Shooting the GAAP

Straying from standards could result in slide down a slope

Ever since the invention of the double entry bookkeeping system during the Italian Renaissance in the 15th Century, the accounting profession has slogged forward on a long, slow march toward development of uniform standards so that anyone reading an organization’s books could understand them. There were stops and starts – the stock market crash of 1929 was maybe a low point – but eventually the preferred standard of accounting became known as Generally Accepted Accounting Principles, or GAAP.

Initially implemented in the private sector, in the second half of the 20th Century the use of GAAP for American governments underwent a gradual development until 1984, when the Governmental Accounting Standards Board (GASB) was established as a private, non-profit group in Connecticut. Since then, attainment of GAAP has been the near-uniform goal of government auditors across the country.

It’s the Bible of the business – which is what makes it difficult for Travis County Auditor Susan Spataro, who has taught accounting at the Universities of Ohio and Texas, to suggest that the GAAP standard just be ignored for the purpose of accounting for retiree health benefits.

“Being on GAAP is always preferable, because you’ve got a common methodology and principles that you can compare to. As a CPA, as a professional, I would certainly prefer GAAP,” Spataro said. “I have to tell you that it’s a hard thing as a professional for me to say, but (in this instance) we need to go off GAAP because it’s just not right. It’s not accurate.”

Spataro returns to her teaching background to explain her problems with GASB 45, the new rule that attempts to dictate how state and local governments account for the retiree benefits for their employees.

When a claim is submitted to the county for payment, she explained, the first thing an auditor looks at is whether it is an actual liability – to be one, it must be either the result of a contractual obligation by the commissioners court, or it must be unavoidable, such as when the county loses a lawsuit. A key function of a county auditor is to inspect bills to make sure they were obligated by commissioners court, not by an independent official or department head, she noted.

The second step in determining how to post an item on the books is to determine whether the obligation is measurable – if it’s not a finite number, how can it be written down as a debt the county – and the taxpayer – owes? Fuzzy numbers don’t compute.

When Spataro took a serious look at GASB 45, her accounting instincts told her that the new rule failed to meet the basic standards of accounting on both counts.

On the first question, GASB is “saying that if in fact you have provided benefits in the past and employees think they ought to get them, you have an obligation to post on them on your books.”

That didn’t make sense to Spataro, so she persuaded the commissioners court to employ Vinson & Elkins, a respectable Houston law firm with a national reputation, to review the county’s past actions to see if they had made any agreements or statements that county employees were promised any future retirement benefits and to determine whether the commissioners court had an obligation to continue funding benefits in the future.

In both cases, the answer was “no.”

During each year’s budget discussions, Spataro pointed out, the Travis County court makes adjustments to the county’s retirement benefits, adjusting co-pays and deductibles as well as adding or subtracting medical treatments that will be covered.

“It’s really almost no different from any other (budget) decision that they look at. Every year, they look at what we’re going to cover, what it’s going to cost, who’s going to be on it, what the county’s going to pay and what we can afford,” she explained. “They make that annual decision, enter into a contract, and then when claims are paid according to the approved contract, then we pay those. So it is absolutely their authority to have a plan and to change it.”

On the question of whether the future obligation to pay benefits is measurable, Spataro drew on the county’s experience in setting aside money annually for its self-insured medical coverage. Every year, the county hires an actuary to make a best-guess estimate of its upcoming claims.

The actuaries “do the very best job they can, but the truth is, very often, they’re not close,” she said.

One year, for example, the county was forced to transfer $2.3 million out of reserves to fund their medical claims for the second half of the year. “It is difficult to forecast (medical costs) on an annual basis, much less 30 years out.”

To get a sense of the reliability of actuarial forecasts, Travis County hired two respected firms, gave them the same data on current county employees’ ages and other relevant facts and asked them to come back with the long-term estimate of future retiree health costs. The estimates that came back, she said, varied by 300 percent – “hundreds of millions of dollars in difference.”

Spataro pointed out that the variables in the task of estimating future health costs over three decades are endless – what will happen to the cost of drugs, for example, or more significantly, will a still-to-be-developed Wonder Drug provide a cure for heart disease or diabetes, two of the major cost drivers of health care?

So the answer to the second question was that the potential obligation was not measurable, she said.

