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Letter of Comment No. 18 File Reference: 3-17E Date Received: 6/15/12 WASHINGTON SOCIETY OF CERTIFIED PUBLIC ACCOUNTANTS June 14, 2012 David R. Bean, Director of Research and Technical Activities Governmental Accounting Standards Board Project No. 3-17 401 Merritt 7 P.O. Box 5116 Norwalk, Connecticut 06856-5116 Re: Exposure Draft-Government Combinations and Disposals of Government Operations, Project No. 3-17 Dear Mr. Bean: The following is the response of the Government Accounting and Auditing Committee of the Washington Society of Certified Public Accountants (WSCPA). The views expressed are the views of the Committee and not necessarily the views of the individual members or the WSCPA as a whole. We are pleased to have the opportunity to respond to the Governmental Accounting Standards Board’s (GASB) Exposure Draft (ED) Government Combinations and Disposals of Government Operations. We support the mission of GASB, to establish and improve standards of state and local governmental accounting and financial reporting. Overview of Our Response: We support this ED because it is consistent with private sector accounting principles, yet makes appropriate adjustments for differences between the private and public sectors regarding the nature of combinations and disposals of operations. We also agree that carrying values should be used to measure assets and liabilities in most cases. In addition to its consistency with private sector guidance, we appreciate that this ED is principles-based as opposed to rules-based as professional judgment is an important aspect of proper financial reporting. However in practice, there may be some hybrids of the categories discussed in this ED and some discussion of potential hybrid situations and suggested guidance is welcome. In some cases combinations and disposals may be directed or influenced by external forces such as litigation (or avoidance thereof), public initiatives or tax codes. These situations suggest that the transaction may not an “armslength” transaction between two unaffiliated entities. As such, the guidance in this ED Letter of Comment No. 18 File Reference: 3-17E Date Received: 6/15/12 David R. Bean June 14, 2012 Page 2 of 4 regarding measuring assets and liabilities using acquisition values may not be appropriate or complete. We believe that the acquiring entity should be allowed to record an asset (or deferred outflow) for costs to organize the new entity and cost involved in acquiring the operations (legal fees, asset inventories, etc.) as opposed to this ED’s requirement to expense such costs that benefit future periods. Specific ED Comments: We agree with the service continuation requirement (paragraph 9) of an operation as defined in paragraph 4. We also agree with the definitions of the three types of combinations (paragraphs 10-12). However, we believe there are certain circumstances in which these definitions can become blurred. While we understand that no standard can cover all potential situations, we offer two examples to illustrate our concern about the completeness of these definitions or whether additional guidance to address transactions that may have attributes of several different defined categories is warranted. Example 1: A “transfer of operations” occurs between two entities, in which either one or both entities are an unwilling partner (forced by litigation, law or other such external force). All assets and certain liabilities (and continuing operations) are obtained by the new entity. The agreement requires the new entity to issue new bonds in the new entity’s name and make “significant consideration” (paragraph 11) to the previous operator in the amount of the “old” bonds outstanding. In this case, we expect that using carrying values (transfers of operations) versus acquisition values (government acquisitions) would not be significantly different because it shouldn’t make a difference whether a liability is assumed by the new government or paid to the prior government. However, we expect that this transaction might be construed as an acquisition given the current ED wording, when acquisition accounting is not appropriate. Let’s assume, for the purpose of this illustration, that the settlement requires additional “significant consideration” to be paid for committed future revenues over a several year period. While deposits on these future revenues are recorded as liabilities (or perhaps unearned revenue) there is no asset recognition for this future stream of revenues according to current GAAP (the revenue has not yet been earned). As such, a payment has been made for an asset that cannot be recognized. While the ED paragraph 39 allows for recording a deferred outflow, we believe that this transaction should qualify as a transfer of operations and not as an acquisition because it more closely represents the underlying economics of the transaction (regardless of current GAAP limitations on asset recognition). Paragraph 32 states that the acquisition value is a “market-based” entry price based on an orderly transaction. However, this example is not orderly or market based and not currently addressed by this ED. Letter of Comment No. 18 File Reference: 3-17E Date Received: 6/15/12 David R. Bean June 14, 2012 Page 3 of 4 Example 2: A special purpose government enters into a Low-Income Housing Tax Credit Partnership (LIHTCP) with a private entity (or several) that is/are the limited partner(s) (LP). The LIHTCP is a component unit of the government because it is the general partner and controls the partnership. The LP(s) makes an initial contribution in exchange for the tax credit and future tax preference items (such as their share of depreciation, etc.). At the end of the tax compliance period, the LP surrenders its equity to the government general partner (which might be considered as “significant consideration”). At the time that the LP interest is surrendered, the legal entity automatically changes because it is no longer a limited partnership. While this ED’s paragraph 7 states that this ED does not address transactions for the purposes of changes in control under GASB Statement number 14, this example does not result in a change of control because the government already controls both the old entity and the new entity. The value to the LP(s) is in the tax credit and tax preference items, which is not recorded in the partnership. The value (tax preferences) received by the LP(s) that is not recorded in the LIHRCP books is in excess of the partnership interest the PL is “gifting” to the government. The entire operation of the low-income housing project is transferred from one legally separate entity to another in connection with a significant (negative) consideration. However, from an underlying economic transaction standpoint, very little has changed. We see this situation as having attributes of a merger, acquisition, transfer and disposal of operations and we suggest that this situation is common. In either of these examples, we believe paragraph 41 is incomplete. Contributions should not be limited to recognizing in an agreement that “economic aid is intended” as the contribution may be reflective of avoidance of future harm to the old entity or an economic value has already been obtained by the old entity (that is not recorded). This paragraph should be replicated in other transaction type sections as appropriate. Finally, as previously stated, we believe that the acquiring entity should be allowed to record an asset (or deferred outflow) for costs to organize the new entity and cost involved in acquiring the operations (legal fees, asset inventories, etc.) as opposed to this ED’s requirement to expense such costs that benefit future periods. Summary of Specific ED Comments: We agree with this ED and believe it improves accounting and financial reporting for state and local governments. We believe this ED can be improved by providing principled guidance to assist preparers, auditors and users in addressing hybrid situations that do not fit neatly into this ED’s definitions. We also believe that costs involved in organizing a new entity and the costs involved in accomplishing a merger, acquisition, transfer or disposal of operations should be recorded as an asset or a deferred outflow of resources instead of requiring immediate expense recognition. Letter of Comment No. 18 File Reference: 3-17E Date Received: 6/15/12 David R. Bean June 14, 2012 Page 4 of 4 Thank you for the opportunity to respond. If you have any questions or need additional information regarding this response, please contact Steve Miller at (206) 281-0281. Sincerely, SENT VIA E-MAIL to [email protected] Lisa Lam, CPA, Chair Government Accounting and Auditing Committee Washington Society of Certified Public Accountants