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This book is printed on acid-free paper. 1 2 3 4 5 6 7 8 9 0 DOC/DOC 1 0 9 8 7 6 5 4 3 2 1 0 ISBN 978-0-07-352705-5 MHID 0-07-352705-X Vice President and Editor-in-Chief: Martin Lange VP SEM, EDP, Central Publishing Services: Kimberly Meriwether David Editorial Director: Stewart Mattson Publisher: Tim Vertovec Sponsoring Editor: Donna Dillon Marketing Manager: Dean Karampelas Development Editor: Emily Hatteberg Project Manager: Melissa M. Leick Design Coordinator: Brenda Rolwes Cover Designer: Studio Montage, St.
Louis, Missouri USE Cover Image Credit: Eyewire (Photodisc)/PunchStock Senior Production Supervisor: Laura Fuller Media Project Manager: Suresh Babu / Balaji Sundararaman, Hurix Systems Pvt. Ltd. Compositor: MPS Limited, A Macmillan Company Typeface: 10. 5/12pt Times Roman Printer: R. R. Donnelley Apago PDF Enhancer All credits appearing on page or at the end of the book are considered to be an extension of the copyright page. Library of Congress Cataloging-in-Publication Data Copley, Paul A. Essentials of accounting for governmental and not-for-profit organizations / Paul A. Copley. — 10th ed. p. cm. Includes index.
ISBN 978-0-07-352705-5 1. Administrative agencies—United States—Accounting. 2. Nonprofit organizations—United States— Accounting. I. Title. HJ9801. H39 2011 657′. 83500973—dc22 2009054187 www. mhhe. com Preface Thank you for considering the tenth edition of Essentials of Accounting for Governmental and Not-for-Profit Organizations. The tenth edition is updated for recent changes including: • GASB Statement 54: Fund Balance Reporting and Governmental Fund Type Definitions. • FASB Statement 164, Not-for Profit Entities: Mergers and Acquisitions. • IRS Form 990 Return of Organization Exempt From Income Tax.
In addition, the text includes a new chapter on Federal Government reporting. I have used the text with stand-alone, three semester-hour classes, with half-semester GNP courses, and as a module in advanced accounting classes. It is appropriate for accounting majors or as part of a public administration program. The coverage is effective in preparing candidates for the CPA examination. The focus of the text is on the preparation of external financial statements. Among the more challenging aspects of state and local government reporting is the preparation of government-wide financial statements.
Our approach is similar to that used in practice. Specifically, day-to-day events are recorded at the fund level using the basis of accounting for fund financial statements. Governmental activities are recorded using the modified accrual basis. The fund-basis statements are then used as input in the preparation of government-wide statements. The preparation of government-wide statements is presented in an Excel worksheet. This approach has two advantages: (1) it is the approach most commonly applied in practice, and (2) it is an approach familiar to students who have studied the process of consolidation in their advanced accounting classes.
State and local government reporting is illustrated using an ongoing example integrated throughout Chapters 2 through 8 and 13. Additional features of the text are available on the instructor or student Web sites and include: Apago PDF Enhancer • A continuous homework problem throughout Chapters 2 through 8 and 13. • Instructor’s guide. • Suggested quiz and examination questions and problems. • PowerPoint slides. • Excel-based assignments. • An additional practice set. I thank Sandra Bitenc, University of Texas—Arlington; Angele Brill, Castleton State College; Richard C.
Brooks, West Virginia University; Bradley Childs, Belmont University; Dori Danko, Grand Valley State University; Gertrude Eguae-Obazee, Albright College; Gladys Gomez, University of Mary Washington; Marina Grau, Houston Community iii iv Preface College; David J. Harr, George Mason University; Maggie Houston, Wright State University; Tom Hrubec, Franklin University; Mary Jepperson, Saint John’s University; Beth Kern, Indiana University South Bend; John Lasik, Central Washington University; Rodney A. Oglesby, Drury University; Jim Shelton, Harding University; Chuck Smith, Iowa Western Community College; D.
Terry Balkaran, Queens College; and Bradley Trimble, Columbus State Community College for reviewing the ninth edition and providing suggestions. I wish to thank my colleague Loretta Manktelow; co-author of the Instructor’s Guide and author of the Test Bank as well as Maggie Houston of Wright State University for her work on the online quizzes. Finally, I am indebted to the many users of the text for their comments. Additional comments and suggestions are welcome and can be addressed to me at [email protected] edu. Paul A. Copley Apago PDF Enhancer
In memory of those lost: — Northern Illinois University, February 14, 2008 — Virginia Tech, April 16, 2007 Contents Preface iii Chapter One INTRODUCTION TO ACCOUNTING AND FINANCIAL REPORTING FOR GOVERNMENTAL AND NOT-FOR-PROFIT ORGANIZATIONS 1 Generally Accepted Accounting Principles 3 Objectives of Accounting and Financial Reporting 6 Objectives of Accounting and Financial Reporting for the Federal Government 8 Objectives of Financial Reporting by Not-for-Profit Entities 8 Objectives of Accounting and Financial Reporting for State and Local Governmental Units 9
Chapter Two OVERVIEW OF FINANCIAL REPORTING FOR STATE AND LOCAL GOVERNMENTS 20 The Governmental Reporting Entity 21 Reporting by Major Funds 23 Overview of the Comprehensive Annual Financial Report (CAFR) 23 Introductory Section 24 Financial Section: Auditor’s Report 25 Management’s Discussion and Analysis (MD&A) 26 Statement of Net Assets 28 Government-wide Statement of Activities 30 Governmental Funds: Balance Sheet 32 Governmental Funds: Statement of Revenues, Expenditures, and Changes in Fund Balance 34 Proprietary Funds: Statement of Net Assets 36 Proprietary Funds: Statement of Revenues, Expenses, and Changes in Fund Net Assets 38 Proprietary Funds: Statement of Cash Flows 40 Fiduciary: Statement of Fiduciary Net Assets 42 Fiduciary: Statement of Changes in Fiduciary Net Assets 42 Notes to the Financial Statements 44 Required Supplementary Information Other than MD&A 46 Combining Statements 48 Statistical Information 48
Apago PDF Enhancer State and Local Government Financial Reporting 10 Comprehensive Annual Financial Report 10 Measurement Focus and Basis of Accounting 12 Fund Structure for State and Local Government Accounting and Reporting 13 Number of Funds Required 16 Budgetary Accounting 16 Additional Resources 17 Special-Purpose Governments 49 v vi Contents Public Colleges and Universities 49 Other Governmental Not-for-Profit Organizations 50 Illustrative Case—General Fund Interfund Transfers 91 Interfund Reimbursements 91 Chapter Three MODIFIED ACCRUAL ACCOUNTING: INCLUDING THE ROLE OF FUND BALANCES AND BUDGETARY AUTHORITY 55 Modified Accrual Accounts
Balance Sheet Accounts 56 Financial Statement Activity Accounts 61 Budgetary Accounts 63 56 Expenditure Cycle 63 Revenue Recognition for Nonexchange Transactions 65 Summary 68 Appendix: Budgetary Accounting Illustrated 69 Budgets and Budgetary Accounts 69 Recording the Budget 70 Accounting for Revenues 71 Accounting for Encumbrances and Expenditures 73 Budget Revisions 76 Budgetary Comparison Schedule 76 Classification of Estimated Revenues and Revenues 77 Classification of Appropriations and Expenditures 78 Apago PDF Enhancer Chapter Four ACCOUNTING FOR THE GENERAL AND SPECIAL REVENUE FUNDS 87 Overview of Modified Accrual Accounting 88 Interfund Transactions 89 Illustrative Case—Special Revenue Fund 108
