Governmental Accounting

and Reporting

Publication Date: October 2019

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Governmental Accounting and Reporting

Copyright © 2019 by

DELTACPE LLC

All rights reserved. No part of this course may be reproduced in any form or by any means, without permission in

writing from the publisher.

The author is not engaged by this text or any accompanying lecture or electronic media in the rendering of legal,

tax, accounting, or similar professional services. While the legal, tax, and accounting issues discussed in this

material have been reviewed with sources believed to be reliable, concepts discussed can be affected by changes

in the law or in the interpretation of such laws since this text was printed. For that reason, the accuracy and

completeness of this information and the author's opinions based thereon cannot be guaranteed. In addition,

state or local tax laws and procedural rules may have a material impact on the general discussion. As a result, the

strategies suggested may not be suitable for every individual. Before taking any action, all references and citations

should be checked and updated accordingly.

This publication is designed to provide accurate and authoritative information in regard to the subject matter

covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other

professional service. If legal advice or other expert advice is required, the services of a competent professional

person should be sought.

--From a Declaration of Principles jointly adopted by a committee of the American Bar Association and a Committee

of Publishers and Associations.

All numerical values in this course are examples subject to change. The current values may vary and may not be

valid in the present economic environment.

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Course Description

This course on accounting for governmental entities is intended to be used by anyone who would like to gain

knowledge of accounting and financial reporting currently recommended for state and local governmental units.

The course provides an overview of (1) the fundamental concepts underlying state and local governmental

accounting and reporting, (2) the importance of budgetary accounting in government, and (3) the recognition

rules and journal entries related to governmental financing. It also describes (1) the accounts and journal entries

related to transactions specific to governmental entities, (2) the process of defining the governmental reporting

entity, (3) the components of the comprehensive annual financial report (CAFR), (4) the reporting requirements

for government- wide and fund-based financial statements, and (5) other required information in the CAFR.

Field of Study Accounting

Level of Knowledge Basic to Intermediate

Prerequisite None

Advanced Preparation None

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Table of Contents

Chapter 1: Governmental Accounting: An Overview ..............................................................................................1

Learning Objectives ................................................................................................................................................1

Characteristics of Nonbusiness Entities .................................................................................................................2

Differences between Governmental and Private Sector Accounting ....................................................................3

Background of Governmental Accounting .............................................................................................................4

Major Concepts of Governmental Accounting .......................................................................................................5

Chapter 1 Review Questions - Section 1 ............................................................................................................. 13

Financial Reporting of Governmental Entities .................................................................................................... 14

Chapter 1 Review Questions – Section 2 ............................................................................................................. 27

Budgetary Aspects of Governmental Operations................................................................................................ 29

Accounting for Expenditures ............................................................................................................................... 31

Accounting for Fixed Assets................................................................................................................................. 41

Long-Term Debt and Capital Leases .................................................................................................................... 43

Lease Accounting ................................................................................................................................................. 43

Investments ......................................................................................................................................................... 45

Interfund Activities .............................................................................................................................................. 47

Overview of Accounting and Financial Reporting for the General Fund ............................................................. 50

Comprehensive Illustration of Accounting for the General Fund ....................................................................... 52

Chapter Summary ................................................................................................................................................ 65

Chapter 1 Review Questions – Section 3 ............................................................................................................. 67

Chapter 2: Special Funds and Financial Reporting ................................................................................................ 69

Learning Objectives ............................................................................................................................................. 69

Governmental Funds Worksheets ....................................................................................................................... 73

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Special Revenue Funds ........................................................................................................................................ 73

Capital Projects Funds ......................................................................................................................................... 77

Debt Service Funds .............................................................................................................................................. 82

Chapter 2 Review Questions – Section 1 ............................................................................................................. 88

Permanent Funds ................................................................................................................................................ 89

Governmental Funds Financial Statements ........................................................................................................ 90

Proprietary Funds ................................................................................................................................................ 94

Enterprise Funds .................................................................................................................................................. 95

Chapter 2 Review Questions – Section 2 ........................................................................................................... 102

Internal Service Funds ....................................................................................................................................... 104

Fiduciary Funds .................................................................................................................................................. 112

Trust Funds ........................................................................................................................................................ 117

Agency Funds ..................................................................................................................................................... 121

The Government Reporting Model ................................................................................................................... 123

Additional Considerations ................................................................................................................................. 139

Chapter Summary .............................................................................................................................................. 148

Chapter 2 Review Questions – Section 3 ........................................................................................................... 149

Appendix: Four Major Issues of the Government Reporting Model ..................................................................... 151

Glossary ................................................................................................................................................................. 154

Index ...................................................................................................................................................................... 173

Review Question Answers ..................................................................................................................................... 174

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Chapter 1: Governmental Accounting: An Overview

Learning Objectives

After studying this chapter, you will be able to:

1. Identify the basic differences between governmental and private sector accounting.

2. Recognize major concepts of governmental accounting.

3. Identify basic concepts for financial reporting in governmental accounting.

4. Recognize the differences between the various governmental fund types.

Nonbusiness organizations, the collective term used by the FASB to refer to governmental units as well as to

colleges and universities, hospitals, voluntary health and welfare organizations, and all other nonprofit

organizations, account for at least 40 percent of the GDP of the U. S. Activities financed by expenditures of

governmental and nonprofit entities affect the safety, health, and general well-being of everyone; almost

everyone contributes a portion of the resources which finance the expenditures. Since each of us is vitally

affected it is important that we be able to read intelligently the financial reports of governmental and nonprofit

entities. Accounting and financial reporting principles which have been developed by authoritative bodies for use

by governmental and nonprofit entities are explained in this course.

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Characteristics of Nonbusiness Entities

The term nonbusiness itself suggests to the reader that entities in this classification exist for reasons other than

the attempt to earn net income for owners or investors. Indeed, a nonbusiness entity has no "owners" in the

sense that businesses do. Persons and organizations who contribute resources to establish a nonbusiness entity

do so without the expectation of receiving a financial "return on investment," or, even, a return of investment.

The typical reason for the organization of a nonbusiness entity is to render services to a group of constituents. In

the usual case, administrators of a nonbusiness organization attempt to determine in advance the outflows of

resources needed to provide services during a given time period, then attempt to secure an inflow of resources

needed to support the desired outflow. This approach of nonbusiness organizations is contrary to that of

businesses which incur expenses in the expectation of generating revenues.

Some entities in the nonbusiness category may operate under very detailed and specific legal restrictions as to

the sources of financial resources they may utilize, the amounts they may raise from each source, and the uses

they may make of the proceeds from each source-this is particularly true of state and local governmental units.

Other entities in the nonbusiness sector are about as free as business enterprises from legal restriction as to the

sources and uses of financial resources, but all entities are subject to some degree of regulation.

In summary, three characteristics distinguish nonbusiness organizations.

1. Nonbusiness organizations have transactions that are infrequent in businesses, such as grants and

contributions.

2. Nonbusiness organizations have no single indicator of performance such as net income.

3. Nonbusiness organizations report net position rather than equity.

Short Quizzes

Indicate whether each of the following is true or false.

1. Governmental entities and other types of nonprofit organizations are collectively referred to as

"nonbusiness organizations" by the FASB.

2. Nonbusiness organizations are relatively unimportant in the United States economy, as compared with

business organizations.

3. NFPOs, other than governmental units, may have owners or investors just as business organizations do.

4. The typical reason for the organization of a nonbusiness entity is to render services to a group of

constituents.

5. Governmental units are subject to a greater degree of legal constraint as to the sources of financial

resources they may utilize, and the uses they may make of the proceeds of each source, than is generally

true of business organizations.

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Answers

1. True. The phrase nonbusiness organizations was originated by the FASB as a collective phrase to include

all governmental units and all other types of NFPOs.

2. False. Nonbusiness organizations in the U.S. account for at least 40 percent of the GDP.

3. False. It is a characteristic of all nonbusiness organizations that they do not have owners in the same sense

that business organizations do. However, individuals, financial institutions, and mutual funds may invest

in the bonds or other debt instruments of nonbusiness organizations just as they do in the debt, or equity,

instruments of businesses.

4. True. Usually the services rendered to constituents are those no business organization exists to offer, or

exists to offer as advantageously.

5. True. All entities are subject to some degree of regulation, but governmental units typically are subject to

more detailed regulation as to sources and uses of financial resources than are business organizations or

other types of nonprofit entities.

Differences between Governmental and Private Sector

Accounting

Governmental entities have operating objectives different from those of commercial entities; therefore,

governmental accounting is different from accounting for commercial enterprises.

Governmental accounting differs from corporate financial accounting primarily because governments lack a

profit motive and must focus on accountability to the public. The major differences between governmental and

for-profit entities are as follows:

1. Governmental accounting must recognize that governmental units collect resources and make

expenditures to fulfill societal needs. 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.

2. 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.

3. 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. The

governmental accounting system must make it possible to determine and demonstrate compliance with

finance-related legal and contractual provisions. Governmental units are subject to extensive regulatory

oversight through laws, grant restrictions, bond indentures, and a variety of other legal constraints.

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4. 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.

5. 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.

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 that they are in compliance with the many

legal regulations governing its operations.

6. 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.

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

the purchase of assets such as equipment and buildings as expenditures of the period. A separate record

of the fixed assets and long-term debt is maintained within the governmental unit.

8. An important objective of governmental financial reporting is accountability. Governments must be able

to explain and justify to citizens and to other governments the raising and using of public resources. A key

element of accountability is interperiod equity in which it is determined if current-year revenues are

sufficient to pay for services provided during that year, or if future taxpayers will be required to assume

burdens for services previously provided or deficits created in prior years.

Background of Governmental Accounting

Although the Financial Accounting Standards Board (FASB) is considered, in the United States, to be the one

authoritative source of statements on financial accounting standards for business organizations, authoritative

statements of accounting and financial reporting principles deemed appropriate for use by state and local

governmental units are found in the American Institute of Certified Public Accountants (AICPA) audit guide, Audits

of State and Local Governmental Units. The audit guide, originally published in 1974, has been amended from time

to time by AICPA Statements of Position. The AICPA publications are based, with minor modifications, upon

publications of the National Council on Governmental Accounting (NCGA).

In 1984, the Financial Accounting Foundation (FAF), the fully independent panel that oversees the FASB, created

the Governmental Accounting Standards Board (GASB) to establish GAAP for state and local governments in the

U.S. On November 30, 1989, the trustees of the FAF reaffirmed the GASB as the standard setter for state and local

governments. Thus, after November 30, 1989, FASB pronouncements are not effective for state and local

governments unless adopted by the GASB.

GASB Statements have the highest level of authority for state and local governments.

In GASB Statement No. 1, Authoritative Status of NCGA Pronouncements and AICPA Industry Audit Guide (GASB

1), released in July 1984, the GASB stated that all NCGA statements and interpretations issued and in effect on

that date were accepted as generally accepted accounting principles for governmental accounting. In 1985, the

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GASB published a codification of the existing GAAP for state and local governments entitled Codification of

Governmental Accounting and Financial Reporting Standards. The first section of the codification is virtually

identical to NCGA 1 as amended by subsequent NCGA statements. Section 2 presents the financial reporting issues

for governmental entities. Sections 3 and 4 present specific balance sheet and operating statement topics. The

GASB continues to publish updated codifications periodically. The codification is an authoritative source for

accounting and financial reporting principles for governmental units. The GASB has issued 90 Statements, 6

Interpretations, and 6 Concepts Statements as of December 2018.

The world of governmental accounting underwent a monumental change in 1999 with the release of GASB

Statement No. 34. Previously, all state and local governments were required to report detailed fund-level

information in their general-purpose financial statements. The typical governmental financial statement was thus

a series of columns marching across the page, each containing obscure, specialized information for a certain group

of funds. This format made it difficult for the average voter to get a comprehensive picture of where the money

was coming from and where it was going.

Note: One of the awkward aspects of the old reporting regime was the use of account groups, so called because

they did not exactly qualify as funds. They were simply areas where long-lived assets and long-term debt were

parked in the absence of a conceptually sound place to put them in statements focused on current resources. This

was obviously an extremely unsatisfying practice, which are long gone now.

GASB Statement No. 34, Basic Financial Statements—and Management's Discussion and Analysis—for State and

Local Governments), issued in 1999 brought a new level of clarity to state and local government reporting.

Governments now produce two separate sets of financial statements, one containing detailed fund information

and the other providing a high-level picture of the government as a whole. This standard also required several

footnote and schedule disclosures that increase the transparency of governmental reporting.

Accounting for governmental entities is given the general name of fund accounting to distinguish it from

accounting for commercial entities. This chapter first presents an overview of fund accounting, including

accounting for typical transactions and providing required financial statements for a governmental entity. A

comprehensive illustration is presented of accounting and financial reporting for the general fund, typically the

most important fund of most governmental entities. Chapter 2 presents the accounting for the remaining funds

of a governmental entity and the required financial statements for a governmental entity. The comprehensive

illustration provides integrated examples of the governmental accounting and financial reporting concepts that

are discussed in the first part of this chapter.

Major Concepts of Governmental Accounting

Governmental accounting is different from commercial accounting. Governmental entities use a fund-based

accounting system in which some of the funds use a modified-accrual accounting method as opposed to the

accrual method used by commercial entities. Also, the financial statements of governmental entities have a

foundation in the individual funds but aggregate to a government-wide level. The following section discusses the

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major concepts for governmental accounting.

Elements of Financial Statements

The GASB’s Concepts Statement No. 4, Elements of Financial Statements, published in 2007, that defined each of

the seven elements of financial statements of state and local governments. Each definition uses the central focus

of a resource, which is an item having a present capacity to provide, directly or indirectly, services for the

governmental entity. This present service capacity may be in the form of direct provision of services as well as

those items having the ability to affect cash flows in the future.

The five elements of a statement of financial condition are

1. Assets are resources with present service capacity that the entity presently controls.

2. Liabilities are present obligations to sacrifice resources that the entity has little or no discretion to avoid.

3. A deferred outflow of resources is a consumption of net position that is applicable to a future reporting

period.

4. A deferred inflow of resources is an acquisition of net position that is applicable to a future reporting

period.

5. Net position is the residual of all other elements presented in a statement of financial condition.

The two elements of the resource flows statements are

1. An outflow of resources is a consumption of net position that is applicable to the current reporting period.

2. An inflow of resources is an acquisition of position that is applicable to the current reporting period.

Note: As a result of GASB Statement No. 63, the statement of financial position for state and local governments

will refer to net position rather than net assets.

The central focus of present service capacity for defining the elements of governmental financial statements is

different from the focus used by the FASB in its Statement of Financial Accounting Concepts No. 6, Elements of

Financial Statements.

The FASB developed its definitions of the elements of financial statements based on the usefulness of financial

reporting information to investors and creditors in making economic decisions for allocating scarce resources

among alternative uses. The GASB followed that its concepts statement provides a framework that will enhance

consistency in setting future governmental accounting standards and serve as guidance for preparers and auditors

when evaluating transactions that are not explicitly included in existing governmental accounting standards.

Expendability of Resources versus Capital Maintenance Objectives

The major differences between commercial and governmental accounting and reporting stem from the objectives

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of the entities. In commercial, profit-seeking enterprises, the measurement focus is on the flow of all economic

resources of the firm. The accrual method of accounting is used to match the revenues and expenses during a

period, with the purpose of measuring profitability. The company's balance sheet contains both current and

noncurrent assets and liabilities, and the change in retained earnings reflects the company's ability to maintain its

capital investment.

In contrast, the measurement focus for the governmental funds of a government entity is on changes in current

financial resources available to provide services to the public in accordance with the government entity's legally

adopted budget. The modified accrual method of accounting is used to measure the revenues that are available

to finance current expenditures and the expenditures made during the period. The balance sheet reports only

current assets, current liabilities, and a fund balance. Operating authorization for a fiscal period's transactions is

initiated by the passage of a budget by the legislative governing body. 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.

Definitions and Types of Funds

Because all governmental units (and almost all other not-for-profit organizations (NFPOs) receive financial

resources which may be used only in accord with restrictions established by law or by agreements with donors or

grantors, their accounting systems must enable their officials to demonstrate compliance with the restrictions.

This need led to the development of the fund accounting concept, which is so basic that the term fund accounting

is often used to denote the kind of accounting recommended for state and local governmental units and by

nonprofit entities.

The word fund has a special technical meaning in the nonbusiness sector. The NCGA defines the term as follows:

A fund is defined as a fiscal and accounting entity with a self-balancing set of accounts recording cash and

other financial resources, together with all related liabilities and residual equities, or balances, and

changes therein, which are segregated for the purpose of carrying on specific activities or attaining certain

objectives in accordance with special regulations, restrictions, or limitations.

The dual meaning of fund should be noted. A fund is an accounting entity; it is also a fiscal entity created, in most

instances, by operation of law. The term law is used in its most general sense. The accounting and financial

reporting of state and local governmental units may be prescribed (or circumscribed) by state constitutions, state

statutes, bond indentures, agreements with employees, provisions of grants from federal or other governmental

agencies, and agreements with individuals or private organizations which have donated assets to be used for

specified purposes. Local governmental units are also bound by administrative regulations of agencies of higher

jurisdictions, and by ordinances and resolutions enacted by the legislative component of the local unit. Public

schools, colleges and universities, hospitals, voluntary health and welfare organizations, and other nonprofit

organizations generally have fewer categories of legal restrictions than do governmental units, but do have grants

and gifts restricted by donors, agreements with employees and creditors, and in some cases, governmental

appropriations, which indicate the desirability of fund accounting.

The operations of a governmental unit also must be broken down into periodic reporting intervals of fiscal years

because the management of these public operations may change as a result of elections or new appointments.

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Thus, governmental accounting must recognize the many different purposes, the different sources of revenue,

the mandated expenditures, and the fiscal periodicity of the governmental unit. To accomplish the objectives of

the governmental unit, the unit establishes a variety of funds as fiscal and accounting entities of the governmental

unit. A fund is a separate accounting group with accounts to record the transactions and prepare the financial

statements of a defined part of the governmental entity that is responsible for specific activities or objectives.

Each fund records those transactions affecting its assets, related liabilities, and residual fund balance.

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

resources from taxes on property, income, or commercial sales; they also may obtain resources as grants from

other governmental agencies, from fines or licenses, and from charges for services. 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. The fire department may make expenditures only as directly

related to its function of providing fire protection.

Each governmental fund has its own asset and liability accounts and its own revenue and expenditures accounts.

The term expenditures refers to decreases in net financial resources available under the current financial resources

measurement focus. Expenditures are made in accordance with the budget established by the government unit's

governing body, and the internal control structure of a vouchers payable system is generally used prior to

payments to external vendors. Upon receipt and acceptance of the goods or services from the external vendor,

the journal entry to recognize the approved expenditure is a debit to expenditures and a credit to vouchers

payable. The increase in the payables decreases the net financial resources available. The payment of the vouchers

payable must then be approved by the government's governing body.

Separate fund-based financial statements must be prepared for each fiscal period. In this manner, governing

bodies or other interested parties may assess the fiscal and operating performance of each fund in fulfillment of

the specific purposes for which each fund was established.

Governmental accounting systems are established on a fund basis in three major categories: governmental,

proprietary, and fiduciary. Exhibit 1 presents an overview of each of the funds and provides a brief description of

the types of activities accounted for in each fund.

Governmental Funds

Five types of governmental funds are used to provide basic governmental services to the public. These are (1)

general fund, (2) special revenue funds, (3) capital projects funds, (4) debt service funds, and (5) permanent funds

(see Exhibit 1). The number of governmental funds maintained by the governmental entity is based on its legal

and operating requirements. Each governmental entity creates only one general fund, but it may create more

than one of each of the other types of governmental funds based on the entity's specific needs. For example,

some governmental entities establish a separate capital projects fund for each major capital project.

Proprietary Funds

Some activities of a governmental unit, such as the operation of a public swimming pool or a municipal water

system, are similar to those of commercial enterprises. The objective of the governmental unit is to recover its

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costs in these operations through a system of user charges. The two types of proprietary funds typically used by

governmental entities are enterprise funds and internal service funds (see Exhibit 1).

Enterprise funds are used to account for operations similar to those of private businesses. This rendition of

services by the enterprise fund to the general fund is presumably at prices equivalent to external exchange values

and is classified as an interfund service provided and used. The result is revenue to the seller and an expenditure

to the buyer, a governmental fund. Unpaid amounts are interfund receivables or payables. The entry is to debit

expenditures control and credit due to enterprise fund.

Internal Service Funds differ from Enterprise Funds because Internal Service Funds provide goods and services

primarily to other government agencies. Accounting and reporting for a proprietary fund are similar to accounting

for a commercial operation. Both use the accrual basis of accounting like commercial businesses. The financial

statements of proprietary funds focus on determination of operating income, changes in net position (or cost

recovery), financial position, and cash flows. A proprietary fund accounts for the business-type functions of a

government. Users of the financial statements for proprietary funds may find profitability information to be

valuable. The statement of net position of each proprietary fund reports all assets, including long-term capital

assets, and all liabilities, including long-term liabilities. Two types of funds are classified by the NCGA as proprietary

funds:

a) Internal Service Funds. Internal service funds are established by governmental units as a means of

providing services to other funds or departments of the same unit, or to other governmental units,

on a cost-reimbursement basis. Examples include centralized IT operations, central motor pools

and garages, centralized risk-financing activities, and central stores.

b) Enterprise Funds. Enterprise funds are operated to provide electric, water, gas, or other services

to the general public on a user-charge basis. Except for ownership, they bear a close resemblance

to investor-owned utility or other service enterprises. Enterprise funds are also used to account

for activities for which the governmental body desires periodic computation of revenues earned,

costs incurred, or net income.

Fiduciary Funds

Four types of fiduciary funds are provided for a governmental unit. Three are trust funds that account for financial

resources maintained in trust by the government. These three are pension and other employee benefit trust

funds, investment trust funds, and private-purpose trust funds. The fourth fiduciary fund, agency funds, is used

to account for resources held by the government solely in a custodial capacity (see Exhibit 1). Note that the

permanent fund, which is a governmental fund, includes resources that are legally restricted so that the

governmental entity must maintain the principal and can use only the earnings from the fund's resources to

benefit the government's programs for all of its citizens. The 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. Chapter 2 presents examples of fiduciary funds.

Short Quizzes

Indicate whether each of the following statements is true or false.

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1. Fund accounting is a term used to describe an accounting concept which is common throughout all

governmental and other nonprofit entities.

2. One of the principal characteristics which distinguishes accounting for state and local governmental units

from accounting for business organizations are the use of fund accounting.

3. The word fund in the term fund accounting is used in the same sense as it is ordinarily used in financial

accounting for businesses.

4. A fund is an accounting entity; it is also a fiscal entity.

5. A fiscal entity is a group of assets, together with all related liabilities and residual equities, which is set

aside by special regulations, restrictions, or limitations for the purpose of carrying on specific activities or

attaining certain objectives.

6. An accounting entity is a self-balancing set of accounts.

Answers

1. True. Fund accounting is often used to denote the kind of accounting recommended for governmental

and nonprofit entities.

2. True. Fund accounting was developed in recognition of the fact that governmental units operate under

many more legal constraints as to the sources and uses of financial resources than do business

organizations.

3. False. The word fund in financial accounting may have several different meanings, none of which are the

same as the technical definition.

4. True. A fund must be both a fiscal entity and an accounting entity.

5. True. This definition is taken from the definition of fund.

6. True. This definition is taken from the definition of fund.

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Exhibit 1

Fund Structure

Governmental Fund Types

1. General fund Accounts for all financial resources except for those accounted for in another fund. Includes transactions for general governmental services provided by the executive, legislative, and judicial operations of the governmental entity.

2. Special revenue fund

Accounts for the proceeds of specific revenue sources that are restricted for specified purposes. Includes resources and expenditures for operations, such as public libraries, when a separate tax is levied for their support.

3. Capital projects fund

Accounts for financial resources for the acquisition or construction of major capital facilities that benefit many citizens, such as parks and municipal buildings. This fund is in existence only during the acquisition or construction of the facilities and is closed once the project is completed.

4. Debt service fund

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.

5. Permanent fund

Accounts for resources that are restricted such that only earnings, but not principal, may be used in support of governmental programs that benefit the government or its citizenry.

Proprietary Fund Types

6. Enterprise fund

Accounts for operations of governmental units that charge for services provided to the general public. 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. 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.

7. Internal service fund

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

Fiduciary Fund Types and Similar Component Units

8. Pension (and other employee benefit) trust fund

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.

9. Investment trust fund Accounts for the external portion of investment pools reported by the sponsoring government.

10. Private-purpose trust fund

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

11. Agency fund

Accounts for assets held by a governmental unit in an agency capacity for employees or for other governmental units. An example is the city employees' payroll withholding for health insurance premiums.

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Short Quizzes

Indicate whether each of the following statements is true or false.

1. The seven types of funds recommended by the NCGA are classified as either governmental funds or

proprietary funds.

2. The general fixed assets group and the general long-term debt group are accounting entities, but not fiscal

entities; therefore, they are not funds.

3. General funds, special revenue funds, and permanent funds are the only NCGA fund types which are

classified as governmental funds.

4. Governmental funds focus upon the flow of resources, rather than upon income determination.

5. The proprietary fund designation indicates that the funds operate in a manner similar to investor-owned

enterprises.

Answers

1. False. The eleven fund types are classified in three categories: governmental funds, proprietary funds, and

fiduciary funds.

2. True. A fund is both a fiscal entity and an accounting entity.

3. False. In addition to the three types listed, capital projects funds and debt service funds are also classified

as governmental funds.

4. True. Governmental funds focus upon the flow of revenues and expenditure not upon the matching of

revenues and expenses as a business does.

5. True. The proprietary fund designation indicates that the funds operate in a manner similar to investor-

owned enterprises.

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Chapter 1 Review Questions - Section 1

1. Fund accounting is used by governmental units with resources that must be ____________

A. Composed of cash or cash equivalents.

B. Incorporated into combined or combining financial statements.

C. Segregated for the purpose of carrying on specific activities or attaining certain objectives.

D. Segregated physically according to various objectives.

2. What is the focus of accounting and reporting for proprietary funds of governmental units?

A. Determination of operating income

B. Project completion

C. Current financial resources

D. Adherence to the budget

3. A governmental unit could use which of the following types of funds?

A. Fiduciary but not Proprietary

B. Fiduciary and Proprietary

C. Proprietary but not Fiduciary

D. Neither Fiduciary nor Proprietary

14

Financial Reporting of Governmental Entities

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, which consists

of:

1. The primary government such as a state government, a general-purpose local government, or a

special-purpose local government that has a separately elected government body.

2. Component units, which are legally separate 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.

GASB Statement No. 14, The Financial Reporting Entity (GASB 14), 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.

The governmental financial reporting model is specified in GASB Statement No. 34, Basic Financial Statements—

and Management's Discussion and Analysis—for State and Local Governments (GASB 34). Exhibit 2 presents the

names of the financial statements and the other major information specified by GASB 34. The reporting model

has two integrated levels of financial statements.

1. The first level is the fund-based financial statements because governments continue to use fund-based

accounting to record transactions in accordance with the legal or budgetary requirements established by their

governing body. These fund-based financial statements demonstrate fiscal accountability of the management

of each of the funds.

2. The second level is the government-wide financial statements. After preparing the fund-based financial

statements, the government prepares reconciliation schedules to go from the governmental fund financial

statements to the government-wide financial statements. In addition to the governmental funds, the

reporting entity includes other funds in the government-wide financial statements, such as proprietary funds.

The government entity's capital assets, such as buildings and equipment, and long-term debt also are included

in the government-wide financial statements. The government-wide financial statements demonstrate the

operational accountability of the management of the governmental unit as a whole. Government-wide

financial statements exclude the fiduciary funds.

This chapter and the first part of Chapter 2 focus on the fund-based financial statements. After completing our

discussion of each fund type in the next chapter, the government-wide financial statements are presented.

15

Fund-Based Financial Statements: Governmental Funds

Two financial statements are required for the governmental funds: (1) balance sheet and (2) statement of

revenues, expenditures, and changes in fund balance.

Exhibit 2

The Government Reporting Model

1. Independent auditors' report

2. Management's Discussion and Analysis (required supplementary information)

3. Government-wide financial statements

a. Statement of Net Position

b. Statement of Activities

4. Fund-based financial statements

a. Governmental funds

(1) Balance Sheet

(2) Statement of Revenues, Expenditures, and Changes in Fund Balances

(3) Reconciliation Schedules (of each of the two governmental fund-based statements to their

related government-wide financial statements, either at the bottom of each of the two fund-

based financial statements or in an accompanying schedule)

b. Proprietary funds

(1) Statement of Net Position

(2) Statement of Revenues, Expenses, and Changes in Fund Net Position

(3) Statement of Cash Flows

c. Fiduciary funds

(1) Statement of Fiduciary Net Position

(2) Statement of Changes in Fiduciary Net Position

5. Notes to the financial statements

6. Required Supplementary Information (RSI) (in addition to the MD&A)

a. Budgetary Comparison Schedules

b. Information about Infrastructure Assets

c. Information about Pensions

16

Balance Sheet for Governmental Funds

The format of the balance sheet, with added parenthetical guidance for learning assistance, for each of the

governmental funds, is given Exhibit 3.

Exhibit 3

Balance Sheet for Governmental Funds

Assets (financial resources available for current use; presented in order of liquidity) $X,XXX

Total Assets $X,XXX

Liabilities and Fund Balances

Liabilities (due and expected to be paid from current financial resources;

presented in order of due date) XXX

Fund Balances

Nonspendable $XX

Spendable:

Restricted XX

Limited XX

Assigned XX

Unassigned XX XX

Total Liabilities and Fund Balances $X,XXX

The five governmental funds use the current financial resources measurement focus. Under this method, the asset

section of the balance sheet reports only financial assets such as cash or other assets that will convert into cash

(e.g., receivables) in the normal course of operations over the near future. Some governments report inventories

or other prepayments because these save the entity from the incurrence of future outflows of current financial

resources. Long-term capital items such as equipment or buildings are not reported on the fund-based balance

sheet because these amounts are no longer currently available for expenditure. However, the long-term capital

assets of the governmental entity are scheduled and reported in the government-wide financial statements, as

illustrated in Chapter 2.

The liability section of the balance sheet reports only those liabilities that have become due and that will require

current financial resources to liquidate, such as vouchers payable or the current portion of long-term debt. Funds

recognize expenditures for principal and interest on general long-term debt only when these amounts are due. A

short-term debt often used in governmental funds is tax-anticipation notes. These notes represent loans obtained

using future taxes as collateral for the notes. Most states restrict these borrowings to those taxes that have been

levied but not yet collected. These notes payable are paid from the first tax collections of the tax levy to which

the notes are related. The principal of long-term debt not due within the next year is not reported on the balance

sheet because it will not be settled in the near term with current financial resources. However, the governmental

unit's long-term debt is scheduled and is reported in the government-wide financial statements.

The third section of the balance sheet for the five governmental funds reports the net fund balance, which is the

amount of the difference between reported assets and reported liabilities. GASB 54 specifies that the fund

balances for the governmental funds should be segregated into two categories:

1. Nonspendable fund balances represent amounts that are (a) not in spendable form, such as amounts

related to inventories and prepaid items, or (b) required by legal or contractual provisions to be

17

maintained intact, such as the principal of a permanent fund.

2. Spendable fund balances represent amounts that are available for spending. Amounts in this portion of

the fund balance would be further classified as (a) restricted, (b) limited, (c) assigned, or (d) unassigned.

The classification would be based on an examination of requirements imposed by legal or contractual

provisions and then of any constraints established by the governing body of the government entity.

Note: The GASB published a standard, GASB 54, entitled Fund Balance Reporting and Governmental Fund Type

Definitions. This statement modifies the definitions of some of the governmental funds to make the definitions

consistent across all government units. Furthermore, the standard establishes a fund balance classification system

for the governmental fund types. Note that this statement applies only to the governmental fund types, not to

proprietary or fiduciary fund types. The governmental fund balance classification system uses a hierarchy based

on the extent to which a government is required to comply with constraints placed upon the use of resources

reported in governmental funds. The hierarchy separates the fund balance between nonspendable and spendable

resources. Note that the accounting is not changed by the proposed statement, only the presentation of the fund

balances for the governmental funds.

Statement of Revenues, Expenditures, and Changes in Fund Balance for Governmental

Funds

This is often called the operating statement of the governmental funds, but the financial statements for the

governmental funds use the full title. The statement of revenues, expenditures, and changes in fund balance has

four major sections:

1. Operating section. The top section includes the revenues less expenditures for the period, with the difference

shown as the excess (or deficiency) of revenues over expenditures.

2. Other financing sources or uses. This section includes nonrevenue items such as bond issue proceeds and

interfund transfers. (Note that issuance of bonds and debt refundings of governmental long-term debt are

shown in this section although the long-term debt is not shown on the fund's balance sheet.)

3. Special and extraordinary items. This section presents extraordinary items that are both unusual and

infrequent, such as losses due to a hurricane. Special items are transactions or events within the control of

management that are either unusual or infrequent in occurrence. An example of a special item would be the

one-time sale of county park land.

4. Fund balance. The bottom portion presents both the beginning and the ending fund balance.

The format of the statement of revenues, expenditures, and changes in fund balance, with added parenthetical

guidance, is shown Exhibit 4.

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Exhibit 4

Statement of Revenues, Expenditures, and Changes in Fund Balance

Revenues (recognized when both measurable and available; presented by

source of revenue) $XX,XXX

Expenditures (approved decreases in net financial resources; presented by

function and character) X,XXX

Excess of Revenues over Expenditures $XXX

Other Financing Sources or Uses (other increases or decreases in net financial

resources available, such as bond issue proceeds and interfund transfers) XX

Special Items and Extraordinary Items (X)

Net Change in Fund Balance XX

Fund Balance—Beginning XXX

Fund Balance—Ending (reconciles to total fund balance on balance sheet) $XXX

Under the current financial resources measurement focus and the modified accrual basis of accounting, revenues

are recognized when they become both measurable and available to finance expenditures of the fiscal period.

Profit-seeking businesses measure revenue by the accrual basis as it is earned, but the current financial resources

measurement focus requires that the expected timing of the revenue-related inflow be evaluated. Availability

means that the transaction will result in financial resources collectible within the current period or soon thereafter

in order to be used to pay liabilities of the current period.

The expenditure portion of the operating statement reports reductions in available current financial assets.

Expenditures are recognized when approved services or goods are received by the governmental entity.

Expenditures are usually measurable and should be recognized when the related liability is incurred. Vouchers

Payable or some other payable is credited when the expenditure is recognized. The increase in liabilities decreases

the net financial resources still available for spending to meet the public purposes established by the governing

body. Expenditures also include amounts to purchase capital assets such as trucks or buildings. These are

expenditures because they result in a net outflow of current financial assets. Note that once the expenditure has

been made for a capital asset, that amount is no longer currently available to spend. Thus, although expenditure

is recognized for the purchase of a capital asset, the capital asset (e.g., truck) is not reported on the governmental

fund's balance sheet.

Other financing sources and uses, the second section of the operating statement under the current financial

resources measurement focus, reports changes in current financial resources from nonrevenue items, such as

sales of bonds or interfund transfers with other funds of the governmental entity. Note that under the current

financial resources focus, the proceeds from a sale of bonds are reported in the operating statement, but the long-

term bond payable is not reported in the liabilities on the governmental fund's balance sheet. Interfund transfers

are discussed in depth later in this chapter.

The special items section presents unusual or infrequent items that affect the fund balance but are not revenue

or expenditure items. Finally, the fund balance section presents the change in the fund balance to obtain the

ending fund balance. The ending fund balance amount should reconcile to the total fund balance shown on the

balance sheet.

19

After each governmental fund prepares its financial statements, it prepares a combined balance sheet and a

combined operating statement. These combined statements include all the governmental funds. The format for

the combined government funds statements is multicolumnar, with a separate column for each of the major

governmental funds and a separate column for the aggregated nonmajor (small) governmental funds. The

columns are then added together horizontally and a total column for each line item in the governmental funds is

presented. We will illustrate combined governmental financial statements in Chapter 2.

Measurement Focus and Basis of Accounting

Because the concepts of measurement focus and basis of accounting are so important in understanding

accounting for the various funds of state and local governments, a brief review of these two concepts is presented

first. Then, coverage is provided of the accounting measurement and recognition requirements applicable to

revenues and expenditures in the governmental funds.

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. The accrual basis

recognizes revenue or expenditures when the transaction or event takes place. 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 flow of current financial resources measurement focus. This

measurement focus is 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. 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.

The accrual basis is used in funds that have a 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. The proprietary funds and

fiduciary funds have this focus.

In addition, as is presented in Chapter 2, the government-wide financial statements are based on the accrual basis.

This necessitates a reconciliation schedule for those items accounted for under the modified accrual basis for

governmental fund accounting to obtain the accrual basis amount that is reported on the government-wide

financials. The reconciliation schedule is discussed in depth in Chapter 2.

Basis of Accounting-Governmental Funds

The current financial resources measurement focus and the modified accrual basis of accounting are used for

the governmental funds financial statements. The modified accrual basis is applied as follows:

1. Revenue is recorded in the accounting period in which it is both measurable and available to finance

expenditures made during the current fiscal period. They are increases in (sources of) fund financial

resources other than from interfund transfers, debt issue proceeds, and redemptions of demand bonds.

The major source classifications are taxes, licenses and permits, intergovernmental revenues, charges for

services, fines and forfeits, and miscellaneous revenues.

2. Expenditures are recognized in the period in which the liabilities are both measurable and incurred and

are payable out of current financial resources.

20

Note: Measurable means that the amount of the revenue or expenditure can be objectively determined.

Available means due or past due and receivable within the current period and collected within the current period

or expected to be collected soon enough thereafter to be used to pay current-period liabilities. The definition of

"soon enough thereafter" has been stated for property taxes as a period of not more than 60 days after the end

of the current fiscal period.

Recognition of Revenue

The accrual method of accounting recognizes revenues from exchange transactions (sales of goods or services)

and from nonexchange transactions in which the government gives or receives value without directly receiving

or giving equal value in exchange. In GASB Statement 33, Accounting and Financial Reporting for Nonexchange

Transactions (GASB 33), issued in 1998, the GASB classified nonexchange transactions into four categories. GASB

33 was written from the viewpoint of the accrual basis, and modifications are required to this statement when

using the modified accrual basis of accounting. How revenues are recognized depends on the category. The four

categories are discussed next.

1. Derived tax revenues, resulting from assessments on exchange transactions. Examples are income taxes and

sales taxes.

a. The asset (cash or receivable) is recognized when the underlying transaction occurs or resources are

received, whichever comes first.

b. Revenue recognition depends on the accounting basis used to measure the transaction. Under accrual

accounting (proprietary and fiduciary funds), revenue is recognized when the underlying exchange

transaction occurs. Under modified accrual accounting (governmental funds), revenue is recognized when

the underlying exchange has occurred and the resources are available.

Resources received prior to the exchange transaction would be reported as deferred revenue (reported as a

liability) until the revenue recognition requirement is met for the fund receiving the resources.

2. Imposed nonexchange revenues, resulting from assessments on nongovernmental entities, including

individuals. Examples include property taxes and fines.

a. The asset (cash or receivable) is recognized when the government has an enforceable legal claim to the

resources or the resources are received, whichever comes first.

b. Revenue recognition is made in the period when use of the resources for current expenditures is first

permitted or required, or at the time the asset is recorded if no time restriction on the fund's use of the

resources exists.

Resources received or recorded as receivables prior to the period in which they can be recognized as revenue

should be reported as deferred revenues.

The next two categories have additional eligibility requirements that the providers of financial resources often

impose. These eligibility requirements must be met before the transaction can be completed, that is, before

the receiving governmental unit can recognize an asset and the associated revenue. The four types of eligibility

requirements are typically (1) required characteristics of the recipient as specified by the provider of the

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financial resources (e.g., the receiving entity must be a school district), (2) time requirements for expending

the resources (e.g., the resources must all be expended within a specific fiscal period), (3) reimbursements for

only those costs determined to be allowable and incurred in conformity with a program's requirements, and

(4) contingencies in which the recipient has met all actions required by the provider. If the recipient has met

all of the eligibility requirements imposed by the provider, then the provider should recognize the liability (or

decrease in assets) and expense, and the recipient should recognize the receivable (or increase in assets) and

revenue at the time the eligibility requirements have been met. The two categories are as follows:

3. Government-mandated nonexchange transactions, resulting from one governmental unit's provision of

resources to a governmental unit at another level and the requirement that the recipient use the resources for

a specific purpose. An example of this type is federal programs that state or local governments are required to

perform.

4. Voluntary nonexchange transactions, resulting from legislative or contractual agreements, other than

exchanges. Examples include certain grants and private donations.

To aid in understanding the appropriate timing of revenue recognition, Exhibit 5 outlines the criteria for each

classification of nonexchange transactions.

22

Exhibit 5

Classes and Timing of Recognition of Nonexchange Transactions

Class Recognition

Derived tax revenues

Examples: sales taxes, personal and corporate

income taxes, motor fuel taxes, and similar taxes

on earnings or consumption

Assets*

Period when underlying exchange has occurred or when

resources are received, whichever is first.

Revenues

Period when underlying exchange has occurred. (Report

advance receipts as deferred revenues.) When modified

accrual accounting is used, resources also should be

"available."

Imposed nonexchange revenues

Examples: property taxes, most fines and

forfeitures

Assets*

Period when an enforceable legal claim has arisen or when

resources are received, whichever is first.

Revenues

Period when resources are required to be used or first

period that use is permitted (for example, for property

taxes, the period for which levied). When modified accrual

accounting is used, resources also should be "available."

(For property taxes, apply NCGA

Interpretation 3, as amended.)

Government-mandated nonexchange

transactions Examples: federal government

mandates on state and local governments

Voluntary nonexchange transactions

Examples: certain grants and entitlements, most

donations

Assets* and liabilities

Period when all eligibility requirements have been met

or (for asset recognition) when resources are received,

whichever is first.

Revenues and expenses or expenditures

Period when all eligibility requirements have been met.

(Report advance receipts or payments for use in the

following period as deferred revenues or advances,

respectively. However, when a provider precludes the sale,

disbursement, or consumption of resources for a specified

number of years, until a specified event has occurred, or

permanently [for example, permanent and term

endowments, report revenues and expenses or

expenditures when the resources are, respectively,

received or paid and report resulting net position, equity, or

fund balance as restricted.] When modified accrual

accounting is used for revenue recognition, resources also

should be “available.”

*If there are purpose restrictions, report restricted net position (or equity or fund balance) or, for governmental

funds, a reservation of Fund Balance.

23

Note: Governmental fund revenues are increases in fund financial resources other than from interfund transfers,

debt issue proceeds, and redemptions of demand bonds. Thus, revenues of a capital projects fund include grants.

Under GASB 33, the grant (a voluntary nonexchange transaction) is recognized when all eligibility requirements,

including time requirements, have been met. When modified accrual accounting is used, as in a capital projects

fund, the grant must also be "available." Other financing sources include proceeds from bonds and interfund

transfers in.

GASB Statement No. 36, Recipient Reporting for Certain Shared Nonexchange Revenues (GASB 36) amended GASB

33 for government-mandated and voluntary nonexchange situations in which a providing government provides

part of its own derived tax units to recipients. Typically, the providing government provides the recipients with a

periodic report of the amount of shared revenues the recipients should anticipate. GASB 36 states that if the

notification from the providing government is not available in a timely manner, the recipient governments should

use a reasonable estimate of the amount to be accrued and not wait until the actual receipt of the cash resources.

The following examples present the accounting, under the modified accrual basis of accounting, as used in

preparing the governmental funds financial statements.

1. Property taxes. Property taxes involve a series of steps that guide the recognition of the property tax asset and

the property tax revenue. A typical process is as follows:

Year 1:

Step 1: Levy filed for enforceable claims to property taxes for year 1.

Step 2: Assessment notice presenting assessed value as of levy date is mailed to each property owner

and any appeals are heard.

