To address the challenges facing governments in reporting accounting changes and error corrections, GASB issued Statement 100. This standard aims for greater uniformity in practice and provides guidance for the presentation of accounting changes and error corrections in governmental financial statements, and establishes disclosure requirements for the notes to the financial statements. It also includes guidance for the treatment of accounting changes and error corrections within the supplementary information (both required and discretionary), an integral part of government annual reports.
In June 2022, GASB issued Statement 100, Accounting Changes and Error Corrections. An amendment to Statement 62, the standard clarifies practice by providing guidance for the classification and financial reporting treatment of various accounting changes and error corrections. Effective for fiscal years beginning after June 15, 2023, the standard will affect the year-end June 30, 2024, financial statements of many local governments (2023 for early adopters). Many governments will likely apply this new standard for the first time as they implement GASB Statement 101, Compensated Absences (described in the Sidebar).
GASB Statement 100 provides guidance for changes in the financial reporting entity, accounting principles, and estimates used to prepare financial information. The new standard also prescribes the treatment for the correction of errors in previously issued financial statements.
Central to the reporting of accounting changes is classifying the type of change. The reporting requirements differ between changes in the reporting entity, accounting principles, and accounting estimates. Changes in accounting estimates are treated prospectively, with no restatement or cumulative effect reported. In contrast, changes in the reporting entity and changes in accounting principle require restatement of beginning net position, fund balance, or fund net position (hereafter referred to as beginning residual equity). Changes in accounting principle must be applied to all periods presented in comparative financial statements, whereas changes in the reporting entity are applied only to statements for the year of change.
Additionally, the reporting of accounting changes differs from that of error corrections. Exhibit 1 provides examples of events that qualify for each of these categories, as well as events that do not. Exhibit 2 summarizes the accounting treatment and note disclosures required for accounting changes and error corrections. The following discussion more fully describes the requirements of this new GASB standard.
Classification of Accounting Changes with Examples
Presentation in Comparative Financial Statements
Changes in Reporting Entity
Because of the disaggregated nature of governmental reporting, governmental auditing standards employ the concept of opinion units. Under this structure, materiality is separately determined for each major fund and component unit, the aggregate of nonmajor funds, and both the governmental and business-type columns of the government-wide statements; GASB adopted a similar concept.
A change in accounting entity occurs when identifiable government operations move between fund-basis financial statements or between columns in a given statement. For example, a government could choose to move a government service (such as trash collection) from the General Fund by creating a new enterprise fund. Because proprietary and governmental funds are reported in separate sets of fund-basis statements, the move of this (ongoing) service causes a change in entity for both affected fund types. Furthermore, because governments report governmental and business-type activities in separate columns of the government-wide Statement of Net Position, the government would report a change in the reporting entity for both segments of the primary government.
Government financial statements are further disaggregated through the practice of reporting major funds. Governmental and enterprise funds that exceed quantitative thresholds must be reported as major funds in separate columns of the fund-basis statements. Because major funds are determined based upon the size of the fund relative to other funds within the primary government, the set of major funds can vary from year to year. A change in a fund’s presentation as major or nonmajor qualifies as a change in the reporting entity under GASB Statement 100.
Similarly, changes in the reporting entity may result from the reporting of component units. Modifications to the governance structure of a component unit could result in the addition or removal of the component unit from a government’s financial report. For example, a change from an appointed to an elected governing board could result in a component no longer meeting the criteria for inclusion in the government’s financial statements. Similarly, if a change in governance had the result that the governing board of a blended component unit and the reporting government were no longer the same, the financial information of the component unit might move from being a fund within the governmental or proprietary fund statements to a separate column (i.e., discrete presentation) in the government-wide financial statements. This change in the method of reporting would also be treated as a change in the reporting entity.
Within the private sector, changes in the reporting entity are largely limited to changes in the set of businesses included within the consolidated financial statements. Because they may arise from diverse sources, changes in the reporting entity among governments are more common. It is also interesting to note that the reporting treatment of changes in entity differs between the private and public sectors. Commercial businesses report changes in the reporting entity by restating the financial statements of all periods presented in the financial report.
In contrast to practices in the private sector, GASB requires governments to apply the change in entity to the current period, as if it occurred at the beginning of the period. The government should determine the cumulative effect of the change on all affected accounts as of the beginning of the current year. That cumulative effect is reported as an adjustment to the beginning residual equity. If comparative financial statements are presented, the financial statements of the earlier years are not restated for changes in the reporting entity. GASB’s rationale for this treatment is that a change in the entity results from a change in circumstances that did not exist in earlier periods.
Changes in Accounting Principle
A change in accounting principle exists when a government changes from one generally accepted accounting principle to another generally accepted accounting principle, provided the newly adopted principle is preferable in terms of the qualitative characteristics of financial reporting. (Qualitative characteristics are described in GASB Concept Statement No. 1 and include: understandable, reliable, relevant, timely, consistent, and comparable.) A change from an accounting method that is not generally accepted is a correction of an error, not a change in principle. Changes between two generally accepted principles are unusual in the public sector. It is much more common for a change in accounting principle to come about through the adoption of newly promulgated accounting standards. An example of such a change is described in the Sidebar, which summarizes the newly issued GASB Statement 101 for compensated absences.
