I’m teaching a governmental accounting course this term at FSU Panama City. State and local governments use something called “funds” to track the source and use of resources involved with carrying out governmental activities. You’ve likely heard of terminology like the “General Fund” before, for example. The objective of accounting for governmental activity is to achieve “fiscal” accountability.

I’m introducing the notion of fiscal accountability only for the purpose of showing why we as common stock shareholders in publicly-traded for-profit businesses need more than just a report of fiscal accountability in order to predict something about a company’s future as it relates to generating positive cash flow from its business. Fiscal accountability simply focuses on monies currently available to be used and monies that have been spent without any regard for whether the monies spent have future revenue generating potential. For example, if a General Fund uses money to acquire a fleet of police cars for a certain town, it simply regards the money as an expenditure at the time the cars are purchased. It, in effect, shows the money as used up and does not reflect the economic substance (within the General Fund) of the fact that there is a fleet of cars that can be used for several years to come, thereby serving the town beyond the “current” year. Fiscal accountability focuses on the current period only without regard over whether future potential is being achieved.

While fiscal accountability may work for a town’s General Fund report, again, stockholders of publicly-traded companies need to know how a company’s revenues (sales) are being put to work. If a company buys a fleet of company cars, those cars should not be written off in the year of purchase but rather recorded as long term assets and depreciated gradually across the life of the cars. That’s because the cars continue to work for the company beyond the year of purchase. Thus, the company is deriving longer term future benefit from the money spent on the cars that would not be recognized if accounting had a “fiscal responsibility” focus. Rather, common stockholders need an economic accountability focus — a longer term focus of how resources are employed.

If you were to look at a state or local government’s general fund balance sheet (is labeled a bit different than “balance sheet” but it’s a balance sheet nonetheless), you would see only current assets and current liabilities. When you look at a for-profit balance sheet, you will see current and non-current assets and current and non-current liabilities. At the heart of the this difference in balance sheet presentation is the concept of economic accountability for business vs. fiscal accountability for governmental activities. Again, as stockholders, we need to be able to predict future cash flows from doing business. If a publicly-traded company simply writes off a fleet of cars, for example, as soon as it buys them, we as company shareholders are left without knowledge of the fact that the cars will continue to be useful to the business in its attempt to generate revenue in the years to come.

So, economic accountability is the name of the game for corporate America financial accounting and reporting. It is the very notion that shareholders need to make economic judgements about the financial prospects of a company’s future operations in order to make wise investment decisions today that explains the necessity of “accrual accounting.”

More to come in the weeks ahead; have a good next week everyone!