Specific Application of the Requirements of GASBS 31

Except as discussed in the following paragraphs, GASBS 31 requires that governmental entities, including governmental external investment pools, report investments at fair value in the balance sheet or statement of financial position. Fair value is the amount at which an investment could be exchanged in a current transaction between willing parties, other than in a forced liquidation or sale.

Generally, if a quoted market price is available for an investment, the fair value is calculated by multiplying the market price per share (or other trading unit) by the number of shares (or trading units) owned by the governmental entity. If an entity has purchased put option contracts or written call option contracts on securities, and it has those same securities among its investments, it should consider those contracts in determining the fair value of those securities to the extent that it does not report those contracts at fair value.

There are several exceptions to the general rule of reporting investments within the scope of GASBS 31 at fair value. These exceptions are described in the following paragraphs.

Interest‐earning investment contracts. Valuation of investments in interest‐earning investment contracts depends on whether the contracts held by the government are participating contracts or nonparticipating contracts.

• Participating contracts are investments whose value is affected by market changes that are tied to interest rate changes. If these contracts are negotiable or transferable, or if their redemption value considers market rates, they should be considered participating. Investments in participating contracts should generally be valued in the financial statements at fair value. However, participating interest‐earning investment contracts that have a remaining maturity at the time of purchase of one year or less may be reported at amortized cost, provided that the fair value of the investment is not significantly affected by the impairment of the credit standing of the issuer or by other factors. (Note that the remaining maturity to be considered is that at the time the investment was purchased, not the remaining maturity at the balance sheet date.) Looking at the most extreme instance, if the counterparty to the contract declares bankruptcy and the fair value of the participating interest‐bearing investment contract falls significantly, amortized cost would not be an appropriate measure for including this investment in the financial statements, even if the other conditions above are met. Also note that in determining the remaining maturity in applying the above test, it is the remaining maturity at the time of purchase, not the original maturity of the investment, which is considered. Accordingly, a five‐year negotiable participating interest‐bearing investment contract purchased six months before its maturity would meet the above test of having a remaining maturity of less than one year.
• Nonparticipating contracts are those such as nonnegotiable certificates of deposit, where the redemption terms do not consider market rates. Nonparticipating interest‐earning investment contracts should be reported in the financial statements using a cost‐based measure, provided that the fair value of those contracts is not significantly affected by the impairment of the credit standing of the issuer or other factors.

Money market investments. Money market investments are short‐term, highly liquid debt instruments, including commercial paper, bankers’ acceptances, and U.S. Treasuries and agency obligations. GASBS 31 does not include derivative securities within its definition of money market investments, nor does it include either of the following:

• Asset‐backed securities, which are assets composed of, or collateralized by, loans or receivables. Collateralization can consist of liens on real property, leases, or credit‐card debt.
• Structured notes, which are debt securities whose cash flow characteristics (such as coupon, redemption amount, or stated maturity) depend on one or more indexes, or that have embedded forwards or options.

Money market investments generally should be reported in the financial statements at fair value. Money market investments that have a remaining maturity at the time of purchase of one year or less may be reported at amortized cost, provided that the fair value of the investment is not significantly affected by the impairment of the credit standing of the issuer or by other factors. This exception is similar to that described above for participating interest‐earning investment contracts.

External investment pools. For investments in external investment pools that are not registered with the SEC, regardless of sponsorship by a governmental entity (such as bank short‐term investment funds, which are nongovernmental pools not required to be registered with the SEC), fair value should be determined by the fair value per share of the pool’s underlying portfolio, unless it is a 2a7‐like pool, discussed below. Legally binding guarantees provided or obtained by the pool sponsor to support share value should be considered in determining the fair value of the participants’ investments and should be evaluated in light of the creditworthiness of the sponsor. If a governmental entity cannot obtain information from a pool sponsor to allow it to determine the fair value of its investment, it should estimate the fair value of that investment and make the disclosures discussed later in this chapter.

A 2a7‐like pool is an external investment pool that is not registered with the SEC as an investment company but has a policy that it operates in a manner consistent with the SEC’s Rule 2a7 of the Investment Company Act of 1940. Rule 2a7 allows SEC‐registered mutual funds to use amortized cost rather than market value to report net position to compute share prices, if certain conditions are met. Those conditions include restrictions on the types of investments held, restrictions on the term‐to‐maturity of individual investments and the dollar‐weighted average of the portfolio, requirements for portfolio diversification, requirements for divestiture considerations in the event of security downgrades and defaults, and required actions if the market value of the portfolio deviates from amortized cost by a specified amount. Investment positions in 2a7‐like pools should be determined by the pool’s share price.

The GASB issued Statement No. 59 (GASBS 59), Financial Instruments Omnibus, to make slight changes to the language of GASBS 31 to make clear that the intent of the GASB is for 2a7‐like pools to meet the requirements of SEC Rule 2a7 for mutual funds. Accordingly, the following paragraph replaces the similar requirements of that of GASBS 31 and addresses the SEC’s Rule 2a7 references to boards of directors and their responsibilities:

Investments in 2a7‐like pools should be measured at the net asset value per share provided by the pool. A 2a7‐like pool is an external investment pool that operates in conformity with the Securities and Exchange Commission’s (SEC) Rule 2a7 as promulgated under the Investment Company Act of 1940, as amended. The net asset value per share generally is calculated on a basis other than fair value, such as by the “amortized cost” method that provides a net asset value per share that approximates fair value. To qualify as a 2a7‐like pool, the pool should satisfy all SEC requirements of Rule 2a7, including that a group of individuals fulfills the functions of a board of directors. The following conditions do not preclude a pool from being considered 2a7‐like:

1. The principal executive officer of the pool, who can be an elected official, has the power to enter into contracts and make personnel decisions: however, investment policies should nevertheless be set by the group of individuals that fulfills functions of a board of directors.
2. The pool is not required to register with the SEC.

In addition, the GASB issued Statement No. 79 (GASBS 79), Certain External Investment Pools and Pool Participants. Rule 2a7 was significantly amended in 2014 to essentially result in these external investment pools to report their net asset value at fair value. The GASB desired to allow pools that previously were reported at net asset value based upon amortized cost to continue to do so. As such, GASB established requirements, through GASBS 79, whereby pools meeting the requirement could continue to report their net asset value using amortized cost.

Compliance with Amortized Cost Criteria

GASBS 79 provides that an external investment pool may elect to measure for financial reporting purposes all of its investments at amortized cost if it meets all of the following criteria, each of which are described in greater detail below:

1. Transacts with its participants at a stable net asset value per share (for example, all contributions and redemptions are transacted at $1.00 net asset value per share).
2. Meets the portfolio maturity requirements.
3. Meets the portfolio quality requirements.
4. Meets the portfolio diversification requirements.
5. Meets the portfolio liquidity requirements.
6. Meets the shadow pricing requirements.

GASBS 79 notes that an external investment pool that is significantly noncompliant with any of these criteria during the reporting period generally should not measure for financial reporting purposes all of its investments at amortized cost for that reporting period. Instead, that pool should apply the provisions of GASBS 31, as amended. Such a pool may still report short‐term debt investments with remaining maturities of up to 90 days at the reporting date at amortized cost, provided that the fair value of those investments is not significantly affected by the impairment of the credit standing of the issuer or by other factors.

GASBS 79 provides that professional judgment should be used to determine if the noncompliance, individually or in the aggregate, is significant. Factors that may indicate the noncompliance is significant include, but are not limited to:

1. The noncompliance was not promptly identified.
2. The noncompliance was due, at least in part, to factors within the control of the external investment pool’s management.
3. The noncompliance was not an isolated incident.
4. Necessary corrective or remedial action was not promptly taken.

Under GASBS 79, when an external investment pool did not measure all of its investments at amortized cost for financial reporting purposes in the previous reporting period, the pool may make an election to change from fair value measurement to amortized cost‐based measurement in the subsequent reporting period, only if the pool meets all the criteria specified above and justifies a change in accounting principle as prescribed in paragraphs 73 and 74 of Statement No. 62, Codification of Accounting and Financial Reporting Guidance Contained in Pre–November 30, 1989 FASB and AICPA Pronouncements.

Portfolio Maturity Requirements

In order to measure for financial reporting purposes all of its investments at amortized cost, a qualifying external investment pool should meet certain portfolio maturity requirements contained in GASBS 79. A qualifying external investment pool should maintain its portfolio maturity consistent with a stable net asset value per share, as provided in this section.

