To save the Commission's time, I will summarize pages 1 through 7 of my statement and then read the remainder.

THE FEDERAL ACCOUNTING STANDARDS ADVISORY BOARD
First, I will explain the role of the Federal Accounting Standards Advisory Board, which I will refer to hereafter simply as "the Board." The Board does the same thing for federal agencies as the Financial Accounting Standards Board does for business enterprises and not-for-profit entities and the Governmental Accounting Standards Board does for state and local governments ­ it develops accounting standards for external financial reporting. The federal Board goes a step farther than the other two, it also develops standards for managerial cost accounting.

To be clear on a point of some significance to the Commission, the Board does not set standards for federal budget presentations, that is, the presentation of estimates in the President's Budget. The federal accounting model simply tracks the Budget. It provides the actuals that back up the estimates in whatever form they may be presented.

That point leads to another point, relating specifically to capital budgeting. From the Board's perspective, capital budgeting, has two distinct aspects. One aspect, which is not unique to governmental entities, has to do with the decision process for making capital acquisitions. The other aspect, which is unique to governmental entities, has to do with federal budget presentation, that is, configuring the budget in some way to segregate capital outlays from operating outlays. The Board is vitally concerned with providing information that would be useful for making capital acquisition decisions, but it has no direct role in determining the methodology for making those decisions. Likewise, the Board is concerned with providing the actual results to back up any form of capital budget presentation that might be adopted for the President's Budget, but its only role is to deal with the accounting capabilities needed to support the presentation.
 

FEDERALACCOUNTING IN TRANSITION
Largely because of several pieces of financial management legislation in recent years, federal accounting is in the middle of a revolution. The accounting model is in transition from a basic budgetary accounting model to a more sophisticated management information and external financial reporting model. It is moving from a minimal compliance model, reporting on an agency's accountability for compliance with laws governing appropriations, to an effectiveness and efficiency model, reporting on an agency's accountability for managing its assets and liabilities and for managing its program operations. The essential statements in the new model are:

A conventional balance sheet showing all of an agency's operating assets and liabilities, supplemented by statements of what the Board calls stewardship assets and liabilities and stewardship investments.

A statement of net cost, serving somewhat the same purpose as the expense portion of a business income statement but expanded to show a breakdown of expenses (net of related revenues, if any) by responsibility segment and major program.

A statement of performance measures, serving somewhat the same purpose as the revenue portion of a business income statement but including nonfinancial as well as financial measures. The Board has not yet addressed the content of this statement, but I presume that, like the statement of net cost, it would include a breakdown by responsibility segment and major program.

I will now pick up with the text of my statement starting after the caption "Implications for Capital Budgeting" at the bottom of page 7.

The Federal Accounting Standards Advisory Board is not exactly a household name, like Smuckers, so I will briefly describe its role in federal accounting. I will refer to it hereafter simply as "the Board". The Board has no specific statutory basis. It was established under authority of the Federal Advisory Committee Act by the heads of the federal government's three central financial management agencies, the Secretary of the Treasury, the Director of the Office of Management and Budget, and the Comptroller General.

The General Accounting Office in the legislative branch and the Treasury and the Office of Management and Budget in the executive branch have overlapping statutory authorities for regulating federal accounting. There is no place to turn to resolve that kind of inter-branch jurisdictional issue short of the Supreme Court. A judicial solution seemed a little extreme to achieve an objective that all three agencies sought, which was to improve federal accounting. So they came up with a better way. They created the Board as a neutral body to bridge the constitutional division of powers.

The Board has its own staff and follows its own rules of procedure in developing accounting standards. However, because the Board has no regulatory authority in its own right, it submits its standards as recommendations to the three central financial agencies. After acceptance by all three agencies, the recommended standards are issued in the form of regulations by the Office of Management and Budget and the General Accounting Office. Since the Board's creation, all of its recommended standards have been accepted.

The Board has nine members. Three are from the private sector, including the chair. Two are from the legislative branch, one each from the General Accounting Office and the Congressional Budget Office. And four are from the executive branch, one each from the Treasury, the Office of Management and Budget, a defense agency and a civilian agency. As you can see, there are ties to both the legislative and executive branches, but the Board as a whole is designed to be independent of undue influence by either.

The Board develops accounting standards following an extensive due process that is similar to that of the Financial Accounting Standards Board in the private sector. Throughout the process there is a great deal of interaction between the Board and the users, preparers, and auditors of federal financial reports.
 
 
Federal Accounting in Transition

I turn now to federal accounting and capital budgeting. First, I want to be clear about the Board's role regarding budgeting generally and capital budgeting in particular. The Board develops standards to meet the objectives of federal financial reporting. One of those objectives is budget integrity, which calls for reporting on compliance with spending authorizations, commonly called budgetary accounting. The Board does not develop standards for the presentation of budget estimates. It does provide for reporting the actuals that back up the estimates in whatever form they may be presented in the President's Budget. However, accounting capabilities are a constraint on budget presentation standards in that the budget realistically has to present estimates that can be backed up by actuals from the accounting system. In that sense, accounting standards and budget presentation standards are complementary.

