Public sector entities may acquire or create entities that carry on a business. These entities, called government business enterprises (GBEs), can normally operate with revenues from their business without outside financial assistance. They are reported as investments, rather than consolidated on a line-by-line basis, in the financial statements of the government reporting entity.
Section PS 3070, Investment in Government Business Enterprises, establishes standards on how to account for and report an entity’s investment in GBEs applying the modified equity method of accounting.
What Is a GBE?
A GBE is a government organization that:
- is a separate entity with the power to contract in its own name and that can sue and be sued;
- was delegated the financial and operational authority to carry on a business;
- sells goods and services to individuals and organizations outside of the government reporting entity as its principal activity; and
- can, in the normal course of its operations, maintain its operations and meet its liabilities from revenues received from sources outside of the government reporting entity.
How to Account for an Investment in a GBE
An entity accounts for its investment in a GBE using the modified equity method. Under this method:
- the accounting policies of a GBE are not adjusted to conform with those of the entity; and
- inter-organizational transactions and balances are generally not eliminated; the exceptions are:
- unrealized inter-organizational gains and losses on assets remaining within the government reporting entity; and
- amortization of premium and discount on inter-organizational bond holdings.
An entity’s investment in a GBE is reported separately in the consolidated statement of financial position.
Initial Investment Reported
An entity’s initial investment in a GBE is its costs. The cost of a created GBE is the carrying value of the net assets transferred to the GBE as reflected in the consolidated statement of financial position at the date it was created.
The cost of an acquired GBE is the purchase cost of the enterprise. It is the sum of the fair value of the consideration given in the acquisition and any expenses an entity incurred to effect the acquisition.
Investment Reported in Subsequent Periods
An entity’s investment in a GBE reported in subsequent periods is its cost of the investment (identified above), adjusted for certain inter-organizational gains and losses (identified above), and the entity’s proportionate share of the GBE’s accumulated:
- dividends paid or payable;
- prior period adjustments;
- capital transactions;
- other comprehensive income; and
- foreign currency translation adjustments.
For an acquired GBE, additional adjustments may be necessary for the accumulated:
- amortization of any purchase premium, which is amortized no longer than twenty years;
- amortization of any fair value increments on depreciable assets, which is amortized over the useful lives of the related assets; and
- write-down associated with any impairments in the value of the purchase price discrepancy.
How to Account for Income from an Investment in a GBE
Under the modified equity method, income from an investment in a GBE reported by an entity includes its proportionate share of the GBE’s earnings and the elimination of certain inter-organizational gains and losses (identified above).
For an acquired GBE, additional adjustments may be necessary for:
- the amortization of any purchase premium;
- the amortization of any fair value increments on depreciable assets;
- write-down associated with any impairments in the value of the purchase price discrepancy; and
- write-off of unamortized purchase premium and fair value increments related to any disposal of assets.
An entity’s income from an investment in a GBE is reported separately in the consolidated statement of operations. Its proportionate share of the other comprehensive income of a GBE is reported separately in the consolidated statement of remeasurement gains and losses.
How to Account for a Sale of an Investment in a GBE
When all or part of an entity’s investment in a GBE is sold, the gain or loss would be based on the carrying value of the investment in the consolidated statement of financial position at the date of sale. Also, any related unamortized purchase premium and fair value increments would be included in determining the gain or loss on the sale.
When the entire investment in a GBE is sold, income from the investment would be recognized up to the date of sale in the consolidated statement of operations.
When part of an investment in a GBE is sold and the entity retains control of the organization, how the part of the organization that remains would be accounted for (i.e., modified equity method or line-by-line consolidation) depends on whether it meets the definition of a GBE.
When part of an investment in a GBE is sold and the entity no longer retains control of the organization, the organization would no longer form part of the government reporting entity. It would be accounted for in accordance with Section PS 3041, Portfolio Investments, and Section PS 3450, Financial Instruments, if it is determined to be a portfolio investment.
How to Account for an Investment in an Organization that No Longer Meets the Definition of a GBE
If the status of a GBE changes to a governmental unit as a result of an observable event, the entity would apply the modified equity method up to the date the status of the organization changes. From that date forward, the individual revenues and expenses of the governmental unit would be included in the consolidated statement of operation on a line-by-line basis.
If the status of a GBE changes over time, the entity would consolidate the organization as a governmental unit for the entire period in which the change in status is identified.
The effect of conforming the accounting policies of the organization to those of the government reporting entity and the write-off of unamortized purchase premium, if any, would be included in the consolidated operating results in the period in which the status of the organization changed.
The financial position and results of prior periods would not be adjusted to reflect the change in status of the organization as if it had always been a governmental unit.
What Information Is Disclosed
An entity discloses the following condensed financial information of its GBEs:
- the financial position and results of operations, including:
- total assets and liabilities segregated by main classification;
- net assets or liabilities, separately displaying accumulated other comprehensive income;
- total revenues and expenses;
- net income or loss for the period; and
- other comprehensive income for the period;
- the nature and amount of any adjustments of the net assets or the net income, as shown in the financial statements of the GBE, to arrive at the amount in the entity’s consolidated statement of financial position and consolidated statement of operations;
- transactions and balances with other organizations in the government reporting entity;
- contractual obligations and contingencies;
- the nature and terms of any guarantees provided by the entity relating to outstanding debt issued by the GBE; and
- the entity’s percentage of ownership of any GBE that it does not wholly own.
In the reporting period in which a GBE is acquired, an entity discloses the following additional information:
- the name and a brief description of the GBE acquired;
- the percentage of voting shares held if shares are acquired;
- the date of acquisition and the period for which the results of the acquired GBE are included in the consolidated statement of operations and the consolidated statement of remeasurement gains and losses;
- net assets acquired including the carrying amount of total assets and total liabilities in the books of the GBE and the amount assigned to them;
- the amount and type of consideration given at fair value;
- the amount of any purchase premium and the period and method of amortization; and
- a description of the nature of the purchase premium and how its useful life was determined.
An entity discloses the amount of any write-down associated with the purchase price discrepancy in a reporting period, and the facts and circumstances leading to the impairment.
In the period in which the status of its investment in a government organization changed from a GBE to a governmental unit, an entity discloses the following:
- the underlying reasons for the change in status;
- the change in accounting treatment; and
- the financial effect of the change.
Lydia So, CPA, CA
Principal, Public Sector Accounting Board
Phone: +1 (416) 204-3281