Puzzling Pieces: Component Unit Identification, Classification, Disclosure, and Display.

• Author: Levine, Michele Mark
• Position: ACCOUNTING

Although the basic shape of the financial reporting entity for state and local governments has been around for nearly 30 years, the Governmental Accounting Standards Board (GASB) has made many incremental changes over time. Most recently, GASB Statements No. 84, Fiduciary Activities, No. 90, Majority Equity Interests, (1) and No. 97, Certain Component Unit Criteria, and Accounting and Financial Reporting for Internal Revenue Code Section 457 Deferred Compensation Plans (2) have introduced such changes. So, it is not terribly surprising that governments sometimes struggle to determine which entities should be included in a set of basic financial statements prepared in accordance with generally accepted accounting principles (GAAP), how they should be reported, and how both determinations should be explained.

Financial accountability

Basic financial statements are built around an organizing principle of the financial accountability of elected officials. The elected officials of one government are often financially accountable for both the government they were elected to lead and for one or more legally separate entities, so several legal entities together must be the subject of a set of basic financial statements. The "main" government, often a general purpose government such as a state, county, or municipality, is referred to as the primary government, (3) and those legally separate entities for which the primary government's elected officials are financially accountable, or for which exclusion would cause the primary government's financial statements to be misleading, (4) are called component units. (5) Together, a primary government and its component units, if any, compose a single financial reporting entity. (6)

In most cases, a component unit meets two criteria, one which can be thought of as a primary factor and the other as a secondary factor. The primary factors are either that (1) the primary government (mayor, governor, legislature) appoints a voting majority of the separate entity's governing board, referred to as board appointment; or (2) the primary government has substantive authority to make or approve key financial decisions for the separate entity, referred to as fiscal dependence.

Board appointment authority must be both:

* Substantive. The choice of appointees cannot be significantly limited, such as to those nominated by another government, organization, or outside individual. If the government's role is to confirm appointments made by another, the confirmation must be more than just a formality. (7)

* Ongoing. The choice of future appointees must remain that of the primary government, rather than, for example, the primary government just choosing the initial membership of a self-perpetuating board. Alternatively, the primary government may have the authority "to unilaterally abolish" the separate entity, giving the primary government ongoing authority over the entity even if the future board members are selected by another means.

Even appointing a majority of a governing board's members, however, might not be sufficient to make one government financially accountable for a separate legal entity--such as in the case where the primary government appoints 60 percent of the board members--but all financial decisions must be made by a 75 percent supermajority. Thus, the primary factor of board appointment must be accompanied by one of two secondary factors.

The secondary factors are either that (a) the primary government is able "to significantly influence the programs, projects, activities, or level of services performed or provided by" the separate entity, referred to as imposition of will, (8) or (b) the separate entity has the potential to provide specific financial benefits to, or impose specific financial burdens on, the primary government, referred to as a financial benefit or burden relationship. Generally, if the primary government has the ability to, at will, appoint and remove members of the separate entity's governing board or its management; to approve or modify the separate entity's budget, rates, or fees; or to overrule other decisions of the governing board, it has the ability to impose its will on that separate entity. A financial benefit or burden relationship exists when the primary government (1) can access the separate entity's resources, (2) is obligated to finance the deficits of the separate entity, (3) is somehow responsible for its debt, or (4) is obligated to make contributions to a defined benefit postemployment benefit plan, if one exists. (9)

Fiscal dependence, the second of the two primary factors, exists when the separate entity requires the primary government's substantive authority to, for example, approve the separate entity's budget, fees, or debt issuances, or if the primary...