NO. 063 SEPTEMBER 1989 Governmental Accounting Standards Series

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1 NO. 063 SEPTEMBER 1989 Governmental Accounting Standards Series Statement No. 9 of the Governmental Accounting Standards Board Reporting Cash Flows of Proprietary and Nonexpendable Trust Funds and Governmental Entities That Use Proprietary Fund Accounting Governmental Accounting Standards Board of the Financial Accounting Foundation

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3 Summary This Statement establishes standards for cash flow reporting. It requires a statement of cash flows (instead of a statement of changes in financial position) as part of a full set of financial statements for all proprietary and nonexpendable trust funds and governmental entities that use proprietary fund accounting. It exempts public employee retirement systems and pension trust funds from the requirement to present either a statement of cash flows or a statement of changes in financial position. This Statement requires that a statement of cash flows classify cash receipts and payments according to whether they stem from operating, noncapital financing, capital and related financing, or investing activities, and it provides definitions of each category. Governmental enterprises are encouraged to report cash flows from operating activities directly by showing major classes of operating cash receipts and payments (the direct method), although the indirect or reconciliation method may be used. If the direct method is used, a reconciliation of operating income to net cash flow from operating activities is required to be provided. Information about investing, capital, and financing activities not resulting in cash receipts or payments in the period is required to be provided separately. This Statement is effective for annual financial statements for fiscal years beginning after December 15, Restatement of financial statements for earlier years provided for comparative purposes is encouraged but not required. Unless otherwise specified, pronouncements of the GASB apply to financial reports of all state and local governmental entities, including public benefit corporations and authorities, public employee retirement systems, and governmental utilities, hospitals, colleges, and universities. Paragraph 5 discusses the applicability of this Statement. i

4 Statement No. 9 of the Governmental Accounting Standards Board Reporting Cash Flows of Proprietary and Nonexpendable Trust Funds and Governmental Entities That Use Proprietary Fund Accounting September 1989 Governmental Accounting Standards Board of the Financial Accounting Foundation 401 Merritt 7, PO Box 5116, Norwalk, Connecticut ii

5 Copyright 1989 by Financial Accounting Foundation. All rights reserved. Content copyrighted by Financial Accounting Foundation may not be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the Financial Accounting Foundation. iii

6 Statement No. 9 of the Governmental Accounting Standards Board Reporting Cash Flows of Proprietary and Nonexpendable Trust Funds and Governmental Entities That Use Proprietary Fund Accounting September 1989 CONTENTS Paragraph Numbers Introduction and Background Information Scope of This Statement...1 Background Standards of Governmental Accounting and Financial Reporting Applicability of This Statement...5 Financial Reporting of Cash Flows...6 Purpose of a Statement of Cash Flows...7 Focus on Cash and Cash Equivalents Gross and Net Cash Flows Classification of Cash Receipts and Cash Payments Distinguishing between Capital and Noncapital Financing...29 Content and Form of a Statement of Cash Flows Information about Noncash Investing, Capital, and Financing Activities...37 Effective Date and Transition...38 Appendix A: Basis for Conclusions Appendix B: Illustrative Statement of Cash Flows Appendix C: Codification Instructions...78 iv

7 Statement No. 9 of the Governmental Accounting Standards Board Reporting Cash Flows of Proprietary and Nonexpendable Trust Funds and Governmental Entities That Use Proprietary Fund Accounting September 1989 INTRODUCTION AND BACKGROUND INFORMATION Scope of This Statement 1. This Statement establishes standards for reporting cash flows of proprietary and nonexpendable trust funds and governmental entities that use proprietary fund accounting. 1 This Statement also eliminates the requirements for public employee retirement systems (PERS) and pension trust funds to provide a statement of changes in financial position. It supersedes the June 15, 1987 GASB Codification of Governmental Accounting and Financial Reporting Standards Section 2200, Comprehensive Annual Financial Report, paragraph.106, and related requirements in that section, in Section 2600, Reporting Entity and Component Unit Presentation and Disclosure, and in Section Pe5, Pension Funds Accounting. 2 1 GASB Codification Section 1300, Fund Accounting, paragraph.102b, states that proprietary fund types are used to account for a government s ongoing organizations and activities that are similar to those often found in the private sector (enterprise and internal service funds). All assets, liabilities, equities, revenues, expenses, and transfers relating to the government s business and quasi-business activities where net income and capital maintenance are measured are accounted for through proprietary funds (footnote reference omitted). Also, as stated in Codification Section 2200, paragraph.106b(3), nonexpendable trust funds are similar to proprietary funds and should be reported similarly. 2 Further references to the Codification are abbreviated. For example, Section 2200, paragraph.106, is referred to as Cod. Sec

8 Background 2. In November 1987, the Financial Accounting Standards Board (FASB) issued Statement No. 95, Statement of Cash Flows. That Statement establishes standards for cash flow reporting for all business enterprises. It supersedes Accounting Principles Board (APB) Opinion No. 19, Reporting Changes in Financial Position, and requires a statement of cash flows in place of a statement of changes in financial position as part of a full set of financial statements. 3. FASB Statement 95 points out that since Opinion 19 was issued, cash flow information has gained significance. Paragraph 13 of FASB Concepts Statement No. 5, Recognition and Measurement in Financial Statements of Business Enterprises, states that a full set of financial statements for a period should show:... [c]ash flows during the period. Paragraph 78 of GASB Concepts Statement No. 1, Objectives of Financial Reporting, also focuses on the need for, and importance of, cash flow information (Cod. Sec b). It states that an objective of financial reporting is to provide information about how the governmental entity financed its activities and met its cash requirements. 4. To provide guidance on cash flow reporting by proprietary and nonexpendable trust funds and governmental entities that use proprietary fund accounting, the Board concluded that the provisions of FASB Statement 95 could be adapted to reflect more closely the nature of governmental operations. The major differences between this Statement and FASB Statement 95 are that (a) four categories are used for classifying cash transactions instead of the three required by FASB Statement 95 and (b) the operating category is more narrowly focused. The categories were redefined accordingly. 2

9 STANDARDS OF GOVERNMENTAL ACCOUNTING AND FINANCIAL REPORTING Applicability of This Statement 5. The provisions of this Statement are applicable to proprietary funds, nonexpendable trust funds, and governmental entities that use proprietary fund accounting, 3 including public benefit corporations and authorities, governmental utilities, and governmental hospitals. 4 PERS and pension trust funds are exempt from the requirement to present a statement of cash flows. In addition, PERS that report in accordance with NCGA Statement 6, Pension Accounting and Financial Reporting: Public Employee Retirement Systems and State and Local Government Employers, and pension trust funds are not required to present a statement of changes in financial position. However, PERS and pension trust funds are not precluded from presenting a statement of cash flows if the information provided is considered useful. Financial Reporting of Cash Flows 6. Governmental enterprises should present a statement of cash flows for each period for which results of operations are reported. Purpose of a Statement of Cash Flows 7. The primary purpose of a statement of cash flows is to provide relevant information about the cash receipts and cash payments of an entity during a period. When used with related disclosures and information in the other financial statements, the information a statement of cash flows provides should help financial report users assess (a) an entity s ability to generate future net cash flows, (b) its ability to meet its obligations as they come 3 Unless otherwise noted, future references in this Statement to affected funds and entities will simply be to governmental enterprises. 4 Some governmental colleges and universities report their transactions and balances within the governmental model using National Council on Governmental Accounting (NCGA) Statement 1, Governmental Accounting and Financial Reporting Principles. This Statement applies to the proprietary and nonexpendable trust funds of those governmental colleges and universities. However, this Statement is not required to be applied to those governmental colleges and universities that follow the specialized industry accounting and reporting principles contained in the American Institute of Certified Public Accountants (AICPA) Industry Audit Guide, Audits of Colleges and Universities (1975). 3

10 due, (c) its needs for external financing, (d) the reasons for differences between operating income (or net income if operating income is not separately identified on the operating statement) and associated cash receipts and payments, and (e) the effects on the entity s financial position of both its cash and its noncash investing, capital, and financing transactions during the period. To do this, a statement of cash flows should report the cash effects during the reported period of an entity s operations, its noncapital financing transactions, its capital and related financing transactions, and its investing transactions. Related information should report the investing, capital, and financing transactions that affect an entity s financial position but do not directly affect cash flows during the period. A reconciliation of operating income (or net income if operating income is not separately identified on the operating statement) to net cash flow from operating activities also should be provided. This reconciliation generally will provide information about the net effects of operating transactions and other events that affect operating income and operating cash flows in different periods. Focus on Cash and Cash Equivalents 8. A statement of cash flows should explain the change during the period in cash 5 and cash equivalents regardless of whether there are restrictions on their use. The statement should use a descriptive term such as cash or cash and cash equivalents rather than the term funds, which has several different meanings in governmental accounting. The total amounts of cash and cash equivalents at the beginning and end of the period shown in the statement of cash flows should be easily traceable to similarly titled line items or subtotals shown in the statements of financial position as of those dates. 9. For purposes of this Statement, cash equivalents are defined as short-term, highly liquid investments that are both 5 Consistent with common usage, cash includes not only currency on hand, but also demand deposits with banks or other financial institutions. Cash also includes deposits in other kinds of accounts or cash management pools that have the general characteristics of demand deposit accounts in that the governmental enterprise may deposit additional cash at any time and also effectively may withdraw cash at any time without prior notice or penalty. 4

