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Essentials of Accounting for Governmental and Not-for-Profit Organizations Apago PDF Enhancer Tenth Edition
Paul A. Copley, Ph. D., CPA
KPMG Professor Director, School of Accounting James Madison University

ESSENTIALS OF ACCOUNTING FOR GOVERNMENTAL AND NOT-FOR-PROFIT ORGANIZATIONS, TENTH EDITION Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY, 10020. Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. Previous editions © 2008, 2007 and 2004. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of The McGraw-Hill Companies, Inc., including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning. Some ancillaries, including electronic and print components, may not be available to customers outside the United States. This book is printed on acid-free paper. 1 2 3 4 5 6 7 8 9 0 DOC/DOC 1 0 9 8 7 6 5 4 3 2 1 0 ISBN 978-0-07-352705-5 MHID 0-07-352705-X Vice President and Editor-in-Chief: Martin Lange VP SEM, EDP, Central Publishing Services: Kimberly Meriwether David Editorial Director: Stewart Mattson Publisher: Tim Vertovec Sponsoring Editor: Donna Dillon Marketing Manager: Dean Karampelas Development Editor: Emily Hatteberg Project Manager: Melissa M. Leick Design Coordinator: Brenda Rolwes Cover Designer: Studio Montage, St. Louis, Missouri USE Cover Image Credit: Eyewire (Photodisc)/PunchStock Senior Production Supervisor: Laura Fuller Media Project Manager: Suresh Babu / Balaji Sundararaman, Hurix Systems Pvt. Ltd. Compositor: MPS Limited, A Macmillan Company Typeface: 10.5/12pt Times Roman Printer: R. R. Donnelley

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All credits appearing on page or at the end of the book are considered to be an extension of the copyright page. Library of Congress Cataloging-in-Publication Data Copley, Paul A. Essentials of accounting for governmental and not-for-profit organizations / Paul A. Copley. — 10th ed. p. cm. Includes index. ISBN 978-0-07-352705-5 1. Administrative agencies—United States—Accounting. 2. Nonprofit organizations—United States— Accounting. I. Title. HJ9801.H39 2011 657'.83500973—dc22 2009054187 www.mhhe.com

Preface
Thank you for considering the tenth edition of Essentials of Accounting for Governmental and Not-for-Profit Organizations. The tenth edition is updated for recent changes including: • GASB Statement 54: Fund Balance Reporting and Governmental Fund Type Definitions. • FASB Statement 164, Not-for Profit Entities: Mergers and Acquisitions. • IRS Form 990 Return of Organization Exempt From Income Tax. In addition, the text includes a new chapter on Federal Government reporting. I have used the text with stand-alone, three semester-hour classes, with half-semester GNP courses, and as a module in advanced accounting classes. It is appropriate for accounting majors or as part of a public administration program. The coverage is effective in preparing candidates for the CPA examination. The focus of the text is on the preparation of external financial statements. Among the more challenging aspects of state and local government reporting is the preparation of government-wide financial statements. Our approach is similar to that used in practice. Specifically, day-to-day events are recorded at the fund level using the basis of accounting for fund financial statements. Governmental activities are recorded using the modified accrual basis. The fund-basis statements are then used as input in the preparation of government-wide statements. The preparation of government-wide statements is presented in an Excel worksheet. This approach has two advantages: (1) it is the approach most commonly applied in practice, and (2) it is an approach familiar to students who have studied the process of consolidation in their advanced accounting classes. State and local government reporting is illustrated using an ongoing example integrated throughout Chapters 2 through 8 and 13. Additional features of the text are available on the instructor or student Web sites and include:

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• A continuous homework problem throughout Chapters 2 through 8 and 13. • Instructor’s guide. • Suggested quiz and examination questions and problems. • PowerPoint slides. • Excel-based assignments. • An additional practice set. I thank Sandra Bitenc, University of Texas—Arlington; Angele Brill, Castleton State College; Richard C. Brooks, West Virginia University; Bradley Childs, Belmont University; Dori Danko, Grand Valley State University; Gertrude Eguae-Obazee, Albright College; Gladys Gomez, University of Mary Washington; Marina Grau, Houston Community iii

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College; David J. Harr, George Mason University; Maggie Houston, Wright State University; Tom Hrubec, Franklin University; Mary Jepperson, Saint John’s University; Beth Kern, Indiana University South Bend; John Lasik, Central Washington University; Rodney A. Oglesby, Drury University; Jim Shelton, Harding University; Chuck Smith, Iowa Western Community College; D. Terry Balkaran, Queens College; and Bradley Trimble, Columbus State Community College for reviewing the ninth edition and providing suggestions. I wish to thank my colleague Loretta Manktelow; co-author of the Instructor’s Guide and author of the Test Bank as well as Maggie Houston of Wright State University for her work on the online quizzes. Finally, I am indebted to the many users of the text for their comments. Additional comments and suggestions are welcome and can be addressed to me at [email protected] Paul A. Copley

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In memory of those lost: — Northern Illinois University, February 14, 2008 — Virginia Tech, April 16, 2007

Contents
Preface iii Chapter One INTRODUCTION TO ACCOUNTING AND FINANCIAL REPORTING FOR GOVERNMENTAL AND NOT-FOR-PROFIT ORGANIZATIONS 1 Generally Accepted Accounting Principles 3 Objectives of Accounting and Financial Reporting 6 Objectives of Accounting and Financial Reporting for the Federal Government 8 Objectives of Financial Reporting by Not-for-Profit Entities 8 Objectives of Accounting and Financial Reporting for State and Local Governmental Units 9

Chapter Two OVERVIEW OF FINANCIAL REPORTING FOR STATE AND LOCAL GOVERNMENTS 20 The Governmental Reporting Entity 21 Reporting by Major Funds 23 Overview of the Comprehensive Annual Financial Report (CAFR) 23 Introductory Section 24 Financial Section: Auditor’s Report 25 Management’s Discussion and Analysis (MD&A) 26 Statement of Net Assets 28 Government-wide Statement of Activities 30 Governmental Funds: Balance Sheet 32 Governmental Funds: Statement of Revenues, Expenditures, and Changes in Fund Balance 34 Proprietary Funds: Statement of Net Assets 36 Proprietary Funds: Statement of Revenues, Expenses, and Changes in Fund Net Assets 38 Proprietary Funds: Statement of Cash Flows 40 Fiduciary: Statement of Fiduciary Net Assets 42 Fiduciary: Statement of Changes in Fiduciary Net Assets 42 Notes to the Financial Statements 44 Required Supplementary Information Other than MD&A 46 Combining Statements 48 Statistical Information 48

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State and Local Government Financial Reporting 10
Comprehensive Annual Financial Report 10 Measurement Focus and Basis of Accounting 12 Fund Structure for State and Local Government Accounting and Reporting 13 Number of Funds Required 16 Budgetary Accounting 16

Additional Resources

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Special-Purpose Governments

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Public Colleges and Universities 49 Other Governmental Not-for-Profit Organizations 50

Illustrative Case—General Fund

Interfund Transfers 91 Interfund Reimbursements

91

Chapter Three MODIFIED ACCRUAL ACCOUNTING: INCLUDING THE ROLE OF FUND BALANCES AND BUDGETARY AUTHORITY 55 Modified Accrual Accounts
Balance Sheet Accounts 56 Financial Statement Activity Accounts 61 Budgetary Accounts 63

56

Expenditure Cycle 63 Revenue Recognition for Nonexchange Transactions 65 Summary 68 Appendix: Budgetary Accounting Illustrated 69

Budgets and Budgetary Accounts 69 Recording the Budget 70 Accounting for Revenues 71 Accounting for Encumbrances and Expenditures 73 Budget Revisions 76 Budgetary Comparison Schedule 76 Classification of Estimated Revenues and Revenues 77 Classification of Appropriations and Expenditures 78

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Chapter Four ACCOUNTING FOR THE GENERAL AND SPECIAL REVENUE FUNDS 87 Overview of Modified Accrual Accounting 88 Interfund Transactions 89

Illustrative Case—Special Revenue Fund 108

Recording the Budget 92 Re-establishment of Encumbrances 92 Recording Prior-Year Property Taxes as Revenues 92 Tax Anticipation Notes Payable 93 Payment of Liabilities as Recorded 93 Encumbrance Entry 93 Recording Property Tax Levy 94 Collection of Delinquent Taxes 94 Collection of Current Taxes 94 Other Revenues 95 Repayment of Tax Anticipation Notes 95 Recognition of Expenditures for Encumbered Items 95 Payrolls and Payroll Taxes 96 Payment on Account and Other Items 97 Correction of Errors 97 Amendment of the Budget 97 Interfund Transactions 98 Write-off of Uncollectible Delinquent Taxes 100 Reclassification of Current Taxes 100 Accrual of Interest and Penalties 101 Deferral of Property Tax Revenue 101 Special Item 101 Preclosing Trial Balance 101 Closing Entries 103 Year-End Financial Statements 105

91

Interfund Loans 89 Interfund Services Provided and Used 91

Recognition of Inventories in Governmental Funds 111

Motor Fuel Tax Revenues 108 Expenditures for Road Repairs 108 Reimbursement to General Fund 109 Reimbursement Grant Accounting 109 Closing Entry 109 Year-End Financial Statements 110

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Chapter Five ACCOUNTING FOR OTHER GOVERNMENTAL FUND TYPES: CAPITAL PROJECTS, DEBT SERVICE, AND PERMANENT 122 Capital Projects Funds
Illustrative Case

Chapter Six PROPRIETARY FUNDS
Internal Service Funds 156

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Other Issues Involving Acquisition of Capital Assets 130

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Other Issues Involving Internal Service Funds 161 Enterprise Funds Risk Management Activities 161 Implications for Other Funds 162 Illustrative Case—Water Utility Fund 164

Establishment and Operation of Internal Service Funds 157 Illustrative Case—Supplies Fund 157

Debt Service Funds

Acquisition of General Fixed Assets by Lease Agreements 130 Construction of General Fixed Assets Financed by Special Assessment Debt 131 The Modified Accrual Basis—As Applied to Debt Service Funds 132 Additional Uses of Debt Service Funds 133 Debt Service Accounting for Serial Bonds 133 Illustrative Case—Regular Serial Bonds 134

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Proprietary Fund Financial Statements 168

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Summary 176

Statement of Net Assets 170 Statement of Revenues, Expenses, and Changes in Fund Net Assets 170 Statement of Cash Flows 170 Accounting for Municipal Solid Waste Landfills 174 Pollution Remediation Costs 175

Other Issues Involving Payment of Long-Term Debt 136

Permanent Funds 138 Financial Reporting for Governmental Funds 140 Balance Sheet—Governmental Funds 140 Statement of Revenues, Expenditures, and Changes in Fund Balances— Governmental Funds 144

Debt Service Accounting for Deferred Serial Bonds 136 Debt Service Accounting for Term Bonds 136 Debt Service Accounting for Capital Lease Payments 137 Bond Refundings 137

Chapter Seven FIDUCIARY (TRUST) FUNDS 189
Agency Funds
Tax Agency Funds 192 Accounting for Tax Agency Funds Financial Reporting for Agency Funds 194

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Private-Purpose Trust Funds

Investment Trust Funds 199 Public Employee Retirement Systems (Pension Trust Funds) 200 Accounting and Reporting for Defined Benefit Pension Plans 201

Accounting for Investments 194 Illustrative Case—Private-Purpose Trust Funds 197 A Note about Escheat Property 199

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Summary

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Contents

A Final Comment on Fund Accounting and Reporting 209

A Note about Other Postemployment Benefits 205 Summary of Employer Reporting 206 A Note about IRS 457 Deferred Compensation Plans 209

Accounting for General Capital Assets, Including Infrastructure 248 The Modified Approach for Reporting Infrastructure 249 Collections 250 Asset Impairment 251 Types of General Long-Term Debt 252 Debt Disclosures and Schedules

Accounting for Long-Term Debt

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Chapter Eight GOVERNMENT-WIDE STATEMENTS, FIXED ASSETS, LONG-TERM DEBT 220 Conversion from Fund Financial Records to Government-wide Financial Statements 221 Capital Asset–Related Entries 223 Long-Term Debt–Related Entries 228 Adjusting to Convert Revenue Recognition to the Accrual Basis 229 Adjusting Expenses to the Accrual Basis 231 Adding Internal Service Funds to Governmental Activities 231 Eliminating Interfund Activities and Balances within Governmental Activities 236 Worksheet to Illustrate the Adjustments 237

Chapter Nine ACCOUNTING FOR SPECIAL-PURPOSE ENTITIES, INCLUDING PUBLIC COLLEGES AND UNIVERSITIES 267 Gasb Statement 34 Reporting Rules for Special-Purpose Entities 267 Reporting by Special-Purpose Local Governments Engaged in Governmental Activities 268 Reporting by Special-purpose Local Governments Engaged Only in Business-type Activities 270 Reporting by Special-purpose Local Governments Engaged Only in Fiduciary-type Activities 273

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Accounting and Financial Reporting for public Colleges and Universities 274

Government-wide Financial Statements 237

Summary 247 Appendix: Accounting for Capital Assets and Long-Term Debt in Governmental Activities 248

Statement of Net Assets 237 Statement of Activities 241 Required Reconciliation to Government-wide Statements 244

Summary

The Environment of Public Higher Education 274 Accounting and Financial Reporting for Public Institutions of Higher Education 275 Illustrative Case—Northern State University—Beginning Trial Balance 276 Illustrative Case—Journal Entries 278 Illustrative Case—Closing Entries 284 Illustrative Case—Financial Statements 286

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Chapter Ten ACCOUNTING FOR PRIVATE NOT-FOR-PROFIT ORGANIZATIONS 300 Organizations Covered in this Chapter 302 Overview of Not-for-Profit Accounting 302

Split-Interest Agreements 348 Summary—Private College and University Reporting 353

Illustrative Transactions 341 Illustrative Financial Statements for Private Colleges and Universities 348

Illustrative Transactions and Financial Statements 308
Beginning Trial Balance 308 Transactions 309 Financial Statements 315 Alternative Procedure for Recording Fixed Assets 320 Mergers and Acquisitions

Three Classes of Net Assets 302 Financial Reporting 303 Note Disclosures 304 Accounting for Contributions, Including Reclassifications of Net Assets 304 Reporting of Expenses and Assets 305 Special Topics: Accounting for Contributions 306

Chapter Twelve ACCOUNTING FOR HOSPITALS AND OTHER HEALTH CARE PROVIDERS 362 Accounting and Reporting Requirements of the Health Care Guide 364 Financial Statements Revenues 366 Classifications 366 364

Beginning Trial Balance 367 Apago PDF Enhancer for Private-Sector Illustrative Statements

Illustrative Transactions and Financial Statements 367

Performance Evaluation

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Summary of Not-for-Profit Accounting and Reporting 323

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Chapter Eleven COLLEGE AND UNIVERSITY ACCOUNTING—PRIVATE INSTITUTIONS 335 Overview of Private College and University Accounting 337

Financial Reporting for Governmental Health Care Entities 375 Financial Reporting for Commercial (For-Profit) Health Care Entities 378 Summary and Conclusions Regarding Health Care Accounting and Reporting 378

Not-for-Profit Health Care Entities 373

Illustrative Transactions and Financial Statements 341

Financial Statements 337 Net Asset Classification 338 Revenue Reduction versus Expenses 339 Academic Terms Encompassing More Than One Fiscal Year 339 Expenses 339 Other Accounting Guidance 340

Chapter Thirteen AUDITING, TAX-EXEMPT ORGANIZATIONS, AND EVALUATING PERFORMANCE 386 Governmental Auditing
The Single Audit Act and Amendments 393 The Sarbanes-Oxley Act 396 Applying for Tax-Exempt Status 398 Federal Filing Requirements 398

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Tax-Exempt Organizations

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Evaluating Performance

State Filing Requirements 401 Unrelated Business Income Tax (UBIT) 401 IRS Oversight 403 Summary and Some Conclusions Related to Exempt Entities 403 Analysis of Not-for-Profit Organization Financial Statements 404 Analysis of State and Local Government Financial Statements 405 Service Efforts and Accomplishments Reporting 410

404

Consolidated Financial Report of the U.S. Government 425 Budgetary and Proprietary Accounting 429 Budgetary Accounts 429 Proprietary Accounts 432

Statement of Net Cost 423 Statement of Changes in Net Position 423 Statement of Budgetary Resources 424 Statement of Custodial Activity 425

Summary of Federal Government Reporting 432 Appendix: Illustrative Example 433

Chapter Fourteen FINANCIAL REPORTING BY THE FEDERAL GOVERNMENT 420 Federal Government Accounting Standards 421 Financial Reporting by Federal Agencies 422 Balance Sheet 423

Glossary: Governmental and Not-for-Profit Accounting Terminology G-1 Index I-1

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Chapter One
Introduction to Accounting and Financial Reporting for Governmental and Not-For-Profit Organizations The truth is that all men having power ought to be mistrusted. If men were angels, no government would be necessary. If angels were to govern men, neither external nor internal controls on government would be necessary. James Madison, fourth president of the United States and principal author of the U.S. Constitution Learning Objectives • Obtain an overview of financial reporting for nonbusiness entities. • Distinguish between private and public sector organizations. • Identify the sources of authoritative accounting standards for various public and private sector organizations. • Define the 11 fund types used by state and local governments.

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n its relatively short existence, the United States has grown to be the largest and most successful economy in history. Why then would a country founded on the principles of free markets and private investment rely on governments to provide many goods and services? The answer lies in understanding the incentives of a free enterprise economy. There are many services that simply cannot be priced in a

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way that naturally encourages commercial entrepreneurs to enter the marketplace. Commonly this is because the service is subject to free-riding. For example, public safety and a clean environment benefit every citizen, whether or not they contribute to its cost. Because there is no practical means for businesses to sell this service, governments are called upon through the political process to provide those services that citizens demand. In other instances, free market incentives do not align with public interest. For example, society finds it desirable to provide a K–12 education to all its citizens, not just those with the ability to pay.1 Although the majority of products and services are provided by either businesses or governments, in some circumstances private organizations are formed to provide goods or services without the intent of earning a profit from these activities. Examples include public charities, trade associations, and civic groups. Again, the goods or services they provide often cannot be priced in a way that encourages commercial entrepreneurship. For example, a public radio broadcast cannot be effectively restricted to only those individuals choosing to support the public radio station. While this explains why the services are not provided by businesses, why aren’t governments called upon to provide them? In some instances, obstacles exist that prevent government involvement. For example, the U.S. Constitution provides for separation of church and state. Therefore, any group that wishes to promote religious activities must do so through private organizations rather than through government. More commonly the reason is lack of political influence. Support for the arts may be important to a group of individuals but unless that group is sufficiently large to influence the political process, it is unlikely that elected officials will use government funds for that purpose. However, support for the arts could still be provided by forming a charitable foundation with no relationship to the government and having the foundation solicit donations from that segment of the public who finds the arts important. The organizations introduced in the preceding paragraphs are the focus of this book: governmental and not-for-profit organizations. They are distinguished from commercial businesses by the absence of an identifiable individual or group of individuals who hold a legally enforceable residual claim to the net assets. Throughout the text a distinction will be made between public and private organizations. Public organizations are owned or controlled by governments. Private organizations are not owned or controlled by governments and include businesses as well as private not-for-profit organizations. Not-for-profit organizations lack a residual ownership claim and the organization’s purpose is something other than to provide goods and services at a profit. Because significant resources are provided to governments and not-for-profit organizations, financial reporting by these organizations is important. To paraphrase the James Madison quotation provided at the beginning of the chapter, because humans (not angels) operate governments, controls are necessary. Financial reports that reflect the policies and actions of governmental managers are an effective means to control the actions of those entrusted with public resources. To be effective, external financial reports must be guided by a set of generally accepted accounting

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The branch of economics that studies the demand for government services is termed public choice.

Introduction to Accounting and Financial Reporting

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principles. The generally accepted accounting principles for governmental and private not-for-profit organizations are the subject of this book. The first nine chapters of the text deal with public sector (state and local government) organizations and Chapters 10, 11, and 12 deal primarily with private not-for-profit organizations. Chapter 13 discusses auditing and tax-related issues unique to governments and private not-for-profits and also evaluates performance of these entities. Chapter 14 describes financial reporting by the federal government.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
Organisms evolve in response to characteristics of their environment. Similarly, accounting principles evolve over time as people find certain practices useful for decision making. Further, we expect organisms in different environments to evolve differently. Similarly, if the environments in which governments and not-for-profits operate differ in important ways from that of commercial enterprises, we would expect the accounting practices to evolve differently. The Governmental Accounting Standards Board published a document titled Why Governmental Accounting and Financial Reporting Is—and Should Be— Different (http://www.gasb.org/white_paper_full.pdf). This white paper identifies five environmental differences between governments and for-profit business enterprises and describes how those differences manifest in differences in the objectives and practice of financial reporting.

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1. Organizational Purposes. While the purpose of a commercial business is to generate a profit for the benefit of its owners, governments exist for the well-being of citizens by providing public services—whether or not the services are profitable undertakings. Since taxes and many other government revenues are not equivalent to sales, the excess of revenues over expenses cannot be interpreted as an effectiveness measure in the manner of business net income. Whereas the purpose of government operations differs greatly from commercial businesses, the purpose of governmental accounting is the same—to provide information that is useful to stakeholders in making decisions. However, governments have vastly different sets of users of accounting information. Like businesses, governments have creditors who are interested in assessing the creditworthiness of the government. Citizens and businesses, both within the government’s jurisdiction and those considering relocation to the jurisdiction, are also stakeholders who rely on governmental reporting to make economic decisions. In addition, governments receive resources from other governments and grantors who may require financial reports and audits as a condition of the grant. Since this diverse set of resource providers have varying interests, the information needs of one group may not meet the needs of another. The result is that governments report far more disaggregated information than commercial enterprises. 2. Sources of Revenues. Net income is a universally accepted measure of business performance. The calculation of net income begins with sales. A sale

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occurs when an independent party perceives that the service offered both provides value and is fairly priced. Net income then simply determines whether this measure of demand (sales) exceeds the cost of providing the service and is an accepted measure of performance for business organizations. On the other hand, governments derive many of their resources from taxes. Individuals and businesses pay taxes to avoid penalty, not voluntarily because they perceive government services to be of value and fairly priced. Since taxes do not involve an earnings process, the timing of the recognition of tax revenue is not always clear. 3. Potential for Longevity. Because the U.S. and state constitutions grant state and local governments the ability to tax, governments very rarely go out of business. This long-term view of operations changes the focus of accounting from one of near-term recovery of amounts invested in assets to a longer-term focus on the sustainability of services and the ability to meet future demand. As a result, shortterm fluctuations in the value of assets or liabilities are less likely to be recognized in government financial statements. For example, changes in the fair value of assets in employee pension plans are not recognized in the short term. 4. Relationship with Stakeholders. Taxes are generated through the legislative process by officials elected by the citizens. Because citizens and businesses are then required to pay these taxes, governments have an obligation to demonstrate accountability for these public funds. Whereas a business can use its resources as it deems appropriate, governments frequently receive resources that are restricted to a particular purpose. For example, a city may collect a telephone excise tax legally restricted to operating a 911 emergency service. In an effort to provide assurance that resources are used according to legal or donor restrictions, governments use fund accounting. A fund represents part of the activities of an organization that is separated from other activities in the accounting records to more easily demonstrate compliance with legal restrictions or limitations. 5. Role of the Budget. Many businesses prepare budgets, but these are for planning and control purposes and are rarely made available to creditors or investors. In contrast, government budgets are expressions of public policy and often carry the authority of law, preventing public officials from spending outside their budgetary authority. The increased importance of budgets is reflected in government financial reports by a required report comparing budgeted and actual amounts.

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For these and other reasons, the accounting practices of governmental organizations evolved differently from those of businesses. As you will see in later chapters, the accounting practices of not-for-profit organizations more closely resemble those of commercial businesses. However, the not-for-profit environment shares some important characteristics with governments. Similar to governments, not-forprofits do not have residual owners. “Investors” in not-for-profits are diverse and include donors, volunteers, and members. In addition, as with governments, the excess of revenues over expenses is not an effective measure of organizational performance. Finally, like governments, not-for-profits receive resources with donorimposed restrictions.

