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3/7/2016
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Granof, et al. – 7th edition Chapter 7 |
Chapter 7Capital Assets and Investments in Marketable Securities
© 2016 John Wiley & Sons, Inc. All rights reserved. 1
Granof, et al. – 7th edition Chapter 7 |
Learning ObjectivesWhy and how governments account for capital assets in both fund and government-wide statements
Why and how governments account for transactions involving donated assets, trade-ins, and collectibles
GASB’s controversial provisions regarding infrastructure
What special problems asset impairments create
How investments should be reported
Why investments in marketable securities may be of high risk
© 2016 John Wiley & Sons, Inc. All rights reserved. 2
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General Capital AssetsAssociated with the government as a whole, rather than with any specific fund
Non financial in character.
Distinguished from other capital assets that are specifically associated with activities reported in proprietary and fiduciary funds.
Examples: The City of Austin defines capital assets as assets with an initial individual cost of $1,000 or more and an estimated useful life of greater than one year. The City of Houston defines capital assets as assets with an initial cost of more than $5,000 (amount not rounded) and an estimated useful life in excess of four years.
© 2016 John Wiley & Sons, Inc. All rights reserved. 3
Granof, et al. – 7th edition Chapter 7 |
Common Classifications of GCAsLand
Buildings
Equipment
Improvements to land and buildings
Construction in progress
Works of art
Historical treasures
Infrastructure (e.g., roads, bridges, tunnels, drainage system)
Intangible assets
© 2016 John Wiley & Sons, Inc. All rights reserved. 4
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Acquisition and Common Financing Sources for GCAs & DCAsAcquisition: Purchase, Construction, Contributed/Donated (DCA), Annexed, Capital Leases, Foreclosure, Eminent domain, Escheat
Financed: Tax-supported bonds, Grants from other governmental units, Transfers from other funds, Special assessment bonds or taxes, Capital leases
© 2016 John Wiley & Sons, Inc. All rights reserved. 5
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Accounting for GCAsGovernment-wide Statements:
•Capitalized in the governmental activities column
•Depreciated
Fund Statements:
•Full Cost debited to Expenditures in the appropriate governmental fund—when the assets are acquired.
© 2016 John Wiley & Sons, Inc. All rights reserved. 6
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Accounting for GCAs - ExampleExample: The Sample city purchased office equipment for the Mayor’s
office and paid $50,000 cash from the General Fund.
General Fund: Dr. Cr._____
Expenditures-Capital Outlay $50,000
Cash 50,000
Gov’t –wide (Gov’tal Act.)*:
Equipment $50,000
Net Assets, Invested in Cap Assets 50,000
*Note: This entry is not made on the books. It is only a conversion at eoy
© 2016 John Wiley & Sons, Inc. All rights reserved. 7
Granof, et al. – 7th edition Chapter 7 |
Placing a value (assigning costs) on GCAs
•For Purchased Assets:• Capitalized cost should include purchase price + transportation + installation costs
• For land: Legal fees + title fees + appraisal costs + closing costs + costs of demolishing existing structures that cannot be used
• All other necessary and reasonable costs incurred to put an asset into use (less cash or other discounts and financing charges)
•For constructed assets: • Direct labor and materials + overhead + architect fees + insurance premiums
•Capitalize interest on constructed assets per GASB Std. # 34
© 2016 John Wiley & Sons, Inc. All rights reserved. 8
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Placing Value (assigning costs) on GCAs(Miscellaneous items)Initially unrecorded assets (i.e. “discovered assets” or a new inventory of assets) Record at estimated cost
Foreclosures◦ 1) Record at aggregate of accumulated taxes, interest, penalties, legal cost, OR
◦ 2)FMV whichever is lower
Trade-Ins Record at FMV of the new asset
© 2016 John Wiley & Sons, Inc. All rights reserved. 9
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Placing Value (assigning costs) on DCAsDonated assets: reported at estimated acquisition value (replacement cost).
Exhaustible assets are depreciated over the remaining useful lives in their government-wide statements.
