preparing governmental financial statements under gasbs

GFST09

SELF�STUDY CONTINUING PROFESSIONAL EDUCATION

Companion to PPC's Guide to

PreparingGovernmental

FinancialStatements

Under GASBSNo. 34

Fort Worth, Texas(800) 323�8724trainingcpe.thomson.com

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Interactive Self�study CPE

Companion to PPC's Guide to Preparing Governmental Financial Statements Under GASBS No. 34

TABLE OF CONTENTS

Page

COURSE 1: Introduction to Governmental Financial Reports and Fund Accounting Overview

Overview 1. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Lesson 1: Introduction to Governmental Financial Reports 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Lesson 2: Fund Accounting Overview 69. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Glossary 127. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Index 131. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

COURSE 2: Budgetary Reporting, Other RSI, MD&A, and CAFR

Overview 133. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Lesson 1: Budgetary Reporting and Other Required Supplementary Information (RSI) 135. . . . . . .

Lesson 2: Management's Discussion and Analysis (MD&A) 161. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Lesson 3: Comprehensive Annual Financial Reports (CAFR) 211. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Glossary 249. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Index 253. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

COURSE 3: Capital Assets

Overview 255. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Lesson 1: The Basics of Capital Assets, Including Valuation, Reporting, and Capitalization 257. . . .

Lesson 2: Capital Assets, Infrastructure, and Impairment 321. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Glossary 387. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Index 391. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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To enhance your learning experience, the examination questions are located throughoutthe course reading materials. Please look for the exam questions following each lesson.

EXAMINATION INSTRUCTIONS, ANSWER SHEETS, AND EVALUATIONS

Course 1: Testing Instructions for Examination for CPE Credit 393. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Course 1: Examination for CPE Credit Answer Sheet 395. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Course 1: Self�study Course Evaluation 396. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Course 2: Testing Instructions for Examination for CPE Credit 397. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Course 2: Examination for CPE Credit Answer Sheet 399. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Course 2: Self�study Course Evaluation 400. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Course 3: Testing Instructions for Examination for CPE Credit 401. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Course 3: Examination for CPE Credit Answer Sheet 403. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Course 3: Self�study Course Evaluation 404. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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INTRODUCTION

Companion to PPC's Guide to Preparing Governmental Financial Statements Under GASBS No. 34 consists of threeinteractive self�study CPE courses. These are companion courses to PPC's Guide to Preparing Governmental

Financial Statements Under GASBS No. 34 designed by our editors to enhance your understanding of the latestissues in the field. To obtain credit, you must complete the learning process by logging on to our Online GradingSystem at OnlineGrading.Thomson.com or by mailing or faxing your completed Examination for CPE CreditAnswer Sheet for print grading by October 31, 2010. Complete instructions are included below and in the TestInstructions preceding the Examination for CPE Credit Answer Sheet.

Taking the Courses

Each course is divided into lessons. Each lesson addresses an aspect of preparing governmental financialstatements under GASBS No. 34. You are asked to read the material and, during the course, to test yourcomprehension of each of the learning objectives by answering self�study quiz questions. After completing eachquiz, you can evaluate your progress by comparing your answers to both the correct and incorrect answers and thereason for each. References are also cited so you can go back to the text where the topic is discussed in detail.Once you are satisfied that you understand the material, answer the examination questions which follow eachlesson. You may either record your answer choices on the printed Examination for CPE Credit Answer Sheet orby logging on to our Online Grading System.

Qualifying Credit HoursQAS or Registry

PPC is registered with the National Association of State Boards of Accountancy as a sponsor of continuingprofessional education on the National Registry of CPE Sponsors (Registry) and as a Quality Assurance Service(QAS) sponsor. Part of the requirements for both Registry and QAS membership include conforming to theStatement on Standards of Continuing Professional Education (CPE) Programs (the standards). The standards weredeveloped jointly by NASBA and the AICPA. As of this date, not all boards of public accountancy have adopted thestandards. Each course is designed to comply with the standards. For states adopting the standards, recognizingQAS hours or Registry hours, credit hours are measured in 50�minute contact hours. Some states, however, require100�minute contact hours for self study. Your state licensing board has final authority on accepting Registry hours,QAS hours, or hours under the standards. Check with the state board of accountancy in the state in which you arelicensed to determine if they participate in the QAS program or have adopted the standards and allow QAS CPEcredit hours. Alternatively, you may visit the NASBA website at www.nasba.org for a listing of states that acceptQAS hours or have adopted the standards. Credit hours for CPE courses vary in length. Credit hours for eachcourse are listed on the �Overview" page before each course.

CPE requirements are established by each state. You should check with your state board of accountancy todetermine the acceptability of this course. We have been informed by the North Carolina State Board of CertifiedPublic Accountant Examiners and the Mississippi State Board of Public Accountancy that they will not allow creditfor courses included in books or periodicals.

Obtaining CPE Credit

Online Grading. Log onto our Online Grading Center at OnlineGrading.Thomson.com to receive instant CPEcredit. Click the purchase link and a list of exams will appear. You may search for the exam using wildcards.Payment for the exam is accepted over a secure site using your credit card. For further instructions regarding theOnline Grading Center, please refer to the Test Instructions preceding the Examination for CPE Credit AnswerSheet. A certificate documenting the CPE credits will be issued for each examination score of 70% or higher.

Print Grading. You can receive CPE credit by mailing or faxing your completed Examination for CPE Credit AnswerSheet to the Tax & Accounting business of Thomson Reuters for grading. Answer sheets are located at the end ofall course materials. Answer sheets may be printed from electronic products. The answer sheet is identified with thecourse acronym. Please ensure you use the correct answer sheet for each course. Payment of $79 (by check orcredit card) must accompany each answer sheet submitted. We cannot process answer sheets that do not includepayment. Please take a few minutes to complete the Course Evaluation so that we can provide you with the bestpossible CPE.

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You may fax your completed Examination for CPE Credit Answer Sheet to the Tax & Accounting business ofThomson Reuters at (817) 252�4021, along with your credit card information.

If more than one person wants to complete this self�study course, each person should complete a separateExamination for CPE Credit Answer Sheet. Payment of $79 must accompany each answer sheet submitted. Wewould also appreciate a separate Course Evaluation from each person who completes an examination.

Express Grading. An express grading service is available for an additional $24.95 per examination. Courseresults will be faxed to you by 5 p.m. CST of the business day following receipt of your Examination for CPE CreditAnswer Sheet. Expedited grading requests will be accepted by fax only if accompanied with credit cardinformation. Please fax express grading to the Tax & Accounting business of Thomson Reuters at (817) 252�4021.

Retaining CPE Records

For all scores of 70% or higher, you will receive a Certificate of Completion. You should retain it and a copy of thesematerials for at least five years.

PPC In�House Training

A number of in�house training classes are available that provide up to eight hours of CPE credit. Please call ourSales Department at (800) 323�8724 for more information.

GFST09 Companion to PPC's Guide to Preparing Governmental Financial Statements Under GASBS No. 34

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COMPANION TO PPC'S GUIDE TOPREPARING GOVERNMENTAL FINANCIAL STATEMENTS UNDER GASBS NO. 34

COURSE 1

INTRODUCTION TO GOVERNMENTAL FINANCIAL REPORTSAND FUND ACCOUNTING OVERVIEW (GFSTG091)

OVERVIEW

COURSE DESCRIPTION: This interactive self�study course provides an introduction and overview ofgovernmental accounting and fund accounting, including budgetary reporting. Thegeneral requirements of GASBS No. 34 is introduced and discussed. This coursecovers all three categories of funds as well as how to account under each fund forthe sources and uses of financial resources as well as capital assets, long�termliabilities and fund balances, net assets and fund equity.

PUBLICATION/REVISIONDATE:

October 2009

RECOMMENDED FOR: Users of PPC's Guide to Preparing Governmental Financial Statements UnderGASBS No. 34

PREREQUISITE/ADVANCEPREPARATION:

Basic knowledge of governmental accounting and reporting

CPE CREDIT: 8 QAS Hours, 8 Registry Hours

Check with the state board of accountancy in the state in which you are licensed todetermine if they participate in the QAS program and allow QAS CPE credit hours.This course is based on one CPE credit for each 50 minutes of study time inaccordance with standards issued by NASBA. Note that some states require100�minute contact hours for self study. You may also visit the NASBA website atwww.nasba.org for a listing of states that accept QAS hours.

Yellow Book CPE Credit: This course is designed to assist auditors in meeting thecontinuing education requirements included in GAO's Government AuditingStandards.

FIELD OF STUDY: Accounting (Governmental)

EXPIRATION DATE: Postmark by October 31, 2010

KNOWLEDGE LEVEL: Basic

LEARNING OBJECTIVES:

Lesson 1Introduction to Governmental Financial Reports

Completion of this lesson will enable you to:� Define governmental entity and financial reporting entity.� Describe the governmental environment.� Identify the uses and users of governmental financial reports as well as the objectives of governmental financial

reporting.� Describe the GASB project on service efforts and accomplishment reporting and establishing GAAP for state

and local governments.� Identify the requirements of GASBS No. 34.

Lesson 2Fund Accounting Overview

Completion of this lesson will enable you to:� Identify the three categories of funds and the types of funds of each category.

GFST09Companion to PPC's Guide to Preparing Governmental Financial Statements Under GASBS No. 34

2

� Summarize the requirements of measurement focus and basis of accounting for all three types of funds.� Choose the proper accounting and reporting treatment of capital assets, debt and long�term liabilities and

interfund activity.� Define the proper terms for the difference between fund assets and liabilities for each fund category and record

the appropriate accounting entries for each fund category.� Identify the importance of governmental budgets as well as the requirements for reporting of budgetary

comparisons.

TO COMPLETE THIS LEARNING PROCESS:

Send your completed Examination for CPE Credit Answer Sheet, Course Evaluation, and payment to:

Thomson ReutersTax & AccountingR&GGFSTG091 Self�study CPE36786 Treasury CenterChicago, IL 60694�6700

See the test instructions included with the course materials for more information.

ADMINISTRATIVE POLICIES:

For information regarding refunds and complaint resolutions, dial (800) 323�8724 for Customer Service and yourquestions or concerns will be promptly addressed.


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Lesson 1:�INTRODUCTION TO GOVERNMENTALFINANCIAL REPORTS

INTRODUCTION

This lesson discusses the definitions of governmental entity and the financial reporting entity. It describes thegovernment environment as well as the uses, users and objectives of the statements. The general requirementsof the GASB No. 34 reporting model is introduced and discussed to aid the preparer and auditor of governmen�tal financial statements.


Completion of this lesson will enable you to:

� Define governmental entity and financial reporting entity.

� Describe the government environment.

� Identify the uses and users of governmental financial reports as well as the objectives of governmental financialreporting.

� Describe the GASB project on service efforts and accomplishment reporting and establishing GAAP for stateand local governments.

� Identify the requirements of GASBS No. 34.

GENERAL INFORMATION

Scope of the State and Local Governmental Sector

In 2007, the U.S. Bureau of the Census identified more than 89,000 units of local government, in addition to the 50states, classified as follows:

a. Counties 3,033

b. Municipalities 19,492

c. Townships 16,519

d. School districts 13,051

e. Special districts 37,381

89,476

Municipalities, counties and townships include cities, towns, villages, parishes, boroughs, etc. Special districtsinclude port authorities, industrial development and housing agencies, water, park, and planning commissions,etc. In addition, there are thousands of subordinate agencies of these governments, that is, statutory authorities,commissions, corporations, etc., with governmental characteristics that are subject to administrative or fiscalcontrol of independent local governments.

States, counties, cities, towns, etc., provide a broad range of services to citizens, whereas special districts usuallyprovide narrower, specialized services. In addition, governments may operate organizations such as hospitals,colleges, universities, employee benefit plans, or other nonbusiness organizations to provide services.

By any measure, state and local governments play a significant role in the U.S. economy. In 2005�2006, forinstance, state and local governments raised more than $2.7 trillion in revenue, nearly 54% of it in the form of


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property, sales, or income taxes. They spent more than $2.5 trillion, 29% of it for education. In 2006, state and localgovernments employed more than 16.1 million people. Debt at the end of 2006 totaled $860 billion for states and$1.3 trillion for local governments.

The American Recovery and Reinvestment Act of 2009 (Recovery Act) is having a significant impact on spendingby state and local governments. The Recovery Act is providing $250 billion to state and local governmentspri�marily for infrastructure, healthcare, education, and general fiscal stabilization. The federal government has esti�mated that allocation of Recovery Act funds to individual states range from 4.8% to 25.2% of a state's budget. Otherelements of the Recovery Act indirectly benefit state and local governments; for example, bond subsidies and aidto individuals. Recovery Act funding (and spending by state and local governments) can be tracked atwww.recovery.gov.

Besides their economic significance, local governments affect all individuals and organizations in the UnitedStates. They regulate aspects of daily and commercial life through laws, ordinances, regulations, etc. They provideservices such as education, police and fire protection, court systems, transportation, water supply and otherutilities, streets and highways, parks, libraries, etc.

The role of state and local governments, relative to that of the federal government, has expanded in the last fewdecades due, in part, to reduced federal spending at the state and local level along with growth of federallymandated programs imposed upon states and localities. In addition, there has been an increased demand bycitizens for public services. One result has been an increase in the number of special districts created to providespecialized servicesover 43 percent since 1977.

Financing methods have also changed, due, in part, to taxpayer resistance to new taxes and initiatives to limit taxincreases, as well as to governments reaching their debt capacity limits. As a result, traditional financing sourcessuch as property taxes have decreased while sales taxes and user fees have increased.

Scope of This Course

This course is concerned with the measurement, presentation, and disclosure of transactions and balances inaccordance with GAAP in governmental financial statements. Thus, it focuses on the accounting and financialreporting standards for governmental entities as promulgated by the Governmental Accounting Standards Board(GASB). It is not a bookkeeping manual, that is, it is not concerned with preparation of books of original entry.However, it does provide journal entries to illustrate discussion of the accounting for various transactions, particu�larly complex ones or those that affect more than one fund.

GASB Pronouncements Considered. This course includes relevant technical developments as of October 2008.It is current as of:

� GASB Statement No. 56, Codification of Accounting and Financial Reporting Guidance Contained in the

AICPA Statements on Auditing Standards.

� GASB Interpretation No. 6, Recognition and Measurement of Certain Liabilities and Expenditures in

Governmental Fund Financial Statements.

� GASB Technical Bulletin 2006�1 No. 2008�1, Determining the Annual Required Contribution Adjustment for

Postemployment Benefits.

� GASB Concepts Statement No. 5, Service Efforts and Accomplishments Reportingan amendment of

GASB Concepts Statement No. 2.

Nonspecialized Accounting Standards for Business�type Activities. Business�type activities (enterprise funds)have the option to follow FASB pronouncements issued after November 30, 1989, that are developed for businessenterprises. However, this course does not discuss those FASB pronouncements because they are applicable onlyto the very limited number of business�type activities that have elected to apply them.


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Specialized Accounting Standards Not Covered. This course does not cover the specialized accounting stan�dards in the following documents:

a. AICPA Audit and Accounting Guide, Health Care Organizations. Although this course does not discuss theprovisions of the AICPA Health Care Guide in any detail, it will be helpful to preparers of governmentalhealthcare entity financial statements to the extent that GASB requirements apply.

b. FASB Statement No. 71, Accounting for the Effects of Certain Types of Regulation, and related FASBStatements (Nos. 90, 92, and 101).

GASBS No. 34 eliminated the option for governmental not�for�profit organizations to follow the AICPA Not�for�Profitmodel. GASBS No. 35, Basic Financial Statementsand Management's Discussion and Analysisfor Public

Colleges and Universities, requires public colleges and universities to follow the special�purpose governmentprovisions of GASBS No. 34, eliminating the provisions previously in GAAP that allowed public colleges anduniversities to follow the AICPA Audit and Accounting Guide, Audits of Colleges and Universities.

AICPA Not�for�Profit Model. GASBS No. 34 superseded the interim guidance provided by GASBS No. 29, The

Use of Not�for�Profit Accounting and Financial Reporting Principles by Governmental Entities. However, GASBS No.34, paragraph 147, allows governments that reported under the GASBS No. 29 AICPA Not�for�Profit model as ofJune 30, 1999 to report using enterprise fund accounting and reporting even though they may not meet the criteriafor an enterprise fund under GASBS No. 34, paragraph 67. Paragraph 5a. of GASBS No. 29 defined the AICPANot�for�Profit model as being the accounting and financial reporting contained in SOP 78�10 and the AICPA Auditand Accounting Guide, Audits of Voluntary Health and Welfare Organizations. Question 7.103.1 in the GASBComprehensive Implementation Guide2009 clarifies that only those governments reporting under the GASBSNo. 29 AICPA Not�for�Profit model as of June 30, 1999 (the date GASBS No. 34 was issued), qualified for thisexception. Most of these governmental nonprofits do not meet the GASBS No. 34 definition of an enterprise fund.Therefore, the GASB created this limited exception to �grandfather" those governments as business�type activitiesto prevent their having to create governmental fund and modified accrual information for fund�based statements.Now that all the effective dates of GASBS No. 34 have passed, no governmental entity may report using the AICPAnot�for�profit model.

States and Special�purpose Governments. The focus of this course is on governmental accounting principles asthey apply to general purpose governmentscities, other municipalities, and counties. However, the guidance isalso generally applicable to states as well as school districts and many other special�purpose governments.

Performance and Reporting Standards Not Covered. This course covers financial statement preparation stan�dards, that is, GAAP applicable to financial statements of governmental entities. Its guidance is useful to preparersof GAAP financial statements, whether those preparers are accountants in government or in public practice.Performance standards are the standards and procedures that a CPA in public practice must follow when associ�ated with, and reporting on, the financial statements of a client. Performance and reporting standards includestandards for the compilation, review, or audit of financial statements. Discussion of performance and reportingstandards is beyond the scope of this course. Guidance on the performance and reporting for compilation andreview engagements may be found in PPC's Guide to Compilation and Review Engagements and guidance onperformance and reporting for audits of governmental financial statements may be found in PPC's Guide to Audits

of Local Governments. In addition, guidance on performing Single Audits for entities receiving federal awards isprovided in PPC's Guide to Single Audits.

Quality Control Standards Not Covered. Quality control standards relate to the internal system that a CPA firmuses to provide itself with reasonable assurance of conforming to the professional standards (including perfor�mance and reporting standards) in financial statement engagements. Quality control standards apply to compila�tion, review, attestation, and audit engagements. Discussion of quality control standards is beyond the scope of thiscourse. Guidance may be found in PPC's Guide to Quality Control.

Ethics Standards Not Covered. Ethics standards relate to the performance of professional responsibilities by allmembers of the AICPA, whether they are in public practice, government, industry, or education. Those standardsare codified in the AICPA Code of Professional Conduct.


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Acronyms for Authoritative Pronouncements. This course uses the following acronyms to refer to authoritativepronouncements:

a. GASBS No. XGovernmental Accounting Standards Board Statement No. X.

b. GASBC No. XGovernmental Accounting Standards Board Concepts Statement No. X.

c. GASBI No. XGovernmental Accounting Standards Board Interpretation No. X.

d. GASBTB No. XX�XGovernmental Accounting Standards Board Technical Bulletin No. XX�X.

e. GASB Cod. sec. xxxx.xxxGASB Codification section xxxx.xxx (all references are to the June 30, 2009edition).

f. BFCThe Basis for Conclusions section of a referenced GASB standard.

g. GASB Comprehensive Implementation Guide2009this GASB publication contains all previouslyissued GASB Implementation Guides including the April 2009, Guide to Implementation of GASB Statement

53 on Accounting and Financial Reporting for Derivative Instruments and updates them for the effects ofnew GASB pronouncements.

h. SLGThe AICPA Audit and Accounting Guide, State and Local Governments (updated as of March 2009).

i. NCGAS XNational Council on Governmental Accounting Statement No. X.

j. SAS No. XStatement on Auditing Standards No. X.

k. FASBS No. XFASB Statement of Financial Accounting Standards No. X.

l. APBO No. XAccounting Principles Board Opinion No. X.

m. 2005 GAAFRThe GFOA Governmental Accounting, Auditing, and Financial Reporting, issued in 2005(also called The Blue Book).

DEFINING OF A GOVERNMENTAL ENTITY

Definition of a GovernmentTHE BASICS

� Any entity that meets the definition of a government must follow GASB pronouncements(other than the federal government). All others follow FASB pronouncements.

� Nearly all general purpose governments meet the definition of a government simply basedon the fact that they are public corporations or bodies corporate and politic.

� Other organizations may be governments based on one of the four characteristics discussedbelow.

What is a governmental entity? In some cases, the answer is obvious. A state or a city, for instance, obviously is agovernment. In other cases, however, it may not be obvious whether a particular entity should be consideredgovernmental for the purpose of determining whether governmental accounting and reporting standards apply.The determination may be particularly difficult for special districts or entities created under general corporation ornot�for�profit corporation laws and that perform some governmental functions, have some characteristics of gov�ernment, or are controlled by a governmental entity. For example, is a community services center that providesyouth recreation and job training services and is financed through government grants and city contracts a govern�mental entity or a nongovernmental entity? The answer depends on other specific circumstances discussed in thefollowing paragraphs.

The GASB has jurisdiction over accounting and financial reporting standards for state and local governmentalentities, and the Financial Accounting Standards Board (FASB) has jurisdiction over standards for nongovernmen�


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tal organizations. Thus, the determination of whether an entity is a governmental entity or not has importantaccounting consequences.

In March 1996, the GASB and the FASB met jointly to clear the proposed AICPA Audit and Accounting Guide,Health Care Organizations. During that meeting, the GASB and the FASB agreed on a definition of a governmentalorganization that should be used in determining whether an entity should follow GAAP for governments.

Rather than issue a Statement, the two Boards decided to clear AICPA audit and accounting guides containing thedefinition, which rank as level �b" source of GAAP. Previous nonauthoritative guidance in this area consisted of aNovember 1993 GASB staff paper titled �Applicability of GASB Standards" (the GASB Staff Paper). Readers of thiscourse should be aware that determining that an organization is governmental based on the definition does notsupersede guidance in GASBS No. 14, The Financial Reporting Entity, regarding whether to include the organiza�tion in a particular governmental financial reporting entity.

Definition

The following definition of a governmental entity is stated in paragraph 1.01 of The AICPA Audit and AccountingGuide, State and Local Governments (SLG):

Public corporations and bodies corporate and politic are governmental entities. Other entities aregovernmental entities if they have one or more of the following characteristics:

� Popular election of officers or appointment (or approval) of a controlling majority of themembers of the organization's governing body by officials of one or more state or localgovernments;

� The potential for unilateral dissolution by a government with the net assets reverting to agovernment; or

� The power to enact and enforce a tax levy.

Furthermore, entities are presumed to be governmental if they have the ability to issue directly(rather than through a state or municipal authority) debt that pays interest exempt from federaltaxation. However, entities possessing only that ability (to issue tax�exempt debt) and none of theother governmental characteristics may rebut the presumption that they are governmental if theirdetermination is supported by compelling, relevant evidence.

Common Examples

Black's Law Dictionary describes a public corporation as a municipality or a governmental corporation that hasbeen created to administer public affairs or as an instrumentality of the state, founded and owned in the publicinterest. The following entities are common examples of governmental entities.

a. States, territories of the United States, and the District of Columbia.

b. Entities created by or under a state constitution, statute, statutory enabling legislation, or other localordinance, including

(1) Cities.

(2) Counties.

(3) Towns.

(4) Townships.

(5) Villages.


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(6) Parishes.

(7) Boroughs.

(8) School districts.

(9) Special districts.

(10) Public authorities.

c. Entities considered to be a �municipal corporation" because they are declared by statute to be a �publiccorporation" or a �body corporate and politic." Legally separate special�purpose entities may be sodesignated so that they can avoid limitations or requirements placed on the general government, such aslimitations on debt issuance or civil service requirements.

Example of Determination As to Governmental Nature

As an example of the definition in the paragraph above, consider the question posed earlier in this lesson about thegovernmental nature of a community services center that provides youth recreation and job training services andis financed through government grants and city contracts. Presented below are two situations in which the centerwould be considered governmental and one in which it would not. Although these examples are based onIllustration 1 in the GASB Staff Paper, they remain applicable based on the revised definition of a governmentalorganization.

a. The center would be considered to be a governmental organization if it was created by a city ordinancepursuant to state enabling legislation as a �body corporate and politic" and its governing board wasappointed by the city's mayor, and if the center could issue its own tax�exempt debt.

b. The center would be considered to be a governmental organization if it was incorporated as an IRC Section501(c)(3) not�for�profit corporation under the state's not�for�profit corporation laws and if its governingboard consisted entirely of city officials serving ex officio, that is, serving by virtue of their status as cityofficials. The status as governmental would apply even if the center could not issue its own tax�exempt debt.

c. The center would not be considered to be a governmental organization if it was organized by a private civicgroup and incorporated as a Section 501(c)(3) not�for�profit corporation under the state's not�for�profitcorporation laws and if its governing board consisted entirely of private, nongovernmental individuals. Itwould be nongovernmental because it was not created by a governmental organization, no governmentalorganization has control over its operations, and it does not possess any characteristics of government,such as popularly elected officials or the power to tax. The status as nongovernmental would apply evenif a governmental agency issued tax�exempt debt on the center's behalf.

In the first two situations, the center's accounting and financial reporting would be subject to the standards�settingauthority of the GASB. In the third situation, the center would be subject to the standards�setting authority of theFASB. Note that this could result in different accounting and financial reporting by two entities that engage in thesame activities and differ only with respect to their being governmental or nongovernmental organizations.

DETERMINING THE FINANCIAL REPORTING ENTITY

Governments, such as cities, provide services and engage in activities through a variety of organizations that mayhave differing degrees of autonomy from the city's elected officials and differing degrees of financial independenceof the city. Which of these entities should be included in the city's financial statements? The financial reporting entity

refers to the units of government, organizations, and activities included in a particular set of financial statements.

GASBS No. 14, The Financial Reporting Entity, as amended, establishes the criteria for determining what makes upthe financial reporting entity. The financial reporting entity is comprised of a primary government and organizationsfor which the primary government is financially accountable. A primary government is a state government, general


9

purpose local government, or special�purpose government that meets certain criteria of GASBS No. 14 denoting itsindependence from other state or local governments. Those criteria include the ability to set its own tax rates andto issue debt.

One should not confuse the definition of a governmental entity with the GASBS No. 14 criteria for a primarygovernment. That is, an entity might meet the definition of a government but not meet the definition of a primarygovernment. Similarly, an entity may not meet the definition of a government but may still be included as acomponent unit of a governmental entity.

Definition of Component Unit

A component unit is a legally separate organization for which the primary government is financially accountable.GASBS No. 14 gives the indicators of financial accountability, such as ability to approve or modify the potentialcomponent unit's budget or service fee rates or being obligated for the unit's debt. A component unit may be agovernmental entity, a nonprofit corporation, or a for�profit corporation. Only its relation to the primary governmentis important in determining whether it is part of a governmental reporting entity. GASBS No. 39, Determining

Whether Certain Organizations Are Component Units, amends GASBS No. 14. It provides guidance on when certainlegally separate tax�exempt organizations for which the primary government is not financially accountable (oftenreferred to as �affiliated organizations") should, nonetheless, be included in a government's financial reportingentity.

Discrete Presentation of Component Units

There are two ways of reporting a component unit in the financial statements of the reporting entity: discretepresentation and blending. These are not options; the method for which the unit qualifies must be followed. Mostcomponent units are discretely presented. Discrete presentation refers to presentation of data for the componentunit in a column to the right of the data columns for the primary government.

Blending of Component Units

Blending means that the component unit is so closely related to the primary government that it is, in effect, the sameas the primary government. In this case, the data for the component unit's funds are combined with the data forcorresponding funds of the primary government.


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11

SELF�STUDY QUIZ

Determine the best answer for each question below. Then check your answers against the correct answers in thefollowing section.

1. What guidance did the GASB and the FASB agree upon as the highest authority containing the definition ofgovernmental organization in March of 1996?

a. A new Statement issued at the March 1996 session.

b. The AICPA audit and accounting guides.

c. GASBS No. 14, The Financial Reporting Entity.

2. High Five is a community youth recreation center that also provides job training. High Five is financed throughgovernment grants and city contracts. Under which situation below would High Five be considered anongovernmental organization?

a. High Five is a Section 501(c)(3) organization incorporated under the state's not�for�profit corporation laws.Its board consists entirely of city officials serving ex officio. They do not issue their own tax�exempt debt.

b. High Five is a Section 501(c)(3) not�for�profit corporation, and its board consists entirely of privateindividuals. The organizing group is a private civic group. A governmental agency issues tax�exempt debton High Five's behalf.

c. High Five was created by a city ordinance based on state legislation as a �body corporate and politic," andits board was appointed by the mayor. High Five issues its own tax�exempt debt.

3. Swimming Fish Marina's accountant is trying to determine if they should be included in the city's financialstatements. Which indicator would positively confirm that the Marina is financially accountable to the city?

a. Swimming Fish Marina is a legally separate organization from the city.

b. Swimming Fish Marina is a governmental entity.

c. The city can approve Swimming Fish Marina's budget and service fee rates.

d. Swimming Fish Marina is a nonprofit corporation.

4. Ace Flies North is a nonprofit corporation that is financially accountable to Hay Springs, TX. If the financial datafor Ace Flies North is presented in a column to the right of the data columns for Hay Springs, what method ofreporting is being used?

a. Discrete presentation.

b. Blending.

c. Affiliated.

d. Component unit.


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SELF�STUDY ANSWERS

This section provides the correct answers to the self�study quiz. If you answered a question incorrectly, reread theappropriate material. (References are in parentheses.)

1. What guidance did the GASB and the FASB agree upon as the highest authority containing the definition ofgovernmental organization in March of 1996? (Page 7)

a. A new Statement issued at the March 1996 session. [This answer is incorrect. The FASB and GASBdecided not to issue a new Statement to define governmental organization.]

b. The AICPA audit and accounting guides. [This answer is correct. The GASB and FASB met jointlyand cleared the AICPA audit and accounting guides which contain the definition for governmentalorganization.

c. GASBS No. 14, The Financial Reporting Entity. [This answer is incorrect. GASBS No. 14 contains guidanceabout whether a governmental organization should be included in a particular governmental financialreporting entity.]

2. High Five is a community youth recreation center that also provides job training. High Five is financed throughgovernment grants and city contracts. Under which situation below would High Five be considered anongovernmental organization? (Page 8)

a. High Five is a Section 501(c)(3) organization incorporated under the state's not�for�profit corporation laws.Its board consists entirely of city officials serving ex officio. They do not issue their own tax�exempt debt.[This answer is incorrect. In this situation High Five possesses one or more of the defining characteristicsof being a governmental organization.]

b. High Five is a Section 501(c)(3) not�for�profit corporation, and its board consists entirely of privateindividuals. The organizing group is a private civic group. A governmental agency issues tax�exemptdebt on High Five's behalf. [This answer is correct. In this situation High Five is a nongovernmentalorganization. There are no characteristics present that define a governmental entity. A governmen�tal agency issuing tax�exempt debt on the center's behalf is not enough to define it as governmental.]

c. High Five was created by a city ordinance based on state legislation as a �body corporate and politic," andits board was appointed by the mayor. High Five issues its own tax�exempt debt. [This answer is incorrect.In this situation High Five would be a governmental organization because the center possesses one ormore of the defining characteristics.]

3. Swimming Fish Marina's accountant is trying to determine if they should be included in the city's financialstatements. Which indicator would positively confirm that the Marina is financially accountable to the city?(Page 9)

a. Swimming Fish Marina is a legally separate organization from the city. [This answer is incorrect. Anorganization being legally separate is not enough information to deem it accountable to the city. Thedefining factor would be its relationship to the city, which is not included here.]

b. Swimming Fish Marina is a governmental entity. [This answer is incorrect. A component unit may be agovernmental entity, but still not be financially accountable. We would need to know what the relationshipis between Swimming Fish Marina and the city.]

c. The city can approve Swimming Fish Marina's budget and service fee rates. [This answer is correct.Because the city has the authority of the Marina's budget approval and setting of service fees, theMarina is accountable to the city according to GASBS No. 14, which gives the indictors of financialaccountability. Another indicator would be if the city were responsible for the Marina's debt.]

d. Swimming Fish Marina is a nonprofit corporation. [This answer is incorrect. A component unit may be anonprofit corporation and still not be financially accountable. The relationship between the city and theMarina is what would indicate whether there is financial accountability.]


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4. Ace Flies North is a nonprofit corporation that is financially accountable to Hay Springs, TX. If the financial datafor Ace Flies North is presented in a column to the right of the data columns for Hay Springs, what method ofreporting is being used? (Page 9)

a. Discrete presentation. [This answer is correct. There is not an option for how Ace Flies North andHay Springs, TX report their financial data. The method for which the unit qualifies must be followed.Discrete presentation is how most component units must report.]

b. Blending. [This answer is incorrect. If blending were the method of presentation, Ace Flies North's fundnumbers would be combined with Hay Springs fund numbers. This method is used because Ace FliesNorth, as the component unit, is so closely related to Hay Springs which is the primary government thatit is, in effect, the same as the primary government.]

c. Affiliated. [This answer is incorrect. An affiliated organization is not a method of financial presentation, butrather a term used to describe legally separate tax�exempt organizations for which the primary governmentis not financially accountable.]

d. Component unit. [This answer is incorrect. A component unit is not a method of financial presentation, butrather a term used to describe legally separate organizations for which the primary government isfinancially accountable.]


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UNDERSTANDING THE GOVERNMENT ENVIRONMENT

Some aspects of the governmental sector are similar to the nongovernmental sector. For example, fees may becharged to users of some government services, and the governmental service activity may be operated on acost�recovery basis. In general, the accounting and financial reporting for such �business�type" (proprietary)activities are similar to the accounting for similar activities provided by business enterprises in the private sector.Other aspects of the governmental sector, however, are quite different from the private sector, and the accountingand financial reporting for those aspects are unique. Thus, it is important to understand those unique environmen�tal characteristics.

GASBC No. 1, Objectives of Financial Reporting, paragraph 13, identifies, among others, the following significantgovernment environmental characteristics:

a. Government structure and services

(1) The representative form of government and separation of powers.

(2) The relationship of taxpayers to services received.

b. Control characteristics

(1) The budget as an expression of public policy and as a method of providing control.

(2) The use of fund accounting for control purposes.

c. Other

(1) The political process.

(2) Significant investment in non�revenue�producing capital assets.

The following paragraphs discuss these characteristics and how they affect governmental accounting and financialreporting.

Governmental Structure and Budget

State and local governments operate as representative forms of government in which elected officials and separatebranches of government ultimately are accountable to the electorate. For example, the executive branch preparesa budget that, when approved by the legislative branch, authorizes expenditures and has the force of law. Citizensplay a role in the budget�adoption process, for example, by commenting on a proposed budget at budgethearings. Thus, the adopted budget becomes an expression of public policy of service objectives and priorities.The legally adopted budget also serves as a form of control and a means of demonstrating accountability.

The governmental accounting model recognizes the annual budget's significance by focusing on the flows ofcurrent financial resources in the governmental fund financial statements. This measurement focus is the same asor similar to the measurement focus used in most governments' legally adopted budgets. Using this measurementfocus, certain noncurrent, nonfinancial resources, liabilities, and expenditures are given unique treatment so thatthese assets and liabilities are reported in the same manner as they are in most legally adopted budgets. Inaddition, GAAP requires governments to present budget�to�actual comparisons for their general fund and eachmajor special revenue fund that has a legally adopted annual or biennial budget to demonstrate whether govern�ment officials adhered to the spending authorizations and limitations inherent in the budget.

Fund Accounting. Besides the budget, other legal and contractual provisions govern how governments may raiseand spend resources. For example, a debt agreement may specify the use for which borrowed monies may bespent and may require the accumulation of resources for repaying the debt. Or, legislation authorizing a new tax orfee may restrict the revenues to use for a specific purpose. Or, a grant agreement may stipulate how grant


15

resources received from another level of government may be used. Fund accounting is a way governmentstraditionally have controlled the use of resources designated for a specific purpose and have demonstrated thatlegal or contractual provisions governing specific resources have been complied with. Even though computerizedaccounting systems may have diminished the need for fund�based accounting systems, fund�based financialreporting is still a way for governments to demonstrate that resources were used as authorized and that otherfinance�related legal or contractual requirements were adhered to.

Relationship of Taxpayers to Services Received

In a representative democracy, the electorate as a whole authorizes, through actions of elected officials, theimposition of taxes to raise resources needed to provide basic government services. However, individual taxpayersmust abide by that taxing decision and pay taxes whether they want to or not and whether they receive all theauthorized services or not. Because taxes may be based on factors such as income or the value of property owned,the amount of taxes an individual citizen pays usually will not bear a direct relationship to the value of tax�supportedservices that the taxpayer receives. For example, property owners must pay property taxes to finance publiceducation even though they do not have any children in public schools. The fact that individual taxpayers areinvoluntary resource providers increases the need for governmental financial reporting to demonstrate fiscalaccountability to those resource providers.

Absence of Exchange Relationship, Profit Motive, and Competition

There is not an exchange relationship between resources provided to governments and many general governmentservices provided by governments. For example, the fire department generally does not bill a citizen for its servicesin fighting a fire on the citizen's property. Also, governments provide many services that the private sector would notfind cost�effective or profitable to provide, for example, public transportation. The result is that, in some instances,the government is the only provider of a service.

This monopolistic quality and the lack of a profit�motive for providing services can result in difficulty in measuringthe efficiency of many government operations. Unlike the private business sector, the government is not measuredin terms of profit or loss or return on shareowners' investment. Instead, governmental financial reporting mustprovide other methods of evaluating the government's efficiency and effectiveness. Concepts and standards formeasuring governmental service efforts and accomplishments are only now beginning to be developed.

Political Nature of Government

Government is by definition a political process. Elected officials attempt to balance competing claims for limitedresources and conflicting taxpayer desires for more services without tax increases. Elected officials often serve forrelatively short terms and thus have a short�term horizon. There is some incentive for elected officials to satisfycitizens' desires for current services by deferring other services or deferring necessary maintenance of infrastruc�ture (such as streets and bridges) and other non�revenue�producing capital assets. Also, officials may pay forservices with nonrecurring, short�term revenues or by deferring the cash effects of certain types of transactions tomore remote periods. In the past, the focus on measuring and recognizing long�term or deferred commitments orliabilities has been given less emphasis than the focus on current resources and expenditures that correspond tothe time frame of the annual budget. However, management's discussion and analysis (MD&A) and government�wide financial statements, required by GASBS No. 34, address the longer�term focus, that is, interperiod equity.

Business�type Activities of Governments

Some of the unique characteristics of governmental activities, and the related accounting and financial reportingimplications, can be better understood by contrasting those characteristics with characteristics of business�type(proprietary) activities that governments engage in. Business�type activities have counterparts in the private sectorand include activities such as water utilities, sanitation services, golf courses, parking lots and garages, etc. Theseactivities provide the same types of services as are provided by private enterprises. Thus, often there is competitionthat may be absent from governmental activities. If there is competition, the customers have a choice whether touse the government's proprietary service or not (unless the activity is a monopoly of a necessary service, such asa water utility). Both GASBC No. 1 and GASBS No. 34 use the terms governmental activities and business�type

activities. However, those terms are defined only in GASBS No. 34, paragraph 15. Governmental activities �gener�


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ally are financed through taxes, intergovernmental revenues, and other nonexchange revenues." Business�typeactivities �are financed in whole or in part by fees charged to external parties for goods and services." Governmentsare required to report business�type activities separately in their government�wide financial statements.

Exchange Relationship and User Fees. Like private enterprises, government business�type activities charge userfees and thus have an exchange relationship with service recipients. The government�owned activity may chargeuser fees at a level that will recover all costs. However, the activity may be subsidized by the government to keepuser fees at a level considered politically or economically acceptable. In either case, however, fund financialreporting for these activities focuses on measuring all costs of the activity, including, for example, depreciation andcosts related to long�term commitments. It also focuses on reporting net operating income, either to determine thenecessary level of user fees or to determine the extent of subsidization necessary. This measurement focus is thesame as for private�sector enterprises.

Revenue�producing Assets. Business�type activities of governments usually are capital intensive. But becausethe capital assets are revenue�producing (unlike most capital assets associated with governmental activities), theremay be less incentive to defer necessary maintenance. Maintenance will be performed because it is necessary toprovide effective and efficient service that will generate revenue. Because the activity reports depreciation and otherlong�term costs, the related capital assets and long�term liabilities are included in the activity's balance sheet.

Different Status of Budget. Because government business�type activities are fully or partially self�supporting fromuser fees (rather than from taxes), and because they have an exchange relationship with the customers and somerelationship between user fees and services, there is less need for a legally adopted budget like that for governmen�tal activities. Business�type activities use budgets for internal planning and control, but the budgets generally donot have the legal status or political nature of governmental activity budgets. For instance, usually they are notsubject to public comment and are not formally adopted by a legislature or governing body.

Because the budget for proprietary activities generally is not a legal authorization of, or limitation on, spending,there is less need to demonstrate compliance with it. Thus, GAAP financial reporting includes budgetary compari�sons only for certain governmental funds (activities).

Absence of Fund Accounting. For similar reasons, business�type activities generally do not use fund accountingin their financial reporting (although the entire activity may be reported in one separate enterprise fund when theactivity is included in the financial report of the government as a whole). Business�type activities typically maydecide how to spend their revenues and resources to provide the service in the most efficient and effective way.Because the resources usually are not restricted to specified uses, there is no need to segregate the resources andtheir expenditures into funds for financial reporting purposes. (Debt agreements may specify how debt proceedsare to be used and may require the maintenance of certain �funds," but those funds are treated as accounts forfinancial reporting purposes and are not equivalent to fund accounting.)

The differences discussed in the preceding paragraphs are not absolute. For one thing, the organizationaldemarcation between governmental and business�type activities is not always clear. For example, one governmentmay organize its parks as a department of the general government while another government may organize themas a separate business�type activity. As previously mentioned, business�type activities may be subsidized, andtherefore subject to the same political process of obtaining tax�supported subsidies and to resulting heightenedaccountability to the taxpayers. The activities may be a monopoly of necessary service, which affects the relation�ship with the service recipients. Rates, particularly of utilities, may be subject to regulation, which also increasespolitical considerations and affects the relationship with service recipients. The activity may receive governmentgrants that have restrictions on their use and require demonstration of compliance with those restrictions.


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SELF�STUDY QUIZ


5. What is a characteristic of a nongovernmental entity that is similar to a governmental entity?

a. The legally adopted budget serving as a form of control and a means of accountability demonstration.

b. The exchange relationship between the taxes paid and the services received.

c. The profit motive driving the services provided.

d. The accounting and financial reporting for the user fees charged to the user for the services offered.

6. How do governments demonstrate that resources were used as authorized and that other finance�related legalor contractual requirements were adhered to?

a. Budget process.

b. GAAP requirements.

c. Fund�based financial reporting.

d. Resource raising procedures.

7. Sammy Sanitation is a city�governed waste management company that is financed in part through feescharged to external parties for services. What classification of activity is this?

a. Governmental.

b. Business�type.

c. Private enterprise.

d. Private sector.

8. Which statement listed below best describes the difference between business�type and governmentalactivities?

a. Competition is generally present in governmental activities, but absent in business�type activities.

b. The measurement focus of government activities is reporting of net operating income and themeasurement focus is fund accounting for business�type activities.

c. Capital assets of business�type activities are generally revenue�producing and they are not ingovernmental activities.


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5. What is a characteristic of a nongovernmental entity that is similar to a governmental entity? (Page 14)

a. The legally adopted budget serving as a form of control and a means of accountability demonstration. [Thisanswer is incorrect. This is a unique environmental characteristic of the governmental sector. The budgetprepared by the executive branch, approved by the legislative branch, and adopted as an expression ofpublic opinion becomes the basis for measurement of meeting legally authorized expenditures.]

b. The exchange relationship between the taxes paid and the services received. [This answer is incorrect. Agovernmental entity may be financed through taxation, which means individual taxpayers are legallybound to pay the taxes regardless of whether or not they receive any of the authorized services.]

c. The profit motive driving the services provided. [This answer is incorrect. Some services which areprovided by governments are not profitable, for example public transportation, and so nongovernmentalentities might not find it cost effective to offer such services.]

d. The accounting and financial reporting for the user fees charged to the user for the services offered.[This answer is correct. This is one aspect that is generally similar between governmental andnongovernmental entities. Business�type activities provided by governments that charge user feeshave similar accounting and financial reporting procedures as these same activities provided bybusiness enterprises in the private sector.]

6. How do governments demonstrate that resources were used as authorized and that other finance�related legalor contractual requirements were adhered to? (Page 15)

a. Budget process. [This answer is incorrect. Budgets can serve as an expression of public policy of serviceobjectives and priorities and once adopted can serve as a form of control and a means of demonstratingaccountability of the resources received but does not indicate whether other finance�related legal orcontractual requirements were adhered to.]

b. GAAP requirements. [This answer is incorrect. GAAP requirements are concerned with financial reportingand do not deal with the legal or contractual requirements of the funding resource.]

c. Fund�based financial reporting. [This answer is correct. Fund�based accounting systems can reportfinancial results in such a way as to demonstrate that legal or contractual requirements werecomplied with and that the use of financial resources were used for the special purpose for whichthey were designated.]

d. Resource raising procedures. [This answer is incorrect. How governments tax the citizenry or apply forgrant or federal subsidies does not demonstrate how the financial resources are used.]

7. Sammy Sanitation is a city�governed waste management company that is financed in part through feescharged to external parties for services. What classification of activity is this? (Page 15)

a. Governmental. [This answer is incorrect. Governmental activities are financed through taxes, intergovern�mental revenues, and other nonexchange revenues. The user fees demonstrate that this is not agovernmental activity.]

b. Business�type. [This answer is correct. The financing for business�type activities come in part orin whole from fees charged to external parties for the goods or services offered. These activitiesprovide the same type of services as are provided by private enterprise.]

c. Private enterprise. [This answer is incorrect. Because the city governs this entity, it is not a privateenterprise.]


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d. Private sector. [This answer is incorrect. Sammy Sanitation is governed by the city and, therefore, is nota part of the private sector.]

8. Which statement listed below best describes the difference between business�type and governmentalactivities? (Page 16)

a. Competition is generally present in governmental activities, but absent in business�type activities. [Thisanswer is incorrect. The exact opposite is true. Many times there are counterparts in the private sector thatcan provide competition for business�type activities offered by a government. Examples of these servicesmight be water utilities or sanitation services.]

b. The measurement focus of government activities is reporting of net operating income and themeasurement focus is fund accounting for business�type activities. [This answer is incorrect. The exactopposite is true. The measurement focus of net operating income for business�type activities is the samefor private�sector enterprises. This analysis helps the government set the user fees or know how muchsubsidization is necessary.]

c. Capital assets of business�type activities are generally revenue�producing and they are not ingovernmental activities. [This answer is correct. User fees (revenue produced by the capital assets)apply to business�type activities. Furthermore, because business�type activities can be capitalintensive and the capital assets are necessary to produce revenue by way of user fees, maintenanceon those assets is not likely to be deferred.]


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THE USES FOR AND THE USERS OF GOVERNMENTAL FINANCIALREPORTS

Users

Who are the users of governmental external financial reports? GASBC No. 1, paragraphs 30�31, identifies thefollowing user groups:

a. Citizens. The government is primarily accountable to the citizenry. This user group includes citizen voters,taxpayers, and service recipients, the media, and advocate groups.

b. Legislative and Oversight Bodies. These bodies represent the citizens and include members of statelegislatures, county commissions, city councils, boards of trustees, school boards, and executive branchofficials who have oversight responsibility for other levels of government or for separately organizedbusiness�type activities.

c. Investors and Creditors. Investors and creditors include individual and institutional investors and creditors,municipal security underwriters, bond rating agencies, bond insurers, and other financial institutions.

Internal government management officials use external financial statements, but they are not identified as a primaryuser because they have access to the information through internal financial reports.

Uses

What use do the users identified in the preceding paragraph make of external governmental financial statements?GASBC No. 1, paragraph 32, lists the following uses:

a. Comparing actual financial results with the legally adopted budget.

b. Assessing financial condition and results of operations.

c. Assessing compliance with finance�related legal and contractual requirements.

d. Assessing efficiency and effectiveness.

The accounting and financial reporting objectives and standards discussed in this course are influenced by theuses made of governmental financial statements.

Comparing Actual and Budgeted Results. All user groups use governmental financial reports to compare actualto budgeted results. Citizens and legislative and oversight bodies make the comparison to assess whetherresources were used as authorized. Other groups assess whether deviations from the budget reflect managementweaknesses, poor budgeting practices, or other circumstances. The budget has less significance for business�typeactivities. Thus, users of financial statements of business�type activities typically are less interested in comparingactual and budgeted results.

Assessing Financial Condition and Results of Operations. Citizens assess whether the reported financialcondition and operating results indicate that the government can continue to provide the current level of serviceswith the current level of resources and the likelihood of tax or service fee increases. Legislative and oversight bodiesuse reported information in planning budgets and programs and to determine the need for tax, fee, or subsidychanges. Investors and creditors use reported information on financial condition to assess the government's abilityto meet its debt service obligations.

Assessing Compliance with Finance�related Legal and Contractual Requirements. Legal and contractualprovisions such as debt covenants, grant restrictions, and statutory taxing or debt limits may control governmentactivities or expenditures. Grantors use governmental fund financial statements to assess whether grant require�ments have been adhered to, and investors and creditors use them to assess compliance with debt covenants.


21

Citizens, too, are concerned with the government's compliance with such legal and contractual provisions becauseof the possible consequence of noncompliance, such as loss of grant funds.

Assessing Efficiency and Effectiveness. Citizens and legislative and oversight bodies are particularly concernedwith the economy, efficiency, and effectiveness with which government uses resources provided through taxes orgrants from other levels of government.

GASB OBJECTIVES FOR GOVERNMENTAL FINANCIAL REPORTING

GASBC No. 1 provides the conceptual framework for accounting and financial reporting for state and localgovernments. In GASBC No. 1 (GASB Cod. Appendix B), the GASB articulated the broad external financialreporting objectives that underlie existing, or will influence future, accounting and financial reporting standards.Many, but not all, of the reporting objectives have been achieved in the GASBS No. 34 financial reporting model.Familiarity with the objectives can increase understanding of the nature and purpose of existing standards and thetrend of future standards.

Accountability

GASBC No. 1, paragraph 56, states that �accountability is the cornerstone of all financial reporting in government."That paragraph describes �accountability" as:

Accountability is the cornerstone of all financial reporting in government. . . . The dictionarydefines accountable as �being obliged to explain one's actions, to justify what one does."Accountability requires governments to answer to the citizenryto justify the raising of publicresources and the purposes for which they are used.

Accountability implies stewardship. A government is accountable to citizens for its stewardship of resourcesbecause individual taxpayers provide the resources involuntarily. Many laws and constitutions reflect the conceptof the accountability of government to the people. So should governmental accounting. In paragraph 58, the GASBexpressed the conclusion that governmental financial reporting should demonstrate accountability by providinginformation that will assist in assessing whether a government was �operated within the legal constraints imposedby the citizenry."

Interperiod Equity

GASBC No. 1, paragraph 61, notes that �interperiod equity is a significant part of accountability and is fundamentalto public administration." Although the term �interperiod equity" is not defined in GASBC No.�1 or in other account�ing literature, the Board does discuss the term in the context of balanced budget laws in paragraph 60. It notes thatthe intent of those laws is that �the current generation of citizens should not be able to shift the burden of paying forcurrent�year services to future�year taxpayers." Paragraph 77 introduces other facets of interperiod equity, specifi�cally, whether previously accumulated resources were used up in providing service in the current period or whethercurrent�year revenues were not only sufficient but also increased accumulated resources. As far back as the 1920s,commentators noted that the ease of issuing public debt often led governments to finance unfair portions ofexpenditures through the sales of bonds and thus to unfairly shift the repayment burden to future years. Currently,there is not a perceived problem of capital debt being issued with a term that exceeds the life of the asset itfinances; however, issues involving interperiod equity exist with respect to operating debt, unfunded pensioncontributions, deferred maintenance, claims and judgments, compensated absences, and other postemploymentbenefits.

Many state and local laws and constitutions recognize the need for interperiod equity. For instance, most state andlocal governments have laws requiring balanced budgets and limiting debt to amounts that can be repaid over thelife of the assets that are acquired with the debt. Because of the political nature of government and the resultingshort�term outlook of elected officials, there is a temptation to ignore interperiod equity when providing services tothe current electorate. Thus, as GASBC No. 1, paragraph 59, explains, these laws attempt to �achieve fairness fromone year, one term of office, or one generation to another."

GASBC No. 1, paragraph 61, states that an objective of financial reporting is to provide information to assesswhether current�year revenues are sufficient to pay for current�year services or whether future�year taxpayers willhave to assume the burden for those services.


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The concept of interperiod equity is related to the concept of accountability in that government officials areaccountable for compliance with balanced budget and debt limitation laws that seek to achieve interperiod equity.Thus, financial reporting that demonstrates accountability by providing information that will assist in assessingwhether a government was �operated within the legal constraints imposed by the citizenry" also demonstrates theextent of interperiod equity. The financial reporting objectives of GASBC No. 1 discussed in the following para�graphs reflect the primacy of accountability and interperiod equity.

Financial Reporting Objectives

From this focus on accountability and interperiod equity, the GASB established three basic objectives of financialreporting by state and local governments. GASBC No. 1, paragraphs 77�79, presents the three main financialreporting objectives, each with three subobjectives. The objectives apply to both governmental and business�typeactivities because both types are part of a government and thus are accountable to the public. There may be,however, differences in emphasis in applying the objectives to each type of activity. The objectives are as follows:

a. Assist in Assessing Accountability. Financial reporting should assist in fulfilling government's duty to bepublicly accountable and should enable users to assess that accountability.

(1) Financial reporting should provide information to determine whether current�year revenues weresufficient to pay for current�year services. This objective implies that financial reporting should enablethe assessment of interperiod equity.

(2) Financial reporting should demonstrate whether resources were obtained and used in accordancewith the legally adopted budget and should demonstrate compliance with other finance�related legalor contractual requirements.

(3) Financial reporting should provide information to assist users in assessing the governmental entity'sservice efforts, costs, and accomplishments. Such information will help users assess government'sefficiency and effectiveness.

b. Assist in Assessing Operating Results. Financial reporting should assist users in evaluating thegovernmental entity's operating results for the year.

(1) Financial reporting should provide information about sources and uses of financial resources.

(2) Financial reporting should provide information about how the governmental entity financed itsactivities and met its cash requirements.

(3) Financial reporting should provide information necessary to determine whether the entity's financialposition improved or deteriorated as a result of the year's operations.

c. Assist in Assessing Services and Obligations. Financial reporting should assist users in assessing the levelof services that the governmental entity can provide and its ability to meet its obligations as they becomedue.

(1) Financial reporting should provide information about the governmental entity's financial position andcondition and about resources and obligations that are both actual and contingent, current andnoncurrent.

Because the major sources of resources are taxes and debt issues, financial reporting should alsoprovide information about tax sources, tax limitations, and debt limitations. [Some of this informationis presented in the operating statement and some in statistical schedules required to be included ingovernment CAFRs.]

(2) Financial reporting should provide information about physical and other nonfinancial resourceshaving useful lives that extend beyond the current year, including information useful in assessing theservice potential of those resources and long�term and short�term capital needs.

(3) Financial reporting should disclose legal or contractual restrictions on resources and risks of potentialloss of resources.


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THE GASBS NO. 34 REPORTING MODEL AND FINANCIAL REPORTINGOBJECTIVES

GASBS No. 34, which established a new and very different financial reporting model for governments in 1999,provided the GASB with its first opportunity to explore exactly what it meant by making accountability (andinterperiod equity) the cornerstone of governmental financial reporting. GASBC No. 1 established a very diverse listof objectives of financial reporting. To achieve as many objectives as possible (and meet as many user needs aspossible), the GASB found itself in the position of having to distinguish between types of accountability. Paragraph204 of the GASBS No. 34 Basis for Conclusions (BFC) cites both fiscal and operational accountability:

Fiscal accountability is the responsibility of governments to justify that their actions in the currentperiod have complied with public decisions concerning the raising and spending of publicmoneys in the short term (usually one budgetary cycle or one year).

. . . Operational accountability is governments' responsibility to report the extent to which theyhave met their operating objectives efficiently and effectively, using all resources available for thatpurpose, and whether they can continue to meet their objectives for the foreseeable future.

GASBS No. 34, BFC paragraph 207, notes that the use of fund accounting and financial statements that show thesources and uses of current financial resources (e.g. taxes, capital outlay, debt service) are accounting andreporting practices that help demonstrate fiscal accountability.

On the other hand, the use of the economic resources measurement focus and full accrual basis of accountingrequired in the government�wide financial statements puts users in a better position to assess operational account�ability. By providing information about all operating costs (both financial and capital), users can assess the level ofservices that can be provided as well as the effect that current period operations have on future resource needs. Asdiscussed in BFC paragraph 223, operating costs provide a consistent basis for evaluating whether revenues weresufficient to cover costs, both for the current period and over time.

The GASB's perceived need to provide information about both operational and fiscal accountability eventuallycaused it to require three different types of financial statements/schedules within a single set of basic financialstatements and RSI, including:

� Government�wide Financial Statementsconsisting of a statement of net assets and a statement ofactivities. These statements provide aggregated information for the government as a whole prepared usingthe economic resources measurement focus and full accrual basis of accounting and meet the need foroperational accountability.

� Fund Financial Statementsconsisting of governmental fund financial statements, proprietary fundfinancial statements, and fiduciary fund financial statements. Governmental fund statements, including abalance sheet and statement of revenues, expenditures, and changes in fund balances, are prepared usingthe current financial resources measurement focus and modified accrual basis of accounting.Governmental fund statements provide information about fiscal accountability by focusing on currentfinancial resources and using a measurement focus that is similar to most governments' legally adoptedbudgets.

� Budgetary Comparison Schedules/Statementspresented only for a government's general fund (or itsequivalent) and each major special revenue fund that has a legally adopted budget. These schedules/statements provide fiscal accountability by comparing original and final budgeted revenues andexpenditures to actual revenues and expenditures on the entity's own budgetary basis of accounting.

An overview of the GASBS No. 34 financial reporting model is provided later in this lesson.


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25

SELF�STUDY QUIZ


9. Who is not a primary user of governmental external financial reports?

a. Citizen.

b. Legislative & oversight board.

c. Investors & creditors.

d. Internal government management officials.

10. One of the uses for external governmental financial statements is assessing financial condition and results ofoperation. Of the following choices, which exemplifies this use?

a. A creditor determining a government's ability to meet its debt service obligations.

b. A creditor determining a government's compliance with debt covenants.

c. A citizen determining a government's ability to use resources effectively.

d. An oversight body determining if budget deviations reflect management weakness.

11. What is not correct about accountability?

a. Stewardship is implied by accountability.

b. Because taxpayers provide resources to government involuntarily, governments must be accountable tothe citizens.

c. Governments must provide financial information that assist citizens to determine they are operating withinthe legal constraints imposed by the citizenry.

d. Accountability of governments is covered in GASBC No. 34.

12. The GASB established three basic objectives of financial reporting by state and local governments. Which basicobjective is met by the subobjective of �financial reporting should provide information about sources and usesof financial resources"?

a. Assist in Assessing Accountability.

b. Assist in Assessing Operating Results.

c. Assist in Assessing Services and Obligations.

d. Assist in Assessing Compliance with GAAP.

13. Which type of financial statements/schedules include a balance sheet and statement of revenues,expenditures, and changes in fund balances?

a. Government�wide financial statements.

b. Budgetary comparison schedules/statements.

c. Fund financial statements.

d. Operational accountability statements.


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9. Who is not a primary user of governmental external financial reports? (Page 20)

a. Citizen. [This answer is incorrect. Government is accountable to its citizens, and the citizens are a primaryuser of the external financial reports. Examples of who is included in the citizenry are the voters, taxpayers,and media.]

b. Legislative & oversight board. [This answer is incorrect. Because these bodies have oversightresponsibility for governmental activities they are considered primary users of external financialstatements. Examples of users included in this category are boards of trustees, school boards, and countycommissions.]

c. Investors & creditors. [This answer is incorrect. Investors and creditors are both primary users of thegovernments external financial reports. Examples of users in this category are bond rating agencies, bondinsurers, and institutional creditors.]

d. Internal government management officials. [This answer is correct. Internal government manage�ment need and use the external financial reports, but because they have access to the sameinformation through internal financial reports, they are not identified as primary users.]

10. One of the uses for external governmental financial statements is assessing financial condition and results ofoperation. Of the following choices, which exemplifies this use? (Page 20)

a. A creditor determining a government's ability to meet its debt service obligations. [This answer iscorrect. The creditor's objective is to assess the financial condition of the government. An investormight use the external financial statements for the same reason. A citizen might use this informationto assess if the government can continue to offer the same level of service or the likelihood of aservice fee increase.]

b. A creditor determining a government's compliance with debt covenants. [This answer is incorrect. Thiscreditor's objective is to assess compliance with finance�related legal and contractual requirements.]

c. A citizen determining a government's ability to use resources effectively. [This answer is incorrect. Thiscitizen's objective is to assess efficiency and effectiveness of the government's use of resources and coulduse the financials to make sure resources were used as authorized, but not for financial condition.]

d. An oversight body determining if budget deviations reflect management weakness. [This answer isincorrect. The objective of this group is to compare actual and budgeted results to look for deviations andthen determine what those deviations might mean but not to assess financial operations.]

11. Which of the following is not correct about accountability as defined in the GASB objectives? (Page 21)

a. Stewardship is implied by accountability. [This answer is incorrect. The government is accountable to thecitizens for its stewardship of the resources received by that government because individual taxpayersprovide the resources by obligation.]

b. Because taxpayers provide resources to government involuntarily, governments must be accountable tothe citizens. [This answer is incorrect. Citizens are required to pay assessed taxes regardless of whetheror not they use the services provided with those tax dollars. Therefore, the government must beaccountable for those resources.]

c. Governments must provide financial information that assist citizens to determine they are operating withinthe legal constraints imposed by the citizenry. [This answer is incorrect. The citizenry impose legal


27

constraints through the laws of the government. In turn, governments are accountable to the citizens toprovide the financial information to assist the citizens in determining that the government is operatingwithin those legal constraints.]

d. Accountability of governments is covered in GASBC No. 34. [This answer is correct. Accountabilityof governments is covered in GASBC No. 1, paragraph 56.]

12. The GASB established three basic objectives of financial reporting by state and local governments. Which basicobjective is met by the subobjective of �financial reporting should provide information about sources and usesof financial resources"? (Page 22)

a. Assist in Assessing Accountability [This answer is incorrect. This objective of financial statements dealswith having the reports assist users to assess the government's public accountability. One subobjectiveof this basic objective is that �financial reporting should provide information to determine whethercurrent�year revenues were sufficient to pay for current�year services."]

b. Assist in Assessing Operating Results [This answer is correct. This object of financial statementsdeals with having the reports assist users in evaluating the governmental entity's operating resultsfor the year. Another subobjective of this basic objective is that �financial reporting should provideinformation about how the governmental entity financed its activities and met its cashrequirements."]

c. Assist in Assessing Services and Obligations [This answer is incorrect. This objective of financialstatements deals with having the reports assist users to assess the level of services that the governmentalentity can provide and its ability to meet its obligations as they become due. One subobjective of this basicobjective is that �financial reporting should provide information about physical and other nonfinancialresources having useful lives that extend beyond the current year."]

d. Assist in Assessing Compliance with GAAP [This answer is incorrect. This is not one of the three basicobjectives of financial statements established by GASB. The basic objectives are to assist users inassessing accountability, operating results, and services and obligations.]

13. Which type of financial statements/schedules include a balance sheet and statement of revenues,expenditures, and changes in fund balances? (Page 23)

a. Government�wide financial statements. [This answer is incorrect. This category consists of a statement ofnet assets and a statement of activities.]

b. Budgetary comparison schedules/statements. [This answer is incorrect. This category presentsschedules/statements of the government's general fund and each major special revenue fund that has alegally adopted budget.]

c. Fund financial statements. [This answer is correct. This type provides information about fiscalaccountability by focusing on current financial resources and using a measurement focus that issimilar to most governments' legally adopted budgets.]

d. Operational accountability statements [This answer is incorrect. This is not a type of financial statementsreferred to by GASB. However, operational accountability is the governments' responsibility to report theextent to which they have met their operating objectives efficiently and effectively.]


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THE GASB PROJECT RELATED TO SERVICE EFFORTS ANDACCOMPLISHMENTS REPORTING

Citizens and legislative and oversight bodies are concerned with the economy, efficiency, and effectiveness withwhich governments use resources. One objective of governmental financial reporting is to provide information forassessing a government's service efforts, costs, and accomplishments. GASBC No. 2, Service Efforts and Accom�

plishments Reporting (SEA), was the first step towards achieving that objective. GASB Concepts Statement No. 5,

Service Efforts and Accomplishments Reporting, amends GASBCS No. 2 to incorporate the results of the GASB'sresearch on the project since GASBCS No. 2 was issued in 1994. An important modification is the addition of astatement that it is beyond the scope of the GASB's jurisdiction to establish (a) the goals and objectives of state andlocal governments, (b) specific nonfinancial measures and indicators of service performance, and (c) benchmarksfor service performance. The Concepts Statement did not establish any SEA reporting standards, but only provideda framework for the future development of standards for general purpose external reporting of SEA.

GASBC No. 2 contemplates that SEA will be reported in a report separate from the CAFR. It concludes thatassessing a government's performance requires information about the acquisition and use of resources, theoutputs and outcomes of the services provided, and the relationship between the use of resources and theiroutputs and outcomes. SEA reporting should focus on financial and nonfinancial measures of service efforts (inputindicators), service accomplishments (output and outcome indicators), and their relationship (efficiency and cost�outcome indicators).

Financial measures of input include expenditures (in total and as a ratio of some other measure) in providing aservice, for example, costs of salaries, supplies, equipment, etc., spent on road maintenance and on per lane�mileof road maintenance. Nonfinancial measures of input include the number of employees or employee�hours used inproviding a service, for example, the number of road maintenance workers in total or per lane�mile of road.

Measures of service accomplishments report what was provided and achieved with the resources used. Outputsmeasure the quantity of services provided and the quantity that meets some standard of quality, for example, thenumber of lane�miles of road repaired and the percentage of lane�miles of road repaired to a certain minimum levelof condition. Outcomes measure results from the services provided, for example, the percentage of lane�miles ofroad in excellent, good, or fair condition.

Efficiency measures relate the cost of resources used per unit of output, for example, the cost per lane�mile of roadrepaired. Cost�outcome measures relate the cost per unit of outcome, for example, the cost per lane�mile of roadmaintained in excellent, good, or fair condition.

GASBC No. 2 concludes that extensive further experimentation and analysis are needed before any requirement toreport specific SEA measures can be imposed. The government�wide financial statements provide a basis forreporting SEA. GASBS No. 34, BFC paragraph 234 points out that the government�wide financial statementsshould contribute towards achieving the SEA objectives of operational accountability, economy, and efficiency.Nonfinancial information is not provided in the government�wide financial statements, but a link is providedbetween the financial statements and SEA reporting. In 2006, the GASB staff completed the second phase of itsresearch on SEA and in April 2007, the GASB added a formal SEA project to its current agenda. In April 2008, theGASB issued an exposure draft of a proposed amendment to GASBC No. 2.

THE BASICS OF ESTABLISHING GAAP FOR STATE AND LOCALGOVERNMENTS

GAAP for GovernmentsTHE BASICS

� The AICPA Code of Professional Conduct Rule 203 names the GASB as the body with theauthority to establish accounting principles for state and local governments.

� The hierarchy of GAAP for governments is set forth in GASB No. 55 (Exhibit NO�TAG).

� For state and local governments, GASB pronouncements take precedence over standardsset by any other organization.


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GAAP for GovernmentsTHE BASICS (Continued)

� FASB pronouncements specifically made applicable to governments by the GASB have thesame level of authority to the extent they do not conflict with or contradict the GASB.

� The GASB has made some FASB pronouncements applicable only to certain types ofactivities and in certain basic financial statements. (See Exhibit 1�1.)

History of Standards Setting

The first formal government standards setting can be traced back to the establishment of the National Committeeon Municipal Accounting (NCMA) in 1934. In 1968, a group called the National Committee on GovernmentalAccounting, which had replaced the NCMA, issued a document titled Governmental Accounting, Auditing, and

Financial Reporting (the 1968 GAAFR, also called The Blue Book). It represented an authoritative compilation inone document of governmental accounting principles that had been developed in various documents by severalpredecessor groups. In 1974, the AICPA issued an Industry Audit Guide titled Audits of State and Local Governmen�

tal Units (1974 ASLGU), which endorsed and recognized (subject to some modification) the general acceptance ofthe accounting principles in the 1968 GAAFR.

The National Council on Governmental Accounting. In 1979, the National Council on Governmental Accounting(NCGA), which had replaced the National Committee on Governmental Accounting, issued Statement 1 (NCGAS1), which updated and expanded the accounting principles in the 1968 GAAFR as they had been modified by the1974 ASLGU. The Government Finance Officers Association (GFOA) was the sponsor of, and publisher for, theNCGA and its predecessor committee. The GFOA published the 1968 GAAFR and also published revised editionsof it in 1980, 1988, 1994, 2001, and 2005 as a nonauthoritative guide to application of GAAP for governments.

The NCGA issued several Statements and Interpretations on accounting principles for governmental units. How�ever, there were questions about who was the standards�setter for governments, particularly when conflicts arosebetween standards in NCGA Statements and in FASB Statements or when a FASB Statement addressed a situationnot addressed in an NCGA Statement. The GASB was established in an attempt to resolve this jurisdictionquestion.

The Governmental Accounting Standards Board

The GASB is the primary standards�setting body for state and local governmental accounting. The GASB wasestablished in 1984 and replaced the NCGA. The GASB operates much like the FASB [being subject to oversightof the Financial Accounting Foundation (FAF) Board of Trustees, having a full�time staff, following a due�processprocedure with meetings open to the public. The GASB issues pronouncements called Statements, Interpretations,Technical Bulletins, etc.

In February 2009, the FAF approved changes to its own structure as well as to the structure of both the FASB andGASB. The FAF's own structure changed in that government organizations are permitted to nominate trustees butthe final decision on appointment rests with the trustees. In the past, organizations, such as the GovernmentFinance Officers Association, appointed the trustee of their choice. The changes also increased the level ofoversight that the FAF has over both the FASB and GASB. Other changes affected two aspects of the GASB itself.First, the FAF agreed to secure a stable and permanent funding source for the GASB. Second, the FAF changed theagenda�setting process for the GASB by vesting the GASB chairperson with the power to set the Board's agenda.Previously, the GASB's agenda was driven by the approval of the majority of the Board.

The GASB's first authoritative pronouncement was Statement No. 1 (GASBS No. 1), Authoritative Status of NCGA

Pronouncements and AICPA Industry Audit Guide. GASBS No. 1 recognized the Statements and Interpretations thathad been issued by the NCGA and the accounting guidance in the 1974 ASLGU and related Statements of Positionas being encompassed within GAAP for governmental units. GASBS No. 1 continues those standards in force untilthey are superseded by GASB pronouncements, and they have been incorporated in the GASB Codification of

Governmental Accounting and Financial Reporting Standards (the GASB Codification) and the GASB Original

Pronouncements.


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The GASB Codification

In 1986, the GASB began issuing pronouncements that supersede portions of previous authoritative standards.Each GASB Statement includes Codification instructions that indicate what literature it supersedes, if any. Also, theGASB annually updates the Codification to reflect current standards. Each paragraph in the GASB Codificationindicates its origin, for example, from a certain paragraph of a particular NCGA Statement or from a certainparagraph of a particular GASB Statement.

The addition of new guidance or removal of superseded guidance in the Codification can cause its paragraphnumbers to change when it is updated. The Codification does not indicate where paragraph numbers havechanged from prior editions. For this reason, this course refers to the original GASB pronouncement and paragraphnumber, where possible, instead of to its specific location in the Codification. (However, the broad Codificationsection number in which the GASB Statement is codified is also indicated.) An exception is Codification paragraphsthat originated in NCGA Statements rather than in GASB pronouncements; those paragraphs are referred to bytheir GASB Codification location. An appendix in the Codification presents a finding list of original pronouncementsthat indicates either where each paragraph of each NCGA or GASB Statement appears in the Codification or thatit was superseded by another GASB Statement. Also, as previously mentioned, the GASB annually publishes abook of all original pronouncements.

GASB Comprehensive Implementation Guide

In 1991, the GASB began to issue Implementation Guides for some of its more detailed standards. As of October2009, the GASB had issued twelve Implementation Guides, including:

� Guide to Implementation of GASB Statement 3 on Deposit with Financial Institutions, Investments (Including

Repurchase Agreements), and Reverse Repurchase Agreements: Questions and Answers

� Guide to Implementation of GASB Statement 9 on Reporting Cash Flows of Proprietary and Nonexpendable

Trust Funds and Governmental Activities That Use Proprietary Fund Accounting: Questions and Answers

� Guide to Implementation of GASB Statement 10 on Accounting and Financial Reporting for Risk Financing

and Related Insurance Issues: Questions and Answers

� Guide to Implementation of GASB Statement 14 on the Financial Reporting Entity: Questions and Answers

� Guide to Implementation of GASB Statements 25, 26, and 27 on Pension Reporting and Disclosure by State

and Local Government Plans and Employers: Questions and Answers

� Guide to Implementation of GASB Statement 31 on Accounting and Financial Reporting for Certain

Investments and for External Investment Pools: Questions and Answers

� Guide to Implementation of GASB Statement 34 on Basic Financial Statementsand Management's

Discussion and Analysisfor State and Local Governments: Questions and Answers

� Guide to Implementation of Statement 34 and Related Pronouncements: Questions and Answers

� Guide to Implementation of GASB Statement 40 on Deposit and Investment Risk Disclosures: Questions and

Answers

� Guide to Implementation of GASB Statements 43 and 45 on Other Postemployment Benefits: Questions and

Answers

� Guide to Implementation of GASB Statement 44 on the Statistical Section: Questions and Answers

� Guide to Implementation of GASB Statement 53 on Accounting and Financial Reporting for Derivative

Instruments: Questions and Answers


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Guidance in GASB implementation guides is limited to clarifying, explaining, or elaborating on an underlyingstandard. They are classified as category d. in the hierarchy of GAAP.

In May 2003, the GASB began to issue an annual publicationa comprehensive implementation guide. The GASBComprehensive Implementation Guide2009 is a consolidation of all previously issued guides. It not only codifiesthe questions and answers in these guides, but also updates the answers, as appropriate, to recognize the effectsof any new standards issued since the original guides were issued. In addition, some new questions are added andsome are deleted. The 2009 edition of the guide is based on all GASB standards through GASBS No. 56,

Codification of Accounting and Financial Reporting Guidance Contained in the AICPA Statements on Auditing

Standards, GASBI No. 6, Recognition and Measurement of Certain Liabilities and Expenditures in Governmental

Fund Financial Statements, and Technical Bulletin 2008�1, Determining the Annual Required Contribution Adjust�

ment for Postemployment Benefits.

All references to implementation guides in this course are to the GASB Comprehensive Implementation

Guide2009.

Authority of GASB Pronouncements

Original Authority. When the GASB was established, it was agreed that the GASB would establish accounting andfinancial reporting standards for activities and transactions of state and local governmental entities and that theFASB would continue to establish standards for all other entities.

The Council of the AICPA designated the GASB as the body with the authority to establish accounting principles forstate and local governmental entities under Rule 203 of the AICPA Code of Professional Conduct. Rule 203 providesthat an AICPA member may not express an opinion that financial statements conform to GAAP if the statementscontain a departure from an accounting principle promulgated by a body designated by the AICPA Council ashaving authority to establish accounting principles. The Council action gave GASB pronouncements an equivalentstatus to FASB pronouncements; that is, both represented the highest level of authoritative support for governmen�tal accounting principles, and if there was not a GASB pronouncement applicable to particular circumstances of agovernmental entity, relevant FASB pronouncements applied.

The result of this arrangement was that each new FASB pronouncement would apply to governmental entitiesunless the subject matter was covered by a GASB pronouncement or unless the GASB took specific action statingthat the new FASB pronouncement was not applicable to governmental entities (�negative standards�setting"). Forexample, when the FASB issued FASBS No. 87, Employers' Accounting for Pensions, establishing new employerpension accounting standards, the GASB issued GASBS No. 4 prohibiting governmental employers from adoptingFASBS No. 87 because the GASB had its own pension accounting project in progress.

Current Authority and Hierarchy of GAAP for Governmental Entities. In March 2009, the GASB issued State�ment No. 55 (GASB Cod. Sec. 1000), The Hierarchy of Generally Accepted Accounting Principles for State and

Local Governments. GASBS No. 55, which was effective on issuance, establishes the hierarchy of GAAP within theGASB literature. Previously, the hierarchy of GAAP could be found only the auditing literatureSAS No. 69, The

Meaning of Present Fairly in Accordance with Generally Accepted Accounting Principles. Although its presentationis somewhat different (category e�other accounting literature"is presented in a paragraph rather than as acategory), the GASB concluded that the hierarchy's transition from auditing literature to GAAP should be asundisruptive as possible. As a result, GASBS No. 55 leaves the application of GASB, FASB, and other sources ofaccounting guidance for state and local governments unmodified.

Using Similar Guidance and Prohibited Applications of GAAP. When specific guidance in not available in categoriesa through d, GASBS No. 55, paragraph 5, states that governments should consider accounting principles forsimilar transactions or events within those categories and may consider other accounting literature. This should notbe done, however, when a pronouncement prohibits its application to that particular transaction or event orotherwise indicates that accounting treatment should not be applied by analogy. For example, GASBS No. 49,Accounting and Financial Reporting for Pollution Remediation Obligations, prohibits its application to future pollu�tion remediation activities that are required upon retirement of an asset.


32

Other Accounting Literature. GASBS No. 55, paragraph 6, describes what was previously known as GAAP hierar�chy, category e. Other accounting literature should be applied when there is no similar guidance. The GASB�defines" other accounting literature by giving examples, including the following:

� GASB Concepts Statements;

� Pronouncements in categories (a)�(d) of the FASB GAAP hierarchy for nongovernmental entities if notspecifically made applicable to state and local governmental entities by the GASB;

� Financial Accounting Standards Board Concepts Statements;

� Federal Accounting Standards Advisory Board (FASAB) Statements, Interpretations, Technical Bulletins,and Concepts Statements;

� AICPA Issues Papers;

� International Public Sector Accounting Standards of the International Public Sector Accounting StandardsBoard or International Financial Reporting Standards of the International Accounting Standards Board, orpronouncements of other professional associations or regulatory agencies;

� AICPA Technical Information Service Inquiries and Replies as Technical Practice Aids; and

� Accounting textbooks, handbooks, and articles.

The GASB notes that for all of these examples, the appropriateness of using other accounting literature dependson its relevance, the specificity of its guidance, and the authority of the literature's issuer or author. For example,GASBS No. 55 notes that a GASB Concepts Statements would normally have more influence than other sourcesof other accounting literature.

FASB Pronouncements Specifically Made Applicable to State and Local Governments

Before the issuance of GASBS No. 34, NCGA and GASB pronouncements specifically made certain FASB pro�nouncements applicable to state and local governments. For example, NCGAS 5, Accounting and Financial

Reporting Principles for Lease Agreements of State and Local Governments, required governments to adoptFASBS No. 13, Accounting for Leases. Those pronouncements continue to apply to governmental fund reporting,as illustrated in Exhibit 1�1. However, GASBS No. 34, paragraph 17, also requires all FASB pronouncements (andthose of its predecessors) issued before November 30, 1989 that do not conflict with GASB pronouncements to beapplied to governmental activities (and business�type activities) in the government�wide financial statements.Applicable standards are:

� FASB Statements and Interpretations

� Accounting Principles Board (APB) Opinions

� Accounting Research Bulletins (ARBs) of the Committee on Accounting Procedure.

These pronouncements apply as amended at November 30, 1989. That is, as discussed in Question Z.20.1 of theGASB Comprehensive Implementation Guide2009, it does not matter whether the FASB subsequently super�sedes or amends these pronouncements. (Certain GASB standards applicable only to proprietary funds also weremade applicable to governmental activities in the government�wide financial statements.)

As a result of GASBS No. 34, there is a difference in the applicability of FASB pronouncements depending on whichtype of basic financial statements are being prepared. Exhibit 1�1 provides a visual illustration of their applicability.Fortunately, most of the FASB pronouncements made applicable in the government�wide financial statements haveto do with the application of the full accrual basis of accounting, which is not used in governmental fund financialstatements. Accounting differences that arise because of the application of FASB pronouncements must beincluded in the required reconciliation of governmental fund financial statements to the government�wide financialstatements.


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Hierarchy and FASB Accounting Standards Codification. In June 2009, the FASB issued its revised hierarchy ofGAAP in Statement No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted

Accounting Principles. FASB Statement No. 168 replaces the previous four part hierarchy with a single source ofGAAPthe FASB Accounting Standards Codification or, �FASB ASC." As a result, the hierarchy of GAAP fornongovernmental entities consists of only two sourcesauthoritative and nonauthoritative. Nonauthoritative litera�ture is not listed as a category of GAAP, but, rather, is described in a separate paragraph in FASBS No. 168 in thesame way that GASBS No. 55 describes �other accounting literature." (The FASB ASC is effective for periodsending after September 15, 2009. All future pronouncements of the FASB will be issued as amendments to theFASB ASC.

The FASB ASC took all sources of GAAP under the previous hierarchy and merged them into a codification, similarto the GASB Codification, into areas, topics, subtopics, sections, and subsections. Although a tool in the electronicASC can be used to tell where a particular piece of guidance came from in the first ASC, there will no longer bereferences to FASB Statements, APB Opinions, and so forth. Generally, the FASB ASC does not change GAAP.

The GASB is in the process of identifying and codifying all FASB and AICPA sources of GAAP issued beforeNovember 30, 1989, that are likely to be applied by governments. An exposure draft resulting from this project isexpected to be issued early in 2010. Based on discussion with GASB staff, this course continues to refer to FASBpronouncements by their pre�Codification titles and names.

GASBS No. 55 GAAP Hierarchy for State and Local Governments

a. Officially established accounting principlesGASB Statements and Interpretations. GASB Statementsand Interpretations are periodically incorporated in the Codification of Governmental Accounting andFinancial Reporting Standards.

b. GASB Technical Bulletins and, if specifically made applicable to state and local governmental entitiesby the AICPA and cleared by the GASB, AICPA Industry Audit and Accounting Guides, and AICPAStatements of Position. (AICPA documents made applicable to governments should be presumed tohave been cleared by the GASB.)

c. AICPA Practice Bulletins if specifically made applicable to state and local governmental entities andcleared by the GASB, as well as consensus positions of a group of accountants organized by the GASBthat attempts to reach consensus positions on accounting issues applicable to state and localgovernmental entities.

d. Implementation guides (Q&As) published by the GASB staff, as well as practices that are widelyrecognized and prevalent in state and local government.

* * *


34

Exhibit 1�1

FASB Pronouncement Applicability by Financial Statement Typea

Basic Financial Statement Applicable Pronouncements

Governmental fund financialstatements:Balance sheetStatement of revenues, expen�

ditures, and changes infund balances

Pronouncements specifically made applicable by GASB pronouncementsother than GASBS No. 34, paragraph 17, including:

� APBO No. 22, Disclosure of Accounting Policies (GASB Cod. sec.2300.106)

� APBO No. 30, Reporting the Results of OperationsReporting the

Effects of Disposal of a Segment of a Business, and Extraordinary,

Unusual and Infrequently Occurring Events and Transactions

(GASB Cod. sec. 1800.131).� FASBS No. 5, Accounting for Contingencies (loss liabilities outside

the scope of GASBS No. 10) (GASB Cod. sec. C50.150)� FASBS No. 6, Classification of Short�Term Obligations Expected to

Be Refinanced (GASB Cod. sec. B50)� FASBS No. 13, Accounting for Leases, as amended and inter�

preted prior to November 30, 1989, including FASB TechnicalBulletin No. 79�10, Fiscal Funding Clauses in Lease Agreements

(GASB Cod. sec. L20)

Proprietary fund financialstatements:Statement of net assetsStatement of revenues,

expenses, and changes infund net assets

Cash flows statement

FASB Statements and Interpretations, APB Opinions,b and AccountingResearch Bulletins issued on or before November 30, 1989 unless theyconflict with GASB pronouncements.

For enterprise funds only, optional application of FASB Statements andInterpretations issued after November 30, 1989.

Fiduciary fund financial state�ments

See governmental fund financial statements, above.

Government�wide financialstatements:Statement of net assetsStatement of activities

FASB Statements and Interpretations, APB Opinions,b and AccountingResearch Bulletins issued on or before November 30, 1989 unless theyconflict with GASB pronouncements.

For business�type activities only, optional application of FASB Statementsand Interpretations issued after November 30, 1989.

Notes:

a Pronouncements listed in this exhibit do not reflect the FASB Accounting Standards Codification (FASB ASC),which became effective for nongovernmental entities September 15, 2009. The FASB ASC took all sources ofnongovernmental GAAP under the previous hierarchy and merged them into a codification, similar to theGASB Codification. The FASB ASC no longer refers to FASB Statements or APB Opinions. Based ondiscussion with GASB staff, this Guide continues to refer to FASB pronouncements by their pre�Codificationtitles and names because the FASB ASC does not apply to governmental entities. The GASB is in the processof identifying and codifying all FASB and AICPA sources of GAAP issued before November 30, 1989 that arelikely to be applied by governments.

b GASBS No. 34, footnote 13, provides a single exception. Changes in accounting principles, addressed in APBOpinion No. 20, as amended, should be reported as restatements of beginning net assets/fund equity, not as


35

a separately identified cumulative effect in the government�wide statement of activities or proprietary fundstatement of revenues, expenses, and changes in fund net assets.

* * *

Prospective Application of Certain Pronouncements. While proprietary activities were previously subject toFASB pronouncements issued on or before November 30, 1989 as well as GASB standards made applicable onlyto proprietary funds, the effective dates of GASBS No. 34 represented the first time that many of these pronounce�ments were made applicable to governmental activities. Although many of the transactions covered by FASBstatements will rarely, if ever, take place in governmental activities (for example, goodwill recognition), others hadan effect in determining beginning balances for prior transactions in the initial year of adoption of GASBS No. 34.The GASB reviewed the newly applicable GASB and FASB pronouncements and, in an effort to ease the imple�mentation burden, agreed to only require prospective reporting for the following pronouncements to governmentactivities, except as indicated [GASBS No. 34, paragraph 146, as amended by GASBS No. 37, Basic Financial

Statementsand Management's Discussion and Analysisfor State and Local Governments: Omnibus, para�graphs 6 and 7]:

� APBO No. 12, Omnibus Opinion1967; and No. 21, Interest on Receivables and Payables, require deferraland amortization of debt issue premium or discount. Deep�discount (discount of at least 20 percent at timeof issuance) and zero�coupon debt, however, are ineligible for prospective reporting only and should berestated.

� GASBS No. 23, Accounting and Financial Reporting for Refundings of Debt Reported by Proprietary

Activities, requires deferral and amortization of the difference between the reacquisition price and netcarrying amount of old debt in a debt�refunding transaction.

Question 7.102.1 in the GASB Comprehensive Implementation Guide2009 confirms that governmental activitiesmay retroactively report the effects of these pronouncements; however, only prospective treatment is required(except for governmental activity debt that is deep�discount or zero�coupon debt).

AICPA Pronouncements Specifically Made Applicable to State and Local Governments

As noted in Exhibit 1�1, AICPA Industry Audit and Accounting Guides and AICPA Statements of Position (SOPs)specifically made applicable to state and local governments and cleared by the GASB are included in the level �b"of the hierarchy of GAAP. Principal among these is SLG. Accounting guidance provided in SLG is discussedthroughout this Guide. In addition to SLG, the GASB has also made applicable these guides and SOPs:

� Audit and Accounting Guide, Audits of Property and Liability Insurance Companies. (For public entity riskpools.)

� Auditing and Accounting Guide, Health Care Organizations.

� SOP 98�2, Accounting for Costs of Activities of Not�for�Profit and State and Local Governmental Entities That

Include Fund Raising.

The Hierarchy of GAAP for Business�type (Proprietary) Activities of Governmental Entities

The hierarchy of GAAP shown in Exhibit 1�2 applies equally to governmental� and business�type activities. A keydifference, however, is the extent to which GASB pronouncements have made FASB pronouncements applicableto business�type activities. GASBS No. 20, paragraph 6, as amended by GASBS No. 34, requires that proprietaryactivities apply all applicable GASB pronouncements as well as any FASB Statements and Interpretations, APBOpinions, and ARBs issued on or before November 30, 1989, that do not conflict with or contradict GASBpronouncements. FASBS No. 102, Regulated EnterprisesAccounting for the Discontinuation of Application of

FASB Statement No. 71, and FASB Interpretation No. 38, Determining the Measurement Date for Stock Option,

Purchase, and Award Plans Involving Junior Stock, are the last pronouncements issued by the FASB on or beforethat date.


36

In addition to this requirement, GASBS No. 20, paragraph 7, as amended by GASBS No. 29, paragraph 7, andGASBS No. 34, paragraph 17, permits enterprise funds and business activities to also apply all FASB Statementsand Interpretations issued after November 30, 1989, that do not conflict with or contradict GASB pronouncementsso long as they are developed for business enterprises. This course does not cover FASB pronouncements issuedafter November 30, 1989, because those pronouncements apply only to the limited number of business�typeactivities (generally public power utilities) that have elected to follow new FASB pronouncements. Informationabout such FASB pronouncements generally can be found in PPC's Guide to Preparing Financial Statements. (InAugust 2009, the GASB tentatively agreed to eliminate the option provided by GASBS No. 20, paragraph 7.

GASBS No. 29, paragraph 7, amended GASBS No. 20 to require that only those FASB pronouncements issuedafter November 30, 1989 that are developed for business enterprises should apply. This provision has the effect ofexcluding these pronouncements:

� FASBS No. 116, Accounting for Contributions Received and Contributions Made.

� FASBS No. 117, Financial Statements of Not�for�Profit Organizations.

� FASBS No. 124, Accounting for Certain Investments Held by Not�for�Profit Organizations.

� FASBS No. 136, Transfers of Assets to a Not�for�Profit Organization or Charitable Trust That Raises or Holds

Contributions for Others.

� FASBS No. 164, Not�for�Profit Entities: Merges and Acquisitions.

Enterprise funds and business�type activities may not choose which FASB pronouncements they wish to apply.Under GASBS No. 20, paragraph 7 (as amended), they must either apply all FASB pronouncements issued afterNovember 30, 1989 (unless they conflict with or contradict GASB pronouncements), or apply none of them. GASBSNo. 20 encourages consistent application of pronouncements to all proprietary activities within the financialreporting entity, including component units.

AICPA Pronouncements. GASBS No. 20, BFC paragraph 33, notes that the same logic that makes new FASBpronouncements applicable to business�type activities should be applied to AICPA Guides and SOPs not specifi�cally made applicable to state and local governments. Information about SOPs issued after November 30, 1989generally can be found in PPC's Guide to Preparing Financial Statements. The GASB website lists these AICPApronouncements that may be of particular interest:

� Audit and Accounting Guides, Depository and Lending Institutions: Banks and Savings Institutions, Credit

Unions, Finance Companies and Mortgage Companies

� SOP 93�7, Reporting on Advertising Costs

� SOP 94�6, Disclosure of Certain Risks and Uncertainties (This SOP does not apply to business�typeactivities to the extent that disclosures are required by GASBS No. 10, Accounting and Financial Reporting

for Risk Financing and Related Insurance Issues, and GASBS No. 49, Accounting and Financial Reporting

for Pollution Remediation Obligations.)

� SOP 97�1, Accounting by Participating Mortgage Loan Borrowers

� SOP 97�3, Accounting by Insurance and Other Enterprises for Insurance�Related Assessments

� SOP 98�5, Reporting on the Costs of Start�Up Activities.

Conflicts between GAAP and Legal Accounting Requirements

GAAP, as it is applied to governmental entities, gives recognition to the many and varied finance�related legal andcontractual requirements inherent in the governmental environment. For instance, the fund structure, bases ofaccounting, and presentation of budgetary comparisons reflect consideration of legal requirements. Also, GAAP


37

requires disclosure of material violations of legal or contractual provisions. Nevertheless, as stated in GASB Cod.sec. 1200.101, adherence to GAAP should assure that governmental financial statements are uniform with respectto fund types and measurement and classification criteria, regardless of differing legal requirements and customs.

However, there may be conflicts between GAAP and legal requirements. For example, statutes or other legal orcontractual provisions may require establishment of specific funds to account for particular transactions whereGAAP would require use of another fund, or they may require use of the cash basis of accounting for situationswhere GAAP would require the accrual basis. GASB Cod. sec. 1200.108 observes that such differences often resultbecause �constitutional, charter, or other legal provisions governing fiscal operations are antiquated and difficult tochange."

The GASB has authority to establish GAAP but it does not have authority over laws and contractual provisions.Thus, GASB Cod. sec. 1200.110 states that when GAAP and legal or contractual provisions related to accountingrecords conflict, accounting systems should be maintained on the legally required basis but should includeenough supplemental information and records so that GAAP financial statements can be prepared.

In some cases, GAAP itself may require that a financial statement be presented on a legally required basis thatdiffers from GAAP; however, presentation of a reconciliation to the GAAP basis would also be required. Forexample, many governments have budgetary bases of accounting that are different from the modified accrual basisof accounting required in the governmental fund financial statements. When this is the case, GAAP requiresgovernments to include a reconciliation showing the differences from the GAAP basis in their required budgetarycomparisons.

Finally, if the GAAP financial statements do not demonstrate compliance with finance�related legal and contractualprovisions, the financial report should include additional schedules and explanations to demonstrate necessarycompliance.


38


39

SELF�STUDY QUIZ


14. What type of measurement of Service Efforts and Accomplishments Reporting (SEA) results from the servicesprovided by the government entity, such as percentage of lane�miles of road in excellent, good, or faircondition?

a. Outputs.

b. Outcomes.

c. Efficiency.

d. Financial.

15. Who oversees the Governmental Accounting Standards Board (GASB)?

a. Financial Accounting Foundation (FAF) Board of Trustees.

b. Financial Accounting Standards Board (FASB).

c. National Council on Governmental Accounting (NCGA).

16. Which of the following statements is correct concerning the requirements of GASBS No. 20, Accounting and

Financial Reporting for Proprietary Funds and Other Governmental Entities That Use Proprietary Fund

Accounting?

a. Paragraph 6 requires governmental activities to apply GASB pronouncements as well as any FASBStatements and Interpretations, APB Opinions, and ARBs issued on or before November 30, 1989, thatdo not conflict with GASB pronouncements.

b. Paragraph 7, as amended by GABS No. 29 and 34, disallows enterprise funds and business activities fromapplying the FASB Statements and Interpretations issued after November 30, 1989.

c. Paragraph 7 (as amended) reads that enterprise funds and business�type activities may choose whichFASB pronouncements they wish to apply.


40



14. What type of measurement of Service Efforts and Accomplishments Reporting (SEA) results from the servicesprovided by the government entity, such as percentage of lane�miles of road in excellent, good, or faircondition? (Page 28)

a. Outputs. [This answer is incorrect. Outputs measure quantity and how much of that met the standardquality. An example of output measurement is the number of illiterate students who completed theafter�school literacy program.]

b. Outcomes. [This answer is correct. Outcomes measure results from the services provided. Anexample of outcome measurement is percentage of illiterate students in the after�school literacyprogram who passed the literacy test last year.]

c. Efficiency. [This answer is incorrect. The cost of resources used per unit of output is the efficiencymeasurement. An example of efficiency measurement is the cost per illiterate student in the after�schoolliteracy program.]

d. Financial. [This answer is incorrect. The expenditures in providing a service is the financial measurement.An example of financial measurement is total cost of putting on the after�school literacy program last year.]

15. Who oversees the Governmental Accounting Standards Board (GASB)? (Page 29)

a. Financial Accounting Foundation (FAF) Board of Trustees. [This answer is correct. The FAF providesfunding and nominates board members for the GASB. They have oversight of the GASB and theFASB. In February 2008, the FAF agreed to several changes, including securing a stable andpermanent funding source for the GASB.]

b. Financial Accounting Standards Board (FASB). [This answer is incorrect. The FASB has jurisdiction overstandards for nongovernmental organizations. The Council of the AICPA gave the GASB pronouncementsan equivalent status to FASB pronouncements, however if there is not a GASB pronouncement applicableto the situation, the relevant FASB pronouncements would apply.]

c. National Council on Governmental Accounting (NCGA) [This answer is incorrect. The NCGA was replacedby the GASB in 1984. The GASB`s first authoritative pronouncement recognized the Statements andinterpretations that had been issued by the NCGA when it was the authoritative body.]

16. Which of the following statements is correct concerning the requirements of GASBS No. 20, Accounting and

Financial Reporting for Proprietary Funds and Other Governmental Entities That Use Proprietary Fund

Accounting? (Page 35)

a. Paragraph 6 requires governmental activities to apply GASB pronouncements as well as any FASBStatements and Interpretations, APB Opinions, and ARBs issued on or before November 30, 1989, thatdo not conflict with GASB pronouncements. [This answer is incorrect. The statement is true for proprietaryactivities as opposed to governmental.]

b. Enterprise funds and business activities are allowed by paragraph 7 of GASBS No. 20 to apply theFASB Statements and Interpretations that were issued after November 30, 1989. [This answer iscorrect. GASBS No. 20, paragraph 7, as amended by GASBS No. 29, paragraph 7, and GASBS No.34, paragraph 17, permits enterprise funds and business activities to also apply all FASB Statementsand Interpretations issued after November 30, 1989, that do not conflict with or contradict FASBpronouncements so long as they are developed for business enterprises.]

c. Paragraph 7 (as amended) reads that enterprise funds and business�type activities may choose whichFASB pronouncements they wish to apply. [This answer is incorrect. They may not pick and choose whichones they wish to apply. They must apply all or none of them.]


41

THE GASBS NO. 34 REPORTING MODEL

This following discussion is intended to provide an overview of the governmental financial reporting model estab�lished by GASBS No. 34, including its format, objectives, scope, and required reporting.

Objective of Statement

The objective of GASBS No. 34, as stated in paragraph 1, is to �enhance the understandability and usefulness ofthe general purpose external financial reports of state and local governments" for the following primary usergroups:

� CitizenryThose to whom the government is primarily accountable, including intermediaries such as themedia, advocacy groups, and public finance researchers.

� Legislative and Oversight BodiesThose who directly represent the citizens, including governing boardsand agencies that make oversight decisions.

� Investors and CreditorsThose who lend or participate in the lending process.

Although the Statement cannot be expected to meet all information needs of all users, the Board believes theinformation needs of the primary user groups are equally important and that the Statement meets those needs byproviding relevant, reliable, and understandable financial information.

Issuance of GASBS No. 34 is one part of an ongoing effort by the Board to improve financial reporting bygovernments to better meet the accountability (both fiscal and operational) and other objectives in GASBC No. 1.GASBS No. 34, paragraph 2, indicates that the new reporting model will result in greater accountability by providingmore useful information to a wider range of users, including the following:

� Comparing actual financial results with the legal budget.

� Assessing financial condition and results of operations.

� Assisting in determining compliance with finance�related laws, rules, and regulations.

� Assisting in evaluating efficiency and effectiveness.

Scope and Applicability of Statement

General Purpose and Special�purpose Governments. GASBS No. 34 establishes accounting and financialreporting standards for general purpose external financial reporting by all state and local governmental entities,including component units as determined by GASBS No. 14. Question 7.2.1 in the GASB Comprehensive Imple�

mentation Guide2009 details the following list of governments subject to the statement:

� General purpose governments (states, cities, counties, towns, and villages).

� Public school districts.

� Public benefit corporations and authorities.

� Public employee retirement systems.

� Public utilities.

� Public hospitals and other health care providers.

� Public colleges and universities.

The above list of governments includes both general purpose and special�purpose governments.


42

Colleges and Universities. Originally, public colleges and universities were excluded from the scope of GASBSNo. 34. However, GASBS No. 35, Basic Financial Statementsand Management's Discussion and Analysisfor

Public Colleges and Universities, removed that exclusion and requires public colleges and universities to follow thespecial�purpose government provisions of GASBS No. 34. Although most of the Statement is written from theperspective of general purpose governments, the requirements for special�purpose governments are detailed inparagraphs 134�141.

Exclusions. GASBS No. 34 does not address the reporting requirements for the following:

� Federal government or its agencies.

� Other comprehensive bases of accounting (OCBOA), such as the cash basis or the regulatory basis ofaccounting.

� Comprehensive annual financial report (CAFR).

� Reports about individual funds.

While changes in the financial reporting model affect the financial section of a CAFR, GASBS No. 34 does notaddress the entire CAFR (for example, the statistical section or even the entire financial section). GASB StatementNo. 44, Economic Condition Reporting: The Statistical Section, establishes requirements for governments thatchoose to present a statistical section with their basic financial statements.

Minimum Reporting Requirements

GASBS No. 34, paragraph 7, requires general purpose governments to present the following basic financialstatements and RSI in order for the financial statements to be in accordance with GAAP:

� Management's discussion and analysis (MD&A).

� Government�wide financial statements.

� Fund financial statements.

� Notes to the financial statements.

� Required supplementary information (RSI), including budgetary comparison schedules, infrastructurecondition data, and other data required by previous GASB pronouncements, if applicable.

The MD&A and RSI, though not part of the basic financial statements, are required for general purpose govern�ments. Exhibit 1�2 illustrates this information graphically.

Question 7.3.3 of the GASB Comprehensive Implementation Guide2009 indicates that the exclusion of any pieceof the information presented in Exhibit 1�2 results in an incomplete presentation of the external reporting require�ments for a general purpose government. Special�purpose governments, however, are allowed to omit the govern�ment�wide financial statements or combine the government�wide and fund financial statements in certaincircumstances.


43

Exhibit 1�2

Minimum Financial Reporting Requirements

Information Type

RSI

Basic Financial Statements

Basic Financial Statements

Required Financial Information

Management's Discussion and Analysis

Government�wideFinancial Statements

Fund FinancialStatements

Notes to the Financial Statements

RSI RSI (other than MD&A)

* * *

Management's Discussion and Analysis

MD&A is a narrative report prepared in an easy�to�read format by the government's financial manager. It should:

� Introduce the basic financial statements, and

� Provide an analytical overview of the government's financial activities for the year based on the financialmanager's knowledge of the transactions, events, and conditions reflected in the financial report and thefiscal policies that control the government's operations. Use of charts, tables, and graphs is encouraged.

Scope. The narrative should be based on information that management has as of the date of the auditor's report.The focus of the MD&A should be on the primary government, and the analysis should distinguish betweeninformation that pertains to the primary government and that of its component units.

RSI. The MD&A must be presented as RSI before the basic financial statements. This helps assure that theinformation is presented and that auditors are associated with it at a reasonable cost. Under auditing standards,auditors are required to apply certain limited procedures to RSI even though it is not part of the basic financialstatements. Explanatory paragraphs are required in the auditor's report if the information is presented but departsmaterially from the prescribed guidelines or if the information is omitted. Most RSI follows the notes to the financialstatements, but an exception was made for the MD&A. Some believe that users may have bogged down in readingthe financial statements and would not have made it to the more reader�friendly MD&A if it followed the financialstatements. Its placement should improve its chances of being read.

Required Components. GASBS No. 34 was amended by GASBS No. 37 to make it clear that while the followingeight components of MD&A are stated in general rather than specific terms, the information in MD&A must beconfined to the following:

� A brief discussion of the relationships of the basic financial statements to each other and the majordifferences in the information provided in each.


44

� A comparison in condensed form of information presented in the government�wide financial statementsfor the current and prior year.

� An analysis of the government's overall financial position and results of operations to help users determinewhether financial position has improved or deteriorated due to current�year activities.

� An analysis of significant changes that occurred in individual funds and any limitations that might affect theavailability of fund resources in the future.

� An analysis of significant budget variances (original versus final budget and final budget versus actualresults) for the general fund or its equivalent, including reasons for those variances that may affect futureservices or liquidity.

� A summary of significant capital asset and long�term debt activity with a discussion of commitments andlimitations that may affect future financing of planned facilities or services.

� A discussion of infrastructure assets (if the government has elected not to depreciate such assets).

� A description of facts, conditions, or decisions of which management was aware on or before the auditreport date that is expected to have a significant effect on financial position or results of operations afterthe reporting date.

Relationship of MD&A to Transmittal Letter. GASBS No. 34 encourages governments that present a transmittalletter in a CAFR not to duplicate information contained in MD&A. The transmittal letter may focus more oninformation that is more subjective (such as prospective information) or elaborate on information in the MD&A.

Government�wide Financial Statements

The first group of basic financial statements required by GASBS No. 34 is the government�wide financial state�ments. These statements are comprised of a statement of net assets and a statement of activities. The government�wide financial statements must be prepared using the economic resources measurement focus and the full accrualbasis of accounting. The statements should use a columnar presentation that separately reports governmentalactivities, business�type activities, and component units. A total column should be presented for the primarygovernment. A total column may be presented for the entity as a whole but is not required.

Key elements of the government�wide financial statements include:

� The statement of net assets and statement of activities focus on the government �taken as a whole" ratherthan on fund types. (In addition to the net asset format, the traditional balance sheet format is alsopermissible.)

� The statement of net assets reports all capital assets, including general capital and general infrastructureassets, and the statement of activities reports depreciation expense on those assets. However,governments can avoid depreciating infrastructure by (a) using an asset management system withprescribed characteristics and (b) documenting that the assets are being preserved at an established anddisclosed condition level. (Governments using this exceptioncalled the �modified approach"mustmake certain infrastructure disclosures as RSI.)

� The statement of net assets reports all long�term liabilities, including general long�term debt. As notedabove, separate columns distinguish governmental long�term liabilities from liabilities associated withbusiness�type activities.

� Net assets are classified in the three categories: (a) invested in capital assets, net of related debt; (b)restricted; and (c) unrestricted. Capital contributions to both governmental and business�type activities arereported as revenues.

� The statement of activities measures �net (expense) revenue" for each of the government's functions andreports revenues by program, with general revenues (such as taxes) reported separately. The level of detail


45

of the government�wide statements must be at a minimum by function for activities accounted for ingovernmental funds, the same minimum required in the fund financial statements. Activities accounted forin enterprise funds should be presented at a minimum by different identifiable activities in the statementof activities.

� Special and extraordinary items must be segregated from other revenues and expenses. (Extraordinaryitems must be both unusual and infrequent. Special items are significant transactions within management'scontrol that are unusual or infrequent.)

� Fiduciary activities are excluded from the government�wide statements because those resources are notavailable to finance the government's programs.

� Most interfund balances and activities must be reclassified and eliminated in the total primary governmentcolumn.

Because governmental funds continue to be reported in the fund financial statements on the modified accrual basisof accounting, many governments are expected to only record the accruals as adjusting entries when preparing thegovernment�wide financial statements. Those adjustments change the results of operations for governmentalactivities and could significantly decrease net assets when including such items as compensated absences andother long�term operating liabilities as expenses. However, adjustments for currently deferred receivables orrevenues and capital assets will result in an increase in net assets.