Recording the Budget 92 Re-establishment of Encumbrances 92 Recording Prior-Year Property Taxes as Revenues 92 Tax Anticipation Notes Payable 93 Payment of Liabilities as Recorded 93 Encumbrance Entry 93 Recording Property Tax Levy 94 Collection of Delinquent Taxes 94 Collection of Current Taxes 94 Other Revenues 95 Repayment of Tax Anticipation Notes 95 Recognition of Expenditures for Encumbered Items 95 Payrolls and Payroll Taxes 96 Payment on Account and Other Items 97 Correction of Errors 97 Amendment of the Budget 97 Interfund Transactions 98 Write-off of Uncollectible Delinquent Taxes 100 Reclassification of Current Taxes 100 Accrual of Interest and Penalties 101 Deferral of Property Tax Revenue 101 Special Item 101 Preclosing Trial Balance 101 Closing Entries 103 Year-End Financial Statements 105 91 Interfund Loans 89 Interfund Services Provided and Used 91 Recognition of Inventories in Governmental Funds 111 Motor Fuel Tax Revenues 108 Expenditures for Road Repairs 108 Reimbursement to General Fund 109 Reimbursement Grant Accounting 109 Closing Entry 109 Year-End Financial Statements 110 Contents vii Chapter Five ACCOUNTING FOR OTHER GOVERNMENTAL FUND TYPES: CAPITAL PROJECTS, DEBT SERVICE, AND PERMANENT 122 Capital Projects Funds Illustrative Case Chapter Six PROPRIETARY FUNDS Internal Service Funds 156 154 Other Issues Involving Acquisition of Capital Assets 130 125 124
Other Issues Involving Internal Service Funds 161 Enterprise Funds Risk Management Activities 161 Implications for Other Funds 162 Illustrative Case—Water Utility Fund 164 Establishment and Operation of Internal Service Funds 157 Illustrative Case—Supplies Fund 157 Debt Service Funds Acquisition of General Fixed Assets by Lease Agreements 130 Construction of General Fixed Assets Financed by Special Assessment Debt 131 The Modified Accrual Basis—As Applied to Debt Service Funds 132 Additional Uses of Debt Service Funds 133 Debt Service Accounting for Serial Bonds 133 Illustrative Case—Regular Serial Bonds 134 162 Proprietary Fund Financial Statements 168 132
Apago PDF Enhancer Summary 176 Statement of Net Assets 170 Statement of Revenues, Expenses, and Changes in Fund Net Assets 170 Statement of Cash Flows 170 Accounting for Municipal Solid Waste Landfills 174 Pollution Remediation Costs 175 Other Issues Involving Payment of Long-Term Debt 136 Permanent Funds 138 Financial Reporting for Governmental Funds 140 Balance Sheet—Governmental Funds 140 Statement of Revenues, Expenditures, and Changes in Fund Balances— Governmental Funds 144 Debt Service Accounting for Deferred Serial Bonds 136 Debt Service Accounting for Term Bonds 136 Debt Service Accounting for Capital Lease Payments 137 Bond Refundings 137
Chapter Seven FIDUCIARY (TRUST) FUNDS 189 Agency Funds Tax Agency Funds 192 Accounting for Tax Agency Funds Financial Reporting for Agency Funds 194 190 192 Private-Purpose Trust Funds Investment Trust Funds 199 Public Employee Retirement Systems (Pension Trust Funds) 200 Accounting and Reporting for Defined Benefit Pension Plans 201 Accounting for Investments 194 Illustrative Case—Private-Purpose Trust Funds 197 A Note about Escheat Property 199 194 Summary 144 viii Contents A Final Comment on Fund Accounting and Reporting 209 A Note about Other Postemployment Benefits 205 Summary of Employer Reporting 206 A Note about IRS 457 Deferred Compensation Plans 209
Accounting for General Capital Assets, Including Infrastructure 248 The Modified Approach for Reporting Infrastructure 249 Collections 250 Asset Impairment 251 Types of General Long-Term Debt 252 Debt Disclosures and Schedules Accounting for Long-Term Debt 251 252 Chapter Eight GOVERNMENT-WIDE STATEMENTS, FIXED ASSETS, LONG-TERM DEBT 220 Conversion from Fund Financial Records to Government-wide Financial Statements 221 Capital Asset–Related Entries 223 Long-Term Debt–Related Entries 228 Adjusting to Convert Revenue Recognition to the Accrual Basis 229 Adjusting Expenses to the Accrual Basis 231 Adding Internal Service Funds to Governmental Activities 231 Eliminating Interfund Activities and Balances within Governmental Activities 236 Worksheet to Illustrate the Adjustments 237
Chapter Nine ACCOUNTING FOR SPECIAL-PURPOSE ENTITIES, INCLUDING PUBLIC COLLEGES AND UNIVERSITIES 267 Gasb Statement 34 Reporting Rules for Special-Purpose Entities 267 Reporting by Special-Purpose Local Governments Engaged in Governmental Activities 268 Reporting by Special-purpose Local Governments Engaged Only in Business-type Activities 270 Reporting by Special-purpose Local Governments Engaged Only in Fiduciary-type Activities 273 Apago PDF Enhancer Accounting and Financial Reporting for public Colleges and Universities 274 Government-wide Financial Statements 237 Summary 247 Appendix: Accounting for Capital Assets and Long-Term Debt in Governmental Activities 248 Statement of Net Assets 237 Statement of Activities 241 Required Reconciliation to Government-wide Statements 244 Summary
The Environment of Public Higher Education 274 Accounting and Financial Reporting for Public Institutions of Higher Education 275 Illustrative Case—Northern State University—Beginning Trial Balance 276 Illustrative Case—Journal Entries 278 Illustrative Case—Closing Entries 284 Illustrative Case—Financial Statements 286 291 Contents ix Chapter Ten ACCOUNTING FOR PRIVATE NOT-FOR-PROFIT ORGANIZATIONS 300 Organizations Covered in this Chapter 302 Overview of Not-for-Profit Accounting 302 Split-Interest Agreements 348 Summary—Private College and University Reporting 353 Illustrative Transactions 341 Illustrative Financial Statements for Private Colleges and Universities 348 Illustrative Transactions and Financial Statements 308 Beginning Trial Balance 308 Transactions 309 Financial Statements 315 Alternative Procedure for Recording Fixed Assets 320 Mergers and Acquisitions
Three Classes of Net Assets 302 Financial Reporting 303 Note Disclosures 304 Accounting for Contributions, Including Reclassifications of Net Assets 304 Reporting of Expenses and Assets 305 Special Topics: Accounting for Contributions 306 Chapter Twelve ACCOUNTING FOR HOSPITALS AND OTHER HEALTH CARE PROVIDERS 362 Accounting and Reporting Requirements of the Health Care Guide 364 Financial Statements Revenues 366 Classifications 366 364 Beginning Trial Balance 367 Apago PDF Enhancer for Private-Sector Illustrative Statements Illustrative Transactions and Financial Statements 367 Performance Evaluation 320 Summary of Not-for-Profit Accounting and Reporting 323 321 Chapter Eleven COLLEGE AND UNIVERSITY ACCOUNTING—PRIVATE INSTITUTIONS 335 Overview of Private College and University Accounting 337
Financial Reporting for Governmental Health Care Entities 375 Financial Reporting for Commercial (For-Profit) Health Care Entities 378 Summary and Conclusions Regarding Health Care Accounting and Reporting 378 Not-for-Profit Health Care Entities 373 Illustrative Transactions and Financial Statements 341 Financial Statements 337 Net Asset Classification 338 Revenue Reduction versus Expenses 339 Academic Terms Encompassing More Than One Fiscal Year 339 Expenses 339 Other Accounting Guidance 340 Chapter Thirteen AUDITING, TAX-EXEMPT ORGANIZATIONS, AND EVALUATING PERFORMANCE 386 Governmental Auditing The Single Audit Act and Amendments 393 The Sarbanes-Oxley Act 396 Applying for Tax-Exempt Status 398 Federal Filing Requirements 398 387 Tax-Exempt Organizations 397 x Contents Evaluating Performance
State Filing Requirements 401 Unrelated Business Income Tax (UBIT) 401 IRS Oversight 403 Summary and Some Conclusions Related to Exempt Entities 403 Analysis of Not-for-Profit Organization Financial Statements 404 Analysis of State and Local Government Financial Statements 405 Service Efforts and Accomplishments Reporting 410 404 Consolidated Financial Report of the U. S. Government 425 Budgetary and Proprietary Accounting 429 Budgetary Accounts 429 Proprietary Accounts 432 Statement of Net Cost 423 Statement of Changes in Net Position 423 Statement of Budgetary Resources 424 Statement of Custodial Activity 425 Summary of Federal Government Reporting 432 Appendix: Illustrative Example 433
