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2007 Monticello Auditor's Management Letter i~ ~; Management Report for City of Monticello, Minnesota December 31, 2007 CERTIFIED PUBLIC ACCOUNTANTS To the City Council City of Monticello, Minnesota PRINCIPALS Kenneth W. Malloy, CPA Thomas M. Montague, CPA Thomas A. Karnowski, CPA Paul A. Radosevich, CPA William J. Lauer, CPA James H. Eichten, CPA Aaron J. Nielsen, CPA Victoria L. Holinka, CPA We have prepared this management report in conjunction with our audit of the City of Monticello, Minnesota's (the City) financial records for the year ending December 31, 2007. The purpose of this report is to communicate information relevant to city finances in Minnesota and to provide comments resulting from our audit process. We have organized this report into the following sections: • Audit Summary • Funding Cities in Minnesota • Governmental Funds Overview • Financial Trends and Analysis • Accounting and Auditing Updates We would be pleased to further discuss any of the information contained in this report or any other concerns that you would like us to address. We would also like to express our thanks for the courtesy and assistance extended to us during the course of our audit. This report is intended solely for the information and use of management, those charged with governance or the City, and those who have responsibility for oversight of the financial reporting process. ~a I~OK, /' ~0/tf"49t1~~ /'~u~!'Yl6W~j~G,~ ~a~OsQ~/~c ~~ ~ ~v.~ ~• /~• June 17, 2008 JJ t ' Malloy, Montague, Karnowski, Radosevich & Co., P.A. 5353 Wayzata Boulevard Suite 410 Minneapolis, MN 55416 Telephone: 952-545-0424 Telefax: 952-545-0569 www.mmkr_com 4 1 i~ t AUDIT SUMMARY The following is a summary of our audit work, key conclusions, and other information that we consider important or that is required to be communicated to the City Council, administration, or audit committee of the City. UNDERSTANDING THE AUDITOR'S RESPONSIBILITY Our responsibility, as described by professional standards, is to express opinions about whether the financial statements prepared by management with your oversight are fairly presented, in all material respects, in conformity with accounting principles generally accepted in the United States of America. Our audit of the financial statements does not relieve you or management of your responsibilities. As part of our audit, we considered the internal control of the City. Such considerations were solely for the purpose of determining our audit procedures and not to provide any assurance concerning such internal control. PLANNED SCOPE AND TIMING OF THE AUDIT We performed the audit according to the planned scope previously discussed and coordinated with the City in order to obtain sufficient audit evidence and complete an effective audit. The reporting of the audit to the City Council was delayed due to difficulties encountered during our audit procedures. These difficulties were mainly due to the number of audit entries recorded and the need for additional reconciling procedures recommended and performed by city staff as part of the financial reporting process. AUDIT OPINION AND FINDINGS • We have issued an unqualified opinion on the City's financial statements. We reported eight findings related to the City's internal controls over financial reporting. These include findings on the following: o Inadequate segregation of duties o Numerous audit adjusting journal entries o Inadequate account reconciliation procedures o Preparation of financial statements o Deficiencies in the entity-level internal controls over financial reporting o Inadequate controls over community center cash receipts o Inadequate documentation of the components of internal controls o Deficiencies in the entity-level internal controls over information technology • We reported two findings related to the City's compliance with Minnesota laws and regulations. These findings include the following: o Assignment of collateral o Contract language for the payment of subcontractors e 1 -1- ~r SIGNIFICANT ACCOUNTING POLICIES The City's management is responsible for the selection and use of appropriate accounting policies. In accordance with the terms of our engagement letter, we advise management about the appropriateness of accounting policies and their application. The significant accounting policies used by the City are described in Note 1 of the notes to basic financial statements. No new accounting policies were adopted and the application of existing policies was not changed during the year. We noted no transactions entered into by the City during the year for which there is a lack of authoritative guidance or consensus. There are no significant transactions that were recognized in the financial statements in a different period than when the transaction occurred. AUDIT ADJUSTMENTS Professional standards