Net available assets as a proxy for financial condition: a model for measuring and reporting resources available to a local government.

A framework that blends an economic resources measurement focus with a current financial resources measurement focus provides a systematic approach to reporting financial condition.

A standardized and useful tool is needed to enable public financial managers to cope with the scarcity of available resources and the degree of fiscal stress being encountered by local governments today. A statement of financial condition for local governments will meet this need. This article develops and presents a model for a new approach to measuring and reporting on the financial condition of a local government.

What is financial condition? Why is it important? How is it measured and reported? What is the current measurement basis and reporting model? What changes have been proposed by the Governmental Accounting Standards Board (GASB)? What will be the impacts of these changes? How will finance officials prepare for these changes? These are just some of the pertinent questions that must now be considered by local government leaders in order to adequately assess the state of their financial health.

The following article is an attempt to develop a statement of financial condition that combines the best of both the current reporting models and those proposed by GASB. The main purpose for utilizing a statement of financial condition is to provide public financial managers with a means of making tough financial decisions for their locality based on meaningful and reliable financial information that is standardized for analytical and comparative purposes. Simplifying a local government's ability to measure its financial condition at a point in time and as a trend over time, as well as in comparison to other localities, should enable these organizations to exercise proactive and not reactive financial management practices.

In the end, public financial managers need to know their current status before responding to internal and/or external environmental forces. A statement of financial condition for a local government must be specially tailored to meet the needs of its users and accomplish its primary objective of accountability - especially compliance, performance, and program accountability. Providing local governments with a tool that can be easily applied and understood should be paramount in the minds of those proposing changes to their financial reporting model. Simplicity and usefulness should be the guiding light even though local governments are complex and diverse organizations that demand care and expertise. The authors have sought to incorporate these basic concepts into the structure of this model.

Elements of the Model

It is the authors' view that existing approaches to measuring and reporting financial performance have limitations in explaining performance levels, how to improve performance, and what contributes to outcomes and that a greater knowledge of and expertise in applying the techniques is essential to determine the financial condition of a local government in the future. The model developed herein is a hybrid that blends the best of current theory and practice into an approach for measuring and reporting financial condition for a local government's governmental activities in a consolidated statement of financial condition. Its thrust is to build on the traditional balance sheet approach that focuses on financial position and to establish a new working definition and framework for measuring and reporting financial condition for a local government.

This model relies on a new working definition of the concept of "net available assets," which is the liquidated value of net assets that are currently available, spendable, and appropriable after all liabilities, commitments, contingencies, and restrictions have been satisfied. It structures the working definition into a consolidated financial statement that measures and reports on net available assets as a proxy for financial condition. This model offers a simplified yet comprehensive determination of net available assets, which emphasizes the details of the different classifications within the assets, liabilities, and equity sections of the balance sheet in order to accomplish this goal. Such an emphasis involves an assessment of the nature of the transactions and events that are recorded in the various accounts combined into each classification. Every balance sheet classification has its own identity and is comprised of homogenous accounts which, when combined, constitute a single element of financial position. Classified balance sheets divide assets and liabilities between current (within one year) and long-term (beyond one year) liquidity, while nonclassified balance sheets list all assets and liabilities in the order of liquidity without any such division.

The central focus of the model is a consolidation of the operating, capital, and debt components of the governmental activities of a local government, inclusive of its school board component unit. The funds included in this grouping are the general, storm water, debt service, and capital projects funds of the primary government (as well as the General Fixed Assets Account Group - GFAAG and General Long-Term Debt Account Group - GLTDAG) plus a combination of the school operating and food services funds of the school board component unit of the primary government. Additionally, in order to facilitate the combination of funds and account groups (as well as reclassifications, eliminations of inter-fund balances, and other adjustments), columns are presented for unadjusted, adjustments, and adjusted consolidated totals.

Phase 1: Four Basic Measures. The initial phase in developing the model was determining which specific consolidated measures of financial condition should be presented. Four basic measures were decided upon, as follows:

* the current ratio,

* the debt-to-equity ratio,

* the operating ratio, and

* the equity-to-property tax base ratio.

