Chapter two

Principles of accounting and financial reporting of governmental entities

1. Activities of government
• Government entities involved in both
a. Governmental-type activities
• Fire, police, courts, social services
a. Business-type activities
• Utilities (electricity, water, sewer)
• Transportation (bus / airports)
• NB. Accounting and reporting standards are different for each type of activity
Statement of Principles
Accounting & Reporting Capabilities (GASB principle #1)
• Accounting systems are required to comply with
 GAAP and
 Legal/contractual requirements
• Most common difference - budgetary basis differs from GAAP-Maintain accounts on a
legal / budgetary basis and convert to GAAP at year end
Fund Accounting System (GASB principle # 2)
• Governmental accounting systems should be organized & operated on a fund basis.
• In ordinary conversation fund is a “resource of money”
• “fund” is defined as a fiscal & accounting entity with a self balancing set of accounting record like:
 cash & other financial resources
 liabilities & residual equities and balances
• Types of Funds (Principle # 3)
• There are seven types of funds, which are subdivided into three categories:
I. GOVERNMENTAL FUNDS
1. The General Fund- to account for all financial resources except those required to be accounted for in another
funds.
2. Special Revenue Funds- to accounts for the proceeds of specific revenue sources (other than expendable trusts or
for major capital projects) that are legally restricted to expenditure for specific purposes.
3. Capital Project Fund- to account for financial resources to be used for the acquisition or construction of major
capital facilities (other than those financed by proprietary & trusts funds)
4. Debt Service Funds- to account for the accumulation of resources for & the payment of general long term debt
principal & interest
II. PROPRIETARY FUNDS
5. Enterprise Funds- to accounts for operations:
• That are financed and operated in a manner similar to private business enterprises.
• That the governing body has decided the periodic determinations of revenues earned, expenses
incurred and net income is appropriate.
6. Internal Service Funds- to account for the financing of goods or services provided by one
department or agency to the department.
III. FIDUCIARY FUNDS
7. Trust fund- To account for assets held by governmental unit in a trustee capacity.
These include:
a. Expandable trust funds: used to account resources that are used up entirely usually within one
fiscal year
The accounting equation for an expendable fund cash plus other financial resources minus
liabilities = fund balance. (C + OR - L = FB)
b. Non-expendable trust funds: they used when maintenance of capital is desire and the fund is
not returned.
c. Pension trust funds: used to account resources held for pension benefits.
d. Agency fund:To report resources held as a custodial agent
Number of Funds (Principle # 4)
The government unit must have one and only one General fund
If the government unit required to have other types of funds can utilized in the way that
will allow compliance with legal and other restrictions
Provisions for minimizing number of funds
• Use GF to account for resources restricted to purposes normally financed through GF
◦ SRFs not required unless legally mandated
◦ DSFs not required unless
Legally mandated, or
Accumulating resources for future debt payments
◦ DSF not necessary for long-term notes, leases
◦ DSF typically required for bond issue debt service
Accounting for general fixed assets & long-term liabilities (Principle #5)
General fixed assets include land, buildings, and improvements other than assets
accounted by the four fund types.
General long-term liabilities are liabilities of of the entire governmental entity rather than
by a specific fund
Valuation of Fixed Assets (PRINCIPLE # 6)
• Fixed assets should be accounted for at 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.
Deprecation of Fixed Assets (PRINCIPLE # 7)
• Depreciation is not recognize 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.
• Proprietary fund fixed assets depreciation is recognized as an expense in proprietary fund.
Basis of Accounting (PRINCIPLE # 8)
• 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 and
measurable, except for non-matured interest on General Long-Term Debt which should be recognized
when it is due.
• Proprietary fund revenues & expenses should be recognized on the accrual basis.
