GASB 34…Are You Prepared?

Background
Local governments in the U.S. invest over a billion dollars annually in construction, improvement and rehabilitation of capital assets, including water and sewer systems, bridges, roads. These expenditures are significant, representing more than one out of every ten dollars spent by those agencies. Borrowing, that is, selling municipal bonds and using the proceeds to pay for construction of the infrastructure, finances the majority of infrastructure investments.

The need for public accountability arises when such funds are spent and when current and future generations are committed to repay such debts. The public wants to know how much their city spends on infrastructure construction and how much they borrow to finance it. The public also wants to know if city or county officials subsequently are caring for the infrastructure they have built with public resources.

Although the need for information about infrastructure is clearly shown, the primary instruments for demonstrating fiscal accountability—the government’s annual financial statements—currently do not support accounting. The current accounting method for preparing local government financial statements focuses on short-term financial resources like cash and investments, which leaves infrastructure off the balance sheet and does not including any charge (debit) on the income statement for the cost of using those infrastructure assets to provide services.

The new reporting rules of GASB 34 address many of the shortcomings of current financial reporting. Under the new rules, local governments will continue to provide information for major funds. However, they will also provide government-wide statements using full accrual accounting so that all revenues and all expenses in a fiscal year are reported. That includes all measurable assets and liabilities, short-term and long-term, financial and capital, whether they support local government activities or fee-for-service activities. The government-wide statements will look at government from an economic perspective, which views a city or a county as a single economic unit, not just a collection of separate funds.

The government-wide statements will give users the information they need to answer these questions:

Is the city paying for police patrols with money collected from utility customers?
How much does the city spend to maintain treatment plants, bridges, etc.?
What is the full cost of the services provided by the county?
Does the city have sufficient resources to meet future obligations?
Does the county spend more than it takes in each year, or is it running a surplus?
Is the city’s overall debt increasing, placing a burden on future taxpayers?
Are the city's parks and recreational facilities self-supporting or do they require funding from general taxes?

These guidelines offer cities and counties the opportunity to develop or enhance practices and systems for reporting and maintaining infrastructure assets over the long term. The new reporting guidelines also will provide more and better information to help policymakers and the public better determine their taxing and spending priorities.

Financial Accounting and Reporting
In the next few years these local governments will begin to produce new financial statements that include infrastructure and other assets with long service lives. For the first time, cities and counties will show in their financial statements all of the resources available to them for the provision of public services. Those financial statements will also reflect the cost of providing government services more completely by encompassing the capital assets employed to support service delivery.

While most local governments currently use this type of accounting for fee-for-service enterprises like water and sewer utilities, they do not do so for the majority of their services. Many private sector firms and nonprofit organizations, as well as many other governments around the world, already include their capital assets and the cost of using them in their financial statements. This accounting method spreads the purchase or construction price of their long-lived assets over the years those assets are expected to be used, often in equal amounts.

For example, currently if a public water utility buys some water pumps, the purchase price of $1 million would be divided by the 10 years the pumps are expected to last, to arrive at an annual amount of $100,000. In each of those 10 years, then, the utility’s income statement would include a $100,000 charge, commonly called "depreciation expense." On the other hand, a city that builds a $10 million bridge would show the entire $10 million expenditure in the year it was built, and no charges in subsequent years as the bridge provides transportation services to the public.

Cities and counties can take several approaches toward developing systems for complying with GASB 34. Options run the gamut: local governments might rewrite code, install middleware, install new financial management software, modify current software or simply modify spreadsheets. One approach is to simply install a PC and software to run reports annually for legislators. But if agencies want to use detailed financial information frequently as an integral management tool, they should consider using GASB 34 as an opportunity to develop both advanced technical solutions (i.e., geographic information systems, maintenance management systems), and improve infrastructure asset maintenance practices.

Two Approaches
GASB 34 provides for two ways in which local governments may analyze and report the value of infrastructure assets. The “depreciation approach” is analogous to the manner in which private businesses determine and report the value of assets. It is based ascertaining historical cost, determining a useful life of the asset, then reducing the initial value of the asset over the useful life in accordance with an accepted depreciation formula.

The second, alternative, approach is potentially more useful for many local governments. This approach, the “modified approach,” aims at documenting the preservation of the asset. The modified approach does not require ascertaining historical cost. For this reason, it may be a useful approach for older infrastructure elements for which records regarding historical cost may not be as solid as desirable.

Even for infrastructure elements for which such records are available, the modified approach may make more sense. Since it focuses on preservation, the appearance of exhausting the asset is avoided. The depreciation approach implies that at the end the infrastructure element is somehow used up. On the other hand, the preservation approach implies that some types of infrastructure are immortal with timely, periodic investments in them.

Neither implication is completely true, of course. Perhaps the major benefit of the modified approach flows to the community. For those in the community concerned about husbanding infrastructure assets, the comparison of required upkeep dollars to actual upkeep dollars can be telling.

Infrastructure Asset Maintenance Practices
Traditionally during a city’s program budget development process, predictive and preventive maintenance programs for infrastructure assets have not done well in competing for fiscal resources with reactive forms of maintenance; capital improvements; or other governmental programs such as public safety, education, or social services. GASB 34 provides local governments the opportunity to emphasize the strategic importance of predictive and preventative maintenance practices. As a result, there will be policy implications of GASB’s 34 infrastructure reporting requirements as they relate to budgeting and allocating fiscal resources between infrastructure construction and maintenance practices, as well as between infrastructure and non-infrastructure programs.

As local governments begin looking at implementing or improving maintenance practices, it will likely require them to make a major shift from viewing maintenance as a business expense, to viewing it as a revenue center. This means moving from being reactive, viewing infrastructure asset maintenance as an expense, to proactive, seeing maintenance as a value-added effort, including innovation as well as rehabilitation. A number of key initiatives are essential for implementing maintenance practices, as well as complying with GASB 34. These include:

Commitment to infrastructure asset management requires leadership at the highest level. It is essential because any successful change as a result of this effort must be led from the top. There must be an internal champion, perceived to be high enough in organization to make the rest of the employees believe management is committed to complying with GASB 34.
All infrastructure asset related work must be recorded on work orders, all non-emergency work must be entered in advance of assignment, emergencies must be entered as soon as possible, job plans must be created, and work orders must be closed out.
Formal advance infrastructure asset management planning must be used for all nonemergency work, always in advance of assignment; job plans must include materials, labor, and safety information.
Use performance indicators is the only way to track progress of infrastructure asset maintenance. Metrics are essential to obtain data for knowledgeable decisions, provide feedback on maintenance activity, form the justification for staffing changes, and provide improved forecasting through the analysis and trending of data.
Planned maintenance and predictive maintenance program development are essential, as these are some of the strongest tools, providing high payback on infrastructure asset investment. They can lead to maintenance cost savings of up to 40 percent, increased equipment reliability, and extended equipment life, when linked to equipment criticality and actual equipment condition to determine the appropriate level of service.
Inventory control of the infrastructure asset being maintained must be integrated with maintenance through a Maintenance Management System (MMS). All transactions must be recorded in the MMS to support overall tracking of the infrastructure assets.

Utilities and public works agencies will be challenged to come up with acceptable methodologies and practices for infrastructure maintenance to support the reporting and depreciation requirements of GASB 34, as well as becoming increasingly more accountable for the conditions of their infrastructure assets.