Questions. About the Government Reporting Entity

Transcription

1 Public Sector Accounting Board 20 Questions About the Government Reporting Entity THE CANADIAN INSTITUTE OF CHARTERED ACCOUNTANTS

2 Public Sector Accounting Board 20 Questions About The Government Reporting Entity THE CANADIAN INSTITUTE OF CHARTERED ACCOUNTANTS

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4 Foreword This publication answers some basic questions about a government s financial reporting entity what it is, why it s important and how its financial statements are put together. Who Should Read this Publication? Elected officials of Canada s federal, provincial, territorial and local governments, the media, taxpayers and other interested individuals will find this guide useful for: Understanding the need for, and the benefits of, a government s consolidated financial statements. Determining why certain organizations are included in, or excluded from, a government s summary financial statements. Furthering the understanding of control and what it means for governments. Gaining insights into how a government accounts for its individual organizations. Assessing the extent of the financial affairs and resources entrusted to a government. Asking appropriate questions about what is and should be included in the scope of a government s financial statements. Why should you read this guide? A government s financial statements are designed to communicate information useful for assessing its financial position, results of operations and cash flows at a particular point in time. To permit that assessment, it is important that its financial statements describe the full nature and extent of all of its financial activities and resources. The individual financial statements of each organization under a government s control can provide only a fragmented view of its overall financial position and results. Understanding what makes up a government s financial reporting entity is important because it establishes the criteria for determining which organizations are part of a particular government and how those organizations are accounted for in that government s financial statements. This aspect of government financial statements helps users understand the size of government and provides the necessary accountability reporting that users expect. What is a reporting entity? A reporting entity is any unit or activity that uses resources to provide goods or services. A unit or activity encompasses legal, administrative, economic, accounting and other entities. For the purposes of external financial reporting, a reporting entity is an organization that is obliged to prepare general purpose financial reports. This obligation arises when users of financial information depend on those reports for the information they need to make financial decisions but are unable to ask for specific information from the reporting organization directly. It is generally the existence of these dependent users that determines whether an organization is a reporting entity. A non-reporting entity, on the other hand, could be a small company whose owners are also the managers and does not have to prepare general purpose financial statements. Who sets the standards? The Public Sector Accounting Board (PSAB) of the Canadian Institute of Chartered Accountants (CICA) sets generally accepted accounting principles (GAAP) for the public sector in Canada. One of the fundamental building blocks of GAAP for governments is a standard that defines what a government reporting entity is and how organizations within that government-as-whole entity should be accounted for. That standard is found in the Public Sector Accounting (PSA) Handbook Section PS 1300, GOVERNMENT REPORTING ENTITY.

5 Contents Questions See Page 1 Why do we need consolidated financial statements? 5 2 Why is defining the reporting entity important? 6 3 How do you decide which organizations are part of government? 7 4 What is control? 8 5 Are there different types of control? 10 6 How do you know whether government control exists? 11 7 What are the main indicators of government control? 12 8 What are other indicators of government control? 13 9 How is control assessed considering the definition and indicators? What is temporary control? What is not control? If an organization is restricted, can it be controlled? How important is the legal form of the relationship between a government and an organization? What types of government organizations are there? How should controlled organizations be accounted for in government financial statements? Why are government business enterprises treated differently? What impact does the revised standard have on the budget process? When does the standard apply? What types of organizations are likely to be accounted for using the transitional provisions? Did the revised definition of the government reporting entity change the government reporting entity in every jurisdiction? 30

