Solution manual advanced accounting 11th edition joe ben hoyle chap017

Chapter 17 - Accounting for State and Local Governments, Part II CHAPTER 17 ACCOUNTING FOR STATE AND LOCAL GOVERNMENTS, PART II Chapter Outline I This chapter looks at the reporting for a number of significant transactions that are common for state and local governments For example, these entities often obtain property by lease rather than by purchase A Leases are recorded as either capital leases or operating leases based upon the criteria first established by the Financial Accounting Standards Board (FASB) for the reporting of for-profit businesses Thus, a lease that meets any one of the following criteria is a capital lease for either a state or local government or a for-profit business a The lease transfers ownership of the property to the lessee by the end of the lease term b The lease contains an option to purchase the leased property at a bargain price c The lease term is equal to or greater than 75 percent of the economic life of the leased property d The present value of minimum lease payments equals or exceeds 90 percent of the fair value of the leased property B For a state or local government, the recording of a capital lease depends on the set of financial statements being prepared a In government-wide financial statements, a capital lease is reported as an asset and liability at the present value of the minimum leases payments and then depreciation expense (of the asset’s cost) and interest expense (on the liability balance) are recognized over time b In the fund financial statements for the governmental funds, the present value of the minimum lease payments is recorded as an expenditure and as an other financing source Eventual interest and principal payments are recorded as expenditures No depreciation is reported because capital assets are not recognized in the governmental funds II Governments often establish solid waste landfills for use by the citizens and businesses These facilities can be recorded either within the proprietary funds, if a user fee is assessed, or as part of the General Fund if the landfill is open to the public without a charge A A landfill can eventually create a large liability for the government because of closure costs and postclosure maintenance and monitoring B On government-wide financial statements, recognition of this liability is based on accrual accounting and the economic resource measurement focus Thus, the liability is recognized proportionally as the available space becomes filled If the landfill is recorded as an Enterprise Fund, this same reporting is also appropriate for fund financial statements C If the landfill is reported within the General Fund, the liability is only reported on the fund statements when a claim to current financial resources comes into existence 17-1 Chapter 17 - Accounting for State and Local Governments, Part II III Many, if not most, governments incur a liability for compensated absences (vacations, for example, and sick pay) earned by employees such as school teachers, police officers, and sanitation workers A Government-wide financial statements require recognition of this liability and expense as incurred based on accrual accounting and the economic resource measurement focus B Fund financial statements record a liability only if the claim is to be paid from current financial resources (such as within a specified period into the subsequent year) IV Works of Art and Historical Treasures A Artworks, historical treasures, and similar assets should be capitalized at cost (or fair value at the date of donation) in government-wide financial statements B An expense rather than an asset can be recorded but only if the item does not generate economic benefits and meets the following three criteria a Held for public exhibition, education, or research in furtherance of public service, rather than financial gain b Protected, kept unencumbered, cared for, and preserved c Subject to the policy that revenues generated from sales of items in the collection be used to add to the collection C If capitalized, depreciation is not required if this type of asset is considered to be inexhaustible D On fund financial statements for the governmental funds, an expenditure is recognized for any acquisitions because the acquired property is not a current financial resource V Infrastructure Assets and Depreciation A Newly-acquired infrastructure assets (such as roads, bridges, and sidewalks) are capitalized at historical cost in the government-wide financial statements and recorded as an expenditure in the fund financial statements A Major general infrastructure assets put into service since 1980 are also capitalized although an estimation of current book value may be necessary if accurate cost figures were not retained B Depreciation of all capital assets other than land and inexhaustible artworks is required Thus, infrastructure items are also subject to depreciation C However, the “modified approach” allows the expensing of maintenance costs in lieu of depreciation for infrastructure assets if certain criteria are met a A minimum acceptable condition level is established for a network of infrastructure assets and documentation is provided to verify that this minimum level has been maintained b An asset management system must be in place to monitor the condition of the items in this system of assets VI Primary governments must produce a comprehensive annual financial report (CAFR) which includes general purpose external financial statements These statements are divided into three distinct sections A Management’s discussion and analysis (MD&A) which provides a broad range of information to help decision-makers evaluate the operations and financial position of the government entities 17-2 Chapter 17 - Accounting for State and Local Governments, Part II B Financial statements a Government-wide financial statements b Fund financial statements c Notes to the financial statements C Other required supplementary information VII In governmental accounting, general purpose governments (such as a city, town, county, state or the like) are primary governments that must produce a CAFR In producing this CAFR, the government may also have to include component units which are legally separate organizations or activities A Any agency, board, of the like that meets either of the following two criteria are also reported as component units within the CAFR of the primary government even though they are independent operations a It must be fiscally dependent upon the primary organization and the primary government and the component unit must be financially interdependent (there is a relationship of potential financial benefit or burden between the two of them) or b The primary government must appoint a voting majority of the governing board and either be able to impose its will on the board or the organization provides a financial benefit or it imposes a financial burden on the primary government B Once identified, component units can be discretely presented in a separate column on the right side of the government-wide statements or blended with the primary government as if it made up one of the funds within the primary organization C In addition, a special purpose government (such as a school board, university, or water commission) qualifies