Many state and local officials know their agencies should convert to modern, “true accrual” financial reporting but fear the political consequences because conversion would force the recognition of higher expenses in the short term. However, much higher expenses would be avoided later.
Under a non-accrual system, a $100 expense not recognized today grows into a $150 expense in 10 years, but a $100 expense recognized today under a true accrual system is never again an expense. Still, conversion to accrual is a tough decision for the ordinary politician who won’t be in office when the benefits are realized. But an extraordinary politician — Gov. Jerry Brown — could make the change now.
Imagine this: A CEO hired under a three-year contract that pays him or her an annual bonus based upon the company’s profits. In hopes of artificially boosting those profits, the CEO gets the company’s employees to defer receipt of 15 percent of their salaries until the day after the CEO’s tenure ends. Fortunately, the CEO’s gambit will fail because of true accrual accounting, which matches benefits with costs. True accrual is the worldwide gold standard of accounting, but it’s not yet the standard of state and local government accounting.
This is how the California state budget will ignore 15 percent, or more than $3 billion, of employee compensation and benefits. And that’s why a recent UCLA Law Review article characterizes state and local bookkeeping as “misleading and dangerous” financial reporting that “omits long-term consequences, blinds citizens to long-term repercussions, obscures problems, prevents corrective actions, and creates incentives for accounting gimmicks.”
Declaring that “the gravest shortcoming is incomplete implementation of accrual accounting” and that “inter-generational equity would be better served by true accrual accounting,” the authors call on state and local governments to follow the “governments around the world (that) have increasingly adopted accrual accounting.”
Since Brown took office in 2011, California has enjoyed record tax revenue from surging stock markets. Those revenues are big enough to absorb many of the higher costs that would be recognized under true accrual accounting. That would lead to lower costs in the future — a future that Brown has said will otherwise bring devastation to California budgets when markets stop surging. In a recent budget statement, he noted, “balanced budgets (in California) have been quickly followed by huge deficits” and “another recession is on the way — we just don’t know when.”
As the Economist recently pointed out, his state is more exposed than ever to recessions, due in part to growing amounts of cash required to service $195 billion in debt created by unrecognized expenses. That form of debt has grown sharply under Brown, and unless he moves to accrual accounting, it will keep growing.
Brown has three years left in office. Conversion to true accrual would be the most powerful step he could take to protect future generations, set an example for other states and establish a fitting legacy.
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