How GASB 11 will affect municipal governments' financial reporting.

Understanding the statement now may make it easier to implement in 1994.

As recently as 1989, the existence of the Governmental Accounting Standards Board was in doubt. The Financial Accounting Foundation, which oversees both the GASB and its more-established sibling the Financial Accounting Standards Board, was reviewing the GASB's first five years. In addition, the FASB was issuing statements on private and publicly run hospitals and universities which the GASB found inappropriate for government-owned entities.

Nevertheless, the FAF's 1989 review was positive, praising the GASB. and providing it with additional financial resources. The FAF also authorized the GASB to set standards for government-run institutions when similar institutions exist in the private sector as long as comparability is considered. (GASB statements do not apply to financial reports of the federal government.) This action prevented possible defections from the GASB by the Governmental Finance Officers Association (GFOA) and other government accountants and financial personnel.

With newly gained confidence, the GASB launched a project to review and modify, as necessary, financial reporting for state and local governments. The first fruits of this effort are found in GASB Statement no. 11, Measurement Focus and Basis of Accounting--Governmental Fund Operating Statements. Implementation is prohibited until years beginning after June 15, 1994; however, the statement is significant now both because of the reporting changes it calls for and the potential it signals for other major changes in subsequent statements as the project continues.

The purpose of this article is to review the background and scope of Statement no. 11, discuss the major changes it calls for, illustrate its impact on one government's financial statements and suggest ways to prepare for its implementation.

PROJECT BACKGROUND

Statement no. 11 initially was introduced as a discussion memorandum in 1985 as part of an overall financial reporting project. Numerous comment letters and four hearings provided a significant forum for an exchange of views.

The DM included the following three measurement focuses:

* Current financial resources (the present government-type funds model).

* Economic resources (similar to private sector accounting).

* Total financial resources (a new concept).

The total financial resources focus includes cash, claims to cash (debt securities and receivables), claims to goods and services (prepaid items) and inventories and equity securities. Adopting such a concept means supplies, prepaid items and noncurrent securities are included in the balance sheet.

Two exposure drafts on measurement focus were issued subsequent to the DM. In the first ED issued in 1987, the GASB settled on a financial resources focus but was uncertain if a change should be made to full accrual. Although flow of current resources-modified accrual basis and flow of economic resources-accrual basis had numerous proponents, an intermediate position, flow of total financial resourcesaccrual basis found acceptance by the second exposure draft in 1989.

Statement no. 11 established a measurement focus (which resources are measured and how) and an accounting basis (when to recognize the effect on resources of transactions or events) for government fund and expendable trust fund operating statements. The statement applies not only to state and local governments but also to government and expendable trust funds of some government-operated colleges and universities.

Statement no. 11 addressed some liability issues: for example, balance sheet treatment of general long-term capital debt. However, the GASB indicated in the first ED in 1987 that it was deferring a number of liability-related issues for treatment in a separate statement.

MAJOR ISSUES

Although Statement no. 11 characterizes government financial reporting as an evolutionary process, some provisions appear revolutionary. Particularly significant are the increased focus on total financial resources and full accrual basis and the increased emphasis on interperiod equity; the emphasis on the role of the government's budget in financial reporting has been decreased accordingly.

The total financial resources concept requires events affecting financial resources to be recognized when they occur, regardless of when cash changed hands. In addition, interperiod equity is best measured by full accrual accounting. Therefore, the full accrual basis is to be used for most transactions as long as the taxable event (such as for sales taxes) has occurred, or the time period for accrual (such as for income taxes) has been met, and the government has demanded taxes; this meets a "measurable and demanded" standard.

Examples of revenues generally to be recorded under full accrual instead of modified accrual include sales and income taxes, fines and donations of financial resources. Donated capital assets generally should be recorded and treated as another financing source when sold and should be directly recorded in the general fixed-asset account group upon receipt. Licenses and permits, as well as certain taxpayer-assessed taxes that are collected by other governments, may still be recorded as revenue when cash is received.

