Back in the heyday of the American automobile industry, one quote summed up the power of U.S. car manufacturers: “As goes General Motors, so goes the nation.” The industry—and GM in particular—was so massive that its fortunes exerted great influence over the U.S. economy and government policies. In the late 1970s many accountants took this axiom to its logical conclusion: accounting practices for a firm as massive as GM ought to work equally well for other large entities—governments. The Kellogg School’s Allan Drebin (Professor of Accounting Information and Management) disagreed, and took on the issue in his classic paper Is Accounting That’s Good for General Motors Good for Detroit?
Published in 1981, the paper asserted that the differences between financial practices in business and government militate against applying business accounting to government. While the argument was settled soon after the paper appeared, it has risen again recently as municipalities try to use business-style accounting approaches to deal with their short-term financial difficulties.
Drebin addressed a relatively simple issue in his paper. The Financial Accounting Standards Board (FASB), the independent nonprofit body that sets accounting standards for all organizations barring governmental ones, was pressing to oversee governmental accounting as well. “There were a lot of articles in the literature at the time saying: ‘Why should we have a different accounting method for the government?’ ” Drebin recalls. In his paper, published in the Government Accountants Journal, he set out reasons why that would not work. The object of the paper, he says, “was to show the need for separate accounting methods.”
An Argumentative Approach
Unlike many scholarly articles, Drebin’s paper presented his opinion rather than his research. “I was working on a government accounting framework at the time, and did some research on what users needed from government accounting,” he recalls. “But this paper was largely analytical rather than statistical; it was argumentative. The gist is that the needs of users of government accounting are different from business accounting and require different types of reporting.”
Drebin concedes that proponents of the FASB’s proposal offered reasoned arguments for a single accounting board. “They boiled down to saying that everyone understands business accounting, while government accounting is a strange animal,” he says. But as he saw the situation then—and still sees it now—three main arguments countered that view.
First, while government accounting is no simple task, neither is business accounting the simple procedure that its proponents made it out to be. Over the last decade, two companies—GM and Enron—have proved this point. FASB requires that companies include all subsidiaries in which it has more than 50 percent ownership in its accounting statements. Three years ago, GM sold 51 percent of its GMAC subsidiary. As a result, it did not have to consolidate GMAC into its accounts the following year, even though it still owned 49 percent of the company. The accounting system thus made it appear that GM had rid itself of millions of dollars in debt—a ghost transaction that substantially improved its debt-to-equity ratio. A few years before that, Enron had applied FASB’s principles in a similar way, using special purpose entities to move debt off its books. Enron, however, took the process to criminal lengths.
Different Roles in Society
Government accounting also differs from commercial accounting because their roles in society differ. “Business accounting is based on income. General Motors went into bankruptcy because it didn’t have any income,” Drebin explains. “Government, by contrast, is supposed to break even. Funds coming in must balance those going out.” Drebin illustrated that difference in his paper with an analogy to a fishing trip. “Although the transactions may be the same—rowing a boat, baiting a hook, pulling a line—it makes a difference whether the purpose of the venture is commercial or recreational,” he wrote. “The commercial venture would have to be evaluated in terms of the economic value of the catch relative to the costs of bait, boat, line, etc. On the other hand, a recreational fishing activity might be deemed successful even if the economic value of the catch were less than the cost of the input factors.”
Another difference between business and government involves the availability of funds. “Money is fungible in corporations,” Drebin explains. “But if governments collect a tax that is restricted, they cannot spend it on other issues.”
“The ‘bottom line’ is that the information needs of persons interested in governmental organizations are different from those of investors in profit-seeking businesses,” Drebin stated in his paper. “It follows that the objectives of financial reporting should also be different.”
The Issue Reemerges
The FASB’s bid to oversee government accounting—the specific concern that Drebin addressed—went away soon after his paper appeared. In 1984 the foundation that oversaw FASB created the Government Accounting Standards Board (GASB). However, the issue has reemerged recently as the economic downturn has pressured cash-strapped governments to balance their books. Early this year, the Chicago City Council approved Mayor Richard Daley’s proposal to sell the city’s future revenues from parking meters for the next three-quarters of a century to a private company for $1.1 billion.
“That amount is considered as revenue this year, to help balance the fiscal year 2009 budget,” Drebin points out. “But they’ve given away their revenues for the next seventy-five years. They’ve essentially sold the right to all the parking fees that they receive.” In fact, the transaction did not apply government accounting standards at all. Doing so would have required the city to segregate the $1.1 billion into a separate fund devoted to roads and highways. Instead, the money went into the city’s general fund.
FASB accounting can also cause problems for nonprofit institutions. Unlike for-profit corporations but like governments, nonprofits can take in revenues restricted to specific uses. Their balance sheets thus have temporarily and permanently restricted lines. “If a donor gives a restricted gift to Northwestern University for its science programs, the university can’t use it for its athletic teams,” Drebin points out. Nevertheless, private universities’ accounting follows FASB’s rules. Making the situation more perplexing, public universities—run by state governments—follow GASB rules in their accounting. Northwestern and the nearby University of Illinois at Chicago, therefore, do their accounting in entirely different ways.
Three decades after Drebin’s classic paper, selecting an appropriate accounting practice is not the only source of confusion in the accounting profession. Even today, he says, “there’s still a lot of accountants who don’t understand government accounting.”