5.1.

Historical Background of Public Enterprises in Ethiopia

Pretest

Dear learners, what are public enterprises? How were they developed? What features
distinguish them from private businesses? React to these questions before going on
studying this subunit.

This section briefly acquaints you with characteristics, accounting and managerial implications of
state owned enterprises in Ethiopian context. It also addresses the reorganization of Ethiopian
public enterprises with Proclamation Number 25/1992.

What are Public Enterprises?

In other courses you may have read the various types of funds, one of which was an enterprises
fund. You remember that an enterprise fund is under the category of proprietary fund which is
operated and managed in similar manner to commercial businesses.

Public Enterprise is abusinessorganization wholly or partly owned by the state and controlled
through a public authority. Some public enterprises are placed under public ownership because, for
social reasons, it is thought that the service or product should be provided by a state monopoly.
Utilities (gas, electricity, water, etc.), broadcasting, telecommunications and certain forms of
transport are examples of this kind of public enterprise.
Background of Ethiopian Public Enterprises

Public Enterprises in Ethiopia: Proclamation No. 25/1992

 Definition of terms:
 Public Enterprise (Art. 2 (2)): a wholly state owned public enterprise established
pursuant to Proclamation No.25/1992 to carry on for gain: manufacturing, distribution,
service rendering or other economic and related activities.
 Total Assets (Art. 2 (3)): all immovable and movable property, receivables, cash and
bank balances of the enterprise including intangible assets, deferred charges and other
debit balances.
 Net Total Assets (Art. 2 (4)): total assets less current liabilities, long-term debts,
deferred income and other liabilities.
 Capital (Art.2 (5)): the original value of the net total assets assigned to the enterprise by
the state at the time of its establishment or any time thereafter.
 Net profit (Art.2 (7)):any excess of all revenue and other receipts over costs and
operating expenses properly attributable to the operations of the financial year including
depreciation, interest and taxes.
 State Dividend (Art.2 (9)): remaining balance after deduction of the transfers to the
legal reserve fund and other reserve fund from the net profits.
 Paid up capital (Art.20 (1)): the paid up capital shall not be less than 25% of the
authorized capital at the time of establishment.
 Authorized capital (Art.20 (2)): the authorized capital of the enterprise shall be fully
paid up within 5 years from the date of its establishment.
 Legal reserve (Art. 29 (2)): five percent (5%) of net income of the financial year.

Accounting and Financial Reporting

Articles 27- 29:
 Public enterprise follow generally accepted accounting principles.
 The financial year is determined by the supervising authority.
 Accounts should be closed at least once a year, within three months following the end of
the financial year.
  The enterprise shall prepare a report on the state of its activities and affairs during the
last financial year, including a statement of achievements and major plans and programs
to be implemented in the near future.
 Legal reserve 5% of net profits until such reserve equals 20% of the capital of the
enterprise. The legal reserve is used to cover losses and unforeseeable expenses and
liabilities.
 Other reserve funds may be established with the approval of the supervisory authority.
 Auditor General
Articles 32 – 34 deal with the appointment of Auditors; obligation to cooperate; and powers,
duties, & liability of auditors. It is the supervising authority that will ascertain that external
auditors appointed by it satisfy the criteria set by the Auditor General and that they are free
from being under any form of influence. Plus, the supervising authority shall determine the
term of external auditors. The establishment of the Supervising Authority came to the scene
through Proclamation No. 412/2004.
The term public enterprise is used widely, but there is no single, generally accepted definition
that attaches to the term. But, it is important to understand what is being referred to. This is
because Public Enterprises have features of both private and public sector organizations. Like
private companies, they are engage in commercial activity with the intent of profit-making,
often in competition with other private sector companies. Like public sector agencies, they
are required to execute government policies, often in the form of delivering non-commercial
services or community service obligations.
As suggested in some literatures, three characteristics are considered to be essential in
classifying an organization as a public enterprise: (i) its principal function is to engage in
commercial activities in the private sector, (ii) it is controlled by government, and (iii) it has
an independent legal existence from government and the executive.
Although the provision of these services by public enterprises is a common practice in Ethiopia and
elsewhere, private companies are generally allowed to provide such services subject to strict legal
regulations. In some countries industries such as railways, coal mining, steel, banking, and insurance
have been nationalized for ideological reasons, while another group, such as armaments and aircraft
manufacture, have been brought into the public sector for strategic reasons.
  Commercial Activities

