Chapter 6

SPECIAL-PURPOSE GOVERNMENTS AND SPECIAL PURPOSE FRAMEWORKS

LEARNING OBJECTIVES

After completing this chapter, you should be able to do the following:

  • Recognize the reporting requirements for special-purpose governments engaged in governmental, business-type, and fiduciary activities.
  • Identify the special purpose frameworks applicable to state and local governments.
  • Identify the required disclosures for special-purpose financial statements.
  • Recognize the appropriate format for the auditor's reports for special purpose financial statements.

ARE THESE REPORTS DIFFERENT?

How should financial statements for things like public colleges, hospitals, housing authorities, or organizations engaged in only one program be reported? Do they have to produce both fund financial statements and government-wide statements and do the statements have to look the same? That depends on a number of different factors. This chapter will try to answer these questions.

Background

Most of the information in this course has been directed to general-purpose governments — such as states, cities, counties, and towns. However many governmental entities do not fit this category and are referred to as special-purpose governments. These organizations are separate legal entities that may be component units of another government or may be stand-alone governments that do not meet the definition of a general-purpose government.

Special-purpose governments that are engaged in more than one program or that have both governmental, and business-type activities should produce both fund financial statements and government-wide financial statements.

For example, a school district may have programs for regular instruction, special education, vocational education, and adult education. Those entities should generally follow the guidance set out in previous chapters. However, for entities only engaged in a single program or only in a business-type or fiduciary activity, different financial statements are appropriate.

SPECIAL-PURPOSE GOVERNMENTS ENGAGED IN ONLY GOVERNMENTAL ACTIVITIES

Some governmental entities are only engaged in a single program. Some examples include

  • cemetery districts,
  • levee districts,
  • assessment districts, and
  • drainage districts.

For these entities engaged in only a single program, the fund financial statements and government-wide statements may be combined using a columnar format. This format would present the reconciling items in separate columns, as opposed to the bottom of the statement.

However, a special-purpose government engaged in only governmental activities can also present separate fund financial statements and government-wide statements. In this case, it can use a different format to report the statement of activities. The alternative format can present the statement in a single column by first reporting expenses, followed by program revenues, and then general revenues. Other items like special and extraordinary items, and transfers would then be reported.

KNOWLEDGE CHECK

1.     Which is accurate regarding special-purpose governments?

  1. Special-purpose governments that are engaged in more than one program or that have both governmental and business-type activities should produce both fund financial statements and government-wide financial statements.
  2. All special-purpose governments report government-wide statements.
  3. For special purpose governments only engaged in a single program or only in a business-type or fiduciary activity, different financial statements are not appropriate.
  4. A special-purpose government engages solely in fiduciary-type activities.

SPECIAL-PURPOSE GOVERNMENTS ENGAGED IN ONLY BUSINESS-TYPE ACTIVITIES

Some special-purpose governments are engaged in only the following business-type activities:

  • Water and electric authorities
  • Housing authorities
  • Public colleges and universities
  • Hospitals
  • Port authorities

These entities will report as special-purpose governments engaged only in business-type activities.

Business-type activities are reported as enterprise funds. Because the fund financial statements information for enterprise funds is basically the same information presented in the government-wide statements for business-type activities, there is no need to present both types of statements. For these types of governmental entities, the basic financial statements and required supplementary information consist of the following items:

  • Management discussion and analysis (MD&A)
  • Enterprise fund financial statements

—     Statement of net position or balance sheet

—     Statement of revenues, expenses and changes in fund net position

—     Statement of cash flows

  • Notes to the financial statements
  • Required supplementary information (other than MD&A) if applicable

These entities would follow the financial reporting requirements for enterprise funds.

KNOWLEDGE CHECK

  • 2. Which is accurate regarding special-purpose governments?
    1. Special-purpose governments cannot be engaged in only business-type activities.
    2. Special-purpose governments engaged in only business-type activities report the fund financial statements required for fiduciary funds.
    3. Some special-purpose governments are only engaged in fiduciary activities, for example, pension plans.
    4. Special-purpose governments only engage in business-type activities.

