Have you ever looked at a governmental annual comprehensive financial report and wondered what is going on?
The “Government-wide” or consolidated financial statements are similar to business financial statements. There are a few, but we will discuss only two here.
The first statement is the Income Statement, otherwise called the Statement of Activities by governments. Much like an income statement for a business calculates the net income, revenues minus expenses, for the period. In addition to general revenues, the Statement of Activities includes program revenues such as charges for services and operating grants. Expenses are listed by program, and net expenses are included by governmental and business activities and by component units.
The second statement is called the Statement of Net Position, which is comparable to the Balance Sheet of a business. The first thing to note is that it is divided into governmental, business, and component units. Each of these is reported separately because their fundamental purposes are different, at least in theory. For example, governments have the role of reporting responsible and accountable use of taxpayer dollars, while business components must be sustainable if not profitable. This, it is said, is why the reporting is separate.
The second thing on the Statement of Net Position is the separate sections you would not see in business reporting, deferred inflows, and outflows.
Deferred Outflows
In the Statement of Net Position, deferred outflows are positioned right beneath Assets. Assets are those things that will provide future economic benefits to the organization—we all like assets. Deferred outflows are treated like assets but aren’t assets. What?
Examples are losses incurred when the government issues debt to pay off old debt and decreases in the market value of complicated hedging derivatives. Instead of recognizing these losses and decreases immediately, governments reported them as deferred outflows and amortized them over time. Governments are also allowed to shield their financial position and current expenses from increases in their pension debt. For example, suppose the value of pension assets decreases due to unrealized losses in the market. In that case, the majority of the decrease is reported as a deferred outflow which is included on the asset side of the balance sheet. In some way, market losses masquerade as assets.
Deferred Inflows
Conversely, deferred inflows are resources on the Statement of Net Position below liabilities. Examples are grants received in advance when all eligibility requirements except timing requirements have been met, special assessments that have not been collected, and property taxes received for a future period. By placing these in deferred inflows, governments handle them like businesses would handle them as deferred revenues.
But some decreases in the government’s pension liabilities are also reported as deferred inflows and amortized over time. This includes unrealized gains in pension assets. Therefore an increase in the value of pension assets is, in essence, reported as a government liability. As a result, it decreases the net position of an entity in this period when in reality, they might improve it in the future. In this case, the deferred inflow resembles a debt yet is a future asset in sheep’s clothing.
Confusing, right?
Losses are assets, and gains are liabilities. And so it goes in governmental accounting. So, in a nutshell, those are two basic issues in government-wide financial statements.
Simple - right?