Solution Advanced Accounting 7e Thomas Beechy

1. CHAPTER 11
Public Sector Financial Reporting
This chapter continues the discussion of non-business organizations by addressing the
specific issues of governmental financial reporting.
The chapter first discusses the general nature of government—more specifically, the types
of government organizations and how the characteristics of government that can affect
financial reporting. Next, financial reporting for governments is reviewed. The issues of
compliance, objectives, and qualitative characteristics are discussed and a sample set of
financial statements is illustrated.
Finally, the major reporting issues are addressed within the context of the characteristics,
reporting objectives, and qualitative criteria of government reporting. Issues that are
particularly noteworthy for governments are (1) determining the reporting entity, (2)
revenue recognition, (3) financial instruments, (4) tangible capital assets and (5) liability
measurement. These reporting issues are discussed in the context of the practical problems
faced by governments.
SUMMARY OF ASSIGNMENT MATERIAL
Case 11-1: Province of Majestic Lakes
Students are required to respond to a member of the provincial legislature asking
questions on the Government Reporting Model.
Case 11-2: Comparison of Objectives
Students are required to describe the major differences in reporting between a large
corporation and a large municipality.
Case 11-3: Town of Evergreen
Students are asked to assume the role of a public accountant to assist a town councilor in
identifying potential problems with the financial reporting of a municipality.
Case 11-4: Harvest Province
Students are required to prepare financial statements for a mythical province.
Case 11-5: Green Province
Students are required to prepare financial statements for a mythical province that reports
using the statement of remeasurement gains and losses.
Case 11-6: District of Maple Ridge
Students are required to indentify several strengths of the financial reporting of a real
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2. Chapter 11 – Public Sector Financial Reporting
municipality that has won multiple awards for the quality of its annual reports.
ANSWERS TO REVIEW QUESTIONS
Q11-1: The budget is important because it portrays public policy. It forms a key part of
the government’s financial report and is explicitly incorporated into two of the financial
statements. Including the budget in the financial report allows for a better evaluation of
the government’s fiscal management and thus serves to improve accountability.
Q11-2: Governments are generally characterized by a much broader user group than
either businesses or not-for-profit organizations. The main users are the public (either
directly or as represented by legislators and councillors), the civil service, other
governments, debt investors such as pension funds, and analysts. The primary user group
for NFP statements is the primary funders, whether they be members, government
ministries, or granting agencies.
Q11-3: The focus on debt is important because, due to their taxing authority,
governments have a tremendous capacity to borrow. The debt bears interest and the
principal must be repaid sometime in the future. If the level of debt rises, the burden of
rising debt servicing costs will affect a government’s ability to provide services to the
public in the future.
Q11-4: The nine unique characteristics that influence governmental reporting are:
1. Public Accountability
2. Multiple Objectives
3. Rights, powers and responsibilities (constitutional or devolved)
4. Lack of equity ownership
5. Operating and financial frameworks set by legislation
6. The importance of the budget
7. Governance structures
8. Nature of resources
9. Non-exchange transactions
Q11-5: The public sector is defined in the Public Sector Accounting Handbook (PSA
Handbook) as consisting of the federal, provincial, territorial and local governments, and
government organizations.
Q11-6: The three types of organizations and their sources of GAAP are:
- Government business enterprises (GBEs) – IFRS (as directed by PSAB)
- Government not-for-profit organizations (GNPOs) – PSA Handbook
- Other government organizations (OGOs)—PSA Handbook or IFRS (choose
best option based on organization’s objectives)
Q11-7: The Public Sector Accounting Board issues accounting recommendations for
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3. Chapter 11 – Public Sector Financial Reporting
governmental reporting. Its mandate is to serve the public interest by issuing
recommendations for accounting in the public sector and strengthen accountability in the
public sector by developing, recommending and gaining acceptance of accounting
standards and financial reporting standards.
Q11-8: Government auditors report in accordance with legislation in their province or, for
the federal government, with federal statute. The public sector accounting standards are
recommendations, not requirements for the senior levels of government.
Q11-9: Municipal government reporting practices are controlled by provincial legislation.
