LEARNING OBJECTIVES

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

• Recognize the format and requirements of the government-wide statements.
• Identify steps in the process required to produce the government-wide statements.
• Identify what must be included in a Comprehensive Annual Financial Report (CAFR).

KNOWLEDGE CHECK

1. Which is correct regarding the government-wide financial statements?
   1. The government-wide financial statements are used to address fiscal accountability.
   2. Government-wide statements were created with the advent of GASB Statement No. 68.
   3. The purpose of the government-wide financial statements is to demonstrate operational accountability.
   4. The government-wide financial statements are a summary of the fund's financial statements.

To meet the goal of providing operational accountability, the government-wide statements use the flow of economic resources measurement focus and accrual accounting to report activities. The statements provide information about the economic resources and activity available to the overall government, including the primary government and its component units (reporting entity). However, fiduciary funds and fiduciary component units are excluded from the government-wide statements because these resources are not available to support the government's programs.

KNOWLEDGE CHECK

2.     Which is correct regarding the government-wide financial statements?

1. To meet the goal of providing operational accountability, the government-wide statements use the flow of economic resources measurement focus and accrual accounting to report all activities.
2. These statements are just a summary of the information in the fund financial statements.
3. Fiduciary funds and fiduciary component units are emphasized in the government-wide statements because these resources are not available to support the government's programs.
4. Deferred inflows of resources and deferred outflows of resources are not a component of the government-wide financial statements.

There are two government-wide statements:

• The Statement of Net Position
• The Statement of Activities

In both statements, information is reported in separate columns in order to distinguish between resources and activities of the primary government and its component units. In addition, separate columns and rows are used to distinguish between the primary government's governmental activities and business-type activities. Governmental activities are usually reported in governmental funds and internal service funds. Business-type activities are usually reported in enterprise funds. The government-wide statements must report the following columns:

• Primary government's governmental activities
• Primary government's business activities
• Total for the primary government
• Component units (If there is more than one component unit, each major component unit may be displayed in separate columns, or this information can be displayed in other sections of the basic financial statements.)

The government also has an option to report a total column for the reporting entity.

THE STATEMENT OF NET POSITION

The statement of net position is similar to a balance sheet in that it reports assets + deferred outflows of resources, liabilities + deferred inflows of resources, and net position for the government. Governments are encouraged to use a net position format, [assets + deferred outflows of resources - liabilities - deferred inflows of resources = net position] for this statement, but a balance sheet format, [(assets + deferred outflows of resources) = (liabilities + deferred inflows of resources + net position)] may also be used. Governments should present assets and liabilities in order of their relative liquidity (although a classified approach is also allowed). For liabilities that have average maturities that are more than one year, separate amounts are reported for the amount due within one year and the amount due in more than one year.

The statement of net position should minimize the reporting of internal balances (the reporting of receivables and payables among the different parts of the government). Interfund receivables and payables among the funds that make up governmental activities are eliminated. The same is true for business-type activities. Payables and receivables between governmental activities and business-type activities are eliminated in the total primary government column. Receivables and payables between the primary government and its component units are treated as external transactions and are not eliminated.

The difference between assets + deferred outflows of resources, and liabilities + deferred inflows of resources should be reported as net position. Net position is divided into three components:

• 1. Net Investment in Capital Assets is the component of net position that represents the government's net equity in its capital assets. It consists of capital assets, net of accumulated depreciation less any outstanding debt related to the capital assets. If there are unspent debt proceeds related to capital assets, both the unspent proceeds and related debt should be reported as part of restricted net position.
  2. Restricted Net Position is used when constraints are placed on net position. The constraints can be either externally imposed, for example debt covenants or grantor restrictions, or imposed by constitutional provisions or enabling legislation. In the case where there are endowment-type funds, two components of restricted net position should be displayed - expendable and non-expendable net position.
  3. Unrestricted Net Position includes all other net position not included in the above two categories. Unlike fund balance, designations of unrestricted net position should not be reported on the face of the financial statements.

KNOWLEDGE CHECK

3.     Which is correct regarding the government-wide statement of net position?

1. The statement of net position is similar to a balance sheet in that it reports assets, deferred outflows of resources, liabilities, deferred inflows of resources, and net position for the government.
2. The difference between (assets + deferred outflow of resources) and (liabilities — deferred outflows of resources) should be reported as net position.
3. Net position is divided into five components.
4. Net position is comprised of unrestricted net position, commitments, restricted net position, and assignments.

