GASB Statement No. 34: THE DAWN of a New Governmental Financial Reporting Model .

By Laurence E. Johnson and David R. Bean

In Brief

What does the day hold?

GASB has labored over a new financial reporting model for state and local governments for well over 10 years. The last year or so has been extremely intense as the Board struggled with a major dilemma: how to show the economic resources of a government on a full accrual basis while maintaining presentation of governmental funds on the traditional financial resources, modified accrual basis without the long-term debt and fixed asset account groups. At one point in the process, GASB proposed a dual but equal presentation. A major breakthrough in the deliberations came with the idea of directly reconciling the statements for the governmental funds, presented in the traditional way, with the full accrual government-wide statements. That is the essence of the new model required under GASB Statement No. 34. The result is better accountability by governments, because the government-wide statements call for a full accounting for capital assets, including infrastructure.

But, this new information will not come without cost. The government-wide information should make a governmental unit's financial viability more apparent to readers. Moreover, financial statement readers will clearly see the large investments in infrastructures of governments that have seldom been reported in current practice. The changes are intended to meet unfilled needs of users based on extensive due process. Will the new model bring more users into the fold? Only the full light of the sun will tell.

A major advance in state and local governmental financial reporting is on the horizon. The labors of GASB (and those of thousands of interested preparers, users, auditors, and academics that participated in the extensive due process) bore fruit in June when the Board unanimously adopted Statement No. 34, Basic Financial Statements--and Management's Discussion and Analysis--for State and Local Governments. The reporting model established by Statement No. 34 includes many time-tested aspects of conventional governmental financial reporting and several new features (including government-wide financial statements and management's discussion and analysis) to enhance the usefulness of governmental financial reports.

GASB's objective in developing the new reporting model was to improve governments' accountability in financial reporting and provide additional information for decision-making. The new model includes a focus on medium- to long-term operational accountability in addition to the traditional focus on current-year fiscal accountability. In the course of generating the new financial reporting requirements, GASB's due process procedures garnered valuable suggestions that weighed heavily on GASB's decisions.


Under the new reporting model, governments will issue annual basic financial statements (BFS) preceded and followed by required supplementary information (RSI). This information replaces the general purpose financial statements currently required.

The leadoff RSI is management's discussion and analysis (MD&A) of the government's financial activities. The basic financial statements consist of 1) government-wide financial statements displaying information about the reporting government as a whole, 2) fund financial statements, which primarily report information about major funds individually and nonmajor funds in the aggregate, and 3) notes to the financial statements. The basic financial statements are followed by additional RSI, as necessary.

The government-wide statements are prepared using the economic resources measurement focus (MF) and the accrual basis of accounting (BA). The government-wide financial statements will report all capital assets (including infrastructure) and depreciation thereon in order to help financial statement users--

* determine the adequacy of current-year revenues relative to the cost of current-year services,
* assess the service efforts and costs of government programs, and
* assess the government's financial position and changes therein.

The governmental fund financial statements retain the current financial resources and modified accrual MFBA used under existing practice.

Management's Discussion and Analysis

Statement No. 34 provides that MD&A "should provide an objective and easily readable analysis of the government's financial activities" based upon facts, decisions, or conditions known to management as of the auditor's report date. MD&A should focus on the primary government, though comments on individual discrete component units may be included when appropriate. MD&A should emphasize current-year activities but include prior-year comparisons when relevant.

Statement No. 34 establishes certain minimum content requirements for MD&A while encouraging flexibility in its preparation. Briefly, these requirements include the following:

* A description of the basic financial statements and the relationship of the government-wide financial statements to the fund financial statements. The discussion should assist readers to understand whether measurements and results presented in the fund financial statements reinforce the information in the government-wide statements or provide additional information.
* Comparative condensed financial information derived from the government-wide financial statements.
* Explanations for significant improvement or deterioration in financial position and results of operations from the prior year, addressing both governmental and business-type activities.
* Analysis of significant changes in balances and transactions of individual funds.
* Analysis of significant differences between 1) the original and final budget amounts and 2) the final budget amounts and actual budgetary results, for the general fund.
* Descriptions of capital asset and long-term debt activities taking place during the year.

The purpose of classifying MD&A as RSI is twofold--first, to ensure that governments do, in fact, present MD&A, and second, to ensure appropriate auditor association with MD&A at a reasonable cost. The auditor would apply limited procedures outlined in SAS No. 52, Omnibus Statement on Accounting Standards--1987 (AU Section 558). Because the primary focus of MD&A is on analysis, information obtained from the auditor's analytical review of the financial statements could be incorporated into MD&A.

