BAR CPA Exam: Understanding the Disclosure Requirements for the Notes to the Basic Financial Statements of State and Local Governments

Introduction

Purpose of Notes to Financial Statements

In this article, we’ll cover understanding the disclosure requirements for the notes to the basic financial statements of state and local governments. The notes to the basic financial statements are a critical component of financial reporting, especially for state and local governments. They serve as a narrative guide, explaining the figures presented in the financial statements and providing the necessary context to fully understand the financial health and operations of the government entity. Without the notes, users—such as taxpayers, creditors, and oversight bodies—may struggle to interpret key financial metrics, which can lead to misinformed decisions.

These notes offer additional details that are not always apparent in the financial statements themselves. For example, the notes will describe significant accounting policies, explain unusual or complex transactions, and clarify contingent liabilities. This allows for more transparency and ensures that users can evaluate the financial statements in their proper context.

In essence, the notes complement the basic financial statements by elaborating on key data points, thus making the financial reports more useful for stakeholders. They ensure that the financial reporting process upholds principles of full disclosure and transparency, which are vital for the accountability of state and local governments.

Scope of Disclosure Requirements

The Governmental Accounting Standards Board (GASB) sets the standards that govern how state and local governments in the United States prepare their financial statements, including the notes. GASB’s rules are designed to ensure that government financial reporting is consistent, transparent, and provides useful information to users.

The disclosure requirements outlined by GASB focus on several key areas:

• Accounting Policies: Governments must disclose the significant accounting policies they use in preparing their financial statements. This includes methods for recognizing revenues, valuing assets, and depreciating capital assets.
• Detailed Explanations of Financial Line Items: Notes should provide additional detail about key items in the financial statements, such as cash and investments, capital assets, and long-term liabilities.
• Commitments and Contingencies: Governments are required to disclose potential liabilities or obligations that could affect their future financial position.
• Interfund Activity: Details on transfers between different governmental funds must be disclosed to provide clarity on how resources are allocated within the government.

Through GASB guidelines, the notes aim to provide comprehensive information that clarifies the content of financial statements, while ensuring that users understand the assumptions, methods, and risks that underpin the reported data. These requirements create a uniform reporting system, making it easier to compare financial reports across different government entities and fostering trust in the financial information provided.

Regulatory Framework

GASB Guidelines

The Governmental Accounting Standards Board (GASB) is the primary authority responsible for establishing accounting and financial reporting standards for state and local governments in the United States. GASB’s standards are designed to ensure that government financial reports provide reliable and transparent information to the public and other key stakeholders, including taxpayers, creditors, and oversight bodies.

GASB issues accounting standards in the form of Statements, Concepts Statements, and Technical Bulletins that guide the preparation and presentation of financial statements. The key standard for the disclosure requirements in the notes to financial statements is GASB Statement No. 34, which sets the foundation for modern financial reporting by state and local governments. This standard introduced the requirement for governments to present both government-wide and fund-level financial statements, along with comprehensive notes that explain and clarify the financial data.

Other relevant GASB standards that influence the disclosure requirements include:

• GASB Statement No. 68: This standard sets the guidelines for disclosing pension liabilities, one of the most significant disclosures for state and local governments.
• GASB Statement No. 87: This addresses the disclosure of lease obligations, ensuring that governments properly account for and disclose leasing arrangements.
• GASB Statement No. 75: Focuses on post-employment benefits other than pensions (OPEB) and requires governments to disclose the liability and funding status of these plans.

These standards ensure consistency and comparability across financial reports, which is crucial for the accountability of government entities. By adhering to GASB guidelines, state and local governments provide financial statements that are standardized and transparent, allowing users to make informed decisions based on consistent data.

Purpose of Disclosure Requirements

The primary purpose of disclosure requirements in state and local government financial statements is to provide comprehensive and relevant information that goes beyond the numbers presented in the basic financial statements. These disclosures serve several important functions:

1. Transparency: Disclosures explain the underlying assumptions, accounting methods, and significant decisions made in preparing the financial statements. This allows users to understand how figures like assets, liabilities, revenues, and expenses are calculated, offering a clearer picture of the government’s financial position.
2. Full Disclosure: The financial statements alone may not provide all the information necessary for a complete understanding of a government’s financial situation. The notes help fill this gap by providing details on key issues such as pension obligations, long-term debt, and the impact of leases. By disclosing this information, governments avoid misleading financial statement users and ensure compliance with full-disclosure principles.
3. Risk Assessment: Disclosures help stakeholders assess the potential risks facing the government, such as legal contingencies, environmental liabilities, or exposure to volatile financial instruments. By outlining these risks, the notes provide a basis for evaluating the government’s ability to meet its financial obligations in the future.
4. Accountability: Government entities are accountable to the public and must demonstrate responsible financial management. Disclosures related to interfund transfers, debt service requirements, and contingent liabilities ensure that financial statements convey the true state of government finances and any potential risks.

