GASB's New Hornet's Nest: 'Economic Condition' Reporting
Should financial projections be "required supplementary information"?
The Governmental Accounting Standards Board (GASB) has issued a new preliminary views (PV) document that is likely to stir up another hornet's nest in the municipal finance community. At the same time that the board is moving toward requiring more complete disclosure of pension obligations on the financial statements, GASB is now considering a requirement for state and local governments to also include a new schedule showing five-year projections of the following financial information:
- Projections of cash inflows and cash outflows, with explanations of the known causes of fluctuations
- Projections of the financial obligations, including bonds, pensions, other post-employment benefits (OPEB), and long-term contracts, with explanations of the known causes of fluctuations
- Projections of annual debt service payments, including principal and interest
- Narrative discussion of governments' dependencies on other governments to provide its services.
The GASB document is very preliminary in that the board is already divided on whether this information is appropriate or necessary in an audited financial statement (see page 30 for two members' "alternate views"). So this document is likely to invite a very spirited debate about what data belongs in an annual financial report. I won't be surprised if it also engenders another round of criticism of GASB itself from those who construe its standards-setting mission and charter more narrowly. Don't be surprised to see terms like "burdensome" and "overreaching" in some of the public comments and during GASB advisory board meetings in coming months. I have no doubt that small municipalities will howl that this kind of data is beyond their capacity to produce and will be either superfluous or misguided.
Next year, after I have a chance to confer with several of my colleagues on technical matters as well as the policy implications, I'll have more to say about this GASB project. As a former board member and a practicing consultant in the field of public finance, it's important for me to be Switzerland on this issue -- at least for now. But here are a few observations and suggestions to help frame the discussion and debates that are likely to ensue:
- Although there are accounting, auditing and disclosure standards for forward-looking financial information in the commercial sector, many governmental CFOs and auditors will wonder whether they are being "picked on" to assume a new level of legal and professional attestation risk in the governmental accounting sector when there is no comparable strong corollary in the private sector. As two of the GASB board members noted in their alternative views, many governmental auditors will probably be nervous about their role in reviewing these projections if the standards fail to provide guidance on the methodologies required.
- The board has lumped together a lot of information that is not necessarily indicative of the "economic condition" but rather "fiscal sustainability." I wonder if the latter phrase might be the better focus and title of this project. Refer to number 6 below regarding pensions and debt service, where a longer view of fiscal sustainability is preferable, feasible and less problematic than operating fund projections.
- Property tax revenues in many states are subject to local government budgetary decisions that are "challenging" for a finance officer to project, predict or anticipate. For entities subject to a tax cap and levying the full rate allowed by law, the projection process might be straightforward, but I'd hate to be a finance officer making projections of future tax rates that could be adjusted at will by the governing body in the budgetary process. Although the PV document makes reference to current policy, it's not uncommon for many local governments in some states to make annual adjustments to tax rates (a normal policy decision) that would avert a projected budgetary deficit or a tax surplus. Wouldn't projections of future tax revenues in such situations be subjective, conjectural and politically toxic for finance officers? This model could cross the line of the policy/administration dichotomy that is revered in the profession of public administration, if CFOs are forced to become mind readers.
- One of the largest components of governmental expenditures is employee compensation -- which is often governed by collective bargaining agreements. To the extent future years' projections are based on definitive pay obligations under those agreements, a forward-looking approach is viable, but what happens in the out-years when the contracts will have expired? Will finance officers' projections of future compensation rates be used against the employers as commitments, or used in arbitration proceedings as evidence? Won't compensation assumptions used in making forward projections be speculative? Will finance officials be required to confer with elected officials on what numbers to use? In the collective bargaining world, this required public information could be a can of worms for the employer. If the required revenue and compensation projections are deemed "reliable" in accounting jargon, they could become an albatross for public employers in the hardball world of labor negotiations and arbitration.
- Given that most governments lack an in-house economist to make revenue projections, GASB will have to give consideration to a "safe harbor" economic data set that could be referenced as authoritative in making these projections, as well as guidelines for reliable data projection sources and methods that a statement preparer can rely upon to avoid criticism or even litigation for misestimation. Just how they might do that without stepping onto budgeters' turf is hard for me to imagine at this early stage of the discussion. If we go back to the fundamental qualitative characteristics for financial reporting referenced in the PV document (on page 23), including reliability, comparability and consistency, it is clear that widespread variations in practice could immediately undermine the value of this information just as much as irrelevant assumptions and national averages that bear no resemblance to local conditions. Either way, GASB could be treading on thin ice with its core principles.