Government-wide Financial Statements

The government-wide financial statements report the financial position and operating results of the government as an economic entity, without reference to the government's underlying fund structure. As such, the government-wide financial statements provide information for assessing operational accountability. Two government-wide presentations are included in the basic financial statements: a statement of net assets and a statement of activities.

The focus of these statements is on the primary government (as defined in Statement No. 14, The Financial Reporting Entity),; they include separate columns for governmental and business-type activities. Information pertaining to discrete component units generally should be presented in the aggregate. Entity-wide totals and prior-year data are optional. The government-wide statements exclude information about fiduciary activities because such activities benefit third parties rather than support the government's programs or other services and also exclude information about internal service activities that constitute "double counting." Likewise, interfund ("internal") balances are eliminated.

The statement of net assets is illustrated in Exhibit 1.. GASB encourages governments to prepare this statement according to a net assets format. (The conventional balance sheet format is also acceptable.) This statement reports capital assets, including infrastructure assets, at historical cost or estimated historical cost, generally net of depreciation.

General Capital Assets Reporting. Treatment of fixed assets has long been an Achilles' heel of governmental financial reporting. Over the years, many governments kept no records of any fixed assets. Implementation of the reporting requirements of NCGA Statement 1, Governmental Accounting and Financial Reporting Principles, largely cured the "fixed assets problem" as related to such assets as land, buildings, and equipment, but noncapitalization of infrastructure assets was still permitted on practical grounds. This is no longer the case.

Though it recognized the controversial nature of its decision, GASB concluded that "reporting infrastructure assets is essential to provide information for assessing financial position and changes in financial position, and for reporting the costs of programs or functions." Accordingly, Statement No. 34 requires capitalization and depreciation (using a systematic and rational method) of infrastructure assets in the government-wide financial statements. All governments must capitalize and depreciate general infrastructure assets prospectively.

Governments with revenues of $10 million or more (based on the first financial statements issued after periods ending after June 15, 1999) must retroactively report major infrastructure assets according to a phased implementation schedule. Governments with less than $10 million in revenues are encouraged, but not required, to apply the retroactive provisions.

To ease the burden of retroactive infrastructure capitalization, Statement No. 34 provides three practical accommodations. First, only major infrastructure acquired in fiscal years beginning after June 15, 1980, need be capitalized. Second, asset cost may be estimated using replacement cost deflated by a price-level index. Third, infrastructure assets that are part of a network or a subsystem of a network need not be depreciated if a government meets certain conditions (See the Sidebar).

Presentation. Assets and liabilities should each appear in liquidity order; however, a classified statement may be presented. In all circumstances, liabilities with an average maturity of greater than one year must be presented in current and long-term components. The long-term liabilities presented in the statement of net assets will include those previously reported in the general long-term debt account group, such as bonds, capital leases, compensated absences, and claims and judgments liabilities. Net assets should be reported in one of three categories as "invested in capital assets, net of related debt," "restricted," or "unrestricted."

Invested in Capital Assets, Net of Related Debt. The balance reported as "invested in capital assets, net of related debt" represents total capital assets (including infrastructure and restricted capital assets), net of accumulated depreciation, and net of long-term borrowings attributable to acquisition, construction, or improvement of capital assets. Unspent proceeds of borrowings made for capital investment should not be considered in calculating the amount of investment in capital assets. Such unspent proceeds and the related debt would be included in calculating restricted net assets.

Restricted Net Assets. Net assets must be classified as "restricted" to the extent that those assets are subject to restrictions imposed either 1) externally, such as by creditors, grantors, contributors, or laws of other governments, or 2) internally, by constitutional provision or enabling legislation. Debt covenants are an example of an external restriction. An example of an internal restriction could be a charter provision that gasoline tax proceeds be spent only for road construction and maintenance.

Unrestricted Net Assets. Unrestricted net assets are those net assets that do not meet the definition of "invested in capital assets, net of related debt" or "restricted," as discussed above. Management's designations of unrestricted net assets (typically, designations of fund balances) should not be reported on the face of the statement of net assets; however, these designations can be disclosed in the notes to the financial statements.

Statement of Activities

An example statement of activities appears in Exhibit 2. A distinguishing feature of the statement of activities is its focus on the net revenues (expenses) of the government's individual functions or programs, categorized as governmental activities, business-type activities, and discrete component unit activities. Using a row/column format, the statement first presents the direct expenses (including depreciation to the extent that capital assets are identifiable with specific programs) of each program. (At a government's option, indirect expenses--including interest on general long-term liabilities in most cases--may be allocated to programs, but the allocation must be presented in a separate column.) Additional columns present program revenues, primarily charges for services and operating and capital grants or contributions restricted to specific programs. These columns crossfoot to net program revenue (expense) balances.

