Chapter 5: Financial Reporting — Financial Statements

GASB Statement 34 does not mandate that governments prepare and publish an annual financial report. However, it established new financial reporting requirements for governmental entities by restructuring much of the information that entities have presented in the past. Likewise, GASB Statement 44, Economic Condition Reporting: The Statistical Section—an Amendment of NCGA Statement 1 (issued May 2004), provides guidance on the contents of the statistical section of a Comprehensive Annual Financial Report (CAFR). Exhibit 7 is a complete summary of the contents of a CAFR. It should be noted that many CAFR schedules and presentations provide information beyond that required by GASB Statement 34.

Table 5 in the 2003 edition of this handbook compared the contents of the CAFR under the new reporting model per GASB Statement 34 with the contents of the CAFR under the previous model. These comparisons identified key components of each section for an overall comparison of the sections between models. The table was not intended to be an item-by-item comparison of the models. As all districts should now have implemented the provisions of GASB Statement 34, and given that other elements of the CAFR (e.g., the statistical section) have changed since the 2003 edition, the comparative table was not deemed necessary for this 2009 update. However, if a comparison between pre-Statement 34 CAFRs and post-Statement 34 CAFRs is of interest, refer to the 2003 edition.

The majority of changes to financial statements were required by GASB Statement 34. This subsection describes the major elements of these financial statements and related disclosures addressing the following areas:

• basic financial statements;
• Management's Discussion and Analysis (MD&A) and other Required Supplementary Information (RSI); and
• component units.

Basic Financial Statements

Under the new financial reporting model, the basic financial statements include the following:

• government-wide financial statements;
• fund financial statements; and
• note disclosures.

The basic financial statements replace the combined general-purpose financial statements (GPFS) required by the former reporting model.

Government-Wide Financial Statements
The purpose of government-wide financial statements is to present the financial position and the operating results of the governmental entity as a whole. The statements are expected to provide users with operational accountability information and to enable them to do the following:

• understand the true financial position of the governmental entity, including capital and financial assets and long-term as well as short-term liabilities;
• determine whether the entity is able to continue to provide current service levels and meet its obligations as they become due; and
• determine the operating results of the entity, including the economic cost and the net cost of services, and assess the economy, efficiency, and effectiveness of operations.

GASB Statement 34 (paragraphs 130 and 131) allows governments to elect to present budgetary comparison information as part of the basic financial statements rather than as RSI.

The government-wide financial statements are as follows:

• statement of net assets; and
• statement of activities.

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Statement of Net Assets. The statement of net assets presents the financial position of the governmental entity and its discretely presented component units. This statement is required to present all financial and capital resources on the accrual basis of accounting. GASB Statement 34 encourages the use of a net assets format, which subtracts liabilities from assets to reflect the net assets, rather than the standard balance sheet format, which presents a total for assets equal to a total of liabilities and net assets. However, either presentation is acceptable.

The statement of net assets provides a columnar presentation of the assets, liabilities, and net assets of the reporting entity in two categories: governmental activities and business-type activities. Discretely presented component units are reflected in a separate column or columns on the face of the statement. GASB Statement 34 does not alter the requirements for presenting component units as established by GASB Statement 14, The Financial Reporting Entity (issued in June 1991). The statement of net assets include the following:

• Focus on governmental and business-type activities;
• Reporting on economic resources measurement focus and accrual basis of accounting for all assets and liabilities;
• Reporting on general capital assets and general long-term liabilities; and
• Reporting on infrastructure assets.

As previously mentioned, GASB Statement 34 requires separate columns for the governmental activities and business-type activities of the reporting entity in the statement of net assets. Definitions within this statement for these activity types include the following:

Government activities

• Activities financed by taxes and intergovernmental revenues and other nonexchange revenues;
• Activities reported in governmental funds and internal service funds as applicable; and
• Internal clearing account funds (e.g., payroll-clearing accounts), which should be reported in the governmental activities column. Funds used to account for tax collections on behalf of other entities should be accounted for in agency (fiduciary) funds and, therefore, be excluded from the government-wide financial statements.

Business-type activities

• Activities for which fees are charged to external parties for goods or services; and
• Activities reported in enterprise funds and internal service funds (as applicable).

GASB Statement 34 states that although internal service funds are reported as proprietary funds of the reporting entity, the activities accounted for in internal service funds are usually more governmental than business-type in nature. If enterprise funds are the predominant or only participants in an internal service fund, however, the entity should report the internal service fund's residual assets and liabilities within the business-type activities column in the statement of net assets.

