Governmental accounting: who's in charge?by Hardiman, Patrick F.
You might well ask yourself--what's going on? Who's on first? How will I know if I'm in the right ballpark?
What's going on is this:
1. There are differences of opinion as to who sets accounting standards for government.
2. There is ambiguity over GASB's jurisdiction and the hierarchy of GAAP for government.
3. A process is near completion to resolve this confusion.
This article reviews these issues.
The first national organization to address the governmental accounting and reporting area was the National Committee on Government Accounting ("National Committee") organized by the Municipal Finance Officers Association (MFOA) in 1934. The National Committee issued "Municipal Accounting and Auditing" in 1951 and "Classification of Municipal Accounts" in 1953, which at the time were considered the "bibles" of municipal accounting. In 1968, the National Committee issued Governmental Accounting, Auditing and Financial Reporting (GAAFR, a.k.a. the Blue Book) which combined and revised the two prior publications and constituted the most authoritative and widely accepted statement of municipal accounting and reporting principles.
The Accounting Principles Board and the AICPA neither endorsed nor recognized the standards set by the National Committee. Nevertheless, the GAAFR unofficially became GAAP for government bodies.
During 1973, an MFOA task force circulated a proposal under which the National Committee would be reorganized as a permanent, quasi- independent body; its name would be changed in 1974 to the National Council on Governmental Accounting (NCGA) and it would conduct and sponsor research, hold public hearings, and issue formal statements and interpretations with respect to principles and standards of governmental budgeting, accounting, reporting and auditing.
The NCGA was created out of a recognized need for a quasi-independent standard-setting body that followed a due process system similar to the for-profit standard-setting body. Since the NCGA was limited, both in staff and funding, the due process system was not always able to include discussion memoranda and public hearings. However, an exposure draft or proposed statement was generally issued and public comments were considered before a final statement of interpretation was issued.
The official acceptance of NCGA pronouncements as GAAP for state and local governments was first addressed by the AICPA in its State and Local Audit and Accounting Guide (the Guide) issued in 1974. The Guide established that GAAFR's principles, as modified by the Guide, constituted GAAP for governmental entities.
In 1979, the NCGA issued its first official pronouncement, Statement 1, to achieve greater harmony between GAAFR and the AICPA Guide. The AICPA followed by issuing SOP 80-2 "Accounting and Reporting by Governmental Units" which recognized NCGA Statement 1 as part of the whole body of GAAP which dealth specifically with governmental units. This SOP was an amendment to the 1974 Guide and constituted acceptance of the NCGA as a rulemaking body for government GAAP.
The NCGA, however, was unable to address the increasing number of issues in a timely fashion because it had part-time members and limited resources. A number of public interest groups, including the NCGA, AICPA, MFOA, U.S. General Accounting Office and National State Auditors Association, held public hearings. The consensus which resulted from these hearings was that the governmental community needed a permanent standard-setting body with a full-time staff, together with recognition of its standards under AICPA Ethics Rule 203. Furthermore, the government public interest groups demanded a voice in the establishment and overseeing of any standard-setting process.
The FAF took on the role of getting all parties together to set up a rule-making body to which the AICPA could grant Ethics Rule 203 recognition. The FAF agreed to the governmental community's representation on the FAF board. The final Agreement between the FAF, AICPA and government public interest groups was reflected in the Structural Agreement, which was incorporated into the FAF's bylaws. This document created the Governmental Accounting Standards Board (GASB) in 1984.
The Current Conflict
When GASB was created the FAF clearly stated: "The GASB will establish standards for activities and transactions of state and local governmental entities, and the FASB will establish standards for activities and transactions of all other entities." Yet, consider the following cases:
Case 1: The FASB issued Statement 87, Employers' Accounting for Pensions, in December 1985, providing guidance on the determination by employers of net periodic pension cost and pension liability, and on employer pension disclosures. In September 1986, GASB issued Statement 4, Applicability of FASB Statement 87, "Employers' Accounting for Pensions," to State and Local Governmental Employers, which allowed state and local governmental employers not to change their accounting and financial reporting of pension activities as a result of the issuance of FASB Statement 87.
Case 2: The FASB issued Statement 93, Recognition of Depreciation by Not-for-Profit Organizations, in August 1987. It required not-for- profit organizations to recognize the cost of using up (depreciation of) their long lived tangible assets. GASB, in January 1988, followed by issuing Statement No. 8, Applicability of FASB Statement No. 93, "Recognition of Depreciation by Not-for-Profit Organizations," to Certain State and Local Governmental Entities, which provides that governmental entities whose private sector counterparts are considered by FASB to be not-for-profit organizations should not change their accounting and reporting for depreciation as a result of FASB Statement 93.
Case 3: The FASB issued Statement 95, Statement of Cash Flows, in November 1987, requiring a statement of cash flows in place of a statement of changes in financial position. GASB followed with the adoption of a project on the applicability of FASB 95 to state and local governments and issued an exposure draft in November 1988, which differs from the FASB standard.
