12/12/2012 by Alexandra Bjerg
How do California’s accounting practices stack-up nationally?
Accounting procedures across the 50 states should be more transparent, according to a study recently published by The States Project, a joint venture of Harvard University's Institute of Politics, the University of Pennsylvania's Fels School of Government and the American Education Foundation.
The report says, among other things, that “states do not account to citizens in ways that are transparent, timely or accessible.”
The States Project was created to provide non-partisan and reliable information on states’ financial health in an easily accessed and digestible manner. The project is “an important effort to shed light on the true financial condition of our states today," said Trey Grayson, Director of Harvard's Institute of Politics, in a statement.
"In these tough economic times and uncertain future, promoting more openness and information between citizens and their government is a critical goal."
Although researches relied primarily on data from state Comprehensive Annual Financial Reports (CAFRs), the authors argue that their untimely release detracts from their usefulness as a planning tool to craft future budgets.
California, like every other state, is required to produce a CAFR, an annual report of expenditures, revenues, assets, and liabilities, detailing how much was actually spent in a given year. Nearly six months since the close of FY 2012, California’s 2012 CAFR has yet to be issued. Conversely, federal agencies are required to publish their financial statements within 45 days of the end of each fiscal year.
“By the time CAFRs are released, the state government has passed a budget for the interim year and is submitting budget proposals to be debated for the year thereafter,” the report states. Not publishing financial reports in time to be useful in the budget process provides legislators with the incentive to ignore them. Not to mention they are too complex for the general public to digest, making it difficult for folks to truly understand their state’s financial situation.
In addition to lengthy timelines, the study found that CAFRs based on cash accounting do not accurately report, in fact they understate, a state’s unfunded liabilities for public employee pensions and healthcare. Unlike the Federal government and most U.S. corporations who use accrual accounting to compile their financial statements, most states rely on the cash basis system.
Cash accounting recognizes revenues or expenses only once they have been received or paid, which is most helpful when calculating short-term borrowing needs. By contrast, accrual accounting records revenue and expenditures at the time they are earned or incurred, revealing a clearer and longer-term view of budget surpluses and deficits. Combining both current and future costs creates a more reliable picture of a state’s financial situation while more accurately reflecting the future consequences of policy decisions made today.
The authors urge states to move toward accrual accounting, as California has done, as it makes obscuring deficit spending more difficult by better reflecting future obligations faced by states.
Although most states are required to pass a balanced budget and not permitted to run a deficit, the aforementioned procedures have facilitated the development of a number of budget gimmicks used by governors and legislators to “close” budget gaps.
For example, “covering deficits by borrowing money and counting it as revenue for cash purposes and not showing it as a liability is one type of creative accounting practice favored by California budget makers,” said Fred Silva, California Forward’s Senior Fiscal Policy Advisor. At the close of the 2012-13 budget, the budget related obligations will approach $28 billion.
“These accounting practices have masked the state’s long term budgetary imbalance,” said Silva. By providing timely, reliable, and transparent financial reports that account for borrowed resources as liabilities, legislators and governors will enter the budget decision-making process with a more informed and accurate understanding of the state’s fiscal situation and the public will be better able to hold them accountable.
At a time when cash-strapped states are forced to stretch budgets even farther to cover costs, it’s of critical importance that accounting and budgeting procedures remain transparent and accessible to the public to ensure limited resources are being spent wisely.