Governmental Accounting Standards Series

NO. 32 JANUARY 29, 2010 Governmental Accounting Standards Series EXPOSURE DRAFT Proposed Statement of the Governmental Accounting Standards Board Codification of Accounting and Financial Reporting Guidance Contained in Pre-November 30, 1989 FASB and AICPA Pronouncements This Exposure Draft of a proposed Statement of Governmental Accounting Standards is issued by the Board for public comment. Written comments should be addressed to: Director of Research and Technical Activities Project No. 32 Comment Deadline: July 31, 2010 Governmental Accounting Standards Board of the Financial Accounting Foundation

CODIFICATION OF ACCOUNTING AND FINANCIAL REPORTING GUIDANCE CONTAINED IN PRE-NOVEMBER 30, 1989 FASB AND AICPA PRONOUNCEMENTS REQUEST FOR WRITTEN COMMENTS Deadline for submitting written comments: July 31, 2010 Requirements for written comments. Comments should be addressed to the Director of Research and Technical Activities, Project No. 32, and emailed to director@gasb.org or mailed to the address below. OTHER INFORMATION Public hearing. The Board has not scheduled a public hearing on the issues addressed in this Exposure Draft. Public files. Written comments will become part of the Board s public file and will be available for inspection at the Board s offices. Copies may be obtained for a specified charge. Orders. Any individual or organization may obtain one copy of this Exposure Draft on request without charge until July 31, 2010, by writing or phoning the GASB Order Department. For information on prices for additional copies and copies requested after July 31, please contact the Order Department. The Exposure Draft also may be downloaded from the GASB s website at www.gasb.org/exp. Governmental Accounting Standards Board 401 Merritt 7 PO Box 5116 Norwalk, CT 06856-5116 Telephone Orders: 1-800-748-0659 Please ask for our Product Code No. GE74. GASB publications also may be ordered at www.gasb.org. Copyright 2010 by Financial Accounting Foundation. All rights reserved. Permission is granted to make copies of this work provided that such copies are for personal or intraorganizational use only and are not sold or disseminated and provided further that each copy bears the following credit line: Copyright 2010 by Financial Accounting Foundation. All rights reserved. Used by permission. i

Notice to Recipients of This Exposure Draft The Governmental Accounting Standards Board (GASB) is responsible for developing standards of state and local governmental accounting and financial reporting that will (1) result in useful information for users of financial reports and (2) guide and educate the public, including issuers, auditors, and users of those financial reports. The due process procedures that we follow before issuing our standards are designed to encourage broad public participation in the standards-setting process. As part of that due process, we are issuing this Exposure Draft setting forth a proposed Statement that would directly incorporate into the GASB s authoritative literature accounting and financial reporting requirements applicable to state and local government financial statements that currently reside in the following pronouncements issued on or before November 30, 1989, which do not conflict with or contradict GASB pronouncements (Financial Accounting Standards Board [FASB] and American Institute of Certified Public Accountants [AICPA] pronouncements): 1. FASB Statements and Interpretations 2. Accounting Principles Board Opinions 3. Accounting Research Bulletins of the AICPA s Committee on Accounting Procedure. The proposed Statement also would supersede Statement No. 20, Accounting and Financial Reporting for Proprietary Funds and Other Governmental Entities That Use Proprietary Fund Accounting. Appendices C E are included to assist you in comparing the standards of this proposed Statement to the standards in the FASB and AICPA pronouncements. Appendix C includes the status (that, is superseded, not applicable to governments, rarely applicable, applicable, or conflicts/contradicts GASB pronouncements) of all the FASB and AICPA pronouncements. Appendix D includes the text of the FASB and AICPA pronouncements that are applicable to governments in markup form to identify the modifcations proposed for incorporation into the GASB literature. Appendix E provides a list of all the paragraphs of the standards section of this proposed Statement with references to the provisions of the FASB and AICPA pronouncements from which they were derived. The information provided in these appendices identifies FASB and AICPA pronouncements that we have excluded, either in full or in part, from the proposed Statement on the basis that the requirements conflict with or contradict GASB pronouncements or the requirements rarely apply to state and local governments. We invite your comments on all matters in this proposed Statement. Because this proposed Statement may be modified before it is released as a final Statement, it is important that you comment on any aspects with which you agree as well as any with which you disagree. We would especially appreciate any comments that you may have regarding the following: ii

a. Whether you believe specific accounting and financial reporting requirements from the FASB and AICPA pronouncements are appropriately excluded b. Specific accounting and financial reporting requirements from the FASB and AICPA pronouncements that we have included in the proposed Statement that you believe conflict with or contradict GASB pronouncements and should, therefore, be excluded from the proposed Statement c. Specific accounting and financial reporting requirements from the FASB and AICPA pronouncements that we have excluded from the proposed Statement on the basis that the requirements rarely apply to state and local governments or the requirements conflict with or contradict GASB pronouncements that you believe should be included in the proposed Statement. To facilitate our analysis of comment letters, it would be helpful if you explain the reasons for your views, including alternatives that you believe we should consider. All responses are distributed to the Board and to staff members assigned to this project, and all comments are considered during the Board s deliberations leading to a final Statement. When the Board is satisfied that all alternatives have adequately been considered and modifications, if any, have been made, a vote is taken on the Statement. A majority vote is required for adoption. iii

