Asset Impairment, Idle Assets, and Insurance Recoveries

1
GASB Update
Maryland GFOA Winter Conference January 21, 2005
2
Comprehensive Implementation Guide (QA)

• Released in September 2004
• Updates the 2003 edition which consolidated the
  existing guides
• Statement 40 Guide incorporated
• 800 pages, includes 1,245 questions
• Exhibits and exercises
• Annual Updates

3
Statement No. 40Deposit and Investment Risk
Disclosures
Issued March 2003 Effective for Periods
Beginning After June 15, 2004
4
Deposits and Investments Risks

• Risks are the focus
• Fair value considers variabilities of cash flows
  discounted for time value and risk

5
Disclosures by Investment Type
General Principles

• Investments should be organized by investment
  type, such as
• U.S. Treasuries
• Corporate bonds
• Commercial paper
• Dissimilar investments should not be aggregated.

6
Level of Detail
General Principles

• Generally, the disclosures should be made for
  the primary government for which disclosures are
  essential for fair presentation.

7
Level of Detail
General Principles

• Risk disclosures should also be made for
  governmental and business-type activities,
  individual major funds, nonmajor funds in the
  aggregate, or fiduciary fund types when the risk
  exposures are significantly greater than the
  deposit and investment risks of the primary
  government.

8
Level of DetailAn example
General Principles

• A capital projects fund, because of its
  investment in one issuer of corporate bonds, is
  exposed to a concentration of credit risk.
  However, the primary governments total
  investments might not indicate a concentration
  risk. In this case, additional disclosure should
  be made for the capital projects funds exposure
  to a concentration of credit risk.

9
Interest Rate Risk

• The risk that changes in interest rates may
  adversely affect an investments fair value
• Five methods identified, must choose one
• Specific identification
• Weighted average maturity
• Duration
• Simulation model
• Segmented time distributions

10
Specific Identification
11
Segmented Time Distribution Investment Maturities
(in Years)
12
Highly Sensitive Investments

• A debt investment with contract terms that make
  the investments fair value highly sensitive to
  interest rate changes.

13
Highly Sensitive InvestmentsExamples

• Inverse floaters
• Variable coupons with multiplier (for example,
  coupon varies by 125 percent of London Interbank
  Offered RateLIBOR)
• Collateralized mortgage obligations, such as
  interest-only or residual tranches

14
Credit Risk

• Disclose credit quality as of year-end
• Includes corporate debt, state and local
  governments, external investment pools
• Exempt Debt investments with explicit guarantee
  of US governmentGNMA
• If not rated, indicate as much

15
Custodial Credit Risk

• Disclose only Category 3
• Deposits that are uninsured and uncollateralized
• Uninsured investments that are either held by
  the
• Counterparty, or
• Counterpartys trust department, but not in the
  name of the government

16
Concentration of Credit Risk

• Defined as investments of more than 5 percent in
  any one issuer
• Excluded
• US government debt
• Debt explicitly guaranteed by the US government
• Pooled investments such as mutual funds or
  external investment pools

17
Foreign Currency Risk

• Applies to deposits and investments
• Disclose currency
• If debt security, disclose interest rate risk

18
Deposit and Investment Policies

• Disclose only those policies that are relevant to
  the risks that are disclosed.
• In other words, if there is no risk disclosure,
  no policy disclosure is required.

19
Effective Date

• Fiscal years beginning after June 15, 2004
• Earlier application is encouraged

20
Statement No. 42Impairment of Capital Assets
and Insurance Recoveries
Issued in November 2003
21
Definition

• Asset impairment is a significant unexpected
  decline in the service utility of a capital asset
• Service utility is the usable capacity to provide
  service
• Service utility is NOT the same as utilization

22
Identifying Impairments

• Events or changes in circumstance that indicate
  impairment should be prominent
• Generally expected to have prompted discussion by
  governing board, management, or media

23
Indicators of Impairment

• Evidence of physical damage
• Change in legal or environmental factors
• Technological development or evidence of
  obsolescence
• A change in the manner or expected duration of
  usage of an asset
• Construction stoppage.

