© 2000 John Petroff

A- Traditional Russian accounting

To present a workable outline of the Russian accounting system without falling into details, a summary was commissioned from an accounting professor at the St Petersburg University. This summary is translated into English in the following section. It is labeled as the "official" description of the Russian accounting system, because, while the summary states the guiding rules, it does not give a tangible reflection of how the rules were applied. For that, we turn in the section after the following one, to a practitioner who tells what had to be done to cope with difficulties of applying the rules. It must be kept in mind that the Russian accounting system described below is one that has already [supposedly] been adapted for a market economy. It dates back to 1995, or more than five years after the fall of communism and two or three years after mass privatization of a large number of government organizations. That is why the term of firm is used throughout.

See review questions Q-7A.1 and Q-7A.2.

1)- The official description of the Russian accounting system

The transition to a market economy, the privatization of government property, the formation of various forms of business organizations, have considerably increased the role and the importance of accounting information in the field of management, control and analysis of conduct of business.

Today [in 1995], the general rules of organization and conduct of accounting recording and verification in Russia are regulated by such documents as
1- Regulation of accounting and bookkeeping in Russian Federation, confirmed by order No. 170 of the Ministry of Finance issued on 26 December, 1994, with effective date of 1 January, 1995.
2- Chart of accounts for the accounting of financial activity of businesses, and instructions for its use, confirmed by Order No. 56 of the Ministry of Finance of USSR issued on 1 November, 1991, with amendments by Order No. 173 of the Ministry of Finance of Russia issued 28 December 1994.

These documents affect all businesses and organizations which constitute legal entities according to the laws of the Russian Federation, regardless of affiliation, form of ownership or type of activity (except banks). Therefore, they must be looked upon as accounting standards. In addition, these documents include provisions for the rights of businesses to determine unilaterally concrete forms and methods of organization of accounting, control, spheres of activity, qualification of personnel, and other questions.

The practical expression of this independence is embodied in the obligation to work out a company's own accounting policy in which must be determined
- rules and order of production, purchase of valuable items and pricing of such items;
- method of recording of production expenses and calculation of the cost of goods produced;
- method of determination of market price and sale of goods;
- method of calculation of depreciation and other rules.
The accounting policy must comply with requirements of completeness, verifiability, emphasis of substance over form, non-conflicting data and rationality. Also in the accounting policy must be included an operational charter of accounts of the firm. The accounting policy is affirmed by management of the company.

Three types of accounting are distinguished:
- operational accounting used for current managerial purposes of running the firm in aspects of scheduling, producing, sourcing materials, selling, shipping and borrowing;
- statistical accounting intended to report [to the government statistical office] data about prices, quantities produced, types of employees, which impact the economy and society;
- accounting verification consisting in a complete and continuous reflection of the firm's activity, in which completeness implies a mandatory verification of all property, inventory, production, funds received and borrowed, and in which continuity implies a substantiation of all records by documents.

To conduct all three forms of accounting, accounting [ratio] measurements are necessary to assess the quantitative, qualitative and global reflection of individual operations as well as the activity of the entire firm. Three units of measurement are utilized: physical (pieces), labor (hours) and monetary (roubles).

The object of accounting is the conduct of business of the firm, which can be grouped in two preoccupations: the resources received (with method of obtaining them) and the production generated (with consequent results). The resources received are divided on the basis of their economic maintenance into
- fixed assets: building, equipment, machinery and tools which are used in production and which are depreciated (causing their cost to be included in cost of goods produced); rates of depreciation, depletion or amortization are set by government regulations; these resources are recorded at cost, and an increase in value can only result from asset improvement;
- intangible assets: author's rights, patents, know-how and other rights are recorded at their purchase price or cost of production, and are amortized according to their useful lives;
- revolving resources: materials in which are included cost of acquisition, and all related costs including interest, taxes, duties, freight and commission paid; the balance of inventory on hand can be determined using either average, LIFO or FIFO methods;
- monetary resources: in bank account and in cash register;
- accounts receivable: debt of other firms for sales on credit;
- financial deposits: investment and marketable securities; if the securities have not been paid in full they are recorded at cost with balance owed shown as liability;
- deflected resources: portion of profits owed as taxes.

