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C H A P T E R 1

The Government andNot-for-Profit Environment

CHAPTER HIGHLIGHTS

� How governments and not-for-profits differ from businesses and how the differences affectfinancial reporting

� The objectives, uses, and users of financial reports� How differences in accounting principles may affect users’ decisions� The roles of the GASB and the FASB in financial reporting

Virtually all decisions and events that affect governments and not-for-profit organizationshave financial ramifications and are thereby captured in the entities’ budgets or financial

statements. Government and not-for-profit budgeting, accounting, and reporting are nec-essarily complex. The financial impact of decisions and events can be measured and reportedin any number of ways. So too can the financial position of an entity at a particular point intime. As a consequence, all individuals involved with government and not-for-profit entitiesin a decision-making capacity should have a grasp of the fundamentals of budgeting andaccounting. If they do not, they are at the mercy of those who do. The objective of this text isto provide that basic understanding.

Chapters 3 through 11 of this book focus on state and local governments, including publiccolleges, universities, hospitals, and museums, as well as general-purpose governments.Chapters 12 and 13 discuss not-for-profits, such as private colleges, universities, hospitals,museums, and charities. Chapters 2, 14, and 15 address both governments and not-for-profits.This chapter sets the stage for later chapters bydiscussinghowgovernments andnot-for-profitsdiffer frombusinesses andwhy they require unique accountingprinciples andpractices.Wealsoidentify the users of government and not-for-profit financial reports, their information needs,and the resultant objectives of financial reporting. The final section spotlights the Govern-mental Accounting Standards Board (GASB) and the Financial Accounting StandardsBoard (FASB). The GASB sets the accounting and financial reporting standards for state andlocal governments, whereas the FASB is the standard-setter for all other entities except thefederal government. Federal accounting standards are set by the Federal Accounting Stan-dards Advisory Board (FASAB) and are beyond the scope of this text.

HOW DO GOVERNMENTS AND NOT-FOR-PROFITSCOMPARE WITH BUSINESSES?.............................................................................................................

Governments and not-for-profits provide services that are targeted to groups of constituentswho advocate a political or social cause or who carry out research or other activities for the

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betterment of society. The objectives of governments and not-for-profits cannot gener-ally be expressed in dollars and cents and are often ambiguous. Moreover, governmentsand not-for-profits have relationships—and relationships that are unlike those had bybusinesses—with the parties providing their resources.

DIFFERENT MISSIONS A key objective of financial reporting is to provide informationabout an entity’s performance. The main objective of a typical business is to earn a profit.Financial statements that key on net income are in harmony with that objective because netincome is a measure of how well a business achieved its goals. Businesses also may seek topromote the welfare of their executives and employees and improve their surroundingcommunities. But business accounting and reporting are concerned almost exclusivelywith the goal of maximizing profits or cash flows.

The financial reports of governments and not-for-profits also can provide informationabout inflows (revenues) and outflows (expenditures) of cash and other resources. A continu-ing excess of expenditures over revenues generally signals financial distress or poor manage-rial performance. However, an excess of revenues over expenditures is not necessarilycommendable. It may be achieved, for example, by reducing services, something that maybe at odds with the entity’s objectives.

To report properly on their accomplishments, governments and not-for-profits mustaugment their financial statements with nonfinancial data relating to their objectives. Aschool, for example, might include statistics on student test scores or graduation rates. Acenter for the homeless might present data on the number of people fed or adequately housed.

BUDGETS, NOT THE MARKETPLACE, GOVERN Governments and not-for-profits aregoverned mainly by their budgets, not by the marketplace. Revenues and expendituresare controlled or strongly influenced through the budgetary process. A government’srevenues may be determined by legislative fiat, so that the government may not be subjectto the forces of competition faced by businesses. A not-for-profit’s revenues are notestablished by legal mandate but may be obtained from contributions, dues, tuition, oruser charges, none of which are comparable to the sales of a business.

EXPENDITURES MAY DRIVE REVENUES Governments and many not-for-profits establishthe level of services they provide, calculate costs, and then set tax rates and fees to generate thenecessary revenues. In sum, expenditures may drive revenues. These organizations cannot,however, simply raise revenues without regard to their services or increase taxes without limit.Governments may be constrained by political forces. Universities may have to keep tuitionrates close to those of peer schools. Furthermore, some not-for-profits, such as the UnitedWay or organizations that fund medical research, base their expenditures exclusively on theirrevenues. The more funds they raise, the more they spend.

PREEMINENCE OF THE BUDGET, NOT THE ANNUAL REPORT For businesses, the annualreport is the most significant financial document. An announcement of annual earnings (thepreview of the annual report) may make front-page news. By contrast, the annual budget is aninternal document that is seldom made available to investors or to the general public.

A government or not-for-profit’s release of its annual report is customarily ignored. Itseldom contains surprises; if revenues and expenditures were markedly different from theinitial budget, the entity probably was required to amend the budget during the year. Bycontrast, the budget takes center stage, because it is the culmination of the political process. Itencapsulates almost all of the organization’s important decisions. It determines whichconstituents give to the entity and which receive, which activities are supported and whichare assessed. As a result, the budget is a source of constituent concern and controversy.Government budget hearings often draw standing room–only crowds. Church and synagoguebudget debates are frequently marked by more intense fervor than worship services.

2 CHAPTER 1 / THE GOVERNMENT AND NOT-FOR-PROFIT ENVIRONMENT

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A government’s budget may be backed by the force of law and should not be taken lightly.Government officials are ordinarily prohibited from overspending and can even go to jail forsevere violations of budgetary mandates.

IMPORTANCE OF BUDGETS IN ACCOUNTING AND FINANCIAL REPORTING Constitu-ents want assurance that spending has not exceeded authorized amounts and that revenue andexpenditure estimates are reliable. The accounting system and resulting financial reportsmust be designed to provide that information. Managers need an accounting system thatinforms themwhether they are on target to meet budget projections and, evenmore critically,a system that prevents overspending or warns that it is about to occur. The budget is a controldevice, but it needs a complementary accounting and reporting system.

Auditors and other evaluators need a basis for assessing an organization’s performance.State-of-the-art budgets establish that basis by indicating how much will be spent on aparticular activity and what the activity will achieve. A post-period assessment can focus onwhether the entity has met its revenue and expenditure projections and whether it hasachieved expectations. Evaluators can assess organizational efficiency and effectivenessby comparing inputs (such as dollar expenditures) with outputs and outcomes (results).The accounting system should be designed to facilitate these comparisons, ensuring that theorganization reports and categorizes revenues and expenditures that are consistent withthe budget. Currently, few organizations have budgetary and accounting systems thatmeasureand report adequately on nonmonetary performance. However, both standard-settingauthorities—the GASB and the FASB—have recognized the importance of performancemeasures and are taking steps to ensure that they will eventually be provided routinely.

NEED TO ENSURE INTERPERIOD EQUITY Most governments are required by law, andmost not-for-profits are expected by policy, to balance their operating budgets. This ensuresthat, in any period, revenues cover expenditures and that the entity’s constituents, as a group,pay for what they receive. If organizations borrow to cover operating deficits, the cost ofbenefits enjoyed by today’s citizens must be borne by tomorrow’s citizens.

The concept that constituents should pay for the services they receive and should notshift the burden to their children has traditionally been labeled intergenerational equity. Inrecent years, the term interperiod equity has been accepted as more appropriate, toemphasize that entities should not transfer costs even to future years, let alone to futuregenerations. The accounting systems of governments and not-for-profits must provideinformation about whether interperiod equity is being maintained. Table 1-1 comparesfiscal practices that promote interperiod equity with those that do not.

The concept of interperiod equity applies only to borrowing for operating, not capital,expenditures. A government-constructed highway or university-purchased lab equipmentproduces benefits over more than one year. It is only fair to incorporate related debt servicecosts into the taxes or tuition charges of the citizens or students who receive the benefits.

REVENUES NOT INDICATIVE OF DEMAND FOR GOODS OR SERVICES For competitivebusinesses, and if prices are held constant, the greater the revenues are, the greater thedemand is—an indication that the entity is meeting a societal need. For governments andnot-for-profits, revenues may not be linked to constituent demand or satisfaction. An increasein tax revenues, for example, tells nothing about the amount or quality of services provided.Therefore, a conventional statement of revenues and expenditures cannot supply informationabout the demand for services. Supplementary information is required.

NO DIRECT LINK BETWEEN REVENUES AND EXPENSES Furthermore, government andnot-for-profit revenues may not be related to expenditures. Donations to a not-for-profit mayincrease from one year to the next without a corresponding increase in the quantity, quality,

HOW DO GOVERNMENTS AND NOT-FOR-PROFITS COMPARE WITH BUSINESSES? 3

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or cost of the services provided. Thus, thematching concept—business accounting’s centralnotion that expenditures must be paired with corresponding revenues—may have a differentmeaning for governments and not-for-profits than for businesses. Businesses attempt tomatch the costs of specific goods or services with the revenues they generate. Governmentsand not-for-profits can sometimes associate only overall revenues with the broad categories ofexpenditures they are intended to cover.

DIFFERENT ROLE FOR CAPITAL ASSETS Unlike businesses, governments and not-for-profits make significant investments in assets that neither produce revenues nor reduceexpenditures. Therefore, conventional business practices for valuing assets, such as compar-ing the present values of the asset’s expected cash outflows and inflows, may not apply togovernments and not-for-profits. A highway being considered by a government will not yieldcash benefits—at least not directly to the government. A proposed college library may enrichthe community’s intellectual life, but not the college’s coffers. In fact, some government andnot-for-profit ‘‘assets’’ may be more properly interpreted as liabilities, because maintainingthem consumes rather than provides resources.

RESOURCES MAY BE RESTRICTED In contrast to business resources, many governmentand not-for-profit assets are restricted for particular activities or purposes. For example, if thefederal government gives a local government a grant for construction of low-income housing,the award can be used only for that purpose, no matter how worthy other purposes may be.

Taxes and membership dues may also be restricted. A city’s hotel tax may be dedicated tofinancing a local convention center. A cemetery association may have to set aside part of itsfees for land acquisition. Governments and not-for-profits must assure the parties thatprovided restricted funds that they are used properly. Financial reports must show that the

T A B L E 1 - 1Fiscal Practices That Promote or Undermine Interperiod Equity

Promote Undermine

1. Setting aside resources for employee pensionsduring the year in which the employees providetheir services.

2. Issuing conventional 30-year bonds to finance thepurchase of a new building that is expected tohave a useful life of 30 years; repaying the bonds,along with appropriate amounts of interest, overthe 30-year period.

3. Paying the current-year costs of an administrativestaff out of current operating funds.

4. Charging payments of wages and salaries made inthe first week of the current fiscal year to theprevious fiscal year, that in which the employeesactually provided their services.

5. Charging the cost of supplies as expenditures inthe year in which they were used rather thanwhen they were purchased

6. Recognizing interest on investments in the yearin which it is earned, irrespective of when it isreceived.

7. Setting aside funds each year to pay for an antici-pated 20-year renovation of a college dormitory.

1. Paying the pensions of retired employees out ofcurrent operating funds.

2. Financing the purchase of the new building with30-year zero-coupon bonds that permit the entireamount of principal and interest to be paid uponthematurity of the bonds; making no provision toset aside resources for payment of principal andinterest on the bonds until the year they mature.

3. Issuing 30-year bonds to finance the current-yearoperating costs of an administrative staff.

4. Charging wages and salaries applicable to ser-vices provided in the last week of the currentfiscal year to the following fiscal year, that inwhich the payments were made.

5. Charging the cost of supplies as expenditures inthe year they were purchased, irrespective of theyear in which they were used.

6. Recognizing interest in the year in which it isreceived, irrespective of when it is earned.

7. Paying for an anticipated 20-year renovation of acollege dormitory out of current funds in the yearin which the work is performed.


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restricted resources are unavailable for other purposes. Therefore, the financial statementsmust either segregate restricted from unrestricted resources or disclose by other means thatsome resources can be used only for specific purposes.

Slip-ups regarding restrictions carry serious consequences. At the very least they maycause the organization to forfeit past and future awards. The organization must design itsaccounting system so that management cannot inadvertently misspend restricted resources.To this end, governments and not-for-profits employ a system of accounting known as fundaccounting. It is described in Chapter 2.

NO DISTINCT OWNERSHIP INTERESTS Unlike businesses, governments and not-for-profits typically cannot be sold or transferred. If they are dissolved, there are no stockholdersentitled to receive residual resources. Thus, their financial statements must be prepared forparties other than stockholders. Themain groups of statement users are identified later in thischapter. The lack of ownership interests implies that, unless the entire entity is closed and itsassets liquidated, there may be little interest in the market values of its resources. Govern-ments typically cannot sell their highways and sewers. Museums may be required to use theproceeds from selling collection items to acquire similar assets.

LESS DISTINCTION BETWEEN INTERNAL AND EXTERNAL ACCOUNTING AND REPOR-TING The line between external and internal accounting and reporting is less clear-cut forgovernments and not-for-profits than for businesses. First, although the external reports ofbusinesses focus on profits, few organizational units are profit centers in which managementcontrols all the key factors that affect profits. Therefore, internal reports present data onother measures of performance, such as total fixed costs (those that do not vary by levels ofoutput) or per-unit variable costs. For governments and not-for-profits, profit is not anappropriate performance measure for either external parties or internal departments. Therelevant performance measures must stem from the organizations’ unique goals and objec-tives and are unlikely to be the same for all user groups.

Second, in business the budget is only an internal document. In governments andnot-for-profits, the budget is the key fiscal document and is as important to taxpayers,bondholders, and other constituencies as it is to managers.

Third, the distinction between internal and external parties is more ambiguous ingovernments and not-for-profits than in business. Taxpayers and organizational memberscannot be neatly categorized as either ‘‘insiders’’ or ‘‘outsiders.’’ They are not paid managers(and, thus, not traditional insiders), but they may nevertheless have the ultimate say as toorganizational policies through direct vote or elected officers.

WHAT OTHER CHARACTERISTICS OF GOVERNMENTSAND NOT-FOR-PROFITS HAVE ACCOUNTING IMPLICATIONS?.............................................................................................................

Several other characteristics of governments and not-for-profits may not distinguish themfrom businesses but have significant accounting and reporting implications.

MANY DIFFERENT TYPES OF GOVERNMENTS AND NOT-FOR-PROFITS Per the 2007Census of Governments, there were 89,527 governments in the United States. If that numberseems surprisingly large, consider how many separate governments have jurisdiction over atypical neighborhood. The neighborhood may be part of a town, and several towns may forma township. The township may be part of a county, which may be a subdivision of a state.Furthermore, the neighborhood school, hospital, water supply, and bus system may beadministered by, respectively, an independent school district, a hospital district, a utility

WHAT OTHER CHARACTERISTICS HAVE ACCOUNTING IMPLICATIONS? 5

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authority, and a transportation authority. There might also be a community college districtand an airport authority. Each category of government probably differs from others in theservices it provides, the types of assets it controls, its taxing and borrowing authority, and theparties to which it is accountable. Even governments in the same category may providedifferent services. For example, New York and Dallas are among the nation’s 10 largest cities.But New York operates its own school system, whereas Dallas’s schools are under the controlof an independent school district.

There are also over a million not-for-profit organizations offering a wide range ofservices. They are sometimes referred to as the independent sector. Not-for-profits includeschools; hospitals; social service organizations; advocacy groups; civic, social, and fraternalorganizations; religious and cultural organizations; and foundations.

The diversity of governments and not-for-profits makes it difficult to have a commonaccounting model (set of accounting and reporting principles) that is suitable for all govern-ments and not-for-profits—or even for any particular type of entity. Assuming that compa-rability among entities is a desirable characteristic of financial reporting, standard-settingauthorities (the GASB and the FASB) face a policy question. Should they adopt commonstandards for all governments and not-for-profits or only for entities of the same type?Whenentities are similar, common standards may promote comparability. When entities are notsimilar, common standards may, like ill-fitting clothes, distort reality. As discussed insucceeding chapters, the GASB and the FASB are heading in the direction of one set ofcommon principles for all state and local governments and another set for all nongovernmentnot-for-profits.

GOVERNMENTS AND NOT-FOR-PROFITS ENGAGE IN BUSINESS-TYPE ACTIVITIESMany governments and not-for-profits engage in business-type activities. Cities, for example,may operate utilities, trash collection services, and golf courses. Universities operate bookstores and cafeterias. Environmental organizations publish and sell magazines. These enter-prises may, and perhaps should, be managed as though profits were a major objective. If so,their managers and constituents need the same type of financial information as businessoperators and owners. The appropriate accounting and reporting practices may differ fromthose suitable for nonbusiness activities. Thus, the challenge of developing accounting andreporting principles for governments and not-for-profits is made more formidable by thepotential need for more than one set of standards—even for a single organization.

DIFFERENCES BETWEEN GOVERNMENTS AND NOT-FOR-PROFITS In addition to dif-fering from businesses, governments and not-for-profits differ from each other in importantways that affect financial reporting. Governments, unlike not-for-profits, have the authorityto command resources—the power to tax, collect license and other fees, and impose charges.This ability suggests that a government’s balance sheet may not report all of the assets underits control. To obtain a comprehensive picture of a government’s financial health, it may benecessary to consider not only the resources it actually owns, but also those that it has thepower to summon. We return to this point in Chapter 15.

WHATARE THE OVERALL PURPOSES OF FINANCIAL REPORTING?.............................................................................................................

How the external financial reports of governments and not-for-profits are used varies fromuser to user.1 For the most part, external financial reports should allow users to do thefollowing:

1These purposes are drawn from the GASB Concepts Statement No. 1, Objectives of Financial Reporting (May 1987).


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� Assess financial position and economic condition.Users need to analyze the entity’s past resultsand current financial position (assets compared with liabilities) and its overall economiccondition to determine the entity’s ability to meet its obligations and to continue toprovide expected services. By examining trends, users are better able to predict futurefinancial developments and foresee the need for changes in revenue sources, resourceallocations, and capital requirements.

� Compare actual results with the budget. Users want assurance that the entity adhered to itsadopted budget. Significant variations may signify poor management or unforeseencircumstances that require an explanation.

� Determine compliance with laws, regulations, and restrictions on the use of the funds.Users wantto be assured of compliance with legal and contractual requirements, such as bondcovenants, donor and grantor restrictions, taxing and debt limitations, and applicablelaws. Violations can have serious financial repercussions and can jeopardize the entity’sviability.

� Evaluate efficiency and effectiveness.Users want to know whether the entity is achieving itsobjectives and, if so, how efficiently and effectively. They need to compare accomplish-ments (outcomes) with service efforts and costs (resource inputs).

WHO ARE THE USERS AND WHATARE THE USESOF FINANCIAL REPORTS?.............................................................................................................

The main users of the financial reports of governments and not-for-profits are the parties towhom the organizations are accountable. They include governing boards; investors andcreditors; taxpayers, other citizens, and organizational members; donors and grantors;regulatory and oversight agencies; and employees and other constituents.

The basic financial statements and other information in external financial reports aretargeted mainly at parties outside the organization. As in business accounting, externalreports may not be appropriate for managerial decisions. Executives, agency heads, and othermanagers should rely on the internal reporting system for the financial information theyrequire. Nevertheless, the information needs of internal and external parties overlap, andinternal parties may rely on external financial reports for much of the data they need.

GOVERNING BOARDS In governments and not-for-profits, as well as in businesses, theauditors’ reports on the financial statements are directed to the organizations’ governingboards. This is typically an elected or appointed legislature, such as a city council or board ofcommissioners, for a government, and a board of trustees or directors for a not-for-profit.Governing boards cannot neatly be categorized as either internal or external users. Custom-arily, their members come from outside the management team. However, in most organiza-tions, they approve budgets, major purchases, contracts, executive employment agreements,and significant operating policies, thereby not only overseeing managers, but also gettinginvolved in their decisions.

INVESTORS AND CREDITORS Governments and not-for-profits use the same financialmarkets as businesses to satisfy their debt-financed capital requirements. InMarch 2009, stateand local governments had an estimated $2.7 trillion of bonds outstanding, compared with$6.7 trillion for U.S. corporations.2 The amounts highlight the economic significance of themunicipal bond segment. Governments issue bonds primarily to finance long-term assets,

2 Securities Industry and Financial Markets Association (SIFMA), Statistics, ‘‘Outstanding U.S. BondMarket Debt.’’

WHO ARE THE USERS AND WHAT ARE THE USES OF FINANCIAL REPORTS? 7

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such as buildings, roads, highways, and utility systems. Not-for-profits use bond financing forbuildings and equipment.

Investors commonly include government and not-for-profit bonds, as well as corporatebonds, in their investment portfolios. For both kinds of securities, they want assurance thatthe issuer will meet scheduled interest and principal payments. Most bondholders are onlyindirect users of financial reports and rely more on the assessments of bond-rating services,such as Standard & Poor’s, Moody’s, and Fitch Ratings. These services assign to publiclytraded bonds a rating (e.g., AAA, AA, A, BBB) that is reflective of the securities’ risk of default.

Governments and not-for-profits also borrow routinely from banks and other financialinstitutions to finance new facilities or short-term imbalances between cash receipts anddisbursements. Lenders use the financial statements of governments and not-for-profits justas they would those of businesses—to help assess the borrowers’ credit-worthiness.