GASBS 79 provides the following:

• A qualifying external investment pool should acquire a security or other investment only if the investment has a remaining maturity of 397 calendar days or less.
• The portfolio of a qualifying external investment pool should maintain a weighted average maturity of 60 days or less. A weighted average maturity measure expresses investment time horizons—the time when investments become due and payable—in this case, days weighted to reflect the dollar size of individual investments. However, certain maturity shortening features, such as interest rate resets, should be taken into account. Those features are described below.
• The portfolio of a qualifying external investment pool should maintain a weighted average life of 120 days or less. A weighted average life measure expresses the average length of time that each dollar of principal remains unpaid without taking into account the maturity shortening features used in calculating the weighted average maturity.

For the purposes of applying the requirements above, GASBS 79 provides that the maturity of a security or other investment should be the period remaining until the date on which the total or remaining principal amount is required to be unconditionally repaid in accordance with the terms of the investment, unless the investment is one of the types described in the following paragraphs. If a security or other investment is subject to a demand feature and the qualifying external investment pool is not relying on that demand feature, that demand feature should be disregarded for the purposes of determining maturity.

GASBS 79 provides that if a security or other investment has a variable interest rate (one that changes on set dates) and its carrying value approximates fair value, the maturity of that security should be determined as follows:

1. The maturity of a U.S. government security, including its agencies and instrumentalities, and any certificates of deposit insured by the U.S. government or its agencies and instrumentalities, should be the period remaining until the next readjustment of the interest rate.
2. The maturity of an investment that is not a U.S. government security and for which the principal amount is due in 397 calendar days or less should be the shorter of the period remaining until the next readjustment of the interest rate or the period remaining until the principal amount can be recovered through demand.
3. The maturity of an investment that is not a U.S. government security and for which the principal amount is due in more than 397 calendar days should be the longer of the period remaining until the next readjustment of the interest rate or the period remaining until the principal amount can be recovered through demand.

If a security or other investment has a floating interest rate (one that changes based on an index or other market conditions, which may reset daily or at another frequency) and its carrying value approximates fair value, GASBS 79 provides that the maturity of that security should be determined as follows:

1. The maturity of a U.S. government security, including its agencies and instrumentalities, and any certificates of deposit insured by the U.S. government or its agencies and instrumentalities, should be one day.
2. The maturity of an investment that is not a U.S. government security and for which the principal amount is due in 397 calendar days or less should be the shorter of the period remaining until the interest rate resets or the maturity date of the investment.
3. The maturity of an investment that is not a U.S. government security and for which the principal amount is due in more than 397 calendar days should be the period remaining until the principal amount can be recovered through demand.

The maturity of a repurchase agreement or a portfolio lending agreement should be either (a) the period remaining until the date on which the repurchase (or return) of the underlying securities is scheduled to occur or (b) the duration of the notice period applicable to a demand for the repurchase (or return) of the securities, such as a put option.

In addition, the maturity of an investment in a money market fund or in another external investment pool should be the period within which the fund or the pool is required to make a payment upon redemption.

Portfolio Quality Requirements

GASBS 79 notes that an investment should be acquired by a qualifying external investment pool only if it presents minimal credit risk as provided in the following paragraphs.

A security that has been rated by a nationally recognized statistical rating organization (NRSRO) should be acquired only if the security is denominated in U.S. dollars and has a credit rating within the highest category of short‐term credit ratings (or its long‐term equivalent category). The highest category of short‐term credit ratings (or its long‐term equivalent category) as established by an NRSRO may have multiple subcategories or gradations indicating relative standing (that is, several different ratings may constitute the single highest category). If an external investment pool is aware that a security has multiple ratings and the rating categories conflict, the following provisions apply:

1. If a security has two ratings, the security should be considered to be in the lower category.
2. If a security has more than two ratings, the security should be considered to be in the highest category of ratings as determined by at least two ratings.

A security that has not been rated by any NRSRO may be acquired only if the security is denominated in U.S. dollars and is determined (based upon the qualifying external investment pool’s analysis) to be of comparable credit quality to securities that have been rated within the highest category of short‐term credit ratings (or its long‐term equivalent category).

GASBS 79 provides that a qualifying external investment pool may continue to hold a security that meets the qualifications in the two paragraphs above at acquisition but subsequently experiences a decline in credit quality if, at the reporting date, the pool holds no more than 3% of its total assets in the following:

1. Securities that have credit ratings within the second‐highest category of short‐term credit ratings (or its long‐term equivalent category), and
2. Securities that are not rated but are determined to be of comparable credit quality to securities that have been rated within the second‐highest category of short‐term credit ratings (or its long‐term equivalent category).

At the reporting date, a qualifying external investment pool should not hold any security that has a credit rating below the second‐highest category of short‐term credit ratings (or its long‐term equivalent category) or is determined to be of comparable credit quality to a security that has been rated below the second‐highest category of short‐term credit ratings (or its long‐term equivalent category).

In addition, a security or other investment subject to a guarantee should be considered to have met the rating requirements described above if one of the following criteria is met:

1. The guarantee has received a credit rating within the highest category of short‐term credit ratings (or its long‐term equivalent category) or, if no credit rating is available, is determined (based upon the qualifying external investment pool’s analysis) to be of comparable quality.
2. The guarantor has obtained a credit rating within the highest category of short‐term credit ratings (or its long‐term equivalent category) or, if no credit rating is available, is determined (based upon the qualifying external investment pool’s analysis) to be of comparable quality. However, if a security or other investment is subject to a guarantee and the qualifying external investment pool is not relying on that guarantee, that guarantee should be disregarded for the purposes of determining quality.

GASBS 79 provides that a security or other investment subject to a conditional demand feature may be acquired if, in addition to meeting the credit rating requirements discussed above, the conditional demand feature has received a credit rating within the highest category of short‐term credit ratings (or its long‐term equivalent category) or, if no credit rating is available, is determined (based upon the qualifying external investment pool’s analysis) to be of comparable quality. If a security or other investment is subject to a demand feature and the qualifying external investment pool is not relying on that demand feature, that demand feature should be disregarded for the purposes of determining quality.

In addition, securities held by a qualifying external investment pool should not be exposed to custodial credit risk as described by paragraph 9 of Statement 40.

GASBS 79 also provides that the credit quality of a deposit should be evaluated in terms of either the credit quality of the depository institution or the exposure of the deposit to custodial credit risk. A deposit should be one of the following:

1. Held by a depository institution with a credit rating within the highest category of short‐term credit ratings (or its long‐term equivalent category) or determined (based upon the qualifying external investment pool’s analysis) to be of comparable quality. If the depository institution has multiple ratings, the quality determination requirements described above should be applied.
2. Insured or collateralized such that it is not exposed to custodial credit risk as described in paragraph 8 of Statement 40.

The credit quality of a repurchase agreement should be evaluated in terms of the credit quality of the counterparty or its parent and in terms of the credit quality of the underlying collateral. Any underlying collateral should meet the applicable credit quality requirements of described above. In addition, a counterparty or its parent should meet one of the following criteria:

1. Be a primary dealer as defined by the Federal Reserve Bank of New York.
2. Have a credit rating within the highest category of short‐term credit ratings (or its long‐term equivalent category), following the quality determination requirements provided earlier.
3. Be determined (based upon the qualifying external investment pool’s analysis) to be of comparable quality to (b).

A repurchase agreement should be collateralized fully by meeting both of the following criteria:

1. The fair value of the securities collateralizing the repurchase agreement (including loss of interest that the qualifying external investment pool reasonably could expect to incur if the counterparty defaults) is at least equal to the resale price provided in the repurchase agreement.
2. The securities collateralizing the repurchase agreement are not exposed to custodial credit risk.

Portfolio Diversification Requirements

In accordance with GASBS 79, a qualifying external investment pool should acquire a security or other investment only if, after acquisition, the external investment pool would hold no more than 5% of its total assets in investments of any one issuer of securities subject to the additional requirements set forth below.