Case 4: The GASB issued Statement 3, in April 1986, Deposits with Financial Institutions, Investments (including Repurchase Agreements) and Reverse Repurchase Agreements, requiring disclosure about the risk of deposits and investments. In November 1987 the FASB issued an exposure draft, Disclosures about Financial Instruments, requiring disclosure of the risks of financial instruments including deposits and investments. The FASB document does not mention GASB Statement 3 and would be applicable to government entities should GASB not issue another negative pronouncement.
It should be apparent that the outcome of the long series of attempts to establish officially recognized GAAP for governmental entities is jurisdictionally ambiguous. The source of the ambiguity is easy to identify. Its resolution is more difficult.
In 1980 the FASB issued Concepts Statement No. 4, Objectives of Financial Reporting by Non-Business Organizations. It effectively ignited the conflict over authority for GAAP for governments. The Concepts Statement stated: "From its outset, the project leading to the Statement has included governmental units in its scope, and the Exposure Draft included governmental examples. On the basis of its study to date, the Board is aware of no persuasive evidence that the objectives in this Statement are inappropriate for general purpose external financial reporting of governmental units." Throughout the negotiations among interested parties on the creation of the GASB, the FASB echoed conclusions of Concepts Statement No. 4 and argued that it should be the sole standard setter. The government community, however, recognizing very real potential political difficulties with FASB's solution, would not accept "corporate rulemakers" setting standards for governmental units. The result of the negotiations on GASB's creation was a compromise regarding jurisdiction which introduced the current ambiguity to the process.
Ambiguity over standards jurisdiction exists in two areas. The first deals with the general applicability of FASB pronouncements to state and local governments. The second deals with the applicability of GASB pronouncements to certain industries which have public and private sector counterparts.
The "Agreement Concerning the Structure for a Governmental Accounting Standards Board (GASB)" (the Structural Agreement) states: "The GASB will establish standards for activities and transactions of state and local governmental entities, and the FASB will establish standards for activities and transactions of all other entities." At the same time, however, it continued a hierarchy of GAAP for state and local governments which, in retrospect, became the root of the confusion over standard-setting authority. The top of the hierarchy was set up as follows:
1. Pronouncements of the GASB.
2. Pronouncements of the FASB.
This means that in the absence of a GASB pronouncement every FASB pronouncement automatically applies to state and local governments unless exempted by the FASB, or if GASB issues a "negative standard." To date, FASB has not chosen to exempt state and local governments. Consequently, GASB has in fact had to issue "negative standards" for each FASB pronouncement which it determines should not apply. In 1988, the GASB issued two negative standards, issued an exposure draft modifying the application of a FASB standard, and deferred action on the FASB exposure draft on financial instruments pending resolution of the jurisdiction issue. FASB has, in effect, dictated part of GASB's agenda.
In addition, the Structural Agreement set the stage for development of two sets of standards for certain entities. It states: "Generally accepted accounting principles applicable to separately issued general purpose financial statements of certain entities or activities in the public sector should be guided by standards of the FASB except in circumstances where the GASB has issued a pronouncement applicable to such entities or activities. These entities and activities include utilities, authorities, hospitals, colleges and universities, and pension plans. GASB standards would also apply to those entities or activities when included in combined general purpose financial statements issued by state and local governmental units." Thus, for these entities FASB statements may govern when separate financial statements are issued and GASB statements may govern when the entities are included in state and local government financial statements. Furthermore, some of these entities may be unrelated to government and, therefore, required to follow FASB. For example, a municipal hospital is required to disclose information about deposits and investments pursuant to GASB Statement No. 3, whereas a not-for-profit hospital need not follow it.
Resolution of the Ambiguity
The GASB Structural Agreement calls for a "mandatory review of the governmental accounting standard-setting structure after GASB has been in operation for approximately five years...," and consequently a review of the structure and operation of FASB. Among the choices specified in the Structural Agreement are the following:
* Combining FASB and GASB;
* Putting GASB under an independent foundation separate from the FAF;
* Continuing with two Boards with some modifications to the GASB and/or FASB structure; and
* Continuing with two Boards without modification to the structure.
The Five Year Review, as it is called, is currently underway and is expected to be completed so the FAF can institute the changes, if any, by the end of 1989 (the end of GASB's first five-years). The GASB portion of the review is being conducted by a joint Review Committee comprised of the FAF and the Governmental Accounting Standards Advisory Committee (GASAC). GASAC is under the auspices of the FAF and includes representatives of the various state and local government public interest groups.
The Review Committee has sought information on the attitudes of various constituencies toward the GASB and GASAC and toward the current standard-setting structure and process. Lou Harris and Associates was contracted to interview approximately 500 preparers, users and auditors. The Review Committee interviewed 50 knowledgeable and prominent individuals, and sought public comment on these issues:
* GASB's jurisdiction and effect on its constituency;
* The make-up and organizational structure of the GASB;
* The economy and efficiency of the GASB's operation;
* The effectiveness of the GASB's due process and pronouncements;
* The timeliness, objectivity and independence of the GASB; and
* The operation of the GASAC.
