GASB finalizing new standard
The Governmental Accounting Standards Board (GASB) issued a provocative proposal in March 1996 that would require state and local governments to report the value of their investments at “fair value,” rather than at the actual cost of acquisition. Fair value, the amount at which an investment could be exchanged in a current, unforced sale between willing parties, is similar to market value, but an investment need not be actively traded for its fair value to be determined.
Understandably, the GASB proposal has generated a certain amount of controversy. Some critics have argued, for example, that the public, as well as local and state officials, are not knowledgeable enough to distinguish between fair value gains and losses versus realized gains and losses. Thus, reporting investments at fair value on government financial statements would only create unnecessary confusion.
Other critics have argued just the opposite: Fair value reporting is unnecessary because citizens and officials are actually quite knowledgeable about how market changes affect financial conditions, since news of financial markets is reported hourly in the media.
However, government financial statements do not currently reflect the impact of market changes, and it is often impossible to know when a paper loss will become a realized loss. The GASB believes that investments should be reported at fair value to remove the element of surprise from news about governments’ financial health.
Indeed, the biggest criticism from the GASB and others of the current cost-based standard is its ability to surprise the unsuspecting with unpleasant news. For example, during late 1994 and throughout 1995, headlines routinely reported large losses suffered by governments as the extent of their volatile investments was revealed. These losses were characterized as paper losses, but in many cases they became realized losses when governments were forced to liquidate their holdings.
Also, since gains and losses are recognized only when investments are sold, the cost-based standard can create an incentive for local governments to keep losing investments even when the wiser course of action would be to dispose of them.
Likewise, investments with unrealized gains may be selectively sold to boost investment income. Since many investment prices have built-in interest revenue prices, income is only recognized when the investment is sold. Consequently, investment income can be artificially managed by the timing of investment maturities.
The GASB is attempting to catch up to the rest of the accounting world, one that has already moved to fair value. For example, money market and mutual funds were required to adopt the fair value standard in 1940. Likewise, commercial organizations went to fair value in 1994, as did not-for-profits this year.
Fair value reporting provides financial statement users with better information to assess accountability, the level of services a government can provide and the government’s financial condition. In other words, it more accurately reports a government’s resources available to provide services.
Still, some argue that fair value information should remain in the notes that are presented in the back of the financial statements. Others point out that this would render the fair value information inconsequential and that the intent of note disclosures is to supplement, not supplant, information in the financial statements.
The GASB is currently evaluating these comments and other responses to its proposal on fair value and plans to issue a final statement by the end of this year. The new policy would be effective for fiscal years beginning after June 15, 1997.