1. 1 GASB Update Karl Johnson Project Manager Governmental Accounting Standards Board Norwalk, CT 13 th Annual Rutgers Governmental Accounting & Auditing Update Conference Piscataway, NJ, December 18, 2006

2. 2 What is the GASB? An independent, professional standard-setting Board established in 1984 by agreement of sponsoring organizations involved in the preparation, auditing, or use of financial reports issued by state and local governments (SLG) in the United States Operates within an organizational structure provided by the Financial Accounting Foundation (as does the FASB) Establishes generally accepting accounting principles (GAAP) for general purpose external financial reporting by SLG entities There are 87,000+ SLG entities, but not all issue GAAP financial statements GASB is researching how many do and do not—and, if not, why not—and hopes to encourage broader adoption of GAAP reporting The views expressed in this presentation are those of the speaker and are not official representations of the Governmental Accounting Standards Board, which expresses itself through written pronouncements issued after extensive due process.

3. 3 Other Postemployment Benefits Statement 45 Related Statements and Other Guidance

4. 4 In a Nutshell: GASB Statement 45 (for Employers) Subject: accounting and reporting by employers for their OPEB expenses and obligations—most notably, for retiree healthcare benefits Applies to all employers that pay all or part of the cost of the benefits, including “implicit rate subsidies”

5. 5 In a Nutshell: GASB Statement 45 (for Employers) (continued) Requires a change from PAYGO accounting (expense not recognized until obligation paid in years after retirement) to accrual-basis accounting (recognition of expense during years of active service)

6. 6 In a Nutshell: GASB Statement 45 (for Employers) (continued) Requires measurement and disclosure of the total and unfunded actuarial accrued liabilities for past service costs—and related information about the funded status of the benefits Requires actuarial valuations for accounting and financial reporting purposes—generally, every 2 or 3 years for OPEB

7. 7 Objective of Statement 45 To faithfully represent (reflect like a good mirror) the financial effects of the exchange transaction between an employer and its employees that creates OPEB—in which an employer Acquires employee services, for which it Pays salaries, active-employee healthcare, etc., and promises to pay or provide a pension and OPEB such as retiree healthcare, as components of a total compensation package

8. 8 Measurement Approach: Broad Steps of Process to Develop Information for Accrual Accounting and Financial Reporting 1. Project cash outflows for benefits 2. Discount projected benefits to present value (PV) 3. Allocate the PV of projected benefits to periods using an acceptable actuarial cost method

9. 9 254062 80 Employee Age Timeline Age when hired Present age Assumed age at retirement Life Expectancy Service Period

10. 10 254062 80 1) Project Benefits 2) Discount A.P.V. 3) Actuarial cost method

11. 11 How Allocated Cost Information is Used in Accounting and Financial Reporting Amounts allocated to past periods ~ actuarial accrued liabilities Total AAL are disclosed in notes to F/S and presented as part of funding progress trend information in RSI The amount needed to amortize the total AAL over < 30 years is included as a component of the ARC (annual required contribution of the employer) and annual OPEB cost (expense) Amount allocated to current period ~ normal cost (service cost) Normal cost also is included as a component of the ARC and annual OPEB cost (expense) Amounts allocated to future periods ~ future normal cost Contrary to many interpretations in the media, GASB 45 does not (repeat, not) require employers to report future OPEB costs

12. 12 The Substantive Plan Benefits should be projected based on: The current substantive plan (the plan as understood by the employer and plan members), including changes made and communicated to plan members, at the time of the actuarial valuation, and (or including) The historical pattern of sharing of costs between employer and plan members to that point Anticipated future changes in plan design should not be included in the projection of benefits A legal or contractual benefit cap (as distinguished from a cap on contributions), should be considered in the projection of benefits if the cap is deemed effective

13. 13 Accounting for Employee and Retiree Healthcare Benefits in a Combined Group Illustrative situation: Single-employer plan with 500 plan members (400 actives, 100 retirees) State law requires employer to allow retirees to participate in healthcare group with actives at blended premium rates. Employer pays blended rate for each active employee; retirees pay blended premium rate for their coverage Required accounting: Active and retiree benefits should be accounted for separately, under GASB 10 and 45, respectively Employer’s share of the current coverage cost for each group should be calculated as the difference between (a) the claims costs, or age-adjusted premiums, for that group and (b) the amount contributed by members of that group (i.e., it includes “implicit rate subsidies”) Employer’s share of current-year cost for retiree coverage—determined in that manner—establishes the starting point for the actuarial projection of benefits for financial accounting purposes