6 1 Why do we need consolidated financial statements? How a government chooses to deliver its services should not significantly alter the financial information it reports. It is a fact that governments differ in the way they choose to provide some programs even though the actual programs are essentially similar in nature. For example, one government may choose to manage a licensing function through a department while another may choose to establish a separate board for that purpose. Although many government organizations prepare their own financial statements, individually those statements can provide only a fragmented view of the overall activities of their host government. Without summary financial statements, it is impossible to get a complete picture of the government s overall activity, whether for decisionmaking purposes or for demonstrating accountability for the resources provided by, and managed on behalf of, the resource providers. One cannot determine if these individual organizations are actually part of that government. If an organization that should be part of government is accounted for outside a government s reporting boundaries: The revenues and expenses of that activity will not be reported in the government s financial statements, therefore understating the total revenue-raising and costs of government programs. Assets and liabilities attributable to the excluded organization will not appear in the government s financial statements, thereby understating the assets and liabilities. Advances between the organization and the government will be treated as assets and liabilities by both, thereby overstating these amounts. Yet, in reality, the government is merely lending money to one of its component parts and will end up repaying itself. Similarly, if a person transfers money from one of his pockets to another, he is not better or worse off. A government s summary financial statements provide an accounting of the full nature and extent of its financial affairs and resources, including those of its agencies and enterprises. Summary financial statements are a key element of government financial reporting because governments use them to report on how they managed their financial affairs and resources at an overview level. Summary financial statements recognize that, even though a government and its organizations may be separate legal or organizational entities, together they make up a single economic unit. Consolidation ensures that the financial statements reflect only transactions and balances with third parties. Providing consolidated information helps users gain an overall understanding of a government s assets and liabilities, revenues and expenses and cash flows. What you need to know: What are the total assets and liabilities for which the government is responsible? What are the government s total revenues and expenses? What were the government s total cash requirements and how did it meet those requirements?

7 2 Why is defining the reporting entity important? For the purposes of financial reporting, the phrase reporting entity describes which departments, funds, agencies, boards, commissions, Crown corporations and not-for-profit organizations assets, liabilities, revenues, expenses and cash flows are part of a government s summary financial statements and which are not. In broad terms, governments are seen to be responsible for many things that would not ordinarily be included in their financial statements. For example, although a government may be responsible for the provision of healthcare, this does not mean that it is responsible for the assets and liabilities of a particular private sector healthcare provider. The issue of what should be included when a government prepares its summary financial statements is critical because choosing to include or exclude certain organizations can have an enormous impact on the financial statements and the picture they provide about government finances. No issue has a greater impact on a government s financial reporting than establishing the boundaries of its financial statements. Think of the Enron scandal and you will understand how important it is to have clear criteria for what organizations should be included in a government s financial statements. Summary financial statements are supposed to tell users what the financial position and results are for the government as a whole. And so the rules for deciding what is part of government what a government is responsible for and what it is not need to be clear. As a starting point for understanding the reporting entity issue in the public sector, consider whether the federal, provincial, territorial and local governments are one consolidated reporting entity or separate reporting entities. Answering this question paints a rather different picture of government finances. The government reporting entity standard helps to draw a circle around the activities a government should report in its summary financial statements. The standard looks at the substance of the relationship between a government and the various organizations it uses to carry out its policies and deliver services to determine what organizations should be included in the financial statements. Having clear boundaries for including or excluding organizations helps users understand and assess the magnitude of the public financial affairs and resources entrusted to governments. It also helps elected officials understand the extent of the financial affairs and resources for which they are responsible. Some public sector organizations are clearly part of government. Others clearly are not. And the status of some public sector organizations is less obvious. PSAB s reporting entity standard provides criteria to help governments know which organizations should be reported as part of their financial statements. What you need to know: Does the audit opinion contain any reservations regarding organizations that should be included or excluded from the government s financial statements? If so, what effect would including (or excluding) these organizations have on financial position and results? Do the notes to the financial statements include a listing of the major organizations that make up the government s reporting entity?

