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Financial Reporting and Regulatory Update

Third Quarter 2018

From the GASB

Final standards

Accounting for interest cost incurred before the end of a construction period

On June 22, 2018, the GASB issued Statement No. 89, “Accounting for Interest Cost Incurred Before the End of a Construction Period,” to improve the relevance and comparability of information about capital assets and the cost of borrowing for a financial reporting period for both governmental activities and business-type activities.

Prior to the issuance of this statement, guidance for construction period interest expense capitalization was contained in GASB Statement 62, “Codification of Accounting and Financial Reporting Guidance Contained in Pre-November 30, 1989 FASB and AICPA Pronouncements.” According to Statement 62, the amount of interest cost to be capitalized for qualifying assets was intended to be that portion of the interest cost incurred during the assets’ acquisition periods that theoretically could have been avoided if outlays for the assets had not been made. The guidance in Statement 62 required capitalization only for business-type activities and enterprise funds and not governmental activities. Also, the calculation of interest to be capitalized differed based on whether the acquisition of a capital asset was financed from the proceeds of tax-exempt debt as opposed to taxable bonds or nonqualifying tax-exempt debt.

Statement 89 simplifies the accounting for interest cost incurred before the end of a construction period by requiring this interest cost be recognized as an expense in the period in which the cost is incurred for financial statements prepared using the economic resources measurement focus. As a result, interest cost incurred before the end of a construction period will not be included in the historical cost of a capital asset reported in a business-type activity or enterprise fund, thus resulting in consistency with the current accounting treatment for this interest cost in governmental activities.

This statement also reiterates that in financial statements prepared using the current financial resources measurement focus, interest cost incurred before the end of a construction period should be recognized as an expenditure on a basis consistent with governmental fund accounting principles.

Effective date

The revised construction period interest cost accounting provided for in Statement 89 is effective for reporting periods beginning after Dec. 15, 2019, and should be applied prospectively. Earlier application is encouraged.

Majority equity interests

On Sept. 4, 2018, the GASB issued Statement 90, “Majority Equity Interests – an Amendment of GASB Statements No. 14 and No. 61,” to clarify the accounting and financial reporting requirements for a state or local government’s majority equity interest in an organization that remains legally separate after acquisition.

Under Statement 90, a government’s majority equity interest in a legally separate organization that meets the GASB’s definition of an investment should be reported as an investment. GASB Statement 72, “Fair Value Measurement and Application,” defines an investment as “a security or other asset that (a) a government holds primarily for the purpose of income or profit and (b) has a present service capacity based solely on its ability to generate cash or to be sold to generate cash.” A majority equity interest that meets this definition of an investment should be measured using the equity method, unless the government is engaged only in fiduciary activities or is an endowment. These governments should report the majority equity investment at fair value.

For holdings of a majority equity interest in a legally separate entity that do not meet the definition of an investment, this statement establishes that ownership of a majority equity interest in a legally separate organization results in the government being financially accountable for the legally separate organization, and therefore the government should report that organization as a component unit.

Statement 90 also establishes guidance for measuring a component unit’s assets, deferred outflows of resources, liabilities, and deferred inflows of resources when a government acquires 100 percent equity interest in that component unit. In these situations the component unit should measure these elements in accordance with the provisions of GASB Statement 69, “Government Combinations and Disposals of Government Operations,” at acquisition value as of the date on which the government acquires the 100 percent equity interest.

Effective date

The requirements of this statement are effective for reporting periods beginning after Dec. 15, 2018. Early application is encouraged. The requirements should be applied retroactively, except for the provisions related to 1) reporting a majority equity interest in a component unit and 2) reporting a component unit if the government acquires a 100 percent equity interest. Those provisions should be applied on a prospective basis.

Proposals

Conduit debt obligations

On July 30, 2018, the GASB issued an exposure draft, “Conduit Debt Obligations,” to address diversity in practice associated with how government issuers report conduit debt obligations. Conduit debt obligations are debt instruments issued by a state or local government to provide financing for a specific third party that is not part of the issuer’s financial reporting entity and primarily is liable for repaying the debt instrument.

