Presented by Eric S. Berman, CPA Deputy Comptroller Commonwealth of Massachusetts April 2009 If Its Monday, We Must be in Norwalk and Other Updates from.

Presented by Eric S. Berman, CPADeputy ComptrollerCommonwealth of MassachusettsApril 2009

If It’s Monday, We Must be in Norwalk and Other Updates from GASB 2009

First… a word from our sponsors

The views expressed in this presentation are those of the speaker. Official positions of the Commonwealth of Massachusetts are

determined only after extensive due process and deliberation.

GASB Statements Implementation

2009 2010Statement No. 43, Financial Reporting for Postemployment Benefit Plans Other Than Pension Plans

Phase 3 Plans < $10 million

Statement No. 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pension Plans

Phase 2 Employers > $10 million <

$100 million

Phase 3 Employers < $10 milion

Technical Bulletin 2004-2, Recognition of Pension and OPEB Expenditures / Expense and Liabilities by Cost-Sharing Employers

With OPEB Implementation

Technical Bulletin 2006-1, Accounting and Financial Reporting for Employers and OPEB Plans… Medicare Part D

With OPEB Implementation

Technical Bulletin 2008-1, Determining the Annual Required Contribution Adjustment for Post-Employment Benefits

With OPEB Implementation

GASB Statements-Future Dates

2009

·Statement No. 49,

Accounting and Financial Reporting for Pollution Remediation Obligations

RETROACTIVE APPLICATION

·Statement No. 52,

Land and Other Real Estate Held as Investments by Endowments

RETROACTIVE APPLICATION

GASB Statements-Future Dates2009 2010 2011

Statement No. 51, Accounting and Financial Reporting for Intangible Assets

RETROACTIVE APPLICATION IN 2010

STATEMENT No. 53, Accounting and Financial Reporting for Derivative Instruments

RETROACTIVE APPLICATION IN 2010

GASB Statements-Future Dates2009 2010 2011

NEW AND HOT!! Statement No. 54, Fund Balance Reporting and Governmental Fund Type Definitions

RETROACTIVE APPLICATION IN 2011

EVEN HOTTER!! STATEMENT No. 55, The Hierarchy of Generally Accepted Accounting Principles for State and Local Governments

IMMEDIATE IMPLEMENTATION

EVEN HOTTER!! STATEMENT No. 56, Codification of Accounting and Financial Reporting Guidance Contained in the AICPA Statements on Auditing Standards

IMMEDIATE IMPLEMENTATION

HOT OFF THE PRESSES

7

Just the facts on OPEB for those stragglers!

What is the substantive plan from the employers/employees perspective?

Does an implicit rate subsidy exist? Has a qualifying trust been established? Are the actuarial assumptions reasonable? What constitutes a contribution to the plan? What is required to be presented in the financial

statements?

Statement 49 — Accounting and Financial Reporting for Pollution Remediation Obligations –

- aka the sleeping giant

Where Superfund, Priority List and RCRA Sites are in Tennessee per EPA

There’s one right nearby!Our Hotel

11

What Do You Need To Know About Statement 49? Thresholds are required to be met before the clock starts

on recognition Measurement is based on expected cash flows Amounts should be reasonably estimable Some obligations will result in the recognition of an asset Recoveries—depend on the source

12

Recognition Threshold Determine whether one of more

components of a pollution remediation obligation are recognizable as a liability when . . . Government knows or reasonably believes

that a site is polluted, and Obligating event occurs (the criteria

effectively serve as a safe harbor)

Decision Tree on PollutionPart 1 Obligating Events

Decision Tree on Pollution Part 2 – Measurement Guidance

From Part 1

Go to Part 5 Go to Part 3

Decision Tree on Pollution Part 3 – Capitalization Guidance

From Part 2 Yes

Go to Part 4

Prepping property to sell OR to reuse

Decision Tree on Pollution Part 4 – Liability Guidance

From Part 3

Go to Part 5

Decision Tree on Pollution Part 5 – Disclosure

From Part 2 – (if not estimable)

From Part 4

Three Contingencies – GASB 49 Recognition – Leaky Storage Tank in Road Project

Case Expected Outlays

(a)

% Probability

(b)

Outlays x %

(a x b)