The net program revenues (expenses) are then adjusted for general revenues (for example, all tax revenues) and other items (including separate display of special items--transactions within management's control that are either unusual in nature or occur frequently--and extraordinary items as defined in APB Opinion No. 30, Reporting the Results of Operations--Discontinued Events and Extraordinary Items) to arrive at the changes in net assets for governmental, business-type, and component unit activities. The statement of activities thus displays the extent to which each function or program of the government draws from the general revenues of the government or is self-financing through fees, contributions, and intergovernmental aid.

The level of detail presented in the statement of activities will normally be affected by the level of services provided by a government. For example, a state government may have hundreds of major programs, which will generally limit the statement of activities presentation to a functional presentation. A school district, however, may be able to provide users with information at the major program level.

Fund Financial Statements

The fund financial statements retain their traditional focus (short-term fiscal accountability for governmental funds and longer-term operational accountability for proprietary funds). Statement No. 34, however, makes certain changes to the existing fund structure. The established fund categories (governmental, proprietary, and fiduciary) remain; however, as stated earlier, the fiduciary fund category is redefined to exclude funds that account for resources not available to finance primary government programs--basically, pension trust and other employee benefit funds, investment trust funds, agency funds, and remaining fiduciary funds classified as private-purpose. Moreover, most expendable trust funds will be reclassified as special revenue funds; and most nonexpendable trust funds should be reclassified to permanent funds, a new governmental fund type. All fiduciary funds will now be reported using the economic resources/accrual MFBA.

The new reporting model eliminates the combined fund-type financial statements. Instead, governments will present financial statements for individual major funds, as defined (see Sidebar), and nonmajor funds in the aggregate, within the governmental and proprietary categories. This means, for example, that the balance sheet for the general fund (and one or more individual special revenue, capital projects, debt service, or permanent funds) can appear together in adjacent columns on the same page. A single column presents all nonmajor funds within the broad category (regardless of fund type) in the aggregate. The individual major funds columns and the nonmajor funds column crossfoot to the fund category total. The fiduciary statements will continue to be presented by fund type. The content and order of financial statement presentation largely follow existing practice, though Statement No. 34 makes certain changes (discussed later).

Statements required for the governmental funds are--

* balance sheet
* statement of revenues, expenditures, and changes in fund balance.

For proprietary funds, the required statements include--

* statement of net assets or balance sheet
* statement of revenues, expenses, and changes in fund net assets or fund equity
* statement of cash flows.

The required fiduciary fund statements are--

* statement of fiduciary net assets
* statement of changes in fiduciary net assets.

Consistent with the government-wide statement of activities, the governmental fund statement of revenues, expenditures, and changes in fund balances and the proprietary fund statement of revenues, expenses, and changes in fund net assets also display extraordinary items and "special" items, as appropriate.

Governmental Fund Statements. Fund financial statements for the governmental funds include reconciliations to the government-wide statements to show the relationships between the two. Thus, the governmental fund balance sheet (see Exhibit 3) displays the significant items needed to reconcile 1) total ending fund balance to 2) the governmental activities net asset balance in the government-wide statement of net assets. Similarly, the statement of revenues, expenditures, and changes in fund balances (see Exhibit 4) displays the significant items reconciling 3) the total net change in fund balance to 4) the change in net assets of governmental activities on the government-wide statement of activities. Alternatively, these reconciliations can be presented in accompanying schedules (see Exhibit 5) and may require additional disclosures in the notes to the financial statements in certain circumstances.

Proprietary Fund Statements. Statement No. 34 requires governments to present the assets, liabilities, and net assets of the proprietary funds classified between current and long term, using either the "net assets" format or the conventional balance sheet format. Moreover, Statement No. 34 eliminates the conventional proprietary equity classifications, contributed capital and retained earnings. Instead, proprietary fund net assets are reported consistent with the classifications in the government-wide statement of net assets.

The statement of revenues, expenses, and changes in fund net assets or fund equity must be prepared according to the "change in net assets" format, meaning that capital contributions appear on the statement as components of the net asset change, rather than being treated as balance sheet transactions, as is currently the case. Under Statement No. 34, governments will distinguish between proprietary operating and nonoperating revenues and expenses generally in terms of how the underlying transaction would be categorized on the cash flows statement. Note that there normally will be no need to reconcile from the proprietary fund financial statements to the government-wide financial statements because 1) both are prepared using the same MFBA and 2) internal service activities are reported in a manner that will significantly reduce the need for a reconciliation of these statements (as described below).

Statement No. 34 requires that the statement of cash flows be prepared using the direct method. Cash flows statements also must include a reconciliation of operating cash flows to operating income.

