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HomeMy WebLinkAboutR-1996-075 Governmental Accounting StandardsRESOLUTION NO. 96- 75 A RESOLUTION authorizing the Director of Finance and Budget to respond to Exposure Draft 132-A of the Governmental Accounting Standards Board. WHEREAS, the Governmental Accounting Standards Board has issued Exposure Draft 132-A which would have significant impact on the way the City of Yakima accounts for investments and records investment income, and WHEREAS, the Director of Finance and Budget has determined that of the seven issues presented in Exposure Draft 132-A, six issues are not in the best interest of the City of Yakima, BE IT RESOLVED BY THE CITY COUNCIL OF THE CITY OF YAKIMA: The Director of Finance and Budget is hereby authorized and directed to respond to the Governmental Accounting Standard Board Exposure Draft 132- A Accounting For Certain Investments and for External Investment Pools, and issues one through seven contained in that draft. ADOPTED BY THE CITY COUNCIL this 4th day of June, 1996. ATTEST: Ka R A `20Gam,.( CITY CLERK JH Resolution - TJ -5/31 /96 DEPARTMENT OF FINANCE & BUDGET 129 North Second Street Yakima, Washington 98901 May 31, 1996 Director of Research, Project 26-1 Governmental Accounting Standards Board Box 5116 Norwalk, CT 06856-5116 Dear Sir: DRAFT We are writing to respond to Exposure Draft 132-A on Accounting for Certain Investments and for External Investment Pools. By this date, we are sure you are aware of the concerns of state and municipal treasurers when recognizing unrealized gains and losses in the Financial Statements. Aside from the budgetary concerns already articulated by many professionals around the country, we are concerned that this standard could actually compromise the consistency of some financial statements and confuse many readers who don't understand the concept of fair value accounting for investments. We take special exception to the theory that investment holdings could conceivably be written up above cost and that this transaction could create net worth, available for appropriation. Further, the whole concept of fair value concerns us since this is a polar shift from lower of cost or market theory, used successfully by the accounting profession for decades. The Board really did not explain this position shift in sufficient detail we believe. We disagree that marking a portfolio to market represents any kind of operating result primarily because the revenue cycle is not completed (i.e., no sale occurred). We also disagree with the Board's conclusions that a marking to market one (1) day out of 365 is meaningful in an arena as volatile as the bond market. Thank you for the opportunity to respond to the Exposure Draft. Sincerely, John R. Hanson, Director Department of Finance & Budget HDB/Dail. Tim Jensen/1 Customer Service (509) 575-6080 • Finance (509) 575-6070 • Information Systems (509) 575-6098 Yakima trend '1 1 1► 1994 DEPARTMENT OF FINANCE & BUDGET 129 North Second Street Yakima, Washington 98901 May 31, 1996 Governmental Accounting Standards Board Box 5116 Norwalk, CT 06856-5116 rat Je F ri Issue 1: This proposed Statement includes within its scope interest-bearing investment contracts, such as time deposits with financial institutions and repurchase agreements. As explained in paragraph 38 of the Basis for Conclusions, the Board included those contracts within the scope of this proposed Statement because they are used as alternatives to other investment types that are covered by the proposed Statement and because not requiring them to be reported using the same method might cause unintended changes in investment activity. Do you agree that it is appropriate for interest—bearing investment contracts to be included in the scope of this proposed Statement? Why or why not? Response: We agree that the types of investments described in Paragraph 38 of the Draft, namely interest—bearing contracts or (CD's) and similar vehicles, should be treated the same as any other investment in an entity's portfolio. Since no easily determined market or fair value is available for these types of investments, we would ask the Board how such value would be calculated? Booking a gain or loss from fluctuations in market value for this type of investment seems like a fairly subjective matter, certainly open to exactly the types of manipulation the Board is trying to avoid with the proposed Standard. Furthermore, since these securities have no marketability per se, how could any option other than holding them to maturity exist? If they must be held to maturity to have their value realized, why would a gain or loss need to be recognized at al]? It seems to us that this view on behalf of the Board is inconsistent within its own directive. To mark to market something with no market value doesn't make sense an the context of providing meaningful disclosure to users of Financial Statements. Because of the paradox of this issue, we disagree that these types of investments should have their changes in market value (whatever that might be), recorded in the operating statement, or recorded anywhere in the body of the statements. Issue 2: This proposed Statement would require debt security investments to be reported at fair value, even if the governmental entity has the ability and intent to hold those investments to maturity. An alternative would be to allow them to be reported at amortized cost. The Board did not provide a held -to -maturity category for debt investments for the reasons explained in paragraph 44 of the Basis for Conclusions. Do you agree that amortized cost should not be permitted for held—to—maturity investments? Why or why not? If you believe that amortized cost should be permitted for held--to—maturity investments, what restrictions, if any, should be placed on the use of that method? W4-Daily/TJ Customer Service (509) 575-6080 • Finance (509) 575-6070 • Information Systems (509) 575-6098 DRAFT Response: The Board recognizes the difficulty of verifying intent when considering a hold—to—maturity category within a portfolio. We disagree with the Board that this method should not be allowed, however. Objective evidence, such as sinking fund contracts, buyback agreements or even debt indentures drawn by the entity itself may exist, which definitely tie a specific principal amount and maturity date of an investment to a specific obligation or event at a corresponding time in the future. Clearly, ability and intent is verifiably exhibited in such an arrangement and the Board should consider those criteria, particularly where contractual agreements and/or covenants exist. To continue this thought, since debt securities all mature at par, recording interperiod changes in market value is unnecessary when they are bought with the verifiable intent of holding until maturity. We do not disagree with the notion of open and full disclosure of investment holdings, but we disagree with the premise that the recognition of market value over amortized cost produces any real benefit when contrasted with the budgetary havoc possible with such financial statement presentation. Additionally, and most importantly, we believe the consistency and comparability of financial statements may be compromised because of the volatility possible in the Bond market from year-to-year. As a sideline, somewhat outside the scope of this exposure draft, we question the prudence of theory that investment holdings could be recorded at an amount above amortized cost. This is precisely the logic that landed the savings and loan industry in such a devastating predicament. Our understanding of the Accounting Convention of Conservatism always dictated that (paraphrased) "you don't book what you don't have." and "Always use lower of cost or market (LCM) when presenting the value of assets." FASB 12 promulgated that no recoveries in market value above cost be recognized in the Financial Statements. This theory has worked for the profession for over twenty years. We wonder what has changed? We realize that FASB 12 was written with respect to equities, but the principal when applied to debentures shouldn't change. Why not write all assets up to market value if we don't care about lower of cost or market? In the real estate market for instance, the gains not realized could be more permanent than in bonds. This is a disturbing idea to us, and we disagree categorically that any asset should be written up above cost under any circumstances prior to a sale being realized. Further, we disagree with the idea that a single dated presentation of a large diverse investment portfolio is meaningful when interest rates, and corresponding values, can vary widely over a short period of time. A subsequent event note in the Financial Statements, if missed, could distort the readers opinion of the overall financial condition of an entity in a volatile bond market. The Board seems to be trying to respond to the Orange County, CA situation, but we don't think this proposal addresses that issue. Again, we agree in principal with full and complete disclosure of investment holdings in the notes. But, if one reads Orange County's Financial Statements for June 30, 1993 and 1994, problems were evident. If Orange County used this proposal for their June '93 Financial Statements, they would have been able to get into worse trouble because they could have spent money that vaporized in the Bond Market in 1994. It seems to us that these artificial fluctuations in overall net worth can only confuse readers in the majority of cases. As we already mentioned, comparability of one year's Financial Statements could be impaired by extraordinary movement in the bond market. This is a questionable accounting practice in our opinion, particularly when we consider that nothing happened! No money changed hands; not even a notional transaction took place. W4-Daily/TJ DRAFT We disagree for the reasons stated above with the Board that amortized cost should not be allowed for debt securities. Issue 3: This proposed Statement would require all changes in the fair value of investments to be reported as revenue in the operating statement or other statement of activities of all funds and entities. The Board is proposing recognition of unrealized gains and losses for the reasons explained in paragraph 47 through 49 of the Basis of Conclusions. a. Do you agree in general that unrealized gains and ]losses shouldl be recognized? Why or why not? If you believe such recognition should be delayed, how should the unrealized gains and losses be reported? b . Do you agree with recognition of all unrealized gains and losses in governmental and similar trust funds that report using a current financial resources measurement focus and modified accrual basis of accounting? Why or why not? If you believe there should be some modification of that recognition, describe that proposed modification and its application. Response: a. We disagree categorically that unrealized gains and losses should be recognized in the operating statement. We believe using this philosophy to calculate total return for note disclosure and performance evaluation, to be appropriate, however. But where outside users are depending on consistent, comparable, year-to-year financial statements, this notion can only confuse the true financial position of an entity. We also disagree with the ]Board that market fluctuations and changes in fair value represent "results". Webster's Dictionary defines a result as a consequence or conclusion to events. In the case of unrealized gains and losses, no conclusion has occurred because no transaction settled. How can we have a result to book if we don't have any action taking place? The Board seems overly concerned with displaying the results of investment strategy and performance of investment personnel on the face of the Financial Statements. We don't understand this focus. We feel it would be better to disclose these issues in the Notes rather than the face of the Financial Statements. In conclusion, we believe unrealized losses should not be recognized for the reasons stated above and many of the reasons in our response to Issue 2 as well. We feel these unrealized losses should be disclosed for what they are, changes in asset valuation, and shown as a contra -asset and a deferred charge. We do not feel any unrealized gains above original cost should be recognized under any circumstances, period. We think the theory in FASB 12 is still best. General Accounting theory has always taught that revenue should be recognized upon the completion of the most crucial task in the earnings process. Where investment earnings other than interest are the issue, the only crucial task is a sale and settlement of the securities, in our opinion. That is when a result occurs. A simple change in market value is not a result since no transaction has been consummated. The Board has not made a compelling enough case in our opinion to change long-standing and successful accounting theory where recognition of unrealized gains above cost are in question. W4-Daily/TJ DRAFT Response: b. We disagree with recognition of unrealized gains and losses in governmental and similar trust funds that report using a current financial resource focus and modified accrual accounting. With respect to gains, we do so primarily because of the revenue recognition theories explained in the response to part 'a' of this issue. In our opinion, whether modified accrual or full accrual, accounting is used, these theories of completion should be constant. Where other than permanent declines in market value are suffered, we agree with the Board that an accurate presentation of available resources is appropriate. We would suggest the same treatment as discussed in part 'a' Response, not a recognition of profit and loss activity that hasn't happened. Issue 4. Except for the separate reports of governmental external investment pools, this proposed Statement would prohibit the financial statement display of realized gains and losses separately from unrealized gains and losses in the financial statements. It would permit disclosure of realized gains and losses in the notes to financial statements provided that certain information about the nature of those amounts and their relationship to the amounts recognized also is disclosed. The Board believes that display of realized gains and losses in the financial statements is inappropriate when investments are measured using fair value for the reasons explained in paragraph 51 of the Basis for Conclusions. Those requirements have previously been provided in GASB Statement No. 25, Financial Reporting for Defined Benefit Pension Plans and note Disclosures for Defined Contribution Plans. Do you believe that prohibiting display of realized gains and losses is appropriate? Why or why not? If not, how do the reporting objectives or user needs for reporting investments differ from those of defined benefit pension plans? Response: We do not agree with the Board that unrealized gains and losses should be recognized in the Financial Statements, therefore, we also disagree that prohibiting display of realized gains and losses is appropriate. Realized transactions are what matters. The trend toward fair value is a dangerous one in our opinion. It can only lead to confusion among users and help to reduce confidence in the accounting profession's grasp on reality. Fair value is a concept that is simply too esoteric when applied to investments. We ought to keep ourselves firmly rooted in conservatism and simplicity to remain viable as a profession. If we are required to recognize unrealized gains in the statements, then we believe there should be an option to report realized and unrealized gains and losses separately on a consistent basis. Issue 5. This proposed Statement would require governmental external investment pools to issue separate annual financial reports and would provide standards for the minimum information to be provided in those reports. It also would require a governmental entity that sponsors an external investment pool to describe in the notes to the financial statements how to obtain that report or, in the absence of a separate report, to disclose much of the information that would have been provided in the separate report. The Board is