Every year, for decades, the City of Chicago claimed to balance its budget as required by state law. Yet the City of Chicago still accumulated many billions of dollars of unfunded but real obligations, even as it “balanced its budget.” How?
To the detriment of many state and local governments, budget decisions are being made based on bad accounting information. Now the Governmental Accounting Standards Board is in the latter stages of a multiyear project that would reinforce these deceptive practices.
Every taxpayer and beneficiary of government services and benefits should care about good government accounting. Accountants and other financial professionals should take special note because GASB is attempting to change one of the basic tenets of accounting. This is a rare opportunity to convince GASB to reverse course and move toward true accrual accounting in budgeted funds statements.
GASB currently has two exposure drafts out for public comment:
The proposals, most importantly, do not relate to government-wide financial statements such as the Statement of Net Position (a balance sheet) and Statement of Activities (an income statement), both of which have significantly firmed up their accrual accounting foundations in the last decade. GASB’s proposals relate instead to governmental funds statements, such as those for general funds, which are widely used for budgeting purposes.
Governments — particularly in the United States — have been much slower than the private sector in grounding their accounting practices in valuable accrual-based foundations. Various political forces have combined to rely on cash-basis practices as a means for producing budgets falsely advertised to be “balanced,” and therefore compliant with law and rhetoric. GASB’s latest efforts would effectively continue to reinforce these unsustainable practices.
Consider how GASB is attempting to create a new convoluted definition of accrual accounting. The definition of the “short-term financial resources measurement focus and accrual basis of accounting” in the proposed concept statement reads as follows:
“Balances, outflows of resources, and inflows of resources from short-term transactions and other events would be recognized as the underlying transaction or other event occurs. Balances, outflows of resources, and inflows of resources from long-term transactions and other events would be recognized when payments are due.”
GASB falsely erects a distinction between “short-term” and “long-term” transactions that would allow the accumulation of debt to be unrecognized in governmental fund balance sheets, either from long-term borrowing or growing retirement benefit obligations. Yet this treatment would recognize cash borrowing proceeds, and cash balances “generated” by underfunding pension obligations, on a timely basis.
Meanwhile, GASB — well aware of the long road it has taken to get to accrual accounting — cynically tries to ease its task by calling these cash-basis-like principles “accrual accounting.”
The foundations of accrual accounting include the revenue recognition principle and the matching principle. The revenue recognition principle calls for revenue to be recognized when it is earned, not necessarily when cash is received — and especially not when it is borrowed. The matching principle compels expenses to be allocated to the period in which the related revenue is recognized, not necessarily when cash expenditures are actually paid.
What does it mean to “earn” revenue in government, compared to the private sector? Governments have the power to tax — they compel payment by force of law and generate tax revenue. Businesses generally have to inspire consumers to enter freely into transactions with them. Governments aren’t entirely immune from market forces, however — people can choose to move to different places when faced with government financial conditions they aren’t willing to accept. Even governments have to “earn” their keep.
GASB’s latest proposals would continue a practice that effectively allows borrowing proceeds to serve as revenue. Neither businesses nor governments “earn revenue” when they borrow money.
Some argue that the differences between government and businesses call for different accounting standards for governments. Even if governments have different accounting standards, however, those differences should make true accrual accounting more important, not less important, for governments.
GASB’s proposals would allow governments to say they are using accrual accounting for their major budgeted funds, but the fund “balance sheets” prepared under this new definition would not include long-term liabilities, including bonded and unfunded pension debt.
This helps explain why Martin Ives, former vice-chair of GASB, penned the very first comment letter on GASB’s proposed concept statement with the following observation: “In my opinion, stating that the Board’s proposal regarding fund reporting results in the ‘accrual basis of accounting’ is grossly misleading and must be dropped.”
The irony gets thicker when a reader of GASB’s proposals learns the proposed treatments that would help grease the wheels for kick-the-can-down-the-road financial management are grounded in principles called “fiscal accountability” and “interperiod equity.”
Introducing a 2002 Senate hearing examining the Enron debacle, Senator Carl Levin, D-Michigan, stated: “It is now common knowledge that Enron engaged in accounting deceptions to convince investors, lenders, analysts and the public that the company was in better financial shape than it really was. … The purpose of all the complexity was to hide a loan, so it wouldn't appear as debt on Enron’s books. This structural deception had a clear purpose. There’s a big difference in the financial world between cash that comes from business activity versus cash that comes from a loan, and there is supposed to be a big difference in the accounting treatment.”
GASB’s latest proposals would enshrine Enron-like deceptions in the rules themselves. GASB’s “short-term financial resources measurement focus and accrual basis of accounting” is an oxymoron — a contradiction in terms.
We can do better than this. State and local governments should move toward real accrual-based-accounting in their budgeting practices, and GASB should do the same regarding the accounting principles for governmental funds statements.
GASB is accepting comment letters on its proposals until Feb. 26, 2021. You can learn more about the proposals at
