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Glenn Hegar  ·  Texas Comptroller of Public Accounts

Reporting Requirements for Annual Financial Reports of State Agencies and Universities

Notes & Samples

NOTE 3 – Deposits, Investments and Repurchase Agreements
General

  • Agencies contract with the Texas Treasury Safekeeping Trust Company (Trust Company) to manage various investments. Agencies are responsible for reporting and disclosing cash, interest receivables and investments held by the Trust Company.
    • Uninvested balances are reported as cash in bank and disclosed as a deposit identified as Treasury Safekeeping Trust.
    • Invested balances in the overnight repurchase agreement pool are reported as a cash equivalent and identified as Repurchase Agreement – Texas Treasury Safekeeping Trust Co.
    • Other invested balances are reported in their applicable accounts and disclosed by applicable investment type.
  • Report cash collateral on securities lending transactions as securities lending collateral and:
    • If not reinvested — disclose the amount as a deposit.
    • If reinvested — disclose the amount by investment type.
  • Report CDs as cash equivalents and disclose as follows:
    • Nonnegotiable CDs are placed directly with financial institutions and are generally subject to penalty for early redemption. Disclose in the cash in bank carry amount as a deposit.
    • Negotiable CDs are securities that can be traded in a secondary market. Disclose as a miscellaneous investment type.
  • Report money market deposit accounts similar to other deposit accounts.
  • Disclose mutual funds (including money market investment funds) as an investment in the fixed income money market and bond mutual fund, the other commingled fund or the mutual fund investment type, as applicable.
  • Margin deposits are classified as a current receivable from the broker. Futures contracts require an initial margin deposit with a futures broker and maintenance of margin as long as the futures contract is open. Futures contracts are “marked-to-market” daily and require cash settlements in the margin account for changes in the contract’s fair value. Accordingly, the balance in the futures margin account at each reporting date represents a deposit that could be withdrawn from the account should the position be closed.
  • Report bankers’ acceptances as cash equivalents or short-term investments and disclose as a miscellaneous investment type. Bankers’ acceptances are money market investments and are not treated the same as money market deposit accounts.
  • Disclose cash equivalents (with the exception of a nonnegotiable CD) as an investment. Cash equivalents are defined as short-term, highly liquid investments that are both readily convertible to cash and so near to maturity that they present insignificant risk of changes in value because of changes in interest rates. Examples of items commonly considered to be cash equivalents are:
    • Treasury bills
    • Commercial paper
    • CDs
    • Money market funds
    • Cash management pools
  • For foreign securities, use the custodial arrangements to identify if there is custodial credit risk. Specifically, determine:
    • The mechanics of the clearing process
    • If the securities are held in paper or book entry form
    • The function of any intermediaries in the process
  • Report land and other real estate held as investments by endowments and permanent funds at fair value. Report changes in fair value during the fiscal year as investment income.
  • Report investments in unallocated insurance contracts as interest-earning investment contracts.
  • Report investment fund contingent commitments in Note 15.

    Follow the disclosure provisions in GASB 31, paragraph 15 and GASB 72, paragraphs 80–82.

    For more information on Note 3, refer to the following GASB Statements, Interpretation, Technical Bulletins and GASB Implementation Guides:

    GASB 40 establishes and modifies disclosure requirements related to investment risks:

    • Credit risk including custodial credit risk and concentration of credit risk
    • Interest rate risk
    • Foreign currency risk

    GASB 40 also establishes and modifies disclosure requirements for deposit risks:

    • Custodial credit risk
    • Foreign currency risk

    This statement does not require disclosure of how the above risks are managed through hedge transactions. Under GASB 40, disclosure of carrying value of investments is not required.

    GASB 72 supersedes GASB 31’s definition of fair value. According to GASB 72, fair value is “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”

    Fair value is a market-based measurement — not an entity-specific measurement. For some assets and liabilities, observable market transactions or market information might be available; for others, it might not be available — but in either case, the objective of fair value is the same — to determine the price at which an orderly transaction to sell the asset or to transfer the liability would take place between the market participants at the measurement date under current market conditions.

    Fair value is an exit price at the measurement date from the perspective of a market participant that controls the asset or is obligated for the liability.

    GASB 72 identifies the following three acceptable valuation approaches to determine the fair value:

    • Market approach
    • Cost approach
    • Income approach

    Apply valuation techniques consistently from fiscal year to fiscal year and use the approach that is appropriate under the circumstances. Sufficient data must be available for the valuation technique used in order to maximize observable inputs and minimize unobservable inputs.

    GASB 72, paragraph 32, establishes Fair Value Hierarchy that includes three levels of inputs based on the reliability and objectivity of the information:

    • Level 1 — inputs are quoted prices (unadjusted) in active markets for assets or liabilities identical to the ones being measured. Level 1 inputs receive the highest priority.
    • Level 2 — inputs are observable for similar assets or liabilities, either directly (quoted market prices for similar assets or liabilities) or indirectly (corroborated from observable market information).
    • Level 3 — inputs are unobservable (for example: management’s assumption of the default rate among underlying mortgages of a mortgage-backed security). Level 3 inputs receive the lowest priority.

    Per GASB 72, the state uses the net asset value (NAV) per share as a method for determining fair value for its investments in:

    • Commingled funds
    • Real assets
    • Private equity
    • Fixed income
    • Hedge funds
    • Mutual funds
    • Real estate
    • Risk parity

    These investments calculate the NAV (consistent with FASB’s measurement principles for investment companies). These investments are exempt from classification within the fair value hierarchy when the state does not intend to sell all or portion of the investment for an amount that is different from the NAV.

