chap003 (2)
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Essentials of Accounting for
Governmental andNot-for-Profit Organizations
Chapter 3
Modified Accrual Accounting:Including the Role of Fund Balances and
Budgetary Authority
McGraw-Hill/Irwin Copyright 2010 by The McGraw-Hill Companies, Inc. All rights re
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Overview of Chapter 3
The basic accounts used by governmentalfunds.
Recognition criteria for revenues andexpenditures under the modified accrualbasis.
Fund balance classifications forgovernmental funds.
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Modified Accrual Accounting
The modified accrual basis is a distinctsystem of accounting that contains financial
statement elements that appear nowhereelse.
Among these are expenditures and fundbalances.
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Modified Accrual Accounting
Although, revenues appear in the financialstatements of accrual and modified accrual
funds, revenues follow different recognitioncriteria between the two bases.
Finally, there are no expenses in modifiedaccrual funds
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Account Structure Permanent AccountsAccounts that are not closed at year end
(Balance Sheet)
Assets:Cash and Cash Equivalents
InvestmentsReceivables: -
Taxes ReceivableAccounts ReceivableDue from Other Governments
Supplies Inventories
Restricted Assets (typically cash)
Liabilities:Accounts Payable
Accrued LiabilitiesDeferred Revenues
Fund Balances:NonspendableRestrictedCommitted
AssignedUnassigned
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Account Structure - Nominal AccountsAccounts that are closed at year end
Budgetary Accounts
Financial Statement Activity Accounts
Estimated RevenuesAppropriations
Estimated Other Financing SourcesEstimated Other Financing UsesEncumbrances
RevenuesTax Revenues
Charges for ServicesExpenditures Current
Capital OutlayDebt Service
Other Financing Sources
Transfers InDebt Proceeds
Other Financing Uses Transfers Out
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Assets and Liabilities
Modified Accrual Funds use the CurrentFinancial Resources Measurement Focus
Generally speaking, the assets represent cashand assets that may be expected to be convertedinto cash in the normal course of operations. (nolong-term assets)
Similarly, these funds report only those liabilitieswhich will be settled with current financialresources. (no long-term liabilities)
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Fund Balance - interpretation
Since only current financial resources and claims againstthose resources are recognized in these funds, thedifference between assets and liabilities (fund balance)
represents the net resources of the fund that are currentlyavailable for future spending.
However, even current financial resources vary in theextent to which government managers have discretion
over their future use and this is reflected by assigningfund balance to five categories (nonspendable, restricted,committed, assigned and unassigned).
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The objective of Statement No. 54 is toprovide clearer fund balance classifications.
Users want to know whether the use of amountsreported in governmental funds is constrained andhow binding those constraints are.
GASB 54 Establishes theReporting of Fund Balances
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Statement No. 54 affects only fund-basisstatements of the Governmental Type
funds Does not affect reporting of Net Assets by Proprietary
or Fiduciary Funds
Does not affect reporting of Net Assets ofGovernmental Activities in the government-widestatements.
