Journal Entries

This recurring website feature highlights articles from The GASB Report, the GASB’s monthly newsletter. The current article appeared in the December 2011 issue.

GASB Presents Preliminary Views on Financial Projections

In late November, the GASB approved a Preliminary Views, Economic Condition Reporting: Financial Projections, presenting the Board’s initial views on the key issues related to reporting financial projections and the accompanying narrative that will assist users in assessing a government or governmental entity’s economic condition. The GASB is seeking public input on the views expressed in the Preliminary Views before considering the next step in the Board’s due process.

The focus of this project is on forward-looking information that would provide users of governmental financial reports with information they need to assess a government’s current financial health and its ability to continue to meet its commitments going forward. The information that the Board’s preliminary views would yield is not predictions or forecasts of what is likely to take place but, rather, projections, which use historical and known information and extrapolate that information into the future. Accompanying narrative discussion would help the reader to place these projections into context and better understand why the changes are expected.

Broadly speaking, the GASB’s larger economic condition reporting project is concerned with improving the communication of decision-useful information to financial statement users about a governmental entity’s financial position, fiscal capacity, and service capacity to assist them in assessing the entity’s overall economic condition.

The Preliminary Views on financial projections represents the third phase of the GASB’s project on economic condition reporting. The first project phase focused on background research, including a literature review that was completed in 2002 and was updated in 2006. The second project phase included user panels and surveys of users, preparers, and auditors. The Board developed a working definition of economic condition during the second project phase that included three elements: financial position, fiscal capacity, and service capacity.

User participants in this project phase told the GASB that they received the information necessary to assess financial position but that they needed additional information to fully assess fiscal capacity. In addition, they said current financial reporting at that time yielded none of the information they need to assess service capacity. This second phase of the project led to the issuance in May 2004 of Statement No. 44, Economic Condition Reporting: The Statistical Section, and focused on the reporting of economic condition information that existed at that time.

GASB research indicates that while users of state and local governmental financial statements find it important to understand a government’s past and present economic condition, they also need forward-looking information to aid them in assessing a government’s fiscal sustainability.

The GASB began deliberations in August 2010 on this current project phase, which focuses on the additional information users of financial statements need to assess economic condition, specifically, the fiscal sustainability of a governmental entity. Board deliberations over the past 15 months led to the issuance of this Preliminary Views, which identifies the additional information needed by users as financial projections and related narrative discussion.

The Preliminary Views

The Board’s preliminary view is that five components of information are necessary to assist users of state and local government financial reports in assessing a governmental entity’s fiscal sustainability:

• Projections of total cash inflows and major individual cash inflows, in dollars and as a percentage of total cash inflows, with explanations of the known causes of fluctuations in cash inflows
   
• Projections of the total cash outflows and major individual cash outflows, in dollars and as a percentage of total cash outflows, with explanations of the known causes of fluctuations in cash outflows
   
• Projections of total financial obligations and major individual financial obligations, including bonds, pensions, other postemployment benefits, and long-term contracts, with explanations of the known causes of fluctuations in financial obligations
   
• Projections of annual debt service payments (principal and interest)
   
• A narrative discussion of major existing intergovernmental service interdependencies and their nature.

Under the Board’s preliminary view, all of these components of fiscal sustainability are essential for placing a government’s basic financial statements and accompanying notes in an operational or economic context and would be required to be included in the required supplementary information (RSI) of all governmental entities’ comprehensive annual financial reports or annual financial reports. Two Board members, however, hold an alternative view to the Preliminary Views. While these Board members believe that the development of forward-looking information is within the scope of the GASB and is appropriate for the Board’s agenda, they do not believe its reporting is essential, and, consequently, it is not believed appropriate for inclusion in RSI.

Extensive research conducted by the GASB has demonstrated that users of state and local governmental financial statements need information on the five components described above to assess a government’s financial health in a comprehensive manner and to make their assessment regarding an entity’s fiscal sustainability. With the exception of projections of annual debt service payments, which are already required for outstanding debt and leases to be disclosed in the notes to financial statements, all of the components are new components of fiscal sustainability information.

In addition, projections of inflows and outflows of resources are essential to assessing interperiod equity, or a government’s ability to meet annual spending needs with current-period resources, rather than delaying payments to the future or consuming accumulated resources. Projections of financial obligations, such as bonds and unfunded pension liabilities, reflect the future financial impact of a government’s past decisions and help users to evaluate a government’s capacity to meet those financial demands as they come due.

