Back to Square One: Six Questions About GASB’s Financial Reporting Model Project

When the Governmental Accounting Standards Board (GASB) met on June 27, 2023, it had already spent two years reworking the standards it proposed in a June 2020 Exposure Draft (ED), Financial Reporting Model Improvements, to address the public comments it received. According to the notice of meetings, the GASB planned to discuss the tentatively revised standards for governmental fund financial statements. Instead, after an hour of discussion, a majority of the GASB members had surprisingly voted to drop governmental funds from the project entirely. Given the potential implications of the GASB’s decision, numerous questions have surfaced. We’ve identified and answered six critical questions surrounding the GASB’s decision and the future direction of the project.¹

What is the financial reporting model and why is the GASB reexamining it?

The financial reporting model essentially is a detailed blueprint of the financial report required under generally accepted accounting principles (GAAP) for governments. Its foundation is Statement No. 34, Basic Financial Statements—and Management’s Discussion and Analysis—for State and Local Governments, which the GASB issued in 1999 and which governments implemented in the early 2000s. Statement 34 heralded revolutionary changes to government financial reports. Among its innovations were government-wide financial statements encompassing all the activities of a state or local government and reporting all of its assets (including capital assets and infrastructure, like bridges and underground water mains) and liabilities (including outstanding debt and other long-term amounts owed). It also required a narrative introduction to the financial statements—management’s discussion and analysis (MD&A)—and presentation of a government’s most prominent funds in separate columns.

Why is the GASB reexamining the reporting model?

Since 2017, when the GASB issues major Statements, it initiates a post-implementation review (PIR) to monitor governments as they apply the standards and to collect information about the cost and effort governments and other stakeholders incur related to implementation. Prior to PIR, when major standards had been in place for a number of years, the GASB would conduct reexamination research to evaluate:

1. 1. Whether the standards were functioning as expected.

1. 1. Whether any unexpected changes had occurred because of them.

1. 1. Whether the information they required was valuable to financial statement users.

1. 1. The costs and benefits of the standards.

The GASB directed the staff in 2013 to conduct reexamination research on the financial reporting model standards.² Over the next two years, the staff gathered input via roundtables, surveys, and interviews with more than 900 stakeholders from governments, accounting firms, legislative bodies, investment companies, academia, citizen groups, and more. The staff also examined the financial reports of 465 governments of various types and sizes, studied relevant academic and professional literature, and reviewed the comparable standards of other standards setters. The research concluded that the reporting model was performing well but that stakeholders had identified areas that could be significantly improved. Based on those findings, the GASB added a project to its technical agenda to reexamine and, if possible, improve upon several requirements. The project’s centerpiece was developing a replacement for the measurement focus and basis of accounting (MFBA) used in the governmental fund financial statements.

What did GASB think was wrong with the governmental funds?

A measurement focus tells a government what types of assets, liabilities, deferrals, revenues, and expenses should be reported in financial statements. The basis of accounting is the rules that tell a government when to report those items after a transaction or event has occurred. All financial statements except for those for the governmental funds (and the cash flows statement for the proprietary funds) are based on the economic resources measurement focus and accrual basis of accounting. As a result, they report all assets from cash to highways and all liabilities from payables to employee pensions. The governmental fund financial statements are prepared using the current financial resources measurement focus and modified accrual basis of accounting, resulting in a focus on short-term finances—assets that will be consumed or converted to cash mostly within a year and liabilities that are payable as of the end of the fiscal year. That short-term orientation is not itself problematic; financial statement users consider the information to be highly valuable, in part because of its similarity in some respects to budgetary information. However, the governmental funds MFBA were assembled piecemeal over many decades, and its core was a variety of policies and conventions that governments had followed in practice that were codified into standards before the GASB was created (i.e., at least 40 years ago). Consequently, the MFBA is inconsistent. For example, despite a focus on current financial resources, the governmental funds balance sheet includes some assets that are not current—such as loans receivable—or not financial—such as inventory. Some liabilities that would be considered current (due within a year) are not reported, such as claims and accrued interest on bonds and leases. The governmental funds’ equivalent of an income statement limits revenue to available amounts—collected during the year or shortly thereafter—and reports expenditures instead of expenses. It is unlikely that a person would end up with current financial resources and modified accrual if they were starting with a clean slate and the intention to create an MFBA that provides a short-term view of a government’s finances. The GASB set out to do just that.