Fund Financial Statements

Funds used by governments fall into three broad categoriesgovernmental, proprietary, and fiduciary. Exhibit 1�3lists the fund types used under GASBS No. 34.

Exhibit 1�3

Fund Financial Statement Information

Fund Categories Governmental Proprietary Fiduciary

Fund Types General FundSpecial Revenue FundsCapital Projects FundsDebt Service FundsPermanent Funds

Enterprise FundsInternal Service Funds

Pension (and otheremployee benefit) TrustFunds

Investment Trust FundsPrivate�purpose Trust

FundsAgency Funds

MeasurementFocus/Basis ofAccounting

Current FinancialResources/ModifiedAccrual

Economic Resources/Full Accrual

Economic Resources/FullAccrual

RequiredFinancialStatements

Balance SheetStatement of Revenues,

Expenditures, andChanges in FundBalances

Statement of Net Assetsor Balance Sheet

Statement of Revenues,Expenses, andChanges in Fund NetAssets or Fund Equity

Statement of Cash Flows

Statement of Fiduciary NetAssets

Statement of Changes inFiduciary Net Assets

* * *


46

Separate fund financial statements are presented for each fund category with the reporting emphasis on individualmajor funds. Exhibit 1�3 lists the required financial statements, measurement focus, and basis of accounting foreach fund category. Key elements of the fund financial statements include:

� Separate columns are required for the general fund and other major governmental and enterprise funds.Major funds are those whose revenues, expenditures/expenses, assets, or liabilities are at least 10 percentof corresponding totals for all governmental or all enterprise funds and for which the same element is atleast 5 percent of the combined totals of the governmental and enterprise funds. In addition, any other fundthat government officials believe has importance to financial statement users may be reported as a majorfund. Nonmajor funds are reported in the aggregate in a separate column. Major fund reporting does notapply to internal service funds or fiduciary funds. Proprietary fund statements should report internal servicefunds in the aggregate in a separate column. Fiduciary fund statements continue to report by fund type.

� A summary reconciliation to the government�wide financial statements, is required to be presented at thebottom of the governmental fund financial statements or in an accompanying schedule. This is necessarybecause different measurement focuses are used in the statements. Common reconciling items includecapital assets and long�term liabilities.

� Governmental fund balances are classified as reserved or unreserved and proprietary fund net assets asinvested in capital assets, net of related debt; restricted; and unrestricted. (GASBS No. 54, Fund Balance

Reporting and Governmental Fund Type Definitions, replaces these components of governmental fundbalances with five new classifications, effective for periods beginning after June 15, 2010.)

� Capital contributions to proprietary funds are reported as revenues.

� Cash flow reporting for proprietary funds must be based on the direct method.

Notes to the Financial Statements

GASBS No. 34 indicates the notes to the financial statements should focus on the primary government (that is, thegovernmental activities, business�type activities, major funds, and nonmajor funds in the aggregate). In addition,the Statement addresses specific disclosures that include the following:

� A summary of significant accounting policies based on the requirements of the Statement.

� Information about capital assets and long�term liabilities (including separate disclosure of capital assetsnot being depreciated).

� Information about donor�restricted endowments.

� Segment information for enterprise funds.

The guidance on note disclosures in GASBS No. 34 is limited to those areas directly affected by the Statement.Subsequent to the issuance of GASBS No. 34, the GASB finished its note disclosure project resulting in theissuance of GASBS No. 38, Certain Financial Statement Note Disclosures.

Required Supplementary Information (RSI)

GASBS No. 34 generally requires RSI, other than MD&A, to be presented immediately after the notes to thefinancial statements. In addition to MD&A, RSI includes the following:

� Supplementary information required under GASBS Nos. 10, 25, 27, 43, and 45.

� Budgetary comparison schedules for the general fund and each major special revenue fund with a legallyadopted budget (unless the government elects to include the required information in a budgetarycomparison statement as part of the basic financial statements rather than as RSI). GASBS No. 41,Budgetary Comparison SchedulesPerspective Differences, provides guidance for governments with


47

budgetary structures (for example, certain program�based budgets) that prevent them from presentingbudgetary comparison information.

� Schedules and accompanying disclosures of certain infrastructure assets (only if a government elects notto depreciate these assets by using the modified approach).

GASBS No. 34 requires that the original and final budgets reported in the budgetary comparison schedule. Thoughencouraged, a column with variance calculations between actual and either budget amounts is not required.


48


49

SELF�STUDY QUIZ


17. What financial information though not included as part of the basic financial statements, are required by GAAPfor general purpose governments by GASBS No. 34, paragraph 7?

a. Notes to the financial statements.

b. Fund financial statements.

c. Required supplementary information (RSI).

d. Government�wide financial statements.

18. Government�wide financial statements are the first group of basic financial statements required by GASBS No.34. What is one of the key elements of these financial statements?

a. The statement of activities should be reported by fund type.

b. Reclassify and eliminate interfund balances for the total primary government column.

c. Capital contributions to governmental activities should not be reported as revenue.

d. Include all fiduciary activities in the statement of activities.

19. Each fund category should have separate fund financial statements with the reporting emphasis on individualmajor funds. What is one of the key elements of these fund financial statements?

a. All funds are required to be reported in separate columns.

b. Proprietary fund balances are classified as reserved or unreserved.

c. Cash flow should be reported on the indirect method for proprietary funds.

d. A summary reconciliation is required to be presented.


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17. What financial information, though not included as part of the basic financial statements, is required by GAAPfor general purpose governments by GASBS No. 34, paragraph 7? (Page 42)

a. Notes to the financial statements. [This answer is incorrect. These are required and part of the basicfinancial statements required by GASBS No. 34, paragraph 7, and if excluded would result in an incompletepresentation of the external reporting requirements for a general purpose government.]

b. Fund financial statements. [This answer is incorrect. Fund financial statements are required and a part ofthe basic financial statements stated in GASBS No. 34, paragraph 7; however, special�purposegovernments are allowed to combine these with the government�wide financials in certain circumstances.]

c. Required supplementary information (RSI). [This answer is correct. Neither management'sdiscussion and analysis (MD&A) or RSI are part of the basic financial statement package requiredby GASBS No. 34; however, they are required by GAAP for a complete presentation for a generalpurpose government.]

d. Government�wide financial statements. [This answer is incorrect. These are part of the basic financialstatements required by GASBS No. 34 for general purpose governments; however, they may be omittedby special�purpose governments in certain circumstances.]

18. Government�wide financial statements are the first group of basic financial statements required by GASBS No.34. What is one of the key elements of these financial statements? (Page 44)

a. The statement of activities should be reported by fund type. [This answer is incorrect. The focus on boththe statement of net assets and the statement of activities should be on the government �taken as a whole"rather than on fund types.]

b. Reclassify and eliminate interfund balances for the total primary government column. [This answeris correct. The statements should be prepared with columns separately reporting governmentalactivities, business�type activities, and component units with a total column presented for theprimary government as required by GASBS No. 34. Reclassification and elimination of most of theinterfund balances and activities is necessary for the total primary government column.]

c. Capital contributions to governmental activities should not be reported as revenue. [This answer isincorrect. Capital contributions to both governmental and business�type activities should be reported asrevenues as stated in GASBS No. 34.]

d. Include all fiduciary activities in the statement of activities. [This answer is incorrect. Because the resourcesfrom fiduciary activities are not available to finance the government's programs, those activities must beexcluded from the government�wide statements.]

19. Each fund category should have separate fund financial statements with the reporting emphasis on individualmajor funds. What is one of the key elements of these fund financial statements? (Page 46)

a. All funds are required to be reported in separate columns. [This answer is incorrect. Separate columns arerequired for only the general fund and other major governmental and enterprise funds. Major funds arethose whose revenues, expenditures, assets or liabilities are at least 10% of corresponding totals for allgovernmental or all enterprise funds and for which the same element is at least 5% of the combined totalsof the governmental and enterprise funds.]

b. Proprietary fund balances are classified as reserved or unreserved. [This answer is incorrect. This is trueof governmental funds and a requirement of GASBS No. 34.]


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c. Cash flow should be reported on the indirect method for proprietary funds. [This answer is incorrect. Cashflow reporting for proprietary funds must be based on the direct method.]

d. A summary reconciliation is required to be presented. [This answer is correct. The summaryreconciliation should be presented at the bottom of the governmental fund financial statements orin an accompanying schedule as required by GASBS No. 34. Capital assets and long�term liabilitiesare common reconciling items.]


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EFFECTIVE DATES FOR GASBS NOS. 34, 43, 45, AND 51

Due to the significance of the implementation effort required of most governments to implement the provisions ofGASBS No. 34, the GASB divided the implementation process into two categories, each with three�year phased�ineffective dates based on the government's total annual revenues (size). The first category is implementation of thegeneral provisions of the Statement, including the prospective reporting of general infrastructure assets. Thesecond category is the retroactive reporting of major general infrastructure assets. Within each of these twocategories, the GASB established three phases delineating three sizes of governments and defined them based on1999 revenues. Exhibit 1�4 shows these categories and phases. The GASB adopted the same phases for itsstandards on other postemployment benefits (OPEB) reporting for employers and OPEB plans. The GASB alsoadopted the same phases for retroactive capitalization of intangible assets upon implementation of GASB State�ment No. 51, Accounting and Financial Reporting for Intangible Assets.

Exhibit 1�4

GASBS No. 34 Phases and Effective Dates

General StatementProvisions

Retroactive GeneralInfrastructure Reporting

Phase Total Annual Revenues (Fiscal periods beginning after June 15)

1 $100 million or more 2001 2005

2 $10 million to less than $100 million 2002 2006

3 Less than $10 million 2003 Reporting is optional

* * *

Total Annual Revenues

The phased�in effective dates, as discussed in GASBS No. 34, paragraphs 143 and 470, are based on thegovernment's total annual revenues for its first fiscal year ending after June 15, 1999. The first fiscal year is used asthe determination date even if revenues increase (or decrease) for the second or later fiscal years ending after June15, 1999. This one�time determination is the basis for determining the effective dates of both the general GASBSNo. 34 provisions and the retroactive general infrastructure reporting provisions. Total annual revenues for thispurpose include all revenues of the primary government's governmental and enterprise funds (including blendedcomponent units), except for other financing sources, transfers in, and extraordinary items. It does not includerevenues of internal service funds, fiduciary funds, or discretely presented component units. Special�purposegovernments engaged only in fiduciary activities should use additions rather than revenues in determining theirrequired effective date.

Previous editions of the GASB Comprehensive Implementation Guide clarified that the definition of revenues is thatused in the pre�GASB 34 reporting model. For example, although capital contributions to an enterprise fund andtransfers to the primary government from a component unit are considered revenues under GASBS No. 34, theywere not revenues under the previous reporting model and should not be included in determining total revenues forthe government. The modified accrual (GAAP) basis, rather than budgetary basis, should be used to determinegovernmental fund revenues.

Non�GAAP Financial Statements. Some governments may have presented non�GAAP financial statements intheir first fiscal year ending after June 15, 1999. For example, some governments may have prepared primary�gov�ernment�only financial statements, excluding component units that would have been required to be included basedon the requirements of GASBS No. 14, The Financial Reporting Entity. Other governments may have been pre�sented cash or modified cash basis statements. To determine the appropriate implementation phase, these


53

governments need to estimate the effect of these non�GAAP presentations. For example, estimated total annualrevenues for blended component units will need to be added to amounts reported in primary�government�onlyfinancial statements. However, preparers should keep in mind the broad range of dollar amounts in each of thethree phases. For example, it is unlikely that a city that reports total annual revenues of $15 million in its primary�government�only financial statements will become a Phase 1 government (total annual revenues of $100 million ormore) by adding the total annual revenues of its blended component units. Similarly, absent a significant (nonextra�ordinary) one�time transaction, it is unlikely that a change from the cash basis to the accrual basis will cause asignificant change in total annual revenues because both methods include 12 month's worth of revenues.

Broader Application of GASB Phases

Although all of the effective dates of GASBS No. 34 have passed, the GASB has continued to use the same phasesdefined for purposes of GASBS No. 34 to establish effective dates for other pronouncements. For example, asdiscussed in GASB Statement No. 45, Accounting and Financial Reporting by Employers for Postemployment

Benefits Other Than Pensions, issued in June 2004 is also effective in three phases. Governments are required toimplement GASBS No. 45 in the same phase as used in implementing GASBS No. 34 (e.g., a Phase 1 governmentfor implementing GASBS No. 34 would be a Phase 1 government for implementing GASBS No. 45). Postemploy�ment benefit plans other than pension plans must adopt the provisions of GASBS No. 43, Financial Reporting for

Postemployment Plans Other Than Pension Plans, a year earlier than the effective dates established for employers.Component units are required to implement GASBS No. 45 at the same time as their primary government.

GASBS No. 51, Accounting and Financial Reporting for Intangible Assets, issued in June 2007, also relies on theGASBS No. 34 Phases to establish transition requirements for intangible assets. Governments of all sizes areexempt from retroactively reporting intangible assets that have indefinite lives or that would be considered internallygenerated under GASBS No. 51, paragraph 7. Phase 1 and phase 2 governments are required to report all otherintangible assets retroactively. If determining the actual historical cost of these intangible assets is not practical dueto the lack of sufficient records, phase 1 and 2 governments are required to report the estimated historical cost forthese intangible assets that were acquired in fiscal years ending after June 30, 1980. Phase 3 governments are notrequired to retroactively report any intangible assets within the scope of GASBS No. 51.

Illustration

Exhibit 1�5 illustrates excerpts from a government's financial statements for the year ended June�30, 1999 (thedetermination period). In this example, total revenues for the determination period are $39 million. Based on Exhibit1�5, this government is considered a phase 2 government and was required to implement the general provisions ofGASBS No. 34 for its fiscal year ending June 30, 2003, and the retroactive major general infrastructure reportingprovisions will be required to be implemented for the year ending June 30, 2007. As an employer, this governmentwould be required to adopt the OPEB provisions of GASBS No. 45 for its financial statements for periods beginningafter December 15, 2007.

Note that other financing sources and transfers�in as well as revenues from fiduciary funds, internal service funds,and discretely presented component units are excluded from the determination period revenues.


54

Exhibit 1�5

Total Annual Revenues Illustration(Dollars in Thousands)

Governmental Fund TypesFiduciaryFund Type

TotalPrimary

Government

TotalReporting

Entity

GeneralCapitalProjects

ExpendableTrust (Memo Only)

ComponentUnits (Memo Only)

Revenues $ 18,000 $ 7,000 $ 1,000 $ 26,000 $ 2,000 $ 28,000Other Financing

Sources � 20,000 500 20,500 500 21,000

Proprietary Fund TypesFiduciaryFund Type

TotalPrimary

Government

TotalReporting

Entity

EnterpriseInternalService

NonexpendableTrust (Memo Only)

ComponentUnits (Memo Only)

Revenues $ 12,000 $ 3,000 $ 500 $ 15,500 $ 3,000 $ 18,500Nonoperating

Revenues 2,000 � 500 2,500 1,000 3,500Transfers in 500 � � 500 � 500Extraordinary

Gains 1,000 � � 1,000 � 1,000

Total Revenues Calculation:

Total primary government revenues from the combined statement of revenues, expenditures andchanges in fund balances $ 26,000

Less fiduciary revenues (1,000 )Total primary government governmental fund type revenues 25,000Plus enterprise revenues ($12,000 operating and $2,000 nonoperating) 14,000

Total revenues for the determination period $ 39,000

* * *

GASBS No. 34/43/45/51 Phases and Component Units

GASBS No. 34, paragraph 142, indicates that all component units should implement the statement at the sametime as their primary government, regardless of their total revenues. GASBS No. 45 anticipated the issue of OPEBreporting by component units. Paragraph 36 states that all component units must adopt OPEB recognition andreporting requirements no later than the same year as their primary government.

The simultaneous adoption requirement also applied to component units whose year�ends precede their primarygovernment's required implementation date but are included in the same financial statements in accordance withGASBS No. 14. For example, a phase 3 component unit with a December 31, 20X2 year�end would normally haveimplemented the statement for its December 31, 20X4 year�end. However, its phase 2 primary government wasrequired to implement GASBS No. 34 for its June 30, 20X3 year�end. Because the component unit's December 31,20X2 financial statements were required by GASBS No. 14 to be included in the primary government's June 30,20X3 financial statements, the component unit had to implement GASBS No.�34 before its primary government's


55

year end. It is believed that similar requirements should be applied to a component unit's adoption of GASBS No.45.

The reference to the GASBS No. 34 effective dates in GASBS No. 51 does not affect the initial application of the newstandard for intangible assets. It affects only the retroactive application of the standard. Nevertheless, the sameconcepts discussed above for application to component units applies. Component units of phase 3 governmentsare not required to retroactively report intangible assets.

FINANCIAL STATEMENT MATERIALITY UNDER GASBS NO. 34

Determining MaterialityTHE BASICS

� The AICPA, not GASB, is responsible for establishing the methods of determining materiality.

� SLG requires that separate materiality determinations be made for each opinion unit, not forthe entity as a whole.

Background

The methodology for determining materiality for GASBS No. 34 financial statements has been a controversialquestion since GASBS No. 34 was issued. The GASB Comprehensive Implementation Guide2009 addressescertain materiality issues. More importantly, materiality is also addressed in the SLG. SLG provides that the basicmateriality determination for planning, performing, evaluating, and reporting under the GASB 34 model is based onan opinion unit.

GASB Implementation Guidance

An extended period of long and often difficult discussions between the GASB Board and staff members and theAICPA's Audit Issues Task Force (AITF) resulted in the GASB including six questions in the GASB Comprehensive

Implementation Guide2009 that address materiality considerations when preparing financial statements in con�formity with GASBS No. 34. Questions 7.4.1 through 7.4.3 address the basic financial statements, includingreconciliations and major funds. Questions 7.4.4 through 7.4.6 address component units. While this guidance maynot be that critical for the financial statement preparer, it serves as a basis for the auditor to determine the necessarymateriality levels required for opining on the financial statements. Paragraphs 4.28 and 4.29 of SLG contain theguidance provided by GASB on materiality determinations.

Question 7.4.1 of the GASB Comprehensive Implementation Guide2009 indicates that governmental activities,business�type activities, and major fund columns (both governmental and enterprise) be used for determiningquantitative materiality. It also notes that information about the remaining fund informationnonmajor funds,internal service funds, and fiduciary fundsmay or may not be quantitatively material. The question suggestsseveral ways the remaining information could be evaluated. However, qualitative materiality aspects should beconsidered in all materiality decisions. Question 7.4.2 notes that materiality of the information in the reconciliationsshould be considered in conjunction with the related financial statements. Question 7.4.3 indicates that oncegovernmental and enterprise funds are presented as major in the fund financial statements, they are all treated thesame regardless of whether their major determination was due to quantitative or qualitative reasons.

Questions 7.4.4 and 7.4.5 point out the differences between major funds and major component units and indicatethat materiality should be based on an evaluation of both the component unit's significance in relation to the totalof all discretely presented component units and the nature and significance of the unit's relationship to the primarygovernment. Question 7.4.6 notes that professional judgment should be applied when considering materialityissues for component unit information when there are no major component units. That judgment includes consider�ing relevant qualitative factions and the relationship of the nonmajor component unit information to other appropri�ate information in the financial statements.

Opinion Units. Paragraph 4.31 and Exhibit 4�1 of SLG require that separate materiality determinations be made oneach of the following opinion units, if applicable:

� Governmental activities.


56

� Business�type activities.

� Each major governmental fund.

� Each major enterprise fund.

� Aggregate discretely presented component units.

� Aggregate remaining fund information (includes nonmajor governmental and enterprise funds, internalservice fund type, and fiduciary fund types).

Each major fund is a separate opinion unit regardless of whether the fund is reported as �major" based on thequantitative calculation or based on management discretion. The auditor should consider the information in therequired reconciliations from the fund financial statements to the government�wide financial statements as it relatesto the presentation of the governmental activities and the business�type activities opinion units.

The two aggregate opinion units (discretely presented component units and remaining fund information) can becombined into one single opinion unit when either of the two aggregate opinion units is quantitatively andqualitatively immaterial to the primary government. The resulting combined opinion unit is called the aggregatediscretely presented component unit and remaining fund information. No further combining or aggregations ofopinion units is allowed, even though Question 7.4.1 of the GASB Comprehensive Implementation Guide2009

suggests that financial statement preparers further disaggregate the remaining fund information for materialitypurposes. (However, such information may affect the nature, timing, and extent of audit procedures on that opinionunit.) As a result, most general purpose governments will have at least five separate opinion unitsone for each ofthe first four bullets listed above and one combined aggregate opinion unit.

A separate materiality determination must be made for each of the opinion units if the corresponding financialinformation is presented in the basic financial statements. The qualitative or quantitative factors from one opinionunit do not affect the other opinion units. The auditor's report on the basic financial statements will include oneopinion on each opinion unit.

PPC Guidance on Materiality

PPC's Guide to Audits of Local Governments provides detailed guidance on determining materiality for opinionunits and preparing audit reports on governmental financial statements.

OCBOA FINANCIAL STATEMENTS OR PARTIALLY IMPLEMENTING THENEW REPORTING MODEL

Since the issuance of GASBS No. 34, questions have arisen as to what the effect would be on the auditor's reportif a governmental unit continued to present (past the required implementation date) its financial statements underthe pre�GASB 34 model calling it an other comprehensive basis of accounting (OCBOA). Other questions havearisen as to the effect of only partially implementing the model, such as presenting:

� only government�wide financial statements,

� only fund financial statements,

� cash or modified cash basis statements not in the GASBS No. 34 format, and

� basic financial statements, excluding required infrastructure assets.

Neither a financial statement presentation under the pre�GASB 34 model nor a partial GASBS No. 34 implementa�tion is an other comprehensive basis of accounting. Those types of presentations do not meet the criteria in SAS


57

No. 62, Special Reports, for OCBOAs. However, governmental units may be allowed to prepare regulatory or cashbasis OCBOA financial statements under SAS No. 62 in the following circumstances:

� If the presentation is required by a regulatory agency that has jurisdiction over the government and is issuedin accordance with SAS No. 62, as amended by SAS No. 77. Reporting on financial statements that areprepared on a regulatory basis is discussed in PPC's Guide to Audits of Local Governments.

� If the format and disclosures in a cash or modified cash basis presentation satisfy the GASBS 34 formatand disclosure requirements.

If financial statements that must be presented in accordance with GASBS No. 34 are presented under the pre�GASB 34 model or are presented as only a partial implementation of GASBS No. 34, auditors should modify theiropinions based on the magnitude and pervasiveness of the omitted information. Paragraph 14.10 of SLG indicatesthat omitting required government�wide or fund financial statements would result in an adverse opinion on thefinancial statements taken as a whole. Report modifications are discussed in PPC's Guide to Audits of Local

Governments.

FINANCIAL REPORTING AND AUDITOR INDEPENDENCE

Governments should realize that there are certain limits to how much assistance an external auditor can provide tothe client while maintaining independence. For example, many audits of governments are performed underGovernment Auditing Standards (the Yellow Book) issued by the U.S. Government Accountability Office (GAO).Auditors performing Yellow Book audits must comply with the independence standards in the Yellow Book.

The independence standards in the Yellow Book are more restrictive on some issues than the independencestandards of the AICPA. The Yellow Book recognizes three general classes of impairment to independence:personal, external, and organizational. Each of these classes of impairment can impact whether an auditor mayperform the specified audit work.

Yellow Book Independence Standards

While the Yellow Book addresses a wide range of auditor independence issues, one of the most significant rulesconcerns preventing auditors from performing certain nonaudit services, commonly referred to as consultingservices, and also providing audit services to the same client. Although the Yellow Book specifies certain nonauditservices that would and would not impair auditor independence, it acknowledges that it would be impossible todefine every situation. Therefore, it uses a principle�based approach for determining that the auditor maintainsindependence in fact and appearance, supplemented with certain safeguards, as follows:

� Overarching Principles. The new standard for nonaudit services is based on the following two overarchingprinciples:

�� Audit organizations must not perform management functions or make management decisions.

�� Audit organizations must not audit their own work or provide nonaudit services in situations where theservices involved are significant or material to the subject matter of the audit.

� Safeguards. Auditors may perform nonaudit services for their client that comply with those principles aslong as several specified safeguards are also followed, such as precluding personnel who performnonaudit services from performing on related audit work, and satisfying extensive documentation andcommunication requirements.

Independence Implementation Guidance. In July 2002, the GAO issued implementation guidance titled Govern�

ment Auditing Standards: Answers to Independence Questions (GAO Q & A). The guidance in the GAO Q&A is stillapplicable. The implementation guidance responds to questions related to the independence standard's imple�mentation time frame, underlying concepts, and application in specific nonaudit circumstances. Questions 55 and61 specifically address auditor assistance with implementing a new accounting principle, such as GASBS No.�34.They state that providing routine advice or technical assistance does not impair independence. Therefore, anauditor could sit on the GASBS No. 34 implementation team providing advice on reporting alternatives and


58

monitoring the implementation process while maintaining independence. However, services beyond routine adviceshould be considered in relation to the overarching principles and safeguards. For example, the preparation ofMD&A or the performance of extensive valuation services for infrastructure go beyond performing routine advice.These activities would have to be evaluated in light of the overarching principles and safeguards to determine if theauditor could maintain independence.

Questions 46 and 53 address auditor involvement with preparing a trial balance, draft financial statements, andaccrual entriesactivities that would be common in assisting clients with the implementation of GASBS No. 34.These activities are considered technical assistance as part of the audit as long as the auditor does not makemanagement decisions and the client is knowledgeable enough to evaluate, approve, and take responsibility foreach of the items prepared by the auditor. Question 49 indicates that the auditor may assist the client withpreparation of depreciation schedules without impairing independence as long as the client (a) determines themethod, rate, and salvage value of the assets and (b) takes responsibility for the depreciation schedules. If any ofthese conditions do not exist, the auditor will have impaired his independence for performing the audit of thefinancial statements.

FUTURE DEVELOPMENTS

GASB Project on Codification of Pre�November 1989 FASB Pronouncements

In April 2009, the GASB started a project to identify and codify provisions in private�sector GAAP that the GASB hasmade applicable to governments. Although the GASB had considered adding this project for quite some time, itwas made more urgent with the issuance of the FASB ASC, which replaces all previous sources of private sectorGAAP with a single Codification. In addition, the Codification no longer refers to Statement or Opinion numbers butto a new numbering system that includes topics, subtopics, sections, and subsections.

The GASB project will:

� Identify the provisions of the FASB pronouncements, as amended as of November 30, 1989, that areapplicable to state and local governments,

� Further identify applicable provisions that conflict with or contradict GASB pronouncements (and thereforeare not GAAP for governments), and

� Assess which of the remaining provisions should be adopted and incorporated into GASB pronounce�ments �as is" or modified and incorporated into GASB pronouncements.

In a related decision, the GASB tentatively agreed at its August 2009 meeting to revoke paragraph 7 of GASBS No.20, which currently permits governmental business�type activities to continue to follow new FASB pronouncementsthat do not contradict or conflict with GASB pronouncements. An Exposure Draft on this project, including thedecision on GASBS No. 20, paragraph 7, is currently planned for January 2010. The progress of this project can betracked on the GASB's website atwww.gasb.org.


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SELF�STUDY QUIZ


20. Town ABC, a governmental entity, shows total revenues for the year ended June 30, 1999 (Town ABC'sdetermination period) to be $62 million. Based on the GASBS No. 34 implementation phases, what phase ofgovernment is Town ABC?

a. Phase 1.

b. Phase 2.

c. Phase 3.

21. Using the information in question 20, when would Town A be required to implement the general statementprovisions of GASB No. 34?

a. Fiscal year ending June 30, 2001.

b. Fiscal year ending June 30, 2002.

c. Fiscal year ending June 30, 2003.

d. Fiscal year ending June 30, 2004.

22. Which of the following is considered an opinion unit by the SLG?

a. Only funds reported as �major" based on quantitative calculation.

b. Combined opinion unit of governmental and business�type activities.

c. Each major governmental fund.

23. If a governmental unit did not include a required government�wide or fund financial statement, what would thecorrect auditor's opinion be?

a. Adverse opinion on the financial statements taken as a whole.

b. Qualified opinion because statements would be presented in accordance with pre�GASB 34 model.

c. Unqualified opinion as long as statements are presented with at least a partial implementation of GASBNo. 34.

d. Unqualified opinion on financial statements prepared on an other comprehensive basis of accounting(OCBOA).


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20. Town ABC, a governmental entity, shows total revenues for the year ended June 30, 1999 (Town ABC'sdetermination period) to be $62 million. Based on the GASBS No. 34 implementation phases, what phase ofgovernment is Town ABC? (Page 52)

a. Phase 1. [This answer is in incorrect. Total annual revenues would have to be more than $100 million tobe in this phase and Town ABC's revenue did not total more than $100 million for the year.]

b. Phase 2. [This answer is correct. Governmental entities with total annual revenues of $10 million toless than $100 million for the first fiscal year ending after June 15, 1999 are phase 2 governments.]

c. Phase 3. [This answer is incorrect. Total annual revenues would have to be less than $10 million to be inthis phase and Town ABC's revenue is more than $10 million.]

21. Using the information in question 20, when would Town ABC be required to implement the general statementprovisions of GASB No. 34? (Page 52)

a. Fiscal year ending June 30, 2001. [This answer is incorrect. If Town ABC had more than $100 million in totalrevenue in their determination year, the general statement provisions would be effective for fiscal periodsbeginning after June 15, 2001.]

b. Fiscal year ending June 30, 2002. [This answer is incorrect. According to the amount of total revenue thatTown ABC had in their determination year, the governmental unit will be subject to the general statementprovisions in a different year than one beginning July 1, 2001.]

c. Fiscal year ending June 30, 2003. [This answer is correct. Town ABC would need to phase in thegeneral statement provisions for fiscal periods beginning after June 15, 2002. This answer fits thatcriteria of GASBS No. 34.]

d. Fiscal year ending June 30, 2004. [This answer is incorrect. If town ABC had less than $10 million in totalrevenue in their determination year, the general statement provisions would be effective for fiscal periodsbeginning after June 15, 2003. However ABC had more than this amount of total revenue.]

22. Which of the following is considered an opinion unit by the SLG? (Page 55)

a. Only funds reported as �major" based on quantitative calculation. [This answer is incorrect. Every majorfund is considered a separate opinion unit regardless if the reason is because of quantitative calculationor management discretion.]

b. Combined opinion unit of governmental and business�type activities. [This answer is incorrect. There aretwo units that can be combined (the two aggregate units combined into one that is called aggregatediscretely presented component unit and remaining fund information), but no further combining of opinionunits is allowed.]

c. Each major governmental fund. [This answer is correct. Separate materiality determinations mustbe made on this unit. The other units that must be considered are (1) governmental activities, (2)business�type activities, (3) each major enterprise fund, (4) aggregate discretely presentedcomponent units, and (5) aggregate remaining fund information.]

23. If a governmental unit did not include a required government�wide or fund financial statement, what would thecorrect auditor's opinion be? (Page 57)

a. Adverse opinion on the financial statements taken as a whole. [This answer is correct. This is therequirement for omitting the required government�wide or fund financial statement per paragraph14.10 of SLG]


61

b. Qualified opinion because statements would be presented in accordance with pre�GASB 34 model. [Thisanswer is incorrect. The omitted statement would not cause the statements to be in accordance withpre�GASB 34 model. If the statements were presented in accordance with pre�GASB 34 modeling, theauditor would need to modify his opinion depending on the magnitude and pervasiveness of the omittedinformation.]

c. Unqualified opinion as long as statements are presented with at least a partial implementation of GASBNo. 34. [This answer is incorrect. An auditor must modify the report for statements that are only a partialimplementation of GASB No. 34. The extent of the modification would be dependent on the magnitude andpervasiveness of the omitted information.]

d. Unqualified opinion on financial statements prepared on an other comprehensive basis of accounting(OCBOA). [This answer is incorrect. Omitting these required statements does not meet the criteria in SASNO. 62, Special Reports, for OCBOAs. Neither financial statements under pre�GASB 34 model or financialstatements prepared with a partial implementation of GASB 34 are considered an other comprehensivebasis of accounting.]


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EXAMINATION FOR CPE CREDIT

Lesson 1 (GFSTG091)

Determine the best answer for each question below. Then mark your answer choice on the Examination for CPECredit Answer Sheet located in the back of this workbook or by logging onto the Online Grading System.

1. Who has primary jurisdiction over accounting and financial reporting standards for state & local governmentalentities?

a. Financial Accounting Standards Board (FASB).

b. National Council on Governmental Accounting (NCGA).

c. Financial Accounting Foundation (FAF) Board of Trustees.

d. Governmental Accounting Standards Board (GASB).

2. Which characteristic if possessed separate from the others may not presume an entity as governmental?

a. Officers elected by popular vote or appointed by government officials.

b. Ability to directly issue federal tax�exempt debt.

c. Authorization to enact and enforce tax levies.

d. A government can unilaterally dissolve the entity with net assets reverting to government.

3. When considering indicators of financial accountability under GASBS No. 14, which of the following is a legallyseparate organization for which the primary government is financially accountable?

a. Component Unit.

b. Financial Reporting Entity.

c. Governmental Entity.

d. Primary Government.

4. Fearless Families, a nonprofit corporation, is financially accountable to Parent City. If the financial data forFearless Families' funds are combined with the financial data for Parent City's funds on the financial statements,what method of reporting is being used?

a. Discrete presentation.

b. Affiliated.

c. Blending.

d. Component unit.

5. What is required by GAAP concerning reporting actual results compared to budgets?

a. Governments must present budget�to�actual comparisons for their general fund and each major specialrevenue fund that has a legally adopted budget.

b. Governments have the option, but are encouraged to present budget�to�actual comparisons for theirgeneral fund and each major special revenue fund that has a legally adopted budget.


63

c. Governments must present budget�to�actual comparisons for their general fund and have the option, butare encouraged, to present these comparisons for each major special revenue fund that has a legallyadopted budget.

d. There is no requirement or encouragement by GAAP concerning the reporting of budget�to�actualcomparisons.

6. Which statement below is correct concerning the exchange relationship, profit motive, and competition ingovernment services?

a. There is an exchange relationship between resources provided to governments and services provided bygovernments.

b. The government's efficiency and effectiveness is measured in terms of profit or loss.

c. Competition between government provided services and public sector provided services is strong.

d. The development of concepts and standards for measuring governmental service efforts andaccomplishments are only now beginning to be developed.

7. Creature Preservation is a state�governed program that is financed through taxes and federal governmentsubsidies. What classification of activity is this?

a. Governmental.

b. Business�type.

c. Proprietary.

d. Private enterprise.

8. Which statement listed below best describes the difference between business�type and governmentalactivities?

a. Legally adopted budget is not necessary for governmental activities but it is for business�type activities.

b. Fund accounting is not necessary for governmental activities, as it is with business�type activities.

c. GAAP financial reporting requires budgetary comparisons for certain governmental activities, but not forbusiness�type activities.

d. Organization demarcation between governmental and business�type activities is usually very clear.

9. To whom is the government primarily accountable?

a. Citizenry.

b. Legislative & oversight board.

c. Investors & creditors.

d. Internal government management officials.


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10. One of the uses for external governmental financial statements is assessing compliance with finance�relatedcontractual requirements. Of the following choices, which exemplifies this use?

a. A legislative body planning budgets & programs.

b. An oversight body determining need for user fee changes.

c. Grantors verifying that grant requirements have been adhered to.

d. A legislative body determining if tax resources were used effectively.

11. What does GASBC No. 1, paragraph 56, say is the �cornerstone of all financial reporting in government"?

a. Compliance.

b. Funding.

c. Efficiency.

d. Accountability.

12. The GASB established three basic objectives of financial reporting by state and local governments. Match thesubobjective with the basic objective.

Subobjectives Basic Objectives

1. The financial reporting information providedshould be necessary to determine whether theentity's financial position improved or deterioratedas a result of the year's operations.

i. Assist in Assessing Accountability

2. The legal and contractual restriction disclosures onresources and risks of potential loss of resourcesshould be included in the financial report.

ii. Assist in Assessing Operating Results

3. Information provided to assist users in assessingthe governmental entity's service efforts, costs, andaccomplishments should be included in the finan�cial reporting.

iii. Assist in Assessing Services and Obligations

a. 1 i; 2 ii; 3 iii.

b. 1 iii; 2 ii; 3 i.

c. 1 iii; 2 i; 3 ii.

d. 1 ii; 2 iii; 3 i.

13. According to GASBS No. 34, what does the use of fund accounting and financial statements showing thesources and uses of current financial resources demonstrate?

a. Operational accountability.

b. Fiscal accountability.

c. Accomplishment reporting.

d. Economic resources measurement.


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14. One of the objectives of governmental reporting is providing information for assessing a government's serviceefforts, costs, and accomplishments. GASBC No. 2, Service Efforts and Accomplishments Reporting (SEA), isthe first step towards achieving that objective. Match the type of measurement with the proper example.

Type of Measurement Example

1. Financial i. Number of students who took the community driverseducation program and passed their driving test onthe first try

2. Nonfinancial ii. Number of hours of instruction given; Number ofstudents in the community drivers education pro�gram

3. Outputs iii. Cost per hour of instruction; Cost per student

4. Outcomes iv. Total cost of the community drivers educationprogram

5. Efficiency v. Cost per student who took the community driverseducation program and passed their driving test onthe first try

6. Cost�outcome vi. Number of city employee hours expended oncommunity drivers education program

a. 1 iv; 2 vi; 3 ii; 4 i; 5 iii; 6 v.

b. 1 iv; 2 ii; 3 vi; 4 i; 5 iii; 6 v.

c. 1 iii; 2 vi; 3 i; 4 ii; 5 v; 6 iv.

d. 1 v; 2 i; 3 ii; 4 iii; 5 vi; 6 iv.

15. The GASB has issued Implementation Guides for some of its more detailed standards. The guides clarify,explain, or elaborate on the standards. What classification in the hierarchy of GAAP are these guides?

a. Category a.

b. Category b.

c. Category c.

d. Category d.

16. Based on GASBS No. 55 GAAP Hierarchy, which of the following falls into category �a" of GAAP hierarchy forstate and local governments?

a. FASB Statements of Financial Accounting Standards and Interpretations.

b. AICPA Statements of Position not cleared by the FASB.

c. GASB Statements and Interpretations.

d. Consensus positions of the GASB Emerging Issues Task Force.


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17. Which item below has its reporting requirements addressed in GASBS No. 34?

a. The comprehensive annual financial report for a city government entity.

b. The general purpose external financial reporting of a city's public hospital.

c. The general fund report of an agency of the federal government

d. The cash basis financial statements for a state government entity.

18. What is the proper order for the minimum financial reporting requirements?

a. MD&A; Government�wide and Fund Financial Statements; Notes to the Financial Statements; RSI.

b. Government�wide and Fund Financial Statements; Notes to the Financial Statements; MD&A, RSI.

c. Government�wide and Fund Financial Statements; MD&A; Notes to the Financial Statements; RSI.

d. MD&A; RSI; Government�wide and Fund Financial Statements; Notes to the Financial Statements.

19. Major funds must be reported in a separate column on the fund financial statements. At least what percentageof revenues, expenditures/expenses, assets, or liabilities compared to the corresponding totals for allgovernmental or all enterprise funds determines that a fund is major? At least what percentage does the sameelement have to be compared to the combined totals of the governmental and enterprise funds to bedetermined as major?

a. 5%; 10%.

b. 10%; 5%.

c. 10%; 10%.

d. 5%; 5%.

20. GASBS No. 34 has an implementation process with two categories: (1) implementation of the generalprovisions of the Statement; and (2) the retroactive reporting of major general infrastructure assets. Within eachof these categories, the GASB established three phases delineating three sizes of governments and definedthem based on 1999 revenues. The table below shows these categories and phases. What are total annualrevenues missing from the table?

General Statement Provisions

Retroactive GeneralInfrastructure Reporting

Phase Total Annual Revenues Fiscal periods beginningafter June 15

Fiscal periods beginningafter June 15

1 A 2001 2005

2 B 2002 2006

3 C 2003 Reporting is Optional

a. A = Less than $10 million; B = $10 million to less than $100 million; C = $100 million or more.

b. A = $100 million or more; B = $10 million to less than $100 million; C = Less than $10 million.

c. A = Less than $1 million; B = $1 million to less than $10 million; C = $10 million or more.

d. A = $10 million or more; B = $1 million to less than $10 million; C = Less than $1 million.


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21. Presented below are excerpts from a government's financial statements for the year ended June 30, 1999 (thedetermination period). Using this financial data, how much are total revenues for the determination period?

Governmental Fund Types Fiduciary FundType

TotalPrimary

Government

TotalReporting

Entity

General CapitalProjects

ExpendableTrust

(Memo Only) ComponentUnits

(MemoOnly)

Revenues $ 20,000 $ 8,000 $ 2,000 $ 30,000 $ 2,000 $ 32,000

OtherFinancingSources

20,000 1,000 20,500 500 21,000

Proprietary Fund Types Fiduciary FundType

TotalPrimary

Government

TotalReporting

Entity

Enterprise InternalService

NonexpendableTrust

(Memo Only) ComponentUnits

(MemoOnly)

Revenues $ 10,000 $ 3,000 $ 500 $ 15,500 $ 3,000 $ 18,500

NonoperatingRevenues

5,000 500 2,500 1,000 3,500

Transfers in 500 —— 500 500

ExtraordinaryGains

1,000 —— 1,000 1,000

a. $ 43,000.

b. $ 46,000.

c. $ 47,000

d. $ 63,000

22. Who is responsible for establishing the methods of determining materiality for GASBS No. 34?

a. AICPA.

b. GASB.

c. FAF.

d. FASB.


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23. The GASB Comprehensive Implementation Guide2008 provides guidance on materiality determinationissues. The SLG also addresses materiality. According to the SLG, what is the basic materiality determinationfor reporting, evaluation, performing, and planning under the GASB 34 model based on?

a. Entity as a whole.

b. Fund type and account group.

c. Component unit.

d. Opinion unit.


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Lesson 2:�FUND ACCOUNTING OVERVIEW

INTRODUCTION

This lesson provides an overview of fund accounting. Discussion centers around the descriptions of the three catego�ries of funds as well as the requirements and considerations for each category in relation to measurement focus,basis of accounting, capital assets, long term liabilities, interfund activity and fund balances, net assets and fundequity. The lesson concludes with a discussion on budgetary reporting.

Lesson 1 discussed unique government environmental factors, including the wide variety of services a typical localgovernment provides. The lesson also introduced the concepts of fund accounting, measurement focus, and basisof accounting that are unique to governmental accounting.

Most of these basic accounting principles originated in NCGA Statement No. 1, Governmental Accounting and

Financial Reporting Principles, which the GASB adopted and incorporated into the General Principles or FinancialReporting sections of its Codification of Governmental Accounting and Financial Reporting Standards (the Codifica�tion, GASB Cod. sec. 1100�2900). Because most of these general principles originated in an NCGA Statementrather than in a GASB Statement, most of the citations in this lesson are to the sections of the GASB Codificationinto which the general principles were incorporated.


Completion of this lesson will enable you to:� Identify the three categories of funds and the types of funds of each category.� Summarize the requirements of measurement focus and basis of accounting for all three types of funds.� Choose the proper accounting and reporting treatment for capital assets, debt, and long�term liabilities and

interfund activity.� Define the proper terms for the difference between fund assets and liabilities for each fund category and record

the appropriate accounting entries for each fund category.� Identify the importance of governmental budgets as well as the requirements for reporting of budgetary

comparisons.

GASBS NO. 34GOVERNMENTAL FINANCIAL REPORTING MODEL

GASBS No. 34, Basic Financial Statementsand Management's Discussion and Analysisfor State and Local

Governments, establishes the basic financial statements and required supplementary information (RSI) that gen�eral purpose governments must, at minimum, present in generally accepted accounting principles (GAAP) financialreports.

Under GASBS No. 34, most general purpose governments, such as a cities or counties, are required to present:

� Management's discussion and analysis (RSI).

� Government�wide financial statements.

� Fund financial statements consisting of:

�� Governmental fund financial statements

�� Proprietary fund financial statements

�� Fiduciary fund statements

� Notes to financial statements.

� Other RSI, including budgetary comparison information for the general fund and major special revenuefunds.


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Fund financial statements consist of three separate sets of financial statementsone for each of a government'sthree fund categories:

a. Governmental fund category, including:

(1) General fund type.

(2) Special revenue fund type.

(3) Capital projects fund type.

(4) Debt service fund type

(5) Permanent fund type

b. Proprietary fund category, including:

(1) Enterprise fund type.

(2) Internal service fund type.

c. Fiduciary fund category, including:

(1) Pension (and other employee benefit) trust fund type.

(2) Investment trust fund type.

(3) Private�purpose trust fund type.

(4) Agency fund type.

The funds reported in the fund financial statements are limited to the funds of the primary government and itsblended component units.

GASBS No. 34 requires governmental funds to be reported using the current financial resources measurementfocus and the modified accrual basis of accounting. Proprietary and fiduciary funds are reported using theeconomic resources measurement focus and the accrual basis of accounting. (However, GASBS No. 25, Financial

Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined Contribution Plans, and GASBS No.43, Financial Reporting for Postemployment Benefit Plans Other Than Pension Plans, provide separate guidance onrecognition of pension and other postemployment benefit obligations in pension and other employee benefit trustfunds.)

FUND ACCOUNTING FOR GOVERNMENTAL FINANCIAL REPORTING

Fund accounting is not new to governmental financial reporting. State and local governments have used fundreporting for most, if not all, of the 20th century as a means of segregating resources that are required to be usedfor specific purposes. General purpose governments and most special�purpose governments use fund accountingto maintain their books of original entry. Journal entries to record their activities and transactions during the year areprepared on this basis.


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Definition of a Fund

GASB Cod. sec. 1100.102 defines a fund as follows:

. . . a fiscal and accounting entity with a self�balancing set of accounts recording cash and otherfinancial resources, together with all related liabilities and residual equities or balances, andchanges therein, which are segregated for the purpose of carrying on specific activities orattaining certain objectives in accordance with special regulations, restrictions, or limitations.

GASB Cod. sec. 1300.101 gives the rationale for using fund accounting. It explains that the diversity of activitiesreported by governments and the need to show legal compliance makes it necessary for most governments to useseveral (and often many) separate funds, each reporting their own assets, liabilities, and equity. For this reason,from an accounting and reporting standpoint, each government is a combination of a broad variety of funds, �eachhaving a separate set of accounts and functioning independently of other funds."

Categories and Types of Funds

A governmental entity may have more than one fund in a fund type (for example, several special revenue funds),except that it may have only one general fund. The classification of funds by category and type is significantbecause, as is discussed later in this lesson, different categories use different bases of accounting and becausespecific accounting standards can differ by fund category or type.

Funds Versus Activities

GAAP require most governments to present fund financial statements. Most governments also are required topresent government�wide financial statements, which report on governmental and business�type activities insteadof funds. As shown below, these activities are defined in part by the funds typically used to report those activities inthe fund financial statements. However, it is important to clearly distinguish between funds (and fund categories)and activities and understand their role in GAAP financial reports. GASBS No. 34, paragraph 15, defines govern�

mental activities as follows:

Governmental activities generally are financed through taxes, intergovernmental revenues, andother nonexchange revenues. These activities are usually reported in governmental funds andinternal service funds.

Paragraph 15 defines business�type activities as follows:

Business�type activities are financed in whole or in part by fees charged to external parties forgoods or services. These activities are usually reported in enterprise funds.

These definitions are not restrictive. Governments may choose, for example, to report an activity reported in anenterprise fund in the fund financial statements as a governmental activity in the government�wide financialstatements.

Governmental Fund Category

Governmental funds are the funds through which most functions typically associated with government are financedand accounted for. The focus of governmental funds is on current financial resources, accounting for the acquisi�tion, use, and balances of financial resources and related current liabilities. Financial assets are segregated into agovernmental fund according to the purposes for which they may be used, and liabilities are segregated into thegovernmental fund from which they are to be paid, with the difference between the assets and liabilities being fundbalance. The following paragraphs discuss the five types of governmental funds. The GASB has issued StatementNo. 54, Fund Balance Reporting and Governmental Fund Type Definitions, which modifies the definitions of allgovernmental funds effective for periods beginning after June 15, 2010.

General Fund. GASB Cod. sec. 1300.104 defines the general fund as a fund that �account[s] for all financialresources except those required to be accounted for in another fund." It usually is the government's main operating


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fund and accounts for typical general government revenues (such as property and sales taxes) and a wide varietyof activities that benefit citizens as a whole (such as general government finance, legislation, and administration;police and fire protection; courts and corrections; health and welfare services; maintenance of streets, lights, andsignals; parks and libraries; etc.). Resources or expenditures not restricted for a particular purpose are accountedfor in the general fund. Restricted resources also can be accounted for in the general fund if there is no requirementto use another fund.

Special Revenue Funds. According to GASB Cod. sec. 1300.105, special revenue funds �account for the pro�ceeds of specific revenue sources (other than trusts for individuals, private organizations, or other governments orfor major capital projects) that are legally restricted to expenditure for specified purposes." Special revenue fundsmay be used to report a government's restricted own�source revenues, such a hotel room tax, or other restrictedrevenues, such as grants. Use of special revenue funds is not required unless legally mandated, with one excep�tion: the general fund of a blended component unit must be reported as a special revenue fund.

Capital Projects Funds. GASB Cod. sec. 1300.106 defines capital projects funds as funds to �account for financialresources to be used for the acquisition or construction of major capital facilities (other than those financed byproprietary funds or in trust funds for individuals, private organizations, or other governments)." Capital outlays thatare financed by general obligation debt should always be reported in capital projects funds. Use of a capitalprojects fund also is generally necessary when construction of capital assets is financed with restricted resources,such as intergovernmental grants. However, capital projects funds may also be used to provide accounting controlover a capital project's expenditures, even if the project is not financed by restricted resources or long�term debt.The acquisition or construction of capital assets financed by, or for the benefit of, proprietary funds is accounted forin the proprietary fund, not in a capital projects fund.

Because the measurement focus of governmental funds is on current financial resources, long�term debt used tofinance capital projects is not reported in the capital projects fund but as a general long�term debt in the govern�mental activities column in the government�wide statement of net assets. The capital projects fund reports the bondproceeds as a financing source, and reports any investment securities and related interest income from temporaryinvestment of the bond proceeds until the proceeds are needed during the construction phase. The fund alsoreports capital expenditures and amounts payable to contractors for engineering, architectural, and constructionservices during the construction phase. Construction in progress, however, is a general capital asset, not a financialresource, and is reported only in the governmental activities column in the government�wide statement of netassets. Upon completion of the project, the capital projects fund would be closed. Exhibit 2�1 presents journalentries that illustrate this scenario.

Debt Service Funds. As stated in GASB Cod. sec. 1300.107, debt service funds �account for the accumulation ofresources for, and the payment of, general long�term debt principal and interest." Debt service funds are requiredif legally mandated or if financial resources are being accumulated for principal and interest payments maturing infuture years. Absent an accumulation of resources or a legal mandate, debt servicing is reported in the govern�ment's general fund or the governmental fund associated with the debt.

Debt service funds also report current financial resources and are not used to report the long�term debt, but onlythe servicing of the debt. General long�term debt is reported only in the governmental activities column in thegovernment�wide statement of net assets. Also, debt service of proprietary fund debt generally is not accounted forin a debt service fund but in the proprietary fund.

Debt service funds accumulate resources from tax revenues, particularly property taxes (that are earmarked fordebt service), from transfers from other funds such as the general fund, and from interest earned on the temporaryinvestment of those resources until they are needed to service debt. The debt service fund records an expenditurewhen the debt service payment is made.

As an example, a debt service fund would be used to account for the $500,000 general obligation bonds issued forthe capital project illustrated in Exhibit 2�1. Assume that the debt matures in 25 years and has a 6% interest rate. Forsimplicity, assume that the interest is payable annually (semi�annual payments are typical). Assume also that thedebt instrument requires that resources be accumulated in a debt service fund to pay the principal when it maturesand that it has been determined that annual additions of $8,000 will accumulate the $500,000 needed at the end of25 years. Finally, assume that property taxes of $20,000 are earmarked for the debt service, are levied for thecurrent period, and are received directly by the debt service fund and invested until needed for debt service. Exhibit2�2 presents the journal entries for this scenario.


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Exhibit 2�1

Journal Entries for a Capital Project

1. A government issues $500,000 in long�term general obligation bonds to finance construction of a communitycenter. The construction project is accounted for in the capital projects fund. For simplicity, assume that theproject is begun and completed in one reporting period. Also, for simplicity, debt discounts and issuance costsare not considered and it is assumed that the bonds are the only source of financing. Other typical financingsources for capital projects, such as transfers from other funds, grants, private contributions, and specialassessments, are not illustrated. Finally, assume that there is no sale of a bond anticipation note as a sourceof interim financing.

Capital Projects Fund

Cash $ 500,000Other financing sourcesproceeds of general

obligation bonds $ 500,000

(To record the bond proceeds in the capital projects fund.)

2. The capital projects fund temporarily invests $200,000 of the debt proceeds.

Investments $ 200,000Cash $ 200,000

(To record temporary investment.)

3. $300,000 is expended on construction costs.


Capital outlay expenditures $ 300,000Contracts payable $ 300,000

Contracts payable 300,000Cash 300,000

(To record capital outlay expenditures. The government also would record constructionin progress in its general capital assets ledger.)

4. The temporary investment matures and related interest income is received.

Cash $ 202,800Investments $ 200,000Revenuesinterest 2,800

5. $202,800 is expended on construction costs to complete the project.


Capital outlay expenditures $ 202,800Cash $ 202,800

(To record construction expenditures and completion of the project. The governmentalso would record the remaining costs in its general capital assets ledger and move theasset from construction in progress.)

* * *


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Exhibit 2�2

Journal Entries for a Debt Service Fund

1. Assume that $20,000 in property taxes earmarked for debt service of a $500,000 term bond are levied annuallyand received directly by the debt service fund. For simplicity, it is assumed that 100% of the taxes levied arecollected. (The journal entry recording issuance of the long�term bond is presented in entry 1 of Exhibit 2�1.)

Taxes receivablecurrent year property taxes $ 20,000Revenueproperty taxes $ 20,000

(To record the property tax levy in the debt service fund.)

2. The current year property taxes are collected.

Cash $ 20,000Taxes receivablecurrent year property taxes $ 20,000

(To record property tax collections.)

3. Property tax collections are invested.


(To record investment of property tax receipts.)

4. An interfund transfer of $17,750 is received from the general fund. This amount includes $9,500 for paymentof the current year's interest, $250 for the escrow agent's fee, and $8,000 for accumulation to pay the debtprincipal when it matures.

General Fund

Other financing usestransfer outdebt service fund $ 17,750Cash $ 17,750

(To record the general fund interfund transfer to debt service fund.)

Debt Service Fund

Cash $ 17,750Other financing sourcestransfer ingeneral fund $ 17,750

(To record interfund transfer received from the general fund.)

5. The debt service fund invests $8,000 of the interfund transfer.


(To record investment of a portion of operating transfer proceeds.)

6. The investment of property tax receipts matures. The proceeds include $500 of interest.

Cash $ 20,500Investments $ 20,000Revenuesinterest 500

(To record proceeds, including interest income, on matured investment.)


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7. At year end, interest of $35 is accrued on the investment of $8,000 of the interfund transfer.

Accrued interest receivable $ 35Revenuesinterest $ 35

(To record accrued interest on investment.)

8. The annual interest payment ($30,000, which equals 6% of $500,000) is remitted to the escrow agent at yearend. The escrow agent's fee of $250 is also remitted.

Cash with escrow agent $ 30,000Expenditures 250

Cash $ 30,250

(To record transmittal of cash for annual interest payment and agent's fee to escrowagent.)

Expendituresdebt serviceinterest $ 30,000Interest payable $ 30,000

(To record expenditure for annual bond interest.)

9. The escrow agent notifies the government that it has paid the interest to bondholders.

Interest payable $ 30,000Cash with escrow agent $ 30,000

(To record payment of interest to bondholders by escrow agent.)

* * *

Permanent Funds. GASBS No. 34, paragraph 65, established permanent funds to �be used to report resourcesthat are legally restricted to the extent that only earnings, and not principal, may be used for purposes that supportthe reporting government's programsthat is, for the benefit of the government or its citizenry [emphasis added]."Permanent funds are most likely to be used for resources legally restricted to cemeteries, libraries, museums,parks, public land maintenance, social services, and scholarships. If the resources (principal or earnings) can onlybe used for the benefit of individuals, private organizations, or other governments, the resources are fiduciary innature and should be reported in a private�purpose trust fund, not a permanent fund.

Proprietary Fund Category

Proprietary funds account for a government's ongoing organizations and activities that are similar to those oftenfound in the private sector, such as a water and sewer utility, a municipal parking lot, a maintenance garage for thecity's vehicles, or a print shop to print the government's documents. According to GASB Cod. sec. 1300.102b,proprietary funds focus �on the determination of operating income, changes in net assets (or cost recovery),financial position, and cash flows." The focus of proprietary funds is on all economic resources (both financial andcapital and current and noncurrent resources). Thus, proprietary funds account for all the assets, liabilities,equities, revenues, expenses, and transfers relating to a government's business�like activities. Proprietary fundsconsist of two types of fundsenterprise and internal service funds.

Enterprise Funds. Enterprise funds generally are used to report activities that the government operates more likea business. GASBS No. 34, paragraph 67, permits the use of enterprise funds whenever a fee is charged to externalusers for goods or services. Paragraph 67, requires governments to report an activity in an enterprise fund if anyone of the following three criteria is met:

a. The activity is financed with debt that is secured solely by a pledge of the net revenues from fees andcharges of the activity. Debt that is secured by a pledge of net revenues from fees and charges and the full


76

faith and credit of a related primary government or component uniteven if that government is notexpected to make any paymentsis not payable solely from fees and charges of the activity. (Some debtmay be secured, in part, by a portion of its own proceeds but should be considered as payable �solely"from the revenues of the activity.) [However, this type of pledge should not affect a decision about whethercriterion a is met.]

b. Laws or regulations require that the activity's costs of providing services, including capital costs (such asdepreciation or debt service), be recovered with fees and charges, rather than with taxes or similarrevenues.

c. The pricing policies of the activity establish fees and charges designed to recover its costs, including capitalcosts (such as depreciation or debt service).

Enterprise fund reporting is required in two circumstances. Public entity risk pools and state unemploymentcompensation funds must both be reported using enterprise fund accounting and reporting.

Internal Service Funds. GASBS No. 34, paragraph 68, provides that �internal service funds may be used to reportany activity that provides goods or services to other funds, departments, or agencies of the primary governmentand its component units, or to other governments, on a cost�reimbursement basis." Internal service funds shouldbe used only if the reporting government is the predominant participant in the activity. If not, the activity should bereported as an enterprise fund.

Fiduciary Fund Category

According to GASBS No. 34, paragraph 69, fiduciary funds �should be used to report assets held in a trustee oragency capacity for others and therefore cannot be used to support the government's own programs." Amountsheld in trust to support the reporting government's own programs must be reported in governmental funds orenterprise funds, as appropriate. There are four fiduciary fund typespension (and other employee benefit) trustfunds, investment trust funds, private�purpose trusts, and agency funds. A difference between trust funds andagency funds is that agency funds are relatively simple clearing accounts in which assets are primarily cash andinvestments and equal liabilities. The overarching rule for all fiduciary funds is that they should never be used toreport assets that can be used for programs of the reporting government. In addition, GASBS No. 34, paragraph 69,requires that a trust or fiduciary arrangement exist with individuals, private organizations, or other governments foreach of the three trust fund types. Like proprietary funds, the focus of fiduciary funds is on all economic resources(both financial and capital and current and noncurrent resources).

Pension and Other Employee Benefit Trust Funds. GASBS No. 34, paragraph 70, requires that �pension (andother employee benefit) trust funds should be used to report resources that are required to be held in trust for themembers and beneficiaries of defined benefit pension plans, defined contribution plans, other postemploymentbenefit plans, or other employee benefit plans." Examples of activities commonly reported in pension (and otheremployee benefit) trust funds include pension benefits plans, other postemployment benefit plans, and deferredcompensation plans.

Investment Trust Funds. The investment trust fund type was established by GASBS No. 31, Accounting and

Financial Reporting for Certain Investments and for External Investment Pools. Governments that sponsor aninvestment pool in which some participants are outside (external to) the sponsoring government's reporting entityshould use investment trust funds to report the assets of those outside participants (and not those of the sponsor�ing government).

Private�purpose Trust Funds. GASBS No. 34, paragraph 72, provides that private�purpose trust funds should be�used to report all other trust arrangements under which principal and income benefit individuals, private organiza�tions, or other governments." In essence, it is the default fund type for assets held in trust for someone outside thereporting government.

Agency Funds. GASBS No. 34, paragraph 73, provides that agency funds should be used to report resources heldin a purely custodial capacity for individuals or organizations outside the reporting government. The reportinggovernment's only responsibility is custodialto hold the assets and remit them to individuals or organizations thatown them.


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General Capital Assets and General Long�term Debt

GAAP distinguish between two types of capital assets and two types of long�term debt. The distinction arisesbecause of the different measurement focuses used for governmental funds versus proprietary and fiduciary funds.Governmental fund reporting measures only current financial resources (the current financial resources measure�ment focus). Proprietary and fiduciary fund reporting generally measures both financial and capital resources (theeconomic resources measurement focus).

�General capital assets" are defined in GASB Cod. sec. 1400.114 as the default category of capital assets. Generalcapital assets consist of all capital assets that are not specifically related to activities reported in proprietary orfiduciary funds. However, because they are not financial resources, general capital assets are not reported asassets in governmental funds but are reported only in the governmental activities column in the government�widestatement of net assets.

�General long�term debt" is defined in GASB Cod. sec. 1500.103 as the �unmatured principal of bonds, warrants,notes, and special assessment debt for which the government is obligated in some manner." General long�termdebt also includes the noncurrent portion of any other operating liability or formal debt issue that is not reported asa liability in a proprietary or fiduciary fund. However, GASB Cod. sec. 1500.103 limits operating liabilities that maybe reported as general long�term debt to liabilities on capital and operating leases, compensated absences, claimsand judgments, pensions, termination benefits, landfill closure and postclosure care, pollution remediation obliga�tions, and other commitments. General long�term liabilities also are not reported in the fund financial statements.Rather, they are reported only in the governmental activities column in the government�wide financial statements.


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79

SELF�STUDY QUIZ


24. What is �a fiscal and accounting entity with a self�balancing set of accounts recording cash and other financialresources, together with all related liabilities and residual equities or balances, and changes therein, which aresegregated for the purpose of carrying on specific activities or attaining certain objectives in accordance withspecial regulations, restrictions or limitations"?

a. A governmental entity.

b. A fund.

c. An opinion unit.

d. A governmental activity.

25. There are five types of governmental funds. What type of fund accounts for the proceeds of specific revenuesources that are legally restricted to expenditures for specified purposes?

a. Special Revenue Fund.

b. General Fund.

c. Proprietary Fund.

d. Permanent Fund.

26. What type of funds focus on both financial and capital and current and noncurrent resources?

a. General Funds.

b. Governmental Funds.

c. Proprietary Funds.

d. Special Revenue.

27. GASBS No. 34 requires governments to report an activity in an enterprise fund if certain criteria are met. Whichof these is one of those criteria?

a. Pricing policy is set by competition.

b. Regulations require that the activity's costs be recovered by taxes.

c. Net revenue from fees is pledged to debt as its sole security.

d. External users are charged a fee for goods or service.


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24. What is �a fiscal and accounting entity with a self�balancing set of accounts recording cash and other financialresources, together with all related liabilities and residual equities or balances, and changes therein, which aresegregated for the purpose of carrying on specific activities or attaining certain objectives in accordance withspecial regulations, restrictions or limitations"? (Page 71)

a. A governmental entity. [This answer is incorrect. Government entities are public corporations and bodiescorporate and politic or an entity that has one or more of three distinct characteristics as stated in SLGparagraph 1.01.]

b. A fund. [This answer is correct. A government is a combination of a broad variety of funds from anaccounting and reporting standpoint. Because there is a diversity of activities reported by agovernment, there is a need to use several separate funds, each reporting their own assets,liabilities, and equity.]

c. An opinion unit. [This answer is incorrect. An opinion unit refers to the level at which the basic materialitydetermination is made for planning, performing, evaluating, and reporting under the GASB 34 model.]

d. A governmental activity. [This answer is incorrect. A governmental activity is an activity financed throughtaxes, intergovernmental revenues, and other nonexchange revenues.]

25. There are five types of governmental funds. What type of fund accounts for the proceeds of specific revenuesources that are legally restricted to expenditures for specified purposes? (Page 72)

a. Special Revenue Fund. [This answer is correct. These funds can be used to report restrictedrevenues such as grants. If funds are not legally mandated, the use of the special revenue fundswould not be required.]

b. General Fund. [This answer is incorrect. The general fund �account[s] for all financial resources exceptthose required to be accounted for in another fund."]

c. Proprietary Fund. [This answer is incorrect. A proprietary fund is not a governmental fund. Ratherproprietary funds account for ongoing organizations that are similar to those found in the private sector.]

d. Permanent Fund. [This answer is incorrect. A permanent fund is used to report resources that are legallyrestricted to the extent that only earnings, and not principal, may be used for purposes that support thereporting government's programs. This might include parks, libraries, and museums.]

26. What type of funds focus on both financial and capital and current and noncurrent resources? (Page 75)

a. General Funds. [This answer is incorrect. The general fund is usually the government's main operatingfund and accounts for typical general government revenues and expenditures. Its focus is on currentfinancial resources only.]

b. Governmental Funds. [This answer is incorrect. Governmental funds focus on current financial resourcesonly. Financial assets are segregated into a governmental fund according to the purposes for which theyare used, and liabilities are segregated into the governmental fund from which they are to be paid.]

c. Proprietary Funds. [This answer is correct. Proprietary funds focus on all economic resources andtherefore account for all the assets, liabilities, equities, revenues, expenses, and transfers relatingto a government's business�like activities per GASB Code sec. 1300.102b.]

d. Special Revenue [This answer is incorrect. This governmental fund would be focused on current resourcesonly. Specific revenue sources that are legally restricted to expenditure for specified purposes areaccounted for in these funds.]


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27. GASBS No. 34 requires governments to report an activity in an enterprise fund if certain criteria are met. Whichof these is one of those criteria? (Page 75)

a. Pricing policy is set by competition. [This answer is incorrect. For this to be one of the three criteria requiredby GASBS No. 34, that would require a government to report an activity in an enterprise fund, pricing policywould need to be designed to recover its costs, not based on competitive pricing.]

b. Regulations require that the activity's costs be recovered by taxes. [This answer is incorrect. Fees andcharges would need to be legally mandated as the means of cost recovery, not taxes or similar revenuesas stated in the requirements of GASBS No. 34.]

c. Net revenue from fees is pledged to debt as its sole security. [This answer is correct. If the activityis financed with debt that is secured solely by a pledge of the net revenues from fees of the activity,the activity must be reported in an enterprise fund per GASBS 34, paragraph 67.]

d. External users are charged a fee for goods or service [This answer is incorrect. GASBS No. 34, paragraph67, permits the use of the enterprise fund, but does not require it when a fee is charged to external usersfor goods or services.]


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THE MEASUREMENT FOCUS FOR GOVERNMENTAL FINANCIALSTATEMENTS

The term measurement focus refers to what is being expressed in reporting financial position and performance, thatis, which resources are being measured. For example, the economic resources measurement focus measures bothfinancial and capital resources. A financial resources measurement focus measures only financial resources. Arelated aspect of measurement focus is consideration of when the effects of transactions affecting those resourcesare recognizedthe basis of accounting. Examples of bases of accounting include cash, budgetary, accrual, anda variety of possible modifications to accrual. Current GAAP for governments limits reporting to two pairings ofmeasurement focuses and bases of accounting, depending on which funds or activities and financial statementsare being presented:

� The current financial resources measurement focus and modified accrual basis of accounting are used toreport governmental funds in the fund financial statements.

� The economic resources measurement focus and accrual basis of accounting are used to reportproprietary and trust funds in the fund financial statements and governmental and business�type activitiesin the government�wide financial statements. (Exceptions apply to pension and other employee benefittrust funds.)

Because of the custodial nature of agency funds (that is, they do not have operations), the concept of measurementfocus, which centers on operations, is not applicable to agency funds.

GASBC No. 4, Elements of Financial Statements, paragraph 6, defines the term �resource" in the governmentalreporting context as, �an item that can be drawn on to provide services to the citizenry." GASB and NCGAstandards add the modifiers, �financial," �economic," �capital," �expendable," and �nonexpendable" to establishdefinitions of the financial resources and economic resources measurement focus and accrual and modifiedaccrual bases of accounting. Although GASB Concepts Statements are not authoritative, they are intended toprovide conceptual guidance that can be used as a basis for establishing consistent financial reporting standards.The GASB is currently working on a concepts project on recognition and measurement that is expected to clarifythe concepts of the two measurement focuses and bases of accounting. Initial deliberations on that project beganin December 2007; the GASB currently plans to issue a Preliminary Views document on the project in the firstquarter of 2010.

It is easy to confuse measurement focus and basis of accounting. In some cases, the two seem inextricably linked.This is particularly true for the financial resources measurement focuses. Using a financial resources measurementfocus, the basis of accounting helps to define which financial resources are measured. The current financialresource measurement focus uses the modified accrual basis of accounting to define which financial resources arecurrent.

Flow of Current Financial Resources Measurement FocusGovernmental Funds

The flow of current financial resources measurement focus provides useful information in governmental fundswhere the focus is on fiscal accountability. GASBS No. 34, paragraph 23, defines fiscal accountability as:

. . . is the responsibility of governments to justify that their actions in the current period havecomplied with public decisions concerning the raising and spending of public moneys in theshort term (usually one budgetary cycle or one year).

Use of the current financial resources measurement focus stems from the importance of legal appropriations andbudgetary control over the activities traditionally reported in governmental funds. Annual budgets estimate theresource inflows (revenues) expected primarily from taxes and the expenditure of those resources to providegeneral government services. The government's focus is on raising revenues and providing services for the year,not on earnings or the determination of net income. Thus, the measurement focus is on net financial resourcesavailable to provide services and the flow of those resources.


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Revenues and Expenditures. Under the flow of current financial resources measurement focus, revenues for aperiod are increases in expendable financial resources and expenditures are decreases in available expendablefinancial resources. Expenditures may be actual resource outflows or incurrences of liabilities that normally areexpected to be liquidated with expendable available financial resources. (GASBI No. 6, Recognition and Measure�

ment of Certain Liabilities and Expenditures in Governmental Fund Financial Statements, paragraph 14, asamended, defines this phrase by listing the modifications that make up the modified accrual basis of accountingand that define �current" financial resources.) For example, an expenditure and related liability for accrued payrollwould be reported. In addition to revenues and expenditures, governmental fund operating statements report�other financing sources" and �other financing uses," such as proceeds from debt issues and interfund transfers.

Assets. The flow of current financial resources measurement focus reports all financial resources in the govern�mental fund balance sheet but offsets those that are not available by deferred revenue or a reservation of fundbalance. Expendable financial resources are resources that are available for expenditure, that is, cash and claimsto cash (such as marketable securities and taxes receivable) that are expected to result in a cash receipt earlyenough in the following reporting period to be available to liquidate the current period's liabilities. If the nonexpend�able financial resource resulted from a revenue transaction (for example, a tax receivable expected to be collectedover an extended period of time), deferred revenue is recorded. If the nonexpendable financial resource resultedfrom a balance sheet transaction (for example, a long�term loan receivable), a reservation of fund balance isrecorded.

Liabilities. As a general rule, the current financial resources measurement focus reports all liabilities when they areincurred in the governmental fund balance sheet. However, GASBI No. 6, as amended, provides a list of excep�tionsthe long�term portion of those liabilities that the GASB has agreed do not require the use of availableexpendable financial resources (for example, general long�term debt, long�term tax anticipation notes payable, andcompensated absences).

Capital Assets. Under the flow of current financial resources measurement focus, when a general capital asset isacquired, the entire cost is recorded as an expenditure in the acquiring fund's operating statement. The consis�tency of this treatment with the measurement focus is apparent if the capital asset is acquired with cash. In thatcase, an expendable resource (cash) was used, and an expenditure equal to the use of financial resources isrecorded. The treatment as an expenditure is the same if the asset is acquired by incurring a liability, such as along�term note payable or a capital lease. In that case, the recording of an expenditure in the amount of the capitalasset would offset the recording of the related debt proceeds as an �other financing source" because the debtproceeds provided a capital asset instead of cash on hand. Exhibit 2�3 presents journal entries to illustrate therecording of capital asset acquisitions by a general fund.

Acquired capital assets do not provide financial resources. Thus, capital assets are not reported in the governmen�tal funds balance sheet. Instead, capital assets are reported only in the governmental activities column in thegovernment�wide statement of net assets. (However, it is recommended that governments maintain some form ofsubsidiary capital assets ledger to record all general capital asset transactions.) Exhibit 2�3 presents journal entriesto illustrate this acquisition of capital assets. When a general capital asset is donated to a government, no capitalexpenditure is reported because no financial resources have been used to acquire them. The fair value of thecapital asset is simply added to the government's general capital asset ledger.

Depreciation expense and amortization expense for intangible assets are not reported in the governmental fundoperating statement because the entire cost of the asset is recorded as an expenditure at the time it is acquired.Also, because depreciation and amortization do not decrease financial resources, not recording them in theoperating statement is consistent with the definition of an expenditure under the current financial resourcesmeasurement focus. (Depreciation/amortization expense is reported on general capital assets, however, in thegovernment�wide statement of activities.)


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Exhibit 2�3

Journal Entries for General Fund Acquisition of General CapitalAssets with Cash and with Issuance of General Long�term Debt

1. Assume that the general fund purchases a police car for $20,000. For simplicity, assume that it pays for the carwith cash available in the general fund.

General Fund

Expenditurespublic safetycapital outlay $ 20,000Cash $ 20,000

(To record purchase of police car. The government would also record the cost of the newasset in its general capital assets ledger.)

2. Assume that the general fund acquires two fire trucks for a total price of $150,000 and issues long�term generalobligation bonds to finance the purchase. For simplicity, assume that there were no debt issue costs and thatthere is no legal mandate for use of a debt service fund and that the debt service on the bonds will be paid fromunrestricted resources of the general fund.

General Fund

Cash $ 150,000Other financing sourcesproceeds of general

obligation bonds $ 150,000

(To record proceeds from issuance of long�term bonds.)

Expenditurespublic safetycapital outlay $ 150,000Cash $ 150,000

(To record purchase of fire trucks. The government would also record the cost of the newasset in its general capital assets ledger.)

* * *

Long�term Debt. A government's issuance of general long�term debt provides expendable financial resources(cash). Thus, the debt proceeds are reported as an �other financing source" in the governmental fund operatingstatement. However, the unmatured portion of general long�term debt (and other long�term obligations, such as forcompensated absences) is not payable from expendable available financial resources (as defined by GASBI No. 6)at the end of the reporting period. Instead, such obligations will be paid from future financial resources. Thus,general long�term debt and other noncurrent obligations (listed in GASBI No. 6, as amended) are not reported inthe balance sheet of governmental funds. Such obligations are reported only in the governmental activities columnof the government�wide statement of net assets. Item 2 in Exhibit 2�3 presents journal entries to record the issuanceof long�term debt in a governmental fund. Exhibit 2�4 illustrates entries to record the retirement of maturedlong�term debt.

When general long�term debt matures and is paid, the repayment decreases expendable available financialresources and the repayment is reported as an expenditure in the period when it is repaid. The debt is also nolonger reported in the governmental activities column of the government�wide statement of net assets. Exhibit 2�4illustrates entries to record the retirement of matured general long�term debt.


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Exhibit 2�4

Journal Entries to Record Retirement of General Long�term Debt

1. Assume that the $150,000 debt in item 2 of Exhibit 2�3 matures and is repaid from unrestricted resources of thegeneral fund. (For simplicity, assume that the bond is a term bond that matures all at the same time. Also, forsimplicity, interest payments are not illustrated. Use of a debt service fund for interest payments is illustratedin Exhibit 2�2.)

General Fund

Expendituresdebt serviceprincipal retirement $ 150,000Cash $ 150,000

(To record payment of matured general obligation bond principal.)

* * *

Flow of Economic Resources Measurement FocusProprietary and Fiduciary Funds

Proprietary fund reporting focuses on the determination of operating income, changes in net assets (or costrecovery), financial position, and cash flows. This focus stems from the fact that proprietary funds engage inbusiness�like activities and intend to recover some or all of the cost of the services provided through the user feescharged to the recipients of the services. All of the activity's costs must be determined to establish the appropriateuser fee. This is true whether the government's intent is that the proprietary activity operate at a profit (user fee willexceed costs), that it only break even (user fee will equal costs), or that it be subsidized (the user fee will not recoverall costs, but the true cost of providing the services must be determined to calculate the amount of the subsidynecessary). Thus, proprietary fund reporting focuses on the flow of economic resources, not just on currentfinancial resources. GASB Cod. sec. 1300.102c states that fiduciary funds reporting focuses on net assets andchanges in net assets. For this reason, fiduciary funds are reported using the same measurement focus.

Assets and Liabilities. The flow of economic resources measurement focus reports all resources and assets,whether financial (for example, cash) or capital (for example, capital assets), expendable or nonexpendable,current or noncurrent. The proprietary fund and fiduciary fund statements of net assets include all assets andliabilities, including capital assets and long�term debt and obligations. (In pension and other employee benefit trustfunds, however, recognition of liabilities of defined benefit pension and other postemployment benefit plans and isgoverned by GASBS No. 25, Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for

Defined Contribution Plans, and GASBS No. 43, Financial Reporting for Postemployment Benefit Plans Other Than

Pension Plans.) The acquisition and retirement of capital assets and long�term debt are reported in the samemanner as for a private�sector business enterprise. That is, the acquisition or retirement of the capital asset orlong�term debt is recorded as an increase or decrease in the statement of net assets, rather than as an expenditureor financing source.

Revenues and Expenses. The flow of economic resources measurement focus means that revenues areincreases earned from the provision of goods or services and that expenses are costs incurred to provide thoseservices, including the allocation of costs to the period in which the revenues were earned. (Taxes, contributions,and most grants are not �earned." These revenues should be recognized based on the criteria provided by GASBSNo. 33, Accounting and Financial Reporting for Nonexchange Transactions.) Note that the usual term �expenses,"is used, rather than the governmental term �expenditures." The major implication is that depreciation expense isrecorded in proprietary funds.

THE BASIS OF ACCOUNTING FOR GOVERNMENTAL FINANCIALSTATEMENTS

Whereas measurement focus refers to what types of resources are reported in fund financial statements, basis ofaccounting refers to when transactions are recognized. GASB Cod. sec. 1600.101 defines �basis of accounting" asfollows:


86

�Basis of accounting" refers to when revenues, expenditures, expenses, and transfersand therelated assets and liabilitiesare recognized in the accounts and reported in the financialstatements. Specifically, it relates to the timing of the measurements made. . . .

Thus, the measurement focus determines whether a fund balance sheet/statement of net assets reports financial oreconomic resources; the basis of accounting determines when those resources (or commitments/uses of thoseresources) should be recognized in the funds. GAAP provides for the use of two different bases of accounting bygovernmentsthe accrual basis and the modified accrual basis. The statement of principle at the beginning ofGASB Cod. sec. 1600 states that financial statements for governmental funds should be presented using themodified accrual basis of accounting and that proprietary and fiduciary fund financial statements should bepresented using the accrual basis of accounting.

Modified Accrual BasisGovernmental Funds

Revenue. The modified accrual basis of accounting is closely related to the flow of financial resources measure�ment focus used by governmental funds (general, special revenue, capital projects, permanent funds, and debtservice funds). GASB Cod. sec. 1600.106 states that, under the modified accrual basis of accounting, revenues andother increases in financial resources (such as bond proceeds) should be recognized when they become suscepti�ble to accrualthat is, when they become �both measurable and available" to pay liabilities of the current period.Measurable means that the amount is known or can be reasonably estimated. GASB Cod. sec. 1600.106 states thatavailable means that the amount is �collectible within the current period or soon enough thereafter" to be used topay current period liabilities.

The �measurable and available" criterion for revenue recognition under the modified accrual basis is most signifi�cant for tax revenue recognition. For example, taxes levied for the current period that are expected to be collectedwithin 60 days after the reporting period (the �availability period") are recognized as revenue because they will becollected soon enough to pay current�period liabilities. On the other hand, taxes levied for the current periodreceived more than 60 days after the end of the reporting period are generally not recognized as revenue in thecurrent period because they will not be collected soon enough to pay current�period liabilities.

Expenditures. NCGAS 1, GASBI No. 6, and GASBS No. 49, Accounting and Financial Reporting for Pollution

Remediation Obligations, together define the modifications that make up the modified accrual basis of accountingfor expenditure recognition. These modifications help governments to distinguish between the portions of liabilitiesthat should be reported as (a) fund liabilities and (b) general long�term debt. In the absence of an explicitrequirement to do otherwise (modification), expenditures should be recognized in the period in which a liability isincurred, if measurable. GASB Cod. sec. 1600.116 states that �most expenditures . . . are measurable and shouldbe recorded when the related liability is incurred."

GASB Cod. sec. 1600.120 establishes the first modification. It provides that governmental fund liabilities andexpenditures for debt service on general long�term debt (including capital leases and certain special assessmentdebt) should be recognized when due, not when incurred. This includes debt principal as well as interest. OtherGASB standards, principally GASBI No. 6, paragraph 14, as amended, provide a second set of modifications.Governmental fund liabilities and expenditures should only be recognized when they maturethat is, are due forpaymentfor these transactions:

� Compensated absences, claims and judgments, and landfill closure and postclosure care costs (GASBINo. 6, paragraph 11)

� Termination benefit costs (GASBS No. 47, paragraph 16)

� Expenditures arising from operating leases with scheduled rent increases. (GASBS No. 13, Accounting for

Operating Leases with Scheduled Rent Increases, paragraphs 5 and 6, as amended)

� Pension contributions (GASBS No. 27, as amended and clarified.)

� Other postemployment benefit (OPEB) contributions (GASBS No. 45, Accounting and Financial Reporting

by Employers for Postemployment Benefits Other Than Pensions, paragraphs 19 and 23, as clarified.)


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� Pollution remediation obligations (GASBS No. 49, paragraph 24).

Finally, GASBI No. 6, paragraph 17, also provides that there may be other long�term commitments that are notproperly recorded in governmental funds. This paragraph acknowledges that there may be other forms of generallong�term debt that should be excluded from governmental fund financial statements. An example would be thenoncurrent portion of landfill closure and postclosure care costs before explicit recognition criteria (GASBS No. 18,Accounting for Municipal Solid Waste Landfill Closure and Postclosure Care Costs) were issued.

Accrual BasisProprietary Funds

Using the accrual basis, transactions are recorded when they occur, regardless of when cash is received or paid.Proprietary fund revenues and expenses (and assets and liabilities) should be recognized on the accrual basis,with revenues recognized in the accounting period when they are earned (or when certain recognition require�ments are met for nonexchange transactions) and become measurable, and expenses recognized in the periodincurred, if measurable. Thus, for example, a proprietary fund recognizes revenue in the period in which a serviceis provided, regardless of how long after the end of the period the revenue is expected to be collected. The accrualbasis of accounting is consistent with the proprietary fund reporting focus on determining operating income andchanges in net assets (cost recovery).

Accrual BasisFiduciary Funds

Using the accrual basis of accounting, fiduciary funds record most transactions when they occur (or when certainrecognition requirements have been met for grants and contributions), regardless of when cash is received or paid.An exception is recognition of certain liabilities of defined benefit pension plans and postemployment healthcareplans.


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89

SELF�STUDY QUIZ


28. The concept of measurement focus applies to all except for?

a. Agency funds.

b. Governmental funds.

c. Proprietary funds.

d. Trust Funds.

29. Where is the government's primary focus in governmental activities such as general government services?

a. Determination of net income for the year.

b. Earnings for the current period.

c. Net financial resources available for the current year.

d. Raising revenue and providing services for the next five years.

30. Which transaction would result in recording of a reservation of fund balance?

a. An expendable financial resource not yet received, but expected to be received to liquidate the currentperiod liabilities.

b. An expendable financial resource resulting from receipt of cash.

c. A nonexpendable financial resource resulting from a revenue transaction.

d. A nonexpendable financial resource from a balance sheet transaction.

31. What entry should be made to the government's books for the donation of a general capital asset?

a. Fair value of asset is recorded in the government fund balance sheet.

b. Fair value of the capital asset is added to the government's general capital asset ledger only.

c. Fair value of asset is recorded in the activities column in the government�wide statement of net assets.

32. When should bond proceeds be recognized in a governmental fund?

a. When they are measurable.

b. When they are recorded, regardless of if it was received.

c. When they become susceptible to accrual.


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33. Absent a requirement to do otherwise, when should an expenditure be recognized under the modified accrualbasis of accounting?

a. When a liability matures.

b. When a liability is due.

c. When a liability is incurred, if measurable.


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28. The concept of measurement focus applies to all except for? (Page 82)

a. Agency funds. [This answer is correct. Measurement focus refers to which resources are beingmeasured in the reporting of financial position and performance. In other words, measurementfocus centers on operations which is not applicable to agency funds as they are being held in thegovernment's custody only. Agency funds do not have operations.]

b. Governmental funds. [This answer is incorrect. Measurement focus applies to governmental funds bymeans of the current financial resources measurement focus and modified accrual basis of accounting.]

c. Proprietary funds. [This answer is incorrect. Measurement focus applies to proprietary funds by mean ofthe economic resources measurement focus and accrual basis of accounting.]

d. Trust Funds. [This answer is incorrect. Trust funds are reported by use of the economic resourcesmeasurement focus and accrual basis of accounting. Exceptions apply to pension and other employeebenefit trust funds and are governed by GASBS No. 24 and GASBS No. 43.]

29. Where is the government's primary measurement focus in governmental activities such as general governmentservices? (Page 82)

a. Determination of net income for the year. [This answer is incorrect. The government's focus can't be ondetermining net income due to the focus on fiscal accountability, which is not about net income.]

b. Earnings for the current period. [This answer is incorrect. Due to the focus on fiscal accountability wheregovernments are responsible for justifying their actions in the current period, earnings is not one of theiractions the government needs to focus on.]

c. Net financial resources available for the current year. [This answer is correct. The government mustbe focused on raising revenues and providing services for the current year, and therefore, themeasurement focus is on net financial resources available to provide services and the flow of thoseresources, and not on earnings or determination of income.]

d. Raising revenue and providing services for the next five years. [This answer is incorrect. Governments arefocused on the current year only. They are working with the raising and spending of moneys in the shortterm which is usually one budgetary cycle or one year.]

30. Which transaction would result in recording of a reservation of fund balance? (Page 83)

a. An expendable financial resource not yet received, but expected to be received to liquidate the currentperiod liabilities. [This answer is incorrect. Although the financial resource is not yet available, it will beavailable in the current period and will be available to liquidate the current liabilities. Therefore, noreservation of fund balance needs to occur for this current year.]

b. An expendable financial resource resulting from receipt of cash. [This answer is incorrect. The receipt ofcash would result in a tangible financial resource that would not cause a reservation of fund balance. Ratherthe entry would be an increase in cash and an increase in the source of cash such as tax proceeds.]

c. A nonexpendable financial resource resulting from a revenue transaction. [This answer is incorrect. Arevenue transaction of nonexpendable financial resources results in deferred revenue. An example of thiswould be a tax receivable expected to be collected over an extended period of time.]

d. A nonexpendable financial resource from a balance sheet transaction. [This answer is correct. Allfinancial resources in the governmental fund balance sheet are reported by the flow of current


92

financial resources measurement focus, but the offset is deferred revenue or a reservation of fundbalance for those financial resources that are not currently available. A balance sheet transactionof nonexpendable financial resources results in a reservation of fund balance. An example of thiswould be a long�term loan receivable.]

31. What entry should be made to the government's books for the donation of a general capital asset? (Page 83)

a. Fair value of asset is recorded in the government fund balance sheet. [This answer is incorrect. Capitalassets, however they are acquired, purchased or donated, do not provide financial resources, so they arenot reported in the governmental funds balance sheet.]

b. Fair value of the capital asset is added to the government's general capital asset ledger only. [Thisanswer is correct. Because no financial resource was used to acquire the asset, no capitalexpenditure is reported. Adding the asset to the government's general capital asset ledger is all thatis required.]

c. Fair value of asset is recorded in the activities column in the government�wide statement of net assets. [Thisanswer is incorrect. If the capital asset was purchased by the government, this is what would have beendone, but, because the asset was donated, there is another method.]

32. When should bond proceeds be recognized in a governmental fund? (Page 86)

a. When they become measurable to pay current liabilities. [This answer is incorrect. It would depend onwhether the availability period was in relation to the reporting period.]

b. When they are recorded, regardless of if it was received. [This answer is incorrect. This is the basis fortransactions in the proprietary fund using the accrual basis.]

c. When they become susceptible to accrual. [This answer is correct. Governmental funds are requiredto present their statements on the modified accrual basis of accounting. Under that basis ofaccounting, revenues should be recognized when they become susceptible to accrual, whichmeans when they become �both measurable and available" to pay liabilities of the current period.]

33. Absent a requirement to do otherwise, when should an expenditure be recognized under the modified accrualbasis of accounting? (Page 86)

a. When a liability matures. [This answer is incorrect. In the case of an explicit requirement to do otherwise(modification), an expenditure could be recognized in this way, but this is not the standard procedure.]

b. When a liability is due. [This answer is incorrect. The first modification is established in GASB Cod. Sec.1600.120. It provides that governmental fund liabilities and expenditures for debt service on generallong�term debt should be recognized when due, not when incurred.]

c. When a liability is incurred, if measurable. [This answer is correct. GASB Cod. Sec. 1600.116 statesthat �most expenditures . . . are measurable and should be recorded when the related liability isincurred."]


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ACCOUNTING FOR AND REPORTING ON CAPITAL ASSETS

GAAP distinguish between two types of capital assets of governments�general capital assets" and capital assetsreported in proprietary funds and in fiduciary funds. The distinction arises because of the different measurementfocuses used for governmental funds versus proprietary and fiduciary funds. Governmental fund reporting mea�sures only financial resources. Proprietary and fiduciary fund reporting generally measures both financial andcapital resources.

Reporting Capital Asset Transactions in Governmental Funds

GASB Cod. sec. 1400 Statement of Principle provides this general rule:

A clear distinction should be made between general capital assets and capital assets ofproprietary and fiduciary funds. Capital assets of proprietary funds should be reported in both thegovernment�wide and fund financial statements. Capital assets of fiduciary funds (and similarcomponent units) should be reported only in the statement of fiduciary net assets. All other capitalassets of the governmental unit are general capital assets. They should not be reported as assetsin governmental funds but should be reported in the governmental activities column in thegovernment�wide statement of net assets.

General capital assets are the default category of capital assets. General capital assets consist of all capital assets,including intangible assets, that are not specifically related to activities reported in proprietary or fiduciary funds.Because they are not financial resources, general capital assets are not reported as assets in governmental fundsbut are reported in the governmental activities column in the government�wide statement of net assets.

Governmental funds report only the financial resource flows that arise from capital asset acquisition or disposition.Capital assets acquired with cash or debt are reported as capital expenditures equal to the amount of cash paidand/or debt incurred (for example, bonds or capital leases). Transactions in which capital assets are acquiredwithout financial resourcesfor example through donation or through transfer from a proprietary funddo notaffect and are not reported in governmental fund financial statements.

Sales of general capital assets are reported in the governmental fund operating statement only if cash or areceivable is generated by the transaction. If an asset is given away, razed, or hauled off to the dump, nothing isreported unless the contractor or hauler charges a fee for its services (resulting in an expenditure) or pays thegovernment for the scrap (a miscellaneous revenue).

Maintaining a General Capital Assets Ledger. Prior to GASBS No. 34, the general fixed assets account group(GFAAG) was used to establish accounting control and accountability for a government's general fixed (capital)assets. Although GASBS No. 34 eliminated the use of a GFAAG for financial reporting purposes, it is recommendedthat governments continue to maintain some form of subsidiary capital assets ledger that is, in effect, a databasefor general capital assets reported on the accrual basis in the government�wide statement of net assets.

Acquisition of General Capital Assets. Capital assets may be acquired in many ways. They may be purchasedwith cash or by incurrence of debt or a capitalizable lease. They may be acquired by trade�in of another asset orthey may be constructed or otherwise internally generated by the government. Also, they may be acquired bydonation, grant, or transfer from a proprietary fund. Particularly for constructed assets, a capital projects fund isinvolved in the accounting for the resources used in the acquisition, and the accounting can be complex. Theaccounting in the capital projects fund was briefly summarized earlier in this lesson. Exhibit 2�1 presents thecorresponding journal entries. The accounting for internally generated intangible assets can also be quite complex.

Under the flow of current financial resources measurement focus, when a general capital asset is acquired,constructed, or internally generated the entire cost is reported as an expenditure in the acquiring fund's operatingstatement. The consistency of this treatment with the measurement focus is apparent if the capital asset is acquiredwith cash. In that case, an expendable resource (cash) was used, and an expenditures equal to the use of financialresources is recorded. The treatment as an expenditure is the same if the asset is acquired by incurring a liability,such as a long�term note payable or a capital lease. In that case, the recording of an expenditure in the amount of


94

the capital asset would offset the recording of the related debt proceeds as an �other financing source" because thedebt proceeds would have provided a capital asset instead of cash on hand. According to GASBS No. 49,paragraph 19, outlays associated with intangible assets should be reported as expenditures when incurred. Exhibit2�3 illustrates journal entries needed to record general capital asset acquisitions by a general fund.

When a general capital asset is donated to a government, no capital expenditure is reported because no expend�able resources have been used to acquire the asset. The fair value of the capital asset is simply added to thegovernment's general capital assets ledger.

Depreciation/amortization expense is not reported in governmental funds. Depreciation is neither a source nor ause of governmental fund financial resources, and thus is not properly recorded in the accounts of those funds.

Sales and Other Dispositions of General Capital Assets. If a general capital asset wears out and is discarded oris lost or destroyed, no entry is made in the governmental fund financial statements. (The cost of the asset lessaccumulated depreciation is removed from the general capital asset ledger). However, the sale of a general capitalasset is recorded in a governmental fund operating statement because the sale provides an expendable financialresource (for example, cash). The cash proceeds are reported either in the fund that originally paid for the asset orin the general fund as an �other financing source."

If an asset is traded for another asset, the accounting for the disposition of the traded�in asset is part of theaccounting for the acquisition of the new asset.

Reporting Capital Assets in Proprietary and Trust Funds

Capital assets of proprietary and trust funds are reported in the same manner as that of private�sector businessenterprises. GASB Cod. sec. 1400.115�.116 requires capital assets of proprietary and fiduciary funds to beaccounted for in those funds. Thus, a proprietary fund reports capital assets (at historical cost) and accumulateddepreciation in its statement of net assets and depreciation expense in its statement of revenues, expenses, andchanges in fund net assets. (GASBS No. 51, Accounting and Financial Reporting for Intangible Assets, clarifies thatthe term depreciation includes amortization of intangible assets.) A trust fund reports capital assets and accumu�lated depreciation in its statement of fiduciary net assets and depreciation expense in its statement of changes infiduciary net assets. GASBS No. 25 and GASBS No. 52, Land and Other Real Estate Held as Investments by

Endowments, require different accounting and reporting for capital assetssuch as real estateheld as invest�

ments.

Capitalization. Subject to the governmental entity's capitalization threshold all proprietary fund capital assetsshould be capitalized in the proprietary fund statements of net assets. Purchased, constructed, or internallygenerated assets of proprietary funds are recorded at cost, including capitalized interest. Contributed assetsshould be recorded at their estimated fair value.

Depreciation Expense. As discussed in GASB Cod. sec. 1400.104, proprietary and trust fund capital assetsshould be depreciated/amortized over their estimated useful lives unless they are inexhaustible, are intangibleassets with indefinite useful lives, or are infrastructure assets reported using the modified approach.

Sales of Capital Assets. Sales or other dispositions of capital assets of proprietary and trust funds normallygenerate a gain or loss reported in the fund's operating statement. Special rules apply to trade�ins.

CONSIDERATIONS FOR DEBT AND OTHER LONG�TERM LIABILITIES

Because of the different basis of accounting used in governmental funds versus proprietary (and fiduciary) funds,the long�term portion of formal debt issuances and other long�term operating liabilities is reported differently inthese two fund categories.

Governmental Funds

Current versus Long�term Debt. The distinction of debt as current or long�term has significant accountingimplications for governmental funds. Debt that is not considered long�term is reported in the fund balance sheet as


95

a fund liability and its acquisition and repayment are accounted for in the same manner as for a business enterprise.Long�term debt is recorded in governmental fund balance sheets when it matures (comes due for payment).

Sometimes the determination of whether debt should be accounted for as long�term debt is not clear�cut. Forexample, some long�term bonds have a demand provision that allows bondholders to demand redemption beforethe specified maturity date. Or, a government may issue a bond anticipation note (BAN), which is a short�term noteissued with the intent of replacing it with a long�term bond.

Also, note that the portion of general long�term debt that matures within the current year is not reported in thegovernmental fund balance sheet except in two instances. First, if the current portion of debt principal and interestremains unpaid at its due date, the current portion is reported as a fund liability until paid. Second, governmentshave the option to report the current portion of principal and interest as a fund liability if due early in the followingyear when resources have already been set aside for payment of these amounts in a debt service fund.

Short�term Debt. GASB Cod. sec. B50.101 requires that governmental funds report certain bond anticipationnotes as a liability of the fund that receives the debt proceeds. The debt service fund is not used to account for debtservice (interest or principal) of such short�term debt. The debt service fund is required to be used only if legallyrequired or if resources are being accumulated for the payment of general long�term debt interest and principal.GASB Cod. sec D30 establishes criteria for assessing when certain demand bonds should be reported as fundliabilities and not as general long�term debt.

Thus, when governmental fund debt that meets specific criteria as short�term debt is issued, it is reported directlyas a fund liability in the governmental fund balance sheetthe proceeds are not reported as an �other financingsource" in the fund operating statement. Principal repayment is reported as a reduction of the fund liability ratherthan as a debt service expenditure.

General Long�term Debt. The proceeds from the issuance of general long�term debt (including capital leases) arereported as an �other financing source" in a governmental fund's operating statement. Entry 1 of Exhibit 2�1illustrates the entry recording issuance of a long�term general obligation bond.

Exhibit 2�2 illustrates the use of the debt service fund to report resources transferred to it, or accumulated by it, toservice debt interest and principal. Interest paid from resources of the debt service fund is reported as an expendi�ture in the debt service fund operating statement. Principal paid is also reported as an expenditure of the debtservice fund.

Note that a debt service fund is not always used when general long�term debt is issued and serviced. As previouslyexplained, use of a debt service fund is not required unless resources for debt servicing are accumulated or unlessits use is legally mandated. Sometimes, interest and principal payments on general long�term debt are made fromunrestricted assets of the general fund and are reported as expenditures in that fund. Exhibit 2�3, example 2, andExhibit 2�4 present such an example.

A government may issue long�term debt to finance capital projects, with the resources to repay the debt to beprovided from special assessments on the property owners that benefit from the capital project.

When current interest rates are below the rate at which a government issued long�term debt, the government maytake advantage of the rate decline by issuing new long�term debt at the lower rate. The new debt proceeds may beused to refund the old, more costly debt in advance of its maturity date or to provide lower�cost resources forpayment of interest or principal on the old debt as it becomes due or matures.

Governmental Long�term Obligations Other Than Debt. Certain long�term operating liabilitiesother thanformal debt issuancesare also reported as general long�term liabilities in eight defined situations that make upthe modified accrual basis of accounting for governmental fund expenditures. These include liabilities for claimsand judgments, compensated absences, termination benefits, landfill closure and postclosure care, liabilitiesrelated to operating leases with scheduled rent increases, pension and other postemployment benefits, andpollution remediation obligations. These liabilities are not reported in governmental funds because they do notrepresent claims on current financial resources, but on future financial resources. Rather, they are reported asexpenditures and liabilities when due and payable.


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Debt of Proprietary Funds

Short�term and long�term debt of proprietary funds and trust funds and debt expected to be paid from assets ofthose funds are accounted for in the same manner as debt of private�sector business enterprises. Generalobligation bonds are backed by the full faith and credit of the government. However, if general obligation debt isexpected to be paid from a proprietary fund, the debt (and its interest and principal payments) should be reportedin the proprietary fund's statement of net assets, not as general long�term debt. The debt is reported in theproprietary fund statement of net assets, and its issuance or repayment does not affect the proprietary fund'soperating statement.

Proprietary funds may refund old debt by issuing new debt at lower interest rates. Section 908 discusses theaccounting requirements for debt refundings and debt extinguishments; the requirements differ from those applica�ble to refundings by governmental funds.

GASB Cod. sec. 1500.102 also requires long�term liabilities such as for capital leases, claims and judgments,compensated absences, termination benefits, pollution remediation obligations, and pensions �directly related toand expected to be paid from proprietary funds and trust funds" to be included in those fund accounts.

REPORTING INTERFUND ACTIVITY

From an accounting and reporting standpoint, each government is a combination of a broad variety of funds, �eachhaving a separate set of accounts and functioning independently of other funds. . . ." Yet, these separate andindependently functioning funds often interact with each other. For example, one fund may pay a bill on behalf ofanother fund for convenience and then seek reimbursement from that other fund. An internal service fund bills otherfunds for services it provides to them. Or, one fund may borrow money from another fund. Also, the general fundmay subsidize the operations of a proprietary fund. These are just some of the activities that may take placebetween funds.

A unique characteristic of governmental financial reporting is that these interfund activities and balances are notrequired to be eliminated in the fund financial statements. They generally are not eliminated because each fundaccounts for resources that cannot be intermingled with those of other funds. GASBC No. 4, Elements of Financial

Statements, paragraph 40, notes that interfund balances and activities do not meet the definition of �elements" offinancial statements but are needed to fairly present the reporting units of governmentstheir funds. Thus, thereare unique and specific terminology, accounting, and financial reporting standards related to a government'sinterfund activities and balances. (The GASB does not use the label interfund �transactions" because the termtransactions is limited to describing external eventsthat is, flows of resources to or from someone or somethingoutside the primary government.) For this purpose, interfund means between the funds of the primary government,including those of its blended component units. Discretely presented component units are treated as external to theprimary government.

GASBS No. 34, paragraph 112, defines four types of interfund activity and classifies each either as reciprocal

interfund activity or nonreciprocal interfund activity. Reciprocal interfund activity is the internal counterpart toexchange and exchange�like transactions entered into with entities outside the primary government. In anexchange transaction, each party to the transaction receives and gives up essentially equal values. An example isa charge for the use of electricity or water. Reciprocal interfund activity consists of:

� Interfund loans, and

� Interfund services provided and used.

Nonreciprocal interfund activity is the internal counterpart to nonexchange transactions entered into with entitiesoutside the primary government. It consists of:

� Interfund transfers, and

� Interfund reimbursements.


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In a nonexchange transaction, a government gives (or receives) value without directly receiving (or giving) equalvalue in return. Most grants and contributions are examples of nonexchange transactions.

Reimbursements

GASBS No. 34, paragraph 112, defines interfund reimbursements as �repayments from the funds responsible forparticular expenditures or expenses to the funds that initially paid for them." Interfund reimbursements are requiredto be reported �net" and, therefore, are not displayed in the financial statements. For example, expenditures forsupplies properly chargeable to several special revenue funds may have been paid by the general fund. Repay�ments made by the special revenue funds would be reported as expenditures in those funds and as reductions ofexpenditures in the general fund. GASBS No. 34, paragraph 410b, notes that, in essence, reimbursements simplyreallocate revenues and expenditures or expenses between funds.

Reimbursements often are made for expediency, administrative convenience, or because of a fund classificationerror when first recording an item. For example, the general fund may have paid (and recorded as an expenditure)the salary of a person who is working on a program reported in the special revenue fund because at the time thesalary was paid it was not evident that the salary related to the special revenue fund program. The general fundwould charge the special revenue fund for the salary paid.

Interfund Services Provided and Used

As defined in GASBS No. 34, paragraph 112, interfund services provided and used are �sales and purchases ofgoods and services between funds for a price approximating their external exchange value." Interfund servicesprovided and used should be reported as revenues in seller funds and expenditures or expenses in purchaserfunds. Unpaid amounts should be reported as interfund receivables and payables in the fund balance sheets orfund statements of net assets.

Interfund services provided and used are the only interfund activities for which it is proper to recognize revenuesand expenditures or expenses in the funds when the transactions are not external to the primary government andits blended component units. These transactions result in revenues reported in the fund providing the goods orservices and expenditures or expenses reported in the fund receiving the goods or services. The accountingrecords should only record an interfund service provided or used when these services are routinely provided toexternal organizations and the charges are at established standard rates.

If, for instance, a general fund obtained printing services from a private�sector commercial printer, the general fundwould record an expenditure for the printing bill. In the same way, if the general fund obtains the printing servicefrom an internal service fund instead of from a private�sector printer and is billed for the service, the general fundshould record an expenditure and the internal service fund should record revenue.

Interfund Transfers

GASBS No. 34, paragraph 112, defines interfund transfers as �flows of assets (such as cash or goods) withoutequivalent flows of assets in return and without a requirement for repayment." In governmental funds, operatingtransfers should be reported as other financing uses in the funds making transfers and as other financing sourcesin the funds receiving transfers. In proprietary funds, transfers should be reported after nonoperating revenues andexpenses and capital contributions. Transfers should be reported in the period in which the interfund receivableand payable arises.

GASBS No. 34, paragraph 112, establishes that payments in lieu of taxes �that are not payments for, and are notreasonably equivalent in value to, services provided" should be reported as interfund transfers in both the payingand receiving funds. (If a government is able to demonstrate that payments in lieu of taxes are for identifiableservices and that the amount of the payments is reasonably equivalent to the value of the services, they should bereported as interfund services provided and used.)

Interfund Loans

Defined in GASBS No. 34, paragraph 112, interfund loans are �amounts provided with a requirement for repay�ment." Interfund loans should be reported as interfund receivables in the balance sheets/statements of net assets


98

of the lender funds and interfund payables in borrower funds. Because they are internal, they should not bereported in the same way as other debt issuances in governmental funds. That is, they should not be reported asother financing sources or uses in the governmental fund financial statements. With the single exception (certainunpaid pension or other postemployment benefits contributions), liabilities arising from interfund activities shouldalways be reported as fund liabilities in governmental funds, never as general long�term liabilities.

Interfund loans are amounts provided between funds with a requirement for repayment. Interfund loans may resultfrom:

� Interfund reimbursements.

� Interfund transfers.

� Interfund services provided and used.

� Overdraft of a fund's share of an internal investment pool.

� Properly authorized loans and advances between funds.

Governments may but are not required by GAAP to distinguish between the types of interfund loansfor example,with labels such as �due to/from" or �advances to/from." However, it is recommended that governments continueto distinguish between the types of interfund loans using the classification scheme that predated GASBS No. 34.Under that scheme, interfund loans are broadly grouped as follows:

a. Due to/from balances.

b. Fund equity in pooled cash.

c. Advances to/from.


