International Journal of Public Sector Management
Account abilit y and t he account ing regime in t he public sect or: Some messages f rom t he NHS Howard Mellett Jan Williams
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To cite this document:Howard Mellett Jan Williams, (1996),"Accountability and the accounting regime in the public sector", International Journal of Public Sector Management, Vol. 9 Iss 1 pp. 61 - 70
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Some messages
from the
NHS
61
A ccountability and the
accounting regime in the
public sector
Some messages from the NHS
Howard Mellett
Cardiff Business School, Cardiff, UK, and
Jan Williams
West Glamorgan Health Authorities, Swansea, UK
Introduction
A continuing theme pursued by the present Government in the UK is to attempt to transplant private sector ideolog y into public sector organizations. T his transfer is seen as crucial to the perceived need to control expenditure while, at the same time, deliver an acceptable level of serv ice: “ Only by taking a prog ressively more business-like approach can the Government continue to bear down on the cost to the taxpayer of delivering public services… ”[1]. T he adoption of accruals accounting, in those parts of the public sector where it is not already operated, is part of this process, and a consultation paper was issued by the UK Treasury in 1994 dealing w ith this subject[1]. In the consultation paper, the accounting system is discussed as though it is a passive recording and reporting instrument, but in practice it can be influential in achieving objectives of the type sought by the Government:
T he lang uage, pressures and requirements of the marketplace can be infused into the organization as a result of a strategic realignment of organizational structures, internal patterns of organizational segmentation and flows of information, including accounting information[2].
T he increasing role of business-like approaches can be seen in the stated objectives of the NHS. Under the 1946 A ct, which established the NHS, a duty was placed on the Minister of Health to “promote the establishment… of a comprehensive health service designed to secure improvement in the physical and mental health of the people… and the prevention, diagnosis and treatment of illness”[3]. T his can be contrasted with the 1990 A ct which, rather than expressing objectives in terms of health gain, includes the obligation for every Trust: “ To ensure that its revenue is not less than sufficient… to meet outgoings… [and]… To achieve such financial objectives as may from time to time be set by the Secretary of State”[4].
T his paper examines the consequences of adopting a more business-like approach as part of the reform of the NHS which introduced a quasi market for health. T he changes have now been in place for five years, which is long enough
International Journal of Public Sector Management, Vol. 9 No. 1, 1996, pp. 61-70. © MCB University Press, 0951-3558
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to allow their practical operation to be compared with the outcomes initially envisaged. Differences between anticipated and actual operations can be used to inform discussion on the proposed introduction of similar reforms to other areas of public sector activity. T he emphasis is on the role of the accounting process, using the experience of an NHS Trust hospital in Wales to illustrate the impact of the changes. T he paper is divided into sections which:
• outline the changes to the environment within which it was envisaged that Trusts would function w hen their creation w as first mooted, drawing comparisons with the private sector and examining the extent to which these freedoms have been allowed;
• compare the anticipated environment with that which has been created in practice;
• outline the accounting regime which has been established; and
• examine the validity of pursuing objectives measured in accounting terms when seeking to deliver health care.
The environment foreseen for NHS Trusts
T he creation of NHS Trusts was first put forward in the W hite Paper Working for Patients[5], in which there are a number of statements suggesting that the participants would be encouraged to mimic a private sector market, with its associated freedoms, and be left to bargain among themselves. T he funds to be used in the market are provided by the Government and distributed to health authorities and selected general practitioners broadly on the basis of the size of the population they serve. T hese organizations have the task of entering into contracts to purchase the health services required by their populations, and are given freedom to operate in the market:
• A health authority… [can buy services]… from its own hospitals, from another authority’s hospitals, from NHS Hospital Trusts or from the private sector (para. 9.1).
• Large GP practices will be able to apply for their own budgets to obtain a defined range of services direct from hospitals (para. 1.9).
T he demand created by the purchasers is met by providers, where, for those units within the NHS, responsibility is placed clearly on local management:
• A s much power and responsibility as possible will be delegated to local level (para. 1.9).
• T hose who take decisions which involve spending money must be accountable for that spending … most decisions are better taken at local level (para. 1.16).
• Hospitals and other management units will be expected to carry more direct responsibility for managing their own affairs (para. 11 ).
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• Local management must … be allowed to get on w ith the task ofmanaging (para. 2.2).
• T hose who are actually providing the services are also responsible for day-to-day decisions about operational matters (para. 2.10).
