The news in this publi
cation is released for the
press on receipt.
THE UNIVERSITY OF NORTH CAROLINA
NEWS LETTER
Published Weekly by the
University of North Caro
lina Press for the Univer
sity Extension Division.
OCTOBER 10,1923
CHAPEL HILL, N. C.
VOL. IX, NO. 47
Bdiforisl Bimrdi B. C. Biranson, S. H. Hobbs. Jr., L. R, Wilson, E. W. Eaigrbt, D. D. Carroll, J. B. Ballitt, H. W. Odum.
Entered as second-class matter November 14,1914, at the Postoffice at Chapel Hill, N. C., under the actof Augrust 24. 1911
THE STATE’S BALANCE SHEET
The News Letter has withheld com
ment on the investigation of the finan
cial condition of the State until the
complete audit made by Price, Water-
house and Company was before it.
Now that this has been published in
full, and the State Auditor has issued
a supplementary formal statement, it
lays before its readers an analysis of
the situation, based on the facts shown
in these reports, covering the follow
ing questions:
(1) Did the State, on December 31,
1922 (the date of the audit) have suffi
cient cash on hand to meet the expen
ses it had incurred up to that date?
Has it sufficient cash on hand today to
meet the expenses incurred since that
date? In other words is the State be
ing operated on a pay-as-you-go basis?
(2) What is the underlying principle
of the cash or pay-as-you-go policy of
financing, and of the accrual policy?
(3) If the State is not running at
present on a pay-as-you-go or cash
basis, when and how was the change
effected?
(4) Is the accrual basis sound?
(6) On the basis of financing adopted
by the State did the State, up to De
cember 31, 1922, live within its resour
ces?
(6) Is the State during the present
period, that is, since December 31,
1922, living within its resources?
Report of the Auditors
The balance sheet submitted by
Price, Waterhouse and Company shows
the condition of the current general
fund of the State on December 31,
1922, as follows:
Resources
Cash (overdraft, per con
tra) $
Uncollected revenues (part
ly estimated) 4,730,915.64
Advanced to counties, re
coverable: Principal
$243,070.00
Accrued interest receivable
$11,382.87 254,462.87
Lapsed appropriations re
coverable from other funds 211,632.60
Expenditures applicable to
the half year ending June
30, 1923, prepaid _ 68^070.03
Total resources at Dec. 31,
1922 $6,264,970.94
Excess of obligations over
resources at Dec. 31, 1922 477,194.76
$6,732,166.69
Obligations
Cash overdraft $2,189,970.49
Notes payable 2,764,744.00
W arrants payable 131,692,61
Miscellaneous accounts pay
able 112,133.75
Matured bonds unpaid 28,600.00
Matured bond interest un
paid 80,108.00
Provision for institutional
deficits . • 61,000.00
Revenues applicable to the
half-year ending June 30,
1923, prepaid 373,916.94
$5,732,166.69
What the Audit Shows
This balance sheet shows that the
State's obligations on December 31,
1922, amounted to $6,732,166.69 and
that its resources on the same date a-
mounted to $5,254,970.94. The excess,
therefore, of obligations over resources
constituted, on Dec. 31, 1922, a deficit
of $477,194,76, say the auditors. Fur
thermore, under obligations against the
general fund there was included by the
auditors a note of $710,000 issued by
the extra session of the legislature of
1921 to care for an accumulated deficit
in the special school funds of the State
when the method of financing the pub
lic schools was changed. It seems not
to have been intended by the legisla
ture that the note should be charged a-
gainst the general fund, but the audi
tors have so treated it. If this note is
not included, the State on December 31,
1923, had according to the auditor’s re
port a surplus of resources over obliga
tions amounting to $232,806.26.
Why, then, has there been such con
fusion in the public mind concerning the
financial condition of the state? Simply
because this statement of the auditors’,
like any similar statement of the con
dition of any corporation, can be inter
preted from two different points of
view, which again go back to two diff
erent policies as to how a state should
be financed, namely the pay-as-you-go
policy and the accrual policy.
It is very important, in understand
ing the State’s financial condition, to
keep clearly in mind these two differ
ent policies.
The Cash Basis
The theory underlying the pay-as-
you-go policy holds that the State
should operate on a cash basis; that it
should conduct its finances as does a
man who never buys anything until he
has the actual cash in his pocket to pay
for it. Naturally, no state can operate
one hundred percent on that basis, as
.its revenues come in irregularly and
its expenditures from its operating
funds are continuous. But, under its
former system of taxation, the State of
North Carolina tried to approximate
such a basis. That is, its main source
of revenue was from taxes levied on
property, which were listed in May and
due in October of the same year. The
cash to meet the year's expenditures
under this system was for the most
part supposed to be in hand before the
end of the year, if not when the ex
penditures were incurred.
