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cliftonlarsonallen.com

Accounting Complexities Facing Local Governments IIByAndrew Laflin, CPAAssurance & Advisory Manager, CliftonLarsonAllen

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Learning Objectives• This session will provide answers to a series of questions

that present complex and often overlooked accounting and financial reporting issues. Examples include– Prepaid expenses– Debt related transactions– Operating lease with scheduled rent increase– Impairment of capital assets– Termination benefits– Intangible assets: website development

• Your knowledge of old TV comedy sitcoms from the 70s, 80s, and early 90s will also be tested

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Question #1• On September 1, 2013, Somers #201 Fire District paid a

$30,000 premium relating to a commercial auto insurance policy on its fire trucks. The premium was to cover the months of September, October, and November. The District’s Finance Director, John Ritter, questioned whether or not to expense the full $30,000 on September 1st, or record an expenditure for $10k and a prepaid asset for $20k at 9/30/13 within the District’s general fund. How should Mr. Ritter account for this payment? And would the accounting treatment be different if this was a proprietary fund?

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Answer #1• GASB Cod. Sec. 1600.127b: expenditures by governmental

funds for insurance or similar services that extend over more than one reporting period are not required to be allocated, but may be accounted for as expenditures in the period paid

• If the interperiod allocation method is used, a prepaid expenditure is reported in the asset section of the governmental fund balance sheet.

• Under GASBS 54: fund balances resulting from prepaid amounts must be reported as nonspendable

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Answer #1, Continued

• In proprietary funds and in government-wide financial statements, interperiod allocation is required for significant prepaid expenses

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Question #2• On March 10, 2013, the City of Urkel issued $7,500,000 of

general obligation bonds to finance the construction of a new recreation center. Debt issuance costs were $60,000, and the bonds were issued at a discount of $282,000. The bond discount and $44,000 of underwriters’ fees, bond insurance, and rating agency fees were deducted from the bond proceeds. A month later, the City paid the remaining $16,000 of issuance costs upon receiving an invoice from bond counsel. The initial debt service payment is due on 11/10/13, which includes $150,000 of interest.

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Question #2, continued

• Within the debt service fund on the governmental fund financial statements, the City recorded $7,174,000 ($7,500,000 minus 282,000 minus $44,000) as an other financing source. The remaining $16,000 of issuance costs was recorded as an expenditure when paid. Furthermore, since the debt service payment was to be made within 60 days after year end, the City recorded accrued interest of $125,000 relating to the period 3/10/13 to 9/30/13. Did Urkel record this correctly?

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Answer #2• GASB 34, para 87 requires bond issuance costs to be

reported as expenditures, not as other financing uses or netted against bond proceeds, on the closing date

• GASB 34, para 88, as amended by GASB 37, para 16, requires issuance discounts and premiums related to general long term debt to be reported as separate financing sources and uses

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Answer #2, continued• GASBI No. 6, para 13 states that a government may report a

liability and expenditure for debt service on general long-term debt before it is due for payment only if:– “Dedicated” financial resources have been accumulated in a debt

service fund AND– The debt service is due and payable within one to several days

after year end but no more than one month after year end

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Question #3

• Travolta County rents a portion of its County-owned community center to Sweathogs Yoga Group. As an inducement to agree to a five year lease, the County offered Sweathogs a rent holiday for the first year. Annual rent for years 2 through 5 is $10,000 per year, payable on January 1st of each year. How should Travolta County recognize rent from this operating lease each year? Does it make a difference if this revenue is getting reported to a governmental fund or enterprise fund?

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Answer #3• GASBS No. 13, Accounting for Operating Leases with

Scheduled Rent Increases, as amended by GASBS No. 62, applies to all governmental fund types, that is, to governmental, proprietary, and trust funds. It allows revenue from operating leases with scheduled rent increases to be recognized in the same way as for regular operating leases if the payment schedule in the lease is “systematic and rational”

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Answer #3, continued

• Systematic and rational means that the scheduled rent increases are intended to cover factors such as the following:– Cost increases due to inflation. – Property value appreciation due to appreciation in the general

real estate market or in the specific property as it matures. – The property's availability for use.

• If these criteria are met, revenue is recognized each year equal to the year's payment required by the lease

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Answer #3, continued• GASBS No. 13, para 6: “Sometimes an operating lease with

scheduled rent increases contains payment requirements in a particular year or years that are artificially low when viewed in the context of earlier or later payment requirements. This situation may take place, for example, when a lessor provides a rent reduction or “rent holiday” that constitutes a financing arrangement between the lessor and the lessee. As another example, a lessor may provide a lessee reduced rents as an inducement to enter into the lease.”

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Answer #3, continued

• “…In these cases, the operating lease transactions should be measured using either of the following methods. – The operating lease transactions may be measured on a

straight-line basis over the lease term. – The operating lease transactions may be measured based

on the estimated fair value of the rental. The implicit financing by the lessor of the lessee's cash flow should be accounted for using the interest method. That is, interest should be calculated for each period so that it results in a constant rate of interest over the lease term on the period's outstanding accrued lease receivable or payable.”