Many states and municipalities require budgets to be "in balance" for government funds. At present, the statement of revenues, expenditures and changes in fund balance budgeted and actual--(one of the general purpose financial statements) compares budgeted and actual results. The GASB discovered that budgetary laws and practices differ between governments and that the spirit or intent of budgetary laws often is circumvented.

The GASB found, for example, shifting the burden of paying for current services to future taxpayers was inconsistent with the spirit of balanced-budget laws. Government financial statements, the GASB concluded, should consider budgetary methods but not be driven by them. Rather, interperiod equity should be emphasized as more consistent with the spirit of balancedbudget laws.

OTDHER ISSUES

In addition to focusing on total financial resources, using full accrual accounting and emphasizing interperiod equity, Statement no. 11

* Makes a distinction between general long-term capital debt and operating debt based on the interperiod equity concept. The operating statement will show all costs associated with capital debt and will include only issue costs associated with operating debt. Capital debt is defined as debt used to acquire capital assets, refurbish or augment infrastructure and perform certain nonrecurring activities with long-term economic benefits.

* Replaces the "measurable and available" standard with a "measurable and demanded'' standard for tax revenues. Determining whether taxes have been demanded is based on factors such as setting a due date and administrative lead time.

* Requires inventory be kept on the consumption method (in accordance with the total financial resources focus) instead of offering a choice between the purchases and consumption methods. In addition, prepaid items, such as insurance or rent, must be reported on the balance sheet under the consumption method if material. Before Statement no. 11, prepaid items generally were not included in the balance sheet.

* Indicates compensated absence accounting for vested sick leave and other absences, such as vacations and holidays, are to be recognized as expenditures when the following conditions are met:

1. Compensation rights are tied to previously rendered services.

2. Rights are either accumulating or vesting.

3. Payment of compensation is probable.

4. The amount can be reasonably estimated.

If only 1 through 3 apply, a footnote similar to that for reasonably possible contingencies is required. Unvested sick leave is an expenditure when taken by an employee.

EFFECT'S OF GASB 11 ON A SAMPLE MUNICIPAL GOVERNMENT

The anticipated impact of Statement no. 11 is illustrated in a set of financial statements for the year ended June 30, 199X. The figures used in the exhibit on page 56 are for illustrative purposes only and are reasonable but not exact for this government. The government presenting the underlying financial statements has been awarded the Certificate of Excellence in Financial Reporting by the GFOA for the past 10 years.

Statement no. 11 will affect three major operating statement items for this municipal government: taxes and related penalties and interest, sales taxes and compensated absences. The greatest impact comes from recognition of property tax revenue; this is followed by sales taxes and the liability for compensated absences.

Adjustment (1) shows an increase of $4,799,821 in tax revenue and a corresponding decrease in uncollected property taxes. There also are increases in related interest and penalties of $386,631 and $193,315. The government presently defers revenue on property taxes until the following year, since these taxes become delinquent on March 1.

Adjustment (2) indicates a $3,343,463 increase in sales tax revenue. The state government collects sales taxes and forwards them to this municipal government with a two-month lag. This adjustment would be a one-time adjustment to capture the twomonth lag; subsequent years would show 12 months of revenue. Alternative approaches that enhance comparability between years for sales tax revenue include adding a separate line noted "change. in accounting principle-sales taxes" and making a direct adjustment to fund balances.

Adjustment (3) reflects compensated absence changes. This year's compensated absences were posted as a current liability, while prior amounts were left in the general long-term debt account group.

Several changes mandated by Statement no. 11 do not affect this government. Supplies, if material, would be accounted for under the consumption method. All debt issues outstanding would qualify as capital debt. Fines and fees are immaterial to total revenue and therefore would not require adjustment.

Statement no. 11 left numerous questions unanswered regarding the effect of changes such as compensated absences on government financial statements. Two subsequent GASB publications, the. ED on compensated absences and the preliminary views document on balance sheet display based on Statement no. 11, should be consulted for additional guidance.