Finally, it is suggested that the Trusts would be given a similar range of powers to those enjoyed by private sector enterprises:
• NHS Hospital Trusts should be free to settle the pay of their staff (para. 2.18).
• T he [NHS Hospital] Trust will be free to dispose of its assets (para. 3.13).
• T he [NHS Hospital] Trust will be free to borrow … subject to an overall financing limit (para. 3.14).
• NHS Trusts… will take fuller responsibility for their own affairs (para. 1.9).
T he extent of the envisaged freedoms for NHS Trusts was indicated in even more detail in a Working Paper[6] which accompanied the W hite Paper:
… they will have far more freedom to take their own decisions… without detailed supervision from above… Each Trust… will have a range of powers and freedoms not available to existing NHS health authorities and hospitals (p. 3).
… they will be given further extensive powers and freedoms… [for example] … to acquire, own and dispose of assets to ensure the most effective use of them… to retain operating surpluses and build up reserves… to set their own management structures… to determine pay (pp. 5-6).
The extent of change
A ll of the liberties envisaged for the reformed operating units in the NHS are analogous with those enjoyed as a matter of routine by organizations in the private sector. However, in the private sector these rights are constrained by the fact that the effectiveness of the organization will be judged by the “bottom line” of its profit and loss account. T he expected outcome of any decision can be evaluated by its impact on profitability, and profit also is a common denominator with which it is possible to compare the results of different entities undertaking many different types of activity. Drucker[7] defines the problem of outcome measurement in the public sector with the question: “W hat is the bottom line when there is no bottom line?”
A s well as being developed to measure profit, the private sector accounting practices operated today also evolved in the contex t of a separation of ownership and management. Ownership provides the capital and appoints a board of directors; it is then the job of the board to invest the funds and account to the owners for how productively it has used them. T he periodic accounting statements published by limited companies “are intended primarily to inform those persons interested in companies who have limited authority, ability, or resources to obtain information about them”[8].
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The development of the public sector approach traditionally relied far more on verifying that cash provided has been spent in accordance with the purpose for which it was g iven and that spending has been properly autho rized. One consequence of this difference, and the traditional view, is that: “Public sector accounting is different from private sector accounting”[9]. T here has been no single g roup of account users, like shareholders, whose needs for information predominate. However, increasing interest in the economic aspects of the world “is providing a powerful basis for accounting change, particularly… in the public sector”[2, p. 15].
T he more “hands-off ” approach of the market model has had consequences fo r the accounting reg ime of the NHS. W hile b udgets are still of g reat importance, accountability upwards has been established by requiring Trusts to prepare annual accounts following, so far as is applicable, the generally accepted accounting principles applicable to a private sector limited company. T his development implies a similar relationship between Trusts and the National Health Serv ice Manag ement Ex ecutive (NHSME), to w hic h the accounts are delivered, as that between the owners and directors of a limited company. Trusts also have to prepare, for more general circulation, an annual report which not only deals with financial aspects but also gives a review of its activ ities in mo re descriptive terms; this is analogous to the chairman’s statement and directors’ report in the published accounts of limited companies. T he logic of the accounting changes made in the NHS can be summarized thus:
• NHS Trusts operate in an environment analogous to that experienced by private sector organizations;
• a developed accounting regime exists in the private sector for such organizations; and therefore
• the accounting regime which exists in the private sector is appropriate for the NHS.
T his line of reasoning is predicated on the situation envisaged when the reforms to the NHS were first published. Now that the reforms have been operated for some time, it is possible to examine the extent to which the envisaged freedoms have in fact materialized.
With regard to the general thrust of the policy that NHS Trusts would be given more responsibility to manage their own affairs, there are a number of ways in which this is being eroded. T here is increasing central guidance being issued in respect of what services should be delivered, for example, the Government has published outlines of the improvements it expects to see in the nation’s health. The manner of delivery is also subject to central standards, established in the Patients Charter, for such matters as waiting times and the individual contracts between purchasers and prov iders are becoming more prescriptive. A lso, central authorities are taking the lead in the reorganization of services, as shown by the changes proposed in cardiac and intensive care services in Wales.
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Local setting of pay levels has not yet been established, and the Governmentcontinues to maintain control over the levels of public sector pay. T he maximum permitted rise is set centrally in response to recommendations from pay review bodies, and, in the latest pay round, an element has been left to local discretion. However, the establishment of local pay barg aining is opposed by many employee g roups. A lthough the Government wishes to see further moves towards local determination, there is still a long way to go before it could be said that NHS Trusts are free to set their own pay levels.