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SELF�STUDY QUIZ


34. Which statement concerning capital assets listed below is correct?

a. The sale of a general capital asset should be reported in the governmental fund operating statement.

b. The scrap cash proceeds from the sale of a capital asset to a hauler should be reported in the general fundas an �other financing source."

c. GASB No. 34 requires that a general fixed assets account group (GFAAG) is used to establish accountingcontrol and accountability for a government's general fixed assets.

d. When an general capital asset that wears out and is discarded, an entry is made to the fund's operatingstatement.

35. How should long�term governmental fund debt be reported?

a. Report proceeds as an �other financing source" in the fund operating statement.

b. Principal and interest repayment are always reported as debt service expenditures.

c. Report in the governmental fund balance sheet as a fund liability when incurred.

d. Principal and interest repayment are always reported as general fund expenditures.

36. Interfund activity occurs because there are separate and independently functioning funds interacting with oneanother. Which statement listed below is correct concerning how interfund activity is accounted for?

a. Interfund activities and balances are required to be eliminated in the fund financial statements.

b. Reciprocal interfund activity consists of interfund transfers and interfund reimbursements.

c. Payments received in lieu of taxes that are identifiably related, and equivalent in value to, the servicesprovided should be reported as interfund services provided.

d. Liabilities that arise from interfund activity should always be reported as general long�term liability.


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34. Which statement concerning capital assets listed below is correct? (Page 94)

a. The sale of a general capital asset should be reported in the governmental fund operating statement.[This answer is correct. An expendable financial resource is provided with the sale of the asset. Thecash proceeds are reported as an �other financing source" in the fund that originally paid for theasset or the general fund.]

b. The scrap cash proceeds from the sale of a capital asset to a hauler should be reported in the general fundas an �other financing source." [This answer is incorrect. The proceeds should be reported asmiscellaneous revenue as the asset was basically discarded or thrown away.]

c. GASBS No. 34 requires that a general fixed assets account group (GFAAG) is used to establish accountingcontrol and accountability for a government's general fixed assets. [This answer is incorrect. GASBS No.34 eliminated the use of a GFAAG. However, it is recommended that governments continue to use this tool.]

d. When an general capital asset that wears out and is discarded, an entry is made to the fund's operatingstatement. [This answer is incorrect. No entry needs to be made in the governmental fund financialstatements. All that needs done is the cost of the asset less accumulated depreciation is removed fromthe general capital asset ledger.]

35. How should long�term governmental fund debt be reported? (Page 95)

a. Report proceeds as an �other financing source" in the fund operating statement. [This answer iscorrect. The entry to record the proceeds receipt would be a debit to cash and a credit to �OtherFinancing SourcesProceeds of General Obligation Bonds" in the capital projects fund.]

b. Principal and interest repayment are always reported as debt service expenditures. [This answer isincorrect. Debt is only reported in the debt service fund if legally required or the resources to repay the debtare being accumulated.]

c. Report in the governmental fund balance sheet as a fund liability when incurred. [This answer is incorrect.Long�term debt should not be reported on the governmental fund balance sheet until the debt hasmatured, which means it is due to be paid.]

d. Principal and interest repayment are always reported as general fund expenditures. [This answer isincorrect. Under certain circumstances, principal and interest repayment should be reported in the debtservice fund.]

36. Interfund activity occurs because there are separate and independently functioning funds interacting with oneanother. Which statement listed below is correct concerning how interfund activity is accounted for? (Page 97)

a. Interfund activities and balances are required to be eliminated in the fund financial statements. [Thisanswer is incorrect. This is a unique characteristic of governmental financial reporting that interfundactivities and balances are not required to be eliminated from the fund financial statements. This is becauseintermingling of funds is not allowed.]

b. Reciprocal interfund activity consists of interfund transfers and interfund reimbursements. [This answer isincorrect. These are activities classified as nonreciprocal interfund activities as they are nonexchangetransactions occurring between funds.]

c. Payments received in lieu of taxes that are identifiably related, and equivalent in value to, theservices provided should be reported as interfund services provided. [This answer is correct.


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Payments that cannot be identified with a specific service and not reasonably equivalent to theservice provided should be reported as an interfund transfer per GASBS No. 34, paragraph 112.]

d. Liabilities that arise from interfund activity should always be reported as general long�term liability. [Thisanswer is incorrect. Liabilities arising from interfund activities should always be reported as fund liabilitiesin governmental funds, never as general long�term liabilities. The single exception to this rule is certainunpaid pension or other postemployment benefits contributions.]


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FUND BALANCES, NET ASSETS, AND FUND EQUITY

As with measurement focus and basis of accounting, the terms used to describe the difference between fundassets and liabilities of governmental versus proprietary and fiduciary funds (and specific components of thatdifference) are dissimilar. This difference is labeled �fund balance" for governmental funds. Components of thatdifference may be labeled, �reserved," �unreserved," �designated," or �undesignated." The use of these termsstems from the importance of legal appropriations and budgetary control over the activities traditionally reported ingovernmental funds. (The GASB has issued Statement No. 54, Fund Balance Reporting and Governmental Fund

Type Definitions, which replaces the current components of governmental fund balances with five new classifica�tions. GASBS No. 54 is effective for periods beginning after June 15, 2010.) Proprietary funds, on the other hand,must label the difference between assets and liabilities as �net assets" or �fund equity." Components of netassets/fund equity are �invested in capital assets, net of related debt," �restricted net assets," and �unrestricted netassets." These labels are the same as those required in the government�wide statement of net assets. Fiduciaryfunds, which report only assets held in a trustee or agency capacity for individuals, private organizations, or othergovernments, report only �net assets held in trust."

Governmental Fund Reserves

GASB Cod. sec. 1800.142 states that a reserve is �that . . . portion of the fund balance [that] is not appropriable forexpenditure or is legally segregated for a specific future use." Both types of reserves generally represent itemsreported in the balance sheet that are not available for use at the balance sheet date, either because of their natureor because of legal restrictions on their use. Note that a valuation allowance, for instance, an allowance foruncollectible accounts receivable, is not the same thing as a reserve. Thus, the term �reserve" should not be usedfor valuation allowances. For instance, instead of �reserve for uncollectible accounts," terminology such as �allow�ance for uncollectible accounts" should be used.

Governmental Fund Reserves for Assets Unavailable for Future Appropriation

For governmental funds, the measurement focus is on current financial resources, that is, on cash and claims tocash (such as marketable securities and taxes receivable) expected to result in a cash receipt soon enough in thefollowing reporting period to be available to liquidate the current period's liabilities. Generally, only availableexpendable financial resources are reported as fund assets in governmental fund balance sheets. However, thereare a few exceptions where nonmonetary or nonliquid assets are reported but are also offset by a reserve of fundbalance to indicate their nonexpendable nature. These exceptions include interfund advances and other long�termreceivables, inventory, and prepaid items. They are discussed in the following paragraphs.

Reserves for Advances and Long�term Receivables. Long�term interfund advances are reported in governmen�tal fund balance sheets. Other long�term receivables not associated with revenue recognition may also be reportedin the governmental fund balance sheet, for example, a long�term loan receivable. Because the receivables arelong�term, they are not expected to result in cash receipts soon enough after the balance sheet date to be availableto pay the current period's liabilities. Thus, a portion of fund balance is reserved to indicate this fact. The reclassifi�cation entry to record the reserve would be as follows:

Fund balanceunreserved, undesignated $ XXXFund balancereserved for interfund advances $ XXX

If a long�term receivable is associated with revenue that has been deferred, then a fund balance reservation is notnecessary because the deferred revenue balance indicates the nonavailable nature of the receivable. For instance,a reservation of fund balance is not required for the capital improvement special assessment receivables becausedeferred revenue is also reported.

Reserves for Inventory and Prepaid Items. GASB Cod. sec. 1600.127 gives governmental funds two options foraccounting for inventories and prepaid itemsthe �purchases" method or the �consumption" method. Using thepurchases method, materials and supplies are charged as an expenditure when the item is acquired. When thismethod is used, GASB Cod. sec. 1600.127a requires significant amounts of inventory to be reported in the balancesheet. Thus, materials and supplies on hand at the reporting date are recorded as an asset (a debit), with a


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corresponding credit to fund balance as a reserve for inventory. Note that the expenditure previously recorded isnot reversed. Thus, the final result is that the governmental fund reports the inventory both as an expenditure andan asset. The reserve is required because the amount has already been charged as an expenditure.

GASB Cod. sec. 1600.127b states that prepaid items, such as insurance premiums, may be accounted for as anexpenditure when acquired and need not be allocated among periods. A governmental fund that uses such apurchases method for prepaid items may report a prepaid item by reserving fund balance, but unlike the inventorysituation described in the preceding paragraph, is not required to do so.

Under the consumption method, materials and supplies or prepaid items are reported as inventory or a prepaidasset when purchased and are recognized as an expenditure when used. The consumption method does notrequire a reservation of fund balance. However, as noted in SLG, paragraph 10.14, some governments reclassify aportion of unreserved fund balance to reserved for inventories or prepaid items to indicate the portion of total fundbalance represented by resources that are not available for other discretionary expenditures. The primary use fora reservation of fund balance in conjunction with the consumption method occurs when the purchases method isused in the budget. In such cases, from the budget perspective, inventory would not be a resource available forexpenditure. A portion of fund balance also might be reserved if the government is required to maintain a certainamount of inventory. Some accountants believe such reserves are not appropriate under the consumption methodbecause the inventory or prepaid amounts have not been charged to an expenditure and thus are available for afuture charge to expenditure.

Governmental Fund Reserves for Legal Restrictions

Reserves for Encumbrances. GASB Cod. sec. 1800.139 identifies encumbrances as an example of a governmen�tal fund balance reservation for a legal segregation. GASB Cod. sec. 1700.128 defines encumbrances as �commit�ments related to unperformed (executory) contracts for goods or services."

Governments commonly use encumbrance accounting as a form of budgetary control, that is, as a guard againstoverspending of the appropriated budget. Under the encumbrance system, when goods or services are ordered,the amount of the order is recorded as an encumbrance and the remaining budget appropriation is reduced by thesame amount. This entry is made in the budgetary accounts. When the good or service is received, the encum�brance is reversed in the budgetary accounts and an expenditure is recorded in the general ledger accounts. In thisway, the government always knows how much budgetary appropriation remains for future expenditure and shouldnot be surprised by purchase commitments that exceed available budget authority. Exhibit 2�5 presents anexample of encumbrance accounting.

At year end, there may be encumbrances outstanding, representing orders for goods or services that have not yetbeen received. Depending on government statutes, unexpended budget appropriations may carry over into thefollowing year or may legally lapse, even if encumbered. That is, outstanding encumbrances may legally lapse atyear end, and the government's authority to pay for the goods or services when they are received may lapse. If theencumbered appropriation lapses, the government may still intend to honor outstanding commitments theyrepresent. (If the government intends to honor them even though the budget appropriation lapsed, it must obtaina new appropriation for them in the new year. If the government does not intend to honor them, it must cancel thepurchase orders.)

According to GASB Cod. sec. 1700.128d, when outstanding encumbered appropriations do not lapse at year end,the encumbrances should be reported as reservations of fund balance. In addition, according to GASB Cod. sec.1700.128c, when the government intends to honor outstanding encumbrances that lapse, they should either bereported as a reservation of fund balance or disclosed in the notes to the financial statements. Note that, as statedin GASB Cod. sec. 1700.128b, encumbrances outstanding at year end do not constitute expenditures or liabilitiesand should not be reported as such. Rather, the fund balance reservation indicates that the outstanding encum�brances represent amounts previously recorded as expenditures in the budget (if the purchases method was usedin the budget) or amounts to be reported as expenditures in future financial statements. (However, GASB Cod. sec.1700.128e does state that if the performance on the contract is complete or virtually complete, an expenditure andliability should be recognized rather than an encumbrance.) Entry 4 in Exhibit 2�5 illustrates the reservation of fundbalance for outstanding encumbrances.


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Exhibit 2�5

Journal Entries for Encumbrance Accounting

Assume that the annual budget for the general fund with a December 31 fiscal year end includes an appropriationof $30,000 for small equipment items (that is, for items individually below the capitalization threshold). Assume thatduring the year, two orders are placed for numerous small equipment items; the orders are for $12,000 and$16,000.

1. The first order is placed in mid�year.

Encumbrances $ 12,000Budgetary reserve for encumbrances $ 12,000

(To record purchase order for $12,000 worth of small equipment items in the budgetaryaccounts. Note that this entry is made in a budgetary ledger that shows the appropriation,encumbrance transactions, and resulting unencumbered appropriation balanceseethe table at the end of this exhibit. Recording the encumbrance reduces the remaining,or unencumbered, appropriation amount from $30,000 to $18,000 in the budgetaryaccounts.)

2. Shortly thereafter, the goods and a bill for them are received.

Expendituresgeneral governmentother $ 12,000Accounts payable $ 12,000

(To record expenditure in the general ledger accounts for small equipment items receivedand billed by vendor.)

Budgetary reserve for encumbrances $ 12,000Encumbrances $ 12,000

(To reverse encumbrance in the budgetary accounts.)

3. Shortly before the year end, an order is placed for $16,000 worth of small equipment items. The items are notreceived before year end.

Encumbrances $ 16,000Budgetary reserve for encumbrances $ 16,000

(To record purchase order for $16,000 worth of small equipment items in the budgetaryaccounts. This entry reduces the unencumbered appropriation balance from $18,000 to$2,000.)

4. At year end, because the second set of ordered equipment items has not been received, no expenditure andno liability are reported in the financial statements. Outstanding encumbrances remain at $16,000. Thegovernment's policy is that outstanding encumbrances carry over to the next year. Thus, at year end, thegovernment reserves a portion of fund balance in the general ledger accounts for the amount of the outstandingencumbrances.

Fund balanceunreserved, undesignated $ 16,000Fund balancereserved for encumbrances $ 16,000

(To reclassify fund balance for outstanding encumbrances that carry over to the followingyear.)


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5. The following table summarizes the preceding activity:

Date Description Encumbrances Expenditure

UnencumberedAppropriation

Balance

1/1 Record budget $ 30,000

5/1 Purchase order $ 12,000 (12,000 )

5/27 Items received (12,000 ) $ 12,000

12/29 Purchase order 16,000 (16,000 )

$ 16,000 $ 12,000 $ 2,000

6. Note that as part of the year�end closing out of the budgetary accounts, entry 3 is reversed. In the new fiscalyear, the encumbrance is reinstated in the budgetary accounts by reinstating entry 3 and reversing the generalledger fund balance reservation in entry 4.

If only $11,950 of goods were received in entry 2, the journal entries to record expenditures and to reverseencumbrance accounts would be as follows. In this example, assume that the government has accepted the$11,950 of goods as a full shipment and will not reorder additional items. Differences in the amountsordered/encumbered and the amounts received/billed are common and could be the result of a number offactors, including price and quantity variances.

Expendituresgeneral governmentother $ 11,950Accounts payable $ 11,950

(To record expenditure in the general ledger accounts for actual amount of smallequipment items received and billed by vendor.)

Budgetary reserve for encumbrances $ 12,000Encumbrances $ 12,000

(To reverse the encumbrance in the budgetary accounts. The amount reversed shouldequal the amount originally encumbered.)

* * *

Reservations versus RestrictionsGovernment�wide Reporting

When activities reported in governmental funds are reported in the government�wide financial statements, thereporting is on restricted net assets, not reserved fund balances. This occurs because of differences in themeasurement focus and basis of accounting used in the government�wide and governmental fund financialstatements. In addition, the term �reserved" is broader than the term �restricted," which generally is limited toconstraints placed on the government by third parties or by enabling legislation. �Reserved" sometimes simplymeans that resources are not available for spending because they are not cash, such as �reserves for inventories."

Proprietary Fund Net Assets/Fund Equity

Proprietary funds focus on all economic resources, not just on available financial resources as governmental fundsdo. Unlike governmental funds, they do not have a budgetary focus. Thus, proprietary funds do not reserve ordesignate the differences between assets and liabilities based on their availability (advances and long�termreceivables, inventories and prepaids, and encumbrances). Rather, proprietary fund net asset reporting focusesfirst on net assets that represent the activity's net capital investment and secondly on legal restrictions on the useof the remaining net assets.

GASBS No. 34, paragraph 98, requires proprietary fund net assets to be displayed in the three components:

� Invested in capital assets, net of related debt.


106

� Restricted (distinguishing between major categories of restrictions and, in some cases, betweenexpendable and nonexpendable).

� Unrestricted.

This information must be presented on the face of the statement of net assets in the net assets section.

Net Assets Invested in Capital Assets, Net of Related Debt. The proprietary fund net asset balance representinginvested in capital assets, net of related debt is calculated based on the following equation:

� Capital asset balances in the statement of net assets, including restricted capital assets.

Less

� The amount reported as accumulated depreciation (if capital assets are not reported net).

Less

� Outstanding balances of any bonds, mortgages, notes, or other borrowings (�capital related debt") thatare attributable to the acquisition, construction, or improvement of those assets.

However, amounts reported in a restricted capital debt sinking fund that was funded by debt principal should bereported as a component of restricted net assets.

Restricted Net Assets. GASBS No. 34 requires proprietary funds to separately report certain restricted assets,revenues, and balances. GASBS No. 34, paragraph 34, defines the term restricted in the context of restricted netassets as follows:

Net assets should be reported as restricted when constraints placed on net asset use are either:

a. Externally imposed by creditors (such as through debt covenants), grantors, contributors, or laws orregulations of other governments.

b. Imposed by law through constitutional provisions or enabling legislation.

Proprietary funds often issue revenue bonds to finance the construction of capital projects. The bond covenant,which is a legal document, often requires restricted accounts to hold (a) the bond proceeds for the sole use on theproject specified in the bond issue, as well as revenues from the proprietary fund operations that must be restrictedfor (b) one month's operating expenses, (c) repairs and replacements of assets acquired with the bond proceeds,(d) the next twelve months' debt service, and (e) future debt service beyond the next twelve months. Restrictedassets would be reported for the sum of the restricted assets in accounts (a) through (e). Restricted net assetswould be reported for the sum of restricted assets and any debt principal amount (as opposed to proprietary fundearnings) that was used to establish the debt sinking fund. Exhibit 2�6 illustrates adjusting journal entries used totrack restricted assets.


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Exhibit 2�6

Revenue Bond Restricted Assets/Restricted Net Assets

Assume that on January 1, a proprietary (enterprise) fund with a December 31 fiscal year end issues $1,000,000 ofcapital equipment revenue bonds that mature in 10 years and pay 6% interest, payable on July 1 and January 1.Assume that the bond covenant requires that restricted asset accounts hold the following:

One month's operating expenses (assumed to be $75,000) $ 75,000$25,000 for repairs and replacement of the equipment financed by the

bond 25,000The next twelve months' interest ($1,000,000 �.06 = $60,000) 60,000One�tenth of the principal amount to be added each year for the

10�year term of the debt $1,000,000 � 1/10 = $100,000) 100,000

Total $ 260,000

Assume that during the year, the enterprise earnings exceed the amounts required to be restricted.

1. The entry to reclassify unrestricted assets to restricted assets for the preceding items is as follows:

Restricted assetsrevenue bond operations $ 75,000Restricted assetsrevenue bond repairs and

replacement 25,000Restricted assetsrevenue bond current debt service 60,000Restricted assetsrevenue bond future debt service 100,000

Cash (and/or investments) $ 260,000

(To record restriction of assets as specified in bond covenant. For simplicity, interestincome earned on the restricted assets during the period is not considered. It would bereported as a restricted asset.)

2. On July 1, $30,000 of interest is paid.

Interest expense $ 30,000Restricted assetsrevenue bond current debt

service $ 30,000

(To record July 1 interest payment on revenue bonds.)

3. At year end, $30,000 of interest payable on January 1 is accrued.

Interest expense $ 30,000Accrued interest payable from restricted assets $ 30,000

(To record accrued interest on revenue bonds.)

4. At year end, a reclassification entry is made to replenish the restricted assets for current debt service to therequired $60,000 level.

Restricted assetsrevenue bond current debt service $ 30,000Cash (and/or investments) $ 30,000

(To restore the restricted asset account to its required level.)


108

5. At year end, $230,000 of net assets are restricted, equal to the difference between the amounts in the restrictedasset accounts ($260,000) and the non�capital debt liabilities payable from those assets ($30,000 of accruedinterest payable from the current debt service restricted asset account.) Capital debt is always deducted fromthe carrying amount of capital assets unless the sinking fund itself (or a portion of it) consists of debt proceeds.

Net assetsunrestricted $ 230,000Net assetsrestricted for revenue bond operations $ 75,000Net assetsrestricted for revenue bond repairs and

replacement 25,000Net assetsrestricted for revenue bond current

debt service 30,000Net assetsrestricted for revenue bond future debt

service 100,000

(To reclassify net assets for amounts in revenue bond restricted asset accounts.)

* * *

Customer Deposits. Enterprise funds such as utilities typically hold customer deposits. These deposits arereported as restricted assets in the statement of net assets with an offsetting liability for customer deposits payablefrom the restricted assets. Because the liability offsets the restricted assets, there are no net assets to report asrestricted.

Public Entity Risk Pool Net Assets Restricted for Future Catastrophe Losses. GASBS No. 10 (GASB Cod. sec.Po20), Accounting and Financial Reporting for Risk Financing and Related Insurance Issues, defines a public entityrisk pool as an entity that finances an exposure, liability, or risk, and it requires all public entity risk pools to beaccounted for in an enterprise fund. A public entity risk pool may collect premiums specifically identified for futurecatastrophe losses. Use of the premiums may be restricted to that future use by contractual provisions or by a legalrestriction imposed by an outside individual or entity. If those contractual provisions or other legal restrictions meetthe GASBS No. 34 definition of restricted, the premium should be separately identified as a restriction of poolequity. Assets set aside without a contractual or legal obligation to do so may be disclosed as designated netassets. GASBS No. 34, paragraph 98, prohibits governments from presenting designations on the face of theproprietary fund statement of net assets.

Designations. Designations are sometimes used in proprietary funds to reflect tentative managerial plans or intent.Designations usually are approved by senior management. However, they do not meet the definition of restricted

and management may change its plans. For these reasons, GASBS No. 34, paragraph 98, prohibits governmentsfrom reporting designated net assets on the face of the proprietary fund statement of net assets. Governments may,but are not required to, disclose designations of net assets in the notes to their basic financial statements.

Fiduciary Fund Net Assets

Fiduciary funds are not required to distinguish between types of net assets. Net assets should be reported simply,for example, net assets held in trust for pension benefits.


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SELF�STUDY QUIZ


37. What entry listed below would require a reservation of fund balance?

a. Reporting inventory under the consumption method.

b. Reporting marketable securities that will be converted to cash in the first month of next reporting period.

c. Reporting inventory under the purchases method.

d. A long term receivable associated with revenue that has been deferred.

38. Which of the following is one of the main focuses of proprietary fund net asset reporting?

a. Net assets that represent the activity's capital investment.

b. Legal restrictions on the source of revenues.

c. The budget.

d. Reservation of funds based on their availability.


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37. What entry listed below would require a reservation of fund balance? (Page 102)

a. Reporting inventory under the consumption method. [This answer is incorrect. Because the items arereported as inventory when purchased and recognized as an expenditure when used, there is norequirement for a reservation of fund balance. The amount of inventory at the end of the reporting periodshould be the same as what is on the books.]

b. Reporting marketable securities that will be converted to cash in the first month of next reporting period.[This answer is incorrect. The marketable securities will be available soon enough in the following reportingperiod to liquidate the current period's liabilities; therefore, no reservation of fund balance is required.]

c. Reporting inventory under the purchases method. [This answer is correct. Expenditures arerecorded every time inventory is purchased under the purchases method per GASB Cod. sec.1600.127. At the end of the reporting period, a reservation of fund balance is required for the amountof inventory on hand. The entry is a debit to �Inventory" and a credit to �Fund balancereserved forinventory." Because the amount was already reported as an expenditure, a reserve of fund balancewould be required. The result is the amount reported as both an asset and an expenditure.]

d. A long term receivable associated with revenue that has been deferred. [This answer is incorrect. Becausedeferred revenue is reported, a reservation of fund balance is not required. However, if the long termreceivable is an interfund loan that had no revenue recognition associated with it, a reserve of fund balancewould be required by debiting �Fund balanceunreserved, undesignated" and crediting �Fundbalancereserved for interfund advances."]

38. Which of the following is one of the main focuses of proprietary fund net asset reporting? (Page 105)

a. Net assets that represent the activity's capital investment. [This answer is correct. Proprietary fundsfocus on all economic resources. They do not focus on a budget; therefore, they don't reserve assetsbased on their availability. Their second focus is on the legal restrictions on the use of the remainingnet assets.]

b. Legal restrictions on the source of revenues. [This is incorrect. The second focus of proprietary fund netasset reporting is the legal restrictions on the use of the remaining net assets. Governmental funds havethe focus of the raising of revenues.]

c. The budget. [This answer is incorrect. Proprietary funds are not focused on a budget. Governmental fundshave a budgetary focus.]

d. Reservation of funds based on their availability. [This answer is incorrect. Because proprietary funds arenot focused on just available financial resources as governmental funds are, but they are focused on all

economic resources, proprietary funds do not have to reserve or designate the differences between assetsand liabilities based on their availability.]


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BUDGETARY REPORTING FOR GOVERNMENTS

Importance of Governmental Budgets

Governmental funds focus on the raising of revenues to provide government services to citizens. Annual budgetadoption and expenditure appropriations are an integral part of this focus. A budget, consisting of proposedexpenditures and means of financing them, is presented to the legislative body, which typically publishes it forcitizen inspection or holds public budget hearings on it and possibly modifies it. The legislative body then enactsthe budget into law through acts or ordinances appropriating expenditures and levying taxes. The appropriatedexpenditures constitute the legal maximum unless they are subsequently amended by the legislative body. Thus,GASB Cod. sec. 1700.107 states that annual budgets authorize and are the basis for control of a government'sfinancial operations. GASB Cod. sec. 1700.125 adds that �the budget determines the nature and scope of mostgovernmental fund financial operations by setting the amounts and sources of estimated revenues and transfers in,on the one hand, and the amounts and purposes of authorized expenditures and transfers out, on the other." Mostgovernmental fund budgets are fixed budgets, where the estimates are fixed amounts.

Levels of Budgets

The various levels of budgetary control and authority are as follows:

a. Executive Budget RecommendationThe total estimated revenues and proposed budgetary expendituressubmitted to the legislative or governing body in detail by the chief executive and the budget office.

b. Appropriated BudgetThe authority, documented by appropriation bills or ordinances signed into law, toexpend estimated revenues. The appropriated budget includes all expenditure, reserve, transfer andallocation authority resulting from the original enactment, supplemental appropriation, budget amendmentor transfer, or other legally authorized legislative and/or executive changes.

c. Nonappropriated BudgetA legally authorized review and approval process representing financial plansfor an organization, program, activity, or function. While the process is legally authorized, the results arenot subject to appropriation and therefore are outside the �appropriated budget" authority.

d. Budgetary Execution and ManagementAll other nonbudgeted financial activities relevant for soundfinancial management that are not subject to the appropriated or nonappropriated budget review andapproval process. These activities include all allocations, contingencies, reserves, transfers, allotments,and encumbrance controls without formal legislative enactment.

Budgetary Integration

Because of the importance of the appropriated budget and its status as the legal maximum on expenditures, mostgovernments integrate the budget into the accounting system. As GASB Cod. sec. 1700.118 states, �budgetaryaccounting techniques are an extremely important control aspect of accounting for general, special revenue, andsimilar governmental funds, because the annual budget is a legal compliance standard against which the opera�tions of such funds are evaluated." Budgetary integration involves the recording of budgeted revenue and expendi�ture amounts into fund ledgers so that actual amounts can be compared to budgeted amounts during the year.

For example, a property tax subsidiary ledger may have separate columns to record the budgeted revenue amount,to record actual revenue transactions, and to record the unrealized revenue balance (that is, the difference betweentotal budgeted revenues and cumulative actual revenues) after each actual transaction. For each budgetedexpenditure item, a page in the subsidiary ledger may have separate columns to record the appropriated (bud�geted) amount (as well as any supplemental appropriations made during the year), to record encumbrances, torecord actual expenditures, and to record the unencumbered balance remaining after each transaction. Exhibit 2�5illustrates the budgetary integration for an expenditure item involving encumbrances.

Allotments. For further budgetary control of expenditures, a governmental fund may use an allotment system.Allotments are allocations of the total appropriated amount of an expenditure to a time period, say a fiscal month or


112

quarter. Allotments guard against spending at such a fast rate early in the fiscal period that the total appropriationwould be used up before the end of the fiscal period. Allotments may also be used to guard against budget deficitsif there is uncertainty that the budgeted revenue amount will actually be realized. In that case, the allotment reducesthe spending rate during the early part of the period below the rate implicit in the appropriated amount untilrealization of the budgeted revenue amount becomes more certain.

Effect of Budgetary Integration on Actual Results. When the budget is integrated into the accounting system, thebudgeted amounts are reversed in the process of closing the books at year end. As a result, budgetary entries haveno effect on reported governmental fund balances or on the changes in its fund balance.

GASB Authority and Recommendations Related to the Budget

The introduction to GASB Cod. sec. 1700 states that every governmental unit should adopt an annual budget.GASB Cod. sec. 1700.101 states that �every governmental unit should prepare a comprehensive budget coveringall governmental, proprietary, and fiduciary funds for each annual (or in some states, biennial) fiscal period." Bothrecommendations go beyond the GASB's authority over financial reporting. GASB Cod. sec. 2400.101 recognizesthis limit on its authority, stating that �the scope and method of state and local government budgetary practices areoutside the scope of financial reporting standards. However," it adds, �financial reporting guidance for budgetarycomparisons is within that scope."

Budgetary Basis of Accounting. GASB Cod. sec. 1700.116 recommends that the governmental fund annualbudget be prepared on the modified accrual basis of accounting, which is the basis required by GAAP forgovernmental fund financial reporting. However, GASB Cod. sec. 1700.117 notes that legal requirements maydictate that the budget be prepared on another basis. For example, a government may be required to prepare itsbudget on the cash basis.

Requirement for Budgetary Comparisons

GASB Cod. sec. 1700.116 notes that �budgetary compliance is a paramount consideration in government."GASBC No. 1, paragraph 77b, cites demonstrating whether resources have been obtained and used as requiredby the entity's legally adopted budget as an objective of financial reporting by state and local governments.Because of this, GASBS No. 34, paragraphs 130 and 131 (as amended), require governments to present budgetarycomparisons. Individual comparisons are required for the general fund and for each major special revenue fund ifthose funds have legally adopted annual or biennial budgets. At a minimum, the comparisons should present threecolumns, including one for the original appropriated budget, the final appropriated budget, and actual inflows andoutflows on the government's budgetary basis. Governments are encouraged to provide a fourth columnshow�ing the difference between final budget and actual amounts. Governments also have the option of providinganother column to report the variance between original and final budget amounts. Governments may present theircomparisons using the same format, terminology, and classifications used in their governmental fund statement ofrevenues, expenditures, and changes in fund balances. Or, they may use the format, terminology, and classifica�tions used to prepare their own budget document.

Governments are encouraged to present their budgetary comparisons as schedules in required supplementaryinformation (RSI). However, GASBS No. 34, footnote 53 (as amended by GASBS No. 41, Budgetary Comparison

SchedulesPerspective Differences), permits certain governments to present their budgetary comparisons asbasic financial statements, presented with the fund financial statements. Governments with significant perspectivedifferences that result in their not being able to present budgetary comparison for their GAAP general fund andmajor special revenue funds must present their comparisons as RSI.

GAAP Reporting Limited to General Fund and Major Special Revenue Funds

Regardless of whether they are presented as RSI or as basic financial statements, the budgetary comparisonsshould be presented only for a government's general fund and its major special revenue funds and only if thosefunds have legally adopted budgets.

Governments that prepare a comprehensive annual financial report (CAFR) should include budgetary comparisonsfor individual nonmajor special revenue funds and other governmental funds as supplementary information within


113

their combining and individual fund statements. However, capital projects funds and debt service funds often donot legally adopt annual budgets. In the case of debt service funds, the bond indenture for the debt issue relatedto the fund may serve as the authorization for, and control of, the revenues and debt service expenditures reportedin the fund. Capital projects funds legally may adopt a project�length budget that corresponds to the expectedlength of the construction project instead of adopting an annual budget. Also, sometimes a budget is not legallyadopted for a special revenue fund that reports a grant program because the grant agreement provides budgetarytype control on the program expenditures.

GASB Cod. sec. 1700.101 recommends that budgets be prepared for proprietary and fiduciary funds, GAAPreporting requirements exclude these funds from budgetary reporting requirements. Governments that wish topresent budgetary comparisons for their proprietary funds may do so as supplementary information in the combin�ing and individual fund statements portion of their CAFR. GASB Cod. sec. 1700.120 states that �the nature of mostoperations financed and accounted for through proprietary funds is such that the demand for the goods andservices provided largely determines the appropriate level of revenues and expenses." Thus, budgets for propri�etary funds usually are flexible budgets, that is, budgets prepared for several levels of activity, which, when formallyadopted are not viewed as appropriations but only as approved plans.

GASBS No. 34, paragraph 69, modified the previous definition of fiduciary funds. Under the current definition,fiduciary funds should be used to report only assets held in a trustee or agency capacity for individuals, privateorganizations, or other governments. As such, budgetary considerations for these resources areby definitionthe responsibility of organizations outside of the reporting government.

CURRENT DEVELOPMENTS

GASBS No. 54

In February 2009, the GASB issued Statement No. 54, Fund Balance Reporting and Governmental Fund Type

Definitions. Effective for periods beginning after June 15, 2010, with early implementation encouraged, GASBS No.54 eliminates the requirement to report governmental fund balances as reserved, unreserved, or designated. Itreplaces those categories with five possible classifications of governmental fund balances. GASBS No. 54 alsoredefines the governmental funds for clarity and to be consistent with these new fund balance classifications.Finally, GASBS No. 54 also establishes criteria under which stabilization amounts may be reported as restricted,committed, or unassigned fund balance.

Overarching Principle

The overarching principal and goal of GASBS No. 54 is to report governmental fund balances based on a hierarchythat shows, from the highest to the lowest, the level or form of constraints on fund balance and, accordingly, theextent to which governments are bound to honor them. GASBS No. 54 establishes five classifications of fundbalancenonspendable, restricted, committed, assigned, and unassigned. Exhibit 2�7 illustrates the new fundbalance classifications. Governments should first determine and report nonspendable balances, then restricted,then committed, and so forth. Fund balances that are constrained for more than one reason (for example, fundbalance arising from gas sales tax revenue that is restricted by enabling legislation) may be assigned to purchasesupplies but should always be reported at the highest level of constraintin this case as restricted.


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Exhibit 2�7

GASBS No. 54 Hierarchy of Fund Balance Classifications

Highest

Lowest

Level/Form of Constraint

Classification of Fund Balance

RestrictedConstraints established by parties outside the government

or by enabling legislation

CommittedConstraints established by the highest level of the

government's decision�making authority

AssignedConstraints established by intent expressed

by the governing body or bodydesignated by the governing body

UnassignedNo constraints; residual balance ingeneral fund or negative balances

in other funds

NonspendablePermanently nonspendable balances, and, in general, other

resources that are not expected to be convertible to cash(e.g., inventories, prepaids, long�term receivables)

* * *

Governmental Fund Balance Classifications

GASBS No. 54 establishes the following five classifications of governmental fund balances:

a. Nonspendable. Fund balances that cannot be spent because they are either:

� Not in spendable formgenerally, amounts that are not expected to be converted to cash; forexample, this classification include fund balances related to inventory or prepaids. This classificationalso includes long�term notes and loans receivable and property acquired for resale. However, ifamounts eventually collected on receivables or from the sale of properties would be restricted,committed, or assigned, the relevant other category should be used, not the nonspendable category.


115

� Legally or contractually required to be maintained intactThe amount that represents the corpus orprincipal of a permanent fund is an example of an amount that is legally or contractually required tobe maintained intact.

b. Restricted. This category of fund balance is nearly identical, with a single exception, to amounts reportedas restricted net assets in the government�wide and proprietary fund financial statements. The singleexception is that the corpus or principal of a permanent fund would be reported as restricted,nonexpendable net assets under GASBS No. 34 but is reported as nonspendable fund balance ingovernmental funds.

c. Committed. This category consists of fund balance that can only be used for specific purposes establishedby formal action of the government's highest level of decision�making authority. Such commitments shouldhave the consent of both the legislative and executive branches, and should include contractual obligationsof fund assets. Fund balance commitments can only be removed or changed by the same type of action(for example, legislation, resolution, ordinance) of the same body employed to previously commit thoseamounts. The constraints should occur before year�end, even if the amount may not be determined untilthe subsequent period.

d. Assigned. This category is best explained in two steps. First, it consists of all remaining balances ingovernmental funds (that is, those not classified as nonspendable, restricted, or committed) except for thegeneral fund. Second, in the general fund, remaining balances that a government intends to use for specificpurposes should be reported as assigned. Intent can be expressed by the government's governing bodyor by a body (for example, a budget finance committee) or official that has been delegated the authorityto assign fund balances to a specific purpose. In this case, assigned general fund balance tells the financialstatement user that the balance is intended to be used for a purpose that is more narrow than the generalpurposes of the government itself. Assigned fund balances should not be reported in the general fund,however, if doing so causes the government to report a negative unassigned general fund balance.

e. Unassigned. Fund balance of the general fund that is not nonspendable, restricted, committed, orassigned should be reported as unassigned. In all other governmental funds, negative fund balancesremaining after reporting nonspendable, restricted, and committed balances should be reported asunassigned.

Not all governments with governmental funds will use all five classifications of fund balances. Some may have onlyone level of decision�making authoritysuch as a small cityand would not report assigned balances; and only afew general purpose governments have significant amounts of assets or fund balances required to be maintainedin perpetuity.

Fund Balance Flow Assumptions

Consistent with the GASBS No. 34 requirement to disclose whether restricted or unrestricted net assets are usedfirst in governmental and business�type activities, governments should decide and disclose which governmentalfund balance resources are being used first. And, because there are four possible spendable fund balance levels,governments need to agree on the spending order of all four classifications. Management may need to create apolicy before it can decide on what remains in each classification. Legal requirements may dictate at least a portionof that policy. If a government does not create its own policy for unrestricted balances, GASBS No. 54, paragraph18, establishes a default policy for governmentscommitted first, assigned next, and unassigned last.

Negative Fund Balances

In governmental funds other than the general fund, the assigned fund balance is the remaining spendable amountthat is not restricted or committed. When this remaining amount is negative, assigned amounts should be elimi�nated to the extent of the negative balance. If, after all assigned balances have been eliminated, and the fund stillreports a negative balance, the fund should report a negative unassigned balance. It is never appropriate to reporta negative balance in nonspendable, restricted, committed, or assigned fund balances. In the general fund, anyunassigned fund balance should be a positive amount.


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�Rainy Day" or Stabilization Arrangements

GASBS No. 54, paragraphs 20 through 21, discusses �rainy day" or stabilization arrangements. Governments thathave formal arrangements to maintain resources for emergency situations or for budgetary or revenue stabilizationshould report related general fund balances as restricted or committed if they meet either of those classificationdefinitions, based on the source of the constraint of their use. If either of those definitions is not met, stabilizationamounts should be reported as unassigned in the general fund. Governments should not report these amounts asassigned. Stabilization arrangements should only be reported in a separate special revenue fund if the source ofthose resources is a specific restricted or committed revenue source. Governments that chose not to establishstabilization arrangements but instead have formally adopted a minimum fund balance policy are required todisclose that policy.

Level of Display and Disclosure

GASBS No. 54, paragraph 22, requires that, at a minimum, aggregate amounts for each fund balance classificationappear on the face of the governmental fund balance sheet. Governments have the option to provide a moredetailed display on their balance sheet. However, somewhere in the financial statementseither on the face of thestatement or in the notes, the following levels of detail should be provided:

� Nonspendable

�� Not in a spendable form

�� Legally or contractually required to be maintained intact

� Restricted

�� Major restrictions

� Committed

�� Major commitments

� Assigned

�� Major assignments

Governments should also disclose the following fund balance classification policies and procedures:

� For committed fund balance, details about the highest levels of decision making authority that can createconstraints for governmental funds and what formal action it would take to establish and modify thoseconstraints.

� For assigned fund balance, the policy that gives a body or individual the authorization to assign amountsto a specific purpose and the particular body or individual given that authority.

� Whether the government considers restricted or unrestricted amounts to have been spent when anexpenditure is incurred for purposes for which both restricted and unrestricted fund balance is available.

� Whether committed, assigned, or unassigned amounts are considered to have been spent when anexpenditure is incurred for purposes for which amounts in any of those unrestricted fund balanceclassifications could be used.

Encumbrances and Disclosures

Under GASBS No. 54, the term encumbrance will no longer appear on governmental fund balance sheets.Encumbered amounts for specific purposes for which amounts have been previously restricted, committed, or


117

assigned will be reported within one of those classifications of fund balances. However, they will not be separatelydisplayed within those classifications. Encumbered amounts for specific purposes for which amounts have notbeen previously restricted, committed, or assigned should be reported in the committed or assigned fund balanceclassifications based on the definitions and criteria of those classifications (see GASBS No. 54, paragraphs10�16)the unassigned classification should not be used. Significant encumbrances will need to be disclosed inthe notes to the financial statements by major funds and for nonmajor funds in the aggregate, along with otherrequired disclosures about significant commitments.

New Governmental Fund Definitions

In conjunction with its fund balance revisions, the GASB also concluded that it was necessary to clarify thedefinitions of governmental funds to be consistent with the new fund balance classifications. However, except forspecial revenue funds, the fund definitions are relatively unchanged. The goal of GASBS No. 54 is to clarify what isreported in fundsboth in terms of revenues/expenditures and in terms of fund balances.

General Fund. According to GASBS No. 54, paragraph 29, the general fund should be used to account for andreport all financial resources not accounted for and reported in any of the other funds.

Special Revenue Funds. The biggest change in fund definitions in GASBS No. 54 is in the definition of specialrevenue funds. Under GASBS No. 54, paragraph 30, special revenue funds are used to account for and report theproceeds of specific revenue sources that are restricted or committed for specified purposes other than debtservice or capital projects. A special revenue fund should not be reported unless one or more specific restricted orcommitted revenues is its foundation. These restricted or committed revenue sources should be expected tocontinue to comprise a substantial portion of the fund's inflows. (In the case of revolving loan funds that are initiallyfunded with restricted grant revenues, the restricted resources should continue to be a substantial portion of fundbalance.) Governments are required to disclose which revenues and other sources are reported in major specialrevenue funds, in addition to the GASBS No.34 requirement to disclose the purpose of the fund.

Other resources may also be reported in special revenue fundssuch as investment earnings or interfund trans�fersbut only if they are also restricted, committed, or assigned to the same specified purpose as the restricted orcommitted revenues that are the foundation of the fund. Neither of these resourcestaken on their ownmayserve as a foundation for a special revenue fund. Stabilization resources should not be reported in a specialrevenue fund unless the source of those resources is a specific restricted or committed revenue source.

Although the new definition of special revenue funds is a significant change, the previous definition limited specialrevenue funds to use for resources that are legally restricted to expenditure for specified purposes.

Special revenue funds should not be used to account for resources held in trust for individuals, private organiza�tions, or other governments. GASBS No. 34, as amended, requires these resources to be reported in a trust fund.

Capital Projects Funds. GASBS No. 54, paragraph 33, indicates that capital projects funds should be used toaccount for and report financial resources that are restricted, committed, or assigned to expenditure for capitaloutlays, including through construction or acquisition of capital facilities and other capital assets. Capital projectsfunds should not be used to report capital asset outflows financed by proprietary or trust funds. Note that the newdefinition does not limit the use of Capital Projects Funds to �major" capital projects, but permits use of a capitalproject fund to account for any capital project. Note also that the GASB continued the requirement that capitalprojects funds be used to account for projects financed with general obligation bonds or other debt instruments.

Debt Service Funds. According to GASBS No. 54, paragraph 34, debt service funds are used to account for andreport financial resources that are restricted, committed, or assigned to expenditure for principal and interest. Theyalso should be used if legally mandated. Also, financial resources that are being accumulated for principal andinterest maturing in future years should be reported in debt service funds.

Permanent Funds. GASBS No. 54, paragraph 35, states that permanent funds should be used to account for andreport resources that are restricted to the extent that only earnings, and not principal, may be used for purposesthat support the government's programs; in other words, that are for the benefit of the government or its citizenry.GASBS No. 54 clarifies that resources reported in permanent funds are no longer �legally restricted" but instead�restricted" as defined in GASBS No.34encompassing both contractual and legislative restrictions.


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What Should Governments Be Doing Now?

Some governments tend to look at new standards later rather than sooner and sometimes even after the year endto which they apply. However, because of the GASBS No. 54, paragraph 12, requirement that commitments of fundbalances should occur before year end, governments will not be able to report anything other than nonspendable,restricted, and assigned governmental fund balances unless the body that is their highest level of decision makingauthority acts before year end to establish committed fund balances, including rainy day or stabilization arrange�ments. Likewise, decisions as to which person(s) have direct or delegated authority to assign fund balance shouldbe decided by year end.

In addition, because special revenue funds may only be used to report restricted and committed resources,governments may need to eliminate existing special revenue funds used to report unrestricted resources from theirreports unless they act to commit those resources before year end. Governments may find themselves in theposition of having budgeted resources for special revenue funds that no longer exist for financial reportingpurposes. (Financial statement preparers should note that annual budgetary restrictions do not constitute �com�mitted" resources because their authority lapses at the end of each year.)

Capital projects and debt service funds are also limited in that they can only be used to report restricted, com�mitted, and assigned resources. If these funds currently report other than restricted resources, the government willneed to take action to commit or assign resources that are to be reported in these funds (in the case of commit�ments, action needs to be taken before year end).

Finally, although the effective date of GASBS No. 54 is for periods beginning after June 15, 2010, paragraph 36requires governments to use the new governmental fund balance classifications for all periods presented, includingopening fund balances.


119

SELF�STUDY QUIZ


39. Which statement below is correct about governmental budgeting?

a. Government fund's budgets must be prepared on the modified accrual basis of accounting.

b. Budgetary numbers can be integrated into the accounting system by recording the budgeted revenue andexpenditure amounts into the system.

c. A requirement of GASBS No. 34 is for budgetary comparisons presented in two columns: one for budgetand one for actual results.

d. Budgets are required for both governmental funds and proprietary funds.

40. Which funds are required to present budgetary comparisons?

a. General fund only.

b. General fund and all major special revenue funds.

c. General fund and major special revenue funds that have a legally adopted budget.

d. All governmental funds, proprietary funds, and fiduciary funds.


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39. Which statement below is correct about governmental budgeting? (Page 111)

a. Government fund's budgets must be prepared on the modified accrual basis of accounting. [This answeris incorrect. Although this is the recommendation of GASB Cod. Sec. 1700.116, and the modified accrualbasis of accounting is required by GAAP for governmental fund reporting, legal requirements might requirethe budget to be prepared on another basis.]

b. Budgetary numbers can be integrated into the accounting system by recording the budgetedrevenue and expenditure amounts into the system. [This answer is correct. To close the books atyear end, the accountant needs to reverse the budgeted amounts so that the budgetary entries haveno effect on reported governmental fund balances or on the changes in its fund balance at year end.]

c. A requirement of GASBS No. 34 is for budgetary comparisons presented in two columns: one for budgetand one for actual results. [This answer is incorrect. The requirement is for a minimum of three columns,including one for the original appropriation, another for the final appropriation, and the third for actualresults.]

d. Budgets are required for both governmental funds and proprietary funds. [This answer is incorrect.Budgets for proprietary funds are not viewed as appropriations, but only as approved plans. They are notrequired, however, GASB Cod. Sec. 1700.101 recommends that budgets be prepared for proprietary andfiduciary funds.]

40. Which funds are required to present budgetary comparisons? (Page 112)

a. General fund only. [This answer is incorrect. Budgetary comparisons are required for the general fund, aswell as others. Governments are encouraged to present their budgetary comparisons as schedules inrequired supplementary information (RSI).]

b. General fund and all major special revenue funds. [This answer is incorrect. This answer is not inclusiveof all the requirements. Although comparisons require at least three columns, it is recommended that afourth column be presented that provides variance between original and final budget amounts.]

c. General fund and major special revenue funds that have a legally adopted budget. [This answer iscorrect. All funds with a legally adopted budget must present budgetary comparison schedules perGASBS No. 34. Certain governments are permitted to present the budgetary comparisons as basicfinancial statements.]

d. All governmental funds, proprietary funds, and fiduciary funds. [This answer is incorrect. Proprietary andfiduciary funds are excluded from budgetary reporting requirements.]


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Lesson 2 (GFSTG091)


24. There are three separate sets of financial statements included in fund financial statements. Match the fundcategory to the fund type.

Fund Category Fund Type

1. Governmental fund category i. Agency fund type

2. Proprietary fund category ii. Debt service fund type

3. Fiduciary fund category iii. Internal service fund type

a. 1 i; 2 ii; 3 iii.

b. 1 ii; 2 iii; 3 i.

c. 1 ii; 2 i; 3 iii.

d. 1 iii; 2 i; 3 ii.

25. Requirements as to how governmental, proprietary, and fiduciary funds are reported are included in GASBSNo. 34. Match the governmental fund with the correct/appropriate reporting method(s).

Category of Fund Reporting Method

1. Governmental Funds i. Current financial resources measurement focus

2. Proprietary Funds ii. Accrual basis of accounting

3. Fiduciary Funds iii. Separate guidance listed in GASBS No. 25

4. Pension Trust Funds iv. Modified accrual basis of accounting

v. Economic resources measurement focus

a. 1 v and ii; 2 i and iv; 3 i and iv; 4 iii.

b. 1 v and iv; 2 i and ii; 3 iii; 4 ii.

c. 1 i and iv; 2 v and ii; 3 v and ii; 4 iii.

d. 1 i and ii; 2 v and ii; 3 v and iv; 4 ii.


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26. There are five types of governmental funds which are used for the accounting and financing of most of thefunctions associated with the government. Match the appropriate fund type with the government resource orexpenditure.

Governmental Fund Type Government Resources or Expenditure

1. General Fund i. $600,000 capital outlay financed by general obliga�tion debt

2. Special Revenue Funds ii. The monthly salaries of the city's police officers

3. Capital Projects Funds iii. $600,000 general obligation bonds legally man�dated and issued for a capital project

4. Debt Service Funds iv. Monthly costs of the city's cemetery paid from legallyrestricted funds for this purpose

5. Permanent Funds v. Financial resources received from the city's hotel tax

a. 1 ii; 2 v; 3 i; 4 iii; 5 iv.

b. 1 v; 2 iv; 3 i; 4 iii; 5 ii.

c. 1 ii; 2 v; 3 iii; 4 i, 5 iv.

d. 1 v; 2 iii; 3 i; 4 iii; 5 iv.

27. Which two funds are both included in proprietary funds?

a. Fiduciary & pension.

b. Debt service & permanent.

c. General & special revenue.

d. Enterprise & internal service.

28. If the reporting government is the predominate participant in an activity that provides goods or services to otherfunds of the primary government on a cost�reimbursement basis, what fund should the activity be reported in?

a. Agency.

b. Enterprise.

c. Fiduciary.

d. Internal service.


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29. There are four fiduciary fund types that should be used by the government to report assets held in a trusteeor agency capacity for others. Match the appropriate fund with each example of a governmental asset.

Fiduciary Fund Type Asset

1. Agency Fund i. Resources held in trust for a nongovernmentalorganization

2. Investment Trust Fund ii. Assets of a deferred compensation plan

3. Pension Trust Fund iii. Assets of a government�sponsored investment poolowned by participants outside the government

4. Private�purpose Trust Fund iv. Custody of assets owned by nongovernmentalorganization.

a. 1 iv; 2 iii; 3 ii; 4 i.

b. 1 i; 2 iii; 3 ii; 4 iv.

c. 1 iv; 2 ii; 3 iii; 4 i.

d. 1 iii; 2 iv; 3 ii; 4 i.

30. Generally, when are liabilities reported under the current financial resources measurement focus?

a. When they are due.

b. When they are incurred.

c. Whey they mature.

d. Generally, liabilities are not reported under this measurement focus.

31. Which of the following is correct concerning the accounting for general long�term debt?

a. The unmatured portion of general long�term debt is recorded in the balance sheet of governmental funds.

b. The proceeds from the general long�term debt are recorded as �other financing sources" on thegovernment fund operating statement.

c. Payback of general long�term debt is recorded as an expenditure in equal increments beginning in theperiod following receipt of proceeds through the year of maturity.

d. Nonexpendable financial resources are provided when a government issues general long�term debt.

32. Proprietary funds have a different reporting focus than governmental funds. Why is the focus different?

a. The need to set appropriate user fees connected to governmental funds.

b. The intention of breaking even connected to governmental funds.

c. The cost recovery factor connected to proprietary funds.

d. The importance of budgetary control over the activities reported in proprietary funds.


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33. GASB establishes the modifications to the accrual basis of accounting used to account for liabilities andexpenditures for governmental accounting funds. Match the examples needing one of the modifications andthe appropriate method of accounting for the example covered by the modification.

Example of Liability and Expenditure Appropriate Accounting Modification

1. Debt principal on a capital lease i. Recognize when due, not whenincurred

2. Pension contributions ii. Recognize when they mature, mean�ing due for payment

3. Landfill closure costs iii. Exclude from governmental fund finan�cial statements

4. Interest on general long�term debt iv. Recognize when incurred, if measur�able

5. Noncurrent portion of landfill postclosure care costsbefore explicit recognition criteria were issued

a. 1 ii; 2 i; 3 i; 4 ii; 5 iii.

b. 1 iv; 2 ii; 3 i; 4 iv; 5 i.

c. 1 i; 2 i; 3 ii; 4 iv; 5 iii.

d. 1 i; 2 ii; 3 ii; 4 i; 5 iii.

34. How should short�term governmental fund debt be reported?

a. Report proceeds as an �other financing source" in the fund operating statement.

b. Report principal repayment as a debt service expenditure.

c. Report directly in the governmental fund balance sheet as a fund liability.

d. Report interest payment as a debt service expenditure.

35. What statement below is correct concerning debt of proprietary funds?

a. Report the debt in the proprietary fund statement of net assets.

b. Proceeds should be reported as revenue in the proprietary fund's operating statement.

c. Repayment should be reported as expenditures in the proprietary fund's operating statement.

d. Interest payments should be reported as general long�term debt.


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36. GASBS No. 34, paragraph 112, defines four types of interfund activity. Match the activity with the properaccounting procedure.

Interfund Activity Accounting Procedure

1. Interfund Loan i. Report as revenue or as expenditure; any unpaidamounts are reported as interfund receivables orpayables

2. Interfund Service Provided and Used ii. Report as other financing uses or other financingsources

3. Governmental Interfund Transfer iii. Report after nonoperating revenue and expenses,and capital contributions

4. Interfund Reimbursement iv. Required to report at net and, therefore, are notdisplayed in the financial statements

5. Proprietary Interfund Transfer v. Report as interfund receivable on the balance sheetand the statement of net assets or interfund payableon the balance sheet

a. 1 i; 2 ii; 3 iii; 4 iv; 5 v.

b. 1 v; 2 i; 3 ii; 4 iv; 5 iii.

c. 1 v; 2 i; 3 iv; 4 ii; 5 iii.

d. 1 iv; 2 v; 3 ii; 4 iii; 5 i.

37. What happens if a government plans to honor an encumbered appropriation that lapsed at the end of the year?

a. The government must cancel the purchase order.

b. The government must obtain a new appropriation for next year.

c. The government should report the amount of the encumbered appropriation as a liability.

d. Record as encumbrances outstanding at year end.


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38. On July 1, a proprietary fund of the city issued $1,000,000 of capital equipment revenue bonds that mature in10 years and pay 6% interest to finance the purchase new fire trucks. The city has a fiscal year end of June 30.From July 1 to June 30, this proprietary fund of the city earned $300,000. One month's operating expenses is$50,000; and there is $30,000 for repairs and replacement of the fire trucks financed by the bond. The proceedswere invested in a money market fund to be used to pay for the trucks as they were received. At year end thefund had earned $10,000 in interest. The bond covenant requires the city to hold the following:

The bond proceeds for the sole use on the building the fire station and the revenues from the fund's operationsthat must be restricted for:

� One month's operating expenses

� Repairs and replacements of assets acquired with the bond proceeds

� The next twelve months' debt service

� Future debt service beyond the next twelve months

Assuming that the enterprise earnings exceed the amounts required to be restricted, how much of those earn�ings must be restricted?

a. $210,000.

b. $240,000.

c. $250,000.

d. $300,000.

39. Which level of budgeting control is subject to a legally authorized review and approval process for the financialplans of an organization, activity, function, or program?

a. Appropriated Budget.

b. Nonappropriated Budget.

c. Budgetary Execution and Management.

d. Executive Budget Recommendation.

40. What helps guard against budget deficits if there is uncertainty that the budgeted revenue amount will actuallybe realized?

a. Comparisons.

b. Appropriations.

c. Encumbrances.

d. Allotments.


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GLOSSARY

Accountability: The cornerstone of all financial reporting in government. The obligation of the government to explainits actions, to justify what it does to the citizenry.

Accountable: Being obliged to explain one's actions, to justify what one does.

Affiliated organization: Legally separate tax�exempt organizations for which the primary government is notfinancially accountable. Sometimes these organizations are still to be included in a government's financial reportingentity.

Allotments: Allocations of the total appropriated amount of an expenditure to a time period.

Basis of accounting: Refers to when revenues, expenditures, expenses, and transfersand the related assets andliabilitiesare recognized in the accounts and reported in the financial statements. Specifically, it relates to the timing

of the measurements made.

Blending: The component unit is so closely related to the primary government that it is, in effect, the same as theprimary government.

Bond Anticipation Note (BAN): A short�term note issued with the intent of replacing it with a long�term bond.

Business�type activities: Activities financed in whole or in part by fees charged to external parties for goods andservices. These activities are usually reported in enterprise funds.

Citizenry: Those to whom the government is primarily accountable, including intermediaries such as the media,advocacy groups, and public finance researchers.

Component unit: A legally separate organization for which the primary government is financially accountable.

Discrete presentation: Presentation of data for the component unit in a column to the right of the data columns forthe primary government.

Encumbrance: Commitment related to unperformed (executory) contracts for goods or services.

Enterprise funds: Funds used to report activities that the government operates more like a business.

Ex officio: City officials serving by virtue of their status as city officials.

External events: Flows of resources to or from someone or something outside the primary government.

Fiduciary funds: Funds that should be used to report assets held in a trustee or agency capacity for others andtherefore cannot be used to support the government's own programs. There are four fiduciary fund typespension(and other employee benefit) trust funds, investment trust funds, private�purpose trust, and agency funds.

Financial reporting entity: The units of government, organizations, and activities included in a particular set offinancial statements.

Fiscal accountability: The responsibility of governments to justify that their actions in the current period havecomplied with public decisions concerning the raising and spending of public moneys in the short term (usually onebudgetary cycle or one year).

Fund: A fiscal and accounting entity with a self�balancing set of accounts recording cash and other financialresources, together with all related liabilities and residual equities or balances, and changes therein, which aresegregated for the purpose of carrying on specific activities or attaining certain objectives in accordance with specialregulations, restrictions, or limitations.


128

Fund accounting: An accounting system that allows governments to control the use of resources designated fora specific purpose and demonstrate that legal or contractual provisions governing specific resources have beencomplied with.

General capital assets: The default category of capital assets consisting of all capital assets that are not specificallyrelated to activities reported in proprietary or fiduciary funds.

General long�term debt: Unmatured principal of bonds, warrants, notes, and special assessment debt for whichthe government is obligated in some manner.

Governmental activities: Activities financed through taxes, intergovernmental revenues, and other nonexchangerevenues. These activities are usually reported in governmental funds and internal service funds.

Governmental entity: Public corporations and bodies corporate and politic are governmental entities. Other entitiesare governmental entities if they have one or more of the following characteristics:

� Popular election of officers or appointment (or approval) of a controlling majority of the members of theorganization's governing body by officials of one or more state or local governments;

� The potential for unilateral dissolution by a government with the net assets reverting to a government; or

� The power to enact and enforce a tax levy.

� The ability to issue directly (rather than through a state or municipal authority) debt that pays interestexempt from federal taxation. Note however, If this is the only characteristic an entity possesses, it wouldnot be presumed governmental if there is compelling, relevant evidence available to deem otherwise.

Interfund: Between the funds of the primary government, including those of its blended component units.

Interfund reimbursements: Repayments from the funds responsible for particular expenditures or expenses to thefunds that initially paid for them.

Interfund services provided and used: Sales and purchases of goods and services between funds for a priceapproximating their external exchange value.

Interperiod equity: Focus on current services used being paid in current period. The intent of interperiod equity isthat the current generation of citizens should not be able to shift the burden of paying for current�year services tofuture�year taxpayers.

Investors and creditors: Those who lend or participate in the lending process.

Legislative and oversight bodies: Those who directly represent the citizens, including governing boards andagencies that make oversight decisions.

Management's Discussion and Analysis (MD&A): A narrative report prepared in an easy�to�read format by thegovernment's financial manager.

Measurement focus: The term refers to what is being expressed in reporting financial position and performance,that is which resources are being measured.

National Council on Governmental Accounting (NCGA): Replaced the National Committee on GovernmentalAccounting in 1979. Issued several Statements and Interpretations on accounting principles for governmental units.However, when conflicts arose with FASB, the NCGA was replaced with GASB to resolve the jurisdiction question.

Nonexchange transaction: Government gives (or receives) value without directly receiving (or giving) equal valuein return. Most grants and contributions are examples of nonexchange transactions.


129

Nonreciprocal interfund activity: The internal counterpart to nonexchange transactions entered into with entitiesoutside the primary government consisting of interfund transfers, and interfund reimbursements.

Operational accountability: Governments' responsibility to report the extent to which they have met their operatingobjectives efficiently and effectively, using all resources available for that purpose, and whether they can continueto meet their objectives for the foreseeable future.

Opinion unit: The level at which the basic materiality determination is made for planning, performing, evaluating,and reporting under the GASBS No. 34 model.

Primary government: A state government, general purpose local government, or special�purpose government thatmeets certain criteria of GASBS No. 14 denoting its independence from other state or local governments. Thosecriteria include the ability to set its own tax rates and to issue debt.

Proprietary funds: Funds that account for a government's ongoing organizations and activities that are similar tothose often found in the private sector, such as a water and sewer utility.

Reciprocal interfund activity: The internal counterpart to exchange and exchange�like transactions entered intowith entities outside the primary government consisting of interfund loans, and interfund services provided and used.

Reserve: �That portion of the fund balance [that] is not appropriable for expenditure or is legally segregated for aspecific future use."

The Governmental Accounting Standards Board (GASB): The primary standards�setting body for state and localgovernmental accounting.

Transaction: Limited to describing external events.


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131

INDEX

A

ACCOUNTING STANDARDS FOR GOVERNMENTS� AICPA pronouncements specifically made

applicable to state and local governments 35. . . . . . . . . . . . . . . . . � Authority of GASB pronouncements 31. . . . . . . . . . . . . . . . . . . . . .

�� Current authority and hierarchy of GAAP for governmental entities 31. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

�� Original authority 31. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Conflicts between GAAP and legal accounting

requirements 36. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � FASB pronouncements specifically made applicable

to state and local governments 32. . . . . . . . . . . . . . . . . . . . . . . . . . �� Prospective application of certain

pronouncements 35. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � GASB Comprehensive Implementation Guide 30. . . . . . . . . . . . . . � Governmental Accounting Standards Board (GASB) 29. . . . . . . . � History of standards setting 29. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

�� National Council on Governmental Accounting (NCGA) 29. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

� The GASB Codification 30. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� AICPA pronouncements 36. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

AICPA NOT�FOR�PROFIT MODEL 5. . . . . . . . . . . . . . . . . . . . . . . . . .

ALLOTMENTS 111. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

AUDITOR INDEPENDENCE IN FINANCIAL REPORTING� Independence implementation guidance 57. . . . . . . . . . . . . . . . . . � Yellow Book independence standards 57. . . . . . . . . . . . . . . . . . . .

B

BASIS OF ACCOUNTING� Accrual basisfiduciary funds 87. . . . . . . . . . . . . . . . . . . . . . . . . . . � Accrual basisproprietary funds 87. . . . . . . . . . . . . . . . . . . . . . . . . � Definition 85. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Modified accrual basisgovernmental funds 86. . . . . . . . . . . . . .

�� Expenditures 86. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Revenue 86. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

BUDGETARY REPORTING� Budgetary integration 111. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

�� Allotments 111. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Effect of budgetary integration on actual results 112. . . . . . . .

� GAAP reporting limited to general fund and major special revenue funds 112. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

� GASB authority and recommendations related to the budget 112. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Budgetary basis of accounting 112. . . . . . . . . . . . . . . . . . . . . .

� Importance of governmental budgets 111. . . . . . . . . . . . . . . . . . . . � Levels of budgets 111. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Requirement for budgetary comparisons 112. . . . . . . . . . . . . . . . .

C

CAPITAL ASSETS� Reporting in governmental funds 93. . . . . . . . . . . . . . . . . . . . . . . . .

�� Acquisition of general capital assets 93. . . . . . . . . . . . . . . . . . . �� Maintaining a general capital assets ledger 93. . . . . . . . . . . . . �� Sales and other dispositions of general capital

assets 94. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Sales of capital assets 94. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

� Reporting in proprietary and fiduciary funds 94. . . . . . . . . . . . . . . �� Capitalization and valuation 94. . . . . . . . . . . . . . . . . . . . . . . . . . �� Depreciation expense 94. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

COLLEGES AND UNIVERSITIES 5. . . . . . . . . . . . . . . . . . . . . . . . . . .

D

DEBT AND OTHER LONG�TERM LIABILITIES� Debt of proprietary funds 96. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Governmental funds 94. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

�� Current versus long�term debt 94. . . . . . . . . . . . . . . . . . . . . . . . �� General long�term debt 95. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Governmental long�term obligations other

than debt 95. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Short�term debt 95. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

DEFINITION OF A GOVERNMENTAL ENTITY� Common examples 7. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Definition 7. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Example of determination as to governmental nature 8. . . . . . . .

DEPOSITS, CUSTOMER 108. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

DESIGNATIONS 108. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

E

ENCUMBRANCE ACCOUNTING� Reserves of governmental fund balance for 103. . . . . . . . . . . . . . .

F

FINANCIAL REPORTING ENTITY� Blending of component units 9. . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Definition of component unit 9. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Discrete presentation of component units 9. . . . . . . . . . . . . . . . . . � General 8. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

FUND ACCOUNTING 14. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Categories and types of funds 71. . . . . . . . . . . . . . . . . . . . . . . . . . . � Definition of a fund 71. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Fiduciary fund category 76. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

�� Agency funds 76. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Investment trust funds 76. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Pension and other employee benefit trust funds 76. . . . . . . . . �� Private�purpose trust funds 76. . . . . . . . . . . . . . . . . . . . . . . . . . .

� Funds versus activities 71. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � General 69, 70. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � General capital assets and general long�term debt 77. . . . . . . . . � Governmental fund category 71. . . . . . . . . . . . . . . . . . . . . . . . . . . .

�� Capital projects funds 72. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Debt service funds 72. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� General fund 71. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Permanent funds 75. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Special revenue funds 72. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

� Proprietary fund category 75. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Enterprise funds 75. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Internal service funds 76. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

FUND BALANCES/NET ASSETS/FUND EQUITY� Fiduciary fund net assets 108. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Governmental fund reserves 102. . . . . . . . . . . . . . . . . . . . . . . . . . . . � Governmental fund reserves for assets unavailable

for future appropriation 102. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Reserves for advances and long�term receivables 102. . . . . . �� Reserves for inventory and prepaid items 102. . . . . . . . . . . . .

� Governmental fund reserves for legal restrictions 103. . . . . . . . . . �� Reserves for encumbrances 103. . . . . . . . . . . . . . . . . . . . . . . . .

� Proprietary fund net assets/fund equity 105. . . . . . . . . . . . . . . . . . �� Customer deposits 108. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Designations 108. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Net assets invested in capital assets, net of

related debt 106. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Public entity risk pool net assets restricted for future

catastrophe losses 108. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


132

�� Restricted net assets 106. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Reservations versus restrictionsgovernment�wide

reporting 105. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

G

GASBS NO. 34 AND FINANCIAL STATEMENT MATERIALITY� Background 55. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � GASB implementation guidance 55. . . . . . . . . . . . . . . . . . . . . . . . .

�� Opinion units 55. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � PPC guidance on materiality 56. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

GASBS NO. 34 EFFECTIVE DATES� Broader application of GASB phases 53. . . . . . . . . . . . . . . . . . . . . � GASBS No. 34 effective dates and component units 54. . . . . . . . � Illustration 53. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Total annual revenues 52. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

GOVERNMENT ENVIRONMENT� Absence of exchange relationship, profit motive, and

competition 15. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Budget 111. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Business�type activities of governments 15. . . . . . . . . . . . . . . . . . .

�� Absence of fund accounting 16. . . . . . . . . . . . . . . . . . . . . . . . . . �� Different status of budget 16. . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Exchange relationship and user fees 16. . . . . . . . . . . . . . . . . . �� Revenue�producing assets 16. . . . . . . . . . . . . . . . . . . . . . . . . . .

� Government structure and budget 14. . . . . . . . . . . . . . . . . . . . . . . . �� Fund accounting 14. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

� Political nature of government 15. . . . . . . . . . . . . . . . . . . . . . . . . . . � Relationship of taxpayers to services received 15. . . . . . . . . . . . .

H

HEALTH CARE ORGANIZATIONS 5. . . . . . . . . . . . . . . . . . . . . . . . . .

I

INTERFUND ACTIVITY AND BALANCES� Interfund loans 97. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Interfund services provided and used 97. . . . . . . . . . . . . . . . . . . . . � Interfund transfers 97. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Reimbursements 97. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

INTERFUND LOANS� Types of interfund loans 97. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

M

MEASUREMENT FOCUS� Definition 82. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Flow of current financial resources measurement

focusgovernmental funds 82. . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Assets and liabilities 83. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Capital assets 83. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Long�term debt 84. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Revenues and expenditures 83. . . . . . . . . . . . . . . . . . . . . . . . . .

� Flow of economic resources measurement focusproprietary and fiduciary funds 85. . . . . . . . . . . . . . . . . . . . �� Assets and liabilities 85. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Revenues and expenses 85. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

N

NATIONAL COUNCIL ON GOVERNMENTAL ACCOUNTING(NCGA) 29. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

O

OBJECTIVES OF GOVERNMENTAL FINANCIAL REPORTING� Accountability 21. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Financial reporting objectives 22. . . . . . . . . . . . . . . . . . . . . . . . . . . . � Financial reporting objectives and the GASBS

No. 34 reporting model 23. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � GASB project on service efforts and accomplishments

reporting 28. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � General 21. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Interperiod equity 21. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

OCBOA FINANCIAL STATEMENTS OR PARTIALIMPLEMENTATION OF THE NEW REPORTING MODEL 56. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

OVERVIEW OF GASBS NO. 34� Effective dates 52. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Fund financial statements 45. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Government�wide financial statements 44. . . . . . . . . . . . . . . . . . . . � Management's discussion and analysis 43. . . . . . . . . . . . . . . . . . .

�� Relationship of MD&A to transmittal letter 44. . . . . . . . . . . . . . �� Required components 43. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� RSI 43. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Scope 43. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

� Minimum reporting requirements 42. . . . . . . . . . . . . . . . . . . . . . . . . � Notes to the financial statements 46. . . . . . . . . . . . . . . . . . . . . . . . . � Objective of statement 41. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Required supplementary information (RSI) 46. . . . . . . . . . . . . . . . � Scope and applicability of statement 41. . . . . . . . . . . . . . . . . . . . .

�� Colleges and universities 42. . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Exclusions 42. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� General purpose and special�purpose

governments 41. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

P

PREPAID ITEMS 102. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

S

SCOPE OF THE STATE AND LOCAL GOVERNMENTALSECTOR 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

SCOPE OF THIS COURSE 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � AICPA not�for�profit model 5. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Ethics standards not covered 5. . . . . . . . . . . . . . . . . . . . . . . . . . . . . � General 4. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Nonspecialized accounting standards for

business�type activities 4. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Performance and reporting standards not covered 5. . . . . . . . . . � Quality control standards not covered 5. . . . . . . . . . . . . . . . . . . . . � Specialized accounting standards not covered 5. . . . . . . . . . . . . . � States and special�purpose governments 5. . . . . . . . . . . . . . . . . .

SERVICE EFFORTS AND ACCOMPLISHMENTS� GASB concepts statement on 28. . . . . . . . . . . . . . . . . . . . . . . . . . . .

U

USERS OF GOVERNMENTAL FINANCIAL REPORTS� Assessing compliance with finance�related legal and contractual

requirements 20. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Assessing efficiency and effectiveness 21. . . . . . . . . . . . . . . . . . . . � Assessing financial condition and results of operations 20. . . . . . � Comparing actual and budgeted results 20. . . . . . . . . . . . . . . . . . � General 20. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

USES OF GOVERNMENTAL FINANCIAL REPORTS 20. . . . . . . . .


133

COMPANION TO PPC'S GUIDE TO

PREPARING GOVERNMENTAL FINANCIAL STATEMENTS UNDER GASBS NO. 34

COURSE 2

BUDGETARY REPORTING, OTHER RSI, MD&A, AND CAFR (GFSTG092)

OVERVIEW

COURSE DESCRIPTION: This interactive self�study course addresses aspects of the governmental financialreporting model under GASBS No. 34. This course covers various aspects ofbudgetary reporting and other required supplementary information. Also, thecourse provides a detailed study of Management's Discussion and Analysis(MD&A) of governmental financial reports. Finally, the components of aComprehensive Financial Annual Report (CAFR) are discussed in detail.

PUBLICATION/REVISION

DATE:

October 2009


PREREQUISITE/ADVANCE

PREPARATION:

Basic knowledge of governmental accounting and reporting








Lesson 1Budgetary Reporting and Other Required Supplementary Information (RSI)

Completion of this lesson will enable you to:� Identify GASB requirements related to required supplementary information of governmental financial

statements.� Discuss budgetary reporting rules related to the basic financial statements of a governmental entity.

Lesson 2Management's Discussion and Analysis (MD&A)

Completion of this lesson will enable you to:� Recognize the appropriate inclusions for MD&A to correspond with GASB objectives.� Describe effective ways to present objective and comprehensible information in MD&A.� Identify the general and required components of MD&A.� Discuss the GASB requirements for MD&A and effective writing techniques for MD&A.


134

Lesson 3Comprehensive Annual Financial Reports (CAFR)

Completion of this lesson will enable you to:� Discuss the differences between the requirements for GAAP and a CAFR, including the advantages of

preparing a CAFR.� Determine the presentation required in the financial section of a CAFR.� Identify the appropriate information to be included in the statistical section of a CAFR.



Thomson Reuters

Tax & AccountingR&G

GFSTG092 Self�study CPE

36786 Treasury Center

Chicago, IL 60694�6700





135

Lesson 1:�BUDGETARY REPORTING AND OTHER

REQUIRED SUPPLEMENTARY INFORMATION (RSI)

INTRODUCTION

This lesson discusses the required supplementary information to be included in governmental financial statementsunder GASBS No. 34. It also discusses the GASB requirements related to budgetary reporting in the financialstatements of a government, including required elements of budgetary analysis, placement in the financial state�ments, and the funds on which an analysis is required.


Lesson 1Budgetary Reporting and Other Required Supplementary Information (RSI)

Completion of this lesson will enable you to:� Identify GASB requirements related to required supplementary information of governmental financial

statements.� Discuss budgetary reporting rules related to the basic financial statements of a governmental entity.

THE BASICS OF RSI

Required Supplementary InformationTHE BASICS

� Current GAAP define RSI as essential information that should be presented with, but not asa part of, the basic financial statements and notes.

� All governments must present a Management's Discussion and Analysis (MD&A) as RSI.

� Governments may be required to present RSI in five other situationsto present budgetarycomparison schedules, to report claims development information for public entity risk pools,to report trend data on pension funding and on other postemployment benefit funding, or toreport infrastructure condition when the modified approach is used.

� Except for MD&A, RSI should be presented immediately after the notes to the financialstatements.

Definition and Description

The GASB requires that certain types of information be reported along with, but separate from, the basic financialstatements of a government. This additional information, presented outside of the basic financial statements, isreferred to as required supplementary information (RSI). GASB Concepts Statement (GASBC) No. 3, Communica�

tion Methods in General Purpose External Financial Reports That Contain Basic Financial Statements, clarifies thatRSI is supporting information that the GASB considers to be essential for placing basic financial statements andnotes to the basic financial statements in an appropriate operational, economic, or historical context. RSI shouldhave a clear and demonstrable relationship to information in the basic financial statements or notes to which itrelates. RSI, together with the basic financial statements and notes, comprise the minimum requirements forfinancial reporting in accordance with generally accepted accounting principles (GAAP). Concepts Statements areclassified by GASBS No. 55, The Hierarchy of Generally Accepted Accounting Principles for State and Local

Governments, as �other accounting literature." When specific guidance on the accounting treatment for a transac�tion or event is not available in GAAP Hierarchy categories a�d, governments should consider accounting prin�ciples for similar transactions or other events within those categories and may consider other accounting literature.

RSI Placement


Governments, paragraph 8, requires that MD&A precede the basic financial statements. The other RSI items should


136

immediately follow the notes to the financial statements (an exception is claims development information). TheMD&A was separated from the other RSI by the GASB to improve its chances of being read.

Comparison to Supplementary Information

RSI differs from other supplementary information that is often presented in comprehensive annual financial reports(CAFRs). Supplementary information generally consists of combining statements supporting amounts in the basicfinancial statements or schedules providing additional detail or demonstrating compliance with legal or contractualprovisions. While such information is required for the preparation of a CAFR, it is not required for fair presentationin accordance with GAAP. In contrast, presentation of the RSI is required by the GASB to meet the minimumfinancial reporting requirements.

Auditor Reporting on RSI

Because RSI is not part of the basic financial statements, errors in RSI or its omission do not affect the auditor'sopinion on the basic financial statements. The AICPA Auditing Standards Board establishes standards for auditorsreporting on RSI. As discussed in AICPA Statement on Auditing Standards (SAS) No. 52 (AU 558), Required

Supplementary Information, the auditor should apply certain limited procedures to RSI. AU 558.07 requires theauditor to:

a. Inquire of management about the methods of preparing the information (whether it meets the standards,whether changes have been made in measurement methods from the prior period, and whether significantassumptions were made).

b. Compare the information with management's responses to the inquiries above, the audited financialstatements and other knowledge obtained during the examination for consistency.

c. Consider whether RSI should be covered in management's representation letter.

d. Apply any additional procedures prescribed for specific types of RSI.

e. Make additional inquiries if the foregoing procedures indicate measurement or presentation issues.

If there are deficiencies in the information or if the information is omitted, the auditor should comment on this in theaudit report. For example, if Management's Discussion and Analysis (MD&A) is omitted, its absence does not affectthe auditor's opinion on the basic financial statements. However, the auditor's report should include an explanatoryparagraph stating that certain supplementary information, although not a required part of the basic financialstatements, has been omitted. Similarly, if the information is presented but departs materially from the prescribedguidelines, an explanatory paragraph is also required.

In addition to the required instances of reporting on required supplementary information, SAS No. 98, Omnibus

Statement on Auditing Standards2002, allows auditors to report on required supplementary information when ithas been subjected to the auditing procedures performed as part of the financial statement audit.

THE REQUIREMENTS OF RSI

GAAP requires presentation of RSI in six situations:

a. All governments must present an MD&A, which is required by GASBS No. 34, paragraphs 8 through 11.

b. When a government has a legally adopted budget for its general fund or its major special revenue funds,GASBS No. 34, paragraphs 130 and 131 require presentation of budgetary comparison schedules forthose funds in RSI. However, footnote 53 notes that governments may elect to present required budgetarycomparisons as basic financial statements rather than as RSI.

c. GASBS No. 30, Risk Financing Omnibus, paragraph 7, requires public entity risk pools to present 10�yearrevenue and claims development information as RSI. However, GASBS No. 30, footnote 7 permitsgovernment to present that information within the statistical section of a CAFR in certain cases.


137

d. GASBS No. 25, Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined

Contribution Plans, and GASBS No. 27, Accounting for Pensions by State and Local Governmental

Employers, both as amended by GASBS No. 50, Pension Disclosures, require that trend data on pensionfunding be presented as RSI by employers and defined benefit pension plans.

e. GASBS No. 34, Basic Financial Statementsand Management's Discussion and Analysisfor State and

Local Governments, paragraphs 132 and 133, require governments that use the modified approach toreport their infrastructure assets to present information about the condition of those assets in RSI.

f. GASBS No. 43, Financial Reporting for Postemployment Benefit Plans Other Than Pension Plans, andGASBS No. 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than

Pensions, require that trend data on other postemployment benefit funding be presented as RSI byemployers and by postemployment benefit plans other than pension plans. (GASBS Nos. 43 and 45 areboth effective in three phases, with the earliest effective date for plans being for periods beginning afterDecember 15, 2005 and for employers being for periods beginning after December 15, 2006.


138


139

SELF�STUDY QUIZ


1. How should required supplementary information (RSI) generally be reported in the basic financial statementsof a government?

a. As part of the notes to the financial statements.

b. Within the separate summary reconciliation of each governmental fund of the financial statements.

c. Before the basic financial statements or after the notes to the financial statements.

d. As part of the Statement of Revenues, Expenditures, and Changes in Fund Balances.

2. What is one difference between other supplementary information and RSI?

a. Other supplementary information provides details of financial information contained in the basic financialstatements.

b. RSI is required by GASB.

c. Auditors are required to perform substantive testing on RSI to express an unqualified opinion on the basicfinancial statements.

3. Which of the following is required by all governments in the governmental reporting model?

a. Statement of Fiduciary Net Assets.

b. Management's Discussion and Analysis.

c. Financial statements using the accrual basis of accounting.


140



1. How should required supplementary information (RSI) generally be reported in the basic financial statementsof a government? (Page 135)

a. As part of the notes to the financial statements. [This answer is incorrect. RSI is distinguished from the notesto the financial statements of a government. Notes to the financial statements might include, but are notlimited to, a summary of significant accounting policies and debt service requirements.]

b. Within the separate summary reconciliation of each governmental fund of the financial statements. [Thisanswer is incorrect. A separate summary reconciliation is required to show the relationship between thegovernmental activities of the primary government and the funds of the government. This reconciliationis not considered RSI.]

c. Before the basic financial statements or after the notes to the financial statements. [This answer is

correct. Paragraph 8 of GASB No. 34 indicates the proper placement of RSI. Placement depends on

the nature of the RSI being presented.]

d. As part of the Statement of Revenues, Expenditures, and Changes in Fund Balances. [This answer isincorrect. This is one of the basic financial statements required of a governmental fund. RSI would not beincluded in this statement.]

2. What is one difference between other supplementary information and RSI? (Page 136)

a. Other supplementary information provides details of financial information contained in the basic financialstatements. [This answer is incorrect. Both RSI and other supplementary information may provide detailwhich assists financial statement users interpret the basic financial statements.]

b. RSI is required by GASB. [This answer is correct. In order to meet minimum financial reporting

requirements of a governmental entity, RSI is required by GASB. Other supplementary information

presented in comprehensive annual financial reports is not required.]

c. Auditors are required to perform substantive testing on RSI to express an unqualified opinion on the basicfinancial statements. [This answer is incorrect. RSI does not affect the auditor's opinion on the basicfinancial statements; however, an auditor should apply certain limited procedures to such information.]

3. Which of the following is required by all governments in the governmental reporting model? (Page 136)

a. Statement of Fiduciary Net Assets. [This answer is incorrect. This financial statement is required only forfunds in the fiduciary fund category, such as an employee pension fund.]

b. Management's Discussion and Analysis. [This answer is correct. Management's Discussion and

Analysis (MD&A) is required by GASB and is intended to provide financial information pertinent to

user groups.]

c. Financial statements using the accrual basis of accounting. [This answer is incorrect. Certaingovernmental units are required to be reported on a basis other than the accrual basis of accounting.]


141

THE BASICS OF BUDGETARY REPORTING

Budgetary ReportingTHE BASICS

� A budgetary comparison must be presented for the general fund and each major specialrevenue fund (including blended component units) that have a legally adopted annual orbiennial budget.

� These comparisons may be presented as schedules in RSI or as basic statements with thegovernmental fund financial statements.

� The comparisons must include at least three columnsoriginal appropriated budget, finalbudget, and actual inflows and outflows on the government's budgetary basis.

� Variance columns (difference between final budget and actual or between original and finalbudget) are optional.

� Required disclosures must accompany the comparisoneither in notes to RSI or in notes tothe basic financial statements.

Purpose and Placement

As discussed in GASB Concepts Statement No. 1, Objectives of Financial Reporting, the purpose of the budgetarycomparison information is to demonstrate the government's compliance in obtaining and using financial resourcesin accordance with its legally adopted budget. GASBS No. 34 does nothing to change this purpose or, asdiscussed in Question 7.91.1 of the GASB Comprehensive Implementation Guide2009, to change the level atwhich budgetary compliance should be reported.

GASBS No. 34, paragraph 130, as amended by GASBS No. 41, Budgetary Comparison SchedulesPerspective

Differences, encourages governments to present budgetary comparison information in schedules as part of RSI.However, footnote 53 allows governments to elect to report the same information in budgetary comparisonstatements as a basic financial statement rather than as RSI. Question 7.91.7 in the GASB Comprehensive Imple�

mentation Guide2009 states that all of the required budgetary comparison information should be reported eitheras RSI or in the basic financial statements. For example, governments may not present the general fund budgetarycomparison statement as a basic financial statement, and then present budgetary compliance schedules as RSI formajor special revenue funds. Question 7.91.8 indicates that a government electing to present the required budget�ary comparison information in the basic financial statements should include it with the governmental fund financialstatements after the related statement of changes in revenues, expenditures, and changes in fund balance.

The GASB does not establish standards for budget accounting practices or the budgetary basis of accounting. Asa result, the GASB believes budgetary compliance is more appropriately presented as RSI. However, the GASBrecognizes that some governments believe that this budgetary reporting is essential and has made an allowancefor governments to continue to present budgetary comparison information as basic financial statements. In fact, theGovernment Finance Officers Association (GFOA) has formally recommended that budgetary comparisons bereported as basic financial statements. Many GASBS No. 34 implementers have elected to continue to present thebudgetary comparison as a basic financial statement. Regardless of whether a government elects to presentbudgetary comparisons in RSI or as basic statements, all reporting requirements discussed in the followingparagraphs apply.

Budgetary Comparison Requirements

Scope/Required Funds. Budgetary comparisons must be provided for the following funds:

� General fund with a legally adopted annual budget.

� Each major special revenue fund with a legally adopted annual budget.

Although the GASBS No. 34 requirement refers to an �annual" budget, Question 7.91.10 in the GASB Comprehen�

sive Implementation Guide2009 indicates that it also applies to biennial budgets. Question 7.380 clarifies that the


142

fund classifications referred to above are those used in the fund financial statements and not those used for internalaccounting purposes. A separate comparison is required for each fund. Funds cannot be combined.

Budgetary comparisons for all other funds must be presented as supplementary information (not as RSI or as basicfinancial statements). The financial activity of capital project funds, debt service funds, and permanent fundsgenerally are not determined on an annual basis or are determined based on legal or outside conditions orrequirements, making an annual budget comparison less relevant. Though only major special revenue funds maybe included, Question 7.91.2 in the GASB Comprehensive Implementation Guide2009 clarifies that all specialrevenue funds reported as major funds are subject to this requirement, whether designated as major based on thepercentage criteria or management's discretion. In other words, including an otherwise nonmajor special revenuefund in the budget to actual comparison automatically would promote it to a major special revenue fund. It wouldneed to be reported in a separate column (because it is a major fund) in all of the governmental fund financialstatements, as described in Question 7.91.5 of the GASB Comprehensive Implementation Guide2009.

Legally Adopted Budgets. Governments should only present budgetary comparison schedules/statements fortheir general fund and major special revenue funds if those funds have legally adopted budgets. The GASB

Comprehensive Implementation Guide2009, Question 7.91.14, clarifies that a �legally adopted" budget existswhen the government has no legal authority to spend resources until it adopts a budget. If a government can spendmoney without a budget, it has no legally adopted budget. Question 7.91.13 clarifies that this may be true of agovernment's general fund or its special revenue funds or both. The AICPA Audit and Accounting Guide: State and

Local Government (SLG) requires certain disclosures when a government is not required to legally adopt a budgetfor its general fund or special revenue funds.

Perspective Differences. Some governments use a different fund structure for their budgets that is not consistentwith the funds required by GAAP. For example, some governments budget by program, not by fund type, and thusdo not have a budget labeled �general fund" or �special revenue fund." As discussed later in this lesson, thesedifferences are called perspective differences. Some governmentsmostly stateshave perspective differencesthat are so significant that they find that they are unable to prepare budgetary comparison information for therequired funds. For this reason, GASBS No. 34 was amended by GASBS No. 41 to require these governments topresent their budgetary comparison information using the budgetary funds, organization, or program structureused for their legally adopted budget (rather than the fund structure used in their financial statements). Regardlessof how the comparison information is presented, it must include all of the activities that are reported in the generalfund and each major special revenue fund in the GAAP statement of revenues, expenditures and changes ingovernmental fund balances. Because of differences in reporting, these governments are prohibited from reportingtheir budgetary comparison information in a basic financial statement. It must be reported as RSI.

As discussed in NCGA Interpretation (NCGAI) 10, State and Local Government Budgetary Reporting, paragraph 25,budget�GAAP reconciliation should be used to show adjustments needed to reclassify activities that should not beincluded, such as activities that are reported in other fund types or in nonmajor special revenue funds in thegovernmental fund statements. In addition, reclassifications should be used to shift revenues and expendituresfrom the budgetary funds, organizations, or program structures to the general fund and major special revenuefunds used in the GAAP operating statement. The reconciliation may be to the total for the general fund and majorspecial revenue funds or the total for all governmental funds (both major and nonmajor). An illustration of a budgetcomparison schedule with perspective differences is in Exhibit 1�3.

Required Information. Budgetary comparisons should contain the following information for each fund (generallyin columns):

� Original Budget. The first complete, legally appropriated budget adjusted for appropriate changesoccurring before the beginning of the fiscal year. Question 7.92.1 in the GASB Comprehensive

Implementation Guide2009 clarifies that original budget refers to the first budget that covers the entirefiscal period. It does not refer to interim budgets that serve as temporary spending authority that do notcover the entire fiscal period.

Actual appropriated amounts automatically carried over from the preceding year should also be includedin the original budget. For example, a local or state law may require inclusion of an amount in the budget


143

to cover prior�period encumbrances, even if the actual amount is not known. It is likely that the amount willbe known by the end of the fiscal period and that amount should be included in the original budget amount.

� Final Budget. The original budget adjusted for appropriate legal changes applicable to the fiscal year,including those occurring during and after the end of the fiscal year.

� Actual Inflows, Outflows, and Balances on the Budgetary Basis. Actual fund financial activity presented onthe same basis as the legally adopted budget (budgetary basis).

Although variance columns are not required, GASBS No. 34, paragraph 130, encourages governments to add acolumn showing the variance between the final budget and actual amounts. In general, most GASBS No. 34implementers have elected to present the variance between final budget and actual amounts. This variance oftenis labeled as being positive/negative, over/under, or favorable/unfavorable, although some accountants believethat favorable/unfavorable should be avoided because it is a qualitative assessment rather than an objectiveassessment.

Governments often adopt budget amendments near or after year end so that the final budget closely resembles theactual amounts. This practice limits the effectiveness of the budgetary comparison information. In response,GASBS No. 34 added the original budget to the budgetary comparison requirements. This addition allows users toassess the effect of issues encountered during the year and provides accountability to users of the original budget.Presentation of the variance between the original and final budget is allowed but not required or encouraged. MostGASBS No. 34 implementers have elected not to present the variance between original and final budget amounts.However, significant variations between the original and final budget amounts for the general fund must bediscussed in MD&A.

Format. GASBS No. 34, paragraph 131, allows the budgetary comparison to be presented using either the sameformat, terminology, and classifications as used in the budget document or in the governmental fund statement ofrevenues, expenditures, and changes in fund balances (operating statement). The budget document format optionwas added to make it easier to demonstrate budgetary compliance, and some governments are taking advantageof this format option. The GASB does not prefer one format over the other. Budgetary comparisons presented usingthe budget document format, however, often require several pages for the general fund alone. Governments shouldconsider whether this is appropriate when presenting their budgetary comparison statements as basic financial

statements. One alternative would be to present two budgetary comparisonsone summary comparison in thebasic financial statements using the GAAP operating statement format and a second detailed comparison using thebudget document format as supplementary information in the government's CAFR.

Required Disclosures

The GASB Codification and SLG require several budget�related disclosures that must accompany budgetarycomparisons. These are:

� When the budgetary basis of accounting used to report actual inflows and outflows is different from GAAP,NCGAI 10 requires a budget�GAAP reconciliation that shows how budget�basis amounts differ from GAAP.

� The budgetary basis of accounting.

� Any excess of expenditures over appropriations in any individual funds not included in the budgetarycomparisons.

� When the government has no legally adopted budget for its general fund or for any of its major specialrevenue funds, disclosure of that fact.

Each of these disclosures, when applicable, should follow the budgetary comparisons. That is, when budgetarycomparisons are presented as schedules in RSI, the disclosures should be presented in notes to RSI. Whencomparisons are presented as basic financial statements, the disclosures should be included in the notes to thebasic financial statements.


144

Budget�GAAP Reconciliation. GASB Cod. sec. 2400.109�.119, based on NCGAI 10, as amended, notes thatdifferences between the budgetary and GAAP basis may be of the following types:

a. Basis Differences. Basis of accounting differences arise when the basis of accounting used to develop andapprove the budget differs from the basis of accounting required by GAAP for financial reporting. Two suchdifferences are use of the cash basis of accounting for the budget and treating encumbrances asexpenditures for the budget. The primary government may control or minimize these differences, if any.However, greater differences may arise between the primary government and a blended component unitactivity reported as a major special revenue fund.

b. Timing Differences. Timing differences include variances between budgetary practices and GAAP financialreporting concerning continuing appropriations, project appropriations, automatic reappropriations, andbiennial appropriations. These differences result if the legally adopted budget is for a different or longertime period than the GAAP financial statements.

For example, a government may be required to make appropriations for a grant on a fiscal period thatcorresponds to the grant fiscal period and not the government's fiscal year.

c. Perspective Differences. According to GASB Cod. sec. 2400.113, perspective differences refer to thestructure of the financial information for budgetary purposes, which may include the fund structure andindividual fund differences, organization structure, or program structure.

Traditionally, GAAP and budgeting follow the GAAP fund structure. Perspective differences arise when thisis not the case. For example, a budget based on organizational or program structure may cut across agovernment's GAAP fund structure. A program budget often represents groups of activities to achieve acommon purpose that usually cuts across the fund and organization structure. As another example, insteadof preparing a budget for a major special revenue fund as a whole, a government may prepare separatebudgets for each program reported in the special revenue fund. Yet, the GAAP financial statements reportthe fund as a whole, not as component programs.

d. Entity Differences. Entity differences arise when the appropriated budget either includes or excludesorganizations, programs, or activities that are inconsistent with the GASBS No. 14 criteria for including orexcluding organizations in the financial reporting entity. Or, a governmental type fund that is included in thefinancial reporting entity may not have legally adopted a budget. For example, the general fund of ablended component unit reported as a major special revenue fund may not be included in the budget ofthe primary government and may not have a budget of its own.

When any of these differences exist, GASB Cod. sec. 2400.109 requires governments to present a reconciliation ofbudgetary comparison information to GAAP information either in a separate schedule or in the notes to RSI. Forexample, if the government reports encumbrances as expenditures and liabilities on the budgetary basis, the effectof that basis difference is generally shown in a reconciling schedule at the bottom of the budgetary comparisonschedule. Note that governments are not required to classify the differences by category, that is, as a basis, timing,or entity differences.

The physical format of the budgetary comparison (budget format versus operating statement format) should not beconfused with the basis of the presentation of the actual column (GAAP versus budget). If the actual inflows/out�flows column is prepared on the GAAP basis (i.e., the government's budgetary basis is the same as that requiredby GAAP), no reconciliation is necessary.

Budgetary Basis of Accounting. The budgetary �basis of accounting" refers to when changes in resources aremeasured in the individual government's legally adopted budget. The GASB has no jurisdiction over the basis ofaccounting that a government may choose when setting its legally adopted budget. NCGAI 6, Notes to the

Financial Statements Disclosure, paragraph 5, requires governments to disclose their budgetary basis of account�ing when it is different from the modified accrual basis used to report governmental funds. Governments that arerequired to budget on a GAAP basis would make no disclosures.

Excess of Expenditures Over Appropriations. Governments should disclose any excess of expenditures overappropriations in any individual funds included in the budgetary comparisons as required by NCGAI 6, paragraph4, as amended. Regardless of where a government presents its budgetary comparisons (as RSI or as basic


145

financial statements), overexpenditures in any individual fund (including those not required to be presented in thebudgetary comparison, such as nonmajor special revenue, capital projects, or debt service funds) that are materialviolations of finance�related legal provisions must be disclosed in the notes to the financial statements, as dis�cussed in Question 7.93.2 of the GASB Comprehensive Implementation Guide2009. Question 7.93.1 points outthat GASBS No. 38, Certain Financial Statement Note Disclosures, requires disclosure of the actions taken toaddress significant violations.

Absence of Legally Adopted Budget. If a budget is not adopted for the general fund or a major special revenuefund because it is not legally required (thus eliminating the requirement to present budgetary comparison informa�tion), the SLG, paragraph 11.16, requires that fact be disclosed. If other budgetary comparisons are presented inRSI, then the disclosure should be made in RSI. Otherwise, disclosure should be made in the notes to the basicfinancial statements. If there is no legal requirement for either general fund or special revenue fund budgets,disclosure of that fact in the notes to the basic financial statements is generally recommended.

Supplementary Budget Information

Governments that prepare a CAFR often include budgetary comparisons for debt service, capital projects, andother funds that have legally adopted budgets as supplementary information. Question 7.91.3 in the GASBComprehensive Implementation Guide2009 indicates that governments may continue this practice and maychoose to, but are not required to, present the information in accordance with GASBS No.�34 presentationrequirements. In other words, the required general fund and major special revenue fund budget comparisons mustbe shown in accordance with GASBS No. 34, but other supplementary budgetary information may be presented inwhatever format the government chooses.

Illustrations

Exhibit 1�1 illustrates a required budgetary comparison schedule for a city with a general fund and a major specialrevenue fund presented as RSI. It is presented in the budget document format with the budget�GAAP reconciliationpresented as a note to the schedule. The city elected to present the optional variance column between final budgetand actual results.

Exhibit 1�2 illustrates the same information as Exhibit 1�1 for the general fund in the revenues, expenditures, andchanges in fund balances (operating statement) format presented as a basic financial statement. The budget toactual reconciliation is presented in an additional column in the schedule. The city elected not to present anyvariance columns.

Exhibit 1�3 illustrates budgetary comparison schedules for a city with perspective differences using the city'sbudget document format. The general operating budgetary fund includes all of the activities of the general fund andthe road improvement major special revenue fund. The HUD programs fund is also a major special revenue fund.However, it is budgeted on a GAAP basis. A note to the schedule reconciles the actual amounts on a budgetarybasis for the budgetary funds to the actual amounts on a GAAP basis for the general and major special revenuefunds. The city elected to present the optional variance column between final budget and actual results. Theinformation is presented as RSI as required by GASBS No. 41.

COMMON ERRORS

In reviewing the financial statements of governments that have implemented GASBS No. 34 for PPC's Governmen�

tal Financial Statements Illustrations and Trends, a list of common errors related to presenting budgetary RSI hasbeen identified. Financial statement preparers should review the following list to avoid making the same errors.

� Budget�related notes should accompany RSI, not remain in notes. This error is pervasive. More often thannot, when a government presents its budgetary comparison as a schedule in RSI, information related tothe budget is disclosed in the notes to the basic financial statements.

� Budgetary schedules should be confined to those that are for the legally adopted budgets of the generalfund and major special revenue funds. It is never appropriate to present additional information in RSI.Conversely, some governments have presented a comparison schedule for only the general fund whenother major special revenue funds have legally adopted budgets.

� If the legally adopted budget has a different perspective than the funds used in the basic financialstatements, then the budgetary comparison must appear as RSI rather than as a basic financial statement.


146

Exhibit 1�1

Illustrative Budgetary Comparison ScheduleBudget Format

SAMPLE CITY

BUDGETARY COMPARISON SCHEDULEGENERAL FUND

Year Ended December 31, 20X2

Budgeted AmountsActual Amounts

(Budgetary Variance with

Original Final

(BudgetaryBasis)

(See Note A)a

Variance with

Final BudgetPositive (Negative)b

Budgetary fund balance, January 1 $ 3,528,750 $ 2,742,799 $ 2,742,799 $ �

Resources (inflows):

Property taxes 52,017,833 51,853,018 51,173,436 (679,582 )

Franchise taxes 4,546,209 4,528,750 4,055,505 (473,245 )

Public service taxes 8,295,000 8,307,274 8,969,887 662,613

Licenses and permits 2,126,600 2,126,600 2,287,794 161,194

Fines and forfeitures 718,800 718,800 606,946 (111,854 )

Charges for services 12,392,972 11,202,150 11,374,460 172,310

Grants 6,905,898 6,571,360 6,119,938 (451,422 )

Sale of land 1,355,250 3,500,000 3,476,488 (23,512 )

Miscellaneous 3,024,292 1,220,991 881,874 (339,117 )

Interest received 1,015,945 550,000 552,325 2,325

Transfers from other funds 939,525 130,000 129,323 (677 )

Amounts available for appropriation 96,867,074 93,451,742 92,370,775 (1,080,967 )

Charges to appropriations (outflows):

General government:

Legal 665,275 663,677 632,719 30,958

Mayor, legislative, city manager 3,058,750 3,192,910 2,658,264 534,646

Finance and accounting 1,932,500 1,912,702 1,852,687 60,015

City clerk and elections 345,860 354,237 341,206 13,031

Employee relations 1,315,500 1,300,498 1,234,232 66,266

Planning and economic development 1,975,600 1,784,314 1,642,575 141,739

Public safety:

Police 19,576,820 20,367,917 20,246,496 121,421

Fire department 9,565,280 9,559,967 9,559,967 �

Emergency medical services 2,323,171 2,470,127 2,459,866 10,261

Inspections 1,585,695 1,585,695 1,533,380 52,315

Public works:

Public works administration 388,500 385,013 383,397 1,616

Street maintenance 2,152,750 2,233,362 2,233,362 �

Street lighting 762,750 759,832 759,832 �

Traffic operations 385,945 374,945 360,509 14,436

Mechanical maintenance 1,525,685 1,272,696 1,256,087 16,609

Engineering services:

Engineering administration 1,170,650 1,158,023 1,158,023 �

Geographical information system 125,625 138,967 138,967 �

Health and sanitation:

Garbage pickup 5,756,250 6,174,653 6,174,653 �

Cemetery:

Personal services 425,000 425,000 422,562 2,438

Purchases of goods and services 299,500 299,500 283,743 15,757

Culture and recreation:

Library 985,230 1,023,465 1,022,167 1,298

Parks and beaches 9,521,560 9,786,397 9,756,618 29,779

Community communications 552,350 558,208 510,361 47,847

Nondepartmental:

Miscellaneous � 259,817 259,817 �

Contingency 2,544,049 � � �

Transfers to other funds 2,970,256 2,163,759 2,163,759 �

Funding for school district 22,000,000 22,000,000 21,893,273 106,727

Total charges to appropriations 93,910,551 92,205,681 90,938,522 1,267,159

Budgetary fund balance, December 31 $ 2,956,523 $ 1,246,061 $ 1,432,253 $ 186,192

See accompanying note to budgetary comparison schedules.


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SAMPLE CITY

BUDGETARY COMPARISON SCHEDULEHUD PROGRAM FUND


Budgeted Amounts

Actual

Amounts

(BudgetaryVariance with

Final Budget

Original Final

(Budgetary

Basis)

(See Note A)a

Final Budget

Positive

(Negative)b

Budgetary fund balance, January 1 $ 1,600,000 $ 1,618,441 $ 1,618,441 $ �

Resources (inflows):

Federal grants 2,000,000 2,000,000 1,963,526 (36,474 )

State grants � 600,000 614,665 14,665

Interest on investments 85,000 85,000 87,106 2,106

Miscellaneous 50,000 50,000 66,176 16,176

Amounts available for appropriation 3,735,000 4,353,441 4,349,914 (3,527 )

Charges to appropriations (outflows):

Community development:

Ombudsman office 1,725,000 1,725,000 1,687,422 37,578

Weatherization program 700,000 1,300,000 1,279,104 20,896

Transfers to other funds 350,000 350,000 348,046 1,954

Total 2,775,000 3,375,000 3,314,572 60,428

Budgetary fund balance, December 31 $ 960,000 $ 978,441 $ 1,035,342 $ 56,901



148

SAMPLE CITY

NOTE TO BUDGETARY COMPARISON SCHEDULES

NOTE ABUDGET�TO�ACTUAL RECONCILIATIONc

An explanation of the differences between budgetary inflows and outflows and revenues and expendituresdetermined in accordance with generally accepted accounting principles follows:

General

Fund

HUD Program

Fund

Sources/inflows of resources:

Actual amounts (budgetary basis) �available for appropriation" from thebudgetary comparison schedule $ 92,370,775 $ 4,349,914

Differencesbudget to GAAP:

The fund balance at the beginning of the year is a budgetary resourcebut is not a current�year revenue for financial reporting purposes (2,742,799 ) (1,618,441 )

Transfers from other funds are inflows of budgetary resources but arenot revenues for financial reporting purposes (129,323 ) �

The proceeds from the sale of the park land are budgetary resourcesbut are regarded as a special item, rather than revenue, for financialreporting purposes (3,476,488 ) �

Total revenues as reported on the statement of revenues, expenditures,and changes in fund balancesgovernmental funds $ 86,022,165 $ 2,731,473

Uses/outflows of resources:

Actual amounts (budgetary basis) �total charges to appropriations" fromthe budgetary comparison schedule $ 90,938,522 $ 3,314,572

Differencesbudget to GAAP:

The City budgets for claims and compensated absences only to theextent expected to be paid, rather than on the modified accrual basis 129,100 3,900

Encumbrances for supplies and equipment ordered but not received arereported in the year the order is placed for budgetary purposes, but inthe year the supplies are received for financial reporting purposes (186,690 ) (16,037 )

Transfers to other funds are outflows of budgetary resources but are notexpenditures for financial reporting purposes (2,163,759 ) (348,046 )

Total expenditures as reported on the statement of revenues, expenditures,and changes in fund balancesgovernmental funds $ 88,717,173 $ 2,954,389

Notes:

a Actual amounts are presented on the budgetary basis of accounting necessitating a budget�to�GAAPreconciliation. The reconciliation may be in the schedule, as a separate schedule, or in the notes to RSI.Available space and the complexity of the reconciliation may influence the preparer's choice as to location.

b Presentation of the budget to actual variance column is encouraged but not required.

c This illustration includes examples of basis, timing, and perspective differences, as discussed in NCGAI No.10, paragraphs�15�25. There were no �entity" differences in the sample government illustrated here.