Many interested parties have commented in response to the FAF's solicitation. In addition, the FASB staff was asked to prepare a "neutral discussion of changes to the existing agreement and the implications of those changes." FASB's staff provided a draft of the analysis to GASB for their review and incorporated changes in the draft to address GASB's concerns. The FASB staff paper provides a very well- balanced analysis and provides useful insight into the current direction of FAF's deliberations.
FASB Staff paper
The paper "starts with the presumption that there will continue to be two Boards and that each will have primacy within its defined jurisdiction. It then examines alternatives to the existing agreement and objections that might be raised to each alternative." The paper also focuses on entities that occupy the middle ground, which FASB's staff characterizes as Mixed Private-Sector Entities, (such as charitable organizations, membership organizations, private not-for-profit hospitals and colleges), and Mixed Public-Sector Entities, (such as government-owned utilities, hospitals and colleges). The paper avoids dealing with the jurisdiction of pure private-sector and pure public- sector entities. It discusses the issues but makes no recommendations. Six jurisdiction options are discussed. These are:
Option 1: Continuation of the existing jurisdictional arrangement.
Option 2: Designate GASB as the principal source of guidance for separately issued general-purpose financial statements of pure public- sector entities. All other entities would look to FASB.
Option 3: Designate FASB as the principal source of guidance for separately issued general-purpose financial statements of pure private- sector entities. All other entities would look to GASB.
Option 4: Modify the existing jurisdictional arrangement to permit the FAF to designate the other Board as the primary source of guidance.
Option 5: Give each Board "the responsibility for a distinct accounting model." Mixed private sector and mixed public sector entities would choose the model that best presents their activities.
Option 6: Establish FASB as the primary source of guidance for all business activities and transactions. All non-business activities including governmental and not-for-profit activities would be governed by GASB pronouncements.
The FASB staff paper also elaborated on the GAAP hierarchy issue. It discussed these three alternatives:
Alternative 1: Place both Board pronouncements on the second level in the hierarchy for the other constituents. This would leave the state and local hierarchy unchanged but place GASB in the hierarchy after FASB pronouncements for all other entities.
Alternative 2: Place both Board pronouncements on the lowest level in the hierarchy for the other constituents. This level includes other accounting literature. This would remove FASB from the second level in the state and local governmental hierarchy. GASB already is at the last level for all other type entities.
Alternative 3: Place both Board pronouncements at the top of the hierarchy in the absence of a pronouncement by the principal Board to the contrary. This would make GASB pronouncements applicable to all non-governmental entities unless FASB issued a "negative standard." It would leave the state and local governmental hierarchy effectively unchanged. This is close to a joint action alternative.
The FASB staff also addressed the often mentioned possibility of requiring some form of joint FASB and GASB action on any project that might affect both public and private sector entities. However, in this case the staff felt a joint action approach was not "desirable or workable."
This FASB staff paper, and the Harris poll, including interviews and comments from interested parties, were considered by the Review Committee in its report to the FAF, submitted January 26, 1989.
Review Committee Report
The Committee concluded: "The primary finding is that the GASB has performed well in the public interest and should continue to function under the FAF. It is structurally sound, has produced effective standards, and has won an impressive measure of respect from its constituents. We considered and rejected the options of combining the GASB and the FASB and of putting the GASB under an independent foundation separate from the FAF, neither having persuasive arguments in its favor in light of the performance thus far of the GASB under the FAF."
Regarding the GAAP hierarchy issue, the Committee recommended that the "...Statements, Interpretations, and other pronouncements of the FASB issued since the founding of the GASB not be applicable (emphasis added) to governmental entities unless the GASB takes specific action to state that they are applicable."
Regarding the jurisdiction issue, the Committee concluded that "...hospitals, gas, water and electric utilities; and colleges and universities (other than two year colleges with the power to tax)..." should follow FASB standards for separately issued general purpose financial statements. The GASB, however, would be "...responsible to promulgate, only for those entities that are government-owned, requirements to present such additional information as the GASB determines is necessary in the interest of public accountability." This conclusion, however, was not a consensus. The Committee report notes "a minority of the Committee believe that colleges and universities should be placed solely under the jurisdiction of the GASB."
The confusion caused by the ambiguity over the jurisdiction and hierarchy of GAAP for state and local governments, and mixed public and private sector entities, is being addressed. The Committee report, The Structure for Establishing Governmental Accounting Standards, and its companion, The Structure for Establishing Financial Accounting Standards, were widely distributed for public comment. Comments were due by April 1, 1989. The FAF plans to decide on changes to the structure of governmental accounting standards and to have them implemented by 1990.
It is not entirely clear what the new arrangement between FASB and GASB will be. Nevertheless, we are hopeful that at the end of the FAF's process, we will be able to agree upon who's in charge of governmental accounting standards.
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