as a primary government if it meets the following three criteria: a It has a separately elected governing body b It is legally independent c It is fiscally independent of any other state and local governments VIII Public colleges and universities are required to meet GASB standards for reporting purposes, whereas private schools are required to use FASB standards A Private colleges and universities generally depend more on tuition and usually have greater endowments whereas governments generally provide the major support for public schools B GASB assumes public colleges and universities are special purpose entities so that they have to use the same reporting model as a state or local government However, many of these schools assume that they function solely as an Enterprise Fund (open to the public for a user charge) These schools are allowed to produce fund financial statements (for a proprietary fund) without need for government-wide statements The government-wide statements are viewed as redundant 17-3 Chapter 17 - Accounting for State and Local Governments, Part II Answer to Discussion Question Is It Part of the County? In financial accounting for a for-profit organization, the boundary for the reporting entity and its various activities (or subsidiaries) is relatively easy to determine US GAAP provides the basis for inclusion in the consolidated financial statements, which includes all entities over which a company has control In accounting for state and local governments, the distinction is not so clear What constitutes a reporting entity? Obviously, a primary government such as a city or county is a reporting entity What about other governmental operations and activities that exist but which are separate from a primary government? When those operations qualify as special purpose governments and when should they be viewed as component units to be reported along with a primary government? A special purpose government is also a primary government for reporting purposes To qualify, it must have a separately elected governing body, be legally independent, and also be fiscally independent Fiscal independence constitutes setting its own budget, levying taxes, and/or issuing bonds without outside approval Here, the industrial development commission is not fiscally independent of Harland County Harland County has the ability to impose its will on the separate organization by its right to approve the commission’s budget Therefore, the industrial development commission is not a special purpose government Is the industrial development commission a component unit? An activity is classified as a component unit if it is fiscally dependent on a primary government In addition, the primary government and the component unit must be financially interdependent (there is a relationship of potential financial benefit or burden between the two of them) Here, because the commission’s budget must be approved by the county government and deficits will be covered by the county, the commission appears to qualify as a component unit for Harland County Can the commission also be a component unit of the state? There is not fiscal dependence but a component unit does exist if the primary government appoints a voting majority of the board and (a) the primary government can impose its will on that board or (b) the separate organization provides a financial benefit for the primary government or imposes a financial burden The state appoints 15 out of 20 of the board members Appointment of that number of board members indicates state control However, there is no evidence or information here that indicates that the state can impose its will on the board or that the separate organization provides a financial benefit or imposes a financial burden on the state (as it does on the county) Therefore, unless other information becomes available indicating that one these requirements is present, the industrial commission is not a component unit of the state However, because of the appointment of the majority of the board, the commission is a related organization to the state In that case, the state must disclose the nature of the relationship in its financial statements 17-4 Chapter 17 - Accounting for State and Local Governments, Part II Answers to Questions State and local governments apply FASB’s rules to determine whether a lease is a capital lease or an operating lease A lease that meets any one of the following criteria is held to be a capital lease: a The lease transfers ownership of the property to the lessee by the end of the lease term b The lease contains an option to purchase the leased property at a bargain price c The lease term is equal to or greater than 75 percent of the estimated economic life of the leased property d The present value of rental or other minimum lease payments equals or exceeds 90 percent of the fair value of the leased property Within the government-wide financial statements, the accounting for capitalized leases is the same as for-profit enterprises The asset and liability are recorded initially at the present value of the minimum lease payments Accrual accounting and the economic resource measurement basis are appropriately followed The equipment is increased along with the liability obligation Subsequently, both depreciation expense and interest expense must be recognized The entries in the fund financial statements are the same if a proprietary fund is involved The recording of a capital lease in one of the governmental funds (within the fund financial statements) involves the following three steps: a The initial entry reports the present value of the liability as an other financing resource b The present value is also recorded as an expenditure consistent with the current financial resources approach being used c When each subsequent lease payment is made, the debt and interest are both recorded as expenditures In government-wide financial statements, the lease payment is treated the same as it is in for-profit organizations: part of the payment is considered interest and reported as an expense with the rest viewed as a payment of the lease obligation In fund financial statements, the recording is the same as above if a proprietary fund is involved However, the fund recording of a capital lease payment in the governmental funds involves the recording of expenditures for both the reduction of the debt and the payment of interest Solid waste landfills can be a significant source of liability for local governments The federal government has strict rules on groundwater monitoring and postclosure activities These legal obligations can involve large payments over an extended period of time long after the landfill is closed 17-5 Chapter 17 - Accounting for State and Local Governments, Part II Government-wide financial statements recognize expenses on the accrual and economic resource measurement basis Therefore, seven percent of the expected landfill closure liability cost is accrued during the current year as an expense along with the related liability In the fund financial statements, the entry is the same as above if an Enterprise Fund is involved In the fund statements, if the landfill is recorded in the General Fund, the only charge to expenditures is for any current payment, if it is made, or for any claim against current financial