David C. Jones is a part-time research fellow at the Center for Urban Development Studies of the Graduate School of Design, Harvard University. He has been associated with the university since 1987 when he retired from the World Bank, where he served as financial adviser for water supply and urban development.
He joined the World Bank as a senior financial analyst in 1970, after working as a technical assistance adviser for the British government in East Africa. He began his career in British local government.
He is a chartered public finance accountant and a chartered certified accountant. He is the author of "Municipal Accounting for Developing Countries," originally published by the World Bank and the Chartered Institute of Public Finance and Accountancy in 1982.
Following are excerpts from his conversation with United Press International Senior Business Correspondent Sam Vaknin.
UPI: Can you compare municipal and corporate accounting and financing practices as far as governance and control are concerned?
Jones: In corporate accounting practice, the notional owners and managers are the shareholders. In practice, through the use of proxies and other devices, the real control is normally in the hands of a board of directors. Actual day-to-day control reverts to the company chairman, president, chief executive or chief operating officer. The chief financial officer is often -- though not necessarily -- an accountant and he or she oversees qualified accountants.
In local government accounting practice, the public trustees and managers are normally a locally elected council. Often, the detailed control over financial management is in the hands of a finance committee or finance commission, usually comprised only of elected members.
Traditionally, only the elected council may take major financial decisions, such as approving a budget, levying taxes and borrowing. Actual day-to-day control of a local government may be by an executive mayor, or by an elected or appointed chief executive.
There normally is a chief financial officer, often -- though not necessarily -- an accountant in charge of other qualified accountants. It is the responsibility of the accountants of the local government to produce the annual and other financial statements. It is not the responsibility of the auditors, whose obligation is to report to the local elected council on the credibility and legality of the financial statements.
It is common in many countries for local government financial statements to be audited by properly authorized public officials. Auditors should be qualified, independent, experienced and competent. It is unclear whether or not public official auditors always fulfill these conditions.
Q: Are we likely to witness municipal Enrons and WorldComs?
A: We already have! Remember the financial downfall and restructuring of New York City in the '70s. Other state and local governments have had serious defaults in the United States and elsewhere. Shortcomings in their accounting, politicians choosing to ignore predictive budgeting, borrowing used to cover operating expenditures -- similar to WorldCom.
More recently, I testified to Congress about Washington D.C., where the city council ran up a huge accumulated operating deficit of $700 million. It then sought Congressional approval to cover this deficit by borrowing.
Even more recently, Virginia decided to abolish the property tax on domestic vehicles. This left a huge gap in the following year's current budget. The governor proposed to use a deceptive accounting device and set up a separate -- and, thus not subject to a referendum -- "revenue" bond-issuing entity (shades of Enron's "Special Purpose Entities").
The bonds were then to be serviced by expected annual receipts from the negotiated tobacco settlement, at that time not even finalized. This crazy and illegal plan was abandoned.
The fact that both accounting and financial reporting for local governments are often in slightly modified cash-based formats adds to the confusion. But these formats could be built on.
Indeed, in the very tight budgetary situations facing virtually every local government, it is essential that cash management on a day-to-day basis be given high priority.
Still, the system can be misleading. It produces extremely scant information on costs -- the use of resources -- compared with expenditures (i.e., cashflows).
More seriously, cash accounting allows indiscriminate allocation of funds between capital and recurrent purposes, thus permitting no useful assessment of annual or other periodic financial performance.
A cash-based system cannot engender a credible balance sheet. It produces meaningless and incoherent information on assets and liabilities and the ownership, or trusteeship, of separate (or separable) funds. It is not a sound system of budgetary control.
When year-end unpaid invoices are held over, it creates a false impression of operating within approved budgetary limits. Thus, local government units can run serious budgetary deficits that are hidden from public view merely by not paying their bills on time and in full! A cash accounting system will not reveal this.
Still, moving to an accrual system should be done slowly and cautiously ... Skills, tools and access to proper professional knowledge are required before this is attempted.
Q: Can accounting cope with derivatives, off-shore entities and stock options? Or is there a problem in the very effort to capture dynamics and uncertainties in terms of a static, numerical representation?
A: Most, if not all, of these matters can be handled by proper application of accounting principles and practices. How to value stock options and when to recognize them is not clear. A paper on the topic identified 16 valuation parameters. But accountants are accustomed to dealing with such practical matters.
Q: What about recent trends of municipal finance not just in the United States and Europe but also Latin America and in the emerging economies of Central and Eastern Europe?
A: There are no standard practices for governmental accounting. The International Federation of Accountants urged accountants to follow various practices. It subsequently settled mainly on accrual accounting standards.
Some countries -- the United Kingdom, for local government and New Zealand for both central and local government -- use full accrual at current value, which is beyond many private-sector practices. This is being reviewed in the United Kingdom. The central government there is introducing "resource-based" accounting, approximating full accrual at current value.
Q: How did the worldwide trend of devolution affect municipal finance?
A: Outside of the former Soviet Union and Eastern Europe, municipal finance was not significantly affected by devolution, though there has been a tendency for decentralization.
Central governments hold the purse strings and almost all local governments operate under legislation engendered by the national, or -- in federal systems -- state governments. Local governments rarely have separate constitutional authority, although there are varying degrees of local autonomy.
It may be appropriate, under certain circumstances, for a central government to run budgetary deficits, whether caused by current or capital transactions. In local government units, there is almost always a necessity to distinguish between such transactions. In most countries, local government units are required by law to have balanced budgets, without resort to borrowing to cover current deficits.
A corporate body, whether a private- or a public-sector entity, has a separate legal identity from the central government and from the members, shareholders or electorate who own and manage it. It has its own corporate name.
Typically, its formal decisions are by resolution of its managing body (board or council). Written documents are authenticated by its common seal. The relationship is arms-length and not hands-on.
Q: Local authorities issue bonds, partake in joint ventures, lend to small and medium enterprises -- in short, encroach on the turf previously exclusively occupied by banks, the capital markets and business. Is this a good or a bad thing?
A: Local governments are established to provide services and perform activities required or allowed by law. Normally, they won't seek or be permitted to engage in commercial activities best left to the private sector.
However, there have always been natural monopolies (such as water supply), coping with negative economic externalities (such as sewerage and solid waste management), the provision of whole or partial public goods (such as street lighting or roads), merit goods (such as education, health and welfare), and services that the community, for economic or social reasons, seeks to subsidize (such as urban transport).
Left to the private marketplace, these services would be absent or under-supplied, or over-charged for.
What has changed in recent years is that local governments have been encouraged and empowered to outsource these services to the private sector or to "public-private" partnerships.
Charges for services, and revenues from taxation, cover current operating expenditures with a small operating surplus used to partly fund capital expenditure or service long- or medium-term debt, such as bond issues secured against future revenues.