FUND BALANCE DESIGNATIONS

Thomas E. Delaney, CPA Pamela W. Baker. CPA

PASBO Accounting Committee Members

Q. Who should designate a fund balance (ie. the local school board or the

administration)?

As background, if only administrators make designations they can affect and limit a school board's right to set the property tax levy. A tax levy in Pennsylvania can be adjusted by using unreserved fund balance. A tax levy in Pennsylvania cannot be adjusted by applying designated or reserved fund balances. If administrators, by themselves, are allowed to independently make fund balance designations, then they would have the ability to change the amount of unreserved and available fund balance available to the school board for tax levy, and subvert the intent of the state legislature.

A. Per GASB Project Manager, Dean Michael Mead (GASB) There is no official literature that answers your question about who can make designations. Common sense suggests that it is the body or person that is ultimately accountable for the financial statements and/or who has the power to adopt and modify the budget. I am not familiar with Pennsylvania school districts in particular, but it has always been my assumption that that body is the School Board, and that the administrators of the school district work for the Board. Therefore, designations might be suggested by the finance officer, but ultimately the Board must accept the recommendation. I stress that this is not a hard and fast rule, and certainly is not part of the literature – it just makes sense. Regardless of what one thinks the answer is, one possible reporting solution may be to report designations by the Board as "Board designations" and thereby make a distinction from designations initiated by the administrators. Governments are welcome to include as much detail about designations as they wish, since designations are not required. However, I repeat that if the Board is ultimately responsible for the financial statements, then all designations would ultimately be Board designations because the Board would have to agree to their presence on the balance sheet.

PDE ACCOUNTING MANUAL In the old state accounting manual, designated fund balance is described as "An unreserved fund balance designation may be established and reported to indicate tentative plans to use financial resources in a future period. Two examples include but are not limited to contingencies or replacement equipment. Designations represent School Board approved plans or intent that may never be legally authorized or result in expenditure. Therefore, designations are clearly distinguished from reserves and are available to fund other expenditures." Accounting Manual Accounts Fund Balance Reserves 0751 - Std. Reserve for Inventory 0752 - Std. Reserve for Prepayments 0753 - Std. Reserve for Encumbrances Control 0760 - Specific Fund Balance Reserves

– Restricted Federal Programs – Retirement of Bonded Indebtedness

Fund Balance 770 Unreserved 771 Designated - subject to tentative management plans (Board approved), representing planned

actions, not actual commitments 772 Undesignated - available for appropriation PDE Accounting Manual Appendix A.9 Accounting For Fund Balances WHAT IS A FUND BALANCE? The equity for Governmental and Fiduciary Funds is known as a “fund balance.” The calculation for fund equity may be reduced to a mathematical equation written as: Assets – Liabilities = Fund Balance The fund balance of the General Fund is of primary significance because the General Fund is the primary fund through which most functions are financed and which includes state aid and local taxes. One primary criterion of rating agencies for school bonds is the relative amount of undesignated, unreserved fund balance. Bond rating agencies view undesignated, unreserved fund balances as a reflection of the financial strength of school districts and show concern when fund balances decrease. Governmental fund balances do not always represent cash in the bank or funds available for expenditures. Accordingly, it is necessary to determine what portions of the gross fund balance pertain to: __ Reserved fund balances; __ Designated, unreserved fund balances; and __ Undesignated, unreserved fund balances.

Fund balances are divided into two (2) parts: “reserved” and “unreserved.” A Reserved Fund Balance identifies the part of the fund balance not available for appropriation. Unreserved Fund Balance identifies the part that is available for appropriation. The elements of a fund balance are shown on exhibit 1. The equity for Proprietary Funds is not classified as a fund balance. It is divided instead into “contributed capital” and “retained earnings.” The Proprietary Fund retained earnings is comprised of reserved and unreserved retained earnings. The term “retained earnings” is used because these funds measure profit and loss and are operated like a business. PDE Accounting Manual Appendix A.10 Reserved Fund Balances The term “reserve” should be used in governmental fund financial reporting only to identify the portion of the fund balance that is: Not available for appropriation or expenditure (for example, reserve for inventories) and / or legally earmarked for a specific future use, i.e., legal restriction on the use of assets (for example, reserve for encumbrances). For Proprietary Funds, reserves relate only to the latter item above. Generally, reserves should represent restrictions imposed by external parties of the school district. The amount and nature of the reservation of fund balance should be disclosed on the face of the financial statements. The description may need to be supplemented by disclosure in the notes to the financial statements. EXHIBIT 1 - ELEMENTS OF FUND BALANCE Undesignated Unreserved Available For Any Legal Expenditure Designated Unreserved Construction Repairs Capital Expenditures Claims and Judgments Self Insurance – Contingencies Reserved Self Insurance – Known Liability Inventories Prepaid Items Long-Term Receivables Retirement of Funded Indebtedness Outstanding Encumbrances Construction Federal and State Programs NOTE: The specific categories of designations and reservations indicated above are not all-inclusive.

