Bankrupt Local Governments

Local governments of all sizes are facing significant budget deficits and have been for years. These deficiencies have eroded municipalities’ ability to pay their debts. As a result some municipalities have resorted to filing for bankruptcy protection under Chapter 9, Title 11, of the United States Code. Chapter 9 is available exclusively to municipalities to assist them in restructuring their debts. Most recently the city of Detroit, Michigan took advantage of Chapter 9 and became the largest municipal bankruptcy in U.S. history with debts totaling over $18 billion. Detroit replaced Jefferson County Alabama, as the largest municipal bankruptcy with debts of over $4.2 billion.

According to the website Governing, municipal bankruptcy remains relatively rare. A Governing analysis estimated that only one of every 1,668 eligible general-purpose governments (counties and cities) filed for bankruptcy protection over the past five years. One of the reasons for this low level of bankruptcy filings is that states must have in place laws authorizing municipal bankruptcy before a municipality can take advantage of Chapter 9. Only about half of the states have enacted such laws. The state then must approve of the municipality entering bankruptcy. States that have not enacted such laws often have other measures providing financial relief.

The cause of most municipal bankruptcies can frequently be attributed to the accumulation of large amounts of debt, usually from one or more of the following:

• Unfunded pension liabilities
• Unfunded health care benefits
• Mismanagement
• Over-budget capital projects
• Reduced state and federal aid
• Reduced tax revenues

According to the Wall Street Journal, “Detroit’s municipal pension funds awarded retirees, in some years, more than a 20% return on their annuities even as the funds lost value” contributing to the financial crisis. The pension debt has ballooned to nearly one-fifth of the city’s total debt. CNN reported that “Detroit spends roughly 38 percent of its annual budget on these types of ‘legacy’ costs leaving only 62 percent of spending for education, infrastructure, police and firefighters.”

Municipal bankruptcies are handled at the federal level, so constitutional issues prevent the judge from dictating how a municipality is run. Thus, the judge cannot mandate actions such as tax increases, budget cuts, asset sales or the removal of local politicians.

I think that there should be a mandatory requirement for all politicians, including the ones in Washington, D.C., to take, and pass, a course on fundamental accounting before being allowed to take office. It seems that no one understands the basic concept that if you spend more than you take in, year after year, you will eventually end up like the city of Detroit--bankrupt!

What do you think?

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Checkpoint Learning offers Fiscal Cliff CPE webinars in addition to hundreds of online and webinar tax and accounting courses; click here to check them out: http://cl.thomsonreuters.com/CourseFinder/Search?keyword=W198T,W197T

GAO Makes Major Changes to 2011 Government Auditing Standards

On December 21, 2011 the GAO issued the final revised 2011 Government Auditing Standards (The Yellow Book). Following is a summary of the major changes to the standards.

• Added a conceptual framework for independence to provide a means for auditors to assess their independence to activities that are not expressly prohibited. The conceptual framework requires auditors to make independence determinations based on facts and circumstances that are often unique to specific audit environments. The conceptual framework achieves further harmonization with AICPA and international standards.

• Removed specific references to personal, external, and organizational impairments, and overarching independence principles (GAGAS 2007). However, the underlying concepts related to these categories have been retained in the new conceptual framework for independence.

• Established requirements for auditors performing nonaudit services for entities they audit, to document their assessment of whether management possesses suitable skill, knowledge, or experience to oversee the nonaudit service (3.33-3.44).

• Revised substantially the guidance on nonaudit services that always impair an auditor’s independence with respect to audited entities and on certain nonaudit services that may be permitted under appropriate conditions (3.45-3.58).

• Added a summary of requirements for documentation necessary to support adequate consideration of auditor independence incorporating requirements applicable under the new conceptual framework (3.59).

• Removed certain SAS and SSAE requirements that were repeated in GAGAS.

• Discussed separately the three categories of attestation engagements, (1) examination, (2) review and (3) agreed-upon procedures. Auditors are not permitted to deviate from the reporting elements prescribed by the AICPA.

• The reporting requirements for fraud now include only those occurrences that are significant within the context of the audit objectives for performance audits.

The numbers in parentheses refer to paragraphs in the 2011 Government Auditing Standards (GAGAS) unless otherwise noted.

The effective date for financial audits and attestation engagements is for periods ending on or after December 15, 2012. The effective date for performance audits is for audits beginning on or after December 15, 2011. Early implementation is not permitted.