The New Face of Government Balance Sheets

Illustrating the Changes under GASB Statements 63 and 65

Major changes are coming to state and local government financial statements. Two recently issued Governmental Accounting Standards Board (GASB) pronouncements-GASB Statement 63, Financial Reporting of Deferred Outflows, Deferred Inflows, and Net Position (effective for fiscal years ending December 15, 2012, and later), and GASB Statement 65, Items Previously Reported as Assets and Liabilities (effective for fiscal years ending December 15, 2013, and later)-are altering the face of government balance sheets and statements of net assets.

GASB Statement 63 renamed the statement of net assets to the statement of net position. The statement requires governmental fund balance sheets and both government-wide and fond statements of net position to include two new financial statement classifications- deferred outflows of resources and deferred inflows of resources-in addition to assets and liabilities. One year later, GASB Statement 65 requires several items previously reported as assets and liabilities (and reported as assets and liabilities under GASB Statement 63) to be reclassified as deferred outflows or deferred inflows. GASB Statement 65 also requires recognition of revenues or expenses in the period received or incurred for numerous other items reported as assets and liabilities in the flow of economic resources financial statements under current GAAP (including GASB Statement 63).

Adding financial statement elements to a financial statement is a rare occurrence, as is reclassifying or eliminating numerous distinct types of assets and liabilities in one standard. The lace of all state and local government balance sheet-type statements-both fund-type and government-wide-are changing dramatically as a result of these pronouncements.

The Seed: GASB Concepts Statement 4

GASB Statement 63 's requirement that balance sheets should report not only assets and liabilities, but also deferred outflows and deferred inflows, is a natural consequence of the adoption of GASB Concepts Statement 4, Elements of Financial Statements, in June 2007. Concepts Statement 4 established and defined the financial statement elements to be reported in government financial statements including the following:

* Assets-resources with present service capacity that the government presently controls

* Liabilities-present obligations to sacrifice resources that the government has little or no discretion to avoid

* Deferred outflows of resources-a consumption of (decrease in) net assets (assets less liabilities) by the government that is applicable to a future reporting period

* Deferred inflows of resources-an acquisition of (increase in) net assets by the government that is applicable to a future reporting period

* Net position-the residual of all other elements presented in a statement of financial position.

A simple way to think of deferred outflows is as a decrease in net assets that does not meet the criteria for recognition as either an expenditure (in governmental fund operating statements) or an expense (in other government operating statements). Similarly, deferred inflows can be thought of as an increase in net assets (from revenue sources) that does not meet the criteria for revenue recognition in the respective operating statements. If assets increase but the government has a performance obligation, the performance obligation will result in reporting an offsetting liability, not deferred inflows. Likewise, if a government prepays for a service, the prepaid service represents present service capacity and thus is an asset, not a deferred outflow. In these cases, net assets do not increase, which is necessary for a deferred outflow of resources.

Deferred Outflows and Deferred Inflows Introduced into GAAP

After adopting Concepts Statement 4, GASB began to consider whether transactions addressed in new accounting standards resulted in reporting items in the government-wide and proprietary fund statements of net assets (and sometimes in the fiduciary funds statement of net assets) that met the definitions of deferred outflows and deferred inflows. GASB first identified such items in GASB Statement 53, Accounting and Financial Reporting for Derivative Instruments. Consequently, GASB required governments to report accumulated decreases and accumulated increases in the fair value of derivative instruments, such as interest rate swaps that qualify for hedge accounting, as deferred outflows of resources and deferred inflows of resources, respectively, in their statements of net assets. Then, in GASB Statement 60, Accounting and Financial Reporting for Service Concession Arrangements, GASB required transferor governments in service concession arrangements to report, in the same financial statements, deferred inflows of resources equal to the net consideration recognized in the agreement. (Neither standard applies to reporting in governmental funds.)

But the deferred outflows identified in fliese standards continued to be reported as assets and the deferred inflows as liabilities, a situation clearly at odds with Concepts Statement 4. In this statement, deferred outflows of resources and deferred inflows of resources are, by definition, not assets and liabilities. Similarly, the residual balances on the statements of net assets still were called net assets rather than net position.

GASB Statement 63 Aligns GAAP with Concepts Statement 4

The adoption and implementation of GASB Statement 63 will begin to remedy the discrepancy between state and local government GAAP and Concepts Statement 4. But one important fact to observe is that GASB Statement 63 does not identify any additional items to be reported as deferred outflows of resources or as deferred inflows of resources. The standard simply requires that government balance sheets and statements of net assets (now statements of net position) incorporate the financial statement elements identified in Concepts Statement 4. Under GASB Statement 63, only the effective hedging derivatives and service concession arrangement deferred outflows and deferred inflows are reported in these new classifications.

