The City of Providence, RI: A Case Examining the Financial.

The City of Providence, RI: A Case Examining the Financial… The City of Providence, RI: A Case Examining the Financial Condition of a U.S. Municipality Christine E. Earley, Nancy Chun Feng, and Patrick T. Kelly ABSTRACT: This case is intended for use in a wide variety of learning contexts, including undergraduate and graduate government and not-for-profit accounting courses, advanced accounting courses, public policy courses, along with courses that address municipal pensions at the college or university level, or other training programs. The case achieves four primary objectives: developing proficiency in ratio analyses for a municipality, conducting research related to the financial status of a municipality, improving critical thinking and problem-solving skills, and developing an awareness of potential public interest issues facing municipal leaders. We find that students benefit from analyzing the financial condition of the City of Providence, RI and develop critical thinking skills through their analyses. Keywords: government accounting; municipality; financial distress; ratio analysis; pensions. INTRODUCTION The economic recession and financial crisis of 2008 had a dramatic impact on the financial position of government entities, particularly at the state and local levels. There are numerous articles in the popular press and media stories of clashes between state governments and their citizens, and cities and towns on the verge of bankruptcy and, in some extreme cases, going bankrupt. We have developed this case to enable students to learn firsthand about the challenges government entities face by having students perform an in-depth study and analysis of the financial condition of a medium-sized city—Providence, RI—which is currently facing significant financial challenges. Through this analysis students will deepen their understanding of governmental accounting issues and better understand the public interest complexities that occur in decision making for governmental entities. BACKGROUND City of Providence Overview The city of Providence, Rhode Island was founded in 1638 by Roger Williams, who fled religious persecution in Massachusetts and started a settlement based on religious and political freedom (GoProvidence.com 2012). Providence is a medium-sized city, ranking 134th of U.S. cities in terms of size (Citymayors.com 2013), with a population of 178,042 based on the 2010 U.S. census (United States Census Bureau 2010). Mayor Angel Taveras, the 37th mayor and first Latino mayor of Providence, began serving in January 2011 (Smith 2011). Due to its easy accessibility by water, Providence has a rich history as a major world seaport; but it has also been vulnerable to hurricanes, experiencing devastating effects from the great New England Hurricane of 1938 and Hurricane Carol in 1954. In the late 1970s the city’s infrastructure was greatly enhanced, and in the 1990s two major rivers running through the city were uncovered and moved, adding a pleasing aesthetic aspect to the city. As a result of the major improvements to the infrastructure, as well as significant building projects in the 1990s and the first decade of the 21st century, the city has experienced a cultural revival and has been successful in attracting visitors to its world-renowned restaurants and cultural events, particularly Waterfire, an event that occurs over numerous weekends in the summer and early fall. Cultural institutions include the Tony award-winning Trinity Repertory Company and Providence Performing Arts Center. Providence is also home to a number of colleges that lend an academic and innovative air to the city including Brown University, Providence College, Rhode Island College, the Rhode Island School of Design (RISD), and Johnson & Wales University (JWU). The prominence of RISD has led to growth in the Providence arts scene, and JWU’s culinary school has fueled the growth and national reputation of the Providence restaurant scene (GoProvidence.com 2012). The Providence Economy Manufacturing was the predominant industry in Providence from the 1830s until the 1980s, with the production of textiles, light metals, and jewelry being most prevalent. The textile industry saw a sharp decline in the late 1920s, as companies in the northern states faced increasing competition from those in the south, and therefore jewelry and light metal manufacturing grew to be the dominant manufacturing sectors during the middle part of the 20th century. However, after World War II, Providence saw a big decline in population and many of the large manufacturing companies left the city for the suburbs. By 1970, four of the five largest companies with a strong manufacturing presence during the industrial revolution of the 1800s had left the city, and only Gorham Silver remained. Other companies, such as Speidel, Federal Products, and Imperial Knife, were also present but were not as dominant as their earlier counterparts. During this time service industries, such as financial, educational, and health services, were beginning to overtake manufacturing as growth industries (Conley and Campbell 2012). Today, the largest companies in the city include Textron, a large manufacturing and financing conglomerate, which bought Gorham and Speidel in the late 1960s/early 1970s (Textron 2012), and GTECH, a manufacturer of lottery machines and provider of lottery and gaming solutions (GTECH