Similar to private sector practices, governments will now report changes in accounting principle by restating the financial statements of all periods presented in the financial report. Prior to Statement 100, restatement of prior years was not required. The cumulative effect of the change for periods prior to the earliest year appearing in the comparative statements is reported as a restatement of beginning residual equity for the first year presented. GASB’s rationale for this treatment is that the effect of a change in accounting principle is not attributable to the current period, and therefore should not be reported within the current period’s activities.
GASB Statement 101: Compensated Absences
At the same time GASB issued Statement 100, the board issued Statement 101 requiring governments to report a liability for certain types of employee leave (i.e. compensated absences). The standard is required for fiscal years beginning after December 15, 2023, with early adoption encouraged.
Governments often provide paid leave to employees for absences due to sickness, vacation, the birth of a child, or military service. Some governments have a “use-it or lose-it” policy in which any unused leave is forfeited at the end of the year, while others permit employees to accumulate leave for use in a future period. This new statement differentiates among the types of leave and provides guidance for reporting the cost of employee leave and any resulting obligations. The key issue is when a government should recognize a liability for employee leave; that is, should the government recognize the obligation over time or wait until the leave commences?
In making this determination, GASB separated leave that is dependent upon the occurrence of an infrequent event and only affects a portion of employees. Specifically, employee leave for jury duty, military service, or parental leave (birth or adoption of a child) is not recognized as a liability until the leave commences. Similarly, holiday leave that occurs on a specific date is recognized at the date of the holiday. Other forms of compensated absence should be recognized as a liability if: the leave is attributable to employee services already rendered, if the leave accumulates, or if it is more likely than not to be used for time off or paid in cash.
The liability is to be measured using an employee’s rate of pay at the date of the financial statements and not discounted to present value. The liability and associated expense are reported in the government-wide statements and the financial statements of proprietary funds for workers employed by those departments. Governmental funds, however, recognize expenditures only to the extent the compensated absence payment comes due each period. Adoption of GASB Statement 101 is to be treated as a change in accounting principle in accordance with Statement 100.
Sometimes, a new GASB pronouncement can result in both a change in accounting principle and a change in the reporting entity. For example, GASB Statement 84 established criteria for identifying which activities to report within fiduciary funds. Some governments that previously reported retirement savings plans within the fiduciary category determined those activities did not meet the new standard’s criteria; the affected governments stopped reporting the plans among fiduciary activities. Determining whether a change resulting from a new GASB standard is a change in principle or a change in the reporting entity is important, because the accounting treatment differs between the two. Statement 100 removes ambiguity by requiring changes from new pronouncements be treated as changes in accounting principle, effectively making restatement the default treatment.
Changes in Accounting Estimates
GASB carried forward the prospective treatment for changes in accounting estimates; that is, governments apply the change in estimate to the current period, but not to prior years. GASB’s rationale is that a change in estimate is the result of new information, changing circumstances, or experience. Because these were not available in earlier periods, the change in estimate should not have an effect on prior periods. However, GASB cautions that a change in estimate is in fact a correction of error if the factors leading to the change are ones that management should have known and considered when the earlier financial statements were issued.
Accounting estimates are calculated using a set of inputs. In deciding whether changes in estimate require explanation, GASB distinguishes between changes in an input and changes to an input. For example, estimates may change because of period-to-period changes in prices within a specified price index (an input). Because this is a change in the value of an input, it does not require disclosure. However, an estimate may change because of changes in the goods and services that make up the index. Such a change is a change to the index and would require disclosure and explanation in the notes.
An exception exits to the general rule of prospective treatment. If a GASB standard provides specific guidance for how a change in estimate should be treated, that guidance takes precedence. For example, GASB Statement 68 prescribes the treatment of changes in assumptions used to estimate pension obligations that differs from the prospective treatment. Therefore, the requirements of Statement 100 for a change in accounting estimate apply only in the absence of other specific guidance.
Correction of Errors
Errors can occur as a result of mathematical and posting mistakes, accounting treatments that conflict with GAAP, or ignoring or misusing facts that existed at the date of the financial statements. GASB carried forward the retroactive accounting treatment for error correction, requiring restatement of all prior periods presented in comparative statements. In addition, the cumulative effect of the error for periods prior to the earliest year appearing in the comparative statements is reported as a restatement of beginning residual equity of the first year presented. GASB’s rationale for retroactive treatment is that the financial effects of prior period errors are not attributable to the current period. Furthermore, it is misleading to continue to present prior period information that includes known errors.
