Governmental Accounting: New and Not So NewAlaska GFOAAnchorage, AlaskaNovember 17, 2014

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Topics

• Pension accounting changes• Government combinations• Nonexchange financial guarantees• Deferred outflows and inflows• Common misconceptions

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PENSION ACCOUNTING CHANGESPart 1

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Our focus

• Defined benefit plans• Single-employer & agent multiple employer

plans• Cost-sharing plans

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• No effect on governmental funds• Report expenditures rather than expense• No effect on fund balance

Preliminary note

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Single-employer and agent multiple-employer plans

Employers in

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1. Employer liability2. Employer expense3. Discount rate4. Actuarial method5. Amortization

Key changes

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• Current: Annual required contribution (ARC)

Less: Actual contributions Net pension obligation (NPO)

• New: Total pension liability (TPL)

Less: Fiduciary net position (FNP) Net pension liability (NPL)

1. Employer liability

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Employer liability - Illustration

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2. Employer expense

• Current guidance• Calculation tied to funding• ARC adjusted for the cumulative effect of prior

differences between required contributions and actual contributions

• New guidance• Calculation tied to cost• Changes in the net pension liability (NPL)

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3. Discount rate

• Current guidance• Estimated long-term investment yield for the

plan, with consideration given to the nature and mix of current and expected plan investments

• New guidance• Modification necessary if it is expected that

FNP will not be sufficient to pay benefits to active employees and retirees• Single blended rate

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Discount rate – single blended rate• Single rate equivalent to the combined

effect of using the following rates:• For projected cash flows up to the point the

FNP will be sufficient• Long-term expected rate of return on plan

investments

• For projected cash flows beyond that point• A yield or index rate on tax-exempt 20-year, Aa-or-

higher rated municipal bonds.12

• Current guidance• Whatever actuarial method is used for funding• Six acceptable methods• Must be applied within parameters defined by GASB

• New guidance• No tie to actuarial method used for funding• All employers will use the entry age method for

accounting and financial reporting purposes (with service cost determined as a percentage of pay)

4. Actuarial method

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• Background• Circumstances that could affect the net pension

liability (NPL)A. Changes in benefit termsB. Changes in economic and demographic assumptionsC. Differences between economic and demographic

assumptions and actual experience (other than investment returns)

D. Differences between expected and actual investment returns

5. Amortization

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• Current guidance• Effect amortized over a period not to exceed

30 years• New guidance• Effect to be amortized over a much shorter

period• Different periods, depending on the circumstances

Amortization (cont.)

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• Amortization periodA. Changes in benefit terms• Immediate recognition

B. Changes in economic and demographic assumptions• Closed period equal to average remaining service

period of plan members• Average remaining service period of retirees = 0 years

Amortization (cont.)

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• Periods (cont.)C. Differences between economic and

demographic assumptions and actual experience (other than investment returns)• Closed period equal to average remaining service

period of plan members • Average remaining service period of retirees = 0 years

D. Differences between expected and actual investment returns• Closed 5-year period

Amortization (cont.)

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Cost-sharing plansEmployers in cost-sharing plans

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1. Employer liability2. Employer expense

Key changes

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1. Employer liability

• Current guidance• Liability only if employer contribution is less

than the contractually required amount• New guidance• Liability equal to the employer’s

proportionate share of the total NPL of all participating employers

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2. Employer expense

• Current guidance• Expense = contractually required

contribution• New guidance• Expense = employer’s proportionate share of

total pension expense of all participating employers

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• Implementation first required• Fiscal year ending 6/30/15• Earlier application encouraged

Effective date

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Implementation 23

Major challenges

• Audit implications• Funding guidelines• Explaining the change

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Audit implicationsGASB Statement No. 68 implementation challenges

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Responsibility for financial statements•Management • Independent auditors

