Annual Financial Reporting Options: GAAP-Basis
This blog article is the second of a series of four. The first described the authority and context for the two reporting options for Washington local governments. This article describes the GAAP-reporting option, and the next will discuss the cash-basis reporting option. The last will evaluate pros and cons to each approach.
Generally Accepted Accounting Principles (GAAP)
Generally Accepted Accounting Principles (GAAP) for government are primarily found in the work of the Government Accounting Standards Board (GASB). The GASB website provides the following:
Established in 1984, the Governmental Accounting Standards Board is the independent, private-sector organization based in Norwalk, Connecticut, that establishes accounting and financial reporting standards for U.S. state and local governments that follow Generally Accepted Accounting Principles (GAAP).
The GASB standards are recognized as authoritative by state and local governments, state Boards of Accountancy, and the American Institute of CPAs (AICPA). The GASB develops and issues accounting standards through a transparent and inclusive process intended to promote financial reporting that provides useful information to taxpayers, public officials, investors, and others who use financial reports.
The Financial Accounting Foundation (FAF) supports and oversees the GASB. Established in 1972, the FAF is the independent, private-sector, not-for-profit organization based in Norwalk, Connecticut responsible for the oversight, administration, financing, and appointment of the GASB and the Financial Accounting Standards Board (FASB).
The Washington State Auditor’s Office (SAO) bases the principles for accounting and financial reporting found in its GAAP guidance on the GASB’s Codification of Governmental Accounting and Financial Reporting Standards.
Intent of GAAP
A focus for GAAP is the effect of activity, which occurs in a given fiscal year regardless of when the financial aspects of this activity actually occur. For example, if the agency acquires an asset that will provide service for many years, that asset should be “expensed” over the years for which it will provide service (i.e., “depreciation”). Another example would be recognition of revenues in the reporting period that revenue was earned regardless of when the cash was received — such as billing for utilities. We recognize utility rate revenues earned during the reporting period regardless of when utility bills were actually invoiced or paid in that same period (We call these accrued revenues and illustrate the outstanding balance due with a “receivable” account).
By consistently reporting the financial effects of activity in the reporting period during which the underlying activity occurred, we are illustrating the impact on the overall economic condition of the entity for that fiscal year. A common example (and the topic of much discussion these days) is the extent to which retirement obligations have accumulated while the resources to meet these obligations has lagged. Under GAAP reporting, related future payments earned while providing service to the public should be recorded during the fiscal period in which it was earned. If that had been the case, the future pension obligations, along with what is known as “other post-employment benefits” (OPEB), such as medical benefits, would have been expensed when earned (and when the related service to the community was being performed). Instead, GAAP for governments lagged and large pension and OPEB obligations grew without recognition during the related reporting periods.
GAAP Financial Statements
Governments utilizing the GAAP BARS manual can use any bookkeeping method during the fiscal year (often this is a method that enables efficient comparison with budgets), but the annual financial report must conform to GAAP. This is where it can get complicated. With GASB’s Statement 34, they essentially created three different ways to illustrate the same information (we call these “basis of accounting”), including full accrual, modified accrual, and budgetary basis.
Full accrual (as described above) is consistently reporting the financial effects of activity in the reporting period during which the underlying activity occurred. Accountants call this the “economic resources measurement focus.” All enterprise fund activity is always presented on a full-accrual basis. Governmental fund activity is presented using full accrual only in the government-wide financial statements. As a result, all information is consistently presented on a full accrual basis of accounting in the government-wide financial statements.
Modified accrual is what I refer to as a halfway point between full accrual and cash basis. Accountants call this the “current financial resources measurement focus.” Certain expenditures and certain revenues are accrued to the fiscal year reporting period but not to the extent required in full accrual. For example, we do not record the depreciation of an asset in modified accrual, but we do record the recognition of revenue that is measurable and (reasonably) available. One example would be utility rate revenues we reasonably expect to collect within a period of time wherein they could be used for expenses related to the current fiscal year. We use modified accrual for governmental funds when reported at the fund financial statements level.
Budgetary basis may also apply when presenting supplementary information in the financial report. This includes any fund that has a legally required adopted budget, such as the general fund and each major special revenue fund (Major funds are those that represent at least 10% of the total of the fund type or where the designation of such is established to provide for desired level of reporting by the entity).
The budgetary basis may be different than either the full accrual or modified accrual basis. For example, when I worked at the City of Renton, we utilized a cash basis of accounting for budget purposes.
A Review of the Requirements
Annual financial reports using GAAP will therefore include the following:
Basic Financial Statements
- Government-wide financial statements (illustrating all reporting funds of the entity on a full-accrual basis)
- Fund financial statements (full accrual for proprietary funds, modified accrual for governmental funds)
- Notes to the financial statements
Required Supplementary Information
- Management discussion and analysis
- Budgetary statements
Since it is common for local governments to maintain their financial activity on a cash or modified accrual basis, some conversion of the results of this activity into the correct basis of accounting for the annual financial report is required. This year-end activity is painstaking and tedious. It requires careful attention to detail and a thorough understanding of both the theoretical concepts (as many issues might not be clear as to their treatment within GAAP) and practical experience in making these adjustments.
Conclusion and Resources
This article provides a few examples of the differences between GAAP and cash-basis reporting as well as some of the rationale for GAAP and where the authority for GAAP-based guidance originates. It provides only a very high-level view of these issues and further study of this subject can be undertaken in the Accounting and Reporting sections of the SAO BARS manuals. In addition, the GASB website provides several resources to further expound on this subject. Lastly, a common source of reference for governmental accountants is the Government Finance Officers Association publication Accounting, Auditing and Governmental Reporting, also known as the Blue Book. Happy reading.
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