From time to time, I have clients ask me “What is funded depreciation?” And more importantly, they ask, “How can this technique make my organization more profitable and less stressful?”
Here’s a simple explanation.
Funded depreciation is the setting aside of cash in amounts equal to an organization’s annual depreciation. The purpose: to fund future purchases of capital assets with cash.
Suppose you buy a $10,000 whiz-bang gizmo—a piece of equipment—that you expect to use for ten years, and at the end of the ten years you expect it to have no value. Your annual depreciation is $1,000.
In this example, a $1,000 depreciation expense is recognized annually on your income statement (depreciation decreases net income) even though no cash outlay occurs. The balance sheet includes the cost of the whiz-bang gizmo, but at the end of ten years, the equipment has a $0 book value, being fully depreciated.
The smart manager will annually set aside $1,000 in a safe investment—such as a certificate of deposit or money market account—for the future replacement of the whiz-bang gizmo.
If the company does not annually invest the $1,000, it has a few options at the end of the ten-year period:
Borrow the full amount for the replacement cost
Seek outside funding (e.g., grants)
Use other funds from within the organization
Lease the equipment
Ask U2 to do a special benefits concert—just kidding
Obviously, if you borrow money to replace the equipment, you will have to pay interest—another cash outlay. Suppose the rate is 10%. Now the organization must pay out $1,100 each year. So, if the organization funds the depreciation (invests $1,000 annually), it earns interest. But if the entity chooses not to fund depreciation, it pays interest.
Businesses that fund depreciation are always making money from interest (granted not much these days) rather than paying for it.
Another advantage to funding depreciation: you know you will have the money to purchase the capital asset. You’re not concerned with whether a creditor will lend you the money for the acquisition. You’re financially stronger.
Why Doesn’t Every Entity Fund Depreciation?
So why doesn’t everyone fund depreciation?
Some don’t understand the concept
Some had rather spend the cash flows for the ten years (e.g., owners taking too much in distributions)
Some need the money just to run the organization
In governments, elected officials desire to keep tax rates low while they are in office
In growing businesses, the owners may need the money to fund the growth of the company
Most importantly, it may require two cash payments
Concerning the last point, if the business had to borrow money to purchase the initial capital asset, then it must make debt service payments (cash outlay 1). If the company also funds depreciation for that same asset (making investments equal to the annual depreciation), another cash flow occurs (cash outlay 2). Nevertheless, if the business can ever get into a position where it pays cash for new equipment, it will be better off. Then only one cash outlay (investment funding) occurs, and the company is making–not paying–interest.
What if the organization cannot–due to cash flow constraints–fund depreciation for all new equipment purchases? Consider doing so for just one or two pieces of equipment–over time, the entity may be able to move into a fully funded position.
Who Should Fund Depreciation?
So, who should fund depreciation?
Organizations with sufficient cash flow and discipline. It’s the smart thing to do.
Imagine a world with no debt, a world where you don’t have to wonder how you will pay for equipment. Dreaming? Maybe, but funded depreciation is worth your consideration.
You’ve heard about the new Yellow Book (effective for audits of years ending June 30, 2020, and after). So, now you’re wondering if there are any changes in CPE requirements. This article explains the Yellow Book continuing education requirements.
Below we will address (1) who is subject to the Yellow Book CPE requirements and (2) what CPE classes satisfy those requirements.
Paragraph 4.16 of the Yellow Book states “Auditors who plan, direct, perform engagement procedures for, or report on an engagement conducted in accordance with GAGAS should develop and maintain their professional competence by completing at least 80 hours of CPE in every 2-year period.”
Nevertheless, Paragraph 4.26 states “nonsupervisory auditors who charge less than 40 hours of their time annually to engagements conducted in accordance with GAGAS may be exempted by the organization from all CPE requirements in paragraph 4.16.” Additionally, paragraph 4.27 allows an audit organization to exempt “college and university students employed on a temporary basis.”
Auditors not exempted by the provisions in paragraphs 4.26 or 4.27 must take at least 20 hours of CPE in each year of the two years.
So, there is an 80 requirement. Additionally, there are two more requirements:
56-hour (every two years)
24-hour (every two years)
Below we’ll see:
Who is subject to each requirement?
What classes qualify for each requirement?
