Since 13th century Italian traders modified earlier systems, accountants have used double-entry bookkeeping systems.  This method of accounting consists of balancing assets and liabilities to ensure that all transactions are recognized and have been included in a book of accounts.  With nearly 800 years of experience tallying assets and liabilities, one would think the accounting profession would have a generally accepted definition of what a “liability” is.
Not exactly.

This past week, the Governmental Accounting Standards Board tackled the notion of what constitutes a recordable liability.  The Board, known as the GASB, has the mission of developing “effective standards of accounting and financial reporting for state and local government.”   To meet this goal, the GASB periodically examines the state of the accounting art to propose changes that the Board believes will improve transparency, accountability and provide information that leads to more informed public policy.
Under discussion last week were potential changes in the way that state and local governments account for pension and other post-employment benefits for public sector employees.  The controversy stems from the practices public sector entities use to account for—and fund—the pensions that have been promised to their employees.

In the extreme, some believe that pension benefits are obligations that will only become payable in the future and do not need to be recognized in the present.  After all, they will not be due for years.  On the other hand, some accountants believe that employees earn a small piece of their pension every year they are on the job and that such an accumulating obligation should be recognized in the year that it arises.  Thereafter, this obligation should be carried forward each and every year, into the future, until it is paid to the beneficiaries.
The first viewpoint, the one that puts off recognition until the bills actually become payable, is known as “cash basis” accounting.  The folks that believe in recognizing future obligations when they are created favor “accrual” accounting.  Currently, the practice is something called “modified accrual” accounting that allows public entities to avoid directly recognizing accruing and significant pension and other retirement costs on their financial statements by putting the information in footnotes to their statements.

That’s where the question of what’s a liability arises.  Pensions, and to a lesser degree, other retirement benefits, are obligations that are calculable, reasonably certain and will be paid at known, future times.  This is especially true with many governmental employers because state constitutions often guarantee the payment of benefits, once earned.  These qualities certainly seem to fit the definition of a liability and, one would think, be necessary to recognize in a state or municipality’s financial statements.

The trouble with that logical course is that it runs afoul with politics in state capitals and city halls.  That’s because putting the accruing employee costs in public budgets and financial statements would consume some of the entity’s revenues.  That’s a problem because almost all state and local governments are required to balance their budgets, which means that politicians cannot spend more than is available to spend.  By failing to account for currently accruing pension costs, that is, deferring the recognition of pension costs into the future, more money is available to spend today.  That’s why politicians would prefer to defer recognizing their certain obligations. 

One of the primary purposes of balanced budget requirements is to keep one generation from transferring its obligations to the next generation by borrowing explicitly or in the case of unrecognized pensions, implicitly.  This notion is known as intergenerational equity and it is an imperative we should respect for our children’s sake.  By failing to recognize the promised pension and other post-employment benefits as a liability, immediately on becoming an obligation, public sector accounting frustrates the very purpose—and effectively evades—the balanced budget requirement’s objective.

These are among the points Sheila Weinberg, Founder and CEO of The Institute for Truth in Accounting, brought to the GASB’s board’s attention in invited public testimony last week.   It is her hope that the board will come to the conclusion that all liabilities should be recognized as soon as they become evident.  Sustainable public policy is possible only by understanding a state or local government’s  true financial picture and that includes recognizing accruing personnel costs.  While the IFTA was the only representative of the general public, Sheila was followed by the American Institute of Certified Public Accountants which presented its own testimony that agreed with the Institute’s points  in almost every particular.

The GASB board will consider the Institute’s testimony and the testimony of others interested in the subject.  It is the Institute’s belief that the best decision would be to immediately recognize all the accrued costs and define them as a liability.   This is what private companies did more than a decade ago and while momentarily painful, telling the truth has had long-term benefits for them.  One hopes the GASB will answer the 800 year old question and do the right thing.