The term 'commercial activities' refers to 'the sale of goods or services for financial return in
an open market, that is, in a market where the consumers of the goods or services are not
limited to government-funded bodies'.
It should be noted that not all Public Enterprises engage in commercial activities in the same
way. Some are monopoly suppliers of goods or services (such as Ethiopian
Telecommunications Corporation (ETC), Ethiopian Electric Power Corporation (EEPCO),
Ethiopian Air Lines (EAL), etc.), while others (such as Meta Abo, Bedelle, Harar Breweries,
commercial Bank of Ethiopia (CBE), etc.) operate in competitive markets with private sector
companies. Commercial activity need not be the only activity of a public enterprise but it will
be its principal activity.
It allows that Public Enterprises will often be required to discharge community service
obligations (that is, provide goods or services at subsidized or less than market prices and
which might therefore not be provided if the public enterprise operated on a purely
commercial basis).
 Government Control
There are also variations on the Government control. The question of control lies at the heart
of accountability. Control is a vague term; it can be exercised generally or in relation to
specific issues.
 It can be exercised permanently or intermittently;
 It can come from inside the public enterprise or be imposed from outside,
 It can be actual or potential (sometimes control is exercised by the threat or potential of
actual control), and
 It can be a combination of these factors.
Two methods of control that have been used in relation to Public Enterprises are:
 the appointment of government officers to the board of management, or
 Direct ownership.
Some Public Enterprises are controlled by virtue of being wholly owned by the government,
whereas, other Public Enterprises are partly owned by private sector interests, often as a step
towards the full privatization of the entity.
In partly-owned Public Enterprises, there is a question about the level of ownership which is
necessary to give the government control over the entity. There are no precise answers to this
question. As we move along the scale from 100 per cent ownership through 50 per cent to
minority government ownership, we encounter entities which are more properly regarded as
private, although the point at which this happens will vary depending on the company.
One attempt at a categorical answer is relying on a test which is similar to that found in the
FASB statements for defining the relationship of holding company to subsidiary company.
That is, the Government is said to control a public enterprise if the Government:
 controls the composition of the Public Enterprises board of directors
 can cast, or control the casting of, more than one half of the maximum number of votes that

might be cast at a general meeting of the company, or

 holds more than one-half of the issued shares in the public enterprise.

However, there are other standards of control that might be used. For example, we could
borrow the control threshold which is used in regulating company takeovers, and say that
anything over a 20 per cent ownership of voting shares constitutes effective control.
 Independent Legal Existence
Ethiopian Public Enterprises Proclamation No. 25/1992 in article 7 has put legal personality
and Liability of public enterprises. According to this article, sub (1), a public enterprise shall
have legal personality stating in sub (2) that it may not be held liable beyond it total assets.It
is important to stress that the formal independence of a public enterprise will not be negated
by the level of control which government exercises over the public enterprise.
Accounting for Formation and Operation of Public Enterprises
 Accounting for Formation
Illustrative Example: Assume that the Government formed ABC Enterprise with authorized
capital of Br.75 million in accordance with the requirements of Proc. No. 25/1992 with
investment of cash, Br.22.5 million; and equipment, at current fair value, Br.1.05 million.
The journal entry to record the investment in ABC Enterprise as follows:
Cash --------------------------------------------------------------------- 22,500,000
Equipment (at fair value) -------------------------------------------- 1,050,000
State Capital -------------------------------------------------- 23,550,000
To record investment in ABC Enterprise.
 Accounting for Operation
To illustrate accounting for operation of public enterprise, the trial balance for ABC
Enterprise for the financial year ending June 30, 2008 is presented as follows:
___________________________________________________________________________
ABC Enterprise
Trial Balance
June 30, 2008
(In ‗000 Birr)
Cash ------------------------------------------------------------------- Br.15,075
Accounts Receivable ----------------------------------------------- 3,900
Property, Plant & Equipment ------------------------------------- 3,300
Accumulated Depreciation ---------------------------------------- Br. 75
Accounts Payable --------------------------------------------------- 225
Notes Payable ------------------------------------------------------- 300
State Capital --------------------------------------------------------- 23,550
Sales ----------------------------------------------------------------- 7,500
Operating Expenses ----------------------------------------------- 4,425
Purchases ----------------------------------------------------------- 4,950 ________
Br.31,650Br.31,650

