Essentials of Accounting for Governmental and Not-for-Profit Organizations Chapter 3 Modified Accrual Accounting: Including the Role of Fund Balances.

Essentials of Accounting for Governmental and Not-for-Profit Organizations
Chapter 3 Modified Accrual Accounting: Including the Role of Fund Balances and Budgetary Authority McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Overview of Chapter 3 The basic accounts used by governmental funds.
Recognition criteria for revenues and expenditures under the modified accrual basis. Fund balance classifications for governmental funds.

Modified Accrual Accounting
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.

Modified Accrual Accounting
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

Account Structure – Permanent Accounts
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

Account Structure - Nominal Accounts
Accounts that are closed at year end Budgetary Accounts Financial Statement Activity Accounts Estimated Revenues Appropriations Estimated Other Financing Sources Estimated Other Financing Uses Encumbrances Budgetary Fund Balance – Reserve for Encumbrances Revenues Tax Revenues Charges for Services Expenditures Current Capital Outlay Debt Service Other Financing Sources Transfers In Debt Proceeds Other Financing Uses Transfers Out

Assets and Liabilities
Modified Accrual Funds use the Current Financial Resources Measurement Focus Generally speaking, the assets represent cash and assets that may be expected to be converted into cash in the normal course of operations. (no long-term assets) Similarly, these funds report only those liabilities which will be settled with current financial resources. (no long-term liabilities)

Fund Balance The account category, Fund Balance, is unique to governmental funds. 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.

Fund Balance - interpretation
Since only current financial resources and claims against 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).

GASB 54 – Establishes the Reporting of Fund Balances
The objective of Statement No. 54 is to provide clearer fund balance classifications. Users want to know whether the use of amounts reported in governmental funds is constrained and how binding those constraints are.

GASB 54 – Fund Balances Financial Statements
Statement No. 54 affects only fund-basis statements of the Governmental Type funds Does not affect reporting of Net Assets(Position) by Proprietary or Fiduciary Funds Does not affect reporting of Net Assets(Position) of Governmental Activities in the government-wide statements.

GASB 54 – Fund Balances Summary
Fund balances of governmental type funds are reported within 5 categories Nonspendable Restricted Committed Assigned Unassigned

Two Step Process Step 1: Nonspendable resources
Identify those fund resources that are Nonspendable Nonspendable resources include: Inventories and prepaids (also incudes assets held for sale and long-term receivables) The principal (corpus) of a Permanent Fund

Two Step Process Step 2: Spendable resources
All remaining net resources of a fund after removing those determined to be Nonspendable Spendable resources are further classified according to the nature of any constraints imposed on their use, using a hierarchy of constraints

GASB 54 – Fund Balances Constraint Heirarchy
Most constrained Restricted Funds Committed Funds Assigned Funds Unassigned Funds No Constraint (General Fund)

Constraint Heirarchy: Restricted Funds
Restricted : Constraints placed on the use of resources are: Externally Imposed (debt covenant, grantor, contributors, or other governments) Imposed by law (constitutionally or enabling legislation) i.e. enforceable requirement that resources be used only for specified purposes

Constraint Heirarchy: Restricted Funds
In general, the definition of “restricted fund balance” is nearly identical to that of “restricted net assets(position)” in the Government-wide Statements Exception is Permanent Fund Principle which is classified as Nonspendable in the governmental funds and restricted in the government-wide statements Fund-Basis Governmental Funds Balance Sheet Government -Wide Statement of Net Assets(Position) Net assets – restricted $ xxx Restricted fund balance $ xxx

Constraint Heirarchy: Committed Funds
Committed: Constraints placed on the use of resources by: The formal action of the government’s highest level of decision making authority. GASB 54 specifically identifies Contractual Obligations as one form of committed resources

Constraint Heirarchy: Rainy Day Funds
Statement 54 also provides guidance on the classification of budget stabilization or rainy day funds 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.

