In recent revelations about Internal Revenue Service spending on a lavish conference in California, the problem with using fund accounting in government was laid bare. An IRS official appearing before Congress testified that another conference location would have cost $1 million less, but "the funding was there," so they chose Anaheim.

It is time that all governments started keeping their books using the same accounting system that for-profit businesses use. Governments should think and act as if they are profit-making entities. They should compare actual revenues to actual expenditures and show a surplus or deficit depending on whether or not they took in more money than they spent. Such a shift would incentivize government workers to cut expenditures and thereby reduce the deficit. In other words, it is time for governments to stop using fund accounting.

There have been millions of words written about government waste, its possible causes, and its possible remediation. Yet it does not appear that anyone has written, either directly or indirectly, that the fund accounting system itself is part of the problem.

Fund accounting is used to account for transactions of nonprofit entities and for governments at all levels, including federal, state, county and local governmental entities. It is different from accounting used by for-profit businesses, (hereinafter "regular accounting"). The fund accounting chart of accounts and the financial statements prepared from those accounts include budgeted numbers. For-profit businesses do not include budgeted numbers as an integral part of their chart of accounts or their financial statements. For-profit businesses compare revenues to expenses and determine a bottom-line number -- a profit or loss depending on which is higher, revenues or expenses. Governments compare budgeted revenues to actual revenues and budgeted expenses to actual expenses.

The problem with fund accounting is that it has created a paradigm that results in government waste, and costs the taxpayers tens of billions of dollars in waste each year. Ending it could save vast sums each year without increasing taxes or making significant changes to entitlements.

Millions of government employees are impacted by fund accounting, and most have no idea how fund accounting works or that it even exists. The vast majority of government employees at all levels throw money and manpower at operating issues without any regard to the efficiency of the investment. Why is this happening? One answer is that the model created by fund accounting ignores the efficiency of operations and personnel.

 

SPEND IT OR LOSE IT!

If a government supervisor sees opportunities for eliminating waste, the supervisor will most likely ignore those opportunities because it is disadvantageous to be the only one not working the system by hoarding people, supplies, services and equipment. Department heads protect their departments from across-the-board budget cuts by spending the entire amount allocated to their area of responsibility. They also spend their full budget every year, because otherwise the assumption is that they did not need all of those funds, which causes less money to be allocated to their department in the following year. So nine employees do the work of seven employees; perfectly good filing cabinets are replaced with new ones; new computers are purchased instead of upgrading two-year-old computers; storage closets are filled to capacity with pens, pencils and reams of paper. Memoranda are distributed asking if anyone can think of something the entity needs because the end of the fiscal year is approaching and there is still money left to spend.

Over time, the pace of innovation has increased, and governments have become much more complicated. Like it or not, governments engage in many more activities than they used to, which results in many more sources of revenue and ways of spending that revenue. It no longer makes sense for a government to assume that it can predict with certainty how much money it will take in, to enter that amount in the books, and to allocate that amount to the functions being performed by that government.

Such a top-down approach is a disaster in complex times. The goal should not be to spend all revenue, but to spend less, end with a surplus, and reward those who make it happen.

Adopting regular accounting for governments would encourage budgeting from the bottom up and not from the top down. In addition, employee incentive plans modeled after those used in the private sector could be introduced to motivate employees to eliminate waste. Employee bonuses should be available to those who spend less money to operate their department than they spent in the previous year.

The loss of jobs is one reason that some managers may shy away from ending fund accounting in government; but this is a short-sighted view. If governments cost less because waste -- including some jobs -- is eliminated, then taxes will go down. This will increase the funds available for the public to spend and, in turn, increase demand for products and services, resulting in the creation of more private-sector jobs. Many argue that governments are too big and too complex to rein in waste. But the sheer size and complexity of government is the very reason that a new across-the-board operating model is needed. Ending fund accounting will not be like waving a magic wand. Managers at all levels will need to be indoctrinated into the new model. Even then, it will take years to maximize the benefits. But as we have seen in the recent revelations about IRS conference spending, we will be much worse off if we allow the present system to continue.

Ending fund accounting is not the only answer to ending government waste; however, ending the fund accounting paradigm could prove to be the most effective way of reducing government waste at all levels -- federal, state and local.

Herbert Chubin, CPA, MBA, is the former internal auditor of the public school system of Trenton, N.J., and an adjunct professor of accounting.

Register or login for access to this item and much more

All Accounting Today content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access