From a federal accounting perspective, capital budgeting involves two distinct kinds of decision, the capital asset acquisition decision and the budget presentation decision. The Board is vitally concerned with the acquisition decision from the standpoint of providing standards for accounting information that is useful both for selecting from among various capital acquisition alternatives and for evaluating the decision after a capital asset is acquired. The Board is also concerned with the budget presentation decision, but its only role is to deal with the accounting capabilities needed to support any presentation that might be adopted for the President's Budget.

The federal accounting model is in transition from a basic budgetary accounting model to a more sophisticated management information and external financial reporting model. I will try to explain where it stands now, where it is headed, and how it might cope with a capital budget, however structured.

The old, and still existent, accounting model is compliance oriented. It supports the current budget process by providing assurance that the purposes of appropriations have been carried out properly and by tallying cash outlays as they occur.

The new, and still emerging, accounting model is performance oriented. It focuses on the effectiveness and efficiency of federal program operations. If the new model comes to fruition as contemplated, it will support the current budget process in the same way that the old model does, and it will do a whole lot more. It will provide information useful for many kinds of decision, including capital asset acquisition decisions, and it will be adaptable to almost any form of capital budget presentation that the Commission might choose to recommend.

The current budget process will not necessarily change even though the accounting model changes. But the budget process could change to take advantage of accounting information not previously available. So it might be useful for the Commission to understand the key differences between the old and new models insofar as capital budgeting is concerned. The differences are most important at the micro level of individual appropriations or programs. For government-wide reporting, they tend to cancel out. Most of the differences center on the process of acquiring and using economic resources. That process entails a cycle of four significant economic events:

1. A purchase order is placed for goods or services. In federal accounting that is called an obligation incurred.

2. The goods or services are delivered to the ordering entity. That is usually called an expenditure or a cost.

3. The goods or services are consumed. That is called an expense.

4. The goods or services are paid for. That is a cash outflow called an outlay.

The budgetary accounting model that supports the current budget process is essential but minimal. Federal accounting has been more of a clean-up chore than a tool of a dynamic management process. Because of that, over the years a few pioneer agencies have expanded their accounting models to meet management needs, well beyond the minimum accounting needed to support the current budget process, and recent legislation expanded the model to provide for external financial reporting much like the private sector.

The new accounting model integrates all four of the financial events in the cycle just described. However, it shifts the event focus from obligations incurred and outlays, which are events affecting financial resources, to expenditures and expenses, which are events affecting real resources. And it shifts the entity focus from individual appropriations, which tend to be input oriented, to agency programs, which are output oriented. In keeping with an output orientation, the new model contemplates the addition of a fifth event to the cycle of key events:

5. Goods or services are delivered to a program's customers or beneficiaries. That is called an output or an outcome (or a revenue if the output is sold).

The addition of performance measures to the accounting model will eventually permit the matching of program inputs (resources consumed) and program outputs (services rendered) in each fiscal period. That matching will not be quite as neat or as easy as matching expense and revenue to come up with net income, as in business income statements, but it is the same concept. It is a breakthrough for those interested in assessing the effectiveness and efficiency of program operations and in providing the tools and incentives for improving program management.

I will sum up the comparison of the old and new accounting models this way. For the old model, the essential financial statements for an agency are:

A statement of end-of-period appropriation balances, with a breakdown by obligated and unobligated.

A statement of cash flows for the period -- outlays and receipts ­ with a breakdown by appropriation.

A conventional balance sheet showing all of an agency's operating assets and liabilities, supplemented by statements of what the Board calls stewardship assets and liabilities and stewardship investments.

A statement of net cost, serving somewhat the same purpose as the expense portion of a business income statement but expanded to show a breakdown of expenses (net of related revenues, if any) by responsibility segment and major program.

A statement of performance measures, serving somewhat the same purpose as the revenue portion of a business income statement but including nonfinancial as well as financial measures. The Board has not yet addressed the content of this statement, but I presume that, like the statement of net cost, it would include a breakdown by responsibility segment and major program.

Much implementation work has been done. All major agencies and the federal government as a whole issued audited financial statements for 1997. Some got clean audit opinions, some got qualified opinions, and some got disclaimers of opinion. That will improve. The President has set a goal to have a clean opinion on the consolidated government-wide statements for 1999.

Much more needs to be done. Some agencies cannot even reconcile their bank accounts. Most agencies do not have adequate cost accounting systems. All agencies are struggling with the development of performance measures. So the new model will not be in full bloom for some time, but the momentum is clearly accelerating.
 
 
Implications for Capital Budgeting
 
As I noted earlier, the new accounting model when fully implemented will be supportive of capital acquisition decision making and adaptable to almost any form of federal budget presentation that the Commission might want to consider. Because of its power and versatility, the new model might give the Commission room to think outside the frame within which capital budgeting has usually been discussed.

