Chapter 2

Download as doc, pdf, or txt
Download as doc, pdf, or txt
You are on page 1of 10

CHAPTER 2:

2
PRINCIPLES OF ACCOUNTING AND FINANCIAL REPORTING FOR STATE
AND LOCAL GOVERNMENTAL UNITS

2.2 STATEMENT OF THE PRINCIPLES

2.2.1 Accounting & Reporting Capabilities (principle #1)

A government accounting system must make it possible both


(a) To present fairly & with full disclosure the financial operation of the funds & account
groups of the governmental unit in conformity with Generally accepted accounting
principles (GAAP) &
(b) To determine & demonstrate compliance with finance-related legal and contractual
provisions.
2.2.2 Fund Accounting System (Fund defined) (principle # 2)

- The word FUND is given special definition as it relates to Fund Accounting. The narrow
definition of Fund as used in ordinary conversation is a “resource of money”. However
in this course it is given the special definition above. It has key phrases indicating the
following points; It is by itself is an entity, having its own accounting existence and a
self balancing set of books (double entry system). That set of books is established for
recording a specific financial activity. The establishment of the fund will attain a specific
objective and will have regulations, restrictions or limitations.

2.2.3 Types of Funds (Principle # 3)

There are seven types of funds, which are subdivided into three categories:

I. GOVERNMENTAL FUNDS

1. 1. The General Fund-


Fund- to account for all financial resources except those required
to be accounted for in another funds. The general fund is used for general
government services. It is basically used for services that do not require a separate
fund.
2. Special Revenue Funds-
Funds- to accounts for the proceeds of specific revenue sources
(other than expendable trusts or for major capital

1
projects) that are legally restricted to expenditure for
specific purposes.
3. Capital Project Fund-
Fund- to account for financial resources to be used for the acquisition
or construction of major capital facilities (other them those
financed by proprietary & trusts funds)
4. Debt Service Funds-
Funds- to account for the accumulation of resources for & the payment
of general long term debt principal & interest.
All governmental funds are Expendable Funds

II. PROPRIETARY FUNDS

5. Enterprise Funds-
Funds- to accounts for operations
1. That are financed and operated in a manner similar to private business
enterprises-where the intention of the governing body is that the costs
(expenses, including depreciation) of providing goods or services to the
general public on a continuing basis be financed or recovered primarily
through user charges; or
2. Where the governing body has decided that periodic determinations of
reveries earned, expenses incurred and/or net income is appropriate for
capital maintenance, public policy, management control, accountability, or
other purposes.

6. Internal Service Funds-


Funds- to account for the financing of goods or services provided
by one department or agency to the another
department or agency of the governmental unit, or to
the other governmental units on a cost reimbursement
basis.

III. FIDUCIARY FUNDS


7. Trust And Agency Funds- To account for assets held by governmental unit in a
trustee capacity or as an agent for individual private
organizations, other governmental units & or funds.
Example, Inland Revenue Authority.
Authority. Fiduciary fund
include:
include
1. Expandable trust funds
2. Non-expendable trust funds

2
3. Pension trust funds
4. Agency funds

All governmental funds are Expendable Funds; expendable funds are meant to be
expended or their resources are used up entirely usually within one fiscal year. As a
practical matter, any money that remains in an expendable fund at the end of the year
typically must be returned to its source. The accounting equation for an expendable fund
(from the definition of Fund above) is cash plus other financial resources minus liabilities
= fund balance. (C + OR - L = FB). There are no ownership interests in an NFP. So there
is no capital or owners equity. There is only a balance remaining to be used for specific
purpose.

Non-Expendable Funds are used when maintenance of capital is desired, and the
unexpended funds are not meant to be returned. All proprietary funds are non-expendable
funds

2.2.4 Number of Funds (Principle # 4)


Governmental units should establishes and maintain those funds require by law & sound
financial administration. Only the minimum number of funds in consistent with legal and
operating requirements should be established, however since unnecessary funds result in
inflexibility, undue complexity & inefficient financial administration.

The seven fund types are to be used if needed by Governmental unit to demonstrate
compliance with legal requirements or if needed to facilitate sound financial
administration.

2.2.5 Accounting for fixed assets & long-term liabilities (Principle #5)
A clear distinction should be made between Fund fixed assets & general fixed assets &
Fund long-term liabilities & General long-term debt

A. Fixed assets related to specific proprietary funds & trust funds should be
accounted for through those funds.
All other fixed assets of governmental units should be accounted for through the
general fixed asset account group.
B. Long term liabilities of proprietary funds & trusts fund should be accounted for
through those funds.

3
All other unmanured general long-term liabilities of governmental unit including
special assessments debt for which the government is obligated in some manner
should be accounted for through the general long-term debt account group.

2.2.6 Valuation of Fixed Assets (PRINCIPLE # 6)


Fixed assets should be accounted for at cost,
cost, or if the cost is not practically
determinable, at estimated cost, donated fixed assets should be recorded at their estimated
fair value at the time received.