CITIZENS ANDORGANIZATIONAL MEMBERS Citizens (or taxpayers) are invariably placednear the top of any list of users of government financial reports. In reality, few citizens ever seethe annual reports of their governments, perhaps in part because the reports are slow toappear and because reporting practices are not user-friendly. But citizens are, nevertheless, asignificant user group. They obtain financial data through a variety of ‘‘filters,’’ includingcivic associations, such as the League of Women Voters, political action groups, and themedia. They may not pay attention to the annual report, but they definitely take notice, at anytime of the year, of instances of financial mismanagement or other circumstances that maycause unexpected revenue shortfalls or cost overruns.

How much interest the members of a not-for-profit take in their organization’s financialstatements or related data depends on the organization’s size and the members’ involvement.A country club’s members may pay more attention to financial affairs than do the members ofbroader-based organizations, such as the National Geographic Society, because the countryclub’s financial position and performance more directly affect its dues and fees.

DONORS AND GRANTORS Few individuals request financial statements before they dropcoins into Salvation Army kettles or Muscular Dystrophy Association canisters. But majordonors and grantors, such as the United Way, the Ford Foundation, and federal, state, andlocal governments, analyze financial reports and other financial information from supplicantassociations as carefully as a banker making a loan. Individual donors also should obtainfinancial information before contributing. Information should be available from the organi-zation or regulatory authorities about the allocation of resources—the proportion ofcontributions that goes to programs, as opposed to fund-raising and executive salaries.Moreover, the tax returns of not-for-profit organizations are in the public domain and can beaccessed from various websites.

REGULATORY AGENCIES Local governments are usually required to file financial reportswith state agencies; charitable organizations with state or local authorities; and religious andfraternal associations with their national organizations. Recipients use these reports to ensurethat the entities are spending and receiving resources in accordance with laws, regulations, orpolicies; to help assess management’s performance; to allocate resources; and to exercisegeneral oversight.

EMPLOYEES AND OTHER CONSTITUENTS Few employees spend their off-hours poringover their organization’s financial statements. But officers of their unions or employeeassociations may examine such statements, looking for ways to free up resources for salaryincreases or for projects in which they have a special interest. Other constituent or interestgroups also use financial reports on an ad hoc basis. Probably few students have seen thefinancial statements of the college or university they attend. However, students have been


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known to use budgets and annual reports to support their claims that the college or universityneed not raise tuition or can afford a new student center.

WHATARE THE SPECIFIC OBJECTIVES OF FINANCIAL REPORTING AS SETFORTH BY THE GASB AND FASB?.............................................................................................................

The overall objective of financial reporting is to meet the information needs of report users.But financial reports cannot possibly satisfy all requirements of all users. Therefore, theGASB and the FASB have established objectives that circumscribe the functions of financialreports. These objectives are the foundation for their financial reporting standards.

GASBOBJECTIVES Because of the unique characteristics of governments and their environ-ment, the GASB has established accountability as the cornerstone of financial reporting.‘‘Accountability,’’ it says, ‘‘requires governments to answer to the citizenry—to justify theraising of public resources and the purposes for which they are used.’’ Accountability ‘‘isbased on the belief that the citizenry has a ‘right to know,’ a right to receive openly declaredfacts that may lead to public debate by the citizens and their elected representatives.’’3

The GASB has divided the objective of accountability into three subobjectives:4

� Interperiod equity. ‘‘Financial reporting should provide information to determine whethercurrent-year revenues were sufficient to pay for current-year services.’’

� Budgetary and fiscal compliance. ‘‘Financial reporting should demonstrate whether re-sources were obtained and used in accordance with the entity’s legally adopted budget; itshould also demonstrate compliance with other finance-related legal or contractualrequirements.’’

� Service efforts, costs, and accomplishments. ‘‘Financial reporting should provide informationto assist users in assessing the service efforts, costs, and accomplishments of thegovernmental entity.’’

The GASB established two additional objectives, each of which has three subobjectives.These are set forth in Table 1-2.

3GASB Concepts Statement No. 1, para. 56.4 Ibid., para. 77.

T A B L E 1 - 2Governmental Accounting Standards Board’s Additional Objectives

of Financial ReportingFinancial reporting should assist users in evaluating the operating results of the governmental entity for theyear.

a. Financial reporting should provide information about sources and uses of financial resources. Financialreporting should account for all outflows by function and purpose, all inflows by source and type, and theextent to which inflows met outflows. Financial reporting should identify material nonrecurring financialtransactions.

b. Financial reporting should provide information about how the governmental entity financed its activitiesand met its cash requirements.

c. Financial reporting should provide information necessary to determine whether the entity’s financialposition improved or deteriorated as a result of the year’s operations.

(continued )

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The GASB objectives, taken independently, are unquestionably reasonable. But takentogether, do they establish the basis for resolving specific issues and establishing specificstandards? Consider the following highly stylized example:

E X A M P L E Clash Among Reporting Objectives........................................................................................................

In its first year of operations, a newly established county sanitary district prepared acash-based budget and engaged in the following summary transactions, all of which occurredwithout variance from the budget.

� It purchased sanitation vehicles, having anticipated economic lives of 10 years, for $10million cash.

� It billed residents for $9 million, but because bills for the last month of the year were notmailed until early the following year (as planned), it collected only $8.2 million.

� It incurred operating expenses, all paid in cash, of $6 million.

Let us prepare a statement of revenues and expenses using accounting standards that areconsistent with the GASB objectives.5 Two problems are readily apparent:

� Should the district report vehicle-related expenses of $10 million (the amount paid) or $1million (one-tenth of the assets consumed during the period)? The broader question iswhether governments should charge depreciation.

� Should the district recognize as revenues the $9 million billed or the $8.2 millioncollected? More generally, should revenues be recognized on a cash basis (i.e., only whencash is collected) or on an accrual basis (i.e., when the event giving rise to the revenueoccurred, irrespective of when the cash is received)?

Financial reporting should assist users in assessing the level of services that can be provided by the governmentalentity and its ability tomeet its obligations as they become due.

a. Financial reporting should provide information about the financial position and condition of a govern-mental entity. Financial reporting should provide information about resources and obligations, bothactual and contingent, current and noncurrent. The major financial resources of most governmentalentities are derived from the ability to tax and issue debt. As a result, financial reporting should provideinformation about tax sources, tax limitations, tax burdens, and debt limitations.

b. Financial reporting should provide information about a governmental entity’s physical and othernonfinancial resources having useful lives that extend beyond the current year, including informationthat can be used to assess the service potential of those resources. This information should be presented tohelp users assess long- and short-term capital needs.

c. Financial reporting should disclose legal or contractual restrictions on resources and risks of potential lossof resources.

Source: GASB Concepts Statement No. 1, Objectives of Financial Reporting (1987).

T A B L E 1 - 2(Continued)

5 In a later chapter, we explain the distinction between expenses and expenditures, a term commonly used ingovernment accounting. For now consider them to be the same.


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Because the district’s budget is cash-basis, a statement that fulfilled the GASB’s objectiveof budgetary and fiscal compliance would also have to be on a cash basis. The district wouldrecognize revenue as the cash is collected; it would record vehicle-related expense in theperiod in which the vehicles are acquired and paid for. Thus (in millions),

Revenues from customersOperating expensesVehicle-related expenseExcess of revenues over expenses

$ 6.010.0

$ 8.2

16.0$(7.8)

Under this cash-basis statement, the entire expense for the vehicles falls on the taxpayersof the year in which the vehicles were purchased. In the following nine years, the districtwould report no expenses related to the purchase or ‘‘consumption’’ of these assets. Thus,management would appear far more efficient in those years than in the first year. Also, if taxrates were set so that revenues covered expenses, taxpayers would enjoy a rate decrease.However, because the taxpayers of all 10 years benefit from the assets, the reporting objectiveof interperiod equity would not be served. On the other hand, the district would be creditedwith only $8.2 million in revenues, even though it provided $9.0 million in services—another,though opposite, violation of the interperiod equity concept.

By contrast, a statement that fulfilled the interperiod equity objective would recognizethe district’s $10 million expense for the vehicles over the 10 years of use and the $9.0 inrevenues in the years in which the services were provided. Thus,

Revenues from customersOperating expensesVehicle-related expenseExcess of revenues over expenses

$6.01.0

$9.0

7.0$2.0

But this accrual-basis statement cannot readily be compared to the district’s adoptedbudget and therefore cannot, without adjustment, be used to demonstrate its budgetarycompliance.

As will be apparent throughout this text, the conflict between the two objectivescharacterizes many of the issues that government accountants, and the GASB in particular,have to face in ensuring that financial statements are informative and useful to the parties thatrely upon them. In particular, the conflict casts doubt upon whether the objectives can befulfilled with a single set of financial statements or whether, as an alternative, two sets—oneon a full accrual basis, the other on a budget or near-budget basis—may be necessary.

GASB STATEMENT NO. 34: TWO SETS OF FINANCIAL STATEMENTS Upon its establish-ment in 1984, the GASB undertook to develop a new model for state and local governmentreporting. However, owing to numerous controversial issues, it was unable to do so until June1999. Statement No. 34, Basic Financial Statements—and Management’s Discussion and Analysis—for State and Local Governments, required the most significant changes to the reporting model in60 years and, in fact, requires that governments prepare the two sets of financial statements citedin the previous paragraph.

FASB OBJECTIVES FASB objectives for not-for-profits, which are summarized in Table1-3, seem to be generally similar to GASB objectives for governments. However, a carefulreading reveals significant differences in emphasis. These disparities have resulted inaccounting and reporting standards that give decidedly different looks to the financialreports of the two types of entities. For example, FASB objectives refer only obliquely tobudgetary compliance. They provide that information should be useful in ‘‘assessing how

WHAT ARE THE SPECIFIC OBJECTIVES OF FINANCIAL REPORTING? 11

17

managers of a nonbusiness organization have discharged their stewardship responsibilities.’’6

The FASB stresses that external financial statements can ‘‘best meet that need by disclosingfailure to comply with spending mandates [presumably expressed in budgets] that mayimpinge on an organization’s financial performance or its ability to provide a satisfactory levelof services.’’7 By contrast, the GASBmakes budgetary and fiscal compliance a central concernof financial reporting. As a consequence, government financial statements incorporatenumerous mechanisms to demonstrate that the entity has complied with budgetary mandates,the provisions of grants and contracts, and all applicable laws and regulations. Thesemechanisms include reporting by fund, accounting for encumbrances (goods and serviceson order), and required actual-to-budget comparisons. Moreover, although the FASBstatement of objectives, like that of the GASB, lists a wide range of potential users, inpractice the FASB standards aim at a far narrower group of users—mainly donors and othercontributors of resources.

REPORTING SERVICE EFFORTS AND ACCOMPLISHMENTS SEEN AS A LONG-TERMGOAL GASB and FASB objectives both endorse the notion that financial reporting encom-passes information on service efforts and accomplishments. This information cannot easily beexpressed inmonetaryunits andhasnot traditionally been included infinancial statements.Bothboards emphasize that the ability to measure accomplishments is still undeveloped. They seethis aspect of performance reporting as a long-term goal rather than an immediate imperative.In the government arena, this objective has proven especially controversial. The GovernmentFinance Officers Association (an organization of municipal accounting and finance officials)has actively opposed GASB involvement in setting performance-related standards. Althoughacknowledging that governmentsmust certainlymeasure and report upon their performance, it

6 FASB Statement of Financial Accounting Concepts No. 4, Objectives of Financial Reporting by Nonbusiness Organiza-tions (December 1980), para. 40.7 Ibid., para. 41.

T A B L E 1 - 3Financial Accounting Standards Board’s Objectives of Financial Reporting

� Financial reporting by nonbusiness organizations should provide information that is useful to present andpotential resource providers and other users in making rational decisions about the allocation of resourcesto those organizations.

� Financial reporting should provide information to help present and potential resource providers and otherusers in assessing the services that a nonbusiness organization provides and its ability to continue to providethose services.

� Financial reporting should provide information that is useful to present and potential resource providersand other users in assessing howmanagers of a nonbusiness organization have discharged their stewardshipresponsibilities and about other aspects of their performance.

� Financial reporting should provide information about the economic resources, obligations, and netresources of an organization and about the effects of transactions, events, and circumstances that changeresources and interests in those resources.

� Financial reporting should provide information about the performance of an organization during a period,periodic measurement of the changes in the amount and nature of the net resources of a nonbusinessorganization, and information about the service efforts and accomplishments of an organization.

� Financial reporting should provide information about how an organization obtains and spends cash orother liquid resources, about its borrowing and repayment of borrowing, and about other factors that mayaffect an organization’s liquidity.

� Financial reporting should include explanations and interpretations to help users understand financialinformation provided.

Source: FASB Statement of Financial Accounting Concepts No. 4. Objectives of Financial Reporting by Nonbusiness Organizations (1980).


18

contends that performance measures should be presented in documents other than those thatinclude the conventional financial statements. Hence, they argue, setting standards for serviceefforts and accomplishments reporting is beyond the purview of the GASB.

DO DIFFERENCES IN ACCOUNTING PRINCIPLES REALLY MATTER?.............................................................................................................

Financial statements demonstrate what happened to an entity in the past. But they present theevidence from the perspective of the accountant who prepared them. Other accountants maydescribe the events differently. The underlying accounting principles dictate how theevidence is presented. An important issue is whether differences in accounting principlesaffect the decisions made on the basis of financial statements.

Just as a witness’s explanation of an accident cannot change what actually occurred,neither can an accountant’s report on an entity’s past transactions change what actuallytranspired. In the sanitation district example, the district paid $10 million in cash for vehicles,billed its customers $9 million for services, and paid $6 million in operating expenses.Whether the district’s financial statements report revenues over expenses of $2 million,expenses over revenues of $7.8 million, or any amount in between is irrelevant to the actualevent. Moreover, financial statements, no matter how they are prepared, do not directly affectthe economic worth of an entity. At year-end the district’s customers owed it $0.2 million,whether the district reported a receivable of that amount (as it would under an accrual basis ofaccounting) or of zero (as it would under a cash basis of accounting).

USER ADJUSTMENTS Users of financial statements can be indifferent to how an entity’sfiscal story is told, as long as they are given adequate information to reconfigure thestatements to a preferred form. Research in the corporate sector provides compellingevidence that stockholders are able to see through differences in accounting practices andadjust financial statements to take the differences into account. Thus, if one firm reportshigher earnings than another solely because it employs more liberal accounting principles,the total market value of its shares is no greater.

The efficiency of the municipal bond market—the extent to which it incorporates allpublic information in pricing debt securities—has been investigated much less than theefficiency of the stock market. Nevertheless, the available evidence suggests that investors intax-exempt bonds, like their stock market counterparts, understand the effects of differencesin accounting practices.

ECONOMIC CONSEQUENCES Accounting principles frequently have economic conse-quences. Important decisions are made based on financial data, as presented and withoutadjustment.

We noted earlier that budgets are governments’ paramount financial documents. Mostjurisdictions must present balanced budgets (expenditures cannot exceed revenues) in accordwith accounting principles that they either select themselves or have imposed upon them byhigher-order governments. The choice of accounting principles is critical.Whereas one set ofaccounting principles may result in a balanced budget, another, which includes identicalrevenue and expenditure proposals, may not. Most governments budget on a cash ornear-cash basis. If they were required to budget on a full accrual basis, their budgets mightquickly become unbalanced.

Governments may face restrictions on the amount of debt they can incur. The use of oneset of accounting principles in defining and measuring debt (for example, not counting a leaseas an obligation) might enable them to issue additional bonds without violating the legallimits. The use of a different set (for example, counting the lease as a liability) might causethem to exceed the limits and be barred from further borrowing.

DO DIFFERENCES IN ACCOUNTING PRINCIPLES REALLY MATTER? 13

19

This text includes many other examples of how specific reporting practices haveeconomic consequences.

WHO ESTABLISHES GENERALLYACCEPTED ACCOUNTING PRINCIPLES?.............................................................................................................

Generally accepted accounting principles (GAAP) embrace the rules and conventions thatguide the form and content of basic financial statements. These principles are expressedmainly in pronouncements of the GASB and the FASB for their respective jurisdictions andshould be consistent with the objectives that they have established. However, in the absenceof specific pronouncements, GAAP may also be derived from historical convention andwidespread practice.

THE FUNCTION OF THE GASB, THE FASB, AND THE AICPA The GASB and the FASBhave been sanctioned by the American Institute of Certified Public Accountants (AICPA) toestablish accounting principles for their respective jurisdictions pursuant to Rule 203 of theAICPA’s Code of Professional Conduct. Rule 203 provides that a CPA should not express anunqualified audit opinion on financial statements that violate the standards established by thedesignated authorities. In addition, the AICPA provides accounting guidance through‘‘industry audit guides’’ and ‘‘statements of position’’ (SOPs) on issues not yet addressedby either the GASB or the FASB.

The FASB was established in 1973 and the GASB in 1984. The GASB has a full-timechairman and six part-time members. The FASB has five full-time members, including itschairman. Each board has a full-time staff and is supported by an advisory council composedof representatives of constituent groups—the Governmental Accounting Standards AdvisoryCouncil (GASAC), for the GASB, and the Financial Accounting Standards Advisory Council(FASAC), for the FASB. The boards share facilities in Norwalk, Connecticut.

Until 2002 accounting standard-setting for businesses and state and local governmentswas carried out mainly in the private sector by the FASB, the GASB, and (to a limitedextent) the AICPA. Auditing standards were set by the AICPA. As a result of Enron/Andersen and numerous other corporate scandals involving financial accounting andreporting, Congress passed the Sarbanes-Oxley Act of 2002 (Public Law 107-204). Thismeasure established the Public Company Accounting Oversight Board to (1) oversee theaudit of public companies that are subject to the securities laws; (2) establish audit reportstandards and rules; and (3) inspect, investigate, and enforce compliance on the part ofregistered public accounting firms, their associated persons, and certified public accountants.Per Sarbanes-Oxley, the FASB is funded by fees from Securities and Exchange Commission(SEC) registrants. The GASB, by contrast, has to rely, as it has in the past, on contributionsfrom constituents and proceeds from the sale of its publications. The GASB traditionallyreceived a significant portion of its contributions fromCPA firms. However, starting in 2011,in the spirit of Sarbanes-Oxley and in an effort to enhance its independence, it opted to nolonger accept contributions from the public accounting profession. Sarbanes-Oxley isdiscussed in greater detail in Chapter 14.

ENTITIES COMMON TO THE GOVERNMENT AND NOT-FOR-PROFIT SECTORS A con-troversial and politically sensitive issue arose soon after theGASB was established: Should theGASB or the FASB set standards for entities, such as colleges and universities, that arecommon to both the government and the not-for-profit sectors? Some constituents assertedthat there are few conceptual or operational differences between same-type entities in thetwo sectors that justify different accounting standards and hence separate standard-settingauthorities. Others contended that government hospitals, utilities, and universities havefundamentally different rights, responsibilities, and obligations than their not-for-profit


20

counterparts. For example, theymay have the ability to impose taxes and issue tax-exempt debtandmaybe accountable to the citizenry at large rather than to aboardof trustees.Concernsoversovereignty made the issue more complex. Some managers of not-for-profits maintained thattheyhad little in commonwithgovernments anddidnotwant tobeunder theGASB’s authority.Similarly, government officials refused to yield standard-setting control over any of theircomponent units to the FASB, a board concerned mainly with the private sector.

In 1989 the Financial Accounting Foundation and the constituents of the two boardsagreed upon a jurisdictional formula that, in essence, reaffirmed the status quo since theGASB’s inception: the GASB would have authority over all state and local governmententities, and the FASB would have authority over all nongovernment entities. Thus, publiccolleges and universities (such as The State University of New York) are subject to GASBstandards; private colleges and universities (such as New York University) come under FASBstandards.

If the GASB or the FASB has not issued a pronouncement on a particular issue,organizations within each of their jurisdictions can look to other sources for guidance.These sources are set forth in two ‘‘hierarchies’’ that are part of the jurisdiction agreementand were adopted by the AICPA in Statement on Auditing Standards No. 69, ‘‘The Meaning ofPresent Fairly in Conformity with Generally Accepted Accounting Principles in the Inde-pendent Auditor’s Report.’’

The GASB’s hierarchy was incorporated into accounting standards through GASBStatement No. 55, The Hierarchy of Generally Accepted Accounting Principles for State andLocal Governments (March 2009). As summarized in Table 1-4, the hierarchy in StatementNo. 55 has four levels, in descending order of application. Pronouncements in level a. areincorporated into the GASB’s Codification of Governmental Accounting and Financial ReportingStandards. If the accounting treatment for a transaction is not specified by a level a.pronouncement, a government should look for guidance in levels b., c., or d., in that order.