GASB 54 Fund BalancesFinancial Statements
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Fund balances of governmental type funds
are reported within 5 categories Nonspendable
Restricted
Committed
Assigned
Unassigned
GASB 54 Fund BalancesSummary
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Two Step Process Step 1:
Identify those fund resources that are
Nonspendable Nonspendable resources include:
Inventories and prepaids (also incudes assets held for sale andlong-term receivables)
The principal (corpus) of a Permanent Fund
Two Step ProcessStep 1: Nonspendable resources
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Step 2: Spendable Resources
All remaining net resources of a fund after
removing those determined to beNonspendable
- Spendable resources are further classified
according to the nature of any constraintsimposed on their use, using a hierarchy ofconstraints
Two Step ProcessStep 2: Spendable resources
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Restricted Funds
Committed Funds
Assigned Funds
Unassigned Funds
GASB 54 Fund BalancesConstraint Heirarchy
No Constraint
Most constrained
(General Fund)
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RestrictedRestricted : Constraints placed on the useof resources are: Externally Imposed (debt covenant, grantor,
contributors, or other governments)
Imposed by law (constitutionally or enablinglegislation)
i.e. enforceable requirement that resources be
used only for specified purposes
Constraint Hierarchy:Restricted FundsRestricted Funds
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In general, the definition of restricted fund balanceis nearly identical to that of restricted net assets in theGovernment-wide Statements Exception is Permanent Fund Principle which is classified as
Nonspendable in the governmental funds
Constraint Hierarchy:Restricted FundsRestricted Funds
Government -WideStatement of Net Assets
Fund-BasisGovernmental
Funds Balance Sheet
Net assets restricted $ xxx Restricted fund balance $ xxx
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Committed:Committed: Constraints placed on theuse of resources by:
The formal action of the governments highest level of
decision making authority.
GASB 54 specifically identifiesContractual Obligations as one form ofcommitted resources
Constraint Hierarchy:Committed FundsCommitted Funds
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Statement 54 also provides guidance on the classification ofbudgetstabilization orrainy dayfunds Such stabilization amounts that meetcertain criteria are classified as committed or (less commonly)restricted, if imposed externally or by law.
Rainy day funds are classified as committed only if they are created bya resolution or ordinance that identifies the specific circumstancesunder which the resources may be expended. Rainy day amounts that are available in emergencies or in periods of revenue
shortfalls would not be classified as committed unless the emergency or shortfallcondition is specified and of a magnitude to distinguish it from events that occurroutinely.
Rainy day funds not meeting these conditions are reported as unassigned fundbalance in the General Fund.
Constraint Hierarchy:Rainy Day FundsRainy Day Funds
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AssignedAssigned: The government has anexpressed intent to use resources forspecific purpose:
For governmental funds other than the General Fund,this is the category for all remaining (positive) amounts.
For the General Fund, assignment conveys a narrowerintended use than the general purposes of thegovernment
Constraint Hierarchy:Assigned FundsAssigned Funds
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Unassigned:Unassigned: Residual classification ofthe General Fund
Only the General Fund can report a positive unassignedfund balance
For other governmental funds this is used only for anegative fund balance (in any of the previous 3 constraint
categories)
Constraint Hierarchy:Unassigned FundsUnassigned Funds
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Classification: Step 1 CITYBalance Sheet
Governmental Funds
As of December 31, 2009
General SpecialRevenue Capital Projects Debt Service Permanent
ASSETS Fund Fund Fund Fund Fund
Cash and cash equivalents 6,408,214 627,837 895,300 230,000 25,366
Investments 3,312,992
Receivables (net)
Taxes receivable 2,872,611
Accounts Receivable 679,215 14,177
Due from Other Governments 1,085,184 243,264
Supplies Inventory 23,747
Restricted Assets 3,933,126
TOTAL ASSETS 18,315,089 642,014 1,138,564 230,000 25,366
Are there assetsnot in spendable
form? e.g.Inventory &prepaids
Required tomaintain
permanent fundcorpus?
No
Proceed tospendablecategories
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Classification: Step 1 CITY
Balance Sheet
Governmental Funds
As of December 31, 2009
General SpecialRevenue
Capital Projects Debt Service Permanent
ASSETS Fund Fund Fund Fund Fu
Cash and cash equivalents 6,408,214 627,837 895,300 230,000 25,366Investments 3,312,992
Receivables (net)
Taxes receivable 2,872,611
Accounts Receivable 679,215 14,177
Due from Other Governments 1,085,184 243,264
Supplies Inventory 23,747
Restricted Assets 3,933,126
TOTAL ASSETS 18,315,089 642,014 1,138,564 230,000 25,366
LIABILITIES
Assume the permanent fundcorpus is $ 25,000.
yes
Assets not inspendable form?