require us to accumulate all known and likely misstatements identified during the audit, other than those that are trivial, and communicate them to the appropriate level of management. Professional standards define an audit adjustment as a proposed correction of the financial statements that, in our judgment, may not have been detected except through our auditing procedures. An audit adjustment may or may not indicate matters that could have a significant effect on the City's financial reporting process (that is, cause future financial statements to be materially misstated). During our audit we made numerous audit adjustments that had a significant impact on the financial statements. These audit adjustments were reviewed and approved by management and incorporated into the annual financial report of the City. ACCOUNTING ESTIMATES AND MANAGEMENT JUDGMENTS Accounting estimates are an integral part of the basic financial statements prepared by management and are based on management's knowledge and experience about past and current events and assumptions about future events. Certain accounting estimates are particularly sensitive because of their significance to the financial statements and because of the possibility that future events affecting them may differ significantly from those expected. The most sensitive estimates affecting the financial statements were as follows: • Depreciation -Management's estimates of depreciation expense is based on estimated useful lives of assets. • Land Held for Resale -Management's estimates of this asset is based on net realizable value (lower of cost or estimated sales price). • Compensated Absences -Management's estimate is based on current rates of pay and sick leave balances. Management expects any differences between estimates and actual amounts of these estimates to be insignificant. We reviewed and tested management's procedures and underlying supporting documentation in the area discussed above. We concluded that the accounting estimates and management judgments appeared to consider all significant factors and resulted in appropriate accounting recognition. DIFFICULTIES ENCOUNTERED IN PERFORMING THE AUDIT We encountered no significant difficulties in dealing with management in performing and completing our audit. -2- 1 1 it DISAGREEMENTS WITH MANAGEMENT For purposes of this letter, professional standards define a disagreement with management as a financial accounting, reporting, or auditing matter, whether or not resolved to our satisfaction, that could be significant to the financial statements or the auditor's report. We are pleased to report that no such disagreements arose during the course of our audit. MANAGEMENT REPRESENTATIONS We have requested certain representations from management that are included in the management representation letter dated June 17, 2008. MANAGEMENT CONSULTATIONS WITH OTHER INDEPENDENT ACCOUNTANTS In some cases, management may decide to consult with other accountants about auditing and accounting matters, similar to obtaining a "second opinion" on certain situations. If a consultation involves application of an accounting principle to the City's financial statements or a determination of the type of auditor's opinion that may be expressed on those statements, our professional standards require the consulting accountant to check with us to determine that the consultant has all the relevant facts. To our knowledge, there were no such consultations with other accountants. OTHER MATTERS We generally discuss a variety of matters, including the application of accounting principles and auditing 1 standards, with management each year prior to retention as the City's auditors. However, these discussions occurred in the normal course of our professional relationship and our responses were not a condition to our retention. OTHER COMMENTS AND RECOMMENDATIONS Based on our audit, we offer the following additional comments for the improvement of the City's financial and accounting controls and procedures: New Auditing Standards As you may be aware, the audit process changed dramatically this year. Because of our extensive experience with Minnesota municipalities, we have always taken a very customized approach to auditing cities. We find this to be both an efficient and effective method to accomplish a quality audit. So much of what we do now is the same as what we have done in the past, with the addition of the new risk-based model or approach. The new model involves a much more thorough review, analysis, and documentation of the City's environment, systems, procedures, and internal controls. This documentation includes a comparison of the City's internal controls with a standard comprehensive framework for internal controls developed by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). This process provides for an assessment of risk for material misstatement