Step 3: Property tax bills for year 1 mailed to each property owner. (Property tax on each property

based on assessed value multiplied by the tax rate. The tax rate is determined based on the

requirements specified in the levy request filed by each unit of government within the taxing

district.)

Year 2:

Step 4: First installment of property taxes for year 1 are due.

Step 5: Second (and last) installment of property taxes for year 1 are due.

The levy creates an enforceable claim to the future collection of property taxes and a property tax receivable

should be recorded at that date along with a deferred property tax revenue credit. As presented above, the

property tax bill is mailed to each property owner in one fiscal period and the property taxes applicable to that

fiscal period are then collected in the next fiscal period. There normally is a legally imposed time restriction on the

use of the property tax resources until, in this example, year 2, at which time the resources become available for

expenditure. In this example, property tax revenue would not be recognized until year 2 when the time restriction

is extinguished. The year 2 entry would include a debit to deferred property tax revenue and a credit to property

tax revenue. While this example presents the levy date in year 1 and the collection in year 2, some governmental

entities do make the levy and the collection within the same fiscal period. The key to the timing of recognizing

24

revenue from property taxes is to determine the fiscal period in which the use of the resources for current

expenditures is permitted, not necessarily when the property taxes are levied or collected (Exhibit 6).

Exhibit 6

Timing of Revenue Recognition of Property Taxes

NCGA Interpretation No. 3, Revenue Recognition—Property Taxes (NCGA 3), specifies that property taxes must

be collectible within a maximum of 60 days after the end of the current fiscal period in order to be recognized as

revenue in the current period. Taxes collectible 60 days or more after the current period ends are recorded as

deferred revenue for the current period and then accounted for as next period's revenue.

Revenue from another governmental unit or tax-exempt entity in lieu of taxes, such as a payment by a university

to a city for police and fire protection, should be accrued and recorded as revenue when it becomes billable.

Revenue from property taxes should be recorded net of any uncollectibles or abatements. The Property Taxes

Receivable account is debited for the full amount of the taxes levied, with estimated uncollectibles recorded

separately in an allowance account reported as a contra account to the receivable.

2. Interest on investments and delinquent taxes. Interest on investments or delinquent property taxes is

accrued in the period in which the interest is earned and available to finance expenditures in the period. The

governmental funds may temporarily invest available cash in interest-generating financial instruments such as

certificates of deposit and federal or state securities. Governmental entities should carefully determine the credit

risks and market risks of possible investments to minimize their potential loss. Governmental funds report their

own current and long-term financial investments and any accrued interest receivable as assets of the funds.

3. Income taxes and sales taxes. These derived tax revenues are recognized as assets under the modified

accrual basis of accounting in the period in which the tax is imposed or when the resources are received, whichever

comes first. These taxes must be available to finance expenditures made during the current fiscal period before

recognition as revenue for the period. Income tax revenue should be reported net of any anticipated refunds to

taxpayers. Sales taxes collected by another governmental unit (e.g., the state government) but not yet distributed

should be accrued prior to receipt by the governmental unit to which they will be distributed (e.g., a city) if the

taxes are both measurable and available for expenditure. Measurability in this case is based on an estimate of the

sales taxes to be received, and availability is based on the ability of the governing entity (the city) to obtain current

resources through credit by using future sales tax collections as collateral for the loan.

4. Miscellaneous revenue. Miscellaneous revenues such as license fees, fines, parking meter revenue, and

charges for services are generally recorded when the cash is received because these cannot be predicted

accurately. Often states take custody of private property when its legal owner cannot be found, as with unclaimed

estates or abandoned bank accounts. The property is said to escheat (or revert) to the state government. The

government should record the property as revenue at its fair market value less a liability for any anticipated claims

25

from possible heirs or other claimants. States generally record the net revenue in the general fund, but some

states prefer to account for these resources in a separate, private-purpose trust fund.

5. Grants, entitlements, and shared revenue. These are resources received from other governmental units.

Grants are contributions from another governmental unit to be used for a specified purpose, activity, or facility.

Entitlements are payments local governments are entitled to receive as determined by the federal government.

Shared revenue is levied by one governmental unit but shared with others on some predetermined basis (e.g.,

revenue from taxes on the retail sale of gasoline collected by the state). Grants are recognized as revenue in the

period in which all eligibility requirements have been met. This may be at the point the grant is authorized, but,

in practice, some governmental units wait until the cash is received because the grant may be withdrawn by the

grantor. Some grants are made to reimburse a governmental unit for expenditures made in accordance with legal

requirements. The revenue from such grants should be recognized only when the expenditure is made and all

other eligibility requirements have been met. For example, a state government might agree to provide a grant for

a local government's purchase of fire-fighting vehicles. Typically, the local government must meet all the

requirements of the grant before it receives the monies from the state government. In these cases, the local

government would record the grant revenue at the time it is received. In a few cases, such as a state grant of

reimbursement for the purchase of the firefighting vehicles, the local government may receive grant monies

before all the steps of the required expenditure are completed. In those few cases, the local government may be

required to record the receipt of the grant monies as an unearned revenue (liability) until all the requirements

have been met and the grant is expendable—at which time the unearned revenue is reclassified as earned

revenue.

Proceeds from the sale of bonds are not revenue! These proceeds are reported as other financing sources on the

statement of revenues, expenditures, and changes in fund balance. Although bond sales do increase the resources

available for expenditure, bonds must be repaid, whereas revenue of the governmental unit does not need to be

repaid.

Recognition of Expenditures

Under the modified accrual basis of accounting, expenditures are recorded in the period in which the related

liability is both measurable and incurred. Specific examples are as follows:

1. Costs for personal services, such as wages and salaries, are generally recorded in the period paid because

they are normal, recurring expenditures of a governmental unit.

2. Goods and services obtained from outside the governmental entity are recorded as expenditures in the

period in which they are received.

3. Capital outlays for equipment, buildings, and other long-term facilities are recorded as expenditures in the

period of acquisition.

4. Interest on long-term debt is recorded in the period in which it is legally payable.

GASB Statement No. 89, Accounting for Interest Cost Incurred before the End of a Construction Period, establishes

accounting requirements for interest cost incurred before the end of a construction period. GASB 89 states that:

26

• In financial statements prepared using the economic resources measurement focus, interest cost

incurred before the end of a construction period should be recognized as an expense in the period in

which the cost is incurred. Such interest cost should not be capitalized as part of the historical cost of a

capital asset.

• In financial statements prepared using the current financial resources measurement focus, interest cost

incurred before the end of a construction period should be recognized as an expenditure on a basis

consistent with governmental fund accounting principles.

The GASB No. 89 requirements are effective for reporting period beginning after December 15, 2019. Earlier

application is encouraged.

27

Chapter 1 Review Questions – Section 2

4. On January 2, City of Walton issued $500,000, 10-year, 7% general obligation bonds. Interest is payable

annually, beginning January 2 of the following year. What amount of bond interest is Walton required to report

in the statement of revenue, expenditures, and changes in fund balances of its governmental funds at the close

of this fiscal year, September 30?

A. $0

B. $17,500

C. $26,250

D. $35,000

5. Dayne County's general fund had the following disbursements during the year: Payment of principal on long-

term debt =$100,000; Payments to vendors = $500,000; Purchase of a computer = $ 300,000. What amount should

Dayne County report as expenditures in its governmental funds statement of revenues, expenditures, and changes

in fund balances?

A. $300,000

B. $500,000

C. $800,000

D. $900,000

6. For the budgetary year ending December 31, 2002, Maple City's general fund expects the following inflows of

resources: Property taxes, licenses, and fines =$9,000,000; Proceeds of debt issue = $5,000,000; Interfund

transfers for debt service = $1,000,000. In the budgetary entry, what amount should Maple record for estimated

revenues?

A. $9,000,000

B. $10,000,000

C. $14,000,000

D. $15,000,000

7. Property taxes and fines represent which of the following classes of nonexchange transactions for governmental

units?

A. Derived tax revenues

B. Imposed nonexchange revenues

C. Government-mandated nonexchange transactions

D. Voluntary nonexchange transactions

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8. In which situation(s) should property taxes due to a governmental unit be recorded as deferred revenue? 1)

Property taxes receivable are recognized in advance of the year for which they are levied; 2) Property taxes

receivable are collected in advance of the year in which they are levied.

A. 1 only.

B. Both 1 and 2.

C. 2 only.

D. Neither 1 nor 2.

9. The renovation of Fir City's municipal park was accounted for in a capital projects fund. Financing for the

renovation, which was begun and completed in 20X3, came from the following sources: Grant from state

government = $400,000; Proceeds from general obligation bond issue = $ 500,000; Transfer from Fir's general

fund =$100,000. In its 20X3 governmental fund statement of revenues, expenditures, and changes in fund

balances, how should Fir report these amounts?

A. Revenues =$1,000,000; Other Financing Sources =$0

B. Revenues =$900,000; Other Financing Sources =$100,000

C. Revenues =$400,000; Other Financing Sources = $600,000

D. Revenues =$0; Other Financing Sources = $1,000,000

29

Basis of Accounting—Proprietary Funds

The two major proprietary funds are the internal service fund and the enterprise fund. Proprietary funds are

established for governmental operations that have a management focus of income determination and capital

maintenance; therefore, the accrual method as used by profit–seeking corporate entities is used to account for

these funds. Proprietary funds record their own long-term assets, and depreciation is recognized on these assets.

Long-term debt is recorded and interest is accrued as it is for commercial operations. The accrual basis of

accounting is used for all proprietary funds.

Basis of Accounting—Fiduciary Funds

The accrual basis of accounting is used for all fiduciary funds. Agency funds are for those resources for which the

governing unit is the temporary custodian. Agency funds have only assets and liabilities; no fund equity, revenue,

or expenditures are used. An example of an agency fund is a county's billing and collecting taxes on behalf of other

governmental entities, such as a city and a school district. After collection is completed on the "tax roll," the county

properly distributes the taxes in accordance with each governmental entity's approved levy.

These funds ordinarily account only for the receipt, temporary investment, and payment of resources to

individuals, private organizations, or other governments. Thus, tax agency funds are used when a governmental

entity is the collection agent of taxes for disbursement to other governmental units, e.g., school districts, city

governments, or special taxing districts.

For fiduciary trust funds, the economic resources measurement focus and the accrual basis of accounting are

used. Note that the fiduciary trust funds include those funds in which both the principal and income may be used

for the benefit of specific individuals, organizations, or other governments, in accordance with the terms under

which the trust fund was established. Agency and trust funds are discussed in depth in Chapter 2.

Budgetary Aspects of Governmental Operations

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.

For state governments, budgets are proposed by governors and debated by the legislative bodies. After passage,

the budget usually becomes part of the fiscal period's state law. For local governments, the mayor or the major

administrator may propose the budget. Public hearings and discussions of the budget are then held by governing

boards such as the city council, county board, or township board prior to the adoption of the final budget.

A governmental unit may have several types of budgets, including the following:

1. 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

30

employees, supplies, and goods and services to be obtained from outside the governing unit. Operating

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

2. 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.

Although budgets may be prepared for proprietary funds, these budgets do not serve as a primary control vehicle.

Budgets in the proprietary funds are advisory in much the same way budgets are used in commercial entities.

Recording the Operating Budget

Budgets are such an important control vehicle that those governmental funds with legally adopted annual

operating budgets should enter their budgets into the formal accounting records, although capital budgets are

not normally entered. Recording the operating budgets permits better management control and facilitates a

year-end comparison of budgeted and actual amounts. This comparison is part of the required supplementary

information for the government reporting model for the funds that must have operating budgets. A budget-to-

actual comparison provides an assessment of management's stewardship of the governmental entity and allows

citizens and others to determine whether the governmental entity remained within its operating budgetary

limits.

To help understand the process of accounting for operating budgets, this course uses the technique illustrated in

Governmental Accounting, Auditing, and Financial Reporting (GAAFR), in which the budgetary accounts are

identified with all capital letters.

Note: Governmental Accounting, Auditing, and Financial Reporting is updated periodically by the Government

Finance Officers Association (Chicago). Capitalization of the budgetary accounts clearly separates the budgetary

nominal accounts from the operating accounts of the governmental unit.

The recording of the operating budget for the general fund is shown with the following example. Assume that at

January 1, 20X2, the first day of the new fiscal period, the city council of Bancroft City approves the operating

budget for the general fund, providing for $900,000 in revenue and $850,000 in expenditures. 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

made in the general fund's accounting records on this date is as follows:

January 1, 20X3

(1) ESTIMATED REVENUES CONTROL 900,000

APPROPRIATIONS CONTROL 850,000

BUDGETARY FUND BALANCE—UNASSIGNED 50,000

Record general fund budget for year.

Note the word CONTROL used as part of the account titles. In governmental accounting, control accounts often

are used in the major journals, with subsidiary accounts recording the detail behind each control account. This

method is similar to a commercial entity's using a control account for its accounts receivable and then using

31

subsidiary ledgers for the specific customer transactions. Throughout this chapter, the control account level is

illustrated to focus on the major issues. In practice, detailed accounting is maintained for each separate

classification of revenue and appropriation, either in the major journal or in a subsidiary ledger.

The ESTIMATED REVENUES CONTROL account is an anticipatory asset; that is, the governmental unit anticipates

receiving resources from the revenue sources listed in the budget. The estimated revenues control account is

created when revenues are both measurable and available to finance expenditures of the fiscal period. The

APPROPRIATIONS CONTROL account is an anticipatory liability; that is, the governmental unit anticipates incurring

expenditures and liabilities for the budgeted amount. The excess of estimated revenues over anticipated

expenditures is the budget surplus and is recorded to BUDGETARY FUND BALANCE—UNASSIGNED. Some

approved budgets have budget deficits in which expected expenditures exceed anticipated revenue. These

budgets are recorded with a debit to BUDGETARY FUND BALANCE—UNASSIGNED.

Recording the budget in the governmental entity's books makes the budget a formal accounting control

mechanism for the fiscal period. In addition, having the budget in the accounting records provides the necessary

information for the budgetary comparison schedules that are part of the required supplementary information

(RSI) footnotes required by the government reporting model in GASB 34. At the end of the year, after the

appropriate financial statements have been prepared, all the budgetary accounts are closed.

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.

The Expenditure Process

The expenditure process in governmental accounting comprises the following sequential steps: appropriation,

encumbrance, expenditure, and disbursement.

Step I. Appropriation

The budget provides the appropriating authority to make future expenditures. Operating budgets are prepared

for the general, special revenue, and often the debt service funds. The capital projects fund prepares capital

budgets.

The appropriation was recorded in the budget entry made previously in entry (1) for the general fund of Bancroft

City. Recall that a total of $850,000 in anticipated expenditures was approved in the budget.

Step 2. Encumbrance

An encumbrance is a reservation of part of the budgetary appropriation and is recognized at the time an order

is placed for goods or services. Encumbrances are a unique element of governmental accounting. Their purpose

is to ensure that the expenditures within a period do not exceed the budgeted appropriations. The appropriation

level was established by the approved budget and sets the legal maximum that may be expended for each

budgeted item. The managers of the governmental unit must be sure that they do not exceed this budgetary

authority. Thus, encumbrances provide a control system and safeguard for governmental unit administrators.

32

When an order is placed for goods or services to be received from outside the governmental unit, the budgeted

appropriation is encumbered for the estimated cost of the order.

Encumbrances are of greatest use when an order is placed and a period of time expires before delivery. Payroll

costs, immaterial costs, and costs for goods acquired from within the governmental entity typically are not

encumbered because these are normal and recurring and the managers of the governmental unit are able to

predict these costs based on past experiences and other administrative controls, such as employment

agreements.

A sensible approach should be used with an encumbrance system. For example, it is not necessary to establish an

individual encumbrance when an employee orders a pad of paper. Rather, a blanket purchase order with a

maximum dollar amount, for example, a total of $500, should be prepared and encumbered, and then it can serve

as the control for small, routine supply purchases. Encumbrances provide the unit administrators an important

accounting control to fulfill their responsibilities to manage within an approved budget.

To illustrate encumbrance accounting, assume that on August 1, 20X2, Bancroft City completed a purchase order

(PO) from an outside vendor for goods that are estimated to cost $15,000. The entry to record this application of

part of the budgeted appropriation authority for the period is as follows:

August 1, 20X2

(2) ENCUMBRANCES 15,000

BUDGETARY FUND BALANCE—ASSIGNED FOR

ENCUMBRANCES

15,000

Record order for goods estimated to cost $15,000.

Note that the ENCUMBRANCES account is a budgetary account that is reserving part of the appropriation authority

of the budget. For detailed accounting, governmental entities often maintain a subsidiary ledger including

accounts for specific types of encumbrances to correspond to each specific type of appropriation. For purposes of

this illustration, the single title ENCUMBRANCES is used to indicate a control-level account to focus attention on

the major aspects of governmental accounting. In practice, very detailed account titles and classification numbers

are used to fully account for each type of transaction.

Note: The BUDGETARY FUND BALANCE—ASSIGNED FOR ENCUMBRANCES is a reservation (or restriction) of the

budgetary fund balance, not an actual liability.

Step 3. Expenditure

An expenditure and a corresponding liability are recorded when the governmental entity receives the goods or

services ordered in step 2. When the goods are received, the encumbrance entry is reversed for the amount

encumbered and the expenditure is recorded for the actual cost to the governmental entity. Although the actual

cost is typically very close to the encumbered amount, some differences may exist because of partially

completed orders, less expensive replacements, or unforeseen costs. Assume that the goods are received on

September 20, 20X2, at an actual cost of $14,000. The entries to reverse the encumbrance for the goods and to

record the actual expenditures are as follows:

33

(3) September 20, 20X2

BUDGETARY FUND BALANCE—ASSIGNED FOR ENCUMBRANCES

ENCUMBRANCES

15,000

15,000

Reverse encumbrances for goods received.

(4) Expenditures

Vouchers Payable

14,000

14,000

Receive goods at cost of $14,000

At any time, the remaining appropriating authority available to the fund managers can be determined by the

following equation:

Appropriating authority remaining available

= APPROPRIATIONS — (ENCUMBRANCES + Expenditures)

If performance of an executory contract is complete or virtually complete, e.g., because wages and salaries have

been earned by employees, an expenditure and a liability should be recognized, not an encumbrance. An

encumbrance is recorded for budgetary control purposes only when a commitment has been made related to an

unperformed contract for goods or services. An expenditure is recorded when a current liability is to be liquidated

with expendable available current resources.

Step 4. Disbursement

A disbursement is the payment of cash for expenditures. Disbursements usually must be approved by the

governing board or council as an additional level of control over expenditures.

Virtually all governmental entities use a comprehensive voucher system to control cash outflows. The governing

board receives a schedule of vouchers to be approved for payment by vote of the board. This is usually one of the

early agenda items in any board or council meeting as a vote is taken to "pay all bills." Checks are then written

and delivered to the supplier of the goods. If the Bancroft City council approved the voucher at its October 8

meeting and a check was prepared in the amount of $14,000 and mailed on October 15, 20X2, the following entry

records the disbursement:

October 15, 20X2

(5) Vouchers Payable

Cash

14,000

14,000

Payment of voucher for goods received.

34

Classification of Expenditure Transactions and Accounts

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, character, function (or

program), organizational unit, activity, and principal classes of objects. Exhibit 7 describes the major expenditure

classifications.

Exhibit 7

Major Expenditure Classifications for Governmental Funds

Classification Description

Fund The fund is identified to show the specific source of the expenditure. For example, the

general fund would be noted for expenditures from that fund.

Character Character classifications are based primarily on the period the expenditures are

anticipated to benefit. Four major character classifications are current, capital outlay,

debt service, and intergovernmental.

Function (or program) Functions are group-related activities directed at accomplishing a major service or

regulatory responsibility. Standard classifications of function include general

governmental; public safety; highway and streets; sanitation; health and welfare; culture

and recreation; and education.

Organizational unit Classifying by organizational unit maintains accountability by each unit director. The

organizational unit is determined by the governmental unit's organization chart. For

example, public safety could be broken down into police, fire, corrections, protective

inspection (such as plumbing and electrical code inspections), and other protection (such

as flood control, traffic engineering, and examination of licensed occupations).

Activity Activities within a function are recorded to maintain a record of the efficiency of each

activity. For example, the police function could be broken down into the following

activities: police administration, crime control and investigation, traffic control, police

training, support service (such as communication services and ambulance services),

special detail services, and police station and building maintenance. Each of these

activities could be broken down further, if desired.

Object class Object class is a grouping of types of items purchased or services obtained. For example,

operating expenditures include personal services, purchased and contractual services,

and commodities. Each of these objects could be further broken down, depending on the

information needs of the governing entity. For example, purchased services could include

utility services, cleaning services (such as custodial, lawn care, and snow plowing), repair

and maintenance services, rentals, construction services, and other purchased services,

such as insurance or printing.

35

Many governmental units have a comprehensive chart of accounts with specific coding digits that provide the

basis for classifying each expenditure. For example, an expenditure journal entry might specify the expenditure

account to be charged as number 3100.23-101. The chart of accounts shows that the 3100.23 account is for public

safety: police—crime control and investigation—patrol, as follows:

3100. Public safety

3100. Police

3100.2 Crime control and investigation

3100.23 Patrol

The -101 suffix indicates that this expenditure is for personal services in the form of salaries and wages for regular

employees. The level of specificity in the chart of accounts depends on the particular governing entity's

information needs. Classifying information with such specificity allows the governing entity to maintain complete

database control over the expenditure information, which it can use at any time in aggregate or relational analysis.

For the examples in this chapter, only the expenditure control level is presented; in practice, a complete

specification of the expenditure is made.

Outstanding Encumbrances at the End of the Fiscal Period

In the previous Bancroft City example, the goods were received within the same fiscal period in which they were

ordered. What happens if the goods are ordered in one fiscal year and received in the next year? In this case, the

encumbrance is not reversed before the end of the fiscal period.

Accounting for these outstanding encumbrances depends on the governmental unit's policy. The government may

allow outstanding encumbrances to lapse; that is, the governmental unit is not required to honor these

encumbrances carried over to the new year, and the new year's budget must rebudget them. In virtually all cases,

the encumbrances will be rebudgeted and honored; however, this policy specifically recognizes the legal authority

of the new governing board to determine its own expenditures. A second method is to carry over the

encumbrances as nonlapsing spending authority. This method recognizes practical aspects of encumbrances

outstanding at the end of a fiscal period. Either method may be used in governmental accounting.

To illustrate the differences between the lapsing and nonlapsing methods of accounting for encumbrances,

assume the following:

1. On August 1, 20X2, $15,000 of goods are ordered and an appropriate entry is made to record the

encumbrance.

2. The goods have not been received on December 31, 20X2, the end of the fiscal period.

3. The goods are received on February 1, 20X3, at an actual cost of $14,000.

Exhibit 8 presents a comparison of the journal entries that would be required under each of the two methods of

accounting for unfilled encumbrances at year-end.

.

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Exhibit 8 Comparison of Accounting for Lapsing and Nonlapsing Encumbrances at Year-End

Item Outstanding Encumbrances Lapsing at Year End Outstanding Encumbrances Nonlapsing at Year-End

December 31, 20X2 Close remaining budgetary encumbrances Reserve actual fund balance for outstanding

encumbrances at end of 20X2 expected to be honored in 20X3

January 1, 20X3 Reverse prior year encumbrance reserve Establish budgetary control over encumbrances

renewed from prior period Reclassify reserve from prior year

February 1, 20X3

Receive goods and remove budgetary reserve for encumbrances

Record actual expenditure for goods received

December 31, 20X3

Close expenditures account

BUDGETARY FUND BALANCE—ASSIGNED FOR ENCUMBRANCES

ENCUMBRANCES

15,000

15,000

BUDGETARY FUND BALANCE—ASSIGNED FOR ENCUMBRANCES

ENCUMBRANCES

15,000

15,000

Fund Balance—Unassigned Fund Balance—Assigned for

Encumbrances

15,000

15,000

Fund Balance—Unassigned Fund Balance—Assigned for

Encumbrances

15,000

15,000

Fund Balance—Assigned for Encumbrances

Fund Balance—Unassigned

15,000

15,000

ENCUMBRANCES BUDGETARY FUND BALANCE—

ASSIGNED FOR ENCUMBRANCES

15,000

15,000

Fund Balance—Assigned for Encumbrances

Fund Balance—Assigned for Encumbrances-20X2

15,000

15,000

BUDGETARY FUND BALANCE—ASSIGNED FOR ENCUMBRANCES

ENCUMBRANCES

15,000

15,000

Expenditures Vouchers Payable

14,000 14,000

Expenditures-20X2 Vouchers Payable

14,000 14,000

Fund Balance—Unassigned Expenditures Expenditures

14,000 14,000

Fund Balance—Assigned for

Encumbrances-20X2 Expenditures-20X2

Fund Balance—Unassigned

15,000

14,000 1,000

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Outstanding Encumbrances Lapse at Year-End

The closing entries on December 31, 20X2, close the remaining budgetary encumbrances and establish a reserve

of the actual fund balance on the December 31, 20X2, balance sheet. Although the GAAFR recommends that a

reserve for lapsing encumbrances be reported on the balance sheet, the GASB's codification allows the alternative

of only footnote disclosure of lapsing orders at year-end that are expected to be honored in the next fiscal period.

If only footnote disclosure is used, the governmental entity would have only the first closing entry on December

31, 20X2, to close out the budgetary accounts related to the encumbrance. No balance sheet reserve is established

if the footnote disclosure alternative is used.

Normal procedure for many governmental entities is that the next year's governing board meets after elections

or appointments for the next year take place and this meeting is generally held shortly before the beginning of

the next fiscal year so that the budget is effective beginning on January 1 of the next year. Thus, the incoming

governing board will typically make a decision during the budget process as to whether or not year-end

outstanding encumbrances will be honored in the next fiscal period. If the new governing board decides not to

honor the 20X2 year-end outstanding encumbrances, then only the closing entry to close the remaining budgetary

encumbrances would be made on December 31, 20X2. If the governmental entity uses the footnote disclosure

alternative, no footnote disclosure in the 20X2 financial statements would be made for those outstanding

encumbrances not expected to be renewed in the next fiscal year.

If the new governing board decides to honor the outstanding encumbrances from 20X2, then the outstanding

encumbrances must be included in the 20X3 budgeted appropriations. An entry is made as of January 1, 20X3, to

establish budgetary control over the expected expenditure. A "fresh start," new spending authority is established,

and the sequence of entries continues as if this is a new purchase order effective for 20X3.

In the unusual case that the new governing board makes a decision as of January 1, 20X3, not to honor the

outstanding encumbrances, and the December 31, 20X2, entry had already been recorded, then the following

entry would be made as of January 1, 20X3, to record the cancellation of the outstanding encumbrance from 20X2:

January 1, 20X3

(6) Fund Balance—Assigned for Encumbrances 15,000

Fund Balance—Unassigned 15,000

Eliminate reserve for outstanding encumbrances not being

renewed.

If the January 1, 20X3, entries had already been made, and the governing board later decides not to honor the

outstanding encumbrance from 20X2, reversing entries would be made to eliminate the actual fund balance

reserve and the budgetary fund balance reserve that had been created on January 1, 20X3. If the governmental

entity used only footnote disclosure in its 20X2 financial statements for the year-end outstanding encumbrances

expected to be honored, then only a reversing entry would be required to reverse the January 1, 20X3, entry that

had established the budgetary encumbrances and budgetary fund balance reserve. The governmental entity then

simply cancels the order with the external vendor.

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Outstanding Encumbrances are Nonlapsing at Year-End

Some governing entities carry over the prior year appropriations authority as nonlapsing encumbrances. In this

case, the budget for the second fiscal period does not show these carryovers because they arose from the

appropriations authority of the prior year. The nonlapsing encumbrances are dated for the prior year to indicate

they arose from that year's appropriating authority. Some governmental accountants believe this method is

realistic for many situations in which orders placed with outside vendors cannot easily be canceled.

The 20X2 year-end closing entries presented in Exhibit 4 show the required reservation of the actual fund balance.

Note that these are the same two entries made under the lapsing method with balance sheet recognition of the

reserve of the fund balance. The differences between the two methods become apparent during the second fiscal

period. Under the nonlapsing method, it is important to identify separately expenditures made from spending

authority carried over from prior periods. Typically this is done in a reclassification entry on the first day of the

second fiscal period, which dates the Fund Balance—Assigned for Encumbrances. No budgetary entry is made in

the second year because the appropriation authority comes from the first year's budget. When the goods are

received, the expenditures account is also dated to indicate that the expenditure authority emanated from 20X2.

At the end of 20X3, the Expenditures-20X2 account is closed directly to the Fund Balance—Assigned for

Encumbrances-20X2. Note that the $1,000 difference between the actual $14,000 cost and the $15,000 assigned

amount is closed to Fund Balance—Unassigned because the actual cost is less than the amount encumbered from

the prior year's appropriation authority. If the actual cost is more than the reserve, the difference must be

approved as part of the appropriation authority for 20X3.

Short Quizzes

Indicate whether each of the following statements is true or false.

1. The three budgetary accounts which should be incorporated in the accounting system of a general fund

or a special revenue fund are ESTIMATED REVENUES CONTROL, REVENUES, and APPROPRIATIONS

CONTROL.

2. An encumbrance of an appropriation should be recorded when goods or services are ordered.

3. Encumbrances, in addition to expenditures, must be deducted from each legally approved appropriation

in order to determine the amount of the available appropriation.

Answers

1. False. The three budgetary accounts are ESTIMATED REVENUES CONTROL, APPROPRIATIONS CONTROL,

and ENCUMBRANCES.

2. True. Ordering goods or services will, in the normal course of events, result in their receipt and,

consequently, an expenditure of an appropriation.

3. True. It is contrary to law to over expend appropriations, therefore it is important to know the estimated

amount of open encumbrances as well as the total of expenditures to date.

39

Key Observations from the Illustrations

As a practical matter, almost all outstanding encumbrances at year-end are honored and completed in the next

fiscal period. The method of accounting for open encumbrances at year-end is based on the governmental unit's

budgetary policy, which may be affected by legal statutes controlling carryover of appropriating ability from one

fiscal period to the next. Both methods are used in practice. It is important to note that, in this example, the 20X2

statement of revenues, expenditures, and changes in fund balance will report no expenditures relating to this

item. In 20X3, $14,000 of expenditures will be recognized. Under the nonlapsing method, expenditures made in

20X3 but carried over from 20X2 encumbrances are dated to note they arose from 20X2 's appropriations. The

comprehensive illustration presented later in this chapter uses the lapsing method because of its widespread use.

Reporting of Encumbrances under the New Standard on Fund Balance Reporting

GASB 54 does not report any reserves of fund balance on the balance sheet. Rather, the amount of encumbrances

is included as part of the spendable fund balance, usually in the assigned category. Only footnote disclosure is

now used to report the aggregate amount of encumbrances, along with the required disclosures about other

significant commitments. Since governments will continue to use encumbrance accounting because of the control

and management information an encumbrance system provides, we continue to show encumbrance accounting

even though encumbrances are no longer reported in the balance sheet. GASB 54 does not restrict the accounting

systems used by governments.

Expenditures for Inventory

If purchasing is centralized, the supply activities of a governmental unit are usually accounted for in an internal

service fund. However, an internal service fund is a proprietary fund for which net position, not a fund balance, is

reported. Moreover, smaller entities often record the purchases of supplies inventory in the general fund. In

accounting for supplies, the entire expenditure may be recognized in the period of purchase (the purchases

method). An alternative is the consumption method; it recognizes expenditures for only the amount of inventory

used in the period. In the former case, a significant inventory must be recognized as an asset at the end of the

period, with a corresponding reservation of fund balance. In the latter case, fund balance is reserved for inventory

only if amounts must be maintained and are therefore not available for expenditure. The specific method to follow

depends on the governing unit's policy and how inventory expenditures are included in the budget.

A second issue is whether to show inventory as an asset on the balance sheet of the governmental funds. Inventory

is not an expendable asset; that is, it may not be spent as the governing entity wishes. NCGA 1 states that inventory

should be shown on the balance sheets for governmental funds if the amount of inventory is material. Immaterial

inventories need not be shown on the balance sheet. If the inventory is material, it is presented as an asset on the

balance sheet; an amount equal to the inventory also should be shown as a reservation of the fund balance,

indicating that that amount is no longer expendable.

Note: Exhibit 9 presents the entries to account for inventories under both the purchase method and the

consumption method. The illustration assumes that Bancroft City acquires $2,000 of inventory on November 1,

20X2, having held no inventory previously. On December 31, 20X2, the end of Bancroft City's fiscal year, a physical

count shows $1,400 still in stock. During 20X3, $900 of this inventory is used, resulting in a $500 remaining balance

of supplies on December 31, 20X3.

40

Exhibit 9 Comparison of Accounting for Inventories—Purchase versus Consumption Method

Item

Purchase Method of Accounting Consumption Method of Accounting

November 1, 20X2 Record acquisition of $2,000 of inventory

Expenditures 2,000 Vouchers 2,000

Expenditures 2,000 Vouchers 2,000

December 31, 20X2 Recognize ending inventory of $1,400

Inventory Supplies 1,400 Fund Balance – Nonspendable 1,400

Inventory Sup 1,400 Expenditures 1,400 Fund Balance Unassigned 1,400 Fund Balance – Nonspendable 1,400

December 31, 20X3 Record remaining supplies having been consumed during 20X3

Fund Balance – Nonspendable 900 Inventory Sup 900

Expenditures 900 Inventory Sup 900 Fund Balance – Nonspendible 900 Fund Balance – Unassigned 900

Purchase Method of Accounting for Inventories

Under the purchase method, the entire amount of inventory acquired is charged to Expenditures in the period

acquired. On December 31, 20X2, the end of the fiscal year, an adjusting entry is made to recognize the $1,400

remaining inventory as an asset and to restrict the fund balance for the nonexpendable portion applicable to

inventories.

The expenditure of $2,000 is closed into Fund Balance—Unassigned for 20X2 in a closing entry made at the end

of the fiscal year. The December 31, 20X2, balance sheet includes the inventory of supplies as an asset in the

amount of $1,400, and Fund Balance—Assigned for Inventories is shown as a fund balance reserve for $1,400. The

20X2 operating statement shows a $2,000 expenditure for supplies.

At the end of 20X3, an adjusting entry is made to recognize the use of the $900 of supplies of the $1,400 remaining

from the 20X2 purchase. This entry reduces the reservation of the fund balance and decreases inventory. At the

end of 20X3, Inventory of Supplies is $500, and Fund Balance—Assigned for Inventories is $500, for the remaining

unused supplies.

In summary, the $2,000 expenditure is recognized in the period in which the supplies are purchased. No

expenditures are recognized in subsequent periods although some of the supplies are used in those periods.

41

Consumption Method of Accounting for Inventories

Under the consumption method, expenditures for a period are reported only for the amount consumed. In this

case, the budget for the period should be based on the expected amount of use so that the budgeted and actual

amounts compared at the end of the year are on the same basis.

A net expenditure of $600 ($2,000 - $1,400) for supplies used is reported in 20X2, the year the supplies were

acquired. With $500 of inventory remaining at the end of 20X3, an expenditure of $900 is reported in the 20X3

operating statement to show the amount of supplies consumed during 20X3. The consumption method relates

the expenditures with the use of the inventory.

A comparison of selected account balances under the purchase method and consumption method shows the

different amounts reported under these two methods:

Purchase Method Consumption Method

20X2 Expenditures $2,000 $ 600 Inventory of Supplies 1,400 1,400

20X3 Expenditures –0– 900 Inventory of Supplies 500 500

Note that the choice of methods has no effect on the balance sheet amounts; the only effect is on the period in

which the expenditures for inventory are reported.

Note: Both inventory methods are used in practice. The method used by a specific governmental unit depends on

its budgeting policy. If the governmental unit includes all inventory acquisitions in its appropriations for the period,

the purchase method should be used. If the governmental unit includes only the expected amount of inventory

to be used during a period in that period's appropriations, the consumption method should be used.

Reporting of Inventory under the New Standard on Fund Balance Reporting

Inventories, if they are material in amount, are reported as an asset on the balance sheet. Under the proposed

standard, reserves of fund balance are not reported on the face of the balance sheet. But the fund balance

associated with inventories is reported in the non-spendable fund balance category.

Accounting for Fixed Assets

Governmental entities may acquire equipment that has an economic life of more than one year. Accounting for

this acquisition depends on which fund expends the resources for the acquisition. The governmental funds are

concerned with the expendability and control over available resources and account for the acquisitions of

equipment as expenditures. In the governmental funds, the entire amount of the cost of the acquisition of

equipment and other capital assets is recognized as an expenditure in the year the asset is acquired. No capital

assets are recorded in the general fund; they are treated as expenditures of the period.

42

The proprietary funds are concerned with capital maintenance and account for acquisitions of capital assets in the

same manner as commercial entities. Thus, the accounting for the purchase of a capital asset differs in the five

governmental funds from the accounting used in the proprietary funds.

For example, assume that Bancroft City acquires a truck. The acquisition is made from the resources of, and is

accounted for in, the general fund. The encumbrance is $12,000, but the actual cost is $12,500 because of minor

modifications required by the city.

The general fund makes the following entries to account for the acquisition of the truck:

(7) ENCUMBRANCES 12,000 BUDGETARY FUND BALANCE—ASSIGNED FOR

ENCUMBRANCES 12,000

Order truck at estimated cost of $12,000. (8) BUDGETARY FUND BALANCE—ASSIGNED FOR

ENCUMBRANCES 12,000

ENCUMBRANCES 12,000 Cancel reserve for truck received.

(9) Expenditures 12,500 Vouchers Payable 12,500 Receive truck at actual cost of $12,500.

The truck is not recorded as an asset in the general fund; it is an expenditure in this fund. Sales of capital assets

are recorded as a debit to Cash (or receivable) and a credit to Other Financing Sources—Sales of General Capital

Assets for the amount received from the sale. If the amount from the sale is immaterial, the government entity

may elect to record the credit to other revenues. A schedule of the acquisition or sale of capital assets by any

governmental fund should be maintained, but that record is only for the government-wide financial statements,

which do report the assets of a government unit.

Works of Art and Historical Treasures

For the purposes of government-wide financial statements, governments should capitalize works of art, historical

treasures, and similar types of assets at their historical costs at acquisition or at their fair values at the date of the

contribution. For example, if the general fund expended $10,000 for a work of art, it reports an expenditure for

that amount. However, when preparing the government-wide financial statements, the cost of the work of art is

reported as an asset of the government. If the assets are donated, contribution revenue is recognized in the

government-wide financial statements.

The GASB provided practical guidance to the general rule of capitalizing works of art and historical treasures. For

example, many collections have a very large number of items collected over long periods of time, and it is virtually

impossible to determine the cost or fair value at the times of acquisition. A provision in GASB 34 states that the

government is not required but is still encouraged to capitalize a collection of art or historical treasures if the

government meets all three of the following provisions: (1) holds the collection for public exhibition, education,

or research; (2) protects and preserves the collection; and (3) has an organizational policy that requires the

proceeds from sales of collection items to be used to acquire other items for collections. If contributed items are

not capitalized, the government-wide financial statements report both a program expense and a contribution

revenue for the fair market value of the item at the time of its donation.

43

Capitalized collections that are exhaustible, such as displays of works whose useful lives are reduced due to

display, or used for education or research, should be depreciated over their estimated useful lives. Collections or

individual items whose lives are inexhaustible are not depreciated.

Long-Term Debt and Capital Leases

Commercial, profit-seeking businesses recognize long-term debt and capital leases as noncurrent liabilities. The

debt or capital lease is entered into to earn income, and the liability is recognized under the flow of economic

resources measurement focus model. However, accounting for long-term liabilities in governmental funds is

directly affected by the flow of current financial resources measurement focus model.

The governmental funds, which include the general fund, record the proceeds from a bond issue as a debit to Cash

and a credit to Bond Issue Proceeds, an other-financing source. Bond issue proceeds are not revenue because the

bonds must be repaid. Other financing sources are shown in the middle section of the statement of revenues,

expenditures, and other changes in fund balances. Bonds are not reported on the governmental funds' balance

sheets but only on the government-wide financial statements.

Capital leases are accounted for in a manner similar to long-term debt. If a proprietary fund (e.g., internal service

or enterprise fund) enters into a capital lease, the lease is accounted for using methods similar to those used by

commercial, profit-seeking entities, with the recording of an asset and a lease liability. However, if a governmental

fund (e.g., general fund) enters into a capital lease, the capital lease is accounted for in a manner similar to a

bond's accounting.

The GASB issued GASB Statement No. 87, Leases, fundamentally changing lease recognition, measurement, and

related disclosures for both government lessees and lessors. For example, the GASB’s rules eliminate all

distinctions between operating and capital leases and treat all leases as financings (similar to capital lease

accounting). Detailed requirements are discussed in the following section.

Lease Accounting

In 2017, the GASB issued GASB Statement No. 87, Leases, to establish a single model for lease accounting based

on the foundational principle that leases are financings of the right to use an underlying asset. A lease is defined

as a contract that conveys control of the right to use another entity’s nonfinancial asset (e.g. buildings, land,

vehicles, and equipment) as specified in the contract for a period of time in an exchange or exchange-like

transaction. To determine whether a contract conveys control of the right to use the underlying asset, a

government should assess whether it has both of the following:

1. The right to obtain the present service capacity from use of the underlying asset as specified in the

contract

2. The right to determine the nature and manner of use of the underlying asset as specified in the contract.

The GASB treats all leases as financing—there is no distinction between operating and financing lease

classifications for financial reporting purposes. Thus, government entities will have to report operating leases on

44

the balance sheets (with certain exceptions discussed below). Specifically, government entities that lease

nonfinancial assets, such as vehicles, equipment, and buildings, must treat these leases as financings of the right

to use an underlying asset. In other words, lease liabilities will be considered as long-term debt and lease payments

as capital financing.

The major changes outlined in GASB 87 include:

• Leases that extend beyond 12 months will have a balance sheet impact on both the lessee and lessor.

• Leases will be classified as “short-term,” “contracts that transfer ownership,” and “all other”. GASB no

longer contemplates the subjective determination/distinction between an “operating lease” and a

“capital lease”

• The lessee should recognize a lease liability and a lease asset at the start of the lease term, unless the

lease is a short-term lease, or it transfers ownership of the underlying asset

• The lessee will no longer report rent expense for today’s operating-type leases, but will instead report

interest expense on the liability and amortization expense related to the asset

• A lessor generally should recognize a lease receivable and a deferred inflow of resources at the start of

the lease term. However, certain exceptions exist for leases of assets held as investments, certain

regulated leases, short-term leases, and leases that transfer ownership of the underlying asset.

• In cash flow statements, lease payments will be classified as capital financing outflows

• Financial statement disclosures and schedules will be required for contracts that transfer ownership and

non-short-term leases.

• There will be no disclosure requirement for short-term lease outflows.

There are some important exceptions or types of contracts that do not qualify for lease accounting under GASB

87. These include contracts for intangible assets, biological assets, inventory, service concession arrangements,

supply contracts and leases with a maximum possible term of 12 months or less (short-term lease). For example,

lessees and lessors should recognize short-term lease payments as outflows of resources or inflows of resources,

respectively, based on the payment provisions of the lease contract. GASB 87 also makes a significant exception

for certain regulated leases, such as aviation leases between airports and air carriers, where cost recovery is

controlled, and other leases with similar characteristics. In these cases, the lessor has limited disclosure

requirements and should only recognize revenue based on payment provisions in the contract.

The following table summarizes general requirements by the lessee and lessor under GASB 87.

Requirements Lessee Lessor

At the

commencement

of the lease

term

• Recognizing a lease liability and a lease

asset

• Exception: Short-term lease, and leases

that transfer ownership of the underlying

asset

• Recognizing a lease receivable and a

deferred inflow of resources

• Exceptions: Leases of assets held as

investments, certain regulated leases,

short-term leases, and leases that transfer

ownership of the underlying asset.

45

Measurement

of Lease Value

• Lease Liability: Measured at the present

value of payments expected to be made

during the lease term (less any lease

incentives)

• Lease Asset: Measured at the amount of

the initial measurement of the lease

liability, plus any payments made to the

lessor at or before the commencement of

the lease term and certain direct costs.