THE STATEMENT OF ACTIVITIES

The statement of activities reports the results of operations for the government. In some regards, it is like an income statement. However, it looks nothing like an income statement for a business. Why? The purpose of a business is to generate income in such a fashion that it also generates net income for the owners. The purpose of government is to provide certain services to the public and to generate sufficient revenues to pay for those services. This is why the statement of activities begins with expenses, followed by revenues.

Expenses in the statement of activities are reported in the following three categories:

1. Governmental activities
2. Business-type activities
3. Component units

Governmental activities expenses should be reported at least at the same level of detail reported in governmental fund statements. Business-type activities expenses should be reported by different identifiable activities.

The statement format is also designed to report the net expense or revenues of the different functions of governments. The first column in the statement of activities reports the expenses of the different functions of government. The next three columns are used to report different types of program revenue. Program revenues reduce the net cost of the function. The net (expense) revenue of a function indicates the relative benefit or burden the function has to or on the taxpayers and other general revenues of the government.

Separate columns are used in the statement of activities to report the net (expense) revenues for governmental activities, business-type activities, total for the primary government, and component units.

For example, assume that the public safety function reports $100,000 of expenses for the year. In addition, suppose this function also generated $25,000 in fees and charges for services and received $10,000 in grants (restricted for this purpose) from other governments. The net cost of this function would be $65,000 ($100,000 - $25,000 - $10,000), which must be paid from taxes and other general revenues. The reporting of net (expense) revenues of functions is unique to the government-wide statements. The fund financial statements do not show the relationship of program revenues to expenditures.

Program revenues are related to the different functions of governments and reduce the net costs of these functions. They are generally generated from fees, fines and forfeitures, and charges for services from the different functions or come from parties outside the government's taxpayers or citizens (such as intergovernmental grants restricted to a particular function). All taxes, even if restricted in purpose, should be reported as general revenues.

Program revenues are normally reported in the statement of activities using the following three separate columns:

1. Charges for Services—This category includes charges to customers or applicants for the purchase of goods and services, or privileges provided. Some examples are fees charged for services (water and garbage collection), licenses and permits (dog licenses and building permits), and for operating special assessments (street cleaning and street lights). Fines and forfeitures would also be reported under this category (parking tickets and court fines).
2. Operating Grants and Contributions—This category includes revenues generated from mandatory and voluntary nonexchange transactions (for example, grants and contributions) with other governments, organizations, and individuals that are restricted for use in a particular program. The grants and contributions reported in this category should be for operating purposes. Restricted operating grants and contributions reduce the net expenses of certain functions for the reporting government.
3. Capital Grants and Contributions—This category is very similar to operating grants and contributions, except the purpose of the program revenue is for capital purposes. For example, grants for the purchase, construction, or renovation of a capital asset would fit this category.

Revenues that do not fit the definition of program revenues are classified as general revenues. All taxes and interest, grants, and contributions that are not restricted to a particular program are reported as general revenues. General revenues of the government are reported in the bottom of the statement.

Any contributions to endowments and permanent funds, special and extraordinary items, and transfers are reported immediately after general revenues in the statement of activities.

The statement also reports change in net position for the year. This is the “bottom line” measure for the results of operations for the government.

Generally, the statement of activities should eliminate the double recording of expenses related to goods and services provided by internal service funds. Only the programs that consume the goods and services should report the expenses (this is discussed in more detail later in the chapter). However, the revenues and expenses of services provided and used between different functions of governments should not be eliminated. For example, the sale of water by an enterprise fund to the general government should be reported as revenue by the function providing the goods and as an expense by the function consuming the goods.

This completes the discussion of the requirements and general format of the two government-wide statements. The next section discusses how the statements are prepared.

Producing Government-Wide Statements

It is now time to talk about how the two government-wide statements are produced. This section will give a general overview of the process.

Governments generally maintain their accounting records on a fund basis. This will facilitate budgetary reporting throughout the year and will be helpful in producing the fund financial statements. Where this is the case, producing the government-wide statements will be a worksheet exercise. This section will discuss a worksheet approach to creating these statements.

It is important to remember that the fund financial statements follow two different measurement focuses and bases of accounting.