Summary The objective of this proposed Statement is to incorporate into the GASB s authoritative literature certain accounting and financial reporting guidance that is included in the following pronouncements issued on or before November 30, 1989, which does not conflict with or contradict GASB pronouncements: 1. Financial Accounting Standards Board (FASB) Statements and Interpretations 2. Accounting Principles Board Opinions 3. Accounting Research Bulletins of the American Institute of Certified Public Accountants (AICPA) Committee on Accounting Procedure. Hereinafter, these pronouncements collectively are referred to as the FASB and AICPA pronouncements. This proposed Statement also would supersede Statement No. 20, Accounting and Financial Reporting for Proprietary Funds and Other Governmental Entities That Use Proprietary Fund Accounting. Organization of This Statement The provisions of this proposed Statement are organized by topic. Each topic contains provisions derived from FASB and AICPA pronouncements that address the subject matter. The order in which the topics are presented corresponds to the order of the primary locations within the GASB Codification of Governmental Accounting and Financial Reporting Standards where the topics will be codified. How the Changes in This Proposed Statement Would Improve Financial Reporting The requirements in this proposed Statement would improve financial reporting by contributing to the GASB s efforts to codify all sources of generally accepted accounting principles for state and local governments so that they derive from a single source. This effort brings the authoritative accounting and financial reporting literature together in one place, with that guidance modified as necessary to appropriately recognize the governmental environment and the needs of governmental financial statement users. It would eliminate the need for financial statement preparers and auditors to determine which FASB and AICPA pronouncement provisions apply to state and local governments, thereby resulting in a more consistent application of applicable guidance in financial statements of state and local governments. In addition, all FASB and AICPA pronouncements became nonauthoritative literature for the private sector on July 1, 2009, the effective date of the FASB Accounting Standards Codification. Although certain FASB and AICPA pronouncements are still available in the archive section of the FASB s Codification on a limited basis, this proposed Statement would make accessible in the GASB s authoritative literature all applicable accounting and financial reporting guidance previously residing only in the FASB and AICPA pronouncements. iv

Unless otherwise specified, pronouncements of the GASB apply to financial reports of all state and local governmental entities, including general purpose governments; public benefit corporations and authorities; public employee retirement systems; and public utilities, hospitals and other healthcare providers, and colleges and universities. Paragraph 3 discusses the applicability of this Statement. v

Proposed Statement of the Governmental Accounting Standards Board Codification of Accounting and Financial Reporting Guidance Contained in Pre-November 30, 1989 FASB and AICPA Pronouncements January 29, 2010 CONTENTS Paragraph Numbers Introduction... 1 2 Standards of Governmental Accounting and Financial Reporting... 3 503 Scope and Applicability of This Statement... 3 4 Capitalization of Interest Cost... 5 22 Assets Qualifying for Interest Capitalization... 8 10 The Amount of Interest Cost to Be Capitalized... 11 15 The Capitalization Period... 16 18 Capitalization of Interest Cost in Situations Involving Certain Tax-Exempt Borrowings and Certain Gifts and Grants... 19 20 Disposition of the Amount Capitalized... 21 Disclosures... 22 Revenue Recognition for Exchange Transactions... 23 Revenue Recognition When Right of Return Exists... 24 28 Criteria for Recognizing Revenue When Right of Return Exists... 26 28 Statement of Net Assets Classification... 29 44 Current Assets... 30 32 Classification and Disclosure of Allowances... 33 Current Liabilities... 34 35 Classification of Short-Term Obligations Expected to Be Refinanced... 36 44 Classification... 37 38 Ability to Consummate the Refinancing... 39 43 Disclosure of Short-Term Obligations... 44 Special and Extraordinary Items... 45 50 Adjustment of Amounts Reported in Prior Periods... 50 Comparative Financial Statements... 51 53 Related Parties... 54 57 Disclosures... 55 56 Glossary... 57 Prior-Period Adjustments... 58 62 Disclosure of Prior-Period Adjustments and Restatements of Reported Changes in Net Assets... 62 vi

Paragraph Numbers Accounting Changes and Error Corrections... 63 89 Types of Accounting Changes... 65 75 Change in Accounting Principle... 66 68 Change in Accounting Estimate... 69 70 Change in the Reporting Entity... 71 Correction of an Error in Previously Issued Financial Statements... 72 Justification for a Change in Accounting Principle... 73 74 General Disclosure A Change in Accounting Principle... 75 Reporting a Change in Accounting Principle... 76 82 Cumulative Effect of a Change in Accounting Principle... 78 Pro Forma Effects of Retroactive Application... 79 Pro Forma Amounts Not Determinable... 80 Cumulative Effect Not Determinable... 81 Reporting Accounting Changes under Other Pronouncements... 82 Reporting a Change in Accounting Estimate... 83 85 Disclosure... 85 Reporting a Change in the Entity... 86 87 Disclosure... 87 Reporting a Correction of an Error in Previously Issued Financial Statements... 88 89 Disclosure... 89 Disclosure of Accounting Policies... 90 95 Content... 93 94 Disclosure of Depreciation... 95 Contingencies... 96 116 Probability Classifications for Loss Contingencies... 100 Accrual of Loss Contingencies... 101 108 Disclosure of Loss Contingencies... 109 113 General or Unspecified Operations Risks... 114 Gain Contingencies... 115 Other Disclosures... 116 Construction-Type Contracts Long-Term... 117 126 Generally Accepted Methods... 119 126 Selection of Method... 119 Percentage-of-Completion Method... 120 122 Completed-Contract Method... 123 126 Extinguishments of Debt... 127 130 Circumstances for an Extinguishment of Debt... 128 Accounting for Extinguishment of Debt... 129 Glossary... 130 Troubled Debt Restructuring... 131 167 Accounting by Debtors... 139 151 Transfer of Assets in Full Settlement... 140 141 vii

