about protection of the municipal property were
introduced. This view of the protection of municipal property was the basis of the accounting
model (KRK-56) that in 1956 was introduced by the precursor to the Swedish Association of
Local Authorities. This model was in practice until the middle of the 1980s, when another

8
new accounting model (Kf/Lf-86) was introduced. An important occurrence was a bill
introduced in Parliament by the Opposition in 1983 (Brorström, Haglund and Solli, 1999).
This bill dealt with the need for reform in local government accounting, to facilitate
comparisons and better support for economic decisions. Even though the proposal came from
the Opposition, the standing committee on finance expressed its attraction to the proposal.
Suddenly, the local government sector was facing the 'threat' of an Accounting Act for local
governments. The reaction of the Swedish Association of Local Authorities was to set up a
committee with the task of presenting a new and reformed accounting model that would
respond to the new requirements for comparison and better support for economic decisions.
The new accounting model (Kf/Lf-86) was for the most part built upon the same principles as
the accounting model in the private sector. The basic reason for the changes, besides the
'threat' of legislation, was to increase the understanding of local government accounting and
thereby facilitate access to information for decision-makers and other interested parties
(stakeholders) (Brorström, Falkman, Haglund and Lagebro 2000). By replacing the complex
accounting model of 1956 with a model with more traditional standard format and concepts
from business economics, the local government accounting should be more easily accessible
and user-friendly (Petersson, 1996; Bergevärn and Olson, 1987; Brorström et. al. 2000)
In the 1991 Municipal Act, the rules about protection of local government property were
excluded and replaced by a regulation about good economic management. This means that the
law was adjusted to conform to current practice. The idea of good economic management
was, however, not defined either in the wording of the law or in the preparatory drafting work
on the law.
In time, the requirement of good economic management was not considered to have enough
control effect. To prevent, or even to put a check on the continuing deterioration of the local
governments’ economy, a requirement of a balanced budget was introduced in the Municipal
Act of 1998. This requirement for a balanced budget was in force from the financial year
2000. In connection with this requirement, a special law for local government accounting also
was implemented. This law, the Municipal Accounting Act, does not regulate all the
principles and rules underlying the functions of bookkeeping, accounting, and reporting. The
Act is constructed as a framework law. The law refers to generally accepted accounting
principles and presumes that standard setting will be developed through practice and
statements from rule-making bodies. A special rule-making body, the Council for Municipal
Accounting, was founded in connection with the passing into law of the Municipal
Accounting Act.

9
 There were at least two important reasons to legally regulate local government accounting
when the requirement for balanced budgets was implemented. First, the central
government feared that this requirement could lead to 'creative accounting', and make it
impossible for the accounting information to lend valid support for relevant decision-
making built upon objective principles. Secondly, the central government wanted to
maintain a coordinated and harmonized accounting (Brorström et al. 2000).

The Municipal Accounting Act establishes three main functions for local government
accounting. It states that the bookkeeping shall be arranged so that (a) the economic results
from the operations can be compared against the budget that the municipal council has
confirmed, (b) sufficient control of the operations can be maintained, (c) satisfactory financial
statistics can be distributed to various parties.
The main receivers of local governments accounting information, besides the internal users,
are the citizens represented by the local government council, other local governments, and the
central government. On the basis of the accounts, the local governments must deliver
information to the central government agency, Statistics Sweden, which is responsible for the
National Accounts. The accounting information is an important source for central government
calculations, follow-up, and evaluation of municipal operations on an aggregate as well as
local level. The central government, for example, uses the accounting information as support
when deciding about direct government grants to municipalities and as a basis for deciding
general principles for the system used to straighten out economic differences amongst local
governments.
The Swedish Association of Local Authorities cooperates with Statistics Sweden to
harmonize as much as possible the municipalities’ reported information with the information
in the National Accounts. The Association then uses the reported data and information to
produce and publish comparative figures among the local governments. These comparisons
are important information when the efficiency of local government operations is evaluated by
internal as well as external parties.
In summary, internal as well as external parties use accounting information to develop
standards for evaluating efficiency and to provide a basis for decisions of resource allocation.
The accounting information also provides important supporting documentation when
evaluating whether political decisions have been implemented.

