Issues Analysis Use of Appropriations

Prepared by Staff of the Public Sector Accounting Board September 2012 TABLE OF CONTENTS
PARAGRAPH

Introduction ......................................................................................................... Background ......................................................................................................... Need for new standard ..................................................................................... Section PS 3410, government transfers ...................................................... Issue is not significant................................................................................. Retaining discretion .................................................................................... Non-authoritative guidance......................................................................... Requiring departmental or ministerial financial statements ....................... Recognition in financial statements ............................................................. Reported in the statement of operations ..................................................... Not revenue that has been earned ............................................................... Not a benefit ................................................................................................ As a source of financing ............................................................................. Recognition of capital appropriations ......................................................... Section 3800, government assistance ......................................................... Not part of annual surplus or deficit ........................................................... Terminology......................................................................................................... Recognition prior to authorization ................................................................ Presentation in the statement of operations .............................................. Presentation in the statement of cash flow ................................................ Reconciliation to the original or adjusted appropriation ........................

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Introduction
.01 This issues analysis is a supporting document to the Public Sector Accounting Board (PSAB) Exposure Draft, Use of Appropriations. It provides information on how significant matters arising from comments received on the Statement of Principles, Use of Appropriations, have been dealt with in the Exposure Draft. The analysis has not been issued under the authority of PSAB. Prior to approving a final standard, the Board will review and deliberate responses submitted to the Exposure Draft.

Background
.02 The Statement of Principles was issued for comment in February 2012. PSAB received 17 responses. There were no responses from local governments and other government organizations (Crown corporations, government not-for-profit organizations). The definition of a government organization in the Introduction to Public Sector Accounting Standards was an issue for a number of respondents. It was argued that FINANCIAL STATEMENT CONCEPTS, Section PS 1000, does not extend to department and ministry financial statements. The issue of the definition of a government organization is beyond the scope of this project. It is being addressed in other projects. Several respondents suggested that this project be deferred until the completion of these other projects. PSAB is of the view that, given the current diverse reporting practices, development of this standard should proceed. The major issues raised by respondents included: (a) the need for a new standard; (b) recognition of the use of appropriations in financial statements; (c) reporting the use of appropriations in the statement of operations; (d) the timing of recognition of capital appropriations; (e) the need for clarification of terminology used in the proposed recognition criteria; (f) allowing recognition of the use of appropriations prior to authorization; (g) providing additional guidance on the presentation of the use of appropriations in the statement of operations; (h) the provision of guidance on how the use of appropriations would be presented in the statement of cash flow; and (i) reconciliation to the original or adjusted appropriation.

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Need for a new standard

.06 Those opposed to the development of a standard argued that: (a) GOVERNMENT TRANSFERS, Section PS 3410, provides sufficient guidance for accounting for the use of appropriations; (b) the issue of accounting for the use of appropriations is not significant as it affects only two senior governments;

(c) each jurisdiction should retain its discretion over how ministerial or departmental financial information is presented to ensure strong accountability and useful reporting for users: (d) proposals for accounting for the use of appropriations should not be in the form of authoritative guidance; and (e) issuing a standard could mean that all government departments and ministries in each jurisdiction would be required to prepare financial statements. .07 Section PS 3410, government transfers A number of respondents did not agree with issuing a separate standard outside Section PS 3410 arguing that a government's decision to centrally manage an entity's cash disbursement is a business decision that does not change the economic substance of the transaction. The respondents were concerned that having two separate standards (appropriations and transfers) for similar transactions will increase the risk of inconsistent financial reporting. They favoured using Section PS 3410. These respondents recognized the need for additional guidance relating to appropriations and proposed that Section PS 3410 could be amended to deal with specific disclosure requirements. They argued that the economic substance of appropriations is similar to government transfers and the proposed recognition criteria are consistent with Section PS 3410. This would ensure consistency of reporting regardless of whether appropriations are received in cash or managed through a consolidated revenue fund or its equivalent. It is the view of PSAB that appropriations received by an entity in the form of an actual transfer of monetary assets should be accounted for under Section PS 3410. PSAB is also of the view that a separate standard on the use of appropriations, other than those received by an entity in the form of an actual transfer of monetary assets, is required. In such cases, the authority to use appropriations does not meet the definition of government transfers in Section PS 3410. Guidance is needed, given the unusual circumstances that can arise, such as yearend lapsing. As well, users of financial statements require specific additional disclosures about the use of appropriations to help them assess whether resources and financial affairs were administered in accordance with legislative authorities. In the absence of a standard, public sector entities would be required to develop their own accounting policies in accordance with GENERALLY ACCEPTED ACCOUNTING PRINCIPLES, Section PS 1150, potentially creating inconsistencies. Issue is not significant Some respondents noted that this issue was not significant enough for PSAB to develop a standard. They commented that it was only two senior governments that needed such a standard. However, the respondents did not take into account that there are number of local governments and, potentially, government organizations

