Understanding Similarities and Differences Between Accrual and	 
Cash Deficits (01-DEC-06, GAO-07-117SP).			 
                                                                 
Two key measures that have been used as indicators of the	 
government's annual fiscal condition are the unified budget	 
deficit measured primarily on a cash basis and the net operating 
cost measured on an accrual basis for financial statement	 
purposes. The unified budget deficit has historically been the	 
focus of budget debates and media reports in part because it	 
closely approximates the government's short-term borrowing needs.
Cash accounting can also be useful for controlling spending in	 
the current year. However, the cash measure of fiscal condition, 
which is similar to keeping a checkbook, by nature excludes	 
information about the long-term consequences of today's policy	 
decisions and operations. Indeed, understanding our nation's	 
long-term fiscal outlook is important because, as GAO's long-term
simulations show, current fiscal policy is unsustainable. The	 
accrual measure primarily provides more information on the	 
longer-term implications of today's policy decisions and	 
operations by showing certain costs incurred today but not	 
payable for years to come, such as civilian and military pensions
and retiree health care. While cash and accrual measures each	 
serve different purposes, they present complementary information 
and can be used together to provide a more comprehensive picture 
of the government's fiscal condition today and over time. The	 
goal of this primer is to improve understanding of the accrual	 
deficit by describing (1) how it is similar and different from	 
the more commonly reported cash budget deficit, (2) the key	 
drivers behind changes in accrual deficits relative to cash	 
budget deficits, and (3) how the two measures complement each	 
other and give a fuller picture of the government's overall	 
fiscal condition.						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-07-117SP					        
    ACCNO:   A64004						        
  TITLE:     Understanding Similarities and Differences Between       
Accrual and Cash Deficits					 
     DATE:   12/01/2006 
  SUBJECT:   Accountability					 
	     Auditing standards 				 
	     Budget cuts					 
	     Budget deficit					 
	     Budget outlays					 
	     Deficit reduction					 
	     Economic analysis					 
	     Federal funds					 
	     Fiscal policies					 
	     Future budget projections				 
	     Payments						 
	     Strategic planning 				 

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GAO-07-117SP

Accrual and Cash Deficits [1]GAO-07-117SP

GAO-07-117SP Accrual and Cash Deficits

United States Government Accountability Office

Understanding Similarities and Differences between
Accrual and Cash Deficits

December 2006

[2]GAO-07-117SP

Preface

Two key measures  that have been  used as indicators  of the  government's
annual fiscal condition are the unified budget deficit measured  primarily
on a cash basis and  the net operating cost  measured on an accrual  basis
for  financial  statement  purposes.   The  unified  budget  deficit   has
historically been the focus  of budget debates and  media reports in  part
because it  closely  approximates the  government's  short-term  borrowing
needs.1 Cash accounting can also be useful for controlling spending in the
current year.  However, the  cash measure  of fiscal  condition, which  is
similar to keeping a checkbook,  by nature excludes information about  the
long-term consequences of today's policy decisions and operations. Indeed,
understanding our nation's long-term fiscal outlook is important  because,
as  GAO's   long-term  simulations   show,   current  fiscal   policy   is
unsustainable.2 The accrual measure primarily provides more information on
the longer-term implications of today's policy decisions and operations by
showing certain costs incurred  today but not payable  for years to  come,
such as civilian and military pensions and retiree health care.

While cash  and  accrual  measures each  serve  different  purposes,  they
present complementary information and  can be used  together to provide  a
more comprehensive picture of the government's fiscal condition today  and
over time. The  goal of  this primer is  to improve  understanding of  the
accrual deficit by describing (1) how it is similar and different from the
more commonly reported  cash budget  deficit, (2) the  key drivers  behind
changes in accrual deficits relative to cash budget deficits, and (3)  how
the two measures complement  each other and give  a fuller picture of  the
government's overall fiscal condition.

Throughout this report, we primarily  used data from the Financial  Report
of the  United  States Government,  referred  to  in this  report  as  the
Financial Report, which is prepared by the Department of the Treasury,  in
coordination with  the  Office of  Management  and Budget.3  However,  the
reader is cautioned  not to  focus on the  precise amount  of the  accrual
deficit, its  components,  or  their  change from  year  to  year  because
significant issues  regarding  the  reliability and  presentation  of  the
federal government's financial information still need to be addressed. GAO
is responsible for auditing the  consolidated financial statements of  the
U.S. government, but  we have been  unable to express  an opinion on  them
because  the  government   could  not  demonstrate   the  reliability   of
significant portions of the financial  statements or that the  reconciling
differences between accrual and cash  deficits were complete. The  primary
reasons for this disclaimed opinion are described in this primer.

The Financial Report  can be  found on  the Department  of the  Treasury's
website at [3]http:// [4]www.fms.treas.gov/fr/index.html . Information  on
the most  recent  President's  budget  can  be  found  on  the  Office  of
Management  and  Budget's  website  at   [5]http://www.whitehouse.gov/omb/
[6]budget/ .

This primer  is  structured in  a  question  and answer  format.  The  key
questions are shown at the top of each page. To find the answers, flip  to
the page with your question highlighted. For easy reference, key terms are
defined in the glossary located in appendix I--these glossary terms appear
in bold type the first  time they are used  in the text. Many  definitions
come from A Glossary of Terms  Used in the Federal Budget Process.4  Other
related GAO products are listed at the end of this report.

Unless otherwise  indicated,  the years  referred  to in  the  primer  are
federal fiscal years, which run from October 1 through September 30.

This report was prepared under the direction of Susan J. Irving, Director,
Federal Budget Analysis,  Strategic Issues,  who may be  reached at  (202)
512-9142 or [7][email protected] if there are any questions. Gary T.  Engel,
Director, Financial Management and Assurance, and his staff also  provided
key assistance. He may be reached at (202) 512-8815 or [8][email protected] .
Contact points  for  our Offices  of  Congressional Relations  and  Public
Affairs may be  found on  the last  page of  this report.  Copies of  this
report are  available upon  request. In  addition, this  document will  be
available at no charge on the GAO Web site at [9]http://www.gao.gov .

[10]Preface

How Are Cash and Accrual Deficits Measured?

[11]The Unified Budget Deficit--The Net Cash Deficit

[12]Net Operating Cost--The Accrual Deficit

[13]What Purpose Does Each Measure Serve?

How Are Cash and Accrual Deficits Similar? How Are They Different?

[14]How Are Cash and Accrual Deficits Similar?

[15]How Are Cash and Accrual Deficits Different?

[16]How Do You Get to the Cash Deficit from the Accrual Deficit?

[17]What Drives Changes in Cash and Accrual Deficits from Year to Year?

[18]What Areas Explain the Largest Differences between Cash and Accrual
Deficits?

[19]How Are Military Employee  Benefits Recorded in  the Cash and  Accrual
Deficits?

[20]How Are Civilian Employee  Benefits Recorded in  the Cash and  Accrual
Deficits?

[21]How  Is  Veterans  Compensation  Recorded  in  the  Cash  and  Accrual
Deficits?

[22]How Are Environmental  Liabilities Recorded  in the  Cash and  Accrual
Deficits?

[23]How Are Insurance Programs Recorded in the Cash and Accrual Deficits?

[24]How Are Capital Assets Recorded in the Cash and Accrual Deficits?

How Can Accrual and Cash Measures Complement Each Other?

[25]Other Measures Are Also Needed  to Understand the Government's  Fiscal
Condition

[26]Some Federal Programs Use Both Cash and Accrual Measures in the Budget

but More Could Be Done

[27]Appendix I: Glossary of Key Terms

[28]Appendix II: Budget Outlays Measured on an Accrual Basis

[29]Appendix III: Obligational Accounting

[30]Related GAO Products

Ordering Information

[31]Contacts

Image Sources
Front cover: GAO.
Inside front cover: GAO.

Abbreviations

CFS consolidated financial statements of the United States government
                                         CSRS Civil Service Retirement System
                                                    DOD Department of Defense
                                                     DOE Department of Energy
                                      FERS Federal Employee Retirement System
            Financial Report Financial Report of the United States Government
                                GAAP generally accepted accounting principles
                                          OMB Office of Management and Budget
                                        NFIP National Flood Insurance Program
                                    PBGC Pension Benefit Guaranty Corporation
                                          PP&E property, plant, and equipment
                                          Treasury Department of the Treasury
                                            VA Department of Veterans Affairs

How Are Cash and Accrual Deficits Measured?

The Unified Budget Deficit--The Net Cash Deficit

The federal budget5  is the  government's primary  financial planning  and
control6 tool. It  helps establish  national spending  priorities and  the
allocation of resources. It also  helps ensure that the government  spends
taxpayers' money in accordance with applicable laws. The President submits
his forward-looking budget to Congress each February and the Department of
the Treasury (Treasury) reports  the budget results  in October after  the
end of the fiscal year.