11 a. Readily convertible to known amounts of cash. b. So near their maturity that they present insignificant risk of changes in value because of changes in interest rates. Generally, only investments with original maturities 6 of three months or less meet this definition. 10. Examples of items commonly considered to be cash equivalents are Treasury bills, commercial paper, certificates of deposit, money market funds, and cash management pools. Cash purchases and sales of those types of investments generally are part of the entity s cash management activities rather than part of its operating, capital, investing, and financing activities, and details of those transactions should not be reported in a statement of cash flows. 11. Not all investments that qualify are required to be treated as cash equivalents. An entity should establish a policy concerning which short-term, highly liquid investments (that satisfy the definition of cash equivalents in paragraph 9) it will treat as cash equivalents. An entity should disclose its policy for determining which of those items are treated as cash equivalents. Any change in that policy is a change in accounting principle that should be reported by restating financial statements for earlier years presented for comparative purposes. Gross and Net Cash Flows 12. Generally, information about the gross amounts of cash receipts and cash payments during a period is more relevant than information about the net amount of cash receipts and payments. However, the net amount of related receipts and payments provides sufficient information not only for cash equivalents, as noted in paragraph 10, but also for certain other classes of cash flows specified in paragraphs 13, 14, and Original maturity means the original maturity to the entity holding the investment. For example, both a three-month U.S. Treasury bill and a three-year Treasury note purchased three months from maturity qualify as cash equivalents. However, a Treasury note purchased three years ago does not become a cash equivalent when its remaining term is three months. 5

12 13. Items that qualify for net reporting because their turnover is quick, their amounts are large, and their maturities are short are cash receipts and payments pertaining to (a) investments (other than cash equivalents), (b) loans receivable, and (c) debt, provided that the original maturity of the asset or liability is three months or less In addition, in certain circumstances governmental enterprises may report net the purchases and sales of their highly liquid investments rather than report the gross amounts. Net reporting is allowed if (a) during the period, substantially all of the governmental enterprise s assets were highly liquid investments (for example, marketable securities and other assets for which a market is readily available) and (b) the governmental enterprise had little or no debt, based on average debt outstanding during the period, in relation to average total assets. Classification of Cash Receipts and Cash Payments 15. A statement of cash flows should classify cash receipts and cash payments as resulting from operating, noncapital financing, capital and related financing, or investing activities. Cash Flows from Operating Activities 16. Operating activities generally result from providing services and producing and delivering goods, and include all transactions and other events that are not defined as capital and related financing, noncapital financing, or investing activities. Cash flows from operating activities generally are the cash effects of transactions and other events that enter into the determination of operating income. 8 7 For this purpose, amounts due on demand are considered to have maturities of three months or less. Examples of items that could be reported net based on the criteria in paragraph 13 are most repurchase agreements (assuming the entity chooses not to include them as cash equivalents) and loans to and from other funds to cover temporary (three months or less) cash needs. 8 Although operating income is not defined in authoritative governmental accounting literature, the term has become widely used. A nonauthoritative illustration of the calculation of operating income (operating revenues less operating expenses) is provided in Cod. Sec

13 17. Cash inflows from operating activities include a. Cash inflows from sales of goods or services, including receipts from collection of accounts receivable and both short- and long-term notes receivable from customers arising from those sales. b. Cash receipts from quasi-external operating transactions with other funds. c. Cash receipts from grants for specific activities that are considered to be operating activities of the grantor government. (A grant arrangement of this type is essentially the same as a contract for services.) d. Cash receipts from other funds for reimbursement of operating transactions. e. All other cash receipts that do not result from transactions defined as capital and related financing, noncapital financing, or investing activities. 18. Cash outflows for operating activities include a. Cash payments to acquire materials for providing services and manufacturing goods for resale, including principal payments on accounts payable and both short- and long-term notes payable to suppliers for those materials or goods. b. Cash payments to other suppliers for other goods or services. c. Cash payments to employees for services. d. Cash payments for grants to other governments or organizations for specific activities that are considered to be operating activities of the grantor government. e. Cash payments for taxes, duties, fines, and other fees or penalties. f. Cash payments for quasi-external operating transactions with other funds, including payments in lieu of taxes. g. All other cash payments that do not result from transactions defined as capital and related financing, noncapital financing, or investing activities. 19. Cash flows from operating activities also include transactions of certain loan programs. Even though loan activities are usually classified as investing activities, certain loan programs are not intended to be investments, but are undertaken instead to fulfill a governmental responsibility. These program loans are made and collected as part of a governmental program, for example, low-income housing mortgages or student loans. For cash flow reporting purposes, these loan activities are the operating activities of the governmental enterprise; therefore, the related cash flows should be classified as operating activities. All loans made and collected (including interest) should be considered operating cash outflows and inflows, respectively. Any proceeds from bonds issued to finance the loan program and subsequent debt service payments (principal and interest) should be classified as noncapital financing activities. 7

14 Cash Flows from Noncapital Financing Activities 20. Noncapital financing activities include borrowing money for purposes other than to acquire, construct, or improve capital assets and repaying those amounts borrowed, including interest. This category includes proceeds from all borrowings (such as revenue anticipation notes) not clearly attributable to acquisition, construction, or improvement of capital assets, regardless of the form of the borrowing. Also included are certain other interfund and intergovernmental receipts and payments. 21. Cash inflows from noncapital financing activities include a. Proceeds from issuing bonds, notes, and other short- or long-term borrowing not clearly attributable to acquisition, construction, or improvement of capital assets. b. Cash receipts from grants or subsidies 9 except (1) those specifically restricted for capital purposes (paragraph 24b) and (2) those for specific activities that are considered to be operating activities of the grantor government (paragraph 17c). c. Cash received from other funds except (1) those amounts that are clearly attributable to acquisition, construction, or improvement of capital assets (paragraph 24c), (2) quasi-external operating transactions (paragraph 17b), and (3) reimbursement for operating transactions (paragraph 17d). d. Cash received from property and other taxes collected for the governmental enterprise and not specifically restricted for capital purposes. 22. Cash outflows for noncapital financing activities include a. Repayments of amounts borrowed for purposes other than acquiring, constructing, or improving capital assets. b. Interest payments to lenders and other creditors on amounts borrowed or credit extended for purposes other than acquiring, constructing, or improving capital assets. c. Cash paid as grants or subsidies to other governments or organizations, except those for specific activities that are considered to be operating activities of the grantor government (paragraph 18d). 10 d. Cash paid to other funds, except for quasi-external operating transactions (paragraph 18f). 9 For example, grants or subsidies provided to finance operating deficits would be classified as noncapital financing activities. 10 For grantor classification purposes, it is irrelevant whether the grantee uses the grant as an operating subsidy or for capital purposes. The grantor should classify all grants, except for those addressed in paragraph 18d, as noncapital financing activities. 8

15 Cash Flows from Capital and Related Financing Activities 23. Capital and related financing activities include (a) acquiring and disposing of capital assets used in providing services or producing goods, (b) borrowing money for acquiring, constructing, or improving capital assets and repaying the amounts borrowed, including interest, and (c) paying for capital assets obtained from vendors on credit. 24. Cash inflows from capital and related financing activities include a. Proceeds from issuing or refunding bonds, mortgages, notes, and other short- or long-term borrowing clearly attributable to the acquisition, construction, or improvement of capital assets. b. Receipts from capital grants awarded to the governmental enterprise. c. Receipts from contributions made by other funds, other governments, and other organizations or individuals for the specific purpose of defraying the cost of acquiring, constructing, or improving capital assets. d. Receipts from sales of capital assets; also, proceeds from insurance on capital assets that are stolen or destroyed. e. Receipts from special assessments or property and other taxes levied specifically to finance the construction, acquisition, or improvement of capital assets. 25. Cash outflows for capital and related financing activities include a. Payments to acquire, construct, or improve capital assets. b. Repayments or refundings of amounts borrowed specifically to acquire, construct, or improve capital assets. c. Other principal payments to vendors who have extended credit to the governmental enterprise directly for purposes of acquiring, constructing, or improving capital assets. d. Cash payments to lenders and other creditors for interest directly related to acquiring, constructing, or improving capital assets. Cash Flows from Investing Activities 26. Investing activities include making and collecting loans (except program loans, as discussed in paragraph 19) and acquiring and disposing of debt or equity instruments. 27. Cash inflows from investing activities include a. Receipts from collections of loans (except program loans) made by the governmental enterprise and sales of other entities debt instruments (other than cash equivalents) that were purchased by the governmental enterprise. b. Receipts from sales of equity instruments and from returns of investment in those instruments. 9

