Much has been bandied about during the last few months regarding the City’s accounting and reporting systems. Statements are now coming out about how the City’s financial reporting practices led to an inability to produce understandable and or accurate pictures of the City’s financial state. It has been suggested that the City has now found an additional $2 million that can be used to offset upcoming deficits. What is going on here?
First, let’s discuss the three different methods for determining the City’s financial condition.
The first is cash basis accounting, which shows only cash as the City’s net position — just as a person might determine their cash position by looking at their bank account. Money owed (accounts payable) or money due (accounts receivable) are not included in the computation of your cash position. Several on the City Council keep referring to the city’s cash balance as being the appropriate way of analyzing our current financial condition. The problem with using this method is that it is way too easy to manipulate. If you want to make the city look poor, you just pay off a bunch of bills. You are still in the exact same financial state (you have less cash, but you also owe less money) although your statements say you are poor as you have less cash.
The next method is accrual accounting. Here your balance (working capital) is figured by taking current assets (cash plus accounts receivable, or what you are due) minus your current liabilities (accounts payable, or what you owe) and then the net is your working capital balance. This is standard practice in the business world and gives a good indication of the ability to maintain short-term operations. If you pay off some bills, your working capital does not change as the reduction in cash is offset by a reduction in accounts payable. If you collect on receivables, your balance does not change, since the amount of cash you collect is offset by the fact that you are now owed less money.
The last method, and the one that has been used by the City of Edmonds, is called modified accrual accounting. This is used primarily by government organizations as an attempt to present as conservative an approach to financial condition as is possible. What this does is take the city’s cash minus its current liabilities (what it owes), with the difference being the working capital balance. The thought here is that cash is 100-percent solid and what an organization owes is 100-percent solid, but accounts receivable is less than 100-percent guaranteed because it depends on whether you collect it. In summary, this method takes into consideration all the money you owe, but does not include money owed to you until it is collected. This is the method Edmonds has used for a number of years. Here is a link to a description of this method. Modified Accrual Accounting
This chart shows how the three different systems would reflect the City’s balances differently if you took $500,000 and paid off some bills. The cash-based system would show a reduction in the City’s financial condition, while both of the accrual systems would show that nothing is changed. The difference between the two accrual systems is only that the balance would be stated more conservatively in the modified accrual system.
The cash basis is not a good system as it is too easy to manipulate by paying or not paying bills at the end of a period to gain the desired picture of the financial condition. As to which is best between the two accrual methods, that is just a question of how conservative you want to be. In all three cases, the City’s actual financial condition is the same — just the numbers on the report are different.
So, no, there have been no new reserves found as a result of all this digging into the City’s financial reporting. In fact, even interim Finance Director Jim Tarte has said that he found little differences in the final numbers he gave for year end when compared to what his predecessor, Lorenzo Hines, had produced. He also stated that there is not sufficient staff to produce the reports that the City Council expects of the department. He has been more cooperative with the council, however, and that goes a long way in making councilmembers feel comfortable with the numbers.
Whatever method the city uses for computing its financial condition, the key is to be consistent from year to year so you can see trends. If the council wants to change from modified to standard accrual accounting, so be it. Once that’s decided, however, it’s important to not change it from year to year — otherwise, we won’t be able to detect the trend of our financial state.
This was verified in a discussion with representatives of the State Auditors Office two weeks ago. Consistency is the key when looking at financial statements.
There has been no magic found in the City’s Finance Department in the last few months. The numbers are the same, the problems are the same. The main difference is that the Finance Director has been much better at communicating the numbers to the City Council. There still insufficient staff to produce the kind of reporting council wants. The magic that has been found is this: The existing information is being presented in a far less adversarial manner.
Edmonds resident “Citizen Harry” Gatjens provides regular reports to My Edmonds News on the workings of the Edmonds city government, including the Citizens Levy Committee and the Citizens Technology Advisory Committee. Gatjens, an accountant, also offers insight into the workings of the city budget.