Handbook for municipal finance officers - 2007
3 September 2007
Presentation of financial statements
Section B3
Pronouncement: GRAP 1 - Presentation of Financial Statements
1. Introduction
The purpose of this chapter section is to provide an overview general understanding of the general concepts underlying the presentation of financial statements, to ensure comparability both between the municipality’s own financial statements of previous periods, as well as those of other municipalities.
To meet these objectives, the overall considerations for the presentation of financial statements, guidelines for the structure and minimum requirements for their content are discussed.
Reading about Tthese overall requirements for financial statements will enable management to respond to t for the most important objective of financial statements – “communicating relevant and reliable financial information about the municipality to its various stakeholders”.
2. What are financial statements?
Financial statements are a structured representation of the financial position and financial performance of a municipality – information that is useful to a wide range of users in making decisions. Furthermore, is it shows the results of management’s stewardship of the resources entrusted to it.
Municipalities are to some extent dependent on external funding (e.g. loans, grants and donations) to fund their operating and capital activities. The financial statements should therefore also provide information regarding the municipality’s performance against the approved budget by way of comparison (if the budget and financial statements were prepared on the same basis) or reconciliation (if the budget and financials statements were not prepared on the same basis).
As the financial statements provide users with information regarding the municipality’s resources and obligations at the reporting date, as well as the result of management’s stewardship of the resources entrusted to it, the transactions the municipality enter into are classified as either: –
· Assets (transactions that embody resources and potential, e.g. infrastructure, debtors, cash and investments, etc.).
· Liabilities (transactions that embody obligations, e.g. creditors, long-term loans, provisions, etc.).
· Net assets (representing “wealth”, e.g. accumulated surplus, capital replacement reserve, revaluation surplus, etc.).
· Cash flow.
· Revenue., and
· Expenditure.
This information along with additional information provided in the financial statements, assist the users to predict the municipality’s cash flows and in particular, their timing and certainty. A number of reports have been developed to ensure users are provided with reliable and relevant financial information. The reports that a municipality is required to prepare in terms of GRAP 1 and the MFMA, are: -
· a statement of financial position;,
· a statement of financial performance;
· a statement of changes in net assets (although it has not been specifically listed in the MFMA, reference is made to any other statement that may be prescribed);
· performance against budget;
· a cash flow statement, and
· explanatory notes to the financial statements, including a summary of significant accounting policies applied when preparing the financial statements.
Circular [1]1836 issued in terms of the MFMA contains an illustrative set of financial statements that demonstrates the format and content of the various reports. The specimen financial statements are updated annually by the Accountant General.
Municipalities are encouraged to provide additional information in cases where the prescribed financial statements do not provide all the information necessary for the users to evaluateing the municipality’s past performance and make decisions about the future allocation of resources.
3. Overall considerations to be applied when preparing financial statements
GRAP 1 identifies the following 7 considerations for the preparation and presentation of financial statements: ;
1. Fair presentation and compliance with GRAP
The financial position, financial performance and cash flows of a municipality should be fairly presented in its financial statements.
In order to achieve fair presentation in the financial statements as intended by GRAP 1, the effects of transactions, events and other circumstances and conditions should be faithfully represented in accordance with the definition and recognition criteria for assets, liabilities, revenue and expenditure as set out in the Framework. An item/transaction is faithfully represented when the users of financial statements are assured that the impact of that item/transaction on the financial position, financial performance and cash flows of the municipality are appropriately represented. For instance, the line-item “provisions” in the statement of financial position indeed only represents those items that met the definition and recognition criteria stipulated GAMAP 19.
Compliance with Standards of GRAP and GAMAP (where applicable) and the faithful representation of the effects of transactions, events and other circumstances and conditions, will usually will achieve fair presentation in the financial statements. Financial statements that fairly presents the financial position, financial performance and cash flows of a municipality, imply that the municipality: –
· select and apply accounting policies in accordance with GRAP 3 Accounting policies, changes in accounting estimates and errors;
· present the information in the financial statements in a way that is relevant, reliable, comparable and understandable; and
· provide additional information in the notes to the financial statements where the specific requirements of a standard are insufficient to enable users to understand the impact of the transaction/event on the financial position, financial performance or cash flows of the municipality.
The notes to the financial statements should include a statement of compliance with Standards of GRAP only when all relevant standards have been complied with. It should however be noted that no extent of disclosure can rectify inappropriate accounting treatment.
In exceptional cases where management is of the opinion that compliance with a particular standard may be misleading to such an extent that it is in conflict with the purpose of financial statements as stipulated by the Framework, the municipality may depart from that specific standard. Information will be considered in conflict with the purpose of financial statements if it does not faithfully represent the effects of transactions, events and other circumstances and conditions and as a result influence the economic decisions of the users of financial statements..
Where a municipality cannot comply with the relevant standards, or part thereof, a written application for exemption, as stipulated in section 177(1)(b) of the MFMA, may be made to the National Treasury, for further guidance refer to MFMA Circular 4 or Section 12.
Government Gazette No. 30013 to be read with the Circular 44 issued by National Treasury provides exemptions to High and Medium Capacity Municipalities to the extent that the, “Basis for Preparation for the Annual Financial Statements of Municipalities and Municipal Entities”, they are required in the preparation of their financial statements to comply with the standards and parts or aspects of standards as specified in the Annexure to the Notice. This exemption applies in respect of the 2006/07 and 2007/08 financial years and is based on conditions that need to be met, e.g. implementation plan to be submitted to the National Treasury and the relevant provincial treasury reflecting progress toward full compliance of the Act and exemptions to be disclosed in an Annexure to the financial statements. Low capacity municipalities need to continue to apply the basis for preparation applied for 2006/07 and must also submit and implementation to the National and provincial treasury. Municipal entities must in respect of 2006/07, 2007/08 and 2008/09 financial years, prepare and submit their annual financial statements using the same basis of accounting applied in the 2005/06 financial year. Refer to Section B0 for detail guidance on the requirements.
