Financial Statements in Government: A Compliance and Liquidity Approach

Summary of chapter III of Financial Reporting in Government
By Dr. John Sacco , George Mason University
Revised Saturday, April 12, 1997
The purpose of this chapter is to examine the formal approach that state and local governments use to present their financial statements. The chapter surveys these financial statements: These statements are designed to assess the financial success , conditions , and compliance of government performance. However, in government the focus of the financial statements is on individual funds not the government as a whole. Government is also much more concerned about success, conditions, and compliance for a given year rather than long term period. Over the past century a model called the compliance and liquidity model has prevailed as the guide for governmental accounting and financial reporting. There are several key elements in the compliance and liquidity model . This means that funds, a cash accounting basis, and the annual budget serve as the foundation for financial statements in government. It is a highly detailed, short term approach to reporting on financial performance. A considerable amount of information is given for any single fund and for that year but not for the government as a whole and not for long term periods. Thus reporting about long term debt and fixed assets are deemphasized in the financial statements. Adding to the detail and complexity of government financial statements, funds are reported by subunits of government. A government may have a primary unit then many subunits created by that primary unit. For example, the primary unit may have created a water authority, a hospital district, and sewage district. It is possible for each of these to have separate and distinct funds. One reason for the fund and subentity approach goes back to the reform efforts of the early 20th century to control in detail the raising and spending of money. The fund approach also fits with the plural character of U.S. politics. Interest groups use funds and subentities to develop and protect activities beneficial to them. In actuality each financial statement is for only one fund, although the physical presentation is a column format showing the subunits and funds next to each other. The statement of revenues, expenditures, and changes in fund balance can be compared to the income statement in business. The main difference is that government allows borrowing to be included in this statement to offset or balance spending; business does not. In essence, then, this statement is a statement of inflows and outflows of money not just revenues and expenditures. The next statement is the balance sheet . The main point of the balance sheet is the degree to which the government has sufficient liquid assets to cover liabilities that will come due within the next few months. It is really produces a short term picture. Long term information is given in something called the account groups . In other words, there is no easy or direct way to discern or measure the capacity of the government to meet long term obligations from information in these account groups. The third major financial statement in this chapter is revenue, expenditures, and changes in fund balance -- budget and actual . This statement is presented mainly to assess compliance. Did the actual inflows meet budgeted inflows? Similarly, did the actual outflow meet the budgeted outflows? Legislators are often keenly interested in this statement. It is presented for any fund that had a budget. Because there can be many specific funds in one fund type, financial statement must aggregate by fund type. There are three possible levels of aggregation. All funds of one type presented in summary form are referred to a the combined level. Each financial statement will have a combined level. Below the combined level is a more detailed level, with all the funds in a specific type. To differentiate it from the combined, it is called the combining. Finally, for someone who wants to look at each single and separate fund there is the individual fund statements. More recent discussion of government performance from those interested in reinventing government has been critical of the minutiae that has crept into government in general and financial reporting in particular. Funds are perceived as part of governments heavy rule laden operations. Funds can be so numerous and detailed that the general reader of financial reports gets lost and is unable to tell if mandates are being carried out and if the jurisdiction as a whole performed well. There are three basic types of funds and many subtypes within the basic types. A list of the three main types -- governmental funds , proprietary funds , and fiduciary funds -- and subtypes is given below:
Governmental Funds
Proprietary
Fiduciary
Financial statements should speak to the financial performance of the government. At the end of the year, the financial statement should help determine whether the government had a good or poor year in terms of handling and spending money? Notwithstanding the rhetoric of the recent GASB objectives to increase accountability, intergenerational equity, and efficiency, governmental financial statements are really set up for one main purpose -- compliance -- or how to make sure that money designated for a particular fund is raised and spent according to annual legislative mandate. Broader assessments of financial success and conditions for the entire jurisdiction are difficult, but not impossible, to make. Things like future revenue capacity, ability to pay short term debt, ability to pay long term debt, and ability to handle many specific obligations such as pension payment can be assessed by gather more data about the community. But things like intergenerational or interperiod equity which is mentioned in the GASB objectives would be extremely difficult to assess from information in the CAFR. In sum, these statements are directed toward whether the government brought in enough money to pay its bills during the period; whether the government had enough money at the end of the period to pay outstanding bills; and whether the government followed legislative and other legal mandates in raising and spending money. Intergenerational equity, or whether the government has raised enough revenue to cover all costs (spending, promises and use) is mentioned as an objective by GASB but no serious effort has been made to direct the financial statements to assess it. As a result, the statements focus on the annual and short term items. The short term emphasis probably reflects the short term nature of U.S. politics, with its many elections and its focus on satisfying many interest group demands.
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