Chapter 5: Financial Reporting — Liabilities

Liabilities represent financial obligations of an entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. Although governments are required to record liabilities in the period in which they are incurred, it is necessary to distinguish obligations that represent fund liabilities, which are amounts that are due and payable, from unmatured long-term indebtedness, which represents a general long-term liability. GASB Interpretation No. 6, Recognition and Measurement of Certain Liabilities and Expenditures in Governmental Fund Financial Statements, explains that governmental fund liabilities include those that are due and payable in full when incurred. Additionally, the matured portion of long-term indebtedness, to the extent that it is expected to be liquidated with expendable available financial resources, should also be recorded as a fund liability. This applies to the matured portions of formal debt issues as well as to other forms of general long-term indebtedness, such as compensated absences, capital leases, and claims and judgments. The unmatured portion of the long-term indebtedness represents a general long-term liability.

GASB Interpretation No. 6 clarifies financial reporting guidance relative to governmental funds. Because proprietary funds use an accrual basis of accounting for liability recognition, all obligations of the fund should be reflected as fund liabilities.

The following subsections identify the primary obligations typical of most governments.

Accounts Payable

Accounts payable are those liabilities incurred in the normal course of business for which goods or services have been received but payment has not been made as of the end of the fiscal year.

Salaries and Related Benefits Payable

Expenditures should be recorded and reported in the period in which the liability has been incurred. Therefore, unpaid salaries and related benefits that have not yet been paid at the close of the accounting period should be accrued.

Due to/From Other Funds

Each fund is a separate self-balancing set of accounts. Therefore, amounts due to/from other funds generally arise from interfund loans or services used/services provided between funds. For instance, one fund may make an advance to another fund, or one fund may provide services to another without payment at the time the services are provided. Although interfund receivables and liabilities may be classified as current or noncurrent depending on the terms for repayment, all such transactions must be reflected as fund receivables and liabilities. The advancing fund should reserve fund balance for the noncurrent portion of amounts due from another fund.

Compensated Absences

Paragraphs 31 and 119 of GASB Statement 34 provide guidance for the accounting and financial reporting of compensated absences on both a short-term and a long-term basis. Compensated absences include future vacations, sick leave, sabbatical leave, and other leave benefits.

The need for a governmental entity to accrue a liability for vacation leave or other similar compensated absences is based on the following criteria:

• The government's obligation relating to employees' rights to receive compensation for future absences is attributable to employees' services already rendered, and
• that it is probable that the entity will compensate employees for the benefits through paid time off or some other means (e.g., cash payments at termination or retirement).

Sick leave benefits that have been earned but will only be used as sick leave should not be accrued as compensated absences. Liabilities for compensated absences should be calculated at the end of each fiscal year and adjusted (and recorded) to current salary rates, unless payment will be made at rates other than the current salary rate. This liability also includes the employer's share of social security and Medicare taxes as well as other liabilities. A fund liability for the governmental funds may be recorded only when amounts are due and payable. Any liability not due and payable is recorded as a government-wide liability. For proprietary funds, all of the liability is a fund liability.

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Deferred Compensation Plans, Pension Plans, Other Postemployment Plans, and Termination Benefits

A deferred compensation plan allows employees to defer the receipt of a portion of their salary and, therefore, the associated tax liability on that salary. Authorization for deferred compensation plans is established by the Internal Revenue Service (IRS) and is described in Internal Revenue Code Chapter 457.

Employees of many school districts participate in statewide retirement systems. However, districts may establish deferred compensation plans and other pension plans at their discretion, some of which are locally funded. School districts may also provide pension benefits to employees through locally funded pension plans. Locally funded pension plans should be accounted for in a pension and other employee benefits trust fund. If the school district has significant administrative or fiduciary responsibility for a deferred compensation plan, such as managing the plan's investments, a pension and other employee benefits trust fund should be used. This is not the case for most school districts. If a governmental entity does not have significant administrative or fiduciary responsibility, the plan should not be reported in the entity's funds.

Many districts provide significant other postemployment benefits (OPEB) such as health care, life insurance, disability, and long-term care benefits. Recent changes in GAAP now require entities to account and report such plans in a manner similar to the existing reporting requirements for pensions, as described above. Such OPEB plans should also be accounted for in a pension or other employment benefits trust fund.

GASB recently issued Statement 47, Accounting for Termination Benefits, which provides accounting and financial reporting guidance for governmental entities that offer benefits such as early retirement incentives or severance to employees who are involuntarily terminated. In general, involuntary termination benefits should be recognized in the period in which the government becomes obligated to provide the benefits, which often is different from the period in which the benefits are actually provided. Voluntary termination benefits, such as early retirement incentives, should be recognized in the period in which the offer is accepted by the employees.