in the financial statements due to error or fraud, and those additional audit procedures we need to perform to address those risks. Although the intent of the new standards is to increase the quality of audits in our profession, a positive by-product is getting management and governance of the City more involved in reviewing and improving procedures and controls. This is very important, as the mayor, City Council, and management play critical roles in the City's financial controls. -3- ' LEGISLATION 1 FUNDING CITIES IN MINNESOTA The following is a brief summary of recent legislative activity affecting the finances of Minnesota cities: Levy Limitations -The recently completed 2008 Legislature passed a law that will limit general operating property tax levy increases for Minnesota cities to 3.9 percent annually for the next three years. Local Government Aid (LGA) -Cities are still adapting to the formula changes for allocating LGA to cities that went into effect in 2004. The transition to the new formula has caused many cities to experience volatility in their aid payments from year-to-year. This is mainly due to the elimination of the grandfather clause, which guaranteed minimum payment amounts to cities. Market Value Homestead Credit (MVHC) -After several years of cuts, the MVHC reimbursement aid was restored in 2007 for all cities. PROPERTY TAXES 1 1 Our management report tracks the evolution of property tax reform in Minnesota, and explains its impact on cities and their property owners. Now, with very little change in property tax formulas, attention is turned toward our current real estate and housing environment, mortgage foreclosures, and the world economy. Property values within Minnesota cities experienced average increases of 12.0 percent for taxes payable in 2006 and 11.0 percent for those payable in 2007. However, the valuation for taxes payable in 2007 is based on estimated values as of January 1, 2006, and a lot has happened to values since then. In comparison, the City's market value increased by 12.7 percent in 2006 and 16.8 percent in 2007. The following graph shows the City's changes in taxable market value over the past five years: Market Value 1 1 J 1 $1,200,000,000 $1,000,000,000 $800,000,000 $600,000,000 $400,000,000 $200,000,000 $- 2003 2004 2005 2006 2007 1 Tax capacity is considered the actual base available for taxation. It is calculated by applying the state's property classification system to each property's market value. Each property classification has a different calculation and uses different rates. The following graph shows the City's change in tax capacities over the past five years: Tax Capacity $20,000,000 $15,000,000 $10,000,000 $5,000,000 $- 2003 2004 2005 2006 2007 Although it is impossible to consider every aspect and variable of local government spending, average tax rates are often used as a benchmark. Rates expressed as a percentage of net tax capacity All Cities Seven-County State-Wide Metro Area City of Monticello 2006 2007 2006 2007 2006 2007 Average tax rate City 37.1 36.1 34.3 33.4 51.0 42.5 County 40.1 38.5 35.5 35.2 32.6 30.7 School 22.9 22.2 23.0 22.7 24.4 23.2 Special taxing 5.4 5.5 5.8 6.8 2.3 3.0 Total 105.5 102.3 98.6 98.1 110.3 99.4 The City's portion of the tax capacity rates for Monticello residents was well above the state-wide and metro area averages the last two years. The City's 2007 total average tax rate is similar to all cities state-wide and the seven-county metro area averages. The City experienced a significant decline in the average tax rate in 2007 mainly due to the significant increase in taxable market value and tax capacity. -5- 1 1 1 ii 1 1 _~ 1 L 1 1 r 1 1 GOVERNMENTAL FUNDS OVERVIEW This section of the report provides you with an overview of the financial trends and activities of the City's governmental funds. Governmental funds include the General Fund, special revenue funds, debt service funds, and capital projects funds. We have also included the most recent comparative state-wide averages available from the State Auditor. The reader needs to consider the effect of inflation and other known changes or differences when comparing this data. Also, certain data on these tables may be classified differently than how they appear on the City's financial statements in order to be more comparable to the state-wide information, particularly in separating capital expenditures from current expenditures. We have designed this section of our management report using per capita data in order to better identify unique or unusual trends and activities of your city. We intend for this type of comparative and trend information to complement, rather than duplicate, information in the Management's Discussion and Analysis. An inherent difficulty in presenting per capita information is the accuracy of the population count, which for most years is based on