IPSAS 1, 2 and 3: Financial Statements, Cash Flows and Accounting Policies

If every government and agency presented its accounts in its own way, nobody could compare one ministry with another or a ministry this year with the same ministry last year. International Public Sector Accounting Standard (IPSAS) 1 fixes the shape of the general purpose financial statements: which statements there are and what must appear on their faces.

IPSAS 2 deals with the one statement that the others do not explain well: the cash flow statement, which shows how an entity obtained and used its cash, whatever its accounting basis. IPSAS 3 deals with the choices and changes behind all the statements: how accounting policies are selected, when they may be changed, what to do when an estimate changes and how to correct errors of earlier years.

Together they form the foundation of accrual accounting for the public sector, and they underlie most of the calculation questions in the paper.

This topic covers the components of financial statements and the minimum line items on the faces of the statement of financial position and the statement of financial performance, with an example; the cash flow statement, its terms, the three activities, the direct and indirect methods and worked examples; and accounting policies, changes in estimates and prior period errors, with the disclosures.

The next topic is notes to the financial statements and the qualitative characteristics of reporting.

IPSAS 3 was tested in November Diet, 2021, Question 2 (20 marks), where part (b) asked what the standard says about selecting and changing accounting policies; the cash flow statement features in several compulsory questions. Read local government expenditure and final accounts first.

IPSAS 1: presentation of financial statements

The aim is to prescribe the format in which general purpose financial statements are presented so that they can be compared with the entity’s statements of earlier periods and with those of other entities in the same sector.

Components

1. a statement of financial position;
2. a statement of financial performance;
3. a statement of changes in net assets or equity;
4. a cash flow statement;
5. a statement of accounting policies and notes; and
6. a statement comparing budget and actual amounts.

The face of the statement of financial position

As a minimum, the face shows: property, plant and equipment; investment property; intangible assets; financial assets (other than those shown separately); investments accounted for by the equity method; inventories; recoverables from non-exchange transactions (taxes and transfers); receivables from exchange transactions; cash and cash equivalents; taxes and transfers payable; payables under exchange transactions; provisions; financial liabilities (other than those shown separately); non-controlling interest within net assets or equity; and net assets or equity attributable to the owners of the controlling entity.

Assets and liabilities are split into current and non-current.

The face of the statement of financial performance

As a minimum: revenue; finance costs; the share of the surplus or deficit of associates and joint ventures accounted for by the equity method; the pre-tax gain or loss on disposal of assets or settlement of liabilities attributable to discontinued operations; and the surplus or deficit.

Expenses are classified by nature or by function. A ministry may show them by function (general public services, defence, public order and safety, education, health, social protection, housing and community amenities, recreation, culture and religion, economic affairs, environmental protection), and if by function, must give the nature of expenses in the notes.

Worked example (₦m). A ministry’s operating revenue is: taxes 300; fees, fines and licences 60; exchange transactions 90; transfers from other government entities 80; other 250: total 780. Operating expenses by function total 410, so the operating surplus is 780 − 410 = 370. Finance costs of 60 and a gain on sale of equipment of 40 give a surplus from ordinary activities of 370 − 60 + 40 = 350.

IPSAS 2: cash flow statement

The standard requires a statement of the historical changes in cash and cash equivalents, classifying cash flows into operating, investing and financing activities. It is based on the private sector standard IAS 7. Neither the statement of financial performance nor the statement of financial position explains how an entity obtains and uses its cash; the cash flow statement shows whether a government, parastatal or board has adequate liquid resources.

To prepare it you need the statements of financial position at the start and end of the year and the statement of financial performance for the year.

• Cash is cash on hand and demand deposits. Cash equivalents are short-term, highly liquid investments readily convertible to cash, with insignificant risk of change in value. Cash flows are inflows and outflows of cash and cash equivalents.

Operating activities

They show how far the entity is financed by taxes or by the sale of goods or services.