    The state has some investments that are not subject to GASB 72. Investments not measured at fair value include money market investments and participating interest-earning investment contracts that have a remaining maturity (at the time of purchase) of one year or less. These investments are reported at amortized cost.

    Common Stock

    To record common stock, ask yourself if the common stock meets the definition of investment:

    • Yes — record the value using the fair value or equity method
    • No — record at cost or equity method if any equity interest

    Use the equity method when there is a significant influence, such as:

    • Representation on the governing body
    • Participation in policy making process
    • Significant intra-entity transactions
    • Interchange of management personnel
    • Technological dependency

    The following are specific investment exclusions from the equity method:

    • External investment pools
    • Pension or other postemployment benefit plans
    • Deferred compensation plans (IRS Section 457)
    • Endowments (including permanent and term) and permanent funds

    Recognize all investment income (including changes in the fair value of investments) as either:

    • Revenues in the statement of activities, statement of revenues, expenses and changes in net position
    • Additions in the statement of changes in fiduciary net position

    When identified separately as an element of investment income, label the change in the fair value of investments as “net increase (decrease) in the fair value of investments.” Do not display realized gains and losses separately from the net increase (decrease) in the fair value of investments in the financial statements. However, you may display separately the realized gains and losses in separate reports of governmental external investment pools.

    The net appreciation (depreciation) in the fair value of pension plan investments includes realized gains and losses on investments that were both bought and sold during the fiscal year. Do not display realized and unrealized gains and losses separately in the financial statements.

    Investment disclosures in Note 3 are organized by investment type. Investments with significantly different risk profiles are not aggregated into a single investment type. Disclose the following investment types in the AFR:

    Investment Type Examples of what the type includes (not all inclusive)
    U.S. Treasury Securities

    U.S. Treasury Bills, Notes or Bonds

    Only available as short-term investments.

    Risk level: Low

    U.S. Treasury Strips

    U.S. Treasury Strips

    Do not offer periodic interest payments. All payments are received upon maturity.

    Risk level: Low

    U.S. Treasury TIPS

    U.S. Treasury TIPS

    Protect against inflation and are long-term investments (mature in 5, 10 or 30 years).

    Risk level: Low

    U.S. Government Agency Obligations

    Asset and mortgage backed securities issued by government sponsored enterprises such as Fannie Mae, Freddie Mac or Ginnie Mae

    Risk level: Moderate

    Corporate Obligations

    Domestic corporate obligations

    Risk level: Low to High depending on the corporation’s credit rating

    Corporate Asset and Mortgage Backed Securities

    Collateralized mortgage obligation, mortgage backed securities or commercial mortgage backed securities

    Risk level: Low to High depending on the payments affected by mortgage rates

    Equity

    Domestic equity

    Risk level: Low to High depending on diversification, generally less risky than investing directly in stocks

    International Obligations

    Foreign obligations issued by governments and corporations or ADRs

    Risk level: Low to High depending on the foreign entity

    International Equity

    Foreign equity (including foreign securities that are U.S. dollar denominated)

    Risk level: Low to High depending diversification

    Repurchase Agreements

    Repurchase agreements

    Risk level: Low

    Fixed Income Money Market and Bond Mutual Fund

    Pooled investments of fixed income securities

    Risk level: Low

    Mutual Funds

    Mutual funds registered with the Securities and Exchange Commission, bank loans

    Risk level: Low to moderate depending diversification

    Other Commingled Funds

    Other commingled funds

    Risk level: Low to moderate

    International Other Commingled Funds

    Foreign securities of other commingled funds

    Risk level: Low to moderate

    Commercial Paper

    Commercial paper

    Risk level: Moderate due to rollover risk

    Invested Collateral

    Reinvested cash collateral related to securities lending and derivative activity

    Risk level: Low to moderate depending on type of reinvestment (usually money market or repurchase agreements)

    Securities Lending Collateral Investment Pool

    Securities lending collateral investment pool

    Risk level: Low to moderate

    Real Estate

    Real estate, REITS, mineral rights

    Risk level: Moderate to high

    Derivatives

    Forwards, futures, options, swaps

    Risk level: Moderate to high

    Externally Managed Investments (Alternative Investments)

    Private equity, venture capital, hedge fund

    Risk level: High

    Miscellaneous

    Political subdivisions and other investments

    Risk level: Low to high

    The required disclosures are:

    • A brief description of the investment types (including repurchase agreements) authorized by legal or contractual provisions for your agency. This includes authorization provided in your agency’s investment policy and any statutory investment authority.
    • A brief description of deposit and investment policies related to the risks being disclosed. Do not include all details of deposit and investment policies.

    If no deposit or investment policy exists that addresses a specific type of risk exposure, disclose that fact in Note 3.

    GASB 40 considers the investment policy to be a formally adopted policy that sets forth an agency’s allowable deposits or investments. An investment policy may be formally adopted through legal or contractual provisions or by other means, usually by the governing board. General investment practices or informal policies are not a required disclosure.

    • The methods and significant assumptions used to estimate the fair value of investments — if that fair value is based on other than quoted market prices.
    • GASB 72, paragraphs 32-44, establishes the fair value by three input levels of valuation:
      • Level 1 — inputs are quoted prices (unadjusted) in active markets for assets or liabilities identical to the ones being measured. Level 1 inputs receive the highest priority.
      • Level 2 — inputs are observable for similar assets or liabilities, either directly (quoted market prices for similar assets or liabilities) or indirectly (corroborated from observable market information).
      • Level 3 — inputs are unobservable (for example: management’s assumption of the default rate among underlying mortgages of a mortgage-backed security). Level 3 inputs receive the lowest priority.
    • Investments reported at NAV are disclosed by investment strategy. Within each strategy, agencies must disclose:
      • Redemption frequency
      • Redemption notice period
      • Amount of unfunded commitments
    • Any significant violations of legal or contractual provisions during the period for deposits and investments. This includes any inadequate collateralization of deposits that occurred at any time during the year, regardless of the status at year-end.

