Unique Aspects of Accounting Local Governments – Part I: Chapter Twelve Lecture Notes Unique Aspects of Accounting for State and Local Governments – Part I: The Recording Process

A Third Basis of Accounting: Modified Accrual Cash Accounting recognizes revenues when cash is received and expenses when bills are paid (focus on cash movement). Accrual Accounting recognizes revenue when goods or services have been provided and recognizes expenses when resources have been used (focus on when revenues are earned or resources are consumed). Governmental funds use Modified Accrual Accounting. Expenditures are recognized when resources are received. Revenues are recognized when they are measurable and available within the accounting period or shortly afterwards (focus on financial resources). Financial resources are cash or assets that can be translated to cash, less current liabilities.

Inflow (Revenue) Recognition Measurable and Available Earned Collected Payment has been received or will be received soon. Payment has been received. Service has been provided. Accrual Basis emphasize that the three conditions do not have to be in the exact time order shown. For example, it is possible to collect revenue before it is earned. Modified Accrual Basis Cash Basis Note: Governmental resource inflows are available if they are deemed to be collectable during or shortly after the end of the accounting period. This may happen before cash is received.

Outflow (Expense or Expenditure) Recognition Payment Encumbrance Delivery Use Appropriation Authorization to spend money. Order has been placed. Order has been received by buyer. Payment is made. Item is consumed. the order or events may also be different with resource outflows. For example, a resource might be used before it is paid for. Accrual Basis Expense now. No expense at this time - any basis. No expense at this time - any basis. Modified Accrual Basis - Expenditure now. Cash Basis Expense now.

Implications of Modified Accrual Accounting No long-term assets. - Long-term acquisitions such as buildings and equipment are recognized as expenditures when acquired. - There is no recognition of depreciation. No long-term liabilities. - Principal (repayment of debt) and interest are recognized as expenditures when paid. Proceeds from borrowing are treated as a nonrevenue source of fund balance rather than as a liability.

Differences Between Bases of Accounting Accrual Modified Accrual Outflows (Expenses or Expenditures) When resource is used When resource is acquired, legal obligation to pay exists and payment will come from available resources Inflows (Revenues) is earned When resource is legally owed, measurable and available Assets Current and long term Current Liabilities Current and long term

Governments and Fund Accounting Governments use funds to account for separate sub-entities. Governments have three major classes of funds: - Governmental funds account for the operating activities of governments (Modified Accrual Accounting). - Proprietary funds account for activities that are run on a business-like basis (Accrual Accounting). - Fiduciary funds account for the government's activities as trustee and agent (Accrual Accounting).

The Governmental Funds Governmental funds include: - General Fund used for the bulk of the day-to-day revenues and expenditures of the government. - Special Revenue Funds for the revenues and expenditures of specific activities that are subject to legal or management-imposed restrictions. - Capital Project Funds to account for major acquisitions of plant or equipment. Debt Service Funds to account for the accumulation of resources to pay for principal and interest on long-term debt. - Permanent Funds, which are similar to endowment funds.

Proprietary Funds Proprietary Funds are used for activities that are run on a business-like basis. Revenues come from fees, tolls, and other charges: - Internal Service Funds are established to account for elements of the government that provide services to other governmental units. - Enterprise Funds are established to track the activities of governmental units which provide goods and services to individuals and organizations outside of the government.

Fiduciary Funds Fiduciary funds are held for another. They are not the resources of the government. - Trust Funds are established whenever money is given to a government under the terms of a trust agreement such as for an employee pension plan or an unemployment compensation fund. - Agency Funds are used to account for money that a government is holding for some other operating entity like a volunteer fire department or another level of government.

Modified Accrual Transactions The Town of Millbridge buys and receives some fireworks on January 15th that it intends to use on July 4th. It receives a bill from the manufacturer for $50,000. How would the transaction be recorded by the Town under modified accrual accounting? Modified accrual accounting (purchase approach) Assets = Liabilities + Fund Balance No Change = A/P + $50,000 - Expenditure $50,000 Governments generally record transactions using modified accrual, but have the option of using modified accrual or accrual for prepayments, materials, and supplies.