T A B L E 1 - 4A Summary of the ‘‘Hierarchy’’ of Generally Accepted Accounting Principles

Government Entities Nongovernment Entities

Category

a. Officially established accounting principles—GASB Statements and Interpretations

b. GASB Technical Bulletins and, if applicable tostate and local governments and cleared (notobjected to) by the GASB, AICPA Industry Auditand Accounting Guides and AICPA Statementsof Position

c. AICPA Practice Bulletins, if cleared by theGASB, and consensus positions on accountingissues of a group of accountants organized by theGASB (if and when established)

d. Implementation guides (Q&As) published by theGASB staff, as well as practices widely recognizedand prevalent in state and local government

Level

1. Authoritative. Codification of FASB Statementsand Interpretations; AICPA Accounting Re-search Bulletins; Accounting Principles BoardOpinions; FASB Technical Bulletins; AICPAIndustry Audit Guides, Statements of Position,and Practice Bulletins, if cleared (not, objectedto) by the FASB; consensus positions of the FASBEmerging Issues Task Force; Implementationguides published by the FASB staff; AICPAaccounting interpretations and implementationguides

2. Nonauthoritative. Practices widely recognizedand prevalent generally or in the industry; otheraccounting literature, such as concepts state-ments, textbooks, etc.

Other accounting literature, such as pronounce-ments of the FASB, AICPA, and other specifiedstandard-setters, GASB and FASB concepts state-ments, guidance from professional and regulatoryorganizations, textbooks, handbooks, etc.

WHO ESTABLISHES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES? 15

21

If no accounting treatment is specified in any of the four categories, the government may lookto other sources, such as those listed under ‘‘other accounting literature’’ in Table 1-4.

The FASB incorporated a two-level hierarchy—authoritative and non-authoritative—into its FASB Accounting Standards Codification (July 1, 2009). As summarized in Table 1-4, theauthoritative literature includes pronouncements and other guidance similar to those in levelsa. through d. of the GASB’s hierarchy, except that ‘‘widely recognized and prevalentpractices’’ are not authoritative. If an accounting treatment is not specified in the FASB’sCodification, nongovernment entities may look for guidance in nonauthoritative sources.

The FASB’s influence on government accounting practices is greater than may appearfrom the hierarchies because governments engage in many business-type activities, such aselectric utilities, parking garages, and hospitals. Governments have traditionally accountedfor these activities in the same way as their private-sector counterparts, and the GASBrequires them to adhere to all FASB standards that were issued before the 1989 jurisdictionagreement and that do not conflict with a GASB standard. Moreover, business-type activitiesmay elect to apply all FASB standards issued after 1989 that do not conflict with GASBstandards or to apply none of those standards, unless specifically required by the GASB.

QUESTIONS FOR REVIEWAND DISCUSSION............................................................................................................

1. What is the defining distinction between for-profit businesses and not-for-profit entities,including governments? What are the implica-tions of this distinction for financial reporting?

2. Why is the budget a far more important docu-ment in both governments and not-for-profitsthan it is in businesses?

3. How and why might the importance of thebudget affect generally accepted accountingprinciples for external (general-purpose) reports?

4. What is meant by ‘‘interperiod equity’’? Whatis its consequence for financial reporting?

5. Why may the ‘‘matching concept’’ be less rele-vant for governments and not-for-profits than itis for businesses?

6. What is the significance for financial reportingof the many restrictions that are placed upon agovernment’s resources?

7. Why is it difficult to develop accounting prin-ciples that are appropriate for governmentswithin the same category (e.g., cities, counties)

and even more difficult to develop them forgovernments within different categories?

8. What is the significance for financial reportingof a government’s power to tax? How does itaffect the government’s overall financialstrength?

9. Why has it proven especially difficult to estab-lish accounting principles that enable govern-ments to satisfy all three elements of GASB’sfirst objective of financial reporting in a singlestatement of revenue and expenditures or bal-ance sheet?

10. Why aremeasures of ‘‘service efforts and accom-plishments’’ of more concern in government andnot-for-profits than they are in businesses?

11. In what key ways does the FASB influencegenerally accepted accounting principles forgovernments?

12. Why is it more difficult to distinguish betweeninternal and external users in governments thanit is in businesses?

EXERCISES AND PROBLEMS.........................................................................................................

1-1

1. The traditional businessmodel of accounting isinadequate for governments and not-for-profitorganizations primarily because businesses

differ from governments and not-for-profitsorganizations in that

a. they have different missions

b. they have fewer assets


22

c. their assets are intangible

d. taxes are a major expenditure of businesses

2. If businesses are ‘‘governed by the market-place’’ then governments are governed by

a. legislative bodies

b. taxes

c. budgets

d. state constitutions

3. The primary objective of a not-for-profitorganization or a government is to

a. maximize revenues

b. minimize expenditures

c. provide services to constituents

d. all of the above

4. In governments, in contrast to businesses,

a. expenditures are driven mainly by the abil-ity of the entity to raise revenues

b. the amount of revenues collected is a signalof the demand for services

c. there may not be a direct relationship be-tween revenues raised and the demand forthe entity’s services

d. the amount of expenditures is independentof the amount of revenues collected

5. The organization responsible for settingaccounting standards for state and local gov-ernments is the

a. FASB

b. GASB

c. FASAB

d. AICPA

6. The number of governmental units in theUnited States is approximately

a. 900

b. 9,000

c. 90,000

d. 900,000

7. Governments differ frombusinesses in that they

a. do not raise capital in the financial markets

b. do not engage in transactions in which they‘‘sell’’ goods or services

c. are not required to prepare annual financialreports

d. do not issue common stock

8. Interperiod equity refers to a conditionwhereby

a. total tax revenues are approximately thesame from year to year

b. taxes are distributed fairly among all tax-payers regardless of income level

c. current-year revenues are sufficient to payfor current-year services

d. current-year revenues cover both operatingand capital expenditures

9. Which of the following is not one of GASB’sfinancial reporting objectives?

a. providing information on the extent towhich interperiod equity is achieved

b. ensuring that budgeted revenues are equalto, or exceed, budgeted expenses

c. reporting on budgetary compliance

d. providing information on service effortsand accomplishments

10. Which of the following is not one of FASB’sfinancial reporting objectives?

a. providing information about economic re-sources, obligations, and net resources

b. providing information to help resource pro-viders make rational decisions

c. reporting on budgetary compliance

d. providing information on service effortsand accomplishments

1-2

1. Rule 203 of the AICPA’s Code of ProfessionalConduct pertains to

a. CPAs’ independence

b. authorities designated to establish account-ing standards

c. standards of competency

d. solicitation of new clients by a CPA

2. Which of the following rule-making authori-ties would establish accounting standards forStanford University (a private university)?

a. the AICPA

b. the FASB

c. the FASAB

d. the GASB

3. Which of the following rule-making authori-ties would establish accounting standards forthe University of Texas (a public university)?

a. the AICPA

b. the FASB

c. the FASAB

d. the GASB

EXERCISES AND PROBLEMS 17

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4. If the GASB has not issued a pronouncementon a specific issue, which of the following istrue with respect to FASB pronouncements?

a. they would automatically govern

b. they could be taken into account but wouldhave no higher standing than other account-ing literature

c. they are irrelevant

d. they could be taken into account by thereporting entity, but only if disclosure ismade in notes to the financial statements

5. The FASB is to the GASB as

a. a brother is to a sister

b. a father is to a son

c. a son is to a father

d. a daughter is to a friend

6. Standards promulgated by the FASB are mostlikely to be adhered to by which of the follow-ing governmental units?

a. a police department

b. a public school

c. an electric utility

d. a department of highways

7. Which of the following practices is most likelyto undermine interperiod equity?

a. paying for a new school building out ofcurrent operating funds

b. paying the administrative staff of a schoolout of current operating funds

c. issuing 20-year bonds to finance construc-tion of a new highway

d. recognizing gains and losses on marketablesecurities as prices increase and decrease

8. The term ‘‘independent sector’’ refers to

a. states that have opted not to receive federalfunds

b. not-for-profit organizations

c. churches that are unaffiliated with a partic-ular denomination

d. universities that are not affiliated with aparticular athletic conference

9. Which of the following is not an objective ofexternal financial reporting by either theGASB or the FASB?

a. to enable the statement user to detect fraud

b. to disclose legal or contractual restrictionson the use of resources

c. to provide information about how the or-ganizations meet their cash requirements

d. to provide information that would enable auser to assess the service potential of long-lived assets

10. Which of the following is the least appropriateuse of the external financial statements of agovernment?

a. to assess the entity’s financial position

b. to assess whether the compensation of man-agement is reasonable in relation to that incomparable entities

c. to compare actual results with the budget

d. to evaluate the efficiency and effectivenessof the entity in achieving its objectives

1-3

Budgeting practices that satisfy cash requirements maynot promote interperiod equity.

The Burnet County Road Authority wasestablished as a separate government to maintaincounty highways. The road authority was grantedstatutory power to impose property taxes on countyresidents to cover its costs, but it is required tobalance its budget, which must be prepared on acash basis. In its first year of operations it engagedin the following transactions, all of which wereconsistent with its legally adopted, cash-basedbudget:

� Purchased $10million of equipment, all of whichhad an anticipated useful life of 10 years. Tofinance the acquisition, the authority issued $10million in 10-year term bonds (i.e., bonds thatmature in 10 years)

� Incurred wages, salaries, and other operatingcosts, all paid in cash, of $6 million

� Paid interest of $0.5 million on the bonds

� Purchased $0.9 million of additional equipment,paying for it in cash. This equipment had a usefullife of only three years

1. The authority’s governing board levies prop-erty taxes at rates that are just sufficient tobalance the authority’s budget. What is theamount of tax revenue that it is required tocollect?

2. Assume that in the authority’s second year ofoperations, it incurs the same costs, except thatit purchases no new equipment. What amountof tax revenue is it required to collect?

3. Make the same assumption as to the tenth year,when it has to repay the bonds. What amountof tax revenue is it required to collect?


24

4. Comment on the extent to which the author-ity’s budgeting and taxing policies promoteinterperiod equity. What changes would yourecommend?

1-4

The dual objectives of assessing interperiod equity andensuring budgetary compliance may necessitate differentaccounting practices.

A city engages in the transactions that follow.For each transaction, indicate the amount of reve-nue or expenditure that it should report in 2012.Assume first that the main objective of the financialstatements is to enable users to assess budgetarycompliance. Then assume alternatively that the mainobjective is to assess interperiod equity.

The city prepares its budget on a ‘‘modified’’cash basis (that is, it expands the definition of cashto include short-term marketable securities), andits fiscal year ends on December 31.

1. Employees earned $128,000 in salaries andwages for the last five days in December2012. They were paid on January 8, 2013.

2. A consulting actuary calculated that, per anaccepted actuarial cost method, the city shouldcontribute $225,000 to its firefighters’ pensionfund for 2012. However, the city contributedonly $170,000, which is the amount budgetedat the start of the year.

3. The city acquired three police cars for $35,000cash each. The vehicles are expected to last forthree years.

4. OnDecember 1, 2012, the city invested $99,000in short-term commercial paper (promissorynotes). The notes matured January 1, 2013.The city received $100,000. The $1,000 differ-ence between the two amounts represents thecity’s return (interest) on the investment.

5. On January 2, 2012, the city acquired a new$10 million office building, financing it with25-year serial bonds. The bonds are to berepaid evenly over the period during whichthey are outstanding—that is, $400,000 peryear. The useful life of the building is 25 years.

6. On January 1, 2012, the city acquired another$10 million office building, financing this fa-cility with 25-year term bonds. These bondswill be repaid entirely when they mature Jan-uary 1, 2037. The useful life of this building isalso 25 years.

7. City restaurants are required to pay a $1,200annual license fee, the proceeds of which thecity uses to fund its restaurant inspection pro-gram. The license covers the period July 1through June 30. In 2012 the city collected

$120,000 in fees for the license period begin-ning July 1, 2012.

8. The city borrowed $300,000 in November2012 to cover a temporary shortage of cash.It expects to repay the loan in February 2013.

1-5

Year-end financial accounting and reporting can revealthe economic substance of government actions that havebeen taken mainly to balance the budget.

Public officials, it is often charged, promotemeasures intended to make the government ‘‘lookgood’’ in the short-term, but that may be deleteri-ous in the long term. Assume that a city’s budget ison a cash or near-cash basis. Further assume thatthe following actions, designed to increase areported surplus, were approved by the city counciland did indeed reduce budgetary expenditures orincrease budgetary revenues:

a. The city reduced its contributions to theemployee defined benefit pension plan fromthe $10 million recommended by the city’sactuary to $5 million. Under a defined benefitplan, the employer promises employees speci-fied benefits upon their retirement, and the levelof benefits is independent of when and howmuch the employer contributes to the planover the employees’ years of service.

b. It reduced by $1 million the city’s cash transferto a rainy-day reserve that is maintained to coverpossible future reductions in tax collectionsattributable to a downturn in the region’seconomy.

c. It sold securities that had been held as aninvestment. The securities had been purchasedfive years earlier at a cost of $2 million. Marketvalue at the time of sale was $5 million.

d. It delayed until the following year $10million ofmaintenance on city highways.

1. Suppose that you were asked to proposeaccounting principles for external reportingthat would capture the true economic natureof these measures—actions that, in substance,did not improve the city’s financial perform-ance or position. For each measure, indicatehow you would require that it be accounted forand reported.

2. Can you see any disadvantages to the princi-ples that you propose?

1-6

Choice of accounting principles may have significanteconomic consequences.

In preparing its budget proposals, a city’sbudget committee initially estimated that total


25

revenues would be $120 million and total expen-ditures would be $123 million. In light of thebalanced budget requirements that the city has tomeet, the committee proposed several measuresto either increase revenues or decrease expendi-tures. They included the following:

a. Delay the payment of $0.4 million of city billsfrom the last week of the fiscal year covered bythe budget to the first week of the next fiscalyear.

b. Change the way property taxes are accountedfor in the budget. Currently, property taxes arecounted as revenues only if they are expectedto be collected during the budget year. Newbudgetary principles would permit the city toinclude as revenues all taxes expected to becollected within 60 days of the following fiscalyear, in addition to those collected during theyear. The committee estimates that the changewould have a net impact of $1.2 million.

c. Change the way that supplies are accountedfor in the budget. Currently, supplies arerecognized as expenditures at the time they

are ordered. The proposal would delay re-cognition of the expenditure until the suppliesare actually received. The committee esti-mates a net effect of $0.8 million.

d. Defer indefinitely $1.5 million of maintenanceon city roads.

Except as just noted with respect to supplies,the city currently prepares its budget on a cashbasis, even though other bases are also legallypermissible. It prepares its year-end financial state-ments, however, on an accrual basis.

1. Indicate the impact of each of the proposals onthe city’s (1) budget, (2) annual year-end fi-nancial statements, (3) ‘‘substantive’’ eco-nomic well-being. Be sure to distinguishbetween direct and indirect consequences.

2. It is sometimes said that choice of accountingprinciples doesn’t matter in that the principlesaffect only the way in which the entity’s fiscal‘‘story’’ is told; they have no impact on theentity’s actual financial history or current sta-tus. Do you agree? Explain.


26

C H A P T E R 2

Fund Accounting

CHAPTER HIGHLIGHTS

� The nature and purpose of fund accounting� The meaning of ‘‘basis of accounting’’ and ‘‘measurement focus’’� The types of funds that governments use� How the funds of not-for-profits differ from those of governments

I n Chapter 1, we set forth key characteristics that distinguish governments andnot-for-profits from businesses and we discussed their implications for accounting and

reporting. In particular we noted that governments and not-for-profits establish their account-ing systems on a fund basis. In this chapter, we explain the rationale for fund accounting,describe the main types of funds maintained, and examine the relationships among funds. InChapter 3, we show how funds are included in a government’s financial statements.

WHAT IS A FUND?.............................................................................................................

In business accounting, ‘‘funds’’ typically refers to working capital (current assets less currentliabilities) or selected elements of it (such as cash and investments). But in government andnot-for-profit accounting the term fund has a different meaning.

Fund accounting is a system in which a government’s or not-for-profit’s resources aredivided among two or more fiscal and accounting entities known as funds. As a fiscal (orfinancial) entity, each fund accounts for resources, and the claims against them, that aresegregated in accord with legal or contractual restrictions or to carry out specific activities. Asan accounting entity, each fund has its own self-balancing set of accounts fromwhich separatefinancial statements can be prepared. Governments and not-for-profits customarily useseveral funds to account for their resources and activities. For example, a church may useone fund for general operations, another for resources set aside to construct a new building,and a third for its religious school.

WHAT CHARACTERIZES FUNDS?.............................................................................................................

As suggested by the earlier reference to a ‘‘self-balancing set of accounts,’’ each fund of agovernment or not-for-profit uses the accounting equation:

assets ¼ liabilitiesþ fund balance

This is a variation of the business accounting equation (assets¼ liabilitiesþ owners’ equity).The term fund balance replaces owners’ equity, because governments and not-for-profits

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may not have owners. Fund balance, like owners’ equity, is a residual and is often referred toas net assets. Fund balance, or net assets, is the amount left to the parties with rights to theassets after all other claims against those assets have been liquidated.

Because the basic accounting equation is the same, funds can be accounted for by thesame double-entry system of bookkeeping as businesses, and their current status and pastperformance can be summarized by similar financial statements. For example, the balancesheet of a fund can detail the specific assets, liabilities, and elements of fund balance thatunderlie the accounting equation as of any point in time. A statement of revenues,expenditures (or expenses), and other changes in fund balance can explain the reasons forchanges in fund balance during a specified period.1 A statement of cash flows can reconcile thechanges in cash between the end and the beginning of a period.

USE OF MULTIPLE FUNDS TO ACCOUNT FOR AN ENTITY Funds may seem similar tobusiness subsidiaries, but they are established for quite different reasons. Businesses generallyestablish subsidiaries to account for their activities by product or region, to isolate certainbusiness risks, or to minimize their tax obligations. Governments and not-for-profits, on theother hand, most commonly separate resources into funds to ensure that they adhere to therestrictions placed upon them by legislators, grantors, donors, or other outside parties. Forexample, a university that received a donation to be used only for scholarships would accountfor it in a special scholarship fund.

Fund accounting promotes control and accountability over restricted resources. To alesser extent, governments and not-for-profits establish funds to account for certain activities,often those of a business type, that are different from their usual activities. For example, agovernment might account for its golf course, which operates similarly to a privately ownedcourse, in a fund that is separate from the one used to account for its general operations. Byaccounting for these types of activities in their own accounting and fiscal entities, govern-ments and not-for-profits are better able to control the activities’ revenues and expendituresand to assess their overall performance.

To appreciate the relationship among two or more funds used to account for a singleorganization, remember that each fund is a separate accounting entity. Thus, every transac-tion that affects a fund must be recorded by at least one debit and one credit. Any transactionthat affects two or more funds must be accounted for as though it affected two or moreindependent businesses and must be recorded individually in each fund. Suppose, forexample, that a city maintains two funds: a general fund, which accounts for its unrestrictedresources and general operations, and a utility fund, which accounts for a utility that sellselectricity to city residents and other government departments. The utility bills the other citydepartments—all accounted for in the general fund—for $10,000. The following entrieswould be appropriate:

Utility FundAccounts receivable (from general fund)

Revenue from sale of electricityTo record the sale of electricity to general fund

$10,000$10,000

General FundElectricity expenditure

Accounts payable (to utility fund)To record the use of electricity

$10,000$10,000

1As addressed later in the text, in government accounting ‘‘expenditures’’ are distinguished from ‘‘expenses.’’ Fornow, suffice it to note that ‘‘expenditures’’ is used in connection with funds that are not accounted for on a full accrualbasis, whereas ‘‘expenses’’ is used in connection with those accounted for on a full accrual basis.

22 CHAPTER 2 / FUND ACCOUNTING

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BASIS OF ACCOUNTING AND MEASUREMENT FOCUS Basis of accounting determineswhen transactions and events are given accounting recognition. For instance, if an entityadopts the full accrual basis of accounting, a transaction is recognized when it has itssubstantive economic impact, irrespective of when cash is received or paid. If, on the otherhand, it adopts the cash basis, the transaction is recognized only as the related cash is receivedor paid. An entity’s measurement focus determines what is being reported upon—whichassets and liabilities are given accounting recognition and reported on the balance sheet.

The two concepts are closely related; the selection of one implies the selection of theother. For example, if an entity adopts a cash basis of accounting, its measurement focus isupon cash. Only cash is reported on its balance sheet. Correspondingly, measurement focusalso determines whether the entity reports net profit (the net increase in all economicresources) or merely the net change in selected resource flows (such as current financialresources, e.g., cash, short-term receivables, and short-term investments).

