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letter styles Revised April 2013 WHY GOVERNMENTAL ACCOUNTING AND FINANCIAL REPORTING IS—AND SHOULD BE—DIFFERENT Executive Summary Governments are fundamentally different from for-profit business enterprises in several important ways. Their organizational purposes, processes of generating revenues, stakeholders, budgetary obligations, and propensity for longevity differ. These differences require separate accounting and financial reporting standards in order to provide information to meet the needs of stakeholders to assess government accountability and to make political, social, and economic decisions. Although state and local governments (herein after referred to as “governments”) in the United States have had separate standards for over 100 years, the question is sometimes asked: Why can’t general purpose governments (cities and counties, for example) simply apply the standards established for business enterprises? 1 The following questions and answers briefly address that issue, and the accompanying paper and its appendices provide an expanded discussion. Why Are Separate Accounting and Financial Reporting Standards Essential for Governments? Separate accounting and financial reporting standards are essential because the needs of users of financial reports of governments and business enterprises differ. Due to their unique operating environment, governments have a responsibility to be accountable for the use of resources that differs significantly from that of business enterprises. Although businesses receive revenues from a voluntary exchange between a willing buyer and seller, most governments obtain resources primarily from the involuntary payment of taxes. Taxes paid by an individual taxpayer often bear little direct relationship to the services received by that taxpayer. Overall, taxpayers collectively 1 The term business enterprise is used to refer to private-sector entities organized for the purpose of earning profit. Business enterprises in the United States apply accounting pronouncements of the Financial Accounting Standards Board. Business enterprise does not refer to and should not be confused with business-type activities of governments. Revised April 2013 ii focus on assessing the value received from the resources they provide to a government. Governmental accounting and financial reporting standards aim to address this need for public accountability information by helping stakeholders assess how public resources were acquired and either used during the period or are expected to be used. Such reporting also helps users to assess whether current resources were sufficient to meet current service costs (or whether some costs were shifted to future taxpayers) and whether the government’s ability to provide services improved or declined from the previous year. The longevity of most governments and their role to maintain and enhance the well-being of citizens through the provision of public services also result in information demands that differ from those of business enterprises. For example, most governments do not operate in a competitive marketplace, face virtually no threat of liquidation, and do not have equity owners. Consequently, measures of net income and earnings per share have no meaning to users of governmental financial reports. Instead, users need information to assess the government’s stewardship of public resources, including information to evaluate the manner and extent to which resources are devoted to specific services and the costs of providing those services. Users also need information to determine compliance with legally authorized spending authority. Creditors of both businesses and governments are interested in information on the ability to repay debt. However, government creditors focus more on information regarding the government’s ongoing ability to generate resources and the costs of activities that could compete for those resources, rather than on information about how earnings are generated. How Do Existing accounting and Financial Reporting Standards Reflect the Different Needs of Stakeholders? The needs of the users of governmental financial reports are reflected in differences in the components of the conceptual framework for setting accounting and financial reporting standards and in specific accounting and financial reporting standards themselves. Although investors and creditors are important constituencies of every standards-setting organization, the Governmental Accounting Standards Board’s (GASB) conceptual framework also places priority on addressing the informational needs of citizens and elected representatives, two constituencies not identified as users of business enterprise financial statements by the Financial Accounting Standards Board Revised April 2013 iii (FASB). Consequently, the GASB’s financial reporting objectives consider accountability to be the cornerstone on which all other financial reporting objectives should be built. Some of the most significant examples of how GASB standards address differences between governmental and business financial reporting include (1) the view that capital assets are primarily used to provide services to citizens rather than to contribute to future cash flows; (2) the measurement and recognition of certain types of revenues (for example, taxes and grants); (3) the use of fund accounting and budgetary reporting to meet public accountability needs; (4) the use of accountability notions rather than equity control to define the financial reporting entity; and (5) the view that governments and their pension plans generally are ongoing entities with the ability to take a career-long view of the employment exchange. These and other accounting and reporting differences are described more fully beginning on page 12 and in Appendix B. Why Is There an Ongoing Need to Set Additional Governmental Accounting and Financial Reporting Standards? Since its inception in 1984, the GASB has strived to meet the needs of the users of governmental financial reports by issuing standards that reflect their particular concerns and the unique features of the government environment. Although the GASB has established a substantial body of standards, the need to develop and improve accounting and financial reporting standards for governments still exists. For example, additional components of the conceptual framework, which enhances consistency in setting government standards, are still being addressed. In addition, governments and the governmental environment continue to evolve over time and new types of transactions or variations on existing transactions continue to arise, resulting in an ongoing need to update existing standards and to adopt new ones. Revised April 2013 iv TABLE OF CONTENTS Page Number Introduction and Scope ............................................................................................................... 1 Why Are Separate Accounting and Financial Accounting Reporting Standards Essential for Governments? ..................................................................................................... 2 Major Environmental Differences between Governments and Businesses ......................... 3 How Do Existing Accounting and Financial Reporting Standards Reflect the Different Needs of Stakeholders? ............................................................................................ 7 Conceptual Framework Differences .................................................................................... 7 Accounting and Financial Reporting Standards Differences .............................................. 9 Why Is There an Ongoing Need to Set Additional Governmental Accounting and Financial Reporting Standards? ............................................................................................. 12 Conclusion ................................................................................................................................ 13 Appendix A: Distinguishing Characteristics of the Governmental Environment ................... 14 Appendix B: Additional Examples of How Governmental Accounting Differs from