The User's Perspective

December 2011


Deferrals: What They Are and What the GASB Is Doing with Them

          This article gets to the bottom of what deferrals are, why it is important that governments are reporting them, and what the GASB is doing related to deferrals.

What Are Deferrals?

          GASB Concepts Statement 4, Elements of Financial Statements, which was issued in 2007, identifies consumptions and acquisitions of net assets related to future reporting periods as deferred outflows of resources and deferred inflows of resources (deferrals), respectively. Simply put, deferrals result from inflows and outflows of resources that have already taken place but which are not ready to be recognized in the financial statements as revenues and expenses because some future event has yet to occur.

          Consider, for example, a transaction in which a state government gives an unrestricted grant to a county, but stipulates that the county cannot use the grant money until next year. The county has an asset in hand—cash—but because the cash cannot be expended until next year, conceptually it would be more appropriate for the county to recognize that inflow as revenue next year than this year. Likewise, although the state no longer has the cash, conceptually it would be more appropriate for the state to recognize the outflow as expense next year than this year. We say conceptually, because the GASB’s standards that govern such transactions were issued before this concept was put forth in Concepts Statement 4, and those standards have not yet been revised to be consistent with the concepts. This is about to change, as explained further below.

          Concepts Statement 4 sees deferrals fitting into the elements that comprise a statement of financial position as follows:

Assets + deferred outflows of resources – liabilities – deferred inflows of resources
= net position

Why Are Deferrals Important?

          Similar to assets, deferred outflows of resources have a positive effect on net position, and similar to liabilities, deferred inflows of resources have a negative effect on net position. Despite these similarities, however, Concepts Statement 4 clearly establishes that deferrals are not assets and liabilities, and should not be reported as such in a statement of financial position.

          The ability to distinguish between assets and liabilities, on the one hand, and deferrals on the other is important for several reasons. Assets represent resources (cash) or claims on resources (receivables) and factor into assessments of a government’s ability to make payments as they come due in both the short and long run. Items that meet the definition of a deferred outflow are reported among the assets at present, but the early grant payment made by the state government mentioned earlier, for instance, is no longer a resource to the state and cannot be used to pay bills. Consequently, they should not be included when calculating ratios that include assets, such as the current ratio (current assets divided by current liabilities). Based on the previous accounting model, if it was not appropriate to report a transaction as an expense (or expenditure) of the period, the only alternative was to report the amount related to the transaction as an asset.  Although it may first appear to be a simpler approach, the result is either an overstatement of assets or an overstatement of expenses (or expenditures), both of which could have an adverse effect on a user’s analysis of financial statements.

          Liabilities are obligations to sacrifice financial resources that a government has little or no discretion to avoid. Things that meet the definition of a deferred inflow are currently reported among the liabilities. Deferred inflows, however, are inflows of resources that have already occurred but are applicable to future periods; they are not claims against a government’s financial resources. Therefore, including them among liabilities would overstate a government’s indebtedness. Like the asset example above, the overstatement of liabilities or revenues would have an adverse effect on financial ratios.

          Another key reason governments should report deferrals separately from assets and liabilities is to help users of their financial statements assess interperiod equity. Interperiod equity is the degree to which a government raises sufficient resources in a year to cover its costs, rather than drawing down resources accumulated in the past or pushing off costs to future reporting periods. (See “Interperiod Equity and What It Means to You” from the June 2009 issue for a more in-depth discussion.) The use of deferrals helps to ensure that expenses and revenues are aligned with the years they are related to, thus making it easier for financial statement users to determine whether governments are living within their means from year to year.

What Are the Current Requirements Regarding Deferrals?

          Currently, two GASB pronouncements require the recognition of deferrals. Statement No. 53, Accounting and Financial Reporting for Derivative Instruments, which was issued in 2008, requires the deferral of changes in the fair value of hedging derivatives. (See Derivative Instruments: A Plain-Language Summary of GASB Statement No. 53 for a fuller discussion.)As long as a hedging derivative remains effective in offsetting the changes in fair value or cash flows of the debt or other item it is associated with, it begins and ends with a zero fair value and has no net impact on investment income over its term. Reporting the annual increases and decreases in its fair value as a part of investment income would overstate or understate revenue, respectively, because the changes are temporary and will not result in resources a government can call upon (assets) or obligations to sacrifice resources (liabilities). To do so would hinder a user’s ability to evaluate interperiod equity.

