Accounting Complexities Facing Government Entities

Accounting Complexities Facing Government Entities By Andrew Laflin, CPA CliftonLarsonAllen 1 1

Learning Objectives This session will provide answers to a series of questions that present complex and often overlooked accounting and financial reporting issues. Examples include Capitalization of interest Revenue recognition from non-exchange transactions Accounting for materials & supplies Interfund loans Pollution remediation obligation On-behalf fringe benefit payments Debt refunding transactions and more!! We re going to try to have a little fun while doing it 2

Question #1 The Finance Director for the City of Tatooine stated that the City records expenditures for materials and supplies in its governmental funds under the purchases method (report as an expenditure immediately when purchased). Therefore, there will never be an ending inventory asset balance on the City s governmental fund balance sheet. Is this accounting treatment correct? 3

Answer #1 Expenditures for materials and supplies of governmental funds may be reported using either the purchases method or the consumption method (the original purchase of materials or supplies is reported as an asset, and an expenditure is reported when the supplies are actually used, or consumed). Regardless of which method is used, significant amounts of inventory should be reported in the governmental fund balance sheet of the City of Tatooine at its fiscal year end. Materiality considerations would need to be made. [Guidance: GASB Cod. Sec. 1600.127a] 4

Question #2 The general fund for Naboo County advanced the golf course fund $150k this year to help it sustain itself, since revenues are down considerably. The golf course fund is expected to pay the general fund back once greens fees start to pick up again, which won t be any time soon. Since this transaction seems to be a long term advance, we didn t record it in the general fund because repayment isn t expected within the availability period. Is this accounting treatment correct? 5

Answer #2 Interfund loans should be reported as fund assets and liabilities, even if the loan or advance payable is not considered currently due and payable and bears interest. For interfund loans receivable, resulting fund balance equal to the long-term portion of the receivable should generally be reported as nonspendable. (GASB 34, para 112) GASB 34, para 112 also requires that if repayment of an interfund loan is not expected within a reasonable time, the interfund balances should be eliminated. 6

Question #3 The City of Coruscant s water & sewer fund issued bonds to finance the construction of a new water purification plant. The bond indenture does not restrict the use of the bond proceeds to that specific project. So for that reason, can we conclude it s not necessary to capitalize any interest, since, after all, the whole concept of capitalization of interest seems pretty stupid anyways? 7

Answer #4 Short answer: Yes, you need to capitalize interest if it s material to that fund. FASB 34 provides guidance for capitalization of interest on qualifying assets whenever an entity has outstanding debt. FASB 62 amends FASB 34 to prohibit the capitalization of interest for assets acquired by contributions and grants that restrictively specify the type of asset that may be purchased or constructed. It also provides different guidance in situations in which a government issues tax-exempt debt that is externally restricted by the bond indenture to finance specific capital assets. GASB 37, para. 6, clarifies that these standards do not apply to general capital assets. 8

FASB 34 Cap Interest Sample Problem 9

FASB 34 Cap Interest Sample Solution 10

FASB 34 Cap Interest Sample Solution cont. 11

FASB 34 Cap Interest Sample Solution cont. 12

FASB 62 Cap Interest Sample Problem 13

FASB 62 Cap Interest Sample Solution 14

FASB 62 Cap Interest Sample Solution cont. 15

FASB 62 Cap Interest Sample Solution cont. 16

Question #4 The City of Endor constructed various roadway and landscaping improvements in the City s downtown area. This was at the request of a developer, who had undertaken major redevelopment projects along a strip of retail centers downtown. The developer has agreed to fund the incremental improvements initially paid for by the City. The developer has agreed to fund at the earlier of Certificate of Occupancy for the new building they are constructing or 4 years. The City funded the roadway and landscaping improvements with LOGT (local option gas tax) revenues received from the state that are required by state statute to be used only for roadway maintenance and improvement projects. The capital outlay activity is recorded in the City s Gas Tax special revenue fund. 17

Question #4, cont. Upon analyzing revenue recognition in this scenario, does GASB 33 apply? Would the answer be different if the developer didn t own property in the City s downtown district and made a donation b/c he s super wealthy and is a big proponent of downtown improvement projects? Should a receivable from the developer be recorded? If so, when and at what amount? Should the receivable just offset the costs, or should the receivable generate revenue and the costs remain on the books as a long-term asset? What impact does this have on governmental fund balance and government-wide net assets? 18