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ILLUSTRATION 1–1
Reporting Organization

Summary of Standards-Setting Organizations
Standards Setting Board Federal Accounting Standards Advisory Board (FASAB) Governmental Accounting Standards Board (GASB) Governmental Accounting Standards Board (GASB) Financial Accounting Standards Board (FASB) Financial Accounting Standards Board (FASB)

Federal government State and local governments Public not-for-profits Private not-for-profits Investor-owned businesses

Further complicating this issue is the fact that we have three levels of government (federal, state, and local) and not-for-profits may be either publicly or privately owned. This is important because different standards-setting bodies have authority for establishing reporting standards for these groups. Illustration 1–1 summarizes the various organizational types and the bodies with primary standardsetting authority. Accounting and financial reporting standards for the federal government are recommended by the Federal Accounting Standards Advisory Board (FASAB). Recommendations of the FASAB are reviewed and become effective unless objected to by one of the principals, the U.S. Government Accountability Office (GAO), the U.S. Department of the Treasury, or the U.S. Office of Management and Budget (OMB). These standards apply to financial reports issued by federal agencies and to the Consolidated Financial Report of the United States Government. Accounting and financial reporting standards for the federal government are illustrated in Chapter 14. Accounting and financial reporting standards for state and local governments in the United States are set by the Governmental Accounting Standards Board (GASB). The GASB also sets accounting and financial reporting standards for governmentally related not-for-profit organizations, such as colleges and universities, health care entities, museums, libraries, and performing arts organizations that are owned or controlled by governments. Accounting and financial reporting standards for profit-seeking businesses and for nongovernmental not-for-profit organizations are set by the Financial Accounting Standards Board (FASB). The GASB and the FASB are parallel bodies under the oversight of the Financial Accounting Foundation (FAF). The FAF appoints the members of the two boards and provides financial support to the boards by obtaining contributions from business corporations; professional organizations of accountants and financial analysts; CPA firms; debt-rating agencies; and state and local governments. Because of the breadth of support and the lack of ties to any single organization or government, the GASB and the FASB are referred to as “independent standards-setting bodies in the private sector.” Standards set by the FASAB, GASB, and FASB are the primary sources of generally accepted accounting principles (GAAP) as the term is used in accounting and auditing literature. FASAB, GASB, and FASB standards are set forth primarily in documents called Statements. From time to time, the boards find it necessary to expand on standards

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in documents called Interpretations. Boards also issue Technical Bulletins to explain the application of standards in certain situations or industries. Because FASB, GASB, and FASAB Statements, Interpretations, and Technical Bulletins do not cover all possible transactions, government and not-for-profit entities may need to refer to other publications for guidance. However, these other publications do not take precedence over standards issued by the standard-setting boards. The result is that financial statement preparers follow a hierarchy of generally accepted accounting standards. Until recently this hierarchy was established by the American Institute of Certified Public Accountants (AICPA). However each of the standard-setting organizations has now published its own hierarchy of GAAP. This hierarchy is summarized in Illustration 1–2. The final category includes practices that have evolved within an industry without specific authoritative action by any standard-setting body. Some organizations possess certain characteristics of both governmental and nongovernmental not-for-profit organizations, and it is necessary to determine whether those organizations are governmental or nongovernmental for purposes of applying GAAP, in accord with the hierarchy shown in Illustration 1–2. For this reason, the FASB and GASB agreed upon a definition of a government. As reproduced in the AICPA Audit and Accounting Guide: Not-for-Profit Organizations, the definition is as follows: Public corporations and bodies corporate and politic are governmental organizations. Other organizations are governmental organizations if they have one or more of the following characteristics: a. 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; b. The potential for unilateral dissolution by a government with the net assets reverting to a government; or c. The power to enact and enforce a tax levy. Furthermore, organizations are presumed to be governmental if they have the ability to issue directly (rather than through a state or municipal authority) debt that pays interest exempt from federal taxation.

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OBJECTIVES OF ACCOUNTING AND FINANCIAL REPORTING
All three standards-setting organizations—the Federal Accounting Standards Advisory Board, the Financial Accounting Standards Board, and the Governmental Accounting Standards Board—take the position that the establishment of accounting and financial reporting standards should be guided by conceptual considerations so that the body of standards is internally consistent and the standards address broad issues expected to be of importance for a significant period of time. The cornerstone of a conceptual framework is said to be a statement of the objectives of financial reporting.

ILLUSTRATION 1–2

GAAP Hierarchy
GASB Statement 55 State and Local Governments FASAB (Exposure Draft) Federal Government and Agencies • FASAB Statements and Interpretations, • AICPA and FASB pronouncements specifically made applicable to federal governmental entities by FASAB Statements or Interpretations. • FASAB Technical Bulletins and, • if specifically made applicable to federal governmental entities by the AICPA and cleared by the FASAB, AICPA Industry Audit and Accounting Guides and Statements of Position. • AICPA AcSEC Practice Bulletins if cleared by the FASAB. • Technical releases of the FASAB Accounting and Auditing Policy Committee. • Implementation guides published by the FASAB staff, and • practices that are widely recognized and prevalent in the federal government.

Category

FASB Statement 162 Nongovernmental Entities (commercial and private not-for-profits) • FASB Statements and Interpretations, • FASB Staff Positions, and • AICPA Accounting Research Bulletins and Accounting Principles Board Opinions that are not superseded by actions of the FASB. • FASB Technical Bulletins and, • if cleared by the FASB, AICPA Industry Audit and Accounting Guides and Statements of Position.

• GASB Statements and Interpretations.

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A.

B.

• GASB Technical Bulletins and, • if cleared by the GASB, AICPA Industry Audit and Accounting Guides and Statements of Position. • AICPA Practice Bulletins that have been cleared by the GASB.

C.

• AICPA Practice Bulletins that have been cleared by the FASB, and • consensus positions of the FASB Emerging Issues Task Force. • Implementation guides (Q&As) published by the FASB staff, • AICPA Accounting Interpretations, Industry Audit and Accounting Guides and Statements of Position not cleared by the FASB, and • practices that are widely recognized and prevalent either generally or in the industry.

D.

• Implementation guides (Q&As) published by the GASB staff, and • practices that are widely recognized and prevalent in state and local governments.

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Objectives of Accounting and Financial Reporting for the Federal Government The Federal Accounting Standards Advisory Board (FASAB) was established to recommend accounting and financial reporting standards to the principals—the U.S. Office of Management and Budget, the U.S. Department of the Treasury, and the U.S. Government Accountability Office. The FASAB has issued six Statements of Federal Financial Accounting Concepts (SFFACs). These concepts apply to financial reporting for the federal government as a whole and for individual reporting agencies. SFFAC 1, Objectives of Federal Financial Reporting, outlines four objectives that should be followed in federal financial reporting. The first, budgetary integrity, indicates that financial reporting should demonstrate accountability with regard to the raising and expending of moneys in accord with the budgetary process and laws and regulations. The second, operating performance, suggests that financial reporting should enable evaluation of the service efforts, costs, and accomplishments of the reporting entity. The third, stewardship, reflects the concept that financial reporting should enable an assessment of the impact on the nation of the government’s operations and investments. Finally, the fourth, systems and controls, indicates that financial reporting should reveal whether financial systems and controls are adequate. Other federal government accounting concept statements include: • SFFAC 2—Entity and Display, • SFFAC 3—Management’s Discussion and Analysis, • SFFAC 4—Intended Audience and Qualitative Characteristics for the Consolidated Financial Report of the United States Government, • SFFAC 5—Definitions of Elements and Basic Recognition Criteria for AccrualBasis Financial Statements, and • SFFAC 6—Distinguishing Basic Information, Required Supplementary Information, and Other Accompanying Information.

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Objectives of Financial Reporting by Not-for-Profit Entities FASB has issued seven concepts statements, including one dedicated to nonbusiness entities. In its Statement of Financial Accounting Concepts No. 4, the FASB identifies the information needs of the users of nonbusiness financial statements. These include providing information that is useful to present and potential resource providers in the following: • Making decisions about the allocation of resources to those organizations, • Assessing the services that a nonbusiness organization provides and its ability to continue to provide those services, • Assessing management’s stewardship and performance, and • Evaluating an organization’s economic resources, obligations, and effects of changes in those net resources.

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Objectives of Accounting and Financial Reporting for State and Local Governmental Units The Governmental Accounting Standards Board was established in 1984 as the successor to the National Council on Governmental Accounting (NCGA). In 1987 the GASB issued its Concepts Statement No. 1, Objectives of Financial Reporting, for state and local governments. In that statement the Board noted the following: Accountability requires governments to answer to the citizenry—to justify the raising of public resources and the purposes for which they are used. Governmental accountability is based on the belief that the citizenry has a right to know, a right to receive openly declared facts that may lead to public debate by the citizens and their elected representatives. Financial reporting plays a major role in fulfilling government’s duty to be publicly accountable in a democratic society.2

Financial reports of state and local governments, according to the Governmental Accounting Standards Board, are used primarily to: (1) compare actual financial results with the legally adopted budget; (2) assess financial condition and results of operations; (3) assist in determining compliance with finance-related laws, rules, and regulations; and (4) assist in evaluating efficiency and effectiveness. Concepts Statement No. 3, Communication Methods in General Purpose External Financial Reports that Contain Basic Financial Statements, was issued in 2005. The Statement defines methods of presenting information in financial reports and presents the following disclosure hierarchy: 1. Recognition in the basic financial statements: Assets, liabilities, revenues, expenses or expenditures, and other elements of a financial statement that can be measured with sufficient reliability should be recorded in the financial statements. 2. Disclosure in notes to the financial statements: Notes enhance the user’s understanding of items in the financial statements and may include management’s objective explanations. Disclosure in the notes is not an adequate substitute for recognition in the financial statements when an event can be measured reliably. 3. Presentation as required supplementary information (RSI): RSI is information the GASB has determined is essential for placing financial statement and note information in an appropriate context. The information must be objective and does not include predictions or subjective assessments. 4. Presentation as (other) supplementary information: This is information that is useful (but not essential) for placing financial statement and note information in an appropriate context. The GASB does not require supplementary information, unless identified as RSI. Concepts Statement No. 4, Elements of Financial Statements provides key definitions, including: • Assets are resources with present service capacity that the government presently controls, 2

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Governmental Accounting Standards Board, Concepts Statement No. 1, Objectives of Financial Reporting (Norwalk, CT., 2001).

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• Liabilities are present obligations to sacrifice resources that the government has little or no discretion to avoid, • Net position is the residual of all other elements presented in a statement of financial position, • Inflows of resources are acquisitions of net assets by the government that are applicable to the reporting period, and • Outflows of resources are consumption of net assets by the government that are applicable to the reporting period. Concepts statements 2 and 5 relate to the reporting of service efforts and accomplishments reporting. These statements recognize the limitations of traditional financial statements which are not well designed for evaluating the government’s effectiveness in delivering public services. Service efforts and accomplishments reporting will be more fully described in Chapter 13.

STATE AND LOCAL GOVERNMENT FINANCIAL REPORTING
GASB Concepts Statements stress that accounting and reporting standards for state and local governments should meet the financial information needs of many diverse groups: citizen groups, legislative and oversight officials, and investors, and creditors. The Concepts Statements also make clear that reporting standards for governments recognize that decisions made by these groups involve political and social decisions as well as economic ones. Accordingly, governmental financial reporting standards are much more inclusive than FASB standards, which consider the needs of only investors and creditors concerned with economic decisions.

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Comprehensive Annual Financial Report
The discussion of financial reporting in the GASB Codification Sec. 2200 sets standards for the content of the comprehensive annual financial report of a state or local government reporting entity. A comprehensive annual financial report (CAFR) is the government’s official annual report prepared and published as a matter of public record. In addition to the basic financial statements and other financial statements, the CAFR contains introductory material, an auditor’s report, certain RSI, schedules necessary to demonstrate legal compliance, and statistical tables. Chapter 2 presents an extensive discussion and illustration of the basic financial statements and the other major components of the CAFR. Illustration 1–3 presents an overview of the financial reporting process for state and local governments. While a business will typically have a single general ledger, the activities of governments are broken down into subunits called funds. A typical town or county government could have a dozen funds while cities and states

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ILLUSTRATION 1–3

Financial Reporting Process for State and Local Governments
Government-wide Statement of Net Assets and Statement of Activities

Combining Worksheet and Journal Entries Enterprise Funds

Internal Service Funds

Change to the Accrual Basis from Modified Accrual

Fund-basis Financial Statements: Governmental Activities

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Accounting Ledgers: Governmental Activities

Records of General Fixed Assets and Long Term Debt

Accounting Ledgers: Accounting Ledgers: Fiduciary Business-type Activities Activities

generally have many more. Each fund requires its own general ledger and general journal. These are represented at the bottom of Illustration 1–3. In addition, records are kept of general fixed assets and long-term debt. Governments have two levels of financial statement reporting. The first is the fund-basis financial statements. Fund-basis statements are presented for three categories of activities: governmental, proprietary, and fiduciary. These categories

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and the funds comprising each are described in detail later in this chapter. While the fund-basis statements present an in-depth record of individual activities of the government, it is difficult for the financial statement user to pull this disaggregated information together and form an overall view of the government’s finances. For that reason, governments are required to present government-wide financial statements. The government-wide statements combine the governmental and businesstype activities of the government for the purpose of presenting an overall picture of the financial position and results of operations of the government. An important feature of the government-wide financial statements is that they are prepared using a common measurement focus and basis of accounting.

Measurement Focus and Basis of Accounting
State and local governments prepare their financial reports using two general accounting methods. One method assumes an economic resources measurement focus and the accrual basis of accounting, and the other method assumes a flow of current financial resources measurement focus and modified accrual accounting. Each of these two methods is discussed below. Economic Resources Measurement Focus and the Accrual Basis of Accounting The government-wide statements and the fund statements for proprietary funds and fiduciary funds use the economic resources measurement focus and the accrual basis of accounting. Measurement focus refers to what items are being reported in the financial statements. An economic resource measurement focus measures both current and long-term assets and liabilities and is the measurement focus used by commercial businesses. A balance sheet prepared on the economic resource focus reports the balances in fixed assets and long-term liabilities. Basis of accounting determines when transactions and events are recognized in the accounting records. The accrual basis of accounting recognizes revenues when they are earned (and are expected to be realized) and recognizes expenses when the related goods or services are used up. Again, this is the basis of accounting used by commercial businesses.

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Current Financial Resources Measurement Focus and the Modified Accrual Basis of Accounting The fund statements for governmental funds are presented using the current financial resources measurement focus and modified accrual basis of accounting. Many of the transactions in governmental funds are nonexchange in nature; that is, they are activities undertaken in response to the needs of the public. Activities reported in governmental funds are heavily financed by taxes and involuntary contributions from persons (and organizations) who do not receive services in direct proportion to the contribution they make. GASB standards provide that accounting systems of governmental funds are designed to measure (a) the extent to which financial resources obtained during a period are sufficient to cover claims incurred during that period against financial resources and (b) the net financial resources available for future periods. Thus, governmental funds are said to have a flow of current financial resources measurement

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focus, as distinguished from the government-wide, proprietary fund, and fiduciary fund statements, which have a flow of economic resources measurement focus. Activities of governmental funds are said to be expendable; that is, the focus is on the receipt and expenditure of resources. These resources are further defined as expendable resources, generally but not totally restricted to current assets and liabilities. Modified accrual accounting, as the term implies, is a modification of accrual accounting. As will be discussed much more fully in Chapters 3, 4, and 5, revenues are generally recognized when measurable and available to finance the expenditures of the current period. Expenditures (not expenses) are recognized in the period in which the fund liability is incurred. Long-term assets, with minor exceptions, are not recognized; the same is true of most long-term debt. Capital (fixed) assets and long-term debt are not reported in governmental funds. It should be noted that governmental funds are reported using the modified accrual basis of accounting; however, governmental-type activities are reported in the government-wide statements using the accrual basis of accounting, including fixed assets and long-term debt. As shown in Illustration 1–3, the governmental activities fund-basis financial statements and the records of general fixed assets and long-term debt serve as inputs to the government-wide financial statements. The governmental activities balances are changed through combining worksheets and journal entries to reflect an economic resource measurement focus and the accrual basis of accounting before being presented in the government-wide financial statements.

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Fund Structure for State and Local Government Accounting and Reporting Traditionally, state and local government financial reporting has been based on fund accounting. Fund accounting and reporting permit governmental managers to demonstrate compliance with legal and contractual requirements. Fund accounting and the term fund, are defined by the GASB as follows: Governmental accounting systems should be organized and operated on a fund basis. 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.3

Note that the definition of the word fund requires that two conditions must be met for a fund, in a technical sense, to exist: (1) there must be a fiscal entity—assets set aside for specific purposes, and (2) there must be a double-entry accounting entity created to account for the fiscal entity.

3

National Council on Governmental Accounting, Statement No. 1, par 2. (Norwalk, CT).

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State and local governments use 11 fund types. These fund types are organized into three categories: governmental funds, proprietary funds, and fiduciary funds. Governmental Funds Five fund types are classified as governmental funds: 1. The General Fund accounts for most of the basic services provided by the government. Technically, it accounts for and reports all financial resources not accounted for and reported in another fund. 2. Capital projects funds account for and report financial resources that are restricted, committed, or assigned to expenditure for capital outlays. As such, it accounts for the purchase or construction of major capital improvements, except those purchased or constructed by a proprietary (and less commonly, fiduciary) fund. 3. Debt service funds account for and report financial resources that are restricted, committed, or assigned to expenditure for principal and interest, other than interest or principal on proprietary or fiduciary activities. 4. Special revenue funds account for and report the proceeds of specific revenue sources that are restricted or committed to expenditure for a specified purpose other than debt service or capital projects. These include activities funded by federal or state grants or by taxes specifically restricted to certain activities. 5. Permanent funds account for and report resources that are restricted to the extent that only earnings, and not principal, may be used for purposes that support the reporting government’s programs.

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Every government will have a single General Fund but may have multiple funds in each of the other categories. Accounting for the General Fund and special revenue funds is discussed in Chapters 3 and 4, while capital project, debt service, and permanent fund accounting is illustrated in Chapter 5. Proprietary Funds Two types of funds used by state and local governments are classified as proprietary funds. The term indicates that the funds are used to account for a government’s ongoing organizations and activities that are similar to those often found in the commercial sector. Proprietary funds are discussed in Chapter 6. There are two types of proprietary funds: 1. Enterprise funds are used when resources are provided primarily through the use of sales and service charges to parties external to the government. Examples of enterprise funds include water and other utilities, airports, swimming pools, and transit systems. 2. Internal service funds account for services provided by one department of a government to another, generally on a cost-reimbursement basis. In some cases, these services are also provided to other governments. Examples of internal service funds include print shops, motor pools, and self-insurance funds.

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Fiduciary Funds Fiduciary funds, sometimes known as trust and agency funds, account for resources for which the government is acting as a collecting/ disbursing agent or as a trustee. Fiduciary funds are covered in Chapter 7. Four types of fiduciary funds exist: 1. Agency funds are used to account for situations in which the government is acting as a collecting/disbursing agent. An example would be a county tax agency fund, where the county collects and disburses property taxes for other taxing units within the county, such as independent school districts. 2. Pension (and other employee benefit) trust funds are used to account for pension and employee benefit funds for which the governmental unit is the trustee. 3. Investment trust funds account for the external portion of investment pools reported by the sponsoring government. 4. Private-purpose trust funds report all other trust arrangements under which principal and income benefit individuals, private organizations, or other governments. Illustration 1–4 summarizes the fund types, basis of accounting, and required fundbasis financial statements for each fund category. The table is presented in reverse order to assist in identifying the appropriate fund to record a given transaction. Starting at the top, determine whether a given transaction is a fiduciary activity. If it is, identify which of the four fiduciary fund types is appropriate and do not consider

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ILLUSTRATION 1–4
Fund Category Fiduciary Fund

Summary of Funds Used by State and Local Governments
Basis of Accounting Accrual Fund-basis Financial Statements • Statement of Fiduciary Net Assets • Statement of Changes in Fiduciary Net Assets • Statement of Net Assets • Statement of Revenues, Expenses, and Changes in Net Assets • Statement of Cash Flows • Balance Sheet • Statement of Revenues, Expenditures, and Changes in Fund Balances

Private-Purpose Trust Investment Trust Pension Trust Agency Internal Service Enterprise

Proprietary

Accrual

Governmental

Permanent Debt Service Capital Project Special Revenue General

Modified accrual

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the proprietary or governmental-type funds. If it is not fiduciary, determine whether it is a proprietary activity, and if it is, determine whether it is internal service or enterprise. Any transaction that is not fiduciary or proprietary must be a governmental activity. Again, start at the top of the governmental activity funds and determine first whether the transaction meets the definition of a permanent fund. If it does not, move down through the list. Any transaction that has not been identified as a permanent, debt service, capital projects, or special revenue fund transaction must be accounted for in the General Fund.

Number of Funds Required
In the GASB Summary Statement of Principles, the principle that follows the definition of fund types is often overlooked. This principle states that governmental units should establish and maintain those funds required by law and sound financial administration. If state law and/or agreements with creditors do not require the receipt of revenues that are raised solely for a defined purpose and if administrators do not feel that use of a separate fund is needed to be able to demonstrate that revenues were raised solely for that particular purpose, the General Fund should be used.

Budgetary Accounting
GASB standards recognize that state laws generally require administrators of state agencies and of local governmental units to obtain the appropriate legislative body’s formal approval of all plans to raise revenues and make expenditures. Additionally, it is common for state agencies to be given the responsibility for monitoring the financial plans and financial operations of local governmental units within the state. Therefore, GASB standards contain the following three-part budgetary principle:

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1. An annual budget(s) should be adopted by every governmental unit. 2. The accounting system should provide the basis for appropriate budgetary control. 3. Budgetary comparisons should be included in the appropriate financial statements and schedules for governmental funds for which an annual budget has been adopted. Part 1 of the principle is not an accounting or financial reporting principle, but it is a necessary precondition to parts 2 and 3. A budget, when adopted according to procedures specified in state laws, is binding upon the administrators of a government. Accordingly, a distinctive characteristic of governmental accounting is the formal reporting of the legally approved budget compared with actual results for the General Fund and all major special revenue funds that have a legally adopted annual budget. This report is included as a part of required supplementary information (RSI) in the CAFR. The nature and operation of accounting and budgetary reporting are explained in appropriate detail in Chapter 3.

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ADDITIONAL RESOURCES
Individuals interested in studying the original sources of GAAP may consult the GASB Codification.4 The Codification lists GASB pronouncements by topic; alternatively, you may consult the GASB Original Pronouncements that provide the information in statement order.5 All of these sources are described on the GASB Web site (www.gasb. org) which also provides information regarding current activities, including exposure drafts of new standards. The American Institute of Certified Public Accountants (AICPA) provides guidance regarding state and local governmental accounting and auditing, especially in its Audit and Accounting Guide: State and Local Governmental Units.6 The AICPA Web site is www.aicpa.org. The Government Finance Officers Association of the United States and Canada (GFOA) is the professional organization of the preparers of governmental financial statements. Detailed guidance is available in their publication, Governmental Accounting, Auditing, and Financial Reporting.7 The GFOA Web site is www.gfoa.org. Now that you have finished reading Chapter 1, complete the multiple choice questions provided on the text’s Web site (www.mhhe.com/copley10e) to test your comprehension of the chapter.

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4

Governmental Accounting Standards Board, Codification of Governmental Accounting and Financial Reporting Standards (Norwalk, CT: GASB). 5 Governmental Accounting Standards Board, Original Pronouncements: Governmental Accounting and Financial Reporting Standards (Norwalk, CT: GASB). 6 American Institute of Certified Public Accountants, Audit and Accounting Guide: State and Local Governmental Units (New York, AICPA, 2007). 7 Stephen J. Gautier, Governmental Accounting, Auditing, and Financial Reporting Using the GASB 34 Model (Chicago: Government Finance Officers Association, 2001).