      Federal depository insurance funds (such as those maintained by the FDIC and FSLIC) currently insure up to $250,000 per deposit. However, separately named accounts of an agency in a single financial institution may not be treated as separate deposits for purposes of applying the $250,000 limit. The agency should investigate the extent to which it is covered by the federal depository insurance at each financial institution.

    • Any violations of legal, regulatory or contractual provisions as a result of holding or writing (selling) investment derivative instruments.
    • A brief description of the legal or contractual provisions for Reverse Repurchase Agreements.
    • Any significant violations of legal provisions relating to Reverse Repurchase Agreements during the period.

Or click on the headings below to open a topic individually.

Deposits of Cash in Bank [+]

Deposits of cash in bank include the principal of petty, travel and imprest cash in the cash in bank balance if the money is deposited to or paid out of a local bank. Principal includes all outstanding reimbursements.

  • Do not report cash on hand, petty cash on hand, travel cash on hand and imprest cash on hand.
  • Do not report outstanding reimbursements as accounts receivable. If the money is not deposited in a bank, it is considered cash on hand and therefore not reported in the note.
  • Provide the carrying amount (the amount shown per agency’s books) of the cash balance in the bank. This amount must reconcile to the balance of cash in bank, restricted cash in bank and petty cash in bank accounts.
  • Provide the bank balance (the amount shown on the financial institution’s records)

Additional note disclosures are required for deposits of cash in bank with custodial credit risk or foreign currency risk.

  1. Custodial credit risk for deposits is the risk that, in the event of the failure of a depository financial institution, the agency will not be able to recover deposits or will not be able to recover collateral securities that are in the possession of an outside party. Deposits are exposed to custodial credit risk if they are not covered by depository insurance and are either:
    • Uncollateralized
    • Collateralized with securities held by the pledging financial institution
    • Collateralized with securities held by the pledging financial institution’s trust department or agent but not in the agency’s name

    If the agency has cash in bank deposits at fiscal year-end that are exposed to custodial credit risk, disclose:

    • the amount of those bank balances
    • the fact that the balances are uninsured
    • whether or not the balances are exposed on the basis of the type of custodial credit risk
  2. Foreign currency risk for bank balances is the risk that changes in exchange rates will adversely affect the deposit. If the agency has deposits denominated in foreign currency, disclose the U.S. dollar balances of such deposits organized by currency denomination.

Investments and Repurchase Agreements [+]

  1. GASB 79 amends GASB 31 by identifying the criteria that must be met to allow an external investment pool to be recorded at amortized cost. GASB 31 is applicable to all investments held by governmental external investment pools and certain investments held by governmental entities other than external investment pools, defined benefit pension plans, and IRC Section 457 deferred compensation plans. An external investment pool is an arrangement that has the following criteria:
    • Commingles (pools) the moneys of more than one legally separate entity
    • Invests (on the participants’ behalf) in an investment portfolio
    • One or more of the participants is not part of the sponsor’s reporting entity

    Texpool is an example of an external investment pool.

    The agency providing investment pool services reports the external portion of each pool as a separate fund. Fund type 18 is used for this purpose.

    GASB 31 applies to all funds except pension trust funds unless the pension trust fund holds any of the following investments:

    • Securities subject to purchased put option contracts and written call option contracts
    • Open-end mutual funds
    • External investment pools
    • Interest-earning investment contracts

    For these four investment types, pension trust funds are reported in accordance with GASB 31. Pension trust funds report all other investments in accordance with GASB 72.

    For governmental entities other than pools, GASB 31 does not apply to investments such as:

    • Real estate
    • Mortgages
    • Venture capital
    • Limited partnerships
    • Nonparticipating interest-earning investment contracts

    Report current and noncurrent investments, including repurchase agreements, at fair value as of the reporting date on the statement of net position, balance sheet and/or statement of fiduciary net position (except as noted below). Report defined benefit pension plan investments at fair value. Include the net appreciation (depreciation) in the fair value of plan investments in the net investment income reported in the additions section of the statement of changes in fiduciary net position.

    Report the change in fair value of investments as a net increase (decrease) in the fair value of investments on the statement of activities, statement of revenues, expenses and changes in net position and/or statement of changes in fiduciary net position except for those investments excluded from GASB 31 treatment noted below. Realized gains and losses are not reported separately on the statements.

    For investments in open-end mutual funds, determine fair value by the fund’s current share price.

    The investments below may report at amortized cost that approximates fair value rather than reporting at fair value:

    • Report nonparticipating contracts (such as nonnegotiable certificates of deposit with redemption terms that do not consider market rates) using a cost-based measure, provided the fair value of those contracts is not significantly affected by the impairment of the credit standing of the issuer or other factors.
    • Agencies may report money market investments and participating interest-earning investment contracts at amortized cost if it has remaining maturity of one year or less at time of purchase — provided that the fair value of those contracts is not significantly affected by the impairment of the credit standing of the issuer or other factors. This exception does not apply to external investment pools.
    • Determine investment positions in 2a7-like pools by the pool’s share price. 2a7-like pools may report their investments at amortized cost.

    An agency may use amortized cost if the fair value of those investments is not significantly affected by the impairment of the credit standing of the issuer or by other factors. Asset-backed securities, derivatives and structured notes do not fall under this classification. Disclose the policy in Note 3 for determining which investments, if any, are reported at amortized cost.

