McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc. All rights reserved.

17

Governmental Entities: Introduction and General Fund Accounting

17-2

Governmental Entities

• In the early 2000s, the combined annual spending of federal, state, and local governments exceed $4.0 trillion.

• Governmental purchases of goods and services constitute approximately 20 percent of the total gross national product of the United States.

17-3

Governmental Entities

• Each of the 50 states follows relatively uniform accounting standards; however, some states have unique statutory provisions for selected items.

• Local governments are political subdivisions of state government.

17-4

Governmental Entities

• The 87,000 plus local governmental units in the United States are classified as:

• General-purpose local government, such as counties, cities towns, villages, and townships.

• Special-purpose local government, such as soil conservation districts.

• Authorities and agencies, such as the New York Port Authority and local housing authorities.

17-5

Governmental Entities

• Authorities and agencies differ from other governmental units because they typically do not have taxing power and may sell only revenue bonds, not general obligation bonds.

17-6

Governmental Entities

• Governmental entities have operating objectives different from those of commercial entities; therefore, governmental accounting is different from accounting for commercial enterprises.

• The major differences between governmental and for-profit entities are specified in the next seven slides.

17-7

Governmental Entities

• Governmental accounting must recognize that governmental units collect resources and make expenditures to fulfill social needs.

17-8

Governmental Entities

• Society expects governmental units to develop and maintain an infrastructure of highways, streets, and sewer and sanitation systems as well as to provide public protection, recreation, and cultural services.

17-9

Governmental Entities

• Except for some proprietary activities such as utilities, governmental entities do not have a general profit motive.

• Police and fire departments do not have a profit motive; instead, these units must be evaluated on their abilities to provide for society’s needs.

17-10

Governmental Entities

• Governmental operations have legal authorization for their existence, conduct revenue raising through the power of taxation, and have mandated expenditures they must make to provide their services.

17-11

Governmental Entities

• The governmental accounting system must make it possible to determine and demonstrate compliance with laws, regulations, grant restrictions, bond indentures, and a variety of other legal constraints.

17-12

Governmental Entities

• Governmental entities use comprehensive budgetary accounting, which serves as a significant control mechanism and provides the basis for comparing actual operations against budgeted amounts.

• The budget is a legally established statutory control vehicle.

17-13

Governmental Entities

• The primary emphasis in governmental fund accounting is to measure and report on management’s stewardship of the financial resources committed to the objectives of the governmental unit.

17-14

Governmental Entities

• Accountability for the flow of financial resources is a chief objective of governmental accounting. The managers of the governmental unit must be able to show they are in compliance with the many legal regulations governing its operations.

17-15

Governmental Entities

• Governmental entities typically are required to establish separate funds to carry out their various missions.

• Each fund is an independent accounting and fiscal entity and is responsible for using its own resources to accomplish its specific responsibilities.

17-16

Governmental Entities

• Many fund entities do not record fixed assets or long-term debt in their funds.

• A separate record of the fixed assets and long-term debt is maintained within the governmental unit.

17-17

Expendability of Resources versus Capital Maintenance Objectives

• The major differences between commercial and governmental accounting are due to the objectives of the entities.

• In commercial, profit-seeking enterprises, the emphasis is on the measurement of the flow of all economic resources of the firm.

17-18

Expendability of Resources versus Capital Maintenance Objectives

• In contrast, the major measurement focus for the governmental funds of a government entity is on the changes in current financial resources available to provide services to the public in accordance with the governmental entity’s legally adopted budget.

17-19

Expendability of Resources versus Capital Maintenance Objectives

• Operating authorization for a fiscal period’s transactions is initiated by the passage of a budget by the legislative governing body.

17-20

Expendability of Resources versus Capital Maintenance Objectives

• Managers of governmental units must be fiscally accountable to show that resources are expended in compliance with the legal and financial restrictions placed on the governmental entity by its legislative body.

17-21

GASB

• In 1984, the Financial Accounting Foundation created a companion group to the Financial Accounting Standards Board.

• The Governmental Accounting Standards Board (GASB) is now responsible for maintaining and developing accounting and reporting standards for state and local governmental entities.

17-22

Fund Accounting

• Accounting for governmental units is given the general description of fund accounting to distinguish it from accounting for commercial entities.