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that issue departmental financial statements. The issue is more pervasive than just the two senior governments. .13 In addition, the practices followed by those who do issue departmental or ministerial financial statements in accordance with the CICA Pubic Sector Accounting (PSA) Handbook vary significantly. The issue relates to whether appropriations should be included in the calculation of annual surplus or deficit. In some jurisdictions it is and in others it is not. The standard would provide consistency in reporting. Retaining discretion Some respondents were concerned that a standard would predetermine how a government would establish its accountability structure and financial reporting for accountability purposes. Generally, it was argued that each jurisdiction should have discretion over how it segments its activities, establishes accountability structures and reports on its various departments and ministries. PSAB agrees that a government should have flexibility over how it segments its activities, its accountability structure and whether its departments and ministries should issue financial statements. PSAB is of the view that when a government chooses to issue general purpose financial statements for accountability purposes, the financial statements should be prepared in accordance with an acceptable accounting framework Non-authoritative guidance Several respondents, while not supporting development of a standard, suggested that proposals should be in the form of non-authoritative guidance. This would provide guidance for those entities that wish to apply the proposals without imposing a standard on every entity that uses the PSA Handbook as their basis of accounting. Respondents with opposing views commented that many jurisdictions have legislation that requires certain core government departments or ministries to issue financial statements prepared in accordance with generally accepted accounting principles. There is a need for guidance on how to consistently account for the funding that is accessed under the authority of an appropriation. A standard to explain the nature of appropriations in the context of various legislative frameworks, recognition criteria and disclosure issues could be helpful. Non-authoritative guidance would not meet the needs of government organizations that prepare general purpose financial statements. A reporting entity is generally required to prepare financial statements that are in accordance with a financial reporting framework, audited, issued annually and available to all interested parties. The auditor must form an opinion on whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework. Non-authoritative guidance could not be used by an auditor as the basis upon which to form an opinion on the financial statements.

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Requiring departmental or ministerial financial statements Some respondents were concerned that if PSAB introduced this as a new standard on reporting the use of appropriations, governments would be compelled to issue financial statements for their departments and ministries. The PSA Handbook does not require any public sector entity to prepare and present general purpose financial statements. Similarly, the PSA Handbook does not discuss objectives of the applicable financial reporting framework for the preparation and presentation of special purpose financial statements or other financial reports published by an entity. PSAB is of the view that once the decision is made that a public sector entity should prepare general purpose financial statements, determining the most appropriate basis of accounting is a matter of judgment. The PSA Handbook only applies in those situations where a decision to issue general purpose financial statements has been made, at which point they should be prepared in accordance with the PSA Handbook.

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Recognition in financial statements

.22 The majority of respondents agreed that the use of appropriations should be recognized in financial statements. Those respondents disagreeing argued that an appropriation is simply the legislative authority to spend public money and not a transaction that should be recorded in financial statements. Appropriations can exist without ever being used in a transaction and generally expire if not used by year end. Several of these respondents may have interpreted the Statement of Principles as proposing recognition of an asset and revenue when an appropriation was approved rather than when an eligible transaction or event occurred. It was not PSABs intention that appropriations be recognized when the authority was put in place. Rather, the Exposure Draft clarifies that a reporting entity would recognize the use of appropriations when it has been authorized by an appropriation, supply act or other legislation and the entity has an eligible transaction or event, not before.