Other presentation requirements relative to the statement of net assets are as follows:

• A total column is required for the primary government. A total column for the entity as a whole, including the discretely presented component units, may be presented but is not required.
• Comparative financial statements are not required, but may be presented at the option of the governmental entity. If comparative financial statements are presented, all columns must be included for both years.
• Fiduciary funds and fiduciary component units are specifically excluded from the government-wide statements because fiduciary resources cannot be used to support the entity's programs or other services.
• GASB Statement 34 encourages the presentation of assets and liabilities based on their relative liquidity. A classified presentation, which distinguishes between current and long-term assets and liabilities, is also acceptable. Definitions of liquidity of assets and liabilities include the following:

Assets

• Determined by how readily the asset is expected to be converted into cash and whether restrictions limit use of resources.

Liabilities

• Based on maturity, or when cash is expected to be used for liquidation; and
• Liabilities whose average maturities are greater than 1 year should be reported in two components—the amount due within 1 year and the amount due in more than 1 year.

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Statement of Activities. The operations of the governmental unit should be presented in a net (expense) revenues format in the statement of activities. General revenues, contributions to term and permanent endowments, contributions to permanent fund principal, special and extraordinary items, and transfers should be reported separately after the total net expenses of the entity's functions to arrive at the "change in net assets" for the period. The purpose of using this format is twofold

• to report the relative financial burden of each of the government's functions or programs on its taxpayers; and
• to identify the extent to which each function (program) draws from the general revenues of the organization or is self-supporting through fees and intergovernmental aid.

As outlined in the previous discussion, revenues must be categorized according to their purpose as either general or program revenues in the statement of activities.

Fund Financial Statements
Fund financial statements are categorized into three fund types described as follows.

Governmental Fund Financial Statements. Governmental fund financial statements (including financial statements for the general, special revenue, capital projects, debt service, and permanent funds) should be prepared using the current financial resources measurement focus and the modified accrual basis of accounting. Under this measurement focus and basis of accounting, revenues should be recognized in the accounting period in which they become available and measurable, and expenditures should be recognized in the accounting period in which the fund liability is incurred, if measurable, except for unmatured interest on general long-term debt, which should be recognized when due.

Proprietary Fund Financial Statements. Proprietary fund financial statements (including financial data for enterprise and internal service funds) should be prepared using the economic resources measurement focus and the accrual basis of accounting. Accordingly, revenues should be recognized in the accounting period in which they are earned and become measurable, and expenses should be recognized in the period incurred, if measurable.

Fiduciary Fund Financial Statements. Fiduciary fund financial statements (including financial data for fiduciary funds and similar component units) should be prepared using the economic resources measurement focus and the accrual basis of accounting. Revenues should be recognized in the accounting period in which they are earned and become measurable, and expenses should be recognized in the period incurred, if measurable.

Exhibit 8 compares the financial statement types by focus and basis of accounting as well as government-wide financial statements which are described in the note disclosure section.

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Note Disclosures
Section 2200 of GASB Codification, Comprehensive Annual Financial Report, requires notes to the financial statements that are essential to present fairly the financial position and results of operations (and the cash flows of those types of funds and discretely presented component units that use proprietary fund accounting). The notes to the financial statements should focus on the primary government and its discretely presented component units.

Summary of Significant Accounting Policies (Additional Disclosure Requirements). GASB Statement 34 did not amend the existing general note disclosure requirements, but did require additional disclosures. The additional disclosure requirements directly related to GASB Statement 34, as well as the significant disclosure requirement changes in recently issued pronouncements, include the following:

• a description of the new government-wide financial statements indicating the elements of the statement of net assets and the statement of activities, noting the exclusion of fiduciary funds and component units that are fiduciary in nature, and the measurement focus and basis of accounting used;
• the policy for eliminating internal activity in the statement of activities;
• the policy for applying FASB pronouncements issued after November 30, 1989, to proprietary funds and government-wide financial statements;
• the policy for capitalizing assets and for estimating useful lives (for calculating depreciation expense);
• a description of the types of transactions included in program revenues and the policy for allocating indirect expenses to functions in the statement of activities;
• the policy for defining operating and nonoperating revenues of proprietary funds; and
• the policy regarding whether the government first applies restricted or unrestricted resources when an expense is incurred for purposes for which both restricted and unrestricted net assets are available. In other words, governments are required to state whether they spend restricted funds only when unrestricted amounts are insufficient or unavailable or whether they spend restricted funds first and use unrestricted resources when the restricted funds are depleted. Disclosure of this policy is essential to help readers understand the significance of restricted and unrestricted net assets relative to total net assets.

