Response to the GASB Invitation to Comment on Financial Reporting Model Improvements—Governmental Funds (Project No. 3-25I)

The committee commends the Governmental Accounting Standards Board (GASB) on its efforts to make continued improvements to the financial reporting model for governmental entities with the proposal of three alternatives to the current model. The committee agreed that either a short-term or near-term focus should be continued, in combination with the accrual-based government-wide statements. The following presents the comments of the committee to the questions posed by the GASB in the Invitation to Comment, Project No. 3-25I.

The questions were divided into two categories. The first set of questions addressed recommendations and comments on the three proposed recognition approaches for reporting governmental funds. The second set of questions addressed other governmental fund financial statement issues. The numbering scheme used below is a correlation to the numbering scheme used in the GASB ITC No. 3-25I.

The ability to provide educated citizens a way to see the government activities that align with the way the governmental units are managed provides value. However, students struggle with learning this display and question the focus on the current resource flow since it differs from their prior understanding. Thus, one may conclude that the majority of users are not really aware of the different information lens through which the governmental fund financial statements should be analyzed. As we explain later, research shows that sophisticated users are able to glean information from both governmental fund and government-wide statements. There still is value in educating all financial statement users as to the reasons and benefits of the shorter time focus afforded to governmental funds, while simultaneously understanding the economic resource perspective afforded in government-wide statements. Providing appropriate heading descriptions to the governmental fund statements and reconciliation to net position of governmental activities on the same page will be beneficial for all financial statement users.

Reporting the governmental funds using a shorter time frame provides information from the perspective of inflows provided and outflows used by each fund. This useful information would not be apparent if the governmental fund reporting were changed to a full accrual, long-term reporting focus. The overall health of the governmental organization should be analyzed by the government-wide statements. Omitting the long-term reporting perspective for each individual fund does not affect the ability to analyze the overall organization. However, changing from the current shorter time perspective for reporting governmental funds would reduce the information reported to external users of the financial reports. This could potentially be mitigated by requiring that each fund also provide a statement of cash flows. It is our opinion that keeping a shorter time perspective would continue to provide useful information without the need to add additional required reports.

From a research perspective, early analyses show that accrual-based government-wide statements provide additional information to the near and short-term focused modified accrual fund statements. Since GASB 34 has only been in effect for 16 or so years, and statistical analyses require sufficient sample sizes, there are only a few studies that examine the informativeness of modified and full accrual government financial information. Plummer, Hutchison, and Patton (2007) examine the association between default risk and various financial measures from both the government-wide statements and governmental fund statements. In their sample of 530 Texas school districts, they find that financial position as reported in the government-wide statements is significantly associated with default risk but that measures of financial performance as reported in the government-wide statement of activities and accrual-based current liabilities do not explain default risk. Governmental fund measures of performance and modified accrual current liabilities are associated with default risk but not governmental fund balance. When compared to one another, government-wide financial position is more informative than governmental fund balance, but governmental fund performance and modified accrual current liabilities are more informative than government-wide performance and accrual-based current liabilities. This suggests that both measurement foci are informative to users.

Pridgen and Wilder (2013) extend the Plummer et al. (2007) study through the use of a different sample and by examining additional financial indicators. Using 409 cities, villages, and townships, the authors find that financial position, financial performance, leverage, and liquidity, as well as the three categories of net assets as measured in the government-wide statements for both governmental and business-type activities are related to debt ratings. Comparing government-wide financial information (full accrual, long term) to government fund financial information (modified accrual, near to short term), the authors find that the full accrual information for financial position is incrementally more informative of debt ratings than that of the modified accrual financial position measure. However, they also find that the modified accrual measure is incrementally more informative of debt ratings than the full accrual measure. Opposite of the Plummer et al. (2007) findings, this study finds that government-wide leverage and performance measures are incrementally more informative to governmental fund performance and leverage measures. Although the results of this study are mixed, we believe this is another finding that supports that modified accrual financial information does provide information in the presence of full accrual financial information.

