Chapter 18 AN INTRODUCTION TO ACCOUNTING FOR STATE AND LOCAL GOVERNMENTAL UNITS Questions The Governmental Accounting Standards Board has primary responsibility for setting standards that provide GAAP for state and local governmental units The most authoritative literature includes GASB Statements of Standards and GASB Interpretations The second level of authoritative literature includes GASB Technical Bulletins and those AICPA audit and accounting guides and statements of position that the AICPA intended to make applicable to governments and that the GASB has cleared Before 1984, the Municipal Finance Officers Association (MFOA) and its National Committee on Governmental Accounting provided guidance via the publication of Municipal Accounting and Auditing in 1951 and Governmental Accounting, Auditing, and Financial Reporting (GAAFR) in 1968 Since 1974, the AICPA has also issued industry audit guides for audits of state and local governmental units The Municipal Finance Officers Association (MFOA), now referred to as the Government Finance Officers Association (GFOA), first issued Governmental Accounting, Auditing, and Financial Report (GAAFR) in 1968 For many years, this resource book – often referred to as the Blue Book due to its distinctive blue cover - constituted the most complete frameworks of accounting principles specific to governmental units, and provided standards for preparing and evaluating the financial reports of governmental units Updated periodically to reflect changes to governmental accounting, the 2005 GAAFR is the most recent version According to the AICPA’s Audit and Accounting Guide, a governmental entity is generally created for the administration of public affairs and has one or more of the following characteristics: ▪ Popular election of officers or appointment (or approval) of a controlling majority of the members of the organization’s governing body by officials of one or more state or local governments; ▪ The potential for unilateral dissolution by a government with the net assets reverting to a government; or ▪ The power to enact or enforce a tax An organization may also be classified as a governmental entity if it possesses the ability to issue debt that is exempt from federal taxation A fund is a separate fiscal and accounting entity with a self-balancing set of accounts, “segregated for the purpose of carrying on specific activities or attaining certain objectives in accordance with special regulations, restrictions, or limitations.” [GASB Codification] Fund accounting facilitates budgetary control A governmental unit may have hundreds of funds, but only eight fund types The Codification discusses three fund categories (governmental, proprietary, and fiduciary) and eight fund types (general, special revenue, permanent, capital projects, debt service, internal service, enterprise, and trust and agency funds) Governmental funds are “expendable” or “source and disposition” funds through which most governmental functions are financed These funds are essentially working capital entities They include the general fund, special revenue funds, permanent funds, capital projects funds, and debt service funds Proprietary funds are “nonexpendable” or “commercial type” funds used to account for ongoing activities that are similar to those found in private enterprise They use the business accounting equation and their reporting parallels that of a business entity in most regards They include two fund types— enterprise funds and internal service funds © 2009 Pearson Education, Inc publishing as Prentice Hall 18-1 18-2 Fiduciary funds are used to account for assets held by the governmental unit as trustee or agent for individuals, private organizations, and other governmental units Fiduciary funds include trust funds (pension, investment, and private purpose) and agency funds The five types of governmental funds are the general fund, permanent funds, special revenue funds, capital projects funds, and debt service funds Each is a working capital entity, therefore, each is used to account for a portion of a government’s general government working capital They are distinguished by the purpose for which the resources of each fund may (must) be used Working capital to be used for construction/acquisition of major general government fixed assets should be accounted for in capital projects funds; that to be used to pay principal and interest on general long-term debt should be accounted for in debt service funds Special revenue funds are used to account for portions of working capital to be used for other specific general operating purposes Permanent funds report resources that are legally restricted to the extent that only earnings, and not principal, may be used for purposes that support the reporting government’s programs—that is, for the benefit of the government of its citizenry The governmental fund accounting equation is: Current Assets - Current Liabilities = Fund Balance The two types of proprietary funds are enterprise funds and internal service funds Both charge fees for their