• Lease Receivable: Measured at the

present value of lease payments expected

to be received during the lease term.

• Deferred Inflow of Resources: Measured

at the value of the lease receivable plus

any payments received at or before the

commencement of the lease term that

relate to future periods

Accounting

Treatments

• Lease Liability: Reduce the lease liability as

payments are made and recognize an

outflow of resources (for example,

expense) for interest on the liability

• Lease Asset: Amortize the lease asset in a

systematic and rational manner over the

shorter of the lease term or the useful life

of the underlying asset.

• Lease Receivable: Recognize interest

revenue on the receivable

• Deferred Inflows of Resources: Recognize

revenue from the deferred inflows of

resources over the term of the lease

Disclose

• A description of leasing arrangements

• The amount of lease assets recognized

• A schedule of future lease payments to be

made

• A description of leasing arrangements

• The total amount of inflows of resources

recognized from leases

The requirements of Statement No. 87 are effective for reporting periods beginning after December 15, 2019,

with earlier application encouraged. Leases should be recognized and measured using the facts and circumstances

that exist at the beginning of the period of implementation (or, if applied to earlier periods, the beginning of the

earliest period restated). However, lessors should not restate the assets underlying their existing sales-type or

direct financing leases. Any residual assets for those leases become the carrying values of the underlying assets.

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 Statement No. 31, Accounting and

Financial Reporting for Certain Investments and for External Investment Pools (GASB 31), established a general

rule of fair market valuation for investments held by a government entity. The following investments are to be

valued at fair value, if determinable, in the asset section of the balance sheet for the governmental entity: (1)

investments in debt securities; (2) investments in equity securities (other than those accounted for under the

equity method as provided for in APB 18), including option contracts, stock warrants, and stock rights; (3)

investments in open-end mutual funds; (4) investment pools in which a governmental entity combines with other

investors; and (5) interest-earning investment contracts in which the value is affected by market (interest rate)

changes. GASB Statement No. 52, Land and Other Real Estate Held as Investments by Endowments (GASB 52),

extended the general rule of using fair value to real estate investments by endowments. The periodic changes in

the fair value of all the types of investments included in GASB 31 and GASB 52 should be recognized as an element

46

of investment income in the operating statement (or statement of activities) of each fund making the investment.

In the case of an internal investment pool that combines the resources of several of the governmental entity's

funds, for financial reporting purposes the pool's assets and its income are allocated to each individual fund based

on its percentage of the total invested.

Many state and local governments have deposits and make investments that are open to a variety of risks. GASB

Statement No. 40, Deposit and Investment Risk Disclosures (GASB 40), established detailed note disclosure

requirements related to the following types of investment risks: credit risk (including concentrations of credit risk),

interest rate risk, and foreign currency risk, as well as for deposit risks of custodial credit risk and foreign currency

risk. The main objective of GASB 40 is to require footnote disclosures of the policies and the profiles of the

government's investment portfolios, such as the credit quality ratings debt securities and other fixed-income

securities, and the terms of investments whose fair value is highly sensitive to changes in the interest rate.

GASB Statement No. 79, Certain External Investment Pools and Pool Participants. Statement No. 79, establishes

new criteria to continue amortized cost accounting for certain external investment pools and adds disclosure

requirements for qualifying pools and their participants. Under this Statement, qualifying external investment

pools are permitted to measure pool investments at amortized costs for financial reporting purposes. If an

external investment pool does not meet the criteria established by this Statement, that pool should apply the

provisions of Statement No. 31, Accounting and Financial Reporting for Certain Investments and for External

Investment Pools.

GASB Statement No. 90, Majority Equity Interests, modifies previous guidance for reporting a government’s

majority equity interest in a legally separate organization. It also provides guidance for reporting a component

unit if a government acquires a 100 percent equity interest in that component unit:

1. Reporting a Majority Equity Interest in a Legally Separate Organization: A government can own or acquire

a majority of the equity interest in a legally separate organization (e.g. through acquisition of voting stock

of a corporation) If a government’s holding of that equity interest, the equity interest should be reported

as an investment and measured using the equity method. The legally separate organization should not be

reported as a component unit of the government.

If a government’s holding of a majority equity interest in a legally separate organization does not meet

the definition of an investment, the holding of the majority interest results in the government being

financially accountable for the organization and, therefore, the government should report the legally

separate organization as a component unit. A majority equity interest in an organization reported as an

asset of the government or fund that holds the equity interest, measured using the equity method.

2. Reporting a Component Unit if a Government Acquires a 100 percent Equity Interest: If a government

acquires a 100 percent equity interest in a legally separate organization that is reported as a component

unit, the component unit should measures its assets, deferred outflows of resources, liabilities, and

deferred inflows of resources.

The provisions of GASB 90 are effective for fiscal years beginning after December 15, 2018.

47

Interfund Activities

A basic concept in governmental accounting is that each fund is a separate entity and has separate sources of

resources, sometimes including the power to levy and collect taxes. The revenues of each fund must then be

expended in accordance with the budget and restrictions established by law. Because a single governmental entity

has a number of separate funds, it sometimes becomes necessary to transfer resources from one fund to another.

Interfund activities are resource flows between fund entities. In a consolidated financial statement for a

commercial entity, intercompany transactions are eliminated to report only the effect of transactions with

external entities. Governmental accounting, on the other hand, requires the separate maintenance and reporting

of interfund items. The governing body must approve any interfund transfers and transactions to provide a public

record and to prevent distortion of fund uses. Many governmental entities include interfund activities anticipated

during a fiscal year in the operating budgets for the year. Budgetary entries for interfund activities are illustrated

in the comprehensive example of Haas City presented later in this chapter. Interfund transfers must be accounted

for carefully to ensure that the legal and budgetary restrictions are followed and that resources intended for one

fund are not used in another.

GASB 34 establishes four types of interfund activities, as follows: (1) interfund loans, (2) interfund services

provided and used, (3) interfund transfers, and (4) interfund reimbursements. A discussion of the four interfund

items follows; they are illustrated in Exhibit 10.

(1) Interfund Loans

State law may allow lending or borrowing activities between funds. The loans must be repaid, usually within one

year or before the end of the fiscal period. Loans and advances are not shown on a fund's statement of revenues,

expenditures, and changes in fund balance; however, all outstanding loans or advances must be shown on the

balance sheet as payables or receivables. Interest usually is not charged on interfund financing arrangements. If

interest is charged, it is accounted for in the funds in the same manner as for other interest income or expense.

Some governmental entities distinguish between short-term and long-term financing arrangements by using the

term Advances to (or from) to denote a long-term agreement and Due to (or from) for a short-term agreement.

The illustration of an interfund financing transaction in Exhibit 10 assumes that Bancroft City's general fund loans

the internal service fund $4,000 for two months. The general fund reports a receivable for the amount of the loan

until the loan is repaid.

Exhibit 10 Interfund Transactions and Transfers

Item Entry in General Fund Entry in Other Fund

Interfund loan Interfund

INTERNAL SERVICE FUND:

Due from Int Service Fund Cash 4,000

4,000 Cash

Due to General Fund 4,000

4,000

Cash Due from Int Service Fund

4,000

4,000

Due to General Fund Cash

4,000 4,000

INTERNAL SERVICE FUND:

48

service provided and used Interfund transfer Interfund reimbursement

Expenditures Due to Int Service Fund

100 100

Due from General Fund Charge for Services

100 100

Due to Int Service Fund

Cash 100

100 Cash

Due from General Fund 100

100 CAPITAL PROJECTS FUND: Other Financing Uses—

Transfer Out to Capital Projects Fund

Cash

10,000

10,000

Cash Other Financing Sources—

Transfer In from General Fund

10,000 10,000

CAPITAL PROJECTS FUND: Cash

Expenditures 3,000

3,000

Expenditures Cash

3,000 3,000

(2) Interfund Services Provided and Used

These interfund activities are transactions that would be treated as revenue, expenditures, or expenses if they

involved parties external to the governmental unit. These interfund activities are still reported as revenue,

expenditures, or expenses but are different because they are entirely within the governmental unit. These

interfund activities are often normal and recurring items, usually involving at least one proprietary fund. Three

examples are as follows:

1. The general fund purchases goods or services from an internal service or enterprise fund.

2. Payments are made to the general fund from the enterprise fund for fire and police protection.

3. A transfer of resources from the general fund to the pension trust fund is made to pay for the city's cost

of pension benefits for its employees. This is a cost associated with employee services provided to the city

and is therefore an expenditure of the general fund.

Usually these transfers involve the recognition of a receivable or payable because of the time lag between the

purchase of the services and the disbursement of funds. A "Due to (or from)" account is used for short-term

interfund receivables and payables rather than a formal Vouchers Payable account.

The illustration of this type of interfund activity in Exhibit 10 assumes that Bancroft City's general fund uses an

auto from the city motor pool. The motor pool operates as an internal service fund. The general fund is billed $100

based on mileage and pays the bill 30 days later.

(3) Interfund Transfers

The general fund often transfers resources into another fund to be used by the receiving fund for its own

operations; occasionally, the general fund receives resources from other funds. These interfund transfers are not

expected to be repaid. Such transfers are not fund revenues or expenditures but are instead called "interfund

transfers." These transfers are classified under "Other Financing Sources or Uses" in the operating financial

statements of the funds. The reason that the receiving fund does not recognize these transfers as revenue is that

the issuing fund has already properly recognized these resources as revenue. Thus, the recording of these transfers

as other financing sources eliminates the possibility of double counting the same resources as revenue in two

different funds of the combined governmental entity. Examples include the following:

49

1. A transfer of resources, such as cash or other assets, is made from the general fund to an enterprise fund

or internal service fund that has an operating deficit that must be eliminated.

2. A transfer of resources from the general fund to a capital projects fund is made to help finance new

construction.

3. A transfer of resources from the general fund to the debt service fund is made to pay principal and

interest.

The illustration of an interfund transfer in Exhibit 10 assumes that the general fund of Bancroft City agrees to

provide $10,000 to the capital projects fund toward the construction of a new library. The Transfer Out account

in the general fund is closed to its Unassigned Fund Balance at the end of the fiscal period. The capital projects

fund also closes its Transfer In account at the end of the fiscal period to its Unassigned Fund Balance. These

interfund transfers are not expected to be repaid.

Interfund Transfers and Financial Reporting

The reporting of transfers is different in the government-wide and fund financial statements (see Exhibit 11).

1. Transfers within the governmental activities section are not reported in the government-wide statements.

These transfers result in no overall change in governmental activities.

2. Transfers between governmental activities and business-type activities are reported in both the

government-wide statements and the fund statements.

Exhibit 11

Interfund Transfers and Financial Reporting

(4) Interfund Reimbursements

A reimbursement transaction is for the reimbursement of a fund's expenditure or expense that was initially made

from the fund but that is properly chargeable to another fund. These initial payments are sometimes made either

because of improper classification to the wrong fund or for expediency within the governmental entity. The

reimbursement from one fund to another is recorded as a reduction of the expenditure in the fund initially

recording the expenditure and a recording of the expenditure in the proper fund for the appropriate amount.

Two examples are as follows:

50

1. An expenditure properly chargeable to the special revenue fund is initially recorded and paid by the

general fund, and the general fund subsequently is reimbursed by the special revenue fund.

2. The general fund records and pays for an expenditure to provide preliminary architectural work on the

planning for a new sports arena. The sports arena enterprise fund later reimburses the general fund.

The illustration of an interfund reimbursement in Exhibit 11 assumes that the general fund of Bancroft City

recorded a $3,000 expenditure for a bill from outside consultants that is later discovered to be properly chargeable

to the capital projects fund. Upon notification, the capital projects fund reimbursed the general fund and properly

recorded the expenditure in its fund.

Short Quizzes

Indicate whether each of the following is true or false.

1. Interfund loans or advances, operating transfers, and residual equity transfers are examples of interfund

transactions which should not affect Revenue or Expenditures accounts.

2. Interfund transactions which constitute reimbursements of one fund for expenditures initially recognized

by it, but which are properly applicable to another fund, should be recognized as expenditures by the

reimbursing fund and as a reduction of expenditures by the fund which is reimbursed.

3. Interfund transactions, which would result in the recognition of revenues, expenditures, or expenses, if

one of the parties were external to the governmental unit, properly are reported as resulting in fund

revenues, expenditures, or expenses.

4. Transfers within the governmental activities section are not reported in the government-wide statements.

Answers

1. True. The listed transactions are reported in the manner described previously.

2. This is a specific provision of the NCGA.

3. True. These transactions should be reported as if one of the parties were external to the governmental

unit.

4. True. These transfers result in no overall change in governmental activities.

Overview of Accounting and Financial Reporting for

the General Fund

Exhibit 12 presents an overview of the accounting for the general fund, including accounting for the interfund

activities on the general fund's operating statement, the statement of revenues, expenditures, and changes in

fund balance. Note that the interfund loans are reported only on the fund's balance sheet.

51

Exhibit 12 Overview of General Fund

Item Description

Measurement focus Flow of current financial resources—expendability.

Accounting basis Modified accrual.

Budgetary basis Operating budget.

Financial statements 1. Balance sheet. 2. Statement of revenues, expenditures, and changes in fund

balance. Balance Sheet

Current assets Includes current financial resources such as cash, certificates of deposit,

accrued property taxes receivable, and estimated allowance for

uncollectible taxes.

Interfund loans receivable are included as assets. Material inventories

reported.

Long-term productive assets

(buildings, etc.)

Fixed assets not reported in general fund.

Current liabilities Vouchers payable is primary current liability. Interfund loans payable also

included as liabilities.

Long-term debt Governmental unit long-term debt not reported in general fund.

Fund balance Unassigned fund balance and reservations of fund balance (e.g.,

encumbrances and inventories).

Statement of Revenues, Expenditures, and Changes in Fund Balance

Revenue Recorded when measurable and available under the modified accrual

basis of accounting. Interfund services provided and used also included in

revenues for expenditures).

Expenditures Recognized in period when measurable and fund liability arises.

Other financing sources and uses Includes bond issue proceeds and interfund transfers.

Changes in fund balance Reconciles changes in fund balance during period, including changes in

reservations of fund balance.

The illustration uses the financial reporting requirements under GASB 34. The highlights of the proposed

statement for fund balance reporting are covered in the additional considerations section of this chapter. Chapter

2 presents an example of the fund balance reporting for the governmental fund types under the proposed

statement.

52

Comprehensive Illustration of Accounting for the

General Fund

The following example illustrates the accounting for the general fund of Haas City for the January 1, 20X3, to

December 31, 20X3, fiscal year. The entries are presented by topic, not necessarily in chronological order. The

balance sheet for the general fund as of December 31, 20X2, presented in Exhibit 13, represents the opening

balances for fiscal 20X3.

Exhibit 13

General fund balance sheet sheet at the Beginning of 20X3

HAAS CITY

General Fund Balance

December 31, 20X2

Assets:

Cash $ 50,000

Property Taxes Receivable—Delinquent $100,000

Less: Allowance for Uncollectibles—Delinquent (5,000) 95,000

Inventory of Supplies 14,000

Total Assets $159,000

Liabilities and Fund Balance:

Vouchers Payable $ 30,000

Fund Balance:

Nonspendable:

Supplies inventory $14,000

Spendable:

Assigned to:

General Government Services 11,000

Unassigned 104,000 129,000

Total Liabilities and Fund Balance $159,000

53

Adoption of the Budget

Haas City’s budget summarizes the four major functions of the city: general government, streets and highways,

public safety (fire and police), and sanitation (see Exhibit 14). In the complete budget used by the city council, the

expenditures in each of the four functions are broken down into the following categories: personal services,

supplies, other services and charges, and capital outlay. The public safety budget includes a budgeted capital

outlay of $50,000 for a new fire truck.

Exhibit 14

General Fund Operating Budget

HAAS CITY

General Fund

Operating Budget

For Period of January 1, 20X3, to December 31, 20X3

Estimated Revenue:

Property Taxes $775,000

Grants

55,000

Sales Taxes

25,000

Miscellaneous 20,000

Total Estimated Revenue $875,000

Appropriations:

General Government

$200,000

Streets and Highways

75,000

Public Safety 400,000

Sanitation

150,000

Total Appropriations (825,000)

Excess of Estimated Revenue over Appropriations $ 50,000

Other Financing Uses:

Transfer out to Capital Projects Fund $

(20,000)

Transfer out to Initiate Internal Service Fund (10,000)

Total Other Financing Uses (30,000)

Excess of Estimated Revenue and Interfund Transfers over Appropriations and Interfund Transfers

$ 20,000

Among the city's accounting policies, it elects to use the following:

1. Consumption method for inventories. The city budgets the supplies inventory on the consumption

method, including only the costs of expected inventory use during the year.

2. Lapsing method of accounting for encumbrances. The city uses the lapsing method for accounting for

any encumbrances outstanding at the end of fiscal periods. The APPROPRIATIONS CONTROL for fiscal

54

20X3 includes a reappropriation of the $11,000 of outstanding encumbrances as of December 31, 20X2.

3. Use of control accounts. The city uses a comprehensive system of control accounts for its major journals.

The following accounts have extensive subsidiary ledgers that correspond to the entries made in the

journal: ESTIMATED REVENUES CONTROL,

4. APPROPRIATIONS CONTROL, ENCUMBRANCES, and Expenditures. The specific details supporting each

of these control accounts are maintained in the subsidiary records. For purposes of focusing on the

major aspects of governmental accounting, the Haas City illustration includes the control-level entries

only.

5. Budgeted interfund activities. The city includes in the budget all anticipated interfund activities during

the fiscal year. The general fund is expected to have the following interfund transfers:

OTHER FINANCING USES:

Transfer Out to Capital Projects Fund $20,000

Transfer Out to Internal Service Fund 10,000

The interfund transfer out to the capital projects fund is to pay for the city's share of a municipal courthouse

addition project, and the transfer out to the internal service fund is to initiate the internal service fund.

The following entries are made to record the budget and to renew the lapsing encumbrances from the prior

period:

January 1, 20X3 (10) ESTIMATED REVENUES CONTROL 875,000 APPROPRIATIONS CONTROL 825,000 ESTIMATED OTHER FINANCING USES—TRANSFER OUT TO CAPITAL

PROJECTS 20,000

ESTIMATED OTHER FINANCING USES—TRANSFER OUT TO INTERNAL SERVICE

10,000

BUDGETARY FUND BALANCE—UNASSIGNED 20,000 Record budget for fiscal 20X3.

(11) Fund Balance—Assigned for Encumbrances 11,000 Fund Balance—Unassigned 11,000 Reverse prior-year encumbrances reserve.

(12) ENCUMBRANCES 11,000 Fund Balance—Unassigned 11,000 Renew encumbrances from prior period as included in

budgeted appropriations in 20X3.

Note: The technique of capitalizing the account titles of all budgetary accounts continues through the comprehensive illustration. This technique is used in the course to assist differentiation of the budgetary from the operating accounts. In practice, the budgetary accounts are not capitalized.

55

Property Tax Levy and Collection

Most municipalities obtain resources from property taxes, which are recorded as a receivable when an

enforceable legal claim arises. Revenue is recorded if the property taxes are measurable and available for current

expenditures. Recall that the 60-day rule for property taxes allows the recognition of revenue for the current

fiscal period if the property taxes are expected to be collected within 60 days of the end of the current fiscal

period. A deferred revenue account is credited if the property taxes are not available for current expenditures. For

Haas City, the property taxes are due and available for use within the fiscal period and therefore are recorded as

revenue as of the levy date.

Note: A provision for uncollectibles must be recorded, and this provision is a reduction of property tax revenue, not a bad debts expense as in commercial accounting. Governmental funds have no such account as bad debts expense. The receivables are classified as current, collectible within this period, or delinquent, for past-due accounts.

The entries in Haas City's general fund for the transactions relating to property taxes are as follows:

(13) Property Taxes Receivable—Current Allowance for Uncollectible Taxes—Current Revenue—Property Tax

785,000 10,000

775,000 Property taxes levied for this fiscal year with a reduction from

revenues for the estimated uncollectibles.

(14) Cash Property Taxes Receivable—Current Property Taxes Receivable—Delinquent

791,000 695,000

96,000 Collect portion of property taxes including $96,000 of past due

accounts.

(15) Allowance for Uncollectible Taxes—Delinquent Property Taxes Receivable—Delinquent

4,000 4,000

Write off remaining $4,000 of delinquent property taxes.

(16) Allowance for Uncollectible Taxes—Delinquent Allowance for Uncollectible Taxes—Current Revenues—Property Tax

1,000 5,000

6,000 Revise estimate of uncollectibles from $10,000 to $5,000 and close

remaining $1,000 balance of allowance account for delinquent accounts.

(17) Property Taxes Receivable—Delinquent Allowance for Uncollectible Taxes—Current Property Taxes Receivable—Current Allowance for Uncollectible Taxes—Delinquent

90,000 5,000

90,000 5,000

Reclassify remaining receivables and allowance account from current to delinquent.

Other Revenue

Other sources of income are grants from other governmental units, a portion of the sales tax collected on retail

sales made within the city, and miscellaneous revenue from parking meters, fines, and licenses. Grants from other

governmental units should be recognized as revenue when the grants become available and measurable. The

city's policy is to recognize these grants as the monies are received because the grants may be withdrawn by the

grantor at any time up to the actual transmittal of the monies. In our example, the city receives only 60 percent

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of the expected grant that had been budgeted at $55,000. Sales tax revenue may be accrued if the city can make

a good estimate of the amount to be received and if the sales tax revenue is available for current expenditures.

The city's policy is to recognize the sales taxes when received. Miscellaneous revenue is recognized as received.

The entries to record the other sources of income are as follows:

(18) Cash 33,000 Revenue--Grant 33,000 Receive only 60 percent of expected grant.

(19) Cash 32,000 Revenue—Sale Tax 32,000 Receive sales tax revenue from state.

(20) Cash 18,000 Revenue--Miscellaneous 18,000 Receive miscellaneous revenue from fines, license fees, minor disposals

of equipment, and other sources.

Expenditures

The appropriations were recorded in the budget entry [entry (10)] with a renewal of the encumbrances carried

over from the prior period under the lapsing method of accounting for encumbrances [entries (11) and (12)].

Orders for goods and services from outside vendors are encumbered, and a voucher system is used. Recall that a

governmental entity typically does not encumber internal payroll.

Haas City makes the following entries for the encumbrances, expenditures, and disbursements made in the

general fund during the year:

(21) ENCUMBRANCES 210,000 BUDGETARY FUND BALANCE—ASSIGNED FOR ENCUMBRANCES 210,000 Encumber for purchase orders for goods and services ordered from

outside vendors.

(22) BUDGETARY FUND BALANCE—ASSIGNED FOR ENCUMBRANCES 5,000 ENCUMBRANCES 5,000 Reverse encumbrance for portion of order that is not deliverable

because item has been discontinued.

(23) BUDGETARY FUND BALANCE—ASSIGNED FOR ENCUMBRANCES 190.000 ENCUMBRANCES 190.000 Reverse reserve for partial order of goods received. (24) Expenditures 196,000 Vouchers Payable 196,000 Receive goods at actual cost of $196,000 that had been

encumbered for $190,000. Difference due to increase in cost of items. Includes supplies for inventory.

(25) BUDGETARY FUND BALANCE—ASSIGNED FOR ENCUMBRANCES 11,000

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ENCUMBRANCES 11,000 Reverse reserve for goods received that were ordered in prior year. (26) Expenditures 9,000 Vouchers Payable 9,000

Receive goods ordered in prior year. Actual cost is $9,000 on

encumbered amount of $11,000. Difference due to price reduction

as part of special sale.

(27) Expenditures 550,000 Vouchers Payable 550,000 Payroll costs to employees for period.

(28) Vouchers Payable 730,000 Cash 730,000 Vouchers approved by city council and paid during period,

Acquisition of Capital Asset

The budget for the fire department includes $50,000 for a new fire truck. This capital outlay is accounted for as

any other expenditure of available resources. The resources for the fire truck are encumbered when the order is

placed with the truck manufacturer. The entries in the general fund for the fire truck acquisition are as follows:

(29) ENCUMBRANCES 50,000 BUDGETARY FUND BALANCE—ASSIGNED FOR ENCUMBRANCES 50,000 Order fire truck at estimated cost of $50,000 (30) BUDGETARY FUND BALANCE—ASSIGNED FOR ENCUMBRANCES 50,000 ENCUMBRANCES 50,000 Reverse reserve for fire truck received (31) Expenditures 58,000 Vouchers Payable 58,000 Receive fire truck at actual cost of $58,000 due to approved

additional items to meet new fire code.

(32) Vouchers Payable 58,000 Cash 58,000 Voucher approved and disbursement made for fire truck

Asset Retirement Obligations

Existing laws and regulations require state and local governments to take specific actions to retire certain tangible

capital assets, such as the decommissioning of nuclear reactors, removal and disposal of wind turbines in

windfarms, dismantling and removal of sewage treatment plants, and removal and disposal of x-ray machines.

Obligations to retire certain tangible capital assets also arise from contracts or court judgments. Accounting and

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financial reporting standards exist for costs of the closure and post-closure care of municipal solid waste landfills,

but those standards do not address retirement obligations associated with other types of tangible capital assets.

In 2016, the GASB issued GASB Statement No. 83, Certain Asset Retirement Obligations, to establish standards of

accounting and financial reporting for certain asset retirement obligations (AROs). An ARO is a legally enforceable

liability associated with the retirement of a tangible capital asset (that is, the tangible capital asset is permanently

removed from service). The retirement of a tangible capital asset encompasses its sale, abandonment, recycling,

or disposal in some other manner; however, it does not encompass the temporary idling of a tangible capital asset.

A government should recognize an ARO when the liability is incurred and reasonably estimable. Incurrence of a

liability is manifested by the occurrence of both an external obligating event and an internal obligating event

resulting from normal operations. An obligating event refers to an event whose occurrence determines the timing

for recognition of an ARO. Examples of external obligating events include:

1. Approval of federal, state, or local laws or regulations

2. Creation of a legally binding contract

3. Issuance of a court judgment.

When an ARO is recognized, a government also should recognize a corresponding deferred outflow of resources.

If a tangible capital asset is permanently abandoned before it is placed into operation, a government should

immediately report an outflow of resources (for example, an expense) rather than a deferred outflow of resources

when an ARO is recognized.

A government should determine the types of activities to be included in the measurement of an ARO based on

relevant legal requirements; that is, the relevant laws, regulations, contracts, or court judgments. The

measurement of an ARO should be based on the best estimate of the current value of outlays expected to be

incurred. Current value is the amount that would be paid if all equipment, facilities, and services included in the

estimate were acquired at the end of the current reporting period.

Subsequent to initial measurement, a government should at least annually adjust the current value of its ARO for

the effects of general inflation or deflation. A government also should at least annually evaluate all relevant factors

to determine whether the effect of one or more of those factors is expected to significantly increase or decrease

the estimated outlays associated with the ARO. Factors that may lead to a significant change in the estimated

outlays include, but are not limited to the following:

1. Price increases or decreases due to factors other than general inflation or deflation for specific

components of the estimated outlays

2. Changes in technology

3. Changes in legal or regulatory requirements resulting from changes in laws, regulations, contracts, or

court judgments

4. Changes in the type of equipment, facilities, or services that will be used to meet the obligations to retire

the tangible capital asset.

Changes in the estimated outlays should be recognized as an increase or decrease in the carrying amount of the

ARO in one of the following ways:

• For a liability that increases or decreases BEFORE the time of retirement of the tangible capital asset, a

government should adjust the corresponding deferred outflow of resources.

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• For a liability that increases or decreases AT or AFTER retirement of the tangible capital asset, at which

time the corresponding deferred outflow of resources has been fully recognized as outflows of resources,

a government should recognize an outflow of resources or an inflow of resources in the reporting period

in which the increase or decrease occurs.

The requirements of GASB 83 are effective for reporting periods beginning after June 15, 2018. Earlier application

is encouraged.

Interfund Activities

The anticipated interfund items are included in the budget for the fiscal period. They include the estimated

transfer out of $10,000 to initiate the internal service fund and the estimated transfer out of $20,000 for capital

improvements to a capital projects fund. In addition to these transfers, the general fund also has an interfund

transaction with the internal service fund for services received in the amount of $1,000, and it lends the enterprise

fund $3,000.

The following entries in the general fund record the general fund's side of the inter-fund activities during the year.

Chapter 2 continues the comprehensive example of Haas City and presents the entries for these interfund

transactions and transfers in each of the related funds so that both sides of accounting for interfund items are

illustrated for the Haas City example:

(33) Other Financing Uses—Transfer Out to Internal Service Fund 10,000 Due to Internal Service Fund 10,000 Recognize the transfer out and associated liability to the internal service

fund as included in the budget.

(34) Other Financing Uses—Transfer Out to Capital Projects Fund 20,000 Due to Capital Projects Fund 20,000 Recognize the transfer out and associated liability to the capital projects

fund as included in the budget.

(35) Due to Internal Service Fund 10,000 Cash 10,000 Pay cash to internal service fund for payable from interfund transfer out

previously recognized.

(36) Due to Capital Projects Fund 20,000 Cash 20,000 Pay cash to capital projects fund for payable from interfund transfer out

previously recognized.

(37) Expenditures 1,000 Due to Internal Service Fund 1,000 Pay cash to internal service fund for payable from interfund transfer out

previously recognized.

(38) Due to Internal Service Fund 1,000 Cash 1,000 Pay cash to eliminate payable. (39) Due from Enterprise Fund 3,000 Cash 3,000 City Council approves loan to enterprise fund to be repaid in 90 days.

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Adjusting Entries

Certain adjusting entries are required to state correctly the balance sheet items for the year. Assume that a

physical count of the inventory shows an ending balance of $17,000 on December 31, 20X3. This is a net increase

of $3,000 from the beginning balance of $14,000.

The policy of the general fund is to recognize inventory as an asset and to report a reserve against fund balance

for the ending balance. Recall that the city is using the consumption method of accounting for inventories. The

entries required to adjust the ending balance of the supplies inventory are as follows:

(40) Inventory of Supplies 3,000 Expenditures 3,000 Adjust ending inventory to $17,000 and reduce expenditures

to net amount consumed during the period.

(41) Fund Balance—Unassigned 3,000 Fund Balance—Assigned for Inventories 3,000 Adjust the reserve for inventories from beginning balance of

$14,000 to its ending balance of $17,000.

Closing Entries

The final set of entries closes the nominal accounts. The format presented first reverses the budget entry and then

closes the operating revenues and expenditures. Some governmental entities close the accounts in a slightly

different order by closing budgeted revenue against actual revenue and budgeted appropriations against actual

expenditures. The specific order of closing the accounts has no impact on the final effect; all budgetary accounts

and nominal operating accounts must be closed at year-end.

A preclosing trial balance is presented in Exhibit 15.

Exhibit 15

Preclosing Trial Balance for General Fund

HAAS CITY General Fund

Preclosing Trial Balance December 31, 20X3

Debit Credit

Cash Property Taxes Receivable-Delinquent

$102,000 90,000

Allowance for Uncollectible Taxes-Delinquent $5,000

Due from Enterprise Fund 3,000

Inventory of Supplies 17,000

Vouchers Payable 55,000

Fund Balance-Nonspendable 17,000

Fund Balance-Unassigned 112,000

Revenue-Property Tax 781,000

Revenue-Grant 33,000

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Revenue-Sales Tax 32,000

Revenue-Miscellaneous 18,000

Expenditures 811,000

Other Financing Uses-Transfer Out to Capital Projects Fund 20,000

Other Financing Uses-Transfer Out to Internal Service Fund 10,000

ESTIMATED REVENUES CONTROL 875,000

APPROPRIATIONS CONTROL 825,000

ESTIMATED OTHER FINANCING USES-TRANSFER OUT TO CAPITAL PROJECTS 20,000

ESTIMATED OTHER FINANCING USES-TRANSFER OUT TO INTERNAL SERVICE 10,000

ENCUMBRANCES 15,000

BUDGETARY FUND BALANCE-ASSIGNED FOR ENCUMBRANCES 15,000

BUDGETARY FUND BALANCE-UNASSIGNED 20,000

Total $1,943,000 $1,943,000

Recall that the city is using the lapsing method of accounting for encumbrances open at the end of the fiscal year.

The closing entries for the general fund of Haas City for fiscal 20X3 follow:

December 31, 20X3

(42) APPROPRIATIONS CONTROL 825,000 ESTIMATED OTHER FINANCING USES—TRANSFER OUT TO

CAPITAL PROJECTS 20,000

ESTIMATED OTHER FINANCING USES—TRANSFER OUT TO INTERNAL SERVICES

10,000

BUDGETARY FUND BALANCE—UNASSIGNED 20,000 ESTIMATED REVENUES CONTROL 875,000 Close budgetary accounts. (43) BUDGETARY FUND BALANCE—ASSIGNED FOR ENCUMBRANCES 15,000 ENCUMBRANCES 15,000 Close remaining encumbrances by reversing remaining budgetary

balance.

(44) Fund Balance—Unassigned 15,000 Fund Balance—Assigned for Encumbrances 15,000 Reservation of fund balance for encumbrances that lapse but are

expected to be honored in 20X4.

(45) Revenue—Property Tax 781,000 Revenue—Grant 33,000 Revenue—Sales Tax 32,000 Revenue—Miscellaneous 18,000 Expenditures 811,000 Other Financing Uses—Transfer Out to Capital Projects Fund 20,000 Other Financing Uses—Transfer Out to Internal Service Fund 10,000 Fund Balance—Unassigned 23,000 Close operating statement accounts.

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The following reconciliation explains the calculation of the Fund Balance-Unassigned account balance:

Fund Balance-Unassigned

Bal. 1/1/X2 104,000

(41) 3,000 (11) 11,000

Bal. Preclosing 112,000

(44) 15,000 (45) 23,000

Bal. 12/31/X2 120,000

General Fund Financial Statement Information

The general fund is always specified as a major governmental fund type. The two required statements for a major

governmental fund are (a) the balance sheet and (b) the statement of revenues, expenditures, and changes in

fund balance For purposes of illustration, the two financial statements for the general fund are provided, applying

the requirements of GASB 34, and then a presentation is made of the fund balance section of the balance sheet

under the proposed governmental accounting statement on fund balance reporting and governmental fund type

definitions.

The Balance Sheet

The balance sheet required under GASB 34 is presented in Exhibit 16. This balance sheet includes the supplies

inventory for $17,000 and the associated reservation of fund balance, reflecting that the portion of the fund

balance already applied to inventory is not expendable. The $3,000 receivable from the interfund loan transaction

with the enterprise fund is shown as a current asset. The outstanding encumbrances of $15,000 are a reservation

of fund balance indicating that a portion of the year's appropriation has been used but that the ordered goods or

services have not yet been received.

Exhibit 16

General Fund Balance Sheet Information

at the End of the Fiscal Period

HAAS CITY General Fund

Balance Sheet Information December 31, 20X3

Assets:

Cash $102,000 Property Taxes Receivable—Delinquent $ 90,000 Less: Allowance for Uncollectibles—Delinquent

(5,000) 85,000

Due from Enterprise Fund 3,000 Inventory of Supplies 17,000

Total Assets $207,000

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Liabilities and Fund Balance:: Vouchers Payable $ 55,000 Fund Balance: Nonspendable: Supplies Inventory $ 17,000 Spendable: Assigned to General Government Services 15,000 Unassigned 120,000 152,000

Total Liabilities and Fund Balance $207,000

The General Fund's Balance Sheet under GASB 54

The new statement on fund balance reporting and governmental fund type definitions does not change the

reporting of assets or liabilities. It affects only the reporting of the fund balance for governmental fund types that

includes the general fund. The fund balance section of the balance sheet could report only aggregate amounts for

the nonspendable and spendable categories with detail presented in the footnotes. Alternatively, the balance

sheet can report the detailed items within each category of the general fund balance. The nonspendable category

includes the two classifications of amounts not in spendable form, such as inventories, or amounts that are legally

or contractually required to be maintained. The spendable category includes resources that are in spendable form

and are considered to be available for spending, such as fund balance related to cash, investments, and

receivables. Amounts in the spendable fund balance category can then be classified as restricted, limited,

assigned, or unassigned based on a hierarchy of the level of control over the spending of the resources.

Under the implemented GASB 54, reserves are not reported on the balance sheet; rather, the amount of

encumbrances is reported in a footnote along with other commitments. The Haas City government has no

restricted or limited spendable fund balances, but it does have an assigned amount for the amount of resources

intended by the government to be used for the specific purpose of paying currently outstanding encumbrances

from goods and services ordered to be used for general government functions.

The Statement of Revenues, Expenditures, and Changes in Fund Balance

This required statement is presented in Exhibit 17 and has the following sections:

1. Operating section. Revenues less expenditures, resulting in an excess of revenues over expenditures for

the period. Expenditures include the interfund services provided and used, and separate reporting of

outlays for capital assets.

2. Other financing sources (uses). This section includes interfund transfers and nonrevenue proceeds such as bond issues.

3. Reconciliation of fund balance. The ending balance in fund balances, including both assigned and unassigned, is reconciled for (a) the results of operations, (b) other financing sources or uses, and (c) special or extraordinary items in the period.

Revenues should be classified by major sources, and expenditures by character and major functions. Although the

entries presented in the illustrations for Haas City did not break down the expenditures by function (general

government, streets and highways, public safety, and sanitation), this breakdown is done in the actual

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governmental accounting process so each expenditure can be classified by both function and object (personal

services, supplies, and other services and charges). The amounts presented in the expenditures section in Exhibit

17 are the assumed amounts from a comprehensive accounting system. Total expenditures do reconcile to the

expenditures recorded in the Haas City illustration.

The statement of revenues, expenditures, and changes in fund balance presents the total fund balance, including

both assigned and unassigned. Note that in this example, Haas City reported no extraordinary items or special

items. Special items would include significant transactions or other events within the control of management that

were either unusual in nature or infrequent in occurrence. An example of a special item could be a one-time sale

of some city park land. If the city did have a special item or extraordinary item, it would be reported below the

other financing sources (uses) section.

Exhibit 17

General Fund Statement of Revenues, Expenditures, and Changes in Fund Balance Information for Fiscal 20X3

HAAS CITY Statement of Revenues, Expenditures, and Changes in Fund Balance Information

General Fund For the Year Ended December 31, 20X3

Revenue:

Property Taxes $781,000 Grants 33,000 Sales Taxes 32,000 Miscellaneous 18,000

Total Revenues $864,000 Expenditures: General Government $206,000

Streets and Highways 71,000

Public Safety 335,000 Sanitation 141,000 Capital Outlay: Public Safety 58,000

Total Expenditures 811,000

Excess of Revenues over Expenditures $ 53,000 Other Financing Sources (Uses): Transfer Out to Capital Projects Fund $ (20,000) Transfer Out to Internal Service Fund (10,000)

Total Other Financing Sources (Uses) (30,000)

Net Change in Fund Balances $ 23,000 Fund Balance, January 1 129,000

Fund Balance, December 31 $152,000

The General Fund's Statement of Revenues, Expenditures, and Changes in Fund Balance under the Proposed Statement

GASB 54 on governmental fund type balances does not require any changes in the statement of revenues,

expenditures, and changes in fund balance. The reconciliation in this financial statement is to total fund balance,

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not to a specific classification of the fund balance. Therefore, this financial statement is the same under GASB 54

as was previously required under GASB 34.

Chapter Summary

Accounting for state and local governmental units requires the use of fund accounting to recognize properly the

variety of services and objectives of the governmental unit. 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; and

fiduciary funds. The basis of accounting for each fund depends on the fund's objective. The current financial

resources measurement focus and the modified accrual basis of accounting are used for the governmental fund

financial statements. The economic resources measurement focus and accrual basis of accounting are used for

the government-wide statements, the proprietary fund statements, and the fiduciary fund statements.

Under the modified accrual basis, revenue is recognized when it is both measurable and available for financing

expenditures of the period. A major source of revenue is property tax levies, but other sources may include sales

taxes; grants from other governmental units; and fines, licenses, or permits. Note that in the five governmental

funds, the estimated uncollectible property taxes are a reduction of the property tax revenue, not an expense as

in commercial accounting. Expenditures are recognized in the period in which the related liability is both

measurable and incurred. The expenditure process usually begins with a budget, which establishes the spending

authority for the fund. Encumbrances are used for purchases outside the governmental entity to recognize the

use of a portion of the spending authority for the period and to avoid overspending the expenditure authority.

Under current GAAFR, encumbrances outstanding at the end of a fiscal period are reported as a reserve of the

fund balance and may be accounted for as lapsing or nonlapsing. Another type of fund balance reserve is a reserve

for inventories, which is used if the amount of inventory is material.

The general fund is responsible for offering many of the usual services of governmental units. Fire and police

protection, the local government's administrative and legislative functions, and many other basic governmental

services are administered through the general fund. The general fund will provide balance sheet information and

statement of revenues, expenditures, and changes in fund balances information to the governmental funds

financial statements.

The government reporting model, as established by GASB 34, specifies that both fund-based financial statements

and government-wide financial statements must be presented. The general fund uses the modified accrual basis

of accounting to recognize revenue and expenditure transactions. Furthermore, no long-term capital assets or

general long-term debt is recorded in the general fund. However, a reconciliation schedule will be required to go

from the governmental fund types financial statements to the government-wide financial statements. 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 2 after the conclusion of that

chapter's discussion of the remaining funds.

Interfund activities must be evaluated carefully to ensure that the legal and budgetary controls of the

governmental unit are not violated. Four types of interfund activities exist: (1) interfund loans, (2) interfund

services provided and used, (3) interfund transfers, and (4) interfund reimbursements. Outstanding interfund

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loans are presented as receivables 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. Interfund

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

Interfund reimbursements are not reported separately on the fund's financial statements.

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Chapter 1 Review Questions – Section 3

10. When is the estimated revenues control account of a governmental unit debited?

A. When actual revenues are recorded

B. When actual revenues are collected

C. When the budget (appropriation) is recorded

D. When the budget is closed at the end of the year

11. Taxes collected and held by Franklin County for a separate school district are accounted for in which fund?

A. Special revenue

B. Internal service

C. Trust

D. Agency

12. A county's balances in the general fund included the following: Appropriations = $745,000; Encumbrances =

$37,250; Expenditures = $298,000; Vouchers payable = $55,875. What is the remaining amount available for use

by the county?

A. $353,875

B. $391,125

C. $409,750

D. $447,000

13. During its fiscal year ended June 30, 20X3, Cliff City issued purchase orders totaling $5 million, which were

properly charged to encumbrances at that time. Cliff received goods and related invoices at the encumbered

amounts totaling $4.5 million before year-end. The remaining goods of $500,000 were not received until after

year-end. Cliff paid $4.2 million of the invoices received during the year. What amount of Cliff's encumbrances

were outstanding at June 30, 20X3?

A. $0

B. $300,000

C. $500,000

D. $800,000

14. Which of the following amount(s) is (are) included in a general fund's encumbrance account? I) Outstanding

vouchers payable amounts; II) Outstanding purchase order amounts; or III) Excess of the amount of a purchase

order over the actual expenditure for that order.

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A. I only

B. I and III only

C. II only

D. II and III

15. Which of the following journal entries should be made in the general fund of a city to record $250,000 for

salaries and wages incurred during the month of May?

A. Debit Salaries & wages Expense $250,000; Credit Appropriations $250,000

B. Debit Salaries & wages expense $250,000; Credit Encumbrances $250,000

C. Debit Encumbrances $250,000; Credit Salaries payable $250,000

D. Debit Expenditures – salaries & wages $250,000; Credit Salaries payable $250,000

16. When a snowplow purchased by a governmental unit is received, what should it be recorded as in the general

fund?

A. An encumbrance

B. An expenditure

C. A general capital asset

D. An appropriation

17. Which of the following fund types used by a government most likely would have a fund balance reserved for

an inventory of supplies?