16 c. Interest and dividends received as returns on loans (except program loans), debt instruments of other entities, equity securities, and cash management or investment pools. 11 d. Withdrawals from investment pools that the governmental enterprise is not using as demand accounts. 28. Cash outflows for investing activities include a. Disbursements for loans (except program loans) made by the governmental enterprise and payments to acquire debt instruments of other entities (other than cash equivalents). b. Payments to acquire equity instruments. c. Deposits into investment pools that the governmental enterprise is not using as demand accounts. Distinguishing between Capital and Noncapital Financing 29. Borrowings for capital purposes generally are readily distinguishable from borrowings for other purposes. For example, mortgages, capital improvement bonds, and time-pay arrangements for purchasing equipment are clearly for capital purposes. Sometimes, however, determining whether debt proceeds and repayments should be classified as capital and related financing or noncapital financing may be more difficult. In general, any debt that is clearly attributable to capital construction, acquisition, or improvement should be considered capital debt, and the debt proceeds and subsequent payments of principal and interest should be classified as capital and related financing. The following provides guidance for other situations: a. Debt that is not clearly attributable to capital construction, acquisition, or improvement should be considered noncapital debt, and the debt proceeds and subsequent payments of principal and interest should be classified as noncapital financing. b. Principal and interest payments on debt that was issued to acquire, construct, or improve capital assets that have been sold or otherwise disposed of should remain classified as capital and related financing. c. In a defeasance of debt, the proceeds of a refunding debt issue used to refund capital debt should be reported as a cash inflow in the capital and related financing category and the payment to defease the existing capital debt should be reported as an outflow in that category. Similarly, subsequent principal and interest payments on the refunding debt should also be reported as cash outflows in the capital category. If the refunding issue is in excess of the amount needed to refund the existing capital debt, 11 Interest credited directly to a deposit account that has the general characteristics described in footnote 5 is a cash outflow of the payor and a cash inflow to the payee when the entry is made. 10

17 the total proceeds and the subsequent principal and interest payments should be allocated between the capital category and the noncapital financing category based on the amounts used for capital and noncapital purposes. Content and Form of a Statement of Cash Flows 30. A statement of cash flows for the period should report net cash provided or used in each of the four categories, as well as the net effect of those flows on cash and cash equivalents during the period in a manner that reconciles beginning and ending cash and cash equivalents. 31. In reporting cash flows from operating activities, governmental enterprises are encouraged to report major classes of gross cash receipts and gross cash payments and their arithmetic sum the net cash flow from operating activities (the direct method). Governmental enterprises that do so should, at a minimum, separately report these classes of operating cash receipts and payments: a. Cash receipts from customers. b. Cash receipts from quasi-external operating transactions with other funds. c. Other operating cash receipts, if any. d. Cash payments to other suppliers of goods or services. e. Cash payments to employees for services. f. Cash payments for quasi-external operating transactions with other funds, including payments in lieu of taxes. g. Other operating cash payments, if any. Governmental enterprises are encouraged to provide further detail of operating cash receipts and payments if the detail is considered useful. 32. Governmental enterprises that choose not to provide information about major classes of operating cash receipts and payments by the direct method as encouraged in paragraph 31 should determine and report the same amount for net cash flow from operating activities indirectly by adjusting operating income (or net income if operating income is not separately identified on the operating statement) to reconcile it to net cash flow from operating activities (the indirect or reconciliation method). This method requires adjusting operating income to remove the effects of depreciation, amortization, and other deferrals of past operating cash receipts and payments, such as changes during the period in inventory, deferred revenue, and the like, and all accruals of expected future operating 11

18 cash receipts and payments, such as changes during the period in receivables and payables. If the reconciliation is to net income rather than operating income, the effects of all items whose cash effects are capital and related financing, noncapital financing, or investing cash flows must also be removed. 33. The reconciliation of operating income (or net income if operating income is not separately identified on the operating statement) to net cash flow from operating activities described in paragraph 32 should be provided regardless of whether the direct or indirect method of reporting net cash flow from operating activities is used. That reconciliation should separately report all major classes of reconciling items. For example, at a minimum, changes during the period in receivables pertaining to operating activities, in inventory, and in payables pertaining to operating activities should be separately reported. Governmental enterprises are encouraged to provide further detail of those categories if the detail is considered useful. 34. If the direct method of reporting net cash flow from operating activities is used, the reconciliation of operating income (or net income if operating income is not separately identified on the operating statement) to net cash flow from operating activities should be provided in a separate schedule. If the indirect method is used, the reconciliation should be reported within the operating activities section of the statement of cash flows or provided in a separate schedule. If the reconciliation is presented within the operating activities section of the statement of cash flows, all adjustments to operating income (or net income if operating income is not separately identified on the operating statement) to determine net cash flow from operating activities should be clearly identified as reconciling items. If the reconciliation is presented in a separate schedule, it may be presented on the same page as the statement of cash flows, if space permits. 35. Except for the items described in paragraphs 13 and 14, cash inflows and outflows in the other categories should be reported separately in a statement of cash flows--for example, outlays for acquisitions of capital assets should be reported separately from the proceeds from sales of capital assets, and proceeds of borrowing should be reported separately from repayments. 12

19 36. On the statements of cash flows of individual funds, the gross amounts of interfund transfers should be presented in the appropriate categories. However, interfund cash transfers may be eliminated in the combined and combining statements of cash flows for all proprietary funds if interfund transfers are also eliminated in the combining process for other financial statements. 12 In addition, only one method (direct or indirect) should be used in a combined or combining statement of cash flows. Information about Noncash Investing, Capital, and Financing Activities 37. Information about all investing, capital, and financing activities of a governmental enterprise during a period that affect recognized assets or liabilities but do not result in cash receipts or cash payments in the period should be reported. This information should be presented in a separate schedule, which may be in either a narrative or a tabular format, and it should clearly describe the cash and noncash aspects of transactions involving similar items. The schedule may be presented, if space permits, on the same page as the statement of cash flows. Examples of noncash transactions are acquiring assets by assuming directly related liabilities, such as purchasing a building by incurring a mortgage to the seller; obtaining an asset by entering into a capital lease; and exchanging noncash assets or liabilities for other noncash assets or liabilities. Some transactions are part cash and part noncash; only the cash portion should be reported in the statement of cash flows. EFFECTIVE DATE AND TRANSITION 38. The provisions of this Statement are effective for annual financial statements for fiscal years beginning after December 15, Earlier application is encouraged. Restatement of comparative annual financial statements for earlier years is encouraged but not required. The provisions of this Statement need not be applied to immaterial items. 12 The subject of interfund eliminations is addressed in Cod. Sec through.112. Each reference notes that each of the combined or combining basic financial statements may contain a total column, with or without interfund and similar eliminations. 13

20 This Statement was adopted by the affirmative votes of four members of the Governmental Accounting Standards Board. Mr. Defliese dissented. Although he is in general agreement with the thrust and conclusions of this Statement, Mr. Defliese dissents because of the failure to exempt from the requirement to present a statement of cash flows those governmental enterprises that are effectively investment companies or similar entities and that meet the criteria specified in paragraph 14. (He notes that the FASB has wisely granted this exemption to such entities.) Instead, the Statement requires a cash flow statement but permits the use of net purchases and sales of highly liquid investments instead of gross amounts. Mr. Defliese believes that cash flow statements of such operations add nothing to the achievement of the Board s objective to provide information about how the governmental entity financed its activities and met its cash requirements (GASB Concepts Statement No. 1, Objectives of Financial Reporting). He thinks that, being entirely liquid, such governmental enterprises need no statements beyond balance sheets and operating statements to demonstrate liquidity, and, having no debts, they have no need to demonstrate their ability to pay debts. Mr. Defliese believes that governmental financial reporting presently is excessively cluttered and that he requirement to provide an additional statement with what he considers useless net-change information (generally available by subtraction) is disclosure overkill. Members of the Governmental Accounting Standards Board: James F. Antonio, Chairman Martin Ives, Vice-Chairman Philip L. Defliese W. Gary Harmer Elmer B. Staats 14