  2. Marketable securities’ classification is largely dependent on management’s intent. Classify the securities as a current asset if management intends to dispose of the securities and the proceeds from operations in the next fiscal year.
  3. Report interest income at the stated interest rate and do not amortize any premiums or discounts on debt securities for all investments reported in accordance with GASB 31.
  4. Provide the fair value of investments disclosed by type of investment as previously shown in the General section of this note. Generally, the fair value of a repurchase agreement is the principal plus accrued interest of the agreement. It is not based on the value of the underlying securities.

    Agencies must record land and real estate held as investments at fair value. As a result of the implementation of GASB 52, this treatment is consistent across all types of entities.

  5. Prepare a reconciliation tying the total fair value presented in the investment table to current and non-current investments presented on the statement of net position, balance sheet and/or statement of fiduciary net position. This reconciliation, however, does not tie directly to the balance sheet line item amounts if CDs are included as investments on the balance sheet and are appropriately included as deposits in the note.
  6. Custodial credit risk for investments is the risk that, in the event of the failure of the counterparty, the agency will not be able to recover the value of its investments or collateral securities that are in the possession of an outside party. Investment securities are exposed to custodial credit risk if the securities are uninsured, are not registered in the agency’s name and are held by either:
    • The counterparty
      –OR–
    • The counterparty’s trust department or agent but not in the agency’s name

    Agencies with investment securities at fiscal year-end that are exposed to custodial credit risk must disclose:

    • The investments’ type
    • The carry value
    • The reason for the exposure to custodial credit risk for the investments and repurchase agreements (see items A–F above)

    Investments whose existence is not evidenced by securities that exist in physical or book entry form are not exposed to custodial credit risk. These include:

    • External investment pools
    • Open-end mutual funds

    Investments that are evidenced by contracts rather than securities are not exposed to custodial credit risk. These include investments in:

    • Venture capital
    • Limited partnerships
    • Real estate
    • Annuity contracts
    • Guaranteed investment contracts

    Securities underlying reverse repurchase agreements are not exposed to custodial credit risk because they are held by the buyer-lender. Custodial credit risk includes the portion of the fair value of any repurchase agreement that exceeds the fair value of the underlying securities.

    Collateral on securities lending reported in the statement of net position, balance sheet and/or statement of fiduciary net position is subject to custodial credit risk disclosure requirements unless it has been invested in a securities lending collateral investment pool or another type of investment that is not exposed to custodial credit risk. The underlying securities are not subject to custodial credit risk disclosure requirements if the collateral for those loans is reported in the statement of net position, balance sheet and/or statement of fiduciary net position.

    If the collateral on securities lending is not reported in the statement of net position, balance sheet and/or statement of fiduciary net position the underlying securities on those loans must follow the custodial credit risk disclosure requirements. This disclosure is based on the type of collateral and the custodial arrangements for the collateral.

  7. Foreign currency risk is the risk that investments will be adversely affected due to changes in exchange rates. If the agency has investments denominated in foreign currency, disclose the U.S. dollar carrying value of such investments organized by currency denomination and either international obligations, international equity or international other commingled funds investment type, as applicable.

    An investment in an international mutual fund does not require disclosure of the individual investments within the fund provided an agency does not hold a significant portion of its assets in an international mutual fund.

  8. Credit risk is the risk that an issuer or other counterparty to an investment will not fulfill its obligations. Provide information about the credit risk associated with such investments by disclosing the credit quality ratings of investments by type of debt security as described by Standard & Poor’s as of fiscal year-end. Credit quality rating downgrades after fiscal year-end may expose the agency to a significantly higher level of credit risk exposure and may require disclosure as a subsequent event.

    Unless there is information to the contrary, obligations of the U.S. government or obligations explicitly guaranteed by the U.S. government (for example, Ginnie Mae) are not considered to have credit risk and do not require disclosure of credit quality. Disclose the credit quality ratings of external investment pools, money market funds and other pooled investments of fixed-income securities in which they invest. The credit quality rating disclosure is required for an investment in a mutual fund that is restricted to obligations of the U.S. government or those explicitly guaranteed by the U.S. government. If a credit quality disclosure is required and the investment is unrated, indicate that fact in the disclosure.

    Note: Government-sponsored enterprises are subject to credit risk disclosures if they are not backed by the full faith and credit of the U.S. government. Government-sponsored enterprises not backed by the full faith and credit of the U.S. government include Freddie Mac and Fannie Mae.

    If a debt investment is unrated but the issuer is rated, indicate that the debt investment is unrated. Disclosing the credit quality ratings of issuers may be misleading as to the credit risk of the individual debt investment.

    Repurchase agreements are not subject to credit risk if the securities underlying the repurchase agreement are exempt from credit risk disclosures.

    Disclose the credit quality ratings of external investment pools, money market funds, bond mutual funds and other pooled investments of fixed-income securities in which the agency is invested. Bankers’ acceptances are subject to credit risk disclosure.

  9. Concentration of credit risk is the risk of loss attributable to the magnitude of investment in a single issuer. Disclose concentration of credit risk in Note 3. Disclose (by fair value and issuer) investments in any one issuer that represent five percent or more of total investments. Investments issued or explicitly guaranteed by the U.S. government and investments in mutual funds, external investment pools and other pooled investments are excluded from this requirement.
  10. Interest rate risk is the risk that the fair value of an investment will be adversely affected due to changes in interest rates. Disclose information about the interest rate risk of debt investments.

    Attention: Interest rate risk disclosure is only necessary for agencies required to prepare their AFR in accordance with GAAP. If an agency uses a Note 3 format in its published AFR other than the required Note 3 format, the agency can submit a supplement to the AFR with the interest rate risk disclosure in compliance with the required format shown in the Note 3 Sample.

