CHICAGO -- Instituting a GAAP-based accounting system can be traumatic.
Just ask officials in Iowa. The adoption of generally accepted accounting principles has sparked a lawsuit by a taxpayers group that claims the state's move to GAAP has uncovered an unlawful deficit.
Generally accepted accounting principles are a series of standards, conventions and rules set by the Government Accounting Standards Board that accountants follow in preparing financial statements. The method essentially requires governments to accrue revenues and expenditures at the time they are received or committed to be spent, rather than when the money actually changes hands, said James Antonio, chairman of the Government Accounting Standards Board.
The state constitution prohibits the state from ending a fiscal year more than $250,000 in debt, unless the debt has been approved by voters. But Iowa, which is in its third year of a five-year GAAP switch-over process, reported a $130 million GAAP deficit for fiscal 1990, which ended June 30, and projects a $228 million GAAP deficit for fiscal 1991.
Iowans for Tax Relief plans to refile a suit against the state charging that its current cash-accounting budget system, which shows an estimated $18 million surplus at the end of the current fiscal year, is unconstitutional. The group, which claims using the cash-accounting system hides an unconstitutional deficit, says switching to GAAP right now would reveal the true deficit.
The group will ask the Polk County District Court to order the state to sue GAAP in determining its end-of-the-year balance. Its previous lawsuit was dismissed in April on technical grounds.
Under current law, Iowa must completely switch to a GAAP-based accounting system and eliminate any GAAP deficit by the end of fiscal 1993.
"When you move to GAAP, many times there are expenditure liabilities that heretofore were not recognized, while most of the revenues have been recognized," explained Relmond Van Daniker, executive director of the National Association of State Auditors, Comptrollers and Treasurers. "So possibly you are increasing the amount of your expenditures, and that is very traumatic because you are forced to look at things you never looked at before."
And those "things" being looked at could shift a state's finances into the red.
"What happens often when a state moves to reporting on a GAAP basis is it ends up reporting a weaker financial position than its budgetary or cash basis indicated," explained Steve Hochman, assistant director of state ratings at Moody's Investors Service.
Most State's Methods
Industry officials said most states that adopt GAAP reporting continue to use their own accounting methods for budgetary purposes. Wisconsin is one such state.
For Wisconsin, which is in the final stages of putting out its first audited comprehensive annual financial report on a GAAP basis, the general fund deficit could exceed $1 billion. Under the state's statutory or cash basis of accounting, the last time Wisconsin experienced a deficit was in fiscal 1983.
In its official statements, the state has been listing the major differences between its current accounting system and GAAP, as well as its calculations that under GAAP the unreserved fund balance of the state's general fund would have experienced a deficit of $302 million in fiscal 1987 and $335 million in fiscal 1988.
But last month, the state released a supplemental disclosure message for a $60.5 million general obligation bond issue prior to the issue's competitive selling date of May 16.
In the message, the state pointed out that in the process of preparing the GAAP audit for fiscal 1990, the possibility arose that the auditors would accrue state revenue-sharing payments to local governments in the fiscal year they are estimated even though the money is not dispersed until the following fiscal year.
According to the message, the accrual of those payments would have increased the deficit in 1987 and 1988 by about $779 million.
State officials said the actual GAAP balance for fiscal 1990, which ended June 30, will not be known until the audited report is completed sometime this month.
Still, the spector of sizeable GAAP deficit had no negative effect on the bidding process, according to Frank Hoadley, the state's capital finance director. He said the true interest cost for the offering -- 6.4477% -- was the best the state has had since 1980.
Mr. Hoadley also said the fact that his office spent extra time talking to potential bidders on the issue to ensure that they understood the supplemental disclosure message and the presence of a strong market may have worked in Wisconsin's favor.
How big a problem a state could suffer in terms of a deficit uncovered by GAAP reporting will depend on its current accounting system, according to Mr. Antonio.
Mr. Antonio said states using cash-basis accounting for both receipts and expenditures "tend to look not too well off under GAAP." Other states that apply cash accounting to revenues but accrue expenditures, on the other hand, "look the same or better" under GAAP, he added.
But regardless of the problems involved, Mr. Antonio said he cannot think of a reason not to implement GAAP, which he said gives an overall indication of a government's ability to generate money to pay its bills on time. All but two of the 50 states have incorporated GAAP into their financial reporting or are in the process of adopting the system, according to the state auditors, comptrollers, and treasurers association.
Mr. Antonio said one of the prime motivators for the movement to GAAP has been the call by rating agencies for more informative financial reporting.
Hyman Grossman, a managing director at Standard & Poor's Corp., said GAAP accounting allows the agency and the governments to "compare apples and apples" -- states with other states and cities with other cities.
In fact, Standard & Poor's, in its criteria statement for municipalities, considers the absence of financial reports prepared in accordance with GAAP "a negative factor."
Mr. Hochman at Moody's said even if GAAP reporting reveals a detrimental shift in a state's financial position, it does not mean a change in a state's credit rating is imminent: The rating agency may have already been aware of an expenditure that was not accounted for under the state's normal accounting system.
"What may occasionally change our view is if a GAAP report reveals a problem not previously known," he said. "And that doesn't happen very often."
With Wisconsin's bond issue last month, both Standard & Poor's and Moody's affirmed their double-A ratings of the state's GO debt. However, while officials at the agencies said they were not concerned about a GAAP deficit for Wisconsin at the present time, they would review the state's first audited GAAP report when it comes out.
Meanwhile, Wisconsin's next trip to the market has been scheduled for June 19 with a competitive sale of up to $525 million of tax and revenue anticipation notes for cash-flow purposes. Mr. Hoadley said by then he hopes to "remove any question of doubt" as to whether the accrual of the revenue sharing payments will occur.
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He added that the state's Legislative Audit Bureau, which is conducting the independent audit report, could decide any time on that question.
Will the GAAP audit affect the state's creditworthiness? Maybe.
"We don't take the audit per se and make a rating adjustment," said Catherine Fleischmann, an assistant vice president at Moody's. "It's one of many factors we use."
'A Consistent Picture'
In Iowa, the definition of what entails a deficit according to the state's 150-year-old constitution may ultimately be decided in court. Still, state officials said the accounting change is long overdue.
"I think it's all worth it to go onto GAAP because you have a clear, true, consistent picture of our finances," said state Treasurer Michael Fitzgerald, adding that under the current cash-accounting basis, "our bottom line is essentially meaningless."
He said Iowa's rating has been hurt by the lack of GAAP reporting. When the state did its first tax and revenue anticipation note issue in 1985, Iowa's "confusing" accounting system was one reason the issue did not earn the highest short-term ratings from Standard & Poor's and Moody's, he added.
In Wisconsin, which has a constitutional requirement for a balanced budget, the state's attorney general has ruled that the state can meet the requirement through its statutory-based accounting method, Mr. Hoadley said.
Wisconsin will continue to use its statutory-based accounting method along with GAAP reporting
