Chapter 1

The Government and Not-For-Profit Environment

TRUE/FALSE (CHAPTER 1)

1. The main objective of a typical governmental or not-for-profit entity is to earn a profit.

2. A government’s budget may be backed by the force of law.

3. Governmental entities have no need for an accounting system.

4. A government’s internal managers rely on general purpose financial statements for a

considerable amount of information about their government.

5. Governments and not-for-profits may never engage in business-type activities.

6. Lenders use the financial statements of governments and not-for profits just as they would
those of businesses, that is, to help assess the borrower’s credit-worthiness.

7. Financial statements, no matter how prepared, do not directly affect the economic worth of
an entity.

8. The Financial Accounting Standards Advisory Board’s standards do not apply to the federal
Department of Treasury.

9. Governments may be subject to the same pressures that led to accounting scandals like
Enron.

10. The Governmental Accounting Standards Board establishes generally accepted accounting
principles for all state and local government entities, as well as all not-for-profit entities.

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MULTIPLE CHOICE (CHAPTER 1)

1. A primary characteristic that distinguishes governmental entities from business entities is

a) The need to generate revenues equal to or in excess of expenditures/expenses.
b) The importance of the budget in the governing process.
c) The need to provide goods or services.
d) The correlation between revenues generated and demand for goods or services.

2. A primary characteristic that distinguishes not-for-profit entities from business entities is

a) The need to generate revenues equal to or in excess of expenditures/expenses.
b) The importance of the budget in the governing process.
c) The need to provide goods or services.
d) The correlation between revenues generated and demand for goods or services.

3. Which of the following characteristics distinguishes a governmental or not-for-profit entity

from a business entity?
a) There is always a direct link between revenues generated and expenditures/expenses
incurred.
b) Capital assets are used to produce revenues and save costs.
c) Revenues are always indicative of demand for goods and services.
d) The mission of the entity will determine the goods or services provided.

4. The most significant financial document provided by a governmental entity is the

a) The balance sheet.
b) The operating statement.
c) The operating budget.
d) The cash flow statement.

5. Which of the following statements is true?

a) Governments may engage in activities similar to activities engaged in by for-profit
entities.
b) There are a limited number of different types of governments.
c) All governmental entities engage in the same activities.
d) Managers may have a long-term focus and thereby sacrifice the short-term liquidity of
the entity.

6. Which of the following activities is NOT an activity in which a governmental entity might
engage?
a) Selling electric power.
b) Operating a golf course.
c) Operating a bookstore.
d) All of the above are activities that might be carried out by a government.

7. In which of the following activities is a not-for-profit entity least likely to engage?

a) Providing educational services.
b) Providing health-care services.
c) Providing for terrorism defense.
d) Retail sales of cookies.

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8. Which of the following can be affected by GAAP?
a) Legal ability to issue bonds.
b) Ability to balance the budget.
c) Amount reported as employee pension plan contributions.
d) Claims and judgments settled.

9. Which of the following characteristics is unique to a governmental entity?

a) The ability to have activities financed with tax-exempt debt.
b) The power to impose fees.
c) The ability to issue tax-exempt debt.
d) The ability to have activities financed by Federal grants.

10. To obtain a comprehensive understanding of a government’s fiscal health, a financial analyst

should obtain an understanding of which of the following?
a) All of the resources owned by the governmental entity.
b) All of the resources which may be summoned by a governmental entity.
c) Demographic data about the residents served by the governmental entity.
d) All of the above.

11. Which of the following is common to both governments and not-for-profit entities but
distinguishes these entities from for-profit entities?
a) The budget is a legal, financial document.
b) Revenues are usually indicative of demand for goods or services.
c) There is direct matching of revenues and expenses.
d) There are no defined ownership interests.

12. Which of the following is NOT a purpose of external financial reporting by governments?
External financial reports should allow users to
a) Assess financial condition.
b) Compare actual results with the budget.
c) Assess the ability of elected officials to effectively manage people.
d) Evaluate efficiency and effectiveness.