The requirement for additional significant accounting policy disclosure relates only to the government-wide statements and essentially calls for descriptive comments about the elements, purposes, and scope of the statements of net assets and activities. The MD&A, in contrast, relates to both government-wide and fund financial statements and is oriented more toward the relationship between the two.

The summary of significant accounting policies may also need to be slightly modified to incorporate the disclosure requirements of GASB Statement 46, Net Assets Restricted by Enabling Legislation—an Amendment of GASB Statement No. 34. Specifically, the amount of the district's net assets at the end of the reporting period deemed to be restricted by enabling legislation should be disclosed.

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Required Disclosures for Cash and Investments. As noted earlier, GASB Statement 40, Deposit and Investment Risk Disclosure—an Amendment of GASB Statement No. 3, modified and/or enhanced disclosures required by GASB Statement 3, Deposits With Financial Institutions, Investments (including Repurchase Agreements), and Reverse Repurchase Agreements. The following summarizes the new requirements that are in addition to the existing relevant guidance on required disclosures for cash and investments (refer to GASB Statement 40 for detailed or background information regarding these disclosures):

• Investment disclosures should be identified by type of investment.
• Deposit or investment policies should be briefly disclosed. Particular focus should be placed on the types of risks to which a district's portfolio is exposed (i.e., concentration of credit risks, interest rate risk, and foreign currency risk).
• Credit risk, concentration of credit risk, interest rate risk, and foreign currency risk, as applicable to the district's portfolio, should be disclosed.

It should be noted that certain disclosures required by GASB Statement 3 were eliminated by GASB Statement 40. Specifically, districts are no longer required to identify custodial credit risk for "category 1" or "category 2" deposits and investments, as defined by GASB Statement 3. Also, activity disclosures from during the year are no longer required. Likewise, investments are only required to be disclosed at their book value, which typically equals the fair value unless certain valuation exceptions are met.

Required Disclosures for Capital Assets. GASB Statement 34 requires disclosure of each major class of capital assets, including capitalized collections of works of art, historical treasures, and similar assets. Capital assets associated with governmental activities should be reported separately from those associated with business-type activities, capital assets should be depreciated separately from those that are not being depreciated, and the valuation basis should be shown separately from accumulated depreciation. For each class, the following information should be presented, if applicable:

• beginning- and end-of-year balances, with accumulated depreciation by asset class shown separately from the valuation basis;
• capital acquisitions;
• sales or other dispositions; and
• current-period depreciation expense, including the amounts charged to each function in the statement of activities.

The disclosure should also contain a description of the noncapitalized collections of works of art and the reasons for noncapitalization of these assets.

In addition to these capital asset disclosures, GASB Statement 42, Accounting and Financial Reporting for Impairment of Capital Assets and for Insurance Recoveries, may be applicable to a district and thus affect disclosure requirements. The following summarizes the potential disclosure requirements:

a general description of any impairment, including the amount and the financial statement classification of the impairment loss if such information is not apparent on the face of the financial statements;

the carrying amount of any impaired capital assets, whether deemed to be temporarily impaired or permanently impaired, that are idle as of the end of the reporting period; and

the amount and financial statement classification of any insurance recoveries that are not apparent in the financial statements.

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Required Disclosures for Long-Term Liabilities. The note disclosures should contain information about such long-term liabilities as long-term debt instruments (e.g., bonds, notes, loans, and leases payable), as well as other long-term liabilities, such as compensated absences, claims, and judgments, as follows:

• beginning- and end-of-year balances;
• increases;
• decreases;
• the portions of each item that are due within 1 year of the statement date; and
• information on the governmental funds typically used to liquidate long-term liabilities in prior years. The disclosure should also indicate whether the government has decided to depart from the historical trend and use other funds to liquidate liabilities. The purpose of this disclosure is to give readers additional information about future claims against financial resources to help them assess the fund balances of specific funds.

Information about net pension obligations is required to be disclosed in a separate pension note using the requirements of GASB Statement 27, Accounting for Pensions by State and Local Governmental Employers. Likewise, if a district provides an OPEB plan, as defined earlier in this chapter, similar disclosure requirements will apply. Specifically, GASB Statement 43, Financial Reporting for Postemployment Benefit Plans Other Than Pension Plans and/or GASB Statement 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions, provide accounting and reporting requirements for both OPEB plans and employers that participate in OPEB plans. Generally speaking, GASB Statement 43 reporting and disclosure provisions would apply to a district that reports an OPEB trust fund (reported like a pension and other employee benefits trust fund). GASB Statement 45 reporting and disclosure provisions would apply to any districts that provide OPEB to its retirees, whether or not they report an OPEB trust fund. Currently, it will be more common for districts that provide OPEB to continue you do so on a "pay-as-you-go" basis. Therefore, in practice, GASB Statement 45 will have more widespread applicability to districts than GASB Statement 43. It should be noted, however, that any OPEB liability that a district may have will in almost all situations only affect the government-wide financial statements. Refer to both GASB statements, however, to assess their applicability and for the specific disclosure requirements.