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Challenge

• Reasonable basis needed for assuming responsibility• Systems managed, governed, and audited

separately• Impossible to audit numbers that the employer

cannot support or document

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Meeting the challenge

• Need for cooperation between plan auditor and employer auditor• Guidance from AICPA• Whitepapers (best practices)• Interpretations of auditing standards• Forthcoming creation of a pension chapter

for State and Local Governments (“Audit Guide”)

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Solution – cost-sharing plans

• Information needed on the employer’s proportionate share of total for all employers• Supplemental schedule of employer

allocations (audited by plan auditor)• Schedule of plan pension amounts by

employer (audited by plan auditor)

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Schedule of employer allocations

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EmployerActual

Employer Contributions

Employer Allocation

PercentageA 72,000$ 32%B 58,000$ 25%C 36,000$ 16%D 8,000$ 4%E 12,400$ 5%F 16,000$ 7%G 5,000$ 2%H 18,500$ 8%I 2,000$ 1%

Total 227,900$ 100%

Funding guidelinesGASB Statement No. 68 implementation challenges

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Information challenge

• Accounting and financial reporting information no longer directly useful in assessing the adequacy of funding

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Funding guidelines

• “Big 7” public interest groups • GFOA• National Association of State Auditors,

Comptrollers, and Treasurers• National Association of State Retirement

Administrators• National Council on Teacher Retirement

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• Use actuarially determined contributions (ADC) as a basis for actual employer contributions• Guidelines for making principled decisions

regarding the calculation of the ADC• Actuarial cost method• Asset smoothing • Amortization• Provide information needed to assess

funding progress34

Essential elements

• Adopts and adapts funding guidelines• Specific recommendations on how to apply

the guidelines• Recognition that a transition period may be

necessary

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GFOA best practice

Explaining the changeGASB Statement No. 68 implementation challenges

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Nothing has “happened”

• The accounting and financial reporting has changed, not the underlying factual situation• Essential information already in the note

on employer funding progress

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Response to the NPL

• Different liabilities are funded differently• Compensated absences are not funded in

advance because they are already budgeted as payroll

• Key consideration with pension liabilities = disciplined, systematic funding over time• Assured by actuarially determined contributions• Appropriate actuarial method and assumptions

• Comparison – funding a child’s college education

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Employer contributions vs. expense• Difference• What something costs (expense)• How we pay for it (contributions)

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GOVERNMENT COMBINATIONSPart 2

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• Private-sector guidance largely inapplicable• Presumes conditions and circumstances

typically not present in public-sector combinations

• Fails to address important factors typically present in public sector combinations

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Why guidance needed?

GASB response

• GASB Statement No. 69, Government Combinations and Disposals of Government Operations

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• Loss of separate legal identity • Included as part of a completely new entity

(A+B = C)• Absorbed into an existing entity (A + B = B+)• Specific operation moved to separate legal

entity• Including “spinoff” of an operation as a

separate legal entity43

Types of government combinations

• Loss of separate legal identity?• Exchange of significant consideration?• Yes = acquisition• No = merger

• Specific operation moved to separate legal entity• Transfer of operations

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Terminology

Clarification

• Transfers of operations• Distinguish from• Purchase, contribution, or disposal of assets• Assumption of liabilities

• Two essential criteria• Operation = an integrated set of activities conducted

and managed for the purpose of providing identifiable services with associated assets or liabilities• Operation must continue to provide essentially the

same services45

Mergers - timing

• Recognize as of the date the combination becomes effective (merger date). • Creation of new entity (A + B = C)• Reporting period starts as of merger date

• Absorption into continuing government (A + B = B+)• Report as though merger had occurred as of the

start of the continuing government's fiscal period

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Mergers – measurement of financial statement elements• Two possible situations• Merger date = reporting date of merged

entity• Carrying value as of merger/reporting date

• Merger date ≠ reporting date of merged entity• Carrying value that would have been as of the

reporting date

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Mergers – capital asset impairments• Intent = disposal• Use prior to disposal?• Report at carrying value until disposal

