Susan Kane won the mayoral election in the City of Ashley partly on the basis of her charge that Allen Ross, the former mayor, was responsible for the budget deficit. After taking office, she hired a major international accounting firm to straighten

things out. This excerpt appeared in an article from a leading business publication, West End Business Review: [A riddle] Q: When is a budget deficit not a deficit? A: When it is a surplus, of course. Ashley Mayor Susan Kane was once again caught with egg on her face last week as she and her financial advisers tried to defend that riddle. On one hand, Comptroller Jim Guan, a Kane appointee, testified in hearings that the city had actually ended 20x5 with a $6 million surplus, not the much-reported deficit. He said further that the modest surplus grew to $54 million as a result of tax-enrichment supplements to the 20x5 balance sheet. On the other hand, the mayor stuck by the same guns she used last year on her predecessor. The city had ended 20x5, under the Allen Ross administration, not merely without a surplus, but with a deficit. The apparent discrepancy can be explained. Like most U.S. cities, Ashley operates under a modified accrual accounting basis. This is a combination of the cash basis and the accrual basis. The modified accrual basis differs from the accrual basis in that revenue is recorded when it is collected. The collection of Ashley's parking tax, which is assessed on all city parking lots and garages, is an example. The tax is assessed and collected on a quarterly basis, but the city doesn't collect the amount due for the last quarter of 20x6 until the first quarter of 20x7. Under ideal accrual methods, the parking revenues should be recorded in the 20x6 financial statements. Under a cash approach, the revenues would be recorded in the 20x7 budget. What the city did before was to record the money whenever it was advantageous politically. That, combined with the infamous revolving funds, allowed the city to hide the fact it was running large deficits under former Mayor Ross. That also means that no one really knew where the city stood. The auditors are now reallocating the parking revenues to the 20x7 budget but are accruing other revenues by shifting the period of collection from a year in the past. Overall, more revenues were moved into earlier fiscal years than into later years, inflating those budgets. Thus, the 20x7 deficit is a surplus. The article concluded: The upshot is that both Mayor Kane and Mr. Guan (the comptroller) were correct. There was a deficit in the 20x5 corporate or checkbook fund, but because of corrections taking place now, a surplus exists. a. Do you agree with the way the auditors handled parking revenues? Support your answer by explaining which method of accounting you think a city should use. b. Comment on the statement, "Systematically applied accounting principles will allow all to know exactly where the city stands."

a. The question to be resolved is whether parking revenues should be recorded in the period in which they are earned (accrual accounting) or in the period in which they are collected (modified accrual accounting). The city was inconsistent in how it handled the parking revenues. In other words, it did whatever was politically expedient. The auditors are using the modified accrual basis. This is a generally accepted method used by governmental units and so is an acceptable method for the city of Ashley to use. The reasoning behind this method is that governmental units are not-for-profit organizations and therefore do not benefit greatly by using accrual accounting, a primary objective of which is to measure earnings. There are, however, strong advocates of accrual accounting for governmental units. They feel that governmental units should be subject to the same accounting principles that business organizations are.

b. Regardless of the relative merits of the two methods, the worst situation from a financial reporting standpoint is for the city to use different methods in different years. Having chosen the modified accrual method, the auditors should (and did) apply the method consistently to all the years involved (20x5, 20x6, and 20x7). Using the same method consistently for all years simplifies comparison of the financial reports and removes political bias.