GASBS 79 notes that some securities or other investments have credit support in the form of a guarantee or through a demand feature. A qualifying external investment pool should acquire a security or other investment with credit support only if, after acquisition, the qualifying external investment pool would hold no more than 10% of its total assets with any one issuer of credit support. An issuer of credit support also can be an issuer of securities or other investments. In that case, the securities or other investments to which the issuer has pledged credit support should be combined with the securities or other investments of the issuer itself so that the combined position related to that issuer is limited to no more than 10% of the pool’s total assets. However, if a security or other investment is subject to a demand feature or guarantee and the external investment pool is not relying on that demand feature or guarantee, that demand feature or guarantee should be disregarded for the purposes of determining portfolio diversification.

GASBS 79 also provides that if a qualifying external investment pool holds securities at the reporting date with credit ratings within the second‐highest category of short‐term credit ratings (or its long‐term equivalent category), such securities of any one issuer should be no more than one‐half of 1% of the pool’s total assets. If such securities are subject to demand features or guarantees, the qualifying external investment pool should hold at the reporting date no more than 2.5% of its total assets in such securities from any one provider of demand features or guarantees. If a security or other investment is subject to a demand feature or guarantee and the qualifying external investment pool is not relying on that demand feature or guarantee, that demand feature or guarantee should be disregarded for the purposes of determining portfolio diversification.

GASBS 79 notes that U.S. government securities, including its agencies and instrumentalities, and any certificates of deposit insured by the U.S. government or its agencies and instrumentalities are exempt from the diversity calculations described above.

For the purposes of calculating the diversification limits GASBS 79 provides, the following additional considerations should be made:

1. Two or more issuers of securities should be considered to be a single issuer if one issuer controls the other or the two issuers are under common control. Control is assumed to be present if one entity owns more than 50% of the issuer’s voting securities.
2. The acquisition of a repurchase agreement should be considered to be the acquisition of the underlying securities if the repurchase obligation is collateralized fully without regard to maturity date.
3. The acquisition of a refunded security should be considered to be the acquisition of the escrowed securities.
4. A conduit debt obligation as described in paragraph 2 of Interpretation No. 2, Disclosure of Conduit Debt Obligations, should be considered to be issued by the entity responsible for the payments related to the obligation rather than the governmental issuer.
5. An asset‐backed security should be considered to be issued by the entity that issued the security except:
   1. If the obligations of a single entity constitute 10% or more of the assets that back the security, that entity itself should be considered to be the issuer of that portion of the asset‐backed security. For example, an external investment pool holds asset‐backed commercial paper that is 3% of the external investment pool’s total assets. Fifteen percent of the assets that back the commercial paper are receivables from a single bank. For purposes of the diversification calculation, 0.45% of the pool’s total assets are considered to be issued by that bank.
   2. If some or all of the assets that back the security are themselves asset‐backed securities (secondary asset‐backed securities), any entity that issues obligations constituting 10% or more of the assets that back the secondary securities should be considered to be the issuer of that portion of the asset‐backed security. For example, an external investment pool holds asset‐backed commercial paper that is 3% of the pool’s total assets. Twenty percent of the assets that back the commercial paper are other asset‐backed securities (secondary securities). Fifteen percent of the assets that back the secondary securities are receivables from a single bank. For purposes of the diversification calculation, 0.09% of the pool’s total assets are considered to be issued by that bank.

Portfolio Liquidity Requirements

GASBS provides that qualifying external investment pool should hold liquid assets sufficient to meet reasonably foreseeable redemptions. This determination may be based on the pool’s knowledge of the expected cash needs of its participants. A qualifying external investment pool should only acquire a security or investment if, after acquisition, the external investment pool meets the additional requirements set forth in GASBS 79 below.

A qualifying external investment pool should acquire an illiquid investment only if, after acquisition, the qualifying external investment pool would hold no more than 5% of its total assets in illiquid investments. GASBS 79 defines an illiquid investment is an investment that cannot be sold or disposed of in the ordinary course of operations at its amortized cost value within five business days. GASBS 79 uses the example of a nonparticipating interest earning investment contract as described in GASBS 31—such as a nonnegotiable certificate of deposit that does not mature within five business days—is an illiquid investment.

A qualifying external investment pool should acquire a security or other investment only if, after acquisition, the qualifying external investment pool would hold at least 10% of its total assets in daily liquid assets.

Under GASBS 79, only the following are daily liquid assets:

1. Cash, including demand deposits and certificates of deposit that mature within one business day.
2. U.S. government securities that are direct obligations.
3. Securities that will mature within one business day, with maturity determined without taking into account the maturity shortening features described in the maturity requirements section above.
4. Securities subject to a demand feature that is exercisable and payable within one business day.
5. Amounts receivable and due unconditionally within one business day on pending sales of portfolio securities.

GASBS 79 also provides that a qualifying external investment pool should acquire a security or other investment only if, after acquisition, the qualifying external investment pool would hold at least 30% of its total assets in weekly liquid assets.

Under GASBS 79, only the following are weekly liquid assets:

1. Cash, including demand deposits and certificates of deposit that mature within five business days and are expected to be held to maturity.
2. U.S. government securities that are direct obligations.
3. Securities that (1) are U.S. government securities that are not direct obligations, (2) are issued at a discount without provision for the payment of interest, and (3) have a remaining maturity of 60 days or less.
4. Securities that will mature within five business days, with maturity determined without taking into account the maturity shortening features described in the maturity requirements section above.
5. Securities subject to a demand feature that is exercisable and payable within five business days.
6. Amounts receivable and due unconditionally within five business days on pending sales of portfolio securities.

The liquidity of an investment in a money market fund or another external investment pool should be evaluated consistent with any redemption gates or other limitations. GASBS 79 uses the example that an investment in another external investment pool that imposes a five‐business‐day redemption notice period is considered a weekly liquid asset.

If a security or other investment is subject to a demand feature or guarantee and the qualifying external investment pool is not relying on that demand feature or guarantee, that demand feature or guarantee should be disregarded for the purposes of determining portfolio liquidity.

Shadow Pricing Requirements

GASBS 79 defines shadow price as the net asset value per share of a qualifying external investment pool, calculated using total investments measured at fair value at the calculation date.

GASBS 79 provides that a qualifying external investment pool should calculate its shadow price at a minimum on a monthly basis. The monthly calculation of the shadow price should occur no earlier than five business days prior to and no later than the end of the month. At each calculation date, that shadow price should not deviate by more than one half of 1% from the net asset value per share calculated using total investments measured at amortized cost.

Accounting and Financial Reporting for Participants in External Investment Pools

While the above discussion focuses on the requirements for an external investment pool to use amortized cost to compute its net asset value, GASBS 79 also logically provides that if an external investment pool meets these criteria and measures all of its investments at amortized cost, the pool’s participants also should measure their investments in that external investment pool at amortized cost for financial reporting purposes. If an external investment pool does not meet the criteria, the pool’s participants should measure their investments in that pool at fair value.

Disclosures

Internal Investment Pools

Internal investment pools are arrangements that commingle or pool the moneys of one or more fund or component unit of the reporting entity. Investment pools that include participation by legally separate entities that are not part of the same reporting entity as the pool sponsor are not internal investment pools, but rather are considered to be external investment pools.

The equity position of each fund or component unit in an internal investment pool should be reported as an asset in those funds and component units.

Assignments of Interest

The asset reported should be an investment or a cash equivalent, not a receivable from another fund. In some cases, the income from investments associated with one fund is assigned to another fund because of legal or contractual provisions. In that situation, GASBS 31 specifies that the accounting treatment should be based on the specific language of the legal or contractual provisions. That is, if the legal and contractual provisions require a transfer of the investment income to another fund, the income should be reported in the fund that is associated with the assets, with an operating transfer to the recipient fund. However, if the legal or contractual provisions require that the investment income be that of another fund, no transfer of resources should be reported. Instead, the amount should be recognized in the recipient fund.

If the investment income is assigned to another fund for other than legal or contractual reasons, the income should be recognized in the fund that reports the investments. The transfer of that income to the recipient fund should be reported as an operating transfer.

Accounting and Financial Reporting Standards for External Investment Pools and Individual Investment Accounts

In addition to providing accounting and financial reporting for investments held by governments, GASBS 31 also provides accounting and financial reporting guidelines for external investment pools and individual investment accounts.