services that are intended to recover part, if not all, of the costs of providing goods or services The key distinction between the two is that the predominant customers of internal service funds are other departments or agencies of the government, whereas the predominant customers of enterprise funds are outside entities or individuals The accounting equation for a proprietary fund is essentially the business accounting equation— Current assets + Noncurrent assets – Current liabilities – Noncurrent liabilities = Net Assets 10 Under the modified accrual basis of accounting, fixed assets are not recorded in the general fund, because general fixed assets not represent financial resources available for current expenditures, i.e., they are not working capital items In the fund financial statements, the general fund is used to account for unrestricted resources that can be expended currently for operating purposes Since fixed assets result from expending resources for long-term needs, they are not included in the fund financial statements With the advent of GASB 34, the general fund is reported in the governmentwide statements under the accrual basis of accounting General fund fixed assets – which have typically been documented informally in the accounting records and noted in the old general fixed asset account group – will appear in the governmentwide statement of net assets 11 Modified accrual accounting is the system of accounting in which revenues are recognized in the accounting period in which they become available and measurable and expenditures are recognized in the accounting period in which the related fund liability is incurred and objectively measurable Unmatured interest on general long-term debt is an exception for which the expenditure is recognized when due Modified accrual accounting applies to governmental funds (general fund, special revenue funds, permanent funds, debt service funds, and capital projects funds) and to asset and liability accounting for agency funds 12 Governmental and proprietary funds use different focuses when measuring financial positions and operating results in the fund financial statements The two types of focuses are the “economic resources” measurement focus and the “flow of current financial resources” measurement focus The accrual basis (used with proprietary funds and trust funds) refers to recognition of revenues and expenses as in business accounting and follows the economic resources measurement focus, whereby all economic resources, whether current or noncurrent, are reported The modified accrual basis of accounting (used with © 2009 Pearson Education, Inc publishing as Prentice Hall 18-3 governmental funds) is consistent with a flow of current financial resources measurement focus, whereby funds report on current resources and current obligations Under GASB 34, both governmental funds and proprietary funds use the accrual basis of accounting and the “economic resources” measurement focus in the governmentwide statements 13 Governmental revenue sources, addressed in GASB 33, are varied and include taxes, grant receipts, and collections of user fees and fines Exchange transactions are those “in which each party receives and gives up essentially equal values.” Nonexchange transactions are those “in which a government gives (or receives) value without directly receiving (or giving) equal value in exchange.” Many of the transactions in governmental funds are nonexchange in nature, because general governmental activities often address the needs of the public and are funded by taxpayers who generally not receive benefits in direct relation to their tax payments 14 A short term note payable will generally be paid with current resources, thus it is accounted for as a liability of the governmental fund Long-term debt is not included in the fund financial statements, since it will be repaid with future, not current financial resources The long term debt will, however, appear as a liability in the governmentwide statement of net assets This is one of the reconciling items between the fund and governmentwide statements 15 Interfund transfers are not expenditures or expenses, and they are classified separately from revenues, expenditures, and expenses in the financial statements of the various funds Interfund transfers are essentially shifts of resources between funds, not costs or liabilities incurred by the entity Interfund transfers consist of residual equity transfers (nonrecurring or nonroutine transfers of equity between funds) and operating transfers (all other legally authorized transfers between funds) Interfund transactions that would be treated as revenues, expenditures, or expenses if they involved an external entity are not interfund transfers, but rather are quasi-external transactions and are treated as revenue, expenditures, or expenses in the normal fashion 16 An appropriation is an authorization from the legislative body to make expenditures for specified purposes If approval by the legislative body is for each detailed expenditure item in the budget (a line-item budget), the legislative body will have maximum control because each detailed change would require legislative approval If the budget is approved in total or by major categories but not for each detailed item, the city manager (or other chief executive) can shift resources within the categories approved without legislative approval An appropriation by department, for example, permits a city manager to shift appropriations for police supplies to police equipment or overtime pay without legislative approval 17 Under GASB 34, the governmental and proprietary fund financial statements of a general-purpose government include the following: Fund financial statements Governmental Funds Balance sheet – governmental funds (modified accrual basis) Statement of revenues, expenditures, and changes in fund balances (modified accrual basis) Proprietary Funds Statement of net assets (accrual basis) Statement of revenues, expenses, and changes in net assets (accrual basis) Statement of cash flows (accrual basis, direct method) 18 A reciprocal transfer is one which is expected to be repaid by the fund borrowing the money; whereas with a nonreciprocal transfer repayment is not expected 19 The GAAP Guidelines, listed in descending order of authority are as follows: GASB Statements and GASB Interpretations This category also includes AICPA and FASB pronouncements made applicable to state and local governments by a GASB Statement or Interpretation © 2009 Pearson Education, Inc publishing as Prentice Hall 18-4 GASB Technical Bulletins This category also includes AICPA Industry Audit and Accounting Guides and Statements of Position if specifically made applicable to state and local governments by the AICPA and cleared by the GASB Consensus positions of GASB’s Emerging Issues Task Force (EITF) and AICPA Practice Bulletins if specifically made applicable to state and local governments by the AICPA and cleared by the GASB Implementations Guides published by the GASB staff and industry practices that are widely recognized and prevalent in state and local government Other accounting literature (including FASB standards not made applicable to governments by a GASB standard) GASB statements are the most authoritative 20 Interfund loans are loans that are made by one fund to another and must be repaid Interfund transfers occur when one fund provides resources to another for legally authorized purposes (an operating transfer) or when one fund helps to establish or enhance another (a residual equity transfer) Interfund services provided and used include sales and purchases between funds at approximate external market value An interfund reimbursement is necessary when an expenditure applicable to one fund is made by a different fund 21 Expenses reflect the cost of assets or services used by an entity, and they are recognized in the period incurred Expenditures, unique to government accounting, typically reflect the use of governmental fund working capital Proprietary funds recognize expenses, whereas governmental funds recognize expenditures 22 A comprehensive annual financial report (CAFR) contains three major sections—introductory, financial and statistical The introductory section of a CAFR includes a table of contents, a letter of transmittal, a list of principal officers, and an organizational chart The financial section includes the management’s discussion and analysis, the auditor’s report, the government-wide financial statements, and the fund financial statements The statistical section contains statistical tables with comparative data from several periods of time 23 Fiscal accountability is the responsibility of a government to demonstrate compliance with public decisions regarding the use of financial resources Operational accountability measures the extent of a government’s success at meeting operating objectives efficiently and effectively and its ability to meet operating objectives in the future SOLUTIONS TO EXERCISES E18-1 c a c d d E18-2 [AICPA adapted] d c c a c E18-3 b a a d b © 2009 Pearson Education, Inc publishing as Prentice Hall 18-5 E18-4 E18-5 c b d b d c b d c d E18-6 trust and agency funds enterprise funds general funds debt service funds permanent funds special revenue funds internal service funds capital projects funds E18-7 Current assets Current liabilities Fund balance -30,000 +2,500 -32,500 Current assets Current liabilities Fund balance +98,000 -+98,000 Current assets Current liabilities Fund balance +60,000 +60,000 Current assets Current liabilities Fund balance Assumes repayment during the same year borrowed If the note had not matured by the end of the year of the borrowing, interest expenditures and interest payable would be accrued -63,150 -60,000 -3,150 Current assets Current liabilities Fund balance At the same time a memo entry will be made noting a liability in the long-term debt records This is used to prepare the governmentwide statements where long-term debts are recorded in governmental funds +600,000 -+600,000 Current assets Current liabilities Fund balance At the same time