The sources of funds with which the resources can be acquired are
- chartered capital: sum of funds placed into the firm according to founding charter;
- reserve fund: allocated profits for unpredictable expenses;
- special fund: allocated profits for expansion and for utilization for social development;
- profits: result of difference between sales receipts and expense incurred.
The borrowed sources are
- bank credit: debt to bank;
- borrowed funds: debt to other firms;
- accounts payable: debt for purchases from other firms.

Processes of purchasing, production and selling constitute in essence the activity of the firm, and are regulated by the charter. The most important process is selling because from it depend financial results.

The method of accounting recording are based on documentation, inventory taking, double-entry bookkeeping, evaluation, calculation, balance and accounting statements. Each one of these aspects is regulated by instructions, acts and statutes issued by government and tax authorities.

Documentation is regulated by the law on documents No. 105 issued by the Finance Ministry of USSR of 29 July 1983. Documents must bear the date of the transaction. Documents must be prepared on prototype forms or on specially designed forms. Documents must have legal power, and bear parties names (with signature) and nature of transaction.

Inventory taking must take place periodically to verify accounting records. The actual dates of inventory taking is set by the firm. Inventory taking is mandatory before end-of-year, before a change in management, in case of a catastrophe, damage of valuable assets, fire, riot or other such events.

Double-entry accounts are devised to reflect the movement of resources. Accounts are opened for each item of the balance sheet. Accounts can exist for assets, liabilities, debit/credit accounts, balance sheet items and off-balance sheet items. Each of these accounts has its own pattern of recording debit and credit entries. The debit/credit accounts are used for results of operations and for accounts receivable and payable. Balance sheet accounts must be organized according to the charter of accounts. Off-balance sheet accounts are used for assets in possession of the firm but that do not belong to it. The accounts listed in the balance sheet are known as synthetic accounts and may have sub-accounts, as well as analytical accounts. The sum of balances of analytical accounts must match the balance of the corresponding synthetic account. Analytical accounts are used to reflect specific activities of the firm.

Evaluation and calculation are necessary to give a monetary value to assets owned by the firm. In particular, calculation of cost of goods produced is regulated by law No. 552 of the Government of the Russian Federation of 5 August 1992, on "the composition of expenses allowable in the cost of goods produced and determination of results of operations subject to tax on profits", as amended by law No. 661 of the Government of the Russian Federation of 1 July 1995.

A balance sheet is used as the device to gather together all resources of the firm and their source of funding. It is the most important accounting document. The preparation of the balance sheet is regulated by laws previously cited, and must be carried out quarterly. The form used for the balance sheet is the same for all types of business and organization.

Filing of financial statements is the final step of an accounting. In the financial statements, the results of operations and the financial position of the firm are reflected from the information contained in the closing of accounts and the preparation of the balance sheet. Firms must prepare the financial statements for submission to
- owners,
- tax authorities and
- other government branches that have the responsibility to oversee the operations of the firm.
According to law, the accounting year is the calendar year and the first year of operation is either the current year if activity started before October 1, or the following year if it started after October 1. The annual financial statements are made available for publication for use by banks, investment companies and creditors, and are confirmed by an audit of an external organization. The forms for the annual financial statements mandated by the Ministry of Finance are
- balance sheet
- account of financial results and their application
- addendum to the balance sheet relating to
- change in funds
- change in borrowed funds
- accounts payable and receivable
- composition of intangible assets
- list and changes of fixed assets
- financial contributions
- social indicators
- certified statement of movement of financial capital contributions
- certified statement of possession of off-balance sheet assets

See review questions Q-7A1.1 through Q-7A1.17.

2)- Russian approach to financial analysis

Tradition, socio-political context and economic system also have a bearing on financial analysis. This is especially true when we look at how financial analysis was conducted in the former soviet countries, which is still essentially the approach used in many Russian and CIS firms today.

