New PS 3410—Recipient Accounting for Government Transfers—Liability Indicators

Purpose

The new PS 3410 “Government transfers” section is applicable to periods beginning on or after 1 April 2012. Under the new PS standard, government transfers should be recognized as revenue, except when a transfer has stipulations that give rise to an obligation that meets the definition of a liability for the recipient in accordance with LIABILITIES, Section PS 3200 [PS 3410.19].

The purpose of the following guidance is to help assess a) when transfer stipulations either alone or together with actions and communications of the recipient government may create obligations that meet the definition of a liability (PS 3410.19), and b) when the liability is settled and revenue is recognized (PS 3410.25).

Key Standards References

Liabilities are present obligations of the recipient government to others arising from past transactions or events, the settlement of which is expected to result in the future sacrifice of economic benefits. Liabilities have three essential characteristics [PS 3200.05]:

1. they embody a duty or responsibility to others, leaving a [recipient] little or no discretion to avoid settlement of the obligation;
2. the duty or responsibility to others entails settlement by future transfer or use of assets, provision of goods or services, or other form of economic settlement at a specified or determinable date, on occurrence of a specified event, or on demand; and
3. the transactions or events obligating the [recipient] have already occurred.

Stipulations are terms imposed by a transferring government regarding the use of transferred resources or the actions a recipient must perform in order to keep a transfer. Stipulations must be met by recipients who have already qualified to receive (by meeting eligibility criteria), or have received, a transfer. Stipulations must be met by recipients who have already qualified to receive (by meeting eligibility criteria), or have received, a transfer. The nature and substance of stipulations is such that they are met after a transfer is provided. They are often terms that need to be satisfied through direct application of the transfer (PS 3410 Glossary).

Stipulations may include the following:

Circumstances may exist when the stipulations of a transfer alone are too broad to create an obligation that meets the definition of a liability. In such cases, a recipient government would review its own actions and communications by its financial statement date to evaluate whether they are consistent with the substance and intent of the transfer stipulations, and determine whether the nature and extent of those actions and communications together with the transfer stipulations create an obligation that meets the definition of a liability (PS 3410.21). Obligations inferred from the facts in a particular situation, in this case, broad stipulations taken together with the actions and communications of the recipient government are considered constructive obligations [PS3200.04d)].

Office Guidance

Determining whether circumstances create an obligation that meets the definition of a liability requires the application of professional judgment. The indicators developed below should be applied to the particular facts of each government transfer, and the preponderance of evidence for each liability characteristic must be considered in assessing whether transfer stipulations give rise to an obligation that meets the definition of a liability.

All three liability characteristics set out in the PS3200 definition of a liability have to be met in order to qualify as a liability. Since the third characteristic is met when a transfer agreement is authorized and eligibility criteria, if any, have been met by the recipient, the guidance focuses on indicators supporting the assessment of the two other characteristics: 1) loss of discretion, and 2) future economic settlement at a specified date.

Careful assessment of the circumstances and evidence used to support the initial recognition is crucial in that these circumstances and evidence are also used to determine when the liability is settled and revenue is recognized. (PS3410.26)

Characteristic 1: “Loss of discretion to avoid”—The recipient must have little or no discretion to avoid settling an obligation. To lose discretion, an entity must be bound to a particular course of action (PS3200.07), meaning that it does not have the freedom to make further choices, judgements, or decisions related to that particular course of action (PS 3200.08)). To determine when a recipient entity has lost discretion in relation to a transfer, we need to consider:

1. Stipulations alone (PS 3410.20(a)), or
2. Stipulations taken together with the actions and communications of the recipient government before the financial statement date (PS 3410.20(b)) that create a valid expectation among others resulting in its inability to withdraw from the obligation and having no realistic alternative but to settle the obligation.

Indicators providing evidence that an entity has lost discretion include:

• Stipulations (alone or taken together with the recipient’s actions and communications) include sufficient specificity regarding the purpose of use of resources transferred (purpose stipulations) (PS3200.07 - .08) and when the resources must be used (time stipulations) (PS3200.21) to bind the entity to a particular course of action
• Stipulations (alone or taken together with the recipient’s actions and communications) include sufficient specificity to permit objective assessment of non-compliance. If they do not, this indicates that the entity has retained discretion over the use of the resources and/or when the resources must be used.
• The stipulations (alone or taken together with the recipient’s actions and communications) impose specific performance obligation that are over and above the recipient’s routine activities. Otherwise, the entity may retain alternatives or choices such as substituting the funding received through the transfer for other sources of funding to finance an existing or previously planned program or activity. The ability to make these choices suggests that the recipient has not lost discretion.
• Recipient entity has formally advised those ultimately affected by the entity’s settlement of the obligation (e.g., recipient of services/activities related to transfer) of how the resources will be used and when. Communications with this level of detail can provide further evidence of the entity’s acceptance of the obligation and the nature and timing of its settlement. Whereas, vague communications may indicate that the entity has the ability to withdraw from the obligation.
• Performance is monitored by, or on behalf of, the transferring government on an ongoing basis.
• The transferring government has or can impose consequences for non-compliance, which may include
  • a return obligation or
  • the option to seek significant penalty.
• Substance over form. Unless there is evidence to the contrary, we assume that the legal form of a stipulation equals its substance (i.e. the government would impose consequences in breach situations). However, where there is a history demonstrating that the recipient entity has discretion to make decisions about the use of the transferred funds (e.g., decisions on particular activities to undertake or when to undertake those activities) or that the government does not monitor and impose consequences in breach situations, this indicates that in substance a liability may not exist.

Characteristic 2: “Sacrifice of economic benefits at a specified time”—The duty to use a transfer in a certain way is otherwise known as a performance obligation. Performance obligations are demonstrated through PURPOSE and TIME STIPULATIONS.

Indicators that provide evidence that entity has the obligation to sacrifice economic benefits to others at a specified time include:

• Obligation must be to a third party (outside of the entity’s reporting entity)—the entity cannot be obligated to itself.
• Stipulations include sufficient specificity regarding when the resources must be used (time stipulations) to assess the timing of settlement. Stipulations that are too broad may indicate that timing of the settlement is not determinable (e.g., no specified or determinable date or no specified or determinable event). When settlement is dependent on a specified future event, a liability would not exist until the occurrence of such future event.
• The sacrifice of economic benefits in a typical capital transfer scenario occurs when the asset resulting from the transfer (e.g., capital asset bought or built with transferred funds) is used by others. A recipient’s own use of an asset in the delivery of services within the scope of its public policy mandate is a FIDUCIARY duty and does not in itself result in the sacrifice of economic benefits giving rise to a liability.

In the case of parliamentary appropriations used to finance capital expenditures, they will normally be recognized as revenue either upon receipt or when spent. We currently do not foresee scenarios where a liability would exist past the point when funds are spent.

Key Messages to audit entities and audit teams

• The default of the new standard is revenue unless a liability can be demonstrated. Based on our current position and the work performed to date, we expect that only in rare circumstances a transfer stipulation will create a liability. In the event a government or an entity argues that a liability exists, the government/entity should provide to the audit team a detailed position paper documenting its position and underlying rationale. We expect the adoption of the new PS 3410 will have the most impact on capital transfers.
• We encourage audit teams to discuss with audit entities their approach for implementing the new standard. Following is a suggested approach to implementation:
  • Gain a good understanding of the new standard and the areas where significant judgment may be required.
  • Make an inventory of transactions and account balances that may be impacted by the new standard. Pay particular attention to agreements signed in prior years that are still effective at the date of adoption of the new standard.
  • Obtain and review agreements, legislation, regulation and other relevant documents supporting the transaction.
  • Document analysis of entity’s assessment of the proper accounting treatment of the transfer transaction/balance under the new standard. Entity management and audit team should discuss the acceptable level of audit documentation necessary to satisfy documentation requirements.
  • Consult with legal counsel as appropriate to understand relevant legislative approval processes and terms of transfer agreements.
  • Compute and assess impact on financial statements.
  • Share results of analysis with audit team.
  • Decide on retroactive or prospective application of the accounting changes that may result from the adoption of the new standard.
  • Consider new disclosure requirements for liabilities arising from transfer transactions.
  • Communicate with Audit Committee as appropriate.
• Involving AAPT—To mitigate the risk of inconsistent application of professional judgment in similar circumstances during the first year of adoption of the new standard, we encourage audit teams to inform AAPT of the proposed accounting for significant government transfer transactions under the new standard before providing signing-off. The Accounting Champion Network will also be used during the implementation period to facilitate sharing of information among audit teams.
• Presentation on statement of operations—While this is not specifically required by PSAB, the Office maintains its traditional preference for a recipient to present government transfers and parliamentary appropriations on a separate line below net costs of operations. We believe this presentation to be the most appropriate in communicating the extent to which the recipient relies on government assistance.