          Statement No. 60, Accounting and Financial Reporting for Service Concession Arrangements, which will become effective for fiscal years beginning January 1, 2012, and later, requires the deferral of up-front payments a government receives under a service concession arrangement from an entity it has contracted with to operate a major capital asset, such as a toll road. Rather than recognize the up-front cash payment as revenue right away, it is deferred and recognized as revenue over the term of the contract. Although the cash has already been received, the inflow is in fact associated with the future years of the contract—recognizing the revenue now would adversely affect the assessment of interperiod equity.

Where Are Deferrals Reported?

          One could reasonably ask, if these deferred items should not be reported as assets and liabilities in a statement of financial position, where should they be reported? The accrual-based statements report assets, liabilities, and net assets; the modified accrual balance sheet reports assets, liabilities, and fund balance. Neither includes deferrals. The issuance of Statement No. 63, Financial Reporting of Deferred Outflows of Resources, Deferred Inflows of Resources, and Net Position, in June 2011, answered that question by providing a new statement of net position format.

          Statement 63, which will become effective for fiscal years beginning January 1, 2012, and later, requires that deferred outflows be reported separately from assets and deferred inflows separately from liabilities. The financial position in the accrual-based statements will be called net position rather than net assets, but retains the same three categories—net investment in capital assets (previously called invested in capital assets, net of related debt), restricted, and unrestricted.

Are There Other Potential Deferrals?

          Statement 63 provides financial statement presentation guidance for the existing deferral requirements in Statements 53 and 60, but does not identify additional items that should be recognized as deferrals. Concepts Statement 4 explicitly states that recognition of deferrals should be limited to instances identified in GASB authoritative pronouncements. In other words, governments should not take it upon themselves to designate items as deferrals if the accounting standards do not. One might ask, is the Board expected to identify more? In a word, yes.

          To ensure consistency in financial reporting in regard to assets, liabilities, and deferrals, the GASB added a project to the technical agenda in late 2010 to determine if items currently reported in statements of net position as assets and liabilities are actually deferred outflows of resources or deferred inflows of resources, respectively. In August 2011, the GASB approved an Exposure Draft of a proposed Statement, Reporting Items Previously Recognized as Assets and Liabilities, which proposes reclassifying certain items currently reported as assets and liabilities.

          The Board examined the existing GASB literature for items that could potentially meet the criteria for recognition as deferred outflows of resources and deferred inflows of resources. The document proposes that some assets would continue to be classified as assets, others would be recognized as deferred outflows of resources, and still others would be recognized as outflows of resources in the current reporting period. Similarly, some liabilities would continue to be classified as liabilities, others would be recognized as deferred inflows of resources, and still others would be recognized as current inflows of resources. The following are some examples of what the GASB has proposed:

Item

Example

Currently reported as:

Proposal—report as:

Prepayments

Rent for the first 6 months of next year paid in advance

Asset

Asset

Resources advanced to another government when the passage of time is the only requirement that has not yet been met

Unrestricted state aid to a local government that cannot be spent until the following year

Asset (advance to the local government until time requirement is met) of the state

Deferred outflow of resources of the state

Debt issuance costs, other than prepaid insurance

Underwriter fees associated with the issuance of long-term bonds

Asset (amortized and reported as annual expenses over the maturity of the debt)

Current-period outflow of resources (expenses)

Resources received in advance in relation to a derived tax revenue

Payment on next year’s income tax liability received this year

Liability (deferred revenue)

Liability

Resources received in advance from an imposed nonexchange transaction

Payment on next year’s property tax levy received this year

Liability (deferred revenue)

Deferred inflow of resources

Loan origination fees, excluding any portion related to points, related to lending activities

Amounts charged to borrowers in an economic development loan program

Liability (amortized and reported as annual revenue over the maturity of the loan)

Current-period inflow of resources (revenue)

What Is Ahead for Deferrals?

          The comment deadline for the GASB’s deferrals proposal was mid-November, and in December the Board began to review the feedback it received. The current GASB technical plan expects a final Statement in March 2012.

          The Board’s current conceptual framework project is examining when elements of financial statements should be recognized and how they should be measured. This effort could potentially provide further guidance and clarification regarding deferrals. (See the GASB’s due process document in this project, Preliminary Views, Recognition of Elements of Financial Statements and Measurement Approaches.)

          In addition, there are aspects of the project on pension accounting and financial reporting that could result in the reporting of deferrals. For example, the GASB has proposed that changes in the pension liability relating to active employees resulting from the use of new assumptions would be reported as deferrals and introduced into pension expense over the average remaining period of service of those active employees. These changes are related to future periods over which employees are going to work and earn benefits and should therefore be incorporated into expense in those periods rather than immediately. (See the Plain-Language Supplement, Pension Accounting and Financial Reportingand the article in the July 2011 issue.)

Further Reading