It now appears that almost all municipalities are effectively compelled to comply with
PSAB recommendations. All provinces either have a legislative requirement for
municipalities to comply with PSAB or require compliance in order for the municipality to
receive specific funds from the province. The result will likely be very high compliance
with PSAB recommendations.
Q11-10: The objectives of governmental reporting are:
1. to provide an accounting of financial affairs and resources under the
government’s control;
2. to demonstrate government’s ability to finance activities, meet liabilities, and
provide future services;
3. to account for sources, allocation, and use of government resources; to
evaluate how activities affect net debt; and to show how activities were
financed and how cash requirements were met; and
4. to display the state of a government’s finances and evaluate if the finances are
in accordance with legislative requirements.
Q11-11: The first key message on the SFP is net debt. Remember that debt is a very
important issue for governments. Therefore, to help users assess a government’s ability to
finance its activities and meet its liabilities, the government’s “net debt” is presented in the
SFP. Net debt is the total of government liabilities less the total of its financial assets. Net
debt is important because debt has to be serviced and repaid and therefore will impact a
government’s ability to deliver programs and services in the future. For users, net debt is
an important indicator of a government’s financial position.
The second key message on the SFP is the accumulated deficit or surplus. Tangible capital
assets (and other non-financial assets) are viewed in terms of their unexpired or future
service potential and not in terms of future cash flows. Thus, the total of tangible capital
assets will help users assess a government’s ability to deliver its services and programs in
the future.
Net debt is thought of as claims that could reduce future services, while tangible capital
assets can be thought of as prepaid future service potential. The two items are combined
on the SFP to produce an accumulated deficit or surplus. For users, accumulated deficit or
surplus is another important indicator of a government’s financial position because it
shows the recognized economic resources that a government has available.
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4. Chapter 11 – Public Sector Financial Reporting
Q11-12: The additional element was accountability value. The addition of accountability
value reflects the importance of stewardship in governments. It is manifested in the
inclusion of budget figures in the financial statements.
Q11-13: The following five statements are recommended for governments: statement of
financial position; statement of operations; statement of remeasurement gains and losses;
statement of change in net debt; and statement of cash flow.
Q11-14: Persuasive evidence of control may be indicated by the government having:
a. the power to appoint a majority of the members of a governing body;
b. access and control over the assets of the organization;
c. the majority of the voting shares; or
d. unilateral power to dissolve the organization.
Q11-15: Investments in a GBE (government business enterprise), such as a public utility,
should be reported using the modified equity method. Under the modified equity method,
the net profit or loss of the business enterprise is included in the government’s statement
of operations (net of dividends or distributions) and is added to the investment account
related to that enterprise. It is called a modified equity method because the accounting
principles for the GBE are not changed to government accounting principles.
Q11-16: A government transfer is the provision of either monetary or tangible capital
assets by one entity to another entity (i.e., government, organization or individual). The
transferor does not receive any goods or services in return, nor expect to be repaid or
expect a financial return. The transfer is a non-exchange transaction. Two kinds of transfer
terms can be imposed by the government transferring the resources: eligibility criteria and
stipulations. If a term of the transfer must be met before the transfer occurs, it is an
eligibility criterion. Typically an eligibility criterion will specify who can receive the
transfer or what must be done to receive the transfer. If a term of the transfer can only be
met after the transfer occurs, it is a stipulation. Typically, a stipulation describes how the
resources must be used or what must be done to keep the transfer.
Q11-17: The transferring government (transferor) will recognize an expense when the
transfer is fully authorized and the eligibility criteria have been met. The transfer is fully
authorized when is has been approved by the legislature or council. In rare cases, the
transferor may recognize the expense before it is fully authorized if two conditions are
met. First, the preponderance of the evidence must suggest that the government is
committed to the transfer and second, the transfer must receive approval from the
legislature or council in the “stub” period (i.e., the period after the government’s year-end
but before it issues its financial statements).