Chapter Fourteen FINANCIAL REPORTING BY THE FEDERAL GOVERNMENT 420 Federal Government Accounting Standards 421 Financial Reporting by Federal Agencies 422 Balance Sheet 423 Glossary: Governmental and Not-for-Profit Accounting Terminology G-1 Index I-1 Apago PDF Enhancer Chapter One Introduction to Accounting and Financial Reporting for Governmental and Not-For-Profit Organizations The truth is that all men having power ought to be mistrusted. If men were angels, no government would be necessary. If angels were to govern men, neither external nor internal controls on government would be necessary. James Madison, fourth president of the United States and principal author of the U. S. Constitution Learning Objectives • Obtain an overview of financial reporting for nonbusiness entities. Distinguish between private and public sector organizations. • Identify the sources of authoritative accounting standards for various public and private sector organizations. • Define the 11 fund types used by state and local governments. Apago PDF Enhancer n its relatively short existence, the United States has grown to be the largest and most successful economy in history. Why then would a country founded on the principles of free markets and private investment rely on governments to provide many goods and services? The answer lies in understanding the incentives of a free enterprise economy. There are many services that simply cannot be priced in a I 2
Chapter 1 way that naturally encourages commercial entrepreneurs to enter the marketplace. Commonly this is because the service is subject to free-riding. For example, public safety and a clean environment benefit every citizen, whether or not they contribute to its cost. Because there is no practical means for businesses to sell this service, governments are called upon through the political process to provide those services that citizens demand. In other instances, free market incentives do not align with public interest. For example, society finds it desirable to provide a K–12 education to all its citizens, not just those with the ability to pay. Although the majority of products and services are provided by either businesses or governments, in some circumstances private organizations are formed to provide goods or services without the intent of earning a profit from these activities. Examples include public charities, trade associations, and civic groups. Again, the goods or services they provide often cannot be priced in a way that encourages commercial entrepreneurship. For example, a public radio broadcast cannot be effectively restricted to only those individuals choosing to support the public radio station. While this explains why the services are not provided by businesses, why aren’t governments called upon to provide them? In some instances, obstacles exist that prevent government involvement. For example, the U. S. Constitution provides for separation of church and state.
Therefore, any group that wishes to promote religious activities must do so through private organizations rather than through government. More commonly the reason is lack of political influence. Support for the arts may be important to a group of individuals but unless that group is sufficiently large to influence the political process, it is unlikely that elected officials will use government funds for that purpose. However, support for the arts could still be provided by forming a charitable foundation with no relationship to the government and having the foundation solicit donations from that segment of the public who finds the arts important. The organizations introduced in the preceding paragraphs are the focus of this book: governmental and not-for-profit organizations.
They are distinguished from commercial businesses by the absence of an identifiable individual or group of individuals who hold a legally enforceable residual claim to the net assets. Throughout the text a distinction will be made between public and private organizations. Public organizations are owned or controlled by governments. Private organizations are not owned or controlled by governments and include businesses as well as private not-for-profit organizations. Not-for-profit organizations lack a residual ownership claim and the organization’s purpose is something other than to provide goods and services at a profit. Because significant resources are provided to governments and not-for-profit organizations, financial reporting by these organizations is important.
To paraphrase the James Madison quotation provided at the beginning of the chapter, because humans (not angels) operate governments, controls are necessary. Financial reports that reflect the policies and actions of governmental managers are an effective means to control the actions of those entrusted with public resources. To be effective, external financial reports must be guided by a set of generally accepted accounting Apago PDF Enhancer 1 The branch of economics that studies the demand for government services is termed public choice. Introduction to Accounting and Financial Reporting 3 principles. The generally accepted accounting principles for governmental and private not-for-profit organizations are the subject of this book.
The first nine chapters of the text deal with public sector (state and local government) organizations and Chapters 10, 11, and 12 deal primarily with private not-for-profit organizations. Chapter 13 discusses auditing and tax-related issues unique to governments and private not-for-profits and also evaluates performance of these entities. Chapter 14 describes financial reporting by the federal government. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES Organisms evolve in response to characteristics of their environment. Similarly, accounting principles evolve over time as people find certain practices useful for decision making. Further, we expect organisms in different environments to evolve differently.
Similarly, if the environments in which governments and not-for-profits operate differ in important ways from that of commercial enterprises, we would expect the accounting practices to evolve differently. The Governmental Accounting Standards Board published a document titled Why Governmental Accounting and Financial Reporting Is—and Should Be— Different (http://www. gasb. org/white_paper_full. pdf). This white paper identifies five environmental differences between governments and for-profit business enterprises and describes how those differences manifest in differences in the objectives and practice of financial reporting. Apago PDF Enhancer 1. Organizational Purposes.
While the purpose of a commercial business is to generate a profit for the benefit of its owners, governments exist for the well-being of citizens by providing public services—whether or not the services are profitable undertakings. Since taxes and many other government revenues are not equivalent to sales, the excess of revenues over expenses cannot be interpreted as an effectiveness measure in the manner of business net income. Whereas the purpose of government operations differs greatly from commercial businesses, the purpose of governmental accounting is the same—to provide information that is useful to stakeholders in making decisions. However, governments have vastly different sets of users of accounting information.
Like businesses, governments have creditors who are interested in assessing the creditworthiness of the government. Citizens and businesses, both within the government’s jurisdiction and those considering relocation to the jurisdiction, are also stakeholders who rely on governmental reporting to make economic decisions. In addition, governments receive resources from other governments and grantors who may require financial reports and audits as a condition of the grant. Since this diverse set of resource providers have varying interests, the information needs of one group may not meet the needs of another. The result is that governments report far more disaggregated information than commercial enterprises. 2. Sources of Revenues.
