Recognizing Expenditures in Governmental Funds Chapter 5 Chapter 5 Granof & Khumawala-6e Recognizing Expenditures in Governmental Funds

Thought to Ponder: Chapter 5 The same prudence which in private life would forbid our paying our own money for unexplained projects, forbids it in the dispensation of public moneys. President Thomas Jefferson Granof & Khumawala-6e

Learning Objectives Modified accrual basis Full accrual basis Accounting for different expenditures Types of interfund activities and how they are reported Other Financing Sources and Uses Chapter 5 Granof & Khumawala-6e

Financial Statements Two types of financial statements: Governmental Fund financial statements Basis of Accounting: Modified accrual basis Provides information relating to Inter-period equity Government-wide F.S. Basis of Accounting: Full accrual basis Presents revenues and expenses from the perspective of the entity as a whole and not of the individual funds. Chapter 5 Granof & Khumawala-6e

GAAP GASB Codification, paragraphs 1600.102 through 1600.105. Chapter 5 GASB Codification, paragraphs 1600.102 through 1600.105. The Codification asserts that the “accrual basis is the superior method of accounting for the economic resources of any organization,” and states that the “use of the accrual basis to the fullest extent practicable is recommended.” Granof & Khumawala-6e

Governmental Fund Statements Required Financial Statements Balance sheet presents the fund’s resources at a particular point in time. Operating statement presents the net change in resources during a particular period of time. Basis of Accounting Modified accrual basis All measurements are in accordance with GAAP. Chapter 5 Granof & Khumawala-6e

Modified Accrual Accounting Criteria : Measurable and Available Measurable : Government is able to determine or reasonably estimate the amount. Available : Collectible within the current period or soon enough thereafter to be used to pay liabilities of the current period. Chapter 5 Granof & Khumawala-6e

Expenditures vs. Expenses Definition: “measure of fund liabilities liquidated with current resources” Decreases net current financial resources (i.e. Fund Net Assets) Used in Modified Accrual Basis -- i.e. Fund Financial Statements Expenses Definition: “measure of costs expired or consumed during a period” Reduction in net economic resources (overall net assets) Used in Full Accrual Basis -- i.e. Government-wide Statements Chapter 5 Granof & Khumawala-6e

Expenditures Closely tied to cash flows and near-cash flows Governmental funds report only current liabilities and not long-term liabilities. Expenditures recognized when cash is paid or fund liability accrued* for goods/services received. * next slide . . . Chapter 5 Granof & Khumawala-6e

. . . liability accrued* “Revised” Expenditure Definition: Decreases in net current financial resources (i.e. Fund Net Assets) NOT resulting from transfers (and refunding transactions) NORM – Recognize when FUND Liability is incurred Exceptions include: Materials, Supplies, and Prepaid Items Recognize based on either Purchases or Consumption Basis Debt Service Expenditures on Government Long Term Debt Recognize when Legally Due Pensions, Claims and Judgments, Compensated Absences Recognize when Payable from Available Expendable Financial Resources Capital Leases Recognize based on Substance vs. Form Basis Chapter 5 Granof & Khumawala-6e

Salaries and Wages Chapter 5 May be earned in one fiscal year but paid in the next Recognize the expenditure in the period in which it is earned by the employee (provided the government’s obligation will be liquidated with expendable available financial resources.) Granof & Khumawala-6e

Example 1 Governmental fund vs. for-profit (full accrual) payroll accounting similar, except expenditures, not expenses are recorded. Example: Wages and related benefits of employees for the last pay period in December 2013 were $40 million. Employees are to be paid on January 6, 2014. The fiscal year ends December 31. General Fund Dr. Cr. Wages and benefits expenditures $40M Accrued wages payable 40M Government-wide: same (except for “expense” label). Remember, no entries are made under government-wide. There is only a conversion done on the Working Papers at the end of the year. Chapter 5 Granof & Khumawala-6e

Example 2 Dr. Expenditures (for the full amount of payroll) Cr. Liabilities (for withholdings from employees pay) Cr. Cash for the amount paid to employees Timbaktu City recognized its payroll for the most recent two week pay period for employees paid from the General Fund. GF General Journal Dr. Cr. Expenditures--2013 948,000 Due to Federal Gov’t 86,000 Due to State Gov’t 49,000 Cash 713,000 The Subsidiary Ledger provides the details of the total expenditure as follows: General Government 178,000 Public Safety 480,000 Public Works 290,000 Chapter 5 Granof & Khumawala-6e

Salaries and Wages (cont’d.) Dr. expenditures for the employer’s payroll costs (including employer’s share of FICA) Cr. Liability to federal government. GF General Journal Dr. Cr. Expenditures--2013 188,000 Due to Federal Gov’t. 188,000 Expenditures Subsidiary Ledger: Contributions for Retirement 188,000 Encumbrances usually are not recorded for recurring expenditures such as payroll. Chapter 5 Granof & Khumawala-6e

