The User's Perspective
Touring the Financial Statements, Part V: Supporting Information
Generally accepted accounting principles (GAAP) require that a financial report contain the following, at a minimum—basic financial statements, notes to the basic financial statements, and required supplementary information (RSI). Some governments voluntarily go beyond the minimum requirements. Many of these governments issue a comprehensive annual financial report (CAFR). A CAFR contains the aforementioned required contents, plus voluntarily provided supplementary information (SI)—an introductory section, supporting schedules with more detailed financial information than is found in the financial statements, and a statistical section.
This article, the fifth and final in the series examining the contents of state and local government annual financial reports, examines supporting information, which encompasses both RSI and SI. The article begins by describing the nature of supporting information and how it relates to the information in the basic financial statements and notes. The article then proceeds to identify the major types of RSI and SI and what they can tell you about a government’s financial health.
The Relationship between Financial Statements and Supporting Information
According to GASB Concepts Statement No. 3, Communication Methods in General Purpose External Financial Reports That Contain Basic Financial Statements, as amended, the information in basic financial statements and notes to basic financial statements is essential to understanding a government’s financial position—the status of its assets, deferred outflows, liabilities, and deferred inflows—at a given point in time and its inflows and outflows of resources during a given period. Supporting information is important to the understanding of the information contained in financial statements and notes because it places the information in the appropriate operational, economic, or historical context.
The difference between RSI and SI is more significant than the fact that the former is required by the GASB to be included in all financial reports and the latter is not. RSI is required because it has been considered to be essential to placing the financial statements and notes in a proper context for understanding financial position and inflows and outflows of resources. On the other hand, SI is considered useful for providing context, but not essential.
RSI and SI can greatly enhance the decision usefulness of the basic financial statements and the notes. While the financial statements and notes can be interpreted on their own, the information they convey can become significantly more meaningful when it is framed within the context of a government’s particular circumstances.
If you want to understand various aspects of a government’s financial health, there is a need to have some understanding of the economic and demographic environment in which the government operates. For nearly all questions one might ask about a government, historical perspective is critical. Information from prior fiscal years—such as that found in the statistical section’s ten-year historical schedules—allows you to understand not just where a government stands financially now, but how it got here. Consider two governments in exactly the same financial health, based on a set of financial ratios, at the exact same time: One might look at the two governments differently if historical trends showed that one government had been improving over the past several years to reach this point, whereas the other had been in declining financial health.
Required Supplementary Information
A government’s RSI typically includes management’s discussion and analysis (MD&A) and information about pensions and other postemployment benefit information. If the budgetary comparisons are not presented in the basic financial statements, they are found as RSI. Some governments also present RSI about capital assets and public entity risk pools. With the exception of MD&A, RSI appears following the notes.
Management’s Discussion and Analysis
MD&A precedes and introduces the information in the basic financial statements, providing condensed financial information for the current and prior fiscal years and a summary assessment of the government’s financial health. Reading MD&A is not intended to replace your own review and analysis of the basic financial statements, notes, and other RSI, but it does offer you an overall sense of a government’s financial well being. MD&A is prepared by government officials and is intended to be a readable, objective analysis of the government’s financial activity during the year.
MD&A covers the following areas:
- Description of the financial statements and how they relate to one another
- Analysis of the financial information in the statements, including explanations of significant changes from the prior to the current year and significant variations in the budget over the course of the year
- Activities during the year regarding capital assets and long-term debts, including depreciation, construction, acquisition, and disposal of capital assets, repayment of debt, and issuance of new debt
- Physical condition of infrastructure and related maintenance efforts (if a government reports infrastructure using the modified approach, described below)
- Currently known facts bearing on the government’s future finances.
Pensions and Other Postemployment Benefits
There are two schedules relating to defined benefit pension plans and other postemployment benefit (OPEB) plans that are presented as RSI in a pension plan’s financial report: the schedule of funding progress and the schedule of employer contributions. The schedule of funding progress provides information about the degree to which the obligation for pension benefits or OPEB is matched by assets held by the plan. The schedule of employer contributions compares the actual contributions of the employer to the plan with the annual required contribution (ARC) of the employer.
State and local governments that participate in specific types of pension or OPEB plans also present RSI. Governments in single-employer plans or agent multiple-employer plans (those in which the accounts of the individual participating governments are separately reported) are required to present separate schedules of funding progress for pensions and OPEB, accompanied by notes to the schedules addressing factors having a significant effect on the trends information identified in the reported amounts. In general, the schedule covers the last three actuarial valuations. Governments participating in a cost-sharing multiple-employer plan (one in which the costs of providing benefits are shared among the participating governments) are required to present both the schedule of funding progress and the schedule of employer contributions for the pension or OPEB plan as a whole if the plan does not issue its own financial report.
These schedules help you determine the extent to which the government has set aside resources to finance the retirement benefit promises made to its public employees. If adequate resources have not been set aside, you have the information necessary to determine the size of the shortfall, and to establish whether the funding situation is improving or worsening.
