Modernizing California City Financial Reporting

Marc Joffe and Max Neiman
Marc Joffe, Principal Consultant at Public Sector Credit Solutions and Max Neiman, Senior Resident Scholar at the Institute of Governmental Studies and Professor Emeritus, University of California, Riverside

We are all aware of the highly publicized cases of city bankruptcies in California, and while these are individually serious cases, there has been a lot of speculation, often without solid analysis, concerning how vulnerable many of California’s stressed cities are to bankruptcy or default on bonds.  Much of the inaccurate guesswork and sensationalism is abetted by the fact that fiscal data for California’s municipalities are not being compiled nor made accessible in a form that permits timely and suitable analysis.

There is a way and opportunity to remedy this problem and improve public confidence and trust in their local governments, provide needed information to take advantage of crowdsourcing, and also, in the long run, enhance the efficiency and accessibility of public finance information.

Suitably available data, in a format and at a time when it can help us pinpoint troubled localities is necessary in helping to dispel unwarranted or inaccurate conjectures. Here is our proposed solution.

Every year since 1911, the California State Controller’s Office has been publishing data that can greatly assist in the effort to provide timely analysis of local government spending. The SCO data set, known as the Cities Annual Report is available on the Controller’s website and can be retrieved in PDF format or in database form.  Cities, among other local governments, are required to report financial data to the state.  However, a major drawback in these data is the fact that it is woefully late and, therefore, useless as the basis for an early warning system.  Indeed, as of today, the earliest available data, at least on the Controller’s website, is for the 2010-11 fiscal year.  It is also unfortunate because cities are also submitting similar data to other entities.

Under current procedures, the Controller’s report is released at least 14 months after the fiscal year end, and usually even longer. Further, the reported values do not correspond to audited financial statements or Comprehensive Annual Financial Reports (CAFRs) that most cities are required to file.

In 1984, the Government Accounting Standards Board (GASB) was formed. GASB standards apply to virtually all governments of significant size. Governments issuing municipal bonds are typically obligated to file financial statements conforming to government accounting standards. And, under the Federal Single Audit Act, local governments that receive federal grants in excess of $500,000 annually are required to file audited financials – which usually adhere to GASB studies.

In a recent study, one of us found that the vast majority of California cities with population over 25,000 had filed 2012 audited financials by the end of April 2013.  These data should be far more accessible, not only to public officials, but also to members of the public. Audited financial reports are typically published either on individual cities’ web sites or on the Municipal Securities Rulemaking Board’s Electronic Municipal Market Access system (EMMA) web site or on both.  Although some reports are late, the overwhelming percentage of cities file within a year of the due date, and these data should, therefore, be available far earlier than are the Annual Reports from California’s Controller.

Reforms to the SCO reporting system and technology improvements can greatly improve the quality and timeliness of California municipal financial reporting. We propose three such reforms below.

First, we recommend that SCO accept audited financial reports in lieu of filings based on its existing format. The few cities that are not required to prepare audited financials should migrate to a GASB-compliant reporting format.

Second, the State should set a single deadline for local governments to complete audited financials and align this deadline with SCO’s filing deadline. This will ensure that local agencies have time to submit audited financials to SCO.

Finally, the SCO reporting capability should be overhauled to display each city’s data shortly after it is reported. Right now, there is an 11 month gap between the city reporting deadline and the publication of that year’s Cities Annual Report. The report includes data for all but a handful of cities that fail to file.

One way to reduce the lag between city reporting and SCO publication is to apply greater automation. Currently, local agency audits are typically published in PDF form. This means that someone, either in the city or at SCO, would have to retype or laboriously copy and paste the audited financial statements into a database.

Today, the SEC requires companies to file their financial statements in a machine readable-format called eXtensible Business Reporting Language (XBRL).  To implement our idea, SCO would have to create an XBRL taxonomy consistent with US Government Accounting Standards and then implement a system to load conforming XBRL submissions from local agencies into a central database. The XBRL community includes a number of non-profits and commercial firms that can advise and assist in this task. For example, the non-profit Financial Accounting Standards Board has a unit that maintains the XBRL taxonomy for corporate financial reporting. Another not-for-profit, XBRL.US acts as industry group for XBRL users and service providers.

With access to relatively current, machine readable data, municipal bond analysts and public interest researchers will be able to the number crunching needed to more quickly identity at-risk cities. As they do in the corporate world, analysts will be able to identify and monitor financial ratios that provide early warnings of trouble.

Hiram Johnson’s administration left California with a legacy of progressive reforms that remain relevant today. To remain effective, these reforms need care and feeding. Just as the system of popular democracy requires updating in an era of special interests and mass media, Johnson’s mandate for local government financial reporting needs to advance into the internet era. By aligning SCO reports with financial audits and developing a language for standardized machine readable reports, we can leverage Johnson’s legacy to address today’s need to identify and address cases of municipal financial distress.

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