2005 Midwest Regional Professional Development Conference Roberta Reese May 12, 2005 AGA Topeka Chapter

Overview New Implementation Guide New Implementation Guide Statement 40: Investment disclosures Statement 40: Investment disclosures TB : Derivatives disclosures TB : Derivatives disclosures Statement 46: Restricted net assets Statement 46: Restricted net assets Pollution remediation obligations Pollution remediation obligations Sales and pledges Sales and pledges Statement 44: Statistical section Statement 44: Statistical section

Comprehensive Implementation Guide –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 2004

Issued March 2003 Effective for Periods Beginning After June 15, 2004 Statement No. 40—Deposit and Investment Risk Disclosures

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

Disclosures by Investment Type Investments should be organized by investment type, such as: Investments should be organized by investment type, such as: –U.S. Treasuries –Corporate bonds –Commercial paper Dissimilar investments should not be aggregated Dissimilar investments should not be aggregated

Level of Detail Generally, the disclosures should be made for the primary government for which disclosures are essential for fair presentation Generally, the disclosures should be made for the primary government for which disclosures are essential for fair presentation

Level of Detail Risk disclosures should also be made for: 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

Level of Detail— An Example 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 government’s total investments might not indicate a concentration risk. In this case, additional disclosure should be made for the capital projects fund’s exposure to a concentration of credit risk. 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 government’s total investments might not indicate a concentration risk. In this case, additional disclosure should be made for the capital projects fund’s exposure to a concentration of credit risk.

Interest Rate Risk The risk that changes in interest rates may adversely affect an investment’s fair value The risk that changes in interest rates may adversely affect an investment’s fair value Five methods identified, must choose one: Five methods identified, must choose one: –Specific identification –Weighted average maturity –Duration –Simulation model –Segmented time distributions

Specific Identification Maturities Fair Value State investment pool Not applicable $1,506,980 U.S. Treasury bill Jan , ,980 Government National Mortgage Association Mar 2003 Mar , ,230 ABC Corp. commercial paper Jan , ,000 DEF Corporation bonds Mar ,000 50,000 Total$2,642,190

Fair Value < > 10 Repos$150$150 U.S. Treasury Corporate bonds Certificate of deposit __ Total Segmented Time Distribution

Highly Sensitive Investments A debt investment with contract terms that make the investment’s fair value highly sensitive to interest rate changes A debt investment with contract terms that make the investment’s fair value highly sensitive to interest rate changes

Highly Sensitive Investments: Examples Inverse floaters Inverse floaters Variable coupons with multiplier [for example, coupon varies by 125% of London Interbank Offered Rate (LIBOR)] Variable coupons with multiplier [for example, coupon varies by 125% of London Interbank Offered Rate (LIBOR)] Collateralized mortgage obligations, such as interest-only or residual tranches Collateralized mortgage obligations, such as interest-only or residual tranches

Credit Risk Disclose credit quality as of year-end Disclose credit quality as of year-end Includes corporate debt, state and local governments, external investment pools Includes corporate debt, state and local governments, external investment pools Exempt: Debt investments with explicit guarantee of US government—GNMA Exempt: Debt investments with explicit guarantee of US government—GNMA If not rated, indicate as much If not rated, indicate as much

Custodial Credit Risk Disclose only “Category 3” Disclose only “Category 3” –Deposits that are uninsured and uncollateralized –Uninsured investments that are either held by the: Counterparty, or Counterparty, or Counterparty’s trust department, but not in the name of the government Counterparty’s trust department, but not in the name of the government

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

Foreign Currency Risk Applies to deposits and investments Applies to deposits and investments Disclose currency Disclose currency If debt security, disclose interest rate risk If debt security, disclose interest rate risk

Deposit and Investment Policies Disclose only those policies that are relevant to the risks that are disclosed 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 In other words, if there is no risk disclosure, no policy disclosure is required

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

Technical Bulletin Disclosures for Derivatives Not Reported at Fair Value

Derivatives—Disclosures Previous guidance provided in Technical Bulletin 94-1 Previous guidance provided in Technical Bulletin 94-1 Final TB issued in June 2003 Final TB issued in June 2003 Effective date—Periods ending after June 15, 2003 (FYE June 30, 2003) Effective date—Periods ending after June 15, 2003 (FYE June 30, 2003)