Before we get into the details, you may be wondering, “How do I know if I am subject to the Yellow Book CPE requirements?” To answer that question, consider whether a Yellow Book report is to be issued (or whether one was issued in a prior engagement). If yes, then consider the requirements below. In most audit reports, you’ll see the Yellow Book report just after the notes to the financial statements. And when must an entity comply with the Yellow Book requirements? Usually when a law or a grant requires it.
Now, let’s start our review of Yellow Book CPE requirements.
The 24-Hour Requirement – Who is Subject?
Who is subject to the 24-hour requirement? If you work on a Yellow Book engagement as an auditor, you are subject to the 24-hour requirement. Even so, if you are a nonsupervisory auditor that works less than forty hours annually on Yellow Book engagements, your audit organization can exempt you from Yellow Book requirements. (See paragraph 4.26 of the Yellow Book.) Additionally, audit organizations can exempt college students hired temporarily. (See paragraph 4.27 of the Yellow Book.)
Next, let’s see who is subject to the 56-hour requirement?
The 56-Hour Requirement – Who is Subject?
Who is subject to the 56-hour requirement? Auditors who are involved in:
1. Planning, 2. Directing, or 3. Reporting
These are usually partners, managers, and in-charges.
Additionally, the 56-hour requirement applies to auditors who are not involved in planning, directing, or reporting but charge 20 percent or more of their annual time to GAGAS engagements. This category usually includes professional staff personnel.
So, consider this example. You have a staff member that has:
2,000 hours of total time each year
140 hours in two GAGAS (Yellow Book) engagements for the year
He is not involved in planning, directing, or reporting
He is not subject to the 56-hour requirement (his GAGAS time is less than 20% of the total hours), though he is subject to the 24-hour requirement.
But suppose he is promoted during the year and becomes a manager on the second Yellow Book engagement. Even though his time is less than 20% of his annual time, he is now subject to the 56-hour requirement. Why? He is directing the engagement.
Now, let’s see what classes qualify for Yellow Book CPE.
What Classes Qualify for Yellow Book CPE?
Paragraph 4.21 of the Yellow Book states, “Determining what subjects are appropriate for individual auditors to satisfy the CPE requirements is a matter of professional judgment to be exercised by auditors in consultation with appropriate officials in their audit organization.” Moreover, there are differences in the 56-hour requirement and the 24-hour requirement. Otherwise, only one category would exist. The 56-hour requirement is broader and the 24-hour requirement is more specific.
Okay, let’s define the differences in the 56-hour and 24-hour requirements.
The 56-Hour Rule – Classes that Qualify
The 56-hour rule is broad, encompassing any CPE that enhances the auditor’s professional expertise to conduct engagements. So, CPE classes about better writing, for example, would qualify.
Paragraph 4.24 of the Yellow Book provides the following as examples of acceptable topics:
Subject matter categories for the 24-hour requirement listed in paragraph 4.23 (the 24-hour requirement–see below)
General ethics and independence
Communicating clearly in writing or verbally
Now, let’s compare the general 56-hour requirements with the more specific 24-hour requirements.
The 24-Hour Rule – Classes that Qualify
Each auditor performing work under GAGAS should complete, every two years, at least twenty-four hours of CPE that directly relates to government auditing, the government environment, or the specific or unique environment in which the audited entity operates.
Paragraph 4.23 of the Yellow Book provides the following as examples of acceptable topics:
GAO generally accepted government auditing standards (GAGAS)
AICPA Statements of Auditing Standards (SASs)
AICPA Statements on Standards for Attestation Services (SSAEs)
AICPA Statements on Accounting and Review Services (SSARS)
Standards issued by the Institute of Internal Auditors
Standards issued by the Public Company Accounting and Oversight Board
U.S. Generally Accepted Accounting Principles (FASB and GASB)
Standards for Internal Control in the Federal Government
COSO Internal Controls–Integrated Framework
Relevant audit guides (including information technology auditing and forensic auditing)
Fraud and abuse in a governmental environment
Compliance with laws and regulations
Topics related to the governmental environment such as financing, economics, appropriations, program performance
Governmental ethics and independence
Notice these topics are more directly related to auditees than those in the 56-hour requirement. But again, use judgment to determine whether a CPE class is in the 24-hour or the 56-hour bucket.
Since the GAO, a governmental agency, issues the Yellow Book, we tend to associate Yellow Book engagements with audits of governments. But the Yellow Book can be in play for entities such as banks or electric membership corporations.
