Proper determination and reporting of component units is essential for complete and accurate financial reporting. However, complexity in this area poses a challenge to governments in identifying and assessing the component units and the correct presentation. This article provides an overview of the accounting standards defining the financial reporting entity, the types of component units and criteria for each, and financial reporting requirements for component units to assist with this process.
Note – The authoritative guidance presented herein for component unit determination and reporting requirements is found in GASB Codification Section 2100, Defining the Financial Reporting Entity, and Section 2600, Reporting Entity and Component Unit Presentation and Disclosure.
Background
Government entities come in all shapes and sizes and provide a variety of public services. The proliferation of government entities over time has resulted in many relationships with related but legally separate organizations. Robust financial reporting that upholds the tenet of accountability requires certain separate organizations be included with others if certain conditions are present.
Integral to financial reporting is the proper identification and presentation of government entities that meet the definition of a primary government or a component unit.
Primary Government
A single government with an elected governing body is referred to as a primary government. A primary government is any state government or general-purpose local government (such as a city or county). Another type of government (referred to as a special-purpose government) may also be considered a primary government if it meets all the following criteria[1]:
| Criteria | Definition |
| Separately elected governing body | Governing body separately elected by citizens in a general election (as opposed to being appointed or elected by a governing body)[2] |
| Legally separate | Organization created as a body corporate and politic, or otherwise possesses the corporate powers that would distinguish it as being legally separate from the primary government (such as the capacity to have a name, the right to sue or be sued individually without recourse to another government unit, right to buy, sell, lease, or mortgage property in its own name)[3] |
| Fiscally independent | Authority to do all the following without substantive approval[4] by a primary government:
Ø Determine its budget Ø Levy taxes, set rates or charges Ø Issue bonded debt[5] |
Question – Is the requirement for a state agency to review a government’s bond offering for compliance with state laws concerning debt service coverage an example of substantive approval that would indicate the government is not fiscally independent?
Answer – No, the requirement is compliance oriented in nature and alone does not suggest the government lacks the authority to issue debt without approval by another government.
Component Units
A special-purpose government that is not a legally separate organization is reported as part of the government entity that has legal authority over it. A legally separate organization that does not meet the other criteria required for a primary government may be a potential component unit. Whether the legally separate organization is a component unit hinges on whether there is another government that has financial accountability over the organization.
Financial Accountability
Financial accountability arises when a primary government has the power to appoint a simple majority of a potential component unit’s governing board[6] [7] in combination with either the (1) ability to impose its will[8] on that potential component unit or (2) if the potential component unit provides specific financial benefits[9] to or imposes specific financial burdens[10] on the primary government. Financial accountability may also arise if the potential component unit is fiscally dependent upon the primary government and the potential component unit provides specific financial benefits to or imposes specific financial burdens on the primary government. There is one other situation where a primary government is financially accountable for a legally separate organization: if the primary government holds a majority equity interest in a legally separate organization that does not meet the definition of an investment.[11]
The following table summarizes the potential criteria and the possible combinations necessary to establish financial accountability:
| Criteria 1 | Criteria 2 |
| Fiscal dependence | Financial benefit or burden relationship |
| Power to appoint voting majority of board | Financial benefit or burden relationship |
| Power to appoint voting majority of board | Ability to impose will |
| Majority equity interest | Does not meet the definition of an investment |
Component Units Where the Primary Government is Not Financially Accountable
While financial accountability between a primary government and a legally separate organization is integral to a component unit relationship, it is possible for a legally separate organization for which the primary government is not financially accountable to be presented as a component unit if the nature and significance of the relationship is such that exclusion would cause the reporting entity’s financial statement to be misleading under the misleading the exclude criteria.
A legally separate, tax-exempt organization should be reported as a component unit if all the following criteria are met:
Misleading to Exclude
A legally separate organization not meeting the required criteria of a component unit should still be reported as a component unit if exclusion would cause the financial statements to be misleading. Whether the exclusion of a potential component unit would cause the financial statements to be misleading is a matter of professional judgment. Consideration should be given to the nature and significance of the relationship between the primary government and potential component unit.[13] Organizations that are closely related to or financially integrated with the primary government should be evaluated.[14]
Component Unit Reporting
Financial statements of the reporting entity should provide an overview of the entity yet allow users to distinguish between the primary government and its component units. An organization that is a component unit of a financial reporting entity may have component units of its own. The component unit financial data that are incorporated into a reporting entity’s financial statements should include the data from all its component units. In effect, the provisions of GASB Cod. Sec. 2100 should be applied in layers “from the bottom up.” At each layer, the definition and display provisions should be applied before the layer is included in the financial statements of the next level of the reporting government.[15]
Presentation
Component units that are not fiduciary in nature are presented either discretely or are blended as though they are part of the primary government. As such, non-fiduciary component units are referred to as either discretely presented or blended component units. A component unit is typically discretely presented unless it meets a combination of specific criteria for blending. There are five scenarios that result in a component unit being presented as blended.[16]
| Scenario | Criteria present |
| 1 | The component unit’s governing body is substantially the same as the governing body of the primary government and a financial benefit or burden relationship between the component unit and primary government exists. |
| 2 | The component unit’s governing body is substantially the same as the governing body of the primary government and management of the primary government has operational responsibility[17] for the component unit. |
| 3 | The component unit provides services entirely or almost entirely to the primary government or otherwise exclusively, or almost exclusively, benefits the primary government. |
| 4 | The component unit’s total debt outstanding, including leases, is expected to be repaid entirely or almost entirely with resources of the primary government. |
| 5 | The component unit is a not-for-profit corporation in which the primary government is the sole corporate member. |
The blending of component units results in the financial data of a component unit being presented in a manner similar to the balances and transactions of the primary government. As such, the funds of a blended component unit are presented as funds of the primary government except for a blended component unit’s general fund, which is reclassified as a special revenue fund in the primary government’s financial statements. Proprietary-type entities (for example, hospitals and utilities) that only present a single column in their financial statements with blended component units are allowed to consolidate the blended component unit balances with accompanying note disclosures presenting the amounts blended.[18]
Discretely presented component unit information is presented as separate columns and rows on the face of the financial statements. Individual discretely presented component units should be classified as either major or nonmajor. Whether a discrete component unit is major is based on the nature and significance of its relationship to the primary government.[19] Major discretely presented component units should be reported as separate columns and rows on the statements of net position and activities or may be combined and reported as a single column or row on the face of the financial statements, with either a combining statement of major components units reported in the basic financial statements after the fund financial statement, or condensed financial statements presented in the notes to the financial statements. Nonmajor component units should be aggregated and presented in a single column. Whether a combining statement of nonmajor component units is included is optional. If presented, it should be presented as supplementary information.