3.3 Legal framework and other influences for the accrual accounting reform process

10
Local government finance, budgeting, and accounting are regulated in two laws: the
Municipal Act (1991:900) and the Municipal Accounting Act (1997:614) (Lag om kommunal
redovisning).
The Municipal Act (Kommunallagen) devotes one chapter to issues concerning finance,
budgeting, and accounting in the county councils and municipalities. Most paragraphs in that
chapter are rather general, referring to the more detailed regulation that is laid down in the
Municipal Accounting Act.
The Municipal Act has been changed several times since the first version was issued in 1866.
During the 1990s several changes were made in the chapter on finance, budgeting, and
accounting. Important changes concern, for example the requirements on balance in local
government finances.
The more specific legislation on local government accounting is a relatively new phenomenon
in Sweden. It was not until 1998 that the Municipal Accounting Act came into effect. Prior to
that, local government finance, budgeting and accounting could differ considerably across
different municipalities and county councils, although for instance, recommendations and
developmental activities carried out by the Swedish Association of Local Authorities (Svenska
kommunförbundet) and the Federation of County Councils (Landstingsförbundet) had a
certain standardizing effect. The following arguments were made in connection with the work
on that law. Firstly, local government makes up a relatively large proportion of the public
finances and, therefore, it is important that decisions concerning the sector are based upon
robust information about the sector's financial position. Secondly, the increasingly bad
financial situation in the sector, may give incentives for “creative bookkeeping”. Thirdly, the
regulations on finance, budgeting and accounting that are laid down in the Municipal Act are
too general. Fourthly, it is important to be able to make comparisons between different county
councils and municipalities (Ds 1996:30).
In addition to the two laws regulating local government finance, budgeting, and accounting,
different rule-making bodies issue recommendations (rekommendationer). The
recommendations are especially focused on interpretations of the regulations laid down in the
laws, and they do have an important role in the development of generally accepted accounting
principles. One reason for this impact is that the county councils and municipalities are
obliged to comment in footnotes on any deviations from the recommendations.
Developmental work in the area of local government finance, budgeting, and accounting by
for example, the Swedish Association of Local Authorities and the Federation of County
Councils often results in white papers, manuals, and instructions (handledningar, cirkulär

11
etc.). The suggestions presented in these documents are not mandatory. Nevertheless, it is
reasonable to assume that they do affect the development of practice in the area (see Table 2).

Table 2. The hierarchy of regulation - local government finance, budgeting, and accounting

Type of regulation Examples Standard setting body

Fundamental laws - -

The Municipal Act

Laws The Municipal The Riksdag
Accounting Act

Recommendations etc. Accounting standards The Council for Municipal Accounting

Statements of good White papers, manuals, The Swedish Association of Local

practice and instructions Authorities, Federation of County Councils

Several actors affect the regulatory framework of finance, accounting, and budgeting in the
public sector. Some of these actors have a direct influence by virtue of their formal decision-
making power, while others have a more indirect influence that is linked to various kinds of
activities in the area. From a formal regulatory point of view, the Riksdag clearly plays an
important role. It is the Riksdag, which decides upon the laws and thereby sets the overall
regulatory framework for both central government (through the Instrument of Government
Act, the Riksdag Act and the Budget Act) and local government (through the Municipal Act
and the Municipal Accounting Act). As for the rest of the framework, central government and
local government are regulated in different ways.
The Council for Municipal Accounting is the main standard setter in local government
accounting. It is an independent, non-profit organization whose members are the Government,
the Swedish Association of Local Authorities and the Federation of County Councils. It was
established at the same time as the Municipal Accounting Act came into force, that is, in
1998. Its function is to develop recommendations for accounting issues where the specific
nature of the municipalities must be taken into consideration. The reason for that kind of
consideration is that local government finance, budgeting, and accounting has adopted many
of its main principles from the private sector, though there are striking differences between
the two sectors.

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The legal framework of finance, budgeting, and accounting in the public sector in Sweden is a
very important basis for the development in the area. Nevertheless, it is obvious that several
other influential actors and several activities other than the issuing of formal rules, too, are
important for that development.
For example, the developmental work carried out by the Federation of County Councils and
the Association of Local Authorities for the county councils and municipalities, respectively,
is of importance. This work usually results in manuals, white papers, and other documents
which are distributed to the county councils and municipalities, respectively, and which are
also often presented and discussed at seminars and conferences.
Influences from the private sector
Other parties with potential influence on the development of public sector finance, budgeting,
and accounting through their own development work are the Swedish Accounting Standards
Board (Bokföringsnämnden) and the Accounting Council (Redovisningsrådet). These
organizations are responsible for the development of generally accepted accounting principles
in private companies, but their work may well have an impact on developments in the public
sector also.
The potential impact of the Swedish Accounting Standards Board and the Accounting Council
also relates to the more general question of influences from the private sector on public sector
finance, budgeting, and accounting. It is not an easy task to assess the degree to which this
kind of influence is an important factor in development. However, during recent decades, the
public sector has adopted the main principles of private sector budgeting and accounting. In
the area of accounting, this has led to adoption in the public sector of the rules issued for the
private sector. One example of this development is that the issuing of a law concerning
private sector annual reports seems to have been one important trigger behind the
developmental work on the Municipal Accounting Act (Broström et al., 1999). It is also a
general observation that the development in the public sector in Sweden from cash accounting
to accrual accounting, at least to some extent, is an attempt to adopt the accounting principles
that are applied in the private sector.
A related issue is the degree to which international standard setters influence public sector
accounting in Sweden. There is no doubt that Swedish standard setters at both central and
local levels closely monitor the work on International Public Sector Accounting Standards
(IPSAS) by the International Federation of Accountants (IFAC) - Public Sector Committee
(PSC). The National Financial Management Authority is even engaged in some of the steering
groups within IFAC-PSC. Therefore, it is most likely that there is some degree of influence of