• No use prior to disposal?• Evaluate for potential impairment

• Intent = change in manner or duration of use• Evaluate for potential impairment

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Acquisitions - timing

• An acquisition should be recognized as of the date the acquiring government obtains control of the assets and becomes obligated for the liabilities of the acquired entity (acquisition date)• Normally: acquisition date = closing date

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Acquisitions – measurement of financial statement elements•Measurement = acquisition value

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Acquisition value - assets

•Market-based entry price • Price to acquire similar assets having similar

service capacity

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Acquisition value - liabilities

• Amount necessary to discharge liabilities assumed• Exceptions: regular GASB rules apply to• Compensated absences• Pension and OPEB obligations• Obligations for termination benefits• Obligations for municipal solid waste landfill

closure and postclosure care costs• Obligations for pollution remediation 52

Acquisition value – deferred outflows/inflows• Normally = carrying value

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Acquisitions – consideration

• Amount of consideration • Assets remitted + liabilities incurred• Contingent amounts • Report as liability when probable and

measurable

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Consideration > net position

• Deferred outflow of resources • Recognized in operations in a systematic and

rational manner consistent with the circumstances of the acquisition

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Consideration < net position

• Form of economic assistance?• Yes• Difference = contribution

• No• Reduce acquisition values assigned to noncurrent

assets (other than financial assets)• Excess = special item

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Acquisition costs

• Recognize when services received

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Acquisitions – within the financial reporting entity• Assets acquired continue to be reported at

their carrying value• Difference between acquisition price and

carrying value • Reporting entity statements• Blended component unit = transfer• Discretely presented component unit = subsidy

• Separate financial statements• Special item

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Transfers of operations

• Government reporting continuing operations• Treated like a merger• Transferring government• Treated like a disposal (gain or loss = special

item )

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Application to governmental funds• Report only financial statement elements

consistent with measurement focus and basis of accounting• No capital assets• No long-term debt• Net change in fund balance = special item

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• Implementation first required• Fiscal year ending 12/31/14• Prospective implementation

• Earlier application encouraged

Effective date

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NONEXCHANGE FINANCIAL GUARANTEES

Part 3

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Why guidance needed?

• Private sector• Financial guarantees almost always arise

from exchange transactions• Public sector• Financial guarantees frequently arise

independently (nonexchange financial guarantees)

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GASB response

• GASB Statement No. 70, Accounting and Financial Reporting for Nonexchange Financial Guarantees

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Definition of financial guarantee• Agreement to indemnify a third party

should the issuer of the guaranteed obligation not fulfill its requirements under the obligation• Three separate parties • Issuer of the obligation being guaranteed• Those entitled to payment • Guarantor

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Scope

• Excludes • Obligations related to revenue-supported

debt• Obligations related to special assessments• “Joint and several” obligations• Obligations that are not legally binding.

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Guarantors - recognition

• Two-step approach• Consider qualitative factors and historical

data that indicate likelihood of payments • Point of recognition = “more likely than not”

to occur

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Guarantors – qualitative factors

• Issuer bankruptcy or financial reorganization• Issuer breach of debt covenant• Indicator of significant financial difficulty• Issuer receipts intercepted• Debt holder concessions• Significant investment losses• Loss of a major revenue source• Significant increase in noncapital

disbursements• Issuer subject to financial supervision

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Obligations with similar characteristics• Example = student loan receivables•May need to consider qualitative factors

and historical data from perspective of group as a whole

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Guarantors - point of recognition• “More likely than not”• Likelihood as little as 51%• Contrast with normal treatment of

contingencies• “Probable”• Likelihood well in excess of 50 percent

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Guarantors - valuing the liability• Discounted present value of estimated

future payments • Range of possible values? Normal rules apply• One amount = “best estimate” • Recognize that amount

