Banking & Finance and Government

New rule changes how financial statements look

Some governmental entities will appear to be in the red.

May 22, 2015
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A new accounting rule issued by the Governmental Accounting Standards Board that takes effect this June, known as GASB 68, will have an impact on local governments’ financial statements — and could make some of them appear in bad financial shape, when the opposite is true.

According to Jennifer Mausolf, marketing and product development director for the Municipal Employees’ Retirement System, the new rule changes how government entities that offer defined benefit plans report pension liabilities.

According to Mausolf, governments currently include “only yearly contributions as an expense on their financial statements, and the long-term cost of benefits, called unfunded accrued liability, is included in the notes section of the comprehensive annual financial report.”

Under the new GASB 68 rules, government entities will be required to include their net pension liability on their balance sheet. This change could cause some financial positions to appear to be in the red, even when they are not, she said.

The new requirement “does not change the way MERS calculates how much municipalities need to contribute to cover benefits in any given year,” she said, and “the financial situation of the retirement plan has not actually changed.”

“In issuing these new standards, one of the things the GASB was trying to emphasize is a pretty important concept called the concept of ‘inter-period equity,’” explained Michelle Watterworth, a member of Plante Moran’s governmental standards practice.

Watterworth said financial reports are supposed to “help a user assess whether the current year revenue that the local unit is collecting is sufficient to pay for the services the local unit provided throughout the year.”

She said the previous practice of including the unfunded accrued liability in the footnotes did not paint a true picture.

“The prior standard really just measured from a funding perspective, to the extent that if you did not contribute the amount the actuary said into the plan then you’d have a liability,” Watterworth said. “But if you contributed that amount, no matter how well-funded that pension plan is, the local unit did not have a liability on its financial statement.

“It was purely looking at things from a funding perspective: Did you fund the amount the actuary told you to fund? As a result, you could end up with local units of government that are only funding their pension system at 50 to 70 percent. It really wasn’t measuring this concept of inter-period equity.”

GASB 68 has essentially “divorced” funding from accounting, she said.

“Now we have these accounting standards that go off in a different direction and really no longer mirror the funding perspective the local unit is going to continue doing,” Watterworth said.

“What we are looking at is truly a measurement of, ‘Have you funded the entire liability related to those services that your participants in the plan — not only your current retirees, but also the employees that are in the plan and eligible once they reach a certain age — to get payments out of that pension plan?’”

To the extent the liability has not been funded will now be recorded as a liability on a government’s financial statements.

“You, as a local unit of government, may have a very large liability coming on your financial statements upon implementation of GASB 68 that you did not have before,” Watterworth said. “As a result, we may find that some local units of government go from a positive unrestricted net position to a deficit situation.”

Stephen Duarte, fiscal services director for Kent County, said the change would not negatively impact Kent County’s 2015 end-of-year financial statements, which will be reported in summer of 2016.

“We are definitely remaining in the black,” Duarte said. “As it is right now, Kent County will be showing a surplus, an overfunding if you will, based on the new calculations. What that means is, rather than showing a liability, we will be showing an asset.”

Duarte said it’s important to note the numbers could change, particularly based on market fluctuations.

“It’s an annual type thing,” he said. “I wouldn’t expect it to disappear overnight, but I want you to understand it’s a pendulum that can swing both ways, but right now we are on the positive side of that pendulum.

“Right now … the fair value of the asset actually exceeds the valuation assets,” he said.

The reason is that Kent County uses what is called “a four-year smoothing effect” so that “the ups and downs of the market are stabilized.”

“So you don’t have such a change in valuation each and every year,” Duarte said. “Currently, our fair value is above the valuation assets because of the four-year smoothing effect.”

The city of Grand Rapids is also not too concerned with how the rule change will impact its financial statements.

“Our net position for governmental activities last year exceeds our current unfunded liability,” said Sara VanderWerff, city comptroller. “We aren’t anticipating that we are going to see an overall negative number.”

VanderWerff noted the city has two funds: the general retirement system, which she said has been closed to new hires; and the police and fire pension plan, which is currently almost fully funded.

“Looking at the projections right now, everything is going well. The unfunded liability is scheduled to decrease and we have closed the general plan, which has the larger of the two, but there are so many different factors that play into it,” she said.

One of the biggest factors is market fluctuation. VanderWerff said the market downturn was most likely a precursor to GASB 68.

“That was the biggest hit that we took during the financial downturn,” she said. “Everybody took a hit — anybody that had money invested; it was 40 percent across the board. If you were in a situation where you could just ride out the market, eventually for those of us that weren’t currently retired, you aren’t taking anything out so your loss is only on paper, and then for the most part, people recovered their 40 percent in the financial market.

“If you have a plan and you are obligated to pay out and the market is down, you run the risk of depletion if you are paying out faster than you can recover from a downturn.”

Although financial statements will show a greater liability following implementation of GASB 68, Watterworth and VanderWerff both said it’s unlikely a government entity’s bond rating will be negatively impacted.

“I wouldn’t anticipate this changing the bond rating,” VanderWerff said. “I think the rating agencies are already ahead of that game.”

Watterworth agreed.

“We’ve talked to Moody’s and Fitch and they’ve said because the information has been there, they have taken that into consideration in the past, so they don’t expect a significant change in the bond ratings. They’ve already taken that into consideration. They haven’t been limiting their reviews to just what’s on the balance sheet,” she said.

GASB 68 is really just a first step by the board in changing what is presented on the balance sheet.

“For retiree health care we are going to see the same thing happen in the next three to four years,” Watterworth said.

She said that liability would likely change the balance sheet even more drastically.

“For most units of government, that is a bigger number,” Watterworth said.

VanderWerff agreed, speaking in general terms.

“I could see that if there is more underfunding in those areas, then logically that would have a larger impact,” she said.

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