ACC 545 Governmental Case (Completed in Pairs as Shown on D2L)

ACC 545 Governmental Case (Completed in Pairs as Shown on D2L)

The primary objective of this case is to enhance your understanding of governmental financial reporting through a detailed analysis of the Comprehensive Annual Financial Report (CAFR) for the State of Illinois and its pension-related disclosures. The case chronicles a large increase in the State’s unfunded pension liability since 1973 and largely unsuccessful legislative measures taken to stem its growth. This provides an opportunity to examine governmental accounting in a striking real-world setting. You will examine the State’s CAFRs from multiple perspectives – of taxpayer/citizen, state legislator, and investor – and will compare it to another state’s CAFR. We pay particular attention to pensions because you spend substantial time in intermediate accounting courses studying accounting for defined benefit pension plans for corporate entities. However, defined benefit plans are becoming less important in corporations. On the other hand, they are common in state and local governments, and state legislatures expend considerable resources in assessing the funding requirements of these plans. Further, an analysis of pension liability and expense are essential to any assessment of a state’s financial condition due to the large numbers involved.

Pension computations are very complex. Most voters and policy-makers do not understand them, which leads to decisions with potentially large and unexpected consequences. Accountants have the responsibility to assess and communicate the financial position of governmental entities, yet a majority of accounting majors are not sufficiently familiar with CAFRs, which contain a wealth of useful information but are voluminous and hard to read. Current accounting standards require governments to recognize the net pension liability and pension expense on governmentwide financial statements. However, these items do not appear as line items on the Statement of Net Position and Statement of Activities of many entities even when material, and need to be searched in the footnotes.

Introduction Illinois is the fifth-largest state in the U.S. in population and gross state product (the state version of GDP). Services provided by the state include education, social and health services, construction and maintenance of highways, public safety, conservation of natural resources, economic development, and recreation facilities. Governmental activities of the state are funded primarily through taxes. The State of Illinois has a vigorous service sector with strength in professional and business services, education and healthcare services, and leisure and hospitality services. The largest private employers in the State include retailers, healthcare providers, equipment manufacturers, and nationwide financial service providers.

Economic growth continued at a steady pace in Illinois during fiscal year 2017, with measures of economic activity showing gradual improvement after a sharp decline in 2009 and 2010. The average Illinois unemployment rate decreased from 6.2% and 6.0% in fiscal years 2015 and 2016, respectively, to 5.0% at June 30, 2017 (Illinois 2017, 29). 

Illinois’ Comprehensive Annual Financial Report (CAFR) for 2017, however, indicates deep financial woes and a significant deterioration in the State’s financial condition during the year. The deficit for net financial position of governmental activities increased from $131.57 billion on June 30, 2016, to $141.66 billion on June 30, 2017 (Illinois 2017, 33). This deficit, computed on an accrual basis, represents a deferral of payments for current and prior year costs to future years. Cash flow problems caused the State to withhold $10.50 billion in payments and interfund transfers from the General Fund as of June 30, 2017 (Illinois 2017, 25). The State’s general obligation bonds were rated just a notch above junk bond status: Baa3 with a Negative Outlook by Moody’s Investor Services, BBB− with a Negative Outlook by Standard and Poor’s, and BBB with a Negative Outlook by Fitch Ratings as of June 30, 2017.

The 2017 CAFR’s Management Discussion and Analysis concludes by stating that: “(t)he State continues to show an inability to generate sufficient cash from its current revenue structure to pay operating expenditures on a timely basis… the accumulated deficit in the General Fund, continued growth in the net pension liability and postemployment benefit costs, and rating downgrades on debt issuances of the State may impact the State’s ability to access credit markets to pay operational expenditures more timely and may increase interest costs of those borrowings.” (Illinois 2017, 30) The State’s largest liability arises from its underfunded pension plans. At the end of fiscal year 2017, the net pension liability totaled $137.67 billion, an increase of 18.7 percent from fiscal year 2016. The net pension liability (pension expense) is not reported as a distinct line item in its government-wide Statement of Net Position (Statement of Activities). Information on these is provided in footnote disclosures

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