Net income is a universally accepted measure of business performance. The calculation of net income begins with sales. A sale 4 Chapter 1 occurs when an independent party perceives that the service offered both provides value and is fairly priced. Net income then simply determines whether this measure of demand (sales) exceeds the cost of providing the service and is an accepted measure of performance for business organizations. On the other hand, governments derive many of their resources from taxes. Individuals and businesses pay taxes to avoid penalty, not voluntarily because they perceive government services to be of value and fairly priced.
Since taxes do not involve an earnings process, the timing of the recognition of tax revenue is not always clear. 3. Potential for Longevity. Because the U. S. and state constitutions grant state and local governments the ability to tax, governments very rarely go out of business. This long-term view of operations changes the focus of accounting from one of near-term recovery of amounts invested in assets to a longer-term focus on the sustainability of services and the ability to meet future demand. As a result, shortterm fluctuations in the value of assets or liabilities are less likely to be recognized in government financial statements. For example, changes in the fair value of assets in employee pension plans are not recognized in the short term. 4.
Relationship with Stakeholders. Taxes are generated through the legislative process by officials elected by the citizens. Because citizens and businesses are then required to pay these taxes, governments have an obligation to demonstrate accountability for these public funds. Whereas a business can use its resources as it deems appropriate, governments frequently receive resources that are restricted to a particular purpose. For example, a city may collect a telephone excise tax legally restricted to operating a 911 emergency service. In an effort to provide assurance that resources are used according to legal or donor restrictions, governments use fund accounting.
A fund represents part of the activities of an organization that is separated from other activities in the accounting records to more easily demonstrate compliance with legal restrictions or limitations. 5. Role of the Budget. Many businesses prepare budgets, but these are for planning and control purposes and are rarely made available to creditors or investors. In contrast, government budgets are expressions of public policy and often carry the authority of law, preventing public officials from spending outside their budgetary authority. The increased importance of budgets is reflected in government financial reports by a required report comparing budgeted and actual amounts. Apago PDF Enhancer For these and other reasons, the accounting practices of governmental organizations evolved differently from those of businesses.
As you will see in later chapters, the accounting practices of not-for-profit organizations more closely resemble those of commercial businesses. However, the not-for-profit environment shares some important characteristics with governments. Similar to governments, not-forprofits do not have residual owners. “Investors” in not-for-profits are diverse and include donors, volunteers, and members. In addition, as with governments, the excess of revenues over expenses is not an effective measure of organizational performance. Finally, like governments, not-for-profits receive resources with donorimposed restrictions. Introduction to Accounting and Financial Reporting 5 ILLUSTRATION 1–1 Reporting Organization Summary of Standards-Setting Organizations
Standards Setting Board Federal Accounting Standards Advisory Board (FASAB) Governmental Accounting Standards Board (GASB) Governmental Accounting Standards Board (GASB) Financial Accounting Standards Board (FASB) Financial Accounting Standards Board (FASB) Federal government State and local governments Public not-for-profits Private not-for-profits Investor-owned businesses Further complicating this issue is the fact that we have three levels of government (federal, state, and local) and not-for-profits may be either publicly or privately owned. This is important because different standards-setting bodies have authority for establishing reporting standards for these groups.
Illustration 1–1 summarizes the various organizational types and the bodies with primary standardsetting authority. Accounting and financial reporting standards for the federal government are recommended by the Federal Accounting Standards Advisory Board (FASAB). Recommendations of the FASAB are reviewed and become effective unless objected to by one of the principals, the U. S. Government Accountability Office (GAO), the U. S. Department of the Treasury, or the U. S. Office of Management and Budget (OMB). These standards apply to financial reports issued by federal agencies and to the Consolidated Financial Report of the United States Government. Accounting and financial reporting standards for the federal government are illustrated in Chapter 14.
Accounting and financial reporting standards for state and local governments in the United States are set by the Governmental Accounting Standards Board (GASB). The GASB also sets accounting and financial reporting standards for governmentally related not-for-profit organizations, such as colleges and universities, health care entities, museums, libraries, and performing arts organizations that are owned or controlled by governments. Accounting and financial reporting standards for profit-seeking businesses and for nongovernmental not-for-profit organizations are set by the Financial Accounting Standards Board (FASB). The GASB and the FASB are parallel bodies under the oversight of the Financial Accounting Foundation (FAF).
The FAF appoints the members of the two boards and provides financial support to the boards by obtaining contributions from business corporations; professional organizations of accountants and financial analysts; CPA firms; debt-rating agencies; and state and local governments. Because of the breadth of support and the lack of ties to any single organization or government, the GASB and the FASB are referred to as “independent standards-setting bodies in the private sector. ” Standards set by the FASAB, GASB, and FASB are the primary sources of generally accepted accounting principles (GAAP) as the term is used in accounting and auditing literature. FASAB, GASB, and FASB standards are set forth primarily in documents called Statements. From time to time, the boards find it necessary to expand on standards Apago PDF Enhancer 6 Chapter 1 in documents called Interpretations.
Boards also issue Technical Bulletins to explain the application of standards in certain situations or industries. Because FASB, GASB, and FASAB Statements, Interpretations, and Technical Bulletins do not cover all possible transactions, government and not-for-profit entities may need to refer to other publications for guidance. However, these other publications do not take precedence over standards issued by the standard-setting boards. The result is that financial statement preparers follow a hierarchy of generally accepted accounting standards. Until recently this hierarchy was established by the American Institute of Certified Public Accountants (AICPA).
However each of the standard-setting organizations has now published its own hierarchy of GAAP. This hierarchy is summarized in Illustration 1–2. The final category includes practices that have evolved within an industry without specific authoritative action by any standard-setting body. Some organizations possess certain characteristics of both governmental and nongovernmental not-for-profit organizations, and it is necessary to determine whether those organizations are governmental or nongovernmental for purposes of applying GAAP, in accord with the hierarchy shown in Illustration 1–2. For this reason, the FASB and GASB agreed upon a definition of a government.
As reproduced in the AICPA Audit and Accounting Guide: Not-for-Profit Organizations, the definition is as follows: Public corporations and bodies corporate and politic are governmental organizations. Other organizations are governmental organizations if they have one or more of the following characteristics: a. Popular election of officers or appointment (or approval) of a controlling majority of the members of the organization’s governing body by officials of one or more state or local governments; b. The potential for unilateral dissolution by a government with the net assets reverting to a government; or c. The power to enact and enforce a tax levy.
Furthermore, organizations are presumed to be governmental if they have the ability to issue directly (rather than through a state or municipal authority) debt that pays interest exempt from federal taxation. Apago PDF Enhancer OBJECTIVES OF ACCOUNTING AND FINANCIAL REPORTING All three standards-setting organizations—the Federal Accounting Standards Advisory Board, the Financial Accounting Standards Board, and the Governmental Accounting Standards Board—take the position that the establishment of accounting and financial reporting standards should be guided by conceptual considerations so that the body of standards is internally consistent and the standards address broad issues expected to be of importance for a significant period of time.
