LEARNING OBJECTIVES

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

• Identify what must be included in the management discussion and analysis (MD&A) and required supplementary information (RSI).
• Identify major funds for reporting purposes.
• Recognize format and requirements of funds' financial statements.
• Identify the reporting entity of a government.

What a Government Reports

Governments are required to include certain minimum information in their external financial reports. The requirements are designed to meet the basic needs of a broad group of external users. A government's general purpose external financial statements contain, at a minimum, the following items: management's discussion and analysis, basic financial statements, and required supplementary information.

MD&A

MD&A should be presented before the basic financial statements and is part of RSI that must be presented in the financial statements (the nature of RSI is discussed in the next section).

MD&A provides an objective and easily readable analysis of the government's financial activity for the year. This is written by management and highlights events important to the readers.

It is based on currently known facts, decisions, and conditions and must discuss both positive and negative aspects of the current year activity.

MD&A comprises up to eight separate elements, depending on the government, as follows:

• A discussion of the basic financial statements

—     The MD&A should focus on the activities of the primary government. The decision to include comments about a government's component units is a matter of professional judgment and should be based on the significance and relationship of the component unit with the primary government. Any information presented for a component unit should be clearly distinguished from that of the primary government.

—     The MD&A includes a discussion on the basic financial statements and the relationship between government-wide statements and fund financial statements. This discussion enables readers to understand the differences between financial results reported in the two sets of financial statements.

• Condensed comparative data

—     The MD&A should discuss current year results in comparison with the prior year. This is the only place in the general purpose external financial reports where governments are required to present comparative information.

• An analysis of the government's overall financial position and results of operations

—     The MD&A discusses the overall financial position and results of operations for the government. This analysis provides reasons that explain why the financial position of the government has either increased or decreased for the year. The analysis should also address the financial activities of both governmental and business-type activities as reported in the government-wide statements.

• An analysis of the funds

—     The MD&A also addresses any significant changes in the fund balances or fund net position for the year, and it provides comments on any significant restrictions or commitments affecting the availability of fund resources at the end of the year.

• An analysis of the budget to actual statement or schedule

—     The MD&A also should provide an analysis of any significant variation between the original budget and final budget and between the final budget and actual budget results for the general fund.

• Capital asset and debt activities

—     A description of significant capital asset and long-term debt activities is also included in the MD&A. This discussion should include any significant commitments, changes in credit ratings, debt limitations that may affect the financing of planned facilities or services, and new debt issuances.

• Infrastructure if applicable

—     If a government is using the modified approach for certain infrastructure capital assets, the MD&A should discuss any significant changes in assessed condition of eligible infrastructure, how the current assessed condition compares with the level set by the government, and any significant differences in the amount spent to maintain infrastructure from the annual amount estimated to maintain those assets.

• Economic conditions and outlook

—     The MD&A also includes a description on any currently known facts, decisions, or conditions that are expected to have a significant financial effect on the government. Currently known facts would include any items that occurred after year-end but before the date of the auditors' report.

       Governments are also encouraged to use charts, graphs, and tables in the MD&A to enhance the understandability of the information.

—     Examples could include the following:

o     Changes in tax rates, tax base, or population

o     Loss of significant employers

o     Settlement of significant lawsuits

o     New labor contracts

o     Deficit reduction measures.

Governments must also provide condensed financial information (from the government-wide statements) comparing the current year with the prior year. Governments are required to report the following condensed financial information:

KNOWLEDGE CHECK

1.     Which statement is accurate regarding MD&A?

1. It is based on currently known facts, decisions, and conditions and must discuss both positive and negative aspects of the current year activity.
2. Any information presented for a component unit should not be distinguished from that of the primary government.
3. MD&A should be presented after the basic financial statements.
4. The auditors give an opinion on the MD&A.

RSI (OTHER THAN MD&A)

RSI (including MD&A) is information that a government must present as part of its financial presentation, but is unaudited.

Auditors are required to perform certain limited procedures on RSI to include the following:

• Inquiries of management about the methods of preparing the RSI.
• Comparing the information for consistency with management's responses to inquiries, the basic financial statements, and other knowledge the auditor obtained during his or her audit of the basic financial statements.

However, the absence of, or deficiencies in, RSI does not affect the auditor's opinion on the financial statements. In such cases, the auditor adds information to the audit opinion describing the situation.

As stated earlier, the MD&A is presented before the basic financial statements. Other RSI is presented after the basic financial statements. Governments may be required to report the following additional items as part of RSI:

• Budgetary Comparison Schedule. Governments must present Budgetary Comparison Schedules for the following:

—     General fund

—     Each major special revenue fund with a legally adopted annual budget.

