1. McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17 Governmental Entities: Introduction and General Fund Accounting

2. 17-2 Governmental Entities In the early 2000s, the combined annual spending of federal, state, and local governments exceed $3.5 trillion. Governmental purchases of goods and services constitute approximately 20 percent of the total gross national product of the United States.

3. 17-3 Governmental Entities Each of the 50 states follows relatively uniform accounting standards; however, some states have unique statutory provisions for selected items. Local governments are political subdivisions of state government.

4. 17-4 Governmental Entities The 80,000 local governmental units in the United States are classified as: General-purpose local government, such as counties, cities towns, villages, and townships. Special-purpose local government, such as soil conservation districts. Authorities and agencies, such as the New York Port Authority and local housing authorities.

5. 17-5 Governmental Entities Authorities and agencies differ from other governmental units because they typically do not have taxing power and may sell only revenue bonds, not general obligation bonds.

6. 17-6 Governmental Entities Governmental entities have operating objectives different from those of commercial entities; therefore, governmental accounting is different from accounting for commercial enterprises. The major differences between governmental and for-profit entities are specified in the next seven slides.

7. 17-7 Governmental Entities Governmental accounting must recognize that governmental units collect resources and collect expenditures to fulfill social needs. Society expects governmental units to develop and maintain an infrastructure of highways, streets, and sewer and sanitation systems as well as to provide public protection, recreation, and cultural services.

8. 17-8 Governmental Entities Except for some proprietary activities such as utilities, governmental entities do not have a general profit motive. Police and fire departments do not have a profit motive; instead these units must be evaluated on their abilities to provide for society’s needs.

9. 17-9 Governmental Entities Governmental operations have legal authorization for their existence, conduct revenue raising through the power of taxation, and have mandated expenditures they must make to provide their services. The governmental accounting system must make it possible to determine and demonstrate compliance with laws, regulations, grant restrictions, bond indentures, and a variety of other legal constraints.

10. 17-10 Governmental Entities Governmental entities use comprehensive budgetary accounting, which serves as a significant control mechanism and provides the basis for comparing actual operations against budgeted amounts. The budget is a legally established statutory control vehicle.

11. 17-11 Governmental Entities The primary emphasis in governmental fund accounting is to measure and report on management’s stewardship of the financial resources committed to the objectives of the governmental unit. Accountability for the flow of financial resources is a chief objective of governmental accounting. The managers of the governmental unit must be able to show they are in compliance with the many legal regulations governing its operations.

12. 17-12 Governmental Entities Governmental entities typically are required to establish separate funds to carry them out their various missions. Each fund is an independent accounting and fiscal entity and is responsible for using its own resources to accomplish its specific responsibilities.

13. 17-13 Governmental Entities Many fund entities do not record fixed assets or long-term debt in their funds. A separate record of the fixed assets and long- term debt is maintained within the governmental unit.

14. 17-14 Expendability of Resources versus Capital Maintenance Objectives The major differences between commercial and governmental accounting are due to the objectives of the entities. In commercial enterprises, the emphasis is on the measurement of the flow of all economic resources of the firm. In contrast, the major focus for many of the operations within the governmental funds of a governmental entity is the flow of current financial resources available to provide services to the public.

15. 17-15 Expendability of Resources versus Capital Maintenance Objectives In commercial enterprises, the accrual basis of accounting is used to match the revenues and expenses during a period with the objective of measuring profitability. The company’s balance sheet contains both current and non-current assets and liabilities, and the change in retained earnings reflects the company’s ability to maintain its capital investment.

16. 17-16 Expendability of Resources versus Capital Maintenance Objectives Operating authorization is initiated by a budget that is passed by the legislative governing body. Managers of governmental units must be very careful to ensure that resources are expended in full and complete compliance with the legal and financial restrictions placed upon the governmental entity. The focus on expendability of resources affects many of the accounting and financial reporting standards of governmental entities.

17. 17-17 GASB In 1984, the Financial Accounting Foundation created a companion group to the Financial Accounting Standards Board. The Governmental Accounting Standards Board (GASB) is now responsible for maintaining and developing accounting and reporting standards for state and local governmental entities.

18. 17-18 Fund Accounting Accounting for governmental units is given the general description of fund accounting to distinguish it from accounting for commercial entities. Fund accounting reflects the unique aspects of governmental operations.

