What Is the 2011 U.S. Debt Ceiling Crisis?

The 2011 U.S. Debt Ceiling Crisis was a contentious debate in Congress that occurred in July 2011 regarding the maximum amount of debt the federal government should be allowed.

Understanding the 2011 U.S. Debt Ceiling Crisis

The federal government has rarely achieved a balanced budget, and its budget deficit ballooned following the 2007-08 Financial Crisis. In the 2008 fiscal year, the deficit stood at $458.6 billon, widening to $1.4 trillion in 2009 as the government engaged in a massive fiscal policy response to the economic downturn.

Between 2008 and 2010, Congress raised the debt ceiling from $10.6 trillion to $14.3 trillion. In 2011, as the economy showed early signs of recovery and federal debt approached its limit once again, negotiations began in Congress to balance spending priorities against the ever-rising debt burden. 

Heated debate ensued, pitting proponents of spending and debt against fiscal conservatives. Pro-debt politicians argued that failing to raise the limit would require immediate cuts to spending already authorized by Congress, which could result in late, partial, or missed payments to Social Security and Medicare recipients, government employees, and government contractors.

Moreover, they asserted the Treasury could suspend interest payments on existing debt rather than withhold funds committed to federal programs. The prospect of cutting back on already promised spending was labeled a crisis by debt proponents.

On the other hand, the specter of a technical default on existing Treasury debt roiled financial markets. Fiscal conservatives argued that any debt limit increase should come with constraints on the growth of federal spending and debt accumulation.

Outcome of the 2011 U.S. Debt Ceiling Crisis

Congress resolved the debt ceiling crisis by passing the Budget Control Act of 2011, which became law on August 2, 2011. This act allowed the debt ceiling to be raised by $2.4 trillion in two phases, or installments.

In the first phase, a $400 billion increase would occur immediately, followed by another $500 billion unless Congress disapproved it. The second phase allowed for an increase between $1.2 trillion and $1.5 trillion, subject to Congressional disapproval as well. In return, the act included $900 billion in slowdowns in planned spending increases over a 10-year period. It also established a special committee charged with finding at least $1.5 trillion in additional savings.

In effect, the legislation incrementally raised the debt ceiling from $14.3 trillion to $16.4 trillion by January 27, 2012.

Following the passage of the act, Standard & Poor’s took the radical step of downgrading the United States long-term credit rating from AAA to AA+, even though the U.S. did not default. The report says, “The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.” The credit rating agency cited the unimpressive size of deficit reduction plans relative to the likely future prospects for politically driven spending and debt accumulation.

Debt Approval Process Leading to the 2011 U.S. Debt Ceiling Crisis

The U.S. Constitution gives Congress the power to borrow money. Before 1917, this power was exercised by Congress authorizing the Treasury to borrow specified amounts of debt to fund limited expenses, such as war-time military spending, which would be repaid after the end of hostilities. This kept the national debt directly linked to authorized spending.

In 1917, Congress imposed a limit on federal debt as well as individual issuance limits. In 1939, Congress gave the Treasury more flexibility in how it managed the overall structure of federal debt, giving it an aggregate limit. However, by delegating debt management authority to the Treasury, Congress was able to break the direct connection between authorized spending and the debt that finances it. 

While allowing greater flexibility to raise spending, this practice also created a need for Congress to repeatedly raise the debt limit when spending threatens to overrun available credit. Due to occasional political resistance to the idea of continually expanding the federal debt, this process of raising the debt limit has at times engendered controversy, which occurred during the 2011 Debt Ceiling Crisis.

The Bottom Line

Following the 2007-08 Financial Crisis, in an effort to slow down the severe recession as well as the persistently high unemployment rate, the government increased federal spending. As a result, the federal debt reached its limit on multiple occasions from 2008 to 2011 which led to a series of increases of the debt limit. In 2011, the Treasury asked for its borrowing capacity to be extended.

The 2011 U.S. Debt Ceiling Crisis was a contentious debate in Congress that occurred in July 2011 regarding the maximum amount of debt the federal government should be allowed. Congress resolved the debt ceiling crisis by passing the Budget Control Act of 2011, which became law on August 2, 2011. This act allowed the debt ceiling to be raised by $2.4 trillion in two phases, or installments.

What Is Accrued Liability?

