UNIT ONE: part two

II. PUBLIC ENTERPRISES

Nature of Public Enterprises

 Definition of PEs
 Objectives of PEs
 Benefits of PEs
Accounting for Public Enterprises (PEs)

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Definition: International Center for Public Enterprises
(ICPE) has adopted the following definition:
Any commercial, financial, industrial, agricultural or
promotional undertaking – owned by public authority,
either wholly or through majority shareholding – which is
engaged in the sale of goods and services;
whose affairs are capable of being recorded in balance
sheets and profit and loss accounts; and
Which may have diverse legal and corporate forms, such
as departmental undertakings, public corporations, and
statutory agencies, established by Acts of Parliament or
Joint Stock Companies registered under the Company Law
– For example in Ethiopia: Enterprise (Ethiopian Airlines Enterprise),
a share company (Construction and Business Bank S.C) or a 2

corporation(Ethiopian Sugar Corporation).

Definition in pub enter. Proc. No. 25/1992, Ethiopia :
A Public Enterprise is defined as a wholly state owned
public enterprise established to carry on for gain
manufacturing, distribution, service rendering or other
economic and related activities.

 Alternative Terms: Public corporations, state

enterprise, state corporation, chartered bodies,
parastatals, state development agencies, state
marketing boards.
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The definition on proc. embodies three basic elements
that determine the feature of a public enterprise.
The first element relates to ownership and requires an
enterprise to be wholly owned by the state so that it can
be characterized as a public enterprise. The law
excludes enterprises in which we find joint investment of
the two sectors, namely, private and public, irrespective
of the quantum of the investment.
Chapter 1 4
However:
Article 2(10) of Investment Proclamation No.
769/2012( and also the proclamation No. 412/2004 to
establish Privatization and Public Enterprises supervising
Agency) defines the term as an enterprise, partially or
wholly owned by the federal or regional government
established to engage in production, distribution, service
rendering or related economic activities in the form of
Chapter 1 5
commerce.
The second element requires establishment under the proclamation.
The proclamation sets the legal framework for entities established
by the State for the purpose of economic activities for gain. The
requirements for their formation, operation, structure, and exit are
embodied in the proclamation.
The third element is the purpose of the entity which distinguishes it
from the main function of the State. Public enterprises are
commercial entities as distinguished from administrative agencies
which carry out regulatory activities and render public service.
Chapter 1 6
 Supervision of Public Enterprises: Ethiopia

A supervising authority/
now MoPE

A management board

A general manager,
deputy general
managers as may be
necessary.
The necessary staff

Chapter 1 7
 Objectives of PEs
There are several reasons for the establishment of PEs. These
include:
(a) national security for areas such as defense industries and
public transport;
(b) revenue raising in particular in events such as where tax
collection is difficult or impossible;
(c) Economic control and self-reliance;
(d) lack of private investment in undertakings where large-
scale investment is required;
(e) equity considerations when private companies fail to
function profitably (inelasticity of demand); and
(f) the fear of private monopoly situations. 8
 Benefits of Public Enterprises
Public enterprises are now significant instruments of macro-
economic policy in many countries following different economic
system. The contribution of public enterprises can be viewed
from the following two perspectives:
 Economic Benefits
-Generate revenue for the government through various means.
Dividend, interest on loans, excise duty, sales taxes,
corporate taxes etc are paid to the government by public
enterprises.
-Exploit the natural and technological resources of the state.
This maximizes the social welfare and developmental
opportunities in the economy.
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 Benefits of Public Enterprises…
− Save scarce foreign exchange either by exporting the
foreign currency generating goods and services of the
country or by substituting imported products.
− Reducing regional disparities through fair dispersal of
industries.
− Provide infrastructural facilities for the development of the
economy and the private sector.
 Social Benefits
On the social area, public enterprises are considered as a
welfare promoting organizations. The social benefits of public
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enterprises can be summarized as follows.
 Benefits of Public Enterprises…
- Provide job opportunity,
-serve as model for employers by providing various welfare
benefits like housing, medical, transport, staff centers and
other social services,
-safeguard the interest of the consumers by offering
subsidized goods at fairly low price, they insure provision of
goods and services to low income groups at cheaper prices.
-produce residual surplus, which may be used for public
welfare, which will maximize the social satisfaction of the
public and

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 Summary of Nature of PEs

Essential Elements of PE

Enterprise dimension Public dimension

field of activity of
business character Public purpose

investment & return Public Ownership

marketing of output Public Control

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 Summary of Nature of PEs

Corporation

Public Sector Private Sector

With Stock Without Stock

Open Enterprises Closed Enterprises

Listed Enterprises Unlisted Enterprises

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 Accounting for Public Enterprises
 The proclamation assumes GAAP.
 Definition of terms (Proclamation No. 25/1992):
• Total Assets, Net Total assets, Capital, Paid-up
Capital, Authorized Capital, Increase of Authorized
Capital, Decrease of Capital, Net Profit, etc.