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Reported in the statement of operations

.25 The Statement of Principles analyzed eight alternatives for reporting appropriations using two broad approaches, namely the capital approach and the income approach. Based on the analysis, the Statement of Principles proposed the income approach and that the use of appropriations, either as an increase in assets or a decrease in liabilities, should be reported as revenue in the statement of operations. The recognition of the use of appropriations in the statement of operations would also be consistent with FINANCIAL STATEMENT OBJECTIVES, Section PS 1100. Financial statements show an entitys sources of revenues and the difference

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between revenues and expenses explains the change in net financial position in the period. .27 The majority of respondents agreed with the proposal in the Statement of Principles. Those respondents who did not agree argued as follows: (a) The use of appropriations does not meet the definition of revenue as it was not earned from operations or a result of the actions of the entity during the period. (b) Cash provided by the government under the authority of appropriations is not a benefit and should not be included in the statement of operations. The statement of operations depicts the operational and program activities of the entity. A comparison to budget is provided so that users can understand how well an entity has managed these resources. (c) The use of appropriations should be reflected as a source of financing in the statements of financial position and cash flows of the departments concerned. The use of appropriations represents allocation of resources by a government to finance the expenditure incurred by a department to provide services and goods and/or acquisition of tangible capital assets in accordance with the department's mandate. (d) Recognition of capital appropriations on the statement of operations is inappropriate since it results in a net surplus in year one followed by a series of deficits over several periods. The proposal would not provide information as to whether the entity is operating within the fiscal constraints imposed upon it. This reinforces the point that cash provided by the government under the authority of appropriations is not a benefit and should not be included in the statement of operations. (e) Under GOVERNMENT ASSISTANCE, Section 3800 in Part II of the CICA Handbook Accounting, government assistance received by an entity by virtue of the government's position as shareholder is credited to contributed surplus. The concept reflects the fact that the funding received is financing. (f) If the use of appropriations is not reported within net assets on the statement of financial position, it is best reflected on the statement of operations within the reconciliation of opening and closing accumulated surplus/deficit separately reporting current year surplus/deficit and net financing provided by the parent government. Not revenue that has been earned The definition of revenue is not restricted to those amounts that are earned. Revenues, including gains, can come from many sources such as government assistance. Similarly shared cost agreements, whether reimbursement or financing arrangements, result in recognition of the transfer in revenue by a recipient under Section PS 3410. Not a benefit Under existing standards, there are a number of instances when benefits not resulting from operational activities are recognized as revenue in the statement of

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operations. Consider a loan forgiven. There is clearly a benefit gained from having expenditures paid for by others that does not result from an entitys revenue generating capacity. As a source of financing PSAB is of the view that entities dependent on appropriations to fund their activities are unlikely, as their principle activity, to be able to maintain their operations and meet their obligations from revenues without ongoing assistance. The economic substance of appropriations is more in the nature of an income item similar to a government transfer. The benefits received from a transfer are typically for the reimbursement of certain eligible expenses incurred in the current or future periods or provide assistance toward the acquisition of fixed assets. Similarly, appropriations are intended to fund the activities of the entity. They are normally depleted as a result of activities of the public sector reporting entity. Recognition of capital appropriations Three respondents commented that recognition of capital appropriations on the statement of operations was inappropriate since it results in a net surplus in year one followed by a series of deficits over several periods as a result of amortization of the asset. Consequently, they argued that the financial statements would not provide information as to whether an entity was operating within the fiscal constraints imposed upon it by appropriations. One respondent commented that this reinforces the point that cash provided by the government under the authority of appropriations is not a benefit and should not be included in the statement of operations. The Statement of Principles considered the issues related to timing of revenue recognition from the use of capital appropriations and the impact that timing could have on annual surplus or deficit. Some entities that currently report the use of appropriations in the statement of operations generally defer the portion of a parliamentary appropriation used to finance the acquisition of tangible capital assets. These entities recognize revenue in the statement of operations on the same basis as the asset is amortized. On the other hand, entities that report the use of appropriations directly to accumulated surplus/deficit generally do not defer recognition. Deferral of revenue recognition is a similar issue that arose in developing the standard on government transfers. The Statement of Principles did not anticipate that the exercise of authority under an appropriation may similarly create an obligation that meets the definition of a liability. Providing presentation options may resolve the issue of recognizing capital appropriations, at least in the year of acquisition. It would not resolve the issue in subsequent years when amortization expense is recognized. The issue persists even under current reporting practices. The governing conditions in an appropriation may describe how related economic benefits must be used. Under existing standards, depending on their nature and

