Leases and Financial Reporting for Fiduciary Responsibilities
The Governmental Accounting Standards Board (GASB or the “Board”) recently issued for public comment two Preliminary Views (PV) documents. The first, Leases, includes proposals to improve the accounting and financial reporting for leases for state and local governments from both a lessee and lessor perspective, and the second, Financial Reporting for Fiduciary Responsibilities, presents the Board’s current thinking on fundamental issues associated with the reporting of activities in which a government has a fiduciary responsibility.
The objective of the Leases project is to reexamine issues associated with accounting and financial reporting for leases and consider improvements to existing guidance. Specifically, the project seeks to answer the following questions:
a. Are current accounting and financial reporting standards, including the distinction between types of leases, appropriate to meet essential user needs for decision-useful or accountability information regarding governmental leases?
b. If current standards are not considered adequate, what other requirements should be considered?
Under the preliminary views, a lease would be defined as a contract that conveys the right to use a nonfinancial asset (the underlying asset) for a period of time in an exchange or exchange-like transaction. Any contract that meets this definition would be accounted for under the leases guidance, unless specifically excluded. Leases that transfer ownership or contain a bargain purchase option would be accounted for as financed purchases and would not be accounted for under the leases guidance.
Contracts that contain both lease and service components generally would be separated so that each component is accounted for on its own. Contracts that contain leases of multiple assets may be separated in certain circumstances. Contracts entered into at or near the same time with the same counterparty would not be presumed to be part of the same lease unless there is evidence to the contrary.
The lease term would be defined as the period during which a lessee has a noncancellable right to use an underlying asset, plus the following, if applicable:
1. Periods covered by a lessee’s option to extend the lease if it is probable, based on all relevant factors, that the lessee will exercise that option
2. Periods covered by a lessee’s option to terminate the lease if it is probable, based on all relevant factors, that the lessee will not exercise that option.
Fiscal funding or cancellation clauses would continue to be disregarded for financial reporting purposes if the possibility of cancellation is remote. A government would reassess the lease term only if the lessee does one or both of the following:
1. Elects to exercise an option to extend the lease even though the government had previously determined that it was not probable that the lessee would do so, and/or
2. Does not elect to exercise an option to terminate the lease even though the government had previously determined that it was probable that the lessee would do so.
Lessees would recognize a lease liability and an intangible lease asset at the beginning of a lease, unless it is a short-term lease as defined below. The liability would be measured at the present value of certain lease payments to be made over the lease term. The lease asset would be measured at the value of the lease liability plus any prepayments and certain initial direct costs. A lessee would recognize interest expense on the lease liability and amortization expense on the lease asset. Disclosures would include a description of leasing arrangements, the amount of lease assets recognized, and a schedule of future lease payments to be made.
Lessors would recognize a lease receivable and a deferred inflow of resources at the beginning of a lease, unless it is a short-term lease as defined below. The receivable would be measured at the present value of certain lease payments to be received over the lease term. The deferred inflow of resources would be measured at the value of the lease receivable plus the amount of any payments received at or prior to the beginning of the lease that relate to future periods. A lessor would recognize interest revenue on the lease receivable and also would recognize revenue over the term of the lease from the deferred inflow of resources. A lessor would not derecognize the underlying asset in the lease. Disclosures would include a description of leasing arrangements, the total amount of revenue recognized from leases, and a schedule of future lease payments to be received.
A short-term lease would be defined as a lease that, at the beginning of the lease, has a maximum possible term under the contract, including any options to extend, of 12 months or less. A lessee in a short-term lease would not follow the regular accounting for leases but, instead, would recognize lease payments as expenses or expenditures based primarily on the payment terms of the contract. A lessor in a short-term lease would not follow the regular accounting for leases but, instead, would recognize lease payments as revenue based primarily on the terms of the contract.
