Public Finance: Full Accrual Accounting and Governmental Accounting Standards Board Testimony
If you can't account for the promises when made, then you're not really promising
Yesterday, I gave testimony to the Governmental Accounting Standards Board: [mine begins at about 1 hour, 4 minutes into the video]
I had prepared remarks which are about 10 minutes, and the remaining 20 minutes of my time are Q&A.
Here is the PDF of my prepared remarks: GASB testimony MPC 21 April 2021. I did not hew exactly to this script, but it is substantially what I delivered in my testimony.
Letters I submitted in this comment period: December 2020 and February 2021 letters – combined in a single file.
Letters I submitted in a prior comment period: January 2019 letter.
Cash accounting vs. full accrual accounting
Accountants (and other financial reporting folks) will know the difference, and if you’re not familiar, I understand this may sound like quibbling detail. That said, there have been serious results for following cash accounting instead of trying to match up values when they were earned.
I will give a very simple example: suppose Netflix makes a deal where instead of you paying for a year’s subscription at a time, you can get a big discount if you pay for 2 years’ subscription.
Subscribers love the deal and pay for it….
….and then Netflix says their sales doubled in their financial reports. That’s IF they followed cash-based accounting, which records cash flows.
But they don’t, because accounting standards boards (outside the government sphere) know that this is just a trick to boost how financials look under cash accounting. And there are loads of these tricks. I just gave one simple example. The trick of getting people to pre-pay for sales to boost the numbers is a well-known ploy on the revenue side. A well-known ploy on the expenses side is to put off paying bills.
This is obviously distorting recognizing the true economic arrangement underlying these transactions, and some of the tricks make for a more fragile economic position for specific businesses. It was always the marginal businesses, which were barely hanging on, where cash-basis accounting tempts into trickery, which usually ends in financial failure. So accounting standards have developed to prevent this stuff.
Most long-term concerns in accounting have to use accrual basis accounting, in which you record what was earned, not the specific cash flows. So in the Netflix example, you’d record the cash flow, but in the income statement, for the current year you’d have the revenue associated with subscriptions for that year. The pre-paid subscriptions would be acknowledged as revenue in the next year’s financials.
And this is how real accounting is done now — if you see these sorts of multi-period subscription deals, the reason companies do it now is not an accounting trick.
In any case, governmental accounting at the “funds” level is essentially cash accounting. This is why all sorts of questionable behavior that has been stamped out in the private sector persists in the governmental sector.
Truth in Accounting has had a campaign to call for full accrual accounting at all levels of government.
References in testimony
As noted with the video above, I did not necessarily follow my prepared text, so what I list below may refer to either the written or the video testimony.
California SB400: This was a state bill that retroactively boosted retirement benefits, and had a cascading effect throughout California government. I have mentioned SB400 in passing in the following blog posts:
Detroit’s bankruptcy: biggest municipal bankruptcy in U.S. history (so far), it really made news by being the first one in which retiree benefits – of people already retired – were cut in the bankruptcy proceedings. Posts on Detroit:
Prichard, Alabama: a small town in Alabama (and there’s a bunch of stuff here) that tried to do municipal bankruptcy…. but they had no bonds. Their unsecured creditors were the pensioners. If I remember correctly, ultimately the ruling is that just not being able to support the pensions does not mean you get to use the municipal bankruptcy process. (I am not a lawyer at all, much less a municipal bankruptcy lawyer.) Retirees got nothing for over a year. I understand something eventually got settled, but obviously a lot of people had economic disaster in their lives because they got paid nothing. I believe at least one person died by suicide due to this. Prichard is mentioned in these posts:
Feb 2020: The Moral Case for Pension Reform
Illinois vendors: I mentioned this in passing in the Q&A portion of the testimony, but this is one of the craziest bits of Illinois finance (to me). Illinois has a huge bill backlog for operational expenses. It runs to the billions of dollars, and this is money owed for services right then. This is just for vendors to the state. Imagine running up credit card debt because you couldn’t cover your groceries. This isn’t even a case of deferred benefits like pensions. And Illinois keeps claiming to have balanced budgets… they barely squeak through on a cash basis. Let me just pick a couple posts relating to Illinois vendors:
April 2013: Illinois Vendors and Other Operating Expenses to Go On Credit Card — this is from one of the pre-STUMP blogs I used to write at. This has been going on for a very long time.
I think that covers most of the situations I mentioned in passing, and for round-ups, you can look at some of my collections of old lists of posts on Illinois and Kentucky. New Jersey, I mainly leave to John Bury at burypensions.