The cornerstone of a conceptual framework is said to be a statement of the objectives of financial reporting. ILLUSTRATION 1–2 GAAP Hierarchy GASB Statement 55 State and Local Governments FASAB (Exposure Draft) Federal Government and Agencies • FASAB Statements and Interpretations, • AICPA and FASB pronouncements specifically made applicable to federal governmental entities by FASAB Statements or Interpretations. • FASAB Technical Bulletins and, • if specifically made applicable to federal governmental entities by the AICPA and cleared by the FASAB, AICPA Industry Audit and Accounting Guides and Statements of Position. • AICPA AcSEC Practice Bulletins if cleared by the FASAB. Technical releases of the FASAB Accounting and Auditing Policy Committee. • Implementation guides published by the FASAB staff, and • practices that are widely recognized and prevalent in the federal government. Category FASB Statement 162 Nongovernmental Entities (commercial and private not-for-profits) • FASB Statements and Interpretations, • FASB Staff Positions, and • AICPA Accounting Research Bulletins and Accounting Principles Board Opinions that are not superseded by actions of the FASB. • FASB Technical Bulletins and, • if cleared by the FASB, AICPA Industry Audit and Accounting Guides and Statements of Position. • GASB Statements and Interpretations. Apago PDF Enhancer A. B. GASB Technical Bulletins and, • if cleared by the GASB, AICPA Industry Audit and Accounting Guides and Statements of Position. • AICPA Practice Bulletins that have been cleared by the GASB. C. • AICPA Practice Bulletins that have been cleared by the FASB, and • consensus positions of the FASB Emerging Issues Task Force. • Implementation guides (Q&As) published by the FASB staff, • AICPA Accounting Interpretations, Industry Audit and Accounting Guides and Statements of Position not cleared by the FASB, and • practices that are widely recognized and prevalent either generally or in the industry. D. • Implementation guides (Q&As) published by the GASB staff, and • practices that are widely recognized and prevalent in state and local governments. 7 8 Chapter 1
Objectives of Accounting and Financial Reporting for the Federal Government The Federal Accounting Standards Advisory Board (FASAB) was established to recommend accounting and financial reporting standards to the principals—the U. S. Office of Management and Budget, the U. S. Department of the Treasury, and the U. S. Government Accountability Office. The FASAB has issued six Statements of Federal Financial Accounting Concepts (SFFACs). These concepts apply to financial reporting for the federal government as a whole and for individual reporting agencies. SFFAC 1, Objectives of Federal Financial Reporting, outlines four objectives that should be followed in federal financial reporting.
The first, budgetary integrity, indicates that financial reporting should demonstrate accountability with regard to the raising and expending of moneys in accord with the budgetary process and laws and regulations. The second, operating performance, suggests that financial reporting should enable evaluation of the service efforts, costs, and accomplishments of the reporting entity. The third, stewardship, reflects the concept that financial reporting should enable an assessment of the impact on the nation of the government’s operations and investments. Finally, the fourth, systems and controls, indicates that financial reporting should reveal whether financial systems and controls are adequate.
Other federal government accounting concept statements include: • SFFAC 2—Entity and Display, • SFFAC 3—Management’s Discussion and Analysis, • SFFAC 4—Intended Audience and Qualitative Characteristics for the Consolidated Financial Report of the United States Government, • SFFAC 5—Definitions of Elements and Basic Recognition Criteria for AccrualBasis Financial Statements, and • SFFAC 6—Distinguishing Basic Information, Required Supplementary Information, and Other Accompanying Information. Apago PDF Enhancer Objectives of Financial Reporting by Not-for-Profit Entities FASB has issued seven concepts statements, including one dedicated to nonbusiness entities.
In its Statement of Financial Accounting Concepts No. 4, the FASB identifies the information needs of the users of nonbusiness financial statements. These include providing information that is useful to present and potential resource providers in the following: • Making decisions about the allocation of resources to those organizations, • Assessing the services that a nonbusiness organization provides and its ability to continue to provide those services, • Assessing management’s stewardship and performance, and • Evaluating an organization’s economic resources, obligations, and effects of changes in those net resources. Introduction to Accounting and Financial Reporting 9
Objectives of Accounting and Financial Reporting for State and Local Governmental Units The Governmental Accounting Standards Board was established in 1984 as the successor to the National Council on Governmental Accounting (NCGA). In 1987 the GASB issued its Concepts Statement No. 1, Objectives of Financial Reporting, for state and local governments. In that statement the Board noted the following: Accountability requires governments to answer to the citizenry—to justify the raising of public resources and the purposes for which they are used. Governmental accountability is based on the belief that the citizenry has a right to know, a right to receive openly declared facts that may lead to public debate by the citizens and their elected representatives.
Financial reporting plays a major role in fulfilling government’s duty to be publicly accountable in a democratic society. 2 Financial reports of state and local governments, according to the Governmental Accounting Standards Board, are used primarily to: (1) compare actual financial results with the legally adopted budget; (2) assess financial condition and results of operations; (3) assist in determining compliance with finance-related laws, rules, and regulations; and (4) assist in evaluating efficiency and effectiveness. Concepts Statement No. 3, Communication Methods in General Purpose External Financial Reports that Contain Basic Financial Statements, was issued in 2005.
The Statement defines methods of presenting information in financial reports and presents the following disclosure hierarchy: 1. Recognition in the basic financial statements: Assets, liabilities, revenues, expenses or expenditures, and other elements of a financial statement that can be measured with sufficient reliability should be recorded in the financial statements. 2. Disclosure in notes to the financial statements: Notes enhance the user’s understanding of items in the financial statements and may include management’s objective explanations. Disclosure in the notes is not an adequate substitute for recognition in the financial statements when an event can be measured reliably. 3.
Presentation as required supplementary information (RSI): RSI is information the GASB has determined is essential for placing financial statement and note information in an appropriate context. The information must be objective and does not include predictions or subjective assessments. 4. Presentation as (other) supplementary information: This is information that is useful (but not essential) for placing financial statement and note information in an appropriate context. The GASB does not require supplementary information, unless identified as RSI. Concepts Statement No. 4, Elements of Financial Statements provides key definitions, including: • Assets are resources with present service capacity that the government presently controls, 2 Apago PDF Enhancer
Governmental Accounting Standards Board, Concepts Statement No. 1, Objectives of Financial Reporting (Norwalk, CT. , 2001). 10 Chapter 1 • Liabilities are present obligations to sacrifice resources that the government has little or no discretion to avoid, • Net position is the residual of all other elements presented in a statement of financial position, • Inflows of resources are acquisitions of net assets by the government that are applicable to the reporting period, and • Outflows of resources are consumption of net assets by the government that are applicable to the reporting period. Concepts statements 2 and 5 relate to the reporting of service efforts and accomplishments reporting.
These statements recognize the limitations of traditional financial statements which are not well designed for evaluating the government’s effectiveness in delivering public services. Service efforts and accomplishments reporting will be more fully described in Chapter 13. STATE AND LOCAL GOVERNMENT FINANCIAL REPORTING GASB Concepts Statements stress that accounting and reporting standards for state and local governments should meet the financial information needs of many diverse groups: citizen groups, legislative and oversight officials, and investors, and creditors. The Concepts Statements also make clear that reporting standards for governments recognize that decisions made by these groups involve political and social decisions as well as economic ones.
Accordingly, governmental financial reporting standards are much more inclusive than FASB standards, which consider the needs of only investors and creditors concerned with economic decisions. Apago PDF Enhancer Comprehensive Annual Financial Report The discussion of financial reporting in the GASB Codification Sec. 2200 sets standards for the content of the comprehensive annual financial report of a state or local government reporting entity. A comprehensive annual financial report (CAFR) is the government’s official annual report prepared and published as a matter of public record. In addition to the basic financial statements and other financial statements, the CAFR contains introductory material, an auditor’s report, certain RSI, schedules necessary to demonstrate legal compliance, and statistical tables.