8 3 How do you decide which organizations are part of government? A government reporting entity comprises all organizations controlled by that government. The challenge is to understand what control means in the public sector because that is a major part of what governments do control. PSAB decided that a principles-based approach to determining what organizations should be included in a reporting entity was best because of the wide variety of organizations out there and their different relationships with government. It was not possible to provide a list of organizations that would be included because each government is different and ever changing. This approach recognizes that, in different jurisdictions, organizations may be treated in different ways depending on whether or not they are controlled by a government. So, for example, in some provinces, hospitals may be part of a government reporting entity if it is determined that they are controlled by that government. In other provinces, hospitals may not be part of the government reporting entity because it does not control them. Organizations are included as part of a government reporting entity because they are controlled, not because they are a particular type of organization. Section PS 1300, therefore, relies on an evaluation of the substance of the relationship between a government and an organization rather than on the organization s legal form. While some organizations may have a certain legal form, it is important not to allow this form to cloud the determination of whether an organization is included or excluded from the reporting entity. If, in substance, a government controls an organization (as defined in the standard), then regardless of the legal form of the relationship, that organization should be included in the government s financial statements. An organization is outside the government reporting entity if the government cannot exercise control over it. A determination of whether an organization is included or excluded from a government reporting entity is based on legislation existing at the reporting date. The fact that a government can introduce new legislation or change existing legislation and, thus, change the nature of its relationship with an organization in the future, doesn t affect whether that organization is included as part of the government at the reporting date. Given the government s ability to influence, without this requirement, virtually every economic unit could be included in a government s reporting entity. Also, without this requirement, it might be necessary to make judgments in some jurisdictions about a government s ability to change legislation. Such judgments might depend on whether a majority or minority government existed. In local jurisdictions, where elected officials are non-partisan, the ability to make legal changes may be even more uncertain. Therefore, it was concluded that Section PS 1300 should be based on the legislative framework existing at the reporting date. What you need to know: Was control used as the criteria for determining which organizations comprise the reporting entity? Have any organizations come into or gone out of the reporting entity in the current period? Are there instances where legislation has made changes affecting the reporting entity?

9 4 What is control? The standard defines control as: the power to govern the financial and operating policies of another organization with expected benefits or the risk of loss to the government from the other organization s activities. It helps to think of the concept of control using a continuum (see Figure 1). Governments achieve their objectives through a wide range of organizations which, individually in their relationship with a particular government, fall somewhere along a continuum. At one end of the continuum are Figure 1 Government Organization CONTINUUM OF INFLUENCE organizations clearly within the boundaries of government, for example, a government department or a Crown corporation. These organizations do not have the power to act independently and are controlled by the government. At the other end, organizations do act independently and, while the government may have some influence on them, it will be clear that there is no control. An example might be an independently constituted for-profit organization that contracts with the government. The middle of the continuum contains many other organizations under varying levels of government influence. Private Organization Control exists Control does not exist but government may regulate or fund Along the continuum, the nature of the relationship between a government and an organization needs to be considered to determine whether the government does, in fact, control the organization. In theory, there is a point on the continuum at which control exists. In reality it is likely not a set point, but rather a grey area where control will be difficult to determine. Professional judgment will be necessary to evaluate the status of each organization. The goal of the standard is to provide guidance that narrows down the grey area and helps determine whether an organization within this grey area is controlled by a government. Care needs to be taken when assessing control as there is a difference between control, regulation and financial dependence.

10 Having the power to govern There are three main elements to this definition of control. The first is that having control does not depend on actually having to exercise that control. Even if a government never exercises control, the fact that it has the power to do so is sufficient. An organization that has been delegated a financial and operational authority must operate within the parameters established by the government and, as long as the organization is doing what it is supposed to, there is no need for government intervention. If it doesn t, however, the government has the power to re-direct the operations of that organization. The financial and operating policies The second element of the definition of control relates to governing an organization s financial and operating policies. Financial and operating policies are principles and practices that determine how an organization carries out its activities or conducts its business. The ability to govern these policies is an important element of government control because, together, these policies establish the fundamental basis for how the organization operates and achieves its mission and mandate. The financial and operating policies may be governed in different ways: A government may establish an organization s fundamental purpose and, by predetermining its financial and operating policies, eliminate or significantly limit the ability of that organization to make future decisions. A government may direct the organization s financial and operating policies on an ongoing basis. A government may veto, overrule or modify the organization s financial and operating policies. A government does not need to manage an organization s activities on a day-to-day basis to control it. It is the government s authority to determine the policies governing those activities that is important. Government expects to benefit The final element necessary to establish control is that a government must expect to benefit (or be exposed to the risk of loss) from the controlled organization s activities. Benefits may be financial or non-financial. For example, the government might require the organization to cooperate in pursuing the government s public policy objectives. Or a government may benefit financially by receiving dividends. A government may also be exposed to the risk of loss or be responsible for an organization s net liabilities. Such benefits or risks would have to flow directly from the control relationship and not just be incidental benefits or risks. And, they would have to accrue to the government itself rather than affecting the public at large. What you need to know: What factors were considered when determining whether a particular organization is controlled by a government? Does the government actively or passively exercise its control over that organization? What are the benefits or risks associated with this organization?