T he ability to obtain finance, both internally generated and from outside, has been restricted. T he freedom to dispose of assets has been curtailed. In Wales, a Trust may retain up to £ 100,000 provided that the asset was owned in the name of the Trust, but anything in excess of this amount must be remitted to the centre where it is used to support the A ll Wales Capital Prog ramme. To be allowed to retain a surplus, the Trust must prove that it has been generated by prudent management and has not resulted from fortuitous savings. On the question of freedom to borrow, strict guidelines have been established and any borrowing is subject to Welsh Office approval. T he need for borrowings to fit within the overall public expenditure limit for Wales has effectively meant that this has been a theoretical freedom.
In addition to curtailing what the private sector would regard as natural operational freedoms, there is also evidence that the market itself is not going to be left alone. Rules, entitled “Local Freedoms, National Responsibilities”, have been introduced w hic h allow the central autho rities to intervene in any contracts which are not considered to be competitive enough. T he aim is to remove any collusion between purchasers and providers, or sets of providers, which results in price fix ing, market sharing o r unjustifiable suppo rt of inefficient health units.
A s well as controlling anti-competitive aspects of the market, central action has been taken in some cases to prevent a hospital losing custom and so being left unviable through competition. In one case, the Health Secretary intervened to prevent the loss to another hospital of contracts worth £ 20 million which would have left the losing hospital unviable. Similarly, the market has not been left alone in London to identify those units which are to prosper and which to fail. Instead, a report was commissioned[10], and its ramifications are still being settled with a significant input of a political nature.
T his analysis, therefore, suggests a considerable gap between the private sector model and that being operated for the NHS. T he market is being left to function so far as it produces the results which are acceptable to those in central control. T his raises the question of whether the NHS and private sector models are close enough in nature to support the adoption, in the public sector, of the accounting procedures which evolved in the private sector.
The accounting regime
A ccounting systems exist to measure, in financial terms, the prog ress and position of an entity. First, the financial objectives of the org anization are
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specified, and then the appropriate accounting procedures are put in place to measure and report the extent of their achievement. A feature of corporate reports in the private sector is their concentration on the amount of profit generated in a particular period, with financial stability also being important. T hese aspects are of obvious interest to the users of these accounts who want to know how well the firm is achieving its profit-making objectives and remaining financially stable.
In the NHS prior to the reforms, the term “surplus” was used in the context of a cash surplus, which meant that the unit had not spent all of the money it had been allocated; this was generally held to be an undesirable outcome. T he idea of profit, or surplus, based on matching income with expenditure, was not recognized as an objective and was not measured in the accounting reports. T his does not mean it did not exist as an abstract concept, rather that it was not considered to be an objective and so know ledge of it w as not wo rth the expenditure related to its calculation. Similarly, conventional balance sheets were not produced to show all of the assets and liabilities of the units, the assumption being that financial viability was guaranteed by the Government. Instead, the objectives were given in, albeit vague, terms of health gain with the result that the Royal Commission on the NHS in 1977[11] noted an “absence of detailed and publicly declared principles and objectives for the NHS” and so it put forward its own set of explicit objectives: “the NHS should:
• encourage and assist individuals to remain healthy;
• provide equality of entitlement to health services;
• provide a broad range of services of a high standard;
• provide equality of access to these services;
• provide a service free at the time of use;
• satisfy the reasonable expectations of its users;
• remain a national service responsive to local needs”.
T he idea of profit or surplus, or any other financial aspect, is noticeably absent from these objectives. However, the introduction of financial objectives has not excluded the non-financial ones, and the W hite Paper which presaged the reforms saw a continuity of these underlying objectives: “T he principles which have guided it [the NHS] for the last 40 years will continue to guide it into the twenty-first century”[5, p. 2].
NHS Trusts are required to publish a set of audited annual accounts. A brief comparison of one of these sets of accounts with those produced by a limited company reveals clear similarities. T his is not unex pected, as “ the new accounts format is designed to reflect best commercial practice modified to meet the specific circumstances of the NHS”[12]. One of the main innovations seen as a result of the switch from traditional public sector to accruals-based accounting in this way is the adoption of depreciation accounting. T he observed impact is the appearance of an annual depreciation charge in the cost
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statements and the preparation of a balance sheet which reports categories offixed assets at their written-down values.
