1. Environment & Characteristics Chapter 1

2. Welcome Contrary to what you may have heard, governmental and nonprofit accounting is not a “whole new ball game” However, it is a game played by slightly different rules The purpose of this chapter is to lay the groundwork for those rules The rest of the chapters will examine those rules more closely

3. Learning Objectives Unique characteristics Types of G&NP organizations Similarities & differences between profit-seeking and G&NP organizations Characteristics, concepts, & objectives of GNP accounting & financial reporting Users and uses of financial information Determining what GAAP to apply GAAP hierarchy

4. Characteristics of G&NP Organizations Absence of profit motive Owned by constituents – no stock Contributors of resources do not receive proportional share of benefits Decisions made – directly or indirectly – by voters Meetings where decisions are made usually open to the public

5. Types of G&NP Organizations Governments: Federal, state, county, city, township, village, and special districts Education: kindergartens, elementary & secondary schools, vocational & technical schools, and colleges & universities Health and welfare: hospitals, nursing homes. Religious: Salvation Army, and church-related organizations Charities: United Way, Community Chest, & other fund- raising organizations Foundations: Private trust that operate religious, educational, or charitable organizations

6. Similarities to the Private Sector Operate in the same economy and compete for same resources: financial, capital, and human Acquire & convert scarce resources into goods & services Use of accounting & other information systems Need to operate economically, effectively, & efficiently Provide goods and services, many of which may be similar

7. Differences from the Private Sector Organizational objectives Sources of financial resources Methods of evaluating performance and operating results

8. Organizational Objectives Businesses Operating Motive: maximize income from revenues and other resources Operational Focus: report quarterly but look to the long-tem as well G&NPs Operating Motive: maximize services provided from revenues and other resources Operational Focus: operate on annual budget, so current year is of primary importance

9. Organizational Objectives In sum, whereas private business seek to increase their wealth for the benefit of their owners, G&NP organisations seek to expand their available financial resources for the benefit of their constituencies.

10. Sources of Financial Resources Businesses raise resources from sales or from capital stock & debt transactions – must account for different sources separately Governments raise resources from sales or debt transactions – typically no distinction made in sources

11. Unique G&NP Sources Involuntary contributions – taxes! Donations Appropriations and grants from other governmental entities

12. Evaluating Performance & Operating Results In business, continuing a product or service determined by success in marketplace In G&NP organizations: – Profit not a motive and frequently cannot be measured – Services not found elsewhere so there is no competition – Face rules and regulations not found in private sector

13. Special Regulations & Controls Applied to Governments Organization structure – form; board composition; number & duties of personnel Personnel policies & procedures – who has power to appoint or hire personnel; tenure; termination policies; promotion policies Sources of financial resources – types and amounts of taxes, licenses, fines or fees; procedure for setting user charges

14. Special Regulations (continued) Use of financial resources – purposes, including legal restrictions; purchasing procedures; budgeting methods Accounting Financial reporting – type & frequency of reports; format; recipients Auditing – frequency; who performs; scope & type; time & place

15. Development of GAAP

16. Both the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB) are financed and overseen by the Financial Accounting Foundation (FAF). The GASB is responsible for establishing accounting and financial reporting standards for activities and transactions of state and local governments

17. Defining a “Government” Overall characteristics: Public corporations – “an instrumentality of the state, founded and owned in the public interest, supported by public funds, and governed by those deriving their authority from the state Bodies corporate and politic

18. Other Characteristics of a “Government” Popular election of officers or appointment (or approval) of a controlling majority of members of governing body by one or more SLGs Potential for unilateral dissolution by a government with net assets reverting to government Power to enact and enforce a tax levy Ability to issue tax exempt debt

19. Financial Reporting Standards-Setting Process

20. SLG GAAP Hierarchy A.GASB Statements & Interpretations, which are periodically incorporated into the Codification B.GASB Technical Bulletins and AICPA Audit Guides and SOPs if made applicable to SLGs and cleared by GASB C.Positions of GASB EITF (does not currently exist) and AICPA Practice Bulletins if made applicable to SLGs and cleared by GASB D.GASB staff Implementation Guides (Q&As) and widely accepted practice E.Other accounting literature

21. Typical Activities of a SLG Governmental activities – unique to SLGs – Police and fire protection – Education – Social Services – Courts Business-type activities – similar to private sector operations – Utilities – Golf Courses – Airports

22. The governmental – type activity environment is unique in several aspects. These aspects include the distinctive SLG

23. (1) Purpose of Governmental Activities Provide goods and services that all constituents need regardless of ability to pay for goods and services

24. Absence of the profit motive in governmental – type activities underlies several other differences between governments and business, which are: (1) Net income (the basic performance evaluation measure in business) does not apply to government – type activities. (2) Most governments do not obtain significant financial resources for governmental – type activities from service charges to individual recipients in proportion to the services received.

