Knowledge check

1. Which statement is correct regarding proprietary funds?
   1. Either an enterprise or an internal service fund can be used any time there is a fee charged for goods and services.
   2. Internal service funds may not be used to report an activity that provides goods or services to the general fund.
   3. Using a proprietary fund prohibits the government from measuring the cost of providing such goods and services.
   4. Governments are never required to use an enterprise fund.
2. Which statement is not correct regarding internal service funds?
   1. Internal service funds generally operate on a cost-reimbursement basis.
   2. Internal service funds should be used only when the reporting government is the predominant participant in the activity.
   3. Internal service funds are used to account for the general operations of a government.
   4. Internal service funds usually provide services to internal customers.

Debt refunding

Proprietary funds report debt refunding differently than do governmental funds. The reporting also differs from how a business reports such transactions. This is one case where GASB guidance (GASB Statement No. 23, Accounting and Financial Reporting for Refundings of Debt Reported by Proprietary Activities) differs from FASB guidance for business-type activities.

In a debt refunding, new debt is issued to retire existing debt. The old debt can either be redeemed or be considered defeased. Often the cost of retiring the old debt (either through redemption or defeasance) will be different than the carrying value of the old debt. The GASB requires that this difference be initially deferred as either a deferred inflow of resources or a deferred outflow of resources. The difference is then amortized over the remaining life of the old debt or the life of the new debt, whichever is shorter. The unamortized portion of the deferred amount is reported as an adjustment to the carrying value of the new debt. In contrast, the FASB requires that this difference be reported in the current-period income statement.

For example, a county water enterprise fund issues new bonds in the amount of $700,000 to advance-refund existing debt. The existing debt has a carrying value of $750,000. The county is required to place $800,000 in escrow trust to service the future debt payments of the existing debt. Journal entries follow.

Entry for sale of bonds:

Entry for payment to escrow agent:

GASB Statement No. 86, Certain Debt Extinguishment Issues, addresses when a government places cash and other monetary assets acquired with only existing resources in an irrevocable trust to extinguish the debt. The cost of retiring the old debt (either through redemption or defeasance) will often be different than the carrying value of the old debt. For financial statements using the economic resources measurement focus, GASB Statement No. 86 requires that this difference be reported separately as a gain or loss.

Pension cost

Pension cost is another area for which the GASB has issued separate guidance for governments. GASB Statement No. 68, Accounting and Financial Reporting for Pensions — An Amendment of GASB Statement No. 27, brought significant changes to how pension expense is measured and reported in proprietary funds and in government-wide statements. This statement uses an accounting approach instead of a funding approach to report pension costs.

GASB Statement No. 68 requires that the difference between a plan’s assets (plan net position) and the present value of projected benefits for past service (total pension liability) be reported as a net pension liability in the proprietary funds’ financial statements. In addition, this statement provides guidance on how to measure the plan’s assets, total pension liability, and pension expense.

GASB Statement No. 68 replaced the requirements of GASB Statement No. 27, Accounting for Pensions by State and Local Governmental Employers, as well as the requirements of GASB Statement No. 50, Pension Disclosures — An Amendment of GASB Statements No. 25 and No. 27, as they relate to pensions that are provided through pension plans administered as trusts or equivalent arrangements (hereafter jointly referred to as “trusts”) that meet certain criteria. GASB Statement No. 73, Accounting and Financial Reporting for Pensions and Related Assets That Are Not Within the Scope of GASB Statement 68, and Amendments to Certain Provisions of GASB Statements 67 and 68, provides guidance for pensions that are not covered by the scope of GASB Statement No. 68.

In addition, GASB Statement No. 71, Pension Transition for Contributions Made Subsequent to the Measurement Date — An Amendment of GASB Statement No. 68, provides transition guidance as governments implement GASB Statement No. 68. It corrects a potential understatement of beginning net position and pension expense in the year of implementation.

GASB Statement No. 71 requires governments to recognize a beginning deferred outflow of resources for its pension contributions made during the time between the measurement date of the beginning net pension liability and the beginning of the initial fiscal year of implementation.