14. 14 How It Appeared Before: Nominal (Stated) Employer Contributions Based on Blended Premiums Blended premium rate = $2,880 / member Total premiums for group = $1,440,000 Nominal contributions at blended rates: 400 Active 100 Employees Retirees Total Total blended premiums$1,152,000$288,000$1,440,000 Less: Member contributions0288,000 288,000 Employer contributions$1,152,000$0$1,152,000

15. 15 How It Looks After: Employer Contributions Based on Age- Adjusted Premiums Reflective of Claims Costs Total premiums for group = $1,440,000 Age-adjusted premiums (determined by actuary): Retirees: $4,810 / retired member Actives: $2,397.50 / active member Age-adjusted contributions at age-adjusted rates approximating claims costs: 400 Active 100 Employees Retirees Total Total age-adjusted premiums$ 959,000$481,000$1,440,000 Less: Member contributions0288,000 288,000 Employer contributions$ 959,000$193,000$1,152,000

16. 16 The Bottom Line: Implicit Rate Subsidies are Real Note that the employer’s nominal contribution for active-employee benefits ($1,152,000) exceeds the actual cost of providing coverage to active employees ($959,000) by $193,000 The $193,000, therefore, has nothing to do with insuring active employees but reflects the increase in blended rates as a result of the inclusion of retirees in the group The $193,000 is an actual cash contribution by the employer toward the cost of covering retirees in the plan for the current year It is the relevant starting point for the projection of future employer cash outlays for benefits for OPEB accounting purposes The amount of this contribution might be expected to increase over time (other things being equal) as the combined result of (a) the healthcare cost trend and (b) changing demographics (increasing number and proportion of retirees)

17. 17 Selection of a Discount Rate The discount rate, for calculating the PV of projected benefits, should be the estimated long-term yield on the investments expected to be used to finance the payment of benefits The relevant investments might be plan investments, employer investments, or a proportionate combination of the two— depending on the method of financing Planning consideration: The discount rate for unfunded plans (PAYGO) could tend to be lower than the discount rate for funded plans, because policies and options for investment of employer assets tend to be more restrictive; thus, a PAYGO employer generally will get less help from investment yield in paying promised benefits A lower discount rate generally will result in a higher UAAL, ARC, annual OPEB cost, and net OPEB obligation

18. 18 Annual OPEB Cost and Net OPEB Obligation: Illustration (Employer in Year 2 of Applying Statement 45) Normal cost (current service cost) $ 350,000 Amortization of the UAAL (for past services) 600,000 Annual required contribution (ARC)*950,000 Interest on beginning net OPEB obligation* 50,000 ARC adjustment* (58,500) Annual OPEB cost* = expense 941,500 Actual employer contribution* (PAYGO method of financing) (250,000) Increase in net OPEB obligation* 691,500 Net OPEB obligation—beginning* 650,000 Net OPEB obligation—ending* 1,341,500 * The ARC, the annual OPEB cost and its components, actual employer contributions, and changes in the net OPEB obligation are required to be disclosed in the employer’s notes to the financial statements.

19. 19 What Do the ARC and the Net OPEB Obligation Tell Me as a Reader of the Financial Report? The ARC expressed as a % of covered payroll represents the level of employer contribution effort that would be needed on a sustained, consistent basis to cover normal cost and amortize the UAAL over not more than 30 years: An indicator of the “size” of the employer’s commitment, expressed in terms of the ongoing contribution effort required to sustain it An indicator of potential long-term demands on future cash flows The net OPEB obligation indicates whether since implementation of Statement 45 an employer has contributed less (more) than the ARC

20. 20 Funded Status Information: Illustration (Two Employers) Information Disclosed in Notes to Financial Statements and Presented in RSI Govt. AGovt. B UnfundedPartially (PAYGO)Funded Actuarial accrued liabilities (AAL) (a)$13,500,000$13,500,000 Actuarial value of plan assets (b) -0-- 9,000,000 Unfunded actuarial accrued liabilities (UAAL) (a-b) 13,500,000 4,500,000 Funded ratio (b/a) 0.0% 66.7% Covered payroll (c) $7,600,000 $7,600,000 UAAL as a % of covered payroll (a-b/c) 177.6% 59.2%

21. 21 What Does the UAAL Tell Me as a Reader of the Financial Report? The UAAL is the portion of the present value of projected benefits attributed to past periods It can be thought of as a measure of the value of employee services that were received by the employer and tax/rate payers or constituents in past periods but not paid or funded Other things being equal, the higher the UAAL, the higher will be the following going forward: Amortization component of the ARC The ARC Annual OPEB cost, or expense Demands on future cash flows, or budgets

