This news was a surprise to this author. After all, state and local governments have become very large economic drivers, rivalling big business. Governments have a larger impact on more people than corporations because every American pays taxes and receives government services and benefits. Isn’t it important for CPAs to learn and understand government accounting?
A better question might be, “Why do we need governmental accounting at all, much less on the CPA exam?” As former Senator Mark Kirk (R-Ill.) once asked the author, “Isn’t one plus one in the private sector the same as one plus one in the public sector?”
Most CPAs are familiar with generally accepted accounting principles (GAAP) for corporations, but another GAAP exists for state and local governments, set by GASB. Recently, government GAAP took a step closer to corporate GAAP in that pension and retiree healthcare liabilities must now be reported on governments’ balance sheets, known as the statement of net position. Nevertheless, large differences between the two GAAPs still exist.
For example, government GAAP includes “deferred out-flows” and “deferred inflows,” which are included on the government-wide balance sheet. These confusing deferrals—which are not found anywhere in corporate accounting—can inaccurately inflate or understate a government’s net position. For example, when the assets in a government’s pension plan experience an investment loss, a deferred outflow is reported, with the loss being amortized over a period of five years. The balance in this account is then added to the assets, thereby misleadingly inflating the government’s net position.
Additional confusion exists because government GAAP requires governments to maintain two sets of books using two different bases of accounting. The government-wide (consolidated) statements are prepared using the full accrual basis, while the governmental funds are prepared using the modified accrual basis. GASB points out that this basis of accounting, similar to the cash basis, has “no conceptual basis.” The largest governmental fund is the general fund, which is the focus of most government budget decisions.
The Problems with Modified Accrual
The modified accrual basis of accounting is a hybrid between accrual and cash basis accounting, with a focus on current financial resources available. Fixed assets and long-term debt are not included on the balance sheet, and the accounting for the activities in the general and other governmental funds includes loan proceeds and expenditures, not expenses.
This basis of accounting does not take into account the fact that governments have expanded beyond providing for current services and benefits. For the last several decades, elected officials have increasingly made long-term commitments, such as pension and retiree health care benefits, to government employees. Because only checks that have been written are included in the governmental fund statements, compensation costs include only the amounts elected officials chose to pay into the pension plans, not the benefits as they are earned and incurred.
These two sets of books result in decisions being made based on misleading and contradictory financial information. The Chicago Sun-Times reported on a particularly egregious example in January 2019 (Mitchell Armentrout, “CPS Finishes Year with a Budget Surplus—Just in Time for CTU [Chicago Teachers Union] Contract Talks,” Jan. 23, 2019, http://bit.ly/2IHYP4X). The story focused on the nearly $600 million surplus reported in the general fund statement for Chicago Public Schools (CPS) and quotes a union leader as saying this means the school district has “more money and more resources.” Based upon the belief that CPS had a $600 million surplus, the school board negotiated a new contract with the unions that will increase spending by $1.5 billion over the next five years. The consolidated statement of activities for CPS, however, reported a loss of almost $751 million and more than $14 billion of liabilities in excess of its assets. The spending increase was negotiated despite CPS having trouble making its pension contributions.
This short-sighted modified accrual basis of accounting has supported government officials’ claims that their budgets have been balanced (and even accumulated surpluses) while millions, if not billions, of dollars of debt, including unfunded pension and retiree health care benefits, have been incurred. Research by Truth in Accounting (of which this author is chief executive) has found that the 50 states and the 75 most populated cities have amassed unfunded pension debt of $824 billion and $176.2 billion, respectively, and unfunded retiree healthcare debt of $664.6 billion and $149.8 billion, respectively.
This basis of accounting does not take into account the fact that governments have expanded beyond providing for current services and benefits.
A Way Forward
In the late 1990s, Ian Ball, Tony Dale, William D. Eggers, and John Sacco studied New Zealand’s switch from cash basis accounting to full accrual accounting (“Reforming Financial Management in The Public Sector: Lessons U.S. Officials Can Learn From New Zealand,” Heartland Institute, June 1, 1999, http://bit.ly/38LLaok). They noted that “the idea that governments are so different from market options that they must rely largely on cash-based compliance reports is outdated. Governments are involved in markets in so many ways that accounting issues relevant to markets are relevant to governments.” Ball et al. urged GASB to follow the lead of New Zealand and Australia and switch to full accrual accounting for all government activities. The Government Accountability Office (GAO) has noted that in Australia there are no longer government accountants and corporate accountants, but simply accountants. The accounting principles are so similar that accountants can easily switch from the public sector to the private sector and vice versa. This would provide valuable flexibility in the United States, where significant numbers of government accountants are nearing retirement.
Instead of having governmental accounting on the CPA exam, the AICPA and CPAs throughout the country should work to change government GAAP to more closely align with corporate GAAP. They should also work with state and local governments to move to full accrual budgeting. There should be no need for governmental accounting on the CPA exam because accounting should be accounting and GAAP should be GAAP.
The AICPA will consider all responses to its exposure draft received at [email protected] on or before April 30, 2020.