19. 17-19 Fund Accounting This chapter presents an overview of fund accounting and illustrates accounting in the general fund, typically the most important part of most governmental units. Chapter 18 presents the accounting for the remaining funds of a governmental entity and the financial statements required of government units.

20. 17-20 Types of Funds Governmental units must provide a large range of services, such as fire and police protection, water and sewerage, legal courts, and construction of public buildings and other facilities. In addition, governmental units receive their resources from many different sources and must make expenditures in accordance with legal restrictions.

21. 17-21 Types of Funds To accomplish the objectives of the governmental unit, the unit establishes a variety of funds as fiscal and accounting entities of the governmental unit. Different funds are established for the specific functions that a government must provide.

22. 17-22 Types of Funds Most funds obtain resources from taxes on property, income, or commercial sales; they may also obtain resources as grants from other governmental agencies, from fines or licenses, and from charges for services. Each fund must make its expenditures in accordance with its specified purposes. For example, a fund established for fire protection cannot be used to provide school buses for the local school.

23. 17-23 Types of Funds Each fund has its own asset and liability accounts, and its own revenue and expenditures accounts. The term expenditures refers to the outflow of resources in funds providing governmental services.

24. 17-24 Types of Funds Separate fund-based financial statements must be prepared for each fiscal period. In this manner, governing bodies or other interested parties may assess the financial performance of the funds in the fulfillment of the specific purposes for which they were established.

25. 17-25 Types of Funds Funds are separate fiscal and accounting entities established to segregate, control, and account for resource flows. Three types of funds are used by governmental units: –governmental funds, of which the general fund is usually the most important –Proprietary funds –Fiduciary funds

26. 17-26 Governmental Funds The following five governmental funds are used to provide basic governmental services to the public: General fund. Special revenue funds. Capital projects funds. Debt service funds. Permanent funds.

27. 17-27 Governmental Funds The number of governmental funds maintained by the governmental entity is based on the legal and operating requirements of the governmental entity. Only one general fund will be created by each governmental entity, but more than one of each of the other types of governmental funds may be created based on the specific needs of the entity. For example, some governmental entities establish a separate capital projects fund for each major capital project.

28. 17-28 Governmental Funds General Fund: –Accounts for all financial resources except for those required to be accounted for in another fund. –Includes transactions for general governmental services provided by the executive, legislative, and judicial operations of the governmental entity.

29. 17-29 Governmental Funds Special Revenue Funds: –Accounts for the proceeds of revenue sources that are legally restricted for specified purposes. –Includes resources and expenditures for operations such as public libraries when a separate tax is levied for their support.

30. 17-30 Governmental Funds Capital Projects Funds: –Accounts for financial resources for the acquisition or construction of major capital projects that benefit many citizens, such as parks and municipal buildings. –This fund is in existence only during the acquisition for construction of the facilities and is closed once the project is completed.

31. 17-31 Governmental Funds Debt Service Funds: –Accounts for the accumulation of resources for, and the payment of, general long-term debt principal and interest. –This fund is used for servicing the long-term debt of the government.

32. 17-32 Governmental Funds Permanent Funds: –Accounts for resources that are legally restricted such that only earnings, but not principal, may be used in support of governmental programs.

33. 17-33 Proprietary Funds Some activities of a government unit, such as operation of a municipal water system, are similar to those of commercial enterprises. In turn, the objective of the governmental unit is to recover its costs in these operations through a system of user charges.

34. 17-34 Proprietary Funds Accounting and reporting for a proprietary fund is similar to accounting for a commercial operation. The balance sheet of each proprietary fund reports all assets, including long-term capital assets, and reports all liabilities, including long-term liabilities.

35. 17-35 Proprietary Funds There are two types of proprietary funds typically used by governmental entities: –Enterprise Funds –Internal Service Funds

36. 17-36 Proprietary Funds Enterprise Funds: –Accounts for operations of governmental units that charge for services provided to the general public. –Includes those activities financed in a manner similar to private business enterprises where the intent of the governing body is to recover the costs of providing goods or services to the general public on a continuing basis through user charges.

37. 17-37 Proprietary Funds Enterprise Funds (Continued): –Also includes those operations that the governing body intends to operate at a profit. –Examples include sports arenas, municipal electric utilities, and municipal bus companies.

38. 17-38 Proprietary Funds Internal Service Funds: –Accounts for the financing of goods or services provided by one department or agency to other departments or agencies of the governmental unit. –The services are usually provided on a cost- reimbursement basis and are offered only to other governmental agencies, not the general public. Examples are municipal motor vehicle pools, city print shops, and central purchasing operations.