    In addition, the following agencies must disclose interest rate risk:

    • Treasury – Fiscal (Agency 311)
    • Texas Education Agency (Agency 701)
    • Texas A&M University System (Agency 798)
    • University of Texas System (Agency 799)

    Organize interest rate risk information by type of investment and amount using one of the following acceptable methods:

    1. Segmented time distribution
    2. Specific identification
    3. Weighted average maturity
    4. Duration
    5. Simulation model

    If a method requires an assumption regarding timing of cash flows, interest rate changes or other factors that affect interest rate risk information, disclose that assumption. Disclose interest rate risk information (according to one of the methods above) if the agency has investments in mutual funds, external investment pools or other pooled investments that do not meet the definition of a 2a7-like pool.

    Agencies may choose to use different interest rate risk disclosure methods in succeeding years. However, any agency choosing to change interest rate risk disclosure methods must also disclose the nature and reason for the change in the year of the change.

    Use only one method per type of debt investment when applying more than one interest rate risk disclosure method.

    Disclose the use of either the macaulay duration, modified duration, or effective duration when applying the duration interest rate risk disclosure method.

    The terms of a debt investment may cause its fair value to be highly sensitive to interest rate changes. Some of the acceptable interest rate risk disclosure methods above incorporate sufficient information about these investments with fair values that are highly sensitive to interest rate changes. Disclose the terms and fair value of investments whose terms are not considered in the interest rate risk disclosure requirements. Terms include such information as:

    • Coupon multipliers
    • Benchmark indexes
    • Reset dates
    • Embedded options

    Interest rate risk disclosure methods can adequately communicate the effects of call options with the exception of the specific identification method. Therefore, agencies using the specific identification method are required to disclose call options.

Reverse Repurchase Agreements [+]

  1. Disclose the credit risk by comparing the total amount of obligations under the agreements (including accrued interest) with the aggregate fair value (including accrued interest) of the securities underlying reverse repurchase agreements other than yield maintenance agreements.
  2. Disclose the fair value of the securities to be repurchased and a description of the terms of the agreements (such as settlement price ranges, agreed-on yields, maturity dates, etc.) for commitments as of the reporting date to repurchase securities under yield maintenance agreements.
  3. Disclose losses recognized during the period due to default by counterparties to reverse repurchase agreements and amounts recovered from prior-period losses if not separately displayed on the operating statement.
  4. Report reverse repurchase and fixed coupon reverse repurchase agreements as a fund liability captioned “obligations under reverse repurchase agreements” and report the underlying securities as “investments.” Do not net the assets and liabilities arising from these agreements on the statement of net position, balance sheet and/or statement of fiduciary net position.
  5. Report income from repurchase and fixed coupon repurchase agreements as interest income. Report interest cost as interest expenditure/expense. Do not net interest cost associated with these instruments with interest earned on any related investments.
  6. Account for yield maintenance repurchase and reverse repurchase agreements as purchases and sales, and sales and purchases of securities, respectively and recognize gains or losses.

Investments in Oil & Gas Reserves [+]

Calculating of fair value reported of oil and gas reserves is divided into two categories:

  1. Reported Reserves — Petroleum engineers prepare a reserve report and estimate the remaining quantities of oil and gas (reserves) expected to be recovered from existing properties.
  2. Non-reported Reserves — No reserve report is prepared. Instead, provide the royalty revenues from prior 12 months.

Reported Reserve Calculation

For an oil or gas deposit to be classified as “reserves,” you first need to establish technical and commercial certainty of extraction using existing technology. Once this has been established, the degree of this certainty is then decided, breaking reserves down into three distinct categories:

  • Proved Reserves — 90% Certainty of Commercial Extraction
  • Probable Reserves — 50% Certainty of Commercial Extraction
  • Possible Reserves — 10% Certainty of Commercial Extraction

The Society of Petroleum Engineers (SPE) establishes standards for each category.

3P reserves refers to the combination of all three of these totals (for example: Proved + Probable + Possible).

Valuation experts generally use reserve reports based on New York Mercantile Exchange (NYMEX) futures prices in effect as of the valuation date through some date in the future. These prices are usually adjusted for regional and quality differentials and are based on actual prices received as compared to NYMEX benchmarks.

Proved reserves are reported as 100% of these reserves multiplied by the adjusted future price of the NYMEX. The future net revenue has been discounted at an annual rate of 10% (PV10) to determine its present worth.

Note: PV10 is the present value of approximated oil and gas revenues in the future, minus anticipated expenses, discounted using a yearly discount rate of 10%. PV10 is primarily used in reference to the energy industry — a very helpful tool in estimating the value of an entity’s proven oil and gas reserves

To determine its present worth, probable reserves are:

  • Multiplied by the adjusted futures price of the NYMEX and discounted at an annual rate of 10%
  • Then adjusted by the mean factor for Probable Undeveloped as indicated in the Reserve Adjustment Factors as published by the Society of Petroleum Evaluation Engineers (SPEE)

The mean is also known as the expectation or the expected value. It is the average value over the entire probability range, weighted with the probability of occurrence.

Possible reserves are calculated by the same method used for probable reserves above — but you also use the mean factor for “Possible Undeveloped” as indicated in the “Reserve Adjustment Factors” as published by the SPEE.

Report the total of these calculations as the “fair value.”

Non-reported Reserve Calculation

Valuing oil and gas properties held by individuals or estates at three times the annual cash flow (“3x Cash Flow”), has been a widely used rule of thumb for decades according to Stout Risius Ross Global Financial Advisory Services. This approach is so simple and avoids petroleum engineering or appraisal fees, which is why it is so widely used — particularly for smaller, nominal properties.