resources The eventual liability is ignored unless it will be paid from current financial resources Government-wide financial statements recognize expenses on the accrual and economic resource measurement basis At the end of the first year, 11 percent is multiplied times the expected closing and other related costs and that figure is recognized as both an expense and a liability Current costs are used for this estimation At the end of the second year, 24 percent is multiplied times the expected costs (which may have changed since the end of year one) and the liability to be reported is then raised to this new amount It is the change in the liability that creates the amount of expense to be reported for the second year For fund financial statements, assuming the landfill is reported in the General Fund, no recording is made unless (a) an actual payment is made because of the eventual closure or (b) some part of that liability represents a claim to current financial resources in this period The amount accrued, $2,000 in this case, should be recorded on the government-wide financial statements as an expense at the end of 2013 along with the related liability It is a liability and should be reported As a governmental fund transaction, the fund financial statements only include an amount as a liability at the end of 2013 if it is to be paid early enough in 2014 (such as within 60 days) to require the use of current financial resources held at the end of 2013 (which does not appear to be the case) Because of the accrual recorded on the government-wide financial statements at the end of 2013, the actual payment simply reduces both cash and the liability balance On the fund financial statements, assuming no accrual was reported in 2013, the payment in 2014 is a reduction in cash along with the recognition of an expenditure If the amount is to be recorded within the proprietary funds, it is treated the same as in government-wide statements However, a teacher is unlikely to be working for an activity recorded within the proprietary funds 17-6 Chapter 17 - Accounting for State and Local Governments, Part II Governments should capitalize donated works of art, historical treasures, and similar assets at the fair value at the date of the gift However, if no charge is assessed for admission to see the art, it is difficult to consider it an asset in a traditional sense because it generates no direct economic benefit for the government Thus, the artwork does not have to be capitalized if all of the following criteria are met: a Held for public exhibition, education, or research in furtherance of public service, rather than financial gain b Protected, kept unencumbered, cared for, and preserved c Subject to an organizational policy that requires the proceeds from sales of collection items to be used to acquire other items for collections If capitalized, depreciation is only required if the asset is viewed as exhaustible (the asset is used up by display, education, or research) Otherwise, depreciation is not required 10 Revenue still must be reported because of the donation If the government chooses not to record the qualifying asset in the government-wide financial statements, an expense is reported in place of the asset whether purchased or received as a gift If the item is received by donation, the revenue portion of the entry is still required 11 The modified approach is an alternative to depreciating infrastructure assets This approach allows the government to expense all maintenance costs rather than record depreciation but only if certain guidelines are met The government must accumulate certain information about particular infrastructure assets within either a network or subsystem of a network The government must establish a minimum acceptable level for the network or subsystem of the network and maintain documentation that this level is being maintained An asset management system has to be in place to monitor and provide records of the infrastructure assets The ongoing condition is assessed and an annual estimation made of the cost of maintaining and preserving the infrastructure to meet the established condition levels Government officials must decide whether this amount of effort and cost should be incurred simply to avoid the recording of depreciation 12 If the modified approach is applied, depreciation of infrastructure assets is not recorded but all maintenance costs are expensed Certain disclosures are required on the governmentwide financial statements This includes disclosure that the government is accumulating certain information about particular infrastructure assets within either a network or subsystem of a network The disclosure must include specific information about the minimum acceptable level for the network or subsystem of the network and that this level is being maintained and monitored by an asset management system 13 A Management’s Discussion and Analysis (MD&A) similar to profit-making financial statements is now required for state and local governments.The MD&A is presented before the financial statements and provides the following information: (1) A brief discussion of the financial statements and information provided and their relationships to each other (2) Condensed financial information at least including a Total capital and other assets b Total long-term and other liabilities 17-7 Chapter 17 - Accounting for State and Local Governments, Part II (3) (4) (5) (6) (7) (8) c Total net assets, including amounts invested, in capital assets net of debt, restricted and unrestricted amounts d Program revenues, by major source e General revenues, by major source f Total revenues g Program expenses, by function h Total expenses i Excess or deficiency before contributions to term and permanent fund principal, special and extraordinary items, and transfers j Contributions k Special and extraordinary items l Transfers m Change in net assets n Ending net assets Overall financial position and results of operations Balances and transactions analyses with explanation of significant changes Analysis of significant variations between original and final budget amounts Description of significant capital asset and long-term debt activity Information about the modified approach for infrastructure assets Any known facts, decisions, or conditions that are expected to significantly impact on financial position or results of operations 14 The Comprehensive Annual Financial Report (CAFR) includes three sections a Introductory Section Letter of transmittal Organizational chart List of principal officers b Financial Section MD&A (Management’s Discussion & Analysis) General purpose financial statements Auditor’s report Other required supplementary information c Statistical Section 15 A general purpose government is a traditional government such as a city, county, or state A special purpose government (such as a school system or transit authority) can also be a primary government for reporting purposes if certain requirements are met Classification as a special purpose government requires meeting three criteria: a It has a separately elected governing body b It is legally independent It can sue and be sued and buy, sell, and lease property c It is fiscally independent of other state and local governments It can determine its own budget, levy and set tax rates, and