25. (2) Sources of Financial Resources (not found in private sector) Because significant revenues from sales of services are not available to finance governmental – type activities, governments must raise financial resources from other sources. Two primary examples of these revenue sources are: Taxes and grants and subsidies.

26. Sources of Financial Resources (not found in private sector) Taxes: property taxes, sales taxes, and income taxes Taxation is thus a nonexchange transaction or event that eliminates any direct association between: (1)The amount and quality of the services a constituent receives from the government, and (2)The amount the constituent pays to the government.

27. Sources of Financial Resources (not found in private sector) Intergovernmental revenues: such as grants and subsidies from other higher level governments.

28. (3) Resource Allocation Mechanisms General government financial resource allocations are derived from processes clearly different from business enterprises. Absence of a direct relationship between the financial resources provided by an individual taxpayer and the services provided to that individual taxpayer makes it impossible for the resource allocations to be made in the same manner as for business enterprises.

29. Resource Allocation Mechanisms Two concepts determine how the allocation are made: Restrictions placed by providers: typical of grantors, taxes for specific purposes. One level of restriction requires that certain resources be used for a particular purpose or program.

30. These numerous restrictions are the primary reason for the use of funds and nonfund accounts. These accounts are account for financial resources segregated according to the purpose for which they may or must be used and any related capital assets and long – term liabilities, respectively.

31. Resource Allocation Mechanisms Budget: is an expression of public policy and intent. It is also a financial plane that indicates the proposed expenditures for the year and the means of financing them It allocates resources to functions Therefore, taxes and other revenues are allocated to various uses by placing even more detailed budgetary restrictions on their use.

32. Resource Allocation Mechanisms An adopted budget has the force of law, It both: (1) Authorizes amounts to be expended for various specified purposes, and (2) Limits the amount that may be expanded for each of those purpose.

33. (4) Accountabilities Accountabilities: determining to whom accountable and the focuses of their accountability. To whom accountable: the need for accountability exists between (1) SLGs and their constituencies, (2) SLGs and other governments, and (3) the SLGs own legislative and executive bodies.

34. Accountabilities Accountability focus: The financial reports for governmental – type activities focus on two types of accountability: (1) fiscal accountability: is a government’s responsibility to demonstrate its compliance with public decision about the raising and spending of public monies in the short – term.

35. Accountabilities (2) Operational accountability: is a government’s responsibility to demonstrate the extent to which it has met its operating objectives and whether it can continue to meet its objectives in the foreseeable future.

36. (5) Reporting Issues & Problems Demonstrate compliance with restrictions on use of financial resources Budgetary reporting Impact of restrictions on revenue recognition Difficulty in measuring effectiveness and efficiency of operations Opportunity to hide or disguise availability of resources Tax and debt limits Impact of materiality of reporting certain actions

37. Financial Report Users The citizenry: Those to whom the government is primarily accountable, including (citizens, taxpayers, the media). Legislative and oversight bodies: Those who directly represents the citizens, including (members of state legislatures, city councils) Investors and creditors: Those who lend or participate in the lending process, including (individuals and institutional investors and creditors, bond insurer).

38. Financial Report Uses Comparing results with legally adopted budgets Assessing financial condition and results of operations Assisting in determining compliance with finance-related laws, rules & regulations Assisting in evaluating efficiency & effectiveness

39. Purposes of Business-Type Activities Provide same types of services as found in private sector Charge fee for services received Separate, self-sufficient operations

40. Issues in Business-Type Activities Relationship between services received and resources provided by consumer In that exchange relationship, a user fee is charged for a specific service provided. Therefore, users of financial reports focus on measuring the costs of providing the service, the revenues obtained from the service, and the difference between the two.

41. Issues in Business-Type Activities Revenue-producing capital assets Similarly designated activities: the business – type activities of government often perform only a single function. Nature of political process: some government business – type activities are designed to be insulated from the political process. Budgets and fund accounting

42. Financial Reporting Objectives of Business-Type Activities Enable users to assess accountability Provide information about operating results for the period Provide information to assess level of services provided

43. Characteristics of SLG Accounting & Reporting Use of fund accounting Funds: are separate fiscal and accounting entities and include both cash and noncash resources – segregated according to the purposes or activities for which they are to be used – as well as related liabilities.