proposing this reporting for the reasons explained in paragraphs 55 and 59 of the Basis for Conclusions. Do you agree with those reporting requirements? Why or why not? If you do not agree with those requirements, what alternatives do you consider preferable? W4-Daily/TJ DRAFT Response: In general, we agree with those reporting requirements for governmental external investment pools, particularly that separate financial statements should be prepared. We are also in favor of full disclosure reporting for government sponsored external pools in the notes of the sponsoring government if no separate report for the pool is prepared. Issue 6. This proposed Statement would require governmental entities that sponsor external investment pools to report the external portion of each pool as a separate, investment trust fund. (Internal portions are attributed among the funds and component units.) The investment trust fund would be a new fiduciary fund that reports transactions and balances using the economic resources measurement focus and accrual basis of accounting and that presents a statement of net assets and a statement of changes in net assets. The Board is proposing that sponsor reporting of external investment pools for the reasons explained in paragraphs 56 through 58 of the Basis for Conclusions. Do you agree with those requirements? Why or why not? If you do not agree with those requirements, what alternatives do you prefer? Response: We agree that reporting the external portion of these pools in a separate trust fund is appropriate. Within the meaning of GASB #14 there is clearly a fiduciary relationship here. The economic resources measurement focus and accrual accounting is also clearly appropriate here. We support the Board on this issue. Issue #7: This proposed Statement would require governmental entities to report their investments in external investment pools at fair value. For investments in 2a7 -like pools, fair value would be determined by the pool's share price. For investments in other pools, fair value would be determined by the fair value per share of the pool's underlying portfolio. If a governmental entity cannot obtain information from a pool sponsor, it would be required to make its best estimate of fair value and to disclose the reason for having to make that estimate. The Board[ is proposing those requirements for the reasons explained in paragraphs 62 and 63 of the Basis for Conclusions. Do you agree with those requirements? Why or why not? If you do not agree with those requirements, what alternatives do you prefer? Response: Since we disagree with the idea that we recognize our own investments at fair value, we accordingly disagree with the idea that we recognize fair value of our investments in external pools. This is the Board's best argument in our opinion, however. We saw with Tex Pool, a Government-sponsored and guaranteed pool can be run on, causing extreme liquidity problems in a pool with longer maturities in a bear market. There are constraints which can be used by external pools to prevent runs on capital in a down market. Maximum withdrawals, maximum deposits for one investor, or lead time requirements on major withdrawals are good examples of these. Tex Pool had a longer than usual average maturity compared with most pools of this type we are familiar with. This factor exacerbated their problem. Our point is this is unusual and most government-sponsored pools are structured so that runs on capital aren't disastrous. In the case of non -Government sponsored short-term pools, most of the same arguments hold true. We feel there is no basic difference and therefore non-government pools should also reject fair value accounting for investments. W4-Daily/TJ NO. 132-A I MARCH 13, 1996 Governmental Accounting Standards Series EXPOSURE DRAFT Proposed Statement of the Governmental Accounting Standards Board Accounting and Financial Reporting for Certain Investments and for External Investment Pools This Exposure Draft of a proposed Statement of Governmental Accounting Standards is issued by the Board for public comment. Written comments should be addressed to: Director of Research Project No. 26-1 Comment Deadline: June 14, 1996 • • 0 01•111•IGASB • GOVERNMENTAL ACCOUNTING STANDARDS BOARD OF THE FINANCIAL ACCOUNTING FOUNDATION Copyright © 1996 by Governmental Accounting Standards Board. All rights re- served. Permission is granted to make copies of this work provided that such copies are for personal or intraorganizational use only and are not sold or dis- seminated and provided further that each copy bears the following credit line: "Copyright © 1996, by Governmental Accounting Standards Board. All rights re- served. Used by permission." GOVERNMENTAL ACCOUNTING STANDARDS SERIES (ISSN 0886-2885) is published monthly by the Financial Accounting Foundation. Second-class postage paid at Norwalk, CT and at additional mailing offices. The full sub- scription rate is $130 per year. POSTMASTER: Send address changes to Governmental Accounting Standards Board, 401 Merritt 7, P O. Box 5116, Norwalk, CT 06856-5116. ACCOUNTING AND FINANCIAL REPORTING FOR CERTAIN INVESTMENTS AND FOR EXTERNAL INVESTMENT POOLS Notice of Public Hearings and Request for Written Comments Hearings: May 22. 1996,' beginning at 9.00 a.m. Convention Center Portland, OR (In contunction with the annual meeting of the Government Finance Officers Association) Deadline for Written Notice of Intent to Speak in May: May 8, 1996 June 14, 1996,' beginning at 9.00 a.m. R. R. Donnelly Building 75 Park Place, 81h floor Rooms S1 and S2 New York, NY Deadline for Written Notice of Intent to Speak in June: May 24, 1996 Basis for hearings. The Governmental Ac- counting Standards Board (GASB) has sched- uled public hearings to obtain information from interested individuals and organizations about the issues discussed in this Exposure Draft. The hearings will be conducted by one or more members of the Board and its staff. The Board encourages the participation of interested parties at the public hearings and through Writ len response. Oral presentation requirements. Individuals or organizations that want to make an oral pre- sentation at the public hearings should pro- vide, by the deadline for nonce of intent to speak, a written notification of that intent and a copy of written comments addressing the standards proposed in this Exposure Draft. The notification and written submission should be addressed to the Director of Re- search, Protect No. 26-1, at the address be- low. The public hearings may be canceled un- less sufficient respondent interest is ex- pressed by the deadline. The Board intends to schedule all respond- ents who want to make oral presentations and will notify each individual or organization of the expected location and time of the presenta- tion. The Board anticipates that the lime allot- ted each individual or organization will be lim- ited to about 30 minutes -10 minutes to summarize or elaborate on the written sub- mission, or to comment on the written submis- sions or presentations of others; and 20 min- utes to respond to questions from those conducting the hearings. Observers. Observers are welcome at the public hearings and are urged to submit writ- ten comments. WRITTEN COMMENTS Deadline for Submitting Written Comments: June 14. 1996 Requirements for wntten comments. Any individual or organization that wants to provide written comments but does not intend to par- ticipate in the public hearings should provide these comments by June 14. Comments should be addressed to the Director of Re- search, Protect No. 26-1 OTHER INFORMATION Public files Written comments and a tran- script rima. Written c n.. .. script of the public hearings will be part of the Board's public file and will be available for in- spection at the Board's offices. Copies of those materials may be obtained for a speci- fied charge. Orders. Any individual or organization may obtain one copy of this Exposure Draft on re- quest without charge until June 14 For infor- mation on prices for additional copies and copies requested atter June 14, please con- tact the GASB Order Department at the ad- dress shown below. Governmental Accounting Standards Board 401 Merritt 7 PO Box 5116 Norwalk, CT 06856-5116 Telephone Orders: (203) 847-0700, ext. 10 Please ask for our Product Code No. GE39. ' Extens en to an additional date or dates may be announced at the hearings. Notice to Recipients of This Exposure Draft The Governmental Accounting Standards Board is responsible for developing standards of state and local governmental accounting and financial reporting that will (a) result in useful information for users of financial reports and (b) guide and educate the public, including issuers, auditors, and users of those financial reports. The due process procedures that we follow before issuing our standards and interpretations are designed to encourage broad public participation in the standards -setting process. As part of that due process, we are issuing this Ex- posure Draft (ED) setting forth a proposed Statement on accounting and finan- cial reporting for certain investments and for external investment pools. We invite your comments on all matters in this proposed Statement and par- ticularly on the following specific issues that the Board will consider before issu- ing a final document: Issue 1: This proposed Statement includes within its scope interest-bearing in- vestment contracts, such as time deposits with financial institutions and repurchase agreements. As explained in paragraph 38 of the Ba- sis for Conclusions, the Board included those contracts within the scope of this proposed Statement because they are used as alterna- tives to other investment types that are covered by the proposed Statement and because not requiring them to be reported using the same method might cause unintended changes in investment activity. Do you agree that it is appropriate for interest-bearing investment con- tracts to be included in the scope of this proposed Statement? Why or why not? Issue 2: This proposed Statement would require debt security investments to be reported at fair value, even if the governmental entity has the ability and intent to hold those investments to maturity. An alternative would be to allow them to be reported at amortized cost. The Board did not provide a held -to -maturity category for debt investments for the rea- sons explained in paragraph 44 of the Basis for Conclusions. Do you agree that amortized cost should not be permitted for held -to -maturity investments? Why or why not? If you believe that amortized cost should be permitted for held -to -maturity investments, what restric- tions, if any, should be placed on the use of that method? issue 3: This proposed Statement would require all changes in the fair value of investments to be reported as revenue in the operating statement or other statement of activities of all funds and entities. The Board is pro- posing recognition of unrealized gains and losses for the reasons ex- plained in paragraphs 47 through 49 of the Basis for Conclusions. a_ Do you agree in general that unrealized gains and losses should be recognized? Why or why not? If you believe such recognition should be delayed, how should the unrealized gains and losses be reported? b. Do you agree with recognition of all unrealized gains and losses in governmental and similar trust funds that report using a current fi- nancial resources measurement focus and modified accrual basis of accounting? Why or why not? 11 you believe there should be some modification of that recognition, describe that proposed modification and its application. Issue 4: Except for the separate reports of governmental external investment pools, this proposed Statement would prohibit the financial statement display of realized gains and losses separately from unrealized gains and losses in the financial statements. It would permit disclosure of realized gains and losses in the notes to financial statements provided that certain information about the nature of those amounts and their relationship to the amounts recognized also is disclosed. The Board believes that display of realized gains and losses in the financial state- ments is inappropriate when investments are measured using fair value for the reasons explained in paragraph 51 of the Basis for Con- clusions. Those requirements have previously been provided in GASB Statement No. 25, Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined Contnbution Plans. Do you believe that prohibiting display of realized gains and losses is appro- priate? Why or why not? If not, how do the reporting objectives or user needs for reporting investments differ from those of defined benefit pension plans? Issue 5: This proposed Statement would require governmental external invest- ment pools to issue separate annual financial reports and would pro- vide standards for the minimum information to be provided in those reports. It also would require a governmental entity that sponsors an external investment pool to describe in the notes to the finanicial state- ments how to obtain that report or, in the absence of a separate report, to disclose much of the information that would have been provided in the separate report. The Board is proposing this reporting for the rea- sons explained in paragraphs 55 and 59 of the Basis for Conclusions. Do you agree with those reporting requirements? Why or why not? If you do not agree with those requirements, what alternatives do you consider preferable? Issue 6: This proposed Statement would require governmental entities that sponsor external investment pools to report the external portion of each earl as a separate investment trust fend (Internet portions are attrib- uted among the funds and component units.) The investment trust fund would be a new fiduciary fund that reports transactions and balances using the economic resources measurement focus and accrual basis of accounting and that presents a statement of net assets and a statement of changes in net assets. The Board is proposing that sponsor reporting of external investment pools for the reasons explained in paragraphs 56 through 58 of the Basis for Conclusions. Do you agree with those re- porting requirements? Why or why not? If you do not agree with those requirements, what alternatives dQ you prefer? issue 7: This proposed Statement would require governmental entities to report their investments in external investment pools at fair value. For invest- ments in 2a7 -like pools, fair value would be determined by the pool's share lance. For investments in other pools, fair value would be deter- mined by the fair value per share of the pool's underlying portinlio. If a governmental entity cannot obtain information from a pool sponsor, 11 would be required to make its best estimate of lair value and to disclose the reason for having to make that estimate. The Board is proposing those requirements for the reasons explained in paragraphs 62 and 63 of the Basis for Conclusions. Do you agree with those requirements? Why or why not? It you do not agree with those requirements, what al- ternatives do you prefer? Whether you wish to comment on the entire document or only a portion of it, we encourage you to send us your comments. Because the ED may be modified before its issuance as a final Statement, it is important that you respond even if you agree with the Board's proposals. All comments are distributed to the Board and to staff members assigned to this protect, and all comments are considered when we deliberate on the final Statement. When we are satisfied that all reasonable alternatives have ad- equately been considered, a vote is taken on the Statement. A majonty vote is required tor adoption of a final Statement. Summary This proposed Statement would establish accounting and financial reporting standards for all investments held by governmental external investment pools. For most other governmental entities, it would establish fair value standards for investments in (a) interest-earning investment contracts, (b) external investment pools and open-end mutual funds, (c) debt securities, and (d) equity securities, option contracts, stock warrants, and stock rights that have readily determinable lair values. For defined benefit pension