Knowledge check

1. Which is correct regarding governmental fund revenues?
   1. Governmental funds receive revenues from a variety of sources.
   2. Normally, two of the smallest revenue sources for governmental funds are taxes and intergovernmental revenue.
   3. Governments report revenues by minor source.
   4. The amount of revenue estimated to be uncollectible is recorded as bad debt expenditure.

Nonexchange transactions

GASB Statement No. 33, Accounting and Financial Reporting for Nonexchange Transactions, provides guidance on recognizing both receivables and revenues for nonexchange transactions. Nonexchange transactions are transactions that do not involve an exchange of value. Most taxes and grants fall into this category. The GASB has classified nonexchange transactions into the following four categories:

1. Derived tax revenues — Taxes assessed on exchange transactions (for example, sales tax imposed on sales transactions and income tax imposed on earnings)
2. Imposed nonexchange transactions — Taxes assessed on something other than exchange transactions (most commonly, property taxes and fines and forfeitures)
3. Government-mandated nonexchange transactions — Resources provided by a higher-level government with the requirement that they be used for a purpose established by the higher-level government
4. Voluntary nonexchange transactions — Resources provided by legislative or contractual agreements (other than exchange) entered into willingly by the parties (for example, certain government grants and entitlements and donations)¹

GASB Statement No. 33 provides guidance on recording revenue for nonexchange transactions under both the accrual method (used by proprietary funds and for all activities reported in the government-wide statement) and for the modified accrual method (used by governmental funds).

The following table summarizes the guidance on reporting nonexchange transactions from GASB Statement No. 33:

Governments often share their own derived tax revenues or imposed nonexchange revenues with other governments. For example, a state may share a portion of its sales tax revenue with local governments. In this case, the local government would report this transaction using the guidance for government-mandated and voluntary nonexchange transactions.

Tax abatements are widely used by state and local governments to induce behavior by individuals and entities that is beneficial to the government or its citizens, such as in encouraging economic development. Financial statement users need information about certain limitations on a government’s ability to raise resources. GASB Statement No. 77, Tax Abatement Disclosures, requires disclosure of tax abatement information about (1) a reporting government’s own tax abatement agreements and (2) agreements entered into by other governments that reduce the reporting government’s tax revenues.

Knowledge check

2. Which statement is correct regarding nonexchange transactions?
   1. GASB Statement No. 33 provides guidance on recognizing both receivables and revenues for nonexchange transactions.
   2. Sales taxes are a type of imposed nonexchange revenue.
   3. Nonexchange transactions are transactions that involve an exchange of value.
   4. Property taxes are a type of government-mandated nonexchange transaction.

Investments

GASB Statement No. 72, Fair Value Measurement and Application, defines an investment as a security or other asset held primarily for the purpose of income or profit. A government-held investment has a present service capacity based solely on its ability to generate cash or to be sold to generate cash. GASB Statement No. 72 generally requires investments to be reported at fair value. However, certain investments are excluded from being measured at fair value, such as money market investments, qualified external investment pools, investments in life insurance contracts, common stock meeting the criteria for applying the equity method, unallocated insurance contracts, and synthetic guaranteed investment contracts.

GASB Statement No. 72 defines fair value as an exit price — the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This statement requires a government to use valuation techniques appropriate under the circumstances. These techniques should be consistent with at least one of the following approaches: the market approach, the cost approach, and the income approach.

Income on investments should be recorded as revenue when earned. The change in fair value should be reported as part of investment income. In addition, realized gain and losses should not be reported separately from unrealized gains and losses in the financial statements.

Debt service payments

The first exception deals with debt service payments on general long-term liabilities. Governmental entities typically budget resources to meet current-year principal and interest payment requirements. Recording accrued interest at year-end would not be consistent with how these costs are often budgeted. Therefore, expenditures for interest and principal payments should be recorded when they become due.

The exception to the exception: if a government provides resources during the current period to a debt service fund for a payment due early in the next fiscal year (but not more than one month), the government may record an expenditure for such interest and principal payment.

Inventories and prepaid items

A modification to the expenditures recognition is allowed for inventory of material and supplies. In general, purchases of material and supplies consume financial resources and should be recorded as an expenditure when purchased. This is known as the purchase method of accounting for inventories.

However, significant amounts of inventory should be reported as an asset even when the purchase method is used. A year-end adjusting entry for an inventory balance of $25,000 allows for significant amounts of inventory to be reported as both an expenditure and as an asset, as follows:

Because the entry does not adjust expenditures, the full amount of inventory purchased remains reported as an expenditure. Future year-end adjustments for inventory would be made to the same two accounts. For example, if inventory decreased by $3,000 the next year, a debit to nonspendable fund balance and a credit to inventory for $3,000 would be made.

Governments are also allowed to use the consumption method of accounting for inventories. This method is similar to the method businesses use. Expenditures would be reported when materials and supplies are used, not when purchased.

