Cost vs. Fund Accounting
A new method of financial reporting enables citizens to better evaluate government efficiency

In the wake of a series of public finance scandals and a slumping economy, many questions have been raised recently about the financial stability of various governments. Close to home, for example, Lexington Mayor Teresa Ann Isaac has mentioned the city’s budget problems and the need for an increase in revenue and a reduction in expenditures. This pattern is becoming all too familiar as cities and states around the nation find themselves in the same situation. And, despite this greater awareness and closer scrutiny of government financial issues, many questions involving the actual cost of government services remain largely unanswered.

Many government financial packages are so large and intimidating that only a few even attempt an analysis of what they contain. The way information is presented in the statements can be misleading or confusing to the uneducated viewer, complicating interpretation even further. Why is this the case? Government financial statements should be similar to those of the private sector, which are purportedly more easily understood by the average citizen.

History of governmental reporting
Since 1984, financial reporting by state and local governments has been subject to the authority of the Governmental Accounting Standards Board (GASB). This authority was given to the GASB through an agreement of state and local government groups that recognized the need for changes in financial reporting. The mission of the GASB was, and still is, to develop standards of governmental accounting and financial reporting that will (a) result in useful information for users of financial reports and (b) guide and educate the public, including issuers, auditors and users of this information. The ultimate goal was to develop standards for financial statements that would ensure they provide useful information about government to citizens.

In the private sector, revenues can be used to cover business expenses, as well as provide dividends for the owners of the business. Management often chooses to restrict revenues for certain activities, but these restrictions are rarely mandated by law. A major goal of the private sector is to generate sufficient revenue to cover all the costs incurred and to have a profit as a residual amount. The desire to record all of the revenue generated, whether the funds were collected or not, and record all costs either paid for or otherwise incurred, has resulted in the use of what is called “accrual accounting.” Information acquired through accrual accounting methods is used to examine the excess of revenues over expenses as a measure of an entity’s success.

Governments, however, operate based on a series of laws. The executive branch proposes a budget and the legislative branch approves the proposed budget or some modification of it. Within the budget, revenues are often restricted by law to be spent for certain programs or activities. In order to provide information on these restricted revenues and costs for associated activities, and be able to audit mandated appropriations, government developed “fund accounting.” Since programs or activities in this model are not established as profit centers, only revenue received and expenses incurred and paid are considered. This method is known as “modified accrual” accounting.

Additionally, revenues are recorded when received and expenditures are recorded when paid or soon to be paid after the end of the year. Revenues that are not received are not recorded, because without receipt, there are no funds available to pay the cost of the program or activity.

Number of funds
In government, legislative bodies can establish any number of funds to restrict revenues for individual programs, complicating the accounting and financial reporting for these programs. Hawaii, for example, at one time had over 4,000 funds. Funds that are restricted for road improvements cannot be used for social programs. Property taxes collected for the library are to be used for the library and no other program. These ‘funds” or “cookie jars” may serve as restrictive devices for the government, but they can also cloud the presentation of information on the financial status of the entire government.

But the question remains: Is the financial status of the government merely the aggregate of all its funds? If the funds are truly restrictive, can they be added together in a meaningful fashion? Is the information valuable if individual fund reports are (or are not) aggregated?

Such accounting and reporting may appear to be inefficient, but it reflects the desire of citizens and the government to use specific resources for specific programs. In our democratic society, we want a series of checks and balances to control the expenditure of funds. After all, government is here to provide services to citizens, not to make a profit.

Governmental financial reporting has been criticized for its focus on reporting on all the little “cookie jars.” Even though there is need for this information on a legal basis, there has always been the need to provide information about the cost of activities in government. Fund accounting does not provide information about the cost of activities. Rather, this method reflects cash flows. If someone is interested in knowing the cost of services, fund reporting must be modified using accrual accounting instead of modified accrual accounting as is currently done in many governments, since information about cost of services requires the recognition of revenues earned but not received, and expenses incurred but not paid.

Changes in financial reporting
Initially, GASB attempted to fashion a compromise between these two methods. Unable to reach an acceptable compromise, in 1999 the GASB issued Statement No. 34, Basic Financial Statements and Management Discussion and Analysis for State and Local Governments. Statement No. 34 provides for the continuation of fund statements, while also requiring the development of new government-wide financial statements. In essence, governments are now required to produce two sets of financial statements.

The GASB believes that the new government-wide financial statements better help users in the following ways:

1. Determining whether a government’s overall financial position has improved or deteriorated.
2. Evaluating whether a government’s current year revenues are sufficient to pay for current year services.
3. Seeing the cost of providing services to its citizens.
4. Seeing how a government finances its programs through user fees and other program revenues versus general tax revenue.
5. Understanding the extent to which a government has invested in capital assets, including roads, bridges and other infrastructure assets.
6. Making better comparisons between governments.

The entity-wide financial statements focus on reporting economic activity. Providing information about operating costs requires a measurement focus on economic (capital as well as financial) resource flows. Accrual accounting is used because economic transactions and other events are recognized when they occur rather than when the inflow or outflow of cash or other financial resources happens. Changes are made to operations in the period when goods and services are used or consumed rather than when they are acquired. For example, a garbage truck would be depreciated over the useful life, rather than being charged against the appropriation that provided the funds to purchase the truck. Thus, the cost of garbage collection for each year can be determined. This cost can then be compared to the previous year. This also allows the cost of services in one city to be compared to costs from other cities, providing a reliable measure of efficiency. Costs can also be evaluated in terms of whether or not the services could be outsourced to save money.

By having this cost information, we can begin to evaluate the efficiency of government programs. Year-to-year comparisons can provide decision makers with the information to expand or contract programs and empowers decision makers to make better-informed choices on behalf of the citizens they serve.

However, for any real benefit to occur as a result of improved government financial reporting, more people must read and evaluate the financial statements. It is a responsibility that we all share.

Relmond Van Daniker is executive director of the National Association of State Auditors, Comptrollers and Treasurers.
editorial@lanereport.com

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