The statement of net position (i.e., a balance sheet) of a midsized city reports outstanding debt of $1,200,000,000. The city has a population of 800,000. The city is about to adopt the provisions of a new GASB pronouncement that changes the way defined benefit pension plans are accounted for and reported. A defined benefit pension plan promises employees a certain amount of income after they retire. The payments to the retirees are dependent on their last years' salary and the number of years that they have been employed.
Per the new rules the city will have to report on its balance sheet an additional $600,000,000 of pension liabilities. Such an amount was previously reported in the notes to the financial statements but was not accorded accounting recognition on the balance sheet itself. The new accounting rules affect only the way the pension obligation is reported; they have no effect on the actual promises made to current employees or those already retired.
1. Compute the city's per capita debt (as reported on the statement of net position) prior to the adoption of the new accounting rules.
2. Compute the city's per capita debt after the city adopts the new accounting rules.
3. In an editorial, the local newspaper wrote, "By increasing per capita debt by more 50 percent, the new rules put the city in a precarious fiscal position. Almost certainly the bond rating agencies will take notice and lower the city's bond rating, thereby causing interest rates on any new debt that the city issues to increase significantly."
a. Do you agree with the newspaper editorial that the change in accounting principles will cause the city's fiscal position to deteriorate? Explain.
b. If you were an analyst with the agency that rated the city's bonds, would the change in accounting principle cause you to lower the city's credit rating? Explain.