Under the Board’s working definition of the term, an intergovernmental service interdependency exists when one governmental entity provides a service on behalf of another governmental entity or together with one or more governmental entities. The component regarding narrative discussion of major existing intergovernmental service interdependencies would provide users with information to assess the fiscal implications of a major service interdependency and how changes in this major service interdependency may impact a governmental entity’s fiscal sustainability.

Economic Condition and Fiscal Sustainability Defined

While earlier phases of this project employed a tentative definition of economic condition, the Board determined that, at this point, it is necessary to formally define the term. The Board’s preliminary view is that economic condition is a composite of a government’s:

• Financial position—the status of assets, liabilities, deferred outflows and inflows of resources, and net position, as of a point in time
   
• Fiscal capacity—the ability and willingness to meet financial obligations as they come due on an ongoing basis
   
• Service capacity—the ability and willingness to meet commitments and provide services on an ongoing basis.

Because there is no generally accepted definition of fiscal sustainability at present, the Board determined it was necessary to formally propose a definition of this term. The Board’s preliminary view defines fiscal sustainability as a government’s ability and willingness to generate inflows of resources necessary to honor current service commitments and to meet financial obligations as they come due, without transferring financial obligations to future periods that do not result in commensurate benefits.

In addition, it is the Board’s preliminary view that economic condition and fiscal sustainability are related and that economic condition is broader than fiscal sustainability. Fiscal sustainability is the forward-looking aspect of economic condition.

How Projections Would be Done

As noted earlier, annual financial projections would be based on current policy, informed by historical information, and adjusted by known events and conditions that affect the projection periods. Current policy includes policy changes that have been formally adopted by the end of the reporting period but do not become effective until future periods.

Inflows and outflows would be projected on a cash basis of accounting, and financial obligations would be projected on an accrual basis of accounting. The Board believes that projections of inflows and outflows using the cash basis of accounting would provide users with information that would be useful when assessing fiscal sustainability. Using the accrual basis of accounting when projecting financial obligations, the Board believes, would provide users with more complete projected information on the financial obligations incurred than if the cash basis of accounting was used.

Assumptions underlying the projections would be based on historical information, as well as events and conditions that have already occurred and affect the future. The assumptions would be (1) consistent with each other and with the information used as the basis for the assumptions and (2) comprehensive by considering significant trends, events, and conditions. Under this approach, the use of specific assumptions would not be prescribed.

Disclosures of assumptions would be required in order to help users understand how the financial projections were made and to assess how reasonable they are. The Board believes that identifying guiding principles rather than specifying particular mechanics would result in governmental entities making more reliable financial projections. Financial projections would be made for a minimum of five individual years beyond the reporting period for external reporting purposes.

The components of fiscal sustainability information would be reported for the primary government, including both governmental activities and business-type activities with net subtotals (inflows less outflows) for the general fund, other governmental activities, total governmental activities, total business-type activities, and a net total for the entire primary government. Notes to RSI would be necessary in instances when one or more activities are determined to significantly affect the fiscal sustainability of the primary government.

An individual cash inflow, cash outflow, and financial obligation of a governmental or business-type activity would be projected separately if it is viewed as “major,” which means it represents at least 10 percent of total cash inflows, total cash outflows, or total financial obligations, respectively, for all activities of that type in any reported projection period.

All cash outlays for capital and capital-related cash inflows from bond proceeds, capital grants, or other sources restricted or committed to capital outlays would be considered major and reported separately. Any other cash inflow, cash outflow, or financial obligation may be reported as major if the government believes that information is particularly important to users when making an assessment of the primary government’s fiscal sustainability. It would be a matter of professional judgment to determine which intergovernmental service interdependencies are considered major.

Under the Board’s preliminary view, a cautionary notice should precede the financial projections and related narrative discussion to place the information into context. The cautionary notice would inform readers that the projections do not represent a forecast or prediction of the most likely outcome. Because projections are based on assumptions that are inherently subject to uncertainty and changes, the notice would caution readers that actual future financial results may be significantly different from those reported.

How to Obtain Copies of the Preliminary Views

Copies of the Preliminary Views may be downloaded at no cost from the GASB website, www.gasb.org. The comment deadline is March 16.

Additional details on how to provide comments and participate in the public hearings scheduled for March 29 in Los Angeles and April 17 in New York City are available in the document.