11 5 Are there different types of control? No. Control, from the perspective of Section PS 1300, is a fact. There are, however, different ways a government can control another organization. These different methods of control result in variations in the level of influence the government has. 10

12 6 How do you know whether government control exists? Having established that a government reporting entity should include all the organizations a government controls, the real work is in deciding which organizations the government actually controls. Such determinations can be difficult. The starting point in assessing control is the definition of control (see Question 4) and the related guidance set out in the PSA Handbook Section PS 1300, GOVERNMENT REPORTING ENTITY. Control is determined by looking at the particular circumstances of each organization. In applying the guidance, it is necessary to determine the substance of the relationship between a government and an organization. All relevant aspects and implications of the relationship would be considered in determining whether or not the government controls the organization. The standard sets out various indicators that provide evidence that control exists. Because of the complexity and diversity of relationships between a government and the many organizations under its purview, no one criterion provides sufficient evidence of control in all cases. In other words, there is no bright line or silver bullet test to indicate control exists. Rather, it is the preponderance of evidence that, taken in its totality, allows such a judgment to be made. The factors that provide evidence of control can be thought of as badges of control. Some badges are bigger than others and some provide better evidence of control, particularly when they exist together with certain other badges. Whether a government controls an organization is a matter of professional judgment based on the definition of control and the particular circumstances of each case. For each possible indicator, the degree of government influence involved would determine its importance as evidence of control. The degree of importance of each indicator depends on the particular circumstances in each case. As noted, each indicator might provide a badge of control that, together with other badges, would provide sufficient evidence to conclude that control exists. In some circumstances, it will be easy to determine the existence of control, for example, when an organization s relationship with a government lies on the extremes of the control continuum. In other cases, it will be more difficult and the degree of professional judgment required will be higher. For example, whether a government has the power to appoint a majority of an organization s governing body is generally a question of fact it either exists or it does not. Whether a government is in a position to govern an organization s financial and operating policies might be less clear. Although a government might directly determine some organizational policies, it is a matter of judgment to determine if this is evidence of control and the size of the badge it represents. 11

13 7 What are the main indicators of government control? 12 There are four persuasive indicators of control: 1. The government has the power to unilaterally appoint or remove a majority of the members of the organization s governing body. If the government can appoint a majority of the board members, this would be an indicator of control. Similarly, the government s ability to remove board members could be an indicator of control. 2. The government has ongoing access to the assets of the organization, has the ability to direct the ongoing use of those assets, or has ongoing responsibility for losses. If a government can access the organization s assets on an ongoing basis or is responsible for its liabilities, that can be an indicator of control. A government can access assets when it can force an organization to pay a dividend. A persuasive indicator of government control might exist if, on dissolution of the organization, the assets revert back to the government. Similarly, if on such dissolution, the government is on the hook for the liabilities, this responsibility could be an indicator of control. 3. The government holds the majority of the voting shares or a golden share that confers the power to govern the financial and operating policies of the organization. Government organizations don t often have voting shares. But, if they do, and the government owns a majority of them, this ownership would be a persuasive indicator of control. A golden share refers to a class of shares entitling the holder to specified powers or rights exceeding those normally associated with the holder s ownership interest in the organization or representation on its governing body. In other words, the golden share grants rights that are consistent with controlling the organization. 4. The government has the unilateral power to dissolve the organization and thereby access its assets and become responsible for its obligations. A government may create an organization and establish parameters around governance. The ability of the government to dissolve the organization is also a factor to consider. If a government can step in and dissolve an organization without consultation, this ability may be an indicator of control. While none of these indicators on its own is a silver bullet for control, each is persuasive evidence of control. If all of them were to exist together, for example, it would be hard to conclude that the government does not control the organization. What is important in assessing control is not the absolute number of indicators but, rather, applying the definition of control and examining the nature of the evidence that describes a government s relationship with an organization.