Constraint Heirarchy: Assigned Funds
Assigned: The government has an expressed intent to use resources for specific purpose: For governmental funds other than the General Fund, this is the category for all remaining (positive) amounts. For the General Fund, assignment conveys a narrower intended use than the general purposes of the government

Constraint Heirarchy: Unassigned Funds
Unassigned: Residual classification of the General Fund Only the General Fund can report a positive “unassigned fund balance” For other governmental funds – this is used only for a negative fund balance (in any of the previous 3 constraint categories)

not in spendable form? – e.g. Inventory & prepaids
Classification: Step 1 CITY Balance Sheet Governmental Funds As of December 31, 2009 General Special Revenue Capital Projects Debt Service Permanent ASSETS Fund Cash and cash equivalents 6,408,214 627,837 895,300 230,000 25,366 Investments 3,312,992 Receivables (net) Taxes receivable 2,872,611 Accounts Receivable 679,215 14,177 Due from Other Governments 1,085,184 243,264 Supplies Inventory 23,747 Restricted Assets 3,933,126 TOTAL ASSETS 18,315,089 642,014 1,138,564 LIABILITIES Accounts payable 2,085,358 70,000 207,134 Accrued liabilities 543,064 19,398 Deferred Revenues 4,408,087 TOTAL LIABILITIES 7,036,509 226,532 - FUND BALANCE Nonspendable Permanent fund principal Are there assets not in spendable form? – e.g. Inventory & prepaids Required to maintain permanent fund corpus? No Proceed to spendable categories 3-22

Classification: Step 1 3-23 yes
CITY Balance Sheet Governmental Funds As of December 31, 2009 General Special Revenue Capital Projects Debt Service Permanent ASSETS Fund Cash and cash equivalents 6,408,214 627,837 895,300 230,000 25,366 Investments 3,312,992 Receivables (net) Taxes receivable 2,872,611 Accounts Receivable 679,215 14,177 Due from Other Governments 1,085,184 243,264 Supplies Inventory 23,747 Restricted Assets 3,933,126 TOTAL ASSETS 18,315,089 642,014 1,138,564 LIABILITIES Accounts payable 2,085,358 70,000 207,134 Accrued liabilities 543,064 19,398 Deferred Revenues 4,408,087 TOTAL LIABILITIES 7,036,509 226,532 - FUND BALANCE Nonspendable 23,747 Permanent fund principal 25,000 Assets not in spendable form? – Inventory & prepaids Required to maintain permanent fund corpus? yes Assume the permanent fund corpus is $ 25,000. 3-23

Classification: Step 2a (Restricted Funds)
CITY Balance Sheet Governmental Funds As of December 31, 2009 General Special Revenue Capital Projects Debt Service Permanent ASSETS Fund Cash and cash equivalents 6,408,214 627,837 895,300 230,000 25,366 Investments 3,312,992 Receivables (net) Taxes receivable 2,872,611 Accounts Receivable 679,215 14,177 Due from Other Governments 1,085,184 243,264 Supplies Inventory 23,747 Restricted Assets 3,933,126 TOTAL ASSETS 18,315,089 642,014 1,138,564 LIABILITIES Accounts payable 2,085,358 70,000 207,134 Accrued liabilities 543,064 19,398 Deferred Revenues 4,408,087 TOTAL LIABILITIES 7,036,509 226,532 - FUND BALANCE Restricted Bond Sinking Fund 200,000 School lunch grant 370,000 Highway grant 302,000 Are restrictions imposed by outside creditors, grants, or imposed by law? yes Assume the following: Bond sinking fund Federal school lunch grant State highway grant 3-24

Classification: Step 2b (Committed Funds)
CITY Balance Sheet Governmental Funds As of December 31, 2009 General Special Revenue Capital Projects Debt Service Permanent ASSETS Fund Cash and cash equivalents 6,408,214 627,837 895,300 230,000 25,366 Investments 3,312,992 Receivables (net) Taxes receivable 2,872,611 Accounts Receivable 679,215 14,177 Due from Other Governments 1,085,184 243,264 Supplies Inventory 23,747 Restricted Assets 3,933,126 TOTAL ASSETS 18,315,089 642,014 1,138,564 LIABILITIES Accounts payable 2,085,358 70,000 207,134 Accrued liabilities 543,064 19,398 Deferred Revenues 4,408,087 TOTAL LIABILITIES 7,036,509 226,532 - FUND BALANCE Committed Construction Contracts 120,000 School construction 450,000 Rainy Day Funds 3,500,000 Has city council formally committed funds to specific activities? yes Assume the following: Construction contracts School construction funds Rainy day reserve 3-25