Questions and Exercises
1–1 Obtain a copy of a recent Comprehensive Annual Financial Report (CAFR). These may be obtained by writing the director of finance in a city or county of your choice. Your instructor may have one available for you, or you may obtain one from the GASB Web site: www.gasb.org. It would be best, but not absolutely necessary, to use a CAFR that has a Certificate of Excellence in Financial Reporting from the Government Finance Officers Association. You will be answering questions related to the CAFR in Chapters 1 through 9. Answer the following questions related to your CAFR. a. What are the inclusive dates of the fiscal year? b. Write the name and address of the independent auditor. Is the auditor’s opinion unqualified? If not, describe the qualification. Is the opinion

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1–2

1–3 1–4 1–5 1–6

1–7 1–8 1–9

limited to the basic financial statements, or does the opinion include combining and individual fund statements? c. Is the report separated into the three distinct sections: introductory, financial, and statistical? Does the report have a “single audit” section at the end? (A few CAFRs include their single audit report in the CAFR—see Chapter 13 for more detail of the single audit requirements.) d. Does the report contain an organization chart? A table of contents? A list of principal officials? A letter of transmittal? Is the letter of transmittal dated and signed by the chief financial officer? List the major items of discussion in the letter of transmittal. e. Does the report include a Management’s Discussion and Analysis? List the major items of discussion. f. Does the report include the government-wide statements (Statement of Net Assets and Statement of Activities)? g. Does the report reflect fund financial statements for governmental, proprietary, and fiduciary funds? List those statements. List the major governmental and proprietary funds (the funds which have separate columns in the governmental and proprietary fund statements). Identify and describe the five environmental differences between governments and for-profit business enterprises as identified in the Governmental Accounting Standards Board’s Why Governmental Accounting and Financial Reporting Is—and Should Be—Different. Identify and briefly describe the three organizations that set standards for state and local governments, the federal government, and nongovernmental notfor-profit organizations. What is the definition of a government as agreed upon by the FASB and GASB? Describe the “hierarchy of GAAP” for state and local governments, the federal government, and nongovernmental not-for-profit organizations. Accounting and financial reporting for state and local governments use, in different places, either the economic resources measurement focus and the accrual basis of accounting or the current financial resources measurement focus and the modified accrual basis of accounting. Discuss the differences in measurement focus and basis of accounting related to (a) the conceptual differences, (b) differences in revenue recognition, (c) differences in expense/ expenditure recognition, (d) differences in recognition of fixed assets, and (e) differences in the recording of long-term debt. Distinguish between private and public sector organization. GASB considers budgetary accounting and reporting to be important. List the principles outlined by GASB related to budgetary accounting and reporting. Go to the GASB Web site (www.gasb.org). What is the mission of GASB?

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1–10 For each of the items below, identify which fund would be used to account for the item and provide a justification for your answer. a. A city government issued general obligation bonds to finance the construction of a new jail. b. A state government collected a tax of $1.00 per pack of cigarettes which is (by law) required to be used to fund health and fitness programs in public schools. c. A county government expended $1 million to expand the water treatment plant. d. A donor provided investments totaling $4 million to create an endowment, the earnings of which will be used to provide scholarships. e. A donor provided $50,000 to be used to purchase newspaper and magazine subscriptions for the public library. There is no requirement that the original principal may not be spent. f. A city government sold surplus street maintenance trucks for $10,000.

Continuous Problem
1–C. Chapters 2 through 9 deal with specific knowledge needed to understand accounting and financial reporting by state and local governments. A continuous problem is available on the text’s Web site (www.mhhe.com/copley10e) to keep the entire accounting area in perspective. The problem assumes the government is using fund accounting for its internal record-keeping and then at year-end makes necessary adjustments to prepare the government-wide statements. The problem covers all of the funds of the City of Everlasting Sunshine. At appropriate stages, preparation of the fund and government-wide statements are required. The following funds are included in this series of problems.

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General Special revenue—Street and Highway Fund Capital projects—City Hall Annex Construction Fund Debt service—City Hall Annex Debt Service Fund Debt service—City Hall Debt Service Fund Internal service—Stores and Services Fund Enterprise—Water and Sewer Fund Agency—Tax Collection Fund Investment trust—Area Investment Pool Fund Private-purpose—Student Scholarship Fund Pension trust—Fire and Police Retirement Fund

Chapter Two
Overview of Financial Reporting for State and Local Governments Particulars on government expenditures and taxation should be plain and available to all if the oversight by the people is to be effective. Thomas Jefferson, third president of the United States and author of the Declaration of Independence Learning Objectives • Obtain an overview of the contents of a governmental financial report. • Define the governmental reporting entity. • Illustrate the basic financial statements for a state or local government.

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C

hapters 3 through 9 of this text describe and illustrate detailed accounting and financial reporting requirements for state and local governments. The purpose of this chapter is to provide background information so students may better understand the material that follows. This chapter presents a detailed look at financial statements and certain required schedules. State and local governments are encouraged to prepare a Comprehensive Annual Financial Report (CAFR). According to the GASB Codification Sec. 2200: A comprehensive annual financial report should be prepared and published, covering all funds and activities of the primary government (including its blended component units) and providing an overview of all discretely presented component units of the reporting entity—including introductory section, management’s discussion and analysis (MD&A), basic financial statements, required supplementary information other than MD&A, combining and individual fund statements, schedules, narrative explanations, and statistical section.

While governments are encouraged to prepare a complete CAFR, the GASB has identified a set of statements and disclosures that are required to be in compliance with generally accepted accounting principles (GAAP). The minimum required contents of a governmental financial report appear in Illustration 2–1.

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ILLUSTRATION 2–1

Required Contents of Governmental Financial Reports

1. Management’s Discussion and Analysis 2. Basic Financial Statements a. Government-wide Financial Statements Government-wide Statement of Net Assets—Illustration 2–5 Government-wide Statement of Activities—Illustration 2–6

b. Fund Basis Financial Statements Governmental Type Funds Balance Sheet—Illustration 2–7b Statement of Revenues, Expenditures and Changes in Fund Balances—Illustration 2–8b Reconciliation of governmental statements to government-wide statements— Illustration 2–7a and Illustration 2–8a Proprietary Funds Statement of Net Assets—Illustration 2–9 Statement of Revenues, Expenses and Changes in Fund Net Assets—Illustration 2–10 Statement of Cash Flows—Illustration 2–11 Fiduciary Apago Funds PDF Enhancer Statement of Fiduciary Net Assets—Illustration 2–12 Statement of Changes in Fiduciary Net Assets—Illustration 2–13

c. Notes to the Financial Statements—Illustration 2–14 3. Required Supplementary Information (Other than MD&A) Information about infrastructure assets using the modified approach—Illustration 2–15 Budgetary comparison schedule (General and major Special Revenue Funds)—Illustration 2–16 Schedule of funding progress of pension plans Schedule of employer contributions of pension plans Schedules required for external financing pools

The remainder of this chapter presents (1) a discussion of the financial reporting entity, (2) an overview of the CAFR contents, and (3) a detailed presentation of the Comprehensive Annual Financial Report, including illustrative statements.

THE GOVERNMENTAL REPORTING ENTITY
One of the most fundamental accounting issues is identifying the accounting entity. This is made more difficult by the fact that general-purpose governments such as states, counties, and large cities typically are complex organizations that include semiautonomous boards, commissions, and agencies created to accomplish projects

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or activities that, for one reason or another (generally restrictive clauses in state constitutions or statutes), may not be carried out by a government as originally constituted. For many years, separate annual reports were issued for each legal entity. GASB Statement 14, The Financial Reporting Entity, establishes that the financial reporting entity is the primary government together with its component units. The primary government can be a state government, a general-purpose local government such as a city or county, or a special purpose government such as a school district. Component units are legally separate organizations for which the elected officials of the primary government are financially accountable. In addition, a component unit can be an organization for which the nature and significance of its relationship with a primary government are such that exclusion would cause the reporting entity’s financial statements to be misleading or incomplete. Statement 14 provides guidance in determining when a primary government has financial accountability for another organization. First, the primary government either appoints a voting majority of the governing body of the other organization or members of the primary government’s governing body hold a majority of the seats of the other organization’s board. Second, the relationship meets one of the following two criteria: 1. The other organization provides either a financial burden or benefit to the primary government; or 2. The primary government can impose its will on the other organization. A financial burden exists, for example, if the primary government is responsible for liabilities or accumulated deficits of the other organization. A financial benefit exists, for example, if the primary government is entitled to the other organization’s assets. Examples of the ability to impose its will include the right to replace the other organization’s management or to approve its budget. Once it is determined that an organization is a component unit of a primary government, the issue becomes how to include its financial information in the primary government’s financial reports. GASB standards provide two methods for including component unit financial information with that of the primary government. The first is known as blending, because the financial information becomes part of the financial statements of the primary government. Blended organizations are reported as though they were funds of the primary government. Blending is appropriate only when the component unit is so intertwined with the primary government that they are in substance the same entity. This may be the case if the two entities’ governing boards are identical or if the component unit provides services solely to the primary government. More commonly, component units are reported using discrete presentation. In discrete presentation, the financial information of the component is presented in a column, apart from the primary government and not included in the totals reported for the primary government. Discretely presented component units appear as separate columns in the government-wide statements. If there is more than one component unit, combining statements are provided showing financial information for each component unit.

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Overview of Financial Reporting for State and Local Governments

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REPORTING BY MAJOR FUNDS
In addition to the government-wide statement, governments are required to prepare fund financial statements within the three categories of funds: governmental, proprietary, and fiduciary. Because governments may have many governmental and proprietary funds, governments are only required to present separate columns for each major fund. The General Fund is always considered a major fund. Other governmental funds are considered major when both of the following conditions exist: 1. total assets, liabilities, revenues, or expenditures of that individual governmental fund constitute 10 percent of the total for the governmental funds category, and 2. total assets, liabilities, revenues, or expenditures of that individual governmental fund are 5 percent of the total of the governmental and enterprise categories, combined. Similar tests are applied to determine major enterprise funds. Additionally, a government may designate any fund major if reporting that fund separately would be useful. Any funds not reported separately are aggregated and reported in a single column under the label nonmajor funds. If the reporting government is preparing a complete CAFR, a schedule showing the detail of nonmajor funds is provided in the other supplementary information section.

OVERVIEW OF THE COMPREHENSIVE ANNUAL FINANCIAL REPORT (CAFR) The Comprehensive Annual Financial Report has three major sections: introductory, financial, and statistical. The CAFR is to include blended component units and discretely presented component units. An outline of the CAFR was presented in Illustration 2–1. Information appearing in the CAFR is described and illustrated in the following sections, beginning with the Introductory Section, Illustration 2–2.

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Chapter 2

Example Comprehensive Annual Financial Report Introductory Section

Introductory Section
The Introductory Section of a CAFR includes the table of contents, a letter of transmittal from the preparer (typically the government’s Finance Director), a list of government officials, and an organizational chart. If a government received a Certificate of Achievement for Excellence in Financial Reporting from the Government Finance Officers Association in the prior year,1 the introductory section will include a reproduction of that certificate. The introductory section is not audited. ILLUSTRATION 2–2 Introductory Section of CAFR

Letter of Transmittal from the Finance Director

List of Government Officers

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Organizational Chart
CEO/General Manager Project Management Human Resources Information Services Finance and Administration

GFOA Certificate (if awarded)

Facilities

Marketing

Research & Development Customer Support Supply and Distribution

Manufacturing/ Production

1

The Government Finance Officers Association of the United States and Canada sponsors a Certificate program to encourage and promote excellent financial reporting. To receive that certificate, a government must have an unqualified audit opinion and have its report reviewed, using an extensive checklist, by independent reviewers who are experienced in financial reporting. See www.gfoa.org

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Example Comprehensive Annual Financial Report Financial Section: Auditor’s Report

Financial Section: Auditor’s Report
The auditor’s report (Illustration 2–3), placed at the beginning of the financial section, normally expresses an opinion on the basic financial statements. Like other audits, CPAs are required to conduct government audits according to auditing standards issued by the American Institute of Certified Public Accountants. In addition, specialized governmental auditing standards must be followed. These standards are issued by the Government Accountability Office (GAO). GAO is an agency of the federal government and is the investigative arm of Congress. Governmental auditing standards are discussed in more detail in Chapter 13. ILLUSTRATION 2–3 Independent Auditor’s Report

Kelly & Koch, LLC Certified Public Accountants We have audited the accompanying financial statements of the governmental activities, the business-type activities, the aggregate discretely presented component units, each major fund, and the aggregate remaining fund information of the City of Salem as of and for the year ended December 31, 2012, which collectively comprise the City’s basic financial statements as listed in the table of contents. These financial statements are the responsibility of the City of Salem’s management. Our responsibility is to express opinions on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinions. In our opinion, the financial statements referred to above present fairly, in all material respects, the respective financial position of the governmental activities, the business-type activities, the aggregate discretely presented component units, each major fund, and the aggregate remaining fund information of the City of Salem as of December 31, 2012, and the respective changes in financial position and cash flows, where applicable, thereof for the year then ended in conformity with accounting principles generally accepted in the United States of America.

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Additional paragraphs address required supplementary information, other supplementary information, and the statistical tables. Illustration 13–2 provides an example of a complete (unqualified) opinion. [Signature] [Date]

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Chapter 2

Example Comprehensive Annual Financial Report Financial Section: Required Supplementary Information Management’s Discussion and Analysis

Management’s Discussion and Analysis (MD&A)
The MD&A (Illustration 2–4) provides an opportunity for the government to provide, in plain terms, an overview of the government’s financial activities. This section is considered Required Supplementary Information, which means that it is required and entails some auditor responsibility, but not as much as the basic financial statements. Auditors review the material to establish that it is not misleading in relation to the basic statements but do not include the MD&A in the scope of the audit. A number of specific items must be included: 1. A brief discussion of the financial statements. 2. Condensed financial information derived from the government-wide financial statements, comparing the current year with the prior year. GASB Statement 34 identifies 14 specific items for discussion. 3. An analysis of the government’s overall financial position and results of operations to assist users in assessing whether financial position has improved or deteriorated as a result of the year’s operations. 4. An analysis of balances and transactions of individual funds. 5. An analysis of significant variations between original and final budget amounts and between final budget amounts and actual results for the General Fund. 6. A description of significant capital asset and long-term debt activity during the year. 7. A discussion by governments that use the modified approach to report infrastructure assets (discussed in Chapter 8), that includes: discussion of changes in the condition of infrastructure assets, comparison of assessed condition with the condition level established by the government, and disclosure of the difference between the amount needed to maintain infrastructure assets and the amount actually expended. 8. A description of any known facts, decisions, or conditions that would have a significant effect on the government’s financial position or results of operations.

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GASB Statement 37 makes it clear that MD&A is limited to the preceding eight items. However, governments may expand the discussion of these items if deemed appropriate.

Overview of Financial Reporting for State and Local Governments

27

Example Comprehensive Annual Financial Report Financial Section: Required Supplementary Information Management’s Discussion and Analysis Management’s Discussion and Analysis

ILLUSTRATION 2–4

Financial Highlights Highlights for the City of Salem’s government-wide Financial Statements

° ° °

The City’s total net assets of governmental activities were $38.4 million at December 31, 2012. Net assets for the business-type activities were $47.9 million. Total revenues of governmental activities exceeded total expenses by $3.3 million. The City’s total debt at December 31, 2012, was $62.2 million, a net increase of $6.5 million. The City issued $9.7 million in general obligation bonds during 2012 to renovate the courthouse.

Overview of the Financial Statements The financial section of this annual report consists of four parts: (1) management’s discussion and analysis, (2) the basic financial statements, (3) required supplementary information, and (4) other supplementary information. The basic financial statements include two kinds of statements that present different views of the City: of the City’s ° The government-wide financial statements provide readers with a broad overviewfinancial finances, including long-term and short-term information about the City’s overall status. fund focus on ° The City’s financial statementsdetail thanthe individual parts of the City government, reporting the operations in more the government-wide statements.

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Government-wide Financial Statements The government-wide financial statements report information about the City of Salem as a whole using accounting methods similar to those used by private-sector companies. The statement of net assets and the statement of activities are the government-wide statements. These statements include all of the government’s assets and liabilities using the accrual basis of accounting. All revenues and expenses are reported, regardless of when cash is received or paid. The City’s total net assets exceeded liabilities by $86 million at December 31, 2012. The largest portion of the City’s net assets (70%) reflects its investments in capital assets, less accumulated depreciation and any related outstanding debt used to acquire those assets. The City uses these assets to provide services to its citizens and customers, therefore these assets are not available for future spending. Presented below is a table comparing the three categories of net assets for the City’s governmental, business-type, and component unit activities for fiscal years 2011 and 2012. Management’s discussion and analysis continues typically for 10 or more pages.

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Chapter 2

Example Comprehensive Annual Financial Report Financial Section: Basic Financial Statements Government-wide Financial Statements: Statement of Net Assets

Statement of Net Assets
The Statement of Net Assets (Illustration 2–5) presents the asset, liability, and net asset balances (measured on the accrual basis and economic resources measurement focus) for the entity’s governmental and business-type activities. Together, the governmental and business activities comprise the primary government. Similar information is presented in a separate column for the government’s discretely presented component units. Fiduciary activities, however, are not included in the governmentwide statements. Prior year balances may be presented, but are not required. Assets are generally reported in order of liquidity. A classified approach (presenting separate totals for current and noncurrent items) may be used, but is not required. Note in particular that capital assets (property and equipment) are presented in the governmental activities column. This will not be the case when we examine the governmental fund basis financial statements. The capital assets include infrastructure and are reported net of accumulated depreciation. Similarly, long-term debt is presented in the governmental activities column of the government-wide Statement of Activities, but is not presented for governmental funds in the fund basis balance sheet. The difference between assets and liabilities is called net assets and is reported in three categories. Invested in capital assets, net of related debt is computed by taking the capital assets, less accumulated depreciation, and deducting outstanding debt that is related to the financing of capital assets. Liabilities incurred to finance operations (including long-term liabilities for compensated absences or employee benefits) would not be deducted. Restricted net assets include resources that are restricted by (a) external parties, including creditors, grantors, contributors, or by laws or regulations of other governments; or (b) laws or constitutional provisions of the reporting government. The remaining amount, unrestricted net assets, is a “plug” figure that is determined by deducting the balances of the other two categories from the overall excess of assets over liabilities.

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Overview of Financial Reporting for State and Local Governments

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Example Comprehensive Annual Financial Report Financial Section: Basic Financial Statements Government-wide Financial Statements: Statement of Net Assets

ILLUSTRATION 2–5

Statement of Net Assets CITY OF SALEM
Statement of Net Assets As of December 31, 2012 Primary Government

Assets Cash and cash equivalents Investments Inventory Receivables (net): Taxes receivable Accounts receivable Due from other governments Restricted assets Capital assets (net of accumulated depreciation) Total assets Liabilities Accounts payable Accrued liabilities Noncurrent liabilities due within one year Noncurrent liabilities due in more than one year Total liabilities Net assets Invested in capital assets net of related debt Restricted Unrestricted TOTAL NET ASSETS

Governmental Activities $ 8,242,998 3,312,992 1,072,963 2,872,611 722,215 1,328,448 3,933,126

Business-type Activities $ 4,814,724 10,350,334 30,779 ——— 2,657,326 ——— 2,295,043

Primary Government $13,057,722 13,663,326 1,103,742 2,872,611 3,379,541 1,328,448 6,228,169

Component Units $ 84,733 ——— ——— ——— ——— ——— ——— 11,197,985 11,282,718 710 ——— ——— ——— 710

Apago PDF 48,894,402 114,584,775 Enhancer 65,690,373
87,175,726 2,425,447 4,340,108 2,164,521 39,834,882 48,764,958 69,042,608 493,849 473,168 1,342,717 18,858,187 21,167,921 156,218,334 2,919,296 4,813,276 3,507,238 58,693,069 69,932,879

23,690,970 3,933,126 10,786,672 $38,410,768

28,693,498 ——— 19,181,189 $47,874,687

52,384,468 3,933,126 29,967,861 $86,285,455

11,197,985 ——— 84,023 $11,282,008

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Chapter 2

Example Comprehensive Annual Financial Report Financial Section: Basic Financial Statements Government-wide Financial Statements: Statement of Activities

Government-wide Statement of Activities
Note the general format of the Statement of Activities (Illustration 2–6). Expenses are measured on the accrual basis and reported first. Expenses for governmental activities are reported initially, followed by the business-type activities and the component units (reading from top to bottom). Direct expenses, including depreciation, are required to be reported by function (General Government, Judicial Administration, etc.). Although rarely done, governments may allocate indirect expenses to functions. However, the government is required to show a separate column for these allocated amounts. Depreciation that relates to assets serving multiple functions may be allocated as an indirect expense, charged in total to general government, or displayed in a separate line. Interest on long-term debt would be included in direct expenses if the interest related to a single function. Most interest, however, cannot be identified with a single function and should be shown separately. Interest incurred during construction of capital projects is capitalized and included in the capital asset on the Statement of Net Assets. Revenues that can be directly associated with functions are deducted, and a net expense or revenue is presented. General revenues are presented in the lower righthand section of the statement, and the change in net assets is computed. General revenues include tax revenues and those revenues that are not associated directly with a particular function or program. All taxes levied by the government, including those restricted to a particular purpose, are reported as general revenues. Program revenues include charges for services, operating grants, taxes levied by a state and shared with the local government, and capital grants and contributions. Charges for services include charges by enterprise funds as well as fines and forfeits. Grants and contributions are typically resources provided by other governments. Contributions to endowments and extraordinary items (items that are both unusual and infrequent) are reported separately after general revenues. However, special items (items within the control of management but which are unusual in nature or infrequent in occurrence) are shown in a separate line within general revenues. The Statement of Activities is a consolidated statement within columns (governmental activities, business-type activities, and component units), which means that interfund services provided and used and transfers between two governmental funds are eliminated. Transfers between governmental and business-type activities are displayed in the general revenues section and offset.