Best $150,000 25% $ 37,500

Most Likely

$320,000 60% 192,000

Worst $450,000 15% 67,500

100% $297,000

Implementation Ideas

Internal controls to ensure obligating events identified

For example—Year-end inquiry to departmentsSimilar to contingent liability

inquiries, but for obligating events

20

Recognition Overview

Component recognition approachCost accumulation, not fair valueCurrent value, not present valueExpected cash flow technique

Expected Recoveries from Potential Responsible Parties and Insurance Reduce expense (and expenditure, if

available) and . . . If not realized or realizable—

Net against remediation liabilities When realized or realizable

Increase liability and report separate recovery assets (cash or receivable)

22

Effective Date

Fiscal periods beginning after

June 15, 2008 (FY09)

Land and Other Real Estate Held as Investments by Endowments

GASB 52

Land and Other Real Estate Held as Investments by Endowments

Resolves conflict between governmental and fiduciary funds that hold land investments – also includes investment pools

Land held for investment will be held at fair market value, instead of historical cost Changes in value = investment income

Effective for periods beginning after June 15, 2008 – (FY09)

Accounting and Financial Reporting For Intangible Assets

GASB 51

Introduction Intangible assets included in description of capital

assets in GASB 34 Inconsistency in practice on how intangible assets

are treated for accounting and financial reporting: As capital assets As intangible assets as considered in APB 17 Expensed in period that costs are incurred

Objective of Statement is to reduce the inconsistency in reporting

27

Description

An intangible asset is an asset that possesses all of the following characteristics:Lack of physical substance Nonfinancial natureInitial useful life extending beyond a

single reporting period

Scope

Examples may include: Easements (right-of-way, permissive,

restrictive) Land use rights (water, timber, mineral,

air rights) Internally developed computer software Patents, trademarks, copyrights Licenses, permits and other rights

Recognition

An intangible asset should only be recognized if it is identifiable:The asset is separable from the

government; orThe asset arises from contractual or

other legal rights, regardless of whether rights are separable

Classification All intangible assets subject to provisions should be classified as

capital assets Existing guidance related to capital assets should be applied to

intangible assets as appropriate: Recognition Measurement Depreciation (amortization for intangibles) Impairment Presentation Disclosure

Rest of standard provides guidance specific to intangibles that should be applied in addition to, or in lieu of if appropriate, capital asset guidance

31

Basic Guidance All intangible assets subject to Statement should be

classified as capital assets: All existing authoritative guidance related to capital assets

should be applied to these intangible assets Since considered capital assets, not reported as assets in

modified accrual financial statements Scope exceptions:

Intangible assets acquired or created primarily for directly obtaining income or profit

Capital leases Goodwill from a combination transaction

Internally Generated Intangibles – e.g. Software2 characteristics:

Can be created or produced by the government or an entity contracted by the government OR

Acquired from a 3rd party and more than an incremental effort to customize to put in service

Internally Generated Intangibles – e.g. Software – supersedes AICPA SOP 98-1

Preliminary Development OperationsDetermination of objective of project and is feasibleDemonstration that intent is there to complete the project

Management authorizes and commits to fundingSoftware is coded, tested and implemented

Software is accepted and operating

EXPENSE CAPITALIZE EXPENSE

Future betterments that add to useful life - Capitalize

Helpful Best Practices

RETROACTIVE IMPLEMENTATIONGo look for intangibles starting

NOWInclude legal counsel help as well

as IT staff

35

Effective Date and Transition Effective date is fiscal periods beginning after

June 15, 2009 Provisions generally should be retroactively

applied Exceptions for retroactively reporting

intangible assets: Permitted but not required for intangible assets with

indefinite useful lives at transition Required for all other intangible assets acquired in fiscal

years ending after June 30, 1980 by phase 1 or 2 governments

Encouraged but not required for all other intangible assets of phase 3 governments

36

Statement 53

Accounting and Financial Reporting for Derivative Instruments

Derivatives Notional amounts outstanding, 1987-present

$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

$700,000

Bil

lio

ns

1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Source: International Swaps and Derivatives Association, Inc., 2008

$683.7 trillion in June 2008

Types of Derivatives that Accountants Encounter

12% 9%

68%2%

1%

8%

Foreign Exchange Contracts Interest Rate Contracts

Equity - Linked Contracts Commodity Contracts

Credit Default Swaps Other

% of notional amounts outstanding – as of June 2008 – Source Bank for International Settlements

Ponder this about pooled securities such as mortgage backed derivatives:

Executive Summary of GASB Statement No. 53 Complex statement that:

Defines derivatives and exclusions Presents requirements for recognition and

measurement of derivatives Describes and calculates hedge accounting, efficient

and inefficient hedge accounting Contains a full set of examples and note disclosures,

as well as transition guidance

Supersedes Technical Bulletin 2003-1 Amends pieces of Statement Nos. 7, 23, 25, 31,

40 and 43

Executive Summary of GASB Statement No. 53 What is a derivative?

