The User's Perspective
Touring the Financial Report, Part I: The Statement of Net Assets
GASB Statement No. 34, Basic Financial Statements—and Management’s Discussion and Analysis—for State and Local Governments, introduced a number of financial reporting innovations, foremost of which may be the government-wide financial statements. These statements—the statement of net assets and the statement of activities—bring together information that previously had been spread among various funds and reported on different accounting bases. This article explores the statement of net assets and the information it contains. ( A separate article in this issue looks at the statement of activities.)
The Government-wide Financial Statements
Traditionally, state and local government financial reports contained financial statements arranged around funds—the governmental funds, proprietary funds, and fiduciary funds. Although the fund financial statements were widely used, they did not allow financial statement users to get an overall view of a government’s finances for two reasons. First, the funds could not simply be added together, because doing so would double-count any financial activity occurring between funds. In other words, an amount owed from one fund to another would show up as both an asset and a liability, overstating both.
Second, the funds reported very different information. The proprietary and fiduciary funds report information using an accrual basis and economic resources measurement focus, similar to the type of information reported in the financial statements of not-for-profit organizations and corporations. This form of reporting includes all economic transactions and presents both long- and short-term consequences. The governmental funds, however, report information using the modified accrual basis and current financial resources measurement focus. The governmental funds focus on the short run and generally do not include assets lasting more than one year (such as infrastructure) or liabilities that are not due and payable (such as bonds). Consequently, for the bread-and-butter activities accounted for in the governmental funds, such as public safety and education, major pieces of financial information were missing.
The government-wide statements ignore the partitions created by the funds, bringing the financial activity together in one place and using just one type of information—accrual-based economic resources. As a result, all assets and liabilities are accounted for, as well as all inflows and outflows of resources. The government-wide statements organize information by whether it relates to governmental activities or business-type activities. Generally, the governmental activities are those accounted for in the governmental funds and the internal service funds (one of the two types of proprietary funds). The business-type activities are typically synonymous with the enterprise funds (the other type of proprietary fund).
Trusts and agency funds are not included in the government-wide statements, because the resources they account for are being held in a fiduciary capacity by the government. The governmental and business-type activities combine to represent the total primary government. Additionally, discretely presented component units—legally separate entities for which the primary government is financially accountable—are shown on the face of the government-wide statements but are not included in the total for the primary government.
The Statement of Net Assets
The statement of net assets presents the same information as a balance sheet: It assesses the balance of a government’s assets—the resources it can use to provide service and operate the government—against its liabilities—its obligations to turn over resources to other organizations or individuals. The difference between a government’s assets and its liabilities is called net assets. The name of the statement reflects its emphasis on what a government would have left over after satisfying its liabilities. Net assets are an indicator of a government’s financial position—its financial standing at a given point in time (typically, the end of the fiscal year). Financial position can be tracked over time to assess whether a government’s financial health is improving or deteriorating.
Assets are presented in order of their relative liquidity. (See Figure 1.) In other words, the statement starts off with cash and assets that are most easily converted to cash or consumed, such as receivables, and leads to those assets expected to be used for many years, such as buildings and other capital assets. Some governments present their statement of net assets in a classified format that separates current assets from noncurrent assets (as well as current liabilities from noncurrent liabilities). Current assets are those that are expected or required to be converted to cash or consumed within a year. Noncurrent assets either are expected to be liquidated or consumed beyond one year or are restricted from being liquidated in the current year.
Figure 1. Sample Government-wide Statement of Net Assets
The amounts reported for assets are determined in a variety of ways. Cash amounts essentially equal balances as of the end of the period covered by the financial statements. Most investments are reported at their fair value as of that date—the price they are expected to have if sold on the open market between two unrelated willing parties or the value of their future cash flows in today’s dollars. (Some investments with maturities of less than a year when purchased, such as money market investments, may be reported at amortized cost.)
Capital assets generally are reported at historical cost, less accumulated depreciation. Depreciation is a method of spreading the cost of constructing or acquiring a capital asset over the asset’s useful life. Most commonly, this is done by dividing the difference between the original cost of a capital asset and its salvage value by the number of years of useful life of the asset.
Governments have the option of employing a modified approach to reporting infrastructure assets—bridges, tunnels, water mains, and other especially long-lived, stationary capital assets. If a government can demonstrate that a network or subsystem of infrastructure assets is being maintained at or above a predetermined physical condition level, the historical cost of those assets is not depreciated. (Governments that employ the modified approach present supporting schedules following the notes to the financial statements that (a) track the condition level over the past three assessments and (b) compare the amount estimated to be needed to maintain and preserve the assets with the amounts actually spent in each of the past five years.)