39. 17-39 Fiduciary Funds Four fiduciary funds are provided for a governmental unit. Three are trust funds that account for financial resources maintained in trust by the government: Pension and Other Employee Benefit Trust Funds. Investment Trust Funds. Private-Purpose Trust Funds.

40. 17-40 Fiduciary Funds The fourth fiduciary fund, agency funds, is used to account for resources held by the government solely in a custodial capacity.

41. 17-41 Fiduciary Funds Pension (and other employee benefit) Trust Funds: –Accounts for resources required to be held in trust for the members and beneficiaries of pension plans, other post-employment benefit plans, or other employee benefit plans.

42. 17-42 Fiduciary Funds Investment Trust Funds: –Accounts for the external portion of investment pools reported by the sponsoring government.

43. 17-43 Fiduciary Funds Private-Purpose Trust Funds: –Accounts for all other trust arrangements under which the fund’s resources are to be used to benefit specific individuals, private organizations, or other governments, as specified in the trust agreement.

44. 17-44 Fiduciary Funds Agency Funds: –Accounts for assets held by a government unit in an agency capacity for employees or for other governmental units. –An example is the city employees’ payroll withholding for health insurance premiums.

45. 17-45 Permanent versus Private-Purpose Note that the permanent fund, which is a governmental fund, includes resources that are legally restricted, such that the principal must be maintained by the governmental entity and only the earnings from the fund’s resources may be used to benefit the government’s programs for all of its citizens. [Continued on next slide.]

46. 17-46 Permanent versus Private-Purpose In contrast to the permanent fund, private- purpose trust funds include trusts under which the principal may or may not be expendable, but for which the trust agreement specifies the principal, if expendable, and the earnings, may be used only for the benefit of specific individuals, organizations, or other governments.

47. 17-47 Reporting Entity The financial statements of a governmental entity include the primary governmental unit, such as a state government, a general-purpose local government, or a special-purpose local government that has a separately elected governing body, and its component units for which the primary governmental unit has financial accountability. This is defined as the reporting entity.

48. 17-48 Reporting Entity A governmental unit may have a variety of boards, commissions, authorities, or other component units under its control. GASB 14 states that financial accountability exists for these component units if the primary government unit appoints a majority of an organization’s governing body and is able to impose its will on the organization or possesses a financial benefit or assumes a financial burden for the organization.

49. 17-49 Reporting Entity The government reporting model, as established by GASB 34, specifies that both fund financial statements, and government-wide financial statements, must be presented for most governmental units. Some funds, such as the general fund, use the modified accrual basis of accounting to recognize revenue and expenditure transactions.

50. 17-50 Reporting Entity Furthermore, no long-term capital assets, or general long-term debt, are recorded in the general fund. However, a reconciliation schedule will be required to go from the fund financial statements to the government-wide financial statements.

51. 17-51 Reporting Entity The government-wide financial statements use the accrual basis of accounting and report all capital assets and all long-term debt. Government-wide financial statements are presented in Chapter 18 after the conclusion of discussion on the remaining funds.

52. 17-52 Measurement Focus and Basis of Accounting (MFBA) The basis of accounting refers to the timing of recognizing a transaction for financial reporting purposes. For example, the cash basis recognizes revenue or expenditures when cash is received or paid. In contrast, the accrual basis recognizes revenue or expenditures when the transaction or event takes place.

53. 17-53 MFBA The modified accrual basis is a hybrid system that includes some aspects of accrual accounting and some aspects of cash-basis accounting. The modified accrual basis is used in funds that have a current financial resources measurement focus.

54. 17-54 MFBA The current resources measurement focus in on the flow of current financial resources and the proper expendability of the resources for designated purposes and determination of the available resources remaining to be expended. Expenditures recognized under the modified accrual basis are the amounts that would normally be liquidated with expendable available financial resources. The five governmental funds have this focus.

55. 17-55 MFBA The accrual basis method is used in funds that have an flow of economic resources measurement focus. This measurement focus is concerned with all economic resources available to a fund during a particular time period, thereby allowing for a comparison of revenues and expenses and a focus on maintenance of capital.

56. 17-56 MFBA The proprietary funds and fiduciary funds have this focus. In addition, as is presented in Chapter 18, the government-wide financial statements are based on the accrual basis method.