An examination of the auditors’ re
port shows that, on this pay-as-you-go
basis, the State was approximately five
million dollars behind on December 31,
1922. There appears not only a deficit
of $477,194.76, but, under the item of
resources, a sum of $4,730,915.54 which
is not cash in hand but an estimate of
taxes levied but collectible later.
A condition in general similar to
this would be shown were the State’s
books to be audited today, or on any
date that might be chosen. The State,
in other words, is in the position of
having to borrow large sums against
anticipated revenues. It has been in
this position since 1921, and will be in
this position as long as the present
method of state financing obtains.
The Accrual Basis
The second policy, that now is in
■force in the State is that of operation
on what is known as the accrual basis.
The State adopted this policy in 1921
when it put in effect its new taxation
system. The essential thing about the
accrual basis is the use of anticipated,
that is of accruing income through the
machinery of credit. To take a simple
illustration, this is the basis which is a-
dopted by a man who is living, say, on
a monthly salary, and who buys during
the month on credit and pays for what
he buys when his salary check for the
month comes in on the first of the suc
ceeding month. His salary is accruing
all during the month, but is not collec
tible until the month is up. Most cor
porations adopt the same system. They
constantly borrow large sums against
resources which they cannot at once
turn into cash, but which are later col
lectible—that is, are potential but not
actual cash. Very few business houses
of any size fail to make large use of
credit in this way. Modern business is
too complex as a rule to be conducted
on the pay-as-you-go plan. Thus the
resources of a large business consist,
as a rule, on any date, not only of cash
on hand, but of assets collectible with
in a reasonable period, of assets that
are known, and are well secured, that
are accruing, but not necessarily due
until a later time.
How the Change Came About
The State went on such an accrual
basis when, instead of raising its main
revenues from property, it began to
raise them from incomes. A tax on
property can be collected daring the
same year that it is levied; the policy in
North Carolina was to levy in May and
collect in October of the same year.
But an income tax cannot be collected
until after the end of the year for
which it is levied. The reason is a
simple one. It is because few indi
viduals or corporations who pay in
come taxes are in a position to com
pute how much these will amount to
until the year’s operations on which
they are levied have ended, and they
know how much their incomes for the
year have been.
When the State in 1921 discontinued
its property tax for state purposes and
began to rely heavily on income taxes,
it levied an income tax on the new
basis for 1921. But this tax, though
levied on incomes of 1921, was not due
and collectible until March 16, 1922, for
reasons just stated.
At the same time the State discon
tinued its property tax, which, on the
old basis, would have been due in Oc
tober of that year. This tax is now,
and has been since 1921, utilized -alto
gether for county and local purposes.
The State government derives no sup
port from property taxes. Therefore,
during 1921, the State received neither
a property tax nor the newly author
ized income tax. The income tax, how
ever, which was levied on incomes of
1921 (though not collectible until 1922)
was a potential, an accruing, asset of
the State, and, once collected, it could
be applied to the expenses of the State
incurred during 1921. The State, there
fore, in order to operate during 1921,
borrowed money against the income
tax (and other minor sources of reve
nue) accruing during that year, but
collectible later. This is how the
change of basis came about.
Is the Accrual Basis Sound?
Plainly enough, an individual, a busi
ness, or a government living on the ac
crual basis may or may not be in a sound
financial position. Credit may be used
legitimately, or it may not. The tests
of sound financing on this basis are
simple. They are, first, that the a-
mount of credit used shall not exceed a
legitimate estimate of the resources
from which credit operations must be
covered at the proper time, and, sec
ond, that the credit used must be ob
tainable at a reasonable rate of interest.
These tests apply to individuals, to
business operations, and to govern
ments alike. The man on salary who is
paid monthly, who uses credit at the
stores because his salary, though accru
ing, is not collectible until the first of
the succeeding month, is employing
sound finance only when he does not
buy more than his accruing income
warrants, when the prices he is charg
ed for the use of credit are not too high.
The farmer who meets his living ex
penses by mortgaging a crop is not in
a sound position, as his crop may not
turn out well and the rates he must
pay for the accomodations are high. A
corporation that is constantly borrow
ing large sums at low rates of interest
against adequate accruing assets that
are well secured and collectible within
reasonable periods is, on the other
hand, sound.
