In the municipal market, there are debt issuers that follow cash-basis accounting and those that practice accrual-basis accounting. Cash-basis accounting recognizes expenditures only when the cash is actually disbursed, while accrual-basis accounting matches revenues with expenses. The difference in accounting methodologies is material to determining the credit worthiness of an issuer because cash-basis accounting is susceptible to manipulation and could potentially present a false financial picture. Most municipal issuers, with the exception of local governments in New Jersey, practice US GAAP accrual-basis accounting for fiscal year-end financial reporting. However, almost all municipalities and states use cash-basis practices for budgeting. This is problematic because it is easy for a municipality to use budget gimmicks to show a balanced budget, when in fact its financial position may be deteriorating. Recently we heard of California’s $2 billion+ budget surplus, credit rating upgrade, and credit spread compression. At the same time, California pension liabilities grew by $10 billion+, which could lead to diminishing balance sheet strength. It is important to remember that a cash-basis budget is the road map for a municipality to follow during the year. A budget estimates tax revenues and sets spending priorities based on the agenda of an elected leadership. In no way does a balanced budget mean a high level of credit worthiness. A balanced cash-basis budget does provide insight into management’s character and its ability to adjust spending to match economic condition. This is the reason we spend so much time analyzing year-end financial reports and give them more weight than annual budget plans.