Examples: receipts from taxes, levies and fines; receipts from sales of goods and services; grants and transfers from central government or other public bodies; payments to suppliers; payments to other public sector entities; receipts of royalties, fees and commissions; payments to and for employees; receipts and payments of an insurance entity; payments of local property tax or income tax; receipts and payments on contracts held for trading; litigation settlements; and flows from discontinued operations.

IPSAS 2 permits either the direct method or the indirect method; the standard-setter recommends the direct method, with a reconciliation of the surplus or deficit from ordinary activities to net cash flow from operating activities within the statement or the notes.

Investing activities

Cash spent to acquire resources that will help future service delivery, and cash from selling them:

• payments to acquire property, plant and equipment, intangibles and other long-term assets (including capitalised development costs and self-constructed assets)
• receipts from selling them
• payments to acquire and receipts from selling equity or debt instruments of other entities and interests in joint ventures (other than cash equivalents and instruments held for dealing)
• advances and loans made to other parties and their repayment (other than by a public financial institution)
• payments and receipts on futures, forwards, options and swaps (unless held for dealing or classified as financing)

Financing activities

These show the claims of the providers of capital:

• proceeds from debentures, loans, notes, bonds, mortgages and other borrowings
• repayments of amounts borrowed
• payments by a lessee to reduce a finance lease liability

Other rules

• Major classes of gross receipts and gross payments from investing and financing are reported separately, unless the standard permits a net basis.
• Foreign currency cash flows are recorded at the exchange rate at the date of the cash flow.
• Interest and dividends received and paid are disclosed separately and classified consistently as operating, investing or financing.
• Taxes on surplus are operating flows unless they can be allocated to investing or financing.
• Cash flows from acquiring or disposing of subsidiaries are shown separately as investing.
• The components of cash and cash equivalents are disclosed and reconciled with the amounts in the statement of financial position.

Direct and indirect methods

The direct method discloses major classes of gross cash receipts and payments. The indirect method starts with the surplus or deficit and adjusts for non-cash items such as depreciation and amortisation, and for changes in receivables, payables and provisions, and for gains or losses on disposals, which belong to investing.

Worked example (₦m). Surplus from ordinary activities 340. Indirect method:

• add depreciation 40 and amortisation 20
• add increase in payables 15
• deduct increase in receivables 30 and in inventories 20
• deduct gain on sale of equipment 25 (it belongs in investing): net operating cash flow = 340 + 40 + 20 + 15 − 30 − 20 − 25 = 340

Direct method: receipts from taxes 500, fees 90, transfers 55 and other 40 = 685; payments to suppliers 180, employees 120 and other public entities 45 = 345; net = 685 − 345 = 340, the same. Investing: purchase of equipment (150), proceeds of sale 60, purchase of investments (40): net (130).

Financing: borrowings 80, repayments (50): net 30. Net increase in cash = 340 − 130 + 30 = 240; with opening cash of 120, closing cash is 360, which must equal cash and cash equivalents in the statement of financial position.

IPSAS 3: accounting policies, changes in estimates and errors

The standard sets the criteria for selecting and changing accounting policies and the treatment and disclosure of changes in policies, changes in estimates and corrections of errors.

Definitions

• Accounting policies: the specific principles, bases, conventions, rules and practices applied in preparing and presenting the statements.
• Change in accounting estimate: an adjustment of the carrying amount of an asset or liability, or of the periodic consumption of an asset, that results from assessing the present status of, and expected future benefits and obligations from, assets and liabilities. Changes in estimates come from new information or developments and are not corrections of errors.
• Prior period errors: omissions and misstatements in the statements for one or more earlier periods from failure to use, or misuse of, reliable information that was available when the statements were authorised and could reasonably have been obtained. They include arithmetical mistakes, mistakes in applying policies, oversights or misreadings of facts, and fraud.
• Material: items are material if they could, alone or together, influence users’ decisions on the basis of the statements; materiality depends on nature, size or both.

