CHAPTER 17
ACCOUNTING FOR STATE AND LOCAL GOVERNMENTS
(PART TWO)
Chapter Outline
I. This chapter looks at the reporting for a number of significant transactions that are common
for state and local governments. For example, these entities often obtain property by
lease rather than by purchase.
A. Leases are recorded as either capital leases or operating leases based upon the criteria
first established by the Financial Accounting Standards Board (FASB) for the reporting
of for-profit businesses. Thus, a lease that meets any one of the following criteria is a
capital lease for either a state or local government or a for-profit business.
a. The lease transfers ownership of the property to the lessee by the end of the lease
term.
b. The lease contains an option to purchase the leased property at a bargain price.
c. The lease term is equal to or greater than 75 percent of the economic life of the
leased property.
d. The present value of minimum lease payments equals or exceeds 90 percent of
the fair value of the leased property.
B. For a state or local government, the recording of a capital lease depends on the set of
financial statements being prepared.
a. In government-wide financial statements, a capital lease is reported as an asset
and liability at the present value of the minimum leases payments and then
depreciation expense (of the asset’s cost) and interest expense (on the liability
balance) are recognized over time.
b. In fund financial statements for the governmental funds, the present value of the
minimum lease payments is recorded as an expenditure and as an other financing
source. Eventual interest and principal payments are recorded as expenditures.
No depreciation is reported because capital assets are not recognized in the
governmental funds.
II. Governments often establish solid waste landfills for use by the citizens and businesses.
These facilities can be recorded either within the proprietary funds, if a user fee is
assessed, or as part of the General Fund if the landfill is open to the public without a
charge.
A. A landfill can eventually create a large liability for a government because of closure
costs and postclosure maintenance and monitoring.
B. On government-wide financial statements, recognition of this liability is based on
accrual accounting and the economic resource measurement focus. Thus, the liability is
recognized proportionally as the available space becomes filled. If the landfill is
recorded as an Enterprise Fund, this same reporting is also appropriate for fund
financial statements.
C. If the landfill is reported within the General Fund, a liability is only reported on the fund
statements when a claim to current financial resources comes into existence.
III. Many state and local government entities have defined benefit pension plans for their
employees such as school teachers and police officers. Pension trust funds are often set
up as fiduciary funds to manage the money and investments held to pay for these
pensions. As fiduciary funds, these pension trust funds are not included in government-
wide financial statements.
A. Government-wide financial statements must now report a net pension liability if the
present value of the estimated future payments that relate to past work is greater than
the net position of the pension trust fund. That is a net pension liability.
B. GASB requires that in most cases, but not all, the present value of the future benefits is
determined based on the estimated long-term investment yield for plan assets. That
decision has created a significant amount of controversy because it creates a lower
amount of reported debt.
C. The components to be recognized as pension expense are the service cost for the
current period, interest expense on the total pension liability, and projected earnings on
plan investments. In addition, any increases or decreases in the liability caused by
changes in benefit terms are also included in pension expense immediately.
IV. Works of art and historical treasures
A. Artworks, historical treasures, and similar assets should be capitalized at cost (or fair
value at the date of donation) in government-wide financial statements.
B. An expense rather than an asset can be recorded but only if the item does not generate
economic benefits and meets the following three criteria.
a. Held for public exhibition, education, or research in furtherance of public service,
rather than financial gain.
b. Protected, kept unencumbered, cared for, and preserved.
c. Subject to the policy that revenues generated from sales of items in the collection be
used to add to the collection.
C. If capitalized, depreciation is not required if this type of asset is considered to be
inexhaustible.
D. On fund financial statements for the governmental funds, expenditures are recognized
for any purchases because the acquired property is not a current financial resource.
V. Infrastructure Assets and Depreciation
A. Newly-acquired infrastructure assets (such as roads, bridges, and sidewalks) are
capitalized at historical cost in the government-wide financial statements and also in
fund financial statements for proprietary funds.
B. In fund financial statements for the governmental funds, these acquisitions are recorded
as expenditures.
B. If capitalized, depreciation of all capital assets other than land and inexhaustible
artworks is required.
C. Infrastructure assets are also subject to depreciation. However, the “modified
approach” allows the expensing of maintenance costs in lieu of depreciation for
infrastructure assets if specified criteria are met.
a. A minimum acceptable condition level is established for a network of infrastructure
assets and documentation is provided to verify that this minimum level has been
maintained.
b. An asset management system must be in place to monitor the condition of the items
in this system of assets.
VI. Primary governments produce a comprehensive annual financial report (CAFR) which
includes general purpose external financial statements. These statements are divided into
three distinct sections.