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Financial Section: Basic Financial Statements Government-wide Financial Statements: Statement of Activities

ILLUSTRATION 2–6 Statement of Activities
CITY OF SALEM
Statement of Activities For the Year Ended December 31, 2012

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Primary Government Net (Expense) Revenue and Change in Net Assets Businesstype Activities $ ——— ——— ——— ——— ——— ——— ——— ——— ——— ——— 3,452,938 1,886,458 (220,762) 5,118,634 5,118,634 ——— ——— ——— ——— ——— 729,488 (615,062) 114,426 5,233,060 42,641,627 $47,874,687

Program Revenues Charges for Services $ 1,144,018 56,497 275,492 ——— ——— ——— 604,359 51,611 ——— 2,131,977 6,385,233 2,351,433 261,107 8,997,773 11,129,750 9,979 Operational Grants and Contributions $ 263,178 1,002,525 750,109 2,903,982 2,861,389 73,300 302,672 298,495 ——— 8,455,650 ——— 6,594 ——— 6,594 8,462,244 20,000

Functions/Programs Governmental activities General government Judicial administration Public safety Public works Health and welfare Education Parks and recreation Community development Interest on long-term debt Total governmental activities Business-type activities Water Solid waste Parking Total business-type activities Total primary government Component units Industrial development authority

Expenses $ 3,734,068 1,433,650 9,265,997 6,167,650 4,436,534 9,292,427 3,217,236 1,720,121 1,422,428 40,690,111 6,041,987 2,556,633 481,869 9,080,489 49,770,600 4,322,849

Capital Grants and Contributions $ ——— ——— 277,700 1,853,091 4,203 ——— 500 156,361 ——— 2,291,855 3,109,692 2,085,064 ——— 5,194,756 7,486,611 4,193,964

Governmental Activities $ (2,326,872) (374,628) (7,962,696) (1,410,577) (1,570,942) (9,219,127) (2,309,705) (1,213,654) (1,422,428) (27,810,629) ——— ——— ——— ——— (27,810,629) ——— 15,382,482 5,729,224 4,998,045 2,724,725 1,611,886 615,062 31,061,424 3,250,795 35,159,973 $38,410,768

Total $ (2,326,872) (374,628) (7,962,696) (1,410,577) (1,570,942) (9,219,127) (2,309,705) (1,213,654) (1,422,428) (27,810,629) 3,452,938 1,886,458 (220,762) 5,118,634 (22,691,995) ——— 15,382,482 5,729,224 4,998,045 2,724,725 2,341,374 ——— 31,175,850 8,483,855 77,801,600 $86,285,455

Component Units $ ——— ——— ——— ——— ——— ——— ——— ——— ——— ——— ——— ——— ——— ——— ——— (98,906) ——— ——— ——— ——— 1,172 ——— 1,172 (97,734) 11,379,742 $11,282,008

General revenues Property taxes Sales taxes Hotel and meals taxes Grants Miscellaneous Transfers Total general revenues Change in net assets Net assets, beginning Net assets, ending

31

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Chapter 2

Example Comprehensive Annual Financial Report Financial Section: Basic Financial Statements Governmental Funds Statements: Balance Sheet

Governmental Funds: Balance Sheet
Illustration 2–7b presents a Balance Sheet for the governmental funds, including the General, special revenue, capital projects, and debt service funds. The City of Salem does not have a permanent fund or it would be presented here as well. Each of the city’s governmental funds is considered a major fund and presented separately. If the city had multiple smaller funds, they would be aggregated and reported in a single column labeled nonmajor funds. The governmental fund statements are prepared using the current financial resources focus and the modified accrual basis of accounting. For this reason, capital assets and long-term debt do not appear on the balance sheet. The excess of assets over liabilities is labeled fund balance, an account title used only in the governmental funds. All other funds and the government-wide statements label the difference between assets and liabilities as net assets. Several features of the Balance Sheet should be noted. First, a total column is required. Secondly, fund balance is displayed within the categories of nonspendable, restricted, committed, assigned and unassigned. These will be more fully described in later chapters, but represent varying degrees of constraint placed on the use of the (net) resources of governmental funds. Finally, total fund balances reported in the total column ($12,922,626) must be reconciled to total net assets ($38,410,768) presented in the governmental activities column of the government-wide Statement of Net Assets. The reconciliation is presented separately in Illustration 2–7a (below). These amounts differ because the two statements have different bases of accounting and because most internal service funds are included in the governmental activities column on the government-wide statements

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ILLUSTRATION 2–7a Reconciliation to (Government-wide) Statement of Net Assets Fund Balance reported in the Governmental Funds Balance Sheet Amounts reported for governmental activities in the Statement of Net Assets are different because: Capital Assets used in government operations are not financial resources and therefore are not reported in the funds Some liabilities are not due and payable in the current period and are not reported in fund liabilities The assets and liabilities of internal service funds in included in governmental activities for the Statement of Net Assets Receivables on the statement of net assets that do not provide current financial resources are reported as deferred revenue in the funds. Net Assets of Governmental Activities in the Statement of Net Assets $12,992,626

65,621,772 (41,999,403) 436,475 1,359,298 $38,410,768

Example Comprehensive Annual Financial Report Financial Section: Basic Financial Statements Governmental Funds Statements: Balance Sheet

ILLUSTRATION 2–7b

Governmental Funds Balance Sheet CITY OF SALEM
Balance Sheet Governmental Funds As of December 31, 2012 Special Revenue Fund $627,837 ——— ———

Assets Cash and cash equivalents Investments Receivables (net) Taxes receivable Accounts Receivable Due from Other Governments Supplies inventory Restricted Assets TOTAL ASSETS Liabilities Accounts payable Accrued liabilities Deferred Revenues Total Liabilities Fund Balance Nonspendable - Supplies inventory Restricted - Intergovernmental grants - Bond sinking fund Committed - Rainy day fund - Courthouse renovation Assigned - School lunch program - Other capital projects - Other purposes Unassigned TOTAL FUND BALANCE TOTAL LIABILITIES AND FUND BALANCE

General Fund $6,408,214 3,312,992 2,872,611 679,215 1,085,184 23,747 3,933,126 $18,315,089

Courthouse Renovation Fund
——— ——— ———

Debt Service Fund
——— ——— ——— ——— ——— ———

Total Governmental Funds $8,161,351 3,312,992 2,872,611 693,392 1,328,448 23,747 3,933,126 $20,325,667

$895,300 $230,000

14,177
——— ——— ———

243,264
——— ———

642,014

1,138,564

230,000

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543,064 4,408,087 7,036,509
——— ———

——— ——— ——— ———

19,398
———

2,362,492 562,462 4,408,087 7,333,041

70,000

226,532

23,747
——— ———

———

———

——— ———

23,747 812,000 230,000 4,500,000 380,000 260,014 712,532 236,800 5,837,533 12,992,626

312,000
——— ——— ———

500,000
——— ———

230,000
——— ——— ——— ——— ——— ———

4,500,000
——— ———

380,000
———

260,014
——— ——— ———

680,500 236,800 5,837,533 11,278,580

32,032
——— ———

572,014

912,032

230,000

$18,315,089

$642,014 $1,138,564 $230,000

$20,325,667

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Chapter 2

Example Comprehensive Annual Financial Report Financial Section: Basic Financial Statements Governmental Funds Statements: Statement of Revenues, Expenditures, and Changes in Fund Balance

Governmental Funds: Statement of Revenues, Expenditures, and Changes in Fund Balance Illustration 2–8b presents the operating statement for the same governmental funds appearing in the balance sheet. Again, the statement is prepared using the current financial resources measurement focus and the modified accrual basis of accounting. Revenues are reported by source and expenditures (not expenses) are reported by character: current, debt service, and capital outlay. Within the current category, expenditures are presented by function: general government, judicial administration, public safety, and so on. Within the debt service category, expenditures are displayed as interest or principal. Following revenues and expenses, other financing sources and uses are displayed. These reflect interfund transfers and the proceeds of issuing debt. Most of the items appearing in this section are eliminated when preparing the government-wide financial statements. Like all operating statements, reconciliations to the balance sheet are required. In this case, the operating statement is reconciled to total fund balances by adding the beginning of year fund balance. The excess of revenues and other sources over expenditure and other uses ($1,485,357) is reconciled to the change in net assets ($3,250,795) for the governmental activities column in the government-wide statement of activities. This reconciliation would normally appear at the bottom of the statement of revenues, expenditures, and changes in fund balance, but is presented in Illustration 2–8a due to space considerations.

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ILLUSTRATION 2–8a Reconciliation to Statement of Activities Amounts reported for governmental activities in the Statement of Activities are different because of the following: Excess of revenues and other sources over (under) expenditures and other uses. Governmental funds report the cost of capital assets as expenditures, while they are capital assets in the government-wide statements. Debt proceeds provide current financial resources to the governmental funds but are liabilities in the government-wide statements. Depreciation is not recorded in the governmental funds, but is expensed in the Statement of Activities. Income earned by Internal Service funds is included in governmental activities on government-wide statements. Payments of principal on long-term debt are expenditures in the governmental funds but reduce the liability in the government-wide statements. Property taxes expected to be collected more than 60 days after year end are deferred in the governmental funds. Change in net assets of governmental activities

$(1,485,357) 10,924,818 (9,675,400) (1,691,116) 23,964 1,155,326 3,998,560 $3,250,795

Example Comprehensive Annual Financial Report Financial Section: Basic Financial Statements Governmental Funds Statements: Statement of Revenues, Expenditures, and Changes in Fund Balance

ILLUSTRATION 2–8b Governmental Funds Statement of Revenues, Expenditures, and Changes in Fund Balance
CITY OF SALEM
Statement of Revenues, Expenditures, and Changes in Fund Balances—Governmental Funds For the Year Ended December 31, 2012 General Revenues Property taxes $15,361,830 Other local taxes 11,761,522 Charges for services 1,601,435 Intergovernmental 7,098,698 Miscellaneous 1,262,549 Total revenues 37,086,034 Expenditures Current: General government 3,353,502 Judicial administration 1,456,734 Public safety 8,216,347 Public works 4,602,273 Health and welfare 4,418,294 Education 8,887,834 Parks and recreation 3,055,325 Community development 899,209 Capital outlay ——— Debt service: ——— Principal ——— Interest ——— Total expenditures $34,889,518 Revenues over (under) expenditures 2,196,516 Other financing sources (uses) Issuance of debt ——— Transfers from other funds Transfers (to) other funds (3,256,899) Total other financing sources (uses) (3,256,899) Excess of revenues and other sources over (under) expenditures and other uses (1,060,383) Fund balance— Beginning of Year 12,338,963 Fund balance—End of Year $11,278,580 Special Revenue $ ——— ——— 291,243 3,456,194 ——— 3,747,437 Courthouse Renovation $ ——— ——— ——— 441,548 ——— 441,548 Debt Service Total Governmental

$ ——— $15,361,830 ——— 11,761,522 ——— 1,892,678 ——— 10,996,440 ——— 1,262,549 ——— 41,275,019

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——— 1,981,144 ——— ——— ——— ——— ——— 1,093,804 ——— ——— ——— ——— 3,074,948

——— ——— ——— ——— ——— ——— ——— ——— 10,924,818 ——— ——— ——— 10,924,818

——— ——— ——— ——— ——— ——— ——— ——— ——— ——— 1,155,326 924,818 2,080,144

3,353,502 3,437,878 8,216,347 4,602,273 4,418,294 8,887,834 3,055,325 1,993,013 10,924,818 ——— 1,155,326 924,818 50,969,428 (9,694,409) 9,675,400 2,080,144 (3,546,492) 8,209,052

672,489 (10,483,270) ——— (289,593) (289,593) 9,675,400 ——— 9,675,400

(2,080,144) ——— 2,080,144 ——— 2,080,144

382,896 189,118 $572,014

(807,870) 1,719,902 $912,032

——— 230,000

(1,485,357) 14,487,983

$230,000 $12,992,626

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Chapter 2

Example Comprehensive Annual Financial Report Financial Section: Basic Financial Statements Proprietary Funds Statements: Statement of Net Assets

Proprietary Funds: Statement of Net Assets
Illustration 2–9 presents a Statement of Net Assets for the proprietary funds. Again, major funds must be presented in separate columns. An enterprise fund is considered major if: (a) assets, liabilities, revenues, or expenses are 10 percent or more of the total for all enterprise funds, and (b) its assets, liabilities, revenues, or expenses are 5 percent or more of the total of the governmental and enterprise categories, combined. In this case, the parking enterprise fund does not meet the requirements, but the government chooses to display it separately rather than label it a nonmajor fund. Internal service funds are also presented in a separate column in the proprietary fund statement of net assets. However, internal service funds do not follow the procedures described for major funds. Governments with more than one internal service fund combine the funds into one column for the Statement of Net Assets. Detailed financial statements for each internal service fund are included in the other supplementary information. The proprietary funds report using the economic resources measurement focus and the accrual basis of accounting. Since this is the same as the government-wide statements, reconciliations between the two sets of statements are typically not needed. In this example, you should be able to trace amounts reported in the total column for the enterprise funds to the business activities column of the statement of net assets. GASB requires a classified balance sheet where separate totals are reported for current and noncurrent assets and liabilities. Both noncurrent assets and liabilities are presented. The excess of assets over liabilities is reported as net assets, in the same manner as the government-wide statement of net assets. In particular, net assets are reported as: (1) invested in capital assets net of related debt, (2) restricted, or (3) unrestricted. Illustration 2–9 uses a “net asset” format (assets minus liabilities equal net assets), but a balance sheet format is also acceptable (assets equal liabilities plus net assets).

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Overview of Financial Reporting for State and Local Governments

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Example Comprehensive Annual Financial Report Financial Section: Basic Financial Statements Proprietary Funds Statements: Statement of Net Assets

ILLUSTRATION 2–9

Proprietary Funds: Statement of Net Assets CITY OF SALEM
Statement of Net Assets—Proprietary Funds As of December 31, 2012 Governmental Activities— Internal Service Fund $81,647 ——— 330,759 ——— ——— 28,824 ——— 441,230

Business-type Activities—Enterprise Funds Assets Water Solid Waste Parking Total Current assets: Cash and cash equivalents $3,801,978 $ 847,889 $164,857 $4,814,724 Investments 4,433,039 5,917,295 ——— 10,350,334 Inventory 30,779 ——— ——— 30,779 Receivables (net) ——— ——— ——— ——— Accounts receivable 2,307,643 342,394 7,289 2,657,326 Due from other funds ——— ——— ——— ——— Restricted assets 1,394,787 900,256 ——— 2,295,043 Total current assets 11,968,226 8,007,834 172,146 20,148,206 Noncurrent assets: Capital Assets (net of accumulated depreciation) 37,975,852 4,611,754 6,306,796 48,894,402 Total assets $49,944,078 $12,619,588 $6,478,942 $69,042,608 Liabilities Current liabilities: Accounts payable 317,131 174,087 2,631 493,849 Accrued liabilities 437,363 25,854 9,951 473,168 Total current liabilities 754,494 199,941 12,582 967,017 Liability for landfilll closure and postclosure care costs ——— 2,063,637 ——— 2,063,637 Capital leases payable Bonds payable 16,114,097 ——— 2,023,170 18,137,267 Total noncurrent liabilities 16,114,097 2,063,637 2,023,170 20,200,904 Total liabilities 16,868,591 2,263,578 2,035,752 21,167,921 Net assets Invested in capital assets net of related debt 21,861,755 4,611,754 4,283,626 30,757,135 Restricted 1,394,787 900,256 ——— 2,295,043 Unrestricted 9,818,945 4,844,000 159,564 14,822,509 TOTAL NET ASSETS $33,075,487 $10,356,010 $4,443,190 $47,874,687

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68,603 $509,833

62,958 3,309 66,267 ——— 7,091 ——— 7,091 73,358

61,512 ——— 374,963 $436,475

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Chapter 2

Example Comprehensive Annual Financial Report Financial Section: Basic Financial Statements Proprietary Funds Statements: Statement of Revenues, Expenses, and Changes in Fund Net Assests

Proprietary Funds: Statement of Revenues, Expenses, and Changes in Fund Net Assets Illustration 2–10 presents a Statement of Revenues, Expenses, and Changes in Fund Net Assets for the propriety funds. GASB requires that operating revenues and expenses be reported first, followed by operating income or loss. Note that depreciation expense is separately displayed as an operating expense. Nonoperating revenues and expenses are reported after operating income. Interest revenue and expense are nonoperating. Capital contributions, additions to endowments, special and extraordinary items, and transfers appear after the nonoperating revenues and expenses. Capital contributions frequently represent contributions of capital assets by neighborhood and commercial property developers. The change in net assets is reconciled to the statement of net assets by adding the beginning balance of net assets for the period. Note that the $436,475 total net assets appearing at the bottom of the Internal Service Fund columns in this statement and the Statement of Net Assets (Illustration 2–9) appears in the reconciliation at the bottom of the Governmental Funds balance sheet (Illustration 2–7a). That is because the internal service fund’s assets and liabilities (net assets) are reported as governmental activities in the governmentwide statement of net assets.

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Overview of Financial Reporting for State and Local Governments

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Example Comprehensive Annual Financial Report Financial Section: Basic Financial Statements Proprietary Funds Statements: Statement of Revenues, Expenses, and Changes in Fund Net Assests

ILLUSTRATION 2–10 Proprietary Funds: Statement of Revenues, Expenses, and Changes in Fund Net Assets CITY OF SALEM
Statement of Revenues, Expenses, and Changes in Fund Net Assets—Proprietary Funds For the Year Ended December 31, 2012 Governmental Activities— Internal Service Fund $663,162 ——— 663,162 591,010 2,698 34,622 6,654 100 4,256 ——— 639,340 23,822 700 ——— (558) 142 23,964 ——— ——— ——— 23,964 412,511 $436,475

Business-type Activities—Enterprise Funds Water Solid Waste Parking Total Operating revenues Charges for services Miscellaneous Total revenues Operating expenses Personnel services Repairs and maintenance Contractual services Depreciation Utilities Other Landfill closure costs Total operating expenses Operating income (loss) $6,335,022 45,499 6,380,521 $2,292,322 58,827 2,351,149 $261,088 $8,888,432 ——— 104,326 261,088 8,992,758

1,576,088 1,164,629 126,466 2,867,183 Apago PDF Enhancer 389,271 50,296 ——— 439,567 1,107,169 1,374,214 186,195 699,009 ——— 5,331,946 1,048,575 439,355 353,411 1,173 332,110 215,659 2,556,633 (205,484) ——— 153,097 40,619 63,766 ——— 383,948 (122,860) 1,546,524 1,880,722 227,987 1,094,885 215,659 8,272,527 720,231

Nonoperating revenues (expenses) Interest Income 452,718 279,924 1,558 734,200 State aid 23,746 6,878 ——— 30,624 Interest expense (710,042) ——— (97,901) (807,943) Total nonoperating revenue (233,578) 286,802 (96,343) (43,119) Income before contributions and transfers 814,997 81,318 (219,203) 677,112 Capital contributions 3,085,946 2,085,064 ——— 5,171,010 Transfers in ——— ——— 179,440 179,440 Transfers out (92,300) (702,202) ——— (794,502) Change in net assets 3,808,643 1,464,180 (39,763) 5,233,060 Net assets—beginning of year 29,452,090 8,842,556 4,346,981 42,641,627 Net assets—end of year $33,260,733 $10,306,736 $4,307,218 $47,874,687

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Example Comprehensive Annual Financial Report Financial Section: Basic Financial Statements Proprietary Funds Statements: Statement of Cash Flows

Proprietary Funds: Statement of Cash Flows
Proprietary funds are the only funds that report a Statement of Cash Flows, presented here in Illustration 2–11. Several differences exist between the GASB format cash flow statement and the FASB format required of commercial businesses: 1. GASB requires governments to prepare cash flows from operating activities on the direct method. 2. The reconciliation of income to cash flows from operating activities of the proprietary fund, which appears in the bottom section of the statement, begins with operating income, not net income (or total change in net assets). 3. The statement has four sections, rather than the three observed in FASB format statements. These include: • Operating activities are those associated with operating income. As a result, cash flows from interest expense, interest revenue, and investment income do not appear in the operating activities section. • Noncapital-related financing activities involve the borrowing and payment (including interest) of loans for purposes other than financing capital additions, chiefly, borrowing for operations. • Capital and related financing include grants and debt transactions (including interest) used to finance capital additions. • Investing activities involve the acquisition and sale of investments as well as cash received from investment income.

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One purpose of a cash flow statement is to help in explaining changes between the beginning and ending balances of assets and liabilities. Differences resulting in cash inflows and outflows are reflected in the body of the statement. However, some investing, capital, and financing activities may not affect cash. Capital leases, for example, result in a capital asset and a long-term liability, but do not involve cash at the inception. Noncash investing, capital, and financing activities, such as this, are disclosed below the cash flow statement. Illustration 2–11 presents another example of a noncash capital-related transaction, the contribution to the city of $5,171,000 of capital assets by developers or other governments. The amounts of such contributions are disclosed at the bottom of the cash flows statement.

Example Comprehensive Annual Financial Report Financial Section: Basic Financial Statements Proprietary Funds Statements: Statement of Cash Flows

ILLUSTRATION 2–11 Proprietary Funds: Statement of Cash Flows CITY OF SALEM
Statement of Cash Flows Proprietary Funds For the Year Ended December 31, 2012 Governmental Activities— Internal Service Funds $649,426 (630,437) ——— ——— 18,989

Business-type Activities—Enterprise Funds Water Cash flows from operating activities Cash received from customers $6,388,018 Cash paid to suppliers (2,490,241) Cash paid to employees (948,035) Other (588,974) Net cash provided by 2,360,768 operating activities Cash flows from noncapital financing activities Operating grants received ——— ——— Transfers from other funds Transfers to other funds (92,300) Net cash provided by noncapital financing activities (92,300) Solid Waste $2,343,431 (822,363) (764,032) (322,472) 434,564 Parking $259,946 (80,137) (99,517) (50,430) 29,862 Total

$8,991,395 (3,392,741) (1,811,584) (961,876) 2,825,194

6,594 ——— (702,202) (695,608)

——— 179,440 ——— 179,440

6,594 179,440 (794,502) (608,468)

——— ——— ——— ——— ——— (3,719) ——— (3,719) 700 700 15,970 65,677 81,647 23,822 6,654 (13,736) (46,535) 48,784 ——— $18,989

Cash flows from capital and related financing activities Acquisition of capital assets (543,169) (456,179) Principal paid on long-term debt (1,014,887) ——— Interest paid (535,567) ——— Net cash provided from capital and related financing activities (2,093,623) (456,179) Cash flows from investing activities Interest received Net cash provided from investing activities Increase in cash Cash and cash equivalents beginning of year Cash and cash equivalents end of year 287,725 287,725 462,570 9,167,234 9,629,804 279,924 279,924 (437,299) 8,102,739 7,665,440

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——— (128,420) (95,961) (224,381) 1,558 1,558 (13,521) 178,378 164,857

(999,348) (1,143,307) (631,528) (2,774,183) 569,207 569,207 11,750 17,448,351 17,460,101

Reconciliation of operating income to net cash provided by operating activities: Operating income 1,048,575 (205,484) (122,860) 720,231 Depreciation 1,374,214 353,411 153,097 1,880,722 (Increase) decrease in receivables 21,097 122,828 (375) 143,550 (Increase) decrease in inventory ——— ——— ——— ——— Increase (decrease) in accounts payable (83,118) ——— (83,118) Increase in landfill closure liability ——— 163,809 ——— 163,809 Net cash provided by operating activities $2,360,768 $434,564 $29,862 $2,825,194 Noncash investing, capital, and financing activities: Contributions of capital assets from developers $3,085,946 $2,085,064 $ ——— $5,171,000

$———

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Example Comprehensive Annual Financial Report Financial Section: Basic Financial Statements Fiduciary Funds Statements: Statement of Fiduciary Net Assets; Statement of Changes in Fiduciary Net Assests

Fiduciary: Statement of Fiduciary Net Assets
Illustration 2–12 presents a Statement of Fiduciary Net Assets. Fiduciary funds are reported by fund type, not major funds. GASB requires that fiduciary fund statements be included for all trust and agency fund types and for component units that are similar in nature. GASB also requires, if separate GAAP basis financial statements are not issued for individual pension and other employee benefit plans, that those reports be included in the notes to the basis financial statements. The fiduciary funds use the economic resources measurement focus and may include capital and other noncurrent assets and long-term liabilities. Note in Illustration 2–12 that the excess of assets over liabilities is labeled net assets and the statement indicates that the net assets are held in trust for some purpose.

Fiduciary: Statement of Changes in Fiduciary Net Assets
Illustration 2–13 presents a Statement of Changes in Fiduciary Net Assets. Note that the agency fund does not appear in this statement. That is because assets equal liabilities in agency funds (zero net assets). Although fiduciary funds use accrual accounting, the activity accounts are not labeled Revenues and Expenses. Rather the terms additions and deductions are used to reflect the fact that the government has only custody of the resources. Recall also that fiduciary funds are not included in the government-wide financial statements. Trust funds frequently have substantial investments activities. GASB requires that investments be reported at fair market value. Changes in the value of investments are reflected in the Statement of Changes in Fiduciary Net Assets as increase (decrease) in the fair value of investments. In the case of the City of Salem, this totals $163,050.

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Example Comprehensive Annual Financial Report Financial Section: Basic Financial Statements Fiduciary Funds Statements: Statement of Fiduciary Net Assets; Statement of Changes in Fiduciary Net Assests

ILLUSTRATION 2–12 Statement of Fiduciary Net Assets
CITY OF SALEM
Statement of Fiduciary Net Assets As of December 31, 2012
Assets Cash and cash equivalents Interest and dividends receivable Investments at fair value Corporate bonds Corporate stocks U.S. government securities TOTAL ASSETS Liabilities Accounts payable Due to other governments Total liabilities Net assets Held in trust for pension benefits Held in trust for other purposes TOTAL NET ASSETS Employee Pension Trust $ 172,000 13,690 2,725,600 6,852,300 1,325,000 $11,088,590 $ 105,000 105,000 10,983,590 ——— $10,983,590 Private-purpose Trust $12,500 ——— ——— ——— 900,256 912,756 7,600 7,600 ——— 905,156 $905,156 Agency Fund $2,369,000 ——— ——— ——— ——— 2,369,000 ——— 2,369,000 2,369,000 ——— ——— $ ———

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CITY OF SALEM
Statement of Changes in Fiduciary Net Assets For the Year Ended December 31, 2012

ILLUSTRATION 2–13 Statement of Changes in Fiduciary Net Assets

Additions Contributions: Plan members Employer Individuals Total contributions Investment income: Interest Dividends Increase in fair value of investments Total investment income Total additions Deductions Administrative expenses Benefits Refunds of contributions Total deductions Change in net assets Net assets—beginning of year Net assets—end-of-year

Employee Pension Trust $ 912,000 1,600,000 ——— 2,512,000 18,560 63,000 163,050 244,610 2,756,610 12,900 883,600 35,000 931,500 1,825,110 9,158,480 $10,977,590

Private-purpose Trust $ ——— ——— 100,000 100,000 8,500 ——— ——— 8,500 108,500 ——— 7,600 ——— 7,600 100,900 804,256 $905,156

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Example Comprehensive Annual Financial Report Financial Section: Basic Financial Statements Notes to the Financial Statements

Notes to the Financial Statements
The notes to the financial statements are an integral part of the basic financial statements. As presented in Illustration 2–14, the first note is a summary of the significant accounting policies and the first of these is generally a description of the reporting entity. Any event significant to understanding and interpreting the financial statements should be described in the notes, whether or not it is specifically required by GASB standards. Following is a description of typical contents to the notes: 1. Summary of significant accounting policies, including: • A brief description of the component units and their relationship to the reporting entity. • A description of the activities reported in each of the following columns presented in the basic financial statements: major funds, internal service funds, and fiduciary fund types. • A description of the government-wide statements and the measurement focus and basis of accounting used in the government-wide statements. • The revenue recognition policies used in the fund financial statements, including the length of time used to define available for purposes of revenue recognition in the governmental fund financial statements. • The policy for eliminating internal activity in the government-wide statement of activities. • The policy for capitalizing assets and for estimating the useful lives of those assets. • A description of the types of transactions included in program revenues and the policy for allocating indirect expenses to functions (if applicable) in the statement of activities. • The policy for defining operating and nonoperating revenues of proprietary funds. • The policy for applying FASB pronouncements issued after November 30, 1989, to business-type activities and to enterprise funds of the primary government. • The definition of cash and cash equivalents used in the statement of cash flows for the proprietary funds. • The government’s policy with regard to restricted and unrestricted resources when an expense is incurred for purposes for which both restricted and unrestricted resources are available.