Corporation 2012). Although both companies have their corporate headquarters in Providence, their manufacturing facilities are located elsewhere. Providence has been positioning itself at the forefront of the ”Knowledge Economy,” and has attempted to attract companies to the city in industries such as technology and healthcare, which focus on innovation. In keeping with this strategy, a district of the city once known as the Jewelry District, which housed the major jewelry manufacturers, has been transformed into the ”Knowledge District,” with the new location of the Brown University Medical School (Brown University 2011) and an IBM grant in 2011 of $400,000 to encourage innovation (Official Website of the City of Providence Rhode Island 2011). In 2011, Providence ranked at 110 of the top 200 largest U.S. cities for job growth according to the Milken Institute (Milken Institute 2011). Current Economic Challenges Despite the investment in infrastructure and growth of cultural opportunities during the first decade of the 21st century, Providence has faced significant challenges, many associated with the downturn in the real estate market nationwide and the financial crisis of 2008. Unemployment during the economic downturn has been higher in Providence than in other parts of the country. For example, while the national unemployment rate in 2011 was 9 percent, the unemployment rate in Providence was 11.2 percent (U. S. Department of Labor 2012). In addition, because many of the businesses in the city, such as colleges and hospitals, are not-for-profit entities and therefore not subject to property taxes, the city has had to forgo property tax revenues from these entities. The not-for-profit entities have all agreed to make payments in lieu of property taxes (known as PILOT), which when combined with state of RI, PILOT Payments total over $29 million per year (Commission to Study Tax Exempt Institutions 2010). Although this amount seems generous, a report generated by a commission of the Providence City Council estimates that if these entities paid the same tax rates as for-profit organizations, the total tax revenue would be over $82 million per year (i.e., over $53 million per year more than the PILOT payments) (Commission to Study Tax Exempt Institutions 2010). In addition, the city was dealt a blow in the failure of a new Knowledge Economy company when the 38 Studios video game company, started by Curt Schilling (former pitcher for the Boston Red Sox), defaulted on state loans and went bankrupt resulting in hundreds of lost jobs in 2012 (Stanton 2012; Kain 2012). Also in 2012, both Fitch and Moody’s downgraded the credit rating of the city of Providence, limiting the city’s ability to raise additional funds through borrowing (McGowan 2012; Thomson/Reuters 2012). CASE DESCRIPTION Assume you are a recent graduate of a business program and have been hired for a budgeting/ accounting position in the Director of Administration office for the city of Providence, RI. You are excited about this position for a variety of reasons. First, significant responsibility is associated with this position, and you will be a key individual in both the administration office and the mayor’s staff. Your specific responsibilities include working on the development of the city’s budget and financial statements, along with providing financial information to other members of the mayor’s office. Like many cities in the United States, Providence has some financial challenges involving both sources of revenues (nobody likes paying higher taxes!) and expenditures associated with city operations, including costs related to public safety (police and firefighters) and the education system. It is your first week on the job and to orient you to your new position, your supervisor has given you the following assignment. In approaching this assignment, you want to do an excellent case analysis to make a favorable first impression. REQUIREMENTS Please use the Comprehensive Annual Financial Reports (CAFRs) of the city of Providence from 2011 to 2013 (see Appendix A). More specifically, the financial statements in the CAFRs for 2011 to 2013 are on pages 12 to 22 in each year’s CAFR. For example, on pages 12-13 in all three years of reports, you will find the Statement of Net Assets and the Statement of Activities for both Government Activities and Business-type Activities. Pages 14-22 provide more specific information on Government Funds, Proprietary Funds, and Fiduciary Funds. Search for articles about the city of Providence from 2011 to the present in the library databases such as LexisNexis and popular media outlets like the Wall Street Journal. Answer the following case questions using the CAFRs and the articles that you have found. Part I A. Background Questions/General Knowledge of Accounting for Municipalities (1) Typically, which branch of the city level of government structure is responsible for managing the city’s expenditures within the budget and maintaining the accounting, budget, and financial reporting systems? What financial reports does a municipality need to prepare? What standards guide the preparation of municipal financial reports? Municipalities use the modified accrual basis of accounting. How does this differ from accrual accounting?