plans and Internal Revenue Code Sec- tion 457 deferred compensation plans, it would provide guidance for applying fair value to certain investment transactions. Governmental entities, including governmental external investment pools, would report investments at fair value in the balance sheet or other statement of financial position. Fair value is the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. However, governmental entities would be allowed to report short-term debt investments at amortized cost, provided that the fair value of those investments is not positively or negatively affected by changes in interest rates, the impairment of the credit standing of the issuer, or other fac- tors. For that purpose, short-term investments would be those with remaining maturities of up to ninety days. This proposed Statement would also provide guidance for reporting the fair value of and disclosing information about invest- ments in open-end mutual funds and external investment pools. All investment income, including changes in the fair value of investments, would be reported in the operating statement or other statement of activities of all entities and funds. For internal and external investment pools, this proposed Statement would require the equity position of each fund and component unit of the reporting entity that sponsors the pool to be reported as assets in those funds and component units. It also would provide reporting standards when in- come from investments associated with one fund is assigned to another fund. Governmental external investment pools that are 2a7 -like pools would be al- lowed to report their investments at amortized cost. A 2a7 -like pool would not be registered with the Securities and Exchange Commission (SEC) as an invest- ment company, but nevertheless has a policy to and operates in a manner con- sistent with the SEC's Rule 2a7 of the Investment Company Act of 1940. The rule allows money market mutual funds to use amortized cost to report net as- sets. This proposed Statement would establish minimum requirements for the financial statements to be presented and the disclosures to be made in the fi- nancial reports of governmental extemal investment pools. A governmental entity that sponsors one or more external investment pools would report the external portion of each pool as an investment trust fund that reports transactions and balances using the economic resources measurement focus and accrual basis of accounting. This proposed Statement would establish minimum requirements for the financial statements to be presented and the dis- closures to be made in the sponsor's report concerning those pools, including ex- panded disclosure requirements if pool financial reports are not issued. It would also provide standards for reporting individual investment accounts that a govern- mental entity provides to other entities. The provisions of this proposed Statement would be effective for financial statements for penods beginning after June 15, 1997. Earlier application would be encouraged. Unless otherwise specified, pronouncements of the GASB apply to finan- cial reports of all state and local governmental entities, including general purpose governments, public benefit corporations and authorities, public employee retirement systems, utilities, hospitals and other healthcare providers, and colleges and universities. Paragraphs 4 and 5 discuss the applicability of this Statement. Proposed Statement of the Governmental Accounting Standards Board Accounting and Financial Reporting for Certain Investments and for External Investment Pools March 13, 1996 CONTENTS Paragraph Numbers lntroductinn 1 Standards of Governmental Accounting and Financial Reporting 2-19 Scope and Applicability of This Statement 2— 6 Accounting and Financial Reporting for Investments 7-11 Valuation ........ 7— 8 Recognition and Reporting 9-10 Disclosures ........... 11 Additional Standards for External investment Pools and for Individual Investment Accounts 12-16 Pool Reporting 13 Reporting by Sponsonng Governments 14-16 Externa! Invectment Pnntc 14-15 Individual Investment Accounts 16 Investments in Open -End Mutual Funds and External Investment Pools_ 17-19 Effective Date and Transition 20 Glossary ...... .. 21 Appendix A. Background Information 22-33 Appendix 8: Basis for Conclusions 34-68 Appendix C. Illustration of Fair Value Accounting for Investments 69 Appendix D Codification Instructions 70 Proposed Statement of the Govemmental Accounting Standards Board Accounting and Financial Reporting for Certain Investments and for External Investment Pools March 13, 1996 INTRODUCTION 1. Except for certain entities.1 the GASB has not established valuation stand- ards for Investments? Many general and special-purpose governments, in- cluding governmental extemal investment pools, use cost or amortized cost accounting for investments. Recent economic events have focused concern on the limited guidance for investments and the appropriateness of cost -based methods for reporting investments of governments. This Statement establishes valuation standards for many investments. It also establishes certain financial reporting standards, including standards for governmental external investment pools and for governments that sponsor investment pools and individual Investment accounts for other entities. STANDARDS OF GOVERNMENTAL ACCOUNTING AND FINANCIAL REPORTING Scope and Applicability of This Statement 2. This Statement establishes accounting and financial reporting standards for all investments held by governmental external investment pools. For govern- tThe GASB has established investmerd valuation standards in Statements No. 2, Financial Re- porting of Deferred Compensation Plans Adopted under the Provisions of Internal Revenue Code Section 457; No. 10. Accounting and Financial Reporting for Risk Financing and Related Insur- ance Issues; and No. 25, Financial Reporting for Defined 13enefrt Pension Plans and Note Disclo- sures for Defined Contribution Plans. The provisions of certain other GASS Statements, such as Statement No. 15. Governmental College and University Accounting and Financial Reporting Models. had permitted certain governmental entities to adopt investment standards promulgated by other standards -setting organizations. 2Terms defined in the glossary (paragraph 21) are printed In boldface type the first time they are used in this Statement. 1 EXPOSURE "AFT EXPOSURE ^9AFT mental entities other than external investment pools, defined benefit pension plans, and Internal Revenue Code Section 457 deterred compensation plans. it establishes accounting and financial reporting standards for investments in: a. Interest-earning investment contracts b. External investment pools c. Open-end mutual funds d. Debt securities e. Equity securities, option contracts, stock warrants, and stock rights that have readily determinable fair values. 3. The fair value of equity securities, option contracts, stock warrants, and stock rights is readily determinable if sales prices or bid -and -asked quotations are cur- rently available on a securities exchange registered with the Securities and Ex- change Commission (SEC) or in the over-the-counter market, provided that those prices or quotations for the over-the-counter market are publicly reported by the National Association of Securities Dealers Automated Quotations sys- tems or by the National Quotation Bureau. The fair value of restricted stock3 is not readily determinable. The fair value of equity securities, option contracts, stock warrants, and stock rights traded only in a foreign market is readily deter- minable if that foreign market is of a breadth and scope comparable to one of the U.S. markets referred to in this paragraph. 4. Statements 2 and 25 contain standards for the valuation and reporting of the tnveclm,etJ of certain deferredn o1J01JOto1plan. al0 0J UGfIII0Ibenefit pen- sion sion plans, respectively. Those plans should apply the provisions of para- graphs 7 and 17 through 19 to report the fair value of investments in: a. Securities subject to purchased put option contracts and written call option contracts b. Open-end mutual funds c. External investment pools. 3For the purpose of this Statement. restricted stock means equity securities for which sale is re- stricted at acquisition by legal or contractual provisions (other than in connection with being pledged as collateral) except if that restriction terminates within one year or if the holder has the power by contract or otherwnse to cause the requirement to be net within one year. Any portion of the security that can reasonably be expected to qualify for sale within one year. such as may be the case under SEC Rule 144 (17 Code of Federal Reguiabons §230.144) or similar rules of the SEC. is not considered restncted. 2 5. This Statement does not apply to investments in equity securities that are accounted for under the equity method, as provided for in APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. 6. This Statement amends Statement 2, GASB Statement No. 3, Deposits with Financial Institutions, Investments (including Repurchase Agreements), and Re- verse Repurchase Agreements, and GASB Statement No. 28, Accounting and Financial Reporting for Securities Lending Transactions, by replacing the previ- ously used term market value with the term Fair value. it further amends State- ment 3 by including in its glossary this Statamant's definitions of fair value; se- curity, debt security, and equity security. This Statement also amends the investment standards for public entity risk pools in paragraphs 40, 41, 46, and 47 of Statement 104 and for governmental funds in paragraphs 64-67 of GASB Statement No. 11, Measurement Focus and Basis of Accolinti.ig— Govemmental Fund Operating Statements. Accounting and Financial Reporting for Investments Valuation 7. Except as provided in paragraphs 8 and 12, governmental entities, including governmental external investment pools, should report investments at fair value in the balance sheet or other statement of financial position. Fair value is the amount at which a financial instrument could be exchanged in a current transac- tion between ,.,lith^,. parliec other than in or liquidation sale. 1f a quoted aJGI[lGGa, A y rJ4\r sou , other than •a a a forced yr ••yvva-••v. v-•......- .�.-....-.- market pnce is available for an instrument, the fair value to be used in applying this Statement is the total of the number of trading units of the instrument times the market price per unit. If an entity has purchased put option contracts or writ- ten call option contracts on securities and it has those same securities among its investments, it should consider those contracts in determining the fair value of those secunties to the extent that it does not report those contracts at fair value. 8. Governmental entities may report short-term debt investments at amortized cost, provided that the fair value of those investments is not affected—positively or negatively—by changes in interest rates, the impairment of the credit stand- ing of the issuer, or other factors. For this purpose, short-term investments are °All provisions of those paragraphs are amended except the paragraph 46 provisions relating to loregn currency and futures contract hedges, the accrual of private -placement bonds. and the reporting of investment income as a component of other income. This Statement also does not amend the paragraph 47 provision concerning impairment losses on investments that are meas- ured using cost -based values. 3 EXPOSURE DRAFT those with remaining maturities of up to ninety days. For an investment originally purchased with a longer maturity, the investment's fair value on the day it be- comes a short-term investment should be the basis for purposes of applying amortized cost. Recognition and Reposing 9. All investment income, including changes in the fair value of investments, should be recognized as revenue in the operating statement or other statement of activities of all funds and entities. Realized gains and losses should not be displayed separately from unrealized gains and losses in the financial state- ments, except that those amounts may be separately displayed in the separate reports of governmental external investment pools. (See paragraph 13.) An en- tity may disclose realized gains and losses in the notes to the financial state- ments, provided that it discloses all realized gains and losses, computed as the difference between the proceeds of the sale and the original cost of the invest- ments sold.5 10. The equity position of each fund or component unit in an Internal invest- ment pool should be reported as assets in those funds and component units. Often, income from investments associated with one fund is assigned to another fund because of legal or contractual provisions. In that situation. the accounting treatment should be based on the specific language of the legal or contractual provisions.6 If, however, the investment income is assigned to another fund for reasons other than legal or contractual provisions—for example, management decision—the income should be recognized in the fund that reports the invest- ments. The transfer of that income to the recipient fund should be reported as an operating transfer. 5The disclosure of default losses and recoveries on reverse repurchase agreements and securi- ties lending transactions as provided by paragraph 80 of Statement 3 and paragraph 15 of State- ment 28, respectively, does not constitute a reporting of realized tosses that under the provisions of this Statement would require reporting of both realized gains and losses for the year. 6That is, if the legal or contractual provisions require a transfer of the investment income to an- other other fund, the income should be reported in the fund that is associated with the assets, with an operating transfer to the recipient fund.11, however, the legal or contractual provisions require that the investment income be that of another fund, no transfer o1 resources should be reported. In- stead, the amounts should be reported as income in the recipient fund. 4 EXPOSUnc GRAFT Disclosures 11. Governmental entities should make the following disclosures in the notes to the financial statements: a. The methods and significant assumptions used to estimate the fair value of investments, when that fair value is based on other than quoted market prices b. The policy for determining which short-term investments, if any, are reported at amortized cost. External investment pools that report and other entities that disclose realized gains and losses should also disclose that (1) the calculation of realized gains and losses is independent of a calculation of the net change in the fair value of investments and (2) realized gains and losses on investments that had been held in more than one fiscal year and sold in the current year were included as a change in the fair value of investments reported in the prior year(s) and the cur- rent year. Further, if income from investments associated with one fund is as- signed to another fund. that fact should be disclosed. Additional Standards for Extemal Investment Pools and for Individual Investment Accounts 12. The accounting and financial reporting standards in paragraphs 7 through 11 apply to all investments of governmental external investment pools, except that 2a7 -like pools may report their investments at amortized cost. Pool Reposing 13. Annual financial reports should be issued for governmental external invest- ment pools. Those reports should include a statement of net assets and a state- ment of changes in net assets prepared on the economic resources measurement focus and accrual basis of accounting, as well as a detailed list that includes the carrying amount and fair value of each investment. All applicable GASB pro- nouncements (for example. Statements 3 and 28) should be applied in those re- ports. In addition, the financial reports of governmental external investment pools should disclose: a. A brief description of any regulatory oversight (including whether the pool is registered with the SEC as an investment company) b. The frequency and purpose of determining the fair value of investments 5 EXPOSU - AFT c. The method used to determine participants' shares sold and redeemed and whether that method differs from the method used to report investments d. Whether the pool sponsor has provided or obtained any legally binding guar- antees during the period to support the value of shares e. The extent of involuntary participation in the pool, if any.7 Further, if the financial report distinguishes among different components of in- vestment income (for example. interest, dividend, and other income versus the change in fair val1e), the nom chnuiri diccince the accounting pokey for defining each of the components it reports. Reporting by Sponsoring Governments External Investment Pools 14. In addition to the separate investment pool reports required by paragraph 13, a governmental entity that sponsors one or more external investment pools (sponsoring government) should report the external portion of each pool as a separate investment trust fund (a fiduciary fund) that reports transactions and bat- ances using the economic resources measurement focus and accrual basis of ac- counting. (The external portion of an external investment pool is the portion that belongs to legally separate entities that are not part of the sponsonng govern- ment's financial reporting entity. The internal portion of each external investment pool is the portion that belongs to the primary government and its component units and should be reported as provided in paragraph 10 for the equity in internal investment pools.) In its fund financial statements, the sponsoring government should present for each investment trust Lund a statement of net assets and a statement of changes in net assets. The difference between the external pool as- sets and liabilities should be captioned net assets held in trust for pool participants. In the combined financial statements, investment trust funds should be combined in the balance sheet with trust and agency funds. A separate statement of changes in net assets should be presented for the combined investment trust funds, al- though that statement may be presented with other, similar trust funds. 