Chapter TwoFUND ACCOUNTING

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Thought to Ponder: Chapter 2

“A democratic society depends upon an informed and educated citizenry."

-Thomas Jefferson

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Learning ObjectivesAfter studying Chapter 2, you should understand:

• The nature of funds• The elements of financial statements• The hierarchy classification of fund balances • The three basic fund types of a state or local

government:o Governmental fundso Proprietary fundso Fiduciary funds

• The main components of a CAFR• The primary F/S issued by governments• The difference between the fund structures and

financial reports of not-for-profits and governmental entities

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Business• One company• “Fund” used as an informal term (multiple

meanings)oMay refer to working capital (current net

assets)oMay refer to cash or investments availableoMay have other definitions

• The company is a single fiscal and accounting entity

oA = L + E (“E” usually called “Owners’ Equity”)

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GovernmentalMultiple “entities”

• “Fund” used as a formal term (single meaning)o “A fiscal and an accounting entity with a self-

balancing set of accounts.”• Each fund is like its own “entity”o In other words, a fund is an entity with its own

set of books (i.e., chart of accounts , general journal, general ledger, trial balances, and financial statements)

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Elements of Government Financial Statements• GASB Concepts Statement No. 4: Elements of

Financial Statements (2007)• Seven Key elements -Five relating to financial position

and two relating to resource flowso Assets are resources with present service capacity o Liabilities are present obligations to sacrifice resources o A deferred outflow of resources is the consumption of net

assets applicable to a future reporting period o A deferred inflow of resources is the acquisition of net

assets applicable to a future reporting period o Net position is the residual of all elements presented in a

statement of financial position; that is the assets + deferred outflows - the liabilities - deferred inflows.

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Elements of Government Financial Statements (Cont’d)

o An outflow of resources is a consumption of net assets that is applicable to the reporting period.

o An inflow of resources is an acquisition of net assets that is applicable to the reporting period.

• GAAP: GASB Statement No. 63, Financial Reporting of Deferred Outflows of Resources, Deferred Inflows of Resources, and Net Position (2011) requires that governments, unlike businesses, must now report the deferred items in a separate category. Thus, a statement of position might be,

Assets + Deferred outflow of resources - Liabilities – Deferred inflow of resources= Net Position • GAAP: GASB Statement No. 65, Items Previously Reported as

Assets and Liabilities (March 2012) specifies the items that may be classified as deferred outflows and inflows of resources.

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FUNDSBased on GASB Statement No. 63, fund accounting uses the equation• Assets + deferred outflows = liabilities + deferred inflows + fund

balance • In a slightly different form Assets + deferred outflows – liabilities – deferred inflows = fund balance.An important distinction:In financial statements that are prepared on a full accrual basis, the residual amount is referred to as “net position;” in statements that are prepared on a modified accrual basis it is referred to as “fund balance.”

Note:Both fund balance and net position, like owners’ equity, are residuals—the difference between assets (and deferred outflows) and the claims against those assets (liabilities and deferred inflows)

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GASB Statement No. 54In February 2009, the GASB issued Statement No. 54, Fund Balance Reporting and Governmental Fund Type Definitions, to improve the usefulness, and understandability of governmental fund balance information.

• According to GASB Statement No. 54, the fund balance (the residual in modified accrual-based governmental funds) is reported in a hierarchy of classifications.

• Thus it affects only the fund balance reported on the balance sheet of governmental type funds.

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Brief Summary (GASB Stmt. No 54)• Fund balances of governmental type funds are now to be

reported based on a hierarchy in five different classifications:o Nonspendableo Restrictedo Committedo Assignedo Unassigned

• The reporting of Reserve for Encumbrances is eliminated• According to GASB Statement No. 54, only the Fund balance

reported on the balance sheet of Governmental type funds is affected.

• It does not affect the reporting of net assets by proprietary or fiduciary funds.

• It also does not affect the reporting of net assets of governmental activities in the government-wide financial statements.

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GASB Stmt. No 54 (Cont’d)• Effect on Financial Statements• The next PPT slide shows the marked up area on the

Balance Sheet of Governmental Funds which is impacted by this stmt.

• The Fund Balance accts in the block are now presented based on the new 5 part classification as presented in the following two PPT slides ( Exhibit 1 & 2 presents the reporting of Fund Balance as illustrated by GASB under Stmt. 54).