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2. 3. 4. 5.

Description of cash deposits with financial institutions. Investments. Contingent liabilities. Encumbrances outstanding.

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Example Comprehensive Annual Financial Report Financial Section: Basic Financial Statements Notes to the Financial Statements

ILLUSTRATION 2–14

Notes to the Financial Statements

1. Summary of Significant Accounting Policies The City of Salem was established as a town in 1861 and incorporated as a city by an act of the State Legislature in 1930. The City has an area of 19.9 square miles and a population of 23,875, according to the 2010 Census. The City provides a full range of services, including general government, judicial administration, public safety, public works, health and welfare, education, parks and recreation, community development, water utility, refuse disposal, and parking facilities. The financial statements of the City have been prepared in accordance with accounting principles generally accepted (GAAP) in the United States applicable to governmental units as specified by the Governmental Accounting Standards Board. The following is a summary of the more significant accounting policies of the City: A. The Financial Reporting Entity As required by GAAP, these financial statements present the City (primary government) and its component unit. The Salem Industrial Development Authority is reported as a separate and discretely presented component unit of the City. The City has no blended component units. The Salem Industrial Development Authority has the responsibility to promote industry and develop trade by inducing manufacturing, industrial and other commercial enterprises to locate or remain in the City. The City appoints all seven members of the Authority’s Board of Directors. In addition the City issued $10 million in general obligation bonds in 2004 to provide a capital grant to the Authority. As a result, the Authority imposes a financial burden on the City. Complete financial statements of the Authority may be obtained from the Salem Industrial Development Authority’s offices, located at 10 West Main Street.

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The notes typically continue for 20 or more pages.

6. Effects of events subsequent to the date of the financial statements. 7. Annual pension cost and net pension obligation. 8. Violations of finance-related legal and contractual provisions and actions taken to address violations. 9. Debt service requirements. 10. Commitments under noncapitalized (operating) leases. 11. Construction and other significant commitments. 12. Required disclosures about capital leases. 13. Required disclosures about long-term liabilities. 14. Deficit fund balances or net assets of individual nonmajor funds. 15. Interfund receivables and payables. 16. Disclosures about donor-restricted endowments. 17. For component units, the nature and amount of significant transactions with other units of the reporting entity. Of course, the disclosures just listed are not required when they do not apply. For example, lease disclosures are not applicable if the government has no noncancelable leases.

Example Comprehensive Annual Financial Report Financial Section: Required Supplementary Information Other than Management’s Discussion and Analysis

Required Supplementary Information Other than MD&A
Recall that required supplementary information appears in two parts of the financial section: the MD&A precedes the basic financial statements and certain required supplementary information (RSI) schedules follow the notes. Among the required schedules are the following: information required when using the modified approach to infrastructure, budgetary comparison schedule, pension schedules (illustrated in Chapter 7), and schedules of risk management activities. Modified Approach for Reporting Infrastructure As an alternative to depreciating infrastructure assets, governments may choose to use a modified approach (described in Chapter 8). Governments that choose to use the modified approach must present a schedule of the assessed condition of infrastructure assets and a schedule comparing the estimated cost to maintain infrastructure assets with the amounts actually expended. These schedules are part of the RSI and are presented in Illustration 2–15. ILLUSTRATION 2–15 Required Schedules When Using the Modified Approach for Infrastructure CITY OF SALEM

Condition Rating of City’s Street System

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Fiscal Years 2006–2009 % of Streets 35 26 39 Fiscal Years 2010–2012 % of Streets 85 13 2 Excellent to Good Fair Poor to Substandard

Comparison of Needed-to-Actual Maintenance Expenditures for City’s Street System 2009 Needed to maintain Actual amount expended $ 1,113,851 $ 1,111,346 2010 $1,251,518 1,248,703 2011 $1,406,200 1,403,037 2012 $1,580,000 1,576,446

The City has an ongoing street rehabilitation program, funded in the General Fund, that is intended to improve the condition rating of the City’s streets. The rehabilitation program is formulated based on deficiencies identified as part of its Asset Management System.

Budgetary Comparison Schedule Illustration 2–16 presents a budgetary comparison schedule, which is required of the General Fund and each major special revenue fund that has a legally adopted budget. This schedule includes the original budget, the final appropriated budget, and the actual results computed on the same basis as the budget. When the basis of accounting used in the budget differs from that in the statement of revenues, expenditures, and changes in fund balance, the two must be reconciled in the schedule or in notes to the RSI. In the case of the City of Salem, the city uses the GAAP basic for budgeting and no reconciliation is required. Governments have the option of reporting a budget comparison statement as part of the basic financial statements rather than this schedule in the RSI. 46

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Example Comprehensive Annual Financial Report Financial Section: Required Supplementary Information Other than Management’s Discussion and Analysis

ILLUSTRATION 2–16 Schedule of Revenues, Expenditures, and Changes in Fund Balance—Budget and Actual: General Fund
CITY OF SALEM
Schedule of Revenues, Expenditures, and Changes in Fund Balance— Budget and Actual: General Fund For the Year Ended December 31, 2012 Budgeted Amounts Actual Amounts Budgetary Basis $15,361,830 11,761,522 1,601,435 7,098,698 1,262,549 37,086,034 Variance with Final Budget $695,830 199,022 (11,576) (949,209) (125,836) (191,769)

Revenues Property taxes Other local taxes Charges for services Intergovernmental Miscellaneous Total revenues Expenditures Current General Government Judicial Administration Public Safety Public Works Health and Welfare Education Parks and Recreation Community Development Total expenditures Revenues over (under) expenditures Other financing sources (uses): Transfers (to) other funds

Original $14,666,000 11,562,500 1,613,011 7,892,080 1,504,977 37,238,568

Final $14,666,000 11,562,500 1,613,011 8,047,907 1,388,385 37,277,803

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3,567,838 1,321,048 7,753,002 4,541,651 4,823,267 8,963,248 2,983,861 872,594 34,826,509 2,412,059 3,489,870 1,497,845 8,325,564 4,984,353 4,440,167 8,929,725 3,097,528 904,168 35,669,220 1,608,583 3,353,502 1,456,734 8,216,347 4,602,273 4,418,294 8,887,834 3,055,325 899,209 34,889,518 2,196,516 136,368 41,111 109,217 382,080 21,873 41,891 42,203 4,959 779,702 587,933

(3,560,000) (3,560,000)

(3,257,000) (3,257,000)

(3,256,899) (3,256,899)

101 101

Excess of revenues and other sources over (under) expenditures and other uses (1,147,941) Fund balance— beginning of year 12,338,963 Fund balance— end of Year $11,191,022

(1,648,417) 12,338,963 $10,690,546

(1,060,383) 12,338,963 $11,278,580

588,034 ——— $588,034

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Example Comprehensive Annual Financial Report Financial Section: Other Supplementry Information

Combining Statements
A complete CAFR presents combining statements to reflect its nonmajor funds whenever a nonmajor column is used in one of the fund statements. Any fund that was not large enough to be reported as a major fund will be presented in the combining statement. The total column in the combining statements will be the same as the nonmajor funds column in the basic financial statements.

Example Comprehensive Annual Financial Report Statistical Section

Statistical Information
Governments wishing to present the more complete comprehensive annual financial report (CAFR) will include a statistical section. This section is not part of the CAFR’s financial section and, like the introductory section, is not audited. Governments typically present 10 years of information in each table or schedule. The purpose of the statistical section is to provide historical (trend) information and additional detail to help the financial statement user better understand and assess a government’s economic condition. Failure to include the statistical section will not result in a qualified or adverse audit opinion. GASB Statement 44, Economic Condition Reporting: The Statistical Section (May 2004), provides guidance on the content of the statistical section. Statistical information, when presented, should be presented in five categories.

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1. Financial trends information assists users in understanding how a government’s financial position has changed over time. 2. Revenue capacity information is used to assess the government’s ability to generate revenue from its own sources (i.e., taxes, service charges, and investments). 3. Debt capacity information is used to assess a government’s debt burden and ability to take on more debt. 4. Demographic and economic information describes a government’s socioeconomic environment and is used to interpret comparisons across time and between governments. 5. Operating information provides contextual information about a government’s operations such as number of government employees, volume and usage of capital assets, and indicators of the demand for government services. The sources of information and important assumptions must be described. Governments may provide other information as long as it is consistent with the objectives of improving the understanding and assessment of a government’s economic condition.

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SPECIAL-PURPOSE GOVERNMENTS
The reporting outlined in previous sections is for general-purpose governments, such as states, municipalities, and counties. However, many governments are special purpose, including school districts, sanitary districts, public employee retirement systems, tollway systems, and fire protection districts. How financial information is reported by special-purpose governments depends on whether those governments are governmental or business-type in nature, or both. GASB Statement 34 provides the following definitions: Governmental activities generally are financed through taxes, intergovernmental revenues, and other nonexchange revenues. These activities are usually reported in governmental funds and internal service funds. Business-type activities are financed in whole or in part by fees charged to external parties for goods or services. These activities are usually reported in enterprise funds.

Special-purpose governments that have more than one governmental activity, or that have both governmental and business-type activities, are required to present both government-wide and fund reporting, as described previously. This reporting includes MD&A, the basic financial statements and notes, and RSI. Special-purpose governments that have only one governmental program may combine the fund and government-wide statements, using separate columns and a reconciliation, or use other simplified approaches. See Illustrations 9–2 and 9–3 for examples. Specialpurpose governments that have only business-type activities should report only the financial statements required for enterprise funds. These would include:

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• • • • • •

MD&A Statement of Net Assets, or Balance Sheet Statement of Revenues, Expenses, and Changes in Fund Net Assets Statement of Cash Flows Notes to the Financial Statements RSI, other than MD&A, as appropriate.

Special-purpose governments that are fiduciary only in nature, such as public employee retirement systems (PERS), are to prepare only those statements required for fiduciary funds, including MD&A, a Statement of Fiduciary Net Assets, a Statement of Changes in Fiduciary Net Assets, and notes to the financial statements.

PUBLIC COLLEGES AND UNIVERSITIES
GASB Statement 35, Basic Financial Statements—and Management’s Discussion and Analysis—for Public Colleges and Universities. Statement 35 requires that public colleges and universities report in a manner consistent with Statement 34. These institutions choose between reporting as business-type activities (only), governmental activities (only), or as governmental and business-type activities. The latter would most likely be chosen only by community colleges with the power to

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tax. Most other institutions report as business-type activities. Illustrative financial statements are provided in Statement 35. Accounting for public colleges and universities is discussed, along with accounting for other governmental not-for-profit organizations, in Chapter 9.

OTHER GOVERNMENTAL NOT-FOR-PROFIT ORGANIZATIONS
Certain not-for-profit organizations may be determined to be governmental in nature for accounting purposes, under the definition outlined in Chapter 1. This might include foundations of public colleges and universities, public schools, and other governmental units. Museums, performing arts organizations, and public health organizations might also be considered governmental. The general rule is the same as it is for public colleges and universities and for special-purpose governments. Required reports would depend on whether the entity is considered governmental, businesstype, or governmental and business-type in nature. An exception is made for certain not-for-profit governmental units that had been following the provisions of GASB Statement 29. Not-for-profit governmental entities using prior accounting and reporting principles under AICPA Statement of Position 78–10 or under the AICPA Audits of Voluntary Health and Welfare Guide (see Chapter 10) may choose to report as business-type activities, even if the criteria are not met. This is to avoid requiring those governmental not-for-profits to create modified accrual accounting statements.

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Now that you have finished reading Chapter 2, complete the multiple choice questions provided on the text’s Web site (www.mhhe.com/copley10e) to test your comprehension of the chapter.

Questions and Exercises
2–1. Using the Comprehensive Annual Financial Report obtained for Exercise 1–1, answer the following questions. a. Compare the items discussed in the MD&A in your CAFR with the list of items in this chapter. Which topics listed in this chapter are not in your CAFR? Which topics are in your CAFR that are not listed in this chapter? Do you think your CAFR has a reasonably complete discussion? b. From the MD&A in your report, write a short summary of (1) the financial condition of your government, (2) a comparison of revenues compared with the prior year, (3) a comparison of expenses compared with the prior year, and (4) a comparison of budgeted and actual activity. c. From the Statement of Net Assets, write down the following: (1) unrestricted net assets—governmental activities; (2) unrestricted net assets—businesstype activities; (3) restricted net assets by restriction—governmental activities; (4) restricted net assets by restriction—business-type activities; and (5) unrestricted and restricted net assets—component units.

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2–2.

2–3.

2–4. 2–5.

d. From the Statement of Activities, write down the following: (1) net program expense (or revenue)—governmental activities; (2) net program expense (or revenue)—business-type activities; (3) net program expense (or revenue)—component units; (4) change in net assets—governmental activities; (5) change in net assets—business-type activities; and (6) change in net assets—component units. Do the ending net asset figures in this statement agree with the net asset figures in the Statement of Net Assets? e. From the Statement of Revenues, Expenditures, and Changes in Fund Balances for Governmental Funds, identify the names of the major governmental funds.Write down the net change in fund balance for each major fund. f. From the governmental fund statements, take one major fund (other than the General Fund) and prove, using the 10 percent and 5 percent criteria described in this chapter, that the fund is required to be reported as a major fund. g. From the Statement of Revenues, Expenses, and Changes in Fund Net Assets list the major enterprise funds. For each, write down: (1) the operating income, (2) the net income (loss) before contributions and (3) the change in net assets. With regard to GASB rules for the financial reporting entity, answer the following: a. Define the financial reporting entity. b. Define and give an example of a primary government. c. Define and give an example of a component unit. d. Define and describe the two methods of reporting the primary government and component units in the financial reporting entity. With regard to the Comprehensive Annual Financial Report (CAFR): a. What are the three major sections? b. List the government-wide statements. Indicate the measurement focus and basis of accounting used for the government-wide statements. c. List the governmental fund statements. Indicate the measurement focus and basis of accounting used for the governmental fund statements. d. List the proprietary fund statements. Indicate the measurement focus and basis of accounting used for the proprietary fund statements. e. List the fiduciary fund statements. Describe the measurement focus and basis of accounting used for the fiduciary fund statements. f. Outline the reports and schedules to be reported as required supplementary information. Describe the test for determining whether a governmental fund is a major fund. Describe the test for determining whether an enterprise fund is a major fund. Describe how the cash flow statement of an enterprise fund differs in format from the cash flow statements of private-sector organizations such as commercial businesses.

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2–6. Describe the net asset classification appearing on the government-wide statement of net assets. 2–7. The following information is available for the preparation of the governmentwide financial statements for the city of Southern Springs as of April 30, 2012: Cash and cash equivalents, governmental activities Cash and cash equivalents, business-type activities Receivables, governmental activities Receivables, business-type activities Inventories, business-type activities Capital assets, net, governmental activities Capital assets, net, business-type activities Accounts payable, governmental activities Accounts payable, business-type activities Noncurrent liabilities, governmental activities Noncurrent liabilities, business-type activities Net assets, invested in capital assets, net, governmental activities Net assets, invested in capital assets, net, business-type activities Net assets, restricted for debt service, governmental activities Net assets, restricted for debt service, business-type activities $ 1,880,000 850,000 559,000 1,330,000 520,000 12,500,000 10,340,000 650,000 659,000 5,350,000 3,210,000 8,123,000 7,159,000 754,000 223,000

From the preceding information, prepare, in good form, a Statement of Net Assets for the city of Southern Springs as of April 30, 2012. Include the unrestricted net assets, which are to be computed from this information. Include a total column. 2–8. The following information is available for the preparation of the governmentwide financial statements for the city of Northern Pines for the year ended June 30, 2012:

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Expenses: General government Public safety Public works Health and sanitation Culture and recreation Interest on long-term debt, governmental type Water and sewer system Parking system Revenues: Charges for services, general government Charges for services, public safety Operating grant, public safety Charges for services, health and sanitation Operating grant, health and sanitation Charges for services, culture and recreation Charges for services, water and sewer Charges for services, parking system Property taxes Sales taxes Investment earnings, business-type

$10,300,000 22,900,000 11,290,000 6,210,000 4,198,000 621,000 11,550,000 419,000 1,110,000 210,000 698,000 2,555,000 1,210,000 2,198,000 12,578,000 398,000 27,112,000 20,698,000 319,000

Overview of Financial Reporting for State and Local Governments Special item—gain on sale of unused land, governmental type Transfer from governmental activities to business-type activities Net assets, July 1, 2011, governmental activities Net assets, July 1, 2011, business-type activities

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1,250,000 688,000 11,222,000 22,333,000

From the previous information, prepare, in good form, a Statement of Activities for the city of Northern Pines for the year ended June 30, 2012. Northern Pines has no component units. 2–9. The following General Fund information is available for the preparation of the financial statements for the city of Eastern Shores for the year ended September 30, 2012: Revenues: Property taxes Sales taxes Fees and fines Licenses and permits Intergovernmental Investment earnings Expenditures: Current: General government Public safety Public works Health and sanitation Culture and recreation Debt service—principal Debt service—interest Proceeds of long-term, capital-related debt Transfer to special revenue fund Special item—proceeds from sale of land Fund balance, October 1, 2011 $27,000,000 13,216,000 1,124,000 1,921,000 868,000 654,000

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8,192,000 24,444,000 6,211,000 1,693,000 2,154,000 652,000 821,000 2,210,000 1,119,000 821,000 13,211,000

From the information given above, prepare, in good form, a General Fund Statement of Revenues, Expenditures, and Changes in Fund Balances for the city of Eastern Shores General Fund for the Year Ended September 30, 2012. 2–10. The following water and sewer fund information is available for the preparation of the financial statements for the City of Western Sands for the year ended December 31, 2012: Operating revenues—charges for services Operating expenses: Personal services Contractual services Utilities Repairs and maintenance Depreciation Interest revenue $18,387,000 6,977,000 2,195,000 888,000 1,992,000 5,922,000 129,000

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Chapter 2 Interest expense Capital contributions Transfer to general fund Net assets, January 1, 2012 834,000 1,632,000 965,000 10,219,000

From the information given above, prepare, in good form, a Water and Sewer Fund column for the proprietary fund Statement of Revenues, Expenses, and Changes in Fund Net Assets for the year ended December 31, 2012. 2–11. Use the CAFR information for the City of Salem (Illustrations 2–2 through 2–16) to find the following items. In your answer, both indicate which financial statement contained the information and the item and the dollar amount. Ex A. B. C. D. E. F. G. Information Item Amounts due from other governments to support governmental activities Total capital outlay for the courthouse renovation Total cash paid for capital additions for the Solid waste fund Interest paid (not expense) on general long-term debt Interest paid (not expense) on water department debt Capital asset (net) for the government’s component units Contributions received for use by the private purpose trust Noncurrent liabilities associated with governmental activities that are due in more than one year. Noncash contributions of capital assets for the Water department. Statement Balance Sheet— Governmental Funds $ Amount $1,328,448

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H.

2–12. Use the CAFR information for the City of Salem (Illustrations 2–2 through 2–16) to find the following items. Each item will appear in two separate financial statements. In your answer indicate both financial statements that contained the information item and the dollar amount. Ex Information Item Investments held by the Enterprise funds Total fund balance of the Special Revenue Fund Net assets available for employee pensions Operating income for the Internal Service Funds Total net assets of the primary government Statements Statement of Net Government-wide Assets—Proprietary Statement of Net Funds Assets $ Amount $10,350,334

A. B. C. D.

Chapter Three
Modified Accrual Accounting: Including the Role of Fund Balances and Budgetary Authority When the people become involved in their government, government becomes more accountable, our society is stronger, more compassionate, and better prepared for the challenges of the future. Arnold Schwarznegger, 38th Governor of California

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Sure there are dishonest men in local government. But, there are dishonest men in national government too. Richard M. Nixon, 37th President of the United States and the only president to resign the office. Learning Objectives • Describe the basic accounts used by governmental funds. • Identify the recognition criteria for revenues and expenditures under the modified accrual basis. • Apply fund balance classifications for governmental funds. • Prepare journal entries for the expenditures cycle using both budgetary and activity accounts.

he most distinguishing feature of governmental accounting is the use of the modified accrual basis (and current financial resources measurement focus) of accounting.1 Although the use of modified accrual accounting is limited to one type 1

T

The term modified accrual is used throughout this chapter to represent both the current financial resources measurement focus and the modified accrual basis of accounting.

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of fund (i.e., governmental funds) and then only to the fund-basis statements, this does not mean it is inconsequential. Recall that every general purpose government will have (at least) a General Fund, and the General Fund is commonly the largest fund when measured in terms of government expenditures. Further, since most tax revenue is received by the General and other governmental funds, these funds are of particular interest to taxpayers. Before describing exactly what the modified accrual basis is, it may be useful to describe what it is not. The modified accrual basis is not equivalent to the cash basis. Governmental funds record receivables (e.g., taxes receivable) and recognize revenues before collection, which is not true of a cash-basis system. Similarly, governmental funds record many liabilities (e.g., salaries payable) and accrue expenditures when payable, rather than waiting until payment occurs. The modified accrual basis is also not merely a “light” version of the accrual basis, differing only in its failure to recognize long-term assets and liabilities. The modified accrual basis is a distinct system of accounting that contains financial statement elements that appear nowhere else. Among these are expenditures and fund balances. At the same time, the modified accrual basis contains other elements that are shared with the accrual basis, such as assets and liabilities. Although revenues appear in the financial statements of accrual and modified accrual funds, revenues follow different recognition criteria between the two bases. Finally, there are no expenses in modified accrual funds. The following sections describe the account structure and recognition criteria for governmental funds. The modified accrual basis evolved from the demand for accountability over public resources and is therefore closely tied to the budget function. Budgetary accounting is illustrated in the appendix to this chapter.

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MODIFIED ACCRUAL ACCOUNTS
Balance Sheet Accounts
Illustration 3–1 provides the typical account structure for a governmental fund using modified accrual accounting. Panel 1 displays the Balance Sheet accounts. Because governmental funds report under the current financial resources measurement focus, long-term assets are not presented. Generally speaking, the assets represent cash and assets that may be expected to be converted into cash in the normal course of operations. Similarly, these funds report only those liabilities that will be settled with current financial resources. Therefore, long-term liabilities are not reported in governmental funds. The account category, Fund Balance, is unique to governmental funds. Neither property owners nor voters have a legal claim on any excess of fund assets over liabilities; therefore, Fund Balance is not analogous to the capital of an investor-owned entity. However, Fund Balance serves a purpose similar to retained earnings, in that activity accounts are closed to this account at the end of each accounting period. While mathematically comparable to retained earnings, fund balances are very different in interpretation. Because only current financial resources and claims against

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ILLUSTRATION 3–1

Account Structure of Governmental Funds

Panel 1. Accounts that are not closed at year-end (Balance Sheet) Assets Cash and cash equivalents Investments Receivables: Taxes receivable Accounts receivable Due from other governments Supplies inventories Restricted assets (typically cash) Liabilities Accounts payable Accrued liabilities Deferred revenues Fund Balances Nonspendable Restricted Committed Assigned Unassigned

Panel 2. Accounts that are closed at year-end Budgetary Accounts Estimated Revenues Financial Statement Activity Accounts Revenues Tax revenues Charges for services Expenditures Current Capital outlay Debt service

Appropriations

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Estimated other financing sources Other financing sources Transfers in Debt proceeds Other financing uses Transfers out

Estimated other financing uses

Encumbrances

those resources are recognized in these funds, the difference between assets and liabilities (fund balance) represents the net resources of the fund that are currently available for future spending. However, even current financial resources vary in the extent to which government managers have discretion over their future use, and this is reflected by assigning fund balance to five categories (nonspendable, restricted, committed, assigned, and unassigned). A recent GASB pronouncement (GASB Statement 54 Fund Balance Reporting and Governmental Fund Type Definitions) establishes reporting requirements for fund balances.2 GASB Statement 54 establishes five new categories of fund balance 2

GASB Statement 54 is required for fiscal years ending in June 2011 and later.