A fiduciary component unit, when reported in the fiduciary fund financial statements of a primary government, should combine its information with its own component units that are fiduciary component units and aggregate that combined information with the primary government’s fiduciary funds.[20]
Question – Should a primary government report the component units of a component unit as their own?
Answer – No. A component unit of a financial reporting entity may have its own component units. While a component unit’s financial data incorporated into the financial reporting entity’s financial statements should include data from all its component units, the definition and display provisions apply from the financial reporting entity’s point of view and do not look through to a lower level.
For example, consider a county (primary government) reporting a discretely presented component unit (county hospital). The county hospital also has a component unit (medical center). The county would include the medical center’s financial data in its financial statements as part of the county hospital but would not report the medical center as a component unit.
Challenges In Identifying Potential Component Units
Identifying potential components units can be difficult. Relationships between organizations may lack transparency. What is written in terms of documentation may be ambiguous and open to interpretation. Moreover, relationships between organizations are dynamic and susceptible to change.
The following are some of the more common developments that can change relationships between organizations:
Question – Once a component unit, always a component, correct?
Answer – Incorrect. The criteria presently requiring a legally separate organization to be presented as a component unit can change. Governments must remain cognizant of potential changes in relationships between organizations and re-assess when necessary.
Tips For Ensuring Complete and Accurate Component Unit Presentation
Governments should view the completeness and accuracy of component unit presentation in their financial statements as an integral part of financial reporting. To accomplish this, governments should ensure processes and controls over component unit presentation are properly designed and operating effectively. This consists of, but is not limited to:
Written by Sam Thompson. Copyright © 2023 BDO USA, P.C. All rights reserved. www.bdo.com
[1] GASB Cod. Sec. 2100.112
[2] GASB Cod. Sec. 2100.112
[3] GASB Cod. Sec. 2100.114
[4] When assessing fiscal independence, only the requirement for substantive approval by another government, as opposed to ministerial or compliance approvals, is relevant for determining fiscal independence. Ministerial or compliance approvals, which are akin to general oversight in nature, are common and alone do not prevent fiscal independence.
[5] GASB Cod. Sec. 2100.115
[6] If financial decisions require the approval of more than a simple majority, the primary government is not accountable for the organization
[7] A primary government’s appointment authority should be substantive.
A primary government’s appointments cannot be considered substantive if there are limitations or restrictions over their ability to independently select and appoint board officials (e.g., by restricting the potential appointees to individuals from a pool of pre-determined candidates)
[8] The ability to significantly influence the programs, projects, activities, or levels of services performed or provided by an organization
[9] Legal entitlement to, or the ability to otherwise access, the resources of an organization
[10] An obligation, legal or otherwise, to finance the deficits of, or provide financial support to, an organization; an obligation in some manner for the debt of an organization; or an obligation, legal or otherwise, to make contributions to an organization that is a defined benefit pension plan that is administered through a trust that meets the criteria in paragraph .101 of GASB Codification Section Pe5 or a defined benefit OPEB plan that is administered through a trust that meets the criteria in paragraph .101 of Section Po50
[11] GASB Cod. Sec. 2100.120
[12] GASB Cod. Sec. 2100.142
[13] GASB Cod. Sec. 2100.140
[14] GASB Cod. Sec. 2100.143
[15] GASB Cod. Sec. 2100.100d
[16] GASB Cod. Sec. 2600.113
[17] Management of a primary government has operational responsibility for a component unit if it manages the activities of the component unit in essentially the same way it manages its own programs, department, or agencies (GASB Cod. Sec. 2600.113a)
[18] GASB Cod. Sec. 2600.115
[19] A component unit is considered major if (a) the services provided by the component unit to the citizenry are such that separate reporting as a major component unit is considered essential to the financial statement users, (b) there are significant transactions with the primary government, (c) there is a significant financial benefit or burden relationship with the primary government (GASB Cod. Sec. 2600.108)
[20] GASB Cod. Sec. 2100.145