24
Impairment Test

• The magnitude of the decline in utility
• The unexpected nature of the decline in utility

25
Has The Impairment Test Been Met?

• Magnitude
• Unexpected

26
Temporary Impairments

• Impairments are assumed to be permanent, unless..
• Evidence is available to demonstrate impairment
  is temporary
• Temporary impairments should not be recorded

27
Measurement of Impairment

• Assets that are continuing to be used by the
  government
• Restoration cost approach for assets with
  physical damage
• Service units approach for legal/ environmental
  changes, technological obsolescence, change in
  duration
• Deflated depreciation replacement cost for assets
  with a change in manner of use

28
Measurement of Impairment

• Assets that are not being used and construction
  stoppage
• Lower of carrying value or fair value

29
Reporting Impairment Losses

• As program expense, special item, or
  extraordinary item per Statement 34
• Disclose amount and identity if not evident from
  financial statements

30
Assets That Do Not Meet Impairment Test

• If asset presents an indicator of impairment,
• but does not meet the magnitude test and is not
  part of the normal lifecycle,
• Reevaluate depreciation estimates
• Remaining useful life
• Salvage value

31
Insurance Recoveries

• Net an impairment loss with insurance recovery
• Replacement/restoration of asset is a separate
  transaction
• Applies to all insurance recoveries, not only
  those related to impairment

32
Insurance Recoveries

• Governmental funds would not report an impairment
  loss. Insurance recovery would be reported as an
  Other Financing Source. Replacement would be
  expenditure.
• Government-wide, proprietary net impairment loss
  with insurance recovery. Replacement is
  capitalized.

33
Effective Date

• Years beginning after December 15, 2004
• Retroactive implementation

34
Other Postemployment Benefits
Statements 43 and 45
35
Other Postemployment Benefits (OPEB)

• Refers to postemployment benefits other than
  pensions.
• OPEB includes
• Postemployment healthcare benefits (medical,
  dental, vision, hearing, etc.)
• Other forms of postemployment benefits when
  provided separately from a pension plan (e.g.,
  life insurance, long-term care, cash stipends if
  compensation for services).
• Also. . . . .

36
Implicit Rate Subsidies

• Difference between premium charged and rate if
  retirees rate calculated as separate group
• Original ED proposed to not require measurement
  if there is no explicit employer cash commitment
• Board reversed its positionresulted in
  reexposure in January 2004

37
Other Postemployment Benefits (OPEB)

• OPEB does not include
• Termination offers and benefits
• for example, early retirement incentive programs
• Sick leave conversions
• treat as compensated absences under Statement 16

38
Substance of the OPEB Transaction

• Postemployment benefits (pensions and OPEB) are
  part of the compensation for services rendered by
  employees (that is, are part of an exchange
  transaction).
• Benefits are earned, and obligations accrue or
  accumulate, during employment.
• Payment is deferred until after employment.

39
Current OPEB Practice (Generally)

• Plans are financed on a pay-as-you-go basis.
• The measurement focus of financial reporting is
  on contributions or benefits paidoutflows of
  current financial resources.
• Long-term financial implications of the OPEB
  transaction, including the accrued obligation and
  the potential demand on future cash flows, are
  not reported.
• And often have not been estimated

40
Objectives of Developing an Accrual-Basis Standard

• Recognize OPEB cost (expense) systematically over
  employees years of service
• Provide relevant information about
• the accrued OPEB obligation
• the cost of services including the cost of OPEB
• the progress made in funding the plan
• Report pensions and OPEB consistently

41
A GASB Statement 27 Approach

• All postemployment benefits (OPEB as well as
  pensions) will be reported using the same general
  approach.
• May be characterized as funding friendly in
  regard to OPEB because
• It harmonizes financial reporting with funding to
  the extent appropriate for accrual accounting
  purposes.
• An employer that chooses to fund OPEB, now or
  later, need not use different measures for
  financial reporting and funding.

