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October 9, 2014

Analysis: Accrual accounting in the US, not in my backyard

US accounting firms will continue paying their taxes under a cash-based accounting system, at least for one more fiscal year, as Congress prepares for mid-term elections and legislative proposals to tax partnerships on an accrual basis should be reintroduced when a new Congress begins in January 2015.

American CPAs have been particularly active through their professional body, the American Institute of Certified Public Accountants (AICPA), lobbying Congress to preserve the current exception for partnerships to be taxed using the cash basis method and not the accrual system.

Accounting firms are partnerships and the profits they make are distributed to the partners who are taxed on a cash basis on their individual returns. Otherwise partners would have to pay taxes on income they might not have received.

The AICPA initiative was successfully received in Congress. In August nearly half of the US senators, 46 out of a 100, signed a letter to the chairman of the Senate Finance Committee opposing the switch to accrual accounting for tax purposes.

The letter responded to the proposals of The Cost Recovery and Accounting Discussion Draft published by the US Senate Finance Committee in November 2013, which forms part of a broader tax reform under consideration by the US Congress.

In August, a spokesperson from the AICPA told The Accountant that any tax reform should meet two tests, which are simplicity and fairness.

"The accrual requirement fails on both counts. It is under consideration only because it would allow the government to collect revenue from affected businesses sooner – although it would put those businesses at a serious economic disadvantage by doing so," he said.

In September, 233 members of the House of Representatives signed a letter calling on the House leadership to maintain the status quo and allow partnership to continue being taxed on a cash basis.

In September AICPA chief executive Barry Melancon said: "Colleagues from state CPA societies and our members have been instrumental in this effort. The accrual accounting mandate is bad tax policy that should be abandoned by the House and Senate."

Governmental accrual accounting Meanwhile, a more ambitious initiative proposing full accrual accounting for the federal government across budgeting, financial reporting and financial management received lukewarm support from just five congressional sponsors.

The initiative spurred the ongoing debate about improving the public sector accounting and financial management through a switch to accrual-based systems within government.

Under cash accounting liabilities are not recognised until governments pay for them. Whereas under accrual accounting liabilities should be recorded, even before payment, when they have been promised, billed or contractually stipulated.

As a consequence, figures will be different depending on what accounting treatment is used and what liabilities are brought into the balance sheet.

That bill demanding full accrual accounting for the federal government was introduced by former Congressman Joe DioGuardi, who was the first practising CPA ever elected to Congress where he served from 1985 until 1988.

DioGuardi, currently head of the watchdog Truth in Government, introduced a second resolution in Congress aimed at restructuring the US accounting standard setter for the public sector, the Federal Accounting Standards Advisory Board (FASB).

"FASAB is influenced by Congress through the CBO [Congressional Budget Office] and the Treasury department. The Treasury doesn’t want to put these liabilities on the balance sheet, therefore its pronouncements in accounting are tainted," he claimed.

Those liabilities, according to DioGuardi, are but not limited to Social Security and Medicare, which would show a different picture of the US public debt, worth $17.8tr as of 30 September 2014.

The US public debt is divided in two types. First, debt held by the public, or the Treasury securities sold to investors to offset cumulative deficits.

Second, debt held by government accounts, which represents primarily the balances on federal trust funds. These are accounting mechanisms, such as the Social Security, Medicare or Civil Service Retirement and Disability funds.

Of the two, only debt held by the public, $12.7tr, is reported as a liability in the federal government financial statements.

DioGuardi disagreed with this approach and estimated those liabilities are worth at least $72tr. He included obligations that, according to him, should be shown in the balance sheet, rather than in the footnotes of the financial statements as the federal government report them.

In particular, DioGuardi included: Medicare or the health insurance for people over 65 ($27.3tr); Social Security ($12.9tr); pensions for federal employees and military ($6.5tr); Miscellaneous liabilities ($1.3tr), which would include wholly owned corporations such as the Pension Benefit Guaranty Corporation; And the rest would be Medicaid which is the health insurance program for people with low-income.

"Some people argue the total debt is bigger than $72tr, if you include more liabilities such as those derived from GSEs [government-sponsored enterprises]. For example the obligations from bailing out Freddie Mac and Fannie Mae," DioGuardi said.

The second resolution introduced by DioGuardi received 19 sponsors. Both of them were sent to the Committee on Oversight and Government Reform, where no further action was taken since April and May respectively.

That means those resolutions will need to be re-introduced in January when the next term of the Congress will begin, due to the mid-term elections on 4 November.

DioGuardi said his colleagues, although active, are not being aggressive enough in making the case for full accrual accounting in the US.

"The profession is being distracted. Because congressmen don’t understand accrual that much, they don’t get why the accounting profession would want it for the US books but not to pay for their taxes," he said. "CPAs may feel they could lose their tax law exception by being unfriendly to certain people in Congress."

Whether this is a case of nimbyism or a justified exception to taxation laws, this debate is another example of the US isolationist approach to the questions raised at international level. Indeed, while IFAC has been making the case worldwide for accrual accounting as a system that could bring more transparency to public finances, the US profession seems more focused on defending the interests of its guild.

Related storiesEditor’s letter: Double standards

Accrual accounting in the US: A seventy-two-trillion-dollar question?

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