13
this international body on developments in Sweden. Furthermore, since both the Swedish
Accounting Council and IFAC-PSC harmonize their recommendations with the International
Accounting Standards (IAS)/International Financial Reporting Standards (IFRS), which are
issued by the International Accounting Standards Board (IASB), it can be argued that public
sector accounting in Sweden is heavily influenced by international private sector accounting
standards. On the other hand, since Sweden has applied accrual principles of accounting at all
levels of the public sector for a large number of years, it is less likely that the development of
IPSAS per se have had any direct impact on overall trends in the development of accounting
in the public sector in Sweden.
It is a more difficult task to assess the influence of auditors on the development of generally
accepted accounting principles and practice in the county councils and municipalities. The
reasons for this difficulty relate to the organization, authority, and responsibility of auditors in
this sector. In general, there is no requirement on the professional auditing of local
government in Sweden. Instead, each county council and municipality has an elected auditing
body consisting of politicians. Their knowledge of accounting and performance measurement
may vary considerably. They are free to hire a professional auditing firm, and most
municipalities and county council elected auditors do so. However, in light of this institutional
arrangement, it can be expected that the role of the auditors in the development of financial
accounting principles has been relatively weak, and that this may be even truer with respect to
the development of practice in performance management, financing, and budgeting.

To sum up: It is fair to say that the regulation of government and private sector accounting
today is quite similar respecting legislation and regulating bodies. Nevertheless, there are
fundamental differences between the control and sanctions that could be applied to agents in
the two sectors. In this sense, the private sector is formally more regulated. However, the
similarities will probably decrease in the near future, when the private sector implements the
IASB regulation in accordance with the regulation that was adopted 7 June 2002 by the
European Union's Council of Ministers.

4 Accrual Accounting Reform Process in the Local governments in Finland

4.1 Local governments in Finland

14
The State sector and the municipal sector are considered as two separate governmental sectors
in Finland. Each municipality is an independent legal person and an economic and
accounting entity. Municipalities have self-government or autonomy in relation to the State.
The responsibilities are divided so that the State passes laws that guarantee basic rights to
public services for the people and gives funding in the form of State grants to the
municipalities. Municipalities are responsible for producing or alternatively providing the
statutory public services to their residents. Based on the 'financing principle', the State should
ensure that municipalities are able to manage all the statutory tasks for which they are
responsible.
The municipal sector in Finland consists of basic municipalities and joint municipal
authorities (kuntayhtymä). The number of municipalities (in 2003) are 446 and the number of
joint municipal authorities between one and two hundred. In addition, there are twenty
statutory regional councils (maakuntaliitto), which also operate according to the principles of
local self-governance.
Municipal self-government is safeguarded in the Constitution (Chapter 11, Section 121) that
states: "Finland is divided into municipalities, whose administration shall be based on the self-
government of their residents." As a consequence of municipal autonomy and self-
governance, the municipalities have the right to levy municipal taxes. Provisions on the
general principles governing tax liability and the grounds for the tax as well as on the legal
remedies available to the persons or entities liable to taxation are laid down by an Act
(Constitution of Finland, Chapter 11, Section 121). The national Government also steers the
service production of municipalities by means of legislation and by financing municipalities
with sector and general State grants.
In Finland local authorities provide about two thirds of all public services and the national
Government about one third. The municipalities have constitutional autonomy and the
possibility to arrange their administration and service production or provision as their
democratically elected governments see fit. At the same time municipalities have statutory
obligations to provide basic services, e.g. in health care, social services and education
(OECD, 2001, p. 4).
The highest decision-making power in municipalities is exercised by the municipal council
elected for four years by the residents. In addition to the council, municipal organs comprise a
municipal board, committees and their sub-committees, boards of management, and
commissions. The council sets up the municipal board and the auditing committee. The
council may also set up committees working under the municipal board to handle functions of

15
a permanent character, and boards of management to handle a municipal enterprise or other
institution or function.
The municipal board is responsible for the administration and financial management of local
authorities, and for preparing, executing and watching over the legality of council decisions.
The municipal board shall watch over the local authority's interests and, unless the standing
order specifies otherwise, represent the local authority and exercise its right to be heard (The
Finnish Local Government Act, 365/1995, Section 23,1: Municipal boards) .

