In an apparent departure from “generally accepted accounting principles,” federal agencies will be permitted to publish financial statements that are altered so as to protect information on classified spending from disclosure.

The new policy was developed by the government’s Federal Accounting Standards Advisory Board (FASAB) in response to concerns raised by the Department of Defense and others that a rigorous audit of agency financial statements could lead to unauthorized disclosure of classified information.

In order to prevent disclosure of classified information in a public financial statement, FASAB said that agencies may amend or obscure certain spending information. “An entity may modify information required by other [accounting] standards if the effect of the modification does not change the net results of operations or net position.”

Agencies may also shift accounts around in a potentially misleading way. “A component reporting entity is allowed to be excluded from one reporting entity and consolidated into another reporting entity. The effect of the modifications may change the net results of operations and/or net position.” See Statement of Federal Financial Accounting Standards 56, FASAB, July 5, 2018 (final draft for sponsor review).

In response to an earlier draft of the new standard that was issued last December, most government agencies endorsed the move to permit modifying public financial statements.

“The protection of classified information and national security takes precedence over financial statements,” declared the Central Intelligence Agency in its comments (submitted discreetly under the guise of an “other government agency”).

“It is in the best interest of national security to allow for modification to the presentation of balances and reporting entity in the GPFFR [the publicly available General Purpose Federal Financial Report],” CIA wrote.

But in a sharply dissenting view, the Pentagon’s Office of Inspector General said the new approach was improper, unwise and unnecessary.

It “jeopardizes the financial statements’ usefulness and provides financial managers with an arbitrary method of reporting accounting information,” the DoD OIG said.

“We do not agree that incorporating summary-level dollar amounts in the overall statements will necessarily result in the release of classified information.”

“This proposed guidance is a major shift in Federal accounting guidance and, in our view, the potential impact is so expansive that it represents another comprehensive basis of accounting.”

“The Board should clarify whether this proposed standard, or subsequent Interpretations, could permit entities to record misstated amounts in the financial statements to mislead readers with the stated purpose of protecting classified information. We believe that no accounting guidance should allow this type of accounting entry.”

“We do not believe that… the Board’s proposed guidance would effectively protect classified information, comply with GAAP [generally accepted accounting principles], or serve the public interest,” the DoD OIG wrote.

The Kearney & Company accounting firm also objected, saying that it would be better to classify certain financial statements or redact classified spending than to misrepresent published information.

“Generally Accepted Accounting Principles (GAAP) should not be modified to limit reporting of classified activities. Rather, GAAP reporting should remain the same as other Federal entities and redacted for public release or remain classified.”

If a published account is modified “so material activity is no longer accurately presented to the reader of financial statements, its usefulness to public users is limited and subject to misinterpretation.”

“This approach limits the value, usefulness, and benefits of financial statements as currently defined by GAAP. Financial statements of classified entities should remain classified or redacted like other classified documents before release to the public.”

“The integrity of current GAAP as it applies to all Federal entities should be retained,” Kearney said in its comments.

But the FASAB ultimately rejected those views.

“The Board determined that options other than those permitted in this Statement may not always adequately resolve national security concerns,” according to the final draft of the policy, which the Board provided to Secrecy News.

“Without this Statement, there is a risk that reporting entities may need to classify their entire financial statements to comply with existing accounting standards, which would likely result in the need to classify a large portion of the government-wide financial statements.”

In practice, the Board suggested, “Modifications may not be needed to prevent the disclosure of certain classified information. Therefore, this Statement permits, rather than requires, modifications on a case-by-case basis.”

The new accounting standard is expected to be approved by the FASAB sponsors — namely the Secretary of Treasury, the Comptroller General, and the Director of the Office of Management and Budget — by the end of a 90 day review period in October.

Last month, the FASAB issued a separate classified “Interpretation” of the new standard that addressed the policy’s implementation in detail. The contents of that document are not publicly known.

The topic of accounting for classified spending has been a challenging one for the Board, said Assistant Director Monica R. Valentine on Monday. “This is the first time we’ve had to deal with this sort of issue.”