Paragraph Numbers Troubled Debt Restructuring (continued) Modification of Terms... 142 144 Combination of Types... 145 Related Matters... 146 149 Disclosure by Debtors... 150 151 Accounting by Creditors... 152 167 Receipt of Assets in Full Satisfaction... 153 154 Modification of Terms... 155 157 Combination of Types... 158 Related Matters... 159 164 Disclosure by Creditors... 165 166 Substitution or Addition of Debtors... 167 Foreign Currency Transactions... 168 175 Exchange Rates... 171 172 Disclosure... 173 174 Glossary... 175 Interest Costs Imputation... 176 190 Note Exchanged for Cash... 179 180 Unstated Rights or Privileges... 181 Note Exchanged for Property, Goods, or Services... 182 183 Determining Present Value... 184 185 Determining an Appropriate Interest Rate... 186 187 Amortization of Discount and Premium... 188 189 Statement Presentation of Discount and Premium... 190 Inventory... 191 204 Definition of Inventory... 192 193 Accounting for Inventories... 194 203 Cost Basis... 194 196 Lower of Cost or Market Basis... 197 201 Stating Inventories above Cost... 202 Net Losses on Firm Purchase Commitments... 203 Disclosure... 204 Investments in Common Stock... 205 213 Criteria for Applying the Equity Method... 208 211 Applying the Equity Method... 212 Disclosures... 213 Leases... 214 274 Classification of Leases... 215 Criteria for Classifying Leases (Other Than Leveraged Leases)... 216 218 Accounting and Reporting by Lessees... 219 226 Capital Leases... 219 224 Operating Leases... 225 viii

Paragraph Numbers Leases (continued) Disclosures... 226 Accounting and Reporting by Lessors... 227 234 Sales-Type Leases... 227 228 Direct Financing Leases... 229 Operating Leases... 230 Participation by Third Parties... 231 233 Disclosures... 234 Leases Involving Real Estate... 235 241 Leases Involving Land Only... 236 Leases Involving Land and Building(s)... 237 Leases Involving Equipment as Well as Real Estate... 238 Leases Involving Only Part of a Building... 239 241 Leases between Related Parties... 242 243 Sale-Leaseback Transactions... 244 246 Sale-Leaseback Transactions Involving Real Estate... 247 259 Criteria for Sale-Leaseback Accounting... 248 249 Terms of the Sale-Leaseback Transaction... 250 Continuing Involvement... 251 254 Sale-Leaseback Transactions by Regulated Enterprises... 255 257 Financial Statement Presentation and Disclosure... 258 259 Accounting and Reporting for Subleases and Similar Transactions... 260 266 Accounting by the Original Lessor... 261 262 Accounting by the Original Lessee... 263 265 Accounting by the New Lessee... 266 Accounting and Reporting for Leveraged Leases... 267 273 Disclosures... 273 Glossary... 274 Nonmonetary Transactions... 275 284 Basic Principle... 277 Modifications of the Basic Principle... 278 280 Fair Value Not Determinable... 278 Exchanges... 279 280 Applying the Basic Principle... 281 282 Disclosure... 283 Glossary... 284 Sales of Real Estate... 285 352 Real Estate Sales Other Than Retail Land Sales... 287 326 Recognition of Gain by the Full Accrual Method... 287 289 Consummation of a Sale... 290 Buyer s Initial and Continuing Investment... 291 296 Release Provisions... 297 300 Future Subordination... 301 ix

Paragraph Numbers Sales of Real Estate (continued)... 285 352 Continuing Involvement without Transfer of Risks and Rewards... 302 Recognition of Gain When the Full Accrual Method Is Not Appropriate... 303 Sale Not Consummated... 304 305 Initial or Continuing Investments Do Not Qualify... 306 307 Receivable Subject to Future Subordination... 308 Continuing Involvement without Transfer of Risks and Rewards... 309 326 Retail Land Sales... 327 333 Recognition of Gain... 328 331 Change from Installment to Percentage-of-Completion Method... 332 Disclosures... 333 Description of Certain Methods of Accounting for Real Estate Sales Transactions... 334 352 Installment Method... 335 340 Cost Recovery Method... 341 343 Deposit Method... 344 346 Reduced Gain Method... 347 Full Accrual Method Retail Land Sales... 348 Percentage-of-Completion Method Retail Land Sales... 349 352 Costs and Initial Rental Operations of Real Estate Projects... 353 376 Acquisition, Development, and Construction Costs... 356 367 Preacquisition Costs... 356 357 Insurance... 358 Project Costs... 359 Amenities... 360 361 Incidental Operations... 362 Allocation of Capitalized Costs to the Components of a Real Estate Project... 363 Revisions of Estimates... 364 Donations and Changes in Use... 365 367 Costs Incurred to Sell and Rent Real Estate Projects, Including Initial Rental Operations... 368 374 Costs Incurred to Sell Real Estate Projects... 368 370 Costs Incurred to Rent Real Estate Projects... 371 372 Initial Rental Operations... 373 374 Recoverability... 375 Glossary... 376 Research and Development Arrangements... 377 387 Accounting and Reporting... 378 Obligation Is a Liability to Repay the Other Parties... 379 383 Obligation Is to Perform Contractual Services... 384 385 Loan or Advance to the Other Parties... 386 x