13. Which of the following is NOT a reason why users need governmental and not-for-profit
external financial statements?
a) To determine the ability of the entity to meet its obligations.
b) To determine the ability of the entity to continue to provide services.
c) To predict future fiscal solvency.
d) To evaluate the overall profitability of the entity.

14. Users of government financial statements should be interested in information about

compliance with laws and regulations for which of the following reasons?
a) To determine if the entity has complied with bond covenants.
b) To determine if the entity has complied with taxing limitations.
c) To determine if the entity has complied with donor restrictions on the use of funds.
d) To determine all of the above.

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15. Which of the following is NOT generally considered a main user of government and not-for-
profit entity external financial statements?
a) Investors and creditors.
b) Taxpayers.
c) Donors.
d) Internal managers.

16. Which of the following is a probable use a donor would make of the external financial
statements of a not-for-profit entity?
a) To determine the proportion of entity resources directed to programs as opposed to fund-
raising.
b) To determine the creditworthiness of the entity for investment purposes.
c) To determine the salaries paid to all employees of the entity.
d) To determine the budget of the entity.

17. A regulatory agency would use the external financial statements of a local government for
which of the following purposes?
a) To assure that the entity is spending and receiving resources in accordance with laws,
regulations or policies.
b) To determine how resources should be allocated.
c) To exercise general oversight responsibility.
d) To do all of the above.

18. Which of the following constituency groups would be most likely to evaluate government
financial statements to determine likely areas in which to achieve cost-savings?
a) Creditors.
b) Union officials representing the government’s employees.
c) Federal agencies that provide purpose-restricted grants.
d) Students of governmental accounting.

19. Which of the following objectives is considered to be the cornerstone of financial reporting
by a governmental entity?
a) Accountability.
b) Budgetary compliance.
c) Interperiod equity.
d) Service efforts and accomplishments.

20. Which of the following is an objective of financial reporting by governmental entities as

established by GASB?
a) Financial reporting should assist users in assessing the management skills of top
management.
b) Financial reporting should assist users in determining if current-period revenues were
sufficient to pay for current-period services.
c) Financial reporting should assist users in evaluating the cash management operations of
the governmental entity for the year.
d) Financial reporting should assist users in assessing whether the government provided
appropriate services to its constituents in the current year.

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21. Which of the following is an objective of financial reporting for not-for-profit entities as
established by FASB? Financial reporting should provide information that is useful to
present and potential resource providers and other users in:
a) Assessing the types of services provided and the need for those services.
b) Assessing the services provided and the entity’s ability to earn a profit.
c) Making rational decisions about the allocation of resources to those organizations.
d) Assessing how managers have managed personnel.

22. As used by GASB, interperiod equity refers to which of the following? Financial reporting
should:
a) Demonstrate compliance with finance-related contractual requirements.
b) Provide information to determine whether current-year revenues were sufficient to pay
for current-year services.
c) Demonstrate whether resources were obtained and used in accordance with the entity’s
legally adopted budget.
d) Provide information to assist users in assessing the government’s economy, efficiency,
and effectiveness.

23. Given a specific set of data, the basis of accounting selected by or imposed on a
governmental entity will least affect which of the following?
a) Determining whether or not the governmental entity has a balanced budget.
b) Determining whether or not the governmental entity has the ability to issue debt.
c) Determining whether or not certain economic events occurred.
d) Determining the annual payments to a government-sponsored pension plan.

24. The basis of accounting selected by or imposed on a governmental entity can influence which
of the following?
a) A decision to contract-out a specific service rather than provide that service itself.
b) The amount of salary increases proposed by union negotiators.
c) The amount that is available to spend on a donor-specified project or service.
d) All of the above.

25. The Governmental Accounting Standards Board is the primary standard-setting body for:
a) All governments.
b) All state and local governments.
c) All governments and all not-for-profit entities.
d) All state and local governments and all not-for-profit entities.

