CHAPTER TWO

ACCOUNTING FOR PUBLIC ENTERPRISES IN ETHIOPIA

2.0 Learning Objectives
After completing this chapter, you will be able to:
 Define what public enterprises are and differentiate them from private
businesses,
 List and explain briefly the basic characteristics of public enterprises,
 Identify the factors behind the creation of public enterprises,
 Define the term privatization and describe the most common privatization
modalities,
 List and explain the benefits and risks of privatization, and
 Discuss privatization in the Ethiopian environment
2.1 What is Public Enterprise?
Public Enterprise is a business organization wholly or partly owned by the state and
controlled through a public authority. They are autonomous or semi-autonomous
bodies owned by the government and engaged in providing services and or
products. 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.

The growth of public enterprises has been partly by nationalization and partly
through creation of new ones. Some industries are also reserved for the public
sector as a matter of national policy. Such industries could be airways, defense
industries, railways, telecommunication and the like.

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.

Definition
State enterprise is an undertaking owned and controlled by the local or state or
central government. The government does either whole or most of the investment.
The basic aim of a state enterprise is to provide goods and services to the public at
a reasonable rate though profit earning is not excluded but their primary objective

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 is social service. A.H. Hansen says, “Public Enterprise means state ownership
and operation of industrial, agricultural, financial and commercial undertakings.”

S.S. Khera defines state enterprises as “the industrial, commercial and economic
activities, carried on by the central or by a state government, and in each case
either soley or in association with private enterprise, so long it is managed by self-
contained management.”

“Public enterprises are autonomous or semi-autonomous corporations and

companies established, owned and controlled by the state and engaged in
industrial and commercial activities.” -N.N. Mallya

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.

i. Commercial Activity
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).

ii. 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,

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  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.

iii. Independent Legal Existence

Ethiopian Public Enterprises Proclamation No. 25/1 992 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.

2.2 Characteristics of Public Enterprises

a. Financed by Government: Public enterprises are financed by the government.
They are either owned by the government or majority shares are held by the

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 government. In some undertakings private investments are also allowed but the
dominant role is played by the government only.

b. Government Management: Public enterprises are managed by the government.

In some cases government has started enterprises under its own departments. In
other cases, government nominates persons to manage the undertakings. Even
autonomous bodies are directly and indirectly controlled by the government
departments.

c. Financial Independence: Though investments in government undertakings are

done by the government, they become financially independent. They are not
dependent on the government for their day- to-day needs. These enterprises
arrange and manage their own finances. An element of profitability is also
considered while pricing their products. It has helped the enterprises to finance
their growth themselves.

d. Public Services: The primary aim of state enterprises is to provide service to the
society. These enterprises are started with a service motive. A private
entrepreneur will start a concern only if possibilities of earning profits exist but
this is not the purpose of public enterprises.
e. Useful for Various Sectors: State enterprises do not serve a particular section of
the society but they are useful for everybody. They serve all sectors of the
economy.
f. Direct Channels for Using Foreign Money: Most of the government to
government aid is utilized through public enterprises. Financial and technical
assistance received from industrially advanced countries is used in public
enterprises.
g. Helpful in Implementing Government Plans: Economic policies and plans of
the government are implemented through public enterprises

h. Autonomous or Semi-autonomous Bodies: These enterprises are autonomous

or semi-autonomous bodies. In some cases they work under the control of
government departments and in other cases they are established under statutes
and under Companies Act.
2.3 Why Public Enterprises Needed?
The need to have public enterprises may be justified on a number of grounds, such
as:
 Limitation of the free Price Mechanism: It is realized that in spite of all its
advantages, a free price mechanism had serious limitations which had to be
overcome in the long term interests of the economy. An economy cannot sustain
itself and grow unless it is healthy in terms of production potential which should

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 increase with the passage of time that is development of different economic
sectors in harmony or proper sectorial balance. However, the nature of market
mechanism is such that all economic activities are guided by economic
rationalism which in the case of provision of products or services means
profitability. Market mechanism would refuse to run those productive services
which could not yield adequate profits. But such ventures are necessary for the
development of the economy. The public authorities thus maintain these projects
at a loss and meet the loss from their tax revenue.

