By Randall L. Kinnersley and G. Robert Smith, Jr.
Fixing the Shortcomings of GASB 34
The Government Accounting Standards Board (GASB) recently decided to reevaluate the reporting requirements of GASB 14, The Reporting Entity, which established component unit reporting. The authors propose a new definition of major discretely present component units (DPCU). They believe that their proposal merits consideration and that GASB should change the options for reporting these component units in the basic financial statements of the new reporting model. The authors’ analysis of more than 200 comprehensive annual financial reports (CAFR) has led them to believe that many governments already have the DPCUs that would meet the proposed definition.
In addition, if GASB were to reduce the options of reporting DPCUs in government-wide financial statements to just one—all DPCUs reported in a single column on the government-wide statements—governments could then provide additional information about major and nonmajor DPCUs in a combined component unit statement similar to the statements required for governmental and business-type activities.
Government Accounting Standards Board (GASB) Statement 34, paragraph 126, requires that “blended component units should be reported in accordance with Statement 14, paragraphs 52 through 54.” A blended component unit (BCU) is considered so closely related to the legal entity that the BCU funds appear as if the funds are integral parts of the primary government (PG). Generally, a user of financial statements cannot distinguish between a fund of the PG and a BCU without studying the notes to the financial statements.
BCU funds follow the same reporting requirements as PG funds. Statement 34, paragraph 76, provides three steps to determine whether a BCU’s governmental or enterprise fund is a major fund:
All other PG and BCU funds of a government should be reported as nonmajor and included in the nonmajor fund column on the appropriate statement.
A casual reader of the requirement may infer that if a PG or BCU fund passes the 10% test for one element, such as total assets, and the 5% test for another element, such as total revenues, the fund qualifies as a major fund. However, the “Guide to Implementation of GASB Statement 34 on Basic Financial Statements—and Management’s Discussion and Analysis—for State and Local Governments” (Implementation Guide) clarifies this issue. In the answer to Question 183, GASB clarifies that the fund should pass both the 10% and 5% tests for the same element. Exercise 5 in the Implementation Guide (pages 232-233) demonstrates this process. GASB statement 37 adopts this same requirement.
To determine the impact component units—both blended and discretely presented—have on financial reporting, the authors examined 317 comprehensive annual financial reports (CAFR) to see how they reported component units. Table 1 summarizes the results of these reviews; Table 2 and Table 3 summarize the results of the component unit analysis.
The analysis used 222 of the 317 CAFRs. Of the 95 CAFRs eliminated, 42 were dropped because the government did not have any component units. Another 42 were dropped because they did not receive the Government Finance Officers Association’s Certificate of Achievement for Excellence in Financial Reporting. Finally, 11 CAFRs were dropped because the governments incorrectly reported component units.
The 222 analyzed reports contained 528 BCU funds in 113 CAFRs (some BCUs had more than one fund). The most BCU funds found in any CAFR was 41, while 26 governments (11.7% of the total sample and 23.0% of those having BCUs) had only one BCU fund. The findings indicated that 95 of the 528 BCU funds (18%) met the major fund criteria in 61 different CAFRs. The remaining 433 BCU funds would be reported in the “other [nonmajor] funds” column of the appropriate fund statement, unless the government decided to report them as major (under the third GASB 34 criteria mentioned above).
Reporting Discretely Presented Component Units
Reporting options. Statement 34 requires the reporting of discretely presented component units (DPCU) in separate columns or rows on the government-wide statements; specifically, paragraph 126 requires that information about each major component unit be provided on the basic financial statements of the reporting entity. Governments can satisfy that requirement by presenting each major component unit in a separate column in the reporting entity’s statements of net assets and activities; including combined statements of major component units in the reporting entity’s basic statements after the fund financial statements; or presenting condensed financial statements in the notes to the reporting entity’s financial statements. Thus, the options provided for reporting DPCUs in Statement 34 are very similar to those provided in Statement 14.
Consider an example with three DPCUs: X, Y, and Z. X is a major unit, whereas Y and Z are nonmajor. Exhibit 1 shows three acceptable options for reporting the three DPCUs in a statement of net assets. Option A uses the format most commonly illustrated by Statement 34, except that it includes a reporting entity total column, which is labeled “optional” to indicate that reporting entity totals are not required. This format requires either a “component unit statement of net assets” (essentially a combining statement) or a “condensed component unit statement of net assets” in the notes, because each major DPCU must be reported individually.
Both Option B and Option C meet the requirement of reporting the major unit (X) separately on the government-wide statement of net assets. Option B and Option C do not require a “component unit statement of net assets” or a “condensed component unit statement of net assets” in the notes, because the major DPCU is already reported separately on the government-wide statements. Thus, Options B and C avoid additional financial statement reporting in the basic financial statements.
In practice, of the 160 governments surveyed that had at least one DPCU, 103 used Option A. Of these 103, 53 governments had only one component unit and 50 other governments had two or more component units but elected to use only one column to report them in the combined statements. Of the 57 governments not using Option A, 22 used Option B, and 35 used Option C.