15. If an external investment pool issues a separate report, the annual financial report of the sponsoring government should describe in the notes to the finan- cial statements how to obtain that report. If an external investment pool does not 7lnvoluntary participants are those that are required by legal provisions to invest in the external investment pool. 6 EXPOSfii' issue such a report, the annual financial report of the sponsoring government should include the following in the notes to the financial statements: a. The disclosures required in paragraph 13, for each pool. b. The disclosures required by Statements 3 and 28 and other cash and invest- ment standards, separately for the external portion of each pool. c. Condensed statements of net assets and changes in net assets, for each pool. If a pool includes both internal and external investors, those condensed finan- cial statements should include both portions and should distinguish between them. Individual Investment Accounts 16. Governmental entities that provide individual investment accounts to other, legally separate entities that are not part of the same financial reporting entity should report those investments in one or more separate investment trust funds, using the guidance of paragraph 14 of this Statement.8 The requirements of paragraphs 13 and 15 do not apply to those funds. Investments in Open -End Mutual Funds and External Investment Pods 17. For investments in open-end mutual funds, fair value should be determined by the fund's current share pnce. The disclosure of investments by type, as re- quired by Statement 3, paragraph 68, should indicate those investments as be- ing in SEC -registered mutual funds. 18. For investment positions in external investment pools that are not SEC reg- istered, whether or not sponsored by a governmental entity,9 fair value should be determined by the fair value per share of the pool's underlying portfolio, unless the pool is a 2a7 -like pool. Legally binding guarantees provided or obtained by the pool sponsor to support share value should be considered in determining the fair value of the participants' investments. For investments in 2a7 -like pools, fair value should be determined by the pool's share price. Governments participat- ing in external investment pools that are not SEC registered should also disclose 911 individual accounts are offered as an alternative to a pooled position, the individual accounts should be reported in a different investment trust fund from the pool. 9For example, bank short-term investment funds are nongovernmental pools that are not re- quired to be SEC registered - 7 EXPOSURE DRAFT (a) a brief description of any regulatory oversight for the pool and (b) whether the fair value of its position in the pool is the same as the value of its pool shares. In addition, governments that are involuntary participants In such pools should dis- close that fact. 19. I1 a governmental entity cannot obtain information from a pool sponsor to allow it to determine the fair value of its investment in accordance with para- graph 18, it should make its best estimate of the fair value of that investment and disclose the methods and significant assumptions made in determining that fair value and the reasons for having had to make such an estimate. EFFECTIVE DATE AND TRANSITION 20. The provisions of this Statement are effective for financial statements for periods beginning after June 15, 1997. Earlier application is encouraged. Ac- counting changes adopted to conform to the provisions of this Statement should be applied retroactively, if practical, by restating financial statements for all prior periods presented. If restatement of financial statements for prior periods pre- sented is not practical, the cumulative effect of applying this Statement, if any, should be reported as a restatement of beginning fund balance or retained earn- ings, as appropriate, for the earliest period restated. In the period this Statement is first applied, the financial statements should disclose the nature of any re- statement and its effect. Also, the reason that it was not practical to restate prior periods presented should be explained. The provisions of this Statement need not be applied to immaterial Items. 8 EXPOSURE uHAFT GLOSSARY 21 This paragraph contains definitions of certain terms as they are used in this Statement: the terms may have different meanings in other contexts. Debt security Any security representing a creditor relationship with an entity. It also in- cludes (a) preferred stock that either is required to be redeemed by the is- suing entity or is redeemable at the option of the investor and (b) a collater- alized mortgage obligation (CMO) or other instrument that is issued in equity form but is accounted for as a nonequity instrument. However, it ex- cludes option contracts, financial futures contracts, and forward contracts. • Thus, the term debt security includes, among other items, U.S. Treasury securities. U.S. government agency securities, municipal securities, cor- porate bonds, convertible debt. commercial paper, negotiable certificates of deposit, securitized debt instruments (such as CMOs and real estate mortgage investment conduits—REMICs), and interest -only and principal -only strips. • Trade accounts receivable arising from sales on credit and loans receiv- able arising from real estate lending activities of proprietary activities are examples of receivables that do not meet the definition of a security; thus, those receivables are not debt securities. (If, however. they have been securitized, they would then meet the definition.) Equity security Any security representing an ownership interest in an entity—for example. common, preferred, or other capital stock. However, the term equity secu- rity does not include convertible debt or preferred stock that either is re- quired to be redeemed by the issuing entity or is redeemable at the option of the investor. External Investment pool An arrangement that commingles (pools) the moneys of more than one legally separate entity and invests, on the participants' behalf, in an invest- ment portfolio. An external investment pool can be sponsored by an indi- vidual government, jointly by more than one government, or by a nongov- ernmental entity. An investment pool that is sponsored by an individual state or local government is an external investment pool if it includes par- ticipation by a legally separate entity that is not part of the same reporting 9 EXPOSI IAFT entity as the sponsoring government. If a government-sponsored pool in- cludes only the primary government and its component units, it is not an external investment pool, but rather is an internal investment pool. Fair value The amount at which a financial instrument could be exchanged in a cur- rent transaction between willing parties, other than in a forced or iiquida- lion sale. Individual investment accounts An investment service provided by a governmental entity for other, legally separate entities that are not part of the same reporting entity. With indi- vidual investment accounts, specific investments are acquired for indi- vidual entities and the income from and changes in the value of those in- vestments affect only the entity for which they were acquired. Interest-earning investment contract A direct contract, other than a mortgage or other loan, that a government enters into as a creditor of a financial institution, broker-dealer, investment company, insurance company, or other financial services company and for which it receives, directly or indirectly, interest payments. Interest- earning investment contracts include time deposits with financial institu- tions (such as nonnegotiable certificates of deposit), repurchase agree- ments, and guaranteed and bank investment contracts (GICs and BICs). Internal investment pool An arrangement that commingles (pools) the moneys of more than one fund or component unit of a reporting entity. Investment pools that include participation by legally separate entities that are not part of the same re- porting entity as the pool sponsor are not internal investment pools, but rather are external investment pools. Investment A security or other asset acquired primarily for the purpose of obtaining income or profit. Open-end mutual fund An SEC -registered investment company that sells shares of its stock to investors and invests, on the shareholders' behalf, in an investment port- folio. An open-end mutual fund creates new shares to meet investor de- mand, and the value of an investment in the fund depends directly on the value of the underlying portfolio. Open-end mutual funds include govern - 10 EXPOSURE mental external investment pools that are registered as investment com- panies with the SEC and that operate as open-end funds. Option contract A contract giving the buyer (owner) the right, but not the obligation, to pur- chase from (call option) or sell to (put option) the seller (writer) of the con- tract a fixed number of items (such as shares of equity securities) at a fixed price on a given date or at any time on or before a given date. The fixed price to be paid for the securities is known as the "strike price." Security A transferable financial instrument that evidences ownership or creditor - ship, whether in physical or book entry form. Sponsoring govemment A governmental entity that provides investment services—whether an in- vestment pool or individual investment accounts—lo other entities and that therefore has a fiduciary responsibility for those investments. Stock rights Rights given to existing stockholders to purchase newly issued shares in proportion to their holdings at a specific date. Stock warrants Certificates entitling the holder 10 acquire shares of stock at a certain pnce within a stated period. Warrants often are made part of the issuance of bonds or preferred or common stock. 2a7 -like pool An external investment pool that is not registered with the Securities and Exchange Commission (SEC) as an investment company, but neverthe- less has a policy that it will and does operate in a manner consistent with the SEC's Rule 2a7 of the Investment Company Act of 1940 (17 Code of Federal Regulations §270.2a-7). Rule 2a7 allows SEC -registered mutual funds to use amortized cost rather than market value to report net assets to compute share prices if certain conditions are met. Those conditions include restrictions on the types of investments held, restrictions on the term -to -maturity of individual investments and the dollar -weighted aver- age of the portfolio, requirements for portfolio diversification, requirements for divestiture considerations in the event of secunty downgrades and de- faults, and required actions d the market value of the portfolio deviates from amortized cost by a specified amount. 11 EXPOSURE uriAFT Appendix A BACKGROUND INFORMATION 22. For several years, the GASB has considered the need for a project on in- vestment measurement and reporting. It addressed certain disclosure issues in Statement 3 in response to governmental losses in repurchase and reverse re- purchase agreements. It provided for cost -based measurement standards for investments in Statement 11 10 However. paragraph 191 of the Basis for Con- clusions of Statement 11 indicates that the Board adopted the cost -based meas- ures used in current practice until it could thoroughly examine the issues in- volved in the valuation of investments. 23. The only broad standard of investment accounting for general purpose gov- ernmental entities is in the AICPA Audit and Accounting Guide, Audits of State and Local Governmental Units. Paragraph 7.15 of that Guide states that govern- mental fund investments generally are reported at cost unless there are de- creases in market value and the decline is not due to a temporary condition. Preparers and auditors experienced difficulty applying that standard during the changing market conditions of 1994 and 1995. In 1994, with some governments carrying Tong -term debt securities at cost -based values significantly higher than their fair value, questions arose concerning how to evaluate whether a decline was due to an other -than -temporary condition. Some made the evaluation based on the government's ability and intent to hold the securities to maturity, which necessarily involved substantial professional judgment. The following year, when some of the securities that had been written down to a new cost basis recovered some of their value, that recovery could not be reflected in the financial statements, causing some to question the appropriateness of the standard. Some suggested that a fair value -based standard might better have reported events affecting investment portfolios during that time. 24. The Board was concerned that the disclosure of fair value in the notes to the financial statements may not have allowed financial statement users to be suffi- ciently aware of the potential effect of investment gains and losses. The Board agreed that it was time to address the issue of whether the cost methods used in current practice were appropriate, and in July 1995 it adopted a project to con- sider the valuation and reporting of investments. In this project, the Board is I °The effective date of Statement 11 was deferred indefinitely by GASB Statement No. 17. Meas- urement Focus and Basis of A al Fund operating Statements: Amend- ment of the Effective Dates of GASB Statement No. 11 and Related Statements. 13 EXPOSIT" "'RAFT EXPnSUiRr Fr considering the measurement and reporting of certain investments held by all governmental entities except for Internal Revenue Code Section 457 deferred cmmpensatinn mans anti riefineri henafif rwncinn nIanc 11 The Rnard agreed to start its deliberation of valuation issues by considering the investment types cov- ered by and valuation and recognition standards in FASB Statements No. 115, Accounting for Certain Investments in Debt and Equity Secunties, and No. 124, Accounting for Certain Investments Held by Not.or-Profit Organizations. A task force of twenty-two persons representing general and special-purpose govern- ments, public accounting, external investment pools, and financial statement us- ers met in December 1995 to counsel the Board on issues relating to this project. 