Accrual Budgeting: The Good, the Bad, and the Useful.

• Author: Marlowe, Justin

George Washington was an expert cherry orchard manager, a skilled river crosser, and an exceptional administrator. He was also one of our earliest budget philosophers. He famously once said, "We must consult our means rather than our wishes."

The General's musing points toward a key question in government budgeting: How should we "consult our means?" Does "our means" suggest balancing the annual budget? Not issuing debt? Holding the line on tax rates? How we answer this question says a lot about how we budget. And that's why state and local budget professionals should be aware of some emerging new thinking about what we mean by "our means."

How we consult our means starts with accounting. Recall that in traditional cash basis accounting, a government recognizes a transaction when cash flows in or out of its coffers. Accrual accounting takes a much broader view. It takes note if a transaction makes resources available or requires the government to commit resources, even if no cash changes hands.

This is more than just a technical distinction. Let's assume for a moment that Martha gives George a $10 monthly budget for nights out with his troops. Then say George puts a $3 ale on his tab at the Fraunces Tavern. From an accrual perspective, he has $7 left.

But on the cash basis nothing happens until he pays his tab next month, so he has $10 left. Is George living within his means? It depends. But it's clear that on an accrual basis, he'll at least think twice before ordering another round.

Generally accepted accounting principles (GAAP) require US states and localities to prepare their financial statements on an accrual basis, with some additional information presented on the modified accrual basis. There's lots of state-by-state variation, but accrual basis accounting is the norm for most larger jurisdictions. However, there's no such standard for budgeting. In fact, most states and localities regardless of size budget on a cash basis.

This is a sharp contrast with other types of organizations. Most for-profit entities prepare accrual basis financial statements and budgets, so the budget is effectively just a projected profit/loss statement. The same is true in many parts of the public sector outside the US. Almost 20 countries around the world require some form of accrual basis budgeting for national and subnational governments.

Accrual budgeting is popular because, in concept, it leads to better long-term fiscal outcomes. When the New York...