Two additional studies that directly compare the information in the full accrual government-wide statements and the modified accrual fund statements are Benson and Marks (2014) and Bloch (2016). Benson and Marks (2014) examine how bond insurers use the full accrual government-wide statement data compared to modified accrual fund statement data using a sample of 274 Texas cities. They start with a model of bond insurance premiums (and also bond ratings) that uses many bond characteristics in addition to measures from the governmental fund statements. They then compare that model to a model that includes all the variables from the first model in addition to measures from the government-wide statements. In explaining bond insurance premiums, financial measures from governmental fund statements are still significant in the presence of financial measures based on government-wide statements. These results do not hold for bond ratings. Unrestricted net assets and net assets invested in capital assets significantly explain bond ratings, while fund balance and revenues minus expenditures do not. These results are different than Plummer et al. (2007) and provide additional evidence that modified accrual financial information provides information in the presence of full accrual financial information, which supports using a near- or short-term focus in the governmental fund statements.

Bloch (2016) surveyed members of the National Federation of Municipal Analysts (NFMA), and from 107 responses (73 with experience before and after the implementation of GASB 34) found that analysts in general feel that the information provided by GASB 34 has improved transparency in reporting. However, survey respondents still relied on information provided in the fund financial statements more than the government-wide financial statements. This survey was conducted in 2013 after GASB 34 had been in practice for at least ten years. This shows that information that focuses on fiscal accountability is still important and used by investors and creditors.

What we can infer from these studies is that both measurement foci in the basic financial statements, current financial resources, and economic resources are valued by users. Changing the measurement focus of governmental fund financial information to more closely align with government-wide financial information (through the long-term focus approach) may reduce the usefulness of the basic financial statements.

Yes, we believe that providing budgetary comparison information is essential to providing useful information to users of the financial statements. Reporting the original budget and the revised budget compared to actual spending improves accountability and allows users to access the government's proficiency in managing its resources.

Since the majority of local governments have balanced budget requirements, budgetary comparison statements remain relevant to the way the governmental units are operated. Pridgen and Wilder (2013) find that the ratio of fund balance to total fund revenue provides information incremental to ratios calculated from government-wide data. In addition, Callahan and Waymire (2015) examine the relationship between bond ratings and budgetary variances from the budgetary comparison schedules of 54 cities over four years. They find that revenue variances are significantly associated with lower bond ratings and that favorable expenditure variances are associated with higher bond ratings. This study's findings suggest that creditors use budgetary information in their analyses. Pridgen and Wilder's (2013) research is consistent with beliefs that transparency of management's compliance with the budget provides an avenue for citizens to become involved in affecting change of the spending patterns within their local government.

Fiscal accountability is best demonstrated by the near-term approach. Although by displaying solely a near-term focus, decision makers and financial statement users lose sight of long-term needs or demands. The near-term approach is fundamentally different than the economic approach of the government-wide statements; thus, it needs to be starkly reflected. The precision in calling for different statements to be named and labeled distinctly appropriately highlights the differences. We commend the GASB on the inclusion of clarifying information on the face of the statements about the different recognition foci, and for providing to the reader the subsequent direction to the government-wide statements. Also, the inclusion of the reconciliation on the same page is beneficial. If the GASB elects to choose the long-term approach, there will be an important aspect of fiscal accountability reporting lost; although perhaps it will mean an easier time interpreting the economic resource approach across the detailed reports from the governmental unit.

Reporting the proceeds and payments of the anticipation notes within the same section on the resource flows statement is beneficial by providing a more transparent representation of the short-term borrowing activity. Therefore, the current and long-term activity format provides more useful information in regard to the anticipation notes. In addition, the current and long-term activity format provides more useful information regarding the capital outlay activities. However, the terminology is confusing since tax anticipation notes and revenue anticipation notes are, by nature, short-term financing to meet current operating obligations. We suggest using the format of the current and long-term activity report, but maintain the headings from the exiting format. The heading “Other Financing Sources and Uses” more appropriately describes the anticipation note proceeds and payments.