The primary changes required by GASB Statement 63 are as follows:

* The statements of net assets for proprietary funds, fiduciary funds, and government-wide reporting have been renamed statements of net position, along with corresponding changes to the names of the proprietary fund and fiduciary fund operating statements, in order to indicate that they reflect changes in net position rather than in net assets.

* The deferred outflows of resources classification has been added after total assets in the statements of net position. (GASB prefers that assets and deferred outflows not be combined to present a subtotal in the statements of net position. They are totaled in governmental fund balance sheets-but these will not be affected until GASB Statement 65 becomes effective.)

* The deferred inflows of resources classification has been added after total liabilities. (GASB prefers that there be no subtotal of these two elements in the statements of net position.)

* Net assets have been renamed net position, with corresponding changes in the three net asset subclassifications. The new net position classifications are net investment in capital assets, restricted net position, and unrestricted net position. (Fund balance classifications are not changed.) The composition of the new net position classifications, incorporating deferred outflows and deferred inflows, is presented in Exhibit 1.

GASB Statement 63 requires the disclosure of individual types of deferred outflows and deferred inflows if needed because of their aggregation in the financial statements or, in certain situations, their impact on a net position classification.

Effect of Implementing GASB Statement 63

Implementing GASB Statement 63 will not, by itself, change most governments' financial statements significantly. Governmental fund balance sheets are not affected, because no existing deferred outflows or deferred inflows are reported in govemmental fund balance sheets-those elements will not appear in governmental fund balance sheets prior to implementation of GASB Statement 65. Because most governments do not have deferred outflows of resources or deferred inflows of resources related to derivative instruments or service concession arrangements, most also do not have deferred outflows or deferred inflows to report in their statements of net position prior to the implementation of GASB Statement 65. These governments will not add deferred outflows of resources or deferred inflows of resources to their statements of net position. They will simply rename their statements of net assets as statements of net position and rename their net assets classifications using the new net position classifications: net investment in capital assets, restricted net position, and unrestricted net position. The amounts reported for each classification will be the same that would have been reported if the three net assets classifications were still in use.

Governments with deferred outflows for an accumulated decrease in the fair value of derivative instruments will include a deferred outflows of resources section and report such amounts in that section. Those governments with deferred inflows for an accumulated increase in the fair value of derivative instruments or service concession arrangements must include a deferred inflows of resources classification after liabilities for these amounts. All governments must report the new net position classifications required by GASB Statement 63, but these amounts are the same as they would have been if the net assets classifications were still used. Renaming the statements of net assets as the statements of net positions is required, as are corresponding changes to the title of the related fund operating statements. GASB Statement 63 does not affect the operating statements of any government, except for replacing the term net position with net asset. The statement of net position is illustrated at the end of this article.

Effects of Implementing GASB Statement 65

The implementation of GASB Statement 65 is a different matter; in a sense, this statement gives teeth to GASB Statement 63. Most governments will have one or more deferred outflows or deferred inflows to report upon implementing GASB Statement 65. Certain amounts previously reported as assets (or as contra liabilities) will be reported as deferred outflows of resources or expensed as incurred and not included in the balance sheet at all. Certain other amounts previously reported as liabilities (or as contra assets) will be reported as deferred inflows of resources or recognized as revenues in the period the transaction occurs. The total net position, and each individual net position classification, of a proprietary fund or fiduciary fund or in the government-wide statement of net position might well change significantly upon the implementation of GASB Statement 65.

In developing Statement 65, GASB looked at every item currently reported as an asset or liability (or as a related valuation account) to determine if it qualified as an asset or liability as defined in Concepts Statement 4. If not, GASB considered whether it met the definition of a deferred outflow or deferred inflow. Items that do not qualify as any of these four balance sheet elements must be reported as revenues, expenses, or expenditures, per GASB Statement 65. Exhibit 2 illustrates the possible classifications from this process. These determinations were made separately for 1) governmental fund reporting and 2) government-wide, proprietaryfund, and fiduciary-fund reporting. GASB Statement 65 will result in much more noticeable and more substantive changes in government financial statements- including operating statements, as well as balance sheets and statements of net position-than will GASB Statement 63.