The goal of financial analysis in Russia is naturally no different from the one developed in the previous chapters: to assess the value of a firm. As it has been shown above, the entire Russian accounting process is conceived for an assessment of 1) the means put at the firm's disposal and 2) the manner in which the firm has used them. In the resulting financial analysis, the balance sheet components are evaluated, and the efficiency of the firm's performance is scrutinized.

The growth in reserves is used as an indication of increasing value. This growth is at the heart of the investigation which concerns the government, as well as management itself. Thus, the analysis is almost entirely conducted on the balance sheet, with just a confirmation that the profitability has permitted the "stability of economic growth coefficient" (which in Western financial analysis is called the rate of reinvestment of profits). Positive signs are increases in each component of assets, and negative signs are significant changes in accounts payable or receivable, and increases in loss for the year or provision for bad debt.

This approach, which is a summary of financial analysis as presented in Russian textbooks in 1995, differs significantly from the Western approach, as will be apparent throughout the following chapters. Yet, this approach can be explained by the tradition of financial responsibility under communism. Even if today's firms are no longer owned by the government, the method of evaluation of government owned organizations was so ingrained in the minds of all those who teach or study finance in Russia in 1995, that it influenced the approach used. That and the accounting system which results from it, explain current approach of Russian financial analysis.

Under communism, each productive unit - i.e. firm - was assigned targets of performance in terms of volume of production and amount of supplies to be used, and was given all necessary means to carry out these targets. Management had no control over sales of its finished goods or deliveries of required supplies. Thus management could not be held accountable on the basis of sales or purchasing. All expenses were dictated by procedural manuals. Neither the firm nor its management had any significant control over prices of its output, prices of its resources, or wages of its employees. The point of view of the government was the only one that deserved consideration in financial analysis. Indeed, no other entity could have an apparent interest in the firm which would justify a financial analysis. The interest of the government as owner and tax collector were interconnected and inseparable.

Evaluation of communist firms was therefore based on four aspects:
- achievement of quota of production
- non-dilapidation of assets (received from government budget)
- ability to make payments back into the budget (i.e. pay taxes)
- ability to set aside some reserves
The same four aspects are still dominant today [in 2001]. The accounting system imposed on all firms is intended to measure these elements with precision. Even today, and even for non-governmental companies, the same rules apply. As shown above, the system of accounts adopted in 1991 and all the accounting procedures tied to it, were essentially those used in the previous regime. This made sense, since privately owned firms did not yet exist in large numbers in 1991, and even for the few that did exist, it was not known how the accounting system should be changed.

Naturally, private firms are very different from government organizations of a communist state. That difference comes from the fact that they must be held accountable for a wide spectrum of decisions and serve a wide spectrum of sometimes conflicting interests. Judging these decisions from the varying points of view is the purpose of financial analysis. To make this multi-faceted financial analysis possible financial reporting must adapt to supply the needed information, as it has been argued in the previous chapter.

See review questions Q-7A2.1 through Q-7A2.5.

3) Russian accounting in practice

What stands out in the Russian accounting system for a corporate accountant responsible for carrying out the accounting duties is that certain valuable assets have been placed in the hand of the management of the firm, these assets must be continuously accounted for and must be in active and efficient use in production. Naturally, originally, the provider of these assets to the firm was the government itself, and as such, the government has an inherent right to expect that the assets be productively used. If the assets would happen not to be in productive use, accountants knew that the government would take the assets away. That is why, even for private firms the emphasis on the balance sheet remained even after the fall of communism. The same reasoning explains why inventory should be taken several times a year. For most Russian manufacturing firms it is taken once a month, and for retail operations once a week.