Three versions of each ratio were presented: 1) either a traditional (current and debt-to-equity ratios) or standard (operating equity and equity-to-property tax base ratios) version of total equity, 2) a net assets version, and 3) a net available assets version. The current ratio is the difficult ratio to convert to a net assets and/or a net available assets version. Since the current ratio is current assets divided by current liabilities, the net assets and net available assets versions of the current ratio require proper tracking and application of the ' additions and subtractions of each classification of current assets and liabilities to both the numerator and denominator of the ratio. The debt-to-equity ratio is much simpler in that it only involves changing the net assets or the net available assets amount in the denominator. The operating equity ratio utilizes an actual expenditures amount in the denominator for each of the total equity, net assets, and net available assets versions. The equity-to-property tax base ratio utilizes the actual assessed property tax value in the denominator for each of the total equity, net assets, and net available assets versions.

Phase 2: Two Classifications of Total Equity. The next phase is the presentation of a classified balance sheet format that is divided into two classifications of total equity: 1) fund balance and 2) net long-term assets and liabilities. Net long-term assets and liabilities include the current portion of long-term debt that is ultimately reclassified in an adjustments column of the current liabilities section of the balance sheet. This accomplishes two goals: it enables the presentation of a classified balance sheet on a consolidated basis and it separates equity into current and long-term based on the nature of the classification. In this case, the current portion of long-term debt is presented separately but combined with the long-term debt accounted for in the GLTDAG as a reduction of long-term equity that is payable from future resources. The revenue collections projected for the next fiscal year in the local government's annual operating budget will be used to cover the annual debt service payments.

Phase 3: Commitments and Contingencies. The third phase of the model is to reflect all reservations and designations of fund balance as commitments and contingencies. Total equity is reduced by commitments and contingencies, which are treated and presented as additional liabilities, to yield net assets. Net assets are the combination of unreserved, undesignated fund balance (current net assets), and net long-term assets and liabilities (long-term net assets).

The concept of net assets mirrors the basic financial statement requirements of the new reporting model proposed by the GASB. However, the new reporting model is designed with only a pure economic resources measurement focus, whereas this model is designed to forge a new path toward a modified version of the current financial resources measurement focus, which also incorporates the economic resources measurement focus as the foundation for measuring and reporting the assets (resources) and liabilities (uses of resources) included in the determination of net available assets. The major accounting difference between this model and the new reporting model is that this model does not record infrastructure assets and depreciation of capital assets.

Phase 4: Unavailable Assets. The fourth phase is the identification of unavailable net assets (subtractions) and resources to be provided and made available (additions). Net assets less subtractions plus additions equals net available assets. There are five types of subtractions (existing assets that will not become or are not considered to be available as a resource for future use): 1) city treasurer's cash, 2) receivables (net), 3) due from other governmental units (less school board), 4) long-term capital investment (net), and 5) capital improvement program (CIP) costs. City treasurer's cash is cash held by the treasurer and included in cash and cash equivalents, but not readily available for operations. Receivables (net) is comprised of all receivables, net of an allowance for uncollectible accounts, less accrued interest receivable and reserves for receivables in commitments and contingencies. Due from other governmental units is a combination of receivables from component units and other governments, less amounts due from the school board that are eventually eliminated in the consolidation process. Long-term capital investment (net) comprises fixed assets less related long-term debt (bonds payable), exclusive of other long-term liabilities. The CIP represents the anticipated future expenditure of existing and to-be-provided capital projects resources.