• Fiduciary funds revenue and expenses or expenditures (as appropriate) accrual or modified
Eg. Nonexpendable trusts and Pension Trust Funds should be accounted for on the accrual basis;
• Expendable trust funds and Agency fund assets and liabilities should be accounted for modified
Transfers of financial resources among funds should be recognized in all funds affected in the
period in which the inter fund receivables & payable(s) arise
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 unit’s funds, for which an annual budget has been adapted. [Budget with Actual]
Financial Reporting (Principal # 10)
• Interim financial reports
A. Appropriate interim financial statements & reports of financial position, operating results &
other pertinent information should be prepared to facilitate management control
• Interim reporting is used:
 For good management
 For the legislature (legal compliance)
 For external reporting (perhaps for those who have loaned money to it)
• A comprehensive annual financial report covering all funds & account gropes of the governmental unit should be
prepared & published.
• 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.
Classification and Terminology (Principle # 11, 12)
Classification (principle # 11)
1. Classification of Transfers
a. Inter fund loans
• ◦ Loan between funds that expected to be repaid. It is receivable in the lending fund and Payable in the borrowing
fund
b. Inter fund services provided / used
◦ Sales and purchases between funds and Price should approximate Similar to outside purchase (i.e., utilities). It is
revenue in the selling fund; expenditure or expense in the purchasing fund.
c. Inter fund transfers
◦ Nonreciprocal flow of assets among funds without an exchange or expectation of repayment. Governmental fund
report as other financing sources (uses) and Proprietary fund report after no operating revenues and expenses.
d. Inter fund reimbursements
• One fund pages a bill on behalf of another or Expenditures/expenses initially recorded in wrong fund.
Reimbursements not displayed in financial statements
e. General long-term debt (GLTD) proceeds
◦ Not recorded as fund liabilities but it Recorded as “Bond Issue Proceeds” in the “other financing sources” (not
revenue) section of governmental fund operating statement. Record liability as a “general long-term liability”
(Not applicable to proprietary and fiduciary long-term debt)
f. Extraordinary items, special items, and transfer are reported as separate line items near the bottom of the
government-wide statement of activities
◦ Extraordinary items—both unusual in nature and infrequent in occurrence; usually beyond the control of
management
◦ Special items—either unusual or infrequent; must be within the control of management
g. Quasi-external transactions- transactions that would be treated as revenues, expenditures, or expenses if the
organization external to the government unit
2. Classification of Revenues and Expenditures
Governmental fund
• Revenues should be classified by fund and source (Taxes, Licenses and permits, Intergovernmental, service & mis.)
• Expenditures should be classified by fund, function (operating, capital outlay & debt service)
• Proprietary fund revenues & expenses should be classified in essentially the same manner as those of similar
business organizations functions or activities
Terminology (Principle #12)
• A common terminology and classification:
• should be used consistently throughout
 Budgets
 Accounts
 Financial reports (financial statements)
• A prerequisite to valid comparisons
Annual Financial Reports (Principle #13)
Comprehensive annual financial report (CAFR) including:
 Introductory section
 Management’s discussion and analysis (MD&A)
 Basic financial statements ( ) BFS)
 Other required supplementary information (RSI)
 Combining and individual fund statements
 Schedules
 Narrative explanations
 Statistical section
Basic financial statements (BFS) includes:
 Management’s discussion and analysis
 Basic financial statements
 Government-wide financial statements
 Fund financial statements –
 Individual fund statements and schedules
 Combining fund statements and schedules
 Notes to the financial statements
Characteristics of Governmental Fund
1. Governmental funds are created in accordance with legal requirements.
 Each fund has only those resources allowed by law
 The measurement focus is flow of financial resources
 Governmental funds are expendable
 Revenues & expenditures funds are recognized on the “modified accrual basis of account”.
2. Legal constraints on the raising of revenue & the expenditure
3. It account only for financial resource
4. It account for only those liabilities to be paid from fund assets.
5. The difference between fund assets & fund liability is called fund equity which could either be reserved
or not.
The portion of fund equity that is not reserved is called fund balance
Characteristics of proprietary fund
1. They provide services to users on a cost reimbursement basis
2. They are part of the government that is run like a private business. The fund is
expected at least to cover part of the expenses.
