GAAP and State and Local Governments

Overview

Preparing a financial report in compliance with Generally Accepted Accounting Principles (GAAP) establishes greater accountability and transparency between a government and its citizens, legislative and oversight bodies, investors, and creditors.

GAAP-based financial reports provide the public with the information necessary to assess the accountability of a government, primarily by:
  • Assessing the financial condition and results of operations
  • Comparing actual financial results with the legally-adopted budget, and
  • Assisting in determining compliance with finance-related laws, rules, and regulations.
This type of information is helpful to assess a government’s accountability for labor negotiations, economic development initiatives, real estate assessments, and the services the government provides to its citizens. This information also is used when making economic, political, or social decisions relative to a government’s operations.

Preparing a financial report in compliance with GAAP can make it less expensive for a government to borrow money and control its expenses.
Preparing a financial report in compliance with GAAP also can make it less expensive for a government to borrow money and control its expenses. For example:
  • A government may be able to obtain financing (through municipal bonds, bank loans, lines of credit, and so on) more easily because of a government’s ability to demonstrate to its lenders that it has the ability to pay back its debt. The more transparent the information, the easier it is for a lender to analyze a government’s risk. 
  • If a government issues debt, bond market analysts prefer and are accustomed to using financial information prepared in accordance with GAAP. This, in turn, reflects well on the government and its management, which could positively influence the bond rating for a government that prepares its financial statements in accordance with GAAP.
  • Finally, because of the accrual-basis information required to be reported under GAAP, a government will be able to better assess its finances and determine whether it can afford and attend to the commitments it has made to its citizens. Accrual-basis information provides accountability for longer-term obligations of a government (such as pensions and other postemployment benefits).

Why GAAP is Important For State and Local Governments, Part 1

What U.S. State and Local Governments Follow GAAP?

Many governments voluntarily prepare financial statements following GAAP for the reasons already stated.

Every state in the U.S. follows GAAP.

Some states also require governments within their borders to follow GAAP. For example:
  • Roughly half of the states require all of their counties to follow GAAP and a few require it only for their largest counties.
  • Roughly half of the states require GAAP for some or all cities, towns, and other localities.
  • About two thirds of states require all independent school districts to follow GAAP and a few require GAAP for the largest school districts.

Do Some Governments Choose Not to Comply With GAAP?

Some governments, particularly small localities, choose to prepare their financial reports using an Other Comprehensive Basis of Accounting (OCBOA) or regulatory basis in lieu of GAAP.

Common OCBOA used by governments are the cash basis (in which inflows and outflows are recorded only when cash changes hands) and the modified cash basis (in which some accounts receivable and accounts payable may be recorded as inflows and outflows).

However, preparing financial reports in compliance with GAAP, specifically the reporting of accrual information, provides users with the most comprehensive measures of financial health available by reporting the full cost of providing government services, the resources that a government can call upon to meet citizen needs (such as investments and capital assets), and the debts that a government has incurred and must repay with its resources.

The “pay-as-you go” cash basis and modified cash basis do not measure the full cost of providing services, only what was paid for in cash. As a result, financial information reported in compliance with GAAP meets the needs of users in ways OCBOA or a regulatory basis cannot.

GAAP-based financial information enables rating agencies to compare governments, while helping investors obtain more comprehensive and reliable information on a government’s finances.
For example, GAAP-based financial information enables rating agencies to compare one government to another, while helping investors obtain more comprehensive and reliable information on a government’s finances.

Additionally, taxpayer associations, unions, and other stakeholder groups are provided with access to much of the information they need, and elected officials have a more accurate picture of their government’s financial position.


Why GAAP is Important For State and Local Governments, Part 2