57. 17-57 Budgetary Aspects Budgets are used in governmental accounting to assist in management control and to provide the legal authority to levy taxes, collect revenue, and make expenditures in accordance with the budget. Budgets establish the objectives and priorities of governing units.

58. 17-58 Operating Budgets Operating budgets specify expected revenue from the various sources provided by law. The operating budget includes expected expenditures for various line items, such as payrolls of employees, supplies, and goods and services to be obtained from outside the governing unit. Operating budgets are used in the general fund, special revenue funds, and sometimes the debt service funds.

59. 17-59 Capital Budgets A capital budget is prepared to provide information about proposed construction projects such as new buildings or street projects. Capital budgets are used in the capital projects funds.

60. 17-60 Appropriation Approval of the budget provides the legal authority to levy the local property taxes and to appropriate resources for the expenditures. The term appropriation is the legal description of the authority to expend resources. The entry to record general fund budget is as follows (all amounts assumed): Estimated Revenues Control $900,000 Appropriations Control $850,000 Budgetary Fund Balance – Unreserved $50,000

61. 17-61 Accounting for Expenditures The governmental funds use a variety of controls over expenditures to ensure that each expenditure is made in accordance with any legal restrictions on the fund. For example, the encumbrances account is a budgetary account this is reserving part of the appropriation authority of the budget. Encumbrances are a unique element of governmental accounting.

62. 17-62 Accounting for Expenditures To illustrate encumbrance accounting, assume that on August 1, 20X1, Barb City completed a purchase order for goods from an outside vendor that are estimated to cost $15,000. The entry to record this order for goods is as follows: Encumbrances $15,000 Budgetary Fund Balance–Unreserved for encumbrances $15,000

63. 17-63 Expenditure Transactions Governmental accounting places many controls over expenditures, and much of the financial reporting focuses on the various aspects of an expenditure. Expenditures should be classified by fund, function (or program), organizational unit, activity, character, and principal classes of objects.

64. 17-64 Fund The fund is identified to show the specific source of the expenditure. For example, the general fund would be noted for expenditures from that fund.

65. 17-65 Function (or Program) Functions are group-related activities directed at accomplishing a major service or regulatory responsibility. Standard classifications of function include general governmental; public safety; highway and streets; sanitation, health and welfare; culture and recreation; and education.

66. 17-66 Organizational Unit Classifying by organization unit maintains accountability by each unit director. The organization unit is determined by the governmental unit’s organization chart. For example, public safety could be broken down into police, fire, corrections, protective inspection (such as plumbing and electrical code inspections), and other protection (such as flood control, traffic engineering, and examination of licensed occupations).

67. 17-67 Activity Activities within a function are recorded to maintain a record of the efficiency of each activity. For example, the police function could be broken down into the following activities: police administration, crime control and investigation, traffic control, police training, support service (such as communication services and ambulance services), special detail services, and police station and building maintenance. Admittedly, each of these activities could be broken down further, if desired.

68. 17-68 Character Character classifications are based primarily on the period the expenditures are anticipated to benefit. Four major character classifications are current, capital outlay, debt service, and intergovernmental.

69. 17-69 Object Class Object class is a grouping of types of items purchased or services obtained. For example, operating expenditures include personal services, purchased and contractual services, and commodities.

70. 17-70 Object Class (Continued) Each of these objects could be further broken down, depending on the information needs of the governing entity. For example, purchased services could include utility services, cleaning services (such as custodial, lawn care, and snow plowing), repair and maintenance services, rentals, construction services, and other purchased services, such as insurance or printing.

71. 17-71 Interfund Activities Interfund activities are resource flows between fund entities. Interfund activities must be evaluated carefully to ensure that the legal and budgetary controls of the governmental unit are not violated.

72. 17-72 Interfund Activities There are four types of interfund activities: Interfund loans. Interfund services provided and used. Interfund transfers. Interfund reimbursements.

73. 17-73 Interfund Activities Outstanding interfund loans are presented as receivable or payables on the fund’s balance sheet information. Interfund services provided and used are reported as part of the revenues and expenditures on the operating statements.

74. 17-74 Interfund Activities Interfund transfers are reported separately in the other financing sources (uses) section of the operating statement. Interfund reimbursements are not reported on the fund’s financial statements.

75. 17-75 You Will Survive This Chapter !!!! The fun continues in Chapter 18 !!! HINT: FUND ACCOUNTING

76. McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 17 End of Chapter