If an entity adopts a full accrual basis of accounting, which is required of businesses, itsmeasurement focus is automatically upon all economic resources, and its balance sheetreports on all assets and liabilities, both current and noncurrent. Increases or decreases incapital assets and long-term obligations are not recognized as revenues or expenses. Capitalassets are long-lived assets, such as land, buildings, equipment, vehicles, roads, bridges, andstreetlights. Suppose, for example, that an organization purchases a vehicle for $35,000 bygiving a note for the entire amount. The following entry is appropriate:

VehiclesNotes payable

To record the acquisition of a vehicle

$35,000$35,000

Because governments and not-for-profits may be primarily concerned with the assetsneeded to satisfy current-year obligations, they may adopt a modified accrual basis ofaccounting and a measurement focus on mainly short-term financial assets and liabilities formany of their funds.2 Modified accrual is between the cash and full accrual bases. Under themodified accrual basis used by governments, revenues and some expenditures are recognized ona cash or near-cash basis; other expenditures are recognized on a full accrual basis. Because themeasurement focus is on current financial resources, capital assets and long-term liabilities areexcluded from the balance sheet, and net changes in short-term financial assets and liabilities arerecognized as revenues or expenditures. For example, if a government borrows $35,000 (issuinga long-term note) and uses the proceeds to purchase a vehicle, the following entries are proper:

CashProceeds from borrowing

To record the issuance of a long-term noteExpenditure for vehicles

CashTo record the purchase of the vehicle

$35,000

$35,000

$35,000

$35,000

The government reports neither the vehicle nor the long-term note on its fund balance sheet.Instead it records both the increase and subsequent decrease in a financial asset (cash) on thefund’s statement of revenues and expenditures. The vehicle, in effect, is written-off (expensed)at the time acquired. The proceeds from the note are recorded as proceeds from borrowing,an increase in fund balance that (like a revenue) is closed to fund balance.

Governments can report their funds on different bases for different purposes. Forexample, to provide a measure of the full cost of services, a government may report some

2Although not-for-profits may adopt a modified accrual basis of accounting for internal management and control,FASB standards require that they prepare their general-purpose external reports on a full accrual basis. In contrast,GASB standards require governments to report certain activities on both a modified accrual and a full accrual basis.The modified accrual basis used by governments is discussed in more detail beginning in Chapter 4.

WHAT CHARACTERIZES FUNDS? 23

29

of its funds on a full accrual basis. To demonstrate compliance with budgetary constraints, itmay report other funds on a modified accrual basis. Businesses, of course, also use two ormore bases to account for their operations. They prepare their financial statements on a fullaccrual basis, their tax returns on a basis specified by the Internal Revenue Service, and theirreports to state or federal agencies on a basis defined by the relevant regulatory authority.

Irrespective of whether an entity reports capital assets and long-term liabilities on its fundbalance sheets, it must still maintain accounting control over them. Management andconstituents need to be concerned with all the entity’s resources and obligations—notjust those reported on its balance sheet. Therefore, the entity must maintain accountingrecords of all assets and liabilities and must include in its financial statements schedules thatsummarize them and show the changes during the year.

Earlier we mentioned that governments and not-for-profits commonly use multiplefunds to report their activities. To reinforce the purposes of fund accounting and therelationships among funds, we now present a simple example of a fund accounting system.We use as our illustration a public school district, which accounts for its funds on a modifiedaccrual basis, with a measurement focus on current financial resources. In particular theillustration is intended to emphasize that

� Each fund is a separate accounting and fiscal entity.� Because the funds are not on a full accrual basis, some economic resources (primarilycapital assets) and obligations (primarily those that are long-term) are not reported onthe fund’s balance sheet as assets and liabilities (and hencemust be accounted for either inoff-the-balance-sheet records or on statements prepared on a full accrual basis).

E X A M P L E Fund Accounting in a School District........................................................................................................

A newly formed public school district accounts for its operations on a modified accrual basis,with a measurement focus on current financial resources. It maintains four funds:

� A general fund. This fund accounts for taxes and other unrestricted resources.� A capital projects fund.This fund accounts for the proceeds of bonds that are restricted forthe construction of buildings and other capital assets.

� A debt service fund. This fund accounts for resources that are to be set aside each year toensure that the district has the wherewithal to make its required payments of interest andprincipal on its long-term debt. It may be viewed as a savings account (or sinking fund)for resources restricted by either the debt covenants (agreements) or by policies of thedistrict itself.

� A special revenue fund. This fund accounts for state grants that must be used for specificpurposes.

The following is a highly aggregated summary of the district’s first year of operations:

1. The district levied $90 million of general property taxes, of which it actually collected$88 million. It expects to collect the balance shortly after year-end. These taxes areunrestricted; they can be used for any legitimate educational purpose. Therefore, thedistrict should record them in its general fund.

General fundCash $88Property taxes receivable 2

Property tax revenue $90To record property taxes


30

2. The district received a state grant of $2 million to purchase computers. This grant isrestricted for a specific purpose and therefore must be recorded in a restricted fund, thespecial revenue fund.

3. The district issued $120 million in long-term bonds to construct a school building. Theproceeds must be used for the intended purpose and therefore must be recorded in thecapital projects fund. Because the district is on amodified accrual basis of accounting andcurrent financial resources measurement focus, which excludes the recognition of bothcapital assets and long-term liabilities, the proceeds from borrowing are recognized in arevenue-type account—one that causes fund balance, rather than a liability, to increase.Of course, the district must maintain a record of both its capital assets and long-termobligations in supplementary ledgers or other off-the-balance-sheet lists. These assetsand liabilities are also reported in government-wide financial statements, which areaddressed in Chapter 3.

4. The district constructed the school building for $110 million. The construction must beaccounted for as an expenditure, rather than as a capital asset. The asset must be recordedin a supplementary ledger or list.

5. The district incurred $60 million in general operating expenditures, of which it actuallypaid $55 million.

6. Using its state grant, the district purchased computers for $1 million. As with theconstruction of the building, the district recognizes the acquisition as an expenditure butrecords the capital asset in a supplementary ledger or list.

7. The district transferred $11 million from the general fund to the debt service fund tomake the first payments of both principal and interest that are due in the following year.

Special revenue fundCash $ 2

Grant revenue $2

Capital projects fundCash $120

Proceeds from borrowing $120To record the issuance of bonds

Capital projects fundConstruction of building (expenditure) $110

Cash $110To record the costs of constructing the school building

General fundGeneral operating expenditures $60

Cash $55Accounts payable 5

To record general operating expenditures

Special revenue fundAcquisition of computers (expenditure) $1

Cash $1To record the acquisition of computers

WHAT CHARACTERIZES FUNDS? 25

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Broken into its components, this transaction is straightforward, involving simple entriesto each of two funds:

Tables 2-1 and 2-2 summarize the transactions into balance sheets and statements ofrevenues and expenditures for the three funds. To emphasize that each fund is a separateaccounting and reporting entity, combined totals are deliberately omitted.

General fundTransfer-out to debt service fund $11

Cash $11To record transfer to the debt service fund

Debt service fundCash $11

Transfer-in from general fund $11To record transfer from the general fund

T A B L E 2 - 2School District’s Statement of Fund Revenues, Expenditures

and Other Changes in Fund Balances (in millions)

General Special Revenue Capital Projects Debt Service

Property tax revenue $ 90Revenue from state grant $2

Total revenues $ 90 $2Operating expenditures $ 60Construction of building $ 110Acquisition of computers $1

Total expenditures $ 60 $1 $ 110Excess of revenues over

expenditures $ 30 $1 $(110)Other increases and decreases

in fund balances:

Transfers-in/(out) (11) $11Proceeds from borrowing 120 ___

Net increase in fund balance $ 19 $1 $ 10 $11

T A B L E 2 - 1School District’s Funds Balance Sheet (in millions)

GeneralSpecialRevenue

CapitalProjects

DebtService

Assets

Cash $22 $1 $10 $11Property taxes receivable 2Totals $24 $1 $10 $11

Liabilities and fund balances

Accounts payable $ 5Fund balances (net assets) 19 1 10 11Totals $24 $1 $10 $11


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The sections that follow present an overview of the main funds maintained by govern-ments and not-for-profits, respectively. Bear in mind that each fund, like a subsidiary of acorporation, is a separate accounting and fiscal entity, for which separate financial statementscan be prepared. Just as the financial statements of a corporation can be prepared on differentbases (e.g., full accrual, cash, tax, regulatory), so too can those of individual funds (e.g.,modified accrual, full accrual). And just as the financial statements of a company’s subsidiariescan be combined in different ways (e.g., by region, by product line, by size), so too can those ofa government or not-for-profit (e.g., by type, by dollar value, by nature of restrictions). Weaddress in Chapter 3 how a government’s funds may be aggregated for greater simplicity infinancial reporting.

WHATARE THE MAIN TYPES OF GOVERNMENTS’ FUNDS?.............................................................................................................

Most general purpose governments engage in three broad categories of activities:

� Governmental activities are those financed predominantly through taxes and inter-governmental grants.

� Business-type activities are those financed predominantly through user charges.

� Fiduciary activities are those for which the government acts as a trustee or agent forindividuals, external organizations, or other governments.

Corresponding roughly to these three kinds of activities, governments classify funds intothree broad categories: governmental funds, proprietary funds, and fiduciary funds. Asshown in Table 2-3, each category contains several different types of funds, each having adifferent purpose.

Governmental funds may be characterized as expendable funds, in that their resourcesare received from taxes, grants, or other sources and are then spent. There is no expectationthat the funds will be reimbursed for services rendered to constituents or other departments.By contrast, proprietary funds are said to be nonexpendable (or revolving) funds. That is,the government may make an initial contribution to establish a proprietary fund, butthereafter the fund is expected to ‘‘pay its own way’’ (at least in part) through customercharges. Fiduciary funds differ from governmental and proprietary funds in that theiractivities and resources benefit only parties other than the government—not the governmentitself.

A government should have only one general fund, but it may have any number of theother types of funds. For example a city may maintain a separate special revenue fund for eachrestricted revenue source, a separate capital projects fund for each major capital project, and aseparate debt service fund for each issue of outstanding bonds.

We now take a comprehensive look at each of the types of funds.

WHAT’S NOTABLE ABOUT EACH TYPE OF GOVERNMENTAL FUND?.............................................................................................................THE GENERAL FUND The general fund should be used to account for and report allfinancial resources that are not accounted for or reported in another fund.3 All funds are notcreated equal; the general fund is more equal than the others. In a city or other generalpurpose government, the general fund embraces most major government functions—police,fire, street maintenance, sanitation, and administration.

3The definitions of governmental fund types in this section are drawn from GASB Statement No. 54, Fund BalanceReporting and Governmental Fund Type Definitions (February 2009), paras. 29, 30, and 33–35.

WHAT’S NOTABLE ABOUT EACH TYPE OF GOVERNMENTAL FUND? 27

33

Why does one single fund cover so many functions? Recall the rationale for fundaccounting. Funds are established mainly to ensure that governments adhere to resourcerestrictions. A government’s fund structure rarely mirrors its organizational structure. Fundsdivide a government into categories of resource restriction, not functional departments oroperations. To keep their accounting systems as simple as possible, governments should

T A B L E 2 - 3The Fund Structure of State and Local Governments

Governmental Funds

Purpose: To account for and report governments’ operating and financing activities financedpredominantly through taxes and intergovernmental grants.Basis of accounting/measurement focus:Modified accrual/current financial resources

There are five kinds of governmental funds:

� General fund—to account for and report all financial resources not accounted for and reported in anotherfund

� Special revenue funds—to account for and report the proceeds of specific revenue sources that are restrictedor committed for specified purposes other than debt service or capital projects (e.g., gas tax revenuesrequired to be used for road repairs)

� Debt service funds—to account for and report financial resources that are restricted, committed, or assignedto expenditure for principal and interest

� Capital projects funds—to account for and report financial resources that are restricted, committed, orassigned to expenditure for capital outlays, including the acquisition or construction of capital facilities,such as buildings and highways, and other capital assets

� Permanent funds—to account for and report resources restricted in that only the earnings on investments,not the principal, may be used to support the reporting government’s programs for the benefit of thegovernment or its citizenry (e.g., maintenance of a public cemetery or park)

Proprietary FundsPurpose: To account for and report governments’ activities that are similar to those carried out in theprivate sector and financed predominantly through user chargesBasis of accounting/measurement focus: Full accrual/economic resources

There are two kinds of proprietary funds:

� Enterprise funds—to account for and report business-type activities that serve the public at large (e.g., anelectric utility)

� Internal service funds—to account for and report goods and services provided to departments of the samegovernment (e.g., a centralized purchasing function or motor pool).

Fiduciary FundsPurpose: To account for and report resources held by governments as trustees or agents for another partyor partiesBasis of accounting/measurement focus: Full accrual/economic resources

There are two kinds of fiduciary funds:

� Trust funds, including� Pension (and other employee benefit) trusts—to account for and report resources accumulated to paypension, healthcare, and other benefits to the government’s retired or disabled employees (e.g., a localgovernment’s pension plan for its employees)

� Investment trusts—to account for and report investment pools in which other governments participate(e.g., a state government pool open to local governments within the state)

� Private purpose trusts—to account for and report resources held for individuals or external organiza-tions (e.g., a scholarship fund for employees’ children, funded by a donation from a citizen)

� Agency funds—to account for and report resources held on a short-term basis on behalf of individuals,organizations, or other governments (e.g., taxes collected on behalf of another government). These fundshave only assets and liabilities—no revenues or expenses.


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establish only the minimum number of funds necessary to ensure legal compliance or efficientadministration. Governments finance their general operations mainly with unrestrictedresources, such as property taxes. Therefore, they can legally intermingle these resourcesand can properly account for all activities financed with unrestricted resources in a singlefund. However, governments also may account for and report restricted resources in thegeneral fund when a separate fund is not required by law or the governing body.

As noted in Table 2-3, the general fund uses a modified accrual basis of accounting and ameasurement focus on current financial resources. This basis of accounting andmeasurementfocus are discussed in more detail in Chapter 4. For now, recall that a modified accrual basisfalls between the cash basis and the full accrual basis. Thus, the general fund records andreports on its balance sheet cash and other current financial resources, including primarilytaxes receivable, accounts receivable, and short-term investments of unrestricted resources,but not capital assets or long-term debt. Obviously a general-purpose government, such as acity, owns police cars, fire equipment, computers, and buildings, and it probably financedsome of its capital assets with long-term debt. If the general fund were accounted for on a fullaccrual basis (economic resources measurement focus), these assets and liabilities would bereported on the fund’s balance sheet. Instead, they have apparently been written off asacquired (and presumably listed in off-the-balance sheet ledgers or other records). However,as shown in Chapter 3, capital assets and long-term debt associated with the general fund orother governmental funds are reported in financial statements that are prepared on the fullaccrual basis for the government as a whole.

SPECIAL REVENUE FUNDS Special revenue funds are established to account for and reportthe proceeds of specific revenue sources that are restricted or committed4 for specifiedpurposes other than debt service or capital projects. Examples of typical restrictions orcommitments include

� Gasoline tax revenues that must be used for highway maintenance� A state law-enforcement grant that must be used to train police officers� Private donations that must be used to maintain parks and other recreational facilities� Lottery fund proceeds committed to expenditures for education

Special revenue funds use the same basis of accounting and measurement focus as thegeneral fund and, indeed, all governmental funds. Accordingly, almost all of the guidelines setforth in this text for the general fund also apply to special revenue funds and othergovernmental funds.

DEBT SERVICE FUNDS Debt service funds are maintained to account for and reportfinancial resources that are restricted, committed, or assigned to expenditure for principaland interest, including financial resources that are being accumulated for principal andinterest that are maturing in future years. Debt service funds should be used to reportresources if legally mandated. They have much in common with sinking funds (resources setaside to retire debt) maintained by businesses.

The balance sheet of a debt service fund does not include the obligation for the debtbeing serviced. The purpose of the fund is to account for the resources being accumulated toservice the debt—not the debt itself. Also, debt service funds are governmental funds, and nogovernmental fund records long-term obligations. As shown in the next chapter, long-termdebt, for which resources are being accumulated in a debt service fund, is reported only in fullaccrual financial statements for the government as a whole and in supplementary schedules.

4The terms restricted, committed, and assigned denote different strengths of the constraints placed on how govern-mental fund resources can be used. We address the distinctions in Chapter 3.

WHAT’S NOTABLE ABOUT EACH TYPE OF GOVERNMENTAL FUND? 29

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The one exception is interest and principal that have matured and are therefore currentobligations. They are reported in a debt service fund as matured interest payable or maturedbonds payable. But this exception is of little practical import. On the day the interest orprincipal matures, it should be paid and the obligation satisfied. Therefore, a liability forinterest or principal should be reported in year-end fund financial statements only whenpayment is due but has been delayed.

Debt service funds derive their resources from other funds (e.g., transfers from thegeneral fund) or from taxes or fees dedicated to debt service. Fund resources are expended topay principal and interest. Governments commonly invest accumulated resources for debtservice in commercial paper, treasury bills, and other financial instruments that, althoughsecure, still provide a reasonable return. Typically, therefore, many debt service fundtransactions relate to the purchase and sale of marketable securities and the recognitionof investment earnings and related costs.

CAPITAL PROJECTS FUNDS Capital projects funds account for and report financialresources that are restricted, committed, or assigned to expenditure for capital outlays,including the acquisition or construction of capital facilities and other capital assets, such asbuildings, highways, and equipment. Governments often issue bonds to finance a specificproject. The resources received must be placed in a capital projects fund and expended forthat project. Capital projects funds typically derive their resources from the proceeds ofbonds. However, they may also receive resources that were initially received by other fundsand subsequently committed or assigned for the acquisition of capital assets.

Just as debt service funds account for resources accumulated to service a debt—but notthe debt itself—capital projects funds likewise account for resources that have been set asideto purchase or construct capital assets, but not the assets themselves. The assets, whether inthe form of construction in progress or completed projects, are reported only in the financialstatements for the government as a whole and in supplementary schedules. As with theresources accumulated to service their debts, governments must invest any excess cash that isawaiting expenditure for capital projects. Therefore, many transactions of typical capitalprojects funds, like those of debt service funds, relate to investment activities.

PERMANENT FUNDS Permanent funds are a type of trust fund, but they are categorized asgovernmental funds, not fiduciary funds. They are similar to private purpose trusts (fiduciaryfunds) in that usually only the income from fund investments, not the principal, may be spent.They differ, though, in that programs financed by permanent funds are for the benefit of thegovernment itself or its citizenry, whereas the activities of private purpose trusts—and allfiduciary funds—benefit individuals, private organizations, or other governments.

Suppose, for example, that a government received a donation to support one of its parks.The resources received were to be invested, and only the income, not the principal, could beexpended. The government establishes a permanent fund to account for the donation (theprincipal). As income is earned, it is transferred to a special revenue fund, fromwhich it is usedfor the intended purpose. By contrast, if the government received a donation to providescholarships to its employees’ children, it would report the gift in a private purpose trust(fiduciary) fund.

WHAT’S NOTABLE ABOUT EACH TYPE OF PROPRIETARY FUND?.............................................................................................................

Proprietary funds—enterprise funds and internal service funds—are used to account foractivities that are operated in a manner similar to private business enterprises and when agovernment’s intent is to recover costs primarily through user charges. Because a typicalobjective in providing the service is to break even at least, the government officials responsible


36

for the activity require the same types of financial information as their business counterparts.For example, they need data on the full cost (including depreciation) of the services providedso that they can establish prices. Outsiders, such as tax or rate payers, concerned with theactivity’s performance or financial position, need the same general information as corporateshareholders. For this reason, proprietary funds are accounted for in essentially the samemanner as in private businesses. The funds employ the full accrual basis of accounting, andtheir measurement focus is on all economic resources. Therefore, their financial statements,unlike those of governmental funds, report capital assets, long-term debt, and depreciation, asdiscussed further in Chapter 3.

ENTERPRISE FUNDS Enterprise funds account for services provided to the public at largeand may include these services:

� Utilities, such as electric, gas, and water� Golf courses� Hospitals� Mass transportation� Parking garages� Airport and harbor facilities� Housing authorities.

Many government enterprises are financed similarly to businesses. A government enterprisedoes not sell stock to the general public, but it may issue bonds (called revenue bonds).Revenue bond principal and interest are payable exclusively out of revenues of the funditself—not out of the general revenues of the government at-large. Therefore, the fund’sresources must be kept intact and cannot be commingled with those of other funds.

INTERNAL SERVICE FUNDS Internal service funds account for the provision of goods orservices to other departments within the same government (or, occasionally, to othergovernments). They bill the receiving departments at rates intended to cover the cost ofthe goods or services. Although there are no specific guidelines as to which within-government activities should be accounted for in internal service funds, the following areexamples:

� A maintenance and repair service for the cars and trucks of the police department, firedepartment, sanitation department, etc.

� A motor pool that acts as a within-government rental car agency� An electronic data-processing department that services other government departments� A store that sells office supplies to the other government departments� A print shop that provides government-wide printing services.

Internal service funds are typically established with resources contributed from the generalfund or another fund and thereafter are expected to be self-sustaining. As such, they use fullaccrual accounting and the economic resources measurement focus. Most of their transac-tions are with other funds, and their accounting is relatively straightforward, as long as eachfund is seen as a separate accounting entity. When an internal service fund bills anotherdepartment, it recognizes a revenue and a receivable from another fund. Simultaneously, thefund that accounts for the other department records an expenditure or expense and a payableto the internal service fund. Most of the departments to which an internal service fund sells itsgoods or services are likely to be accounted for in the general fund or an enterprise fund. Thisis primarily because most government operations (as opposed to accumulations of resourcesfor specific purposes) are accounted for in those funds.

WHAT’S NOTABLE ABOUT EACH TYPE OF PROPRIETARY FUND? 31

37

WHAT’S NOTABLE ABOUT EACH TYPE OF FIDUCIARY FUND?.............................................................................................................