There are also five types of additions (existing liabilities or anticipated future resources that will become or are considered to be available for future use): 1) deferred revenue, 2) subsequent year's operating budget appropriation: expenditures - other current liabilities, 3) subsequent year's capital budget appropriation: revenue-receivables and due-from-other-funds, 4) other long-term liabilities to be provided, and 5) bonds/loans authorized but not yet issued. Deferred revenue are unearned resources offsetting taxes, notes, and other receivables that will be earned in the subsequent year but are currently available. Subsequent year's operating budget appropriation: expenditures - other current liabilities is an addback for resources to be provided in the subsequent year's operating budget to cover operating expenditures included in other current liabilities. Subsequent year's capital budget appropriation: revenue - receivables and due from other funds is an addback for resources to be provided in the subsequent year's capital budget to cover capital expenditures included in the capital improvement program for which related receivables and due from other funds are not but should be included as available. Other long-term liabilities to be provided is the noncurrent portion of other long-term liabilities included in the net long-term assets and liabilities classification of net assets which is not payable out of the unreserved, undesignated fund balance classification of net assets. Bonds/loans authorized but not yet issued are resources to be provided from the sale of bonds in a subsequent year to cover CIP costs.

Phase 5: Consolidation Process. The fifth and final phase of the development of the model is the consolidation process. The general, storm water, debt service, capital projects, and school board (operating and food services) funds and the GFAAG and GLTDAG are combined into an unadjusted consolidated total. Reclassification of assets and liabilities between current and long-term is included in the adjustments column, which usually involves the current portions of long-term receivables (the current portion of notes receivable) and liabilities (the current portion of long-term debt and other long-term liabilities). Eliminations of interfund balances (due to and from other funds and component units) are included in the adjustments column as well. Other adjustments for accruing receivables (accrued interest and bond proceeds receivable) and payables (accrued interest and unfunded pension obligations payable) are also included in this column. Actual expenditure and assessed property tax value amounts are presented underneath net available assets and the three versions of the four ratios are presented in the consolidated measures of financial condition section of the statement of financial condition.

The model requires the preparation of a consolidating worksheet for each fiscal year in order to properly account for the balance sheet classifications and components defined for and established by the new framework. Once the consolidation process is completed, it enables a relatively simple comparative analysis of results.

Four-City Comparative Analysis

Four city governments from the Commonwealth of Virginia were selected to demonstrate the model's framework for measuring and reporting financial condition and providing a standardized approach to comparative analysis. Norfolk, Portsmouth, and Richmond were chosen as older urban centers that share many common traits, and Virginia Beach, as a young growing city that shares certain traits with but is a striking contrast to urban centers, was chosen for comparative purposes. The demographics of these cities are presented in Table 1. Audited financial statement information for the fiscal year ended June 30, 1996, from each city's CAFR was used to demonstrate the model. The combined and individual fund balance sheets and the notes to the financial statements were primary sources of audited financial information.

The consolidated totals from each city's consolidating statement of financial condition are also presented in a comparative summary of consolidated financial condition. The comparative summary provides an overview of each city's consolidated financial condition as well as a comparison between each of the cities using the standardized format of the model. In addition, the consolidated measures of financial condition section of the summary presents three versions of four ratios selected as the four basic measures; this provides yet another picture of financial condition for each city and a means of comparing the financial condition of one city with another. Presenting the three versions of each ratio adds an extra dimension to developing an understanding from the consolidated results for each city.

One of the most readily apparent outcomes from developing and working with the model is that net available assets provides a more meaningful and useful measure of the financial condition and liquidity of a local government within the context of current spendable and available financial resources than does total equity, fund balance, net assets, or undesignated fund balance. These types of equity, while meaningful and useful, do not provide the clarity or perspective on financial condition that net available assets provides. One of the main reasons that net available assets is a more reliable measure of financial condition is that total equity and net assets are both skewed by the inclusion of long-term assets and liabilities (fixed assets and other long-term liabilities) and fund balance and undesignated fund balance have not been adjusted to reflect the net effect of liquidating assets to meet liabilities as a means of determining the expendable, available, and appropriable financial resources of a local government.