• No amount better than any other• Recognize the minimum amount of the range

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Guarantors – governmental funds• Report an expenditure only when due and

payable• Classify in the same manner as

grant/financial assistance payments

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Issuer accounting/reporting

• Guaranteed obligation • Continue to report until legally released as obligor• Ultimate decrease = revenue

• Reclassify payments that must be reimbursed to guarantor

• Receivable recognition• Normal rule against recognizing gain

contingencies• Exception = guarantees within the primary government• Liability to issuer matched by issuer receivable 73

Implementation

• Implementation first required FYE 6/30/14• Earlier application encouraged• Application generally retroactive• Exception• Prospective disclosure for cumulative payments• Disclose starting date

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DEFERRED OUTFLOWS AND INFLOWSPart 4

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Why guidance needed?

• GASB Concepts Statement No. 4 introduced two new financial statement elements • Deferred outflows of resources• Previously classified as assets

• Deferred inflows of resources• Previously classified as liabilities

• GASB reserves the right to identify which specific items qualify for deferral 76

GASB response

• GASB Statement No. 65, Items Previously Reported as Assets And Liabilities

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Assets vs. deferred outflows

• Assets• Resources with present service capacity that

the government presently controls• Example: prepaid rent

• Deferred outflows• Consumption of net assets applicable to a

future reporting period

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Liabilities vs. deferred inflows

• Liability • Present obligations to sacrifice resources that

the government has little or no discretion to avoid

• Deferred inflow • Acquisition of net assets applicable to a

future reporting period

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• GASB Statement No. 53 – derivatives• Change in the fair value of a derivative used

as part of an effective hedge• GASB Statement No. 60 – service

concession arrangements• Consideration received from the operator

(less any contractual obligations reported as liabilities)

Previous decisions

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• Review items currently reported as assets or liabilities• Three options• Continue to report as asset/liability• Report instead as a deferred outflow/inflow

of resources• Report as an outflow/inflow of the period

GASB’s objective

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GASB’s approach

• Test 1:• Meet the definition of an asset or liability?• Yes? - report as asset or liability

• Test 2:• Meet the definition of a deferred outflow/

inflow of resources?• Yes? - report as deferred outflow/inflow of resources

• Default:• Outflow/inflow of the current period 82

• Resources provided to a grantee when the only eligibility criterion that has not been met by the recipient is a time requirement• If other eligibility requirements are not met =

receivable• Excess of the reacquisition price of

refunded debt over its net carrying amount

Asset deferred outflow

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• Debt issuance costs (other than prepaid insurance)

Asset outflow

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• Revenue of a governmental fund that is not recognized solely because it is not yet considered to be available• Property taxes received or recognized as a

receivable prior to the period they were intended to finance

Liability deferred inflow

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• Other imposed nonexchange revenues received or recognized as a receivable prior to the period when the use of the resources is either required or first permitted• Resources received from a grantor when

the only eligibility criterion that has not been met by the recipient is a timing requirement• If other eligibility criteria not met = liability

Liability deferred inflow (cont.)

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• The excess of the net carrying amount of refunded debt over its reacquisition price• A reduction in the present value of the

payments due from a lessee under a capital lease as a result of the lessor’s passing on the economic advantages of a refunding of tax-exempt debt

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Liability deferred inflow (cont.)

• Rates set in anticipation of future charges• Deferred inflows or resources• Expenses or losses recoverable from future

rates• Deferred outflows of resources

Specialized accounting for regulated industries (optional)

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• Application of 10 percent and 5 percent tests• Assets + deferred outflows of resources• Liabilities + deferred inflows of resources

Determination of major funds (10 percent and 5 percent tests)

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• Current practice – used to describe• Unearned amounts (liability)• Amounts related to future periods (deferred

inflows of resources)• Unavailable amounts (deferred inflow of

resources)• Future practice• Use limited to deferred outflows/inflows of

resources

Use of the term “deferred”

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• First mandatory for FYE 12/31/13• Earlier application encouraged

Effective date

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COMMON MISCONCEPTIONSPart 5

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Background

•Most often the product of “half truths”• “Believability factor”

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“Number of funds” principle

• Half truth: • The “number of funds principle” means “the

fewer funds the better”• Full truth:• Use all the funds and fund types needed, but

only the funds and fund types needed—no more, no less• It is possible to report “too few” funds.