Paragraph Numbers Research and Development Arrangements (continued) Disclosure... 387 Broadcasters... 388 391 License Agreements for Program Material... 389 Financial Statement Presentation... 389 Barter Transactions... 390 Glossary... 391 Cable Television Systems... 392 402 Prematurity Period... 393 398 Depreciation of Capitalized Costs... 399 Hookup Revenue and Costs... 400 401 Glossary... 402 Insurance Enterprises... 403 433 General Principles... 404 407 Premium Revenue Recognition... 408 409 Claim Cost Recognition... 410 413 Costs Other Than Those Relating to Claims... 414 Acquisition Costs... 415 417 Premium Deficiency... 418 420 Reinsurance... 421 423 Policyholder Dividends... 424 425 Retrospective and Contingent Commission Arrangements... 426 Investments... 427 430 Real Estate Used in Operations... 431 Disclosures... 432 Glossary... 433 Lending Activities... 434 454 General... 436 Loan Origination Fees and Costs... 437 439 Commitment Fees and Costs... 440 441 Fees and Costs in Refinancings or Restructurings... 442 444 Purchase of a Loan or Group of Loans... 445 446 Other... 447 Application of the Interest Method and Other Amortization Matters... 448 450 Statement of Net Assets Classification... 451 Flows Statement Classification... 452 Application to Leasing Activities... 453 Glossary... 454 Mortgage Banking Activities... 455 478 Mortgage Loans... 456 462 Servicing Fees... 463 Costs of Issuing Certain GNMA Securities... 464 Servicing Rights... 465 468 Loan and Commitment Fees... 469 xi

Paragraph Numbers Mortgage Banking Activities (continued) Loan Origination Fees and Costs... 470 Fees for Services Rendered... 471 Fees Relating to Loans Held for Sale... 472 473 Fees Relating to Loans Not Held for Sale... 474 Expired Commitments and Prepayments of Loans... 475 Disclosures... 476 477 Glossary... 478 Regulated Operations... 479 503 General Standards of Accounting for the Effects of Regulation... 483 486 Specific Standards Derived from the General Standards... 487 495 Allowance for Resources Used during Construction... 488 Intra-Entity Profit... 489 490 Accounting for Impairments of Regulatory Assets... 491 494 Disallowances of Costs of Recently Completed Plants... 495 Other Disclosure... 496 497 Refunds... 496 Recovery without Return on Investment... 497 Discontinuation of Accounting for the Effects of Certain Types of Regulation... 498 503 Accounting and Reporting When the Criteria for Regulated Operations Are No Longer Met... 500 Accounting to Reflect the Discontinuation of Accounting for the Effects of Certain Types of Regulation... 501 502 Disclosure... 503 Effective Date and Transition... 504 Appendix A: Background... 505 513 Appendix B: Basis for Conclusions... 514 594 Appendix C: Status of FASB and AICPA Original Pronouncements... 595 601 Appendix D: Markup of FASB and AICPA Original Pronouncements... 602 612 Appendix E: Finding List of Incorporated FASB and AICPA Original Pronouncements... 613 Appendix F: Codification Instructions... 614 xii

Proposed Statement of the Governmental Accounting Standards Board Codification of Accounting and Financial Reporting Guidance Contained in Pre-November 30, 1989 FASB and AICPA Pronouncements January 29, 2010 INTRODUCTION 1. Statement No. 34, Basic Financial Statements and Management s Discussion and Analysis for State and Local Governments, paragraph 17 provides that reporting for governmental and business-type activities should be based on all applicable GASB pronouncements as well as the Financial Accounting Standards Board (FASB) Statements and Interpretations, Accounting Principles Board (APB) Opinions, and Accounting Research Bulletins of the American Institute of Certified Public Accountants (AICPA) Committee on Accounting Procedure, issued on or before November 30, 1989 (collectively, the FASB and AICPA pronouncements ), unless those pronouncements conflict with or contradict GASB pronouncements. The primary objective of this Statement is to directly incorporate the applicable guidance from those FASB and AICPA pronouncements into the state and local government accounting and financial reporting standards. 2. Statement No. 20, Accounting and Financial Reporting for Proprietary Funds and Other Governmental Entities That Use Proprietary Fund Accounting, as amended by Statement 34, provides guidance for business-type activities regarding the applicability of FASB and AICPA pronouncements, including FASB pronouncements issued after November 30, 1989. An objective of this Statement also is to address the status of Statement 20. STANDARDS OF GOVERNMENTAL ACCOUNTING AND FINANCIAL REPORTING Scope and Applicability of This Statement 3. This Statement establishes accounting and financial reporting standards for the financial statements of state and local governments. The requirements of this Statement apply to accounting and financial reporting for governmental activities, business-type activities, and proprietary funds, except that: a. Paragraphs 5 22 pertaining to the capitalization of interest costs only apply to interest costs reported for business-type activities and enterprise funds 1