Debt

Governmental entities borrow money on a short-term basis either to meet operating cash needs or in anticipation of long-term borrowing at later dates. School districts usually borrow money on a long-term basis to finance capital acquisitions or construction or infrastructure improvements. Borrowing may also occur for the initial funding of a risk-retention program, the payment of a claim or judgment, or the financing of an accumulated operating deficit.

Short-term debt obligations and long-term debt obligations are defined (based on the initial maturity of the obligation) as follows:

• Short-term obligations are loans, negotiable notes, time-bearing warrants, or leases with a duration of 12 months or less, regardless of whether they extend beyond the fiscal year. Using the current financial resources measurement focus, short-term debt should be reflected in the balance sheet of the governmental fund that must repay the debt. The presentation of the liability on the balance sheet of a governmental fund implies that the debt is current and will require the use of current financial resources. Bond anticipation notes may be classified as long-term debt if the criteria of FASB Statement No. 6, Classification of Short-Term Obligations Expected to be Refinanced, are met.
• Long-term obligations are loans, negotiable notes, time-bearing warrants, bonds, or leases with a duration of more than 12 months. Noncurrent obligations that will be repaid from revenues generated by proprietary funds should be recorded in the related proprietary fund, whereas noncurrent obligations to be repaid from governmental funds should be reported only on the government-wide statement of net assets.

The following subsection concentrates on long-term debt presentation in different types of funds and the related accounting requirements and disclosures. It is organized as follows:

• recording of long-term liabilities in different types of funds;
• types of debt instruments; and
• extinguishment of debt.

Recording of Long-Term Debt in Different Types of Funds
The accounting for debt-related transactions differs depending on whether the debt is related to proprietary and fiduciary funds or a governmental fund.

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Long-Term Liabilities in Proprietary and Fiduciary Funds. GASB Codification states:

Bonds, notes and other long-term liabilities (for example, for capital and operating leases, pensions, claims and judgments, compensated absences, special termination benefits, landfill closure and postclosure care, and similar commitments) directly related to and expected to be repaid from proprietary funds and fiduciary funds should be included in the accounts of such funds. These are specific fund liabilities, even though the full faith and credit of the governmental unit may be pledged as further assurance that the liabilities will be paid. Too, such liabilities may constitute a mortgage or lien on specific fund properties or receivables. (GASB 2005a, section 1500.102)

The proceeds of the debt will thus be recorded as an increase in cash and long-term debt accounts; there will be no effect on operations. If the debt was issued at a discount, the discount should be recorded as a reduction from the face value of the debt and amortized over the term of the debt. All debt issue costs should also be recorded as a deferred charge and amortized over the term of the debt. Currently, the only specific accounting guidance on debt transactions in proprietary funds is GASB Statement 23, Accounting and Reporting for Refundings of Debt Reported by Proprietary Activities, discussed later in this chapter. Therefore, Generally Accepted Accounting Principles for commercial enterprises should be followed for debt transactions in proprietary and fiduciary funds.

Long-Term Liabilities in Governmental Funds. A clear distinction should be made between long-term fund liabilities and general long-term liabilities. Long-term liabilities of proprietary and fiduciary funds should be accounted for in those funds and presented in the fund financial statements. Long-term liabilities for the proprietary funds, but not the fiduciary funds, should also be reported in the government-wide statements. However, general long-term liabilities of the entity should be accounted for and reported only in the government-wide statement of net assets.

Types of Debt Instruments
Debt instruments have different characteristics, terms, and legal authority. A summary description of the types of debt follows:

Bonds

• General obligation bonds are issued for the construction or acquisition of major capital assets. The security pledged for the bonds is the general taxing power of the government. General obligation bonds are usually either term bonds, which are due in total on a single date, or serial bonds, which are repaid in periodic installments over the life of the issue.
• Revenue bonds are issued to acquire, purchase, construct, or improve major capital facilities. The revenue generated by the facility or the activity supporting the facility is pledged as security for the repayment of the debt.

