Fitch: Brazilian States May Delay Programs if IPSAS Changes Slow

Brazilian states' compliance with The International Public Sector Accounting Standards (IPSAS) will significantly improve the transparency and quality of their accounting, Fitch Ratings says. However, it will also continue to be cumbersome and delays will occur.

Some states will be forced to pay penalties if they miss the deadline set by the federal government for December. The federal government may also stop transferring some assets to states and not authorize new credit extensions after the deadline passes. In our view, these penalties could delay state programs funded by credit operations.

Some states are more likely to be ready for the deadline than others. For example, Santa Catarina 'BBB-/AA(bra)' has made more progress than Maranhao 'BB+/AA-(bra)'.

Currently, state expenses are recorded on an accrual basis while their revenues use cash accounting. We view the adoption of accrual accounting for both as positive as it ensures commonality between expenses and revenues and it will allow for clearer assessment of state collections efforts and efficiencies.

Also under IPSAS, states must consolidate their sizable pension deficits and disclose the fiscal incentives granted to companies, as well as the corresponding impact of these incentives on their fiscal performance. States incentives to companies to operate in their territory translate into a tax loss for the state and have commonly been justified by job creation. However, only a few states disclose the amount of fiscal incentives and the intrinsic benefits associated with them. They will also need to calculate the amount of provisions for credits with doubtful recovery and disclose those risks based on their probability.

States in Brazil face fiscal restrictions in reinforcing their accounting departments and updating systems to meet the growing complexity of the new standards. Some states are resorting to third party consultancy to support the accounting transition, a change that requires consolidation of accounts and the elimination of double accounting. The cost of these changes is likely to be offset by efficiency gains in the medium term.

Fitch will evaluate the impact of the elimination of double accounting of revenues and expenditures by state-owned companies. For example, in some cases a public company is paid by the state to offer services to other state bodies, thus equally inflating both revenues and the expenditures.

This accounting conversion, which began in Brazil in 2008, took as much as ten years in some European countries. Several notable countries have not adopted the rules. In the Americas, only the US and Canada apply accounting standards that are broadly consistent with IPSAS. In Russia and China, budget accounting is cash based.

Additional information is available on www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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