It may be a surprise, but a good number of municipal governments do not use Generally Accepted Accounting Principles (GAAP) when preparing their financial reports. According to a GASB survey of 17,577 local governments (out of the over 87,000 non-federal governments in the U.S.) about 67 percent use GAAP.
Is this a problem? Publicly traded companies must be GAAP compliant but bond-issuing municipalities need not comply. A January 2011 study by GAO finds that stakeholders (analysts and issuers), consider GAAP reports more accurate and complete, but there are other sources of information on the quality of municipal securities. Interestingly the decline in the use of bond insurance – a piece of information that investors use in lieu of GAAP statements – may increase the need for local governments to comply with GAAP in their annual financial statements.
The main argument against local governments using GAAP is that it is complex and thus costs more money to prepare the reports. Having reviewed the financials of several municipal governments with looming long-term obligations I suggest GAAP accounting might have helped to better alert officials to the potential risks on their books.
Along with many municipal governments, Surprise, Arizona is facing budget problems this year. In addition to decreased revenues, some of the city’s problems are coming from its history of poor budgeting practices.
The city’s Accounting Division says that department adheres to Generally Accepted Accounting Standards (GAAP), which are industry guidelines for following the principles of sound accounting. In light of recent finance problems in Surprise, the Arizona Republic questions whether the Finance Department actually has been following GAAP guidelines. Faulty accounting may have led to a budget shortfall in fiscal year 2009 that was revealed this fall.
Financial messiness in Surprise is minor compared to many of the accounting problems common in government budget offices. One of the most common areas for accounting gimmicks is in government pension funds, where budget offices can relatively easily alter cost estimates. However, even more blatant gimmicks have resulted when states have moved their employees’ year-end pay checks to the next fiscal year in order to close budget shortfalls. The Daily Reporter outlines other shocking budget antics here.
In the private sector, scandals have unfolded around firms such as Enron and Worldcom that engaged in similar fraudulent practices, but public sector employees and elected officials do not face the same consequences when they use unorthodox methods to balance their budgets.