22. 22 Disclosure of Actual Employer Contributions as a Percentage of Annual OPEB Cost A key factor affecting the funded status of the benefits is the level of employer contributions Accordingly, employers also should disclose for each of the past three years the annual OPEB cost, the percentage of annual OPEB cost actually contributed, and the ending net OPEB obligation

23. 23 Effective Dates and Transition Staggered implementation of Statement 45 based on a government’s phase for implementing GASB 34: Phase 1 ($100M+ revenue)—first fiscal year beginning after Dec. 15, 2006 Phase 2 ($10M to < $100M revenue)—one year setback Phase 3 (< $10M revenue)—two year setback Earlier implementation is encouraged Employers may apply Statement 45 prospectively—that is, may report zero beginning net OPEB obligation as of the beginning of the year of implementation

24. 24 Statement 45 Concluding Comments Don’t underestimate what may be involved in planning for implementation of Statement 45 or wait too long to start Planning tasks may include, for example: Analyzing and classifying benefits offered Gathering information about plan terms and covered group Obtaining an initial actuarial valuation and absorbing results Separating active-employee and retiring healthcare benefits for accounting purposes, if combined If funding or partially funding, establishing a qualifying trust

25. 25 Statement 45 Concluding Comments (continued) In the end, the information required to be developed and reported is intended to provide the diverse users of governments’ financial reports: A more transparent accounting for employers’ costs and obligations associated with OPEB More decision-useful financial information to better inform discussion and decision-making about important matters such as: 1. Benefits and plan design 2. Cost sharing between the employer and plan members 3. The method of financing benefits

26. 26 Related Statements and Other Guidance Statement 43—OPEB Plan Reporting About stewardship of plan (i.e., trust) assets Similar to Statement 25 Coordinated with Statement 45 for employers Statement 47—Termination Benefits Accounting for voluntary and involuntary termination benefits—i.e., incentives to end employment, or paid because of early termination of employment (contrast with postemployment benefits, which by definition are compensation for services) Generally requires recognition of liability and expense when offer is made and accepted, or when a plan of involuntary terminations is communicated Measurement and recognition requirements include variations depending on circumstances—for example, termination benefits that add to or extend pension benefits or OPEB should be added to pension or OPEB accounting calculations

27. 27 Related Statements and Other Guidance (continued) Technical Bulletin 2004-2 Includes guidance on modified-accrual recognition of liabilities and expenditures for employers in a cost-sharing OPEB plan Technical Bulletin 2006-1 Provides guidance on accounting for payments received from the federal government under the Retiree Drug Subsidy option of Medicare Part D Subsidy should be accounted for as a separate transaction from OPEB (this option only) If to plan, account for subsidy as an on-behalf payment (GASB 24) If to employer, account for subsidy as a voluntary nonexchange transaction (GASB 33)

28. 28 Related Statements and Other Guidance (continued) Implementation Guide to Statements 43 and 45 Poses and answers 258 questions about the OPEB Statements—210 of them about Statement 45 Comprehensive Implementation Guide—2006-2007 Incorporates and adds to the original OPEB Guide, which will not be updated as a separate guide, as Chapter 8 Includes 14 new OPEB questions and answers

29. 29 Other Notable GASB Projects: Most Recent Document Issued Sales and Pledges of Receivables and Future Revenues— Statement 48, 9/06 Pollution Remediation Obligations—Statement 49, 12/06 Conceptual Framework: Elements–Exposure Draft, 8/06 Pension Disclosures (Conforming Changes)–Exposure Draft, 12/06 Intangible Assets–Exposure Draft, 12/06 Derivatives and Hedging—Preliminary Views, 4/06 Fund Balance Reporting and Governmental Fund Definitions— Invitation to Comment, 10/06

30. 30 Statement 48: Sales and Pledges Addresses whether an exchange of a government’s interest in its expected future cash flows from collecting specific receivables or future revenues for immediate cash payments is (a) a sale or (b) a collateralized borrowing Provides criteria for determining whether proceeds should be reported as revenue or a liability Criteria should be used to determine to what extent government relinquishes control over the receivables or future revenues (how much continuing involvement?) If sale criteria not met, account for transaction as a borrowing

31. 31 Statement 48: Sales and Pledges (continued) If receivables are sold, recognize sale price difference in change statements in period of sale If future revenues are sold, generally defer and amortize revenue Statement also addresses: Situation where government does not receive immediate cash payment, but pledges future cash flows Transfers of assets between components of a common reporting entity (including between individual funds)