GASB Statement No. 82, Pension Issues — An Amendment of GASB Statements No. 67, No. 68, and No. 73, addresses issues regarding the presentation of payroll-related measures in required supplementary information, the selection of assumptions and treatment of deviations from the guidance in an actuarial standard of practice (ASOP) for financial reporting purposes, and the classification of payments made by employers to satisfy employee (plan member) contribution requirements. GASB Statement No. 82 clarifies that a deviation from the ASOPs is also a deviation from generally accepted accounting principles.

GASB Statement No. 78, Accounting and Financial Reporting for Pensions, excludes certain pension plans from the scope of GASB Statement No. 68. It excludes pensions provided to employees of state or local governmental employers through a cost-sharing, multiple-employer defined benefit pension plan that (1) is not a state or local governmental pension plan, (2) is used to provide defined benefit pensions both to employees of state or local governmental employers and to employees of employers that are not state or local governmental employers, and (3) has no predominant state or local governmental employer (either individually or collectively with other state or local governmental employers that provide pensions through the pension plan).

Postemployment benefits other than pensions

Governments may offer postemployment benefits other than pension (OPEB) benefits, including postemployment healthcare and other non-pension benefits. GASB Statement No. 75, Accounting and Financial Reporting for Postemployment Benefits Other Than Pensions, requires that OPEB follow similar accounting and reporting requirements for pensions under GASB Statement No. 68.

GASB Statement No. 75 requires that the difference between a plan’s assets (plan net position) and the present value of projected benefits for past service (total OPEB liability) be reported as a net OPEB liability in the proprietary funds’ financial statements. In addition, GASB Statement No. 75 provides guidance on how to measure the plan’s assets, total OPEB liability, and OPEB expense.

This statement replaced the requirements of GASB Statement No. 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions.

Termination benefits

Governments may provide benefits to hasten employees’ voluntary termination of services (for example, early-retirement incentives). In addition, governments may provide benefits following involuntary terminations (such as severance benefits). GASB Statement No. 47, Accounting for Termination Benefits, provides guidance on these types of costs.

GASB Statement No. 47 generally requires governments to recognize a liability and expense for voluntary termination benefits when an offer is accepted and the amount can be estimated. A liability and expense should be recognized for involuntary termination benefits when the plan for termination has been approved by those with the authority to commit a government to the plan, the plan has been communicated to the employees, and the amount can be estimated. If a plan of involuntary termination requires that employees render future service to receive benefits, the employer should recognize a liability and expense for the portion of involuntary termination benefits that will be provided after completion of future service ratably over the employees’ future service period, beginning when the plan otherwise meets the recognition criteria.

Landfill

Governments often account for solid waste landfills in an enterprise fund. There are certain significant costs related to closing a landfill and monitoring the closed landfill. These costs are landfill closure and postclosure care costs and are accrued over the life of the landfill.

Closure and postclosure care costs should be estimated using current costs. The amount of expense recognized each period should be based on updated current cost data multiplied by the current estimate of the portion of the landfill capacity used, less the amount previously recorded. The following example reflects how the expense is determined:

This approach allows for any changes in estimates to be recorded in the current-period expense.

Risk financing

Governments often pool some of or all their risk financing activities. For example, governments may self-insure for worker compensation; they can account for this activity as part of the general fund or in a separate internal service fund. The accounting issue is how to account for the charges that an internal service fund collects for risk financing activities from other funds. Generally, internal service funds should record the amount charged to other funds as revenue.

However, the internal service fund should recognize revenue only to the extent that the amount charged to other funds is based on

1. probable and measurable losses for the period; or
2. charges based on some actuarial funding method; and
3. in addition to item 2 above, reasonable provision for anticipated catastrophic losses.

Any amount charged in excess of this should be reported as a transfer, not as revenue.

Payments in lieu of taxes

Because enterprise funds are part of the government, they usually do not pay taxes to that government. However, some governments charge enterprise funds an amount “in lieu of taxes.” If these payments represent charges for services received by the enterprise fund, they should be reported as an expense by the enterprise fund. Typically, no clear relationship exists between the amount charged in lieu of taxes and the services received. In this case, the payment should be reported as a transfer, not as an expense.

Payments in lieu of taxes should be evaluated to determine if they are, in substance, a tax abatement that should be disclosed in accordance with GASB Statement No. 77, Tax Abatement Disclosures.