Multiply the sum of the prior 12 months’ royalty revenues by 3 — report the total of this calculation as the “fair value.”

Investments in Common Stock [+]

GASB 62 establishes accounting and financial reporting guidelines for investments in common stock.

This section does not apply to investments in common stock held by:

  • Governmental external investment pools
  • Defined benefit pension or other postemployment benefit plans
  • Internal Revenue Code Section 457 deferred compensation plans
  • Joint ventures
  • Component units as discussed in GASB 14 (as amended)
  • Any common stock investments not discussed in the following paragraphs

Common stock can be accounted for by either the:

  • Cost Method — Record at cost and treat the distributions since the date of investment as dividends received. Distributions subsequent to the investment date are recognized as dividends only to the extent of net accumulated earnings. Dividends in excess of net accumulated earnings are considered a return of investment and are recorded as reductions of the cost of investment. Recognize operating losses that are other than temporary.
    –OR–
  • Equity Method — Initially record at cost and later adjust the carrying amount to recognize the respective share of earnings or losses after the acquisition date. Dividends received reduce the carrying amount. Recognize operating losses that are other than temporary.

Account for common stock without readily determinable fair value (and not under the GASB 62 criteria of paragraphs 205–208) under the cost method.

Criteria for Applying the Equity Method

Equity method is applied when the investment allows the government to exercise significant influence over the investee’s operating and financial policies despite holding less than 50 percent of the voting stock. Significant influence can be determined by factors such as:

  • Having representation on the governing body
  • Ability to participate when the investee makes new policies
  • High involvement in intra-entity transaction
  • Interchangeable management
  • Technological dependency
  • Level of ownership regarding shareholdings
  • Significant influence is not always easily identifiable — but generally a 20 percent or greater share of voting stock may presume that the government has significant influence unless lack of such influence is overcome by other factors
  • Significant influence will need to be further supported if the investor holds an investment of less than 20 percent
  • Only consider voting-stock interest that allows present voting privileges as the potential voting privileges are disregarded
  • The following factors may preclude a government from exercising significant influence:
    • Investee opposes such influence via litigation or complaints to regulatory bodies
    • Investing government surrenders significant privileges via a written agreement
    • Small group of shareholders encompass majority ownership and run the investee without consideration to the government’s views
    • Government is unable to apply the equity method because it cannot obtain the necessary financial information on the investee
    • Government is unable to obtain representation on the investee’s board of directors

    Other factors may also apply and the presence of any of the above factors does not necessarily imply lack of significant influence. However, if any of the above factors exists, a government with ownership of 20 percent should evaluate all facts and circumstances to determine whether it holds significant influence over the investee’s financial and operating policies.

Applying the Equity Method

The government will apply the following procedures when applying the equity method:

  • Eliminate intra-entity profits and losses until realized by the government or investee.
  • Account for the difference between the cost of an investment and it’s equity as goodwill and amortize appropriately.
  • Investments in common stock and government’s portion of earnings and losses are displayed in a single amount in the statement of net position and the statement of cash flows, respectively.
  • Government’s portion of special and extraordinary items and prior period adjustments in the investee’s financial statements should conform to the applicable rules (GASB 34 paragraphs 45–50 & 55 and GASB 62 paragraphs 58-62, respectively).
  • Account for the sale of investee’s stock as gains or losses resulting from the difference between the selling price and carrying amount of the stock sold at the time of the sale.
  • If the timeliest financial statements of the investee are not available to apply the equity method, the government should use the most recent available financial statements to record its share of earnings or losses. Any reporting lags should be consistent each period.
  • An other than temporary loss in value of the investment is recognized similarly to a loss in value of other long-term assets. The following factors are evaluated when determining whether the loss is other than temporary:
    • Inability to recover the carrying amount of the investment
    • Inability of the investee to maintain earnings that support the carrying amount
    • Current fair value is below the carrying amount
  • A government stops using the equity method when the investment is reduced to zero and not recognize any additional losses unless the government has agreed to further support the investee’s finances or has guaranteed obligations. Any further net income by the investee allows the government to reapply the equity method only when the government’s share of net losses not previously recognized has been absolved.
  • If an investee has outstanding cumulative preferred stock, deduct the investee’s declared or undeclared preferred dividends before computing the government’s share of earnings or losses.
  • Government’s share of ownership may fall below 20 percent due to events such as the government selling a portion of the investment, sales of additional stock by the investee, etc. leading to the government losing its significant influence over the investee’s policies. Henceforth, discontinue accruing the government’s portion of earnings and losses that no longer qualify for the equity method. The previously accrued earnings and losses along with the ones relating to the retained stock will remain as part of the carrying amount of the investment. Do not adjust the investment account retroactively under these circumstances. Reduce the carrying amount by the dividends that continue to be received as they exceed the government’s share of earnings for such periods.
  • Conversely to the previous point, use the equity method if a government’s share of ownership increases due to the purchase of additional stock or retirement of voting stock by the investee if the equity method was not previously used due to insufficient percentage of ownership.
  • The difference between the carrying amount and the underlying equity in net position of the investee resulting from the equity method is accounted for as goodwill and amortized appropriately.

Disclosure

Investments in common stock accounted for by the equity method generally require the following disclosures in the notes to the financial statements:

  • Name of each investee and percentage of common stock owned.
  • The government’s accounting policies for each investment.
  • If applicable, the accounting treatment of the difference between the carrying amount and the underlying equity in net position.
  • Aggregate value of the quoted market price of the investment if available.
  • When investments are significant to the government’s financial position or operations, it may be necessary for summarized information to be presented in the notes.
  • Conversion of outstanding securities, exercise of outstanding options and warrants, and other contingent issuances are disclosed in the notes as well.