What happened next?

Over the course of the next five years, the GASB issued three documents for public comment:

• • An Invitation to Comment (ITC) in 2016 that laid out the areas of improvement identified by stakeholders and potential improvements to those standards

• • A Preliminary Views (PV) in 2018 that, based on the feedback on the ITC, first proposed a short-term financial resources and accrual MFBA for the governmental funds

• • An ED of a proposed Statement in 2020 that retained the PV’s MFBA with improvements reflecting stakeholder input on the PV.

The stakeholder response to the three proposals was sizable: more than 400 comment letters, over 100 testifiers at 11 public hearings, and almost 80 participants at 7 user forums. The governmental funds MFBA received the lion’s share of their attention, providing the GASB with a vast number of often-contradictory opinions to consider. The GASB began to redeliberate the ED proposals in May 2021.

Why did the GASB decide to drop governmental funds from the project?

The project’s original objective was to craft a new MFBA for the governmental funds that was conceptually based, internally consistent, and responsive to the information needs of financial statement users. By the time of the ED, the GASB’s proposed MFBA already contained features that might have negatively affected conceptual consistency. There is a natural tension in standards setting between concepts and rules. Most people agree that accounting standards should accurately capture the economic substance of the transaction and result in information that maximizes relevance, reliability, understandability, comparability, consistency, and timeliness. Some people believe those standards should be conceptually based to adapt to the varying facts and circumstances of individual governments and changes over time in their operating environment and the transaction. Others believe those standards should be rules-based, providing guidance that is as specific as possible to minimize divergence in how governments apply the standards. GASB standards (and those of the FASB, IASB, FASAB, and other standards setters, for that matter) usually represent a compromise between concepts and rules. Where possible, the standards espouse broad principles that are rigid enough to maintain comparability and consistency—both crucial factors for financial statement users—but flexible enough to apply to governments of varying types, sizes, and circumstances. That is a difficult balance to achieve. The broadness of concepts raises questions about how they should be applied in specific situations. Answering such questions typically trades off the conceptual nature of the standards for more rules. Conceptually and rules-based standards both present challenges to governments and their auditors*. As noted, concepts don’t tend to answer questions about specific circumstances. Rules answer those questions but, in trying to anticipate multiple possible circumstances, can become complicated and complex—and, therefore, more difficult and costly for governments and auditors to follow. In June 2023, after two years of making further adjustments to the MFBA to address stakeholder concerns and struggling to accommodate their disparate views, the project had reached a point that, in the view of the six Board members who voted to drop governmental funds, had become too complicated and strayed too far from the objective of conceptual consistency. Although they believe the benefits of the proposed MFBA would be significant, they deemed the costs of compliance no longer would justify those benefits. One of the GASB’s most important guiding principles is, “To establish standards only when the expected benefits justify the perceived costs.”

What will happen with the project now?

According to its August 2023 technical plan, the GASB is proceeding with the other proposals from ED, all of which have been reviewed based on stakeholder feedback. Those proposals include improvements to the standards for:

• • MD&A

• • Unusual or infrequent items (called special and extraordinary items at present)

• • Structure of the proprietary fund financial statements

• • Definitions of operating and nonoperating

• • Reporting major component units in financial statements, and

• • Presenting budgetary comparisons as required supplementary information.

The technical plan says the Board will review a final draft and consider issuing a Statement at its April 16–18, 2024 meeting. When the Board voted in June to drop governmental funds from the project, it briefly discussed the possibility of making some “tweaks” to the existing MFBA in a separate project. The August technical plan did not include such a project, so it is unclear what form it will take, what aspects of the MFBA it might tweak, or when a proposed Statement will be published for public comment. The GASB is expected to discuss the next iteration of its technical plan, for the first four months of 2024, at its December 12–14, 2023, meeting. In the meantime, please contact your CRI advisor for any questions regarding GASB or its forthcoming plans and projects. ¹ Note: The author was on the staff of the GASB through June 2022 and supervised the research described in this article. He was not, however, on the team for the Financial Reporting Model project. ² In addition to Statement 34, the reporting model standards include several other important pronouncements, including Interpretation 6 and Statements 35, 37, 41, and 46.