b. Paragraphs 45 50 pertaining to special and extraordinary items also apply to governmental funds, subject to the accounting and financial reporting distinctions of governmental funds c. Paragraphs 54 57 pertaining to related parties also apply to governmental funds, subject to the accounting and financial reporting distinctions of governmental funds d. Paragraphs 96 116 pertaining to accounting for contingencies also apply to governmental funds, subject to the accounting and financial reporting distinctions of governmental funds e. Paragraphs 191 204 pertaining to inventory apply only to business-type activities and proprietary funds f. Paragraphs 214 274 pertaining to accounting for leases also apply to governmental funds, subject to the accounting and financial reporting distinctions of governmental funds g. Paragraphs 479 503 pertaining to regulated operations apply only to certain business-type activities that meet the criteria in paragraph 479. 4. This Statement supersedes Statement 20; NCGA Statement 1, Governmental Accounting and Financial Reporting Principles, footnote 7; Statement No. 10, Accounting and Financial Reporting for Risk Financing and Related Insurance Issues, footnote 7; Statement No. 31, Accounting and Financial Reporting for Certain Investments and for External Investment Pools, footnote 6; Statement No. 33, Accounting and Financial Reporting for Nonexchange Transactions, footnote 7; Statement 34, paragraphs 17, 93, 94, and 115(d); Statement No. 56, Codification of Accounting and Financial Reporting Guidance Contained in the AICPA Statements on Auditing Standards, footnote 1. In addition, this Statement amends NCGA Statement 4, Accounting and Financial Reporting Principles for Claims and Judgments and Compensated Absences, paragraph 14; NCGA Statement 5, Accounting and Financial Reporting Principles for Lease Agreements of State and Local Governments, paragraphs 11, 12, 16, 18, 22, and 24 27; NCGA Interpretation 9, Certain Fund Classifications and Balance Sheet Accounts, paragraph 12; Statement 10, paragraph 45; Statement No. 13, Accounting for Operating Leases with Scheduled Rent Increases, footnote 3; Statement No. 29, The Use of Not-for-Profit Accounting and Financial Reporting Principles by Governmental Entities, paragraphs 4, 5a, and 7; Statement 31, paragraph 5; Statement 34, paragraphs 55, 95, and 97 and footnotes 12, 13, and 25; Statement No. 42, Accounting and Financial Reporting for Impairment of Capital Assets and for Insurance Recoveries, footnote 2 and paragraph 17; Statement No. 49, Accounting and Financial Reporting for Pollution Remediation Obligations, footnotes 2 and 7. Capitalization of Interest Cost 5. Paragraphs 5 22 establish standards of financial accounting and reporting for capitalizing interest cost as a part of the historical cost of acquiring certain assets. For the purposes of applying paragraphs 5 22, interest cost includes interest recognized on 2

obligations having explicit interest rates, 1 interest imputed on certain types of payables in accordance with paragraphs 176 190, and interest related to a capital lease determined in accordance with paragraphs 214 274. 6. Paragraphs 188 and 190 provide that the discount or premium that results from imputing interest for certain types of payables should be amortized as interest expense over the life of the payable and reported as such in the flows statement. 2 Paragraph 221 provides that, during the term of a capital lease, a portion of each minimum lease payment should be recorded as interest expense. Paragraphs 5 22 modify paragraphs 176 190 and paragraphs 214 274 in that the amount chargeable to interest expense under the provisions of those paragraphs is eligible for inclusion in the amount of interest cost capitalizable in accordance with paragraphs 5 22. 7. The historical cost of acquiring an asset includes the costs necessarily incurred to bring it to the condition and location necessary for its intended use. 3 If an asset requires a period of time in which to carry out the activities 4 necessary to bring it to that condition and location, the interest cost incurred during that period as a result of outlays for the asset is a part of the historical cost of acquiring the asset. Assets Qualifying for Interest Capitalization 8. Interest should be capitalized for the following types of assets ( qualifying assets ): a. Assets that are constructed or otherwise produced for a government s own use (including assets constructed or produced for the government by others for which deposits or progress payments have been made) b. Assets intended for sale or lease that are constructed or otherwise produced as discrete projects (for example, real estate developments) c. Investments (equity, loans, and advances) accounted for by the equity method while the investee has activities in progress necessary to commence its planned principal operations provided that the investee s activities include the use of resources to acquire qualifying assets for its operations d. Assets that are donated or granted to other governments. 9. However, interest cost should not be capitalized for inventories. In addition, interest should not be capitalized for the following types of assets: a. Assets that are in use or ready for their intended use b. Assets that are not undergoing the activities necessary to get them ready for use 1 Interest cost on these obligations includes amounts resulting from periodic amortization of discount or premium and issue costs on debt. 2 For purposes of applying paragraphs 5 22, the term flows statement includes the government-wide statement of activities for business-type activities and the proprietary fund statement of revenues, expenses, and changes in fund net assets. 3 The term intended use embraces both readiness for use and readiness for sale, depending on the purpose of acquisition. 4 See paragraph 16 for a definition of those activities for purposes of applying paragraphs 5 22. 3