 Basic industries need Huge Investment: Private enterprise is either not able to
raise the necessary funds or not ready to assume such large risks. In such
cases, even if these enterprises could possibly be profitable, the government has
to step in to establish them. Cases of very long term projects also come in this
category.

 Government’s duty to help in Economic Development: Such a policy entails

a number of responsibilities and some of these results in the governments going
in for various types of public enterprises. In an underdeveloped country,
additionally, we find that there is an overall shortage of capital. It becomes,
therefore, the task of the authorities to assume the responsibility of filling the
gap and thereby removing the specific shortages. The role of basic and key
industries which provide an impetus and necessary basis for the general
economic development may also be mentioned in this connection. It is not very
likely that the private sector which moves solely on the basis of profit motive, will
find it always convenient to move ahead and establish these industries in time
and adequate measure. The private sector would find it easier and more
profitable to expand at a rapid rate once basic inputs like skilled human
resource are created through education and training.

 Creation of economic surpluses and their utilization: A number of public

undertakings directly add to the capital assets of the economy in the form of
roads, bridges, factories and the like. They are, in so far as they are not in the
public sector by virtue of nationalization only, net additions to the capital stock
of the country and, therefore, they contribute to its total productive power. Such
an addition might also result from utilization and exploitation of resources which
were hitherto going waste; or from change in the allocation of resources. Public
enterprises can also help the economy a lot by diverting its productive resources
into those lines which will accelerate the growth process later through a
provision of an infrastructure, basic and key industries and so on.

 Final choices of projects are made in the interest of the economy as a

whole: If social benefits exceed social costs in the case of any service, then its
production should be taken up. But it is possible that on grounds of social

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 benefits some projects are sound but not on grounds of commercial profitability.
Under such circumstances, these projects can be taken up by authorities in the
public sector.

 Limitation on demand of merit goods on account of price if left in private

hands: Merit goods are those expected to enhance the general welfare of the
community and should be provided through public enterprises either along with
public enterprises or in place of it. It is generally believed that the supply of such
services should be adequate and should be available at low or zero prices so as
to encourage their consumption. In case of education, the government may not
only provide it for free but also insist that all children up to a certain age must
attend schools.
 The overall economic policy of a country may dictate the use of public
enterprises in some sectors: There are some industries like electricity
generation where there are economies of scale. If such services are provided by a
large number of firms competing with each other, it wouldn’t be possible to reap
these economies. Authorities may, therefore, think it more desirable to have a
public monopoly than private monopoly for such services.

 Effective control of the economy: Effective economic control of the whole

economy is sought to be brought in the hands of the state. In other words, the
argument of not letting the emergence of a monopoly in private hands is
extended to the whole economy. The authorities might plan to have a strategic
control over the working of the whole economy through controlling certain key
sectors.

 Better protection of Natural Resources: In the case of some natural resources

like forests, mines and the like, the commercial interests of a private enterprise
often come into conflict with those of the nation. A private jungle contractor
authorized to cut trees is likely to make a quick profit by cutting down as many
trees as possible. This may result in a large scale and quick denuding of the land
causing soil erosion and upsetting the ecological balance.

2.4 Accounting for Public Enterprises

Providing adequate accounting system for the public enterprise, first and foremost,
depends on the relationship and organization structure of the State Corporation,
state enterprise, and supervising authority, that is, whether accounting is
centralized at the corporation or at the enterprise level paralleling the extent of
centralization or decentralization of authority and responsibility of the organs
related to it.