42
Measurement Approach

• Broad Steps
• Project cash outflows for benefits.
• Substantive plan continuation
• Periodic actuarial valuations
• Alternative measurement method
• 2. Discount projected benefits to present value
  (PV).
• Long-term earnings rate
• 3. Allocate the PV of projected benefits to
  periods using an acceptable actuarial cost method
  (choose from six methods).
• ARCNormal cost, UAAL

43
Recognition in Government-wide and Proprietary
Fund Financial Statements

• Employers should report OPEB expense in an amount
  equal to annual OPEB cost for the period,
  regardless of the amount paid
• The cumulative difference between amounts
  expensed and contributions or benefits paid
  creates a liability (or asset) called the net
  OPEB obligation

44
RecognitionGovernmental Fund Financial Statements

• Employers should recognize as OPEB expenditures
  the amount contributed to the plan or expected
  to be liquidated with expendable available
  financial resources (no change)

45
Contributions

• An employer would be deemed to have contributed
  to an OPEB plan if the employer
• Made direct payments of benefits,
• Paid insurance premiums, or
• Irrevocably transferred assets to a dedicated
  trust, or third party acting in that capacity, to
  fund benefits as they come due in the future

46
Frequency of Calculations

• Plans with total membership over 200
• actuarial valuations at least biennially
• Plans with total membership of 200 or
  feweractuarial valuations at least triennially
• Plans with total membership of 100 or
  feweroption to use alternative calculation
  method with certain simplifying assumptions
  (defined and illustrated)

47
Note Disclosure Changes (Highlights)

• Required note disclosure of the funded status of
  single-employer and agent plans in which the
  employer participates as of the most recent
  actuarial valuation

48
Note Disclosure Changes (Highlights)

• Expanded explanatory disclosures about actuarial
  methods and assumptions in an attempt to make
  information understandable to a wider range of
  financial report users

49
Required Schedule ofFunding Progress (RSI)

• Discloses multi-year trend information about the
  UAAL and progress made in funding the plan, as
  for pension plans, including
• Actuarial accrued liability (AAL)
• Actuarial value of plan assetsgenerally
• a market related value
• UAAL (AAL minus plan assets)

50
Required Schedule ofFunding Progress (RSI)

• Funded ratio (actuarial value of plan assets/AAL)
• Ratio of UAAL to covered payroll
• Notes to RSI regarding changes affecting the
  interpretation of trends in the amounts reported

51
Schedule of Funding Progress New Requirement

• An employer that uses the aggregate actuarial
  cost method must prepare the Schedule of Funding
  Progress using, as a surrogate, another actuarial
  cost method (entry age) that separately measures
  and amortizes an AAL.

52
Implementation Provisions

• Prospective implementation
• Initial net OPEB obligation may be set at zero
  however, preparers that have actuarial
  information for prior years may calculate and
  report a net OPEB obligation at transition.

53
Effective Dates

• Phased implementation FYE 6/30/2008 to FYE
  6/30/2010
• Based on same phase used for Statement 34
  implementation

54
Statement No. 44

• Economic Condition Reporting
• The Statistical Section

55
The Statistical SectionObjectives

• For assessing economic condition
• Provide perspective, context, and detail relative
  to the financial statements
• Provide information (outside the financial
  statements) about the demographic and economic
  environment

56
The Statistical Section

• Applicability
• Any government that provides a statistical
  section
• Focus
• On the primary government
• Status
• Supplementary information

57
Types of Statistical Section Information

• Financial trends information
• Revenue capacity informationfactors affecting
  ability to generate own-source revenues
• Debt capacity information
• Demographic and economic information
• Understand socio-economic environment
• Facilitate comparisons over time and among
  governments
• Operating informationcontextual information
  about operations and resources

58
Transition Provisions

• Effective Date Periods Beginning after June 15,
  2005
• Retroactive reporting encouraged, but not
  required
• Encouraged, but not required, to report
  government-wide information retroactively to the
  year Statement 34 was implemented

59
Pollution Remediation Obligations
60
Pollution Remediation Obligations

• What types of obligations are out there?
• Range from superfund sites to brownfields
• Issues to be addressed in the project
• What is the obligating event?
• How should the obligation be measured?
• Preliminary Views expected in Early 2005

61
Pollution Remediation Obligations

• Scope
• Pollution Remediation Obligations
• Except Statement 18 (landfills)
• No asset retirement obligations
• No pollution prevention obligations
• Cost accumulation, not fair value
• Current cost, not present value
• Expected cash flow, not best estimate

62
Two ContingenciesNeither is Probable
63
Probable Together
64
Pollution Remediation Obligations

• Recognition Triggersliability when.)
• Imminent endangerment compels action
• Named as responsible party
• Named in lawsuit to enforce action
• Cleanup or containment commenced
• Recognize component when measurable (Benchmarks
  approach)

65
Pollution Remediation Obligations

• Current Cost based on reasonable and supportable
  assumptions about future events
• laws expected to be in effect
• technology expected to be used

66
Pollution Remediation Obligations

• What costs are to be included in liability?
• Pre-cleanup site assessment, feasibility study,
  design, etc.
• Cleanup, containment, disposal activities
• Oversight and enforcement costs
• Operation and maintenance of the remedy and
  monitoring
• Entity must decide whether to include indirect
  and non-incremental costs

67
Pollution Remediation Obligations

• What is the debit entry?
• Generally expense
• Can defer expense under FASB Statement 71
• Capitalize in certain situations
• Do NOT record liabilities for capitalizable costs!