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while eliminating the previous categories of reserved and unreserved. The standard affects only the equity section of the balance sheet of governmental funds. It does not change the reporting of net assets of proprietary and fiduciary funds or the government-wide Statement of Net Assets. The new standard is GASB’s response to credit market participants who sought greater information about the availability of reported fund balances. In particular, bond investors and rating agencies wish to understand the extent to which the net financial resources of governmental funds are constrained and how binding those constraints are. For example, fund resources can be restricted by creditors, donors, or granting agencies. Resources may also be formally committed by elected officials to specific activities. Alternatively, constraints may merely be nonbinding indications of management’s intent to use resources for a particular purpose. Statement 54 establishes new fund balance classifications to reflect these varying levels of constraint. Nonspendable Fund Balances Illustration 3–2 summarizes the reporting requirements for fund balances under Statement 54. The first step in applying Statement 54 is to identify those fund resources that are nonspendable. (This is identified as step 1 in the illustration.) Inventories and prepaid items typically appear in governmental funds because they are current assets. However, these resources are nonspendable because they are used in operations rather than converted into cash. The principal (corpus) of a permanent fund that may not be spent but is required to be maintained would also be classified as nonspendable. Other examples include assets held for sale and long-term receivables, which are sometimes reported in governmental funds. The remaining resources (net of liabilities) of the fund include cash and items expected to be converted into cash in the next period. These “spendable” resources are further classified according to the nature of any constraints imposed on their use, using a hierarchy of constraints. The hierarchy ranges from “restricted” for the most constrained to “unassigned” for the least.

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Restricted Fund Balances Restricted fund balance (item 2a in the illustration) represents the net resources of a governmental fund that are subject to constraints imposed by external parties or law. Restrictions arising from external parties include debt covenants (such as a requirement for a sinking fund) or constraints imposed by legislation or federal and state agencies on the use of intergovernmental revenues. Restrictions can also result from legally enforceable requirements that resources be used only for specific purposes. For example, some states permit cities and counties to propose taxes on the sale of prepared food and beverages. If approved by the voters, the referendum commonly restricts the use of the tax proceeds (typically to capital projects). The unexpended resources derived from this tax would be displayed as restricted fund balance. The net position (i.e., equity) section of the government-wide Statement of Net Assets (GASB 34) classifies net assets within three categories, including restricted net assets. With one exception, those resources classified as restricted net assets

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ILLUSTRATION 3–2

Diagram of GASB Statement 54

1

Are there assets (inventory or prepaids) not in spendable form? or Is the government required to maintain a permanent fund principal?

Report as “Nonspendable Fund Balance”

2a

Are there net resources with restrictions imposed by law or as a result of requirements by outside creditors, contributors, or granting agencies?

Is the balance negative or positive?

Report as “Restricted Fund Balance” Has the governing body formally committed net resources to specific activities? Are there contractual obligations outstanding?

2b

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Report as “Committed Fund Balance” Are there residual balances in funds other than the General Fund?

2c

Are there net resources in the General Fund that are intended for identified purposes?

Is the balance negative or positive? Reduce any assigned fund balances by the amount of the negative balance. If a negative balance remains Report as “Unassigned Fund Balance”

Report as “Assigned Fund Balance”

2d
Residual balance in General Fund

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in the government-wide statements would also be classified as restricted fund balance in the fund basis statements. The exception is permanent fund principle. These resources are classified as restricted net assets under GASB 34 and nonspendable fund balance under GASB 54. Committed Fund Balances Committed fund balance (item 2b in the illustration) represents the net resources of a governmental fund that the governing body has specified for particular use. To be classified as committed, the resources should have been designated through ordinance or resolution by the government’s highest level of authority (e.g., state legislature, city council, or county board of supervisors). Committed resources differ from restricted in that the constraint is imposed by a government upon itself. GASB 54 also provides that amounts representing contractual obligations of a government should also be classified as committed fund balance, provided that existing resources in the fund have been specifically committed for use in satisfying the contractual obligation. The statement offers no examples of such contractual obligations, but it seems reasonable that they would be of sufficient significance to involve the formal action of the governing board. For example, board approval of large construction contracts would typically represent commitment of the funds. Assigned Fund Balances Assigned fund balance (item 2c in the illustration) represents the net resources of governmental funds that the government intends for a specific purpose. Assigned resources differ from committed in that the committed resources require a formal action by the governing body of the government. Constraints imposed on assigned resources are more easily modified or removed. For governmental funds other than the General Fund, this is the category for all (positive) residual fund balances. The rationale is that the act of recording resources in special revenue, capital projects, debt service, or permanent funds is evidence of the government’s intent to use the resources for a specific purpose. Resources in the General Fund may also be assigned to a specific purpose if that is the intent of the government. Intent may be expressed through the governing body by means other than ordinance or resolution or by committees or individuals with the authority to assign resources to specific activities. Assignment within the General Fund implies an intended use that is more limited than merely support of the general purposes of the government.

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Unassigned Fund Balances Unassigned fund balance (item 2d in the illustration) is the residual category for the General Fund. Within the General Fund, governments should not report assigned fund balance amounts if the assignment for specific purpose results in a negative unassigned fund balance. Negative fund balances could occur if expenditures for a specific purpose exceed the resources available in the fund. However, Statement 54 does not permit the reporting of negative restricted, committed, or assigned fund balances. If this occurs, the government should reduce any assigned fund balances (in that fund) by the amount of the negative balance. If a deficit remains once all assigned fund balances are zero, the remaining negative amount should be reported as unassigned fund balance.

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Statement 54 also provides guidance on the classification of budget stabilization or rainy day funds. Rainy day funds are amounts set aside for future periods of economic downturn. Such stabilization amounts that meet certain criteria are classified as committed or (less commonly) restricted, if imposed externally or by law. Rainy day funds are classified as committed only if they are created by a resolution or ordinance that identifies the specific circumstances under which the resources may be expended. Rainy day amounts that are available “in emergencies” or in periods of “revenue shortfalls” would not be classified as committed unless the emergency or shortfall condition is specified and of a magnitude to distinguish it from events that occur routinely. Rainy day funds not meeting these conditions are reported as unassigned fund balance in the General Fund. Illustration 3–3 provides an annotated example of fund balance reporting for the City of Salem example used in Chapter 2. Note that the governmental funds balance sheet is the only financial statement affected by Statement 54.

Financial Statement Activity Accounts
Panel 2 of Illustration 3–1 presents activity and budgetary accounts for governmental funds. The activity accounts reflect sources and uses of funds; examples are given in detail in Chapters 4 and 5. Revenues and Other Financing Sources are sources (or inflows) of financial resources while Expenditures and Other Financing Uses represent uses (or outflows) of financial resources. Other Financing Sources include transfers in from other funds and the proceeds of long-term borrowing. Revenues are defined as all other inflows and include taxes, charges for services, and amounts provided by other entities such as the state or federal government. Because taxes and many other revenues do not involve exchange transactions, governments cannot determine the point at which these revenues are earned. Therefore, revenue recognition occurs when the resulting resources are deemed to be both measureable and available to finance expenditures of the current period. Revenue recognition for specific types of nonexchange transactions is described later in this chapter. Expenditure is a term that replaces both the terms costs and expenses used in accounting for commercial businesses. Expenditures are recognized when a liability is incurred that will be settled with current financial resources in the fund. Expenditures may be for salaries (current), land, buildings, or equipment (capital) or for payment of interest and principal on debt (debt service). Transfers out of a fund to other funds are classified as Other Financing Uses. An example of the use of transfer accounts occurs when a portion of the taxes recognized as revenue by the General Fund is transferred to a debt service fund that will record payments of interest and principal on general obligation debt. The General Fund would record the taxes as Tax Revenue and the amounts transferred to the debt service fund as Other Financing Uses—Transfers Out. The debt service fund would record the receipt of the transfer as Other Financing Sources—Transfer In and the subsequent payments of interest and principal as Debt Service Expenditures. Thus, use of the transfer accounts achieves the desired objective that revenues are recognized in the fund that levied the taxes (i.e., General Fund) and expenditures are recognized in the fund that expends the cash (i.e., debt service fund).

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ILLUSTRATION 3–3

Example of Fund Balance Reporting CITY OF SALEM
Balance Sheet—Fund Balance Section Governmental Funds As of December 31, 2012 General Fund Special Revenue Fund Courthouse Debt Renovation Service Fund Fund Total Governmental Funds

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FUND BALANCE Nonspendable Supplies inventory Restricted Intergovernmental grants Bond sinking fund Committed Rainy day fund Courthouse renovation Assigned School lunch program Other capital projects Other purposes Unassigned TOTAL FUND BALANCE

This amount equals the balance of supplies inventories in the asset section of the balance sheet. These represent resources that are restricted by outside parties through grant agreements and bond covenants. These represent resources that are restricted by City Council as a reserve for revenue shortfalls (General Fund) and by contractual obligation (capital projects fund). These include the residual balance of the special revenue, and capital projects funds. It also includes amounts assigned within the General Fund by expressed intent (e.g., by purchase orders). This is the residual balance of the General Fund.

23,747

———

———

———

23,747

——— ———

312,000 ———

500,000 ———

——— 230,000

812,000 230,000

4,500,000 ———

——— ———

——— 380,000

——— ———

4,500,000 380,000

——— 680,500 236,800 5,837,533 11,278,580

260,014 ——— ——— ——— 572,014

——— 32,032 ——— ——— 912,032

——— ——— ——— ——— 230,000

260,014 712,532 236,800 5,837,533 12,992,626

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Budgetary Accounts
GASB standards require governments to present a comparison of budgeted and actual results for the General Fund and special revenue funds with legally adopted budgets. Although GASB standards guide the format of this comparison, the GASB does not prescribe budgetary accounting practices and does not require governments to maintain budgetary accounts. Budgetary accounts do not appear in the general purpose financial statements.3 Nevertheless, governments typically record budgets, and governmental accounting systems are designed to assure compliance with budgets. The accounts appearing in the left-hand side of Illustration 3–1, Panel 2 serve this budgetary (rather than external reporting) function of the government. A government may raise revenues only from sources allowed by law. Laws commonly establish the maximum amount of a tax or set a maximum tax rate. Revenues to be raised pursuant to law during a budget period are set forth in an Estimated Revenues budget. Resources raised by the government may only be expended for purposes and in amounts approved by the governing body or legislature. This is known as the appropriations process. An Appropriations budget, when enacted into law, is the legal authorization for the government to incur liabilities for purposes specified in the appropriations statute or ordinance. The amount expended may not exceed the amount appropriated for each purpose. In this manner, a government budget has the effect of law by limiting spending to approved levels. Estimated Other Financing Sources and Estimated Other Financing Uses are budgetary accounts reflecting anticipated inflows and outflows of resources from sources other than revenues and spending. When a purchase order or contract is issued as authorized by an appropriation, the government recognizes this commitment as an encumbrance. An encumbrance is not a liability because the goods or services have merely been ordered, not received. The process by which a government moves from budgetary authority to expending fund resources is described in the following section.

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EXPENDITURE CYCLE
Illustration 3–4 depicts the expenditure cycle and corresponding journal entries for the General Fund or a special revenue fund with a legally adopted budget. To save space, we demonstrate journal entries using control accounts for activity (revenues and expenditures) and budgetary accounts (estimated revenues, appropriations, and encumbrances). Entries to control accounts would be supported with detailed entries in subsidiary accounts. These summarized postings are adequate to demonstrate the accounting concepts addressed. With the development of drop-down menus and other technological improvements, many accounting 3

GASB Statement 54 eliminated the reporting of Budgetary Fund Balance—Reserve for Encumbrances within the fund balance section of governmental fund balance sheets, removing the only instance of budgetary accounts appearing in the general purpose financial statements.

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ILLUSTRATION 3–4
City Council approves the fiscal year budget for the General Fund

Expenditure Cycle
City departments issue purchase orders for goods and services Goods and services are received and invoices are presented for payment

Journal Entries — Budgetary Accounts
Estimated Revenues …. Dr Estimated Other Financing Sources …. Dr Appropriations ………….. Cr Estimated Other Financing Uses ……..….. Cr Budgetary Fund Balance... Cr Record the budget Encumbrances Control …. Dr Budgetary Fund Balance Reserve for Encumbrances... Cr To establish the encumbrance Budgetary Fund Balance Reserve for Encumbrances... Dr Encumbrances Control …... Cr To reverse the encumbrance

Journal Entries — Financial Statement Accounts No entry No entry

Expenditures (Current) ... Dr Accounts Payable ..……... Cr To record the liability

information systems have discontinued the use of control accounts. You may wish to use detailed accounts (for example revenues by source) when preparing end-ofchapter exercises. The process begins with the governing board or legislature approving a budget. At first glance the budgetary accounts may appear to have balances opposite what would be expected—Estimated Revenues have debit balances and Appropriations have credit. However, the entry is designed to reflect the anticipated effect on the fund’s net resources (Budgetary Fund Balance) if everything went according to expectations. Because budgeted revenues and other financing sources exceed budgeted expenditures and other uses, fund balance is expected to increase (credit). However, if budgeted expenditures and other uses are expected to exceed budgeted revenues and other financing sources, Budgetary Fund Balance would be debited in the entry. The appendix to this chapter presents more detailed budgetary entries, including budget amendments. A department (such as police or health) cannot commit the government to expend resources until it is granted budgetary authority through its appropriations. Once that authority exists, departments can begin to commit resources by placing purchase orders or signing contracts. These commits are reflected in the budgetary accounts through the recording of Encumbrances and the corresponding Budgetary Fund Balance—Reserve for Encumbrances. GASB Statement 54 requires that significant encumbrances be disclosed in the notes along with required disclosures

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Modified Accrual Accounting

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about other commitments. However, there is no separate reporting of encumbrances within the fund balance section of the governmental funds balance sheet. Rather, encumbered resources should be reported within the restricted, committed, or assigned categories in a manner consistent with the criteria for those classifications. GASB Statement 54 provides no examples as guidance on how to classify encumbered amounts. At the very least, the existence of an encumbrance suggests that the government has an expressed intent to use resources for a particular purpose and therefore these resources should not be classified as unassigned. Encumbrance accounting may also be used in the case of contractual obligations, such as construction contracts. GASB Statement 54 requires that resources obligated to contractual obligations be classified as committed. We will examine the relation of encumbrances to the classification of fund balances in more detail in Chapters 4 and 5. Once goods or services are received, the government has a liability. At this point, two journal entries are necessary. The first reverses the encumbrance at its original amount. Since the government has incurred an actual liability, it is no longer necessary to reflect a commitment for the outstanding purchase orders or contracts. The second entry records the liability (Accounts Payable) and an Expenditure in the amount of the invoice. Recall that expenditures may be for current operations, capital assets, or debt service, including payment of principal on long-term debt. Governments can choose not to record encumbrances for all expenditures, particularly those that are relatively predictable in amount. For example, salaries may be initially recorded only as expenditures when due without having been formally encumbered. At the end of the budget period unencumbered, unexpended appropriations lapse, that is, administrators no longer have the authority to incur liabilities under the expired appropriations. In nearly all cases, administrators continue to have the authority to disburse cash in payment of liabilities legally incurred (and recorded as expenditures) in a prior period. However, appropriations that are encumbered may or may not carry forward to the next accounting period, depending on the government’s policy. If they do not carry forward and must be appropriated again in the following year, the encumbrances are said to lapse. The entry to record a lapsed encumbrance is the same as the reversal entry when a good or service is received (debit Budgetary Fund Balance—Reserve for Encumbrances and credit Encumbrances—Control).

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REVENUE RECOGNITION FOR NONEXCHANGE TRANSACTIONS
Under modified accrual accounting, revenues are recognized when they are both measurable and available to finance expenditures of the current period. Many governmental revenues result from nonexchange transactions. Nonexchange transactions are transactions in which a government receives resources without

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directly giving equal value in exchange. These are in contrast to exchange transactions, such as the purchase of goods or services. The most common forms of nonexchange transactions are tax revenues and intergovernmental grants. Most of the activities of governmental funds are supported by revenues generated through nonexchange transactions. Before a government may recognize revenue resulting from nonexchange transactions, it must meet a number of eligibility requirements. The eligibility requirements are as follows: 1. Required Characteristics of Recipients. The recipient must have the characteristics specified by the provider. For example, a state can provide funding on a per student basis to public schools. In order to recognize this revenue, the entity must be a public school as defined by state laws. 2. Time Requirement. If time requirements (for expenditure) are specified by the resource provider or legislation, those time requirements must be met. For example, a state can provide funding to support park districts for the next fiscal year. In that case, the revenue would not be recognized by the park districts until that fiscal year. If the resource provider does not specify time requirements, then no condition exists and the revenue would be recognized as soon as other eligibility requirements are met. 3. Reimbursement. For those grants and gifts that are payable only upon the incurrence of qualifying outlays, revenues would be recognized only when the expenditures have been incurred. 4. Contingencies. Resources pledged that have a contingency attached are not recognized as revenue until the contingency has been met. For example, if a donor indicates that $100,000 will be donated to build an addition to the city library when funds in an equal amount have been pledged by others, that revenue would be recognized only after the “matching” $100,000 has been raised from other donors.

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Illustration 3–5 identifies the four types of nonexchange transactions and describes when revenues resulting from these transactions are recognized under the modified accrual basis of accounting. The last column of Illustration 3–5 provides representative journal entries, illustrating the application of the measurable and available recognition criteria. In some cases, revenues resulting from nonexchange transactions are recognized in different periods in the fund basis and government-wide financial statements. For this reason, we will revisit this illustration in Chapter 8, which deals with the preparation of government-wide statements. Imposed nonexchange transactions are taxes and other assessments imposed by governments that are not derived from underlying transactions. Examples include property taxes, special assessments, and fines and forfeits. A special rule applies to property taxes. Property taxes collected within 60 days after the end of the fiscal year may be deemed to be available and recorded as revenue in the year assessed, rather than the year collected. Amounts expected to be collected more than 60 days after year-end are not recognized as revenue when assessed, but as deferred revenue (a liability).

ILLUSTRATION 3–5
Type

Classes and Timing of Recognition of Revenue from Nonexchange Transactions Modified Accrual Basis (Governmental Fund Basis) Record the receivable (and an allowance for uncollectibles) when an enforceable claim exits. Representative Transactions 1. Property taxes levied Example Journal Entry (Governmental Fund Basis Reporting) 1. Taxes Receivable ............ Dr Estimated Uncollectible Taxes ...... Cr Revenues Control .................... Cr 2. Revenues Control .......... Dr Deferred Revenues—Property Taxes ..Cr

Description and Examples

Imposed Taxes and other assessments Nonexchange that do not result from an Revenues underlying transaction. Examples include property taxes and special assessments imposed on property owners. Also includes fines and forfeits.

Revenues should be recognized in 2. Deferral of portion the period for which the taxes are expected to be collected levied (i.e., budgeted), but are > 60 days after year-end also subject to the availability rule. Property tax revenues expected to be collected > 60 days after yearend are deferred.

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Derived Tax Revenues

These are taxes assessed on exchange transactions conducted by businesses or citizens. Examples include sales, income, and excise taxes.

Record the receivable when the taxpayer’s underlying transaction takes place. Revenues should be recognized when available and measurable. Revenues not expected to be collected in time to settle current liabilities are deferred (i.e., available and measurable criteria). The recognition rules are the same for mandated and voluntary nonexchange grants. Record the revenue when all eligibility requirements have been met.

1. Income tax withholdings are received.

1. Cash ............................. Dr Revenues Control ........................Cr

2. Additional income 2. Taxes Receivable ............Dr taxes expected to be Revenues Control ........................Cr received after year end. Deferred Revenues—Income Taxes ..Cr Part of this will not be received in time to be available to settle current liabilities. Reimbursement-type grant: 1. Incur qualified expenditures. 1. Expenditures Control .....Dr Accounts Payable/Cash ............... Cr 2. Due from grantor ..........Dr Revenues Control ........................Cr

Governmentmandated Nonexchange Transactions

Grants from higher levels of government (federal or state) given to support a program. Since the program is required, the lower-level government has no choice but to participate.

Voluntary Donations and grants given to Nonexchange support a program. Since the Transactions program is not required, the receiving government voluntarily agrees to participate.

2. Recognize revenue. 3. Cash ............................. Dr In the case of reimbursement Deferred Revenues—Grants ........Cr grants, revenue is recognized only Advance funded grant: 4a. Expenditures Control …Dr when qualified expenditures have 3. Receipt of advance Accounts Payable/Cash ...............Cr funding. been incurred. 4. Incur expenditures and 4b. Deferred Revenues— In the case of advanced funded Grants .................Dr recognize revenue in an grants, recognize revenues as qualified expenditures are incurred. equal amount. Revenues Control ........................Cr

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Derived tax revenues result from taxes assessed on exchange transactions. Examples include taxes on retail sales, income, and gasoline. The amounts due are recorded in the time period the underlying transaction took place. For example, revenues due from taxes on the sale of gasoline should be recorded along with a receivable (from the retailers) in the month that the gasoline was sold. The revenue is recognized at the time of the exchange transaction provided the cash is expected to be collected shortly after the current fiscal year. If collection is expected to take place after the period considered available to pay current period liabilities (e.g., 60 days), it should be credited to deferred revenue of the current period. Government mandated and voluntary nonexchange transactions are recorded as revenue when the eligibility requirements have been met. Generally this is when the receiving government has made qualifying expenditures under the grant agreement. Once qualifying expenditures have been made, the government records the grant revenue. The two types of grants differ in whether or not the government has the ability to refuse to participate. For example, governmentmandated grants are typically from higher levels of government (federal or state) given to support a required program. Because the program is required, the lowerlevel government has no choice but to accept. For example, a state may require school systems to mainstream certain students in the schools and provide funds to carry out this mandate.

SUMMARY

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The current financial resource measurement focus and modified accrual basis of accounting are unique to the governmental funds of state and local governments. The focus is on the flow of financial resources rather than income measurement. Key elements include: • Revenues. Inflows of net financial resources from sources other than interfund transfers and debt proceeds. Revenues are recognized when they are both measurable and available to finance current expenditures. • Expenditures. Outflows of net financial resources from sources other than interfund transfers that are recognized when a governmental fund incurs a liability pursuant to budgetary authority provided by appropriation. • Fund balance. The net position (assets less liabilities) of a governmental fund and can be classified as nonspendable, restricted, committed, assigned, or unassigned. The General Fund and many special revenue funds record budgets and their accounting systems are designed to assure compliance with budgets. Budgetary accounting is illustrated in the appendix to this chapter. Now that you have completed reading Chapter 3, complete the multiple choice questions provided on the text’s Web site (www.mhhe.com/copley10e) to test your comprehension of the chapter.

