Federal financial statements: the revolution is here!
* IN THE FISCAL YEAR ENDED September 30, 1998, federal executive branch agencies for the first time prepared financial statements in accordance with a comprehensive set of federal accounting principles.
* THERE WAS LITTLE AGREEMENT in the past within the federal government about appropriate federal financial accounting standards. As a consequence, federal agencies used a variety of accounting methods.
* NEW STANDARDS CREATED BY THE FASAB are an effort to remedy this problem. Given the new focus on reporting standards, CPAs who work in or with federal government agencies should be familiar with these pronouncements.
* OMB BULLETIN NO. 97-01 MANDATES that a federal reporting entity prepare an annual financial statement consisting of (1) an overview of the reporting entity, (2) principal statements and related notes, (3) required supplemental stewardship information and (4) required supplemental information. Important differences exist between many of these Items and corporate financial statements.
What CPAs need to know about the new comprehensive set of federal accounting standards.
In the fiscal year ended September 30, 1998, a long-awaited revolution began as federal executive branch agencies prepared their financial statements in accordance with a comprehensive set of federal accounting standards. The Federal Accounting Standards Advisory Board has spent the last eight years deliberating on standards tailored to reflect the unique characteristics of the federal government (see the sidebar on page 55). The FASAB standards have been accepted by the GAO, OMB and the Treasury Department and are issued by OMB and the GAO as statements of federal financial accounting concepts (SFFAC) and statements of federal financial accounting standards (SFFAS). Given the new focus on reporting standards, CPAs who work in or with federal government agencies should be familiar with these pronouncements and their requirements.
DEVELOPING A FRAMEWORK
Before formation of the FASAB in 1990, federal agencies used a variety of accounting methods, which created inconsistency. The new standards attempt to remedy this problem. SFFAC no. 1, Objectives of Federal Financial Reporting, establishes the objective that federal financial reporting provide information about budgetary integrity, operating performance, stewardship and systems and control. SFFAC no. 2, Entity and Display, specifies criteria for determining what entities must be included in federal general purpose financial statements. Determining which entities to include was a troublesome issue because the federal government is one economic entity with undefined boundaries, unlike state and local governments and the private sector, federal financial entities issue financial statements for dependent subunits of that economic entity. Because there are many quasi-federal and federally funded organizations, it was necessary to establish guidelines on which subunits are parts of the federal reporting entities.
SFFAC no. 2 also addressed the appropriate content of general purpose financial reports issued by federal entities. This content is now covered in OMB Bulletin no. 97-01, Form and Content of Agency Financial Statements. This bulletin stipulates that each federal reporting entity must prepare an annual financial statement consisting of
* An overview of the reporting entity, which is similar to the management discussion and analysis of private-sector financial statements.
* Principal statements and related notes.
* Required supplemental stewardship information.
* Required supplemental information.
OMB requires that an entity's annual financial statement include numerous principal statements. To acquaint CPAs with these statements, they are described below, along with a discussion of the content of the required supplementary stewardship reports and other supplementary information requirements. Other footnote and disclosure requirements of the new federal reporting model are beyond the scope of this article.
THE BALANCE SHEET
Federal agency balance sheets (see exhibit 1, at right) include nonentity assets, meaning assets that are not available for spending because the recipient is going to transfer them to another federal reporting entity. For example, when the Bureau of Customs collects import taxes or duties and transfers them to the Treasury, the Customs balance sheet would show them as nonentity assets.
[Exhibit 1 ILLUSTRATION OMITTED]
A federal entity's assets include normal balance sheet entries plus a few items unique to government. One example is the fund balance with the Treasury, which is the aggregate amount in accounts with the Treasury that the entity can use. Property, ,plant and equipment is another balance sheet element worthy of comment. (Note: Not all individual assets are included in the exhibits--just the categorizations that are uniquely federal.) For a federal entity, it includes only assets used for and chargeable to the cost of government goods and services, such as government-owned buildings, automobiles and computers. Entities do not report the remaining and vast majority of federal PP&E (such as federal parklands, weapon systems and monuments) on federal balance sheets. They are considered stewardship assets, and their accounting is contained in the required supplementary stewardship information.