Disclosures Relating to Donor-Restricted Endowments. The following information relating to donor-restricted endowments is required in the notes:

• amounts of net appreciation on investments available for authorization for expenditure by the governing board and a description on how amounts are reported in net assets;
• state laws relating to the ability to spend net appreciation; and
• policy for authorizing and spending investment income.

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Segment Disclosures. Section 2200 of GASB Codification, Comprehensive Annual Financial Report, requires presenting segment information for certain individual enterprise funds of the governmental entity, including its blended component units. The term "segment" in Section 2200 refers to an individual enterprise fund of a state or local government. GASB Statement 34 redefines segment, in relation to the needs of users for additional financial information, as an identifiable activity reported as or within an enterprise fund or other stand-alone entity for which one or more revenue bonds or other revenue-backed debt instruments are outstanding.

The definition of a segment requires that a specific identifiable revenue stream be pledged in support of revenue bonds or other revenue-backed debt. It is not a requirement that the debt be backed solely by pledged revenues. The identifiable activity is typically the source of the pledged revenues. In addition, there must be an externally imposed requirement to separately account for the activity's revenues, expenses, gains and losses, assets, and liabilities (GASB Statement 37, Paragraph 17).

Segment disclosures are not required for an activity in which the only outstanding debt is conduit debt for which the entity has no obligation beyond the resources provided by related leases or loans. In addition, segment reporting is not required when an individual fund is a segment, but is reported as a major fund.

GASB Statement 34 requires the following segment disclosures:

• type of goods and services provided by the segment;
• condensed statement of net assets;
• condensed statement of revenues, expenses, and changes in net assets;
• condensed statement of cash flows;
• statement of activities (encouraged, but not required, for governments that want to present disaggregated information for multiple function enterprise funds in addition to the information above); and
• externally imposed requirements to track each element needed for condensed financial statements.

Additionally, GASB Statement 38, Certain Financial Statement Note Disclosures, expanded note disclosures within the summary of significant accounting policies to include (1) the activities accounted for in major funds, internal service funds, and fiduciary fund type columns; and (2) disclosure of the period used to define "available" for revenue recognition purposes. Other disclosure requirements addressed by this statement include (1) violations of finance-related legal or contractual provisions, (2) debt service for debt and lease obligations, (3) short-term debt obligations, (4) disaggregation of receivable and payable balances, and (5) details of interfund balances and transfers.

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Management's Discussion and Analysis and Other Required Supplementary Information

Management's Discussion and Analysis (MD&A) is part of the Required Supplementary Information; however, it precedes the financial statements. It should be based on currently known facts as of the date of the audit report and should

• provide a concise, unbiased, and easily readable description of the government's financial activities; and
• help users understand the relationship between the results reported in the governmental activities in the government-wide financial statements and the results reported in the governmental funds financial statements (usually focused on the major funds).

The focus of the MD&A should be on the primary government. However, information on any discretely presented component units may be presented as well. GASB has stated that both the positive and negative aspects of the government's operations should be presented to inform the reader about whether the government is in better or worse financial condition than in the prior year. The focus should be on significant or material items only.

The MD&A is restricted to the following topics, although there is no limit to the amount of information that may be presented:

• Information and discussion on the basic financial statements presented, their relationship to one another, and the significant differences in the information they provide. The discussion should include the different methods of accounting used in the government-wide and fund financial statements.
• Condensed financial information comparing the current year and the prior year. The analysis should include specific economic factors that contributed to the change. Charts and graphs may be used to supplement information in the condensed statements, but should not be used in place of it.
• Objective analysis of the governmental entity's financial condition as a whole. Analysis of the government's overall financial position and results of operations should address both governmental and business-type activities separately.
• An analysis of balances and transactions on a fund basis, addressing the reasons for significant changes in fund balances or fund net assets. The analysis should also include information on whether restrictions, commitments, or other limitations significantly affect the availability of fund resources for future use.
• A discussion on significant variances among the entity's original budget, final budget, and actual expenditures for the general fund or its equivalent and the impact of these variances on the entity's future liquidity.
• A description of activity relating to the government's capital assets and long-term debt activity during the year. This discussion should include commitments made for capital expenditures, changes in credit ratings, and debt limitations affecting the financing of planned facilities or services.
• A discussion of information about the modified approach used to report some or all of the infrastructure assets, if applicable.
• A description of currently known facts, decisions, or conditions expected to have an impact on financial position and results of operation. The term currently known is limited to events or decisions that have occurred, or have been enacted, adopted, agreed on, or contracted as of the date of the auditor's report. The discussion should address expected effects on both governmental and business-type activities.

