Statement No. 56 of the Governmental Accounting Standards Board - codification of accounting and financial reporting guidance contained in the AICPA statements on auditing standards.

SUMMARY

The objective of this Statement is to incorporate into the Governmental Accounting Standards Board's (GASB) authoritative literature certain accounting and financial reporting guidance presented in the American Institute of Certified Public Accountants' Statements on Auditing Standards. This Statement addresses three issues not included in the authoritative literature that establishes accounting principles--related party transactions, going concern considerations, and subsequent events. The presentation of principles used in the preparation of financial statements is more appropriately included in accounting and financial reporting standards rather than in the auditing literature.

This Statement does not establish new accounting standards but rather incorporates the existing guidance (to the extent appropriate in a governmental environment) into the GASB standards.

How the Changes in This Statement Will Improve Financial Reporting

The requirements in this Statement will improve financial reporting by contributing to the GASB's efforts to codify all sources of generally accepted accounting principles for state and local governments so that they derive from a single source. This effort is important from the perspective of bringing the authoritative accounting and financial reporting literature together in one place, with that guidance modified as necessary to appropriately recognize the governmental environment and the needs of governmental financial statement users.

Unless otherwise specified, pronouncements of the GASB apply to financial reports of all state and local governmental entities, including general purpose governments; public benefit corporations and authorities; public employee retirement systems; and public utilities, hospitals and other healthcare providers, and colleges and universities. Paragraph 2 discusses the applicability of this Statement.

CONTENTS

Introduction

1. Standards of Governmental Accounting and Financial Reporting/2-19

Scope and Applicability of This Statement/2-3

Related Party Transactions/4-7 Subsequent Events/8-15

Going Concern Considerations/16-19

Effective Date/20

Appendix A: Background/21-23

Appendix B: Basis for Conclusions/24-39

Appendix C: Codification Instructions/40

INTRODUCTION

1. Certain accounting and financial reporting guidance has been included in Statements on Auditing Standards of the American Institute of Certified Public Accountants (AICPA). The objective of this Statement is to incorporate that guidance into the state and local governmental accounting and financial reporting standards.

STANDARDS OF GOVERNMENTAL ACCOUNTING AND FINANCIAL REPORTING

Scope and Applicability of This Statement

2. This Statement establishes accounting and financial reporting standards for related party transactions, subsequent events, and going concern considerations. This Statement applies to all state and local governments.

3. This Statement amends paragraph 26 of the National Council on Governmental Accounting (NCGA) Statement 5, Accounting and Financial Reporting Principles for Lease Agreements of State and Local Governments.

Related Party Transactions

4. State and local governments are required to disclose certain related party transactions. (1) If the substance of a particular transaction is significantly different from its form because of the involvement of related parties, financial statements should recoguize the substance of the transaction rather than merely its legal form.

5. Examples of transactions with related parties that have features that may indicate that governments should consider whether a form-over-substance condition exists include:

a. Borrowing or lending on an interest-free basis or at a rate of interest significantly above or below market rates prevailing at the time of the transaction

b. Selling real estate at a price that differs significantly from its appraised value 

c. Exchanging property for similar property in a nonmonetary transaction

d. Making loans with no scheduled terms for when or how the loans will be repaid.

6. Determining the substance of a related party transaction may pose challenges not present in assessing transactions between unrelated parties. For example, a related party relationship may result in transactions that would not take place between unrelated parties or would be subject to different terms and conditions. In such cases, the substance of the related party transaction may differ from its legal form due to the related party relationship. (2)

7. It may not be possible to determine whether a particular transaction would have taken place if the parties had not been related, or what the terms and conditions would have been. Therefore, it may be difficult to determine whether a transaction was consummated on terms comparable to those that would be present in arm's-length transactions.

Furthermore, governments frequently enter into transactions and engage in activities that are driven by societal needs and concern for the "public good." Therefore, it may not be appropriate to compare some governmental programs and arrangements to what might have occurred in an arm's-length transaction in the private sector or with unrelated parties.