PDE Accounting Bulletin #2003-02 SUBJECT: General Fund Balance Effective Immediately Date: June 9, 2003 This accounting bulletin is applicable to each Local Educational Agency (LEA) and should be followed as a normal accounting practice with regard to the General Fund Balance. As discussed in Appendix D of the Manual of Accounting and Financial Reporting for Pennsylvania Public Schools (Manual), a fund balance represents the difference between the assets and liabilities of a governmental fund. Although all governmental funds may have a fund balance, the most significant one is the General Fund. Furthermore, fund balances have two parts: reserved and unreserved, which are detailed on the balance sheet as part of the basic financial statements. The reserved portion of an LEA’s fund balance reflects funds that are not available for appropriation or expenditure. These funds are legally earmarked for a specific future use, which could include, for example, inventories, prepaid items, or reserve for encumbrances. It is important to ensure that only those funds that are legally restricted and are not available for spending be treated as reserved. The unreserved fund balance represents that portion of the fund balance that is available for appropriation; or, the current available financial resources of an LEA. For planning purposes,a part of an LEA’s unreserved fund balance may be identified as designated. This designation is established to reflect tentative plans for future use of the funds, and requires Board approval. However, designations are not the same as reserves since they do not reflect actual commitments of the funds. Therefore, if plans change, the funds may be appropriated for uses other than those originally intended if a need arises. Some examples of designated unreserved funds are construction, claims and judgments, and capital expenditures. Questions regarding this bulletin may be directed to: School Finance Division at (717) 783-9102. FAX: 717-787-3593 Contact Person: Bonnie L. Kabonick Mary Kay Beer Bureau/Div: School Finance Division School Finance Division E-mail: bkabonick@state.pa.us mbeer@state.pa.us National Center for Education Statistics The Financial Accounting for Local and State School Systems: 2003 Edition lists the "Designated, Unreserved Fund Balance" as "Portions of fund balance may be designated by management to reflect tentative plans or commitments of governmental resources. Designations general reflect board action to earmark the balance for purposes that will be fulfilled at a later time, but specific board action is not required. Designations represent planned actions, that than actual commitments. Because they typically arise from internal actions (management decisions) rather than actions external to the entity (encumbrances), designations are reported as part of unreserved fund balance.

EDUCATION BUDGET ACT 48 of 2003 “LIMITATIONS ON CERTAIN UNRESERVED FUND BALANCES: FOR THE 2005-2006 SCHOOL YEAR AND EACH SCHOOLYEAR THEREAFTER, NO SCHOOL DISTRICT SHALL APPROVE AN INCREASE IN REAL PROPERTY TAXES UNLESS IT HAS ADOPTED A BUDGET THAT INCLUDES AN ESTIMATED ENDING UNRESERVED UNDESIGNATED FUND BALANCE LESS THAN THE PERCENTAGES SET FORTH AS FOLLOWS: SCHOOL DISTRICT ESTIMATED, ENDING UNRESERVED UNDESIGNATED TOTAL BUDGETED FUND BALANCE AS PERCENTAGE OF EXPENDITURES TOTAL BUDGETED EXPENDITURES LESS THAN OR EQUAL TO $11,999,999 12% BETWEEN $12,000,000 AND $12,999,999 11.5% BETWEEN $13,000,000 AND $13,999,999 11% BETWEEN $14,000,000 AND $14,999,999 10.5% BETWEEN $15,000,000 AND $15,999,999 10% BETWEEN $16,000,000 AND $16,999,999 9.5% BETWEEN $17,000,000 AND $17,999,999 9% BETWEEN $18,000,000 AND $18,999,999 8.5% GREATER THAN OR EQUAL TO $19,000,000 8% BY AUGUST 15, 2005, AND AUGUST 15 OF EACH YEAR THEREAFTER, EACH SCHOOL DISTRICT THAT APPROVES AN INCREASE IN REAL PROPERTY TAXES SHALL PROVIDE THE DEPARTMENT OF EDUCATION WITH INFORMATION CERTIFYING COMPLIANCE WITH THIS SECTION. SUCH INFORMATION SHALL BE PROVIDED IN A FORM AND MANNER PRESCRIBED BY THE DEPARTMENT OF EDUCATION AND SHALL INCLUDE INFORMATION ON THE SCHOOL DISTRICT'S ESTIMATED, ENDING UNRESERVED UNDESIGNATED FUND BALANCE EXPRESSED AS A DOLLAR AMOUNT AND AS A PERCENTAGE OF THE SCHOOL DISTRICT'S TOTAL BUDGETED EXPENDITURES FOR THAT SCHOOL YEAR. AS USED IN THIS SECTION, "ESTIMATED, ENDING UNRESERVED UNDESIGNATED FUND BALANCE" SHALL MEAN THAT PORTION OF THE FUND BALANCE, WHICH IS APPROPRIABLE FOR EXPENDITURE OR NOT LEGALLY OR OTHERWISE SEGREGATED FOR A SPECIFIC OR TENTATIVE FUTURE USE, PROJECTED FOR THE CLOSE OF THE SCHOOL YEAR FOR WHICH A SCHOOL DISTRICT'S BUDGET WAS ADOPTED AND HELD IN THE GENERAL FUND ACCOUNTS OF THE SCHOOL DISTRICT.” The budget was passed Dec 19 2003 using fund balance definition and limitation provisions from SB 80. Those provisions were drawn from an earlier SB 680. In both versions, one provision reads that " Estimated, ending unreserved un-designated fund balance(s) shall mean that portion of the fund balance which is appropriable for expenditure or not legally or otherwise segregated for a specific or tentative future use, PROJECTED FOR THE CLOSE OF THE SCHOOL YEAR FOR WHICH A SCHOOL DISTRICT'S BUDGET WAS ADOPTED and held in the general fund accounts of the school district."

There may be some confusion about the requirement for the Board to annually affirm, revise or delete the designation vs. not being required to actually spend down the designated funds in one year. The Boards should annually, and as part of the budget process, review, update and approve the upcoming designated fund balance, if any. But the Board is not required to spend down those designated funds over any specific time frame. To be required to spend those designated funds within one fiscal year would preclude Boards from designating funds to build cash over several years for a foreseen future cash outlay concern, such as designations for post employment benefits, debt service stabilization, or one time charges for future curriculum changes. District boards can move fund balance from unreserved, undesignated to unreserved, designated to help meet the 8% rule imposed with the new law. Further, these designated funds can be drawn down over a number of years.