Liabilities are reported in order of their relative maturity—when they are expected to be paid off or otherwise satisfied. If the classified format is used, the current and noncurrent liabilities are separated. Otherwise, long-term liabilities are shown in two components—the portion due within the following year and the portion due beyond one year.
Amounts shown for liabilities typically represent the balances remaining to be paid, though there are some exceptions. Long-term debt amounts may include amortized discounts or premiums. Certain long-term liabilities, such as claims and judgments and compensated absences, are not known precisely as of the date of the financial statements and are therefore estimated based on prior experience and professional judgment. Information about how estimates are made can be found in the notes to the financial statements.
Finally, deferred revenues are reported as liabilities. Deferred revenues under accrual accounting are resource inflows that have not yet been recognized as revenue, generally because certain conditions have not been met. For instance, a county may be required to provide a particular service or contribute resources of its own before it qualifies to use resources provided by the state or federal governments. Alternatively, certain resources may not be allowed to be used until after a particular date. A government may be required to return those resources if the conditions are not met, but as a general rule deferred revenues are eventually recognized as revenue and are not returned to the resource provider.
Net assets are divided into three components—invested in capital assets (net of related debt), restricted, and unrestricted. The first component is the difference between the amount shown for capital assets and the outstanding debt incurred to finance those capital assets. It should be noted that not all long-term debt may be deducted from capital assets—only the debt issued to finance the government’s (reporting entity’s) capital assets is subtracted. Long-term debt issued for other purposes or to finance capital assets not belonging to the government is subtracted from the other components of net assets.
This issue may be significant for governments that finance the acquisition or construction of capital assets for other governments. For instance, some states, counties, and local governments issue debt to pay for school construction, but the school facilities appear on the financial statements of the school districts rather than on the financial statements of the governments issuing the debt. That debt is therefore subtracted from the unrestricted net assets of the governments issuing the debt rather than from net assets invested in capital assets.
Some believe that the governments issuing the debt look worse off financially, despite doing something that might be considered laudable. Value judgments aside, however, it is an accurate depiction of those governments’ financial standing—they have outstanding debt they are required to repay, but they do not own an offsetting asset. Governments in this situation are likely to explain the situation, either in the notes to the financial statements or in management’s discussion and analysis (the narrative section preceding the financial statements that was introduced to governments by Statement 34).
Restricted net assets represent resources that are constrained to a particular purpose. These constraints may derive, for example, from the provider of the resources, such as a higher level of government or a donor, or from a law or regulation imposed on a government by another government. Governments themselves may impose restrictions through the use of enabling legislation. Enabling legislation is a law passed by a government that (a) creates a new revenue source and (b) limits the use of the revenue to a particular purpose. Enabling legislation may create an entirely new revenue stream, or it may add to an existing rate (such as an additional percentage point on a sales tax), but it rises above a mere “earmarking” of existing resources. Furthermore, the limitation imposed by enabling legislation has to be legally enforceable. That means that, even though the government passed the legislation itself, it cannot undo the limitations at its own whim—an external party could compel the government, perhaps through legal action, to use the resources as promised.
Restricted net assets are presented according to the purposes to which they are limited. The illustrative statement of net assets in Figure 1 displays net assets restricted to being used for capital projects, debt service, and community development. Furthermore, net assets representing permanent endowments or permanent fund principal are divided into two categories—expendable and nonexpendable. The principal in a permanent endowment or fund can be invested to generate income, but the principal amount may not be spent. The nonexpendable portion of net assets is the permanent principal that must be retained in perpetuity.
Unrestricted net assets are the last component, essentially being all resources not included in the other components. These resources can be considered usable for any purpose, though they may not be in a spendable form, like cash. It is not uncommon, particularly in the governmental activities column, to see an unrestricted net assets deficit. Figure 1 contains a nearly $5.9 million negative unrestricted net assets number. The existence of such a deficit does not necessarily mean that a government is on the brink of fiscal disaster—additional information is needed to place it in context.
The situation described above in which a government issues debt to build capital assets for another government may be one explanation for such a deficit. Unrestricted net asset deficits also are created because many governments have long-term liabilities that they fund on a pay-as-you-go basis, appropriating resources each year as payments come due, rather than accumulating assets in advance. Common examples include judgments and claims and termination pay for departing employees.
Pertinent Note Disclosures
There are a variety of very useful notes to the financial statements related to assets, liabilities, and net assets. Although this article will not delve into them in any detail, the following is a selected list:
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