Accountants are in a unique position to help their state and local governments. Most elected officials do not have an accounting background and may not know much about finances and financial reports. Accountants could use their experience and expertise to educate their elected officials and fellow citizens about their government’s financial condition.
Private sector accountants, however, need to understand some unique aspects of governmental accounting before they can help. First, state and local governments use Generally Accepted Accounting Principles to prepare their financial reports, but this GAAP is not corporate GAAP, which is set by the Financial Accounting Standards Board. Government GAAP (GGAAP) is set by the Governmental Accounting Standards Board.
One of the big differences between corporate GAAP and GGAAP was, until recently, that governments were required not to report their full pension liabilities on their balance sheets, which are called “Statements of Net Position.” Many governmental officials believed that pensions are like a mortgage that will be paid off over time, so the liability amount is not a current obligation. But just as in the private sector, the obligation to sacrifice resources for pensions is a present obligation because it was created as a result of employment exchanges that already have occurred.
In 2014, states only reported 13 percent of their unfunded pension liabilities on their balance sheets. A specific example of the old bewildering pension accounting standard can be found in Detroit. In the year the city went bankrupt, while it disclosed a $985 million pension liability in its financial report’s required supplemental information, the city reported a $1.2 billion pension asset on its balance sheet. The good news is that for the 2015 fiscal year, GGAAP finally required state and local governments to report their “Net Pension Liabilities'' on their balance sheets.
For the 2018 fiscal year, governments were required to report their “Net OPEB Liabilities” (Other Post Employment Benefits). This means that the amounts reported on each government’s balance sheet and income statement, which governments call a “Statement of Net Activities” are fairly accurate and can finally be used for decision-making purposes.
Two sets of books
The second thing accountants need to understand about governmental accounting is governmental financial reports, called "Comprehensive Annual Financial Reports" (CAFRs), include two sets of books. This makes the reports confusing and voluminous, but not totally incomprehensible to a trained accountant.
The two sets of books include the “Government-Wide” statements, which are prepared using accounting principles similar to corporate GAAP, and the fund statements, which are prepared using “modified accrual accounting,” similar to cash basis accounting.
Accountants need to encourage elected officials and their fellow citizens to focus not on the Governmental Funds Statements, but on the Government-Wide (GW) statements. These statements are comprehensive, including all government assets, liabilities and activities. They are prepared on a full-accrual basis so long-term debt is included. The most valuable piece of information found in these statements is the government’s “unrestricted net position,” which can be compared to a corporation’s shareholders’ equity.
Shareholders’ equity is theoretically the amount shareholders would get if all of the corporate assets were liquidated and the corporate debt was paid off. A corporation can have negative shareholders’ equity to account for accumulated losses and large borrowing to cover accumulated losses. A negative shareholders’ equity doesn’t mean shareholders will have to make up for those losses. Laws limit shareholders’ liability to the amount of money they invested.
Just as shareholders’ equity can be used to measure the financial health of a corporation, the unrestricted net position can be used to measure the financial health of a government. But unlike a corporation where shareholders’ liability is limited, taxpayers could have to pay taxes in the future to cover a negative unrestricted position.
A government’s unrestricted net position can be found on its Statement of Net Position. This is the residual amount of a government’s net position after removing capital assets, net of related debt, and restricted assets. In general, a positive balance in an unrestricted net position represents the amount of money available to be used to meet a government’s ongoing operations costs.
A negative unrestricted net position usually means the government has incurred debt in excess of the money it has available to pay this debt. This generally means the government has not truly balanced its budget because costs have been pushed onto future taxpayers. These costs are usually compensation costs that have been deferred through pension and retiree health care schemes.
Accountants should also study and educate their elected officials and fellow citizens about information in their government’s GW Statement of Activities. The most important piece of information in this statement is the “Change in Net Position.” Like a corporation’s net income (loss) this amount will indicate whether the government reported it made or lost money in the year.
Governmental funds
The second set of books is the fund statements, which include governmental funds. The most important fund is the general fund, which is the largest budgeted and operating fund. Government and elected officials will occasionally point to the positive change in the general fund as evidence that the government ran a surplus. Unfortunately, since the general fund statement is in essence prepared on the cash basis, it can include the inflow of loan proceeds and doesn’t include significant incurring costs. For example, the pension and retiree health care benefits earned by employees and incurred during the year are not included.
There can be large differences between the amounts reported on the GW Statement of Activities and the Governmental Funds’ Statement of Revenues, Expenditures and Changes in Fund Balances because they are prepared using two different methods of accounting. Illinois’ 2018 CAFR provides a good example. In August 2019, Comptroller Susana Mendoza issued a
To assist accountants and others in understanding their government’s CAFR, Truth in Accounting has produced
Accountants are urged to find their state or local government’s CAFR online, review it and discuss it with their elected officials. Accountants would be using their expertise to do a service to their community.