Unlike governmental and proprietary funds, fiduciary funds only benefit parties other thanthe government itself, including employees, other governments, and specific individuals,corporations, or not-for-profits. Their activities do not result in revenues or expenses to thegovernment—only additions and deductions to their own net assets. Therefore, they arereported only in fiduciary fund financial statements. They are not included in the financialstatements for the government as a whole.

TRUST FUNDS Kohler’s Dictionary for Accountants defines a trust fund as a ‘‘fund held by oneperson (trustee) for the benefit of another, pursuant to the provisions of a formal trustagreement.’’5 There are three types of trust funds:

� Pension (and other employee benefit) trust funds provide retirement income, disabilityincome, health care insurance, and other benefits to retired or disabled employees of thegovernment and their beneficiaries (e.g., a local government’s pension plan for itsfirefighters).

� Investment trust funds, which are similar to mutual funds, benefit the parties, usuallyother governments, that have entrusted their resources to the fund (e.g., an investmentpool maintained by one government for other governments).

� Private purpose trust funds encompass all other trust funds that benefit specificindividuals, other governments, external organizations, or businesses (e.g., a scholarshipfund for children of a government’s employees, funded by a donation from a citizen).

Trust funds commonly hold their resources in noncurrent as well as current investments, andfund performance is important to beneficiaries and fund managers. Therefore, trust funds usefull accrual accounting, and their measurement focus is on economic resources.

AGENCY FUNDS Agency funds are used to account for assets held, usually for a short period,on behalf of other governments, funds, or individuals. Most commonly they are established tomaintain control over

� Taxes collected by one government for the benefit of another� Special assessments collected to repay debt that the government services but for which itis not responsible

� Refundable deposits� Pass-through grants—those requiring a government (e.g., a state) to distribute funds toother parties (e.g., school districts or individuals), but for which the government has nofinancial involvement and for which it performs no significant administrative functions,such as selecting recipients or monitoring performance.

Custodial in nature, agency funds are not used to account for significant governmentoperations. Consequently, agency funds are a student’s delight—entities of the utmostsimplicity. Their balance sheets show only assets (commonly, cash and investments) andliabilities (the amounts owing to the beneficiaries). Assets always equal liabilities, and hencethere are no net assets. Accordingly, governments need not prepare a statement of revenuesand expenses.

5W.W. Cooper and Yuji Ijiri (eds.), Kohler’s Dictionary for Accountants, 6th ed. (Englewood Cliffs, NJ: Prentice-Hall,Inc., 1983), p. 516.


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HOW DO THE FUNDS OF NOT-FOR-PROFITSDIFFER FROM THOSE OF GOVERNMENTS?.............................................................................................................

Although the GASB mandates fund-based reporting for governments, the FASB imposes nosimilar requirement upon not-for-profits. As stressed earlier, fund accounting is an expedientmeans of control that helps ensure that governments or other organizations use resourcesonly for the purposes for which they have been dedicated. But fund accounting is not the onlymeans. After all, private businesses also must account for resources that are restricted (e.g.,income taxes withheld from employees, sales taxes collected from customers, advancepayments on government contracts, proceeds from bond issues that must be spent on specificprojects). Yet businesses do not employ fund accounting.

Nevertheless, for purposes of internal accounting and control, most not-for-profitsemploy fund accounting, and they maintain funds that are comparable to those of govern-ments. Most not-for-profits maintain a current fund, which is like a government’s generalfund. Similarly, most not-for-profits maintain one or more current restricted funds, whichare, in essence, special revenue funds. Theymay alsomaintain, as needed, funds to account forresources that have been set aside for the acquisition of capital assets and for the repayment ofdebt. Many colleges and universities categorize all funds having to do with capital assets andthe related debt as plant funds. These include an unexpended plant fund (similar to a capitalprojects fund), a retirement of indebtedness fund (analogous to a debt service fund), and aninvestment in plant fund (which accounts for both capital assets and related long-term debt).

Although the FASB does not require fund accounting, it requires that not-for-profitsclassify their net assets into three categories based on the restrictions of donors:

� Unrestricted� Temporarily restricted� Permanently restricted.

The classification is based exclusively on the restrictions of donors, rather than, for example,on those of banks or other lenders, because donors are the prime group of not-for-profitstatement users.

Temporarily restricted resources are those that must be used for a specific purpose (e.g.,to support donor-designated programs or activities) or that cannot be spent until some timein the future (e.g., when a donor makes good on a pledge). Permanently restricted resourcesare typically endowments, only the income from which can be spent.

FASB accounting standards for not-for-profits are generally similar to business standards.However, the FASB imposes some accounting and reporting requirements that are unique tonot-for-profits. We devote Chapters 12 and 13 to those standards, the form and content ofnot-for-profit financial statements, and other issues that are specific to not-for-profits.

In Chapters 3 through 11, we focus on government accounting and financial reporting. InChapter 14, we address auditing requirements for governments and not-for-profits. InChapter 15, we discuss how the financial statements and other information reported forgovernments and not-for-profits may be used to help assess their financial position andeconomic condition.


1. Distinguish between funds as the term isused in government and not-for-profitaccounting as contrasted with businessaccounting.

2. Inwhat way, if any, does the accounting equationas applied in government and not-for-profitaccounting differ from that as applied in businessaccounting?

QUESTIONS FOR REVIEW AND DISCUSSION 33

39

3. Upon examining the balance sheet of a largecity, you notice that the total assets of thegeneral fund far exceed those of the combinedtotal of the city’s 10 separate special revenuefunds. Moreover, you observe that there are nofunds for public safety, sanitation, health andwelfare, and general administration—all impor-tant functions of the government. Why do yousuppose the city hasn’t attempted to ‘‘even out’’the assets in the funds? Why does it not main-tain funds for each of its major functional areas?

4. Why are there generally no capital projects (workin progress or completed assets) in governments’capital projects funds? Why are there generallyno long-term debts in debt service funds?

5. The balance sheets of both enterprise funds andinternal service funds report long-lived assetsand long-term debt. What does that tell you

about the funds’ measurement focus and basis ofaccounting? Explain.

6. As emphasized later in this text, depreciation isrecorded in proprietary funds—but not in gov-ernmental funds. What is the rationale forrecording depreciation in proprietary funds?

7. What are fiduciary funds? What are two maintypes? What is the distinction between them?

8. What is ‘‘permanent’’ about a permanent fund?

9. What is an agency fund? Why is it the easiestfund for which to account?

10. Distinguish among the three categories of re-strictiveness into which the net assets ofnot-for-profit organizations must be separatedfor purposes of external reporting. Explain. Bywhom must restrictions be imposed for re-sources to be considered restricted?


2-1

The following relate to the town of Coupland(in thousands):

� Equipment used in a vehicle repairservice that provides service to otherdepartments on a cost reimbursementbasis. The equipment has a 10-yearlife with no salvage value. $1,400

� Property taxes levied and collected 6,300

� Hotel taxes (restricted for promotionof tourism) collected 1,200

� Proceeds of bonds to build a parkinggarage that must be repaid fromuser charges 4,000

� Proceeds of general obligation bondsto finance construction of a new cityhall. The building, which wascompleted during the year, has auseful life of 30 years, with nosalvage value. 9,000

� Proceeds of a federal grant to hireadditional police officers 1,000

� Fees collected from customers by theelectric utility 8,000

Refer to the two lists below. Select the appropriateamounts from the lettered list for each item in thenumbered list. An amount may be selected once,more than once, or not at all.

___ 1. Revenue to be recognizedin an enterprise fund

___ 2. Revenue to be recognized inspecial revenue funds

___ 3. Bonds payable to be recog-nized in the general fund

___ 4. Bonds payable to be recog-nized in enterprise funds

___ 5. Depreciation expenditure tobe recognized in the generalfund

___ 6. Depreciation expense to berecognized in internal ser-vice funds

___ 7. Revenue to be recognized inan internal service fund

___ 8. Revenue to be recognized inthe general funds

___ 9. Long-lived assets to be recognized inthe general fund

___ 10. Long-lived assets to be rec-ognized in internal servicefunds

2-2

1. Oak Township issued the following bondsduring the year:

a. 0

b. 140

c. 900

d. 1,260

e. 1,040

f. 1,400

g. 2,200

h. 4,000

i. 6,300

j. 8,000

k. 8,500

l. 10,400


40

Bonds to acquire equipmentfor a vehicle repair serviceaccounted for in an inter-nal service fund

Bonds to construct a new cityhall

Bonds to improve its waterutility, which is accountedfor in a enterprise fund

$3,000,000

$8,000,000

$9,000,000

The amount of debt to be reported in thegeneral fund is

a. $0

b. $3,000,000

c. $8,000,000

d. $20,000,000

2. Oak Township should report depreciation inwhich of the following funds:

a. general fund

b. special revenue fund

c. internal service fund

d. capital projects fund

3. Assuming that Bevo County receives all of itsrevenues from unrestricted property taxes, it ismost likely to account for the activities of itspolice department in its

a. police department fund

b. police enterprise fund

c. property tax fund

d. general fund

4. The city of Alpine incurred the following costsduring the year in its property tax collectiondepartment:

Purchase of computer equipmentSalaries and wagesPurchase of electricity from the

city-owned electric utilityPurchase of supplies, all of

which were used duringthe year

$ 10,000$400,000

$ 40,000

$ 10,000

As a consequence of these transactions, theamount that Alpine should report as expendi-tures in its general fund is

a. $400,000

b. $410,000

c. $450,000

d. $460,000

5. Grove City received the following resourcesduring the year:

Property taxesA federal grant to acquire

police carsHotel taxes, which must be

used to promote tourismProceeds of bonds issued to

improve the city’s electricutility

$50,000,000

400,000

3,000,000

12,000,000

The amount that the city should most likelyreport as revenue in its special revenue fund is

a. $400,000

b. $3,000,000

c. $3,400,000

d. $15,400,000

e. $65,400,000

6. A city issues $20 million of general obligationbonds to improve its streets and roads. Inaccordance with the bond covenants, it setsaside $1 million to help ensure that it is able tomeet its first payment of principal and $0.1million for its first payment of interest. Theamount of liability that the city should reportin its debt service fund is

a. $0

b. $18.9 million

c. $19 million

d. $20 million

7. During the year, Brian County collects $12million of property taxes on behalf of UrtonTownship. Of this amount, it remits $10 mil-lion to the township, expecting to remit thebalance shortly after the end of its fiscal year.The amount of revenue that the Countyshould report is

a. $0

b. $2 million

c. $8 million

d. $10 million

8. The City of Round Lake receives a contribu-tion of $20 million. The donor stipulates thatthe money is to be invested. The principal is toremain intact, and the investment proceeds areto be used to support a city-owned naturecenter. The city should report the contribu-tion in a

a. special revenue fund

b. permanent fund

c. fiduciary fund

d. agency fund


41

9. A city receives a $30 million contribution. Thedonor stipulates that the money is to be in-vested. The principal is to remain intact, andthe investment proceeds are to be used toprovide scholarships for the children of cityemployees. The contribution should be reportedas revenue of a

a. special revenue fund

b. permanent fund

c. fiduciary fund

d. agency fund

10. The Summerville Preparatory School (a pri-vate school) receives a donation of $14 million.The donor stipulates that the entire amountmust be used to construct a new athletic fieldhouse. The School should classify the dona-tion as

a. unrestricted

b. temporarily restricted

c. permanently restricted

d. semi-restricted

2-3

A special district’s balance sheet may not capture itseconomic resources and obligations.

A special district accounts for its general fund (itsonly fund) on a modified accrual basis. In a particularperiod, it engaged in the following transactions.

a. It issued $20 million in long-term bonds.

b. It acquired several tracts of land, at a total costof $4 million, paying the entire amount in cash.

c. It sold a portion of the land for $1 million,receiving cash for the entire amount. The tractsold had cost $0.8 million.

d. It repaid $2 million of the bonds.

e. It lost a lawsuit and was ordered to pay $9million over three years. It made its first cashpayment of $3 million.

1. Prepare journal entries to record the transac-tions in the general fund.

2. Based on your journal entries, prepare a bal-ance sheet and a statement of revenues, expen-ditures, and other changes in fund balance.

3. Comment on the extent to which the balancesheet captures the district’s economic re-sources and obligations. How can you justifysuch a balance sheet?

4. Comment on the extent to which the state-ment of revenues, expenditures, and other

changes in fund balance captures the district’scost of services. How can you justify such afinancial statement?

2-4

Funds are separate fiscal and accounting entities, eachwith its own self-balancing set of accounts.

The newly established Society for EthicalTeachings maintains two funds—a general fundfor operations and a building fund to accumulateresources for a new building. In its first year, itengaged in the following transactions.

a. It received cash contributions of $200,000, ofwhich $40,000 was restricted for the acquisi-tion of the new building.

b. It incurred operating costs of $130,000, ofwhich it paid $120,000 in cash.

c. It earned $3,000 of interest (the entire amountreceived in cash) on resources restricted for theacquisition of the new building.

d. It transferred $17,000 from the operating fundto the new building fund.

e. It paid $12,000 in fees (accounted for asexpenses) to an architect to draw up plans forthe new building.

1. Prepare journal entries to record the transac-tions. Be certain to indicate the fund in whichthey would be made.

2. Prepare a statement of revenues, expenditures,and other changes in fund balances and abalance sheet. Use a two-column format,one column for each of the funds.

2-5

Typical transactions can often be identified with specifictypes of funds.

Boxer City maintains the following funds:

a. General

b. Special revenue

c. Capital projects

d. Debt service

e. Enterprise

f. Internal service

g. Permanent

h. Agency

For each of the following transactions, indicate thefund in which it would most likely be recorded:

1. The city collects $3 million of taxes on behalf ofthe county in which it is located.


42

2. It spends $4 million to pave city streets, usingthe proceeds of a city gasoline tax that is dedi-cated for road and highway improvements.

3. It receives a contribution of $5 million. Per thestipulation of the donor, the money is to beinvested in marketable securities, and the inter-est from the securities is to be used to maintain acity park.

4. It collects $800,000 in landing fees at the cit-y-owned airport.

5. It earns $200,000 on investments that have beenset aside to make principal payments on thecity’s outstanding bonds. The bonds wereissued to finance improvements to the city’stunnels and bridges.

6. It pays $4 million to a contractor for work onone of these bridges.

7. It pays $80,000 in wages and salaries to policeofficers.

8. It purchases, from an outside supplier, $40,000of stationery to ‘‘sell’’ to its various operatingdepartments.

2-6

Each fund must account for interfund activity as if itwere a separate accounting entity.

The newly formed Buffalo School Districtengaged in the following transactions and otherevents during the year:

a. It levied and collected property taxes of $110million.

b. It issued $30 million in long-term bonds toconstruct a building. It placed the cash receivedin a special fund that was set aside to accountfor the bond proceeds.

c. During the year, it constructed the buildingat a cost of $25 million. It expects to spendthe $5 million balance in the following year.The building has an estimated useful life of25 years.

d. It incurred $70 million in general operatingcosts, of which it paid $63 million. It expects topay the balance early the following year.

e. It transferred $12 million from its generalfund to a fund established to account forresources that were set aside to service thedebt. Of this amount, $10 million was forrepayment of the debt; $2 million was forinterest.

f. From the special fund established to servicethe debt, it paid $2 million in interest and$6 million in principal.

g. It collected $4 million in hotel taxes restrictedto promoting tourism. Because the resourceswere restricted, they were accounted for ina special restricted fund. During the year, thedistrict spent $3 million on promotingtourism.

h. The district established a supplies store, toprovide supplies to the district’s various de-partments, by transferring $4 million fromthe general fund. It accounted for the store ina proprietary fund. During the year, the storepurchased (and paid for) $2 million in sup-plies. Of these, it ‘‘sold’’ $1 million, at cost(for cash), to departments accounted for inthe general fund. During the year, thesedepartments used all of the supplies thatthey had purchased.

1. Prepare journal entries to record the transac-tions and other events in appropriate funds.Assume that governmental funds areaccounted for on a modified accrual basis,and focus only on current financial resources(and, therefore, do not give balance sheetrecognition to either capital assets or long-term debt). Proprietary funds are accountedfor on a full accrual basis.

2. Prepare a combined balance sheet—one thathas a separate column for each of the fundsthat you established.

3. Prepare a combined statement of revenues,expenditures, and changes in fund balancesfor all governmental funds—one column foreach fund. Prepare a separate statement of rev-enues, expenses, and changes in fund balancesfor any proprietary funds that you established.

2-7

Long-term assets and liabilities are denied recognitionon funds statements.

Entrepreneurs Consultants, a state agency,was established to provide consulting services tosmall businesses. It maintains only a single generalfund and accounts for its activities on a modifiedaccrual basis. During its first month of operations,the association engaged in, or was affected by, thefollowing transactions and events:

a. It received an unrestricted grant of $100,000.

b. It purchased five computers at $2,000 each.

c. It paid wages and salaries of $6,000.

d. It borrowed $24,000 from a bank, to enable itto purchase an automobile.

e. It purchased the automobile for $24,000.


43

f. It made its first payment on the note—interestof $200.

g. It destroyed one of its computers in an acci-dent. The computer was not insured.

1. Prepare journal entries in the general fund torecord each of the transactions or other events.

2. Prepare a balance sheet and a statement ofrevenues, expenditures, and changes in fundbalance for the general fund.

2-8

The more complete presentation is not always the easierto understand.

Bertram County maintains a fund account-ing system. Nevertheless, its comptroller (whorecently retired from a position in private indus-try) prepared the following balance sheet (inmillions):

Assets:CashInvestmentsConstruction in progressFixed assetsTotal assets

$ 6001,800500

1,200$4,100

The fund balance restricted for debt service repre-sents entirely principal (not interest) on the bondspayable.

1. Recast the balance sheet, as best you can, intoseparate balance sheets for each of the fundsthat are apparently maintained by the county.Assume that the county uses a modified accrualbasis of accounting that excludes recognitionin its funds of both capital (fixed) assets andlong-term debt. Assume also that cash andinvestments are divided among the funds inproportion to their fund balances.

2. In your opinion, which of the two presenta-tions gives the reader a more complete pictureof the county’s financial status? Why? Whichpresentation is easier to understand?

Liabilities and fund balance:

Bonds payable $1,700

Fund balance

Restricted for capital projects $ 600

Restricted for debt service 200

Unrestricted 1,600 2,400

Total liabilities and fund

Balance $4,100


44

C H A P T E R 3

Government FinancialReporting

CHAPTER HIGHLIGHTS

� The objectives of financial reporting and GASB Statement No. 34� Basic financial statements—government-wide statements

� Basic financial statements—fund statements

� Notes and required supplementary information

I n Chapter 2, we discussed the reasons why governments use fund accounting, and wedescribed the purposes of the funds that they maintain. In Chapters 4 through 10, we will

examine the principal transactions of the various types of funds. Our goal in this chapter is toprovide a broad understanding of the purpose, form, and general content of the basic financialstatements that are required by generally accepted accounting principles (GAAP).

The basic financial statements are the end product of the accounting system. Armed withan overview of this end product, students should find it easier to appreciate the discussions inthe next few chapters. Those chapters should fill in the blanks regarding how information isselected and recorded in the various funds, and how recorded information is summarized forexternal reporting.

In Chapter 11 we will address additional reporting issues, including the scope of thereporting entity (e.g., which affiliated organizations should be included in a government’sreport) and the supplementary information included in a government’s comprehensive annualfinancial report (CAFR). In Chapter 14, we will discuss the importance and requirements ofauditing, and in Chapter 15, we will explain the elements of financial statement analysis.

The financial statements illustrated in this chapter, and some of the statements insubsequent chapters, are from the CAFR of the City of Vero Beach, Florida, for the fiscal yearending September 30, 2008.1

HOW CAN FUNDS BE COMBINED AND CONSOLIDATED?.............................................................................................................

As discussed in Chapter 2, fund accounting provides accountability for, and control of, publicmonies. Each fund is a separate fiscal and accounting entity with its own self-balancing set ofaccounts. Thus, financial statements, such as a balance sheet and a statement of revenues and

1 Students can learnmore about Vero Beach and its financial reporting online at www.covb.org. The city’s CAFRs for2008 and other years can be found under ‘‘City Departments—Finance.’’ Management’s discussion and analysis inthe 2008 CAFR provides an introduction to and overview of the financial statements discussed in this and subsequentchapters.

3945

expenditures or expenses, can be prepared for each individual fund. However, governmentsmaymaintain hundreds of funds. A way is needed to summarize fund information for financialreporting so that the reports are of a manageable size but still provide useful information,including the restrictions on resources that funds represent. One possibility is simply tocombine or aggregate the funds—add them together without adjusting for interfund activitiesand balances. Another is to consolidate the funds—add them together, but eliminate interfundactivities and balances—and prepare financial statements for the government as a singleeconomic entity.

WHAT IS GASB STATEMENT NO. 34?.............................................................................................................

After years of considerable debate, the GASB issued its Statement No. 34, Basic FinancialStatements—andManagement’s Discussion and Analysis—for State and Local Governments, in June1999. Upon its release, the GASB chairman characterized Statement No. 34 as ‘‘the mostsignificant change in the history of governmental accounting.’’2 The GASB’s goal withStatementNo. 34 was to update the financial reporting requirements for governments in waysthat would further the objectives of financial reporting established in Concepts StatementNo. 1 and that would result in more useful information for the various groups of users ofgovernment financial reports.

