The Evolution of the Financial Statement
Can a Private Sector Rule-Making Board Change the Way We Count?
I just finished my column for Business First for September. It is about a technical subject that has huge implications. We all know the fiscal problems that state and local governments are facing. And we know the tuition and Medicaid reimbursement pressures that public universities and hospitals are facing. We know of these problems because we see their budgets and we see financial statements about their surpluses or deficits. To know this we need accounting statements that can tell us about this in a sufficiently concrete way that decision-makers will believe the numbers and take appropriate action.
Well, the concreteness is eroding. This all started with a paper a good friend of mine, Robert Berne of New York University, wrote in 1992. He argued that financial reporting should focus on financial condition. Great sounding word, but financial condition is subjective. Are you healthy or not? Financial condition also is a balance sheet concept. Nonprofits and governments traditionally focus on their income statements: what revenues do we have and what do we have to pay for this year? And are we liquid enough to have cash when we need it?
FASB and GASB, the rule-making bodies for for-profits, nonprofits, and public entities want financial statements to address every issue. And financial condition as their rallying cry has been supplemented by fiscal sustainability. As you would expect from my books and articles, I don’t agree. A good report addresses a specific question. Change the question and you need a different report. Trying to have financial statements answer all questions is a futile goal. And in the meantime a lot of damage can occur.
Sustainability requires looking into the future, which in turn requires financial modeling. Financial statements cannot do this. But FASB and GASB are trying.
Sustainability is great but much more immediate is the issue of whether you can pay your bills. The budget is universally accepted as the method for making and recording the decisions that reflect priorities, resources and services. FASB’s introduction of temporarily restricted and permanently restricted net assets has led to nonprofit financial statements that look good even when there is no cash to make payroll. GASB has adopted this concept and next year public entities will move in this direction (Statement No. 54). Recall that in the 1990s (Statement No. 34) they dropped the requirement that financial statements report results compared to budget. GASB’s new “project” may drop the tie to budget concepts entirely.
Experts in financial reporting who are grounded in the reality of government finance and budgeting have sounded the alarm. Professors Robert Freeman and Craig Shoulders in the August 2010 edition of Government Finance Review warn “if modified accrual accounting is ‘cleansed’ of its budgetary ties, it will become a sanitized accounting approach with no strong ties or usefulness to government’s most significant and pervasive decision-making processes and information needs.” The Government Finance Officers Association, the professional association of public finance officers, issued this statement: “GFOA adamantly opposes any effort on the part of the GASB to set standards of reporting for fiscal sustainability.”
Why should you care? State and local governments have balanced budget requirements. If account rules add a lot of future bills onto the income statement, balanced budget requirements will force those governments to fund them now. Think accrued but unused vacation, pension liabilities, bond obligations, etc. Either governments will break the law and refuse to balance according to GAAP (in which case we will have no idea how well they are performing) or they will make huge cuts in payments to contracted nonprofits and grants to nonprofits or they will enact enormous tax and fee increases. They do this not because revenues are down or expenses are up, but because a private sector rule-making board has decided to change how we count.
Nuts to GASB!