The User's Perspective
Interperiod Equity and What It Means to You
The notion of interperiod equity really should be pretty straightforward, but it is described in a variety of ways that sometimes seem similar and other times seem quite opposite. GASB Chairman Bob Attmore describes it as the state at which current-year taxpayers have provided adequate resources to pay for the cost of current-year services. Another way to look at it is as a state of equilibrium in which a government is neither deferring costs to the future nor using accumulated resources to provide current-period services. It is important to note that for financial reporting purposes, interperiod equity is a relevant metric to assess accountability rather than a goal that is expected to be met in any specific reporting period. For users of financial statements, the concept of interperiod equity is particularly important because it addresses the implications of fiscal decisions a government makes today but that may be felt well into the future.
A financial reporting objective related to both accountability and decision usefulness, interperiod equity makes its first appearance in GASB literature in Concepts Statement No. 1, Objectives of Financial Reporting. In that document, the GASB uses companion notions like “living within our means” and “balanced budget” and “fairness” to help illustrate the concept. The idea is that by achieving interperiod equity, taxpayers of today pay for the services that they receive and the burden of payment for services today is not shifted to taxpayers of the future. Of course, whether interperiod equity is achieved is a policy decision of the government. From a financial reporting perspective, the extent to which interperiod equity has been achieved can be indicated and a determination of whether taxpayer contributions are appropriate can be assessed.
In Concepts Statement No. 4, Elements of Financial Statements , the GASB added a description of interperiod equity as “the state in which current period inflows of resources equal current period cost of services.” When this is achieved, it goes on to say, “the burden of the cost of [current period] services is borne by present-year taxpayers and revenue providers” rather than “shifted to future-year taxpayers or revenue providers through an increase in the level of borrowing” or paid from net resources accumulated in past periods. It is easy to understand why the GASB considers this a relevant metric to assess accountability.
Interperiod equity should not be interpreted as meaning that governments should live only from year to year, and not do financial planning for the long term. Again, that decision is based on the policies of the government. For example, many would argue that it is appropriate to use long-term debt to pay for capital assets, or to accumulate resources annually over many years to do so.
How the GASB's Standards Address Interperiod Equity
As an example of the relevance of this concept today, the GASB is currently examining its pension and other postemployment benefits (OPEB) standards to determine, among other things, whether the existing standards help financial report users to assess the degree to which interperiod equity has been achieved and, if not, consider if the standards should be amended to better allow for that assessment.
Let us be clear—GASB standards do not take a position on whether it is most appropriate to pay for all costs in the periods they are incurred, or to accumulate assets over time to make future payments, or to shift current costs to future periods. The standards are objective in this regard. Rather, because it is clearly important to many kinds of users to be able to tell if costs are being covered within a given period or not, the standards require reporting of information that allows users to make that assessment.
Furthermore, it should not be assumed that governments that pass a burden of debt down the road for future generations to contend with do so because they are unscrupulous. More commonly, the explanations may be found in the political pressures of annually balancing the budget or a lack of a full understanding about the long-term implications of the benefit promises that were made to employees. Statement No. 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions, was met with resistance from some corners when it was issued because it requires governments to recognize the costs of benefits as they are earned, rather than later when they are paid to retirees and to estimate and report the size of their long-term obligation. In retrospect, however, it has served to shine a spotlight on the magnitude of the costs of health insurance and other OPEB, allowing financial statement users a more comprehensively informed view of a government’s financial commitments.
Interperiod equity is not limited to recognizing costs—expenditures or expenses—in the proper period, but also extends to revenues. A GASB pronouncement that addresses the concept of reporting revenues in their appropriate periods is Statement No. 48, Sales and Pledges of Receivables and Future Revenues and Intra-Entity Transfers of Assets and Future Revenues. Under the 1998 U.S. tobacco industry agreements with state governments that released the companies from present and future smoking-related liabilities, the companies agreed to make payments to the affected governments in perpetuity based on future tobacco sales. Some sought to securitize the money to be received in the future through bond sales. A question arose: Could they recognize all of the proceeds of the bond sales as revenue now? The Board concluded in Statement 48 that the answer is no from a financial reporting perspective—affected governments had to recognize the revenue over the periods to which the future inflows relate.
As governments seek ways to close budget gaps and meet capital investment needs, “public/private partnerships” are financing options that more and more governments are considering. The GASB is currently engaged in a project addressing service concession arrangements, which are a type of public/private partnership in which a public entity, like a state highway department, enters into an agreement with a private entity to build or operate a public asset, for example, a toll road. The project, for which a proposed Statement was issued in June (see the accompanying article), raises questions directly related to interperiod equity, including how inflows from upfront payments to the public entity should be recognized, and whether and how the government should report the property as a capital asset. In some circumstances, the GASB’s approach to those questions involves amortizing such payments over the life of the contract or the capital asset.
The accrual basis of accounting itself is intended to ensure that costs and revenues are reported in keeping with the appropriate period and that the government is living within its means. Under full accrual, all flows of resources—and therefore all changes in net assets—during the year are recorded regardless of whether they involved cash flowing into our out of the government. When a government follows full accrual, it reports in each year’s financial statements every transaction that occurs during the year that has an impact on its finances, even if cash did not change hands. The nature of this basis of accounting, then, is well-suited to allow users of financial statements to make judgments about what kind of job a government is doing with respect to interperiod equity.
The notion of fiscal sustainability considers whether a government is on a path that can be sustained into the future. Earlier this year, the United States Treasury Department published a report that concluded the current financial path the U.S. government is on is not fiscally sustainable. Without getting into the details, the current fiscal policies are projected to produce a relatively flat level of revenues in the next decades, but the corresponding debt service and entitlement program spending commitments are projected to grow by multiples over that same time horizon. During the course of the next generation, according to the projections, the federal government not only will lose its discretionary spending capacity, but also its ability to pay for entitlement programs will be severely challenged due to surging debt service payments.
The federal government has, until now, bridged its fiscal gaps by issuing additional debt rather than attempting to achieve interperiod equity. State and local governments, however, are generally required to balance budgets. The GASB has been studying the importance of the notion of fiscal sustainability to the users of state and local government financial reports and the kinds of information they use to assess it. The GASB will consider whether a project should be added to its current technical agenda to better address economic condition and fiscal sustainability reporting.
“What is to be done then?” you might ask. The purpose of this article is simply to bring these issues into focus and to show how this important concern of users is taken into account in standards of accounting and financial reporting. In keeping with the GASB’s goals of improving transparency and providing better accountability, citizens and other users of financial statements ought to be able to look at financial reports and be able to discern the fiscal path a government is on.
For 25 years the GASB has worked to develop accounting standards for state and local governments that result in transparent financial reporting. At the same time, it has helped these entities to be more accountable to their citizens and taxpayers by giving them the tools to demonstrate their stewardship over the resources entrusted to them. A concept like interperiod equity is not in itself the solution, but it is certainly part of it.