c. Assets that are not included in the financial statements d. Investments accounted for by the equity method after the planned principal operations of the investee begin e. Investments in regulated investees that are capitalizing both the cost of debt and equity capital f. Assets acquired with gifts and grants that are restricted by the donor or grantor to acquisition of those assets to the extent that resources are available from such gifts and grants. Interest earned from temporary investment of those resources that is similarly restricted should be considered an addition to the gift or grant for this purpose. 10. Land that is not undergoing activities necessary to get it ready for its intended use is not a qualifying asset. If activities are undertaken for the purpose of developing land for a particular use, the outlays to acquire the land qualify for interest capitalization while those activities are in progress. The interest cost capitalized on those outlays is a cost of acquiring the asset that results from those activities. If the resulting asset is a structure, such as a parking facility, interest capitalized on the land outlays is part of the acquisition cost of the structure. If the resulting asset is developed land, such as land that is to be sold as developed lots, interest capitalized on the land outlays is part of the acquisition cost of the developed land. The Amount of Interest Cost to Be Capitalized 11. The amount of interest cost to be capitalized for qualifying assets is intended to be that portion of the interest cost incurred during the assets acquisition periods that theoretically could have been avoided (for example, by avoiding additional borrowings or by using the resources expended for the assets to repay existing borrowings) if outlays for the assets had not been made. 12. The amount capitalized in an accounting period should be determined by applying an interest rate(s) ( the capitalization rate ) to the average amount of accumulated outlays for the asset during the period. 5 The capitalization rates used in an accounting period should be based on the rates applicable to borrowings outstanding during the period. If a government s financing plans associate a specific new borrowing with a qualifying asset, the government may use the rate on that borrowing as the capitalization rate to be applied to that portion of the average accumulated outlays for the asset that does not exceed the amount of that borrowing. If average accumulated outlays for the asset exceed the amounts of specific new borrowings associated with the asset, the capitalization rate to be applied to such excess should be a weighted average of the rates applicable to other borrowings of the government. 13. In identifying the borrowings to be included in the weighted average rate, the objective is a reasonable measure of the cost of financing acquisition of the asset in terms 5 If qualifying assets are financed with the proceeds of tax-exempt borrowings and those resources are externally restricted to the acquisition of specified qualifying assets or to service the related debt, the amount of interest cost capitalized should be determined in accordance with paragraphs 19 and 20. 4

of the interest cost incurred that otherwise could have been avoided. Accordingly, judgment will be required to make a selection of borrowings that best accomplishes that objective in the circumstances. However, the use of judgment in determining capitalization rates should not circumvent the requirement that a capitalization rate be applied to all capitalized outlays for a qualifying asset to the extent that interest cost has been incurred during an accounting period. 14. The total amount of interest cost capitalized in an accounting period should not exceed the total amount of interest cost incurred by the government in that period. 15. For the purposes of applying paragraphs 5 22, outlays to which capitalization rates are to be applied are capitalized outlays (net of progress payment collections) for the qualifying asset that have required the payment of cash, the transfer of other assets, or the incurring of a liability on which interest is recognized (in contrast to liabilities, such as trade payables, accruals, and retainages on which interest is not recognized). However, reasonable approximations of net capitalized outlays may be used. For example, capitalized costs for an asset may be used as a reasonable approximation of capitalized outlays. The Capitalization Period 16. The capitalization period should begin 6 when three conditions are present: a. Outlays (as defined in paragraph 15) for the asset have been made b. Activities that are necessary to get the asset ready for its intended use are in progress c. Interest cost is being incurred. Interest capitalization should continue as long as those three conditions are present. The term activities is to be construed broadly. It encompasses more than physical construction; it includes all the steps required to prepare the asset for its intended use. For example, it includes administrative and technical activities during the preconstruction stage, such as the development of plans or the process of obtaining permits from governmental authorities; it includes activities undertaken after construction has begun in order to overcome unforeseen obstacles, such as technical problems, labor disputes, or litigation. If the government suspends substantially all activities related to acquisition of the asset, interest capitalization should cease until activities are resumed. However, brief interruptions in activities, interruptions that are externally imposed, and delays that are inherent in the asset acquisition process should not require cessation of interest capitalization. 17. The capitalization period should end when the asset is substantially complete and ready for its intended use. Some assets are completed in parts, and each part is capable of being used independently while work is continuing on other parts. For such assets, interest capitalization should stop on each part when it is substantially complete and ready for use. 6 In situations involving qualifying assets financed with the proceeds of tax-exempt borrowings that are externally restricted as specified in paragraphs 19 and 20, the capitalization period begins at the date of the borrowing. 5