Answer #4 If not considered an exchange transaction, then this contribution to the City is in the form of a pledge or promise. Revenue should be recognized when all eligibility requirements are met. However, GASB 33, paragraph 25 establishes additional recognition thresholds for these types of contributions the promise/pledge must be verifiable and the revenues must be measurable and probable of collection. The term probable is defined in the same way as in GASB 10. Probable, according to GASB 10, is defined as the future event or events are likely to occur. 19

Answer #4, cont. Per GASB 33, paragraph 20, there are four kinds of eligibility requirements: 1) Required Characteristics of Recipients (i.e. the recipient has the characteristics specified by the provider) 2) Time Requirements (i.e. period in which resources are required to be used, as specified by the provider 3) Reimbursements 4) Contingencies (i.e. the provider s offer of resources is contingent upon a specified action of the recipient. For example, the recipient is required to raise a specific amount of resources from third parties or to dedicate its own resources for a specified purpose). 20

Answer #4, cont. Q Should the amount reported in governmental funds as restricted fund balance equal the amount reported as restricted net assets for governmental activities in the government-wide statement of net assets? (GASB Comprehensive Implementation Guide Q&A2010-Z.54.10) A There are three reasons why those amounts will generally be different. First, the principal amount of a permanent fund is classified as nonspendable fund balance in the governmental fund financial statements but is included in restricted net assets in the government-wide statement of net assets. Second, reconciling items that represent basis of accounting differences may cause the amounts to be different. And, finally, internal service fund net assets are generally included with governmental activities. 21

Question #5 22 Elevated levels of arsenic were detected in isolated areas at the Town of Alderaan s public nature park preserve, portions of which used to be a former landfill site many moons ago. Safeguards such as access restrictions using fencing and warning signs were put into place to protect the public. The Minnesota Pollution Control Agency indicated that, despite these efforts, further action was necessary before the case could be closed. A site assessment including soil and groundwater sampling was completed. The soil sample indicated that the material of concern is not isolated to a few locations, but that there are low levels of contaminated soil across the site. More sampling is needed to meet the Agency s assessment requirements, which is the current status of this situation. Does a pollution remediation obligation liability need to be recorded? If so, to what fund?

Answer #5 According to GASB 49, once any of the five obligating events specified below occurs, a government is required to estimate the components of expected pollution remediation outlays and determine whether outlays for those components should be accrued as a liability. 1) Compelled to take action b/c of an imminent endangerment 2) Violation of pollution prevention-related permit or license 3) Named, or will be named, by a regulator as a responsible party or potentially responsible party (PRP) for remediation, or as a government responsible for sharing costs 4) Named, or will be named, in a lawsuit to compel participation in pollution remediation 5) Commencement, or legally obligates itself to commence pollution remediation 23

Answer #5, cont. Next question: is the range of outlays for one or more components of the pollution remediation obligation reasonably estimable? (GASB 49 does not define reasonably estimable). If estimable, then record a liability (upon considering possible capitalization of all or a portion of the cost and reducing by potential recoveries) If not estimable, then disclose only 24

Question #6 The State of Florida levies a tax on property, casualty, and auto insurance premiums, the proceeds of which are distributed to local governmental entities that maintain qualified police officers and firefighters pension plans. Degobah City received an annual $70,000 distribution of state premium tax collections for its municipal firefighter pension plan. The City s accounting clerk recorded a $70k increase in assets and contribution revenue within the municipal fire pension trust fund; no other entries were made relating to this state contribution. Was this accounting treatment proper? 25

Answer #6 The chapter 175/185 state premium tax refunds contributed to local government police officer and firefighter pensions are considered on-behalf payments for fringe benefits. According to GASB 24, on-behalf payments for fringe benefits and salaries are direct payments made by one entity to a third-party recipient for the employees of another legally separate entity (the employer government). An employer government should recognize revenue and expenditures or expenses for on-behalf payments for fringe benefits and salaries. [GASB 24 Accounting and Financial Reporting for Certain Grants and Other Financial Assistance] 26