Classification: Step 2c (Assigned Funds)
CITY Balance Sheet Governmental Funds As of December 31, 2009 General Special Revenue Capital Projects Debt Service Permanent ASSETS Fund Cash and cash equivalents 6,408,214 627,837 895,300 230,000 25,366 Investments 3,312,992 Receivables (net) Taxes receivable 2,872,611 Accounts Receivable 679,215 14,177 Due from Other Governments 1,085,184 243,264 Supplies Inventory 23,747 Restricted Assets 3,933,126 TOTAL ASSETS 18,315,089 642,014 1,138,564 LIABILITIES Accounts payable 2,085,358 70,000 207,134 Accrued liabilities 543,064 19,398 Deferred Revenues 4,408,087 TOTAL LIABILITIES 7,036,509 226,532 - FUND BALANCE Assigned School lunch program 202,014 Capital projects 40,032 30,000 Other purposes 366 Are there positive residual balances in non-General Fund Governmental funds? yes 3-26

Classification: Step 2c (Assigned Funds)
CITY Balance Sheet Governmental Funds As of December 31, 2009 General Special Revenue Capital Projects Debt Service Permanent ASSETS Fund Cash and cash equivalents 6,408,214 627,837 895,300 230,000 25,366 Investments 3,312,992 Receivables (net) Taxes receivable 2,872,611 Accounts Receivable 679,215 14,177 Due from Other Governments 1,085,184 243,264 Supplies Inventory 23,747 Restricted Assets 3,933,126 TOTAL ASSETS 18,315,089 642,014 1,138,564 LIABILITIES Accounts payable 2,085,358 70,000 207,134 Accrued liabilities 543,064 19,398 Deferred Revenues 4,408,087 TOTAL LIABILITIES 7,036,509 226,532 - FUND BALANCE Assigned School lunch program 202,014 Capital projects 75,000 40,032 30,000 Other purposes 366 Library acquisitions 25,000 Are there specific resources in the General Fund that are intended for identified purposes? yes Assume the government has outstanding encumbrances for the following: Library acquisitions Other capital projects 3-27

Classification: Step 2d (Unassigned Funds)
CITY Balance Sheet Governmental Funds As of December 31, 2009 General Special Revenue Capital Projects Debt Service Permanent ASSETS Fund Cash and cash equivalents 6,408,214 627,837 895,300 230,000 25,366 Investments 3,312,992 Receivables (net) Taxes receivable 2,872,611 Accounts Receivable 679,215 14,177 Due from Other Governments 1,085,184 243,264 Supplies Inventory 23,747 Restricted Assets 3,933,126 TOTAL ASSETS 18,315,089 642,014 1,138,564 LIABILITIES Accounts payable 2,085,358 70,000 207,134 Accrued liabilities 543,064 19,398 Deferred Revenues 4,408,087 TOTAL LIABILITIES 7,036,509 226,532 - FUND BALANCE Nonspendable Permanent fund principal 25,000 Restricted Bond Sinking Fund 200,000 School lunch grant 370,000 Highway grant 302,000 Committed Construction Contracts 120,000 School construction 450,000 Rainy Day Funds 3,500,000 Assigned School lunch program 202,014 Capital projects 95,000 40,032 30,000 Other purposes 366 Library acquistions Unassigned 7,634,833 TOTAL FUND BALANCE 11,278,580 572,014 912,032 All negative restricted, committed, or assigned net resources are classified as Unassigned. The remaining net resources of the General Fund are classified as Unassigned 3-28