Interest capitalization

Proprietary funds often finance the construction of capital assets with tax-exempt debt or grants.

The amount of interest that should be capitalized when tax-exempt debt is used is limited to the difference between the interest costs incurred during construction and any interest earned on the proceeds of the debt issued. In the case of projects financed with capital grants, no interest should be capitalized.

For example, a county water enterprise fund has a major capital project underway funded by $1 million in grants and $4 million in tax-exempt bonds. During the year, the county spent $2.5 million on the project. The bonds were issued at the beginning of the year and interest on the bonds for the year totaled $160,000. The proceeds from the bonds were invested and earned interest income of $110,000.

The water enterprise fund should capitalize $50,000. This is the difference between the interest costs of $160,000 and the interest earned of $110,000. No interest should be capitalized related to the grant.

GASB Statement No. 89, Accounting for Interest Cost Incurred before the End of a Construction Period, removes the requirement to capitalize interest costs incurred before the end of a construction period; such costs are expensed. The requirements of this statement are effective for reporting periods beginning after December 15, 2019; earlier application is encouraged. The requirements of this statement should be applied prospectively.

Leases

GASB Statement No. 87, Leases, was issued in June 2017 and is effective for reporting periods beginning after December 15, 2019. One of the principal changes this statement brings to accounting for leases its establishment of a single model for lease accounting rather than the historical approach of classifying leases as either operating or capital leases. In general, a lease asset and liability will be recorded for a contract that conveys control of the right to use another entity’s nonfinancial asset (the underlying asset) for longer than 12 months. A lessee should recognize a lease liability and an intangible right-to-use the lease asset (a capital asset, hereinafter referred to as the “lease asset”) measured at the present value of payments expected to be made during the lease terms.

A lessee should reduce the lease liability as payments are made and recognize an expense for interest on the liability. The lessee should amortize the lease asset in a systematic and rational manner over the shorter of the lease term or the useful life of the underlying asset.

Contributed capital and special items

Proprietary funds often receive grants to purchase capital assets. This type of revenue should be displayed separately as “capital contribution” and reported after nonoperating revenue and expenses in the statement of revenues, expenses, and changes in net position. Proprietary funds also report “special items” in a manner similar to capital contributions.

Pollution remediation obligations

GASB Statement No. 49, Accounting and Financial Reporting for Pollution Remediation Obligations, sets forth the key circumstances under which a government would be required to report a liability related to pollution remediation. According to the statement, a government would have to determine whether one or more components of a pollution remediation liability are recognizable.

GASB Statement No. 49 indicates that pollution remediation liabilities should be measured at their current value using the expected cash flow technique, which measures the liability as a sum of probability-weighted amounts in a range of possible estimated amounts. Expected recoveries from other responsible parties and from insurers reduce the amount of remediation expense. GASB Statement No. 49 also specifies criteria for capitalization of some pollution remediation outlays.

Asset retirement obligations

GASB Statement No. 83, Certain Asset Retirement Obligations, sets forth the key circumstances under which a government would be required to report a liability related to an asset retirement. According to the statement, a government would recognize an asset retirement obligation (ARO) when the liability is incurred and reasonably estimable. A liability is incurred by the occurrence of both an external obligating event and an internal obligating event resulting from normal operations.

The measurement of an ARO should be based on the best estimate of the current value of outlays expected to be incurred. When an ARO is recognized, a government also should recognize a corresponding deferred outflow of resources. A government should recognize a reduction of the deferred outflow of resources as an outflow of resources (for example, expense) in a systematic and rational manner over a period of time.

GASB Statement No. 83 is effective for periods beginning after June 15, 2018.

Intangible assets

GASB Statement No. 51, Accounting and Financial Reporting for Intangible Assets, provides guidance regarding how to identify, account for, and report intangible assets. GASB Statement No. 51 requires that all intangible assets not specifically excluded by its scope provisions (see following chart) be classified as capital assets.

Accordingly, existing authoritative guidance related to accounting and financial reporting for capital assets should be applied to intangible assets covered by GASB Statement No. 51, as applicable. GASB Statement No. 51 provides authoritative guidance that specifically addresses the nature of these intangible assets. Such guidance should be applied in addition to existing authoritative guidance for capital assets.