(2) In the city of Providence, who is responsible for developing the budget? How is the budget voted on and implemented? (3) Using articles from LexisNexis or other business media, along with the Letters of Transmittal for 2011-2013 (pp. i-x for 2011 and 2012; pp. i-vii for 2013), write a brief summary of recent events that are related to the city of Providence and its financial condition. B. Preliminary Analysis of the City of Providence CAFR (4) Find the total assets, total liabilities, net assets, unrestricted net assets, total revenues, total expenses, and change in net assets of the city of Providence for 2011, 2012, and 2013. Explain the trends. (5) Calculate the current ratio and the debt ratio for 2011, 2012, and 2013. How is the city of Providence’s 2013 performance on these measures relative to 2011 and 2012? Part II: Additional Analysis of the CAFR (6) Discuss the financial performance of the city over the last three years. Pay attention to specific items from the Financial Statements that reflect the city’s performance. (7) An article by Trussel and Patrick (2009) titled ”A Predictive Model of Fiscal Distress in Local Governments” summarizes the ways to measure fiscal distress and related financial risk factors of municipalities. a. Trussel and Patrick (2009, 590) define the condition of fiscal distress ”as a local government that experiences a significant and persistent imbalance between revenues and expenditures.” Trussel and Patrick ”operationalize the definition of fiscal distress as a local government that experiences three consecutive years of operating deficits (scaled by total revenues) with a cumulative three-year operating deficit of more than 5 percent.” By reading the three-year financial statements of the city of Providence, do you think the city is experiencing fiscal distress? Explain how you derive your conclusion regarding the city’s financial condition. b. Trussel and Patrick (2009) identify risk factors or indicators of fiscal distress and use the risk factors to develop a model to predict the likelihood of fiscal distress. They use the following risk factors or indicators of fiscal distress: revenue concentration, administrative expenditures, debt usage, and entity resources. The definitions and measurements of thesefactors are listed in the following table (Trussel and Patrick 2009):Risk Factor                                   Measure                                 Expected Relation with Fiscal DistressTaxes to Revenues                       Tax Revenues                                                             +                                                         Total Revenues Inter-Governmental Revenues       Revenues from Federal and State                          +                                                           Total Revenues Administrative Cost Ratio                Administrative Expenses                                          –                                                             Total ExpensesDebt Level                                             ln(Total Liabilities)                                                    +Debt to Revenue                                   Total Liabilities                                                           +                                                                 Total Revenues Size                                                           ln (Total Assets)                                                        -Revenue Growth                                     Total Revenuest-Total Revenuestt-1                        -Total                                                          Revenuest- Calculate three risk ratios suggested by Trussel and Patrick (2009) for the city of Providence for2011, 2012, and 2013, and report your findings. Use charts or graphs to support your points.(8) City of Providence officials considered a number of ideas to mitigate the financialpressures facing the city, including reducing the education budget and instituting anincome tax for the city of Providence. Comment on these ideas.(9) The 2011-2013 Letters of Transmittal (pp. i-x for 2011 and 2012; pp. i-vii for 2013)described a number of actions taken to avoid the fiscal crisis facing the city. Given yourunderstanding of these Letters and the Financial Statements, how would you assess theeffectiveness of the actions taken in 2011 (e.g., did they improve Providence’s financialposition and permit a more sustainable fiscal approach for the city)? What are the short and long-term long-term implications of the cost-saving initiatives? Will the initiatives provide long-term solutions to the city’s problems?(10) Given your answer to Question 9, what fiscal and operational challenges does Providenceface in the next few years? What else should the city of Providence do to achieve financialand operational success?Part III: Analysis of Pension and Other Post-Employment Benefit Costs(11) Find the annual pension cost, pension contributions made, net pension obligation, andactuarial accrued liabilities of the city of Providence as reported in the 2011, 2012, and2013 CAFRs. How well does the city of Providence fund its Employees’ RetirementSystem (ERS) for 2011, 2012, and 2013? (Hint: the annual pension cost, pensioncontributions made, and net pension obligation for all three years are listed in the 2013financial statement footnotes.)(12) The city’s annual other Post-Employment Benefit (OPEB) cost is calculated based on theannual required contribution of the employer, an amount actuarially determined inaccordance with the provisions of GASB Statement 45. Find the annual OPEB cost,contributions made, and net OPEB obligations of the city of Providence for 2011, 2012,and 2013. How well does the city of Providence fund its OPEB?