estimates. GOVERNMENTAL FUNDS REVENUE The amounts received from the typical major sources of revenue will naturally vary between cities based on their particular situation. This would include the City's stage of development, location, size and density of its population, property values, services it provides, and other attributes. The following table presents the City's revenue per capita of its governmental funds for the past three years, together with state-wide averages: Governmental Funds Revenue per Capita With State-Wide Averages by Population Class State-Wide City of Monticello Year December 31, 2005 2005 2006 2007 Population 2,500-10,000 10,000-20,000 20,000-100,000 10,662 11,136 11,136 Property taxes $ 283 $ 276 $ 306 $ 631 $ 580 $ 556 Tax increments 40 52 50 71 71 74 Franchise fees and other taxes 15 23 31 - - 13 Special assessments 88 69 73 313 180 279 Licenses and permits 43 33 42 90 68 56 Intergovernmental revenues 260 272 155 35 84 158 Charges for services 116 95 78 377 251 259 Other 125 108 76 390 598 216 Total revenue $ 970 $ 928 $ 811 $ 1,907 $ 1,832 $ 1,611 The City has generated more property tax revenue for its governmental fund revenues compared to the average Minnesota city. The City continues to generate more tax increment revenue per capita than average, as it has made use of this tool to finance commercial development. The City generates more special assessment revenue (typically used for new development) as the City continues to be in a growth phase. The City's per capita governmental fund revenue for 2007 was $1,611, a decline of about 12.1 percent from the prior year. The decrease is mostly in other revenue which declined due to a significant gain on the sale of land in 2006. -6- GOVERNMENTAL FUNDS EXPENDITURES Similar to our discussion of revenues, the expenditures of governmental funds will vary from state-wide averages and from year-to-year, based on the City's circumstances. Expenditures are classified into three types as follows: • Current -These are typically the general operating-type expenditures occurring on an annual basis, and are primarily funded by general sources such as taxes and intergovernmental revenues. • Capital Outlay and Construction -These expenditures do not occur on a consistent basis, more typically fluctuating significantly from year-to-year. Many of these expenditures are project-oriented, which are often funded by specific sources that have benefited from the expenditure, such as special assessment improvement projects. • Debt Service -Although the expenditures for debt service may be relatively consistent over the term of the respective debt, the funding source is the important factor. Some debt may be repaid through specific sources such as special assessments or redevelopment funding, while other debt maybe repaid with general property taxes. The City's expenditures per capita of its governmental funds for the past three years, together with state-wide averages, are presented in the following table: Governmental Funds Expenditures per Capita With State-Wide Averages by Population Class State-Wide City of Monticello Year December 31, 2005 2005 2006 2007 Population 2,500-10,000 10,000-20,000 20,000-100,000 10,662 11,136 11,136 Current General government $ 113 $ 103 $ 78 $ 145 $ 157 $ 171 Public safety 192 201 198 156 248 144 Street maintenance and lighting 97 94 75 435 323 175 Recreation 57 76 76 221 204 199 All other 76 105 82 106 227 115 $ 535 $ 579 $ 509 $ 1,063 $ 1,159 $ 804 Capital outlay and construction $ 438 $ 335 $ 293 $ 1,138 $ 1,174 $ 577 Debt service Principal $ 157 $ 142 $ 106 $ 179 $ 306 $ 304 Interest and fiscal 61 50 37 134 213 203 $ 218 $ 192 $ 143 $ 313 $ 519 $ 507 The City's governmental funds current per capita expenditures are higher than state-wide averages for cities in the same population class. The City's current operating costs are higher than average in most categories other than public safety costs. The City's per capita expenditures for capital are higher than state-wide averages, but will vary on a yearly basis depending on current, ongoing capital projects. Debt service costs are significantly higher than other cities state-wide. -7- ' TREND A FINANCIAL S ND ANALYSIS GENERAL FUND The City's General Fund accounts for the financial activity of the basic services provided to the community. The primary services included within this fund are the administration of the municipal operations, police and fire protection, building inspection, streets and highway maintenance, and parks and recreation. ' The graph below illustrates the change in the General Fund financial position over the last five years. We have also included an expenditure line to reflect the change in the size of the General Fund operation over the same period. r t 1 t 1 1 I i ~_ t $8,000,000 $7,000,000 $6,000,000 $5,000,000 $4,000,000 $3,000,000 $2,000,000 $1,000,000 $- General