• Governmental funds follow the flow of financial resources and modified accrual basis of accounting.
• Proprietary funds follow the flow of economic resources and accrual basis of accounting.

The government-wide statements report all financial information using the flow of economic resources and accrual accounting.

Therefore, the challenge in producing the government-wide statements is with converting governmental funds to governmental activities. Information from proprietary funds should flow easily into the government-wide statements. Therefore, the discussion in this chapter is focused on converting governmental funds to governmental activities.

So how is a worksheet set up to convert governmental funds to governmental activities?

There are a number of different ways to do a worksheet; however, they all follow the same basic approach. The approach is to begin with the totals from the fund financial statements and then to make adjustments for capital assets, long-term liabilities, and other adjustments needed to convert from modified accrual to accrual basis of accounting. The following chart summarizes this approach.

First, apply this approach to the statement of net position. A worksheet would begin with the total column from the fund-based balance sheet (assets, liabilities, and fund balances). Adjustments are made to add capital assets, pension and long-term liabilities, and other adjustments needed to convert from the modified accrual to the accrual basis of accounting. Eliminations are also needed to remove interfund receivables and payables among the governmental funds.

Some explanation is needed about internal service funds. If internal service funds primarily serve governmental funds, they should be reported as part of governmental activities. If they serve primarily enterprise funds, they should be reported as part of business-type activities. In the case where they are reported as part of governmental activities, their assets, deferred outflows of resources, liabilities, deferred inflows of resources, and net position are added to the worksheet. Any receivables or payables with governmental funds are also eliminated.

One more step is needed to complete the worksheet. The balance sheet for governmental funds reports fund balances where the statement of net position reports net position. Annually, fund balance needs to be reclassified into the three components of net position.

Another way to view this process is in reviewing the reconciliation that must be reported as part of the balance sheet in the fund financial statements. This schedule reconciles fund balance for governmental funds to net position for governmental activities. The reconciliation contains the adjustments needed to produce the government-wide statements. Eliminations are not reported in the reconciliation because they do not affect net position. The following is an example of a reconciliation schedule.

The statement of activities is somewhat more difficult to set-up on a worksheet because of the format of the statements. However, the process and adjustments needed to the fund financial information is similar to those discussed for the statement of net position. A worksheet would begin with the totals from the statement of revenues, expenditures, and changes in fund balances. Adjustments are made to convert the year's activities related to capital assets and long-term liabilities from the flow of financial resources to the flow of economic resources measurement focus. For example, purchase of capital assets needs to be removed from the fund financial information and depreciation expenses recorded. These adjustments are discussed in more detail as follows.

Adjustments to the worksheet are also needed to convert the fund financial information from modified accrual to the accrual basis of accounting. For example, certain revenue sources need adjustments, and interest on long-term liabilities needs to be accrued.

Adjustments for internal service funds are somewhat more complicated (assuming they are reported as part of governmental activities). Eliminations are needed to remove the double recording of expenses related to goods and services provided by internal service funds. The goal of this process is to have only the programs that consume the goods and services report the expenses. This can be done on a worksheet in a number of ways.

Most of the non-operating items of an internal service fund, such as interest expenses and income, would not be eliminated. These items represent revenues and expenses of the government.

Eliminations are also needed for any transfers among governmental funds (and internal service funds if reported as part of governmental activities).

Additional adjusting entries are needed to properly report program revenues. These adjustments are needed to reclassify certain revenues as program revenues and do not affect the change in net position. Revenues that are program revenues must first be identified as to what function of government they support and then classified into one of the three types of program revenues discussed earlier.

Again, another way to view this process is in the reconciliation that must be reported in the statement of revenues, expenditures, and changes in fund balances in the fund financial statements. This schedule reconciles the change in fund balances for governmental funds to the change in net position for governmental activities. The reconciliation contains the adjustments needed to produce the government-wide statements. Eliminations and the reclassification of program revenues are not reported in the reconciliation because they do not affect the change in net position.

The following is an example of the reconciliation schedule that is included in the statement of revenues, expenditures, and changes in fund balances:

CAPITAL ASSETS ADJUSTMENTS

Because capital assets are not reported by governmental funds, they play a major role in the conversion of governmental funds from the flow of financial resources to the flow of economic resources measurement focus. Detailed capital assets records must be maintained by the government to support this conversion.