• Fund accounting reflects the unique aspects of governmental operations.

17-23

Fund Accounting

• This chapter presents an overview of fund accounting and illustrates accounting in the general fund, typically the most important part of most governmental units.

• Chapter 18 presents the accounting for the remaining funds of a governmental entity and the financial statements required of government units.

17-24

Types of Funds

• To accomplish the objectives of the governmental unit, the unit establishes a variety of funds as fiscal and accounting entities of the governmental unit.

• Different funds are established for the specific functions that a government must provide.

17-25

Types of Funds

• Most funds obtain resources from taxes on property, income, or commercial sales; they may also obtain resources as grants from other governmental agencies, from fines or licenses, and from charges for services.

•

17-26

Types of Funds

• Each fund must make its expenditures in accordance with its specified purposes. For example, a fund established for fire protection cannot be used to provide school buses for the local school.

17-27

Types of Funds

• A fund is a separate accounting group with accounts to record transactions and to prepare financial statements of a defined part of the government entity that is responsible for specific activities or objectives.

• Each fund has records of its transactions affecting its assets, related liabilities and residual equity balance.

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Types of Funds

• Separate fund-based financial statements must be prepared for each fiscal period. In this manner, governing bodies or other interested parties may assess the financial performance of each fund in the fulfillment of the specific purposes for which it was established.

17-29

Types of Funds

• Funds are separate fiscal and accounting entities established to segregate, control, and account for resource flows. Three types of funds are used by governmental units:

– Governmental funds, of which the general fund is usually the most important

– Proprietary funds

– Fiduciary funds

17-30

Governmental Funds

• The following five governmental funds are used to provide basic governmental services to the public:

• General fund.

• Special revenue funds.

• Capital projects funds.

• Debt service funds.

• Permanent funds.

17-31

Governmental Funds

• The number of governmental funds maintained by the governmental entity is based on the legal and operating requirements of the governmental entity.

17-32

Governmental Funds

• Only one general fund will be created by each governmental entity, but more than one of each of the other types of governmental funds may be created based on the specific needs of the entity. For example, some governmental entities establish a separate capital project fund for each major capital project.

17-33

Governmental Funds

• General Fund:

– Accounts for all financial resources except for those required to be accounted for in another fund.

– Includes transactions for general governmental services provided by the executive, legislative, and judicial operations of the governmental entity.

17-34

Governmental Funds

• Special Revenue Funds:

– Accounts for the proceeds of revenue sources that are legally restricted for specified purposes.

– Includes resources and expenditures for operations such as public libraries when a separate tax is levied for their support.

17-35

Governmental Funds

• Capital Projects Funds:

– Accounts for financial resources for the acquisition or construction of major capital projects that benefit many citizens, such as parks and municipal buildings.

– This fund is in existence only during the construction of the facilities and is closed once the project is completed.

17-36

Governmental Funds

• Debt Service Funds:

– Accounts for the accumulation of resources for, and the payment of, general long-term debt principal and interest.

– This fund is used for servicing the long-term debt of the government.

17-37

Governmental Funds

• Permanent Funds:

– Accounts for resources that are legally restricted such that only earnings, but not principal, may be used in support of governmental programs for all its citizens.

17-38

Proprietary Funds

• Some activities of a government unit, such as operation of a municipal water system, are similar to those of commercial enterprises.

• In turn, the objective of the governmental unit is to recover its costs in these operations through a system of user charges.

17-39

Proprietary Funds

• Accounting and reporting for a proprietary fund is similar to accounting for a commercial operation.

• The balance sheet of each proprietary fund reports all assets, including long-term capital assets, and reports all liabilities, including long-term liabilities.

17-40

Proprietary Funds

• There are two types of proprietary funds typically used by governmental entities:

– Enterprise Funds

– Internal Service Funds

17-41

Proprietary Funds

• Enterprise Funds:– Accounts for operations of governmental units

that charge for services provided to the general public.

17-42

Proprietary Funds

• Enterprise Funds (Continued):– Includes those activities financed in a manner

similar to private business enterprises where the intent of the governing body is to recover the costs of providing goods or services to the general public on a continuing basis through user charges.

17-43

Proprietary Funds

• Enterprise Funds (Continued):

– Also includes those operations that the governing body intends to operate at a profit.