What distinguishes an asset from a deferred outflow? According to GASB Concepts Statement 4, an asset must have service capacity; a deferred outflow does not. What distinguishes a liability from a deferred inflow? A liability must represent an obligation to sacrifice resources (including performance obligations); a deferred inflow should not represent an obligation to provide assets or services in tie future. The most common distinguishing feature of deferred outflows and deferred inflows identified in GASB Statement 65 appears to be that only cash collection (with respect to governmental funds) or the passage of time (with respect to reporting for all fund categories and government-wide reporting) prevents recognition of the amount in the operating statement.

Although it is important to understand the differences between assets and deferred outflows of resources and between liabilities and deferred inflows of resources, it is critical to know that GASB Statement 65 prohibits reporting any item as a deferred outflow or deferred inflow that GASB has not specifically required to be reported as such. The standard also prohibits using the term "deferred" in the title of an item reported as an asset or as a liability-its use is limited to the deferred outflows of resources and deferred inflows of resources. In essence, GASB Statement 65 is a list of items that are to be reported as deferred outflows of resources or as deferred inflows of resources, along with a list of items that are to be reported as revenues or expenses immediately instead of being reported in the balance sheet and recognized over time, as in the past.

GASB Statement 65 also changes two of the four quantitative tests for identifying major funds. The assets test now includes both assets and deferred outflows of resources. Similarly, the liabilities test now includes both liabilities and deferred inflows of resources. Because of these changes, the tests should give the same results as before GASB Statement 63 was implemented-at least, until GASB Statement 65 is implemented as well. Even then, the results of the tests will only differ in some marginal situations.

Exhibit 3 identifies the items that GASB Statement 65 requires to be reported as deferred outflows or deferred inflows in the future, as well as the current reporting classification and the determinants of the subsequent recognition of expenditures/expenses and revenues. Panel A of Exhibit 3 addresses governmental fund balance sheet classifications. The other panels address government-wide financial statements, as well as proprietary fund and fiduciary fund financial statements. Accordingly, the organization of the reclassifications of previously reported assets and liabilities required by GASB Statement 65 is as follows:

Governmental Funds

* Panel A-Assets or liabilities reclassified as defened outflows of resources or deferred inflows of resources, respectively. Government-Wide, Proprietary Funds, and Fiduciary Funds

* Panel B-Assets reclassified as deferred outflows of resources; contra assets reclassified as deferred inflows of resources.

* Panel C-Liabilities reclassified as deferred inflows of resources; contra liabilities reclassified as deferred outflows of resources.

* Panel D-Assets and liabilities removed from the statements of net position and reclassified as revenues and expenses in the period incurred or received.

Some of the reclassified items will be common for many governments; however, as noted in Exhibit 3, others will be much less common. GASB Statement 65 also reclassifies some items previously reported as assets and liabilities in regulated industries. These relatively uncommon items have been omitted from the list in Exhibit 3. The following sections highlight the most commonly encountered reclassified items.

Key Governmental Fund Reclassifications (Panel A)

Of particular significance in governmental funds are several of the reclassifications of governmental fund liabilities as deferred inflows. Of the reclassified items listed in Panel A, deferred revenues related to the availability criterion (requiring collection by a certain cutoff date for revenue recognition) will be found for one or more revenue sources in at least the general fund of virtually every government reporting governmental funds. Taxes collected in advance will be somewhat common, but often limited in amount. For governments in states where the property tax calendar requires levying taxes in one year to finance the budget of the next year, the resulting deferred revenues that must be reported as deferred inflows of resources may approximate the net realizable value of the tax levy and exceed the amount of total liabilities for the fund.

Finally, note that grants collected in advance (or paid in advance) of eligibility are deferred inflows (or deferred outflows) only when all eligibility requirements except a time requirement are met for recognition of the grant revenues (or expenditures). Therefore, most advance collection of grants will still result in reporting liabilities (or assets for the grantor), not deferred inflows or deferred outflows. This liability cannot be called deferred revenues under GASB Statement 65, so it should be reported as unearned revenues. In order for most of the items reclassified as deferred outflows or deferred inflows to be recognized as expenditures or as revenues, only the passage of time or collection of the revenues is required.