A. General

B. Internal service

C. Private-purpose trust

D. Capital projects

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Chapter 2: Special Funds and Financial Reporting

Learning Objectives

After studying this chapter, you will be able to:

1. Recognize the basic differences in financial reporting requirements of the different fund types.

2. Identify how governmental funds are reported and rules for separate reporting as major funds.

3. Recognize key elements of government-wide financial statements.

A government should establish those funds required by law and the specific operating and management needs of

the government entity. Unnecessary, additional funds add unneeded complexity and do not enhance the

operational efficiency of the government. A general rule followed in many governmental entities is that all

activities should be accounted for in the general fund unless specifically required by law or the different

measurement focus used for proprietary and fiduciary funds. This rule does not prohibit the creation of additional

funds but places a reasonable restraint on the proliferation of additional funds. The structure of funds discussed

in this chapter is the typical one used in most state and local governmental systems.

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Exhibit 1 presents the typical fund organization for a local government.

Exhibit 1 Typical Fund Structure

Governmental Fund Types 1. General fund 2. Special revenue funds 3. Debt service funds 4. Capital projects funds 5. Permanent funds

Proprietary Fund Types 1. Enterprise funds 2. Internal service funds

Fiduciary Fund Types 1. Pension trust funds 2. Investment trust funds 3. Private-purpose trust funds 4. Agency funds

One event may require entries in several funds. For example, the construction of a new municipal building through

the issuance of general obligation bonds may require entries in both a capital project fund and a debt service fund.

In addition, interfund activities require entries in two or more funds.

The governmental funds use the modified accrual basis of accounting, and the proprietary and fiduciary funds

use the accrual basis of accounting. Governmental entities recognize estimated uncollectible amounts as a

reduction of revenue, not as an expense. The five governmental funds do not report long-term assets or long-

term debt, but the government-wide statements do report them. Investments are reported in the appropriate

funds and are valued at their fair market values at each balance sheet date. The government entity's financial

report includes both fund-based and government-wide financial statements. The government-wide statements

are prepared using the accrual basis of accounting. Reconciliation schedules are required to show the differences

between the amounts reported in the governmental funds financial statements, presented using the modified

accrual basis of accounting, and the amounts reported in the government-wide financial statements, presented

using the accrual basis of accounting.

Some governmental units have pension trust funds for their employees. Accounting and reporting for pension

trust funds is quite complex. Pension trust funds are covered briefly in the "Additional Considerations" section of

this chapter.

This chapter continues the example of Haas City started in Chapter 1, where the entries and financial reports for

the general fund were presented for 20X3. Haas City uses the lapsing method of accounting for encumbrances

and the consumption method for inventories and records all expected budgetary accounts including anticipated

interfund transactions. The techniques of capitalizing all budgetary accounts and recording journal entries at the

control level are continued from Chapter 1. The financial statements for the illustration are prepared using the

requirements of GASB 34. Many of the numbers for the Haas City example are assumed in order to focus on the

main concepts of accounting and financial reporting for a governmental entity. Thus, some of the numbers cannot

be computed from the data given. Instead, focus on the concepts being discussed. We present the fund balance

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reported for the governmental funds that is now required under the new GASB 54. The final section of this chapter

presents the government-wide financial statements for Haas City.

Exhibit 2 presents an overview of the major accounting and financial standards for the individual funds. This exhibit

can be used as a continual reference point during study of this chapter.

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Exhibit 2 Overview of Accounting and Financial Reporting for Governments

Governmental Funds Proprietary Funds Fiduciary Funds General Fund Special

Revenue Funds

Capital Projects Funds

Debt Service Funds

Permanent Funds

Enterprise Funds Internal Service Funds

Trust Funds

Agency Funds

Government- wide

Financials Measurement focus Current financial

resources

Current financial

resources

Current financial

resources

Current financial resources

Economic resources

Economic resources

Economic resources

Economic resources

Economic resources

Basis of accounting

Modified accrual Modified accrual

Modified accrual

Modified accrual

Modified accrual

Accrual Accrual Accrual Accrual Accrual

Budgetary basis recorded (budgetary accounts are typically used when a legally adopted annual operating budget is passed)

Operating budget often recorded

Operating budget often

recorded

Capital budget

usually not recorded

Not required Not required Rarely

Rarely

No

Long-term productive assets (buildings, equipment, etc.) reported

No No No No No Yes Yes Yes No Yes

Long-term debt reported No No No No No Yes Yes Yes No Yes Encumbrances recorded Yes Yes Possibly Possibly Possibly No No No No Financial Statements Balance sheet X X X X X Statement of net position X X X Statement of revenues, expenditures, and changes in fund balance

X X X X X

Statement of revenues, expenses, and changes in fund net position

X X

Statement of activities X Statement of cash flows X X Statement of fiduciary net position

X X

Statement of changes in fiduciary net position

X X

73

Governmental Funds Worksheets

Each of the five governmental funds will report three fund-based financial statements: the balance sheet, the

statement of revenues, expenditures, and changes in fund balance. Rather than presenting each of the separate

governmental funds' financial statements in the chapter, we provide worksheets to summarize all governmental

funds' financial statements. Specifically, Exhibit 3 presents the individual fund information that will be used to

prepare the governmental funds' balance sheet. Exhibit 4 presents the individual governmental funds information

that will be used to prepare the governmental funds' statement of revenues, expenditures, and changes in fund

balance. The amounts for the general fund are taken from the information in Chapter 1.

The amounts for the other funds will be developed throughout this chapter. We use these two worksheets

throughout the chapter as the basis for preparing the governmental funds' financial statements that will be

presented later in the chapter. The worksheets also include major funds tests that will be discussed later in the

chapter. Thus, we develop the two worksheets through the discussions of each fund type in this chapter.

Special Revenue Funds

Current governmental resources may be restricted to expenditure for specific purposes, such as development of

the state highway system, roadway repairs, maintenance of public parks, or operation of the public school system,

city libraries, and museums. The necessary revenue often comes from special tax levies, such as the gasoline taxes

to finance road repairs, or federal or state governmental grants. Some minor revenue may be earned through user

charges, but these charges are usually not sufficient to fully fund the service.

Special revenue funds are used to account for such restricted resources. The governmental entity usually has a

separate special revenue fund for each different activity of this type. Thus, a city may have several special revenue

funds. The accounting for special revenue funds is identical to the accounting for the general fund. The modified

accrual basis of accounting is used, no fixed assets or depreciation are recorded, the operating budget is typically

recorded in the accounts, and no long-term debt is recorded.

Special revenue fund accounting is not illustrated in the chapter because the principles for the special revenue

fund are the same as those for the general fund as covered in Chapter 1.

For purposes of the governmental funds statements, assume that $62,000 of property taxes were collected for

the special revenue fund and that $49,000 was expended for the designated culture and recreation purposes for

which the special revenue fund was established. The focus of this chapter is on the unique or interesting aspects

of governmental accounting and financial reporting. Exhibit 3 presents the assumed numbers for the special

revenue fund's balance sheet and Exhibit 4 presents the revenues ($62,000) and expenditures ($49,000) assumed

for the special revenue fund.

74

Exhibit 3

Worksheet for the Balance Sheet for the Governmental Funds

Governmental Funds Total Governmental

Funds Enterprise

Fund

Total Governmental and Enterprise General

Special Revenue

Capital Projects

Debt Service Permanent

Assets Current

Cash 102,000 15,000 16,000 2,000 13,000 Property Taxes (net of allowances) 85,000 1,000 3,000 Due from Enterprise Fund 3,000 Inventory of Supplies 17,000

Noncurrent Investment in Government Bonds

90,000

Total Assets 207,000 16,000 16,000 5,000 103,000 347,000 140,000 487,000

Liabilities and Fund Balances Vouchers Payable 55,000 3,000 Contract Payable-Retainage 10,000

Total Liabilities 55,000 3,000 10,000 -0- -0- 68,000 112,000 180,000

Fund Balances Nonspendable:

Inventories 17,000 Permanent Fund 103,000

Spendable: Assigned to:

General Government Services 15,000 6,000 Debt Service 5,000

Unassigned, reported in: General Fund 120,000 Special Revenue Fund 7,000 Capital Projects Fund 6,000

Total Fund Balances 152,000 13,000 6,000 5,000 103,000 279,000

Total Liabilities and Fund Balances 207,000 16,000 16,000 5,000 103,000 347,000

Major Fund Tests on Total Assets: 10% Test of Total Governmental or Enterprise

4.61% 4.61% 1.44% 29.68%

100.00%

75

Exhibit 4

Worksheet for the Statement of Revenues, Expenditures, and Changes in Fund Balances for the Governmental Funds

Governmental Funds Total Governmental

Funds Enterprise

Fund

Total Governmental and Enterprise General

Special Revenue

Capital Projects

Debt Service Permanent

Revenues Property Taxes 781,000 62,000 33,000 Sales Taxes 32,000 Grants 33,000 10,000 Miscellaneous 18,000 8,000

Total Revenues 864,000 62,000 10,000 33,000 8,000 977,000 37,000 1,014,000

Expenditures Current General Government 206,000 Streets and Highways 71,000 Public Safety 335,000 Sanitation 141,000 Culture and Recreation 49,000 5,000 Miscellaneous Debt Service Principal Retirement 20,000 Interest Charges 10,000 Capital Outlay 58,000 124,000

Total Expenditures/Expenses 811,000 49,000 124,000 30,000 5,000 1,019,000 35,000 1,054,000

Excess (Deficiency) of Revenues over Expenditures

53,000 13,000 (114,000) 3,000 3,000 (42,000)

Other Financing Sources (Uses) Proceeds of Bond Issue 102,000

Transfers In 20,000 2,000 Transfers Out (30,000) (2,000)

5% Test of Governmental Plus Enterprise 3.29% 3.29% 1.03% 21.15% 28.75% Major Fund Test (Yes or No) Yes No No No Yes Yes

Major Fund Tests on Total Liabilities: 10% Test of Total Governmental or Enterprise 4.41% 14.71% 0.00% 0.00% 100.00% 5% Test of Governmental Plus Enterprise 1.67% 5.56% 0.00% 0.00% 62.22% Major Fund Test (Yes or No) Yes No Yes No No Yes

76

Total Other Financing Sources and Uses (30,000) -0- 120,000 2,000 -0- 92,000

Special Item Contribution 100,000 100,000

Net Change in Fund Balances 23,000 13,000 6,000 5,000 103,000 150,000 Fund Balances-Beginning 129,000 -0- -0- -0- -0- 129,000

Fund Balances-Ending 152,000 13,000 6,000 5,000 103,000 279,000

Major Fund Tests on Total Revenues:

10% Test of Total Governmental or Enterprise

6.35% 1.02% 3.38% 0.82%

100.00%

5% Test of Governmental and Enterprise 6.11 % 0.99% 3.25% 0.79% 3.65%

Major Fund Test (Yes or No) Yes No No No No No

Major Fund Tests on Total Expenditures/Expenses:

10% Test of Total Governmental or Enterprise

4.81% 12.17% 2.94% 0.49%

100.00%

5% Test of Governmental and Enterprise 4.65% 11.76%

2.85% 0.47% 3.32%

Major Fund Test (Yes or No) Yes No Yes No No No

77

Capital Projects Funds

Capital projects funds account for financial resources that are specified for the acquisition or construction of

major capital facilities or improvements that benefit the public. Typical examples are the construction of libraries,

civic centers, fire stations, courthouses, bridges, major streets, and city municipal buildings. A separate capital

projects fund is created at the time the project is approved and ceases at its completion. Each project or group of

related projects usually is accounted for in a separate capital projects fund.

Accounting for capital projects funds is similar to accounting for the general fund. The modified accrual basis of

accounting is used, no fixed assets or depreciation are recorded in the capital projects funds, and no long-term

debt is recorded in these funds. Capital projects funds, however, typically do not have annual operating budgets.

Instead, a capital budget is prepared as a basis for selling bonds to finance a project, and the capital budget is the

control mechanism for the length of the project. The capital budget for the project may, or may not, be formally

recorded in the accounts. Theoretically, encumbrances are part of the budgetary system and should flow from

the appropriating authority of the budget. However, encumbrances may be recorded even if the capital project

budget is not recorded.

The capital projects fund records capital outlays as expenditures. Thus, no fixed assets are recorded in this fund.

A record of the construction in progress, however, may be maintained in memorandum format.

Why Capital Projects Funds Exist

The receipt and disbursement of resources to be utilized for the construction or acquisition of capital facilities to

be used in the performance of activities financed by governmental funds is accounted for by capital projects funds.

Receipts for such purposes arise from the sale of general obligation bonds, grants from other governmental units,

transfers from other funds, or gifts from individual or organizations. For instance, special assessments such as

levies on affected property owners to install sewers are accounted for in a capital project fund.

The reason for creating a fund to account for each capital project is the reason for creating special revenue funds:

to provide a formal mechanism to enable administrators to ensure that revenues dedicated a certain purpose are

used for that purpose and no other, and to enable administrators to report to creditors, and other grantors of

capital projects fund resources, that their requirements regarding the use of the resources were met.

Capital projects funds differ from general and special revenue funds in that the latter categories have a year-to-

year life, whereas each capital projects fund exists only for the duration of the project. A fund is created when a

capital project or a series of related projects is legally authorized; it is closed when the project is in itself an

appropriation of the total amount which may be obligated for the construction or acquisition of the capital asset

specified in the project or series is completed.

Budgetary accounts need not be used because the legal authorization to engage in the project is in itself an

appropriation of the total amount which may be obligated for the construction or acquisition of the capital asset

specified in the project authorization. Estimated revenues need not be recorded because few contractors will

start work on a project until financing is ensured through sale of bonds or receipt of grants or gifts. To provide

78

control over the issuance of contracts and purchase orders, which may be numerous and which may be

outstanding for several years in construction projects, it is recommended that the encumbrance procedure be

used. Since the purpose of the capital project fund is to account for the acquisition and disposition of revenues

for a specific purpose, it (as is true for general and special revenue funds) contains proprietary accounts for only

liquid assets and for the liabilities to be liquidated by those assets.

As discussed previously, the acquisition of capital assets from current revenues of a general and special revenue

fund is budgeted and accounted for by that fund; no capital projects fund would be involved in accounting for

these more or less routine acquisitions involving relatively modest amounts.

In some jurisdictions annual revenues are raised for the expressed purpose of financing major repairs to existing

capital assets, or for replacement of components of those assets (for example, furnaces, air conditioning systems,

roofs, and so forth). Revenues of the nature described are accounted for by a capital improvements fund,

sometimes called a cumulative building fund. The specific repairs and replacements to be undertaken in a given

year are not necessarily known at the time the revenues are budgeted. The appropriation process described in

previous chapters is used to authorize expenditures form capital improvement funds when the nature and

approximated costs of needed repairs and replacements become known. Necessary expenditures which cannot

be financed by appropriation of the Fund Balance of a capital improvement fund, nor from the general fund or

special revenue funds, may occasion the establishment of a capital projects fund.

Illustrative Transactions

On January 1, 20X3, Haas City establishes a capital projects fund to account for a capital addition to the municipal

courthouse. The expected cost of the addition is $120,000. A $100,000, 10 percent general obligation bond issue

is sold at 102, for total proceeds of $102,000. The bond is a five-year serial bond with equal amounts of $20,000

to be paid each year, beginning on December 31, 20X3, until the debt is extinguished. The bond proceeds are not

revenue to the capital projects fund; they are reported in the other financing sources section of the fund's

statement of revenues, expenditures, and changes in fund balance. Any debt issue costs such as underwriting fees

or attorney fees are recognized as expenditures when the liabilities are both measurable and incurred, and are

payable out of current financial resources.

The capital projects fund is not entitled to the $2,000 premium on the sale of bonds. This premium is transferred

as a transfer out to the debt service fund immediately upon receipt. The debt service fund records the receipt of

the transfer as a transfer in (see entry [15] later in this chapter). The premium is viewed as an adjustment of the

interest rate, not as a part of the funds expendable by the capital projects fund. If bonds are sold at a discount,

either the amount expended for the improvement must be decreased or the general fund must make up the

difference to the face value of the bonds.

In addition, a federal grant for $10,000 is received as financial support for part of the capital addition, and the

capital projects fund receives an interfund transfer in of $20,000 from the city's general fund. Recall that an

interfund transfer is an interfund transaction in which resources are moved from one fund, usually from the

general fund, to another fund to be used for the operations of the receiving fund. The general fund records this

79

transfer of $20,000 as an interfund transfer out (see entry [34] in 1). The following entries are recorded for the

20X3 fiscal year.

Capital Projects Revenue and Bond Proceeds

The sale of the bonds and receipt of the federal grant and operating transfer in are recorded as follows:

(1) Cash 102,000

Other Financing Sources—Bond Issue 100,000

Other Financing Sources—Bond Premium 2,000

Issue $100,000 of bonds at 102.

(2) Other Financing Uses—Transfer Out to Debt Service Fund

2,000

Cash 2,000

Forward bond premium to debt service fund.

(3) Cash 10,000

Revenue—Federal Grant 10,000

Receive federal grant to be applied to courthouse addition.

(4) Due from General Fund 20,000

Other Financing Sources—Transfer In from General Fund 20,000

Establish receivable for interfund transfer in from general fund.

(5) Cash 20,000

Due from General Fund 20,000

Receive transferred resources from general fund.

Entry (3) recognizes the $10,000 grant from the federal government as revenue when the grant is received. Some

grants from the federal government are termed "expenditure-driven" grants, for which revenue can be recognized

only as expenditures are incurred in conformity with the grant agreement. For these expenditure-driven grants,

the local governmental entity recognizes revenue only after the eligibility requirements for the government-

mandated nonexchange transaction have been met: that is, the allowable expenditures have been made.

Capital Projects Fund Expenditures

The following encumbrances, expenditures, and disbursements are recorded in 20X3.

(6) ENCUMBRANCES 110,000

BUDGETARY FUND BALANCE—ASSIGNED FOR ENCUMBRANCES 110,000

Budgetary entry to record the issuance of a construction contract for $110,000.

80

(7) BUDGETARY FUND BALANCE—ASSIGNED FOR ENCUMBRANCES 110,000

ENCUMBRANCES 110,000

Budgetary entry to record the completion of the construction project. Reverse reserve for encumbrances.

(8) Expenditures 118,000

Contract Payable 108,000

Contract Payable—Retained Percentage e--Grant 10,000

Actual construction cost of courthouse addition is $118,000. Additional cost is approved. Contract terms include retained percentage of $10,000 until full and final acceptance of project.

(9) Expenditures

6,000

Vouchers Payable 6,000

Additional items for courthouse addition.

(10) Vouchers Payable 6,000

Contract Payable 108,000

Cash 114,000

Pay current portion of construction contract and vouchers.

In entry (8), Contract Payable is credited for $108,000 for the current portion due, and Contract Payable—Retained

Percentage is credited for $10,000. In entry (10), the $108,000 current portion of the contract liability is paid in

full. A normal practice of governmental units is to have a retained percentage of the total amount due under a

construction contract held back to ensure that the contractor fully completes the project to the satisfaction of the

governmental unit. For example, a city may stipulate that 10 percent of the total contract price is retained until

the project is fully completed and accepted. This retainage payable is released and paid upon final acceptance of

the project by the governmental unit.

Closing Entries in the Capital Projects Fund

The nominal accounts are closed with the following entries:

(11) Revenue—Federal Grant 10,000

Fund Balance—Unassigned 114,000

Expenditures 124,000

Close operating accounts of revenue and expenditures.

(12) Other Financing Sources—Bond Issue

100,000

Other Financing Sources—Bond Premium

2,000

81

Fund Balance—Unassigned 102,000

Close other financing sources.

(13) Other Financing Sources—Transfer In from General Fund 20,000

Other Financing Uses—Transfer Out to Debt Service Fund 2,000

Fund Balance—Unassigned 18,000

Close interfund transfers.

No encumbrances are outstanding as of the end of the fiscal year. At this point, the Fund Balance—Unassigned

account has a credit balance of $6,000. Upon completion and final approval of a capital project, the remaining

fund balance is transferred either to the general fund or to the debt service fund, depending on the policy of the

governmental unit. The transfer is a transfer out for the capital projects fund and a transfer in for the receiving

fund because it involves the one-time transfer of the remaining resources in the capital projects fund. In the

preceding example, Haas City decided that the fund should remain open through the first part of the next fiscal

year in case any minor modifications of the new courthouse addition are required. If no further modifications are

required, and the courthouse addition project is officially accepted, the $10,000 in the Contract Payable—

Retained Percentage account is paid to the contractor. Any remaining resources in the capital projects fund are

then transferred and the capital projects fund is closed.

Financial Statement Information for the Capital Projects Fund

The financial statement information for the capital projects funds is presented in Exhibit 3 for the balance sheet

and in Exhibit 4 for the statement of revenues, expenditures, and changes in fund balances. The Bancroft City

capital projects fund was created on January 1, 20X3, the date the capital addition was approved and the serial

bonds were sold. Exhibit 3 shows that the only asset remaining in this fund on December 31, 20X3, is $16,000 of

cash, which includes the $10,000 for the contract payable—retainage. Exhibit 4 for the capital projects fund

column presents the $102,000 of proceeds from the bond issue, which is reported among other financing sources,

with a reduction for the transfer out of the $2,000 premium to the debt service fund, and the transfer in of

$20,000, netting against the large excess of expenditures over revenue in the amount of $114,000. The statement

of revenues, expenditures, and changes in fund balance reconciles to the $6,000 fund balance at the end of the

fiscal period.

Short Quizzes

Indicate whether each of the following is true or false.

1. Generally accepted accounting principles require that all governmental expenditures for long-lived

assets be accounted for by a capital projects fund.

82

2. Capital projects funds should use the accrual basis of accounting for revenues and expenditures.

3. Although capital projects funds do not use the ESTIMATED REVENUES and APPROPRIATIONS

CONTROL accounts, it is recommended that the ENCUMBRANCES CONTROL account be used.

4. Capital Improvement Fund is an acceptable alternative name for a capital projects fund.

5. Construction contracts for governmental projects often provide that a stipulated percentage of each

billing by the contractor will be retained by the governmental unit until the project is inspected and

accepted upon completion.

Answers

1. False. If the acquisition of long-lived assets can be financed form use of general fund, or special revenue

fund, revenues a capital projects fund need not be utilized.

2. False. GAAS recommends the use of the modified accrual basis.

3. True. Contracts and purchase orders for a project accounted for by a capital projects fund may be

numerous and may be outstanding for several years. Thus, it is recommended that the encumbrance

procedure be used.

4. False. A capital improvement fund accounts for annual revenues raised to finance major repairs to existing

capital assets or replacement of components of existing capital assets.

5. True. Presumably this clause is considered to protect the governmental unit against careless work by the

contractor.

Debt Service Funds

Debt service funds account for the accumulation and use of resources for the payment of general long-term debt

principal and interest. A government may have several types of general long-term debt obligations, as follows:

1. Serial bonds. The most common form of debt issued by governments is in the form of serial bonds. The bonds

are repaid in installments over the life of the debt. A serial bond is called "regular" if the installments are equal

and "irregular" if they are not equal.

2. Term bonds. This form of debt is less frequent now than in the past. The entire principal of the debt is due at

the maturity date.

3. Special assessment bonds. Special assessment bonds are secured by tax liens on the property located within the

special assessment tax district. The governmental unit also may become obligated in some manner to assume

the payment of the debt in the event of default by the property owners. Special assessment bonds may be

used to finance capital projects or to acquire other assets such as ambulances or fire engines necessary to

83

operate the governmental unit. Construction of sidewalks in a new subdivision financed by special assessment

bonds is a capital project. Special assessment bonds sold to acquire enterprise fund assets, however, should

be accounted for within the enterprise fund. The special assessment feature simply states the source of

financing and means of repayment.

4. Notes and warrants. These consist of debt typically issued for one or two years. These debts are usually secured

by specific tax revenue, which must first be used to repay the debt. Property tax anticipation warrants are an

example.

5. Capital leases. Governmental entities must record capital leases in accordance with GAAP. These leases then

become long-term liabilities of the governmental unit.

Some governmental entities service long-term debt directly from the general fund, thereby eliminating the need

for a debt service fund as a separate fiscal, accounting, and reporting entity. However, if a governmental entity

has several long-term general obligations outstanding, it may be required by bond indentures or other regulations

to establish a separate debt service fund for each obligation to account for the proper servicing of each debt

obligation.

The accounting and financial reporting for debt service funds are the same as for the general fund. The modified

accrual basis of accounting is used, and only that portion of the long-term debt that has matured and is currently

payable is recorded in the debt service funds.

Revenues are recognized when they are measurable and available. Moreover, assets from imposed nonexchange

revenue transactions, such as property tax levies, should be recognized when an enforceable legal claim arises or

the resources are received, whichever is earlier. If the legal claim arises in the period after that for which the

property taxes are levied, a receivable is recognized when revenues are recognized. Revenues are recognized in

the period for which the taxes are levied if the availability criterion is met. For property taxes, this criterion is met

if they are collected within the current period or soon enough thereafter (not exceeding 60 days) to pay current

liabilities.

Interest payable on long-term debt is not accrued; interest is recognized as a liability only when it comes due and

payable. The "when due" recognition of interest matches the debt service expenditures with the resources

accumulated to repay the debt. This approach prevents an understatement of the debt service fund balance. For

example, if interest is accrued before it is actually due, the fund balance may show a deficit because of the excess

of liabilities over assets. The function of the debt service fund is to accumulate resources to pay debt principal and

interest as they become due. Thus, the when-due recognition of interest is consistent with the fund's objectives.

Note: Construction of sidewalks in a new subdivision financed by special assessment bonds is a capital project

that results in a general capital asset that will be recognized only in the governmental activities column of the

government-wide statement of net position. If the governmental unit is obligated in some manner on the special

assessment debt, this capital improvement may be accounted for in the same way as other capital transactions.

Hence, the transactions of the construction phase are reported in a capital projects fund. Transactions of the debt

service phase are reported in a debt service fund, if one is required. If the government is not obligated, the

construction transactions may still be reported in a capital projects fund, but the debt service transactions are

84

recorded in an agency fund.

Illustrative Transactions

Haas City establishes a debt service fund to service the $100,000, five-year, 10 percent serial bond issued on

January 1, 20X3, to finance the capital project courthouse addition. The bond initially sold at a premium of $2,000.

The resources to pay the bond principal and interest as they become due will be obtained from a property tax levy

specifically for debt service.

Adoption of Debt Service Fund Budget

Debt service funds are not required to adopt annual operating budgets because the fund's expenditures are

generally mandated by bond agreements and an operating budget may be viewed as unnecessarily redundant.

Nevertheless, there is no restriction against having an operating budget for the debt service fund as part of a

comprehensive budgeting system for a governmental entity, as illustrated here. The appropriations budget of a

debt service fund should include amounts which will be required during the budget period to pay interest on

outstanding long-term debt and to repay any maturing issues or installments.

The annual operating budget for the debt service fund is adopted at the time the fund is created to service the

serial bonds sold for the courthouse addition. Appropriations of $30,000 are budgeted to pay $20,000 of maturing

principal and $10,000 of interest for the year. Haas City budgets all expected interfund transactions, and the

anticipated interfund transfer in of the $2,000 premium on the serial bonds sold is recorded with the budget:

(14) ESTIMATED REVENUES CONTROL

ESTIMATED OTHER FINANCING SOURCES—TRANSFER IN 30,000

APPROPRIATIONS CONTROL 2,000

BUDGETARY FUND BALANCE 30,000

Adopt budget for 20X3.

2,000

The budgetary accounts ESTIMATED REVENUES CONTROL and APPROPRIATIONS CONTROL are used to account

for servicing serial bonds.

Debt Service Fund Revenue and Other Financing Sources

In this example, the debt service fund obtains revenue from a specified property tax levy. The bond premium

received from the capital projects fund is recognized as a transfer in. Note that the capital projects fund records

this transfer as an interfund transfer out (see entry [2] earlier in this chapter). The entries to record the receipt of

the bond premium and the levy and collection of taxes are as follows:

85

(15) Cash 2,000

Other Financing Sources—Transfer In from Capital Projects Fund

2,000

Receive bond premium from capital projects fund.

(16) Property Taxes Receivable 35,000

Allowance for Uncollectible Taxes 5,000

Revenue—Property Tax 30,000

Levy property taxes and provide for allowance for uncollectible taxes. Estimated uncollectible property taxes reduce Revenue.

(17) Cash 30,000

Property Taxes Receivable 30,000

Receive portion of property taxes.

(18) Property Taxes Receivable—Delinquent 5,000

Cash 5,000

Allowance for Uncollectible Taxes 5,000

Revenue—Property Tax 3,000

Allowance for Uncollectible Taxes—Delinquent 2,000

Reclassify remaining property taxes as delinquent and reduce allowance for uncollectible taxes from $5,000 to $2,000.

Debt Service Fund Expenditures

The primary expenditures of the debt service fund are for the first annual payment of principal and for interest on

the serial bonds payable. An encumbrance system is typically not used for matured principal and interest because

the debt agreement serves as the expenditure control mechanism:

(19) Expenditures—Principal 20,000

Matured Bonds Payable 20,000

Recognize matured portion of serial bond: $100,000 ± 5 years

(20) Expenditures—Interest 10,000

Matured Interest Payable 10,000

Recognize interest due this period: $100,000 x 0.10 x 1 year

(21) Matured Bonds Payable 20,000

Matured Interest Payable 10,000

Cash 30,000

Pay first year's installment plus interest on bond.

86

Closing Entries in the Debt Service Fund

The nominal accounts are closed as follows:

(22) APPROPRIATIONS CONTROL 30,000

BUDGETARY FUND BALANCE 2,000

ESTIMATED REVENUES CONTROL 30,000

ESTIMATED OTHER FINANCING SOURCES—TRANSFER IN 2,000

Close budgetary accounts.

(23) Revenue—Property Tax

33,000

Expenditures—Principal

20,000

Expenditures—Interest

10,000

Fund Balance—Assigned for Debt Service

3,000

Close operating revenue and expenditures.

(24) Other Financing Sources—Transfer In from Capital Projects Fund 2,000

Fund Balance—Assigned for Debt Service 2,000

Close interfund transfer.

If the debt service fund services term bonds, a different budgetary account system is used. The following

budgetary entry would be made for term bonds for the periods prior to the maturity date:

REQUIRED CONTRIBUTIONS XXX REQUIRED EARNINGS XXX

BUDGETARY FUND BALANCE XXX

The budgetary amounts are determined based on a computation of the contributions needed each period to be

invested, earning a given return to accumulate to the amount required for the payment of the bonds. The debt

service fund may then receive resources from the general fund or from a tax levy, which it would invest until the

term bonds became due. In the period the term bonds reach maturity, the debt service fund pays the matured

principal and interest from its available resources. The debt service fund may make temporary investments of

excess cash in order to maximize the return from its resources. These investments are reported as an asset of the

debt service fund. Most temporary investments are made in low-risk U.S. Treasury securities or in certificates of

deposit from larger banks. Interest income is accrued as earned. The investments are valued in accordance with

GASB Statement No. 31, Accounting for Financial Reporting for Certain Investments and for External Investment

Pools (GASB 31). The general valuation standard in GASB 31 is fair value for most investments made by a

governmental entity. However, an exception is allowed for governmental entities other than external investment

pools, so that market investments may be reported at amortized cost, provided the investment has a remaining

maturity of one year or less from the date of purchase. Unrealized gains or losses on investments are combined

87

with realized gains or losses and are reported on the governmental entity's operating statements as net

investment income or loss.

Financial Statement Information for the Debt Service Fund

The financial statement information for the debt service fund for the governmental funds is presented in Exhibit

3 for the balance sheet and in Exhibit 4 for the governmental funds statement of revenues, expenditures, and

changes in fund balance.

Short Quizzes

Indicate whether each of the following is true or false.

1. Debt service funds exist to accumulate resources to pay general obligation bond issues at maturity.

Interest on such bonds is paid from general fund appropriations.

2. Debt service funds are established only for bonded debt, not for debt arising from use of notes or

warrants.

3. Budgetary control accounts for ESTIMATED REVENUES and APPROPRIATIONS are used by debt service

funds, but ENCUMBRANCES is not used.

4. General obligation bond debt service is ordinarily handled through the banking system.

5. Two types of serial bonds are: regular and ordinary.

Answers

1. False. Debt services are created to account for revenues raised for interest expenditures as well as for

principal repayment.

2. False. Debt service funds should be used to account for revenues raised to account for debt service on all

forms of general obligation debt.

3. True. Debt service funds ordinarily have no need for encumbrance accounting.

4. True. Bondholders may live many miles from the governmental unit.

5. False. Two types of serial bonds are: regular and irregular.

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Chapter 2 Review Questions – Section 1

1. Lake County received the following proceeds that are legally restricted to expenditure for specified purposes:

Levies on affected property owners to install sewers = $500,000; and Gasoline taxes to finance road repairs =

$900,000. What amount most likely will be accounted for in Lake's special revenue funds?

A. $1,400,000

B. $900,000

C. $500,000

D. $0

2. Kew City received a $15 million federal grant to finance the construction of a center for rehabilitation of drug

addicts. In which fund should the proceeds of this grant be accounted for?

A. Special revenue funds

B. General fund

C. Capital projects funds

D. Trust funds

3. In what fund type should the proceeds from special assessment bonds issued to finance construction of

sidewalks in a new subdivision be reported?

A. Agency fund.

B. Special revenue fund.

C. Enterprise fund.

D. Capital projects fund.

4. When should a public school district recognize revenue from property taxes levied for its debt service fund?

A. When bonds to be retired by the levy are due and payable.

B. When assessed valuations of property subject to the levy are known.

C. When funds from the levy are measurable and available to the district.

D. When proceeds from collection of the levy are deposited in the district's bank account.

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Permanent Funds

Permanent funds are established in those cases in which there is a donor restriction that the fund principal must

be preserved. Permanent funds are classified in the governmental funds category because the income resources

in these funds are to be used toward the government's programs and services for its general citizenry. The

donation may be from individuals, estates, and public or private organizations. The modified accrual basis of

accounting is used in this fund and the financial statements for the permanent funds are the same as for all other

governmental funds.

Illustrative Transactions

On January 1, 20X3, Haas City receives a $100,000 bequest from a long-term city resident. The will stipulates that

the $100,000 be invested and the income be used to provide for maintenance and improvement of the city park.

Note that a private-purpose fund, which would be a fiduciary fund, is one in which the government is required to

use the principal or earnings for the benefit of specific individuals, private organizations, or other designated

governments, as stated in the trust agreement. This bequest is for the benefit of the general citizenry, however,

and is established as a permanent fund that is a governmental fund type. The entries in this permanent fund

during 20X3 are as follows:

(25) Cash 100,000

Contributions 100,000

Accept permanent fund resources.

This contribution will be reported as a special item, after other financing sources and uses, toward the bottom of

the statement of revenues, expenditures, and changes in fund balance,

Investment and Interest

The fund's resources are used to acquire $100,000 face value, high-grade, 8 percent governmental securities at

90 to yield an effective interest rate of 10 percent. Interest income is accrued under the modified accrual method,

which means that the revenue recognition may be for only that amount of interest that is both measurable and

available to finance expenditures made during the current fiscal period. Therefore, only the $8,000 of accrued

interest receivable is available for expenditures this period, and the discount amortization would not be shown in

the modified accrual basis financial statements.

(26) Investment in Bonds 90,000

Cash 90,000

Acquire $100,000 face value government securities at 90.

(27) Accrued Interest Receivable 8,000

Interest Revenue 8,000

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Accrue interest: $8,000 = $100,000 x 0.08, nominal (coupon) rate

(28) Cash 8,000

Accrued Interest Receivable 8,000

Collect accrued interest on securities.

Expenditures

The permanent trust fund expends $5,000 during the period for maintenance of the city park and recognizes the

following entry:

(29) Expenditures 5,000

Cash 5,000

Expenditures made for maintenance of the city park.

The balance sheet information for the permanent fund as of December 31, 20X3, is presented in Exhibit 3. The

entire amount of the fund balance for the permanent fund is classified as unspendable because the principal must

be preserved and the income in this fund is required to be used for specified purposes. The information for the

statement of revenues, expenditures, and changes in fund balance for the permanent fund is presented in Exhibit

4. Note that the $100,000 contribution is not part of operations but is reported at the bottom of the operating

statement.

Governmental Funds Financial Statements

GASB Statement No. 34, Basic Financial Statements—and Management's Discussion and Analysis—for State and

Local Governments (GASB 34), requires two financial statements for the governmental funds. Exhibit 5 presents

the first, the governmental funds balance sheet, and Exhibit 6 presents the second, the governmental statement

of revenues, expenditures, and changes in fund balance. The worksheets in Exhibits 3 and 4 are the basis for

preparing these two financial statements. In practice, the two financial statements will be prepared for each

individual governmental fund and these individual fund statements are the foundation for the financial

statements prepared for the governmental entity. But the fund-based financial statements for the governmental

entity's annual report separately report only major governmental funds, not necessarily individually each of the

five governmental funds. GASB 34 specifies that the general fund is always a major fund. But some of the other

governmental funds may not be determined to be major funds, and these nonmajor funds are aggregated and

reported in a single column as other governmental funds. GASB 34 establishes criteria that also encompass the

enterprise funds. To determine which of the other governmental or specific enterprise funds are major, GASB 34

specifies that both of the following criteria must be met:

1. 10 percent criterion: Total assets, liabilities, revenues, or expenditures/expenses of that individual

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governmental or enterprise fund are at least 10 percent of the corresponding total (assets, liabilities,

revenues, or expenditures/expenses) for all funds of that category or type (i.e., total governmental funds or

total enterprise funds).

2. 5 percent criterion: Total assets, liabilities, revenues, or expenditures/expenses of the individual governmental

fund or enterprise fund are at least 5 percent of the corresponding total for all governmental plus enterprise

funds combined.

Exhibit 5

HAAS CITY Balance Sheet

Governmental Funds

December 31, 20X3

General Capital

Projects Permanent

Other Governmental

Funds

Total Governmental

Funds

Assets Current

Cash $102,000 $16,000 $13,000 $17,000 $148,000 Property Taxes (net of allowances) 85,000 4,000 89,000 Due from Enterprise Fund 3,000 3,000 Inventory of Supplies 17,000 17,000

Noncurrent Investment in Government Bonds

90,000

90,000

Total Assets $207,000 $16,000 $103,000 $21,000 $347,000

Liabilities and Fund Balances Vouchers Payable 55,000 3,000 $ 58,000 Contract Payable-Retainage $10,000 10,000

Total Liabilities $ 55,000 $10,000 $ 3,000 $ 68,000

Fund Balances: Nonspendable:

Inventory $17,000 $ 17,000 Permanent Fund Principal $100,000 100,000

Spendable: Restricted for: Maintain City Park 3,000 3,000

Limited to: Culture & Recreation $13,000 13,000

Assigned to: General Government 15,000 15,000 Courthouse Project $ 6,000 6,000 Debt Service 5,000 5,000

Unassigned 120,000 120,000

Total Fund Balances $152,000 $ 6,000 $103,000 $18,000 $279,000

Total Liabilities and Fund Balances $207,000 $16,000 $103,000 $21,000 $347,000

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Exhibit 6

Governmental Funds Statement of Revenues, Expenditures, and Changes in Fund Balance

HAAS CITY

Statement of Revenues, Expenditures, and Changes in Fund Balance Governmental Funds

For the Year Ended December 31, 20X3

General Capital Projects Permanent

Other Governmental

Funds

Total Governmental

Funds

Revenues Property Taxes $781,000 $95,000 $ 876,000 Sales Taxes 32,000 32,000 Grants 33,000 $10,000 43,000

Miscellaneous 18,000 $ 8,000 26,000

Total Revenues $864,000 $10,000 $ 8,000 $95,000 $ 977,000

Expenditures Current

General Government $206,000 $ 206,000 Streets and Highways 71,000 71,000 Public Safety 335,000 335,000 Sanitation 141,000 141,000 Culture and Recreation $ 5,000 $49,000 54,000

Debt Service Principal Retirement 20,000 20,000 Interest Charges 10,000 10,000

Capital Outlay 58,000 $ 124,000 182,000

Total Expenditures $811,000 $ 124,000 $ 5,000 $79,000 $1,019,000

Excess (deficiency) of Revenues over Expenditures

$ 53,000 $(114,000) $ 3,000 $16,000 $ (42,000)

Other Financing Sources (Uses)

Proceeds of Bond Issue $ 102,000 $ 102,000 Transfers In 20,000 $ 2,000 22,000 Transfers Out $ (30,000) (2,000) (32,000)

Total Other Financing

Sources and Uses $ (30,000) $ 120,000 $ -0- $ 2,000 $ 92,000

Contributions, Special Items and Extraordinary Items:

Contribution $100,000 $ 100,000

Net Change in Fund Balances

$ 23,000 $6,000 $103,000 $18,000 $ 150,000

Fund Balances-Beginning 129,000 -0- -0- -0- 129,000

Fund Balances-Ending $152,000 $6,000 $103,000 $18,000 $ 279,000

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Note that the major fund reporting requirements apply to a governmental or enterprise fund only if the same

element (e.g., assets, liabilities, revenues, or expenditures/ expenses) exceeds both the 10 percent and the 5

percent criteria. These major funds tests are presented at the bottom of Exhibits 3 and 4. To prepare the tests,

information is also required for the enterprise funds. The underlying transactions for Haas City's enterprise fund

are presented in the next section of this chapter. The information for the total assets, liabilities, revenues, and

expenses of Haas City's enterprise fund is taken from the enterprise fund's financial statement information. For

right now, the information for the enterprise fund is presented solely to discuss the major funds tests. More detail

on the enterprise fund will be presented immediately after the following discussion of the two major funds tests.

10 Percent Criterion Tests

To compute the 10 percent criterion tests for the five governmental funds, the denominators of the four tests

(assets, liabilities, revenues, and expenditures) are the totals from the five governmental funds. For example,

Exhibit 3 shows the total assets of the governmental funds as $347,000. Note again that the general fund is always

a major fund, so no percentages need be computed for that fund. The 10 percent asset test shows that the

permanent fund meets the 10 percent criterion for total assets (29.68% = $103,000 ÷ $347,000). Continuing down

to the liabilities, only the capital projects fund meets the 10 percent criterion for total liabilities (14.71% = $10,000

÷ $68,000). Information in Exhibit 4 indicates that none of the nongeneral governmental funds meets the 10

percent criterion for revenues. For expenditures, the capital projects fund meets the 10 percent criterion for total

expenditures (12.17% = $124,000 ÷ $1,019,000). Thus, the only two nongeneral governmental funds that meet

the 10 percent criterion tests for a major fund are (1) the permanent fund (for total assets) and (2) the capital

projects fund (for both total liabilities and for total expenditures).

5 Percent Criterion Tests

To compute the 5 percent criterion tests, the second group of major fund tests, the GASB specifies that the

denominator of each of the four tests (assets, liabilities, revenues, and expenditures/expenses) is the combined

total of each of these items for the five governmental funds plus the enterprise funds. For example, Exhibit 3

shows the combined total assets for the 5 percent asset test is $487,000 ($347,000 from the governmental funds

plus $140,000 from the enterprise fund). For the nongeneral governmental funds, the permanent fund is the only

one that meets the 5 percent criterion for total assets (21.15% = $103,000 ÷ $487,000). For total liabilities, the

capital projects fund meets the 5 percent criterion (5.56% = $10,000 ÷ $180,000). Exhibit 4 shows that for

revenues, the special revenue fund meets the 5 percent criterion (6.11% = $62,000 ÷ $1,014,000). For

expenditures/expenses, only the capital projects fund meets the 5 percent criterion (11.76% = $124,000 ÷

$1,054,000).

Note that a governmental fund other than the general fund must meet both the 10 percent and the 5 percent

criterion tests for at least one of the four financial statement items to be classified as a major fund. Thus, the

following governmental funds are classified as major funds: (1) the general fund—always a major fund, (2) the

capital projects fund (for liabilities and expenditures), and (3) the permanent fund (for assets). As shown in Exhibits

5 and 6, the governmental funds financial statements present details on these three funds. The two nonmajor

funds, special revenue and debt service, are combined into a single Other Governmental Funds column. However,

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management of the governmental unit may elect to provide separate disclosure on any nonmajor fund that it

believes is important for users of the financial statements to fully understand. GASB 34 requires that a total for

all governmental funds be provided. Note that enterprise funds are not governmental-type funds.