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Answer #3, continued

• Governmental funds should apply this recognition criterion on the modified accrual basis of accounting and proprietary funds and trust funds should apply the recognition criteria on the accrual basis

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Question #4• Rose County purchased land and constructed a warehouse

that served as a storage facility for utility parts and supplies, as well as several utility trucks. Construction was completed, and the building became operational on 4/1/04 at a total cost of $1,700,000, which included $200,000 cost to acquire the land. The building is being depreciated on a straight line basis over 40 years. Then, in the beginning of June of 2013, a tropical storm caused damage to the roof of the building, along with additional flood damage. Total restoration costs totaled $260,000. 20% of those costs were related to demolition and mold removal, and the remaining 80% were related to rebuilding walls and roof.

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Question #4, continued• In addition, four utility trucks were parked in the

driveway of the warehouse (not parked inside the warehouse). A large tree branch snapped and fell onto the vehicles, severely denting each hood. The trucks could not be safely driven until the hoods were replaced. The total repair estimate according to the body shop was $44,000. The County has a commercial insurance policy that will cover the damage, less a $5,000 deductible for each vehicle. The cost to replace all of the trucks would be $225,000. The trucks were purchased brand new in June of 2011 for $260,000, and are being depreciated over 7 years.

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Question #4, continued

• The County also carried commercial insurance coverage on the building, but it did not include a flood policy. Insurance recoveries totaled $200,000. The Accounting Manager, Sophia Petrillo, is trying to figure out how much impairment loss, if any, should be recorded at 9/30/13, and she’s calling us for help!

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Answer #4

• GASBS 42, Accounting and Financial Reporting for Impairment of Capital Assets and Insurance Recoveries

• Impairment Tests– Magnitude Test– Unexpected Nature Test

• Measuring Impairment– Restoration Cost Approach– Service Units Approach– Deflated Depreciated Replacement Cost Approach– Lower of Carrying Amount or Fair Value

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Answer #4, continuedCalculating Building Impairment Loss Using the Restoration Cost Approach

Historical Cost (4/1/04) $1,500,000

Less: A/D (thru 6/1/13) (343,750)

Net Book Value 1,156,250

Total Repair Cost 260,000

Restoration Cost 208,000

Deflated Restoration Cost 168,972

Restoration Cost Ratio 11.2648%

Impairment Loss 130,249

Insurance Recovery 200,000

Net Gain $69,751

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Answer #4, continued

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Answer #4, continued

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Answer #4, continuedCalculating Vehicle Impairment Loss Using the Restoration Cost Approach

Historical Cost (6/1/11) $260,000

Less: Accumulated Depreciation 74,286

Carrying Amount 185,714

Restoration Cost (current dollars) 44,000

Replacement Cost (current dollars) 225,000

Restoration Cost Ratio 19.556%

Impairment Loss $36,318

Insurance Recovery (24,000)

Net Loss $12,318

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Answer #4, continued

• In the governmental fund f/s, report the restoration costs as expenditures and insurance recoveries as other financing sources

• In proprietary fund and government-wide f/s, impairment gains/losses should be reported as program expense (or non-operating revenue in enterprise fund operating statements), or report as special item or extraordinary item if the definition under GASBS 34 is met

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Answer #4, continued• The GASB Comprehensive Implementation Guide—2012-2013,

Question Z.42.12, suggests two ways in which a government may recognize the effect of the impairment in its capital asset accounts. First, governments may increase accumulated depreciation by the amount of the impairment loss. This has the effect of reporting the loss as if additional years of the asset's life had been used up. Second, governments may reduce both the historical cost of the asset and accumulated depreciation proportionately so that the decrease in the net carrying value of the asset equals the impairment loss. Using this method treats the impairment as if a portion of the asset has been disposed of

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Question #5• The City of Balki decided to utilize a management company

to operate its municipal golf course, called Bartokomous Golf & Country Club. The management company, whose owner was a former sheepherder, had a solid reputation for improving both playing conditions and participation rate at the courses it manages. There were 15 City employees that worked at the golf course. The City Council approved a plan to terminate the positions as of November 1st, 2013, at which time the golf course management company would take over operations. The termination plan was communicated to these employees on April 1st, 2013. There are two components to the plan.

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Question #5, continued

1. Each terminated golf course employee will receive a termination benefit in the form of a single cash payment equal to three times their final monthly salary. This cost for all 15 employees was calculated at $135,000. The payment would be made regardless of when the employee terminated employment.

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Question #5, continued

2. The City needs to retain at least a portion of the workforce until November 1st in order to continue operating the course until that time. So as an incentive, each terminated employee that renders service until October 31 will receive an additional one-time cash payment of $2,000. Any employee that leaves voluntarily before October 31 will not be eligible to receive any portion of the $2k benefit. The City anticipates that maintenance staff will take advantage of this incentive, while all others will leave early. 10 of the 15 employees were maintenance employees.