2.2.7 Deprecation of Fixed Assets (PRINCIPLE # 7)

1. Depreciation is not recognized in as expenditure in governmental funds


because it is not a decrease in fund financial resources. However, It should be
calculated in the general fixed asset account group because knowing depreciation
is helpful for good financial management and helps in planning for the
replacement of assets in the future.
2. Proprietary fund fixed assets depreciation is recognised- because a proprietary
fund needs to know that it is covering all its costs, it includes depreciation as an
expense in its accounts. Remember that accounting in a proprietary fund is similar
to FP accounting.

2.2.8 Basis of Accounting (PRINCIPLE # 8)


The Modified Accrual or accrual basis of accounting as appropriate should be utilized in
measuring financial position & operating results.

A. Governmental fund revenues & expenditures should be recognized on the


modified accrual basis. Revenues should be recognized in the accounting in
which they become available & measurable. expenditures should be recognized in
the accounting period in which the fund liability is incurred, if measurable, except
for unmatured interest on General Long-Term Debt which should be recognized
when due.
B. Proprietary fund revenues & expenses should be recognized on the accrual
basis.
C. Fiduciary funds revenue and expenses or expenditures.
expenditures. It is sufficient to say
that the basis of accounting for Fiduciary funds depends on whether or not the

4
nature of the fund is expendable or non-expendable. Both kinds are possible in
fiduciary funds.
Modified accrual basis
 For Expendable trust funds and Agency fund
Accrual basis
 For Nonexpendable trusts and Pension Trust Funds
D. Transfers of financial resources among funds should be recognized in all funds
affected in the period in which the interfund receivables & payable(s) arise.

2.2.9 Budget and Budgetary Accounting (Principle # 9)


A. An annual budget (s) should be adapted by every governmental units.
B. The accounting system should provide the basis for appropriate budgetary control.
C. Budgetary comparisons should be included in the appropriate financial statement &
schedules for governmental units funds, for which an annual budget has been adapted.
[Budget with Actual]
Budgeting is the process of allocating of resource to meet unlimited demands.
There are three primary questions to ask when preparing a budget.
Q, How much will we spend?
Q, Why will we spend it?
Q, Where will we get the money?

2.2.10 Financial Reporting (Principal # 10)

Interim financial reports


In NFP accounting interim reporting is used if it fulfils one of these three purposes:
1. For good management
2. For the legislature (legal compliance)
3. For external reporting (perhaps for those who have loaned money to it)
Comprehensive Annual Financial Reports (CAFR)
A comprehensive annual financial report covering all funds & account gropes of the
governmental unit including appropriate combined, combining & individual fund
statements, notes to the F.S, schedules, narrative explanations & statistical tables
should be prepared & published.

5
1. Combined statement would should the operations of the entire governmental entity
constituting all the individual funds in to one statement. Combining would
candidate the results of all funds of same type e.g. all special revenue funds.
Individual fund statement would be prepared for each individual fund.

General purpose Financial Statement (GPFS)


General purpose F.S may be used separately from the comprehensive annual financial
report. Such statement should include the basic F.S & notes to the financial statement that
are essential to fair presentation of financial position and operating results (changes in
financial position of proprietary funds & similar funds)

Classification and Terminology (Principle # 11,12)

Classification (principle # 11)


11)

I. Classification of Transfers
Inter fund transactions are transactions between individual funds. Inter fund transactions
are of particular interest to financial statement preparers and users because failure to
report these transactions properly results in two funds being misstated. Additionally,
because most of these transactions are eliminated in the government wide statements, it is
particularly important they be identified in the accounts of the affected funds. Like related
party transactions, transactions between funds of the same government may not be
assumed to be arm’s length in nature. An arm’s length transaction is one in which both
parties act in their own self-interest and are not subject to pressure or influence. GASB
standards require that inter fund transactions be classified into two categories, each with
two subcategories. Journal entries to record inter fund transactions are based on these
classifications. Reciprocal inter fund activity is the internal counterpart to exchange and
exchange-like transactions and includes inter fund loans and inter fund services
provided and used. Nonreciprocal inter fund activity includes inter fund transfers
and inter fund reimbursements.

Inter fund Loans

Inter fund loans are resources provided from one fund to another with the requirement for
repayment. The fund providing the resources records an inter fund receivable (Due from

6
Other Funds ) and the fund receiving the resources records an inter fund payable ( Due to
Other Funds ). Long-term loans use the terms Advance to Other Funds and Advance from
Other Funds. Inter fund loan receivables and payables are separately reported on the
balance sheets of the affected funds.

Journal entry

Fund Making the Payment Fund Receiving the Payment


Due from Other Fund …Dr Cash ………………. Dr
Due to Other Fund ………. Cr
Cash ………………………......... Cr If the loan is long-term, Advance from
If the loan is long-term, Advance to Other Other Funds is used in place of Due to
Funds is used in place of Due from Other Other Funds.
Funds.