Governments Vs. Business 7 Major differences 1) Compensated absences (Ch. 5 & 8) 2) Pension accounting (Ch. 10) 3) Claims and Judgments (Ch. 8) 4) Inventory accounting (Ch. 5) 5) Prepayments (Ch. 5) 6) Accounting for capital assets (Chs. 6 & 7) 7) Accounting for interest and principal (Chs. 6 & 8) Chapter 5 Granof & Khumawala-6e

(1) Compensated Absences (CA) Overview Earned in one period but often not paid until several periods later (i.e. It’s not current.) Amount to be paid is often uncertain. Compensation is based on the salary/wage rate in effect when the time off is taken. GASB standard: Vacation leave and compensated absences should be accrued as a liability as the benefits are earned if BOTH the following conditions are met: Attributable to services already rendered and Probable that compensation will occur (paid time off or other means) Chapter 5 Granof & Khumawala-6e

(1) Vacation Leave Vacation pay expenditures and related fund liabilities should be recognized in the periods in which they are due. Until those periods, those liabilities are reported ONLY in the schedule of long-term obligations. Chapter 5 Granof & Khumawala-6e

Example 1-a Example: City employees earned $300,000 in vacation leave they did not take in 2013. The leave vests and can be taken at any time up to retirement. No entry in the governmental funds Government-wide: (no real entry here either) But this will be the conversion at year end. Dr. Cr. Vacation pay expense 300,000 Accrued vacation payable 300,000 Chapter 5 Granof & Khumawala-6e

Example 1-b Example: City employees earn $8 million in vacation leave. Of this amount, they are paid $6 million in 2010 and defer the balance until future years. Governmental fund DR CR Vacation pay expenditure $6M Cash (or Wages Payable) $6M The $2 million deferred until future periods should be reported in a schedule of long-term obligations. Government-wide statements (no real entry here either). But this will be the conversion at year end. DR CR Vacation Pay expense $8M Cash (or Wages Payable) $6M Accrued Vacation Pay 2M Chapter 5 Granof & Khumawala-6e

(2) Sick Leave Beyond the control of both the employee and the employer. GASB states that sick leave is recognized as a liability only if it is probable that the employer will compensate the employees for the benefits through cash payments conditioned on the employees’ termination or retirement. It should be recorded ONLY when expected to be paid to employees upon their resignation or retirement. Chapter 5 Granof & Khumawala-6e

Example 2-a Example: City employees earned $170,000 in sick leave but were only paid for $140,000. The leave accumulates but does not vest. Governmental fund DR CR Sick leave expenditure $140,000 Cash $140,000 The city will not have to compensate employees for leave not taken as a termination benefit. It should charge as an expenditure only the amount that was liquidated with expendable financial resources. It need not report a liability even in the schedule of long-term obligations. Government-wide*: Same rules apply. Only the $140,000 paid needs to be charged as an expense. *No actual journal entry is made. But this will be the conversion at year end. Chapter 5 Granof & Khumawala-6e

Example 2-b Example: A city pays for its employees’ unused sick leave up to thirty days only if they terminate at least after 10 years of service. In 2013, the city had the following estimates: Sick leave earned = $12 mil; Payments in the future to employees = $8 mil Payments to 10-year employees upon termination = $1mil Amount that will not be paid = $3 mil Governmental fund: No entry is required. The city recognizes a liability only for the $1 million to be paid in termination benefits. Assuming that those termination benefits are not paid in the current year, it is recognized in the schedule of long-term obligations Government-wide: (again no actual journal entry is made) DR CR Sick leave termination benefit expense $1M Accrued Sick Leave 1M Chapter 5 Granof & Khumawala-6e

(3) Sabbatical Leave After a specified term of service, employees may be granted a paid leave. They are offered to benefit both the employee and the employer in the future, not the past. The employees are required to perform other activities that will enhance their job-related abilities during their time off. GASB standard: Accounting depends on the purpose of the leave Activities to enhance their job-related skills --Account for in the period the leave is taken “Compensated unrestricted time off” --Liability is accrued during the period the leave is earned. Chapter 5 Granof & Khumawala-6e

Example 3-a City teachers are entitled to sabbatical leaves of six months every 7 years for research and renewal. The 2013 share of leave costs to be taken in the future was $300,000. Governmental Fund: Sabbatical leaves need not be recognized as a liability if it is a reward for past service (i.e. it is for unrestricted time off). It need not be accrued if it constitutes merely a change in assigned duties (e.g. research instead of teaching). Government-wide: Same. Chapter 5 Granof & Khumawala-6e

