Question

Option #2: Governmental Reporting Entities

Instructions:

Provide complete answers to the following:

The Governmental Accounting Standards Board has established rules for determining when a government should include another entity in its financial statements.

Distinguish between a primary government and a component unit. Include one example of each.

GASB permits two methods of reporting component units in the financial reporting entity. Describe the two methods and indicate when each should be used.

The City of X is deciding whether or not to include a transit system in its financial report and how the transit system would be reported if a positive decision were made. The transit system is a legally separate entity, has its own governing board, not appointed by the city, has a different auditor, and issues its own financial report. The city has signed an agreement that, for the next ten years (the life of a bond issue related to transit operations), it will make up the deficit of the transit system. During the last two years, the deficit has been $10 million, approximately 50% of the amount reported as a profit of its other enterprise operations. Make recommendations to the city, including whether or not to include the transit system and, if so, how to report it.

Answer 1

Solution:-

a. Distinguish between a primary government and a component unit. Include one example of each:-

A primary government is a state or a general-purpose local government, such as a municipality or a county. It may also be a special purpose government that has a separately elected governing board, is legally separate, and is fiscally independent of other state or local governments. A component unit is a legally separate organization for which the elected officials of a primary government are financially accountable. In addition, a component unit can be another organization for which the nature and significance of its relationship with a primary government are such that exclusion would cause the reporting entity's financial statements to be misleading or incomplete.

An example of a primary government would be a city. An example of a component unit might be a library that is legally separate and has its own board but is financially dependent on the city.

b. GASB permits two methods of reporting component units in the financial reporting entity. Describe the two methods and indicate when each should be used:-

The two methods are blending and discrete presentation.

Blending is the reporting of a component unit in the government-wide financial statements as a part of the primary government. Blending is appropriate only when the component unit is “so intertwined with the primary government that they are in substance the same entity”.

Discrete presentation involves presenting financial information of the component in a separate column apart from the primary government and not included in the totals for the primary government. Discrete presentation is the most commonly used method.

c. The City of X is deciding whether or not to include a transit system in its financial report and how the transit system would be reported if a positive decision were made. The transit system is a legally separate entity, has its own governing board, not appointed by the city, has a different auditor, and issues its own financial report. The city has signed an agreement that, for the next ten years (the life of a bond issue related to transit operations), it will make up the deficit of the transit system. During the last two years, the deficit has been $10 million, approximately 50% of the amount reported as a profit of its other enterprise operations. Make recommendations to the city, including whether or not to include the transit system and, if so, how to report it:-

c) In this case, I would recommend that the transit system be incorporated as a component unit based on the idea that “exclusion would cause the reporting entity's financial statements to be misleading or incomplete.” The Statement of Activities would show the operating loss of the transit system and the transfer from the primary government to make up the deficit. I would report it discretely, not blended, as the transit system is generally separate.