Accounting changes set to take effect over the next several years will dramatically alter state and local government financial statements, potentially affecting everything from credit ratings to demand for municipal bonds.
The changes come from the two groups that develop formal reporting standards for the accounting industry: the Governmental Accounting Standards Board and the Financial Accounting Standards Board.
For municipal issuers, the major news from GASB is a plan, known as Statement 11, to make governmental accounting more closely resemble the "full accrual" system that guides corporate America's accountants.
Full Accrual Proposal
FASB's major contribution is a plan to force banks to value investments like long-term municipal bonds at market prices, rather than their original cost. The change could reduce demand for tax-exempts, bank executives say.
Under full accrual, entities account for revenues and expenses as bills are incurred or tax liabilities accumulate, rather then when money actually comes in or is paid out.
The switch will not truly be to a full accrual system because it does not take into account depreciation, but it will be much closer to full accrual than the system now in place, explained Martin Ives, a GASB vice chairman.
"We're trying to look at whether, in a particular period, the government's revenues are sufficient to pay for the services rendered," Mr. Ives said, explaining the purpose of the switch. "If services were rendered but no expenses recorded, we want to record it."
The implications of such a switch, set to take effect for fiscal years beginning after June 15, 1994, will be felt on every level of governmental operating statements from debt service and pension plans to paid vacations and sick leave.
One of the key questions at GASB that still needs to be resolved before implementation is how to account for zero coupon bonds under the new system, Mr. Ives said.
The question is whether principal and interest, which are not paid until zero coupon bonds mature, should be reflected in financial statements at maturity or gradually over the life of the debt.
Effect on Pension Plans
Pension plans are another area in which the effects of GASB's pending switch will be felt. Under the current method of accounting for governments' pension liabilities, governments typically record expenses when a beneficiary retires and begins collecting.
But full accrual would require a system that gradually accounts for the liability as it accumulates during a person's period of employment.
Similarly, compensated absences from work accumulate gradually, and must be periodically accounted for under the full accrual system, Mr. Ives said.
Debt service that accumulates during the months between scheduled payments is another area being scrutinized for reporting changes.
Government officials would also be required to estimate likely legal liabilities when lawsuits are filed and account for the money immediately, rather than when an exact settlement or judgment is rendered.
Some municipal market participants, most notably the former chairman of Financial Guaranty Insurance Co., Gerald L. Friedman, have called for including depreciation in the new governmental accounting system.
But GASB's plan is only to develop a "deferred maintenance" category, which would note failure to adequately maintain infrastructure assets.
Analysts agree the effects of Statement 11 will include increased revenues and increased expenditures reflected on government operating statements. Mr. Ives said he expects expenditure accruals to outpace revenue accruals, but he does not see major credit implications for government entities.
Hyman C. Grossman, a managing director at Standard & Poor's Corp., said in recent edition of the rating agency's Credit Week Municipal that Statement 11 will "increase the accountability of government finance officials and may affect the way S&P views the fiscal condition of local governments."
Mr. Grossman predicted municipalities may be forced to increase their use of short-term borrowing to cover spending in areas in which revenues have not yet been received. But he said rating moves would be an unlikely consequence.
"Although S&P sees no immediate credit rating changes resulting from the rule changes, governments and users of financial reports need to begin to understand them so they can begin to prepare for the new accounting environment," Mr. Grossman said.
He predicted property taxes would be the prime source of higher revenues, because the new system recognizes the entire amount of taxes due. Under the current system, property taxes are recognized if they are collected within the fiscal year or within 60 days after the end of the year in which they are due.
Sales and income taxes are also expected to show increases because they too, would be recorded when due, analysts say.
Expenditures would be higher because they will be recognized in the period incurred, regardless of when cash is paid, Mr. Grossman said. The biggest increases will likely be in the area of compensated absences, such as vacation and sick leave.
Another major change in the works is the treatment of long-term debt. Capital financing will not be affected, but municipalities will no longer be permitted to use operating debt as a source of revenues. That means government officials can no longer use long-term debt to offset financial statement deficits.
Apart from the issues surrounding implementation of Statement 11, GASB is studying how to track, from an accounting point of view, governments' effectiveness at providing services with available resources, Mr. Ives said.
One example of such an accounting requirement might be the ontime performance of a rapid transit system, he said. GASB would not prescribe what the on-time performance should be, he added, only that it be disclosed in some way in governments' financial statements.
"Private industry accounting deals with performance of a company, so what would be the reasonable measure of performance in government?" Mr. Ives said.
He stressed that the idea is extremely preliminary and at least several years from implementation.
While GASB continues its work on revisions to government accounting procedures, the financial standards board has been considering its own changes.
FASB's most significant proposal would require banks to value their investments at current market prices, rather than original cost.
Under current accounting rules, banks must report only assets held for short-term trading at market value, while long-term investments are recorded at cost.
Bank executives warn that the change, known as mark to market, could affect demand for tax-exempts by discouraging banks from investing in longer-term municipal bonds.
Their argument is that major swings in interest rates would create big swings in reported earnings, which banks could avoid by not buying fixed-rate medium- and long-term bonds.
Since many small issuers around the country depend on banks to buy their bonds, they could be particularly hard hit, according to analysts.
Nevertheless, the FASB board voted last month to require mark-to-market accounting for banks. Public hearings are expected early next year, and a final rule could take effect in late 1993.
Securities and Exchange Commissioner Richard Roberts supports the move, and said in March that the board's shift would not reduce demand for long-term municipal bonds.
But Treasury Secretary Nicholas Brady took the opposite stance, saying that banks would try to avoid volatility in reported earnings and capital by cutting holdings of mortgage-backed and municipal bonds.