Classification Completed
General Special Revenue Capital Projects Debt Service Permanent FUND BALANCES Fund Nonspendable Supplies Inventory 23,747 Permanent fund principal 25,000 Restricted Bond Sinking Fund 200,000 School lunch grant 370,000 Highway grant 302,000 Committed Construction Contracts 120,000 School construction 450,000 Rainy Day Funds 3,500,000 Assigned School lunch program 202,014 Capital projects 95,000 40,032 30,000 Other purposes 366 Library acquisitions Unassigned 7,634,833 TOTAL FUND BALANCE 11,278,580 572,014 912,032 230,000 25,366 3-29

GASB 54 – Fund Balances Encumbrances
Under past reporting practices, outstanding encumbrances at year end were reported in the governmental funds as fund balance: reserve for encumbrances. Statement 54 requires that significant encumbrances be disclosed in the notes along with required disclosures 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 54 – Fund Balances Encumbrances
Encumbrances – Interpretation 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. Statement 54 requires that resources obligated to contractual obligations be classified as committed.

GASB 54 – Fund Balances Negative balances
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. The rationale is that if expenditures exceed restricted or committed resources, then funds have in effect been reallocated to the purpose used. If a deficit remains once all assigned fund balances are zero, the remaining negative amount should be reported as unassigned fund balance.

Activity Accounts – Sources of funds
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.

Activity Accounts – Uses of funds
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.

Classification of Inflows and Outflows on Budget Schedule
Revenues are classified by source Where the money came from: taxes, licenses and permits, charges for service, etc May be subdivided further such as by type of tax, sometimes shown in separate schedule Expenditures and Encumbrances may be classified by function, program, department, activity, character, or object

Outflow Classifications
Character groupings are always: CURRENT, CAPITAL OUTLAY, and DEBT SERVICE Current are typically classified by function: General government, public safety, streets and highways Public safety could be subdivided by department: Police and fire Police could be subdivided further by activity: Traffic and drug enforcement Activities in the traffic area could be divided into objects of expenditure: Policeman’s salary, gas for automobiles

Budgetary Accounting 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. While 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.

Recording Budgets Although budgetary accounts do not appear in the general purpose financial statements, governments typically record budgets and governmental accounting systems are designed to assure compliance with budgets.

Budgetary Accounts Revenues to be raised pursuant to law during a budget period are set forth in an Estimated Revenues budget. An Appropriation, when enacted into law, is the legal authorization for the government to incur liabilities for purposes specified in the appropriations statue or ordinance. 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 expenditures

Encumbrances 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 since the goods or services have merely been ordered, not received.

Encumbrances Commitments are reflected in the budgetary accounts through the recording of Encumbrances and the corresponding Budgetary Fund Balance - Reserve for Encumbrances.

Expenditure Cycle 3-42

Encumbrance to Expenditure
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.

Why Record Encumbrances?
In business accounting, orders are not entered into the general ledger Governments recognize that an outstanding order will turn into an expenditure and a liability when the goods arrive To prevent over-spending, outstanding orders are entered into the books

Encumbrance Example Place an order for $150,000 which consists of three mini-buses costing $50,000 each. Recorded as: Encumbrances 150,000 Budgetary Fund Balance - Reserve for Encumbrances 150,000 Assume two of the buses arrive, but with freight, they cost $102,000 instead of $100,000. First, reverse a part of the encumbrances: Reserve for Encumbrances 100,000 Encumbrances 100,000 Second, record the actual amount of expenditure: Capital Expenditure 102,000 Accounts Payable ,000

Accounting for Revenues
Since 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 Nonexchange transactions are transactions in which a government receives resources without directly giving equal value in exchange. The most common forms of nonexchange transactions are tax revenues and intergovernmental grants. Before a government may recognize revenue resulting from nonexchange transactions, it must meet a number of eligibility requirements.

Eligibility Requirements Non-Exchange Revenues
Required Characteristics of Recipients. The recipient must have the characteristics specified by the provider. Time Requirement. If time requirements (for expenditure) are specified by the resource provider or legislation, those time requirements must be met 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. Contingencies. Resources pledged that have a contingency attached are not recognized as revenue until the contingency has been met.