By ensuring that these objectives are met, the disclosure requirements mandated by GASB provide users with a more complete and accurate understanding of the financial health and obligations of state and local governments.

Key Disclosure Requirements

Summary of Significant Accounting Policies

One of the first and most important disclosures in the notes to the basic financial statements is the Summary of Significant Accounting Policies. This section outlines the key accounting methods and assumptions used by state and local governments to prepare their financial statements. These policies provide transparency into how governments recognize revenues, measure expenses, value assets, and more.

Governments must disclose several critical accounting policies, including:

• Basis of Accounting: Whether the government uses accrual accounting (used in government-wide statements) or modified accrual accounting (used in fund-level statements).
• Capitalization Thresholds: The minimum amount that determines when a purchase is classified as a capital asset.
• Depreciation Methods: The methods used for depreciating capital assets, including the estimated useful lives of different asset classes.
• Revenue Recognition: The criteria for recognizing various forms of revenue, such as taxes, grants, and service charges.

Relevance of Policy Disclosures

The disclosure of accounting policies is essential because it allows users of the financial statements to understand the framework under which the government operates financially. Different governments may use different methods to account for assets, liabilities, and revenues, and this can significantly impact the reported financial position and performance. For example, if a government uses a shorter useful life for depreciating its capital assets, its depreciation expense will be higher compared to another government that uses a longer useful life, even if the assets themselves are similar.

By understanding these policies, users such as investors, creditors, and taxpayers can make more accurate comparisons between different governments and better assess a government’s financial health and decision-making processes.

Explanation of Financial Statement Line Items

State and local governments are also required to provide detailed explanations for key line items presented in the financial statements. These notes offer more in-depth information on specific financial elements that are crucial to understanding the overall financial condition of the entity.

Assets

The assets section of the notes explains key items such as:

• Cash and Investments: Governments must disclose the types of investments they hold, the risks associated with those investments (such as credit risk, interest rate risk, and custodial credit risk), and how cash and investments are valued. They must also disclose any restrictions on cash, such as those related to debt service requirements.
• Receivables: This section details amounts owed to the government, including taxes receivable, grants receivable, and other sources of revenue. Governments also explain the allowance for doubtful accounts, which represents amounts they do not expect to collect.
• Capital Assets: Governments provide information on the value of capital assets, including land, buildings, equipment, and infrastructure. Disclosures also include accumulated depreciation, as well as any additions or retirements of capital assets during the reporting period.

These disclosures are critical in understanding how well the government is managing its resources and how efficiently it is investing in and maintaining its capital assets.

Liabilities

Governments must provide comprehensive disclosures about their liabilities, which include:

• Debt Obligations: Details on outstanding bonds, loans, and other forms of long-term debt, including repayment terms, interest rates, and maturities. Governments must also disclose any refundings of debt that occurred during the year.
• Leases: Information on lease obligations, including lease terms and payment schedules, must be disclosed under the guidelines set forth by GASB.
• Pension Liabilities: With increasing scrutiny on pension obligations, governments must disclose their liabilities related to employee pension plans, including actuarial assumptions, funding status, and contributions required in the future.
• Other Post-Employment Benefits (OPEB): Governments must also disclose liabilities related to OPEB, such as retiree health care benefits, which can have significant financial implications.

Understanding these liabilities is crucial for stakeholders to assess the government’s financial obligations and its ability to meet future payment requirements.

Net Position/Fund Balances

Governments are required to classify their net position or fund balances into categories that reflect the nature of the funds available:

• Net Investment in Capital Assets: This category represents the portion of net position related to capital assets, net of accumulated depreciation and any related debt used to acquire those assets. It reflects the government’s investment in its infrastructure.
• Restricted: Net position that is legally or externally restricted for specific purposes, such as for debt service, capital projects, or grants.
• Unrestricted: The portion of net position that is not restricted and can be used for any purpose. This is a key indicator of the government’s financial flexibility.