The problem of the relationship of the state corporation to the enterprise centers
around the accounting issue of whether the corporate entity constitutes one entity

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 or embodies more than one entity, whether, the legal entity is the enterprise or the
corporation, and whether the accounting entity, legal entity, and economic entity
coincide. This accounting dilemma is conceptualized in the framework of (a) Head
office and Branch, (b) Principal and Agent, (c) Parent and Subsidiary, (d) Holding
company views. Accounting for the public enterprises must be based on clear
understanding of the underlying assumptions to be made on the character of the
public enterprise, and the type or structural relationship established. The workable
assumptions in this case are:
 The public enterprise is involved in profit.
 The economic performance of the public enterprise is measured by its financial
profitability. Financial profitability is determined by net income or surplus.
Financial profitability must be distinguished from social profitability that should
be measured also additionally where possible.
 The public enterprise is self-costing and perhaps price setter. From the above
assumptions, entity accounting or enterprise accounting would seem to be most
suitable accounting concept for adaption to public enterprise accounting except
in the capital of proprietorship section and accumulation and distribution of
earnings. Entity accounting is accounting for a separate organization that has
legal personality of its own separate from its owners. This is the foundation for
the corporate accounting.

The accounting equation: Assets equal liabilities plus capital could be applicable in
its entirety to the public enterprise. The double entry system of accounting together
with the accrual basis of accounting are essential for more adequate follow-up of
the enterprise business transaction in view of earlier rationale (characteristics).
Most of asset accounting is the same as in private corporate entity accounting
except for variations in classification and valuation procedures. Liabilities that
represent accruals to and claims of outsiders, will also be accounted for in similar
manner as in private corporate accounting entity except for classification. The
procedures for income measurement and recognition involving accounting for
revenue and expense transactions including gains and losses are similar to those
accounting procedures for private corporate entities.

2.5 Distinctive Features of Ownership Equity Section of Public Enterprises

Capital in the private corporate accounting entity stands for the owner’s equity or
owner’s claim on assets. This is represented by capital stock account indicating the
stockholders’ equity. Legal right usually classifies the right hand side of the balance
sheet, i.e., it is the legal right of the owners (owner’s equities) and that of the
creditors (creditors’ equities) that make a classification in the right hand side of the
balance sheet of business enterprises. The public enterprise capital, on the other
hand, has no share or shareholders and the capital representing government equity
(as owner and investor) is identified by an overall capital account, and the right

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 hand side of the balance sheet is best classified by the objectives they are
designated for. Of course, when there are liabilities, these also are disclosed
separately by the amount they claim out of total assets. In corporate entity of
market economy the proprietorship/ownership equity section is composed of the
following items:
 Capital stock: represents capital paid up initially, and or subsequently
increased or decreased as changed by additional investment, transfers from
earnings and paid-in capital (surpluses) or appraisal surplus. Initial investment
could be in money (cash) or other assets (in kind). It is the legal paid-up
invested capital representing owner’s equity or assets less liabilities.
 Additional paid-in capital or paid-in surplus is surplus or excess obtained from
capital transactions above specified initial value of stated capital. It is a result of
capital transactions.
 Retained earnings are the sum of accumulated past net incomes from
operations plus other additions or subtractions perhaps arising from
corrections of prior years or extraordinary losses and gains or non-operating
gains and losses.
 Appropriations are earmarked earnings be it from retained earnings or paid-in-
capital, which may or may not be followed by segregation of real assets.
 Dividends are distribution of incomes (earnings) and or surplus to shareholders
in return for their investment.
 Appraisal surplus is excess obtained from appraisals of assets, which
represents unrealized gains.

In Ethiopia according to Proclamation No. 25/1992 that governs the

establishment, operation, and dissolution of public enterprises contains the
following important accounting related provisions and definition of terms:
 Enterprise: a wholly state owned public enterprise established pursuant to this
Proclamation to carry on for gain manufacturing, distribution, service rendering
or other economic and related activities;
 Total Assets: 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: total assets less current liabilities, long-term debts, deferred
income and other liabilities.
 Capital: 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.
 Paid-up Capital: The paid up capital shall not be less than 25 % of the
authorized capital at the time of establishment.
 Authorized Capital: The authorized capital of the enterprise shall be fully paid
up within 5 years from the date of its establishment. Where the authorized
capital is not fully paid up as provided under sub-article 2 of this Article, the

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 supervising authority shall, without prejudice to the rights of third parties, adjust
the capital to the level of the paid up capital.
 Increase of Authorized Capital: The supervising authority may cause the funds
needed to increase the capital of an enterprise to be allocated by the Government
or to be paid out of the net profits of the enterprise.
 Decrease of Capital: The capital of an enterprise may without prejudice to the
rights of third parties, be decreased where 1) the auditors have proposed that the
capital should be decreased; 2) it was decided to decrease the capital following a
proposal by the board to this effect; and 3) the authorized capital of the enterprise
has not been fully paid.
 Net Profit: 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.