4.2 The innovation and reform process of accrual accounting in the local governments in
Finland

Traditionally, budgeting and accounting in the municipal sector in Finland have been based
on the cameral system, with the consequence that the form and content of the accounts and
financial reports have been inseparable from the form and content of the budget. The annual
budget has been the most important planning and control mechanism in the public sector, and
therefore the main function of accounting has been to control the execution of the budget. The
most important accounting information in the cameral system was based on comparisons
between the budget and actual figures.
Two things, the disclosure of financial information useful in making economic decisions (the
decision-usefulness approach) and information for accountability purposes (the accountability
approach) are commonly regarded as being the two-fold objectives of financial reporting in
the public sector. The accountability approach can be regarded as having primary importance,
in particular for public administration financial accounting and reporting. Accountability or
the “obligation to render account” has constituted the backbone of municipal accounting in
Finland from the early years of 1900s down to the 1950s and 1960s. During that period the
authors on the subject of municipal accounting based their text on accounting (bookkeeping)
on the assumption that those who hold and use funds that do not belong to them selves are
obliged to give an account to the owners of the funds. In the municipality context
accountability in practice meant giving an account of the carrying out of the budget approved
by the municipal council.
Until the 1970’s accounting in the Finnish local governments consisted of the cameral system,
annual budgeting and cameral bookkeeping. During the 1970s a wider concept of municipal
accounting was lounged and defined as a tool to produce information for the needs of various
stakeholders. In this new framework accounting was seen primarily as a tool to aid in

16
municipal financial management and decision-making. The most important users of
accounting information were the political decision makers and officials with managerial
responsibilities. This wider accounting concept was represented more in the level of thought
than practice.
Double-entry bookkeeping has been obligatory for the Finnish municipal sector only since the
1990 Municipal Act reform. In practice however, the municipal sector had applied double-
entry bookkeeping in recording its budgetary expenditures, revenues and finance transactions
for several decades.
The main function of the cameral accounting – and the budgetary accounting in general – thus
is to control the execution of the annual budget. The cameral budgeting and accounting
system and thinking continued until 1997 in the Finnish municipal sector financial
accounting. The expenditure and revenue concepts, the account system, recording principles
and annual accounts served the need to monitor budget execution. There existed, however, an
idea of 'income calculation' in the cameral system, too: all the revenue and expenditure
accounts were closed on the 'Income Account' in order to show the surplus, deficit or balance
of the budgetary revenues and expenditures. In case of imbalance, there were many options to
balance the annual accounts: transfers to and from funds and reservations, and also borrowing
(See also Myllyntaus 2002, p. 119).
The accrual accounting and budgeting reform in the Finnish local governments must be seen
as the frame of reference of the New Public Management or New Public Financial
Management (NPFM) concepts. The NPFM ideology prefers private sector accounting and
management control systems to the conventional public sector systems. One can also talk
about “a myth of business-like methods” that exists and holds belief that “private companies
are always more efficient than the public sector units and that the administrative techniques
used in the private units must also be efficient” (Bergevärn and Olson, 1989, p. 32).
Functions of accounting in the local governments or the performance gaps of the cameral
system were not much discussed during the accrual accounting reform process in Finland.
Some perceived characteristics of the commercial or accrual accounting (these two terms
were often used as synonyms in the Finnish discussions) were stressed in the Finnish rather
scarce debate. The Report of the Local Government Committee (1993:33), which was
produced by the committee that prepared the new local government legislation (Local
Government Act 365/1995), is the most important document where the criteria used to argue
for the accrual accounting reform in the Finnish local governments can be found. According
to this report, the main objective of the reform was “to ensure that income measurement and