68
Pollution Remediation Obligations

• Capitalize if
• Cleanup to prepare property for sale (limited to
  FV)
• Polluted property bought and cleaned for service
  (cap)
• Asset impaired and cleanup restores lost service
  utility (cap)
• -Capitalize if incurred within a reasonable
  period

69
Pollution Remediation Obligations

• Recoveries--net against Expense
• Recoveries from Other Parties
• Recognize consistent with liability (expected
  cash flow technique)
• Insurance Recoveries
• Recognize as separate recovery assets when
  realized or realizable
• If not realized or realizableoffset against
  liabilities

70
Pollution Remediation Obligations

• Accretion
• Adjust liability annually for changes
• Inflation or deflation
• Price increases/decreases for specific cost
  elements
• Changes in technology
• Changes in laws or regulations
• Same as Statement 18

71
Pollution Remediation Obligations

• Timetable
• Preliminary ViewsMarch 2005
• Exposure DraftDecember 2005
• StatementFall-Winter 2006

72
Statement 46-- Net Assets Restricted byEnabling
Legislation
73
Background

• Statement 34 identifies three sources of
  restrictions on net assetsexternal parties,
  constitutional provisions, and enabling
  legislation
• Enabling legislation is a type of legislation
  that authorizes the raising of a new revenue
  (i.e., it does not earmark existing revenues) and
  that contains a legally enforceable restriction
  on the purpose for which those revenues can be
  used

74
Objectives

• Statement 46 is intended to address difficulties
  some governments were having interpreting the
  legal enforceability requirement
• Statement 46 also specifies how net assets should
  be reported when the circumstances surrounding
  enabling legislation change

75
Legal Enforceability

• Legal enforceability means that an external
  partysuch as citizens, a public interest group,
  or the judiciarycan compel a government to abide
  by the restriction
• Legal enforceability remains a matter of
  professional judgment, which may include
  reviewing determinations for similar legislation,
  obtaining the advice of legal counsel, or other
  actions

76
Legal Enforceability

• Statement 46 emphasizes that restrictions should
  be reviewed on a case-by-case basis
• If a restriction is found to no longer be legally
  enforceable, a government may reevaluate the
  legal enforceability of similar restrictions, but
  should not necessarily conclude that all such
  restrictions are unenforceable
• Prohibitions against one legislature binding a
  subsequent legislature generally are not, on
  their own, sufficient basis for determining a
  restriction is not enforceable

77
Changes in Circumstances

• If new enabling legislation is passed to replace
  prior enabling legislation, or if resources are
  used for purposes not specified by enabling
  legislation, a government should review the legal
  enforceability of the restriction
• Statement 46 specifies the conditions under which
  net assets should be reported as restricted or
  unrestricted and provides illustrative scenarios

78
Reporting Requirement

• Statement 46 requires that the portion of net
  assets restricted by enabling legislation should
  be disclosed in the notes to the financial
  statements
• The Exposure Draft proposed to require separate
  display of enabling legislation restrictions on
  the face of the statement of net assets, but the
  Board changed the requirement to disclosure in
  response to the public comments it received

79
Effective Date

• Statement 46 is effective for periods beginning
  after June 15, 2005

80
Other Projects

• TB 2004-2, Recognition of Pension and Other
  Postemployment Benefit Expenditures/Expenses and
  Liabilities by Cost-Sharing Employers
• Accounting for Termination Benefits, ED released
  December 10, 2004, comments due by March 11, 2005
• Derivatives and Hedging
• Sales and Pledges of Receivables and Future
  Revenues

81
Questions

• Ken Schermann
• Telephone[phone]
• E-mail krschermann_at_gasb.org
• Web sitewww.gasb.org