Pensions Overview (Ch 10) Definition: Amount of money paid to retired or disabled employees. If the Government makes the required contribution to the pensions in full -- amount recorded = amount of contribution. GASB Standard: The expenditure should be the amount that will be liquidated with expendable available financial resources. Chapter 5 Granof & Khumawala-6e

Claims and Judgments (CJ) Overview (Ch 8) GASB Std. #10, Claims and Judgements, para. 53. (also FASB Std. # 5) Liability accrued if: Probable that Asset Impaired/Liability Incurred by Balance Sheet date Loss can be reasonably estimated Expenditure amount: Recognize in the governmental fund only the portion of liability that is normally to be Liquidated with Available Expendable Financial Resources Liability recorded at “face value.” Balance of liability is in the Schedule of LT Obligations – No expenditure recognized Expense is recognized in the government-wide statements at the time the loss liability first satisfies the FASB No. 5 criteria. (probable and estimatable) Chapter 5 Granof & Khumawala-6e

(4) Materials and Supplies--Overview Are not expendable available financial resources. Unlike businesses, governments do not acquire inventories with the intention to resell them. Instead, they use it to carry out day-to-day operations. Two Primary issues pertaining to governmental funds are: Timing of the expenditure Reporting of the assets Chapter 5 Granof & Khumawala-6e

Overview (cont’d) Accounting for Inventory Two methods of accounting available Consumption Method Purchases Method Each method assumes periodic rather than perpetual inventory accounting All purchases are debited to Expenditures The Inventory of Supplies account is updated at year-end as an adjusting entry Chapter 5 Granof & Khumawala-6e

Example 1 – Consumption Method Consumption Method. Assume the following data: Beginning inventory $ 20,000 Purchases during year 150,000 Available for use 170,000 Ending inventory (15,000) Amount consumed $155,000 Adjusting Journal Entries: Dr. Cr. Expenditures--2010 $5,000 Inventory of Supplies 5,000 Fund Balance - Reserved for Inventories 5,000 Fund Balance – nonspendable 5,000 Chapter 5 Granof & Khumawala-6e

Example 2 – Purchases Method Purchases Method. Assuming the same data: Beginning inventory $ 20,000 Purchases during year 150,000 Available for use 170,000 Ending inventory (15,000) Amount consumed $155,000 Adjusting Journal Entries: Dr. Cr. Fund Balance-nonspendable $5,000 Inventory of Supplies 5,000 (Note that the Expenditures account is not affected by the adjusting entry) Chapter 5 Granof & Khumawala-6e

Materials and Supplies (cont’d) Chapter 5 Government-wide statements: Should be reported on a consumption basis. Supplies expense (not expenditure) would be debited. No need for inventory reserve. Granof & Khumawala-6e

Example 3 Common Entries*: Dr. Cr. In 2013 the City ordered supplies that cost $4 million, received supplies that cost $3.5 million, paid for supplies that cost $3 million and used supplies that cost $3.3 million. Common Entries*: Dr. Cr. Encumbrances $4 Reserve for encumbrances $4 Reserve for encumbrances $3.5 Encumbrances $3.5 Accounts Payable $3 Cash $3 * Common under both Consumption and Purchases method Chapter 5 Granof & Khumawala-6e

Example 3 (cont’d) Purchases method: DR CR Supplies expenditure $3.5 Accounts Payable $3.5 Supplies inventory $0.2 Fund balance-nonspendable $0.2 Consumption method: Supplies Inventory $3.5 Accounts payable $3.5 Supplies expense $3.3 Supplies Inventory $3.3 Fund balance (unassigned) $0.2 Fund balance -nonspendable $0.2 Government-wide: Must use consumption method. Chapter 5 Granof & Khumawala-6e

(5) Prepayments: Overview GASB standards: Fund Statements: Either purchases or consumption method can be used Government-wide statements: Only consumption method must be used If services extend over more than one accounting period Need not be allocated between or among accounting periods GASB does not distinguish between current and long-term prepayments. --i.e. the unused portion of insurance policy for two or more years would be reported as an asset – the same as a one-year policy Chapter 5 Granof & Khumawala-6e

Example 1 On June 15, 2013 the city acquired and paid for an insurance policy that cost $300,000. The policy covers the two-year period beginning July 1. Purchases method: DR CR Insurance expenditure $300 Cash $300 Consumption method: Prepaid insurance $300 Government-wide: Must use consumption method. Chapter 5 Granof & Khumawala-6e

Capital Assets Overview (Ch 6) Provide services in periods beyond those in which they are acquired. GASB standards: General capital assets – are not specifically related to activities that are reported in proprietary or fiduciary funds. General capital assets are neither reported on governmental fund balance sheets nor depreciated on governmental fund statements of revenues, expenditures, and changes in fund balance. Governments reports general capital assets in the period requiring the outflow of expendable available financial resources. Accounting for capital assets Fund Statements --Expenditure as purchased Government-wide statements --Capitalize and Depreciate (like business) Chapter 5 Granof & Khumawala-6e