It is a contract that has settlement factors which could beone or more reference rates, notional amounts, payment provisions or any combination

It has leverage It can be settled net

Executive Summary of GASB Statement No. 53 What are settlement factors?

Reference Rate – an interest rate, security price, commodity price, exchange rate, other variables

Notional Amount(s) – the face amount of the contract, which includes the number of units, shares, bushels, pounds etc.

Executive Summary of GASB Statement No. 53 Requirements of the statement:

Derivatives should be reported on the statement of net assets at fair value except for synthetic guaranteed investment contracts

Unless hedging derivative, changes in fair values are part of investment revenue in statement of activities, changes etc.

If hedging, then changes are deferred inflows or outflows

If hedged derivative is terminated, P&L event

Executive Summary of GASB Statement No. 53 How to measure fair value

Market price if there is a market Discounted expected cash flows One of a number of different pricing

models and methodsIF using a pricing service and the method to

calculate is NOT disclosed by the service, then management must make an assessment of propriety based on the information received

Executive Summary of GASB Statement No. 53 Termination occurs when

Hedging derivative not effective Government becomes exposed to adverse changes in

fair values or cash flows Hedged asset or liability is sold or retired, refunded or

defeased Derivative is terminated Forward transaction occurs (e.g. sale of bonds or

purchase of commodity) Reporting – investment revenue, balance sheet

activity caption “increase (decrease) upon hedge termination”

46

Examples of Derivatives Interest rate swap

Variable-rate to fixed-rate Fixed-rate to variable-rate

Basis swap Exchange payments based on the changes of two

variable rates Swaption

Gives the purchaser of the option the right, but not the obligation, to enter into an interest rate swap

Commodity swap Reduce exposure to a commodity’s price risk

47

Principle

Fair value with hedge accountingChanges in fair value of derivative are

deferred for qualifying transactionsChanges in fair value of derivative would not

be deferred ifThe related asset (for example, investment) is

reported at fair valueThe hedge does not meet the effective criteria

How is that operationalized?

What is a hedge?

A hedge is a contract entered into to reduce some form of risk in cash flows or fair values

Hedges that accomplish the goal of reducing risk as expected are commonly referred to as effective.

What is a hedge?

It must be associated with a hedgeable item Asset, Liability, Expected Transaction (swaption,

forward etc.) Notional amount = principal amount Derivative is in the same fund as hedgeable

item Term or time period is consistent between

derivative and hedgeable item It is effective in reducing the risk

How to evaluate effectiveness?

Initial Year If terms of derivative (years, amounts, rates) are

consistent with debt, asset etc., then automatically effective – known as consistent critical terms

If inconsistent, then at least one of many quantitative methods must be used

Subsequent Years Use the same method as first year, but can use other

method Evaluation of effectiveness is done by measuring

cash flows or overall changes in fair values

How to evaluate effectiveness?

Quantitative methods include Synthetic instrument method (combine debt

cash flows and derivative to create a third item)

Dollar offset method (measure changes in cash flows)

Regression analysis method (statistical relationship between debt and derivative changes)

Can use other quantitative methods

Effectiveness Corridors

Synthetic instrument method

Dollar Offset

Regression analysis

Synthetic rate should be within 90% - 111% of fixed rate

Derivative cash flows 80% - 125% of debt

R2 (measure of the proportion of the variance in a dependent variable about its mean that can be explained by changes in the independent variable.) must be ≥ 0.80

F-statistic (confidence level) must have 95% confidence

Corridor must be 80% - 125% of debt

Note Disclosure

Summary table of informationOrganized by governmental, BTA,

fiduciary fundsSubdivisions for hedging derivatives and

investment derivativesWithin each categories – aggregate

information by type (received fixed swaps, pay fixed swaps, swaptions, caps, basis swaps, futures etc.)