21 Appendix A BASIS FOR CONCLUSIONS Introduction 39. This appendix discusses factors considered significant by Board members in reaching the conclusions in this Statement. Individual Board members gave greater weight to some factors than to others. 40. An Exposure Draft (ED), Reporting Cash Flows of Proprietary and Nonexpendable Trust Funds and Governmental Entities That Use Proprietary Fund Accounting, was issued for public comment on November 21, Prior to issuance, advance copies of the ED were sent to organizations (the Healthcare Financial Management Association and the American Public Power Association) and certain individuals (including state comptrollers with oversight over governmental enterprises in their state and CPAs involved in governmental accounting and auditing) along with a letter asking for help in notifying affected parties of the upcoming ED. Various organizations publicized the ED in their newsletters. The Board received seventy-nine letters of comment in response to the ED. Most of the respondents supported the proposal. Relationship with FASB Statement The release of FASB Statement 95 in November 1987 caused some people to question whether its existence invalidated the GASB Codification reference to Opinion 19. At its January 1988 meeting, the Board discussed the applicability of FASB Statement 95 to proprietary and similar trust funds and agreed that the existing requirements to prepare a statement of changes in financial position in accordance with Opinion 19 did not change, even though that Opinion was superseded by FASB Statement 95 in the private-sector accounting literature. The Board determined that if it took no action with regard to FASB Statement 95, Opinion 19 would continue to apply to proprietary and similar trust funds. However, the Board noted that except for the manner of reporting noncash investing and financing activities, statements of cash flows prepared in conformity with FASB Statement 95 were also in conformity with Opinion 19. The Board 15

22 encouraged preparers of state and local governmental financial statements to apply FASB Statement 95 subject to compliance with the requirements of Opinion 19. Nevertheless, some preparers continued to believe that proprietary funds were required to present a statement of cash flows in accordance with FASB Statement 95 because Cod. Sec b states that the generally accepted accounting principles here [for proprietary funds] are those applicable to similar businesses in the private sector To avoid further confusion over the applicability of FASB Statement 95, the Board reconsidered the need to address cash flow reporting and formally added a cash flow reporting project to its agenda. The Board concluded that the best approach to the project was to provide prompt, interim guidance for proprietary and similar trust funds and, after completion of the measurement focus and basis of accounting project, to evaluate the need for cash flow reporting by governmental funds. This evaluation will be made as part of the overall reexamination of the governmental financial reporting model. 43. Pending further study, the Board believes it would be desirable to prescribe a cash flow format that is appropriate for both governmental and proprietary funds. Although the format prescribed in this Statement for proprietary funds may also be appropriate for governmental funds, the Board notes that further study for governmental funds may indicate that a somewhat different format may provide the optimal approach for both governmental and proprietary funds. As a result, readers should be aware that the overall reexamination of the governmental financial reporting model will also include a reexamination of the requirements of this Statement. 44. In developing its statement of cash flows, the FASB pointed out that a weakness of Opinion 19 is that it permits presentation of a statement of changes in financial position on either a cash or a working capital basis. Paragraph 2 of FASB Statement 95 notes that certain problems were identified in the use of Opinion 19, including the ambiguity of terms such as funds, lack of comparability arising from diversity in the focus of the statement (cash, cash and short-term investments, quick assets, or working capital) and the resulting differences in definitions of funds flows from operating activities (cash or working capital), differences in the format of the statement (sources and uses format or 16

23 activity format), variations in classifications of specific items in an activity format, and the reporting of net changes in amounts of assets and liabilities rather than gross inflows and outflows. 45. Paragraphs 45 through 50 of FASB Statement 95 set forth the reasoning underlying the FASB s decision to replace the statement of changes in financial position (required by Opinion 19) with a statement of cash flows. Those paragraphs include excerpts from the FASB concepts Statements that document the need for, and desirability of, cash flow data and the complementary role that a statement of cash flows plays with other basic financial statements. 46. The GASB also acknowledges the importance of cash flow reporting and refers to cash flow information in GASB Concepts Statement 1 (Cod. Sec. 100). For example, Cod. Sec b states, as one of the financial reporting objectives, that financial reporting should provide information about how the governmental entity financed its activities and met its cash requirements. Cod. Sec points out that to assess financial condition, investors and creditors use cash flow data to look for trends that may indicate strengths and weaknesses in the ability of the government to repay debt. Applicability to PERS and Pension Trust Funds 47. The Board discussed whether PERS and pension trust funds should be required to provide a statement of cash flows as a basic financial statement. Cod. Sec. Pe5.102 lists three sources of acceptable accounting and reporting principles for PERS: NCGA Statement 1, NCGA Statement 6, and FASB Statement A PERS that reports in accordance with FASB Statement 35 is not required to include a statement of changes in financial position as a basic financial statement, nor is it required to present a statement of 13 NCGA Statement 1, Governmental Accounting and Financial Reporting Principles (1979); NCGA Statement 6, Pension Accounting and Financial Reporting: Public Employee Retirement Systems and State and Local Governmental Employers (1983); FASB Statement No. 35, Accounting and Reporting by Defined Benefit Pension Plans (1980). 17

24 cash flows. Research indicates that only one-half of all PERS currently prepare statements of changes in financial position. 14 Cod. Sec had required pension trust funds to provide a statement of changes in financial position in accordance with Opinion The Board evaluated the pros and cons of including PERS and pension trust funds in the scope of this Statement and concluded that they should be exempted from the requirements of this Statement; however, a statement of cash flows may be presented if it is believed the information provided would be useful. The Board s decision was based, in part, on the fact that accounting and reporting by PERS is the subject of a separate GASB project and that including PERS in the scope of this Statement is tantamount to a piecemeal approach to establishing financial reporting standards for PERS. The Board questions whether the cash flow reporting format in this Statement will provide the most useful information regarding the cash flows of a PERS. In addition, the Board does not support the notion of requiring all PERS to provide a statement of cash flows when there is no single set of standards for the other basic financial statements that apply to all PERS. The decision to also exempt pension trust funds from the requirement to provide a statement of cash flows is a practical extension of the exemption granted to PERS. For essentially the same reasons, the Board decided to eliminate the requirement for PERS and pension trust funds to provide a statement of changes in financial position. Definition of Cash and Cash Equivalents 49. In its ED, the GASB used the same definition of cash equivalents as the FASB did in Statement 95. Some respondents object to the proposed definition because it is inconsistent with the cash management practices of their particular governmental enterprises. These respondents suggested various alternatives, including a focus on pure cash, cash plus cash equivalents maturing in one year, and cash plus all investments. The 14 Paul Zorn and Michael Hanus, Public Pension Accounting and Reporting: A Survey of Current Practices (Chicago: Public Pension and Benefits Consortium, Government Finance Research Center of the Government Finance Officers Association, 1987), p

25 FASB acknowledges in paragraph 53 of Statement 95 that the definition of cash equivalents is based on a somewhat arbitrarily determined limit to the maturity of items that can qualify as cash equivalents, but the three-month limit should result in treating as cash equivalents only those items that are so near cash that it is appropriate to refer to them as the equivalent of cash. The Board considered the various alternatives suggested by the respondents and concluded that they would also be arbitrary. It was not persuaded to modify the definition of cash equivalents as provided in the ED. Cash Management and Investment Pools 50. Some respondents suggested that deposits in a cash management or investment pool should be considered cash equivalents rather than investments. The ED required that the cash flows of the pools be allocated to the participants. Respondents commented that it would be difficult to accumulate that information. In addition, they suggested that the result would often be an arbitrary allocation that, for cash flow reporting purposes, is relatively meaningless because cash does not necessarily flow immediately into or out of the enterprise as a result of the pool s activities. The Board decided that participants transactions with entity-wide cash management pools are similar to those with external investment pools, such as mutual funds or money market accounts; therefore, the cash flows should be reported as though they were external cash flows. FASB Statement 95 specifies that cash includes accounts that have the general characteristics of demand deposits in that the customer may deposit additional funds at any time and also effectively may withdraw funds at any time without prior notice or penalty (footnote 1). The GASB, after considering the issues, concluded that cash management pools that are used essentially as demand deposit accounts should be treated the same as any other demand deposit account. Those pools that are not used as demand deposit accounts (for example, revenue bond reserve investment pools) should not be considered cash; therefore, transfers into and out of them should be reported as investing activities. Restricted Assets 51. An important characteristic, common to governmental enterprises, that is not addressed in FASB Statement 95 is the existence of restricted asset accounts. These 19

26 accounts (or portions of them) may meet the definitions of cash and cash equivalents in paragraphs 8 and 9 of this Statement. Accounting Research Bulletin (ARB) No. 43, Restatement and Revision of Accounting Research Bulletins, defines current assets to exclude cash and claims to cash which are restricted as to withdrawal or use for other than current operations, are designated for expenditure in the acquisition or construction of noncurrent assets, or are segregated for the liquidation of long-term debts (Chapter 3A, paragraph 6; footnote reference omitted). Some believe that it follows that items not qualifying as current assets likewise should not be considered cash or cash equivalents for purposes of a statement of cash flows. The Board believes, however, that the guidance in ARB 43 is intended to apply only to the manner of presentation in a classified balance sheet and is not intended to be a factor in determining what should be included in the definition of cash and cash equivalents. Also, the Board believes that separately identifying the flows of restricted cash as separate line items within the statement of cash flows may be informative but should not be required. 52. The Board believes that restricted cash and cash equivalents should be included with unrestricted cash and cash equivalents for cash flow reporting purposes. The only exception is one that applies equally to restricted and unrestricted cash equivalents. Subject to the provisions of paragraph 11, governmental enterprises may choose to treat their restricted cash equivalents or unrestricted cash equivalents as investments. However, if they do so, they must disclose in the notes their policy for defining cash equivalents. Categories for Classifying Cash Receipts and Payments 53. Despite the acknowledged usefulness of cash flow reporting for both business and governmental enterprises and the numerous other similarities between some governmental enterprises and their private-sector counterparts, there are differences that many believe cause the categories provided in FASB Statement 95 to be less than optimal for governmental enterprises. Perhaps the most obvious difference is the absence of transactions with owners in governmental enterprises. Governmental enterprises do not sell stock, pay dividends, or engage in other transactions with owners; consequently, the significance of the financing category as defined in FASB Statement 95 is diminished. The absence of ownership interests and infusion of owners capital, however, does not 20