- Capital projects and capital budgets can be very controversial, and the best laid plans of governmental engineers are often scrapped when the public has a chance to voice its views on projects included in a typical five-year capital program. If projected capital outlays were to be included in the GASB schedule, will this confer undue status on capital plans that elected officials would be reluctant to make public? Would it invite omission of inevitable but unpopular projects that would later break the bank? Finance officers would be damned if they do include certain controversial and necessary projects that elected officials could view as subjects of election campaigns that they are not ready to fight. On the other hand, failure to include vitally needed infrastructure work in the projections would look like deception and invite poor fiscal management.
- Mathematically and statistically, operating budget projections become increasingly imprecise as the projection period is lengthened, so five years is probably a practical limit. But for pension, OPEB and debt service projections, the numbers are much "crisper" and can be derived from other public information sources to make meaningful projections for 10, 15 or even 20 years. I have previously suggested to GASB that such long-term projections should be disclosed for public retirement plans, and continue to advocate such extended forward-looking disclosure. Perhaps this longer-term data (which addresses "fiscal sustainability" more than "economic conditions" anyway) would be more usefully presented in a distinct, separate schedule.
- Will financial statement readers and users actually find GASB's proposed format for information useful for decision-making? Are there other formats that would be more helpful? I'm not even sure that the cash basis is the right model here: We have enough mischief with cash-basis budget gimmicks in some states and localities already, and this format may invite similar problems such as planned pension holidays and pay-as-you-go OPEB funding to keep the cash flows looking better than GASB's own proposed accounting standards. Could a sale-leaseback of a capital facility like a parking structure distort this model? After years of migrating governments to accrual accounting for the general purpose financial statements, GASB's proposed approach here may seem curious if not incredulous to municipal accountants who came kicking and screaming after GASB Statement 34, which mandated accrual accounting.
- Would presentation of historical trends in intergovernmental revenue dependency be sufficient to alert readers of that exposure if local officials are not well qualified to make guesses about the capacity of the federal and state governments to continue funding on which they rely?
- Does this project invite a "Big GAAP, Little GAAP" approach that exempts smaller municipalities from the burden of these projections? Perhaps there should be a way for a government's legislative body to voluntarily exempt itself formally from this projection if it declares that (a) its current financial plan is sustainable, (b) that it foresees no structural budget deficits that cannot be funded with available discretionary tax and revenue authority, (c) that it now funds its pension and retiree medical plan using prudent actuarial contributions compliant with professionally recognized standards, and (d) the professional costs and litigation risks of making these forward-looking projections are burdensome and outweigh the potential benefits to financial statement readers. That would relieve the finance officer and the auditor of disclosure liability and put the monkey on the backs of the elected officials if they decide to conclude officially that this information is extraneous, and not cost-beneficial. Although this approach has its merits from the standpoint of local determination, the problem with this slippery slope standards strategy is that the most misguided local government officials will be inclined to make such declarations without a genuine foundation, and their taxpayers will ultimately suffer when the truth comes out.
These are just a sampling of the kinds of thorny issues that the GASB board and the governmental finance community must consider and discuss in 2012. If the stakeholder professional associations object to GASB's approach to disclosure of forward-looking financial information, it would be helpful if they proactively included something similar in their guidelines for comprehensive annual financial reports, budget documents or bond-issuance financial disclosures, and not just file objections.
I encourage readers to read the entire PV document, and read the questions the GASB board has thoughtfully framed, very closely. This new research project may be unpopular in some circles, and I have no doubt that the focus and presentation formats can be improved. That said, GASB cannot be faulted for raising the issues outlined in its PV document, and for making suggestions for improved disclosure of important information needed to evaluate fiscal sustainability of state and local governments. If historical financial information alone won't show elected officials and bond investors the handwriting on the wall for adopting sustainable financial policies and making intelligent investments in muni bonds, then we clearly need more and better information including forward-looking data to support improved decision-making. Otherwise, "sustainable public finance" in state and local government is nothing more than a vacuous conference slogan that means nothing in practice, and we are ultimately no better than Greece -- just a few years behind them.
Disclosure and disclaimer: Girard Miller's comments, suggestions and views herein are his independent views and do not necessarily reflect those of any organization with which he was or is presently affiliated.