25. This project is the first phase of the Board's financial instruments project. That project will examine various issues relating to the recognition, measure- ment, and reporting of transactions in financial instruments. Some of those is- sues may concern reporting on investment portfolio structure, characteristics, and performance; fair value measures for specific instrument types (such as real estate, foreign exchange transactions, and derivatives); accounting for hedging transactions; and valuation and reporting of financial instruments other than investments—liabilities as well as assets. The FASB's Investments Statements 26. in May 1993, the FASB issued Statement 115 on accounting for invest- ments in all debt secunties and in equity securities with readily determinable fair values. That Statement requires an enterpnse to classify its investment securi- ties into one of three categories at acquisition. The carrying amount of the secu- rities and the reporting of unrealized gains and losses depend on how a security is classified. a. Held -to -maturity securities are debt securities that the enterprise has both the positive intent and the ability to hold to maturity. They are reported at amortized cost. Holding gains and losses are not recognized in earnings until realized or until there is an other -than -temporary decline in the fair value of a security below cost. b. Trading securities are debt and equity secunties that are bought and held principally for the purpose of selling them to make a profit. They are reported at lair value, with unrealized holding gains and fosses Included in earnings. 11Fair value standards tor the investments of those plans were established by Statements 2 and 25. respectively. However, this Statement provides guidarx;e to those plans on applying lair value to certain investments. c. Securities that do not fit the definition of either held -to -maturity or trading se- cunties are classified as available -tor -sale. They are reported at fair value, with unrealized holding gains and 14.0000 reported as a net amount in a sepa- rate component of shareholders' equity. Holding gains and losses are not rec- ognized in earnings until realized or until there is an other -than -temporary decline in the fair value of a security below cost. 27. Statement 115 does not apply to not-for-profit organizations. The FASB pro- vided investment standards for those organizations in Statement 124, issued in November 1995. That Statement includes the same securities within its scope as does Statement 115, and it requires that those securities be reported at fair value. Realized and unrealized gains and losses are reported in the statement of activities as increases or decreases in net assets. Governmental External Investment Pools and Individual Investment Accounts 28. in 1994 and 1995, some governments announced significant realized and unrealized losses in the investment pools they sponsored for other govern- ments. Those announcements caused numerous parties—among them audi- tors, rating agencies, and pool participants—to examine the operations and portfolios of investment pools. The GASB considered the need tor a limited - scope project on the accounting and financial reporting by governmental exter- nal investment pools and by participants for their investment positions in those pools. Upon conducting initial research on the need for and feasibility of such a project, however, the Board determined that it could not address the accounting for investments held by pools without also addressing the accounting for invest- ments held in other than pooling arrangements. Because many investment pools include participation by the entities that are part of the reporting entity that sponsors the pool, if the Board were to establish standards only for governmen- tal external investment pools, significantly different accounting standards for in- vestments could result depending on the structure of the sponsoring govern- ment's investment function. 29 There are two basic types of governmental external investment pools, al- though hybnds of these two may exist. The first type of pool is sponsored by an individual state or local government. Many of these "sponsored pools" are oper- ated as part of the government's treasury or investment function, although in some cases the government may hire one or more private -sector companies to 14 15 EXPOSURE DRAFT provide administrative and investment advisory functions. In some cases, spon- soring governments have established a legally separate entity, such as a busi- ness trust. to operate the pool. However, the government retains a fiduciary re- sponsibility for the pool. 30. The second type of governmental external investment pool is created under a state's joint powers or interlocal agreement law, which allows governments to jointly undertake activities and services they are individually empowered to per- form. Generally, these "joint powers" pools are created by a declaration of trust, with a board of trustees comprising representatives from some of the participat- ing governments. These pools usually hire one or more private -sector compa- nies to provide administrative and investment advisory functions. 31. Governmental external investment pools are exempt from registration with the SEC under the Investment Company Act of 1940 because of the provisions of Section 2b, which states that no provision of the Act applies to or includes "a State. or any political subdivision of a State, or any agency, authority, or instru- mentality of any one or more of the foregoing, or any corporation which is wholly owned directly or indirectly by any one or more of the foregoing, or any officer, agent, or employee of any of the foregoing acting as such in the course of his official duty...." Despite this exemption, however, some governmental external investment pools have registered with the SEC as investment companies. 32. Some governmental external investment pools operate in a manner con- sistent with the SEC's Rule 2a7 of the Investment Company Act of 1940. That rule allows SEC -registered mutual funds to use amortized cost rather than mar- ket to report net assets to compute share prices if certain conditions are met. At present, some of the significant conditions are: a. The board of directors has to determine that the fund will continue to use amortized cost only as long as the board believes that it fairly reflects the market-based net asset value per share. b. The fund has to maintain a dollar -weighted portfolio maturity appropriate to maintaining a stable net asset value. However. the dollar -weighted average portfolio maturity cannot exceed ninety days. c. The fund may not purchase any investments with a remaining maturity of greater than 397 days. To use amortized cost. an SEC -registered mutual fund also has to limit invest- ments to U.S.-denominated investments that present minimal credit risk and that meet certain credit quality requirements. Rule 2a7 also includes requirements 16 EXPOSURE DRAFT for portfolio diversification, divestiture considerations in the event of security downgrades and defaults, and required actions if the market value of the port- folio deviates more than 0.5 percent from amortized cost. 33 Some governmental entities provide investment services to other entities on other than a pooled basis. For example, a county treasurer may maintain individual investment accounts for the municipal governments in the county. Specific investments are acquired for the individual municipalities, and the in- come from and changes in the value of those investments affect only the munici- pality for which they were acquired. Sometimes. such individual accounts are offered as an alternative to the sponsoring government's external investment pool; in other cases, only individual investment accounts are provided. 17 EXPOSE `RAFT Appendix B BASIS FOR CONCLUSIONS Introduction and Overview 34 This appendix discusses factors considered significant by Board members in reaching the conclusions in this Statement. It includes discussion of the alterna- tives considered and the Board's reasons for accepting some and rejecting oth- ers. Individual Board members gave greater weight to some factors than to others. 35. As discussed in paragraphs 22 and 23 of Appendix A, the Board has long considered adopting a project on investment measurement and reporting. Re- cent market conditions gave greater urgency to those issues. Users of govern- mental financial statements have expressed a need for additional information about investments and external investment pools. and this Statement is a step toward satisfying that need. The Board believes that when investments are re- ported at fair value in the financial statements, users will be able to obtain more relevant information about an entity's investments and the effects of its invest- ment practices. Scope of and Terminology in This Statement 36. This Statement provides a definition of the term investment to clarify that its measurement and reporting guidance is intended only for instruments that are held pnmanly for the purpose of income or profit. This Statement does not apply to securities or other instruments if they are not held by the government for in- vestment purposes, either for itself or for parties for which it serves as invest- ment manager or other fiduciary. Therefore, this Statement would not apply, for example, to seized debt securities that the government holds as evidence or as a potential fine, not as an investment. This Statement also would not apply to contractors' deposits of debt securities (although a government might neverthe- less value those securities at fair value if the contractor is required to maintain the deposit at a certain value). Further, it would not apply to the ownership of equity securities that represent a component unit rather than an investment. Paragraph 55 of GASB Statement No. 14, The Financia! Reporting Entity, con- tains requirements for reporting the ownership of a for-profit corporation as a component unit. 19 EXPOSURE DRAFT EXPOSURE DRAFT 37 In establishing the scope of this Statement. the Board started with all debt securities and equity securities with readily determinable fair values. The Board agreed to include within the scope of this Statement all investments in option contracts with readily determinable fair values—whether the option is for equity securities, debt securities, indexes, commodities. or so forth. (Because this Statement applies only to investments in option contracts. it applies only to pur- chased put and call option contracts. Written option contracts represent obliga- tions of the writer and are not investments.) The Board does not believe d needs to consider hedge accounting before establishing accounting standards for op- tion contracts. Although large numbers of general purpose governments do not have significant positions in option contracts, the Board believes it is better to provide some guidance at this time. 38. This Statement's definition of security is taken from the GASB's Guide to Implementation of GASB Statement 3. In addition to securities, the Board also agreed to include within the scope of this Statement investments in open-end mutual funds and external investment pools. as well as interest-earning invest- ment contracts, which include time deposits with financial institutions, repur- chase agreements, and guaranteed and bank investment contracts. The Board concluded that because governmental investment managers sometimes use interest-earning investment contracts as alternatives to short-term debt securi- ties. not requiring them to be reported using the same method might cause un- intended changes in investment activity. 39. To be consistent with the private -sector standards for investment companies, the Board included within the scope of this Statement all investments held by gov- ernmental external investment pools. Those other types of investments might in- clude, for example, real estate, mortgage and other loans, futures and forward contracts, venture capital, and limited partnerships. The Board agreed not to simi- larly expand the scope of this Statement for governmental entities other than pools because of complexities involved in measurement vis-a-vis the scope of this project. Although the Board understands that those measurement complexities might exist for pools, it believes it would be inappropriate for pools to report some types of investments at fair value and others at cost or amortized cost (except for this Statement's provision relating to short-term debt investments). 40 Many of the definitions used in this Statement are similar in all important respects to the definitions used in FASB Statements 115 and 124. In particular, the term fair value has the same definition. Although that definition differs in wording from the definition of that term in GASB Statement 25, the meanings are the same, resulting in the same measurements. 20 41 As with Statement 25, this Statement uses the term fair value to avoid con- fusion between fair value and market value: some might associate the term mar- ket value only with items that are traded in active secondary markets. However, the Board does not make that distinction, intending the term to apply whether the market for an investment is active or inactive, primary or secondary. To pro- vide consistency with this Statement's use of fair value, this Statement amends GASB Statements 2, 3, and 28 to replace the term market value with fair value. Accounting and Financial Reporting for Investments Relevance of Fair Value for Reporting Investments 42. The Board believes fair value is a better measure of a government's invest- ments than is cost. Fair value provides users with information to help them as- sess a government's accountability, the level of services that it potentially can provide, and its financial position and condition—thereby helping to achieve several financial reporting objectives. The Board notes that governmental man- agers continually decide whether to hold an investment or to sell or redeem it and redirect resources to other investments or other uses. Fair value information is more useful than cost -based information in evaluating performance. The Board also believes fair value is the more relevant and faithful representation of the asset and more accurately reports the resources available to provide serv- ices because it portrays the market's estimate of the net future cash flows of investments. discounted to reflect both time value and risk. 43. The ability to meaningfully evaluate an entity's investment performance—to compare its returns, adjusted for risk, to those of common market indicators or to other entities—is enhanced when investments are reported at fair value. Cost - based measures of the same investment can vary among and within organiza- tions: fair value measures vary little, if at all. The value of investments comes from an entity's ability to generate income and to convert them to cash, and to use the resulting cash to support its activities. Cash flows from investments do not depend on which organization owns them or the amount for which an organ- ization acquired them; thus, the reporting of investments should not vary among or within organizations. The Board also notes that requiring all governments to report investments at fair value builds on current and evolving practices and re- quirements in both the public and private sectors. 44. The Board considered whether amortized cost should be acceptable for re- porting debt investments when a government has the ability and intent to hold those investments to maturity. If debt investments are held to maturity, absent a default by the issuer, the holder will recover the full face amount of the 21 EXPOSUP- -RAFT EXPOSUV AFT investment, and any interim unrealized gains and losses will reverse. Therefore, supporters of cost -based accounting argue that it would be inappropriate to re- port lair value changes in debt securities that will be held until they mature. The Board. however, finds fair value as relevant for debt securities to be held to ma- turity as for other investments. Changes in fair value of those securities reflect the success or failure of the holder's strategy for purchasing and holding longer- term rather than shorter -term instruments in a changing interest rate environ- ment. Further, the Board believes that a measurement standard that vanes ac- cording to whether a government does or does not have the ability and intent to hold a particular investment to maturity would be difficult to apply and to verify. 