Much of the debate centered on whether governments should prepare combined,fund-based financial statements or, instead, consolidated financial statements for the gov-ernment as a whole, similar to the financial statements of businesses. An important part of thisdebate was whether the statements should focus on current financial resources and use themodified accrual basis of accounting, or focus on all economic resources (including capitalassets) and use the full accrual basis of accounting.

The GASB concluded that the objectives of financial reporting established in ConceptsStatement No. 1 could not all be achieved by using either fund-based reporting or consoli-dated financial statements alone; nor could they all be achieved using a single measurementfocus and basis of accounting. For example, recall the discussion in Chapter 1 about theconflict between the objectives of reporting on budgetary and fiscal compliance as opposed toreporting on interperiod equity. Realization of the compliance objective requires financialstatements prepared on a budget or near-budget basis (i.e., a cash basis or a modified accrualbasis), but fulfillment of the interperiod equity objective requires financial statements on a fullaccrual basis, with a focus on economic resources.

FISCAL VERSUS OPERATIONAL ACCOUNTABILITY According to Concepts StatementNo. 1, the overriding objective of all financial reporting is accountability. The GASBconcluded that accountability has different forms that reflect variations in users’ informationneeds. Traditionally, governmental funds have focused on fiscal accountability, whereas thefocus of the proprietary (business-type) funds has been on operational accountability. TheGASB defines the two types of accountability as follows:

� Fiscal accountability is the responsibility of governments to justify that their actions in thecurrent period have complied with public decisions [e.g., the legally adopted budget]concerning the raising and spending of public monies in the short term (usually onebudgetary cycle or one year).

� Operational accountability is governments’ responsibility to report the extent to which theyhave met their operating objectives efficiently and effectively, using all resources

2GASBNews Release, ‘‘GASB Releases New Standard ThatWill Significantly Change Financial Reporting by Stateand Local Governments,’’ June 30, 1999.

40 CHAPTER 3 / GOVERNMENT FINANCIAL REPORTING

46

available for that purpose, and whether they can continue to meet their objectives for theforeseeable future.3

The GASB concluded that to meet users’ needs for short-term financial information andbudgetary comparisons, the governmental funds should focus on fiscal accountability, andthat the modified accrual basis of accounting, with a measurement focus on current financialresources, is appropriate for that purpose. Proprietary funds should focus on operationalaccountability (all economic resources), using the full accrual basis. However, governmentsshould also prepare consolidated financial statements to provide information on the financialposition and operating results of the government as a single economic entity. That is, theconsolidated financial statements should provide operational accountability information forboth governmental and proprietary activities, and therefore should focus on economicresources, using the full accrual basis of accounting. The GASB also concluded that fiduciaryactivities (such as pension trust funds) should be excluded from the consolidated statements(but should be reported in fund statements), because trust and agency resources belong to thebeneficiaries of the trust or agency relationship. Thus, they should not be included inassessments of the government’s financial position.

WHATARE THE REQUIRED BASIC FINANCIAL STATEMENTS?.............................................................................................................

Statement No. 34 mandates that governments’ basic financial statements (those required forcompliance with generally accepted accounting principles, or GAAP) include two separatebut related sets of financial statements. The first set, the government-wide financial statements,concentrates on the government as a whole. It consolidates all of a government’s ownoperations (excluding its fiduciary activities) and includes within its measurement focus all ofthe government’s economic resources, including capital assets. The statements are presentedon a full accrual basis. Tables 3-1 and 3-2 (discussed later in the chapter) illustrate thegovernment-wide statements of Vero Beach, Florida.

The second set, the fund financial statements, views the government as a collection ofseparate funds grouped into three categories: governmental, proprietary, andfiduciary funds. Aseparate financial statement is presented for each category, and each statement has multiplecolumns if there is more than one fund in each category. However, governments are notrequired to include a separate column for each fund they maintain in each category. Thegovernmental and proprietary funds statements focus on the major funds. For example, thegovernmental funds statement includes one column for the general fund (always consideredmajor), one for each of the other major funds (whether they are special revenue funds, capitalprojects funds, or debt service funds), and one for all nonmajor funds combined. Although thefund statements include ‘‘totals’’ columns, they combine rather than consolidate the funds.Hence, interfund items (such as receivables and payables or transfers from one fund to another)are not eliminated.

Proprietary funds are maintained on a full accrual basis and measure all economicresources. Governmental funds, however, focus on current financial resources and use amodified accrual basis of accounting.Therefore, to prepare their government-wide statements,governments must adjust the governmental fund statements to the full accrual basis. (They donot, of course, have tomaintain two sets of books.) StatementNo. 34 requires that a summary ofthe principal adjustments be presented with the statements, so that users can more readilyunderstand the relationship between the fund statements and the government-wide statements.Tables 3-3 through 3-9 (discussed later in the chapter) illustrate the governmental and

3GASB Statement No. 34, Basic Financial Statements—and Management’s Discussion and Analysis—for State and LocalGovernments (June 1999), para. 203.

WHAT ARE THE REQUIRED BASIC FINANCIAL STATEMENTS? 41

47

proprietary funds statements of Vero Beach, Florida. Fiduciary fund statements will bediscussed in Chapter 10.

As illustrated in Figure 3-1, the basic financial statements must include notes andmust befollowed by required supplementary information—which includes, for example, budget-to-actual comparisons and data relating to pension plans and certain types of risks. StatementNo. 34 also requires that governments present, along with the basic financial statements, amanagement’s discussion and analysis (MD&A). Similar in nature to the MD&A thataccompanies business financial statements, this narrative presents a brief, nontechnicaloverview of the government’s financial performance during the year and of its financialposition at year-end.

WHATARE THE GOVERNMENT-WIDE FINANCIAL STATEMENTS?.............................................................................................................

There are just two government-wide statements: a statement of net assets (or a balance sheet)and a statement of activities.

GOVERNMENT-WIDE STATEMENT OF NET ASSETS The statement of net assets (illus-trated in Table 3-1) is similar to the balance sheet of a business. However, unlike that of abusiness, it has separate columns for governmental activities, business-type activities, andtotal primary (reporting) government. If the government has component units (Vero Beachdoes not), they should be reported in an additional column or columns after the total primarygovernment column. Component units are entities (such as building or housing authorities)that are economically intertwined with the government, albeit legally separate; they will bediscussed in Chapter 11.

The governmental activities column in the statement of net assets includes consolidatedinformation (i.e., with interfund activities and balances eliminated) from the governmentalfunds (and generally also from internal service funds, as discussed later in this chapter and inChapter 9). The business-type activities column includes consolidated information from theenterprise funds. The column for the total primary government consolidates the informationreported in the governmental and business-type activities columns.

Management’s discussionand analysis

Government-widefinancial statements

Notes to the financial statements

Fund financialstatements

Required supplementaryinformation

(other than MD&A)

FIGURE 3-1 Minimum Requirements for Government Financial Reporting

Source:GASB Statement No. 34, Basic Financial Statements—andManagement’s Discussion and Analysis—for State and Local Governments (June1999), para. 7.


48

The illustrated statement is in the format ‘‘assets less liabilities equals net assets.’’ Themore traditional format, ‘‘assets equals liabilities plus net assets,’’ is also acceptable.

Consistentwith the focus on economic resources and the full accrual basis of accounting,the assets section of the statement of net assets includes both capital and financial assets. Thecapital assets, including infrastructure, such as highways and bridges, as well as land,buildings, and equipment, are generally reported net of accumulated depreciation. (Anexception will be discussed in Chapter 7.) Similarly, the liabilities section includeslong-term obligations. To highlight the proportion of government resources invested incapital assets, the net assets section of the statement distinguishes between the net capitalassets (capital assets less the obligations incurred to construct or purchase them) and the netnoncapital assets.

IMPORTANCEOF RESTRICTIONS ON NETASSETS Governments differ from businesses inthat a substantial portion of their resources is restricted for specific purposes by law or byexternal parties (such as grantors or donors). It is essential that these resources be distin-guished from those that are unrestricted and thereby available to meet all the government’sneeds. Thus, the GASB requires that net assets be displayed in three separate categories:

1. Amounts invested in capital assets (net of related debt, such as mortgages or bonded debt),which obviously cannot be spent unless the assets are sold

2. Amounts restricted for specific purposes, such as capital projects or debt service, which thuscannot be used for other purposes

3. Unrestricted amounts, which can be used for any purpose.

As shown in Table 3-1, 71% of Vero Beach’s reported net assets for governmentalactivities and 82% of its business-type net assets are either tied up in capital assets or areotherwise restricted (not usable to meet general financing needs).

GOVERNMENT-WIDE STATEMENT OF ACTIVITIES In contrast to the government-widestatement of net assets, which is similar to a business balance sheet, the government-widestatement of activities (illustrated in Table 3-2) bears little resemblance to the incomestatement of a business. At first glance, it seems quite daunting, but the logic behind it is easyto follow. The statement is particularly useful to users, such as taxpayers and other resourceproviders, who are interested in how much the government’s programs and other servicescost.

Unlike a business income statement, the aim of the activities statement is to show the netcost of each of the government’s main functions and programs.4 The net cost is the amount offunctional or program expenses that must be covered by taxes and other general revenues, incontrast to fees and charges of the function or program itself. Accordingly, the first column ofthe statement of activities reports total expenses for each program or function, subdivided, asin the statement of net assets, between governmental and business-type activities of theprimary government (and followed by expenses of component units).

The next three columns report revenues that directly help defray the expenses, such asthose from charges for services and program-specific grants. Then, two columns (one forgovernmental activities and one for business-type activities) show the difference between

4A function is a group of related activities aimed at providing a major service, whereas a program is an operation ororganizational unit directed to attain a specific purpose or objective within a function. For example, culture andrecreation is a function; programs within that function might include a library service, a parks department, and amuseum.Governments are encouraged to report by program, but theminimum level of detail required is by function.The reporting level should be the same for governmental activities reported in the government-wide statement ofactivities as it is for expenditures reported in the governmental funds (GASB StatementNo. 34, para. 39, as amended).The City of Vero Beach reports by function.

WHAT ARE THE GOVERNMENT-WIDE FINANCIAL STATEMENTS? 43

49

T A B L E 3 - 1Statement of Net Assets

CITY OF VERO BEACH, FLORIDA

STATEMENTOFNET ASSETS

September 30, 2008

GovernmentalActivities

Business-typeActivities Total

ASSETSEquity in pooled cash and investments $ 27,609,617 $ 17,672,314 $ 45,281,931Receivables:

Accounts receivable, net 180,835 15,617,105 15,797,940Accrued interest receivable 205,004 175,833 380,837Special assessment receivable 149,517 769,035 918,552

Due from other governments 622,160 882,593 1,504,753Internal Balances - - -Inventories 113,537 6,801,027 6,914,564Prepaid expenses - 6,435 6,435Restricted assets:

Equity in pooled cash and investments - 12,664,488 12,664,488Net pension obligation asset 1,471,761 - 1,471,761

Capital assets (net of accumulated depreciation)

Land - non-depreciable 12,820,931 10,140,182 22,961,113Buildings 7,293,329 94,893,462 102,186,791Improvements other than buildings 1,062,591 68,026,056 69,088,647Machinery and equipment 2,981,485 57,649,934 60,631,419Infrastructure 10,623,961 - 10,623,961Construction in progress 1,638,367 9,600,756 11,239,123

Power plant emission credits - 438,525 438,525Unamortized bond costs - 626,902 626,902

Total assets 66,773,095 295,964,647 362,737,742

LIABILITIES

Accounts and contracts payable 573,385 1,992,659 2,566,044Accrued liabilities 697,315 7,808,713 8,506,028Due to other governments - 666,900 666,900Accrued interest payable - 1,120,800 1,120,800Deposits - 3,870,079 3,870,079Long-term liabilities:

Due within one year 2,515,495 4,166,776 6,682,271Due in more than one year 21,246,269 83,012,602 104,258,871

Total liabilities 25,032,464 102,638,529 127,670,993

NET ASSETS

Invested in capital assets, net of related debt 20,349,914 156,249,140 176,599,054Restricted for:

Special revenue projects 2,064,183 - 2,064,183Capital projects 6,987,162 - 6,987,162Plant replacement and renewal - 2,000,000 2,000,000Plant operations - 800,000 800,000Debt service 3,739 - 3,739Law enforcement 48,832 - 48,832Perpetual care - expendable 65,499 - 65,499Perpetual care - nonexpendable 49,630 - 49,630

Unrestricted 12,171,672 34,276,978 46,448,650Total net assets $ 41,740,631 $ 193,326,118 $ 235,066,749


50

the total expenses for each function or program and the directly attributable revenues(called program revenues). The amounts in those two columns indicate the net cost totaxpayers (amounts that must be subsidized from general revenues) of the functions orprograms.

CALCULATING THE NET COST TO TAXPAYERS For example, in Table 3-2, Vero Beach’spublic safety function reports expenses of $8.1 million (column 1) which is partially financedby specific charges for program services ($157,792, column 2) and capital grants andcontributions to the program ($10,144, column 4). This leaves approximately $8 million

T A B L E 3 - 2Statement of Activities


STATEMENTOF ACTIVITIES

For the Year Ended September 30, 2008

Program Revenues

Net (Expense) Revenue and

Changes in Net Assets

Primary Government

Function/Program Expenses

Charges for

Services

Operating

Grants and

Contributions

Capital

Grants and

Contributions

Governmental

Activities

Business-type

Activities Total

Governmental activities:

General government $ 11,452,290 $ 3,530,467 $ 306,748 - $ (7,615,075) - $ (7,615,075)

Public safety 8,094,139 157,792 - $ 10,144 (7,926,203) - (7,926,203)

Physical environment 185,442 146,996 - - (38,446) - (38,446)

Transportation 3,374,155 - - 174,437 (3,199,718) - (3,199,718)

Culture and recreation 923,899 - - 402,104 (521,795) - (521,795)

Interest on long-term debt 453,842 - - - (453,842) - (453,842)

Total governmental

activities

24,483,767 3,835,255 306,748 586,685 (19,755,079) - (19,755,079)

Business-type activities:

Electric system 96,414,156 98,489,596 22,609 660,724 - $ 2,758,773 2,758,773

Water and sewer system 16,400,519 14,392,131 264,423 904,231 - (839,734) (839,734)

Municipal airport 2,753,855 2,624,696 651 2,709,295 - 2,580,787 2,580,787

Municipal marina 1,754,468 1,652,540 1,183 - - (100,744) (100,744)

Solid waste 2,493,815 2,433,243 10,660 - - (49,912) (49,912)

Recreation 4,125,518 620,170 56,682 - - (3,448,666) (3,448,666)

Total business-type

activities

123,942,331 120,212,376 356,208 4,274,250 - 900,504 900,504

Total primary government $ 148,426,098 $ 124,047,631 $ 662,956 $ 4,860,935 (19,755,079) 900,504 (18,854,575)

General revenues:

Property taxes 5,344,705 - 5,344,705

Sales taxes 5,127,694 - 5,127,694

Utility taxes 3,792,531 - 3,792,531

Investment earnings 1,147,970 1,224,617 2,372,587

Miscellaneous 32,416 421,365 453,781

Total general revenues 15,445,316 1,645,982 17,091,297

Transfers 3,479,999 (3,479,999) -

Total general revenues and transfers 18,925,315 (1,834,017) 17,091,297

Change in net assets (829,764) (933,514) (1,763,278)

Net assets - beginning 42,570,395 194,259,632 236,830,027

Net assets - ending $ 41,740,631 $ 193,326,118 $ 235,066,749

WHAT ARE THE GOVERNMENT-WIDE FINANCIAL STATEMENTS? 45

51

(column 5) that must be financed from general revenues. Thus, the net cost of the publicsafety function to the taxpayers is $8 million.

The lower portion of the statement summarizes the taxes and other general revenues ofthe government at large—those that cannot be associated directly with specific functions orprograms and that can be used to cover the net cost of all of the government’s services. InTable 3-2, the net cost of all functions of the primary government (the City of Vero Beach) is$18.9 million (total net expense for the primary government, column 7), most of which wasfinanced from $17.1 million in general revenues (taxes, investment earnings, and otheramounts not restricted to specific functions or programs, reported in column 7 below the netexpense figure). The remaining $1.8 million of net cost reduced the government’s net assets(change in net assets, column 7) from $236.8 million at the beginning of the year to an endingbalance of $235.1 million, as reported in the statement of net assets (Table 3-1).

The government-wide statements are on a full accrual basis. Therefore, as already noted,the statement of net assets includes both capital assets and long-term debt. Correspondingly,the expenses reported in the statement of activities include charges for depreciation of capitalassets, even though they are not broken out separately.

WHATARE THE FUND FINANCIAL STATEMENTS?.............................................................................................................

The three categories of funds necessitate three sets of statements, each containing a slightlydifferent blend of statements. The following are the basic statements required for each fundcategory (illustrated in the indicated tables):

� Governmental funds:� Balance sheet (Table 3-3)� Statement of revenues, expenditures, and changes in fund balances (Table 3-5)

� Proprietary funds:� Statement of net assets (or a balance sheet) (Table 3-7)� Statement of revenues, expenses, and changes in fund net assets (Table 3-8)� Statement of cash flows (discussed and illustrated in Chapter 9)

� Fiduciary funds:� Statement of fiduciary net assets� Statement of changes in fiduciary net assets

Both statements are discussed and illustrated in Chapter 10.

GOVERNMENTAL FUNDS The general fund and each of the government’s other major fundsshould be reported in separate columns. Major funds are defined as the general fund andother funds in which total assets, liabilities, revenues, or expenditures/expenses of the fund areat least 10% of the corresponding total for the relevant fund category (governmental orenterprise) and also at least 5% of the corresponding total for all governmental and enterprisefunds combined. The remaining nonmajor governmental funds are combined into the columncaptioned other governmental funds. Tables 3-3 and 3-5 present the governmental fundsbalance sheet and statement of revenues, expenditures, and changes in fund balances for VeroBeach. The general fund is the city’s only major fund.

The governmental fund balance sheet is followed by a reconciliation (Table 3-4) of totalgovernmental fundbalances ($19.2million)with thenet assets of governmental activities ($41.7million) per the government-wide statement of net assets. A similar reconciliation (Table 3-6)ties the changes in fund balances, per the governmental fund statement of revenues, expendi-tures, and changes in fund balances ($526,125), with the change in the net assets of govern-mental activities per the government-wide statements (a reduction of $829,764).


52

Governmental Funds Balance Sheet In contrast to the government-wide statement ofnet assets, the governmental funds balance sheet (Table 3-3) uses the more traditional formatthat presents assets as being equal to liabilities plus fund balances. Recall that as indicated bythe list of long-term items in the reconciliation (Table 3-4), governmental funds focus oncurrent financial resources. (Inventories and prepaid items such as insurance—discussed inChapter 5—are considered current financial resources for reporting purposes.) Thus thebalance sheet does not include capital or other noncurrent assets. Similarly, all reportedliabilities, including deferred revenues (discussed in Chapter 4), include only amountspayable or recognizable as revenue within one budgetary cycle or one year.

Classification of Fund Balances As illustrated in Table 3-3, the City of Vero Beach hassubdivided its governmental funds balance sheet into amounts that are reserved and unreserved,rather than restricted and unrestricted, as reported in the government-wide statement of netassets (Table 3-1). A reserved fund balance is similar in concept to a restriction of resources for aspecific purpose.However, each fund (except the general fund) itself represents a restriction onthe use of the resources for which it accounts. Thus, a reservation of fund balance is, in essence,an additional restriction on fund resources. It indicates within a governmental fund the amountof the fund balance that is not available for appropriation for new expenditures, because theamount either is not expendable (e.g., is tied up in inventory) or it has been legally restricted orcommitted for specified purposes—such as, in Table 3-3, encumbrances (i.e., outstandingpurchase orders or contracts), debt service, and law enforcement. As a result, although the city’sgeneral fund has a fund balance of $9,945,121, only $9,781,447 is available for appropriation.

The fund balance classification illustrated in Table 3-3 complied with GASB standards atSeptember 30, 2008, when the City of Vero Beach prepared its governmental funds balancesheet. However, in February 2009, the GASB issued its Statement No. 54, which establishednew classifications of governmental fund balances for reporting periods beginning after June15, 2010. The GASB’s research found that many financial statement users and preparers wereconfused about the distinction between restricted net assets in the government-widestatements and reserved fund balances in the governmental fund statements. Also, govern-ments were interpreting the existing standards in different ways. As a result, the reporting offund balance information was inconsistent across governments, making it difficult forfinancial statement users to understand.

GASB StandardsGASB Statement No. 54, Fund Balance Reporting and Governmental Fund Type Definitions,requires governments to report governmental fund balances using the following classifica-tions, which reflect the relative strength of constraints on how specific amounts can be spent:

� Nonspendable fund balance comprises amounts that are not in a spendable form (e.g.,inventory) or that must be maintained intact (e.g., the principal of an endowment fund).

