August 20, 2002

TO: CITIZENS’ FINANCIAL ADVISORY COMMITTEE

FROM: JUDY SMITH, ASSISTANT CITY MANAGER

SUBJECT: GASB 34 – NEW FINANCIAL REPORTING MODEL FOR GOVERNMENTAL ENTITIES

Every year, an outside auditing firm examines the City’s financial records. After the audit, the City prepares a Comprehensive Annual Financial Report (CAFR). This report is prepared in conformance with standards established by the Governmental Accounting Standards Board (GASB). Our report has won the Government Finance Officers Association (GFOA) national award given for excellence in financial reporting for 11 consecutive years.

In June 1999, GASB released requirements for a new governmental financial reporting model known as GASB Statement No. 34. The purpose of the new model is to incorporate important business financial components to governmental financial reporting. Financial reporting between business and government differ in several areas. The new reporting model is intended to eliminate some of these differences, as highlighted below:

• Fund Accounting – Businesses prepare financial reports as single financial entity, while government reporting is focused on funds. Governments prepare "combined" financial statements rather than consolidated (single entity). The new model will require consolidated, government-wide financial statements in addition to the fund-based reporting. The required government-wide reports include a Statement of Net Assets and Statement of Activities (by function, e.g.: general government, public safety, public works). Examples of these are attached.

• Budgetary reporting – While a budget in a business represents a financial plan; a government entity budget is a "legal" document, representing the authority for appropriations as approved by the governing body. Government financial reporting focuses on demonstrating compliance with budgets (budget to actual comparison). Under the new model, budget comparisons will be "required supplemental information" following the notes to financial statements, rather than a basic financial statement in its own right.

• Measurement focus and basis of accounting – For governmental funds (general and special revenue funds), the measurement focus is on changes in current financial (expendable) resources. Modified accrual is used as the basis of accounting. This type of reporting emphasizes a near-term financial focus typical of a government’s operating budget. Business financial reporting focuses on changes in economic resources (changes in net assets) and as such, the accrual basis of accounting is used. The new reporting model will require additional information – including converting data of governmental activities from current financial resources measurement to the economic resources measurement and accrual basis of accounting. The most important component of this change will be reporting of general infrastructure assets (streets, storm drains, sewers) and the depreciation or maintenance of capital assets. This information will be included in the two reports noted above – Statement of Net Assets and Statement of Activities.

The reporting of general infrastructure assets is the item relevant to this Committee’s discussion. While we have previously reported the value of capital assets (land, buildings, machinery, equipment), these items were not depreciated. Until now, cities never had to report the value of infrastructure assets. There are two issues associated with this requirement – 1.) Determining a value for the infrastructure assets and 2.) depreciation of the infrastructure assets.

We are in the process of determining the asset values (replacement cost) and the value of accumulated depreciation. In the financial report, capital assets are reported net of accumulated depreciation and depreciation expense is reported as part of the total expense shown in the Statement of Activities. Details on depreciation costs are only shown in the Notes to the Financial Statements (example attached). Land and land improvements are not depreciated.

Implementation of GASB 34 is phased, based on a jurisdiction’s total revenue. Palos Verdes Estates must implement the new model for financial reports ending June 30, 2003. That means our current fiscal year (2002-03) audit report will be in the form required by GASB 34.