The GASB is in the midst of due process on this project. It issued a Discussion Memorandum (DM) in June 1988 and an Exposure Draft (ED) of a proposed statement in March 1990. The Board considered the comments received on both documents, as well as a field test conducted in the spring of 1989.

The proposed statement would be effective for years beginning after June 15, 1991.

Definition of the Financial Reporting Entity or What to Include in the Financial Reporting Entity

The definition of the reporting entity as proposed in the ED is based on accountability, a precept of financial reporting formalized in GASB Concepts Statement 1, "Objectives of Financial Reporting, " paragraph 56 of which notes that "accountability is the cornerstone of all financial reporting in government" and financial reporting plays a major role in fulfilling government's duty to be publicly accountable in a democratic society."

This emphasis on accountability seems too important to ignore; but, how should accountability be reported? Are we talking about the accountability of elected officials to their electorate, the accountability of those elected officials for other organizations, or the accountability of others to elected officials?

According to paragraph 2 of the ED, "financial reporting based on accountability should enable the financial statement reader to see beyond the boundaries established by the creation of separate organizations and to focus on the body of organizations that are related by a common thread of accountability to the constituent citizenry." Therefore, the ED's answer to the above question is both accountability to constituents and accountability of others. Those "other" organizations that most people think of when they think of inclusion in a governmental reporting entity are quasi-governmental public authorities or public benefit corporations created to serve a public function.

Shadow Governments

Examples include the following authorities: mass transit, turnpike, port, regional utility, downtown redevelopment, housing and low interest mortgage, building, and various special districts. They are organized outside of a traditional governmental unit, often a state government, to overcome governmental bureaucracy. Restrictions on debt issuance, competitive bidding processes, and other limitations imposed on governmental operations are designed to protect constituents, but sometimes the red tape results in hampering the effective and efficient provision of public services.

Some have referred to these organizations as "shadow governments." Most are governed by boards appointed, at least in part, by elected officials. They are not governments" in the traditional sense; therefore, they are not directly accountable to an electorate. They are not profit-seeking corporations; therefore, the typical manager/shareholder agency relationship does not exist, and it is possible that they are exempt from certain legislation and regulation, such as SEC and banking regulations.

A basic premise of existing entity standards is that all governmental organizations are responsible to elected governing officials at the federal, state, or local level. Under our republican form of government, elected governing officials are held accountable for their public policy decisions, regardless of whether those decisions are carried out directly by the elected officials or by their designates. Therefore, the GASB defined accountability to be synonymous with appointment, and proposed that "a primary government is accountable for legally separate organizations if the primary government appoints a voting majority of the organization's governing body." The primary government, such as a municipality or a state, is the nucleus of the financial reporting entity.

But What Really is Accountability?

The notion of accountability is, in a sense, similar to the notion of control as defined by other standard-setting bodies. In the private sector, control is most often linked with ownership of a majority of the stock of a corporation. Although it is acknowledged that effective control can also be achieved through other means, an emphasis is placed on the assumption that, through voting control (resulting from ownership of a majority of stock) over the decisions of a board of directors, a majority owner has the power to establish the subsidiary's operating and financing policies and thus is able to direct the subsidiary's economic activities in essentially the same way it could if it engaged in similar activities directly. To draw an analogy in the governmental environment, the Board concluded that accountability results from the appointment of a voting majority of a governing body of an organization, which is parallel to majority representation on a board of directors. However, the similarity ends there. In the private sector, the nature of the relationship between a corporation and its majority shareholders is usually financial or economic. In the public sector, the appointors of an organization's governing body do not necessarily have an ongoing financial interest. Often, there is, instead, a financial responsibility because the organization was likely created to perform a traditional government function and the related government, therefore, may provide subsidies or guarantee debt.

Some Disagreement

Approximately 60% of the respondents to the ED were categorized as supporting the accountability-based approach to defining the financial reporting entity. However, the other 40% of the respondents either disapproved of the Board's definition of accountability or suggested changing it. Some of the respondents believe that the accountability approach does not sufficiently reflect that the primary government's accountability is secondary or that the extent of accountability can vary from one organization to another.

A number of respondents believe that "control" should replace accountability" as the benchmark for inclusion. In fact, most of the respondents that suggest modifying the definition of accountability to include the notion of authoritative appointments would introduce some notion of control. To these respondents, it seems inappropriate to hold a primary government accountable for component units over which it has no control. For example, in some states a governor with a four-year term may have occasion to appoint members to 10-year terms on an authority's governing board, possibly without legislative approval. That governor, as well as others that follow, may have no ability to affect the operations of the authority. Certain respondents refer to this type of accountability as "political" accountability and state that only fiscal" or financial" accountability has a place in financial reporting.

Display of the Financial Reporting Entity or How to Include Those Organizations That Meet the Entity Definition

Having adopted a "broad" definition of the entity and of accountability, the Board embraced a "nuance" approach to displaying the financial reporting entity. The financial statements of the reporting entity generally should allow the users to distinguish between the primary government and its component units (the organizations that meet the definition of the financial reporting entity and, therefore, should be included). They should also attempt to show the nuances in the relationships between the primary government and its component units and convey the financial effects of the component units on the primary government rather than create an "artificial entity" by reporting the totality of the primary government and its components as if the totality were one organization. The primary government is the focal point of the financial statements.

But How?