Chapter 2 presents an extensive discussion and illustration of the basic financial statements and the other major components of the CAFR. Illustration 1–3 presents an overview of the financial reporting process for state and local governments. While a business will typically have a single general ledger, the activities of governments are broken down into subunits called funds. A typical town or county government could have a dozen funds while cities and states Introduction to Accounting and Financial Reporting 11 ILLUSTRATION 1–3 Financial Reporting Process for State and Local Governments Government-wide Statement of Net Assets and Statement of Activities Combining Worksheet and Journal Entries Enterprise Funds
Internal Service Funds Change to the Accrual Basis from Modified Accrual Fund-basis Financial Statements: Governmental Activities Apago PDF Fund-basis Financial Fund-basis Financial Enhancer Statements: Statements: Proprietary Activities Fiduciary Activities Accounting Ledgers: Governmental Activities Records of General Fixed Assets and Long Term Debt Accounting Ledgers: Accounting Ledgers: Fiduciary Business-type Activities Activities generally have many more. Each fund requires its own general ledger and general journal. These are represented at the bottom of Illustration 1–3. In addition, records are kept of general fixed assets and long-term debt.
Governments have two levels of financial statement reporting. The first is the fund-basis financial statements. Fund-basis statements are presented for three categories of activities: governmental, proprietary, and fiduciary. These categories 12 Chapter 1 and the funds comprising each are described in detail later in this chapter. While the fund-basis statements present an in-depth record of individual activities of the government, it is difficult for the financial statement user to pull this disaggregated information together and form an overall view of the government’s finances. For that reason, governments are required to present government-wide financial statements.
The government-wide statements combine the governmental and businesstype activities of the government for the purpose of presenting an overall picture of the financial position and results of operations of the government. An important feature of the government-wide financial statements is that they are prepared using a common measurement focus and basis of accounting. Measurement Focus and Basis of Accounting State and local governments prepare their financial reports using two general accounting methods. One method assumes an economic resources measurement focus and the accrual basis of accounting, and the other method assumes a flow of current financial resources measurement focus and modified accrual accounting. Each of these two methods is discussed below.
Economic Resources Measurement Focus and the Accrual Basis of Accounting The government-wide statements and the fund statements for proprietary funds and fiduciary funds use the economic resources measurement focus and the accrual basis of accounting. Measurement focus refers to what items are being reported in the financial statements. An economic resource measurement focus measures both current and long-term assets and liabilities and is the measurement focus used by commercial businesses. A balance sheet prepared on the economic resource focus reports the balances in fixed assets and long-term liabilities. Basis of accounting determines when transactions and events are recognized in the accounting records. The accrual basis of accounting recognizes revenues when they are earned (and are expected to be realized) and recognizes expenses when the related goods or services are used up.
Again, this is the basis of accounting used by commercial businesses. Apago PDF Enhancer Current Financial Resources Measurement Focus and the Modified Accrual Basis of Accounting The fund statements for governmental funds are presented using the current financial resources measurement focus and modified accrual basis of accounting. Many of the transactions in governmental funds are nonexchange in nature; that is, they are activities undertaken in response to the needs of the public. Activities reported in governmental funds are heavily financed by taxes and involuntary contributions from persons (and organizations) who do not receive services in direct proportion to the contribution they make.
GASB standards provide that accounting systems of governmental funds are designed to measure (a) the extent to which financial resources obtained during a period are sufficient to cover claims incurred during that period against financial resources and (b) the net financial resources available for future periods. Thus, governmental funds are said to have a flow of current financial resources measurement Introduction to Accounting and Financial Reporting 13 focus, as distinguished from the government-wide, proprietary fund, and fiduciary fund statements, which have a flow of economic resources measurement focus. Activities of governmental funds are said to be expendable; that is, the focus is on the receipt and expenditure of resources.
These resources are further defined as expendable resources, generally but not totally restricted to current assets and liabilities. Modified accrual accounting, as the term implies, is a modification of accrual accounting. As will be discussed much more fully in Chapters 3, 4, and 5, revenues are generally recognized when measurable and available to finance the expenditures of the current period. Expenditures (not expenses) are recognized in the period in which the fund liability is incurred. Long-term assets, with minor exceptions, are not recognized; the same is true of most long-term debt. Capital (fixed) assets and long-term debt are not reported in governmental funds.
It should be noted that governmental funds are reported using the modified accrual basis of accounting; however, governmental-type activities are reported in the government-wide statements using the accrual basis of accounting, including fixed assets and long-term debt. As shown in Illustration 1–3, the governmental activities fund-basis financial statements and the records of general fixed assets and long-term debt serve as inputs to the government-wide financial statements. The governmental activities balances are changed through combining worksheets and journal entries to reflect an economic resource measurement focus and the accrual basis of accounting before being presented in the government-wide financial statements. Apago PDF Enhancer Fund Structure for State and Local Government Accounting and Reporting Traditionally, state and local government financial reporting has been based on fund accounting.
Fund accounting and reporting permit governmental managers to demonstrate compliance with legal and contractual requirements. Fund accounting and the term fund, are defined by the GASB as follows: Governmental accounting systems should be organized and operated on a fund basis. A fund is defined as a fiscal and accounting entity with a self-balancing set of accounts recording cash and other financial resources, together with all related liabilities and residual equities or balances, and changes therein, which are segregated for the purpose of carrying on specific activities or attaining certain objectives in accordance with special regulations, restrictions, or limitations. 3
Note that the definition of the word fund requires that two conditions must be met for a fund, in a technical sense, to exist: (1) there must be a fiscal entity—assets set aside for specific purposes, and (2) there must be a double-entry accounting entity created to account for the fiscal entity. 3 National Council on Governmental Accounting, Statement No. 1, par 2. (Norwalk, CT). 14 Chapter 1 State and local governments use 11 fund types. These fund types are organized into three categories: governmental funds, proprietary funds, and fiduciary funds. Governmental Funds Five fund types are classified as governmental funds: 1. The General Fund accounts for most of the basic services provided by the government.
Technically, it accounts for and reports all financial resources not accounted for and reported in another fund. 2. Capital projects funds account for and report financial resources that are restricted, committed, or assigned to expenditure for capital outlays. As such, it accounts for the purchase or construction of major capital improvements, except those purchased or constructed by a proprietary (and less commonly, fiduciary) fund. 3. Debt service funds account for and report financial resources that are restricted, committed, or assigned to expenditure for principal and interest, other than interest or principal on proprietary or fiduciary activities. . Special revenue funds account for and report the proceeds of specific revenue sources that are restricted or committed to expenditure for a specified purpose other than debt service or capital projects. These include activities funded by federal or state grants or by taxes specifically restricted to certain activities. 5. Permanent funds account for and report resources that are restricted to the extent that only earnings, and not principal, may be used for purposes that support the reporting government’s programs. Apago PDF Enhancer Every government will have a single General Fund but may have multiple funds in each of the other categories.
Accounting for the General Fund and special revenue funds is discussed in Chapters 3 and 4, while capital project, debt service, and permanent fund accounting is illustrated in Chapter 5. Proprietary Funds Two types of funds used by state and local governments are classified as proprietary funds. The term indicates that the funds are used to account for a government’s ongoing organizations and activities that are similar to those often found in the commercial sector. Proprietary funds are discussed in Chapter 6. There are two types of proprietary funds: 1. Enterprise funds are used when resources are provided primarily through the use of sales and service charges to parties external to the government. Examples of enterprise funds include water and other utilities, airports, swimming pools, and transit systems. 2.