Exhibit 1

FOUR-CITY RANKING OF EQUITY TYPE

                                                  Rank
Equity Type                         1         2         3         4

Total equity                       VB         N         P         R
Net assets                         VB         P         N         R
Net avail. assets                  VB         N         R         P

N: Norfolk P: Portsmouth R: Richmond VB: Virginia Beach

The comparative analysis of equity type of the four cities, as shown in Table 2, yielded the rankings shown in Exhibit 1 and in Table 2 of Exhibit 2. The one constant of the equity type comparison was that Virginia Beach ranked first for all three equity measures. Norfolk ranked second twice and third once. The reason for the change in the rankings for net assets was primarily due to the relative amount of commitments and contingencies reducing total equity to arrive at net assets: these reductions were nearly 30 percent for Norfolk, 10 percent for Portsmouth, 130 percent for Richmond, and 8 percent for Virginia Beach. The explanation for the change in rankings from net assets to net available assets is due to a combination of the decline for Portsmouth, which resulted from the high percentage of long-term equity included in unavailable net assets, and the increase for Richmond, which resulted from the low percentage of long-term equity included in unavailable net assets.

The total FY 96 expenditures and the total FY 96 assessed (property tax) value (AV) amounts are also shown in Table 3 in order to facilitate the computation of the four consolidated measures of financial condition presented in the comparative summary. The relative rankings of 1) Virginia Beach, 2) Richmond, 3) Norfolk, and 4) Portsmouth for both measures are understandable in light of the fact that Norfolk and Portsmouth have tax revenue bases that are limited by geographic size (land-locked), population (declining), [TABULAR DATA FOR EXHIBIT 2 OMITTED] economic growth (slow), and property tax base (high nontaxable composition).

The four consolidated measures (ratios) of financial condition displayed in Table 4 also result in an identifiable trend in the rankings, due to the influence of the three equity types used to compute the three different versions of each ratio. For the current, operating equity, and equity-to-property tax base ratios, the rankings from one to four are in the descending order of the highest to lowest numbers or percentages, while the ranking (from one to four) for the debt-to-equity ratio is in the ascending order of the lowest to highest numbers or percentages. The similarities in rankings between the three versions of the current, debt-to-equity, and equity-to-property tax base ratios as displayed in Table 4 is undeniable.

All three of these ratios for the total equity and net assets versions yielded the same results in ranking, as follows: 1) Virginia Beach, 2) Portsmouth, 3) Norfolk, and 4) Richmond. The rankings for net available assets versions of the three ratios were the same for the current and operating equity ratios, as follows: 1) Virginia Beach, 2) Norfolk, 3) Portsmouth, and 4) Richmond. However, the ranking for the net available assets version of the debt-to-equity ratio resulted in the following order: 1) Virginia Beach, 2) Norfolk, 3) Richmond, and 4) Portsmouth. The explanation for the reversal in ranking for the latter two cities in this version of the debt-to-equity ratio was directly related to the reduction of a high proportion of net long-term equity that worked to the disadvantage of Portsmouth as opposed to the reduction of a low proportion of net long-term equity that worked to the advantage of Richmond.

The results from ranking the equity-to-property tax base ratios were the same for the total equity and net assets versions, but different from the current, debt-to-equity, and operating equity ratios for the two versions, as reflected in this order: 1) Portsmouth, 2) Virginia Beach, 3) Norfolk, and 4) Richmond. This shift in ranking between Portsmouth and Virginia Beach for these two versions of this ratio is due to Portsmouth's relatively small AV amount, which ranked fourth. Once again, the ranking for the net available assets version of the property tax base ratio reverts back to the trend established for the other three ratios, as follows: 1) Virginia Beach, 2) Norfolk, 3) Portsmouth, and 4) Richmond.

The comparative analysis between these four cities yields a composite ranking of: 1) Virginia Beach, 2) Portsmouth, 3)Norfolk, and 4) Richmond, but the rankings for the net available assets version of each ratio were consistently in the order of: 1) Virginia Beach, 2) Norfolk, 3)Portsmouth, and 4) Richmond. The composite ranking was arrived at by averaging each locality's rankings for all four ratios. In summary, Virginia Beach is in the best overall financial condition of the four localities.