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extent, the governing conditions in the enabling legislation may create an obligation that meets the definition of a liability. If a liability is created, the governing conditions would define the terms of the liability and, thus, would be examined to determine the timing of revenue recognition. Depending on the circumstances and evidence used to support the initial recognition of a liability, the timing of revenue recognition would be as the related liability is settled. Section 3800, government assistance It is important to understand the context of Section 3800 when considering whether the standard could be analogized in developing a standard for reporting the use of appropriations in the PSA Handbook. It is based on the fact that some government business enterprises and similar organizations maintain their operations and meet their liabilities from revenues generated by selling goods and services. In these circumstances, the economic substance of government assistance may represent an investment that meets the definition of contributed surplus. Owners invest money in an organization to provide resources necessary for the organization to generate profits and provide a return on that investment. For organizations receiving government assistance, in the form of transfers or appropriations, these amounts are generally provided to assist in the funding of various transactions and events rather than providing an equity infusion. It is for these reasons that PSAB does not have an equity element. Any funding provided that is considered to be an equity item is generally provided to government business enterprises. These organizations follow international financial reporting standards and recognize equity inflows and outflows. However, other government organizations generally rely on government assistance to fund their operations. Without this funding, they would not be able to sustain their operations and meet their obligations. It is from this perspective that appropriations are treated as an income item. Not part of annual surplus or deficit Respondents said that the sources for funding allocated through appropriations may be from revenues that have already been recognized or from borrowings of the government. Therefore, use of appropriations should be reflected as a source of financing in net assets and cash flows of the departments concerned. If it is important that the financing is presented on the statement of operations, rather than within net assets on the statement of financial position, appropriations are best reflected within the reconciliation of opening and closing accumulated surplus/deficit. Given that PSAB has taken an income approach to accounting for the use of appropriations, it had considerable debate over whether the use of appropriations should be reported in the statement of operations or reported in accumulated surplus or deficit.

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In deliberating the issue, consideration has been given to the divergence of current reporting practices. Two senior governments have a longstanding practice of reporting the use of appropriations directly in net assets but not part of the accumulated surplus or deficit on the statement of financial position. Local government boards, commissions and agencies generally report the inflows as revenue in the statement of operations and part of the accumulated surplus or deficit. PSAB recognizes that taking an income approach may be different than some current practices that exclude appropriations from accumulated surplus or deficit. The Board is of the view that the use of appropriations was an income, not a capital, item and should be considered part of accumulated surplus or deficit. From the Boards perspective, the question became how to include appropriations in accumulated surplus or deficit. The Exposure Draft proposes that, for presentation purposes, the use of appropriations would be reported as part of accumulated surplus or deficit. It proposes two alternative approaches: (a) in the statement of operations when determining the operating surplus/deficit for the period; or (b) in the reconciliation to the closing accumulated operating surplus/deficit. PSAB recognizes that providing an option may result in inconsistent reporting of similar transactions such as transfers depending on whether the reporting entity is within or outside the scope of the standard.