17
financial indicators as well as the valuation of the balance sheet assets are performed in
accordance to generally accepted and comparable accounting principles and practice.” Thus
the most emphasized characteristics of the accrual accounting were its basis formed by
generally accepted accounting principles. This “GAAP”-basis was seen important from the
point of view of income measurement and financial indicators as well as comparability. In
addition, some itemized lists of reasons leading to the choice of the (Finnish) business
accounting model in the local governments were mentioned in the Report. All these reasons
were quite general in nature and left without further argumentation. According to the
Committee Report “the accounts of administrative or cameral bookkeeping are no longer able
to meet the increased information requirements concerning local government authorities’
activities and economic control. The growing tendency to set up companies to take care of
municipal activities and the growth in the number of join municipalities make necessary a
consolidated balance sheet, with which a municipality can direct and monitor the activities of
its subordinate organisations and their part of the municipal economy.” One argument was
that there is a “need in the municipal accounting for a set of norms laid out in legislation, to
replace the current forms presented only as recommendations”.
Need of financial statements were stated in the Report in a form of following sentences: “The
income statement and profit calculation are needed to show the effect of the financial result of
an accounting period on the owners’ equity within the local government body, and to show
how well revenues and income cover depreciations and interest costs.” The balance sheet is
needed for the estimation of self-sufficiency and indebtedness, and for the calculation of
equity capital and its distribution between restricted and unrestricted capital.” Adaptation of
the Finnish Expenditure-Revenue theory and the ensuing accounting legislation were said to
provide local governmental accounting and reporting with a ready-made generally accepted
and well-known set of norms, to improve financial statement information, and ensure
comparability of financial statements between municipalities and municipalities and other
economic entities.
The arguments of the Report were very general and represented more ideological reasoning
than explicit thinking concerning functions of local government accounting and concrete
performance gaps of the traditional cameral accounting system. The justification for choosing
the accrual accounting model were given as a list of what will be achieved through the
adoption of the accrual accounting model. The income statement was regarded as necessary
for measuring a result and the balance sheet for analysing the asset and financial structure.
Also a general comparability consideration was emphasized.

18
Business accounting thought became to break the supremacy of the cameral accounting
tradition. A decision was made to apply business accounting legislation and thought in the
financial accounting and reporting of the local governments. This decision was compatible
with the increased role of market mechanisms and competition in the municipal service
production, increased pricing and charging for services, the striving to use capital as
effectively as possible and other such endeavours adopted in the public sector in Finland
during the 1990s. In the Finnish local governments, the reform of accrual financial accounting
and reporting was seen as arising from the local government authority’s own needs. It would
provide the “owners” with a useful tool.
The Report of the Local Government Committee (1993:33) played an important role both in
terms of knowledge and awareness and formation of attitudes. The Local Government Act is
not reformed very often in Finland. Therefore each single reform awakes interest from the
very beginning of the preparation work of a new legislation. A key actor (municipal
accounting elite person) behind the Committee Report can be traced. He is a person who was
asked by the Ministry of Interior to prepare his statement in the topic “(Commercial Sector)
Accounting Act and the Municipal Accounting”. From beginning of the 1997, a modified5
accrual accounting model has been applied in the whole municipal sector in Finland. The
change from a cameral budgeting and accounting system and thinking to result-based
budgeting and business-type accounting thinking has meant a change in the basic idea of
accountancy. Besides the Execution of the Budget Statement, financial statements, such as the
Income Statement, the Balance Sheet and the Fund Statement, are prepared and presented
based on the municipal bookkeeping data.
This new municipal (accrual) accounting has now two main functions: the first is to produce
information – give a true and fair view - of the financial result and financial position of the
municipality. The second function of municipal accounting is to monitor the execution of the
annual budget, which in terms of its form and content is compatible with the accounting
system. Owing to the unified form and content of the budget and accounting, one double-
entry bookkeeping system is sufficient to fulfil the two accounting functions mentioned
above.

5
The municipal accounting model is modified accrual due to the following reason among others: donated assets
are left off-the balance sheet as well as the assets purchased e.g. by state grants. Only the assets or the share of
assets which are financed by the municipality itself are recognised as assets on the balance sheet. Therefore if 50
per cent of the finance for a building comes from the municipality’s own money and 50 per cent from a state
grant, the building will be valued at the 50 per cent of the acquisition cost on the balance sheet (before
depreciation).