Q11-18: The direct transfer of tangible capital assets is recognized when the transfer has
been fully authorized by the transferor and the eligibility criteria have been met. The
revenue would only be deferred if the transfer created a liability for the recipient. This
deferred revenue would then be recognized when the liability had been settled.
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5. Chapter 11 – Public Sector Financial Reporting
Q11-19: Tax concessions are amounts that affect the taxes that an entity currently owes or
previously owed. They are provided only to taxpayers and only through the tax system.
They reduce the taxes that would otherwise be owed and result in foregone revenue for
the government.
Q11-20: PSAB introduced the statement of remeasurement gains and losses in Section
PS 1201. It allows public sector entities to defer unrealized gains and losses on items
denominated in a foreign currency and fair value items from recognition on the statement
of operations. PSAB believes that the concept of remeasurement gains and losses is more
meaningful and easier to understand for users than concepts such as other comprehensive
income (OCI) and hedge accounting.
CASE NOTES
Case 11-1: Province Of Majestic Lakes
Objectives of the Case
This case is designed to provide a discussion of the key aspects of the “Government
Reporting Model”. This case should be written as a report to the member of the provincial
legislature.
Report to Member of the Provincial Legislature
The following report summarizes the answers to the questions that you have asked on the
“Government Reporting Model.”
What characteristics are unique for governments and what are the reporting implications?
In designing the new government reporting model, the PSAB identified the unique
characteristics of a government and how that differs from businesses. These characteristics
have reporting implications that mean the financial statements for government should not
look like those of a business.
Characteristics of Public Sector Entities, prepared by the Conceptual Framework Task
Force on August 2011, identifies the following nine unique characteristics of governments:
- 1. Public Accountability
- 2. Multiple Objectives
- 3. Rights, powers and responsibilities (constitutional or devolved)
- 4. Lack of equity ownership
- 5. Operating and financial frameworks set by legislation
- 6. The importance of the budget
- 7. Governance structures
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6. Chapter 11 – Public Sector Financial Reporting
- 8. Nature of resources
- 9. Non-exchange transactions
What are the five key messages in the model?
The new government reporting model issued in January 2003 focuses on economic rather
than financial resources. The new model sends the following five messages about
government finances:
- net debt/net financial assets
- accumulated surplus/deficit
- annual surplus/deficit
- change in net debt
- change in cash and cash flows that contributed to the change
What are the required financial statements and what are they like? What key information
should I look for in each of the statements?
The required financial statements are:
- statement of financial position – reports net debt and then deducts non-financial
assets from net debt to measure the government’s accumulated surplus or deficit.
- statement of operations – shows excess (or deficiency) of revenues over expenses.
- statement of remeasurement gains and losses - reconciles the accumulated
remeasurement gains and losses at the beginning of the period with the
accumulated remeasurement gains and losses at the end of the period. The
accumulated remeasurement gains and losses balance on this statement is
increased as unrealized gains or losses are recognized and reduced as the gains
and losses are realized. The statement captures unrealized gains and losses that
arise from the changes in value of items denominated in a foreign currency and
from the changes in value of financial instruments carried at fair value. These
changes in fair value are relevant to users to help them assess how well the
government has maintained its economic resources.
- statement of change in net debt – reconciles a government’s total expenses for the
period to its spending on operations for the period. It also reports the capital
spending in the period, the extent to which total government spending was
financed by revenues earned in the period and the opening and closing net debt
balances.
- statement of cash flow – calculates the cash flow from operating activities. Capital
transactions are shown as a separate section.
What is the key impact of the change to “accrual” accounting?
The model sees the deferral of expenditures and measurement of the net cost of services
as the ultimate goal.
Why is it important to have a comparison with budgeted numbers?
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7. Chapter 11 – Public Sector Financial Reporting
The new reporting model requires that budget and actual numbers must be reported on the
Statement of Operations and the Statement of Change in Net Debt. This highlights the
differences between the two, which provides accountability or a measure of the
government’s achievement of their objectives.
Why is it important to account for capital assets?
“Many in the government were concerned that the existing modified accrual or
“expenditure” model was creating a bias against spending on capital assets – a bias that
was contributing to the “infrastructure deficit” in Canada. Governments needing to
balance their budgets found that putting off capital spending was an easy way to meet this
objective.”