Other Types of Debt

• Tax anticipation notes and other revenue anticipation notes are often issued to pay current operating expenditures prior to the receipt of the revenues. The proceeds from the revenue sources are pledged as security for the notes.
• Installment financing may be used either for constructing or acquiring property. The security for the financing is the property being acquired or constructed.
• Certificates of participation are a type of installment financing that may also be used either for constructing or acquiring property. Typically, more parties than the borrowing government and the financing institution are involved in the transaction. The security for such financings are commonly the property being acquired or constructed, though some arrangements may involve revenue streams as collateral.
• Leases are agreements between two parties that convey the use of property for a specified period of time. A lease must be classified as capital if it meets the criteria of FASB Statement 13, Accounting for Leases, or as operating if it does not qualify as a capital lease. Capital leases are considered to be debt financing; operating leases are not. Capital leases are in substance an acquisition of an asset. This determination is made using the following criteria:
  • the ownership of the property transfers to the lessee at the end of the lease term;
  • the lease contains a bargain purchase option;
  • the lease term is equal to 75 percent or more of the estimated useful life of the leased property; or
  • at the inception of the lease, the present value of the minimum lease payments is equal to 90 percent or more of the fair value of the leased property.

  When a capital lease satisfies one of the criteria above, an asset and a liability should be recorded. If the lease obligation is incurred by a governmental fund, the asset and the liability should be reported in the government-wide statement of net assets. The initial value of the asset should be recorded as the lesser of the fair value of the leased property or the present value of the net minimum lease payments.

  Generally Accepted Accounting Principles require governmental entities to disclose a range of information related to both capital and operating leases in the annual financial statements. The GASB Codification should be consulted for detailed disclosure requirements.

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Extinguishment of Debt
GASB has established a range of accounting and reporting requirements for debt refundings. These requirements are presented primarily in GASB Codification Section D20 and GASB Statement 23, Accounting and Financial Reporting for Refundings of Debt Reported by Proprietary Activities.

The extinguishment of debt is the reacquisition or calling of the debt or the removal of the debt prior to or at the maturity of the debt. When debt is extinguished, the entity either has no further legal responsibilities under the original debt agreement or continues to be legally responsible for the debt but the extinguishment is considered an in-substance defeasance (retirement). GASB Statement 23 concludes that debt is considered to be extinguished when one of the following criteria is met:

• The debtor pays the creditor and is relieved of all obligations with respect to the debt.
• The debtor is legally released as the primary obligor under the debt either judicially or by the creditor, and it is probable that the debtor will not be required to make future payments with respect to the debt under the guarantees.
• The debtor irrevocably places cash or other assets with an escrow agent in a trust to be used solely for satisfying scheduled payments of both interest and principal of the defeased debt, and the possibility that the debtor will be required to make future payments on that debt is remote. In this circumstance, usually referred to as "in-substance defeasance," debt is extinguished even though the debtor is not legally released as the primary obligor under the debt obligation.

The most common method of debt extinguishment is advance refunding.

Advance Refunding. In an advance-refunding transaction, new debt is issued to provide funds to pay principal and interest on old, outstanding debt as it becomes due, or at an earlier call date. Advance refunding occurs before the maturity or call date of the old debt, and the proceeds of the new debt are invested until the maturity or call date. Debt may be advance refunded for a variety of reasons, including to

• take advantage of lower interest rates;
• extend maturity dates;
• revise payment schedules; or
• remove or modify restrictions contained in the old debt agreements.

Some advance refundings are intended to achieve short-term budgetary savings by extending debt service requirements further into the future. In these cases, total debt service requirements over the life of the new debt may be more or less than total service requirements over the life of the existing debt. Advance refundings undertaken for other reasons, such as to remove undesirable covenants of the old debt, may also result in higher or lower total debt service requirements. It may be necessary in an advance refunding to issue new debt in an amount greater than the old debt. In these cases, savings may still result if the total new debt service requirements (interest and principal payment) are less than the old debt service requirements. Most advance refundings result in defeasance of debt.

Debt Defeasance. Defeasance of debt can be either legal or in-substance. A legal defeasance occurs when debt is legally satisfied on the basis of certain provisions in the debt instrument even though the debt is not actually paid. An in-substance defeasance occurs when debt is considered defeased for accounting and financial reporting purposes, as discussed below, even though a legal defeasance has not occurred. When debt is defeased, it is no longer reported as a liability on the face of the balance sheet; only the new debt, if any, is presented in the financial statements.

Debt is considered defeased in-substance for accounting and financial reporting purposes if the school district irrevocably places cash or other assets with an escrow agent in a trust to be used solely for satisfying scheduled payments of both interest and principal of the defeased debt and when the possibility that the debtor will be required to make future payments on that debt is considered remote. The trust that is created should be restricted to monetary assets that are essentially risk-free as to the amount, timing, and collection of interest and principal.

Certain disclosures are required on defeasance of debt. GASB Codification Section D20.111 requires that a general description of the transaction be provided in the notes to the financial statements in the year of refunding and that the disclosure should include, at a minimum, the following:

• the difference between the cash flows required to service the old debt and the cash flows required to service the new debt and complete the refunding; and
• the economic gain or loss resulting from the transaction.

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