Government units are permitted to disclose, on the governmental funds’ balance sheet, designations of

unassigned funds. A designation is not a legal reservation or restriction but is similar to an appropriation of

retained earnings for a commercial entity. The designation represents management's plans for the intended use

of the resources and is a communication to users of the financial statements. However, designations are not

permitted to be reported on the government-wide financial statements.

GASB 34 requires a reconciliation schedule to the government-wide financial statements to be presented either

at the bottom of each of the two fund financial statements or in accompanying schedules. These two schedules

reconcile the modified accrual basis of accounting used for the governmental funds to the accrual basis of

accounting used for reporting in the two government-wide financial statements. The reconciliation schedules are

presented later in this chapter within the discussion of presenting the government-wide financial statements.

Proprietary Funds

Some activities of a governmental unit, such as the operation of a public swimming pool or a municipal water

system, are similar to those of commercial enterprises, and use the accrual basis of accounting. The objective of

the governmental unit is to recover its costs in these operations through a system of user charges.

Accounting and reporting for a proprietary fund are similar to accounting for a commercial operation. The financial

statements of proprietary funds include (1) statement of cash flows, (2) statement of net position, and (3)

statement of revenues, expenses and changes in net position. A proprietary fund accounts for the business-type

functions of a government. Users of the financial statements for proprietary funds may find profitability

information to be valuable. The statement of net position of each proprietary fund reports all assets, including

long-term capital assets, and all liabilities, including long-term liabilities. The two types of proprietary funds

typically used by governmental entities are: enterprise funds and internal service funds.

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Enterprise Funds

Enterprise funds and internal service funds are both classified as proprietary funds. Internal service funds (to be

discussed later), are used to account for services provided by one department or agency of a governmental unit

to other departments or agencies, or to other governmental units on a user-charge basis. Enterprise funds differ

from special revenue funds in that the costs of enterprise fund activities are recovered by user charges. Therefore,

the primary difference between establishing a special revenue fund and an enterprise fund is the source of

revenue.

Enterprise funds may also be used to account for any operations “where the government body has decided that

periodic determination of revenues earned, expenses incurred, and/or net income appropriate for capital

maintenance, public policy, management control, accountability, and or other purposes.” From this description,

and from the fact that the word “enterprise” is often used as a synonym for “business,” it may be apparent that

enterprise funds should use the same basis of accounting and account for all assets used in the production of

goods or services offered by the fund. Similarly, if long-term debt is to be serviced by the fund it is accounted for

by the fund. Distinction should be made in fund equity accounts between equity contributed to the fund, and

earnings resulting from operations of the fund.

The amounts charged to customers are intended to recover all or most of the cost of these goods or services. A

city may operate electric, gas, and water utilities; transportation systems such as buses, trains, and subways;

airports; sports arenas; parking lots and garages; and public housing. Other examples of governmental enterprise

are public utilities, notably water and sewer utilities. Services of the kinds mentioned are generally accounted for

by the enterprise funds because they are intended to be largely self-supporting. However, they are properly

accounted for by a revenue fund by those municipalities which support the activities largely from general or

special revenue sources other than user charges, and are not concerned with measuring the cost of the activities.

Almost every kind of enterprise operated by a municipality has its counterpart in the private sector. In order to

take advantage of the work done by regulatory agencies and trade associations to develop useful accounting

information systems for the investor-owned enterprise, it is recommended that municipally-owned enterprises

use the accounting structures developed for investor-owned enterprise of the same nature. Budgetary accounts

should be used only if required by law. Debt service and construction activities of a municipal enterprise are

accounted for within the enterprise fund, rather than by separate debt services and capital project funds. Thus,

the reports of enterprise funds are self-contained, and creditors, legislators, or the general public can evaluate

the performance of investor-owned enterprise in the same industry.

Enterprise funds have a measurement focus of all economic resources and use the accrual basis of accounting.

Capital assets, such as equipment, are reported in the government-wide statement of net position and in the

proprietary fund statement of net position. They must be depreciated over their estimated useful lives unless they

are inexhaustible or are infrastructure assets that meet certain requirements.

Proprietary funds report fixed assets, which are depreciated, and long-term debt, if issued, and they focus on

income determination and capital maintenance, the same as for commercial entities. The financial statements for

proprietary funds are very similar to those for commercial entities: (1) the statement of net position (balance

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sheet), (Current assets + noncurrent assets - current liabilities - noncurrent liabilities = net position). (2) the

statement of revenues, expenses, and changes in fund net position (income statement), and (3) the statement of

cash flows. Note: proprietary funds would there not have encumbrances.

Budgeting in the proprietary funds also has the same role as in commercial entities. A budget may be prepared

for management planning purposes; however, the budget is normally not entered into the accounts.

Illustrative Transactions

Haas City has a municipal water utility that it operates as an enterprise fund. The trial balance of the water utility

as of January 1, 20X3, the first day of the 20X3 fiscal year, is presented here:

Haas CITY

Trial Balance for Water Utility Enterprise Fund

January 1, 20X3

Debit Credit

Cash $9,000 Machinery and Equipment 94,000 Buildings 40,000 Accumulated Depreciation—Machinery and Equipment $15,000 Accumulated Depreciation—Buildings 2,000 Bonds Payable, 5% 100,000 Net Position: 17,000 Invested in Capital Assets, Net of Related Debt 9,000 Unrestricted Totals $143,000 $143,000

One difference between balance sheet accounts for commercial entities and those for proprietary funds is the

absence of a stockholders' equity section in governmental accounting. The general public is the theoretical owner

of all governmental assets. Furthermore, no stock certificates are issued; therefore, a net position section is used

instead of common stock and additional paid-in capital. GASB 34 requires the separate disclosure of the net

position invested in capital assets, net of related debt, which reports the book value (cost basis less accumulated

depreciation) invested in capital assets such as land, buildings, machinery, equipment, and other tangible and

intangible assets having expected useful lives exceeding one year. These resources are not readily available for

other unrestricted uses as are the current assets. The related debt is that directly associated with the capital assets

and is typically long-term in nature. For our example, assume the $100,000 of bonds payable is related to the

$117,000 of net capital assets ($134,000 cost less $17,000 of accumulated depreciation). Other interesting

differences are the large relative amounts of fixed assets and long-term debt because enterprise funds typically

require large investments in productive assets in order to provide the necessary level of service to the public, and

these investments are usually financed by long-term revenue bonds.

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The water utility sells its product to the residents of Haas City based on a user charge. In addition to water revenue,

the water utility receives a $3,000 short-term interfund loan from the general fund and obtains its office supplies

from the city's centralized purchasing operation, which is accounted for as an internal service fund. During the

year, the water utility acquires a new pump costing $6,000.

Enterprise Fund Revenues

The water utility provides service during the period and bills its customers for the amount of water used. The

utility estimates that 7.5 percent of its billings will not be collected. Note that revenues are reported net of

uncollectibles. These transactions are recorded as follows:

(30) Accounts Receivable 40,000 Allowance for Uncollectibles 3,000 Revenue—Water Sales 37,000 Bill customers for water used as indicated by meter readings.

Estimate $3,000 of billings will be uncollectible.

(31) Cash 32,000 Accounts Receivable 32,000 Collect portion of accounts receivable.

Capital Asset Acquisition

The water utility acquires a new pump during the year.

(32) Equipment 6,000 Vouchers Payable 6,000 Receive new pump for well house. (33) Vouchers Payable 6,000 Cash 6,000 Pay voucher for new pump.

Interfund Activities

Several interfund transactions occur during the year. First, in an interfund financing transaction, the water utility

receives $3,000 from the general fund as a short-term loan to be repaid within 90 days. The general fund records

this as a short-term receivable, Due from Enterprise Fund (see entry [39] in Chapter 1). Second, the utility acquires

its office supplies from the internal service fund in an interfund services provided and used transaction. The

internal service fund reports this as a revenue transaction (see entry [48] later in this chapter):

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Enterprise Fund Expenses

The water utility fund incurs $9,000 of operating expenses during the period. In addition, several adjusting journal

entries are required at the end of the fiscal year to recognize additional expenses. Note that these adjusting entries

are similar to those of a commercial entity:

(37) General Operating Expenses 9,000

Vouchers Payable

9,000

Incur operating expenses during year.

(38) Vouchers Payable 6,000

Cash 6,000

Pay approved vouchers for operating expenses.

(39) General Operating Expenses 3,000

Supplies Inventory 3,000

Adjust for $3,000 of supplies consumed.

(40) Depreciation Expense 18,000

Accumulated Depreciation—Machinery and Equipment 15,000

Accumulated Depreciation—Buildings 3,000

Recognize depreciation expense for year.

(41) Interest Expense 5,000

Accrued Interest Payable 5,000

Accrue interest on bond payable: $100,000 x 0.05 x 1 year

(34) Cash 3,000 Due to General Fund 3,000 Recognize payable for loan from general fund. (35) Supplies Inventory 3,000 Due to Internal Service Fund 3,000 Receive office supplies from centralized purchasing department at a cost

of $3,000.

(36) Due to Internal Service Fund 2,000 Cash 2,000 Approve payment of $2,000 to centralized purchasing department for

supplies received.

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Closing and Reclassification Entries in the Enterprise Fund

The nominal accounts are closed, the period's profit or loss is determined, and, at the close of the fiscal year, the

government reclassifies the various components of net position based on the year-end amount of net position

invested in capital assets, net of related debt:

(42) Revenue—Water Sales 37,000

General Operating Expenses 12,000

Depreciation Expense 18,000

Interest Expense 5,000

Profit and Loss Summary 2,000

Close nominal accounts into profit and loss summary.

(43) Profit and Loss Summary 2,000

Net Position—Unrestricted 2,000

Close profit and loss summary into net position.

(44) Net Position—Invested in Capital Assets, Net of Related Debt 12,000

Net Position—Unrestricted 12,000

To reclassify net position as of end of fiscal period: 12/31/20X2 balance: $ 5,000 = $105,000 capital assets - $100,000 of related debt 1/1/20X2 balance: 17,000 = $117,000 capital assets - $100,000 of related debt $12,000 = Decrease during period in net position invested in capital assets, net of related debt

Financial Statements for the Proprietary Funds

Three financial statements are required for the proprietary funds. If a governmental entity has more than one

enterprise fund, each must be individually assessed by both the 10 percent criterion and the 5 percent criterion

tests to determine whether it is a major fund. Haas City has only one enterprise fund. Exhibit 7 presents the

statement of net position for the enterprise proprietary fund and for the internal service proprietary fund that

will be discussed in the next section of this chapter. Exhibit 8 presents the statement of revenues, expenses, and

changes in fund net position for Haas City's two proprietary funds. Exhibit 9 presents the statement of cash flows

for these two proprietary funds.

The statement of net position in Exhibit 7 is similar to that required for commercial entities. Proprietary funds

report their own fixed assets, investments, and long-term liabilities. The amount of the net position invested in

capital assets, net of related debt, is computed as capital assets less accumulated depreciation, less outstanding

principal of related debt. For purposes of this example, assume that the information in Exhibit 7 shows that the

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enterprise fund has $5,000 of net position invested in capital assets, net of related debt ($105,000 - $100,000),

and the internal service fund has $2,000 invested in capital assets, net of related debt ($2,000 - $0).

The statement of revenues, expenses, and changes in fund net position is similar to the income statement for

commercial entities. A separation of operating and nonoperating revenues and expenses is made to provide more

information value regarding the operations of the proprietary funds. Contributions and transfers in or out are

reported below the income (loss) line in the statement of revenues, expenses, and changes in fund net position.

Contributions would include any capital asset transfers from a governmental fund to a proprietary fund. For

example, the general fund may transfer equipment to an enterprise fund. Note that the governmental funds

describe the interfund transfers as other financing sources or uses, but the proprietary funds use only the terms

transfer in or transfer out to describe these nonoperating interfund transactions. And both interest income and

interest expense are reported as nonoperating items.

The sequence of items in the all-inclusive format shown below must be followed in each column of the statement:

Operating revenues (detailed) + Total operating revenues

Operating expenses (detailed) - Total operating expenses

Operating income (loss) +/- Nonoperating revenues and expenses (detailed) = Income before other revenues, expenses, gains, losses, and transfers +/- Capital contributions, additions to endowments, special and extraordinary items, and interfund transfers = Change in net position + Net position -- beginning = Net position -- ending

The statement of cash flows for enterprise funds is specified by GASB Statement No. 9, Reporting Cash Flows of

Proprietary and Nonexpendable Trust Funds and Governmental Entities That Use Proprietary Fund Accounting

(GASB 9). This standard provides a format that differs somewhat from the three-section format of the statement

of cash flows for commercial entities. Because of the large number of capital asset acquisition and financing

transactions in proprietary funds, the GASB specified four sections of the statement of cash flows, as follows:

1. Cash flows from operating activities. This first section includes all transactions from providing services and

delivering goods. GASB 34 requires the use of the direct method of computing cash flows from operating

activities. It includes cash flows from interfund operating transactions and reimbursements from other funds.

2. Cash flows from noncapital financing activities. This second section includes activities such as borrowing or repaying money for purposes other than to acquire, construct, or improve capital assets. It includes cash for financing activities received from, or paid to, other funds except that which is specified for capital asset use.

3. Cash flows from capital and related financing activities. This third section includes all activities clearly related to, or attributable to, the acquisition, disposition, construction, or improvement of capital assets. This section also includes the interest paid on borrowings for capital assets.

4. Cash flows from investing activities. This fourth section includes all investing activities, interest and dividend revenue, and acquisition and disposition of debt or equity instruments.

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In addition to the statement of cash flows, proprietary funds also are required to provide a supplementary

schedule that reconciles the cash flow from operating activities with the operating income or loss reported on the

statement of revenues, expenses, and changes in fund net position.

Short Quizzes

Indicate whether each of the following is true or false.

1. Enterprise funds and permanent funds are classified by the NCGA as “proprietary funds.”

2. Enterprise funds are used by state and local governmental units to account for services which are provided

to the general public on a user charge basis or to account for any services which the governing body of

the governmental units has decided should be accounted for on a “business basis.”

3. Public utilities owned and operated by governmental units are the most common examples of activities

customarily accounted for as enterprise funds.

Answers

1. 1. False. Enterprise funds and internal service funds are classified as proprietary funds.

2. True. Even if user charges are not the primary source of revenues, the enterprise fund approach may be

used for any activities for which the governing body desires periodic determination of revenues earned,

expenses incurred, and/or net income.

3. True. Almost any kind of enterprise may be operated by a governmental unit, but public utilities are the

most common examples.

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Chapter 2 Review Questions – Section 2

5. In the fund financial statements of which of the following fund types of a city government are revenues and

expenditures recognized on the same basis of accounting as the general fund?

A. Private-purpose trust

B. Internal service

C. Enterprise

D. Debt service

6. During the year, a city's electric utility, which is operated as an enterprise fund, rendered billings for electricity

supplied to the general fund. Which of the following accounts should be debited by the general fund?

A. Appropriations

B. Expenditures

C. Due to electric utility enterprise fund

D. Other financing uses -- interfund transfer

7. On January 2, Basketville City purchased equipment with a useful life of three years to be used by its water and

sewer enterprise fund. Which of the following is the correct treatment for the asset?

A. Record the purchase of the equipment as expenditure

B. Capitalize; depreciation is optional

C. Capitalize; depreciation is required

D. Capitalize; depreciation is not permitted

8. The statement of revenues, expenses, and changes in fund net position for proprietary funds __________

A. Combines special and extraordinary items in a subtotal presented before nonoperating revenues and

expenses.

B. Must report revenues at gross amounts, with discounts and allowances disclosed parenthetically.

C. Distinguishes between operating and nonoperating revenues and expenses.

D. Must define operating items in the same way as in the statement of cash flows.

9. The following transactions were among those reported by Corfe City's electric utility enterprise fund for 20X3:

Capital contributed by subdividers = $ 900,000; Cash received from customer households = $2,700,000; Proceeds

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from sale of revenue bonds = $4,500,000. In the proprietary funds statement of cash flows for the year ended

December 31, 2002, what amount should be reported as cash flows from the electric utility enterprise fund's

capital and related financing activities?

A. $4,500,000

B. $5,400,000

C. $7,200,000

D. $8,100,000

104

Internal Service Funds

All of the municipal funds discussed previously (general, special revenue, capital projects, debt service, and

permanent funds) owe their existence to legal constraints placed upon the raising of revenue and/or the use of

resources for the provision of services to the public or segments thereof, and for the acquisition of facilities to aid

in the provision of services. As governmental units became more complex it became apparent that efficiency

should be improved if services used by the several departments or funds, or even several governmental units,

were combined in a single administrative unit. A logical name for a fiscal and accounting entity created to account

for resources used for providing centralized services is Internal Service Fund. The reason for the creation of funds

in this category is to improve the management of resources; however, it should be stressed, a fund is a fiscal entity

as well as an accounting entity, consequently establishment of a fund is ordinarily subject to legislative approval.

Internal service funds, and enterprise funds are classified by the National Council on Governmental Accounting as

proprietary funds. That is, funds which are accounted for in a manner similar to investor-owned business

enterprises. Accordingly, proprietary funds account for all fixed assets used in their operations and for long-term

debt to be serviced from revenues generated from their operations, as well as current assets and current liabilities.

Distinction should be made in the equity accounts of internal service funds between equity contributed to the

fund and retained earnings resulting from operations of the fund. Proprietary funds do not record their budgets

in their accounting systems.

Internal service funds account for the financing of goods or services provided by one department or agency to

other departments or agencies on a cost-reimbursement basis. These services are not available to the general

public, making the internal service fund different from the enterprise fund. Examples are central motor vehicle

pools and garages, central IT facilities, printing shops, central risk financing activities, and centralized purchasing

and storage facilities. Separate internal service funds are established for each of these functions maintained by

the local governmental unit.

Accounting and financial reporting for internal service funds are the same as for enterprise funds or for

commercial entities. The accrual basis is used to measure revenue and expenses (not expenditures), and the

balance sheet may include fixed assets, which are depreciated, and long-term debt, if issued. The statement of

revenue, expenses, and changes in fund net position reports the fund's income for the period. The statement of

cash flows also is required.

Establishment and Operation of Internal Service Funds

The ordinance, or other legislative action, which authorizes the establishment of an internal service fund should

also specify the source, or sources, of financial resources which are to be used for fund operations. The original

allocation of resources to the fund may be derived from a transfer of assets of another fund, such as the general

fund or an enterprise fund, intended as a contribution not to repaid, or a transfer which is in the nature of a long-

term advance to be repaid by the internal revenue service fund over a period of years. Alternatively, or

additionally, the resources initially allocated to an internal service fund may be acquired from the process of a

general obligation bond issue, or transfers from other governmental units that anticipate utilizing the services to

105

be rendered by the internal service fund. Since service funds are established to improve the management of

resources, it is generally considered that they should be operated and accounted for as a business--in order that

their financial statements can disclose their success in maintaining their capacity to continue to render service to

using funds and units. For that reason internal service funds follow the business accounting practice of reporting

accumulated net income (or losses) in a net position account.

Illustrative Transactions

Haas City decides to establish a centralized purchasing and storage function as an internal service fund. This

centralized purchasing department provides office supplies to all other funds of the local government on a user-

charge basis. After acquiring the necessary supplies, the centralized purchasing department makes the following

sales:

Buying Selling Cost to Internal Fund Price Service Fund General fund $1,000 $ 500 Enterprise fund 3,000 1,500

The following entries are made during the year to record the activities of the centralized purchasing and storage

department.

Establishment of Internal Service Fund and Acquisition of Inventories

The fund is started with a transfer in from the general fund in the amount of $10,000, which the internal service fund then uses to acquire inventory and equipment. The general fund records this interfund transfer as a transfer out (see entry [33] in Chapter 1):

(45) Cash 33,000

Transfer In 33,000

Receive interfund transfer in from general fund to initiate centralized purchasing and storage function.

(46) Inventory 33,000

Vouchers Payable 33,000

Acquire inventory of supplies.

(47) Machinery and Equipment 33,000

Vouchers Payable 33,000

Acquire equipment.

106

Internal Service Fund Revenue

The revenue of the internal service fund is earned by selling supplies to other funds and billing them for the value

of the supplies. The billing rate is typically established at more than the operating costs of the internal service

fund so that the fund may acquire replacement assets or new assets:

(48) Due from General Fund 1,000

Due from Enterprise Fund 3,000

Charges for Services 4,000

Recognize revenue from providing supplies to general fund and enterprise fund.

(49) Cash 3,000

Due from General Fund

Due from Enterprise Fund 1,000

Collect portion of receivables. 2,000

The general fund records the $1,000 for supplies as an interfund expenditures transaction (see entry [37] in

Chapter 1). The enterprise fund records the $3,000 as an interfund inventory purchase transaction (see entry [35]

earlier in this chapter).

Internal Service Fund Expenses

The internal service fund incurs $4,000 of operating expenses, including payroll, during the period. In addition,

cost of goods sold of $2,000 and $1,000 of depreciation expense are recognized in adjusting entries. The $9,000

of vouchers paid includes a voucher in the amount of $3,000 for the equipment acquired in entry (47) above:

(50) General Operating Expenses 4,000

Vouchers Payable 4,000

Incur operating expenses.

(51) Vouchers Payable 9,000

Cash 9,000

Pay approved vouchers.

(52) Cost of Goods Sold 2,000

Inventory 2,000

Recognize cost of supplies sold.

(53) Depreciation Expense 1,000

107

Accumulated Depreciation 1,000

Depreciation of equipment.

Closing Entries in the Internal Service Fund

The closing and reclassifying entries for the internal service fund follow. Profit and Loss Summary is used here in

the closing process; however, some governmental units use the account called Excess of Net Revenues over Costs

to perform the same function.

(54) Charges for Services 4,000

Profit and Loss Summary 3,000

Cost of Goods Sold 2,000

General Operating Expenses 4,000

Depreciation Expense 1,000

Close revenue and expenses.

(55) Transfer In 10,000

Profit and Loss Summary 3,000

Net Position—Unrestricted 7,000

Close profit and loss summary and transfer in to net position.

(56) Net Position—Unrestricted 2,000

Net Position—Invested in Capital Assets, Net of Related Debt 2,000

To reclassify net position as of end of fiscal period: $2,000 = $2,000 net capital assets - $0 related debt.

Financial Statements for Internal Service Funds

The financial statements required for internal service funds are the same as those required for the enterprise

fund. Exhibit 7 presents the statement of net position, and Exhibit 8 presents the statement of revenues, expenses,

and changes in fund net position for the internal service fund. Exhibit 9 presents the statement of cash flows for

the internal service fund.

108

Exhibit 7

Proprietary Funds - Statement of Net Position

HAAS CITY

December 31, 20X3

Enterprise Fund

Internal Service Fund

Assets: Current Assets:

Cash $ 30,000 $ 4,000

Accounts Receivable (net) 5,000

Due from Other Funds 1,000

Inventory of Supplies 6,000

Total Current Assets $ 35,000 $11,000

Noncurrent Assets:

Capital Assets:

Machinery and Equipment $100,000 $ 3,000

Less: Accumulated Depreciation (30,000) (1,000)

Buildings 40,000

Less: Accumulated Depreciation (5,000)

Total Noncurrent Assets $105,000 $ 2,000

Total Assets $140,000 $13,000

Liabilities:

Current Liabilities:

Vouchers Payable $ 3,000 $ 6,000

Accrued Interest Payable 5,000

Due to Other Funds 4,000

Total Current Liabilities $ 12,000 $ 6,000

Noncurrent Liabilities:

Bonds Payable, 5% 100,000

Total Liabilities $112,000 $ 6,000

Net Position:

Invested in Capital Assets, Net of Related Debt

$ 5,000 $ 2,000

Unrestricted 23,000 5,000

Total Net Position $ 28,000 $ 7,000

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Exhibit 8

Proprietary Funds Statement of Revenues, Expenses, and Changes in Fund Net Position

HAAS CITY

For the Year Ended December 31, 20X3

Enterprise Fund Internal Service

Fund

Operating Revenues: Charges for Services $37,000 $ 4,000

Total Operating Revenues $37,000 $ 4,000

Operating Expenses: General Operating $12,000 $ 4,000 Cost of Goods Sold 2,000 Depreciation 18,000 1,000

Total Operating Expenses $30,000 $ 7,000

Nonoperating Revenue (Expenses): Interest Expense $(5,000)

Total Nonoperating Expense $ 5,000

Income (Loss) before Contributions and Transfers $ 2,000 $(3,000) Transfer In 10,000

Change in Net Position $ 2,000 $ 7,000 Net Position—Beginning 26,000 -0-

Net Position—Ending $28,000 $ 7,000

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Exhibit 9

HAAS CITY

Statement of Cash Flows - Proprietary Funds

For the Year Ended December 31, 20X3

Enterprise Fund Internal Service Fund

Cash Flows from Operating Activities:

Receipts from Customers $32,000 $ 3,000

Cash Payments for Goods and Services (6,000) (6,000)

Cash Paid to Internal Service Fund for Supplies (2,000)

Net Cash Provided (Used) by Operating Activities $24,000 $(3,000)

Cash Flows from Noncapital Financing Activities:

Cash Received from General Fund for Noncapital Loan $ 3,000 $ 7,000

Net Cash Provided by Noncapital Financing Activities $ 3,000 $ 7,000

Cash Flows from Capital and Related Financing Activities:

Acquisition of Capital Asset $ (6,000) $(3,000)

Cash Received from General Fund for Capital Activity 3,000

Net Cash Provided (Used) for Capital Financing Activities

$ (6,000) $0-

Cash Flows from Investing Activities $ -0- $0-

Net Increase in Cash $21,000 $ 4,000

Balances—Beginning of Year 9,000 -0-

Balances—End of Year $30,000 $ 4,000

Reconciliation of Operating Income to Net Cash Provided by

Operating Activities:

Operating Income $ 7,000 $(3,000)

Adjustments to Reconcile Operating Income to Net Cash

Provided (Used) by Operating Activities:

Depreciation 18,000 1,000

Change in Assets and Liabilities:

Increase in Net Accounts Receivable (5,000)

Increase in Due from Other Funds from Billings (1,000)

Increase in Inventory of Supplies (6,000)

Increase in Vouchers Payable 3,000 6,000

Increase in Due to Internal Service Fund 1,000

Net Cash Provided (Used) by Operating Activities $24,000 $(3,000)

111

Short Quizzes

Indicate whether each of the following is true or false.

1. Internal service funds are classified as governmental funds.

2. Internal service funds are accounted for in a manner similar to investor-owned businesses: among other

features, the accrual basis is used and all of the property, plant, and equipment used in fund operations

is accounted for by the using fund.

3. Internal service funds account for any long-term debt to be serviced from revenues derived from fund

operations.

4. The Encumbrances account should be used by an internal service fund in the same manner as by a general

fund.

5. Internal service funds account for operating expenses on the accrual basis.

6. Revenue of internal service funds should be accounted for on the modified accrual basis.

7. Internal service funds should account for depreciation of their plant and equipment in a manner similar

to that used by business organizations.

Answers

1. False. Internal service funds are classified as proprietary funds.

2. True. The features described are characteristic of the AIPA/NCGA recommended accounting for

proprietary funds.

3. True. Long-term debt of an internal service fund ordinarily result from advances from other funds or

governmental units, not from outside creditors.

4. False. Internal service funds should debit appropriately named asset accounts for all fixed assets as well

as current assets used in fund operations. The Encumbrances account is not used because legal

appropriation accounting is not in conformity with GAAP for internal service funds.

5. True. Internal service funds account for expenses, not expenditures, and use the accrual basis.

6. False. Revenues of internal service funds should be accounted for on the accrual basis.

7. True. Depreciation accounting for an internal service fund is the same as for a business organization.

112

Fiduciary Funds

Fiduciary funds are used to account for assets held by a government unit acting as a trustee or agent for

individuals, organizations, other government units, or other funds of the same governmental unit. In law there is

a clear distinction between an agency relationship and a trust relationship. In practice the legalistic distinctions

between trust funds and agency funds are not of major significance. The important and perhaps the sole

consideration from an accounting standpoint is: What can and what cannot be done with the fund’s assets, in

accordance with the laws and other pertinent regulations?

Four types of fiduciary funds are provided for a governmental unit. Three are trust funds that account for financial

resources maintained in trust by the government. These three are pension and other employee benefit trust

funds, investment trust funds, and private-purpose trust funds. A pension and other employee benefit trust fund

is a separate category of trust fund because of the importance of disclosure of pension funds and because both

the assets contributed to the trust fund and the earnings thereon may be expended for the purposes and in the

amounts set forth in the pension agreement. An agency fund accounts for assets held by a governmental unit

temporarily as agent for individuals, organizations, other funds, or other governmental units.

GASB Statement No. 84, Fiduciary Activities, establishes specific criteria for identifying activities that should be

reported as fiduciary activities and clarifies whether and how business-type activities should report their fiduciary

activities. Specifically, it provides the criteria for three types of activities:

1. Fiduciary component units

2. Pension and OPEB arrangements that are not component units

3. Other fiduciary activities

The focus of the criteria is on:

• Whether a government controls the assets of the fiduciary activity, and

• The beneficiaries with whom a fiduciary relationship exists.

A government is considered in control of the assets if the government holds the assets or has the ability to direct

the use of the assets in a manner that provides benefits to the specified or intended recipients. The assets also

cannot be derived from the government’s own source revenues (or from government-mandated or voluntary non-

exchange transactions). With respect to the assets related to the specified or intended beneficiaries, one or more

of the following criteria of GASB 84 in paragraph 11c(1) and (2) must be met:

1. Be administered through a trust

2. The government itself is not the beneficiary

3. Dedicated to providing benefits in accordance with the benefit terms

4. Legally protected from the government’s creditors

5. For the benefit of individuals and the government has no administrative or direct financial involvement

with the assets

113

An activity meeting the above criteria should be reported in the basic financial statements in one of the following

four fiduciary funds, as applicable:

1. Pension (and other employee benefit) trust funds

2. Investment trust funds

3. Private-purpose trust funds

4. Custodial funds

Custodial funds are used to report fiduciary activities that are not required to be reported in pension (and other

employee benefit) trust funds, investment trust funds, or private-purpose trust funds. The use of agency funds

has been eliminated with GASB 84 and replaced with custodial funds. Therefore, most existing agency funds that

meet the criteria to be reported as a fiduciary fund under GASB 84 should fall under the custodial fund reporting

unless the assets are held in a trust. Custodial funds is reported in a statement of fiduciary net position. In

addition, the statement of changes in fiduciary net position includes custodial fund activity. This change results in

more detail of additions to and deductions from custodial funds than previously reported for agency funds.

Governments should ensure they have a system in place to identify the sources of the asset additions and the

types of deductions for financial reporting.

Finally, a business-type activity, including enterprise funds, may report an asset and liability that should be

reported as a custodial fund within the business-type activity statement of net position, if the assets are normally

held for three months or less.

The following table summarizes the key requirements of GASB 84.

Fiduciary Fund

Type Criteria

Financial Reporting Requirements

Statement of

Fiduciary Net

Position

Statement of

Changes in

Fiduciary Net

Position

Pension (and

other employee

benefit) trust

funds

1. Pension and other postemployee benefit meet criteria

of GASB 67 and GASB 74, respectively

2. Other employee benefit plans for which resources are

held in a trust that meets the criteria of GASB 84 in

paragraph 11c(1) and (2) as listed above (pg 112) • Assets

• Deferred

Outflows

• Liabilities

• Deferred

Inflows

• Fiduciary

Net

Positions

• Additions

• Deductions

Investment trust

funds

1. Investment trust funds are used to report fiduciary

activities from the external portion of investment

pools and individual investment accounts

2. They are held in a trust that meets the criteria of GASB

84 in paragraph 11c(1) as listed above

Private-purpose

trust funds

Private-purpose trust funds are used to report all fiduciary

activities that:

1. Are not required to be reported in pension (and

other employee benefit) trust funds or

investment trust funds and

114

2. Are held in a trust that meets the criteria of GASB

84 in paragraph 11c(1)

Custodial funds

1. Custodial funds are used to report fiduciary activities

that are not required to be reported in pension (and

other employee benefit) trust funds, investment trust

funds, or private-purpose trust funds.

2. The external portion of investment pools that are not

held in a trust that meets the criteria of GASB 84 in

paragraph 11c(1) should be reported in a separate

external investment pool fund column, under the

custodial funds classification.

The provisions of GASB 84 are effective for fiscal years beginning after December 15, 2018.

GASB 84 provides the following example of the fiduciary fund financial statements for a hypothetical government.

115

Illustration of the Fiduciary Fund Financial Statements

Government ABC

Statement of Fiduciary Net Position − Fiduciary Funds

June 30, 20X2 (in thousands)

Pension (and Other

Employee Benefit) Trust

Funds Investment Trust Funds

Private-Purpose Trust

Funds Custodial

Funds

ASSETS

Cash and cash equivalents $ 184,351 $ 840,693 $ 104,747 $ 58,196

Receivables:

Employee 2,123 - - -

Employer 83,004 - - -

Taxes for other governments - - - 206,937

Interest and dividends 175,402 12,166 - -

Sale of investments 30,879 - - -

Total receivables 291,408 12,166 - 206,937

Investments at fair value:

Short-term investments 2,268,960 241,645 61,591 -

Bonds, notes, mortgage, and preferred stock 14,115,391 804,576 187,650 -

Common stock 20,342,440 - 520,196 -

Real estate 3,408,145 - - -

International investments 1,723,951 - - -

Mutual funds 72,315 178,046 - -

Pooled investment funds 23,128 - - -

Total investments 41,954,330 1,224,267 769,437 -

Securities lending collateral 1,746,544 - - -

Other assets 13,519 181 81,157 361

Total assets 44,190,152 2,077,307 955,341 265,494

LIABILITIES

Accounts payable and other liabilities 130,846 1,361 61,447 1,451

Due to local governments - - - 164,201

Obligations under securities lending 1,346,544 - - -

Other long-term liabilities 1,617 - 7,870 -

Total liabilities 1,479,007 1,361 69,317 165,652

NET POSITION

Restricted for:

Pensions 29,897,802 - - -

Postemployment benefits other than pensions 12,813,343 - - -

Pool participants - 2,075,946 - -

Individuals, organizations, and other governments - - 886,024 99,842

Total net position $ 42,711,145 $ 2,075,946 $ 886,024 $ 99,842

116

Government ABC

Statement of Changes in Fiduciary Net Position − Fiduciary Funds

For the Year Ended June 30, 20X2 (in thousands)

Pension (and Other Employee

Benefit) Trust Funds

Investment Trust Funds

Private-Purpose Trust

Funds Custodial

Funds

ADDITIONS

Contributions:

Members $ 297,846 $ - $ - $ -

Employers 1,259,384 - - -

Other plans 148,792 - - -

Gifts and bequests - - 197,258 -

Total contributions 1,706,022 - 197,258 -

Investment earnings:

Net increase in fair value of investments 1,852,408 64,663 33,702 -

Interest dividends, and other 1,416,448 58,465 30,378 -

Securities lending income 76,075 - - -

Total investment earnings 3,344,931 123,128 64,080 -

Less investment costs:

Investment activity costs 32,281 50,236 63 -

Securities lending costs 73,642 - - -

Net investment earnings 3,239,008 72,892 64,017 -

Capital share and individual account transactions:

Share sold - 2,817,210 - -

Reinvested distributions - 72,892 - -

Shares redeemed -

(2,776,843) - -

Net capital share and individual account trans. - 113,259 - -

Sales tax collections for other governments - - - 1,811,120

Miscellaneous 1,130 - - 1,468

Total additions 4,946,160 186,151 261,275 1,812,588

DEDUCTIONS

Benefits paid to participants or beneficiaries 1,963,047 - - -

Medical, dental, and life insurance for retirees 536,027 - - -

Refunds and transfers to other systems 170,514 - - -

Administrative expense 19,920 - 43 293

Beneficiary payments to individuals - - 211,179 -

Payments of sales tax to other governments - - - 1,811,120

Distributions to shareholders - 72,892 - -

Total deductions 2,689,508 72,892 211,222 1,811,413

Net increase (decrease) in fiduciary net position 2,256,652 113,259 50,053 1,175

Net position - beginning 40,454,493 1,962,687 835,971 98,667

Net position - ending $ 42,711,145 $ 2,075,946 $ 886,024 $ 99,842

117

Trust Funds

Trust funds are a fiduciary fund type that accounts for resources held by a government unit in a trustee capacity.

The governmental unit acts as a fiduciary for monies or properties held on behalf of individuals, employees, or

other governmental agencies. The three main types of fiduciary trust funds are (1) pension and other employee

benefit trust funds, (2) investment trust funds, and (3) private-purpose trust funds.

The accrual basis of accounting is used for the fiduciary funds, and the financial statements required for fiduciary

funds are the statement of fiduciary net position (Exhibit 10) and the statement of changes in fiduciary net position

(Exhibit 11). The statement of fiduciary net position includes all trusts and agency funds. The statement of changes

in fiduciary net position includes only the trust funds because agency funds do not have a net position balance;

their assets must equal their liabilities (Assets = Liabilities). An agency fund does not report revenues. Agency

funds are discussed after trust funds.

Private-purpose trust funds account for trust agreements for which the principal and/or income benefits specific

individuals, private organizations, or other governments. Note that the benefit is limited to private, rather than

general public, purposes. The trust agreement may require the principal to be preserved (i.e., nonexpendable

principal), in which case an endowment is created. In other trust agreements, both the principal and income may

be used for the specific purposes for which the trust was created. The governmental entity does not have to accept

the donation if it is not consistent with the government's objectives. However, there are many cases in which a

governmental entity accepts the donation and agrees to its provisions because of the benefits that can be

achieved with the resources. For example, a citizen group may donate money to a city to be used for award

recognition for businesses located in the downtown area that update and improve the appearances of their

storefronts. The governmental entity is typically allowed to charge the private-purpose trust fund a fee for

managing the trust's resources, which would include investing the resources and making the allowed expenditures

from the resources.

An example of a private-purpose trust fund is illustrated in the next section of this chapter. Public employee

pension funds are discussed in the "Additional Considerations" section later in the chapter.

118

Illustration of Private-Purpose Trust Fund

On January 1, 20X3, Haas City receives a $50,000 donation from Charles Alt, a citizen of Haas City. The terms of

the trust agreement specify that the city is to use about $25,000 each year for the next two years to help alleviate

the cost of transporting senior citizens to and from the senior citizens' center. The city accepts the donation and,

as allowed by the trust agreement, invests $25,000 in highly rated bonds. The remaining $25,000 is deposited in

a bank account that earns 4 percent interest. The terms of the trust agreement allow the city to deduct $1,000

per year for its administrative costs of managing the trust and the transportation services. During the first year,

20X3, $23,000 is paid out of the fund for transportation services. The fund pays out the remaining resources in

20X4.

(57) Cash 50,000

Additions—Contributions 50,000

The city accepts a private-purpose trust fund of $50,000.

(58) Investment in Bonds

25,000

Cash 25,000

The city invests half of the trust funds, as allowed by the trust agreement.

(59) Cash 600

Additions—Interest 600

Interest earned during the year on the monies deposited in the bank is recognized from bank statements.

(60) Deductions—Transportation Benefits

23,000

Cash 23,000

Transportation costs during the year are paid.

(61) Deductions—Administration Costs

1,000

Cash 1,000

The $1,000 of administrative costs allowed to the city are recognized and paid.

An adjusting journal entry is made on December 31, 20X3, to revalue the investment in bonds to their fair values,

as follows:

(62) Investment in Bonds

1,200

Additions—Investment Revalued 1,200

The fair value of the investment in bonds increased by $1,200 by the end

119

of the year.

Note that this private-purpose trust fund had an expendable principal as well as earnings. The requirement for a

private-purpose trust fund is that its resources may be used only for specific individuals, organizations, or other

governmental units as specified by the donor. Some private-purpose trust funds specify that the principal is

nonexpendable and that only the earnings may be used for the private purpose. A private-purpose trust fund is

differentiated from a permanent fund, which is part of the governmental funds. A permanent fund must maintain

its principal, but the earnings are used to support the government's programs that benefit all citizens. A private-

purpose trust fund must be used only for the specific purposes specified by the donor or grantor of the trust fund

and is not available to support the government's general programs.

Exhibit 10 reports the statement of fiduciary net position for the fiduciary funds for Haas City, including the

private-purpose fund and agency fund. Exhibit 11 presents the statement of changes in fiduciary net position for

the private-purpose trust fund. Agency funds are presented in the next section of the chapter.

Exhibit 10

HAAS CITY

Statement of Fiduciary Net Position

Fiduciary Funds

December 31, 20X3

Private-Purpose Funds

Agency Funds

Assets:

Cash $1,600 $1,000

Investments, at Fair Value:

Municipal Bonds 26,200

Total Assets $27,800 $1,000

Liabilities:

Due to Insurance Company $1,000

Total Liabilities $-0- $1,000

Net Position Held in Trust $27,800

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Exhibit 11

Fiduciary Funds Statement of Changes in Fiduciary Net Position

HAAS CITY

Statement of Changes in Fiduciary Net Position

Fiduciary Funds

For the Year Ended December 31, 20X3

Private-Purpose Fund

Additions:

Contributions $50,000

Investment Earnings:

Increase in Fair Value of Investments $1,200

Interest 600

Total Investment Earnings 1,800

Total Additions $51,800

Deductions:

Benefits $23,000

Administrative Costs 1,000

Total Deductions $24,000

Change in Net Position $27,800

Net Position—Beginning of Year -0-

Net Position—End of Year $27,800

GASB Statement No. 81: Split-Interest Agreements

Split-interest agreements are a type of giving agreement used by donors to provide resources to tow or more

beneficiaries, including governments. Split-interest agreements can be created through trusts or other legally

enforceable agreements with characteristics that are equivalent to slit-interest agreements in which a donor

transfers resources to an intermediary to hold and administer for the benefit of a government and at least one

other beneficiary. Examples of these types of agreements include charitable lead trusts, charitable reminder

trusts, and life-interests in real estate.

Statement No. 81 requires that a government that receives resources pursuant to an irrevocable split-interest

agreement:

• Recognize assets, liabilities, and deferred inflows of resources at the inception of the agreement;

• Recognize assets representing its beneficial interests in irrevocable split-interest agreements that are

administered by a third party, if the government controls the present service capacity of the beneficial

interests, and

• Recognize revenue when the resources become applicable to the reporting period.

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Agency Funds

An agency fund comes into existence because the governmental unit, in its capacity as agent for accomplishing

some particular mission, becomes incidentally a custodian of assets. When this occurs, accounts are required to

record on the accrual basis not only the assets received but also the liabilities to those for whose benefit they

were received. The other major transaction (or transactions) of the fund is disbursement of the assets to their

real owners. Although revenue and expenditure transactions are not impossible for an agency fund, they are not

typical. Furthermore, an agency fund will have little or no Fund Balance; the proceeds of any fee levied for the

service rendered belong to some other fund and should be shown as a liability to that fund.

Agency funds are a fiduciary fund type that accounts for resources held by a governmental unit as a custodial

agent for individuals, private organizations, other funds, or other governmental units. Examples are tax collection

funds that collect property taxes and then distribute them to local governmental units and employee benefit funds

for such items as dental insurance or charitable contributions that employees authorize as withholdings from their

paychecks.

The agency relationship does not always require creation of an agency fund. For example, a municipality must act

as agent of the federal and state governments in the collection of employees’ withholding taxes, social security

taxes and retirement contributions. As illustrated in the chapters dealing with revenue funds, amounts withheld

from employee’s pay be the municipality acting as agent for higher levels of government are ordinarily credited

to a revenue fund current liability account at the time the withholding is recorded, and debited to the same liability

account when the amount is remitted to the stated or federal government. If required by law or administrative

decision in a given jurisdiction, a separate agency fund is operated by the municipality to account for employees’

taxes and contributions. If a separate agency fund is not required by law, it appears perfectly acceptable for the

fund which accounts for the gross pay to account for the withholdings and contributions; this is so because the

agency relationship is incidental to the primary purposes of the fund which accounts for gross pay, the amounts

tend to be small in relation to total expenditures, and the agency relationship is ordinarily discharged on a rather

current basis. The accounting equation for an agency fund is Assets = Liabilities.

