## 1. Summary Extended Accounts, Clean Surpluses

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### I. INTRODUCTION — purpose and approach
- Problem statement:
  - Government accounts often fail to reveal full fiscal effects in the year decisions are made, enabling "deficit devices" that reduce short-term deficits only to increase them later (Easterly, 1999; Koen and van den Noord, 2005; Irwin, 2012).
- Analytical aim:
  - Clarify the relationship between accounting devices and accounting rules; analyze the problem rather than catalog manifestations.
- Methodology:
  - Begin with a world where assets and liabilities are unambiguous and analyze devices as transactions involving assets/liabilities that are not recognized on the government balance sheet.
  - Extend to a world with multiple kinds of assets/liabilities and multiple accounting systems (cash, modified accrual, full accrual) to show nested vulnerability.
- Key conceptual recommendation:
  - Present a set of integrated fiscal accounts that include several measures of the deficit, including one equal to the decline in the net present value of all projected cash flows under current policies.

### II. ONE TRUE DEFICIT — framework and core identities
- Core framework (two-period, zero-interest):
  - Intertemporal budget constraint: 02 .ww  (equation (1) as printed).
  - Clean surplus definition: 2 1 .ttt sww     (equation (2) as printed).
  - Alternative notation: surplus as change in net worth: .tt sw  
- Clean/comprehensive surplus concept:
  - Surplus defined as increase in net worth (clean surplus).
- Off-balance-sheet/unrecognized assets/liabilities decomposition:
  - True net worth decomposed: onoff .tt t ww w    (equation (3) as printed).
  - Reported (assumed clean) surplus: onon 1 .tt t sw w      (equation (4) as printed).
  - Difference between reported and true surplus: off .ttt s s w       (equation (5) as printed).
- Debt and reporting relationships:
  - Reported net worth when all debt b recognized: ononon .tttt wabl l     (equation (6) as printed).
  - Increase in debt equals reported deficit plus stock-flow adjustment as given in source.
- Typical deficit-device mechanisms:
  - Takeovers of private pension schemes that transfer assets but assume unrecognized liabilities.
  - Building arrears when accounts payable are not counted as debt.
  - Off-market swaps creating liabilities counted in the deficit but not counted as debt.

### III. MULTIPLE DEFICITS — nested accounting systems and extended accounts
- Heterogeneity of assets/liabilities:
  - Assets/liabilities differ by kind (firm commitments vs. custom/expectations) and by valuation precision, producing many possible accounting systems.
- Notation and combinatorics:
  - J denotes an accounting system arising from recognition of set J; net worth wJ and clean surplus 1 .JJJ ttt s w w    .
  - With m kinds of assets and n kinds of liabilities there are 2 .mn  possible systems (as printed); example with five of each yields more than a thousand systems.
- Important nested sets (as presented in Figure 1):
  - Cash (C), Financial assets and liabilities (F), All currently recognized assets and liabilities (R), and all future cash-flow rights/obligations (E).
  - Set relationship (as printed): .CFRE        (equation (7) as printed).
- Accounting-system vulnerabilities and examples:
  - Any accounting system based on a subset of R is vulnerable to devices involving elements outside that subset.
  - Empty set accounting (pure cash-flow accounting): 00 0 .tt sw         — any transaction that reduces true net worth can function as a deficit device.
  - Cash accounting (C): CCc .ttt swa     — reported surplus equals increase in bank balance; borrowing can be used as a device by treating debt proceeds as revenue.
  - Modified accrual (F): .FF t t s w   ; reported surplus = true surplus less increase in nonfinancial assets: nf .F ttt ss a    
  - Full accrual (R): recognizes nonfinancial assets as well; still vulnerable to devices (e.g., operating vs finance leases; contingent assets/liabilities such as guarantees where fees count as revenue).
- Extended accounts (E):
  - E denotes recognition of assets/liabilities associated with all projected future spending and revenue.
  - Extended net worth equals net present value of all projected future cash flows under current policy; extended surplus equals change in extended net worth.
  - Extended accounts would supplement but not replace existing accounts.
  - Caveats: present values of future taxes/spending are extremely uncertain, volatile, and large relative to current balance-sheet items; fluctuations could swamp recognized asset/liability changes.
- Summary extended accounts format (as printed):
  - For each set (C, F, R, E): Opening Balance + Clean Surplus = Closing Balance, e.g. 1 C t w  + C t s = C t w, etc.

### III.B — Deficit devices in the nested-sets view
- Definition:
  - A deficit device increases a targeted surplus sJ without increasing surpluses derived from supersets K ⊃ J.
- Operational mechanism:
  - Sell assets or incur liabilities in K\J in return for assets (or cancellation of liabilities) in J.
- Role of extended accounts:
  - Extended accounts do not prevent devices but reveal them by showing whether broader measures also improved.