a memo entry will be made noting an asset in the fixed asset records This is used to prepare the governmentwide statements where fixed assets are recorded in governmental funds -25,000 25,000 Current assets Current liabilities Fund balance At the same time a memo entry will be made removing the asset from the fixed asset records +1,200 -+1,200 © 2009 Pearson Education, Inc publishing as Prentice Hall 18-6 Current assets Current liabilities Fund balance At the same time a memo entry will be made noting a liability in the long-term debt records This is used to prepare the governmentwide statements where long-term debts are recorded in governmental funds E18-8 Current assets Noncurrent assets Current liabilities Long-term liabilities Net Assets -30,000 -+2,500 32,500 Current assets Noncurrent assets Current liabilities Long-term liabilities Net Assets Actually, the net asset increase is reported as a $100,000 increase (revenues) and a $2,000 decrease (uncollectible accounts expense) Further, it is relatively uncommon to have tax revenues in proprietary activities +98,000 -+98,000 Current assets Noncurrent assets Current liabilities Long-term liabilities Net Assets Assumes repayment during the same year borrowed If the note had not matured by the end of the year of the borrowing, interest expense and interest payable would be accrued +60,000 -+60,000 - Current assets Noncurrent assets Current liabilities Long-term liabilities Net Assets -63,150 60,000 3,150 Current assets Noncurrent assets Current liabilities Long-term liabilities Net Assets Interest expense should be accrued on proprietary fund long-term debt as well as on proprietary fund short-term debt Current assets Noncurrent assets Current liabilities Long-term liabilities Net Assets © 2009 Pearson Education, Inc publishing as Prentice Hall +600,000 +600,000 -25,000 +25,000 Current assets Noncurrent assets (Fully depreciated) Current liabilities Long-term liabilities Net Assets Current assets Noncurrent assets Current liabilities Long-term liabilities Net Assets 18-7 +1,200 +1,200 -+50,000 -50,000 E18-9 debt service fund permanent fund special revenue fund agency fund capital projects fund, debt service fund E18-10 capital projects fund, debt service fund internal service fund enterprise fund special revenue fund general fund E18-11 pension trust fund enterprise fund internal service fund general fund general fund (may also be allocated to other funds after collection) E18-12 General Fund Current assets Current liabilities Fund balance -95,000 95,000 General Fund Current assets Current liabilities Fund balance -+25,000 -25,000 Year end accrual Current assets Current liabilities ($25,000 × 08 × 5) Fund balance At the same time a memo entry will be made noting an asset in the fixed asset account records © 2009 Pearson Education, Inc publishing as Prentice Hall -+1,000 -1,000 18-8 General Fund Current assets Current liabilities Fund balance At the same time a memo entry will be made removing the asset from the fixed asset records +30,000 -+30,000 General Fund Current assets Current liabilities Fund balance -27,000 -26,000 -1,000 General Fund Current assets Current liabilities Fund balance +500,000 -+500,000 Enterprise Fund Current Assets Noncurrent Assets Current liabilities Long-term liabilities Net Assets -500,000 500,000 General Fund Current assets Current liabilities Fund balance +70,000 -+70,000 E18-13 Capital Projects Fund Current assets Current liabilities Fund balance At the same time a memo entry will be made noting a liability in the long-term debt records This is used to prepare the governmentwide statements where long-term debts are recorded in governmental funds General Fund Current assets Current liabilities Fund balance At the same time a memo entry will be made noting an asset in the fixed asset records Enterprise Fund Current assets Noncurrent assets Current liabilities Long-term liabilities Net Assets © 2009 Pearson Education, Inc publishing as Prentice Hall +10,000,000 -+10,000,000 -22,000 22,000 +500,000 +500,000 18-9 Capital Projects Current assets Current liabilities Fund balance At the same time a memo entry will be made noting a construction work in process asset in the fixed asset records -2,000,000 2,000,000 General Fund Current assets Current liabilities Fund Balance -4,500 +500 -5,000 General Fund Current assets Current liabilities Fund balance +7,500 +7,500 © 2009 Pearson Education, Inc publishing as Prentice Hall ... accrual accounting is the system of accounting in which revenues are recognized in the accounting period in which they become available and measurable and expenditures are recognized in the accounting. .. governments by the AICPA and cleared by the GASB Implementations Guides published by the GASB staff and industry practices that are widely recognized and prevalent in state and local government Other accounting. .. in business accounting and follows the economic resources measurement focus, whereby all economic resources, whether current or noncurrent, are reported The modified accrual basis of accounting