 Additional information
 Ending inventory is Br.2.4 million.
 The Board of Directors‘ has decided to establish other reserves of Br.150,000 from the
net income of the year.
 The current profit tax rate is 30%.
 Required
1. Prepare an income statement for ABC Enterprise for the year ended June 30, 2008.
2. Prepare journal entries for transfer of net income to legal reserve and other reserves,
and to recognize state dividend payable.
3. Prepare the balance sheet at June 30, 2008.
1. Income Statement ABC Enterprise
Income Statement
For the Year Ended June 30, 2008
(In ‗000 Birr)
Sales --------------------------------------------------------------------------- Br.7,500
Cost of Goods Sold ---------------------------------------------------------- 2,550
Gross Profit ------------------------------------------------------------------- Br.4,950
Operating Expenses --------------------------------------------------------- 4,425
Income before tax ----------------------------------------------------------- Br. 525
Income tax expense (30%) ------------------------------------------------- 157.5
Net Income ------------------------------------------------------------------- Br.367.5
2. Journal Entries
Income Summary ---------------------------------------------------------------- 367,500
 Legal Reserve (5% × Br.367,500) ----------------------------------------- 18,375
Retained Earnings ------------------------------------------------------------ 150,000
State Dividend Payable ------------------------------------------------------ 199,125
Income Tax Expense ------------------------------------------------------------ 157,500
Income Tax Payable --------------------------------------------------------- 157,500
3. Balance Sheet
ABC Enterprise
Balance Sheet
June 30, 2008
(In ‗000 Birr)
Assets
Cash -------------------------------------------------------------------------------- 15,075
Accounts Receivable ------------------------------------------------------------- 3,900
Inventory --------------------------------------------------------------------------- 2,400
Property, Plant & Equipment ----------------------------------- 3,300
Less: Accumulated Depreciation ------------------------------ (75) 3,225
Total Assets -------------------------------------------------------------------- 24,600
Liabilities and Capital
Accounts Payable ------------------------------------------------------------- 225
Income Tax Payable ---------------------------------------------------------- 157.5
Notes Payable ----------------------------------------------------------------- 300
State Dividend Payable ------------------------------------------------------ 199.1
State Capital ------------------------------------------------------------------- 23,550
Legal Reserve ----------------------------------------------------------------- 18.4
Other Reserves ---------------------------------------------------------------- 150
Total Liabilities and Capital ------------------------------------------------ 24,600

Activity 3.3

1. What are the three basic characteristics of public enterprises?

2. What does the term commercial activity refer to?
5.2. Privatization of Public Enterprises in Ethiopia
Pretest

Dear learners, what do you think is privatization of public enterprises? What are the
objectives of privatization? You are required to respond to these questions first.

 Privatization Defined
Privatization can be defined as the act of reducing the role of government, or increasing the role of
the private sector, in an activity or in the ownership of assets.

The privatization process covers not only the ownership and management transfer of a public
enterprise (PE) to the private sector through sales, but also other forms of privatization such as lease
arrangements, management contracts, cutbacks in government activities, denationalization,
deregulation, etc. Thus, privatization is basically the transfer of government owned assets to the
private sector.

 Objectives of Privatization
In principle, public enterprises (PEs) could operate in much the same way as private enterprises,
maximizing or at least concentrating on profits. In practice, however, PEs are rarely pure profit
maximize. This is partly due to the greater weight attached to social objectives rather than financial
objectives.

The assertion that the state is relatively inefficient in production, distribution and financial sector is
rather without proof; the issue that the private sector is relatively more efficient in this area of
activities is inconclusive. Theoretically, with the prevalence of competitive market, a public
enterprise, allowed fully to operate competitively in the market is likely to perform as efficient as
the corresponding private sector enterprise in that same market.

Generally, the change of ownership from state to private may not necessarily improve the efficiency
and profitability of enterprises. But in practice, the new private owners, pushed by the need for
more profit and survival in the competitive environment, could invest more on new technologies,
make managers accountable for bad performance, as a result inefficiencies could be minimized and
profitability improved.

Different stakeholders are to view the objectives of privatization differently. The economists’ case
for privatization rests on the expectation that it will enhance efficiency in the supply of a product or
service and expect privatized firms to be more efficient than state owned ones. Privatization is
designed to substitute the single objective of maximizing profits for the typically mixed objectives of
public enterprises, and focuses on the task of raising revenue and lowering costs.