Subsequent Events

8. Events or transactions that affect the financial statements sometimes occur subsequent to the statement of net assets (3) date but before financial statements are issued. Some of those transactions and events (referred to as recognized events) require adjustments to the financial statements while others (referred to as nonrecognized events) may require disclosure in the notes to the financial statements. 9. Recognized events consist of those events that provide additional evidence with respect to conditions that existed at the date of the statement of net assets and affect the estimates inherent in the process of preparing financial statements. All information that becomes available prior to the issuance of the financial statements should be used in evaluating the conditions on which the estimates were based. The financial statements should be adjusted for any changes in estimates resulting from the use of such evidence.

10. Nonrecognized events consist of those events that provide evidence with respect to conditions that did not exist at the date of the statement of net assets but arose subsequent to that date. These events should not result in adjustment of the financial statements. Some of these events, however, may be of such a nature that their disclosure is essential to a user's understanding of the financial statements.

11. Identifying recognized events that require adjustment of the financial statements calls for the exercise of professional judgment and knowledge of the facts and circumstances. For example, a water utility's loss from an uncollectible account receivable as a result of a major customer's deteriorating financial condition leading to the bankruptcy of that customer subsequent to the statement of net assets date may be indicative of conditions existing at the statement of net assets date, thereby calling for adjustment of the financial statements before their issuance. In contrast, a similar loss resulting from that customer's major casualty, such as a fire or flood, subsequent to the statement of net assets date would not be indicative of conditions existing at the statement of net assets date, and adjustment of the financial statements would not be appropriate. The settlement of litigation for an amount different from the liability recorded in the accounts would require adjustment of the financial statements if the event that gave rise to the litigation, such as a personal injury occurring on government property, had taken place prior to the statement of net assets date.

12. Subsequent events affecting the realization of assets such as receivables and inventories or the settlement of estimated liabilities will ordinarily require adjustment of the financial statements because such events typically represent the culmination of conditions that existed over a relatively long period of time. Subsequent events such as changes in the quoted market prices of securities ordinarily should not result in adjustment of the financial statements because such changes typically reflect a concurrent evaluation of new conditions.

13. Other examples of nonrecognized events that require disclosure in the notes to the financial statements but should not result in adjustment include the issuance of bonds, the creation of a new component unit, or the loss of a government facility as a result of a tornado, fire, or flood.

14. When financial statements are reissued, certain events may have occurred subsequent to the original issuance that require disclosure. Events requiring disclosure are those that are considered essential to a user's understanding of the reissued financial statements. These events, occurring between the time of original issuance and reissuance of financial statements, should not result in adjustment of the financial statements unless the adjustment meets the criteria for the correction of an error or the criteria for prior-period adjustments. That also is the case for events occurring subsequent to the original issuance when financial statements are reissued in comparative form with financial statements of subsequent periods.

15. Statement No. 34, Basic Financial Statements--and Management's Discussion and Analysis--for State and Local Governments, paragraph 11(h), requires a discussion in management's discussion and analysis (MD&A) of currently known facts, decisions, or conditions that are expected to have a significant effect on the government's financial position or results of operations. It may be necessary to include a discussion of subsequent events in the MD&A, depending on the facts and circumstances.

Going Concern Considerations

16. Continuation of a legally separate governmental entity as a going concern is assumed in financial reporting in the absence of significant information to the contrary. Information that may significantly contradict the going concern assumption would relate to a governmental entity's inability to continue to meet its obligations as they become due without substantial disposition of assets outside the ordinary course of governmental operations, restructuring of debt, submission to the oversight of a separate fiscal assistance authority or financial review board, or similar actions. Financial statement preparers have a responsibility to evaluate whether there is substantial doubt about a government's ability to continue as a going concern for 12 months beyond the financial statement date. Moreover, if there is information that is currently known to the government that may raise substantial doubt shortly thereafter (for example, within an additional three months), it also should be considered.