[SOURCE:�Adapted from GASB's Comprehensive Implementation Guide2009, Appendix 7�1, Exhibits 12, 13,and 14.]

* * *


149

Exhibit 1�2

Illustrative Budgetary Comparison StatementOperating Statement Format

SAMPLE CITY

STATEMENT OF REVENUES, EXPENDITURES, AND CHANGES IN

FUND BALANCESBUDGET AND ACTUAL GENERAL FUND


Budgeted AmountsActual

Amounts

Budget to

GAAP Actual

Original Final

AmountsBudgetary

Basisa

GAAPDifferences

Over (Under)b

Actual

AmountsGAAP Basis

REVENUES

Property taxes $ 52,017,833 $ 51,853,018 $ 51,173,436 $ � $ 51,173,436

Other taxesfranchise and public service 12,841,209 12,836,024 13,025,392 � 13,025,392

Fees and fines 718,800 718,800 606,946 � 606,946

Licenses and permits 2,126,600 2,126,600 2,287,794 � 2,287,794

Intergovernmental 6,905,898 6,571,360 6,119,938 � 6,119,938

Charges for services 12,392,972 11,202,150 11,374,460 � 11,374,460

Interest 1,015,945 550,000 552,325 � 552,325

Miscellaneous 3,024,292 1,220,991 881,874 � 881,874

Total revenues 91,043,549 87,078,943 86,022,165 � 86,022,165

EXPENDITURES

Current:

General government (including contingen�cies and miscellaneous) 11,837,534 9,468,155 8,621,500 (1) (9,335 ) 8,630,835

Public safety 33,050,966 33,983,706 33,799,709 (1) 70,086 33,729,623

Public works 5,215,630 5,025,848 4,993,187 (1) 17,412 4,975,775

Engineering services 1,296,275 1,296,990 1,296,990 (1) (2,655 ) 1,299,645

Health and sanitation 5,756,250 6,174,653 6,174,653 (1) 104,621 6,070,032

Cemetery 724,500 724,500 706,305 � 706,305

Culture and recreation 11,059,140 11,368,070 11,289,146 (1) (122,539 ) 11,411,685

Educationpayment to school district 22,000,000 22,000,000 21,893,273 � 21,893,273

Total expenditures 90,940,295 90,041,922 88,774,763 57,590 88,717,173

Excess (deficiency) of revenueover expenditures 103,254 (2,962,979 ) (2,752,598 ) 57,590 (2,695,008 )

OTHER FINANCING SOURCES (USES)

Transfers in 939,525 130,000 129,323 � 129,323

Transfers out (2,970,256 ) (2,163,759 ) (2,163,759 ) � (2,163,759 )

Total other financing sources and uses (2,030,731 ) (2,033,759 ) (2,034,436 ) � (2,034,436 )

SPECIAL ITEM

Proceeds from sale of park land 1,355,250 3,500,000 3,476,488 � 3,476,488

Net change in fund balance (572,227 ) (1,496,738 ) (1,310,546 ) 57,590 (1,252,956 )

Fund balancesbeginning 3,528,750 2,742,799 2,742,799 (2) 165,523 2,908,322

Fund balancesending $ 2,956,523 $ 1,246,061 $ 1,432,253 $ 223,113 $ 1,655,366

Explanation of differences:

(1) The City budgets for claims and compensated absences only to the extentexpected to be paid, rather than on the modified accrual basis $ (129,100 )

Encumbrances for equipment and supplies ordered but not received arereported in the year the orders are placed for budgetary purposes, but arereported in the year the equipment and supplies are received for GAAPpurposes 186,690

Net increase in fund balancebudget to GAAP $ 57,590


150

(2) The amount reported as �fund balance" on the budgetary basis ofaccounting derives from the basis of accounting used in preparing the City'sbudget. (See Note XX for description of the City's budgetary method.) Thisamount differs from the fund balance reported in the statement of revenues,expenditures, and changes in fund balances because of the cumulativeeffect of transactions such as those described above

Notes:

a Actual amounts are presented on the budgetary basis of accounting necessitating a budget�to�GAAP reconciliation.

b The budget�to�GAAP reconciliation may be presented in the schedule, as a separate schedule, or in the notes to RSI. This illustration

presents the reconciliation in an optional column. Available space and the complexity of the reconciliation may influence the preparer�s

choice as to location.

[SOURCE:�GASB's Comprehensive Implementation Guide2009, Appendix 7�2, Exhibit 13.]

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151

Exhibit 1�3

Illustrative Budgetary Comparison SchedulePerspective Differences

SAMPLE CITY

BUDGETARY COMPARISON SCHEDULE

GENERAL OPERATING FUND


a b



152

SAMPLE CITY

Budgetary Comparison Schedule

HUD Programs Fund


ba



153

Note to Budgetary Comparison Schedule

Notes:a Actual amounts are presented on the budgetary basis of accounting using the budgeted structure necessitating a budget�to�GAAP

reconciliation. The reconciliation may be in the schedule, as a separate schedule, or in the notes to RSI. Available space and the

complexity of the reconciliation may influence the preparer's choice as to location.b Presentation of the budget to actual variance column is encouraged but not required.

Note:�This illustration includes examples of basis, timing, and perspective differences, as discussed in NCGAI No.�10, paragraphs 15�25.There were no �entity" differences in the sample government illustrated here.

[SOURCE: Adapted from GASBS No. 41, Budgetary Comparison SchedulesPerspective Differences, Appendix�C, Exhibits 1a, 1b, and 1c.]

* * *


154


155

SELF�STUDY QUIZ


4. Why does the GASB believe budgetary compliance should be presented as part of RSI instead of as part ofthe basic financial statements?

a. GASB has not established budget accounting practices or the budgetary basis of accounting.

b. GASBS No. 34 ultimately requires all governmental entities to present budgetary compliance as RSI forfiscal years ending after December 15, 2008.

c. GASB believes that the reporting of this information in the RSI more appropriately satisfies the statedpurpose of its presentation.

d. GASB believes that, since outside auditors do not perform tests of transactions on this information, itshould not be presented as part of the basic financial statements.

5. For which of the following funds would a budgetary comparison most likely required to be made?

a. A permanent fund dedicated to the arts established by a patron of the city.

b. A fund used for internal accounting purposes.

c. A fund established for the building of a new city hall paid for out of bond proceeds.

d. A fund that is dedicated to street and highway maintenance paid for with a gasoline tax.

6. Why are some states required to include their budgetary comparison information in RSI?

a. Because changes made to the original budget due to legal issues affect the fiscal year's reporting.

b. Because they use a fund structure that is not consistent with GAAP.

c. Because certain state funds do not have a legally adopted budget.

7. Why does GASBS No. 34 require the presentation of the original budget in budgetary comparison information?

a. Because some governments budget by program, not by fund type.

b. Because governments frequently reclassified amounts throughout the year to ensure that budgetedamounts approximated actual amounts.

c. Because GASB requires the presentation of the variance between the original budget and final budget toaid users in the interpretation of the basic financial statements.

d. Because it is common practice for governments to amend original budgets close to the end of the yearto approximate actual amounts.

8. A municipality treats encumbrances as expenditures for budgetary purposes. This is an example of what typeof difference between budgetary and GAAP basis accounting?

a. Basis difference.

b. Timing difference.

c. Perspective difference.

d. Entity difference.


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9. What is a common error often made by governments in their attempts to comply with GASBS No. 34?

a. Placing budget�related notes in RSI, instead of in the notes to the financial statements.

b. Presenting budgetary schedules for funds that don't have legally adopted budgets.

c. Disclosing budgetary information of capital projects funds as supplementary information and not inaccordance with GASBS No. 34.

d. Electing to use a basis of accounting other than GAAP when setting a legally adopted budget.


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4. Why does the GASB believe budgetary compliance should be presented as part of RSI instead of as part ofthe basic financial statements? (Page 141)

a. GASB has not established budget accounting practices or the budgetary basis of accounting. [This

answer is correct. Since the GASB has not adopted formalized methods to present this information,

it believes that budgetary compliance is more appropriately presented as RSI, not as part of basic

financial statements.]

b. GASBS No. 34 ultimately requires all governmental entities to present budgetary compliance as RSI forfiscal years ending after December 15, 2008. [This answer is incorrect. There is no such requirement inGASBS No. 34. In fact, many practitioners who have implemented GASBS No. 34 continue to report thisinformation as part of the basic financial statements.]

c. GASB believes that the reporting of this information in the RSI more appropriately satisfies the statedpurpose of its presentation. [This answer is incorrect. This answer choice does not properly reflect thereason why the GASB prefers the presentation of budgetary compliance as part of RSI. Budgetarycompliance information presented as either RSI or as part of the basic financial statements achieves asimilar purpose.]

d. GASB believes that, since outside auditors do not perform tests of transactions on this information, itshould not be presented as part of the basic financial statements. [This answer is incorrect. Whetherpresented as part of the basic financial statements or as RSI, auditors, at a minimum, perform limitedprocedures on this information.]

5. For which of the following funds would a budgetary comparison most likely required to be made? (Page 142)

a. A permanent fund dedicated to the arts established by a patron of the city. [This answer is incorrect. Thefinancial activity for this type of fund generally is based on outside criteria and the annual budgetingprocess would be less relevant.]

b. A fund used for internal accounting purposes. [This answer is incorrect. Fund accounting statementswould not be required for these types of funds; therefore, the budgetary comparison requirements wouldnot apply.]

c. A fund established for the building of a new city hall paid for out of bond proceeds. [This answer is incorrect.Expenditures related to capital projects are determined by legal or other conditions and an annual budgetcomparison might not prove useful for this type of one�time project.]

d. A fund that is dedicated to street and highway maintenance paid for with a gasoline tax. [This answer

is correct. In all likelihood, this fund would be considered a major special revenue fund with a legally

adopted annual budget and thus subject to the budgetary comparison requirements.]

6. Why are some states required to include their budgetary comparison information in RSI? (Page 142)

a. Because changes made to the original budget due to legal issues affect the fiscal year's reporting. [Thisanswer is incorrect. Changes made to the original budget due to legal issues have no bearing on therequirement that some states report their budgetary comparison information in RSI.]

b. Because they use a fund structure that is not consistent with GAAP. [This answer is correct. Since

these differences exist, the governmental entities in question must perform reconciliations with

their funds to total general funds or special funds used in a GAAP�based operating statement.]

c. Because certain state funds do not have a legally adopted budget. [This answer is incorrect. If certaingeneral and special revenue funds do not have legally adopted budgets, budgetary comparisoninformation should not be presented.]


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7. Why does GASBS No. 34 require the presentation of the original budget in budgetary comparison information?(Page 143)

a. Because some governments budget by program, not by fund type. [This answer is incorrect. While thisis a true statement, this type of budgetary process might affect how the budgetary comparison informationis presented. It is not a factor in the requirement that an original budget be presented.]

b. Because governments frequently reclassified amounts throughout the year to ensure that budgetedamounts approximated actual amounts. [This answer is incorrect. Governments sometimes mustreclassify amounts when they use different fund structures for their budgets, but the GASB did not requireoriginal budgetary information due to this practice.]

c. Because GASB requires the presentation of the variance between the original budget and final budget toaid users in the interpretation of the basic financial statements. [This answer is incorrect. GASB does notrequire the presentation of the variance between the original and final budget.]

d. Because it is common practice for governments to amend original budgets close to the end of the

year to approximate actual amounts. [This answer is correct. The practice of amending budgets at

the end of the year diminished the usefulness of budgetary comparisons. By requiring the

presentation of the original budget, the GASB forced governments to be held accountable for

original assumptions.]

8. A municipality treats encumbrances as expenditures for budgetary purposes. This is an example of what typeof difference between budgetary and GAAP basis accounting? (Page 144)

a. Basis difference. [This answer is correct. This difference relates to a difference in the modified

accrual basis of accounting used by a government. A reconciliation must accompany the budgetary

comparisons of this municipality.]

b. Timing difference. [This answer is incorrect. Timing differences generally result when the appropriationperiod for a project does not correspond to a government's fiscal year.]

c. Perspective difference. [This answer is incorrect. Perspective differences occur when a governmentmaintains its budgetary fund structure on a basis different from GAAP.]

d. Entity difference. [This answer is incorrect. When a government's budget includes or excludes certainactivities that are inconsistent with GASB criteria, entity differences result and must be disclosed.]

9. What is a common error often made by governments in their attempts to comply with GASBS No. 34?(Page 145)

a. Placing budget�related notes in RSI, instead of in the notes to the financial statements. [This answer isincorrect. Budget�related notes should be disclosed in RSI, not the notes to the financial statements.]

b. Presenting budgetary schedules for funds that don't have legally adopted budgets. [This answer is

correct. For funds that don't have legally adopted budgets, this information should never be

presented in RSI.]

c. Disclosing budgetary information of capital projects funds as supplementary information and not inaccordance with GASBS No. 34. [This answer is incorrect. Only the general fund and major specialrevenue funds are required to comply with the GASBS No. 34 requirements. Other funds that have legallyadopted budgets may present budgetary information as supplementary information in whatever format thegovernment chooses.]

d. Electing to use a basis of accounting other than GAAP when setting a legally adopted budget. [This answeris incorrect. The GASB has no jurisdiction on what basis a government chooses to present its budgetaryinformation. The government must, however, provide a reconciliation of the differences.]


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Lesson 1 (GFSTG092)


1. Which of the following would be presented as required supplementary information (RSI) when a governmentalentity uses the modified approach?

a. Total taxable value of property in a city's jurisdiction.

b. The top ten employers in a county.

c. Information related to the condition of bridges within city limits.

d. The ten highest revenue sources to a city, as long as the top ten sources are at least 50% of total revenues.

2. Why did the Governmental Accounting Standards Board (GASB) require Management's Discussion andAnalysis (MD&A) to be separated from other RSI?

a. To improve its chances of being read by financial statement users.

b. To place emphasis on the introductory section of comprehensive annual financial report (CAFR).

c. Because MD&A includes audited information and other RSI does not.

d. Because MD&A contains information related to political initiatives on the part of a government that are notverifiable by auditors.

3. What should an auditor do if a government does not provide RSI?

a. Withdraw from the engagement.

b. Comment on the omission in the auditor's report.

c. Modify the opinion on the basic financial statements.

d. Perform additional procedures on the basic financial statements in order to issue an unqualified opinion.

4. Where might a government include budgetary comparison information?

a. Notes to the financial statements.

b. Schedules in MD&A.

c. Statistical section of the CAFR.

d. Basic statements with the governmental fund financial statements.

5. Which of the following is a required element in the budgetary comparisons of a government?

a. The variance between the original budget and actual amounts.

b. The variance between the original budget and final budget.

c. The budget variance by program.

d. Actual inflows on the budgetary basis.


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6. What is one problem when presenting the budgetary comparison using the same format as the budgetdocument?

a. The GASB prefers the budgetary comparison to be made in the same format as the operating statement.

b. The length of the budget document format might preclude its use as a basic financial statement.

c. Budgetary comparisons using the operating statement format make it easier to demonstrate budgetarycompliance.

d. Budgetary comparisons using the same format as the budget document make the reconciliation of budgetand GAAP basis differences more difficult to disclose.

7. Where should a government present a reconciliation of budgetary comparison information to GAAPinformation?

a. In a separate schedule with the budgetary comparison information.

b. In the notes to the basic financial statements.

c. In the statement of activities.

d. In the supplementary individual funds financial statements.

8. With respect to budgetary comparison information, which of the following must be disclosed by a government?

a. When any expenditure exceeds appropriations for individual funds included in the required budgetarycomparisons.

b. When material variances exist for funds that do not have a legally adopted budget.

c. When debt service funds have legally adopted budget and expenditures are less than appropriations inthe budgetary comparison information.

d. When the budgetary basis used to report governmental funds is the modified accrual basis.


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Lesson 2:�MANAGEMENT'S DISCUSSION AND

ANALYSIS (MD&A)

INTRODUCTION

This lesson includes a comprehensive study of Management's Discussion and Analysis in governmental financialstatements. The lesson discusses the objectives, authorship, and focus of MD&A relating to governmental financialstatements. Also, the general and specific requirements of MD&A are reviewed in detail. Finally, constructiveguidance on how to compose MD&A for its intended audience is presented to assist writers and reviewers ofMD&A.


Completion of this lesson will enable you to:� Recognize the appropriate inclusions for MD&A to correspond with GASB objectives.� Describe effective ways to present objective and comprehensible information in MD&A.� Identify the general and required components of MD&A.� Discuss the GASB requirements for MD&A and effective writing techniques for MD&A.

THE BASICS OF MD&A

The first required component of GAAP financial statements is Management's Discussion and Analysis (MD&A).MD&A is an analysis of the financial condition and operating results of the government written by its financial

managers. MD&A must be presented in every financial report that includes basic financial statements presented inaccordance with generally accepted accounting principles. Although it is required supplementary information(RSI), the GASB requires that MD&A be presented firstbefore the basic financial statements. It introduces thebasic financial statements and notes. GASBS No. 34, Basic Financial Statementsand Management's Discussion

and Analysisfor State and Local Governments, paragraph 8, states that MD&A should provide an �objective andeasily readable analysis of the government's financial activities based on currently known facts, decisions, orconditions." MD&A, along with the government�wide financial statements are intended to provide financial informa�tion that will be of interest to user groups who historically have not shown much interest in a government's financialreports, including the citizenry. Some GASB members believe the addition of MD&A has the greatest potential tointerest new users, particularly citizens and taxpayers. This lesson discusses the required components of MD&A indetail and provides guidance for making that presentation �easily readable." It also includes many illustrations ofindividual elements of MD&A presented by governments that have implemented GASBS No. 34 and discussessome of the common pitfalls in preparing MD&A.

GASB OBJECTIVES RELATED TO MD&A

In its Concepts Statement (GASBC) No. 1, Objectives of Financial Reporting, the GASB established a number ofobjectives of financial reporting by state and local governments. Of these objectives, the GASB believes that MD&Awill help users to:

� Evaluate the operating results of the government for the year (GASBC No. 1, paragraph 78) by providingan easily readable summary of operating results and the reasons for changes in the components ofoperating results.

� Assess the financial position and condition of the government and determine whether the government'sfinancial position improved or deteriorated as a result of the year's operations (paragraphs 78c and 79a)by providing financial management's analysis directed specifically to this point, including the reasons forchanges.

� Determine whether current�year revenues were sufficient to pay for current�year services (paragraph 77a)by discussing operating results, including decisions already made that will affect future operations.


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� Understand the sources and uses of financial resources (paragraph 78a) by providing an analysis of thebalances and transactions of individual funds, particularly for governmental funds.

� Understand how the government financed its activities and met its cash requirements (paragraph 78b) bydescribing (a) important economic factors, such as changes in tax or employment bases, that significantlyaffected operating results for the year; and (b) debt limitations that may affect the financing of plannedfacilities or services and any changes in credit ratings.

� Determine whether resources were obtained and used in accordance with the entity's legally adoptedbudget (paragraph 77b) by providing management's analysis of significant variations between original andfinal budget amounts and between final budget and actual amounts for the government's general fund.

� Assess the service efforts, costs, and accomplishments (SEA) of the governmental entity (paragraph 77c)by discussing currently known facts that are expected to affect the services a government provides andthe cost of those services.

� Assess the level of services that can be provided by the government and its ability to meet obligations asthey become due (paragraph 79) by describing debt limitations, changes in credit ratings, reasons forsignificant budget variations that are expected to have an effect on future services or liquidity, significantchanges in individual fund balances and the effect of any limitations on their use, as well as importanteconomic factors that significantly affected operating results for the year.

� Gain information about a government's physical and other nonfinancial resources having useful lives thatextend beyond the current year (paragraph 79b) by describing significant capital assets activity during theyear, commitments made to acquire new capital assets, and in some cases, the condition level ofinfrastructure assets.

� Assess legal or contractual restrictions on resources and risks of potential loss of resources (paragraph79c) by describing debt limitations and any changes in credit ratings, limitations on individual fundbalances, as well as currently known facts, decisions, or conditions that are expected to have a significanteffect on financial position or results of operations.

Many of these GASBC No. 1 objectives will already be met in whole or in part in the basic financial statements andrelated notes. However, the GASB believes it is important to expand the ways in which governments can communi�cate information that meets these objectives. An important feature of MD&A is that it goes beyond the basic financialstatements by providing an analysis of the data contained in those statements. The GASB realizes that financialmanagers of governments are knowledgeable about the transactions, events, and conditions that are reflected inthe government's financial report and of the fiscal policies that govern its operations. In MD&A, financial managersare asked to share their insights.

MD&A REQUIREMENTS, INCLUDING TRANSITION

Management's Discussion and AnalysisTHE BASICS

� All governments, including single�purpose and special purpose governments, must prepareand present an MD&A.

� MD&A should be written by a government's financial managers.

� Present MD&A before the basic financial statements, but after the letter of transmittal (if any)and the auditor's report.

� Focus on the primary government, distinguishing between governmental and business�typeactivities.

� Limit analysis to the eight topics required by the GASB.

� Discuss only currently known facts related to those topics.


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GASBS No. 34, paragraph 11, as amended by GASBS No. 37, Basic Financial Statementsand Management's

Discussion and Analysisfor State and Local Governments: Omnibus, requires that the topics discussed in MD&Abe confined to those listed below. The requirements are general rather than specific. The GASB hopes that this willencourage financial managers to report only the most relevant information and to avoid �boilerplate" discussion.Briefly, the required components of MD&A are:

� A Brief Discussion of the Basic Financial Statements. The basic financial statements include government�wide financial statements and fund statements. The two �sets" of statements are quite different from eachother. The GASB believes that users will benefit from a brief discussion of how the two sets of statementsrelate to each other and differ in the information they provide.

� Condensed Comparative Financial Information. This information is derived from, but not identical to, theinformation presented in the government�wide financial statements. GASBS No. 34 lists the minimumelements of the statement of net assets and statement of activities that must be reported (if relevant).

� Analysis of the Government's Overall Financial Position and Results of Operations. This analysis is intendedto help users assess whether the government's financial position has improved or deteriorated over thepast year. It should discuss why things changed, not just the amount or percentage of change.

� Analysis of Balances and Transactions of Individual Funds. Focusing on the fund financial statements, thisanalysis is intended to help users understand significant changes in individual fund balances, includingtheir effect on future transactions.

� Analysis of Significant General Fund Budgetary Variations. This analysis focuses on variances betweenoriginal and final general fund budget amounts and variances between final budget and actual results. Theanalysis also requires financial managers to discuss the reasons for variations and how current conditionsare expected to affect the availability of future general fund resources.

� Description of Significant Capital Asset and Long�term Debt Activity. This activity includes additions to andsales of capital assets, new debt issuances and retirements, and changes in debt ratings and availablecredit that have occurred during the year.

� Descriptions of Significant Changes in Condition and Estimated Maintenance Expenses for Infrastructure

Assets. This requirement applies only when a government is using the modified approach to report itsinfrastructure assets.

� Discussion of Currently Known Facts, Decisions, or Conditions. Perhaps the most important part of MD&Ais the requirement to report on currently known facts, decisions, or conditions that are expected to havea significant effect on the government's financial position (net assets) or results of operations (revenues,expenses, and other changes in net assets). This information is intended to help users assess future

operations of the government. However, financial managers are not asked to make projections. The termcurrently known means information that management is aware of as of the date of the auditor's report.

WHO SHOULD PREPARE THE MD&A

MD&A should be prepared by the financial managers of the government�the controller, director of finance, or otherhead of the government's financial affairs (GASBS No. 34, paragraph 8). The GASB believes that the financialmanagers of governments are knowledgeable about the transactions, events, and conditions that are reflected inthe government's financial statements and notes. They also best understand the fiscal policies that govern itsoperations. Unlike the letter of transmittal or other introductory materials, MD&A provides financial managers theopportunity to share a financial perspective on the current year's operations on the government.

Government Auditing Standards (the Yellow Book), issued by the U.S. Government Accountability Office (GAO),includes independence standards that are more restrictive than the independence standards of the AICPA. Ques�tion 55 of the GAO's �Answers to Independence Standard Questions" (GAO Q&A), notes that auditor preparation ofthe audited entity's MD&A goes beyond providing routine advice. Thus, the auditor's involvement with MD&A would


164

have to be evaluated in light of the overarching principles (one of which is that audit organizations should notperform management functions) and safeguards to determine if the auditor could maintain independence.

THE MD&A'S FOCUS

The focus of MD&A should be on the primary government and the two types of activities that are provided by thatprimary governmentgovernmental activities and business�type activities. Discretely presented component unitinformation should be discussed in MD&A when necessary to present a financial analysis of the primary govern�ment, but only after giving consideration to the component unit's significance to the total of all discretely presentedcomponent units and that component unit's relationship with the primary government. This same rule of thumbapplies to determining whether to present note disclosures about discretely presented component units. In allcases, it is appropriate to refer the reader of MD&A to the MD&As presented in the component units' own separatelyissued financial reports.

As an example, many local governments report power utilities as discretely presented component units. Becausethese utilities invest heavily in power plant and other capital assets, they tend to be significant in comparison to thetotal of all other discretely presented component units reported by local governments. In addition, many localgovernments rely on payments in lieu of taxes from these utilities to support their general fund operations. Assumethat in the current year the utility's operating results were significantly reduced because of deregulation in the stateand that this drop in operating revenues significantly reduced the amount paid to the general fund as payments inlieu of taxes. This effect will likely continue and perhaps worsen in the next year. Based on the significance of theutility to the component units reported in total and based on its financial relationship with the primary government'sgeneral fund, it is clear that this component unit utility should be discussed in MD&A. Areas where this discussionwould be required include:

� the analysis of government�wide operating results (GASBS No. 34, paragraph 11c),

� the analysis of transactions within the general fund (paragraph 11d), and

� the description of currently known facts, decisions, or conditions that are expected to have a significanteffect on financial position or results of operations (paragraph 11h).

Each of these discussions should make it clear that the utility is a discretely presented component unit and not apart of the primary government.

Reporting on the Primary Government

Although the focus of MD&A is on the primary government, the analysis should distinguish between governmentaland business�type activities. According to GASBS No. 34, paragraph 15, governmental activities are those gener�ally financed through taxes, intergovernmental revenues, and other nonexchange revenues. Business�type activi�ties are financed in whole or in part by fees charged to those who use the services. This requirement applies to all

of the components of MD&A where there are differences between the two types of activities. For example, in mostcases the discussion of long�term debt activity will include both general obligation debt (generally governmentalactivities) and revenue bonds (generally business�type activities). In addition, the discussion of currently knownfacts, decisions, or conditions may affect only one activity or both. Question 7.5.14 in the GASB Comprehensive

Implementation Guide2009 specifically extends this requirement to the currently known facts, decisions, orconditions component (GASBS No. 34, paragraph�11h).

PLACING MD&A IN THE FINANCIAL STATEMENTS

GASBS No. 34, paragraph 8, requires that MD&A precede the basic financial statements. Although it is classified asRSI for attestation purposes, MD&A serves as a financial introduction to those statements. MD&A is designed,among other things, to guide readers through the basic financial statements and notes. Putting MD&A behind thefinancial statements with the remaining components of RSI (such as pension information) would not make sensefor users. If MD&A followed the financial statements, some believe that users may get bogged down in reading thefinancial statements and would not make it to the more reader�friendly MD&A.


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Many governments prepare a CAFR, including a letter of transmittal as suggested in NCGAS No. 1, Governmental

Accounting and Financial Reporting Principles. In these situations, Question 7.5.1 in the GASB Comprehensive

Implementation Guide2009 states that MD&A should appear after the letter of transmittal and before the basicstatements. The letter of transmittal serves as an introduction to the entire CAFR. It contains both financial andnonfinancial information and, in some cases, projections about the future.

Questions have also arisen concerning the placement of MD&A in relation to the auditor's report. In the list of theelements of the financial section of a CAFR, GASB Cod. sec. 2200.105 lists the auditor's report as preceding theMD&A. This placement is consistent with the presumption that anything included after the auditor's report has beenconsidered by the auditor (unless otherwise indicated).

THE MD&A REQUIREMENT FOR OBJECTIVE INFORMATION

MD&A carries with it two basic requirementsthat it be objective and easily readable. Objective means that MD&Ashould be a fact�based analysis. This is important for two reasons. First, presenting only objective informationdistinguishes MD&A from a letter of transmittal or other similar information that is sometimes presented with anannual financial report. MD&A is based solely on information that can be derived from the basic financial state�ments and on facts, decisions, or conditions that are known by financial management as of the date of the auditor'sreport. It must discuss both the positive and negative aspects of the government's operations. In contrast, atransmittal letter or other communication in the front of a CAFR may contain projections about the future, commentsabout the appropriateness of specific operating policies, or glowing assessments of the past year's operations. Itmay be quite political and may contain comments from someone other than a financial manager of the government.

The GASB is not commenting on the quality of those types of introductory materials. Rather, it is concerned aboutauditor involvement with MD&A. Requiring some level of auditor involvement is the only way that the GASB canrequire financial information to be presented outside of the basic financial statements and notes. Presenting MD&Aas RSI requires the auditor to be associated with the information, as discussed in the following paragraphs.

Reporting as RSI

The AICPA Auditing Standards Board establishes standards for auditors reporting on RSI. As discussed in AICPAStatement on Auditing Standards (SAS) No. 52 (AU 558), Required Supplementary Information, the auditor shouldapply certain limited procedures to RSI. If there are deficiencies in the information or if the information is omitted,the auditor should comment on this in the audit report. AU 558.07 requires the auditor to:

a. Inquire of management about the methods of preparing the information (whether it meets the standards,whether changes have been made in measurement methods from the prior period, and whether significantassumptions were made).

b. Compare the information with management's responses to the inquiries above, the audited financialstatements and other knowledge obtained during the examination for consistency.

c. Consider whether RSI should be covered in management's representation letter.

d. Apply any additional procedures prescribed for specific types of RSI.

e. Make additional inquiries if the foregoing procedures indicate measurement or presentation issues.

If MD&A is omitted, its absence does not affect the auditor's opinion on the basic financial statements. However, theauditor's report should include an explanatory paragraph stating that certain supplementary information, althoughnot a required part of the basic financial statements, has been omitted. Similarly, if the information is presented butdeparts materially from the prescribed guidelines, an explanatory paragraph is also required.

Derived from the Basic Financial Statements

In most cases, information presented in MD&A should be derived from the basic financial statements and notes.This means that the user (or auditor) should be able to link each number to the financial statements and notes. This


166

does not mean that governments are limited to the specific numbers on the face of the financial statements. Forexample, GASBS No. 34, paragraph 11b(6), requires MD&A to report �total revenues" in the condensed financialinformation. The government�wide statement of activities does not present an amount labeled �total revenues."Total revenues is the sum of program revenues (charges for services, operating grants and contributions, andcapital grants and contributions) and general revenues, both of which do appear on the face of the statement. Otherinformation, such as current�year and prior�year bond ratings, may be found in the notes to financial statements forthe current and prior year. Some information may not be contained in the financial reports but should still beverifiable. For example, a government that reports an upcoming change in landfill fees or a major capital assetacquisition should be able to show that those plans were approved in the minutes of the meetings of its governingbody. Similarly, a government that reports that economic growth in its area is favorable in comparison to theremainder of the state should be able to back up the comment with economic data provided by the federal or stategovernment.

Importance of Currently Known Facts

Information presented in MD&A should also be based on currently known facts. GASBS No. 34, footnote 6, definescurrently known facts as �information that management is aware of as of the date of the auditor's report." The GASBprovided this definition to eliminate concerns expressed during the comment period on GASBS No. 34. TheExposure Draft that preceded GASBS No. 34 implied to some that financial forecasts would be required, that is, thatfinancial managers would be required to estimate future operating results. Many auditors commented that theywould be unable to be associated with prospective information in MD&A even if it were presented only as RSI. Thedefinition of currently known facts clarifies the Board's intention that the discussion in MD&A should be limited toobjective statements based on facts, decisions, or conditions.

Question 7.5.13 in the GASB Comprehensive Implementation Guide2009 indicates governments should notdiscuss in MD&A the possible effect of events that might happen. (If desired, those things could be addressed inthe transmittal letter instead.) For example, predicting how much sales tax revenues will be generated if a majoreventsuch as a World's Fairis held within the city's borders or suggesting that a new convention center underconsideration �will pay for itself" over a period of time are examples of statements that are not based on currentlyknown facts, decisions, or conditions.

THE MD&A REQUIREMENT FOR EASILY READABLE INFORMATION

GASBS No. 34, paragraph 8, requires MD&A to be easily readable. Although the GASB expects that all financialstatement users will benefit from MD&A, many believe that nontraditional userssuch as citizens, taxpayers, ornewspaper reportersmay benefit the most. This means that MD&A should be easy to read for users with differentlevels of understanding. However, there has been much debate in both commercial and governmental sectors asto the level at which financial information should be written. It is difficult to envision writing MD&A for someone whoknows nothing about finances or for someone who possesses only basic reading skills. On the other hand, it isdifficult to envision MD&A being useful if it is written at a level at which only the most sophisticated financial analystcan understand. In the GASB's discussions of this issue, the Board agreed that MD&A should be written for areader with some knowledge of finances and a willingness to put forth the effort to understand the financialstatements. This means that not all accounting terms or jargon should be eliminated, but some may need to beexplained. It means presenting some information in graphs and charts. It also means making an effort to presentthe information in what some call �plain English."

Use of Charts, Graphs, Tables

GASBS No. 34, paragraph 9, encourages governments to use charts, graphs, and tables to enhance the under�standability of MD&A. Using visual displays of information increases the clarity of MD&A by cutting down on theamount of text that has to be presented. GASBS No. 34, paragraph 11b, requires presentation of condensedfinancial information in the form of financial statements. Question 7.5.10 in the GASB Comprehensive Implementa�

tion Guide2009 states that governments may use charts or graphs to supplement or elaborate on this informa�tion, but these should not be used in place of the information presented in the condensed statements. For example,governments may use a pie chart to visually display the percentage and sources of its tax revenues. Bar charts areespecially good for visually displaying both the positive and the negative aspects of a particular area of a govern�


167

ment's financial performance. Other information required for MD&A that may be well suited for display in tables, piecharts, and graphs includes the following:

� A pie chart showing capital asset activity for the year by type of activity.

� A table comparing elements of general fund budgetary results�original, final, actual, and related variances.

� A bar graph comparing the condition of infrastructure assets in the current year compared to the prior yearand compared to the condition level that the government has established (for assets reported using themodified approach).

Avoid using charts and graphs, however, when they add nothing to the analysis. For example, a pie chart showingthe percentage sources of revenue for a single year adds nothing to an analysis of why revenues changed from theprior year. Using computer software, such as Microsoft Excel, can make presenting a government's financial resultsgraphically much easier. In addition, these charts, graphs, and tables can be �pasted" into the text of MD&A usingmost word�processing programs.

Avoiding Boilerplate

Governments that make their MD&A easily readable will also want to avoid boilerplate, as discussed in GASBS No.34, paragraph 11. The term boilerplate describes information that appears in every edition of a document and is thesame regardless of the author. A good example of boilerplate is the language that used to appear in the footnotesof many governmental financial statements describing the fund types used for financial reporting purposes.Certainly, boilerplate is easy to read. Most readers skip right over it once they recognize what it is. Avoidingboilerplate in MD&A means making it a living document. The authors of MD&A should start each year with a freshsheet of paper. They should not begin with last year's MD&A, crossing out what is no longer relevant to the currentyear. Rather, they should begin with the required condensed financial statements (GASBS No. 34, paragraph 11b)and begin to tell the story of what happened in the current year compared to last year. From there, the authorsshould move through the remainder of required componentsfund transactions, budgetary information, capitaland debt activities, economic factors, and currently known facts.

The only potential area where language from prior years could be repeated is the �brief discussion of the basicfinancial statements, including the relationships of the statements to each other . . ." required by GASBS No. 34,paragraph 11a. This language should be the financial manager's best effort at describing to users how the financialstatements work. Financial managers should also make this a �living" document by thinking each year about howearlier presentations of the financial report went. Did the city council understand what you were saying in MD&A?Were there other words that would have worked better? What happened when the local paper �interpreted" theinformation? By thinking about how the financial statements were �received" each year, government financialmanagers can keep this section of MD&A from becoming useless boilerplate.

SEC Guidance on Effective Writing

In February 1998, the U.S. Securities and Exchange Commission (SEC) issued an important ruleto requirecompanies selling stock to write the cover page, summary, and risk factors section of their prospectuses in �plainEnglish." In its final rule, it noted:

We believe that using plain English in prospectuses will lead to a better informed securitiesmarketa market in which investors can more easily understand the disclosure required by thefederal securities law. [SEC Release No. 33�7497]

The SEC notes that writing in �plain English" does not mean deleting complex information to make the documenteasier to understand, rather:

Plain English means analyzing and deciding what information investors need to make informeddecisions, before words, sentences, or paragraphs are considered. A plain English documentuses words economically and at a level the audience can understand. Its sentence structure istight. Its tone is welcoming and direct. Its design is visually appealing. A plain English documentis easy to read and looks like it's meant to be read.


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As a follow�up to its plain English rule, the SEC's Office of Investor Education and Assistance published �A PlainEnglish Handbook: How to create clear SEC disclosure documents." In his preface to the Handbook, well�knowninvestor Warren Buffett notes that �too often, I've been unable to decipher just what is being said or, worse yet, hadto conclude that nothing was being said . . . In some cases, moreover, I suspect that a less�than�scrupulous issuerdoesn't want us to understand a subject it feels legally obligated to touch upon." Although the Handbook waswritten for SEC registrants, it discusses a number of topics that are also valuable to governmental financialmanagers who prepare MD&As. [A free copy of the Handbook can be obtained from the SEC's website atwww.sec.gov/news/extra/handbook.htm or by contacting the SEC at (800) SEC�0330.]

GENERAL REQUIREMENTS FOR MD&A

MD&A ContentsTHE BASICS

� Present only the eight required topics listed below.

� When the same information is required to be presented both in MD&A and in the notes,summarize the information in MD&A and refer the reader to the notes to the financialstatements.

� Present two�years' worth of government�wide data in MD&A when governments preparesingle�year financial statements.

� Present three years' worth of data when governments present two�year (comparative)financial statements.

Required Components

GASBS No. 34, paragraph 11, was amended by GASBS No. 37, paragraph 4, to make it clear that while thefollowing eight topics or components of MD&A are stated in general rather than specific terms, the information mustbe limited to or confined to the following:

� Describe the basic financial statements.

� Provide condensed government�wide financial information in the form of condensed financial statements.

� Analyze overall financial position and results of operations for governmental activities and business�typeactivities using the condensed financial statements as a starting point.

� Discuss significant transactions and changes in individual funds.

� Discuss what happened with the general fund budget this year.

� Describe capital asset and long�term debt activity during the year.

� Describe what happened to infrastructure assetsif those assets are reported using the modifiedapproach.

� Describe any currently known facts, decisions, or conditions expected to have a significant effect on nextyear and beyond.

Because MD&A is RSI, a government should not address additional topics outside these eight components. Thecomponents of MD&A were carefully considered to avoid requiring information with which auditors would find itdifficult to be associated. However, there is no limit to the information that may be provided if it provides additionaldetails about the required components. Some governments may provide only minimal information to meet eachrequirement. Others will provide more information to meet the requirement. However, those who want to provideinformation about something other than the required components should do so in their letter of transmittal or insupplementary informationafter the basic financial statements and RSI. The Exposure Draft that precededGASBS No. 34 described MD&A as a �brief, objective, and easily readable analysis . . ." (emphasis added).Although the GASB dropped �brief" from the list of requirements in its final Statement, bear in mind that manyreaders may feel overwhelmed before they even begin to read if they see that MD&A continues for pages and


169

pages. Also, bear in mind that much of the nonanalysis material in MD&A probably also appears in the notes to thefinancial statements.

The GASB illustrative MD&A includes several examples of information that go beyond the minimum level of detailneeded to meet the eight components. However, all the information relates to one of the required components. Forexample, the �Financial Highlights" section provides an executive summary of the most significant informationrequired in the eight components discussed in MD&A. A summary is not required, but it helps introduce the readerto MD&A and makes it much easier to understand overall.

Relationship to the Notes to Financial Statements

In some cases, the information required by MD&A may already be discussed in the notes to the financial state�ments. As a rule of thumb, MD&A should not repeat detailed information that appears in the notes. Nevertheless,the author should not automatically omit all information that appears in the notes from MD&A. For example,information about long�term debt activity during the year (required by GASBS No. 34, paragraph 11f) is alsorequired in the notes. Financial managers should not repeat in MD&A all the details that appear in the notes. Rather,MD&A should present the highlights of that information and perhaps present it in a more user�friendly format. Forexample, MD&A could state that $2.8 million of general obligation debt was issued during the year at interest ratesranging 5.75% to 6.25%, and a pie chart could be used to visually display the purposes for which the new debt wasissued:

ÂÂÂ

ÍÍÍÍÍÍÍÍÍÍÍÍÍÍÍ

Uses for New General Obligation Debt

Roads $750,000

New Middle School

$1,100,000ÍÍÍÍ

Computer Upgrades$120,000

Fire Trucks $500,000

Other $200,000

As a reminder, all information that is necessary for fair presentation must appear in the notes to the financialstatements, as discussed in NCGAI 6, Notes to Financial Statements Disclosure, paragraph 3. Presenting informa�tion only in MD&A is not a substitute for providing the information in the notes.

Comparative Data

GASBS No. 34, paragraph 9, requires financial managers to discuss the current�year results in comparison with theprior year, with emphasis on the current year. This requirement applies not just to the requirement for condensedcomparative financial statements but to all components of MD&A. General purpose governments typically do notpresent comparative financial information in their basic financial statements. Requiring governments to presentcomparative data in MD&A is one significant way that GASBS No. 34 improves on information provided to financialstatement users.

When governments do present comparative basic financial statements, MD&A must discuss the results for the pastthree years, with emphasis on the current and previous year. Question 7.5.4 in the GASB Comprehensive Imple�

mentation Guide2009 clarifies that each year presented in the government's comparative basic financial state�ments must be addressed in MD&A. For example, if a government issued a financial report that includes basic


170

financial statements for the years ending in 20X1 and 20X2, the condensed comparative information presented inMD&A should include the years ending in 20X0, 20X1, and 20X2. In the same way, the accompanying analysisshould cover two financial reporting periods. It should compare the year preceding the prior year to the previousyear, and it should compare the prior year to the current year. Several governments have failed to present threeyears of data in the MD&A when comparative basic financial statements were presented. However, completelyseparate MD&As are not required. Question 7.5.6 adds that the presentation of comparative data, such as aprior�year total column, does not require adding another year to MD&A.

The Big PictureIllustration

Although technically not required, the first thing presented in MD&A should be an overview or executive summarythat highlights the most significant information discussed in the eight required components of MD&A. This sum�mary should begin by discussing the overall change (or lack thereof) in the government's net assets because of theyear's operations. Next, it should highlight the most significant factors leading to that change.


171

SELF�STUDY QUIZ


10. Why do GASB members feel the inclusion of MD&A is important in the presentation of the financial statementsof a governmental entity?

a. Because MD&A makes forecasts and projections of a governmental entity's ability to meet its futureobligations, information which is vital for users of the financial statements, such as potential investors.

b. Because MD&A allows elected officials to address issues related to governmental entities with theirconstituents.

c. Because MD&A has the potential to interest user groups who have not been interested in governmentalfinancial reports.

d. Because MD&A shows the financial position and condition of the government and whether it hasdeteriorated or improved over the previous year.

11. Which of the following would be considered a business�type activity of the primary government?

a. Maintenance of streets.

b. Maintenance of a municipal golf course.

c. Maintenance of a fire department.

d. Maintenance of a school district.

12. What is a primary difference between a transmittal letter and the MD&A of a government's financial report?

a. Testing of the transmittal letter's components is part of the required standards in an audit of a governmentalunit.

b. The transmittal letter may contain nonfinancial information.

c. The transmittal letter must be dated as of the date of the auditor's report.

d. The transmittal letter may contain projections of the future.

13. Which of the following statements describes a strategy for writing MD&A?

a. Use charts and graphs as a substitute for the required condensed financial information to be included inthe MD&A.

b. Use boilerplate language to enhance the consistency and comparability of the information in MD&A fromyear�to�year.

c. Use prior year's MD&A as a template, updating the information on an as needed basis.

d. Use language that a person with some knowledge of finances will be able to understand.

14. What is one way in which GASBS No. 34 improved on the information available to users of governmentalfinancial statements?

a. By requiring the MD&A to be a �brief" analysis.

b. By requiring information in the MD&A to be repeated in the notes to the financial statements.

c. By requiring MD&A to include comparative data.


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10. Why do GASB members feel the inclusion of MD&A is important in the presentation of the financial statementsof a governmental entity? (Page 161)

a. Because MD&A makes forecasts and projections of a governmental entity's ability to meet its futureobligations, information which is vital for users of the financial statements, such as potential investors. [Thisanswer is incorrect. While certain financial information discussed in MD&A is relevant to an entity's abilityto meet future obligations, MD&A is based on �currently known facts, decisions, or conditions."]

b. Because MD&A allows elected officials to address issues related to governmental entities with theirconstituents. [This answer is incorrect. MD&A is not written by the elected officials of a governmental entity.It is written by the government's financial managers.]

c. Because MD&A has the potential to interest user groups who have not been interested in

governmental financial reports. [This answer is correct. MD&A is designed to be easily readable and

provide insight and analysis that is useful to the average citizen of a government.]

d. Because MD&A shows the financial position and condition of the government and whether it hasdeteriorated or improved over the previous year. [This answer is incorrect. This can be illustrated in therequired financial statements of a governmental entity. MD&A is supposed to provide further insight intothe data contained in the required statements.]

11. Which of the following would be considered a business�type activity of the primary government? (Page 164)

a. Maintenance of streets. [This answer is incorrect. Maintenance of streets is generally financed through thecollection of taxes on all residents of a municipality; therefore, it would not be considered a business�typeactivity.]

b. Maintenance of a municipal golf course. [This answer is correct. Business�type activities are

generally financed in whole or in part by fees charged to those who use the services. A municipal

golf course is one example of this type of activity.]

c. Maintenance of a fire department. [This answer is incorrect. Fire department salaries and capital needs arepaid for by taxes paid by all taxpayers, not just the users of the services. Thus, this would not be considereda business�type activity.]

d. Maintenance of a school district. [This answer is incorrect. Property taxes assessed on all taxpayers, notjust those with children attending school, provide the means by which school districts are maintained.Consequently, this is not a business�type activity.]

12. What is a primary difference between a transmittal letter and the MD&A of a government's financial report?(Page 165)

a. Testing of the transmittal letter's components is part of the required standards in an audit of a governmentalunit. [This answer is incorrect. Auditor involvement is not required with respect to the transmittal letter.]

b. The transmittal letter may contain nonfinancial information. [This answer is incorrect. Both the transmittalletter and the MD&A may contain nonfinancial information.]

c. The transmittal letter must be dated as of the date of the auditor's report. [This answer is incorrect. Sincethe transmittal letter is not covered in the auditor's report, the date of the transmittal letter does not haveto coincide with the auditor's report.]

d. The transmittal letter may contain projections of the future. [This answer is correct. The MD&A is

based solely on information that can be derived from the basic financial statements, while the

transmittal letter may contain projections about the future.]


173

13. Which of the following statements describes a strategy for writing MD&A? (Page 166)

a. Use charts and graphs as a substitute for the required condensed financial information to be included inthe MD&A. [This answer is incorrect. Charts and graphs are appropriate supplements for this information;however, they should not replace the presentation of the condensed financial statements.]

b. Use boilerplate language to enhance the consistency and comparability of the information in MD&A fromyear�to�year. [This answer is incorrect. While certain elements of the MD&A might use boilerplate language,repetitive language serves to reduce the usefulness and freshness of the information to a variety of users.]

c. Use prior year's MD&A as a template, updating the information on an as needed basis. [This answer isincorrect. From an efficiency standpoint, this might represent the best strategy; however, simply repeatingthe prior year's structure while changing numbers doesn't impart a �new" story related to the current year'sevents.]

d. Use language that a person with some knowledge of finances will be able to understand. [This

answer is correct. The users of the financial statements are not expected to experts in governmental

accounting, nor are they expected to be novices with respect to business jargon.]

14. What is one way in which GASBS No. 34 improved on the information available to users of governmentalfinancial statements? (Page 169)

a. By requiring the MD&A to be a �brief" analysis. [This answer is incorrect. The Exposure Draft that precededGASBS No. 34 included the word �brief," but it was ultimately dropped in the final statement. While �brief"was ultimately not included in the description of properly written MD&A, it should not be so cumbersomeas to overwhelm the users of the financial statements.]

b. By requiring information in the MD&A to be repeated in the notes to the financial statements. [This answeris incorrect. MD&A should only summarize information that is also discussed in the notes and refer thereader to a more complete discussion of the information in the notes to the financial statements.]

c. By requiring MD&A to include comparative data. [This answer is correct. Most governments only

present required financial statements for one period. The requirement to include comparative

information in the MD&A enhances the usefulness to the financial statement users.]


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REQUIRED COMPONENTS OF MD&A

Required Component: Brief Discussion of Basic Financial Statements

The first required component of MD&A is:

A brief discussion of the basic financial statements, including the relationships of the statementsto each other, and the significant differences in the information they provide. This discussionshould include analyses that assist readers in understanding why measurements and resultsreported in fund financial statements either reinforce information in government�wide statementsor provide additional information. [GASBS No. 34, paragraph 11a]

For many state and local governments, GASBS No. 34 required an entirely new set of financial statements. Thesegovernment�wide statements only agree with the fund financial statements because of a brief reconciliation at thebottom of the fund statements. The fund financial statements no longer include the general fixed assets accountgroup and the general long�term debt account group. They no longer contain columns for each of the fund types.The fiduciary funds are in separate statements, and the budgetary comparison schedule may be presented outsidethe basic financial statements. These changes provide an obvious reason for this first requirement. If the �audi�ence" intended for MD&A is someone who has used the government's financial statements in the past, thesereaders will be interested in how the statements have changed and how they �work" now. Perhaps more impor�tantly, this portion of MD&A is the ideal place to keep readers from misunderstanding the basic financial statements.For example, the financial manager might use this discussion to:

� Explain why the government�wide financial statements present information that is different from thegovernmental fund information. Question 7.5.9 in the GASB Comprehensive Implementation Guide2009

indicates that this component can help users understand why a significant decrease in net assets ofgovernmental activities occurred when at the same time the general fund experienced an increase in itsfund balance.

� Explain why it is important to keep presenting information about governmental funds using measures thatare closer to the way that the government keeps its budget. Uninformed readers may be tempted to believethe government is �keeping two sets of books." Also, explain the benefits of reporting using the samemeasures used by companies in the governmental�wide financial statements.

� Explain how to use the government�wide statement of activities. Just because a city's education functionis generating a net program cost, it does not mean that the schools should be eliminated.

� Explain why net assets are reported in three categories. Help readers understand which of these categoriesmay be available to spend on new programs.

� Explain the financial statement effect of recording debt in advance of the related infrastructure assets duringGASBS No. 34's transition period.

� Talk about amounts reported for the first time as the government's investment in infrastructure assets.Explain why they were not reported before and how they are financed.

� Talk about how the reconciliation on the bottom of the fund financial statements shows the reader whatchanges are made to convert from governmental funds to governmental activities.

In addition, although it may not appear to be �brief," the GASB illustration embellished on this required componentby adding broader descriptions of each of the components of the basic financial statements. The GASB noted thatsuch discussions may be very useful in the first few years that GASBS No.�34 is applied.

Governments may be tempted to simply copy the GASB's example. However, financial managers should be carefulnot to copy details that do not apply to their government. For example, MD&A should not present the explanationof what a fiduciary fund is unless the government has fiduciary activities. Also, the focus of this component is the


175

basic financial statements. It should not describe the government or its financial reporting entity (the GFOA stillrequires these in the letter of transmittal) or financial statements and other information properly presented outsidethe basic financial statements and RSI.

Required Component: Condensed Comparative Financial Statements

Condensed Financial InformationTHE BASICS

� Condensed financial information must be presented in table form, like financial statements.

� Separate columns must be presented for governmental activities, business�type activities,and the total for the primary government.

� When comparative basic financial statements are presented, condensed financial informationshould cover three years instead of two.

The second component of MD&A is the requirement to present condensed comparative financial statementsderived from the government�wide financial statementsthe Statement of Net Assets and the Statement of Activi�ties (GASBS No. 34, paragraph 11b, as amended by GASBS No. 37, paragraph 4). The GASB specifies theelements that must be presented, if relevant. However, it also requires that additional information be provided ifnecessary to support the required analysis of financial position and results of operations. The elements specified inGASBS No. 34, paragraph 11b, are as follows:

a. Total assets, distinguishing between capital and other assets.

b. Total liabilities, distinguishing between long�term liabilities and other liabilities.

c. Total net assets, distinguishing among amounts invested in capital assets, net of related debt; restrictedamounts; and unrestricted amounts.

d. Program revenues, by major source (that is, charges for services, operating grants and contributions, andcapital grants and contributions).

e. General revenues, by major source (such as taxes by type, general grants and contributions, investmentearnings, and miscellaneous earnings).

f. Total revenues.

g. Program expenses, at a minimum by function.

h. Total expenses.

i. Excess (deficiency) before contributions to term and permanent endowments or permanent fund principal,special and extraordinary items, and transfers.

j. Contributions.

k. Special and extraordinary items.

l. Transfers.

m. Change in net assets.

n. Ending net assets.

Governmental activities must be reported in a separate column from business�type activities and a total primarygovernment column must also be presented. Information may also be presented for discretely presented compo�


176

nent units. However, it is more likely that component unit information will be provided in the narrative discussion as

necessary. Special�purpose governments engaged only in business�type activities or fiduciary activities do notpresent government�wide statements.

This required information must be presented in the form of comparative condensed financial statements. (However,the statement of activities format is not used.) This ensures that two years' worth of financial information will beavailable at a glance to financial statement users. It also provides a structure for the analysis that follows. Prior�yearinformation must be taken from last year's basic financial statements if comparative data is not presented in thecurrent�year statements. If comparative financial statements are presented, the condensed information shouldcover three years. GASBS No. 37, paragraph 4, modified GASBS No. 34, paragraph 11b, to specify that only theelements relevant to each government should be presented. That is, governments should include only thoseelements that have a dollar amount in one of the years presented. For example, few general purpose governmentswill have received contributions to permanent or term endowments. Because extraordinary items are just that, fewwill report extraordinary items.

The focus of the MD&A analysis required in GASBS No. 34, paragraph 11c, is on net assets and changes in netassets. In contrast, the focus of the government�wide statement of activities is on the extent to which the govern�ment's programs draw on the general revenues of the government. For this reason, this component of MD&Arequires the statement of activities information be recast in a traditional operating statement format, for example:

� �Total revenues" must be calculated by adding together all program revenues and all general revenues.

� �Excess (deficiency) before contributions, special and extraordinary items, and transfers" will only appearon the face of the Statement of Activities if a subtotal is provided. Otherwise, this amount must be calculatedby deducting these items from �Change in net assets."

Illustration. Exhibit 2�1 illustrates where most of the information required for MD&A appears in the government�wide statement of activities.


177

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Required Component: Analysis of Financial Position and Results of Operations

Required Government�wide AnalysisTHE BASICS

� Prepare the analysis in the same way an auditor would prepare a variance analysis.

� Address governmental and business�type activities separately.

� Discuss only significant changes from the prior year.

� Most importantly, provide reasons for those changes.

� Give users the information they need to draw a conclusion. Don't draw conclusions for them.

The third component of MD&A is the required analysis of the government's overall financial position and results ofoperations based on information reported in the government�wide financial statements (GASBS No. 34, paragraph11c). This component is perhaps the most important of the eight. It should assist users in assessing whether thegovernment's financial position has improved or deteriorated as a result of the year's operations. The emphasis ison assist for this component. MD&A should not state, for example, �The district's financial status improvedsubstantially" or �The City's fund balance is healthy." This component of MD&A should focus on net assets andchanges in net assets as a measure of financial position or financial health. The GASB does not require manage�ment to determineand reportwhether the government's financial position improved or deteriorated during theperiod. At best, this is a subjective assessment. For example, the figure reported as �net assets" may haveimproved over the previous year. But what if the improvement had been achieved at the expense of not maintaininglong�lived assets or eliminating insurance coverage? A significant increase in assets, liabilities, revenues, orexpenses will be obvious to the reader. What will not be obviousand is the responsibility of financial managers inwriting MD&Ais what factors caused the increase. It could be that a decline in the unemployment rate generatedhigher income tax revenues. On the other hand, it could be that interest rates dropped significantly on thegovernment's variable�rate debt.

Defining Significant. The GASB frequently uses the word significant to describe the changes that should bediscussed in MD&A. When is something significant? Unfortunately, the GASB does not define the term, just as itdoes not define the term material. In its Concepts Statement No. 2, Qualitative Characteristics of Accounting

Information, the Financial Accounting Standards Board (FASB) discusses the concept of material or materiality:

The essence of the materiality concept is clear. The omission or misstatement of an item in afinancial report is material if, in the light of surrounding circumstances, the magnitude of the itemis such that it is probable that the judgment of a reasonable person relying upon the report wouldhave been changed or influenced by the inclusion or correction of the item. [FASB ConceptsStatement No. 2, paragraph 132]

During GASB discussions of the term significant, most Board members expressed the belief that the term meant achange that is the same as or close to material. For this reason, if an item is material to the financial statementsbeing discussed (for example, the fund statements), then it should also be considered significant for purposes ofMD&A.

Preparing the Analysis. Preparing this component of MD&A should be a lot like preparing a variance analysis inthe course of an audit or in closing the books for the year. The first step is to compareat a minimumtheelements of assets, liabilities, revenues, and expenses in the condensed financial statements to those of the prioryear. Once areas of significant change have been identified, list the factors or transactions that contributed to eachof those changes. This listing can serve as a rough first draft for this part of MD&A.

Several important things should be considered when preparing this component of MD&A.

� The analysis should use as its starting point the condensed financial statements.

� As a result, the analysis should discuss changes in accrual�basis information, not cash receipts andexpenditures.


179

� The analysis should address both governmental and business�type activities.

� The analysis should include both the amounts and percentages of changes and the reasons for the

changes. In the GASB's discussions with municipal analysts, most analysts frequently commented thatthey are not in the least interested in an �elevator" analysisone that only tells what went up and what wentdown.

� The analysis should not be limited to the figures reported in the financial statements. Important economicfactors, such as changes in the tax or employment bases, that significantly affected operating results forthe year should be discussed.

� As financial managers for the government, the authors of MD&A are in the best position to know why thingschanged financially. MD&A gives the authors an excellent opportunity to share their expertise.

Illustrations. The GASBS No. 34 illustration of this requirement divides the analysis into several distinct piecescombined net assets, net assets of governmental activities, net assets of business�type activities, changes incombined net assets, etc. This format goes from the big picture (in this case, the government as a whole) to thedetails (information about governmental activities and business�type activities). The overall discussion is labeled,�The City as a Whole," because of its initial focus on the government�wide financial information.

Financial statements issued by governments also provide good examples of this required component of MD&A.For example, these discussions comment on changes in the current assets and current liabilities elements of thecondensed statement of net assets:

Current liabilities reflect a substantial decrease due to less contracts payable outstanding at theend of the year as certain capital projects were completed during the year. Also, while $4.3 millionin tax anticipation notes were retired during the year, only $2.0 million in new notes were issued.

***

The increase in Governmental Activities current assets is due to three major items: (1) issuance ofthe Spring Training Facility Revenue Bonds ($7 million), (2) accumulation of optional sales taxesfor future projects ($6.3 million), and (3) accumulation of funds for future transportation projects($7.4 million). These items are also responsible for most of the increase in Governmental Activi�ties restricted net assets. Governmental Activities noncurrent liabilities increased due to issuanceof the Spring Training Facilities Bonds ($16.8 million) reduced by principal reductions ($2.2million) of other long�term liabilities.

The increase in Business�type Activities current assets is primarily due to capital contributions forthe County Utilities System and the accumulation of funds for the future needs of the CountyLandfill. These items are also responsible for the increase in Business�type Activities restrictednet assets.

***

Other MD&A authors discussed the changes in the three components of net assetsinvested in capital assets, netof related debt, restricted, and unrestricted:

The water and sewer activity increased its overall net assets for the year by $10,578,195, but thisincrease was the combination of a $13,290,800 increase in capital assets, net of related debt, a$6,491 increase in restricted net assets, and a $2,719,546 decrease in unrestricted net assets.These changes in the components of net assets reflect the large investment the City is making inthe infrastructure of the water and sewer utility and the fact that this investment was partiallyfunded using previously unrestricted net assets.

Net assets of the City's governmental activities decreased by 4.93% ($9.16 million compared to$9.63 million). Unrestricted net assetsthe part of net assets that can be used to finance day�to�


180

day operations without constraints established by debt covenants, enabling legislation, or otherlegal requirementsshowed little changefrom $1.85 million to $1.83 million at the end of thisyear. The category of governmental net assets that decreased the most was �invested in capitalassets, net of debt." The nearly half million dollar decrease resulted from an increase in accumu�lated depreciation as well as from a transfer of the newly completed water well to the City'sbusiness�type activities.

***

Unrestricted net assets are available for future use as directed by the City Council. In total, thisamount decreased $1.7 million. Unrestricted net assets of the City's governmental activitiesdeclined $2.1 million while unrestricted net assets of the business�type activities increased $0.4million. The decline in unrestricted net assets of governmental activities is to be expected in a yearin which the City makes significant amounts of capital purchases that are not financed with debt.The purchase of a capital asset with cash increases net assets invested in capital assets andreduces unrestricted net assets. The downtown Streetscape project in 2001 was funded withunrestricted cash. That project was completed at a cost of about $3.9 million. That cost waspartially offset by the use of about $1.3 million in federal and state grant funds.

***

Examples of analysis of changes arising from current�year government�wide operations include:

Governmental activities increased the County's net assets by $7.2 million, accounting for 89.6percent of the total growth in the net assets of the County. Key elements of this increase are asfollows:

� Property taxes increased by approximately $2.5 million (5.3 percent) during the year. Most of thisincrease resulted from increased taxable values and residential growth.

� Intergovernmental revenue, primarily state shared revenue, increased by approximately $2.9million (6 percent) during the year because of population growth as documented by the 2000census.

� Operating grants for governmental activities increased by $2.9 million, mostly as a result of anaggressive grant application strategy undertaken by the County during the current fiscal year.The new grant awards furnished resources to support three of the County's functions: publicsafety, justice, and health and social services.

� Investment income decreased approximately $750,000 due in part to a lower volume of investedfunds. This resulted primarily from the significant amount of building authority expendituresduring 2001 for construction purposes.

***

Charges for services increased by 6.7 percent, or by $1 million. Close to 90 percent of thisincrease came from the utility operations. These increases were the result of continued residentialand commercial development in the unincorporated areas of the County. The majority of cus�tomer base increase came from the annexation of the Double Diamond district, while Arrow Creekand Desert Springs areas contributed to the total growth as well.

***

The Water and Wastewater Department previously contracted with an outside organization fortheir operations. However in fiscal year 2001, the operations were brought in�house resulting insignificant increases/decreases in expenses, which ultimately offset each other. For instance,contractual services, materials, and supplies decreased $6,434, or 36.1 percent, in comparison


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to the prior year. Salaries and wages, employee benefits, utilities, and repairs and maintenanceincreased $3,011 (224.3 percent), $792 (183.5 percent), $1,642 (514.1 percent), and $1,114(3,071 percent) respectively, in comparison to the prior year.

***

Certain Public Works expense allocations are subject to annual classification as either mainte�nance (shown as an expense) or capital (capitalized and therefore not reported as an expense).How these specific projects are classified each year can materially affect the comparable level ofPublic Works expenses.

***

The Fire increase was primarily a result of union�contract salary increase (approximately $1.6�mil�lion) and is not the result of any increase in overall strength.

***

The reduction in Parking System expenses was due to a nonrecurring loss on the sale of propertyof $3.1 million during the 1999/2000 fiscal year.

***

Required Component: Analysis of Balances and Transactions of Individual Funds

Individual Fund AnalysisTHE BASICS

� Focus on significant changes in major governmental fund transactions and balances whenthe reasons for change are different from those discussed in the government�wide analysis.

� Focus on significant changes in available financial resources by discussing reserved andunreserved fund balances.

� Include nonmajor funds in the analysis when changes are significant to the government asa whole.

The fourth component of MD&A is an analysis of balances and transactions of individual funds (GASBS No. 34,paragraph 11d). This analysis is much the same as the analysis required for the government as a whole. There aretwo significant differences, however. First, condensed financial information is not required to be presented for theindividual funds. (This presents a good opportunity for using charts and graphs.) Second, many of the significantchanges will have already been discussed in the analysis of the government�wide financial resultsparticularly forenterprise funds. In fact, because enterprise fundsreported in total as business�type activities in the government�wide statementshave the same measurement focus and basis of accounting and the same elements of netassets in both the government�wide and the fund statements, financial managers may find it necessary to say littleabout them here.

For this reason, the focus of this analysis generally should be on the reasons for significant changes in governmen�

tal fund balances and on any restrictions, commitments, or other limitations that significantly affect the availabilityof governmental fund resources for future use. �Significant" in this case appears to require financial managers tofocus on the government's major governmental funds. Information about nonmajor funds is not precluded asdiscussed in Question�7.5.8 of the GASB Comprehensive Implementation Guide2009. However, the significanceof nonmajor fund information should be judged in comparison to the government's major funds or other qualitative

factors. Of course, one of the most important pieces of information reported in governmental fund financialstatements is available fund balance. Although this information may not convey much about the long�term financialhealth of the entity, it is extremely important to those users who are considering whether next year's programs canbe financed and whether new programs can be added.

Even though the GASB requires financial managers to describe the differences between government�wide andgovernmental fund reporting in the first component of MD&A, it may be necessary to provide specific details about


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those differences in this analysis. For example, assume that the government issued general obligation debt justbefore the end of the last fiscal year. As a result, the capital projects fund balance was quite high, reflecting unspentdebt proceeds. When the debt proceeds are spent in the current year, the capital projects fund reports a significantdecline in fund balance compared to the prior year. In the government�wide statement of net assets, however,amounts spent to acquire or construct capital assets are not reported as expendituresthey are capitalized.Readers will need to understand why total governmental fund balances reported a significant reduction in thecurrent year without a similar decline in net assets of governmental activities. In other cases, the results reported inthe governmental funds will support (or be about the same as) what was reported in the government�widestatements. In that case, the discussion should focus on significant changes in available financial resources (bydiscussing reserved and unreserved fund balances).

Required Component: General Fund Budgetary Analysis

General Fund Budgetary AnalysisTHE BASICS

� Limit this analysis to the general fund budget.

� Discuss any currently known reasons for budgetary variations that are expected to have asignificant effect on future services or liquidity.

� Discuss both changes between the original and final general fund budget as well as variationsbetween the final budget and actual amounts.

� Most importantly, provide reasons for the changes and variances.

The fifth component of MD&A is an analysis of significant variations between original and final budget amounts andbetween final budget amounts and actual budget results for the general fund (or its equivalent) (GASBS No. 34,paragraph 11e). Although other funds may have legally adopted budgets, only the general fund should bediscussed. The requirement to discuss significant variations between the original and final budgets in MD&A is notmeant to imply that the Board believes that budgetary changes are, by their nature, undesirable. Rather, theinformation should be provided in the interest of accountability to those who are aware of, and perhaps madedecisions based on, the original budget. Because the notions of �original" and �revised" budgets may be new tomany readers, governments may wish to explain the nature of their budgeting process. For example, one schooldistrict noted:

As mentioned earlier, the School Board revises its budget as it attempts to deal with unexpectedchanges in revenues and expenditures. The final amendment to the budget was actually adoptedafter year�end, which is not prohibited by state law.

Alternatively, governments may refer readers to the description of their budgetary process, suggested by the GFOAas one element of a government's letter of transmittal.

The budgetary analysis also should discuss any currently known reasons for budgetary variations that areexpected to have a significant effect on future services or liquidity. Financial managers should not say just whathappened, but why (again, no �elevator" reports), and for how long the effect will continue. The guidance inQuestion 7.5.11 of the GASB Comprehensive Implementation Guide2009 indicates that it is not sufficient simplyto state that the original budget was increased to cover higher�than�expected expenditures. For example, supposea government's salary expenditures exceeded budget in the current year. The analysis should explain the following:

� Salary increases caused the current year's actual salary expenditures to exceed the original but not the finalbudgetary amounts. (What happened?)

� This was due to a contract with the police that was settled early in the fiscal year, including a salary increasethat was higher than originally estimated. (Why?)

� The contract also called for the addition of two officers during the overnight shift. (Why?)

� The contract is a five�year contract; so the increased cost will continue at this rate for the next five years.(How long will it continue to affect the government?)


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On the other hand, suppose the contract had still not been settled, and the current rates had been imposed by amediator. In this case, it would be inappropriate for the financial managers to suggest how costs may change or forhow long. The details of the unsettled contract in this case are not currently known facts, decisions, or conditions.

Illustrations. By the time financial managers get to this component of MD&A, it may have been possible to havealready discussed the consequences of budget variances. For example, one city noted in its analysis of financialposition and results of operations (GASBS No. 34, paragraph 11c) that:

Both net asset categories benefited from increased economic activity, which resulted in budgetedrevenues being exceeded by actual revenues.

***

In general, governments that have implemented GASBS No. 34 tended to focus on significant variations betweenoriginal and final budgets. For example:

Differences between the original and final amended budgets for expenditures resulted in a3.6�percent increase ($2 million increase in appropriations). There were $1.5 million in increasesallocated to the Sheriff's Department, representing a 6.0% change. Of this, $0.9 million was theresult of additional revenue brought in through police services contracts and prisoner boarding.The remaining adjustments were to cover medical costs in the jail, uniform allowances approvedin collective bargaining, and overtime resulting from increased security on and around Septem�ber 11. There was also an adjustment for $0.3 million in Clerk/Register of Deeds office forcontractual help and overtime to process a record volume in the Register of Deeds division. Thisadjustment was offset by an adjustment to the revenues generated by this volume.

***

The only significant variation of actual results compared to the General Fund original budget wasthat transfers�in were $8.4 million compared to a budget of $9.2 million, a variance of $.8 million.This variance is entirely due to the transfer from the Municipal Income Tax Fund. Amountsreceived from the City's income tax are paid into the Municipal Income Tax Fund and 80% of thenet proceeds after collection are transferred to the General Fund. The budget had projected agrowth in income tax collection in 2001 of about 4% over 2000. However, due to the economicslowdown, actual income tax cash collections, net of refunds, increased only 1.2%. The City hassufficient unreserved fund balance to absorb that shortfall, but if such a trend continues for aprolonged period of time, it will become necessary to reprioritize long�range capital plans andconsider other user charges and fees to offset the revenue loss.

***

Required Component: Significant Capital Asset and Long�term Debt Activity

Significant Capital Asset and Long�term Debt ActivityTHE BASICS

� Summarize the information that appears in required note disclosures about changes incapital assets, debt, and other long�term operating liabilities.

� Discuss significant commitments for capital expenditures.

� Discuss changes in credit ratings, if any.

� Discuss any debt limitations.

The sixth component of MD&A is a description of significant capital asset and long�term debt activity during theyear (GASBS No. 34, paragraph 11f). �Long�term debt" includes all long�term liabilities of the governmentnot justthose for which general obligation or other debt has been issued. At first glance, this component has the potentialto be a lengthy requirement. However, GASBS No. 34 also requires governments to present detailed note disclo�


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sures about changes in capital assets and long�term liabilities. For this reason, it is sufficient for this component ofMD&A to summarize the information in those notes and refer the reader to the required disclosures. (The MD&Adiscussion of debt should exclude special assessment debt for which the government has no obligation, just asthat debt is excluded from financial statement balances, as discussed in the GASB Comprehensive Implementation

Guide2009, Question 7.5.12.)

Three other types of information are required for this component of MD&A that will not necessarily (or ever) appearwithin the note disclosures. These are as follows:

� Significant Commitments Made for Capital Expenditures. Again, the term �significant" is generallysynonymous with �material." All significant commitments should be included in the capital budget forgovernmental activities. Similar capital plans should be available for business�type activities. Thisdiscussion should also indicate how the government intends to finance planned expenditures.

� Changes in Credit Ratings. Both good and bad changes should be discussed, including a brief descriptionof the reason for the change.

� Debt Limitations That May Affect the Financing of Planned Facilities or Services. Most states imposelimitations on the amount of debt that may be issued by local governments or by overlapping localgovernments. Other limitations may be established by the governmental entity's charter or by its governingbody. However, the focus of this discussion should be on limitations that meet the definition of �restrictions,"as that term is used in GASBS No. 34, paragraph 34.

Paragraph 7.59 of SLG provides these examples of the types of currently known facts related to capital assets thatwould merit discussion in this component of MD&A:

� The award and acceptance of a major capital grant.

� A successful bond referendum for capital improvements or construction.

� Failure of a referendum that would have renewed a property tax millage dedicated to capital improvementsor construction.

� A governing board decision to significantly change the condition level at which infrastructure assets willbe maintained.

� Finalization of contracts to rebuild a school heavily damaged by fire.

Paragraph 8.114 of SLG also provides these examples of the types of currently known facts related to expensesand long�term liabilities that would merit discussion in this or other components of MD&A:

� Settlement or completion of a significant lawsuit.

� Renegotiation of a labor contract with governmental employees.

� Significant damage caused by natural disasters, such as a flood, to a government's infrastructure.

Illustrations. The following example MD&As include capital asset and debt discussions:

� Significant capital commitments:

The County's fiscal year 2003 capital budget calls for spending $75.9 million for capitalprojects, which includes $42.1 million for the primary government and $33.8 million for theSchool Board component unit. Principal projects for the primary government includeparks improvements, emergency systems integration, water lines, and the replacement ofa wastewater pump station. School projects are principally for school buildingimprovements. The County plans to issue additional debt to finance these and future


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projects as identified in the Capital Improvement Program 2003�2008. More detailedinformation about the County's capital assets is presented in Note 8 to the financialstatements.

� Changes in credit ratings:

In August 2003, the County received a bond rating upgrade by Moody's Investor Service.The upgrade reflects the County's available operating tax rate margin and alternativerevenue sources available for debt service payments. Other considerations cited for theupgrade are growing taxable resources, favorable debt profile, and consistently solidfinancial operations. During the current year, general obligation debt issued by the Countyreceived ratings from Aaa to Aa3 by Moody's and A+ to AAA from Standard and Poor's.

***

The County has ratings on its debt from Standard and Poor's (S&P), Fitch Ratings, andMoody's Investors Services (Moody's). As of September 30, 2001, the rating agencieshave announced upgrades in several of the County's key credit ratings. For example, therating for the County's general obligation bonded debt was raised from Aa3 to Aa2 byMoody's. The ratings for the Water and Wastewater System Enterprise Fund bonds wereupgraded from A3/BBB+/A to Aa3/AA�/AA�, respectively, as a result of the utility system'ssteadily improving financial condition. The higher ratings are notable because theygenerally lead to lower interest costs on debt issued by the County.

� Debt limitations:

Ohio law restricts the amount of debt that the City may issue. The aggregate principalamount of unvoted �net indebtedness" may not exceed 5.5% of the assessed valuation forproperty tax purposes of all real and personal property located within the City. Certaindebt with a repayment source other than general tax revenues is excluded from thedefinition of net indebtedness. Under that definition, the City has approximately $2.6million of net indebtedness as of December 31, 2001, leaving a legal debt margin forunvoted debt of approximately $20.4 million. An additional statutory limitation restrictstotal indebtednessboth voted and unvotedto 10.5% of the real and personal propertyassessed valuation. That limitation would restrict total City net indebtedness to $43.9million, leaving a total debt margin of approximately $41.4 million.

***

State statute (NRS244A.059) limits the amount of general obligation debt a governmententity may issue to 10 percent of its assessed valuation. The current limitation for ourCounty is $910 million, which is significantly higher than the County's outstanding generalobligation debt of $102.8 million.

Required Component: Infrastructure Assets

Infrastructure Asset ConditionTHE BASICS

� Present this component of MD&A only if the government's assets are reported using themodified approach.

The seventh component of MD&A is required to be presented only for governments that use the modified approach

to report their infrastructure assets (GASBS No. 34, paragraph 11g). This approach allows governments to not

report depreciation expense for eligible infrastructure assets if the government:

� has an up�to�date inventory of its eligible infrastructure assets,


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� performs condition assessments of those assets and summarizes the results using a measurement scale,and

� estimates each year the annual amount to maintain and preserve its infrastructure assets at the conditionlevel it has established and disclosed.

In addition, the government must:

� perform complete condition assessments for eligible infrastructure assets in a consistent manner at leastevery three years, and

� document that the results of those assessments provide reasonable assurance that the assets are beingpreserved at or above the condition level established by the government.

That the GASBS No. 34 model requires infrastructure reporting at all is evolutionary. The modified approach, then,can be categorized as revolutionary. The required discussion in MD&A, along with note disclosure requirementsand other RSI, should allow users to assess the effects of using this unusual approach. The MD&A discussionshould include the following:

� Significant changes in the assessed condition of eligible infrastructure assets from previous conditionassessments.

� How the current assessed condition compares with the condition level the government has established.

� Any significant differences from the estimated annual amount to maintain/preserve eligible infrastructureassets compared with the actual amounts spent during the current period.

Illustration. The GASB provided the following illustration of the MD&A requirement for governments using themodified approach:

The City manages its streets using the XYZ pavement management system. The City's policy is tomaintain 85 percent of its streets at a pavement condition index of at least 70 (on a 100 percentscale) and no more than 10 percent of its streets at a pavement condition index below 50. Themost recent assessment found that the City's streets were within the prescribed parameters with87 percent having a pavement condition index of 70 or better and only 2 percent of the streetshaving a pavement condition index below 50.

Required Component: Currently Known Facts, Decisions, or Conditions

Currently Known FactsTHE BASICS

� Currently known facts are information that management is aware of as of the date of theauditor's report.

� Currently known facts should not be presented only in the last section of MD&A. They shouldbe used throughout to help users assess the effect of current period changes.

The final component of MD&A is a requirement to describe currently known facts, decisions, or conditions that areexpected to have a significant effect on financial position (net assets) or results of operations (revenues, expenses,and other changes in net assets) (GASBS No. 34, paragraph 11h). Currently known facts are information thatmanagement is aware of as of the date of the auditor's report. Of all of the components of MD&A, this one is likelyto be integrated within the others. For example, our earlier explanation of a budget overrun in salaries included thefact that a new contract had been approved that established a significantly higher pay rate and other changes. Thisis a currently known fact that is expected to have a material effect on results of operations, yet it makes the mostsense to include it with the budgetary discussion. There is no need to repeat it in the final component.


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Some other examples of currently known facts, decisions, or conditions that may be relevant to MD&A include thefollowing:

� An approved change in tax rates, fees, or tuitions.

� An approved change in rates charged for services in business�type activities.

� An award and acceptance of a major grant or contract.

� Prices contained in contracts signed for supplies, services (such as outsourcing), or capital construction.

� Decisions to eliminate current programs or start new ones.

� Agreements/decisions by companies to start or stop operations that will affect the local economy.

� Economic conditions, such as a decline in employment rates when the local government relies on personalincome tax or sales tax revenues.

� Changes in credit availability.

GASBS No. 56, Codification of Accounting and Financial Reporting Guidance Contained in the AICPA Statements

on Auditing Standards, states that the discussion of currently known facts, decisions, or conditions may need toinclude subsequent events or going concern issues, depending on the facts and circumstances.

Governments should not discuss in MD&A the possible effect of events that might happen, just as it would notinclude �what ifs" in the notes to the financial statements. Some MD&A authors have made statements that areoutside the definition of currently known facts. For example:

� We anticipate capital additions will be comparable to the 20X0�20X1 fiscal year.

� We have projected an excess of $55,000 for the 20X2�20X3 fiscal year with no major uncertaintiesanticipated in the future.

Other MD&A authors made statements about currently known facts, but then elaborated into areas that might havebeen difficult for auditors to consider. For example:

� We anticipate, as indicated by the strength of the construction segment and building permits issued in thelast six years, future economic expansion.

� The industrial segment continues to lead our economy and is erratic. We expect this pattern to continue.

Preparers are encouraged to discuss future prospects in the letter of transmittal. For example, this MD&A refersreaders to the letter of transmittal for information that is outside the definition of currently known facts:

The local economy continues to grow as demonstrated in the schedule in our Transmittal Letter(see page vi), and various tax revenues reflect this growth. City property tax revenue grew basedon a 15.9% taxable value increase. The City has maintained the same millage rate (6.066), withina 10 mil constitutional cap, for the last 11 years. For the new year (2001�2002), the millage ratehas been reduced to 5.6916.

Illustrations. The following example MD&As include discussions of currently known facts (highlighted). The firsttwo examples appear in the last section of MD&A. The last example shows how a discussion of currently knownfacts can be blended into another required component of MD&Ain this case, the analysis of the government'soverall financial position (GASBS No. 34, paragraph�11c).

The State of Missouri is experiencing a significant crunch on its available resources and has

begun reducing the reimbursement rates for certain services provided by local governments. Wedo not yet know the effect these cuts will have on the County's operations.

***

Due to the recent information received from the state on revenue shortfalls for FY 2003 and in aneffort to be proactive, the County has continued the freeze on capital purchases, employee travel,


188

and vacancies. In addition, departments were asked to identify reductions totaling 5 percent oftheir budgets, including the freezes, in anticipation of reductions in state revenues to the County.

***

The main story in business�type activities is the meteoric rise in natural gas cost. The city's costto obtain natural gas rose to as much as four times that of the previous year's cost. While a goodportion of that increased cost was passed on to the customer, the city's gas utility still did notcover the entire increase as shown in Table 2. The city has signed a fixed�price contract for natural

gas for 2002.


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SELF�STUDY QUIZ


15. Which of the following elements is included in MD&A to satisfy the requirement that MD&A present condensedcomparative financial statements?

a. An explanation of why net assets are reported in three categories.

b. A separate column should be presented for governmental activities and fiduciary activities.

c. Three years of condensed financial information should be included when comparative basic financialstatements are presented.

d. Comparative condensed financial statements using the statement of activities format.

16. One of the required components of MD&A is a government�wide analysis of financial position and results ofoperations. Which of the following statements would be used to comply with this requirement?

a. Explaining that a decrease in net assets was due to a large transfer to cover future employee health carecosts.

b. Informing users of a city's financial statements that the financial health of the city has greatly improved overthe prior year.

c. Producing a pie chart that breaks down expenditures of a school district by administration, classroom, andmaintenance expenditures.

17. When preparing the government�wide analysis of financial position and results of operations, what is one matterthe writers of MD&A should consider?

a. The writer should include a comprehensive discussion of the entirety of activities in which a governmentalentity is involved during the fiscal year.

b. The writer should consider economic factors that are not presented in the financial statements.

c. The writer should initially approach the analysis from the point of view of an auditor performing substantivetests of transactions on balances presented in the financial statements.

d. The writer should focus on the credit rating of the municipality to provide underwriters with the informationnecessary to price future bond issuances.

18. What is one major difference between the government�wide analysis of financial results and the analysis ofbalances and transactions of individual funds?

a. Writers are required to present additional detail regarding enterprise funds in their analyses of balancesand transactions of individual funds.

b. Discussion of nonmajor funds is required in the analysis of balances and transactions of individual funds.

c. The analysis of balances and transactions of individual funds should contain a general explanation of thedifference between government�wide and governmental fund reporting.

d. Condensed financial information is not required for the analysis of individual funds.


190

19. One of the required components of MD&A is a variance analysis. Which of the following statements would mostlikely address this requirement?

a. An explanation of a 15% decrease in actual revenue at the city�owned water park compared to the finalbudgeted amount.

b. The reason that the original budget for administrative salaries increased by 10% compared to the finalbudget.

c. The cause of a 20% difference between the actual fuel expenses of the police department and the originalbudgeted amounts.

d. A statement that the current contribution rate of city employees to the pension fund should decrease nextyear based on the expectation of better�than�expected investment returns on investments by the pensiontrustee.

20. One of the required components of MD&A is a discussion of significant capital assets and long�term debtactivity. Which of the following statements would be included to address this requirement?

a. Due to the increase in commercial construction and increased property values, the city expects that its debtrating will be upgraded by Moody's Investor Service sometime during the next fiscal year.

b. More detailed information regarding the city's capital assets is presented in the required supplementaryinformation (RSI) following the notes to the financial statements.

c. The district has entered into a contract with ABC Construction Co. to build a new high school.

21. Which of the following is a requirement of a government that uses the modified approach to report itsinfrastructure assets?

a. Performance of complete condition assessments for eligible infrastructure assets in a consistent mannerat least every three years.

b. Document that the results of condition assessments provide absolute assurance that the assets are beingpreserved at a level established by the government.

c. Estimate on a biennial basis the amounts necessary to maintain and preserve the assets at the conditionlevel established by the government.

d. Report on changes in the assessed condition of eligible assets from previous condition assessments.

22. Where is the most appropriate place for the preparer to present future prospects for the entity?

a. The transmittal letter.

b. The notes to the financial statements.

c. MD&A.


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15. Which of the following elements is included in MD&A to satisfy the requirement that MD&A present condensedcomparative financial statements? (Page 171)

a. An explanation of why net assets are reported in three categories. [This answer is incorrect. An explanationof why net assets are reported in three categories is generally a part of MD&A; however, this element is notfound in the condensed comparative financial statements.]

b. A separate column should be presented for governmental activities and fiduciary activities. [This answeris incorrect. A separate column is not required for fiduciary activities.]

c. Three years of condensed financial information should be included when comparative basic

financial statements are presented. [This answer is correct. Although most governmental financial

statements are not presented on a comparative basis, MD&A must include condensed financial

information for three years when governments elect to present basic financial statements on a

comparative basis. This is required by GASB No. 34.]

d. Comparative condensed financial statements using the statement of activities format. [This answer isincorrect. Using the format of the basic financial statements would hinder the ability to present condensedfinancial information available to the users at a glance. Thus, the format of the statement of activities is notused.]

16. One of the required components of MD&A is a government�wide analysis of financial position and results ofoperations. Which of the following statements would be used to comply with this requirement? (Page 178)

a. Explaining that a decrease in net assets was due to a large transfer to cover future employee health

care costs. [This answer is correct. The purpose of this required component of MD&A is to explain

to the reader the causes of changes in financial information, not simply repeat what the condensed

financial information already tells the user. The increase or decrease is obvious to the reader. the

responsibility of the financial manager in writing the MD&A is the factors that caused the increase

or decrease, for example, explaining that the decrease in net assets is in direct correlation to the

transfer for health care costs.]

b. Informing users of a city's financial statements that the financial health of the city has greatly improved overthe prior year. [This answer is incorrect. The analysis of financial position and results of operations shouldassist users in drawing their own conclusions regarding the overall health of the governmental operation,not draw conclusions for them.]

c. Producing a pie chart that breaks down expenditures of a school district by administration, classroom, andmaintenance expenditures. [This answer is incorrect. While this type of graphic representation may proveuseful to readers, it does not satisfy this required component of MD&A.]

17. When preparing the government�wide analysis of financial position and results of operations, what is one matterthe writers of MD&A should consider? (Page 178)

a. The writer should include a comprehensive discussion of the entirety of activities in which a governmentalentity is involved during the fiscal year. [This answer is incorrect. The analysis is not required to discussevery matter affecting a government's financial statements throughout the year, only significant changesfrom the prior year.]

b. The writer should consider economic factors that are not presented in the financial statements. [This

answer is correct. Economic factors such as an influx of new jobs due to a corporate relocation or

discovery of energy resources within a city's boundaries may cause an increase in revenues and

should be discussed in the analysis of the financial information.]


192

c. The writer should initially approach the analysis from the point of view of an auditor performing substantivetests of transactions on balances presented in the financial statements. [This answer is incorrect. A writermight approach the analysis using the same approach an auditor uses when performing variance analysisor analytical procedures, not substantive tests of transactions.]

d. The writer should focus on the credit rating of the municipality to provide underwriters with the informationnecessary to price future bond issuances. [This answer is incorrect. Credit ratings and related mattersshould be discussed in other required components of MD&A.]

18. What is one major difference between the government�wide analysis of financial results and the analysis ofbalances and transactions of individual funds? (Page 181)

a. Writers are required to present additional detail regarding enterprise funds in their analyses of balancesand transactions of individual funds. [This answer is incorrect. In many cases, the enterprise funds havealready been thoroughly dissected in the government�wide analysis component in connection with thediscussion of business�type activities.]

b. Discussion of nonmajor funds is required in the analysis of balances and transactions of individual funds.[This answer is incorrect. An analysis of nonmajor funds is only required when changes are significant tothe government as a whole.]

c. The analysis of balances and transactions of individual funds should contain a general explanation of thedifference between government�wide and governmental fund reporting. [This answer is incorrect. Ageneral explanation of the differences between these methods of reporting is required in the firstcomponent of MD&A; however, some specific details may be needed in this analysis.]

d. Condensed financial information is not required for the analysis of individual funds. [This answer

is correct. The lack of a requirement for condensed financial information provides writers with

greater flexibility in the presentation of their analyses of individual funds.]

19. One of the required components of MD&A is a variance analysis. Which of the following statements would mostlikely address this requirement? (Page 182)

a. An explanation of a 15% decrease in actual revenue at the city�owned water park compared to the finalbudgeted amount. [This answer is incorrect. The budgetary analysis should be limited to the general fundbudget. This variance relates to an enterprise fund.]

b. The reason that the original budget for administrative salaries increased by 10% compared to the

final budget. [This answer is correct. A budgetary analysis should discuss the causes of significant

differences between original and final budgeted amounts, explain why and how long it is expected

to last.]

c. The cause of a 20% difference between the actual fuel expenses at midyear of the police department andthe original budgeted amounts. [This answer is incorrect. Comparisons should be made between actualand final budgeted amounts. Significant variances should be explained in the budgetary analysis.]

d. A statement that the current contribution rate of city employees to the pension fund should decrease nextyear based on the expectation of better�than�expected investment returns on investments by the pensiontrustee. [This answer is incorrect. Any discussion of future cash outflows should only be based on currentlyknown information. Expected investment returns do not meet this criterion.]

20. One of the required components of MD&A is a discussion of significant capital assets and long�term debtactivity. Which of the following statements would be included to address this requirement? (Page 186)

a. Due to the increase in commercial construction and increased property values, the city expects that its debtrating will be upgraded by Moody's Investor Service sometime during the next fiscal year. [This answer isincorrect. While current conditions might portend a debt rating upgrade, a government should not includeinformation that is prospective in nature in its MD&A.]


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b. More detailed information regarding the city's capital assets is presented in the required supplementaryinformation (RSI) following the notes to the financial statements. [This answer is incorrect. While referenceto more detailed information regarding capital assets and debt is required, this information should not befound in the RSI.]

c. The district has entered into a contract with ABC Construction Co. to build a new high school. [This

answer is correct. A signed contract with a construction company is an example of a known fact that

relates to capital asset activity of a governmental entity.]

21. Which of the following is a requirement of a government that uses the modified approach to report itsinfrastructure assets? (Page 185)

a. Every three years, a complete condition performance assessment for eligible infrastructure assets

completed in a consistent manner from one year to the next. [This answer is correct. Among other

requirements, this is required to use the modified approach. To the extent it uses the modified

approach, the government must include a discussion of the condition of its infrastructure in MD&A.

This is required by GASB No. 34.]

b. Document that the results of condition assessments provide absolute assurance that the assets are beingpreserved at a level established by the government. [This answer is incorrect. The standard of assurancefor eligible assets is not absolute assurance, but rather reasonable assurance that the assets are beingpreserved at a level established by the government.]

c. Estimate on a biennial basis the amounts necessary to maintain and preserve the assets at the conditionlevel established by the government. [This answer is incorrect. The government must estimate these costseach year, not every other year, to use the modified approach.]

d. Report on changes in the assessed condition of eligible assets from previous condition assessments. [Thisanswer is incorrect. The MD&A discussion would include changes in the assessed condition of eligibleassets from previous condition assessments only if the changes are significant.]

22. Where is the most appropriate place for the preparer to present future prospects for the entity? (Page 187)

a. The transmittal letter. [This answer is correct. Future prospects or other information should be

presented in the transmittal letter since the possible effects of events that might happen should not

be discussed in the MD&A. This is a GASB No. 34 requirement.]

b. The notes to the financial statements. [This answer is incorrect. The notes to the financial statements mustinclude information that can be verified and not possible effects that might happen. This is a GASB No. 34requirement.]

c. MD&A. [This answer is incorrect. MD&A is a form of RSI. Governments should not include �what�ifs" in theMD&A. This is a GASB No. 34 requirement.]


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MD&A REQUIRED FOR SPECIAL�PURPOSE GOVERNMENTS

MD&A is required as a part of all governmental financial statements prepared in accordance with GAAP. Thisincludes all special�purpose governments. Special�purpose governments that engage in both governmental andbusiness�type activities should include all of the applicable MD&A components.

Special�purpose Governments Engaged Only in Governmental Activities

Some special�purpose governments are engaged only in governmental activities. An MD&A for these governmentsgenerally includes all of the components of MD&A discussed in this lesson. However, as for all governments, somecomponents of MD&A may not apply. For example, a special�purpose government engaged only in governmentalactivities may not have a legally adopted budget and will have no business�type activities to report. The GASBallows a single�program government to combine its government�wide and fund financial statements. However,because the statements still report both kinds of information (government�wide and fund), all of the components ofMD&A that apply should be discussed.

Special�purpose Governments Engaged Only in Business�type Activities

Other special�purpose governments may be engaged only in business�type activities. An MD&A for these govern�ments will also include all of the components of MD&A to the extent they apply. The following comments should beconsidered in these instances:

� Although these special�purpose governments do not present two types of basic financial statements(government�wide and fund), they should provide a brief explanation of the financial statements presented,including the cash flows statement.

� Although many of these special�purpose governments may have several different activities, they generallyreport using a single enterprise fund. An analysis of balances and transactions for the �single fund" shouldbe included. As discussed in the GASB Comprehensive Implementation Guide2009, Question 7.97.1, aspecial�purpose government engaged only in business�type activities may have multiple enterprise funds.If this is the case, MD&A should focus on an analysis of major funds, when they exist. However,governments are not precluded from commenting on nonmajor funds.

� While some business�type activity special�purpose governments have budgets, they are generallyplanning tools. Unless the budget is legally adopted for the equivalent of a general fund and carries theforce of law, MD&A should not include budgetary analysis.

Again, common sense dictates that if the situation does not exist, it should not be addressed in MD&A. MD&Ashould not go beyond the required components listed in GASBS No. 34.

Condensed Comparative Financial Data. Like general purpose governments, special�purpose governmentsengaged in business�type activities should present condensed comparative financial information in their MD&A.However, because the operating statement presented by a business�type activity special�purpose government isquite different from a government�wide statement of activities, the items presented might include the following, ifrelevant:

� Operating revenues, by major source.

� Nonoperating revenues, by major source.

� Total revenues.

� Operating expenses (reported by function or natural classification, depending on the classifications usedin the statement of revenues, expenses, and changes in net assets).

� Nonoperating expenses.


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� Capital contributions.

� Special and extraordinary items.

� Contributions to term and permanent endowments.

� Transfers.

� Change in net assets.

� Ending net assets.

Most business�type activity special purpose governments present comparative financial statements. If a govern�ment presents complete comparative information (that is, basic financial statements and RSI for each year), MD&Ashould include condensed comparative financial statements for the past three years. A single MD&A shoulddiscuss both years in comparison to the prior year. A separate MD&A for each year should not be presented.

Special�purpose Governments Engaged Only in Fiduciary Activities

Other special�purpose governments may be engaged only in fiduciary�type activities. An MD&A for these govern�ments will also include all of the components of MD&A discussed in this lesson to the extent they apply.

HOW THE LETTER OF TRANSMITTAL IS RELATED TO MD&A

The recommended components of a CAFR are discussed in detail later in this course. One component is a letter oftransmittal, which introduces and precedes the financial section of a CAFR. The Government Finance OfficersAssociation (GFOA) establishes recommendations for the content of a letter of transmittal. The GASB suggests onlythat a letter of transmittal not duplicate the information required to be presented in MD&A (GASBS No. 34, footnote7).

GASBS No. 34 establishes the required components for MD&A. Question 7.5.2 in the GASB Comprehensive

Implementation Guide2009 states that it is not appropriate to avoid duplication by placing any of these requiredcomponents in the letter of transmittal and not in MD&A. Rather, the GASB is suggesting that duplication should beavoided in the letter of transmittal. Given the characteristics of MD&A, a positive general statement about the letterof transmittal is that it should:

� only build upon information contained elsewhere in the financial report by making specific references tothe notes to the financial statements or MD&A for information already included,

� present information that the government wishes to provide voluntarily (as opposed to RSI), and

� be used to present information about the more subjective aspects of the required components of MD&A(for example, the effect of something that might happen).

GFOA recommendations for the contents of a letter of transmittal are consistent with this statement.

Where Should the MD&A and the Letter of Transmittal Letter Be Placed?

MD&A introduces the basic financial statements and is required to precede the basic financial statements. For thisreason, the letter of transmittal may be presented anywhere before MD&A. MD&A is RSI. Placing the transmittalletter between MD&A and the basic financial statements may cause readers to incorrectly assume that the auditor'sinvolvement with the letter is the same as with MD&A.


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A COMPARISON OF GASB MD&A AND SECURITIES AND EXCHANGECOMMISSION REQUIREMENTS

MD&A for state and local governments is RSI. By requiring MD&A to be presented as RSI, the GASB is able torequire that the information be presented and that it have some level of auditor involvement. Investor�ownedcompanies, on the other hand, have a regulatory bodythe U.S. Securities and Exchange Commission(SEC)that enforces the requirement to present MD&A without making it RSI.

Many auditors and some preparers of governmental MD&A are aware of the SEC requirements for MD&A. Thereare a number of significant similarities and differences between the two MD&As, including the following:

� Beginning in 2003, the SEC required registrants to provide specific information and analysis aboutoff�balance sheet arrangements and aggregate contractual obligations. The GASB has not modified itsrequirements for MD&A since the issuance of GASBS No. 37, Basic Financial Statementsand

Management's Discussion and Analysisfor State and Local Governments: Omnibus.

� Many of the SEC MD&A requirements focus on trends and other factors that may affect the certainty offuture cash flows (liquidity). Although governmental fund information considers financial resource flows,much of the focus of GASB MD&A is on the improvement or deterioration of net assets and thegovernment's ability to continue to provide programs through an analysis of changes in net assets.

� The SEC MD&A requires a focus on �material" changes, events, and trends. GASBS No. 34 focuses on�significant" changes. Because the GASB appears to use the term �significant" as an equivalent to�material," there generally should be no differences in this focus of the two MD&As.

� Both the SEC and the GASB require companies or governments to comment on future operations basedon �presently known data" or �currently known facts, decisions, or conditions," respectively.

� The SEC provides �safe harbor" for projections about future operations in MD&A. This allows SECregistrants to provide forward�looking information in MD&A without fear of prosecution should thoseforecasts turn out to be incorrect. The GASB has no power to provide �safe harbor" and does not allowforecasts in MD&A.

� The SEC requires MD&A to describe events to the extent necessary to provide an understanding of theregistrant's business as a whole, including its consolidated subsidiaries. It also focuses on off�balancesheet arrangements. The GASB focus is on the primary government. Comments about discretelypresented component units will generally not be presented.

� The SEC MD&A focus is on known trends, which are derived from five�year selected financial data. TheGASB MD&A focuses on changes from the prior year to the current year. However, if comparative financialstatements are presented, the GASB MD&A must discuss both years of activity in comparison to theprevious years.

PLAIN ENGLISH WRITING

The SEC's A Plain English Handbook: �How to Create Clear SEC Disclosure Documents" discusses topics that arealso useful for governmental financial managers who wish to write an �easily readable" MD&A. In this section, thefollowing Handbook topics are discussed with the GASB MD&A requirements in mind:

� Writing using a team.

� Knowing your audience.

� Knowing what you need to report.

� Organizing your document.


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� Avoiding long sentences/writing short sentences.

� Using active sentences and strong verbs.

� Using personal pronouns.

� Bringing abstractions down to earth.

� Omitting superfluous words.

� Writing in the positive.

� Replacing jargon and legalese.

� Keeping subject, verb, and object close together.

� Keeping parallel structures.

� Making it look invitingdesign.

Write MD&A Using a Team Approach

The Handbook suggests assembling a team to do the writing. Because the government's financial managers willgenerally write MD&A, your �team" will generally consist of financial managers. However, do not overlook otherswho may help in the review process. If a team is used, the SEC staff provides these pointers:

� Assign a team leader who will be responsible for making final decisions on what needs to be said, whatstays, and what goes.

� Assign a lead writer who will be responsible for making sure MD&A follows a logical structure and usessimple and clear language. The lead writer should also make sure that the final version has a consistenttone when more than one person contributes parts of MD&A.

Know Your Audience

When writing MD&A, keep in mind who is most likely to be reading it. The easiest thing to do is to write MD&A witha particular person in mind.

Know What You Need to Report

GASBS No. 34 lists the required components of MD&A. One way to make MD&A easily readable is to eliminate thethings that do not need to be there. Once you have drafted MD&A, sit down with other members of the team andquestion the need for every statement that appears in the draft. �Because it was there last year" is not a reason tokeep it this year. Also, look to see whether information within MD&A is repeated. Although the GASB has prepareda list of requirements, it does not say that they must be reported in that order. Many of the reasons for changes infinancial condition or financial position overlap. If program expenses were high for a particular program functionand were also well over budget, it is not necessary to repeat this fact to meet the requirements of both paragraphs11c and 11e of GASBS No. 34. In addition, most readers skip over paragraphs of information they think they havealready read.

Organize MD&A

Present the �big picture" before the details. This is what the GASBS No. 34 reporting model doesit presentscondensed information about governmental activities, business�type activities, and component units first in thegovernment�wide statements. This is followed by the detailsreporting on the major funds of the primary govern�ment. GASBS No. 34's requirements for MD&A flow in the same way. Paragraph 11a describes the financialstatements, paragraph 11b presents condensed government�wide statements, paragraph 11c discusses whether


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financial position has improved or deteriorated for the government as a whole, and paragraph 11d discussesindividual funds. Within this broad outline, however, there is still need to organize. One way, illustrated in GASBSNo. 34, is to present an executive summary or �financial highlights" section as the first component of MD&A. Afinancial highlights section gives the reader an overview of what is to come. You should also use descriptiveheadings and subheadings that will help the reader see the flow of MD&A. Also, group related subjects together soit is not necessary to repeat them.

Avoid Long SentencesWrite Short Ones

No MD&A is going to look inviting or be easily readable if a single sentence covers half of the first page or more. Thelonger and more complex a sentence, the harder it is for readers to understand any part of it. One of the reasonsthat sentences get very long is that the writer remembers in midsentence something else the reader needs to knowbefore he or she can understand the main idea of the sentence. Short sentences have a simple structuresubject,verb, object. If the sentences in the MD&A have more than this simple structure, look at them for this problem.Rewrite the sentence into several smaller sentences, going from the big picture to the details, as illustrated in thefollowing example:

Long Sentence:

The government�wide Statement of Net Assets and Statement of Activities, which are reported onthe full accrual basis, report the financial position (net assets) and results of operations (revenues,expenses, and other changes in net assets), respectively, for the City as a wholegovernmentalactivities (reported as governmental funds on the modified accrual basis in the fund statements),business�type activities (reported as enterprise funds in the fund statements), and discretelypresented component unitsand are presented on pages X�XX.

Short Sentences:

� The City consists of three distinct activities:

�� Governmental activities,

�� Business�type activities, and

�� Discretely presented component units.

We report these activities in separate columns in the City's full accrual basis Statement of NetAssets and Statement of Activities. The government�wide Statement of Net Assets reports thefinancial position or net assets of the City as a whole. The government�wide Statement of Activi�ties reports the results of the City's operationsits revenues, expenses, and other changes in netassets. These two statements appear on pages X�XX.

We report the City's governmental activities as governmental funds in the fund financial state�ments, which begin on page XXX. These statements are presented using the modified accrualbasis of accounting. The City's business�type activities are reported as enterprise funds in aseparate set of fund financial statements. These statements begin on page ZX and are preparedusing the same basis of accounting as the government�wide statements.

Although the second version of this sentence is much longereight sentencesit is much easier to understandthan the first long sentence. Remember that using plain English will not necessarily make MD&A shorter, but it willmake it easier to read. (You may have �understood" the first sentence because you skipped all of the things inparentheses. Most people do.)

Use Active Sentences and Strong Verbs

Perhaps the simplest step toward writing in plain English is avoiding the passive voice. Most people who read apassive sentence convert it to an active one as they read, creating an extra mental step. A passive sentence says,


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�The budget was approved by the council." Or, worse yet, �The budget was approved." (And we do not know whodid it!) An active sentence says, �The council approved the budget." Passive sentences can be spotted by theirweak verbsusually some form of to be or to have. Eliminating a passive sentence automatically leads to usingstronger verbs.

�Hidden" verbs are another verb problem. This happens when the writer feels the urge to use more words; so he orshe adds an extra verb and turns the real verb into a noun. For example:

We determined. becomes We made a determination.

He suggested. becomes He made a suggestion.

You can spot most hidden verbs by looking for �ion" at the end of nouns. �Make an application" becomes �apply."�Made a distribution" becomes �distributed." The best way to eliminate these from the MD&A is to go through thedraft looking just for �ion."

Use Personal Pronouns

Many people call personal pronouns the �silver bullet" of plain English. You will find that if the only thing you do isuse personal pronouns, your writing will drastically improve. You can use them no matter how sophisticated youraudience. You may have noticed that we have used them throughout this section. Of course, when writing MD&A,you may not want to use �I" or �we" to avoid taking credit for all of the work. However, you can say �our government"or �your government" if you are directing your MD&A to taxpayers and citizens. If you use �we" and �you," you donot have to worry about saying he/she or him/her. These two pronouns are not gender�specific. Best of all, usingpersonal pronouns allows you to speak directly to your reader. It forces you to use everyday language and use lessabstract terms and concepts. It helps you keep your sentences short.

Bring Abstractions Down to Earth

There are plenty of abstract ideas in financial accounting and in government. For example, think of the phrases�measurement focus and basis of accounting" or �zero coupon bond." You may have found these types of�abstractions" in the draft MD&A but do not know what to do with them. It is hard to eliminate them all. You will needto think about your intended audience before you decide which ones to tackle. The best way to work abstractionsdown into plain English is to explain the idea or concept by creating a scenario. Or, you can describe the conceptas if you were talking to a single person (using personal pronouns, of course!). For example, in the GASB illustrativeMD&A, the Board explained the phrase �financial position" this way:

You can think of the City's net assetsthe difference between assets and liabilitiesas one wayto measure the City's financial health, or financial position.

The SEC staff provided this example in the Handbook:

Before:�No consideration or surrender of Beco Stock will be required of shareholders of Becoin return for the shares of Unis Common Stock issued pursuant to the Distribution.

After:�You will not have to turn in your shares of Beco stock or pay any money to receive yourshares of Unis common stock from the spin�off.