Entities classify liabilities based on whether the reporting entity's budgetary resources cover them. The handling of environmental liabilities illustrates liabilities that are not covered. The FASAB standards require that an agency record a liability equal to the current cost of cleaning up environmental damage, but the budgetary resources to pay for the cleanup are provided yearly. Thus, the cleanup costs to be paid out of future years' budgetary resources appear on a federal agency's balance sheet as a liability not covered by the entity's (current) budgetary resources.
The FASAB standards require recognition of liabilities resulting from both exchange and nonexchange transactions. Nonexchange transactions occur when the government sacrifices value but receives nothing in return--that is, there is no exchange of value. Liabilities generally are recognized if the future outflow of resources is probable and measurable.
Additionally, for nonexchange transactions, only unpaid amounts that are due should be recognized. For example, under current standards, an accrued liability would be recorded for Social Security benefits that are unpaid at the end of the fiscal year; no liability would be recorded for Social Security benefits that could eventually become payable (to everyone covered by the system) under existing legislation. The reporting for the latter type of potential liability will be addressed when the FASAB completes standards for Social Security. The FASAB issued an exposure draft titled Accounting for Social Insurance in early 1998.
The balance sheet further classifies assets as well as liabilities as either intragovernmental or governmental. Total assets minus total liabilities are equal to net position. The net position is further subdivided into unexpended appropriations and the cumulative results of operations. Unexpended appropriations are those not yet obligated or expended, including undelivered orders.
The meaning of "cumulative results of operations" is not as simple as it may seem for two reasons. First, most federal agencies will use federal accounting standards to determine the assets, liabilities and unexpended appropriations they present on the balance sheet and then calculate the cumulative result of operations by subtracting the sum of the total liabilities and unexpended appropriations from total assets. Second, because federal agencies are not economically independent, some will show positive cumulative results and others, such as the Treasury Department--which is responsible for issuing U.S. Treasury bonds and notes--will show negative balances. For this reason, the FASAB has cautioned against using the annual "net results of operations" as a performance measure.
STATEMENT OF NET COST
Recognition of the full cost of federal programs is increasingly seen as necessary to improve decision making. The new statement of net cost (exhibit 2, at right) is designed to help achieve this goal. Costs can be classified by suborganization, by program or by object class or any combination. Note that "unearned" funds, such as appropriations, are not included in determining net cost but are considered financing sources and are reported on a separate statement (see exhibit 6, page 63).
[Exhibits 2 and 6 ILLUSTRATION OMITTED]
Net costs in the statement of net cost refer to the full costs of a federal program or activity less any exchange revenues earned from its activities. For example, to arrive at the net costs of a national park, one would subtract the park entrance and other user fees from total park operating costs. Entities calculate the full costs of a program using accrual accounting, recognizing both costs incurred within the reporting entity as well as interentity costs. Costs incurred to provide goods and services to the public must be displayed separately from those associated with the provision of goods and services within the government.
The statement of net cost is a significant departure from traditional government accounting and financial reporting. For decades, the practice in government has been to restrict the use of accrual-based, full cost accounting to "businesslike" activities of government. The new standards, however, assume that decision makers need to know the full cost of programs to make informed policy decisions.
It is hoped that the statement of net cost will serve as a bridge between federal financial reporting requirements and performance reporting requirements under the Government Performance and Results Act (GPRA). Meaningful performance measurement must relate results--that is, outputs and outcomes--to resources consumed to produce those results. Full costing is necessary to fulfill the intent of GPRA, and federal financial accounting and reporting systems should place due emphasis on full costing as well as on budget execution. The result is an accrual-based statement of net cost. The statement's usefulness is enhanced by a standard on managerial cost accounting to require agencies to develop cost information.
STATEMENT OF CHANGES IN NET POSITION
As a companion to the statement of net cost, the statement of changes in net position (exhibit 3, at right) focuses on how the net cost of operations is financed. It displays other items, such as prior-period adjustments, that affected the entity's net position during the year.
