GASB #40 — Will You Be Ready?
School Advisor, 2005 Issue No. 1

Some of you may remember the introduction of GASB #3, the pronouncement that introduced the concept of disclosing custodial risk in the investment footnote. That was in April 1986, but the painful memories of implementing this standard are still with many of us! Well, not quite 20 years later, they’re back with GASB #40 — Deposit and Investment Risk Disclosures (an amendment of GASB Statement #3). This new standard is effective for the June 30, 2005 financial statements.

First the good news: Custodial Risk is now limited to reporting on those deposits and investments that were previously labeled “Category 3.” Category 1 and Category 2 have been eliminated, so that represents some simplification.

But of course, it doesn’t end there. The new standard adds required disclosures relating to credit risk, concentrations of credit risk, interest rate risk, and foreign currency risk. For the most part, these disclosures are made for the school district (i.e., the primary government) in total; however, additional disclosures may be necessary if the risk is significantly higher for governmental and business-type activities, individual major funds, non-major funds in the aggregate, or fiduciary fund types. On the assumption that Michigan school districts will not be exposed to foreign currency risk, that means three new disclosures. The following are some brief comments on each disclosure:

Credit Risk
Districts need to disclose the credit quality rating of investments as described by nationally recognized statistical rating organizations (rating agencies).

Concentration of Credit Risk
Districts need to disclose, by amount and issuer, investments in any one issuer that represents five percent or more of total investments.
Interest Rate Risk Districts need to disclose information about interest rate risk using one of five different disclosure methods. The two easiest methods of disclosure are:

• Specific Identification — merely lists each investment, its amount, its maturity date, and any call options.
• Segmented Time Distributions — groups investment cash flows into sequential time periods in tabular form.

We’re not done yet! GASB #40 also requires districts to briefly describe their deposit or investment policies, as related to the risks required to be disclosed, or mention the fact that no policies exist. For example, if a government has an exposure to a concentration of credit risk, an investment policy disclosure regarding concentration of credit risk is required; if the government does not have an exposure to concentration of credit risk, then there is no requirement to disclose its investment policies related to concentration risk. Therefore, it may be time to review your district’s policies regarding custodial, credit, concentration, and interest rate risks. It’s our understanding that MSBO is exploring the possibility of providing sample investment policies to assist districts with this requirement.

What will the new footnote look like? Here is a brief example:

FOOTNOTE XX — Deposits and Investments
As of June 30, 2005, the district had the following investments. Except for the investment in LEF Corporation bonds, all investments are in an internal investment pool.

Interest Rate Risk. The district does not have a formal investment policy that limits investment maturities as a means of managing its exposure to fair value losses arising from increasing interest rates.
Credit Risk. State law limits investments in commercial paper, corporate bonds, and mutual bond funds to the top two ratings issued by nationally recognized statistical rating organizations. The district has no investment policy that would further limit its investment choices. As of December 31, 2004, the district’s investment in the state investment pool was rated AAAm by Standard & Poor’s and Aaa by Moody’s Investors Service. The district’s investment in ABC Corporation commercial paper was rated F-1 by Fitch Ratings, A1 by Standard & Poor’s, and P-1 by Moody’s Investors Service. The district’s investments in Federal National Mortgage Association and LEF Corporation bonds were rated AAA by Moody’s Investors Service and AAA by Standard & Poor’s and Fitch Ratings.

Concentration of Credit Risk. The district places no limit on the amount the district may invest in any one issuer. More than five percent of the district’s investments are in ABC commercial paper and the Federal National Mortgage Association. These investments are 13.25% and 10.68%, respectively, of the district’s total investments. All of the investments reported in the district’s Capital Projects Fund are LEF Corporation Bonds.
In addition to reviewing or considering investment risk policies, districts will also need to recognize that applying this new standard to some of the more complicated investment vehicles will be difficult and potentially quite time consuming.

Now is the time to start thinking about what disclosures may be necessary for your district and start gathering the appropriate information and/or considering the adoption of or formalizing existing investment policies.