issue bonded debt without outside approval 16 Classification as a component unit requires an organization to meet one of two criteria: a The activity is fiscally dependent on a primary government It cannot determine its own budget, levy and set tax rates, and issue bonded debt without outside approval In addition, the primary government and the component unit must be financially 17-8 Chapter 17 - Accounting for State and Local Governments, Part II interdependent (there is a relationship of potential financial benefit or burden between the two of them) or b An outside primary government appoints a voting majority of the governing board of the activity The primary government must also be able to one or more of the following: impose its will on the board of the component organization, or provide a financial benefit to the component organization, or the component provides a financial benefit to the primary government 17 If blended, component units are included in the primary government as if they were part of the government (one of its own funds) The component unit is legally separate but so intertwined and substantially the same as the primary government so that inclusion is necessary for appropriate presentation A recent change in GASB standards now requires that a component unit will be blended if its total debt will be repaid entirely, or almost entirely, from resources of the primary government A discretely presented component unit is shown separately on the far right side of the government-wide financial statements because the organization is not substantially the same as the government and can stand alone 18 The two government-wide financial statements are the Statement of Net Assets and the Statement of Activities The Statement of Net Assets includes: a All assets and long-term liabilities b Capital assets net of accumulated depreciation including newly acquired infrastructure assets c The primary government is divided into governmental activities and business-type activities d The internal balances reflect inter-activity transactions between governmental activities and business-type activities These balances are offset in coming up with totals for the government e Discretely presented component units are shown to the far right of the statement The Statement of Activities includes: a Expenses reported by function for governmental activities, business-type activities and component units b Interest expense on long-term debt, often shown as a function c Related program revenues including charges for services, operating grants and contributions, and capital grants and contributions d Net expense or net revenue for each function e Net expense or net revenue for each category of the government f General revenues for governmental activities, business-type revenues, or component units g Special items that are significant transactions or other events within the control of management that are either unusual or infrequent in nature h Transfers between governmental activities and business-type activities 17-9 Chapter 17 - Accounting for State and Local Governments, Part II 19 The two fund financial statements for the governmental funds are the Balance Sheet and the Statement of Revenues, Expenditures, and Changes in Fund Balance The Balance Sheet measures current financial resources and uses modified accrual accounting and includes: a Separate columns are included for the general fund and every other major fund that report current financial resources and claims against current financial resources b Non-major funds are combined and reported as “other governmental funds.” c Totals for government funds d Fund Balance should be classified as nonspendable, restricted, committed, assigned, or nonassigned The Statement of Revenues, Expenditures, and Changes in Fund Balance includes: a The general fund and each major fund in separate columns, with all other funds combined in another column b Revenues c Expenditures d Other financing sources and uses e Special items f A reconciliation between the ending change in fund balances and the ending change in net assets for governmental activities 20 Program revenues are those revenues derived from a specific program (such as parks and recreation) or from outsiders seeking to contribute to the cost of that function They include charges rendered for services, operating grants and contributions, and capital grants and contributions General revenues are those from the population as a whole including property taxes, sales taxes, unrestricted grants, and investment income They are not traced to any individual program, activity, or function This distinction is important because program revenues are matched with expenses for each activity providing a net expense or net revenue figure for each to disclose the cost or the benefit of that activity 21 The net expense or net revenue format allows the readers of a government’s financial statements to determine the relative financial burden (or benefit) that each of its reporting functions has on its taxpayers In other words, the users of the statement can determine what it costs for the government to provide benefits such as public safety or library 22 On government-wide financial statements, internal service funds are combined with the governmental activities (or business-type activities if more appropriate) Their placement is based on the identity of the functions that they primarily serve If an internal service fund is mainly used to serve one or more governmental funds, then it should be included with the governmental activities 23 Fiduciary funds are not reported on government-wide financial statements because these resources must be used for a purpose outside of the primary government Fiduciary funds produce statements to be included with the fund financial statements 17-10 Chapter 17 - Accounting for State and Local Governments, Part II e True – The expense to be recognized each year is the adjustment required in the liability At the end of Year One, that liability should be $99,000 or 11 percent of $900,000 At the end of the second year, the liability has grown to $170,000 (20 percent of $850,000) Increasing the liability from $99,000 to $170,000 necessitates an expense of $71,000 Even though the question relates to the General Fund, government-wide financial statements always accrue expenses as incurred f False – In the governmental funds, a capitalized lease is recorded based on the present value of the future cash flows Thus, the initial recording is an expenditure of $39,000 g False – An Agency Fund is used when passing money through the government to a specified recipient Thus, the only two accounts typically found in an Agency Fund are cash (or similar monetary assets) and the liability to indicate where that cash is destined 42 (continued) h True – The asset is capitalized at $39,000, the present value of the future cash flows Over a six-year life, depreciation expense of $6,500 should be recognized each year A related liability of $29,000 should also be recorded (after the first payment is removed) With an interest rate of 10 percent being used, interest expense of $2,900 should be recognized in the first year Total expenses to be reported are $9,400 ($6,500 plus $2,900) 43 (12 Minutes) (Recording the gift of a work of art) a This gift did not involve a current