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APPENDIX: BUDGETARY ACCOUNTING ILLUSTRATED
Budgets And Budgetary Accounts
The fact that budgets are legally binding upon administrators has led to the incorporation of budgetary accounts in the General Fund and in special revenue funds for which annual budgets are adopted. As indicated earlier, governments are required to report budget-actual comparisons as schedules in Required Supplementary Information. Governments may elect instead to provide those comparisons as one of the basic statements rather than as a schedule. The schedule (or statement) must provide the original budget; the final budget; and the actual amounts of revenues, expenditures, and other financing sources and uses. A variance column between the final budget and actual amounts is encouraged but not required. The format of the schedule (or statement) may be that of the budget document, or in the form used for the Statement of Revenues, Expenditures, and Changes in Fund Balances (see Illustration 2–16). Whichever approach is used, the amounts in the Actual column are to be reported on the basis required by law for budget preparation, even if that basis differs from the basis provided in GASB standards. For example, in some states revenues must be budgeted on the cash basis. If the Budget and Actual columns of the budgetactual comparison schedule differ from GASB standards, the heading of the statement should so indicate. Standards further require that, either on the face of the budgetary comparison schedule or in a separate schedule, the amounts in the Actual column of the budgetary comparison schedule must be reconciled with the amounts shown in the Combined Statement of Revenues, Expenditures, and Changes in Fund Balances prepared in conformity with GAAP. To facilitate preparation of the budgetary comparison schedule, accounting systems of governmental funds incorporate budgetary accounts. The general ledger accounts needed to provide appropriate budgetary control are Estimated Revenues, Appropriations, Estimated Other Financing Sources and Estimated Other Financing Uses control accounts, supported by subsidiary accounts as needed. At the beginning of the budget period, the Estimated Revenues control account is debited for the total amount of revenues expected to be recognized, as provided in the Revenues budget. The amount of revenue expected from each source specified in the Revenues budget is recorded in a subsidiary ledger account so that the total of subsidiary ledger detail agrees with the debit to the control account, and both agree with the adopted budget. If a separate entry is to be made to record the Revenues budget, the general ledger debit to the Estimated Revenues control account is offset by a credit to Budgetary Fund Balance. The account title, Budgetary Fund Balance, is used through the text to identify journal entries to establish or amend the budget. In practice, many governments make budget entries directly to Fund Balance. Since the budgetary accounts are closed at year-end, the choice of account title has no financial statement effect.

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The credit balance of the Budgetary Fund Balance account is the total amount expected to be available to finance appropriations. Consequently, the accounting entry to record the legally approved appropriations budget is a debit to Budgetary Fund Balance and a credit to Appropriations for the total amount appropriated for the activities accounted for by the fund. The Appropriations control account is supported by a subsidiary ledger kept in the same detail as provided in the appropriations ordinance, so that the total of the subsidiary ledger detail agrees with the credit to the Appropriations control account, and both agree with the adopted budget.

Recording the Budget
Assume the amounts appearing below have been legally approved as the budget for the General Fund of a city government for the fiscal year ending December 31, 2012. As of January 1, 2012, the first day of the fiscal year, the total Estimated Revenues should be recorded in the General Fund general ledger accounts, and the amounts that are expected to be recognized during the year from each revenue source specified in the budget should be recorded in the subsidiary ledger accounts. If the budget provided for other financing sources, such as transfers in, Entry 1 would indicate a debit to Estimated Other Financing Sources. An appropriate entry would be as follows:

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General Ledger Debits Credits Subsidiary Ledger Debits Credits

1. Estimated Revenues Control . . . . . . . . . . . . . 1,350,000 Estimated Other Financing Source Control . . 0 Budgetary Fund Balance . . . . . . . . . . . . . . Revenues Ledger: Taxes . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . Licenses and permits . . . . . . . . . . . . . . . . . Intergovernmental revenues . . . . . . . . . . . . Charges for services . . . . . . . . . . . . . . . . . Fines and forfeits . . . . . . . . . . . . . . . . . . . . Miscellaneous revenues . . . . . . . . . . . . . . .

1,350,000 $882,500 125,500 200,000 90,000 32,500 19,500

Subsidiary ledgers provide for the capture of detailed data specific to a business process. With the development of drop-down menus and other technological improvements, many accounting information systems have discontinued subsidiary ledgers. To save space throughout future chapters, we will demonstrate journal entries using control accounts to summarize revenue, expenditure, encumbrance, and

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budgetary accounts as if subsidiary ledgers are in use. These summarized postings are adequate to demonstrate the accounting concepts addressed. The total Appropriations legally approved for 2012 for the General Fund of the same governmental unit should also be recorded in the General Fund general ledger accounts, and the amounts that are appropriated for each function itemized in the budget should be recorded in subsidiary ledger accounts. An appropriate entry would be as follows:

General Ledger Debits Credits

Subsidiary Ledger Debits Credits

2. Budgetary Fund Balance . . . . . . . . . . . . . . . . 1,300,000 Appropriations Control . . . . . . . . . . . . . . . Estimated Other Financing Uses Control . . . . . . . . . . . . . . . . . . . . . . Appropriations Ledger: General government . . . . . . . . . . . . . . . . . Public safety . . . . . . . . . . . . . . . . . . . . . . . Highways and streets . . . . . . . . . . . . . . . . Sanitation . . . . . . . . . . . . . . . . . . . . . . . . . Health . . . . . . . . . . . . . . . . . . . . . . . . . . . . Welfare . . . . . . . . . . . . . . . . . . . . . . . . . . . Culture and recreation . . . . . . . . . . . . . . . Education . . . . . . . . . . . . . . . . . . . . . . . . . Other Financing Uses Ledger: Transfers out . . . . . . . . . . . . . . . . . . . . . . .

1,225,500 74,500 $129,000 277,300 84,500 50,000 47,750 51,000 44,500 541,450 74,500

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It is acceptable to combine the two entries illustrated and make one General Fund entry to record Estimated Revenues, Appropriations, and Estimated Other Financing Uses; in this case there would be a credit to Budgetary Fund Balance for $50,000 (the amount by which Estimated Revenues exceeds Appropriations and Estimated Other Financing Uses).

Accounting for Revenues
During a fiscal year, actual revenues should be recognized in the general ledger accounts of governmental funds by credits to the Revenues Control account (offset by debits to receivable accounts for revenues susceptible to accrual or by debits to Cash for revenues that are recognized when the cash is collected). The general ledger Revenues Control account supported by Revenues subsidiary ledger accounts is kept in exactly the same detail as kept for the Estimated Revenues subsidiary ledger accounts. For example, assume that the General Fund of the government for which

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budgetary entries are illustrated in the preceding section collected revenues in cash from the following sources in these amounts: General Ledger Debits Credits Subsidiary Ledger Debits Credits

3. Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Revenues Control . . . . . . . . . . . . . . . . . . . . . Revenues Ledger: Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . Licenses and permits . . . . . . . . . . . . . . . . Intergovernmental revenues . . . . . . . . . . . Charges for services . . . . . . . . . . . . . . . . . Fines and forfeits . . . . . . . . . . . . . . . . . . . Miscellaneous revenues . . . . . . . . . . . . . .

1,314,500 1,314,500 $881,300 103,000 186,500 91,000 33,200 19,500

Periodically throughout the year, elected officials and government managers will compare Estimated Revenue subsidiary accounts with actual Revenues subsidiary accounts. If revenues fail to reach the levels anticipated when the budget was enacted, budget revisions may be warranted to prevent the government from deficit spending. Illustration 3–6 shows the Licenses and Permits Revenue subsidiary ledger in a typical spreadsheet format. Because Estimated Revenues are recorded with debits and actual Revenues with credits, summing the two amounts provides a measure of the variance from expectations. In this case, Licenses and Permits Revenue did not meet expectations and a budget revision was deemed necessary. Since the budget is recorded at the beginning of the year and actual revenues are recognized throughout the year, Estimated Revenues Not Yet Realized will commonly have a net debit balance.

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ILLUSTRATION 3–6 Revenues Ledger
NAME OF GOVERNMENT
Revenues Ledger General Fund: Licenses and Permits Revenue 2012 Fiscal Year Estimated Revenues Not Yet Realized [ Sum] $ 125,500 $ 22,500 $ 0 $ 0

Transaction (1) (3) (7)

Reference Initial budget Collections Budget revision

Estimated Revenues $125,500

Actual Revenues

($103,000) ($ 22,500) $103,000 ($103,000)

$ Amounts in ( ) denote credits.

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Accounting for Encumbrances and Expenditures
An appropriation is considered to be expended when authorized liabilities are incurred. Purchase orders and contracts are commitments that will result in liabilities when the goods or services are received or the contracts executed. Such expected liabilities are called encumbrances. In order to keep track of purchase orders and contracts outstanding, it is recommended that the Encumbrance Control account (and the subsidiary account for the specific appropriation encumbered) be debited and the Budgetary Fund Balance—Reserve for Encumbrances account credited for the amount of each purchase order or contract issued. When goods or services are received, two entries are necessary: (1) Budgetary Fund Balance—Reserve for Encumbrances is debited, and Encumbrances Control (and the proper subsidiary account) is credited for the amount entered in these accounts when the encumbrance documents were issued; and (2) Expenditures Control (and the proper subsidiary account) is debited and a liability account is credited for the amount to be paid. In order to accomplish the necessary matching of Appropriations, Encumbrances, and Expenditures, it is necessary that subsidiary ledger classifications of all three correspond exactly. The following entries illustrate accounting for Encumbrances and Expenditures for the General Fund. Entry 4 reflects purchase orders issued pursuant to the authority contained in the General Fund appropriations; assumed amounts chargeable to each function for which purchase orders are issued on this date are shown in the debits to the Encumbrances subsidiary accounts.

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General Ledger Debits Credits

Subsidiary Ledger Debits Credits

4. Encumbrances Control . . . . . . . . . . . . . . . . . Budgetary Fund Balance—Reserve for Encumbrances . . . . . . . . . . . . . . . . . Encumbrances Ledger:. . . . . . . . . . . . . . . . . General government . . . . . . . . . . . . . . . . . Public safety . . . . . . . . . . . . . . . . . . . . . . . Highways and streets . . . . . . . . . . . . . . . . Sanitation . . . . . . . . . . . . . . . . . . . . . . . . . Health . . . . . . . . . . . . . . . . . . . . . . . . . . . . Welfare . . . . . . . . . . . . . . . . . . . . . . . . . . . Culture and recreation . . . . . . . . . . . . . . . Education . . . . . . . . . . . . . . . . . . . . . . . . .

500,100 500,100 $ 73,200 115,100 34,600 29,300 16,500 18,700 14,800 197,900

Entries 5a and 5b illustrate entries required to record the receipt of some of the items for which purchase orders were recorded in Entry 4. Note that Entry 4 is made for the amounts estimated at the time purchase orders or other commitment documents are issued. When the purchase orders are filled, the actual amount approved by the government for payment to the supplier often differs from the estimated amount recorded in the Encumbrances account (and subsidiary ledger accounts)

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because some items may have been unavailable, prices of items have changed, and so on. Since the Encumbrances Control account was debited in Entry 4 for the estimated amount, the Encumbrances Control account must be credited for the same estimate, to the extent that purchase orders are filled (or canceled). The balance remaining in the Encumbrances Control account, therefore, is the estimated dollar amount of purchase orders outstanding. Entry 5a shows the entry necessary on the assumption that most purchase orders recorded in Entry 4 have now been filled but purchase orders for general government and education remain outstanding. Expenditures, however, should be recorded at the actual amount the government agrees to pay the vendors who have filled the purchase orders. Entry 5b shows the entry necessary to record the liability for invoices approved for payment. The fact that estimated and actual amounts differ causes no accounting difficulties as long as goods or services are received in the same fiscal period as ordered.4 The accounting treatment required when encumbrances outstanding at year-end are filled or canceled in a following year is illustrated in Chapter 4. General Ledger Debits Credits Subsidiary Ledger Debits Credits

5a. Budgetary Fund Balance— Reserve for Encumbrances. . . . . . . . . . . . Encumbrances Control . . . . . . . . . . . . . . Encumbrances Ledger:. . . . . . . . . . . . . . . . General government . . . . . . . . . . . . . . . . Public safety . . . . . . . . . . . . . . . . . . . . . . Highways and streets . . . . . . . . . . . . . . . Sanitation . . . . . . . . . . . . . . . . . . . . . . . . Health . . . . . . . . . . . . . . . . . . . . . . . . . . . Welfare . . . . . . . . . . . . . . . . . . . . . . . . . . Culture and recreation . . . . . . . . . . . . . . Education . . . . . . . . . . . . . . . . . . . . . . . . 5b. Expenditures Control . . . . . . . . . . . . . . . . . Accounts Payable . . . . . . . . . . . . . . . . . . . Expenditures Ledger: General government . . . . . . . . . . . . . . . . Public safety . . . . . . . . . . . . . . . . . . . . . . Highways and streets . . . . . . . . . . . . . . . Sanitation . . . . . . . . . . . . . . . . . . . . . . . . Health . . . . . . . . . . . . . . . . . . . . . . . . . . . Welfare . . . . . . . . . . . . . . . . . . . . . . . . . . Culture and recreation . . . . . . . . . . . . . . Education . . . . . . . . . . . . . . . . . . . . . . . .

492,300 492,300 $ 68,300 115,100 34,600 29,300 16,500 18,700 14,800 195,000

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491,800 491,800 $ 69,100 115,100 34,400 29,300 16,600 18,700 14,800 193,800

The encumbrance procedure is not always needed to make sure that appropriations are not overexpended. For example, although salaries and wages of government 4

Many governments would require an additional approval (frequently in the form of a revised encumbrance) for amounts in excess of the original purchase order.

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employees must be chargeable against valid and sufficient appropriations in order to give rise to legal expenditures, many governments do not find it necessary to encumber the departmental personal services appropriations for estimated payrolls of recurring, relatively predictable amounts. Entry 6 shows the recording of expenditures of appropriations for salaries and wages not previously encumbered. General Ledger Debits Credits Subsidiary Ledger Debits Credits

6. Expenditures Control. . . . . . . . . . . . . . . . . Accounts Payable . . . . . . . . . . . . . . . . . . . Expenditures Ledger: . . . . . . . . . . . . . . . . . General government . . . . . . . . . . . . . . . . . Public safety . . . . . . . . . . . . . . . . . . . . . . . Highways and streets . . . . . . . . . . . . . . . . Sanitation . . . . . . . . . . . . . . . . . . . . . . . . . Health . . . . . . . . . . . . . . . . . . . . . . . . . . . . Welfare . . . . . . . . . . . . . . . . . . . . . . . . . . . Culture and recreation . . . . . . . . . . . . . . . Education . . . . . . . . . . . . . . . . . . . . . . . . .

663,600 663,600 $ 47,805 143,295 51,000 26,950 27,900 28,100 26,100 312,450

Illustration 3–7 shows a subsidiary ledger for the Education Department that supports all three general ledger control accounts: Appropriations, Encumbrances, and Expenditures. Again the ledger is presented in spreadsheet format. ILLUSTRATION 3–7 Subsidiary Ledger for the Education Department NAME OF GOVERNMENT Appropriations, Expenditures, and Encumbrances Ledger General Fund: Education Department 2012 Fiscal Year Unexpended Appropriation Balance [ SUM] ($541,450) ($343,550)

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Transaction Reference Appropriations (2) Budget ($541,450) (4) Purchase orders issued (5) Invoices received and approved for payment (6) Payrolls ($541,450) $ Amounts in ( ) denote credits.

Encumbrances

Expenditures

$197,900

($195,000) $ 2,900

$193,800 $312,450 $506,250

($344,750) ($ 32,300) ($ 32,300)

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Because Appropriations are recorded as credits and Encumbrances and Expenditures as debits, summing the amounts results in “Unexpended Appropriations Balance.” This may be interpreted as how much the Education Department may continue to expend and remain within its budget. The purpose of encumbrance accounting is to prevent governments from overspending. This becomes apparent in Illustration 3–7. At the time a purchase order is issued (transaction 4), the encumbrance is recorded in this subsidiary ledger as a debit, thereby reducing the balance appearing in the unexpended appropriation column. The $2,900 appearing at the bottom of the encumbrances column represent purchase orders outstanding at year-end.

Budget Revisions
In most cases, governments will prepare and adopt budget revisions. Assume the government in this example decided to revise the Estimated Revenues budget downward by $36,000 and the Appropriations Budget upward by $8,000:

General Ledger Debits Credits

Subsidiary Ledger Debits Credits

7. Budgetary Fund Balance . . . . . . . . . . . . . . . . . Estimated Revenues Control . . . . . . . . . . Appropriations Control. . . . . . . . . . . . . . . Revenues Ledger:. . . . . . . . . . . . . . . . . . . . Licenses and permits . . . . . . . . . . . . . . . . Intergovernmental revenues . . . . . . . . . . . Appropriations Ledger:. . . . . . . . . . . . . . Highways and streets . . . . . . . . . . . . . . . . Sanitation . . . . . . . . . . . . . . . . . . . . . . . . .

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36,000 8,000 $22,500 13,500 1,000 7,000

Budget revisions would require adjustments to the budgetary accounts and balances in the subsidiary ledgers (Illustrations 3–6 and 3–7).

Budgetary Comparison Schedule
Illustration 3–8 presents a budgetary comparison schedule as it might be prepared by the government in the example. Assume a transfer out in the amount of $74,500 as provided in the budget. This schedule would be included as a part of Required Supplementary Information or could be prepared as a basic financial statement.

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ILLUSTRATION 3–8

Budgetary Comparison Schedule NAME OF GOVERNMENTAL UNIT
Budgetary Comparison Schedule General Fund For the Year Ended December 31, 2012 Variance with Final Budget Positive (Negative) $ (1,200) ——— ——— 1,000 700 ——— 500 7,195 18,905 100 750 3,250 4,200 3,600 32,300 70,300

Budgeted Amounts Original Revenues: Taxes Licenses and permits Intergovernmental revenues Charges for services Fines and forfeits Miscellaneous revenues Total revenues Expenditures and encumbrances: General government Public safety Highways and streets Sanitation Health Welfare Culture and recreation Education Total expenditures and encumbrances Excess (deficiency) of revenues over expenditures and encumbrances Other financing sources (uses): transfers out Net change in fund balance Fund balance—beginning Fund balance—ending $ 882,500 125,500 200,000 90,000 32,500 19,500 1,350,000 129,000 277,300 84,500 50,000 47,750 51,000 44,500 541,450 Final $ 882,500 103,000 186,500 90,000 32,500 19,500 1,314,000 129,000 277,300 85,500 57,000 47,750 51,000 44,500 541,450

Actual Amounts (Budgetary Basis) $ 881,300 103,000 186,500 91,000 33,200 19,500 1,314,500 121,805 258,395 85,400 56,250 44,500 46,800 40,900 509,150

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1,225,500

1,233,500

1,163,200

124,500 (74,500) 50,000 332,000 $ 382,000

80,500 (74,500) 6,000 350,000 $ 356,000

151,300 (74,500) 76,800 350,000 $ 426,800

70,800 ——— 70,800 ——— $70,800

Classification of Estimated Revenues and Revenues
A revenue budget is necessary for administrators to determine whether proposed expenditures can be financed by resources available to the budgeting jurisdiction. The budget should include all sources, including interfund transfers and bond issue proceeds as well as taxes, licenses and permits, fees, forfeits, and other revenue

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sources. It should be emphasized that a government may raise revenues only from sources that are available to it by law. The primary classification of governmental revenue is by fund. Within each fund the major classification is by source. Within each major source class it is desirable to have as many secondary classes as are needed to facilitate revenue budgeting and accounting. Commonly used major revenue source classes are: Taxes Licenses and permits Intergovernmental revenues Charges for services Fines and forfeits Miscellaneous revenues

Examples of secondary classes of tax revenues include property taxes, sales taxes, and excise taxes.

Classification of Appropriations and Expenditures
Recall that an appropriation, when enacted into law, is an authorization to incur liabilities on behalf of the government for goods, services, and facilities to be used for purposes specified in the appropriation ordinance, or statute, in amounts not in excess of those specified for each purpose. When liabilities authorized by an appropriation have been incurred, the appropriation is said to be expended. Classification by fund is, of course, essential. Within each fund one or more of the following classification schemes is used to meet the needs of financial statement users: (1) function or program, (2) organization unit, (3) activity, (4) character, and (5) object. Common terminology and classifications should be used consistently throughout the budget, the accounts, and the financial reports of each fund. Examples of classifications by function are general government, public safety, and highways and streets. While most governments report by function, others report by program, such as protection of persons and property and environmental protection. Programs are often performed by more than one department; consequently, program expenditures often cross departmental lines. Reporting expenditures by departments (e.g., police or health) is the most common form of classification by organizational unit. Activities are specific and distinguishable lines of work performed by organizational units. Examples of activities are solid waste collection and solid waste disposal, both in the Public Works Department. Classification by character deals with the time period involved and includes current expenditures, capital outlays, and debt service. Classification by object reports the inputs, or the item or service received, such as personal services, supplies, other services and charges, capital outlays, and debt service. Generally, more detailed object classes are used for each of the major categories.

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Questions and Exercises
3–1. Using the annual report obtained for Exercise 1–1, answer the following questions. a. Look at the Statement of Revenues, Expenditures, and Changes in Fund Balances for the governmental funds. List the revenue source classes. Do they agree with those sources discussed in this chapter? Are expenditures reported by character? List the functional classifications under the current character classification. Do those classifications agree with those listed in the example shown in this chapter? Are Other Financing Sources and Uses presented separately? Does your report show transfers in? Transfers out? Capital leases? Proceeds of bonds? b. Look at the Budgetary Comparison Schedule in the RSI section of your annual Report (or Budgetary Comparison Statement, if that is used by your government) for the General Fund. Is the budgetary format used, or is the schedule in the format used for the Statement of Revenues, Expenditures, and Changes in Fund Balances? Does the report reflect the original budget, revised budget, and actual figures? Are variance columns presented comparing the actual with the revised budget and comparing the original with the revised budget? Is a reconciliation between the budgetary basis of accounting and GAAP presented on the budgetary comparison schedule or in a separate schedule? What are the major differences, if any? Are budgetary comparison schedules (or statements) presented for special revenue funds? Are all special revenue funds included? c. Look at the note that describes the basis of budgeting (usually in the Summary of Significant Accounting Policies). Is the budget prepared on the GAAP basis or some other basis? Are the differences, if any, between the budgetary basis and GAAP clearly explained? Does the note indicate that encumbrance accounting is used? Do unexpended encumbrances lapse at year-end? If unexpended encumbrances lapse, are they normally reappropriated in the following year? Do the notes describe the budget calendar (a separate note may have this information)? Do the notes describe the legal level of budgetary control and the levels at which certain budget revisions might be made? Were budget revisions necessary during the year? 3–2. The City of Oxbow General Fund has the following net resources at yearend: • $100,000 unexpended proceeds of a state grant required by law to be used for health education. • $15,000 of prepaid insurance. • $500,000 rainy day fund approved by city council for use under specified circumstances.

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3–3. 3–4.

3–5.

3–6.

3–7.

3–8.

• $25,000 of contractual obligations for capital projects. • $50,000 unexpended proceeds of a tax required by law to be used for emergency 911 services. • $550,000 to be used to fund government operations in the future. Required: Prepare the fund balance section of the Balance Sheet. How should rainy day funds be reported under GASB Statement 54? Prepare budgetary entries, using general ledger accounts only, for each of the following unrelated situations: a. Anticipated revenues are $10 million; anticipated expenditures and encumbrances are $9.8 million. b. Anticipated revenues are $9.8 million; anticipated expenditures and encumbrances are $10 million. c. Anticipated revenues are $10 million; anticipated transfers from other funds are $1.3 million; anticipated expenditures and encumbrances are $9.8 million; anticipated transfers to other funds are $1.2 million. d. Anticipated revenues are $9.8 million; anticipated transfers from other funds are $1.2 million; anticipated expenditures and encumbrances are $10 million; anticipated transfers to other funds are $1.3 million. For each of the summarized transactions for the Village of Sycamore General Fund, prepare the general ledger journal entries. The year is January 1– December 31, 2012. a. The budget was formally adopted, providing for estimated revenues of $1,000,000 and appropriations of $980,000. b. Revenues were received, all in cash, in the amount of $1,010,000. c. Purchase orders were issued in the amount of $500,000. d. Of the $500,000 in (c), purchase orders were filled in the amount of $490,000; the invoice amount was $480,000 (not yet paid). e. Expenditures, not encumbered, amounted to $460,000 (not yet paid). f. Amounts from (d ) and (e) are paid in cash. a. Distinguish between (1) exchange and (2) nonexchange transactions. b. Identify and describe the four eligibility requirements for a government to recognize revenue in a nonexchange transaction. c. GASB Statement 33 classifies nonexchange transactions into four categories. List the four categories, give an example of each, and outline asset and revenue recognition criteria for each. a. Outline revenue recognition criteria under modified accrual accounting. Include specific requirements for property tax revenue. b. Outline expenditure recognition criteria under modified accrual accounting. Distinguish between the (1) GAAP basis and (2) budgetary basis of reporting for the General Fund.