Because agency funds are custodial in nature, assets always equal liabilities and there is no fund equity. The

financial statement for agency funds is the statement of fiduciary net position as presented in Exhibit 9. Note that

there cannot be any net position balance for agency funds; therefore, no statement of changes in fiduciary net

position is required for agency funds.

Agency funds for Revenue Collection

Sales taxes, gasoline taxes, motor vehicle taxes, and many other taxes are commonly collected by a state

government agency and apportioned, on the basis specified by law, to other state units and to governmental

bodies within the state. At the local government level it is common for the treasurer of each county to serve as

collector for all property taxes owed by persons owning property within the county. Thus it is obvious that tax

agency fund records must be organized in a manner facilitating proper distribution of tax collections to each of

the governmental bodies (and by it to each of its funds) in the proportion the tax levied by the body (or its funds)

bears to the total levied against the parcel for that year. An agency fund does not report revenues.

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Illustrative Transactions in an Agency Fund

Haas City has established an agency fund to account for employees' share of health insurance, which is deducted

from the employees' monthly paychecks and then forwarded to the insurance company on a quarterly basis. For

this example, a total of $9,000 was deducted from the employees' paychecks, and $8,000 was paid to the

insurance company in 20X3. The remaining $1,000 will be paid to the insurance company in the first quarter of

20X4.

Agency Fund Receipts and Disbursements

The receipts and disbursements in the agency fund during 20X3 are as follows:

(63) Cash 9,000 Due to Insurance Company 9,000 Employees' contributory share of health insurance deducted from payroll

checks.

(64) Due to Insurance Company 8,000 Cash 8,000 Pay liability to insurance company for employees' share of insurance cost.

Short Quizzes

Indicate whether each of the following is true or false.

1. Funds used to account for transactions related to assets held by a governmental unit as a trustee or agent

are known as fiduciary funds.

2. There are certain accounting characteristics common to all fiduciary funds.

3. Agency funds should account for assets and liabilities on the modified accrual basis, even though revenue

and expenditure transaction are not common.

4. An agency relationship which usually necessities the creation of an agency funds is the collection of

revenues by one governmental body for several of its funds and/or for other governmental units and their

funds.

Answers

1. True. Agencies and trusteeships are two of the common relationships classified in law as fiduciary

relationships.

2. False. There is no set of accounting characteristics common to all fiduciary funds.

3. True. Agency fund assets and liabilities are to be recognized on the modified accrual basis.

4. True. Agency funds of this nature are commonly found at the state level, and also at the county level.

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The Government Reporting Model

GASB 34 specifies the reporting model for governmental entities. All general-purpose units such as states,

counties, and municipalities must provide all financial statements required in GASB 34. These statements are both

the fund-based financial statements presented earlier in this chapter plus the government-wide financial

statements that will be discussed in a following section of this chapter. Some special-purpose government units

such as cemetery associations that are engaged in a single governmental activity are not required to provide the

government-wide financial statements but still must provide fund-based financial statements.

Government Financial Reports

The annual report of a governmental entity is termed the comprehensive annual financial report (CAFR). Exhibit

12 presents the components of the CAFR along with parenthetical information noting the Exhibit number in the

course, or the number of the GASB standard providing guidance on the information to be included in that item.

The GASB has continued to develop the reporting standards for the statistical section to make it more useful and

comparative for users of the annual report. In 2004, the GASB issued GASB Statement 44, Economic Condition

Reporting: The Statistical Section—an Amendment of NCGA Statement 1 (GASB 44), which specifies the types of

information that should be reported in each of the five sections of the statistical section: (1) financial trends

information, (2) revenue capacity information, (3) debt capacity information, (4) demographic and economic

information, and (5) operating information. The intent of this statement is to further improve the

understandability and usefulness of this section by also requiring the governmental unit to add information about

the sources of the data and the major assumptions used and expand explanations for any unusual information

presented. Thus, the statistical section is an important part of the CAFR.

The fund-based financial statements were discussed previously in this chapter. The following discussion centers

on the government-wide financials and the required supplementary information (RSI).

Exhibit 12

The Comprehensive Annual Financial Report (CAFR)

Section 1: Introductory Section This section contains organizational information and other preliminary items. Section 2: Financial Section The financial section contains the following items: 1. Independent auditors report. 2. Management's discussion and analysis (required supplementary information) (GASB 34). 3. Government-wide financial statements. a. Statement of net position (Exhibit 13). b. Statement of activities (Exhibit 14). 4. Fund-based financial statements. a. Governmental funds. 1. Balance sheet (Exhibit 5). 2. Statement of revenues, expenditures, and changes in fund balances (Exhibit 6). 3. Reconciliation schedules (Exhibits 15 and 16). b. Proprietary funds. 1. Statement of net position (Exhibit 7).

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2. Statement of revenues, expenses, and changes in fund net position (Exhibit 8). 3. Statement of cash flows (Exhibit 9). c. Fiduciary funds. 1. Statement of fiduciary net position (Exhibit 10). 2. Statement of changes in fiduciary net position (Exhibit 11). 5. Notes to the financial statements (GASB 34, 38, and 88). 6. Required supplementary information (RSI). a. Budgetary comparison schedules (Exhibit 17) (GASB 41). b. Information about infrastructure assets (GASB 34 for modified approach). c. Information about pension funding progress and employer contributions to retirement and pension funds (GASB 27, 67, 68, 74, 75 and 84). Section 3: Combining and Individual Fund Financial Statements This section contains the financial statements of each individual fund as well as financial statements showing the combining of individual funds together as a fund type (e.g., combining all individual special projects fund into one fund). Section 4: Statistical Section This section presents the economic condition reporting required by GASB 44 to be presented in the statistical section of the annual report.

Government-wide Financial Statements

The basic financial statements include government-wide financial statements, fund financial statements, and the

notes to the financial statements. Government-wide financial statements do not display funds or fund types but

instead report information about the overall government. They distinguish between the primary government and

its discretely presented component units and between the governmental activities and business-type activities

of the primary government by reporting such information in separate rows and columns.

The government-wide financial statements include (1) the statement of net position and (2) the statement of

activities. GASB 34 requires that government-wide financial statements be prepared on the economic resources

measurement focus with the accrual basis of accounting.

Note: The fiduciary funds (e.g., private-purpose trust funds and agency funds) are not included in the two

government-wide financial statements because fiduciary funds are not available to support government

programs.

Statement of Net Position

Exhibit 13 presents the statement of net position for Haas City. Some important points regarding this statement

of net position follow:

1. Format. The format of the statement is Assets - Liabilities = Net position. This focuses attention on the net

position of the government entity.

2. Columnar presentation. A columnar presentation is used because it emphasizes that the primary

government has two different categories of activities, each needing a net position base to support that

category's activities, and the reporting entity's component units have their own net position base.

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a. The primary government's activities are assigned to either governmental activities or business-type

activities.

b. The internal service funds are included as part of the governmental activities. This is because internal

service funds provide service only to the governmental entity, not to external parties. The enterprise

funds are presented as business-type activities of the primary government. This is because the

enterprise funds offer services to the public, and thus they are more business oriented.

3. Assets. Reported assets include all types of assets of the governmental entity, including infrastructure such

as roads, sewers, and so on. These capital assets are not reported in the governmental funds that, under the

current financial resources measurement focus, record costs of capital assets as expenditures of the period.

GASB 34 requires that all capital and infrastructure assets be reported on the government-wide financial

statements. Capital assets, such as buildings and equipment, will be depreciated and that depreciation will be

presented as an expense on the government-wide statement of activities. Infrastructure assets are, by their

definition, long-lived assets that can be maintained for a much longer time than capital assets. Roads can be

paved over, bridges can be repaired, and water and sewer systems can be maintained. Because of the difficulty

in determining any reasonable estimated useful life for the infrastructure assets, GASB 34 provides for two

methods to account for the depreciating attribute of these infrastructure assets.

a. Report estimated depreciation expense. The first method requires governments to estimate depreciation

expense and report that estimated expense on the government-wide statement of activities.

b. Modified approach. The second approach allows governments to avoid the requirement to estimate

depreciation expense on infrastructure assets that are part of a network or subsystem of a network as

long as the government manages those assets using an asset management system and the government

can document that the assets are preserved approximately at, or above, a condition level established by

the government. Under the modified approach, the government entity annually expenses actual repair

and renewal costs associated with the infrastructure assets. Additions and improvements are added to

the cost basis of the infrastructure asset. Required footnote disclosures include (1) an estimate of the

amount required to maintain or preserve the infrastructure assets, along with the actual costs for each of

the last five years, and (2) the presentation of condition assessments of the infrastructure assets for the

last three years to show that these assets are indeed being maintained.

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Exhibit 13

Government-wide Statement of Net Position

HAAS CITY

Statement of Net Position

December 20X3

Primary Government

Total Component

Unit Governmental

Activities Business-type

Activities

Assets: Cash and Cash Equivalents $ 152,000 $ 30,000 $ 182,000 $3,000 Receivables, Net 89,000 5,000 94,000 Internal Balances 4,000 (4,000) -0- Inventories 23,000 23,000 1,000 Investment in Government Bonds 91,000 91,000 Capital Assets: Land and Infrastructure 3,000,000 3,000,000 Depreciable Assets, Net 1,202,000 105,000 1,307,000 870,000

Total Assets $4,561,000 $136,000 $4,697,000 $874,000

Liabilities: Vouchers Payable $ 64,000 $3,000 $ 67,000 Accrued Interest Payable 5,000 5,000 Contract Payable--Retainage 10,000 10,000 Noncurrent Liabilities: Due in More than 1 Year 80,000 100,000 180,000 $120,000

Total Liabilities $ 154,000 $108,000 $ 262,000 $120,000

Net Position: Invested in Capital Assets, Net of Related Debt

$4,122,000 $5,000 $4,127,000 $750,000

Restricted for: Debt Service 5,000 5,000 Permanent Funds 103,000 103,000

Unrestricted 177,000 23,000 200,000 4,000

Total Net Position $4,407,000 $ 28,000 $4,435,000 $754,000

Many governments use the modified approach rather than the estimated depreciation expense method.

Regardless of the method used for the depreciation element, the government must report the infrastructure

assets in the asset section of the government-wide statement of net position.

Note that Haas City distinguishes between its infrastructure assets and its buildings and equipment. Haas City has

chosen to use the modified approach in recognizing the depreciating factors in its infrastructure assets. Thus, the

depreciation expense reported on the statement of activities is only from the Depreciable Assets category, which

includes items such as buildings and equipment. The asset, Internal Balances, represents interfund receivables/

payables between the governmental activities and the business-type activities. In the Haas City example, the

enterprise fund owes a total of $4,000 to other funds: $3,000 to the general fund for a loan and $1,000 to the

internal fund for supplies purchases. Note again that the internal fund is considered a governmental activity

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because the internal fund provides services and supplies only to other entities within the government's reporting

entity.

The asset Internal Balances represents interfund receivables/payables between the primary government's funds

comprising the governmental activities (governmental funds plus internal service funds) and the funds comprising

the business-type activities (the enterprise funds). These internal balances cancel out each other for the total

column. GASB Statement No. 37, Basic Financial Statements—and Management's Discussion and Analysis—for

State and Local Governments: Omnibus (GASB 37), issued in 2001, eliminated the requirement for capitalizing

construction-period interest on capital assets used in governmental activities. Thus, on the government-wide

financial statements, this interest is now shown as an indirect expense of the period in which it is incurred.

4. Categories of net position. Net position is separated into three categories, as follows:

a. Invested in capital assets, net of related debt.

b. Restricted (by external requirements of creditors, grantors, contributors, or other governmental entities).

c. Unrestricted.

Note that restricted and unrestricted do not mean the same things as assigned and unassigned as used for the

fund-based statements.

Statement of Activities

The statement of activities for Haas City is presented in Exhibit 14. Important observations regarding this

statement of activities follow:

1. Accrual basis. The full accrual basis of accounting is used to measure revenues and expenses for the

government-wide statements. A reconciliation between the modified accrual basis of accounting for the

governmental funds and the accrual basis of the government-wide statements is required.

2. Format. The format of the statement of activities is based on the functions or programs of the government

entity.

a. Program revenues are categorized by type, and the net expenses (revenues) are shown separately for each

of the governmental and business-type activities.

b. The internal service fund is blended into the Governmental Activities because this fund provides service

solely within the governmental entity.

c. The enterprise funds are presented in the Business-Type Activities column because this fund includes

resources obtained by user charges to the public.

d. Fiduciary funds are not reported on the statement of activities because these funds are not available to be

used for providing governmental services.

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e. Note that the component unit, the city library, is discretely presented in its own column.

3. Expenses. The expenses include depreciation of the capital assets and expenses for any infrastructure

assets. However, the expenses would not include any expenditures in the governmental funds that were made

for long-term capital assets. For government-wide statements, these expenditures must be included as

increases to long-term capital assets on the balance sheet.

4. General revenues. General revenues are reported separately on the bottom of the statement. These are

revenues that are not directly tied to any specific program. GASB 34 requires that contributions to permanent

endowments, special items, and extraordinary items be reported in this section for the government-wide

statements. Special items are events within the control of management that are either unusual in nature or

infrequent in occurrence. Haas City has no special or extraordinary items, and the only contribution to a

permanent endowment was the $100,000 contribution received by the permanent fund.

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Exhibit 14

Government-wide Statement of Activities

Charges Operating Capital For Grants and Grants and

Expenses Services Contributions Contributions Governmental

Activities Business-Type

Activities Total Component

Unit

Functions/Programs Primary Government Governmental Activities:

General Government $212,000 $ 4,000 $23,000 $20,000 $(165,0000) $ (165,000) Streets and Highways 71,000 (71,000) (71,000) Public Safety 335,000 (335,000) (335,000) Sanitation 141,000 (141,000) (141,000) Culture and Recreation 54,000 (54,000) (54,000) Depreciation of Capital Assets 120,000 (120,000) (120,000) Interest on Long-Term Debt 10,000 (10,000) (10,000)

Total Government Activities $943,000 $ 4,000 $23,000 $20,000 $ (896,000) $ (896,000)

Business-Type Activities: Water $ 38,000 $40,000 $ 2,000 $ 2,000

Total Business-Type Activities $ 38,000 $40,000

Total Primary Government $981,000 $44,000 $23,000 $20,000 $ (896,000) $ 2,000 $ (894,000)

Component Unit: Library $ 6,000

Total Component Unit $ 6,000 $ -0- $ (6,000)

General Revenues: Taxes:

Property Taxes, Levied for General Purposes $ 781,000 Property Taxes, Levied for Special Purposes 62,000 $ 12,000 Property Taxes, Levied for Debt Service 33,000 Sales Taxes 32,000

Investment Earnings 9,000 Miscellaneous Revenues 18,000

Contribution 100,000 Transfers between Governmental and Business-Type Funds -0-

Total General Revenues, Special Items, and Transfers $1,035,000 $1,035,000

Change in Net Position $ 139,000 $ 2,000 $ 141,000 $ 6,000 Net Position-Beginning 4,268,000 26,000 4,294,000 748,000

Net Position-Ending $4,407,000 $28,000 $4,435,000 $754,000

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Reconciliation Schedules

GASB 34 requires that two reconciliation schedules be presented to reconcile the net change in the total

amounts reported on the governmental funds statements with the amounts reported on the government-

wide statements. These reconciliation schedules may be presented as part of the governmental funds

statements or in an accompanying schedule on the page immediately following the governmental fund

financial statement it supports. The two required reconciliation schedules are as follows:

1. Reconciliation schedule for Statement of Net Position. The first reconciliation schedule, the reconciliation

between the fund balances reported for the governmental funds to the net position for the government-

wide financials, is presented in Exhibit 15. This schedule describes the adjustments necessary to move

from the modified accrual basis used in the governmental funds to the accrual basis used for the

government-wide statements. For example, the balance sheets of the government funds do not include

infrastructure and capital assets. These costs are recognized as expenditures in the periods in which they

are made. However, the government-wide statement of net position must report the balance sheet date

cost less depreciation of these infrastructure and capital assets. In addition, the government-wide

statements must include the accounts of the internal service funds, which are separately reported from

the governmental funds in the fund-based financial statements.

2. Reconciliation schedule for Statement of Activities. The second reconciliation schedule, the reconciliation

between the net change in fund balances reported in the governmental funds' statement of revenues,

expenditures, and changes in fund balance to the change in net position reported in the government-wide

financials, is presented in Exhibit 16. For example, interest revenue on the investment in bonds in the

permanent fund was presented in that fund under the modified accrual basis for the amount of $8,000.

However, under the accrual basis, the interest revenue would be computed based on the effective interest

rate, with amortization of the discount, in the amount of $9,000 ($90,000 x 0.10). The difference of $1,000

is an adjustment both to the change in net position and to the net position.

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Exhibit 15

Reconciliation Schedule for the Statement of Net Position

HAAS CITY

Reconciliation of the Balance Sheet of Governmental Funds to the Statement of Net Position

December 31, 20X3

Fund balances reported in the governmental funds $ 279,000 Amounts reported for the governmental activities in the statement of net positions are different because: Capital assets used in governmental activities are not financial resources and therefore are not reported in the governmental funds. 4,200,000 Internal service funds are used by management to charge the costs of certain activities, such as centralized purchasing and storage functions, to individual funds. The assets and liabilities of the internal service fund are included in governmental activities in the statement of net position. 7,000 Long-term liabilities, including bonds payable, are not due and payable in the current period and therefore are not reported in the funds. (80,000) Interest on bonds in the permanent fund is recognized in that fund under the modified accrual basis but must be adjusted to the accrual basis for the government-wide financial statements. 1,000 Net position of governmental activities $4,407,000

Exhibit 16

Reconciliation Schedule for the Statement of Revenues, Expenditures, and Changes in Fund Balances

HAAS CITY

Reconciliation of the Statement of Revenues, Expenditures, and Changes in Fund Balances of Governmental

Funds to the Statement of Activities

For the Year Ended December 31, 20X3

Net change in fund balances- Governmental funds $150,000

Governmental funds report capital outlays as expenditures. However, in the statement of activities, the costs of those assets are capitalized and depreciated over their estimated useful lives. This is the amount by which capital outlays in the governmental funds ($182,000) exceeded depreciation of the governmental assets ($119,000).

63,000

Bond proceeds provide current financial resources for the governmental funds. However, the issuance of debt increases long-term liabilities in the statement of net position. Repayment of debt principal is an expenditure in the governmental funds, but the repayment reduces the long-term liabilities in the statement of net position. This is the amount by which bond proceeds ($102,000) exceeded the net repayments of principal ($20,000).

(82,000)

Revenues in the statement of activities are recorded on the accrual basis. Interest revenue in the governmental funds is recorded on the modified accrual basis. This is the amount that accrual interest exceeded the interest recognized in the permanent funds.

1,000

Internal service funds are used by management to charge the costs of certain services, such as a centralized purchasing function, to individual funds. The net revenue (expense) of the internal

7,000

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service funds is reported with governmental activities.

Change in net position of governmental activities $139,000

Budgetary Comparison Schedule

GASB 34 requires that a budgetary comparison schedule be presented as required supplementary information

for the general fund and for each special revenue fund that has a legally adopted annual budget. This schedule

may be presented as a separate financial statement after the governmental funds financials or in the footnotes

of the annual report. The budgetary comparison schedule for Haas City's general fund is presented in Exhibit 17.

Exhibit 17

Budgetary Comparison Schedule

HAAS CITY

Budgetary Comparison Schedule General Fund

For the Year Ended December 31, 20X3

Important observations regarding the budgetary comparison schedule follow:

1. GASB 34 requires that both the original budget and the final budget be presented. The original budget is the

first budget for the fiscal period adopted by the government entity. Through the year, many government

entities will modify the original budget because of new events or changes in expectations. These changes

Budgeted Amount Actual Amounts

(Budgetary Basis)

Variance with Final Budget

Positive (Negative) Original Final

Budgetary fund balance, January 1 $129,000 $129,000 $129,000 $ -0- Resources (inflows):

Property taxes 775,000 775,000 781,000 6,000 Grants 55,000 55,000 33,000 (22,000) Sales taxes 25,000 25,000 32,000 7,000 Miscellaneous 20,000 20,000 18,000 (2,000)

Amounts available for appropriation $875,000 $875,000 $864,000 $(11,000)

Charges to appropriations (outflows):

General government $200,000 $200,000 $206,000 $(6,000) Streets and highways 75,000 75,000 71,000 4,000 Public safety 400,000 400,000 393,000 7,000 Sanitation 150,000 150,000 141,000 9,000 Nondepartmental: Transfers out to other funds 30,000 30,000 30,000 -0-

Total charges to appropriations $855,000 $855,000 $841,000 $ 14,000

Budgetary fund balance, December 31

$149,000 $149,000 $152,000 $3,000

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must go through the legislative process of the government, such as the city council. For our example, no

changes were made to the formal budget during the year.

2. The budgetary comparison schedule should be presented on the same format with the same terminology

and classifications as the original budget.

3. A separate column for the variance between the final budget and the actual amounts is encouraged but not

required. It is presented here to provide a complete presentation of the possible disclosures of a

governmental entity.

GASB Statement No. 41, Budgetary Comparison Schedules—Perspective Differences (GASB 41), amended GASB

34 for state and local governments that have significantly different structures for budgetary purposes from the

fund structures in GASB 34. These differences are termed perspective differences. A government with significant

budgetary perspective differences such that the government cannot provide budgetary comparisons for the fund

structure of the general fund and each special revenue fund is then required to present a budgetary comparison

schedule in its required supplementary information based on the fund, program, or organizational structure that

government uses for its legally adopted budget.

Management's Discussion and Analysis

GASB 34 specifies that the Management's Discussion and Analysis (MD&A) be included in the required

supplementary information (RSI) of the government-wide financial statements. The MD&A is presented before

the financial statements and provides an analytical overview of the government's financial and operating

activities. It is based on currently known facts, decisions, or conditions and includes comparisons of the current

and prior years, with an emphasis on the current year, based on government-wide information. Currently known

facts are those of which management is aware at the audit report date.

The purpose of this RSI item is to provide users of the financial statements an objective discussion of whether the

government's financial position has improved or deteriorated during the year. GASB 37 states that the MD&A

should be limited to the items specified in GASB 34 rather than be used to present an abundance of other topics

not specifically required. The GASB believes that additional discussions beyond those required might result in

information that is not objective and cannot be directly analyzed. Governments that wish to provide additional

information may do so in other supplementary information such as footnotes or transmittal letters.

Notes to the Government-wide Financial Statements

Notes to the financial statements are an integral part of the basic financial statements because they disclose

information essential to fair presentation that is not reported on the face of the statements. The focus is on the

primary government's governmental activities, business-type activities, major funds, and nonmajor funds in the

aggregate. GASB Statement No. 34, Basic Financial Statements—and Management's Discussion and Analysis—

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for State and Local Governments (GASB 34), specified a number of required note disclosures in the government-

wide financial statements that include the following:

1. Accounting and measurement policies used in the primary governmental entity.

2. Information about capital assets, including beginning and ending balances, along with capital acquisitions

and sales during the year; and depreciation expense and accumulated depreciation.

3. For collections not capitalized, disclosures describing the collection, along with the reasons for not

capitalizing these collections.

4. Note disclosures about long-term liabilities include a schedule of the beginning and ending balances along

with increases or decreases during the year, for each long-term debt item; the current portion of each

long-term item; and the amount of annual debt service required.

5. Disclosures about donor-restricted endowments should include net increases in investments for which

the income is available for expenditure, and the policy for spending investment income.

6. Segment information is to be provided for the enterprise funds included in the government-wide financial

statements.

In 2018, the GASB issued GASB Statement No. 88, Certain Disclosures Related to Debt, including Direct Borrowings

and Direct Placements, to amend GASB 34. In addition to other requirements to disclose information related to

debt in notes to financial statements, a government should disclose in notes to financial statements summarized

information about the following items:

1. Amount of unused lines of credit

2. Assets pledged as collateral for debt

3. Terms specified in debt agreements related to significant:

• Events of default with financial-related consequences

• Termination events with finance-related consequences, and

• Subjective acceleration clauses

Moreover, a government should separate information in debt disclosures regarding:

1. Direct borrowings and direct placements of debt from

2. Other debt

The provisions of GASB 88 are effective for fiscal years beginning after December 15, 2018.

GASB Statement No. 38, Certain Financial Statement Note Disclosures (GASB 38), stated that the required

footnotes should be modified for the following:

1. In the summary of significant accounting policies, provide descriptions of the activities accounted for in

the major funds, internal service fund type, and fiduciary fund types. This change is a result of GASB 34's

focus on major funds rather than all funds.

2. Delete the requirement to disclose the accounting policy for encumbrances in the summary of significant

accounting policies (i.e., the lapsing or nonlapsing method).

3. Disclose the period of availability used for recording revenues in governmental funds.

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4. Disclose debt service requirements to maturity, separately identifying principal and interest for each of

the subsequent five years and in five-year increments thereafter and changes in variable-rate debt. In

addition, governments should disclose the future minimum payments for each of the five succeeding

years for capital and noncancellble operating leases.

5. Provide a schedule of changes in short-term debt during the year along with the purposes for which the

debt was issued.

6. Add a disclosure of actions taken to address any significant violations of finance-related legal or

contractual provisions to the footnote describing these significant violations.

7. Disclose details of the payable and receivable amounts for interfund balances and the purposes of the

interfund transfers. In addition, disclosures should be made regarding the amounts of interfund transfers

during the period along with a description and amount of significant transfers that are not expected to

occur on a routine basis.

8. Provide details of the components of accounts payable so that the financial statement users can

understand the timeliness and payment priorities of payables.

9. Provide details about significant individual accounts when their nature is obscured by aggregation. For

example, more disclosure could be made for receivables that contain a myriad of different credit risks or

liquidity attributes.

In addition to these requirements, GASB 88 specifies that a government should separate information in debt

disclosures regarding direct borrowings and direct placements of debt from other debt. Details should include:

1. Principal and interest requirements to maturity, presented separately, for each of the five subsequent

fiscal years and in five-year increments thereafter. Interest requirements for variable-rate debt should be

determined using the rate in effect at the financial statement date.

2. The terms by which interest rates change for variable-rate debt.

Note: The focus of governmental and proprietary fund financial statements is on major funds (but major fund

reporting is not required for internal service funds). Each major fund is presented in a separate column, and

nonmajor funds are aggregated in one column. Combining statements are not required for nonmajor funds. The

main operating fund (e.g., the general fund) is always reported as a major fund and any governmental or

enterprise fund believed to be particularly important to users may also be reported in this way. Other individual

governmental or enterprise funds must be reported as major if they meet the quantitative thresholds.

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Illustration of Note Disclosures Related to Debt

The GASB provides the following illustration that includes note disclosures required by GASB 88.

Assumptions

The County government has outstanding general obligation bonds and notes from direct borrowings and direct

placements related to governmental activities totaling $12,530,000 and $941,918, respectively, and notes from

direct borrowings related to business-type activities totaling $70,400.

The County has pledged an undeveloped lot zoned for commercial use as collateral for the notes from direct

borrowings related to business-type activities. The County’s outstanding notes from direct borrowings related to

business-type activities have a termination event that changes the timing of repayment of outstanding amounts

to become immediately due if pledged revenues during the year are less than 120 percent of debt service coverage

due in the following year.

The County’s outstanding notes from direct borrowings related to business-type activities also contain a subjective

acceleration clause that allows the lender to accelerate payment of the entire principal amount to become

immediately due if the lender determines that a material adverse change occurs. All outstanding notes from direct

borrowings and direct placements contain an event of default that changes the timing of repayment of

outstanding amounts to become immediately due if the County is unable to make payment.

The County also has an outstanding line of credit in the amount of $1,500,000.

Disclosure

Changes in long-term obligations for the year ended June 30, 20X2, are as follows:

Balance at July 1, 20X1 Increases Decreases

Balance at July 30, 20X2

Due within One Year

Governmental activities: General obligation bonds $ 21,500,000 $ - $ 8,970,000 $ 12,530,000 $ 7,050,000 Notes from direct borrowings and direct placements 1,412,877 - 470,959 941,918 470,959

Total $ 22,912,877 $ - $ 9,440,959 $ 13,471,918 $ 7,520,959

Business-type activities:

Notes from direct borrowings $ 76,800 $ - $ 6,400 $ 70,400 $ 6,400

The County’s outstanding notes from direct borrowings and direct placements related to governmental activities

of $941,918 contain a provision that in an event of default, outstanding amounts become immediately due if the

County is unable to make payment.

The County’s outstanding notes from direct borrowings related to business-type activities of $70,400 are secured

with collateral of an undeveloped lot zoned for commercial use. The outstanding notes from direct borrowings

related to business-type activities of $70,400 contain (1) a provision that in an event of default, the timing of

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repayment of outstanding amounts become immediately due if pledged revenues during the year are less than

120 percent of debt service coverage due in the following year and (2) a provision that if the County is unable to

make payment, outstanding amounts are due immediately. The County’s outstanding notes from direct

borrowings related to business-type activities of $70,400 contain a subjective acceleration clause that allows the

lender to accelerate payment of the entire principal amount to become immediately due if the lender determines

that a material adverse change occurs.

The County also has an unused line of credit in the amount of $1,500,000.

Debt service requirements on long-term debt at June 30, 20X2, are as follows:

Governmental Activities Business-Type Activities

Notes from Direct Borrowings

Bonds and Direct Placements Notes from Direct Borrowings

Principal Interest Principal Interest Principal Interest

20X3 $ 7,050,000 $ 497,700 $ 470,959 $ 30,024 $ 6,400 $ 2,640

20X4 4,880,000 215,950 470,959

10,008 6,400 2,400

20X5 50,000

21,000

-

- 6,400 2,160

20X6 50,000

19,250

-

- 6,400 1,920

20X7 50,000

17,500

-

- 6,400 1,680

20X8-20Y2 250,000

52,500

-

- 32,000 4,800

20Y3-20Y7 200,000

17,500

-

- 6,400 240

$ 12,530,000 $ 841,400 $ 941,918 $ 40,032 $ 70,400 $ 15,840

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Other Financial Report Items

Governments may choose to provide additional information beyond that required as discussed previously. For

example, some government entities present comprehensive annual financial reports (CAFRs), which include

additional statistical information about the sources of revenues, property tax levies and property values,

demographic statistics, and other miscellaneous statistics that management of the governmental entity believes

will aid users of the financial report. Some governmental entities may additionally disclose financial statements

for individual funds or combined by fund type. Some governments may go beyond the required footnote

disclosures and provide additional schedules and information. As with commercial enterprises, it is up to the

management of the governmental entity to determine how much additional disclosure it wishes to provide in its

annual report.

Interim Reporting

Governmental entities generally are not required to publish interim reports, although many prepare monthly or

quarterly reports to determine the current progress of compliance with legal and budgetary limitations and to

plan for changes in events or developments that were not foreseen when the annual budget was prepared.

Interim reports are a valuable internal management control instrument; they typically are not made available to

the general public.

Auditing Governmental Entities

Most governmental entities are audited annually because of state or federal requirements or because long-term

creditors demand audited statements as part of the debt agreements. The audit of a governmental entity is

different from the audit of a commercial entity. The auditor not only must express an opinion on the fairness of

the audited entity's financial statements in conformity with applicable accounting principles but also must assess

the audited entity's compliance with legal or contractual provisions of state law, debt covenants, terms of grants

from other governmental entities, and other restrictions on the governmental entity. The AICPA publishes the

State and Local Governments—Audit and Accounting Guide that provides guidance relevant to audits of state

and local governments.

The Single Audit Act of 1984 is a federal law specifying the audit requirements for all state and local governments

receiving federal financial assistance. The audit act requires auditors to determine whether (1) the financial

statements fairly present the government's financial condition, (2) the governmental entity has an internal control

system to provide reasonable assurance that it is managing federal financial assistance programs in compliance

with applicable laws and regulations, and (3) the governmental entity has complied with laws and regulations that

may have a material effect on each federal program. The auditors issue not only the standard audit report but

also special reports on items (2) and (3) above.

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Additional Considerations

Special-Purpose Governmental Entities

The accounting and financial reporting standards for general-purpose governments such as states, counties, and

municipalities are discussed in this chapter and 1. However, a number of governments are special-purpose

governments, which are legally separate entities. They may be component units of a general-purpose

government or stand-alone governments apart from a general-purpose government. Special-purpose

governments include governmental entities such as cemetery districts, levee districts, park districts, tollway

authorities, and school districts. Some of these special-purpose government entities may be engaged in

governmental activities that generally are financed through taxes, intergovernmental revenues, and other

nonexchange revenues. These activities are usually reported in governmental or internal service funds. Some of

these entities are engaged in business-type activities that are financed by fees charged for goods or services.

These activities are usually reported in enterprise funds. GASB 34 establishes specific reporting requirements for

each of the following types of special-purpose governments:

1. Engaged in more than one governmental program or in both governmental and business-type activities:

These governmental entities must provide both fund financial statements and government-wide financial

statements as presented earlier in this chapter and in Chapter 1.

2. Engaged in a single governmental program (such as cemetery districts or drainage districts): These

governmental entities may present a simplified set of government-wide and fund-based financial

statements, often combining these two statements.

3. Engaged in only business-type activities: These governmental entities must present only the financial

statements required for enterprise funds. Many public universities and public hospitals will be included in

this category.

4. Engaged in only fiduciary-type activities: These governmental entities are not required to present the

government-wide financials but must provide only the financial statements required for fiduciary funds.

This category includes special-purpose governments responsible for managing pension funds.

Regardless of the category of special-purpose government entity, all governments must include in their financial

reports the Management's Discussion and Analysis, the footnotes, and any required supplementary information.

Government Combinations

The term “government combinations” includes a variety of transactions referred to as mergers, acquisitions, and

transfers of operations. The distinction between a government merger and a government acquisition is based

upon whether an exchange of significant consideration is present within the combination transaction.

Government mergers include combinations of legally separate entities without the exchange of significant

consideration.

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In 2013, the GASB issued Statement No. 69, Government Combinations and Disposals of Government Operations,

satisfies the need for guidance specific to governmental combinations and disposals. This Statement provides

specific accounting and financial reporting guidance for combinations in the governmental environment.

This Statement requires the use of carrying values to measure the assets and liabilities in a government merger.

Conversely, government acquisitions in which a government acquires another entity, or its operations, in

exchange for significant consideration. This Statement requires measurements of assets acquired and liabilities

assumed generally to be based upon their acquisition values. This Statement also provides guidance for transfers

of operations that do not constitute entire legally separate entities and in which no significant consideration is

exchanged.

A disposal of a government’s operations results in the removal of specific activities of a government. Disposal

transactions are required to be recognized as of the effective date at which operations are transferred or sold. A

disposing government would recognize a gain or loss on the disposal of operations, based on the effective transfer

date of a transfer of operations or the date of sale for operations that are sold. Operating activities up to the

measurement date are not included in the calculation of gain or loss—only the costs directly associated with the

disposal should be included.

Nonexchange Financial Guarantees

Many state and local government entities and related entities, such as general purpose government and special

purpose government entities, have issued or received nonexchange financial guarantees related to their debt

issuances during the current budgetary and economic climate. As a result, the GASB believes that a

comprehensive standard is needed for the recognition and disclosure of financial guarantees that could lead to

creditor claims. The disclosures provide investors with information to better assess the probability that

governments will repay the debt holders. In 2013, the GASB issued Statement No. 70, Accounting and Financial

Reporting for Nonexchange Financial Guarantees, requiring state and local government and government agencies

that provide nonexchange financial guarantees to recognize a liability when qualitative factors indicate that it is

more likely than not that the guarantor will have to make payment. Examples of qualitative factors include:

• Bankruptcy or reorganization by the guaranteed entity;

• Breach of a debt covenant or terms or conditions related to a borrowing, such as a default or delinquency

in interest or principal payments by the guaranteed entity, and

• Indicators of significant financial difficulty, such as draw on reserve funds, concessions from deb holders,

significant investment losses or loss of a major revenue sources by the guaranteed party.

Statement No. 70 requires financial statement preparers to:

• Identify the terms and conditions of all nonexchange financial guarantees that are within the scope;

• Gather relevant historical and current data, and

• Develop cash flows models, and associated internal controls, to estimate the liabilities associated with the

guarantees extended.

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Under this Statement, both the guarantor and the issuer of guaranteed obligations need to provide new

disclosures. A guarantor discloses information about the nonexchange guarantees by type of guarantee,

regardless of the likelihood of payment, such as:

• The legal authority and limits for providing the guarantee and types of obligations guaranteed;

• Relationship to the guaranteed issuers;

• The term of the guarantee;

• The terms for recovering payments from the issuer, and

• The total amount of guarantees outstanding at the reporting date.

This Statement enhances the information disclosed about a government’s obligations and risk exposure from

extending nonexchange financial guarantees and augments the ability of financial statements users to assess the

probability that governments will repay obligation holders by requiring disclosures about obligations that are

issued with this type of financial guarantee.

Financial Reporting for Pensions and Other Postemployment Benefits Plans

Most states and many local governments provide a variety of pensions and other postemployment benefits

(OPEB) to their employees. OPEBs include postemployment health care, life insurance, and other nonpension

benefits for persons after retirement from the governmental unit. The GASB has a series of standards that

prescribe the employer's accounting for these costs and the financial reporting by the entity that maintains the

plans. In some cases, the governmental unit administers its own plans, such as a state-based pension plan

covering all state employees in a specific employment category, while in other cases the governmental unit uses

a multiemployer plan, such as a firefighter's retirement plan that includes firefighters from a number of cities.

Two GASB statements present the accounting and financial reporting requirements for the entity that administers

the plan's assets and for the employer of the employees covered by the plans. The first is GASB Statement No.

25, Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined Contribution Plans

(GASB 25), which established the financial reporting requirements for pension plans. Requirements for defined

contribution OPEB plans in this Statement are replaced by Statement No. 74 effective for fiscal years beginning

after June 15, 2016. GASB Statement No. 74, Financial Reporting for Postemployment Benefit Plans Other Than

Pension Plans. Statement No. 74, establishes new accounting and financial reporting requirements for OPEB

plans, replaces:

• Statement No. 43, Financial Reporting by Employers for Postemployment Benefit Plans Other Than Pension

Plans, as amended, and

• Statement No. 57, OPEB Measurements by Agent Employers and Agent Multiple-Employer Plans

This Statement also includes requirements for defined contribution OPEB plans that replace the requirements

for those OPE plans in:

• Statement No. 25, Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined

Contribution Plans, as amended, Statement No. 43 and

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• Statement No. 50, Pension Disclosures

The scope of Statement No. 74 includes OPEB plans−defined benefit and defined contribution−administered

through trusts that meet the following criteria:

✓ Contributions from employers and non-employer contributing entities to the OPEB plan and earnings on

those contributions are irrevocable.

✓ OPEB plan assets are dedicated to providing OPEB to plan members in accordance with the benefit terms.

✓ OPEB plan assets are legally protected from the creditors of employers, non-employer contributing

entities, and the OPEB plan administrator. If the plan is a defined benefit OPEB plan, plan assets also are

legally protected from creditors of the plan embers.

This Statement also include requirements to address financial reporting for assets accumulated for purposes of

providing defined benefit OPEB through OPEB plans that are NOT administered through trusts that meet the

specified criteria.

For defined benefit OPEB plans that are administered through trusts that meet the specified criteria, this

Statement requires two financial statements (a) a statement of fiduciary net position and (b) a statement of

changes in fiduciary net position. In addition to the requirements of this Statement, those plans also are required

to follow all accounting and financial reporting requirements of other standards, as applicable.

This Statement requires that notes to financial statements of all defined benefit OPEB plans that are administered

through trusts that meet the specified criteria include descriptive information, such as the type of OPEB provided,

the classes of plan members covered, and the composition of the OPEB plan’s board. For single-employer and

cost-sharing OPEB plans that are administered through trusts that meet the specified criteria, the following

information also is required to be disclosed:

• Information about the components of the net OPEB liability and related ratios, including the OPEB plan’s

fiduciary net position as a percentage of the total OPEB liability

• Significant assumptions and other inputs used to measure the total OPEB liability and information about

the sensitivity of the measure of the net OPEB to changes in the discount rate and changes in the

healthcare cost trend rate

Employer Accounting for Pensions and OPEB Plan Benefits

GASB statements present the standards for the employer's measurement and display of accounting for the

expenditures/expenses for the benefits and any related liabilities (or assets) for the difference between the

expenditure/expenses recognition and the amount funded by the employer. The first is GASB Statement No. 27,

Accounting for Pensions by State and Local Governmental Employers (GASB 27), which presents the standards for

pensions. The second is GASB Statement No. 45, Accounting and Financial Reporting by Employers for

Postemployment Benefits Other Than Pensions (GASB 45). The general principles for measurement, recognition,

and display in these two standards are similar. The accrual method of accounting is typically used for the

government-wide financial statements to measure the expenses of the employer for pension costs for its

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employees and for the costs of other postemployment benefits for its employees. Actuarial assumptions are

required under the accrual method. The state and local government employers must report the

expense/expenditures and related liabilities (or assets) for both their pension benefits and their OPEBs.

Although GASB 27 and GASB 45 have many of the same measurement and display standards, there are some

differences due to the differences in the nature of the specific benefits given by the employer. Accountants

responsible for accounting for these two sets of postemployment benefits readily acknowledge that some plans

and benefits can be quite complex and require detailed study of the specific requirements in the related GASB

statements.

GASB Statement No. 67, Financial Reporting for Pension Plans - an amendment of GASB Statement No. 25.

Statement No. 67 defines the financial reporting standards for pension plans. In most respects, the requirements

for pension plan financial statements remain unchanged from the prior standards. A defined benefit pension plan

will continue to present two financial statements: a statement of fiduciary net position (the amount held in a trust

for paying retirement benefits) and a statement of changes in fiduciary net position. Statement No. 67 enhances

note disclosures and required supplementary information (RSI) for defined benefit and defined contribution

pension plans.

GASB Statement No. 68, Accounting and Financial Reporting for Pensions - an amendment of GASB Statement No.

27. Statement No. 68 requires governments to report the total pension liability, as well as the fair value of plan

assets available to pay pension benefits. The primary objective of this Statement is to improve accounting and

financial reporting by state and local governments for pensions. It also improves information provided by state

and local governmental employers about financial support for pensions that is provided by other entities. The

difference between a participating government’s total pension liability and the fiduciary net position of the plan

is the net pension liability (NPL) and is reported on the statement of net position of the government-wide and

proprietary fund statements.

GASB Statement No. 73, Accounting and Financial Reporting for Pensions and Related Assets That Are Not within

the Scope of GASB Statement 68, and Amendments to Certain Provisions of GASB Statement 67 and 68. Statement

No. 73 establishes requirements for defined-benefit pensions and defined-contribution pensions not

administered through a trust meeting specified criteria, i.e. those not covered by Statement No. 67 and 68.

Requirements for reporting pensions generally are the same as in Statement No. 68, with modifications as needed

for any assets accumulated for pensions provided through pension plans and not administered through trusts

meeting the criteria specified in Statement No. 68.

When governments implement the provisions of Statement No. 73, assets that are set aside for pension plans that

are not administered as formal trusts will use similar guidance for any assets accumulated for those pensions.

GASB Statement No. 82, Pension Issues−An Amendment of GASB Statement No. 67, No. 68, and No. 73. Statement

No. 82 addresses issues regarding:

• The presentation of payroll-related measures in required supplementary information’

• The selection of assumptions and the treatment of deviations from the guidance in an Actuarial Standard

of Practice for financial reporting purposes, and

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• The classification of payments made by employers to satisfy employee (plan member) contribution

requirements.

