The Governmental Accounting Standards Board has proposed a new standard that would clarify accounting for sales and pledges of receivables and future revenues, including those arising from tobacco settlement agreements.The proposal addresses whether certain transactions should be regarded as collateralized borrowing, or as a sale.

According to GASB senior technical advisor Ken Schermann, determining the difference isn't hard once guidance has been established.

"The primary motivation for this standard is to provide consistent guidance that can be applied by all types of government - general governmental types and business activity types - to account for proceeds they receive in a transaction for the rights to receive cash flows from collection of receivables such as delinquent property taxes or from future revenues yet to be earned by the government," Schermann said.

This would be the first singular standard on this issue available to governments. Currently, governments must refer to at least two of the public company standards of the Financial Accounting Standards Board, and application has been anything but consistent.

The proposed statement started off as a project on accounting for securitization, but because that word has no consistent meaning, the project was renamed "Sales and Pledges of Receivables and Future Revenues."

Recognizing that the effect of sales and pledges of future revenues involving a legally separate entity in a primary government's financial statements is often determined by the current criteria for blending component units, the board agreed that the criteria should be revisited in a future project. That project would review all the criteria established in GASB Statement 14, The Financial Reporting Entity, which was issued in 1991.

The proposed standard establishes that these kinds of transactions are borrowings, unless they meet criteria that would indicate a sale. Receivables, Schermann said, would be more likely to meet those criteria than future transactions would.

Transactions involving future tobacco settlements, however, would tend to qualify as a sale. This would change the accounting established in a GASB technical bulletin that was issued last year. When a government creates an entity to buy future revenues, which is commonly the purpose of governmental entities that receive tobacco settlement funds, the internal sale would call for the revenue to be deferred over the period of the sale agreement.

The standard also changes the accounting of those tobacco settlement entities. In most situations, the standard will allow for a "component unit" tobacco settlement corporation to recognize an asset in their separate financial statements related to the financing of a primary's future settlement revenue. The new asset recognized in the component unit's financial statements will be eliminated when it is blended into a primary government's financial statements, leaving the primary government's net asset position relatively unchanged.

The standard sets different criteria for receivables and future revenues. The underlying principle is based on whether the seller or transferor government retains or transfers control over the receivable or future revenues.

"The big catch on future revenues, the one that will be hard for a lot of governments - especially general governments - to meet is whether or not they continue to have active participation in the generation of the revenues," Schermann said. "That, right out of the chute, almost rules out any type of own-source revenues such as taxes and user fees, where the government continues to produce goods and services that are sold and continue to levy taxes - in other words, are very involved in the generation of the revenue."

Among revenues not involving active participation would be entitlements and shared revenues, such as tobacco settlement proceeds, where the government simply receives the revenues without playing an active role in generating them.

Schermann explained that when the criteria for sales are met, the gain from the sale will be deferred, so that the government cannot accelerate revenue recognition at a faster pace than would have otherwise occurred.

The statement also changes the disclosure requirements for pledged revenues. Historically, there hasn't been much information in notes to financial statements about the extent to which governments have promised future revenues, either their own debt service or the debt service of component units.

Schermann said that the standard should not add to the burden of accounting. "This is not a difficult notion to comprehend," he said. "There isn't a lot of calculation or work involved, so I don't think it's going to be a burden at all. In fact, it should be easier because everyone will have a single standard to refer to."

William J. O'Reilly, principal accountant at the Bureau of Financial Reporting of New York's Office of the State Comptroller, likes the proposed standard. "The standard proposed in this new ED should help financial statement preparers determine if a liability has been incurred in various types of transactions involving legally separate entities where the intent of the primary government is unclear, and can only help government financial statement preparers sort out these relatively complex transactions, often referred to as 'securitization" O'Reilly said.

If approved as proposed, the standard would be effective for financial statements for periods beginning after Dec. 16, 2006.

GASB is requesting comments on the proposal by Dec. 30, 2005.

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