Governments also may use either the purchase or consumption method to report the prepayment of certain costs (such as insurance premiums). When the purchase method is used for prepaid items, however, there is no requirement to report significant amounts of prepaid items as an asset.

Leases

Issued in June 2017, GASB Statement No. 87, Leases, will be effective for reporting periods beginning after December 15, 2019. One of the principal changes this statement brings to accounting for leases is that it establishes a single model for lease accounting rather than the historical approach of classifying leases either as operating leases or as capital leases. In general, a lease asset and liability will be recorded for a contract that conveys 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” is hereinafter referred to as a “lease asset”) measured at the present value of payments expected to be made during the lease term.

Governments may account for lease activities in the general fund or in a special revenue fund. They may also account for the inception of the lease in a capital project fund and the lease payments in a debt service fund.

For governmental funds, this transaction is viewed as long-term borrowing to purchase the right-to-use an asset. This borrowing would be reported as an “other financing source”; the purchase of the right-touse an asset would be reported as an expenditure. Future lease payments would be reported as debt service expenditures.

Consider the following example:

A county enters into a 60-month lease agreement for equipment. The present value of payments expected to be made during the lease term is $300,000, which includes a $25,000 down payment made at the inception of the lease. The entry to record this transaction in a governmental fund is as follows:

For governmental funds, a lease asset and a lease liability are not reported.

Debt refunding

An example of a debt refunding occurs when new debt is issued to retire existing debt. Governments can use the proceeds of the new debt to immediately pay the old debt (current refunding) or place the proceeds with an escrow agent to invest until they are needed to pay the principal and interest of the old debt (advanced refunding).

In advanced refunding, the old debt is considered extinguished, or defeased, if it meets certain criteria. If the debt is considered defeased, the transaction is treated as a retirement of the old debt. If the criteria are not met, then both the old debt and new debt are reported by the government.

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. In such cases, a governmental fund should report a debt service expenditure for the payment into the trust.

For governmental funds, when the proceeds of refunding bonds are either used to redeem existing debt or placed with an escrow agent for the advanced refunding of existent debt, the payment should be reported as an “other financing use.” Debt repayment normally is reported as an expenditure; however, a debt refunding may distort the normal amount reported for debt service and is therefore reported separately as an other financing use. Consider the following example:

A county issues new bonds in the amount of $700,000 to advance-refund existing debt. The county is required to place $800,000 in escrow trust to service future debt payments of the existing debt. Entries to record this would be as follows:

Certain accrued liabilities not reported in governmental funds

Accrued liabilities for such things as salaries payable are recorded in governmental funds. These liabilities will be paid from available current financial resources of governmental funds. However, certain long-term liabilities will not require the use of currently available fund resources. These types of liabilities will not be recorded in the governmental funds until they become due, at which time an expenditure will be recorded.

This treatment applies to the following liabilities:

1. Claims, judgments, and compensated absences. The number of claims, judgments, and compensated absences recorded as expenditures in governmental funds shall be the amount accrued during the year that would normally be liquidated with expendable available financial resources. Because governmental fund balance sheets reflect current liabilities, only the current portion of the liability should be reported in the fund. The current portion is the amount left unpaid at the end of the reporting period that normally would be liquidated with expendable available financial resources. Governments, in general, are normally expected to liquidate liabilities with expendable available financial resources to the extent that the liabilities mature (come due for payment) each period. For example, compensated-absence liabilities are normally liquidated with expendable available financial resources; a governmental fund liability and expenditure should be recognized because payments come due each period on the occurrence of relevant events, such as employee resignations and retirements. The remainder of the liability should not be reported as liabilities in governmental funds but should be reported in the governmental activities column in the government-wide statement of net position.
2. Landfill closure and postclosure costs. For municipal solid waste landfills (MSWLFs) reported in governmental fund financial statements, the measurement of the liability for MSWLF closure and postclosure care should be consistent with proprietary funds. MSWLF expenditures and liabilities should be recognized in governmental funds using the modified accrual basis of accounting. Liabilities for MSWLF closure and postclosure care are normally liquidated with expendable available financial resources; a governmental fund liability and expenditure should be recognized because payments come due each period on receipt of goods and services used in the closure and postclosure care processes. The accumulation of earmarked net assets in a governmental fund for eventual payment of unmatured general long-term indebtedness, including landfill closure and postclosure care costs, does not constitute an outflow of current financial resources and should not result in the recognition of an additional governmental fund liability or expenditure. Long-term liabilities for MSWLF closure and postclosure care reported in governmental funds are general long-term liabilities and should be reported in the governmental activities column in the government-wide statement of net position. In the statement of revenues, expenditures, and changes in fund balances, facilities and equipment acquisitions included in estimated total current cost should be reported as closure and postclosure care expenditures.
3. Pension activities. Pension expenditures from governmental funds should be recognized on the modified accrual basis; that is, the amount recognized should be equal to the amount contributed to the plan or expected to be liquidated with expendable available financial resources. GASB Statement No. 68, Accounting and Financial Reporting for Pensions — An Amendment of GASB Statement No. 27, provides guidance for this type of cost.