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GASB Stmt. No 54 -- Exhibit 1

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GASB Stmt. No 54 -- Exhibit 2

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GASB Stmt. No 54 (Cont’d)Fund Balance should be identified between nonspendable resources and spendable resources • Nonspendable resources include amounts that are

not in spendable form or are required to be maintained intact.o Inventories and prepaids (also includes assets held for sale

and long-term receivables)o The principal (corpus) of a Permanent Fund

• Spendable resources is the remaining balance and is to be reported in a hierarchy of classification (4 categories) based on the extent to which the government is bound by restrictions/constraints on those funds

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Level of Constraints (GASB 54)

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Most constraint

• Restricted

• Committed

• Assigned

No constraint

• Unassigned

Spendable Resources - Restricted• Restricted (most constraint) includes amounts constrained to specific

purposes by their providers, through constitutional provisions, or by enabling legislation. Externally imposed constraints by

o creditors, bondholders, o grant providers, contributors, or o imposed by law through constitution or enabling legislation .

• Enabling legislation (imposed by law) authorizes the government to assess, levy, charge, or mandate payments of resources and includes a legally enforceable requirement that the resources be used only for the specific purpose.

• Thus the level of constraint on restricted fund balance is equivalent to the level of constraint on Net Position-Restricted in proprietary funds and the government-wide statement of net position.

• Ex. In, Table 2-5, the balances for State statute, Special obligation, Public safety, etc are presented as FB Restricted

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Spendable Resources – Committed• Committed fund balance—here the constraints are imposed by

a formal action of the government’s highest level of decision-making authority (for ex. City council committing funds for construction contracts, rainy day fund etc).

• These funds cannot be used for any other purpose unless the government removes or changes the specified use by taking the same formal action that originally imposed the constraint.

• Committed funds include contractual obligations for which existing resources in the fund have been specifically committed for use.

• The funds may also include “rainy day” or “stabilization funds.” • Note: In contrast to fund balance that is restricted by enabling

legislation, amounts in the committed fund balance can be redeployed for other purposes with appropriate due process.

• Ex. In, Table 2-5, assuming FB Reserved for encumbrances is a contractual commitment, it is presented as FB Committed.

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Spendable Resources - AssignedAssigned fund balance –Government’s intent to use the funds for a specific purpose. Here INTENT is the key.• Intent can be expressed by the governing body itself or another

body that has the delegated authority.• In the General Fund, assignment conveys that the intended use is

narrower than the general purposes of the government itself.• Fund Balance in other governmental funds (except General Fund)

that is not restricted or committed is considered as Assigned FB in those funds. In other words it is the residual balance of these funds.

• Note: the authority for making an assignment does not have to be made by the government’s highest level of decision-making authority.

• Thus, constraints imposed on assigned amounts can be more easily removed or modified than those that are classified as committed.

• Ex. In, Table 2-5, the Debt Service fund (the only major fund) has FB Assigned

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Spendable Resources - Unassigned• Unassigned fund balance –this is the residual

classification of the General Fund • Includes amounts that are available for any purpose• Only the GF can report this positive Unassigned FB • For other governmental funds, this category is used to

report only a negative fund balance (i.e. when expenditures have exceeded the revenues).

• Ex. In, Table 2-5, as explained above, the General Fund has an Unassigned fund balance.

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A crosswalk

Governmental-type funds Non

spen

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Rest

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Assig

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Neg

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Special Revenue Funds ? x x ? ? NODebt service funds ? x x x ? NOCapital project funds ? x x x ? NOPermanent funds x ? ? ? ? NOGeneral fund x ? ? ? ? x

Level of Constraints (GASB 54)

X = likely? = possiblyNO = prohibited

* Nonspendable amounts associated with long-term receivables that are restricted, committed or assigned are included in that category instead of the nonspendable category. For permanent funds, the corpus of gifts which must be maintained in perpetuity are designated nonspendable in governmental-type funds but as restricted-nonexpendable in the government-wide financial statements.

Not-for-profit• NFP may use fund accounting internally to ensure

control of funds, but they do not report these funds externally.

• Classifies Net Assets into 3 groups:o Unrestrictedo Temporarily restricted – used for specific purposeo Permanently restricted -explained further on later slides

• FASB regulates NFP reporting for nongovernmental organizations and only requires 6 totals: o Total assetso Total liabilities o Total net assetso Total unrestricted net assetso Total temporarily restricted net assetso Total permanently restricted net assets.