Some assets need to be completed in their entirety before any part of the asset can be used. For such assets, interest capitalization should continue until the entire asset is substantially complete and ready for use. Some assets cannot be used effectively until a separate facility has been completed. For such assets, interest capitalization should continue until the separate facility is substantially complete and ready for use. 18. Interest capitalization should not cease when present accounting principles require recognition of a lower value for the asset than acquisition cost; the provision required to reduce acquisition cost to such lower value should be increased appropriately. Capitalization of Interest Cost in Situations Involving Certain Tax-Exempt Borrowings and Certain Gifts and Grants 19. Interest earned should not be offset against interest cost in determining either capitalization rates or limitations on the amount of interest cost to be capitalized except in situations involving acquisition of qualifying assets financed with the proceeds of taxexempt borrowings if those resources are externally restricted to finance acquisition of specified qualifying assets or to service the related debt. 20. The amount of interest cost capitalized on qualifying assets acquired with proceeds of tax-exempt borrowings that are externally restricted as specified in paragraph 19 should be all interest cost of the borrowing less any interest earned on related interest-bearing investments acquired with proceeds of the related tax-exempt borrowings 7 from the date of the borrowing until the assets are ready for their intended use. Interest cost of a taxexempt borrowing should be eligible for capitalization on other qualifying assets of the entity when the specified qualifying assets are no longer eligible for interest capitalization. Disposition of the Amount Capitalized 21. Because interest cost is an integral part of the total cost of acquiring a qualifying asset, its disposition should be the same as that of other components of asset cost. Disclosures 22. The following information with respect to interest cost should be disclosed in the notes to the financial statements: a. For an accounting period in which no interest cost is capitalized, the amount of interest cost incurred and charged to expense during the period b. For an accounting period in which some interest cost is capitalized, the total amount of interest cost incurred during the period and the amount thereof that has been capitalized. 7 The interest cost and interest earned on any portion of the proceeds of the tax-exempt borrowings that are not designated for the acquisition of specified qualifying assets and servicing the related debt are excluded. The entire interest cost on that portion of the proceeds that is available for other uses (such as refunding of an existing debt issue other than a construction loan related to those assets) is eligible for capitalization on other qualifying assets. 6

Revenue Recognition for Exchange Transactions 23. Revenue from exchange transactions generally should be recognized when a sale, in the ordinary course of operations, is effected unless the circumstances are such that the collection of the sale price is not reasonably assured. Accordingly, revenues from exchange transactions should generally be accounted for at the time a transaction is completed, with appropriate provision for uncollectible accounts. In the absence of the circumstances 8 referred to above or other specific guidance, such as in paragraphs 285 352, the installment method is not acceptable. Revenue Recognition When Right of Return Exists 24. Paragraphs 24 28 specify criteria for recognizing revenue on a sale in which a product may be returned, whether as a matter of contract or as a matter of existing practice, either by the ultimate customer or by a party who resells the product to others. The product may be returned for a refund of the purchase price, for a credit applied to amounts owed or to be owed for other purchases, or in exchange for other products. The purchase price or credit may include amounts related to incidental services, such as installation. 25. Paragraphs 24 28 do not apply to (a) accounting for charges for services if part or all of the service revenue may be returned under cancellation privileges granted to the buyer, (b) transactions involving real estate or leases, or (c) sales transactions in which a customer may return defective goods, such as under warranty provisions. Criteria for Recognizing Revenue When Right of Return Exists 26. If a government sells its product but gives the buyer the right to return the product, revenue from the sales transaction should be recognized at time of sale only if all of the following conditions are met: a. The seller s price to the buyer is substantially fixed or determinable at the date of sale. b. The buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product. c. The buyer s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product. 8 There are exceptional cases in which receivables are collectible over an extended period of time and, because of the terms of the transactions or other conditions, there is no reasonable basis for estimating the degree of collectibility. When such circumstances exist, and as long as they exist, either the installment method or the cost recovery method of accounting may be used. (Under the cost recovery method, equal amounts of revenue and expense are recognized as collections are made until all costs have been recovered, postponing any recognition of profit until that time.) 7

d. The buyer acquiring the product for resale has economic substance apart from that provided by the seller. 9 e. The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer. f. The amount of future returns 10 can be reasonably estimated (paragraph 28). Sales revenue and cost of sales that are not recognized at time of sale because the foregoing conditions are not met should be recognized either when the return privilege has substantially expired or if those conditions subsequently are met, whichever occurs first. 27. If sales revenue is recognized because the conditions of paragraph 26 are met, any costs or losses that may be expected in connection with any returns should be accrued in accordance with paragraphs 96 116. Sales revenue and cost of sales should be reduced to reflect estimated returns. 28. The ability to make a reasonable estimate of the amount of future returns depends on many factors and circumstances that will vary from one case to the next. However, the following factors may impair the ability to make a reasonable estimate: a. The susceptibility of the product to significant external factors, such as technological obsolescence or changes in demand b. Relatively long periods in which a particular product may be returned c. Absence of historical experience with similar types of sales of similar products, or inability to apply such experience because of changing circumstances, for example, changes in the seller s marketing policies or relationships with its customers d. Absence of a large volume of relatively homogeneous transactions. The existence of one or more of the above factors, in light of the significance of other factors, may not be sufficient to prevent making a reasonable estimate; likewise, other factors may preclude a reasonable estimate. Statement of Net Assets Classification 29. Paragraphs 30 44 apply only when a government is preparing a classified statement of net assets for accounting and financial reporting purposes. Paragraphs 34 43 also apply to disclosures made about maturities of obligations reported in both classified and unclassified statements of net assets. Current Assets 30. For accounting and financial reporting purposes, the term current assets is used to designate cash and other assets or resources commonly identified as those that are 9 This condition relates primarily to buyers that exist on paper, that is, buyers that have little or no physical facilities or employees. It prevents sellers from recognizing sales revenue on transactions with parties that the sellers have established primarily for the purpose of recognizing such sales revenue. 10 Exchanges by ultimate customers of one item for another of the same kind, quality, and price (for example, one color or size for another) are not considered returns for purposes of applying paragraphs 24 28. 8