The accrual basis, in other words,
may be either sound or unsound, ac
cording as it makes proper or improper
use of credit. In the case of the State
government, we must ask, first,
whether its borrowings against antici
pated revenues exceed the amounts of
those revenues once they are collected;
in other words, whether the State is
living within its resources, and, second,
whether the State can borrow against
anticipated revenues at advantageous
rates.
As to the second point, that of the
rates which the State must pay for its
borrowings against anticipated rev
enues, the general answer may be giv
en that the State borrows at less than
the legal rate of interest. The News
Letter lacks information as to the ex
act rate of interest paid on each occa
sion, and the question as to how these
compare with the rates paid by other
States during similar conditions of the
money market. It should be recalled,
however, that the individual' taxpayer
gains through the use of h.is money for
the year more than the State loses
through its payment of interest, as his
money is worth the legal rate to him,
and the State can borrow for less.
As to the first point, that of whether
the State is living within its resources,
the data in hand give the following
answer.
Resources and Expenditures
The report of Price, Waterhouse and
Company was made for a period of
twenty-five months ending December
31, 1922. As the State’s fiscal year,
until 1921, ended on November 30 (it
now ends on June 30), it was necessary
for the auditors to go back to Decem
ber 1, 1920, that is, to the beginning of
the first fiscal year of the biennial
period under discussion. The follow
ing table, presented in a form different
from, but checking with, the auditors’
report, shows the facts for these
twenty-five months.
Cash on hand December 1,
1920 $673,098.38
Resources accrued but un
collected on December 1,
im net ..1,372,134.36 $2,045,232.74
Revenue collected from
December 1, 1920, to Dec
ember 31, 1922, in addition
to the above $8,946,962.83
Revenue accrued but uncol
lected on December 31,
1922. (The State Auditor
reports that on September
1, $6,178,965.67 of taxes
due the State on Decem
ber 31, 1922, had been
collected) 4,730,915.54 13,676,878.37
Total revenue to December
31, 1922 $16,722,111.11
Expenditures for the same
period 16,199,306.86
Net deficit on December 31, ^
1922, including school note
of $710,000 477,194.76
Note: If school note be ex
cluded, deduct 710,000.00
Leaving net surplus on Dec
ember 31, 1922 $232,806.26
The table shows the revenues collect
ed for the twenty-five months, and the
revenues accrued but uncollected, and
applicable to the expenditures of the
same period. The State, it will be not
ed, expended from its general fund
during these twenty-five months the
sum of $16,199,305.86. To apply to
these expenditures it had, during the
period, cash in hand amounting to $10,-
991,195.61 including the surplus at the
beginning of the period. It had, to
apply on these same expenditures, a
sum estimated at $4,730,916.54 in rev
enues levied but uncollectible until
after the period ended, leaving a de
ficit of $477,194.75. It is very impor
tant, then, to know whether the esti
mate of $4,730,915.54 was a true esti
mate. This is answered by the State
Auditor’s report published in the state
press on September 21, which in con
densed form is as follows:
Resources
Cash (overdraft per Con
tra).
Uncollected revenues: Col
lected and turned in to
the State treasurer since
December 31, 1923, but
applicable to the estimate
of $4,730,915.54 uncollect
ed revenues, made by the
JointLegisiature Commit-
mittee $6,078,619.96
Collected and in hands of
Commissioner of Revenue
September 1,1923, also ap
plicable to the above esti
mate 100,345.72
$5,178,966.67
Advances to Counties re
coverable: Principal.... $ 243,070.00
Accrued interest receivable 11,382.87
264,462.87
211,632.60
68,070.03
Lapsed appropriations re
coverable from other funds
Expenditures applicable to
the half-year ending June
30, 1923
$5,703,021.07
Obligations
Cash overdraft $2,
Notes payable 2,
Warrants payable
Miscellaneous accounts pay
able
Matured bonds unpaid ...
Matured bond interest un
paid.
Provision for institutional
deficit
Revenues applicable to the
half-year ending June 30,
1923
Surplus.
189,970.49
064,744.00
131,692.51
112,133.75
28,600.00
80,108.00
61,000.00
373,916.94
,022,166.69
680,856.38
$6,703,021,07
Surplus or Deficit
Excess of collections over
estimate:
Estimate of tax to be col
lected $4,730,916.54
Actually col
lected $5,178,966.67
448,060.13
Surplus shown by Legisla
tive Committee Report by
omitting the school note
of $710,000 232,806.25
Surplus $ 680,866.38
What the Report Shows
This statement shows that the esti
mate made on December 31st as to the
amount of revenue accrued but uncol
lected was a conservative estimate.