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TYPES OF FUNDS AND THEIR FOCUS

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Basis of Accounting• Full Accrual: oRevenues recognized when earned; expenses

recognized when incurred• Cash: oRevenues recognized when available;

expenses/expenditures recognized when paid• Modified Accrual: oRevenues are recognized when measurable and

available; expenditures when incurred

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Measurement Focus• What is measured?• Where is the focus of an entity?• Economic resources measurement focus oReport on the determination of net income, financial

position, and cash flows (i.e. capital maintenance)o To measure operational accountability

• Current financial resources measurement focusoReport on the inflows and outflows of current

financial resources (i.e. cash or other items expected to be converted into cash during the current period)

o To measure fiscal accountability; meet the legal and budget needs of government

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Measurement Focus and Basis of Accounting

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Government-wide statements (GASB 34)

Governmental fund statements

Proprietary fund statements

Fiduciary fund statements

Measurement Focus

Economic resources

Current financial resources

Economic resources

Economic resources

Basis of Accounting

Accrual

Modified accrual

Accrual

Accrual

Types of Local GovernmentsCounties 3,031Municipalities 19,522Townships 16,364School districts 12,884Special districts 37,203Total 89,004

Source:U.S. Census Bureau, 2012 Census of Governments, preliminary results, August 2012.http://www.census.gov/govs/cog2012.

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Activities of Government• Governmental Activitieso Core governmental services like police and fire protection,

streets, highways, etc. – Chapters 3-6. These activities are accounted under governmental funds.

• Proprietary Activitieso Public utilities, toll roads (Sam Houston Tollway) and toll

bridges, airports (ex. Houston’s new Toyota Center, Hobby, IAH) – Chapter 9. These activities are accounted under proprietary funds.

• Fiduciary Activitieso Sometimes known as Trust & Agency Funds. Accounts for

resources for which the government is acting in a trustee capacity (ex. Houston Foundation, MacGregor Parks Endowment) – Chapter 10. These activities are accounted under fiduciary funds.

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Types of Funds“Funds divide a government into units to control resources or attain objectives, not functional departments or operations.” • Governmental Funds (5)

o General Fundo Special Revenue Fundso Capital Projects Fundso Debt Service Fundso Permanent Funds

• Proprietary Funds (2)o Internal Service Fundso Enterprise Funds

• Fiduciary Funds (2)o Agency Fundso Trust Funds

Pension (and other employee benefit) Investment Trust Funds Private purpose Trust Funds

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Definition of Fund Types• Governmental Fundso A generic classification used by GASB to refer to all funds

other than proprietary or fiduciaryo No guarantee that the funds will be reimbursed for services

rendered• Proprietary Fundso Government generally makes initial contribution but

thereafter the fund is expected to “pay its own way” through fees for services rendered. Also referred to as business-like or commercial-type funds.

• Fiduciary Fundso Any fund held by a government in a fiduciary capacity. o Simply, the gov’t. holds someone else’s money in trust and

acts as a custodian. Since it is not the government’s money, it is not expendable for the government’s own programs.

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GOVERNMENTAL FUNDS

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Overview• Basis of Accounting:o Modified Accrual

• Measurement Focus:o Current Financial Resources

Other names: “financial flow” focus or spending focusOnly current assets and liabilities are generally included on their

balance sheet (i.e. Capital assets and long-term liabilities are not included)

Reports expenditures (not expenses) of appropriations

• Fund Balance (net current assets) measures “available spendable resources”o Fund Balance = Current Assets – Current Liabilitieso Increased by revenues and other financing sourceso Decreased by expenditures and other financing useso Governmental fund operating statements present these

increases and decreases in net current assets.

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Required financial statements • Balance Sheet • Statement of Revenues, Expenditures, and Changes in

Fund Balances • Reconciliation of the Statement of Revenues,

Expenditures, and Changes in Fund Balances of Governmental Funds to the Statement of Activities at the government-wide level.

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(1) - General Fund (GF)• The operating fund of the government-embraces

most major governmental functions• Accounts for all resources that are not required to

be accounted for in other funds; in essence, it accounts for all unassigned resources.

• Only one per government and is the most significant single fund

• General Activities of city government (ex. Fire, police)

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(2) - Special Revenue Funds (SRF) • Accounts for financial resources that are restricted or

committed (does not include assigned) to expenditure for specific purposes other than debt service or capital projects.

• Accounting and budgeting usually identical to GF• Ex. City of Houston maintains over 17 SRFo Examples include

Public Safety Special Fund (9-1-1 Emergency Network)Public Works Special FundHealth and Housing Special FundParks and Recreation Special FundOther Special Revenue Fund (Cable Television)

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(3) - Capital Projects Funds (CPF)• Accounts for financial resources that are restricted,

committed, or assigned to expenditure for capital outlays.