The term “accrued liability” refers to an expense incurred but not yet paid for by a business. These are costs for goods and services already delivered to a company for which it must pay in the future. A company can accrue liabilities for any number of obligations and are recorded on the company’s balance sheet. They are normally listed on the balance sheet as current liabilities and are adjusted at the end of an accounting period.

Understanding Accrued Liability

An accrued liability is a financial obligation that a company incurs during a given accounting period. Although the goods and services may already be delivered, the company has not yet paid for them in that period. They are also not recorded in the company’s general ledger. Although the cash flow has yet to occur, the company must still pay for the benefit received.

Accrued liabilities, which are also called accrued expenses, only exist when using an accrual method of accounting. The concept of an accrued liability relates to timing and the matching principle. Under accrual accounting, all expenses are to be recorded in financial statements in the period in which they are incurred, which may differ from the period in which they are paid.

The expenses are recorded in the same period when related revenues are reported to provide financial statement users with accurate information regarding the costs required to generate revenue.

The cash basis or cash method is an alternative way to record expenses. But it doesn’t accrue liabilities. Accrued liabilities are entered into the financial records during one period and are typically reversed in the next when paid. This allows for the actual expense to be recorded at the accurate dollar amount when payment is made in full.

Types of Accrued Liabilities

There are two types of accrued liabilities that companies must account for, including routine and recurring. We’ve listed some of the most important details about each below.

Routine Accrued Liabilities

This kind of accrued liability is also referred to as a recurring liability. As such, these expenses normally occur as part of a company’s day-to-day operations. For instance, accrued interest payable to a creditor for a financial obligation, such as a loan, is considered a routine or recurring liability. The company may be charged interest but won’t pay for it until the next accounting period.

Non-Routine Accrued Liabilities

Non-routine accrued liabilities are expenses that don’t occur regularly. This is why they’re also called infrequent accrued liabilities. They aren’t part of a company’s normal operating activities. A non-routine liability may, therefore, be an unexpected expense that a company may be billed for but won’t have to pay until the next accounting period.

Journal Entry for an Accrued Liability

Accounting for an accrued liability requires a journal entry. An accountant usually marks a debit and a credit to their expense accounts and accrued liability accounts respectively.

This is then reversed when the next accounting period begins and the payment is made. The accounting department debits the accrued liability account and credits the expense account, which reverses out the original transaction.

When Do Accrued Liabilities Occur?

Accrued liabilities arise for a number of reasons or when events occur during the normal course of business. For instance:

• A company that purchases goods or services on a deferred payment plan accrues liabilities because the obligation to pay in the future exists.
• Employees may perform work for which they haven’t received wages.
• Interest on loans may be accrued if interest fees were incurred since the previous loan payment.
• Taxes owed to governments may be accrued because they are not due until the next tax reporting period.

At the end of a calendar year, employee salaries and benefits must be recorded in the appropriate year, regardless of when the pay period ends and when paychecks are distributed. For example, a two-week pay period may extend from December 25 to January 7.

Although they aren’t distributed until January, there is still one full week of expenses for December. The salaries, benefits, and taxes incurred from Dec. 25 to Dec. 31 are deemed accrued liabilities. These expenses are debited to reflect an increase in the expenses. Meanwhile, various liabilities will be credited to report the increase in obligations at the end of the year.

Accrued Liability vs. Accounts Payable (AP)

Accrued liabilities and accounts payable (AP) are both types of liabilities that companies need to pay. But there is a difference between the two. Accrued liabilities are for expenses that have not yet been billed, either because they are a regular expense that doesn’t require a bill (i.e., payroll) or because the company hasn’t yet received a bill from the vendor (i.e., a utility bill).

As such, accounts payable (or payables) are generally short-term obligations and must be paid within a certain amount of time. Creditors send invoices or bills, which are documented by the receiving company’s AP department. The department then issues the payment for the total amount by the due date. Paying off these expenses during the specified time helps companies avoid default.

Examples of Accrued Liability

As noted above, companies can accrue liabilities for many different reasons. As such, there are many different kinds of expenses that fall under this category. The following are some of the most common examples:

• Wage expenses: This is for work already performed by employees. The work is paid for in the next accounting period. This is common with employers who pay their employees bi-weekly, because a pay period may extend into the following accounting month or year.
• Goods and services: Some companies place orders and receive goods and services from their suppliers without paying for them immediately. As an accrued expense, the receiving company pays for these goods and services at a later date.
• Interest: A company may have an outstanding loan for which the interest isn’t yet due. The lender may require this expense.

What Is Accrue?