14 8 What are other indicators of government control? There may be other indicators of control as well. In determining whether a government controls an organization, it is necessary to evaluate these other indicators along with all other aspects of a government s relationship with an organization, including the four persuasive indicators of government control set out in Question 7. The other possible indicators of control are: 1. The government provides significant input into the appointment of members of the organization s governing body, by appointing a majority of those members from a list of nominees provided by others or by being involved in the appointment or removal of a significant number of members. While a government may not have the right to appoint the majority of board members, if it can appoint a significant number of members or is heavily involved in those appointments, this may be evidence of control. On its own, this ability is unlikely to be adequate evidence of control, but in conjunction with some of the other indicators, it may be an important factor to consider in the control assessment. 2. The government can appoint or remove the CEO or other key personnel. The ability of the government to hire or fire key personnel, such as the CEO, may provide evidence of control. 3. The government establishes or can amend an organization s mission or mandate. The key to this indicator is whether a government has established an organization s mission and/or mandate to carry out government objectives, including how this will be done. For example, a government may establish in legislation an organization s purpose and how it will carry out this purpose. The government may also establish limits to the organization s mandate. 4. The government approves the organization s business plans or budgets and requires amendments, either on a net or line-by-line basis. If a government approves an organization s budget or business-plan, this approval could be an indicator of control. The approval does not have to be on a line-by-line basis but could be on a net basis only. 5. The government establishes borrowing or investment limits or restricts the organization s investments. If the government establishes organizational borrowing limits or approvals, this may provide evidence of control. Similarly, the government might set investment limits. This factor alone is not adequate evidence but, in combination with other factors, could be an indicator of control. 6. The government restricts the revenue-generating capacity of the organization, notably the sources of revenue. A government may be in a position to control an organization s revenue source. In such cases, the government may be able to direct where revenues are to be earned or limit the organization s ability to earn revenues from certain areas. 13

15 7. The government establishes or can amend the policies an organization uses to manage, such as those governing accounting, personnel, compensation, collective bargaining or deployment of resources. This category relates to a government s ability to influence an organization s financial polices, accounting, personnel, collective bargaining and the deployment of resources. This potential indicator of control is intended to address a myriad of organizational management functions in which the government might be involved. 14 These indicators of control are individually less persuasive than the four described in Question 7. In combination with other indicators they may, however, provide evidence of control. Again, it is important to apply the definition of control and use the indicators as evidence in assessing whether or not control exists. All aspects of a government s relationship with an organization would be evaluated.

16 9 How is control assessed considering the definition and indicators? One way to evaluate the nature and extent of these indicators of control is to summarize them considering the persuasiveness of the indicators and the degree of judgment involved in evaluating and identifying them. For some factors, the degree of judgment required to determine if a control criterion exists could be low or high. For example, it will be fairly straightforward to determine if a government has the ability to appoint an organization s chief personnel. It may be more difficult, however, to determine if the government has the ability to establish the organization s mission and mandate. In addition, when assessing control, some factors will have a greater degree of importance or carry a higher weighting. For example, if a government can appoint a majority of the board or can access the organization s assets at will, then it is highly likely that control exists. These factors carry a higher degree of importance than others. The discussion below illustrates what type of evaluation might be done for a particular control criterion. The discussion is general and should not be considered a definitive judgment of how to evaluate a particular control criterion. A government would need to look at each of the individual relationships with its organizations and determine the appropriate weighting of the control criteria identified for each organization. The degree of importance of the control indicators depends on the circumstances. In some situations, a particular indicator may provide a higher degree of evidence of control, whereas in other situations, the same indicator may not be as important. It is fairly straightforward to determine if a government has the ability to appoint or remove the majority of the members governing an organization. It is normally a factual situation and so requires little judgment to determine if it exists. The government either has the ability to appoint the majority of members or it does not. Because this criterion is one of the four persuasive indicators of control, it is very important in evaluating whether control exists. If a government has this ability, it would be given significant weight when evaluating whether the government controls the organization. In contrast, it might be more difficult to determine if a government has the ability to establish an organization s mission and mandate. One example of the possible analysis is as follows: Having this ability is one of the less persuasive indicators of government control over an organization. In many cases, this ability would be classified as having moderate importance in determining if control exists. Evaluating whether this ability exists for a government may take a significant degree of judgment. You might conclude that when a government has the ability to establish the organization s mission and mandate, this ability should not be given significant weight in determining whether the government controls the organization. Each element of a government s relationship with an organization would be evaluated in the same way. The weighting of the indicators of government control identified for a particular organization will be unique to that government s relationship with that particular organization. Whatever method of evaluation is chosen, it is the preponderance of evidence that will determine whether a government controls an organization. For each applicable indicator, the degree of government influence would determine its importance as evidence of control. In weighing the evidence, it would be necessary to consider the indicators collectively as well as individually. 15