Inter fund Services provided and Used

Inter fund services provided and used represent transactions involving sales and purchases
of goods and services between funds. An example is the sale of water from a water utility
(enterprise) fund to the General Fund. In these transactions, one fund records a revenue
(enterprise, in this example) and the other fund records an expenditure or expense (the
General Fund). Sometimes called quasi-external transactions, these transactions are
reported as if they were transactions with parties outside the government .

Journal entry

Fund Making the Payment Fund Receiving the Payment


Expenditures …………... Dr Cash ………………. Dr
Cash ……………….……........... Cr Operating Revenue …… Cr
If the fund receiving the service is a
proprietary fund, Expense is used in place
of Expenditure.

Inter fund Transfers

Inter fund transfers represent flows of cash or other assets without a requirement for
repayment. An example would be an annual transfer of resources from the General Fund
to a debt service fund. Inter fund transfers act (in terms of debits and credits) as if they are
revenues or expenditures (expenses) but are classified as other financing sources (the debt
service fund) and other financing uses (the General Fund).

Journal entry

7
Fund Making the Payment Fund Receiving the Payment
Other Financing Uses — Transfers Out …… Dr Cash ………………. Dr
Cash …………..………….......... Cr Other Financing Sources —Transfers In.…. Cr

Inter fund Reimbursements

Inter fund reimbursements represent repayments to the funds that initially recorded
expenditures or expenses by the funds responsible. For example, assume the General Fund
had previously debited expenditures to acquire some supplies, but the supplies should
have been charged to a special revenue fund. The reimbursement entry would have one
fund (the special revenue fund) debit an expenditure (or expense) and the other fund (the
General Fund) credit an expenditure or expense.

Journal entry

Fund Making the Payment Fund Receiving the Payment


Expenditures …….... Dr
Cash ……………………..... Cr

(To record initial purchase)

Expenditures …………...Dr Cash ………………. Dr


Cash ……………………………. Cr Expenditures ……………… Cr
If the fund is a proprietary fund, Expense If the fund is a proprietary fund, Expense
is used in place of Expenditure is used in place of Expenditure
(To record the reimbursement) (To record the reimbursement)

II. Classification of Revenues and Expenditures


Governmental fund revenues should be classified by fund and source. Expenditures
should be classified by fund, function (or programmes), organization unit, activity,
character & principal classes of object.

III. Proprietary fund Revenues and Expenses


Proprietary fund revenues & expenses should be classified in essentially the same manner
as those of similar business organizations functions or activities.

Expense is a current period consummation of resources while expenditure is a decrease in


fund financial resources.

8
E.g. in profit making accounting, a car would be considered as an asset & depreciation
would be recorded as an expense as the car is used up on wears out, in a fund the car
would be considered as expenditure at the time of purchase.

Terminology (Principle #12)


#12)
A common terminology & classification should be used consistently through out the
budget, the accounts, the financial reports of each fund.

The common terminology and classification principle is simply a statement of common


sense proposition that if the budgeting, budgetary control, and budgetary reporting
principle is to be implemented, persons responsible for preparing the budgets and persons
responsible for preparing the financial statements and the financial reports should work
with the persons responsible for designing and operating the accounting system.
Agreement on a common terminology and classification scheme is needed to make sure
the accounting system produces the information needed for budget preparation and for
financial statement and report preparation

I. Accounting Characteristics Common to Funds of the Governmental


Fund Category
The four governmental funds (i.e. general, special revenue, capital project & debt service
funds) have common characteristics that would distinguish them from that of the other
two fund types (i.e. proprietary & fiduciary)

1. Governmental funds are created in accordance with legal requirements.


- Each fund has only those resources allowed by law.
- Any governmental unit might or might not use the allowed resource but they should
not utilize unauthorized resources.
- The resources may be expended only for purposes & in amounts approved by the
legislative branch. So the measurement focus of governmental fund accounting is on
the flow of financial resources (as distinguished from business organization focus on
determination of net-income)
- Governmental funds are expendable i.e. resources are received & expended with no
exceptions, that they will be returned through user or departmental charges.
- Revenues & expenditures (not expenses) of governmental funds are recognized on the
“modified accrual basis of account”.

9
II. Accounting characteristics common to funds of the proprietary fund
category.

1. Proprietary fund provide services to users on a cost reimbursement basis.


2. They are for a part of the government that is run like a private business where the
income & fees for services of the fund is expected at least to cover part of the
expenses.
3. They are not subject to income taxation, nor do they have owners in the sense that
business enterprises do.
4. Their account is similar with profit making business.

III. Accounting Characteristics Common to Funds of the Fiduciary Fund


Category
1. All fiduciary funds are used to account assets held by governmental unit as a trustee or
agent.
2. Agency fund & expendable trust funds are to be accounted in the same way as
governmental funds.
3. Non-expendable & pension trust funds are to be accounted in the some way as
proprietary funds.
4. Fiduciary funds can be expendable or non- expendable depending on the purpose of the
fund.
1. An endowment (gift of income producing assets such as bonds) is a good
example of fiduciary funds. The principal of the endowment is to be kept intact
but the income (interest) may be used up. The income would then be accounted
as expendable & the principal non- expendable.

10

You might also like