Accounting Induced Distortions in Public Enterprise Pricing

Abstract

Certain government enterprises not subject to competition (e.g., municipal utilities, irrigation agencies) commonly aim to set prices at average cost. In periods of inflation, unadjusted accounting data understate the economic costs of fixed assets and, thus, generate inefficiently low prices and high consumption rates for outputs of these enterprises. Since dividends and taxes are not involved, the primary function of accounting is cost determination rather than profit measurement. We measure the nature and extent of undercosting and underpricing for a group of government owned water utilities in the arid western United States. Economic costs appear to be two to three times their accounting counterparts for the cases studied.