   GASB Statement No. 68 requires that the liability of employers to employees for defined benefit pensions (net pension liability) be measured as the portion of the present value of projected benefit payments to be provided through the pension plan to current active and inactive employees attributed to those employees’ past periods of service (total pension liability) less the amount of the pension plan’s fiduciary net position. This liability is reported in the government-wide statements but not in governmental funds statements.

4. Postemployment benefits other than pensions (OPEB). Governments may offer postemployment benefits other than pension benefits, including postemployment healthcare and other nonpension benefits. In June 2015, the GASB issued Statement No. 75, Accounting and Financial Reporting for Postemployment Benefits Other Than Pensions. This statement replaces the requirements of Statement No. 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions, as amended, and Statement No. 57, OPEB Measurements by Agent Employers and Agent Multiple-Employer Plans, for OPEB.

   GASB Statement No. 75 requires that OPEB follow accounting and reporting requirements for pensions similar to those found under GASB Statement No. 68. It establishes standards for recognizing and measuring liabilities, deferred outflows and deferred inflows of resources, and expenses and expenditures. In governmental fund financial statements, a net OPEB liability is required to be recognized to the extent the liability is normally expected to be liquidated with expendable available financial resources.²

5. Termination benefits. Governments may provide benefits to hasten employees’ voluntary termination of services (such as early-retirement incentives). Governments also 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.

   In financial statements prepared on the modified accrual basis of accounting, liabilities and expenditures for termination benefits should be recognized to the extent the liabilities are normally expected to be liquidated with expendable available financial resources.

6. Pollution remediation obligations. Governments may have obligations to address the effects of existing pollution by participating in pollution remediation activities. GASB Statement No. 49, Accounting and Financial Reporting for Pollution Remediation Obligations, provides guidance for these types of costs.

   GASB Statement No. 49 excludes pollution prevention or control obligations with respect to current operations. The statement identifies five specific obligating events that would require a government to estimate the expected pollution remediation costs and to determine whether outlays for those components should be accrued as a liability or, if appropriate, capitalized when goods and services are acquired. These obligating events follow:

   1. The government is compelled to take pollution remediation action because of an imminent endangerment.
   2. The government violates a pollution prevention-related permit or license.
   3. The government is named, or evidence indicates that it will be named, by a regulator as a responsible party or potentially responsible party for remediation, or as a government responsible for sharing costs.
   4. The government is named, or evidence indicates that it will be named, in a lawsuit to compel participation in pollution remediation.
   5. The government commences or legally obligates itself to commence pollution remediation.

   GASB Statement No. 49 also provides guidance on how and when to measure the liability for pollution remediation costs.

   Regarding the display of goods and services used for pollution remediation activities in the governmental fund financial statements, amounts that are normally expected to be liquidated with expendable available financial resources should be recognized as liabilities on receipt of those goods and services. In the statement of revenues, expenditures, and changes in fund balances, any facilities and equipment acquisitions for pollution remediation activities should be reported as expenditures.

7. Nonexchange financial guarantees. Some governments extend financial guarantees for the obligations of another organization without directly receiving equal (or approximately equal) value in exchange (in other words, a nonexchange transaction). GASB Statement No. 70, Accounting and Financial Reporting for Nonexchange Financial Guarantees, issued in April 2013, provides guidance for these types of costs.

   GASB Statement No. 70 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 that range.

   Regarding their display in the governmental fund financial statements, liabilities and expenditures should be recognized for the amounts normally expected to be liquidated with expendable available financial resources when it is more likely than not that the government will be required to make a payment on the guarantee.

8. Asset retirement obligations. Governments may have obligations related to the legally enforceable liability associated with the retirement of a tangible asset. GASB Statement No. 83, Certain Asset Retirement Obligations, issued in November 2016, provides guidance for these types of costs.

   GASB Statement No. 83, which is effective for periods beginning after June 15, 2018, requires a government to 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.

   An obligating event refers to an event whose occurrence determines the timing for recognition of an ARO. An external obligating event includes one of the following:

   1. Approval of a federal, state, or local laws or regulations
   2. Creation of a legally binding contract
   3. Issuance of a court judgment

   An internal obligating event includes one of the following:

   1. For contamination-related AROs, the occurrence of contamination
   2. For noncontamination-related AROs, the event could be placing the asset into use, using the asset, or permanently abandoning the asset before it is placed into use
   3. For AROs related to acquired tangible capital assets, the event is the acquisition of the tangible capital asset

   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 should also 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.

   Regarding their display in the governmental fund financial statements, liabilities and expenditures should be recognized for the amounts normally expected to be liquidated with expendable available financial resources.

Knowledge check

3. Which statement is correct regarding governmental fund expenditures?
   1. The purchase of capital assets and payment of debt principal are recorded as investments.
   2. Expenditures are recognized in the period in which the fund liability is incurred.
   3. Governments report expenditures by minor source.
   4. The consumption method must be used for reporting the purchase of inventories.