45. The Board also considered the extent to which governmental investment standards should provide comparability between public -sector special entities and their private -sector counterparts. One possibility would have been to adopt either or both of the FASB investment Statements. The Board did not find the alternative of adopting both Statements viable; it believes that it is important to have a single investment standard for all governmental entities. The Board does not believe that adopting FASB Statement 115 would result in comparability be- tween the public and pnvate sectors because of the flexibility in that Statement; two entities applying those provisions to similar investment portfolios might not have comparable measurements and recognition because of different manage- ment intent. The Board observes that the provisions of this Statement result in measurements and recognition that are similar to those resulting from FASB Statement 124. 46. For cost -benefit purposes, paragraph 8 of this Statement allows govern- mental entities to report short-term debt investments at amortized cost, pro- vided that the fair value of the investments is not affected by market, credit, or other factors. The Board believes that in those situations amortized cost will rea- sonably represent fair value, thus relieving many governments from the burden of establishing systems to track fair value for large portions of their portfolios on other than an exception basis. The Board notes that the American Institute of Certified Public Accountants' (AICPA) Audit and Accounting Guide, Audits of In- vestment Companies, paragraphs 2.35 through 2.37, describes a similar allow- ance for investment companies. This Statement defines short-term investments as those with remaining matunties of up to ninety days, which generally is con- sistent with the guidelines for defining cash and cash equivalents in GASB Statement No. 9, Reporting Cash Flows of Proprietary and Nonexpendable Trust Funds and Governmental Entities That Use Propnetary Fund Accounting. The Board considered defining short -terrain terms of an individual government's definition of cash and cash equivalents. It did not do so, however, because some 22 governments may not have defined that term and because others may have defined it differently for cash flows reporting than they would prefer to define it tar vah tatinn Tho Rnarri aI n rnnsiriprcui riofininn shnrt-►arm as snme period al brae longer than ninety days. The Board decided against a longer period of time because the fair value of longer-term investments is more variable; thus, an "ex- ception" standard for evaluating their fair value would likely not be cost - beneficial. Also, the Board previously concluded in Statement 9 that generally only investments with matunties of three months or less are so near to matunty that they present insignificant risk of changes in value because of changes in interest rates. This Statement defines short-term investments as ail investments with remaining maturities of up to ninety days, not just those with onginal matu- nties of up to ninety days. That provision, again, is consistent with the treatment of that category of investments by investment companies. Reporting Changes in Fair Value 47. The Board believes that financial reporting about investments is improved when the statement of activities reflects the financial and economic results of those events and transactions. Those results arise not only from interest and divi- dend income arid from sales of investments but also from changes in the fair value of the investments during the holding period. The Board believes that different rec- ognition standards for realized and unrealized changes in fair value would -under- mine the validity of a fair value measurement. Reporting only realized gains and losses in the statement of activities is a historical -cost concept, which provides information on investment results only in the year investments are sold. Changes in fair value should be included as part of the year's activities when they occur because they are as relevant as other earnings on investments, such as dividends and interest, to assessments of investment management and performance and financial position. A government is in a better financial position when investment values increase and a worse position when they decline. The Board also notes that reporting at fair value eliminates the potential that the timing of investment sales to produce a particular result will distort investment income. 48. The Board considered but rejected reporting unrealized gains and losses on certain investments as a direct change in a separate component of equity. Besides the reasons discussed in paragraph 47, the Board does not believe this reporting treatment is appropriate in the governmental environment, where most entities report activities in art all-inclusive statement—that is. a statement of ac- tivities that reports all changes affecting fund balances or retained earnings. 23 EXPOSURE DRAFT 49. The Board believes that governmental fund investments—and changes in the lair value of those investments—are appropriately "available," thus menting recognition under the modified accrual basis of accounting. The Board consid- ered whether recognition of the changes in lair value of investments should be modified in some manner in governmental ano similar trust funds, which report using a current financial resources measurement focus and modified accrual ba- sis of accounting. It examined various alternatives for applying the "availability" criterion to changes in fair value. It also considered interpreting how that criterion should be applied to changes in the fair value of investments, but did not want to develop an interpretation outside its financial reporting model project. especially when those standards might become analogized to other types of transactions. Among the potential problems the Board observed with modifying full recogni- tion in those fund types was complexity in the accounting, as well as the possi- bility for (a) the reporting of a net unrealized loss on fund investments in a "de- ferred charge" account. (b) varied application of the "availability" criterion across entities, and (c) the management of reported results. The Board also observed that because of their need for liquidity to meet operating needs, governmental funds generally hold short-term or marketable investments. 50. This Statement requires the equity of an internal investment pool to be at- tributed as assets to the participating funds and component units. This reporting is consistent with current practice. This Statement also provides reporting re- quirements when income from investments associated with one fund is as- signed to another fund. This provision is adopted from Statement 11, para- graph 67, and has previously been incorporated into Statement 28 and GASB Interpretation No. 3, Financial Reporting for Reverse Repurchase Agreements. for the reporting of securities lending and reverse repurchase agreement in- come and costs. Many governments have legal provisions for such redirection of investment income. Except for legally or contractually required transfers of re- sources, the Board believes investment income should be reported in the state- ment of activities of the fund legally or contractually designated to receive it, not in the fund reporting the investment, because the amounts were never intended to be revenue to the fund reporting the investment. However, in the absence of such legal or contractual provisions, the Board believes any income from spe- cific investments is more appropriately recognized in the statement of activities of the fund reporting the investments. If the amounts are then assigned to an- other fund for other than legal or contractual reasons, a transfer is needed to report the movement of the assets between the funds. 51. This Statement includes the prohibition provided in Statement 25 against the separate display of realized and unrealized gains and losses in the state - 24 EXPOS....c DRAFT ment of activities. In Statement 25, the Board concluded that separate display mixes two different measurement bases. is inconsistent with reporting assets at fair value. and can be misleading. However, the Board exempted the separate reports of governmental external investment pools from this prohibition because the investment companies Audit Guide, which many pools apply for financial re- porting purposes, requires the separate display of realized and unrealized gains and losses. The Board is aware that some believe that distinguishing between realized and unrealized gains and losses provides useful information. Therefore, this Statement permits disclosure of realized gains and losses in the notes to the financial statements, provided certain information about the nature of those amounts and their relationship to the amounts recognized also is disclosed. 52. This Statement requires minimum disclosures about the valuation and fi- nancial reporting of investments and investment income. The Board also con- sidered the need to provide at this time additional disclosures on portfolio struc- ture and characteristics, such as investment objectives and maturities. Although those disclosures may be necessary to more fully satisfy the information needs of financial statement users, the Board concluded that they are outside the scope of this measurement project. As discussed in paragraph 25 of Appendix A, the Board will consider such disclosures in a later phase of the financial instru- ments project. Standards for Extemal Investment Pools Pool Reporting Valuation 53. The Board believes that using fair value to report investments and recogniz- ing all changes in fair value in the statement of activities are especially important for governmental external investment pools. If fair value is not used to value par- ticipant shares, there is the potential for the inequitable distribution of changes in value among pool participants. For example, if significant fair value losses are not reflected in a pool's share value, withdrawals from the pool before the loss is recognized in the share value leave an inequitable burden of the loss on remain- ing participants. Similarly, if significant fair value gains are not reflected in a pool's share value, withdrawing participants share only in a portion of the invest- ment returns that took place during their period of investment. Although the Board cannot establish standards for valuing participant shares. it can require the reporting of investments at fair value, which will allow users to more fully compare fair value to share value. 25 EXPOS!"'`' DRAFT 54. This Statement allows an exception from fair value measurements for in- vestments held by 2a7 -like pools. SEC Rule 2a7 allows SEC -registered money market mutual funds to use amortized cost rather than market to compute share prices if certain conditions are met. The Board chose to allow the use of amor- tized cost for 2a7 -like pools because Rule 2a7 is the accepted industry standard for the use of amortized cost accounting for mutual funds. The Board also chose to define 2a7 -like pools by reference to the n'e rather than by incorporating its current provisions into this Statement. That approach will keep the definition of 2a7 -like pools in concert with the rule as it changes over time. The definition of 2a7 -like pools requires not only that the pool operate in a manner consistent with Rule 2a7, but also that it have a policy to do so. This requirement will ensure that the reporting for a pool (and by pool participants) would not change from period to period due only to the pool's investment practices. Separate Pool Reports 55. Some financial statement users maintain that they cannot adequately un- derstand a government's financial position and condition unless they also un- derstand the operations and portfolio of the pools in which that government in- vests. Also, pool participants cannot fully understand the nature of their investments unless they have the opportunity to review current financial infor- mation. The Board believes that to meet those user needs, it is essential for governmental external investment pools to issue separate annual financial re- ports. This Statement provides minimum required statements for such reports to provide a starting point for separate reporting by governmentai poois that previ- ously have not done so; those requirements also allow pools that issue reports using the guidance of the investment companies Audit Guide to continue to do so. This Statement highlights that those pool reports should apply all applicable GASB pronouncements. especially those that apply to cash and investments (including Technical Bulletin 94-1, Disclosures about Derivatives and Similar Debt and Investment Transactions). This Statement also requires certain disclo- sures unique to pool reports—such as a bnef description of regulatory oversight and the frequency and purpose of determining the fair value of pool invest- ments—because they are needed to allow participants and users of partici- pants' financial statements to more fully understand a pool's operations and portioiio. Reporting by Sponsoring Govemments 56. Many governmental entities that sponsor external investment pools pres- ently report them in their annual financial statements, and many of those report - 26 EXPO ' DRAB' ing sponsors classify those pools as agency funds. The Board agrees that to provide accountability for their fiduciary responsibilities, pool sponsors should report external investment pools as separate funds in their financial statements. A governmental entity that sponsors a pool has a fiduciary responsibility for that pool. Paragraph 19 of Statement 14 provides that a primary government should report its fiduciary funds regardless of entity considerations. It states: For ex- ample. there may be organizations that do not meet the definition for inclusion in the financial reporting entity. They should, nevertheless, be reported as a fidu- ciary fund of the primary government if the pnmary government has a fiduciary responsibility for thtim." 57. The Board has determined that prevalent practice is for only the external portion of an investment pool to be reported as a separate fund in the sponsor's report; the internal portion—the portion belonging to the primary government and its component units—generally is allocated as assets to those funds and component units. This is done to avoid duplicate reporting of the assets. State- ment 2 requires the same approach if deterred compensation plan assets appli- cable to component units are administered by the primary government; accord- ing to paragraph 14 of that Statement, those assets are reported by the component unit only. The Board believes that eliminating internal portions from the fiduciary fund that reports an investment pool is appropriate under the cur- rent reporting model and has provided for such reporting in this Statement. 58. The Board believes the nature of external investment pools requires the Spunaur iu report tiiu activity in a separate trust fund that uses the euuituniiu resources measurement focus and accrual basis of accounting and that in- cludes a statement of activities in the general purpose financial statements (GPFS). This separate trust fund classification is similar to that used by pension trust funds. The types of financial statements required. the reporting of partici- pant equity, and the combination of statements in the GPFS for investment pool trust funds also are the same as required for pension trust funds. 