### III.C — Fiscal sustainability in extended-account terms
- Reformulation:
  - Fiscal sustainability requires the present value of future primary surpluses (excluding returns on assets/liabilities in R) to offset imbalance in currently recognized net worth wR.
- Sets and implication:
  - E\R contains proposed new tax assets and spending liabilities.
  - Fiscal sustainability relation (as printed): \RER tt ww    (as printed).
  - From (7): \ 0 .RERE tt ww w    and sustainability implies 0 E t w  .

### IV. DIRTY DEFICITS — nonclean surpluses, decompositions, and specific devices
- Motivation:
  - Many fiscal analyses focus on nonclean surpluses (e.g., net lending/borrowing, net operating balance).
- Decompositions:
  - Clean extended surplus decomposed into nested clean surpluses: \\\ .ECFCRFER s s s s      (as printed).
  - Conventional cash-account decompositions: "above and below the line"; further division into operations and investments in cash-flow statements.
- Examples of devices exploiting nonclean measures:
  - Zero-coupon and inflation-indexed bonds can be reported so that coupon-like appreciation is not recorded as interest, deferring interest recognition.
  - Icelandic accounting example: inflation-driven increases in outstanding debt treated without recording corresponding interest expense (as discussed in source).
  - Eurostat/Irish example: introduction of grace period on debt to Anglo Irish Bank where Eurostat guidance in 2010 allowed not accruing interest during grace period for "zero rate of interest during the grace period"; later 2012 manual tightened guidance requiring recognition of interest during grace periods except in narrowly specified cases (Eurostat, 2010b; Eurostat, 2012).
- Mitigation practice:
  - Modern fiscal statistics typically spread interest costs over life of borrowing (using a discount rate that equates present value of forecast debt-service payments to amount borrowed), reducing scope for such devices (IMF, 2001 paragraphs cited).

### V. CONCLUSION — tradeoffs and pragmatic recommendations
- Core conclusion:
  - If accounting rules require recognition of all assets/liabilities and the surplus is clean, deficit devices vanish and reported deficit equals true deficit.
- Practical reality:
  - Progressively broadening accounting recognition (cash → modified accrual → full accrual → extended) reduces but does not eliminate opportunities for devices.
  - Each step expands the balance sheet with rights/obligations different in character and increases measurement error risk.
  - No single deficit measure is perfectly satisfactory; choosing a single indicator for a deficit target involves trade-offs.
- Policy recommendation:
  - Publish extended accounts that include a sequence of net balance-sheet indicators (cash, net financial worth, net worth, extended net worth) together with the corresponding sequence of clean surpluses and their decompositions.
  - Purpose: reveal accounting devices by showing whether improvements in a targeted deficit are accompanied by improvements in broader indicators.

### Implementation questions (as listed in the source)
- How to define current policy for preparing extended accounts?
- How to avoid double-counting of future cash flows in practice?
- What discount rate or rates should be used to account for the time value of money and possibly the cost of risk-bearing?
- What implications would extended fiscal accounts have for accounts/statistics prepared for the government’s counterparties?

*Source: _wp12228 - 1. Summary Extended Accounts, Clean Surpluses*

### 1. Summary Extended Accounts, Clean Surpluses ..................................................................12

### 1. Summary Extended Accounts, Clean Surpluses

### Figures
- Figure 1: Sets of Assets and Liabilities Recognized in Differenct Accounting Systems ..............................................................8

*Source: _wp12228 - 1. Summary Extended Accounts, Clean Surpluses ..................................................................12*

### References .............................................................................................................

### _wp12228 - References .............................................................................................................

### I. INTRODUCTION — purpose and approach
- Problem statement: government accounts often fail to reveal full fiscal effects in the year decisions are made, enabling "deficit devices" that reduce short-term deficits only to increase them later (Easterly, 1999; Koen and van den Noord, 2005; Irwin, 2012).
- Analytical aim: clarify the relationship between accounting devices and accounting rules; analyze the problem rather than catalog manifestations.
- Methodology:
  - Start with a world where assets and liabilities are unambiguous; analyze devices as transactions involving assets/liabilities that are not recognized on the government balance sheet.
  - Extend to a world with multiple kinds of assets/liabilities and multiple accounting systems (cash, modified accrual, full accrual) to show nested vulnerability.
- Key conceptual recommendation:
  - Present a set of integrated fiscal accounts that include several measures of the deficit, including one equal to the decline in the net present value of all projected cash flows under current policies.

