Exam 2 . Section I . Chapter 1 Influences, Concepts of Financial Reporting and Standards-Setting

1. Exam 2 . Section I . Chapter 1Influences, Concepts of Financial Reporting and Standards-Setting AGA Montgomery Chapter CGFM Exam Review Presented By Steven H. Emerson, CPA, CGFM, CGAP, CFE, CITP, CGMA

2. Governmental Environment “Government ought to be run like a business!” • Governments DO NOT run like a business • Do not operate in the same environment • Do not have the same goals and objectives • Do not rely on the same resources • The U.S. Constitution provides two levels of government • Federal • The federal government has primary authority for national and international affairs, as set forth in the U.S. Constitution • The federal government can also impose certain requirements on the management of state governments, provided the authority is granted in the U.S. Constitution • States • All other powers not set forth in the U.S. Constitution are left to the states

3. Governmental Environment - continued • State Constitutions • Each state has one which sets forth the manner in which the state will function • No two are alike • There are some common requirements for each state constitution • Sets forth the manner by which the executive branch will function and establishes the offices, terms and requirements for holding office • Sets the requirements for the legislative branch, detailing how laws are to be introduced and enacted • Sets forth the manner by which local governmental entities can be formed

4. Governmental Environment - continued • All These Entities • Are subject to specific legal requirements for • Organization • Structure • Ability to levy taxes • Ability to raise other revenues • The types of services to be provided • The sovereign powers that can be exercised • Federal and State Laws • Set forth the manner by which private sector corporations can be organized • Do not go into details • As to what offices are required • What functions they can perform • How they go about making money • This is left to the board of directors of the corporations

5. Governmental Environment - continued • Goals and Objectives • Government entities differ considerably from those in the private sector • Governments • Formed without a profit motive • Exist to provide services • Goals and objectives are established with input from the public • To ensure that the services are consistent with the needs of constituents • Many have gone through a formal process of establishing a mission or vision statement • With input from every sector of the community

6. Governmental Environment - continued • Government Resources • Derived primarily from taxes • No shareholders • No ability to match taxes provided by a constituent to the services received by that constituent • In many instances, services are provided to constituents who pay little for no taxes • Involuntary resource providers pay the taxes • Must establish priorities for the services the government provides • Constant pressure to limit taxes as much as possible

7. Governmental Environment - continued • Government Resources - continued • Receive revenue through grants and revenues from other levels of government • Establish the following to recover some or all of the cost of providing services • User fees • Licenses • Permits

8. Governmental Environment - continued • Government Resources - continued • Contrast with the private sector • Private sector raises revenue through exchange transactions • A customer pays money and receives a good or service • The private entity will stay in business as long as the private entity keeps its customers happy • If it does not, it loses its customers and must either improve its business practices or cease operations • A private entity cannot raise taxes or force its customers to pay • It can ask its shareholders to provide additional resources through the purchase of stock • However, more than likely, existing shareholders would want to sell their shares rather than buy new shares

9. Governmental Environment - continued • Government Resources - continued • Contrast with the private sector - continued • Even not-for-profit organizations need to satisfy customers to stay in business • Many charge a membership fee or rely on voluntary contributions • If they do not keep their customers or members satisfied, they will no longer be able to continue serving their constituents • Measures for success • Private sector measures include increasing market share, earnings per share and staying in business • Governments have no single measure for success • A cynic might say that one measure of success is the re-election of public officials

10. Governmental Environment - continued • Government Resources - continued • Contrast with the private sector - continued • Governments provide services that are intended to enhance the quality of life of its constituents • Police protection • Fire suppression • Street maintenance and repair • Public health • Recreational activities • Refuse collection • Street cleaning • Curb and gutter repairs • Sidewalks • Mail delivery

11. Governmental Environment - continued • Government Resources - continued • Contrast with the private sector - continued • Governments also provide law enforcement • Laws are passed to protect the public against wrongdoing • Individuals who break the law are subject to trial and perhaps incarceration • Governments maintain facilities for trials and incarcerations • Budgets • Since the majority of funding to most governments comes from taxes, governments must establish a method for allocating the money • Commercial entities use budgets as a benchmark for performance, goals for growth and as a management tool for planning