Fund Financial Position Year Ended December 31, 2003 2004 2005 2006 2007 ~ Fund Balance O Cash Balance Expenditures The City's General Fund cash and investments balance at December 31, 2007 was $7,098,830, which increased about $158,387 from 2006. Total fund balance at December 31, 2007 was $5,561,487, up $141,574 from the prior year. Of this total fund balance, $5,372,129 was reserved or designated and $189,358 was undesignated. This fund balance level represents approximately 76.5 percent of the City's annual General Fund expenditures, based on 2007 expenditure levels. Over the last few years, the City has generally been able to maintain or increase cash and fund balance levels. This is an important factor because a government, like any organization, requires a certain amount of equity to operate. Generally, the amount of equity required typically increases as the size of the operation increases. A healthy fund balance is important because a government, like any organization, requires a certain amount of equity to operate. The amount of required equity increases as the size of the operation increases. Increase in the size of the operation is natural, caused by things such as inflation, population growth, desired increases in services, andsomething which has impacted cities significantly in recent years-mandated increases in services and administrative requirements. A healthy financial position allows the City to avoid volatility in tax rates; helps minimize the impact of state funding changes; allows for the adequate and consistent funding of services, repairs, and unexpected costs; and can be a factor in determining the City's bond rating and resulting interest costs. -8- 1 1 t 1 1 The following graph reflects the City's General Fund reliance on its revenue sources for 2007: General Fund Revenue Property Taxes Licenses/Pernuts Intergovernmental Charges for Services Other ss' .000 000 000 000 000^ 000 000^ 000 ~ti, ss~'' ss~" ssp~' ^ Actual ^ Budget 00 0000 ~~, Total General Fund revenues for 2007 were $7,473,158, which was $351,318 (4.9 percent) over the final budget. Property taxes were less than budget by $228,241, mostly due to the MVHC received in the current year recorded in the financial report as intergovernmental revenue that is budgeted as property taxes. License and permit revenues were under budget by $255,949 due to the downturn in the housing market and economy. Franchise fees were under budget by $128,955 due to the City only being able to collect half a year of fees instead of a full year as anticipated. Charges for services exceeded budget by about $526,000, mostly due to engineering fees being about $442,000 over budget. Interest revenue was also higher than budget by $234,447. The following graph presents the City's General Fund revenue sources for the last five years. The graph reflects the City's increasing reliance on taxes and user fees to finance its General Fund operations. General Fund Revenue by Source Year Ended December 31, $5,000,000 $4,000,000 $3,000,000 $2,000,000 $1,000,000 $- 2003 2004 2005 2006 2007 ^ Taxes ^ Intergovernmental ^ Other Overall, General Fund revenues increased $564,015 (8.2 percent) from the previous year, primarily due to increases in engineering fees and increases in intergovernmental revenue of $152,991. This was mainly due to the state restoring the payment of MVHC to city governments in 2007. -9- 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 The following illustrations provide you with the components of the City's General Fund spending for 2007 and for the past five years: General Fund Expenditures General Government Public Safety Public Works Culture and Recreation O O O O O O ~ 00 00 00 00 00 00 00, ~00~ 'L00, X00, 000, X00, O Actual ^ Budget Total General Fund expenditures for 2007 were $7,271,167, which was $228,873 (3.1 percent) under the final budget. The largest variance was in public works, which was about $556,000 over budget, mainly due to capital projects being in excess of budgeted amounts by around $452,000. These costs were offset by capital projects within general government and culture and recreation being under budget by around $400,000. Planning and zoning costs were one of the other areas under budgeted amount by about $150,000, mainly due to the downturn in the number of permits being issued. General Fund Expenditures by Function Year Ended December 31, $2,400,000 $2,000,000 $1,600,000 $1,200,000 $800,000 $400,000 $- Overall, General Fund expenditures increased $752,024 (11.5 percent) from the prior year. Public works increased about $486,000, which is mostly due to an additional $662,910 of capital outlay during 2007 compared to 2006. -10- 2003 2004 2005 2006 2007 ^ General Governmental O Public Safety ^ Public Works ^ Culture and Recreation ^ Other ENTERPRISE FUNDS ' The enterprise funds comprise a considerable portion of the City's