Primary Government
The primary government serves as the nucleus and focus of the financial reporting entity as defined by GAAP. All state governments and general-purpose local governments automatically should be treated as primary governments.5
According to governmental accounting, every reporting entity should prepare a compre- hensive annual financial report. The reporting entity starts with a primary government such as a town, city, county, or state. The CAFR also includes all funds, activities, organi- zations, agencies, offices, and departments that are not legally separate from the primary government.
However, states and localities often have difficulty determining which of these separate activities should be presented with the primary government as part of the reporting entity.
Except in rare cases, a business enterprise such as IBM or Ford Motor Company simply consolidates all corporations over which it has control. A state or locality can interact with nu- merous separate departments, agencies, boards, institutes, commissions, and the like. Should all of these functions be included as either governmental activities or business-type activities within the government’s CAFR? If not, what reporting is appropriate?
The almost unlimited number of activities that can be related to a government raises prob- lems for officials attempting to outline the parameters of the entity being reported. Organiza- tions such as turnpike commissions, port authorities, public housing boards, and downtown development commissions have become commonplace in recent years. The primary govern- ment may have created many of these, but they remain legally separate organizations. Such en- tities are designed to focus attention on specific issues or problems. They often promise better efficiency because of their corporate-style structure.
As an example, in the notes to the financial statements in its 2008 CAFR, the City of Boston, Massachusetts, lists the following separate organizations related to the government but whose financial information had notbeen included with that of the city. The mayor ap- points the members of each governing body, but city authority does not extend beyond mak- ing these appointments:
• Boston Housing Authority.
• Boston Industrial Development Financing Authority.
• Boston Water and Sewer Commission.
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Explain the makeup of a primary government and its relationship to component units.
5Stephen J. Gauthier, Governmental Accounting, Auditing, and Financial Reporting—Using the GASB 34 Model(Chicago: Government Finance Officers Association, 2005), p. 58.
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Accounting for State and Local Governments (Part 2) 731
Conversely, the City of Atlanta, Georgia, at June 30, 2008, indicated a number of activities that were legally separate from the city government but were still presented within that city’s financial information because the city is financially accountable:
• Atlanta-Fulton County Recreation Authority.
• Atlanta Development Authority.
• Atlanta CoRA, Inc.
Clearly, these examples show that activities related to a government can be included in or ex- cluded from the information produced by the primary government. Because of the extremely wide variety of possible activities, determining which functions actually comprise a state or locality is not always an easy task. According to paragraphs 2 and 8 of GASBStatement 14,
“The Financial Reporting Entity,” the major criterion for inclusion in a government’s compre- hensive annual financial report is financial accountability:
Financial reporting based on accountability should enable the financial statement reader to focus on the body of organizations that are related by a common thread of accountability to the constituent citizenry. . . . Elected officials are accountable to those citizens for their public policy decisions, regardless of whether these decisions are carried out directly by the elected officials through the operations of the primary government or by their designees through the operations of specially created organizations.[Emphasis added.]
Component Units
Some activities are legally separate from a primary government but so closely connected that omission from the statements of that primary government cannot be justified. Because of the relationship, elected officials of the primary government are financially accountable for these separate organizations known as component units.That is why the City of Atlanta included the Atlanta-Fulton County Recreation Authority and the other activities mentioned above in its CAFR; they qualified as component units. They are not part of the government but are re- ported by the government.
Despite being legally separate, component units are included within the financial state- ments of the primary government to indicate that the connection is close enough to warrant be- ing part of the reporting entity. Thus, identification of such activities can be quite important.
Two sets of criteria have been established. If either is met, the activity qualifies as a compo- nent unit to be reported within the CAFR of the primary government. The parameters of the reporting entity encompass both the primary government and any component units.
Criterion 1
The separate organization (such as the Atlanta-Fulton County Recreation Authority) is viewed as a component unit if it fiscally depends on the primary government (the City of Atlanta). As defined, fiscal dependencymeans that the organization cannot do one or more of the follow- ing without approval of the primary government: adopt its own budget, levy taxes or set rates, or issue bonded debt.
Criterion 2
First, officials of the primary government must appoint a voting majority of the governing board of the separate organization. Second, either the primary government must be able to im- pose its will on that board or the separate organization provides a financial benefit or imposes a financial burden on the primary government.
For example, a state (the primary government) might establish a legally separate commis- sion to oversee off-track betting. However, if the state appoints a voting majority of the board membership and the financial benefits from revenues generated by the commission accrue to the state, the commission is considered a component unit of the state for reporting purposes.
Three aspects of the second criterion should be explained further to ensure proper application.
Voting Majority of the Governing Board The authority to elect a voting majority must be substantive. If, for example, the primary government simply confirms the choices that other parties make, financial accountability is not present. In the same way, financial accountability
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does not result when the primary government must select the governing board from a limited slate of candidates (such as picking three individuals from an approved list of five). Thus, the primary government must have the actual responsibility of appointing a voting majority of the board before the organization meets this portion of the second criterion.
Imposition of the Primary Government’s Will on the Governing Board Such power is indi- cated if the government can significantly influence the programs, projects, activities, or level of services the organization provides. This degree of influence is present if the primary gov- ernment can remove an appointed board member at will, modify or approve budgets, override decisions of the board, modify or approve rate or fee changes, and hire or dismiss the individ- uals responsible for day-to-day operations.
Financial Benefit or Financial Burden on the Primary Government A financial connec- tion exists between the organization and the primary government if the government is entitled to the organization’s resources, the government is legally obligated to finance any deficits or provide support, or the government is responsible for the organization’s debts.