Pertaining to the legal personality and liability the proclamation states that an
enterprise shall have legal personality and as such it shall have rights and duties
and an enterprise may not be held liable beyond its total assets.
According to Proclamation No. 25/1992, the proprietorship equity section of the
public enterprise is composed of the following parts:
 Capital: 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. The paid up capital
shall not be less than 25% of the authorized capital at the time of establishment.
The authorized capital of the enterprise shall be fully paid up within 5 years from
the date of its establishment.
 Legal reserve: any enterprise shall annually transfer 5% of its net profits to the
legal reserve fund until such reserve fund equals 20% of the capital of the
enterprise. The legal reserve is used to cover losses and unforeseeable expenses
and liabilities.
 Other reserve funds or retained earnings (i.e. appropriations): The board of any
enterprise may, with the approval of the supervising authority, cause other
reserve funds to be established and determine their utilization.
 State Dividend: the remaining balance after deduction of the transfers to the
legal reserve fund and other reserve fund from the net profits.
 Appraisal Surplus: is excess obtained from appraisals of assets, which
represents unrealized gains.

Other provisions relevant to the financial reporting practices of public enterprises

are presented as follows:

 Each enterprise shall keep books of accounts following generally accepted

accounting principles. The supervising authority may issue directives to this
effect.

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  The financial year of an enterprise shall be determined by the supervising
authority.
 Any enterprise shall close its accounts at least once a year. The annual closing of
accounts shall be completed 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 programmers to be implemented in the near future.
 Failure to close, in due time, the accounts of an enterprise may entail liability.
 The relevant laws concerning taxes and duties shall be applicable to enterprises.
 Nothing in this Proclamation shall affect the right of an enterprise to be exempt
from taxes and duties and any other right under any other law.
 Any enterprise shall pay to the Government state dividend within seven months
following the end of the financial year.
 Without prejudice to the powers and duties of the Auditor General under other
laws, the accounts of each enterprise shall be audited by external auditors
appointed by the supervising authority.
 The supervising authority shall 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.
 The supervising authority shall determine the term of the external auditors.

Any person who has received, paid or expended, or is in charge of the accounts of,
the money or property of the enterprise being audited shall, when requested, have
the obligation to produce to the auditors the accounts to be audited and to furnish
the necessary information.

2.6 Formation of a Public Enterprise

Example: The government formed XYZ Enterprise with Authorized Capital of Br
50,000,000 in accordance with the requirements of Proc. No. 25/1992 with
investment of the following assets: Cash Br. 15,000,000.00
Equipment (fair value) 700,000.00
The journal entry for the formation of the XYZ Enterprise would be as follows:
Cash 15,000,000.00
Equipment (fair value) 700,000.00
State Capital 15,700,000.00
(To record investment in XYZ Enterprise)

2.7 Operation of a Public Enterprise

In order to look at the accounting for the operation of a public enterprise assume
the following information for XYZ Enterprise:

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 XYZ Enterprise
Trial Balance
Dec. 31, 2016 (Br ‘000)
Cash Br. 10,050
Accounts Receivable 2,600
Property, Plant and Equipment 2,200
Accumulated Depreciation Br. 50
Accounts Payable 150
Notes Payable 200
State Capital 15,700
Sales 5,000
Operating Expenses 2,950
Purchases 3,300 ____
21,100 21,100

In addition to the above trial balance assume that the ending inventory is Br
1,600,000; the board of directors decided to establish other reserves of Br 100,000
from the net income of the year and profit tax rate is 30%.