A. Management’s discussion and analysis (MD&A) which provides a broad range of
information to help decision-makers evaluate the operations and financial position of the
government entities.
B. Financial statements
a. Government-wide financial statements.
b. Fund financial statements.
c. Notes to the financial statements.
C. Other required supplementary information.
VII. In governmental accounting, a general purpose government (such as a city, town, county,
state or the like) is a primary government that must produce a CAFR. In creating this
CAFR, the government might also have to include component units which are legally
separate organizations or activities.
A. Any agency, board, or the like that meets either of the following two criteria is reported
as a component unit within the CAFR of the primary government even though the
separate organization is an independent operation.
a. It must be fiscally dependent upon the primary organization and the primary
government and the component unit must be financially interdependent (there is a
relationship of potential financial benefit or burden between the two of them) or
b. The primary government must appoint a voting majority of the governing board and
either be able to impose its will on the board or the separate organization provides a
financial benefit or imposes a financial burden on the primary government.
B. Once identified, component units can be discretely presented in a separate column on
the right side of the government-wide statements or blended with the primary
government as if it made up one of the funds within the primary government.
C. In addition, a special purpose government (such as a school board, university, or water
commission) qualifies as a primary government if it meets the following three criteria:
a. It has a separately elected governing body.
b. It is legally independent
c. It is fiscally independent of any other state and local governments
VIII. Government entities will occasionally combine. These transactions can be recorded as
acquisitions or as mergers.
A. In a merger, significant consideration is not exchanged. The governments simply
come together—often to form a new government unit. The net carrying value of all
assets, liabilities, deferred outflows of resources, and deferred inflows of resources
are retained. No excess consideration is paid nor recognized.
B. In an acquisition, significant consideration is exchanged. Assets, liabilities, deferred
outflows of resources, and deferred inflows of resources are recorded at acquisition
value—the amount required to buy or dispose of the items on that day. Any excess
consideration is recorded as a deferred outflow of resources and amortized to expense
over a period of time determined based on a number of factors.
IX. Public colleges and universities are required to meet GASB standards for reporting
purposes, whereas private schools are required to use FASB standards.
A. Private colleges and universities generally depend more on tuition and usually have
larger endowments whereas governments generally provide a major part of the support
for public schools.
A. GASB assumes public colleges and universities are special purpose entities so that
they must use the same reporting model as a state or local government. However,
many of these schools assume that they function solely as an Enterprise Fund (open to
the public for a user charge). Thus, they are allowed to produce fund financial
statements (for a proprietary fund) without need for government-wide statements. The
government-wide statements are viewed as redundant.
Answer to Discussion Question
Is It Part of the County?
In financial accounting for a for-profit organization, the boundary that defines the reporting entity
and its various activities (or subsidiaries) is relatively easy to determine. US GAAP provides the
basis for inclusion in consolidated financial statements, which includes all entities over which a
company has control.
Is the industrial development commission a component unit? An activity is classified as a
component unit if it is fiscally dependent on a primary government. In addition, the primary
by the county, the commission appears to qualify as a component unit for Harland County.
Can the commission also be a component unit of the state? Fiscal dependence is not present
but a component unit does exist if the primary government appoints a voting majority of the
board and (a) the primary government can impose its will on that board or (b) the separate
organization provides a financial benefit for the primary government or imposes a financial
burden. The state appoints 15 out of 20 of the board members. Appointment of that number of
board members indicates state control. However, no evidence or information is presented here
Answers to Questions
1. GASB has adopted the same rules as FASB to determine whether a lease is viewed as a
capital lease or as an operating lease. However, both GASB and FASB are currently
studying the possibility of changes in these rules.
A lease that meets any one of the following criteria is held to be a capital lease:
2. Within government-wide financial statements, the accounting for capitalized leases is the
same as for-profit enterprises. The asset and liability are recorded initially at the present
value of the minimum lease payments. Accrual accounting and the economic resource
measurement basis are appropriately followed. The equipment is increased along with the
liability obligation. Subsequently, both depreciation expense and interest expense must be
recognized. The entries in the fund financial statements are the same if a proprietary fund is
involved.
The recording of a capital lease in one of the governmental funds (within the fund financial
statements) involves the following three steps:
3. In government-wide financial statements, the lease payment is treated the same as in a for-
profit organization: part of the payment is considered interest and reported as an expense
with the rest viewed as a payment of the lease obligation.
4. Solid waste landfills can be a significant source of liability for many local governments. The
5. Government-wide financial statements recognize expenses on the accrual and economic
resource measurement basis. Therefore, seven percent of the expected landfill closure
6. Government-wide financial statements recognize expenses on the accrual and economic
resource measurement basis. At the end of the first year, 11 percent is multiplied times the
expected closing and other related costs and that figure is recognized as both an expense
and a liability. Current costs are used for this estimation process. At the end of the second
(b) some part of that liability represents a claim to current financial resources in this period.