Inventory &prepaids
Required tomaintain
permanent fundcorpus?
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Classification:Step 2a (Restricted Funds)
Are restrictionsimposed by outsidecreditors, grants, or
imposed by law?
Assume the following: Bond sinking fund Federal school lunch grant State highway grant
yes
CITY
Balance Sheet
Governmental Funds
As of December 31, 2009
General Special Revenue Capital Projects Debt Service Permanent
ASSETS Fund Fund Fund Fund
Cash and cash equivalents 6,408,214 627,837 895,300 230,000 25,366
Investments 3,312,992
Receivables (net)
Taxes receivable 2,872,611
Accounts Receivable 679,215 14,177
Due from Other Governments 1,085,184 243,264
Supplies Inventory 23,747
Restricted Assets 3,933,126
TOTAL ASSETS 18,315,089 642,014 1,138,564 230,000 25,366
LIABILITIES
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Classification:Step 2b (Committed Funds)
Has city councilformally committed
funds to specificactivities?
Assume the following: Construction contracts School construction funds Rainy day reserve
yes
CITY
Balance Sheet
Governmental Funds
As of December 31, 2009
General Special Revenue Capital Projects Debt Service Permanent
ASSETS Fund Fund Fund Fund
Cash and cash equivalents 6,408,214 627,837 895,300 230,000 25,366
Investments 3,312,992
Receivables (net)
Taxes receivable 2,872,611
Accounts Receivable 679,215 14,177
Due from Other Governments 1,085,184 243,264
Supplies Inventory 23,747
Restricted Assets 3,933,126
TOTAL ASSETS 18,315,089 642,014 1,138,564 230,000 25,366
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Classification:Step 2c (Assigned Funds)
Are there positiveresidual balances
in non-General FundGovernmental funds? yes
CITY
Balance Sheet
Governmental Funds
As of December 31, 2009
General Special Revenue Capital Projects Debt Service Permanent
ASSETS Fund Fund Fund Fund
Cash and cash equivalents 6,408,214 627,837 895,300 230,000 25,366
Investments 3,312,992
Receivables (net)
Taxes receivable 2,872,611
Accounts Receivable 679,215 14,177
Due from Other Governments 1,085,184 243,264
Supplies Inventory 23,747
Restricted Assets 3,933,126
TOTAL ASSETS 18,315,089 642,014 1,138,564 230,000 25,366
LIABILITIES
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Classification:Step 2c (Assigned Funds)
Are there specificresources in the
General Fund that areintended for identified
purposes?
yes
Assume the government hasoutstanding encumbrances forthe following: Library acquisitions
Other capital projects
CITY
Balance Sheet
Governmental Funds
As of December 31, 2009
General Special Revenue Capital Projects Debt Service Permanent
ASSETS Fund Fund Fund Fund
Cash and cash equivalents 6,408,214 627,837 895,300 230,000 25,366
Investments 3,312,992
Receivables (net)
Taxes receivable 2,872,611
Accounts Receivable 679,215 14,177
Due from Other Governments 1,085,184 243,264
Supplies Inventory 23,747
Restricted Assets 3,933,126
TOTAL ASSETS 18,315,089 642,014 1,138,564 230,000 25,366
LIABILITIES
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Classification:Step 2d (Unassigned Funds)All negative restricted,committed, or assigned
net resources areclassified asUnassigned.