Generally, the accounting and financial reporting guidelines presented in the preceding pages related to governments are applicable to all investments held by external investment pools, except that money market investments and participating insurance contracts must be reported by external investment pools at fair value and that 2a7‐like pools may report their investments at amortized cost. One other clarification is that external investment pools may report short‐term debt investments with remaining maturities of up to ninety days at the date of the financial statements at amortized cost, provided that the fair value of those investments is not significantly affected by the impairment of the credit standing of the issuer or by other factors. For an investment that was originally purchased with a longer maturity, the investment’s fair value on the day it becomes a short‐term investment should be the basis for purposes of applying amortized cost.

External investment pool financial reporting. Separate stand‐alone annual financial reports for governmental external investment pools should include a statement of net position and a statement of changes in net position prepared on the economic resources measurement focus and the accrual basis of accounting. GASBS 31 does not require that a statement of cash flows be presented. All applicable GASB pronouncements should be used to prepare these stand‐alone reports. In addition, the financial statements of governmental external investment pools should include the following disclosures:

• A brief description of any regulatory oversight, including whether the pool is registered with the SEC as an investment company.
• The frequency of determining the fair value of investments.
• The method used to determine participants’ shares sold and redeemed and whether that method differs from that used to report investments.
• Whether the pool sponsor has provided or obtained any legally binding guarantees during the period to support the value of shares.
• The extent of involuntary participation in the pool, if any (involuntary participants are those required by legal provisions to invest in the external investment pool).
• A summary of the fair value, the carrying amount (if different from the fair value), the number of shares or the principal amount, ranges of interest rates, and maturity dates of each major investment classification.
• If the financial statements distinguish among different components of investment income (such as interest, dividend, and other income instead of the net increase or decrease in the fair value of investments), disclosure of the accounting policy for defining each of the components that it reports.

Financial reporting by sponsoring governments. GASBS 31 provides additional financial statement requirements for sponsoring governments, defined as governmental entities that provide investment services, whether an investment pool or individual investment accounts, to other entities, and therefore have a fiduciary responsibility for those investments.

A sponsoring government of an external investment pool should report the external portion of each pool as a separate investment trust fund (that is, a fiduciary fund) that reports transactions and balances using the economic resources measurement focus and the accrual basis of accounting.

• The external portion of an external investment pool is the portion of the pool that belongs to legally separate entities that are not part of the sponsoring government’s financial reporting entity.
• The internal portion of each external investment pool is the portion of the pool that belongs to the primary government and its component units. The internal portion should be reported in the same manner as the equity in internal investment funds, described earlier in this chapter.

The sponsoring government should present in its financial statements for each investment trust fund a statement of net position and a statement of changes in net position. The accounting for investment trust funds is described in Chapter 11.

The following disclosures required by GASBS 31 depend on whether the external investment pool issues a separate report:

• If an external investment pool issues a separate report, the annual financial statements of the sponsoring government should describe how to obtain that report in the notes to the financial statements.
• If an external investment pool does not issue a separate report, the annual financial report of the sponsoring government should include the following in the notes to its financial statements for each pool:
  • The additional disclosures described above for that would have been included in the pool’s separate report.
  • The disclosures required by GASBS 3 and GASB Statement No. 28 (GASBS 28), Accounting and Financial Reporting for Securities Lending Transactions, and other cash and investment standards.
• Condensed statements of net position and changes in net position (if a pool includes both internal and external investors, those condensed financial statements should include, in total, the net position held in trust for all pool participants, and the equity of participants should distinguish between internal and external portions).

Individual Investment Accounts

An individual investment account is an investment service provided by a governmental entity for other legally separate entities that are not part of the same reporting entity. With individual investment accounts, specific investments are required for individual entities, and the income from and changes in the value of those investments affect only the entity for which they were acquired. GASBS 31 requires that governmental entities that provide individual investment accounts to other, legally separate entities that are not part of the same reporting entity report those investments in one or more separate investment trust funds. The disclosure requirements relating to stand‐alone reports for external investment pools would not apply to individual investment accounts.

Level of Detail

GASBS 40 states that its disclosure requirements generally should be made for the primary government including its blended component units. Accordingly, one would expect that the disclosure requirements relate to the cash and investment amounts for the primary government, both unrestricted and restricted, for both the governmental and business‐type activities, in the government‐wide statement of net position.

However, GASBS 40 provides guidance for when additional disclosures may be necessary at a greater level of detail. When risk exposures are significantly greater than the deposit and investment risks of the primary government, risk disclosures should also be made for:

• Governmental activities.
• Business‐type activities.
• Major funds.
• Nonmajor funds in the aggregate.
• Fiduciary fund types.

As for discretely presented component units, the GASBS 40 Implementation Guide refers to the general guidance of GASB Statement No. 14, The Financial Reporting Entity, as amended by GASBS 34 as to reporting specific disclosures relative to component units. These guidelines are discussed in Chapter 6.

The Implementation Guide also clarifies that the previous disclosure requirements under GASBS 3 relating to risks that are higher during the fiscal year than at the end of the fiscal year no longer apply under GASBS 40, which looks at the risk exposure at the date of the financial statements as an indicator of potential loss of resources.

Deposit and Investment Policies

GASBS 40 requires that governments briefly describe their deposit or investment policies that are related to the risks that are required to be disclosed by the Statement. If a government has no deposit or investment policy that addresses a specific type of risk that the government is exposed to, the disclosure should indicate that there is no policy related to that risk.

The Implementation Guide clarifies that GASBS 40 does not require governments to adopt investment policies—it requires that the policies be disclosed related to the identified risks or a disclosure that a policy does not exist relative to a particular risk that is present, if that is the case. In addition, external investment policies, such as those contained in bond covenants, should be considered for disclosure when identified risks warrant such a disclosure. If a government is not exposed to a risk, no disclosure is required. For example, if a government is not exposed to credit risk because it invests only in obligations of the U.S. government or obligations explicitly guaranteed by the U.S. government, the government is not exposed to credit risk and a credit risk policy disclosure is not required.

Custodial Credit Risk

GASBS 40 provides that the disclosures about deposits and investments by the three risk custodial credit categories be changed. Basically, the disclosures are reduced to only requiring that amounts that fall within the former Category 3 (the riskiest as to custodial risk) be disclosed.

• For deposits, a government would need to disclose the amount of bank balances that are “exposed to custodial credit risk.” For a deposit to be exposed to custodial risk means that it is uninsured, and:
  • Uncollateralized;
  • Collateralized with securities held by the pledging financial institution; or
  • Collateralized with securities held by the pledging financial institution’s trust department or agent but not in the government’s name.
• For investments, a government would need to disclose certain information about investments that are “exposed to custodial credit risk.” For an investment to be exposed to custodial credit risk, it would be uninsured, not registered in the name of the government, and held by either:
  • The counterparty; or
  • The counterparty’s trust department or agent but not in the government’s name.

  For investments that are exposed to custodial credit risk, the following disclosures would be required:

• The type of the investment.
• The reported amount.
• How the investments are held.

Investments in external investment pools, open‐end mutual funds, and securities underlying reverse repurchase agreements would not be considered as exposed to custodial credit risk.

Securities Lending Transaction Disclosures

GASBS 40 modifies the disclosure requirements for securities lending transactions. The reported amounts for securities lending collateral and the underlying securities should be disclosed by type of investment and amount. Collateral that is reported in the statement of net position would follow the disclosure requirements for custodial credit risk described above unless it has been invested in a securities lending collateral pool or another type of investment that is not exposed to custodial credit risk. For the underlying securities, the custodial credit risk requirements would be as follows:

• If the collateral for the securities loan is reported on the statement of net position, the underlying securities would not be subject to the custodial credit risk disclosure requirements.
• If the collateral for the securities loan is not reported on the statement of net position, the custodial credit risk disclosures would apply. The disclosure would be based on the type of collateral and the custodial arrangements for the collateral securities.

Concentration of Credit Risk

Governments are required to disclose, by amount and issuer, investments (other than those issued or guaranteed by the U.S. government) in any one issuer that represents 5% or more of total investments. Note that the issuer is considered to be the entity invested in, and not the investment company manager or pool sponsor. These disclosure requirements also do not apply to investments in mutual funds, external investment pools, or other pooled investments.