These disclosures help stakeholders understand the availability and constraints on a government’s resources, making it easier to evaluate its financial health and sustainability.

By providing detailed explanations of assets, liabilities, and net position, state and local governments offer a transparent view of their financial standing, making it easier for users of the financial statements to assess both short-term liquidity and long-term fiscal sustainability.

Commitments and Contingencies

State and local governments are required to disclose any commitments and contingencies that could impact their financial position. These commitments represent obligations that the government has entered into but have not yet resulted in actual transactions or payments, while contingencies are potential liabilities that may arise depending on the outcome of future events. The purpose of this disclosure is to provide transparency regarding risks that could affect the government’s financial health in the future.

Contingent Liabilities

Contingent liabilities are potential obligations that depend on the occurrence of future events. Governments must disclose contingent liabilities if the likelihood of an adverse outcome is considered probable and the amount of the liability can be reasonably estimated. Even if the outcome is less likely but still possible, the government is required to disclose the nature of the contingency and an estimate of the potential financial impact, if available.

Typical contingent liabilities include:

• Legal Claims: Governments must disclose details of ongoing litigation or potential lawsuits that could result in financial loss. This includes claims related to contracts, torts, or other legal disputes that could significantly affect the government’s financial standing.
• Environmental Liabilities: Governments may also have exposure to environmental risks, such as the cleanup of contaminated sites or other environmental remediation efforts. These must be disclosed, particularly if there are regulatory or legal requirements to address the issue.
• Grant Commitments: Governments often enter into agreements with other entities to receive grants, which come with conditions and obligations. If the government is obligated to meet certain conditions to retain or continue receiving grant funds, these commitments must be disclosed.

By providing details about commitments and contingencies, state and local governments ensure that stakeholders have a complete understanding of the potential risks they face. This information is critical for evaluating the government’s ability to meet its financial obligations and manage unforeseen events.

Interfund Balances and Transfers

Interfund balances and transfers are common in state and local governments, as these entities often maintain multiple funds to track specific revenue streams, expenditures, and restrictions. Governments are required to disclose any interfund activity, including transfers of resources and outstanding balances between funds, to ensure that the financial statements accurately reflect the movement of funds within the entity.

Importance of Disclosing Interfund Activity

Interfund activity refers to transactions between different funds within a government’s financial system. These activities typically occur when resources are moved from one fund to another to support operations, fulfill debt obligations, or allocate resources for specific purposes. Disclosing interfund balances and transfers is important because it helps users of the financial statements understand how the government manages its resources across different funds and ensures accountability for the use of those funds.

Types of Interfund Activity

1. Interfund Receivables and Payables: These balances arise when one fund owes money to another fund. For example, if the General Fund temporarily provides cash to a Capital Projects Fund to cover an expenditure, an interfund receivable is recorded in the General Fund and an interfund payable in the Capital Projects Fund. Governments must disclose the nature of these interfund balances, including repayment terms, to provide transparency about resource allocation.
2. Interfund Transfers: Transfers are permanent reallocations of resources between funds. These transfers may be made to support specific programs, pay debt service, or meet other financial obligations. For example, the General Fund may transfer resources to a Debt Service Fund to cover bond payments. Governments must disclose the purpose and amount of these transfers to explain how resources are being used to meet the government’s financial goals.

Examples of Managing Interfund Activity

Governments often use interfund receivables and payables to manage cash flow and allocate resources efficiently. For example:

• A government might transfer excess funds from an Enterprise Fund (e.g., a water utility) to the General Fund to support general government operations.
• Interfund receivables could occur when a Special Revenue Fund temporarily borrows money from the General Fund to cover short-term expenses related to a grant-funded project.

By disclosing these activities, governments provide a clear picture of the financial relationships between their various funds and ensure that financial statement users understand the allocation and movement of resources within the entity. Transparency in these disclosures is crucial for assessing the government’s financial health and its ability to manage its finances across different funds.

These disclosures also help stakeholders identify any potential concerns related to over-reliance on certain funds for financial support or long-term interfund balances that may indicate cash flow issues within specific funds.

Long-Term Debt and Debt Service Requirements

State and local governments often finance long-term projects such as infrastructure development through the issuance of debt. GASB requires detailed disclosure of long-term debt to ensure transparency regarding the government’s financial obligations. These disclosures allow stakeholders to understand the scope of the government’s indebtedness, the repayment terms, and any associated risks.