Accounting standards encourage governments to present their budgetary comparisons as RSI, though governments have the option to present them as basic financial statements and many do. The budgetary comparison schedule presents the original budget, the final modified budget, and the actual results for the fiscal year, allowing you to evaluate a government’s adherence to its budget. Governments have the option of presenting additional columns displaying the variances or differences between the original budget and actual results (or original-to-final, or final-to-actual). The schedule also will reconcile the actual numbers on a budgetary basis with the revenue and expenditure amounts reported on a modified accrual basis in the governmental funds financial statements.
It is important to keep in mind that there are almost always variances between budgeted and actual amounts. Variances can be due to such factors as changes in economic conditions or in a government’s policies. You can use the schedule to assess the magnitude of the individual variances in revenues and expenditures, potentially raising red flags that should be followed up on. Explanations of the variances in MD&A may help you begin to understand the reasons for the variances.
Infrastructure and Risk Pool Information
Governments present RSI about condition assessment for infrastructure assets—for example, highways and bridges—if they account for the assets using the modified approach instead of traditional depreciation. Under the common depreciation approach, the original value of an asset is systematically reduced each year of its useful life, usually in equal annual amounts that are reported as depreciation expense in the government-wide statement of activities and other accrual-based financial statements. Original cost is not diminished under the modified approach, however; rather, governments report expenses equal to the cost of maintaining and preserving the infrastructure asset at a predetermined physical condition level chosen by the government.
The RSI related to the modified approach includes:
- Trends in the physical condition of the infrastructure
- Comparison for the past five years of (a) amounts expected to be needed to maintain and preserve the infrastructure at a predetermined condition level with (b) the amounts actually spent.
This information is useful for tracking whether condition is improving or declining over time and whether a government is spending what is necessary to keep the condition level constant.
RSI schedules on public entity risk pools—arrangements under which multiple governments join together to finance activities involving risk or liability—consists of a reconciliation of claims liabilities by contract and ten-year claims development information. The former schedule presents information about liabilities related to unpaid claims filed with the risk pool for the current and previous year. This information shows how the liabilities have changed due to payment by the pool and new claims. The latter schedule shows how claims have been paid by the pool and the time taken to do so over the past ten fiscal years. The information in these schedules speak directly to the level of claims activity and the risk pool’s ability to keep pace with claims that have been filed.
A CAFR’s introductory section includes unaudited information that helps you get to know the government and its structure, operations, and services, among other things. Having a sense of this type of information can orient you to the environment in which the government’s financial activities occurred.
The introductory section is likely to include the following information in this order:
- Title page
- Table of contents
- Letter of transmittal
- Financial report award (if applicable)
- List of principal officials
- Organizational chart
- Audit committee letter.
Combining and Individual Fund Financial Statements
The financial statements of a CAFR include a multitude of combining statements—statements that present funds individually, offering the detail behind the aggregated amounts in the basic financial statements. This can include combining statements of non-major governmental and enterprise funds, individual internal service funds, and fiduciary funds by type, and budgetary comparisons for individual funds.
The Statistical Section
The schedules in the statistical section present information in five categories:
- Financial trends
- Revenue capacity
- Debt capacity
- Demographic and economic information
- Operating information.
Most of the schedules present information for the past 10 fiscal years, which gives you the historical context that is so valuable to understanding what the financial statements and notes have to say about a government’s financial health. (See the articles in the May 2006 and November 2006 issues for a detailed discussion of the contents of the statistical section.)
The financial trends schedules essentially lay consolidated financial statements from the past 10 years side by side. The four schedules present net assets by component, revenues and expenses on an accrual basis, fund balance by classification, and revenues and expenditures on a modified accrual basis.
Revenue capacity schedules offer information about a government’s most significant own-source revenue (for most general purpose local governments, the property tax). The schedules include revenue base information (for example, assessed and estimated actual property value or retail sales), direct and overlapping rates, principal payers of the revenue, and property tax levies and collections (if the revenue source being reported is a property tax).
Debt capacity schedules contain information about a government’s outstanding long-term debt. The first schedule presents debt by type and ratios of debt per capita and debt divided by personal income. Another schedule examines the subset of debt that is repaid with general resources and present ratios of general bonded debt per capita and divided by property value. The remaining debt capacity schedules cover direct and overlapping debt (debt of other governments that the citizens are responsible for repaying), the margin between debt outstanding and the legal limit on how much debt a government can issue, and the sufficiency of pledged revenues for repaying revenue-backed debt.
The demographic and economic information schedules present a variety of contextual indicators, including population, personal income, per capital personal income, and unemployment rate. A separate schedule shows the principal employers within the government’s jurisdiction for the earliest and most recent year in the past 10 years. Operating information includes the number of a government’s employees by function or program, indicators of the level of or demand for services, and indicators of the capacity or amount of capital assets.
Further Reading: The Touring the Financial Statements Series
- Part I, The Statement of Net Assets
- Part II, The Statement of Activities
- Part III, The Governmental Funds
- Part IV, Note Disclosures