While GASBS 40 disclosures focus on the primary government, including blended component units, it also requires that risk disclosures be made for governmental fund and business‐type activities, individual major funds, nonmajor funds in the aggregate, or fiduciary fund types when the risk exposures are significantly greater than the deposit and investment risks of the primary government. GASBS 40 uses the example of a capital projects fund that is considered a major fund. If an investment in corporate bonds did not meet the 5% criterion for disclosure for total investments of the primary government, but the capital projects fund’s only investment was that of the corporate bonds of one issuer, disclosure should be made for the concentration of credit risk for the capital projects fund.

Interest Rate Risk

The disclosures about interest rate risk contained in GASBS 40 are probably the most significant new area addressed. GASBS 40 requires that governments disclose information about the sensitivity to interest rates of their debt investments. This disclosure is accomplished by communicating either investment maturities or information developed about portfolio volatility under various scenarios.

The FASB issued Statement No. 59 (GASBS 59), Financial Instruments Omnibus, which clarified that the interest rate risk disclosures for a government’s investments in mutual funds, external investment pools, or other pooled investments should be limited to investments in debt mutual funds, external debt investment pools, or other pooled debt investments.

Interest rate sensitivity information would be organized by investment type and amount using one of the prescribed methods described in GASBS 40 as follows:

• Segmented time distributions. This method groups investment cash flows into sequential periods in tabular form.
• Specific identification. This method presents a list of each investment, its amount, its maturity date, and any call options.
• Weighted‐average maturity. This method expresses investment time horizons (the time when investments become due and payable) in years or months, weighted to reflect the dollar size of individual investments.
• Duration. This method uses the present value of cash flows, weighted for those cash flows as a percentage of the investment’s full price to measure a debt investment’s exposure to fair value changes arising from changing interest rates.
• Simulation model. This method estimates changes in an investment’s fair value given hypothetical changes in interest rates.

Governments would be encouraged to select the disclosure method that is most consistent with the method actually used by them to identify and manage interest rate risk.

Specific disclosures are also required for investments whose contract terms cause the investments’ fair value to be highly sensitive to interest rate changes. Both the interest rate sensitivity and contract terms of the investment would be disclosed. The contract terms would be considered to include such information as the amount of the investment, multipliers, benchmark indices, reset dates (i.e., the time that a bond’s variable coupon is repriced to reflect changes in a benchmark index), and embedded options. GASBS 40 provides three examples of these types of investments.

• A variable‐rate investment’s coupon rate that amplifies the effect of interest rate changes by greater than a one‐to‐one ratio, such as 1.25 times the three‐month London Interbank Offered Rate (LIBOR).
• A variable‐rate investment’s coupon amount varies inversely with a benchmark index, such as 4% minus the three‐month LIBOR rate.
• An asset‐backed investment that has repayments that are expected to vary significantly with interest rate changes.

Foreign Currency Risk

If a government’s deposits or investments are exposed to foreign currency risk, the government should disclose the U.S. dollar balances of such deposits or investments, classified by currency denomination and investment type.

Fair Value Measurement of Particular Assets and Liabilities

Because the focus of a fair value measurement is on a particular asset or liability, GASBS 72 provides that a government should take into account the characteristics of the asset or liability that market participants would consider when pricing the asset or liability at the measurement date. Such characteristics include the condition and location of the asset and restrictions, if any, on the sale or use of the asset that are characteristics of the asset and not characteristics of a specific government’s ownership. The effect on the measurement arising from a particular characteristic will differ depending on how that characteristic would be taken into account by market participants.

Unit of Account

GASBS 72 provides guidance as to the unit of account that should be used in determining fair value measurements. The particular asset or liability measured at fair value might be either (a) a single asset or liability (for example, a financial instrument) or (b) a group, whether a group of assets, a group of liabilities, or a group of related assets and liabilities (a partnership is provided as an example).

Measurement, recognition, or disclosure of an asset or liability—whether a single asset or liability or a group—depends on the unit of account of the asset or liability. The unit of account refers to the level at which an asset or a liability is aggregated or disaggregated for measurement, recognition, or disclosure purposes. Once the unit of account is established, relevant measurement attributes and disclosures can be applied.

Markets

Under GASBS 72, a fair value measurement assumes that a transaction to sell an asset or transfer a liability takes place in either (a) a government’s principal market or (b) a government’s most advantageous market, in the absence of a principal market. The most advantageous market is determined after taking into account transaction costs and transportation costs.

However, GASBS 72 provides that a government need not undertake an exhaustive search of all possible markets to identify the principal market or, in the absence of a principal market, the most advantageous market. However, it should take into account all information that is reasonably available. In the absence of evidence to the contrary, the market in which the government normally would enter into a transaction to sell an asset or to transfer a liability is presumed to be the principal market or, in the absence of a principal market, the most advantageous market.

If there is a principal market for the asset or liability, the fair value measurement should represent the price in that market (whether that price is directly observable for an identical asset or whether it is determined using another valuation technique), even if the price in a different market is potentially more advantageous at the measurement date.

A government should have access to the principal (or most advantageous) market at the measurement date. The government’s principal (or most advantageous) market (and, thus, market participants) should be considered from the perspective of the government, thereby allowing for differences between and among entities with different activities.

Although a government should be able to access the market, it does not need to be able to sell the particular asset or transfer the particular liability on the measurement date to be able to measure fair value on the basis of the price in that market.

Even if there are no observable market transactions to provide pricing information about the sale of an asset or the transfer of a liability at the measurement date, a fair value measurement should assume that a transaction takes place at that date, considered from the perspective of a market participant that controls the asset or is obligated for the liability. That assumed transaction establishes a basis for determining the price to sell the asset or to transfer the liability.

Market Participants

GASBS 72 provides that a government should measure the fair value of an asset or a liability using the assumptions that market participants would use in pricing the asset or liability, assuming that market participants act in their economic best interest. In developing those assumptions, a government need not identify specific market participants. Rather, the government should identify characteristics that distinguish market participants generally, considering factors specific to all of the following:

1. The asset or liability.
2. The principal or most advantageous market, as appropriate, for the asset or liability.
3. Market participants with whom the government would enter into a transaction in that market.

Price and Transaction Costs

The price in the principal (or most advantageous) market used to measure the fair value of an asset or a liability should not be adjusted for transaction costs even if those costs are separable. GASBS 72 concludes that transaction costs are not a characteristic of an asset or a liability. Rather, they are specific to a transaction and will differ depending on how a government enters into a transaction for the asset or liability.

Transaction costs do not include transportation costs. If location is a characteristic of the asset (as might be the case for a commodity), the price in the principal (or most advantageous) market should be adjusted for the costs, if any, that would be incurred to transport the asset from its current location to that market.

Valuation Techniques

The next section of GASBS 72 describes valuation techniques and approaches. As discussed below, three different valuation approaches are provided. Within a particular valuation approach, valuation techniques would be used to determine fair value.

GASBS 72 provides that a government should use valuation techniques that are appropriate under the circumstances and for which sufficient data are available to measure fair value, maximizing the use of relevant observable inputs and minimizing the use of unobservable inputs. A government should use valuation techniques consistent with one or more of three approaches to measuring fair value: the market approach, cost approach, and income approach. These approaches are described in the next section.

GASBS 72 provides that a single valuation technique is appropriate in some cases (for example, using quoted prices in an active market for identical assets or liabilities). In other cases, multiple valuation techniques are appropriate (such as using both a present value technique and a market multiples technique for a single asset or liability). In such cases, the results should be evaluated considering the reasonableness of the range of values indicated by those results. A fair value measurement is the point within that range that is most representative of fair value under the circumstances. If an asset or a liability is composed of multiple components, multiple valuation techniques also may be used.

Further, valuation techniques used to measure fair value should be applied consistently from period to period. However, a change in a valuation technique or its application (such as a change in the weighting of individual valuation techniques if multiple valuation techniques are used, or a change in an adjustment applied to a valuation technique) is appropriate if the change results in a measurement that is equally or more representative of fair value under the circumstances. GASBS 72 notes that might be the case if, for example, any of the following included events occur:

1. New markets develop.
2. New information becomes available.
3. Information previously used is no longer available.
4. Valuation techniques improve.
5. Market conditions change.

If the transaction price is a fair value measurement at initial recognition and a valuation technique that uses unobservable inputs will be used to measure fair value in subsequent periods, the valuation technique should be calibrated so that, at initial recognition, the result of the valuation technique equals the transaction price. After initial recognition, when measuring fair value using a valuation technique or techniques that use unobservable inputs, a government should ensure that those valuation techniques reflect observable market data at the measurement date. For example, if the price of a building at acquisition differs from prices of similar buildings due to variances in building quality, the fair value of that building at subsequent measurement dates should be the observable market prices for similar buildings as of the subsequent measurement dates (observable market data), adjusted for building quality (unobservable inputs).