An amendment to a lease contract would be considered a modification unless the lessee’s right to use the underlying asset decreases, in which case it would be a partial termination. A lease termination would be accounted for by adjusting the balances of the lease liability and lease asset by a lessee, or the lease receivable and deferred inflow of resources by a lessor, with any difference being recognized as a gain or loss. A lease modification would be accounted for by adjusting the balances of the related lease liability and lease asset by a lessee, or the related lease receivable and deferred inflow of resources by a lessor. However, if the modification is due to the refunding of related debt, other guidance would apply.
Subleases would be treated as transactions separate from the original lease. A government that has sublet an asset would recognize separately the liability and lease asset as lessee in the original lease and the receivable and deferred inflow of resources as lessor in the sublease. A sale-leaseback transaction would be accounted for under sale-leaseback accounting if there is a qualifying sale. In that case, the sale would be accounted for as any other sale, except any gain or loss would be reported as a deferred inflow of resources or a deferred outflow of resources and recognized over the term of the leaseback.
The leaseback would be accounted for in the same manner as any other lease. A lease- leaseback transaction would be recognized as a net lease liability or lease receivable, with disclosure of the gross lease liability and lease receivable.
A lease between related parties would continue to be recognized based on the substance instead of the form of the transaction. Leases within financial reporting entities would continue to be treated like any other transaction between component units. Leases with blended component units would be eliminated in the financial statements of the reporting entity, while leases with discretely presented component units would be presented separately from other leases.
The Board’s proposed requirements in this Preliminary Views, if ultimately issued as a Statement, would provide updated guidance that is based specifically on issues applicable to state and local governments. The Board believes financial statement users would receive enhanced decision-useful information about the effects of leases on a government’s financial statements. The Board believes that the accounting and financial reporting guidance on leases would be less complex for practitioners. It would provide greater comparability as a single approach would be applied to accounting for leases. It also would provide meaningful simplification compared to the existing complex guidance. The Board considered expected benefits and costs when deliberating the issues and alternatives related to accounting for leases.
FINANCIAL REPORTING FOR FIDUCIARY RESPONSIBILITIES
The second recently issued GASB PV, Financial Reporting for Fiduciary Responsibilities, presents the Board’s current thinking on fundamental issues associated with the reporting of activities in which a government has a fiduciary responsibility. In this context, fiduciary responsibility generally relates to a government controlling assets belonging to others in a trustee or custodial capacity.
The Board believes that users of governmental financial statements need information with which to assess a government’s accountability for its activities as a fiduciary. The Board also believes that a government should be required to report on its fiduciary responsibilities when certain conditions exist.
GASB research shows that users interested in fiduciary activities believe that the information currently reported in the fiduciary fund financial statements is important to their assessment of a government’s accountability for its fiduciary activities. Further, users participating in the GASB’s research stated that information on fiduciary activities of business type activities (BTAs) is either equally or more important to them than information on a general purpose government’s fiduciary activities. The Board’s preliminary views would enhance the consistency and comparability of the reporting of fiduciary activities by: (1) clarifying when a government has a fiduciary responsibility for financial reporting; (2) describing individual fiduciary fund types; (3) clarifying the financial reporting requirements for BTAs that also are engaged in fiduciary activities; and (4) requiring a financial flows statement for all fiduciary fund types. These proposed changes are responsive to the needs of both users of general purpose government financial statements and users of special purpose government financial statements and would provide preparers and auditors with clearer guidance for determining which activities should be reported in fiduciary funds and in which type of fiduciary fund the activities should be reported.
The Board’s preliminary view is that a government is a fiduciary and has a fiduciary responsibility when it controls assets: (1) from a pass-through grant for which the government does not have administrative or direct financial involvement; (2) in accordance with a trust agreement or equivalent arrangement in which the government itself is not a beneficiary; or (3) for the benefit of individuals that are not required to be part of the citizenry as a condition of being a beneficiary, or organizations or other governments that are not part of the financial reporting entity.
The Board further states that a government “controls assets” in a fiduciary capacity if those assets: (1) are used by the government (or its assignee) to provide benefits to specified or intended beneficiaries and (2) have present service capacity that can be (a) used; (b) exchanged for another asset, such as cash; or (c) employed in any other way that provides benefits.