The remaining netresources of the
GeneralFund are classified as
Unassigned
CITY
Balance Sheet
Governmental Funds
As of December 31, 2009
General Special Revenue Capital Projects Debt Service Permanent
ASSETS Fund Fund Fund Fund Fun
Cash and cash equivalents 6,408,214 627,837 895,300 230,000 25,366
Investments 3,312,992
Receivables (net)
Taxes receivable 2,872,611
Accounts Receivable 679,215 14,177
Due from Other Governments 1,085,184 243,264
Supplies Inventory 23,747
Restricted Assets 3,933,126
TOTAL ASSETS 18,315,089 642,014 1,138,564 230,000 25,366
LIABILITIES
Accounts payable 2,085,358 70,000 207,134
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Classification CompletedGeneral Special
RevenueCapital
ProjectsDebt Service Permanent
FUND BALANCES Fund Fund Fund Fund Fund
Nonspendable
Supplies Inventory 23,747
Permanent fund principal 25,000
Restricted
Bond Sinking Fund 200,000
School lunch grant 370,000
Highway grant 302,000
Committed
Construction Contracts 120,000
School construction 450,000
Rainy Day Funds 3,500,000
Assigned
School lunch program 202,014
Ca ital ro ects 95 000 40 032
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GASB 54 Fund BalancesEncumbrances Encumbrances
Under past reporting practices, outstanding encumbrances at yearend were reported in the governmental funds as fund balance:reserve for encumbrances. Statement 54 requires that significant encumbrances be disclosed in the notes
along with required disclosures about other commitments.
However, there is no separate reporting of encumbrances withinthe fund balance section of the governmental funds balance sheet.
Rather, encumbered resources should be reported within the restricted,committed or assigned categories in a manner consistent with the criteria forthose classifications.
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GASB 54 Fund BalancesEncumbrances
Encumbrances Interpretation At the very least, the existence of an encumbrance suggests that the
government has an expressed intent to use resources for a particular purpose
and therefore these resources should not be classified as unassigned.
Encumbrance accounting may also be used in the case of contractualobligations, such as construction contracts. Statement 54 requires thatresources obligated to contractual obligations be classified as committed.
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GASB 54 Fund BalancesNegative balances
Negative Balances Statement 54 does not permit the reporting ofnegative
restricted, committed or assigned fund balances. If this occurs,
the government should reduce any assigned fund balances (inthat fund) by the amount of the negative balance. The rationale is that if expenditures exceed restricted or
committed resources, then funds have in effect beenreallocated to the purpose used.
If a deficit remains once all assigned fund balances are zero,the remaining negative amount should be reported asunassigned fund balance.
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Activity Accounts Sources of funds
Other Financing Sources include transfers infrom other funds and the proceeds of long-termborrowing.
Revenues are defined as all other inflows andinclude taxes, charges for services, andamounts provided by other entities such as the
state or federal government.
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Activity Accounts Uses of funds
Expenditures are recognized when a liability isincurred that will be settled with current financialresources in the fund. Expenditures may be for
salaries (current), land, buildings or equipment(capital) or for payment of interest and principalon debt (debt service).
Transfers out of a fund to other funds areclassified as Other Financing Uses.
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Classification of Inflows andOutflows on Budget Schedule
Revenues are classified by source Where the money came from: taxes, licenses and
permits, charges for service, etc
May be subdivided further such as by type of tax,sometimes shown in separate schedule
Expenditures and Encumbrances may beclassified by function, program, department, activity, character, or
object
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Outflow Classifications
Character groupings are always: CURRENT,CAPITAL OUTLAY, and DEBT SERVICE
Current are typically classified by function:General government, public safety, streets and highways
Public safety could be subdivided by department: Policeand fire Police could be subdivided further by activity: Traffic and
drug enforcement Activities in the traffic area could be divided into objects ofexpenditure: Policemans salary, gas for automobiles
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Budgetary Accounting
GASB standards require governments to present acomparison of budgeted and actual results for theGeneral Fund and special revenue funds with legally
adopted budgets. While GASB standards guide the format of this
comparison, the GASB does not prescribe budgetaryaccounting practices and does not require governmentsto maintain budgetary accounts.
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Recording Budgets
Although budgetary accounts do not appear in thegeneral purpose financial statements, governmentstypically record budgets and governmental accounting
systems are designed to assure compliance withbudgets.