Current guidance for accounting for conduit debt obligations is found in GASB Interpretation No. 2, “Disclosure of Conduit Debt Obligations.” This guidance allows government issuers to recognize conduit debt obligations as their own debt liability or just to disclose the transaction as a note in their financial statements. This option results in a disparity in practice among governments that issue conduit debt obligations, which affects the comparability of financial statement information.

This proposed statement would address this disparity in practice by:

  • Clarifying the definition of a conduit obligation
  • Establishing that a conduit debt obligation is a liability of the third-party obligor, not the issuer, thus eliminating the reporting option found in current guidance
  • Establishing standards for accounting and financial reporting of additional commitments extended by issuers and arrangements associated with conduit debt obligations
  • Improving required note disclosures

While the proposed statement stipulates that an issuer would not recognize a liability for the conduit debt obligation, an issuer would recognize a related liability and expense or expenditure if certain recognition criteria, as defined in the statement, are met. At least annually, the issuer would be required to evaluate whether those criteria are met.

Comments are due to the GASB by Nov. 2, 2018.

Financial reporting model improvements

On Sept. 28, 2018, the GASB issued a preliminary views document, “Financial Reporting Model Improvements,” with the objective of making the reporting model more effective in providing information necessary for decision-making and assessing a government’s accountability. The document considers improvements in selected areas of the existing financial reporting model including governmental funds reporting. The improvements proposed in the governmental funds reporting area are based on public feedback received from the Invitation to Comment, “Financial Reporting Model Improvements – Governmental Funds,” which was issued in December 2016.

The proposed improvements include the following:

  • A short-term financial resources measurement focus for governmental funds that recognizes short-term transactions and other events when incurred and long-term transactions and other events when due
  • A format for governmental fund financial statements that distinguishes between current and long-term resource flows
  • Clarified explanations of operating and nonoperating revenues and expenses
  • An additional subtotal in proprietary fund financial statements for operating income (loss) and noncapital subsidies
  • Presentation of all budgetary comparison information as required supplementary information and required presentation of two variance columns
  • Communication of major component unit information either in the governmentwide statements or in combining financial statements
  • A new schedule of governmentwide expenses by natural classification as supplementary information in comprehensive annual financial reports

The document also contains alternative views to some of the improvements proposed. These include:

  • Modifications of the proposed measurement focus and criteria for governmental funds financial statements
  • Addition of cash flows information for the primary government in the governmentwide financial statements together with elimination of existing requirements for cash flows reporting in proprietary funds financial statements

Comments are due to the GASB by Feb. 15, 2019.

Recognition of elements of financial statements

On Sept. 28, 2018, the GASB issued a preliminary views document, “Recognition of Elements of Financial Statements,” with the objective of improving financial reporting by enhancing the framework through which the GASB can increase consistency in future standards-setting. The proposed concepts address the recognition of elements of financial statements, such as assets and liabilities, which is a necessary component of a complete framework for reporting in financial statements.

Recognition concepts encompass two aspects of state and local government financial statements:

  • The measurement focus of a specific financial statement determines what items should be reported.
  • The related basis of accounting determines when those items should be reported.

The document proposes that an item being considered for recognition in financial statements would be evaluated using a hierarchy for recognition of elements. The hierarchy would require the GASB to follow a specific order of elements when considering if an item should be recognized and as what element (for example, as an asset, as deferred outflows of resources, or as an expense). The document also proposes a recognition framework for both the short-term financial resources measurement focus and the economic resources measurement focus.

In addition, the document contains alternative views that include a modification of the proposed measurement focus and criteria for governmental funds financial statements in order to improve clarity and reduce the complexity of the concepts proposed in the preliminary views.

Comments are due to the GASB by Feb. 15, 2019.