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Question #5, continued

• The City’s Finance Director, Larry Appleton, is confused about how to record these payroll transactions. He feels he should simply record them when paid but is seeking our advice. Larry also wondered what the accounting treatment would be if he sold the course (i.e. land, buildings, inventory, etc.) to the management company.

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Answer #5

• GASBS 47, para. 13: recognize a liability and expense for the portion of the involuntary termination benefit that does not have a future service requirement when the plan is communicated to employees (April 1st)

• Recognize the entire liability on that date

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Answer #5, continued

• GASBS 47, para. 15: recognize a liability and expense for the portion of the involuntary termination benefit that has a future service requirement ratably over the period from April 1 (communication date) to October 31 (the end of the required future service period).

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Answer #5, continued

• GASBS 47, para. 16: In governmental fund statements, liabilities and expenditures should be recognized to the extent the liabilities are normally expected to be liquidated with expendable available financial resources

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Answer #5, continued

• If selling the golf course and eliminating the golf course fund altogether:– Extraordinary items: material transactions or other events

that are both unusual in nature and infrequent in occurrence

– Special items: significant transactions or other events within control of management that are either unusual in nature or infrequent in occurrence

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Answer #5, continued

• Recognize termination benefits resulting from the cessation of golf operations as a special item?

• Examples of special items, provided by the GASB Comprehensive Implementation Guide—2012-2013, Question 7.43.3, include sales of certain general governmental capital assets, special termination benefits resulting from workforce reductions due to the sale of utility operations, early-retirement benefits offered to all employees, and significant forgiveness of debt

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Answer #5, continued

• Sell the golf course…how to record the disposition and elimination of the golf course fund?

• GASBS 69, Government Combinations and Disposals of Government Operations, para 51: “A disposing government should recognize a gain or loss on the disposal of operations, if applicable. Gains or losses on the disposal of operations should be reported as a special item in the period in which the disposal occurs, based on either the effective transfer date of a transfer of operations, or the date of sale for operations that are sold”

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Question #6

• Pendant County hired an employee to join the County’s IT staff. This employee, J Peterman, was a web designer for a previous employer. Part of J Peterman’s role at the County was to improve its existing website. Upon hire, a 2 year plan was developed to add new features and functionality to a number of different sites within the County’s website. The project is to take place in stages with different projected completion dates, based on different links within the website (utilities, recreation, etc.).

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Question #6, continued

• The Director of Finance, Mr. Lippman, wondered if any of these costs over this two year period should be capitalized and, if so, what should be capitalized and what should be expensed.

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Answer #6

• GASB Implementation Guide 2012-13, Question Z.51.2: Websites should be considered computer software. If the website meets the description of internally generated computer software, the outlays associated with its development should be accounted for based on the guidance in paragraphs 10–15 of Statement 51

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Answer #6, continued

• Costs associated with modifying computer software already in use should be capitalized if the modification results in one or more of the following:– An increase in functionality of the software– An increase in efficiency of the software– An extension of the estimated useful life of the software

• Any modifications outside of these three situations are considered maintenance, and the related costs should be expensed as incurred

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Answer #6, continued

• Developing and installing internally generated computer software consists of three stages:– Preliminary Project Stage– Application Development Stage– Post-implementation/Operation Stage

• Costs related to activities in the application development stage should be capitalized; costs in preliminary project and post-implementation/operation stage should be expensed as incurred

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Answer #6, continued• GASB Comprehensive Implementation Guide 2012-13, Question

Z.51.13 lists common preliminary project stage activities:– Making decisions to allocate resources between alternative projects at

a given point in time. – Determining the performance/user needs for the computer software

project.– Determining the systems requirements for the software project and

whether the technology needed to achieve those requirements exists. – Exploring alternative methods of achieving the required performance

—for example, by evaluating whether internal development of the computer software would be more beneficial than modifying commercially available software.

– Choosing a vendor if commercially available software will be acquired. – Selecting a consultant to help develop or install the software

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Answer #6, continued

• GASB Comprehensive Implementation Guide 2012-13, Question Z.51.12 asks if a government developing an ERP system with multiple modules should apply the guidance of GASBS 51 to each individual module within the system or to the ERP system as a whole.

• Answer: Since each module will have its own development cycle, particularly as it relates to application development-stage and post-implementation/operation-stage activities, guidance should be applied for each individual module.

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Answer #6• Could interest capitalization requirements apply to this

project…YES• GASB Comprehensive Implementation Guide 2012-13,

Question Z.51.11: Paragraph 8(a) of GASBS 62 states that the interest capitalization requirements apply to assets that are constructed or otherwise produced for a government's own use. Internally generated intangible assets meet this description. Therefore, the interest capitalization requirements should be applied, as appropriate, for internally generated intangible assets of business-type activities and enterprise funds

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cliftonlarsonallen.com

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Andrew LaflinManager - Assurance & Advisory Servicesandrew.laflin@cliftonlarsonallen.com813-384-2711

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