Question #7 Hoth County issued $10,410,000 (5 yr. $10m 9% bond issued in an 8% market) of Utility System Refunding Bonds to refund the Utility System Revenue Bonds, Series 1996, within its Water & Sewer Fund. The remaining principal balance on the revenue bonds was $8,800,000, along with accrued interest of $325,000. The proceeds were also used to pay $150,000 of issuance costs incurred on the refunding bonds, as well as a fee of $45,000 in order to retire the revenue bonds before their actual maturity date. The $8.8m revenue bonds had a remaining unamortized discount of $221,000 plus remaining unamortized bond issue costs of $67,000. 27

Question #7, cont. Is this considered a current refunding or advance refunding? What s the difference between the two? Does Hoth County have gain or loss on the bond refunding? Does that get taken into income immediately or deferred? If it must be deferred, can Hoth County use the straight-line method to amortize it? Can Hoth County use the straight line method to amortize the premium and the issuance costs on the refunding bonds? Ok, no more questions! 28

Answer #7 Refundings involve the issuance of new debt whose proceeds are used to repay previously issued ( old ) debt. The new debt proceeds may be used to repay the old debt immediately (a current refunding); or the new debt proceeds may be placed with an escrow agent and invested until they are used to pay principal and interest on the old debt at a future time (an advance refunding). As described in paragraphs 3 and 4 of GASB Statement 7, an advance refunding may result in the in-substance defeasance of the old debt provided that certain criteria are met. [GASBS No. 23] 29

Answer #7, cont. Reacquisition Price of the Old Debt (Principal amount remaining on the old debt plus any call premium or any miscellaneous reacquisition costs that must be paid to refund the debt currently) (Accrued interest should not be included in the reacquisition price for a current refunding, but should be recorded as interest expense, as discussed in the GASB Comprehensive Implementation Guide 2011-2012, Question Z.23.1.) Less: Net Carrying Amount of the Old Debt (Amount due at maturity for the old debt plus or minus any unamortized debt premium/discount and debt issue costs related to the old debt.) [GASBS No. 23] 30

Answer #7, cont. The deferred amount should be reported in the proprietary fund statement of net assets as a deduction from or an addition to the new debt liability. The deferred amount may be reported in the statement of net assets either on a net basis or on a gross basis. A deferred amount reported on a net basis is added to, or deducted from, the refunding debt liability, with either parenthetical or note disclosure of the deferred amount on refunding. Reporting on a gross basis means displaying both the debt liability and deferred amount in the statement of net assets (the deferred amount should not be reported as an asset). Premiums/discounts and debt issue costs pertaining to the new debt issue should be deferred and amortized separately. 31

Answer #7, cont. GASBS No. 23, paragraph 5, requires deferral of the difference between the net carrying amount of the prior refunding debt and the cost/reacquisition price of the new debt, together with the unamortized balance from the prior refunding. The deferred amount should be amortized as an element of interest expense in a systematic and rational manner over the shorter of the original amortization period remaining from the prior refundings or the life of the latest refunding debt (the new debt). 32

Answer #7, cont. APBO No. 21, Interest on Receivables and Payables, and GASBS No. 62, paragraph 185, require a debt issuance discount or premium to be amortized as interest expense or interest income over the life of the debt using the interest method. APBO No. 12, Omnibus Opinion 1967, paragraph 16, and GASBS No. 62, paragraph 186, describe the interest method as follows: The objective of the interest method is to arrive at a periodic interest cost (including amortization) that will represent a level effective rate on the sum of the face amount of the debt and (plus or minus) the unamortized premium or discount and expense at the beginning of each period. The difference between the periodic interest cost so calculated and the nominal interest on the outstanding amount of the debt is the amount of periodic amortization. 33

Answer #7, cont. APBO No. 12 and GASBS No. 62, paragraph 187, also require proprietary and fiduciary funds to defer debt issue costs and amortize those costs as a component of interest expense over the life of the debt. These costs should be reported separately as deferred charges. They should not be reported as a deduction from the reported amount of debt. The bond issuance costs should be amortized as an element of interest expense in a systematic and rational manner over the shorter of the original amortization period remaining from the prior refundings or the life of the latest refunding debt (the new debt). 34

Question #8 Death Star County has a water and sewer fund. All utilities customers are required to pay an initial deposit as part of the application process to hook up into the County s water & sewage system. The deposit is refunded once the property s ownership is transferred to a new customer. The refund includes both the original deposit plus interest earned over that time period. How does this get reported on Death Star County s Proprietary Statement of Cash Flows? 35