[Exhibit 3 ILLUSTRATION OMITTED]
The statement of changes in net position starts with the net cost of operations and then identifies common financing sources, including money provided to and used by an agency through appropriations, taxes, donations and transfers to and from other federal agencies. It includes imputed financing, which is described in SFFAC no. 2 as costs incurred by the reporting entity but financed by another entity or costs attributable to the reporting entity's activities that do not require a direct, out-of-pocket payment. Imputed financing reflects the fact that federal agencies are not independent economic entities. For example, the Office of Personnel Management (OPM) pays certain pension benefits to civilian retirees of federal agencies. These unreimbursed benefits are out-of-pocket costs to OPM but would be considered imputed financing to the employer agency. Creating appropriate systems for tracking interentity costs poses a tremendous challenge to many federal entities and it may take them several years to comply fully.
Another item on the statement of changes in net position that requires explanation is increase (decrease) in unexpended appropriations. If an entity does not use all of its budget expenditures in one year, it may be able to carry the unused budget authority over to the next as unexpended appropriations.
STATEMENT OF CUSTODIAL ACTIVITIES
This statement is required only for federal entities whose primary mission is collecting nonexchange revenue, such as taxes and duties that finance the operations of the entire federal government, or at least the programs of other federal entities. Examples of "collecting entities" are the Bureau of Customs and the IRS.
Exhibit 4, page 60, displays the statement outline, listing the custodial funds collected and their disposition, including an item for amounts retained by the collecting entity. As a consequence, the bottom line of this statement--net custodial activity--always should equal zero. Entities are to use the accrual basis, so the statement includes two items that adjust cash basis figures to accrual amounts: the accrual adjustment and the increase (decrease) in amounts to be transferred.
[Exhibit 4 ILLUSTRATION OMITTED]
STATEMENT OF BUDGETARY RESOURCES
This statement (exhibit 5, below) provides information on budgetary resources available and outlays for the fiscal year, as well as the status of budgetary resources at the fiscal year-end. It includes a reconciliation of obligations incurred with cash outlays during the fiscal year. Entities are to prepare it using budgetary accounting rules, which are a modified cash basis of accounting. The terminology and definitions used in this statement are defined in OMB Circular A-34, Instructions on Budget Execution (December 1995 revision).
[Exhibit 5 ILLUSTRATION OMITTED]
This statement is especially significant because it subjects federal budget execution to audit at the level of the reporting entity for the first time. Entities must make disclosures if the information in this statement differs from that shown in the "actual" column of the president's budget.
STATEMENT OF FINANCING
The primary purpose of this statement (exhibit 6, page 63) is to reconcile the difference between obligations, as reported in the federal budget and the statement of budgetary resources, and the net cost of operations as shown in the statement of net cost.
The top of the statement lists obligations incurred and nonbudgetary resources, such as donations and exchange revenue not included in the budget. The next section displays resources that do not fund the net cost of operations. Two examples are (1) the change in the amount of goods, services and benefits ordered but not yet received or provided (often termed "undelivered orders") and (2) costs of equipment purchased during the year and capitalized on the balance sheet (and therefore not included as an expense in arriving at net cost of operations). The third section lists costs included in determining the net cost of operations that do not require resources in the current fiscal period. A classic example is depreciation expense, which requires no cash outlay in the period when it is recorded.
The next major item on this statement is financing sources yet to be provided or amounts needed in the future to cover current costs. For example, net cost of operations of a federal entity generally includes accrued expenses to cover future employee sick leave. Budgetary resources (for example, cash outlays) to cover the sick leave, which normally are provided in future periods when employees actually use the leave, are a financing source yet to be provided.
The bottom line for this statement is the net cost of operations. It is equal to
* Obligations and nonbudgetary resources
* less resources that do not fund the net cost of operations
* plus costs that do not require resources
* plus financing sources yet to be provided
REQUIRED SUPPLEMENTARY STEWARDSHIP REPORTS
The FASAB believes a general purpose federal financial report would not be complete without some type of accountability reporting for resources and responsibilities that cannot be presented meaningfully in traditional financial statements. Required supplementary stewardship information (RSSI) covers three areas:
* Stewardship PP&E. Although they are similar to traditional PP&E, the nature of these assets make valuation or cost allocation difficult. These assets fall into three categories: heritage assets, such as federal monuments and museum collections, which are to be reported in terms of physical units rather than monetary values; national defense PP&E (for example, military weapon systems), which are reported using either historical cost or the latest acquisition cost valuation method; and stewardship land, such as forests and parks, which also are reported in physical units (such as acres) rather than monetary values. Entities are to report beginning and ending balances, additions and deletions for each category. They also must disclose the condition of the assets, including reference to the required footnote on deferred maintenance.
