Since revenue is primarily recorded on a modified cash basisA term used to describe the federal government's hybrid system for accounting for revenues from taxes and duties. Under a modified cash basis, revenue is recognized when received in cash except for tax receivables (taxes owed from taxpayers but not yet collected) and refunds payable (refunds owed to taxpayers but not yet paid by the federal government), which are both measured on an accrual basis. in the financial statements, there is very little difference between cash receipts and accrual revenue. On the spending side, many programs are recorded similarly because the time between the transaction and the payment is relatively short. As a result, for some program areas, such as federal civilian and military employee salaries or grants to states, there is little difference between accrual and cash measures.

Federal salaries illustrate similarities between measures

For federal salaries, the time between when salaries are earned and when they are paid is a little over a week, a relatively short period. Under accrual accounting, an expense for federal salaries is recognized when the salaries are earned. Under cash accounting an outlay is recorded in the following week when the salary is paid. At year's end, there is little difference between the cash and accrual measure of salaries because both include salary payments or expenses for roughly 52 weeks of work. The cash and accrual measures, however, may not include the exact same 52 weeks of salary. Because the accrual deficit includes an expense as the salary is earned, regardless of when paid in cash, it will include the 52 weeks of salary earned in the current year. However, the cash deficit reflects cash payments made in the current year—including those for hours worked in the last week of the previous year—and excludes cash payments for salaries earned in the last week of the current year that will be paid in the next year.

Cash and accrual measures both exclude the value of

1. 1. future payments for certain contingencies and financial commitments and
2. 2. future benefits for social insurance and other entitlement programs.

Contingencies and Financial Commitments

The accrual deficit reflects contingenciesAn existing condition, situation, or set of circumstances involving uncertainty as to possible gain or loss to an entity that will ultimately be resolved when one or more future events occur or fail to occur., such as those that arise from federal insurance programs, that are assessed as "probable" as to the likelihood of loss and that can be reasonably measured. However, many contingencies are not reflected in the accrual deficit in part because it is difficult to anticipate the amount to be paid. For example, the potential costs associated with future natural disasters are not recorded in the accrual deficit. Financial commitmentsFor federal proprietary accounting, contractual obligations that require the future use of resources., such as contracted goods or services that have not yet been delivered, are not recorded in the accrual deficit until the goods or services are delivered. However, these commitments are disclosed in the notes to the financial statements. Both contingencies and financial commitments are reflected in the cash deficit once the government makes the cash payment.

Social Insurance and Other Entitlement Programs

While both the cash and accrual deficits include payments to current beneficiaries for entitlement programs, including social insurance, neither the cash nor accrual deficit reflects the serious future fiscal challenges of Social Security, Medicare, and other social insurance programs. Future scheduled benefits and estimated receipts are included in the Statement of Social Insurance in the Financial Report. However, future benefits and receipts are not recorded as a liabilityFor federal proprietary accounting, a probable future outflow or other sacrifice of resources as a result of past transactions or events. under federal accounting standards and therefore are not included in the accrual deficit.

The differences between cash and accrual deficits are almost entirely on the spending side since revenues are recorded similarly in the budget and financial statements. Differences arise when a cost is accrued (and affects the accrual deficit) in one fiscal year but paid (and affects the cash deficit) in another fiscal year.

There are a number of areas in the federal government where differences exist, but the seven listed below have accounted for the largest differences between accrual and cash deficits in recent years:

• Military employee benefits,
• Civilian employee benefits,
• Veterans compensation,
• Environmental liabilities,
• Insurance and guarantee programs,
• Capital assets, and
• Financial assets and liabilities.

For all of these areas except capital assets and financial assets and liabilities, the key difference between the accrual and cash measures is the annual change in the liability. Each year as expenses are accrued, those that are not paid (and not reflected in the budget) increase the government's liability. As such, the liability represents unpaid expenses. The change in the liability from year to year is generally equal to accrued expenses less cash payments made to reduce the liability. The example below illustrates this point using federal employee benefits other than salaries.

Difference between Accrual and Cash Measures of Federal Employee Benefits

The accrual deficit includes an accrued expense for the portion of each current employee's pension and other retirement benefits that is earned during the employee's current year of work but not paid until sometime in the future when the employee retires. The accrual deficit also includes interest on the accrued liability, the effects of changes in assumptions, and differences between actual and previously projected costs. In contrast, the cash deficit does not include these elements and only reflects payments made to current retirees. (These cash payments reflect past accrual expenses.) The difference between the accrued retirement costs recognized and cash payments made during the year is generally the change in the liability from year to year, and the difference between what is recorded in the accrual and cash deficits.

Capital assets are also treated differently. When capital assetsLand, structures, equipment, intellectual property (e.g., software), and information technology (including information technology service contracts) that are used by the federal government and have an estimated useful life of 2 years or more. such as structures and equipment are purchased, the budget records an obligation for the full cost up front in order to provide decision makers with the information and incentives to make efficient decisions at the only time that they can control the cost. Outlays are recorded when a capital asset is paid for and therefore increases the cash deficit in the year that the outlay is made. However, under the accrual basis of accounting used in the financial statements, the cost of the asset is initially recorded on the balance sheet. The cost of the asset is then spread over its expected useful life to match the asset's cost with its use. Therefore, each year the accrual deficit only reflects one year's worth of cost, called depreciationThe systematic and rational allocation of the acquisition cost of an asset, less its estimated salvage or residual value, over its estimated useful life. expense.