There are a variety of legal structures or custodial arrangements that define the relationship of a governing body to a fiduciary activity, including: (1) directly holding the assets; (2) serving as the trustee for the assets held in a trust agreement or equivalent arrangement; or (3) being legally separate from the entity (other than a trust) that holds or administers the assets. In addition, one of the key responsibilities highlighted in the definition of control in GASB Concepts Statement No. 4, Elements of Financial Statements, relates to a government’s responsibility for administering the exchange of assets. The Board believes that when a government can make decisions about the types of assets held, assign the responsibility for those decisions, and reassign the responsibility for those decisions, it would be considered to have sufficient responsibility for administering the exchange of assets.
The Board’s preliminary view is that a government’s control of fiduciary assets should be determined by a combination of the legal structure that defines the relationship of the governing body to the fiduciary activity and whether the government has a responsibility for administering the exchange of assets, as follows:
A government has control of assets if:
It is directly holding the assets, regardless of its responsibility for administering the exchange of those assets
It is directly responsible for administering the exchange of assets, regardless of the legal structures that might separate the government and the entity that is holding the assets
It has assigned its responsibility for administering the exchange of assets (for example, to an asset manager) but maintains the ability to reassign that responsibility, regardless of the legal structures that might separate the government and the entity that is holding the assets.
A government does not have control of assets if:
It is acting as a trustee for assets and only has responsibility for establishing parameters (for example, providing a selection of investment options) for those that have the responsibility for administering the exchange of assets
It is neither directly holding nor acting as a trustee for assets and only has responsibility for establishing parameters for those that have the responsibility for administering the exchange of assets
It is not directly holding assets and has no responsibility for administering the exchange of assets.
Fiduciary funds would continue to be used to report the fiduciary activities of a government in its basic financial statements. The Board is proposing that the classification of fiduciary activities as a particular fiduciary fund would be determined in part by the presence or absence of a trust agreement or equivalent arrangement. To be reported in an investment trust fund or private-purpose trust fund, a fiduciary activity would need to be administered through a trust agreement or equivalent arrangement in which both of the following conditions are met:
Trust assets are dedicated to providing benefits to recipients in accordance with the benefit terms.
Trust assets are legally protected from the creditors of the government that is acting as the fiduciary.
The Board also is proposing a new custodial fund type to report any fiduciary activity that is not administered through a trust agreement or equivalent arrangement. A custodial fund would be reported as a fiduciary fund and would include certain funds previously classified as agency funds or as trust funds, but for which there is no trust agreement or equivalent arrangement.
A liability would be recognized in fiduciary funds when an event has occurred that compels a government to disburse fiduciary resources. A government would be compelled to disburse fiduciary resources when no further action or condition is required to be met by the beneficiary to be entitled to receive the resources.
All fiduciary funds would report additions and deductions in the statement of changes in fiduciary net position in the basic financial statements. The Board believes that users need detailed information about the additions to and deductions from fiduciary funds. Therefore, governments engaged in fiduciary activities would present: (1) additions disaggregated by source and, if applicable, by net investment income, including separate display of investment income and investment costs, and (2) deductions disaggregated by type and, if applicable, separate display of administrative costs.
Some special-purpose governments engaged only in fiduciary activities that are component units of another government have component units of their own that are engaged only in fiduciary activities. Fiduciary fund financial statements of a primary government would include the combined information of that component unit and its component units that are fiduciary in nature.
Finally, the Board’s preliminary view is that a stand-alone business-type activity (BTA) also engaged in fiduciary activities should present fiduciary fund financial statements within its basic financial statements.
Individuals or organizations that would like to provide comments on these preliminary views documents are encouraged to provide written comments by March 6, 2015. Comments should be addressed to the Director of Research and Technical Activities, Project No. 3-24P (for the Leases PV) or Project No. 3-13P (for the Fiduciary Responsibilities PV), and emailed to firstname.lastname@example.org.