### II. ONE TRUE DEFICIT — framework and core identities
- Basic two-period, zero-interest framework:
  - Intertemporal budget constraint: 02 .ww  (equation (1) as printed).
  - Clean surplus definition: 2 1 .ttt sww     (equation (2) as printed).
  - Alternative notation: surplus as change in net worth: .tt sw  
- Concept of clean/comprehensive surplus: surplus defined as increase in net worth (clean surplus).
- Off-balance-sheet/unrecognized assets/liabilities:
  - Decomposition of true net worth into recognized and unrecognized parts: onoff .tt t ww w    (equation (3) as printed).
  - Reported (assumed clean) surplus: onon 1 .tt t sw w      (equation (4) as printed).
  - Difference between reported and true surplus equals decline in unrecognized net worth: off .ttt s s w       (equation (5) as printed).
- Debt relationship:
  - Reported net worth when all debt b recognized: ononon .tttt wabl l     (equation (6) as printed).
  - Increase in debt equals reported deficit plus stock-flow adjustment: onon .tt t bs a l          (as given).
- Mechanisms governments use when fiscal rules bind:
  - Takeovers of private pension schemes that transfer assets but assume unrecognized liabilities.
  - Building arrears (if accounts payable are not counted as debt).
  - Use of off-market swaps that create liabilities counted in the deficit but not counted as debt.

### III. MULTIPLE DEFICITS — nested accounting systems and extended accounts
- Recognition that assets/liabilities differ in kind (firm commitments vs. custom/expectations) and valuation precision, producing many possible accounting systems.
- Notation: J denotes an accounting system arising from recognition of set J; net worth wJ and clean surplus 1 .JJJ ttt s w w    .
- Combinatorics: with m kinds of assets and n kinds of liabilities there are 2 .mn  (as printed) possible systems; example with five of each yields more than a thousand systems.
- Important nested sets (as presented in Figure 1):
  - Cash (C), Financial assets and liabilities (F), All currently recognized assets and liabilities (R), and all future cash-flow rights/obligations (E).
  - Graphic/textual relationships emphasized in source.
- Accounting-system vulnerabilities:
  - Any accounting system based on a subset of R is vulnerable to devices involving elements outside that subset.
  - Empty set accounting (pure cash-flow accounting) yields 00 0 .tt sw         and makes any transaction that reduces true net worth function as a deficit device.
  - Cash accounting (C): CCc .ttt swa     — reported surplus equals increase in bank balance; borrowing can be used as a device by treating debt proceeds as revenue.
  - Modified accrual (F): .FF t t s w   ; reported surplus = true surplus less increase in nonfinancial assets: nf .F ttt ss a    
  - Full accrual (R): recognizes nonfinancial assets as well; still vulnerable to devices (e.g., operating vs finance leases; contingent assets/liabilities such as guarantees where fees count as revenue).
- Extended accounts (E):
  - Proposal to recognize assets/liabilities associated with all projected future spending and revenue; E denotes full set.
  - Extended net worth equals net present value of all projected future cash flows under current policy; extended surplus equals change in extended net worth.
  - Extended accounts would supplement but not replace existing accounts.
  - Caveats: present values of future taxes/spending are extremely uncertain, volatile, and large relative to current balance-sheet items; fluctuations could swamp recognized asset/liability changes.
- Relationship of sets (as printed):
  - .CFRE        (equation (7) as printed).
- Summary extended accounts format (Table 1 as printed):
  - For each set (C, F, R, E): Opening Balance + Clean Surplus = Closing Balance, expressed as e.g. 1 C t w  + C t s = C t w etc. (table entries reproduced in the source).

### III.B — Deficit devices in the nested-sets view
- Definition: a deficit device increases a targeted surplus sJ without increasing surpluses derived from supersets K ⊃ J.
- Operational mechanism: sell assets or incur liabilities in K\J in return for assets (or cancellation of liabilities) in J.
- Extended accounts do not prevent devices but reveal them by showing whether broader measures also improved.

### III.C — Fiscal sustainability in extended-account terms
- Reformulation of sustainability: present value of future primary surpluses (excluding returns on assets/liabilities in R) must offset imbalance in currently recognized net worth wR.
- Identifies E\R as set containing proposed new tax assets and spending liabilities.
- Fiscal sustainability implication (as printed):
  - \RER tt ww    (as printed).
  - From (7): \ 0 .RERE tt ww w    and sustainability implies 0 E t w  .