A revision resulting from a change in the valuation technique or its application should be accounted for as a change in accounting estimate in accordance with GASBS 72.

Valuation Approaches

As mentioned above, GASBS 72 provides for the use of three different valuation approaches. These are the market approach, cost approach, and income approach. The following provides the description of these approaches provided by GASBS 72.

Fair Value Hierarchy

The most noticeable impact that GASBS 72 will have on government financial statements is the establishment of a fair value hierarchy and the categorization and disclosures related to assets and liabilities reported at fair value in the financial statements.

The fair value hierarchy categorizes the inputs to valuation techniques used to measure fair value into three levels. These levels are defined by GASBS 72 as follows:

• Level 1 inputs are quoted prices (unadjusted) for identical assets or liabilities in active markets that a government can access at the measurement date.
• Level 2 inputs are inputs (other than quoted prices included within Level 1) that are observable for an asset or liability, either directly or indirectly.
• Level 3 inputs are unobservable inputs for an asset or liability.

The additional detail regarding these three levels that is provided by GASBS 72 is discussed below. The fair value hierarchy promulgated by GASBS 72 gives the highest priority to Level 1 inputs and the lowest priority to Level 3 inputs. In other words, fair value should be measured using the highest (or most objective) level possible. The highest level possible (Level 1) has the lowest numeric value of a level (1), so these shouldn’t be confused. Further, GASBS 72 provides that if a price for an identical asset or liability is not observable, a government should measure fair value using another valuation technique that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs.

If the fair value of an asset or a liability is measured using inputs from more than one level of the fair value hierarchy, the measurement is considered to be based on the lowest priority level input that is significant to the entire measurement.

To illustrate this, GASBS 72 provides the following example. If there are three inputs significant to a certain fair value measurement, two of them are Level 2 inputs, and one is a Level 3 input, the fair value measurement would be categorized in Level 3 of the fair value hierarchy. Assessing the significance of a particular input to the entire measurement requires professional judgment, taking into account factors specific to the asset or liability.

GASBS 72 notes that the availability of relevant inputs and their relative subjectivity might affect the selection of appropriate valuation techniques. However, the fair value hierarchy prioritizes the inputs to valuation techniques, not the valuation techniques used to measure fair value. For example, a measurement of fair value that uses a present value technique might be categorized within either Level 2 or Level 3, depending on the inputs that are significant to the entire measurement and the level of the fair value hierarchy within which those inputs are categorized.

If an observable input requires an adjustment using an unobservable input and that adjustment results in a significantly higher or lower fair value measurement, the resultant measurement would be categorized within Level 3 of the fair value hierarchy. GASBS 72 uses the following example to illustrate this. If a market participant takes into account the effect of a restriction on the sale of an asset when determining the price for the asset, a government would adjust the quoted price to reflect the effect of that restriction. If that quoted price is a Level 2 input and the adjustment is an unobservable input that is significant to the entire measurement, the measurement would be categorized within Level 3 of the fair value hierarchy.

GASBS 72 provides much more detail about each of these levels, which is discussed below.

Measuring Fair Value If the Volume or Level of Market Activity for an Asset or a Liability Has Significantly Decreased

GASBS 72 notes that the fair value of an asset or a liability might be affected if there has been a significant decrease in the volume or level of activity in relation to normal market activity for the asset or liability (or similar assets or liabilities). Determining the price at which market participants would be willing to enter into a transaction at the measurement date under current market conditions if there has been a significant decrease in the volume or level of activity for the asset or liability depends on the facts and circumstances at the measurement date and requires professional judgment. To determine whether, on the basis of the available evidence, there has been a significant decrease in the volume or level of activity for an asset or liability, GASBS 72 provides that a government should evaluate the significance and relevance of factors such as the following:

1. There are few recent transactions.
2. Price quotations are not developed using current information.
3. Price quotations vary substantially either over time or among market makers (for example, some brokered markets).
4. Indices that previously were highly correlated with the fair values of an asset or liability are demonstrably uncorrelated with recent indications of fair value for that asset or liability.
5. There is a significant increase in implied liquidity risk premiums, yields, or performance indicators (such as delinquency rates or loss severities) for observed transactions or quoted prices when compared with a government’s estimate of expected cash flows, taking into account all available market data about credit and other nonperformance risk for the asset or liability.
6. There is a wide bid–ask spread or a significant increase in the bid–ask spread.
7. There is a significant decline in the activity of a market for new issues (that is, a primary market) for an asset or liability or similar assets or liabilities, or there is an absence of such a market.
8. Little information is publicly available (for example, for transactions that take place in a principal‐to‐principal market).

If a government concludes that there has been a significant decrease in the volume or level of activity for an asset or liability in relation to normal market activity for the asset or liability (or similar assets or liabilities), further analysis of the transactions or quoted prices is needed. A decrease in the volume or level of activity on its own may not indicate that a transaction price or quoted price does not represent fair value or that a transaction in that market is not orderly, as described below. However, a government may determine that a transaction or quoted price does not represent fair value (for example, there may be transactions that are not orderly). If so, an adjustment to the transactions or quoted prices will be necessary if (a) the government uses those prices as a basis for measuring fair value, and (b) that adjustment is significant to the fair value measurement in its entirety. Adjustments also may be necessary in other circumstances (for example, if a price for a similar asset requires significant adjustment to make it comparable to the asset being measured, or if the price is stale).

Regardless of the valuation technique used, GASBS 72 provides that a government should include appropriate risk adjustments, including a risk premium reflecting the amount that market participants would demand as compensation for the uncertainty inherent in the cash flows of an asset or a liability. In some cases, determining the appropriate risk adjustment might be difficult. However, the degree of difficulty alone is not a sufficient basis on which to exclude a risk adjustment.

The risk adjustment should be reflective of an orderly transaction between market participants at the measurement date under current market conditions.

If there has been a significant decrease in the volume or level of activity for an asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate (for example, changing from a technique based on market‐observed prices to an expected cash flow technique).

When weighing indications of fair value resulting from the use of multiple valuation techniques, GASBS 72 provides that a government should consider the reasonableness of the range of fair value measurements. The objective is to determine the point within the range that is most representative of fair value under current market conditions.

A wide range of fair value measurements may be an indication that further analysis is needed.

Measurement Principles

GASBS 72 next provides guidance in applying its fair value principles to nonfinancial assets and liabilities. Generally, measuring nonfinancial assets and liabilities requires additional considerations in addition to those discussed for financial assets.

Nonfinancial Assets

Liabilities

Next, GASBS 72 addresses fair value measurement considerations for liabilities. Surprisingly, measuring the fair value of liabilities is more common than the reader might at first think. Thus measurement considerations for liabilities would apply to an interest rate swap agreement that is in a liability position to a government, which is encountered often in practice.

Basic Principles

GASBS 72 provides that the measurement of the fair value of a liability assumes that the liability is transferred to a market participant at the measurement date. The transfer of a liability assumes the liability would remain outstanding and the market participant transferee would be required to fulfill the obligation. The liability would not be settled with the counterparty or otherwise extinguished on the measurement date. GASBS 72 notes that even if there is no observable market to provide pricing information about the transfer of a liability (for example, because contractual or other legal restrictions prevent the transfer of such items), there might be an observable market for such items if they are held by other parties as assets.

Liabilities Held by Other Parties as Assets

If a quoted price for the transfer of an identical or similar liability is not available and the identical item is held by another party as an asset, GASBS 72 provides that a government should measure the fair value of the liability from the perspective of a market participant that holds the identical item as an asset at the measurement date. In such cases, a government should measure the fair value of the liability as follows:

1. Using the quoted price in an active market for the identical item held by another party as an asset, if that price is available.
2. If the quoted price in (a) is not available, using other observable inputs, such as the quoted price in a market that is not active for the identical item held by another party as an asset.
3. If the observable prices in (a) and (b) are not available, using another valuation technique, such as the following:
   1. Quoted prices for similar liabilities held by other parties as assets (a market approach).
   2. A present value technique that takes into account the future cash flows that a market participant would expect to receive from holding the liability as an asset (an income approach).