Omit Superfluous Words

There are many common wordy phrases that we get in the habit of using. We use them most often when we write,but sometimes we even say them. Most of them can be replaced with fewer words that mean the same thing. The


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shorter phrases are easier for the reader to understand, and you do not have to change anything else in yoursentence to lose a lot of extra words. Here is a short list:

Superfluous Simpler

in order to to

in the event of if

subsequent to after

prior to before

despite the fact that because, since

in light of because, since

owing to the fact that because, since

at this point in time now

at such time then

These are not the only phrases, only the most obvious ones. You may also find that you create many othersuperfluous phrases often because you are trying to sound official or legalistic. Here is a good example from theSEC staff:

(Superfluous words are in bold.)

Before:�Drakecorp has filed with the Internal Revenue Service a tax ruling request

concerning, among other things, the tax consequences of the Distribution to the United Statesholders of Drakecorp Stock. It is expected that the Distribution of Beco Common Stock to the

shareholders of Drakecorp will be tax free to such shareholders for federal income taxpurposes, except to the extent that cash is received for fractional share interests.

After:�While we expect that this transaction will be tax free for U.S. shareholders at the federallevel (except for any cash paid for fractional shares), we have asked the Internal Revenue Serviceto rule that it is.

Write in the Positive

Positive sentences are easier to understand than negative ones. For example:

Before:�Although the City increased its tax rates in 20X0, it still did not raise enough revenue tocover its expenses.

After:�Although our City council increased tax rates in 20X0, our expenses still exceeded ourrevenues.

Your sentences will also be easier to understand if you simply replace negative phrases with single positive words.For example:

Negative phrase Single word

not able unable

not accept reject

not certain uncertain

not unlike similar, alike

does not have lacks

does not include excludes, omits

not many few

not often rarely

not the same different

not . . . unless only if

not . . .except only if

not . . . until only when


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Replace Jargon and Legalese

If you have been working in finance for some time, it may be hard for you to spot accounting jargon and legalese.If so, ask a nonaccountant friend to help spot them. You may not be able to eliminate them all. Even then, you mayneed to leave the tougher ones, adding a definition to try to bring them down to the reader's level. Here is anexample created from the GASB's illustrative MD&A:

(Jargon is in bold.)

Before:�The City did not appropriate amounts needed to pay for compensated absences.

After:�The City did not include in past budgets amounts needed to pay for unused employeevacation and sick days.

Also, when you are forced to explain a complex idea, do not make the situation worse by surrounding it withcomplex words. For example, use �end" rather than �terminate," �use" rather than �utilize," and �pay" rather than�compensate." Finally, avoid the word �respectively." When you use this word, you force your reader to go backand match up the items that belong together.

Keep Subject, Verb, and Object Close Together

When we speak, most of our sentences naturally fall into the ordersubject, verb, objectwith few words inbetween. Your writing will be much clearer if you try to keep this structure when you write. Otherwise, you end upwith passive sentences, superfluous words, and abstractions. Writing with personal pronouns will quickly cure thishabit.

Keep Parallel Structures

When writing a long list of things that describe something or that need to be done, you are always in danger oflosing track of your verb or sentence structure. Losing this structure makes it very difficult for the reader tounderstand the sentence. For example:

The City purchases commercial insurance to ensure that it will have the resources to cover claimswhen they occur, satisfy requirements established by debt covenants, and protection of the Cityagainst the cost of catastrophic events such as hurricanes.

If you pair each one of these phrases with the subject and verb of the sentence, you will see that the last one(�protection of the City") does not work. It says the City purchases insurance to ensure, to satisfy, and to protection.An easy fix is to say �to protect." No matter how careful you are, it is easy to fall into this trap. The best way to curethe problem is to read the MD&A through once looking for this kind of mistake.

Make It Look InvitingDesign

The SEC staff has a number of ideas for making MD&A more visually inviting, including the following:

� Use Headings and Subheadings. Determine what each different level of heading will look like and use themconsistently. Do not use more than six levels. (For example, the first heading level could be bold and12�point type, and the second level could be bold and 11�point type.)

� Choose a Legible Type Size. One that is too large is as difficult to read as one that is too small.

� Never Use All Capital Letters to Emphasize Something. All uppercase sentences slow the mechanics ofreading and bring the reader to a standstill because the shapes of the words disappear. Use bold or italicinstead.

� Use White Space Generously. It helps to emphasize important points and lightens the overall look of MD&A.A wide right or left margin is especially helpful to readers. Keep lines to a reasonable length. A comfortableamount for most readers is between 32 and 64 characters.


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� Keep Paragraphs Relatively Short and Use Bullets to List Information Whenever Possible.

The SEC Handbook also provides ideas for simplifying graphicscharts, tables, graphs. As noted earlier, you candownload a free copy of the Handbook at the SEC's website (www.sec.gov/news/extra/handbook.htm) or get afree copy by contacting the SEC at (800) SEC�0330.

COMMON ERRORS

The following is a list of common errors made when implementing GASBS No. 34 concerning the presentation ofMD&A. Financial statement preparers should review the following list to avoid making the same errors.

� Not updating figures presented in drafted MD&As for final financial statement figures.

� Discussing reasons for increases or decreases in government�wide net assets using current financialresource flows information. For example, several governments attributed overall increases in government�wide expenses to current�year acquisitions of major capital assets. Others cited increased levels ofexpenditures instead of expenses. In the government�wide financial statements, these assets arecapitalized and only affect changes in net assets to the extent that they are depreciated in the current year.Also, expenses, not expenditures, are measured in the government�wide financial statements. (Seeparagraph 1508.13.)

� Including something in MD&A that is not also discussed in the notes. If necessary, refer readers of MD&Ato the notes. For example, some governments stated that they did not report claims liabilities on the accrualbasis in MD&A but did not mention this in the financial statement notes. (See paragraph 1508.4.)

� Not providing three years' worth of data and analysis in MD&A when accompanying financial statementsare comparative (two�year). (See paragraphs 1508.5 and 1508.6.)

� Making assessments of the government's or management's performance in MD&A. Only readers shouldmake assessments. (See paragraph 1509.10.)


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SELF�STUDY QUIZ


23. What is one common difference between the MD&A of a special�purpose government engaged only inbusiness�type activities and that of a general purpose government?

a. The MD&A of a special�purpose government engaged only in business�type activities is required to includea discussion of major and nonmajor enterprise funds.

b. Since a special�purpose government engaged only in business�type activities does not present two typesof basic financial statements, a brief explanation of the financial statements is not necessary.

c. A budget analysis is not present because the budgets of a special�purpose government engaged only inbusiness�type activities are generally planning tools only.

d. Condensed financial information relating to a special�purpose government engaged only in business�typeactivities is required only for the current fiscal year being presented in the report.

24. What is one important distinction between MD&A of an SEC registrant and MD&A of a governmental entity?

a. A �safe harbor" for projections is provided by the SEC about future operations in MD&A.

b. MD&A is required supplementary information (RSI) for an SEC filing.

c. MD&A of an SEC registrant focuses on trend analysis based on the supposition of future events takingplace.

d. Auditor involvement is not required in the MD&A of investor�owned companies' filings with the SEC.

25. According to an SEC handbook, what is one suggested technique for writing effective MD&A?

a. To maintain a consistent tone, assign one writer to create the MD&A.

b. Write short, direct sentences aimed at financial professionals to maximize efficiency.

c. Include an executive summary as one of the first sections of MD&A to give the reader an overview of whatis coming.

d. Repeat the contents of MD&A from year�to�year to ensure continuity for the users of financial information.

26. What is one common error made when complying with GASBS No. 34 relating to the presentation of MD&A?

a. Using personal pronouns, exposing the writers and governments to liability.

b. Using information about current financial resource flows to discuss reasons for increases in thegovernment�wide net assets.

c. Providing too many illustrations using pie charts and graphs, substituting graphic displays for the requiredcondensed information.

d. Failing to assess the financial health of the governmental entity, leading unsophisticated users to arrive atfaulty conclusions.


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23. What is one common difference between the MD&A of a special�purpose government engaged only inbusiness�type activities and that of a general purpose government? (Page 194)

a. The MD&A of a special�purpose government engaged only in business�type activities is required to includea discussion of major and nonmajor enterprise funds. [This answer is incorrect. While a special�purposegovernment engaged only in business�type activities is not precluded from discussing nonmajor funds inits MD&A, it is not required to do so.]

b. Since a special�purpose government engaged only in business�type activities does not present two typesof basic financial statements, a brief explanation of the financial statements is not necessary. [This answeris incorrect. Even though this type of special�purpose government will not have government�wide financialstatements, a brief discussion of the financial statements is required in its MD&A, similar to that of ageneral�purpose government.]

c. A budget analysis is not present because the budgets of a special�purpose government engaged

only in business�type activities are generally planning tools only. [This answer is correct. Since

these budgets do not carry force of law and are not legally adopted, MD&A should not include a

budgetary analysis.]

d. Condensed financial information relating to a special�purpose government engaged only in business�typeactivities is required only for the current fiscal year being presented in the report. [This answer is incorrect.The requirement related to condensed financial information for this type of special�purpose governmentis identical to that of a general�purpose government.]

24. What is one important distinction between MD&A of an SEC registrant and MD&A of a governmental entity?(Page 196)

a. A �safe harbor" for projections is provided by the SEC about future operations in MD&A. [This

answer is correct. The GASB provides no such safe harbor for the MD&A of a government, while a

public company has a limited degree of latitude when discussing prospective trends.]

b. MD&A is required supplementary information (RSI) for an SEC filing. [This answer is incorrect. The SECenforces the requirement for MD&A to be a part of the financial statements of a public company, but it isnot RSI.]

c. MD&A of an SEC registrant focuses on trend analysis based on the supposition of future events takingplace. [This answer is incorrect. Both MD&A of a public company and a governmental entity should focuson �currently known facts," among other things, when writing MD&A.]

d. Auditor involvement is not required in the MD&A of investor�owned companies' filings with the SEC. [Thisanswer is incorrect. Auditors must perform limited procedures on the MD&A and ensure its consistencywith the financial statements on which they are expressing an opinion.]

25. According to an SEC handbook, what is one suggested technique for writing effective MD&A? (Page 197)

a. To maintain a consistent tone, assign one writer to create the MD&A. [This answer is incorrect. The SEChandbook recommends a team to write the MD&A; however, a lead writer should be responsible formaintaining a consistent tone.]

b. Write short, direct sentences aimed at financial professionals to maximize efficiency. [This answer isincorrect. A primary rule of writing is to know the intended audience. MD&A, particularly for governments,is not written solely for financial professionals. The MD&A is written for those not normally involved ingovernment.]


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c. Include an executive summary as one of the first sections of MD&A to give the reader an overview

of what is coming. [This answer is correct. One effective technique is to present the �big picture"

before engulfing the reader in the details of the report. An executive summary accomplishes this

objective.]

d. Repeat the contents of MD&A from year�to�year to ensure continuity for the users of financial information.[This answer is incorrect. While certain required elements must be included, MD&A should not simplyrepeat the contents of the prior year. Items included in previous years that are no longer relevant shouldbe removed.]

26. What is one common error made when complying with GASBS No. 34 relating to the presentation of MD&A?(Page 202)

a. Using personal pronouns, exposing the writers and governments to liability. [This answer is incorrect. TheSEC handbook encourages the use of certain personal pronouns because it assists in producing everydaylanguage and brevity.]

b. Using information about current financial resource flows to discuss reasons for increases in the

government�wide net assets. [This answer is correct. One of the common errors made when

implementing GASBS No. 34 concerning the presentation of MD&A is discussing reasons for

increases or decreases in government�wide net assets using current financial resources flows

information. For example, several governments attributed overall increases in government�wide

expenses to current�year acquisitions of major capital assets. In the governmental�wide financial

statements, these assets are capitalized and only affect changes in net assets to the extent they are

depreciated in the current year. So, expenditures would not affect net assets.]

c. Providing too many illustrations using pie charts and graphs, substituting graphic displays for the requiredcondensed information. [This answer is incorrect. Including graphs and charts in the MD&A is sometimeshelpful; however, their mere inclusion does not provide useful analysis to the readers of the financialstatements.]

d. Failing to assess the financial health of the governmental entity, leading unsophisticated users to arrive atfaulty conclusions. [This answer is incorrect. Writers should not express an opinion on the health of theentity, but should provide enough information and related analysis to assist users in concluding on thefinancial health of the entity themselves.]


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Lesson 2 (GFSTG092)


9. What is one objective established by the GASB that should be achieved in the presentation of MD&A?

a. An analysis of the differences between the basic financial statements and the combining statements fordiscretely presented component units.

b. An analysis of limitations on debt due to changes in credit ratings.

c. An analysis of government achievements relating to awards for excellence in governmental financialreporting.

d. An analysis of the government's financial position focusing solely on possible deterioration.

10. Which of the following persons would be the most appropriate author of MD&A of a local government?

a. The independent auditor.

b. City council member with knowledge of governmental accounting.

c. The mayor.

d. The city manager.

11. What are the major areas of focus of MD&A of a governmental entity?

a. Governmental and component unit activities.

b. Governmental and fiduciary fund activities.

c. Governmental and business�type activities.

d. Governmental and service�type activities.

12. Why is the MD&A presented after the auditor's report?

a. Placement after the auditor's report supports the presumption that information in the MD&A has beenconsidered by the auditor.

b. Placement after the auditor's report ensures that the MD&A appears before the letter of transmittal.

c. Placement after the auditor's report is required by GASBS No. 44.

d. Placement after the auditor's report provides the detailed explanations of financial statement issues thatassist users in understanding the basic financial statements.


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13. What is one procedure an auditor should perform with respect to the information contained in MD&A?

a. The auditor is not required to consider information in MD&A since it is not a part of the basic financialstatements.

b. Confirmation of financial information not contained in the basic financial statements.

c. Request information from management about the method employed in preparing the MD&A.

d. Substantive testing of information contained in MD&A with respect to items that are material to the financialstatements of the governmental entity.

14. Besides the basic financial statements, what might be an appropriate source for information contained inMD&A?


b. Minutes of city council meetings.

c. Economic reports published by Forbes.

d. An analysis done by local college professors of leading economic indicators.

15. MD&A should discuss �currently known facts, decisions or conditions." What date is used to define �currentlyknown" for purposes of management's awareness of information that relates to its financial position?

a. The date of the management representation letter.

b. The date of the auditor's report.

c. The date of the MD&A.

d. The last day of a government's fiscal year.

16. In writing MD&A, authors are encouraged to use �plain English." What is one characteristic of �plain English"?

a. Eliminating all financial terms to make the document easier to understand.

b. Clearly disclosing the increases and decreases in the condensed financial information.

c. Highlighting material differences from previous years to assist reasonable third parties in understandingthe changes in a government's financial condition from the prior period.

d. Analyzing what information investors need to know to make informed decisions.

17. What is one important benefit of the first required component of MD&A, a brief discussion of basic financialstatements?

a. It prevents the reader from misunderstanding the financial statements.

b. It provides a succinct analysis for the changes in net assets.

c. It informs the user of significant changes in the financial condition of the government from the prior year.

d. It alerts the user as to the reasons for variations between the original and final budgets.


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18. Why is the second required component of MD&A, condensed comparative financial statements, presented ina traditional, operating statement format?

a. Because this component explains why the government�wide financial statements present information thatis different from the governmental fund information.

b. Because this component focuses on the extent to which the government's programs draw on the generalrevenues of the government.

c. Because this component reconciles the governmental funds and governmental activities financialstatements.

d. Because this component is required to present only a total primary government column to ensure that twoyears' worth of financial information will be available at a glance for users.

19. Why is the third required component of MD&A, analysis of financial positions and results of operations, arguablythe most important of the eight required components?

a. Because this component requires analysis based solely on figures derived from the financial statementsto provide an objective determination of the financial condition of the government.

b. Because this component helps the users determine whether or not a government's financial condition hasimproved or deteriorated over the previous year.

c. Because this component most closely resembles a variance analysis used in the performance of an audit,drawing conclusions for the user with respect to the performance of the government over the most recentfiscal period.

d. Do not select this answer choice.

20. When considering the fourth required component of MD&A, analysis of balances and transactions of individualfunds, which of the following is likely to receive the least attention?

a. Changes in governmental funds.

b. Differences between government�wide and governmental fund reporting.

c. Changes in enterprise funds.

d. Changes in unreserved and reserved fund balances.

21. The fifth required component of MD&A of a governmental entity is a general fund budgetary analysis. Besidesthis component of MD&A, where might a government include a description of its budgetary process?


b. The statistical section of the CAFR.

c. The notes to RSI.

d. Other supplementary information.


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22. Which of the following items would be found in the sixth required component of MD&A, capital asset andlong�term debt activity?

a. Detailed disclosures about changes in long�term liabilities.

b. Special assessment debt for which the government has no obligation.

c. A successful bond referendum for capital improvements.

d. An economic downturn which might affect the government's credit rating.

23. If a government uses the modified approach, it must include a seventh required component of MD&A, a reporton infrastructure assets. Which of the following accurately describes one of the MD&A disclosures requiredwhen a government uses the modified approach?

a. The depreciation expense recorded for each eligible asset during the current period.

b. The estimated annual amount to improve eligible infrastructure assets.

c. The existing assessed condition of eligible assets compared to the condition level established by thegovernmental entity.

d. References to reports of certified engineers and other professionals supporting the assertions of thegovernment as to the adequacy of the condition of eligible infrastructure assets.

24. The eighth required component of MD&A is a discussion of currently known facts, decisions, or conditions.Which of the following items would be addressed in this section of MD&A for a local college?

a. The current assessment of the college's campus and related buildings.

b. The local college has approved the addition of a nursing program to the curriculum offering.

c. The actual expenses related to employee health benefits for the local college significantly exceeded thefinal budgeted amount.

d. The reserved fund related to capital projects for athletic programs increased from the previous year.

25. All of the following statements correctly describe the relationship between the transmittal letter and the MD&Aof a governmental entity, except:

a. The transmittal letter should not duplicate the information required to be presented in MD&A.

b. The transmittal letter is a component of MD&A.

c. The transmittal letter should be placed after the MD&A.

d. The information contained in the transmittal letter should support any future projections made in the MD&A.

26. What is one important distinction between the MD&A of a government and the MD&A of an SEC registrant?

a. SEC MD&A highlights material changes in financial condition, while governmental MD&A disclosessignificant changes in financial condition.

b. SEC MD&A reveals trends based on selected financial data over five years, while governmental MD&A onlycompares the current year to the prior year.

c. SEC MD&A requires companies to discuss financial trends at the highest corporate level, whilegovernmental MD&A plays down to the details of discretely presented component units of the government.

d. SEC MD&A focuses on cash flow, while governmental MD&A emphasizes the improvement ordeterioration of net assets.


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27. When implementing GASB No. 34, what is a suggestion this course gives to avoid errors?

a. Preparers should use current information about financial resource flows to discuss reasons for decreasesin government�wide net assets.

b. Preparers should use current information about financial resource flows to discuss reasons for increasesin government�wide net assets.

c. Preparers should refer readers of MD&A to the notes instead of duplicating information.

d. Once MD&A is drafted, preparers should not change the financial statement figures.


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Lesson 3:�COMPREHENSIVE ANNUAL FINANCIAL

REPORTS (CAFR)

INTRODUCTION

This lesson introduces the general requirements of a Comprehensive Annual Financial Report (CAFR), as well asthe benefits accruing to a government that prepares a CAFR. The lesson then takes a detailed look at the transmittalletter, the key element of the introductory section of the CAFR. Next, the lesson guides the reader through thefinancial statements and other supporting schedules required in the financial section of the CAFR. Finally, the fiverequired elements of the statistical section of a CAFR are studied in detail.


Completion of this lesson will enable you to:� Discuss the differences between the requirements for GAAP and a CAFR, including the advantages of

preparing a CAFR.� Determine the presentation required in the financial section of a CAFR.� Identify the appropriate information to be included in the statistical section of a CAFR.

CAFR BASICS

CAFRsTHE BASICS

� A Comprehensive Annual Financial Report (CAFR) consists of three sectionsan introduc�tory section, a financial section, and a statistical section.

� Only certain elements of the financial section are required by GAAP. However, manygovernments choose to prepare a CAFR. Governments participating in the GFOA's Certificateof Achievement for Excellence in Financial Reporting Program must prepare a completeCAFR.

� GFOA Program participants must engage their auditors to provide at a minimum an �inrelation to" opinion on combining and individual fund (supplementary) financial statements.

According to GASB Cod. sec. 2200.101, �every governmental entity should prepare and publish, as a matter ofpublic record, a comprehensive annual financial report (CAFR) that encompasses all funds of the primary govern�ment (including its blended component units)." The CAFR represents the governmental entity's official annualfinancial report. It should include both the blended and discretely presented component units of the reportingentity. GASB Cod. sec. 2200.105 provides this basic outline of the content of a CAFR:

a. Introductory Section, including letter of transmittal.

b. Financial Section, consisting of:

(1) Auditor's report.

(2) Management's discussion and analysis (MD&A).

(3) Basic financial statements.

(4) Required supplementary information other than MD&A.

(5) Combining and individual fund statements and schedules.

c. Statistical Section.


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The Government Finance Officers Association's (GFOA) 2005 GAAFR, pages 310 and 311, suggests that othersections may be added to these three basic sections, including investment and actuarial sections. Some govern�ments subject to the federal Single Audit Act Amendments of 1996 may include a single audit section in their CAFRto present the resulting audit reports, audit findings, and the Schedule of Expenditures of Federal Awards. TheSingle Audit Act Amendments of 1996 and Office of Management and Budget Circular A�133, Audits of States,

Local Governments, and Non�Profit Organizations, contain guidance on reporting. Discussion of those reports isbeyond the scope of this course, but guidance may be found in PPC's Guide to Audits of Local Governments orPPC's Guide to Single Audits. Public employee retirement systems (PERS) may add two sections, an actuarialsection, and an investment section.

Is a CAFR Required by GAAP?

NCGAS No. 1, issued in 1979, states that every government �should" prepare a CAFR. However, AICPA SOP 80�2,Accounting and Financial Reporting by Governmental Units, issued a year later, made it clear that only the generalpurpose financial statements (now basic financial statements) are required for a GAAP presentation. GASB State�ment No. 44, Economic Condition Reporting: The Statistical Section, issued in 2004, established new guidelines forpreparing the statistical section of a CAFR. That standard applies only to governmental entities �that prepare astatistical section that accompanies the basic financial statements" (paragraph 2). The 2005 GAAFR recognizesthis fact, noting that �GAAP encourage governments to imbed this minimum presentation within the broaderframework of a CAFR" (page 285). Many government finance officers prepare a CAFR as a result of their desire toparticipate in the GFOA's program, the Certificate of Achievement for Excellence in Financial Reporting. Combiningand individual fund statements and statistical tables are treated as supplementary information. Depending on theterms of the audit engagement, the auditor may or may not express an �in relation to" opinion on some or all ofthese statements or schedules. (Governments interested in participating in the GFOA program must have at leastan �in relation to" opinion to qualify.)

The only components of a CAFR that are required by GAAP are MD&A, the basic financial statements includingnotes, and other required supplementary information (RSI). These components are often referred to as �liftable"because they may be issued separate from the CAFR, often in a governmental entity's official statement related toa debt offering, and still constitute a complete GAAP presentation.

THE CERTIFICATE OF ACHIEVEMENT FOR EXCELLENCE IN FINANCIALREPORTING PROGRAM

The Certificate of Achievement for Excellence in Financial Reporting Program (the GFOA Program) is a voluntarynonauthoritative program of the GFOA. The award signifies a CAFR that is clear and complete and whose contentsconform to the GFOA program standards. The suggested contents of an award�winning CAFR are discussed in the2005 GAAFR, beginning on page 285 and illustrated beginning on page 507. Because award�winning CAFRsinclude much of the information needed for credit assessments, the award can be a positive factor in thoseassessments. However, the GFOA Program only recognizes excellence in financial reportinghow well the govern�ment tells its storyand does not purport to suggest excellence in the financial condition of the government itself.Participants in the GFOA Program receive educational materials, comments on their CAFRs, and suggestions forimprovements that can help them prepare financial statements in conformity with GAAP. (The Association of SchoolBusiness Officials provides a similar program for school district CAFRs.)

Eligibility

To be judged in the GFOA Program, a CAFR must do the following:

a. Include all funds and component units of the entity. For this purpose, �entity" includes separately issuedcomponent unit financial statements and departmental financial statements, provided that the departmentconsists of one or more separate funds and is not part of another fund, such as the general fund.

b. Have the financial statements audited under generally accepted auditing standards (GAAS) or generallyaccepted government auditing standards (GAGAS or the Yellow Book).


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c. Include an auditor's opinion that covers the fair presentation of the basic financial statements (GAAFR 2005,page 315). In addition, the 2005 GAAFR requires at least an in relation to opinion on the combining andindividual fund financial presentations (page 291). In most cases, a qualified opinion or disclaimer ofopinion on the inadequacy or unavailability of the government's accounting records will make the reportineligible for the GFOA Program. However, the GFOA has taken the position that a qualified opinion relatedto reporting of general infrastructure assets will not cause a government to be ineligible for the GFOAProgram. Governments are also ineligible if their auditor's opinion omits a fund type, individual fund, orcomponent unit from its scope.

d. Be postmarked or emailed along with the GFOA Program application no later than six months after the endof the government's fiscal year. CAFRs may be in hard copy or electronic format.

GFOA Recommended Practices

Governments that wish to participate in the GFOA Program also need to be aware of GFOA recommendedpractices on accounting and financial reporting. A complete listing of all recommended practices can be found(and the recommendations downloaded) at www.gfoa.org/. Recommended practices that pertain to accountingand financial reporting include:

� Improving the Effectiveness of Fund Accounting.

� Establishing the Estimated Useful Lives of Capital Assets.

� Establishing Appropriate Capitalization Thresholds for Tangible Capital Assets.

� Considerations on the Use of the Modified Approach to Account for Infrastructure Assets.

� Application of Full�Cost Accounting to Municipal Solid Waste Management Activities.

� Presenting Securities Lending Transactions in Financial Statements.

� Using the CAFR to Meet SEC Requirements for Periodic Disclosures.

� Preparing Popular Reports.

� Presenting Budget to Actual Comparisons Within the Basic Financial Statements (which recommends thatall governments present their required budgetary comparisons as basic financial statements rather thanas RSI).

� Including MD&A in Departmental Reports.

� Web Site Presentation of Official Financial Documents.

� Improving the Timeliness of Financial Reports.

INTRODUCTORY SECTION OF THE CAFR

CAFR Introductory SectionTHE BASICS

� Requirements for a CAFR introductory section are established by the GFOA in its 2005GAAFR.

� The key component is the letter of transmittal (LOT).

� The LOT should not duplicate any information required to be presented in MD&A.

� The LOT should, at a minimum, be signed by the government's chief financial officer.


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GASB standards do not govern the contents, organization, and structure of the CAFR's introductory section.Although a CAFR is not required for a GAAP presentation, the GASB Codification does provide guidelines on thecontent of a CAFR introductory section. In addition to the table of contents, a letter of transmittal, and �othermaterial deemed appropriate by management" as suggested by GASB Cod. sec. 2200.105, certain acceptedpractices have developed.

General Contents

The following are some accepted general contents of a CAFR's introductory section as discussed in the 2005GAAFR:

a. CAFR Cover. The CAFR cover should:

(1) Contain the title, �Comprehensive Annual Financial Report."

(2) Show the name of the government and the state in which it is located.

(3) Show the fiscal period covered by the report.

b. Title Page. The title page should include the same information presented on the CAFR cover as well as thename of the department responsible for preparing the report.

c. Table of Contents. The table of contents should:

(1) Be clearly divided into at least three sectionsthe introductory, financial, and statistical sections.

(2) Clearly subdivide the contents of the financial section between (i) the basic financial statements andnotes, (ii) RSI, and (iii) other contents of that section.

(3) Identify each financial statement by its full title and provide a page reference for all contents.

d. Certificate of Achievement for Excellence in Financial Reporting. Governments that were awarded theProgram certificate in the immediately preceding year are encouraged to reproduce that award in thecurrent year's CAFR.

e. List of Principal Officials. Typically, the officials listed are those who were in office during the fiscal yearcovered by the report. Governments may wish to distinguish between elected and appointed officials.

f. Letter of Transmittal.

g. Organizational Chart. Organizational charts:

(1) May be combined with the list of principal officials.

(2) Reflect the various functions reported in the government�wide statement of activities.

(3) Show organizational reporting relationships and responsibilities.

Transmittal Letter

Before GASBS No. 34 established requirements to present MD&A, the letter of transmittal (LOT) was the only partof the CAFR that generally was read and understood by users unfamiliar with government accounting and financialreporting. However, many of the financial condition issues formerly covered in the LOT are now required compo�nents of MD&A. GASBS No. 34, footnote 7, encourages preparers who present LOTs not to duplicate informationrequired in MD&A.

MD&A is based solely on information that can be derived from the basic financial statements and on facts,decisions, or conditions that are known by financial management as of the date of the auditor's report. It should


215

discuss both the positive and negative aspects of the government's operations. In contrast, a transmittal letter maycontain projections about the future, comments about the appropriateness of specific operating policies, orstatements about the government's performance during the past year. It may be quite political and may containcomments from someone other than a financial manager of the government. Given this, the 2005 GAAFR discus�sion of its LOT requirements focuses on information thatbecause of its natureis best discussed in the LOT, notin MD&A.

The GFOA suggests that ideally, the transmittal letter should be a joint communication from the chief financialofficer and the chief executive officer of the government. At a minimum, however, the government's chief financialofficer should sign the LOT. Management should focus on careful and easily readable explanations of matters,using lay terminology or �plain English" whenever possible. The use of graphics and pictures can enhance readers'understanding of the subject matter and add visual interest to the presentation. (The same guidance that applies towriting an effective MD&A can be applied to the LOT.)

The 2005 GAAFR and the GFOA Program Requirements Checklist suggest that the transmittal letter include thesefour basic elements:

a. Formal transmittal of the CAFR.

b. Profile of the government.

c. Information useful in assessing the government's economic condition provided that it does not duplicateinformation in MD&A.

d. Awards and acknowledgements.

The 2005 GAAFR illustrates these suggested elements. However, the finance officers of a particular governmentshould create their own transmittal letter, discussing the unique nature of their government and the circumstancesof that particular year. Unfortunately, some governments merely copy parts of the GAAFR's illustration word�for�word or make minor or only numeric changes to their own prior year's LOT. Not surprisingly, this results in little orno useful information for users.

Formal Transmittal. The 2005 GAAFR recommends that the LOT begin by citing the legal requirements that causethe government to prepare and publish a financial report. The letter should state that the CAFR is intended to meetthose requirements. In addition, the transmittal portion of the LOT should clearly indicate that the government'smanagement is fully responsible for the contents of the report. Management may also wish to discuss the govern�ment's system of internal accounting controls and the limitations inherent in any system. Finally, the 2005 GAAFRalso recommends that governments discuss the role of the independent auditor and how the audit opinion givesusers an independent assurance for relying on those statements.

Government Profile. Because a CAFR's readership may be quite diverseranging from citizens to analysts toinvestorsthe 2005 GAAFR recommends that the second section of the LOT provide an overview of the govern�ment. Specifically, the GFOA recommends providing:

a. Limited basic background information on the government, including a brief description of the government'sstructure, the types of services it provides, geography, population, and history.

b. A brief discussion of component units and why some potential component units are excluded (if any). (TheLOT could also refer readers to the reporting entity discussion at the beginning of the notes to the financialstatements.)

c. A brief description of the government's budgetary process and the legal level of budgetary control.

Economic Condition. The LOT should not duplicate the eight elements of financial analysis required by MD&A, allof which focus on a government's financial condition and position. All information presented in MD&A should bebased on currently known facts. GASBS No. 34, footnote 6, defines currently known facts as facts that managementis aware of as of the date of the auditor's report. The 2005 GAAFR, on the other hand, encourages LOT writers to


216

focus on the government's economic conditionfocusing on the �prospects that today's financial position willimprove or deteriorate" (page 289).

Because currently known facts about many potential topics may already be presented in MD&A or the notes, the2005 GAAFR suggests that in the LOT, management should briefly identify the topic, refer the reader to MD&A or thenotes, and limit the LOT discussion to the more subjective aspects of the topic (page 249). The 2005 GAAFR (page289) suggests that these four topics be discussed:

� Local economya brief description of major industries, unemployment, and fiscal trends for the past 5 to10 years. Management is encouraged to make its own assessment of the local economy's prospects aswell as to show how the local economy compares to the regional economy.

� Long�term financial planninga brief review of those aspects of the government's long�term financialplanning that are most likely to affect its future financial position. These should be specific to thegovernment and to its present circumstances. Examples include the expected effect of a capital acquisitionplan on future operating costs, long�term revenue and expenditure forecasts and how they may affect fundbalances that are currently unusually low, or a deliberate build up in general fund balances to meet thegovernment's policy of advance funding its capital needs.

� Relevant financial policiesThe GFOA encourages governments to establish a set of policies that willgovern the budget processfor example, a policy for using one�time revenue sources. In the LOT, the 2005GAAFR suggests that governments comment on any specific policies that directly affect the government'scurrent financial situation.

� Major initiativesa government's budget highlights its major initiatives. These initiatives should bediscussed briefly in the LOT if they are expected to affect future financial position.

(Pages 325 and 326 suggest additional information for LOTs in school district CAFRs.)

Awards and Acknowledgements. The 2005 GAAFR suggests that management announce in this portion of theLOT its receipt of an award in the previous year for its participation in the GFOA Program as well as a statement thatthe current year's CAFR has also been submitted for review. Any other financial related awards, such as thoseearned in the GFOA's Distinguished Budget Program or Popular Annual Financial Report Program, should also bementioned. The LOT should also acknowledge those who contributed time and resources to preparation of thecurrent year's CAFR.


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SELF�STUDY QUIZ


27. Which of the following elements of a government's financial statements is required by GAAP to be presented?

a. Transmittal letter.

b. MD&A.

c. Statistical section.

d. Individual fund statements and schedules.

28. How might being awarded the Certificate of Achievement for Excellence in Financial Reporting be beneficialfor a government?

a. Receiving the award recognizes excellence in financial reporting and provides assurance of the health ofthe government's financial condition.

b. Receiving the award recognizes that the government has complied with all the GAAP�related requirementsof governmental financial reporting.

c. Receiving the award might aid a government in its credit assessment by rating agencies.

29. Besides the transmittal letter, what is one content item included in the introductory section of a comprehensiveannual financial report (CAFR)?

a. MD&A.

b. Debt capacity information.

c. Auditor's report.

d. Certificate of Achievement for Excellence in Financial Reporting.

30. In what part of the transmittal letter should a city government discuss the awarding of a major sporting eventto be held within the city in the future?

a. Formal transmittal of the CAFR.

b. Economic condition of the government.

c. Awards and acknowledgements.


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27. Which of the following elements of a government's financial statements is required by GAAP to be presented?(Page 212)

a. Transmittal letter. [This answer is incorrect. A transmittal letter is included as part of the introductory sectionof a comprehensive annual financial report (CAFR), but it is not required by GAAP.]

b. MD&A. [This answer is correct. GAAP requires the presentation of MD&A, the basic financial

statements including notes, and other required supplementary information (RSI).]

c. Statistical section. [This answer is incorrect. This section should be included in a CAFR, but is not requiredby GAAP.]

d. Individual fund statements and schedules. [This answer is incorrect. The financial section of a CAFRincludes individual fund statements and schedules. While not required by GAAP, governments mightpresent a CAFR to raise the level of its financial reporting.]

28. How might being awarded the Certificate of Achievement for Excellence in Financial Reporting be beneficialfor a government? (Page 212)

a. Receiving the award recognizes excellence in financial reporting and provides assurance of the health ofthe government's financial condition. [This answer is incorrect. The certificate only recognizes excellencein financial reporting. It does not express an opinion on the stability of the governmental reporting entity.]

b. Receiving the award recognizes that the government has complied with all the GAAP�related requirementsof governmental financial reporting. [This answer is incorrect. Recipients of the award must go beyond therequirements of GAAP in the reporting of their financial information.]

c. Receiving the award might aid a government in its credit assessment by rating agencies. [This

answer is correct. While being awarded the certificate does not guarantee the soundness of a

government's financial condition, the inclusion of all the required elements may be a �plus" factor

in its credit assessment.]

29. Besides the transmittal letter, what is one content item included in the introductory section of a comprehensiveannual financial report (CAFR)? (Page 214)

a. MD&A. [This answer is incorrect. MD&A should be included in a different section of a CAFR.]

b. Debt capacity information. [This answer is incorrect. While this information is a required component of aCAFR, it is not presented in the introductory section.]

c. Auditor's report. [This answer is incorrect. The auditor's report must be included in a CAFR; however,placement in the introductory section is not appropriate.]

d. Certificate of Achievement for Excellence in Financial Reporting. [This answer is correct. If a

government has received this award, placement in the introductory section is encouraged.]

30. In what part of the transmittal letter should a city government discuss the awarding of a major sporting eventto be held within the city in the future? (Page 216)

a. Formal transmittal of the CAFR. [This answer is incorrect. The formal transmittal letter, among other things,should discuss the legal requirements relating to the publishing of government financial statements.]

b. Economic condition of the government. [This answer is correct. The awarding of a major sporting

event to be held in a city in the future might result in the creation of additional jobs, sales tax revenue,


219

and other economic benefits to the city. Therefore, it is most appropriately addressed in this element

of the transmittal letter.]

c. Awards and acknowledgements. [This answer is incorrect. This element of the transmittal letter relates toawards regarding financial reporting of the government or other financial related awards. Acknowledge�ment of significant contributions on the part of the staff of the government might also be mentioned.]


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FINANCIAL SECTION OF THE CAFR

The CAFR Financial SectionTHE BASICS

� MD&A, basic financial statements, notes to the financial statements, and other RSI arerequired by GAAP.

� The requirements for presenting the remaining components of the financial sectioncombin�ing and individual fund statements and schedulesare provided primarily by the 2005GAAFR.

GASB Cod. sec. 2200.105 lists these components of the financial section of a CAFR:

a. Auditor's report.

b. MD&A

c. Basic Financial Statements, including notes to the financial statements.

d. Required supplementary information (RSI) other than MD&A.

e. Combining statements and individual fund statements and schedules.

This lesson discusses only auditor reports and combining and individual fund statements and schedules as theirpresentation is recommended for participants in the GFOA Program. Because combining and individual fundstatements are not required by GAAP, they are considered to be �supplementary information," not basic financialstatements or required supplementary information, as discussed in SLG, paragraph 2.49.

Auditor's Report

The auditor's report is the first item in the financial section of the CAFR. This placement is consistent with thepresumption that anything included after the auditor's report has been considered by the auditor (unless otherwiseindicated). The audit report presents the independent auditor's opinion on whether the opinion units in the basicfinancial statements are presented fairly in conformity with GAAP. The type of report the independent auditor issuesdepends on the contents of the financial statements and on the scope and results of the audit. Various illustrativeauditor's reports are provided in Appendix A of Chapter 14 of SLG.

The auditor is required to give an opinion on the basic financial statements at a minimum. An audit opinion may ormay not be given on other financial information that accompanies the basic financial statements, including requiredsupplementary information (RSI). The GFOA's Program requires that the auditor at least provide an opinion on thefair presentation, in relation to the basic financial statements, of the combining and individual fund financialpresentations in the financial section of the CAFR.

The auditor's report issued for inclusion in the CAFR is not appropriate for accompanying basic financial state�ments that are �lifted" from the CAFR and issued separately. In such a situation, a separate auditor's report shouldrender an opinion on just the basic financial statements. Detailed guidance on reporting on governmental financialstatements, including illustrative reports, may be found in PPC's Guide to Audits of Local Governments.

Combining Statements and Individual Fund Statements

The 2005 GAAFR states that, �to be truly comprehensive, the CAFR must provide information on each individualfund and component unit" (page 299). GASB Cod. sec. 2200.184 provides a detailed listing of recommendedcombining and individual fund statements:

a. Nonmajor governmental funds.

(1) Combining balance sheets.


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(2) Combining statements of revenues, expenditures, and changes in fund balances.

b. Individual fund balance sheets and statements of revenues, expenditures, and changes in fund balances,and schedules necessary to demonstrate compliance with finance�related legal and contractual provisionsof governmental funds.

c. Internal service funds and nonmajor enterprise funds.

(1) Combining statements of net assets.

(2) Combining statements of revenues, expenses, and changes in fund net assets.

(3) Combining statements of cash flows.

d. Individual statements of net assets, statements of revenues, expenses, and changes in fund net assets andof cash flows; and schedules necessary to demonstrate compliance with finance�related legal andcontractual provisions of proprietary funds.

e. Fiduciary funds. (Combining statements may be required by GAAP for pension and other employee benefittrust funds and investment trust funds.)

(1) A combining statement of fiduciary net assets.

(2) A combining statement of changes in fiduciary net assets.

(3) A combining statement of changes in assets and liabilitiesall agency funds.

Combining and individual fund statements and schedules should follow the same sequence in which the fundtypes are displayed in fund financial statements. Likewise, individual fund statements should follow the same orderin which the funds are displayed in the combining or subcombining statements. Exhibit 3�1 shows the recom�mended sequence for combining and individual fund statements along with other information suggested by theGASB Codification and the 2005 GAAFR (page 304).

Number of Funds. At the outset, the 2005 GAAFR suggests that preparers who are hesitant to present informationon each individual fund in their CAFRs may need to reconsider whether all of a government's funds should beconsidered funds for external financial reporting purposes (page 301). The number of funds principle is discussedin NCGAS No. 1, paragraph 29, and in GASB Cod. sec. 1300. It states, �only the minimum number of fundsconsistent with legal and operating requirements should be established, however, because unnecessary fundsresult in inflexibility, undue complexity, and inefficient financial administration." The 2005 GAAFR, page 301, pointsout, however, that governments have no flexibility in determining the number of funds needed to present a blended

component unit. Even though blended, these component units are, by definition, legally separate entities.

Combining Statements for Funds. Governments are required to present each major fund in a separate column onthe face of their fund financial statements. All nonmajor governmental and enterprise funds are presented in anaggregated, single column on the face of those statements. Internal service and fiduciary fundswhich are neverconsidered to be major fundsalso are presented in aggregated columnsby fund type (internal service, pensionand other employee benefit trust funds, investment trust funds, private�purpose trust funds, and agency funds). Inaddition, governments are required to present information about their major component units as part of their basicfinancial statements.


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Exhibit 3�1

Sequence of Combining and Individual Fund Data

Governmental

funds

Combining financial statements.Subcombining financial statements (as needed).Individual budgetary comparison statements.Other individual fund financial statements (as needed).Schedules and �voluntary" supplementary information related to governmental funds (as

needed).

Proprietary

funds

Combining financial statements for nonmajor enterprise funds.Combining financial statements for all individual internal service funds.Individual fund financial statements (as needed).Schedules and �voluntary" supplementary information related to proprietary funds (as

needed).

Fiduciary

funds

Combining financial statements for individual pension and other employee benefit trustfunds and similar component units.

Combining financial statements for individual private�purpose trust funds.Combining financial statements for individual investment trust funds.Combining financial statements for individual agency funds (including a combining

statement of changes in assets and liabilities).Individual fund statements (as needed).Schedules and �voluntary" supplementary information related to fiduciary funds (as

needed).

Component

units

Combining financial statements for nonmajor discretely presented component units.Basic fund financial statements for multiple�fund, discretely presented component units

for which separately issued GAAP financial statements are not prepared.

* * *

Combining statements are used to provide detail for aggregated columns of nonmajor funds and of internal serviceand fiduciary fund types (including discretely presented component units that are fiduciary in nature). A combiningstatement should be presented for every column in the fund financial statements that presents information for morethan a single fund. Combining statements are also presented for certain discretely presented component units.Considering both nonmajor funds and nonmajor component units, a government could present as many as sevensets of fund combining statements in its CAFR for each of these categories:

� Nonmajor governmental funds.

� Nonmajor enterprise funds.

� Internal service funds.

� Pension and other employee benefit trust funds, including component units that are fiduciary in nature.

� Investment trust funds.

� Private�purpose trust funds.

� Agency funds.

GASBS No. 25 and GASBS No. 26, as amended by GASBS No. 34, require PERS to present combining financialstatements and required schedules for all defined benefit pension plans and postemployment healthcare plans


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administered by the system. These statements are basic financial statements, not supplementary information.When the PERS does not issue separate financial statements, financial statements for each plan must be presentedin the notes to the financial statements of the plan sponsor. Identical requirements apply when PERS and similarfiduciary entities administer defined benefit other postemployment benefit (OPEB) plans, based on GASBS No. 43,Financial Reporting for Postemployment Benefit Plans Other Than Pension Plans, paragraph 13. Similar require�ments apply to sponsors of external investment pools.

The total column for each combining statement should agree with the aggregated or fund type columns presentedin the basic financial statements. Combining statements are not needed when a government has only one fund forany of these seven categories. In this instance, the individual fund is presented on the face of the basic financialstatements. When the individual fund is a nonmajor governmental or enterprise fund, its column should be labeled�nonmajor" on the face of the statement.

Combining statements for nonmajor governmental funds are unique in that they may present as many as fourdifferent fund typesspecial revenue, capital projects, debt service, and permanent funds. When there are manynonmajor governmental funds, the 2005 GAAFR suggests that governments may wish to present �subcombiningstatements" to the combining statements. For example, if a government has 11 funds including one debt servicefund, 3 capital projects funds, and 7 special revenue funds, it could present subcombining statements for itsnonmajor special revenue funds. In this case, the total column of all subcombining statements should link to theaggregated special revenue fund column in the combining statements.

Combining statements should also include a combining statement of changes in assets and liabilities for all agencyfunds, even though GASBS No. 34, paragraph 110, excludes these funds from the fiduciary fund statement ofchanges in fiduciary net assets. Changes in the asset and liability accounts of those funds are relevant to those forwhom the government serves as agent. For example, agency funds are required to be used to report transactionsrelated to special assessment debt issued for which the government is not obligated in any manner.

Combining Statements for Discretely Presented Component Units. Non�fiduciary discretely presented compo�nent units are reported only in the government�wide financial statements. Like governmental and enterprise funds,the focus of reporting for discretely presented component units is on major component units. GASBS No. 34,paragraph 126, gives governments three choices for reporting information about major non�fiduciary componentunits. Major component unit information may be presented using (a) separate columns on the face of the govern�ment�wide financial statements, (b) combining statements presented after the fund financial statements but beforethe notes to the financial statements, or (c) condensed financial statements presented in a note to the basicfinancial statements. When governments choose the third option, the 2005 GAAFR requires GFOA programparticipants to present supplementary combining statements for both major and nonmajor discretely presentedcomponent units (page 300).

Depending on which option a government chooses when presenting its major component units, the total columnfor each nonmajor component unit combining statement should agree with the nonmajor component unit columnpresented either in:

a. The government�wide financial statements,

b. The component unit combining statements presented as basic financial statements, or

c. The condensed component unit financial statements included in the notes to the financial statements.

Combining information for nonmajor discretely presented component units should be taken from the aggregatedtotals in each component unit's government�wide financial statements. Information about a business�type activitycomponent unit should be taken from its fund financial statements. (If a government has only business�type activitycomponent units, it is not required to restate operating statement information in combining statements to conformto the government�wide statement of activities format.)

Fund Financial Statements of Certain Discretely Presented Component Units. When an individual discretelypresented component unit with multiple funds does not issue separate financial statements, a complete set of fundfinancial statements (including proprietary fund cash flows statements) should also be presented within this section


224

of the CAFR, as discussed in the GASB Comprehensive Implementation Guide2008, Questions 4.28.8 and 2.4.1.There is no requirement to present combining statementsthat is nonmajor governmental and enterprise fund,individual internal service and fiduciary fund informationfor these component units.

Individual Fund Statements/Schedules. Consistent with GASB Cod. sec. 2200.184, the 2005 GAAFR, page 302,suggests that there are four reasons to present individual fund statements or schedulesthree of which have to dowith legal or contractual requirements. They are:

� To present budgetary comparison schedules for nonmajor governmental funds of the primary government(including nonmajor special revenue funds, debt service and capital projects funds, and funds of blendedcomponent units) for which there are legally adopted budgets. (Budgetary comparisons presented outsidethe basic financial statements are always referred to as �schedules.") GASB Cod. sec. 2400.105establishes this requirement for CAFRs. GASBS No. 34 requires budgetary comparisons in RSI (or in thebasic financial statements) only for the general fund and major special revenue funds. As discussed in theGASB Comprehensive Implementation Guide2009, Question 7.91.3, governments may, but are notrequired to, present these supplementary comparison schedules in accordance with GASBS No. 34,paragraphs 130 and�131. Budgetary comparisons for these funds should never be presented with thoserequired for the general fund and major special revenue funds, as discussed in the GASB Comprehensive

Implementation Guide2009, Questions 7.91.5 and 7.91.6.

� To present detailed budgetary comparisons for the general fund and major special revenue funds, whenadditional detail is necessary to demonstrate legal compliance. Budgetary comparisons are generallypresented only at the function level to meet GASBS No. 34 requirements. However, GASB Cod. sec.2400.121 notes that individual fund comparisons at the level of budgetary control are required for CAFRs.If that level of detail is voluminous, governments may wish to consider presenting a separate budgetaryreport. When a separate budgetary report is prepared, the notes to the basic financial statements or RSIshould refer the reader to that report.

� To present comparative (two�year) financial statements when required by debt or other contractualagreements. (This is especially true for enterprise funds or business�type activity component units that haverevenue bonds outstanding.)

� To present greater detail. Even in combining statements, governments must use a universal chart ofaccounts to accommodate all of the funds/component units in the combining statements. Governmentsthat wish to present more detail about the assets, liabilities, revenues, or expenditures/expenses ofindividual activities can do so in individual fund statements.

Schedules. GASB Cod. sec. 2200.186, notes that financial statements are often supported by schedules. Sched�ules can be used to present data on a contractually or legally prescribed basis different from GAAP or to providemore detail about certain accounts. For example, schedules may be used to report more detail about expenses fora particular program when expenses are presented only at the function level in the government�wide and fundfinancial statements. Unless referenced in the basic financial statements or the notes to the basic financial state�ments, schedules are considered to be supplementary information.

Narrative Explanations. Narrative explanations may be used with combining and individual fund statements andschedules to help clarify the information provided in those statements. These explanations may be included on thedivider pages, on the statements and schedules themselves, or in a separate section. However, to avoid confusionwith the notes to the basic financial statements, the explanations should not be labeled or called �notes" to thefinancial statements or schedules.

�Voluntary" Supplementary Financial Information. Governments may also wish to include what the 2005 GAAFRcalls �voluntary" supplementary information in the financial section of their CAFRs. This consists of additionalfinancial information that governments think financial statement users may find useful (page 303). The 2005 GAAFRgives a schedule of general fund cash receipts and disbursements as an example.


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SELF�STUDY QUIZ


31. Which of the following funds should have a separate column on the face of the fund financial statements of agovernment in the financial section of a CAFR?

a. Enterprise funds.

b. Internal service funds.

c. Major governmental funds.

d. Fiduciary funds.

32. How is a fund presented in the financial section of a CAFR when a government has only one fund for one ofthe categories requiring a combining statement?

a. In a separate statement after the fund financial statements but before notes to the financial statements.

b. In a subcombining statement after the combining statements.

c. On the face of the basic financial statements.

d. A complete set of separate financial statements should be issued.

33. GASB suggests four reasons to present individual fund statements or schedules. Which of the following is areason why a government would present individual fund statements or schedules in the financial section of aCAFR?

a. To present schedules which provide more detail about certain accounts as required by GASBS No. 34.

b. To comply with legal requirements by presenting additional detailed budgetary comparisons for thegeneral fund.

c. To present budgetary comparison schedules for major governmental funds of the primary government asrequired by GASBS No. 34.

d. To present schedules which provide more detail about individual activities.


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31. Which of the following funds should have a separate column on the face of the fund financial statements of agovernment in the financial section of a CAFR? (Page 217)

a. Enterprise funds. [This answer is incorrect. Enterprise funds would be presented in aggregate form in asingle column on the face of the fund financial statements.]

b. Internal service funds. [This answer is incorrect. Internal service funds would not require a separate columnon the face of the fund financial statements. They are presented in an aggregated, single column on theface of the fund financial statements.]

c. Major governmental funds. [This answer is correct. This is a requirement for all major governmental

funds. Certain funds, such as internal service and fiduciary funds, are never considered major fundsand would be presented in aggregated columns.]

d. Fiduciary funds. [This answer is incorrect. Fiduciary funds would be aggregated by fund type andpresented in a single column on the face of the fund financial statements.]

32. How is a fund presented in the financial section of a CAFR when a government has only one fund for one ofthe categories requiring a combining statement? (Page 223)

a. In a separate statement after the fund financial statements but before notes to the financial statements.[This answer is incorrect. This is the optional placement for a major, non�fiduciary component unit ofgovernmental financial statements.]

b. In a subcombining statement after the combining statements. [This answer is incorrect. If there is only onefund in this category, a subcombining statement would not be necessary.]

c. On the face of the basic financial statements. [This answer is correct. Since only one fund exists for

this particular category, a combining statement is not necessary. The fund information should

simply be presented in a separate column on the face of the basic financial statements.]

d. A complete set of separate financial statements should be issued. [This answer is incorrect. This optionis available for an individual discretely presented component unit with multiple funds.]

33. GASB suggests four reasons to present individual fund statements or schedules. Which of the following is areason why a government would present individual fund statements or schedules in the financial section of aCAFR? (Page 224)

a. To present schedules which provide more detail about certain accounts as required by GASBS No. 34.[This answer is incorrect. GASBS No. 34 does not require schedules to be presented; however, sometimesgovernments will be required by other contractual or legal bases to offer more detail about particularaccounts.]

b. To comply with legal requirements by presenting additional detailed budgetary comparisons for the

general fund. [This answer is correct. While budgetary comparisons are required at the function

level to comply with GASBS No. 34, a separate comparison is required at the level of budgetary

control for CAFRs.]

c. To present budgetary comparison schedules for major governmental funds of the primary government asrequired by GASBS No. 34. [This answer is incorrect. GASBS No. 34 requires these types of budgetarycomparisons in the RSI or the basic financial statements.]

d. To present schedules which provide more detail about individual activities. [This answer is incorrect. TheGFOA requirements exceed that of GAAP; however, schedules considered supplementary informationreporting additional details about certain governmental accounts are not among them.]


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STATISTICAL SECTION OF THE CAFR

GASB Statement No. 44THE BASICS

� GASB No. 44 applies only to governments that present a statistical section with their basicfinancial statements.

� Those governments are required to present information in five different categories�financialtrends, revenue capacity, debt capacity, demographic and economic, and operating.

� Nearly all of the data should be presented for the most recent 10 years.

� Information generally should be presented only for the primary government, including itsblended component units.

� Governments are encouraged but not required to restate previously presented statisticalschedules. Schedules derived from government�wide amounts may but are not required tobe prepared retroactively to the date the government adopted GASBS No. 34.

The purpose of the statistical section of the CAFR is to provide the reader with supplementary data and trends overan extended period, usually 10 years or more. However, some data relates only to a single year. The statisticalsection also presents nonfinancial information, such as social, economic, and demographic data.

Due to the nature of the statistical information (it may include nonaccounting data and generally provides 10 yearsworth of information), it does not usually fall within the scope of the audited financial statements. However, the datashould be reviewed by the auditor for consistency and cross�referencing to the introductory and financial sectionsof the CAFR.

CAFR Statistical TablesGASBS No. 44

GASBS No. 44, Economic Condition Reporting: The Statistical Section (GASB Cod. Sec. 2800), replaced the 15statistical tables listed in NCGAS 1, paragraph 161, as amended. It was effective for periods beginning after June15, 2005. GASBS No. 44 is required to be applied prospectively. However, the GASB encourages all governmentsto apply the new standard retroactively to the date when they adopted GASBS No. 34. There are at least two goodreasons for doing so. First, previous guidance was directed only toward general purpose local governments.GASBS No. 44 finally provides broad guidelines that are applicable to states as well to special�purpose govern�ments, such as public authorities, hospitals, and utilities. Second, none of the previous requirements contemplatedthe government�wide information required by GASBS No. 34. Until GASBS No. 44 was issued, governments wereleft to make their own assumptions as to which types of statistical information might benefit from the new,accrual�based, government�wide information.

Applicability. The GASB does not require governments to prepare a CAFR. As a result, GASBS No. 44 only appliesto those entities that choose to present a statistical section with their basic financial statements (generally as partof a CAFR). Many governments choose to present a CAFR, however, so that they may participate in the GFOAProgram or other similar programs. Neither the GASB nor GASBS No. 44 require governments to prepare andpresent a statistical section.

Scope of Reporting. Required statistical information should focus on the primary government (including itsblended component units) rather than on the reporting entity as a whole. Component units may be �blended" or�discretely presented." Blended component units are reported with the funds of the primary government in the fundfinancial statements. Discretely presented component units other than those that are fiduciary in nature arereported separate from the primary government and only in the government�wide financial statements.

GASBS No. 44, paragraph 4, requires governments to decide whether to include discretely presented componentunit information in the statistical section in the same way that they decide whether component unit note disclosuresshould be made or whether component units should be discussed in MD&A (GASBS No. 14, paragraph 63, asamended). That is, it is a matter of professional judgment and should be done on a component unit�by�componentunit basis. More specifically, GASBS No. 44, paragraph�4, suggests that component unit information that is


228

�beneficial in assessing the economic condition of the primary government" would be included. That paragraphalso notes that the decision to include component unit information in the statistical section should be independentof a decision for note disclosures or for MD&A. Just because component unit information is included in one placedoes not imply that it must be included in all three places.

Trend Data and Transition. Unless otherwise noted, all of the statistical schedules required by GASBS No. 44should be presented for the government's most recent 10 years. None of the schedules are required to be adoptedretroactively. However, the GASB does encourage governments to restate data presented in prior years in situa�tions in which similar tables were required under previous GAAP.

Categories of Required Information. GASBS No. 44 is designed so that it can be applied universally to a widerange of governments. It requires all governments to present five categories of statistical information, including:

a. Financial trends.

b. Revenue capacity.

c. Debt capacity.

d. Demographic and economic.

e. Operating.

It is clear from the discussion and illustrations in the GASB Comprehensive Implementation Guide2009 that therequirements established by GASB No. 44 are minimum requirements. Governments can choose to present anyadditional detail they believe is useful to readersfor example, major categories of restricted net assetsas longas the details required by the standard are provided somewhere within the statistical section. Information presentedin each category will vary depending on the type of reporting government and the resources that it is able tomarshal to finance its operationsfor example, property taxes, income taxes, or fees and charges. For the cityillustrated in GASBS No. 44, Appendix C, this resulted in the presentation of 18 separate statistical schedules.

Narrative Explanations. Statistical schedules should include narrative explanations when necessary. GASBS No.44, paragraph 42, suggests four types of narrative explanations:

a. Explanations about the objectives of statistical information in general and the five categories of information.

b. Explanations about basic concepts with which users might not be familiar.

c. Explanations to identify relationships between information presented within the tables and between thetables and the basic financial statements.

d. Explanations of atypical trends and anomalous data that financial report users would not otherwiseunderstand. This could include explanations of events that may affect trends, such as a material transactionoccurring in a single year, changes in accounting methods or assumptions, major policy changes, or otherevents.

Financial Trends Information

Financial trend information should help users understand how the government's financial position has changedover time. For general purpose governments, this information should be provided in four tables, the first two derivedfrom the government�wide statements and the last two taken from governmental fund financial statements, includ�ing:

a. Information about net assets.

b. Information about changes in net assets.


229

c. Information about governmental fund balances.

d. Information about changes in governmental fund balances.

Governments that do not present government�wide financial statements should omit the last two tables and basethe first two tables on their statement of net assets and statement of changes in revenues, expenses, and changesin net assets (for business�type activities) or their statement of changes in fiduciary net assets (for fiduciaryactivities). A government issuing GAAP financial statements would not present government�wide financial state�ments only if it does not have any governmental funds. Omitting the government�wide financial statements whenthere are governmental funds would be a departure from GAAP.

Information About Net Assets. In this schedule, general purpose governments should list the three componentsof net assets required by GASBS No. 34. These components are (a) invested in capital assets, net of related debt,(b) restricted net assets, and (c) unrestricted net assets as reported in the government�wide statement of netassets. Governments should present governmental activities separate from business�type activities, if any. Whenbusiness�type activities are present, total primary government amounts must also be included. Governments areencouraged to report government�wide statistical data retroactively to the date they adopted GASBS No. 34.

Information About Changes in Net Assets. General purpose governments should present a table that displaysthe following information separately for governmental and business�type activities, if any as presented in theirgovernment�wide statement of activities. When business�type activities are present, governments must also pres�ent information for the total primary government. Changes in net assets information required by GASBS No. 44,paragraph 10, includes:

a. Expenses by function, program, or identifiable activity.

b. Program revenues by categorythat is, charges for services, operating grants and contributions, andcapital grants and contributions.

c. For program revenues reported in the charges for services category (above), a breakdown of the mostsignificant revenues by function, program, or identifiable activity.

d. Total net (expense) revenue (that is, a single number, not totals by function).

e. General revenues and other changes in net assets by type of revenue/change.

f. Total change in net assets.

The minimum level of detail required for expenses is the same as the minimum level required for reporting in thegovernment�wide statement of activities. Greater detail is permitted, even if in a separate table. Governments thatchoose to provide extra detail in the statement of activities are not required to match that level in their statisticalsections. The information does not have to be in the format of a statement of activities. As long as all of the requiredinformation is presented, the government may use any format it chooses.

Special�purpose governments engaged only in business�type activities should present information based on theirstatement of revenues, expenses, and changes in net assets. They should present revenues by major source anddistinguish between operating and nonoperating revenues and expenses. Business�type activities should presentexpenses in the same manner they are presented in their statement of revenues, expenses, and changes in netassetsby object, function, or natural classification. The GASB Comprehensive Implementation Guide2009,Question 9.8.1, states that other changes in net assets should also be presented, such as capital contributions, andshould lead to a total change in net assets amount for business�type activities. GASBS No. 44, paragraph 10b,provides guidance for special purpose governments engaged only in fiduciary activities.

Information About Governmental Funds. As the label implies, this information should be presented only forgovernments that report using governmental funds. The information is taken from both the governmental fundbalance sheet and the governmental fund statement of revenues, expenditures, and changes in fund balances.


230

Most governments will likely present it in two separate schedulesone for each fund statement. Ten�year informa�tion required includes:

� Reserved and unreserved fund balance for the General Fund.

� Reserved and unreserved fund balances for the total of all other governmental funds. (Unreserved fundbalances of other governmental funds must be displayed by fund type.)

� For the total of all governmental funds:

�� Revenues by source.

�� Expenditures by function, separately displaying the interest and principal components of debt serviceexpenditures.

�� Other financing sources (uses).

�� Other changes in fund balances by type.

�� Total change in fund balances.

�� Debt service (interest and principal expenditures combined) as a percentage of noncapitalexpenditures. (Noncapital expenditures are total expenditures less capital outlaysreported as aseparate function and within other functionsthat have been capitalized in the government�widestatement of net assets. This amount is equal to the reconciling entry.)

GASBS No. 44 does not require governments to use the governmental fund operating statement format in this tablenor to present a subtotal for excess of revenues over expenditures.

Governments are encouraged to restate statistical tables presented in accordance with previous GAAP to conformto the GASBS No. 44 requirement. Before GASBS No. 44, the GFOA issued most of the guidance on preparingstatistical sections as a part of its Certificate Program. As a result, practice varied. For example, some governmentspresented statistical data only for certain governmental funds. Others presented financial information based ontheir budgetary basis rather than on the modified accrual basis. Governments that choose to restate governmentalfund information should be aware of these differences. In addition, governments may need to adjust for changes infund structure caused by applying the fund definitions established by GASBS No. 34. If a government chooses notto restate previously reported amounts, a note on the face of the tables should indicate the year in which new datais reported, and which governmental funds are included and which basis of accounting is used (if different) beforethat date.

GASBS No. 54, Fund Balance Reporting and Governmental Fund Type Definitions, which is effective for periodsbeginning after June 15, 2010, modifies the definitions of governmental funds. The GASB encourages but does notrequire governments to retroactively restate fund balances in the statistical section for all prior periods presented.

Revenue Capacity Information

The objective of revenue capacity information is to help users understand the factors that affect a government'sability to generate its most significant revenue source. GASBS No. 44, paragraphs 13 through 21, require informa�tion about three aspects of the governmental entity's most significant �own�source revenue." Some governmentswill also be required to present a fourth schedule containing information on property tax levies and collections.GASBS No. 44, paragraph 45, and the GASB Comprehensive Implementation Guide2009, Question 9.12.2,define own�source revenues as revenues that are generated or imposed by the government itself, even if anothergovernment is responsible for collecting the revenue. As such, it excludes intergovernmental aid and sharedrevenues. Tax revenues and water and sewer charges are common own�source revenues. For some special�pur�pose governments, the most significant own�source revenue may be investment income.

Identifying Most Significant. Governments should consider both quantitative and qualitative aspects when decid�ing which revenue or revenues are their �most significant." The GASB purposefully chose to call for reporting on the


231

�most significant" rather than the �largest" revenue source so that the choice is not just a mathematical calculationof the largest dollar source. The GASB Comprehensive Implementation Guide2009, Question 9.13.7, notes thata government should consider both quantitative and qualitative aspects when choosing its most significant own�source revenue. For general purpose governments, the most significant source is probably the one that does themost to support the basic functions of the governmentthose reported as governmental activities. It could also bethe largest revenue source, but not necessarily. Governments also may choose to present information for morethan one revenue source, particularly when another revenue source is nearly as significant as the one identified orwhen the government expects that another revenue source will be more significant in the near future. Some of thefactors that could be considered are discussed in Exhibit 3�2.

Exhibit 3�2

Identifying �Most Significant" Own�source Revenues

GASBS No. 44, paragraph 13, requires governments to present revenue capacity information for their �mostsignificant" own�source revenue. The table below lists the revenues of four governmental entities anddiscusses the factors that could be considered when deciding which source(s) to report.

Primary Government

Revenue Sources and

PercentagesaCity

Government

County

Government School DistrictWater & Sewer

District

Governmental activities

�Property taxes:

�on real estate 17% 41% 91%

�on motor vehicles 9%

�Sales taxes 12% 32%

�Other taxes 4% 4%

�Investment earnings < 1% 2% 5%

�Other charges for services 7% 8% 3%

Business�type activities (BTA)

�Electricity sales 48%

�Water sales 11%

�Water sales 11% 16%

�Sewer charges 27%

�Tap fees 32%

�Other BTA revenues 4% 6% 11%

�Developer contributions 9%

Note:

a Revenue information for governments engaged in governmental activities may be taken from thegovernment�wide or the fund financial statements, as long as the source of information is consistentfrom year to year. Special items, extraordinary items, and other one�time transactions such as capitalasset sales should, by definition, be excluded from this calculation.

� City GovernmentThis city's most significant own�source revenue is probably real estate property taxrevenues. These revenues support the governmental activitiesthe basic functions of a city. Althoughrevenues from electricity sales are higher than tax revenues, these revenues are likely to be limited byrevenue bonds for use by the city's electric utility. The city could choose to, but is not required to, presentseparate revenue capacity statistical tables for electricity sales revenues as well as for its sales taxrevenues. Note that the city will also be required to report debt coverage information for its electric utilityif it issued revenue bondsas opposed to general obligation debtto finance the utility's operations.

� County GovernmentThis county's most significant own�source revenue is probably real estateproperty taxes. However, the GASB Comprehensive Implementation Guide2009, Question 9.13.5,notes that governments usually aggregate all of their ad valorem tax revenues when determining their


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most significant own�source revenue, even when there are separate levies. In this case, the county couldpresent revenue capacity information for all of its property taxes, including motor vehicle taxes. Thecounty could also choose to present separate revenue capacity schedules for its sales tax revenues,which are nearly as significant as its ad valorem taxes. The GASB staff suggests that governmentschoose the approach and number of revenue sources that would be most helpful to users of theirfinancial reports.

� School DistrictThis school district's most significant own�source revenue is clearly real estateproperty taxes.

� Water & Sewer DistrictThis utility's most significant own�source revenue probably consists of tworevenue sourceswater revenues and sewer revenues. Although GASBS No. 44 requires reporting onlyon one revenue source, it is likely that reporting on both types of revenues would best meet users' needsbecause this utility has two types of operations. Tap fees represent the largest percentage of revenuescollected by the utility. Tap fees are charged to those making first time connections to the system andmay not be a consistent revenue source from year to year. If development slows in the utility district, tapfees may not be a significant source of revenue at all. The GASB Comprehensive Implementation

Guide2009, Question 9.13.3, discusses a scenario in which, over time, another revenue source growslarger than the revenue a government had been reporting as its most significant. The GASB staffsuggests that governments could voluntarily report on both revenue sources before the other revenuesource surpasses the current source. If this utility chose to report tap fees as a significant own�sourcerevenue, it would not need to report principal revenue payers.

* * *

GASBS No. 44, paragraph 13, requires three types of revenue capacity information:

� Revenue base,

� Revenue rates, and

� Principal revenue payers.

A fourth type of capacity information is also required for governments whose most significant own�source revenueis property taxes (or when a government chooses to report property tax information as a second revenue source.Governments that have no own�source revenues or that are fiduciary in nature would not present revenue capacityinformation.

When property taxes are a government's most significant own�source revenue, the required information should bereported based on the period for which levied, as that term is used in GASBS No. 33, Accounting and Financial

Reporting for Nonexchange Transactions. (All of the GASB examples illustrate governments that have the samefiscal year and period for which levied.)

Revenue Base. GASBS No. 44, paragraph 14, requires a schedule that reports the major revenue base compo�nents of the government's most significant own�source revenue for the most recent ten years. A revenue base is thebasic measure against which taxes are assessed or fees are charged. For example, for property taxes the revenuebase is the assessed value of property. Major components of this revenue base might be, for example, residential,commercial, farm, and tax�exempt property. For water utility sales, revenue base could be the number of gallons ofwater sold. Major components might be gallons of water sold to residential, commercial, and industrial customers.A final column is required to show the �total direct rate" or weighted average of all individual component rates thatwere applied to the revenue base for each of the ten years presented (for example, the weighted average tax rateor weighted average water rate). This total column is also required on the schedule showing revenue rates.

Governments that make property tax assessments using a different value than estimated actual value should alsoreport the total estimated actual value of taxable property in a separate column. (If estimated actual value is not


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available because property taxes are not assessed in a way that requires knowing that value, the governmentshould disclose why it is not provided.)

Special�purpose governments that report own�source revenues other than taxes may wish to combine this informa�tion with the required information on revenue rates. Or, special�purpose governments may find it more useful topresent revenue base information as part of their operating indicator schedules rather than as separate schedules.According to the GASB Comprehensive Implementation Guide2009, Question 9.49.2, as long as the requiredinformation components are presented, the order of their appearance and the number of schedules presented areunimportant.

Revenue Rates. The revenue rates schedule should show the individual direct rates, the total direct rate, as well asoverlapping rates that are applied to the rate base. The first column would display the basic rate. It should befollowed by columns displaying any applicable additional rates, such as the mill rate resulting from the issuance ofgeneral obligation debt when each additional rate applies to the entirety of the revenue base, for example, to all realproperty. The total of these columns is the total direct rate and should tie to the rate reported in the revenue baseschedule. When additional rates or levies apply to only a portion of a government's revenue base, for example, asecond levy that applies to real estate within a specified district, governments will need to calculate their total directrate using a weighted average. When a government's rate structure is very complex, it may be more practical todisclose the effective tax rate for a single rate base, as discussed in the GASB Comprehensive Implementation

Guide2009, Questions 9.18.1 and 9.19.1. Governments should note any legal restrictions on their ability to raisetheir direct rates on the face of this schedule.

Overlapping rates should be shown in the next set of columns on this schedule. Overlapping rates are the amountor percentage that is applied to the reporting government's revenue base by other governments that overlapgeographically with the government preparing the statistical section. The overlap may be complete or partial.Component units or joint ventures of the reporting government should be reported as overlapping governmentsunless the primary government has the ability to set, modify, or approve the component unit's or joint venture'srevenue rates (GASB Comprehensive Implementation Guide2009, Question 9.20.3). States are not required toreport overlapping rates for governments that are within their boundaries. Likewise, local governments should notreport overlapping rates applied by their state or state�wide authorities. Regional governmentsincluding coun�tiesare encouraged, but not required to provide overlapping rate information. Governments with large numbersof overlapping governments can aggregate the information by type of government and show their rates as ranges.No total column is presented for direct and indirect rates. When an overlapping government's fiscal year is differentfrom the reporting government's fiscal year, the reporting government should report the overlapping rate for taxesthat were payable in the reporting government's fiscal year (GASB Comprehensive Implementation Guide2009,Question 9.21.1).

Principal Revenue Payers. This schedule reports the largest payers of the government's most significant own�source revenue for the current year and the period nine years before the current year. The schedule should presentthe top 10 payers unless it takes less than 10 to reach 50 percent of the total of the governments most significantown�source revenue. Governments may be prohibited by law from disclosing this informationespecially, forexample, for personal income taxes. When this is the case, the government should provide other information thatwill help financial statement readers to understand the degree to which their revenue sources may be concentrated.(GASBS No. 44, Appendix C, Exhibit C�10 illustrates a schedule that could be used in this circumstance for incometaxes.)

If a government chooses to present revenue capacity information for more than one own�source revenue, principalrevenue payer information must be presented for each revenue source. For example, if a water and sewer utilitypresents revenue capacity information for both water and sewer revenues, the utility will need to list principalrevenue payers for water and principal revenue payers for sewer. This information differs from what was reported inthe past by some governments as principal customers, which typically was based on all revenue sources.

For some special purpose governments, this schedule would not be neededfor example it is likely that mostcolleges would report tuition revenues as their most significant own�source revenue. Because all students payroughly the same tuition, no concentrations would exist.


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Property Tax Levies and Collections. This revenue capacity information is required only for governments thatreport property taxes as a significant own�source revenue. For each of the past ten years, GASBS No. 44,paragraph 21, requires governments to report:

a. The amount of property tax levied for the period.

b. The amount collected within the period for which levied in both a dollar amount and as a percentage of thetotal levy.

c. The total amount collected after the year for which levied.

d. The total amount collected to date for the levy and the total percentage collected to date.

Governments should report actual collections in this schedule, not GAAP�based amounts reported in the fund orgovernment�wide statements (GASB Comprehensive Implementation Guide2009, Question 9.23.4).

Debt Capacity Information

To help users understand a government's debt burden and its ability to issue new debt, GASBS No. 44, paragraph22, requires general purpose governments to present a minimum of four types of debt capacity information:

� Ratios of outstanding debt.

� Direct and overlapping debt.

� Debt limitations.

� Pledged�revenue coverage.

Most general purpose governments will also be required to present a fifth schedule containing ratios about generalbonded debt. For purposes of these schedules, debt is defined as long�term debt instruments, including bonds,capital leases, certificates of participation, loans, and notes. Governments may, but are not required to, presentstatistical schedules showing other long�term obligations, such as compensated absences or other postemploy�ment benefits.

Ratios of Outstanding Debt. For general purpose governments, this schedule compares outstanding debt (bytype) for the primary government to personal income and population. Debt should be reported by type (forexample, general obligation debt, revenue bonds, leases, and so forth) and separately for governmental activitiesand business�type activities. GASB Comprehensive Implementation Guide2008, Question 9.24.6, states that theamounts presented should be the same as those presented in the basic financial statementsthat is, net ofpremiums/discounts and other adjustments (for example, for accreted deep�discount debt). For this reason, themost current year's information can be taken easily from the required note disclosureschedule of changes inlong�term liabilities. A total column for the primary government is required.

The final two columns of the schedule present ratios of total primary government debt as a percentage of totalpersonal income and population (debt per capita). Both of these economic indicators are required along with otherindicators in the schedule. However, total personal income may be presented (by year) in this schedule instead.Personal income should be the estimated amount for the government's jurisdiction. The GASB Comprehensive

Implementation Guide2009, Question 9.26.2, indicates that when personal income and population figures areavailable for some, but not all years, governments may use tentative amounts provided by the U.S. Census or othersources, repeat prior year information properly footnoted, or estimate current�year figures based on trends inprior�year amounts. If this information is not available, governments may use estimated actual value of taxableproperty or another appropriate economic statistic. Population may not be a relevant indicator for many specialpurpose governments where debt is repaid from user charges, not taxes. For example, a utility could present totaldebt per customer or a university could present debt per student.

Ratios of General Bonded Debt. This schedule applies only to governments that have debt that is or could befinanced with any general governmental resources. The GASB Comprehensive Implementation Guide2009,


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Question 9.28.1, states that a government should include all of its general obligation debt in this schedule withoutregard to how it expects to repay that debt or how it is reported in the government�wide statement of net assets. Forexample, if a government issues general obligation debt to finance capital assets for its water utility and reports thatdebt as a liability of its business�type activities, the debt still should be included in this schedule. There is always apossibility that the debt could be required to be repaid from general governmental resources. Governments shouldpresent each type of general bonded debt separately followed by a total column. When resources are set aside andrestricted to repaying principal on this debt, these should be shown in a separate column and deducted from thetotal column to show net general bonded debt.

The total should be followed by two columns of ratios. The first should divide total general bonded debt (or netgeneral bonded debt) by the estimated actual value of taxable property if the debt is repaid from property taxes. Ifit is repaid from another sourcesuch as sales taxesthen total taxable retail sales for the period would be a betterdenominator. The second ratio should divide total general bonded debt (or net general bonded debt) by populationfor the government's jurisdiction. (Depending on the type of government, another indicator may be more appropri�ate than population.)

Governments may combine this schedule with the schedule on debt limitations if the government's legal debtmargin is determined based on general bonded debt.

Direct and Overlapping Debt. This schedule reports the direct and overlapping debt for the current period only. Itis required only for governmental entities, other than states, that report governmental activities. Governmental

activities are defined in GASBS No. 34, paragraph 15, as activities that generally are financed through taxes,intergovernmental revenues, and other nonexchange revenues. Debt of governmental activities is reported only inthe governmental activities column in the government�wide financial statements. Like the schedule of revenuerates, local governments should not include the debts of the state or state�wide authorities as overlapping debt.Counties and other regional governments are encouraged but not required to present this schedule.

Current year information should include these elements:

a. The outstanding dollar amount of individual governmental activity debt issues of overlapping governments.

b. The estimated percentage of overlap between the reporting and overlapping governments.

c. The product of the overlapping debt outstanding multiplied by the percentage of overlap.

d. The total of all amounts calculated in item c.

e. The outstanding direct debt of the reporting government's governmental activities. (This amount is differentfrom total direct debt of the primary government, reported in the schedule of ratios of outstanding debt.)

f. Total direct and overlapping debtthe sum of item d. and item e.

GASBS No. 44, paragraph 28, provides guidance on how to calculate the estimated percentage of overlap. If theestimated actual value of taxable property is the rate base, the ratio used to calculate the percentage would looklike this:

Amount�of�taxable�property�included�in�the�overlap�area

Total�taxable�value�of�property�in�the�overlapping�government�s�jurisdiction

When a local government's debt is not repaid from property taxes, an alternative revenue base must be applied inthe equation. For example, a city whose debt is repaid with income taxes would use personal income or populationas the revenue base. Exhibit 3�3 provides an illustration of a calculation that uses taxable real property values as itsrevenue base.


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Exhibit 3�3

Calculating Overlapping Debt

Assumptions: The City of Bethel is preparing its statistical schedules. It has $75.2 million in bondsoutstanding associated with its governmental activities and reported in the governmental activities columnof its government�wide financial statements. Bonds are repaid with real property tax revenues.

Fairfield Area Grammar School District No. 1 is an independent school district that provides primaryeducation to the students of the City of Bethel as well as several surrounding townships. It has schoolimprovement bonds outstanding of $28.6 million. The District also has capital leases of $9.3 million. Bothdebts are repaid with real property tax revenues levied against homeowners within the District.

Taxable real property located within both the City's jurisdiction and the District's jurisdiction is $77.4 million.Total taxable real property in the District's jurisdiction is $98.2 million.

Calculations: Amounts reported in the City's schedule of direct and overlapping debt of the City'sgovernmental activities would be calculated and displayed as follows:

Governmental Unit

Debt

Outstanding

(in thousands)

Estimated

Percentage

Applicable

Estimated

Share of

Outstanding Debt

Fairfield Area Grammar School District No. 1 SchoolImprovement Bonds $ 28,600 0.788187a $ 22,542b

FAGSD No. 1 capital lease agreements 9,300 0.788187a 7,330Subtotal overlapping debt 29,872City of Bethel Direct Debt 75,200

Total direct and overlapping debt $ 105,072

Notes:

a Estimated percentage overlap = $77.4 � $98.2

b Share of outstanding debt = $28,600 � 0.788187

* * *

Notes to the schedule should explain how the estimated percentage is calculateddescribing both the numeratorand denominator.

Debt Limitations. This schedule applies only to governments with legal debt limitations. It should show how thelegal debt margin is calculated for the current year. For the current year and past nine years, it should show the totalnet debt subject to limitations, the legal debt limit amount, and the first as a percentage of the second. The GASBComprehensive Implementation Guide2009, Question 9.30.3, states that if a government is subject to more thanone legal debt limitation, such as a state limitation and a local limitation, it should base this schedule on the mostrestrictive of those limitations.

When showing how the legal debt margin is calculated for the current year, the following information should beincluded:

� Relevant revenue base (for example total taxable property values or personal income).

� Debt limit amount (and the nature of the limitation).


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� Debt subject to the limit, reserves that may be deducted, and total net debt applicable to the limit.

� Legal debt margin amount.

Pledged Revenue Coverage. This schedule applies only to non�general obligation debt that is secured by apledge of a specific revenue source. The most common examples are special assessment debt and revenue bondsissued for business�type activities. For each type of debt, governments must report:

� Gross revenues related to the specific revenue source.

� If applicable, any operating expenses specified as deductions from pledged revenues by the bondindenture.

� If applicable, net available revenues.

� Each year's principal and interest requirements, reported separately.

� Coverage ratio.

The coverage ratio is net available revenues divided by the total of principal and interest requirements for the year.(If the bond indenture does not specify any operating expenses that should be treated as deductions from grossrevenues, then gross revenues should be used to calculate the coverage ratio.) Individual bond covenants mayrequire that other factors be considered in calculating coverage ratios. However, this schedule should be presentedexactly as described above. As noted in Question 9.31.1 of the GASB Comprehensive Implementation

Guide2009, the schedule is intended to help users assess the government's ability to repay debt, not todemonstrate legal compliance. Notes to the schedule should describe the nature of each type of pledged revenueif it is not clear from the column headings.

Demographic and Economic Information

Demographic and economic information gives users context for understanding the trend information presented inall the other schedules. Two schedules are required for general�purpose governments.

a. Information about principal employers.

b. Information about demographic and economic indicators (including population, total personal income, percapita personal income, and unemployment rate).

Special�purpose governments may present alternative information, tailored to what is most relevant to their operat�ing environments. For example, for a state, the GASBS No. 44 Appendix C, Exhibit E�3 illustration presentspopulation for both the US and the state, per capital personal income, civilian labor force, public school enrollment,and motor vehicles registered as demographic and economic indicators.

Principal Employers. All types of governments should list the principal employers in their jurisdiction for thecurrent year and for nine years earlier. Principal is defined as the ten largest employers in terms of number of peopleemployed. Fewer employers may be listed if it takes less than 10 to reach 50 percent of total employment in thejurisdiction. Information about each employer presented should include the name of employer, number of peopleemployed, and the percentage of total employment in the jurisdiction that the employer represents. Employers maybe public or private, governmental, for�profit, or not�for�profit.

Other Demographic and Economic Information. At a minimum, economic indicators for general purpose govern�ments must include: (a) population, (b) total personal income (if it is not presented with the ratios of outstandingdebt), (c) per capita personal income, and (d) unemployment rate for the past 10 years. Data should be as currentand as specific to the reporting jurisdiction as possible. Notes to the schedule should indicate the source of thestatistics. Other statistics may be added.

Operating Information

The final components of the GASBS No. 44 statistical section have to do with the government's own operations andresourcesboth capital and human. (Financial resources are discussed in many of the early schedules.) It should


238

give users context to help them assess economic condition. A minimum of three types of information is requiredinformation about government employees, operating indicators, and capital assets.

Government Employees. Governments should prepare a schedule that presents the number of employees byfunction, program, or identifiable activity. For governments that present a government�wide statement of activities,the minimum level of detail presented here is the same level required in that statement. Governments may use othercategorizations if they cannot report by function, program, or identifiable activity, or if it would be more meaningfulto do so. The GASB illustration reports based on full�time equivalent employees, although other methods may beused. The GASB Comprehensive Implementation Guide2009, Question 9.36.2, states that the GASB does notspecify whether these numbers should be as of a certain point in time or an average. Governments should pick oneor the other and use the same one from year to year.

Operating Indicators. This schedule should provide at least one operating indicator for each of the same function/activity levels required in the schedule of government employees. The indicators should measure demand or levelof service. The GASB Comprehensive Implementation Guide2009, Question 9.37.1, states that these indicatorsshould be currently available measures; governments are not required to come up with new indicators to generatethis schedule. Examples of operating indicators for a public safety function might include number of 911 callresponses, arrests, and crime rates. A wastewater function might include average daily sewage treatment. A libraryfunction might report the number of books in its collection and the number borrowed in each of the past 10 years.

Capital Assets. GASBS No. 44, paragraph 38, requires this schedule to provide some indication of the �volume ,usage, or nature" of related capital assets. For example, a parks and recreation function might report the numberof acres of parks, number of playgrounds, ball fields, and community centers. A public works function could reportmiles of streets, miles of highways, number of bridges, number of streetlights, and number of traffic signals.

Pension and Postemployment Activities. Special purpose governments engaged only in pension and otherpostemployment benefit fiduciary activities should provide statistical schedules that report information about eachindividual pension or other postemployment benefit plan administered. The schedules should report the number ofretired members by type of benefit and average monthly benefits.


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SELF�STUDY QUIZ


34. In general, statistical information of a government should be presented for a period of how many years?

a. 2 years.

b. 3 years.

c. 5 years.

d. 10 years.

35. When does GASBS No. 44 apply to a government?

a. When the government presents discretely presented component units in its government�wide financialstatements.

b. When the government makes statements of a prospective nature in the transmittal letter.

c. When the government chooses to present a statistical section with their basic financial statements.

36. The statistical section of a CAFR should contain information relating to financial trends. Which of the followingwould be found in the financial trends category?

a. Principal revenue payers.

b. Net assets.

c. Direct and overlapping debt.

d. Employee pension plan information.

37. The statistical section of a CAFR should contain information relating to revenue capacity. Which of the followingstatements best reflects the GASB requirements related to this category?

a. The government should report on the largest revenue source.

b. The government should report on the two highest percentage revenue sources.

c. The government should report on the revenue source that is most beneficial to the financial officers of thegovernment.

d. The government should report on the revenue source that provides the most support for the basic functionsof the government.

38. What additional information would the school district in Exhibit 3�2 most likely have to provide in the revenuecapacity category of statistical information since real estate property taxes is the most significant revenuesource?

a. Property tax levies and collections.

b. Pledged�revenue coverage.

c. The individual taxpayers remitting the 10 highest amounts of property taxes in the district for a particularfiscal year.


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39. What additional schedule will most general purpose governments have to include in their debt capacityinformation in the statistical section of their CAFRs?

a. Debt limitations.

b. Ratio of general bonded debt.

c. Ratios of outstanding debt.

d. Unemployment rates.

40. A government is required to include demographic and economic information in the statistical section of itsCAFR. What data required for this disclosure is also used in the debt capacity information disclosure?

a. Information about principal employers.

b. Total personal income.

c. Per capita personal income.

d. Overlapping debt.


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34. In general, statistical information of a government should be presented for a period of how many years?(Page 227)

a. 2 years. [This answer is incorrect. Some governments may elect to present comparative, basic financialstatements covering two fiscal periods.]

b. 3 years. [This answer is incorrect. Three years of condensed financial information may be included in theMD&A to the extent the government presents comparative financial statements.]

c. 5 years. [This answer is incorrect. The MD&A of an SEC�registrant might present selected financial dataof five years to illustrate trends for that particular company.]

d. 10 years. [This answer is correct. This time period allows users of the financial statements to

examine the data and trends of a government over an extended period of time, resulting in

well�informed conclusions about the condition of a government.]

35. When does GASBS No. 44 apply to a government? (Page 227)

a. When the government presents discretely presented component units in its government�wide financialstatements. [This answer is incorrect. Discretely presented financial statements are presented only in thegovernment�wide financial statements. Their inclusion would not cause a government to fall under thescope of GASBS No. 44.]

b. When the government makes statements of a prospective nature in the transmittal letter. [This answer isincorrect. The transmittal letter might discuss trends that are predictive in nature, but GASBS No. 44 wouldnot apply based on information in the transmittal letter.]

c. When the government chooses to present a statistical section with their basic financial statements.

[This answer is correct. Generally, governments choose to include a statistical section as part of a

CAFR or to participate in the GFOA Program, which would cause GASBS No. 44 to apply.]

36. The statistical section of a CAFR should contain information relating to financial trends. Which of the followingwould be found in the financial trends category? (Page 230)

a. Principal revenue payers. [This answer is incorrect. While the source of revenues is certainly connectedto the financial health of a government, this information would be located in a different category of statisticalinformation.]

b. Net assets. [This answer is correct. General purpose governments should list the three components

required by GASB No. 34. The three components are: (1) invested capital assets, net of related debt,

(2) restricted net assets, and (3) unrestricted net assets as reported in the government�wide

statement of net assets.]

c. Direct and overlapping debt. [This answer is incorrect. A government's ability to access credit markets andsustain current levels of debt is crucial to its financial well�being; however, this information is not presentedin the financial trends category of statistical information.]

d. Employee pension plan information. [This answer is incorrect. An increasing concern on the part ofgovernments is its ability to meet defined benefit pension obligations. This ability is clearly tied to thefinancial health of the government but is presented in a different category of statistical information.]


242

37. The statistical section of a CAFR should contain information relating to revenue capacity. Which of the followingstatements best reflects the GASB requirements related to this category? (Page 230)

a. The government should report on the largest revenue source. [This answer is incorrect. Sometimes thelargest source is not the most appropriate choice, particularly when the revenue may be restricted in useby certain contractual or legal limitations.]

b. The government should report on the two highest percentage revenue sources. [This answer is incorrect.GASBS No. 44 does not require the government to report on more than one revenue source in the revenuecapacity section of statistical information.]

c. The government should report on the revenue source that is most beneficial to the financial officers of thegovernment. [This answer is incorrect. The revenue capacity category should report on information thatis of greatest use to the users of the CAFR, in this case, investors, citizens, and media.]

d. The government should report on the revenue source that provides the most support for the basic

functions of the government. [This answer is correct. GASBS No. 44 only requires a government to

report on one source of revenue. Governments can use judgment when deciding on which source

to detail, but generally the source that contributes the most to governmental activities should be

presented.]

38. What additional information would the school district in Exhibit 3�2 most likely have to provide in the revenuecapacity category of statistical information since real estate property taxes is the most significant revenuesource? (Page 234)

a. Property tax levies and collections. [This answer is correct. Four elements related to revenue

capacity are generally required in the statistical section. In this case, since the school district's

primary own�source revenue is property taxes, it would include information related to property tax

levies and collections, in addition to the other required components.]

b. Pledged�revenue coverage. [This answer is incorrect. Pledged�revenue coverage is presented in adifferent category of statistical information.]

c. The individual taxpayers remitting the 10 highest amounts of property taxes in the district for a particularfiscal year. [This answer is incorrect. Revenue capacity information requires the disclosure of a certainnumber of payers responsible for generating a government's own�source revenue. In this case, however,the amount of property taxes paid by individual taxpayers would generally not be required to be disclosed.]

39. What additional schedule will most general purpose governments have to include in their debt capacityinformation in the statistical section of their CAFRs? (Page 234)

a. Debt limitations. [This answer is incorrect. The debt limitations schedule is one of the required schedulesto be presented in the debt capacity information of all governments with legal debt limitations.]

b. Ratio of general bonded debt. [This answer is correct. Most municipalities will have issued general

obligation debt, and this ratio will assist users in determining a city's ability to repay this debt based

on factors relevant to each particular city.]

c. Ratios of outstanding debt. [This answer is incorrect. This is one of the four types of debt capacityinformation required by GASBS No. 44.]

d. Unemployment rates. [This answer is incorrect. Unemployment rates are relevant to a city's financial healthand might affect a city's ability to meet its long�term obligations; however, this information is foundelsewhere in the statistical section of a city's CAFR.]


243

40. A government is required to include demographic and economic information in the statistical section of itsCAFR. What data required for this disclosure is also used in the debt capacity information disclosure?(Page 237)

a. Information about principal employers. [This answer is incorrect. Information about principal employersin a jurisdiction is required in the demographic and economic information section; however, it is not usedin the calculation of any debt capacity ratios.]

b. Total personal income. [This answer is correct. Total personal income may be used in the debt

capacity ratios. Personal income should be the estimated amount for the government's jurisdiction.]

c. Per capita personal income. [This answer is incorrect. Though per capita personal income is often a vitalstatistic used in the determination of a government's fiscal health, it is not used in the debt capacityinformation category of a CAFR.]

d. Overlapping debt. [This answer is incorrect. Overlapping debt is not reported in the demographic andeconomic information.]


244


Lesson 3 (GFSTG092)


28. Which of the following conditions, if met, would qualify a CAFR to be judged in the GFOA Program?

a. An �in relation to" opinion on the basic financial statements.

b. An investment section must be included in the CAFR.

c. An audit of financial statements conducted under generally accepted auditing standards.

d. A review of individual fund statements conducted under generally accepted government auditingstandards.

29. Which of the following items might be included in the introductory section of a CAFR?

a. Organizational chart.

b. List of governmental funds.

c. Budgetary comparisons.

d. Required supplementary information (RSI).

30. Why have the contents of the letter of transmittal (LOT) changed in recent years?

a. The LOT must now be written by the chief executive officer of the government, politicizing what was oncea strictly financial narrative.

b. Information previously contained in the LOT has moved to MD&A as governments comply with GASBS No. 34.

c. The GFOA now requires the use of �plain English," reducing the amount of financial jargon in the letter.

d. The use of graphics and pictures has been minimized as the GFOA requires a more straightforwardpresentation of governmental financial information.

31. What might be included in the government profile section of the LOT?

a. A list of principal government officials.

b. A brief description of the government's budgetary process.

c. A brief review of the government's long�term financial planning process.

d. An extensive description of the government's structure.


245

32. What is one major difference between the economic condition section of the LOT and the information containedin MD&A?

a. The financial information contained in MD&A focuses on the more subjective aspects of a government'sfinancial condition.

b. The financial information contained in MD&A reflects on fiscal trends for the last five or ten years.

c. The economic condition section of the LOT includes budgetary comparison information enabling usersto draw conclusions regarding the efficiency of the government's budgetary processes.

d. The economic condition section of the LOT focuses on the prospect's that the government's currentfinancial position might improve or deteriorate.

33. Which of the following statements is true regarding GFOA requirements for an auditor's report issued forinclusion in a CAFR?

a. The auditor's report is included immediately after the LOT in the introductory section of the CAFR.

b. The auditor's report included in the CAFR can be issued separately for basic financial statements that arelifted from the CAFR.

c. The auditor's report must issue, at a minimum, an �in relation to" opinion on fair presentation of thecombining and individual fund financial presentations in the financial section of the CAFR.

d. The auditor's report must issue an opinion on the basic financial statements and the RSI, at a minimum.

34. Why might a government want to limit the number of funds it maintains for external reporting purposes?

a. Future implementation of the provisions of GASBS No. 34 will require a limit on the number of funds agovernment can consider funds for external reporting purposes.

b. The inflexibility that accompanies too many funds being reported for external purposes reduces thechance that a government will be awarded the Certificate of Achievement for Excellence in FinancialReporting.

c. Too many funds requiring external reporting increases the complexity of reporting, resulting in inefficientfinancial administration.

d. Because the combining statements and individual fund statements are RSI, the cost of the financial auditincrease as auditors must consider each combining statement and individual fund statement.

35. How many sets of fund combining statements could a government potentially include in its CAFR?

a. 4.

b. 5.

c. 6.

d. 7.


246

36. When might a government present subcombining statements to the combining statements?

a. When there are many nonmajor governmental funds.

b. When the government is required to present combining financial statements for all defined benefit pensionplans.

c. When there are multiple agency funds required to be used to report transactions related to specialassessment debt.

d. When combining statements are presented for certain discretely presented component units.

37. What is the auditor's responsibility with respect to the statistical information section of a CAFR?

a. The auditor should perform analytical procedures on the financial information in this section of the CAFR.

b. The auditor should compare the data for consistency with the introductory and financial sections of theCAFR.

c. The auditor should perform tests of transactions on the accounting data included in this section of theCAFR.

d. The auditor should include a reference in the management representation letter covering assertions madein this section of the CAFR.

38. What is a factor governments must consider when restating financial trend information to comply with GASBSNo. 44?

a. Prior to GASBS No. 44, the GFOA issued more restrictive guidance on the information required for thereserved and unreserved fund balance for the General Fund.

b. Prior to GASBS No. 44, some governments presented information based on the budgetary basis ratherthan the modified accrual basis.

c. Prior to GASBS No. 44, fund balance information was required for the total of all government funds.

d. Prior to GASBS No. 44, the program revenues by category for the total primary government were requiredto be presented in the revenue capacity category.

39. What additional information might be included on the schedule of revenue rates in the revenue capacitycategory of the statistical information?

a. A footnote reporting the top ten sources of revenue from residential, commercial, farm, and tax�exemptpayers.

b. A column for direct and indirect rates in the overlapping rate columns for governments with large numbersof overlapping governments.

c. For colleges or universities, the number of students enrolled paying full tuition, partial tuition, and theaverage tuition paid per student enrolled at the undergraduate and graduate levels.

d. Any legal restrictions on a government's ability to raise direct rates.


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40. ABC School District, located in Anysuburb USA, has total debt outstanding of $55 million related to schoolimprovement bonds. Taxable real property located in the District and the City's jurisdiction is $26 million. Totaltaxable real property in the District's jurisdiction is $40 million. What is the share of overlapping debt thatAnysuburb is required to report in its schedule of direct and overlapping debt?

a. $32,250,000.

b. $35,750,000.

c. $36,500,000.

d. $37,250,000.


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249

GLOSSARY

Agency funds: Fiduciary funds used to account for assets held by a governmental unit in an agency or custodialcapacity [i.e., to account for money collected for some other entity, such astaxes collected for another entity orpayroll withholding (due to state/federal governments)].

Agency funds are purely custodial (assets = liabilities) and do not involve the measurement of the results ofoperations.

Analytical procedures: Substantive tests made by study and comparison of plausible relationships among bothfinancial and nonfinancial data. These tests focus on the reasonableness of expected relationships and theidentification of significant unexpected differences.

Basis of accounting: Refers to when transactions or events are recognized for reporting.

Budget: It is a governmental entity's expression of policy and financial intent. It is a formal quantitative expressionof the plans of the governmenta plan for the coordination of revenues and expenditures or as the amount of moneythat is available for, required for, or assigned to a particular purpose.

Business�type activities: Services provided by a governmental unit that are financed and provided in ways that aresimilar to those of a business enterprise, such as public utilities (water, sewer, gas, electric), parking garages, andgolf courses.

Government business�type activities can be contrasted with general government activities or government�typeservices, which are provided to everyone at no charge (e.g., police and fire protection, education and healthservices).

Capital projects fund: A fund used to account for financial resources to be used for the acquisition or constructionof major long�lived assets (other than those financed by proprietary or trust funds). It is accounted for on the modifiedaccrual basis and has a limited life that encompasses the construction or acquisition period and is terminated at theend of that period, with any remaining assets being transferred to a related debt service fund or to the general fund.

Combining component unit financial statements: In governmental accounting, these statements presentindividual component unit data in adjacent columns and a total column for all component units reported in thestatement. The total column articulates with the corresponding component units column in the combined financialstatements.

Combining financial statements: Financial statements of governmental entities reflecting a lower level ofaggregation, presenting each fund of each fund type (where a governmental unit has more than one fund of a giventype).

Comparative financial statements: Financial statements of two or more periods presented in columnar form.

Comprehensive Annual Financial Report (CAFR): The annual report of the governmental entity composed of anintroductory, financial, and statistical section.

Debt service fund: A fund used to account for the receipt of proceeds from, the accumulation of resources for, andthe payment of principal and interest associated with general long�term debt (recorded in the GLTDAG) as they come

due (mature). Unmatured amounts are not accrued. Debt service funds are accounted for on the modified accrualbasis.

Encumbrance: It is a commitment related to unperformed (executory) contracts for goods and services. It isrecorded for budgetary control purposes to prevent overspending and demonstrate compliance with legalrequirements. An encumbrance does not represent either expenditures or liabilitiesit represents the estimatedamount of expenditure that will result if unperformed contracts (purchase orders) in process are completed.


250

Enterprise funds: Funds that are used to report activities that the government operates more like a business.Enterprise funds are permitted to be used whenever an activity charges a fee for a service to an external user. GASBSNo. 34 requires governments to report an activity in an enterprise fund if any one of three criteria is met:

1. The activity is financed with debt that is secured solely by a pledge of the net revenues from fees andcharges of the activities.

2. Laws or regulations require that the activity's cost of providing services be recovered with fees and charges(rather than with taxes).

3. The pricing policies of the activity establish fees and charges designed to recover its costs, includingcapital costs.

Expenditure: A term used in governmental accounting that refers to a decrease in (use of) the financial resourcesof the entity. Expenditures are recorded under the modified accrual basis when the related liability is incurred, ifmeasurable, except for unmatured interest and principal on general long�term debt, which should be recognizedwhen due. Expenditures should be classified by fund, function (or program), organization unit, activity, character,and principal classes of objects.

Fiduciary activities: Activities that involve holding and managing net assets for specific individuals or other externalparties, in accordance with trust agreements or other custodial arrangements, or fiduciary activities. Examplesinclude the net assets of external participants in government�sponsored investment pools and the net assets ofpension plans and other employee benefit plans held in trust for its employees. Fiduciary activities are reported intrust and agency funds in the fund financial statements.

Financial Accounting Standards Board (FASB): The Financial Accounting Standards Board (FASB) is anindependent authoritative body created in 1973 to replace the American Institute of Certified Public Accountants(AICPA) Accounting Principles Board and authorized by the AICPA Code of Professional Conduct as a promulgatorof generally accepted accounting principles (GAAP), primarily for nongovernment entities.

Financial statement: A presentation of financial data, including accompanying notes, derived from accountingrecords and intended to communicate an entity's economic resources or obligations at a point in time, or the changestherein for a period of time, in accordance with generally accepted accounting principles (GAAP) or anothercomprehensive basis of accounting other than GAAP (OCBOA). The basic financial statements in a typical GAAPfinancial statement presentation are as follows: (1) Statement of Financial Position or Balance Sheet, (2) Statementof Income, (3) Statement of Comprehensive Income, (4) Statement of Retained Earnings or Changes inStockholders' Equity, and (5) Statement of Cash Flows.

Fiscal year: A fiscal year is an accounting year ending on the last day of any month except December.

Fund: It is the primary accounting unit of governmental entities. It is a fiscal and accounting entity with aself�balancing set of accounts recording the cash and other financial resources, together with all related liabilitiesand residual equities or balances, and changes therein, which are segregated for the purpose of carrying on specificactivities or attaining certain objectives in accordance with special regulations (laws and ordinances), restrictions(e.g., bond covenants), or other limitations (e.g., management decision). A fund is a control mechanism to ensurethat resources provided to governmental entities are used as intended.

Fund accounting: A method of accounting for governmental entities by which the accounts are divided into severalseparate funds and nonfund account groups. The diverse nature of governmental operations and the necessity ofassuring compliance with regulations, restrictions, and other limitations preclude recording and summarizing allgovernmental financial transactions and balances in a single accounting entity. Governmental accounting requiresthe use of several distinctly different fiscal and accounting entities (funds and nonfund account groups), each havinga separate set of accounts and functioning independently of each other.

Fund balance: A residual equity account that balances the asset and liability accounts of a governmental fund. Itrepresents the residual amount (unreserved) available for expenditure.


251

General fund: The primary governmental fund, used to account for all financial resources not required to beaccounted for in another fund. It is an omnibus fund used to account for most routine general governmentaloperationsfor a variety of revenue sources and a wide range of activities financed by these resources. Agovernmental unit will have only one general fund.

Generally accepted accounting principles (GAAP): Basic accounting principles and standards and specificconventions, rules, and regulations that define accepted accounting practice at a particular time by incorporationof consensus and substantial authoritative support.

Government Accounting Standards Board (GASB): The body authorized to promulgate standards of financialaccounting and reporting for state and local governmental units. It was created by the Financial AccountingFoundation (FAF) in 1984 as successor to the National Council on Governmental Accounting (NCGA) and isrecognized by the Code of Professional Conduct as an authorized body whose pronouncements must be followedin order to conform to Rules 202 and 203.

Government�wide financial statements: The basic financial statements of a governmental entity comprised of astatement of net assets and a statement of activities, which are prepared using the economic resourcesmeasurement focus and the full accrual basis of accounting. The statements should contain a columnar presentationof governmental activities, business�type activities, and component units. A total column should be presented forthe primary government.

Inquiry: Inquiry is the seeking of appropriate information from knowledgeable persons inside (both managementand staff) or outside the entity (e.g., bankers, attorneys, vendors, customers, predecessor accountant) with theapproval of management. Inquiry is required under the performance standards of a review engagement.

Internal service funds: Funds used to account for the financing of goods and services provided by one agency ordepartment to another of the same governmental unit, or to another governmental unit, on a cost�reimbursementbasis (i.e., an in�house enterprise, such as motor pool, garage, print shop, or data processing center). �Costreimbursement" implies that the costs of the service department are expected to be recovered through charges tothe other departments (service department revenues = billings to other departments). Internal service funds areaccounted for on the accrual basis.

Letter of transmittal: Correspondence which is part of the introductory section of a comprehensive annual financialreport of a government, ideally composed by the chief financial and executive officers of a government. It may containprojections about the future, comments about specific operating policies, statements regarding the performance ofthe government in the past year, or statements of a political nature.

Management's discussion and analysis (MD&A): An analysis of the financial condition and operating results ofthe government written by its financial managers.

Materiality: The magnitude of an omission or misstatement of accounting information which, in light of surroundingcircumstances, makes it probable that the judgment of a reasonable person relying on the information would havebeen changed or influenced by the omission or misstatement.

Notes to Financial Statements: An integral part of financial statements used to present material disclosuresrequired by GAAP that are not otherwise presented in the financial statements, i.e. on the face of the statements orin the �Summary of Significant Accounting Policies."

OCBOA: A comprehensive basis of accounting other than generally accepted accounting principles such as thefollowing: (1) a basis of accounting that the reporting entity uses to comply with the requirements or financialreporting provisions of a governmental regulatory agency to whose jurisdiction the entity is subject; (2) a basis ofaccounting that the reporting entity uses or expects to use to file its income tax return for the period covered by thefinancial statements; (3) the cash receipts and disbursements basis of accounting, and modifications of the cashbasis having substantial support, such as recording depreciation on fixed assets or accruing income taxes; or (4)a definite set of criteria having substantial support that is applied to all material items appearing in financialstatements, such as the price�level basis of accounting.


