Accounting for tobacco settlement revenues.(The Accounting Angle)

In April 2004, the Governmental Accounting Standards Board for the first time promulgated guidance on how state and local governments ought to account for their claim to future payments arising from the settlement between the states and the nation's largest tobacco companies. The new guidance must be implemented in the financial statements for fiscal yearn ending after June 15, 2004. Earlier application is encouraged. This article briefly summarizes the new guidance.

BACKGROUND

In 1998, most states and territories, as well as the District of Columbia, arrived at a legal settlement with the tobacco companies. Under the terms of the Master Settlement Agreement, the "settling governments" agreed to forego all current and future legal claims against the participating tobacco companies in return for a claim in perpetuity to a portion of future revenues from tobacco sales. The amount remitted each year by the tobacco companies is determined using a formula that relates directly to domestic shipments of cigarettes. In two cases--New York and California--state governments participating in the Master Settlement Agreement subsequently agreed to share part of their future tobacco-related revenues with counties and major cities.

Rather than wait for future tobacco-related revenues to materialize, a number of governments have sought immediate access to at least some of these resources by persuading investors to purchase at a discount bonds secured by anticipated future collections. Typically, a legally separate financing authority is created for the express purpose of issuing this debt. The financing authority uses the bond proceeds it receives to "purchase" a portion of the settling government's claim to future tobacco settlement revenues. Amounts later remitted by the tobacco companies to the authority are then used to pay bondholders. Amounts collected by the authority in excess of debt service requirements and administrative costs ultimately belong to the settling government rather than to the authority.

GASB Technical Bulletin 2004-1, Tobacco Settlement Recognition and Financial Reporting Entity Issues, provides guidance on several important aspects of the accounting to be used for the events just described.

FINANCIAL REPORTING ENTITY

A financing authority created to issue tobacco-related debt is legally separate from the settling government that created it. Because such an authority does not constitute a general-purpose government and is not governed by a board chosen by voters in a general election, it does not qualify as a primary government in its own right. Rather, it needs to be considered as a potential component unit of the settling government.