27 mean that governmental enterprises do not engage in financing activities. On the contrary, governmental enterprises can obtain financing from a wide variety of sources, and cash flow information about the sources and uses of financing is needed. 54. Many governmental enterprise funds and public authorities finance their operations and manage their cash flow activities in a manner that makes a clear distinction between operating and capital. Capital budgeting and long-range capital planning are common, and may even be required by law in some jurisdictions. Information about the cash inflows and outflows of a capital program is useful for identifying the level of capital spending and the nature and adequacy of the sources of funding for the projects. Therefore, the Board believes an additional category for capital and related financing activities will provide useful information about the capital activities of governmental enterprises. 55. Funding for governmental capital improvements comes from a wide range of sources, many of which are not available to private-sector enterprises. For example, a typical water and sewer enterprise may obtain cash to finance capital improvements from capital improvement bonds secured by the revenues of the enterprise, capital improvement general obligation bonds secured by the general taxing power of the related government, special assessments levied against specific property owners, ad valorum taxes arising from the creation of a special taxing district, capital contributed from other funds of the government, contributions-in-aid of construction from property owners and developers, loans from other funds of the government, and capital grants awarded by the federal or a state government. 56. In creating the capital category, the Board is also attempting to provide categories and a format that may be appropriate for reporting the cash flows of governmental funds. The coexistence of different measurement focuses for governmental and proprietary fund types may present conflicts in categorizing certain cash transactions common to both fund types using the three categories in FASB Statement 95: Capital outlay might be an investing transaction for proprietary funds in the FASB format and an operating activity in the governmental funds; debt service principal payments might be a financing activity in 21

28 proprietary funds in the FASB format and an operating activity in governmental funds. The availability of the capital and related financing category helps resolve these conflicts so that, if appropriate, a single cash flow format eventually can be developed for all fund types of a governmental entity. 57. Creating the capital and related financing category, of course, results in changes to the contents of the three categories established by FASB Statement 95. Specifically, it results in these modifications: a. Construction and acquisition of capital assets are not classified as investing as specified in FASB Statement 95; instead, they are major elements in the capital and related financing category. b. The financing category in FASB Statement 95 includes cash inflows and outflows related to both capital and noncapital borrowing. Capital borrowing activity is another major element of the capital and related financing category. c. To show the complete picture of all cash inflows and outflows from financing, acquiring, and disposing of capital assets, it is necessary to include interest payments in this category rather than in the operating category. d. Similarly, interest on noncapital debt is classified as noncapital financing so that it is treated consistently with capital interest and gives a more complete picture of all inflows and outflows arising from noncapital debt transactions. e. The nature of investing activity in the governmental environment is focused on the acquisition and disposition of debt and equity instruments of other entities rather than on the investment of ownership capital in capital assets. Therefore, it is more useful to reclassify investment earnings (interest and dividends) as inflows from investing rather than from operating activities. This presents a clearer picture of all the cash flows from investing activities and is consistent with the reclassification of interest expense discussed earlier. Operating Activities 58. As indicated in the standards section of this Statement, the Board decided to classify interest payments as either capital or noncapital financing activity outflows, interest receipts as investing activity inflows, and subsidies received to finance operating deficits as noncapital financing activity inflows. In operating statements that distinguish between operating and nonoperating revenue/expense, these items are generally classified as nonoperating items. Therefore, the Board concluded that the items classified as operating activities would generally represent the cash effects of transactions affecting operating income when operating statements have an operating income classification (operating revenues less operating expenses). Although the term operating income is not defined in 22

29 authoritative governmental accounting literature, there are nonauthoritative references to it in the GASB Codification (see Cod. Sec , example 4), and its use has evolved in practice. 59. Because operating income is not authoritatively defined, there is no assurance that its usage is standardized. Some governmental enterprises may not distinguish between operating income and nonoperating income on their operating statements, and others may use it to refer to something other than what is commonly thought of as operating income. For example, some enterprises may include interest income in operating income rather than nonoperating income, which is contrary to the Codification illustration of operating income. Regardless of what an enterprise includes in operating income, cash flows identified as belonging in one of the three other categories should not be included in the operating activities category. Therefore, even if an enterprise includes interest income in operating income, the cash flows generated from the interest income should be included in the investing activities category and not in operating activities, except that interest from program loans should be classified as operating activities (paragraph 19). (If interest is included in the enterprise s calculation of operating income, the reconciliation of operating income to net cash flow from operating activities would show interest as a reconciling item.) Even if operating income is not designated on the operating statement, the definitions of the categories still apply. All cash flows not falling into the capital and related financing category, noncapital financing category, or investing activities category should be classified as operating activities. 60. In the ED, the Board had expanded the operating activities category to include certain activities that would otherwise be included in one of the three other categories. That expansion of the operating activities category occurred when the activity (financing or investing) was the primary operating activity of the governmental enterprise. Some respondents disagreed with that proposal and were concerned that it would be difficult to identify when it should be applied. The Board reevaluated the provision and decided to limit it specifically to the cash flow reporting of certain loan activities of state and local governments, for example, student loan programs and low-interest mortgage programs. According to the general definition of the investment activities category, these loans 23

30 would be considered investments. The Board concluded that these loans, however, are not investments in the ordinary sense of the term because they are made not for purposes of earning income or profits, but rather in fulfillment of governmental social programs. An example of a student loan program s transactions is provided to illustrate the classification of its cash flows. Cash Flow Proceeds from financing to start up loan program Disbursement of loan funds to students Routine operating expenses Collection of loans (principal and interest) Debt service payments (principal and interest) Category Noncapital financing Operating activities Operating activities Operating activities Noncapital financing 61. The Board considered comments received from some respondents regarding program grants. The ED did not distinguish between grants intended as operating subsidies (to finance general operating deficits) and grants provided to finance specific programs or to purchase specific services. Some respondents noted that some governmental enterprises undertake a particular activity or program solely because another government or organization has agreed to reimburse the costs, and the activity is inherently part of the operations of the grantor. The substance of the arrangement is a purchase of services. It would be misleading to report the revenues as noncapital financing activities as if they were a general operating subsidy on the statement of cash flows of the grantee. As a result, the Board decided to require program grant cash inflows and outflows to be classified as operating activities. 62. The Board reevaluated its ED proposal to require governmental enterprises to identify whether amounts they transferred to other funds or granted to other governments or organizations were used for capital purposes. Some respondents commented that this determination might be difficult to make; in addition, the distinction is irrelevant to the grantor because any capital item acquired, constructed, or improved would not be capitalized by the grantor. The GASB decided to require that all cash outflows for grants and transfers be classified as noncapital financing activities, except for program grants, discussed in the previous paragraph. 24

31 Capital and Related Financing Activities 63. Some respondents commented that it may be difficult to determine which activities qualify as capital. Although the Board reiterated its position that any cash flow that is clearly attributable to a capital asset is a capital and related financing activity and any cash flow that is not clearly attributable to a capital asset is not, the comments raised a related question--what is a capital asset? The Board decided that the determination of what is capitalizable is an accounting issue. The reporting of cash flow information is intended to complement the reporting of other accounting-generated financial information and is not intended to mirror the other financial statements. However, in making a capital/noncapital determination, it is appropriate to be guided by the accounting treatment. For cash flow reporting purposes, both tangible and intangible assets that are capitalized for accounting purposes should be considered capital items; for example, if capital improvements, water rights, or assets acquired subject to a capital lease are capitalized for accounting purposes, the related cash flows should be classified as capital and related financing activities. Investing Activities 64. As stated in paragraph 60, program loans should be classified as operating activities rather than investing activities. All other loan activities should be considered investing activities for cash flow reporting purposes. 65. In the ED, investment activities that occurred as a result of temporary investment of capital debt proceeds were required to be classified as capital and related financing activities. The Board s decision was influenced by the accounting treatment of interest required by FASB Statement No. 62, Capitalization of Interest Cost in Situations Involving Certain Tax-Exempt Borrowings and Certain Gifts and Grants. Some respondents pointed out potential difficulties associated with this treatment. Examples include classifying debt proceeds that are used to fund bond reserves and changing the classification of certain investments that might still exist at the time the capital asset is ready for its intended use. (The Board s original proposal would have required some type of allocation.) After weighing the costs and the benefits of the proposal, the Board decided to delete the provision and to require that all cash flows resulting from temporary investment of capital bond proceeds be classified as investing activities. 25