© 2016 John Wiley & Sons, Inc. All rights reserved. 10
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Granof, et al. – 7th edition 11© 2016 John Wiley & Sons, Inc. All rights reserved. Chapter 7 |
Granof, et al. – 7th edition © 2016 John Wiley & Sons, Inc. All rights reserved. 12
Depreciation included in
Expenses
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-No Capital Assets
Chapter 7 |
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Granof, et al. – 7th edition Chapter 7 |
Infrastructure Infrastructure is:
◦ Government’s capital assets
◦ Immovable, stationary in nature
◦ Preserved for a longer period. Ex: roads, sidewalks, bridges, tunnels, highways, drainage systems,
water and sewer systems, dams, lighting systems etc.
GASB 34: requires that infrastructure be accounted in the same manner as the capital assets.*◦ *Exception: They need not be depreciated if the government can demonstrate that they are being
maintained/preserved at a specified condition level.
◦ To avoid recording depreciation, governments must:
◦ - perform condition assessments at least every three years;
◦ - have an up-to-date inventory of eligible assets
◦ - estimate the amount to maintain and preserve the eligible assets.
© 2016 John Wiley & Sons, Inc. All rights reserved. 20
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TWO Approaches for Infrastructure AccountingTraditional approach:◦ Capitalize & Depreciate
Modified approach: ◦ All expenditures incurred to maintain and preserve those assets should be expensed.
◦ Additions and improvements should be capitalized.
◦ Assessed condition of the assets and the basis of that assessment must be disclosed.
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Granof, et al. – 7th edition © 2016 John Wiley & Sons, Inc. All rights reserved. 22Chapter 7 |
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Expense for either:
-Depreciation or
- Maintenance
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Expenditure for either:
-Maintenance or
-Whole Asset (“Capital
Outlay”)
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Criticisms of Statement No. 34's Approach to InfrastructureNo indication that data on the historical cost of infrastructure would be used.
No need to capitalize those assets because they cannot be stolen or misused.
Comparison between measure of output (performance) and monetary value assigned to the assets is not meaningful.
Infrastructure assets seldom have alternative uses.
Past construction costs are of no significance.
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Transition -- Infrastructure Prospective reporting is required at effective statement date
Retroactive reporting is required as follows:-Phase 1 governments: June 15, 2005
-Phase 2 governments: June 15, 2006
-Phase 3 governments: Never
Retroactive reporting is required only for assets acquired after June 30, 1980.
Illustration: For example, in 2008 the replacement cost of a road constructed in 1994 was
$10 million. A road construction price level index was 90 for 1994 and 120 for 2008. The
road would be recorded at an initial cost of $7.5 million ($10 million times 90/120).
If the road had a useful life of 30 years, then at the end of 2008 (after 15 years, it would be
50% depreciated. Hence it would have a book value of 50% of $7.5 million -- $3.75 million.
© 2016 John Wiley & Sons, Inc. All rights reserved. 26
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Accounting for CollectiblesGASB No. 34 does not require capitalization of artworks if they are:
1) held for public exhibition, education ,or research in furtherance of public service, rather than for financial gain AND
2) protected and preserved AND
3) the proceeds from sale of the collectibles are used to acquire other collectibles.
Art and collectibles that do not meet these conditions must be capitalized.
For capitalized art revenue upon receipt of gifts should be recognized
© 2016 John Wiley & Sons, Inc. All rights reserved. 27
Granof, et al. – 7th edition © 2016 John Wiley & Sons, Inc. All rights reserved. 28Chapter 7 |
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Accounting for Impaired AssetsGASB Std. # 42 “Accounting and Financial Reporting for Impairment of Capital Assets and for Insurance Recoveries.”
Assets that have declined in their service utility significantly and unexpectedly are considered impaired.
If impaired: a portion of the asset’s historical cost representing the impairment must be written off.
Impairment amount measured by 3 methods:
- Restoration cost approach
- Service Units approach
- Deflated depreciated replacement cost approach.
© 2016 John Wiley & Sons, Inc. All rights reserved. 29
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Marketable Securities - OverviewGASB Stmt #31 Accounting and Financial Reporting for Certain Investments and for External Investment Pools.
1) General Investment
Governments either directly invest in stocks or bonds or small governments may participate in investment pools maintained by other governments.