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 Accounting for Public Enterprises
 According to Proclamation No. 25/1992, the
proprietorship section of the public enterprise is
composed of the following parts:
• Capital: establishment
• Legal reserve (5% of its net profits until it equals 20%
of the capital of the enterprise)
• Other reserve funds or retained earnings (i.e.
appropriations) As it is stated in the proclamation, other reserve funds may be
established with the approval of the supervisory authority

• State Dividend
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• Appraisal surplus (revaluation of assets)
1) “Enterprise” means 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;
2) “Supervising authority now MoPE” means an
authority/Ministry that is designated by the Council of Ministers
with a view to protecting the ownership rights of the State;
3) “Total assets” means all immoveable and moveable property,
receivables, cash and bank balances of the enterprise including
intangible assets, deferred charges and other debit balances;
4) “Net total assets” means total assets less current liabilities long-
term debts, deferred income and other liabilities;
5) “Capital” means 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;
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6) “Auditor” means a natural or juridical person who is
empowered under Article 32 of this Proclamation to audit
the accounts of any enterprise;
7) “Net profits” means 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;
8) “Government” means the Central Government;
9) “State dividend” means the remaining balance after
deduction of the transfers to the legal reserve fund and
other reserve fund from the net profits;
10) The paid up capital shall not be less than 25 % of the
authorized capital at the time of establishment.
11)The authorized capital of the enterprise shall be fully
paid up within 5 years from the date of its establishment.
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 Accounting for Public Enterprises
• 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
Equipment (fair value) 700,000
The journal entry for the formation of the XYZ Enterprise
would be as follows:
Cash 15,000,000
Equipment (fair value) 700,000
State Capital 15,700,000
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 Accounting for Public Enterprises
• Operation of a Public Enterprise
Given the following information for XYZ Enterprise for the
year ended December 31, 2006:
XYZ Enterprise
Trial Balance
Dec. 31, 2006 (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
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 Accounting for Public Enterprises
• 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.
• Profit tax rate is 35%.
XYZ Enterprise
Income Statement
For the Year ended Dec. 31, 2006(‘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 (35%) 122.5
Net Income 227.5
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 Accounting for Public Enterprises
Income summary 227,500
Legal Reserve (5% x 227,500) 11,375
Retained Earnings 100,000
State Dividend Payable 116,125
Income tax expense 122,500
Income tax payable 122,500
XYZ Enterprise
Balance Sheet
Dec. 31, 2006(‘000 birr)
Assets Liabilities and Capital
Cash 10,050 Accounts Payable 150
Accounts Receivable 2,600 Income tax payable 122.5
Inventory 1,600 Notes Payable 200
Property, Plant & 2,200 State Dividend Payable 116.1
Equipment
Less: Acc. Depreciation (50) 2150 State Capital 15,700
Legal Reserve 11.4
Other Reserves 100
Total assets 16,400 Total Liabilities and Capital 16,400
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 Accounting for Public Enterprises
• Privatization of Public Enterprises

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:

1. political/Voucher privatization-all the citizens are provided

with share vouchers of state enterprises regardless of their
economic viability, their capital stock and their management.

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 Accounting for Public Enterprises
2. fiscal privatization - the enterprises are sold to the highest
bidder that increases public revenue.
3. 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.
Reasons for privatization:-
Privatizations of public enterprises are caused by internal and
external factors. These are:

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 Accounting for Public Enterprises
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. Failure to meet original objectives
f. lower long term growth.

Process of Privatization
The process of preparing public enterprises for (private) market and
competition takes different stages through what is known as
commercialization and corporatization. 24
 Accounting for Public Enterprises
Commercialization: refers to a process directed at establishing
private sector management principles, values, practices and
policies 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'.
Enterprise ceases to Exist: 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
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company and be replaced by the company.
 Accounting for Public Enterprises
what is privatization in essence?
According to Proclamation on privatization of Public
Enterprises Proc.No. 146/1998 "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.
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Accounting for Public Enterprises

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

the Country's Privatization Programs 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.
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Accounting for Public Enterprises
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. 28
Accounting for Public Enterprises

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, 2006.

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 Accounting for Public Enterprises
XYZ Enterprise
Balance Sheet
Dec. 31, 2006 (Br ‘000)
Assets Cost Market value
Cash 10,050
Accounts Receivable 2,600 2000
Inventory 1,600 2000
Property, Plant and Equipment (net) 2150 3000
Total assets 16,400
Liabilities and Capital
Accounts Payable 150
Income Tax Payable 122.5
Notes Payable 200
State Dividend Payable 116.1
State Capital 15,700
Legal Reserve 11.4
Other Reserves 100
Total Liabilities and Capital 16400

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 Accounting for Public Enterprises
• 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 (2000-1,600) 400
Property, Plant and equipment (3000-2150) 850
Goodwill (note) 3538.6#
State Capital 15,700
Legal Reserve 11.4
Retained Earnings 100
Accounts Receivable (2600-2000)
600 31
X, Capital
Accounting for Public Enterprises
# Note on computation of goodwill:
Cost Br 20,000.00
Less: Market Value of Net Assets 16461.40
Goodwill 3538.60
• Assumption 2: Establishing New Books
Cash 10,050
Accounts Receivable 2000
Inventory 2000
Property, Plant and Equipment (net) 3000
Goodwill 3538.6
Accounts Payable 150
Income Tax Payable 122.5
Notes Payable 200

State Dividend Payable 116.1

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X, Capital 20,000
 Accounting for Public Enterprises
• Amalgamation and Division ( Proc. No. 25/1992: ART. 35-
38)
–No decision to amalgamate or divide if the enterprises
resulting from amalgamation or division are unable to meet the
obligations towards the creditors.
–The rights and obligations of the enterprise are transferred to
the new enterprises.
• Amalgamation:
– Enterprise A + Enterprise B = Enterprise C
– Enterprise A + Enterprise B = Enterprise A or Enterprise B
– Either Goodwill or negative goodwill/bargain purchase is
recorded

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Accounting for Public Enterprises
• Division: Enterprise A = Enterprise A and Enterprise B
• Dissolution and Winding Up (Proc. No. 25/1992: ART.
39-45)
• The Process Involves:
– Sale of assets
– Payment of creditors (if the assets of the enterprise are
not sufficient to pay the debts, and if the authorized
capital is not fully paid up, the liquidator can ask for full
payment of the authorized capital)
– Payment of remaining assets to the government
• Legal personality and liability [proc. 25/1992]
Art. 7.2. An enterprise may not be held liable beyond its
total assets. 34