Nothing has the power of accrual accounting to unmask and curtail reckless fiscal behavior by elected officials. As one example, accrual could’ve stopped the largest non-voter-approved debt issuance in California history.
That happened in 1999, when legislation proposing a retroactive pension increase for state employees was introduced in the California Legislature. Accrual accounting would’ve forced state officials to acknowledge a large expense in the 1999 budget as a result of the legislation. But because the state employed cash accounting and no cash changed hands that year, the deal was hidden from that year’s budget. The legislation was quietly enacted into law without notice that elected officials had just transferred tens of billions of dollars to a special interest.
Since then, cash has been siphoned from the state budget to meet the cost of the legislation, triggering recognition of the expense only in future budgets, not the budget year the obligation was created. While accrual accounting would’ve exposed everything in time to stop the deal, cash accounting provided an “invisibility cloak” to hide the transaction until it was too late. California’s universities, transportation systems, courts, parks, social services, environment and taxpayers are still paying the price and will continue paying the price for years to come.
As with the failure to account for destructive greenhouse gases, one day our descendants will look at the pre-modern cash accounting system California employed to cloak the creation of destructive financial obligations and wonder why we allowed that to happen, especially when weknew the fix. While Governor Jerry Brown would need the legislature or voters to enact (say) arevenue-neutral carbon tax to benefit environmental sustainability, he wouldn’t need the legislature or voters to adopt accrual accounting to benefit fiscal sustainability.
To its credit, the California Legislature is considering legislation to pay down $240 million of previously-cloaked obligations. But that’s just 2 percent of the more than $10 billion of new obligations created-and-cloaked just last year. It’s not enough to remind legislators of a moral obligation to address these unsustainable actions. Accrual accounting would force action on the scale required to protect future generations. Brown should commence the transition to accrual — which is to say, sustainable — accounting without delay.
UPDATE:
In response to my post, a journalist asked if California was not already employing accrual accounting of the type I describe. The short answer is “no.” The accrual basis form of accounting to which I refer in my post is known as “full accrual,” which is defined by the California Department of Finance in the manner pasted at the bottom of this message. The less robust form of accrual accounting California currently employs is known as “modified accrual” accounting, the definition of which is also pasted below.
When it comes to the reporting of expenses, a key difference is that modified accrual doesn’t pick up the creation of non-cash obligations such as pensions and retiree healthcare that will require future fiscal year appropriations. For example, this year California will not include in its budget $3.72 billion of accrued OPEB (retiree healthcare) Cost (see chart on page 8 of 2015 OPEB report here). There are also big differences when it comes to the reporting of revenues, an example of which will be the subject of a future post.