Use of the Model in Norfolk

The City of Norfolk currently calculates a similar version of net available assets under the existing reporting model requirements for its general fund. The city's version of net available assets also treats certain assets, such as receivables and other prepaid or deferred assets, various current liabilities, such as accounts payable and accrued expenses, except deferred revenue which is directly offset versus the receivables, and any fund balance reserves and designations as all being unavailable for future appropriation and spending. This version, however, differs from the authors' model in that it does not employ a consolidated governmental fund and classified balance sheet approach. Therefore, the resulting net available assets computation is one-dimensional and does not provide a comprehensive measure of a local government's financial picture in terms of all liquid funds that may be available for future appropriation and spending.

Despite these limitations, the city's version of net available assets is a very useful tool for measuring and reporting the financial condition of the general or operating fund of a local government. Two approaches are employed in computing the city's net available assets: the cash and cash equivalents approach and the undesignated fund balance approach. The cash and cash equivalents approach starts with total cash and cash equivalents, subtracts imprest cash, liabilities, reserves, and designations, and adds balances due from other funds. The undesignated fund balance approach starts with total undesignated fund balance, subtracts imprest cash and receivables (including due from component units and due from other governments) that are included in undesignated fund balance, and adds deferred revenue that is not included in undesignated fund balance. The simultaneous use of these two approaches serves as a means of checking or reconciling net available assets computations, which ensures accurate and thorough measurement and reporting.

Norfolk's dual-approach version of net available assets is also used as a tool for determining whether sufficient funds are available for supplemental appropriation in the next fiscal year. Knowing in advance that such funds are available makes it easier to plan for and address contingency requirements for unexpected needs and emergencies. Additionally, net available assets can be used as an indicator of currently available future cash flows. The validity of using net available assets to determine the liquidity of a local government, however, has not yet been tried and tested on a large scale, so there is no substitute for exercising due professional care when employing these techniques.

Summary

The compelling need for more useful analytical tools to determine the viability of a local government in terms of its financial condition creates a heavy demand for continuous and methodical experimentation and calculated and informed risk-taking. The authors present the model described in this article as an objective and standardized approach to measuring and reporting a local government's financial condition on a consolidated governmental activity basis. The equity-based measures provided by the model have generated consistent results and trends in the comparative analysis of the four selected cities when using a ranking approach. In addition, there were reasonably simple explanations for all of the identified deviations from established trends. Therefore, the comparative analysis validates the model's usefulness and meaningfulness as a tool for measuring and reporting financial condition.

The model blends the existing and new GASB reporting models into a statement of financial condition by using an iterative classified balance sheet approach to measuring and reporting net available assets as a proxy for financial condition. A conceptual framework that blends both an economic resources measurement focus (which recognizes all appropriate asset and liability components, except for infrastructure assets and accumulated depreciation of capital assets) with a current financial resources measurement focus provides a systematic approach to measure and report financial condition.

The model's working definition of net available assets as the liquidated value of expendable, available, and appropriable resources provides the foundation for an accurate measurement and fair presentation (reporting) of a local government's financial condition. Utilizing net available assets as a means of measuring and reporting financial condition will provide an objective and standard analytical tool that progressive local government needs to assess its past, current, and future financial performance. The model developed herein attempts to anticipate the need to measure and report financial condition when the new reporting model becomes reality for governmental accounting and financial reporting practitioners.

The existence of a limited working version of net available assets that already is being successfully employed by the City of Norfolk under the current reporting model requirements for local governments, provides impetus for development of the model. Even though this version of net available assets is only employed to measure and report the financial condition of the city's general fund, it is a useful tool in determining whether funds are available for future appropriation and spending. []

LANCE W. WOLFF, City Controller of the City of Norfolk, is a CPA with eight years of local government experience and 20 years of experience in public accounting. He has published an article on improving government performance and was chairman of the education committee for the Virginia Government Finance Officers' Association during 1996. DR. JESSE HUGHES, PH.D., Professor of Accounting with the Center for Governmental Financial Management for the College of Business and Public Administration at Old Dominion University in Virginia, has extensive experience in governmental accounting, auditing, and financial reporting. He has published widely and is involved in CPA testing with the AICPA, standard setting with the FASAB, and education as both a professor and founder and active member of the Virginia Government Finance Officers' Association.