Derivatives—Disclosures Objective of the derivative Objective of the derivative Significant terms Significant terms –Notional amount –Interest rates –Embedded options –Effective date and ending date Fair value Fair value

Derivatives—Disclosures Risks Risks –Credit –Interest rate –Basis –Termination –Rollover –Market access Associated debt—effect of the derivative on net cash flow Associated debt—effect of the derivative on net cash flow

Statement 46: Net Assets Restricted by Enabling Legislation

Net Assets Two Issues: Two Issues: –Clarifies “legally enforceable” –Requires separate reporting of net assets restricted by enabling legislation

Net Assets Enabling legislation authorizes the government to assess, levy, charge, or otherwise mandate payment of resources (from external resource providers) and includes a legally enforceable requirement that those resources be used only for the specific purposes stipulated in the legislation Enabling legislation authorizes the government to assess, levy, charge, or otherwise mandate payment of resources (from external resource providers) and includes a legally enforceable requirement that those resources be used only for the specific purposes stipulated in the legislation

Net Assets Legally Enforceable: Legally Enforceable: –The government can be compelled by an external party to use resources only for a specific purpose –Based on presumption (and legal opinion?) May never be proven May never be proven –“Tainting” the pool?

Net Assets “New” enabling legislation to replace existing law “New” enabling legislation to replace existing law –New resources –Remaining balances Noncompliant use of restricted assets Noncompliant use of restricted assets –Re-evaluate classification Reclassify as unrestricted Reclassify as unrestricted Maintain restriction Maintain restriction

Net Assets Net assets restricted by enabling legislation should be displayed separately from other restricted assets Net assets restricted by enabling legislation should be displayed separately from other restricted assets –To emphasize different level of influence

Pollution Remediation Obligations

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

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

Two Contingencies Neither is Probable

Probable Together

Pollution Remediation Obligations Recognition triggers—liability when: Recognition triggers—liability 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) Recognize component when measurable (benchmarks approach)

Pollution Remediation Obligations Current cost based on reasonable and supportable assumptions about future events Current cost based on reasonable and supportable assumptions about future events –laws expected to be in effect –technology expected to be used

Pollution Remediation Obligations What costs are to be included in liability? 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 Entity must decide whether to include indirect and non-incremental costs

Pollution Remediation Obligations What is the debit entry? What is the debit entry? –Generally expense –Can defer expense under FASB Stmt 71 –Capitalize in certain situations Do NOT record liabilities for capitalizable costs! Do NOT record liabilities for capitalizable costs!

Pollution Remediation Obligations Capitalize if 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

Pollution Remediation Obligations Recoveries—net against expense Recoveries—net against expense –Recoveries from other parties Recognize consistent with liability (expected cash flow technique) Recognize consistent with liability (expected cash flow technique) –Insurance recoveries Recognize as separate recovery assets when realized or realizable Recognize as separate recovery assets when realized or realizable If not realized or realizable—offset against liabilities If not realized or realizable—offset against liabilities

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

Pollution Remediation Obligations Timetable: Preliminary Views—March 2005 Preliminary Views—March 2005 Exposure Draft—December 2005 Exposure Draft—December 2005 Statement—Fall/Winter 2006 Statement—Fall/Winter 2006

Sales and Pledges of Receivables and Future Revenues

Sales and Pledges Scope of the project—government receives proceeds from a third party in exchange for the rights to future cash flows from: Scope of the project—government receives proceeds from a third party in exchange for the rights to future cash flows from: –Receivables: Delinquent property taxes Delinquent property taxes Uncollected fines Uncollected fines Mortgages Mortgages Student loans Student loans –Future revenues

Sales and Pledges Scope of the project: Also includes situations in which the government does not receive proceeds, but pledges future cash flows Also includes situations in which the government does not receive proceeds, but pledges future cash flows –Primary government pledges revenues to debt-issuing component unit

Sales and Pledges Added to the agenda in 2004: TB (tobacco settlement) concerns TB (tobacco settlement) concerns Budgetary pressures to accelerate cash flows Budgetary pressures to accelerate cash flows Current lack of disclosures about pledged revenues Current lack of disclosures about pledged revenues Need for government-specific standards Need for government-specific standards