Prior to the issuance of this Statement, Statement No. 67 and No. 68 required presentation of covered-employee

payroll, which is the payroll of employees that are provided with pensions through the pension plan, and ratios

that use that measure, in schedules of required supplementary information. This Statement amends Statement

No. 67 and No. 68 to instead require the presentation of covered payroll, defined as the payroll on which

contributions to a pension plan are based, and ratios that use that measure.

The Statement clarifies that a deviation, as the term is used in Actuarial Standards of Practice issued by the

Actuarial Standards Board, from the guidance in an Actuarial Standard of Practice is NOT considered to be in

conformity with the requirements of Statement No. 67, No. 68, or No. 73 for the selection of assumptions used in

determining the total pension liability and related measures.

The Statement also clarifies that payments that are mad by an employer to satisfy contribution requirements that

are identified by the pension plan terms as plan member contribution requirements should be classified as plan

member contributions for purposes of Statement No. 67 and as employee contributions for purposes of Statement

No. 68. It also requires that an employer’s expense and expenditures for those amounts be recognized in the

period for which the contribution is assessed.

GASB Statement No. 75, Accounting and Financial Reporting for Postemployment Benefit Plans Other than

Pension Plans. The objective of Statement No. 75 is to improve accounting and financial reporting by state and

local governments for postemployment benefits to other than pensions (other postemployment benefits or

OPEB). It also improves information provided by state and local governmental employers about financial support

for OPEB that is provided by other entities. Statement No. 75 replaces the requirements of:

• Statement No. 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other

Than Pensions, as amended, and

• Statement No. 57, OPEB Measurements by Agent Employers and Agent Multiple-Employer Plans

In Statement No. 75, distinctions are made regarding the particular requirements depending upon whether the

OPEB plans through which the benefits are provided are administered through trusts that meet the following

criteria:

✓ Contributions from employers and non-employer contributing entities to the OPEB plan and earnings on

those contributions are irrevocable.

✓ OPEB plan assets are dedicated to providing OPEB to plan members in accordance with the benefit terms.

✓ OPEB plan assets are legally protected from the creditors of employers, non-employer contributing

entities, and the OPEB plan administrator. If the plan is a defined benefit OPEB plan, plan assets also are

legally protected from creditors of the plan embers.

Statement No. 75 requires governments to report the net OPEB liability (total OPEB liability less the OPEB plan’s

fiduciary net position). This Statement also requires governments in all types of OPEB plans to present more

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extensive note disclosures and required supplementary information (RSI) about their OPEB liabilities. The new

RSI includes a schedule showing the causes of increases and decreases in the OPEB liability and a schedule

comparing a government’s actual OPEB contributions to its contribution requirements.

GASB Statement No. 78, Pensions Provided through Certain Multiple-Employer Defined Benefit Pension Plans. The

objective of Statement No. 78 is to address the scope and applicability of Statement No. 68. Prior to the issuance

of Statement No. 78, the requirements of Statement No. 68 applied to the financial statements of all state and

local governmental employers whose employees are provided with pensions through pension plans that are

administered through trusts that meet the criteria of that Statement. Statement No. 78 amends the scope and

applicability of Statement 68 to exclude pensions provided to employees of state or local governmental employers

through a cost-sharing multiple-employer defined benefit pension plan that:

• Is NOT a state or local governmental pension plan;

• Is used to provide defined benefit pensions both to employees of state or local governmental employers

and to employees of employers that are not state or local governmental employers, and

• Has NO predominant state or local governmental employer (either individually or collectively with other

state or local government employers that provide pensions through the pension plan.)

GASB Statement No. 76, The Hierarchy of Generally Accepted Accounting Principles for State and Local

Governments. In June 2015, the GASB reduced its hierarchy with the issuance of Statement No. 76 to two

categories of authoritative GAAP. Category A consists of, GASB Statements, officially established accounting

principles. Category B is created to included GASB Technical Bulletins, GASB Implementation Guides, and AICPA

Literature cleared by the GASB. The distinction between these two categories of GAAP is simple as it is based on

the level of Board member involvement in their creation. All GASB Statements (Category A) must be approved for

issuance by a majority of the GASB members. All the guidance in Category B may be issued if a majority of the

Board members does not object to its issuance.

GASB Statement No. 77, Tax Abatement Disclosures. Statement No. 77 requires governments that enter into tax

abatement agreements to disclose the following information about the agreement:

• Brief descriptive information, such as the tax being abated, the authority under which tax abatements are

provided, eligibility criteria, the mechanism by which taxes are abated, provisions for recapturing abated

taxes, and the types of commitments made ty tax abatement recipients;

• The gross dollar amount of taxes abated during the period, and

• Commitments made by a government, other than to abate taxes, as part of a tax abatement agreement.

Governments should organize those disclosures by major tax abatement program and may disclose information

for individual tax abatement agreements within those programs. Governments may disclose information for

individual tax abatement agreements of other governments within the specific tax being abated. For those tax

abatement agreements, a reporting government should disclose:

• The names of the governments that entered into the agreements;

• The specific taxes being abated, and

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• The gross dollar amount of taxes abated during the period.

GASB Statement No. 72, Fair Value Measurement and Application. Statement No. 72 requires state and local

governments to measure investments at fair value using a consistent definition and valuation techniques and

expands fair value disclosures. Specifically, to determine a fair value measurement, a government should consider

the unit of account of the asset or liability. The unit of account refers to the level at which an asset or a liability is

aggregated or disaggregated for measurement, recognition, or disclosure purposes as provide by the accounting

standards. For example, the unit of account for investment held in a brokerage account is each individual security,

whereas the unit of account for an investment in a mutual fund is each share in the mutual fund held by a

government. Statement No. 72 also requires a government to use valuation techniques that are appropriate

under the circumstances and for which sufficient data are available to measure fair value. The techniques should

be consistent with one or more of the following approaches:

Approach Description

Market Use prices and other relevant information generated by market transactions

involving identical or comparable assets, liabilities, or a group of assets and liabilities.

Cost Reflect the amount that would be required to replace the present service capacity of

an asset.

Income Covert future amounts (such as cash flows or income and expenses) to a single

current (discounted) amount.

Accounting for Termination Benefits

Finally, termination benefits are sometimes offered by governmental entities when an employee is involuntarily

terminated (i.e., fired or laid off) or voluntarily terminates in order to accept early-retirement benefits. These

termination benefits may include health care–related programs, job transition costs, early retirement incentives,

and other similar types of items. The accounting and reporting requirements for these benefits are presented in

GASB Statement No. 47, Accounting for Termination Benefits (GASB 47). In the case of employees who voluntarily

terminate, the employer recognizes a liability and expense when the employee accepts the offer and the amount

can be estimated. The general measurement principle is that the dollar amount recognized should be the

discounted present value of the estimated future payments.

Governmental entities may develop a plan for a reduction in their workforce that involves the involuntary

termination of some employees. A liability and an expense should be recognized when the plan of termination is

approved by the governing body, the plan has been communicated to the employees, and the amount can be

estimated. For the government-wide financial statements, the accrual method is used to recognize the discounted

present value of the estimated future payments.

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Governmental entities have found that they must offer employees benefits similar to those offered in the private

sector in order to attract and employ persons who would otherwise seek employment with business firms in the

private sector. Thus, as the private sector changes what it offers employees, governmental entities will have to

adjust what they offer to their employees.

Short Quizzes

Indicate whether each of the following statements is true or false.

1. The governmental funds use the accrual basis of accounting; the other funds use the modified accrual

basis of accounting.

2. The fiduciary funds must be included in the two government-wide financial statements.

3. Government entities must include required supplementary information (RSI) in their annual financial

reports.

Answers

1. False. The governmental funds use the modified accrual basis of accounting; the other funds use the

accrual basis of accounting.

2. False. The fiduciary funds (e.g., private-purpose trust funds and agency funds) are not included in the two

government-wide financial statements because fiduciary funds are not available to support government

programs.

3. True. Government entities must include RSI in their annual financial reports as specified by GASB 34. This

RSI includes reconciliation schedules and a budgetary comparison schedule. GASB 54 specifies changes

for fund balance reporting in the governmental fund types.

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Chapter Summary

This chapter covered accounting and financial reporting principles used by local and state governments.

Governments may use five governmental fund types, two proprietary fund types, and four fiduciary fund types.

The governmental funds use the modified accrual basis of accounting; the other funds use the accrual basis of

accounting.

The government reporting model is currently specified in GASB 34. Both fund-based financial statements and

government-wide financial statements are required. The government-wide statements are based on the accrual

basis and present both long-term capital assets, including infrastructure assets, and long-term debt. Government

entities must include required supplementary information (RSI) in their annual financial reports as specified by

GASB 34. This RSI includes reconciliation schedules and a budgetary comparison schedule. A new GASB

statement, GASB 54, specifies changes for fund balance reporting in the governmental fund types.

Exhibit 18 provides an overview of minimum elements for general-purpose financial reporting. Exhibit 19

summarizes measurement focus and basis of accounting for financial statements.

Exhibit 18

Minimum Elements for General-Purpose Financial Reporting

Exhibit 19

Measurement Focus and Basis of Accounting for Financial Statements

Financial Statements Measurement Focus Basis of Accounting

Government-Wide Financial Statements Economic Resources Accrual

Governmental Funds Financial Statements Current Financial Resources Modified Accrual

Proprietary Funds Financial Statements Economic Resources Accrual

Fiduciary Funds Financial Statements Economic Resources Accrual

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Chapter 2 Review Questions – Section 3

10. Government-wide financial statements ___________

A. Display individual funds.

B. Display aggregated information about fund types.

C. Exclude information about discretely presented component units.

D. Use separate columns to distinguish between governmental and business-type activities.

11. Which of the following statements is TRUE for budgetary comparison schedules?

A. They must be reported for the general fund and each major special revenue fund with a legally adopted

budget.

B. They must be presented instead of budgetary comparison statements included in the basic statements.

C. They must convert the appropriated budget information to the GAAP basis for comparison with actual

amounts reported on that basis.

D. They must compare only the final appropriated budget with actual amounts.

12. GASB 34, Basic Financial Statements and Management's Discussion and Analysis for State and Local

Governments, financial reporting by general-purpose governments, includes presentation of Management's

discussion and analysis (MD&A) as _________

A. Required supplementary information after the notes to the financial statements.

B. Part of the basic financial statements.

C. A description of currently known facts, decisions, or conditions expected to have significant effects on

financial activities.

D. Information that may be limited to highlighting the amounts and percentages of change from the prior to

the current year.

13. What is the correct approach to presentation of the notes to the financial statements?

A. The notes are essential for fair presentation of the statements.

B. The notes are required supplementary information (RSI)

C. The notes have the same status as MD&A.

D. The notes give equal focus to the primary government and its discretely presented component units.

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14. The focus of certain fund financial statements is on major funds. Accordingly, which of the following

statements is TRUE?

A. Major internal service funds must be presented separately in the statement of net position for proprietary

funds.

B. The main operating fund is always reported as a major fund.

C. Combining statements for nonmajor funds are required.

D. Enterprise funds not meeting the quantitative criteria are not eligible for presentation as major funds.

15. When is a government reported as a special-purpose government?

A. If it has governmental and business-type activities.

B. If it is engaged in two or more governmental programs.

C. If it is not a legally separate entity.

D. If it is engaged in one governmental program (such as cemetery districts or drainage districts).

16. What do fiduciary fund financial statements report?

A. Information by major fund

B. Three components of net position

C. A separate column for each fund type

D. No separate statements for individual pension plans

17. River City has a defined contribution pension plan. How should River report the pension plan in its financial

statements?

A. Amortize any transition asset over the estimated number of years of current employees' service.

B. Disclose in the notes to the financial statements the amount of the pension benefit obligation and the net

position available for benefits.

C. Disclose in the notes to the financial statements the classes of employees covered and the employer's and

employees' obligations to contribute to the fund.

D. Accrue a liability for benefits earned but not paid to fund participants.

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Appendix: Four Major Issues of the

Government Reporting Model

Issue 1: What Organizations Comprise the Reporting Entity?

The first issue to address is the determination of the reporting entity for which the statements will be provided.

The primary government is part of the reporting entity, but this issue concerns what other boards, commissions,

agencies, or authorities should be included with the reporting entity. GASB 34 defines the reporting entity as (a)

the primary government, such as a city, county, or state; (b) a component unit for which the primary government

is financially accountable; and (c) any organization that has a significant relationship with the primary government

and should be included to avoid misleading or incomplete financial statements.

Issue 2: What Constitutes Financial Accountability?

The financial reporting entity is defined as the primary government, organizations for which the primary

government is financially accountable, and other organizations with a relationship with the primary government

such that exclusion would cause the reporting entity's basic financial statements to be misleading or incomplete.

This definition is based on financial accountability. Financial accountability is the basic criterion used to

determine the reporting entity for a governmental unit.

GASB Statement No. 14, The Financial Reporting Entity (GASB 14), states that financial accountability of the

primary government for the component organization is evidenced by either board appointment or fiscal

dependence. Financial accountability is evidenced when the primary government appoints a majority of the

organization's governing board. Thus, the primary government has effective control over the organization, which

in turn may provide specific benefits to, or may impose specific financial burdens on, the primary government.

Financial accountability also may exist if the organization has a separately elected or appointed board but fiscally

depends on the primary government for the financial resources required to operate.

The primary government's ability to impose its will on an organization is evidenced by such things as its ability to

(1) remove appointed members of the organization's governing board, (2) approve or modify the organization's

budget or approve rates or fee changes, (3) veto or overrule the decisions of the organization's governing body,

or (4) appoint, hire, reassign, or dismiss those persons responsible for the organization's day-to-day operations.

The potential for an organization to impose specific burdens on the primary government is evidenced by such

things as the primary government's legal obligation or its assumption of the obligation to finance the deficits, or

otherwise provide financial support to, the organization, or the primary government's obligation in some manner

for the debt of the organization. These criteria indicate that when the primary governmental unit is financially

accountable for legally separate organizations, those organizations should be included in the primary

government's financial statements as component units.

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Issue 3: What Other Organizations Should Be Included in the Reporting Entity?

GASB 14 specifies a third category of organizations to be evaluated to determine if they are part of the reporting

entity with the primary government. These are legally separate, tax-exempt entities for which the primary

government is not financially accountable. GASB Statement No. 39, Determining Whether Certain Organizations

Are Component Units (GASB 39), amended parts of GASB 14 to more fully define what other organizations should

be included in a government's reporting entity. In general, a legally separate, tax-exempt organization is reported

as a component unit of the primary government if all three of the following characteristics are met:

1. The resources of the separate organization are held for the benefit of the primary government, its

component units, or the persons served by the primary government or its component units.

2. The primary government, or its component units, is entitled to, or can use, a majority of the economic

resources of the separate organization.

3. The economic resources of the separate organization that the primary government, or its component

units, can use are significant to the primary government.

Examples of other organizations that should be included in the reporting entity include university foundations and

university alumni associations.

The GASB issued Statement No. 61, The Financial Reporting Entity: Omnibus, an amendment of Statement No.

14 and No. 34. Having the following main focuses:

• Modifying the requirements for inclusion of component units;

• Amending the criteria for blending component units, and

• Clarifying the reporting of equity interests in legally separate organizations.

Prior to issuance of Statement No. 61, a legally-separate organization's fiscal dependency on the primary

government would have required its inclusion as a component unit in the financial reporting entity’s financial

statements. Under Statement No. 61, fiscal dependency alone no longer requires inclusion of a potential

component unit. Instead, to justify inclusion, a financial benefit or burden relationship must also exist between

the potential component unit and the primary government. Statement No. 61 also expands Statement No. 14

blending criterion of having "substantively the same governing body," to also include an assessment as to whether

either (1) a financial benefit or burden relationship exists between the primary government and the component

unit; or (2) management of the primary government (i.e., the person(s) below the level of the governing board

responsible for the day-to-day operations of the of the primary government) has operational responsibility for the

component unit. This Statement requires a primary government to report its equity interest in a component unit

as an asset.

In January 2016, GASB issued Statement No. 80, Blending Requirements for Certain Component Units – an

Amendment of GASB Statement No. 14, requiring state or local governments to use the blending method when

presenting in their financial statements component units organized as not-for-profit (NFP) corporations in which

the primary government is the sole corporate member. The primary government will present activities of an

acquired or created, legally separate NFP corporation similar to a department or activity of the primary

government. Statement No. 80 amends the blending requirements of all state and local governments but is most

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applicable to those engaged in both governmental and business-type activities or only business-type activities,

e.g., public hospitals and institutions of higher education. The Statement does NOT amend existing disclosure

requirements.

Because the statement addresses diversity in practice—and because governments should have sufficient

information regarding their legally separate entities—GASB encourages early application. Governmental entities

would apply the provisions retroactively by restating financial statements, if practical, for all prior periods

presented.

Issue 4: How Should the Financial Results of the Component Units Be Reported?

The fourth issue is how to report the financial results of component units. A choice between two methods must

be made: (1) discrete presentation in a separate column of the primary government's financial statements or (2)

blended presentation by combining the organization's results into the primary government's financial results.

Most component units are discretely presented; however, the blending method should be used when the

component unit is so intertwined with the primary government that, in essence, they are the same governmental

unit. Blending should be used when either (1) the component unit's governing body is substantively the same as

the primary government's governing body or (2) the component unit provides services entirely, or almost entirely,

to the primary government or almost exclusively benefits the primary government. Some of these organizations

are similar to the internal services fund. Component units may use governmental fund accounting or proprietary

fund accounting, depending on their types of activities. Neither discretely presenting nor blending should change

the measurement basis of the type of accounting used by the component unit; however, a general fund of a

blended component unit should be reported as a special revenue fund for the primary government.

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Glossary

Abatement: a complete or partial cancellation of a levy imposed by a governmental unit. Abatements usually

apply to tax levies, special assessments, and service charges.

Account group: a self-balancing set of accounts, but not a fiscal entity; therefore not a fund. One of the awkward

aspects of the old reporting regime was the use of account groups, so called because they did not exactly qualify

as funds. They were simply areas where long-lived assets and long-term debt were parked in the absence of a

conceptually sound place to put them in statements focused on current resources.

Accounting system: the total structure of records and procedures which discover, record, classify, and report

information on the financial position and operations of a governmental unit or any of its funds and organizational

components.

Accounts receivable: amounts owing on open account from private persons, firms, or corporations for goods and

services furnished by a governmental unit (but not including amounts due from other funds of the same

governmental unit).

Accrual basis: the basis of accounting under which revenues are recorded when earned and expenditures are

recorded as soon as they result in liabilities for benefits received, notwithstanding that the receipt of cash or the

payment of cash may take place, in whole or in part, in another accounting period. See also Accrue and Levy.

Accrue: to record revenues when earned and to record expenditures as soon as they result in liabilities for benefits

received, notwithstanding that the receipt of cash or payment of cash may take place, in whole or in part, in

another accounting period. See also Accrual basis, Accrued expenses, and Accrued revenue.

Accrued expenses: expenses incurred during the current accounting period but which are not payable until a

subsequent accounting period. See also Accrual basis and Accrue.

Accrued income: see Accrued revenue.

Accrued interest on investments purchased: interest accrued on investments between the last interest payment

date and the date of purchase.

Accrued interest payable: a liability account which represents the amount of interest expense accrued at the

balance sheet date but which is not due until a later date.

Accrued revenue: revenue earned during the current accounting period but which is not to be collected until a

subsequent accounting period. See also Accrual basis and Accrue.

Acquisition adjustment: premium paid for a utility plant, over and above original cost less depreciation. Similar

to goodwill in nonmonopolistic enterprises.

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Activity: a specific and distinguishable line of work performed by one or more organizational components of a

governmental unit for the purpose of accomplishing a function for which the governmental unit is responsible.

For example, "food inspection" is an activity performed in the discharge of the "health" function. See also

Function, Subfunction, and Subactivity.

Activity classification: a grouping of expenditures on the basis of specific lines of work performed by organization

units. For example, sewage treatment and disposal, garbage collection, garbage disposal, and street cleaning are

activities performed in carrying out the function of sanitation, and segregation of the expenditures made for each

of these activities constitutes an activity classification.

Actuarial basis: a basis used in computing the amount of contributions to be made periodically to a fund so that

the total contributions plus the compounded earnings thereon will equal the required payments to be made out

of the fund. The factors taken into account in arriving at the amount of these contributions include the length of

time over which each contribution is to be held and the rate of return compounded on such contribution over its

life. A trust fund for a public employee retirement system is an example of a fund set up on an actuarial basis.

Ad valorem: in proportion to value. A basis for levy of taxes upon property.

Advance refunding: the issuance of debt instruments to refund existing debt before the existing debt matures or

is callable.

Agency fund: a fund consisting of resources received and held by the governmental unit as an agent for others;

for example, taxes collected and held by a municipality for a school district. Note. Sometimes resources held by

one fund of a governmental unit for other funds of the unit are handled through an agency fund. An example

would be taxes held by an agency fund for redistribution among other funds: See also Allocation.

Allocate: to divide a lump-sum appropriation into parts which are designated for expenditure by specific

organization units and/or for specific purposes, activities, or objects. See also Allocation.

Allocation: a part of a lump-sum appropriation which is designated for expenditure by specific organization units

and/or for special purposes, activities, or objects. In federal usage, a transfer of obligational authority from one

agency to another. See also Allocate.

Allot: to divide an appropriation into amounts which may be encumbered or expended during an allotment

period. See also Allotment and Allotment period.

Allotment: a part of an appropriation (or, in federal usage, parts of an apportionment) which may be encumbered

(obligated) or expended during an allotment period. See also Allot and Allotment period.

Allotment period: a period of time less than one fiscal year in length during which an allotment is effective.

Bimonthly and quarterly allotment periods are most common. See also Allot and Allotment.

Allowance for amortization: the account in which are accumulated the amounts recorded as amortization of the

intangible asset to which the allowance relates.

Allowance for depreciation: the account in which are accumulated the amounts of cost of the related asset which

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have been charged to expense.

Amortization: (1) gradual reduction, redemption, or liquidation of the balance of an account according to a

specified schedule of times and amounts. (2) Provision for the extinguishment of a debt by means of a Debt Service

Fund.

Annuities payable: a liability account which records the amount of annuities due and payable to retired employees

in a public employee retirement system.

Annuity: a series of equal money payments made at equal intervals during a designated period of time. In

governmental accounting the most frequent annuities are accumulations of debt service funds for term bonds

and payments to retired employees under public employee retirement systems.

Annuity, amount of: the total amount of money accumulated or paid during an annuity period from an annuity

and compound interest at a designated rate.

Annuity funds: funds established to account for assets given to an organization subject to an agreement which

binds the organization to pay stipulated amounts periodically to the donor(s).

Annuity period: the designated length of time during which an amount of annuity is accumulated or paid.

Appropriation: an authorization granted by a legislative body to incur liabilities for purposes specified in the

appropriation act.

Appropriation act, bill, ordinance, resolution or order: a legal action giving the administration of a governmental

unit authorization to incur on behalf of the unit liabilities for the acquisition of goods, services, or facilities to be

used for purposes specified in the act, ordinance, etc., in amounts not to exceed those specified for each purpose.

The authorization usually expires at the end of a specified term, most often one year.

Appropriation budget: appropriations requested by departments or by the central administration of a

governmental unit for a budget period. When the appropriation budget has been adopted in accord with

procedures specified by relevant law the budget becomes legally binding upon the administration of the

governmental unit for which the budget has been adopted.

Appropriation expenditures: see Expenditures.

Appropriation expenditure ledger: see Appropriation ledger.

Appropriation ledger: a subsidiary ledger containing an account for each appropriation. Each account usually

shows the amount originally appropriated, transfers to or from the appropriation, amounts charged against the

appropriation, the net balance, and other related information. If allotments are made and a separate ledger is

maintained for them, each account in the appropriation ledger usually shows the amount appropriated, transfers

to or from the appropriation, the amount allotted, and the unallotted balance.

Assess: to value property officially for the purpose of taxation. Note. The term is also sometimes used to denote

the levy of taxes, but such usage is not correct because it fails to distinguish between the valuation process and

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the tax levy process.

Assessed valuation: a valuation set upon real estate or other property by a government as a basis for levying

taxes.

Assessment: (1) the process of making the official valuation of property for purposes of taxation. (2) The valuation

placed upon property as a result of this process.

Assessment roll or ledger: in the case of property subject to ad valorem taxes, the official list containing the legal

description of each parcel of property, its assessed valuation, and name and address of owner. Additionally, in the

case of property in special assessment districts, identification of the district, total amount of assessment, amount

and due date of each installment, interest charges on each installment, and record of collection of all charges.

Assets: financial representations of economic resources owned by an organization or individual.

Audit: the examination of documents, records, reports, systems of internal control, accounting and financial

procedures, and other evidence for one or more of the following purposes:

1. To ascertain whether the statements prepared from the accounts present fairly the financial position and

the results of financial operations of the constituent funds with generally accepted accounting (GAAP)

principles and on a basis consistent with that of the preceding year.

2. To determine the compliance with applicable laws and regulations of a governmental unit's financial

transactions.

3. To review the efficiency and economy with which operations were carried out.

4. To review effectiveness in achieving program results.

Auditor's opinion: a statement signed by an auditor in which he states that he has examined the financial

statements in accordance with generally accepted auditing standards (with exceptions, if any) and in which he

expresses his opinion on the financial condition and results of operations of some or all of the constituent funds

of the governmental unit, as appropriate.

Authority: a governmental unit or public agency created to perform a single function or a restricted group of

related activities. Usually such units are financed from service charges, fees, and tolls, but in some instances they

also have taxing powers. An authority may be completely independent of other governmental units, or in some

cases it may be partially dependent upon other governments for its creation, its financing, or the exercise of

certain powers.

Authority bonds: bonds payable from the revenues of a specific authority. Since such authorities usually have no

revenue other than charges for services, their bonds are ordinarily revenue bonds.

Auxiliary enterprises: activities of a college or university which furnish a service to students, faculty, or staff on a

user-charge basis. The charge is directly related to, but not necessarily equal to, the cost of the service. Examples

include college unions, residence halls, stores, faculty clubs, and intercollegiate athletics.

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Balance sheet: a statement which discloses the assets, liabilities, reserves, and equities of a fund or governmental

unit at a specified date, properly classified to exhibit financial position of the fund or unit at that date.

Board: designated funds-funds created to account for assets set aside by the governing board of an organization

for specified purposes.

Bond: a written promise to pay a specified sum of money, called the face value or principal amount, at a specified

date or dates in the future, called the maturity date(s), together with periodic interest at a specified rate. Note:

The difference between a note and a bond is that the latter runs for a longer period of time and requires greater

legal formality.

Bond anticipation notes: short-term interest-bearing notes issued by a governmental unit in anticipation of bonds

to be issued at a later date. The notes are retired from proceeds of the bond issue to which they are related.

Budgetary accounts: those accounts which reflect budgetary operations and condition, such as estimated

revenues, appropriations, and encumbrances, as distinguished from proprietary accounts. See also Proprietary

accounts.

Capital projects fund: a fund created for all resources used for the construction or acquisition of designated fixed

assets by a governmental unit except those financed by special assessment, proprietary, or fiduciary funds.

Cash basis: the basis of accounting under which revenues are recorded when received in cash and expenditures

are recorded when cash is disbursed.

Character: a basis for distinguishing expenditures according to the periods they are presumed to benefit. See also

Character classification.

Character classification: a grouping of expenditures on the basis of the fiscal periods they are presumed to benefit.

The three groupings are: (1) current expenditures, presumed to benefit the current fiscal period; (2) debt service,

presumed to benefit prior fiscal periods primarily but also present and future periods; and (3) capital outlays,

presumed to benefit the current and future fiscal periods. See also Activity, Activity classification, Function,

Functional classification, Object, Object classification, and Expenses.

Commitments: see Encumbrances, also Obligations.

Control account: an account in the general ledger in which are recorded the aggregate of debit and credit postings

to a number of identical or related accounts called subsidiary accounts. For example, the taxes receivable account

is a control account supported by the aggregate of individual balances in individual property taxpayers' accounts.

See also General ledger and Subsidiary account.

Debt limit: the maximum amount of gross or net debt which is legally permitted.

Debt margin: the difference between the amount of the debt limit and the net amount of outstanding

indebtedness subject to the limitation.

Debt service fund: a fund established to finance and account for the payment of interest and principal on all

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general obligation debt, serial and term, other than that payable exclusively from special assessments, revenues

of proprietary funds, or revenues of fiduciary funds. Formerly called a Sinking fund.

Deficit: (1) the excess of liabilities and reserved equity of a fund over its assets; (2) The excess of expenditures

over revenues during an accounting period; or, in the case of Enterprise and Internal Service Funds, the excess of

expense over income during an accounting period.

Delinquent taxes: taxes remaining unpaid on and after the date on which a penalty for nonpayment is attached.

Even though the penalty may be subsequently waived and a portion of the taxes may be abated or canceled, the

unpaid balances continue to be delinquent taxes until abated, canceled, paid, or converted into tax liens.

Direct debt: the debt which a governmental unit has incurred in its own name or assumed through the annexation

of territory or consolidation with another governmental unit. See also Overlapping debt.

Disbursements: payments in cash.

Donated assets: noncash contributions. Donated assets may be in the form of securities, land, buildings, or

equipment, or materials.

Donated materials: see Donated assets.

Donated services: the services of volunteer workers who are unpaid, or who are paid less than the market value

of their services.

Encumbrances: contingent liabilities in the form of purchase orders, contracts, or salary commitments which are

chargeable to an appropriation and for which a part of the appropriation is reserved. They cease to be

encumbrances when paid or when the actual liability is recorded.

Endowment fund: a fund whose principal must be maintained inviolate but whose income may be expended. An

endowment fund is accounted for as a trust fund.

Enterprise debt: debt which is to be retired primarily from the earnings of governmentally owned and operated

enterprises. See also Revenue bonds.

Enterprise fund: a fund established to finance and account for the acquisition, operation, and maintenance of

governmental facilities and services which are entirely or predominantly self-supporting by user charges; or where

the governing body of the governmental unit has decided that periodic determination of revenues earned,

expenses incurred, and/or net income is appropriate. Government-owned utilities and hospitals are ordinarily

accounted for by enterprise funds.

Entitlement: the amount of payment to which a state or local government is entitled as determined by the federal

government pursuant to an allocation formula contained in applicable statutes.

Entry: (1) the record of a financial transaction in its appropriate book of account. (2) The act of recording a

transaction in the books of account.

Estimated revenue: for revenue accounts kept on an accrual basis this term designates the amount of revenue

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estimated to accrue during a given period regardless of whether or not it is all to be collected during the period.

For revenue accounts kept on a cash basis the term designates the amount of revenue estimated to be collected

during a given period. Under the modified accrual basis estimated revenues include both cash and accrual basis

revenues. See also Revenue, Cash basis, Accrual basis, and Modified accrual basis.

Expendable fund: a fund whose resources, including both principal and earnings, may be expended. See also

Nonexpendable trust fund.

Expenditures: expenditures are recorded when liabilities are incurred pursuant to authority given in an

appropriation. If the accounts are kept on the accrual basis or the modified accrual basis, this term designates the

cost of goods delivered or services rendered, whether paid or unpaid, including expenses, provision for debt

retirement not reported as a liability of the fund from which retired, and capital outlays. Where the accounts are

kept on the cash basis, the term designates only actual cash disbursements for these purposes. Note:

Encumbrances are not expenditures.

Expenses: charges incurred, whether paid or unpaid, for operation, maintenance, interest, and other charges

which are presumed to benefit the current fiscal period.

Fidelity bond: a written promise to indemnify against losses from theft, defalcation, and misappropriation of

public funds by government officers and employees. See also Surety bond.

Fiduciary funds: any fund held by a governmental unit in a fiduciary capacity, ordinarily as agent or trustee. Also

called Trust and agency funds.

Fiscal agent: a bank or other corporate fiduciary which performs the function of paying, on behalf of the

governmental unit, or other debtor, interest on debt or principal of debt when due.

Fiscal period: any period at the end of which a governmental unit determines its financial position and the results

of its operations.

Fiscal year: a 12-month period of time to which the annual budget applies and at the end of which a governmental

unit determines its financial position and the results of its operations.

Fixed assets: assets of a long-term character which are intended to continue to be held or used, such as land,

buildings, machinery, furniture, and other equipment. Note: The term does not indicate the immobility of an asset,

which is the distinctive character of "fixture."

Fixed charges: expenses, the amount of which is set by agreement. Examples are interest, insurance, and

contributions to pension funds.

Fixed liabilities: see Long-term debt.

Full faith and credit: a pledge of the general taxing power for the payment of debt obligations. Note: Bonds

carrying such pledges are usually referred to as general obligation bonds, full faith and credit bonds, or tax-

supported bonds.

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Function: a group of related activities aimed at accomplishing a major service or regulatory responsibility for which

a governmental unit is responsible. For example, public health is a function. See also Subfunction, Activity,

Character, and Object.

Functional classification: a grouping of expenditures on the basis of the principal purposes for which they are

made. Examples are public safety, public health, public welfare, etc. See also Activity, Character, and Object

classification.

Fund: a fiscal and accounting entity with a self balancing set of accounts recording cash and other financial

resources, together with all related liabilities, and residual equities or balances, and changes therein, which are

segregated for the purpose of carrying on specific activities or attaining certain objectives in accordance with

special regulations, restrictions, or limitations.

Fund accounts: all accounts necessary to set forth the financial operations and financial position of a fund.

Fund balance: the excess of the assets of a fund over its liabilities and reserves except in the case of funds subject

to budgetary accounting where, prior to the end of a fiscal period, it represents the excess of the fund's assets

and estimated revenues for the period over its liabilities, reserves, and available appropriations for the period.

Fund balance sheet: a balance sheet for a single fund. See Fund and Balance sheet.

Funded debt: same as Bonded debt, which is the preferred term.

Funded deficit: a deficit eliminated through the sale of bonds issued for that purpose. See also Funding bonds.

Fund type: a group of funds which are similar in purpose and character. For example, several special revenue

funds constitute a fund type. See also Related funds.

Funding: the conversion of floating debt or time warrants into bonded debt.

Funding bonds: bonds issued to retire outstanding floating debt and to eliminate deficits.

General fund: a fund used to account for all transactions of a governmental unit which are not accounted for in

another fund. Note: The general fund is used to account for the ordinary operations of a governmental unit which

are financed from taxes and other general revenues.

General journal: a journal in which are entered all entries not recorded in special journals.

General ledger: a book, file, or other device which contains the accounts needed to reflect, in summary and in

detail, the financial position and the results of financial operations of the governmental unit. Note: In double entry

bookkeeping, the debits and credits in the general ledger are equal, and therefore the debit balances equal the

credit balances. See also Control account, Subsidiary account, and Subsidiary ledger.

General obligation bonds: bonds for whose payment the full faith and credit of the issuing body are pledged.

More commonly, but not necessarily, general obligation bonds are considered to be those payable from taxes and

other general revenues. In some states these bonds are called tax supported bonds. See also Full faith and credit.

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General obligation special assessment bonds: see Special assessment bonds.

General revenue: the revenues of a governmental unit other than those derived from and retained in an

enterprise. Note: If a portion of the net income in an enterprise fund is contributed to another nonenterprise fund,

such as the general fund, the amounts transferred constitute general revenue of the governmental unit.

Governmental funds: a generic classification adopted by the National Council on Governmental Accounting to

refer to all funds other than proprietary and fiduciary funds. The general fund, special revenue funds, capital

projects funds, and debt service funds are the types of funds referred to as "governmental funds."

Grant: a contribution by one governmental unit to another unit. The contribution is usually made to aid in the

support of a specified function (for example, education), but it is sometimes also for general purposes.

Grants-in-aid: see Grant.

Gross bonded debt: the total amount of direct debt of a governmental unit represented by outstanding bonds

before deduction of any assets available and earmarked for their retirement. See also Direct debt.

Gross revenue: see Revenue.

Historical cost: the amount paid, or liability incurred, by an accounting entity to acquire an asset and make it ready

to render the services for which it was acquired.

Industrial aid bonds: bonds issued by governmental units, the proceeds of which are used to construct plant

facilities for private industrial concerns. Lease payments made by the industrial concern to the governmental unit

are used to service the bonds. Such bonds may be in the form of general obligation bonds or revenue bonds.

Interest and penalties receivable on taxes: the uncollected portion of interest and penalties receivable on taxes.

Interest receivable on investments: the amount of interest receivable on investments, exclusive of interest

purchased. Interest purchased should be shown in a separate account.

Interest receivable-special assessments: the amount of interest receivable on unpaid installments of special

assessments.

Interfund accounts: accounts in which transactions between funds are reflected. See Interfund transfers.

Interfund loans: loans made by one fund to another.

Interfund transfers: amounts transferred from one fund to another.

Intergovernmental revenue: revenue from other governments. Grants, shared revenues, and entitlements are

types of intergovernmental revenue.

Interim borrowing: (1) short-term loans to be repaid from general revenues during the course of a fiscal year. (2)

Short-term loans in anticipation of tax collections or bonds issuance. See Bond anticipation notes, Tax anticipation

notes, and Revenue anticipation notes.

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Interim statement: a financial statement prepared before the end of the current fiscal year and covering only

financial transactions during the current year to date. See also Statements.

Internal service fund: a fund established to finance and account for services and commodities furnished by a

designated department or agency to other departments and agencies within a single governmental unit, or to

other governmental units. Amounts expended by the fund are restored thereto either from operating earnings or

by transfers from other funds, so that the original fund capital is kept intact. Formerly called a working capital

fund, or intragovernmental service fund.

Intragovernmental service fund: see Internal service fund.

Investment in general fixed assets: an account in the general fixed assets group of accounts which represents the

governmental unit's equity in general fixed assets. The balance of this account is subdivided according to the

source of funds which financed the asset acquisition, such as general fund revenues, special assessments, etc.

Investments: securities and real estate held for the production of income in the form of interest, dividends,

rentals, or lease payments. The term does not include fixed assets used in governmental operations.

Judgment: an amount to be paid or collected by a governmental unit as the result of a court decision, including a

condemnation award in payment for private property taken for public use.

Judgment bonds: bonds issued to pay judgments. See also Funding.

Judgments payable: amounts due to be paid by a governmental unit as the result of court decisions, including

condemnation awards in payment for private property taken for public use.

Lapse: (verb) as applied to appropriations, this term denotes the automatic termination of an appropriation. Note:

Except for indeterminate appropriations and continuing appropriations, an appropriation is made for a certain

period of time. At the end of this period, any unexpended and unencumbered balance thereof lapses, unless

otherwise provided by law.

Leasehold: the right to the use of real estate by virtue of a lease, usually for a specified term of years, for which a

consideration is paid.

Levy: (verb) to impose taxes, special assessments, or service charges for the support of governmental activities.

(Noun) the total amount of taxes, special assessments, or services charges imposed by a governmental unit.

Liabilities: debt or other legal obligations arising out of transactions in the past which must be liquidated,

renewed, or refunded at some future date. Note: The term does not include encumbrances.

Life income funds: funds, ordinarily of colleges and universities, established to account for assets given to the

organization subject to an agreement to pay to the donor or designee the income earned by the assets over a

specified period of time.

Line item budget: a detailed expense or expenditure budget, generally classified by object within each

organizational unit, and, often, classified within each object as to authorized number of employees at each salary

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level within each job classification, etc.

Loan fund: a fund whose principal and/or interest is loaned to individuals in accordance with the legal

requirements and agreements setting up the fund. Such a fund is accounted for as a trust fund. See also Trust

fund.

Long-term debt: debt with a maturity of more than one year after the date of issuance.

Matured bonds payable: bonds which have reached or passed their maturity date but which remain unpaid.

Matured interest payable: interest on bonds which has reached the maturity date but which remains unpaid.

Modified accrual basis: under the modified accrual basis of accounting, recommended for use by governmental

funds, revenues are recognized in the period in which they become available and measurable, and expenditures

are recognized at the time a liability is incurred pursuant to appropriation authority.

Municipal: in its broadest sense, an adjective which denotes the state and all subordinate units of government. In

a more restricted sense, an adjective which denotes a city or town as opposed to other units of local government.

Municipal bond: a bond issued by a state or local governmental unit.

Municipal corporation: a body politic and corporate established pursuant to state authorization for the purpose

of providing governmental services and regulations for its inhabitants. A municipal corporation has defined

boundaries and a population, and is usually organized with the consent of its residents. It usually has a seal and

may sue and be sued. Cities and towns are examples of municipal corporations.

Net bonded debt: gross bonded debt less any cash or other assets available and earmarked for its retirement.

Net income: a term used in accounting for governmental enterprises to designate the excess of total revenues

over total expenses for an accounting period. See also Operating revenue and Operating expenses.

Nonexpendable trust fund: a fund the principal, and sometimes also the earnings, of which may not be expended.

See also Endowment fund.

Object: as used in expenditure classification, this term applies to the article purchased or the service obtained (as

distinguished from the results obtained from expenditures). Examples are personal services, contractual services,

materials, and supplies. See also Activity, Character, Function, and Object classification.

Object classification: a grouping of expenditures on the basis of goods or services purchased; for example,

personal services, materials, supplies, and equipment. See also Functional, Activity, and Character classifications.

Objects of expenditure: see Object.

Obligations: generally amounts which a governmental unit may be required legally to meet out of its resources.

They include not only actual liabilities, but also unliquidated encumbrances.

Operating expenses: (1) as used in the accounts of governmental enterprises, the term means those costs which

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are necessary to the maintenance of the enterprise, the rendering of services, the sale of merchandise, the

production and disposition of commodities produced, and the collection of enterprise revenues. (2) The term is

also sometimes used to describe expenses for general governmental purposes.

Operating fund: the title of the fund used to account for all assets, and related liabilities used in the routine

activities of a hospital. Also sometimes used by governmental units as synonym for General fund.

Operating income: income of a governmental enterprise which is derived from the sale of its goods and/or

services. For example, income from the sale of water by a municipal water utility is operating income. See also

Operating revenues.

Operating revenues: revenues derived from the operation of governmental enterprises of a business character.

Operating statement: a statement summarizing the financial operations of a governmental unit for an accounting

period as contrasted with a balance sheet which shows financial position at a given moment in time.

Order: a formal legislative enactment by the governing body of certain local governmental units which has the full

force and effect of law. For example, county governing bodies in some states pass "orders" rather than laws or

ordinances.

Ordinance: a formal legislative enactment by the council or governing body of a municipality. If it is not in conflict

with any higher form of law, such as a state statute or constitutional provision, it has the full force and effect of

law within the boundaries of the municipality to which it applies. Note: The difference between an ordinance and

a resolution is that the latter requires less legal formality and has a lower legal status. Ordinarily, the statutes or

charter will specify or imply those legislative actions which must be by ordinance and those which may be by

resolution. Revenue-raising measures, such as the imposition of taxes, special assessments, and service charges,

universally require ordinances.

Original cost: the total of assets given and/or liabilities assumed to acquire an asset. In utility accounting, the

original cost is the cost to the first owner who dedicated the plant to service of the public.

Outlays: sometimes synonymous with disbursements.

Overdraft: (1) the amount by which checks, drafts, or other demands for payment on the treasury or on a bank

exceed the amount of the credit against which they are drawn. (2) The amount by which requisitions, purchase

orders, or audited vouchers exceed the appropriation or other credit to which they are chargeable.

Overhead: those elements of cost necessary in the production of an article or the performance of a service which

are of such a nature that the amount applicable to the product or service cannot be determined accurately or

readily. Usually they relate to those objects of expenditures which do not become an integral part of the finished

product or service, such as rent, heat, light, supplies, management, supervision, etc.

Overlapping debt: the proportionate share of the debts of local governmental units located wholly or in part

within the limits of the reporting government which must be borne by property within each governmental unit.

Pay-as-you-go basis: a term used to describe the financial policy of a governmental unit which finances all of its

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capital outlays from current revenues rather than by borrowing. A governmental unit which pays for some

improvements from current revenues and others by borrowing is said to be on a partial or modified pay-as-you-

go basis.

