Why are we doing this new accounting?

"Why are we doing this new accounting?

This question has been asked often of financial management personnel and, unfortunately, sometimes by financial managers themselves. The "new" accounting in question is the commercial-type accounting that federal organizations have begun to implement in the past few years.

As financial management stewards, it is important for us to understand why we are doing commercial-type accounting and the benefits our federal organizations derive from it. This article offers some perspective on this evolutionary change in business practices within the federal government and gives you some ammunition if you are asked to explain (or defend) our new accounting procedures.

Before proceeding, it is instructive to describe what is driving these accounting changes. As a result of the Chief Financial Officers Act of 1990 (as amended by the Government Management Reform Act of 1994 (GMRA)), all major federal executive departments and agencies now perform commercial-type accounting. These laws also require federal agencies to prepare annual financial statements.

Moreover, these financial statements must be audited by (and receive audit opinions from) independent audit organizations, such as the General Accounting Office (GAO), agency Inspectors General (IGs), or independent professional auditing firms engaged by the GAO or the agency IGs. These financial statements are similar to those prepared by commercial companies as are the audit opinions.

In addition, federal agencies prepare two (and, in some cases, three) financial statements that have no commercial equivalence.

To prepare these financial statements, federal agencies now must account for assets, liabilities, net position, revenues, and expenses. We call this proprietary accounting to distinguish it from budgetary accounting, which is the type of accounting that federal agencies traditionally have performed to track their use of budgetary resources.

One of the concerns typically heard about the new accounting relates to the associated expense incurred by the audited agencies. Since most federal accounting systems currently being used were designed to support budgetary accounting, the implementation of proprietary accounting typically necessitates major investments.

In fact, federal agencies have invested (or will invest) several billion dollars for new accounting systems capable of recording the transactions needed to prepare financial statements. These agencies will also incur significant annual costs to maintain these systems, record the transactions, and obtain the annual audits.

So what are the benefits to be achieved? First, by improving the timeliness and accuracy of financial information available for agency officials, they can make better, more informed business decisions.

Second, the production of financial statements and the audit of those statements (if unqualified) give assurance to the agency's primary stakeholders--the Congress and the public--that the agency is providing good stewardship over the assets entrusted to it. This includes accountability for real and personal property, as reflected in the accounting and subsidiary records used to produce the agency's balance sheet.

Justifying the Additional Costs of Implementing New Accounting--An Example

Although the tangible and intangible benefits are significant, people still may question whether those benefits justify the additional costs. To prove our point, let's explore one of the new financial statements--the Statement of Net Cost.

The Statement of Net Cost is similar to a commercial firm's income statement. Because most federal agencies (other than those resourced with revolving or franchise funds) are more concerned with costs than revenues, their Statements of Net Cost actually are a reverse of the commercial income statement. Rather than showing revenues and then subtracting expenses, this federal statement starts with gross costs and then subtracts revenues (reimbursements) to yield the net cost.

Net cost refers to those resources used in producing goods or services. It is determined using the accrual method of accounting. Within the federal government, accrual accounting refers to the appropriate matching of costs with the goods or services that are provided in an accounting period such as a fiscal year.

In contrast, the budgetary accounting system is based on obligations. Since budgetary systems do not employ full accrual methods, they cannot fully disclose the resources used in agency programs and activities.

As an example, suppose unit "A" and unit "B" each has a budget of $1,000. If both spend their entire budget, their costs using the budgetary (obligation) system are the same: $1,000.

If, however, unit A had spent $900 on September 30 and then ordered $100 in goods to be delivered in the following fiscal year, then its costs--as reflected in the proprietary (accrual) system for the current fiscal year--would be $900. The remaining $100 is shown as a cost in the following year (that is, when the goods are received and used).

Conversely, if unit B spent its entire budget without any orders outstanding at September 30, its costs would be $1,000 under both systems.

The preceding example illustrates why federal agencies have moved to accrual accounting. As a result of the new accounting, we get information on our costs of operations that is more accurate than we could obtain using only our budgetary system.

From here it is appropriate to ask a follow-on question: We may get better cost information, but what value is it?

To answer this question, one must look at another law that actually predated the GMRA: the Government Performance and Results Act (GPRA) of 1993. The GPRA, also known as the "Results Act," was enacted to effect a major change in the way that federal agencies operate. While it is beyond this article to offer an in-depth review of the GPRA, one of its important requirements is that federal agencies develop measurable output and outcome goals.

The GPRA encourages federal managers to focus on results. Agency leaders now must report on what the American public is getting for the money spent on agency programs. The goal is to answer questions such as, How efficient is the Environmental Protection Agency? and Are we getting our money's worth from the Head Start Program?

In the context of the Department of Defense (DAD), one might expect information on the costs of major weapons systems. DoD senior managers could then make better choices on alternative methods to perform a particular mission.

The discipline of recording this information on an accrual basis in DoD Components' accounting records makes it readily available and easy for decision makers to access. The need for extensive cost-finding methods is eliminated and costs can be tracked over time to determine trends and effect changes, as necessary. The information also is available to our stakeholders--the Congress and the public.

The current Administration has added emphasis to the need for measurable program performance by implementing the Program Assessment Rating Tool (PART) to the annual President's Budget submissions. These are, in effect, reviews of agency programs conducted by the Office of Management and Budget. The PART relies on accurate program costs that are not available in the budgetary accounting system. Reviews of DoD programs to date have included Recruiting, Defense Health Program, and Airlift.

While improved accounting accuracy supports the current Administration's efforts to integrate budget and performance, even greater benefits are on the horizon. The real value of the new accounting will be recognized when DoD proprietary accounting systems can provide information on the costs of operations at unit level.

To accomplish this, accrual accounting systems must be sufficiently sophisticated to collect proprietary accounting data at lower levels of DoD organizations. This would result in the availability of financial statement type information at installation level. It also will make accurate cost data available to managers at that level. Armed with accurate information on the costs of their operations, managers then will be able to develop and implement innovative ways to reduce costs.

While this will not be available until well into the future, one recalls the old adage that "a long journey begins with the first step." Accrual accounting is that first step.

Back to our original question. By now, we all should understand the reasons for implementing the new accrual accounting within federal agencies. Several years from now, and possibly earlier than that, I expect federal managers to be asking a different question: "How did we ever get along without the information that this new accounting provides?"

Ken Boerum worked in a variety of financial management positions in his 29-year Air Force career. His lost assignment was as an Appropriation Liaison Officer in the Office of the Under Secretary of Defense (Comptroller). Currently, he is a senior trainer and consultant with Management Concepts in Vienna, Virginia. He is a member of the Washington Chapter of ASMC.