To convert the balance sheet of governmental funds to the statement of net position for governmental activities, capital assets, net of accumulated depreciation, need to be added to assets and an equal amount added to net position.

Several adjustments related to capital assets are needed to convert the statement of revenues, expenditures, and changes in fund balances for governmental funds to the statement of activities for governmental activities. Governmental funds report capital purchases as expenditures. No depreciation is recorded. Also, if a government sells a general capital asset, the proceeds from the sale are recorded in a governmental fund as other financing source.

The adjustments convert the information in the statement of revenues, expenditures, and changes in fund balances to the flow of economic resources measurement focus. The following list of adjustments indicated either an increase (add to) or decrease (subtract from) the reconciliation schedule for the amount reported as changes in fund balances for governmental funds and the amount reported as change in net position for governmental activities:

• Add capital assets purchased. The purchase of a capital asset is not reported as an expense in the statement of activities, but is recorded as an expenditure by governmental funds. Therefore, the amount of capital assets purchased is added back on the reconciliation. This amount would reduce reported expenses in the worksheet for the functional areas that reported the purchase.
• Subtract depreciation. Depreciation expense reduces net position, but is not recorded in the fund financial statements. Therefore, the amount of depreciation expense is subtracted on the reconciliation. This amount would increase expenses in the worksheet for the function that used the capital assets.
• Subtract the book value of capital assets disposed of during the year. Gain and losses from disposal of assets should be reported in the statement of activities, not proceeds, from sale of capital assets reported by governmental funds. Proceeds can be converted to gains and losses by subtracting the book value of the assets sold. This adjustment on the worksheet will convert an other financing source to a gain or loss from the sale of capital assets, which is generally reported as general revenue.

A few additional comments are needed about infrastructure assets. Infrastructure assets are long-lived capital assets that are normally stationary in nature and can be preserved for a long time. Roads, bridges, tunnels, and dams are some examples. Governments were required for the first time to report general infrastructure assets under GASB Statement No. 34. GASB Statement No. 63, Financial Reporting of Deferred Outflows of Resources, Deferred Inflows of Resources, and Net Position amends GASB Statement No. 34. GASB Statement No. 63 was issued June 2011 and is effective for periods beginning after December 15, 2011.

An important point about infrastructure assets is that governments are given the option to use a modified approach for these capital assets. Under the modified approach, infrastructure assets that are part of a network or subsystem of a network are not depreciated as long as two requirements are met. The requirements are that the government maintains an asset management system and that the assets are being preserved at or above a condition level established by the government. If this approach is used, all expenditures made to maintain the assets are expensed. In addition, certain information about these assets must be reported in the required supplementary information section of the financial statements.

GASB Statement No. 51, Accounting and Financial Reporting for Intangible Assets, addresses the accounting and reporting for intangible assets. GASB Statement No. 51 requires that all intangible assets covered by its scope be classified as capital assets. So adjustments may be needed due to intangible assets. As an update to the information presented herein, it should be additionally noted that Paragraph 6 (identifiable intangible assets) and Footnote 4 of GASB Statement No. 51 are amended by GASB Statement No. 63, Section 8.

The above adjustments are needed to properly reflect capital asset activities in the conversion of governmental funds from the flow of financial resources to the flow of economic resources measurement focus.

A final comment regarding capital assets is that GASB Statement No. 42, Accounting and Financial Reporting for Impairment of Capital Assets and for Insurance Recoveries, addresses the accounting and financial reporting for impairment of capital assets and for insurance recoveries.

PENSION AND LONG-TERM LIABILITIES ADJUSTMENTS

Because pension and long-term liabilities are not reported by governmental funds, they also play a major role in the conversion of governmental funds from the flow of financial resources to the flow of economic resources measurement focus. Detailed pension and long-term liabilities records must be maintained by the government to support this conversion.

To convert the balance sheet for governmental funds to net position for governmental activities, pension and long-term liabilities need to be added to liabilities and an equal amount subtracted from net position. The adjustment for long-term liabilities should include any unamortized premiums or discounts on debt.