– Examples include sports arenas, municipal electric utilities, and municipal bus companies.

17-44

Proprietary Funds

• Internal Service Funds:

– Accounts for the financing of goods or services provided by one department or agency to other departments or agencies of the governmental unit.

17-45

Proprietary Funds

– The services are usually provided on a cost-reimbursement basis and are offered only to other governmental agencies, not the general public. Examples are municipal motor vehicle pools, city print shops, and central purchasing operations.

17-46

Fiduciary Funds

• Four fiduciary funds are provided for a governmental unit. Three are trust funds that account for financial resources maintained in trust by the government:

• Pension and Other Employee Benefit Trust Funds.

• Investment Trust Funds.

• Private-Purpose Trust Funds.

17-47

Fiduciary Funds

• The fourth fiduciary fund, agency funds, is used to account for resources held by the government solely in a custodial capacity.

17-48

Fiduciary Funds

• Pension and Other Employee Benefit Trust Funds:

– Accounts for resources required to be held in trust for the members and beneficiaries of pension plans, other post-employment benefit plans, or other employee benefit plans.

17-49

Fiduciary Funds

• Investment Trust Funds:

– Accounts for the external portion of investment pools reported by the sponsoring government.

17-50

Fiduciary Funds

• Private-Purpose Trust Funds:

– Accounts for all other trust arrangements under which the fund’s resources are limited to be used to benefit specific individuals, private organizations, or other governments, as specified in the trust agreement.

17-51

Fiduciary Funds

• Agency Funds:

– Accounts for assets held by a government unit in an agency capacity for employees or for other governmental units.

– An example is the city employees’ payroll withholding for health insurance premiums.

17-52

Permanent versus Private-Purpose

• Note that the permanent fund, which is a governmental fund, includes resources that are legally restricted such that the principal must be maintained by the governmental entity and only the earnings from the fund’s resources may be used to benefit the government’s programs for all of its citizens.

[Continued on next slide]

17-53

Permanent versus Private-Purpose

• In contrast to the permanent fund, private-purpose trust funds include trusts under which the principal may or may not be expendable, but for which the trust agreement specifies the principal, if expendable, and the earnings, may be used only for the benefit of specific individuals, organizations, or other governments.

17-54

Reporting Entity

• A governmental unit may have a variety of boards, commissions, authorities, or other component units under its control. The financial statements of a governmental entity are presented for the reporting entity that consist of:

17-55

Reporting Entity

– 1. The primary governmental unit, such as a state government, a general-purpose local government, or a specifal-purpose local government that has a separately elected government body. [continued on next slide]

17-56

Reporting Entity

– 2. Organizations for which the primary unit has financial accountability.

– 3. Other organizations that have a significant relationship with the primary government and need to be included in the primary government’s financial statements to avoid misleading or incomplete financial representations.

17-57

Reporting Entity

• GASB 14, “The Financial Reporting Entity” states that financial accountability exists for those component units if the primary government unit appoints a majority of an organization’s governing body and:

• (a) is able to impose its will on the organization or

• (b) possesses a financial benefit or assumes a financial burden for the organization.

17-58

Reporting Entity

• Furthermore, no long-term capital assets, or general long-term debt, are recorded in the general fund.

• However, a reconciliation schedule will be required to go from the fund financial statements to the government-wide financial statements.

17-59

Reporting Entity

• The government-wide financial statements use the accrual basis of accounting and report all capital assets and all long-term debt.

• Government-wide financial statements are presented in Chapter 18 after the conclusion of discussion on the remaining funds.

17-60

Measurement Focus and Basis of Accounting (MFBA)

• The basis of accounting refers to the timing of recognizing a transaction for financial reporting purposes.

• For example, the cash basis recognizes revenue or expenditures when cash is received or paid.

17-61

MFBA

• The modified accrual basis is a hybrid system that includes some aspects of accrual accounting and some aspects of cash-basis accounting.

• The modified accrual basis is used in funds that have a current financial resources measurement focus.

17-62

MFBA

• The current resources measurement focus in on the flow of current financial resources and the proper expendability of the resources for designated purposes and determination of the available resources remaining to be expended.

17-63

MFBA

• Expenditures recognized under the modified accrual basis are the amounts that would normally be liquidated with expendable available financial resources.