59. II a separate annual financial report is prepared for a governmental external investment pool, the Board believes it is appropriate for the sponsors report to descnbe how to obtain it. However, the Board understands that some pools may not issue such a separate report. If that is the case, the Board believes that most of the information that would have been provided in that report should be pro- vided in the sponsoring government's report. Although some may believe that this additional disclosure would be burdensome, the Board points out that none 01 it is required it separate reports are prepared for the pools in accordance with this Statement. 27 EXPOSURE DRAFT EXPOSUNE DRAFT 60. Not all investment services provided by a governmental entity to others are on a pooled basis; some governmental entities provide individual accounts, sometimes as an alternative to a pooled investment. The Board believes that the same types of financial statements should be presented for all external invest- ment services, whether or not provided on a pooled basis. Therefore, this State- ment also requires sponsoring governments to use one or more investment trust funds to report external investment services provided through individual ac- counts. Because investors in such accounts do not have an interest in the whole of the fund, separate reports and disclosures for the fund are not required. If individual investment accounts are offered as an alternative to a pooled invest- ment, this Statement requires the sponsoring government to report them in a different investment trust fund from the pool. The Board believes that to combine individual accounts with the investment pool might obscure information that is needed by users of the pool's financial statements. Investments In Open -End Mutual Funds and External Investment Pools 61. This Statement provides guidance for measuring and reporting investment positions in open-end mutual funds and external investment pools. For positions in open-end funds. this Statement requires disclosure of those positions as be- ing in SEC -registered mutual funds to help financial statement users understand the nature of the investment. 62. This Statement's requirements for measuring investment positions in exter- nal investment pools are the same whether the pool is sponsored by a govern- mental or a nongovernmental entity. An example of a nongovernmental pool is a bank short-term investment fund, which many governmental entities use for the investment of cash collateral on securities lending transactions. The reporting of a participant's position in an external investment pool mirrors the reporting re- quirements for the investments held by the pool. Thus. a participant in a non -2a7 -like pool should "look through" the pool and determine its ratable por- tion of the fair value of the pool's investments to report the fair value of its posi- tion. This Statement also provides for pool participants to consider legally bind- ing guarantees provided or obtained by the pool sponsor to support share value in making the fair value measurement. For example, a pool sponsor may obtain an irrevocable bank letter of credit to support its share value when the fair value of the investments it holds is affected. Also, some pool sponsors may guarantee a fixed share value. However, for such a guarantee to meet the requirements of this Statement, it would have to be a stated legal obligation. This Statement also 28 requires governments participating in external investment pools to make certain disclosures about those pools to help financial statement users better assess the nature of the participants' investment. 63. The Board understands that there may be situations in which a pool partici- pant may not be able to obtain the information it needs to determine the fair value of its investment in an external investment pool. For example. the pool and the participant may have different fiscal year -ends and the pool may not have determined the lair value of its portfolio as of the participant's fiscal year-end. In those cases, the Statement permits participants to make their best estimate of fair value and to disclose to financial statement users why such an estimate was needed. Although this provision will not wholly overcome practical problems, those problems do not dissuade the Board from requiring fair value measure- ments for those investments. The Board believes that financial statement users are especially concerned about an entity's investment in external investment pools for which fair value information cannot be obtained. Other lssues Effective Date and Transition 64. This Statement is effective for financial statements for periods beginning af- ter June 15, 1997 (earlier application encouraged). The Board believes this will provide sufficient time for governments to implement the provisions of this State- ment. The Board does not believe that governments should have problems ob- taining the fair value of investments—disclosure of those amounts has been re- quired by Statement 3 since fiscal year 1987 for almost all of the types of investments covered by this Statement. Determining Fair Value 65. The Board concluded that quoted market prices, if available. provide the most reliable measure of fair value. Quoted market prices are easy to obtain, reliable and verifiable, and well understood by investors. creditors, and other us- ers of financial information. Although quoted market prices are not available for all debt securities or for interest-earning investment contracts, the Board be- lieves that a reasonable estimate of fair value can be made or obtained for them. The estimate of fair value should consider market prices for similar investments and the results of valuation techniques, including but not limited to discounted cash flow analysis, matrix pricing, option -adjusted spread models, and funda- 29 EXPOSU` . 'SFT mental analysis. The Board realizes that estimating fair value may require judg- ment but notes that a considerable degree of judgment also is needed when complying with other long-standing accounting and reporting requirements. 66. This Statement provides that put option contracts purchased and call option contracts written should be consideredd when determining the fair value of in- vestment securities to the extent that those contracts are not reported at fair value. The Board believes that if an entity has the right to sell securities under a put option, the combined measures of the security and the option contract should approximate the strike price if that price is above the security's market price. If the put option contract is not reported at fair value (for example, because it does not have a readily determinable fair value), the entity should consider the unrecorded value of the option contract in measuring the underlying security at fair value. Similarly, the Board believes that the combined value of a secunty subject to sale under a call option and the call option liability should approximate the stake pace, if the strike pace is less than the security's market price. If the call option contract is not reported as a liability and is not reported at fair value, an adjustment to the quoted market pace of the underlying security would be needed to properly report its fair value. Impairments of Investments 67. This Statement does not provide a standard for impairments of investments. Such a provision is u..r rct;Cssary when all changes in fair value are recognized in the statement of activities. To the extent that a government reports investments that are outside the scope of this Statement at cost or amortized cost, impair- ment standards are provided by other pronouncements. Illustrations 68. This Statement does not provide illustrative examples of financial statements for governmental external investment pools. The Board intends this Statement to allow flexibility in such reporting and therefore does not want to provide illustra- tions that some may consider to be required or suggested examples. The Board may reconsider the need to provide standardized requirements for pool financial statements later in its financial instruments project. The Statement does, however, illustrate how to calculate the change in fair value of investments. 30 EXPOS' IAF T Appendix C ILLUSTRATION OF FAIR VALUE ACCOUNTING FOR INVESTMENTS 69. This appendix illustrates how to calculate the change in fair value of invest- ments as required by this Statement. The facts assumed in this example are illustrative only and are not intended to modify or limit the requirements of this Statement nr fn indicate the Board's endorsement of the situations or specific methods illustrated. Application of the provisions of this Statement may require calculations other than those illustrated here. Specific Identification Method A Beginning Cost Fair Value Security 1 S100 Security 2 520 Security 3 200 Security 4 330 Year 1 B C D E F Ending Ending Change in Purchases Sales Investments' Fair Value Fair Valuet 5100 S100 5120 540 540 510 240 S250 (10) 0 5330 330 315 S880 5330 S250 S960 S945 'Column 0 - Columns A + 8 - C. 'Column F = Column E - Column 0. Aggregate Method Fair value at December 31, 19X1 Add: Proceeds of investments sold in year 19X1 Less: Cost of investments purchased in year 19X1 Less: Fair value at December 31, 19X0 Change in fair value of investments $ 945 250 (330) (880) $ (15) S 20 (30) 10 (15) S(15) 31 EXPOSURE DRAFT EXPOSURL _ ..AFT Year 2 Specific Identiflcatlon Method A a C D E F Beginning Cost Fair Value Ending Ending Change in Purchases Sates Investments' Fair Value Falr Valuet Security 1 S100 Security 2 520 Security 4 330 Security 5 310 $120 S110 $ 10 S 0 S(10) 510 510 550 40 315 330 (15) 0 15 S310 310 300 (10) S945 S310 S440 S815 S850 S 35 'Column D = Columns A + B - C. tColumn F = Column E - Column D Aggregate Method Fair value at December 31. 19X2 Add: Proceeds of investments sold in year 19X2 Less: Cost of investments purchased in year 19X2 Less: Fair value at December 31, 19X1 Change in fair value of investments $ 850 440 (310) (945) $ 35 • Appendix D CODIFICATION INSTRUCTIONS 70. The sections that follow update the June 30. 1995. Codification of Govern- mental Accounting and Financial Reporting Standards for the effects of this Statement. Only the paragraph number of this Statement is listed if the para- graph will be cited in full in the Codification. • • • SUMMARY STATEMENT OF PRINCIPLES SECTION 1100 Sources: (Add the following:) GASB Statement XX 103c Fiduciary Funds (1) Trust and Agency Funds—to account for assets held by a govern- mental unit in a trustee capacity or as an agent for individuals. private organizations, other governmental units. and/or other funds. These include (a) expendable trust funds, (b) nonexpendable trust funds, (c) pension trust funds, (d) investment trust funds, and (e) agency funds. .108c (Change the penultimate sentence as follows:) Nonexpendable trust. pension trust. and investment trust funds should be accounted for on the accrual basis; expendable trust funds should be accounted for on the modified accrual basis. GENERALLY ACCEPTED ACCOUNTING SECTION 1200 PRINCIPLES AND LEGAL COMPLIANCE 115d (Rename Section 15010 "Investments" and change cross-references as appropriate.) 32 33 EXPOSURE DRAFT FUND ACCOUNTING SECTION 1300 Sources: [Add the following:] GASB Statement XX .102c (Change the penultimate sentence as follows:( Nonexpendable trust funds, pension trust funds,2 and investment trust funds3 are accounted for in essentially the same manner as proprietary funds. (Add "GASES XX. 1114" to the sources.( .104c Fiduciary Funds (1) Trust and Agency Funds—to account for assets held by a govern- mental unit in a trustee capacity or as an agent for individuals, pnvate organizations, other governmental units. and/or other funds. These include (a) expendable trust funds, (b) nonexpendable trust funds, (c) pension trust funds, (d) investment trust funds, and (e) agency funds. (Add "as amended by GASES XX, 1114" to the sources.] 2(Insert current Codification footnote 2.11 3See Sections i50. `investments," and In5,1nvestment Pools (External)" for discussion o1 invest- ment trust funds. (Renumber subsequent footnotes.' BASIS OF ACCOUNTING SECTION 1600 Sources: [Add the following:j GASB Statement XX Statement of Principle Accrual Basis in Governmental Accounting c. [Change the penultimate sentence as follows:) Nonexpendabie trust, pension trust, and investment trust funds should be ac- counted for on the accrual basis; expendable trust funds should be accounted for on the modified accrual basis. (Add "and as amended by GASES XX, 1114" to the source.] 34 cv®na mnrw +r * • 113 investment Income. All investment income, including changes in the fair value of investments, should be recognized as revenue in governmental funds. Realizeri gainc and Ince' should not be displayed . from unrealized -- --- a-...- --.-- • ................ w displayed separately uiir2antcu gains and losses in the financial statements. An entity may disclose realized gains and losses in the notes to the financial statements, provided that it discloses both realized gains and losses, computed as the difference between the proceeds of the sale and the onginaf cost of the investments soki.3 (GASES XX, 118] [Renumber subsequent paragraphs.] 3(GASBS XX. In5) (Change cross-references as appropriate and renumber subsequent foot- notes.) FINANCIAL REPORTING SECTION 1900 Sources: [Add the following:] GASB Statement XX 124 Separate annual financial reports should be issued for governmental ex- ternal investment pools. (See Section In5, "Investment Pools (External)," for fi- nancial reporting and disclosure standards.) (GASES XX, 1113] [Renumber subsequent paragraphs.] NOTES TO FINANCIAL STATEMENTS SECTION 2300 106c Investments. (See Section 150, "Investments.") 107r External investment pools—both in separately issued annual financial re- ports and in annual financial reports of the sponsoring government. (See Sec- tion 150, paragraph .116 and Section 1n5, "Investment Pools (External)," para- graph 102.) [Renumber subsequent subparagraphs.] 35 EXPOSUhc DRAFT CASH DEPOSITS WITH FINANCIAL INSTITUTIONS SECTION C20 Sources: (Add the following:J GASB Statement XX Scope of This Section 101 [Rename Section 150 to "Investments."J Introduction and Background .102 Section 150. paragraphs .904-.922, provides a discussion of the nature and types of deposits with financial institutions and the risks associated with them. That section also establishes accounting and financial reporting stand- ards for Interest-eaming Investment contracts, which include time deposits with financial institutions, such as nonnegotiable certificates of deposit. In addi- tion, paragraphs .501-.545 of that section provide definitions of terms, including those printed in boldface in this section; paragraphs .901 and .902 of that sec- tion illustrate disclosures required by this section. [No changes to the rest of the section.] DEFERRED COMPENSATION PLANS SECTION D25 (IRC SECTION 457) Sources: [Add the following:] GASB Statement XX 104 [Change "market value" to 'lair value.") [Add "as amended by GASBS XX, "6" to source.] .111 The employer's liability to each participant, at any point in time, is reported by the participant's share of the fair value of the plan assets; therefore, plan assets should be valued at fair value. As provided in Section 150, "Investments," paragraph' .105, if an entity has purchased put option contracts or written call option contracts on securities and it has those same securities among its invest- ments, it should consider those contracts in determining the fair value of those securities to the extent it does not report those contracts at fair value. The fair value of investments in open-end mutual funds and external investment pools should be determined in accordance with Section 150, paragraphs .109-.110, 36 EXPOSU.._ GRAFT and the disclosures required by paragraph .119 of that section should be made. If the obligation to plan participants is determined by a measurement other than fair value (such as fixed-rate insurance contracts), the same method used to calculate the obligation by the administrator (for example, contract value) should be used to value the assets. [No further changes to the paragraph.] (GASBS 2, "11, GASBS XX, 117 and Ti 17-" 19J 113 [Rename Section 150 to "Investments.") .901 [Change "fair market value" to "fair value" in Note XX.J [Add "as amended by GASBS XX, 116" to the source.] [Rename the section as follows:] INVESTMENTS SECTION 150 Sources: [Add the following:) GASB Statement XX (Revise the headnote as follows:] [Change "this section" to "paragraphs .904- .960.1 Scope and Applicability of This Section .101 This section establishes accounting and financial reporting standards for all investments' held by governmental external Investment pools? For govern- mental entities other than external investment pools,3 defined benefit pension Terms used in this section and defined in paragraphs .502—.545 are printed in boldface type the first time they are used. (GASBS XX, fn2j 2Financial reporting and disclosure standards for separate annual financial reports by external investment pools are presented in Section 1n5, "Investment Pools (External)." 