Disclosure Requirements for Long-Term Debt

Governments must provide comprehensive information about their long-term debt, including:

• Maturity Dates: A schedule outlining when the debt will mature, detailing short-term (due within a year) and long-term obligations.
• Interest Rates: Disclosure of interest rates associated with the debt instruments, providing insight into the cost of borrowing.
• Payment Schedules: A breakdown of future principal and interest payments over time, giving users of the financial statements an understanding of the government’s future cash flow obligations.
• Bond Covenants: Information regarding any restrictions or covenants imposed by creditors as a condition of borrowing, such as maintaining a minimum reserve level or restricting further debt issuance.

Debt Refundings

When governments refinance or refund debt, they must disclose the terms of the refunding and its impact on the government’s financial position. Key disclosures for debt refundings include:

• The reason for the refunding, whether to reduce interest costs or restructure debt.
• The difference between the carrying amount of the old debt and the consideration paid for the refunding.
• The savings or additional costs resulting from the refunding.

These disclosures provide critical information to assess the government’s debt management strategies and potential risks associated with long-term financial obligations.

Pension Plans and Other Post-Employment Benefits (OPEB)

Governments often provide pension plans and post-employment benefits such as health care (OPEB) for their employees. The disclosure of these obligations is a key part of financial reporting because these liabilities can represent significant long-term financial commitments.

Pension Obligations

Governments must disclose a range of information related to their pension plans, including:

• Funded Status: The difference between the pension plan’s assets and its liabilities, indicating whether the plan is fully funded or underfunded.
• Actuarial Assumptions: Governments must disclose key actuarial assumptions used to calculate pension obligations, such as the discount rate, expected rate of return on plan assets, and demographic assumptions (e.g., retirement ages, mortality rates).
• Contributions: Information on contributions to the pension plan, including the government’s required contributions and any shortfall or excess in actual contributions made.

These disclosures help users evaluate the long-term financial health of the pension system and the government’s ability to meet its future pension obligations.

Other Post-Employment Benefits (OPEB)

In addition to pensions, governments often provide OPEB, such as retiree health care. GASB requires disclosures similar to those for pension plans:

• OPEB Liabilities: The total liability for providing post-employment health care and other benefits, which may be substantial.
• Funded Status: The extent to which OPEB liabilities are funded through assets set aside for this purpose.
• Actuarial Assumptions: Assumptions used to project future OPEB costs, including health care cost trends and demographic factors.

These disclosures ensure that stakeholders are informed of the government’s long-term financial obligations related to employee benefits, which can have a significant impact on financial sustainability.

Leases and Lease Obligations

GASB’s lease accounting standards require governments to disclose key information about leases, both as lessors (lease receivables) and lessees (lease obligations). The disclosures are designed to provide transparency about the government’s lease commitments and the financial impact of leasing arrangements.

Disclosure of Lease Obligations

For leases in which the government is the lessee, the following must be disclosed:

• Lease Terms: The length of the lease, payment amounts, and other key terms such as options for renewal or purchase.
• Lease Payments: A schedule of future lease payments, including both principal and interest components.
• Discount Rate: The discount rate used to calculate the present value of lease liabilities.

For leases in which the government is the lessor, disclosures must include:

• Lease Receivables: The amount of future lease receivables expected, along with the timing of payments.
• Interest Income: The interest income expected to be earned over the life of the lease.

These disclosures are important for understanding the government’s ongoing financial commitments related to leased assets and their impact on future financial statements.

Risks and Uncertainties

Governments face various risks and uncertainties that could impact their financial position. GASB requires disclosure of these risks to ensure that users of the financial statements are aware of potential vulnerabilities. Key risk disclosures include:

Financial Instrument Risks

Governments must disclose risks related to their financial instruments, such as:

• Credit Risk: The risk that counterparties to the government’s investments will fail to meet their obligations, resulting in financial loss.
• Interest Rate Risk: The risk that changes in interest rates will negatively affect the value of the government’s investments or increase the cost of borrowing.
• Foreign Exchange Risk: If a government holds investments in foreign currencies, it must disclose the risk associated with currency fluctuations.

Vulnerability to Concentration Risks

Governments may also need to disclose any vulnerability to concentration risks, where a significant portion of revenue or resources is dependent on a single source or sector. For example:

• A local government that relies heavily on property taxes from a single large employer could face financial uncertainty if that employer relocates or downsizes.
• Exposure to a specific industry or investment type (e.g., municipal bonds) that could be adversely affected by economic conditions.