32 Reconciliation of Net Cash Flow from Operating Activities 66. As stated in paragraph 58, the Board believes the reconciliation of net cash flow from operating activities is simpler and more useful if it is a reconciliation to operating income (loss) rather than to net income (loss) for the year; however, it realizes that, because operating income is not authoritatively defined, governmental enterprises may not use the designation on their operating statements. Therefore, the reconciliation may be to net income (loss) instead. A reconciliation to operating income would be superior to a reconciliation to net income because the operating statements of governmental enterprises often include items that are categorized as nonoperating revenue (expense) or are reported as other changes in fund equity. Interest income, interest expense, gain or loss on sales of capital assets, grants to or from other governments, operating transfers to or from other funds, and residual equity transfers are examples of transactions that are reported in this manner. Furthermore, most of these kinds of transactions are classified in the statement of cash flows in categories other than operating activities. The Board believes that net cash provided by operating activities in governmental enterprises articulates better with the operating income (loss) than with the net income (loss) for the year and that a reconciliation based on that relationship is easier to understand and generally will include fewer reconciling items. 67. In the ED, the requirement for the location of the reconciliation of net cash flow from operations to operating income (or net income) depended on whether the direct or the indirect method had been used. If the direct method had been used, the reconciliation was required to be presented either in a separate schedule or in the notes to the financial statements. If the indirect method had been used, the reconciliation was required either to be presented within the statement of cash flows or to be provided in a separate schedule. It could not be presented in the notes because the reconciliation is, essentially, the indirect method and therefore a significant part of the statement itself. After considering respondents comments, the Board decided to eliminate the option of presenting the reconciliation in the notes to the financial statements even when the direct method is used. 26

33 Location of Noncash Information 68. The ED allowed noncash investing, capital, and financing activities to be disclosed either in narrative or in tabular form and to be presented in a schedule or in the notes to the financial statements. The Board agreed with respondents comments that the information was too important to be separated from the statement of cash flows. The Board therefore eliminated the option to present the information in the notes to the financial statements. Amendments to FASB Statement In February 1989, the FASB issued Statement No. 102, Statement of Cash Flows Exemption of Certain Enterprises and Classification of Cash Flows from Certain Securities Acquired for Resale. The GASB adapted the Statement to the governmental environment, where applicable. 70. The first issue addressed in FASB Statement 102 is an exemption of defined benefit pension plans and certain other employee benefit plans from the requirement to present a statement of cash flows. The GASB had addressed this issue in its ED and similarly exempted PERS and pension trust funds. 71. FASB Statement 102 also exempts certain highly liquid investment companies and certain other enterprises from the requirement to present a statement of cash flows. In order for investment companies to be exempt, they must be subject to the registration and regulatory requirements of the Investment Company Act of 1940 and they must meet four discriminating criteria: (a) substantially all investments must be highly liquid, (b) substantially all investments must be carried at market value, (c) the enterprise must have little or no debt, and (d) a statement of changes in net assets must be provided. In addition, FASB Statement 102 exempts investment enterprises that are essentially the same as the previously mentioned companies except that they are not subject to the Investment Company Act of 1940, as long as they meet the four criteria. The GASB studied the issues to determine whether these exempted organizations have governmental counterparts. The GASB determined that one possible governmental equivalent is an investment pool. Many 27

34 governmental investment pools, however, are accounted for as agency funds rather than proprietary or nonexpendable trust funds; therefore, this Statement would not apply to them. Any governmental investment pools that are accounted for as proprietary or nonexpendable trust funds would be within the scope of this Statement and should present a statement of cash flows as required by this Statement. Alternatively, there are other governmental investment pools that are organized as private-sector investment companies and report in a manner similar to investment companies. These pools, which look to the AICPA Audit and Accounting Guide, Audits of Investment Companies, for accounting and reporting guidance, should be guided by FASB Statements 95 and The FASB s exemption from the requirement to present a statement of cash flows also extends to common trust funds, variable annuity accounts, or similar funds maintained by a bank, insurance company, or other enterprise in its capacity as a trustee, administrator, or guardian for the collective investment and reinvestment of monies, but only if the previously mentioned four conditions are met. After studying the issues, the GASB concluded that certain governmental enterprises would, in many respects, meet the description of a common trust fund qualifying for exemption under FASB Statement 102. In fact, one respondent sought an exemption for its nonexpendable trust fund and referred to FASB Statement 102 as justification. Although certain governmental enterprises are similar to the enterprises exempted by FASB Statement 102, they generally do not provide a statement of changes in net assets as required by the AICPA Guide on audits of investment companies. FASB Statement 102 states that although the purpose and format of a statement of changes in net assets are different from those of a statement of cash flows, much of the information contained in those statements is similar (paragraph 21). Rather than allow certain proprietary and nonexpendable trust funds to adopt a separate basic financial statement (statement of changes in net assets), the GASB decided (see paragraph 14) to allow those governmental enterprises to net the purchase and sale activity of their highly liquid investments. The GASB believes the information provided net in a statement of cash flows is more useful than the information that would be provided in a statement of changes in net assets adapted to the governmental environment. 28

35 73. FASB Statement 102 also addresses the classification of cash flows associated with securities and other assets in trading accounts and certain loans originated or purchased specifically for resale. The FASB concluded that these assets are similar to inventory in that they generally are acquired for resale and are turned over very rapidly; therefore, the related cash flows should be classified as operating activities. The GASB is aware of no precise counterpart in government; consequently, no similar provision was made. However, a related issue is addressed by the Board in this Statement. Paragraph 19 provides for classifying certain program loan activities as operating activities when the program is a fulfillment of a governmental function and is the operation of the governmental enterprise. Other Provisions of FASB Statement Except for the modifications to the categories in FASB Statement 95 (including the expansion of the categories from three to four and the related redefinition of the categories) and the change in the focus of the reconciliation of net cash flow from operating activities, all other applicable provisions of FASB Statement 95 are present in this Statement. For example, the focus on cash and cash equivalents and the definitions of those terms, the general requirement to report gross amounts of cash receipts and payments rather than net amounts, the optional use of the indirect method to report net cash flow from operations, and the required disclosure of noncash investing, financing, and capital transactions are all incorporated in this Statement. To reduce the potential for other departures from FASB Statement 95, which might result from interpretation, the Board decided that, generally, the language in FASB Statement 95 should be repeated, where appropriate, in this Statement. As a result, the requirements and language in this Statement closely follow, and sometimes are identical to, the requirements and language in FASB Statement 95. However, in some instances, the FASB addresses cash flow issues (in FASB Statement 95 and subsequent amendments) that are largely irrelevant to governmental enterprises, and the GASB does not deal with them in this Statement. Certain governmental enterprises may need guidance in these few areas (for example, foreign currency cash flows) and may look to FASB Statement 95 and its amendments. 29

36 Appendix B ILLUSTRATIVE STATEMENT OF CASH FLOWS 75. This appendix provides sample financial statements to illustrate the preparation of a statement of cash flows for a hypothetical water and sewer enterprise fund. The illustrative statement of cash flows and supplemental information are prepared using the direct method and reconciling to operating income rather than net income. The indirect method could be illustrated by either substituting the data in the Reconciliation of operating income to net cash provided by operating activities for the data in the Cash flows from operating activities section of the statement of cash flows or by presenting Net cash provided by operating activities as a single line on the statement of cash flows and the detail (the reconciliation) as a separate schedule. Also included in this appendix are a comparative balance sheet for the water and sewer fund; a statement of revenues, expenses, and changes in retained earnings; and two paragraphs with explanatory details coded for easy reference. The changes in the balance sheet amounts for the year are explained and coded 15 in paragraph 76 to provide a crosswalk to the statement of cash flows. Paragraph 77 reconciles certain operating statement amounts with corresponding amounts in the statement of cash flows. These illustrative statements are intended as examples only and may provide more or less detail than is most useful for a particular governmental enterprise. 15 The letters (A N) correspond to the coding on the statement of cash flows and the reconciliation of operating income to net cash provided by operating activities; the numbers (1 14) correspond to the coding on the balance sheets. 30

37 Water and Sewer Fund Statement of Cash Flows for the Year Ended June 30, 19X2 Increase (Decrease) in Cash and Cash Equivalents Cash flows from operating activities: Cash received from customers $912,000 Cash payments to suppliers for goods and services (450,000) Cash payments to employees for services (300,575) Payment in lieu of taxes (50,000) Other operating revenues 15,075 Net cash provided by operating activities $126,500 Cash flows from noncapital financing activities: Net borrowings (repayments) under revolving loan arrangement $(20,000) J Interest paid on revolving loan (1,500) I Operating grants received 100,000 Operating transfers-out to other funds (75,000) Net cash provided by noncapital financing activities 3,500 Cash flows from capital and related financing activities: Proceeds from sale of revenue bonds $250,000 L Acquisition and construction of capital assets (350,000) F Principal paid on revenue bond maturities and equipment contracts (75,000) K,M Interest paid on revenue bonds and equipment contracts (33,500) H Proceeds from sale of equipment 10,000 Capital contributed by subdividers 60,000 N Net cash used for capital and related financing activities (138,500) Cash flows from investing activities: Purchase of investment securities $(125,000) C Proceeds from sale and maturities of investment securities 75,000 D Interest and dividends on investments 9,000 E Net cash used in investing activities (41,000) Net decrease in cash and cash equivalents (49,500) Cash and cash equivalents at beginning of year 175,600 Cash and cash equivalents at end of year $126,100 31