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Proprietary funds: Funds used to account for the ongoing activities of a governmental unit that are financed andoperated in a manner similar to commercial (business) activities (e.g., utilities, swimming pools, print shops, motorpool) where the intent of the governing body is that the costs (expenses, including depreciation) of providing thegoods or service on a continuing basis shall be financed or recovered primarily through user charges (either externalor internal users). Proprietary funds are accounted for on the accrual basis in exactly the same way as a businessenterprise. Proprietary funds include accounts for all related assets.

Representation letter: Letter signed by client management detailing representations made by management relatedto all financial statements and periods covered by an accountant's review report.

Required supplementary information (RSI): Essential information that should be presented with, but not as partof, the basic financial statements and notes.

SLG: AICPA Audit and Accounting Guide: State and Local Governments

Special revenue funds: Funds used to account for the proceeds of specific revenue sources (other than expendabletrusts or for major capital projects) that are legally restricted to expenditure for specific purposes. Special revenuefunds are accounted for on the modified accrual basis, such as a gasoline excise tax to be used for streetmaintenance. Another example is a hotel/motel bed tax to be used for industrial development or to be allocated tothe arts.

Substantive tests: Tests of details of transactions or balances, or analytical procedures performed to detect materialmisstatements.

Supplementary or Other Information: Detailed schedules, summaries, comparisons, or statistical information thatare not part of the basic financial statements and are not required for a fair presentation in accordance with GAAP,often included in the unaudited financial statements of a nonpublic entity. Examples of supplementary informationinclude, but are not limited to, budgets for an expired period, selling expenses, and details of sales by product line.

Trend analysis: A type of analytical procedure that involves the study of the change in accounts over time.

Trust funds: Fiduciary funds used to account for assets held by a governmental unit in a trustee capacity.


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INDEX

B

BUDGETARY REPORTING� Budgetary comparison requirements 141. . . . . . . . . . . . . . . . . . . .

�� Format 143. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Perspective differences 142. . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Required information 142. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Scope/required funds 141. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

� Common errors 145. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Illustrations 145. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Purpose and placement 141. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Required disclosures 143. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

�� Absence of legally adopted budget 145. . . . . . . . . . . . . . . . . . �� Budgetary basis of accounting 144. . . . . . . . . . . . . . . . . . . . . . �� Budget�GAAP reconciliation 144. . . . . . . . . . . . . . . . . . . . . . . . . �� Excess of expenditures over appropriations 144. . . . . . . . . . .

� Supplementary budget information 145. . . . . . . . . . . . . . . . . . . . . .

C

CERTIFICATE OF EXCELLENCE IN FINANCIAL REPORTING(GFOA)

� School districts�� Certificate program 212. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Eligibility 212. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� GFOA recommended practices 213. . . . . . . . . . . . . . . . . . . . . .

COMMON ERRORS� Management's discussion and analysis 202. . . . . . . . . . . . . . . . . . � Required supplementary information 145. . . . . . . . . . . . . . . . . . . .

COMPREHENSIVE ANNUAL FINANCIAL REPORT (CAFR)� CAFR requirements and definition 211. . . . . . . . . . . . . . . . . . . . . . . � Financial section 220. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

�� Auditor's report 220. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Combining statements and individual

fund statements 220. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Combining statements for discretely presented

component units 223. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Combining statements for funds 221. . . . . . . . . . . . . . . . . . . . . �� Fund financial statements of certain discretely

presented component units 223. . . . . . . . . . . . . . . . . . . . . . . . . �� Individual fund statements/schedules 224. . . . . . . . . . . . . . . . . �� Narrative explanations 224. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Number of funds 221. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Schedules 224. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� "Voluntary" supplementary financial information 224. . . . . . .

� GFOA certificate program 212. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Eligibility 212. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

� Introductory section 214. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Awards and acknowledgements 216. . . . . . . . . . . . . . . . . . . . . �� Economic condition 215. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Formal transmittal 215. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� General contents 214. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Government profile 215. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Transmittal letter 214. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

� Statistical section 227. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Applicability 227. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Capital assets 238. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Categories of required information 228. . . . . . . . . . . . . . . . . . . �� Debt capacity information 234. . . . . . . . . . . . . . . . . . . . . . . . . . . �� Debt limitations 236. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Demographic and economic information 237. . . . . . . . . . . . . . �� Direct and overlapping debt 235. . . . . . . . . . . . . . . . . . . . . . . . . �� Financial trends information 228. . . . . . . . . . . . . . . . . . . . . . . . . �� GASBS No. 44 227. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Government employees 238. . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Information about changes in

net assets 229. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Information about governmental funds 229. . . . . . . . . . . . . . . . �� Information about net assets 229. . . . . . . . . . . . . . . . . . . . . . . . �� Narrative explanations 228. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

�� Operating indicators 238. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Operating information 237. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Other demographic and economic information 237. . . . . . . . �� Pension and postemployment activities 238. . . . . . . . . . . . . . . �� Pledged revenue coverage 237. . . . . . . . . . . . . . . . . . . . . . . . . . �� Principal employers 237. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Principal revenue payers 233. . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Property tax levies and collections 234. . . . . . . . . . . . . . . . . . . �� Ratios of general bonded debt 234. . . . . . . . . . . . . . . . . . . . . . . �� Ratios of outstanding debt 234. . . . . . . . . . . . . . . . . . . . . . . . . . �� Required statistical tablesGASBS No. 44 227. . . . . . . . . . . . �� Revenue base 232. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Revenue capacity information 230. . . . . . . . . . . . . . . . . . . . . . . �� Revenue rates 233. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Scope of reporting 227. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Trend data and transition 228. . . . . . . . . . . . . . . . . . . . . . . . . . .

D

INTRODUCTORY SECTION� Statistical section

�� Identifying most significant revenue source 230. . . . . . . . . . . .

M

MANAGEMENT'S DISCUSSION AND ANALYSIS� Authorship of MD&A 163. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Comparing GASB MD&A and Securities and Exchange

Commission Requirements 196. . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Easily readable information

�� Avoiding boilerplate 167. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� SEC guidance on effective writing 167. . . . . . . . . . . . . . . . . . . . �� Use of charts, graphs, tables 166. . . . . . . . . . . . . . . . . . . . . . . .

� Focus of MD&A 164. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Reporting on the primary government 164. . . . . . . . . . . . . . . .

� GASB objectives for MD&A 161. . . . . . . . . . . . . . . . . . . . . . . . . . . . . � General requirements

�� Comparative data 169. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Illustrationthe big picture 170. . . . . . . . . . . . . . . . . . . . . . . . . . �� Relationship to the notes to financial statements 169. . . . . . . �� Required components 168. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

� Introduction 161. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Overview of requirements, including transition 163. . . . . . . . . . . . � Placement of MD&A 164. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Presenting objective information 165. . . . . . . . . . . . . . . . . . . . . . . .

�� Derived from the basic financial statements 165. . . . . . . . . . . �� Importance of currently known facts 166. . . . . . . . . . . . . . . . . . �� Reporting as RSI 165. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

� Relationship of MD&A to the letter of transmittal 195. . . . . . . . . . . �� Where should the MD&A and the letter of

transmittal letter be placed? 195. . . . . . . . . . . . . . . . . . . . . . . . . � Required components

�� Analysis of balances and transactions of individual funds 181. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

�� Analysis of financial position and results of operations 178. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

�� Brief discussion of basic financial statements 174. . . . . . . . . . �� Budgetary analysis 182. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Capital asset and long�term debt activity 183. . . . . . . . . . . . . . �� Condensed comparative financial statements 175. . . . . . . . . . �� Currently known facts, decisions, or conditions 186. . . . . . . . �� Infrastructure assets 185. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

� SEC guidance on plain English writing�� Avoid long sentenceswrite short ones 198. . . . . . . . . . . . . . �� Bring abstractions down to earth 199. . . . . . . . . . . . . . . . . . . . . �� Keep parallel structures 201. . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Keep subject, verb, and object close together 201. . . . . . . . . �� Know what you need to report 197. . . . . . . . . . . . . . . . . . . . . . . �� Know your audience 197. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Make it look invitingdesign 201. . . . . . . . . . . . . . . . . . . . . . . . �� Omit superfluous words 199. . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Organize MD&A 197. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Replace jargon and legalese 201. . . . . . . . . . . . . . . . . . . . . . . .


254

�� Use personal pronouns 199. . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Write in the positive 200. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Write MD&A using a team approach 197. . . . . . . . . . . . . . . . . .

R

REQUIRED SUPPLEMENTARY INFORMATION� Auditor reporting on RSI 136. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Common errors 145. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Comparison to supplementary information 136. . . . . . . . . . . . . . . � Definition and description 135. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Management's discussion and analysis 161. . . . . . . . . . . . . . . . . . � Placement of RSI 135. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

� RSI requirements 136. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

S

SPECIAL�PURPOSE GOVERNMENTS� Management's discussion and analysis 194. . . . . . . . . . . . . . . . . .

�� Special�purpose governments engaged only in business�type activities 194. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

�� Special�purpose governments engaged only in fiduciary activities 195. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

�� Special�purpose governments engaged only in governmental activities 194. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

� Use active sentences and strong verbs 198. . . . . . . . . . . . . . . . . .


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COMPANION TO PPC'S GUIDE TO PREPARING GOVERNMENTAL FINANCIAL STATEMENTS UNDER GASBS NO. 34

COURSE 3

CAPITAL ASSETS (GFSTG093)

OVERVIEW

COURSE DESCRIPTION: This interactive self�study course studies how governments must deal with capitalassets under GASBS No. 34. Topics discussed include tangible and intangibleassets, asset valuation, estimating useful lives, asset impairments, and reportingrequirements.

PUBLICATION/REVISIONDATE:

October 2009


PREREQUISITE/ADVANCEPREPARATION:

Basic knowledge of governmental accounting.







Learning Objectives:

Lesson 1The Basics of Capital Assets, Including Valuation, Reporting, and Capitalization

Completion of this lesson will enable you to:� Identify the basic elements of capital assets under GASBS No. 34, including the definition of and determining

the ownership of capital assets.� Describe the valuation of a government's tangible and intangible capital assets.� Recognize issues related to estimating useful lives, depreciation expense, and reporting works of art.� Differentiate between reporting capital assets in governmental funds and in proprietary and fiduciary funds.� Calculate the capitalization of interest costs.

Lesson 2Capital Assets, Infrastructure, and Impairment

Completion of this lesson will enable you to:� Identify issues with reporting on capital assets in government�wide financial statements and transitioning to the

GASBS No. 34 general infrastructure asset requirements.� Compare and contrast the depreciation and modified approaches for reporting infrastructure.� Identify the requirements for note disclosures and supplementary information for infrastructure.� Determine the basics of the impairment of capital assets and insurance recoveries.


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Lesson 1:�The Basics of Capital Assets, IncludingValuation, Reporting, and Capitalization

INTRODUCTION

Governments obtain property and equipment in the same manner as most private�sector business enterprises andnonprofit organizations. Fixed or capital assets may be acquired by purchase, construction, lease, donation, orforeclosure. Some intangible assets, a type of capital assets, may be internally generated (i.e., computer software).The method of acquisition may dictate the valuation of, or accounting for, an asset. For example, a donated vehiclewould be reported at its fair value at the time of donation. A leased vehicle would be reported at the net presentvalue of required payments under a capital lease but would not be reported as an asset of the government underan operating lease. This course includes examples of the accounting for a variety of property and equipmenttransactions.

In the fund financial statements, the accounting and financial reporting for capital assets differs depending on thetype of fund that acquires the asset. The basic capitalization distinctions between governmental, proprietary, andfiduciary funds and between fund financial statements and government�wide financial statements are explainedlater in this section.

With the implementation of GASBS No. 34, nearly all capital assets owned by state and local governments arecapitalized (and most are depreciated) in one or more of the required basic financial statements. This includescapital assets associated with governmental activities, including general infrastructure assets.

Certain equipment and facilities related to municipal solid waste landfills (MSWLFs) should be accounted for asspecified by GASBS No. 18 (GASB Cod. sec. L10), Accounting for Municipal Solid Waste Landfill Closure and

Postclosure Care Costs. Certain outlays for property, plant, and equipment related to pollution remediation arerequired to be reported as pollution remediation costs rather than capital assets as required by GASBS No. 49,Accounting and Financial Reporting for Pollution Remediation Obligations.


Completion of this lesson will enable you to:� Identify the basic elements of capital assets under GASBS No. 34, including the definition of and determining

the ownership of capital assets.� Describe the valuation of a government's tangible and intangible capital assets.� Recognize issues related to estimating useful lives, depreciation expense, and reporting works of art.� Differentiate between reporting capital assets in governmental funds and in proprietary and fiduciary funds.� Calculate the capitalization of interest costs.

GASBS NO. 34GOVERNMENTAL FINANCIAL REPORTING MODEL

Capital AssetsTHE BASICS

� GAAP distinguish between two types of capital assets of governments�general capitalassets" and capital assets reported in proprietary funds and in fiduciary funds.

� General capital assets are reported only in the governmental activities column in thegovernment�wide financial statements.


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Capital AssetsTHE BASICS

� Proprietary fund capital assets are reported both in the proprietary fund statement of netassets and in the business�type activities column in the government�wide statement of netassets.

� Fiduciary fund capital assets are reported only in the statement of fiduciary net assets.


Governments, made dramatic changes to the financial reporting requirements for governmental entities. Forgeneral reporting purposes, the Statement became effective in three phases. The first phase was for governmentswith annual revenues of $100 million or more for fiscal years beginning after June 15, 2001; the second phase wasfor those with revenues of $10 million to $100 million, for years beginning after June 15, 2002; and the third phasewas for those with revenues of less than $10 million, for years beginning after June 15, 2003.

Prior to GASBS No. 34, governments were not required to report general infrastructure assetsinfrastructureassets associated with and generally arising from governmental funds and activitiesand most governmentschose not to report them. Many of these same governments did not maintain historical cost information for generalinfrastructure assets. Others retained limited records relating to infrastructure assets. For these reasons, the GASBestablished more liberal rules for reporting general infrastructure assets acquired before the adoption of GASBSNo. 34. These include the following:

� Allowing an extended period of time for retroactively reporting infrastructure assets.

� Limiting retroactive reporting to only major general infrastructure assets acquired, significantly recon�structed, or that received significant improvements in fiscal years ending after June 30, 1980.

� Allowing reporting at estimated historical cost instead of actual historical cost when determining actualhistorical cost is not practical because of inadequate records.

Two Types of Capital Assets

GAAP distinguish between two types of capital assets of governments�general capital assets" and capital assetsreported in proprietary funds and in fiduciary funds. The distinction arises because of the different measurementfocuses used for governmental funds versus proprietary and fiduciary funds. Governmental fund reporting mea�sures only current financial resources (the current financial resources measurement focus). Proprietary and fidu�ciary fund reporting generally measures both financial and capital resources (the economic resourcesmeasurement focus).

GASB Cod. sec. 1400 Statement of Principle provides this general rule:

A clear distinction should be made between general capital assets and capital assets ofproprietary and fiduciary funds. Capital assets of proprietary funds should be reported in both thegovernment�wide and fund financial statements. Capital assets of fiduciary funds (and similarcomponent units) should be reported only in the statement of fiduciary net assets. All other capitalassets of the governmental unit are general capital assets. They should not be reported as assetsin governmental funds but should be reported in the governmental activities column in thegovernment�wide statement of net assets.

General capital assets are defined as the default category of capital assets. General capital assets consist of allcapital assets that are not specifically related to activities reported in proprietary or fiduciary funds. However,because they are not current financial resources, general capital assets are not reported as assets in governmentalfunds but are reported only in the governmental activities column in the government�wide statement of net assets.

Reporting General Capital Assets Activity in Governmental Funds

General capital assets are not reported in governmental funds. Governmental funds report only the financialresource flows that arise from their acquisition or disposition. Capital assets acquired with cash or debt are reported


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as capital expenditures equal to the amount of cash paid or debt incurred (for example, bonds or capital leases).Transactions in which capital assets are acquired without financial resourcesfor example through donation orthrough transfer from a proprietary funddo not affect and are not reported in governmental fund financialstatements.

Sales of general capital assets are reported in the governmental fund operating statement only if cash or areceivable is generated by the transaction. If an asset is given away, razed, or hauled off to the dump, nothing isreported unless the contractor or hauler charges a fee for its services (resulting in an expenditure) or pays thegovernment for the scrap (a miscellaneous revenue).

Reporting Capital Assets in Proprietary and Fiduciary Funds

Capital assets of proprietary and fiduciary funds are reported generally in the same manner as in private�sectorenterprises. The historical cost of capital assets is capitalized and reported on the statement of proprietary fund netassets and statement of fiduciary net assets, respectively. As a general rule, depreciation expense is reported as anannual allocation of the cost of using depreciable capital assets over their estimated useful lives.

Reporting Capital Assets in Government�wide Financial Statements

Except for capital assets specifically related to fiduciary activities, all capital assets are reported in the government�wide financial statements. (Fiduciary funds and activities are excluded from the government�wide financials state�ments.) General capital assets at historical cost are reported in the governmental activities column in thegovernment�wide statement of net assets. Capital assets specifically related to enterprise funds are reported in thebusiness�type activities column. As a general rule, depreciation expense is reported as an annual allocation of thecost of using depreciable capital assets of both governmental activities and business�type activities over theirestimated useful lives.

Capital assets reported in the fund financial statements in internal service funds (a type of proprietary fund) aregenerally reported with general capital assets in the government�wide financial statements.

Intangible Assets, Infrastructure Assets, and Works of Art and Historical Collections

Special provisions apply to reporting intangible assets, infrastructure assets, and works of art and historicalcollections. These provisions are discussed in both Lesson 1 and Lesson 2.

Disclosures about Capital Assets

GASBS No. 34, paragraphs 116 and 117, require note disclosures about capital assets. GAAP also require certainnote disclosures about specific capital assets transactions, such as acquisitions by capital lease. These disclo�sures are discussed throughout this course.

DEFINING CAPITAL ASSETS AND DETERMINING THEIR OWNERSHIP

GASBS No. 34, paragraph 19, (GASB Cod. sec. 1400) provides a very broad definition of capital assets as �tangibleor intangible assets that are used in operations and that have initial useful lives extending beyond a single reporting

period," [emphasis added]. Examples include the following:

� Land and improvements to land, including land associated with infrastructure assets.

� Easements.

� Water rights.

� Buildings and building improvements.


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� Assets acquired through capital leases.

� Zoo animals (GASB Comprehensive Implementation Guide2009, Question 7.21.3).

� Library books (GASB Comprehensive Implementation Guide2009, Question 7.9.2).

� Vehicles.

� Machinery and equipment.

� Works of art and historical treasures. (Some may not require capitalization.)

� Infrastructure assets.

� Intangible assets.

� All other tangible assets that are used in operations.

Question 7.9.1 of the GASB Comprehensive Implementation Guide2009 defines land improvements as �better�ments, other than buildings, that ready land for its intended use." Examples include site excavation and improve�ments; removal, or reconstruction of others' property; retaining walls; parking lots; fencing; and landscaping. Someland improvements are inexhaustible and should not be depreciated, such as fill and grading costs that ready landfor the erection of structures and landscaping. Land improvements related to pollution remediation activities shouldbe reported in accordance with GASBS No. 49, effective for financial statements for periods beginning afterDecember 15, 2007.

Infrastructure

Infrastructure assets are a subset of capital assets and generally should be reported in the same manner as othercapital assets. Although all capital assets have initial useful lives that extend beyond one reporting period, infra�structure assets normally can be preserved for a significantly greater number of years than most other capitalassets. That is, infrastructure assets are distinguished from other capital assets because they normally (a) can bemaintained in a condition that will allow them to be used longer than most other capital assets and (b) are stationaryin nature. Examples of infrastructure assets include roads, highways, bridges, tunnels, drainage systems, waterand sewer systems, dams, and lighting systems. Although buildings would seem to meet the definition of infra�structure assets, they generally are not considered to be infrastructure assets under the provisions of GASBS No.34. Only those buildings that are an ancillary part of a network of infrastructure assets should be consideredinfrastructure assets. For example, tollbooths associated with a turnpike, road maintenance structures such asshops and garages associated with a highway system, and water pumping buildings associated with watersystems may be included as part of infrastructure assets under the ancillary building exception. Networks ofinfrastructure assets are defined in Lesson 2. The GASB Comprehensive Implementation Guide2009, Question7.12.16, notes that land, including land or easements that are associated with infrastructure assets such as rightsof way, should be reported as land or another appropriate category, such as �right�of�way easements," not asinfrastructure. Question 7.16.3, notes that parks, which consist principally of land, do not meet the definition ofinfrastructure assets.

Infrastructure versus General Infrastructure Assets. As discussed in Question 11 of the AICPA's Understanding

and Implementing GASB's New Financial Reporting Model, when reading GASBS No. 34's provisions relating tocapital assets and infrastructure, preparers and auditors should focus on the specific terminology used. Provisionsof GASBS No. 34 that refer to capital assets and infrastructure assets apply to all of the government's capital andinfrastructure assets, regardless of with which fund or activity they are associated. However, when the terms general

capital assets and general infrastructure assets are used, those GASBS No. 34 provisions only apply to infrastruc�ture assets that are also general capital assets.

Determining Ownership of Governmental Capital Assets

Many organizations and individuals provide the resources needed to acquire governmental capital assets, particu�larly infrastructure assets. For example, the federal government contributes substantial amounts during the


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construction of an interstate highway system, states sometimes pay a portion of the cost of local roads, andtaxpayers often pay for sidewalks through special assessments. For this reason and others, some governments arefinding that it is not particularly clear who actually owns individual capital assets. Footnote 67 of GASBS No. 34provided some clarification in cases involving infrastructure assets. It notes that governments with the primaryresponsibility for managing an infrastructure asset should report that asset. The GASB Comprehensive Imple�

mentation Guide2009 also provides a series of five questions and answers that address this issue.

GASB Comprehensive Implementation Guide2009, Question 7.12.2, notes that the guidance in GASBS No. 34,footnote 67, only should be applied in instances where ownership is not clear. Deeds, easements, and contractsshould be the first source of information. Question 7.9.6 notes that �holding title to an asset equates to ownership;"however, there may be situations in which a separate contract, such as a capital lease, conveys all or some of therights of ownership to another entity. Other facts and circumstances also need to be considered. In the absence ofclear ownership, responsibility for managing an asset is discussed in Questions 7.12.3 and 7.12.4. In the first ofthese, the GASB staff notes that governments should not report sidewalks as their own assets when the propertyowner is financially responsible for maintaining (managing) them. In the second question, the staff notes that whenone government is responsible for maintaining an asset and another is responsible for replacing it, the governmentresponsible for maintaining the asset should report it. Again, both of these questions are in the context of situationsin which ownership of the asset is unclear. If title to the asset exists, for example, ownership generally would bebased on that title.

Question 7.9.7 considers situations in which the federal government holds a reversionary interest in capital assets.It notes that the state or local government that uses these assets in its operations and that makes decisions abouthow the assets will be used should report the asset. A federal government reversionary interest generally is in thesalvage value of the assets.

SLG provides additional guidance on determining ownership. Paragraph 7.16 notes that GASBS No.�6, Accounting

and Financial Reporting for Special Assessments, requires capital assets constructed or acquired with capitalimprovement special assessment debt to be reported as the government's capital assets. Paragraph 7.16 of SLGalso discusses situations in which assets are financed by a �cooperative endeavor," such as between the govern�ment and a developer. In these situations, it suggests that if ownership is conveyed to the government or if

ownership is unclear, the government should report the asset. If ownership remains with the developer or with theproperty owners �and the government simply maintains the assets," the government should not report the assetsas its own. Finally, paragraph 7.17 of SLG notes that the location of infrastructure assets does not by itselfdetermine whether assets should be reported. Unless there is ownership orwhen ownership is unclearthegovernment has the primary responsibility for managing the assets, the government should not report the assetseven if located within their jurisdiction (for example, within a state, county, or city).

Capital Assets Subject to Service Concession Arrangements. Some governments enter into public/privatepartnerships or public/public partnerships to provide service through third parties. The GASB has issued anexposure draft on this topic titled, Accounting and Financial Reporting for Service Concession Arrangements. In aservice concession arrangement, a government transfers to another entity the right and obligation to provideservices using the government's assets and the other entity collects fees from third parties. The principal issuediscussed in the exposure draft is whether the transferring government should continue to report the related capitalasset as its own asset.


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SELF�STUDY QUIZ


1. Before the issuance of GASBS No. 34, Basic Financial Statementsand Management's Discussion and

Analysisfor State and Local Governments, the government of Farnsworth City did not report generalinfrastructure assets. How was this city government affected by the release of GASBS No. 34?

a. The release of GASBS No. 34 has no effect on the city government in this case. It still will not have to reportinfrastructure assets.

b. The city government now must report on infrastructure assets, but GASBS No. 34 has liberal rules forretroactive reporting of infrastructure assets that will apply.

c. Under GASBS No. 34, the city government must now report on infrastructure assets, and its retroactivereporting of these assets must meet the same guidelines as assets reported on in the current year.

2. Two types of capital assets exist for governments. List all of the following statements that are true for general

capital assets?

i. They focus on current financial resourcesmeasurement.

v. Their historical cost is capitalized andreported on the statement of proprietaryfund net assets.

ii. They focus on economic resources mea�surement.

vi. Their historical cost is capitalized andreported on the statement of fiduciary netassets.

iii. Their depreciation expense is reported asan annual allocation of cost, and deprecia�ble capital assets over their estimateduseful lives is used.

vii. They are the default category of a govern�ment's capital assets.

iv. Only the financial resource flows that arisefrom their disposition or acquisition arereported in the governmental fund.

viii. They are reported on in a similar manner toprivate�sector enterprises.

a. i., iv., and vii.

b. i., v., and vi.

c. ii., iv., and viii.

d. iii., vii., and viii.

3. What type of capital assets are stationary in nature and can be maintained in such a way that they can be usedlonger than most other capital assets?

a. Land.

b. Zoo animals.

c. Machinery and equipment.

d. Infrastructure assets.


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4. When funds from many individuals and organizations are used to acquire an infrastructure asset, such as asystem of roads, who would be considered the owner of that capital asset under GASBS No. 34?

a. The entity (government or otherwise) that contributed the most funds to the asset.

b. The government that has the primary responsibility for managing the infrastructure asset.

c. Ownership would be split between all entities that contributed funds to the asset.


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1. Before the issuance of GASBS No. 34, Basic Financial Statementsand Management's Discussion and

Analysisfor State and Local Governments, the government of Farnsworth City did not report generalinfrastructure assets. How was this city government affected by the release of GASBS No. 34? (Page 258)

a. The release of GASBS No. 34 has no effect on the city government in this case. It still will not have to reportinfrastructure assets. [This answer is incorrect. The government of Farnsworth City will be affected by theissuance of GASBS No. 34, and infrastructure assets will have to be reported.]

b. The city government now must report on infrastructure assets, but GASBS No. 34 has liberal rulesfor retroactive reporting of infrastructure assets that will apply. [This answer is correct. Becausegovernments were not required to report general infrastructure assets before GASBS No. 34, theyusually did not. Many such governments also did not maintain historical cost information for generalinfrastructure assets. Therefore, GASBS No. 34 has more liberal rules for reporting on such assetsacquired before GASBS No. 34 was released. The Farnsworth City government will have anextended period of time for retroactively reporting infrastructure assets; its retroactive reporting islimited to only major general infrastructure assets acquired, significantly reconstructed, or thatreceived significant improvements in fiscal years ending after June 30, 1980; and it will be allowedto report estimated historical cost when determining actual historical cost is not practical becauseof inadequate records.]

c. Under GASBS No. 34, the city government must now report on infrastructure assets, and its retroactivereporting of these assets must meet the same guidelines as assets reported on in the current year. [Thisanswer is incorrect. GASBS No. 34 does not require governments to report on retroactive reporting ofinfrastructure assets as strictly as it reports on current�year assets, which will help the Farnsworth Citygovernment if it does not have adequate records of historical cost information.]

2. Two types of capital assets exist for governments. List all of the following statements that are true for general

capital assets? (Page 260)

i. They focus on current financial resourcesmeasurement.

v. Their historical cost is capitalized andreported on the statement of proprietaryfund net assets.

ii. They focus on economic resources mea�surement.

vi. Their historical cost is capitalized andreported on the statement of fiduciary netassets.

iii. Their depreciation expense is reported asan annual allocation of cost, and deprecia�ble capital assets over their estimateduseful lives is used.

vii. They are the default category of a govern�ment's capital assets.

iv. Only the financial resource flows that arisefrom their disposition or acquisition arereported in the governmental fund.

viii. They are reported on in a similar manner toprivate�sector enterprises.

a. i., iv., and vii. [This answer is correct. These three factors are all true of a government's generalcapital assets. General capital assets should be reported in the governmental activities column inthe government�wide statement of net assets.]

b. i., v., and vi. [This answer is incorrect. Capital assets reported in proprietary funds and in fiduciary fundsare reported as described in items v. and vi. General capital assets are not reported in proprietary funds.]


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c. ii., iv., and viii. [This answer is incorrect. Capital assets reported in proprietary funds and in fiduciary funds(the other type of capital asset used by a government) measures both financial and capital resources. Thisis the economic resources measurement focus mentioned in item ii.]

d. iii., vii., and viii. [This answer is incorrect. Items iii. and viii. describe how capital assets reported inproprietary funds and in fiduciary funds are reported. General capital assets are reported in other ways,depending on how they were acquired or disposed of.]

3. What type of capital assets are stationary in nature and can be maintained in such a way that they can be usedlonger than most other capital assets? (Page 260)

a. Land. [This answer is incorrect. Land is a type of capital asset held by governments; however, it does notmatch the description provided in the question above. Improvements to land and land associated withinfrastructure assets are also examples of a government's capital assets.]

b. Zoo animals. [This answer is incorrect. This is a type of capital asset that is held by governments, but it isnot the type described above. By nature, zoo animals are not stationary. Other types of capital assetsgovernments can hold include library books, works of art, and historical treasures.]

c. Machinery and equipment. [This answer is incorrect. Though this is not the type of capital asset describedabove, governments can hold capital assets consisting of machinery and equipment. Other examples ofcapital assets held by governments include vehicles, water rights, and intangible assets.]

d. Infrastructure assets. [This answer is correct. Infrastructure assets are a subset of capital assetsand generally should be reported in the same manner as other capital assets. Although all capitalassets have initial useful lives that extend beyond one reporting period, infrastructure assetsnormally can be preserved for a significantly greater number of years than most other capital assets.That is, infrastructure assets are distinguished from other capital assets because they normally (1)can be maintained in a condition that will allow them to be used longer than most other capital assetsand (2) are stationary in nature. Examples of infrastructure assets include roads, highways, bridges,and tunnels.]

4. When funds from many individuals and organizations are used to acquire an infrastructure asset, such as asystem of roads, who would be considered the owner of that capital asset under GASBS No. 34? (Page 260)

a. The entity (government or otherwise) that contributed the most funds to the asset. [This answer is incorrect.Under GASBS No. 34, the amount of funds contributed is not the deciding factor for determining theownership of an infrastructure asset.]

b. The government that has the primary responsibility for managing the infrastructure asset. [Thisanswer is correct. Based on the information provided in Footnote 67 of GASBS No. 34, governmentswith the primary responsibility for managing an infrastructure asset should report that asset.]

c. Ownership would be split between all entities that contributed funds to the asset. [This answer is incorrect.One entity will hold ownership of the infrastructure asset, and that entity will be responsible for reportingthat asset.]


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CAPITAL ASSET VALUATION (OTHER THAN INTANGIBLES)

Valuation of Capital Assets Other Than IntangiblesTHE BASICS

� Most capital assets should be valued at historical cost or estimated historical cost, includingancillary costs incurred to get the asset ready for use.

� Only enterprise fund and business�type activity capital assets should include capitalizedinterest as a component of historical cost.

� Donated capital assets should be valued at their estimated fair value at the time of acquisition.

� Special provisions apply to assets used for environmental purposes.

� Capital assets transferred between the funds of a primary government should not be revalued.They should be reported by the recipient fund at their depreciated historical cost at the timeof transfer.

GASBS No. 34 was the first GASB standard to address capital assets in their entirety. GASBS No. 34, paragraph 19,listed �intangible assets" as one example of capital assets. However, the GASB did not originally define intangibleassets or provide guidance on identifying those assets or measuring their historical cost. GASBS No. 51, Account�

ing and Financial Reporting for Intangible Assets, provides that guidance. This course includes the valuationrequirements of GASBS No. 51 in the section that discusses the valuation of intangible assets. GASBS No. 51,paragraph 5, provides that intangible assets should be reported using the existing guidance for capital assets,including recognition, measurement, depreciation (termed amortization for intangible assets), impairment, presen�tation, and financial statement disclosures.

Historical Cost

In accordance with GASBS No. 34, paragraph 18, all capital assets should be reported at their historical cost.Historical cost is the amount of resources the government spends to purchase or construct a capital asset as wellas the fair value of any donated components. Historical cost should include ancillary charges necessary to placethe asset into its intended location and condition for use. GASBS No. 34, paragraph 18, states that �ancillarycharges include costs that are directly attributable to asset acquisitionsuch as freight and transportation charges,site preparation costs, and professional fees."

The GASB Comprehensive Implementation Guide2009, Question 7.12.17, notes that when capital assets are�purchased" for $1, the purchase does not meet the definition of an exchange transaction. The asset acquired is adonated asset and should be reported at its estimated fair value at the date it was contributed.

Paragraph 7.14 of SLG discusses situations in which additional costs are incurred after a capital asset is placed inservice. It suggests that guidance provided in the GASB Comprehensive Implementation Guide2009 for infra�structure assets reported using the modified approach should also apply to all other capital assets. That is,expenditures that extend the life of the infrastructure asset beyond its initial estimated useful life or that improve itsefficiency or capacity should be added to the asset's historical cost. Expenditures that do not meet these testsshould be reported as repairs/maintenance expense.

Acquisition by Capital Lease. Governments may choose to lease, rather than purchase, certain assets becauseof debt limitations, budgetary constraints, or the costs and time required to authorize, negotiate, and obtain debtfinancing. Subject to the accounting effects of using the modified accrual basis of accounting in governmentalfunds, the provisions of FASB Statement No. 13, Accounting for Leases, as amended by FASB pronouncementsissued on or before November 30, 1989 (GASB Cod. sec. L20), apply to governmental capital and operating leasetransactions. (Enterprise funds may choose to apply FASB amendments issued after November 30, 1989.

Capitalized Interest Cost. FASB Statement No. 34, Capitalization of Interest Cost (and related FASBS Nos. 42, 58,and 62) should be applied only to capital assets specifically related to enterprise funds (business�type activities).GASBS No. 37, paragraphs 6 and 7, amend GASBS No. 34, and have the effect of excluding interest cost as a


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component of the cost of general capital assets. The application of FASBS No. 34 and related pronouncements toenterprise funds and business�type activities are discussed later in this lesson.

Estimated Historical Cost

If documents related to the original purchase or construction of capital assets are not available, historical cost may,as a practical matter, be estimated based on available information. For example, assume that a governmentconducted a capital asset inventory and discovered that certain assets acquired five years ago had not beenrecorded. One method of establishing the original cost would be to contact the vendor, if known, for relevantinformation. Another method would be to determine the current cost of similar equipment from vendors, outsidecontractors, or appraisal firms and deduct an amount for price inflation during the past five years. If no externalinformation is available, then governmental employees, such as purchasing agents, engineers, etc., may need toestimate the original cost or value based on experience and knowledge of similar assets. Special provisions applyto general infrastructure assets acquired prior to the effective dates of GASBS No.�34.

Donated Capital Assets

If a government receives a donation of a capital asset, the asset has no purchase or construction cost. However, itsvalue is still important to financial statement users and the donated asset should be reported at its estimated fairvalue at the time of acquisition plus ancillary charges incurred to put the asset in service, if any. (GASBS No. 33governs when contributions of capital assetsnonexchange transactionsshould be recognized.) Fair value is theamount the asset could be exchanged for in a current transaction between willing parties other than in a forced orliquidation sale. Question 7.9.4 of the GASB Comprehensive Implementation Guide2009 indicates that fair valueat acquisition may be estimated using manufacturers' catalogs or price quotes in periodicals, recent sales ofcomparable assets, or other reliable information. In some instances, governments may estimate fair value based onactual construction costs incurred by the entity contributing the assets. For example, a developer required tocontribute newly constructed infrastructure assets to a government may provide information about the cost of thoseassets, including the cost of right�of�way. However, if contributed assets have been in use for some time, costsincurred by the entity contributing the assets may not be a fair representation of estimated fair value at the time ofthe donation. The GASB has provided separate guidance on the valuation of donated intangible assets. Donatedand purchased easements are required to be reported separately from physical infrastructure assets, as discussedin the GASB Comprehensive Implementation Guide2009, Question 7.12.6. The GASB Comprehensive Imple�

mentation Guide2009, Question 7.21.11, notes that for contributed general infrastructure assets reported for thefirst time under GASBS No. 34, fair value should be as of the date those assets were donated, not the date whenGASBS No. 34 was implemented. Determining fair value does not necessarily require professional assistance.

Capital Assets Acquired with Grants, Contributions, and Other Nonexchange Transactions

According to GASB Cod. sec. 1400.137, capital assets acquired by grants, contributions, and other nonexchangetransactions (including special assessments) should be reported at historical cost, with related revenues reportedin the appropriate fund type and in the government�wide statement of activities.

Assets Used for Environmental Purposes

The GASB has two standards that address assets used for environmental purposes that are normally consideredcapital assets. GASB Statement No. 18, Accounting for Municipal Solid Waste Landfill Closure and Postclosure

Care Costs, provides that equipment expected to be used exclusively in postclosure operations should be includedas part of the estimated current cost of landfill closure and postclosure care, instead of being capitalized anddepreciated. Capital assets that are used as part of the landfill's operation should be fully depreciated by the timethe landfill stops accepting waste.

GASB Statement No. 49, Accounting and Financial Reporting for Pollution Remediation Obligations, paragraph 22,describes four situations in which equipment and other assets normally considered to be capital assets should becapitalized rather than being expensed when acquired as part of settling a pollution remediation obligation. TheGASB Comprehensive Implementation Guide2009 provides new guidance for pollution remediation assets builtaround previously constructed assets, such as sound barriers around existing highways. Question 7.12.10 requires


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that unless these costs are incurred as part of a pollution remediation obligation included in the scope of GASBSNo. 49, these assets should be capitalized if they meet the definition of a capital asset.

Foreclosures

Capital assets received as a result of tax or special assessment foreclosures should be valued at the lower ofappraised value or the book value of the tax receivable, including any penalties, interest, and foreclosure costs.

Eminent Domain

When a government is not able to acquire certain property through a normal purchase or lease transaction, it maypursue ownership through a judicial procedure known as eminent domain. A government normally does notexercise this power unless it seriously needs the property. Eminent domain might be used, for example, if aparticular piece of land is needed on which to construct a street or highway and the owner is not willing to sell theproperty. Property acquired by eminent domain usually is assigned a value by the court and the governmentcompensates the owner by that amount, which becomes the historical cost of the asset.

Intrafund and Intra�entity Transfers

GASBS No. 48 Requirements. GASBS No. 48, Sales and Pledges of Receivables and Future Revenues and

Intra�entity Transfers of Assets and Future Revenues, requires capital assets transfers or purchases/sales betweenthe primary government and one of its component units or between component units of the same financialreporting entity to be reported at the transferor's carrying value. This requirement is without regard to whether thecomponent unit is blended or discretely presented. If the historical cost of the transferred asset is less than thetransferor's capitalization threshold, however, the asset should be reported at zero regardless of the capitalizationthreshold of the fund/component unit receiving the asset, as discussed in the GASB Comprehensive Implementa�

tion Guide2009, Question Z.48.4. This would be true even if the fund or component unit receiving the asset paidan amount for the asset, as discussed in Question Z.48.6. Although GASBS No. 48, paragraph 15, addresses thissituation for intra�entity transfers of capital assets, the same accounting treatment applies for transfers of assetsbetween funds of the primary government, as discussed in the GASB Comprehensive Implementation

Guide2009, Question Z.48.5. In addition, Question 7.9.9 states that the recipient should record the transferredasset at historical cost (or fair value for contributed assets) and separately record accumulated depreciation. Forcapital assets transferred to governmental funds, the historical cost would be recorded in the government's generalcapital assets ledger.

Carrying Value and Capitalization Threshold. Depending on the transferor's capitalization threshold, the carryingvalue of a transferred asset can be either (a) historical cost less accumulated depreciation or (b) zero. A zerocarrying value occurs when the historical cost to acquire an asset is lower than the transferor's then�currentcapitalization threshold.

In the simplest scenario, assume both the recipient and the transferring fund have the same capitalization thresholdand that the historical cost of the transferred assets is more than that threshold. Journal entries to record thetransfer (reclassification) from an enterprise fund to a general governmental activity (general captial assetsaccounts) would be as follows:

Golf Enterprise Fund

Nonoperating expense 2,176,000

Accumulated Depreciation 72,000

Land $ 1,300,000

Equipment 948,000

(To record the transfer of capital assets to governmental activities.)

GASB Comprehensive Implementation Guide2009, Question 7.74.4, indicates that a business�type activity givingup a capital asset to a governmental activity would report nonoperating expense equal to the carrying value of the


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reassigned, assets (i.e., transferred). There would be no governmental fund entry to record the event since there isno flow of current financial resources. Rather, the City would record the receipt of assets as an addition to its generalfund assets accounts.

General Capital Assets Accounts

Land $ 1,300,000

Equipment 948,000

Accumulated depreciation 72,000

(To record the receipt of transferred capital assets from the Golf Enterprise Fund in the General Capital Assets Accounts.)

In a more complex scenario, assume the carrying value of the land was zero based on the transferring fund'scapitalization threshold of $1.5 million, but that the recipient's capitalization threshold for land is $10,000. Absentany cash payments (see below), no entry would be required to record the transfer of the land. Even though the costof the land would have met the recipient's capitalization threshold, the land's carrying value for the transferring fundis zero. The expense of acquiring the land was already reported (written off) in a previous period. Capitalizing thatcost when the asset is transferred to another fund wouldin effectrecognize the cost of that asset twice in theentity's financial statements.

In a third scenario, assume that the carrying value of the transferred land is $1.3 million, the transferring fund'scapitalization threshold is $1.25 million, and the recipient fund's capitalization threshold for land is $1.5 million. Inthis situation, the land would be transferred at the transferring fund's carrying value but would be written off as agovernmental activity expense in the government�wide statement of activities by the recipient.

Capitalized Interest on Capital Assets Transferred From Business�type Activities to Governmental Activities.Proprietary funds and business�type activities are required to capitalize interest expense as a component of thecost of certain capital assets. Governmental activities, on the other hand, are prohibited from capitalizing interest oncapital assets. The GASB Comprehensive Implementation Guide2009, Question 7.10.4, provides that capitalizedinterest should not be eliminated from the historical cost of an asset reassigned from a business�type activity to agovernmental activity.

Interfund and Intra�entity �Purchases." Finally, component units and funds sometimes �pay" for transferredcapital assets. As discussed in Question Z.48.6, this payment does not change the carrying value of the transferredasset. Instead, the capital assets should be recorded as described above and the amount �paid" should bereported as an expenditure (governmental fund)/expense (proprietary fund)/transfer (between funds of the primarygovernance) by the paying fund or component unit and as a revenue (governmental and proprietary funds)/transfer(between funds of the primary governance) by the fund or component unit receiving payment. (The classification ofthe payment depends on the whether the payment is being reported at the fund level and whether the componentunit is blended or discretely presented. The net effect on the entity is zero. Capitalizing the asset at anything otherthan carrying value would have the effect of reporting an additional cost for the same asset in the entity's financialstatements.

Impairments of Capital Assets

GASB Statement No. 42, Accounting and Financial Reporting for Impairment of Capital Assets and for Insurance

Recoveries, requires governments to write off a portion of the historical cost of capital assets in specified circum�stances.

Capitalization Thresholds

Although governments normally create an inventory that lists every capital asset acquired or constructed, mostreport for GAAP purposes only those assets that exceed a specified cost or capitalization threshold. For example,a government may report every capital asset with a historical cost of more than $5,000. Governments may usedifferent capitalization threshold for different types of assets. In addition, governments may use different thresholds


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for compliance with laws and regulations, such as OMB circulars for federal programs. Some grant regulationsprohibit capitalization thresholds in excess of specified dollar amounts. No specific guidance exists in GAAP onsetting capitalization policies. However, preparers of GAAP financial reports may wish to consider materialitythresholds for government�wide and major fund reporting when establishing capitalization thresholds. Govern�ments should disclose the capitalization policies that they use for GAAP reporting purposes in their summary ofsignificant accounting policies. Governments that are uncertain whether a particular asset should be reported as acapital asset should answer two questions:

� Does the asset have an initial useful life that extends beyond a single reporting period?

� Does the historical cost of the asset equal or exceed the government's GAAP capitalization policy orthreshold?

If the answers to both questions are �yes," the asset is a capital asset that should be reported in the statement of netassets. Special provisions apply to collections of works of art or historical treasures as discussed later in thislesson.

The GASB Comprehensive Implementation Guide2009, Question 7.22.17, states that a change in a government'scapitalization threshold does not constitute a change in accounting principle. Only accounting changes should bereported by restating beginning fund or net asset balances, as discussed in APBO No. 20, Accounting Changes.

In PPC's Governmental Financial Statement Illustrations and Trends (GFT), it is noted that several governmentsestablished a capitalization policy that was based not only on the cost of a new asset, but also on its useful life. Forexample, one government capitalized all assets that cost $5,000 or more and that had useful lives of at least twoyears. Others used three and even five years. This course maintains that using a threshold that requires a useful lifeof two or more years is not a GAAP presentation.

As noted in the GASB Comprehensive Implementation Guide2009, Question 7.9.8, capitalization policies shouldensure that all material capital assets, collectively, are reported. That Question notes that while some assetsindividually may be below threshold amounts, collectively they are material to the governmental entity. Examplesprovided include computers, classroom furniture, and library books.

Capital Asset Inventories. An asset may not meet a government's capitalization threshold for financial reportingpurposes. However, governments should continue to keep a record (inventory) of all assets for stewardship andcontrol purposes.

GFOA Recommended Practices. Governments that wish to participate in the GFOA Certificate of Achievement forExcellence in Financial Reporting need to be aware of GFOA recommended practices on accounting and financialreporting. GFOA recommendations on capitalization thresholds (revised in 2006) include the following:

� Assets should be capitalized only if they have a useful life of at least two years.

� Thresholds should be applied to individual assets, not groups of similar assets, unless doing so eliminatesan entire class of assets, such as library books.

� Thresholds should not be less than $5,000 for any type of capital asset.

� Governments that are recipients of federal awards should be aware that federal requirements establishmaximum capitalization thresholds for reimbursement purposes. The current maximum is $5,000.

GFOA Recommended Practices can be downloaded at www.gfoa.org/services/rp/.


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INTANGIBLE ASSET VALUATION

Valuation of Intangible AssetsTHE BASICS

� Intangible assets are a subset of capital assets that lack physical substance, are nonfinancialin nature, and have estimated useful lives extending beyond a single reporting period.

� Intangible assets are recognized in the financial statements only if they are identifiable.

� Except for the specialized measurement requirements discussed in this section, all GAAP forcapital assets apply to intangible assets (including measurement, recognition, depreciation/amortization, impairment, and disclosures).

� Special measurement considerations apply to internally generated intangible assets.

GASBS No. 51, Accounting and Financial Reporting for Intangible Assets, was issued in June 2007. It will beeffective for governmental financial statements for periods beginning after June 15, 2009.

GASBS No. 34, paragraph 19, listed �intangible assets that are used in operations" as one example of capitalassets. As discussed in this course, GASBS No. 34 requires all capital assets to be reported in government�widefinancial statements and in the financial statements of proprietary and fiduciary funds and similar special�purposegovernments. However, the GASB did not originally define intangible assets or provide guidance on identifyingthose assets or measuring their historical cost.

Scope of Standard

GASBS No. 51 is applicable to identifiable intangible assets except for these assets:

a. Intangible assets that are purchased or created primarily to generate income, such as a copyright. Stateddifferently, intangible assets that are not used in a government's operations in the same way as other capitalassets generally should be considered investments. (GASBS No. 51, BFC paragraphs 43 and 44)

b. Assets resulting from lessee capital lease transactions.

c. Goodwill created by one governmental entity combining with another entity. Goodwill should be reportedin accordance with APBO 16, Business Combinations, and APBO 17, Intangible Assets.

d. Intangible assets created through statutes or the inherent nature of governmentsuch as the power to tax,the right of eminent domain, the power to regulate or to require permits or licenses.

The GASB Comprehensive Implementation Guide2009, Question Z.51.6, stresses that the primary use of anintangible asset should govern whether it is measured based on this section or as an investment. An intangibleasset may be used for both purposes. Governments may need to consider the estimated service life of that asset.For example, if the asset will be useful longer as an investment, then it may need to be reported as an investment,not as an intangible asset.

Although criterion �a" above seems to rule out reporting purchased water rights as an intangible asset, the GASBComprehensive Implementation Guide2009, Question Z.51.5, clarifies that any income or profits generated bywater rights used in a utility's operations are generated by that activity's overall operations. However, water rightspurchased for trading purposes, not for operating purposes, would be investments, not intangible assets.

Defining Intangible Assets

GASBS No. 51, paragraphs 2 and 6, define the type of intangible assets that should be reported with capital assetsin the basic financial statements. The GASB relies in part on its definition of an asset, established in GASB ConceptsNo. 4, Elements of Financial Statements. Paragraph 8 of that Concepts Statement defines assets as �resources withpresent service capacity that the government presently controls." A resource is �an item that can be drawn on to


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provide services to the citizenry" (paragraph 6). Finally, the present service capacity of an asset is its �existingcapability to enable the government to provide services, which in turn enables the government to fulfill its mission"(paragraph 9).

In addition to meeting this definition, an intangible capital asset must have all of these four characteristics for theasset to be reported in governmental financial statements:

a. The Asset Must Lack Physical Substance. Modes of containment should not be confused as physicalsubstance. For example, computer software exists on a CD and rights of way are closely associated withland. However, containers and associated assets should not be considered when determining whether anintangible asset lacks substance.

b. The Asset Must Be Nonfinancial in Nature. That is, cash, investments, receivables, and prepayments orother claims to financial resources are not intangible assets.

c. The Asset Must Have a Life Extending Beyond at Least a Single Reporting Period.

d. The Asset Must Be Identifiable. As provided in GASBS No. 51, paragraph 6, to be identifiable, an intangibleasset must meet either one of these two criteria:

(1) The asset is separable, that is, the asset is capable of being separated or divided from the governmentand sold, transferred, licensed, rented, or exchanged, either individually or together with a relatedcontract, asset, or liability.

(2) The asset arises from contractual or other legal rights, regardless of whether those rights aretransferable or separable from the entity or from other rights and obligations.

Examples of intangible capital assets provided in GASBS No. 51, including its Appendix CIllustrations, includewater rights, right�of�way easements or land use rights, internally generated patents, internally generated computersoftware, trademarks, and copyrights.

Classification

Intangible assets within the scope of GASBS No. 51 are capital assets. All GAAP requirements for measurement,recognition, capitalization of interest, impairment, disclosures, and so forth for capital assets should be applied tointangible capital assets. For financial presentation purposes, intangible assets are a separate class of capitalassets and may need to be further classified based on their nature and usage. For example, mineral rights andcomputer software should be considered separate major classes of capital assets, when material. But, water rights,mineral rights, and timber rights are all land use rights and could be reported as a single �land use rights" majorclass of capital assets, as discussed in the GASB Comprehensive Implementation Guide2009, Question Z.51.29.This course discusses the accounting and reporting requirements for capital assets. Measurement and amortiza�tion peculiar to intangible capital assets are discussed in the remainder of this section.

GASBS No. 51 requires governments to report a separate asset category for right�of�way easements associatedwith infrastructure assets, as discussed in the GASB Comprehensive Implementation Guide2009, Question7.12.6. This segregation is not required to be made retroactive to the adoption of GASBS No. 51.

RecognitionGovernment�wide and Proprietary Fund Financial Statements

With the exception of internally generated intangible assets, capital intangible assets should be reported at theirhistorical cost, as described previously. Capitalization of the costs of internally generated intangible assets islimited, as discussed beginning in the �Impairment" paragraph.

All donated capital assets, including intangible assets, should be reported at their fair value at the date of donation.GASBS No. 51, BFC paragraph 75, suggests that donated, permanent right�of�way easements should be valued atthe fair value of the associated land �because the landowner is left with little or no use for the associated land." TheGASB Comprehensive Implementation Guide2009, Question 7.12.6, notes that other reasonable methodologiesmay be used; however, arbitrarily assigning a nominal value to the intangible asset would not be appropriate.


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AmortizationAllocating the Cost of Intangible Assets to Periods. The useful life of an intangible asset is notlimited by deteriorationit has no physical substance. However, the usefulness of many intangible assets is limitedby the life of associated contracts, laws (such as copyright laws), or regulations. When the cost of intangible capitalassets is allocated to operating periods, the allocation is called �amortization." If the life of an intangible asset islimited by contract or regulation, the asset should be amortized over the life of the contract or associated legalprovisions. Evidence in this case should consider the willingness of third parties to renew the contract or the abilityto reengage associated regulations such as copyright laws.

Indefinite�lived Intangible Assets. If there are no legal, contractual, regulatory, technological, or other factors thatlimit the life of an intangible capital asset, the asset has an indefinite useful life and should not be amortized. Aneasement purchased as part of a highway system is a good example of an indefinite lived asset. Computersoftware, on the other hand, always has a limited life. Even if the government has difficulty estimating that life, itshould always be considered finite, as discussed in the GASB Comprehensive Implementation Guide2009,

Question Z.51.24.

RecognitionGovernmental Funds

Costs associated with general intangible assets should be reported as expenditures in governmental funds whenincurred.

Impairment

Like all capital assets, intangible capital assets are subject to impairment. Some common impairments of waterrights, for example, are dam breakage, chemical pollution, or other reservoirs being constructed in the vicinity,which temporarily or permanently reduce available supplies. GASBS No. 42, Accounting and Financial Reporting

for Impairment of Capital Assets and for Insurance Recoveries (GASB Cod. sec. 1400), as amended, applies tointangible capital assets. GASBS No. 51, paragraph 18, amended GASBS No. 42 by adding development stop�page to the list of GASBS No. 42 impairment indicators and requiring that assets impaired by a developmentstoppage should be measured at the lower of carrying value or fair value.

Internally Generated Intangible Assets

GASBS No. 51 gives special measurement/recognition guidance for intangible assets that are internally generatedand that will be used in the government's operations. An intangible assetone that meets the four essentialcharacteristics discussed in the �Defining Intangible Assets" paragraphis internally generated if the asset iseither:

a. Created or produced by the government's personnel or by a third party contractor on behalf of thegovernment, or

b. Acquired from a third party but the government must make more than a minimal effort to modify the assetso that it achieves its expected level of service capacity.

The costs of a project to create an internally generated asset should be capitalized only once the government (itspersonnel) has been able to meet all of these three milestones:

a. The government determines the specific objective of the project and the nature of the service capacity thatit expects the project to provide once it is completed.

b. The government is able to demonstrate the technical or technological feasibility of completing the projectwith the capacity planned in item a.

c. The government demonstrates the current intention, ability, and presence of effort to complete or, for largeror multi�year projects, continue developing the intangible asset.

Any costs incurred before these three milestones have been met should be expensed when incurred. The GASBComprehensive Implementation Guide2009, Question Z.51.10, suggests that evidence of a government's currentintention, ability, and presence of effort can be found, for example, in the following:


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� Committing resources for the project in budgets.

� Discussing the project in strategic planning documents.

� Committing with external parties to assist in creating the asset.

� Hiring or assigning specific personnel to work on the project.

� Seeking to secure the government's legal rights to the results of the project, such as a copyright ortrademark.

Legal costs incurred to successfully defend the rights embodied in an intangible asset, such as a patent, should notbe capitalized, as discussed in the GASB Comprehensive Implementation Guide2009, Question Z.51.20,because those costs only allow the asset to continue to be used over its original useful life.

Computer Software. One of the most common types of internally generated intangible assets is computersoftware. Because of its nature, the GASB also provides a second set of criteria to help governments determinewhether the three milestones in the previous paragraph have been met. The definition of internally generated

discussed previously applies. The second scenario in that definition is more common than the first. Governmentsoften purchase commercial software and modify it to add special reporting capabilities. However, purchasedcommercial computer software placed into operation with minimal effort is not internally generated. It should bereported at cost, as discussed in the next section.

GASBS No. 51, paragraph 10, notes that developing and installing internally generated computer software,including the government's website, consists of three stages:

a. Preliminary Project Stage. Activities in this stage include the conceptual formulation and evaluation ofalternatives, the determination of the existence of needed technology, and the final selection of alternativesfor the development of the software.

b. Application Development Stage. Activities in this stage include the design of the chosen path, includingsoftware configuration and software interfaces, coding, installation to hardware, and testing, including theparallel processing phase. This stage includes data conversion only if it is necessary to make the softwareready to use. Normally, it is part of the post�implementation stage. Training for employees who will developinternally generated software should not be capitalized as a part of the cost of internally generated software,nor should business process reengineering activities, as discussed in the GASB Comprehensive

Implementation Guide2009, Questions Z.51.15 and Z.51.17.

c. Postimplementation/Operation Stage. Activities in this stage include application training and softwaremaintenance.

GASBS No. 51, paragraph 11, states that the three milestones for capitalizing the costs of a project to create aninternally generated asset should be considered to be met for computer software only once both of the followingoccur:

a. The activities noted in the preliminary project stage are completed.

b. Management implicitly or explicitly authorizes and commits to funding, at least currently (in the case of amultiyear project), the software project.

Based on these requirements, all costs associated with the preliminary project stage should be expensed asincurred.

The GASB Comprehensive Implementation Guide2009, Question Z.51.13, lists the following specific tasks com�monly performed during the preliminary project stage for internally generated computer software:

� Making decisions to allocate resources between alternative projects at a given point in time.


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� Determining the performance/user needs for the computer software project.

� Determining the systems requirements for the software project and whether the technology needed toachieve those requirements exists.

� Exploring alternative methods of achieving the required performancefor example, by evaluating whetherinternal development of the computer software would be more beneficial than modifying commerciallyavailable software.

� Choosing a vendor, if commercially available software will be acquired.

� Selecting a consultant to help develop or install the software.

When a project begins with commercially available software and will be modified to the point that it is consideredinternally generated, GASB No. 51, paragraph 11, states that the events in the previous paragraph should beconsidered to have occurred when the government commits to purchase or license the software.

Once the three milestones have been met

� Costs related to activities in the application development stage should be capitalized.

� Capitalization should stop no later than when the software is substantially complete and operational.

� Costs incurred after that point should be expensed as incurred.

It is possible that the development stages for internally generated software may occur in a different sequence thanthe preliminary project stage, application development stage, and postimplementation/operation stage discussedpreviously. This should not affect the costs that are capitalized. GASBS No. 51, paragraph 14, stresses that it is thenature of the activities done in the application/development stage that require capitalization, not their timing. Forexample, outlays associated with application training activities that occur during the application development stageshould be expensed as incurred.

Some software systems, such as enterprise resource planning (ERP) systems consist of a series of modules; forexample, procurement, human resources, and financial reporting. The GASB Comprehensive Implementation

Guide2009, Question Z.51.12, suggests that when each module has its own development cycle, the guidance fordetermining the cost of internally generated software should be applied separately to each module.

Modifications of Software Already in Use. Costs associated with modifying computer software that is already inuse, for example, to make the software compatible with new systems, should be capitalized based on guidance inthe above paragraphs, if the modification results in one of the following:

a. An increase in the functionality of the computer software, that is, the computer software is able to performtasks that it was previously incapable of performing.

b. An increase in the efficiency of the computer software, that is, an increase in the level of service providedby the computer software without the ability to perform additional tasks.

c. An extension of the estimated useful life of the software.

When a government modifies its software outside of these three situations, the modification is maintenance and therelated costs should be expensed as incurred.

Effective Date and GASBS No. 34

The GASB generally requires the provisions of GASBS No. 51 to be applied retroactively for financial statements forperiods beginning after June 15, 2009, by restating financial statements for all periods presented, if practical. Thisis a fairly lengthy implementation period compared to the Statement's June 2007 issuance date. However, govern�


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ments have never been required to capture the cost of intangible assets, particularly software assets, for capitaliza�tion purposes. In addition, before now, most governments have reported certain intangible assets, such aseasements and rights of way, as part of the cost of other tangible capital assets. For this reason, the GASB hasprovided several implementation options, including:

a. Governments are not required to retroactively report intangible assets that have indefinite useful lives at theeffective date of Statement 51. This includes separate reporting of right�of�way or land use rights associatedwith property already owned, as discussed in GASB Comprehensive Implementation Guide2009,

Question Z.51.30. Retroactive application is permitted. However, unlike GASBS No. 34, retroactivereporting is not an all or nothing situation. Governments may retroactively report only the indefinite livedassets for which it has adequate records to determine or estimate historical costs, as discussed in QuestionZ.51.31. When significant, governments should discuss their policy for retroactive reporting in theirsummary of significant accounting policies.

b. Governments are not required to retroactively apply GASBS No. 51 to internally generated intangibleassets, such as computer software. Retroactive application is permitted, however, but not likely. Forexample, most governments will find it impossible to identify these internally generated software costsretroactively or to determine the date when all criteria for capitalization were met. Governments mayretroactively report only the indefinite lived assets for which it has adequate records to determine orestimate historical costs, as discussed in Question Z.51.32. When significant, governments should discusstheir policy for retroactive reporting in their summary of significant accounting policies.

c. For all other intangible assets, phase 1 and phase 2 governments may estimate their historical cost andneed only make estimates for those acquired after June 30, 1980. For phase 3 governments, retroactiveapplication is encouraged for all intangible assets, but not required. This is the same phases concept usedfor retroactively reporting major general infrastructure assets.

d. Governments should capitalize software modification costs prospectively when the criteria in the�Modifications of Software Already in Use" paragraph are met, even if the original cost of the software wasnot capitalized at transition, as discussed in the GASB Comprehensive Implementation Guide2009,

Question Z.51.35.

GASBS No. 51 also provides special provisions for retroactive amortization of newly reported intangible assets.These detailed provisions, discussed in the GASB Comprehensive Implementation Guide2009, QuestionZ.51.34, are as follows:

a. Changes in the useful lives of intangible assets resulting from applying GASBS No. 51 should be appliedretroactively, not prospectively. For example, an intangible asset previously being amortized over a 40�yearlife but determined to have a 15�year life under GASBS No. 51 should be reported retroactively using the15�year life.

b. Previous amortization should be reversed retroactively for governments that had previously amortizedintangible assets but that are considered to be indefinite�lived at the effective date of GASBS No. 51.

c. However, GASBS No. 51 should not be applied to intangible assets that are determined to have finite livesat the effective date of GASBS No. 51, but that were previously considered to be indefinite�lived.


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SELF�STUDY QUIZ


5. Define historical cost.

a. Costs that can be directly attributed to asset acquisition, including transportation charges, freight,professional fees, and costs for site preparation.

b. The cost amount estimated for a capital asset when documentation related to the original construction orpurchase of the asset are not available.

c. The amount of resources a government must spend to construct or purchase a capital asset, includingancillary charges, and the fair value of any components that were donated.

d. Costs applied to capital assets when they are specifically related to business�type activities (enterprisefunds).

6. What type of capital asset should a government value at the lower of the book value or the appraised value ofthe tax receivable?

a. Assets received in a foreclosure.

b. Assets acquired by grant.

c. Assets that were donated.

7. An intangible asset must have four characteristics to be reported in a government's financial statements. Whichof the following is one of those characteristics?

a. The asset must have physical substance.

b. The asset must be financial in nature.

c. The asset's life must extend for at least five reporting periods.

d. The asset must be identifiable.

8. When would costs of modifying computer software already in use be capitalized by the government?

a. When functionality is increased.

b. When efficiency is decreased.

c. When the estimated useful life is maintained.


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5. Define historical cost. (Page 267)

a. Costs that can be directly attributed to asset acquisition, including transportation charges, freight,professional fees, and costs for site preparation. [This answer is incorrect. This is the definition of ancillary

charges associated with capital assets. Ancillary charges include all charges necessary to place the assetinto its intended location and condition for use.]

b. The cost amount estimated for a capital asset when documentation related to the original construction orpurchase of the asset are not available. [This answer is incorrect. This describes estimated historical cost.When the documentation described above is unavailable, governments may estimate historical cost.]

c. The amount of resources a government must spend to construct or purchase a capital asset,including ancillary charges, and the fair value of any components that were donated. [This answeris correct. This is how GASBS No. 34 defines historical cost. According to paragraph 18 of GASBSNo. 34, all capital assets should be reported at their historical cost.]

d. Costs applied to capital assets when they are specifically related to business�type activities (enterprisefunds). [This answer is incorrect. This describes capitalized interest cost. FASB Statement No. 34,Capitalization of Interest Cost, and the related FASB statements, should only be applied to capital assetsspecifically related to enterprise funds (business�type activities). GASBS No. 37 amends GASBS No. 34to exclude interest cost as a component of the cost of general capital assets.]

6. What type of capital asset should a government value at the lower of the book value or the appraised value ofthe tax receivable? (Page 269)

a. Assets received in a foreclosure. [This answer is correct. Capital assets received as a result of taxor special assessment foreclosures should be valued at the lower of appraised value or the bookvalue of the tax receivable, including any penalties, interest, and foreclosure costs per GASBStatement No. 34.]

b. Assets acquired by grant. [This answer is incorrect. This type of asset should be reported at historical cost,with related revenues reported in the appropriate fund type and in the government�wide statement ofactivities per GASB Code Sec. 1400.21. This is also true of assets acquired by contribution or anothernonexchange transaction.]

c. Assets that were donated. [This answer is incorrect. A donated asset should be reported at its estimatedfair value at the time of acquisition plus ancillary charges incurred to put the asset in service, if any. Fairvalue is the amount the asset could be exchanged for in a current transaction between willing parties otherthan in a forced or liquidation sale.]

7. An intangible asset must have four characteristics to be reported in a government's financial statements. Whichof the following is one of those characteristics? (Page 273)

a. The asset must have physical substance. [This answer is incorrect. To qualify as an intangible asset, theasset must lack physical substance per GASB No. 51. Modes of containment should not be confused asphysical substance.]

b. The asset must be financial in nature. [This answer is incorrect. Actually, to qualify as an intangible asset,it must be nonfinancial in nature according to GASB No. 51. Cash, investments, receivables, andprepayments or other claims to financial resources are not intangible assets.]

c. The asset's life must extend for at least five reporting periods. [This answer is incorrect. To be consideredan intangible asset as described in GASB No. 51, the asset's life only has to extend beyond at least a single

reporting period.]


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d. The asset must be identifiable. [This answer is correct. To be identifiable according to GASB No. 51,an asset must either (1) be separable or (2) arise from contractual or other legal rights.]

8. When would costs of modifying computer software already in use be capitalized by the government?(Page 276)

a. When functionality is increased. [This answer is correct. There are three situations when agovernment should capitalize the costs associated with modifying computer software already inuse. One of those situations is when, after the modifications, the software is able to perform tasksthat it was previously incapable of performing.]

b. When efficiency is decreased. [This answer is incorrect. If there is an increase in the level of serviceprovided by the computer software without the ability to perform additional tasks, the costs would becapitalized.]

c. When the estimated useful life is maintained. [This answer is incorrect. The costs would not be capitalizedif the estimated useful life was maintained at the same level, but they would be capitalized if the estimateduseful life of the software was extended.]


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DEPRECIATION EXPENSE AND ESTIMATING USEFUL LIVES

Useful Lives and Depreciation ExpenseTHE BASICS

� GAAP do not prescribe the estimated useful lives of capital assets. A number of factors shouldbe considered in assigning estimated lives to assets.

� Governments may use any of a wide range of depreciation methods.

The accrual basis of accounting requires that the cost of capital assets be allocated over their useful lives. Thisallocation is called depreciation expense (including amortization expense, in the case of intangible capital assets).It involves assigning a useful life to the asset (that is, the amount of time that the government expects to be able touse the asset) and charging a portion of the historical costless salvage or residual valueto each period of thatestimated useful life. Residual or salvage value is the estimated fair value of a capital asset that remains at theconclusion of its estimated useful life (for example, what it could be sold for scrap). Question 7.13.3 of the GASBComprehensive Implementation Guide2009 notes that infrastructure assets, in most cases, will have no residualvalue due to the cost of demolition or removal. Inexhaustible capital assets, such as land and land improvements,and infrastructure assets reported under the modified approach are not depreciated as discussed in Lesson 2.

Depreciation expense is required to be reported in a government's basic financial statements for all capital assetsother than:

� Inexhaustible capital assets,

� Construction in progress, and

� Infrastructure assets reported using the modified approach.

Question 7.9.3 of the GASB Comprehensive Implementation Guide2009 defines an inexhaustible capital asset asone whose economic benefit or service potential is not used up or is used up so slowly that its estimated useful lifeis extraordinarily long. Examples of inexhaustible capital assets include land, certain land improvements, andcertain works of art and historical treasures. Construction in progress is not subject to depreciation until thecompleted asset is ready for use. Capital assets that are required to be depreciated are those that are usedupthat is, are worn out or become obsoleteover time (such as a desk or an automobile).

Calculating depreciation expense requires governments to estimate how long the asset will last (its useful life),estimate whether there will be any residual or salvage value at the end of the asset's useful life, and select adepreciation method.

Determining Estimated Useful Lives

GAAP do not prescribe the estimated useful lives of capital assets. To assign an estimated useful life to an asset,Question 7.14.1 of the GASB Comprehensive Implementation Guide2009 indicates the government shouldconsider a number of factors, including the following:

� The asset's present condition.

� How the asset is used.

� How the asset was constructed.

� The government's maintenance policy for the asset. (For example, does the government perform regularmaintenance or no maintenance?)

� How long the asset is expected to meet service and technology demands.

� Historical information about similar assets. (For example, consider property disposal records, budgetdocuments, and the government's own property replacement policies for equipment or vehicles.)


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Question 7.14.1 of the GASB Comprehensive Implementation Guide2009 states that �useful lives should bebased on the government's own experience and plans for the assets." It may be useful to consider estimates usedfor comparable assets of other governments or guidelines provided by professional or industry organizations.However, property maintenance and management practices, asset use, and other variables (such as weather) canvary significantly between governments and organizations. Governments that estimate the lives of intangible assetsshould also consider contract terms and legal or regulatory requirements that may affect the life of the asset.Governments also should be aware that many schedules of depreciable lives used by private enterprises are basedon federal or state tax regulations and are generally not intended to represent useful lives. Paragraph 7.33 of SLGnotes that the useful lives of assets acquired through capital leases should be limited to the lease term unless thelease provides for transfer of title or includes a bargain purchase option.

PPC's Governmental Financial Statement Illustrations and Trends (GFT) notes that nearly all of the governmentsconsidered disclosed the asset lives they use to calculate depreciation expense. However, most did not provideasset lives for specific assets but provided broad ranges for a class of assets or for several classes of assets. Forexample, one government said that all of its buildings and improvements are depreciated over a period of 30 to 60years. To find more specific examples, preparers may find more useful information on the Internet. For example, theGASB website, www.gasb.org/repmodel/index.html, provides a number of links to sites that discuss capital assetpolicies. The GFOA website provides this linkwww.gfoa.org/index.php?option=com_content&task=view&id=71toits May 2002 GAAFR Review article, �Estimating Useful Lives for Capital Assets," which provides a detailed listingof average useful lives for a variety of capital assets, written by Paul Gruenwald of American Appraisal Associates.Some state Internet sites provide detailed information about the asset lives that are used by the state. Others postdetailed information that is intended to provide guidance to local governments within the state. For example, thestate of Oregon makes its most current accounting manual, which includes its depreciation and amortizationpolicies, available online at http://scd.das.state.or.us/DAS/SCD/SARS/policies/oam/15.60.20.PR.pdf.

In general, this course suggests that governments avoid establishing estimated useful lives based on arbitrarymeasures, such as the term of debt issued to finance an asset or on replacement schedules suggested by themanufacturer. Even if a government's finance department does not have its own historical records or informationabout comparable assets currently in use, it is likely that the engineering, public works, or similar departments ofmost governments have information that is specific to the entity. The GFOA updated its recommended practice,�Establishing the Estimated Useful Lives of Capital Assets," in 2007. Their new recommendation is that the bestsource of relevant information for determining the estimated useful lives of its capital assets is the government'sown past experience with similar assets. When a government's own experience is not adequate, the GFOAsuggests that government should benefit as much as possible from the experience of others, including theexperience of private companies when establishing estimated useful lives. However, it notes governments alsoneed to ensure that the estimates are appropriate for their particular circumstances. When the experience of othersis used, the GFOA recommends three factors to consider before deciding whether using the experience of othersis appropriate, including the quality of the asset, the intended use of the assets, and the physical and regulatoryenvironment in which the asset will be used. GFOA Recommended Practices can be downloaded atwww.gfoa.org/services/rp/.

Because governments consider many factors when establishing estimated useful life, it is necessary to periodicallyreview those estimates to see whether any changes in factors have affected these estimates. Question 7.14.4 of theGASB Comprehensive Implementation Guide2009 provides examples of such changes in factors, including notperforming planned maintenance on the asset, change in the asset's use, or asset damage caused by weather.(Similar factors may also indicate an impairment of an asset.) In addition, governments may delay replacingequipment if appropriations for replacing those assets are not likely to be made. If the government determines thatan estimated useful life should be changed, it should report the effect of the change prospectively in accordancewith paragraph 31 of APBO No. 20, Accounting Changes. For example, if the estimated useful life of an asset isreduced from 15 to 10 years in the seventh year of the asset's use, the remaining undepreciated historical costshould be divided by three to calculate the revised depreciation expense for the remaining three years of useful life.

Sometimes, governments own capital assets that are fully depreciated for GAAP purposes but that are still beingused in their operations. When this happens, it is apparent that the government underestimated the useful life of theasset. However, because all of the cost of the asset has already been reported as depreciation expense, there isnothing that can be done except to leave the asset on the books until it is finally disposed of. According to the GASB


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Comprehensive Implementation Guide2009, Question 7.13.5, writing off the asset while it is still in use underre�ports the historical cost of the government's capital assets.

Salvage Value

Salvage or residual value is the government's estimate of what a capital asset may be sold for when it is no longerused in operations. When there is a salvage value, it is deducted from the historical cost of an asset beforecalculating depreciation expense. (Salvage value should not be deducted, however, if the double�declining bal�ance depreciation method is used.) For example, a local government may estimate that a police car may be soldfor $1,000 at the end of its estimated three�year useful life. If the police car cost $19,000, depreciation expensewould be calculated using $18,000 as the base amount. If the straight�line method of calculating depreciation wereused, annual depreciation expense would be $6,000.

Depreciation Methods

Depreciation expense is an annual or periodic allocation of the net cost of a capital asset (less salvage or residualvalue) over its estimated useful life. Ideally, the amount charged each period for depreciation expense shouldcorrespond to the actual use of the asset. However, it is difficult to make such precise estimates. GASBS No. 34,paragraph 22, simply requires that the cost of capital assets be allocated in any �systematic and rational manner."Question 7.13.2 of the GASB Comprehensive Implementation Guide2009 indicates a number of establisheddepreciation methods that can be used to estimate depreciation expense, including the following:

� The straight�line depreciation method, which assumes that the asset is used up equally over its estimatedlife.

� Decreasing�charge methods, which include declining balance, double�declining balance, and sum�of�the�years'�digits among others.

� Increasing�charge methods.

� Unit of production/service methods, which allocate the depreciable cost of an asset over its expectedoutput.

Nearly all of the governments that implemented GASBS No. 34 considered in GFT used the straight�line method ofdepreciation. Decreasing charge methods are popular for private enterprises because they accelerate expenseand reduce taxable income. Governments generally do not have an incentive to accelerate expenses because theydo not pay taxes. Units of production methods are generally used in manufacturing industries where it is importantto assign a more exact amount of cost to individual products. Straight�line depreciation may be preferred becauseit is easy to use, tends to smooth expenses over time, and reduces the complexity of applying group or compositemethods of calculating depreciation expense. The straight�line method is discussed in the following paragraphs.

Depreciation expense does not have to be calculated for each individual asset. As allowed by GASBS No. 34,paragraph 22, it may be calculated for the following:

a. Class of assets.

b. Network of assets.

c. Subsystem of a network.

d. Individual assets.

A network of assets is defined in GASBS No. 34, footnote 14, as �all assets that provide a particular type of servicefor a government. A network of infrastructure assets may be only one infrastructure asset that is composed of manycomponents. For example, a network of infrastructure assets may be a dam composed of a concrete dam, aconcrete spillway, and a series of locks." A subsystem of a network of assets is defined in GASBS No. 34, footnote15, as �all assets that make up a similar portion or segment of a network of assets. For example, all the roads of a


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government could be considered a network of infrastructure assets. Interstate highways, state highways, and ruralroads could each be considered a subsystem of that network."

All methods of calculating depreciation expense that consider more than one asset at a time are called �group" and�composite" methods. Question 7.15.1 of the GASB Comprehensive Implementation Guide2009 indicates thatgroup methods refer to depreciating a grouping of similar assets (for example, interstate highways in a state).Composite methods refer to depreciating a grouping of dissimilar assets of the same class (for example, all theroads and bridges of a state) using the same depreciation rate. A composite method can be applied to any type ofcapital asset within a single class of assets but should not be applied to dissimilar assets from different classes ofassets, as discussed in the GASB Comprehensive Implementation Guide2009, Questions 7.15.3 and 7.15.4. Forexample, depreciation should not be calculated for a composite of buildings and office equipment. There is nodistinction between composite or group depreciation in the method of accounting and any allocation method maybe used in combination with these methods, such as straight�line or decreasing charge methods. Under either thegroup or composite method, a depreciation rate for the group or composite is determined. This rate is multiplied bythe cost of the grouping of assets to calculate depreciation expense each year.

GASBS No. 34, paragraph 164, notes that a group or composite depreciation rate can be calculated in differentways. It can be calculated based on a weighted average or on a simple average estimate of useful lives of assetsin the grouping. For example, the group depreciation rate of three buildings with estimated remaining useful livesof 10, 20, and 25 years could be calculated using an unweighted average as follows:

110�+�20�+�25/3

� = 5.5%�annual�depreciation�rate

A weighted average depreciation rate would take into consideration the historical cost of each of the buildings inaddition to their remaining useful lives. A composite or group depreciation rate may also be based on an assess�ment of the life of the grouping of assets as a whole. This assessment could be based on condition assessmentsor experience with the useful lives of the asset group. For example, experience may indicate that highwaysgenerally have estimated remaining useful lives of approximately 25 years. In this case, the annual depreciationrate would be 4 percent (1/25 years). This rate is multiplied by the cost of the grouping of highways to determineannual depreciation expense. Accumulated depreciation should not exceed the reported cost of the grouping ofassets.

Question 7.15.2 of the GASB Comprehensive Implementation Guide2009 indicates that all assets are assumed tobe retired at the end of their useful lives under the composite method. No gain or loss is reported in the proprietaryfunds operating statement or in the government�wide statement of activities when an individual asset is replaced.The cost of the replaced asset is removed from both the capital asset account and the accumulated depreciationaccount. The cost of the retired asset may be specifically identified or may be calculated using average cost orusing a flow assumption such as first�in�first�out. The new asset is added to the capital account of the compositegroup at its historical cost and is depreciated using the composite rate. However, the rate should be recalculatedif the composition of the assets or the estimate of average useful lives changes significantly. Average useful lives ofassets may change as assets are capitalized or taken out of service. Lesson 2 provides examples of journal entriesfor infrastructure assets accounted for using the composite depreciation method as well as calculations of depreci�ation using the group or composite methods.

Sales, disposals, or retirements of capital assets that are not reported using the composite depreciation methodshould be reported by reducing the specific related accounts (capital assets and accumulated depreciation, if any)to zero and reporting the difference between the sales price, if any, and the carrying amount as a gain or loss in thegovernment�wide statement of activities (and proprietary and fiduciary fund statements).

Changes in Estimated Asset Lives

Regardless of the depreciation method used, a change in the estimated useful lives of capital assets should bereported prospectively, as required by APBO 20, paragraph 31. As discussed in the GASB Comprehensive

Implementation Guide2009, Question 7.102.2, assets that were still in use at the date of transition to GASBS No.34 should not be reported as fully depreciated. At transition, the estimated useful life is the number of years it hasbeen in service plus its estimated remaining life.


286

REPORTING WORKS OF ART, HISTORICAL TREASURES, AND SIMILARASSETS

GASBS No. 34, paragraph 27, indicates that works of art, historical treasures, and similar assets (such as monu�ments) are capital assets whether they are held singly or in collections. However, as described in the nextparagraph, certain collections are exempted from capitalization and depreciation. Works of art, historical treasures,and similar assets that do not meet the exemption should be reported in the same manner as other capital assetsat their historical cost or their fair value at date of donation. The GASB Comprehensive Implementation

Guide2009, Question 7.21.1, states that the types of organizations that hold collections are the same as thoseincluded in the scope of FASBS No. 116, Accounting for Contributions Received and Contributions Made. FASBSNo. 116, paragraph 128, describes collections as generally being held by museums, botanical gardens, libraries,aquariums, arboretums, historic sites, planetariums, zoos, art galleries, and nature, science and technologycenters, including similar educational, research, and public service organizations with such items. However, the listis not all inclusive and all items held by these entities are not necessarily collections. Capitalized collections orindividual items that are exhaustible, such as exhibits whose useful lives are diminished by display or educationalor research applications, should be depreciated over their estimated useful lives, subject to the government'scapitalization threshold. Just as it is true for other capital assets, governments should not report depreciationexpense for capitalized collections or individual items that are inexhaustible. Question 7.21.9 of the GASB Compre�hensive Implementation Guide2009 indicates that inexhaustible means the individual works of art or historicaltreasures have extraordinarily long useful lives. Because of their value, governments that own these assets protectand preserve the assets in a manner greater than they would for similar assets without such cultural, aesthetic, orhistorical value.

Collections often consist of numerous items acquired over long periods of time. For these collections, it may not becost�beneficial to establish or estimate the aggregate amount at which the collection should be capitalized. For thisreason, GASBS No. 34, paragraph 27, encourages but does not require capitalizing a collection (and all additionsto that collection), whether donated or purchased, if the collection is:

a. held for public exhibition, education, or research in furtherance of public service rather than financial gain;

b. protected, kept unencumbered, cared for, and preserved; and

c. subject to an organizational policy that requires the proceeds from sales of collection items to be used toacquire other items for collections. (Question 7.21.5 of the GASB Comprehensive Implementation

Guide2009 indicates that although this policy is not required to be a formal policy, there should be someevidence to support its existence. Question 7.21.6 notes that this policy is not required for assets that arepermanently installed or immovable, such as a mural.)

As described in GASBS No. 34, footnote 22, although the conditions for exemption from capitalization may be met,collections already capitalized at June 30, 1999, should remain capitalized and all additions to those collectionsmust be capitalized subject to the government's capitalization policy. Question 7.21.8 of the GASB Comprehensive

Implementation Guide2009 clarifies that governments may apply these requirements to the government as awhole (that is, to all of its works of art, historical treasures, and similar assets) or apply them on a collection�by�collection basis. Certain disclosures about collections that are not capitalized are required.

If a government elects to be exempt from capitalization and deprecation of a collection, it should report the fairvalue of donations of works of art, historical treasures, and similar assets that are added to a noncapitalizedcollection during the year as both contribution revenue and program expense in the government�wide statement ofactivities and proprietary and fiduciary fund statements. Governments should recognize contribution revenue whenall eligibility requirements have been met, regardless of whether the collection is capitalized. (Governmental funds,which are reported using the financial resources measurement focus, do not report the addition unless a contrib�uted asset will be held for sale rather than added to a collection.)


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SELF�STUDY QUIZ


9. How does a government determine useful lives for capital assets that must be depreciated?

a. It must use the useful lives prescribed in generally accepted accounting principles (GAAP).

b. It should base useful lives on its plans for the assets and its experience.

c. It should use the same schedules of depreciable lives used by private enterprises.

10. In which of the following scenarios has the government best dealt with estimating useful lives for thedepreciation of its capital assets?

a. Government A establishes estimated useful lives of its machinery and equipment by using the replacementschedules suggested by the manufacturer of the assets.

b. Government B has a fully depreciated asset still in use for its day�to�day operations. It retroactively revisesthe asset's estimated useful life so it can continue to depreciate.

c. Government C reviews the estimated useful lives of its capital assets on an annual basis to determine ifthey are still accurate based on any changes that might affect the estimates.

d. Government D reduces the estimated useful life of an asset from 12 to 10 years in its sixth year of use, butit continues to depreciate the asset at the same amount annually.

11. What is the term for all of the existing assets that provide a particular type of service for a government?

a. A network of assets.

b. A subsystem of a network.

c. A group of assets.

12. Which of the following statements best describes how a government accounts for depreciation?

a. Decreasing�charge depreciation methods are used by most governments.

b. Depreciation must be calculated for each of a government's individual assets.

c. A composite method of depreciation groups dissimilar assets of the same class.

d. Gain or loss should be reported when a government replaces an individual asset at the end of its usefullife.

13. Which of the following circumstances would disqualify a government's collection of art and historical treasuresfor the capitalization exemption?

a. The collection is held for financial gain.

b. The collection is kept unencumbered.

c. Funds from collection sales are used to acquire other collection items.


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9. How does a government determine useful lives for capital assets that must be depreciated? (Page 282)

a. It must use the useful lives prescribed in generally accepted accounting principles (GAAP). [This answeris incorrect. GAAP do not prescribe the estimated useful lives of capital assets. When assigning anestimated useful life to an asset, Question 7.14.1 of the GASB Comprehensive Implementation

Guide2009 is a useful resource for the government to consult.]

b. It should base useful lives on its plans for the assets and its experience. [This answer is correct.Based on the guidance in the GASB Comprehensive Implementation Guide2009, this is how agovernment should estimate useful lives for its capital assets. Things a government should considerinclude the asset's present condition, how it is used, how it was constructed, the government'smaintenance policy for the asset, how long it is expected to meet service and technology demands,and historical information about similar assets.]

c. It should use the same schedules of depreciable lives used by private enterprises. [This answer isincorrect. Such schedules are based on federal or state tax regulations and are generally not intended torepresent useful lives.]

10. In which of the following scenarios has the government best dealt with estimating useful lives for thedepreciation of its capital assets? (Page 283)

a. Government A establishes estimated useful lives of its machinery and equipment by using the replacementschedules suggested by the manufacturer of the assets. [This answer is incorrect. In general, this coursesuggests that governments avoid establishing estimated useful lives based on arbitrary measures, suchas the term of debt issued to finance an asset or on replacement schedules suggested by themanufacturer.]

b. Government B has a fully depreciated asset still in use for its day�to�day operations. It retroactively revisesthe asset's estimated useful life so it can continue to depreciate. [This answer is incorrect. Government Bhas underestimated the useful life of the asset in this scenario. However, because all of the cost of the assethas already been reported as depreciation expense, there is nothing that can be done except to leave theasset on the books until it is finally disposed of. This underreports the historical cost of the government'scapital assets.]

c. Government C reviews the estimated useful lives of its capital assets on an annual basis todetermine if they are still accurate based on any changes that might affect the estimates. [Thisanswer is correct. Because governments consider many factors when establishing estimated usefullife, it is necessary to periodically review those estimates to see whether any changes in factors haveaffected these estimates. Such changes in factors could include not performing plannedmaintenance on the asset, change in the asset's use, or asset damage caused by weather.]

d. Government D reduces the estimated useful life of an asset from 12 to 10 years in its sixth year of use, butit continues to depreciate the asset at the same amount annually. [This answer is incorrect. Such a changeshould be reported prospectively in accordance with paragraph 31 of APBO No. 20, Accounting Changes.In this scenario, the remaining undepreciated historical cost should be divided by four to calculate therevised depreciation expense for the remaining four years of useful life.]

11. What is the term for all of the existing assets that provide a particular type of service for a government?(Page 284)

a. A network of assets. [This answer is correct. A network of assets is defined in GASBS No. 34,footnote 14, as �all assets that provide a particular type of service for a government. A network of


289

infrastructure assets may be only one infrastructure asset that is composed of many components.For example, a network of infrastructure assets may be a dam composed of a concrete dam, aconcrete spillway, and a series of locks."]

b. A subsystem of a network. [This answer is incorrect. A subsystem of a network of assets is defined inGASBS No. 34, footnote 15, as �all assets that make up a similar portion or segment of a network of assets.For example, all the roads of a government could be considered a network of infrastructure assets.Interstate highways, state highways, and rural roads could each be considered a subsystem of thatnetwork."]

c. A group of assets. [This answer is incorrect. Group of assets is not an official term in GASBS No. 34;however, there is a group method for calculating depreciation. GASBS No. 34 also uses the term class of

assets.]

12. Which of the following statements best describes how a government accounts for depreciation? (Page 285)

a. Decreasing�charge depreciation methods are used by most governments. [This answer is incorrect. Thistype of depreciation is popular for private enterprises because they accelerate expense and reduce taxableincome. Governments generally do not have an incentive to accelerate expenses because they do not paytaxes. The straight�line method of depreciation is used by many governments.]

b. Depreciation must be calculated for each of a government's individual assets. [This answer is incorrect.Under GASBS No. 34, governments can calculate depreciation for a class of assets, a network of assets,a subsystem of a network, or for individual assets.]

c. A composite method of depreciation groups dissimilar assets of the same class. [This answer iscorrect. All methods of calculating depreciation expense that consider more than one asset at a timeare called �group" or �composite" methods per GASB Comprehensive Implementation

Guide2009. Group methods refer to depreciating a grouping of similar assets. Compositemethods refer to depreciating a grouping of dissimilar items of the same class using the samedepreciation rate.]

d. Gain or loss should be reported when a government replaces an individual asset at the end of its usefullife. [This answer is incorrect. All assets are assumed to be retired at the end of their useful lives under thecomposite method. No gain or loss is reported in the proprietary funds operating statement or in thegovernment�wide statement of activities when an individual asset is replaced. The cost of the replacedasset is removed from both the capital asset account and the accumulated depreciation account.]

13. Which of the following circumstances would disqualify a government's collection of art and historical treasuresfor the capitalization exemption? (Page 286)

a. The collection is held for financial gain. [This answer is correct. To qualify for the exemption, thecollection must be held for public exhibition, education, or research in furtherance of public servicerather than financial gain per GASBS No. 34, paragraph 27.]

b. The collection is kept unencumbered. [This answer is incorrect. A collection that is protected, keptunencumbered, cared for, and preserved would qualify for the exemption, assuming the otherqualifications are also met.]

c. Funds from collection sales are used to acquire other collection items. [This answer is incorrect. To qualifyfor the exemption, the government must have an organizational policy that requires the proceeds fromsales of collection items to be used to acquire other items for collections. This policy is not required to bea formal policy, but there should be some evidence to support its existence.]


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REPORTING CAPITAL ASSET TRANSACTIONS IN GOVERNMENTALFUNDS

Reporting Capital Transactions in Governmental FundsTHE BASICS

� Only financial resource flows arising from capital asset transactions are reported in thegovernmental fund financial statementscapital expenditures, cash proceeds from sales ofcapital assets, and so forth.

� At the inception of capital leases, governments report a capital expenditure and �otherfinancing sources" in an amount equal to the present value future minimum lease payments.

� Because they result in no financial resource flows, capital contributions and transfers ofcapital assets are not reported in governmental funds.

Elimination of General Fixed Assets Account Group (GFAAG)

GASBS No. 34 eliminated the reporting of account groups in the governmental fund financial statements. Prior toGASBS No. 34, the general fixed assets account group (GFAAG) was used to establish accounting control andaccountability for a government's general fixed (capital) assets. Without the GFAAG, these assets would not havebeen reported in the required financial statements. Although GASBS No. 34 eliminated the use of a GFAAG forfinancial reporting purposes, this course presumes that governments will continue to maintain some form ofsubsidiary capital assets ledger that is in effect a database of general capital assets by type, their acquisition dates,their historical cost, and other information needed to calculate the accrual basis information (including depreciationexpense and accumulated depreciation) required for general capital assets in the government�wide financialstatements.

Purchases of General Capital Assets

Beyond the elimination of the GFAAG, GASBS No. 34 did not modify governmental fund reporting of the acquisi�tion, use, and disposal of general capital assets. The acquisition of general capital assets is reported as a capitalexpenditure in the operating statement of the governmental fund making the purchase. The asset is also added tothe government's capital assets ledger.

Trade�ins. When the purchase of a new general capital asset includes the trade�in of an old asset, a single entry isrequired to record an expenditure for the amount of cash paid or other current financial resources used (such as anaccount payable or short�term debt incurred) to acquire the new asset. However (in contrast to the trade�in of aproprietary fund asset), no gain or loss is recorded for the transaction. However, in the general capital assets ledger,the trade�in value of the old asset should be recorded and used to calculate the adjusted basis (value) of the newasset. Exhibit 1�1 illustrates the journal entry to record a trade�in.

Exhibit 1�1

Journal Entry for a Trade�in of General Capital Assets

Assume that the general fund purchases a new police car costing $30,000 by paying $25,000cash and trading in an old police car. Also, assume that the original cost of the old car was$15,000. The following entry would be made to record the trade�in:

General Fund

Capital expenditures $ 25,000Cash $ 25,000

(To record purchase of police car.)

Note that no gain or loss is recognized, nor is any basis adjustment necessary, due to the flowof current financial resources measurement focus of governmental fund transactions. Because


291

only $25,000 of current financial resources (cash) was expended, this is the amount of capitalexpenditure rather than the actual sales price of $30,000. The new police car should be addedto the government's general capital asset ledger and the old police car removed. In addition,the $5,000 trade�in value of the old police car should be recorded in the capital assets ledgeras an adjustment of the basis (value) of the new vehicle for purposes of reporting in thegovernment�wide financial statements.

* * *

Assets Acquired with Debt. When general capital assets are purchased with debt proceeds, the appropriateaccounting entry depends on the timing of the debt repayment. If the debt issued is short�term debt that will berepaid with currently available financial resources, then the liability for the debt is reported in the acquiring fund.Exhibit 1�2 illustrates journal entries for recording general capital assets acquired with short�term debt. Exhibit 1�3illustrates journal entries for recording general capital assets acquired with the proceeds of long�term debt.

Exhibit 1�2

Journal Entries for the Acquisition ofGeneral Capital Assets with Short�term Debt

Assume that the general fund borrows $110,000 for 90 days to purchase computer equipment. Thejournal entries to record the transaction would be as follows:

General Fund

Cash $ 110,000Short�term note payable $ 110,000

(To record proceeds from issuance of 90�day note.)

Expenditurescapital outlay $ 110,000Cash $ 110,000

(To record purchase of computers.)

* * *

Exhibit 1�3

Journal Entries for the Acquisition of General Capital Assets with Long�term Debt

Assume that the general fund borrows $110,000 on a five�year note to purchase computer equipment. Theentries to record the transaction would be as follows:

General Fund

Cash $ 110,000Other financing sourcesproceeds of five�

year note $ 110,000

(To record proceeds of five�year note.)

General Fund

Expenditurescapital outlay $ 110,000Cash $ 110,000


292

(To record purchase of computers.)

The historical cost of the asset would also be recorded in the government's general capital asset ledger.Note that the general fund has a net financial resources outflow of zero in the year that the equipment ispurchased because the full payment price was borrowed. The principal and interest payments made by thegeneral fund over the next five years will reflect the outflow of resources necessary to service the debt.

* * *

Bargain Purchases. In some instances, assets are transferred between governmental entities at nominal amountsin transactions that could be described as bargain purchases. This course suggests that these additions berecorded at fair value in the government's general capital asset ledger. The difference between the fair value andthe amount paid would be reported as if it were a donated asset. However, in the governmental funds only theamount paid in cash should be reported as a capital expenditure. (The difference between fair value and the capitalexpenditure will be reported as capital contribution revenue in the government�wide financial statements.)

Capital Leases

To properly record and report a lease transaction requires an initial determination of whether the contractualagreement is an operating lease or a capital lease. Operating leases are not reported as an asset or liability of thegovernment. (Disclosures about operating leases are required, however.)

In general, if a lease transaction is required to be capitalized, the accounting is similar to the accounting for an assetpurchase financed by long�term debt. GASB Cod. sec. L20.103 imposes the criteria and requirements of FASBSNo. 13 for reporting capital leases. A long�term (exceeding a 12�month period), noncancelable lease must becapitalized if it has at least one of the following characteristics specified by FASBS No. 13, paragraph 7:

a. It passes title to the lessee.

b. It contains a bargain purchase option.

c. The lease term is at least 75% of the asset's estimated economic life.

d. The present value of the minimum lease payments (discounted at the lower of the implicit interest rate orthe incremental borrowing rate) equals or exceeds 90% of the asset's fair value. Usually, a government'sincremental borrowing rate will be lower than the implicit interest rate because of the tax�exempt status ofgovernment debt.

At the inception of a capital lease agreement, according to GASB Cod. sec. L20.113, leased general capital assetsshould be accounted for similar to a debt�financed purchase, as illustrated in Exhibit 1�3. To record the capitallease, the fund acquiring the asset should record a capital expenditure and �other financing sources" in an amountequal to the present value at the beginning of the lease term of minimum lease payments during the lease term,adjusted for additional payments as discussed in FASBS No.�13, paragraph 10, as amended. In addition, theleased asset should be reported in the government's capital assets ledger. The periodic lease payments should beaccounted for as debt service expenditures. GASB Cod. sec. L20.113 states that a debt service fund or capitalprojects fund need not be used to report capital lease transactions unless its use is otherwise required, such as bya legal mandate. Exhibit 1�4 illustrates the accounting for a capital lease in a governmental fund.

Exhibit 1�4

Capital Lease of a Governmental Fund

Assume that a government's general fund enters into a five�year lease agreement for computer equipment. Thesales price is $110,000 (if purchased), but the equipment is acquired through a noncancelable lease that requires


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no down payment and five equal annual payments of $26,113 (total payments equal $26,113 � 5 = $130,565). Atthe end of the lease, title will pass to the government. The following determinations are made:

1. Capital Lease AnalysisUsing the criteria of FASBS No.�13, the lease should be capitalized because title passesto the government at the end of the lease. Only one of the four criteria must exist for a lease to be a capital lease,but in this example most of the characteristics are present.

2. Accounting TreatmentBecause the value (purchase price) of the equipment is $110,000, the implicit interestrate included in the lease payments can be determined (using either a present value table or a calculator). Inthis case, the implicit interest rate is 6% and the net present value of the annual payments is $110,000. Assumingthat the government's incremental borrowing rate for similar financing arrangements is 8%, then according toFASBS No.�13, the lease would be capitalized using the lower implicit rate of 6%. (In most cases, however, thegovernment's incremental borrowing rate usually would be lower than the implicit rate.)

3. Initial Accounting EntryCapital leases are recorded in a similar manner as debt�financed purchases. Thus, theinitial entry for this transaction is the same as the entry illustrated for a purchased asset in Exhibit 1�3 includingthe principal portion of the lease payable of $110,000 as shown below.

4. Subsequent Year EntriesBecause this lease has been capitalized, a simple amortization table is as follows:

YearAnnual

Payment Principal (6%) InterestUnpaidBalance

Initial 1 $ 26,113 $ 19,513 $ 6,600 $ 110,0002 26,113 20,684 5,429 90,4873 26,113 21,925 4,188 47,8784 26,113 23,240 2,873 24,6385 26,113 24,638 1,475 �

$ 130,565 $ 110,000 $ 20,565

Each year (or period), an entry would be made to the following accounts. The necessary amounts would changebased on the above amortization schedule. The entry at the end of year 1 would be as follows:

General Fund (or debt service fund or capital projects fund, if required, such as by legalmandate)

Expendituredebt serviceprincipal $ 19,513Expendituredebt serviceinterest 6,600

Cash $ 26,113

(To record annual capital lease payment.)

* * *

Capital Lease Disclosures. FASBS No. 13, paragraph 16, as amended by GASBS No. 38, requires the followingdisclosures for capital leases:

a. The gross amount of assets recorded under capital leases at the balance sheet date.

b. Future required minimum lease payments for each of the next five fiscal years, and in five�year incrementsthereafter.

c. Total minimum sublease rentals to be received (if any) in the future.

d. Total contingent rental payments incurred (if any) for each operating statement presented.


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Constructed General Capital Assets

All capital assets that are purchased or constructed are reported at historical cost. For assets constructed byoutside contractors, the determination of cost is based on contractual agreements and vendor invoices. However,if assets are constructed by the government (that is, if labor is supplied by governmental employees), a reasonablesystem for identifying and capturing costs must be used. Costs to be captured would include the cost of materialsand labor, including the cost of attached fixtures (a job�costing system should be used if possible); professionalfees (for example, architects, engineers, attorneys, and appraisers); construction insurance premiums; and relatedcosts incurred during the construction period to place the constructed asset in service. Construction in progress isdiscussed later in this section. Once all applicable costs have been determined, constructed assets should berecorded in the same way as purchased assets described beginning in the �Purchases of General Capital Assets"paragraph. When construction is funded by resources such as debt proceeds, special assessments, or capitalgrant proceeds, general government construction activity is generally reported in a capital projects fund. Regard�less of which governmental fund is used, the accounting for constructed assets is the same.

Donated Assets

When a government receives a contribution or donation of an asset that it intends to use as a general capital asset,no entry is required in governmental funds. No current financial resource flow has taken place. (The asset shouldbe recorded at fair value in the government's general capital assets ledger.) However, when a government receivesdonated capital assets that it does not intend to use as capital assets, but holds them for sale, they should bereported as assets (investments) in the governmental fund balance sheet and as contribution revenue equal to thefair value of the asset contributed. (Deferred revenue should be reported if the assets are not sold within the periodof time that the government uses to define available for purposes of revenue recognition.) Governments mayreceive capital assets as part of the corpus of an endowment reported in a permanent fund. Like other generalcapital assets, these assets are reported only in the governmental activities column in the government�widestatement of net assets, unless the government intends (and is permitted) to convert these assets to financialresources.

Asset Transfers from Proprietary Funds and Component Units

Transfers of assets may be made from a proprietary fund because the proprietary fund service will no longer beprovided or because management has determined that certain equipment would be of more value to the generalgovernment. In other cases, capital assets may be transferred from blended or discretely presented componentunits. Because only current financial resource flows are reported in governmental funds, capital asset transfersbetween governmental funds are not reported in those funds. As discussed previously, the depreciated historicalcost of the assets at the time of transfer should be recorded in the government's general capital assets ledger.

In some circumstances, governments make �payments" for assets that are reassigned to other funds or compo�nent units. Governmental funds should record these payments as transfers to other funds of the primary govern�ment or as capital expenditures when payments are made to legally separate component units.

SLG, paragraph 7.51, suggests that any related proprietary fund debt may also be �moved" to follow the transferredasset. If related debt is long�term, however, it would be reported in the governmental activities column in thegovernment�wide statement of net assets, not in the governmental funds.

Reporting Construction in Progress

The construction period for many capital projects, such as bridges, roads, and even certain buildings, may extendover more than one financial reporting period. Also, some governments elect to construct certain assets (such asparks, roads, or facilities) using government personnel as a cost�saving measure, even though the constructionperiod may be longer than if outside contractors performed the work. For these reasons, some capital projects maystill be in progress at fiscal year end. In such circumstances, expenditures are reported as incurred in the capitalprojects fund. The related asset (construction in progress) is recorded in the government's general capital assetsledger.


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All related project expenditures are accumulated as construction in progress until the project is finished. Uponcompletion, the asset should be reclassified in the government's general capital assets ledger to a completed assetaccount.

Use of Capital Projects Funds

GASB Cod. sec. 1300.106 states that financial resources used to acquire or construct major capital facilities (otherthan those financed by proprietary or fiduciary funds) should be reported in a capital projects fund. Capital projectsfunds should also be used to report capital outlays financed from general obligation debt proceeds. Such facilitiesmay include buildings and improvements, roads, bridges, drainage systems, streets, sidewalks, and most otherinfrastructure assets. (GASBS No. 54, Fund Balance Reporting and Governmental Fund Type Definitions, modifiesthe definitions of all governmental funds for periods beginning after June 15, 2010.)

The initial purchase or construction of these facilities is recorded as an expenditure in the capital projects fund. Asfor all other general capital asset acquisitions, the asset should also be recorded in the government's generalcapital assets ledger. The capital projects fund entry would be as follows:


Capital outlay expendituresbuilding $ 200,000Cash $ 200,000

(To record expenditures for construction of new building.)

Generally, if several projects are conducted simultaneously, separate accounting records are maintained for eachproject. To demonstrate compliance with requirements of funding sources, contractual agreements, and legalprovisions, it is usually necessary to segregate activity of each project from that of other projects. However, theaggregate activity for all capital projects is reported on a combined basis (that is, in a single capital projects fund)in the governmental fund financial statements.

Capital Projects Fund Balance. The financing of capital project fund activities may be obtained from grantproceeds, issuance of debt (bonds), transfers from other funds, or special assessments. The source of financingand related contracts, ordinances, and agreements may prescribe the disposition of any residual fund balance,whether positive or negative (that is, a deficit). Generally, if a capital project is funded by a transfer from anotherfund (for example, the general fund), any residual fund balance for that project remaining after the project iscompleted would be transferred back to the general fund. In cases where debt proceeds are used to finance theproject, there may be a requirement to transfer any positive fund balance to the debt service fund.

For example, if a capital project was funded by transfers from the general fund and $50,000 was the residual fundbalance, the following entries would be made at completion of construction:


Other financing useTransfer out $ 50,000Cash $ 50,000

(To record transfer of residual balances to the general fund.)

General Fund

Cash $ 50,000Other financing sourceTransfer in $ 50,000

(To record transfer of residual balances from the capital projects fund.)

Sales and Other Dispositions of General Capital Assets

General capital assets may be disposed of by sale, transfer, trade�in, theft, loss, or obsolescence. The entries torecord a trade�in are illustrated in Exhibit 1�1. Other dispositions not involving the receipt of cash (theft, loss, or


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obsolescence) require only that the cost of the asset (less accumulated depreciation) be removed from the generalcapital asset ledger. Because no current financial resource is received on such dispositions, no entry is recorded inthe governmental funds.

If a general capital asset is sold, the cash proceeds are recorded either in the fund that originally paid for the assetor in the general fund. The cost (less accumulated depreciation) is also removed from the general capital assetsledger. The following illustrates the entry to record the sale for $2,000 of a police car that originally cost $15,000 bythe general fund. Note that no gain or loss is recognized in governmental funds and that only the proceeds receivedare recorded.

General Fund

Cash $ 2,000Other financing sourcesale of general capital

assets $ 2,000

(To record proceeds from sale of police car.)