Despite the uncertainty, GASB calls for governments that have determined their future liability to set aside adequate funding – from either current revenues or borrowed funds – in an irrevocable trust fund. “Irrevocable means you can’t take it back,” Spataro noted.

The result, she added, was that in the first year alone, Travis County could be required to increase its tax rate by 16 percent just for the GASB set-aside but if the actuarial estimate proves to be too high, the excess money couldn’t be accessed by commissioners court. And because GASB’s goal is to force accounting for future benefits each year as employees “earn” it, future obligations will grow rapidly, according to GASB’s projections.

Faced with these issues, Spataro came up with an alternative approach – amend state law to provide that for the purposes of GASB 45 only, retiree health benefits would be accounted for according to the regulatory basis of accounting; the rest of the government’s books would stay on GAAP.

The immediate reaction by some in the government finance business was to worry about whether that arrangement would result in a government getting a negative review – a qualified opinion or worse, an adverse opinion – from its external auditors.

At least one influential player in the business said he doubted that eventuality.

“In these situations, an (external) auditor would give an opinion that financial statements were accounted for in accordance with another comprehensive basis of accounting other than GAAP,” said George Scott, regional partner at Deloitte & Touche. “It wouldn’t be a qualified opinion because it would be on another basis of accounting.”

Not that Scott agrees with Spataro’s analysis of GASB 45’s implementation.

The regulation refers to each government’s retirement approach as its “substantive plan,” which is a term that could include anything from hard-negotiated union contract to the informal, year-afteryear continuance of the same benefits. “A lot of governments are very informal,” Scott explained. “Some don’t even have written plans, but they’ve been paying this for years and because of the actual practice and procedure, they’re caught in the (GASB) standard.”

A substantive plan as defined by GASB is much broader than a government’s legal plan. And as to the conflict between accounting practices and state laws, that was decided a few years ago in the favor of the accounting rules, he said.

“As far as accounting standards are concerned, the legal determinations do not take precedence,” Scott said. “That was an issue fought and debated for years and was put to bed years ago.”

That battle was over a prior GASB pronouncement, Statement No. 34. It required governments to estimate – and include on their books – the current value of all its assets. That meant counties, for example, had to inventory all its roads, estimate their condition as well as anticipate future costs for repair.

Spataro said that in retrospect, No. 34 was a waste of time that should have been fought when it was adopted in 1999. She pointed that out in a letter to GASB in November.

“Policy makers who have already spent millions on GASB Statement No. 34 compliance and who are under pressure to reduce spending see little practical value in the GASB 34 statement,” she wrote. “Constituents do not understand it and the bond raters do not use it.”

The actions of bond raters is among the concerns that governing bodies are likely to have in deciding how to react to GASB 45.

“We don’t really demand compliance with GASB standards,” said Douglas Benton of Moody’s Investor Service in Dallas. “However at the same time, we believe that the strongest government management teams comply with GAAP, assuming that’s the norm in the state.”

He acknowledged that governments in New Jersey, for example, never adopted GAAP, preferring to remain with state laws that dictated accounting procedures before GAAP was adopted. Governments in similar financial condition there earn the same ratings as GAAP-based governments in other states.

“Investors want to know regardless of what accounting standards or what tax laws they have, that when they buy that bond, they can appropriately price the credit risk,” Benton explained. “It’s our job to filter through all this information and make sure that we’ve got a comparable rating assigned to that on our relative ranking scale.”

In fact, it may not hurt a government’s credit rating even if it posts a large obligation according to GASB 45 without funding it, he said.

The City of Houston, for example, recently published a financial statement that posted $3.95 billion as its GASB 45 outlook. Their rating did not change.

“We do not anticipate wholesale ratings changes just as a function of reporting this information because if you think about it, this is a disclosure of an economic reality that has existed for some time,” he said. “We should not be changing things just because disclosure has gotten more robust.”

Nevertheless, neither Benton, Scott nor Spataro are enthusiastic about any governments straying from the GAAP standard.

“For years, government officials and others have really fought to have one standardized reporting process for all government, and as you start deviating from that, it gets us back to the situation years ago where everyone was reporting without standards,” Scott said. “I would find it very disturbing. I’m always concerned when I see us stepping back. To me, it’s a very slippery slope.”