26. Under certain circumstances a governmental entity might use standards established by which
of the following standard-setting bodies?
a) GASB.
b) FASB.
c) AICPA.
d) All of the above.

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27. The primary standard-setting body for accounting and financial reporting by a state-
supported college or university is:
a) GASB.
b) FASB.
c) AICPA.
d) All of the above.

28. In descending order, the hierarchy of GAAP applicable to a church-owned college may be:
a) FASB Statements and Interpretations, FASB Technical Bulletins, AICPA Industry Audit
Guides, FASB Implementation Guides, other accounting literature—including GASB
Standards.
b) FASB Statements and Interpretations, FASB Technical Bulletins, FASB Implementation
Guides, AICPA Practice Bulletins (if cleared by FASB).
c) GASB Statements and Interpretations, AICPA Industry Audit Guides, GASB
Implementation Guides, other accounting literature—including FASB Standards.
d) GASB Statements and Interpretations, GASB Technical Bulletins, AICPA Industry Audit
Guides, AICPA Practice Bulletins (if cleared by GASB), GASB Implementation Guides,
other accounting literature—including FASB standards.

29. Which of the following entities was a principal in creating the FASAB?
a) U.S. Congress.
b) Office of Management and Budget.
c) Governmental Accounting Standards Board.
d) Securities and Exchange Commission.

30. The purpose of the FASAB is to:

a) Establish accounting standards for not-for-profit entities.
b) Establish accounting standards for federal entities.
c) Establish accounting standards for all governmental entities.
d) Establish accounting standards for non-federal governmental entities.

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PROBLEMS (CHAPTER 1)

1. Thorn County adopted a cash budget for FY2007 as follows. The City budget laws prohibit
budgeting or operating at a deficit. During the year the County collected or spent the
following amounts. Was the County in compliance with budget laws? Did the County
accomplish the goal of interperiod equity? Explain your answers in detail.

Budgeted Collected/Spent
Receipts from Property tax collections
From the 2006 levy $ 100,000 $ -0-
From the 2007 levy $1,000,000 $ 900,000
In advance for 2008 $ 50,000 $ -0-
Receipts from Bonds Issued $ 500,000 $ 500,000
Borrowed from Bank (due in 5 years) $ -0- $ 75,000
Disbursements
Salaries and Wages $ 500,000 $ 500,000
Operating Expenses $ 200,000 $ 275,000
City Hall Annex purchased $ 500,000 $ 500,000
Payments on Debt-Principal $ 150,000 $ 150,000
Payments on Interest $ 50,000 $ 50,000
Pension Contribution $ 80,000 $ -0-

Explanations provided by the City for the differences between budget and actual are as
follows. Property tax collections are down because the major industry in the community
closed and many citizens are currently unemployed. Operating expenses are up because the
only bridge over a river bisecting the City sustained damages by an uninsured motorist and
had to be repaired immediately. The repair was not budgeted.

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2. Save-the-Birds (STB), a not-for-profit entity dedicated to acquiring and preserving habitat for
upland birds, prepares financial statements in accordance with generally accepted accounting
principles. Currently, standards require that a not-for-profit entity report virtually all
contributions as revenue in the year received. During the current year STB received a
donation of several hundred acres of prime habitat for upland birds. STB will require several
hundred thousand dollars in additional donations in order to make the land completely
suitable for the birds. Before embarking on its fund-raising campaign STB prepares financial
statements which are summarized as follows.

Statement of Financial Position (Balance Sheet)

Cash $ 8,000
Supplies $ 2,000
Equipment (net of depreciation) $ 5,000
Land $1,000,000
Total Assets $1,015,000

Liabilities $ 1,000
Net Assets—Unrestricted $ 14,000
Net Assets—Restricted $1,000,000
Total Liabilities and Net Assets $1,015,000

Statement of Activities (Income Statement)

Revenues $1,030,000
Expenses:
Salaries $ 30,000
Change in Net Assets $1,000,000

What difficulties, if any, will Save-the-Birds encounter in its new fund-raising drive?
Knowing that the donation of the land accounted for $1,000,000 of the revenue reported by
Save-the-Birds, do you think the financial statements present fairly the financial position and
results of operations of this not-for-profit entity?