On the basis of the foregoing information we can prepare the income statement for
XYZ enterprise for the year ended Dec. 31, 2016, the balance sheet on Dec. 31,
2016, and journal entries to close the income summary account as follows:

A. Income statement for the year ended Dec. 31, 2016

XYZ Enterprise
Income Statement
For the Year ended Dec. 31, 2016(‘000 Birr)
Sales Br. 5,000
Cost of Goods Sold 1,700
Gross profit 3,300
Operating Expenses 2,950
Income before tax 350
Income tax expense (30%) 105
Net Income 245
B. The journal entries for transfer of net income to legal reserve and other reserves,
and to recognize the state dividend payable would be as follows:
2016 Income summary 245,000
Dec. 31 Legal Reserve (5% x 245,000) 12,250
Retained Earnings 100,000
State Dividend Payable 132,750
Dec. 31 Income tax expense 105,000
Income tax payable 105,000

C. Balance sheet at Dec. 31, 2016.

XYZ Enterprise
Balance Sheet
Dec. 31, 2006(‘000 Birr)

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 Assets Liabilities and Capital
Cash 10,050 Accounts Payable 150
Accounts Receivable 2,600 Income tax payable 105
Inventory 1,600 Notes Payable 200
Property, Plant & Equipment 2,200 State Dividend Payable 132.75
Less: Acc. Depreciation (50) 2150 State Capital 15,700
Legal Reserve 12.25
Other Reserves 100
Total Assets 16,400 Total Liabilities and Capital 16,400

2.8 Privatization of Public Enterprises

With the demise of the Derg regime, the incumbent government adopted a market
oriented economic policy that gives prevalence to the ownership of property by the
private sector. This policy also opened the public enterprises that were in the hands
of the government to private sector ownership. That is to say, the public enterprises
are being privatized with a view to increasing private sector participation in the
market and improving their performance.

In terms of modes of privatization, it should be noted that the types and processes
of privatization could differ from one country to another. There are three types of
privatization: political privatization, fiscal privatization and economic privatization.
In political privatization, all the citizens are provided with share vouchers of state
enterprises regardless of their economic viability, their capital stock and their
management while in fiscal privatization, the enterprises are sold to the highest
bidder that increases public revenue. On the other hand, in economic privatization,
the government or one of its agencies would manage the restructuring of privatized
enterprises and negotiates clauses on employment, social benefits, training and
redundancies with other private entrepreneurs.

Just as the reasons for the creation of public enterprises are varied, the reasons for
their privatization are also varied. In addition to the failure to meet the original
objectives, diminishing profits to the State or continual increase of losses on the
State, privatizations of public enterprises are also caused by other internal and
external factors. These are (a) higher fiscal pressure on governments (high
budgetary deficit, large domestic public debt, and large external debt), (b) higher
dependency on loans from international organizations (WB and IMF), (c) a large
share of SOEs in total investment, (d) inferior and poor performance of SOEs in
production and profitability, and (e) lower long term growth.

The process of preparing public enterprises for (private) market and competition
takes different stages through what is known as commercialization and
corporatization." The stage of commercialization refers to a process directed at
establishing private sector management principles, values, practices and policies

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 within public sector organization without involving the private sector at all.
Corporatization, on the other hand, refers to the legal process of converting an
entity into a company although initially the State is the sole 'shareholder'. Relating
to this, Article 1(2) of the Privatization of Public Enterprises (Amendment)
Proclamation No. 182/1999 provides that an enterprise converted into a share
company shall cease to exist upon registration as Share Company and be replaced
by the company.

It is plain to conclude from this that once a public enterprise is converted into a
share company and is registered as such, the Commercial Code should normally
apply to the company. This is affirmed by Article 5(4) (c) of Proclamation No.
146/1998 where it is stated that the Commercial Code is mutatis mutandis
applicable. Such State owned share companies include the companies engaged in
beverages industry (e.g. Awash Winery S.C and Bedele Brewery S.C), food industry
(e.g. Faffa Food S.C and Kality Food S.C) and textiles such as Akaki Textiles S.C.

"Privatization" means the transfer, through sale, of an enterprise or its unit or

asset or government share holdings in a share company to private ownership and
includes:
 The making of an enterprise a government contribution to a share company to
be formed with the participation of private investors; and
 The privatization of the management of an enterprise.