� Restricted fund balance comprises amounts that can be spent only for the specificpurposes stipulated by external resource providers (e.g., grantors), or constitutionally, orthrough enabling legislation (i.e., legislation that creates a new revenue source andrestricts its use). Restrictions cannot be changed or lifted without the consent of theresource providers.

� Committed fund balance comprises amounts that can be used only for the specific purposesdetermined by a formal action of the government’s highest level of decision-making authority

(continued )

WHAT ARE THE FUND FINANCIAL STATEMENTS? 47

53

Governmental Funds Statement of Revenues, Expenditures, and Changes in FundBalances Similar to the balance sheet, the governmental fund statement of revenues,expenditures, and changes in fund balances is also presented in a more traditional format thanthe government-wide statement of activities. Statement No. 34 requires revenues (discussedin Chapter 4) to be reported by major source, such as property taxes and licenses and permits.Expenditures (discussed in Chapter 5) should be reported, at a minimum, by function, such asadministrative services and public works, similar to the functional breakdown provided in thegovernment-wide statement of activities. As indicated in Table 3-5, Vero Beach goes beyondthe minimum requirements and further groups expenditures by character—i.e., expendituresfor current operations, capital outlay, and debt service.

Revenues and Expenditures versus Other Financing Sources and Uses Followingrevenues and expenditures, the statement includes a section for other financing sources and uses.Similar to revenues and expenditures, these amounts are inflows and outflows of currentfinancial resources, and thus contribute to the net change in fund balances.

However, the terms revenue and expenditure are generally used only for amounts thatincrease or decrease the net assets of the government as a whole—not just those ofindividual funds. In contrast, most other financing sources and uses affect individualfund balances but not the net assets of the government as a whole. Common examplesare interfund transfers and proceeds of debt (see Table 3-5). Interfund transfers areessentially non-repayable subsidies from one fund to another. Proceeds of debt increasea governmental fund balance, because they are an inflow of current financial resources.However, they do not increase the government’s net assets, because the government hasincurred a corresponding liability, which is reported in the government-wide statement of

(e.g., a legislature or city council). Commitments may be changed or lifted only by the sameformal action that imposed them.

� Assigned fund balance comprises amounts that the government intends to use for specificpurposes. Intent can be expressed by the governing body or by an official or entity towhich the governing body delegates the authority. In governmental funds other than thegeneral fund, assigned fund balance represents the amount that is not restricted orcommitted. This indicates that resources in other governmental funds are, at minimum,intended to be used for the purpose of that fund.

� Unassigned fundbalance is the residual classification for the general fund and comprises allamounts not included in the other classifications. Unassigned amounts are available for anypurpose.Only the general fund can report positive unassigned amounts.However, if anothergovernmental fund has a fund balance deficit, it would be reported as a negative amount inthe unassigned classification in that fund.

Governments should disclose their fund balance classification policies and procedures inthe notes to the financial statements.Thedisclosures should include the order of spendingwhenamounts for a particular purpose are available in more than one fund balance classification.

Statement No. 54 also clarifies the definitions of some governmental fund types, whichhad been subject to various interpretations. For example, it clarifies that a special revenuefund may only be established to report a revenue source (or sources) that is restricted orcommitted to a specified purpose other than capital projects or debt service. The revenuesource should constitute a substantial portion of the resources reported in the fund.

GASB STANDARDS (Continued )


54

net assets. Inasmuch as the proceeds of debt are recognized as a liability in the government-wide statements but as a financing source in the fund statements, they must be included inthe reconciliation between the two sets of statements. (See the deduction of capitalimprovement notes in Table 3-6.)

The net effect of other financing sources and uses can be to convert a potentially negativechange in fund balance resulting from an excess of expenditures over revenues to a positivechange due to the receipt of transfers or bond proceeds. Correspondingly, transfers-out canconvert an excess of revenues over expenditures into a negative change in fund balance. Vero

T A B L E 3 - 3Governmental Funds Balance Sheet


BALANCE SHEET

GOVERNMENTAL FUNDS

September 30, 2008

General

OtherGovernmental

Funds

TotalGovernmental

Funds

ASSETS

Equity in pooled cash and investments $ 10,084,994 $ 9,253,629 $ 19,338,623Accounts receivable, net 180,835 - 180,835Accrued interest receivable 85,421 51,261 136,682Special assessments receivable 23,265 126,252 149,517Due from other governments 439,047 183,113 622,160Inventories 113,537 - 113,537

Total assets $ 10,927,099 $ 9,614,255 $ 20,541,354

LIABILITIES AND FUND BALANCES

Liabilities:

Accounts and contracts payable $ 295,176 $ 254,380 $ 549,556Accrued liabilities 686,802 14,578 701,380Deferred revenues - 126,252 126,252

Total liabilities 981,978 395,210 1,377,188

Fund balances:

Reserved for:

Inventory 113,537 - 113,537Encumbrances 50,137 - 50,137Debt service - 3,739 3,739Law enforcement - 24,053 24,053Police education - 24,779 24,779Cemetery care - 115,129 115,129

Unreserved for:

General fund 9,781,447 - 9,781,447Special revenue funds - 2,064,183 2,064,183Capital projects funds - 6,987,162 6,987,162Total fund balances 9,945,121 9,219,045 19,164,166

Total liabilities and fund balances $ 10,927,099 $ 9,614,255 $ 20,541,354


55

Beach’s general fund, for example, reports a revenue/expenditure deficiency of $3.7 millionbut a positive net change in fund balance of $87,803 (Table 3-5). Users should be aware thatonly revenues and expenditures contribute to a change in the net assets of the government as awhole (a total of $1.8 million in Table 3-2).

PROPRIETARY FUNDS Proprietary Funds Statement of Net Assets The statement ofnet assets of proprietary funds (illustrated in Table 3-7) focuses on the major enterprise fundsbut also should include a column for all nonmajor enterprise funds combined5 and a columnfor all internal service funds combined. The measurement focus of proprietary funds is oneconomic resources; accordingly, the funds are accounted for on a full accrual basis. Notsurprisingly, therefore, the format of the proprietary fund statement of net assets closelyresembles that of a business balance sheet. To help users assess liquidity, assets are classified

T A B L E 3 - 4Reconciliation of the Governmental Funds Balance Sheet

to the Government-Wide Statement of Net Assets


RECONCILIATIONOF THE BALANCE SHEETTOTHE STATEMENTOFNET ASSETS

GOVERNMENTAL FUNDS

September 30, 2008

Fund balances—total governmental funds $ 19,164,166Amounts reported for governmental activities in the statement of net assetsare different because:

Capital assets used in governmental activities are not financial resourcesand, therefore, are not reported in the funds. 36,409,823

Internal service funds are used by management to charge the costs ofcertain activities, related to medical and liability insurance, to individualfunds. The assets and liabilities of internal service funds are not included ingovernmental activities in the statement of net assets. 4,391,766

A negative net pension obligation is not considered to represent a financialasset and therefore is not properly reported in a governmental fund,but is reported as a restricted asset in the government-wide statement ofnet assets. 1,471,761

Some revenues in the statement of activities that do not provide current financialresources are not reported as revenues in the funds. 126,252

Long-term liabilities are not due and payable in the current period and therefore,are not reported in the funds. These liabilities and other bond related deferredcharges are composed of the following:

Notes payable (16,070,750)Accrued compensated absences (2,775,387)Net OPEB obligation (NOO) (977,000)

Net assets of governmental activities $ 41,740,631

5Vero Beach has no nonmajor enterprise funds.


56

T A B L E 3 - 5Governmental Funds Statement of Revenues,Expenditures, and Changes in Fund Balances


STATEMENTOF REVENUES, EXPENDITURES,AND CHANGES IN FUND BALANCES

GOVERNMENTAL FUNDS


General

OtherGovernmental

Funds

TotalGovernmental

FundsREVENUES:

Taxes $ 9,769,741 $ 2,094,532 $ 11,864,273Charges for services 3,172,536 146,996 3,319,532Special assessments - 31,706 31,706Fines and forfeitures 95,746 36,434 132,180Intergovernmental 1,723,664 1,029,515 2,753,179Investment earnings 436,853 323,202 760,055Miscellaneous 86,035 - 86,035Grants 316,892 - 316,892Licenses and permits 115,056 - 115,056Rental 90,400 - 90,400Total revenues 15,806,923 3,662,385 19,469,308

EXPENDITURES:

Current:

General government 8,003,090 - 8,003,090Public safety 7,065,511 863,050 7,928,561Physical environment - 185,442 185,442Transportation 3,195,291 - 3,195,291Culture and recreation 875,843 - 875,843

Capital outlay 321,840 1,515,130 1,836,970Debt service:

Principal - 12,462,000 12,462,000Interest - 453,842 453,842Total expenditures 19,461,575 15,479,464 34,941,039

Excess (deficiency) of revenues over(under) expenditures (3,654,652) (11,817,079) (15,471,731)

OTHER FINANCING SOURCES(USES)

Transfers-in 6,980,411 13,608,592 20,589,003Transfers-out (8,734,440) (8,374,562) (17,109,002)Capital contributions - 402,104 402,104Loan proceeds 5,496,484 6,619,267 12,115,751

Total other financing sources (uses) 3,742,455 12,255,401 15,997,856

Net change in fund balances 87,803 438,322 526,125

Fund balances - beginning 9,857,318 8,780,723 18,638,041

Fund balances - ending $ 9,945,121 $ 9,219,045 $ 19,164,166


57

by whether they are current or noncurrent amounts—just as they are in the balance sheets ofbusinesses. In addition, consistent with the emphasis on restrictions previously described forgovernment-wide and governmental fund financial statements, proprietary fund net assets aresubdivided between restricted and unrestricted amounts.

Inasmuch as proprietary funds, unlike governmental funds, are accounted for on a fullaccrual basis in both the government-wide and the fund statements, the net assets section fortotal enterprise funds (Table 3-7) has the same content and amounts as the net assets sectionof the business-type activities column of the government-wide statement of net assets (Table3-1).6 Thus, no reconciliation is necessary between the fund financial statements and thegovernment-wide statements such as is required for the governmental funds.

Internal service funds, like enterprise funds, are proprietary, and are maintained on a fullaccrual basis. In the funds statements they are reported as proprietary funds, along with theenterprise funds. However, internal service fund activities typically serve the functionaldepartments (e.g., police, fire, and administration), the operations of which are consideredgovernmental. As a consequence, per Statement No. 34, internal service fund balancesgenerally are included in the governmental activities column of the government-widestatement of net assets rather than in the business-type activities column. To highlightthis change in category in the government-wide statements, the internal service funds columnin the proprietary funds statement of net assets is reported to the right of the totals column forthe enterprise funds and is captioned governmental activities.

Proprietary Fund Statement of Revenues, Expenses, andChanges inNet Assets Theformat of the operating statement for proprietary funds (illustrated in Table 3-8) is similar tothat of a business income statement. It differs, therefore, from the format of the correspondingstatement (i.e., the business activities column) in the government-wide statement of activities(Table 3-2). The fund statement separates operating revenues and expenses, such as chargesand fees for services, from nonoperating revenues and expenses, such as investment incomeand interest expense on borrowings. Thus, users are provided the information necessary todistinguish between operating income or loss and total income or loss.

Contributed Capital and Transfers The statement also distinguishes capital contribu-tions (e.g., initial infusions of resources to establish the fund) and transfers to and from otherfunds from operating and non-operating revenues and expenses. As discussed previously withrespect to governmental funds, transfers are separately reported, because they do not enhancethe government’s net assets, although they increase fund net assets. Also, the separate reportinginforms users of the extent to which enterprise funds, which users may expect to beself-supporting, are, in fact, subsidized by other funds.

FIDUCIARY FUNDS Fiduciary activities are excluded from the government-wide statements,because the assets of fiduciary funds (per the definition of this fund type) benefit organizationsor individuals other than the government itself. Therefore, per StatementNo. 34, they shouldnot be included in the financial position or operating results of the government. Thegovernment cannot use these funds for its own programs. Nevertheless, the governmentis accountable for the fiduciary activities that it carries out on behalf of others, and for theresources in these funds. Hence, governments are required to include the fiduciary funds inthe fund statements, following those of the governmental and proprietary funds. Transac-tions and reporting requirements for fiduciary funds will be addressed in Chapter 10.

6Net assets restricted for plant replacement and emergencies and net assets restricted for renewal and replacement inTable 3–7 are reported as one amount—restricted for plant replacement and renewal—in Table 3–1.


58

T A B L E 3 - 6Reconciliation of the Governmental Funds Statement of Revenues, Expenditures,and Changes in Fund Balances to the Government-Wide Statement of Activities


RECONCILIATIONOF THE STATEMENTOF REVENUES, EXPENDITURES,

AND CHANGES IN FUND BALANCES OF GOVERNMENTAL FUNDSTOTHE STATEMENTOF ACTIVITIES


Net change in fund balances—total governmental funds $ 526,125

Amounts reported for governmental activities in the statement ofactivities are different because:

Governmental funds report capital outlay as expenditures.However, in the statement of activities, the cost of those assets isallocated over their estimated useful lives and reported asdepreciation expense. This is the amount by which capital outlayexceeded depreciation in the current year.

Expenditures for capital assets $ 1,836,970

Less current year depreciation (1,675,647)

161,323

The net effect of various miscellaneous transactions involvingcapital assets (i.e. sales, trade-ins, and contributions or donations)is to decrease net assets. (26,818)

Repayment of bond principal is an expenditure in thegovernmental funds, but the repayment reduceslong-term liabilities in the statement of net assets. 12,462,000

The addition of new capital improvement notes is a revenueincluded under other financing sources in the governmentalfunds, but the addition increases long-term liabilities in thestatement of net assets. (12,115,751)

Some revenues in the statement of activities that do notprovide current financial resources are not reported asrevenues in funds. (31,706)

Some expenses reported in the statement of activities do notrequire the use of current financial resources and therefore, arenot reported as expenditures in governmental funds. (323,637)

Internal service funds are used by management to charge the costsof certain activities to individual funds. The net of the internalservice funds is reported with governmental funds. (556,373)

Changes in the net pension obligations of the government do notrequire the use of current financial resources and therefore, arenot reported as expenditures in governmental funds. (924,927)

Change in net assets of governmental activities $ (829,764)


59

TABLE

3-7

Proprietary

FundsStatem

entof

Net

Assets

CIT

YOFVERO

BEACH,FLORID

A

STATEM

ENT

OFNET

ASSETS

PROPRIE

TARYFUNDS

Sep

tember

30,2

008

Busin

ess-typeActivities—

Enterprise

Funds

ASSETS

Electric

System

Water

andSew

er

System

Municip

al

Airp

ort

Municip

al

Marin

a

Solid

Waste

Recreatio

nTotals

Govern

men

tal

Activities

Intern

alService

Funds

Curren

tAssets

Equity

inpooled

cashandinvestm

ents

$14,467

,206$

1,119,935$

1,775,662$

213,742$

95,222$

547$

17,672,314$

8,270,994

Acco

untsreceivab

le,net

ofallo

wance

forestim

ated

uncollectib

les

13,025,1

672,225,172

12,684-

354,082-

15,617,105-

Accru

edinterest

receivable

150,202

8,53117,100

--

-175,833

68,322

Special

assessmen

treceivab

le-

769,035-

--

-769,035

-

Duefro

mother

govern

men

ts-

97,425785,168

--

-882,593

-

Inven

tories

6,542,50

8215,486

-43,033

--

6,801,022-

Prep

aiditem

s4,5

13-

--

-1,922

6,435-

Restricted

Assets

-

Equity

inpooled

cashandinvestm

ents

4,248,40

5636,037

--

--

4,884,442-

Total

Curren

tAssets

38,438

,0015,071,621

2,590,614256,775

449,3042,469

46,808,7848,339,316

Noncu

rrentAssets

Restricted

Assets

Equity

inpooled

cashandinvestm

ents

6,980,04

6800,000

--

--

7,780,046-

Total

Restricted

Assets

6,980,04

6800,000

--

--

7,780,046-

Capital

Assets

Property,p

lantandequipmen

t229,642

,630107,956,533

44,544,3046,569,114

3,022,92219,755,230

411,490,73331,816

Less:accu

mulated

depreciatio

n107,193,2

7155,585,327

8,099,678914,241

2,060,5676,928,015

180,781,09920,975

122,449

,35952,371,206

36,444,6265,654,873

962,35512,827,215

230,709,63410,841

Constru

ctionin

progress

1,497,59

42,197,966

5,823,6781,500

-80,018

9,600,756-

Total

Property,P

lantandEquipmen

t,net

123,946,9

5354,569,172

42,268,3045,656,373

962,35512,907,233

240,310,39010,841

5460

Other

Assets

Power

plantem

issioncredits

438

,525

--

--

-438,525

-

Unam

ortized

bondcosts

541

,138

59,765

-25

,999

--

626,902

-

TotalOther

Assets

979

,663

59,765

-25

,999

--

1,065,427

-

TotalNoncu

rren

tAssets

131,90

6,662

55,428

,937

42,268

,304

5,68

2,37

296

2,35

512,907,233

249,155,863

10,841

TotalAssets

$17

0,34

4,663

$60

,500

,558

$44

,858

,918

$5,93

9,14

7$

1,41

1,65

9$

12,909,702

$295,964,647

$8,350,157

LIA

BIL

ITIE

S

Curren

tLiabilities(P

ayab

lefrom

Curren

tAssets)

Accountsandcontractspayable

$546

,072

$74

0,31

8$

648,55

5$

35,867

$2,28

9$

19,558

$1,992,659

$23,829

Accrued

liabilities

7,50

9,610

171,59

724

,775

11,552

40,337

50,842

7,808,713

6,515

Dueto

other

governmen

t-

666,90

0-

--

-666,900

-

Claim

spayable

--

--

--

-1,317,774

Customer

deposits

--

172,16

834

,610

-27,423

234,201

-

Compen

satedabsences

71,806

52,285

7,94

82,20

320

,700

8,760

163,702

3,690

TotalCurren

tLiabilities(Payablefrom

Curren

t

Assets)

8,127

,488

1,63

1,10

085

3,44

684

,232

63,326

106,583

10,866,175

1,351,808

Curren

tLiabilities(P

ayab

lefrom

RestrictedAssets)

Accrued

interestpayable

826,40

520

1,03

7-

93,358

--

1,120,800

-

Customer

deposits

3,63

5,87

8-

--

--

3,635,878

-

Reven

uebondsandloanspayable-curren

t3,422

,000

435,00

0-

146,07

4-

-4,003,074

-

TotalCurren

tLiabilities(Payablefrom

RestrictedAssets)

7,884

,283

636,03

7-

239,43

2-

-8,759,752

-

TotalCurren

tLiabilities

16,011

,771

2,26

7,13

785

3,44

632

3,66

463

,326

106,583

19,625,927

1,351,808

Noncu

rren

tLiabilities

Compen

satedabsences

1,29

5,92

594

3,62

114

3,44

639

,752

373,58

7158,095

2,954,426

66,603

Claim

spayable

--

--

--

-2,539,980

Bondsandloanspayable,n

etofunam

ortized

bond

discount

61,150

,000

14,398

,000

-4,51

0,17

6-

-80,058,176

-

TotalNoncurren

tLiabilities

62,445

,925

15,341

,621

143,44

64,54

9,92

837

3,58

7158,095

83,012,602

2,606,583

TotalLiabilities

78,457

,696

17,608

,758

996,89

24,87

3,59

243

6,91

3264,678

102,638,529

3,958,391

Net

Assets

Invested

incapitalassets,n

etofrelateddebt

59,374,95

339

,736

,172

42,268

,304

1,00

0,12

396

2,35

512,907,233

156,249,140

10,841

Restrictedforplantoperations

-80

0,00

0-

--

-800,000

-

Restrictedforplantreplacemen

tandem

ergencies

1,00

0,000

--

--

-1,000,000

-

Restrictedforrenew

alandreplacemen

t1,00

0,000

--

--

-1,000,000

-

Unrestricted

30,512

,014

2,35

5,62

81,59

3,72

265

,432

12,391

(262,209)

34,276,978

4,380,925

TotalNet

Assets

$91

,886,96

7$

42,891

,800

$43

,862

,026

$1,06

5,55

5$

974,74

6$

12,645,024

$193,326,118

$4,391,766

5561

TABLE

3-8

Proprietary

FundsStatem

entof

Revenues,

Expenses,

andChanges

inFund

Net

Assets

CIT

YOFVERO

BEACH,F

LORID

A

STATEM

ENT

OFREVENUES,EXPENSES,AND

CHANGESIN

FUND

NET

ASSETS

PROPRIE

TARYFUNDS

FortheYear

Ended

Sep

tember

30,2

008

Enterp

riseFunds

Electric

System

Water

andSew

erSystem

Municip

alAirp

ort

Municip

alM

arina

Solid

Waste

Recreatio

nTotals

Govern

men

talActivities

Intern

alService

Funds

Operatin

gReven

ues

Charg

esforservices

(pled

ged

assecu

rityforreven

ue

bonds)

$98,48

9,596$

14,392,131$

2,624,696$

1,652,541$

2,433,243$

620,170$

120,212,377$

6,460,139

Total

Operatin

gReven

ues

98,489,5

9614,392,131

2,624,6961,652,541

2,433,243620,170

120,212,3776,460,139

Operatin

gExp

enses

Productio

n72

,053

,7204,262,484

--

--

76,316,204-

Tran

smissio

nanddistrib

utio

n5,817,44

11,749,748

--

--

7,567,189-

Administrative

andgen

eral5,172,4

163,173,741

--

--

8,346,157-

Pollu

tioncontro

l-

2,575,410-

--

-2,575,410

-Custo

mer

service1,441,5

45-

--

--

1,441,545-

Claim

sexp

ense

--

--

--

-6,411,709

Operatin

gcharg

es-

-1,931,335

1,509,2472,321,656

3,764,3209,526,558

989,182Depreciatio

nexp

ense

6,226

,5122,674,446

822,52051,752

172,159361,198

10,308,5873,536

Total

Operatin

gExpen

ses90,711,6

3414,435,829

2,753,8551,560,999

2,493,8154,125,518

116,081,6507,404,427

Operatin

gIncome(Loss)

7,77

7,962(43,689)

(129,159)91,542

(60,572)(3,505,348)

4,130,727(944,288)

Non-O

peratin

gReven

ues

(Exp

enses)

Investm

entearn

ings

1,035,275

113,57171,907

2,5151,348

-1,224,616

387,915Interest/am

ortizatio

nexp

ense

(5,702,52

2)(1,964,690)

-(193,469)

--

(7,860,681)-

Federal

andState

gran

ts22,60

9264,423

6511,183

10,66056,682

356,208-

Miscellan

eous

199

,47225,949

76,900109,112

8,7211,211

421,365-

Total

Non-O

peratin

gReven

ues

(Expen

ses)(4,445,16

6)(1,560,747)

149,458(80,659)

20,72957,893

(5,858,492)387,915

Income(Loss)

Befo

reContrib

utio

nsandTran

sfers3,33

2,796(1,604,445)

20,29910,883

(39,843)(3,477,455)

(1,727,765)(556,373)

Capital

Contrib

utio

ns

660,724

904,2312,709,295

--

-4,274,250

-Tran

sfers-in-

--

--

3,500,4123,500,412

-Tran

sfers-out

(5,893,00

0)(867,193)

-(74,300)

(145,918)-

(6,980,411)-

Changein

Net

Assets

(1,899,48

0)(1,567,407)

2,729,594(63,417)

(185,761)52,957

(933,514)(556,373)

Net

Assets

-BeginningofPerio

d93,78

6,44744,459,207

41,132,4321,128,972

1,160,50712,592,067

194,259,6324,948,139

Net

Assets

-EndofPerio

d$

91,88

6,967$

42,891,800$

43,862,026$

1,065,555$

974,746$

12,645,024$

193,326,118$

4,391,766

5662

WHATARE NOTES AND REQUIRED SUPPLEMENTARY INFORMATION?.............................................................................................................