38 Reconciliation of operating income to net cash provided by operating activities: Operating income (loss) $(110,500) Adjustments to reconcile operating income to net cash provided by operating activities: Depreciation $245,000 Provision for uncollectible accounts 2,000 B Change in assets and liabilities: Increase in accounts receivable (15,000) A Decrease in inventory 2,000 Decrease in prepaid expenses 500 Increase in accounts payable 2,500 Total adjustments 237,000 Net cash provided by operating activities $ 126,500 Noncash investing, capital, and financing activities: Shortly before the balance sheet date, the Water and Sewer Fund entered into a time-pay agreement to purchase office equipment costing $7,500. There was no down payment and no monthly installments were made before year-end. Disclosure of accounting policy: For purposes of the statement of cash flows, the Water and Sewer Fund considers all highly liquid investments (including restricted assets) with a maturity of three months or less when purchased to be cash equivalents. (Note: This disclosure should be included in the summary of significant accounting policies.) 32

39 Water and Sewer Fund Balance Sheets 6/30/X2 6/30/X1 Change Assets: Cash and cash equivalents $ 125,100 $ 173,100 $(48,000) 1 Customer accounts receivable (net of allowance for uncollectibles of $7,500 and $5,500) 96,500 83,500 13,000 2 Inventory 46,000 48,000 (2,000) 3 Prepaid expenses 600 1,100 (500) 3 Restricted assets: Cash and cash equivalents 1,000 2,500 (1,500) 1 Investments 110,000 60,000 50,000 4 Interest receivable 1,000 1,500 (500) 5 Property, plant, and equipment, at cost 7,066,200 6,714, ,000 6 Accumulated depreciation (3,238,000) (2,995,000) (243,000) 7 Property, plant, and equipment, net 3,828,200 3,719, ,000 Total assets $4,208,400 $4,088,900 $119,500 Liabilities: Accounts payable and accrued expenses $ 68,000 $ 65,500 $ 2,500 3 Accrued interest payable 1, Revolving loan 3,000 23,000 (20,000) 9 Equipment contracts payable 7,500 10,000 (2,500) 10 Revenue bonds 575, , , Total liabilities $ 654,750 $ 489,250 $ 165,500 Fund equity: Contributed capital $1,795,000 $1,915,000 $(120,000) 12 Reserved retained earnings 112,000 64,000 48, Unreserved retained earnings 1,646,650 1,620,650 26, Total fund equity $3,553,650 $3,599,650 $(46,000) Total liabilities and fund equity $4,208,400 $4,088,900 $119,500 33

40 Water and Sewer Fund Statement of Revenues, Expenses, and Changes in Retained Earnings for the Year Ended June 30, 19X2 Operating revenues: Water sales $695,250 Sewer charges 231,750 Other operating revenues 15,075 Total operating revenues $ 942,075 Operating expenses: Costs of sales and services $507,300 Administration 250,275 Payment in lieu of taxes 50,000 Depreciation 245,000 Total operating expenses 1,052,575 Operating income (loss) $ (110,500) Nonoperating revenues (expenses): Interest income $ 6,500 Interest expense (28,000) Gain on sale of equipment 1,000 Operating grants 100,000 Net nonoperating revenues (expenses) 79,500 Net income (loss) before operating transfer (31,000) Transfers to other funds (75,000) Net income (loss) for the year (106,000) Add back depreciation on assets acquired with capital grants 180,000 Increase in retained earnings 74,000 Retained earnings beginning of year 1,684,650 Retained earnings end of year $1,758, The following information provides the details to the changes in the balance sheet amounts. The letters (A N) correspond to the coding on the statement of cash flows and the reconciliation of operating income to net cash provided by operating activities; the numbers (1 14) correspond to the coding on the balance sheets. 34

41 1. Net changes in cash and cash equivalents 2. Increase in customer receivables $15,000 A Increase in allowance for uncollectibles (2,000) B $13, Simple increase (decrease) traces directly to the reconciliation of operating income to net cash provided by operating activities 4. Purchase of investments $125,000 C Sales and maturities (75,000) D $ 50, Interest earned $ 8,500 ($6,500 revenue, $2,000 capitalized) Interest received (9,000) E $ Acquisition and construction $357,500 ($350,000 cash paid, F $7,500 time-pay) Cost of equipment sold (11,000) Net construction period interest: Expense $ 7,500 Income (2,000) 5,500 $352, Depreciation expense $245,000 G Accumulated depreciation on equipment sold (2,000) $243, Interest accrued $ 35,500 ($28,000 expense, $7,500 capitalized) Interest paid (35,000) ($33,500 H capital, $1,500 I noncapital) $ Short-term borrowing $ 5,000 Repayments (25,000) $20,000 J (qualifies for net reporting) 35

42 10. New contracts $ 7,500 Installments on old contracts (10,000) K $ (2,500) 11. New bonds sold $250,000 L Principal payments made (65,000) M $185, Subdivider contribution received $ 60,000 N Depreciation of assets bought with contributed capital (180,000) $(120,000) 13. Decrease in restricted cash and cash equivalents $ (1,500) Increase in restricted investments 50,000 Decrease in restricted interest receivable (500) Net increase in restricted assets $ 48, Net loss for the year $(106,000) Depreciation expense charged against contributed capital 180,000 Net increase in reserves (48,000) $ 26,000 36

43 77. The following information is provided as a reconciliation between certain amounts reported in the statement of cash flows and the amounts in the statement of revenues, expenses, and changes in retained earnings: Water sales $695,250 Sewer charges 231,750 Plus beginning receivables 89,000 Less ending receivables (104,000) Cash received from customers $912,000 Cost of sales and services $507,300 Administration 250,275 Plus: Allowance for uncollectibles, 6/30/X1 5,500 Inventory, 6/30/X2 46,000 Prepaids, 6/30/X2 600 Accounts payable, 6/30/X1 65,500 Less: Allowance for uncollectibles, 6/30/X2 (7,500) Inventory, 6/30/X1 (48,000) Prepaids, 6/30/X1 (1,100) Accounts payable, 6/30/X2 (68,000) Cash paid to suppliers and employees 750,575 Less cash paid to employees (300,575) Cash paid to suppliers $450,000 Proceeds from sale of equipment $ 10,000 Cost of equipment sold (11,000) Accumulated depreciation on equipment sold 2,000 Net gain on sale $ 1,000 37

44 Appendix C CODIFICATION INSTRUCTIONS 78. The sections that follow update the June 15, 1987 Codification of Governmental Accounting and Financial Reporting Standards for the effects of this Statement. Only the paragraph number of this Statement is listed if the paragraph will be cited in full in the Codification. * * * SUMMARY STATEMENT OF PRINCIPLES SECTION 1100 Sources: [Add the following:] GASB Statement c. [Revise parenthetical phrase as follows:] (and cash flows of proprietary fund types and nonexpendable trust funds) e. [Revise parenthetical phrase as follows:] (and cash flows of proprietary fund types and nonexpendable trust funds) [NCGAS 1, pp. 2 4, as amended by GASBS 6, 13 and 15; NCGAS 7, 7, 8, and 25; GASBS 5, 7; GASBS 6, 17; and GASBS 9, 6] * * * FINANCIAL REPORTING SECTION 1900 Sources: [Add the following:] GASB Statement 9 Statement of Principle Interim and Annual Financial Reporting [Revise general principle as follows:] c. [Revise parenthetical phrase as follows:] (and cash flows of proprietary fund types and nonexpendable trust funds) e. [Revise parenthetical phrase as follows:] (and cash flows of proprietary fund types and nonexpendable trust funds) [NCGAS 1, 128; NCGAS 7, 7, 8, and 25; GASBS 5, 7; and GASBS 9, 6] 38