• Ex. Astrodome, Toyota Center, GRB

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(4) - Debt Service Funds (DSF) • Accounts for financial resources that are restricted,

committed, or assigned for the payment of interest and principal on long-term debt.

• Ex. City of Houston as of 6/30/2012oTotal fund balance in DSF

$148,174,000.oTotal long-term liabilities

$15.16 Billion (for FY 2011- $14.8 B)

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(5) - Permanent Funds

Accounts for resources provided that are legally restricted so that only earnings, not principal, may be used to support the government’s programs.

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PROPRIETARY FUNDS

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(1) - Internal Service Funds (ISF)• Accounts for activities in which goods are services are

provided to (1) other departments of the same government (2) other governments for a charge on a cost reimbursement basis

• Examples include central stores, central computing, motor pools, and printing.

• ISF are reported as governmental activities in the government-wide statements because they primarily benefit the government. o ex. City of Houston’s employees Health Benefits and o Long -Term disability.

These funds are covered in depth in Chapter 9.

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(2) - Enterprise Funds (EF)• Accounts for activities in which goods or services

are provided to the general public for a charge• Reported as business-type activities in the

government-wide financial statements• Examples include electric and water utilities,

airports, parking garages, transportation systems, and liquor stores

• Ex. City of Houston’s EFo Airport System o Convention & Entertainment facilities o Combined Utility systemo Non-major Enterprise funds (Houston Area Water

Corporation, Parking Management)

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Overview• Basis of Accounting:o Full Accrualo Operated like a “normal for-profit” business

Ex. City of Houston operates its Airports under a Proprietary fund• Measurement Focus:o Economic Resources

All assets and liabilities (both current and noncurrent) are included in the balance sheet

Accounts for expenses (not expenditures)--Depreciation expense is reported

• Fund Equity (Net Position)o Net Position = Assets – Liabilitieso Increased by revenues and other financing sourceso Decreased by expenses and other financing useso Segregated into contributed capital and retained earnings

components

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Required Financial Statements Similar to those of for-profit entities

• Statement of Net Position • Statement of Revenues, Expenses, and Changes

in Net Position (i.e. operating statement) • Statement of Cash Flows

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FIDUCIARY FUNDS

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(1) - Agency Funds• Accounts for financial resources in which the

government is acting in an “agency” capacity o Agent - Government holds assets on behalf of another

government

• Accounting is simple: assets = liabilities.o No revenue and expense to accrueo No fund equity account

• Examples are tax agency funds, certain special assessment funds, and pass-through agency funds

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Overview• Both Trust funds and Agency funds account for

assets held by the City in a trustee capacity or as an agent for individuals, private organizations, other governments, and/or other funds. o Therefore, the government cannot include these funds in

the government-wide statements.• Basis of Accounting:o Full Accrual

• Measurement Focus:o Economic Resources

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Required Financial Statements

• Statement of Fiduciary Net Position• Statement of Changes in Fiduciary Net Positiono Only Trust Funds may have a change in net position

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(2) - Trust Funds• Each trust is classified for accounting measurement

purposes as either a governmental fund or a proprietary fund (ex. Houston Firefighters Relief and Retirement and Police Officers’ Funds).

• Funds can be either expendable or nonexpendable.• Three types of trust funds

(i) Pension (and other employee benefits) Trust Funds (one or more)

(ii) Investment Trust Funds(iii) Private Purpose Trust Funds G

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Pension (and other employee benefits) Trust Fund• Accounts for financial resources in which the

government (or other designated trustee) is acting in a trustee capacity for the employees of the government to provide retirement benefits.

• Uses business-type accounting practices.

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Investment Trust Funds

• Accounts for external investment pools in which the assets are held for other (external) governments, along with funds of the sponsoring government

• Reports the assets, liabilities, net assets, and changes in net assets corresponding to the equity of the external participants

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Private-purpose Trust Funds• Encompasses all trust funds other than pension and

investment trust funds• Accounts for financial resources in which the

government is acting in a trustee capacity for the benefit of individuals, other organizations, or other governments (e.g., an endowment in which the principal amount must be kept intact)

• Accounting is virtually identical to that for an enterprise fund. G

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GASB Statement No. 34

Basic Financial Statements - and Management’s Discussion and Analysis – for State and Local Governments

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Government – wide Statements1) Statement of Net Position2) Statement of Activities

• Addresses questions that have not been easily answered by fund accounting

• “What do government services really cost, e.g., public safety or recreation?”