T here are three features of NHS Trust accounts, not found in private sector ones. T he first is the presence of a number of pages of detailed analysis giving information about such matters as the cost of running wards or day-care facilities, often reduced to the cost per unit of work, or throughput. T he second is not obvious simply from looking at the contents as it relates to the basis of valuation of fixed assets. Private sector companies record assets at historical cost minus accumulated depreciation; the option is available of carrying out a revaluation, but this is not mandatory. Trusts value fixed assets at current value less accumulated depreciation, based either on figures provided by the district valuer, for land and buildings, or calculated by applying indices to historical cost for plant and equipment. T he final difference is not apparent from a single set of Trust accounts, but arises from the accounting policies used. Detailed uniform accounting policies are specified centrally for Trusts so that, for example, they must all not only use straight-line depreciation, but also the lives to be applied to different groups of assets are also specified along with the indices to be used for revaluation. Companies in the private sector are free to develop their own individual accounting polices within the boundaries of generally accepted accounting practice.
A chievement of objectives
NHS Trusts today have to pursue two objectives. T hroughout its life the NHS has been charged with the intangible task of improving the state of the nation’s health, and now the requirement to make a stated rate of return, currently 6 per cent, on the assets it employs, has been added. T he operating environment within which it has to achieve these objectives is that of competition in a quasi-market. T he fact that a financial surplus has been achieved does not give any indication of whether the activity undertaken to accomplish it has improved the general level of health of the population, and the incentive to concentrate on patient treatment activity could divert resources from alternatives such as preventive medicine and health education.
Improvement in the state of the nation’s health is primarily the responsibility of district health authorities and fund-holding general practitioners. T hey are prov ided w ith funds w hich they use to purc hase the care considered appropriate to the population they serve. T he amount of money available is fixed, and so the objective is to maximize the amount of care that can be acquired; at the margin, rationing takes place as the decision to purchase one procedure is at the opportunity cost of buying a different one for the same price. In the commercial sector, the market is left to allocate resources and competition is meant to drive down prices. A s has already been noted, the NHS health-care market has not been left alone to function in this manner, but is managed by central authorities where they deem appropriate.
Turning to the financial objectives, the extent to which an NHS Trust has been able to meet its target rate of return is reported in its annual accounts.
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Calculation of this measure requires the identification of two values: the return and the capital employed to which it is to be related. T he return is taken from the income and expenditure account and is the surplus (or deficit) befo re interest is either paid or received. Capital employed is the average of the opening and closing values of total net assets taken from the balance sheet, after removing items which do not participate in generating the operating return, such as those in the course of construction and investments; donated assets are also excluded. T he required return is 6 per cent or above; this figure itself has an element of arbitrariness in it, and has remained static through rises and falls in the general levels of inflation and interest rates.
T he figure calculated for the achieved rate of return is measured to one place of decimals. T his exactitude belies the inherent lack of precision associated with accounting measures based on accruals and revaluation. To take a practical example[13], an NHS Trust reported a return of 7.1 per cent, which is well in excess of the required level. T he depreciation charge deducted to measure the surplus was £ 1,276 million and the average value of relevant net assets was £ 25,581 million. T he depreciation charge is based on three arbitrary elements, the anticipated life of the assets, the revaluation indices to be applied to them, and the accounting policy to spread their value over their life. T he extent of arbitrariness for an NHS Trust is compounded by the fact that local decisions cannot be made on how best to allow for local conditions as the procedures related to these three aspects are set centrally.
Because of its arbitrary nature, it is not possible to prove that the depreciation figure should not be 10 per cent larger or smaller[14,15]. Applying this range to the figures given above, the depreciation charge could be £ 0.128 million greater or smaller, with a consequent decrease or increase in average capital employed of £ 0.64 million. Calculations of the related values of return on capital employed give 6.6 per cent and 7.6 per cent respectively. Both of these are comfortably above the required level, but the question arises of the impact if a Trust were just making 6 per cent; this acceptable outcome owes as much to the application of arbitrary accounting practices as it does to actual performance. A lternatively, failure to achieve the required return may be due to location; a hospital on a prime real estate site has to make the same proportional return on its enhanced value as one on relatively inexpensive land.
W hat action can a Trust take if it is making a return of less than 6 per cent? It must generate additional income, with a less than proportional increase in costs, reduce costs, reduce the size of its asset base, or a combination of two or three of these alternatives. A ny of these policies is likely to impinge adversely on the o rg anization’s other objective, namely to deliver health care of an acceptable quality. T herefore, it is necessary to implement quality control systems to ensure that standards are maintained.