For example, the new accounting model is essentially the business model except that performance measures replace revenues for the most part. The absence of revenues makes return on investment calculations inapplicable, but even so the analytic decision making process used by business enterprises for capital acquisitions might be more adaptable to federal programs than in the past. In that connection, it could be useful to consider capital acquisitions in the context of expense-based program-level performance reporting, an approach that the new accounting model emphasizes. A program level perspective on capital acquisitions might throw new light on the subject. My impression is that the federal capital budgeting debate over the years has often been conducted in terms of government-wide and economy-wide impacts. That is important, but capital acquisitions are made to support specific programs from specific appropriations. Looked at individually, some of those decisions may look pretty nitty gritty for the Commission to be worrying about. But that level of decision making is where the effectiveness and efficiency of government operations is ultimately determined.

Be that as it may, there are several features of the Board's accounting standards that are particularly relevant to capital budgeting considerations. I will try to highlight what the new accounting model can and cannot do. In that regard, some capital budget presentation proposals would split capital and operating at the point of outlays and stop there. Others would take further steps to flow the capital outlays from the capital budget to the operating budget in the form of depreciation and amortization. I will try to explain what the accounting capabilities are for depreciation and amortization.

One feature of the new accounting model is that conventional capital assets ­ property, plant, and equipment ­ should be on all agencies' balance sheets by the end of this year or next, with depreciation schedules developed and in place. In the past that would have been a big hurdle to get over before it would have been feasible to adopt any form of budget presentation that included depreciation.

I should note, however, that the standards provide three exceptions to capitalization of property, plant, and equipment. The exceptions are national defense assets, heritage assets, and land not used in regular government operations, commonly called "public lands" or "the public domain." Of those three, only national defense assets are the subject of major on-going acquisitions and therefore of possible importance for capital budgeting. Although not to be capitalized, all three of those classes of assets are subject to special reporting requirements in supplemental statements, so a data base will be available for possible use for capital budgeting purposes. Also, accounting for current acquisitions under a capital budget would not be a problem for any of the three. They are not reported on the balance sheet primarily because of the problems of measuring long-past acquisitions.

A capital asset class with an uncertain accounting status is natural resources. The Board is currently studying federal holdings of natural resources with the objective of including some kind of information in federal financial reports. For the most part, however, the resources already exist on federal lands, so they would not be of major importance for future capital acquisition budgeting. There is a good chance, I believe, that because of uncertainties about quantities and values, most natural resources will be reported in supplemental statements like the public lands rather than being recognized on balance sheets.

Computer software is a major capital outlay for many agencies. Software is an intangible asset but otherwise similar to property, plant, and equipment. The Board is about to recommend a standard requiring software to be capitalized and amortized over its useful life. That will be another hurdle out of the way for capital budgeting considerations.

Then there are three classes of expenditure that might be considered capital expenditures although they do not result in federally owned assets or, in some cases, any assets at all in the conventional accounting sense. They are:

Research and development ­ federally conducted and federally sponsored research and development, both basic and applied.

Human capital ­ education and training programs financed by the federal government that are designed to enhance national economic productive capacity.

Nonfederal property ­ federal grants provided to construct or acquire assets (such as highways) to be owned by state and local governments.

One other current Board project has a bearing on the execution phase of a capital budget. That is a project on reporting the cost of capital. The underlying concern here is that some capital-intensive programs are financed by interest-bearing borrowings from the Treasury and therefore automatically include a cost of capital in their program costs. Other capital-intensive programs are financed by appropriations and do not include a cost of capital. Thus, otherwise identical programs could report different total costs, complicating decision making for budgeting and other purposes. The project is in its early stages so I cannot predict how it will turn out. The objective, however, is to enhance comparability in some way.

Finally, I would like to comment on the capitalization and amortization of intangibles. Some expenditures for research and development, education, and many similar items result without question in intangible assets in the broad sense of creating future economic benefits. But accountants have found it extremely difficult to establish the amount, timing, and relative certainty of the benefits and therefore very few intangibles have been capitalized on balance sheets. This is not a problem for those forms of capital budget presentation that merely segregate capital flows from operating flows at the point of outlay and let it go at that. But it is a severe problem for those forms of capital budget presentation that would take the further steps of sequentially flowing capital costs from the capital budget to the operating budget in the form of depreciation or amortization.

As I noted earlier, the new accounting model will capitalize and amortize computer software. Software is an intangible asset, but it is one with characteristics that make it susceptible to accounting recognition. There are no current plans for similar accounting for other intangibles, most of which have long been considered too uncertain for accounting recognition. A decision to capitalize and amortize other intangibles would push the Board into untamed frontiers of accounting. I do not say this to discourage the Commission from exploring those frontiers. Accountants and economists need to find ways to measure and link the economic costs and benefits of intangibles. My point in bringing it up is to caution that practical accounting solutions are not on the horizon. In that regard, however, the Securities and Exchange Commission sponsored a conference on this subject a couple of years ago and, by coincidence, there is a conference on the subject here in New York next week, at New York University. Those conferences both start from the premise that there are large unrecognized values out there that somehow should be brought into the purview of financial reporting.

That about concludes my statement, ladies and gentlemen. To summarize, I believe that federal accounting capabilities will soon be at their highest level ever, fully up to the job of supporting the capital acquisition decision process and, except for the caveat about intangibles, reasonably capable of backing up any capital budget presentation that might emerge.

Thank you. I will be happy to answer questions.