Specific or Unique Environment in Which the Audited Entity Operates
Suppose you audit electric membership corporations (EMCs) subject to the Yellow Book. A CPE class about electric supply grids qualifies for the 24-hour requirement. Or if you audit banks subject to Yellow Book requirements (e.g., FHA loans), then a CPE class dealing with lending qualifies. These classes address issues unique to the environment in which the entity operates.
So, are there CPE classes that don’t qualify as GAGAS hours?
CPE that Does Not Qualify as Yellow Book Hours
Some CPE classes will not qualify as GAGAS hours. Paragraph 4.36 of the Yellow Book provides the following examples:
Improving parent-child relations
Additionally, paragraph 4.35 states that some taxation classes may not qualify such as estate planning. It is possible that a tax class would qualify if “topics relate to an objective of the subject matter of an engagement.”
Your head might be spinning from all of the above rules. So, you might be wondering, can my audit organization use a standard two-year cycle for all employees? You’d like to keep this as simple as possible.
An audit organization can adopt a standard two-year period for all of its auditors to simplify the administration of CPE requirements.
But can you carry over excess CPE credit earned in the two-year period?
Auditors are not allowed to carry over hours in excess of the 24-hour or 56-hour rule to the next reporting period.
And what are the Yellow Book CPE requirements for a new employee?
Proration of Hours for New-Hires (or Those Newly Assigned to a Yellow Book Audit)
You will prorate the hourly requirements based on the remaining full 6-month intervals in your two-year reporting period. For example, you hire Joan on May 1, 2021, and the firm’s two-year cycle ends on December 31, 2021. There is one remaining full 6-month period. So, if Joan is subject to the 24-hour rule, she will multiply 25% (one six-month period divided by the four six-month periods in the two-year cycle) times 24 to compute the required hours: 6 hours.
And when is the 2018 Yellow Book effective?
Effective Date of Yellow Book Guidance
The 2018 Yellow Book is effective for audits of financial statements for periods ending on or after June 30, 2020. Early implementation is not permitted.
But, didn’t the GAO provide COVID-19 relief? Yes.
COVID-19 GAO Guidance
The above information is provided without consideration of the COVID-19 guidance issued on February 29, 2020. See the GAO COVID-19 guidance here.
In this article, I provide information about Single Audits for local governments and nonprofits.
Your organization received federal funds but you're not sure about Single Audit applicability. Should you engage an audit firm to perform a Single Audit or not?
In this article, I'll help you determine whether a Single Audit is needed. I'll also explain the objectives of such an audit. Why? So you can understand what auditors are looking for.
Single Audit: What is it?
Many nonprofits and local governments receive federal funds from the United States government. And some of those entities are required to have a Single Audit.
But what is a Single Audit? It's just what it says: a single audit. Of what? A single audit of all federal awards received by a nonprofit or a government.
For example, a local government might receive disaster funds from FEMA and a block grant from HUD. But rather than contracting for two separate audits, a Single Audit of both programs is performed. This audit requirement is usually triggered when total federal awards exceed $750,000 in one year.
Next, let's dig a little deeper regarding Single Audit applicability.
Single Audit Applicability
When is a Single Audit required? The Uniform Guidance states: A non-Federal entity that expends $750,000 or more during the non-Federal entity's fiscal year in Federal awards must have a single audit. This is a Single Audit Requirement. (There is an exception. That's when the entity elects to have a program specific audit.)
But what does expend mean? Typically the word means that an entity spends money. But the word expend has a broader meaning in Single Audits. For example, the word includes:
receipt of federal property or goods (e.g., surplus property or commodities)
receipt and use of federal loans
loan balances with the federal government (when there are continuing compliance requirements)
interest subsidies from the federal government
So if the government or nonprofit expends at least $750,000 in federal funds during its fiscal year, a Single Audit is necessary. If it expends less than $750,000, then a Single Audit is normally not required. States may, however, require a Single Audit even though amounts expended are less than $750,000.
Does the entity look solely at funds received directly from the federal government? No. Federal awards may come directly from a federal agency. But they may also come indirectly through a pass-through entity such as a state. The nature of the federal funds does not change as it passes through an entity (e.g., a state). It's still federal money.