Property Tax Transactions Millbridge issues $611,000 in property tax bills this year. Total collections for the year are $600,000 made up of $575,000 of this year's taxes and $25,000 from last year's tax bills. The remaining $36,000 from this year is expected to be collected within 60 days of year-end. It is "available." How would these financial events be recorded? Assets = Liabilities + Fund Balance Recording the property taxes billed this year Taxes Tax Receivable + $611,000 = No Change + Revenue $611,000 Recording the receipt of $600,000 in collected taxes Cash + $600,000 Taxes Receivable - $600,000 = No Change + No Change Where are the $25,000 in last year’s collected taxes and the $36,000 in uncollected taxes from this year in these transactions? the $25,000 in last years taxes are included in the taxes collected as a reduction in taxes receivable. They were reflected in last years revenue. the $36,000 in this years taxes have been reflected in revenue because they meet the definition of "available funds" and are part of the year end property taxes receivable.

Long-Term Liabilities Modified Accrual Accounting When a government borrows money on a long-term basis: - no liability is created on the balance sheet. - cash is increased and the fund balance is increased. This is how a $1,000,000 loan would be recorded: Assets = Liabilities + Fund Balance Other Financing Cash + $1,000,000 = No Change + Sources $1,000,000 Note that the increase in the fund balance is not referred to as revenue.

An Interfund Transaction During the fiscal year the general fund was legally required to transfer $100,000 to the debt service fund. Only $97,000 was transferred. How would this transaction be recorded? Assets = Liabilities + Fund Balance General Fund Due to Other Financing Use Cash - $97,000 = DSF + $3,000 - Transfer to DSF $100,000 Debt Service Fund Cash + $97,000 No Other Financing Source Due from GF + $3,000 = Change + Transfer from GF $100,000

Debt Repayment Transaction The interest and principal due on Millbridge's debt during the year were $15,000 and $50,000, respectively. Payments were made from the debt service fund. How were the payments recorded? Debt Service Fund Assets = Liabilities + Fund Balance Interest Principal Cash = No - expenditure - expenditure - $65,000 Change $15,000 $50,000 Both the interest and the principal were recorded as expenditures. Would the transaction have been recorded in the same way under accrual accounting? Why was there no change in any liability account? No. Under accrual accounting, only the interest payment would have been shown as an expense. The principal repayment would have been recorded ion the balance sheet as a reduction in the long-term debt liability

Acquiring a Building Assume that a building is purchased for $270,000, with full payment in cash. What if the Town issued a bond for $270,000 to pay for the building? Question 1 Under accrual accounting, the organization would have recorded a fixed asset and depreciated it over its useful life. the expense would have reflected use not resource acquisition. Question 2 the proceeds of the bond issue would have resulted in an increase in cash and an increase in the liability for bonds payable

Transactions for Acquiring a Building Capital Projects Fund Assets = Liabilities + Fund Balance Acquisition Using Available Cash Building acquisition Cash - $270,000 = No Change - expenditure $270,000 Purchase of the Building by Issuing Bond Other sources of Cash + $270,000 = No Change + financing $270,000 Building acquisition Cash - $270,000 = No Change - expenditure $270,000

Budgetary Accounting Government budgets are recorded in their accounting systems. Aids compliance with legal spending restrictions. Aids budget control. Uses system of appropriations and encumbrances.

Budgetary Accounting Example – Supplies Budget Appropriation $ 130,000 Less: Expenditures 0 Less: Encumbrances 0 Amount Available for Spending $ 130,000 Supply order for $60,000 is placed. If someone wanted to place another order they would find that the balance available to spend is: Less: Encumbrances 60,000 Amount Available for Spending $ 70,000

Budgetary Accounting Example, continued When the supplies are received, the encumbrance transaction is reversed, and an expenditure transaction is recorded: Appropriation $ 130,000 Less: Expenditures 60,000 Less: Encumbrances 0 Amount Available for Spending $ 70,000 Suppose another order is now placed for $50,000 of supplies. The supplies account would be encumbered, and the new balance available to spend would be $20,000, as follows: Less: Encumbrances 50,000 Amount Available for Spending $ 20,000