### IV. DIRTY DEFICITS — nonclean surpluses, decompositions, and specific devices
- Motivation: many fiscal analyses focus on nonclean surpluses (e.g., net lending/borrowing, net operating balance).
- Decompositions of clean surpluses:
  - Clean extended surplus decomposed into nested clean surpluses: \\\ .ECFCRFER s s s s      (as printed).
  - Conventional cash-account decompositions: "above and below the line"; further division into operations and investments in cash-flow statements.
- Devices that exploit nonclean surplus measures:
  - Zero-coupon and inflation-indexed bonds can be reported so that coupon-like appreciation is not recorded as interest, deferring interest recognition.
  - Example: some Icelandic accounting treated inflation-driven increases in outstanding debt without recording corresponding interest expense.
  - Eurostat/Irish example: introduction of grace period on debt to Anglo Irish Bank where Eurostat guidance in 2010 allowed not accruing interest during grace period for "zero rate of interest during the grace period"; later 2012 manual tightened guidance requiring recognition of interest during grace periods except in narrowly specified cases (Eurostat, 2010b; Eurostat, 2012).
- General mitigation: modern fiscal statistics typically spread interest costs over life of borrowing (using a discount rate that equates present value of forecast debt-service payments to amount borrowed), reducing scope for such devices (IMF, 2001 paragraphs cited).

### V. CONCLUSION — tradeoffs and pragmatic recommendations
- If accounting rules require recognition of all assets/liabilities and the surplus is clean, deficit devices vanish and reported deficit equals true deficit.
- In practice:
  - Progressively broadening accounting recognition (cash → modified accrual → full accrual → extended) reduces but does not eliminate opportunities for devices.
  - Each step expands the balance sheet with rights/obligations different in character and increases measurement error risk.
  - No single deficit measure is perfectly satisfactory; choosing a single indicator for a deficit target involves trade-offs.
- Policy recommendation:
  - Publish extended accounts that include a sequence of net balance-sheet indicators (cash, net financial worth, net worth, extended net worth) together with the corresponding sequence of clean surpluses and their decompositions.
  - Purpose: reveal accounting devices by showing whether improvements in a targeted deficit are accompanied by improvements in broader indicators.
- Implementation questions to be addressed (listed in the source):
  - How to define current policy for preparing extended accounts?
  - How to avoid double-counting of future cash flows in practice?
  - What discount rate or rates should be used to account for the time value of money and possibly the cost of risk-bearing?
  - What implications would extended fiscal accounts have for accounts/statistics prepared for the government’s counterparties?

*Italicized source attribution as provided in the content unit.*

### References

### _wp12228 - References

### Books, Manuals, and Edited Volumes
- Brixi, Hana Polackova, and Ashoka Mody, “Dealing with Government Fiscal Risk: An Overview,” in Brixi and Allen Schick, (editors) Government at Risk: Contingent Liabilities and Fiscal Risk (Washington and New York: World Bank and Oxford University Press).
- Eurostat, 2010b, Manual on Government Deficit and Debt: Implementation of ESA95,  (Luxembourg: European Union, third edition).
- Eurostat, 2012, Manual on Government Deficit and Debt: Implementation of ESA95,  (Luxembourg: European Union, fourth edition).
- International Monetary Fund, 1986, A Manual on Government Finance Statistics (Washington).
- International Monetary Fund, 2001, Government Finance Statistics Manual 2001 (Washington).
- Nobes, Christopher, 2006, Penguin Dictionary of Accounting, (London: Penguin, second edition).
- Stickney, Clyde P., Roman L. Weil, Katherine Schipper, and Jennifer Francis, 2010, Financial Accounting: An Introduction to Concepts, Methods, and Uses, (Mason, OH: South-Western, thirteenth edition).

### Institutional Reports, Manuals, and Financial Statements
- City of Chicago, 2009, 2010 Budget: Overview and Revenue Estimates.
- Eurostat, 2010a, Preliminary View on the ESA95 Accounting Treatment of Time of Recording of Interest Payment on Promissory Notes Payable to the Anglo Irish Bank. Letter to Mr. Aidan Punch, Central Statistical Office of Ireland (November 4).
- FASAB (U.S. Federal Accounting Standards Advisory Board), 2009, Reporting Extended Long-Term Fiscal Projections for the U.S. Government: Statement of Federal Financial Accounting Standards 36, (September 28).
- U.S. Treasury, 2011, 2011 Financial Report of the United States Government.

### Journal Articles, Working Papers, and Discussion Notes
- Easterly, William, 1999, “When Is Fiscal Adjustment an Illusion?” Economic Policy, Vol. 14, No. 28, pp. 55–86.
- Irwin, Timothy C., 2012, “Accounting Devices and Fiscal Illusions,” IMF Staff Discussion Note 12/02, (March 28).
- Koen, V., and P. van den Noord, 2005, “Fiscal Gimmickry in Europe: One-Off Measures and Creative Accounting,” OECD Economics Department Working Papers 417 (Paris: Organisation for Economic Cooperation and Development).

*Source: _wp12228 - References*

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