reasonably expected to be realized in cash or sold or consumed within a year. Therefore, current assets generally include such resources as (a) cash available for current operations and items that are the equivalent of cash; (b) inventories of merchandise, raw materials, goods in process, finished goods, operating supplies, and ordinary maintenance material and parts; (c) trade accounts, notes, and acceptances receivable; (d) receivables from taxpayers, other governments, vendors, customers, beneficiaries, and employees, if collectible within a year; (e) installment or deferred accounts and notes receivable if they conform generally to normal trade practices and terms within the business-type activity; (f) marketable securities representing the investment of cash available for current operations; and (g) prepayments such as insurance, interest, rents, unused royalties, current paid advertising service not yet received, and operating supplies. Prepayments are not current assets in the sense that they will be converted into cash but in the sense that, if not paid in advance, they would require the use of current assets within a year. 31. This concept of the nature of current assets contemplates the exclusion from that classification of such resources as (a) cash and claims to cash that are restricted as to withdrawal or use for other than current operations, that are designated for disbursement in the acquisition or construction of noncurrent assets, or that are segregated 11 for the liquidation of long-term debts; (b) receivables arising from unusual transactions (such as the sale of capital assets) that are not expected to be collected within 12 months; (c) cash surrender value of life insurance policies; (d) land and other natural resources; (e) depreciable assets; and (f) long-term prepayments that are applicable to the operations of several years, or deferred charges such as bonus payments under a long-term lease. 32. Unearned discounts (other than cash or quantity discounts and the like), finance charges, and interest included in the face amount of receivables should be shown as a deduction from the related receivables. Classification and Disclosure of Allowances 33. Asset valuation allowances for losses, such as those on receivables, should be deducted from the assets or groups of assets to which the allowances relate, with appropriate disclosure. Current Liabilities 34. The term current liabilities is used principally to designate obligations whose liquidation is reasonably expected to require the use of existing resources properly classifiable as current assets, or the creation of other current liabilities. As a category in the statement of net assets, the classification is intended to include obligations for items that have entered into the operating cycle, such as payables incurred in the acquisition of materials and supplies to be used in providing services; collections received in advance of 11 Even though not actually set aside in special accounts, resources that are clearly to be used in the near future for the liquidation of long-term debts, payments to sinking funds, or for similar purposes also should, under this concept, be excluded from current assets. However, where such resources are considered to offset maturing debt that has properly been set up as a current liability, they may be included within the current asset classification. 9

the performance of services; 12 and debts that arise from operations directly related to the operating cycle, such as accruals for wages, salaries, commissions, rentals, and royalties. Other liabilities whose regular and ordinary liquidation is expected to occur within a relatively short period of time, usually 12 months, also are intended for inclusion, such as short-term debts arising from the acquisition of capital assets, serial maturities of longterm obligations, amounts required to be expended within one year under sinking fund provisions, and certain agency obligations arising from the collection or acceptance of cash or other assets for the account of third parties. The current liability classification also is intended to include obligations that, by their terms, are due on demand or will be due on demand within one year from the date of the financial statements, 13 even though liquidation may not be expected within that period. 14 It also is intended to include longterm obligations that are or will be callable 15 by the creditor either because the debtor s violation of a provision 16 of the debt agreement at the date of the financial statements makes the obligation callable or because the violation, if not cured within a specified grace period, will make the obligation callable. Accordingly, such callable obligations should be classified as current liabilities unless one of the following conditions is met: a. The creditor has waived 17 or subsequently lost 18 the right to demand repayment for more than one year from the date of the financial statements. b. For long-term obligations containing a grace period within which the debtor may cure the violation, it is probable 19 that the violation will be cured within that period, thus preventing the obligation from becoming callable. Short-term obligations that are expected to be refinanced on a long-term basis, including those callable obligations discussed herein, should be classified in accordance with paragraphs 36 44. 12 Examples of such current liabilities are obligations resulting from advance collections on ticket sales, which normally will be liquidated in the ordinary course of operations by the delivery of services. On the contrary, obligations representing long-term deferments of the delivery of services would not be shown as current liabilities. An example of the latter is the advance receipt by a lessor of rental for the final period of a 10-year lease as a condition to execution of the lease agreement. 13 Date of the financial statements means the end of the most recent accounting period for which financial statements are being presented. 14 Specific guidance for demand bonds is provided in GASB Interpretation No. 1, Demand Bonds Issued by State and Local Governmental Entities, paragraph 10. 15 An obligation is callable at a given date if the creditor has the right at that date to demand, or to give notice of its intention to demand, repayment of the obligation owed to it by the debtor. 16 A violation of a provision is the failure to meet a condition in a debt agreement or a breach of a provision in the agreement for which compliance is objectively determinable, whether or not a grace period is allowed or the creditor is required to give notice of its intention to demand repayment. 17 If the obligation is callable because of violations of certain provisions of the debt agreement, the creditor needs to waive its right with regard only to those violations. 18 For example, the debtor has cured the violation after the date of the financial statements and the obligation is not callable at the time the financial statements are issued. 19 Probable is defined in paragraph 100 as likely to occur and is used in the same sense in this paragraph. 10