The unified budget deficit  (or surplus) is  the federal budget's  "bottom
line." It  represents the  actual  amount by  which total  outlays  exceed
receipts (or  receipts  exceed  outlays), including  any  Social  Security
surplus. For  the  budget  deficit, receipts  and  outlays  are  primarily
measured on  a cash  basis7 --that  is,  they are  recorded when  cash  is
received or  paid, similar  to  keeping a  checkbook. Because  the  budget
deficit is primarily measured on a cash basis, it is hereafter called  the
cash budget deficit or simply cash deficit.

The unified budget is a  comprehensive measure of all federal  activities,
including those that are on-budget  and off-budget. The on-budget  deficit
includes all  budgetary accounts  other than  those designated  by law  as
off-budget. The  off-budget accounts  are the  Postal Service  and  Social
Security trust funds. In fiscal year 2005, the unified budget deficit  was
$319 billion as  reported in  the Financial  Report of  the United  States
Government, hereafter  referred  to  as  the  Financial  Report.8  It  was
composed of a $494 billion on-budget deficit, a Postal Service surplus  of
$2 billion and a Social Security surplus of $173 billion.

Net Operating Cost--The Accrual Deficit

Similar to  a corporation's  annual report,  the Financial  Report is  the
federal government's annual  general-purpose report  of accountability  to
the American public on its finances.  Some primary goals of the  Financial
Report are to provide a comprehensive overview of the cost9 of the federal
government's operations,  the  sources  used  to  finance  them,  and  the
implications  of   long-term  obligations   and  commitments.10   However,
significant  issues  regarding  the  reliability  and  reporting  of  this
financial information still need to be addressed. The Financial Report  is
prepared by Treasury, in  coordination with the  Office of Management  and
Budget (OMB). GAO is responsible  for auditing the consolidated  financial
statements of  the  United  States  government  (CFS).  OMB  requires  the
Financial Report to  be published  in December  following the  end of  the
fiscal year. For example, the Financial Report for fiscal year 2005, which
ended on September 30, 2005, was published in December 2005.

The net  operating  cost  (or  net operating  revenue)  is  found  in  the
Financial Report. Net  operating cost  (or net operating  revenue) is  the
amount by which expenses exceed revenue (or revenue exceeds expenses). For
this measure, expenses  are recorded  on an accrual  basis--in the  period
when goods  are used  or services  are performed  as opposed  to when  the
resulting cash payments are made.11 In some cases, expenses are  estimates
of amounts  that  will  be  outlays  in the  future  and  thus  depend  on
assumptions for interest  rates, inflation, and  wage growth, among  other
things.

Most revenues in  the Financial  Report are  recorded on  a modified  cash
basis.12 This  means they  are essentially  recorded when  collected,  but
there is an accrual adjustment for some taxes due that have not been  paid
by the taxpayer and refunds  due to taxpayers that  have not been paid  by
the government.  A modified  cash  basis of  accounting  is used  in  part
because of inherent limitations estimating  the amount of revenue  arising
from underlying events (e.g., taxpayers may not know their taxable  income
until after the underlying event, they  may not file returns on their  due
dates, or they may underpay).

For simplicity,  the net  operating  cost (or  net operating  revenue)  is
hereafter called the accrual deficit (or surplus).

What Purpose Does Each Measure Serve?

The cash  basis of  accounting  has traditionally  been used  for  federal
budgeting for several reasons. Because cash can be tracked throughout  the
year it can be useful for controlling spending in the current year.  Also,
because the time between the occurrence of a transaction that commits  the
government to make  a payment and  the cash  flow to make  the payment  is
relatively short  for  many  program  areas,  the  cash  measure  provides
adequate information about the government's  total commitment at the  time
budget decisions are  made for  these programs. Finally  and perhaps  most
notably, the  cash budget  deficit closely  approximates the  government's
short-term borrowing  needs and  so  is a  widely used  and  traditionally
accepted measure of the government's effect on current financial markets.

There are several  areas, however,  in which  outlays measured  on a  cash
basis do not provide  complete information about the  total amount of  the
government's obligation upfront when decisions are made. For some of these
program areas, the budget records outlays on an accrual basis. Perhaps the
best known  of  these  are credit  programs--loans  and  loan  guarantees.
Appendix II  provides  more information  on  which programs'  outlays  are
measured on an accrual basis and how they affect the cash budget deficit.

Accrual measures  are useful  for  understanding the  government's  annual
operating cost, including costs incurred  today but not payable for  years
to come.  As  such,  it  adds a  longer-term  focus  to  the  government's
financial  picture   by   providing  more   information   on   longer-term
consequences of  today's policy  decisions and  operations. Under  federal
accounting standards, the long-term costs for social insurance  (primarily
Medicare and Social  Security) are  not included in  the accrual  deficit.
However, the Statement of Social Insurance provides information about  the
future costs of these programs.13

Finally, financial  accounting standards  are intended  to result  in  the
provision of  financial  information  that will  be  useful  for  decision
making. Once  the  information  reported in  the  financial  statement  is
auditable, it  would  provide  integrity to  related  information  in  the
budget,  including  actual  receipts  and  outlays,  if  the  amounts  are
materially consistent and reliable.

How Are Cash and Accrual Deficits Similar?
How Are They Different?

The  cash  and  accrual  deficits   are  based  on  the  same   underlying
activities--the differences arise due to the  timing of when the costs  of
certain activities  are recognized.  For the  accrual deficit,  costs  are
recognized when goods  are used or  services are performed.  For the  cash
deficit, costs are recorded when cash payments are made for goods received
or services performed. For  many program areas,  the timing difference  is
small but for  others the  timing differences  can amount  to billions  of
dollars each year. For example, in 2005, the reported accrual deficit  was
$760 billion--more than twice the size of the $319 billion cash deficit.

Not only are some of the differences caused by timing large, but they  can
cause the  cash  and  accrual  deficits to  send  different  signals.  For
example, accrual  and  cash measures  have  sent different  signals  about
whether the government is  in surplus or deficit.  Figure 1 shows that  in
2001 the budget was running a cash surplus but the accrual measure  showed
a large deficit.

Figure 1: The Cash and Accrual Measures of Fiscal Surplus and Deficit

13The Statement of Social Insurance has been included in the required
supplemental stewardship section of the Financial Report and will be
incorporated into the primary financial statements for fiscal year 2006.

Source: Treasury.

Note: Data from unaudited Financial Reports. In some years, the budget
deficit reported in the Financial Report differs from the final deficit
number published in the President's budget. For example, the 2005
Financial Report issued in December 2005 reported a $319 billion cash
budget deficit. However, the final deficit number published in the
President's budget 2 months later was slightly lower--$318 billion.

The two measures can  also send different signals  about the direction  in
which the government's fiscal condition is heading. For example,  although
both measures were in deficit in  2005, the cash budget deficit  decreased
from the previous year while the accrual deficit increased. This leads  to
questions of how the two measures are similar, how they're different,  and
what drives changes in the two measures.

How Are Cash and Accrual Deficits Similar?

Since revenue  is primarily  recorded  on a  modified  cash basis  in  the
financial  statements,  there  is  very  little  difference  between  cash
receipts and accrued revenue.14

On the spending side,  many programs are  also recorded similarly  because
the time between the occurrence of the underlying transaction and the cash
flow is  relatively short.  So, for  some program  areas such  as  federal
employee salaries and  grants there is  little difference between  accrual
and cash measures.  Figure 2  below illustrates this  point using  federal
salaries.

Figure 2: Cost of Federal Salaries Reflected Similarly in Accrual and Cash
Deficits

For federal salaries, the time between  when salaries are earned and  when
they are paid is short--a little over a week. Under accrual accounting, an
expense for federal salaries is  recognized when the salaries are  earned.
Under cash accounting an outlay is recorded in the following week when the
salary is paid. At year's end, there is little difference between the cash
and accrual measure of  salaries because both  include salary payments  or
expenses for roughly 52 weeks of work.

However, the cash and accrual measures  may not include the exact same  52
weeks of salary. Because  the accrual deficit includes  an expense as  the
salary is earned, regardless of when paid in cash, it will include the  52
weeks of salary  earned in  the current  year. However,  the cash  deficit
includes cash payments for salaries earned in the prior year and  excludes
cash payments for  salaries earned in  the last week  of the current  year
that will be paid in the next year.

Source: GAO.

14The budget uses the term "receipts" while the financial statements use
"revenue." Both have the same meaning.

Cash and accrual measures are also  similar in that they both exclude  the
value of

o future payments for certain contingencies and financial commitments and

o future benefits for entitlement programs, including social insurance.

