"Where's there's smoke, there's bound to be mirrors." - Garry Trudeau

Last week, Moody's Investors Service issued a report on The Bahamas' credit rating. We will discuss the Moody's report in this column next week.
Following the Moody's report, the minister of finance said that The Bahamas government was changing the way that it accounts for budget deficits, from cash to an accrual basis of accounting. He said, "There's no point in trying to hide the truth from the public. The best policy is to be up front and honest."
Therefore, this week, we would like to Consider this... Does the proposal described by the minister to change from a cash to an accrual basis for budgetary purposes represent a genuine characterization - a bona fide switch - in order to show a clearer picture of our actual economic status, or does the minister's proposed change represent what can be more accurately described as smoke and mirrors?

The national budget
Historically, the national budget is prepared on a cash basis. This means that each year the ministry of finance estimates the cash that it intends to collect, and the disbursements it plans to make for the ensuing year. If revenues exceed expenditures, there is a budget surplus. Alternatively, if expenditures exceed revenues, there is a budget deficit. Traditionally, The Bahamas' national budget projects a budget deficit, which is funded by borrowings, thereby increasing the national debt.
A simple way of viewing the national budget is to consider the operation of a food store. All sales in the food store are placed into the cash register. We can think of the cash register as the government's consolidated fund. In the food store, customers pay as they go for whatever items they purchase. Customers do not purchase groceries on credit. Therefore, the food store collects cash from customers, and the same cash is used to defray the store's operation by purchasing inventory, paying salaries, National Insurance, utilities, and other operating expenses. Food stores, like the government, operate on a cash basis.

Switching to an accrual budget
Following the Moody's report, the Ministry of Finance announced that it intended to change from a cash basis to an accrual basis for budgetary purposes. Therefore, the government proposes to include in its budgetary expenditures not only the cash expenditures for the ensuing year, but also all outstanding liabilities that the government has incurred at the end of its fiscal year.
It is noteworthy that, during his extensive budget communication in May, the minister of finance did not make a single mention of the plans to change from a cash to an accrual basis. Therefore, the government's recent decision appears to have been a last minute, ad hoc one that was prompted by the Moody's report.
The accrual basis of accounting, while a preferred method for accounting and budgeting purposes, requires that all liabilities or payables that are not paid during the fiscal period be included in the budgetary expenditures. It also requires that government receivables be included as well as payables. However, it seems that, since the government has indicated the inclusion of only liabilities and not receivables, at best, the Ministry of Finance's proposed change can be described as a "modified accrual basis", which embodies several fundamental fallacies and does not provide the entire picture of our fiscal performance.

Fundamental fallacies
One of the fundamental accounting principles in implementing the accrual system is to include both accrued revenues and accrued expenses. This is referred to as the matching principle because accrued revenues are matched with accrued expenditures. If we are going to move to a comprehensive accrual basis for budgetary purposes, the government will have to include in its budget not only the cash receipts but also the receivables that it realistically expects to collect in the ensuing period. This is not presently done, and neither has the minister suggested that it would be done. Accrued revenue should be matched against accrued liabilities to truly reflect the actual budget surplus or deficit, if it is truly an accrual system.
For example, there are hundreds of millions of taxes, such as real property taxes, business license fees, and value-added taxes that are owed to the government, which it reasonably expects to collect in the ensuing year and which should be included in its budgeted revenues. There is no accounting for such unpaid taxes in its proposed change to the accrual system, which means that the budgeted revenues would be understated and the budgeted deficit would be overstated. The government has only proposed that it will include the expenditures that are paid on a cash basis and the liabilities that are outstanding at the end of the fiscal year, plus the revenue that is actually collected, leaving out of the picture the hundreds of millions of dollars in receivables that is anticipated to be collected.
The decision to add only the outstanding liabilities to the budget deficit appears to be motivated by the government's intention to include such liabilities for purely political reasons, that is, to reflect the level of liabilities that were accumulated by its predecessors in office.
The second fundamental fallacy that flows from the government's stated change from a cash-based to an accrual system is that such presentation violates the fundamental accounting principle of consistency. To compare year-to-year results, budgets for the preceding year and the current year must be presented on the same or consistent basis. Failure to do so would be akin to comparing apples and oranges, because a budget that is prepared on a cash basis in one year and then presented an accrual basis in the following year would result in distinctly different budgets. There is simply no comparison.
The only way to accurately compare year-to-year results would be compare budgets that are prepared on the same or consistent basis for each year that is presented.
The third fundamental fallacy regarding the change to an accrual basis, as proposed, is that it violates the important accounting principle of completeness. Financial statements, including budgets, should be complete in their presentation.
If the government truly intends to move to an accurate accrual basis, then it must also take into account certain liabilities that have historically not been included on the cash basis. For example, there are enormous liabilities that are not reflected in the annual cash basis budget, such as gargantuan funded pension liabilities as well as liabilities related to costs that have been awarded by the courts but remain unpaid, just to mention a few, that must be included in the budget if the government intends to present a complete or comprehensive financial position of its budgeted expenditures.

The global landscape
What is the current state of countries regarding their use of accrual accounting? In a survey that was conducted by PricewaterhouseCoopers in 2013, that firm noted that "24 percent of 100 countries that responded to the survey said they currently used accrual accounting for their central government accounts".
"Of the 32 Organization for Economic Co-operation and Economic Development (OECD) countries, 59 percent currently use accrual accounting for their central government accounts. Only 10 percent of the 68 non-OECD countries surveyed said they currently used accrual accounting."
"The majority of governments today still use cash accounting, which is based on cash payments and receipts being recorded as they occur. This form of accounting fails to capture information on public sector assets and liabilities, and therefore presents a short-term view of public finances."
The survey concluded, "There is a real need for more solidity and transparency in government reporting. Public sector financial statements should reflect the full economic impact of political decisions - and this can only be fully achieved by applying accrual accounting.
"By doing this, governments demonstrate their commitment to achieving greater transparency and accountability, and also to producing better information for decision-making - which in turn should lead to the better use of public resources."

Conclusion
If the government really intends to move to an accrual basis of accounting, which is the developing trend, it must do so comprehensively, not in a partial or piecemeal manner, as contemplated by the minister of finance.
We submit that the government should undertake to phase in this approach with a view to complying with the important accounting principles of matching, consistency and completeness. Anything short of this will result in a purely political exercise of skewed results that a discerning public will recognize as nothing more than smoke and mirrors.

o Philip C. Galanis is the managing partner of HLB Galanis and Co., Chartered Accountants, Forensic & Litigation Support Services. He served 15 years in Parliament. Please send your comments to pgalanis@gmail.com.

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