GASBS notes that a government should adjust the quoted price of a liability held by another party as an asset only if there are factors specific to the asset that are not applicable to the fair value measurement of the liability. A government should ensure that the price of the asset does not reflect the effect of a restriction preventing the sale of that asset. Some factors that may indicate that the quoted price of an asset should be adjusted to determine the fair value of a liability include the following:

1. The quoted price for the asset relates to a similar (but not identical) liability held by another party as an asset. For example, the liability may have a particular characteristic (such as the credit quality of the issuer) that is different from that reflected in the fair value of the similar liability held as an asset.
2. The unit of account for the asset is not the same as for the liability. For example, consider an insured interest rate swap that is in a liability position.

In some cases, the price for such an asset reflects a combined price for a financial instrument comprising both the amounts due from the issuer and a third‐party credit enhancement (for example, debt that is used with a financial guarantee from a third party). If the unit of account for the swap liability is not the combined financial instrument, the objective would be to measure the fair value of the issuer’s liability, not the fair value of the combined package.

Thus, in such cases, GASBS 72 notes that a government would adjust the observed price for the asset to exclude the effect of the third‐party credit enhancement.

Application of Fair Value to Investments

Except for certain types of investments detailed below, GASBS 72 provides that investments should be measured at fair value. An investment is a security or other asset that (a) a government holds primarily for the purpose of income or profit and (b) has a present service capacity based solely on its ability to generate cash or to be sold to generate cash.

Net Asset Value per Share

Net asset value per share is the amount of net assets attributable to each share of capital stock (other than senior equity securities; that is, preferred stock) outstanding at the close of the period. It excludes the effects of assuming conversion of outstanding convertible securities, whether or not their conversion would have a diluting effect.

Readily Determinable Fair Value

An equity security has a readily determinable fair value if it meets any of the following conditions:

• The fair value of an equity security is readily determinable if sales prices or bid‐and‐asked quotations are currently available on a securities exchange registered with the U.S. Securities and Exchange Commission or in the over‐the‐counter market, provided that those prices or quotations for the over‐the‐counter market are publicly reported by the National Association of Securities Dealers Automated Quotations systems or by OTC Markets Group, Inc. Restricted stock meets that definition if the restriction terminates within one year.
  1. The fair value is readily determinable if that foreign market is of a breadth and scope comparable to one of the U.S. markets referred to in the paragraph above.
  2. The fair value of an investment in a mutual fund is readily determinable if the fair value per share (unit) is determined and published and is the basis for current transactions.

GASBS 72 provides that a government is permitted to establish the fair value of an investment in a nongovernmental entity that does not have a readily determinable fair value by using the NAV per share (or its equivalent), such as member units or an ownership interest in partners’ capital to which a proportionate share of net assets is attributed. This method of determining fair value is permitted if the NAV per share (or its equivalent) of the investment is calculated as of the government’s measurement date generally in a manner consistent with the Financial Accounting Standards Board’s measurement principles for investment companies. A government should determine that the NAV per share (or its equivalent) provided by the investee is determined in that manner.

If the NAV per share (or its equivalent) of an investment obtained from the investee is not determined as of a government’s measurement date or is not calculated in a manner consistent with the measurement principles for investment companies, GASBS 72 provides that the government should consider whether an adjustment to the most recent NAV per share (or its equivalent) is necessary. The objective of any adjustment is to determine the NAV per share (or its equivalent) for the investment that is calculated as of the government’s measurement date in a manner consistent with the measurement principles for investment companies.

A government should determine on an investment‐by‐investment basis whether the method of determining fair value above should be applied. The method of determining fair value should be applied consistently to the fair value measurement of the government’s entire position in a particular investment, unless it is probable at the measurement date that the government will sell a portion of an investment at an amount different from the NAV per share (or its equivalent) as described in paragraph 74. In those situations, the government should account for the portion of the investment that is being sold in accordance with other guidance in this Statement (that is, the government should not apply the guidance for using net asset value to measure fair value).

GASBS 72 also provides that the method of determining fair value using net asset value should not be applied if, as of the government’s measurement date, it is probable that the government will sell the investment for an amount different from the NAV per share (or its equivalent). A sale is considered probable only if all of the following criteria have been met as of the government’s measurement date:

1. The government, having the authority to approve the action, commits to a plan to sell the investment.
2. An active program to locate a buyer and other actions required to complete the plan to sell the investment have been initiated.
3. The investment is available for immediate sale subject only to terms that are usual and customary for sales of such investments (for example, a requirement to obtain approval of the sale from the investee, or a buyer’s due diligence procedures).
4. Actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.

Application of Fair Value to Debt Securities

GASBS 72 provides that loans acquired or originated by a government—such as mortgage loans acquired by a housing finance agency—that have been securitized should be measured at fair value.

Equity Interests in Common Stock

Equity interests in common stock, as described in GASBS 62, should be accounted for using the equity method if they meet the criteria specified in GASBS 62 and are not specifically excluded below.

The following investments are excluded by GASBS using the equity method of accounting:

1. Common stock held by:
   1. External investment pools.
   2. Pension or other postemployment benefit plans.
   3. Internal Revenue Code Section 457 deferred compensation plans.
   4. Endowments (including permanent and term endowments) or permanent funds.
2. Investments in certain entities that calculate the NAV per share (or its equivalent) as provided by GASBS 72.
3. Equity interest ownership in joint ventures or component units as provided in GASBS 14, as amended.

Equity interests in common stock that do not meet both the definition of an investment and the criteria in GASBS 62 for using the equity method should be accounted for using the cost method as provided in GASBS 62.

Acquisition Value

GASBS 72 notes that the price that would be paid to acquire an asset with equivalent service potential in an orderly market transaction at the acquisition date, or the amount at which a liability could be liquidated with the counterparty at the acquisition date, is referred to as acquisition value. GASBS 72 provides that the following assets should be measured at acquisition value:

1. Donated capital assets, as provided in GASBS 34, as amended.
2. Donated works of art, historical treasures, and similar assets as provided in GASBS 34, as amended.
3. Capital assets that a government receives in a service concession arrangement as provided in GASBS 60.

Disclosures

GASBS 72 has significant disclosure requirements that will affect virtually all governments and governmental entities, as most entities have investments that are (or will be) measured at fair value. GASBS 72 provides that its required disclosures should be organized by type of asset or liability and the following should be taken into consideration when determining the level of detail and disaggregation and how much emphasis to place on each disclosure requirement:

1. The nature, characteristics, and risks of an asset or a liability. Assets and liabilities that share the same nature, characteristics, or risks may be aggregated. The following example is included in GASBS 72: U.S. Treasury bills may be aggregated with short‐term U.S. Treasury Separate Trading of Registered Interest and Principal Securities (STRIPS) because these investments have similar exposures to interest rate risk.
2. The level of the fair value hierarchy within which the fair value measurement is categorized. A greater degree of uncertainty and subjectivity suggests that the number of types may need to be greater. For example, fair value measurements categorized within Level 3 of the fair value hierarchy may need greater disaggregation.
3. Whether GASBS 72 or another GASB Statement specifies a type for an asset or a liability. Disclosures should be disaggregated by type as specified by relevant accounting standards. For example, GASBS 53 requires derivative instrument disclosures that distinguish between hedging derivative instruments and investment derivative instruments.
4. The objective or the mission of the government. The level of aggregation or disaggregation may differ based upon the objective or mission of the government. The example provided in GASBS 72 concerns an external investment pool, the objective of which is to achieve income or profit, which suggests greater disaggregation compared to a general purpose government.
5. The characteristics of the government. A government may be composed of governmental and business‐type activities, individual major funds, nonmajor funds in the aggregate, or fiduciary fund types and component units. Additional disclosures may be appropriate if the risk exposure of a particular fund is significantly greater than the deposit and investment risks of the primary government. GASBS 72 provides the example of a primary government whose total investments may not be exposed to a concentration of credit risk. However, if the government’s capital projects fund (a major fund) has all of its investments in one issuer of corporate bonds, disclosure should be made for the capital projects fund’s exposure to a concentration of credit risk.
6. Relative significance of assets and liabilities. The relative significance of assets and liabilities measured at fair value compared to total assets and liabilities should be evaluated in terms of the government structure as discussed in (e) above.
7. Whether separately issued financial statements are available. A government may further aggregate disclosures if a component unit issues its own separate financial statements containing disaggregated information. In the example provided by GASBS 72, a state government may consider reduced disclosures of fair value measurements of investments in certain entities that calculate the NAV per share (or its equivalent) if the financial statements of the state’s pension plan include that information.
8. Line items presented in the statement of net position. A type of asset or liability will often require greater disaggregation than the line items presented in the statement of net position. GASBS 72 notes that the statement of net position reports “cash and investments” while GASBS 3 and GASBS 40, Deposit and Investment Risk Disclosures, require disclosures that focus on deposits and investments. These disclosure requirements are discussed earlier in this chapter.