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Blending and fiduciary-type units• Half truth:• Data from fiduciary-type component units

should be “blended”• Full truth:• Technique is the same, but terminology is

different• Term blended = method of including component

unit data in the government-wide financial statements

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Liabilities in governmental funds• Half truth:• Liabilities should be recognized in governmental

funds only if they are due and payable• Full truth:• Applicable only for liabilities not normally

expected to be liquidated with expendable available financial resources• Salaries and wages recognized when earned• Vendor payables recognized when goods and services

provided96

Operating subsidies to component units• Half truth:• Operating subsidies to component units should

be reported as transfers• Full truth:• True for blended component units, but not true

for discretely presented component units• For discretely presented component units, treat like

any other grant (expenditure/expense)

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Criteria for special items

• Half truth:• A special item is a transaction or event that

meets just one of the two criteria for an extraordinary item

• Full truth:• Must also be subject to management control• Exclude natural disasters that are not infrequent in

occurrence (hurricanes in Florida)

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Long-term internal borrowings

• Half truth:• A long-term borrowing within the government

should be reported as a fund liability• Full truth:• True only within the primary government• Borrowing from another fund = liability• Borrowing from a discretely presented component

unit = other financing source

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Transactions with discretely presented component units• Half truth:• Transactions with discretely presented

component units should be treated just like transactions with outside parties

• Full truth:• Capital assets cannot change value within the

financial reporting entity• Difference between carrying value and

consideration given not capitalized• Reported instead as expense/expenditure of purchaser 100

Option to classify a fund as major• Half truth:• A government has the option to voluntarily

classify a given fund as major• Full truth:• Option available only for governmental funds

and enterprise funds• Fiduciary funds can never be reported as major

funds

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Interest capitalization in proprietary funds• Half truth:• Interest capitalization is required in

proprietary funds• Full truth:• Interest capitalization does not apply to

internal service funds• Otherwise interest expense would be reported as a

functional expense in governmental activities

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Application of benefit/burden criterion• Half truth:• A legally separate entity should be included

as a component unit if there is an ongoing relationship of financial benefit or burden.

• Full truth:• Financial benefit/burden only relevant if

either• Fiscal dependency• Board appointment

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Availability criterion

• Half truth:• Revenue should be recognized in

governmental funds as soon as amounts become available.

• Full truth:• Availability is only a consideration

subsequent to earning/eligibility.• Cash received in advance is not revenue, even

though it is available.104

Revenue from expenditure-driven grants• Half truth:• All legal requirements need to be met before

revenue from an expenditure-driven grant can be recognized.

• Full truth:• Routine administrative requirements (filing

grant reports) should not delay revenue recognition.

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Difference between proprietary funds• Half truth:• The difference between internal service

funds and enterprise funds is that the former serve internal customers, whereas the latter serve external customers.

• Full truth:• Internal service funds assume cost recovery

over time, whereas enterprise funds do not• Activities reported in enterprise funds may be

subsidized106

Netting capitalized interest

• Half truth:• Interest expense on tax-exempt debt should

be capitalized net of interest revenue on the reinvested proceeds.

• Full truth:• Interest expense and interest revenue on the

reinvested proceeds are netted only if the related debt is legally restricted to the acquisition or construction of specified qualifying assets.