SPECIAL-PURPOSE GOVERNMENTS ENGAGED IN ONLY FIDUCIARY ACTIVITIES

Some special-purpose governments are engaged only in fiduciary activities—for example,

  • pension and other employee benefit trust funds (GASB Statement No. 67 defines the reporting format for pensions); and
  • investment trust funds.

These entities need report only the financial statements required for fiduciary funds. The basic financial statements and required supplementary information for these entities consist of the following items:

  • MD&A
  • Statement of fiduciary net position
  • Statement of changes in fiduciary net position
  • Notes to the financial statements

Special-Purpose Frameworks

WHY A SPECIAL PURPOSE FRAMEWORK?

Many small governmental entities are frustrated by the complexity inherent in reporting using GAAP and the costs associated with the corresponding audit. Therefore, many governmental units are looking for a simpler alternative accounting framework.

Financial statements prepared using another basis of accounting are referred to as special purpose financial statements. The guidance for the preparation for these types of financial statements can be found in AU-C section 800, Special Considerations—Audits of Financial Statements Prepared in Accordance With Special Purpose Frameworks (AICPA, Professional Standards). This guidance identifies these special purpose frameworks as the cash basis, tax basis, regulatory basis, contractual basis, or an other basis of accounting. With the exception of the contractual basis, these other non-GAAP bases of accounting are often referred to as other comprehensive bases of accounting (OCBOA).

TYPES OF SPECIAL PURPOSE FRAMEWORKS

The special purpose framework allows smaller governmental entities the alternative that they see by

preparing their financial statements in accordance with a special purpose framework other than GAAP.

Those frameworks that are applicable to governments include the following:

  1. The cash basis. A basis of accounting that the entity uses to record cash receipts and disbursements (commonly referred to as pure cash basis), and modifications of the cash basis having substantial support, such as recording depreciation on capital assets (referred to as modified cash basis).
  2. The regulatory basis. A basis of accounting that the reporting entity uses to comply with the requirements or financial reporting provisions of a regulatory agency to whose jurisdiction the entity is subject.
  3. The contractual basis. A basis of accounting that the entity uses to comply with an agreement between the entity and one or more third parties other than the auditor.
  4. Other basis. A basis of accounting that uses a definite set of logical, reasonable criteria that is applied to all material items appearing in financial statements.

AU-C section 800 addresses the requirements related to these financial statements.

FINANCIAL STATEMENTS

The guidance in AU-C section 800 states “that the requirements of the applicable financial reporting framework determines the form and content of the financial statements and what constitutes a complete set of financial statements.” The guidance does not permit special purpose financial statements to omit required basic financial statements or to substitute substantially similar information for a basic financial statement that is required by GAAP. Instead, it permits the substitution of substantially similar information for required display within those financial statements.

For example, GAAP requires specific disclosures related to long-term debt but special purpose financial statements that disclose the repayment terms could sufficiently communicate information about future principal reductions without providing a summary for each of the next five years and five-year increments after that.

Financial statements prepared on the contractual or regulatory basis do not have to include all of the basic financial statements required by GAAP if the contractual agreement or regulatory requirements direct presentation of less than a complete set of financial statements.

For example, a regulatory provision may require the reporting of a schedule of cash receipts and disbursements by fund only. That regulatory basis presentation is not intended to present financial position and is not deficient because it lacks a schedule of cash, nor is the presentation deficient because it lacks other basic financial statements that would be required by GAAP.

KNOWLEDGE CHECK

  • 3. Which is NOT a special purpose framework?
    1. Cash basis.
    2. Contractual basis.
    3. GAAP basis.
    4. Budgetary basis.
  • 4. Which AU-C section is applicable for adequacy of presentation and disclosure for special purpose financial statements?
    1. AU-C section 700.
    2. AU-C section 725.
    3. AU-C section 800.
    4. AU-C section 925

REQUIRED FINANCIAL STATEMENT DISCLOSURES

Required financial statement disclosures for special purpose frameworks include the following:

  • A description of the special purpose framework, including a summary of significant accounting policies, and how the special purpose framework differs from GAAP (quantification of the effects is not required).
  • Informative disclosures similar to those required by GAAP, in the case of special-purpose financial statements that contain items that are the same as, or similar to, those in financial statements prepared in accordance with GAAP.
  • In the case of special purpose financial statements prepared in accordance with a contractual basis of accounting, a description of any significant interpretations of the contract on which the special-purpose financial statements are based.
  • Any additional disclosures beyond those specifically required by the framework that may be necessary for the special purpose financial statements to achieve fair presentation.