17 10 What is temporary control? 16 In looking at the indicators of control that relate to governance, one of the challenging tasks is delineating the differences between these governance abilities under normal circumstances versus a force majeur situation, where a specific event or crisis situation might require a government to step in or otherwise intervene to control an organization. This type of control is temporary and arises only when a specific, infrequent event occurs. A government s ability to take temporary control of an organization in exceptional circumstances (such as a crisis involving bankruptcy or a board failure) doesn t mean that the organization has to be included in the government reporting entity. Temporary control is short term in nature and the intention is to relinquish control as soon as the crisis has been addressed.

18 11 What is not control? The focus of the reporting entity standard is on defining control and providing guidance to help in assessing when control exists. But it s also important to distinguish what doesn t constitute control. Financially dependent controlled Many organizations, both inside and outside a government reporting entity, are financially dependent on a government. This dependence creates a relationship of influence, where the government may require the organization to be accountable for certain things, such as reporting compliance with funding agreements. Financial dependence on its own would not, however, allow a government to control an organization. The governing body of that organization can still make independent decisions on its financial and operating policies. As these policies might have significant financial impacts on the organization, retaining this ability to set policies is important. It means that the governing body has the ability to walk away from the government funding or shut things down if it wants to. A government may require an organization to submit reports to demonstrate compliance with certain funding terms and conditions. But these requirements aren t evidence of control because the government s interest in the organization extends only to the funding aspects of operations. For example, a private sector day care service that receives government funding may be required to demonstrate compliance with the associated terms and conditions. The governing body of the day care provider will, however, retain discretion as to whether it will take funding from, or do business with, the government. Many not-for-profit organizations rely on government funding but that does not mean they are controlled by government. Regulation control Governments often establish the regulatory environment for an industry or to protect the public interest. This role could include establishing regulations imposing conditions or sanctions on the operations of an organization or type of organization. Even in such scenarios, however, the governing bodies of the regulated organizations make independent decisions within that regulatory framework. A government may require the organization to submit reports to demonstrate compliance with the regulations, but these requirements are not evidence of control. The government s interest in these organizations extends only to the regulatory aspects of operations. For example, although a regulator might establish limits on rates for revenue purposes or set limits on borrowing, the regulator does not control the organization. Constitutional responsibility control Many of the responsibilities of Canadian governments, such as defense, health care and education, are set out in the Constitution. When a government has constitutional responsibility for health care, this does not mean that the government necessarily controls all entities delivering health care services. The government may choose to meet its constitutional responsibility by delivering those services directly through a controlled organization, such as a government department, or more indirectly through an independent contractor, which is not a controlled entity. What is relevant is not the nature of the services being provided and who is constitutionally responsible to see that they are delivered, but rather the nature of the relationship between the government and the organization providing the services. 17

19 12 If an organization is restricted, can it be controlled? 18 Some organizations are subject to restrictions or stipulations that limit their ability to do certain things. Arguments have been made that, if a government s ability to access an organization s assets is restricted, such an organization is outside government s control. This approach focuses on the risks and rewards of ownership. The definition of the government reporting entity hinges on control, not the risks and rewards of ownership. The fact that restrictions exist does not change the relationship between a government and an organization. In fact, restrictions don t relate to the right of government access but rather to the degree of access the government has to resources. The fact that an organization has to maintain certain resources which do not necessarily accrue directly to a government isn t a criterion for excluding that organization from the reporting entity though the fact that limits exist under legislation as to how such resources can be used is important information to users and should be disclosed. For example, RESTRICTED ASSETS AND REVENUES, PSA Handbook Section PS 3100, defines internally restricted entities as separate legal entities within the government reporting entity, created by the government s own legislation. This legislation establishes an accountability relationship with parties external to the government reporting entity to use the entity s assets or net assets as specified while that legislation is in effect. Governments do, in fact, control internally restricted entities. As long as a government operates within the defined limitations, it can fully access the resources of these entities and so control them. Although, under the standards set out in Section PS 3100, a government would be required to disclose any such restrictions, the entities involved are controlled and would be included in the government reporting entity. What you need to know: Do the notes to the financial statements include disclosures about restrictions related to internally restricted entities?