When assessing whether compliance with a requirement of GRAP will be misleading, management should answer the following questions: –
1. whyWhy the objective of financial statements will not be achieved by compliance to the requirement?;
2. howHow the municipality’s circumstances differ from other municipalities y’s in similar circumstances that do comply with the requirement?.
When management is of the opinion that the departure from a specific requirement is justified, the following disclosures should be made in the financial statements: –
· that management confirms that the financial statements fairly presents the financial position, financial performance and cash flows of the municipality;,
· that it has complied with all relevant standards except for departure from a specific requirement in order to achieve fair presentation;,
· the title of the standard with the nature of the departure and the treatment prescribed by the standard, along with the reasons why such treatment is considered misleading;,
· a brief description of the accounting treatment applied;, and
· the financial impact on each item in the financial statements if the standard has been complied with.
2. Going concern
When preparing the financial statements, management should assess the municipality’s ability to continue as a going concern. Going concern can be described as the assumption that there is no intention or need to materially curtail the operations of the municipality in the foreseeable future.
Going concern is not only assessed on the basis of the solvency and liquidity as it is done for private businesses, but also external factors, such as:
–
· The Constitution, Section 227(1)(a) determine that a municipality is entitled to an equitable share of revenue raised nationally to enable it to provide basic services and perform the functions allocated to it and may receive other allocations from national government revenue, either conditionally or unconditionally. The existence of a municipality is ensconced in the Constitution but the demarcation is arranged by legislation.
· Tthe power to levy rates may enable a municipality to be considered a going concern, even when operating with negative net assets.;
· multiMulti-year funding agreements or other arrangements that will ensure the continued operation of a municipality.
In assessing the ability of the municipality to continue as a going concern, management shall take into account all available information for a period of at least 12 months from the reporting date, for example: –
· current and expectant performance of the municipality;
· potential and/or announced restructuring of organisational units, e.g. internal restructuring;
· likelihood of additional government funding; or
· potential sources of replacement financing.
3. Accrual basis
The financial statements, except the cash flow statement are prepared on the accrual basis of accounting. The accrual basis implies that transactions are accounted for when they occur and not when cash is received or paid.
4. Consistency of presentation
The consistency-concept implies that there is consistency in the treatment, classification and presentation of similar items within each reporting period, as well as from one reporting period to the next. The presentation of financial statements should only be changed when the changed revised format will provide information that is more relevant and reliable to the users of the financial statements and the revised structure is likely to be sustained.
5. Materiality and aggregation
GRAP 1 states that each material class of similar items should be presented separately in the financial statements. Items of dissimilar nature or function shall be presented separately unless they are immaterial.
An item is considered material if the non-disclosure of the item could influence the decisions of the users based on the financial statements. Materiality is assessed with reference to both the size and nature of an item.
6. Offsetting
Offsetting items against one each other another will influence the ability of users to comprehend the transactions and events that are recorded in the financial statements therefore assets and liabilities, as well as revenue and expenditure should not be offset against one another, except if required or permitted by a standard. The measurement of assets net of any valuation allowances, i.e.e.g. provision for doubtful debts, is not considered offsetting.
7. Comparative information
Enhancing the comparability of information and financial statements assists users in making and evaluating decisions, especially by allowing the assessment of trends in financial information. Therefore, GRAP 1 requires comparative information to be disclosed for all amounts in the financial statements, unless required differently by another standard. When necessary or relevant to understand the current period’s financial statements, comparative information shall also be provided for narrative and descriptive information.
When the presentation or classification of items are amended, comparative information should also be restated unless it is impractical to do so. The financial statements will disclose the nature, amount and reasons for the restatement.
4. Structure and content of financial statements
Standards of GRAP/GAMAP require the disclosure of certain information in the financial statements. Unless specifically stated by a standard, these disclosures may be made either on the face of the statements or in the notes thereto. The following specific disclosures are required by GRAP 1: –
1. Identification of financial statements
As the Standards of GRAP/GAMAP only apply to financial statements and not to other information published in the annual report, such as the performance report, readers and users of financial statements should be able to distinguish it from the other information. The following information has to be indicated preferably on each page of the financial statements: –
· the name of the municipality/entity as well as any changes to the name since the previous reporting date;
· whether it is separate or consolidated financial statements;
· the reporting date or period that is covered by the financial statements
· the presentation currency applied in the financial statements; and
· the level of rounding (thousands or millions) applied in the financial statements.
2. Reporting period
Legislation requires financial statements to be prepared annually, therefore covering a period of 12 months, based on the best available information at his point in time. Where, in the case of a municipal entity, the reporting period covers a longer or shorter period, the financial statements should disclose the reason therefore as well as the fact that comparative information may not be entirely comparable.
3. Statement of financial ppositionosition
a) Distinction between current and non-current assets and liabilities
In order to illustrate the solvency (assets versuss. liabilities) and liquidity (current assets versusvs. current liabilities) positions of the municipality, the financial statements should present current and non-current assets and liabilities separately on the face of the statement of financial position.