Several adjustments related to long-term liabilities are needed to convert the statement of revenues, expenditures, and changes in fund balances for governmental funds to the statement of activities for governmental activities. Governmental funds report in the statement of revenues, expenditures, and changes in fund balances transactions that deal with capital related long-term liabilities. Payment of long-term debt principal is reported as an expenditure. Proceeds from the issuance of debt are reported as an other financing source.

Activities related to noncapital long-term liabilities are not reported in the statement of revenues, expenditures, and changes in fund balances. This includes liabilities for compensated absences, claims and judgments, landfill closure costs, net pension obligations, postemployment benefits other than pensions (OPEB), termination benefits, and pollution remediation obligations.

GASB Statement No. 68, Accounting and Financial Reporting for Pensions, brought significant changes to how pension expense is measured and reported in government-wide statements. This statement uses an accounting approach instead of a funding approach to report pension costs.¹

Some governments extend financial guarantees for the obligations of another organization without directly receiving equal or approximately equal value in exchange (a nonexchange transaction). GASB Statement No. 70, Accounting and Financial Reporting for Nonexchange Financial Guarantees, provides guidance for these types of costs.

This statement requires a government that extends a nonexchange financial guarantee to recognize a liability when qualitative factors and historical data, if any, indicate that it is more likely than not that the government will be required to make a payment on the guarantee. The amount of the liability to be recognized should be the discounted present value of the best estimate of the future outflows related to the guarantee expected to be incurred. When there is no best estimate, but a range of the estimated future outflows can be established, the amount of the liability to be recognized should be the discounted present value of the minimum amount within the range.

The adjustments convert the information in the statement of revenues, expenditures, and changes in fund balances to the flow of economic resource measurement focus. The following list of adjustments indicated either an increase (add) or decrease (subtract) to the reconciliation schedule for the amount reported as changes in fund balances for governmental funds and the amount reported as change in net position for governmental activities:

• Add principal payments — The payment of principal is not reported as an expense in the statement of activities, but reported as an expenditure by governmental funds. Therefore, the amount of expenditures reported for principal payments is added back on the reconciliation. This amount would reduce reported expenses in the worksheet for principal payments.
• Subtract debt proceeds — Debt proceeds do not increase in net position in the statement of activities, but increases fund balance for governmental funds. Therefore, the amount reported as an other financing source for debt proceeds is subtracted on the reconciliation. This amount would eliminate the amount reported for debt proceeds in the worksheet.
• Add or subtract changes in noncapital long-term liabilities — The changes in these liabilities are not reported in the fund financial statements. Therefore, the amount of changes in these liabilities needs to be reported on the reconciliation. For example, if the liability for compensated absences increases for the year, an increase in expenses needs to be recorded and this amount subtracted in the reconciliation. The increase in expense would adjust the appropriate functional expenses on the worksheet (for example, the functional areas related to employees who earned the compensated absences).
• Add or subtract changes in unamortized discounts and premiums — Interest expense in the statement of activities should reflect the amortization of any premiums or discounts on debt issued. The statement of revenues, expenditures, and changes in fund balances does not report such amortization. Therefore the amount of amortization is reported on the reconciliation. The adjustment would either increase or decrease interest expense on the worksheet.

The above adjustments are needed to properly reflect long-term liability activities in the conversion of governmental funds from the flow of financial resources to the flow of economic resources measurement focus.

OTHER ADJUSTMENTS

There are few additional adjustments needed to convert the fund financial information from modified accrual to the accrual basis of accounting.

The first adjustment is related to recognition of revenues. Governmental funds recognize revenues under the modified accrual basis when it is measurable and available. Under the accrual basis, revenues do not need to be available to be recognized. For example, property taxes must be collected during the year or no later than 60 days after the end of the year to be reported as revenues by the General Fund. However, the full amount of the tax levied for that year (less the amount expected to be uncollectible) should be reported as revenue under the accrual basis of accounting.

The second adjustment is related to recognition of interest expense. Governmental funds recognize interest expenditures when they become due. Under accrual accounting, interest expense should be recognized when incurred. This would include accruing interest at year-end and amortizing any premiums or discounts on debt issued.

The last major adjustment is related to debt refunding. Debt refunding is reported differently for governmental funds than it is for proprietary funds. Adjustments are needed to report debt refunding consistent with the treatment used by proprietary funds.

Reminder: In most cases, the adjustments needed to produce the government-wide statements would be made only on worksheets. Governments will generally maintain accounting records on a fund basis using the flow of financial resources and modified accrual basis of accounting for governmental funds. Worksheets will have to be prepared anew each year.