In light of these facts, how does the Uniform Guidance define federal financial assistance? Let's take a look.
What is Federal Financial Assistance?
The Uniform Guidance defines federal assistance in the following manner:
§ 200.40 Federal financial assistance.
(a) Federal financial assistance means assistance that non-Federal entities receive or administer in the form of:
(2) Cooperative agreements;
(3) Non-cash contributions or donations of property (including donated surplus property);
(4) Direct appropriations;
(5) Food commodities; and
(6) Other financial assistance (except assistance listed in paragraph (b) of this section).
(b) For § 200.202 Requirement to provide public notice of Federal financial assistance programs and Subpart F - Audit Requirements of this part, Federal financial assistance also includes assistance that non-Federal entities receive or administer in the form of:
(2) Loan Guarantees;
(3) Interest subsidies; and
Total of Federal Assistance
The non-federal entity adds all federal financial assistance together to see if they exceed the $750,000 threshold. If, for example, a county government expends $500,000 in block grant funds and $450,000 in disaster funds during its fiscal year, then a Single Audit is necessary.
Now that you understand Single Audit applicability, you may be wondering what the objectives are.
Objectives of a Single Audit
The easiest way to understand the objectives of a Single Audit is to look at a Single Audit report. See example 13-1 from the AICPA. There are two main objectives.
1. Opinion on Compliance with Federal Program Requirements
First, understand that the auditor provides an opinion regarding the entity's compliance with major federal program requirements.
A portion of that wording reads as follows:
Opinion on Each Major Federal Program
In our opinion, Example Entity complied, in all material respects, with the types of compliance requirements referred to above that could have a direct and material effect on each of its major federal programs for the year ended June 30,20X1.
2. Reporting on Internal Control Testing
Second, understand that the auditor reports on internal control testing. While no audit opinion is rendered by the auditor, the controls are tested nonetheless.
A portion of that wording reads as follows:
Report on Internal Control Over Compliance
Management of Example Entity is responsible for establishing and maintaining effective internal control over compliance with the types of compliance requirements referred to above. In planning and performing our audit of compliance, we considered Example Entity's internal control over compliance with the types of requirements that could have a direct and material effect on each major federal program to determine the auditing procedures that are appropriate in the circumstances for the purpose of expressing an opinion on compliance for each major federal program and to test and report on internal control over compliance in accordance with the Uniform Guidance, but not for the purpose of expressing an opinion on the effectiveness of internal control over compliance. Accordingly, we do not express an opinion on the effectiveness of Example Entity's internal control over compliance.
Single Audit Applicability and Objectives
In summary, Single Audits are necessary when a local government or nonprofit expends $750,000 or more. And the objectives of the audit are to provide an opinion on compliance with federal requirements and to report on the internal control testing.
Are you looking for GASB 87 lease accounting information? Are you a government that leases assets? Then you're in the right place. Below I provide information about lease terms, discount rates, accounting entries, and disclosure requirements.
Removal of Bright-Line Criteria
Historically governments have followed the guidance in FASB 13, Accounting for Leases. Lease classifications (i.e., operating or capital) were based on bright-line criteria such as whether the government leased an asset for more than 75% of its economic life.
GASB 87, Leases, removes the bright-line criteria and calls for more judgment. (The words reasonably certain appears thirty-nine times in GASB 87.)
The new lease standard provides for various accounting alternatives. Let's see what they are.
Three Potential Accounting Alternatives
Regarding leases, there are now three accounting alternatives:
Contracts that transfer ownership
Contracts that do not transfer ownership
Before we dive deeper, here are three quick points about these alternatives:
First, know that short-term leases do not create a lease liability.
Second, understand that contracts that transfer ownership are a financed sale.
Third, know that contracts that do not transfer ownership create a lease liability. This third category is a catchall for arrangements that don't qualify for short-term lease treatment and don't transfer ownership.
Now, let's see how GASB defines a lease.
Definition of a Lease
GASB defines a lease this way:
A lease is defined as a contract that conveys control of the right to use another entity’s nonfinancial asset (the underlying asset) as specified in the contract for a period of time in an exchange or exchange-like transaction.
There are five points to this definition:
First, the lease must be a contract.
Second, the contract must provide control of the right to use.
Third, this control is in relation to a nonfinancial asset.
Fourth, the control of the nonfinancial asset must be for a period of time.
