Governmental organizations assessing whether they should consolidate another entity should follow the guidance established by the Governmental Accounting Standards Board.
It is generally not appropriate for a non-governmental reporting entity to consolidate a governmental organization or a financing entity established by a governmental organization. There may be limited circumstances when consolidation of a financing entity established by a governmental organization may be appropriate, as discussed in ASC 810-10-15-12(e).
A reporting entity shall not consolidate a governmental organization and shall not consolidate a financing entity established by a governmental organization unless the financing entity meets both of the following conditions:
- Is not a governmental organization
- Is used by the business entity in a manner similar to a VIE in an effort to circumvent the provisions of the Variable Interest Entity Subsections.
The term governmental organization is described in the AICPA Audit and Accounting Guide.
Excerpt from the AICPA State and Local Government Audit Guide 1.01
Public corporations and bodies corporate and politic are governmental entities. Other entities are governmental if they have one or more of the following characteristics:
- Popular election of officers or appointment (or approval) of a controlling majority of the members of the organization’s governing body by officials of one or more state or local governments
- The potential for unilateral dissolution by a government with the net assets reverting to a government
- The power to enact and enforce a tax levy
Furthermore, entities are presumed to be governmental if they have the ability to issue directly (rather than through a state or municipal authority) debt that pays interest exempt from federal taxation. However, organizations possessing only that ability (to issue tax-exempt debt) and none of the other governmental characteristics may rebut the presumption that they are governmental if their determination is supported by compelling, relevant evidence.
Excerpt from AICPA State and Local Government Audit Guide 1.02
Organizations are governmental or nongovernmental for accounting, financial reporting, and auditing purposes based solely on the application of the preceding criteria; other factors are not determinative. For example, the fact that an entity is incorporated as a not-for-profit organization and exempt from federal income taxation under the provisions of IRC Section 501 is not a criterion in determining whether an organization is governmental or nongovernmental for accounting, financial reporting, and auditing purposes.
Whether an entity is a governmental organization or a financing entity established by a governmental organization requires careful consideration. Examples of governmental entities that would not be subject to consolidation include, but are not limited to:
- A governmental organization (or a financing entity established by a governmental organization) that issues tax-exempt debt to finance the construction of an asset leased to the reporting entity
- A tax-increment financing entity established by a municipality to finance certain infrastructure assets on land owned by the reporting entity (commonly referred to as industrial development bonds)
In practice, the governmental scope exception can be difficult to apply, particularly when dealing with an entity established by a governmental organization to finance a project of the reporting entity. If an entity does not meet the definition of a governmental organization, further consideration should be given to whether the entity is, in substance, a financing entity established by a governmental organization. This analysis is subjective and requires an understanding of all of the facts and circumstances.
Although not intended to be all inclusive, some of the factors that may warrant consideration when making the determination of whether an entity is a governmental organization include:
- What was the extent and nature of the government’s involvement in establishing the entity?
- What role, if any, did the government play in selecting the entity’s board members (and/or selecting individuals responsible for directing the activities of the entity)?
- Does the government have the right to unilaterally dissolve the entity?
- What percent (or relative magnitude) of the entity’s activities are conducted on behalf of the government?
- What are the terms of the contract between the government and the entity?
- Do the assets revert back to the government at the end of the contract term?
- Did the government provide any guarantees to the entity?
In addition, consideration should be given to whether the entity was set up to circumvent the VIE model for the purpose of obtaining off-balance sheet treatment for the reporting entity. When making this assessment, the intent and purpose of the entity, as well as whether the reporting entity was involved in the entity’s design should be considered.
Example CG 2-2 illustrates the application of the governmental scope exception.
EXAMPLE CG 2-2
Governmental organization scope exception
Entity A was formed through a competitive bidding process (overseen by a governmental entity) to issue revenue bonds to finance the construction of a power plant (the “facility”). Although Entity A legally owns the facility, the facility was constructed for the sole benefit of a governmental entity.
The equity investors (i.e., owners) of Entity A are in the business of building and managing power plants. The facility was constructed on government-owned land, with the land being leased to Entity A for the estimated life of the facility. At the end of the land lease term, title to the facility will automatically transfer to the governmental entity.
At the inception of the land lease, the governmental entity simultaneously entered into an arrangement with Entity A that requires the governmental organization to purchase 100% of the output of the facility (i.e., electricity) on a long-term basis. The governmental entity also holds a fair value purchase option that allows it to purchase the facility from Entity A at any time during the lease term.
As part of a competitive bidding process, Company X, a party that is unrelated to both Entity A and the governmental entity, entered into an arrangement with Entity A to guarantee the revenue bonds. Company X was not involved in the design of Entity A and there are no indications that Entity A was established in an effort to circumvent the provisions of the VIE guidance.
Does Entity A qualify for the governmental organization scope exception?
Factors that suggest Entity A is a financing entity established by a governmental organization include (1) the governmental entity was integral in the design and is a party to all the critical agreements of Entity A, (2) Entity A was established to finance and construct a power plant whose entire output is intended to be sold to that governmental entity, and (3) it is intended that the governmental entity will ultimately own Entity A’s assets. As a result, even though Entity A would not meet the GASB or Federal Accounting Standards Advisory Board definition of a governmental organization, it is likely that Company X would conclude that Entity A is a financing entity established by a governmental organization and, therefore, would qualify for the governmental organization scope exception. Therefore, Company X would not be required to consolidate Entity A.