In general, the main objectives of privatization often include the following:

 Achieving wider share ownership,

 Introducing more competition,

 Changing the public-private sector mix,

 Improving the performance of public enterprises, and

 Reducing the frequent political interference in the day-to-day activities of public enterprises.

Thus, privatization is widely expected to improve the financial and operating performance. There
are several reasons to expect improved performance in a privatized firm. The first is the issue of
objectives. A privately owned company knows that it will not survive if it is consistently unprofitable;
lenders will not lend and new equity will not be raised. Pursuing of commercial success is a
prerequisite for survival. Profitability is usually a good measure of success. Related to objective is
the issue of accountability. The obligation of the company to account its Board for commercial
performance, and the obligation of the Board to account to equity owners for returns on, and
enhancement of the value of, that equity, is powerful force.

 Advantages and Disadvantages of Privatization

 Advantages of Privatization
The major benefits of privatization can be summarized as follows:

 Greater Efficiency and Productivity of Enterprises: It has been argued that the main benefits of
privatization would come from the greater efficiency and productivity of enterprises after
privatization. Freed from government control with its set of incompatible objectives, privatized
 firms can focus on being competitive to produce, at low cost and acceptable quality. This would
lead to more efficient use of resources and improve economic output.
 Increased Competition in the Economy: Governments see privatization as a way to increase
competition in the economy, and thereby a private sector that is more flexible, more responsive
to customers, and more efficient than the public alternatives.
 Revenue to the Government: The government would generate revenue from both the sale of
assets in public enterprises as well as from increased tax revenues from restructured and more
productive enterprises.
 Capital Market Development: Privatization is also believed to have an impact on capital market
development, which is a key to economic growth.
 Means of Foreign Direct Investment (FDI): Privatization has also a positive impact on attracting
foreign direct investment. Many countries that are privatizing would like to attract strategic
foreign investor into a public enterprise because such investor can bring capital, new
technology, new export market access, and professional management to the enterprise.

 Disadvantages of Privatization
Some of the risks associated with privatization can be summarized as follows:

 Monopolistic tendency: Privatization alone without the introduction of competition may

simply transform a state monopoly into a private monopoly. The privatized firm may pursuit
profits more vigorously, but that pursuit, if it took the form of increased prices, could
worsen allocative efficiency.
 Possibility of Failure: If undertaken without careful preparation, and change in major policy
elements such as the labor, the trade, the finance and the pricing policy, privatization can
cause some firms to fail needlessly. If the transfer of enterprises is made to a private owner
with no vision, plan, and entrepreneurial skill, it will result in unnecessary closure of the
privatized firms. The vision, the capacity and potential of the private sector to run the firms
to be privatized are necessary preconditions to realize the promises of privatization.
 Privatization Modalities
Privatization can be achieved through a number of transactions involving money or not (vouchers).
These transactions are called Modalities, which in simple word mean methods of privatization.
Selection of modality depends on the characteristics of the enterprise as well as the objectives of
the government. Some enterprises may have identifiable needs (investment, management, market,
etc.) while others could be managed by anybody. The government may want to spread ownership,
empower local investor, go out of operation while retaining ownership, etc. The major types of
modalities used throughout the world include the following.

 Voucher Method: This method also called mass privatization or non-sale distribution method
may not raise revenue but it can reduce the level of required subsidies.
 Sale of PE shares to the Public: The ownership of the PE is transferred from the public sector to
the private sector through partial or total sales of shares. Partial sale of shares refers to cases
where the government decides to sell part of its share holdings to the public at large. The
remaining shares may be retained in view of controlling or influencing decisions. Total sales
(complete divestiture) involve the outright sale of all shares to a single buyer, to the public or
to the workers and management of the PE to be privatized.
 Sale of PE Shares to Workers and Management: The selling of shares of the company to its
workers and management through direct give way, leveraged buyout or some combination of
the two.
 Cut Backs in PE’s Activities: Cut backs in PE activities are another approach to privatization. The
encouragement of private capital to participate in the economy as well as the restriction of PE’s
activities will enhance competition and the efficient use of resources.
 Deregulation: Deregulation refers to the removal of specific monopoly rights and other
protective privileges given to PEs. In order to influence the stability of prices or other
regulatory purposes the government usually gives special powers and privileges to certain
government units. The restriction as well as the removal of their special privileges will enhance
the free entry and exit of enterprises in the market and ultimately ensure competition.
 Liquidation and Withdrawal: This method is used in cases where no combination of new
investment, ownership, and operational changes exist which would give the enterprise a
positive net present value in terms of future cash flows. Therefore, in cases where PEs are
chronic money losers and their financial investigation reveal that their long-term viability are at
stake, liquidation is taken as an option.
 Other forms of privatization include:
 Joint ventures,
 Management contract for fee,
 Lease arrangements,
  Restitution of property to former owners,
 Debt-equity swaps,
 Franchising, etc.