Neither contingencies nor financial commitments are reflected in the  cash
deficit  until  the   government  makes  the   cash  payment.  Only   some
contingencies  are  reflected  in  the  accrual  deficit--those  that  are
assessed as "probable" as to the likelihood of loss and can be  reasonably
measured. However, many  contingencies are  not reflected  in the  accrual
deficit in part  because it is  difficult to anticipate  the amount to  be
paid. Contingencies assessed as "reasonably possible" as to the likelihood
of loss, or assessed as "probable" as  to the likelihood of loss but  that
cannot be reasonably measured, are not included in the accrual deficit but
are disclosed in the  notes to the financial  statements. For example,  in
fiscal year  2005,  possible estimated  losses  of $1.2  billion  to  $7.9
billion from  administrative claims  and legal  actions were  assessed  as
"reasonably possible" and therefore not  included in the accrual  deficit.
Also, the potential costs associated with future natural disasters are not
recorded in the accrual deficit even though the public anticipates and has
received large amounts of assistance following natural disasters. Finally,
financial commitments, such as contracted goods or services that have  not
yet been delivered,  are not  recorded in  the accrual  deficit until  the
goods or services  are delivered  but are disclosed  in the  notes to  the
financial statements.15

While both  the cash  and  accrual deficits  include payments  to  current
beneficiaries  for  entitlement  programs,  including  social   insurance,
neither the cash nor  accrual deficit reflects  the serious future  fiscal
challenges of  Social  Security,  Medicare,  and  other  social  insurance
programs. Future scheduled benefits and estimated receipts are included in
the Statement of  Social Insurance.16  However future benefits  are not  a
liability under federal accounting standards.17

15Even though they are not reflected in the cash budget deficit, the
budget records an obligation, or legal liability, under obligational
accounting at the time the government enters into a contract. See app. III
for more information on the differences in when transactions are recorded
under obligational accounting compared to accrual and cash accounting.

16 The Statement of Social Insurance has been included in the required
supplemental stewardship information section of the Financial Report.
Beginning with fiscal year 2006, the statement will be incorporated into
the primary financial statements and audited. Information on the effect of
large social insurance programs on the budget can be found in
[35]GAO-06-1077R .

17A liability is recorded for unpaid amounts due at the end of the fiscal
year. This is similar to how other countries budget and account for social
insurance. See GAO, Accrual Budgeting: Experiences of Other Nations and
Implications for the United States, [36]GAO/AIMD-00-57 (Washington, D.C.:
Feb. 18, 2000).

How Are Cash and Accrual Deficits Different?

The differences between cash and  accrual deficits are almost entirely  on
the spending side since revenues are recorded similarly in the budget  and
financial statements.  Differences  arise  when a  cost  is  accrued  (and
affects the accrual deficit)  in 1 fiscal year  but paid (and affects  the
cash deficit) in another fiscal year.

While there  are  a  number  of areas  in  the  federal  government  where
differences  exist,  the  six  listed   below  account  for  the   largest
differences between accrual and cash deficits:

o civilian employee benefits,

o military employee benefits,

o veterans compensation,

o environmental liabilities (e.g., cleanup and disposal),

o insurance programs, and

o capital assets.

For all of these areas except  capital assets, the key difference  between
the accrual and cash measures is the annual change in the liability.  Each
year as expenses are accrued, those  that are not paid (and not  reflected
in the budget) increase the government's liability. As such, the liability
represents unpaid expenses. The change in the liability from year to  year
is generally equal to  accrued expenses less cash  payments made to  cover
expenses. Figure 3 illustrates this point using federal employee  benefits
other than salaries.

Figure 3: Difference between Accrual and Cash Measures of Federal Employee
Benefits

The  accrual  deficit  includes  an  accrued  expense  for  each   current
employee's pension and other retirement benefits, which are earned  during
the employee's working  years but not  paid until sometime  in the  future
when the employee retires.

The cash budget deficit does not include retirement benefits earned today,
but it  does  reflect  payments  made to  current  retirees.  (These  cash
payments reflect past expenses.)

The difference between the accrued retirement benefits recognized and cash
payments made during  the year is  generally the change  in the  liability
from year to year.  It is also  the amount of  the difference between  the
accrual and cash measures due to employee benefits.

Source: GAO.

o The first  statement shows how  much it  costs on the  accrual basis  of
accounting to operate

Capital assets  are  treated  differently. When  capital  assets  such  as
structures and equipment  are purchased,  the budget  recognizes the  full
cost up front in order to provide decision makers with the information and
incentives to make  efficient decisions  at the  only time  that they  can
control the cost.18 Specifically, the cost of a capital asset is  recorded
as an outlay and  included in the  cash budget deficit  when the asset  is
paid for.  However, under  the accrual  basis of  accounting used  in  the
financial statements, the cost of the  asset is initially recorded on  the
balance sheet. The  cost of  the asset is  then spread  over its  expected
useful life to match the asset's  cost with its use. Therefore, each  year
the  accrual  deficit  only  reflects  1  year's  worth  of  cost,  called
depreciation expense. Figure 4 below illustrates this point.

Figure 4: Difference between Accrual and Cash Measures of Capital Assets

Let's assume that the  federal government purchased  a building this  year
for $50 million  and expected  the building  to be  used for  the next  50
years. The cash  budget deficit would  reflect the $50  million cost  this
year. The accrual  deficit would  only reflect a  $1 million  depreciation
expense (assuming  a straight-line  depreciation method)a  in the  current
year. The remaining cost  of the asset would  be reflected in the  accrual
deficit over the next 49 years at an annual expense of $1 million.

Source: GAO.

aThe straight-line depreciation method assumes the asset will provide an
equal amount of benefit each year. The annual depreciation expense is
calculated by dividing the purchase price of the asset (less its estimated
salvage or residual value) by the estimated useful life of the asset.

18For capital assets, budget authority for the asset's cost must generally
be provided up front before the asset can be purchased.

How Do You Get to the Cash Deficit from the Accrual Deficit?

The Financial Report  includes a  statement called  Reconciliation of  Net
Operating Revenue  (or  Cost) and  Unified  Budget Surplus  (or  Deficit),
hereafter called the "reconciliation statement," that provides a crosswalk
between the net operating  cost (accrual deficit)  and the unified  budget
deficit  (cash  budget  deficit).  Figure   5  below  shows  the   general
relationship underlying the reconciliation statement and how to get to the
cash budget deficit from the accrual deficit.

Figure 5: Moving from the Accrual Deficit to the Cash Budget Deficit
(Using Fiscal Year 2005 Numbers to Illustrate)

1The unified budget deficit is net of any Social Security surplus. See p.
1 for more information.

2GAO,  The Nation's Long-Term Fiscal Outlook: September 2006 Update,
[32]GAO-06-1077R (Washington, D.C.: Sept. 15, 2006).

3For a guide to understanding the Financial Report see GAO, Understanding
the Primary Components of the Annual Financial Report of the United States
Government, [33]GAO-05-958SP (Washington, D.C.: September 2005).

4GAO, A Glossary of Terms Used in the Federal Budget Process,
[34]GAO-05-734SP (Washington, D.C.: September 2005). Other terms are based
on the Federal Accounting Standards Advisory Board's (FASAB) Statements of
Federal Financial Accounting Standards, Current Text, vol. 2 (Washington,
D.C.: June 30, 2004).

5For purposes of this primer, the "federal budget" is used broadly to
include not only planning but also the end fiscal result of that plan
(i.e., the fiscal effect of spending and revenue laws in effect for any
given fiscal year).

6The federal government uses obligational accounting to track and control
the use of funds. However, in the context of the government's fiscal
condition, Congress and the public tend to focus on the cash deficit--and
more recently the accrual deficit. Because of the attention to these two
measures, this primer focuses on them. More information on obligational
accounting is in app. III.

7Credit programs and certain interest payments are not measured on a cash
basis in the budget. For more information see app. II.

8The final deficit number published in the President's budget was slightly
lower--$318 billion. However, the Financial Report reconciles the cash and
accrual measures of fiscal condition, so we will use the number reported
therein.

9The term "cost" can have different meanings depending on the context in
which it is used. Throughout this report, cost is used in a general sense
to mean the value of resources used to produce a program, provide a
service, or achieve an objective.

10Unless otherwise noted, the term "commitments" is used in this report to
mean potential draws on future resources that flow not only from the law
but also from public expectations.

11Accrual accounting, which is also used by private business enterprises
for financial reporting, is generally the basis for U.S. generally
accepted accounting principles (GAAP) for federal government entities.
However, for some revenue, a modified cash basis of accounting is used and
is also considered as GAAP.

12While most revenue, including taxes, duties, and fines, are recorded on
a modified cash basis, revenues from providing goods and services to the
public at a price (e.g., user fees, premiums) are recorded on an accrual
basis.

Figure 6 summarizes the reconciliation statements contained in the CFS for
fiscal years 2001-2005. In the  figure, annual changes in liabilities  can
be either positive or negative:

o If  accrued  expenses  exceed cash  payments,  liabilities  increase  (a
positive change). A positive change  represents accrued expenses that  are
in the accrual deficit but not the cash budget deficit.

o If  cash  payments  exceed accrued  expenses,  liabilities  decrease  (a
negative change). A negative change represents cash payments that are  not
included in  the accrual  deficit  but are  included  in the  cash  budget
deficit.

Figure 6: Crosswalk between Accrual and Cash Deficits/Surpluses

Notes: Data reported in the unaudited Financial Reports for fiscal years
2001-2005.

aThe change in insurance liabilities was not included in the
reconciliation statement prior to the Financial Report for 2005. The 2005
reconciliation statement included comparative data for both 2004 and 2005.

bThe final deficit number published in the President's budget was slightly
lower--$318.3 billion.

While the  reconciliation  statement  is  useful  for  illustrating  which
program areas  explain  large differences  between  the cash  and  accrual
measures in each year, too much focus should not be placed on the  amounts
shown for items  listed in  the reconciliation  statement--nor the  actual
amount of the accrual deficit itself--for  a number of reasons, which  are
discussed below.

First, as of 2005, Treasury has not been able to identify all items needed
to reconcile the  accrual and cash  deficits. As a  result, certain  items
that would cause  the accrual and  cash deficits to  be different are  not
itemized in the reconciliation statement.  To make the statement  balance,
Treasury  includes   an   entry--labeled   "net  amount   of   all   other
differences"--that is needed to force the statement into balance (i.e.,  a
"plug"). In 2005, this entry was $13.2 billion (or 3 percent of the  total
difference between the accrual and cash budget deficits).19

Second, we identified material  weaknesses relating to  some of the  areas
listed   in   the   reconciliation   statement--namely   capital   assets,
environmental liabilities, and military postretirement health  benefits.20
Errors in the reported  expenses for these areas  could lead to errors  in
the amount of  the accrual  deficit itself.  For example,  the failure  to
report a depreciation expense  for a certain capital  asset would tend  to
result in an  understatement of  the accrual  deficit while  overreporting
depreciation expense would overstate the accrual deficit.

Finally, the accrual deficit itself includes an amount needed to force the
CFS into balance (i.e.,  a "plug"). The  accrual deficit should  typically
equal the annual change in net  position, which is the difference  between
the assets  and  liabilities  reported  in  the  balance  sheet.  However,
Treasury could not completely reconcile the difference between ending  and
beginning of  year  net  position  and thus  included  an  amount  labeled
"unreconciled transactions affecting the change in net position" to  force
the CFS into balance. Also, as part of our audit of the CFS, we identified
a number of issues, including problems relating to the compilation of  the
CFS and  the reconciliation  of  intragovernmental activity  and  balances
between federal agencies.21

19For more information on the issues GAO identified with the
reconciliation statement and related recommendations see GAO, Financial
Audit: Process for Preparing the Consolidated Financial Statements of the
U.S. Government Needs Improvement, [37]GAO-04-45 (Washington, D.C.: Oct.
30, 2003).

20See pp. 15-26 for information on weaknesses in the reported expenses of
these program areas.

21For a list of GAO's recommendations addressing these and other
weaknesses in the financial statements, see GAO, Financial Audit:
Significant Internal Control Weaknesses Remain in Preparing the
Consolidated Financial Statements of the U.S. Government, [38]GAO-06-415
(Washington, D.C.: Apr. 21, 2006).

What Drives Changes in Cash and Accrual Deficits from Year to Year?

In  recent  years,  both  cash   and  accrual  measures  show  a   general
deterioration in the government's fiscal condition. This deterioration was
due to both tax and spending legislation, sometimes in response to outside
events, such as the attacks of September 11, 2001 and the ensuing economic
slowdown, operations in Iraq and  Afghanistan, and Hurricanes Katrina  and
Rita,  which  together  affected  the  government's  operating  costs  and
revenue.

Some changes in the cash  deficit from year to year  can be and have  been
due to changes in dates when cash is scheduled to be paid or received. For
example, when October 1 falls on  a weekend, certain federal payments  due
on that  date,  such as  salaries  for  military employees,  are  paid  in
September. This  shifts the  cash outlay  into the  previous fiscal  year.
However, because  these benefits  are recorded  as expenses  when due  and
payable, the  shift in  the  payment date  would  not affect  the  accrual
deficit. In  contrast, Congress  sometimes changes  the due  date for  tax
payments, which can  shift cash receipts  from one year  to the next.  For
example,  Congress  changed  the  corporate  tax  payment  due  date  from
September 15, 2001, to October 1, 2001, resulting in a shift of about  $23
billion in revenue  from fiscal year  2001 to 2002.  Because revenues  are
generally recorded when collected in  both the cash and accrual  deficits,
the change in  the tax due  date would  affect both the  cash and  accrual
deficits.

However, the  accrual deficit  has also  been driven  by three  additional
factors:

o legislation that obligates future government resources,

o changes in methods or assumptions for estimating long-term  liabilities,
and

o changes in federal accounting standards.

For  example,  enacting  a  law  that  expands  future  federal   employee
retirement benefits or insurance  programs would be reflected  immediately
in the accrual deficit but would not affect the cash budget deficit  until
future years when the benefits are paid. Indeed, the largest change in the
accrual deficit  in recent  years occurred  between 2000  and 200122  when
legislation was  passed that  extended TRICARE--health  care benefits  for
military  employees--to  Medicare-eligible  military  retirees  and  their
beneficiaries. This change alone increased  the estimated value of  future
benefit payments and  the accrual deficit  by over $290  billion in  2001.
However, because these benefits will not  be paid until future years,  the
cost was not reflected in the cash budget deficit.

22The accrual measure went from a surplus of $40 billion in 2000 to a
deficit of $515 billion in 2001--a swing of about $555 billion.

Second, whereas the  cash measure is  sensitive to changes  in dates  when
cash is scheduled to be paid  or received, accrual measures are  sensitive
to changes in assumptions--such as future salary increases, changes to the
general price  level, interest  rates,  and technology--used  to  estimate
future payments. For  example, some  future payments  are discounted  into
present value terms  using nominal interest  rate assumptions. Changes  in
interest rates can and have  caused changes--and sometimes large  ones--in
expenses and the accrual deficit. For example, the change in interest rate
assumptions drove wide swings in  the liability for veterans  compensation
in recent  years.  This  liability  increased by  $105  billion  in  2003,
decreased by $30 billion  in 2004, and then  increased by $228 billion  in
2005. From 2003 to  2004, the Department of  Veterans Affairs (VA)  raised
its long-term interest rate assumption from 4.91 to 5.23 percent. In 2005,
VA reduced its long-term interest rate to 4.74 percent.

Finally, changes  in federal  accounting standards  can also  drive  large
changes in  the accrual  deficit without  any effect  on the  cash  budget
deficit. For  example, beginning  in fiscal  year 2003,  a new  accounting
standard was  adopted  that  required national  defense  equipment  to  be
capitalized--that is,  included  on the  balance  sheet--and  depreciated.
Prior to 2003, the purchases  of national defense equipment were  expensed
in the  year they  were bought  and  the assets  were not  capitalized  or
depreciated.23 A  primary  reason  for  the  increase  in  the  amount  of
capitalized assets  reported in  the reconciliation  statement from  $40.9
billion in  2002 to  $102.0  billion in  2003  was the  capitalization  of
national defense equipment purchased in  2003. Also primarily as a  result
of national defense equipment being capitalized, the depreciation  expense
more than tripled from $20.5 billion in 2002 to $71.2 billion in 2003.

While a lot of variation in the  accrual deficit may lead some to  believe
the measure is  less reliable  than the  cash measure,  the changes  often
result  from  improvements  in   government  estimation  methods  or   the
implementation of  new accounting  standards. This  suggests that  caution
must be  taken  when  interpreting year-to-year  changes  in  the  accrual
deficit. Sometimes a change in the  accrual deficit may not mean a  change
in fiscal condition, but  rather a change in  the government's methods  of
measuring its condition. As the reliability issues we raised in our audits
are  addressed,  the  accrual  deficit  will  become  a  more   meaningful
complement to the cash measure.

23National defense equipment was considered stewardship property, plant,
and equipment and reported as required supplemental stewardship
information to the financial statements..

In the following pages,  we provide more detailed  information on the  six
areas that  explain  the  largest differences  between  accrual  and  cash
deficits. As we stated before, the six areas are

o military employee benefits,

o civilian employee benefits,

o veterans compensation,

o environmental liabilities (e.g., cleanup and disposal),

o insurance programs, and

o capital assets.

We explain how each area's costs are reflected under the two measures  and
how the  numbers  in the  reconciliation  statement are  developed.  Also,
because changes in the  accrued liability for these  programs can lead  to
changes in the accrual  deficit without any  corresponding changes to  the
cash budget deficit, we explain what  drives the accrual measures of  each
area and  the key  events or  changes  in assumptions  that led  to  large
changes in their liabilities from fiscal years 2001 to 2005.

Military Employee Benefits

How Are Military Employee Benefits Recorded in the Cash and Accrual
Deficits?

Military employee benefits include retirement benefits, such as  pensions,
health benefits,  and  insurance, for  military  personnel who  remain  on
active duty for  20 years or  more. The cash  budget deficit reflects  the
payments made  to  retired  military  in the  current  year  but  not  the
estimated long-term  costs.24 However,  the  accrual deficit  reflects  an
expense for the estimated  long-term cost of  military pensions and  other
retirement benefits during the years the service members are working.  The
expense reflects services rendered in  the current year, accrued  interest
on the  outstanding  liability,  and  adjustments  for  any  pension  plan
amendments or deviations between actual experience and assumptions used to
estimate past expenses.

Table 1 shows the accrued  liabilities--or the actuarial present value  of
the expected cost of military employee benefits that is unpaid at the  end
of the  reporting  year--and  the  corresponding  year-to-year  change  in
liabilities from 2001 to 2005.

Note: Data from unaudited Financial Reports for 2001 to 2005.

The change in liability from the previous year (in the highlighted row  of
table 1)  represents  the  primary difference  between  accrual  and  cash
measures of  military  employee  benefits.  The  change  in  liability  is
generally equal to expenses accrued for current workers less cash  outlays
to pay  current  retirees' benefits,  which  were expensed  in  the  past.
Therefore a positive change in  the liability represents accrued  expenses
in excess of cash outlays. Because accrued expenses enter into the accrual
deficit as a negative, one must add the change in liability to the accrual
deficit to get to the cash deficit.

24The Department of Defense (DOD) makes contributions for some retirement
benefits but the payments are intragovernmental--that is, they are
recorded as outlays by DOD and receipts by the military retirement trust
funds.  Since no cash actually leaves the government, such contributions
do not affect the governmentwide cash deficit. See app. II for more
information.

What Drives Changes in Military Employee Benefit Liabilities?

Changes in the  military employee benefit  liabilities have accounted  for
large swings in the  accrual deficit without  any corresponding change  in
the cash  budget deficit.  The  largest change  in the  military  employee
benefit liability during the period of 2001 to 2005 was due to a change in
law. In 2001, the  liability for military  employee benefits increased  by
$406.8 billion. A large part  of the increase--over $290  billion--stemmed
from  the  initial  nonrecurring  effect  of  the  2001  National  Defense
Authorization  Act  (Pub.  L.  No.  106-398).  This  legislation  extended
TRICARE--health care benefits for military employees--to Medicare-eligible
military  retirees  and  their  beneficiaries.  Prior  to  2001,  military
retirees who were eligible for Medicare relied on Medicare benefits.

The change  in liability  has also  varied from  year to  year because  of
differences between actual experience and what was originally assumed. For
example, from 2004 to  2005, the change in  the military health  liability
was $108.6 billion. According  to the Department  of Defense (DOD),  about
$60 billion of this change  reflects higher-than-assumed health care  cost
growth.

It should  be  noted  that  DOD  was  unable  to  provide  support  for  a
significant portion  of the  reported military  retiree health  liability.
DOD's auditors found that  DOD's systems could  not accurately report  the
costs of  health  care provided  by  DOD facilities  or  develop  reliable
projections of future health  care costs and  the military retiree  health
liability.

Civilian Employee Benefits

How Are Civilian Employee Benefits Recorded in the Cash and Accrual
Deficits?

Civilian employees earn  pension and  other retirement  benefits over  the
course of their working years, but  these benefits are not paid until  the
employee retires.  Currently,  pensions  represent  the  largest  civilian
employee benefit,  and postretirement  health  benefits are  a  relatively
small but growing share of civilian employee benefits. In the cash budget,
the payments  made  to  retired  employees are  recorded  as  outlays  and
reflected in the cash budget deficit. Any contributions made by  employees
are recorded as receipts and offset  part of the cash outlays.25  However,
the accrual deficit reflects an annual expense for the estimated long-term
cost of  these benefits  each year  as  the employee  renders his  or  her
services. The  annual  expense  includes the  pension,  health,  or  other
benefits accrued for current workers, accrued interest on the  outstanding
liability, and adjustments for  any changes to  assumptions or the  plans'
benefits and  any deviations  between actual  experience and  assumptions.
Contributions made by employees towards pension, health, or other benefits
are recorded as earned revenue, which offset part of the expense.26

The reported civilian employee  benefit liabilities--or the present  value
of the benefits  that have  been earned  but not paid  at the  end of  the
reporting year--and the changes in liabilities are shown in table 2.


Note: Data from unaudited Financial Reports for 2001 to 2005.

25Agencies also make contributions for some accrued pension benefits but
the payments are intragovernmental--that is, they are recorded as outlays
by one agency and receipts by the civil service retirement and disability
trust fund. Since no cash actually leaves the government, such
contributions do not affect the governmentwide cash deficit. See app. II
for more information. Most civilian agencies are not required to make
contributions for future health and life insurance benefits.

26Agency contributions are also recorded as earned revenue but since these
contributions are intragovernmental, they are netted out in the CFS.

The change in the liability from the previous year (in the highlighted row
of table 2)  is the  primary difference between  what is  recorded in  the
accrual  deficit  and  the  cash  budget  deficit  for  civilian  employee
benefits. The  change  in liability  is  generally equal  to  the  accrued
expense less payments made  to current retirees  during the current  year.
Therefore a positive change in  the liability represents accrued  expenses
in excess of cash outlays. Because accrued expenses enter into the accrual
deficit as a  negative, the change  in liability is  added to the  accrual
deficit to get to the cash deficit.

What Drives Changes in Civilian Employee Benefit Liabilities?

Changes in civilian  employee benefit liabilities  can affect the  accrual
deficit with  no corresponding  change  to the  cash budget  deficit.  The
accrued  benefit  expense  depends  on  assumptions  and  projections  for
salaries, years of service, interest rates, inflation, and other  economic
and demographic variables. As  such, deviations between actual  experience
and these assumptions can lead to  large changes in the civilian  employee
benefit liability and the accrual deficit itself. For example, the  change
in liability attributed to pensions in 2002--$16.9 billion--was lower than
in  2001--$41.0  billion--because  actual  pay  raises  given  to  federal
employees and the  cost of living  allowance given to  retirees were  both
less than previously assumed. As  a result, the previous year's  liability
was reduced because of these deviations from the assumptions.  Conversely,
the change in liability attributed to pensions in 2003--$60.6 billion--was
significantly larger than 2002 because actual pay raises were larger  than
assumed.

Most of the  year-to-year changes in  the postretirement health  liability
were also due  to differences  between actual  experience and  assumptions
about health care costs and utilization. Health care cost trends have been
more  volatile  than  factors  underlying  estimates  of  pension  benefit
liabilities (e.g.,  wage growth  and cost  of living  allowances);  hence,
estimates of postretirement health liabilities  can be more volatile  than
pension liability estimates.

Veterans Compensation

How Is Veterans Compensation Recorded in the Cash and Accrual Deficits?

The veterans  compensation program  provides eligible  veterans and  their
survivors with benefits to compensate  for the loss of potential  earnings
due to  service-connected disability  or death.  The cash  budget  deficit
reflects compensation  payments  made  in  the  current  year  to  current
veterans but  not the  estimated costs  of future  benefits. However,  the
accrual deficit  reflects  an  expense  for  future  payments  to  current
veterans  already  receiving  benefits,  veterans  that  aren't  currently
receiving benefits  but will  in the  future, and  a portion  of those  in
active military service assumed by the VA to become eligible for  benefits
in the future.

Table 3 shows the reported veterans compensation liability--or the present
value of the estimated cost of future benefit payments earned but not paid
at the end  of the year--and  the corresponding change  in each year  from
2001 to 2005.

Note: Data from unaudited Financial Reports for 2001 to 2005.


The  difference  between  the  cash  and  accrual  measures  of   veterans
compensation is the  change in  the liability from  year to  year (in  the
highlighted row of  table 3).  The change  in the  liability is  generally
equal to  accrued  compensation  expense  plus  accrued  interest  on  the
outstanding liability  less benefits  paid  to current  beneficiaries.  As
such, a positive change in  the liability represents accrued expenses  (in
excess of cash payments). Because accrued expenses enter into the  accrual
deficit as a negative, one must add the change in liability to the accrual
deficit to get to the cash budget deficit.

What Drives Changes in Veterans Compensation Liabilities?

Changes in  the veterans  compensation liability  can affect  the  accrual
deficit with  no  corresponding change  to  the cash  budget  deficit.  VA
estimates the compensation liability using  assumptions for the number  of
beneficiaries, life  expectancy, future  cost of  living adjustments,  and
interest rates,  among other  things, and  the liability  is sensitive  to
changes in these assumptions.

Indeed, the veterans compensation liability experienced wide  fluctuations
in recent years driven by changes in assumptions. The liability  increased
by $105.6 billion in  2003, decreased by $30.0  billion in 2004, and  then
increased by $197.8 billion in 2005. These large swings resulted not  from
changes to benefit provisions, laws,  or regulations, but from changes  in
the assumptions used--primarily for interest rates--to estimate the  value
of future  benefits.  Beginning  in 2004,  VA  used  current  market-based
interest rates--rather than historical averages--on Treasury securities to
discount future payments into present value terms for presentation in  the
financial  statements.  Interest  rates   can  be--and  have   been--quite
volatile,  which  can  lead  to  volatility  in  the  reported  liability.
Increases in the interest rate used to discount the liability would reduce
the liability whereas decreases  in the interest  rate would increase  the
liability. For example, from 2003  to 2004, rates on longer-term  Treasury
securities increased from 4.91 to 5.23  percent, leading to a $30  billion
reduction in VA's liability. Conversely, for the next year, VA reduced its
long-term interest  rate assumption  from  5.23 percent  in 2004  to  4.74
percent in 2005. Reducing the interest  rate resulted in a higher  present
value estimate of future benefit payments and thus a greater liability.

Environmental Liabilities

How Are Environmental Liabilities Recorded in the Cash and Accrual
Deficits?

Federal,  state,  or  local  laws  and  regulations  require  the  federal
government to clean up hazardous and radioactive waste resulting from  its
operations (e.g., nuclear submarines and nuclear weapons). While the  cash
deficit reflects cleanup  costs when they  are paid, accounting  standards
require agencies to recognize  in their financial  statements each year  a
portion of  the estimated  probable and  measurable environmental  cleanup
costs associated  with assets  as they  are used  operations, even  though
cleanup will not actually occur for many years. In addition, agencies  are
required to  include  estimates  to  clean  up  and  dispose  of  existing
contamination and waste  resulting from nuclear  weapon production  during
World War II and the Cold War--also called "legacy waste." These estimates
make up the  majority of  the Department of  Energy's (DOE)  environmental
liabilities.

Each year a  portion of the  estimated total cleanup  costs for  operating
assets is to  be recognized  as an expense.  Accounting standards  require
that this allocation be based on a systematic and rational method, such as
the expected  life of  the asset  and  the amount  of capacity  used  each
period. So, for example, a nuclear submarine may have an estimated  useful
life of  10 years  and estimated  cleanup costs  of $80  million. Under  a
straight-line allocation method, the expense and liability accrued in each
year of its life would be $8  million. This $8 million would be  reflected
in the accrual deficit for that year  but not the cash budget deficit.  In
contrast, any increase to the estimated  cost of cleaning up legacy  waste
must be recognized in full in the  period it is identified. Table 4  shows
reported environmental liabilities from 2001 to 2005 and the change in the
liability each year.27 The change in the liability from the previous  year
(in the highlighted row of table 4) represents

Note: Data from unaudited Financial Reports for 2001 to 2005.

27For assets in operation, cleanup costs are recognized over the expected
life of the asset and thus the reported liability does not include the
full cleanup cost until the end of the asset's life.

accrued expenses in the current year less payments for current year
cleanup activities, which were expensed in the past:

o If accrued  expenses exceed  cash payments, liabilities  increase and  a
positive change is shown (see 2001 and 2005).

o If cash  payments exceed  accrued expenses, liabilities  decrease and  a
negative change is shown (see 2002, 2003, and 2004).

To move from the accrual deficit  to the cash deficit requires  adjustment
for these accrued expenses and cash payments. Because accrued expenses (in
excess of cash  payments) enter into  the accrual deficit  as a  negative,
they must be  added to the  accrual deficit in  order to get  to the  cash
deficit. Conversely,  cash  payments in  excess  of accrued  expenses  are
subtracted from the accrual deficit to get to the cash deficit.

What Drives Changes in Environmental Liability Estimates?

Estimates of cleanup costs are inherently uncertain. Estimates must assume
the use of current technology and  involve making a number of  assumptions
about the level of restoration of the site; detailed projections about the
schedule of  funding and  cleanup activities;  and inflation.  Costs  (and
hence the liability) may also change if  there is a change in the laws  or
regulations determining the level of restoration. For example, restoration
to "pristine condition"  would have a  higher cost than  restoration to  a
point deemed to "pose no near-term health risks."

The changes in DOE's  estimated environmental liability  in 2002 and  2003
illustrate the role assumptions play  in these estimates. DOE reduced  its
environmental liability  estimate  by  $28.7 billion  in  2002  and  $26.2
billion in 2003 primarily  by assuming it could  accelerate the timing  of
cleanup activities, which would lead to cost savings. However, we reported
in 2005  that while  some progress  had been  made under  its  accelerated
approach, it is not likely DOE will achieve its projected cost  reductions
in part because the plan depends on technological improvements and changes
in regulatory requirements that may not occur as planned.28

While the accrual  deficit reflects more  long-term environmental  cleanup
costs than  does the  cash  deficit, it  does  not include  all  long-term
cleanup costs and  some of  the costs recorded  may not  be reliable.  For
example, if no technology exists to clean  up the site, the costs are  not
measurable and agencies  do not  accrue expenses  for the  site. Also,  we
identified some issues with  DOD's environmental liability estimates.  For
example, DOD's  estimates  have not  reflected  major changes  to  federal
accounting standards that became effective in 2003. Also, the Navy had not
been estimating and  reporting all  costs for disposing  of spent  nuclear
fuel produced by its nuclear ships and submarines.29

28GAO, Nuclear Waste: Better Performance Reporting Needed to Assess DOE's
Ability to Achieve the Goals of the Accelerated Cleanup Program,
[39]GAO-05-764 (Washington, D.C.: July 29, 2005).

29GAO, Environmental Liabilities: Long-Term Fiscal Planning Hampered by
Control Weaknesses and Uncertainties in the Federal Government's
Estimates, [40]GAO- [41]06-427 (Washington, D.C.: Mar. 31, 2006).

Insurance

How Are Insurance Programs Recorded in the Cash and Accrual Deficits?

The federal government insures individuals and firms against a variety  of
risks, such  as  loss  of  deposits from  bank  failures,  crop  failures,
property damages from flood, and loss of pension benefits. Although  there
are  many  federal  insurance  programs,  only  two--the  National   Flood
Insurance Program  (NFIP) and  the  Pension Benefit  Guaranty  Corporation
(PBGC)30--are separately listed in the Financial Report for 2005.

Budget reporting  for insurance  programs focuses  on annual  cash  flows.
Outlays are recorded when  claims are paid  and collections for  insurance
programs--such as premiums--are recorded in the budget when received.  For
example, in 2005,  NFIP paid about  $3.3 billion in  claims and  collected
about $2.1 billion in premiums. Its net effect on the cash budget  deficit
was a net outlay of about $1.2 billion.

In contrast, the Financial Report records expenses or losses for estimated
insurance claims when events  have occurred or are  probable to occur  and
can be  reasonably  estimated. Accordingly,  losses  are recognized  as  a
liability in  the  balance  sheet  when claims  have  not  been  paid  and
generally represent a  difference between the  cash and accrual  deficits.
Whether or  not  the  increase  in  insurance  liability  constitutes  the
majority of the difference between  the accrual and cash deficits  depends
on the type  of federal insurance  program that has  been reported in  the
CFS. Table 5 shows the reported liabilities as of the end of 2004 and 2005
and the change in liability from the previous year.

Notes: Data from unaudited Financial Report for 2005, PBGC 2004 Annual
Report, and Department of Homeland Security Performance and Accountability
Report 2005. Insurance programs were not specifically reported in the
reconciliation statement prior to 2005. Because the Financial Report for
2005 only includes information on fiscal years 2004 and 2005, we did not
include information prior to 2004 in table 5.

aTotal for PBGC and NFIP only; does not equal total reported in CFS.

30Although PBGC's financial activity and balances are shown in the
Financial Report, under current law PBGC's liabilities may be paid only
from PBGC's assets and not from the General Fund of the Treasury or assets
of the government generally.

For NFIP,  the difference  between the  accrual and  cash deficit  is  the
change in insurance  liabilities, which reflects  claims approved but  not
paid and estimated claims for events  that have occurred. The increase  in
the NFIP liability from 2004 to 2005 accounted for $22 billion of the  $31
billion increase in insurance  liabilities for the  year. This means  that
the accrual deficit was $22 billion  greater than the cash budget  deficit
due to changes in NFIP's liability.  Because the accrued expense for  NFIP
enters into the accrual deficit as a negative, the change in the liability
must be added back to the accrual deficit to get to the cash deficit.

PBGC is somewhat  different than  NFIP and other  insurance programs.  For
PBGC, the difference between the cash  and accrual measures is not  simply
the change in the liability from the previous year. The difference between
the cash and accrual deficits attributable to PBGC is also due to  changes
in the value of  plan assets, whereas assets  are not an important  factor
for NFIP's reconciliation.  The difference  between the  cash and  accrual
deficits attributable to PBGC is  composed primarily of (1) losses  (i.e.,
the difference between the present value of estimated future benefits  and
plan assets) that are recorded in  the Financial Report for completed  and
probable pension plan terminations and (2) cash benefit payments that  are
recognized in the budget. The loss represents the amount PBGC estimates it
will ultimately be  responsible for.  Because losses are  included in  the
accrual deficit as a negative they  are added back to the accrual  deficit
to get to  the cash deficit.  This total loss  amount is not  specifically
identified in the reconciliation statement.

What Drives Changes in Insurance Programs?

The change in the NFIP liability  each year is driven by external  factors
such as natural disasters that produce floods and damage property. In  the
2 years shown  in table  5, flood  insurance had  the largest  single-year
effect on the insurance liability and the accrual deficit. The $22 billion
increase in the flood insurance liability  in 2005 was primarily a  result
of Hurricane  Katrina. Many  insurance claims  from individuals  who  lost
property from flooding as a result of Hurricane Katrina were not yet  paid
at the end of the fiscal year.31

The economic  health and  benefit obligations  of companies  that  sponsor
defined-benefit pension plans  are the primary  drivers of accrued  losses
recognized by PBGC.  PBGC estimates the  loss for pension  plans that  are
probable to be terminated  in the near  future by assessing  macroeconomic
conditions that  can  influence firms  and  investments and  the  specific
performance of particular companies. In 2004 PBGC recognized losses due to
probable  plan  terminations  of  $14.4  billion,  primarily  due  to  the
struggling airline  industry.  The  loss  also  includes  adjustments  for
deviations  between  actual  experience  and  PBGC's  estimates  and   the
underlying assumptions.  As  mentioned  above,  the  loss  represents  the
primary difference between the cash and accrual deficits but is not  equal
to the change in liability in table 5.32

31GAO identifies a list of high-risk federal programs that warrant
attention by both Congress and the administration. NFIP was added to the
list for 2006. See GAO's High-Risk Program, [42]GAO-06-497T (Washington,
D.C.: Mar. 15, 2006).

32PBGC's Single-Employer Insurance Program has been listed on GAO's
High-Risk List since 2003. See [43]GAO-06-497T .

Capital

How Are Capital Assets Recorded in the Cash and Accrual Deficits?

The federal government acquires a wide  variety of capital assets for  its
own use including land,  structures, equipment, vehicles, and  information
technology. The differing treatment of  capital assets between the  budget
and the financial  statements is  part of the  reconciliation between  the
accrual deficit  and the  cash budget  deficit. Table  6 below  shows  the
components of the reconciliation statement attributable to capital assets.

Note: Data from unaudited Financial Reports for 2001 to 2005.

To determine the accrual deficit (or  the annual cost of operations),  the
financial  statements  recognize  the  expense  for  a  capital  asset  by
spreading its  cost  over its  expected  useful  life. This  is  known  as
depreciation expense and increases  the accrual deficit  each year of  the
asset's life. Depreciation  is not recognized  in the cash  deficit so  it
must be added back to the accrual deficit to get to the cash deficit.

In addition,  capital assets  may  be sold  or  destroyed or  revalued  to
reflect the true value  of the asset. For  a sale, the difference  between
the amount that is received for the asset upon disposal and the book value
of the asset is recognized  in the accrual deficit  but not in the  budget
deficit.33 The budget deficit reflects a cash receipt for the full  amount
of the sale. Similarly, if an asset is destroyed or revalued to reflect  a
better estimate of its  value, this is recognized  in the accrual  deficit
but not  the cash  deficit.  Disposals and  revaluations can  increase  or
decrease the accrual deficit  and must be  accounted for when  reconciling
between the accrual and cash measures.

33The book value is the amount paid less depreciation already recognized.

In the budget, outlays made to  purchase capital assets are recorded on  a
cash basis. Outlays  are recorded  when capital  assets are  paid for  and
therefore the cost of the asset  increases the cash budget deficit in  the
year that the outlay is made. The cash cost of accrued expenses (in excess
of  assets--called  "capitalized  fixed   assets"  in  table  6--must   be
subtracted from the accrual deficit to get to the cash budget deficit.

What Drives Changes in Depreciation Expense and Capitalized Assets?

Changes in  accounting  standards such  as  what assets  are  included  in
capitalized assets  or how  assets are  depreciated can  cause changes  in
accrual measures. For example, prior to 2003, the depreciation of national
defense equipment (e.g.,  ships, aircraft, combat  vehicles, and  weapons)
was  not  reflected  in  the  accrual  deficit  because  national  defense
equipment was reported as part of "stewardship assets," which were not  on
the balance sheet, and thus not  depreciated. Beginning in 2003, a  change
in accounting standards required that DOD's national defense equipment  be
recorded as capitalized assets on  the balance sheet and depreciated.  The
primary reason for  the increase  in the depreciation  expense from  $20.5
billion in 2002 to  $71.2 billion in  2003 was the  addition of these  DOD
assets. It is important  to note that the  change in accounting  standards
changed what was reported on the  balance sheet and not what was  actually
owned by the government.

Prior to the accounting change relating to national defense equipment, the
cost of purchasing such equipment  was not included in the  reconciliation
statement because it  was reflected in  both the accrual  and cash  budget
deficits. Under the  accounting change,  the cost  of purchasing  national
defense equipment is  now capitalized  and therefore not  included in  the
accrual deficit,  while  such  costs  are still  included  in  the  budget
deficit.  The  capitalization  of  purchases  of  DOD's  national  defense
equipment was  a primary  contributor  to an  increase  in the  amount  of
capitalized assets  reported in  the reconciliation  statement from  $40.9
billion in 2002 to $102.0 billion in 2003.34

Although the addition of national  defense equipment to the balance  sheet
accounted for  a large  part of  the increase  in capitalized  assets  and
depreciation expense, too  much focus should  not be placed  on the  exact
size of  the  increase. As  we  have reported  in  the past,  the  federal
government can  not  satisfactorily  determine  that  capital  assets  are
properly reported  in  the CFS.  A  majority  of capital  assets  are  the
responsibility of the DOD  and it has not  maintained adequate systems  or
sufficient records to provide reliable information on these assets.

34The increase in outlays for capitalized assets reported in the
reconciliation statement only reflects assets that were purchased in 2003.
The total increase in the balance sheet as a result of adding national
defense equipment that was purchased in previous years was much greater..

How Can Accrual and Cash Deficit Measures Complement Each Other?

Neither the accrual  nor the  cash budget  deficit alone  provides a  full
picture of the government's  fiscal condition or  the cost of  government.
For example, the cash deficit provides information on borrowing needs  and
current cash flow. The accrual deficit provides information on the current
cost of government, but it does not  tell one how much the government  has
to borrow  in the  current year  to finance  government activities.  Also,
accrual deficits provide more information on the longer-term  consequences
of current government activities but by nature do not include  information
about the  timing  of  payments  and receipts,  which  can  be  important.
Therefore, just as  investors need income  statements, statements of  cash
flow, and balance sheets to  understand a business's financial  condition,
both cash  and  accrual  measures  are  important  for  understanding  the
government's financial  condition.  Cash  and  accrual  measures  together
provide a more complete  picture of the  government's fiscal stance  today
and over time; however, additional measures of the long-term  implications
of existing programs and tax policies are needed to have a fully  complete
picture.

Other Measures Are Also Needed to Understand the Government's Fiscal
Condition

Beyond accrual and  cash budget  deficits, there are  even more  measures,
statements, and information that are used  or could be used to more  fully
understand the government's fiscal condition, including

o projected cash flows of large spending and tax programs,

o summary present value measures of large spending and tax programs,

o reports on the nation's fiscal exposures,

o governmentwide financial statements of fiscal sustainability, and

o a summary annual report.

Some of  this  information is  currently  available, but  more  should  be
developed or made more transparent.  For example, the long-term cash  flow
is projected for Social Security and Medicare. These cash flow projections
help in understanding the expected timing of future payments and  receipts
and hence the potential effect of these programs on future borrowing needs
and financial markets. Summary  present value measures are  a way to  show
the long-term expected cost  of current or proposed  policies in a  single
number. These  are  also  available  for  Social  Security  and  Medicare.
However, projected cash flows and summary present value measures are still
needed for other major spending  and tax programs--both existing  programs
and new programs or benefits being considered by Congress.

Measures or statements that illustrate the future cost of government as  a
whole would also be  beneficial. For example, we  have suggested that  OMB
report   on   the   nation's   fiscal   exposures--the   wide   range   of
responsibilities,  programs,  and  activities   that  may  explicitly   or
implicitly expose the  federal government to  future spending. This  would
include reporting  liabilities, obligations,  commitments,  contingencies,
and implicit promises embedded in current policy or public expectations.35
Some of  these,  such as  environmental  cleanup and  disposal  costs  and
postretirement benefits,  are  reported  in the  financial  statements  as
liabilities. Others, such as financial commitments, certain contingencies,
and future social insurance benefits  are not reported as liabilities  but
are reported  elsewhere  in  the Financial  Report.36  Pulling  all  these
together into one presentation would  improve transparency and may  prompt
more  explicit   deliberation  of   the  government's   long-term   fiscal
commitments.

An even  more comprehensive  statement illustrating  the long-term  fiscal
sustainability of the government as a whole, including future tax receipts
and the cost of providing basic government services such as education  and
defense, might also  be useful.  Improved reporting would  also involve  a
summary annual report that summarizes in a clear, concise, and transparent
manner key financial and performance information embodied in the Financial
Report. Such a report  could be useful to  both Congress and the  American
people.

