Putting the pieces together: revised criteria for defining the financial reporting entity.

• Author: Shoulders, Craig D.

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The Governmental Accounting Standards Board (GASB) recently issued an exposure draft (ED), The Financial Reporting Entity, an amendment of GASB Statements No. 14 and No. 34, to modify the definition of the financial reporting entity and the most critical subset of the financial reporting entity--the blended entity or primary government.

In launching this project, the GASB waded into one of the most controversial, critical, and complex financial reporting standards-setting issues of the past 30 years. In that time, government standards-setting bodies have engaged in a total of six reporting entity-related projects, with at least one active project during almost the entire three decades. This record testifies to the complexity and controversy surrounding this issue. But most of all, it indicates the critical importance of properly identifying and incorporating the organizations to be included in a government's financial report.

One constant has remained throughout the evolution of the reporting entity standards over time--indeed, even before the National Council on Governmental Accounting (NCGA) adopted the first reporting entity standards in 1981. The focal entity of government financial reports always has been what is often referred to as the "blended entity." The blended entity has been known by other names as well over these 30 years, including: m Reporting entity (or just the government entity)--prior to the first reporting entity standards.

* Reporting entity--in NCGA Statement 3, Defining the Governmental Reporting Entity, and related NCGA pronouncements.

* Primary government or in substance primary government-in GASB Statement No. 14, The Financial Reporting Entity, and subsequent GASB documents.

* Proper definition of the focal entity--identified by both the GASB and its predecessors as the blended entity or primary government--is a prerequisite to fair presentation of a government's financial information. Therefore, the most critical modifications proposed in the ED are the changes to the blended entity or primary government. These changes are addressed first because of their importance--followed by proposed changes in the broader reporting entity definition. (The ED also proposes non-definitional changes that are not discussed in this article, such as improved reporting entity note disclosures.)

BLENDED ENTITY: PROPOSED CHANGES

The GASB proposes two changes to the definition of the blended entity:

* First, a primary government is to blend a component unit based only on its having substantively the same governing body as the primary government, if the primary government also has either (1) a financial benefit or burden relationship with or (2) organizational responsibility for the component unit.

* Second, the GASB proposes to add a new basis for blending. A government is to blend a component unit if the component unit's "total debt outstanding, including leases, is expected to be repaid entirely or almost entirely with the resources of the primary government," according to the ED. We will refer to this as the "total debt repayment responsibility" criterion.

The ED does not contain additional guidance on the other blending criteria. This is somewhat surprising because misinterpretation of the "benefits or serves only the primary government" criterion has resulted in some states erroneously blending their lotteries and some local governments erroneously blending economic development authorities.

The potential effects and implications of the proposed changes on the blended primary government entity are important to understand. They are summarized in Exhibit 1.

BLENDED ENTITY: IMPLICATIONS OF THE CHANGES

Requiring a potential financial benefit or burden relationship or organizational responsibility in addition to substantively the same governing body for a component unit to be blended will eliminate some currently blended component units from the blended entity (i.e., from the primary government). Indeed, it cannot result in additional blended component units, so the only possible impact of this change on any government's blended entity is to reduce it or leave it unchanged.

The ED does not change the definition of financial benefit or burden relationships. As defined in the ED, organizational responsibility means that a government's management below the level of the governing body (e.g., the city manager) manages and oversees the component unit in essentially the same manner as the departments and agencies of the government's legal entity.

Significantly, the ED's basis for conclusions provides a clear signal that the GASB believes a government's blended entity should be as close to the legal entity as possible. The ED gives the following reasons for adding the additional criteria, of which the financial benefit or burden relationships should be the easiest to meet:

* "Not to obscure the financial data of the primary government's legal entity"--the rationale for adding the "financial benefit or burden" criterion.

* "The blending principle is based on the notion that the component unit functions much like a fund or department of the primary government" m the logic for adding the "organizational responsibility" criterion.

The "organizational responsibility" criterion may be largely redundant, given that substantively the same governing body is defined in GASB Statement No. 14 to mean "sufficient representation of the primary government's entire governing body on the component unit's governing body to allow complete control of the component unit's activities." This logic largely overlaps that for the "organizational responsibility" criterion. While these additional criteria for blending appear likely to have a limited effect on the definition of the...