Chapter

9
Accounting for the
Business-Type Activities
 Proprietary Funds

 Reasons for use

 To compare benefits and costs
of the business-type activities of a
government
 Enhances management of activities in which goods or
services are provided on a cost-reimbursement basis to
departments of the same government or to the general
public on a user charge basis
 Proprietary Funds
Accounting equation

Assets - Liabilities = Net Assets

Unrestricted Restricted Invested in Capital

(e.g., for payment of Assets, Net of
debt service) Related Debt
 Proprietary Funds
Accounting Characteristics
 Full Accrual basis
 Capital assets and long-term liabilities accounted for
within the funds
 Flexible rather than fixed budgets recommended;
generally budgetary accounts need not be integrated into
the general ledger
 Depreciation expense and accumulated depreciation are
recorded and reported
 For accounting guidance look to accounting procedures
used by private enterprises of the similar type
 Proprietary Funds
Required Financial Statements
 Similar to those for a for-
profit entity:
 Statement of Net Assets (or
Balance Sheet)
 Statement of Revenues,
Expenses, and Changes in
Net Assets
 Statement of Cash Flows
 Internal Service Funds

 Used when
 authorized by legislative approval
 to account for activities in which goods and services
are provided
 to departments of the same government
 on a cost reimbursement basis
 Internal Service Funds (Cont’d)

 Reasons for use

 Improve management of common resources by
placing them under centralized management and
control
Common Types of Internal Service Funds

 Motor pools
 Central purchasing
 Storage
 Issuance of supplies
 Self-insurance pools
 Central data processing
 Printing
Pricing Policies for Internal Service Funds

 Pricing is set by local management or by

legislative policy

 Pricing objectives vary; can cover full costs (direct

and indirect), direct costs only, or whatever
management desires

 Legislative bodies are sometimes reluctant to

establish ISFs because they are do not wish to let
purchasing occur outside the budget.
 Internal Service Funds
Accounting Procedures

 Generally should use the same accounting

procedures that a similar business entity would use.
 Apply all FASB’s issued prior to November 30,1989
 May elect to adopt FASB’s after that date
 “Billings to Departments” is the revenue account that
is similar to Sales of a for-profit entity
 Revenues and expenses are closed at year-end to
“Excess of Net Billings to Departments over Costs”
(or “Excess of Costs over Net Billings to
Departments”) rather than to Income Summary
 Internal Service Funds
Financial Statements
 Other than the slight difference in terminology, the
financial statements are essentially the same as those of
a comparable for-profit entity.
 Statement of Net Assets
 Statement of Revenues, Expenses, and Changes in Net
Assets
 Statement of Cash Flows with four sections that comply
with GASB standards
 ISF—Statement of Cash Flows

 Similarities between GASB and FASB standards:

 Cash Flows Statement shows cash inflows/outflows

relating to operating, financing, and investing activities

 Both sets of standards define cash flows as cash and cash

equivalents (i.e., time deposits, marketable securities, and
other items readily convertible to cash)
 ISF—Statement of Cash Flows (Cont’d)

Differences between GASB and FASB standards:

 GASB cash flow statement divides financing activities into
noncapital and capital and related financing activities
 Acquisition of capital assets is a capital and related financing
transaction in the GASB Cash Flows Statement rather than an
investing activity.
 Interest expense on long-term debt is a capital and related
financing activity in the GASB cash flow statement rather than
an operating activity
 Cash flows from operating activities must be shown using the
direct method.
 Internal Service Funds (Cont’d)

GASB standards require that an ISF be used for risk

management (self-insurance) pools of a government:
 The ISF should recognize claims expense and a related
liability when:
 it is probable that an asset has been impaired or a liability

has been incurred and the amount is reasonably

estimable, or
 if an estimable loss has been incurred and it is probable

that a claim will be asserted

 Disclose other loss contingencies in the notes.
Terminating an Internal Service Fund