7. The money set aside by this government for its retirement program is maintained in a
pension trust fund that will likely have a positive net position because of the money and
investments being held for future payments. At the same time, an estimate is made of the
8. For state and local government units, pension expense begins with the service cost for the
current year and is increased by interest expense on the amount of the obligation. The
resulting figure is then reduced by any projected earnings on plan investments. In addition,
any increases or decreases in the liability caused by changes in benefit terms are included
in pension expense immediately.
9. Governments should capitalize donated works of art, historical treasures, and similar assets
at the fair value at the date of the gift. However, if no charge is assessed for admission to
see the art, it is difficult to consider it an asset in a traditional sense because no direct
economic benefit is raised for the government. Thus, the artwork does not have to be
capitalized if all of the following criteria are met:
10. Revenue still must be reported because of the donation. If the government chooses not to
11. The modified approach is an alternative to depreciating infrastructure assets. This option
allows the government to expense all maintenance costs rather than record depreciation but
only if specified guidelines are met. The government must accumulate certain information
about the infrastructure assets within either a network or subsystem of a network. The
12. If the modified approach is applied, depreciation of infrastructure assets is not recorded but
all maintenance costs are expensed. Certain disclosures are required on the government-
13. A Management’s Discussion and Analysis (MD&A) similar to that found in for-profit financial
statements is required for state and local governments.The MD&A is presented before the
financial statements and provides the following information:
(1) A brief discussion of the financial statements and information provided and their
relationships to each other.
(2) Condensed financial information at least including
a. Total capital and other assets
b. Total long-term and other liabilities
(3) Overall financial position and results of operations
(4) Balances and transactions analyses with an explanation of significant changes
14. The Comprehensive Annual Financial Report (CAFR) includes three sections
a. Introductory Section
1. Letter of transmittal
2. Organizational chart
3. List of principal officers
15. A general purpose government is a traditional government such as a city, county, or state. A
special purpose government (such as a school system or transit authority) can also be a
primary government for reporting purposes if certain requirements are met.
Classification as a special purpose government requires meeting three criteria:
16. Classification as a component unit requires an organization to meet one of two criteria:
a. The activity is fiscally dependent on a primary government. It cannot determine its own
budget, levy and set tax rates, or issue bonded debt without outside approval. Further,
17. If blended, component units are included in the primary government as if they were part of
the government (one of its own funds). The component unit is legally separate but so
18. The two government-wide financial statements are the Statement of Net Position and the
Statement of Activities.
The Statement of Net Position includes:
a. All assets and long-term liabilities.
b. Capital assets net of accumulated depreciation including newly acquired infrastructure
assets.
d. Net expense or net revenue for each function.
e. Net expense or net revenue for each category of the government.
f. General revenues for governmental activities, business-type revenues, or component
units.
19. The two fund financial statements for the governmental funds are the Balance Sheet and the
Statement of Revenues, Expenditures, and Changes in Fund Balance. The Balance Sheet
measures current financial resources and uses modified accrual accounting and includes:
The Statement of Revenues, Expenditures, and Other Changes in Fund Balance includes:
a. The general fund and each major fund in separate columns, with all other funds
combined in another column.
20. Program revenues are those revenues derived from a specific program (such as parks and
recreation) or from outsiders seeking to contribute to the cost of that function. They include
charges rendered for services, operating grants and contributions, and capital grants and
contributions.
21. The net expense or net revenue format allows the readers of a government’s financial
22. On government-wide financial statements, internal service funds are combined with the
governmental activities (or business-type activities if that connection is more appropriate).
23. A combination is viewed as a merger if two legally separate entities are brought together to
form a new entity and no significant consideration is exchanged. A merger is also formed if
one of those entities ceases to exist while the other continues. In a merger, the net carrying
values for all assets, deferred outflows of resources, liabilities, and deferred inflows of
resources are combined. No additional account balances are recognized. However, in an
acquisition, a significant amount of consideration is exchanged. For government-wide
financial statements, the acquiring government records all of the acquired assets, deferred
24. In for-profit accounting, excess consideration paid in an acquisition is reported as goodwill
and then tested periodically for impairment. For a state or local government, excess
25. From an external reporting perspective, FASB sets accounting standards for private colleges
and universities whereas GASB sets standards for public schools. Operationally, public
26. Many public colleges and universities make the assumption that they are solely an
Enterprise Fund because they are open to the public but have a user charge (tuition and