3(Insert current Codification footnote 2.1 37 EXPosur -*AFT EXPOS' RAFT plans, and Internal Revenue Code Section 457 deferred compensation plans, it establishes accounting and financial reporting standards for investments in: a. Interest-earning investment contracts b. External investment pools c. Open-end mutual funds d. Debt securities e. Equity securities, option contracts, stock warrants, and stock rights that have readily determinable fair values. This section also provides guidance for disclosures by all governmental entities about deposits with financial institutions and investments. Unless otherwise specified, the requirements of this section apply to financial reports of all state and local governmental entities, including public benefit corporations and au- thorities, public employee retirement systems, and governmental utilities, hos- pitals [and other healthcare providers], colleges, and universities. [GASBS 3,111; GASBS XX, 112] .102 [GASBS XX, 113] [Change "Statement" to "section" and change footnote number as appropriate.] .103 Sections D25, "Deferred Compensation Plans (IRC Section 457)," and Pe5, "Pension Plans—Accounting," contain standards for the valuation and re- porting of the investments of those plans. The provisions of paragraph .105 con- cerning securities subject to purchased put option contracts and written call op- tion contracts and of paragraphs .109-.110 for investments in open-end mutual funds and external investment pools apply to those plans for measuring fair value. The disclosures required by paragraphs .119-.132 also apply to those plans. [GASBS 3,111; GASBS XX, 114] .104 [GASBS XX, 115] (Change "Statement" to "section.") .105-.108 [GASBS XX, 117-1110] [Change cross-references and footnote num- bers as appropriate" .109 [Insert the first sentence of GASBS XX, 11171 110 For investment positions in external investment pools that are not SEC registered, whether or not sponsored by a governmental entity,5 fair value 5(GASBS XX. In 91 should be determined by the fair value per share of the pool's underlying portfo- lio, unless the pool is a 2a7 -like pool. Legally binding guarantees provided or nhtainori by thw nnnl cmncnr to c, ,bort char" en!, 'w chn, Jrl h ennciriwrwri in determining the fair value of the participants' investments. For investments in 2a7 -like pools, fair value should be determined by the pool's share price. If a governmental entity cannot obtain information from a pool sponsor to allow it to determine the fair value of its investrnent in accordance with these require- ments, it should make its best estimate of the fair value of that investment. [GASBS XX, 1118-1119] Accounting and Reporting Guidance for Repurchase Agreements 111-.112 [Insert current Codification paragraphs .172 -.173.] Accounting and Reporting Guidance for Reverse Repurchase Agreements 113 Section 155, "Investments—Reverse Repurchase Agreements," provides accounting and reporting guidance for reverse repurchase agreements. Additional Standards for Extemal Investment Pools and for Individual Investment Accounts 114-.117 [GASBS XX, 1112 and 1114-1116, including subhead] (Change cross- references and footnote numbers as appropriate.) Disclosures Valuation and Reporting 118 [GASBS XX, 1111] 119 The disclosure of investments by type, as required by paragraph .125, should indicate those investments that are in SEC -registered mutual funds. Gov- ernments that participate in external investment pools that are not SEC registered should disclose (a) a brief descnption of any regulatory oversight for the pool and (b) whether the fair value of its posrtion in the pool is the same as the value of its pool shares. In addition, governments that are involuntary participants in such pools should disclose that tact. Finally, if a governmental entity cannot obtain in- formation from a pool sponsor to allow it to determine the fair value of its invest - 38 39 EXPOSURE DRAFT EXPOSUHE DRAFT ment and has therefore made its best estimate of its fair value, it should disclose the methods and significant assumptions made in determining that fair value and the reasons for having to estimate the fair value. [GASBS XX, 1117-1119] Deposits with Financial Institutions and Investments .120 [Insert current Codification paragraph .159.) 121 (Insert current Codification paragraph .160. Renumber the footnote. Change the fifth and subsequent sentences as follows:) Additional or separate dis- closures for blended component units. external investment pools, pension trust funds, or other funds or fund types of the primary government should be made in certain circumstances as discussed in paragraphs .117, .122, .127, and .128. Ad- ditional or separate disclosures for individual discretely presented component units also should be made in certain circumstances as discussed in para- graphs .122 and .128. However, additional or separate presentation by fund, fund type, or component unit is not precluded for any other disclosures required by this section. [GASBS 3,1164; GASBS 14,1111 and 1163; GASBS XX, 11151 Legal or Contractual Provisions for Deposits and Investments, including Repurchase Agreements .122-.125 [Insert current Codification paragraphs .161-.164. Change cross- references and footnote numbers as appropriate. Change "market value" to lair value.) [Add "as amended by GASBS XX, $F to the source for paragraph .125.) .126 The categories in paragraph .125 may not apply to all types of invest- ments. In general, investments in external investment pools and in open-end mutual funds should be disclosed but not categorized ... (no further changes to the paragraph]. [GASBS 3, 1169; GASBS XX, 1121) 127 If the credit risk to the primary government is not apparent because (a) the deposit or investment balances of blended component units, pension trust funds, investment trust funds, or other funds of the primary government are significant ... [no further changes to the paragraph). [GASBS 3. 1170, as amended by GASBS 14; GASBS XX) .128-.132 [Insert current Codification paragraphs .167-.171. Change "market value" to "fair value." Change cross-references and footnote numbers as appropriate.) [Add "as amended by GASBS XX, 116" to the source for para- graphs .128 and .1291 DEFINITIONS 501 The following paragraphs define certain terms used in this section. The terms may have different meanings in other contexts. 502-.511 [Insert current Codification paragraphs .501-.510. Change cross- references as appropriate.) .512 Debt security. (GASBS XX, 11211 .513- 514 [Insert current Codification paragraphs .511 and .512.) .515 Equity security. [GASBS XX, 1121) .516 External Investment pool. (GASBS XX. 1121) .517 Fair value. (GASBS XX, 1121) .518-.520 [Insert current Codification paragraphs .513-.515.] .521 Individual investment accounts. (GASBS XX, 1121) .522 Interest-earning investment contract. (GASBS XX, 1121) .523 Internal investment pool. (GASBS XX, 1121) .524 Investment. For purposes of the accounting and financial reporting standards in paragraphs .105 through .119, an investment is a security or other asset acquired primarily for the purpose of obtaining income or profit. (GASBS XX, 1121) .525-.528 [Insert current Codification paragraphs .516-.519. Change "market value" to 'Pair value.") (Add "as amended by GASBS XX, 116" to the source for paragraphs .525 and .5261 .529 Open-end mutual fund. (GASBS XX, 1121) .530 Option contract. [GASBS XX, 1121] .531-.537 [Insert current Codification paragraphs .520-.526.) 40 41 EXPOSURF AFT .538 Security. (GASBS XX, '121] .539 Sponsoring govemmant IGASBS XX, 1121J .540 Stock rights. (GASBS XX, 1121 j .SS41 Stock warrants. (GASES XX, 121 ] .542 (Insert current Codification paragraph .527. Change cross-references as appropriate.] .543 2a7 -like pool. [GASBS XX, 121 ] .544-.545 (insert current Codification paragraphs .528-.529j TECHNICAL BULLETINS EFFECTIVE BEFORE MARCH 15, 1992 Applying Paragraph .125 of This Section .801 [Insert current Codification paragraph .801. Change cross-references and footnote number as appropriate.] I UNAU T HORITATIVE DISCUSSION Illustration of Note Disclosure for Deposits, Investments, and Reverse Repurchase Agreements .901-.902 [Insert current Codification paragraphs .901-.902, including sub- heads. Text and examples will be updated when Statement XX is codified.] Illustration of Modified Accrual Recognition and Reporting .903 [GASBS XX, 169] 42 EAPOSI IAFT Deposits with Financial Institutions, Investments, Risks, and Safeguards .904 -.931 [Insert [Incurrent Codification paragraphs .102-.129, including all sub- heads. Change "market value" to lair value." Change cross-references and foot- note numbers as appropriate.] (Add "as amended by GASBS XX, 116" to the source as appropriate.] .932 (Insert current Codification paragraph .130. Change "pooled investment funds" to "external investment pools" in the first sentence.] _[Add GASBS XX,1121 as a source.j .933-.960 [Insert current Codification naryn rap ss .131-.158, inclsub- heads. including all Change "market value" to lair value." Change cross-references and foot- note numbers as appropriate.] (Add "as amended by GASBS XX, 116" to the source as appropriate.] ACCOUNTING FOR PARTICIPATION IN JOINT SECTION J50 VENTURES AND JOINTLY GOVERNED ORGANIZATIONS 112 (Insert the following before the last sentence:] Entities participating in an external investment pool should follow the accounting and reporting guidance provided in Section 150, "Investments," paragraphs .110 and .119. • • • REVERSE REPURCHASE AGREEMENTS SECTION R10 [This section will be renamed Section 155, "Investments—Reverse Repurchase Agreements," when GASB Statement No. 28, Accounting and Financial Report- ing for Securdies Lending Transactions, becomes effective.] 103- 105 (Change "market value" to lair value," including in footnote 3.) (Add "as amended by GASBS XX, 116" to the sources.] 110- 111 [Change "market value" to lair value.") [Add "as amended by GASBS XX, 116" to the sources.] • 43 EXPOSURE DRAFT EXPOSIir .. DRAFT COLLEGES AND UNIVERSITIES SECTION Co5 Sources: [Add the following:) GASB Statement XX 102 [Change the title of 150 to "Investments."J [Add GASBS XX to the source ( • (Insert new section as follows:) INVESTMENT POOLS (EXTERNAL) Source: GASB Statement XX Scope of This Section • • SECTION In5 .101 This section provides financial reporting and disclosure standards for separate annual financial reports for governmental external investment pools. Section 150. "Investments," provides accounting and financial reporting stand- ards for all investments held by governmental external investment pools, as well as financial reporting and disclosure standards for sponsoring governments.' [GASBS XX] Pool Reporting .102 [GASBS XX, 11131 (Change cross-references and footnote number as appropriate.) 'The standards in Section I50 generally require governmental external investment pools to meas- ure all investments at lair value in the statement of financial positron and to recognize alt changes in fair value in the statement of activities. (GASBS XXI 44 PENSION FUNDS—ACCOUNTING SECTION Pe5 (Insert the following new paragraph at the end of the headnote:] Once State- ment 25 has been codified, this section will be further modified by paragraphs 7 and 17-19 of GASB Statement No. XX, Accounting and Financial Reporting for Certain Investments and for External Investment Pools. Statement XX is effec- tive for periods beginning after June 15, 1997. Earlier application is encouraged. Statement XX is reproduced in this Codification in Appendix Al • • • PUBLIC ENTITY RISK POOLS SECTION Po20 (Add to sources:( GASB Statement XX (Replace current Codification paragraphs .136 and .137 with the following para- graph. Renumber subsequent paragraphs.) .136 Accounting and financial reporting standards for debt securities, market- able equity securities, and certain other similar investments are provided in Sec- tion 150, "Investments." [GASBS XX] .141 [Replace current Codification paragraph .142 with the following:] All invest- ment income, including changes in the fair value of investments (except those that are accounted for as foreign currency or futures contract hedges),6 should be reported in the operating statement as a component of other income, recog- nized in accordance with Section 150, paragraph .107.7 (GASBS 10, 1146; GASBS XX, 119] 6[tnsert current Codification footnote 6.j 7Losses on private -placement bonds should be accrued when both conditions of Section C50, paragraph 110, are met. IGASBS 10. fn8j 45 €XPC/Ro ,r4=: .142 It a decline in the value of any investment reported at cost or amortized cost below its carrying amount is considered to be other than temporary, the naw investment should he re` used to , abzab o vat"- .which becomes '---- ..._-••••. ••,••• ..•........ ................. w n� net •canc•uno vat"-, which uca.vn,c� the new cost basis. The amount of the reduction should be reported as a realized loss. A recovery from the new cost basis should be recognized as a realized gain only at the sale, matunty, or other disposition of the investment. [GASES 16, 147, as amended by GASOS XX, .1171 .143-.146 [Insert current Codification paragraphs .144-.147. Change cross- references as appropnate.] 46 THE CITY COUNCIL YAKIMA, WASHINGTON AGENDA STATEMENT Item No. (:*42-"' For Meeting Of June 4, 1996 ITEM TITLE: Resolution authorizing the Director of Finance & Budget to respond to the Governmental Accounting Standards Board Exposure Draft 132-A ("The Draft") pertaining to accounting and reporting for the City's investments. SUBMITTED BY: Department of Finance & Budget CONTACT PERSON/TELEPHONE: John Hanson, Director of Finance & Budget 575-6C70 Tim Je , ccountant 576-6639 SUMMARY EXPLANATION: In what we believe is a direct result of Orange County's investment losses in 1994, the Governmental Accounting Standards Board has issued an Exposure Draft 132-A, ("The Draft"), parts of which, if implemented, would require governmental entities to record as a gain or loss to fund balance changes in the market value of their investment portfolios in annual financial statements. This proposal is a major departure from current accounting principals which require only footnote disclosure of market values. The Finance Department strongly disagrees with this new proposal for several reasons. • First, we do advocate disclosure of market value in the notes to the financial statements, but we believe that recording an event that probably will not happen is dangerous because of the budgetary implications. • Second, all investments the City of Yakima can legally hold always mature at par. Recording inter -period changes in market value is pointless if the City can hold an investment until maturity. • Third, the recording of a gain or loss would be based on investment values only on the balance sheet date ( December 31 in our case), significant changes in market value can occur by January 2nd or anytime during the year that will make the balance sheet, and fund balance, a different picture entirely. The "Draft" also advocates a change in reporting techniques and basis of accounting for government sponsored investment pools with which we concur, (see Issue #6) of "the Draft". The only opportunity the City has to protect its interests is to respond in this manner during the current comment window which closes on June 14th. We are not aware of any Municipal Finance officials who endorse this proposal. Resolution X Ordinance _ Contract X Other (Specify) Draft Technical response to GASB and a copy of Exposure Draft 132-A, Funding Source r --t APPROVED FOR SUBMITTAL: City Manager STAFF RECOMMENDATION: Approve hesolution BOARD/COMMISSION RECOMMENDATION: COUNCIL ACTION: