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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