44. There are two basic categories of fund accounting entities used by SLGs: (1) Governmental funds: to account for the financial assets, related liabilities, changes in net assets and balances that may be expended in its nonbusiness – type activities (fire and police protection). (2) Proprietary funds: to account for the revenues, expenses, assets, liabilities, and equity of its business – type activities ( utilities, cafeterias)

45. A fund of a commercial enterprise is simply a portion of its assets that has been restricted to specific uses, not a separate and distinct accounting entity. A = L +OE

46. A fund in the G&NP accounting sense is a self – contained accounting entity with its own assets, liability, revenue, expenditure or expense, and fund balance or other equity accounts. A – L = FB (fund balance) (governmental funds) A – L = NA (net assets or fund equity) (proprietary funds)

47. Characteristics of SLG Accounting & Reporting Budgets and appropriations A fixed – dollar budget is commonly prepared for each governmental fund. That is, the organization's chief executive asks the governing body for permission to incur a specified (fixed) amount of expenditures (for salaries, equipment, supplies) during the budget period to carry out the department’s mission.

48. When approved by the governing body, the budgetary expenditure estimates become binding appropriations, which both authorise expenditures for specific purpose and limit the amount that can be expended for each specified purpose. Most governments establish budgetary accounts within governmental fund ledgers to ensure control.

49. The cost measurement focus of proprietary fund accounting and of entity – wide financial reports of G&NP organisations, like that of business accounting, is expenses ( the cost of assets and services consumed during the period).

50. In contrast, The cost measurement focus of governmental fund accounting is expenditures (the amount of net financial resources expended during the period for: (1) Current operations (salaries and utilities). (2) Capital outlay (acquiring capital assets). (3) Long term debt principal retirement and interest.

51. Exercise Family services, a small social service non-profit agency, began operations on January 2007 with $40,000 cash and $150,000 worth of equipment, on which $60,000 was owed on a note to City Bank. The equipment was expected to have a remaining useful life of 15 years with no salvage value. During its first year of operations, ending December 2007, Family services paid or accrued the following: (1)Salaries and other personnel costs, $100,000. (2)Rent and utilities $24,000. (3)Debt service – interest $5,500 and payment on long term note principal $10,000. (4)Capital outlay- additional equipment purchased January $30,000 expected to last 6 years and have a $6,000 salvage value.

52. (5) Other current operating items paid with cash, $4,500. There were no prepayals or unrecorded accruals at December 2007 and no additional debt was incurred during the year. Required: Compute for the Family Services agency, for the year ended December 2007, its total (a) expenses (b) expenditures.

53. Solution Expenses Expenditures Salaries and other personnel costs $100,000 $100,000 Rent and utilities 24,000 24,000 Debt service: a) Interest on note 5,500 5,500 b) Note principal payment — 10,000 Capital outlay/Depreciation: a) Capital outlay — 30,000 b) Depreciation of equipment 14,000 — Other 4,500 4,500 Total $148,000 $174,000

54. Depreciation of equipment i) $150,000/15 = $10,000 ii) ($30,000-$6,000)/6 = 4,000 14,000

55. MCQs 1) Which of the following would not be considered a government or nonprofit organization? A) A software company that sells software exclusively to state and local governments B) A public elementary school C) A church D) A private trust organized for charitable purposes

56. 2) The Financial Accounting Foundation has oversight responsibilities over A) The Financial Accounting Standards Board (FASB). B) The Governmental Accounting Standards Board (GASB). C) The Government Accountability Office (GAO). D) All of the above E) Items A and B only F) Items B and C only

57. 3) Which of the following statements is false? A) The power to tax is unique to governments. B) Taxation is a nonexchange transaction. C) Governmental entities may not finance a function or service with both a user fee and tax revenues. D) All of the above statements are true statements. E) Both items B and C are false statements.

58. 4) The primary users of external financial reports, as identified by the GASB, include all of the following except A) Investors and creditors. B) Citizens. C) Governing boards. D) All of the above are considered to be primary users of external financial reports. E) Both items A and B.

59. 5) Business-type activities differ from governmental-type activities in that A) Most capital assets of business-type activities are considered to be revenue producing capital assets, while those in governmental-type activities generally are not. B) Business-type activities never have the power to levy a tax. C) Business-type activities do not adopt a budget. D) All of the above statements accurately reflect actual differences between business-type and governmental-type activities. E) Items B and C only accurately reflect primary differences between business-type and governmental-type activities.