3. Johnson City prepares its budget on the cash basis and prepares its external financial
statements on the accrual basis. From the following data prepare statements of activity
(income statements) on both the cash basis and the accrual basis. Which statement best
represents the results of operations of the City? Which statement best demonstrates
compliance with laws and regulations? Which statement would you rather see? Which
conveys the best information to the citizens of Johnson City?

The City levies taxes in the current year of $1 million. Of this amount $.9 million is collected
during the current year, $.05 will be collected next year, and $.04 will be collected in the
future. $.01 will never be collected. During the current year the City pays bills from prior
periods $.06 million, bills of the current period $.8 million, and defers payment until future
periods on bills that were received for services consumed during the current period $.1
million.

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4. Certain fiscal practices of governments promote interperiod equity while others do not. For
the situations listed below, indicate whether interperiod equity is promoted or undermined.
Why?
a. Issuing 30-year serial bonds to finance the construction of capital assets with estimated
30 year lives.
b. Paying for the pensions of retired employees out of resources provided by current-period
taxpayers.
c. Charging the cost of supplies as expenditures in the year in which they were used rather
than when they were purchased.
d. Issuing 30-year bonds to finance a portion of the current period operating costs of a city’s
school system
e. Charging payments of wages and salaries made in the first week of a new year to the
previous fiscal year, the year in which the wages and salaries were earned.

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ESSAY (CHAPTER 1)

1. In the United States, educational services can be provided by federal governmental entities,
by non-federal governmental entities, by not-for-profit entities, and by for-profit entities. Are
the accounting and financial reporting standards the same for each of these entities? Should
they be the same?

2. The Governmental Accounting Standards Board (GASB) stated that an objective of financial
reporting is to measure interperiod equity, that is—“Financial reporting should provide
information to determine whether current-year revenues were sufficient to pay for current-
year services.” What is your understanding of interperiod equity? What costs incurred in the
current year should be paid for by the taxpayers of the current period? What costs incurred in
the current year should be paid for by future taxpayers?

3. A not-for-profit entity raises funds to support specific programs, services, and activities. The
recipients of the programs, services, and activities are frequently not the providers of the
resources to deliver the programs, services, and activities. What information would donors to
these not-for-profit entities be interested in seeing? What information would program
beneficiaries be interested in seeing? Identify other users of the financial statements of a not-
for-profit and the types of information in which they would be interested.

4. What is the significance—for financial reporting purposes—of the fact that neither not-for-
profits nor governments have owners (stockholders)?

5. What are some of the definitional criteria that distinguish a governmental entity from a not-
for-profit entity?

6. How does the FASB influence generally accepted accounting principles for state and local
governments?

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ANSWERS TO TRUE/FALSE QUESTIONS (CHAPTER 1)

1. F
2. T
3. F
4. T
5. F
6. T
7. T
8. F
9. T
10. F

ANSWERS TO MULTIPLE CHOICE (CHAPTER 1)

1. b
2. b
3. d
4. c
5. a
6. d
7. c
8. c
9. c
10. d
11. d
12. c
13. d
14. d
15. d
16. a
17. d
18. b
19. a
20. b
21. c
22. b
23. c
24. d
25. b
26. d
27. a
28. a
29. b
30. b

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ANSWERS TO PROBLEMS (CHAPTER 1)

