Accounting for State and Local Governments, Part II Chapter Twelve Accounting for State and Local Governments, Part II McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

12-2 Governmental Leasing Just as for-profits, governments often obtain the use of property through leasing rather than purchasing Rationales: Lower interest rates Limited financial resources Reduced risk of obsolescence Examples: Sanitation equipment Vehicles Telecommunication equipment Land and buildings

12-3 Accounting for Leases For accounting purposes, leases must be identified as either Capital or Operating. Use the same 4 criteria as identified in FASB Statement No. 13 to identify a capital lease. The lease transfers ownership at the end of the lease term. The lease contains a bargain purchase option. The lease term = or > 75% of the asset’s estimated useful life. The minimum lease payments > 90% of the PV of the asset.

Accounting for Operating Leases 12-4 Accounting for Operating Leases Government-Wide Financial Statements: Do not record an encumbrance. Record an expense when the lease payment is made. Fund-Based Financial Statements: Record the encumbrance. Record an expenditure when the lease payment is made.

Accounting for Capital Leases 12-5 Accounting for Capital Leases Government-Wide Financial Statements Record both the asset and the lease obligation. On 1/1/08, Bihan City signs a 10-year capital lease for a $50,000 dump truck with an implied interest rate of 8%. Prepare the journal entry to record the lease agreement for government-wide statements.

Accounting for Capital Leases 12-6 Accounting for Capital Leases Government-Wide Financial Statements Record interest expense & reduce the obligation. At 12/31/08, Bihan City made a $7,452 payment that included interest of $4,000. Prepare the journal entry to record the lease payment for government-wide statements.

Accounting for Capital Leases 12-7 Accounting for Capital Leases Fund-Based Financial Statements Unless it is for a proprietary fund, neither the asset nor the obligation is recorded, because it does not fall within the definition of current financial resources. On 1/1/08, Good City signs a 10-year capital lease for a $50,000 dump truck with an implied interest rate of 8%. An entry does have to made to record the other financing source.

Accounting for Capital Leases 12-8 Accounting for Capital Leases Proprietary funds Account for Capital leases as Do for-profits Fund-Based Financial Statements (Governmental Funds) Record the lease payments as expenditures in the General Fund. At 12/31/08, Good City made a $7,452 payment that included interest of $4,000. Prepare the journal entry to record the lease payment for fund-based statements.

Government-Wide Financial Statements Fund-Based Financial Statements 12-9 Solid Waste Landfill The operation of a solid waste landfill creates long-term liabilities. The EPA imposes requirements that will require large outlays of resources to close that landfill in the future and to deal with such post-closure activities as groundwater monitoring. Government-Wide Financial Statements Record a pro-rated portion of the expected closing costs (as a % of used capacity) each year as an expense and a liability. Fund-Based Financial Statements Make no entry to record a liability. Record cash payments made to fund the future obligation as “expenditures”.

Government-Wide Financial Statements Fund-Based Financial Statements 12-10 Compensated Absences Employees accrue vacation and sick leave at a predetermined rate. Unused/accrued vacation and sick leave are payable upon termination or retirement, creating a liability. Government-Wide Financial Statements Accrue the expense and a liability related to unused/accrued vacation and sick leave. Fund-Based Financial Statements Make an entry only for the portion of the liability that is expected to be paid from current resources.

Works of Art and Historical Treasures 12-11 Works of Art and Historical Treasures GASB No. 34 says governments “should capitalize works of art, historical treasures, and similar assets at their historical cost or fair value at date of donation.” Government-Wide Financial Statements Record the asset and the payment (if purchased) or revenue (if donated). Fund-Based Financial Statements Record an expenditure and the cash payment (if purchased). No entry is made if the item is donated.

Works of Art and Historical Treasures 12-12 Works of Art and Historical Treasures GASB 34 allows for optional capitalization only if the following 3 criteria are met: Item is held for public exhibition, education, or research in furtherance of public service, rather than financial gain Item is protected, kept unencumbered, cared for, and preserved Item is subject to an organizational policy that requires the proceeds from sales of collection items to be used to acquire other items for collections

Infrastructure Assets and Depreciation 12-13 Infrastructure Assets and Depreciation Government-Wide Financial Statements: Record all newly acquired assets. Show approximate cost for all previously acquired major assets that Were acquired after June 30, 1980, or that Had major renovations, restorations, or improvements since that date. Fund-Based Financial Statements: Record the acquisition as an expenditure. Depreciation For government-wide financial statements, depreciation is recorded for all assets except land, art works, and historical treasures that are inexhaustible.