Memorandum-only total columns were optional for combined financial statements prior to Statement 34. Statement 14 had established the appropriate use of memorandum-only total columns on combined financial statements when DPCUs are reported. The standard allowed one of three options for the memorandum-only total columns:
In the new reporting model, GASB determined that designating total columns as “memorandum only” is unnecessary because the government-wide statements use a single measurement focus (economic resources) and basis of accounting (accrual). A consolidated total column for the PG is now required on the government-wide statements, superseding the options permitted in Statement 14. The display of the reporting entity total column remains optional.
The presentation of individual major component units on the government-wide statement of activities is more problematic. The task can be accomplished if the government has only one or two major DPCUs; otherwise, reporting major DPCUs separately is not practical. The statement of activities is complex enough without adding more columns and rows for the DPCU information. Statement 34 does permit reporting multiple component units on the statement of activities, however, and multiple DPCUs are included in the illustration in Statement 34, Appendix C.
Suggested Criteria for Determining DPCUs
Although Statement 34 defines “major fund,” it does not define “major DPCU.” The Implementation Guide answer to Question 240 (p. 57) indicates that the Statement 14 guidance for determining major DPCUs should continue to be used.
With regard to determining major DPCUs, Statement 14, paragraph 51, states: “consideration should be given to each component unit’s significance relative to other component units and the nature and significance of its relationship to the primary government.” The definition of major DPCU requires professional judgment. SAS 69, The Meaning of ‘Fairly Presented’ in the Auditor’s Report, indicates that when judgment is needed, auditors should consider the relevance of other accounting literature, the specificity of the guidance, and the general recognition of the issuer or author as an authority.
Statement 34, paragraph 318, says that BCUs are legally separate in form, but not in substance, from the legal entity. Paragraph 318 also refers to DPCUs as separate both legally and in substance from the legal entity. Recalling that the Statement 34 criteria for major funds do apply to BCU funds, one may conclude that if a fund of a BCU does not meet the major criteria for individual reporting, then a DPCU of similar size should not be reported individually.
One potential method for determining major DPCUs would be to apply a two-step process similar to the one that PGs use to determine major funds:
The display of reporting entity totals is not required in the government-wide financial statements and may have to be calculated. Virtually all DPCUs that meet the proposed 5% criteria will also meet the proposed 10% criteria unless a government has an extraordinary number of large DPCUs. If no DPCUs meet the proposed major criteria, then the government could use Option A for reporting component units, with no need for combining statements for major component units in the basic financial statements.
The CAFR analysis shown in Table 3 identified 435 DPCUs reported in 160 CAFRs. The largest number of DPCUs in any CAFR was 16. The findings indicate that 167 DPCUs (38.4%) met the major criteria proposed above. Additionally, of 107 governments with at least one major DPCU, 62 (57.9%) currently report all their DPCUs in a single column. Clearly, the tendency is to use Option A.
The remaining, nonmajor DPCUs did not need to be reported individually in the basic financial statements. If GASB believes that the PG is more accountable for BCUs than DPCUs of comparable size, it should develop a comparable measure of major DPCUs such as proposed here.
Other Reporting Issues
Reporting component unit fiduciary funds. Statement 34, Paragraph 6b, requires that government-wide financial statements “display information about the government as a whole, except for fiduciary activities.” Fiduciary funds (including legal entity fiduciary funds, BCU fiduciary funds, and DPCU fiduciary funds) are not included in the government-wide statements because they cannot be used to support the government’s programs or services.
Statement 34 does not require DPCU fiduciary funds to be reported separately from PG fiduciary funds. In fact, the Implementation Guide answer to Question 223 states: “each [discretely presented] fiduciary component unit should be reported within the appropriate fiduciary fund types, rather than aggregated in a separate [discretely presented] fiduciary component unit column”.
Budgetary reporting for component units. Statement 34 limits the required budgetary reporting for component units. Budgetary reporting is required for only the general fund of the PG, plus major special revenue funds with legally adopted budgets. Under Statement 14, the general fund of a BCU is reported as a “special revenue fund” when blended into the PG. Thus, the required budgetary reporting for component units is limited to the blended general fund or special revenue funds of major BCUs. In all likelihood, only a small percentage of the BCUs will require a budgetary statement in the required supplementary information of the basic financial statements. GASB never requires budgetary data for DPCUs.
MD&A for component units. Determining whether information about component units should be included in the management’s discussion and analysis (MD&A) of the PG is a matter of professional judgment. BCU information is included in MD&A based on the same criteria used for all other PG funds. The decision to include DPCU information in MD&A should be based on its significance to other DPCUs and the PG. If a government provides DPCU information, MD&A users should be able to distinguish between information related to the PG (including BCUs) and to the DPCU. Exhibit 2 highlights other important issues related to reporting component units in the new reporting model.
Revisiting the Reporting Model
GASB has recently decided to reevaluate the reporting requirements of Statement 14. The authors’ analysis of 222 CAFRs indicates that the proposed definition of major DPCUs merits consideration. In addition, GASB should consider changing the options for reporting these component units in the basic financial statements of the new reporting model. Indeed, GASB makes it abundantly clear in Statement 34 that the focus of the financial statements is to be on the PG. If GASB intends to support this position, it should reduce the options of reporting DPCUs in the government-wide financial statements to one: report all DPCUs in a single column. Governments could then provide additional information about major and nonmajor DPCUs in a combining component unit statement similar to the statements required for governmental and business-type activities.
See the Sidebar for this article. ("Reporting Component Units: A More Radical Approach")
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