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Assets in governmental funds

• Half truth:• Governmental funds should not report land,

buildings, equipment, and similar assets.• Full truth:• Used in operations = capital asset• Not reported in governmental funds

• Acquired for sale = financial asset• Reported in governmental funds

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Netting disaster losses against recoveries• Half truth:• Disaster losses should be netted against

recoveries.• Full truth:• True of insurance recoveries• Netting based on prior transfer of risk to insurer

• Not true of disaster assistance• No prior transfer of risk

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Cash flows: public vs. private sector• Half truth:• The essential difference between the public

and private sectors is the use of two different financing categories

• Full truth:• Categories defined differently• Operating activities (focuses on operating income)• Investing activities (excludes capital outlay)

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Encumbrances and fund balance• Half truth:• Encumbrances should be included in

assigned fund balance.• Full truth:• Not applicable to encumbrances that will be

repaid from restricted or committed resources

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Dedicated taxes as program revenue• Half truth:• Revenues that must be used for a specific

program or function are properly classified as program revenues

• Full truth:• Program revenues must come from outside

the government’s tax base• Dedicated taxes are not program revenues

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Segment disclosure and condensed data• Half truth:• Segment disclosure requires that condensed

financial statements be provided in the notes to the financial statements for each segment.

• Full truth• Only necessary if information not provided in

the financial statements• Unnecessary for segments reported as major

enterprise funds113

Deficits in individual funds

• Half truth:• Deficits in individual funds need to be

disclosed in the notes to the financial statements.

• Full truth:• Not true of major funds, since the deficit

would already be visible

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Condensed data and cash flows

• Half truth:• Condensed financial statements should

include a statement of cash flows.• Full truth• Two situations where condensed financial

statements must be included in the notes• Segment disclosure• Major discretely presented component units

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Condensed data (cont.)

• Full truth (cont.)• Data for discretely presented component

units always drawn from government-wide financial statements• Hence no requirement for statement of cash flows

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Payments to a public-entity risk pool• Half truth:• Payments to a public-entity risk pool should

be treated like insurance premiums.• Full truth:• Appropriate treatment depends on the

characteristics of the pool• Participants transfer risk to pool?• Yes – treat like insurance premium• No – treat like deposit

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MD&A and the letter of transmittal• Half truth:• The same topic should not be addressed in

both management’s discussion and analysis (MD&A) and the letter of transmittal.

• Full truth:• The letter of transmittal is properly used to

provide more subjective information on topics treated in MD&A

118

Project-length budgets

• Half truth:• Budgetary comparisons are not required for

governmental funds with project-length budgets

• Full truth:• Budgetary comparisons are required if a

project-length budget is re-appropriated annually.• Annual reappropriation equivalent to annual

budget119

References to the notes

• Half truth:• Financial statements should refer to the

notes to the financial statements• Full truth• Only if fully audited• Not applicable to combining and individual fund

financial statements that receive only an “in-relation to” opinion

120

10 percent and 5 percent tests

• Half truth:• Governmental funds should be classified as

major if they meet both the 10 percent and 5 percent tests

• Full truth:• Both tests must be met for the same element• Assets and deferred outflows of resources• Liabilities and deferred inflows of resources• Revenues• Expenditures/expense

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Location of budgetary disclosures• Half truth:• If budgets are presented as RSI, related

disclosure should be in notes to RSI.• Full truth:• Excess of expenditures over appropriations =

legal violation, therefore included in notes to the financial statements

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Trust fund liabilities

• Half truth:• Trust funds do not report liabilities to

beneficiaries.• Full truth:• Liabilities are reported when due and

payable to individual beneficiaries

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Condensed data and revenue-supported debt• Half truth:• Segment reporting is required in connection

with revenue-supported debt• Full truth:• Only if there is a requirement to separately

maintain the data needed to present condensed financial statements

• Only if the segment is not already separately reported as a major fund (or a single nonmajor enterprise fund)

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Individual fund statements

• Half truth:• Individual fund statements needed to

support combining financial statements• Full truth:• Only if additional information is provided in

the individual fund statements

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