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Budgetary Accounts
Revenues to be raised pursuant to law during abudget period are set forth in an EstimatedRevenues budget.
An Appropriation, when enacted into law, is the legalauthorization for the government to incur liabilities forpurposes specified in the appropriations statue orordinance.
Estimated Other Financing Sources and EstimatedOther Financing Uses are budgetary accountsreflecting anticipated inflows and outflows of resourcesfrom sources other than revenues and expenditures
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Encumbrances
When a purchase order or contract is issued asauthorized by an appropriation, the governmentrecognizes this commitment as an
Encumbrance. An encumbrance is not a liability since the goods or
services have merely been ordered, not received.
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Encumbrances
Commitments are reflected in the budgetaryaccounts through the recording ofEncumbrances and the corresponding
Budgetary Fund Balance - Reserve forEncumbrances.
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Expenditure Cycle
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Encumbrance to Expenditure
Once goods or services are received, the governmenthas a liability. At this point, two journal entries arenecessary.
The first reverses the encumbrance at its original amount.Since the government has incurred an actual liability, it is nolonger necessary to reflect a commitment for the outstandingpurchase orders or contracts.
The second entry records the liability (Accounts Payable) and
an Expenditure in the amount of the invoice.
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Why Record Encumbrances? In business accounting, orders are not
entered into the general ledger Governments recognize that an outstanding order will
turn into an expenditure and a liability when the goodsarrive
To prevent over-spending, outstanding orders areentered into the books
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Encumbrance Example
Place an order for $150,000 which consists of three mini-busescosting $50,000 each. Recorded as:
Encumbrances 150,000Budgetary Fund Balance -Reserve for Encumbrances 150,000
Assume two of the buses arrive, but with freight, they cost $102,000instead of $100,000. First, reverse a part of the encumbrances:
Budgetary Fund Balance -Reserve for Encumbrances 100,000
Encumbrances 100,000 Second, record the actual amount of expenditure:
Capital Expenditure 102,000Accounts Payable 102,000
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Accounting for Revenues
Since taxes and many other revenues do notinvolve exchange transactions, governmentscannot determine the point at which these
revenues are earned. Therefore revenue recognition occurs when the
resulting resources are deemed to be bothmeasureable and available to finance expenditures
of the current period.
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Revenue Recognition
Nonexchange transactions are transactions in which agovernment receives resources without directly givingequal value in exchange.
The most common forms of nonexchange transactionsare tax revenues and intergovernmental grants.
Before a government may recognize revenue resultingfrom nonexchange transactions, it must meet a number of
eligibility requirements.
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Eligibility RequirementsNon-Exchange Revenues Required Characteristics of Recipients. The recipient must have
the characteristics specified by the provider.
Time Requirement. If time requirements (for expenditure) arespecified by the resource provider or legislation, those time
requirements must be met Reimbursement. For those grants and gifts that are payable only
upon the incurrence of qualifying outlays, revenues would berecognized only when the expenditures have been incurred.
Contingencies. Resources pledged that have a contingency
attached are not recognized as revenue until the contingency hasbeen met.
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Types of Nonexchange Transactions
1. Imposed nonexchange revenuesproperty tax, special assessments, fines/forfeits
1. Derived tax revenuessales, income, motor fuel taxes
1. Government mandated transactionsfederal government requires lower levelexpenditures
1. Voluntary nonexchange transactionsgrants, donations
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Imposed Nonexchange Revenue Taxes and other assessments that do not result
from an underlying transaction.
Examples include property taxes and special assessmentsimposed on property owners. Also includes fines and forfeits.
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Modified AccrualBasis Recognition
Record the receivable (and an allowance foruncollectibles) when an enforceable claim exits.
Revenues should be recognized in the period forwhich the taxes are levied (i.e. budgeted), but arealso subject to the 60 day rule. Revenues
expected to be collected > 60 days after year-endare deferred.