As with business financial statements, notes are considered an integral part of the basicfinancial statements of governments. Voluminous though they may be, notes are tooimportant to be ignored. Per Statement No. 34, and consistent with existing standards,notes should include explanations of the accounting principles used in preparing thefinancial statements, schedules of changes in capital assets and long-term liabilities,schedules of future debt service requirements, disclosures about contingent liabilities,and other information that might affect users’ interpretation of the amounts reported in thestatements themselves.

Required supplementary information (RSI) is information that the GASB requires tobe presented with, but not as part of, the basic financial statements. It includes manage-ment’s discussion and analysis (MD&A), which is presented before the basic financialstatements, as well as information (such as budgetary comparisons and pension schedules)that is presented after the notes. RSI has much in common with notes. Both includeGASB-mandated schedules and data. However, while notes are considered part of the basicfinancial statements, RSI is not. Therefore, RSI may be subject to a lower level of auditorscrutiny than notes.

BUDGETARY COMPARISONS As discussed in Chapter 1, demonstrating compliance withthe legally adopted budget is a primary objective of government financial reporting.Accordingly, Statement No. 34 requires that governments include in their annual reports,as RSI, a comparison of actual results with the budget for the general fund and with thebudget for each special revenue fund for which an annual budget has been adopted.7

Governments unable to present the information for their general and special revenue fundsbecause of significant budgetary perspective differences should present budgetary compari-son schedules as RSI based on the fund, organization, or program structure used for thegovernment’s legally adopted budget.8

TheGASB specifies the accounting principles (GAAP) to which governments must adherein reporting in their external financial reports. It does not have the authority to establishbudgetary principles, which often differ from GAAP. A comparison between the budget andactual results would not be meaningful unless the two sets of information were calculatedusing the same principles. Therefore, per Statement No. 34, the GASB requires thatgovernments present their budget versus actual comparisons on a budgetary basis and includea schedule that reconciles the actual amounts per the budgetary comparison with the GAAPamounts per the financial statements.

Budget-to-actual comparisons may demonstrate either legal compliance or managerialeffectiveness in adhering to budget estimates. Statement No. 34 requires governments topresent both their original and their final appropriated budgets, so that readers can comparethe actual results with both budgets.

Table 3-9 shows the ‘‘revenues and transfers’’ section of Vero Beach’s budget-to-actualcomparison of revenues, expenditures, and transfers for its general fund. The columnreporting the variances between actual results and the final budget is encouraged, but isnot required by GASB standards. Governments may also present a column with variancesfrom the original budget.

7Governments may elect to include the required budgetary comparison information in a statement as part of the basicfinancial statements (GASB Statement No. 34, para. 130, footnote 53).8GASB Statement No. 41, Budgetary Comparison Schedules—Perspective Differences, an amendment of GASB State-ment No. 34 (May 2003), para. 3.

WHAT ARE NOTES AND REQUIRED SUPPLEMENTARY INFORMATION? 57

63

T A B L E 3 - 9General Fund Budgetary Comparison Schedule


SCHEDULE OF REVENUES AND

TRANSFERS—BUDGET AND

ACTUAL—GENERAL FUND


Budget Amounts 2008

Variance with

Final Budget—

Positive

(Negative)Original Final Actual

Taxes:

Property taxes $ 5,257,149 $ 5,341,149 $ 5,344,703 $ 3,554

Utility taxes 2,480,000 2,480,000 2,372,305 (107,695)

Telecommunications tax 1,437,941 1,437,941 1,420,226 (17,715)

Local option gas tax 512,370 512,370 454,420 (57,950)

Local business tax 200,000 200,000 178,087 (21,913)

9,887,460 9,971,460 9,769,741 (201,719)

Licenses and Permits:

Sign permit fees 2,000 7,000 7,540 540

Burglar alarm permit fees 30,000 30,000 24,652 (5,348)

Vehicles for hire permits 1,050 1,050 960 (90)

Miscellaneous license fees 85,000 85,000 81,904 (3,096)

118,050 123,050 115,056 (7,994)

Intergovernmental Revenue:

State revenue sharing 582,991 582,991 565,518 (17,473)

State sales tax revenue 1,288,612 1,288,612 1,158,146 (130,466)

Forestry Tree Grant - 54,669 54,669 -

Hurricane FEMA Reimb - - 220,817 220,817

FDEP Grant - 31,262 31,262 -

LLE Block Grants 10,000 10,000 10,144 144

1,881,603 1,967,534 2,040,556 73,022

Charges for Services:

Planning department 60,000 60,000 57,356 (2,644)

Administrative service 3,023,510 3,023,510 3,023,510 -

Airport security 91,670 91,670 91,670 -

3,175,180 3,175,180 3,172,536 (2,644)

Fines, Forfeitures and Seizures 94,800 94,800 95,746 946

Miscellaneous Revenues:

Investment earnings 535,000 535,000 436,853 (98,147)

Rental 90,650 90,650 90,400 (250)

Miscellaneous 115,000 115,000 86,035 (28,965)

740,650 740,650 613,288 (127,362)

Total Revenues 15,897,743 16,072,674 15,806,923 (265,751)

Transfers from:

Electric revenue fund 5,893,000 5,893,000 5,893,000 -

Water and sewer revenue fund 1,085,100 1,085,100 867,193 (217,907)

Solid waste fund 169,300 169,300 145,918 (23,382)

Marina fund 74,300 74,300 74,300 -

Total transfers 7,221,700 7,221,700 6,980,411 (241,289)

Other Sources: Loan proceeds - 5,496,484 5,496,484 -

Total transfers and Other Sources 7,221,700 12,718,184 12,476,895 (241,289)

Total Revenues, Transfers

and Other Sources $ 23,119,443 $ 28,790,858 $ 28,283,895 $ (507,040)


64

WHATADDITIONAL INFORMATION DO GOVERNMENTSTYPICALLY REPORT?.............................................................................................................

In addition to the basic financial statements and RSI, many governments include in theirCAFRs combining statements for the nonmajor funds—that is, financial statements thatpresent each of the nonmajor funds in a separate column. Governments also providestatistical information relating to trends in revenues and expenditures, population, employ-ment, and property values. This expanded approach to reporting helps users better assess thegovernment’s financial position and its economic condition—its ongoing ability to provideservices and meet its obligations—by providing information that will have a direct bearing onboth the demand for the government’s services and the government’s ability to finance them.The statistical information that governments typically include in their financial reports isdiscussed in Chapters 11 and 15.


1. Distinguish between a financial statement thatcombines funds and one that consolidates them.

2. What is the GASB’s rationale for requiring twosets of financial statements, each with a differentmeasurement focus and basis of accounting forgovernmental activities?

3. How many government-wide statements arerequired? What are they?

4. In what key ways does the format of thegovernment-wide statement of activities differfrom that of a traditional income statement?

5. What are the three categories of fundstatements?

6. What is a committed fund balance in a govern-mental funds balance sheet? How does it differfrom a restricted fund balance?

7. What are internal service funds? Why are theyclassified differently in government-wide thanin fund statements?

8. What are major funds? In what keys ways aremajor funds reported differently than nonmajorfunds?

9. What are fiduciary funds? Why are they notreported in the government-wide statements?

10. How does required supplementary informationdiffer from notes to the financial statements?


3-1

1. Which of the following best describesgovernment-wide statements?

a. combined on a full accrual basis

b. combined on a modified accrual basis

c. consolidated on a full accrual basis

d. consolidated on a modified accrual basis

2. How many government-wide statements is amajor city (e.g., New York, Chicago) requiredto prepare?

a. two

b. three

c. four

d. six

3. The net assets section of a government-widestatement of net assets would typically nothave a separate category to show amountsinvested in

a. capital assets

b. unrestricted assets

c. restricted assets

d. current assets

4. Which of the following funds would not beincorporated into the government-widestatements?


65

a. enterprise funds

b. permanent funds

c. internal service funds

d. fiduciary funds

5. Which of the following funds is least likely tobe separately reported in the governmentalfunds balance sheet?

a. a general fund

b. a nonmajor special revenue fund

c. a major capital projects fund

d. a major permanent fund

6. Which of the following items is least likely tobe reported on Midlake County’s governmen-tal funds balance sheet?

a. the county courthouse

b. amounts due the internal service fund

c. amounts due from other governments

d. amounts invested in federal securities

7. How should a fund balance amount resultingfrom a city council’s formal action to acquireaudiovisual equipment for the city high schoolbe classified in a governmental funds balancesheet?

a. nonspendable fund balance

b. committed fund balance

c. unassigned fund balance

d. restricted fund balance

8. The year-end balance of inventory should bereported in a governmental funds statement asan asset and

a. assigned fund balance

b. nonspendable fund balance

c. restricted fund balance

d. unrestricted fund balance

9. Which of the following would not be shown asa revenue of the function ‘‘public safety’’ onMillburg Township’s government-wide state-ment of activities?

a. a grant from the federal government toacquire radar equipment

b. amounts charged to local funeral homes toprovide police escorts

c. an appropriation from the town council topay police officers

d. fees charged to the surrounding county toprovide services outside of township limits

10. Which of the following would most likely bereported among restricted net assets on a city’sgovernment-wide statement of net assets?

a. the balance in the city’s debt service fund

b. the amount owed to city employees forservices rendered since they received theirlast paychecks

c. the actuarial liability of the city’s pensionfund

d. the cost, less accumulated depreciation, ofthe city’s highway system

3-2

1. Internal service funds are reported as

a. business-type activities in government-widestatements and governmental funds in fundsstatements

b. proprietary funds in funds statements andgovernmental activities in government-wide statements

c. business-type activities in government-widestatements and proprietary funds in fundsstatements

d. governmental funds in funds statements andgovernmental activities in government-wide statements

2. In which of the following statements woulddepreciation not be reported?

a. internal service fund statement of revenues,expenses, and changes in fund net assets

b. government-wide statement of activities

c. capital projects fund statement of revenues,expenditures, and changes in fund balance

d. enterprise fund statement of revenues,expenses, and changes in fund net assets

3. Which of the following is ‘‘required supple-mentary information’’?

a. explanation of accounting principles used inpreparing the financial statements

b. schedule of changes in capital assets

c. budgetary comparison

d. ten-year trend of assessed property values

4. Which of the following is not required to beincorporated into the budgetary comparison?

a. expenditures per the originally adoptedbudget

b. expenditures per the amended budget

c. actual expenditures


66

d. variance between the actual expendituresand those per the amended budget

5. Management’s discussion and analysis(MD&A) is most likely to include informa-tion on

a. service efforts and accomplishments

b. market values of government-owned capitalassets

c. the condition of infrastructure assets

d. financial performance during the periodcovered by the financial statements

6. Which of the following is not one of the threemain categories of funds?

a. governmental funds

b. permanent funds

c. proprietary funds

d. fiduciary funds

7. ‘‘Major’’ funds include

a. all governmental funds plus proprietaryfunds that have fund balances greaterthan 10% of those of all proprietary fundscombined

b. the general fund, special revenue funds,capital projects funds, and debt servicefunds

c. the general fund plus all funds having assetsgreater than 50% of those of the generalfund

d. the general fund plus other funds in whichtotal assets, revenues, or expenditures/expenses of the fund are at least 10% ofthe corresponding total for the relevantfund category (governmental or enterprise)and also at least 5% of the correspondingtotal for all governmental and enterprisefunds combined

8. The assets and liabilities of nonmajor govern-mental funds would be

a. aggregated and reported in the governmen-tal funds balance sheet in a single column

b. excluded from the government-wide state-ment of net assets

c. shownonly innotes to thefinancial statements

d. reported as required supplementaryinformation

9. Which of the following would not bereported on a government-wide statementof activities?

a. a transfer of cash from the general fund tothe debt service fund

b. costs incurred by the recreation departmentfor electricity purchased from the city-owned electric utility

c. depreciation on traffic lights

d. interest on bonds issued by the electricutility department

10. Which of the following is not required to beincluded in a government’s basic financial state-ments or required supplementary information?

a. a reconciliation between proprietary fundfinancial statements and the business-typeactivities column of the government-widefinancial statements

b. a reconciliation between governmentalfund financial statements and the govern-mental activities column of the govern-ment-wide financial statements

c. a reconciliation between revenues reportedon the basis of GAAP and those reported ona budgetary basis

d. a comparison between actual expendituresand expenditures per the amended budget

3-3

Even at this early stage of the course, it is possible toreconstruct journal entries from a balance sheet.

The Sherill Utility District was recently estab-lished. Its balance sheet after one year is presentedon the next page. Note the following additionalinformation:

a. The general fund received all of its revenue—$150 million—from taxes (all collected). It hadoperating expenditures, excluding transfers toother funds, of $100 million (all paid for).

b. The general fund transferred $20 million to thedebt service fund. Of this, $15 million was torepay the principal on bonds outstanding;$5 million was for interest.

c. The district issued $130 million in bonds tofinance construction of plant and equipment.Of this, it expended $40 million.

1. Prepare journal entries to summarize all trans-actions in which the district engaged. You neednot make closing entries. Do not be concernedas to the specific titles of accounts to be debitedor credited (e.g., whether a transfer from onefund to another should be called a ‘‘transfer,’’an ‘‘expense,’’ or an ‘‘expenditure,’’ or whetherproceeds from bonds should be called ‘‘bondproceeds’’ or ‘‘revenues’’).


67

2. Comment on how the district’s government-wide (full accrual) statement of net assetswould differ from the balance sheet presented.

Sherill Utility DistrictBalance Sheet as of End of Year 1

(in millions)

GeneralFund

CapitalProjectsFund

DebtServiceFund Totals

Assets:

Cash $30 $ 30

Investments $90 $20 110

Total assets $30 $90 $20 $140

Liabilities andfund balances:

Fund balances $30 $90 $20 $140

3-4

Funds can be ‘‘consolidated,’’ but only at the risk of lost ormisleading information.The balance sheet below was adapted from the

financial statements of the Williamsburg RegionalSewage Treatment Authority (dates have beenchanged):

Williamsburg Regional SewageTreatment Authority

Balance SheetOctober 31, 2012

GeneralFund

CapitalProjectsFund

Assets:

Cash $ 751 $ 5,021

Time deposits 16,398

Due on insurance claim 9,499

Due from general fund 9,000

Due from participants 66,475 4,414

Total assets $76,725 $34,833

Liabilities and fund balance:

Accounts payable $17,725

Due to capital projects fund 9,000

26,725

Fund balance 50,000 34,833

Total liabilities and fund balance $76,725 $34,833

Fund Types

The transactions of the authority are accounted forin the following governmental fund types:

� General fund—To account for all revenues andexpenditures not required to be accounted for inother funds.

� Capital projects fund—To account for financialresources designated to construct or acquire capi-tal facilities and improvements. Such resourcesare derived principally from other municipal util-ity districts to which the Williamsburg RegionalSewage Treatment Authority provides certainservices.

1. Recast the balance sheets of the two funds intoa single consolidated balance sheet. Show sepa-rately, however, the restricted and the un-restricted portions of the consolidated fundbalance account (not each individual asset andliability). Be sure to eliminate interfund pay-ables and receivables.

2. Which presentation (the unconsolidated or theconsolidated) providesmore complete informa-tion? Explain. Which presentation might beseen as misleading? Why? What advantages,if any, do you see to the presentation that is lesscomplete and more misleading?

3-5

Consolidated balances are not substitutes for individualfund balance sheets.

The combined governmental funds balancesheet of the town of Paris is presented on the facingpage.

Per schedules included in the notes to thefinancial statements, the town had $1,450 of capitalassets (net of accumulated depreciation) and $1,315in long-term liabilities associated with the capitalassets.

1. Recast the balance sheets in the form of asingle consolidated, full accrual balance sheet.

2. Put yourself in the place of an analyst. Thetown mayor presents you with the consoli-dated balance sheet. He asserts that the town’sfinancial position is excellent, as measured bythe exceedingly ‘‘healthy’’ fund balance. Basedon the combined balance sheet that shows theindividual fund types, why might you be skep-tical of his claim?

3. Comment on why a consolidated balance sheetis no substitute for a combined balance sheetthat reports upon major funds.


68

3-6

Exploring Vero Beach’s financial reportRefer to the financial statements of the City of

Vero Beach that are included in this chapter.

1. Per the government-wide statement of activi-ties, howmuch did the city incur in expense forpublic safety? Of this amount, how much hadto be covered from general tax and otherunrestricted revenues?

2. Per the governmental funds statement of rev-enues, expenditures, and changes in fund bal-ances, how much did the city incur inexpenditures for public safety? How do youaccount for the difference between thisamount and your response to question 1?

3. Per the government-wide statement of activi-ties, what was the ending balance in net assetsassociated with governmental activities? Is thisconsistent with the government-wide state-ment of net assets?

4. How much was transferred (net) from business-type to governmental activities during the year?

5. How much in taxes did the city direct to thesupport of business-type activities?

6. Vero Beach’s statements include a schedule(Table 3-6) that reconciles its statement ofrevenues, expenditures, and changes in fund

balances of governmental funds to thegovernment-wide statement of activities.However, the city’s statements do not includea corresponding reconciliation of the state-ment of revenues, expenses, and changesin fund net assets of proprietary funds tothe government-wide statement of activities.Why not?

7. As noted in the text, government-wide state-ments areona full accrual basis, so the statementof activities includes charges for depreciation.How much did Vero Beach charge for depreci-ation on capital assets used during the year forgovernmental activities?

8. How much of the city’s governmental activi-ties assets are classified as capital? Howmuch of the city’s governmental activitiesliabilities were used to finance those capitalassets?

9. Almost 90% of the total amount of capitalassets reported in the government-widestatement of net assets are devoted tobusiness-type activities. What is the mostlikely explanation of why the proportion ofassets directed to business-type activities is somuch greater than that devoted to govern-mental activities?

Town of ParisCombined Balance Sheet

GeneralFund

SpecialRevenueFund

CapitalProjectsFund

DebtServiceFund

Permanent(Endowment)

Fund Totals

Assets:

Cash $ 38 $ 20 $ 35 $340 $ 10 $ 443

Investments 105 60 480 136 960 1,741

Due from other funds — 120 46 39 — 205

Total assets $143 $200 $561 $515 $970 $2,389

Liabilities and fundbalances:Accounts payable $ 8 – – – – $ 8

Due to other funds 205 – – – – 205

Fund balances (70) $200 $561 $515 $970 2,176

Total liabilities andfund balances

$143 $200 $561 $515 $970 $2,389


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