activities. The following information provides trend information on the activities of these funds. ' Water Enterprise Fund At December 31, 2007, the Water Enterprise Fund had a cash balance of $1,826,130 and net assets of $14,445,319. Net assets consisted of $12,405,223 in amounts invested in capital assets and $2,040,096 in unrestricted net assets. f Water Enterprise Fund Year Ended December 31, $1,000,000 $ 800 000 , ' $600,000 $400,000 $200,000 $- ' 2003 2004 2005 2006 O Operating Revenue ~ Operating Expense 2007 Water Enterprise Fund operating revenues for 2007 were $901,907, which were $159,761 higher than the previous year. Most of this increase was related to an increase in the water rates. As shown in the above graph, operating income before depreciation has been steadily increasing over the past several years. It is important that this fund continue to have positive operating results so as not to place additional burden on other city funds. It is also important that the City continue to monitor water rates so that they are designed to also provide for future repairs and replacement of the infrastructure assets. Operating Income (Loss) Before Depreciation -11- Sewer Enterprise Fund At December 31, 2007, the Sewer Enterprise Fund had a cash balance of $2,272,417 and net asset balance of $23,464,837. Net assets consisted of $20,970,058 invested in capital assets and $2,494,779 of unrestricted net assets. Sewer Enterprise Fund Year Ended December 31, $2,200,000 $2,000,000 $1,800,000 $1,600,000 $1,400,000 $1,200,000 $1,000,000 $800,000 $600,000 $400,000 $200,000 $- $(200,000) 2003 2004 2005 2006 2007 O Operating Revenue ~ Operating Expense Operating Income (Loss) Before Depreciation Sewer Enterprise Fund operating revenues for 2007 were $1,225,480, which is $182,272 more than the previous year. Most of this increase relates to an increase in sewer rates. Operating income before depreciation was $247,182 in 2007. ' As shown in the above graph, operating income before depreciation was a deficit in fisca12005 and 2006. ' It is important that this fund has positive operating results so as not to place additional burden on other city funds. It is also important that the City continue to monitor sewer rates so they are designed to also provide for future repairs and replacement of the infrastructure assets. -12- LIQUOR FUND The following graph presents five years of operating results for the Liquor Fund: Liquor Fund Year Ended December 31, $4,000,000 $3,500,000 $3,000,000 $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 $- The Liquor Fund ended 2007 with net assets of $2,464,958, an increase of $129,615 from the prior year. Of the net asset balance, $509,395 represents the investment in liquor capital assets, leaving $1,955,563 of unrestricted net assets. Liquor sales for 2007 were $3,769,077, about $150,000 (4.1 percent) more than last year. Sales have steadily increased over the last several years, increasing by about 12 percent since 2003. The Liquor Fund generated a gross profit of $1,002,933 in 2007, or about 26.6 percent of gross sales. The Liquor Fund gross profit margin has been similar for the last several years, ranging from 25.5 percent to 26.6 percent between 2003 and 2007. Operating expenses for 2007 were $644,857, about $28,000, or 4.5 percent, higher than last year. -13- 2003 2004 2005 2006 2007 O Sales ~ Cost of Sales ~ Operating Expenses Operating Income (Loss) GOVERNMENT-WIDE FINANCIAL STATEMENTS The City's financial statements include fund-based information that focuses on budgetary compliance, and the sufficiency of the City's current assets to finance its current liabilities. The Governmental Accounting Standards Board (GASB) Statement No. 34 reporting model also requires the inclusion of ' two government-wide financial statements designed to present a clear picture of the City as a single, unified entity. These government-wide statements provide information on the total cost of delivering services, including capital assets and long-term liabilities. Statement of Net Assets The Statement of Net Assets essentially tells you what your city owns and owes at a given point in time, the last day of the fiscal year. Theoretically, net assets represent the resources the City has leftover to use for providing services after its debts are settled. However, those resources are not always in spendable ' form, or there may be restrictions on how some of those resources can be used. Therefore, the Statement of Net Assets divides the net assets into three components: net assets invested in capital assets, net of related debt; restricted net assets; and unrestricted net assets. ' The following table presents the City's net assets as of December 31, 2007 for governmental activities and business-type activities: 1 fl 1 Governmental Business-Type Activities Activities Total Net assets Current and other assets $ 