1. The City adopted a cash budget that projected an operating surplus of $170,000;
therefore, it was in compliance with the “budgeting” portion of budget laws. In addition, the
City “balanced” its current period operations. Total inflows are $1,475,000 and total
outflows are $1,475,000. The City was seriously affected by the closure of the major
employer in town. The City compensated for the shortfall in property tax revenues by failing
to make the pension contribution in the current period and by borrowing on a long-term note
at the bank. Although one expenditure category exceeded the budgeted amount (operating
expenses was $75,000 more than budgeted), another was short by $80,000 (pension
contributions). The City has probably complied with the budget laws that prohibit operating
at a deficit (if deficit is defined as a cash deficit). It has probably not complied with the
budget laws if the laws state that current revenues (not including borrowing) must be equal to
or exceed current period costs.
Interperiod equity is another issue. By failing to make the required contribution the City
has passed on to future taxpayers costs that were associated with operations of the current
period. Also, by borrowing at the bank the City has incurred obligations that must be borne
by future taxpayers.

2. Save-the-Birds will be launching a major fund-raising drive with a financial statement

that shows $1,030,000 in donations and only $30,000 in expenses. It may be difficult to
explain to potential donors why the entity is conducting a fund-raising drive at the present
time. The balance sheet should help Save-the-Birds explain why they need the additional
monies. However, many people familiar with financial statements of for-profit entities may
have difficulty understanding how an entity can generate a $1,000,000 ‘profit’ and still need
to be soliciting funds. The equity section shows Net Assets of $1,000,000. It may be difficult
for readers to understand that this is not similar to Retained Earnings in for-profit entities.
The distinction between unrestricted and restricted may be meaningless to the average reader.
[Note: Students may react as readers—why do they need another fund-raising drive now? If
so, they have failed to grasp an important issue for many not-for-profit entities.]
The financial statements of Save-the-Birds present fairly the financial position and results
of operations of the entity. The financial statements do not tell the whole story. It will be
necessary for Save-the-Birds to explain why they need the funds.

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3. Johnson City financial statements would be as follows:

Cash Basis Accrual Basis

$.9 million Property tax receipts

Property tax revenues $.99 million
(.06) million Prior period expenses
Accrued expenses (.1) million
(.8) million Current expenses (.8) million
$.04 million “Net Income” $.09 million

The cash basis financial statement would best demonstrate compliance with the budget but
the non-cash basis financial statement would best convey results of operations. As a citizen, I
would like to see both because legal compliance is important to me but so are results of
operations. It may take both statements to fully inform the public about operations. [Note:
At this point students have not been exposed to 'modified accrual' accounting so they will not
struggle with revenue recognition issues imbedded in this problem.]

4.
a. Promotes interperiod equity. Because the bonds are required to be repaid over the
life of the capital assets, the cost of those assets is allocated to the periods over which
taxpayers benefit from the use of the assets.
b. Undermines interperiod equity. The employee benefits costs—pension benefits—are
paid by an entirely different generation of taxpayers—long after the employees
earned the benefits by providing services.
c. Promotes interperiod equity. Although not particularly material, supplies do not
benefit taxpayers until they are used to provide services. Reporting these as
expenditures when purchased reports the cost in a different period from when the
benefit is provided.
d. Undermines interperiod equity. Using debt to finance operating costs spreads the
cost of providing services provided in a single period over the entire term of the
long-term debt. Interest costs on the debt amplify the problem.
e. Promotes interperiod equity. Again, while possibly immaterial, reporting the cost of
providing services—in the form of wages and salaries—in the period in which
services were provided promotes interperiod equity.

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ANSWERS TO ESSAY QUESTIONS (CHAPTER 1)

1. Accounting standards for educational institutions differ by the nature of the ownership.
Public schools (K-12) are accounted for in the same way as state and local governments, as
are public colleges and universities, theoretically. Private schools, colleges, and universities
are accounted for using not-for-profit standards established by FASB. For-profit educational
institutions would use the FASB rules for other for-profit entities.

Because these entities are all involved in delivering the same basic service—education—it
would appear that they should have the same standards. However, public schools are subject
to the same openness as other government activities. The citizens should have a voice in
determining what services are offered through the schools and how those services are
delivered. The budget process is the opportunity for the public to be heard and the adopted
budget is a plan of action to which citizens can, and should, hold officials accountable. For-
profit schools are organized to generate profits and should measure net income using full
accrual accounting. Not-for-profit entities generate revenues from tuition and solicit
contributions from the public, or a select group of the public. Donors to not-for-profit entities
may be interested in different information than taxpayers are interested in.