Example of Calculating Effectiveness Assumptions

Auction rate bonds issued for $100MM on 7/1/xx. Bonds mature 6/30/x4

Semiannual coupons reset weekly On 7/1/xx, the government enters into a $100MM,

notional, pay fixed, receive variable swap that terminates 6/30/x4. FMV at 7/1xx=$0

Semiannual variable payment reset weekly Variable payment is 49.96% of LIBOR + 78 basis

points Fixed payment is 3.58782%.

Step 1 – Diagram the transaction

Government Counterparty

Fixed pay 3.57872%

Variable receive – LIBOR + 78bps

Bondholders

Auction rate paid

Note that the actual synthetic rate paid will vary depending on the difference between the auction rate paid and the variable rate received.

Step 2, Spreadsheet the cash flows and values

Fair Value Change in Fair Value

1 (2,487,390)$ (2,487,390)$ 2 (4,000,154) (1,512,764) 3 (1,536,286) 2,463,868 4 - 1,536,286

Step 3, Divide and Measure

From Assumptions

Since these are between 90 and 111%, then derivative is effective – changes only reflected in statement of net assets

Journal Entries – HIGHLY SIMPLIFIEDYear 1 Swap Payment to Counterparty

Dr. Interest Expense $3,578,720 Cr. Cash $3,578,720

Swap Receipt from Counterparty Dr. Cash $2,031,713 Cr. Interest Expense $2,031,713

Payment to Bond Holders Dr. Interest Expense $1,789,314 Cr. Cash $1,789,314

Change in Fair Value Dr. Pay-fixed rate swaps $2,487,390 Cr. Deferred Outflow of Resources $2,487,390

Journal Entries – HIGHLY SIMPLIFIEDYear 2 Swap Payment to Counterparty

Dr. Interest Expense $3,578,720 Cr. Cash $3,578,720

Swap Receipt from Counterparty Dr. Cash $1,575,995 Cr. Interest Expense $1,575,995

Payment to Bond Holders Dr. Interest Expense $1,359,205 Cr. Cash $1,359,205

Change in Fair Value Dr. Pay-fixed rate swaps $1,512,764 Cr. Deferred Outflow of Resources $1,512,764

Journal Entries – HIGHLY SIMPLIFIEDYear 4 – FINAL YEAR Swap Payment to Counterparty

Dr. Interest Expense $3,578,720 Cr. Cash $3,578,720

Swap Receipt from Counterparty Dr. Cash $1,940,223 Cr. Interest Expense $1,940,223

Payment to Bond Holders Dr. Interest Expense $1,930,405 Cr. Cash $1,930,405

Change in Fair Value Dr. Deferred Outflow of Resources $1,536,286 Cr. Pay – Fixed Rate Swaps $1,536,286

Note Disclosure

Summary table of information Information includes:

Notional amounts Changes in fair value and where it is reported in

the financial statements Fair values at the end of the year Reclassifications from hedging to investment

derivatives during the period Deferral amounts in investment revenue

Can be narrative if small number of contacts

Note Disclosure

Narratives include Objectives of derivatives Terms of derivatives include

Notional amounts Reference rates, indexes etc. Any embedded options (caps, floors collars) Date of contract and termination or maturity Any cash paid or received

2003-1 risks (credit, interest rate, basis, termination, rollover, market access, foreign currency)

Note Disclosure

OtherHedged debt –follow GASB 38 – disclose

net cash flows If using other quantitative method –

identify and notable features of the method

Investment derivatives2003-1 disclosures along with GASB 40

disclosures

Note Disclosure – June 30, Year 1Item Type Objective Notional

Amount

(000’s)

Effective Date

Matures Terms FMV

(000’s)

A Variable Receive Interest Rate Swap

Hedge of changes in cash flows of series XX bonds

$100,000

7/1/xx 6/30/x4 Receive LIBOR + 78bps, pay 3.57872%

($2,487)

B Fuel contract

Hedge oil market price changes

1 MBTUs

4/30/x0 12/31/x0 Pay $7.50 MBTU, based on pricing point at expiration

111

Disclosure

After table, note the following:Terms not in tableHow fair values calculatedRisks and ratings of counterpartiesContingencies on derivativesTable of all payments and hedged

debt

Disclosure – 2nd tableChanges in Fair Value Fair Value at June 30,xx

Governmental Activities

Classification Amount

(000’s)

Classification Amount

(000’s)

Notional

(000’s)