12. Governmental Environment - continued • Government Resources - continued • Contrast with the private sector - continued • Budgets – continued • Governments are legally bound by the budget • The budget establishes • Spending authorizations • Outlines programs and services to be provided • Defines the sources of revenues that will be used to fund the programs and services • The budget may specify restrictions on the use of resources • The budget process is the primary control device in government • Adherence to the budget is one way government financial managers demonstrate accountability • The budget is a guide to operations in the private sector

13. Governmental Environment - continued • Government Resources - continued • Contrast with the private sector - continued • Governments must provide reports that demonstrate compliance • Since a government organization is grounded in laws, rules and regulations • Since resources are derived from involuntary providers • Since service priorities are established through a legislative system • Financial reports • Is a primary mechanism by which public officials are able to demonstrate accountability • Show how much money was raised, how it was spent and whether the spending was in compliance with the budget

14. Governmental Environment - continued • Government Resources - continued • Contrast with the private sector - continued • Financial reports – continued • Associated performance reports inform users about how well a government is operating and whether it is achieving its goals in an effective and efficient manner • Stockholders, investors and creditors of a commercial entity are interested in the profit to be generated by the commercial entity • Taxpayers, investors, service recipients and creditors of a government are interested in the delivery of services and the ability to meet future obligations • The government financial management system must provide the accounting and reporting that addresses these unique operating requirements

15. Accountability • Accountability • The cornerstone of financial reporting • Public officials have to be accountable to the citizens • To justify the raising of public resources • To justify the purposes for which they are used • Government accountability is based on: • The belief that the public has a right to know • The ultimate power belongs to the people • People can exercise this power • Through the ballot box • Through initiatives and referendums

16. Accountability - continued • Accountability - continued • Financial reporting • Plays a major role in fulfilling government’s duty to be accountable • Demonstrating accountability includes providing information to assist in evaluating whether the government operated within the legal constraints that have been imposed • Governments derive their revenues mostly from taxpayers • Statutory authority imposition, not the payer’s willingness to participate in the following transactions • Tax assessments • Licenses • Fees • Permits • User fees

17. Accountability - continued • Accountability - continued • Governments derive their revenues mostly from taxpayers - continued • The public has no choice but to pay the fee or forgo the service • The authority is vested in the governmental entity • To protect the public welfare • To promote social and economic development • Governments must account for the raising and using of resources • Taxpayers and citizens • Represented by their elected officials • Do not have a direct voice in the allocation of resources • These representatives are accountable to the citizenry

18. Accountability - continued • Accountability - continued • Legal accountability • The need to comply with various laws, rules and regulations • Public officials are accountable for the establishment of processes • The controls that are in place to ensure that transactions are processed properly • That payrolls are calculated accurately • That the payment for goods and services are properly authorized • That services are provided only to eligible recipients • Performance accountability • Ensuring that governments act in an efficient or economic manner • Many public officials are accountable for the results of programs • Ensuring that goals and objectives are met

19. Accountability - continued • Accountability - continued • Fiscal accountability • Associated with the raising of resources and the allocation of those resources to accomplish objectives • Public officials often use their power to impose taxes on their citizens • Public officials use these resources • To provide goods and services • To provide public protection • To enhance the quality of life • Officials are accountable for the resources raised and how they are used • Financial reporting is an important method of demonstrating fiscal accountability

20. Accountability - continued • Accountability - continued • Operational accountability • Associated with the stewardship of public resources • Not only do public officials raise resources, they must ensure that the resources are used appropriately • Performance measures and performance reporting • Are used to address operational accountability • Since governments do not have a profit motive and there needs to be a way to determine if resources are being used wisely

21. Accountability - continued • Accountability - continued • Executive branch • Is accountable to the legislative branch and the public • Is accountable to the public for operating in an effective and efficient manner and for collecting and using resources • Is accountable to the legislative branch for using resources in accordance with legislative mandates within the fiscal constraints imposed by the legislative branch • Is accountable to other governments using resources in accordance with grant requirements and restrictions • Legislative branch • Is accountable to the public for the raising of resources and for determining how those resources are to be used • Both the executive and legislative branch rely on financial reporting as a means of demonstrating accountability