Reclassification of Assets in Statements of Net Position (Panel B)

The assets and contra assets that GASB 65 requires to be reclassified as deferred outflows or deferred inflows in the government-wide, proprietary fund, and fiduciary fund statements of net position are not among the most common items found in these statements. As in governmental funds, grants paid in advance are still classified as assets unless only a time requirement remains to be satisfied. Only grantor governments report this item, making it less common than the advance collection of grants by grantees. Indeed, most of the items listed in Panel B require only the passage of time to be recognized as expenses-no other effort on the part of the reporting government is required.

Reclassification of Liabilities in Statements of Net Position (Panel C)

As shown in Panel C, several common liability and related valuation accounts defined under current GAAP, including GASB Statement 63, will be reclassified as deferred inflows (primarily) or deferred outflows of resources upon implementation of GASB Statement 65. One common item that will be reclassified will be deferred amounts related to refunding transactions. This reclassification will often affect governmental activities, business-type activities, file primary government, and many discretely presented component units in the government-wide financial statements. These deferred amounts also commonly appear in proprietary fund financial statements. Deferred credit balances from refunding transactions are reclassified as deferred inflows of resources. Deferred debit balance amounts from refunding transactions are reported as deferred outflows of resources. The reclassification of deferred amounts from refunding transactions as deferred outflows and deferred inflows also will affect the note on changes in long-term liabilities, because these amounts are not part of liabilities under GASB Statement 65.

Other common situations that will result in the reclassification of liabilities as deferred inflows of resources in statements of net position stem from the same transactions as some of the more common governmental fund liabilities required to be reclassified as deferred inflows in the governmental fund balance sheet. These include the following:

* Deferred revenues for property taxes (or other imposed nonexchange revenues) levied in one year to finance the budget of the next year

* Taxes collected in advance of the period for which they have been levied

* Deferred revenues for amounts received from grantors when only a time requirement must be met to recognize the revenues.

Again, with most of these items, only the passage of time is required for revenue recognition. The sale of a related loan is required for the recognition of deferred inflows related to various loans held for sale. It is important to remember that the availability criterion only applies to governmental funds.

Reclassification of Assets and Liabilities as Expenses and Revenues (Panel D)

In addition to the reclassification of various assets and liabilities and deferred outflows and deferred inflows, GASB concluded that several assets and liabilities should no longer be reported in statements of net position. GASB's analysis determined that these items do not meet the definition of assets and liabilities, nor of deferred outflows and deferred inflows. Therefore, GASB Statement 65 requires several items currently reported as assets and liabilities to be recognized as expenses or revenues in the period incurred or received. Consequently, once GASB Statement 65 is implemented, all debt issuance costs other than prepayments of insurance are to be reported as an expense in the period incurred, as are initial direct costs of operating leases. These items, particularly debt issuance costs, are common and may be substantial.

These reclassifications will affect the operating statements, as well as the statements of net position. In addition, retroactive application of the removal of debt issue costs from the statement will impact the balances of other items that are calculated on the basis of these costs, such as deferred refunding amounts and net position categories. Indeed, each item in Panel D will affect the amount reported for total net position and for one or more components of net position. The reclassifications in Panels B and C should rarely, if ever, affect the net position categories and do not affect total net position. The other items in Panel D relate primarily to lending transactions and are not common across governments.

An Illustration of the Effects of GASB 65

To help visualize the effects of GASB Statement 65, Exhibit 4 presents the balance sheet for the general fund, and Exhibit 5 presents the governmental activities statement of net position column from the government-wide statement of net position of a small Midwestern city-as they would appear both before and after the implementation of GASB Statement 65. The city has an interest rate swap that qualifies for hedge accounting, and it has several items that GASB Statement 65 requires to be reported as deferred inflows of resources. (Some alterations have been made for illustrative purposes.) The following items in the example are affected by GASB Statement 65:

* Deferred revenues that are not available ($1,130,097)

* Deferred revenues for taxes levied to finance the next year's budget ($3,972,846 in the general fund, and $9,600,000 in governmental activities)

* Taxes collected in advance ($800,000 in the general fund, and $1,855,009 in governmental activities)

* Deferred refunding amounts (including debit balance amounts totaling $1,200,500, and one with a credit balance of $500,214)

* Unamortized bond issue costs ($242,375).

The first item affects only the governmental fond balance sheet; the next two affect both the general fund balance sheet and the government-wide statement of net position; finally, the last two affect only the government-wide statement of net position. All of file items that affect the governmental activities in the government-wide statement of net position would also affect business-type activities, the primaiy government, and discretely presented component units, when encountered in those activities and units. Likewise, they would have the same impact on proprietary or fiduciary fund statements of net position, when found in those funds.