Infrastructure Depreciation 12-14 Infrastructure Depreciation GASB 34 provides an alternative, known as the “modified” approach, which eliminates the need for depreciating qualifying infrastructure Additions and improvements must still be qualified, but maintenance costs are immediately expensed in lieu of depreciation Use of the modified approach requires government to accumulate information about particular infrastructure items within either a network or its subsystem Must establish a minimum acceptable condition level and document that it is being met Must have an asset management system in place to monitor the network or subsystem The cost and record-keeping required have so far limited application of the modified approach

GASB Statement 34 - General Purpose Statements 12-15 GASB Statement 34 - General Purpose Statements Three distinct sections: Management’s Discussion and Analysis (MD&A) Financial Statements Government-wide Financial Statements Fund-based Financial Statements Notes to the Financial Statements Required Supplementary Information

Management’s Discussion and Analysis (MD&A) 12-16 Management’s Discussion and Analysis (MD&A) Should provide an Objective and Easily Readable Analysis Should provide both a short- and long-term Analysis of the Government’s Activities Should Compare Current and prior Year Results Use of charts, graphs and tables Encouraged to enhance Understandability

External Reporting Process 12-17 External Reporting Process GASB 34 Stipulates that The CAFR Include: 1.Introductory Section 2.Financial Section 3.Statistical Section Governments prepare a Comprehensive Annual Financial Report (CAFR).

Primary Government and Component Units 12-18 Primary Government and Component Units Reporting entities must produce CAFRs. These units start with a primary government unit (town, city, county or state) Primary government must then include all funds, activities, organizations, agencies, offices and departments that are not legally separate from it Sometimes can be difficult to determine whether certain activities should be included The major criterion for inclusion is “financial accountability”

12-19 Component Units Includes any unit that is legally separate from the primary government, but where financial accountability still exists. Must be included in general purpose financial statements. Can be discretely presented on the fund-based statements or “blended” with the funds of the primary government. Safety Commission

Government-Wide Statements - Statement of Net Assets 12-20 Government-Wide Statements - Statement of Net Assets Include all assets, capital assets, and liabilities (current and long-term). Report capital assets net of accumulated depreciation. Divide the primary government into governmental activities and business-type activities. Show all offsetting internal balances resulting from interactivity transactions. Report Investments at fair market value. Group all discrete component units and show separately from the primary government figures. Assets – Liabilities = Net Assets (not equity) Show restrictions. Capital Assets less related debt are reported separately within Net Assets.

Government-Wide Statements - Statement of Activities 12-21 Government-Wide Statements - Statement of Activities Expenses are shown by function. Interest on general long-term debt is normally an indirect expense. Frequently shown as a separate “function”. Related program revenues should be shown for each “function”. Show the net revenue figure for each function. General revenues are shown at the bottom of the statement.

Fund-Based Financial Statements - Governmental Funds 12-22 Fund-Based Financial Statements - Governmental Funds Balance Sheet Does not include proprietary funds, component units, or internal service funds. No capital assets or long-term liabilities are reported. Separate columns for the General Fund and each major fund. In the Fund Balance section, identify both the “reserved” and “designated” amounts. Statement of Revenues, Expenditures, & Changes in Fund Balances Net revenues are not identified for specific functions. Report Expenditures rather than expenses. Other financing sources and uses are shown to reflect long-term debt, sale of property, and transfers between funds. Reconcile the ending fund balance and the ending change in net assets.

Fund-Based Financial Statements - Proprietary Funds 12-23 Fund-Based Financial Statements - Proprietary Funds Statement of Net Assets Show the combined internal service funds. Assets and liabilities are classified as current and noncurrent. Statement of Revenues, Expenses, & Changes in Fund Net Assets Same rules as for governmental funds. Capital contributions and transfers are reported here. Statement of Cash Flows Four sections: Operating Activities Noncapital Financing Activities Capital and Related Financing Activities Investing Activities.

Public Colleges and Universities 12-24 Public Colleges and Universities Public colleges and universities must follow the same guidelines as state and local governments. (GASB retains primary reporting authority) Their statements will differ from those of private colleges and universities.

12-25 Summary Governments may lease assets, just as for-profit enterprises. The same rules apply for distinguishing between capital and operating leases Landfills create large liabilities for governmental entities. These are accrued in government-wide statements but are not recorded in fund-based statements until claims are actually made Interesting accounting issues are created by government employees earning compensated absences and by governments possessing works of art and historical treasures Governments are required to report MD&A’s and CAFRs Public colleges and universities must follow GASB rules rather than FASB

12-26 Possible Criticisms Some critics attack the different reporting standards required for public colleges and universities versus private institutions. They argue that this violates the basic accounting tenet of similar accounting for similar transactions. Other critics contend that the modified approach favors large governmental entities over smaller units. Some contend that where works of art are displayed without charge they do not fit the definition of an asset, because they do not generate any economic benefit. Therefore, these critics contend that GASB 34’s requirement to capitalize these items is theoretically unjustified. WHAT DO YOU THINK????