financial resource and should not have been recorded in the fund financial statements In this problem, there is no indication that it was recorded in the fund financial statements The recording of the asset and depreciation is only made in the governmentwide statements Thus, the increase in the fund balance of $30,000 was correct and should not be changed 17-49 Chapter 17 - Accounting for State and Local Governments, Part II b Apparently, in the government-wide financial statements, revenue of $15,000 was reported along with an asset of the same value Depreciation recognized for the first year would have been $500 ($15,000 capitalized amount over a 30-year life) so that an increase in the net assets was reported as $14,500 If the allowed alternative had been followed as officials wished, both revenue and expense would have been increased initially by $15,000 for no net effect Consequently, removing the $14,500 increase that was reported (so that no net effect is shown) changes the net expense figure for this function from $130,000 to $144,500 c Government officials wanted to use the alternative which was to record an expense rather than an asset If no entry was made by the art museum, there was no change created in the net asset figure Had the appropriate entry been made, both revenue and expense would have risen by $15,000, but then, again, no net effect would result The revenues and expenses are both understated but the net asset figure is not affected Although the individual totals are wrong, the increase in net assets stays at $140,000 44 (8 Minutes) (Recording the lease of a police car) a On the government-wide statements, an expense of $20,000 was reported but no other entry Instead, an asset and liability of $62,000 should have been reported initially Depreciation on the asset (over a five-year period) would have been $12,400 with interest expense of $6,200 (10 percent of $62,000) for the first year Thus, total expenses should have been reported as $18,600 The reported expense ($20,000) was $1,400 too high Removing that amount of expense from the reporting causes the increase in net assets to rise from $140,000 to $141,400 b A $62,000 expenditure should have been recorded on the first day of the year because of the capitalized lease In addition, a $62,000 “other financing source” should have been recorded Another $20,000 expenditure was properly reported on the last day of the year to record the payment made at that time That entry was correct Because both the initial expenditure ($62,000) and the other financing source ($62,000) were left out, the net effect of the omission is zero The $30,000 increase in the fund balance that is shown for the General Fund is correct 17-50 Chapter 17 - Accounting for State and Local Governments, Part II 45 (5 Minutes) (Reporting a component unit) The revenue of $30,000 and the expense of $42,000 were not included within the primary government figures for the government-wide financial statements They were discretely presented but should have been blended Adding these two figures to the primary government-wide totals reduces the overall increase in net assets by $12,000 ($30,000 minus $42,000) from $140,000 to $128,000 46 (8 Minutes) (Accounting for vacation pay) a No recording was made of the accrued vacation pay In fund financial statements, for the General Fund, only the amount of this liability that will be paid in the next 60 days (2 months) is viewed as a claim against current financial resources Here, that amount is $10,000 (2/12 of $60,000) This expenditure is recorded at the end of Year Four and reduces the increase in the General Fund fund balance by $10,000 from $30,000 to $20,000 b No recording was made of the accrued vacation pay For the governmentwide financial statements, the entire $60,000 liability is recorded in Year Four based on standard accrual accounting The related expense reduces the increase in net assets by $60,000 from $140,000 to $80,000 47 (10 Minutes) (Recording a city landfill) a Apparently, the amounts recorded this year (in the parks which is within the General Fund) were in the wrong fund; the landfill should have continued to be reported as an Enterprise Fund By itself, that does not have any net impact on the net assets reported for the entire government on the government-wide statements The amounts are simply in the wrong columns However, the clean-up liability has not been reported for the current year (the problem says that no other recording was made this year) An additional percent was filled in the current year so that the liability to be reported should have increased by $16,000 (8 percent of $200,000) That reduces the overall increase in net assets from $140,000 to $124,000 17-51 Chapter 17 - Accounting for State and Local Governments, Part II b The revenues ($4,000) and expenses ($15,000) for the current year must now be moved from the General Fund to the Enterprise Funds ($11,000 net reduction) In addition, the $16,000 clean-up liability computed in (a) above should be recorded here so that the overall decrease in net assets in connection with the landfill is $27,000 ($11,000 + $16,000) For the Enterprise Funds, the net increase is net assets is not $60,000 but rather $33,000 c The revenues and expenditures have been correctly reported this year within the General Fund In addition, there is no indication that the cleanup costs for the landfill will require any current financial resources so that no reporting is needed in the fund financial statements The increase in the fund balance of the General Fund of $30,000 appears to be correct 48 (6 Minutes) (Recording and depreciating capital assets) a The modified approach only applies to infrastructure assets and not to machines and the like Thus, $4,000 in depreciation expense for the year ($20,000/5 years) has been incorrectly omitted Including the recording of depreciation reduces the increase in net assets from $140,000 to $136,000 b The depreciation expense discussed in (a) above increases the net expenses for education from $710,000 to $714,000 49 (15 Minutes) (Recording leases in government-wide and fund financial statements) a False – Assuming that the next payment is not due until July 1, Year Two, it is not a claim to current financial resources Therefore, no liability should be reported on the fund financial statements b False – The original liability of $78,000 should be reported and immediately reduced by $20,000 to $58,000 However, interest for the last six months of Year One is accrued ($58,000 x 10 percent x 6/12 year or $2,900) to raise the liability to $60,900 c True – Interest for the last six months of Year One is accrued ($58,000 x 10 percent x 6/12 year) or $2,900 17-52 Chapter 17 - Accounting for State and Local Governments, Part II d False – On the fund financial statements, the expenditure total equals the $78,000 present value of the cash flows plus the first $20,000 payment e True – The asset is initially capitalized at $78,000 At the end of the first year, depreciation of $7,800 should be recognized ($78,000 x 1/5 x 6/12) which reduces the net leased asset to $70,200 f False – On the fund financial statements, the expenditure total equals the present value of the future cash flows As an ordinary annuity rather than an annuity due, the present value is different than $78,000 g False – There are four separate criteria for a capitalized lease One of those is that the life of the lease is 75 percent or more of the life of the asset If the car has an eight-year life, the five year lease is only 62.5% of the life of the asset However, the lease contract might well meet one of the other three criteria so that capitalization would still be necessary h False – Payments totaling $100,000 are being made and the car will be used up The total expense has to be $100,000 on the government-wide statements no matter how the reporting is done For fund financial statements, the present value of the future cash flows is recognized as an expenditure ($78,000) and then the eventual payments are also each recognized as an expenditure (five payments of $20,000 each) This total is more than $100,000 (but the impact is partially offset by the reporting of an other financing source) 50 (10 Minutes) (Reporting by a government of a solid waste landfill) a False – The handling in the government-wide financial statements will be the same whether the landfill is reported as a General Fund or as an Enterprise Fund b False – Because the city has a December 31 year-end, no claim to current financial resources exists at that time Payments will not be for six months c False – The Enterprise Fund should report a liability equal to 26 percent of $2 million less the amount of cash that has already been paid d True – Enterprise Funds are generally reported the same in the government-wide financial statements and the fund financial statements 17-53 Chapter 17 - Accounting for State and Local Governments, Part II e True – The liability is $2 million times 26 percent or $520,000 However, payments of $100,000 have already been made by this time so the reported liability is now only $420,000 f True – In either case, $2 million will be spent That will show up as an expense in the government-wide financial statements and as an expenditure in the fund financial statements (assuming the landfill is reported in the General Fund) 51 (10 Minutes) (Reporting by a government of a landfill) a True – The amount of the liability to be reported in each of the past years would then have been based on $3 million rather than on $2 million b True – The government-wide financial statements accrue all liabilities whether they are governmental activities or business-type activities The government has to report the current obligation for closing the landfill c False – At the end of Year Two, a liability of $420,000 is reported (26 percent of $2 million less $100,000 in payments) At the end of Year Three, a liability of $1,050,000 is reported (40 percent of $3 million less $150,000 in payments) Adjusting the liability balance of $420,000 to $1,050,000 necessitates recognizing an expense of $630,000 d False – Present value is not used for landfill closure costs 52 (12 Minutes) (Reporting the gift of a historical treasure to a government) a True – One of the requirements for being able to choose to not capitalize an art work or historical treasure is that a formal policy must be in place requiring that any proceeds from a future sale be used for a similar purchase b False – If the asset is viewed as being inexhaustible (this document is already over 200 years old), depreciation is not required c False – The city can record the $10,000 value as an expense immediately but it can also choose to capitalize the asset and then depreciate it over its expected useful life 17-54 Chapter 17 - Accounting for State and Local Governments, Part II d False – Revenue recognition is required for gifts of this type It is only the decision as to whether to record an asset or an expense that is at the option of the government e True – Both revenue and an equal expense can be reported for this donation so that net assets are not impacted 53 (8 Minutes) (The presentation of component units) a False – Although the city here appoints a majority of the board members, there is no indication that (a) the city can impose its will on this board, (b) that the library provides a financial benefit or a financial burden for the city, or (c) that the library is financially dependent on the city Appointing a majority of the board makes the library a related organization but not necessarily a component unit b True – If the results of the component unit are included within the governmental activities (like a fund), this reporting is known as blending the component unit This reporting is appropriate when the component unit is closely entwined with the government c False – Blending of a component unit is a judgment made when financial statements are being prepared based on how entwined the activity is with the government In addition, a component unit will need to be blended if its total debt will be repaid entirely, or almost entirely, from resources of the primary government That responsibility is not mentioned here Develop Your Skills Research Case When released in 1999, one of the most controversial aspects of GASB 34 was the capitalization of previously acquired and constructed infrastructure items (such as bridges, sidewalks, streets, and the like) that, in most cases, had always gone unreported In many cases, cost figures were no longer available Determining a reported value, for example, for miles of sidewalks constructed over a number of decades was looked at as an almost impossible feat with little or no reporting value to the readers of the financial statements 17-55 Chapter 17 - Accounting for State and Local Governments, Part II Because of this criticism, GASB tempered this one reporting requirement more than any other First, only a limited number of these earlier assets have to be reported According to GASB Codification, Section 1400.148, “governments are required to capitalize and report major general infrastructure assets that were acquired (purchased, constructed, or donated) in fiscal years after June 30, 1980, or that received major renovations, restorations, or improvements during that period.” So, the reporting of only “major general infrastructure assets” is required That size requirement was identified as a subsystem that made up at least percent of the total of all general capital assets or a network that made up at least 10 percent of the total of all general capital assets In addition, only assets acquired or renovated after June 30, 1980, had to be assessed for reporting purposes This parameter limited the required reporting to assets that were relatively new at that time For example, a bridge constructed in 1922 did not have to be reported unless renovated after June 30, 1980 Finally, governments were given an extra four years beyond the required implementation deadline for GASB 34 to report these previously obtained infrastructure assets This extension was allowed to provide governments sufficient time to make all of the necessary computations To make the actual computation of these figures, GASB Codification explains: “The initial capitalization amount should be based on historical cost If determining historical cost is not practical because of inadequate records, estimated historical cost may be used.” (Section 1400.151) “A government may estimate the historical cost of general infrastructure assets by calculating the current replacement cost of a similar asset and deflating this cost through the