22. Interperiod Equity • Many believe that the current generation of citizens should not be able to shift the burden for paying for current-year services to future-year taxpayers • Assessing whether the government’s financial position improved or deteriorated over the period is important not only because it has financial implications, but also because it has social and political implications • The analysis of why the financial position improved or deteriorated helps to explain whether current-year taxpayers passed on financial burdens to future-year taxpayers without related benefits

23. InterperiodEquity - continued • Interperiod or intergenerational equity • A significant part of accountability • Fundamental to public administration • Some feel that it is generally enforced with balanced budget laws, which mandate that current-year services must be financed with current-year revenues • Unfortunately the definition of what constitutes current-year revenues often allows governments to borrow either short-term or long-term funds to finance current services • Most governments budget on a cash basis or a near cash basis • This allows the possibility for manipulation of the ending balances to give the appearance of “break even” by simply not paying bills when they come due

24. Interperiod Equity - continued • Interperiod or intergenerational equity - continued • Laws and regulations are usually specific in terms of borrowing • i.e. some laws prohibit borrowing for operating purposes or limit borrowing only to meet cash flow needs • Other laws require borrowing to match the useful lives of assets that are being acquired or constructed • However, imaginative financing techniques may undercut the application of these laws and regulations • Interperiod equity therefore needs to be considered when establishing financial reporting objectives

25. Interperiod Equity - continued • Interperiod or intergenerational equity - continued • Financial reporting should help users assess whether current-year revenues were sufficient to pay for the services provided that year and whether future taxpayers will be required to assume a burden for services previously provided • Current financial reporting principles are intended to highlight the government’s efforts to achieve interperiod equity • This concept may be one of the most important issues in government financial reporting

26. Users and Uses • Governments have a wide range of users of their financial reports • Legislators • Other oversight agencies • Citizens • Investors • Creditors • Media • Financial managers • Program managers • This group represents a much broader range of users than is represented by users of commercial financial statements

27. Users and Uses - continued • Legislators • Charged with forming the priorities for delivery of services by the governmental entity • They will look to the financial statements for information about: • Available resources • Operating results • Compliance with laws and regulations • They will often focus on a particular component of the government, but they also pay attention to the government as a whole • Since they establish the budget appropriations, they use the financial reports to see if actual expenditures were within the authorized levels

28. Users and Uses - continued • Citizens and taxpayers • Concentrate of the government’s accountability for the management of public tax dollars • They are concerned with operating results • i.e. Is a surplus being generated? • i.e. Are monies being spent on the services in which I am interested or are the services being cut? • i.e. Are assets being safeguarded? • i.e. Are the services being delivered efficiently? • Public interest groups will be interested in particular programs, but every citizen may have a different issue that triggers his or her concern • Many are interested in information about taxes and other revenue-raising efforts

29. Users and Uses - continued • Investors and creditors • Use financial reports to determine compliance with contractual agreements related to debt issues • Usually they are sophisticated and will be evaluating the government’s financial position with complex analytical tools • They use these tools to assure monies are being treated in a manner consistent with the government’s commitments • Potential investors and creditors will use the tools to determine if they wish to purchase government debt instruments • The long-range view of the government as a whole and its ability to service current and future debt is more important than the short-range view of a particular program

30. Users and Uses - continued • Media • Most governments are subject to specific requirements for publishing financial information through the media or for responding to media inquiries for information • Serves an important role by publicizing requests for public input on developing priorities for the government’s operations • Financial reports play a key role in this two-way communication

31. Users and Uses - continued • Financial and program managers • Government reports are also vital to these users, who focus on the day-to-day operations and delivery of services • Also review compliance issues to ensure that the government is operating within: • Budgetary parameters • Restrictions of laws and regulations • Public policy • Some will be interested only in a particular program while others must evaluate the financial position of the entire government • Employee and employee organizations • Are interested in the status of a government, particularly with respect to funds available for future benefits and collective bargaining