* Stewardship investments. The federal government spends huge amounts on programs to improve the well-being of the nation and its people. Entities use traditional accounting for investment-type expenditures in the principal financial statements, but the FASAB decided additional information should be provided on such expenditures. RSSI, thus, must include data on investments for the current fiscal year plus the four preceding years for three categories of federal investments: human capital, or the costs of government-financed education and training programs; payments for basic and applied research and development; nonfederal physical property, or grants for properties financed by the federal government but owned by state and local governments.
* Stewardship responsibilities. This section measures how well future resources will be able to sustain public services and meet obligations established under current law. Accountability reporting for federal stewardship responsibilities is appropriate at the level of the federal government as a whole. Thus, the FASAB standards require inclusion of a current services assessment (CSA) in the consolidated financial statements of the federal government but not in reports of its component units. A CSA presents receipt and outlay data as published in the president's budget for the base year and projected receipt and outlay data for at least six years subsequent to the base year.
OTHER SUPPLEMENTARY INFORMATION REQUIREMENTS
A general purpose federal financial report should include other types of supplementary information to present a complete picture of the financial results, financial position and financial condition of the reporting entity. For example, OMB bulletin no. 97-01 calls for provision of supplemental information about (1) budgetary information disaggregated by major budget account, (2) information concerning custodial activities and (3) segment data.
A GREAT STEP FORWARD
Tremendous advances in federal accounting and financial reporting are in process. The U.S. government issued its first audited consolidated financial statements for fiscal year 1997. During fiscal year 1998, federal agencies have worked to issue their financial statements using the newly established set of federal accounting principles for the first time. Although a disclaimer of opinion will be issued on many of the 1998 financial statements, the work being accomplished within federal agencies to prepare general purpose financial reports according to federal accounting principles is an historic undertaking. This is truly a revolutionary time in federal accounting and financial reporting. The hope is that the revolution ultimately will lead to improved information, financial management and decision making within the federal sector.
FASAB Statements of Concepts and Standards (*)
SFFAC no. 1, Objectives of Federal Financial Reporting SFFAC no. 2, Entity and Display SFFAS no. 1, Accounting for Selected Assets and Liabilities SFFAS no. 2, Accounting for Direct Loans and Loan Guarantees SFFAS no. 3, Accounting for Inventory and Related Property SFFAS no. 4, Managerial Cost Accounting Standards for the Federal Government SFFAS no. 5, Accounting for Liabilities of the Federal Government SFFAS no. 6, Accounting for Property, Plant, and Equipment SFFAS no. 7, Accounting for Revenue and Other Financing Sources SFFAS no. 8, Supplementary Stewardship SFFAS no. 9, Deferral of Implementation Date for SFFAS no. 4 SFFAS no. 1 O, Accounting for Internal Use Software SFFAS no. 11, Amendments to Accounting for PP&E--Definitional Changes SFFAS no. 12, Accounting for Contingent Liabilities Arising from Litigation SFFAS no. 13, Deferral of Paragraph 55.2 of SFFAS no. 7
(*) SFFAC = statement of federal financial accounting concepts.
SFFAS = statement of federal financial accounting standards.
RELATED ARTICLE: Launching the New Standards at NASA
When the National Aeronautics and Space Administration sought to implement the new federal accounting standards, two areas posed challenges: property, plant and equipment and managerial cost accounting. The PP&E standard was particularly formidable because it required changes in agency capitalization and expensing practices. NASA had to capitalize some assets in space, such as the Hubble Space Telescope, that previously had been expensed when launched. It also was necessary to depreciate capital assets, a practice new to NASA--and to most other federal agencies; their traditional financial focus has been on budget and cash flows. A further complication was the fact that major agency PP&E assets are held by contractors. Under federal policy, these contractors maintain the detailed accounting records for these assets and report summary information annually to NASA.
