Why We Need Accrual Accounting in Washington

First, let me say that the independent accounting professions promulgating “generally accepted accounting principles” (GAAP) for the United States, Australia, New Zealand, Canada, and the United Kingdom have accrual concepts as the foundation for these principles. So, what is the accrual basis of accounting, and why should we continue to be concerned about it? Simply stated, the “cash basis” of accounting records financial transactions when income is received (by cash or check) and expenses are paid (by cash or check). Whereas the accrual basis of accounting recognizes as income what the government has either earned or is entitled to receive, even before payment is received; and, it recognizes as an expense what the government is obligated to pay, when billed or contractually liable, even before payment is made. Accrual/GAAP accounting is considered a better way to measure a large and complex entity’s financial condition and the results of its operation, not only in financial terms, but in an economic sense.

The U.S. government is legally required, by the 1990 CFO Act, to prepare annual consolidated financial statements for all agencies and departments. However, the most recent “Financial Report of the United States Government,” prepared by the Treasury Department, has deemed the accounting system it uses for preparing the annual financial report to be a “modified cash basis,” not the “accrual basis” sanctioned by the SEC for the private sector. Today, countries that have adopted public sector accrual accounting such as Australia and New Zealand are portrayed as paragons of fiscal responsibility, having achieved number one and two rankings out of thirty-four major countries in the Sovereign Fiscal Responsibility Index prepared in 2011 by Stanford University. In the same study, the United States is ranked poorly at number twenty-eight. In 1975, Arthur Andersen & Co. did groundbreaking professional work to enable the U.S. government to bailout New York City through the preparation of conventional, accrual-based financial statements that were required by the Treasury Department and investment bankers on Wall Street to facilitate the now historic bailout. Acting on its own initiative and based on its experience in New York City, the firm prepared the first published U.S. Consolidated Financial Statements on accrual/GAAP basis. Arthur Andersen’s 1975 report, entitled Sound Financial Reporting in the Public Sector, pointed out that a 1956 law (Public Law 84-863) required all government agencies to prepare business-type, accrual-basis financial reports. Andersen’s 1986 report entitled, Sound Financial Reporting in the U.S. Government, aptly described the main difference in government accountability that occurs under a cash basis system of accounting as opposed to an accrual system: “Given the existing practice of cash-basis budgeting and reporting, programs can be adopted and promises can be made without knowledge of their full cost. This lack of accountability creates an incentive for elected officials to curry favor with today’s voters at the expense of tomorrow’s taxpayers. This lack of accountability has long been a root cause of fiscal mismanagement within the U.S. government.” The United States does not use the accrual basis of accounting for calculating its annual budget deficits and the resulting national debt. The Federal Accounting Standards Advisory Board has proposed hybrid-accrual standards for use in the preparation of annual U.S. Consolidated Financial Statements, but such standards do not include using traditional accrual/GAAP for reporting federal pension liabilities and obligations for Social Security and Medicare. Actuaries have estimated these obligations to be over $40 trillion, well above the outstanding current Treasury debt of nearly $16.7 trillion that is subject to the statutory debt limit. For the U.S. government, the implementation of government-wide accounting standards on an accrual basis would have at least two important effects. First, budget and financial reports on an accrual basis would provide a more accurate measure of the U.S. government’s finances and its impact on the nation’s economy. And, second, the use of accrual accounting standards can assist in management improvement for the agencies and departments of the federal government—promoting greater efficiency, publicizing true costs, minimizing government waste, and controlling inefficient spending, especially on long-term government contracts. It is past time for the U.S. Congress to pass legislation adopting accrual-based accounting standards similar to those of America’s private sector, as mandated by the Securities and Exchange Commission for publicly-traded companies. These accounting standards should be applied to all important financial and accounting functions in the federal government—budgeting, preparation of annual financial statements, and evaluating performance at the department and agency levels of the U.S. government.

This Article was Originally Published in The Hill