The second striking feature of Russian accounting is that it is extensively regulated. Forms and other types of documents are prescribed by law, accounts are unchangeable (with the exception of some choice in analytical accounts), entries into accounts are only those predetermined, procedures for inventory taking and verification are also specified in detail. Even amounts of allowable expenses are regulated (for instance, the hourly salary of an employee or the allowable spending on a business trip). In our western practice, one would immediately recognize this as tax accounting. And this is what it really is. The accounting policy left at the discretion of management is really only how to deal with expenses that are not allowable, and that come out of profits after tax. The most important component of these after tax expenses are bonuses to employees to stimulate production or to help employees in need. Others relate to payments made for various social purposes (such as kindergartens for children of employees, recovering employees' rest in a sanatorium, and the like) and disallowed but unavoidable expenses (such as actual price paid for hotel and meals in excess of that permitted by law).

As a by-product of the preoccupation with conservation of assets, depreciation of assets was set in the regulations with very long useful lives. But assets could not be salvaged, even when they no longer can be used, and even after being fully depreciated. To write off an asset in Russia and Kazakhstan, in 1999 (i.e. ten years after the fall of communism), a procedure of forming a commission was necessary to create a protocol stating that all those who had knowledge of how the asset was used, deemed the asset to be worthless. Employees sometimes refused to sign such protocol, for fear that they may be held accountable for the whereabouts of the assets involved. As a result of this, balance sheets were blatantly inflated by useless assets. When privatization started and soaring inflation rates caused balance sheet assets valued [as dictated] at original costs to be reduced to trivial amounts, the government realized that government property could be obtained for very little. It issued new legislation that required reevaluation of assets and depreciation on the basis of inflation indexes. These calculations on a large number of different items and over many years of useful lives, became a significant accounting burden. This did not however prevent unscrupulous management from taking over a firm's assets for minimal prices in spontaneous privatizations.

A consequence of the restrictions on allowable expenses is that managers and employees are forced to conspire with accountants to seek creative ways of getting things done in spite of expense restrictions, but still complying with the letter of government regulations. Here is an example of such inventive accounting which is said to have been widespread in Soviet firms. The management of a firm cannot find anyone to fill a vacancy, and the firm risks of falling behind its production quotas. There are employees that would be willing to work overtime to fulfill the assigned load of the vacant position, but they are not interested in receiving the government imposed maximum of half the hourly salary that the position normally pays [i.e. overtime was paid half not twice the regular hourly rate]. The solution that satisfies all is to hire officially a person who will never come to work, and who will pay over the salary to an employee who already works for the firm, and who actually performs the work after hours. Similar accounting creativity is said to be necessary in many other aspects of running a business: from obtaining supplies on time, speeding approval of documents, reporting output produced to the government, and so on.

One must keep in mind that profit maximization is not a communist dogma. Nor is revenue maximization. These are not the measures by which management of a communist firm would be judged. Aside from dogmatic reasons, the practical reason is simply that management has no control over prices. For a large proportion of commodities, shortages existed for years, but the Soviet government would not free prices and foster a capitalist [money driven] behavior on the part of consumers and organization managers. The Soviet government would set production targets which were repeatedly missed causing shortages. The government strategy was to stimulate plant output by calling on the civic duties of employees, and giving honorary recognition as well as some bonuses, for good performance. At each convention of the Communist Party, managers were urged to achieve quotas, and promised special recognition for exceeding them. The accounting department of an organization would not be directly involved in meeting Soviet government demands other than recording as completed certain finished production that laid unaccounted as such in warehouses. For private Russian firms, quotas no longer exist today, but techniques to manipulate reported performance is still fresh in memory.

Another characteristic of the accountant's plight was the chase for revenues earned by the firm but unavailable in the firm's bank account. Either distributors, retail outlets or manufacturing plants that bought from the organization do not pay, or the bank does not have money on hand and freezes all accounts. The accountant is the one that must explain these difficulties to disgruntled employees who have not received their salaries, and to purchasing managers who cannot purchase supplies. In spite of this payments crisis, organizations are prohibited by law to buy or sell for cash almost anything. This prohibition is essential as a means of control for tax authorities, assuring that all the payments are genuine and fully documented by bank transfers. The control is also enhanced by the third party presence of the bank in each transaction. Also, for non-privatized firms, the government can move credit quicker and with less visibility by intervening through bank payments channels.