GASB Statement No. 51 requires that an intangible asset be recognized in the statement of net position only if it is considered identifiable. An intangible asset is considered identifiable when either of the following conditions is met:

• The asset is separable; that is, the asset is capable of being separated or divided from the government and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, asset, or liability.
• The asset arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.

GASB Statement No. 51 establishes a specified-conditions approach to recognizing intangible assets that are internally generated. Effectively, outlays associated with the development of such assets should not begin to be capitalized until certain criteria are met. Outlays incurred prior to meeting these criteria should be expensed as incurred. GASB Statement No. 51 also provides guidance on recognizing internally generated computer software as an intangible asset.

GASB Statement No. 51 establishes guidance specific to intangible assets related to amortization and discusses issues related to impairment.

Derivative instruments

GASB Statement No. 53, Accounting and Financial Reporting for Derivative Instruments, requires governments to measure most derivative instruments at fair value as assets or liabilities in their accrual-based, government-wide, proprietary fund and fiduciary fund financial statements (but not in the governmental fund financial statements). The fair value of a derivative instrument is either the value of its future cash flows in today’s dollars or the price it would bring if it could be sold on an open market.

In general, the fair value of a derivative instrument as of the end of the period covered by the financial statements will be reported in the statement of net position (balance sheets). Changes in fair value should be reported in the resource flows statements (such as the statement of activities) as investment gains or losses. However, annual changes in the fair value of a hedging derivative instrument should be reported as deferred inflows or deferred outflows on the statements of net position.

Service concession arrangement

GASB Statement No. 60, Accounting and Financial Reporting for Service Concession Arrangements, provides guidance on certain public-private or public-public partnerships. A service concession arrangement (SCA) is an arrangement that meets all the following criteria:

• The transferor conveys to the operator the right and related obligation to provide public services through the operation of a capital asset in exchange for significant consideration, such as an up-front payment, installment payments, a new facility, or improvements to an existing facility.
• The operator collects and is compensated from fees from third parties.
• The transferor determines or has the ability to modify or approve what services the operator is required to provide, to whom the operator is required to provide the services, and the prices or rates that can be charged for the services.
• The transferor is entitled to significant residual interest in the service utility of the facility at the end of the arrangement.

The transferor would continue to report any capital asset transfer to the operator. If the facility associated with an SCA is a new facility purchased or constructed by the operator or an existing facility that has been improved by the operator, then the transferor should report the new facility or the improvement as a capital asset at fair value when it is placed in operation.

The transferor should report the up-front payment or the present value of installment payments as an asset and any contractual obligations recorded as liabilities along with a related deferred inflow of resources. Revenue should be recognized as the deferred inflow of resources is reduced. This revenue should be recognized in a systematic and rational manner over the term of the arrangement, beginning when the facility is placed into operation.

Nonexchange financial guarantees

Some governments extend financial guarantees for the obligations of another organization without directly receiving equal or approximately equal value in exchange (a nonexchange transaction). GASB Statement No. 70, Accounting and Financial Reporting for Nonexchange Financial Guarantees, provides guidance for these types of costs.

This statement requires a government that extends a nonexchange financial guarantee to recognize a liability when qualitative factors and historical data, if any, indicate that it is more likely than not that the government will be required to make a payment on the guarantee. The amount of the liability to be recognized should be the discounted present value of the best estimate of the future outflows related to the guarantee expected to be incurred. When there is no best estimate, but a range of the estimated future outflows can be established, the amount of the liability to be recognized should be the discounted present value of the minimum amount within the range.

Certain accrued liabilities

Governmental funds do not accrue certain long-term liabilities. Unlike governmental funds, proprietary funds should report all accrued liabilities. This includes liabilities for claims and judgments, compensated absences, landfill closure and postclosure costs, net pension liabilities, OPEB, termination benefits, pollution remediation obligations, and asset retirement obligations.

Knowledge check

3. Which is not one of the three categories in which proprietary funds report net position on a balance sheet or a statement of net position?
   1. Net income.
   2. Restricted net position.
   3. Net investment in capital assets.
   4. Unrestricted net position.