Terminology is always a challenge when trying to convey a consistent message to a wide variety of financial statement users. A clear definition of what represents a financial resource is definitely helpful. Paragraph 38 states, “Some view financial resources to be items that can be or are expected to be converted to cash or are consumable in lieu of financial resources. Others view financial resources to be all resources that are not capital resources” (see https://www.gasb.org/jsp/GASB/Document_C/GASBDocumentPage?cid=1176168729663&acceptedDisclaimer=true). The most valuable information depends on the reader. However, consistent application and classification of items as per definition is essential. The committee agrees that prepaid items and inventory are financial resources. As prepaid items are consumed, the entity can avoid the necessity of using cash at a future point in time. Inventory for sale leads to revenue inflow and inventory consumed by the entity in the production of goods or services allows the entity to avoid the outflow of cash in a future period, much like prepaid items.

The committee believes that the governmental funds should continue to reflect the budgeting and actual process by which managers attain fiscal accountability; therefore, a near-term focus is preferable.

The description following the heading on the governmental fund financial statements is useful in communicating that there is a difference between the short-term nature of the governmental fund reports and the government-wide statement. To add clarity, the headings could include the method of accounting for each and more clearly define the long-term reporting of the government-wide statements. For example, the description on the near-term financial resources balance sheet could be reworded as follows: “This financial statement presents a short-term view of the governmental fund activities based on the modified accrual method of accounting, which excludes items of a long-term nature. For a complete portrayal of the financial position of the governmental activities on an accrual basis of accounting, see the government-wide statement of net position, which includes all items of a long-term nature.”

The same-page reconciliation is beneficial to reader understanding; simultaneously, there cannot be enough description as part of the reconciling items. Most governmental entities reduce the description to categories on their current CAFR and have large amounts attached to each line item. It can be easy for a reader to conclude that the reconciliation is simply a mathematical calculation to explain the link from the governmental fund to government-wide financial statements—and not realize the actual impact to the interpretation of the numbers. The current full-page reconciliation allows more space for descriptions and, therefore, should not be omitted. A brief, summarized same-page reconciliation is useful to highlight the differences between governmental funds and government-wide statements, but is restrictive in nature due to the space limitation.

The proposed format of current and long-term activity expands data communication for the financial statement reader/user by separating the financing and long-term activity in with other items, such as leases and transfers. Typically, additional information enhances the organization's transparency and decision-making usefulness of the financial statement. The question is whether removing the “long-term activity” expenditures from other budgeted expenditures creates more confusion for users who are used to seeing items such as capital outlay and debt service reported as outflows of resources. These users may prefer to see total fund expenditures in one category. If that is the case, continue to use the existing format.

If there are changes in the format to move it to a more long-term approach, then the actual cash flow information would be appropriate, and a statement of cash flows would add value to the financial statement user. If a near-term approach is adopted, then there is less incremental information incorporated into this statement, and a statement of cash flows is unnecessary.

Presenting a statement of cash flows for governmental funds would create a steep learning curve. However, once mastered, the additional information may enhance the transparency and relevance of the financial reports. Although, a separate statement may have users confusing the governmental fund cash flow with the proprietary fund cash flow statement unless the title is specific and placement presentation couples all governmental statements together. If the two cash flow presentations are incorporated into a combined statement, a separate column to the cash flow statement may be appropriate. Anytime that a significant change in a report is made, there are learning and educational costs to preparers, users, students, and educators. In addition, requiring a statement of cash flows for governmental funds would impact the future cost of preparing the CAFR in terms of both time and money.

The four classifications, which include operating activities, noncapital financial activities, capital and related financing activities, and investing activities, are appropriate for governmental funds. As stated previously, we believe the near-term approach provides the most useful information for financial statement users. A statement of cash flows would not provide incremental information and, therefore, should not be required for the near-term approach for governmental fund reporting.

If an alternative cash flow classification is deemed to meet the cost-benefit criteria, there needs to be some consistency between statements so that users can interpret the information with some degree of familiarity. If statements with the same name for the different type of fund groups (funds held in trust, governmental business type activities, and governmental) are incorporated in the financial reporting model improvements, the underlying reality of information captured needs to be similar and any major differences easily communicated (e.g., the four classifications).