Answer #8 Cash flows from deposits made by customers, and the eventual repayment of the deposits, should be classified as operating activities because the transactions do not meet the definitions of either the financing activities categories or the investing activities category. (The operating activities category is the residual category.) Although customer deposit transactions are considered operating activities, interest earned on the deposits is an investing activity. (However, distribution of the interest to customers is an operating activity because the cash flow does not meet the definition of any of the other categories.) GASB Comprehensive Implementation Guide 2011-2012, Question 2.21.4 and 2.24.1. 36

Question #9 The Finance Director at the City of Kashyyyk knows that, upon implementing GASB 54, she is not supposed to report the balance of outstanding encumbrances separately on the face of the governmental fund balance sheet. So all encumbrances are reported as assigned. Is this treatment correct even though all purchase orders over $10k are sent to the City Commission for approval? Commissioners are also are a signing party to long term executed contracts with service providers for both operating and capitalrelated projects to the City of Kashyyyk. 37

Answer #9 Paragraph 10 of GASB 54: Committed fund balance also should incorporate contractual obligations to the extent that existing resources in the fund have been specifically committed for use in satisfying those contractual requirements. 38

Answer #9, continued GASB Implementation Guide Q&A 2010 Z.54.11: The agreement between a government and a counterparty (a capital lease agreement or out-of-court settlement award, for example) sufficiently binds the government to spending for a specific purpose and therefore constitutes the commitment. Often, scheduled payments to liquidate or reduce those obligations are included in a government s budget and are expected to be paid from current period revenues. Fund balance should be classified as committed only if the government commits existing resources, rather than future revenues, to satisfy the contractual obligation (to the extent that the obligation is not recognized as a fund liability). 39

Question #10 Ok, I m getting tired of receiving GFOA comments every year on my government s CAFR relating to GASB 40 disclosures on cash & investments. I know it has to do with all those deposit and investment risks that we re supposed to disclose, but it seems like every year we re missing one thing or another. I m about to pull my hair out! Can you please help? 40

General Risk Disclosures Custodial credit risk is my investment backed? Credit Risk is the issuer financially strong? Concentrations of credit risk are all my eggs in one basket? Interest rate risk will changes in interest rates affect fair value? Foreign currency risk are deposits and investments exposed to foreign currency risk 41

General Risk Disclosures Governments are required to disclose their policy related to each of the above risks that apply to that entity If a policy doesn t exist, then state that fact An informal policy is the same as having no policy Do not need to disclose policies for risks that don t apply For ex: If not subject to interest rate risk, then don t disclose your policies related to interest rate risk 42

Custodial Credit Risk Deposits Applies only to deposits Determination should be made based on bank balances Must disclose the balances at risk Required disclosure amounts Uncollateralized amounts Collateralized but with the collateral securities held by the pledging financial institution Collateralized with securities held by the pledging financial institution's trust department or agent but not in the government's name 43

Custodial Credit Risk Investments Only applies to investment securities Exposure exists when investments are Uninsured, and Not registered in your name, and are held by someone else o o Counterparty Counterparty s trust department, but not in your name 44

Credit Risk Applies to the following Debt securities except those explicitly guaranteed by the U.S. government (example U.S. Treasuries, GNMA, not Freddie Mac or FNMA or FHL) External investment pools Money market mutual funds Bond mutual funds Other pools of fixed-income securities A security is a transferrable financial instrument that evidences ownership or creditorship, whether in physical or book entry form. 45

Credit Risk (continued) Disclose credit rating by type (ignore +/-) Disclose the securities that are not rated Disclose investment policy for the risk, or that you don t have a policy 46

Concentration of Credit Risk Disclose investments that exceed 5% of total investments Disclose issuer and dollar amount Excludes o o o o Investments explicitly guaranteed by the U.S. government Mutual funds External investment pools Other pooled investments Disclose investment policy for managing the risk, or that you don t have a policy 47

Interest Rate Risk Disclose type of debt security and amount Excludes equity mutual funds (clarified by GASB 53) Five methods of disclosure Specific identification Segmented time distribution Weighted average maturity Duration Simulation model methods (ya right) Can use more than one method for disclosure Once a choice is made, it must be used consistently 48

Foreign Currency Risk Must disclose the U.S. dollar balances of any deposits or investments exposed to foreign currency risk. Disclosure should be organized by: Currency denomination Investment type if applicable 49

THE END!!! ANY QUESTIONS? 50