To accrue means to accumulate over time—most commonly used when referring to the interest, income, or expenses of an individual or business. Interest in a savings account, for example, accrues over time, such that the total amount in that account grows. The term accrue is often related to accrual accounting, which has become the standard accounting practice for most companies.

How Accrue Works

When something financial accrues, it essentially builds up to be paid or received in a future period. Both assets and liabilities can accrue over time. The term “accrue,” when related to finance, is synonymous with an “accrual” under the accounting method outlined by Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).

An accrual is an accounting adjustment used to track and record revenues that have been earned but not received, or expenses that have been incurred but not paid. Think of accrued entries as the opposite of unearned entries—with accrued entries, the corresponding financial event has already taken place but payment has not been made or received.

Accepted and mandatory accruals are decided by the Financial Accounting Standards Board (FASB), which controls interpretations of GAAP. Accruals can include accounts payable, accounts receivable, goodwill, future tax liability, and future interest expense. 

Special Considerations

The accrual accounting procedure measures the performance and position of a company by recognizing economic events regardless of when cash transactions occur, giving a better picture of the company’s financial health and causing asset or liability adjustments to “build up” over time.

This is in contrast to the cash method of accounting where revenues and expenses are recorded when the funds are actually paid or received, leaving out revenue based on credit and future liabilities. Cash-based accounting does not require adjustments.

While some very small or new businesses use cash accounting, companies normally prefer the accrual accounting method. Accrual accounting gives a far better picture of a company’s financial situation than cost accounting because it records not only the company’s current finances but also future transactions.

If a company sold $100 worth of product on credit in January, for example, it would want to record that $100 in January under the accrual accounting method rather than wait until the cash is actually received, which may take months or may even become a bad debt.

Types of Accrues

 All accruals fall into one of two categories—either revenue or expense accrual.

Accrued Revenue

Revenue accruals represent income or assets (including non-cash-based ones) yet to be received. These accruals occur when a good or service has been sold by a company, but the payment for it has not been made by the customer. Companies with large amounts of credit card transactions usually have high levels of accounts receivable and high levels of accrued revenue.

Assume that Company ABC hires Consulting Firm XYZ to help on a project that is estimated to take three months to complete. The fee for this job is $150,000, to be paid upon completion. While ABC owes XYZ $50,000 after each monthly milestone, the total fee accrues over the duration of the project instead of being paid in installments.

Accrued Expense

Whenever a business recognizes an expense before it is actually paid, it can make an accrual entry in its general ledger. The expense may also be listed as accrued in the balance sheet and charged against income in the income statement. Common types of accrued expense include:

• Interest expense accruals—these occur when a owes monthly interest on debt prior to receiving the monthly invoice.
• Supplier accruals—these happen if a company receives a good or service from a supplier on credit and plans to pay the supplier at a later date.
• Wage or salary accruals—these expenses happen when a company pays employees prior to the end of the month for a full month of work.

Interest, taxes and other payments sometimes need to be put into accrued entries whenever unpaid obligations should be recognized in the financial statements. Otherwise, the operating expenses for a certain period might be understated, which would result in net income being overstated.

Salaries are accrued whenever a workweek does not neatly correspond with monthly financial reports and payroll. For example, a payroll date may fall on Jan. 28. If employees have to work on January 29, 30, or 31, those workdays still count toward the January operating expenses. Current payroll has not yet accounted for those salary expenses, so an accrued salary account is used.

There are different rationales for accruing specific expenses. The general purpose of an accrual account is to match expenses with the accounting period during which they were incurred. Accrued expenses are also effective in predicting the amount of expenses the company can expect to see in the future.

What Is the Average Cost Basis Method?

The average cost basis method is a system of calculating the value of mutual fund positions held in a taxable account to determine the profit or loss for tax reporting. Cost basis represents the initial value of a security or mutual fund that an investor owns.

The average cost is then compared with the price at which the fund shares were sold to determine the gains or losses for tax reporting. The average cost basis is one of many methods that the Internal Revenue Service (IRS) allows investors to use to arrive at the cost of their mutual fund holdings.

Understanding the Average Cost Basis Method

The average cost basis method is commonly used by investors for mutual fund tax reporting. A cost basis method is reported with the brokerage firm where the assets are held. The average cost is calculated by dividing the total amount in dollars invested in a mutual fund position by the number of shares owned. For example, an investor that has $10,000 in an investment and owns 500 shares would have an average cost basis of $20 ($10,000 / 500).