AUDITOR RESPONSIBILITIES

When forming an opinion and reporting on special purpose financial statements, the auditor should apply the requirements in AU-C section 700, Forming an Opinion and Reporting on Financial Statements (AICPA, Professional Standards), and, if applicable, AU-C section 705, Modifications to the Opinion in the Independent Auditor's Report (AICPA, Professional Standards).

The auditor should accomplish the following:

1.     Evaluate whether the special purpose financial statements are

a.     suitably titled,

b.     include a summary of significant accounting policies, and

c.     adequately describe how the special-purpose framework differs from GAAP.

2.     Determine whether additional disclosures are necessary for the special-purpose financial statements to achieve fair presentation.

AUDITING CONSIDERATIONS

1.     The auditor should obtain an understanding of the following:

a.     The purpose for which the financial statements are prepared

b.     The intended users

c.     The steps taken by management to determine that the applicable special purpose financial reporting framework is acceptable in the circumstances.

2.     The auditor should obtain an agreement with management that it acknowledges its responsibilities for the special purpose framework.

3.     The auditor should obtain an understanding of the entity's selection and application of accounting principles.

4.     The auditor should plan, perform, evaluate, and report on the financial statements based on opinion units, except for contractual and regulatory presentations where it might not be applicable.

AUDITOR'S REPORTS

AU-C section 800 states that the auditor's report on the financial statements should also include the

following:

  1. Within the explanation of management's responsibility, reference to management's responsibility for determining that the applicable financial reporting framework is acceptable in the circumstances when management has a choice of financial reporting frameworks in the preparation of the financial statements.
  2. A description of the purpose for which the financial statements are prepared or reference to a note in the financial statements that contains that information when the financial statements are prepared in accordance with a regulatory or contractual basis of accounting.
  3. Except in cases in which the financial statements are prepared in accordance with a regulatory basis and are intended for general use, an emphasis-of-matter paragraph (under an appropriate heading that indicates that the financial statements are prepared in accordance with the applicable special purpose framework) references the note to the financial statements that describes that framework and states that the special-purpose framework is a basis of accounting other than GAAP.
  4. In cases when the financial statements are prepared in accordance with a regulatory or contractual basis of accounting and the financial statements and auditor's report are intended solely for those within the entity, the regulatory agencies to whose jurisdiction the entity is subject, or the parties to the contract or agreement, an other-matter paragraph under an appropriate heading that restricts the use of the auditor's report to those specified intended users in accordance with paragraph .20 of AU-C section 800.

KNOWLEDGE CHECK

  1. In cases in which the financial statements are prepared in accordance with a special purpose framework, other than regulatory or contractual, the auditor's report should include
    1. Reference to management's responsibility for determining the applicable financial reporting framework is acceptable in the circumstances for which there is a choice of financial reporting frameworks.
    2. A description of the purpose for which the financial statements are prepared either in the report or a note referenced in the report.
    3. An other matter paragraph that restricts the use of the report to the specified intended users.
    4. A disclaimer of opinion.

See appendix A for example reports.

See appendix B for an overview of reporting requirements for special purpose financial statements

Practice Questions

  1. Which special-purpose government financial reports must include an MD&A?
    1. Governments engaged only in governmental activities.
    2. Governments engaged only in business-type activities.
    3. Governments engaged only in fiduciary activities.
    4. All of the above.
  2. Which special-purpose government financial reports must include a statement of cash flows?
    1. Governments engaged only in governmental activities.
    2. Governments engaged only in business-type activities.
    3. Governments engaged only in fiduciary activities.
    4. All of the above.
  3. What are the reporting requirements for a special-purpose government engaged only in governmental activities?






  4. Explain the reporting requirements of an authority engaged only in business-type activity.

Appendix A

APPENDIX A—ILLUSTRATIVE AUDITOR'S REPORTS

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Appendix B

APPENDIX B—OVERVIEW OF REPORTING REQUIREMENTS FOR SPECIAL PURPOSE FINANCIAL STATEMENTS

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