By disclosing these risks, governments provide a clearer picture of their financial stability and their ability to manage and mitigate potential uncertainties. This information is crucial for stakeholders in assessing the long-term viability of the government’s financial position.

Leases and Lease Obligations

Under the Governmental Accounting Standards Board (GASB) standards, governments are required to provide detailed disclosures about their leases and lease obligations. GASB Statement No. 87, which governs lease accounting, introduced significant changes to how leases are reported on the financial statements. The primary goal of these disclosures is to provide transparency about the financial impact of leasing arrangements, whether the government is acting as a lessee or a lessor.

Lessee Disclosures

For governments that lease assets (as lessees), GASB requires the following information to be disclosed:

• Lease Terms: The length of the lease, options for renewal, and any termination clauses must be disclosed. This includes the description of the underlying leased asset, such as buildings, vehicles, or equipment.
• Lease Payments: A schedule of future lease payments is required, breaking down the payments into principal and interest components. This helps users understand the government’s future cash outflows and the obligations they face.
• Discount Rate: The discount rate used to calculate the present value of future lease payments is a key component of the disclosures. It provides insight into the financing cost of the lease.
• Variable Lease Payments: Any payments that vary based on factors like usage or performance must be disclosed separately, as they can affect the predictability of future costs.
• Contingent Rent: If the lease includes contingent rent, such as payments tied to inflation or other variables, these must also be disclosed.

Lessor Disclosures

Governments that lease assets to other entities (as lessors) must provide disclosures on:

• Lease Receivables: The government must report the amount of future payments expected from the lessee, providing a clear picture of the receivables that will be collected over the life of the lease.
• Interest Income: The interest income expected from the lease receivable over the term of the lease must also be disclosed. This allows stakeholders to assess the return the government will receive from its leasing activities.
• Renewal and Termination Options: If the lease includes options for renewal or termination, these must be explained, including the likelihood of the lessee exercising these options.

By providing these details, governments ensure transparency in their leasing arrangements, allowing stakeholders to evaluate the impact of leases on the government’s financial position and long-term obligations.

Risks and Uncertainties

Governments are also required to disclose significant risks and uncertainties that could affect their financial health. These disclosures are designed to help stakeholders understand the potential vulnerabilities and exposures that governments face in their financial operations. Common risks that must be disclosed include those related to financial instruments, investments, and reliance on specific revenue sources or sectors.

Financial Instrument Risks

Governments often invest in various financial instruments, which can expose them to different types of risk. GASB standards require disclosure of these risks, including:

• Credit Risk: This is the risk that a counterparty to an investment will default on its obligations, leading to financial loss. For example, if a government holds bonds issued by corporations or municipalities, it must disclose the credit ratings and the risk of default associated with those bonds.
• Interest Rate Risk: Changes in interest rates can affect the value of investments, particularly fixed-income securities like bonds. Governments must disclose their exposure to interest rate risk, including the maturities of their investments and any strategies used to mitigate the impact of interest rate fluctuations.
• Foreign Exchange Risk: If a government holds investments denominated in foreign currencies, it must disclose the risk of exchange rate fluctuations affecting the value of those investments. This is particularly relevant for governments with international exposure or investments in global markets.

Vulnerability to Concentration Risks

Governments are required to disclose any vulnerabilities to concentration risks, which occur when a significant portion of their financial resources or revenues is dependent on a single source, industry, or geographic region. Concentration risks can create financial instability if the government becomes too reliant on one entity or sector.

Examples include:

• Revenue Dependence: A government that relies heavily on a single taxpayer or industry (such as a major corporation or the oil and gas industry) for property tax revenues must disclose this dependency. If that industry experiences a downturn or the corporation relocates, the government’s revenue stream could be significantly impacted.
• Investment Concentration: If a large portion of a government’s investments is concentrated in a particular type of security (e.g., municipal bonds or stocks in a particular sector), the government must disclose the potential risks associated with that concentration. Any significant changes in market conditions could affect the government’s investment portfolio.

Other Risks

Governments must also disclose risks related to economic conditions, legal contingencies, and potential environmental liabilities. These disclosures provide a full picture of the challenges and uncertainties that could impact the government’s ability to meet its financial obligations in the future.

By providing detailed disclosures on risks and uncertainties, governments ensure that stakeholders are fully informed about potential vulnerabilities. This level of transparency helps users of the financial statements assess the government’s financial stability and resilience in the face of various risks.