Governments have the option of including these schedules as part of the fund financial statements as opposed to reporting them as part of RSI.

These schedules must contain a minimum of three columns for each governmental fund reported: original budget, final budget, and actual amounts reported using the budgetary basis of accounting. A variance column may be included to facilitate the comparison of budget and actual amounts, but is not required. The budget comparison schedule can be prepared using the same format and terminology of the budget document or using the same format as the statement of revenues, expenditures, and changes in fund balances.

• Infrastructure Assets. When a government uses the modified approach for certain networks or subsystems of infrastructure, certain information must be disclosed as part of RSI. A schedule must be provided that gives the assessed condition of the infrastructure assets over a period of time. Also, a schedule for the last five years must be provided with the estimated annual amount needed to maintain the assets at the condition level established by the government and the actual amount expensed.

  Additional information must be provided about the basis for the condition measurement and the scale used to assess and report condition. The condition level the government intends to preserve the infrastructure assets must also be disclosed. Factors that significantly affect trends in the information reported in the required schedules must be disclosed.

• Pensions and Postemployment Benefits Other Than Pensions (OPEB). RSI requirements exist related to pensions and OPEB. These requirements are mainly found in GASB Statement Nos. 45, 67, 68, 73, 74, and 75 as follows:

—     GASB Statement No. 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions (amended by GASB Statement No. 63); will be completely superseded upon the effective date of GASB Statement No. 75

—     GASB Statement No. 67, Financial Reporting for Pension Plans (an amendment of GASB Statement No. 25)

—     GASB Statement No. 68, Accounting and Financial Reporting for Pensions (an amendment of GASB Statement No. 27)

—     GASB Statement No. 73, Accounting and Financial Reporting for Pensions and Related Assets That Are Not within the Scope of GASB Statement 68, and Amendments to Certain Provisions of GASB Statements 67 and 68 — Effective for periods beginning after June 15, 2016

—     GASB Statement No. 74, Financial Reporting for Postemployment Benefit Plans Other than Pension Plans — Effective for periods beginning after June 15, 2016

—     GASB Statement No.75, Accounting and Financial Reporting for Postemployment Benefits Other Than Pensions — Effective for periods beginning after June 15, 2017

KNOWLEDGE CHECK

2.     Which statement is accurate regarding RSI?

1. When a government uses the modified approach for certain networks or subsystems of infrastructure, certain information must be disclosed as part of RSI.
2. RSI requirements do not exist related to pensions and OPEB.
3. All RSI is presented before the basic financial statements.
4. Budget to actual comparisons must be presented as part of RSI.

HOW DID THE PARTS DO THIS YEAR?

The fund financial statements provide important information on how the separate parts (funds) of a government did for the year. How much was received, spent, and what is left over for a particular purpose can best be determined with fund financial statements. These statements are additionally used to determine compliance with finance-related laws, rules, and regulations. Through the budget process, governments often make resource allocation decisions by fund. To demonstrate accountability, governments must provide financial information by funds.

Reporting by Major Funds

The number of individual funds a government may have can vary from just a few to several dozen. Generally, a government should have the minimum number of funds necessary for sound financial management and/or to meet legal and accounting requirements. It takes more funds for some governments than others to meet this requirement.

Should information for each fund be reported in the basic financial statements? This could be done, but the reports may become quite long. An alternative may be to report information by fund type. However, information about individual funds would be lost. A final alternative (and the one used) would be to present information about the largest and most important funds separately, and combine the information of the other funds into a single column. The major fund approach allows the user to focus on the most important funds of a government.

Reporting by major funds only applies to governmental funds and enterprise funds. It does not apply to internal service funds or fiduciary funds, which are reported in columns by fund type.

In the governmental and proprietary fund financial statements, governments report separate columns for each major fund. Nonmajor funds as well as internal service funds are combined and reported as single columns in the financial statements.

Now that we understand that reporting is done by major funds, how do we determine which funds are major? First, the general fund is always major. Second, a government can make any governmental or enterprise fund major if the fund is believed to be important to financial statement users.

KNOWLEDGE CHECK

3.     Which statement is accurate regarding major fund reporting?

1. Reporting by major funds only applies to governmental funds and enterprise funds.
2. The general fund is rarely a major fund.
3. The major fund approach prevents the user from focusing on the most important funds of a government.
4. A government cannot make any governmental or enterprise fund major if it believes the fund is important to financial statement users.

