In this video, we walk through 5 BAR practice questions on component units of governments. These questions are from BAR content area 3 on the AICPA CPA exam blueprints: State and Local Governments
The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.
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Component Units of Governments
At a basic level, a component unit is a legally separate organization that still needs to be included in a government’s financial statements because the relationship between the two is significant enough that users should see the financial information together.
The biggest thing to understand is when a component unit exists and whether it should be reported using blended or discrete presentation.
What Is a Component Unit?
A component unit is a legally separate organization for which the primary government is financially accountable. A component unit can also exist when excluding the organization would make the government’s financial statements misleading.
The key phrase here is “legally separate.” The organization technically stands on its own, but the relationship with the government is still close enough that the government cannot simply ignore it in its reporting.
A common mistake is assuming that every organization connected to a government is a component unit. That is not true. The relationship has to be significant enough to require inclusion in the reporting entity.
Most Component Units Are Discretely Presented
In most cases, component units are reported using discrete presentation.
Discrete presentation means the component unit is shown separately from the primary government in the government-wide financial statements. Typically, this means the component unit appears in its own separate column in the statement of net position and statement of activities.
This separate presentation is important because it allows users to distinguish the component unit’s financial information from the primary government’s financial information.
One important exam point is that note disclosure alone is not enough. If a component unit is discretely presented, its financial information must still appear directly in the financial statements.
When a Component Unit Is Blended
Some component units are so closely related to the primary government that separate presentation would not make much sense. In those situations, the component unit is blended into the primary government’s financial statements.
Blending is required if any one of the following conditions exists:
- The component unit is substantively the same as the primary government.
- The component unit serves the primary government exclusively or almost exclusively.
- The component unit is not a separate legal entity.
When blending occurs, the component unit’s financial information is combined with the primary government’s financial information instead of being shown separately.
This is one of the easiest ways to distinguish blended presentation from discrete presentation on the exam: blended means combined together, while discrete means shown separately.
How to Think About Discrete vs. Blended
A good practical way to approach exam questions is to first ask whether any blending criteria are present.
If the component unit exists mainly to serve the primary government or is essentially part of the same entity, blending is probably appropriate.
If the organization operates more independently, even though it is still related to the government, discrete presentation is usually the correct answer.
In other words, discrete presentation is generally the default unless one of the blending rules specifically applies.
Summary
If the organization is closely tied to the government but still operates somewhat independently, think discrete presentation.
If the organization is basically functioning as part of the government itself, think blended presentation.