45 .113b(2)(e) [Revise as follows:] Combined Statement of Cash Flows All Proprietary Fund Types and Nonexpendable Trust Funds [NCGAS 1, 139, as amended by NCGAS 7; GASBS 5, 7; and GASBS 9, 6] * * * COMPREHENSIVE ANNUAL FINANCIAL REPORT SECTION 2200 Sources: [Add the following:] GASB Statement 9 [Revise general principle as follows:] Statement of Principle Annual Financial Reporting b. [Revise parenthetical phrase as follows:] (and cash flows of proprietary fund types and nonexpendable trust funds) [NCGAS 7, 7 and 8; GASBS 5, 7; and GASBS 9, 6].105b(2)(e) [Revise as follows:] Combined Statement of Cash Flows All Proprietary Fund Types and Nonexpendable Trust Funds [NCGAS 1, 139; NCGAS 7, 15; GASBS 5, 7; and GASBS 9, 6].106b(2) [Revise items (b), (d), and (e) as follows:] (b) A Combined Statement of Cash Flows All Proprietary Fund Types (See Section 2450, Cash Flows Statements. ) (d) Combining statements of proprietary fund cash flows (e) Individual statements of revenues, expenses, and changes in retained earnings (or equity) and of cash flows for each proprietary fund type where necessary to present fund operating results and cash flows and schedules necessary to demonstrate compliance with finance-related legal and contractual provisions [NCGAS 1, 143 and GASBS 9, 6].106b(3)(a) [Add the following at the end of the subsection:], except that pension trust funds are not required to present a statement of cash flows [NCGAS 1, 143 and GASBS 9, 6].112 [Revise paragraph as follows (deleting footnote 6):] Statements of Cash Flows. Statements of cash flows are required to be presented for proprietary fund types, 39

46 nonexpendable trust funds, and governmental entities that use proprietary fund accounting. As described above for the other statements at the GPFS (Combined Statements Overview) level, the Combined Statement of Cash Flows All Proprietary Fund Types and Nonexpendable Trust Funds should present the separate data for each major fund type in a columnar format and may contain a total column, with or without interfund eliminations. Total columns of combining statements of cash flows by fund type should agree with the column for that fund type in the Combined Statement of Cash Flows All Proprietary Fund Types and Nonexpendable Trust Funds. Any interfund and similar eliminations made should be consistent with eliminations made in the other financial statements and should be apparent from the headings or disclosed in the notes to the financial statements. [NCGAS 1, 156 and GASBS 9, 6 and 36].129e [Revise as follows:] Combined Statement of Cash Flows All Proprietary Fund Types and Nonexpendable Trust Funds (See Section 2450.) [NCGAS 1, 167; SOP 80-2, 4; GASBS 5, 7; and GASBS 9, 6] Nonauthoritative Discussion [Revise paragraph.607 and related heading as follows:] Combined Statement of Cash Flows All Proprietary Fund Types and Nonexpendable Trust Funds.607 Section 2450 provides an example of a statement of cash flows for proprietary fund types and nonexpendable trust funds. [Delete example.] * * * NOTES TO FINANCIAL STATEMENTS SECTION 2300 Sources: [Add the following:] GASB Statement [Revise as follows:] Section 2200, Comprehensive Annual Financial Report, requires the presentation, within liftable GPFS, of notes to the financial statements that are essential to present fairly the financial position of the fund types and account groups, 40

47 the results of operations by fund type, and the cash flows of proprietary fund types and nonexpendable trust funds. [NCGAI 6, 2 and GASBS 9, 6].104a [Add item (6) as follows:] (6) Definition of cash and cash equivalents used in the statement of cash flows for proprietary fund types and nonexpendable trust funds (See Section 2450, Cash Flows Statements, paragraph.106.) [Add a new section as follows:] * * * CASH FLOWS STATEMENTS SECTION 2450 Source: GASB Statement 9 Scope of This Section.101 This section establishes standards for reporting cash flows of proprietary and nonexpendable trust funds and governmental entities that use proprietary fund accounting, 1 including public benefit corporations and authorities, governmental utilities, and governmental hospitals. [GASBS 9, 1 and 8] Applicability of This Section.102 The provisions of this section are applicable to proprietary funds, nonexpendable trust funds, and governmental entities that use proprietary fund accounting, 2 including public benefit corporations and authorities, governmental utilities, and governmental hospitals. Some governmental colleges and universities report their transactions and balances within the governmental model using National Council on Governmental Accounting (NCGA) Statement 1, Governmental Accounting and Financial Reporting Principles. This section applies to the proprietary and nonexpendable trust funds of those governmental colleges and universities. However, this section is not required to be applied to those governmental colleges and universities that follow the specialized industry 1 [GASBS 9, fn1] 2 [GASBS 9, fn3] [Change Statement to section. ] 41

48 accounting and reporting principles contained in the American Institute of Certified Public Accountants (AICPA) Industry Audit Guide, Audits of Colleges and Universities. [GASBS 9, 5 and fn4] Financial Reporting of Cash Flows.103 [GASBS 9, 6] Purpose of a Statement of Cash Flows.104 [GASBS 9, 7] Focus on Cash and Cash Equivalents [GASBS 9, 8 11] [Change Statement to section, footnote numbers, and cross-references as appropriate.] Gross and Net Cash Flows [GASBS 9, 12 14] [Change footnote number and cross-references as appropriate.] Classification of Cash Receipts and Cash Payments [GASBS 9, 15 28] [Change footnote numbers and cross-references as appropriate.] Distinguishing between Capital and Noncapital Financing.126 [GASBS 9, 29] Content and Form of a Statement of Cash Flows [GASBS 9, 30 36] [Change cross-references as appropriate.] Information about Noncash Investing, Capital, and Financing Activities.134 [GASBS 9, 37] 42

49 Nonauthoritative Discussion.601 [GASBS 9, Appendix B] [Change Statement to section, footnote numbers, and cross-references as appropriate.] * * * SEGMENT INFORMATION FOR ENTERPRISE FUNDS SECTION 2500 Sources: [Add the following:] GASB Statement [Revise the second sentence as follows:] Segment information may also be reported by (a) including individual enterprise fund statements as columns on the Combined Statement of Revenues, Expenses, and Changes in Retained Earnings (or Equity) All Proprietary Fund Types and the Combined Statement of Cash Flows All Proprietary Fund Types and Nonexpendable Trust Funds or (b) including the combining enterprise fund statement of revenues, expenses, and changes in retained earnings (or equity) and the combining enterprise fund statements of cash flows as part of the GPFS. [NCGAI 2, 8 and GASBS 9, 6] * * * REPORTING ENTITY AND COMPONENT UNIT SECTION 2600 PRESENTATION AND DISCLOSURE Sources: [Add the following:] GASB Statement 9 Statement of Principle Reporting Entity and Component Unit Presentations [Revise the general principle as follows:] b. [Revise parenthetical phrase as follows:] (and cash flows of proprietary fund types and nonexpendable trust funds) d. [Revise parenthetical phrase as follows:] (and cash flows of proprietary fund types and nonexpendable trust funds) [NCGAS 1, 128; NCGAS 7, 7 and 8; GASBS 5, 7; and GASBS 9, 6] 43

50 .118b [Revise parenthetical phrase as follows:] (and cash flows of proprietary fund types and nonexpendable trust funds) [NCGAS 7, 25; GASBS 5, 7; and GASBS 9, 6] * * * COLLEGES AND UNIVERSITIES SECTION Co5 Sources: [Add the following:] GASB Statement [Add the following to the beginning of the list in the paragraph:] 2450, Cash Flows Statements 1 [GASBS 2 through 9 and GASBI 1] 1 This section applies to the proprietary and nonexpendable trust funds of those governmental colleges and universities that report their transactions and balances within the governmental model using National Council on Governmental Accounting (NCGA) Statement 1, Governmental Accounting and Financial Reporting Principles. However, this Statement is not required to be applied to those governmental colleges and universities that follow the specialized industry accounting and reporting principles contained in the American Institute of Certified Public Accountants (AICPA) Industry Audit Guide, Audits of Colleges and Universities. [GASBS 9, fn4] * * * HOSPITALS SECTION Ho5 Sources: [Add the following:] GASB Statement [Add the following to the beginning of the list in the paragraph:] 2450, Cash Flows Statements [GASBS 2 through 9 and GASBI 1] * * * PENSION FUNDS ACCOUNTING SECTION Pe5 Sources: [Add the following:] GASB Statement [Revise paragraph as follows:] PERS annual financial statements should contain (a) a balance sheet showing total assets, liabilities, and the total actuarial present value of credited projected benefits, (b) a statement of revenues, expenses, and changes in fund balance, and (c) disclosures in accordance with Section Pe6. PERS and pension trust funds are not required to present either a statement of changes in financial position or a 44

51 statement of cash flows. [NCGAS 6, 27, as amended by GASBS 5, 4; and GASBS 9, 5].602 [Delete Example 3.] * * * PUBLIC BENEFIT CORPORATIONS AND AUTHORITIES SECTION Pu5 Sources: [Add the following:] GASB Statement 9 [Add the following to the beginning of the list in footnote 1:] 2450, Cash Flows Statements [GASBS 2 through 9 and GASBI 1] * * * UTILITIES SECTION Ut5 Sources: [Add the following:] GASB Statement 9 [Add the following to the beginning of the list in footnote 1:] 2450, Cash Flows Statements [GASBS 2 through 9 and GASBI 1] 45