A government needs to test annually all other governmental and enterprise funds to determine if they are major and must be reported in a separate column. A fund is major if it meets both of the following criteria:

• Total assets + deferred outflows of resources, liabilities + deferred inflows of resources, revenues or expenditures /expenses of a fund is at least 10 percent of the corresponding total for those items for all funds of that category (governmental or enterprise).
• Total assets + deferred outflows of resources, liabilities + deferred inflows of resources, revenues or expenditures /expenses of a fund is at least five percent of the corresponding total for all governmental and enterprise funds combined

Testing for major funds is a two-step process. Only if an item (such as total revenues) for a fund passes the first test would the second test be done. Also the same item (such as total revenues) must pass both tests.

For example, the first test would compare a special revenue fund's total assets + deferred outflows of resources, liabilities + deferred inflows of resources, revenues, and expenditures with the total for these same items for all governmental funds. If none of these listed items for the special revenue fund should exceed 10 percent of the totals for all governmental funds, the fund would not be considered major and the second test would not be done.

However, if total revenues for the special revenue fund were the only item that passed the 10 percent test, then total revenues of the special revenues fund would be tested to determine if they were at least 5 percent of the total revenues of governmental and enterprise funds combined. If so, the special revenue fund would be major. The same item has to pass both tests.

The major fund tests need to be done each year. A fund may meet the criteria to be major one year and not the next year. So, it is possible that the major funds reported in separate columns in the fund financial statements could be different each year.

For example, a government may have a large capital project one year and none the next year. During the period where there is much activity, the fund could meet the major fund criteria and be reported in a separate column in the fund financial statements. In periods where there is little activity, the fund is combined and reported with other nonmajor funds. However, a government has the option of continuing to report as major any fund it thinks important.

Below is an example major fund calculation for a special revenue fund:

WHAT IS INCLUDED AS THE PUBLIC SECTOR FINANCIAL REPORTING ENTITY?

In business, it is often easy to determine what separate legal entities should be included in the financial statements of a corporation. It is based on ownership. The financial statements will consolidate financial information of the parent company and legally separate subsidiaries. Often there is no ownership for governments and it is more difficult to determine what entities to include. Governments come in all shapes and sizes. Some general-purpose governments provide a full range of services, although others provide only limited services. Often additional services are provided by separate special-purpose entities. Under what circumstances should these separate legal entities be included in the financial statements of the general-purpose government? This chapter will try to answer that question.

COMPONENT UNITS: SPECIAL-PURPOSE GOVERNMENTS

If a special-purpose government does not meet all the preceding criteria, it becomes a potential component unit of another primary government. To be classified as a component unit of a primary government, a special-purpose government must first be a legally separate entity.

Entities that are not legally separate would normally be included as part of the government that holds the related legal powers.

To be a component unit of a primary government, the legally separate special-purpose government must also be financially accountable to the elected officials of the primary government. How is this determined? If a legally separate special-purpose government meets any of the following three tests, then it is a component unit of the primary government.

Test 1

The primary government appoints the voting majority of the governing board of the entity.

Governments often appoint the majority of certain entities' boards. However, just appointing a majority is not enough to determine if the primary government is financially accountable for this entity. One of the following tests must also be met:

• The primary government must be able to impose its will (see the following examples).
• There is a financial benefit or burden relationship between the primary government and the separate legal entity (see the following examples).

COMPONENT UNITS: CERTAIN TAX EXEMPT ORGANIZATIONS

(Guidance for tax-exempt organizations is contained in GASB Statement No. 39, Determining Whether Certain Organizations are Component Units.)

Certain other organizations warrant inclusion in the primary government's financial statements because of their relationship and significance to the primary government (for example, foundations and other organizations that support the programs of the primary government). A legally separate, tax-exempt organization is considered a component unit of a primary government if it meets all of the following three tests:

• The economic resources received or held by the organization are entirely or almost entirely for the direct benefit of the primary government, its component units, or its constituents.
• The primary government, or its component units, is entitled to, or has ability to otherwise access, a majority of the economic resources of the organization.
• The economic resources received or held by an individual organization that the specific primary government, or its component units, is entitled to, or has the ability to otherwise access, are significant to that primary government.

In addition, other organizations should be evaluated as potential component units if they are closely related to, or financially integrated with, the primary government. Professional judgment is used to determine if the relationship and significance of the organization to the primary government warrant inclusion as a component unit.

Some component units issue separate financial statements. These financial statements should also include any component units of the entity producing the financial statement. If a component unit of the primary government has its own component units, these component units must also be included in the financial statements of the primary government. Separately issued financial statements of a component unit should acknowledge that it is a component unit of another government. The notes to the financial statements should identify the primary government in whose financial reporting entity it is included and describe its relationship with the primary government.

One last thing, an entity can be included only as a component unit by only one primary government even if it passes the tests to be reported as a component unit for more than one government. For example, a state government may appoint an entity's governing board, but the entity may also be fiscally dependent on a local government. Usually, the fiscally dependent test will take precedence over the other tests.