Supplementary and Statistical Information

Additional Information Required

In addition to the core financial statements and notes, state and local governments are often required to provide supplementary disclosures and statistical data. These additional reports enhance the transparency and usefulness of financial statements by offering detailed insights into specific areas that help stakeholders make more informed decisions.

Budgetary Comparison Schedules

One key supplementary disclosure is the budgetary comparison schedule, which compares the government’s actual financial performance to its legally adopted budget. This schedule is important because it:

• Demonstrates Fiscal Responsibility: It allows stakeholders to assess how well the government adhered to its budgetary goals and whether it managed its resources effectively.
• Highlights Variances: The schedule shows significant variances between the budget and actual figures, providing insight into areas where the government may have overspent or underspent.
• Promotes Accountability: By requiring governments to explain significant budget variances, this disclosure ensures greater transparency and holds governments accountable for their financial decisions.

Budgetary comparison schedules are typically presented for the General Fund and other major funds that have legally adopted budgets. This information is crucial for taxpayers, oversight bodies, and policymakers to evaluate the government’s financial performance against its intended goals.

Pension-Related Schedules

Given the long-term financial implications of pension obligations, GASB requires governments to provide pension-related schedules as part of their supplementary disclosures. These schedules help users of the financial statements understand the funded status of pension plans and the government’s future obligations.

Key pension-related schedules include:

• Schedule of Changes in Net Pension Liability: This schedule provides a year-over-year comparison of changes in the government’s pension liability, including contributions made, benefits paid, and any changes in actuarial assumptions.
• Schedule of Employer Contributions: Governments must disclose their actual contributions to pension plans compared to the actuarially determined contribution required. This allows stakeholders to assess whether the government is meeting its funding obligations.
• Pension Plan Investment Returns: The schedule must show the historical rates of return on pension plan investments, helping stakeholders evaluate the performance of the pension fund and the assumptions used for future investment earnings.

These pension-related schedules provide a deeper understanding of the financial health of government pension plans, highlighting areas of risk and sustainability concerns.

Economic Condition Factors

Governments are also required to disclose economic condition factors, which offer insight into the external economic environment that may affect the government’s financial position. These factors are typically presented as part of a statistical section that includes long-term trends and key financial indicators.

Common economic condition factors include:

• Demographic Data: Information on population trends, income levels, and employment rates in the government’s jurisdiction. This data helps users assess the government’s tax base and its ability to generate future revenues.
• Property Value Trends: Data on property valuations and construction activity, which provide insights into the government’s revenue-generating potential from property taxes.
• Debt and Financial Trends: Historical data on long-term debt, debt service requirements, and other financial obligations. These trends provide a basis for evaluating the government’s fiscal sustainability over time.

By disclosing economic condition factors, governments provide valuable context for understanding their current financial position and potential future challenges. This information helps users evaluate the government’s financial health in light of broader economic trends, making it easier to forecast future revenue streams and expenditure needs.

Overall, the supplementary and statistical information required in governmental financial reports enhances the depth and quality of the information provided. These disclosures offer critical insights into a government’s financial management, pension sustainability, and the broader economic environment in which it operates. This allows for better decision-making and increased accountability to the public.

Common Issues and Pitfalls in Disclosure

Inconsistent or Incomplete Disclosures

One of the most frequent issues in governmental financial reporting is the presence of inconsistent or incomplete disclosures. These errors can occur for various reasons, such as a lack of understanding of the requirements, oversight, or a failure to update policies and disclosures in line with new regulations. Some common pitfalls include:

• Failure to Provide Required Detail: Governments sometimes fail to provide sufficient detail in key areas, such as long-term debt, pension obligations, or lease arrangements. Without adequate information, users of the financial statements cannot fully understand the government’s financial position or its future commitments.
• Outdated or Inaccurate Information: Governments may fail to update their disclosures to reflect the most recent financial conditions or regulatory changes. For example, if a government does not account for changes in pension obligations due to new actuarial assumptions, it can mislead stakeholders about the true cost of future liabilities.
• Inconsistent Reporting Across Funds: Sometimes, governments present disclosures that are inconsistent across different funds or financial statements. For instance, interfund balances or transfers may be reported differently in the individual fund financial statements compared to the government-wide statements, leading to confusion for readers.
• Omitting Required Supplementary Information: Governments are required to present certain supplementary disclosures, such as budgetary comparison schedules and pension-related schedules. Omitting this information can lead to noncompliance with GASB standards and result in an incomplete picture of the government’s financial health.
• Lack of Clarity in Risk Disclosures: Many governments struggle to clearly communicate financial risks, such as exposure to investment volatility, credit risk, or economic uncertainties. This lack of clarity can make it difficult for stakeholders to assess the potential challenges the government may face in the future.