19
The municipal sector in Finland applies a modified accrual budgeting and accounting system.
The budgeting and accounting systems are congruent and compatible. The reform was
implemented in 1997. In the beginning the change from the traditional cameral system to a
business-like accrual one was huge. The interpretation of accounting information especially
caused problems in the municipal sector. Today, as a consequence of more experience and
learning, and also public discussions and interpretations of the information, the municipal
sector seems to be quite satisfied with the reform. The reform has proved to be more
successful than what its beginning indicated.
The change from the cameral to the accrual accounting model in 1997 meant a fundamental
accounting reform in the municipal sector. The accomplishment of the reform demanded
much work from accounting people in all the municipalities, but it was an onerous
undertaking especially in the smaller municipalities, where accounting and financial control
tasks are carried out by few and not always well-trained accounting people.
There seems to be very little need for critical discussions concerning municipal sector
budgeting or accounting now. Some problems relating to the current budgeting and
accounting system, however, have been discussed in professional magazines. These topics
include how to interpret financial accounting information, how to evaluate operational targets
and their realization, how to balance the economic and operational targets. The main concern
has been the poor economic situation of most small municipalities.
Finland was not among the first pioneers but in the second wave in reforming its
governmental accounting according to accrual accounting principles. Change from traditional
- cameralistic - budgetary accounting to accrual accounting meant a radical reform, which
took four to five years (1993-1997) to prepare and implement in practice. Public sector
budgeting reforms during the 1990s meant a change from traditional line-itemised input-based
budgeting to output-oriented lump-sum budgeting. Budgeting reforms were necessary to
support the output and performance-based steering and management reforms adopted in both
the national and local governments. Accounting and budgeting reforms have to be seen and
evaluated in the context of much broader reform endeavours.
Several structural reforms were carried out and market-type mechanisms were introduced in
the public sector in Finland during the 1990s. The main aim of the modernisation work was to
rescue the country from the deep depression in the first years of the decade and to prepare
Finland to meet the membership criteria of the European Union. The separation of the
commercial and production functions in the form of enterprises and companies from the
governmental budgets changed the Finnish public sector more than any other reforms. The

20
aim of the process of conversion into a corporations and privatisation was to separate the
public functions operating in areas where there is open competition and market-based
business from the government’s budget economy (cf. Tiihonen, 1999, p. 15-17).
In the core governmental functions, the idea was to streamline steering and management
according to private sector models and in that way to increase the productivity, efficiency and
effectiveness of the government. Accounting and budgeting reforms were concrete and
demanded several years to implement but these administrative reforms represented in a way
only a secondary means to carry out the total reform and to achieve its many aims. The aims
of the structural reorganisations and modifications of the public sector in Finland were the
following (Alam and Kiviniemi, 1996): to restrain the rise in the public spending, to improve
performance and productivity, to introduce market-type mechanisms, to delegate authority
and responsibility from the centre to the local level, to develop the overall functioning of the
municipalities, to increase the capacities of the ministries and agencies, to increase use of data
processing techniques and the accountability of the public sector.

4.3 Legal framework for the accrual accounting reform process

As to administration and finances of the local governments, the most fundamental regulations
are included in the Finnish Constitution. Chapter 11, paragraph 121 is entitled 'Municipal and
other regional self-government' and reads: "Finland is divided into municipalities, whose
administration shall be based on the self-government of their residents. Provisions on the
general principles governing municipal administration and the duties of the municipalities are
laid down by an Act. The municipalities have the right to levy municipal tax. Provisions on
the general principles governing tax liability and the grounds for the tax as well as on the legal
remedies available to the persons or entities liable to taxation are laid down by the Act.
Provisions on self-government in administrative areas larger than a municipality are laid
down by an Act."
The Finnish Constitution guarantees autonomy and self-governance for municipalities. The
Local Government Act (Kuntalaki 365/1995) then includes more detailed provisions on
municipal autonomy, the functions of local authorities, municipal administration, finances etc.
Chapter 8 in the Local Government Act is entitled 'Municipal finances' and Chapter 9
'Auditing the administration and finances'. These two chapters together regulate municipal
finances, budgeting, accounting, reporting and auditing.

21
The Local Government Act provides the general framework for municipal economic
planning, accounting, and auditing. In financial accounting and reporting the municipal sector
applies the same accounting legislation - when applicable - as the private business sector in
Finland. As to municipal accounting, Chapter 8, Section 67 in the Local Government Act
states briefly that "In addition to what is provided in this Act, what is provided in the
Accounting Act (655/1973) shall be applicable to the accounting duty, bookkeeping and
financial statements of local authorities”. The Accounting Act (Kirjanpitolaki 655/1973)
regulates private sector accounting, and this very sentence referring to the Accounting Act in
the Local Government Act means that the private sector accounting legislation - and a
business or accrual accounting model - is applied to municipal accounting, too. The private
sector accounting legislation was reformed in 1997 (The Accounting Act, Kirjanpitolaki
1336/1997 and the Accounting Decree, Kirjanpitoasetus 1339/97) and the changes have been
taken into account in municipal accounting as well.
The Accounting Committees play an important role in accounting standard-setting in Finland.
The Accounting Committees interpret and guide the implementation of accounting legislation
and other accounting norms into practice. The oldest Accounting Committee
(Kirjanpitolautakunta) guides commercial sector accounting and reporting, co-operating with
the Ministry of Trade and Industry, which nominates the members of the Committee. Its
members are accounting professionals i.e. Auditors Approved by the Central Chamber of
Commerce (KHT-tilintarkastaja, KHT-auditor).
As part of the Accounting Committee, there is a specific Municipal Sub-Committee or
Municipal Section (Kirjanpitolautakunnan kuntajaosto), which was established in 1997 when
the municipal sector adopted the accrual accounting model based on the (Commercial)
Accounting Act and Decree. The Municipal Section issues instructions and opinions about the
application of the Accounting Act and the accounting sections of the Local Government Act.
The Association of Finnish Local and Regional Authorities (Suomen Kuntaliitto) has a kind of
standard-setting role and it works for standardizing municipal sector budgeting and
accounting in Finland. The Association gives recommendations, publishes handbooks and
provides guidance and training in municipal budgeting and accounting matters. The
recommendations and guidance are not mandatory in the independent municipalities, but they
help the municipalities by providing ready-made solutions for different practical problems.
Therefore the recommendations of the Association are quite strictly followed in municipal
budgeting and accounting practice. More detailed accounting and budgeting guidelines are
given by the Association of the Finnish Local and Regional Authorities (Suomen Kuntaliitto).