Equity Method Example:

On 1/1/X1, agency A buys 40 percent of the outstanding stock of Company B for $500,000. Nothing indicates that agency A lacks the ability to exert significant influence over the financing and operating policies of Company B. Therefore agency A applies the equity method to record the transaction as follows:

Seq No Batch Type Doc Type Eff Date Fin Agy TC AY PCA COBJ Amount R Appn No Fund Input GL
To Record the Purchase at Cost in Company B.
(1) 5 U MMDDCY XXX 644 XX XXXXX XXXX $ 500,000.00   N/A XXXX 0109
To Record the Cash in Bank.
(2) 5 U MMDDCY XXX 645 XX XXXXX XXXX $ 500,000.00   N/A XXXX 0040

Accounting effect of above entries:

Debit Credit
(1) To Record the Purchase at Cost in Company B.    
  0109 NC Investment-Domestic Equity $ 500,000.00   
  9999 System Clearing    $ 500,000.00
(2) To Record Cash in Bank.    
  9999 System Clearing $ 500,000.00   
  0040 Cash in Bank    $ 500,000.00

During 20X1, Company B reports net income of $100,000 and distributes a total cash dividend to its stockholders of $15,000. Agency A records $40,000 investment income ($100,000 X 40% = $40,000), adjusts the dividend distribution ($15,000 x 40% = $6,000) and reduces the investment carrying amount as follows:

Seq No Batch Type Doc Type Eff Date Fin Agy TC AY PCA COBJ Amount R Appn No Fund Input GL
To Record Investment Income
(1) 5 U MMDDCY XXX 631 XX XXXXX 3873 $ 40,000.00   N/A XXXX 0109
To Record Cash in Bank
(2) 5 U MMDDCY XXX 644 XX XXXXX XXXX $ 6,000.00   N/A XXXX 0040
To Record Adjustment in Investment
(3) 5 U MMDDCY XXX 645 XX XXXXX XXXX $ 6,000.00   N/A XXXX 0109

Accounting effect of above entries:

Debit Credit
(1) To Record Investment Income    
  0109 NC Investment-Domestic Equity $ 40,000.00      
  5100 GAAP Revenue Offset   $ 40,000.00    
(2) To Record Cash in Bank    
  0040 Cash in Bank $ 6,000.00  
  9999 System Clearing   $ 6,000.00
(3) To Record Adjustment in Investment    
  9999 System Clearing $ 6,000.00  
  0109 NC Investment-Domestic Equity   $ 6,000.00

At the end of the year 20X1, Agency A’s investment account appearing on its balance sheet reports a total of $534,000 ($500,000 + 40,000 – 6,000).

Cost Method

Under the cost method, changes in the company’s stock prices are recorded in the unrealized gain (or loss) on investments account and are reported as income. “Unrealized” means that the shares have not yet been sold and a cash gain or loss has not been realized. However, the unrealized gains or losses must still be reported on the statement of revenues, expenses and changes in net position.

Securities Lending Transactions [+]

In securities lending transactions, agencies transfer their securities (the underlying securities) to broker-dealers and other entities for collateral — which may be cash, securities or letters of credit — and simultaneously agree to return the collateral for the same securities in the future. Governmental lenders invest the cash received as collateral and, if the returns on those investments exceed the rebate paid to the borrowers of the securities, the securities lending transactions generate income for the agency. When securities or letters of credit are the collateral, the borrower pays the lender a loan premium or fee for the securities loan. In some cases, the agency may have the ability to pledge or sell the collateral securities before being required to return them to the borrower at the end of the loan.

Disclose the following information for securities lending transactions:

  1. Report underlying securities (the securities lent by the lender to the borrower) as assets on the statement of net position, balance sheet and/or statement of fiduciary net position.

    If applicable, report underlying securities custodial risk when the collateral is not reported on the statement of net position, balance sheet and/or statement of fiduciary net position. Report the risk exposure by the type of collateral and the custodial arrangements for the collateral securities.

  2. Cash received as collateral on securities lending transactions and investments made with that cash are reported as invested collateral in the assets section of the statement of net position, balance sheet and/or statement of fiduciary net position.

    In agent-managed programs, investments of cash collateral in separate accounts are often subject to custodial credit risk because the custodian is the counterparty (the custodian acquires the securities). Select the risk exposure by how the cash collateral is reinvested.

    In certain cases, a lender may not have the right to invest cash collateral. Specifically, a borrower may be allowed to replace securities collateral with cash collateral during the business day. When the borrower delivers cash that the lender does not have the right to invest, account for the transaction as involving securities collateral rather than cash collateral.

  3. Report investments made with cash collateral at fair value. The original value of the cash collateral received must be maintained and reported as a collateral obligation in the liabilities section of the statement of net position, balance sheet and/or statement of fiduciary net position. This original value (cost) represents the cash due back to the borrower at the completion of the securities lending transaction.

    A difference between the securities lending asset and liability accounts will exist if the fair value of investments made using cash collateral is any amount other than cost. Report this difference as a net increase/(decrease) in fair value of investments on the operating statement, statement of changes in fiduciary net position and/or statement of revenues expenses and changes in net position.

    The fair value of invested cash collateral is calculated annually at fiscal year-end. If a difference exists between fair value and cost, make an AFR entry with reversing T-codes to record the security lending collateral asset fair value and any net increase/decrease from cost. The custodian bank for each securities lending plan should be able to provide this information as of Aug. 31, 20CY.