The GASB proposed the implementation of the nuance approach through a three-pronged display methodology that uses blending, discrete presentation, and note disclosure to include component units in the entity. Blending is the method currently used under existing standards to include component units. It essentially reports the unit as though it is a part of the primary government (therefore, it loses its identity at the combined level). Research, including the GASB Research Report, indicates significant discontent with blending because of information loss in the aggregation process. That discontent, however, is related to the indiscriminate use of blending for all component units, regardless of the degree of financial interdependency or control by the primary government.

To Blend or Not to Blend?

The Board acknowledged that blending is appropriate under certain circumstances: the component unit is so intertwined with the primary government that it should be reported as part of the primary government. Blending, as proposed in the ED, would be limited to instances where there is perceived to be complete control or absolute financial interdependency:

* Situations in which the component unit's governing body is substantively the same as that of the primary government (e.g., the city council puts on another "hat" to become the redevelopment authority); and

* Component units that exist to serve only the primary government (e.g., a building authority finances its construction by issuing revenue bonds and then leases the building under a lease-purchase arrangement to the county government).

The Nuance Approach at Its Best

Although blending would be used occasionally, the foundation of the Board's nuance approach to display is discrete presentation. This is the method by which most governmental colleges and universities are currently included in financial reporting entities. Discrete presentation allows presentation of an overview of the financial reporting entity without distorting the financial data of the primary government by aggregating with it the financial data of somewhat autonomous component units. The proposed statement would require that all component units that are not blended but over which the primary government has the ability to impose its will, or that are financially interdependent with the primary government, be discretely presented.

Financial interdependency is present if the primary government is:

* Entitled to the component unit's surpluses;

* Obligated to finance the deficits of, or provide financial support to, the component unit; or

* Obligated for the debt of the component unit.

A primary government has the ability to impose its will on a component unit if it can determine the programs, projects, activities, or services performed or provided by the component unit and can influence how the component unit's resources will be used to provide those programs, projects, activities, or services (possibly through the ability to veto or overrule decisions or the ability to remove appointed officials at will).

Discrete presentation is a single column on the face of the combined financial statements (the part of a governmental comprehensive annual financial report CAFR known as the general purpose financial statements GPFS), shown separately from the primary government columns. All discretely presented component units are aggregated on the balance sheet of the financial reporting entity, regardless of whether they are governmental, proprietary, or follow a different model, such as colleges and universities.

Segment information for individual component units, similar to that required for enterprise funds or segment of business reporting in the private sector, is required to be presented in the notes to the financial statements. In addition, disaggregated information would be available in combining statements supporting the combined totals.

Reaction to Discrete Presentation is Lukewarm

Although over 70% of the respondents to the ED support the nuance approach to displaying the financial reporting entity, only 50% support the Board's proposed use of discrete presentation. Most of the critics were opposed to the aggregation required for much the same reasons that blending is disliked--the meaninglessness of the sum of heterogeneous operations. The Board is aware of the obfuscation that occurs when aggregation is used, which is why it shifted component unit display away from blending. The nuance approach to display focuses on the primary government, and discrete presentation is the only viable method of displaying the financial data of component units on the face of financial statements without compromising the financial statement's focus on the primary government. Certain respondents suggested that discrete presentation not be limited to a single column on the balance sheet. Instead, they suggest a separate column be presented for each different fund type (governmental versus proprietary, for example).

This suggestion would add more columns to the already crowded financial statements, and at what benefit? The additional columns would still contain aggregated financial data from a hodgepodge of different component units. Rather than require individual component unit details to be displayed on the face of the combined financial statements, the Board instead required segment information disclosures and combining statements to report those details.

The GPFS of the financial reporting entity is intended to provide an overview with a focus on the primary government. Users requiring information about a component unit would probably not turn to the financial report of the entity for data but would seek the financial report of the component unit itself.

Is Note Disclosure a Method of Inclusion or Should It Only Describe Related Parties?

According to the ED, component units that do not meet the criteria for blending or for discrete presentation will be included by means of note disclosure. The disclosure required would be minimal, considering the relationship between the note-disclosed component unit and the primary government--the primary government appoints the governing body and is therefore accountable, but there is no imposition of will and no financial interdependency. This is a new concept in entity reporting, but entirely in keeping with the nuance approach. What better way than note disclosure to describe these relationships? However, some respondents consider the use of note disclosure as a method of inclusion to be contradictory.

There is a perception that being "included" as a component unit could mislead readers of the financial statements into believing that the relationship between a primary government and the component unit is stronger than it actually is. The Board is revisiting this issue and is considering the elimination of note disclosure as a method of inclusion, replacing it with a requirement to disclose transactions and balances with "related organizations" for which it appoints governing officials.

What Concerns Practitioners?

What concerns practitioners most is the implementation process, and a number of respondents to the ED commented on problems expected. Frequently mentioned problems relate to audit questions, access to information, and timeliness of reporting. Auditors were concerned about their audit responsibilities for the discrete presentation column. Practitioners are also concerned that they will be unable to obtain the information necessary to include component units in the financial reporting entity and this will delay issuance of an entity's financial report.

The reporting entity project is an integral part of the GASB's overall financial reporting project. The GASB is just beginning its work in reexamining the governmental financial reporting model. A final statement on the financial reporting entity and a DM on the financial reporting model are expected in 1991.