3. They are not subject to income taxation
4. Their account is similar with profit making business:
Proprietary funds are established in accordance with enabling legislation & their operations
and policies are subject to legislative oversight
prepare budget as an essential element in the management planning & control process not as
legal document.
Proprietary funds accounts all assets used in fund operations
They account all current & long-term liabilities
They are non- expendable funds.
Characteristics of Fiduciary Fund
1. They are used to account assets held by governmental unit as a trustee or agent.
2. They can be expendable or non- expendable depending on the purpose of the
fund:
expendable trust funds are to be accounted in the same way as governmental
funds.
Non-expendable & pension trust funds are to be accounted in the some way as
proprietary funds.
Budgeting and uses of budget
• Budgeting is the process of creating a plan to spend money. This spending plan
called budget. Budgeting is the process of allocating of resources 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?
• Budgeting is a continuous year round process going through five phases
1. Executive budget preparation
2. Legislative enactment
3. Budget administration
4. Reporting
5. Post-audit
Uses of budget
The budget as an information document:
◦ Provides information to decision makers
◦ The chief executive decides what information will go to the legislative body
◦ Documents decisions that have been made
◦ The final decisions represent adopted appropriations spending
Typical budget information provided:
◦ Program descriptions
◦ Program objectives
◦ Service efforts (inputs)/accomplishments (outputs)
◦ Benefits of service level increases/decreases
◦ Service delivery and cost-benefit analyse
A good budget process:
◦ Incorporates a long-term perspective
◦ Establishes links to organizational goals
◦ Focuses decisions on results and outcomes
◦ Promotes effective communication
◦ Provides management and employee incentives
Classification of budget
• Budget can be classified in different types
A.Capital or current (operating)
B. Tentative or enacted
C. General or special
• General budgets: Finance governmental activities, General fund, Special revenue funds
and Debt service funds
• Special budgets: Finance any other funds, Capital projects funds, Sometimes enterprise
& internal service funds and rarely fiduciary funds
A.Fixed or flexible
B. Executive or legislative
Approaches to budgeting
• Alternative approaches have a different emphasis on planning, control and evaluation
A.Object of expenditure (traditional) approach
◦ Focus on what is spent (control oriented)
◦ Most widely used, but often incorporated within other approaches
◦ Basic steps in the budget process
1. Agencies submit requests on type of expenditures
2. Chief executive compiles and modifies requests
3. Chief executive submits requests in same format
4. Legislature makes line-item appropriations
Advantages
 Simplicity, ease of preparation and understanding
 Fits organizational responsibility
 Facilitates accounting control and trend comparison
Disadvantages
 Provides no useful information for decision makers
 Overly control focused
 Ignores long-term impacts
 Neglects planning
 Encourages spending rather than economizing
B. Performance budgeting approach
◦ Based on measurable performance of activities
◦ Classifies expenditures by function/activity
◦ Measures activities to obtain maximum efficiency
◦ Bases budget on unit cost standards
Advantages
 Narrative description of activities
 Organized by activities
 Measures output as well as input
Limitations
 Requires added budgetary staff
 Many activities are not readily measurable
 True expense / cost data not always available
C. Planning-program-budgeting (PPB)
◦ Deals with broad planning and costs of activities
◦ crosses organizational lines
◦ relates all activities to governmental objectives
◦ identifies future implications
◦ considers all costs
◦ Analyses alternatives/cost-benefits
Advantages
 States goals and objectives
 States alternative costs and benefits to achieve goals
Limitations
 Goals and objectives difficult to formulate
 Elected officials prefer not to commit to specifics
 Limited data and staff available to evaluate
 Costs difficult to measure over time
D. Zero-base budgeting (ZBB) approach
◦ Every service justified every year
◦ Government divided into decision units and subsequently into “decision packages”
◦ Best options selected to provide services
◦ Service level options then costed
◦ Decision packages are then ranked
 mmm
Thank you for attention pay