Reporting Component Units
Component units are reported in one of two ways: discrete or blended presentation. Many component units are discretely presented at the far right side of the government-wide state- ments. For example, the June 30, 2008, Statement of Net Assets for the City of Detroit, Michigan, shows that the primary government had total assets of more than $10.7 billion whereas its discretely presented component units shown just to the right of the primary gov- ernment reported total assets of $957 million.
According to the financial statements, these component units were made up of the follow- ing separate organizations:
• Detroit Brownfield Redevelopment Authority
• Detroit Public Library
• Detroit Transportation Corporation
• Downtown Development Authority
• Eastern Market Corporation
• Economic Development Corporation
• Greater Detroit Resource Recovery Authority
• Local Development Finance Authority
• Museum of African American History
• Tax Increment Finance Authority
As an alternative placement, a primary government can include component units as an actual part of the reporting government (a process referred to as blending). Although legally separate, the component is so intertwined with the primary government that inclusion is nec- essary to appropriately present the financial information. In discussing the reporting of its three component units, the City of Atlanta, Georgia, indicates that two are discretely presented while the other is blended:
The government-wide financial statements include not only the City itself (known as the primary government), but also the legally separate Atlanta-Fulton County Recreation Authority, Atlanta CoRA Inc., and Atlanta Development Authority for which the City is financially accountable. Financial information for these component units is reported separately from the financial information presented for the primary government itself, except for Atlanta CoRA, Inc., whose statements are blended with the primary government.
One other aspect of the overall reporting process should be noted: the possible existence of related organizations. In such cases, the primary government is accountable because it ap- points a voting majority of the outside organization’s governing board. However, fiscal de- pendency as defined earlier is not present, and the primary government cannot impose its will on the board or gather financial benefits or burdens from the relationship. The organization does not qualify as a component unit to be included in the government’s financial reporting.
However, the primary government must still disclose the nature of the relationship.
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Special Purpose Governments
Cities, counties, states, and the like are known as general purpose governments.They provide a wide range of services such as police protection, road repair, and sanitation. They are pri- mary governments, each within its own reporting entity. However, activities that qualify as special purpose governments are also viewed as primary governments for separate reporting purposes.
Thousands of special purpose governments exist throughout the country; they carry out only a single function for the public or a limited number of functions. Common examples in- clude public school districts, colleges and universities, utilities, hospitals, transit authorities, and library services. A note to the 2008 financial statements prepared for the University of Iowa indicates that “for financial reporting purposes, the University is considered a special- purpose government.”
When reporting a single activity, such as a transit system, school system, or utility, the question arises as to whether it is (1) part of a larger government such as a city or county as either a fund or a component unit, (2) a nongovernmental not-for-profit organization, or (3) a special purpose government that produces its own financial statements according to govern- mental accounting principles.
An activity or function is deemed a special purpose government if it meets the following criteria:
1. Have a separately elected governing body.
2. Be legally independent, which it can demonstrate by having corporate powers such as the right to sue and be sued as well as the right to buy, sell, and lease property in its own name.
3. Be fiscally independent of other state and local governments.
For example, a school system that satisfies all three is reported as a special purpose gov- ernment that produces its own financial statements. However, if that same school system fails to meet any one of these, its financial condition and operations are likely to be maintained within the General Fund or Special Revenue Funds of a city or county government.
As mentioned previously, an activity is normally considered to be fiscally independent if its leadership can determine the activity’s budget without having to seek the approval of an out- side party, levy taxes or set rates without having to seek outside approval, and can issue bonded debt without outside approval.
Discussion Question
IS IT PART OF THE COUNTY?
Harland County is in a financially distressed area in Missouri. In hopes of enticing business to this area, the state legislature appropriated $3 million to start an industrial development commission. The federal government provided an additional $1 million. The state appointed 15 individuals to a board to oversee the operations of this commission, and county officials named 5 members. The commission began operations by raising funds from local citizens and businesses. It received $700,000 in donations and pledges. The county provided cleri- cal assistance and allowed the commission to use one floor of the county office building for its headquarters. The county government must approve the commission’s annual operat- ing budget.
During the current period, the commission spent $2.4 million. It achieved notable suc- cess. Several large manufacturing companies have recently begun to explore the possibil- ity of opening plants in the county.
Harland County is presently preparing its comprehensive annual financial report. Should it include the revenues, expenditures, assets, expenses, and liabilities of the industrial devel- opment commission? Is it a fund within the county’s primary government, a component unit, or a related organization?
Is the industrial development commission a component unit of the State of Missouri?
How should its activities be presented in the state’s comprehensive annual financial report?
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The comprehensive annual financial report for the Charlotte-Mecklenburg County, North Carolina, Board of Education shows total expenses for the year ended June 30, 2008, of more than $1.25 billion as a special purpose government. A note to these statements explains why the Board represents a primary government to be reported separately from the local general purpose government:
The Charlotte-Mecklenburg Board of Education (Board) is a Local Education Agency empowered by State law [Chapter 115C of the North Carolina General Statutes] with the responsibility to oversee and control all activities related to public school education in Charlotte-Mecklenburg, North Carolina. The Board receives State, Local, and Federal government funding and must adhere to the legal requirements of each funding entity. Although Mecklenburg County (the County) levies all taxes, the Board determines how the school system will spend the funds generated for schools. The County cannot modify the school system’s budget, nor is the County entitled to share in any surpluses or required to finance any deficits of the school system. For these reasons, the Board is not fiscally dependent on the County and therefore is recognized as a primary government.