22
Its prescriptions and practical guidelines are in the form of recommendations, not in the form
of obligatory norms. Nevertheless, recommendations and guidelines are obviously very
conscientiously observed “as a source of good accounting practice” in municipal accounting
(Myllyntaus, 2000, pp. 132-33). Therefore, municipal budgets and financial accounts at least
look very similar and comparable. They are prepared following the same recommended
models and forms. In content, however, there might be some differences and non-
comparability.

Type of regulation Examples Standard setting body

Fundamental laws The Finnish Constitution (1999) Parliament (Eduskunta)

Laws and decrees The Local Government Act (1995) Parliamant (Eduskunta)
The Accounting Act and Decree (1997)

Statements, rules How to prepare a Funds Statement. Accounting Committee

How to calculate and record The Municipal Section of
Depreciations according to a preset the Accounting
Plan Committee

Recommendations, Bookkeping Regulations for the The Association of the

Guidance Municipalities and Joint Municipal Finnish Local and
Authorities Regional Authorities
(Kuntaliitto)
Table 3 Hierarchy of regulation - local government finance, budgeting and accounting

Accounting and auditing professionals play an important role as individual members in

committees preparing accounting legislation and in interpreting and implementing approved
legislation in practice, but not as standard-setters belonging to the official system. Accounting
and auditing professionals usually use professional magazines and other journals as their
publication channel and as their means to influence financial accounting, reporting and
auditing practices in Finland.

5. Analysis

23
In Hussein’s (1981) model a performance gap, i.e., a difference between how the present
method work and how it actually is suppose to work, is considered to be the main trigger for
accounting change. According to Jönsson (1985) this performance gap can arise when there is
knowledge about a better solution. In this respect, the early phases of change towards accrual
accounting in the local governments in Sweden and Finland were very similar. In this respect,
the early phases of change towards accrual accounting in the local governments in Sweden
and Finland were very similar. In Finland knowledge about the business sector accounting
models had occupied the local government sector accounting thinkers and developers for
several decades (See e.g. Toiviainen, 1926, 1929, Kilpiö 1950 and Näsi 1990; see also Johns,
1951 and Monsen - Näsi, 20xx). I Sweden the debate did not start until the early 80: s and it
was then initiated by people from the private sector, with none or poor knowledge about the
existing municipal accounting model and they did have a fundamentally different attitude
towards accounting than the traditional attitude represented by the municipal sector (Fihn,
1994; Brorström, 1997). However, in both countries the myth of business-like methods being
better than public sector methods as a central way of thinking in the NPM or NPFM ideology
finally meant a victory for accrual accounting models.
In Finland, an initiative for the accrual accounting reform in the local governments was taken
by the Ministry of Interior Affairs and by the Local Government Committee that prepared the
new local government act (Local Government Act 365/1995). This committee released its
report in 1993 and suggested accrual accounting reform as part of the legislation reform in the
Finnish local government sector. Also the Association for Finnish Local and Regional
Authorities and some individual municipal accounting experts whose opinion asked and
appreciated by the legislative and normative organs acted as change agents in the initiative
phase of the change process. In the Swedish local government it was external parties who
experienced the performance gap. The trigger for change was entirely linked to a felt pressure
for change from the central government.
In both countries there was knowledge about the business sector accounting and a kind of
myth of business-like methods being better than public sector methods. In both countries the
change agents were governmental actors. However, in Finland the reform was introduced
during the financial crisis during the 90’s when there also was a pressure in order to meet the
membership criteria of the European Union. There was a mutual understanding between
central government officials and representatives for the local government.