Instead of $4,730,916.54,. as estimated
on that date, the State actually collect
ed $6,178,966.67, or $448,060.13 more
than was anticipated. This means that
on December 31, 1922, instead of a de
ficit of $477,194.69, as estimated at that
time, the State had, if the school note
be included, a deficit of $29,144.62, or,
if the school note be excluded, a sur
plus of $680,856.38.
It is important to note that the $6,-
178,966.67 collected since December 31,
last, is not applicable to expenditures
incurred since December 31, but to
those incurred prior to that date. It
represented on December 31 a poten
tial asset, already utilized, that is,
borrowed against, by the State, an
asset then accruing but not collected,
and not applicable to the State’s ex
penditures during the first eight months
of 1923.
But, of course, the State’s expendi
tures have continued since December
31. The main source from which these
can be met is the income tax for 1923,
which is not collectible until March 16,
1924, and must then be applied to meet
the State’s ^923 expenses, which the
State is presumably in the meantime
covering by borrowing against this an
ticipated revenue, which is now accru
ing. As already explained, the use of
credit against anticipated income is an
essential feature of the accrual system,
with governments as with business.
One further point should be made
clear. This is that, on December 31,
1920, the State had a surplus on hand,
in cash and accrued revenues, of $2,-
046,232.74. This surplus was absorbed
during the operations of the twenty-
five months period, if the school note
be included, or materially lessened, if
it be excluded; in other words, the rev
enues of the State during the twenty-
five months would not, without the
surplus, have sufficed fully to meet its
expenditures to December 31, 1922.
Present Condition
Is the State since December 31, 1922,
living within its resources? The State
Auditor’s statement deals only with
the conditions affecting the State’s fin
ancial position on December 31, 1922,
and gives no information as to the con
dition at any later date.
As for the six months covering the
balance of the State’s fiscal year from
December 31, 1922 to June 30, 1923,
Price Waterhouse and Company esti
mated that the expenditures would ex
ceed the revenues by $319,273.38. The
News Letter has no data available as
to how this prediction has squared with
the facts. As for the two year period
beginning July 1, 1923, on which date
the State went on its new appropriation
basis, too short a time has since elaps
ed to make successful forecasts possible.
By Way of Conclusion
The News Letter has attempted in
the foregoing to set forth the facts as
to the State’s financial condition. The
following facts stand out from such an
examination:
(1) The State, in terms of actual cash
in hand, lacked on December 31, 1922,
by about five million dollars an amount
sufficient to wipe out its expenses in
curred up to that time. It is presum
ably in about the same position today,
and will be as long as it operates on
its present financial system.
(2) The accrual basis involves the
use of credit as against anticipated
revenues, which accrue during a given
period but are collectible later.
(3) The State shifted to the accrual
basis in 1921, when it changed its sys
tem of taxation, discontinuing the use
of taxation on property for State pur
poses, and beginning systematically to
tax incomes. As the income tax for
1921 was not collectible until 1922, and
as the property tax for State purposes
had been abandoned, the State borrow
ed against the accruing, but later col
lectible, income taxes.
(4) On the accrual basis the tests of
soundness for the State are whether
its expenditures for a given period do
or do not exceed the revenues which
accrue for that period and may later,
when collected, be used to pay the ex
penses of that period, and whether the
State can borrow advantageously.
(6) For the twenty-five months end
ing December 31, 1922, the State’s ac
cruing revenues, once they were col
lected, plus its surplus of $2,046,232.74
on Decemner 1, 1920, were sufficient to
meet its expenditures and leave a sui>
plus of $680,866.38, if the school note
be excluded. If the school note be in
cluded this surplus becomes a deficit of
$29,144.62. Without the initial surplus
on December 1, 1920, its revenues
would not have sufficed to meet its ex
penditures.
(6) Information as to whether the
State during the present two-year
period is living within its resources is
not yet available.
A Question of Policy
The question of whether the state
should operate on the cash or on the
accrual basis is a question of public
policy, altogether apart from an analy
sis of the facts such as the News Let
ter has tried to give. But the ques
tion of the proper basis for financial
operation should not be confused with
the question of the soundness of the
State’s financial condition on the basis
which it has adopted. It is very im
portant that these two issues should be
kept separate in the public mind.