20 13 How important is the legal form of the relationship between a government and an organization? As already mentioned, in assessing control, you consider the substance of the relationship between a government and an organization. It s important to note that the true nature of such a relationship may not be reflected by its legal form. It isn t enough to assess control based on the legal form. All aspects and implications of the relationship need to be considered in determining whether or not control exists. You should not let the legal form cloud the assessment of whether an organization is controlled and, thus, should be included in a government reporting entity. The revised standard in GOVERNMENT REPORTING ENTITY, Section PS 1300, is principles-based. It specifies the characteristics of the organizations that should be included rather than specific types of organizations (e.g., hospitals). This approach means that, sometimes, professional judgment will be required to determine if an organization is controlled and therefore should be included in government financial statements. If, in substance, a government controls an organization (as defined in Section PS 1300), regardless of the legal form of their relationship, the organization should be included in the government s financial statements. An organization is outside of the government reporting entity when the government cannot exercise control over it. 19

21 14 What types of government organizations are there? Governments deliver public programs and services through a wide variety of departments, funds, agencies, boards, commissions, Crown corporations and not-for-profit organizations. Some programs and services are the direct responsibility of a government while, in other cases, this responsibility has been delegated to other organizations. Figure 2 Many of these organizations produce their own financial statements for reporting to the government on their financial affairs, resources and operations, as well as for providing financial information and accountability to external users. To have some consistency in government financial reporting, PSAB identified some broad classifications of government organizations. Government and its Organizations 20 Government Departments, Funds, Ministries Government Business Enterprises Government Business-Type Organizations Government Not-for-Profit Organizations Other Organizations The Introduction to the Public Sector Accounting (PSA) Handbook identifies the different types of government organizations and provides each with specific directions on which GAAP to use in preparing its financial statements. These directions are based on the premise that, for some organizations, something other than government GAAP is more appropriate to their objectives and operations. Some government organizations are directed to use the GAAP used by businesses while others are directed to use GAAP for notfor-profit organizations.

22 Some government organizations, such as government departments, are so integral to the business of government that their objectives and operations are substantially the same as government. These organizations would generally use government GAAP in preparing their financial statements. Other government organizations are structured and have objectives similar to those in the private sector. Government business enterprises (GBEs) A government business enterprise has all of the following characteristics: 1. It is a separate legal entity with the power to contract in its own name and can sue and be sued. 2. It has been delegated the financial and operational authority to carry on a business. 3. It sells goods and services to individuals and organizations outside of the government reporting entity as its principal activity. 4. It can, in the normal course of its operations, maintain its operations and meet its liabilities from revenues received from sources outside of the government reporting entity. GBEs are financially self-sustaining government organizations. They operate as businesses and get very little government funding. They make money (or at least break even) from business activities carried on outside of the government. An example of a GBE would be a provincial Liquor Control Board or a local government s hydro-electric utility. Government business-type organizations (GBTOs) A government business-type organization has the following characteristics: 1. It is a separate legal entity with the power to contract in its own name and can sue and be sued. 2. It has been delegated the financial and operational authority to carry on a business. 3. It sells goods and services to individuals and organizations as its principal activity. Government business-type organizations are different from GBEs because they usually sell goods and services within the government or they get significant government subsidies to help carry on operations. But GBTOs do conduct themselves like businesses and often compete in an open market. An example of a GBTO is the Canadian Broadcasting Corporation (CBC) or a property management Crown corporation such as British Columbia Building Corporation (BCBC). The Introduction to the PSA Handbook tells GBEs and GBTOs to use the GAAP for business set out in the CICA Handbook Accounting when they prepare their financial statements. 21