use of price-level indexes to the acquisition year (or estimated acquisition year if the actual year is unknown) There are a number of price-level indexes that may be used, both private- and public-sector, to remove the effects Research Case (continued) of price-level changes from current prices Accumulated depreciation would be calculated based on the deflated amount, except for general infrastructure assets reported according to the modified approach.” (Section 1400.152) Section 1400.154 goes on to provide additional guidance: “Other information may provide sufficient support for establishing initial capitalization This information includes bond documents used to obtain financing for construction or acquisition of infrastructure assets, expenditures reported in capital project funds or capital outlays in governmental funds, and engineering documents.” Research Case 17-56 Chapter 17 - Accounting for State and Local Governments, Part II The reason for this question is rather obvious: The transit authority has lost money and city officials are concerned by how those negative financial results will impact the financial picture reported by the city The reporting rules for component units were first created by GASB Statement No 14, The Reporting Entity Those rules are now part of the GASB Codification: “Financial statements of the reporting entity should provide an overview of the entity, yet allow users to distinguish between the primary government and its component units (Section 2600.105) “Most component units should be included in the financial reporting entity by discrete presentation Discrete presentation entails reporting component unit financial data in columns and rows separate from the financial data of the primary government.” (Section 2600.107) “Even though it is desirable for users to be able to distinguish between the primary government and its component units, there are nevertheless some component units that, despite being legally separate from the primary government, are so intertwined with the primary government that they are, in substance, the same as the primary government These component units should be reported as part of the primary government in both fund financial statements and the government-wide financial statements That is, the component unit's balances and transactions should be reported in a manner similar to the balances and transactions of the primary government itself This method of inclusion is known as blending.” (Section 2600.112) A recent addition to GASB standards requires that a component unit will need to be blended if its total debt will be repaid entirely, or almost entirely, from resources of the primary government Research Case (continued) In the case presented here, the facts should be easy to determine so that the decision about reporting can be made Is the transit authority fiscally dependent on the city? Does the transit authority create a financial benefit or financial burden for the city? Do transit authority officials have to get permission from the city to adopt its budget or set rates for passenger use? Can the transit authority issue bonds without having to get approval of city officials? These questions should be fairly easy to answer 17-57 Chapter 17 - Accounting for State and Local Governments, Part II The transit authority can also be a component unit of the city if city officials appoint a voting majority of the transit authority’s board In that case, the transit authority is viewed as a component unit if (a) city officials can impose their will on this board or (b) the transit authority provides a potential financial benefit or burden for the city The question of potential financial burden is especially relevant because the transit authority has been losing money Eventually, if that situation does not improve, what responsibility will the city have? Analysis Case Students often appear to believe that the financial reporting that is presently in use has been applied, unchanged, for decades They often not fully appreciate the speed of evolution that can take place in the applicable generally accepted accounting principles Accounting for state and local governments provides an excellent example of the change that can occur, even over a relatively short period of time GASB 34 was issued in June of 1999 and became mandatory a few years later That pronouncement provides a clear line of demarcation between the financial statements that are currently reported and those that were traditionally used for many decades In looking at any source of information prior to 2000, several significant differences should be evident: Only one set of financial statements was reported Government-wide financial statements did not exist The financial statements prior to 2000 will look quite a bit like fund financial statements that are still prepared The columnar presentation will include fund types (General Fund, Special Revenue Fund, Capital Projects Fund, and the like) rather than showing specific major funds within these categories Because only current financial resources were reported, at least in the governmental funds, no capital assets or long-term liabilities are reported However, something called “general fixed asset account group” and “general long-term debt account group” were included as a listing of capital assets and long-term debts Some of the fund type names have changed over the years For example, the Permanent Fund within the governmental funds did not exist prior the passage of GASB 34 Depreciation was not reported in connection with the reporting of assets by the governmental funds 17-58 Chapter 17 - Accounting for State and Local Governments, Part II Infrastructure assets were reported as expenditures as those costs were incurred and, then, probably in no other way No inclusion at all could be seen of bridges, sidewalks, and the like Certain liabilities such as landfill costs were probably ignored Budgetary information is still reported but in a different type of format A management’s discussion and analysis is now included in government financial statements to provide a verbal explanation of the financial events of the period Analysis Case One of the most significant changes in governmental accounting created by GASB 34 in 1999 was the requirement that the Management’s Discussion and Analysis be included as part of the CAFR This written report is meant to be a discussion of the financial information for the government in a verbal rather than a purely quantitative fashion Students often not understand the range of information provided by the MD&A In this assignment, the student can read the MD&A for an actual city Here are just some of the pieces of information discussed in the 2010 MD&A for the City of Phoenix, Arizona The City’s net assets, the amount by which assets exceeded liabilities, were $8.3 billion at the close of the fiscal year The largest portion of the City’s net assets ($5.3 billion or 64.0 percent) reflects its investments in capital assets The restricted portion of the City’s net assets ($910.0 million) represents resources that are subject to external restrictions on how they may be used Major additions to capital assets during the fiscal year included the following: Design and construction related to the Sky Harbor Sky Train valued at $154.5 million The City’s total long-term