With the GASB's effort to enhance the information and decision usefulness of government financial statements, the information provides our students with an appreciation and understanding of the multiple perspectives of the government. The students will also be provided with information to gain an appreciation of governments' near-term and long-term reporting. As educators, our task will be to facilitate the learning process.

We appreciate the opportunity to provide comments regarding the financial reporting model improvements for governmental funds.

Upon completion of the Invitation to Comment period, the GASB redeliberation process began in April 2017 with public hearings regarding the Financial Reporting Model Improvements—Governmental Funds (ITC No. 3-25I). The Committee chairperson had the privilege of participating in the process through an oral presentation to discuss additional questions from the GASB board. The questions raised during the oral presentation are provided below. The questions are labeled R1 through R6 to indicate redeliberation questions. The responses are the result of committee discussions following the report from the chairperson.

If the financial statements in the CAFR were formatted more closely to a for-profit entity, perhaps the users would be less confused by the information. To achieve this, the government-wide statements (full accrual) could be displayed in the main body of the report and the governmental funds reported as footnote disclosures. It would then be necessary to have a statement of cash flows as a part of the government-wide report. The footnote disclosures would report the governmental fund statement using a near-term approach and include a reconciliation to the government-wide report.

Reporting for governmental entities includes two broad statement types based on either a long-term or a short-term focus. The government-wide statements provide a long-term view and governmental fund statements provide a short-term focus. While it might be helpful to know long-term liabilities on a fund-by-fund basis, we believe there is a benefit to the short-term focus of the governmental fund statements. Long-term liabilities could be presented by fund in the footnotes for explanatory purposes. This would provide specific information at a more detailed level for decision makers while not compromising the benefit of the short-term focus of governmental fund reporting.

GASB No. 68 improved the transparency regarding pension liabilities starting for reports for fiscal years beginning after June 15, 2014. Users of the financial statements are just now becoming aware of the effects of this new reporting requirement. It is too soon to say that GASB No. 68 did not go far enough to bring attention to the unfunded pension liabilities. Providing more focus on the long-term (full accrual) government-wide statements should improve the understanding of long-term issues.

It is common in the for-profit arena for analysts to focus more on short-term information in assessing default risk; therefore, a short-term focus is expected. There is less reliability in longer-term default risk assessment. We do not believe this is a problem.

Providing both a full-page reconciliation and including a same-page reconciliation for governmental funds would be useful. The full-page reconciliation adds value by providing more information on the face of the statement. The same-page reconciliation adds value by highlighting the differences on the governmental fund financial resource flows report. The question becomes: does providing both types of statements add incremental value without being a duplication of effort? While the same-page reconciliation reports the same totals, it would simply be a much-abbreviated reconciliation and, therefore, not a duplication of effort. It would highlight the fact that the reports are created using a different basis of accounting and also emphasize that the differences are more than a mathematical calculation.

• The ability of users to assess the inflows and outflows of each governmental fund.

• As a city manager dealing with in-house stakeholders, a majority of their questions are typically relevant to the near term.

• Near-term reported amounts are more easily audited.

• Accounting information systems and governments collect data for the near-term financial approach.

• The potential for manipulation of reporting activity right around the cutoff date. However, this is a disadvantage for any type of arbitrary-timing deadline, so it is equally impactful for any other reporting schema.

• The sheer number of items that would not be recognized of which a reader might not be aware (e.g., accrued interest expense).

The GASB's purpose in issuing the Invitation to Comment (ITC 3-25I) was to obtain stakeholder feedback on potential improvements to the existing financial reporting model for governmental funds. Alternative models were presented for evaluation and comment from stakeholders regarding their perceptions of the benefits and costs of the proposed changes. The process of gathering information from all stakeholder groups increases the likelihood of implementing meaningful changes to improve the outcome. The Committee commends the GASB for its efforts toward improvement in the financial reporting of governmental funds.