Difference between Accrual and Cash Measures of Capital Assets

Let's assume that the federal government purchased a building this year for $50 million and expected the building to be used for the next 50 years and to provide an equal amount of benefit each year. The cash deficit would reflect the $50 million obligation this year. The accrual deficit would only reflect a $1 million depreciation expense in the current year. The remaining cost of the asset would be reflected in the accrual deficit over the next 49 years at an annual expense of $1 million.

The last category listed—financial assets and liabilities—has been more prominent in recent years due to activities related to the government's response to the financial crisis. The government has traditionally issued loans and made loan guarantees that have generally been recorded similarly in the budget and the financial statements. That is, the net present value of the estimated projected cost is recorded when the transaction occurs. However changes in the estimated cost of loans and loan guarantees are reflected at different times. The re-estimated costs are reflected in the Financial Report at fiscal year-end but are not reflected in the budget until the following fiscal year.

The acquisition of certain financial assets, such as equity investments made under the Troubled Asset Relief Program, are recorded similarly to loans and therefore are generally recorded similarly in the budget and financial statements. However, the acquisition of other financial assets, such as those acquired from the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), are treated differently in the budget versus the financial statements. The budget records Treasury’s direct cash infusions to Fannie Mae and Freddie Mac as outlays, which increases the cash deficit. The accrual deficit, on the other hand, generally reflects the change in the assets’ value and the estimated total future payments to Fannie and Freddie. A valuation gain would reduce the accrual deficit and a valuation loss would increase the accrual deficit. (See discussion of Government Sponsored Enterprises (GSEs) in Financial Assets and Liabilities section.)

The Financial Report includes a statement called Reconciliation of Net Operating Cost (or Revenue) and Unified Budget Deficit (or Surplus), hereafter called the "reconciliation statement," that provides a crosswalk between the net operating cost (accrual deficit) and the unified budget deficit (cash deficit). The basic relationship is described below.

The reconciliation statement is useful for illustrating which program areas explain large differences between the cash and accrual deficits each year. The table below summarizes the reconciliation statements contained in the Financial Report for fiscal years 2007 through 2011. In the figure, annual changes in liabilities can be either positive or negative:

• If accrued expenses exceed cash payments, liabilities increase (a positive change). A positive change represents accrued expenses that are in the accrual deficit but not the cash deficit.
• If cash payments exceed accrued expenses, liabilities decrease (a negative change). A negative change represents cash payments that are not included in the accrual deficit but are included in the cash deficit.

Policy decisions can affect both the cash and accrual deficit, although potentially at different times. For example, legislation enacting a freeze in federal employee salaries would affect salary payments in the current year and be reflected similarly in both the cash and accrual deficits. However, enacting a law that changes future federal employee retirement benefits or insurance programs would be reflected immediately in the accrual deficit but would not affect the cash budget deficit until future years when the benefits are paid.

Economic conditions, such as economic growth and inflation, also affect both the cash and accrual deficits, but sometimes differently. Provisions built into the current tax code and entitlement program structure lead to decreases in revenue and, to a lesser extent, increases in spending when the economy slows (and vice versa when the economy expands). These provisions—known as automatic stabilizers—affect the cash and accrual deficits similarly. For example, increases in unemployment automatically reduce payroll tax and income tax receipts and increase spending for some programs, such as unemployment insurance, which are reflected similarly in the cash and accrual deficits. However, the impact of changing economic conditions or other changes on the expected performance of certain financial assets, such as investments in GSEs, would be reflected in the accrual deficit but not the cash deficit. (See discussion of GSEs in the Financial Assets and Liabilities section.)

In addition to changes driven by legislation or the economy, both the accrual and cash deficits can also change for technical reasons. For example, the cash deficit may change if a date on which cash is scheduled to be paid or received falls in a different fiscal year. When October 1 falls on a weekend, federal payments due on that date, such as salaries for military employees, are paid in September. This shifts the cash outlay into the previous fiscal year. For example, October 1, 2011 fell on a Saturday; therefore military active duty pay, veteran’s benefits, and certain Medicare payments were accelerated to September 30, 2011 and reflected in the fiscal year 2011 cash deficit rather than fiscal year 2012. This shift does not affect the accrual deficit because these benefits are recorded as expenses when due and payable.

The cash measure is sensitive to changes in dates when cash is paid or received, but accrual measures are sensitive to changes in assumptions used to estimate future payments, such as future salary increases, changes to the general price level and interest rates. For example, some future payments are discounted into present valueThe worth of a future stream of returns or costs in terms of money paid immediately (or at some designated date). A dollar available at some date in the future is worth less than a dollar available today because the latter could be invested at interest in the interim. In calculating present value, prevailing interest rates provide the basis for converting future amounts into their "money now" equivalents.

The net present value is the present value of estimated future cash inflows minus the present value of cash outflows.  terms using nominal interest rate assumptions. Changes in interest rates can and have caused large swings in expenses and the accrual deficit that did not reflect changes in the underlying programs. For examples, see Differences in Key Programs.

Sometimes a change in the accrual deficit may not mean a change in fiscal condition but rather reflects the evolution of the measurement influenced by factors such as those noted above. For example, changes in liabilities can also result from improvements in government estimation or new accounting standards. This suggests that caution must be taken when interpreting year-to-year changes in the accrual deficit.