Research Corner: Recession, Deficits, and Accrual Accounting
Beyond Numbers · April 2009
By Dr. Kin Lo, CA, Ph.D.
The fact that Canada and the world are in recession is now old news. Governments everywhere are awash in red ink as tax revenues sink and expenditures increase to
mitigate the effects of the recession. Just looking close to home, Alberta is projecting a deficit of $1 billion in fiscal 2009/10, while BC is expecting a deficit of just less than half that amount. To better gauge the meaning of these numbers, it is useful to know that just last year, Alberta forecasted a surplus in excess of $8 billion, while BC forecasted a surplus of $450 million. Thus, Alberta’s budget has swung by $9 billion in the last year, while BC’s has swung by only $1 billion.
The plunge in oil prices from US$150 to less than $50 per barrel certainly have something to do with the more dramatic change in fortunes in Alberta, but another contributor is the significantly different accounting policies followed by the two provincial governments, particularly with respect to drilling rights. BC amortizes these receipts over eight years, while Alberta recognizes all of them as revenue in the year received. Alberta’s accounting results in swings in reported government revenues that follow the boom and bust of the oil industry. The windfall proceeds from the drilling permits contributed to Alberta’s enormous surpluses over the last few years, but as new drilling comes to a virtual standstill, the revenue for drilling rights has slowed to a trickle. On the other hand, the BC government will be able to continue to record hundreds of millions in revenues over the next few years for drilling rights issued in the past few years, resulting in a smoother pattern of revenues.
In somewhat sensationalistic articles last December, the Globe and Mail honed in on this difference in accounting and accused the BC government of “hiding” about $1.25 billion in a “secret surplus.”[1,2] However, it is not at all clear that BC’s revenue recognition policy is bad. In fact, both revenue recognition methods have been approved by Alberta and BC’s respective auditors general.
I suggest that conservatively amortizing revenue from drilling rights has some clear benefits. As already discussed above, this policy results in a smoother pattern of revenues. Smoothing is not, in itself, a desirable objective; however, smoothing has important consequences for governments and public policy, as it facilitates long-term planning and inhibits pressures from lobby groups to increase spending when there are temporary windfalls in government receipts.
In light of the current forecasts for the provincial budgets, the prudence in this policy is particularly prescient, and the Globe and Mail’s criticism especially wrong-headed, in my opinion. Interestingly, most of my students came to the same conclusion when I posed this question to them on their December exam.
Kin Lo, CA, Ph.D., holds the CA Professorship in Accounting in the Sauder School of Business at UBC. The CA Professorship is funded by the CA Education Foundation of BC. Send your questions on accounting research to Kin at email@example.com.
- David Ebner, “B.C.’s $1.7 billion surplus kept under wraps,” Globe and Mail, December 2, 2008.
- Ebner, “Province criticized for ‘smooth’ accounting practices,” Globe and Mail, December 5, 2008.