Changes in accounting policies

A change from one basis of accounting to another (for example cash to accrual), and a change in the treatment, recognition or measurement of a transaction within a basis, are changes in accounting policy. These are not changes in policy: applying a policy to transactions that differ in substance from earlier ones, or applying a new policy to transactions that did not occur before or were immaterial.

Treatment

• Change in policy: applied retrospectively as if the new policy had always been used, adjusting the opening balance of net assets, where practicable.
• Change in estimate: applied prospectively, in the period of change and later periods. Example: an asset costing ₦600 with a 5-year life is depreciated at ₦120 a year.
  After two years its carrying amount is 600 − 240 = ₦360
  if the remaining life is now judged to be 6 years, depreciation becomes 360 ÷ 6 = ₦60 a year from now on, with no restatement of the past.
• Prior period error: corrected retrospectively by restating the comparative figures, or the opening balances if the error predates the earliest period shown. Example: an expense of ₦30 was omitted in the previous year; the previous year’s surplus and the opening net assets are reduced by 30, and the error is disclosed.

Disclosure

• On initial application of an IPSAS that affects the current, prior or future periods: the title of the standard; any transitional provision; the nature of the change; the amount of the adjustment for each line item; and, if retrospective application is impracticable, why, and how and from when the change has been applied.
• On a voluntary change in policy: the nature of the change; why the new policy gives reliable and more relevant information; the adjustment for each line item for the current and prior periods and for periods before those presented, to the extent practicable; and, if retrospective application is impracticable, the circumstances and how and from when the policy is applied.

The ideas in more depth

Why the direct method is recommended

The direct method shows what came in and went out, by class, so a reader can see how much was raised from taxes and how much was paid to staff and suppliers. The indirect method shows only the adjustments from surplus to cash. For a government that wants taxpayers to see where cash comes from and goes, the direct method is clearer; the reconciliation keeps the link to the surplus.

Why estimates are prospective and errors retrospective

An estimate is the best judgement on the information at the time; when new information arrives, the past judgement was not wrong, so the past is left alone. An error is a mistake in using information that was available, so the past statements were wrong and are corrected, otherwise the comparatives would mislead.

Why policy changes are restricted

If an entity could change its policies freely, it could improve its reported surplus by choosing a more flattering policy each year. The rule that a change must give more relevant and reliable information, with disclosure and retrospective application, removes the benefit of changing for appearance.

Sources and references

• International Public Sector Accounting Standards 1, 2 and 3; the Federation Account Allocation Committee’s formats for the direct method.

These points are stated as at 5 November 2026.

Worked examples

1. Calculate.
   340 + 40 + 20 + 15 − 30 − 20 − 25 = 340.

1. Calculate.
   360 ÷ 6 = ₦60.

1. Calculate.
   340 − 130 + 30 = 240
   120 + 240 = 360.

How to answer in the exam

• Name the standard and the rule, then apply it to the case.
• For cash flows, classify each item as operating, investing or financing before adding.
• Remove non-cash items and disposal gains in the indirect method.
• For changes, say whether the treatment is retrospective or prospective and give the disclosure.

Common mistakes in the exam

• Treating a change in estimate as a change in policy.
• Leaving the gain on sale of equipment in operating cash flow.
• Adding depreciation to the cash flow statement as if it were a cash item rather than adjusting back.
• Omitting the reconciliation of cash flow to the statement of financial position.
• Applying a new policy only to the current year.
• Forgetting the statement comparing budget and actual among the components.

Quick revision

• IPSAS 1: six components; minimum line items. IPSAS 2: operating, investing, financing; direct method recommended.
• IPSAS 3: policy change retrospective; estimate prospective; error restated; disclose nature and amounts.

Practice questions

These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.

Recall check: multiple choice

Section B style: written questions

A further written question

Model answers

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