Question

*Choice of accounting principles may have significant economic consequences*

In preparing its budget proposals, a city’s budget committee initially estimated that total revenues would be $120 million and total expenditures would be $123 million. In light of the balanced budget requirements that the city has to meet, the committee proposed several measures to either increase revenues or decrease expenditures. They included the following:

1. Delay the payment of $0.4 million of city bills from the last week of the fiscal year covered by the budget to the first week of the next fiscal year.

2. Change the way property taxes are accounted for in the budget. Currently, property taxes are counted as revenues only if they are expected to be collected during the budget year. New budgetary principles would permit the city to include as revenues all taxes expected to be collected within 60 days of the following fiscal year in addition to those collected during the year. The committee estimates that the change would have a net impact of $1.2 million.

3. Change the way that supplies are accounted for in the budget. Currently, supplies are recognized as expenditures at the time they are ordered. The proposal would delay recognition of the expenditures until they are actually received. The committee estimates a net effect of $0.8 million.

4. Defer indefinitely $1.5 million of maintenance on city roads. Except as just noted with respect to supplies, the city currently prepares its budget on a near‐cash basis, even though other bases are also legally permissible. It prepares its year‐end financial statements, however, on an accrual basis.

a. Indicate the impact that each of the proposals would have on the city’s (1) budget, (2) annual year‐end financial statements, and (3) “substantive” economic well‐being.

b. It is sometimes said that choice of accounting principles doesn’t matter in that they affect only the way the entity’s fiscal “story” is told; they have no impact on the entity’s actual fiscal history or current status. Do you agree? Explain.

Answer 1

a)
Impact	Budet	Financial Statement	substantive
1. Delay the payment of $0.4 million of city bills from the last week of the fiscal year covered by the budget to the first week of the next fiscal year.	The city budgets on a cash basis, delaying the payment of bills by one week would reduce the budget deficit, shifting cost to the next year	No impact on the accrual-based financial statements	A very Minor direct impact on the city’s substantive economic well-being
2. Change the way property taxes are accounted for in the budget. Currently, property taxes are counted as revenues only if they are expected to be collected during the budget year. New budgetary principles would permit the city to include as revenues all taxes expected to be collected within 60 days of the following fiscal year in addition to those collected during the year. The committee estimates that the change would have a net impact of $1.2 million.	Speeding-up recognition of property taxes would also reduce the budget deficit.	No impact on the financial statements	No impact on the city’s substantive economic well-being
3. Change the way that supplies are accounted for in the budget. Currently, supplies are recognized as expenditures at the time they are ordered. The proposal would delay recognition of the expenditures until they are actually received. The committee estimates a net effect of $0.8 million.	Delaying the recognition of expenditures would also reduce the budget deficit	No impact on the financial statements	No impact on the city’s substantive economic well-being
4. Defer indefinitely $1.5 million of maintenance on city roads. Except as just noted with respect to supplies, the city currently prepares its budget on a near‐cash basis, even though other bases are also legally permissible. It prepares its year‐end financial statements, however, on an accrual basis.	Deferring maintenance would reduce the budget deficit	Reduce the expenditures reported in the accrual-based financial statements	Assuming that the initially planned maintenance expenditures were necessary the change would have a negative effect on the city’s substantive well-being.
b)
Accounting principles do not directly affect an entity’s economic well-being. However, if they change the data presented in budgets or other financial reports that are relied upon to make legal determinations, credit assessments, or other decisions, their indirect impact can be profound