Bill Bergman, director of research for Truth in Accounting, joins us to discuss recent proposals by the Government Accounting Standards Board and their effect on accrual accounting. He explores the status of GASB Projects 3-20 and 3-25, whether the new proposals change the definition of accrual accounting, and how they relate to revenue recognition.
By: Bill Hayes, Pennsylvania CPA Journal Managing Editor
Bill Bergman, director of research at Truth in Accounting, has some feelings about recent proposals by the Government Accounting Standards Board and their effect on accrual accounting, feelings he shared in a piece for Accounting Today. Today, we are lucky enough to have him here to discuss GASB projects 3-20 and 3-25, their effect on the concept of revenue recognition, whether governments and businesses should be subject to different accounting standards, and more.
In a piece you wrote for Accounting Today, you said that, and I quote, "GASB is attempting to change one of the basic tenets of accounting." Can you tell us about the current status of GASB projects 3-20 and 32-5? Are they still exposure drafts at this point? How would they change this basic tenet?
[Bergman] The Governmental Accounting Standards Board has issued two new exposure drafts. 3-20 is titled Recognition of Elements of Financial Statements, and 3-25 is titled Financial Reporting Model Improvements. These two proposals are for both a concept statement, a longer story, and a proposed standard for governments. The current status: they're exposure drafts. They've been issued. They've had comment letters, lots of them. And many of those actually inspired by our efforts to get people interested in this topic. They recently completed and I participated in providing testimony to the GASB on these proposals that are currently entering the deliberation stage based on the comment letters and the testimony, which theoretically will last at least until January 2022.
The project though is not so new. It's been underway for more than five years now. And they're in this exposure draft stage, so things are moving toward final implementation with a possible effective date that at least wouldn't happen until fiscal year 2023 for most states, but it's still a timely thing to be interested in for anybody that cares about the integrity of accounting and the implications that governmental accounting has for citizens and taxpayers. That's why we're interested.
What aspects of government accounting do these projects affect most? Are there aspects that would not be affected by this?
[Bergman] There are. Fundamentally, they're more focused on what are called governmental funds statements. They aren't doing a lot to the balance sheet, the fundamental government-wide balance sheet, which in government accounting is called the statement of net position or the fundamental government-wide income statement, which is called the statement of activities. What these proposals matter for are these subsidiary statements that are underneath those overall statements that are called the governmental funds statements. That's one thing that makes government accounting unique compared to the private sector, that they have more statements including these governmental fund statements.
It's those statements that historically, again, where you stand depends on where you sit, and I sit in Chicago in Illinois, where I'm afraid these ... and there's other places too. We're not alone by any stretch … but these underlying governmental fund statements have been both used and abused to advocate or advertise compliance with what are asserted to be balanced budget requirements that they ... well, we can talk about that at more length later, but that's what these proposals are doing. They're impacting the governmental fund statements. Effectively there's a lot of ink on these proposals, but they're effectively reinforcing the status quo in ways that we're concerned about.
At Truth in Accounting, we believe that governments should move toward a more full accrual accounting based basis for the governmental funds account, not just the balance sheet or the income statement, the statement of net position and the statement of activities in government land. We feel relatively good about those statements, given that they have incorporated accrual accounting principles to a greater degree in the last decade, finally. But these fund statements still allow for the accumulation of debt outside of what is called a balance sheet, and they're calling what is the new balance sheet a short-term financial resources balance sheet, which in one sense is more honest that they're actually calling it short-term financial resources, but at the same time, they're still calling it a balance sheet. That's what allows for practices that are not necessarily accrual accounting based to be part of the system.
It would effectively allow, I'm afraid, the same types of practices in many governments that allowed for the things like the accumulation of debt outside of this governmental funds balance sheet with practices like deliberately underfunding your pension or your OPEB obligations as a way to keep too much cash from going out of the door in the short run, but kicking the can down the road with long-term consequences. Another egregious problem, especially where I live, is that the governments have historically thought about and used borrowing proceeds as a form of revenue to balance the budget. I can tell a story or two about that. Unfortunately, the way it's framed, the proposals would allow these types of practices to continue.
Here's a quick story for you from my neck of the woods. The current Chicago mayor is Lori Lightfoot. The previous mayor, prior to his last reelection, had claimed before the reelection to have balanced the budget every year for three years. He said that to do this without raising taxes, we have to make government smaller, smarter, and simpler. That was his line. Trouble is, in all three of those years, when he quote, "balanced the budget,” or the city balanced the budget, by the way, they're required to balance a budget quote, "according to state law," which unfortunately is what teams up with these GASB standards to allow for these assertions that the budget is balanced.