Some Federal Programs Use Both Cash and Accrual Measures in the Budget but
More Could Be Done

Some federal programs use both  cash- and accrual-based measures but  more
can be  done.  For example,  agencies  pay  the cost  of  accrued  pension
benefits for some civilians  (i.e., those hired  since 1984) and  military
personnel (i.e.,  those in  service after  October 1,  1984) as  they  are
earned. While the  accrued cost is  not reflected in  the budget's  bottom
line (i.e., the cash deficit),37 information  on the full cost of  current
services  is  available  to  decision  makers  responsible  for   resource
allocation. However, the full cost of all pensions (i.e., employees  hired
before 1984), retiree health, environmental liabilities, and insurance are
still not recognized in the budget when the commitments are made.

35GAO, Fiscal Exposures: Improving the Budgetary Focus on Long-Term Costs
and Uncertainties, [44]GAO-03-213 (Washington, D.C.: Jan. 24, 2003).

36Information on the long-term costs of social insurance programs has been
included in the required supplemental stewardship information section of
the Financial Report and a Statement of Social Insurance will be
incorporated into the primary financial statements for the first time for
fiscal year 2006.

37See app. II for more information.

Accrual measures  can be  used  to a  greater  extent to  inform  decision
making. Although long-term estimates, including those used in the  accrual
deficit, are  inherently uncertain,  cash measures  alone do  not  provide
information about the  longer-term consequences of  today's decisions.  We
have previously suggested38 that Congress consider expanding the selective
use of accrual-based  measures in  the budget  to program  areas where  it
would enhance spending control  and provide more  information on the  full
cost at the  time decisions to  commit the government  are made (i.e.,  up
front).39 We identified  several alternative approaches  for Congress  and
the Executive Branch  to consider  that would improve  the recognition  of
long-term costs in  the budget.  For example, accrual  budgeting could  be
adopted  for  programs  that  currently  do  not  capture  the   long-term
commitment entered into by the government such as:

o employee pension programs,

o retiree health programs for federal employees,

o federal insurance programs, and

o environmental clean up.

The bottom line  is that  having one measure  without the  other does  not
provide complete information about the government's fiscal condition.  The
government--just like businesses  and individuals--should  not ignore  the
balance in its checking account or its longer-term financial picture.

38See GAO, Budget Issues: Budgeting for Federal Insurance Programs,
[45]GAO/AIMD-97-16 (Washington, D.C.: Sept. 30, 1997), Long-Term
Commitments: Improving the Budgetary Focus on Environmental Liabilities,
[46]GAO-03-219 (Washington, D.C.: Jan. 24, 2003), and [47]GAO/AIMD-00-57 .

39For purchases of capital assets, we do not recommend the use of accrual
accounting for budget decisions because it would sacrifice up-front
control of budgetary resources. Recording depreciation rather than the
purchase cost would delay budget recognition of the resource commitment.

                     Appendix II: Budget Outlays Recorded on an Accrual Basis

Outlays in the cash budget deficit are primarily measured on a cash basis.
However, there are some areas, such as federal credit programs,  pensions,
insurance, and environmental liabilities, where cash measurement does  not
reveal the full extent  of the government's commitment  up front when  the
commitment is made. In some of these areas, the budget records outlays  on
an accrual basis rather than  cash. The accrual-based outlays for  program
areas shown  in  table 7  affect  the  bottom line  cash  budget  deficit.
However, accrual-based outlays for other program areas shown in table 8 do
not affect the  bottom line cash  budget deficit because  the outlays  are
paid by one agency to another (i.e., intragovernmental) and so offset each
other. Only payments that flow from or to entities outside the  government
affect the cash budget deficit.

aSome outlays from the Department of the Treasury to pay interest on
special Treasury securities held by some federal trust funds are also
recorded on an accrual basis but they are intragovernmental and do not
affect the cash deficit.

aFERS is the retirement system for civilian employees hired after 1983.
The Civil Service Retirement System (CSRS) provides defined benefits to
most federal employees hired before 1984. Currently, federal agencies pay
only about 40 percent of the pension costs for CSRS-covered employees.

bUnder the Floyd D. Spence National Defense Authorization Act of Fiscal
Year 2001 (Pub. L. No. 106-398), the Secretary of Defense was required to
make contributions into the Medicare-Eligible Retiree Health Care Fund.
However, beginning in 2006, DOD stopped making contributions because the
Ronald W. Reagan National Defense Authorization Act for Fiscal Year 2005
(Pub. L. No. 108-375) directed the Department of the Treasury to make the
annual contribution instead of DOD.

For additional  information on  program areas  where the  budget does  not
recognize their total commitment up front, see GAO reports titled  Accrual
Budgeting: Experiences of  Other Nations and  Implications for the  United
States, [48]GAO/AIMD-00-57 (Washington,  D.C.: Feb. 18,  2000) and  Fiscal
Exposures:  Improving  the   Budgetary  Focus  on   Long-Term  Costs   and
Uncertainties, [49]GAO- [50]03-213 (Washington, D.C.: Jan. 24, 2003).

                                        Appendix III: Obligational Accounting

In addition to cash and accrual accounting, Congress and federal  agencies
also track funds  using obligational accounting--a  separate and  distinct
administrative control through  which federal  agencies control,  monitor,
and report on the status of the funds at their disposal.

Obligational accounting differs from cash  and accrual accounting by  when
transactions are  recorded.  For example,  an  agency can  incur  a  legal
liability (i.e.,  a  claim  that  may  be  legally  enforced  against  the
government) in a variety of ways, such as by signing a contract, grant, or
cooperative agreement, or by  operation of law. When  an agency creates  a
legal liability, it "obligates"  itself to pay  and records an  obligation
against available funds. Recording  the obligation effectively sets  aside
those funds for the actual cash outlay. Under cash and accrual accounting,
the recognition of  the legal liability  doesn't show up  until later.  No
transaction is recorded  under accrual, or  proprietary accounting,  until
the entity  accepts the  goods  or services,  at  which point  an  account
payable and related expense  will be recorded.  Under cash accounting,  an
outlay is recorded when the obligation is liquidated.

The federal budget and budget process largely use obligational accounting.
The obligational  system of  accounting is  rooted in  the  Antideficiency
Act.1 It is  through this  obligational accounting  that federal  agencies
ensure compliance with the fiscal laws that Congress has enacted including
the Antideficiency Act,  the "recording  statute," and  the "purpose"  and
"time" statutes.  Thus,  if an  agency  controls its  obligations,  it  is
unlikely to overspend its appropriations.

A detailed discussion  of obligations and  obligational accounting can  be
found in  GAO's Glossary  of Terms  Used in  the Federal  Budget  Process,
[51]GAO-05-734SP (Washington, D.C.:  September 2005),  appendix III,  page
120.

1The Antideficiency Act prohibits an officer or employee of the United
States government from: obligating or spending in excess or in advance of
an appropriation, accepting voluntary services except in emergencies, and
obligating or spending in excess of amounts apportioned or in excess of
amounts permitted by agency regulations that subdivide amounts
apportioned.

Related GAO Products

The Nation's Long-Term Fiscal Outlook: September 2006 Update. 
[52]GAO-06-1077R . Washington, D.C.: September 15, 2006.

Financial Audit: Significant Internal Control Weaknesses Remain in
Preparing the Consolidated Financial Statements of the U.S. Government.
[53]GAO-06-415 . Washington, D.C.: April 21, 2006.

Environmental Liabilities: Long-Term Fiscal Planning Hampered by Control
Weaknesses and Uncertainties in the Federal Government's Estimates.
[54]GAO-06-427 . Washington, D.C.: March 31, 2006.

A Glossary of Terms Used in the Federal Budget Process. [55]GAO-05-734SP .
Washington, D.C.: September 2005.

Understanding the Primary Components of the Annual Financial Report of the
United States Government. [56]GAO-05-958SP . Washington, D.C.: September
2005.

Financial Audit: Process for Preparing the Consolidated Financial
Statements of the U.S. Government Needs Improvement. [57]GAO-04-45 .
Washington, D.C.: October 30, 2003.

Fiscal Exposures: Improving the Budgetary Focus on Long-Term Costs and
Uncertainties. [58]GAO-03-213 . Washington, D.C.: January 24, 2003.

Long-Term Commitments: Improving the Budgetary Focus on Environmental
Liabilities. [59]GAO-03-219 . Washington, D.C.: January 24, 2003.

Accrual Budgeting: Experiences of Other Nations and Implications for the
United States. [60]GAO/AIMD-00-57 . Washington, D.C.: February 18, 2000.

Budget Issues: Budgeting for Federal Insurance Programs.
[61]GAO/AIMD-97-16 . Washington, D.C.: September 30, 1997.

Budget Issues: Budgeting for Federal Capital. [62]GAO/AIMD-97-5 .
Washington, D.C.: November 12, 1996.

(450495)

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United States Government Accountability Office

Understanding Similarities and Differences between 
Accrual and Cash Deficits

December 2006

GAO-07-117SP

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