Information that does not address the requirements above should not be included in the MD&A; instead, it may be reported as supplementary information or included in the letter of transmittal.

The entity should ensure that information contained in the MD&A is not duplicated in the letter of transmittal. Differences between the MD&A and the letter of transmittal are outlined in exhibit 9.

If the reporting entity provides comparative financial statements by presenting basic financial statements and RSI for 2 years, a separate MD&A for each year is not required, but it must address both years presented in the comparative financial statements. MD&A should include comparative condensed financial information and related analysis for both years.

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Component Units

It is essential that governmental financial statements provide an overview of the reporting entity that is based on financial accountability, yet allows users to distinguish between the primary government and its component units. GASB Statement 14, The Financial Reporting Entity (issued in June 1991), established criteria for evaluating potential component units and provided guidance on the statement presentation of those entities that met the criteria. Component units are defined as legally separate organizations for which the primary government is financially accountable or for which the nature and significance of the relationship with the primary government are such that exclusion would cause the reporting entity's financial statements to be misleading or incomplete (GASB Statement 14, Paragraph 20).

Financial accountability for a potential component unit is determined by either of the following:

• appointment of the voting majority of the potential component unit governing board by the primary government and either
  • the ability to impose its will on the potential component unit; or
  • a relationship of financial benefit or burden with the potential component unit.
• whether or not the potential component unit is fiscally dependent upon the primary government.

If a potential component unit does not meet either of the two tests above for financial accountability, an organization may still be included in the financial statements of the primary government based on the criterion that exclusion would result in a misleading or incomplete presentation of the financial reporting entity.

In May 2002, GASB issued Statement 39, Determining Whether Certain Organizations Are Component Units, which amended Statement 14 to establish the criteria for the inclusion of organizations on this basis. A legally separate, tax-exempt organization should be reported as a component unit if all of the following criteria are met:

• The economic resources of the separate organization are received or held for the benefit of the primary government, its component units, or its constituents.
• The primary government or its component units may access, or is entitled to, a majority of the economic resources of the separate organization.
• The economic resources of an individual organization that the primary government, or its component units, is entitled to or may access are significant to the primary government (GASB Statement 39, Paragraph 5).

This standard continues the requirement for inclusion of organizations based on the GASB Statement 14, Paragraph 20 "misleading or incomplete" criterion, but emphasizes that "financial integration" may also be a component of all of the aforementioned criteria. Additional guidance on evidence of financial integration is also provided in GASB Statement 39.

Component units may be

• blended, as though they are part of the primary government; or
• discretely presented.

GASB Statement 34 does not amend the definition of component units or the general reporting requirements.

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Blended Component Units
Even though it is preferable to distinguish between the primary government and its component units, certain component units, despite being legally separate from the reporting entity, are so intertwined with the entity that they are, in effect, the same as the primary government. Accordingly, GASB has stated that these component units should be reported as part of the primary government. Thus, the component unit's balances and transactions should be reported in a manner similar to the way balances and transactions of the reporting government itself are reported. This method of inclusion is known as blending.

A component unit should be blended in either of the following circumstances:

• The component unit's governing body is substantively the same as the governing body of the primary government.
• The component unit provides services entirely, or almost entirely, to the reporting entity or otherwise exclusively, or almost exclusively, benefits the entity even though it does not provide services directly to it.

Some component units account for their activities in a single fund; others use all or several fund types. If a component unit is blended, the types of funds of the component unit should be blended with those of the primary government by including them in the appropriate combining statements of the primary government. However, because the primary government's general fund is usually the main operating fund and often is a focal point for report users, a general fund should be presented only for the primary government. The general fund of a blended component unit should be reported as a special revenue fund.

Discretely Presented Component Units
Discrete presentation of component units refers to the method of reporting financial data of component units in a column(s) and row(s) separate from the financial data of the primary government.

When component units are presented in the basic financial statements (i.e., statement of net assets and statement of activities), each statement should distinguish between the governmental and business-type activities of the government, and between the total entity and its discretely presented component units, by reporting each in separate columns (and rows, in the statement of activities). Component units that are fiduciary in nature, however, should be included only in the fund financial statements with the entity's fiduciary funds.

GASB Statement 39 (Paragraph 7) provides that a discrete presentation must be used for an organization that meets the requirements as a component unit under its new criteria.

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