32. Needs for Reporting • Assess accountability • Governmental financial reporting is the primary communication device for assessing accountability • Financial reports • Public officials are responsible for raising resources and for determining how those resources are to be used • Provide the means to determine if the resources that were raised were sufficient to cover the services provided during the operating period • Should allow users to determine if taxpayers of the future are required to pay for services provided in the current year

33. Needs for Reporting - continued • Assess accountability - continued • Budget • On of the primary responsibilities of public officials involves the enactment of the budget • Numerous issues arise during the process involving the allocation of resources • The budget process normally includes a series of public hearings that generate input from the citizenry within the jurisdiction • The legislative branch will incorporate this input as it establishes priorities and defines services that will be provided by the budgetary appropriations • Financial reports give the citizenry a report card on how well the administration performed with respect to the raising of resources and spending in accordance with appropriations and other legal requirements made by the legislative body

34. Needs for Reporting - continued • Assess accountability - continued • Public officials are also accountable for ensuring that resources are used in an effective and efficient manner • The resources are used to carry out programs of the government • Financial reports of those programs must communicate how well the recipients of those services performed • If intergovernmental revenues are involved, grantors will rely on the reports • To compile consolidated program reports • To valuate the effectiveness of resource allocations • To monitor compliance with grant restrictions

35. Needs for Reporting - continued • Assess accountability - continued • Managers of programs • Use financial reports as tools for planning and administration • Can determine if the programs are operating in an effective and efficient manner • Legislators, citizens and investors/creditors • Review the reports to evaluate the cost of services • Evaluate the level of governmental support necessary to maintain services • Financial reports alone are not sufficient to determine whether programs are operating effectively and efficiently • Many governments supplement financial reports with programmatic information and performance measures • This information is often non-financial in nature • Users are able to see what was accomplished with the resources that were provided • Are better able to determine if resources are used effectively and efficiently • More governments are beginning to supplement financial information with performance information

36. Needs for Reporting - continued • Making economic, social and political decisions • Financial reports should provide information as to the types of financial resources that were raised and how they were used • Were the inflows sufficient to meet the required outflows? • If not, what actions were taken? • Was the government able to pay its bills on time? • Was there sufficient cash to meet operating requirements? • Financial reporting provides information that allows users to assess how well the government performed

37. Needs for Reporting - continued • Making economic, social and political decisions - continued • Financial reporting should provide information about the results of operations • Is the government better or worse off as a result of operations? • Often, a government makes a decision to use resources accumulated from past operations • In this instance, it planned to utilize those resources and provided this information in financial reports

38. Needs for Reporting - continued • Making economic, social and political decisions - continued • On the other hand, the government may have financial difficulty due to a downturn in the economy • How did the government address the problem? • Were resources available from reserves? • Did programs have to be cut? • Were additional revenues raised? • Financial reporting also provides users with information as to the financial condition and results of operation of the government • What are the government’s assets? • How much does the government owe? • Are there long-term receivables and obligations that may impact future services? • Governments are responsible for enhancing the quality of life of their constituents • What is the condition of the government’s infrastructure? • Is maintenance being performed in a timely fashion?

39. Reporting in Government • Types of reports • Two types of reports • Point-in-time reports (stock reports) • Provides current information as of the date of the report • i.e. Balance sheet • Period reports (flow reports) • Covers the entire fiscal year • i.e. Operating statement • i.e. Cash flow statement • General purpose external financial reports (GPEFR) • Consists primarily of the audited financial statements, including the notes to the financial statements along with required supplemental information

40. Reporting in Government - continued • Types of reports - continued • Other financial reports include: • Budget • Budget comparison reports • Reports that disclose specific aspects of the government’s condition or operations (special purpose financial reports) • Reports on cash • Reports on receivables outstanding or revenues generated • Offering statements (for governments issuing debt) • Project reports • Reports to grantor agencies • Reports to bondholders and oversight bodies • Popular reports

41. Reporting in Government - continued • Types of reports - continued • Another group of reports that convey more than just financial information • Service efforts and accomplishments reports (SEA) • Economy and efficiency reports • Reports on costs of operations, programs, etc. • Reporting characteristics • Information in financial reports must have the following characteristics to be effective as the means by which governments communicate financial information to users

