From their perspective, the ORS officials have been reluctant to impose deadlines for compliance and penalties for non-compliance because such deadlines and penalties were not in the 1976 Act. Belatedly the ORS has imposed two deadlines, but has not spelled out what penalties it will impose or how. It has required all states and localities to submit their audits by March 1, 1980, or to submit a plan for submitting the audits. The second, final deadline is September 1, 1980, but the ORS has already made it clear that it will extend even this deadline.

To show it is serious, the ORS should hold up its first quarter (April) payment to any localities which have neither submitted an audit nor submitted a plan for submitting an audit. Those who are waiting until September 1 to comply (or fail to comply) face a maximum penalty of loss of their final payment in October 1980.

In sum, we are distressed at the slow rate and inadequacy of compliance with the 1976 audit requirement. In part, this reflects softness on the part of the ORS in enforcing the law. In part, it reflects certain weaknesses in the 1976 law: lack of a requirement that accounts be kept in accordance with generally accepted accounting principles (GAAP), which makes an audit in conformance with GAAS more difficult; lack of a requirement that the GAAS audit be made annually (there is a question whether an audit only once every three years can conform to GAAS); and lack of deadlines and penalties.

Strengthening the Audit Title

To resolve these problems, the renewal of the Revenue Sharing Act should have stricter audit provisions. The Council on Municipal Performance

has developed a set of suggested principles to strengthen the audit title. These are embodied in two statements approved by our Board of Directors in November 1979 and March 1980. They are attached as Appendices B and C of this testimony.

Briefly, we recommend an annual audit conforming to GAAS, a deadline for compliance tied to the end of the recipient's fiscal year, a penalty for non-compliance, and above all reporting of financial data according to GAAP. The quality of audits is directly related to the quality of the principles underlying the preparation of financial statements.

Since actions by state governors, comptrollers and legislative leaders are all required for some states to comply, the new legislation might require a statement regarding any remaining statutory impediments to compliance, and what is being done about them.

Strengthening Accounting Principles

To some extent, requiring GAAS audits by itself strengthens accounting principles because GAAS audits must identify deviations from GAAP. However, there has been a great deal of confusion over who is supposed to decide what GAAP should be for governments, and there has been considerable dissatisfaction with existing statements of governmental GAAP--especially from the point of view of accounting as a management tool and as a means of public enlightenment about governmental spending.5

Part of the problem has been the lack of an enforcement mechanism. From the perspective of the general public, it is more important that there be an authoritative body to make pronouncements about accounting principles for state and local governments than that the authority be vested in one institution rather than another.

One approach which we at the Council on Municipal Performance took initially was to link the accounting authority to the issuance of

municipal securities. We noted that the way in which accounting principles are enforced for business is through the delegation of powers of the Securities and Exchange Commission to the accounting profession. Under the 1933 ard 1934 Securities Acts, the SEC is vested with authority over disclosure in business debt offerings and to a minor degree in municipal bond offerings.

The accounting profession in turn has delegated the standard-setting authority for corporate securities financial statements to the Committee on Accounting Procedure and then the Accounting Principles Board of the American Institute of CPA's. Since 1973 this authority has rested with the Financial Accounting Standards Board (FASB).

We are convinced that it would be logical and simple to extend the authority of the SEC, and therefore of the FASB, to municipal securities issues. Our special legal counsel concluded that the constitutional objections to this step were exaggerated and probably would not be sustained in court because a municipality always had the option of restricting offering its debt to buyers within the borders of its own state..

However, this approach raises concerns about SEC involvement not only in municipal disclosure but in the actions of the underwriters of and buyers of municipal securities. They have a big stake in improved accounting practices, especially because underwriters and bank trust departments are the most vulnerable to damage suits in a situation such as New York's and Chicago's where losses were sustained. A question also

arises under the Securities Acts whether due diligence was pursued by these institutions in reviewing the financial statements. Without the support of the financial institutions, new legislation in this area is

an orphan.

Linking accounting standards for municipal governments to revenue sharing offers many advantages. It is more acceptable to states and localities because the standards are tied to a carrot rather than a stick. Given the division of opinion in Congress on extending revenue sharing at all, it promises to win over support for renewal, and this price is one that states and localities may be (and should be) willing to pay.

It is also more acceptable to the financial community because it restricts Federal oversight to the states and localities, compared to introducing accounting standards through regulation of municipal securities. It also relieves the financial institutions of some due diligence burdens which have no corresponding municipal obligations.

Third, the existing audit framework is an excellent base on which

to build further municipal accounting reform. Under GAAS, auditors have been required to specify deviations from GAAP. We are suggesting now that the new legislation specify who is to set standards for GAAP.

Fourth, the current high interest rates give states and localities additional incentive to improve their accounting practices. A 1976 article in Forbes reported that municipalities with a higher standard of disclosure were being rewarded with lower borrowing rates.6

Finally, tying GAAP to revenue sharing funds offers the recipient

government the option of refusing the funds and continuing to keep its

books according to non-uniform principles. In this sense it is non-coercive. From the public standpoint, it makes revenue sharing more clearly an investment in better government, and offers the benefit of improved municipal management and greater comprehensibility of municipal financial

statements.

The Business Model

In establishing a standard-setting body, an important question is the degree to which municipal accounting standards should differ from business standards. If they differ greatly, it makes it more important to have separate standard-setting bodies.

Readers of

We at the Council on Municipal Performance would prefer to see municipal standards approximate as closely as possible business accounting standards. We believe that we would have on our side most accountants, underwriters, municipal bond buyers and civic leaders. financial statements are accustomed to the business format. Accountants are familiar with business accounting practices, and a body of accounting principles has been developed which could be applied to municipal governments with few modifications.

The argument on the other side, heard mostly from government accountants, is that government accounting is different because it is used for different purposes; that municipalities don't make a profit; that depreciation is inappropriate for municipal assets; that each fund is a legal entity; that enterprise funds are entirely different from general government funds; and that governments are subject to restrictions on the use of their money that have no private parallel.