• The five governmental funds have this focus.

17-64

MFBA

• The accrual basis method is used in funds that have an flow of economic resources measurement focus.

• This measurement focus is concerned with all economic resources available to a fund during a particular time period, thereby allowing for a comparison of revenues and expenses and a focus on maintenance of capital.

17-65

MFBA

• The proprietary funds and fiduciary funds have this focus.

• In addition, as is presented in Chapter 18, the government-wide financial statements are based on the accrual basis method.

17-66

Budgetary Aspects

• Budgets are used in governmental accounting to assist in management control and to provide the legal authority to levy taxes, collect revenue, and make expenditures in accordance with the budget.

• Budgets establish the objectives and priorities of governing units.

17-67

Operating Budgets

• Operating budgets specify expected revenue from the various sources provided by law.

• The operating budget includes expected expenditures for various line items, such as payrolls of employees, supplies, and goods and services to be obtained from outside the governing unit.

17-68

Operating Budgets

• Operating budgets are used in the general fund, special revenue funds, and sometimes the debt service funds.

17-69

Capital Budgets

• A capital budget is prepared to provide information about proposed construction projects such as new buildings or street projects.

• Capital budgets are used in the capital projects funds.

17-70

Appropriation

• Estimated Revenues Control $900,000 Appropriations Control $850,000 Budgetary Fund Balance – Unreserved $50,000

17-71

Appropriation

• Approval of the budget provides the legal authority to levy the local property taxes and to appropriate resources for the expenditures. The term appropriation is the legal description of the authority to expend resources. The entry to record the general fund budget is as follows (all amounts assumed):

17-72

Accounting for Expenditures

• When the goods are received, Barb City makes the following entries:Budgetary Fund Balance $15,000

Reserved for Encumbrances $15,000

• Assuming the cost of the goods is $15,000:Expenditures $15,000

Vouchers Payable $15,000

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Accounting for Expenditures

• The governmental funds use a variety of controls over expenditures to ensure that each expenditure is made in accordance with any legal restrictions on the fund.

17-74

Accounting for Expenditures

• For example, the encumbrances account is a budgetary account is reserving part of the appropriation authority of the budget. Encumbrances are a unique element of governmental accounting.

17-75

Accounting for Expenditures

• To illustrate encumbrance accounting, assume that on August 1, 20X1, Barb City completed a purchase order for goods from an outside vendor that are estimated to cost $15,000. The entry to record this order for goods is as follows:

17-76

Accounting for Expenditures

Encumbrances $15,000

Budgetary Fund

Balance–Reserved

For Encumbrances $15,000

17-77

Expenditure Transactions

• Governmental accounting places many controls over expenditures, and much of the financial reporting focuses on the various aspects of an expenditure.

• Expenditures should be classified by fund, function (or program), organizational unit, activity, character, and principal classes of objects.

17-78

Investments

• Some governmental entities maintain investments in stock or bond securities. The purpose of these investments typically is to obtain an investment return on available resources.

• GASB 31, established a general rule of fair market valuation for certain investments held by a governmental entity.

17-79

Investments

• The GASB continues to examine the accounting and reporting for newer types of investments.

• The GASB’s general guidance for derivatives is to use fair-value reporting for these investment vehicles which would also include recognizing the periodic changes in fair value.

17-80

Interfund Activities

• Interfund activities are resource flows between fund entities.

• Interfund activities must be evaluated carefully to ensure that the legal and budgetary controls of the governmental unit are not violated.

17-81

Interfund Activities

• There are four types of interfund activities:

• Interfund loans.

• Interfund services provided and used.

• Interfund transfers.

• Interfund reimbursements.

17-82

Interfund Activities

• Outstanding interfund loans are presented as receivable or payables on the fund’s balance sheet information.

• Interfund services provided and used are reported as part of the revenues and expenditures on the operating statements.

17-83

Interfund Activities

• Interfund transfers are reported separately in the other financing sources (uses) section of the operating statement.

• Interfund reimbursements are not reported on the fund’s financial statements.

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You Will Survive This Chapter !!!!

• The fun continues in Chapter 18 !!!

• HINT: FUND ACCOUNTING

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc. All rights reserved.

17

Governmental Entities: Introduction and General Fund Accounting

End of ChapterEnd of Chapter