Internal service funds account for services provided by one department of a government to another, generally on a cost-reimbursement basis. In some cases, these services are also provided to other governments. Examples of internal service funds include print shops, motor pools, and self-insurance funds. Introduction to Accounting and Financial Reporting 15 Fiduciary Funds Fiduciary funds, sometimes known as trust and agency funds, account for resources for which the government is acting as a collecting/ disbursing agent or as a trustee. Fiduciary funds are covered in Chapter 7. Four types of fiduciary funds exist: 1. Agency funds are used to account for situations in which the government is acting as a collecting/disbursing agent.
An example would be a county tax agency fund, where the county collects and disburses property taxes for other taxing units within the county, such as independent school districts. 2. Pension (and other employee benefit) trust funds are used to account for pension and employee benefit funds for which the governmental unit is the trustee. 3. Investment trust funds account for the external portion of investment pools reported by the sponsoring government. 4. Private-purpose trust funds report all other trust arrangements under which principal and income benefit individuals, private organizations, or other governments. Illustration 1–4 summarizes the fund types, basis of accounting, and required fundbasis financial statements for each fund category.
The table is presented in reverse order to assist in identifying the appropriate fund to record a given transaction. Starting at the top, determine whether a given transaction is a fiduciary activity. If it is, identify which of the four fiduciary fund types is appropriate and do not consider Apago PDF Enhancer ILLUSTRATION 1–4 Fund Category Fiduciary Fund Summary of Funds Used by State and Local Governments Basis of Accounting Accrual Fund-basis Financial Statements • Statement of Fiduciary Net Assets • Statement of Changes in Fiduciary Net Assets • Statement of Net Assets • Statement of Revenues, Expenses, and Changes in Net Assets • Statement of Cash Flows • Balance Sheet • Statement of Revenues, Expenditures, and Changes in Fund Balances
Private-Purpose Trust Investment Trust Pension Trust Agency Internal Service Enterprise Proprietary Accrual Governmental Permanent Debt Service Capital Project Special Revenue General Modified accrual 16 Chapter 1 the proprietary or governmental-type funds. If it is not fiduciary, determine whether it is a proprietary activity, and if it is, determine whether it is internal service or enterprise. Any transaction that is not fiduciary or proprietary must be a governmental activity. Again, start at the top of the governmental activity funds and determine first whether the transaction meets the definition of a permanent fund. If it does not, move down through the list.
Any transaction that has not been identified as a permanent, debt service, capital projects, or special revenue fund transaction must be accounted for in the General Fund. Number of Funds Required In the GASB Summary Statement of Principles, the principle that follows the definition of fund types is often overlooked. This principle states that governmental units should establish and maintain those funds required by law and sound financial administration. If state law and/or agreements with creditors do not require the receipt of revenues that are raised solely for a defined purpose and if administrators do not feel that use of a separate fund is needed to be able to demonstrate that revenues were raised solely for that particular purpose, the General Fund should be used. Budgetary Accounting
GASB standards recognize that state laws generally require administrators of state agencies and of local governmental units to obtain the appropriate legislative body’s formal approval of all plans to raise revenues and make expenditures. Additionally, it is common for state agencies to be given the responsibility for monitoring the financial plans and financial operations of local governmental units within the state. Therefore, GASB standards contain the following three-part budgetary principle: Apago PDF Enhancer 1. An annual budget(s) should be adopted by every governmental unit. 2. The accounting system should provide the basis for appropriate budgetary control. 3.
Budgetary comparisons should be included in the appropriate financial statements and schedules for governmental funds for which an annual budget has been adopted. Part 1 of the principle is not an accounting or financial reporting principle, but it is a necessary precondition to parts 2 and 3. A budget, when adopted according to procedures specified in state laws, is binding upon the administrators of a government. Accordingly, a distinctive characteristic of governmental accounting is the formal reporting of the legally approved budget compared with actual results for the General Fund and all major special revenue funds that have a legally adopted annual budget.
This report is included as a part of required supplementary information (RSI) in the CAFR. The nature and operation of accounting and budgetary reporting are explained in appropriate detail in Chapter 3. Introduction to Accounting and Financial Reporting 17 ADDITIONAL RESOURCES Individuals interested in studying the original sources of GAAP may consult the GASB Codification. 4 The Codification lists GASB pronouncements by topic; alternatively, you may consult the GASB Original Pronouncements that provide the information in statement order. 5 All of these sources are described on the GASB Web site (www. gasb. org) which also provides information regarding current activities, including exposure drafts of new standards.
The American Institute of Certified Public Accountants (AICPA) provides guidance regarding state and local governmental accounting and auditing, especially in its Audit and Accounting Guide: State and Local Governmental Units. 6 The AICPA Web site is www. aicpa. org. The Government Finance Officers Association of the United States and Canada (GFOA) is the professional organization of the preparers of governmental financial statements. Detailed guidance is available in their publication, Governmental Accounting, Auditing, and Financial Reporting. 7 The GFOA Web site is www. gfoa. org. Now that you have finished reading Chapter 1, complete the multiple choice questions provided on the text’s Web site (www. mhhe. com/copley10e) to test your comprehension of the chapter. Apago PDF Enhancer 4
Governmental Accounting Standards Board, Codification of Governmental Accounting and Financial Reporting Standards (Norwalk, CT: GASB). 5 Governmental Accounting Standards Board, Original Pronouncements: Governmental Accounting and Financial Reporting Standards (Norwalk, CT: GASB). 6 American Institute of Certified Public Accountants, Audit and Accounting Guide: State and Local Governmental Units (New York, AICPA, 2007). 7 Stephen J. Gautier, Governmental Accounting, Auditing, and Financial Reporting Using the GASB 34 Model (Chicago: Government Finance Officers Association, 2001). Questions and Exercises 1–1 Obtain a copy of a recent Comprehensive Annual Financial Report (CAFR). These may be obtained by writing the director of finance in a city or county of your choice.
Your instructor may have one available for you, or you may obtain one from the GASB Web site: www. gasb. org. It would be best, but not absolutely necessary, to use a CAFR that has a Certificate of Excellence in Financial Reporting from the Government Finance Officers Association. You will be answering questions related to the CAFR in Chapters 1 through 9. Answer the following questions related to your CAFR. a. What are the inclusive dates of the fiscal year? b. Write the name and address of the independent auditor. Is the auditor’s opinion unqualified? If not, describe the qualification. Is the opinion 18 Chapter 1 1–2 1–3 1–4 1–5 1–6 1–7 1–8 1–9 imited to the basic financial statements, or does the opinion include combining and individual fund statements? c. Is the report separated into the three distinct sections: introductory, financial, and statistical? Does the report have a “single audit” section at the end? (A few CAFRs include their single audit report in the CAFR—see Chapter 13 for more detail of the single audit requirements. ) d. Does the report contain an organization chart? A table of contents? A list of principal officials? A letter of transmittal? Is the letter of transmittal dated and signed by the chief financial officer? List the major items of discussion in the letter of transmittal. e. Does the report include a Management’s Discussion and Analysis?
List the major items of discussion. f. Does the report include the government-wide statements (Statement of Net Assets and Statement of Activities)? g. Does the report reflect fund financial statements for governmental, proprietary, and fiduciary funds? List those statements. List the major governmental and proprietary funds (the funds which have separate columns in the governmental and proprietary fund statements). Identify and describe the five environmental differences between governments and for-profit business enterprises as identified in the Governmental Accounting Standards Board’s Why Governmental Accounting and Financial Reporting Is—and Should Be—Different.