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Terminology
.47 The Statement of Principles proposed that the use of appropriations should be recognized in the period in which an eligible expenditure/expense has been incurred that complies with the governing conditions under the legislation or equivalent authority. Respondents commented that the Statement of Principles used the terms expenditures and expenses in an almost interchangeable manner. It was suggested that the recognition criteria use a term such as eligible transaction. It was argued that this term may be more flexible and inclusive across the different jurisdictions, while also alleviating some of the potential confusion. The Exposure Draft proposes to use the term eligible transaction. This term is used as appropriations are the legal authority for a public sector entity to spend for operating, capital, financing or investing transactions or events.

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Recognition prior to authorization

.50 One respondent suggested that the standard should address cases in which the authority to spend is not in place at year end but is fully expected to be granted in the near future. It was argued that the standard should allow appropriations

revenue to be recognized provided there is a demonstrated historical practice of issuing the authority subsequent to year end. .51 The Statement of Principles proposed that the use of appropriations should be recognized in the period that the events giving rise to the revenue occurred, provided that the legislation or equivalent authority has been enacted and is in effect. This took into account that the legislation or practice of jurisdictions with regard to lapsing authority varied. The recognition criteria in the Exposure Draft would not allow an asset to be recognized for anticipated future appropriations. An anticipated future appropriation does not have the essential characteristics of an asset. The passing of legislation subsequent to the fiscal period end would not create an existing condition or situation at the financial statement date that would allow the recognition of an asset.

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Presentation in the statement of operations

.53 One respondent commented that the Section should provide additional guidance on the presentation of the use of appropriations on the statement of operations. Proposed guidance on presentation in the Statement of Principles was not intended to indicate preferred formats or to prescribe standardized presentation or note disclosure. The Statement of Principles proposed that preparers must determine the appropriate format, ordering or terminology tailored to their users needs. It also proposed that financial statements would separately disclose the amount. PSAB maintains that flexibility in reporting use of appropriations is important.

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Presentation in the statement of cash flow

.56 One respondent recommend that guidance explicitly address how appropriations managed through the consolidated revenue fund or the equivalent should be presentation on the statement of cash flow. A statement of cash flow is a required statement under FINANCIAL STATEMENT PRESENTATION, Section PS 1201. However, paragraph PS 1201.125 states that the exclusion of non-cash transactions related to capital, investing and financing activities from the statement of cash flow is consistent with the objective of a cash flow statement, as these items do not involve sources or uses of cash in the current period. .58 PSAB is of the view that a statement of cash flow is important because it reports how an entity financed its activities in the accounting period. It is important in assessing future resource requirements. Due to the fact that entities within the scope of this standard directly access funding under the authority of appropriations through a consolidated revenue fund or equivalent, the format of the cash flow statement may be modified to reflect the nature of the funding.

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Reconciliation to the original or adjusted appropriation

.59 One respondent commented that the Statement of Principles was not clear on whether the reconciliation was between actual amounts and the original or adjusted appropriations. Two respondents commented that the requirement in Section PS 1201 to present actual and budgeted results already allows for a comparison with appropriations originally authorized. The Statement of Principles proposed that financial statements should include a reconciliation of amounts recognized in the financial statements to the authorized appropriations. This was considered important accountability information that would help users assess whether the resources and financial affairs of the entity were administered in accordance with legislative authorities. The information is necessary because appropriations are generally prepared on a different basis of accounting than that adopted for the financial statements. As well, appropriations and budgets are commonly amended by legislatures and councils during a fiscal period to take into account unforeseen events and amounts are reallocated between programs. Section PS 1201 requires that planned results be presented for the same scope of activities and on a basis consistent with that used for actual results. Budget amounts presented in financial statements for comparison purposes may not achieve the objectives of this standard because they may be on a different basis of accounting than that used for appropriations. The Exposure Draft proposes that financial statements should disclose a reconciliation between the use of appropriations and the final amounts authorized. This disclosure is important accountability information that helps users assess whether the resources and financial affairs of the entity were administered in accordance with legislative authorities.

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