In 1999, it is estimated that one quarter of all payments (i.e. one quarter of GDP) is not paid in time or not paid at all. The reasons are numerous. First, access to bank loans is limited, and buying on credit is the only way a firm can operate. Second, there is no penalty for paying late: bankruptcy laws are not written or not applied. Government is currently reluctant to enforce bankruptcy laws, close plants and put workers out on the street for fear of social and political consequences. Third, debtors benefit from paying late in periods of high inflation even if payments are expressed in hard currency but bear no interest charge, which they usually do. Also, the common practice of avoiding large bank account balances contributes to firms' inability to pay on time. Firms have a disincentive to maintain large bank balances because of the previously mentioned potential confiscation of assets by the government in socialist countries if the asset remains idle, and the loss of purchasing power due to the recent hyper inflation in these countries once turned to market economies. The managerial and economic consequences of the debt crisis are naturally damaging. Managers are not eager to sell if they suspect that the client will not pay. Suppliers can shut off their shipment if the buyer is even just two days late in paying (as it happened to this author when he was working in a Almaty business school that did not pay for heating on time). Late payment stifles economic activity because raw materials and supplies are denied or available on prepayment terms. Virtually bankrupt firms that are left to vegetate rather than close down.

The debt crisis is not per se an accounting issue. Yet accounting is embroiled in it. Accounts receivable are inflated. Accounts payable are also large. The life blood of business activity is demonetized and is flowing through barter and complex deals in products, materials and supplies. As mentioned above, for employees who do not receive their salary for a month or more sometimes, accountants have no simple remedy. Managers have to find inventive ways of retaining these employees. They give them finished products that employees can sell on the street for cash. When it comes to paying suppliers, accountants identify which of them can wait and which not, and seek ways to cancel a debt in kind. In other words, not paying on time has become common practice in all spheres: salaries, creditors, banks, and even tax collectors.

Again, in this context, profit is not a motive for running a business. It never was under Marxist doctrine, and it still is not for many reasons. For instance, it is unwise to show profits that will only be taxed away at heavy rates. For managers, losses are not a real problem because they can always justify them by pointing to defective and costly supplies and poor employee performance. Thus, managers expect accountants to show minimal profits or no profit at all. Indeed, just as for late payments, there is not real penalty for losses. The government would not close down the business for the reasons given above. If the business has been privatized, the owners are not only scared of receiving dividends because of the tax inspector, but because of the criminals that offer "protection" to every business in the form of a "roof" and would only raise the roof higher if profits are large. If the business was not fully privatized, exceeding quotas and profit expectations can be a managerial mistake because quotas will be raised next year, and achieving them will be more difficult.

To seek and show profits or not, is a managerial prerogative. To hide revenues and boost expenses within the regulations of the Russian accounting system, is an accountant's task. For this, some of the tactics previously seen are used. Finished or unfinished goods given in lieu of salaries or payments are not entered as sales. When products are finished their sale is recognized at the last possible minute, even after receipt of payment occasionally. On the expense side, stretching expenses as much as possible can be done for instance by not letting go of any allowable employee, at least officially. Firing employees is very expensive in the first place. Employers that fire an employee, are liable for at least three months of severance pay, and in certain circumstances a great deal more, including pension, medical care and insurance. This liability exists no matter how inefficient the employee was on the job, even if he had been drunk most of the time, but especially if there were medical problems with the employee. (The bankrupt firms mentioned above do not close down precisely because they would have to fire their employees and the government would incur these large expenses.) As a consequence, it is well known that in many Russian organizations, fictitious or deceased employees are recorded as receiving salaries. As long as there is an allowable employee slot, the slot has to be used and all the proper credentials must be arranged. It is up to the manager, but not the accountant, to pay any bribe a tax inspector may demand. Such bribe is economical for the business because it is a fraction of the potential tax.

See review questions Q-7A3.1 through Q-7A3.18

See research assignment R-7.3.

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