* The GASB ED, Accounting for Compensated Absences, says expenditures to be recognized include services rendered that are not contingent on events beyond the control of government or employees. Any new liability for compensated absences in the fund should be treated as a prior-period adjustment (debit fund balance or retained earnings). Only the current portion of compensated absences should be recorded in government funds, while the remainder should be recorded in the general long-term debt account group. The ED also would modify Statement no. 11 by saying government entities should be able to reasonably estimate compensated absence liabilities; therefore, footnote disclosure would not be an available option. Adjustment (3) in the exhibit reflects the current portion of compensated absences and is based on the GASB ED.

* A GASB preliminary views document, Implementation of GASB Statement Number 11, recommends keeping the effects of noncurrent assets (such as noncurrent intergovernmental revenues and certain prepaid items) and noncurrent liabilities (such as compensated absences and leases) out of the fund balance account. The majority preliminary view, referred to as the "captioning within fund" approach, recommends showing noncurrent assets and liabilities in the fund balance sheet, and creating a new account, "long-term fund equity," to show the difference between noncurrent assets and noncurrent liabilities. Advocates of this view emphasize associating assets and liabilities with the fund in which they were incurred. The majority preliminary view calls for prior-period adjustments and restatement of financial statements to comply with the proposed changes.

The alternative preliminary view, referred to as the "general long-term debt account group" approach, recommends showing noncurrent liabilities resulting from GASB no. 11 implementation in the general long-term debt account group and setting up reserved fund balances for any noncurrent assets resulting from the statement's implementation. Advocates of this view emphasize minimizing disruption from implementing the statement by making only absolutely essential changes. Changes in long-term liabilities would be reported as changes in fund balance. Adjustment (3) in the exhibit is consistent with this view.

PRDEPARE FOR THE CHANGES

Statement no. 11 requires that substantial changes be made in accounting for government-type and expendable trust funds. Of special importance are the new focus on total financial resources, the change to full accrual accounting and an emphasis on interperiod equity.

Financial statement users familiar with accrual reporting for other organizations may find Statement no. 11's accrual emphasis less confusing than the present modified accrual basis. At the same time, CPAs will have to be careful to avoid confusing or misleading users with the effects of implementing one-time changes (such as adjustment (2), which accrues revenue for the sample government) and the presentation of asset and liability accruals (as mentioned in the preliminary views document).

Given the unusually long time remaining until Statement no. 11 can be applied, government CPAs and those auditing governments have sufficient time to prepare for the changes. Continuing education seminars on Statement no. 11 would provide helpful preparation. Some CPAs may wish to prepare workpapers for 1993 statements using Statement no. 11 rules as a way of preparing for the changes.

Since many issues related to expenditure or balance sheet reporting have to be resolved, CPAs with strong opinions on pro* posed changes should write to the GASB or contact state legislators to ensure state law permits government units to use accounting procedures prescribed in Statement no. 11. As a result of legislative inattention, governments may be required to use non*generally accepted accounting principles accounting methods which will imperil both an unqualified audit opinion and pursuit of the Certificate of Excellence in Financial Reporting.

EXECUTIVE SUMMARY

* GASB STATEMENT NO. 11, Measurement Focus and Basis of Accounting-Governmental Fund Operating Statements, emphasizes operating statements of government-type (expendable) funds. The statement is part of a financial reporting project by the GASB.

* THE MEASUREMENT FOCUS of Statement no. 11 for government-type funds is total financial resources. Previously, the focus was on current financial resources; business enterprises have economic resources as their focus.

* STATEMENT NO. 11 generally requires full accrual accounting for government-type funds. The major criterion for revenue measurement under Statement no. 11 is a "measurable and demanded'' standard.

* THE EMPHASIS IN STATEMENT

no. 11 is on interperiod equity as representing the spirit of budgetary laws. Budgetary method is not to be a driving factor in recording transactions.

* LONG-TERM DEBT FOR government-type funds, final settlements, valuation of inventory and prepaid items and compensated absences also is addressed in Statement no. 11.

* STATEMENT NO. 11 DOES NOT take effect until fiscal years beginning after June 15, 1994. Government CPAs and those who audit governments should prepare now for the changes.