Problem 1-6

Choice of accounting principles may have significant economic consequences. In preparing its budget proposals, a city's budget committee initially estimated that total revenues would be $120 million and total expenditures would be $123 million. In light of the balanced budget requirements that the city has to meet, the committee proposed several measures to either increase revenues or decrease expenditures. They included the following:

a. Delay the payment of $0.4 million of city bills from the last week of the fiscal year covered by the budget to the first week of the next fiscal year.

b. Change the way property taxes are accounted for in the budget. Currently, property taxes are counted as revenues only if they are expected to be collected during the budget year. New budgetary principles would permit the city to include as revenues all taxes expected to be collected within 60 days of the following fiscal year, in addition to those collected during the year. The committee estimates that the change would have a net impact of $1.2 million.

c. Change the way that supplies are accounted for in the budget. Currently, supplies are recognized as expenditures at the time they are ordered. The proposal would delay recognition of the expenditure until the supplies are actually received. The committee estimates a net effect of $0.8 million.

d. Defer indefinitely $1.5 million of maintenance on city roads. Except as just noted with respect to supplies, the city currently prepares its budget on a cash basis, even though other bases are also legally permissible. It prepares its year-end financial statements, however, on an accrual basis.

1. Indicate the impact of each of the proposals on the city's (1) budget, (2) annual year-end financial statements, (3) ''substantive'' economic well-being. Be sure to distinguish between direct and indirect consequences.

2. It is sometimes said that choice of accounting principles doesn't matter in that the principles affect only the way in which the entity's fiscal ''story'' is told; they have no impact on the entity's actual financial history or current status. Do you agree? Explain.