In June of 2018, the Governmental Accounting Standards Board (GASB) issued Statement No. 89 (GASB 89), Accounting for Interest Cost Incurred before the End of a Construction Period. This issuance should generate a sigh of relief from those in the public sector because once this statement goes into effect, accounting for interest costs will be much simpler.
What GASB Statement No. 89 Changed
Under current governmental accounting standards, government entities whose financial statements are prepared using the economic resources measurement focus are required to capitalize the interest costs in business type activities and enterprise funds they incur before the end of a construction period. These interest costs are added to the costs of their corresponding capital assets and then expensed over those assets’ useful lives. Not only does this slow down expense recognition, it is burdensome to calculate and inflates asset costs on the financial statement.
GASB 89 lets government entities using the economic resources measurement focus to expense interest costs in the year they are incurred. Entities whose financial statements are prepared under the current financial resources measurement focus should continue to recognize interest costs consistent with existing governmental fund accounting principles.
Once GASB 89 is applied, interest will not be added to the corresponding asset’s historical cost. This will make balance sheets more reflective of the government entity’s true economic worth.
Who Can Apply the Standard and When
GASB 89 will only affect government entities who have been capitalizing interest costs in business type activities and enterprise funds in accordance with GASB 62, Codification of Accounting and Financial Reporting Guidance Contained in Pre-November 30, 1989 FASB and AICPA Pronouncements. The official effective date is drawing near. Businesses can apply the simplified standards on their reports for fiscal years that begin after December 15, 2019, which – for most – is January 1, 2020. Businesses are encouraged to adopt the standard early, on a prospective basis. If you have not already applied the new standard, shoot for making the change at the start of the new year.
How This Change Will Improve Financial Reporting
The GASB believes that this accounting standard change will do three things:
- Provide users of the financial statements with more accurate information about capital assets and borrowing activities.
When interest costs are merged into asset costs, users of the financial statements may get an inaccurate picture about the service capacity of the organization’s assets. Interest expenses do not affect the ability of the assets to do their jobs, so removing interest from these costs and placing them in their own expense category will provide much needed clarity. Additionally, having interest expenses stated plainly will help users of the financial statements see the true costs of borrowing. - Improve comparability of business-type and governmental activities.
Currently, construction period interest incurred in business-type activities is capitalized while construction period interest incurred in governmental activities is not. This means that the government may report different historical costs for two identical assets simply because those assets were used in different capacities. The GASB believes this is misleading and thinks GASB 89 will improve the comparability of all activities. - Reduce reporting complexities for government entities.
Capitalizing construction period interest is not simple. Entities must determine their capitalization rate, figure out which assets were utilized during the construction period (and for how many days they were utilized), then apply the capitalization rate to the assets. Going forward, these organizations can simply expense interest when it is incurred.
Adopting the Standard
Adopting the standard should be straightforward, but watch out if your operations are regulated. If your regulator requires you to capitalize construction period interest, you must continue to do so.
Be aware that your financial statements will look different after adoption. You may need to prepare your financial statement users for this change, or at least be primed to discuss it if the question arises. If you would like guidance on making the switch at the start of 2020, contact a member of LaPorte’s Public Sector Industry Group. We’d love to help.