Plant acquisition adjustment: see Acquisition adjustment.

Proprietary fund: sometimes referred to as "income determination," or "commercial-type," funds of a state or

local governmental unit. Examples are enterprise funds and internal service funds.

Rate base: the value of utility property used in computing an authorized rate of return as authorized by law or a

regulatory commission.

Realize: to convert goods or services into cash or receivables. Also to exchange for property which is a current

asset or can be converted immediately into a current asset. Sometimes applied to conversion of noncash assets

into cash.

Rebates: abatements or refunds.

Receipts: this term, unless otherwise qualified, means cash received.

Recoverable expenditure: an expenditure made for or on behalf of another governmental unit, fund, or

department, or for a private individual, firm, or corporation, which will subsequently be recovered in cash or its

equivalent.

Refund: (noun) an amount paid back or credit allowed because of an overcollection or on account of the return

of an object sold. (Verb) To pay back or allow credit for an amount because of an overcollection or because of the

return of an object sold. (Verb) To provide for the payment of a loan through cash or credit secured by a new loan.

Refunding bonds: bonds issued to retire bonds already outstanding. The refunding bonds may be sold for cash

and outstanding bonds redeemed in cash, or the refunding bonds may be exchanged with holders of outstanding

bonds.

Reimbursement: cash or other assets received as a repayment of the cost of work or services performed or of

other expenditures made for or on behalf of another governmental unit or department or for an individual, firm,

or corporation.

Related funds: funds of a similar character which are brought together for administrative or reporting purposes;

for example. Trust and Agency Funds.

Reserve: an account which records a portion of the fund equity which must be segregated for some future use

and which is, therefore, not available for further appropriation or expenditure. See Reserve for inventory or

Reserve for encumbrances.

Reserve for advance to-fund: a reserve which represents the segregation of a portion of a fund equity to indicate

that assets equal to the amount of the reserve are invested in a long-term loan to another fund and are, therefore,

not available for appropriation.

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Reserve for depreciation: see Allowance for depreciation.

Reserve for employee contributions: a reserve in a Trust Fund for a public employee retirement system which

represents the amount of accumulated contributions made by employee members plus interest earnings credited

in accordance with applicable legal provisions.

Reserve for employer contributions: a reserve in a Trust Fund for a public employee retirement system which

represents the amount of accumulated contributions paid by the governmental unit as employer plus interest

earnings credited in accordance with applicable legal provisions.

Reserve for employer contributions-actuarial deficiency: a reserve in a Trust Fund for a public employee

retirement system which represents the amount of the actuarial deficiency in contributions made by a

governmental unit as employer.

Reserve for encumbrances: a reserve representing the segregation of fund equity in the amount of encumbrances

outstanding. See also Reserve.

Reserve for encumbrances-prior year-encumbrances: outstanding at the end of a fiscal year are designated as

pertaining to appropriations of a year prior to the current year in order that related expenditures may be matched

with the appropriation of the prior year rather than an appropriation of the current year.

Reserve for inventory: a reserve which represents the segregation of a portion of fund equity to indicate that

assets equal to the amount of the reserve are invested in inventories and are, therefore, not available for

appropriation.

Reserve for membership annuities: a reserve in a Trust Fund for a public employee retirement system which

represents the amount set aside for payment of annuities to retired members. In a joint contributory system this

reserve is established at the time of employee retirement by transfers from accumulations in the Reserve for

Employees' Contributions and the Reserve for Employer Contributions accounts.

Reserve for revenue bond contingency: a reserve in an Enterprise Fund which represents the segregation of a

portion of retained earnings equal to current assets that are restricted for meeting various contingencies, as may

be specified and defined in the revenue bond indenture. Reserve for revenue bond debt service-a reserve in an

Enterprise Fund which represents the segregation of a portion of retained earnings equal to current assets that

are restricted to current servicing of revenue bonds in accordance with the terms of a bond indenture.

Reserve for revenue bond retirement: a reserve in an Enterprise Fund which represents the segregation of a

portion of retained earnings equal to current assets that are restricted for future servicing of revenue bonds in

accordance with the terms of a bond indenture.

Reserve for uncollected taxes: a reserve representing the segregation of a portion of a fund equity equal to the

amount of taxes receivable by a fund, thus effectively placing the fund on the cash basis of revenue recognition.

Reserve for undistributed interest earnings: an unallocated reserve in a Trust Fund for a public employee

retirement system which represents interest earnings of the system that have not been distributed to other

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reserves such as the Reserve for Employees' Contributions and the Reserve for Employer Contributions.

Resolution: a special or temporary order of a legislative body; an order of a legislative body requiring less legal

formality than an ordinance or statute. See also Ordinance.

Resources: the contingent assets of a governmental unit, such as estimated revenues applying to the current fiscal

year, and bonds authorized but not yet issued.

Restricted assets: assets (usually of an Enterprise Fund) which may not be used for normal operating purposes

because of the requirements of regulatory authorities, provisions in bond indentures, or other legal agreements,

but which need not be accounted for in a separate fund.

Restricted fund: a fund established to account for assets the use of which is limited by the requirements of donors

or grantors. Hospitals may have three types of restricted funds: specific-purpose funds, endowment funds, and

plant replacement and expansion funds. The governing body or administration cannot restrict the use of assets,

they may only designate the use of assets. See Board designated funds.

Retained earnings: the accumulated earnings of an Enterprise or Internal Service Fund which have been retained

in the fund and which are not reserved for any specific purpose.

Retirement allowances: amounts paid to government employees who have retired from active service, or to their

survivors. See Annuity.

Retirement fund: a fund out of which retirement annuities and/or other benefits are paid to authorized and

designated public employees. A retirement fund is accounted for as a Trust Fund.

Revenue: for those revenues which are recorded on the accrual basis, this term designates additions to assets

which: (a) do not increase any liability; (b) do not represent the recovery of an expenditure; (c) do not represent

the cancellation of certain liabilities without a corresponding increase in other liabilities or a decrease in assets;

and (d) do not represent contributions of fund equity in Enterprise and Internal Service Funds. The same definition

applies to those cases where revenues are recorded on the modified accrual or cash basis, except that additions

would be partially or entirely to cash. See also Accrual basis, Modified accrual basis, Cash basis, and Receipts.

Revenue anticipation note: notes issued in anticipation of the collection of revenues, usually from specified

sources, and to be repaid upon the collection of the revenues.

Revenue bonds: bonds whose principal and interest are payable exclusively from earnings of a public enterprise.

In addition to a pledge of revenues, such bonds sometimes contain a mortgage on the enterprise's property and

are then known as mortgage revenue bonds.

Revenue ledger: a subsidiary ledger which supports both the Estimated Revenues control account and the

Revenues control account of a fund.

Serial bonds: bonds the principal of which is repaid in periodic installments over the life of the issue.

Shared revenue: revenue which is levied by one governmental unit but shared, usually on a predetermined basis,

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with another unit of government or class of governments.

Shared tax: see Shared revenue.

Short-term debt: debt with a maturity of one year or less after the date of issuance. Short-term debt usually

includes floating debt, bond anticipation notes, tax anticipation notes, and interim warrants.

Sinking fund: see Debt service fund.

Sinking fund bonds: bonds issued under an agreement which requires the governmental unit to set aside

periodically out of its revenues a sum which, with compound earnings thereon, will be sufficient to redeem the

bonds at their stated date of maturity. Sinking Fund bonds are usually also term bonds.

Special assessment bonds: bonds payable from the proceeds of special assessments (q.v.). If the bonds are

payable only from the collections of special assessments, they are known as "special-special assessment bonds."

If, in addition to the assessments, the full faith and credit of the governmental unit is pledged, they are known as

"general obligation special assessment bonds."

Special district: an independent unit of local government organized to perform a single governmental function or

a restricted number of related functions. Special districts usually have the power to incur debt and levy taxes;

however, certain types of special districts are entirely dependent upon enterprise earnings and cannot impose

taxes. Examples of special districts are water districts, drainage districts, flood control districts, hospital districts,

fire protection districts, transit authorities, port authorities, and electric power authorities.

Special district bonds: bonds issued by a special district. See Special district.

Special fund: any fund which must be devoted to some special use in accordance with specific regulations and

restrictions. Generally, the term applies to all funds other than the General Fund.

Special revenue fund: a fund used to account for revenues from specific taxes or other earmarked revenue

sources which by law are designated to finance particular functions or activities of government. After the fund is

established, it usually continues year after year until discontinued or revised by proper legislative authority. An

example is a motor fuel tax fund used to finance highway and road construction.

Specific-purpose fund: a fund classification provided for hospitals to record the principal and income of assets

which may be used only for purposes specified by the donor.

Statements: (1) used in a general sense, statements are all of those formal written presentations which set forth

financial information. (2) In technical accounting usage, statements are those presentations of financial data which

show the financial position and the results of financial operations of a fund, a group of accounts, or an entire

governmental unit for a particular accounting period.

Statute: a written law enacted by a duly organized and constituted legislative body. See also Ordinance,

Resolution, and Order.

Subactivity: a specific line of work performed in carrying out a governmental activity. For example, replacing

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defective street lamps would be a subactivity under the activity of street light maintenance.

Subfunction: a grouping of related activities within a particular governmental function. For example, "police" is a

subfunction of the function "public safety."

Subsidiary account: one of a group of related accounts which support in detail the debit and credit summaries

recorded in a control account. An example is the individual property taxpayers' accounts for taxes receivable in

the general ledger. See also Control account and Subsidiary ledger.

Subsidiary ledger: a group of subsidiary accounts the sum of the balances of which is equal to the balance of the

related control account. See also Control account and Subsidiary account.

Subvention: a grant.

Surety bond: a written promise to pay damages or to indemnify against losses caused by the party or parties

named in the document, through nonperformance or through defalcation. An example is a surety bond given by

a contractor or by an official handling cash or securities.

Syndicate, underwriting: a group formed for the marketing of a given security issue too large for one member to

handle expeditiously, after which the group is dissolved.

Tax anticipation notes: notes (sometimes called warrants) issued in anticipation of collection of taxes, usually

retirable only from tax collections, and frequently only from the proceeds of the tax levy whose collection they

anticipate.

Tax anticipation warrants: see Tax anticipation notes.

Tax certificate: a certificate issued by a governmental unit as evidence of the conditional transfer of title to tax-

delinquent property from the original owner to the holder of the certificate. If the owner does not pay the amount

of the tax arrearage and other charges required by law during the specified period of redemption, the holder can

foreclose to obtain title. Also called "tax sale certificate" and "tax lien certificate" in some jurisdictions. See also

Tax deed.

Tax deed: a written instrument by which title to property sold for taxes is transferred unconditionally to the

purchaser. A tax deed is issued upon foreclosure of the tax lien obtained by the purchaser at the tax sale. The tax

lien cannot be foreclosed until the expiration of the period during which the owner may redeem his property

through paying the delinquent taxes and other charges. See also Tax certificate.

Tax expenditure: a revenue loss attributable to provisions of federal tax laws which allow a special exclusion,

exemption, or deduction from gross income, or which provide a special credit, a preferential rate of tax, or a

deferral of tax liability.

Tax levy: see Levy.

Tax levy ordinance: an ordinance by means of which taxes are levied.

Tax liens: claims which governmental units have upon properties until taxes levied against them have been paid.

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Note: The term is sometimes limited to those delinquent taxes for the collection of which legal action has been

taken through the filing of liens.

Tax rate: the amount of tax stated in terms of a unit of the tax base; for example, 25 mills per dollar of assessed

valuation of taxable property.

Tax rate limit: the maximum rate at which a governmental unit may levy a tax. The limit may apply to taxes raised

for a particular purpose, or to taxes imposed for all purposes; and may apply to a single government, to a class of

governments, or to all governmental units operating in a particular area. Overall tax rate limits usually restrict

levies for all purposes and of all governments, state and local, having jurisdiction in a given area.

Taxes: compulsory charges levied by a governmental unit for the purpose of financing services performed for the

common benefit. Note: The term does not include specific charges made against particular persons or property

for current or permanent benefits such as special assessments. Neither does the term include charges for services

rendered only to those paying such charges as, for example, sewer service charges.

Term bonds: bonds the entire principal of which matures on one date.

Term bonds payable: a liability account which records the face value of general obligation term bonds issued and

outstanding.

Time warrant: a negotiable obligation of a governmental unit having a term shorter than bonds, and frequently

tendered to individuals and firms in exchange for contractual services, capital acquisitions, or equipment

purchases.

Time warrants payable: the amount of time warrants outstanding and unpaid.

Trust fund: a fund consisting of resources received and held by the governmental unit as trustee, to be expended

or invested in accordance with the conditions of the trust. See also Endowment fund.

Trust and agency fund: see Agency fund, Trust fund, and Fiduciary fund.

Unbilled accounts receivable: an account which designates the estimated amount of accounts receivable for

services or commodities sold but not billed. For example, if a utility bills its customers’ bimonthly but prepares

monthly financial statements, the amount of services rendered or commodities sold during the first month of the

bimonthly period would be reflected in the balance sheet under this account title.

Underwriting syndicate: see Syndicate, underwriting.

Unencumbered appropriation: that portion of an appropriation not yet expended or encumbered.

Unexpended allotment: that portion of an allotment which has not been expended.

Unexpended appropriation: that portion of an appropriation which has not been expended.

Unliquidated encumbrances: encumbrances outstanding.

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Unrestricted assets: assets which may be utilized at the discretion of the governing board of a governmental or

nonprofit entity.

Unrestricted funds: funds which are established to account for assets or resources which may be utilized at the

discretion of the governing board. Antonym of Restricted funds.

User charge: a charge levied against users of a service or purchasers of a product of an Enterprise Fund or an

Internal Service Fund.

Voucher system: a system which calls for the preparation of vouchers for transactions involving payments and for

the recording of such vouchers in a special book of original entry, known as a voucher register, in the order in

which payment is approved.

Vouchers payable: liabilities for goods and services evidenced by vouchers which have been preaudited and

approved for payment but which have not been paid.

Warrant: an order drawn by the legislative body or an officer of a governmental unit upon its treasurer, directing

the latter to pay a specified amount to the person named or to the bearer. It may be payable upon demand, in

which case it usually circulates the same as a bank check; or it may be payable only out of certain revenues when

and if received, in which case it does not circulate as freely.

Warrants payable: the amount of warrants outstanding and unpaid.

Working capital fund: see Internal service fund.

Zero-based budget: a budget based on the concept that the very existence of each activity must be justified each

year, as well as the amounts of resources requested to be allocated to each activity.

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Index

10 percent criterion, 93 5 percent criterion, 93 Activities, 34 Adjusting entries, 60 Agency funds, 121 Appropriation, 31 Balance sheet, 62 Capital projects funds, 77 Closing entries, 60 Consumption method, 41 Debt service funds, 82 Disbursement, 33 Encumbrances, 31 Enterprise funds, 95 Expenditure, 32 Fiduciary funds, 112 General fund, 50

Governmental entity audits, 138 Government-wide financial statements, 124 Interfund items, 47 Interfund transfers, 49 Internal service funds, 104 Inventory, 39 Long-term liabilities, 43 Pensions, 141 Permanent funds, 89 Private-purpose trust funds, 117 Property taxes, 55 Proprietary fund, 94 Purchase method, 40 Reconciliation schedules, 130 Special revenue fund, 73 Special-purpose governmental entities, 139 Termination benefits, 146

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Review Question Answers

Chapter 1 – Section 1

1. Fund accounting is used by governmental units with resources that must be____________

A. Incorrect. Funds may account for all types of resources, related liabilities, and residuals.

B. Incorrect. The essence of fund accounting is separation of resources into discrete accounting entities.

C. Correct. A fund is a fiscal and accounting entity with a self-balancing set of accounts recording cash and

other financial resources, together with all related liabilities and residual equities or balances, and changes

therein, which are segregated for the purpose of carrying on specific activities or attaining certain

objectives in accordance with special regulations, restrictions, or limitations.

D. Incorrect. Resources must be accounted for separately but need not be physically separated.

2. What is the focus of accounting and reporting for proprietary funds of governmental units?

A. Correct. The financial statements of proprietary funds focus on determination of operating income,

changes in net position (or cost recovery), financial position, and cash flows. A proprietary fund accounts

for the business-type functions of a government. Users of the financial statements for proprietary funds

may find profitability information to be valuable.

B. Incorrect. Projects and programs are entities for which information is accumulated, not measurement

models.

C. Incorrect. Current financial resources is the measurement focus of governmental funds.

D. Incorrect. Governmental funds have a budgetary orientation.

3. A governmental unit could use which of the following types of funds?

A. Incorrect. A governmental unit can use proprietary funds as well.

B. Correct. Three broad categories and eleven generic fund types can be used by a governmental unit in its

fund financial statements. 1) Governmental - general, special revenue, debt service, capital projects, and

permanent funds; 2) Proprietary - internal service and enterprise funds; and 3) Fiduciary - pension (and

other employee benefit) trust, investment trust, private-purpose trust, and agency funds.

C. Incorrect. A governmental unit can use fiduciary funds.

D. Incorrect. A governmental unit can use both fiduciary and proprietary funds.

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Chapter 1 – Section 2

4. On January 2, City of Walton issued $500,000, 10-year, 7% general obligation bonds. Interest is payable

annually, beginning January 2 of the following year. What amount of bond interest is Walton required to report

in the statement of revenue, expenditures, and changes in fund balances of its governmental funds at the close

of this fiscal year, September 30?

A. Correct. The financial statements of governmental funds are prepared using the modified accrual basis of

accounting. It recognizes expenditures for principal and interest on general long-term debt only when

these amounts are due. Because the fiscal year ends on September 30 and the interest is payable on the

following January 2, Walton does not recognize the bond interest.

B. Incorrect. Walton is not required to report 6 months of interest for the fiscal year, or $17,500 [$500,000

x 7% x (6 / 12)].

C. Incorrect. Walton is not required to report 9 months of interest for the fiscal year, or $26,500 [$500,000

x 7% x (9 / 12)]. This amount is recognized in the government-wide statement of activities, which is

prepared using the accrual basis.

D. Incorrect. Walton is not required to report 12 months of interest for the fiscal year, or $35,000 [$500,000

x 7% x (12 / 12)].

5. Dayne County's general fund had the following disbursements during the year: Payment of principal on long-

term debt =$100,000; Payments to vendors = $500,000; Purchase of a computer = $ 300,000. What amount should

Dayne County report as expenditures in its governmental funds statement of revenues, expenditures, and changes

in fund balances?

A. Incorrect. The purchase of a computer is not the only expenditure.

B. Incorrect. The payments to vendors are not the only expenditures.

C. Incorrect. The payment on long-term debt also should be considered an expenditure.

D. Correct. Expenditures are recognized in the fund financial statements of a governmental fund under the

modified accrual basis. They are decreases in (uses of) expendable available financial resources of a

governmental fund. Expenditures are usually measurable and should be recognized when the related

liability is incurred. However, expenditures for principal and interest on general long-term debt are usually

recognized when those amounts are due. The liabilities for payments to vendors and the computer

purchase were most likely incurred in the current year. The liability for payment of the principal on long-

term debt was most likely due in the current year. Thus, general fund expenditures equaled $900,000

($100,000 + $500,000 + $300,000).

6. For the budgetary year ending December 31, 2002, Maple City's general fund expects the following inflows of

resources: Property taxes, licenses, and fines =$9,000,000; Proceeds of debt issue = $5,000,000; Interfund

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transfers for debt service = $1,000,000. In the budgetary entry, what amount should Maple record for estimated

revenues?

A. Correct. Revenues are recognized in governmental funds when they are measurable and available. They

are increases in (sources of) fund financial resources other than from interfund transfers, debt issue

proceeds, and redemptions of demand bonds. The major source classifications are taxes, licenses and

permits, intergovernmental revenues, charges for services, fines and forfeits, and miscellaneous

revenues. Hence, Maple's revenues include taxes, licenses, and fines equal to $9 million.

B. Incorrect. $10,000,000 incorrectly includes the interfund transfers.

C. Incorrect. $14,000,000 incorrectly includes the debt issue proceeds.

D. Incorrect. $15,000,000 incorrectly includes the debt issue proceeds and interfund transfers.

7. Property taxes and fines represent which of the following classes of nonexchange transactions for governmental

units?

A. Incorrect. Derived tax revenues arise from assessments imposed on exchange transactions.

B. Correct. According to GASB 33, Accounting and Financial Reporting for Nonexchange Transactions,

imposed nonexchange revenues arise from assessments on nongovernmental entities, including

individuals, other than assessments on exchange transactions. Examples are fines, forfeitures, and

property taxes.

C. Incorrect. Government-mandated nonexchange transactions occur when one government provides

resources to a government at another level and requires that they be used for a specific purpose.

D. Incorrect. Voluntary nonexchange transactions result from legislative or contractual agreements, other

than exchanges, entered into willingly.

8. In which situation(s) should property taxes due to a governmental unit be recorded as deferred revenue? 1)

Property taxes receivable are recognized in advance of the year for which they are levied; 2) Property taxes

receivable are collected in advance of the year in which they are levied.

A. Incorrect. Property taxes recognized in advance should be initially recorded as deferred revenue.

B. Correct. A property tax assessment is made to finance the budget of a specific period. Hence, the revenue

produced should be recognized in the period for which the assessment was levied, provided it meets the

criteria of being available and measurable. (Property taxes are accounted for in governmental funds,

which use the modified accrual basis.) When property taxes are recognized or collected in advance, they

should be recorded as deferred revenue in a governmental fund. They are not recognized as revenue until

the year for which they are levied. Under GASB 33, a property tax assessment is classified as an imposed

nonexchange revenue transaction. In such a transaction, assets should be recognized when an

enforceable legal claim arises or when resources are received, whichever is earlier. Thus, recognition of a

receivable in a year prior to that for which the property taxes were levied implies that, under the enabling

statute, the enforceable legal claim arose in that prior year.

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C. Incorrect. Property taxes collected in advance should be initially recorded as deferred revenue.

D. Incorrect. Property taxes recognized or collected in advance should be initially recorded as deferred

revenue.

9. The renovation of Fir City's municipal park was accounted for in a capital projects fund. Financing for the

renovation, which was begun and completed in 20X3, came from the following sources: Grant from state

government = $400,000; Proceeds from general obligation bond issue = $ 500,000; Transfer from Fir's general

fund =$100,000. In its 20X3 governmental fund statement of revenues, expenditures, and changes in fund

balances, how should Fir report these amounts?

A. Incorrect. The proceeds from the bond issue and the transfer from the general fund should be reported

under other financing sources.

B. Incorrect. The proceeds from bond issue should be reported under other financing sources.

C. Correct. Governmental fund revenues are increases in fund financial resources other than from interfund

transfers, debt issue proceeds, and redemptions of demand bonds. Thus, revenues of a capital projects

fund include grants. Under GASB 33, the grant (a voluntary nonexchange transaction) is recognized when

all eligibility requirements, including time requirements, have been met. When modified accrual

accounting is used, as in a capital projects fund, the grant must also be "available." Other financing sources

include proceeds from bonds and interfund transfers in. Thus, Fir reports revenues of $400,000 and other

financing sources of $600,000 ($500,000 + $100,000) in its governmental fund statement of revenues,

expenditures, and changes in fund balances.

D. Incorrect. The grant should be reported under revenues.

Chapter 1 - Section 3

10. When is the estimated revenues control account of a governmental unit debited?

A. Incorrect. Revenues control is credited and a receivable is debited when actual revenues are recorded.

B. Incorrect. Cash is debited when actual revenues are collected.

C. Correct. The budgetary accounts are used to record the budget at the beginning of the fiscal period. No

other entries are made in these accounts until the end of the fiscal year, at which time they are closed to

fund balance. The basic entry to record the budget is to debit Est Revenues Control, and credit

Appropriations control and Budgetary fund balance. No other entries are made in these accounts until the

end of the fiscal year, at which time they are closed to fund balance.

D. Incorrect. Estimated revenues control is credited when the budget is closed at the end of the year.

11. Taxes collected and held by Franklin County for a separate school district are accounted for in which fund?

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A. Incorrect. Special revenue funds are governmental funds. Special revenue funds account for proceeds of

specific revenue sources legally restricted to expenditure for specified purposes. However, a special

revenue fund is not required unless legally mandated.

B. Incorrect. Internal service funds may be used for activities that provide goods and services to other

subunits of the primary government and its component units or to other governments on a cost-

reimbursement basis. However, if the reporting government is not the predominant participant, the

activity should be reported as an enterprise fund.

C. Incorrect. A trust fund differs from an agency fund because the trust agreement determines how long

resources are held and the degree of management involvement.

D. Correct. Agency funds report resources held solely in a custodial capacity. These funds ordinarily account

only for the receipt, temporary investment, and payment of resources to individuals, private

organizations, or other governments. Thus, tax agency funds are used when a governmental entity is the

collection agent of taxes for disbursement to other governmental units, e.g., school districts, city

governments, or special taxing districts.

12. A county's balances in the general fund included the following: Appropriations = $745,000; Encumbrances =

$37,250; Expenditures = $298,000; Vouchers payable = $55,875. What is the remaining amount available for use

by the county?

A. Incorrect. $353,875 results from subtracting the vouchers payable balance, the account credited when

expenditures is debited.

B. Incorrect. $391,125 results from subtracting vouchers payable instead of encumbrances.

C. Correct. Appropriations is the account credited in the general fund's budgetary entry. It establishes the

total amount available for use during the period. When a commitment is made to expend resources of a

governmental unit, the appropriations account is encumbered by a journal entry in which the

encumbrances account is debited and the reserve for encumbrances account (a fund balance account) is

credited for the amount of the purchase order. Comparison of encumbrances, appropriations, and

expenditures determines the unencumbered amount of appropriations that may still be expended. The

encumbrances account will be decreased when previously ordered items have been received.

Expenditures and vouchers payable will be increased for the actual amount to be paid for the items.

Accordingly, the remaining amount available for use by the county is $409,750 [($745,000 - ($37,250 -

$298,000)).

D. Incorrect. $447,000 results from not subtracting encumbrances.

13. During its fiscal year ended June 30, 20X3, Cliff City issued purchase orders totaling $5 million, which were

properly charged to encumbrances at that time. Cliff received goods and related invoices at the encumbered

amounts totaling $4.5 million before year-end. The remaining goods of $500,000 were not received until after

year-end. Cliff paid $4.2 million of the invoices received during the year. What amount of Cliff's encumbrances

were outstanding at June 30, 20X3?

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A. Incorrect. Not all of the goods related to the encumbrance amounts were received during the year.

B. Incorrect. $300,000 is the excess of goods received over the amount actually paid on the invoices during

the year.

C. Correct. In fund accounting, when a commitment is made to expend monies, encumbrances is debited

and BUDGETARY FUND BALANCE—ASSIGNED FOR ENCUMBRANCES is credited. When the goods are

received and the liability is recognized, this entry is reversed and an expenditure is recorded. Because

goods totaling $500,000 were not received at year-end, encumbrances outstanding total $500,000

($5,000,000 - $4,500,000).

D. Incorrect. $800,000 is the excess of total encumbrances over the amount paid on the invoices.

14. Which of the following amount(s) is (are) included in a general fund's encumbrance account? I) Outstanding

vouchers payable amounts; II) Outstanding purchase order amounts; or III) Excess of the amount of a purchase

order over the actual expenditure for that order.

A. Incorrect. The encumbrance entry is reversed and the encumbrance is eliminated when the expenditure

and the voucher payable relating to the purchase order are recorded.

B. Incorrect. The encumbrance includes only outstanding purchase order amounts.

C. Correct. The encumbrance account is debited when goods are approved to be purchased, and a purchase

order is prepared. When the contract is complete or virtually complete, the encumbrance account is

credited, effectively eliminating the purchase order amount. It is no longer outstanding. Thus, the

encumbrance account includes only those amounts that represent outstanding purchase orders.

D. Incorrect. When the contract is complete or virtually complete, the original encumbrance entry is

reversed. The actual amount owed is recorded in the expenditures account, so any excess is not reflected

in the encumbrance account.

15. Which of the following journal entries should be made in the general fund of a city to record $250,000 for

salaries and wages incurred during the month of May?

A. Incorrect. Appropriations is credited only when the budget is recorded.

B. Incorrect. Salaries and wages are not encumbered.

C. Incorrect. Salaries and wages are not encumbered expenditures or expenses.

D. Correct. If performance of an executory contract is complete or virtually complete, e.g., because wages

and salaries have been earned by employees, an expenditure and a liability should be recognized, not an

encumbrance. An encumbrance is recorded for budgetary control purposes only when a commitment has

been made related to an unperformed contract for goods or services. An expenditure is recorded when a

current liability is to be liquidated with expendable available current resources.

16. When a snowplow purchased by a governmental unit is received, what should it be recorded as in the general

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fund?

A. Incorrect. An encumbrance is recorded to account for the purchase commitment.

B. Correct. When previously ordered goods are received, the entry includes a debit to expenditures for the

actual amount to be paid. An expenditure is recognized when a liability is incurred, that is, when an

executory contract is complete or virtually complete.

C. Incorrect. General capital assets are reported only in the governmental activities column of the

government-wide statement of net position.

D. Incorrect. Appropriations are accounted for when recording the budget.

17. Which of the following fund types used by a government most likely would have a fund balance reserved for

an inventory of supplies?

A. Correct. If purchasing is centralized, the supply activities of a governmental unit are usually accounted for

in an internal service fund. However, an internal service fund is a proprietary fund for which net position,

not a fund balance, is reported. Moreover, smaller entities often record the purchases of supplies

inventory in the general fund. In accounting for supplies, the entire expenditure may be recognized in the

period of purchase (the purchases method). An alternative is the consumption method; it recognizes

expenditures for only the amount of inventory used in the period. In the former case, a significant

inventory must be recognized as an asset at the end of the period, with a corresponding reservation of

fund balance. In the latter case, fund balance is reserved for inventory only if amounts must be maintained

and are therefore not available for expenditure.

B. Incorrect. A proprietary fund does not have a fund balance.

C. Incorrect. Private-purpose funds accounts for trust arrangements under which the fund's resources are to

be used to benefit specific individuals, private organizations, or other governments, as specified in the

trust agreement.

D. Incorrect. A capital projects fund accounts for the acquisition or construction of capital or fixed assets and

has no need to account for the expenditure of supplies in such a fund.

Chapter 2 – Section 1

1. Lake County received the following proceeds that are legally restricted to expenditure for specified purposes:

Levies on affected property owners to install sewers = $500,000; and Gasoline taxes to finance road repairs =

$900,000. What amount most likely will be accounted for in Lake's special revenue funds?

A. Incorrect. $1,400,000 includes the special assessment for a capital project.

B. Correct. Special assessments for construction activity may be accounted for in a capital projects fund or

other appropriate fund. The gasoline taxes are special revenues received from the state government to

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be expended for a specific purpose and are properly recorded in the special revenue funds. However,

special revenue funds need not be used unless they are legally mandated.

C. Incorrect. $500,000 is the amount of the special assessment for a capital project.

D. Incorrect. $0 is based on the assumption that neither revenue source is accounted for in special revenue

funds.

2. Kew City received a $15 million federal grant to finance the construction of a center for rehabilitation of drug

addicts. In which fund should the proceeds of this grant be accounted for?

A. Incorrect. A special fund used to account for revenues from specific taxes or other earmarked revenue

sources which by law are designated to finance particular functions or activities of government.

B. Incorrect. This fund type does not record resources to be used for major capital facilities.

C. Correct. The capital projects fund is used to account for the receipt and disbursement of resources

restricted for the acquisition of major capital facilities (other than those financed by proprietary and trust

funds) through purchase or construction.

D. Incorrect. A grant for a drug rehabilitation center is to be used for a public purpose, that is, to support the

government's programs and therefore would not be accounted for in a trust fund. A trust fund accounts

for assets held by a governmental entity in the capacity of a fiduciary for individuals, private organizations,

or other governments.

3. In what fund type should the proceeds from special assessment bonds issued to finance construction of

sidewalks in a new subdivision be reported?

A. Incorrect. Agency funds are purely custodial funds. However, an agency fund should report debt service

transactions related to special assessment debt if the governmental unit is not obligated in any manner.

B. Incorrect. Bond proceeds are not considered revenues of a governmental unit. They must be repaid.

C. Incorrect. Enterprise funds account for business-type activities.

D. Correct. Construction of sidewalks in a new subdivision financed by special assessment bonds is a capital

project that results in a general capital asset that will be recognized only in the governmental activities

column of the government-wide statement of net position. If the governmental unit is obligated in some

manner on the special assessment debt, this capital improvement may be accounted for in the same way

as other capital transactions. Hence, the transactions of the construction phase are reported in a capital

projects fund. Transactions of the debt service phase are reported in a debt service fund, if one is required.

If the government is not obligated, the construction transactions may still be reported in a capital projects

fund, but the debt service transactions are recorded in an agency fund.

4. When should a public school district recognize revenue from property taxes levied for its debt service fund?

A. Incorrect. Revenues are recognized when property taxes are levied.

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B. Incorrect. The assessed valuations are necessary for calculating the amount of tax but do not make the

tax revenue available.

C. Correct. Debt service funds apply the modified accrual basis of accounting. Thus, revenues are recognized

when they are measurable and available. Moreover, assets from imposed nonexchange revenue

transactions, such as property tax levies, should be recognized when an enforceable legal claim arises or

the resources are received, whichever is earlier. If the legal claim arises in the period after that for which

the property taxes are levied, a receivable is recognized when revenues are recognized. Revenues are

recognized in the period for which the taxes are levied if the availability criterion is met. For property

taxes, this criterion is met if they are collected within the current period or soon enough thereafter (not

exceeding 60 days) to pay current liabilities.

D. Incorrect. Revenue recognition is not on the cash basis.

Chapter 2 – Section 2

5. In the fund financial statements of which of the following fund types of a city government are revenues and

expenditures recognized on the same basis of accounting as the general fund?

A. Incorrect. A private-purpose trust fund is a fiduciary fund. Its financial statements are prepared on the

same basis as those of proprietary funds.

B. Incorrect. The internal service fund is a proprietary fund. Its financial statements are prepared using the

accrual basis of accounting.

C. Incorrect. The enterprise fund is a proprietary fund. Its financial statements are prepared using the accrual

basis of accounting.

D. Correct. The debt service fund is the only fund listed that is classified as a governmental fund. The other

funds are proprietary or fiduciary. Governmental funds use the modified accrual basis in preparing their

fund financial statements, and proprietary and fiduciary funds use the accrual basis.

6. During the year, a city's electric utility, which is operated as an enterprise fund, rendered billings for electricity

supplied to the general fund. Which of the following accounts should be debited by the general fund?

A. Incorrect. Appropriations is debited when the budgetary accounts are closed.

B. Correct. Enterprise funds are used to account for operations similar to those of private businesses. This

rendition of services by the enterprise fund to the general fund is presumably at prices equivalent to

external exchange values and is classified as an interfund service provided and used. The result is revenue

to the seller and an expenditure to the buyer, a governmental fund. Unpaid amounts are interfund

receivables or payables. The entry is to debit expenditures control and credit due to enterprise fund.

C. Incorrect. Due to enterprise fund should be credited.

D. Incorrect. This transaction is an interfund service provided and used, not an interfund transfer.

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7. On January 2, Basketville City purchased equipment with a useful life of three years to be used by its water and

sewer enterprise fund. Which of the following is the correct treatment for the asset?

A. Incorrect. Under the modified accrual basis, the entity must record the purchase of the equipment as

expenditure if it is acquired with governmental fund financial resources.

B. Incorrect. Only depreciation is mandatory.

C. Correct. An enterprise fund is a proprietary fund. Thus, the economic resources measurement focus and

the accrual basis of accounting are required in its financial statements. Capital assets, such as equipment,

are reported in the government-wide statement of net position and in the proprietary fund statement of

net position. They must be depreciated over their estimated useful lives unless they are inexhaustible or

are infrastructure assets that meet certain requirements.

D. Incorrect. Only depreciation of inexhaustible assets, such as land and land improvements, is prohibited.

8. The statement of revenues, expenses, and changes in fund net position for proprietary funds __________

A. Incorrect. Nonoperating revenues and expenses are presented immediately after operating income (loss).

Moreover, special and extraordinary items are reported separately.

B. Incorrect. Revenues are reported by major source either net with disclosure of discounts and allowances

or gross with discounts and allowances reported beneath the revenue amounts.

C. Correct. A statement of revenues, expenses, and changes in fund net position or fund equity (either label

may be used) is the required operating statement for proprietary funds. Operating and nonoperating

revenues and expenses should be distinguished, with separate subtotals for operating revenues,

operating expenses, and operating income.

D. Incorrect. A government should consistently follow appropriate definitions of operating items. One

consideration in defining these items is the principal purpose of the fund. A second consideration is their

presentation in a cash flows statement. Thus, SGAS 34 provides general guidelines and mandates

consistent use of definitions, but it does not require that the categorization of items in the statement of

cash flows control the definitions of operating items in the statement of revenues, expenses, and changes

in fund net position.

9. The following transactions were among those reported by Corfe City's electric utility enterprise fund for 20X3:

Capital contributed by subdividers = $ 900,000; Cash received from customer households = $2,700,000; Proceeds

from sale of revenue bonds = $4,500,000. In the proprietary funds statement of cash flows for the year ended

December 31, 2002, what amount should be reported as cash flows from the electric utility enterprise fund's

capital and related financing activities?

A. Incorrect. $4,500,000 omits the capital contributed by subdividers.

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B. Correct. Cash flows should be classified as operating, noncapital financing, capital and related financing,

or investing. Operating activities include producing and delivering goods and providing services. Thus,

cash from customer households is a revenue item reported under cash flows from operating activities.

Capital and related financing activities include acquiring and disposing of capital assets, borrowing and

repaying money related to capital asset transactions, etc. Assuming the sale of revenue bonds and the

capital contributions by subdividers are for the acquisition or improvement of capital assets, the amount

to report under capital and related financing activities is $5,400,000 ($900,000 + $4,500,000).

C. Incorrect. $7,200,000 includes customer fees revenue and omits capital contributed by subdividers.

D. Incorrect. $8,100,000 includes customer fees.

Chapter 2 – Section 3

10. Government-wide financial statements ___________

A. Incorrect. Government-wide financial statements do not display funds.

B. Incorrect. Information about fund types is reported in the fund financial statements.

C. Incorrect. Separate rows and columns report information about discretely presented component units.

D. Correct. The basic financial statements include government-wide financial statements, fund financial

statements, and the notes to the financial statements. Government-wide financial statements do not

display funds or fund types but instead report information about the overall government. They distinguish

between the primary government and its discretely presented component units and between the

governmental activities and business-type activities of the primary government by reporting such

information in separate rows and columns.

11. Which of the following statements is TRUE for budgetary comparison schedules?

A. Correct. Certain information must be presented as RSI in addition to MD&A. Budgetary comparison

schedules must be reported for the general fund and each major special revenue fund with a legally

adopted annual budget. A schedule includes the original budgets, that is, the first complete appropriated

budgets; the final appropriated budgets; and the actual inflows, outflows, and balances stated on the

budgetary basis of accounting. Thus, budgetary comparison schedules are not required for proprietary

funds, fiduciary funds, and governmental funds other than the general fund and major special revenue

funds.

B. Incorrect. A government may elect to report budgetary comparison information in a statement as part of

the basic statements.

C. Incorrect. The budgetary comparison schedules compare the budgets with actual inflows, outflows, and

balances stated on the government's budgetary basis. However, a reconciliation to GAAP is required.

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D. Incorrect. The original and final appropriated budgets are compared with the actual inflows, outflows, and

balances.

12. GASB 34, Basic Financial Statements and Management's Discussion and Analysis for State and Local

Governments, financial reporting by general-purpose governments, includes presentation of Management's

discussion and analysis (MD&A) as _________

A. Incorrect. MD&A precedes the basic financial statements.

B. Incorrect. MD&A is not part of the basic financial statements, but a separate presentation.

C. Correct. Management's discussion and analysis (MD&A) is required supplementary information (RSI) that

precedes the basic financial statements and provides an analytical overview of financial activities. It is

based on currently known facts, decisions, or conditions and includes comparisons of the current and

prior years, with an emphasis on the current year, based on government-wide information. Currently

known facts are those of which management is aware at the audit report date.

D. Incorrect. MD&A should state the reasons for change from the prior year, not merely the amounts or

percentages of change.

13. What is the correct approach to presentation of the notes to the financial statements?

A. Correct. Notes to the financial statements are an integral part of the basic financial statements because

they disclose information essential to fair presentation that is not reported on the face of the statements.

The focus is on the primary government's governmental activities, business-type activities, major funds,

and nonmajor funds in the aggregate.

B. Incorrect. RSI mandated by GASB 34 includes MD&A, budgetary comparison schedules for governmental

funds, and information about infrastructure assets reported using the modified approach.

C. Incorrect. Notes to the financial statements are an integral part of the basic financial statements

D. Incorrect. The notes focus on the primary government.

14. The focus of certain fund financial statements is on major funds. Accordingly, which of the following

statements is TRUE?

A. Incorrect. Major fund reporting requirements apply to governmental and enterprise funds but not to

internal service funds.

B. Correct. The focus of governmental and proprietary fund financial statements is on major funds (but major

fund reporting is not required for internal service funds). Each major fund is presented in a separate

column, and nonmajor funds are aggregated in one column. Combining statements are not required for

nonmajor funds. The main operating fund (e.g., the general fund) is always reported as a major fund, and

any governmental or enterprise fund believed to be particularly important to users may also be reported

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in this way. Other individual governmental or enterprise funds must be reported as major if they meet

the quantitative thresholds.

C. Incorrect. Combining statements for nonmajor funds are not required but may be reported as

supplementary information.

D. Incorrect. A government may report any governmental or enterprise individual fund as major if it is

believed to be particularly important to users.

15. When is a government reported as a special-purpose government?

A. Incorrect. A government that has governmental and business-type activities should be reported in the

same manner as a general-purpose government.

B. Incorrect. A government that is engaged in two or more governmental programs should be reported in

the same manner as a general-purpose government.

C. Incorrect. A special-purpose government is a legally separate entity.

D. Correct. Special-purpose governments are legally separate entities that are component units or other

stand-alone governments. If they have governmental and business- type activities or are engaged in two

or more governmental programs, they should be reported as general-purpose governments. A

government is reported as a special-purpose government if it is engaged in one governmental program

(such as cemetery districts or drainage districts). These governmental entities may present a simplified

set of government-wide and fund-based financial statements, often combining these two statements.

16. What do fiduciary fund financial statements report?

A. Incorrect. Major funds are reported only in governmental and enterprise fund statements.

B. Incorrect. Three components of net position are reported only in the government-wide statement of net

position and in the proprietary fund statement of net position.

C. Correct. Fiduciary fund financial statements include information about all fiduciary funds and similar

component units. The statements report information in a separate column for each fund type but not by

major fund. The notes present financial statements for individual pension plans and postemployment

healthcare plans unless separate GAAP reports have been issued. A statement of fiduciary net position is

required for fiduciary funds. It reports assets, liabilities, and net position for each fiduciary fund type but

does not present the three components of net position reported in the government-wide statement of

net position or in the proprietary fund statement of net position.

D. Incorrect. Separate financial statements for individual pension plans and postemployment healthcare

plans are reported in the notes. However, if separate GAAP financial statements have been issued for such

plans, information is given in the notes about how those statements may be obtained.

17. River City has a defined contribution pension plan. How should River report the pension plan in its financial

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statements?

A. Incorrect. No transition asset arises under a defined contribution plan.

B. Incorrect. A pension benefit obligation arises under a defined benefit pension plan.

C. Correct. GASB 25, Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined

Contribution Plans, requires that a defined contribution pension plan report a plan description, a summary

of significant accounting policies, and information about investment concentrations. The plan description

should identify the plan as a defined contribution plan and disclose the number of participating employers

and other contributing entities. The description should also include the classes of employees covered and

the total current membership, a brief description of plan provisions and the authority under which they

are established (or may be amended), and contribution requirements.

D. Incorrect. Under a defined contribution plan, the governmental employer's obligation is for contributions,

not benefits.