GOVERNMENT COMBINATIONS

GASB Statement No. 69, Government Combinations and Disposal of Government Operations, addresses certain types of combinations. The statement defines these as mergers, acquisitions, and transfers of operations. Government mergers include combinations of legally separate entities without the exchange of significant consideration. This statement requires the use of carrying values to measure the assets and liabilities in a government merger and certain transfers of operations.

Government acquisitions are transactions in which a government acquires another entity, or its operations, in exchange for significant consideration. This statement requires measurements of assets acquired and liabilities assumed generally to be based upon their acquisition values.

In some cases, the consideration paid in an acquisition will exceed the amount of net position acquired. The acquiring government should report the excess as a deferred outflow of resources. For other acquisitions where the consideration is less than the amount of net position acquired, the excess net position should be eliminated by reducing noncurrent assets (other than financial assets) that are acquired. If the allocation reduces noncurrent assets to zero, the remaining amount should be recognized as a special item in the government-wide statement of activities.

Comprehensive Annual Financial Report (CAFR)

CAFR: WHAT GOES IN THESE REPORTS?

Governments must include certain minimum financial statements, reports, and other information in their external financial reports. However, governments are encouraged to go beyond the minimum requirements and issue a CAFR. What must be included in the different reports, and where does it go? This chapter will try to answer those questions.

To meet the key financial reporting objectives of accountability, governments are encouraged to go beyond the minimum requirements and prepare a CAFR. The CAFR provides a variety of additional information outside the audited financial statements that is useful in assessing a government's performance and financial condition.

The Government Finance Officers Association (GFOA) provides guidance on what information should be included in the CAFR. The GFOA also administers an award program (Certificate of Achievement for Excellence in Financial Reporting) for governments that meet their requirements.

A CAFR consists of at least three sections:

• Introductory
• Financial
• Statistical

Each section requires certain information and tables. Governments need present only the information and tables that are applicable to them. The requirements of the three sections follow.

INTRODUCTORY SECTION

The introductory section provides an overview of the government's financial position and results of operations. The following items are included in the introductory section:

• Report cover
• Title page
• Table of contents
• Certificate of Achievement for Excellence in Financial Reporting
• List of principal officials
• Organizational chart
• Audit committee letter
• Letter of transmittal

STATISTICAL SECTION

The statistical section of the CAFR provides information that is useful in evaluating the economic condition of a government. In 2004, the GASB issued GASB Statement No. 44, Economic Condition Reporting: The Statistical Section.

GASB Statement No. 44 requires governments to report five categories of statistical information as follows:

• Financial trends

—     Net position

—     Change in net position

—     Fund balances for governmental funds

—     Changes in fund balances for governmental funds

• Revenue capacity (Information about the most significant own-source revenue. If a government has other own-source revenues that are nearly as significant as its largest source, it should consider presenting revenue capacity information for those own-source revenues as well.)

—     Revenue base

—     Revenue rates

—     Principal revenue payers

—     Property tax levies and collections (if a government presents revenue capacity information about a property tax)

• Debt capacity

—     Ratios of outstanding debt

—     Ratios of general bonded debt

—     Direct and overlapping debt

—     Debt limits

—     Pledged-revenue coverage

• Demographic and economic

—     Demographic and economic indicators

—     Principal employers

• Operating

—     Government employees

—     Operating indicators (demand or level of service)

—     Capital asset indicators (volume, usage or nature)

—     GASB Statement No. 44 also contains requirements related to operating information reported by pension plans and OPEB plans in separately issued reports

KNOWLEDGE CHECK

4.     Which statement is accurate regarding the CAFR?

1. FASB provides guidance on what information should be included in the CAFR.
2. The statistical section of the CAFR provides information that is useful in evaluating the social condition of a government.
3. The CAFR provides a variety of additional information outside the audited financial statements that is useful in assessing a government's performance and financial condition.
4. The certificate of achievement for excellence in financial reporting program is administered by the AICPA.

OTHER SECTIONS

In addition to the three sections included in the CAFR, governments are free to include additional sections. For example, a government might include a single audit section or investment section.

The relationship between the minimum requirements for external financial statements and the CAFR is summarized in the following table.