Every one of those three years, the accrual-based expenses in the statement of activities, which we trusted by that time, were more than a billion dollars above the accrual revenues in all three of those years. And I went up to a City Council Finance Committee member. I asked him point blank, how can you claim to balance the budget every year when you're accrual-based revenue is falling short of your expenses by a billion dollars a year? He was almost proud in his response. "We borrow the money. We have access to capital markets, and that's how we make up the difference." Effectively, even in the most recent budgets from the state of Illinois, you can see anticipated borrowing proceeds included in tables that have a section called revenue that includes these anticipated borrowing proceeds.
It's that type of thinking that helps you delay the day of reckoning, build up, and really shift the cost of government to future taxpayers in ways that they don't have a chance to participate in the decisions, including the young and the unborn. That's what Chicago, unfortunately, in Illinois, more than a few places in the United States have enabled historically. I'm afraid, under these current proposals, they could still be abused like that.
You wrote in the piece, again for Accounting Today, and again, a quote, "Governments, particularly in the United States, have been much slower than the private sector in grounding their accounting practices in valuable accrual-based foundations." Why do you think this that this practice is out there?
[Bergman] In my opinion, I'm afraid there's one difference between governance and businesses that relate to my reaction to a presentation by a credit rating agency about the municipal bond market a few years ago. They got up and talked about what they viewed as some of the fundamental strengths of the municipal bond market that they respected. Those strengths first and foremost included these are sovereign credits. By that, they meant that these are entities that have the power to tax, which is a way to inspire revenue in a way that's not quite the same thing in business where businesses have to inspire customers, but governments have a form of, it's a power to tell people to give them money. It's that authority, which is part of our constitutional framework, it's not necessarily illegitimate, but it is something that provides less market discipline than businesses have to abide by.
As a result, the accrual basis has been a means, on the one hand, again, in theory, we have ways to constrain governments from feeding special interest groups in the short run at long run expense. And besides the voting booth and power ... The market discipline isn't absent in governments. People can move, and increasingly looking across the 50 states, you can see, they are increasingly sensitive to these issues. You can see that in the data. But the other thing that's worth noting is that the market discipline that governments maybe aren't facing as much as businesses are theoretically managed through these balanced budget requirements, either in state constitutions or in the actual statutes of the states and local governments, whereby governments say, "We have a requirement that we live up to our balanced budgets."
As a result, the theory there, which is a good one, is that you don't allow the cost of government to be passed onto future taxpayers or future generations. You live within your means. However, given that they have those advertisements and laws, the next thing you do is get creative in your accounting in order to define the ins and outs in ways that allow you to, unfortunately ... I'm a fan of the public choice school of economics, which is a field of economics where we suspend our assumption that governments and government officials necessarily do their best to pursue the general welfare. They're run by individuals like the rest of us that are in economics. The assumption is rationality. Not in the sense that people can add two and two to get the four, but in the sense that we're all self-interested at the end of the day. We all try to make ourselves better off.
It's not necessarily a bad thing in exacting markets. You can have great outcomes from the fact that people are selfish. However, what happens in government when government officials, maybe they're selfish. The prediction from the public choice school of economics is that well organized special-interest groups tend to dominate the governmental wheels at the potential general welfare expense. The average Joe and Jane don't have the connections. When this happens, the next prediction from the public choice school of economics, at least the people that I respect, is that governments realize that they've got to try to live up to the general welfare, but they borrow money in order to ... they don't want to tax people because that's the one way that, if they're self-interested, they don't want to lose their position and get voted out of office. They borrow money to kick the can down the road in order to meet their requirements.
Balanced budget requirements are, in theory, a way to forestall that from happening, but not if borrowing proceeds are revenue and used in a way that's abusable. That's why we believe that GASB, for all their stated good intentions, we think they need to go back to the drawing board on this stuff and get full accrual accounting into the budgetary and fund statements.
We've mentioned it throughout: accrual accounting. You say these changes would basically alter the definition of accrual accounting. I guess to set it up for people, what has been that definition of accrual accounting and how would it be changed?
[Bergman] Well, I guess … I'm not a CPA by the way or an accounting expert, although I have a strong fascination with it, along with economics and finance, and my background includes critical thinking about Federal Reserve accounting, another story. But from my Economics 101 days, accrual accounting, you recognize revenue when it's earned, not necessarily when cash is moving. Conversely, under the matching principle, you will match expenses with revenue as those expenses are incurred. Again, not necessarily when cash moves. A simple example for what we're talking about now, you don't necessarily decide to put less money into your pension fund and thereby balance your budget. You recognize expenses as they're incurred, not necessarily when the cash is going out.