RSI and SI
Required supplementary information (RSI) is information required by standards setters to accompany the financial statements. Although not part of the financial statements, RSI is considered essential to provide context to the financial statements. RSI includes Management’s Discussion and Analysis. Supplementary information (SI) is information voluntarily presented in government annual reports. SI contains combining and individual financial statements and other legally required statements and schedules. RSI and SI disclosures are more prevalent among public sector entities.
RSI and SI often contain information useful in assessing trends and may include up to ten years of information; in contrast, comparative financial statements generally report only two years of financial information. GASB addressed the application of accounting changes and error corrections on RSI and SI appearing in governmental annual reports. Exhibit 3 summarizes the requirements under the new standard. GASB generally concluded that the treatment of accounting changes affecting RSI and SI should parallel that of the financial statements.
Presentation in RSI and SI
Changes in the reporting entity and changes in accounting estimates are reflected in RSI and SI information for the year of the change; prior period information is not restated. For changes in accounting principle, GASB requires governments to restate financial information contained in RSI or SI for the periods for which comparative financial statements are presented, but not for prior periods. For example, a government providing two years of comparative financial statements would adjust RSI and SI disclosures for those two years, but not apply the new accounting principle to earlier years.
The treatment for error correction is significantly different. Again, financial information included in RSI and SI is restated for all periods for which financial statements are presented. But in addition, if the error affects periods prior to those appearing in the comparative financial statements, the RSI and SI financial information should be restated for all affected periods, unless doing so would not be practicable. (Note that the term “not practicable” is a higher standard than “not convenient” or “not inexpensive.” It means that, while not theoretically impossible, there is no realistic way to do it.) GASB’s rationale for retroactive treatment is to avoid presenting prior period information that includes known errors.
Disclosure of Effects on Residual Equity
The beginning balances of residual equity accounts (net position, fund balance, or fund net position) are adjusted for accounting errors, changes in the reporting entity, and changes in accounting principle; this is done on the face of the financial statements. Additionally, the changes must be described and explained in the notes to the financial statements. Statement 100 further requires that governments reconcile the beginning balances of the residual equities as previously reported to beginning balances as restated. The standard requires the reconciliation to be presented in a tabular format in the note disclosures.
A sample reconciliation is presented below. For purposes of this example, assume the following events for a city government:
- Change within the reporting entity. The city moved residential trash pickup operations from the general fund, establishing a new enterprise fund. This represents a change within the reporting entity, affecting the beginning fund balance of the governmental funds, the beginning fund net position of the enterprise funds, and the net position for both the governmental and business-type activities appearing in the government-wide statements.
- Change in accounting principle. The city government is implementing the provisions of GASB Statement 101, Compensated Absences, in the financial statements of the current fiscal year. The city provides two forms of employee leave (vacation and sick), but has previously only accrued vacation leave. Vacation leave is earned each month, carries over without limits at the end of the fiscal year, and any unused portion is paid to the employee upon termination. Accumulated vacation leave meets the criteria of GASB Statement 101 for accrual and will continue to be reported as a liability in the government-wide and proprietary fund financial statements. Because this is not a change in accounting principle, no restatement of beginning net position is required. Sick leave is also earned each month and carries over without limits at the end of the fiscal year. Because unused sick leave is not paid upon termination, however, the city did not accrue a liability in previous years. Under Statement 101, accumulated sick leave meets the first two criteria (attributable to past service and accumulates). The city therefore examined its past experience with accumulated sick leave and estimated the amount of accumulated leave that was more likely than not to be used by employees. This estimate is now to be reported as a liability in the government-wide and enterprise fund financial statements. The portion of this liability that existed at the beginning of the current year (or the earliest year presented in comparative statements) is recognized as a decrease in beginning net position resulting from adoption of a new accounting standard.
- Error correction. In the previous year, the city government failed to accrue sales taxes attributable to retail sales during the last week of the year. This error understated the fund balance of the general fund and the net position of governmental activities in the government-wide statements.
Example Note Disclosure
Reconciliation of Beginning Residual Equity Accounts as Previously Reported to Restated Amounts
Seeking Clarity and Consistency
The disaggregated nature of governmental financial statements creates challenges in the reporting of accounting changes and error correction. To address these challenges and provide greater uniformity in practice, GASB issued Statement 100, Accounting Changes and Error Corrections. This standard provides guidance for the presentation of accounting changes and error corrections in governmental financial statements and establishes disclosure requirements for the notes to the financial statements. In addition, the standard establishes guidance for the treatment of accounting changes and error corrections within the supplementary information (both required and discretionary), which is an integral part of government annual reports. The standard is effective for fiscal years beginning after June 15, 2023.
The project leading to this new standard began in 2018, when GASB undertook research on the effectiveness of Statement 62. The guidance provided in Statement 62 paralleled standards issued by FASB in the 1970s. The research identified issues related to the classification of accounting changes and diversity in practice regarding the disclosure of accounting changes and error corrections. The requirements of Statement 100 are intended to improve clarity in the reporting requirements and lead to greater consistency. These modifications, together with improved note disclosure requirements, will improve user understanding of accounting changes and error corrections.