Sales and Pledges Sale or borrowing? Intent of the parties, terms of the agreement Intent of the parties, terms of the agreement Continuing involvement—control Continuing involvement—control –Does the transferor government retain control, or is control relinquished? –Criteria for receivables –Criteria for sales

Sales and Pledges Are receivables sold or pledged? Transferee’s ability to sell or pledge Transferee’s ability to sell or pledge Isolation Isolation –Legally separate –No access to cash –Source and timing of payments –Satisfaction of accounts –Bankruptcy protection Obligation to replace or repurchase accounts Obligation to replace or repurchase accounts

Sales and Pledges Are future revenues sold or pledged? Transferee’s ability to sell or pledge Transferee’s ability to sell or pledge Transferor’s continuing active involvement in the generation of the revenues Transferor’s continuing active involvement in the generation of the revenues –Excludes own-source revenues Taxes Taxes User charges User charges –Grants, entitlements

Sales and Pledges If not a sale (collateralized borrowing): Pledging government: Pledging government: –Recognizes liability for the proceeds –Does not de-recognize receivables –Continues recognition of revenues pledged –Payments reduce liability (G/F expenditure) Transferee government recognizes a receivable Transferee government recognizes a receivable

Sales and Pledges Meets the conditions for sale treatment: Selling government: Selling government: –De-recognizes receivables –No asset to de-recognize for future revenues –Difference between proceeds and carrying value is gain (loss) Purchasing government: Purchasing government: –Intra-entity—asset at carrying value –Outside of the reporting entity—asset at cost

Sales and Pledges Other assets and liabilities: Residual interests—subordinate note/certificate Residual interests—subordinate note/certificate –Excess receivable collections –Excess future revenues Recourse and other obligations Recourse and other obligations Servicing fees—deferred revenues and charges Servicing fees—deferred revenues and charges

Sales and Pledges Pledging government does not receive proceeds: Pledging government does not receive proceeds: –Government may be prohibited or have limited ability to issue debt –Creates/uses component unit to issue debt –Pledge does not constitute a liability –Liability arises when pledged revenue is recognized

Sales and Pledges Disclosures: Disclosures: –Required for direct or indirect pledges What revenue? What revenue? Purpose of the debt Purpose of the debt For how long? For how long? Significance of pledged amount Significance of pledged amount –Required for future revenues sold: What revenue? What revenue? For how long? For how long? Significance of amount sold Significance of amount sold

Statement No. 44 Economic Condition Reporting: Economic Condition Reporting: The Statistical Section The Statistical Section

The Statistical Section— Objectives For assessing economic condition: Provide perspective, context, and detail relative to the financial statements Provide perspective, context, and detail relative to the financial statements Provide information (outside the financial statements) about the demographic and economic environment Provide information (outside the financial statements) about the demographic and economic environment

The Statistical Section Applicability: Any government that provides a statistical section Any government that provides a statistical sectionFocus: On the primary government On the primary governmentStatus: Supplementary information Supplementary information

Types of Statistical Section Information Financial trends information Financial trends information Revenue capacity information—factors affecting ability to generate own-source revenues Revenue capacity information—factors affecting ability to generate own-source revenues Debt capacity information Debt capacity information Demographic and economic information Demographic and economic information –Understand socio-economic environment –Facilitate comparisons over time and among governments Operating information—contextual information about operations and resources Operating information—contextual information about operations and resources

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

Other Projects TB , Recognition of Pension and Other Postemployment Benefit Expenditures/Expenses and Liabilities by Cost-Sharing Employers TB , Recognition of Pension and Other Postemployment Benefit Expenditures/Expenses and Liabilities by Cost-Sharing Employers Accounting for Termination Benefits, ED released December 10, 2004, comment period ended March 11, 2005 Accounting for Termination Benefits, ED released December 10, 2004, comment period ended March 11, 2005 Derivatives and hedging Derivatives and hedging Electronic reporting Electronic reporting

Questions: Roberta Reese: Roberta Reese: –Telephone—(203) X324 – Web site— Web site—