Treatment of Internal Service Funds. Internal service funds occupy a unique position in governmental accounting in that they are classified as proprietary, yet they serve client funds that are predominantly governmental in nature. Statement No. 34 prescribes a correspondingly unique financial reporting treatment for these funds. Internal service fund information will appear in the proprietary fund financial statements, but only, as noted above, in the aggregate (that is, in a single column) and apart from enterprise fund activity. The current practice of separately reporting internal service fund activity in the current general purpose financial statements (GPFS) double counts internal service fund expenses and client fund expenditures, and thus is not consistent with the economic focus of the government-wide information. Under the new model, the substance of internal service fund activity is reported in the governmental fund statements of revenues, expenditures, and changes in fund balances. Enterprise fund information, in contrast, flows to the business-type columns of the government-wide statements.

Interfund Transfers. The new reporting model also amends the treatment of interfund transfers. Statement No. 34 eliminates the distinction between "operating transfers" and "residual equity transfers." Under existing practice, operating transfers are classified in governmental funds as other financing sources (uses), whereas residual equity transfers are reported as direct changes to fund balance. Statement No. 34 stipulates that transactions currently classified as operating transfers or residual equity transfers simply be captioned as "transfers." They are reported as other financing sources (uses) in governmental fund statements and in a section following "income before contributions and transfers" in proprietary fund statements.

Other Important Provisions of GASB Statement No. 34

Budget to Actual Comparison Reporting. Statement No. 34 significantly changes the manner in which governments will present governmental fund budgetary information. Under existing practice, governments must present budgetary comparisons in the combined financial statements. In the new model, governments can present budgetary comparison schedules as RSI in the basic financial statements or include the budget to actual comparison in the basic financial statements. Under either option, budgetary information must be presented for the general fund and each major special revenue fund having a legally adopted annual budget. The budgetary schedules or statements will present both the original budget and the final amended budget compared with actual resource inflows, outflows, and balances stated on the budgetary accounting basis. The schedule or statement can be reported using either the original budget format (for example, all inflows presented before all outflows) or the GAAP financial statement format.

Use of Enterprise Funds. Statement No. 34 sets forth conditions in which enterprise fund accounting may be used and conditions in which enterprise fund accounting is required. Statement No. 34 provides that enterprise funds may be used to report "any activity for which a fee is charged to external users for goods or services." Enterprise fund accounting is required for activities--

* that are financed with bonds secured solely by a pledge of net revenues from fees or charges of the activity (single-barreled),
* that are subject to laws requiring that the activity's cost be recovered with fees, rather than taxes, or
* for which fees are designed to recover costs, as a matter of policy.

Special-Purpose Government Reporting. Statement No. 34 makes certain reporting accommodations for special-purpose governments. MD&A is required for all governments, as are notes to the financial statements and other RSI (as appropriate). The required financial statements vary with the nature of the government's activities.

Special-purpose governments engaged in a single governmental program (such as a drainage district) may issue statements that present fund data, reconciling items, and government-wide data in adjacent columns on the same statement. However, governments having more than one governmental program or both governmental and business-type activities must prepare government-wide and fund financial statements.

Special-purpose governments engaged in only business-type activities need present only the financial statements required for enterprise funds. Similarly, governments administering only fiduciary activities need present only fiduciary fund financial statements.

Transition Provisions

Statement No. 34 is effective in three successive years, based on government size (as measured by total revenues for the first year ending after June 15, 1999). For "phase 1" governments, those with more than $100 million in total revenues, Statement No. 34 must be implemented for fiscal years beginning after June 15, 2001. "Phase 2" governments, those having total revenues of $10100 million, must implement the statement for fiscal years beginning after June 15, 2002. Governments with less than $10 million in revenues ("phase 3" governments) must implement Statement No. 34 for fiscal years beginning after June 15, 2003. Earlier application of the statement is encouraged. Phase 1 and 2 governments are allowed four additional years after the basic effective date of the statement to implement the required retroactive capitalization of major infrastructure assets noted earlier.

Read the Entire Statement

A new era in governmental financial reporting has begun. The Statement No. 34 reporting model retains the best of existing practice in governmental financial reporting while adding information that will provide users with a more comprehensive view of the government (government-wide statements) and information that will be easier to use (MD&A). As such, governments will continue to report information useful for assessing short-term fiscal accountability while also reporting information helpful for assessing longer-term operational accountability.

Although it is not the accountants' "full employment" act, Statement No. 34 undoubtedly will impose implementation costs on governments. GASB has made several modifications that should reduce the cost of implementation from what had been anticipated in the exposure draft; however, the best recommendation for controlling cost is proper planning. Planning begins with a clear understanding of all the effects of this new standard; the process starts with reading the entire statement. *

Laurence E. Johnson, PhD, CPA, is an associate professor of accounting at Colorado State University.
David R. Bean, CPA, is director of research of the Governmental Accounting Standards Board.

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