(13) GASB No. 68, Accounting and Financial Reporting for Pensions (GASB 2012) iseffective for fiscal years beginning after June 15, 2014. In terms of financial statementreporting, GASB No. 68, Paragraph 20, requires that a liability should be recognized forthe net pension liability. As noted in Paragraph 20, ”The net pension liability should be measured as the portion of the actuarial present value of the projected benefit payments that is attributed to past periods of employee service in conformity with the requirements of Paragraphs 22-32 (Total Pension Liability), net of the pension plan’s net position” (GASB 2012, 9). Assume this requirement existed for 2011 and 2012. While Total Assets do not change for these years, calculate the Total Liabilities, Net Assets, and Debt Ratio for the city of Providence for these two years. Explain your results. (14) A proposal was developed to reduce pensions of retirees as a cost-cutting initiative to mitigate the financial pressures that Providence is facing. Would you support this proposal? Why or why not? What other options are available to Providence to reduce its pension obligations? Are there challenges associated with these options? (15) See the Employee Retirement System Notes for 2011 and 2012 (p. 49 of the CAFR for each year). The investment rate of return is listed as 8.25 percent for each year. Do you agree 8.25 percent is an appropriate rate? What are the pension benefit obligation (PBO) implications of using a lower rate? (16) Various municipalities have been accused of undervaluing pension benefit obligations. Why is this a problem for those municipalities? How does this impact the decision making of city managers? Current or potential city employees?  REFERENCE Brown University. 2011. Brown and Providence: Alpert Medical School’s Contributions to the RI Knowledge Economy. Available at: http://brown.edu/web/providence/med-knowledge-economy.html Citymayors.com. 2013. City Mayor Statistics: The Largest U.S. Cities. Available at: http://www. citymayors.com/gratis/uscities_200.html Commission to Study Tax Exempt Institutions. 2010. A Call to Build the Capital City Partnership for Economic Growth. Providence, RI: Providence City Council. Conley, P. T., and P. R. Campbell. 2012. History of the City: 375 Years at a Glance. Available at: http:// www.providenceri.com/archives/history/city-history GoProvidence.com. 2012. Providence History. Available at: http://www.goprovidence.com/things-to-do/ history-facts/ Governmental Accounting Standards Board (GASB). 2012. Accounting and Financial Reporting for Pensions. Statement No. 68 of the Governmental Accounting Standards Board Available at: http:// www.gasb.org/resources/ccurl/988/315/GASBS%2068.pdf GTECH Corporation. 2012. About GTECH. Available at: http://www.gtech.com/about-us Kain, E. 2012. Curt Schilling: 38 Studios Employees Were ”Blindsided.” Available at: http://www.forbes. com/sites/erikkain/2012/06/22/curt-schilling-38-studios-employees-were-blindsided/ McGowan, D. 2012. New: Providence Credit Rating Downgraded Three Notches. Available at: http://www. golocalprov.com/news/new-providences-credit-downgraded-three-notches/ Milken Institute. 2011. 2011 Best Performing Cities: 200 Largest Metros. Available at: http://bestcities. milkeninstitute.org/ Official Website of the City of Providence, Rhode Island. 2011. Smarter Cities Grant to Help Providence Develop Computerized Land Management System in Jewelry District. Available at: https://www. providenceri.com/mayor/smarter-cities-grant-to-help-providence-develop Smith, M.R. 2011. New Providence Mayor Angel Taveras Sworn In. Available at: http://www.boston.com/ news/local/rhode_island/articles/2010/11/02/taveras_elected_first_hispanic_providence_mayor/ Stanton, M. 2012. Schilling’s 38 Studios Declares Bankruptcy: Law Enforcement Investigating. Available at: http://news.providencejournal.com/breaking-news/2012/06/38-studios-decl.html Textron. 2012. Company History. Available at: http://www.textron.com/about/company/history.php Thomson/Rueters. 2012. Moody’s Downgrades Debt of Providence, R.I. Available at: http://www. moneynews.com/FinanceNews/moodys-downgrade-providence-rhodeisland/2012/03/26/id/433921 Trussel, J. M., and A. P. Patrick. 2009. A predictive model of fiscal distress in local governments. Journal of Public Budgeting, Accounting & Financial Management 21 (4): 578-616. United States Census Bureau. 2010. Providence Rhode Island Quick Facts. Available at: http://quickfacts. census.gov/qfd/states/44/4459000.html U.S. Department of Labor: Bureau of Labor Statistics. 2012. Table of Local Area Unemployment Statistics: Providence-Fall River-Warwick RI-MA Metropolitan Area. Available at: http://www.bls.gov/eag/eag. ri_providence_mn.htm (last accessed on March 12, 2015).  APPENDIX A The financial statements are used with the permission of the City of Providence, RI. CAFR_2011: file:///C:/Users/wakin/Downloads/CAFR%20Year%20ended%2006.30.2011%20City%20of%20Providence.pdfCAFR_2012: file:///C:/Users/wakin/Downloads/CAFR%20Year%20ended%2006.30.2012%20City%20of%20Providence.pdf CAFR_2013:file:///C:/Users/wakin/Downloads/CAFR%20Year%20ended%2006.30.2013%20City%20of%20Providence%20(1).pdf Issues in Accounting Education Volume 30, No. 2, 2015 CBusiness Accounting ACCT 625

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