National Federation of Municipal Analysts Response to the Governmental Accounting Standards Board's Exposure Draft related to the Basic Financial Statements--and Management's Discussion and Analysis--for State and Local Governments

July 7, 1997
Background of the NFMA
The National Federation of Municipal Analysts Society is an association of local analyst societies and individual members intended to enhance professional standards among municipal analysts, who are engaged in the credit analysis of municipal bonds. In total, the Federation includes over 1000 members representing a variety of municipal bond underwriters, bond rating agencies, bond insurance companies, bond funds, independent portfolio and financial advisors.

NFMA's Overall Reporting Objectives
As a prelude to our comments regarding our basic support for the proposed reporting model, it is important that we initially present our objectives and requirements that provide the underlying motivation for our position. We recognize that there are a wide variety of users of state and local government financial reports who will differ on what elements and methods of reporting are important. Nevertheless, we offer our views so that the Board does not lose sight of these, amidst the debate about methods and details, if compromise becomes necessary. Moreover, we believe this project must work towards a resolution consistent with our final objectives even if progress is achieved in increments over time.

By and large, our primary interest in state and local financial reports is to be able to assess a governmental body's ability to repay indebtedness on time now and into the foreseeable future. The financial statement, in our opinion, cannot be viewed merely as a historical document without regard to trends and future creditworthiness.

While an auditor's opinion and review of past financial data may be necessary to establish an entity's compliance with specific budgetary goals, state or local statutes or prudent financial management, the importance of the document does not end there. As a key creditworthiness tool, the financial document must provide a complete picture of both the total real resources from all fund accounts available for repaying creditors as well as an honest assessment of potential demands from all competing interests.

The financial statements must be presented in a conservative presentation that diminishes the possibility of overstating revenues or understating expenses. Legally separated funds must remain distinct and apart if legal controls so require. On the other hand, a picture of total cash flow available for the repayment of indebtedness and other liabilities should be presented even if the cash must be statutorily repaid to a respective fund at year end.

The document must also identify situations in which an entity has postponed spending funds on activities, liabilities or capital demands in the interest of a balanced budget thereby creating a false sense of security on the part of a creditor. Finally, the numbers should not have to speak by themselves to credit quality and financial performance by themselves. A written record by state or local officers explaining the conditions which relate to the adequacy of resources in the current year and the foreseeable future should be a necessary adjunct apart from the factual, quantitative detail contained in the financial statements and the footnotes.

NFMA's Position on GASB's Reporting Model Exposure Draft

With these analytical objectives in mind, the NFMA finds substantial common ground with the proposed financial dual-reporting model. We find useful the entity wide statement since it captures the total financial resources available to the governmental body (excluding trust and agency monies) to repay creditors. At the same time, the preservation of the basic fund accounting format transitions the comparability of historical reporting trends while maintaining the budgetary discipline consistent with the objectives of fund accounting.

Fiscal versus operational accountability
We do not believe that the existing singular reporting methodology adequately captures the special nuances and objectives necessary to determine both fiscal and operational accountability. The dual reporting method recognizes the advantages inherent in each approach.

Capital asset reporting
One of the most important benefits of the entity-wide statement approach is the development of a tool that makes a serious effort to identify the estimated useful life of infrastructure assets. Although we recognize that this approach is not perfect and cannot be viewed in an informational vacuum, this new provision has long been sought so that analysts can better gauge a governmental entity's ongoing commitment to the maintenance and expansion of its infrastructure assets. Moreover, the development of a consistent basis for the valuation of assets and their usage should allow analysts to develop ratios and comparability measures among similar function governmental bodies. The current method of reporting fixed income assets is frequently ignored and generally deficient in making a determination of the using up of capital assets. The current deficiencies of the current fixed income reporting method related to government bodies makes these numbers among the most underutilized and overlooked today.

The obvious complexity and additional cost associated with the appraisal of capital assets at the entity wide perspective is an issue that has drawn legitimate concerns about the cost of implementation. The proposed rules provide a three year window to record an accounting of capital assets (retroactive for the past 25 years) without exception for governmental entities by size or type. While we concur with GASB's intention to make this information useful as soon as possible, we would rather settle for a compromise than further delay our ability to obtain this important missing piece of information for our analysis.. Possible options include: shortening the retroactive accounting period for infrastructure assets or exempting the provision for government units with less than 10,000 population.

Preservation of the governmental funds
Many analysts appreciate the conservatism of the current method of modified accrual fund accounting applied to the governmental accounts. Identifying inflows only on a near term basis would seem to restrain the possibility of overly optimistic revenue recognition . Additionally, we accept the fact that many governments plan their budgets based on a modified accrual approach and the continued existence of this method is consistent with their objectives for fiscal accountability. We are cognizant of the importance of preserving the advantages of an account methodology which focuses on near term resource allocations which are not complicated by "on paper" long term liabilities that would otherwise tend to frequently understate bottom line fiscal year measurements. Finally, the retention of the existing modified accounting approach would allow analysts to continue to use historical fund balance trend comparisons without adjustment.

Management's Discussion and Analysis

We fully support and encourage GASB to implement the MDA as the first part of the CAFR. We believe that this section would substantially aid user understanding of conditions relevant to the current and future credit standing of the governmental entity. We believe that the MDA can provide useful information that places the current numbers in the proper economic and fiscal "why and how" framework. Management's discussion and analysis also should allow the user to assess whether similar results can be expected in the foreseeable future given known or anticipated conditions. The MDA should help contain recent expansionary tendencies recently evident in the footnote section. In addition, the MDA should take on a higher level of objective analysis not currently expected in the letter of transmittal.

Support for the Proposal

As representatives for the membership of the National Federation of Municipal Analysts, we encourage GASB to pursue the dual-reporting financial model. While we are generally satisfied with the direction and intent of the exposure draft, we anticipate that fine tuning of the proposal is inevitable as real situations raise new questions not currently being asked or addressed. Nevertheless, we believe that the compromise approach being offered allows both preparers and users the opportunity to become accustomed to the new methodology without losing any benefits derived from the existing system. The NFMA has long sought information to help analysts better assess the long term accountability of governments, in particular with respect to the proper maintenance of its infrastructure. The entity-wide method goes a long way to provide a gauge to measure and compare governmental maintenance of capital assets. As mentioned above, we are not opposed to a more gradual implementation of fixed asset accounting as long as progress is made in ultimately applying the economic basis approach to all assets.

Note: Any NFMA member wishing to provide feedback concerning the NFMA response to GASB are encouraged to fax their responses to Richard Ciccarone at 630-684-6501.

Submitted on behalf of the National Federation of Municipal Analysts

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