And finally, the lease is an exchange or exchange-like transaction.
I think the terms contract, period of time, and exchange are easily understood. But the terms control and nonfinancial assets might cause some confusion. So let's clarify those.
A government controls an asset if it has the right to the present service capacity and the right to determine the nature and manner of use of the asset.
In other words, the government must have the right to the benefits generated from the asset. A city can drive a leased police car. That is the benefit, the present service capacity.
Additionally, Nature and manner address whether the government controls the use of the asset. A city police officer can, for example, drive a leased police car at 3:00 a.m. And she can drive it as far as she likes. The police department determines the nature and manner of use.
And what is a nonfinancial asset? It's generally anything that is not a financial asset (e.g., cash, receivable). Examples of nonfinancial assets include buildings, land, vehicles, and equipment. There are exceptions, however.
GASB 87 Scope Exclusions
GASB 87 does not apply to:
Leases of intangible assets (e.g., rights to explore for oil and gas)
Leased biological assets (e.g., timber)
Inventory that is leased
Service concession arrangements
Leases in which the underlying asset is financed with outstanding conduit debt (unless the underlying asset and the conduit debt are reported by the lessor)
Supply contracts (e.g., power purchase agreements)
Now let's see how to determine the lease term.
Prior to GASB 87, the minimum lease payments determined the lease term. Not so any more. In some cases, GASB 87 provides for a more subjective determination of a lease's term, one based on what is reasonably certain.
Under GASB 87, lease terms are not just the noncancelable portion of the agreement. Governments add the following to the noncancelable period:
Periods covered by a lessee’s option to extend the lease if it is reasonably certain, based on all relevant factors, that the lessee will exercise that option
Periods covered by a lessee’s option to terminate the lease if it is reasonably certain, based on all relevant factors, that the lessee will not exercise that option
Periods covered by a lessor’s option to extend the lease if it is reasonably certain, based on all relevant factors, that the lessor will exercise that option
Periods covered by a lessor’s option to terminate the lease if it is reasonably certain, based on all relevant factors, that the lessor will not exercise that option.
Reasonably Certain Factors
In determining what reasonably certain is, the government considers factors such as the economic impact of not exercising an option or how the government has acted in the past.
Once the lease term decision is made, document your basis for doing so. Why? So there is a record of the decision. (Your auditors may want to see this. Additionally, the record provides valuable information regarding future lease term decisions.)
Fiscal Funding Clauses Affect on Term
Additionally, you may be wondering if fiscal funding clauses affect leases. (Fiscal funding clauses allow a government to cancel a lease if the government does not appropriate funds for the payments.) If a government is reasonably expected to exercise such a provision, then this factor can impact the lease term. Personally, however, I've never seen a government terminate a lease through such a provision. Fiscal funding clauses will usually not affect lease terms.
So, should governments ever reassess the term period?
Reassessment of Term
Government will generally not reassess the lease term decision.
Nevertheless, reassessment will occur in some cases. Consider this example. The government enters into a fifteen-year lease with a five-year lease extension. The government believes that it will not exercise the five-year extension. But then in year fifteen, it does so. Now the government binds itself for another five years. Therefore, the lease is extended. And the additional five years is added to the lease term.
Now that you know about lease terms, you may be wondering about short-term leases. How does a government account for those?
Treat leases with a maximum possible term of twelve months or less as short-term leases. And do not capitalize such leases.
One word of caution: if there are renewal options, include those in making the short-term lease classification decision, regardless of probability. If, for example, the lease is for twelve months with an option to renew for another six months, then the lease is not short-term. Even if the government believes it will not exercise the option.
So, how do you record short-term lease payments? As expenses.
Contract that Transfers Ownership
If an agreement transfers ownership of the asset to the lessee by the end of the contract, then the contract is a financed purchase. For the lessee, the government records the purchased asset (not an intangible) and the related debt (not a lease liability).
So, what about a lease agreement with a bargain purchase option? Should it be treated as financed purchase? The answer is no. The presence of a bargain purchase option in a lease contract is not the same as a provision that transfers ownership of the underlying asset.
Multiple Components of a Lease Contract
If an agreement has lease and non-lease components, split the transaction.
A government might, for example, lease floors four and five of a ten-story building. In doing so, it is required to pay for common area maintenance. Split this transaction into a lease and a maintenance contract. Record the lease exclusive of the maintenance payments. If, however, it is not practicable to determine the separate price allocation, the government should account for the transaction as a single lease.