Well, the GASB in the new proposals, they actually state that they're based on what becomes a very long acronym, but here's what it is. They call it a new grounding, a new "conceptual foundation" called the short-term financial resources, measurement focus and accrual basis of accounting, which in my view … in our view, I think, you can argue that this is an oxymoron, a contradiction in terms. Is it really accrual accounting to focus only on the short-term financial resources? Historically, GASB had to admit that there wasn't a conceptual foundation for those fund statements, and they were acknowledged to be on "a modified accrual basis," whatever that means, which is more fundamentally a cash basis type of accounting.
I'm afraid with the new proposals, one implication is that GASB is trying to erect a conceptual foundation for this in calling it accrual accounting. I've got to read the actual statement that defines this stuff for your listeners here. It's a long sentence, but bear with me. “Under an accrual basis of accounting, elements of financial statements arising from short-term transactions and other events are recognized as they occur and elements of financial statements arising from long-term transactions and other events are recognized when payments are due.” So the first, what, one, two, three, four, five, six words in that sentence are asserting that this is under an accrual basis of accounting? That's where we wonder if they're stretching the term accrual basis of accounting.
Accounting has made many good contributions to society in the last few centuries, and the accrual basis of accounting is one of them. I'm afraid that they're watering down the term in a way that meets their objectives, not necessarily what good accrual accounting is.
Revenue recognition has been something that CPAs are constantly dealing with. It's evolving. How would these proposals affect the concept of revenue recognition?
[Bergman] As an example, when people raise objections that they're allowing revenue proceeds, I'm sorry, borrowing proceeds to be treated as revenue, GASB reacts quickly and accurately that under their proposals and in past practice, they're strictly speaking, not revenue, and they aren't under the GASB standards. However, effectively they're treated that way by people that abuse the process, and that's what we're concerned about. The standards, strictly speaking, do X, but they allow for less than forthright people using the standards to say Y. That's our concern. They are changing some of the names of things in ways that are interesting, but the name changes are effectively cementing the long-term practices.
They've got a companion project underway currently that relates and dovetails with this stuff, the revenue and expense recognition project. But even now, they're still reporting a balance sheet and they're calling it a short-term financial resources balance sheet. People that are interested can go look at their revenue and expense recognition project for the recognition of revenue.
In your opinion, should governments and businesses be subject to different accounting standards? Would governments benefit in the long run if they were not?
[Bergman] Accounting standards can be productive, but they can also be abused anywhere. In my opinion, we need truthful accounting, no matter where the standards are developed. You could have consolidated accounting for governments and for the private sector through the Financial Accounting Standards Board. Our founder and CEO is someone who's written that, "Wait a minute. Why do we even need government GAAP in the first place? Why don't we just have GAAP?" A longer story there, and she's got a good argument, but in my opinion we need truthful standards, period, whatever they are. That's what counts. The transition is, would that be good for governments? That raises some interesting questions about what governments are and what they should do.
In fact, one of our friends gave some testimony to GASB along these lines, and I really appreciate it. He said, GASB should stop trying to be so ... in their user-friendliness, they tend to focus on the needs of the preparers and the governments, and maybe they should have a wider net in facilitating the ends of government accounting standards. Governments and special interest groups are acts, but in our neck of the woods, in the United States of America, including the federal government, which is a longer story here, we have a government that works for the people, the general welfare, and what's good for governments is narrowly construed as not the general welfare. That's why we care about accounting standards for government in general. Perhaps maybe we would be all better off if we had common standards for businesses and good accrual accounting in governments.
Throughout this conversation, we've been talking about the process under which these proposals have been going on. There was a period when these standards were out for comment, but that expired on February 26th of this year, 2021. For people who would like to act on this, what's their current recourse? Do they have any? What can they do?
[Bergman] Well, the process is the process, but they can do what they want. We live in a free society. Granted, the comment letter period is over, but there's nothing that can stop anyone from going ahead and writing a comment letter today, either under their formal framework or writing a letter to GASB. That would be a good thing, even if it's late. As long as you're genuine, go for it and try to communicate with GASB in other ways. That's maybe the only route to take. With respect to CPAs, for instance, they're citizens and they can do what we can all do.
We can call our U.S. senators and representatives, and we have some ideas along those lines actually that may relate to Pennsylvania that we can talk about, but CPAs also can talk to their clients and inform them and try to inspire them to care about government accounting, especially in a world where the accounting for your clients is "their own accounting." But guess what? We're all in this soup together. Our governments are our own accounting and our own business too. There's a lot that people can do and not feel powerless.