61,404,850 $ 7,037,454 $ 68,442,304 Net book value of capital assets 64,855,170 34,892,612 99,747,782 Current liabilities (4,751,872) (505,996) (5,257,868) Long-term liabilities (52,970,319) (1,011,449) (53,981,768) Total net assets $ 68,537,829 $ 40,412,621 $ 108,950,450 Net assets Invested in capital assets, net of related debt $ 12,476,536 $ 33,971,151 $ 46,447,687 Restricted 31,517,792 - 31,517,792 Unrestricted 24,543,501 6,441,470 30,984,971 Total net assets $ 68,537,829 $ 40,412,621 $ 108,950,450 The City's total net assets at December 31, 2007 were $3,803,832 higher than at the beginning of the year. -14- ~J ACCOUNTING AND AUDITING UPDATES GASB STATEMENT N0.43 -FINANCIAL REPORTING FOR POST-EMPLOYMENT BENEFIT PLANS OTHER THAN PENSION PLANS AND GASB STATEMENT N0.45 -ACCOUNTING AND FINANCIAL REPORTING BY EMPLOYERS FOR POST-EMPLOYMENT BENEFITS OTHER THAN PENSIONS These related statements provide new guidance on accounting and financial reporting ofpost-employment benefits accounted for in trust funds included in the financial statements of plan sponsors or employers, ' and employer accounting and reporting for post-employment benefits other than pensions by employers when the plan is not accounted for in their financial statements. Other post-employment benefits (OPEB) refer to non-pension benefits provided after the termination of employment. One example of this type of benefit is healthcare premiums paid by employers on behalf of former employees. Governmental entities have traditionally accounted for OPEB on apay-as-you-go basis. Only a few governments have funded these benefits in advance of payment. The guidance in these statements rests on the assumption that OPEB should be accrued as an expense as service is provided by employees. For governments offering OPEB, the cost would be recognized using athree-step approach. The government will be required to project future benefits, discount those benefits to their present value, then use an acceptable actuarial method to allocate costs to individual accounting periods. Once calculated, the difference between the present value of OPEB benefits earned by employees as the result of past service and resources set aside to pay those benefits will be considered the "unfunded actuarial liability for OPEB." Every employer will be allowed to start fresh at the time of transition to the new standard. There will be no requirement for an employer to recognize an accounting liability for under-funding prior to the implementation of the new standard. Instead, the unfunded actuarial accrued liability for OPEB at transition would be amortized over 30 years. As long as an employer funds the full amount of required contribution, no asset or liability will be reported on the Statement of Net Assets. However, an employer will need to report an asset or liability if the contributions are less or more than the annual required contribution each year. Nothing in the documents is intended to alter the normal application of modified accrual accounting in the governmental funds of the entity. Thus, OPEB expenditures normally would be recognized when payments are made to the former employees rather than when benefits are earned. The guidance will require that actuarial valuations for OPEB occur at least every two years for plans with ' 200 or more members, and every three years for plans with fewer than 200 members. A sole employer plan with fewer than 100 plan members has the option to apply a simplified alternative measurement method rather than obtain actuarial valuations. ' These statements will become effective in three phases based on the same criteria as those defined for the implementation of GASB Statement No. 34. GASB Statement No. 43 will be phased in for cities over a three-year period, which started with category one cities in the fiscal year ending December 31, 2006. GASB Statement No. 45 will be phased in over athree-year period, which started with category one cities in the fiscal year ending December 31, 2007. For most Minnesota cities, their only exposure under these statements will be the implicit rate subsidy for retirees that remain on the city's health insurance through COBRA. The Minnesota State Auditor recently issued guidance recommending that even cities with over 100 plan members consider using the simplified alternative measurement method to determine whether this liability may be immaterial. If this guidance is followed, this calculation should be done annually and should be reviewed by the city's external auditor well before year-end. If the liability based on this calculation is deemed immaterial, the city would be able avoid the cost of having an actuarial valuation of this liability. However, if the potential liability is not deemed immaterial, cities with over 100 employees in their insurance plan would still need to have an actuary calculate this liability. -15-