GASBS No. 34, paragraph 88, requires proceeds from the sale of general capital assets to be recorded as an �otherfinancing source." As a practical matter, however, immaterial inflows could be reported as miscellaneous revenuesrather than as other financing sources. Current financial resource flows from the sales transaction that meets thedefinition of a special item should be reported separately after other financing sources and uses in the statement ofrevenues, expenditures, and changes in fund balances. Special items are significant transactions or other eventswithin the control of management that are either �unusual in nature" or �infrequent in occurrence" (more informationon this topic can be found in PPC's Guide to Preparing Governmental Financial Statements Under GASBS No. 34).It is possible that a transaction may require reporting as a special item in the fund financial statements but not in thegovernment�wide financial statements (or vice versa).

Impairments and Insurance Recoveries. GASBS No. 42, Accounting and Financial Reporting for Impairment of

Capital Assets and for Insurance Recoveries, provides guidance on identifying and reporting impairments of capitalassets. Impairment losses should not be reported in governmental fund financial statements because the loss is nota flow of current financial resources. However, GASBS No. 42 also provides guidance on insurance recoveries oncapital assets arising from impairment as well as from other reasons, such as theft. Paragraph 22 requires capitalasset insurance recoveries to be reported either as an other financing source or as an extraordinary item. Recogni�tion should take place only when the recovery is realized or realizable and the resources are available. Expendi�tures incurred to repair or replace the related asset should be reported as separate transactions.

Transfers of General Capital Assets to Proprietary Funds and Component Units

Occasionally capital assets are transferred between funds of the primary government or between the primarygovernment and its component units. A transfer of general capital assets to a proprietary fund or component unitcould occur when a new proprietary activity begins or as the result of management's decision to more efficientlyuse the asset in a proprietary activity. SLG, paragraph 7.51, suggests that related debt may follow the transferredcapital asset. When capital assets are transferred to an activity reported in a governmental fund, there is no entry tobe recorded in the governmental fund (because there is no current financial resource flow). However, the assetwould be added to the government's general capital assets ledger.


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REPORTING CAPITAL ASSETS IN PROPRIETARY AND FIDUCIARY FUNDS

Reporting Proprietary and Fiduciary Fund Capital AssetsTHE BASICS

� Capital assets associated with proprietary and fiduciary funds should be reported in the samemanner as in commercial enterprises.

� Historical cost of enterprise fund capital assets and certain internal service fund assets shouldinclude capitalized interest.

� Depreciation expense should be reported for all capital assets used in operations exceptthose that are inexhaustible (such as land and certain intangible assets) or that areinfrastructure assets reported using the modified approach.

The accounting for capital assets of proprietary and judiciary funds is the same as that of private�sector businessenterprises. GASB Cod. sec. 1400.115�.116 require capital assets of proprietary and fiduciary funds to beaccounted for in those funds. Thus, a proprietary fund reports capital assets and accumulated depreciation in itsstatement of net assets and depreciation expense in its statement of revenues, expenses, and changes in fund netassets. A fiduciary fund reports capital assets and accumulated depreciation in its statement of fiduciary net assetsand depreciation expense in its statement of changes in fiduciary net assets.

GASBS No. 25, Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined Contribu�

tion Plans, paragraph 24 (GASB Cod. secs. Pe5 and Pe6), requires different accounting and reporting for capitalassetssuch as real estateheld as investments of pension plans. GASBS No. 52, Land and Other Real Estate

Held as Investments by Endowments, requires a similar treatment for real estate held as investments by endow�ments. For example, governmental colleges and universities often report endowments in their enterprise funds.Real estate investments should be reported at fair value without depreciation expense. Real estate investmentsheld by public entity risk pools should be reported at cost. Real estate assets used in operations, however, arereported in the same manner as other capital assets.

Capitalization and Valuation

Subject to the governmental entity's capitalization threshold, all proprietary fund capital assets should be capital�ized in the proprietary fund statement of net assets. Generally, purchased or constructed assets are recorded atcost. Contributed assets should be recorded at their estimated fair value at the date received. See the �CapitalAsset Valuation (Other Than Intangibles)" section for a detailed discussion of capital asset valuation. The samesection also applies to capital assets used in fiduciary fund operations.

Bargain Purchases. In some instances, assets are transferred between governmental entities at nominal amountsin transactions that could be described as bargain purchases. This course suggests that these additions berecorded at fair value rather than at the nominal amount paid. The difference between the fair value and the amountpaid would be reported as if it were a donated asset.

Interest Capitalization. The discussion in the �Capitalizing Interest Costs" section provides guidance on applyingFASBS No. 34 and FASBS No. 62 on interest capitalization to capital assets of proprietary funds.

Depreciation Expense

As discussed in GASB Cod. sec. 1400.104, proprietary and fiduciary fund capital assets should be depreciated/amortized over their estimated useful lives unless they are inexhaustible, are intangible assets with indefinite lives,or are infrastructure assets reported using the modified approach. Depreciation expense is usually reported as aseparate line of operating expenses in the proprietary fund statement of revenues, expenses, and changes in fundnet assets and as a deduction in the statement of changes in fiduciary net assets. Governments should reportamortization expense for proprietary and fiduciary fund intangible assets with limited useful lives. Depreciationexpense on real estate held for investment purposes by public entity risk pools should be charged to investmentincome, not depreciation expense (GASB Cod. sec. Po20.142).


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Capital Contributions

Prior to the issuance of GASBS No. 33, Accounting and Financial Reporting for Nonexchange Transactions,proprietary funds reported contributions of capital assets as direct additions to contributed capital, an equityaccount. Consistent with this reporting, governments were permitted to reduce contributed capital by currentperiod depreciation expense reported on certain contributed and grant�financed capital assets. However, GASBSNo. 34 completely revised the proprietary fund equity section and eliminated this reporting option.

Under GASBS No. 34, paragraph 100, contributions of capital assets to proprietary funds should be reported ascapital contribution revenues at the bottom of the statement of revenues, expenses, and changes in fund netassets. Contributions of capital assets to fiduciary funds should be reported as additions in the statement ofchanges in fiduciary net assets.

Dispositions and Trade�ins of Proprietary and Fiduciary Fund Capital Assets

Sales or other dispositions of capital assets of proprietary and fiduciary funds normally generate a gain or loss inthe fund's operating statement. When an old asset is traded in as part of the cost to acquire a new asset, no gainis recognized if the net book value of the asset traded in equals the trade�in allowance, as discussed in APBO No.29, Accounting for Nonmonetary Transactions, paragraph 25. That is, the new asset is recorded at the cash paidplus the net book value of the old asset traded in. However, if the net book value of the old asset exceeds the fairvalue of the trade�in allowance, a loss should be reported.

For example, assume that a proprietary fund acquires a new asset with a gross sales price of $30,000 by paying$25,000 and trading in an old asset for a $5,000 trade�in allowance. Assume that the old asset originally cost$15,000 and had accumulated depreciation of $8,000. Thus, it had a $7,000 book value when it was traded in.Because the $7,000 book value of the old asset exceeds the $5,000 trade�in allowance, a loss of $2,000 would berecorded as follows:

Capital assetsnew asset acquired $ 30,000Accumulated depreciationold asset traded�in 8,000Loss on disposition of old asset 2,000

Capital assetsold asset traded�in $ 15,000Cash 25,000

(To record purchase of new asset and trade�in and loss on old asset.)

Contrast this example with the example in Exhibit 1�1 involving the trade�in of a general capital asset. In bothexamples, the facts are the same (cost of old and new asset, amount of cash paid, and amount of trade�inallowance). However, in the example in Exhibit 1�1 no loss is recognized in the governmental fund financialstatements.

Impairments and Insurance Recoveries. Lesson 2 discusses the GASBS No. 42 guidance on identifying andreporting impairments of capital assets. GASBS No. 42 also provides guidance on insurance recoveries on capitalassets arising from impairment as well as from other reasons, such as theft. Paragraph 22 requires insurancerecoveries to be netted against the related loss if the recovery is received in the same period in which the loss isreported. Costs incurred to restore or replace an asset should be reported as a separate transaction. Recoveriesreceived after the period should be reported as a nonoperating revenue or as an extraordinary item, as appropriate.Recognition should take place only when the recovery is realized or realizable, for example, once the insurer hasacknowledged that a covered event has occurred.

Interfund and Intra�entity Transfers. GASBS No. 48 requires capital assets transferred between funds of theprimary government, between the primary government and one of its component units, or between componentunits of the same reporting entity to be reported at the transferor's carrying value, with historical cost and accumu�lated depreciation being recorded separately. Previously journal entries were provided illustrating this requirementfor transfers between enterprise funds or business�type activities. SLG, paragraph 7.51, suggests that related debtmay follow the transferred capital asset.


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When a proprietary fund capital asset is transferred (reclassified) to an activity associated with a governmental fund(or a blended component unit reporting governmental activities), only the proprietary fund records the transfer.(Governmental funds do not report capital resource flows.) GASB Comprehensive Implementation Guide2009,Question 7.74.4, states that proprietary funds to would report the transfer to the governmental type activity as anonoperating expense. The transfer should be reported as follows:

Nonoperating expense $ 410,000

Accumulated depreciationbuildings 315,000

Buildings $ 725,000

(To record the transfer of a building to the city.)

When the reverse is true, and a proprietary fund receives a capital asset, Question 7.74.4 indicates that the transferwould be reported as a capital contribution in the last section of the proprietary fund statement of revenues,expenses, and changes in net assets.

When government�wide financial statements are prepared, amounts reported as nonoperating expense or ascapital contributions in these two scenarios should be reclassified as transfers.


300


301

SELF�STUDY QUIZ


14. In which of the following scenarios did the government correctly adhere to the principles of governmental fundreporting under GASBS No. 34?

a. Government 1 acquires a capital asset. It reports the asset as a capital expenditure in the operatingstatement of the governmental fund that made the purchase.

b. Government 2 trades in an old asset as part of its purchase of a new general capital asset. It records theexpenditure in a single entry, and no gain or loss is recorded. It records the trade�in value of the old assetin the general capital assets ledger.

c. Government 3 purchases general capital assets with long�term debt proceeds. It reports the liability for thedebt in the acquiring fund.

d. Government 4 receives a capital asset from another governmental entity and pays that entity only anominal amount for said asset. Government 4 records the asset at the purchase price in its general capitalasset ledger.

15. A noncancelable lease exceeding a 12�month period must be capitalized if it has which of the followingcharacteristics?

a. It passes title to a third party.

b. It includes a bargain purchase option.

c. Its term is at least 50% of the asset's estimated economic life.

d. The present value of the lease's minimum payments equal 100% of the asset's fair value.

16. The Pecan Valley city government uses labor provided by its own employees to construct a new park. Howshould the government determine the historical cost of this asset?

a. The cost should be based on vendor invoices and contractual agreements.

b. A reasonable system for capturing and identifying costs should be used.

c. The amount of funding assessed for construction should be used to determine the cost.

17. Assume the same details as in the previous question. Additionally, the Pecan Valley government received anestimate that construction on the park will not be complete until six months after the end of the reporting period.How should the construction in progress be reported by the government?

a. The government is not required to make an entry in governmental funds, but it must record the asset atfair value in the general capital assets ledger.

b. The government should report the depreciated historical cost of the asset in the general capital assetsledger, but nothing should be reported in proprietary funds.

c. The government should report expenditures as incurred in the capital projects fund. It should report theasset in the general capital assets ledger.

d. The government should capitalize the costs in a method similar to that used to account for an assetpurchase financed by long�term debt.


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18. Which of the following statements best describes a government's financing of capital projects?

a. If a capital project is financed by a transfer from another fund, any positive balance remaining at thecompletion of the project must be transferred to the debt service fund.

b. A new drainage system financed from general obligation debt proceeds are only recorded in agovernment's general capital assets ledger.

c. A capital project fund can be financed with grant proceeds, the issuance of bonds, special assessments,and transfers from other funds.

19. How does a fiduciary fund report capital assets?

a. Capital assets and accumulated depreciation are reported in a statement of net assets; depreciationexpense is reported in a statement of revenues, expenses, and changes in fund net assets.

b. Capital assets and accumulated depreciation are reported in a statement of fiduciary net assets;depreciation expense is reported in a statement of changes in fiduciary net assets.

c. All capital assets are reported at fair value without any related depreciation expense.

20. Which of the following statements best describes an aspect of reporting capital assets in proprietary andfiduciary funds?

a. All capital assets reported in these types of funds must be depreciated or amortized over their estimateduseful lives.

b. Bargain purchases are only allowed in governmental fund reporting, not in proprietary or fiduciary fundreporting.

c. Proprietary funds report contributions of capital assets as direct additions to the contributed capital in anequity account.

d. Insurance recoveries should be netted against related loss, if the recovery amount is received in the sameperiod the loss is reported.


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14. In which of the following scenarios did the government correctly adhere to the principles of governmental fundreporting under GASBS No. 34? (Page 290)

a. Government 1 acquires a capital asset. It reports the asset as a capital expenditure in the operatingstatement of the governmental fund that made the purchase. [This answer is incorrect. Government 1should have recorded the asset as described in this scenario; however, in addition, the government shouldhave added the asset to its capital assets ledger.]

b. Government 2 trades in an old asset as part of its purchase of a new general capital asset. It recordsthe expenditure in a single entry, and no gain or loss is recorded. It records the trade�in value of theold asset in the general capital assets ledger. [This answer is correct. When the purchase of a newgeneral capital asset includes the trade�in of an old asset, a single entry is required to record anexpenditure for the amount of cash paid or other current financial resources used (such as anaccount payable or short�term debt incurred) to acquire the new asset. No gain or loss is recordedfor the transaction. However, in the general capital assets ledger, the trade�in value of the old assetshould be recorded and used to calculate the adjusted basis (value) of the new asset.]

c. Government 3 purchases general capital assets with long�term debt proceeds. It reports the liability for thedebt in the acquiring fund. [This answer is incorrect. This would be correct if Government 3 purchased theasset with short�term debt proceeds. The appropriate accounting entry depends on the timing of the debtrepayment.]

d. Government 4 receives a capital asset from another governmental entity and pays that entity only anominal amount for said asset. Government 4 records the asset at the purchase price in its general capitalasset ledger. [This answer is incorrect. Government 4 should have recorded the fair value of the asset inits general capital asset ledger. The difference between the fair value and the amount paid would bereported as if it were a donated asset. However, in the governmental funds, only the amount paid in cashshould be reported as a capital expenditure.]

15. A noncancelable lease exceeding a 12�month period must be capitalized if it has which of the followingcharacteristics? (Page 292)

a. It passes title to a third party. [This answer is incorrect. The lease would have to be capitalized if it passedtitle to the lessee, not a third party.]

b. It includes a bargain purchase option. [This answer is correct. FASBS No. 13, paragraph 7, includesfour characteristics that, if they exist in the type of lease described above, the lease would have tobe capitalized. Including a bargain purchase option is one of those characteristics.]

c. Its term is at least 50% of the asset's estimated economic life. [This answer is incorrect. If the lease termis at least 75%, not 50%, of the asset's estimated economic life, the lease would have to be capitalized.]

d. The present value of the lease's minimum payments equal 100% of the asset's fair value. [This answer isincorrect. If the present value of the minimum lease payments (discounted at the lower of the implicitinterest rate or the incremental borrowing rate) equals or exceeds 90% (not equals 100%) of the asset'sfair value, the lease would have to be capitalized.]

16. The Pecan Valley city government uses labor provided by its own employees to construct a new park. Howshould the government determine the historical cost of this asset? (Page 294)

a. The cost should be based on vendor invoices and contractual agreements. [This answer is incorrect. Thiswould be true if the government used outside contractors to construct the road.]


304

b. According to GASBS No. 34, a reasonable system for capturing and identifying costs should beused. [This answer is correct. Costs to be captured would include the cost of materials and labor,including the cost of attached fixtures; professional fees; construction insurance premiums; andrelated costs incurred during the construction period to place the constructed asset in service.]

c. The amount of funding assessed for construction should be used to determine the cost. [This answer isincorrect. Funding does not enter into the cost determination. However, if the construction is funded byresources such as debt proceeds, special assessments, or capital grant proceeds, general governmentconstruction activity is generally reported in a capital projects fund.]

17. Assume the same details as in the previous question. Additionally, the Pecan Valley government received anestimate that construction on the park will not be complete until six months after the end of the reporting period.How should the construction in progress be reported by the government? (Page 294)

a. The government is not required to make an entry in governmental funds, but it must record the asset atfair value in the general capital assets ledger. [This answer is incorrect. This would be the correct reportingmethod if the Pecan Valley government had received a donated asset that it intended to use as a generalcapital asset.]

b. The government should report the depreciated historical cost of the asset in the general capital assetsledger, but nothing should be reported in proprietary funds. [This answer is incorrect. Construction inprogress would not be depreciated or reported in proprietary funds. If a proprietary fund transferred anasset to the government because the proprietary fund service will no longer be provided or becausemanagement has determined that certain equipment would be of more value to the general government,the government would record the depreciated historical cost of the asset at the time of transfer in thegeneral capital assets ledger. Because only current financial resource flows are reported in governmentalfunds, capital asset transfers between governmental funds are not reported in those funds.]

c. The government should report expenditures as incurred in the capital projects fund. It should reportthe asset in the general capital assets ledger. [This answer is correct. Some governments elect toconstruct certain assets (such as parks, roads, or facilities) using government personnel as acost�saving measure, even though the construction period may be longer than if outside contractorsperformed the work. For these reasons, some capital projects may still be in progress at the fiscalyear end. In such circumstances, expenditures and the related asset are reported as described inthis answer choice.]

d. The government should capitalize the costs in a method similar to that used to account for an assetpurchase financed by long�term debt. [This answer is incorrect. This is true of a capital lease transaction,not construction in progress.]

18. Which of the following statements best describes a government's financing of capital projects? (Page 295)

a. If a capital project is financed by a transfer from another fund, any positive balance remaining at thecompletion of the project must be transferred to the debt service fund. [This answer is incorrect. Generally,if a capital project is funded by a transfer from another fund, any residual fund balance for that projectremaining after the project is completed would be transferred back to the general fund. In cases where debtproceeds are used to finance the project, there may be a requirement to transfer any positive fund balanceto the debt service fund.]

b. A new drainage system financed from general obligation debt proceeds are only recorded in agovernment's general capital assets ledger. [This answer is incorrect. The initial purchase of the systemwould be reported as an expenditure in the capital project fund. It would also be recorded in thegovernment's general capital assets ledger.]

c. A capital project fund can be financed with grant proceeds, the issuance of bonds, specialassessments, and transfers from other funds. [This answer is correct. The source of financing andrelated contracts, ordinances, and agreements may prescribe the disposition of any residual fundbalance, whether positive or negative.]


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19. How does a fiduciary fund report capital assets? (Page 297)

a. Capital assets and accumulated depreciation are reported in a statement of net assets; depreciationexpense is reported in a statement of revenues, expenses, and changes in fund net assets. [This answeris incorrect. This is how capital assets are accounted for in proprietary funds.]

b. Capital assets and accumulated depreciation are reported in a statement of fiduciary net assets;depreciation expense is reported in a statement of changes in fiduciary net assets. [This answer iscorrect. GASB Cod. Sec. 1400.115�.116 requires capital assets of proprietary and fiduciary fundsto be accounted for in those funds. The method described in this answer choice is how capital assetswould be accounted for in a fiduciary fund.]

c. All capital assets are reported at fair value without any related depreciation expense. [This answer isincorrect. GASBS No. 25 requires different accounting and reporting for capital assetssuch as realestatethat are held as investments of pension plans. Real estate held as investments by endowmentshave a similar treatment under GASB Statement No. 52. Real estate investments should be reported at fairvalue without depreciation expense. Real estate investments held by public entity risk pools should bereported at cost. Real estate assets used in operations are reported in the same manner as other capitalassets.]

20. Which of the following statements best describes an aspect of reporting capital assets in proprietary andfiduciary funds? (Page 298)

a. All capital assets reported in these types of funds must be depreciated or amortized over their estimateduseful lives. [This answer is incorrect. Inexhaustible assets and infrastructure assets reported using themodified approach would not be depreciated in this manner.]

b. Bargain purchases are only allowed in governmental fund reporting, not in proprietary or fiduciary fundreporting. [This answer is incorrect. In both methods of reporting, it is suggested that the asset be recordedat fair value, not at the nominal amount paid for the asset.]

c. Proprietary funds report contributions of capital assets as direct additions to the contributed capital in anequity account. [This answer is incorrect. This reporting method existed prior to the issuance of GASBSNo. 33. GASBS No. 34 completely revised the proprietary fund equity section and eliminated this reportingoption.]

d. Insurance recoveries should be netted against related loss, if the recovery amount is received in thesame period the loss is reported. [This answer is correct. Costs incurred to restore or replace anasset should be reported as a separate transaction as stated in GASBS No. 42. Recoveries receivedafter the period should be reported as a nonoperating revenue or as an extraordinary item, asappropriate.]


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CAPITALIZING INTEREST COSTS

Capitalization of Interest CostsTHE BASICS

� Interest costs should be included only as a component of the historical cost of enterprise fundand certain internal service fund capital assets.

� FASBS No. 62 requires capitalization of net interest costs in proprietary funds when capitalassets are financed with tax�exempt debt that is externally restricted to financing those assets.

� Interest costs should not be capitalized when certain proprietary fund assets are acquired orconstructed entirely with restricted contributions or grants.

� FASBS No. 34 provides guidance for capitalization of interest costs in all other situations.

Authoritative Literature

Standards for capitalizing interest cost as a component of the historical cost of capital assets are provided byFASBS No. 34, Capitalization of Interest Cost, (issued in October 1979) as amended by FASBS No. 62, Capitaliza�

tion of Interest Cost in Situations Involving Certain Tax�Exempt Borrowings and Certain Gifts and Grants (issued inJune 1982). This section discusses both standards as they apply to proprietary fund capital assets. GASBS No. 37,Basic Financial Statementsand Management's Discussion and Analysisfor State and Local Governments:

Omnibus, paragraph 6, clarifies that these standards do not apply to general capital assets. Because the applicabil�ity of these two standards depends on the type of debt issued and other financial resources expended to financecapital assets, each is discussed separately.

Application to Assets Acquired with Restricted Contributions and Grants. FASBS No. 62 amends FASBS No.34 to prohibit the capitalization of interest for assets acquired by contributions and grants that restrictively specifythe type of asset that may be purchased or constructed. Because such contributions and grants provide monies forthe acquisition of those capital assets, no capitalizable interest cost should be incurred by the government.

Application to Internal Service Funds. As discussed in Lesson 2, it is believed that interest cost should not beincluded as a component of the cost of capital assets of internal service funds that are reported with general capitalassets in the government�wide statement of net assets. When an enterprise fund is the only or predominantparticipant in an internal service fund, however, interest cost should be capitalized as discussed in this sectionwhen there is outstanding taxable or nontaxable debt.

FASB Statement No. 34 Standards for Capitalized Interest

FASBS No. 34 provides guidance for capitalization of interest on �qualifying assets" whenever an entity hasoutstanding debt. FASBS No. 34, paragraph 9, states that qualifying assets include not only assets used by thegovernment, but also assets for sale or lease to others. It also states that interest capitalization applies to assetsconstructed by the government (proprietary fund) and assets constructed by other entities (contractors) for thegovernment, if deposits or progress payments are required (which normally is the case).

FASBS No. 62 amended FASBS No. 34 to provide different guidance in situations in which a government issuestax�exempt debt that is externally restricted by the bond indenture to finance specific capital assets. The require�ments of FASBS No. 62 are discussed later in this section. As amended, FASBS No. 34 applies to all othersituations in which a government acquires capital assets and those assets require a period of time to get themready for their intended use. For governments, this is almost always the case when the capital asset must beconstructed, either by the government itself or by its contractors. Even if no borrowing was incurred to finance theconstruction project, interest capitalization is required if the entity has (old) debt outstanding during the capitaliza�

tion period. FASBS No.�34, paragraph 12, views the failure to pay back (old) outstanding debt as equivalent toborrowing. That is, using existing resources to pay for the project rather than for repayment of outstanding debt isin substance borrowing for the project. In such a case, the two or more interest rates would be used to calculate thecapitalized interest.


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Capitalization Period. According to FASBS No. 34, paragraph 17, the capitalization period begins when all three

of the following conditions exist:

a. expenditures have been made (that is, payment has been made or a liability has been incurred);

b. activities have begun to prepare the asset for its intended use (including plan development, obtainingpermits, and similar preconstruction activities); and

c. interest costs have been incurred (using the accrual basis of accounting).

The capitalization period ends when the asset is substantially complete and ready for its intended use. FASBS No.34, paragraph 18, states that interest capitalization should cease with respect to each portion of a project that iscompleted and ready for use before the entire project is completed.

FASBS No. 34, paragraph 20 indicates that once interest has been capitalized, its disposition should be the sameas that of other components of asset cost. Thus, the capitalized interest would be included in capital assetdepreciation expense.

Interest Capitalization Rate and Method. A capital project may be financed by the proceeds of one specific debtissue or by the proceeds of more than one specific debt issue at different interest rates. FASBS No. 34, paragraph13, states that if a specific borrowing is used to finance the project, the actual interest rate of that issue may be usedduring the capitalization period. Otherwise, a weighted average rate on all outstanding debt should be used.Paragraph 13 also states that capitalizable interest is calculated using the applicable rate applied to the averageaccumulated expenditures during the capitalization period (that is, applied to the weighted average of projectexpenditures).

Note that the average accumulated expenditures for the entire project must be estimated to properly calculateinterim period (fiscal year) capitalization amounts. Any significant changes in actual project costs (different frominitial amounts used to calculate interest capitalization) would change the total amount of capitalized interest on theproject and would be reported as a change in accounting estimate. Exhibit 1�5 illustrates the calculation andrecording of capitalized interest based on FASBS No. 34.

Exhibit 1�5

Calculation of Capitalized Interest under FASBS No. 34

Assume that a proprietary activity issues bonds to finance the construction of a new water utility plant but that thebond indenture does not restrict the use of bond proceeds to that specific project. The following activities takeplace:

1. On 9/1/X4, bonds are issued at par$5,000,000, bearing interest at 10%, with no principal reductions until19X9. The applicable interest rate is 10%.

2. Planning begins and the first expenditures are incurred on 10/1/X4.

3. Expenditures are incurred at a rate of approximately $200,000 per month for 25 months, and the project iscompleted on 11/01/X6.

Because the expenditures were incurred evenly during the construction period, the average accumulatedexpenditure is $2,500,000 ($5,000,000 � 2 = $2,500,000). The capitalization period begins on 10/01/X4 (when allthree conditions listed in the �Capitalization Period" paragraph existed). The capitalization period ends on11/01/X6. The number of months in the capitalization period was 25. Thus, the capitalized interest for the projectwould be calculated as follows:

$2, 500, 000� 10%� 25�12� $520, 833

This amount would be included in the cost of the asset as of 11/01/X6. A similar calculation would be required foreach financial reporting period prior to 11/01/X6. For example, the capitalizable interest for the fiscal year ended9/30/X5 would be calculated as follows:


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Capitalization�period� 12�months�(10�01�X4� 9�30�X5)

$2, 500, 000� 10%� 12�12� $250, 000

The journal entry to record the capitalized interest in the proprietary fund balance sheet would be as follows:

Construction in progresscapitalized interest $ 250,000Interest expense $ 250,000

(To capitalize interest expense on construction in progress at 9/30/X5.)

* * *

Financial Statement Presentation and Disclosure. In situations in which FASBS No. 34 is applicable, interestearned on bond proceeds should be reported separately as revenue and not netted against capitalizable interestexpense (contrary to the reporting prescribed by FASBS No. 62. FASBS No. 34, paragraph 21, requires disclosureof the total amount of interest costs incurred in a period in which some interest cost is capitalized and the amountthat has been capitalized. Paragraph 21 states that if no interest has been capitalized, the amount of interest costincurred and charged to expense should be disclosed in the notes or on the face of the financial statements.

FASB Statement No. 62 Standards for Capitalized Interest Arising from Tax�exempt Debt

FASBS No. 62 applies only to situations in which the use of tax�exempt bond proceeds is externally restricted tofinance the acquisition of a specified qualifying asset or to service the related debt. If the bond indenture or similardocument does not specify the asset(s) to be constructed with the bond proceeds (for example, if the bondindenture states that the proceeds must be spent for capital, rather than operating, purposes but does not givespecific capital purposes), then FASBS No. 34 applies. The definition of a qualifying asset for applying FASBS No.62 is the same as the FASBS No. 34 definition given in the �FASB Statement No. 34 Standards for CapitalizationInterest" paragraph. As stated in that paragraph, interest capitalization is prohibited for most assets acquiredentirely with restricted contributions or grants. Thus, FASBS No. 62 does not apply to such assets.

Capitalization Method and Period. FASBS No. 62 requires the capitalization of the �net effect" of interest revenueand interest expense during the capitalization period. The interest expense component is the total interest on thedebt during the capitalization period. The interest revenue is the amount earned from investing bond proceedsduring the capitalization period. The capitalization period begins on the date of the borrowing (contrast this with theprovisions of FASBS No. 34 in the �Capitalization Period" paragraph) and ends when the asset is ready for itsintended use. Exhibit 1�6 illustrates the calculation and recording of capitalized interest applying the provisions ofFASBS No. 62.

Exhibit 1�6

Calculation of Capitalized Interest under FASBS No. 62

1. Assume that a proprietary fund with a September 30th year end issues tax�exempt bonds to finance theconstruction of a municipal airport terminal. Assume that the airport is a qualifying asset and that the bondindenture restricts the bond proceeds to use on the airport terminal construction. The following activities takeplace:

a. On 10/1/X4 bonds are issued at par$10,000,000, bearing interest at 6%, with no principal reductions until20X5.

b. Bond proceeds (net of expenditures) are continuously invested at a simple rate of 5%, starting on 10/1/X4.

c. The project begins on 10/1/X4 and ends on 6/1/X6. Construction expenditures are incurred (and paid) ata rate of $500,000 per month. Thus, $6,000,000 is spent in fiscal 20X5 and $4,000,000 is spent in fiscal20X6.


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2. The interest expense component for the fiscal year ending 9/30/X5 would be calculated as follows:

$10, 000, 000� .06� $600, 000

The interest income for the year ending 9/30/X5 would be calculated as follows:

Beginning investment $ 10,000,000Ending investment ($10,000,000 bond proceeds � $6,000,000

construction expenditures) + 4,000,000$ 14,000,000� 2

Average invested amount $ 7,000,000Interest rate � .05

Interest revenue $ 350,000

Thus, the net capitalizable interest for the year is $250,000 ($600,000 interest expense � $350,000 interestrevenue = $250,000). The journal entry to record the net capitalized interest would be as follows:

Construction in progressnet capitalized interest $ 250,000Interest expense $ 250,000

(To record current year's net capitalized interest.)

Assuming that as of 9/30/X5, $6,000,000 had been spent on construction, the total construction in progress(capital asset) would be $6,250,000, including the $250,000 of net capitalizable interest.

3. For the year ended 9/30/X6, the same calculations would be made. Capitalizable interest for the year ended9/30/X6 would be calculated as follows:

($10, 000, 000� .06)�� 8�12� $400, 000

Note that the capitalization period ended on 6/01/X6 when the construction was completed and the airportterminal was ready for use. Thus, capitalizable interest expense and revenue occurred for only eight monthsduring this fiscal year. Capitalizable interest revenue for the year ended 9/30/X6 would be calculated as follows:

Beginning investment $ 4,000,000Ending investment + �

$ 4,000,000� 2

Average invested amount $ 2,000,000Interest rate � .05

$ 100,000Capitalization period � 8/12

Interest revenue $ 66,667

Thus, net capitalizable interest for the fiscal year ended 9/30/X6 would be $333,333 ($400,000 interest expense� $66,667 interest revenue = $333,333). The journal entry to record the net capitalized interest would be asfollows:

Airport terminalnet capitalized interest expense $ 333,333Interest expense $ 333,333

(To record current year's net capitalized interest.)


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4. In summary, the total cost of the airport terminal would include the following components:

Construction costsFiscal 20X5 $ 6,000,000Fiscal 20X6 4,000,000

10,000,000Capitalized interest (net)

Fiscal 20X5 250,000Fiscal 20X6 333,333

583,333

Total capital asset cost $ 10,583,333

* * *

Negative Net Capitalized Interest and Effect of Arbitrage Rebate. In any period in which applicable interestrevenues exceed interest expense, the cost of the constructed asset may be reduced (rather than increased). Overthe entire construction period, however, it is unlikely that the cumulative effect of construction period interest wouldyield a net capitalized �revenue" amount. Also, arbitrage earnings can be rebated to the federal government whenproceeds from tax exempt debt are invested.


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SELF�STUDY QUIZ


21. The Appleton city government's proprietary fund issues bonds to finance the construction of a new library, butthe bond indenture does not restrict the use of bond proceeds to any specific project. On January 1, 20X1,bonds are issued at par$7 million, bearing interest at 10% with no principal deductions until 20X6. Theapplicable interest rate is 10%. Planning for the new library begins and the government's first expenditures areincurred on February 1, 20X1. Expenditures are incurred evenly throughout the construction period, whichlasted for 30 months. The new bridge is completed on March 1, 20X3. Calculate the capitalized interest for thisproject.

a. $3,500,000.

b. $875,000.

c. $350,000.

d. $233,333.

22. How do the requirements for interest capitalization under FASBS No. 62 compare to those under FASBS No.34?

a. FASBS No. 62 superceded FASBS No. 34 and applies in all cases.

b. The definition of a qualifying asset is the same for both standards.

c. Both standards apply to general capital assets.

23. A proprietary fund of the Smithville city government issues tax�exempt bonds to finance construction of a newwater utility plant. The proprietary fund has a September 30 year end, the plant is a qualifying asset, and thebond indenture restricts the bond proceeds to use on the plant's construction. On October 1, 20X1, the bondsare issued at par$5 million, bearing interest at 6%, with no principal reductions until 20X2. Bond proceeds(net of expenditures) are continuously invested by the government at a simple rate of 5%. The investments havea starting date of October 1, 20X1. The project begins on October 1, 20X1, and ends on June 1, 20X3. Theconstruction expenditures are incurred and paid at a rate of $250,000 per month. Calculate the total cost of thiscapital asset, including the capitalized interest.

a. $5,291,667.

b. $5,000,000.

c. $291,667.

d. $175,000.


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21. The Appleton city government's proprietary fund issues bonds to finance the construction of a new library, butthe bond indenture does not restrict the use of bond proceeds to any specific project. On January 1, 20X1,bonds are issued at par$7 million, bearing interest at 10% with no principal deductions until 20X5. Theapplicable interest rate is 10%. Planning for the new library begins and the government's first expenditures areincurred on February 1, 20X1. Expenditures are incurred evenly throughout the construction period, whichlasted for 30 months. The new bridge is completed on March 1, 20X3. Calculate the capitalized interest for thisproject. (Page 307)

a. $3,500,000. [This answer is incorrect. Because the expenditures were incurred evenly during theconstruction period, this is the amount of the average accumulated expenditure ($7,000,000/2).]

b. $875,000. [This answer is correct. This is the capitalized interest for Appleton's new librarycalculated under FASBS No. 34 ($3,500,000 x 10% x 30/12). This amount would be included in thecost of the asset as of March 1, 20X3.]

c. $350,000. [This answer is incorrect. This is 10% of the average accumulated expenditure for this project;however, further calculations must be made to determine the capitalized interest for the entire project.]

d. $233,333. [This answer is incorrect. This is the approximate amount that Appleton incurred for each of the30 months of this project.]

22. How do the requirements for interest capitalization under FASBS No. 62 compare to those under FASBS No.34? (Page 308)

a. FASBS No. 62 superceded FASBS No. 34 and applies in all cases. [This answer is incorrect. FASBS No.62 amended FASBS No. 34; however, there are certain situations in which FASBS No. 34 applies and somesituations when FASBS No. 62 applies. FASBS No. 62 applies only to situations in which the use oftax�exempt bond proceeds is externally restricted to finance the acquisition of a specified qualifying assetor to service the related debt.]

b. The definition of a qualifying asset is the same for both standards. [This answer is correct. For bothstandards, a qualifying asset includes not only assets used by the government, but also assets forsale or lease to others. Interest capitalization also applies to assets constructed by the government(proprietary fund) and assets constructed by other entities (contractors) for the government, ifdeposits or progress payments are required.]

c. Both standards apply to general capital assets. [This answer is incorrect. These standards apply toproprietary fund capital assets. According to GASBS No. 37, neither FASBS No. 34 nor FASBS No. 62apply to general capital assets.]

23. A proprietary fund of the Smithville city government issues tax�exempt bonds to finance construction of a newwater utility plant. The proprietary fund has a September 30 year end, the plant is a qualifying asset, and thebond indenture restricts the bond proceeds to use on the plant's construction. On October 1, 20X1, the bondsare issued at par$5 million, bearing interest at 6%, with no principal reductions until 20X2. Bond proceeds(net of expenditures) are continuously invested by the government at a simple rate of 5%. The investments havea starting date of October 1, 20X1. The project begins on October 1, 20X1, and ends on June 1, 20X3. Theconstruction expenditures are incurred and paid at a rate of $250,000 per month. Calculate the total cost of thiscapital asset, including the capitalized interest. (Page 308)

a. $5,291,667. [This answer is correct. The total cost of the new water utility plant, including capitalizedinterest, is calculated as follows: 3,000,000 (total construction costs for fiscal year 20X1) +$2,000,000 (total construction costs for fiscal year 20X2) + 125,000 (net capital interest for fiscalyear 20X1) + 166,667 (net capital interest for fiscal year 20X2).]


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b. $5,000,000. [This answer is incorrect. This is the total of construction costs for Smithville's new water utilityplant ($3,000,000 for fiscal year 20X1 and $2,000,000 for fiscal year 20X2).]

c. $291,667. [This answer is incorrect. This is the total of capitalized net income for Smithville's new waterutility plant ($125,000 for fiscal year 2008 and $166,667 for fiscal year 20X2).]

d. $175,000. [This answer is incorrect. This is the interest revenue for fiscal year 20X1: ($5,000,000 +$2,000,000)/2 = $3,500,000; $3,500,000 x .05 = $175,000.]


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Lesson 1 (GFSTG093)


1. GASBS No. 34, Basic Financial Statementsand Management's Discussion and Analysisfor State and Local

Governments, became effective for governments in three phases. Which of the following most accuratelydescribes those three phases?

a. Phase 1governments with $100 million or more in annual revenues; Phase 2governments with $10million to $100 million in annual revenues; Phase 3governments with less than $10 million in annualrevenues.

b. Phase 1governments with $500 million or more in annual revenues for fiscal years beginning after June15, 2000; Phase 2governments with $100 million to $500 million in annual revenues for fiscal yearsbeginning after June 15, 2001; Phase 3governments with less than $100 million in revenues for fiscalyears beginning after June 15, 2002.

c. Phase 1governments with $100 million or more in annual revenues for fiscal years beginning after June15, 2001; Phase 2governments with $10 million to $100 million in annual revenues for fiscal yearsbeginning after June 15, 2002; Phase 3governments with less than $10 million in revenues for fiscalyears beginning after June 15, 2003.

d. Phase 1the federal government and related organizations; Phase 2state governments; Phase3local governments (cities, towns, counties, etc.).

2. Governments have two types of capital assetsgeneral capital assets and capital assets reported inproprietary funds and fiduciary funds. When reporting on a government's capital assets, which type of capitalassets would be reported in both fund financial statements and government�wide financial statements?

a. General capital assets.

b. Capital assets of proprietary funds.

c. Capital assets of fiduciary funds.


3. Define capital assets as it is used in GASBS No. 34.

a. Both tangible and intangible assets that have initial useful lives extending beyond a single reporting periodand that are used in operations.

b. Assets owned by a government in one of the following areas: land and land improvements, buildings andbuilding improvements, machinery and equipment, and infrastructure assets.

c. General capital assets and general infrastructure assets that are used in a government's day�to�dayoperations.

d. Assets that can be preserved for a greater number of years than most other assets held by a government.


315

4. The city government of Bliss is responsible for maintaining the city's infrastructure assets, but the CrawfieldCounty government is responsible for replacing those assets when such replacement is required. Whichgovernmental entity should report these capital assets?

a. The city government.

b. The county government.

c. Both the city and the county government will report the assets each year.

d. The city government will report the assets unless the county government replaces them that year.

5. Wally Walton sells a building to the Capricorn City government for one dollar. How should the city governmentvalue the building on its financial statements?

a. At historical cost of the exchange transaction between Wally and the city, which is one dollar.

b. At its estimated historical cost, since the city does not have access to Wally's records.

c. At its estimated fair value as of the date Wally contributed the building to the city.

d. At its estimated fair value as of the date GASBS No. 34 was implemented.

6. The Rosebottom County government reports all capital assets with a historical cost of over $3,000. Thegovernment does not participate in the GFOA program for excellence in financial reporting. List all of thefollowing considerations that should apply to this government's decision on whether to report a certain capitalasset.

i. Does the asset's useful life extend to more than one reporting period?

ii. Will the asset's life be at least two years?

iii. Has the asset's historical cost equaled or exceeded $3,000?

iv. Is the government's capitalization threshold applied to individual assets, notasset groups?

v. Is the government's capitalization threshold $5,000 or more?

vi. Does the government receive federal awards?

a. i. and iii.

b. i., iii., and vi.

c. ii., iv., v., and vi.

d. i., ii., iii., iv., v., and vi.

7. What type of intangible asset should be reported at historical cost in government�wide or proprietary fundfinancial statements?

a. All capital intangible assets that a government owns.

b. Capital intangible assets, except for those that are internally generated.

c. All intangible assets that are donated to the government.



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8. There are three milestones that must be met for the costs of a project to create an internally generated assetto be capitalized. When are these milestones considered met for computer software?

a. When the specific objective of the project and the nature of the service capacity are determined.

b. When technological/technical feasibility of completing the project is demonstrated.

c. When current intention, ability, and presence of effort to complete the project are demonstrated.

d. When preliminary project stage activities are complete and management authorizes funding.

9. Governments must report depreciation expense for all capital assets, except:

a. Machinery and equipment.

b. Water rights.

c. Intangible assets.

d. Construction in progress.

10. A government estimates that a truck used by city officials will have a salvage value of $1,500 at the end of itsestimated five�year useful life. The truck originally cost $20,000. Calculate the annual depreciation expenseusing straight�line depreciation.

a. $1,500.

b. $3,700.

c. $4,000.

d. $18,500.

11. What established depreciation method allocates an asset's depreciable cost over its expected output?

a. The straight�line depreciation method.

b. Decreasing�charge methods.

c. Increasing�charge methods.

d. Unit of production/service methods.

12. If a government capitalizes its collection of art and historical treasures, how should the capital assets in thecollection be valued?

a. At their historical cost.

b. At their fair value.

c. At their historical cost, if purchased, or at their fair value at the date of donation, if donated.

d. Using valuation schedules for this unique type of asset that are provided in GASBS No. 34.


317

13. A state government owns a collection of paintings with historical value that are displayed in the state capitolbuilding. As of June 30, 1999, the collection was capitalized. In 2008, a new painting is donated to the collection.Assuming that this collection meets all of the qualifications for the capitalization exemption, how should thisaddition be accounted for?

a. The new item should not be capitalized, and the rest of the collection should be changed from capitalizedto noncapitalized to match.

b. All items capitalized prior to June 30, 1999, should be capitalized, but subsequent additions should notbe capitalized.

c. The whole collection should be capitalized, including any new additions to the collection after June 30,1999.


14. Which of the following was eliminated by GASBS No. 34?

a. The general fixed assets account group (GFAAG).

b. Governmental fund reporting.

c. Proprietary and judiciary fund reporting.

d. Trade�ins of old assets.

15. Which of the following statements does not accurately describe how a government should account for leasedgeneral capital assets?

a. The fund that acquired the asset records a capital expenditure equal to the present value of the asset atthe beginning of the lease term.

b. The fund that acquired the asset records an �other financing sources" equal to the present value of theasset at the beginning of the lease term.

c. Periodic lease payments for the asset are accounted for as debt service expenditures.

d. A debt service fund must always be used to report capital lease transactions.

16. All of the following are disclosures for capital leases required under FASBS No. 13 (as amended by GASBSNo. 38), except:

a. The gross amount of assets that were recorded as capital leases on the balance sheet date.

b. The minimum lease payments for each of the next 10 years in five�year increments.

c. The total minimum sublease rentals that will be received in the future.

d. The total contingent rental payments incurred for every operating statement presented.

17. A building is donated to the Parsons City government. The government plans to sell the building and use theproceeds to fund several government initiatives. How should the building be reported?

a. The government is not required to make an entry for the building in governmental funds.

b. The building should be reported as an investment in the governmental fund balance sheet.

c. The building should be reported at fair value in the general capital assets ledger.



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18. Which of the following would a government not report in its capital projects fund?

a. The acquisition of a major capital asset.

b. An asset for which construction is in progress at the fiscal year end.

c. A capital outlay financed from general obligation debt proceeds.

d. The construction of a major capital asset financed by a proprietary fund.

19. If a government sells a capital asset and the result is not a significant transaction, how should the proceeds berecorded?

a. The proceeds should be recorded as an �other financing source."

b. They should be recorded separately from other financing sources and uses in the statement of revenues,expenditures, and changes in fund balances.

c. The government only needs to remove the asset's cost from the general capital asset ledger.

d. The proceeds should be reported as an extraordinary item.

20. A proprietary fund acquires a new asset using a trade�in. The new asset has a sales price of $50,000. The fundpays $42,000 and trades in an old asset for a $8,000 trade�in allowance. The old asset originally cost $30,000and a book value of $9,000. How much loss, if any, will the fund recognize from this trade�in?

a. $1,000.

b. $8,000.

c. $30,000.

d. No loss will be recognized on this trade�in.

21. When a government acquires or constructs a capital asset, it must consider capitalizing interest costs. List allof the conditions that must exist, according to FASBS No. 34, for the capitalization period to begin.

i. Payment for the capital asset must have been made or the liability incurred.

ii. Activities, such as plan development, have begun to prepare the capital asset for itsintended use.

iii. Interest costs for the capital asset have been incurred under the accrual basis ofaccounting.

a. iii.

b. i. and iii.

c. ii. and iii.

d. i., ii., and iii.


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22. The Pearville city government's proprietary fund issues bonds to finance the construction of a new bridge, butthe bond indenture does not restrict the use of bond proceeds to any specific project. On April 1, 20X1, bondsare issued at par$3 million, bearing interest at 10% with no principal deductions until 20X6. The applicableinterest rate is 10%. Planning for the new bridge begins and the government's first expenditures are incurredon May 1, 20X1. Expenditures are incurred evenly throughout the construction period, which lasted for 25months. The new bridge is completed on June 1, 20X3. Calculate the capitalized interest for this project.

a. $120,000.

b. $150,000.

c. $312,500.

d. $1,500,000.

23. A proprietary fund of the Oakmont city government issues tax�exempt bonds to finance construction of a newwater utility plant. The proprietary fund has an April 30 year end, the plant is a qualifying asset, and the bondindenture restricts the bond proceeds to use on the plant's construction. On May 1, 20X1, the bonds are issuedat par$15 million, bearing interest at 6%, with no principal reductions until 20X2. Bond proceeds (net ofexpenditures) are continuously invested by the government at a simple rate of 5%. The investments have astarting date of May 1, 20X1. The project begins on May 1, 20X1, and ends on January 1, 20X3. The constructionexpenditures are incurred and paid at a rate of $750,000 per month. Calculate the total of net capitalizableinterest for this project.

a. $375,000.

b. $500,000.

c. $875,000.

d. $15,875,000.


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Lesson 2:�Capital Assets, Infrastructure, andImpairment

INTRODUCTION

This lesson discusses several important issues with how governments must treat capital assets under GASBS No.34. Topics covered include how to report capital assets in government�wide financial statements, transitioning tothe GASBS No. 34 requirements for general infrastructure assets, the depreciation and modified approaches forreporting infrastructure assets, note disclosures and required supplementary information, the impairment of capitalassets, and insurance recoveries.


Completion of this lesson will enable you to:� Identify issues with reporting on capital assets in government�wide financial statements and transitioning to the

GASBS No. 34 general infrastructure asset requirements.� Compare and contrast the depreciation and modified approaches for reporting infrastructure.� Identify the requirements for note disclosures and supplementary information for infrastructure.� Determine the basics of the impairment of capital assets and insurance recoveries.

REPORTING CAPITAL ASSETS IN GOVERNMENT�WIDE FINANCIALSTATEMENTS

Government�wide Capital Asset ReportingTHE BASICS

� Except for capital assets associated with fiduciary activities, all capital assets are reported inthe government�wide statement of net assets generally in the same manner as in commercialenterprises.

� Depreciation or amortization expense should be reported for all capital assets except thosethat are inexhaustible (such as land), certain intangible assets, or infrastructure assetsreported using the modified approach.

Government�wide financial statements do not report funds or fund types. Instead, the focus is on governmental

activities and business�type activities. These activities are defined as follows:

� Governmental activities generally are financed through taxes, intergovernmental revenues, and othernonexchange revenues. Examples include fire and police services. Governmental activities are usuallyreported in governmental funds and internal service funds in the fund financial statements.

� Business�type activities are financed in whole or in part by fees charged to those external parties who usethe goods or services. Examples include water sales and golf course green fees. Business�type activitiesare usually reported in enterprise funds in the fund financial statements.

All capital assets (except for those specifically associated with certain fiduciary activities) are reported in thegovernment�wide statement of net assets. Depreciation expense (including amortization expense, in the case ofintangible capital assets) on capital assets, as appropriate, is generally reported with other direct expenses byfunction or identifiable activity in the government�wide statement of activities.

Capital Assets of Business�type Activities

Capital assets of business�type activities consist of those assets reported in the fund financial statements inenterprise funds. Because the measurement focus and basis of accounting is the same for both types of state�ments, the capital asset and depreciation/amortization expense amounts are the same. The reported cost of capital


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assets of business�type activities is required to include capitalized interest. Lesson 1 discusses the application ofFASBS No. 34 and related pronouncements.

Internal Service Fund Capital Assets. As a general rule, capital assets of internal service funds are reported withcapital assets of governmental activities. However, if the internal service fund provides services only or predomi�nantly to enterprise funds, they must be reported as business�type activity capital assets. The GASB does notdefine the term predominantly for this purpose, but it is most likely at least 50 percent and probably higher.

Capital Assets of Governmental Activities

Capital assets of governmental activities consist of the following components:

� General capital assets, consisting of assets reported before GASBS No. 34 as general fixed assets andgeneral infrastructure assets.

� Most internal service fund capital assets.

In contrast to governmental fund reporting, all assets, liabilities, revenues, and expensesboth financial andcapitalare required to be reported for governmental activities in the government�wide financial statements.Capital assets of governmental activities (general capital assets) should be reported as assets in the governmentalactivities column in the government�wide statement of net assets. These assets should be reported at historicalcost net of accumulated depreciation. GASBS No. 51 clarifies that the term depreciation includes amortization ofintangible assets. Except for inexhaustible assets or infrastructure assets reported using the modified approach,depreciation expense related to these assets (including amortization expense, in the case of intangible capitalassets) should be reported as governmental activities program expenses in the government�wide statement ofactivities. Information about capital assets, depreciation expense, and accumulated depreciation must be disag�gregated in the government�wide statements in a variety of different ways.

GASBS No. 34 establishes special transition requirements for general infrastructure asset reporting. However,governments were required, at a minimum, to report prospectively all general infrastructure assets constructed oracquired currently or during the transition period as assets in the government�wide financial statements.

Internal Service Fund Assets. Capital assets of governmental activities generally should include capital assetsreported in internal service funds in the fund financial statements. However, capital assets of internal service fundsshould be excluded from governmental activities if the internal service fund provides services only or predominantlyto enterprise funds. These capital assets should be reported in the same way they were reported in the proprietaryfund financial statements.

The GASB's policy on capitalization of interest on capital assets reported in internal service funds is not stated in itsstandards nor is it discussed in its Implementation Guides. Although it is not likely that internal service funds willactually construct capital assets (and therefore would be within the scope of FASBS No. 34 and its amendments),it is believed that interest cost should not be included in the cost of internal service fund capital assets that arereported with governmental activities in the government�wide statements. The GASB Comprehensive Implementa�

tion Guide2009, Appendix 7�3, Exercise #4, requires significant interest expense reported in internal servicefunds to be separated out and reported in the interest expense function of governmental activities. This requirementis based on the fact that, except in very limited situations, GASBS No. 34, paragraph 46 requires that all interestexpense on general long�term debt be considered an indirect expense reported in a separate line item, notallocable to any function or program. Debt of internal service funds reported with governmental activities is generallong�term debt.

Intra�entity and Intra�activity Transfers of Capital Assets

GASBS No. 48 requires capital asset transfers or sales and purchases between the primary government and oneof its component units or between component units of the same reporting entity to be reported at the transferor'scarrying value, with historical cost and accumulated depreciation being reported separately. This requirement iswithout regard to whether the component unit is blended or discretely presented. The same requirement applies totransfers of capital assets between funds of the primary government.


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When capital assets are transferred between activities reported in governmental funds (including blended compo�nent units) and activities reported in proprietary funds of the primary government, one or more entries are requiredto report the transfer in the government�wide financial statements. First, governmental activities that receive capitalassets from proprietary funds would need an entry to reconcile fund balance and change in fund balance for thereceipt of capital assets, such as the following:

Land $ 1,300,000

Equipment 948,000

Transfer in from Golf Enterprise Fund $ 2,176,000

Accumulated depreciation equipment 72,000

(To record the transfer of land and equipment from the City's Golf Enterprise fund.)

Second, according to the GASB Comprehensive Implementation Guide2009, Question 7.74.4, proprietary fundstransferring capital assets would report the net carrying value of the transferred capital assets as nonoperatingexpense. An entry is needed to reclassify this amount from nonoperating expense to a transfer for presentation inthe government�wide financial statements.

When general capital assets are transferred from governmental activities to proprietary funds, similar entries arerequired in reverse, as follows:

Transfer to utility fund $ 410,000

Accumulated depreciation buildings 315,000

Buildings $725,000

(To record the transfer of buildings to the City's utility fund.)

GASB Comprehensive Implementation Guide2009, Question 7.74.4, states that a proprietary fund receivingreassigned (i.e., transferred) capital assets would report the net carrying value of the assets as a capital contribu�tion. An entry is needed to reclassify this amount from capital contributions to a transfer in the government�widestatement of activities.

TRANSITIONING TO GASBS NO. 34 GENERAL ASSET INFRASTRUCTURE

General Infrastructure Asset TransitionTHE BASICS

� All general infrastructure assets must be reported prospectively from the date that agovernment is required to adopt the basic provisions of GASBS No. 34.

� Governments are given extra time to retroactively report general infrastructure assets. Phase3 governments never have to retroactively report their general infrastructure assets

� Only major general infrastructure assets acquired in years ending after June 30, 1980 or thatreceived major renovations after that date must be reported retroactively.

� GASBS No. 34 permits liberal methods for estimating the historical cost of generalinfrastructure assets at transition, including deflated current replacement cost.

� Retroactively reported general infrastructure assets should be treated as a prior�periodadjustment in the year in which they are first reported.

GASBS No. 34 requires governments to capitalize all (and depreciate most) of their capital assets at some level inthe required basic financial statements. This section discusses the GASBS No. 34 special effective dates andtransition provisions (including measurement provisions) that apply to general infrastructure assets.

Definitions

Infrastructure assets are a subset of capital assets. Although all capital assets have initial useful lives that extendbeyond one reporting period, infrastructure assets normally can be preserved for a significantly greater number of


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years than most other capital assets. That is, infrastructure assets are distinguished from other capital assetsbecause they normally (a) can be maintained in a condition that will allow them to be used longer than most othercapital assets and (b) are stationary in nature. Examples of infrastructure assets include roads, highways, bridges,tunnels, drainage systems, water and sewer systems, dams, and lighting systems. Although buildings would seemto meet the definition of infrastructure assets, they generally are not considered to be infrastructure assets underthe provisions of GASBS No. 34. Only those buildings that are an ancillary part of a network of infrastructure assetsshould be considered infrastructure assets. For example, tollbooths associated with a turnpike, road maintenancestructures such as shops and garages associated with a highway system, and water pumping buildings associatedwith water systems may be included as part of infrastructure assets under the ancillary building exception.Networks of infrastructure assets are defined in the �Networks and Subsystems" paragraph.

Infrastructure versus General Infrastructure Assets. GAAP distinguish between general capital assets andcapital assets specifically associated with proprietary and fiduciary funds. General infrastructure assets are asubset of general capital assets. Provisions of GASBS No. 34 that refer to capital assets and infrastructure assets

apply to all of the government's capital and infrastructure assets, regardless of which fund or activity they areassociated with. However, when the terms general capital assets and general infrastructure assets are used,readers should be aware that the discussion is limited to assets associated with or arising from governmentalactivities.

Auditor Assistance with General Infrastructure

Government Auditing Standards (the Yellow Book), issued by the U.S. Government Accountability Office (GAO),includes independence standards that are more restrictive than the independence standards of the AICPA. Ques�tions 49 and 55 of the GAO's �Answers to Independence Standard Questions" (GAO Q&A) address infrastructure�related issues that would apply to audits of financial statements being performed under the Yellow Book. Question49 indicates that the auditor can assist the client with preparation of depreciation schedules without impairingindependence as long as the client (a) determines the method, rate, and salvage value of the assets and (b) takesresponsibility for the depreciation schedules. Question 55 notes that an auditor's performance of extensive valua�tion services related to recording infrastructure goes beyond providing routine advice. Whether doing so impairsthe auditor's independence should be considered in light of the two overarching principlesone of which is thataudit organizations should not perform management functionsand the safeguards included in the Yellow Bookindependence standards.

Ongoing Infrastructure Transition ProvisionsOverview

One of the most controversial aspects of GASBS No. 34 is the requirement that governments report generalinfrastructure assets at historical cost in the statement of net assets and depreciate infrastructure assets in mostcases. As a result, the GASB made a number of accommodations to make the transition less difficult for state andlocal governments, including the following:

� Extending the deadline for reporting general infrastructure assets retroactively for larger governments byfour years and allowing smaller governments to report on a prospective basis only.

� Limiting required retroactive capitalization to �major" general infrastructure assets, as defined by GASBSNo. 34.

� Limiting the required retroactive capitalization period to years ending after June 30, 1980.

� Allowing initial capitalization using deflated current replacement cost to represent estimated historical cost.

� Permitting bond documents, engineering documents, and capital projects funds expenditures to be usedas source documents when estimating historical cost.

� Permitting composite depreciation rates based on groupings of similar assets or classes of dissimilarassets.

� Giving the smallest governments (phase 3 governments) the option of reporting (or not reporting)infrastructure acquired before the implementation of GASBS No. 34.


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The general infrastructure assets implementation provisions are discussed in this lesson.

Exhibit 2�1 summarizes the effective date of the infrastructure reporting provisions for both prospective andretroactive reporting for different size governments. The basics of determining whether a governmental entity is aphase 1, 2, or 3 government are briefly discussed in the �GASBS No. 34Governmental Financial ReportingModel" paragraphs at the beginning of Lesson 1. It should be noted that a government's phase designation neverchanges. As discussed in GASB Comprehensive Implementation Guide2009, Question 7.104.1, the phase isbased on revenues in the first fiscal year ending after June 15, 1999. Increases in revenues after that year have noeffect on a government's phase designation.

Exhibit 2�1

GASBS No. 34 Phased�in Effective Dates for Infrastructure

Prospective InfrastructureReporting (same as General

Statement Provisions)Retroactive General

Infrastructure Reporting

Phase Revenues (Fiscal periods beginning after June 15)

1 ��$100 million or more 2001 2005

2 ��$10 million to less than��$100�million

2002 2006

3 ��Less than $10 million 2003 Encouraged, but not required, toreport infrastructure retroactively

* * *

By now, all governments reporting on a GAAP basis should be reporting their general infrastructure assets acquiredsince adopting GASBS No. 34. In addition, all phase 1 and 2 governments reporting on a GAAP basis should beretroactively reporting their major general infrastructure assets. Phase 3 governments may or may not retroactivelyreport major general infrastructure assetsthey have the option to do so. As a result, the focus of the discussion inthis section is on the following governments:

� Governments that are preparing GAAP financial statements for the first time.

� Phase 1 and 2 governments that have decided to retroactively report major infrastructure assets acquiredbefore June 30, 1980 (provided they have appropriate supporting documentation).

� Phase 1 and 2 governments that have decided to retroactively report information for nonmajorinfrastructure assets acquired either before or after June 30, 1980, or both.

� Phase 3 governments that have decided to retroactively report some level of general infrastructure assetsfor the first time; for example, major general infrastructure assets acquired after June 30, 1980 and up tothe date they first adopted GASBS No. 34, or information about a particular network of generalinfrastructure assets acquired after June 30, 1980.

� Phase 3 governments that are component units of a Phase 1 or Phase 2 government and that have decidedto retroactively report some level of general infrastructure assets for the first time.

Prohibition Against Partial Reporting. During the GASBS No. 34 transition period, many governments gatheredcost information by network for their infrastructure assets. GASBS No. 34, paragraph 150, permits a government toreport networks of infrastructure assets for which it has information while still gathering information for retroactive


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reporting of all of its major general infrastructure assets. However, Question 7.104.10 of the GASB Comprehensive

Implementation Guide2009 explains that governments are not allowed to report their general infrastructureassets on any partial basissuch as year�by�yearother than by network of general infrastructure assets.

In 2009 the GASB modified its response to its Comprehensive Implementation Guide, Question 7.104.13, to statethat adding assets acquired prior to June 30, 1980 to a network or subsystem of assets that has already beenreported under GASBS No. 34 is considered to be reporting on a year�by�year basis and should not be done.

Prior Period Adjustment Always Required. Regardless of when a governmental entity reports all or some portionof its general infrastructure assets for the first time, the addition of assets should always be treated as a prior�periodadjustment in the year in which it is first reported as discussed in the GASB Comprehensive Implementation

Guide2009, Question 7.104.17. This is true for both the basic financial statements and for the note disclosuresrequired by GASBS No. 34, paragraphs 116 and 117.

Retroactive reporting provisions do not apply to infrastructure assets that are reported in the proprietary fundfinancial statements. (The reporting of proprietary fund infrastructure was already required under the pre�GASB 34reporting model.) Retroactive reporting provisions also do not apply to infrastructure assets of activities that will bereported using enterprise fund accounting and financial reporting for the first time under GASBS No. 34. Examplesinclude colleges and universities or activities that are required to be reported as enterprise funds based on GASBSNo. 34's new definition of enterprise funds.

Effective Date for Component Units. Component units were required to adopt the general provisions of GASBSNo. 34 using the effective dates that applied to their related primary government without regard to the level of theirannual revenues. However, whether a component unit is required to retroactively report its general infrastructureassets should be based on the annual revenues of the component unit, not the related primary government. Forexample, assume that a government qualifies for phase 3 implementation. If that government is a discretelypresented component unit of a phase 1 government, it would (a) implement GASBS No. 34 at the same time as theprimary government, but (b) be exempted from retroactive general infrastructure reporting because it is a phase 3government.

During the initial transition period, paragraph 151 of GASBS No. 34 required governments to make the followingdisclosures in the notes to the financial statements:

� A description of the infrastructure assets being reported and of those that are not.

� A description of any eligible infrastructure assets that the government has decided to report using themodified approach.

There are a number levels at which governments may be reporting their general infrastructure assets and a numberof situations in which governments may still be in the process of adding infrastructure assets to their financialreports. Governments shouldalways disclose the scope of their general infrastructure asset reporting in theirsummary of significant accounting policies. Additional infrastructure disclosures are discussed later in this lesson.

Retroactive Reporting and Debt�financed General Infrastructure Assets. Governments that do not retroactivelyreport debt�financed general infrastructure assets, the amount reported as net assets �invested in capital assets,net of related debt" in the statement of net assets could be small or even negative until the historical cost ofdebt�financed general infrastructure assets has been estimated and reported. Special disclosures that are requiredduring this transition period are addressed in the �Note Disclosures and Required Supplementary Information forInfrastructure" section. These disclosures and management's discussion and analysis (MD&A) may includeexplanations of the financial statement effect of recording debt in advance of the related general infrastructureassets. In addition, governments may choose to record some of their more recent infrastructure acquisitions beforethe retroactive reporting date to offset any negative net assets, provided that these assets are added by network orsubsystem.


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Determining Major General Infrastructure Assets

Steps a.�d. below provide the best sequence for assessing whether a government has major general infrastructureassets acquired before or after June 30, 1980.

a. Determine Whether a Government Owns Infrastructure Assets. For most governments, this is not a difficultquestion. The government can usually prove that it has title to the assets. However, sometimes theownership of infrastructure assets is not so clear. Consider the situation where a county government hasconstructed a road, which was financed by county bonds, but the road is maintained by the state and notitle exists. Footnote 67 to paragraph 154 of GASBS No. 34 indicates governments that have the primaryresponsibility for managing an infrastructure asset should report the asset when ownership is unclear.Footnote 67 states that �a government should report an asset even if it has contracted with a third partyto maintain the asset" [emphasis added]. Therefore, in the situation described above, the state isconsidered to own the road for reporting purposes because it maintains the road.

b. Determine Whether a Government Has General Infrastructure Assets That Were Acquired (Purchased,

Constructed, or Donated), or That Received Significant Reconstructions or Major Renovations, Restora�

tions, or Improvements in Its Fiscal Years Ending after June 30, 1980. Infrastructure assets that meet thiscriterion must be capitalized by phase 1 or 2 governments if they are major general infrastructure assets(Step f.). GASB Comprehensive Implementation Guide2009, Question 7.106.4, notes that governmentsare encouraged, but not required, to report general infrastructure assets acquired prior to a government'sfirst fiscal year ending after June 30, 1980.

c. Determine How the General Infrastructure Assets Determined in Step b., If Any, Should Be Classified in

Networks or Subsystems of Networks.

d. Make Preliminary Cost Estimates for Networks.

e. Determine the Total Cost of General Capital Assets (Excluding Unrecorded Infrastructure Assets) for the

Government's First Fiscal Year Ending after June 15, 1999.

f. Apply the GASBS No. 34, Paragraph 156, Threshold Test to Determine If Major General Infrastructure Assets

Exist. For networks, the threshold is 10 percent of general capital assets reported in the first fiscal yearending after June 15, 1999. For subsystems, the threshold is 5 percent of general capital assets reportedin the first fiscal year ending after June 15, 1999.

Networks and Subsystems. GASBS No. 34 requires the determination of major general infrastructure assets bemade at the network or subsystem level. GASBS No. 34, footnote 14, provides the following definition of a network

of assets:

A network of assets is composed of all assets that provide a particular type of service for agovernment. A network of infrastructure assets may be only one infrastructure asset that iscomposed of many components. For example, a network of infrastructure assets may be a damcomposed of a concrete dam, a concrete spillway, and a series of locks.

Similarly, footnote 15 of GASBS No. 34 defines a subsystem of a network of assets as follows:

A subsystem of a network of assets is composed of all assets that make up a similar portion orsegment of a network of assets. For example, all the roads of a government could be considereda network of infrastructure assets. Interstate highways, state highways, and rural roads couldeach be considered a subsystem of that network.

Networks or subsystems of a network may also be made up of dissimilar assets. The GASB Comprehensive

Implementation Guide2009, Question 7.12.9, notes that �the government may account for any of its capital assetsin groupings that best suit its needs. For example, a road network could consist of pavements, traffic controldevices, and signage." Exhibit 2�2 provides examples of networks of infrastructure assets and subsystems forthose networks.


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Exhibit 2�2

Example Networks and Subsystems of Networks of Infrastructure Assets

Network of Infrastructure Assets Potential Subsystem for the Network

All the roads of a government Interstate highways, state highways, and ruralroads could be subsystems.

A water distribution system of a government Pumping stations, storage facilities, and distribu�tion mains could be subsystems.

Airport pavements Runways, taxiways, and aprons could besubsystems.

Storm sewer system Catch basins, storm drains, and inlets could besubsystems.

* * *

GASBS No. 34 only requires governments to report capital assets in the statement of net assets in two categoriescapital assets that are being (or have been) depreciated and those that are not. However, paragraph 20 of GASBSNo. 34 notes that governments are not precluded from reporting capital assets in greater detail, such as by majorclass of asset. For example, infrastructure, buildings and improvements, vehicles, machinery and equipment andconstruction in progress could be reported separately. (Capital assets must be disclosed by major class in thenotes to financial statements.) Therefore, the categorization of infrastructure assets into networks or subsystems ofnetworks of general infrastructure assets is not necessary for reporting purposes although it is allowed. Categoriza�tion of general infrastructure assets into networks or subsystems of networks is only needed (a) for purposes of thethreshold test and (b) for governments that use the modified approach to report portions of their general infrastruc�ture assets.

Determining Preliminary Cost Estimates for the Threshold Test. As discussed in step f., listed previously,GASBS No. 34, paragraph 156, requires governments to determine their major general infrastructure assets byapplying a threshold test. That test is based on preliminary cost estimates for the networks or subsystems of anetwork of general infrastructure assets, discussed in Step d. In the GASB Comprehensive Implementation

Guide2009, Appendix 7�3, Exercise #10, the GASB staff explains that these �preliminary cost estimates may bemade in various ways and need only be precise enough to permit determination of whether the network orsubsystem would be considered major." The footnote to Exercise #10 states that, �for example, the estimate of theurban arterial subsystem could be made by multiplying the number of lane�miles by current replacement cost perlane�mile. Estimation of the acquisition date and deflation of the replacement cost to this date are unnecessarybecause the preliminary estimate was sufficient to determine that the subsystem would not be considered major."

Threshold Test for Determining Major General Infrastructure Assets. After determining how a government willcategorize its networks or subsystems of networks of general infrastructure assets acquired in its fiscal yearsending after June 30, 1980, and after making preliminary cost estimates for these networks or subsystems, the nextstep in determining whether a government has major general infrastructure assets is to apply the GASBS No. 34,paragraph 156, threshold test. That paragraph establishes two criteria, which should be applied at the network orsubsystem level, for determining major general infrastructure assets:

� The cost or estimated cost of the subsystem is expected to be at least 5 percent of the total cost of all generalcapital assets reported in the first fiscal year ending after June 15, 1999, or

� The cost or estimated cost of the network is expected to be at least 10 percent of the total cost of all generalcapital assets reported in the first fiscal year ending after June 15, 1999.


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Because governments define networks and subsystems of networks differently, the major general infrastructureassets that must be reported retroactively will differ from government to government. A government is not requiredto divide its networks into subsystems when applying the capitalization threshold test. A government that choosesnot to divide its networks into subsystems will apply only the 10 percent test for the network. A government thatchooses to divide its networks into subsystems should apply the 5 percent test, and may also apply the 10 percenttest for networks by simply adding up the estimated cost of the infrastructure assets consisting of all the subsys�tems of a network. However, a government is not required to apply the 10 percent test if its determination forretroactively capitalizing infrastructure assets is only based on subsystems of networks of infrastructure assets.Exhibit 2�3 illustrates the application of the GASBS No. 34, paragraph 156, threshold test for determining majorinfrastructure assets.


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Exhibit 2�3

Applying the GASBS No. 34, paragraph 156, Threshold Test

Assume that a county, a phase 2 government, makes a preliminary estimate of the cost of its general infrastructureassets acquired or that received major renovations, restorations, or improvements in fiscal years ending afterJune�30, 1980. The county intends to implement GASBS No. 34 for its fiscal year ending June 30, 2003. Forpurposes of the capitalization threshold test, the cost estimate only has to be precise enough to permitdetermination of whether the network or subsystem would be major. Therefore, the county used a preliminary grosscost estimate for its roads and bridge spans. (A more precise estimate of the historical cost of infrastructure isnecessary for capitalization purposes.) The county multiplied the number of lane�miles for a category of road by theapplicable current replacement cost per lane�mile for that category. The current replacement costs were thendeflated based on the conservative assumption that the roads had been placed in service 8 years ago. The countydetermined that this would allow for the identification of all major general infrastructure assets because countyengineers stated that the average age of each category of roads in the county was at least 9.5 years. The countydetermined its major general infrastructure assets using the following gross cost estimates:

PreliminaryEstimated

Cost atJune 30, 2002

Percentage ofGeneral Capital Assets

at June 30, 1999($45,524,000)

Roadway network:

Rural access subsystem $ 35,453,000 77.9%

Rural arterial subsystem 55,395,000 121.7%

Urban access subsystem 3,432,000 7.5%

Urban arterial subsystem 1,500,000 3.3%

Total roadway network $ 95,780,000 210.4%

Bridge spans network:

20 to 40 feet subsystem $ 4,875,000 10.7%

41 to 60 feet subsystem 2,500,000 5.5%

Greater than 60 feet subsystem 15,387,000 33.8%

Total bridge spans network $ 22,762,000 50.0%

Conclusion

If the determination of major general infrastructure assets is made at the network level, both networksroadwayand bridge spansare considered major because their preliminary estimated costs each exceed 10 percent of thecost of other general capital assets. If the determination is made at the subsystem level, then all subsystems, exceptthe urban arterial subsystem, would be considered major general infrastructure assets because their preliminaryestimated costs exceed the 5 percent threshold. Initial capitalization at transition would not be required for theurban arterial subsystem although it is encouraged. However, the county would be required to capitalizeacquisition, construction, or significant reconstruction or improvement of all roads, including urban arterial roads,prospectively.

[SOURCE:�Adapted from GASB's Comprehensive Implementation Guide2009, Appendix�7�3, Exercise 10.]

* * *

Total Cost of All General Capital Assets. The total cost of all general capital assets used in the threshold test inthe �Threshold Test for Determining Major General Infrastructure Assets" paragraph is the amount reported asgeneral capital assets in the general fixed asset account group of the government's combined balance sheet for itsfirst fiscal year ending after June 15, 1999. This cost is needed for Step e. in the �Determining General InfrastructureAssets" paragraph. The total cost of a government's general capital assets should be determined before capitaliza�


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tion of any previously unrecorded infrastructure assets. Question 7.106.1 of the GASB Comprehensive Implementa�

tion Guide2009 notes that GASBS No. 34 does not specify whether the calculation of the total cost of all generalcapital assets should be performed using historical cost or net book value of general capital assets. Historical costand net book value could be different if the government has reported accumulated depreciation for general capitalassets in the past. Although this reporting was allowed in the GFAAG under the pre�GASBS No. 34 guidance, itrarely occurred in practice. Net book value of general capital assets is the cost of capital assets (or fair value ofdonated assets) less accumulated depreciation (if reported in the past). Question 7.106.1 also notes that whendetermining the total cost of all general capital assets, general capital assets do not include proprietary or fiduciaryfund capital assets.

Amount to CapitalizeRetroactive Reporting

Capital assets, including general infrastructure assets, should be reported in the statement of net assets athistorical cost (if purchased or constructed) or estimated fair value at the time of acquisition (if donated). Manygovernments have not maintained historical cost records because there was no requirement to report generalinfrastructure assets. In some instances, determining actual historical cost is not practical for a governmentbecause of inadequate records. In such cases, paragraph 157 of GASBS No. 34 allows governments to useestimated historical cost to record general infrastructure assets. While the GASB does not specify a preferredmethod for determining estimated historical cost, a discussion of several alternative methods is included in GASBSNo. 34.

A government may use existing sources of information to provide support for the initial historical cost estimates forits general infrastructure assets. The GASB does not provide guidelines for assessing the acceptability of informa�tion for determining estimated historical costs. Thus, determination of the acceptability of information is a matter ofprofessional judgment and will normally involve consultation and agreement between a government and itsauditors. However, GASBS No. 34, paragraph 160, and GASB Comprehensive Implementation Guide2009,Question 7.107.6, specifically identify some sources of information that may provide sufficient support for establish�ing the initial capitalization amounts. These sources include the following:

� Bond documents used to obtain financing for construction or acquisition of infrastructure assets.

� Expenditures reported in capital project funds or capital outlays in governmental funds in prior financialreports.

� Engineering documents.

� Capital budgets.

� Evidence of contract awards, such as could be found in the minutes of a governing body.

GASBS No. 34, paragraph 158, provides that governments can estimate the historical cost of general infrastructureassets by calculating the current replacement cost of a similar asset and deflating this cost through the use ofprice�level indexes to the acquisition year (or estimated acquisition year if the actual year is unknown). Forgovernments choosing this deflated current replacement cost approach, three critical pieces of information areneeded. First, the current replacement cost of the assets must be determined. Second, the acquisition year orestimated acquisition year must be determined. Third, a price level index must be chosen to deflate the currentreplacement cost to the acquisition or estimated acquisition year. These items are discussed in the followingparagraphs.

Many governments that have implemented GASBS No. 34's infrastructure reporting requirements have chosen toreport all their general infrastructure assets. Many do so by reporting the estimated historical cost of those assetsusing the deflated current cost method. It appears that these preparers found it easier to use this method and applyit to all inventoried assets (generally already maintained by the government's engineering department) than tosearch out actual cost records for assets acquired after 1980.

Current Replacement Costs. Current replacement costs generally can be determined based on a government'scurrent�year construction costs for similar assets or other information that approximates current replacement costs.


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Governments that have current�year construction cost records for similar infrastructure assets can calculate costsper unit using a reasonable and easily applied base. For example, GASB Comprehensive Implementation

Guide2009, Question 7.107.7, indicates that the current replacement costs of �sidewalks could be estimatedusing square footage, curbs using lineal footage or miles, or bridges using span footage." Similarly, paragraph 159of GASBS No. 34 indicates the current cost of roads may be estimated based on lane�miles for similarlyconstructed roads. In determining the current costs of roads, the type of materials used in the construction shouldbe considered (for example, concrete versus asphalt) as well as differences in construction for the intended roadusage (for example, a residential city street versus a four�lane major arterial road). As noted in the GASB Compre�

hensive Implementation Guide2009, Question 7.107.8, sometimes there are changes in the applicable codes,standards, or ordinances that affect the way general infrastructure assets would have been constructed in the pastcompared to current construction standards. If these changes are significant, they need to be taken into consider�ation in the deflated current cost calculation. After a cost per unit has been determined, the calculation of thecurrent replacement cost for infrastructure assets is calculated by multiplying the cost per unit by the number ofunits. Exhibit 2�4 Illustrates this calculation.

Exhibit 2�4

Calculating Current Replacement Costs

A city has constructed 65 lane�miles of city residential streets since its fiscal year ending December 31, 1980.Concrete was used in the construction of 45 lane�miles of streets while asphalt was used for 20 lane�miles. The cityhas not maintained historical cost records and has been unable to reconstruct the records. City managementdecides to determine an estimated historical cost for the roads by deflating the roads' current replacement cost.During the past year, the city constructed two additional lane�miles of concrete residential streets for $1.1 million or$550,000 per lane�mile. Although the city has not constructed any asphalt residential streets during the past year,it recently received a bid to construct a one lane�mile section of a residential street for $400,000. Based on thisinformation, the current replacement costs for 45 lane�miles of concrete residential streets would be $24,750,000($550,000 � 45 lane�miles) and 20 lane�miles of asphalt residential streets would be $8,000,000 ($400,000 � 20lane�miles). The total current replacement cost of the city's residential sheets would be $32,750,000. These costswould need to be deflated to the year (or estimated year) of acquisition to determine the estimated historical costof city residential streets that would be reported in the statement of net assets.

* * *

Acquisition Year. The next step in calculating the deflated current replacement cost of general infrastructure assetsis to determine the acquisition year or estimated acquisition year for these assets. Only general infrastructureassets that were acquired (purchased, constructed, or donated) or that received major renovations, restorations, orimprovements in a government's fiscal years ending after June 30, 1980, must be considered. Many governmentswill have adequate records to estimate the year of acquisition by examining the minutes of governing boards,public works and street department records, bond documents, annexation approvals, approvals and requiredspecifications for new developments, or even newspaper accounts. Another way to estimate the age of generalinfrastructure assets is to consider the age of adjacent buildings. For example, the average age of roads, sidewalks,and drainage systems built in connection with a housing development will be the same as the ages of the homesin that development. Some governments may wish to account for their general infrastructure assets by class,network, or subsystems of a network instead of by individual asset. These governments may find it easier todetermine the estimated acquisition year for general infrastructure assets using a simple average or weighted�aver�age age method.

A simple average age is calculated by adding together the ages of a particular type of general infrastructure assetsand dividing by the number of assets. For example, assume that a state government wants to account for all of itsinterstate highways as a subsystem of a road network. The state has three interstate highways, which were builtapproximately 16, 20, and 24 years ago. Their simple average age would be about 20 years (16 + 20 + 24 � 3).Although this method is simple, it is also imprecise because no weighting is assigned for differences in the roads.The age of a short road (for example, 10 miles of road) is given as much weight as the age of a road that is quitelong (for example, 200 miles). Governments could consult their auditors when deciding whether a simple average


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age method will result in an adequate age estimate. If a simple average age method will not result in an adequateage estimate, a weighted�average age method should be used. GASBS No. 34, paragraph 159, provides anexample of using a weighted�average age method to estimate the age of roads. The weighted�average age methodcan take into consideration any number of road characteristics. Exhibit 2�5 and Exhibit 2�6 illustrate two methods ofcalculating the weighted�average age of roads.

Exhibit 2�5

Calculating the Weighted�average Age of an Infrastructure Subsystem

Summary of Facts

A state government has a 35�mile arterial road that has been subject to multiple construction projects that overlapearlier projects since 1980, as shown in the schedule below:

Year Project Mileposts

1980 1 1�15

1982 2 16�25

1984 3 26�30

1988 4 06�12

1989 5 26�35

If construction costs are known, weighted�average age may be computed based on the proportion of costs to thetotal. Alternatively, weighted�average age may be calculated in proportion to the number of miles constructed.

Age Weighted by Cost Age Weighted by MIles

Year Project MilepostsAge in2002

Cost(in 000s) Cost � Age

Numberof Miles

Miles �Age

1980 1 1�15 22 $ 15,000 $ 330,000 15 3301982 2 16�25 20 10,300 206,000 10 2001984 3 26�30 18 5,500 99,000 5 901988 4 6�12 14 10,500 147,000 7 981989 5 26�35 13 16,000 208,000 10 130

$ 57,300 $ 990,000 47 848

Average age: $ 17.28 18.04

Neither method of computing an average age is recommended over the other. Therefore, governments shouldconsider their own facts and circumstances, including the costs of obtaining the information needed by thealternative methods. However, most governments estimating the cost of infrastructure assets using the deflatedcurrent replacement cost approach generally will be precluded from applying the age weighted by cost methodbecause the age of the assets must be known before an estimated cost can be determined.

[SOURCE:�Adapted from GASB's Comprehensive Implementation Guide2009 Appendix 7�3, Exercise 9.]

* * *


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Exhibit 2�6

Estimating the Historical Cost and Accumulated Depreciation of a Secondary Road SystemUsing the Deflated Current Replacement Cost Approach

Assume that a city, incorporated in 1960, is determining the estimated historical cost of its secondary road systemusing the deflated current replacement cost approach as of its fiscal year ending June 30, 2000, using the followingfacts:

In 2000, the city has a total of 65 lane�miles of roads in a secondary road subsystem, and the current constructioncost of similar roads is $1 million per lane�mile. The estimated total current replacement cost of the secondary roadsubsystem of a highway network, therefore, is $65 million ($1 million � 65).

The weighted�average age is calculated based on the ages of roads that were found in road department records,which indicate when roads were first opened for public use. Although the city has information about the number oflane miles and when each road was initially constructed, it does not have sufficient information to determine thecost of those roads or of major reconstructions. For this reason, the city has chosen to retroactively report all of itsroads using the deflated current cost method.

Year Miles of RoadAge in 2000

(Years) (Miles � Age)

1960 6 40 2401965 5 35 1751970 2 30 601972 3 28 841977 8 23 1841980 15 20 3001985 8 15 1201986 7 14 981992 4 8 321999 7 1 7

65 1300

Weighted�average age of roads(1300/65 miles) 20

As computed above, the roads have an estimated weighted�average age of approximately 20 years in 2000.Therefore, 1980 is considered to be the acquisition year. Based on the U.S. Department of Transportation, FederalHighway Administration's Price Trend Information for Federal�Aid Highway Construction (publication numberFHWA�IF�00�021) for 1980 and 2000, the composite index for 1980 construction costs was 97.2 and the compositeindex for 2000 construction costs was 145.6. Therefore, 1980 road construction costs were 66.76 percent of 2000costs (97.2 � 145.6). As a result, the estimated historical cost of the subsystem is $43,394,000 ($65 million �.6676).

The government's engineers have historical data that shows the life of secondary roads is approximately 30�years.Based on this information, the estimated remaining useful life of this 65 miles of secondary roads is 10 years (30years � 20 years). Assuming no residual value is expected at the end of the 30 years, straight�line current�perioddepreciation expense would be $1,446,466 per year ($43,394,000 � 30); accumulated depreciation would be$28,929,333 ($1,446,466 � 20).

In 2000, the government would have reported the subsystem in its financial statements at a net cost of $14,464,667(estimated historical cost of $43,394,000 less accumulated depreciation of $28,929,333).

* * *

Price�level Indexes. The final piece of information needed to estimate the historical cost of general infrastructureassets using the deflated current replacement cost approach is an appropriate price�level index. The GASB does


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not specify an index. Instead, GASBS No. 34, paragraph 158, indicates that �there are a number of price�levelindexes that may be used, both private� and public�sector," to eliminate the effects of price�level changes fromcurrent replacement costs. Some possible sources for price�level indexes include the following:

� U.S. Department of Transportation, Federal Highway Administration's Price Trend Information for

Federal�Aid Highway Construction. This index is a composite bid price index composed of six indicatoritems necessary for road construction: common excavation costs for roadways; portland cement concretepavement and bituminous concrete pavement for road surface types; and reinforcing steel, structural steel,and structural concrete for structural price trends. The index is based on a 1987 base and covers the years1972 through 2004. It includes price trends for federal�aid highway construction with a breakdown for ruraland urban highways. The most recent indexes are available via facsimile from the Federal HighwayAdministration, Office of Program Administration, Office of Infrastructure, which can be reached at (202)366�4636. Price trend indicators for excavation, resurfacing, and structures and a composite index are alsoavailable at the Federal Highway Administration's website at www.fhwa.dot.gov/policy/ohim/hs04/htm/pt1.htm for years 1960, 1965, and 1970 through 2004.

� Engineering News�Record (ENR) is published by McGraw�Hill and is available on the Internet atwww.enr.com. ENR has two comprehensive composite indexes: the Construction Cost Index (CCI) andthe Building Cost Index (BCI). Both indexes are widely used in the construction industry. However, the CCIwill generally be more useful when estimating the cost of infrastructure projects. The CCI is based on bothlabor and certain construction material costs for 20 U.S. cities and covers the period from 1908 to thepresent. In addition to these indexes, ENR also publishes detailed construction material price indexes forcertain construction material for 20 U.S. cities for the past 12 months. By reviewing a series of past issues,a government could develop its own index to deflate the current replacement cost of infrastructure assets.The construction material price indexes include prices for (a) 21 products for paving asphalt, portlandcement, aggregates, etc.; (b) 20 pipe products including reinforced concrete pipe, corrugated steel pipe,PVC water and sewer pipe, and ductile iron pipe; and (c) 16 products for construction steel includingstructural steel, reinforcing bar, and aluminum and stainless steel sheet and plate. (These indexes can befound by using the link titled, �Cost Indexes" under �Economics" at the center of ENR's home page.)

� American City and County magazine also provides a possible source for price indexes. This magazine haspublished four price level indexes since 1978: (a) the municipal cost index (MCI), (b)�the construction costindex, (c) the consumer price index, and (d) the producer price index. Each�of these indexes is availableonline for each month since September 1978 at www.americancityandcounty.com under the site feature�Municipal Cost Index Archive." Of the indexes published by American City and County, the constructioncost index is probably the most useful for deflating the current replacement of infrastructure assets. Thisis because the construction cost index specifically relates to construction and does not include many ofthe additional factors that are part of the other indexes provided at the website. The construction cost indexis based on the Engineering News�Record's CCI and BCI.

� Appraisal companies are another source for price indexes. Because these companies are in the appraisalbusiness, many of their indexes are proprietary and available only for a fee. Possible sources are AmericanAppraisal Associates (www.american�appraisal.com) and Maximus Inc. (www.maximus.com). Industryrepresentatives provided information about price indexes and methods of estimating useful lives to theGASB when it was considering various methods for initially reporting infrastructure assets.

� State and local highway or engineering departments may maintain cost indexes for road or otherconstruction. Some state highway departments maintain construction cost indexes for highway and roadconstruction in their state since 1980. Some city engineering departments retain detailed cost records thatcould be converted to an index to deflate current replacement costs. However, if an engineeringdepartment has sufficient detail in its cost records, actual historical cost information should be used insteadof estimated historical cost.

Accumulated Depreciation. GASBS No. 34, paragraph 20, requires capital assets that are being or have beendepreciated to be reported net of accumulated depreciation. Unless general infrastructure assets are inexhaustibleor reported using the modified approach, governments must calculate an estimated accumulated depreciation


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amount for retroactively reported infrastructure assets. If the deflated current replacement cost approach is used toestimate the historical cost of general infrastructure assets, accumulated depreciation should also be based on thedeflated amount.

Calculating depreciation expense and accumulated depreciation for retroactively reported general infrastructureassets requires the following information about the assets:

� Historical cost (or estimated cost).

� Expected residual or salvage value, if any.

� Estimated age.

� Estimated useful life.

� A depreciation method.

Governments will have already gathered most of this information if the estimated historical cost of general infra�structure assets was determined by deflating current replacement cost. However, the estimated useful lives ofgeneral infrastructure assets will have to be determined. Guidance for estimating the useful lives of capital assetsand depreciation methods are discussed in Lesson 1. Many governments, particularly state governments, havebegun to make available information about the estimated useful lives that they use or plan to use for theirinfrastructure assets under GASBS No. 34. Two states that have early implemented GASBS No. 34 noted in theirfinancial statements that they depreciate infrastructure assets over 40 years (Oklahoma) and between 15 to 40years (Michigan). Additional information is available on the Internet sites of some states.

The calculation of accumulated depreciation at transition can be simplified by determining an average age forinfrastructure assets. When calculating estimated historical cost by deflating current replacement costs, govern�ments generally will use a simple average age method or an age weighted by miles (or other applicable measure�ment) method. However, in situations where the cost of infrastructure has been calculated by methods other thanthe deflated current replacement cost approach, the government may want to determine accumulated depreciationfor classes, networks, or subsystems of networks using the weighted�average age by cost method to calculate theestimated age of their infrastructure assets. Exhibit 2�5 illustrates how to determine the weighted�average age ofinfrastructure assets by two methodsage weighted by cost and age weighted by miles.

Exhibit 2�6 and Exhibit 2�7 provide comprehensive examples for applying the deflated current replacement costapproach to estimate the historical cost of infrastructure assets and the related accumulated depreciation. The ageweighted by miles method and the simple average age method are used in Exhibit 2�6 and Exhibit 2�7, respectively.

Exhibit 2�7

Estimating the Historical Cost and Accumulated Depreciation of a Rural Access Road Network Usingthe�Deflated Current Replacement Cost Approach

Assume that a county is determining the estimated historical costs of its rural access road network using thedeflated current replacement cost approach as of June 30, 2003, using the following facts:

� Current construction cost per lane�mile for a rural access road is approximately $500,000.

� The county has elected to limit its retroactive reporting of general infrastructure assets at transition to roadprojects that resulted in acquisition, construction, or significant reconstruction or improvement of county roadssince June 30, 1980, as allowed by GASBS No. 34, paragraph 149. During this period, 87 miles of rural accessroads were constructed, reconstructed, or significantly improved.

� Because of the county's consistent, ongoing construction program, the county has determined that the averageage for these projects is 11.5 years. This is based on a simple average of the oldest road (23 years) and thenewest road (0 years).


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� The following price�level changes were obtained from the table of Price Trends for Federal�Aid HighwayConstruction, published in Price Trends for Federal�Aid Highway Construction by the U.S. Department ofTransportation, Federal Highway Administration, Office of Program Administration, Office of Infrastructure.

Year Composite Index

1991 107.5

2003 131.9

Estimation of Historical Cost

Lane�miles � average cost per lane�mile � (year of acquisition index � current�year index), rounded:

87 lane�miles � $500,000 � (107.5 � 131.9) = $35,453,000

Calculation of Accumulated Depreciation as of June 30, 2003

Estimated useful life (based on government engineer's experience with similar roads): 25 years

Estimated historical cost � estimated useful life � average age, rounded:

$35,453,000 � 25 years � 11.5 = $16,308,380 ($16,308,000 rounded)

[SOURCE:�Adapted from GASB's Comprehensive Implementation Guide2009, Appendix 7�3, Exercise 8.]�

* * *

Amount to CapitalizeProspective Reporting

Capital assets, including infrastructure assets, are reported at historical cost if purchased or estimated fair value attime of acquisition if donated. In addition, the cost of capital assets should include ancillary charges. Ancillarycharges include the amounts that are directly attributable to asset acquisition and that are necessary for the assetto be used. The capitalized cost of general infrastructure assets should not include interest cost.


338


339

SELF�STUDY QUIZ


24. How should the depreciation expense of capital assets be reported in government�wide financial statements?

a. With other direct expenses in the government�wide statement of activities.

b. In the fund financial statements of enterprise funds.

c. With the capital assets of governmental activities.

25. Which of the following is a characteristic of an infrastructure asset?

a. Infrastructure assets only have a useful life of one reporting period.

b. Most government buildings are considered infrastructure assets.

c. Infrastructure assets are normally stationary in nature.

26. How does Government Auditing Standards (the Yellow Book) address independence issues related toinfrastructure?

a. The requirements of the Yellow Book independence standards match those of the AICPA independencestandards.

b. An independent auditor can perform extensive infrastructure valuation services, as valuation is consideredproviding routine advice.

c. An independent auditor can assist a client with preparation of infrastructure depreciation schedules, if theclient takes certain actions.

27. Which of the following is an accommodation of GASBS No. 34 to help governments minimize the costassociated with depreciating general infrastructure assets and reporting them at historical cost?

a. Governments can elect not to meet these requirements retroactively.

b. Required retroactive capitalization is limited to years after December 31, 1960.

c. Similar assets can be grouped for depreciation, though dissimilar assets cannot.

d. Engineering documents can be used as source documents to estimate historical cost.

28. Define a network of assets under GASBS No. 34.

a. All assets that provide a government a certain type of service.

b. All major general infrastructure assets owned by a government.

c. All assets making up a similar portion of a network of assets.

d. Assets grouped by the government in ways that best suit its needs.


340

29. If a government includes a water distribution system as one of its networks of infrastructure assets, which ofthe following would potentially be considered part of the network's subsystems?

a. Storm drains.

b. Rural roads.

c. Pumping stations.

d. Aprons.

30. Which of the following statements best describes the threshold test for determining major general infrastructureassets?

a. Major general infrastructure assets will be the same for all governments.

b. A government that does not divide networks into subsystems only uses the 10% test.

c. A government that divides its networks into subsystems must use both the 5 and 10% tests.

d. The threshold test is based on the final historical cost for the infrastructure assets.

31. If a government does not have historical cost records of purchased or constructed general infrastructure assets,how does it report them under GASBS No. 34?

a. The government should report these capital assets at their estimated fair value.

b. The government must estimate the historical cost using the method outlined in GASBS No. 34.

c. The government can use professional judgment and estimate historical cost for these assets.

32. Since its fiscal year ending December 31, 1980, and including the street construction completed this year, acity has constructed 50 lane�miles of city residential streets out of concrete and an additional 25 lane�miles outof asphalt. The government plans to use the deflated current replacement cost approach to estimate historicalcost. The city constructed five lane�miles out of concrete this year for $500,000 per lane�mile. The cityconstructed one lane�mile with asphalt this year for $350,000. Calculate the total current replacement cost ofthe city's residential streets.

a. $8,750,000.

b. $25,000,000.

c. $37,500,000.

d. $33,750,000.

33. Which of the following would not be used as a price�level index under the deflated current replacement costapproach?

a. Price Trend Information for Federal�Aid Highway from the Federal Highway Administration.

b. Engineering News�Record (ENR) from McGraw�Hill.

c. Indexes from state or local highway or engineering departments.

d. The index specified and provided by GASBS No. 34.


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24. How should the depreciation expense of capital assets be reported in government�wide financial statements?(Page 321)

a. With other direct expenses in the government�wide statement of activities. [This answer is correct.Depreciation expense (including amortization expense, in the case of intangible capital assets) oncapital assets, as appropriate, is generally reported with other direct expenses by function oridentifiable activity in the government�wide statement of activities.]

b. In the fund financial statements of enterprise funds. [This answer is incorrect. Capital assets ofbusiness�type activities consist of those assets reported in the fund financial statements in enterprisefunds. Because the measurement focus and basis of accounting is the same for both types of statements,the capital asset and depreciation/amortization expense amounts are the same.]

c. With the capital assets of governmental activities. [This answer is incorrect. As a general rule, capital assetsof internal service funds are reported with capital assets of governmental activities. However, if the internalservice fund provides services only or predominantly to enterprise funds, they must be reported asbusiness�type activity capital assets.]

25. Which of the following is a characteristic of an infrastructure asset? (Page 325)

a. Infrastructure assets only have a useful life of one reporting period. [This answer is incorrect. Although allcapital assets have initial useful lives that extend beyond one reporting period, infrastructure assetsnormally can be preserved for significantly greater number of years than most other capital assets.Infrastructure assets can be maintained in a condition that will allow them to be used longer than most othercapital assets.]

b. Most government buildings are considered infrastructure assets. [This answer is incorrect. Althoughbuildings would seem to meet the definition of infrastructure assets, they generally are not considered tobe an infrastructure asset under the provisions of GASBS No. 34.]

c. Infrastructure assets are normally stationary in nature. [This answer is correct. Per the definition ofa infrastructure asset in GASBS No. 34, they are stationary in nature.]

26. How does Government Auditing Standards (the Yellow Book) address independence issues related toinfrastructure? (Page 324)

a. The requirements of the Yellow Book independence standards match those of the AICPA independencestandards. [This answer is incorrect. The Yellow Book requirements are more restrictive than theindependence standards of the AICPA.]

b. An independent auditor can perform extensive infrastructure valuation services, as valuation is consideredproviding routine advice. [This answer is incorrect. According to the GAO's �Answers to IndependenceStandard Questions," providing extensive valuation services related to recording infrastructure goesbeyond providing routine advice. Whether doing so impairs the auditor's independence should beconsidered in light of the two overarching principlesone of which is that audit organizations should notperform management functionsand the safeguards included in the Yellow Book independencestandards.]

c. An independent auditor can assist a client with preparation of infrastructure depreciationschedules, if the client takes certain actions. [This answer is correct. As long as the client (1)determines the method, rate, and salvage value of the assets and (2) takes responsibility for thedepreciation schedules, the auditor can assist with preparation of depreciation schedules andremain independent per Question 49 of the GAO's �Answers to Independence StandardQuestions."]


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27. Which of the following is an accommodation of GASBS No. 34 to help governments minimize the costassociated with depreciating general infrastructure assets and reporting them at historical cost? (Page 324)

a. Governments can elect not to meet these requirements retroactively. [This answer is incorrect.Governments cannot make such an election, though GASBS No. 34 does include some accommodationsto help minimize the cost of reporting this retroactively. Most opponents of the GASBS No. 34 requirementbelieved the cost of retroactively reporting general infrastructure assets exceeded the benefit derived andthat any such reporting should be on a prospective basis only. The GASB disagreed.]

b. Required retroactive capitalization is limited to years after December 31, 1960. [This answer is incorrect.The accommodation made by GASBS No. 34 was to limit the required retroactive capitalization period toyears ending after June 30, 1980.]

c. Similar assets can be grouped for depreciation, though dissimilar assets cannot. [This answer is incorrect.The accommodation made by GASBS No. 34 was to permit composite depreciation rates based ongroupings of similar assets or classes of dissimilar assets.]

d. Engineering documents can be used as source documents to estimate historical cost. [This answeris correct. Under GASBS No. 34, bond documents, engineering documents, and capital projectsfunds expenditures can be used as source documents when estimating historical cost.]

28. Define a network of assets under GASBS No. 34. (Page 327)

a. All assets that provide a government a certain type of service. [This answer is correct. GASBS No.34, footnote 14, defines a network of assets as being composed of all assets that provide a particulartype of service for a government. A network of infrastructure assets may be only one infrastructureasset that is composed of many components.]

b. All major general infrastructure assets owned by a government. [This answer is incorrect. This is not thedefinition of a network of assets; however, GASBS No. 34 requires that governments make thedetermination of whether an asset is a major general infrastructure asset at the network or subsystemlevel.]

c. All assets making up a similar portion of a network of assets. [This answer is incorrect. This is GASBS No.34's definition for a subsystem of a network of assets.]

d. Assets grouped by the government in ways that best suit its needs. [This answer is incorrect. This is notthe definition of a network of assets. Networks or subsystems of a network may be made up of dissimilarassets. The GASB Comprehensive Implementation Guide2009 notes that �the government may accountfor any of its capital assets in groupings that best suit its needs."]

29. If a government includes a water distribution system as one of its networks of infrastructure assets, which ofthe following would potentially be considered part of the network's subsystems? (Page 328)

a. Storm drains. [This answer is incorrect. This is a potential part of a subsystem for a storm sewer systemnetwork.]

b. Rural roads. [This answer is incorrect. This is a potential part of a subsystem for a network of roads.]

c. Pumping stations. [This answer is correct. Other potential pieces of this subsystem include storagefacilities and distribution mains. A subsystem of a network of assets is defined GASB No. 34,footnote 15.]

d. Aprons. [This answer is incorrect. This is a potential part of a subsystem for an airport pavement network.]


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30. Which of the following statements best describes the threshold test for determining major general infrastructureassets? (Page 329)

a. Major general infrastructure assets will be the same for all governments. [This answer is incorrect. Becausegovernments define networks and subsystems of networks differently, the major general infrastructureassets that must be reported retroactively will differ from government to government.]

b. A government that does not divide networks into subsystems only uses the 10% test. [This answeris correct. A government is not required to divide its networks into subsystems when applying thecapitalization threshold test. A government that chooses not to divide its networks into subsystemswill apply only the 10% test for the network per GASB No. 34, para 156.]

c. A government that divides its networks into subsystems must use both the 5 and 10% tests. [This answeris incorrect. A government that chooses to divide its networks into subsystems should apply the 5% test,and may also apply the 10% test for networks by simply adding up the cost of the infrastructure assetsconsisting of all the subsystems of a network. However, the government is not required to apply both tests.]

d. The threshold test is based on the final historical cost for the infrastructure assets. [This answer is incorrect.The test is based on preliminary cost estimates for the networks or subsystems of a network of generalinfrastructure assets. The preliminary estimates need only be precise enough to permit determination ofwhether the network or subsystem would be considered major.]

31. If a government does not have historical cost records of purchased or constructed general infrastructure assets,how does it report them under GASBS No. 34? (Page 331)

a. The government should report these capital assets at their estimated fair value. [This answer is incorrect.If the assets were donated instead of being purchased or constructed, the government would report themusing the estimated fair value at the time of acquisition.]

b. The government must estimate the historical cost using the method outlined in GASBS No. 34. [Thisanswer is incorrect. The GASB does not provide guidelines for assessing the acceptability of informationfor determining estimated historical costs. Determination will normally involve the government and itsauditors.]

c. The government can use professional judgment and estimate historical cost for these assets. [Thisanswer is correct. GASBS No. 34 allows governments to use estimated historical cost to recordgeneral infrastructure assets. Existing sources of information, such as capital budgets, can be used.Another alternative is to estimate the historical cost by calculating the replacement cost of a similarasset and deflating the cost using price�level indexes to the acquisition year.]

32. Since its fiscal year ending December 31, 1980, and including the street construction completed this year, acity has constructed 50 lane�miles of city residential streets out of concrete and an additional 25 lane�miles outof asphalt. The government plans to use the deflated current replacement cost approach to estimate historicalcost. The city constructed five lane�miles out of concrete this year for $500,000 per lane�mile. The cityconstructed one lane�mile with asphalt this year for $350,000. Calculate the total current replacement cost ofthe city's residential streets. (Page 332)

a. $8,750,000. [This answer is incorrect. This is the current replacement cost for all the city's asphalt streets($350,000 x 25).]

b. $25,000,000. [This answer is incorrect. This is the current replacement cost for all the city's concrete streets($500,000 x 50).]

c. $37,500,000. [This answer is incorrect. To get this answer, the total number of lane�miles (75) owned bythe city was multiplied against the cost for concrete streets ($500,000). The cost for asphalt was not takeninto account.]


344

d. $33,750,000. [This answer is correct. This is the total current replacement cost of the city'sresidential streets ($8,750,000 for the asphalt streets + $25,000,000 for the concrete streets). Tocomplete the deflated current replacement cost approach, the city must deflate the costs to the year(or estimated year) of acquisition.]

33. Which of the following would not be used as a price�level index under the deflated current replacement costapproach? (Page 334)

a. Price Trend Information for Federal�Aid Highway from the Federal Highway Administration. [This answeris incorrect. This index is a composite bid price index composed of six indicator items necessary for roadconstruction. The index is based on a 1987 base and covers the years 1972 through 2004.]

b. Engineering News�Record (ENR) from McGraw�Hill. [This answer is incorrect. The ENR has twocomprehensive composite indexes: the Construction Cost Index (CCI) and the Building Cost Index (BCI).Both indexes are widely used in the construction industry.]

c. Indexes from state or local highway or engineering departments. [This answer is incorrect. Suchdepartments may maintain cost indexes for road or other construction. Some state highway departmentsmaintain construction cost indexes for highway and road construction in their state since 1980. Some cityengineering departments retain detailed cost records that could be converted to an index to deflate currentreplacement costs.]

d. The index specified and provided by GASBS No. 34. [This answer is correct. The GASB does notspecify an index. Instead, GASBS No. 34, paragraph 158, indicates that �there are a number ofprice�level indexes that may be used, both private� and public�sector," to eliminate the effects ofprice�level changes from current replacement costs.]


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THE DEPRECIATION AND MODIFIED APPROACHES TO REPORTINGINFRASTRUCTURE

The Modified Approach to Reporting InfrastructureTHE BASICS

� The modified approach may be applied to eligible infrastructure assets that meet the threecriteria of record keeping, condition assessments, and established condition levels.

� Depreciation expense is not reported for these assets. Rather, all expenditures other thanthose that add to or improve the assets are reported as expenses in the period incurred.

� Specific disclosures about these assets are required in MD&A and in RSI.

The requirement to report general infrastructure assets is one of the most controversial aspects of GASBS No. 34.Although all general infrastructure assets are required to be reported prospectively on the government�widestatement of net assets, the GASB did exempt certain governments from depreciating infrastructure assets in thegovernment�wide statement of activities. This section will review the requirements for reporting infrastructure in thestatement of activities, including using the depreciation approach and the modified approach.

General Reporting Requirements

GASBS No. 34, paragraph 21, states that �capital assets should be depreciated over their estimated useful livesunless they are either inexhaustible or are infrastructure assets reported using the modified approach. . . ." For mostcapital assets, governments are required to allocate the historical cost less estimated salvage value (net cost ofdepreciable assets) over the assets' estimated useful lives in a systematic and rational manner. However, GASBSNo. 34 allows governments an option for reporting the cost of using infrastructure assets in the government�widestatement of activities(a) depreciate the assets or (b) use the modified approach and do not depreciate them.This option is available for general infrastructure and enterprise fund infrastructure. To qualify to use the modifiedapproach, governments must manage their infrastructure assets using an asset management system that hascertain characteristics and document that its infrastructure assets are being preserved at (or above) a conditionlevel established by the government. Governments are not required to use the modified approach for all of theirinfrastructure assets, but may elect to apply the approach to individual networks of infrastructure assets orindividual subsystems of a network.