The new reporting model requires the use of full accrual accounting. This requires that
capital assets are recorded as an asset and the annual expense of owning and using the
capital asset is recognized as an expense.
Case 11-2: Comparison of Objectives
Objectives of the Case
This case is intended to draw out the differences in financial reporting between a large
corporation and a large city.
Discussion
(a) Differences in accounting
• Governments, because their major revenues are characterized by non-exchange
transactions, recognize revenues on receipt (revenues are not earned). Businesses,
because their revenues are characterized by exchange transactions, match expenses
to revenues and recognize revenues when earned.
• Government expenses are shown by program or function (i.e., health or education)
on the financial statements while business expenses are shown by object or type
(i.e., wages or supplies).
• Governments incorporate their budgets into the account structure, while
corporations use budgets only as an indicator.
• Corporations capitalize their capital assets and charge depreciation; governments
also capitalize their capital assets and charge depreciation. Given that one of the
government’s objectives is to provide services (and not to maximize profits) then
tangible capital assets are seen as representing future service capability and not as
representing a source of future cash flows (as in a business). The carrying value of
these assets therefore represents the unexpired service potential of the assets. This
difference has a direct impact on any impairment testing. Write-downs will be based
on the impairment of future service potential and not on the impairment of future
cash flows.
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8. Chapter 11 – Public Sector Financial Reporting
(b) Differences in financial reporting
• The focus of corporate reporting is on the determination of profit for the owners;
the focus of municipal reporting is on the flow of resources and on compliance with
budgetary restrictions.
• Corporate reporting is directly governed by GAAP, whereas governmental
accounting is affected more by legal and contractual requirements. In most
situations local governments must now comply with PSAB.
• The types of financial statements prepared by corporations are the statement of
financial position, statement of operations, statement of changes in shareholder’s
equity and statement of cash flows. Those prepared by governments are the
statement of financial position, statement of operations, statement of remeasurement
gains and losses, statement of changes in net debt and statement of cash flows.
•
Case 11-3: Town of Evergreen
Objectives of the Case
This case is intended to have students focus on revenue recognition issues in a
municipality.
Discussion
- An incentive now exists (the new bonus structure) for the town controller to maximize
reported revenues to maximize his bonus.
- Government grants: The determination of when the town recognizes grant revenue
should not be when “the province recognizes the transfer” as documented in the notes.
The stipulations attached to the grant will affect the timing of the revenue recognition
by the town and these grants should be reviewed to ensure that revenue is being
recognized properly. For example, government grants are received to subsidize the
town recreational program. These grants should be reviewed and if any monies are
received in advance, they should be recorded as deferred revenue. In addition,
government grants received for constructing new streets should be carefully reviewed.
The statements note that “substantial funds are received in advance of construction
projects”. These funds should be recorded in a deferred capital contributions account
and not recognized in revenue. (It could be that they are now being recognized as
revenue in a capital fund and included in consolidated revenues for the town).
- Property taxes: The notes identify that “property taxes are recorded at their gross
amount when the taxable event has occurred”. At the same time, further in the notes, a
rebate on property taxes is identified as a major expense in a campaign to encourage
businesses to set up in town. If this rebate is a tax concession, then the revenue should
be shown net of the tax rebates and not at the gross amount. This program should be
reviewed carefully to ensure that it is being accounted for appropriately. It appears
that the costs related to tax collection are being accounted for properly.
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9. Chapter 11 – Public Sector Financial Reporting
Recommendations:
1. The financial statements should comply with GAAP. Complying with GAAP however
will not eliminate the ability to structure the accounting to maximize bonuses. For
example, bonuses will be paid on any endowment monies received if the restricted
fund method of accounting is used instead of the deferral method. It is unlikely that it
was the intention of the compensation committee to pay bonuses in this manner.
2. The bonus structure of the compensation agreement should be revisited as a bonus
based on revenues is not optimal. A better approach would be to use a balanced
scorecard approach. Further, the compensation committee should meet yearly to
review the performance of the controller.