Example 1 The city acquired a computer system for all its departments at a cost of $3 million, and paid in cash. It has a useful life of three years. General Fund: DR CR Expenditure-acquisition of capital assets $3 Cash $3 Government-wide*: Would capitalize and depreciate *This is not a real entry but conversion is made at the end of the year. Chapter 5 Granof & Khumawala-6e

(7) Interest and Principal on Long-term Debt: Overview Principle: Recorded in schedule of long-term obligations. If a principal repayment extends beyond a fiscal year, expenditures are recognized entirely in the year the payments are due. Interest: Major expenditure for many governments. Source of payments are either general revenues or revenues dedicated for debt service revenues. The government transfers cash from general fund as payments are made. Chapter 5 Granof & Khumawala-6e

Nonexchange Expenditures: Overview GASB Standards (applicable to both modified and full accrual statements): Nonexchange expenditures Should generally be recognized with their revenue counterparts -- (i.e.) when the recipient of the grant has satisfied all eligibility requirements. Nonexchange expenses Grants would be recognized as expenses in the same period in the government-wide as in the fund statements. Modified accrual statements Revenues must be available for expenditure before they can be recognized. Chapter 5 Granof & Khumawala-6e

Example 1 Example: In December 2013, the city approves a $300,000 grant to a not-for profit health clinic. The funds are to be paid in 2014 out of funds budgeted for that year and are intended to support the clinic’s activities in 2014. General Fund: In as much as the clinic cannot use the funds until 2014, the grant is subject to a time requirement. The clinic need not recognize either a liability or an expenditure until 2014, when the time requirement is satisfied. Government-wide: Same. Chapter 5 Granof & Khumawala-6e

Example 2 Example: In Dec. 2013 the city awards a not-for profit clinic $400,000 for the acquisition of emergency communications equipment. Payment is made at the time the award is announced. The clinic is permitted to use the funds upon receipt, but intends to use them in 2014. --Purpose restrictions have no impact on the timing of either expenditure or revenue recognition. The state must recognize an expenditure as soon as it expends the funds and the county is eligible to spend them: Governmental Fund: Grant expenditure $400,000 Cash $400,000 Government-wide*: Same, but expense instead of expenditure. * This is not a real entry but conversion is made at the end of the year. Chapter 5 Granof & Khumawala-6e

Example 3 Example: In Dec. 2013, the city awards a not-for profit $200,000 for the acquisition of emergency communications equipment. The grant is to be paid as the organization incurs and documents allowable costs. In 2014 the organization submits claims for $150,000 of which the city pays $125,000. The city expects to pay the $25,000 balance of claims submitted in Jan 2015 and the $50,000 balance of the grant by June 2015. --- The not-for- profit is eligible for the award only as it incurs and documents allowable costs. In 2014, the city became eligible for $150,000 of the grant—the amount that the state should recognize as an expenditure. General Fund: Grant expenditure $150,000 Cash $125,000 Grants payable 25,000 Government-wide*: Same, but expense instead of expenditure. * This is not a real entry but conversion is made at the end of the year. Chapter 5 Granof & Khumawala-6e

Example 4 Assume a grant of $100,000 is received at the beginning of the fiscal year from the federal government to operate a counseling program for troubled youths. The entry in the special revenue fund is: Dr. Cr. Cash $100,000 Deferred Revenue $100,000 Explanation: Until eligibility requirements for the grant have been met by incurring expenditures for the intended purpose, an “exchange transaction” it is reported as “Deferred Revenue” (a liability). Chapter 5 Granof & Khumawala-6e

Example 4 (cont’d) Assume that during the year the Counseling Program expended $75,000 for costs related to youth counseling, thus meeting the eligibility requirement to expend grant resources. The entries would be: Dr. Cr. Expenditures $75,000 Vouchers Payable $75,000 Deferred Revenues $75,000 Revenues $75,000 (This amount would also be recorded in the Revenue detail account in the Revenue subsidiary ledger). Chapter 5 Granof & Khumawala-6e

Interfund Transfers (Ch. 6-9) Two types of interfund activity: (a) Reciprocal: Equivalent of exchange transactions (b) Nonreciprocal: Equivalent of nonexchange transactions. Chapter 5 Granof & Khumawala-6e

Summary Accrual basis recommended to the fullest extent practicable. 2 criteria must be met before revenues are recognized in governmental funds: Resources must be Measurable and Available Governmental fund expenditures are defined as decreases in net financial resources. Expenses are outflows or consumption of overall net assets. Nonexchange transactions in the governmental fund are accounted for symmetrically to nonexchange revenues. Grants are recognized as expenditures when all the requirements are met. Chapter 5 Granof & Khumawala-6e