An opinion piece by Bill Cox, CPA, CA
As vital accountability tools, budgets play an important role in the public sector. So it’s no surprise that there are public sector accounting standards (PSAS) in this area. Section PS 1201 – “Financial Statement Presentation” of the PSA Handbook is the relevant standard; it requires governments to report actual-to-budget comparisons in their financial statements.
It would be difficult to argue against the merits of presenting budget information. After all, one of the objectives of public sector financial statements is to add accountability value, and, in almost every respect, budget information adds value to public sector financial statements. And yet there are a few areas of tension between budget preparation and accounting that have the potential to derail the benefits of reporting budget figures in the financial statements. Accountants working in the public sector need to consider and address this “mismatch.”
We speak of “mismatch” in many areas of accounting. For example, a financial institution may have a mismatch between the maturities of its assets and liabilities. Or a business may have a mismatch between the life of its plant and related funding. Even the tried and true “matching principle” is not quite dead—it still exists as long as its application does not create deferrals on the balance sheet that are inconsistent with the accounting framework’s definition of assets or liabilities.
In the public sector, “mismatch” results when the methods and concepts used for budget preparation differ from those used in financial reporting. Local governments, for example, need to balance their budgets, but the “balancing” is that of cash inflows and outflows, not revenues and expenses. Of course, inflows and outflows of cash can differ from those of reported accounting revenues and expenses, and this disconnect can lead to puzzling budget results in local government annual financial statements.
One of the most important objectives of local government is to manage, save for, and replace infrastructure, so expenditure on capital items will usually be a significant component of expenditures in any given year. Capital expenditures are not expenses for accounting purposes—they are, instead, amortized over the life of the underlying capital asset. In addition, they are often much higher than amortization expenses due to inflation and the very long lifespan of many infrastructure assets. As a result, it is commonplace for local governments to have a surplus almost every year, and this surplus can be significant in size. This can be difficult for local government councillors and taxpayers to understand. “If we balanced the budget,” they may ask, “why are we running a huge surplus? Are taxes too high?”
A different type of issue can arise for BC Crown corporations and agencies. Crown corporations and agencies form part of the Province of British Columbia reporting entity, and, as such, they also follow PSAS. The combination of adhering to the Budget Transparency and Accountability Act (BTAA) and reporting under PSAS creates problems.
An important concept under PSAS is that transfers to or from reserves or accumulated surplus (collectively referred to as “retained earnings” in the private sector) are not revenues or expenses for accounting purposes. The logic of this concept is obvious, and it’s consistent with other accounting frameworks: If you just move funds from one pocket to another, you are not creating or using resources. Section 23.1 of the BTAA requires the use of PSAS (which is a good thing). Related to the BTAA is the Balanced Budget and Ministerial Accountability Act (BBMAA), which contains a prohibition against forecasting a deficit. In combination, the two acts lead to a result that was likely not anticipated by those who put the original legislation together: Any surpluses that carry over a fiscal year-end can never be spent.
Consider, as an example, a provincial government agency that receives a $6 million unrestricted grant from the federal government on March 30, one day before its fiscal year-end. It would be understandable if the agency did not spend this grant on March 31—indeed, unless detailed expenditure plans were already in place, it would be irresponsible for the agency to do so. Because the $6 million grant has no restrictions, there would be no liability to ever repay the federal government, so the agency would record the grant as revenue. The agency might move $6 million into a reserve fund to ensure that the funds are earmarked for a specific use, but, as noted above, a transfer to a reserve is not an expense.
The agency would end up with a $6 million surplus from this transaction. Once locked away in accumulated surplus, the reserve could never be used. It could never fund expenses because its use (withdrawal from the reserve) would not create revenue for accounting purposes—instead, its use would create an accounting deficit in the year of expenditure. There would be a mismatch between the timing of recording the grant/revenue (when received) and of recording the expense (when spent). In theory, these funds could never be used and would remain locked away indefinitely—not a good use of taxpayer funds.
The result is a misunderstanding among taxpayers and elected representatives about budgeting on a cash flow basis and reporting on a full accrual basis. Fortunately, it would be easy to reduce this misunderstanding. The solution would be to budget on a “PSAS” basis. This would require preparing the budget on exactly the same basis as the entity reports its year-end results. Identical accounting principles, groupings, and terminology should be used. Readers could then make appropriate comparisons between budgets and actual results, and could ask appropriate questions to hold management and elected officials accountable.
Of course, governments do need to balance cash inflows and outflows. Governments could accomplish this by adding a section to the budget after the “bottom line.” This new section would show cash outflows required for items that are not expenses. These type of items include: capital expenditures, cash inflows from new debt issues, transfer to or drawdown of reserve funds, etc. Separating these items in the budget would be helpful. It would allow the reader, with appropriate explanation, to see not only that an accounting surplus or deficit is planned, but why that is and how it will be funded. As noted, it is common for local government to report an accounting surplus because of required infrastructure spending. With this revision to the budget, the reader would see the planned surplus and that it was then used to fund infrastructure—gaining a much clearer picture.
While this would be an improvement, it still would not solve the anomalies that result from the BTAA/BBMAA combination. The change needed here is conceptually easy but politically difficult: The provincial government should amend the BBMAA. The change should require that there cannot be a deficit, determined on a PSAS basis, that exceeds cumulative reserves on hand at the start of the budget period. This change is not complicated, and there is precedence in the requirements of the Community Charter. However, it does take some gumption for any political party to put forward legislation that would make changes to statutes with names that include such positive terms as “Balanced Budget” and “Transparency and Accountability.”
The adoption of PSAS throughout all levels of government has been a terrific positive, and has indeed improved transparency and accountability. The current mismatch between the requirements of legislation and the full-accrual requirements of PSAS need only be a minor speed bump on the road forward. A little courage by provincial politicians and some standardization by local governments could easily get us past the current unfortunate side-effects.
Bill Cox is a partner with BDO Canada LLP, providing audit and assurance services to governments, NPOs, financial institutions, and private businesses. He is a member of the Public Sector Accounting Board and the AcSB/PSAB Joint Not-for-Profit Task Force.