If a lease involves multiple underlying assets (say a police car and a water tank), the government should account for each as a separate lease component.
If the government is leasing an asset, then it will use the following guidance. (An exception exists if the lease is short-term as explained above.)
At commencement, the government recognizes an (1) intangible right-to-use asset and (2) a lease liability.
So the government does not recognize the asset itself (e.g., tractor), but the right to use the asset. This is an intangible asset.
Now let's see how to compute the lease asset.
1. Lease Asset
So. what goes in the lease asset calculation?
The government should include:
Initial lease liability (see below)
Payments made to lessor at or before commencement less any lease incentives received from the lessor at or before the commencement of the lease term
Initial direct costs that are ancillary charges necessary to place the lease asset into service
So what costs are not included in the intangible asset? Governments should exclude any debt issuance costs.
Notice that the lease asset can be greater than the lease liability. The lease asset starts with the lease liability and increases if, for example, the government makes a payment to the lessor prior to commencement of the lease term.
In governmental funds (e.g., general fund), the initial accounting entry is a debit to capital outlay and a credit to other financing sources. In full accrual funds (e.g., enterprise fund), the initial entry is a debit to the intangible lease asset and a credit to the lease liability.
So, how should the lease asset be amortized?
Lease Asset Amortization
Amortize the lease asset in a systematic and rational manner over the shorter of the lease term or the asset's useful life. Usually this will be straight-line amortization.
And what are the journal entries for recording the lease asset?
Lease Asset Accounting
The government records the lease asset and then amortizes it using an entry such as the following (for full-accrual funds; e.g., water and sewer fund):
Accumulated Amortization - Right-of-Use Asset
GASB 87 says to report the amortization as an outflow of resources (e.g., amortization expense). The amortization expense can, for financial reporting purposes, be combined with the depreciation expense of other capital assets.
Modified accrual funds (e.g., general fund) will not record an amortization entry. Why? The asset does not appear on the balance sheet.
2. Lease Liability
How does a government compute the lease liability?
Simply put, the lease liability is the present value of everything you think you're going to pay. Prior to GASB 87, governments used the present value of minimum lease payments. Now governments include payments that are reasonably certain. (See information above regarding what is reasonably certain.)
The computation is made up of the present value of:
Variable payments that depend on an index or a rate (e.g., consumer price index) measured using the index or rate as of the commencement of the lease
Variable payments that are fixed in substance
Amounts that are reasonably certain of being required to be paid by the lessee under residual value guarantees
The exercise price of a purchase option if it is reasonably certain that the lessee will exercise that option
Payments for penalties for terminating the lease
Any lease incentives receivable from the lessor
Any other payments that are reasonably certain of being required based on an assessment of all relevant factors
Variable Payments Based on Future Performance
Governments will not include payments based on future performance or usage in the lease liability. Expense such payments in the period incurred.
For example, if a government leases a vehicle with a provision for 12,000 miles annually but the car is driven 15,000 miles, expense the payment for the additional mileage as incurred.
So, where does the discount rate come from?
Use the rate charged by the lessor if specified in the agreement. If not specified, use the incremental borrowing rate for the government. This is the estimated rate the government would pay if, during the life of the lease, it borrowed the funds for those lease payments.
Lease Liability Accounting
Once the initial lease is recorded as a liability, the government will begin making periodic payments to the lessor. The effective interest rate method will be used. Record the payments as follows (for full-accrual funds; e.g., water and sewer fund):
Post the payments to principal and interest expenditures in modified accrual accounting funds (e.g., general fund).
GASB 87 Disclosures
The following disclosures are required for lessees:
A general description of its leasing arrangements
The total amount of lease assets, and the related accumulated amortization, disclosed separately from other capital assets
The amount of lease assets by major classes of underlying assets, disclosed separately from other capital assets
The amount of outflows of resources recognized in the reporting period for variable payments not previously included in the measurement of the lease liability
The amount of outflows of resources recognized in the reporting period for other payments (e.g., termination penalties) not previously included in the measurement of the lease liability
Principal and interest requirements to maturity, presented separately, for the lease liability for each of the five subsequent fiscal years and in five-year increments thereafter
Commitments under leases before the commencement of the lease term
The components of any loss associated with an impairment
Apply GASB 87 retroactively, if practicable, for all periods presented. Use the facts and circumstances existing at the beginning of the implementation period to record the leases.