32. 32 Statement 49: Pollution Remediation Obligations PRO defined as obligations to address the current or potential effects of existing pollution by participating in pollution remediation activities The following are covered in the PRO Exposure Draft: Five specified obligating events upon occurrence of which a government would be required to estimate the components of a PRO Use of the expected cash flow technique for measurement of the PRO (current values of expected outlays, probability-weighted scenarios with regard to estimated amounts of outlays to be incurred) Accounting for recoveries Circumstances where pollution remediation outlays can be capitalized Required disclosures

33. 33 Exposure Draft (8/06): Conceptual Framework—Elements Fourth in a series of Concepts Statements Establishes definitions for seven elements of financial statements: Assets Liabilities Deferred outflow of resources Deferred inflow of resources Net assets Outflow of resources Inflow of resources Central feature in the definitions is “resource” Item with a present capacity to provide, directly or indirectly, services

34. 34 Exposure Draft (8/06): Conceptual Framework—Elements (continued) ED respondents’ comments have been received and are under consideration Final Elements Concept Statement scheduled to be issued in June 2007 A related conceptual framework project, Recognition and Measurement: Will determine what information should be reported in financial statements (measurement focus) and when that information should be reported (basis of accounting Will determine appropriate measurement attributes for governmental financial statements—for example, historical cost or fair value Is scheduled to begin deliberations in January 2007

35. 35 Exposure Draft: Pension Disclosures (Conforming Changes) Project scope limited to proposed amendments to GASB 25 and 27 to conform with more recently adopted versions of disclosure and RSI requirements in GASB 43 and 45 Proposed changes include: Note disclosure of funded status of plan as of most recent AV (plus multi-AV trend Schedule of Funding Progress as RSI) Funded status note and schedule of funding progress required of plans and employers that use aggregate actuarial cost method plans—using entry age actuarial cost method as a surrogate Explanatory note disclosures re: the general actuarial measurement process and identification of specific actuarial methods and assumptions used Cost-sharing employer required to present plan RSI if plan does not Concurrent related project: Pension Accounting Research

36. 36 Exposure Draft (12/06): Intangible Assets Proposes accounting and reporting requirements for intangible assets including: Easements (right-of-way, permissive, restrictive) Land use rights (water, timber, mineral) Computer software Creative assets (patents, copyrights, trademarks) Intangible assets covered under ED would be classified as capital assets

37. 37 Exposure Draft (12/06): Intangible Assets (continued) Specific additional guidance for intangibles is provided in the following areas: Recognition Internally-generated intangible assets, including computer software Amortization Indefinite useful life Useful lives limited by legal or contractual provisions Impairment ED generally requires retroactive application of all provisions ED to be issued in December 2006

38. 38 Preliminary Views (4/06): Derivatives and Hedging Proposes definition of a derivative Presents the following preliminary views of the Board: Derivatives should be reported at fair value in the statements of net assets/balance sheets Changes in fair value should be reported in the change statements, except if the derivative is an effective hedge, in which case, changes in fair value are deferred and reported in the statements of net assets/balance sheets Disclosures generally consistent with TB 2003-1, with additional disclosures related to hedges

39. 39 Invitation to Comment: Fund Balance Reporting and Governmental Fund Definitions Broad objectives of the project: To assess whether fund balance reporting requirements meet the needs of financial statement users and consider potential changes to improve the usefulness of fund balance information Review current definitions of governmental funds to determine if clarification is needed

40. 40 Invitation to Comment: Fund Balance Reporting and Governmental Fund Definitions (continued) ITC provides three options for fund balance reporting: Model A—Present categories with improvements Model B—Distinguishing resources available for appropriation Model C—Distinguishing restricted resources

41. 41 Invitation to Comment (10/06): Fund Balance Reporting and Governmental Fund Definitions (continued) ITC provides options for clarification of certain aspects of SRF definition: To account for the proceeds of specific revenue sources that are legally restricted to expenditure for specified purposes. ITC also suggests clarification for financial resources accounted for in CPF and DSF: Resources restricted or legally limited to expenditure Resources that gov’t has publicly expressed its intention to use

42. 42 GASB Research Agenda The following projects are on GASB’s research agenda: Economic Condition—Phase III Electronic Financial Reporting Intergovernmental Risk Reporting Pension Accounting and Reporting—assessment of the effectiveness of GASB 25 and 27 in meeting financial reporting objectives Public/Private Partnerships Reporting Unit/Statement 14 Reexamination Service Efforts and Accomplishments

43. 43 GASB Website— www.gasb.org www.gasb.org What’s New Downloads and ordering information: Public comment documents [ED, PV, ITC) Statements, Interpretations, Technical Bulletins Implementation Guides [Q&A]) Summaries of standards Plain language articles Project pages Technical inquiry form Staff contact information