These inconsistent or incomplete disclosures reduce the usefulness of financial statements and make it difficult for stakeholders to evaluate the government’s fiscal health accurately. Addressing these pitfalls is critical for maintaining the integrity of financial reporting.

Importance of Transparency and Compliance

The importance of transparency and compliance in government financial reporting cannot be overstated. GASB guidelines are designed to ensure that financial statements provide a clear, accurate, and comprehensive view of a government’s financial position, including its obligations, risks, and performance. Failure to follow these guidelines can result in significant consequences.

Legal and Financial Implications

Noncompliance with GASB standards can lead to a range of legal and financial repercussions:

• Loss of Public Trust: Governments are accountable to the public, and incomplete or misleading disclosures can erode trust. Stakeholders, including taxpayers and bondholders, rely on transparent financial statements to make informed decisions.
• Legal Risks: If a government’s financial statements do not meet the required standards, it could face legal challenges, particularly if omissions or inaccuracies lead to financial losses for stakeholders or result in violations of contractual agreements, such as bond covenants.
• Impact on Credit Ratings: Credit rating agencies assess a government’s financial health when determining its creditworthiness. Incomplete or inconsistent disclosures can lead to downgrades in credit ratings, increasing borrowing costs and potentially limiting access to capital markets.
• Audit Findings: External auditors may issue unfavorable opinions or include findings in their reports if a government fails to comply with GASB disclosure requirements. Such findings can have a negative impact on the government’s financial standing and lead to further scrutiny from regulatory bodies.

Ensuring Compliance

To avoid these issues, governments must:

• Stay Updated with GASB Standards: GASB periodically issues new standards and updates existing ones. Governments should ensure that they are up to date with the latest requirements and that their financial reporting processes are aligned with these standards.
• Conduct Regular Reviews: Governments should review their financial disclosures regularly to ensure accuracy and completeness. This includes updating information for any new financial transactions, obligations, or risks that have arisen since the previous reporting period.
• Provide Training for Financial Staff: Governments should invest in training for their finance and accounting staff to ensure they understand GASB standards and can apply them correctly in preparing financial statements.

By prioritizing transparency and strict adherence to GASB guidelines, governments can maintain the integrity of their financial reporting. This, in turn, fosters trust among stakeholders and ensures that financial statements provide an accurate reflection of the government’s fiscal condition and long-term sustainability.

Example of Proper Note Disclosures

Sample Notes

To illustrate how state and local governments should properly disclose key financial information, below is an example of proper note disclosures following GASB standards. This mock disclosure covers three key areas: pension obligations, long-term debt, and fund balances. These examples demonstrate the level of detail and transparency required for stakeholders to fully understand the government’s financial position.

Pension Obligations

Note 1: Pension Plan

The City of Exampleville provides pension benefits to its employees through the Exampleville Public Employees Retirement System (EPERS), a defined benefit plan that covers all full-time employees. The pension plan is administered by the Exampleville Pension Fund.

• Plan Description: The plan provides retirement, disability, and survivor benefits to participants. Employees are eligible for retirement benefits after 10 years of service and attainment of age 60.
• Contributions: Employees contribute 6% of their annual salary, while the City of Exampleville contributes an actuarially determined amount each year. For the fiscal year ended June 30, 2024, the City contributed $4.5 million, representing 12.5% of covered payroll.
• Pension Liability: As of June 30, 2024, the total pension liability for the plan was $125 million. The plan’s fiduciary net position was $90 million, resulting in a net pension liability of $35 million.
• Actuarial Assumptions: The total pension liability was determined by an actuarial valuation as of June 30, 2023. Key assumptions include a discount rate of 7.25%, an inflation rate of 2.5%, and salary increases of 3.0% per year.
• Pension Plan Fiduciary Net Position: The plan’s assets are held in trust and invested in a diversified portfolio of equities, fixed income, and real estate. The plan earned a return of 8.1% for the fiscal year.

Pension Schedule:

Fiscal Year	Total Pension Liability	Plan Fiduciary Net Position	Net Pension Liability
2023	$120 million	$85 million	$35 million
2024	$125 million	$90 million	$35 million

Long-Term Debt

Note 2: Long-Term Debt

The City of Exampleville has issued various bonds to finance capital improvements. These bonds are backed by the full faith and credit of the city and will be repaid through property tax revenues.

