The Wonders of Accounting

Blog, Economy, Frontier Centre

It is widely understood, at least within certain knowledgeable circles, that the actions of

Publius Publius

politicians, lawyers and accountants brought about the credit crisis and the worst recession in the developed world since the 1930s.

Politicians strive to be elected and, when in power, to stay in power, and the professions, legal and accounting, serve the politicians through the practice of their art.

At one time, government accounts were kept on a ‘cash basis’, if a government had a road built, that was an expense and went against the government’s revenue of the year in the determination of whether that government had achieved a ‘surplus’ or incurred a ‘deficit’. This approach tended to restrain government expenditures and borrowing.

Two decades ago and since, government accounting ‘moved’ closer to the approach of the commercial world. Spending on ‘infrastructure’ (roads, buildings, equipment, etc.) became ‘investments in capital assets’, to be charged against government’s revenue over the expected service lives of the assets. Assets acquired through borrowing are now ‘expensed’ over decades. Depreciation accounting came to government.

While there are strong arguments for the-then new approach, now well ingrained at the federal, provincial and municipal level, it does facilitate the growth of debt, as borrowing is not a charge against current revenue, only, and not necessarily all of it, the interest on the debt.

So, now what we have is revenue flowing into the coffers of the Government of Manitoba as it is received, while ‘costs’ against that revenue represent both ‘current period’ costs and the year’s amortization of past infrastructure ‘investments’. When government says it is raising taxes to pay for new infrastructure, it fails to note that while the higher tax revenue flows into its account in the year of receipt, the ‘expense’ of the infrastructure occurs over many years, decades in most cases.

The ‘new’ approach,  while consistent with the accounting long in place for private enterprise, allows for ‘stimulus’ and other funding that doesn’t drive up the government’s current period deficit.

Of course, as the aggregate investment in depreciable assets grows, the ‘wiggle room’ for future governments is reduced, as amortization of past investments are charged against current period income.  And, the ability and desire of government to borrow now and ‘pay later’, so to speak, increases when interest rates are low, which while being the current situation likely will not persist for much longer.

The Government of Manitoba ‘owns’ Crown corporations, and makes assessments or charges against those Crown enterprises for various services and purposes (such as the charges made by the government against Manitoba Hydro for capital tax and the fees the government charges for ‘guaranteeing’ Hydro’s debt).

By the way, the guarantee of the government soothes the concerns of credit rating agencies and the buyers of government bonds, though the prospect of actually calling on the guarantee is miniscule, as the government has every intention to have utility ratepayers meet every cost incurred by the utility, including levies against the utility by the government.

The interesting fact is that while the government takes those levies it makes against Manitoba Hydro into income in the year the government makes and receives those charges, Hydro, in its books, doesn’t always record those charges as an expense against its revenue. When part of the capital tax levy and part of the debt guarantee fees charged by the government against Hydro have to do with Hydro’s infrastructure projects, projects that are neither finished nor ‘in service’, Hydro ‘defers’ those costs in its books.

In such a situation in the commercial world, where the controlling corporation levies charges against a subsidiary, the recognition of that revenue in the controlling corporation’s books takes place in synch with the expensing of those charges in the books of the subsidiary. The ‘consolidated result’ published for investors eliminates charges between affiliated companies. In the commercial world, if the subsidiary doesn’t expense the charges made by the parent company in its books, the parent, in its own books, cannot record the income.

That  has not been the case with the books of the Government of Manitoba and Manitoba Hydro. Before Manitoba Hydro begins to expense levies made by the government related to ‘construction in progress’ (capital tax, debt guarantee fees), the government will have recorded revenue in its annual accounts aggregating in the hundreds of millions, likely low billions in the end.

This approach ‘assumes’ that, in the end, Hydro will expense those levies in full, and that ratepayers will meet those costs in higher rates. Of course, the Utility’s recording of the expenses in its current period books and the approval of increases in consumer rates to offset those expenses may not occur for a decade.

(Technically, the levies made by government against Hydro cannot be ‘assumed’ to be reflected,  in the end, in higher rates for consumers, as the rate regulator, expected to follow generally accepted rate setting practices, can only accept into rates costs that it finds prudent.)

This situation needs to be reflected upon, more to come in a subsequent post.