 Transfer ISF's assets to another fund which will

continue same activity

 Terminate activity and distribute assets in-kind to

another fund or funds

 Convert ISF's assets to cash and distribute cash to

another fund or funds
 Enterprise Funds

 Reasons for use:

 account for services provided to the general
public on a user charge basis, or

 where the governing body has determined that

periodic determination of revenues earned,
expenses incurred, and/or net income is
appropriate for capital maintenance, public
policy, management control, accountability, or
other purposes
Common Types of Enterprise Funds

 Water and sewer

 Gas and electric utilities

 Transportation systems

 Airports

 Ports

 Toll roads and bridges

 Parking garages and lots

 Golf courses

 Hospitals

 Liquor stores
Enterprise Funds—Restricted Assets

 Assets whose use is restricted by contractual agreements

or legal requirements
 Typical examples:
 Customer deposits of utilities, assets set aside for repayment
of revenue bond principal, reserves for maintenance of plant,
and funding of depreciation
 Ideally liabilities to be paid from restricted assets should
be reported separately from liabilities to be paid from
unrestricted assets, but not required by GAAP.
 Net Assets - Restricted should be reported in the Equity
section of the Statement of Net Assets.
 EF—Special Current Liabilities

In addition to the usual Accounts Payable and Accrued

Expenses, use two special current liability accounts:
 Customers Advances for Construction
 Usually up-front deposits required to be made by builders
to provide all or part of the cost of connecting new
structures to utility lines. May or may not be refunded in
part upon completion
 Customer Deposits
 Usually reported under the caption “Liabilities Payable
from Restricted Assets”
 Even if not refundable until service is terminated, AICPA
guidance defines this as a current liability
 EF—Long-term Liabilities

 Bonds or other debt that will be repaid from

proprietary fund resources is reported as long-term
debt of the fund.
 Bonds whose interest and principal are to be repaid
from the revenues of a proprietary fund are called
“revenue bonds”
 If bonds primarily or secondarily have general
obligation backing, but are being serviced by a
proprietary fund, they are treated as revenue bonds.
The general obligation contingency is disclosed in
the notes to the financial statements.
EF—Regulatory Accounting Principles (RAP)

 In a few states, municipally-owned utilities are

subject to rate regulation by a state regulatory
agency, which also regulates investor-owned
utilities that operate in the state.
 Those states may require government owned
utilities to follow the regulatory accounting
principles specified by organizations such
NARUC and FERC.
 Enterprise Funds RAP (Cont’d)

 Financial statement differences

 Plant assets and long-term liabilities are often reported above
current assets and current liabilities, respectively

 Plant assets may be reported at depreciated original cost.

Subsequent transfers of ownership require new owners to report
assets at depreciated original cost; any excess of purchase price
above the net book value of the assets on the old owner's books
is reported as "Utility Plant Acquisition Adjustment" in the new
owner’s accounts. Regulators may require this account to be
amortized at a different rate than used for depreciation.
 Enterprise Funds RAP (Cont’d)

Q: Why are plant assets and long-term debt reported above

current assets and current liabilities under RAP?

A: This is because in regulated utilities, the magnitude of

plant assets and long-term debt is great in relation to
current assets and liabilities. Current assets and liabilities
tend to be comparatively immaterial
 Enterprise Funds RAP (Cont’d)

Key RAP definitions:

 Original cost: The (depreciated) cost to the first owner to

place the utility plant into public use

 Utility Plant Acquisition Adjustment: The difference

between the purchase price of a utility plant less the net
original cost of the plant on the seller’s books.
 Municipal Solid Waste Landfills

 An EPA rule requires all municipal

landfills to meet stringent location, design, and
operating requirements to minimize the potential for
environmental damage.
 Operators must also provide financial assurance they
can properly close landfills when full and provide
post-closure ground water monitoring for 30 years
after closure.
 These stringent rules are designed to protect the
environment from irresponsible handling of
hazardous materials
Municipal Solid Waste Landfills (Cont’d)

 Estimate the current cost of hiring a qualified third-

party to close the MSWLF and care for it for 30
years after closure
 Recognize a portion of this cost proportionate to the
ratio of estimated capacity utilized during a year
over the total capacity of the landfill as an expense
of the enterprise fund and as a liability
 Annual adjustments are made as estimates change
from year to year. There are several required note
disclosures as we will discuss in a later chapter.