The notes to the financial statements should disclose the nature of the restatement and its effect.
GASB 87 says that the provisions of this statement need not be applied to immaterial items.
GASB 87 Effective Date
The effective date of GASB 87 is for reporting periods beginning after December 15, 2019.
Many small governments suffer losses from theft since they lack a sufficient number of employees to segregate accounting duties. There are, however, steps you can take to protect your resources. In this post, I provide ideas for fraud prevention in small governments.
Most government officials don’t realize that external audits are not designed to detect immaterial fraud (immaterial can be tens of thousands of dollars – sometimes even more). Such officials incorrectly believe that a clean opinion means no fraud is occurring in their locale – this is a mistake. External financial statement opinion audits are not designed to look for fraud at immaterial levels. Even if your government has an external audit, consider implementing fraud prevention procedures.
In a typical small government accounting setting, the city of In Between (as in between two stop lights) (population 1,202) has a mayor and three council members. The city has one bookkeeper (we’ll call him Dale) who orders and receives all purchased items; he writes all checks, reconciles bank statements, and keys all transactions into the accounting system. Dale also receipts all collections and makes all deposits. Mayor Chester signs all checks (vendor and payroll). (In a long-standing tradition, the mayor also graces the city Christmas parade float as Santa Claus.) With so little segregation of duties, what can be done?
The smaller the government, the greater the need for fraud prevention – even if Santa Claus in involved. And yet, these are the governments that most often don’t have the resources–whether the money to pay for outside assistance or employees to segregate duties–to prevent fraud. Here are few ideas for even the smallest of governments.
Low-Cost Fraud Prevention
First, let’s look at low-cost fraud prevention options:
Have all bank statements mailed directly to Mayor Chester who will open and inspect the bank statement activity before providing the bank statements to Dale; alternatively, provide online access to Mayor Chester who reviews bank statement activity and signs a monthly memo documenting his review
Once or twice a year, have council members pick two months at random (e.g., May and September) and review key bank statement activity (e.g., the operating and payroll accounts)
Once or twice a year, have council members randomly select checks (e.g., ten vendor checks and ten payroll checks) and review supporting documentation (e.g., invoices and time sheets)
Once or twice a year, have the mayor and council review receipt collections and related documentation (e.g., for two days deposits); agree receipts to bank deposits and to the general ledger
Provide monthly budget to actual reports to mayor and council
Provide monthly overtime summaries to mayor and council
Do not allow Dale to sign checks
Require two signatures on checks above a certain level (e.g., $5,000); have two of the council members (in addition to the mayor) on the bank signature cards; supporting documentation (e.g., invoice) should be provided to check signers for review
Require Mayor Chester and Dale to authorize any wire transfers
Have Dale provide the mayor with monthly bank reconciliations; the mayor should document (e.g., initial the reconciliation) his review
Don’t provide Dale with a credit card
If Dale is provided a credit card, provide him with one card; use a low maximum credit limit (e.g., $1,000); Dale’s credit card statements should be provided to the mayor when he signs the related check for payment
Use a centralized receipting location (if possible); receipts should always be written upon collection of a payment
Higher Cost Fraud Fraud Prevention
Now let’s examine some higher cost options (that are probably more effective):
Have an outside CPA or CFE map your internal control system and make system-design recommendations
Have an outside CPA or CFE make surprise unannounced visits (e.g., two per year) to examine the receipting system, payroll, and the payment system; at the beginning of the year, tell Dale that the surprise visits will occur (details of what will be tested should not be communicated to Dale)
Install a security camera to record all of Dale’s collection and receipting activity
Purchase fidelity bond to cover elected officials and Dale
Keep in mind that you can limit the cost of the outside CPA. The contract might read Surprise audit of vendor payments with cost limited to $1,500. Try to contract with a CPA or CFE with governmental experience. The surprise audits and the fidelity bond recommendations are, in my opinion, the most critical steps.
Some states like New York audit local governments for fraud; consequently, if your local government is frequently audited by a state agency, there may be less of a need to hire an outside CPA or CFE to perform fraud prevention procedures.
Additional Fraud Prevention Resources
Click here for a list of local government controls to consider.