Types of Nonexchange Transactions
Imposed nonexchange revenues property tax, special assessments, fines/forfeits Derived tax revenues sales, income, motor fuel taxes Government mandated transactions federal government requires lower level expenditures Voluntary nonexchange transactions grants, donations

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

Imposed Nonexchange Revenue
Modified Accrual Basis Recognition Record the receivable (and an allowance for uncollectibles) when an enforceable claim exits. Revenues should be recognized in the period for which the taxes are levied (i.e. budgeted), but are also subject to the 60 day rule. Revenues expected to be collected > 60 days after year-end are deferred. 1. Property taxes levied 2. Deferral of portion expected to be collected > 60 days after year end 1. Taxes Receivable ………Dr Estimated Uncollectible Taxes ….…..Cr Revenues Control ……………….…Cr 2. Revenues Control ………Dr Deferred Revenues – Property Taxes Cr

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

Derived Tax Revenue Revenue Recognition – Modified Accrual
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). 1. Income tax withholdings are received. 2. Additional income taxes expected to be received after year end. Part of this will not be received in time to be avail-able for current liabilities. 1. Cash …………………….Dr Revenues Control ……………………Cr 2. Taxes Receivable ……….Dr Deferred Revenues – Income Taxes ……Cr

Government Mandated Nonexchange Transactions
These are commonly 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 accept. For example, a state may require schools to mainstream certain students and provide funds to carry out this mandate.

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

Government-Mandated and Voluntary Nonexchange Revenues
Revenue Recognition – Modified Accrual Record the receivable and the revenue when all eligibility requirements have been met. Many of these are reimbursement grants. In this case, revenue is recognized only when qualified expenditures have been incurred. Reimbursement type grants 1. Expenditures Control …..Dr Accounts Payable/Cash ……………..Cr 2. Due from grantor ……… Dr Revenues Control ……………………Cr

Government-Mandated and Voluntary Nonexchange Revenues
Revenue Recognition – Modified Accrual Advance receipts are deferred until expenditures are incurred. Revenue recognition is subject to the available and measurable criteria. Advance funded grant: 1. Receipt of advance funding. 2. Incur qualified expenditures and recognize revenue. 1. Cash ……………………Dr Deferred Revenues – Grants ………..Cr 2a. Expenditures Control …...Dr Accounts Payable/Cash ……………..Cr 2b. Deferred Revenues – Grants .. ……… Dr Revenues Control ……………………Cr

Recording the budget Estimated Revenues 12,000,000 Estimated Other Financing Sources 500,000 Appropriations 11,700,000 Estimated Other Financing Uses 250,000 Budgetary Fund Balance 550,000 In the above entry, Budgetary Fund Balance is the expected change in fund balance assuming actual amounts are exactly as budgeted. It may be either a credit (or less frequenty) or debit balance in the entry.

Budget Revisions Budget revisions may be necessary during the year due to changes in revenue projections or operating conditions … for example, electricity price increases, decrease in sales taxes due to low consumer spending Budget revisions usually are taken back to the appropriate legislative body for approval, although some jurisdictions may allow some percentage of the budget to be transferred between accounts

Recording a budget revision
Budgetary Fund Balance 150,000 Appropriations 70,000 Estimated Revenues 80,000 In the above entry, the budget reflects a decrease in estimated revenues of $ 80,000 and an increase in appropriations of $ 70,000.

Budgetary Comparison Schedule
Both the original and the final adjusted budget is shown The revised appropriations are compared to the Actual Expenditures for the current period plus Outstanding Encumbrances A variance column is typically shown, but is optional

Budgetary Comparison Schedule
The actual column should use the basis of accounting assumed in the budget. This may be different than GAAP basis Another schedule will reconcile the ‘actual’ figures on the budgetary vs. GAAP basis

Essentials of Accounting for Governmental and Not-for-Profit Organizations Chapter 3 Modified Accrual Accounting: Including the Role of Fund Balances.

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Essentials of Accounting for Governmental and Not-for-Profit Organizations Chapter 3 Modified Accrual Accounting: Including the Role of Fund Balances.

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