While the average person might employ an accountant to help them balance their budget, understanding the role that accountants have to play in governments is an extremely complicated prospect.
One need look no further than Detroit’s financial problems to understand the complexities of balancing a city’s budget. It has been a full year since the city declared bankruptcy and began reorganizing in the wake of shedding their $7 billion in debt.
Part of this process has been defaulting on future payments to many of the cities workers. Detroit’s municipal workers found their pensions and health care benefits cut, with many even being asked to repay thousands of dollars in interest accrued on their retirement savings accounts.
The reasons these kinds of debts have been a focus for Detroit now are the same reasons that Detroit bankrupted itself in the first place. They are also the same reasons that many state and local governments across the U.S. are finding themselves dealing with growing debt issues.
The crux of the issue revolves around the difference between two kinds of accounting, accrual accounting and cash-basis accounting. These are two different methods used to determine a budget. Accrual accounting is mandated by the Financial Accounting Standards Board for all public companies. It is a method of accounting that requires all expenses that will be paid in the future to be considered as a part of a current budget, not as a part of the budget during the time that they will be paid.
In other words, if a company buys a 20 dollar product but is not going to have to pay the 20 dollars for three years, that 20 dollars still has to be taken out of this year’s budget when using accrual accounting.
Governments on the other hand are more likely to use cash-basis accounting. Cash-basis accounting plans budgets based on how much money is currently available. However, this means that many governments plan their budgets based around how much money they have without taking into consideration debts they have been incurring that would previously have been taken care of in an accrual accounting system.
They will spend money they have now that should be set aside for future expenses, and then not pay those expenses when time comes to settle their debts. The International Federation of Accountants has been calling out governments on this practice for years, but changing it is an extremely complicated prospect. It means reevaluating budgeting practices and in some cases even rewriting laws.
However, applying standard accounting practices to governments may be necessary to avoid the potential of further bankruptcies like Detroit’s. In the years to come, it will be important for cities and states to deal with their debt expediently as more and more debt holders come calling.