• General Obligation Bonds: As of June 30, 2024, the City had $50 million of general obligation bonds outstanding, with interest rates ranging from 3.0% to 5.5%.
• Revenue Bonds: The City also had $20 million in revenue bonds outstanding, which are secured by water utility revenues. These bonds bear interest rates of 4.0% to 6.0%.
• Debt Maturity Schedule: The following is a summary of the city’s debt service requirements to maturity for general obligation and revenue bonds:

Debt Maturity Schedule:

Fiscal Year	Principal (GO Bonds)	Interest (GO Bonds)	Principal (Revenue Bonds)	Interest (Revenue Bonds)
2025	$5 million	$2 million	$3 million	$1.2 million
2026	$6 million	$1.8 million	$3.5 million	$1.1 million
2027	$7 million	$1.6 million	$4 million	$1 million
2028	$8 million	$1.4 million	$4.5 million	$900,000

• Refunding: In 2024, the City refunded $10 million of its outstanding general obligation bonds to take advantage of lower interest rates. The refunding resulted in a net savings of $1.5 million over the life of the bonds.

Fund Balances

Note 3: Fund Balances

The City of Exampleville reports fund balances in the following categories, in accordance with GASB Statement No. 54:

• Nonspendable Fund Balance: $500,000 is classified as nonspendable, representing amounts that cannot be spent because they are not in spendable form (e.g., inventory, prepaid expenses).
• Restricted Fund Balance: $10 million is restricted for specific purposes as outlined by external parties, legislation, or contracts. Of this amount, $7 million is restricted for debt service, while $3 million is restricted for capital projects.
• Committed Fund Balance: $4 million is committed by formal action of the City Council for future infrastructure improvements.
• Assigned Fund Balance: $2 million is assigned for next year’s budget to cover planned expenditures related to public safety initiatives.
• Unassigned Fund Balance: The General Fund’s unassigned fund balance is $3 million, representing funds that are available for any governmental purpose.

Fund Balance Classification:

Fund Type	Nonspendable	Restricted	Committed	Assigned	Unassigned
General Fund	$500,000	$2 million	$1 million	$2 million	$3 million
Capital Projects Fund	–	$3 million	$2 million	–	–
Debt Service Fund	–	$7 million	–	–	–

These examples demonstrate how governments should present critical financial information in their notes, ensuring transparency and compliance with GASB standards. Proper note disclosures provide clarity and enable stakeholders to make well-informed assessments of the government’s financial health and obligations.

Conclusion

Recap Importance of Disclosures

Accurate and comprehensive disclosures in the notes to the financial statements of state and local governments are fundamental to ensuring accountability and transparency. These disclosures provide essential details that enhance the clarity and context of the financial data presented, allowing stakeholders to fully understand the government’s financial position, obligations, and future risks. The notes explain how key figures are derived, offer insights into potential liabilities, and clarify the methods and assumptions used in financial reporting.

Without detailed disclosures, the financial statements would offer an incomplete picture, limiting the ability of taxpayers, creditors, and oversight bodies to make informed decisions. Disclosures foster public trust, ensure compliance with regulatory standards, and support the efficient functioning of government finance by clearly outlining risks and obligations. This level of transparency is critical for maintaining the integrity of governmental financial reporting and ensuring that governments remain accountable to their constituents.

Future Trends

As financial reporting evolves, state and local governments must keep pace with anticipated changes in disclosure requirements. One key area of focus is the increasing emphasis on environmental, social, and governance (ESG) reporting, which may lead to more detailed disclosures on sustainability initiatives, climate-related risks, and the impact of government operations on the environment.

Additionally, the modernization of technology and increasing reliance on digital infrastructure may introduce new requirements for disclosing risks related to cybersecurity and data privacy, especially as governments continue to adopt cloud computing and other advanced IT systems.

Finally, continued updates from the Governmental Accounting Standards Board (GASB) will likely refine and expand disclosure requirements to improve transparency around debt, pension liabilities, and other post-employment benefits (OPEB). Governments should remain proactive in monitoring these changes to ensure that their financial reporting remains compliant and reflects best practices in accountability and transparency.

By staying ahead of these trends and maintaining robust disclosure practices, governments can continue to meet the needs of their stakeholders and uphold the highest standards of financial integrity.