17. Indicators that there may be substantial doubt about a governmental entity's ability to continue as a going concern include:

a. Negative trends--for example, recurring periods in which expenses/expenditures significantly exceed revenues, recurring unsubsidized operating losses in business-type activities, consistent working capital deficiencies, continuing negative operating cash flows from business-type activities, or adverse key financial ratios

b. Other indications of possible financial difficulties--for example, default on bonds, loans or similar agreements, proximity to debt and tax limitations, denial of usual trade credit from suppliers, restructuring of debt (other than refundings), noncompliance with statutory capital or reserve requirements, or the need to seek new sources or methods of financing or to dispose of substantial assets

c. Internal matters--for example, work stoppages or other labor difficulties, substantial dependence on the success of a particular project or program, uneconomic long-term commitments (burdensome labor contracts, for example), or the need to significantly revise operations

d. External matters--for example, legal proceedings, legislation, or

similar matters that might jeopardize intergovernmental revenues and the fiscal sustainability of key governmental programs; loss of a critical license or patent for a business-type activity; loss of a principal customer, taxpayer, or supplier; or uninsured or underinsured catastrophe such as a drought, earthquake, or flood.

18. In all cases, the effect of the governmental environment should be considered when evaluating the indicators. For example, the taxing power and borrowing capabilities of governments together with the constant demand for the provision of public services are factors that may diminish the possibility that a government would be unable to continue as a going concern. Some conditions or situations identified in the indicators in paragraph 17 should be assessed differently for governments. For example, recurring operating losses are commonplace for some business-type activities such as transit operations or governmental healthcare organizations. However, quality-of-life considerations and the health and welfare needs and interests of the citizenry may create compelling incentives for those operations to be subsidized to the extent necessary by another governmental entity.

19. If it is determined that there is substantial doubt about a governmental entity's ability to continue as a going concern, the notes to the financial statements should include disclosure of the following, as appropriate:

a. Pertinent conditions and events giving rise to the assessment of substantial doubt about the government's ability to continue as a going concern for a reasonable period of time, as discussed in paragraph 16

b. The possible effects of such conditions and events

c. Government officials' evaluation of the significance of those conditions and events and any mitigating factors

d. Possible discontinuance of operations e. Government officials' plans (including relevant prospective financial information)

f. Information about the recoverability or classification of recorded asset amounts or the amounts or classification of liabilities.

In addition, Statement 34, paragraph 11(h), requires a discussion in MD&A of currently known facts, decisions, or conditions that are expected to have a significant effect on the government's financial position or results of operations. It may be necessary to include a discussion of going concern issues in the MD&A, depending on the facts and circumstances.

EFFECTIVE DATE

20. The requirements in this Statement are effective upon its issuance.

The provisions of this Statement need not be applied to immaterial items.

This Statement was issued by unanimous vote of the seven members of the Governmental Accounting Standards Board.

Robert H. Attmore, Chairman

Michael D. Belsky

William W Holder

Jan I. Sylvis

Marcia L. Taylor

Richard C. Tracy

James M. Williams

Copyright [c] 2009 by Governmental Accounting Standards Board. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the Governmental Accounting Standards Board.

(1.) NCGA interpretation 6, Notes to the Financial Statements Disclosure, is the source of this disclosure requirement. Financial Accounting Standards Board Statement No. 57, Related Party Disclosures, which is applicable to governmental entities (to the extent the guidance therein does not conflict with or contradict GASB pronouncements), provides specific disclosure requirements and examples of related party relationships and transactions.

(2.) For example, Statement No. 48, Sales and Pledges of Receivables and Future Revenues and Intra-Entity Transfers of Assets and Future Revenues, includes requirements that affect the basis of assets transferred within the same financial reporting entity That requirement results in a measurement that is different from what would have occurred in an arm's-length transaction with an external party.

(3.) For purposes of this Statement, the term statement of net assets includes the government-wide statement of net assets, governmental fund balance sheet, proprietary fund statement of fund net assets, and statement of fiduciary net assets, which are required to be presented as components of the basic financial statements.