• “How much debt for current services are we shifting to the next generation?”

• “ How much of the cost of government is borne by citizens in the form of general revenues?”

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Reporting Model-Statement 34Fund Presentation• Major funds

o Major funds are those in which total assets plus deferred outflows of resources, liabilities plus deferred inflows of resources, revenues, or expenditures/expenses are at least

o 10 percent of the relevant fund category (governmental or enterprise) and

o 5 percent of the corresponding total for all governmental and enterprise funds combined

• Non-major funds are combined into the column ‘‘other governmental funds” and presented in a single column by categoryo Concept does not apply to fiduciary funds and internal service

funds

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Comprehensive Annual Financial Report - CAFR• The CAFR is the recommended annual report of a

governmental unit. It has 3 sections.o Introduction sectiono Financial sectiono Statistical section

• The minimum requirements for general purpose external reporting include:

• MD&A• Basic financial statements• RSI other than MD&A

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Comprehensive Annual Financial Report - CAFR• Every government should prepare interim

statements as needed for sound management• The Government Finance Officers Association

(GFOA) awarded a Certificate of Achievement for Excellence in Financial Reporting to the City of Houston for CAFR for the fiscal year ended June 30, 2012.

• Note: Please also refer to Chapter 1 slides on CAFR.

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CAFRReviewing again, a CAFR has• Introduction section:

o Letter of transmittal – presents overview of financial and economical conditions. General information about how the government is organized.

• Financial Section:o MD&A – brief overview of financial performance of the government.o Basic financial statements and Noteso Required Supplementary Informationo Combining and individual fund financial statements.

• Statistical section:o Contains current and historical data. Supplemental information to

the basic financial statements

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Component Units (CU)• Entities that are economically intertwined with the government albeit

legally separate.• Criteria to determine whether a primary government (PG) is financially

accountable for another government. (1) PG appoints a voting majority of unit’s governing body

(2) A majority of unit’s governing body is composed of PG’s officials

(3) The PG is able to “impose its will” upon the unit

(4) Unit can cause the PG financial benefits or burdens

• If it meets these criterion, then unit is a CU of PG.• Two Presentations of CU

(1) Blended – CU consolidated with PG in government-wide statements

Presented this way if CU “provides services exclusively or almost exclusively for the city” (see the City of Houston CAFR)

(2) Discrete – CU shown in a separate column in government-wide statements

This topic is discussed in depth as part of Ch. 11.

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NOT-FOR-PROFITS REVISITED

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Financial ReportingNFPs classify and report both current and non current assets & liabilities based on three different donor mandated restriction categories (i.e. 12 different categories (2x2x3 = 12)).

(1) unrestricted (2) temporarily restricted(3) permanently restricted

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Classification of Assets and Liabilities(12 categories)

• “Current unrestricted” -- Analogous to general fund• “Current temporarily restricted” -- Analogous to special revenue funds• “Current permanently restricted” -- Doesn’t exist because it would mean you

have available resources you can never use• “Noncurrent unrestricted”

o Property, Plant, and Equipment used for operationso Accounts Receivables which, once collected, may be usedo Long-term Liabilities

• “Noncurrent temporarily restricted”o Assets analogous to capital projects fundo Accounts Receivable which, once collected, are restricted for a specific use

or time periodo Liabilities analogous to debt service fund and fiduciary funds

• “Noncurrent permanently restricted”o Assets analogous to permanent fundo All Liabilities are either unrestricted or temporarily restricted never

permanently restricted

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Summary• Fund accounting is an effective means of establishing control and

accountability over restricted resources. • Governments normally maintain five types of governmental funds to

account for their operating and financing activities. • Governments maintain two types of proprietary funds to account for their

business-type activities and two types of fiduciary funds to account for resources that they hold for the benefit of parties other than themselves.

• Fund financial stmts. for governmental funds utilize the modified accrual basis of accounting and a current financial resources measurement focus.

• Fund Balance in the fund financial stmts. has to be presented based on a hierarchy of fund balance classification based on GASB Std. # 54

• GASB Std. # 34 requires both government-wide financial statements and fund financial statements.

• GASB in Concepts Stmt. # 4 provides definitions and explanations of seven key elements

• Government-wide financial statements and fund financial statements for proprietary and fiduciary funds follow the full accrual basis of accounting and the economic resources measurement focus (similar to commercial accounting).

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