Case 11-4: Harvest Province
Harvest Province
Consolidated Statement of Financial Position
As at December 31, 20XX
($ millions)
20XX
Financial Assets
Cash 1,000
Receivables 750
Investments 1,500
Investment in GBEs 500
3,750
Liabilities
Payables 2,000
Unmatured debt 5,000
7,000
Net Debt (3,250)
Non-financial assets
Tangible capital assets 2,000
Prepaids 250
2,250
Accumulated deficit (1,000)
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10. Chapter 11 – Public Sector Financial Reporting
Harvest Province
Consolidated Statement of Operations and Accumulated Deficit
For the fiscal year ended December 31, 20XX
($ millions)
20XX
Actual
Revenue
Income Tax 2,750
Sales Tax 1,750
Total Revenue 4,500
Expenses
Health 1,800
Education 1,200
Other 1,200
Total Expenses 4,200
Surplus (Deficit) from government units 300
Loss from GBEs 50
Surplus 250
Accumulated Deficit, Beginning (1,250)
Accumulated Deficit, End (1,000)
Case 11-5: Green Province
Green Province
Consolidated Statement of Financial Position
As as December 31, 20XX
($ millions)
Financial Assets
Cash 300
Receivables 225
Investments 600
1125
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11. Chapter 11 – Public Sector Financial Reporting
Liabilities
Payables 600
Unmatured debt 1500
2100
Net Debt (975)
Non-financial assets
Tangible capital assets 600
Prepaids 75
675
Accumulated deficit (300)
Accumulated deficit is composed of:
Accumulated operating surplus (deficit) (240)
Accumulated remeasurement gains (losses) (60)
(300)
Green Province
Consolidated Statement of Operations and Accumulated Deficit
For the fiscal year ended December 31, 20XX
($ millions)
Revenue
Income Tax 825
Sales Tax 450
Other Revenue 66
Total Revenue 1341
Expenses
Health 540
Education 360
Debt Service 75
Other 300
Total Expenses 1275
Surplus (Deficit) 66
Accumulated Deficit, Beginning (306)
Accumulated Deficit, End (240)
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12. Chapter 11 – Public Sector Financial Reporting
Green Province
Consolidated Statement of Remeasurement Gains and Losses
For the fiscal year ended December 31, 20XX
($ millions)
Accumulated Remeasurement Gains and Losses
at Beginning of Year (69)
Unrealized Gains Attribitable to Portflio
Investments 15
Gain on Portfolio Investments Reclassified
to Statement of Operations (6)
Accumulated Remeasurement Gains and Losses
at End of Year (60)
Case 11-6: Maple Ridge
This is an exercise to get students to become familiar with a “real” set of municipal
financial statements. There are numerous possibilities for discussing the strengths of
Maple Ridge’s financial reporting. The following are several highlights but there are many
other possibilities:
1. Financial section - note the clarity and level of disclosure in the financial statements and
the related notes. For example, see the schedule on debt where both amounts and
interest rates are disclosed.
2. Note the section on major property tax payers – the names and amounts paid are
identified.
3. The section on general comparative statistics contains non-financial information on
major assets and services and the level of debt (expressed in a number of ways) for the
last 5 years and a comparative from 10 years ago.
4. The “revenue and expenditures” section provides a summary of the last five years by
function and by object. The “capital assets acquired” section provides a summary of the
capital assets and sources of funding for the last five years.
5. The Citizens Report should also be reviewed to see an example of an award winning
“readers digest” version of the annual report. It can be found under “Municipal Hall”,
then “Budget and Business Planning” and then under "Budget and Financial Reports."
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13. Chapter 11 – Public Sector Financial Reporting
6. The “See-It” tool should be tried. It is an online performance reporting tool (with
scorecards) that provides an opportunity for feedback. It can be found under “Municipal
Hall”, then under “How are we doing?”. Note that there is a tutorial to assist is using
this tool, if needed (the tool is very easy to use, but given that the tutorial is less than
5 minutes, we would recommend that students listen to the tutorial to make sure they
understand all the features).
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