GASBS 72 provides specific disclosure requirements regarding fair value. In doing so, it distinguishes between recurring and nonrecurring fair value measurements as follows:

• Recurring fair value measurements of assets or liabilities are those that other GASB Statements require or permit in the statement of net position at the end of each reporting period.
• Nonrecurring fair value measurements of assets or liabilities are those that other GASB Statements require or permit in the statement of net position in particular circumstances (for example, when a government measures a mortgage loan held for sale at the lower of carrying value or fair value in accordance with GASBS 62).

GASBS 72 provides that a government should disclose the following information for each type of asset or liability measured at fair value in the statement of net position (or governmental funds balance sheet) after initial recognition.

1. For recurring and nonrecurring fair value measurements:
   1. The fair value measurement at the end of the reporting period.
   2. Except for investments discussed above that are measured at the NAV per share (or its equivalent) and meet the requirements discussed above, the level of the fair value hierarchy within which the fair value measurements are categorized in their entirety (Level 1, Level 2, or Level 3).
   3. A description of the valuation techniques used in the fair value measurement.
   4. If there has been a change in valuation technique that has a significant impact on the result (for example, changing from an expected cash flow technique to a relief from royalty technique or the use of an additional valuation technique), that change and the reason(s) for making it.
2. For nonrecurring fair value measurements: the reason(s) for the measurement.

Additional Disclosures for Fair Value Measurements of Investments in Certain Entities That Calculate the Net Asset Value per Share (or Its Equivalent)

The disclosures in this section that are required under GASBS 72 apply to investments in entities that meet all of the following criteria: (a) calculate the NAV per share (or its equivalent), regardless of whether the method of determining fair value described above has been applied; (b) do not have a readily determinable fair value; and (c) are measured at fair value on a recurring or nonrecurring basis during the period. GASBS 72 notes that a government should disclose information that addresses the nature and risks of the investments and whether the investments are probable of being sold at amounts different from the NAV per share (or its equivalent).

To meet that objective, GASBS 72 provides that a government should disclose the following information for each type of investment:

1. The fair value measurement of the investment type at the measurement date and a description of the significant investment strategies of the investee(s) in that type.
2. For each type of investment that includes investments that can never be redeemed with the investees, but a government receives distributions through the liquidation of the underlying assets of the investees: the government’s estimate of the period over which the underlying assets are expected to be liquidated by the investees.
3. The amount of a government’s unfunded commitments related to that investment type.
4. A general description of the terms and conditions upon which a government may redeem investments in the type (for example, quarterly redemption with 60 days’ notice).
5. The circumstances in which an otherwise redeemable investment in the type (or a portion thereof) might not be redeemable (for example, investments subject to a redemption restriction, such as a lockup or gate).
6. For those otherwise redeemable investments in (e) that are restricted from redemption as of the government’s measurement date: the estimate of when the restriction from redemption might lapse; if an estimate cannot be made, disclose that fact and how long the restriction has been in effect.
7. Any other significant restriction on the ability to sell investments in the type at the measurement date.
8. If a government determines that it is probable that it will sell an investment(s) for an amount different from the NAV per share (or its equivalent) than the reported net asset value that is being used as fair value: the total fair value of all investments that meet the criteria described in the last paragraph of the section on entities that report at net asset value and any remaining actions required to complete the sale.
9. If a group of investments would otherwise meet the criteria described in the last paragraph of the section on entities that report at net asset value but the individual investments to be sold have not been identified (for example, if a government decides to sell 20% of its investments in private equity funds but the individual investments to be sold have not been identified), such that the investments continue to qualify for the method of determining fair value based upon net asset value: the government’s plans to sell and any remaining actions required to complete the sale(s).

Split‐Interest Agreements

Indirectly related to a government’s cash and investments are assets received from donors that include a corresponding liability to the donor over certain periods of time. These arrangements are referred to as split‐interest agreements. To fill a void in accounting guidance for these types of agreements, the GASB issued Statement No. 81 (GASBS 81), Irrevocable Split‐Interest Agreements. These requirements (for both the asset and liability accounting), are discussed below.

GASBS 81 defines an irrevocable split‐interest agreement as an agreement in which the donor enters into a trust or other legally enforceable agreement (with characteristics that are equivalent to a split‐interest agreement) under which the donor transfers resources to an intermediary to administer for the benefit of at least two beneficiaries, one of which could be a government. Under an irrevocable split‐interest agreement, the donor does not reserve, or confer to another person, the right to terminate the agreement at will and have the donated resources returned to the donor or a third party. Irrevocable split‐interest agreements can be created through trusts or other legally enforceable agreements with characteristics that are equivalent to irrevocable split‐interest agreements. Examples of irrevocable split‐interest agreements provided by GASBS 81 include charitable lead trusts, charitable remainder trusts, and life interests in real estate.

GASBS 81 notes that the stipulations of individual agreements can vary with respect to the entity acting as the intermediary (which may or may not be required to be a third party), the assignment of benefits, the term of the agreement, and other general provisions. For example, some donors require that the government that has a beneficial interest also serve as the intermediary in the irrevocable split‐interest agreement.

GASBS 81 also notes that a typical irrevocable split‐interest agreement has two components: a lead interest and a remainder interest. Irrevocable split‐interest agreements can provide resources to a government either throughout the term of the agreement in the form of periodic disbursements (lead interest) or as a final disbursement at the termination of the agreement (remainder interest). In some irrevocable split‐interest agreements, the amount of the disbursements to the lead interest beneficiary is preestablished as a specific amount (annuity). However, other irrevocable split‐interest agreements define the periodic disbursements to the lead interest beneficiary as a variable amount—for example, as a specific percentage of the fair value of the assets measured at each disbursement date (unitrust).

An irrevocable split‐interest agreement terminates after a period‐certain term (for example, a specified number of years); a life‐contingent term (upon the occurrence of a specified event, commonly the death of either the donor or the lead interest beneficiary); or a combination of both terms. As an example, a life‐contingent irrevocable split‐interest agreement might stipulate that, at the death of the donor, the remainder interest be remitted to the government.

A Government Is the Intermediary

Life Interests in Real Estate

GASBS 81 notes that a life interest in real estate is a type of life‐contingent irrevocable split‐interest agreement in which the donor (or parties specified at inception by the donor) retains the right to use the asset, such as a residence.

When the real estate asset is recognized as an investment, the provisions of GASBS 81 described in the following paragraphs should be applied under both the current financial resources measurement focus and the economic resources measurement focus.

When the real estate asset is recognized as a capital asset, the provisions described below should be applied only under the economic resource measurement focus.

The asset should be recognized as either a capital asset or an investment, depending on the terms of the agreement and management’s intent at the time of the donation. If the asset is recognized as a capital asset, the asset should be measured at acquisition value. If the asset meets the definition of an investment as defined in GASBS 72, it initially should be measured according to the provisions of that Statement.

A liability should be recognized if a government assumes a legal obligation to sacrifice financial resources pursuant to the provisions of the life interest in real estate agreement, such as, for insurance, maintenance or repairs of the asset. If a liability is recognized, it should be reduced as the government satisfies the obligations.

A related deferred inflow of resources should be recognized in the amount of the difference between the asset and the liability (if a liability is recognized).

GASBS 81 notes that if the asset is recognized as an investment, changes in the fair value of the investment should be recognized as an increase or a decrease in the related deferred inflow of resources. If the asset is recognized as a capital asset, a systematic and rational allocation of the asset’s initial acquisition value should reduce the carrying value of the asset and the deferred inflow of resources throughout the life of the agreement.

At the termination of the agreement, revenue should be recognized for the deferred inflow of resources, and for any remaining portion of the liability.

A Third Party Is the Intermediary