 Privatization in Ethiopia
As part of the country’s economic policy, the Ethiopian Privatization Agency (EPA) had passed
through a number of years of implementation of the proclamation for privatization of public
enterprises. Since its establishment by Proclamation No. 87/1994, the agency has privatized about
224 Public Enterprises, branches and units which consist of department stores, warehouses, small
hotels and tourism, factories, farms, agro-industries, and so on. It still continues to privatize the
remaining enterprises.

 Privatization Modalities used by EPA

From the different modalities of privatization as discussed above, so far the Agency has put into
practice the following:

 Asset Sale,
 Lease/Hire/Sale,
 Joint Venture with Strategic Investor,
 Management Contract,
 Competitive sale of Shares,
 The restricted tender, and
 Negotiated sale
 Employee and Management Buy Out (Safety Net Program),

Illustrative example:

To illustrate for privatization of public enterprises in Ethiopia, assume that the following information
is given for ABC Company, a public enterprise, which is privatized on June 2014.
___________________________________________________________________________

ABC Company

Statement of Financial Position

June 30, 2014

(In ‘000 Birr)

Assets
Cash -------------------------------------------------------------------------------- 15,075
Accounts Receivable ------------------------------------------------------------- 3,900
Inventory --------------------------------------------------------------------------- 2,400
Property, Plant & Equipment (net) --------------------------------------------- 3,225
Total Assets ----------------------------------------------------------------------- 24,600
Liabilities and Capital
Accounts Payable -------------------------------------------------------------- 225
Income Tax Payable ----------------------------------------------------------- 157.5
Notes Payable ------------------------------------------------------------------ 300
State Dividend Payable ------------------------------------------------------- 199.1
State Capital ------------------------------------------------------------------- 23,550
Legal Reserve ----------------------------------------------------------------- 18.4
Other Reserves ---------------------------------------------------------------- 150
Total Liabilities and Capital ------------------------------------------------- 24,600

An investor agreed on a competitive bid with Br.30 million to acquire the ABC Company.

The market values of the assets are as follows (In ‘000 Birr):

Accounts Receivable Br.3,000

Inventory 3,000

Property, Plant & Equipment (net) 4,500

Require:Journalize the transaction.

This transaction can be journalized under two cases, similar to the one proposed for accounting for
incorporation of partnership under unit two of this module, for which only one set of accounting for
incorporation was illustrated.

Case 1: Continuing (modified) with accounting records of ABC Company (In ‘000 Birr)

Inventory --------------------------------------------------------------------- 600

Property, Plant & Equipment (net)---------------------------------------- 1,275

Goodwill* --------------------------------------------------------------------- 5,306.6

State Capital ----------------------------------------------------------------- 23,550

Legal Reserve --------------------------------------------------------------- 18.4

Retained Earnings ---------------------------------------------------------- 150

Accounts Receivable ---------------------------------------------- 900

Z, Capital ----------------------------------------------------------- 30,000

Cost Br.30,000.00

Less: Net Assets:

State Capital Br.23,550

Legal Reserve 18.4

Retained Earnings 150

Revaluation of Net assets 975 24,693.4

*
Goodwill Br.5,306.6
Case 2: New set of accounting records

Cash -------------------------------------------------------------------------- 15,075

Accounts Receivable ------------------------------------------------------- 3,000

Inventory -------------------------------------------------------------------- 3,000

Property, Plant & Equipment (net) -------------------------------------- 4,500

Goodwill -------------------------------------------------------------------- 5,306.6

Accounts Payable ------------------------------------------------- 225

Income Tax Payable ---------------------------------------------- 157.5

Notes Payable ----------------------------------------------------- 300

State Dividend Payable ------------------------------------------ 199.1

Z, Capital ---------------------------------------------------------- 30,000