  4. Securities lending transactions collateralized by letters of credit or securities that the agency does not have the ability to pledge or sell unless the borrower defaults are not reported as assets and liabilities in the statement of net position, balance sheet and/or statement of fiduciary net position. If applicable, select underlying securities custodial credit risk when the collateral for those loans is not reported in the balance sheet.

    Governmental lenders are considered to have the ability to pledge or sell collateral securities without borrower default if the securities lending contract specifically allows it. If the contract does not address whether the lender can pledge or sell the collateral securities without borrower default, the agency is deemed to not have the ability to do so unless the agency has previously demonstrated that ability or there is some other indication of the ability to pledge or sell the collateral securities.

  5. Disclose the following amounts as of Aug. 31, 20CY, within the securities lending disclosure. If the disclosure is not included in the body of the note, send a separate attachment containing:
    • Fair value of securities on loan
    • Non-cash collateral
    • Securities lending obligation liability balance (cash collateral at cost)
    • Securities lending collateral asset balance (invested cash collateral at fair value)
    • Net increase/(decrease) in fair value (of invested cash collateral)
  6. Disclose the source of legal or contractual authorization for the use of securities lending transactions and any significant violations of those provisions that occurred during the period.
  7. Include a narrative description of participation in a security-lending program and provide a brief description for ALL of the following items for security lending transactions. If the description is not included in the body of the note, send a separate attachment containing:
    • Types of securities lent.
    • Types of collateral received.
    • Whether the government has the ability to pledge or sell collateral securities without borrower default.
    • The amount by which the value of the collateral provided is required to exceed the value of the underlying securities.
    • Any loss indemnification provided by the security lending agents.
    • Restrictions on loan amounts.
    • Any significant violations of contract provisions.
    • Whether the maturities of investments made with cash collateral generally match the maturities of loan agreements.
    • Amount of losses from default related to security lending transactions.
    • Amount of recovered losses from previous periods.
    • Amount of credit risk as of the reporting date. If no credit risk exists, disclose this fact. Credit risk exists when the amount owed the governmental entity exceeds the amount the governmental entity owes the broker/dealer.
  8. Report income earned from investing cash collateral separately from costs reported as expenditures or expenses (for example, borrower rebates or agent fees).

Derivatives [+]

GASB 53 addresses the recognition, measurement and disclosure of information pertaining to derivative instruments. GASB 53 requires the measurement of most derivative instruments at fair value in the government-wide statement of activities and statement of net position (economic resources measurement focus financial statements). GASB 72 requires the fair value hierarchy to be categorized by input valuation technique. If derivatives are recognized in the financial statements, consideration of hedge accounting is necessary. The disclosures required by GASB TB 2003-1 were incorporated into this statement. This statement modifies disclosures required by GASB 40.

Cash received as collateral for derivative transactions and investments made with that cash are reported as invested collateral in the assets section of the statement of net position, balance sheet and/or statement of fiduciary net position. Maintain the original value of the cash collateral received and report as a collateral obligation in the liabilities section of the statement of net position, balance sheet and/or statement of fiduciary net position.

The following note disclosures are required for all investment derivative instruments:

  1. Credit risk is the risk that a counterparty will not fulfill its obligations. The credit risk disclosures do not extend to derivative instruments that are exchange traded (such as futures contracts). Disclosures for amounts held by broker/dealers are evaluated by applying the custodial credit risk disclosures consistent with other investment types. If an investment derivative instrument is reported as an asset that exposes an agency to credit risk, disclose:
    • The credit quality ratings of counterparties as described by nationally recognized statistical rating organizations (rating agencies) as of the end of the reporting period. If the counterparty is not rated, the disclosure must indicate that fact.
    • The maximum amount of loss due to credit risk based on the fair value of the investment derivative instrument as of the end of the reporting period that the agency would incur if the counterparties to the investment derivative instrument failed to perform according to the terms of the contract, without respect to any collateral or other security, or netting arrangement.
    • The agency’s policy of requiring collateral or other security to support derivative instruments subject to credit risk, information about the agency’s access to that collateral or other security and a summary description and the aggregate amount of the collateral or other security that reduces the credit risk.
    • Information about the agency’s policy of entering into any master netting arrangements. These disclosures must include a summary description and the aggregate amount of liabilities associated with those arrangements.
    • The aggregate fair value of derivative instruments in asset (positive) positions net of collateral posted by the counterparty and the effect of master netting arrangements.
    • Significant concentrations of net exposure to credit risk with individual counterparties and groups of counterparties.
  2. Interest rate risk is the risk that changes in interest rates will adversely affect the fair values of an agency’s financial instruments or cash flows. If an investment derivative instrument increases an agency’s exposure to interest rate risk, the agency must disclose the terms of the derivative instrument with fair values that are highly sensitive to changes in interest rates. Disclosure is organized by investment type using one of the following methods:
    • Segmented time distribution
    • Specific identification
    • Weighted average maturity
    • Duration
    • Simulation model

    Also, for an investment derivative instrument type that is an interest rate swap with a fair value highly sensitive to interest rate changes, disclose the aggregate fair value and aggregate notional amount, along with the impact of the reference rates on the interest rate risk and the embedded options.

  3. Foreign currency risk is the risk that changes in exchange rates will adversely affect the fair values of an agency’s financial instruments or cash flows. If a derivative instrument increases an agency’s exposure to foreign currency risk, the agency must disclose the U.S. dollar balances of such investment derivative instruments, organized by currency denomination and, if applicable, investment type.
Glenn Hegar
Texas Comptroller of Public Accounts
Questions? Contact statewide.accounting@cpa.texas.gov
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