Reporting Component Units

Once an entity has been determined to be a component unit of the primary government, the next decision is how it should be reported in the financial statements. There are two different methods, blending and discrete presentation.

Blending combines the financial information of the component unit with the existing funds of the primary government in the financial statements. In essence, a blended component unit appears just as another fund in the financial statements of the primary government. However, the general fund of a blended component unit should be reported as a special revenue fund, not combined with the general fund of the primary government.

KNOWLEDGE CHECK

4.     Which statement is accurate regarding the reporting of component units?

1. There are five different methods used to report component units.
2. In essence, a blended component unit never appears as just another fund in the financial statements of the primary government.
3. Once an entity has been determined to be a component unit of the primary government, the next decision is how it should be reported in the financial statements.
4. Each component unit of the primary government must be shown in a separate column of the financial statements

A government is required to blend the financial information of a component unit if any of the following four circumstances applies (blending does not apply to tax-exempt organizations):

1. The board of the component unit is “substantively” the same as the primary government and there is a financial benefit or burden relationship between the primary government and the component unit.
2. The board of the component unit is “substantively” the same as the primary government and management of the primary government has operational responsibility for the component unit.
3. The component unit serves the primary government exclusively, or almost exclusively (an example of the second criteria would be a financing authority used to finance the government's construction projects).
4. The component unit's total debt is expected to be paid entirely or almost entirely with resources from the primary government.

If the preceding circumstances are not met, then the component unit will be discretely reported in the financial statements (discrete presentation). Discrete presentation reports the financial information of a component unit in a column separate from the primary government in the government-wide financial statements.

What happens if there is more than one discretely presented component unit? GAAP requires that information about each major component unit be provided in the basic financial statements. There are three ways a government can meet this requirement:

1. Use a separate column for each component unit in the government-wide statements.
2. Include a combining statement of major component units after the fund financial statements.
3. Present condensed financial information in notes to the financial statements.

Component units that are fiduciary in nature should not be reported in the government-wide statements. Government-wide statements exclude all fiduciary funds and fiduciary component units. Fiduciary component units are reported only in the fund financial statements along with the primary government's fiduciary funds.

One last issue, a component unit may have a different fiscal year than the primary government. Such a component unit is presented in the basic financial statements using the component unit's fiscal year. Generally, component units' information should not be more than nine months older than the primary government, unless including the newer information would unduly delay issuing the financial statements.

Joint Ventures and Other Organizations

A local government may join with other area governments to provide certain services. These multigovernment arrangements will often not meet the criteria to be treated as a component unit by any individual government. So how should each government report their participation in such arrangements? That depends on the nature of the arrangement.

There are two general types of multi-government arrangements: joint venture and jointly governed organizations. The main difference between the two is that a joint venture creates an ongoing financial relationship with the participating governments, where a jointly governed organization does not. Both types of organizations are included in note disclosures by the participating governments.

For joint ventures, the arrangement may create an explicit, measurable equity interest for the participating governments in some or all of the resources of the joint venture. In this case, a government should report its interest in the joint venture in the government-wide statements as a single line item. For the fund financial statements, governmental funds should report an interest in joint ventures only to the extent that the interest represents financial assets. For proprietary funds, the “investment in joint venture” account reported in a proprietary fund should report the participating government's equity interest calculated in accordance with the joint venture agreement.

Summary

Financial statements for governments include both fund-based and government-wide statements. There are separate sets of fund financial statements for each fund type: governmental, proprietary, and fiduciary. The fund financial statements focus on major funds. Each major fund is reported in separate columns and the nonmajor funds are combined and reported as a separate column. Major fund reporting applies only to governmental and enterprise funds. Internal service funds and fiduciary funds report separate columns for each fund type.

The required financial statements for each fund type are different. Governmental funds report a balance sheet and a statement of revenues, expenditures, and changes in fund balances. Proprietary funds report a statement of net position (or balance sheet), a statement of revenues, expenses, and changes in net position, and a statement of cash flows. Fiduciary funds report a statement of fiduciary net position and a statement of changes in fiduciary net position.

A government's reporting entity includes the primary government and its component units. Component units are separate legal entities that are financially accountable to the elected officials of the primary government. In addition, certain other tax-exempt organizations warrant inclusion in the primary government's financial statements as component units because of their relationship and significance to the primary government. There are a variety of tests used to determine if an entity is a component unit.

Component units are either blended or discretely presented in the financial statements of the primary government. Blending reports component units as funds of the primary government. Discrete presentation reports component units in separate column(s) of the government-wide statements. Other related organizations, such as joint ventures and jointly governed organizations, should be disclosed in the notes to the financial statements.