The User's Perspective
Statement 34, 10 Years Later
The GASB was just a teenager when it issued Statement No. 34, Basic Financial Statements—and Management’s Discussion and Analysis—for State and Local Governments. The rather banal title of Statement 34 belied the nature of its contents. It vastly improved the value of the annual audited financial report, making it possible to comprehensively assess the overall financial health of a city, county, or other government for the first time. As we near the tenth anniversary of Statement 34’s issuance, this article briefly describes the major new features that it introduced to financial reporting and conveys some of what the GASB has learned about the Statement’s impact in the user community.
Statement 34 in a Nutshell
Fifteen years in the making (see the accompanying article in this issue) and running hundreds of paragraphs, Statement 34 made important changes to the appearance and content of the governmental financial report. Perhaps the three most significant were the introduction of management’s discussion and analysis, government-wide financial statements, and major fund reporting.
Management’s Discussion and Analysis
The management’s discussion and analysis (MD&A) is a narrative section governments now present before the basic financial statements in their financial report. The purpose of the MD&A is to make it easier for a broader audience to use the financial report more meaningfully. The MD&A presents summary information drawn from the financial statements and notes to the financial statements, as well as from required supplementary information (RSI) in some instances. The MD&A itself is RSI, which means that it is subject to limited procedures conducted by the auditor. The MD&A is not meant to be a simplified replacement for the financial report as a whole, but rather to better prepare the report reader to examine and utilize the information that follows.
The summary financial information is supplemented by management’s explanation of what the information means. Governments generally are required to present financial information for the current and prior fiscal years, and management’s analysis is geared toward explaining how finances changed from year to year and why they changed. The MD&A also is intended to bring to the financial report user’s attention key issues that affected or will affect a government’s financial health, but which may not otherwise be apparent to the user.
The MD&A has proven to be one of the most popular parts of the Statement 34 financial report. Some of the financial statement users interviewed by the late Professor Gil Crain during the year after Statement 34 was issued already were beginning to use the MD&A. For analysts working in the municipal bond industry, in which judgments about credit worthiness often are made in a very short timeframe, the MD&A has been a boon because it sped the process of identifying key issues and potential red flags.
Five years later, the GASB conducted interviews with almost 250 financial statement users, in part to ascertain the degree to which they had begun to use the new information in the financial reports prepared in compliance with Statement 34. When asked what information they were using, the first thing mentioned by the overwhelming majority of the interviewees was the MD&A. Many interviewees suggested that, when well written, the MD&A can make their jobs easier by answering the questions they often have to call a government to get answers to. “ MD&A’s been a huge value…when it’s done well…because it saves an analyst…a phone call or it shortens the phone call that they’ve got to make. If it’s written well and written within…the spirit of the standard.” By the same token, boilerplate MD&A that are not tailored to the specific government in question are not very useful, according to many interviewees. The quality of the MD&A also appeared to be an indicator to some of the quality of a government’s management.
Government-wide Financial Statements
One of the shortcomings of the financial report pre-Statement 34 was that the information was only disaggregated among a variety of funds and presented on different accounting bases and measurement focuses. Consequently, one could not get a good sense of the overall financial health of the government as a whole. Perhaps the most significant change in Statement 34 was the addition of two government-wide financial statements—a statement of net assets and a statement of activities—that cover the entire government using full-accrual-basis information.
In these two statements, general purpose governments, such as states, counties, and cities, now report all of their assets (including infrastructure and other capital assets) and liabilities (including long-term debt), giving a comprehensive picture of a government’s financial bottom line. (Government business enterprises, such as water and sewer systems, already reported in this manner.) The statement of net assets splits the financial position indicator—net assets, or assets minus liabilities—into three parts: invested in capital assets, net of related debt; restricted (limited to specific purposes by external parties or through constitutional provision or enabling legislation); and unrestricted.
The statement of activities diverges significantly from the traditional operating statement, presenting inflows and outflows in a net cost format. This arrangement compares the costs of services (expenses) with the revenues generated by the services themselves through charges, fees, and grants (referred to collectively as program revenues). The difference between expenses and program revenues—net (expense) revenue—indicates the degree to which programs or functions are self-supporting versus the degree to which they rely on taxes and other general revenues for support.
The jury is still out regarding what impact the new government-wide information has had on financial statement users. During the user needs study interviews in 2005, many interviewees expressed interest in the information but had not yet fully integrated it into their analyses or decision making. At least one supplier of financial information to bond market participants began to publish government-wide ratios right away. Individual users and other organizations were moving more cautiously. Users quickly adopted certain information that represented a more accurate depiction of measures that they had cobbled together in the past as proxies from second-best data. For instance, the availability of historical cost and accumulated depreciation information for capital assets allowed users to calculate average-age-of-capital-assets ratios.
Municipal analysts were quick to say that they required a trend of at least three years’ information in order to factor it into their credit analysis, but would prefer five years. As of 2005, even the states and largest cities had not yet published three financial reports under the Statement 34 model. At this point, all governments that follow generally accepted accounting principles have fully implemented Statement 34 for at least three years. Consequently, at this point one would expect to see analysts utilizing trends in government-wide ratios, but to what extent this has come to fruition is unclear.
Major Fund Reporting
Prior to Statement 34, funds were totaled with other funds of the same type—for instance, special revenue funds—and reported in a single column. Statement 34 replaced fund-type reporting for the governmental funds and the enterprise funds with major fund reporting. Major fund reporting entails reporting the largest or most significant fund individually in their own columns, while reporting the smaller, less significant funds (non-major funds) together in a single column. The primary motivation for this change was to improve transparency (which could be diminished when individual funds were aggregated by type) and increase the usefulness of the information.
Statement 34 identified certain funds that were required to be reported as major:
- The general fund or main operating fund
- Funds with assets, liabilities, revenues, or expenditures equal to at least 10 percent of all governmental fund assets, liabilities, revenues, or expenditures, respectively, and 5 percent of all governmental and enterprise funds combined for the same element.
Governments also may report other governmental funds that do not meet these criteria as major if they believe it is important to do so for the benefit of their report users.
The impact of this change introduced by Statement 34 is less well understood than that of MD&A and government-wide financial statements. The general fund generates the broadest interest among users, and its reporting as an individual column did not change under Statement 34. Some participants in the GASB’s user research mentioned favorably the ability to see the largest funds individually, while some others were concerned about not being able to distinguish smaller funds. The latter issue was a difficulty for users prior to Statement 34. Unless a government presented supplementary combining schedules that showed the funds individually, then the funds aggregated by type could be viewed on their own, and non-major funds that are aggregated in a single column cannot be seen separately either.
- Background Information about Statement 34