Under the managerial cost accounting standard, the requirement for full cost reporting by business lines or segments and related segment outputs also introduced wrinkles such as assigning common costs to agency programs and introducing full cost practices into agency activities.
Resolving the challenges. NASA instituted a variety of changes to implement the new standards effectively. For example, for PP&E, NASA reviewed past budget and available accounting data on previously launched spacecraft and satellites to estimate or establish the historical cost to be used to capitalize such assets. NASA accountants and outside CPAs worked with scientists and engineers to determine the appropriate useful lives for space assets and the appropriate beginning date to initiate depreciation.
In developing approaches and verification procedures, NASA worked carefully with a CPA firm that served as a consultant as well as with the CPA firm that audited NASA's financial statements. Staff responsibilities also shifted toward additional highly complex financial management assignments that required a variety of more complicated financial analysis and disclosure knowledge, skills and abilities.
Costs of implementation. Additional incremental and ongoing expenses included
* Additional staff time.
* Staff training.
* Travel to selected contractors to establish and validate related financial analyses.
* Analytical support from the outside CPA firm.
* Added CPA firm audit activity. Some incremental costs associated with key capabilities in the agency's new integrated financial management system also relate directly or indirectly to the new federal standards.
Meeting deadlines. NASA requires approximately two and half months to prepare agency financial statements. The process is complicated by
* The reconciliations between the agency's numerous accounting and reporting systems.
* The one and a half months required to obtain and integrate the extensive contractor asset reporting that represents approximately one-half of NASA's assets.
The new FASAB standards have complicated the related processes significantly but have not lengthened the time required to prepare financial statements. NASA is pursuing more timely financial statement reporting through process standardization and a new integrated financial management system tool.
Making it work. NASA, as well as other federal agencies, faces a variety of significant challenges in implementing the new FASAB standards, including those to key staff members and systems. Agency staff must enhance their core financial management knowledge, skills and abilities to keep up with the evolving standards. In addition, agencies also must upgrade key financial management systems and performance metric system tools to provide timely, reliable, useful financial and related management information.
In addition to staffing and system improvements, agencies can take a variety of approaches to achieve timely and effective implementation of the new standards. In that regard, it would be prudent to stay abreast of evolving standards and initiate analyses and processes well in advance of the effective implementation date of the new standards. For example, agencies can
* Anticipate and plan for the full implications of the new standards before they become effective.
* Analyze, develop, test and evaluate available analytical approaches to implement the new standards.
* Acknowledge auditors' perspectives in assessing compliance with federal standards.
* Accommodate financial statement readers by clearly disclosing key analytical approaches used to implement the new standards.
--Contributed by Ken Winter, deputy CFO, NASA, Washington, D.C.
RELATED ARTICLE: The Evolution of the FASAB
The Federal Accounting Standards Advisory Board was established in October 1990 by the secretary of the Treasury, the director of the OMB and the U.S. comptroller general to consider and recommend accounting standards and principles for the federal government to improve the usefulness of federal financial reports.
The board is made up of nine part-time members and is chaired by a nonfederal member. Members follow due-process procedures modeled after those used by FASB and GASB. In addition, federal law mandates that all board deliberations occur at public meetings announced at least 30 days in advance.
Representatives of the FASAB last year asked the AICPA board of directors to consider designating FASAB as the body to establish GAAP for federal government financial reporting under AICPA Code of Professional Conduct Rule 203 Accounting Principles. The AICPA governing council is considering rule 203 recognition criteria developed by a special board task force. Council has authority under rule 203 to designate bodies to promulgate accounting standards. To date, Council has designated two: FASB and GASB. To date, no designation exists for the federal government.
WENDY COMES, CPA, is executive director of the Federal Accounting Standards Advisory Board, Washington, D.C. Her e-mail address is email@example.com. ANNE CURTIN RILEY, CPA, DBA, is an assistant professor of accounting, American University, Washington, D.C. Her e-mail address is firstname.lastname@example.org. The views expressed in this article are those of the authors.