24
In Sweden, who was an early adaptor of accrual accounting in the public sector, the trigger
was not the financial situation but rather a strong belief in the ideas of NPM among central
government officials and politicians. In Swedish local government a pressure for change was
felt and the Swedish Association of Local Authorities acted in 1986 by “voluntarily”
preparing a new accounting model and in that way avoiding legislation and recapture the
initiative.
In Finland there was relatively little debate on the functions of accounting in the local
governments, advantages and possible disadvantages of the change during the entire reform
process. Rather than being regarded as theoretically important, the change was considered to
be in the first place technical in its nature. Thus, the focus of discussions was more on the
superiority of the business sector accounting, software systems and technical training of the
financial officers - especially in the smallest municipalities with few accounting professionals
- than on the accounting information needs of the politicians, officials and other stakeholders.
The accounting principles and models used by the business sector were perceived as better
systems per se than the public sector systems, and therefore it made sense to copy the
accounting norms as ready-made from the business sector. In Finland the de jure
implementation preceded the de facto implementation.
In Sweden the change was very much a result of the debate that followed after the bill
introduced in Parliament. The new accounting model was prepared as a respond to the
requirements from central government. The politicians in local government were aware of
the reform from the very beginning. The reform work was lead by the Swedish Association
of Local Authorities in order to satisfy demands from external stakeholders. When
Swedish central government in the late 1990’s choose to regulate municipal accounting by
legislation, the legislation very much became a confirmation of existing practice. In other
words the process in Sweden can be described as a process where the de facto
implementation preceded the de jure implementation.

The Swedish municipal accounting now is regulated by a separate legislation and special
standard setting body has the responsibility for development of good code of accounting
practice in municipal accounting. In Finland the municipal accounting and private sector
accounting is regulated through the same legislation. The same standard setting body is
responsible for the development of good code of accounting practice in both private and
public sector, all though there is a special Municipal Section or Sub-Committee

25
 responsible for accounting issues that origin due to the distinctive character of
municipalities.

The following table summarizes the accrual accounting reform processes in the local
governments in Sweden and Finland, using the main phases of the Hussein’s model
presented in Chapter 2.

Table 4. Differences of the accrual accounting processes in the Swedish and Finnish local
governments

Local governments - Sweden Local governments - Finland

Performance gap perceived - By external stakeholders (the - By the Ministry of Interior
/the initiative taken Central Government) and the Finnish Association
for Local and Regional
Authorities
Knowledge and awareness - External change agent -Appropriateness of the
(central government) business sector accounting
- Awareness of the distinctive model for the public sector
character of public sector and context discussed for decades
non profit organisations versus - Change of opinions of the
private sector and profit- key authorities as part of the
seeking organisations. NPFM ideology
Formation of attitudes - Reliability, Comparability - Generally accepted
(cross sectional, relevant accounting principles and
for external stakeholders) ready-made legislation as
and communicability. the basis for the business
- Experience from business sector (accrual) accounting
accounting model
- Comparability between
municipalities and across
different economic entities in
private and public sectors
Implicit bargaining - Bargaining between Central - Change of legislation;
Government and the Swedish accrual accounting a
Association of Local mandatory system from the
Authorities. beginning of the 1997
- Change of accounting model
in 1986.
- Financial as well as legal
power controlling tool
- Legislation in 1998 that in
substance confirmed practice.
Outcome - An all together well - A comprehensive set of
functioning production of annual financial statement
accounting information (all information
though there are still some - Difficulties - especially in

26
 problems with the observance
in some sub-sectors).
- Compatibility of the
budgeting and accounting
(both modified accrual based)
- Widely spread use of
accounting information among
external as well as internal
stakeholders.
- Special municipal
accounting act
the first years - in
interpretation of accounts in
the governmental context
- Compatibility of the
budgeting and accounting
(both modified accrual based)
- The same accounting
legislation with the private
sector

6. Concluding remarks.
The introduction of accrual accounting has been one the most common trends in the reform
agenda of public organisations during the last decades. It is often argued that this is a uniform
development. However, a comparison between the development in the local governments in
Sweden and Finland clearly shows that there are differences between both the trigger for
change and the main process of accounting change. The trigger for change in Finland was the
perceived betterness of the business accounting model in financial management, to solve the
economic problems caused by the deep economic recession during the first half the1990s and
to prepare Finland for the membership of the European Union. In Swedish local governments
it was an experienced performance gap amongst external stakeholders. An extensive debate
preceded the reform work in local governments in Sweden, while no comparable debate
preceded the reform in Finland. The absence of debate about the accounting reform in the
Finnish local governments can be explained by the fact that it was initiated by municipal
actors or authorities appreciated by the municipal instances and not considered as a
controversial issue among other interested parties. In the Swedish local government the
reform was initiated by external change agents and there was a tension between external
requirements and internal preferences.

27
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