Variable Receive Interest Rate Swap

Deferred Outflow

($2,487) Debt ($2,487) $100,000

Commodity Forward

Deferred Inflow

111 Derivative Instruments

111 1,000 MMBTU’s

Transition Transition periods BEGINNING AFTER

June 15, 2009 Retroactive application for all periods

presented Perform hedge effectiveness evaluation as

of the END of the CURRENT period ONLY. If effective now, assume effective as of the beginning of the contract

Other items included in the Statement Huge (11 page) glossary 12 robust illustrations

Consistent critical terms Interest rate swaps – synthetic method Interest rate swaps – terminations due to

market conditions Regression analysis Dollar offset method

Other items included in the Statement 12 robust illustrations (continued)

Swaptions Full set of note disclosures

Flowchart of hedge effectiveness decisions Codification instructions Still to Come – Implementation Guide –

Watch for it in 2009!

70

Fund Balance Reporting and Governmental Fund Type Definitions

Statement 54

HOT OFF THE PRESSES!!

What Do You Need to Know About Statement 54?Could be a large change2 initial distinctions

Non-spendableCan’t be spent with cashIn a non-spendable formLegally or contractually required to

remain intact

What Do You Need to Know About Statement 54?2 initial distinctions

SpendableCan be spent, but may have

restrictions – those being:RestrictedCommittedAssigned

What Do You Need to Know About Statement 54?Restricted

Same definition as in Statement No. 46Externally imposed by creditors (e.g.

debt covenants)Imposed by law through constitutional

provisions or enabling legislation and has legal enforceability

What Do You Need to Know About Statement 54?

CommittedCan only be used for specific purposes

imposed by formal action of the government’s highest level of decision making authorityCan only be changed by the same type of

action Law, ordinance, resolution

Should occur prior to year end, but can occur after

What Do You Need to Know About Statement 54?

AssignedCan constrained by intent

Should be expressed by governing body or a committee or an official that can assign assets

Includes all remaining amounts NOT in the General Fund

What Do You Need to Know About Statement 54? Unassigned

Includes only unrestricted, uncommitted, unassigned amounts in the General Fund ONLY

General Fund should be the only fund that reports a positive unassigned amount

If a NON-General Fund balance is negative after restricted, committed, assigned, then Reduce assigned and if that goes to zero Negative unassigned

What Do You Need to Know About Statement 54? Governmental Fund Type Definitions

Special revenue fund—used to account for and report the proceeds of specific revenue sources that are restricted or committed to expenditure for specified purposes other than debt service or capital projects.

Capital projects fund—used to account for and report financial resources that are restricted, committed, or assigned to expenditure for capital outlays including the acquisition or construction of capital facilities and other capital assets.

Debt Service, Permanent and General Fund unchanged

What Do You Need to Know About Statement 54?

Rainy Day / Stabilization FundsSatisfies the criteria for a Special Revenue Fund, only if the resources derive from a specific restricted or committed revenue source

What else about Statement 54?

Policies and procedures of committed and assigned should be in the Summary of Significant Accounting Policies Committed:

Who is the highest level of decision making authority? What action is required to establish commitment?

Assigned Who can assign What is the policy of assignment

What else about Statement 54? Encumbrances

Disappear from the face of the financial statements, other than what is already restricted

Disclosed in the notes Stabilization Disclosure

Notes should describe authority, requirements for additions, spending and balance

Minimum fund balance policies disclosed Implementation – periods beginning

after June 15, 2010

Display in the Financial Statements

Either disaggregated or aggregatedComplex governments will probably

aggregate If aggregate on the face of the statements, no

requirement to present disaggregated numbers, unless important to financial statement usersDetail can be put in the notes

How does it look? - Aggregated

How does it look? - Disaggregated

GASB Statement No. 55, The Hierarchy of Generally Accepted Accounting Principles for State and Local Governments Codifies the 4 levels of GAAP, formerly in SAS

69 A. GASB Statements and Interpretations B. GASB Technical Bulletins and if applicable,

AICPA Industry Accounting and Auditing Guides and Statements of Position

C. AICPA technical practice bulletins D. GASB Implementation Guides

If it’s not in A, look at B-D. If not in A-D, look at other literature Immediate implementation

Questions?Eric S. Berman, MSA, CPA

Deputy Comptroller Commonwealth of Massachusetts

617-973-2602

Email: Eric.berman@state.ma.us