General Fund Effects

Tlie general fund balance sheet is presented in Exhibit 4, first under the guidance in GASB Statement 63, then under GASB Statement 65. The general fund balance sheet under GASB Statement 63 does not differ from before that statement's implementation. As noted previously, this standard will not affect the financial reporting of any governmental fund of any state or local government.

Comparing the GASB Statement 65-based general fund balance sheet with the GASB Statement 63-based balance sheet emphasizes the effect that implementing GASB Statement 65 will have on many governments. Slightly more than 80% of the liabilities presented under GASB Statement 63 must be reclassified as deferred inflows under GASB Statement 65. GASB does not view the deferred amounts as obligations of the government.

The effect on many governments' governmental funds may not be as dramatic as this example. Nevertheless, the deferred revenues to be reclassified as deferred inflows in GASB's longstanding implementation guide example of governmental fund financial statements exceed the amounts that will be reported as governmental fund liabilities when GASB Statement 65 is implemented. Note that the liabilities under GASB Statement 63 and the liabilities and deferred inflows under GASB Statement 65 are equal. GASB requires the presentation of total liabilities and deferred inflows of resources (as well as total assets and deferred outflows of resources) in the governmental funds.

Governmental Activities Effects

The effects of GASB Statements 63 and 65 on the statement of net position are presented in Exhibit 5. The information illustrated is for the governmental activities column in the government-wide statement of net position. As noted earlier, the same reclassifications apply in any fund statement of net position or government-wide statement of net position column when similar items are present. The only differences between the GASB Statement 63-based presentation of governmental activities and the presentation required prior to GASB Statement 63 are the changes in the names of the statement, the replacement of the net assets classifications with corresponding net position classifications, and the reporting of the accumulated increase in the fair value of a swap agreement in the new deferred inflows of resources classification rather than in liabilities.

The GASB Statement 65-based presentation of the statement of net position reflects several reclassifications compared to the GASB Statement 63-based presentation:

* Unamortized bond issue costs are no longer reported. This change reduces total assets, total net position, and (in this example) the net investment in capital assets.

* Deferred revenues for future-year taxes, taxes collected in advance, and credit balances of deferred refunding amounts are removed from liabilities and reported in deferred inflows of resources, while the contra liability for debit balances of deferred refunding amounts is reported as a deferred outflow of resources instead of a reduction in liabilities. The total effect of these reclassifications is a reduction of liabilities by almost 21.5%.

While less dramatic than the effects on the governmental fund balance sheet, the reduced liabilities that result from the implementation of GASB Statement 65 are still clearly material for the governmental activities of the city in this example. Its impact on any particular government will depend upon the types and amounts of these new deferred outflows and deferred inflows.

Full Impact of a Conceptual Change

When taken together, GASB Statements 63 and 65 significantly change the face of governments' balance sheet-type financial statements. GASB Statement 63 adds two new elements to those financial statements, primarily affecting statements of net position; however, the full impact will be seen once the requirements of GASB Statement 65 are added. Numerous reclassifications of items previously reported as assets and liabilities are required when governments issue financial statements for calendar years 2013 and later. One of the most noticeable effects for many governments will be a significant reduction in the total liabilities reported- primarily because they will be reclassified as deferred inflows of resources. For governmental funds, these standards affect only the balance sheet, except in the rare instance that the determination of major funds is affected. For other fund categories, GASB Statement 65 will affect the operating statements as well as the statements of net position.

Government accountants and auditors, as well as bond analysts and other statement users, will have to grapple with the meaning and impact of these changes. Deferred outflows of resources and deferred inflows of resources are set to become even more significant in the future. GASB Statement 68, Accounting and Financial Reporting for Pensions, in particular, identifies pension-related deferred outflows and deferred inflows that must be added to the financial statements when those standards are implemented. Undoubtedly, the new other postemployment benefits guidance will be similarly modified in the relatively near future. Understanding the significance of the new distinctions between assets and deferred outflows of resources and liabilities and deferred inflows of resources likely will be a learning process for CPAs over the next few years.

One of the most noticeable effects will be a reduction in total liabilities reported- because they will be reclassified as deferred inflows of resources.

Craig D. Shoulders, PhD, is a member of the accounting faculty at Western Carolina University, Cullowhee, N.C.Joseph P. Lakatos, JD, LLM, CFE, is the Wesley Elingburg Distinguished Professor of Business Innovation and director of the center for entrepreneurship and innovation, also at Western Carolina University.