obligations increased by $194.4 million during the fiscal year just ended, which represents an increase of 2.7 percent The City maintains the following ratings on its general obligation debt: “AAA” from Standard & Poor’s and “Aa1” from Moody’s Investors Service For business-type activities, 82 percent of their revenue came from charges for services Most of the rest came from capital grants and contributions 17-59 Chapter 17 - Accounting for State and Local Governments, Part II Communication Case Students not always fully comprehend the evolutionary nature of financial accounting and reporting In connection with for-profit businesses, ongoing changes have occurred over a number of decades under the Financial Accounting Standards Board, the Accounting Principles Board, and a variety of other organizations In comparison, the Governmental Accounting Standards Board has been in operation for a shorter period of time and has produced fewer official standards The changes that governmental accounting has gone through over the years may be a bit easier for a student to grasp This assignment is simply intended to provide the student with an overview of the recent history of governmental accounting The listed articles (and any others that the students may find through their own library and Internet searches) show how governmental accounting is gradually building up an official set of generally accepted accounting principles to provide a structure for reporting that, up until recently, has been very unstructured The amount of authoritative guidance has gone from almost nonexistent just a few decades ago to a fairly well developed system of financial reporting Communication Case If the city assesses a user charge, then officials always have the right to record the landfill as an Enterprise Fund However, such a classification is not required unless the fee (a) is set at an amount intended to cover the various costs of the service or (b) serves as the sole security for debts of the activity If the landfill is recorded as an Enterprise Fund, then accounting in the government-wide financial statements and fund financial statements is quite similar The statements measure all economic resources and timing is recorded based on accrual accounting Perhaps most importantly, the anticipated cost of closure and post-closure activities must be accrued in both sets of financial statements 17-60 Chapter 17 - Accounting for State and Local Governments, Part II Conversely, if the landfill is recorded within the General Fund, there is no impact on the government-wide financial statements except the all transactions and balances are shown as governmental activities rather than as business-type activities However, in the fund financial statements, as a governmental fund, only current financial resources and the changes in those financial resources are reported Capital assets, in these statements, as well as long-term liabilities such as closure costs are omitted Excel Case This spreadsheet would be extremely helpful for a government attempting to determine the historical cost (less depreciation) of infrastructure assets not previously reported This spreadsheet is designed along the guidelines established in GASB Codification, Section 1400.152-160 There are a number of different ways that a spreadsheet could be created to solve this particular problem Here is one possible approach: In Cell A1, enter text label “City of Loveland—Reported Value of Each Mile of Road” In the next three rows, enter the criteria on which calculations will be based: In Cell A3, enter text label of “Per Mile of Road as of 12/31/2013” and in Cell E3 enter “$2,300,000” In Cell A4, enter text label of “Yearly Inflation” and in Cell E4 enter “8%” In Cell A5, enter text label of “Depreciation” and in Cell E5 enter “2%” Any of the above three variables can be changed to develop different schedules Enter Column Headings: In Cell A7, enter text label of “# of Years.” In Cell B7, enter text label of “Date.” In Cell C7, enter text label of “Inflation Reduced Cost.” In Cell D7, enter text label of “Total Depreciation.” In Cell E7, enter text label of “Reported Value.” 17-61 Chapter 17 - Accounting for State and Local Governments, Part II Enter Row Headings: In Cell A8, enter text label “1” and in Cell A9, enter text label “2.” Once you establish a pattern, Excel can automatically fill in a series of numbers To continue the numbering for Years 3-20, click and drag across Cells A8 and A9 Once these cells are highlighted, you will see a small black box in the lower right corner of this selection, which is the “fill handle.” Click on the fill handle and drag across Cells A10 through A27 and release to display numbers through 20 The numbers will be displayed in increasing order since that is the criteria that was established in Cells A8 and A9 In Cell B8, enter text label “12/31/2012” and in Cell B9, enter text label “12/31/2011.” Perform the same click and drag operation above to fill the date in Cells B10 through B27 The dates will be displayed in decreasing order since that is the criteria that was established in Cells B8 and B9 Enter Formulas: In Cell C8, enter formula to calculate Inflation Reduced Cost as of 12/31/2012 Reduce Per Mile figure established on 12/31/2013 (in Cell E3) by Yearly Inflation Rate (in Cell E4): =+E3/($E$4+100%) (NOTE: Absolute references, which are cell references that always refer to cells in a specific location, can be created by placing a $ symbol before the Column letter and/or the Row number In this problem, we need to always refer to the Yearly Inflation figure in Cell E4 and the Depreciation figure in Cell E5.) In Cell D8, enter formula to calculate Total Depreciation Multiply Inflation Reduced Cost figure on 12/31/2012 by Yearly Depreciation Rate: =+C8*($E$5*A8) In Cell E8, enter formula for Reported Value of road for current year by deducting Depreciation from Inflation: =+C8-D8 In Cell C9, enter formula to calculate Inflation Reduced Cost figure as of 12/31/2011: Reduce Inflation on 12/31/2012 (in Cell C8) by Yearly Inflation Rate (in Cell E4): =+C8/($E$4+100%) Copy formulas from Cells D8 and E8 to Cells D9 and E9 by clicking and dragging fill handle Format Cells to display currency Click and drag across Cells C8 to E9 Select Format, Cells, and under the Number tab, select Currency Change the Decimal places to and click OK 17-62 Chapter 17 - Accounting for State and Local Governments, Part II Copy Formulas: Click and drag across Cell C9 through Cell E9 Place the cursor on the “fill handle” in the lower right corner of this section box and drag the cursor down to Cell E27 and release The formulas are automatically adjusted to correspond to the current year information 17-63 ... viewed as redundant 17-3 Chapter 17 - Accounting for State and Local Governments, Part II Answer to Discussion Question Is It Part of the County? In financial accounting for a for-profit organization,... statements, the accounting for capitalized leases is the same as for-profit enterprises The asset and liability are recorded initially at the present value of the minimum lease payments Accrual accounting. .. must be financially 17-8 Chapter 17 - Accounting for State and Local Governments, Part II interdependent (there is a relationship of potential financial benefit or burden between the two of them)