This leaves unresolved the question of how conflict between quality of care and rate of return is to be reconciled. In the commercial market, the consumer trades off quality and cost, possibly switching to an alternative supplier. This is not always an option in the NHS where local quasi-monopolies may ex ist owing to
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specialization and an unwillingness or inability of patients to travel. A t theextreme, it may not be possible to deliver the desired services at an acceptably low price anywhere, bearing in mind the competing uses for the available funds. In these circumstances, certain types of treatment may become no longer available.
A final objective of the market is to identify and reinforce success while, at the same time, pick out weak facilities for appropriate action. In the private sector, those facilities which fail are wound up and cease to exist. T he NHS market system has identified successful and unsuccessful Trusts in terms of the surpluses or deficits they have generated. In the case of deficits, one solution being pursued is to merge two Trusts, both of which figure in the top ten loss makers for 1992/93. One use made of surpluses in the private sector is to use the funds generated to expand, but the logic of reinforcing financial success by expanding the location where the surplus is generated may not apply in the NHS, as the alternative, that of spending the funds elsewhere, may generate a greater health gain from the national point of view.
Conclusion
T he basic question is whether the quasi-market established for health care within the NHS is sufficiently like a commercial market to justify its control through accounting mechanisms developed for the commercial market context. It is demonstrated here and elsewhere[16] that this condition does not exist. T here is also the question of whether the commercial accounting approach is able to satisfy the requirements of the sector in which it has evolved, let alone one into which it has been transplanted. It appears that the “owners” of the NHS, that is the Government on behalf of the population, are unwilling to relinquish control to the same ex tent as shareholders in private secto r companies.
T he Government now intends to spread resource accounting to the rest of the public sector[1]. T his will use accruals accounting, including depreciation, and fixed asset revaluations similar to the system operated in the NHS. However, the entities operating the system will not generate income, and the depreciation charge will simply appear in a cost statement. Without income, there can be no measurement of surplus or deficit and so the proposals are one further step away from the commercial market. It is possible that a case can be made for changing accounting practices, but this should be based on identifying the weaknesses of the present sy stem and a positive consideration of all the consequences of the new one. Simple faith in private sector procedures is not enoug h, especially as the application of a uniform sy stem of accruals accounting can lead to measurements which are precisely wrong rather than those w hich are about rig ht as a result of being g iven local control over accounting policies.
References
1. HMSO, Better A ccounting for the Taxpayer’s Money: Resource A ccounting and Budgeting in Government, HMSO, London, 1994, p. iii.
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2. Hopwood, A .G., “A ccounting and o rg anization c hange” , A cco unting, A uditing & A ccountability Journal, Vol. 3 No. 1, 1990, pp. 7-17.
3. HMSO, National Health Service A ct, HMSO, London, 1946, p. 1.
4. HMSO, National Health Service and Community Care A ct, HMSO, London, 1990, p. 11. 5. HMSO, Working for Patients, cm 555, HMSO, London, 1989.
6. HMSO, Working for Patients, Self Governing Hospitals, Working Paper 1, cm 555, HMSO, London, 1989.
7. Drucker, P.F., Managing the Non-profit Organization, Butterworth-Heinemann, London, 1990, p. 81.
8. Lee, T.A ., “Company financial statements”, in Lee, T.A . and Parker, R.H. (Eds), T he Evolution of Corporate Financial Reporting, Nelson, London, 1979, p. 15.
9. Jones, R. and Pendelbury, M.W., Public Sector A ccounting, (3rd ed.), Pitman, London, 1992, p. 1.
10. Tomlinson, B., Report of the Inquiry into London’s Health Service. Medical Education and Research, HMSO, London, 1992.
11. Merrison, A .W., Report of the Royal Commission on the National Health Service, cmnd 7615, HMSO, London, 1977, p. 9
12. National Health Service Management Executive, T he A ccounting Framework, Department of Health, London, 1991, p. 3.1.
13. Llanelli/Dinefwr NHS Trust, A nnual A ccounts 1993/94.
14. T homas, A .L., Studies in A ccounting Research # 3, T he A llocation Problem in Financial A ccounting T heory, A merican A ccounting A ssociation, 1969.
15. T homas, A .L., Studies in A ccounting Research # 9. T he A llocation Problem: Part Two, A merican A ccounting A ssociation, 1974.
16. Lapsley, I., “Market mechanisms and the management of healthcare”, T he International Journal of Public Sector Management, Vol. 7 No. 7, 1994, pp. 15-25.
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