Types of Cost Basis Methods

Although many brokerage firms default to the average cost basis method for mutual funds, there are other methods available.

FIFO

The first in, first out (FIFO) method means that when shares are sold, you must sell the first ones that you acquired first when calculating gains and losses. For example, let’s say an investor owned 50 shares and purchased 20 in January while purchasing 30 shares in April. If the investor sold 30 shares, the 20 in January must be used, and the remaining ten shares sold would come from the second lot purchased in April. Since both the January and April purchases would have been executed at different prices, the tax gain or loss would be impacted by the initial purchase prices in each period.

Also, if an investor has had an investment for more than one year, it would be considered a long-term investment. The IRS applies a lower capital gains tax to long-term investments versus short-term investments, which are securities or funds acquired in less than one year. As a result, the FIFO method would result in lower taxes paid if the investor had sold positions that were more than a year old.

LIFO

The last in first out (LIFO) method is when an investor can sell the most recent shares acquired first followed by the previously acquired shares. The LIFO method works best if an investor wants to hold onto the initial shares purchased, which might be at a lower price relative to the current market price.

High-Cost and Low-Cost Methods

The high-cost method allows investors to sell the shares that have the highest initial purchase price. In other words, the shares that were the most expensive to buy get sold first. A high-cost method is designed to provide investors with the lowest capital gains tax owed. For example, an investor might have a large gain from an investment, but doesn’t want to realize that gain yet, but needs money.

Having a higher cost means the difference between the initial price and the market price, when sold, will result in the smallest gain. Investors might also use the high-cost method if they want to take a capital loss, from a tax standpoint, to offset other gains or income.

Conversely, the low-cost method allows investors to sell the lowest-priced shares first. In other words, the cheapest shares you purchased get sold first. The low-cost method might be chosen if an investor wants to realize a capital gain on an investment.

Choosing a Cost-Basis Method

Once a cost basis method has been chosen for a specific mutual fund, it must remain in effect. Brokerage firms will provide investors with appropriate annual tax documentation on mutual fund sales based on their cost basis method elections.

Investors should consult a tax advisor or financial planner if they are uncertain about the cost basis method that will minimize their tax bill for substantial mutual fund holdings in taxable accounts. The average cost basis method may not always be the optimal method from a taxation point of view. Please note that the cost basis only becomes important if the holdings are in a taxable account, and the investor is considering a partial sale of the holdings.

Specific Identification Method

The specific identification method (also known as specific share identification) allows the investor to choose which shares are sold in order to optimize the tax treatment. For example, let’s say an investor purchases 20 shares in January and 20 shares in February. If the investor later sells 10 shares, they can choose to sell 5 shares from the January lot and 5 shares from the February lot.

Example of Cost Basis Comparisons

Cost basis comparisons can be an important consideration. Let’s say that an investor made the following consecutive fund purchases in a taxable account:

• 1,000 shares at $30 for a total of $30,000
• 1,000 shares at $10 for a total of $10,000
• 1,500 shares at $8 for a total of $12,000

The total amount invested equals $52,000, and the average cost basis is calculated by dividing $52,000 by 3,500 shares. The average cost is $14.86 per share.

Suppose the investor then sells 1,000 shares of the fund at $25 per share. The investor would have a capital gain of $10,140 using the average cost basis method. The gain or loss using average cost basis would be as follows:

• ($25 – $14.86) x 1,000 shares = $10,140.

Results can vary depending on the cost-basis method chosen for tax purposes:

• First in first out: ($25 – $30) x 1,000 shares = – $5,000
• Last in first out: ($25 – $8) x 1,000 = $17,000
• High cost: ($25 – $30) x 1,000 shares = – $5,000
• Low cost: ($25 – $8) x 1,000 = $17,000

From strictly a tax standpoint, the investor would be better off selecting the FIFO method or the high-cost method to calculate the cost basis before selling the shares. These methods would result in no tax on the loss. However, with the average cost basis method, the investor must pay a capital gains tax on the $10,140 in earnings.

Of course, if the investor sold the 1,000 shares using the FIFO method, there’s no guarantee that when the remaining shares are sold that $25 will be the selling price. The stock price could decrease, wiping out most of the capital gains and an opportunity to realize a capital gain would have been lost. As a result, investors must weigh the choice as to whether to take the gain today and pay the capital gains taxes or try to reduce their taxes and risk losing any unrealized gains on their remaining investment.