23 22 Government Not-for-Profit Organizations (GNFPOs) Not-for-profit organizations are defined in the private sector as: entities normally without transferable ownership interests, organized and operated exclusively for social, educational, professional, religious, health, charitable or any other notfor-profit purpose. A not-for-profit organization s members, contributors and other resource providers do not, in such capacity, receive any financial return directly from the organization. 1 A government not-for-profit organization meets the definition of a private sector not-for-profit organization and has counterparts outside the public sector. Key to the GNFPO definition is the requirement that the GNFPO be able to compare itself to similar organizations in the private sector. An example of a GNFPO would be a government museum or a public hospital. The Introduction to the PSA Handbook tells GNFPOs to use GAAP for not-for-profit organizations, set out in the CICA Handbook Accounting, when they prepare their financial statements. Other government organizations Although most government organizations will fall into one of these categories, some won t fit quite as easily. These other organizations would typically not have a set of identifiable characteristics but, rather, would be fairly unique and less homogeneous across jurisdictions. Not many government organizations would be classified as other. Some government organizations are clearly not GBEs, GBTOs or GNFPOs, nor such an integral part of government that government GAAP is appropriate for their financial statements. These organizations must evaluate the nature of their primary objectives and operations and choose the GAAP that is most appropriate to their circumstances and then apply it consistently. When preparing their financial statements, many government organizations may apply GAAP that is different from the government GAAP used to prepare the summary whole of government financial statements. When those government organizations are added together to make up the summary financial statements, the government makes sure that everything is converted to government GAAP (see What is consolidation?, Question 15, conforming the accounting policies ). 1 FINANCIAL STATEMENT PRESENTATION BY NOT-FOR-PROFIT ORGANIZATIONS, CICA Handbook Accounting, paragraph

24 15 How should controlled organizations be accounted for in government financial statements? GOVERNMENT REPORTING ENTITY, Section PS 1300, says that government financial statements should consolidate the financial statements of all controlled organizations except government business enterprises (GBEs). GBEs are to be included in government financial statements using the modified equity method. What is consolidation? Consolidation combines the individual financial statements of the organizations that make up a reporting entity to present it as a single economic unit. The financial statement items of controlled organizations are aggregated line-by-line, adding together all of the corresponding assets, liabilities, revenues and expenses. Where needed, the financial statements of the organizations being consolidated would be adjusted so that they are based on the same accounting policies and standards (as set out in the PSA Handbook) as the government s financial statements. This is called conforming the accounting policies of the controlled organizations to those of the government. Once these adjustments are made, any inter-organizational balances and transactions would be eliminated so that only the transactions and balances with parties outside of the government remain. Then, the assets, liabilities, revenues and expenses are added together on a line-by-line basis and the aggregate amount for each financial statement item is reflected in the government s summary financial statements. What is modified equity accounting? The equity method of accounting produces the same net results as consolidation. It, however, reports an organization s net equity and income as one line on the statement of financial position and statement of annual results, respectively, instead of adding the organization s corresponding financial statement items to those of the rest of government on a line-by-line basis. In a pure equity method of accounting, the organization s accounting principles are changed to be consistent with those of the government (i.e., to government GAAP as set out in the PSA Handbook). GBEs, however, are included in government summary financial statements on a modified equity basis. The equity method is modified only to the extent that the GBE s accounting principles are not adjusted to conform to those of the government. GBEs use business GAAP as set out in the CICA Handbook Accounting. The net assets of the GBE are reflected as an investment (a financial asset) on the government s consolidated statement of financial position, while the GBE s net income is presented as a separate item on the government s statement of results. What you should look for: Do the notes to the financial statements include: An accounting policy note explaining consolidation and which organizations are consolidated in government financial statements? An accounting policy note explaining modified equity and which organizations are included in government financial statements on a modified equity basis? An accounting policy note explaining that some government organizations are excluded from consolidation or inclusion on a modified equity basis? An accounting policy note explaining that some government organizations have been included in the financial statements on a basis other than consolidation or modified equity? 23