Reporting infrastructure assets using the modified approach has certain benefits. First, for those governments thatalready manage their infrastructure assets using an asset management system, the modified approach allows agovernment to report the same information about its infrastructure assets that it uses in managing its assets.Second, some municipal bond analysts have indicated that the information disclosed under the modified approachis more useful than reporting depreciation expense because it provides more information about the condition of theassets and when they would need to be replaced. Third, a government does not have to calculate depreciationexpense (and accumulated depreciation) if it chooses the modified approach. One of the reasons that the GASBdeveloped the modified approach was to answer criticisms that governments would have to spend large amountsof time to develop depreciation schedules for infrastructure assets. For governments that already have assetmanagement systems, the modified approach should be relatively inexpensive to implement and eliminates theneed to maintain depreciation schedules.

Even with the benefits that can be gained by using the modified approach, this course expects that manygovernments will follow the traditional depreciation approach for all of their infrastructure assets for these reasons:

� Governments must manage their infrastructure assets using an asset management system if they wish toreport these assets using the modified approach. Many smaller governments do not currently use assetmanagement systems. Unless these governments implement asset management systems, they will not bepermitted to use the modified approach.

� Governments are allowed to use composite methods of depreciation, which should reduce the cost ofapplying the traditional depreciation approach. According to paragraph 163 of GASBS No. 34, compositemethods of depreciation refer to depreciating a group of similar assets or dissimilar assets of the same class


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using a depreciation rate that was determined for the composite. Using composite methods of depreciationmay make the application of the depreciation approach more economical than the modified approach.

� Governments that only have infrastructure assets in enterprise funds, such as water and sewer funds, willlikely not change their method of reporting. These governments have been required to report anddepreciate those assets for over 20 years under the provisions of paragraph 35 of NCGAS No. 1. It is unlikelythat these governments will change to the modified approach.

Depreciation Approach

The depreciation approach requires governments to allocate the cost of infrastructure assets over their useful livesas depreciation expense. Calculating depreciation expense involves assigning a useful life to an infrastructureasset (the amount of time that the government expects to be able to use the asset) and charging a portion of itshistorical cost (less salvage or residual value) to each year of that estimated useful life. GASB acknowledges inQuestion 7.13.3 of the GASB Comprehensive Implementation Guide2009 that, in most cases, infrastructureassets will have no salvage or residual value because of the high cost of demolition or removal of those assets atthe end of their useful lives. When no salvage or residual value is assigned, depreciation expense is simply anallocation of the historical cost of infrastructure assets to each year of the estimated useful life of the asset. Thefactors that should be considered when estimating the useful lives of all capital assets are discussed in Lesson 1.

Paragraph 22 of GASBS No. 34 requires that the allocation of historical costs be made in a �systematic and rationalmanner" over the estimated useful lives of infrastructure assets. There are a number of established depreciationmethods that can be used to assign depreciation expense to periods in this manner, such as the straight�linemethod, which assumes that assets are used up equally over their useful lives. Depreciation methods are dis�cussed in detail in Lesson 1.

The government�wide statement of activities has a unique format that reports on the net (expense) revenue of agovernment's individual functions or programs. Because of this format, governments generally must assigndepreciation expense to functions. However, for general infrastructure assets, GASBS No. 34, paragraph 45,indicates that depreciation expense should not be allocated to the various functions. Instead, �it should be reportedas a direct expense of the function (for example, public works or transportation) that the reporting governmentnormally associates with capital outlays for, and maintenance of, infrastructure assets. . . ." Alternatively, govern�ments may report depreciation expense on general infrastructure as a separate line item on the face of thestatement of activities.

Journal EntriesDepreciation Approach. Exhibit 2�8 illustrates journal entries that would be necessary forgovernments that use the depreciation approach to account for their general infrastructure assets. This exhibit alsoprovides an example of how to apply a group method for depreciating infrastructure assets. Briefly, composite andgroup depreciation methods are very similar and there is no distinction between the methods from an accountingperspective. The GASB staff states in Question 7.15.1 of the GASB Comprehensive Implementation Guide2009

that:

Composite depreciation refers to the calculating depreciation for a collection of dissimilar assets,such as all assets composing a transportation network or building. Group depreciation refers tocalculating depreciation for a collection of similar assets, such as traffic signals or lane�miles ofpavement of a road system.


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Exhibit 2�8

Applying the Depreciation Approach of Accounting for Infrastructure Assets

Summary of Facts

Sample City is adopting GASB No. 34 and retroactively recording its infrastructure for the fiscal year endingJune�30, 2002. During the period July 1, 1980, through June 30, 2001, the city made improvements to855�lane�miles of secondary roads in accordance with its biennial capital budget as listed below. The city plans toaccount for these improvements as a group and to apply the straight�line method of depreciation. The city engineerestimates that roads have a useful life of 25 years and no salvage value.

Historical cost has been estimated as follows:

Project Year Total Project Budget Lane�miles

2001 $ 40,125,000 751999 36,075,000 651997 53,675,000 951995 55,500,000 1001993 22,000,000 401991 35,425,000 651989 54,000,000 1001987 34,775,000 651985 50,350,000 951983 39,375,000 751981 42,000,000 80

$ 463,300,000 855

The next project to be completed is the removal and replacement of 80 lane�miles of secondary roads at a cost of$45,600,000 on June 30, 2003.

Recording Assets at Transition

In order to record the secondary roads at transition, the accumulated depreciation at July 1, 2001the beginningof the transition yearshould be computed. Using the straight�line method, the annual depreciation rate isdetermined directly from the estimated useful life as follows: 1 � 25 = .04 per year.

The city assumes each project was completed at the end of the project year and, therefore, no depreciation isrecognized in that year.

Project Year Estimated CostYears of Accumulated

DepreciationDepreciation

RateTotal Accumulated

Depreciation

2001 $ 40,125,000� 0.04 $ �

1999 36,075,000 2 0.04 2,886,0001997 53,675,000 4 0.04 8,588,0001995 55,500,000 6 0.04 13,320,0001993 22,000,000 8 0.04 7,040,0001991 35,425,000 10 0.04 14,170,0001989 54,000,000 12 0.04 25,920,0001987 34,775,000 14 0.04 19,474,0001985 50,350,000 16 0.04 32,224,0001983 39,375,000 18 0.04 28,350,0001981 42,000,000 20 0.04 33,600,000

$ 463,300,000 $ 185,572,000


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The entry to initially record historical cost and accumulated depreciation of secondary roads in the City's generalcapital assets ledger at transition would be:

Infrastructuresecondary roads $ 463,300,000Accumulated depreciation $ 185,572,000Net assetsinvested in capital assets 277,728,000

Recording Depreciation Expense for the Transition Year

The entry to record depreciation for the year ended June 30, 2002, would be:

Depreciation expense (463,300,000 � 0.04) $ 18,532,000Accumulated depreciation $ 18,532,000

Recording the Replacement of 80 Lane�miles of Road

Using group or composite methods, no gain or loss is recorded upon the retirement of assets within the group.Accordingly, cost (in this example, average cost) is removed from the asset account and charged to theaccumulated depreciation account. The entry to record the replacement of 80 lane�miles of secondary roads atJune 30, 2003, would�be:

Accumulated depreciation (80 lane�miles �[463,300,000 � 855] average cost) $ 43,349,708

Infrastructuresecondary roads $ 43,349,708

Infrastructuresecondary roads $ 45,600,000Cash $ 45,600,000

Computing Annual Depreciation Expense in Future Years

Depreciation expense in future years would be computed by applying the annual depreciation rate to the currentbalance of secondary road account as follows:

Beginning balance of infrastructuresecondary roads $ 463,300,000Retirements (43,349,708 )Additions 45,600,000

465,550,292Depreciation rate 0.04

Depreciation expense $ 18,622,012

[SOURCE:�Adapted from GASB's Comprehensive Implementation Guide2009, Appendix 7�3, Exercise 2.]

* * *

Changing from the Depreciation Approach to the Modified Approach

GASBS No. 34, paragraph 23, allows governments to report certain infrastructure assets using the modifiedapproach, provided that all the requirements for that approach are met.

GASBS No. 37, paragraph 8, provides that governments that change from the depreciation approach to themodified approach should report the change as a change in accounting estimate. A change in accounting estimateshould be reported prospectively only. That is, the infrastructure asset would continue to be reported at cost lessaccumulated depreciation at the time the modified approach is adopted. No restatement of carrying amounts oraccumulated depreciation is required.

A change from the depreciation approach to the modified approach should be reported as a change in accounting

estimate. This type of accounting change requires governments to report the effects of the change prospectively.


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Governments that change to the modified approach simply should stop reporting depreciation expense. Allexpenditures made for qualifying infrastructure assets (after acquisition and except for expenditures for additionsand improvements) should be reported as expenses in the period incurred, as discussed in GASBS No. 34,paragraph 25.

GASBS No. 34, paragraph 20, requires governments to segregate significant balances of capital assets that are notbeing depreciated from those that are being or have been depreciated on the face of the government�widestatement of net assets. Governments that change from the depreciation approach to the modified approachshould reclassify the net amount of eligible infrastructure assets (which had been reported as assets that are beingdepreciated) to assets that are not being depreciated.

Modified Approach

GASBS No. 34 allows governments to use the modified approach for infrastructure asset reporting. The modifiedapproach may be used for any of the government's eligible infrastructure assets, including both general infrastruc�ture assets and enterprise fund infrastructure assets. Eligible infrastructure assets are those that are part of anetwork or subsystem of a network. Both networks and subsystems are defined in the previous section. Question7.16.3 of the GASB Comprehensive Implementation Guide2009 points out that parks generally cannot beconsidered an infrastructure network because they are primarily comprised of land. However, certain improve�ments within a park such as roads or trails could be considered infrastructure eligible for the modified approach.The modified approach permits governments to not depreciate a network or a subsystem of a network of infrastruc�ture assets if the following two requirements noted in paragraph 23 of GASBS No. 34 are met:

� The government manages the eligible infrastructure assets using an asset management system that hascertain characteristics.

� The government documents that the eligible infrastructure assets are being preserved approximately at (orabove) a condition level established and disclosed by the government.

If a government chooses to apply the modified approach for a subsystem of a network and not an entire network,it must meet the two requirements for that subsystem according to GASBS No. 34, paragraph 23, footnote 16. Inaddition, as discussed in the GASB Comprehensive Implementation Guide2009, Question�7.16.5, one depart�ment (or agency) of a government can choose to use the modified approach while another chooses the depreci�ation method as long as those departments do not report parts of the same network or subsystem.

Asset Management Systems. Asset management systems are tools used to gather objective information that isused by a government's management (particularly engineers and those who approve their budgets) to makedecisions about how a government's resources should be used. Asset management systems generally usecomputer technology to inventory infrastructure assets and to assess the age, condition, and maintenance neededfor those assets. For most of the systems, information about the condition of infrastructure assets is based on theprescribed analysis of trained observers (often in the form of checklists or detailed analysis forms), which is thenentered into the computer. The ultimate goal of asset management systems is to provide decision makers withinformation to assess the most cost�effective means of maintaining and preserving a government's infrastructureassets in both the short� and long�term.

Asset management systems are particularly useful in developing and assessing alternative methods and strategiesfor maintaining infrastructure assets. Though asset management systems are still in a relatively early period ofdevelopment, many different systems are available. Several companies sell the computer software necessary foran asset management system. In some cases, a government's own engineers have developed systems internally.They differ greatly in their design because of the different information needs and goals of government managers.However, all asset management systems have certain attributes in common. An overview of one system that theGASB studied extensively when developing the modified approach is provided in Exhibit 2�9.


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Exhibit 2�9

Micro PAVER: An Example of an Asset Management System for Roads

Micro PAVERthe Pavement Maintenance Management Systemis a computer softwarepackage developed by the U.S. Army Corps of Engineers in the late 1970s and is currently usedby more than 400 cities, counties, airports, and consulting firms. It provides users with amanagement tool to perform many functions, including inventory, condition assessment,condition forecasting, inspection scheduling, budget forecasting, localized maintenanceprogramming, and annual and long�range maintenance and rehabilitation work planning. MicroPAVER's capabilities include (a) data storage and retrieval, (b) pavement network identification,(c) pavement condition rating, (d) project priority setting, (e) inspection scheduling, (f)maintenance and repair needs determination, (g) resource planning, and (h) economic analysisand budget planning.

The first step in using the Micro PAVER system is network identification and definition. A networkis made up of a road system and may be identified by use, funding source, and minimumoperational standards. Once identified, the network is divided into �branches" and �sections." Abranch is a readily identifiable part of a network and has a distinct function such as a street.Existing street names are often used as branch names. Because a street may be quite long, itmay not have consistent characteristics for its entire length or area. For this reason, a branch isoften divided into sections. (Each branch has at least one section.) A section is viewed as thesmallest management unit for considering the application and selection of maintenance andrehabilitation treatments. Factors that are considered when dividing a branch into sectionsinclude pavement structure, traffic, construction history, pavement rank (or functional classifica�tion), drainage facilities and shoulders, and condition. Sections are further divided into inspectionunits, or sample units, for purposes of condition assessments.

To make optimal maintenance and budgetary decisions, it is necessary to know the condition ofroads. The Pavement Condition Index (PCI) is the basis for the PAVER pavement managementsystem. The PCI is a composite index of the pavement's structural integrity and operatingcondition based on a visual inspection of sample portions of roads (or �inspection units"). ThePCI is a measurement scale, which ranges from 0 (failed) to 100 (excellent), for determining apavement's condition. It is based on measured distress type, severity, and amount. Nineteendifferent pavement distresses have been identified for both asphalt and concrete roads.Distresses for asphalt roads include alligator cracking, bleeding, bumps and sags, depressions,edge cracking, potholes, rutting, and patch/utility cuts. Each distress is then rated for severity(low, medium, and high) and quantity (for example, 10 square feet). Strict definitions exist for thedistresses and their severity. If no distresses are entered for a sample unit of road, a PCI of 100 isassigned to the unit.

The PCI is used as the basis for planning when road maintenance should occur and to project thecost of various maintenance strategies. A more complete explanation of Micro PAVER and otherinfrastructure asset management systems developed by the U.S. Army Corps of Engineers canbe found at the website for the American Public Works Administration (www.apwa.net/About/SIG/MicroPaver/index.asp).

* * *

Minimum Features of Asset Management Systems. After examining various asset management systems, theGASB determined that asset management systems should possess certain minimum features. GASBS No. 34,paragraph 23, states that a government's asset management system must meet the following minimum require�ments in order for the government to use the modified approach for infrastructure reporting:

� Have an up�to�date inventory of eligible infrastructure assets.


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� Perform condition assessments of the eligible infrastructure assets and summarize the results using ameasurement scale.

� Estimate each year the annual amount needed to maintain and preserve the eligible infrastructure assetsat the condition level established and disclosed by the government.

Each of these minimum requirements is discussed in the following paragraphs.

Up�to�date Inventory. An asset management system must have an up�to�date inventory of eligible infrastructureassets. As noted earlier, paragraph 23 of GASBS No. 34 defines eligible infrastructure assets as assets that are apart of a network or subsystem of a network. Therefore, a government may use the modified approach for all of itsinfrastructure assets or only a portion of its infrastructure assets either at the network or subsystem level. For thispurpose, an infrastructure asset must be functional for a particular type of service to be considered a subsystem ofa network of assets. For example, a subsystem for a road could be a certain type of road (such as a rural road). Itcould not be just part of a road. For example, the pavement surface of a road could not be considered a separatesubsystem without also reporting the road's substructures. The up�to�date inventory required by GASBS No. 34,paragraph 23, is an inventory from an asset management perspective and not an accounting or reporting perspec�tive. Therefore, the determination of whether the up�to�date inventory exists should be based on its adequacy forpurposes of managing the government's assets.

An up�to�date inventory does not mean that every part of a network of infrastructure assets has to be inventoried onan annual basis. For example, if road signs are a part of a network of infrastructure assets, each sign does not haveto be inventoried on an annual basis. Although each sign does not have to be inventoried annually, it should be onthe system's inventory listing and inventoried periodically in order for it to be part of the asset management system.(Signs that are not inventoried cannot be managed using the asset management system.) Roads, particularly roadsurfaces or pavements, are commonly managed using asset management systems. In order to manage roads in acost efficient manner, detailed inventory information about the roads must be maintained by the asset managementsystem. At a minimum, this usually includes the location and dimensions of the road and the materials used in theroad's construction (for example, asphalt or concrete).

Condition Assessments. Condition assessments are generally performed by trained observers using prescribedforms or analysis techniques. However, with advanced technology, some systems are now able to directly inputmachine measurements (such as road roughness measurements) into the computer. GASBS No. 34 does notspecify the attributes of infrastructure assets that should be measured when performing condition assessments.For example, roads are commonly assessed based on pavement condition. However, no standard measure existsfor assessing pavement condition. The Federal Highway Administration requires states to report condition informa�tion for roads based on the International Roughness Index, which measures the roughness of roads. However,many engineers prefer to measure pavement distress indicators, such as cracking and rutting, which provide betterinformation about structural problems than roughness measures. Other engineers believe a condition assessmentfor roads is not complete without measures of surface friction or direct measures of the underlying structure.Because GASBS No. 34 is silent on the measures that should be used to assess the condition of roads or any otherinfrastructure assets, governments may use any single method that measures an attribute or any combination ofattributes that they consider important for a network or subsystem of infrastructure assets. Regardless of themethod of performing condition assessments, the condition assessments should be documented in such a mannerthat they can be replicated. GASBS No. 34, footnote 18, states:

Replicable condition assessments are those that are based on sufficiently understandable andcomplete measurement methods such that different measurers using the same methods wouldreach substantially similar results. Condition assessments may be performed by the governmentitself or by contract.

Question 7.19.3 of the GASB Comprehensive Implementation Guide2009 indicates that the GASB does notprescribe minimum training requirements for governments that perform condition assessments. The only criteria isthat replicable condition assessments be performed in accordance with footnote 18 of GASBS No. 34.

Condition assessment measurements for eligible infrastructure assets should be summarized using a measure�ment scale. Because no standards for measures of condition of infrastructure assets exist, it should not be


352

surprising that no standard exists for measurement scales. Some measurement scales have numerical scalesranging from 1 to 10 or 0 to 100 with 1 or 0 indicating failed roads and 10 or 100 indicating new roads. Instead ofassigning numerical points, some measurement scales may simply rate roads in poor, fair, or good condition withroads rated in poor condition needing immediate reconstruction. Again, the GASB does not require any particularmeasurement scale to be used for summarizing condition assessments.

Annual Estimates. The final feature that an asset management system must have is the ability to estimate eachyear the annual amount needed to maintain and preserve its eligible infrastructure assets at the condition levelestablished and disclosed by the government. A key planning component of asset management systems is theirability to be used to project the estimated cost of maintaining and preserving infrastructure assets over the nextyear and beyond (often five or more years into the future).

Asset management systems are built upon the theory that the past will be repeated in the present. For example,roads constructed with asphalt surfaces generally have a defined life, which is affected by climatic conditions andmaintenance. Generally, all the asphalt roads in a city will follow a similar road degradation curve. For example, cityengineers may know that asphalt road surfaces have an average life of 20 years. At the end of the 20 years, theasphalt road surface has to be removed and reconstructed. However, engineers may also know that the life of theasphalt surface can be extended by another five years with timely and aggressive maintenance. Most roadengineers agree that the overall cost of maintaining a road system at a certain condition level will be greatlyinfluenced by the timing of road maintenance. By entering into a database a road's age and condition, theprojected costs of various maintenance options, and the projected costs of removal and reconstruction of anasphalt surface, a calculation can be made by the asset management system that assesses the costs of differentroad maintenance plans. These cost assessments are the basis for a government's estimate of the annual amountthat is required to maintain and preserve its eligible infrastructure assets at the condition level established by thegovernment.

Because of changes in a government's road maintenance and reconstruction strategies, the annual cost estimatesgenerated by the asset management systems may vary substantially over time. Some strategies will be moreefficient than others, particularly in the long run. GASBS No. 34 does not require government officials to efficientlymaintain their roads or to estimate costs based on an efficient strategy. When using the modified approach, GASBSNo. 34 requires only that governments use an asset management system to determine their estimated annualcosts. These estimated costs should be based on a government's maintenance strategy.

Documenting Preservation at a Condition Level. To qualify for using the modified approach for reportinginfrastructure assets, governments must meet two conditions. The government must (a) manage its eligibleinfrastructure assets using an asset management system that has the characteristics described beginning in the�Asset Management Systems" paragraph and (b) document that its eligible infrastructure assets are being pre�served approximately at (or above) a condition level established and disclosed by the government. GASBS No. 34,paragraph 24, provides the following guidance for documenting that eligible infrastructure assets are beingpreserved:

Determining what constitutes adequate documentary evidence to meet the second requirementin paragraph 23 for using the modified approach requires professional judgment because ofvariations among governments' asset management systems and condition assessmentmethods. These factors also may vary within governments for different eligible infrastructureassets. However, governments should document that:

a. Complete condition assessments of eligible infrastructure assets are performed in a consistentmanner at least every three years. Footnote 19 to item a. states that condition assessments may beperformed using statistical samples that are representative of the eligible infrastructure assets beingpreserved. Governments may choose to assess their eligible infrastructure assets on a cyclical basis.For example, one�third may be assessed each year. If a cyclical basis is used, a conditionassessment is considered complete for a network or subsystem only when condition assessmentshave been performed for all (or statistical samples of) eligible infrastructure assets in that networkor subsystem.


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b. The results of the three most recent complete condition assessments provide reasonable assurancethat the eligible infrastructure assets are being preserved approximately at (or above) the conditionlevel established and disclosed by the government.

The condition of infrastructure assets referred to in item b. above is assessed using condition measures, which aresummarized using measurement scales. The GASB does not prescribe condition measures or measurementscales that must be used for assessing the condition of infrastructure assets. However, GASBS No. 34, paragraph23, footnote 20, indicates, for example, that �condition could be measured either by a condition index or as thepercentage of a network of infrastructure assets in good or poor condition." These measures were mentioned inGASBS No. 34 because they are the most likely outputs from asset management systems.

Established Condition Level. Governments that decide to use the modified approach must document that theyare maintaining their infrastructure assets at a condition level established by the government. The GASB recog�nized that governments have different acceptable levels of condition for their infrastructure assets. For example, asmall rural town in Alaska would likely have a different acceptable condition level for its roads than would an urbancommunity in a prosperous area such as Boca Raton, Florida. Therefore, GASBS No. 34 does not establish aminimum condition level at which infrastructure assets must be maintained. However, a government shoulddocument the condition level at which it intends to preserve its infrastructure asset. GASBS No. 34, footnote 17,states that �the condition level should be established and documented by administrative or executive policy, or bylegislative action." GASB Comprehensive Implementation Guide2009, Question 7.20.2, clarifies that the govern�ment reporting the subsystem or network of infrastructure assets establishes condition levels. Question 7.20.2adds that, �for example, a capital budget prepared by the executive branch and approved by the legislative branchcould be used to document the established condition level."

Governments are allowed to change the condition level at which they intend to maintain their infrastructure assetsat any time. Therefore, if a government is concerned that it may no longer be maintaining its infrastructure assets atthe level that it previously established and is in danger of no longer meeting the requirement to use the modifiedapproach described in item b. above, it may change its established condition level. Any change must be estab�lished and documented by administrative or executive policy, or by legislative action. In addition, the change andthe estimated effect of the change on the estimated annual amount to maintain and preserve the infrastructureassets must be disclosed in its required supplementary information (RSI) disclosures. RSI disclosures are dis�cussed later in this lesson.

Maximum Three�year Testing Cycles. Governments that wish to use the modified approach must have a com�plete condition assessment at least every three years. Networks or subsystems of infrastructure assets that areassessed on a longer cycle may not be reported using the modified approach. As noted in the GASB Comprehen�

sive Implementation Guide2009, Question 7.20.5, three years is the maximum number of years for a cycle. Whenstatistical sampling is used, every asset does not have to be assessed during the three�year period. However, everyasset must have an equal chance of being selected during the period for the assessment to be �complete," asdiscussed in the GASB Comprehensive Implementation Guide2009, Question 7.20.4.

Consistent Assessments. As discussed in item a. of the �Documenting Preservation at a Condition Level"paragraph, paragraph 24 of GASBS No. 34 requires that complete condition assessments be performed in aconsistent manner at least every three years. The GASB Comprehensive Implementation Guide2009, Question7.20.11, explains the meaning of �consistency" in condition assessments as follows:

Consistency is achieved if the condition assessment is performed using the same method, basis,and scale for a complete assessment. For example, if a government performs its conditionassessment over a three�year cycle, it should use the same method, basis, and scale throughoutthe three years in order to maintain consistency. A government may change the method, basis, orscale prior to beginning the subsequent complete assessment.

Governments that perform complete condition assessments on an annual basis usually do not have a consistencyproblem because they use the same condition assessment method, basis, and scale for the entire assessment.Consistency becomes an issue when governments perform a �complete assessment" of all (or a statistical or otherrepresentative sample of all) their infrastructure assets over a two� or three�year period instead of on an annual


354

basis. Governments should disclose any changes in the way they perform condition assessments in the notes toRSI.

Asset management systems are still relatively new and many systems exist. In addition, new condition assessmentmethods are being developed or refined. In Question 7.20.12 of the GASB Comprehensive Implementation

Guide2009, the GASB staff states that �upgrades" to asset management systems that do not change the basicassessment methodology are not considered a change in assessment methodology.

Three Complete Assessments. Because governments are allowed to perform complete condition assessmentsover a three�year period, it may take nine years to accumulate the information referred to in GASBS No. 34,paragraph 23, item b., for the �three most recent complete condition assessments" that are needed to �providereasonable assurance that . . . infrastructure assets are being preserved approximately at (or above) the conditionlevel established and disclosed by the government." Although GASBS No. 34 states that complete conditionassessments should be performed in a consistent manner at least every three years, no �consistency" standardexists for the results of the �three most recent complete condition assessments." Thus, a government is allowed tochange its condition assessment method, basis, or scales from one complete condition assessment to the next.However, there is a caveat. If a government changes its condition assessment method, basis, or scale, it must stillhave sufficient evidence to provide reasonable assurance its infrastructure assets are being preserved. For thisreason, governments should ensure that condition assessment measures comparable to their old system could beobtained from a new system before making a change. In addition, any changes in a government's conditionassessment method, basis, or scale also must be disclosed in RSI.

Reasonable Assurance. The results of a government's three most recent complete condition assessments shouldprovide reasonable assurance that its eligible infrastructure assets are being preserved approximately at (or above)the government's established and disclosed condition level, according to GASBS No. 34, paragraph 24, item b.Providing reasonable assurance is ultimately a matter of professional judgment. As noted in SLG, paragraph 7.70,GASBS No. 34's use of the term approximately allows flexibility. That paragraph notes that condition levels do nothave to equal or exceed the established condition levela reasonable variance is permissible. Two examples of areasonableness test cited in that paragraph include:

� The percentage variance between the actual and established condition levels. (For example, an actual levelof 72 would vary from an established level of 75 by four percent; that is, 72 is 96 percent of 75.)

� The relative cost, size, or other measure of assets in the network or subsystem that fail to meet theestablished condition level compared to the total cost, size, or other measure of all of the assets in thenetwork or subsystem.

In addition, if a government assesses its infrastructure assets using a three�year cycle for one complete conditionassessment, it will take nine years to gather the information needed to assess whether a government is preservingits eligible infrastructure assets at or above its established condition level. Road engineers believe that it takes atleast five years for a measurable change in the condition of roads to occur even if minimal maintenance isperformed. Therefore, it is likely that several years will pass before the condition of infrastructure assets will declinebelow a government's established condition level.

SLG, paragraph 7.70, also notes that a single substandard condition assessment does not necessarily require agovernment to stop using the modified approach. The GASBS No. 34 requirement to consider the three mostrecent condition assessments �requires the preparer and auditor to take a broader perspective to the evaluationand consider the three condition assessments together as a whole." While an upward trend in the conditionassessments taken as a whole would be �more reasonable than a downward trend," the preparer and auditor needto consider the circumstances that resulted in the substandard assessment. The GASB Comprehensive Imple�

mentation Guide2009, Question 7.18.4, reinforces this approach. That Question addresses a situation in which amajor storm in the final year of a three�year assessment cycle caused a government's infrastructure assets to nolonger meet the government's established condition level. Question 7.18.4 also points out that, in any event,governments may establish a new, lower condition level, as discussed previously.

Finally, the judgment is based on a comparison of the three most recent complete condition assessments to acondition level established by the government. If a government determines that it is not preserving its infrastructure


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assets above its established condition level, the government may establish a lower condition level so that it cancontinue to use the modified approach. Because of the flexibility available to governments by allowing changes inthe established condition level, governments that wish to continue using the modified approach will most likely beable to do so. These provisions should also result in there being fewer judgments needed about whether agovernment is preserving its infrastructure assets at its established condition level.

Reporting Infrastructure Assets at Transition Using the Modified Approach. A literal reading of paragraphs 23and 24 of GASBS No. 34 may cause a government to believe it could not adopt the modified approach until threecomplete condition assessments are completed and it is able to document that its infrastructure assets are beingpreserved approximately at (or above) its established and disclosed condition level. The GASB recognized that thiswould prevent many governments from using the modified approach simply because of a lack of information anddocumentation. The GASB did not wish to preclude these governments from using the modified approach; so itprovided the following exception in the transition provisions in GASBS No. 34, paragraph 152:

Governments may begin to use the modified approach for reporting eligible infrastructure assets. . . as long as at least one complete condition assessment is available and the governmentdocuments that the eligible infrastructure assets are being preserved approximately at (or above)the condition level the government has established and disclosed.

As noted in the GASB Comprehensive Implementation Guide2009, Question 7.20.8, this is true even if thegovernment has made previous condition assessments that do not provide reasonable assurance that assets arebeing preserved at the government's established condition level. At transition, only one �working" assessment isneeded. In addition, the GASB Comprehensive Implementation Guide2009, Question 7.105.5, provides thatgovernments that decide to later change from the depreciation approach to the modified approach (in years after

making the initial transition to report infrastructure assets) also would need to have only one complete conditionassessment before adopting the modified approach.

Reporting RequirementsComparing the Modified Approach to the Depreciation Approach

Government�wide Statement of Net Assets. Expenditures made for additions, improvements, and to extend thelife of capital assets should be capitalized and reported in the statement of net assets under the depreciation

approach of accounting for capital assets. Under the modified approach, paragraph�25 of GASBS No. 34 requiresthat only expenditures for additions and improvements be capitalized for eligible infrastructure assets.

As defined in GASBS No. 34, paragraph 25, additions or improvements increase the �capacity or efficiency" ofinfrastructure assets. Question 7.17.6 of the GASB Comprehensive Implementation Guide2009 clarifies themeaning of an increase in capacity or efficiency as follows:

A change in capacity increases the level of service provided by an asset. For example, additionallanes could be added to a road or the weight capacity could be increased. A change in efficiencyalso increases the level of service, but without increasing the size of the asset. For example, thespeed limit of a road may be increased after entrance and exit ramps are added to a statehighway to convert it to an interstate highway.

Significant balances of infrastructure assets reported using the modified approach must be reported separatelyfrom depreciable capital assets on the face of the statement of net assets.

Government�wide Statement of Activities. A government using the modified approach is not required to depreci�ate its eligible infrastructure assets in the statement of activities as would be required with the depreciationapproach. These approaches also differ in terms of the types of expenditures that should be expensed. Under thedepreciation approach, all expendituresexcept for those that result in additions, improvements, or extensions ofthe life of capital assetsshould be expensed in the period incurred. Under the modified approach, paragraph 25of GASBS No. 34 indicates that all expenditures made for eligible infrastructure assets, except for those made foradditions and improvements, should be expensed in the period incurred. Therefore, a major difference between thetraditional depreciation approach and the modified approach is the treatment of preservation costs. When using thedepreciation approach, GASB Comprehensive Implementation Guide2009, Question 7.17.2, defines preserva�

tion costs as outlays that extend the useful life of the asset beyond its original estimated useful life. These costs are


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capitalized. When using the modified approach, however, Question 7.17.2 defines preservation costs as costs thatkeep the infrastructure asset at (or above) the condition level established by the government but that do notincrease the asset's capacity or efficiency. These costs are expensed.

Maintenance costsexpenditures which allow an asset to continue to be used during its originally establisheduseful lifeare expensed in the period incurred regardless of the method of accounting for the asset according toQuestions 7.17.1 of the GASB Comprehensive Implementation Guide2009. In some cases, infrastructure assetsmay be retired. For example, a city may close an older two�lane bridge, rerouting traffic to another existing bridge.When an infrastructure asset is retired under the depreciation approach, the historical cost, net of accumulateddepreciation, is written off (expensed), generally in the function responsible for constructing and maintaininginfrastructure assets. Under the modified approach, however, the amount written off is the entire historical cost ofthe retired asset because depreciation expense/accumulated depreciation will not have been reported for thatasset. (The same is true for situations in which the infrastructure is not �retired" but is transferred to anothergovernment, such as from a county to a city. In this case, the Comprehensive Implementation Guide2009,Question 7.16.6, requires the historical cost of the transferred asset to be reported as functional expense, and theasset account reduced to zero.) Exhibit 2�10 summarizes the accounting treatment for maintenance and preserva�tion costs, additions, improvements, and retirements for the two approaches.

Exhibit 2�10

Treatment of Costs under the Modified and Depreciation Approaches

Modified Approach Depreciation Approach

Maintenance costs Expense Expense

Preservation costs Expense Capitalize

Additions Capitalize Capitalize

Improvements Capitalize Capitalize

Retirements Expense Expense

* * *Although GASBS No. 34 clearly describes the appropriate accounting treatment for the various types of infrastruc�ture expenditures, the practical application of GASBS No. 34 is not always easy. For example, governmentscommonly reconstruct infrastructure assets. Reconstructing infrastructure assets is often a costly endeavor andtypically includes preservation costs (for example, expenditures made to extend the original estimated useful life ofa street) and other costs for additions or improvements (for example, the costs of adding a left�hand turn lane to themiddle of a street). The accounting and reporting difficulty arises from having to determine the amount of costs thatshould be expensed and the amounts that should be capitalized. The Comprehensive Implementation

Guide2009, Question 7.17.3, states that governments should use �any reasonable" method to estimate theamounts of a project that should be expensed and capitalized. The significance/materiality of the amountsexpensed under this method continues to generate confusion among modified approach users and those who areconsidering it. The GASB Comprehensive Implementation Guide2009 includes Question 7.17.5, which askswhether a government should capitalize any of the costs of a new bridge when it builds that bridge (same numberof miles and same weight load) alongside an old one with the intention of tearing down the old one when the newone is completed. The GASB staff's answer is �no" under the modified approach. As long as the new bridge iscomparable in capacity and efficiency, all costs are considered preservation costs that should be expensed, notcapitalized.

Journal EntriesModified Approach. Exhibit 2�11 illustrates the general capital assets ledger journal entries thatwould be necessary for governments that use the modified approach to account for general infrastructure assets.The fact scenario in Exhibit 2�11 is the same as the example used to illustrate journal entries under the depreciationapproach at Exhibit 2�8. A comparison of the two exhibits should illustrate the differences between the modified anddepreciation approaches of accounting and reporting for infrastructure assets.


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Exhibit 2�11

Applying the Modified Approach of Accounting for Infrastructure Assets

Assume that Sample City is adopting Statement 34 and retroactively recording its infrastructure for the fiscal yearending June�30, 2002. However, instead of adopting the depreciation approach as illustrated in Exhibit 2�8, the cityplans to account for its infrastructure assets using the modified approach. During the period July 1, 1980, throughJune 30, 2001, the city made major improvements to 855 lane�miles of secondary roads in accordance with itsbiennial capital budget. Historical cost has been estimated using the biennial capital budget amounts as follows:

Project YearTotal Project

Budget Lane�miles

2001 $ 40,125,000 751999 36,075,000 651997 53,675,000 951995 55,500,000 1001993 22,000,000 401991 35,425,000 651989 54,000,000 1001987 34,775,000 651985 50,350,000 951983 39,375,000 751981 42,000,000 80

$ 463,300,000 855

The next project to be completed is the removal and replacement of 80 lane�miles of secondary roads at a cost of$45,600,000 on June 30, 2003.

Recording Assets at Transition

The entry to initially record the estimated historical cost of the roads in the City's general capital assets ledger attransition would be:

Infrastructuresecondary roads $ 463,300,000Net assetsinvested in capital assets $ 463,300,000

No entry is necessary to record accumulated depreciation because depreciation expense is not recognized whenusing the modified approach.

Recording the Replacement of 80 Lane�miles of Road

Assuming that the replacement of the lane�miles did not improve or add to the road system, but only preserved theroads, the entry to record the replacement of 80 lane�miles of secondary roads would be:

Preservation expense $ 45,600,000Cash $ 45,600,000

If the replacement of lane�miles also resulted in an increase in the weight�capacity for a portion of the roads, theportion of the replacement cost attributable to the improvement should be capitalized. Professional judgment isrequired to determine the amounts that should be expensed and capitalized. If the roads could have been replacedfor $40,000,000 without increasing their weight capacity, the entry to record the replacement of 80�lane�miles ofsecondary roads would be:

Preservation expense $ 40,000,000Infrastructuresecondary roads 5,600,000

Cash $ 45,600,000

* * *


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Changing from the Modified Approach to the Depreciation Approach

There are two reasons why governments that have been using the modified approach may change to the depreci�ation approach. First, governments may voluntarily change because they prefer to use the depreciation approachinstead of the modified approach. Second, they may be required to change to the depreciation approach becausethey no longer meet the requirements for using the modified approach.

Governments should determine if they meet the requirements for using the modified approach on a network�by�net�work or subsystem�by�subsystem basis. That is, a government may no longer meet the requirements to continueto report one network of infrastructure assets (for example, bridges) under the modified approach. However, it maystill meet the requirements to report another network (for example, roads) under the modified approach. Govern�ments may fail to meet the requirements for using the modified approach for several reasons. The GASB Compre�

hensive Implementation Guide2009, Question 7.18.1, provides the following examples:

� A failure to perform a replicable and complete condition assessment at least every three years.

� A failure to document these condition assessments.

� A failure to estimate the annual amount needed to maintain and preserve infrastructure assets.

� The three most recent condition assessments indicate that eligible infrastructure assets are not maintainedapproximately at or above the condition level established by the government.

GASBS No. 34, paragraph 132, requires governments to report as RSI the amounts actually expensed each year tomaintain and preserve infrastructure assets compared to estimated amounts. However, failure to meet estimatedmaintenance needs alone does not require governments to abandon the modified approach, as discussed in theComprehensive Implementation Guide2009, Question 7.20.9.

A government that no longer meets the requirements for using the modified approach should begin to depreciateits infrastructure assets in the year after the requirements are not met and continue for subsequent reportingperiods. APBO No. 20 provides guidance on reporting accounting changes and distinguishes between changes inaccounting estimates and changes in accounting principles. GASBS No.�34, footnote 21, states that a change fromthe modified approach to the depreciation approach �should be reported as a change in accounting estimate."Question 7.18.2 of the Comprehensive Implementation Guide2009 reiterates this guidance and adds:

Application of the modified approach essentially equates to the estimation of a useful life of suchlength that the amount of annual depreciation is insignificant. Therefore, a change in theestimated useful life from almost infinite to a shorter, finite life over which depreciation will berecorded should be reported as a change in estimate.

Reporting a change in accounting estimate requires governments to report the effect of the change prospectively.In this case, governments would not be required to calculate the amount that would have been reported asdepreciation expense (and related accumulated depreciation) in all periods prior to the conversion date. Instead,governments should estimate the remaining useful life at the conversion date and expected residual (or salvage)value of the infrastructure assets at the conversion date. In addition, governments must select a depreciationmethod. (Depreciation methods are discussed in Lesson 1.) Because infrastructure assets seldom have a salvageor residual value, Question 7.18.2 of the GASB Comprehensive Implementation Guide2009 notes that govern�ments most often will simply depreciate the reported historical cost of those infrastructure assets over the periodfrom the date of conversion to the depreciation approach through the end of the asset's remaining useful life. TheGFOA Recommended Practice, Considerations on the Use of the Modified Approach to Account for Infrastructure

Assets, points out that the higher depreciation expense that results is one of several negatives against using themodified approach. GFOA recommended practices can be downloaded at www.gfoa.org/services/rp/.

Additional Disclosure Requirements for Infrastructure

GASBS No. 34 also includes provisions for MD&A, note disclosures, and RSI relating to infrastructure, includingspecial information when the modified approach is used.


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SELF�STUDY QUIZ


34. What qualifies a government to use the modified approach and not depreciate infrastructure assets?

a. Any government that makes the election can use the modified approach and not depreciate these assets.

b. The government must use an asset management program and document the preservation of the assets.

c. The government must be willing to use the modified approach for all of its infrastructure assets.

35. Which of the following will happen if a government changes from the depreciation approach to the modifiedapproach?

a. The government must report the change as a change in accounting estimate.

b. The government must restate all of the accumulated depreciation.

c. The government must report the net amount of eligible infrastructure assets.

d. The government must report the effects of the change retroactively.

36. What makes an infrastructure asset eligible for the modified approach (assuming that the government meetsthe other requirements)?

a. That each department or agency uses the modified approach.

b. That the asset consists primarily of land.

c. That the asset is a network or subsystem.

37. Which of the following would be true about an up�to�date inventory that a government manages in an assetmanagement system?

a. The inventory must be up�to�date from an asset management perspective.

b. Every part of a network of infrastructure assets must be inventoried annually.

c. Certain parts of an infrastructure network do not have to be included in the inventory.

d. Infrastructure assets outside of a network must be included.

38. Under GASBS No. 34, how does a government document that it is maintaining infrastructure assets at acondition level established by the government?

a. The infrastructure assets must meet the qualifications for the minimum condition level outlined in GASBSNo. 34.

b. Administrative or executive policy, or legislative action, should establish and document the condition level.

c. Once a government selects a condition level for its infrastructure assets, that level must be consistent foras long as the modified approach is used.


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39. Which of the following statements best describes the condition assessments that governments must performwhen using the modified approach?

a. If statistical sampling is used, every asset must still be assessed at least once during the three�year testingcycle.

b. A government has up to six years to accumulate the results of three complete assessments as requiredby GASBS No. 34.

c. The results of the condition assessments must match the government's condition level without anyvariance.

d. Consistency can be an issue when a government performs assessments on a two� or three�year cycle.

40. A state government capitalizes expenditures made for additions, improvements, and to extend the life of capitalassets and reported it in the government�wide statement of net assets. What method did this government use?

a. The depreciation approach.

b. The modified approach.

41. What must a government do if it changes to the depreciation approach because of a failure to meet therequirements for the modified approach?

a. Begin to depreciate infrastructure assets the first year the requirements for the modified approach are notmet.

b. Calculate the amount that would have been reported as depreciation expense in all the periods before theconversion date.

c. Estimate remaining useful life as of the date the infrastructure asset began to be used by the government.

d. Estimate expected salvage value as of the conversion date and select a depreciation method.


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34. What qualifies a government to use the modified approach and not depreciate infrastructure assets?(Page 345)

a. Any government that makes the election can use the modified approach and not depreciate these assets.[This answer is incorrect. The modified approach is not available for every government. The governmenthas to meet a certain qualification before it can choose to use the modified approach.]

b. The government must use an asset management program and document the preservation of theassets. [This answer is correct. The modified approach is available for governments that managetheir infrastructure assets using an asset management system that has certain characteristics anddocument that its infrastructure assets are being preserved at (or above) a condition levelestablished by the government per GASBS No. 34.]

c. The government must be willing to use the modified approach for all of its infrastructure assets. [Thisanswer is incorrect. Governments are not required to use the modified approach for all of theirinfrastructure assets, but may elect to apply the approach to individual networks of infrastructure assetsor individual subsystems of a network.]

35. Which of the following will happen if a government changes from the depreciation approach to the modifiedapproach? (Page 348)

a. The government must report the change as a change in accounting estimate. [This answer is correct.GASBS No. 37 provides that governments that change from the depreciation approach to themodified approach should report the change as a change in accounting estimate.]

b. The government must restate all of the accumulated depreciation. [This answer is incorrect. Norestatement of carrying amounts or accumulated depreciation is required if a government makes thechange to the modified approach.]

c. The government must report the net amount of eligible infrastructure assets. [This answer is incorrect.Governments that change from the depreciation approach to the modified approach should reclassify thenet amount of eligible infrastructure assets (which had been reported as assets that are being depreciated)to assets that are not being depreciated.]

d. The government must report the effects of the change retroactively. [This answer is incorrect. Effects of thischange should be reported prospectively, not retroactively. Governments that change to the modifiedapproach simply should stop reporting depreciation expense. The infrastructure asset will continue to bereported at cost less accumulated depreciation at the time the modified approach is adopted.]

36. What makes an infrastructure asset eligible for the modified approach (assuming that the government meetsthe other requirements)? (Page 349)

a. That each department or agency uses the modified approach. [This answer is incorrect. One department(or agency) of a government can choose to use the modified approach while another chooses thedepreciation method as long as those departments do not report parts of the same network or subsystem.]

b. That the asset consists primarily of land. [This answer is incorrect. Assets like a park generally would notbe considered an infrastructure asset because they are primarily comprised of land. However, certainimprovements on the land might qualify.]

c. The asset is a network or subsystem. [This answer is correct. Infrastructure assets that are eligibleunder GASBS No. 34 are those that are part of a network or subsystem of a network.]


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37. Which of the following would be true about an up�to�date inventory that a government manages in an assetmanagement system? (Page 351)

a. The inventory must be up�to�date from an asset management perspective. [This answer is correct.The up�to�date inventory required by GASBS No. 34 is an inventory from an asset managementperspective, not an accounting or reporting perspective. Therefore, the determination of whetherthe up�to�date inventory exists should be based on its adequacy for purposes of managing thegovernment's assets.]

b. Every part of a network of infrastructure assets must be inventoried annually. [This answer is incorrect. Anup�to�date inventory does not mean that every part of a network of infrastructure assets has to beinventoried on an annual basis.]

c. Certain parts of an infrastructure network do not have to be included in the inventory. [This answer isincorrect. To be part of the asset management system, all the parts of the infrastructure network shouldbe on the system's inventory listing and inventoried periodically.]

d. Infrastructure assets outside of a network must be included. [This answer is incorrect. Eligible infrastructure

assets under GASBS No. 34, are assets that are a part of a network or a subsystem of a network.]

38. Under GASBS No. 34, how does a government document that it is maintaining infrastructure assets at acondition level established by the government? (Page 353)

a. The infrastructure assets must meet the qualifications for the minimum condition level outlined in GASBSNo. 34. [This answer is incorrect. The GASB recognized that governments have different acceptable levelsof condition for their infrastructure assets. Therefore, GASBS No. 34 does not establish a minimumcondition level at which infrastructure assets must be maintained.]

b. Administrative or executive policy, or legislative action, should establish and document thecondition level. [This answer is correct. GASBS No. 34, footnote 17, states that �the condition levelshould be established and documented by administrative or executive policy, or by legislativeaction." The government reporting the subsystem or network of infrastructure assets establishesthe condition levels.]

c. Once a government selects a condition level for its infrastructure assets, that level must be consistent foras long as the modified approach is used. [This answer is incorrect. Governments are allowed to changethe condition level at which they intend to maintain their infrastructure assets at any time. Therefore, if agovernment is concerned that it may no longer be maintaining its infrastructure assets at the level that itpreviously established and is in danger of no longer meeting the requirement to use the modifiedapproach, it may change its established condition level.]

39. Which of the following statements best describes the condition assessments that governments must performwhen using the modified approach? (Page 353)

a. If statistical sampling is used, every asset must still be assessed at least once during the three�year testingcycle. [This answer is incorrect. When statistical sampling is used, every asset does not have to beassessed during the three�year period. However, every asset must have an equal chance of being selectedduring the period for the assessment to be �complete," as discussed in the GASB Comprehensive

Implementation Guide2009.]

b. A government has up to six years to accumulate the results of three complete assessments as requiredby GASBS No. 34. [This answer is incorrect. Because governments are allowed to perform completecondition assessments over a three�year period, it may take nine years, not six, to accumulate theinformation referred to in GASBS No. 34, paragraph 23, item b., for the �three most recent completecondition assessments."]

c. The results of the condition assessments must match the government's condition level without anyvariance. [This answer is incorrect. The results of a government's three most recent complete condition


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assessments should provide reasonable assurance that its eligible infrastructure assets are beingpreserved approximately at (or above) the government's established and disclosed condition level. Areasonable variance is permissible.]

d. Consistency can be an issue when a government performs assessments on a two� or three�yearcycle. [This answer is correct. Governments that perform complete condition assessments on anannual basis usually do not have a consistency problem because they use the same conditionassessment method, basis, and scale for the entire assessment. Consistency becomes an issuewhen governments perform a �complete assessment" of all (or a statistical or other representativesample of all) their infrastructure assets over a two� or three�year period.]

40. A state government capitalizes expenditures made for additions, improvements, and to extend the life of capitalassets and reported it in the government�wide statement of net assets. What method did this government use?(Page 355)

a. The depreciation approach. [This answer is correct. The depreciation approach of accounting forcapital assets was used by the government in the government�wide financial statements describedabove and stated in GASBS No. 34.]

b. The modified approach. [This answer is incorrect. The modified approach requires that only expendituresfor additions and improvements be capitalized for eligible infrastructure assets. Under this approach,significant balances of infrastructure assets must be reported separate from depreciable capital assets onthe face of the statement of net assets in the government�wide financial statements.]

41. What must a government do if it changes to the depreciation approach because of a failure to meet therequirements for the modified approach? (Page 358)

a. Begin to depreciate infrastructure assets the first year the requirements for the modified approach are notmet. [This answer is incorrect. A government that no longer meets the requirements for using the modifiedapproach should begin to depreciate its infrastructure assets in the year after the requirements are not metand continue for subsequent reporting periods.]

b. Calculate the amount that would have been reported as depreciation expense in all the periods before theconversion date. [This answer is incorrect. Reporting a change in accounting estimate requiresgovernments to report the effect of the change prospectively. In this case, governments would not berequired to calculate the amount that would have been reported as depreciation (and related accumulateddepreciation) in all periods prior to the conversion date.]

c. Estimate remaining useful life as of the date the infrastructure asset began to be used by the government.[This answer is incorrect. Governments should estimate the remaining useful life at the conversion date,not the date the infrastructure asset began to be used by the government.]

d. Estimate expected salvage value as of the conversion date and select a depreciation method. [Thisanswer is correct. In this situation, the government must estimate the expected residual (or salvage)value of the infrastructure assets at the conversion date according to GASBS No. 34. In addition,governments must select a depreciation method. Because infrastructure assets seldom have asalvage or residual value, governments most often will simply depreciate the reported historicalcost of those infrastructure assets over the period from the date of conversion to the depreciationapproach through the end of the asset's remaining useful life.]


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NOTE DISCLOSURES AND REQUIRED SUPPLEMENTARY INFORMATIONFOR INFRASTRUCTURE

GASBS No. 34 requires certain basic disclosures in the notes to the financial statements and in required supple�mentary information (RSI) relating to infrastructure. Governments that have elected to delay retroactive reporting ofgeneral infrastructure assets under GASBS No. 34's phased�in implementation provisions and governmentselecting to use the modified approach are generally required to make additional disclosures.

Note Disclosure Requirements

Note disclosures relating to infrastructure fall into the following three categories:

� Disclosures in the summary of significant accounting policies relating to infrastructure.

� General disclosures about all capital assets.

� Transition disclosure requirements due to the delayed implementation dates for retroactively reportinggeneral infrastructure assets.

Summary of Significant Accounting Policies. GASBS No. 34, paragraph 115, requires a number of reportingmodel�related disclosures to be included in the summary of significant accounting policies. Specifically, paragraph115e. indicates that the following should be disclosed about capital assets, if applicable:

� The policy for capitalizing assets (including infrastructure assets). [The GASB Comprehensive Implementa�

tion Guide2009, Question 7.85.4, suggests that capitalization thresholds, the methods used forestimating historical cost or fair value, and the extent to which infrastructure assets acquired before June30, 1980, are reported (phase 1 and 2 governments) should be included as a part of this disclosure.]

� The policy for estimating the useful lives of capital assets, which is used to calculate depreciation expense.

� For governments that elect to use the modified approach for infrastructure asset reporting, a descriptionof the modified approach.

The GASB Comprehensive Implementation Guide2009, Question 7.85.5, states that phase 3 governments thatchoose not to retroactively report infrastructure assets should include a disclosure in their summary of significantaccounting policies on an ongoing basis. These governments should indicate that general infrastructure assetsacquired or constructed prior to July 1, 2003 are not reported in the financial statements.

General Capital Asset Disclosures. Paragraph 116 of GASBS No. 34 requires several disclosures about capitalassets, including infrastructure assets, that are reported in the statement of net assets. More information on thistopic can be found in PPC's Guide to Preparing Governmental Financial Statements Under GASBS No. 34.

Transition Disclosure Requirements. There are still a number of situations in which governments may bereporting general infrastructure assets for the first time. Paragraph 151 of GASBS No. 34 addresses the situationwhere sufficient information is available to report some, but not all, networks of infrastructure assets. Paragraph 151allows governments to report those networks for which information is available although all of the government'snetworks are not reported. Question 7.104.10 of the GASB Comprehensive Implementation Guide2009 alsoaddresses partial reporting of infrastructure assets.

Paragraph 151 of GASBS No. 34 requires that governments disclose the following:

� A description of the infrastructure assets being reported and of those that are not.

� A description of any eligible infrastructure assets that the government has decided to report using themodified approach.


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Governmentsgiven the variety of options for retroactive reportingalways disclose the scope of their generalinfrastructure asset reporting in their summary of significant accounting policies.

RSI Requirements

Some members of the GASB have indicated they believe much of the value of the modified approach for reportinginfrastructure assets comes from the required RSI disclosures. Governments that elect to use the modifiedapproach are not required to depreciate infrastructure assets. This means that maintenance and preservation costsare the only costs of using infrastructure assets reported in the statement of activities. If a government is notspending an adequate amount to maintain and preserve its infrastructure assets, these assets will deteriorate at anaccelerating rate. However, because no depreciation expense is charged, the government's financial position willnot reflect the �using up" or deterioration of these assets. Without adequate disclosure concerning the condition ofinfrastructure assets, financial statement readers may assume that a government's financial position is better thanits true position. The GASB believes that it is important to provide readers of financial statements with additionalinformation to help them assess whether a government's infrastructure assets are being maintained and preserved.As a result, GASBS No. 34 requires expanded RSI disclosure for governments choosing the modified approach.The RSI includes both (a) schedules, (b) disclosures to accompany the schedules, and (c) disclosures in MD&A.

RSI Schedules. GASBS No. 34, paragraph 132, requires governments that use the modified approach to presentthe following RSI schedules, derived from information obtained from asset management systems, for all eligibleinfrastructure assets reported using the modified approach:

a. The assessed condition, performed at least every three years, for at least the three most recent completecondition assessments, indicating the dates of the assessments.

b. The estimated annual amount calculated at the beginning of the fiscal year to maintain and preserve at (orabove) the condition level established and disclosed by the government compared with the amountsactually expensed on the accrual basis (for maintenance and preservation as discussed in the previoussection) for each of the past five reporting periods.

Exhibit 2�12, Exhibit 2�13, and Exhibit 2�14 illustrate these schedules.

The estimated annual amount to maintain and preserve infrastructure assets must be determined using thegovernment's asset management system. It should be calculated at the beginning of the fiscal year and shouldrepresent the amount believed necessary to maintain and preserve eligible infrastructure assets at (or above) thecondition level established and disclosed by the government for the upcoming year. The reason for including theestimated amount at the beginning (versus the end) of a government's fiscal year is to provide a meaningfulcomparison with the actual maintenance and preservation costs incurred for infrastructure assets during the year.From a practical perspective, a government should document that it calculated this estimated amount at thebeginning of its fiscal year. This could be accomplished by maintaining the dated copies of printouts from the assetmanagement system that report the estimates. The government's auditor should consider obtaining the estimatesand a copy of the supporting documentation at the beginning of the fiscal year. As part of their audit procedures, theauditor will generally compare the estimate from the beginning of the year to the actual maintenance and preserva�tions costs incurred during the year.


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Exhibit 2�12

RSI Disclosures for a Street System Based on a Percentage of Roadsin Good or Substandard�Condition

Condition Rating of the City's Street System

Percentage of Lane�miles inGood or Better Condition

2002 2001 2000

Main arterial 93.2% 91.5% 92.0%Arterial 85.2% 81.6% 84.3%Secondary 87.2% 84.5% 86.8%Overall system 87.0% 85.5% 87.3%

Percentage of Lane�miles inSubstandard Condition

2002 2001 2000

Main arterial 1.7% 2.6% 3.1%Arterial 3.5% 6.4% 5.9%Secondary 2.1% 3.4% 3.8%Overall system 2.2% 3.6% 3.9%

Comparison of Needed�to�actual Maintenance/Preservation(in Thousands)

2002 2001 2000 1999 1998

Main arterial:Needed $ 2,476 $ 2,342 $ 2,558 $ 2,401 $ 2,145Actual 2,601 2,552 2,432 2,279 2,271

Arterial:Needed 1,485 1,405 1,535 1,441 1,287Actual 1,560 1,531 1,459 1,367 1,362

Secondary:Needed 990 937 1,023 960 858Actual 1,040 1,021 972 911 908

Overall system:Needed 4,951 4,684 5,116 4,802 4,290Actual 5,201 5,104 4,863 4,557 4,541Difference 250 420 (253 ) (245 ) 251

The condition of road pavement is measured using the XYZ pavement management system, which is based on aweighted average of six distress factors found in pavement surfaces. The XYZ pavement management system usesa measurement scale that is based on a condition index ranging from zero for a failed pavement to 100 for apavement in perfect condition. The condition index is used to classify roads in good or better condition (70 to 100),fair condition (50 to 69), and substandard condition (less than 50). It is the City's policy to maintain at least 85percent of its street system at a good or better condition level. No more than 10 percent should be in a substandardcondition. Condition assessments are determined every year.

[SOURCE:�Adapted from GASBS No. 34, Basic Financial Statementsand Management's Discussion and

Analysisfor State and Local Governments, Appendix C, Exhibit G�5.]

* * *


367

Exhibit 2�13

RSI Disclosures for a City's Street System Based on a Condition Index

Pavement Condition Index of City's Street System

2002 2001 2000

Main arterial 81 81 80Arterial 77 74 79Secondary 72 73 74Overall system 76 76 78

Comparison of Needed�to�actual Maintenance/Preservation(in Thousands)

2002 2001 2000 1999 1998

Main arterial:Needed $ 2,476 $ 2,342 $ 2,558 $ 2,401 $ 2,145Actual 2,601 2,552 2,432 2,279 2,271

Arterial:Needed 1,485 1,405 1,535 1,441 1,287Actual 1,560 1,531 1,459 1,367 1,362

Secondary:Needed 990 937 1,023 960 858Actual 1,040 1,021 972 911 908

Overall system:Needed 4,951 4,684 5,116 4,802 4,290Actual 5,201 5,104 4,863 4,557 4,541Difference 250 420 (253 ) (245 ) 251

The condition of road pavement is measured using the Micro PAVER pavement management system. All of thestreets maintained by the city are asphalt�surfaced. Nineteen pavement distress factors are assessed for arepresentative sample of these asphalt�surfaced streets. The Micro PAVER pavement management system uses ameasurement scale that is based on a Pavement Condition Index (PCI) ranging from zero for a failed pavement to100 for a pavement in perfect condition. The City's policy is to maintain an average PCI of at least 70 for each of itsnetwork subsystems: main arterial, arterial, and secondary streets. Complete condition assessments aredetermined every two years.

[SOURCE:�Adapted from GASBS No. 34, Basic Financial Statementsand Management's Discussion and

Analysisfor State and Local Governments, Appendix C, Exhibit G�5.]

* * *


368

Exhibit 2�14

RSI Disclosures for a Network of Bridges

Number of Bridges

2002 2000 1998

BMIPCondition Rating Number % Number % Number %

Acceptable 5.0�7.0 15,582 89.8% 15,182 87.5% 14,835 85.5%Marginally deficient 4.0�4.9 1,232 7.1% 1,544 8.9% 1,666 9.6%Moderately deficient 2.0�3.9 504 2.9% 538 3.1% 781 4.5%Severely deficient 1.0�1.9 33 0.2% 87 0.5% 69 0.4%

Total 17,351 100.0% 17,351 100.0% 17,351 100.0%

Square Feet of Deck Area (1,000s of square feet)

2002 2000 1998

BMIPCondition Rating

SquareFeet %

SquareFeet %

SquareFeet %

Acceptable 5.0�7.0 124,656 85.8% 127,102 87.5% 125,649 86.5%Marginally deficient 4.0�4.9 9,856 6.8% 8,570 5.9% 11,040 7.6%Moderately deficient 2.0�3.9 10,452 7.2% 8,570 5.9% 7,408 5.1%Severely deficient 1.0�1.9 295 0.2% 1,017 0.7% 1,162 0.8%

Total 145,259 100.0% 145,259 100.0% 145,259 100.0%

Comparison of Estimated�to�actual Maintenance/Preservation (in Thousands)

2002 2001 2000 1999 1998

Estimated $ 2,650 $ 2,798 $ 2,541 $ 2,487 $ 2,301Actual 2,322 2,623 2,765 2,245 2,105

The condition of the State's bridges is determined using its Bridge Management and Inspection Program (BMIP).The bridge condition rating, which is a weighted average of an assessment of the ability of individual componentsto function structurally, uses a numerical condition scale ranging from 1.0 (impaired or load restricted) to 7.0 (new).It is the State's policy to keep the number and square footage of deck area of bridges with a condition rating of1.0�to 1.9 below 1 percent. All bridges are inspected every two years.

[SOURCE:�Adapted from GASB's Comprehensive Implementation Guide2009, Appendix 7�2, Exhibit�14.]

* * *

The GASB recognized that, at transition, many governments adopting the modified approach might not haveaccumulated the information necessary to disclose the RSI described in the �RSI Schedules" paragraph. Inparticular, governments adopting the modified approach initially may not be able to obtain information about (a) thethree most recent complete condition assessments and/or (b) the estimated and actual amounts to maintain andpreserve the infrastructure assets for the previous five reporting periods. Instead of disallowing the use of themodified approach in these cases, paragraph 153 of GASBS No. 34 allows governments to initially abbreviate theinformation they disclose in RSI by presenting only as many �complete condition assessments and years ofestimated and actual expenses as are available."


369

RSI Disclosures. GASBS No. 34, paragraph 133, also requires governments using the modified approach forreporting infrastructure assets to present the following RSI disclosures to accompany the schedules discussed inthe preceding paragraphs:

a. The basis for the condition measurement and the measurement scale used to assess and report condition.For example, a basis for condition measurement could be distresses found in pavement surfaces. A scale

used to assess and report condition could range from zero for a failed pavement to 100 for a pavement inperfect condition.

b. The condition level at which the government intends to preserve its eligible infrastructure assets reportedusing the modified approach.

c. Factors that significantly affect trends in the information reported in the required schedules, including anychanges in the measurement scale, the basis for the condition measurement, or the condition assessmentmethods used during the periods covered by the schedules. If there is a change in the condition level atwhich the government intends to preserve eligible infrastructure assets, an estimate of the effect of thechange on the estimated annual amount to maintain and preserve those assets for the current period alsoshould be disclosed.

Illustrative RSI Schedules and Disclosures. The following exhibits illustrate the RSI schedules and disclosuresfor governments using the modified approach to report their infrastructure assets:

� Exhibit 2�12 illustrates how a city could present its RSI disclosure for its street system.

� Exhibit 2�13 adapts Exhibit 2�12 to illustrate how the same city could present its RSI disclosures for a streetsystem if it reported based directly on pavement condition rather than a percentage of roads meeting acertain condition level.

� Exhibit 2�14 illustrates how a state could present its RSI disclosure for a network of bridges.


370

SELF�STUDY QUIZ


42. Which of the following is one of the three categories of note disclosure requirements for infrastructure?

a. Disclosures about required supplementary information (RSI) related to infrastructure.

b. General disclosures about all capital assets.

c. Transition disclosure requirements for governments that prospectively applied GASBS No. 34.

43. Which of the following statements best describes the GASBS No. 34 RSI requirements for a government usingthe modified approach?

a. RSI must include the assessed condition, performed annually, of all the government's eligibleinfrastructure assets.

b. Information included in the RSI must be gathered from historical records, such as bond records,engineering records, or capital budgets.

c. Without adequate RSI, financial statement readers may assume a government's financial position is betterthan it actually is.

d. RSI must include the estimated annual amount for maintenance and preservation for all eligibleinfrastructure assets, as calculated at the end of the prior year.


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42. Which of the following is one of the three categories of note disclosure requirements for infrastructure?(Page 364)

a. Disclosures about required supplementary information (RSI) related to infrastructure. [This answer isincorrect. One required category of note disclosure is disclosures in the summary of significant accountingpolicies relating to infrastructure. GASBS No. 34 does require certain disclosures of RSI related toinfrastructure, but it would not be included in the note disclosures.]

b. General disclosures about all capital assets. [This answer is correct. This is one of the three basiccategories of note disclosures that GASBS No. 34 requires related to infrastructure. Information onthese disclosures are found in paragraph 116 of GASBS No. 34.]

c. Transition disclosure requirements for governments that prospectively applied GASBS No. 34. [Thisanswer is incorrect. One required category of note disclosure is transition disclosure requirements due tothe delayed implementation dates for retroactively reporting general infrastructure assets.]

43. Which of the following statements best describes the GASBS No. 34 RSI requirements for a government usingthe modified approach? (Page 365)

a. RSI must include the assessed condition, performed annually, of all the government's eligibleinfrastructure assets. [This answer is incorrect. The RSI must include the assessed condition, performedat least every three years, for at least the three most recent complete condition assessments, indicatingthe dates of the assessments.]

b. Information included in the RSI must be gathered from historical records, such as bond records,engineering records, or capital budgets. [This answer is incorrect. RSI schedules should be derived frominformation obtained from asset management systems for all eligible infrastructure assets reported usingthe modified approach.]

c. Without adequate RSI, financial statement readers may assume a government's financial positionis better than it actually is. [This answer is correct. Governments that elect to use the modifiedapproach are not required to depreciate infrastructure assets. This means that maintenance andpreservation costs are the only costs of using infrastructure assets reported in the statement ofactivities. If a government is not spending an adequate amount to maintain and preserve itsinfrastructure assets, these assets will deteriorate at an accelerating rate. However, because nodepreciation expense is charged, the government's financial position will not reflect the �using up"or deterioration of these assets. Without adequate disclosure concerning the condition ofinfrastructure assets, financial statement readers may assume that a government's financialposition is better than its true position. Therefore, GASBS No. 34 requires expanded RSI disclosurefor governments using the modified approach.]

d. RSI must include the estimated annual amount for maintenance and preservation for all eligibleinfrastructure assets, as calculated at the end of the prior year. [This answer is incorrect. The RSI mustinclude the estimated annual amount calculated at the beginning of the fiscal year to maintain and preserveat (or above) the condition level established and disclosed by the government compared with the amountsactually expensed on the accrual basis (for maintenance and preservation) for each of the past fivereporting periods.]


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IMPAIRMENT OF CAPITAL ASSETS AND INSURANCE RECOVERIES

Impairments of Capital AssetsTHE BASICS

� An impairment is a significant, unexpected decline in the service utility of a capital asset.

� Tests of impairment are required only when certain impairment indicators are present.

� If both of two impairment tests are met, the extent to which the asset is impaired should bemeasured using one of four methods, depending on the cause of the decline.

The GASB Statement No. 42, Accounting and Financial Reporting for Impairment of Capital Assets and for Insur�

ance Recoveries, provides accounting and financial reporting requirements for impairments of capital assets.Paragraph 5 defines an impairment as an unexpected and significant decline in the service utility of a capital asset.

GASBS No. 42 applies to all capital assets, including general capital assets. (Footnote 3 to Paragraph 4 of GASBSNo. 42 requires land to be considered separately from all other capital assets.) GASBS No. 51, Accounting and

Financial Reporting for Intangible Assets, effective for financial statements for periods beginning after June 15,2009, extends the applicability of GASBS No. 42 to intangible assets within its scope. Intangible assets are a subsetof capital assets and GASBS No. 51, paragraph 5, requires that all existing GAAP for capital assets to be applied tointangible assets.

GASBS No. 42 requires governments to report an impairment loss in proprietary and government�wide financialstatements when the service utility of a capital asset declines significantly and unexpectedly. Determining whetheran asset is impaired is a two�step process. The first step in the process is to identify potential impairments. Thesecond step is to test whether impairment has actually occurred by applying two impairment tests. If both impair�ment tests are met, impairment is required to be measured in one of four ways, depending on the nature of theimpairment and whether the government intends to continue to use the asset.

Definitions of Terms

Three terms are used to define impairment in GASBS No. 42, paragraph 5significant, service utility, unexpected.Consistent with previous standards, the GASB does not define the term significant, an apparent cousin to material.Service utility is defined in paragraph 6 as the usable capacity that an asset was expected to provide at itsacquisition, as opposed to the capacity currently being used. Usable service capacity is different from maximumservice capacity if the asset was acquired with surplus capacity for safety or other reasons. As defined in paragraph5, unexpected means that the event or circumstance was not expected to occur during the life of the asset.

Identifying Potential Impairments

It is clear that the GASB does not want this standard to result in governments spending lots of time placing all oftheir capital assets under the impairment microscope. The opening statement in GASBS No. 42, paragraph 6 isemphatic�The events and changes in circumstances affecting a capital asset that may indicate impairment areprominentthat is conspicuous or known to the government." The GASB adds that these events or changes incircumstances �are expected to have prompted discussion by the governing board, management, or the media."

Paragraph 9 of the standard lists several examples of common indicators that an asset may have been impaired.Absent these indicators, governments are not required to perform the impairment tests discussed in the �Impair�ment Tests" paragraph.

� Evidence of physical damage, for example by fire or flood.

� A change in legal requirements or environmental factors that govern the asset's use, for example,enactment of new water quality standards that cannot be met by an existing water treatment plant.

� Technological changes or evidence of obsolescence, for example, an asset that is no longer used becausea newer model is more efficient.


373

� A change in the way an asset is used or in the length of time it was expected to be used, for example, apiece of equipment used in a utility plant that is being closed before the end of its useful life.

� Construction stoppage, for example, when construction is halted due to lack of funds.

� Development stoppage, for example when a government stops developing internally generated softwaredue to a change in management priorities.

If any of these indicators appear to be temporary, however, special provisions apply.

Impairment Tests

Once a capital asset has been identified as being potentially impaired, GASBS No. 42, paragraph 11, requiresgovernments to apply two impairment testsboth of which must be metbefore an impairment loss is required tobe reported:

a. A Magnitude Test. Would the expenses associated with continuing to operate and maintain the asset (otherthan depreciation) or with restoring the asset be significant in relation to the current service utility of theasset? Management's lack of action to address the impairment indicators (other than those involvingphysical damage) may be an indication that the expenses needed to restore the asset are too high inrelation to the benefits it can provide.

b. An Unexpected Nature Test. Is the restoration cost or other impairment circumstance a part of the normallife cycle of the asset? Establishing the expected use and useful life of an asset is not a precise science,but there is a range of reasonable expectations about an asset's use and life.

Governments should reevaluate the depreciation calculationsestimated useful life and salvage valuesforassets that have impairment indicators but that do not meet the impairment test. Any changes in those calculationsshould be reported prospectively over the remaining useful life of the asset.

Measuring Impairment

If both impairment tests are met and the government expects to continue to use the asset, impairment is requiredto be measured in one of four ways, depending on the nature of the impairment:

a. Restoration Cost Approach. An impairment loss indicated caused by physical damage generally shouldbe measured using this cost approach. The dollar amount of impairment loss should be measured byestimating the cost to restore the asset to its original condition and deflating that estimate by a cost indexbased on the age of the asset. (Or, preparers may apply a ratio of estimated restoration costs over thereplacement cost of the asset to its carrying value.) Exhibit 2�15 illustrates the calculation of an impairmentloss using the restoration cost approach.

b. Service Units Approach. An impairment loss indicated by changes in legal requirements, environmentalfactors, or from technological changes or obsolescence generally should be measured using this costapproach. This approach estimates the total or maximum service units that the asset could have providedboth before and after the event or change in circumstance in its use. The percentage change in units wouldbe applied to the carrying value of the asset to determine the dollar amount of the impairment loss. Thismethod may also be used to measure an impairment loss indicated by a change in the manner or durationof use of the asset. Exhibit 2�16 illustrates the calculation of an impairment loss using the service unitsapproach.

c. Deflated Depreciated Replacement Cost Approach. An impairment loss indicated by a change in themanner or duration of use of an asset generally should be measured using this cost approach. Thisapproach identifies how much it would cost currently to replace the asset at the level of service it nowprovides. This current cost would be depreciated to reflect the fact that the asset is not new and thendeflated to convert it to historical dollars. This would be the new carrying amount of the asset. Theimpairment loss amount would be the difference between the old and new carrying amounts. Exhibit 2�17illustrates the calculation of an impairment loss using the deflated depreciated replacement cost approach.


374

d. Lower of Carrying Amount or Fair Value. This approach may be used only in two circumstanceswhen thegovernment will no longer use an impaired asset and when an asset is impaired as a result of a constructionstoppage. Impairment loss caused by a construction stoppage must be measured as the differencebetween the carrying value of construction in process and the fair value of the asset, if lower. If the carryingvalue of the asset is lower than fair value, no loss has been sustained. When an impaired asset will no longerbe used, the loss should be measured based on the lower of fair value or the historical cost of the assetless accumulated depreciation. This approach should also be used for internally generated intangibleassets impaired for development stoppage, as discussed in GASBS No. 51, paragraph 18.

Exhibit 2�15

Calculating an Impairment Loss Using the Restoration Cost Approach

Assume that in 20X8 a tornado caused extensive damage to City elementary school. The school buildingwas constructed in 20X1 at a cost of $28 million and was expected to provide service for thirty years. The Cityclosed the school building and made repairs costing $3.5 million to restore it to its original, usable condition.The City is �self�insured." It carries commercial insurance coverage only for losses in excess of $5 million.Replacement cost of the school building is not available. However, building construction costs have beenincreasing an average of 3 percent per year over the past seven years.

Impairment loss using the restoration cost approach using a cost index is determined as follows:

a. Historical cost, 20X1 $ 28,000,000

Accumulated depreciation (a./30 � 7) 6,533,333

b. Carrying value, 20X8 $ 21,466,667

Restoration cost $ 3,500,000

Deflation factor, compounded (1/(1.03)7) 0.81309

c. Deflated restoration cost $ 2,845,815

d. Restoration cost ratio (c./a.) 10.1636 %

Impairment loss (b. � d.) $ 2,181,786

The new carrying value of the school building is $ 22,784,881. ($21,466,667 carrying value less $2,181,786impairment loss written off plus current restoration costs of $3,500,000.)

[SOURCE:�Adapted from GASBS No. 42, Appendix C, Illustration 2.]

* * *

Exhibit 2�16

Calculating an Impairment Loss Using the Service Units Approach

In 20X3, a federal agency adopted a regulation requiring all underground gas tanks to be rustproof,double�walled tanks with spill�protection devices. The period for compliance with the regulation is 10 years.The City of Clark installed new underground tanks in its public works fuel facility in 20X2, one year before theregulation was adopted. The new tanks do not meet the requirements that will go into effect in 2X13. Thetanks installed in 20X2 cost $700,000 and had been expected to provide service for 40 years.

An impairment loss using the service units approach would be determined as follows:


375

Historical cost $ 700,000Total service units�years � 40Cost per service unit $ 17,500Number of service units made unusable by �regulation

(40 years � 11 years) � 29

Impairment loss $ 507,500


* * *

Exhibit 2�17

Calculating an Impairment Loss Using the Deflated DepreciatedReplacement Cost Approach

In 2003, Linda City School District closed an elementary school because enrollments in the district declinedunexpectedly due to the bankruptcy of the major employer in the area. The closed school has been converted touse as storage. The school was constructed in 1991 at a cost of $10 million. The estimated useful life of the schoolis fifty years. The City has no evidence that enrollments will increase in the future such that the building would bereopened for use as a school. The current replacement cost for a warehouse of the same size is $4.2 million. Acommercial construction index was at 100 and 150 in 1991 and 2003, respectively.

Impairment loss using deflated depreciated replacement cost would be determined as follows:

Historical cost, 1991 $ 10,000,000

Accumulated depreciation (12/50 years) 2,400,000

a. Carrying amount, 2003 $ 7,600,000

Replacement cost of warehouse, 2003 $ 4,200,000

Accumulated depreciation (12/50 years) 1,008,000

b. Depreciated replacement cost $ 3,192,000

c. Commercial construction index, 1991 100

d. Commercial construction index, 2003 150

e. Deflation factor (c./d.) 0.6667

f. Deflated depreciated replacement cost (b. � e.) $ 2,128,000

Impairment loss (a. � f.) $ 5,472,000

Governments may measure impairment losses indicated by a change in the manner or duration of use of an assetusing either the deflated depreciated replacement cost method (illustrated in this Exhibit) or the service unitsapproach (illustrated in Exhibit 2�16).


* * *

The fourth approach (the lower of carrying amount or fair value approach in item d., listed previously) may only beused in situations in which the government will no longer use the asset or the asset is impaired as a result of a


376

construction stoppage. In other circumstances (items a., b., and c., listed previously), the GASB recommends amethod that generally should be used but states that governments should choose the method that most appropri�ately measures the decline in the service utility of the asset. GASBS No. 42, BFC paragraph 48, states that doing sowill enhance comparability among governments. At the same time, BFC paragraphs 49 through 52 provide reasonswhy the Board thinks the use of each of these approaches is not appropriate in certain circumstances.

Temporary Impairment

In some cases, an impairment indicator may be temporary. GASBS No. 42, paragraph 18, gives an example of aschool building that is closed temporarily due to a drop in enrollment that is expected to reverse itself in the next fewyears. When an impairment is shown to be temporary, the capital asset should not be written down (no loss shouldbe reported). Impairment should always be considered permanent when it is indicated by physical damage.However, for the remaining impairment indicators listed in the �Identifying Potential Impairments" discussion,governments may be able to present evidence that the impairment is temporary. Once an impairment loss isrecognized, however, it should never be reversed, even if the events or circumstances that originally indicated aloss have changed.

Reporting Impairment Losses

Governmental Funds. Because governmental funds measure only the flow of current financial resources, nothingshould be reported in governmental funds as a result of a capital asset impairment. The loss would be recordedonly in the governmental general capital assets ledger.

Proprietary Fund and Government�wide Financial Statements. Impairment losses should be reported as pro�gram expense (or nonoperating revenue in enterprise fund operating statements), extraordinary or special items inthe government�wide statement of activities or proprietary fund operating statement. �Special" items and �extraor�dinary" items are defined in GASBS No. 34. The GASB Comprehensive Implementation Guide2009, QuestionZ.42.12, suggests two ways in which a government may recognize the effect of the impairment in its capital assetaccounts. First, governments may increase accumulated depreciation by the amount of the impairment loss. Thishas the effect of reporting the loss as if additional years of the asset's life had been used up. Second, governmentsmay reduce both the historical cost of the asset and accumulated depreciation proportionately so that the decreasein the net carrying value of the asset equals the impairment loss. Using this method treats the impairment as if aportion of the asset has been disposed of.

Subsequent Measurements. The GASB Comprehensive Implementation Guide2009, the restoration costapproach, discussed previously, requires governments to apply a cost index to deflate a restoration cost estimateto the estimated cost at the date the impaired asset was acquired. Question Z.42.13 asks whether that impairmentloss should be recalculated in subsequent years for the change in the index. It should not. The GASB staff notesthat price level changes affect both costs in the restoration cost equation, not just deflated cost.

Disclosure Requirements. GASBS No. 42 requires governments to present additional information in the notes tothe financial statements in two circumstances:

a. In the year in which an impairment is reported, disclose a general description of the impairment, the amountof the loss, and the classification of the loss in the government�wide and proprietary fund operatingstatements if not apparent from the face of the financial statements. (GASBS No. 42, paragraph 17)

b. When capital assets are idle at year�end, disclose the carrying amount of those assets even if onlytemporarily impaired. (GASBS No. 42, paragraph 20)


377

GASB Illustrations

GASBS No. 42, Appendix C, provides a series of ten illustrations of identifying and measuring impairment of capitalassets. These illustrations include:

Illustration #

1 Physical DamageSchool with Mold Contamination

2 Physical DamageOffice Building with Structural Damage

3 Change in Legal or Environmental FactorsUnderground Storage Tanks

4 Technological Development or Evidence of ObsolescenceUnderutilizedMagnetic Resonance Imaging Machine

5 Change in Manner or Duration of UseSchool Used for Storage

6 Change in Manner or Duration of UseStadium

7 Change in Manner or Duration of UseRail System

8 Change in Manner or Duration of UseStreet Closure

9 Construction StoppageAirport Pavements

10 Demand for ServiceWater Treatment Plant

Insurance Recoveries

Some impairments are covered by insurancesuch as an asset impairment caused by fire. GASBS No. 42provides guidance on reporting insurance recoveries when those recoveries are provided by an organizationoutside the primary government, such as an insurance company or public entity risk pool. The scope of GASBS No.42 also includes insurance recoveries from all other eventsfor example from the theft of capital assets or cash.Recoveries include those from the government's insurance policy, its general fund or internal service fund (for�self�insurance"), as well as from any other sources. For example, a recovery would include a payment from acompany or that company's insurer for damage done in an accident that was the company's fault, as discussed inGASB Comprehensive Implementation Guide2009, Question Z.42.11. Question Z.42.4 notes that FEMA grantfunds are nonexchange transactions (grant/program revenues) and should not be reported as an insurancerecovery.

In the government�wide and enterprise funds statements, insurance recoveries should be netted against the relatedloss if both occur in the same fiscal year. Insurance recoveries that occur after the year the asset is written downshould be reported in the same manner as the write�offas a program revenue (or nonoperating revenue in anenterprise fund), special item, or extraordinary gain.

Insurance recoveries in governmental funds should be reported as an �other financing source" or as an extraordi�nary or special item. Restoration or other costs related to the impairment of a capital asset should be reported asseparate transactions. Recoveries should only be recognized when realized or realizable. The same disclosuresrequired for impairment write�offs would applythat is, disclosure is required only if the amount of the recovery andits financial statement classification are not apparent from the face of the financial statements.

Recoveries provided by a risk financing internal service fund or by the general fund should be reported based onthe requirements of GASB Statement No. 10, Accounting and Financial Reporting for Risk Financing and Related

Insurance Issues.


378

SELF�STUDY QUIZ


44. If an asset has impairment loss because of recent technological changes and has met both impairment tests,what approach should the government use to measure the asset's impairment?

a. The restoration cost approach.

b. The service units approach.

c. The deflated depreciated replacement cost approach.

d. The lower of carrying amount or fair value approach.

45. How should a government report loss for an asset that is only temporarily impaired?

a. No loss should be reported on a temporarily impaired asset.

b. Loss should be reported and reversed later if the impairment indicator changes.

c. Impairment must always be considered permanent, not temporary.


379



44. If an asset has impairment loss because of recent technological changes and has met both impairment tests,what approach should the government use to measure the asset's impairment? (Page 373)

a. The restoration cost approach. [This answer is incorrect. This approach would generally be used if animpairment loss was caused by physical damage.]

b. The service units approach. [This answer is correct. An impairment loss indicated by changes inlegal requirements, environmental factors, or from technological changes or obsolescencegenerally should be measured using this cost approach per GASB Statement No. 42.]

c. The deflated depreciated replacement cost approach. [This answer is incorrect. Generally, an impairmentloss indicated by a change in the manner or duration of use of an asset should be measured using thiscost approach.]

d. The lower of carrying amount or fair value approach. [This answer is incorrect. This approach may onlybe used in two circumstanceswhen the government will no longer use an impaired asset and when anasset is impaired as a result of a construction stoppage.]

45. How should a government report loss for an asset that is only temporarily impaired? (Page 376)

a. No loss should be reported on a temporarily impaired asset. [This answer is correct. In some cases,an impairment indicator may be temporary. When an impairment is shown to be temporary, thecapital asset should not be written down (no loss should be reported) as indicated in GASB No. 42.]

b. Loss should be reported and reversed later if the impairment indicator changes. [This answer is incorrect.Once an impairment loss is recognized, it should never be reversed, even if the events or circumstancesthat originally indicated a loss have changed.]

c. Impairment must always be considered permanent, not temporary. [This answer is incorrect. Impairmentshould always be considered permanent when it is indicated by physical damage. However, for theremaining impairment indicators, governments may be able to present evidence that the impairment istemporary.]


380


Lesson 2 (GFSTG093)


24. Define governmental activities, as related to government�wide financial statements.

a. Activities that are generally financed through taxes, intergovernmental revenues, and other nonexchangerevenues.

b. Activities that are financed (in whole or in part) by the fees charged to external parties who use goods andservices.

c. Do not select this answer choice.


25. Generally, how should the capital assets of internal service funds that are business�type activities be reportedin government�wide financial statements?

a. In the same way they were reported in the proprietary fund financial statements.

b. As business�type activity capital assets.

c. With the capital assets of governmental activities.


26. List all of the following buildings that would be considered infrastructure under GASBS No. 34.

i. Capital building. iv. City hall.

ii. Tollbooths associated with a turnpike. v. Library with government�owned librarybooks.

iii. Road maintenance structures associatedwith a highway system.

vi. Water pumping buildings associated withwater systems.

a. i. and iv.

b. ii., iii., and vi.

c. ii., iii., v., and vi.

d. i., ii., iii., iv., v., and vi.


381

27. If a government has $75 million in revenue annually, when should it have begun retroactively reportinginfrastructure under GASBS No. 34?

a. June 16, 2002.

b. June 16, 2005.

c. June 16, 2006.

d. This government is encouraged, but not required, to report infrastructure retroactively.

28. Which statement about adopting the provisions of GASBS No. 34 is correct?

a. If reporting on a GAAP basis, governments may still choose whether to adopt GASBS No. 34.

b. Component units must adopt all provisions of GASBS No. 34 without regard to revenue.

c. If reporting on a GAAP basis, Phase 1 and 2 governments should retroactively report their major generalinfrastructure assets.

d. Governments can report their general infrastructure assets on a partial basis.

29. All of the following steps will allow a phase 1 or 2 government to determine whether it has major infrastructureassets that must be capitalized and reported, except:

a. Apply the government's capitalization threshold to determine if the asset is major.

b. Determine if the government owns infrastructure assets.

c. Make preliminary cost estimates for infrastructure networks.

d. Determine the cost of general capital assets for the first fiscal year ending after June 15, 1999.

30. Which of the following would be considered a major general infrastructure asset for the first fiscal year endingafter June 15, 1999?

a. A water distribution network that is 5% of the total cost of all general capital assets.

b. An airport subsystem that is 3% of the total cost of all general capital assets.

c. A road network that is 11% of the total cost of all general capital assets.

d. A dam subsystem that is 1% of the total cost of all general capital assets.

31. What are the three pieces of information a government needs to estimate the historical cost of a generalinfrastructure asset using the deflated current replacement cost approach?

a. The asset's estimated fair value, expected salvage value, and depreciation method.

b. The asset's current replacement cost, acquisition year, and a price�level index.

c. The asset's current replacement cost, estimated useful life, and replacement year.

d. The asset's depreciation method, estimated useful life, and a price�level index.


382

32. If a government determines the age of a type of general infrastructure asset by adding the ages of that type ofasset and dividing by the number of assets, what method has been used?

a. A simple average.

b. A weighted average.

c. Record examination.


33. How does the deflated current replacement cost approach relate to accumulated depreciation?

a. An estimated accumulated depreciation amount must be calculated for most general infrastructure assetsunder this method.

b. Calculating accumulated depreciation requires different information than that used in the deflated currentreplacement cost approach.

c. Even if the deflated current replacement cost approach is used, depreciation must be calculated frompresent�day values of the asset.

d. Accumulated depreciation only has to be calculated going forward; it does not have to be calculatedretroactively.

34. For what reason might a government prefer to use traditional depreciation rather than the modified approach?

a. Developing depreciation schedules is easy and inexpensive.

b. It will not have to calculate depreciation expense.

c. It already uses an asset management system.

d. It only has infrastructure assets in enterprise funds.

35. When using the depreciation approach, how should a government report depreciation expense for generalinfrastructure assets in a government�wide statement of activities?

a. It should be assigned or allocated to the various functions.

b. It should be reported as a direct expense of a function.




383

36. List the three minimum features that an asset management system is required to have under GASBS No. 34.

i. An up�to�date inventory of all eligible infrastruc�ture assets.

iv. The ability to perform condition assessmentsand summarize them using a measurementscale.

ii. Budgeting software. v. The ability to estimate the annual amountneeded to maintain and preserve the eligibleinfrastructure assets at the condition levelestablished by the government.

iii. Checklists and detailed analysis forms forobserving eligible infrastructure assets.

vi. A standardized program design based on thespecifics of GASBS No. 34.

a. i., ii., and iii.

b. iv., v., and vi.

c. ii., iii., and vi.

d. i., iv., and v.

37. What is the one criteria that GASBS No. 34 mentions about condition assessments?

a. The people who perform condition assessments must go through a rigorous training class for familiaritywith GASBS No. 34 requirements.

b. GASBS prescribes measurement scales for condition assessments that must be numerical, ranging from1 to 100, with 1 indicating a failed or useless asset and 100 indicating a new asset.

c. The measurement methods should be understandable and complete enough that different measurerswould get substantively similar results with the same methods.

d. Condition assessments must be performed by trained observers who use forms or attribute analysisprescribed by GASBS No. 34.

38. How often must complete condition assessments of eligible infrastructure assets be performed for thegovernment to have adequately documented preservation at a condition level?

a. Every year.

b. Every three years.

c. Every five years.

d. Every ten years.

39. Is it possible for a government to continue using the modified approach if it has a substandard conditionassessment?

a. Yes.

b. No.




384

40. What type of costs are expensed on the government�wide statement of activities when the modified approachis used?

a. Maintenance costs only.

b. Maintenance and preservation costs.

c. Preservation, addition, and improvement costs.

d. Maintenance, preservation, and retirement costs.

41. In which scenario below would the government be required to change from the modified approach to thedepreciation approach?

a. Government A failed to perform a replicable and complete condition assessment in the last three years.

b. Government B's most recent condition assessment indicates infrastructure assets do not meet thegovernment's condition level.

c. Government C failed to meet estimated maintenance needs to maintain and preserve infrastructure assets.

d. Government D correctly documented a replicable and complete condition assessment every three years.

42. Which of the following note disclosures, required by GASBS No 34, would be found in the summary ofsignificant accounting policies?

a. A description of the method used to depreciate capital assets, if the government elects to use thedepreciation approach for infrastructure asset reporting.

b. A description of all infrastructure assets that are being reported, and a description of those that are notbeing reported.

c. A description of the modified approach, if a government elects to use the modified approach forinfrastructure asset reporting.

d. Required supplementary information (RSI) including schedules, disclosures to accompany the schedules,and disclosures in MD&A.

43. If a government uses the modified approach for reporting all major general infrastructure assets, it shoulddisclose all of the following in its RSI, except:

a. The basis for condition measurement.

b. The measurement scale used for condition assessment.

c. The government's condition level for preserving assets.

d. A description of assets reported using the modified approach.


385

44. When would a government be required to report an impairment loss on a capital asset?

a. When either the magnitude or the unexpected nature test is met.

b. When both the magnitude and the unexpected nature tests are met.



45. A government receives insurance recoveries in the same fiscal year as the loss occurred. How should this bereported in its government�wide financial statements?

a. Netted against the related loss.

b. Reported as a program revenue, special item, or extraordinary gain.

c. As an �other financing source."

d. Based on the requirements of GASB Statement No. 10.


386


387

GLOSSARY

Asset management system: Tools used to gather objective information that is used by a government's manage�ment (particularly engineers and those who approve their budgets) to make decisions about how a government'sresources should be used. Asset management systems generally use computer technology to inventory infrastruc�ture assets and to assess the age, condition, and maintenance needed for those assets.

Business�like activities: Activities financed in whole or in part by fees charged to those external parties who use thegoods or services.

Capital assets: Tangible or intangible assets that are used in operations and that have initial useful lives extendingbeyond a single reporting period.

Capitalization: To capitalize a cost is to record it as an asset and defer its recognition as an expense to future periods.

Capital lease: A capital lease is a lease that meets one or more of the following criteria for capitalization. For both thelessee and the lessor (1) the lease transfers ownership of the property to the lessee by the end of the lease term, (2)the lease contains a bargain purchase option, (3) the lease term is equal to 75% or more of the estimated economiclife of the lease property, and (4) the present value at the beginning of the lease term of the minimum lease paymentsequals or exceeds 90% of the excess of the fair market value of the leased property at that time.

Capital projects fund: GASB Cod. sec. 1300.106 states that financial resources used to acquire or construct majorcapital facilities (other than those financed by proprietary or fiduciary funds) should be reported in a capital projectsfund. Capital projects funds should also be used to report capital outlays financed from general obligation debt pro�ceeds.

Condition assessment: Condition assessments are generally performed by trained observers using prescribedforms or analysis techniques. However, with advanced technology, some systems are now able to directly inputmachine measurements (such as road roughness measurements) into the computer. Regardless of the method ofperforming condition assessments, the condition assessments should be documented in such a manner that theycan be replicated. Condition assessment measurements for eligible infrastructure assets should be summarizedusing a measurement scale.

Condition level: A government using the modified approach must document that its eligible infrastructure assets arebeing preserved approximately at (or above) a condition level established and disclosed by the government. Thecondition of infrastructure assets is assessed using condition measures, which are summarized using measurementscales.

Deflated current replacement cost approach: A method for estimating the historical cost of general infrastructureassets by calculating the current replacement cost of a similar asset and deflating this cost through the use of price�level indexes to the acquisition year (or estimated acquisition year if the actual year is unknown).

Depreciation: In the general financial accounting sense, depreciation is a process of systematic, rational allocationof the cost of capital assets used in operations to the accounting periods benefited. It is not a process of valuation. Itdoes not represent a reserve to replace the assetit does not mean that cash will be available to replace the asset.Depreciation attempts to match the cost of the asset to the benefits provided over the life of the asset. It representsaccrual accounting and has no effect on cash flows (is a noncash expense); depreciation expense must be addedback to accounting income when reconciling to cash provided by or used in operations.

Depreciation approach: The depreciation approach requires governments to allocate the cost of infrastructureassets over their useful lives as depreciation expense. Calculating depreciation expense involves assigning a usefullife to an infrastructure asset (the amount of time that the government expects to be able to use the asset) and charg�ing a portion of its historical cost (less salvage or residual value) to each year of that estimated useful life.


388

General infrastructure assets: Infrastructure assets associated with and generally arising from governmental fundsand activities.

Government Accounting Standards Board (GASB): The body authorized to promulgate standards of financialaccounting and reporting for state and local governmental units. It was created by the Financial Accounting Founda�tion (FAF) in 1984 as successor to the National Council on Governmental Accounting (NCGA) and is recognized bythe Code of Professional Conduct as an authorized body whose pronouncements must be followed in order to con�form to Rules 202 and 203. The GASB's authority derives from Appendix A of the Code of Professional Conduct.

Governmental activities: Activities that are generally financed through taxes, intergovernmental revenues, andother nonexchange revenues.

Governmental fund reporting: This type of reporting measures only current financial resources (the current finan�cial resources measurement focus).

Historical cost: The amount of resources the government spends to purchase or construct a capital asset, as well asthe fair value of any donated components. Historical cost should include ancillary charges necessary to place theasset into its intended location and condition for use.

Impairment: Once a capital asset has been identified as being potentially impaired, GASBS No. 42, paragraph 11,requires governments to apply two impairment testsboth of which must be metbefore an impairment loss isrequired to be reported. The two impairment tests are a magnitude test and an unexpected nature test.

Infrastructure assets: A subset of capital assets that generally should be reported in the same manner as other capi�tal assets. Infrastructure assets are distinguished from other capital assets because they normally (1) can be main�tained in a condition that will allow them to be used longer than most other capital assets and (2) are stationary innature.

Intangible assets: A subset of capital assets that lack physical substance, are nonfinancial in nature, and have esti�mated useful lives extending beyond a single reporting period.

Internally generated assets: An intangible asset is internally generated if the asset is either (1) created or producedby the government's personnel or by a third party contractor on behalf of the government, or (2) acquired from a thirdparty but the government must make more than a minimal effort to modify the asset so that it achieves its expectedlevel of service capacity.

Modified approach: GASBS No. 34 allows governments to use the modified approach for infrastructure asset report�ing instead of the depreciation approach if eligible infrastructure assets meet the three criteria of record keeping,condition assessments, and established condition levels. Eligible infrastructure assets are those that are part of anetwork or subsystem of a network.

Network of assets: All assets that provide a particular type of service for a government. A network of infrastructureassets may be only one infrastructure asset that is composed of many components.

Proprietary and fiduciary fund reporting: This type of reporting generally measures both financial and capitalresources (the economic resources measurement focus).

Required supplementary information (RSI): The GASB believes that it is important to provide readers of financialstatements with additional information to help them assess whether a government's infrastructure assets are beingmaintained and preserved. As a result, GASBS No. 34 requires expanded RSI disclosure for governments choosingthe modified approach. The RSI includes (1) schedules, (2) disclosures to accompany the schedules, and (3) disclo�sures in MD&A.


389

Salvage value: Salvage or residual value is the government's estimate of what a capital asset may be sold for when itis no longer used in operations. When there is a salvage value, it is deducted from the historical cost of an asset beforecalculating depreciation expense.

Subsystem of assets: All assets that make up a similar portion or segment of a network of assets.


390


391

INDEX

C

CAPITAL ASSETS� Capital assets, definition and ownership of

�� Infrastructure 260. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Infrastructure versus general infrastructure assets 260. . . . . . �� Ownership of governmental capital assets,

determining 260. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Capitalized leases

�� Definition and ownership of 259. . . . . . . . . . . . . . . . . . . . . . . . . � Estimating useful lives and depreciation expense 282. . . . . . . . . .

�� Changes in estimated asset lives 285. . . . . . . . . . . . . . . . . . . . �� Depreciation methods 284. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Determining estimated useful lives 282. . . . . . . . . . . . . . . . . . . �� Salvage value 284. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

� Introduction and overview�� Capital assets in government�wide financial

statements, reporting 259. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Disclosures 259. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� GASBS No. 34governmental financial reporting

model 258. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Intangible assets, infrastructure assets, and works

of art and historical collections 259. . . . . . . . . . . . . . . . . . . . . . . �� Reporting capital assets in proprietary and

fiduciary funds 259. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Reporting general capital assets activity in

governmental funds 258. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Two types of capital assets 258. . . . . . . . . . . . . . . . . . . . . . . . . .

� Reporting in governmental funds 290. . . . . . . . . . . . . . . . . . . . . . . . �� Assets acquired with debt 291. . . . . . . . . . . . . . . . . . . . . . . . . . . �� Asset transfers from proprietary funds 294. . . . . . . . . . . . . . . . �� Bargain purchases 292. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Capital lease disclosures 293. . . . . . . . . . . . . . . . . . . . . . . . . . . �� Capital leases 292. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Capital projects fund balance 295. . . . . . . . . . . . . . . . . . . . . . . . �� Constructed general capital assets 294. . . . . . . . . . . . . . . . . . . �� Donated assets 294. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Elimination of general fixed assets account

group (GFAAG) 290. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Impairments and insurance recoveries 296. . . . . . . . . . . . . . . . �� Purchases of general capital assets 290. . . . . . . . . . . . . . . . . . �� Reporting construction in progress 294. . . . . . . . . . . . . . . . . . . �� Sales and other dispositions of general capital

assets 295. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Trade�ins 290. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Transfers of general capital assets to proprietary

funds 296. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Use of capital projects funds 295. . . . . . . . . . . . . . . . . . . . . . . .

� Reporting in government�wide financial statements 321. . . . . . . . �� Capital assets of business�type activities 321. . . . . . . . . . . . . . �� Capital assets of governmental activities 322. . . . . . . . . . . . . . �� Internal service fund assets 322. . . . . . . . . . . . . . . . . . . . . . . . . �� Internal service fund capital assets 322. . . . . . . . . . . . . . . . . . . �� Special reporting situations 322. . . . . . . . . . . . . . . . . . . . . . . . .

� Reporting in Proprietary and Fiduciary Funds 297. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Bargain purchases 297. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Capital contributions 298. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Capitalization and valuation 297. . . . . . . . . . . . . . . . . . . . . . . . . �� Depreciation expense 297. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Dispositions and trade�ins of proprietary and

fiduciary fund capital assets 298. . . . . . . . . . . . . . . . . . . . . . . . . �� Impairments and insurance recoveries 298. . . . . . . . . . . . . . . . �� Interest capitalization 297. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Transfers 299. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

� Reporting works of art and historical treasures 286. . . . . . . . . . . . � Valuation of capital assets

�� Acquisition by capital lease 267. . . . . . . . . . . . . . . . . . . . . . . . . �� Capital asset inventories 271. . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Capital assets acquired with grants, contributions,

and other nonexchange transactions 268. . . . . . . . . . . . . . . . . �� Capitalization thresholds 270. . . . . . . . . . . . . . . . . . . . . . . . . . . .

�� Capitalized interest cost 267. . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Donated capital assets 268. . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Eminent domain 269. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Estimated historical cost 268. . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Foreclosures 269. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� GFOA recommended practices 271. . . . . . . . . . . . . . . . . . . . . . �� Historical cost 267. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Impairments of capital assets 270. . . . . . . . . . . . . . . . . . . . . . . . �� Used for environmental purposes 268. . . . . . . . . . . . . . . . . . . .

� Valuation of capital assets other than intangibles 267. . . . . . . . . .

CAPITALIZED INTEREST� Authoritative literature 306. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

�� Application to assets acquired with grant funds 306. . . . . . . . �� Application to internal service funds 306. . . . . . . . . . . . . . . . . .

� FASBS No. 34 standards for capitalized interest 306. . . . . . . . . . . �� Capitalization period 307. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Financial statement presentation and disclosure 308. . . . . . . �� Interest capitalization rate and method 307. . . . . . . . . . . . . . . .

� FASBS No. 62 standards for capitalized interest arising from tax�exempt debt�� Capitalization method and period 308. . . . . . . . . . . . . . . . . . . . �� Negative net capitalized interest and effect of

arbitrage rebate 310. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

I

IMPAIRMENT OF CAPITAL ASSETS AND INSURANCERECOVERIES

� Authoritative Literature, GASBS No. 42 372. . . . . . . . . . . . . . . . . . . � Definitions of terms 372. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � GASB illustrations 377. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Identifying potential impairments 372. . . . . . . . . . . . . . . . . . . . . . . . � Impairment tests 373. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Insurance recoveries 377. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Measuring impairment 373. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Reporting impairment losses 376. . . . . . . . . . . . . . . . . . . . . . . . . . .

�� Governmental funds 376. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Proprietary fund and government�wide financial

statements 376. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Subsequent measurements 376. . . . . . . . . . . . . . . . . . . . . . . . .

INFRASTRUCTURE ASSETS� Amount to capitalizeprospective reporting 337. . . . . . . . . . . . . . � Amount to capitalizeretroactive reporting 331. . . . . . . . . . . . . . .

�� Accumulated depreciation 335. . . . . . . . . . . . . . . . . . . . . . . . . . �� Acquisition year 332. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Current replacement costs 331. . . . . . . . . . . . . . . . . . . . . . . . . . �� Price�level indexes 334. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

� Major general infrastructure assets�� Determining major general infrastructure assets 327. . . . . . . �� Determining preliminary cost estimates for the

threshold test 328. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Networks and subsystems 327. . . . . . . . . . . . . . . . . . . . . . . . . . �� Threshold test for determining major general

infrastructure assets 328. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Total cost of all general capital assets 330. . . . . . . . . . . . . . . .

� Note disclosure requirements 364. . . . . . . . . . . . . . . . . . . . . . . . . . . �� General capital asset disclosures 364. . . . . . . . . . . . . . . . . . . . �� Summary of significant accounting policies 364. . . . . . . . . . . . �� Transition disclosure requirements 364. . . . . . . . . . . . . . . . . . .

� Note disclosures and required supplementary information for infrastructure 364. . . . . . . . . . . . . . . . . . . . . . . . . . . .

� Reporting infrastructuredepreciation and modifiedapproaches�� Additional disclosure requirements for

infrastructure 358. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Annual estimates 352. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Asset management systems 349. . . . . . . . . . . . . . . . . . . . . . . . . �� Changing from the depreciation approach to the

modified approach 348. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Changing from the modified approach to the

depreciation approach 358. . . . . . . . . . . . . . . . . . . . . . . . . . . . .


392

�� Condition assessments 351. . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Consistent assessments 353. . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Depreciation approach 346. . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Documenting preservation at a condition level 352. . . . . . . . . �� Established condition level 353. . . . . . . . . . . . . . . . . . . . . . . . . . �� General reporting requirements 345. . . . . . . . . . . . . . . . . . . . . . �� Government�wide statement of activities 355. . . . . . . . . . . . . . �� Government�wide statement of net assets 355. . . . . . . . . . . . . �� Journal entriesdepreciation approach 346. . . . . . . . . . . . . . �� Journal entriesmodified approach 356. . . . . . . . . . . . . . . . . . �� Maximum three�year testing cycles 353. . . . . . . . . . . . . . . . . . . �� Minimum features of asset management systems 350. . . . . . �� Modified approach 349. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Reasonable assurance 354. . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Reporting infrastructure assets at transition using

the modified approach 355. . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Reporting requirementscomparing the modified

approach to the depreciation approach 355. . . . . . . . . . . . . . . �� Three complete assessments 354. . . . . . . . . . . . . . . . . . . . . . . . �� Up�to�date inventory 351. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

� RSI requirements 365. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Illustrative RSI schedules and disclosures 369. . . . . . . . . . . . . �� RSI disclosures 369. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

�� RSI schedules 365. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Transition to GASBS No. 34 general infrastructure asset

requirements 323. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Auditor assistance with general infrastructure 324. . . . . . . . . . �� Definitions 323. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . �� Effective date for component units 326. . . . . . . . . . . . . . . . . . . �� Effective dates and transition provisionsoverview 324. . . . . �� Infrastructure versus general infrastructure assets 324. . . . . . �� Retroactive reporting and debt�financed general

infrastructure assets 326. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

V

VALUATION OF INTANGIBLE ASSETS 272. . . . . . . . . . . . . . . . . . . . � Classification 273. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Defining intangible assets 272. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Effective date and GASBS No. 34 276. . . . . . . . . . . . . . . . . . . . . . . � Impairment 274. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Internally generated intangible assets 274. . . . . . . . . . . . . . . . . . . . � Recognitiongovernmental funds 274. . . . . . . . . . . . . . . . . . . . . . � Recognitiongovernment�wide and proprietary fund

financial statements 273. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . � Scope of standard 272. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


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Companion to PPC's Guide to Preparing Governmental Financial Statements UnderGASBS No. 34Course 2Budgetary Reporting, Other RSI, MD&A, and CAFR

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