42. Reporting in Government - continued • Reporting characteristics - continued • Information in financial reports must have the following characteristics to be effective as the means by which governments communicate financial information to users – continued • Understandability • It should be expressed as simply as possible • The reports should include explanations and interpretations to help users understand the information provided • Financial reports do not have to be understandable to all users • Users of audited financial statements should have a working knowledge of government accounting

43. Reporting in Government - continued • Reporting characteristics - continued • Information in financial reports must have the following characteristics to be effective as the means by which governments communicate financial information to users – continued • Reliability • It should be verifiable, free from bias and faithfully represent what it purports to represent • To be reliable, it needs to be comprehensive • Nothing material should be omitted • Relevance • This characteristic encompasses many of the others • i.e. If information is not timely or reliable, it is not relevant • Information is relevant if it is capable or making a difference in a user’s assessment of a condition, event or problem

44. Reporting in Government - continued • Reporting characteristics - continued • Information in financial reports must have the following characteristics to be effective as the means by which governments communicate financial information to users – continued • Timeliness • Information should be reported in a time frame that enables users upon which to base decisions • To be timely, precision or detail might have to be sacrificed • A timely estimate is more useful than a precise amount, if the time to produce the precise amount is overly long • Consistency • Once a particular accounting principle or method is used, it is presumed that future information is reported using the same method or principle • If it is necessary to change a method or principle, the nature and reason for the change should be disclosed as well as the effect of the change • Comparability • Financial reports should be comparable • Like entities should report the same information the same way • It does not imply that there cannot be differences among governmental entities • The differences should be due to substantive differences in the underlying transactions or the governmental structure

45. Reporting in Government - continued • Reporting characteristics – continued • Even if the basic characteristics are followed, financial reports have their limitations • It may be necessary to report information based on approximate measures of past events • If the information is not readily available • If firm data does not exist • If it is costly to produce • Information is often based on judgments and estimates because of the application of rules or conventions

46. Reporting in Government - continued • Reporting characteristics – continued • Financial reports are only one source of information that may be needed by users • To make decisions, it may be necessary to utilize several sources and combine the information • i.e. The budget document may contain information at levels of detail not found in audited financial statements • Project and performance reports are also useful sources of information • Financial reports often do not provide non-financial information regarding the performance of government entities • Users not only need information about how much money was spent • They also need information as to what was accomplished • This type of information, although not as readily available, requires more than reports of solely financial amounts

47. Need for Reporting Standards • Companies in the private sector must provide financial reports • Without financial reporting, how does one know if he/she wishes to invest in a company? • Without reporting requirements, how can one evaluate and compare companies? • A major contributing factor to the collapse of the stock market in 1929 was the lack of reporting requirements • Companies would make exaggerated claims about their profitability to induce the public to purchase securities

48. Need for Reporting Standards - continued • In order to protect the public, the Securities and Exchange Commission (SEC) was established in 1934 and vested with the power to regulate securities markets • The establishment of the SEC was based on the belief that investors should have access to information about a potential investment before buying it • The SEC requires companies to disclose certain information • The SEC does not promulgate accounting and reporting standards • The SEC granted that authority to a series of professionally sponsored standard-setters • Financial Accounting Foundation (FAF) • Financial Accounting Standards Board (FASB) • Vested with the authority to establish accounting and reporting standards for the private sector companies

49. Need for Reporting Standards - continued • The SEC has no direct authority over governmental entities • States • Counties • Cities • Schools districts • Etc. • Government entities are sovereign • How does a potential investor in government securities obtain financial information about a city that is going to issue bonds? • For many years, there was a presumption that the public did not need protection with regard to government securities • After all, a city was not going to go out of business

50. Need for Reporting Standards - continued • The FASB believed that it had no jurisdiction for the establishment of accounting and reporting standards for governments • Some government operations such as hospitals, colleges and universities, utilities and pensions chose to use FASB accounting and reporting standards since they were comparable to private sector entities • Most state and local governments had statutes and charter provisions regarding accounting, reporting and budgeting • These provisions generally were geared toward budgetary compliance