1. Property taxes levied
2. Deferral of portion
expected to be collected >60 days after year end
1. Taxes Receivable Dr
Estimated Uncollectible Taxes ...Cr
Revenues Control .Cr
2. Revenues Control DrDeferred Revenues Property Taxes Cr
Imposed Nonexchange Revenue
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Derived Tax Revenues
These are taxes assessed on exchangetransactions conducted by businesses or
citizens. Examples include sales, income, and excise taxes.
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Revenue Recognition Modified Accrual
Record the receivable when the taxpayers underlyingtransaction takes place.
Revenues should be recognized when available andmeasurable. Revenues not expected to be collected intime to settle current liabilities are deferred (i.e. available
and measurable criteria).1. Income tax withholdingsare received.
2. Additional income taxesexpected to be received
after year end. Part of thiswill not be received in timeto be avail-able for currentliabilities.
1. Cash .Dr
Revenues Control Cr
2. Taxes Receivable .Dr
Revenues Control Cr
Deferred Revenues Income Taxes Cr
Derived Tax Revenue
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Government MandatedNonexchange Transactions
These are commonly grants from higher levelsof government (federal or state) given to supporta program. Since the program is required, the lower-level
government has no choice but to accept. For example, a state may require schools to mainstream
certain students and provide funds to carry out thismandate.
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Voluntary NonexchangeTransactions
These include donations and grants given to
support a program.
Since the program is not required, the receivinggovernment voluntarily agrees to participate.
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Revenue Recognition Modified Accrual
Record the receivable and the revenue when alleligibility requirements have been met.
Many of these are reimbursement grants. In thiscase, revenue is recognized only when qualifiedexpenditures have been incurred.
Reimbursement typegrants
1. Expenditures Control ..Dr
Accounts Payable/Cash ..Cr
2. Due from grantor Dr
Revenues Control Cr
Government-Mandated and VoluntaryNonexchange Revenues
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Revenue Recognition Modified Accrual
Advance receipts are deferred until expendituresare incurred. Revenue recognition is subject tothe available and measurable criteria.
Advance fundedgrant:
1. Receipt of advancefunding.
2. Incur qualified
expenditures and recognizerevenue.
1. Cash DrDeferred Revenues Grants ..Cr
2a. Expenditures Control ...Dr
Accounts Payable/Cash ..Cr
2b. Deferred Revenues Grants .. Dr
Revenues Control Cr
Government-Mandated and VoluntaryNonexchange Revenues
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Recording the budget
Estimated Revenues 12,000,000
Estimated Other Financing Sources 500,000
Appropriations 11,700,000
Estimated Other Financing Uses 250,000
Budgetary Fund Balance 550,000
In the above entry, Budgetary Fund Balance is the expected change in fundbalance assuming actual amounts are exactly as budgeted. It may be
either a credit (or less frequently) or debit balance in the entry.
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Budget Revisions
Budget revisions may benecessary during the yeardue to changes in revenueprojections or operatingconditions for example,electricity price increases,decrease in sales taxesdue to low consumer
spending
Budget revisions usuallyare taken back to theappropriate legislativebody for approval,although somejurisdictions may allowsome percentage of thebudget to be transferred
between accounts
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Recording a budget revision
Budgetary Fund Balance 150,000
Appropriations 70,000
Estimated Revenues 80,000
In the above entry, the budget reflects a decrease in estimated revenues of$ 80,000 and an increase in appropriations of $ 70,000.
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Budgetary Comparison Schedule
Both the original and the final adjusted budgetis shown
The revised appropriations are compared to
the Actual Expenditures for the current periodplus Outstanding Encumbrances
A variance column is typically shown, but isoptional
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Budgetary Comparison Schedule
The actual columnshould use the basis of
accounting assumed inthe budget. This maybe different than GAAPbasis
Another schedule willreconcile the actual
figures on thebudgetary vs. GAAPbasis