[Note: Students will have differing opinions about the appropriateness of different
accounting standards for educational institutions determined by ownership rather than by
activity. The question is designed to solicit their thoughts.]

2. Interperiod equity means that the citizens of one time period should pay the costs of the
goods and services consumed during that time period. Interperiod equity as an accounting
concept means that the financial statements should measure the success of a governmental
entity in accomplishing the goal of raising sufficient revenues to pay for the cost of services
consumed during a period. However, interperiod equity is a policy decision, not an
accounting decision.

To achieve interperiod equity, current-year taxpayers should cover the cost of current-year
services. Everyone would agree that current period operating costs should be covered,
including supplies and payroll costs. In addition, a portion of the cost of capital assets or
other improvements, which benefit more than one period, should be considered in the
equation. Finally, certain costs may not be paid until well into the future but arise from
current operations. The government’s employees earn many of these in the current period,
including accumulating vacation benefits, pension benefits, and other postemployment
benefits.

Costs that should not be included in the current year measure of interperiod equity are costs
that will benefit future periods—for example, the portion of the historical cost of capital
assets that will be allocated over future periods.

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3. Donors to not-for-profit (NFP) entities are probably interested in information about the costs
incurred by the not-for-profit. Donors would be interested in comparing the cost incurred in
delivering services by one entity compared to the cost incurred by another entity for
delivering the same type of service. The amount spent on programs compared to the amount
spent on fund-raising and general and administrative costs would be of interest to donors.
Major donors should be very interested in the amounts spent on salaries to top NFP officials
because major donors are, in effect, paying those salaries. Beneficiaries would be interested
in the costs of delivering the goods and services and the success of the NFP in securing the
funds necessary to continue to deliver those goods and services.

Regulatory agencies, such as the IRS, would be very interested in the financial information of
NFP entities to assess whether they should continue to be considered a NFP entity.
Governments would be interested in the financial information of NFP entities. Many
governments are considering outsourcing or privatizing the delivery of goods and services. If
other entities can, indeed, perform those services more efficiently than government, perhaps
the services should be privatized or outsourced.

4. The obvious significance of the fact that neither not-for-profits nor governments have owners
is that neither governments nor not-for-profits report owner’s equity. More important
however, is the fact that financial reports of governments cannot focus on owners. They must
be prepared from the perspective of parties other than stockholders. Generally this focus is
on resource providers and the restrictions they place on the assets they contribute.

In addition, this distinction often means that there is less interest in the fair market values of
assets and liabilities and other accounting measures that rely on fair values, such as pension
expense. No stockholders exist to consider the price/earnings ratios of these entities or a
potential buyout/takeover.

Finally, both the FASB and GASB have called for information on service efforts and
accomplishments. These measures would be used to assess, among other things, how
effectively and efficiently the entities provide services. This information, however, is not
easily expressed in monetary measures and has not yet been included in financial statements.

5. First, and foremost, a governmental entity usually has the power to assess taxes. Not-for-
profit entities do not. In addition, governments may issue tax-exempt debt and their
governing bodies are either elected by taxpayers or appointed by another government. Less
common is the fact that a governmental entity can usually be unilaterally dissolved by
another governmental entity (usually the one that created it) and its assets assumed without
compensation. None of these things are true about not-for-profit entities.

6. The FASB influences generally accepted accounting principles of governments in two key
ways. First, FASB pronouncements are included in the GASB “hierarchy” of GAAP. FASB
pronouncements that the GASB has specifically made applicable to governments are included
in the highest category; those that the GASB has not specifically adopted are included in the
lowest category. Second, the business-type activities of governments are required (with a few
exceptions) to follow the business accounting principles as set forth by the FASB.

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