According to Proclamation No. 146/1998, the objectives of the Country's

Privatization Program are the following:
 To generate revenue required for financing development activities undertaken by
the Government;
 To change the role and participation of the Government in the economy to enable
it exert more effort on activities requiring its attention;
 To promote the Country's economic development through encouraging the
expansion of the private sector.
Moreover article no. 6 of the Proclamation No. 146/1998 calls for valuation of the
enterprise up on privatization and provides the following pertinent provisions:
 The Agency shall cause the valuation of an enterprise or a unit or assets of an
enterprise or government shares prior to privatizing same.
 Valuation shall be done in accordance with guidelines issued by the Board.
 The floor or indicative price determined as the result of the valuation shall be
subject to the approval of the Board.

2.8.1 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.

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 The privatization process covers not only the ownership and management transfer of a
Public Enterprise 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.

Privatization is general effort to relieve the disincentives toward efficiency in public

organizations by subjecting them to the incentives of the private market.

Privatization is a broad and long-term movement, often fueled with strong and emotional
conservative ideology, to reduce government expenditure, to return government assets and
operation to private enterprise and thereby to increase the efficiency and effectiveness of
government.

Privatization is the medicine prescribed by western doctors to all economic ills of a given
nation. It is a sort of imposition without considering the economic, social, cultural and
political contexts of all countries.

Privatization is the transfer of function, production and organization from the public to the
private sector.

2.8.2 Objectives of Privatization

Different stakeholders are to view the objectives of privatization differently. Economists,
civil servants and others tend to view privatization from different point of view. Here we
will focus on the economic objectives of privatization as seen by economists.

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.

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 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.

2.8.3 Benefits and Risks of Privatization

I. Benefits 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.

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 II. Risks 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.

2.8.4 Privatization Modalities used by EPA

From the different modalities of privatization available (as discussed earlier), so far the
Agency has put into practice the following;
 Asset Sale: Retail outlets, hotels and restaurants, manufacturing and mining enterprises.

 Employee and Management Buy-Out /MEBO: Retail outlets, hotels and restaurants through the
Safety Net Program.
 Lease/sale: Adei Ababa Yarn and Dire-Dawa Textile.

 Joint Venture with a Strategic Investor: Tobacco

 Management Contract: Awassa, Kombolcha Textiles.

 Competitive Sale of Shares: Beverage Sector, Awassa Flour.

 Restricted Tender and Negotiated Sale Selale No. 2 and 3, Modjo Dairy Farms and Olma
Agricultural Development.

Example: In order to illustrate the accounting treatment for privatization of a public

enterprise assume the following information that is obtained from the accounting
records of XYZ Company, a public enterprise, which is privatized on Dec. 31, 2016.
XYZ Enterprise
Balance Sheet
Dec. 31, 2006 (Br ‘000)
Assets Cost Market value
Cash 10,050
Accounts Receivable 2,600 2000

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 Inventory 1,600 2000
Property, Plant and Equipment (net) 2150 3000
Total assets 16,400

Liabilities and Capital

Accounts Payable 150
Income Tax Payable 105
Notes Payable 200
State Dividend Payable 132.75
State Capital 15,700
Legal Reserve 12.25
Other Reserves 100
Total Liabilities and Capital 16,400

If an individual investor has paid Br 20,000,000 to acquire the XYZ Company then
the journal entries for privatization of the public enterprise under the following two
alternative assumptions are shown below.

Assumption 1: Continuing with the XYZ Books

Inventory (2,000-1,600) 400
Property, Plant and equipment (3000-2150) 850
Goodwill (note) 3,537.75#
State Capital 15,700
Legal Reserve 12.25
Retained Earnings 100
Accounts Receivable (2,600 -2,000) 600
X, Capital 20,000
# Note on computation of goodwill:
Cost Br 20,000.00
Less: Market Value of Net Assets 16,462.25
Goodwill 3,537.75
Assumption 2: Establishing New Books
Cash 10,050
Accounts Receivable 2000
Inventory 2000
Property, Plant and Equipment (net) 3000
Goodwill 3537.75
Accounts Payable 150
Income Tax Payable 105
Notes Payable 200
State Dividend Payable 132.75
X, Capital 20,000

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