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3–9. The City of South Dundee budget for the fiscal year ended June 30, 2012, included an appropriation for the police department in the amount of $16,000,000. During the month of July 2011, the following transactions occurred (in summary): Purchase orders were issued in the amount of $600,000. Of the $600,000 in purchase orders, $580,000 were filled, with invoices amounting to $575,000. Salaries, not encumbered, amounted to $798,000. A budget appropriations reduction in the amount of $20,000 was approved by the city council.

Prepare an appropriations, expenditures and encumbrances ledger for the police department for the month of July, in a format similar to Illustration 3–7. 3–10. The Budgetary Comparison Schedule for the City of Vienna appears below. Several items of information are missing (denoted**). CITY OF VIENNA

Budgetary Comparison Schedule General Fund For the Year Ended December 31, 2012 Actual Amounts Budgeted Amounts (Budgetary Original Final Basis) $3,200,000 900,000 500,000 100,000 4,700,000 ** 900,000 500,000 104,000 ** $3,400,000 ** 500,000 105,000 **

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Revenues: Taxes Licenses Intergovernmental Miscellaneous Total revenues Expenditures and encumbrances General government Parks Health and welfare Total expenditures and encumbrances Net change in fund balance Fund balance—beginning Fund balance—ending

Variance with Final Budget Positive (Negative) $100,000 (2,000) 0 1,000 99,000

** 2,500,000 1,200,000 ** 50,000 332,000 $ 382,000

** 2,500,000 1,204,000 ** 160,000 350,000 $510,000

925,000 2,400,000 ** ** 428,000 350,000 $778,000

15,000 100,000 54,000 169,000 268,000 0 $268,000

Required: a. Determine the missing amounts. b. During the year, the City made a single budget revision. Prepare the journal entry to record that revision.

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3–11. Appearing below is the subsidiary ledger for the public safety department of the City of Boone. After the first month of the year, five entries have been made to the ledger. Unexpended Appropriation Balance Expenditures [ SUM] ($254,000) ($236,000) ($236,500) ($225,500) ($208,500) ($208,500)

Transaction 1 2 3 4 5

Appropriations ($254,000)*

Encumbrances $18,000 ($15,000)

$14,500 11,000 $25,500

$17,000 ($237,000)

$3,000

* $ amounts in ( ) denote credits.

Describe the most likely event that led to each of the postings (items 1–5). 3–12. Following are transactions and events of the General Fund of the City of Springfield for the fiscal year ended December 31, 2012. 1. Estimated revenues (legally budgeted) Property taxes Sales taxes Licenses and permits Miscellaneous

Apago PDF 4,000,000 Enhancer 1,500,000
500,000 $5,000,000 4,500,000 1,000,000

$5,000,000

2. Appropriations
General government Culture and recreation Health and welfare

3. Revenues received (cash)
Property taxes Sales taxes Licenses and permits Miscellaneous $4,783,541 4,501,009 1,700,000 800,000

4. Encumbrances issued (includes salaries and other recurring items) General government Culture and recreation Health and welfare Estimated $5,100,000 4,650,000 905,000

5. Goods and services received (paid in cash)
General government Culture and recreation Health and welfare Estimated $5,100,000 4,650,000 905,000 Actual $5,035,450 4,610,000 891,550

Modified Accrual Accounting

83

6. Budget revisions
Increase appropriations: General government Culture and recreation $100,000 150,000

7. Fund balance—Unrestricted on January 1, 2012, was $735,000. There were no outstanding encumbrances at that date. a. Record the transactions using appropriate journal entries. b. Prepare a budgetary comparison schedule for the General Fund. 3–13. The town council of Riverside met in December 2011. The council estimated revenues for 2012 to be $750,000 from property taxes and $150,000 from business licenses. The appropriations budget from the council was as follows: General government Parks and recreation Sanitation Streets and sidewalks $500,000 110,000 90,000 160,000

In 2012, heavy spring rains caused some flooding near the river. As a result, a picnic area at River’s Edge Park was ruined and several damaged shops had to shut down. The council adopted an upward revision of $22,000 for the parks and recreation budget and reduced the estimated revenues from business licenses by 10 percent. The General Fund began the year with a balance of $22,888. During 2012, tax collections totaled $748,800 and revenues from business licenses were $137,202. Expenditures were $499,200 for general government, $131,345 for parks and recreation, $91,600 for sanitation, and $157,333 for streets and sidewalks. There are no outstanding encumbrances at year-end. 1. Prepare a budgetary comparison schedule for the General Fund for 2012. 3–14. Presented here are several transactions and events of the General Fund of Johnson County. All transactions and events relate to calendar year 2012. 1. Estimated revenues from the following sources were legally budgeted.

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Sales taxes Fines and forfeits Licenses and permits Intergovernmental revenues Total

$6,000,000 2,000,000 1,750,000 350,000 $10,100,000

2. Appropriations for the following functions were legally budgeted. General government Public safety Culture and recreation Health and welfare Total $2,100,000 3,890,000 700,000 3,000,000 $9,690,000

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3. During the year, revenues were received in cash from the following sources: Sales taxes Fines and forfeits Licenses and permits Intergovernmental revenues Total $ 5,930,000 1,990,000 1,740,000 385,000 $10,045,000

4. During the year, contracts and purchase orders were issued as follows: General government Public safety Culture and recreation Health and welfare Total $ 450,000 800,000 280,000 500,000 $2,030,000

5. Goods and services (these are a portion of the total ordered in transaction 4) were received, as follows: General government Public safety Culture and recreation Health and welfare Total Estimated $ 450,000 500,000 275,000 500,000 $1,725,000 Actual $ 452,000 510,000 276,000 500,000 $1,738,000

6. A budget revision was approved by the County Commission. Estimated revenues for intergovernmental revenues were increased by $35,000. Appropriations for general government were increased by $100,000. 7. Vouchers were issued for items not previously encumbered, primarily personal services, in the following amounts:

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$1,747,000 3,080,000 418,000 2,500,000 $7,745,000

General government Public safety Culture and recreation Health and welfare Total

a. Record the transactions in general journal form. Include subsidiary accounts as illustrated in this chapter. b. Open budgetary, revenue, expenditure, and encumbrance general ledger control accounts and post the transactions. You may use T-accounts. c. Open Revenue and Appropriations, Expenditures, and Encumbrances subsidiary ledgers. Post the transactions. Prove that the control account balances agree with the related subsidiary ledger accounts. d. Assume a beginning Fund Balance—Unreserved of $150,000. Prepare a budgetary comparison schedule for the General Fund. Include encumbrances with expenditures. Use Illustration 3–8 as an example. e. Assuming that encumbered appropriations do not lapse at the end of the budget year, how much of the appropriations, by function, did lapse at the end of 2012? Show computations in good form.

Modified Accrual Accounting

85

Excel-Based Problems
Microsoft Excel templates are available on the text Web site for use with problems 3–15 and 3–16 (www.mhhe.com/copley10e). 3–15. The Budgetary Comparison Schedule for the City of Salem appears in Illustration 2–16. Assume the general and subsidiary ledgers for the General Fund were lost after a water pipe burst. You are charged with reproducing the journal entries that took place during the year ended December 31, 2012. Use the excel file provided to prepare summary journal entries, including subsidiary ledger entries, for the following events. a. Record the original budget. b. Record the revisions to the budget. c. Record the actual revenues. d. Record the encumbrances, assuming all expenditures originated as encumbrances and the encumbrance and expenditure are equal in amount. e. Record the actual expenditures and reversal of the associated encumbrance. You should follow the format of the entries provided in entries 1 to 7 of the appendix to Chapter 3. 3–16. The City of Grafton’s records reflected the following budget and actual data for the General Fund for the fiscal year ended June 30, 2012. 1. Estimated revenues:

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$3,000,000 800,000 300,000 200,000

Taxes (Property) Licenses and permits Intergovernmental revenues Miscellaneous revenues

2. Revenues:
Taxes (Property) Licenses and permits Intergovernmental revenues Miscellaneous revenues $3,000,000 801,320 293,000 198,000

3. Appropriations:
General government Public safety Health and welfare $ 900,000 2,000,000 1,400,000

4. Expenditures of 2012 appropriations:
General government Public safety Health and welfare $ 880,000 1,949,000 1,398,000

5. Encumbrances of 2012 appropriations, outstanding as of June 30, 2012. General government Public safety $18,000 50,000

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Chapter 3

6. Transfer to debt service fund:
Budget Actual $600,000 600,000

7. Budget revisions approved by the city council:
Estimated revenues: Decrease intergovernmental revenues Decrease miscellaneous revenues Appropriations: Decrease general government $10,000 3,000 2,000

8. Total fund balance at July 1, 2011, was $1,038,000. Required: Use the Excel file provided to prepare a budgetary comparision schedule for the City of Grafton for the fiscal year ended June 30, 2012. Include outstanding encumbrances with expenditures. Use the formula feature (e.g., sum, , etc.) of Excel to calculate the amounts in cells shaded blue.

Continuous Problem
Available on the text’s Web site (www.mhhe.com/copley10e).

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Chapter Four
Accounting for the General and Special Revenue Funds
It is evident from the state of the country, from the habits of the people, from the experience we have had on the point itself, that it is impracticable to raise any considerable sums by direct taxation. (Alexander Hamilton, first Secretary of the Treasury, commenting on how to finance government operations) It’s not pretty, but it’s our system of government. And it works. It’s like sausage: no one wants to see it made, and it will eventually destroy your heart. (Stephen Colbert, political satirist and television host)

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Learning Objectives
• Apply the modified accrual basis of accounting in the recording of typical transaction of a General or special revenue fund. • Prepare closing entries and classify fund balances within the framework of GASB Statement 54. • Prepare the fund-basis financial statements for a General or special revenue fund.

odified accrual accounting is illustrated in Chapter 3 along with the use of budgetary accounts. This chapter applies that knowledge by recording common transactions and events in the operation of the General Fund and a special revenue fund of a hypothetical local government, the Village of Elizabeth. We will continue with the Village of Elizabeth in Chapters 5 through 8, demonstrating governmental, proprietary, and fiduciary fund accounting. Chapters 4 through 7 present the required fund-basis financial statements and Chapter 8 illustrates the preparation of government-wide financial statements. In the interest of clarity of presentation, subsidiary ledgers are not illustrated throughout this chapter for the budgetary and operating statement accounts, but keep in mind that subsidiary accounts or more detailed general ledger accounts for revenues, expenditures, and budgetary accounts would be required in actual situations.

M

88

Chapter 4

Recall from Chapter 1 the following fund definitions, as prescribed by GASB Statement 54: • General Fund Accounts for and reports all financial resources not accounted for and reported in another fund. • Special Revenue Funds Account for and report the proceeds of specific revenue sources that are restricted or committed to expenditure for specified purpose other than debt service or capital projects. • Debt Service Funds Account for and report financial resources that are restricted, committed, or assigned to expenditure for principal and interest. • Capital Projects Funds Account for and report financial resources that are restricted, committed, or assigned to expenditure for capital outlays. The purpose of fund accounting is to segregate those financial resources that have constraints or limitations on their use so that the government may demonstrate compliance with those limitations. However, many resources have no limitations on their use and do not require segregation. The General Fund accounts for any resources not reported in one of the other (limited-use) funds. Every general-purpose government will have one, and only one, General Fund. Special revenue funds are an example of a fund established because of constraints placed on the use of government resources. Note, however, that special revenue funds are not used if the resources are required to be used to acquire capital assets or for the payment of interest and principal on long-term debt. GASB Statement 54 provides particular guidance for the use of special revenue funds. Specifically, the standard requires that special revenue funds be used only if a substantial portion of the resources are provided by one or more restricted or committed (not assigned ) revenue sources. Although other resources may supplement a special revenue fund, assignment of resources is not sufficient for the establishment of a special revenue fund. In this respect, special revenue funds are notably different from debt service and capital project funds. Further, if the government expects that a substantial portion of the resources supporting a special revenue fund’s activities will no longer be derived from restricted and committed revenue sources, the government should discontinue the use of a special revenue fund and report the fund’s remaining resources in the General Fund.

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OVERVIEW OF MODIFIED ACCRUAL ACCOUNTING
Governmental fund financial statements are prepared on the modified accrual basis of accounting. Under modified accrual accounting, revenues are recognized when they are both measurable and available to finance expenditures of the current period. The term measurable means that the government is able to determine or reasonably estimate the amount. For example, property taxes are measurable before collection because the government determines the amount assessed and estimates any portion that will ultimately prove to be uncollectible. The term available means the amount is expected to be collected within the current period or soon enough thereafter to be used to pay liabilities of the current period.

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89

The term expenditure rather than expense is used in modified accrual accounting. Expenditures are decreases in net financial resources and are generally recognized when the related liability is incurred. Expenditures may be for current purposes (such as salaries or supplies) for capital outlay, or for debt service (principal or interest). GASB Interpretation 6, Recognition and Measurement of Certain Liabilities and Expenditures in Governmental Fund Financial Statements, clarifies when expenditures should be recognized when using modified accrual accounting. Generally, expenditures are recorded and fund liabilities are recognized when goods and services are received, regardless of whether resources are available in the fund. The most important exception is that debt service expenditures for principal and interest are recorded when due. This means that debt service expenditures are not accrued, but are recognized and fund liabilities are recorded on the maturity date. According to Interpretation 6, expenditures for claims and judgments, compensated absences, special termination benefits, and landfill closure and postclosure care costs of governmental funds should be recognized to the extent that the liabilities are going to be paid with available resources; additional amounts are reported as (long-term) liabilities in the government-wide statements.

INTERFUND TRANSACTIONS
Interfund transactions are transactions between individual funds. Interfund transactions are of particular interest to financial statement preparers and users because failure to report these transactions properly results in two funds being misstated. Additionally, because most of these transactions are eliminated in the governmentwide statements, it is particularly important they be identified in the accounts of the affected funds. Like related party transactions, transactions between funds of the same government may not be assumed to be arm’s length in nature. An arm’s length transaction is one in which both parties act in their own self-interest and are not subject to pressure or influence. GASB standards require that interfund transactions be classified into two categories, each with two subcategories. Journal entries to record interfund transactions are based on these classifications. Reciprocal interfund activity is the internal counterpart to exchange and exchange-like transactions and includes interfund loans and interfund services provided and used. Nonreciprocal interfund activity includes interfund transfers and interfund reimbursements. The accounting for interfund transactions is described below and summarized in Illustration 4–1.

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Interfund Loans
Interfund loans are resources provided from one fund to another with the requirement for repayment. The fund providing the resources records an interfund receivable (Due from Other Funds) and the fund receiving the resources records an interfund payable (Due to Other Funds). Long-term loans use the terms Advance to Other Funds and Advance from Other Funds. Interfund loan receivables and payables are separately reported on the balance sheets of the affected funds.

ILLUSTRATION 4 –1
Interfund Transaction Interfund Loans

Summary of Interfund Transactions
Example Journal Entry: Fund Making the Payment Due from Other Fund …Dr Cash ………………………......... Cr If the loan is long-term, Advance to Other Funds is used in place of Due from Other Funds. Expenditures …………... Dr Cash ……………….……........... Cr If the fund receiving the service is a proprietary fund, Expense is used in place of Expenditure. Other Financing Uses— Transfers Out ….…… Dr Cash …………..………….......... Cr Example Journal Entry: Fund Receiving the Payment Cash ………………. Dr Due to Other Fund ………. Cr If the loan is long-term, Advance from Other Funds is used in place of Due to Other Funds. Cash ………………. Dr Operating Revenue— Charges for Services …… Cr

90

Description In an interfund loan, resources are provided from one fund to another with the expectation they will be repaid. The most common examples are where a governmental fund purchases services from an internal service (or enterprise) fund. In an interfund transfer, resources are provided from one fund to another without the expectation they will be repaid. In an interfund reimbursement, one fund initially records a purchase that belongs in another fund. The fund where the purchase correctly belongs reimburses the fund that made the payment and the paying fund reverses its initial entry.

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Interfund Services

Interfund Transfers

Cash ………………. Dr Other Financing Sources— Transfers In……….…..…. Cr

Interfund Reimbursement

Expenditures …….... Dr Cash ……………………..... Cr

Expenditures …………...Dr Cash ……………………………. Cr If the fund is a proprietary fund, Expense is used in place of Expenditure.

Cash ………………. Dr Expenditures ……………… Cr If the fund is a proprietary fund, Expense is used in place of Expenditure.

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91

Interfund Services Provided and Used
Interfund services provided and used represent transactions involving sales and purchases of goods and services between funds. An example is the sale of water from a water utility (enterprise) fund to the General Fund. In these transactions, one fund records a revenue (enterprise, in this example) and the other fund records an expenditure or expense (the General Fund). Sometimes called quasi-external transactions, these transactions are reported as if they were transactions with parties outside the government.

Interfund Transfers
Interfund transfers represent flows of cash or other assets without a requirement for repayment. An example would be an annual transfer of resources from the General Fund to a debt service fund. Interfund transfers act (in terms of debits and credits) as if they are revenues or expenditures (expenses) but are classified as other financing sources (the debt service fund) and other financing uses (the General Fund).

Interfund Reimbursements
Interfund reimbursements represent repayments to the funds that initially recorded expenditures or expenses by the funds responsible. For example, assume the General Fund had previously debited expenditures to acquire some supplies, but the supplies should have been charged to a special revenue fund. The reimbursement entry would have one fund (the special revenue fund) debit an expenditure (or expense) and the other fund (the General Fund) credit an expenditure or expense.

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ILLUSTRATIVE CASE—GENERAL FUND
Illustration 3–1 (in Chapter 3) presents a Governmental Fund Account Structure that can be used as a guide when studying the following illustrative case and other journal entries in Chapters 4 and 5. Assume that at the beginning of fiscal year 2012, the Village of Elizabeth’s General Fund had the following balances in its accounts: Debits Cash Taxes Receivable—Delinquent Estimated Uncollectible Delinquent Taxes Interest and Penalties Receivable on Taxes Estimated Uncollectible Interest and Penalties Accounts Payable Deferred Revenues—Property Taxes Due to Federal Government Budgetary Fund Balance—Reserve for Encumbrances Fund Balance Totals $100,000 400,000 $ 40,000 25,000 10,000 135,000 20,000 30,000 45,000 245,000 $525,000 Credits

$525,000

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The Deferred Revenues—Property Taxes account reflects the portion of the $400,000 in taxes receivable that have not yet been recognized as a revenue. The Budgetary Fund Balance—Reserve for Encumbrances account represents the amount of purchase orders and contracts, related to the prior year, that remain open at the beginning of 2012.

Recording the Budget
At the beginning of fiscal year 2012, it is necessary to record the budget (assuming that all legal requirements have been met). If the total estimated revenue budget is $6,200,000, the total appropriations are $5,200,000, the total planned transfer to debt service funds is $204,000, and a planned transfer to establish an internal service fund is $596,000, the necessary entry to record the budget would be as follows (keeping in mind that appropriate subsidiary ledger detail would be required in actual situations): Debits Credits

1. Estimated Revenues Control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Appropriations Control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Estimated Other Financing Uses Control . . . . . . . . . . . . . . . . . Budgetary Fund Balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6,200,000 5,200,000 800,000 200,000

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Re-establishment of Encumbrances
Assuming the $45,000 in purchase orders at the beginning ...

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Keywords

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103 104 105 105.43 106 107 108 109 10a 10b 10c 10th 11 11.0 11/2 11/30/07 11/30/08 11/30/09 11/30/10 11/30/11 11/30/12 110 111 112 112.0 11282y 113 114 115 116 117 118 119 11a 11b 11d 11e 11f 12 12/31/2012 120 121 122 1221 123 124 125 126 127 127.7 128 129 12a 12b 12c 13 13.01 130 130.2 130.4 131 132 133 134 135 135.0 136 137 138 139 13a 13b 14 14.1 14.6 14.79 140 141 142 143 144 145 146 147 148 149 14a 14b 14th 15 150 151 152 153 154 1545 155 156 157 157.3 158 159 15th 16 160 161 162 163 164 165 166 167 168 169 16a 16b 17 17.6 170 171 172 173 174 175 176 177 1776 178 178.2 1787 1788 179 18 180 181 182 183 184 185 186 1861 1869 187 1879 188 1885 189 18b 19 19.9 190 191 1916 192 1929 193 1930 1935 194 1940 1947 1948 195 1955 196 1960s 1968 197 1970s 1973 1975 198 1980 1980s 1984 1985 1986 1987 1989 199 1990 1993 1994 1996 1997 19a 19b 1a 1b 1h 1st 2 2.3 2.31 2.5 2.50 2.78 2/12 20 200 2000 2001 2002 2004 2005 2006 2007 2008 2009 2009054187 201 2010 2011 2012 2013 2014 202 203 203.5 204 205 205.8 206 207 208 209 20a 20b 21 210 2100 211 212 213 214 215 216 217 218 219 21a 21b 21st 22 220 2200 2200.922 221 222 223 224 225 226 226.4 227 228 229 22a 22b 23 230 231 232 233 234 235 236 237 238 239 24 240 241 242 243 244 245 246 247 247.8 248 249 24f 25 25.00 250 250.9 251 252 253 254 255 256 257 258 259 26 260 261 262 263 264 265 266 267 268 269 27 270 271 272 273 274 275 275.5 276 277 278 279 28 280 281 282 283 284 285 286 287 288 289 29 29.8 290 290/10 291 292 293 294 295 296 297 298 299 2a 2b 2c 2d 2g 3 3.3 30 300 300/10 301 302 303 304 305 306 307 308 309 31 310 311 312 313 314 315 316 317 318 318.9 319 31st 32 320 321 322 323 324 325 326 327 328 329 33 330 331 332 333 334 335 336 337 338 339 34 340 341 342 343 344 345 346 347 348 349 35 350 351 352 353 354 355 356 357 358 359 35th 36 360 361 362 363 364 365 366 367 368 369 37 370 371 372 373 374 375 376 377 378 379 37th 38 38.4 380 381 382 383 384 385 386 387 388 389 38th 39 390 391 392 393 394 395 396 397 398 399 3a 3b 3rd 4 4.0 4.12 4.22 4.27 4.33 4.44 4/30/12 40 400 401 402 403 404 405 406 407 408 409 41 410 411 412 412.9 413 414 415 416 417 418 419 42 420 421 422 423 424 425 426 427 428 429 43 430 431 432 433 434 435 436 437 438 439 44 440 440.8 441 443 444 445 446 447 448 449 449.5 44th 45 450 452 454 455 456 457 458 459 46 460 462 464 465 466 467 468 469 47 47.9 470 472 473 475 477 478 479 48 480 481 482 483 484 485 486 487 488 489 49 490 491 492 493 494 4947 495 4958 496.5 497 498 499 4a 4b 4th 5 5.50 5/1/11 50 50.72 500 501 502 503 504 505 506 507 508 509 51 510 511 512 513 515 516 517 518 52 520 521 522 523 524 525 527 528 529 53 530 531 532 533 534 535 537 54 540 541 542 543 544 545 546 548 549 55 550 552 554 555 556 557 558 559 56 560 561 562 563 564 566 567 568 569 57 570 572 574 575 576 577 578 58 580 581 581.1 582 583 584 587 588 589 59 590 591 593 594 595 596 597 598 599 5a 5b 6 6.5 6.7 6/12 60 600 601 602 603 604 605 607 608 61 61.4 610 611 612 613 615 616 618 619 62 62.0 62.2 62.5 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contributori control controversi conveni convent convers convert cook cooper coordin copi copley [email protected] copyright cord corner cornerston corpor corpus correct correspond cost cost-outcom cost-reimburs cost-shar costs/obligation cottonwood could council counsel count counterpart counti countri cours court courthous coven cover coverag cpa cpas cpe cr creat creation creativ credit creditor creditors.4 creditworthi crime crimin criteria criterion critic cronkit cross crs.uvm.edu crs.uvm.edu/schlrpt/ cruelti ct cubic cultur cumul currenc current current-year currentyear curtail custodi custom customari customarili cycl d dakota dam damag dame danger danko data databas date david day day-to-day dc dc22 dead dead-tim deal dealer dean death debat debit debt debt-rat debt-rel dec decemb deci deci-s decid decis decision-mak declar declin declining-bal decompos decreas dedic deduct deem def default defeas defect defens defer deferr defici deficit defin definit defray degre delawar 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