Avoiding Paralysis on the Management’s Discussion and Analysis

October 8, 2019 | Article

By Brad Theisen, CPA

Management’s Discussion and Analysis (MD&A) is meant to be a thought-provoking document which describes the changes from prior year, along with certain explanations of increases and decreases in account balances. However, most often the MD&A is simply rolled forward from prior year’s financial statement and updated with new account balances and fluctuations. Many reporters miss the opportunity to describe in a thought provoking way the analysis of the government since they have exhausted much of their time and resources developing the basic financial statements.

What the MD&A Should Tell You
The most common piece missing is the explanation of “why.” Why did the increase or decrease happen? Why are the elements of the basic financial statements important? This issue—the MD&A’s lack of explanation of the underlying reasons for significant changes in fund balances and fund net position from year to year—is one of the more common comments in the Government Finance Officer’s Association’s (GFOA) Certificate of Achievement for Excellence in Financial Reporting program. Instead, preparers tend to provide only balances and transactions for the current and preceding year.

The MD&A component of the financial statement can help readers understand, analyze and compare financial statement information. This information allows the user to assess whether a government is “better off” from one year to the next, especially if the financial statements are not presented in comparative format. For example, a government would want to explain why expenditures relating to debt service increased or decreased to allow the user of the financial statement to judge whether such an increase or decrease appears reasonable in relation to their expectations. If comparative financial information is presented, up to three years of information should be included in the MD&A providing further analysis.

How the New 2018 Yellow Book Impacts Your Audit
The Governmental Accountability Office has released a new version of the Yellow Book, and there are some key changes you should be aware of ahead of your next audit.

Required Components of the MD&A
Additional GFOA findings relate to completing the required elements of MD&A. Preparers, sometimes due to the urgency of a deadline, have skipped out on certain mandatory sections of the MD&A. The required elements of the MD&A are expressed in GASB Codification Section 2200.109 and include:

  1. A discussion of the basic financial statements, including their relationship to each other
  2. Condensed financial information derived from the government wide financials
  3. An analysis of the government’s overall financial position and results of operations to assist users in determining whether financial position has improved or deteriorated
  4. An analysis of significant major fund activity
  5. Significant budget versus actual variations of the general fund
  6. Description of significant capital asset and long-term debt activity
  7. A discussion of the use of the modified approach to infrastructure (if applicable)
  8. Description of currently known facts, decisions, or conditions that are expected to have a significant effect on financial position.

Definition of Currently Known Facts
The last element is another common GFOA finding—the lack of discussion of currently known facts, decisions, or conditions expected to have a significant effect on financial position. Some governments have made the misconception of addressing items of speculation within this portion. However, governments are limited to discussing known events or decisions. “Known” in the standards indicate that the event has actually occurred prior to the issuance of the financial statements. Therefore, governments should only reveal information relating to currently known facts, decisions, or conditions as of the date of the Independent Auditor’s Report. The transmittal letter would be a better destination for any type of speculative information.

Readability and the MD&A
Other common concerns include readability. The MD&A is supposed to be written from the point of view of a knowledgeable user of the financial statements.  A best practice for preparers is to have someone not involved with the financial reporting process to read the draft of the MD&A prior to sending to the auditors.  For example, a school district may have a teacher that can read the MD&A and provide feedback with minimal effort.

Why the MD&A is Important
The Governmental Accounting Standards Board (GASB) has purposefully included MD&A as a required supplementary information due to its significance to the basic financial statements and to ensure the reader has sufficient operational, economic, and historical context. Use of charts and graphs to depict changes from year to year is highly encouraged and can help explain trends to users of the financial statements.

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