2) Derivatives
Governments typically engage in derivative transactions not to speculate but, rather, to reduce the overall investment risk.
3) Repurchase Agreement & Reverse Repurchase Agreement
Repurchase agreement (Repo): short-term investment in which investor transfers cash in exchange for securities and the cash + plus interest is repaid in exchange for the same securities.
Reverse Repurchase agreement (Reverse Repo):Here, government is the borrower rather than the investor.
© 2016 John Wiley & Sons, Inc. All rights reserved. 30
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1) General InvestmentsExample-Footnote
The City of Austin, TX in its CAFR for FY 2013 had the following footnote on investments.
Investments – Certain investments are required to be reported at fair value, based on quoted market prices. Realized gains or losses resulting from the sale of investments are determined by the specific cost of the securities sold. The City carries all of its investments in U.S. government and agency debt securities and money market mutual funds at fair value as of September 30, 2013. Investments in local government investment pools are carried at amortized cost, which approximates fair value.
© 2016 John Wiley & Sons, Inc. All rights reserved. 31
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Disclosure RequirementsGovernments should organize disclosures by investment type
Governments should disclose their vulnerability to specific types of risks
◦ - Credit risks
◦ - Concentration of credit risks
◦ - Interest rate risks
◦ - Foreign currency risks
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City of Houston: Notes on InvestmentsThese funds are managed internally by City personnel. The investments listed below do not include the City's three pension funds, which are described elsewhere in this report.
1. General Investment Pool 9900
The General Investment Pool consists of all working capital, construction and debt service funds which are not subject to yield restriction under IRS arbitrage regulations. The funds of the City's enterprise systems, as well as the general fund are commingled in this pool in order to gain operational efficiency. Approximately 99% of the City's total investable funds are contained in this portfolio.
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2) Derivatives GASB Stmt. No. 53 Accounting and Financial Reporting for Derivative Instruments
Derivatives should be reported at their fair values
Changes in fair value should be reported as gains or losses on both fund and government-wide statements
of changes in net position
Exception: derivative instruments that represent effective hedges against other assets or liabilities should
be deferred and reported on balance sheets as deferred inflows or outflows
Extensive disclosure
◦ - nature of derivative transaction
◦ - reasons why they were entered
◦ - discussion of exposure to credit risk, market risk, and legal risk
◦ - disclose significant terms and any violations of legal, regulatory, or contractual provisions by investing in derivatives
© 2016 John Wiley & Sons, Inc. All rights reserved. 39
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DefinitionsCustodial Credit Risk: Investments are exposed to custodial credit risk if the securities are uninsured, uncollateralized, not in the name of the government itself, or not in the physical possession of the government.
Credit risk is the risk that an issuer or other counterparty to an investment will not fulfill its obligations.
Concentration of credit risk is the risk of loss attributed to the magnitude of an investment in a single issuer.
Interest Rate Risk: All investments carry the risk that changes in market interest rates will adversely affect the fair value of an investment.
Foreign Currency Risk: Foreign currency risk is the risk that fluctuations in the exchange rate will adversely affect the value of investments denominated in a currency other than the US dollar.
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3) Repo & Reverse Repo
© 2016 John Wiley & Sons, Inc. All rights reserved. 41
Repo Transaction
$Cash Securities
Reverse Repo Transaction
Securities $Cash
Granof, et al. – 7th edition Chapter 7 |
SummaryGovernments report general capital assets as expenditures when they construct or acquire them in their governmental fund statements which are accounted for on a modified accrual basis. Thus governments maintain the “off the balance sheet” record of these assets.
GASB Std. # 34 mandates that governments account for their infrastructure assets just as they do other capital assets. However governments are not required to depreciate infrastructure assets if they preserve them at a specified “condition level.”
Investments made by governments are of concern because of the substantial risk that investors can incur through default, declines in value and even fraud.
GASB standards require that with few exceptions all investments, should be reported at fair value. As a consequence, gains and losses in value must be recognized in a flows statement each period as changes in fair value occur.
© 2016 John Wiley & Sons, Inc. All rights reserved. 42