Identify and briefly describe the three organizations that set standards for state and local governments, the federal government, and nongovernmental notfor-profit organizations. What is the definition of a government as agreed upon by the FASB and GASB? Describe the “hierarchy of GAAP” for state and local governments, the federal government, and nongovernmental not-for-profit organizations. Accounting and financial reporting for state and local governments use, in different places, either the economic resources measurement focus and the accrual basis of accounting or the current financial resources measurement focus and the modified accrual basis of accounting.
Discuss the differences in measurement focus and basis of accounting related to (a) the conceptual differences, (b) differences in revenue recognition, (c) differences in expense/ expenditure recognition, (d) differences in recognition of fixed assets, and (e) differences in the recording of long-term debt. Distinguish between private and public sector organization. GASB considers budgetary accounting and reporting to be important. List the principles outlined by GASB related to budgetary accounting and reporting. Go to the GASB Web site (www. gasb. org). What is the mission of GASB? Apago PDF Enhancer Introduction to Accounting and Financial Reporting 19 1–10 For each of the items below, identify which fund would be used to account for the item and provide a justification for your answer. a. A city government issued general obligation bonds to finance the construction of a new jail. b.
A state government collected a tax of $1. 00 per pack of cigarettes which is (by law) required to be used to fund health and fitness programs in public schools. c. A county government expended $1 million to expand the water treatment plant. d. A donor provided investments totaling $4 million to create an endowment, the earnings of which will be used to provide scholarships. e. A donor provided $50,000 to be used to purchase newspaper and magazine subscriptions for the public library. There is no requirement that the original principal may not be spent. f. A city government sold surplus street maintenance trucks for $10,000. Continuous Problem 1–C.
Chapters 2 through 9 deal with specific knowledge needed to understand accounting and financial reporting by state and local governments. A continuous problem is available on the text’s Web site (www. mhhe. com/copley10e) to keep the entire accounting area in perspective. The problem assumes the government is using fund accounting for its internal record-keeping and then at year-end makes necessary adjustments to prepare the government-wide statements. The problem covers all of the funds of the City of Everlasting Sunshine. At appropriate stages, preparation of the fund and government-wide statements are required. The following funds are included in this series of problems.
Apago PDF Enhancer General Special revenue—Street and Highway Fund Capital projects—City Hall Annex Construction Fund Debt service—City Hall Annex Debt Service Fund Debt service—City Hall Debt Service Fund Internal service—Stores and Services Fund Enterprise—Water and Sewer Fund Agency—Tax Collection Fund Investment trust—Area Investment Pool Fund Private-purpose—Student Scholarship Fund Pension trust—Fire and Police Retirement Fund Chapter Two Overview of Financial Reporting for State and Local Governments Particulars on government expenditures and taxation should be plain and available to all if the oversight by the people is to be effective.
Thomas Jefferson, third president of the United States and author of the Declaration of Independence Learning Objectives • Obtain an overview of the contents of a governmental financial report. • Define the governmental reporting entity. • Illustrate the basic financial statements for a state or local government. Apago PDF Enhancer C hapters 3 through 9 of this text describe and illustrate detailed accounting and financial reporting requirements for state and local governments. The purpose of this chapter is to provide background information so students may better understand the material that follows. This chapter presents a detailed look at financial statements and certain required schedules.
State and local governments are encouraged to prepare a Comprehensive Annual Financial Report (CAFR). According to the GASB Codification Sec. 2200: A comprehensive annual financial report should be prepared and published, covering all funds and activities of the primary government (including its blended component units) and providing an overview of all discretely presented component units of the reporting entity—including introductory section, management’s discussion and analysis (MD&A), basic financial statements, required supplementary information other than MD&A, combining and individual fund statements, schedules, narrative explanations, and statistical section.
While governments are encouraged to prepare a complete CAFR, the GASB has identified a set of statements and disclosures that are required to be in compliance with generally accepted accounting principles (GAAP). The minimum required contents of a governmental financial report appear in Illustration 2–1. Overview of Financial Reporting for State and Local Governments 21 ILLUSTRATION 2–1 Required Contents of Governmental Financial Reports 1. Management’s Discussion and Analysis 2. Basic Financial Statements a. Government-wide Financial Statements Government-wide Statement of Net Assets—Illustration 2–5 Government-wide Statement of Activities—Illustration 2–6 b.
Fund Basis Financial Statements Governmental Type Funds Balance Sheet—Illustration 2–7b Statement of Revenues, Expenditures and Changes in Fund Balances—Illustration 2–8b Reconciliation of governmental statements to government-wide statements— Illustration 2–7a and Illustration 2–8a Proprietary Funds Statement of Net Assets—Illustration 2–9 Statement of Revenues, Expenses and Changes in Fund Net Assets—Illustration 2–10 Statement of Cash Flows—Illustration 2–11 Fiduciary Apago Funds PDF Enhancer Statement of Fiduciary Net Assets—Illustration 2–12 Statement of Changes in Fiduciary Net Assets—Illustration 2–13 c. Notes to the Financial Statements—Illustration 2–14 3. Required Supplementary Information (Other than MD&A) Information about infrastructure assets using the modified approach—Illustration 2–15 Budgetary comparison schedule (General and major Special Revenue Funds)—Illustration 2–16 Schedule of funding progress of pension plans Schedule of employer contributions of pension plans Schedules required for external financing pools
The remainder of this chapter presents (1) a discussion of the financial reporting entity, (2) an overview of the CAFR contents, and (3) a detailed presentation of the Comprehensive Annual Financial Report, including illustrative statements. THE GOVERNMENTAL REPORTING ENTITY One of the most fundamental accounting issues is identifying the accounting entity. This is made more difficult by the fact that general-purpose governments such as states, counties, and large cities typically are complex organizations that include semiautonomous boards, commissions, and agencies created to accomplish projects 22 Chapter 2 or activities that, for one reason or another (generally restrictive clauses in state constitutions or statutes), may not be carried out by a government as originally constituted. For many years, separate annual reports were issued for each legal entity.
GASB Statement 14, The Financial Reporting Entity, establishes that the financial reporting entity is the primary government together with its component units. The primary government can be a state government, a general-purpose local government such as a city or county, or a special purpose government such as a school district. Component units are legally separate organizations for which the elected officials of the primary government are financially accountable. In addition, a component unit can be an organization for which the nature and significance of its relationship with a primary government are such that exclusion would cause the reporting entity’s financial statements to be misleading or incomplete.
Statement 14 provides guidance in determining when a primary government has financial accountability for another organization. First, the primary government either appoints a voting majority of the governing body of the other organization or members of the primary government’s governing body hold a majority of the seats of the other organization’s board. Second, the relationship meets one of the following two criteria: 1. The other organization provides either a financial burden or benefit to the primary government; or 2. The primary government can impose its will on the other organization. A financial burden exists, for example, if the primary government is responsible for liabilities or accumulated deficits of the other organization.
A financial benefit exists, for example, if the primary government is entitled to the other organization’s assets. Examples of the ability to impose its will include the right to replace the other organization’s management or to approve its budget. Once it is determined that an organization is a component unit of a primary government, the issue becomes how to include its financial information in the primary government’s financial reports. GASB standards provide two methods for including component unit financial information with that of the primary government. The first is known as blending, because the financial information becomes part of the financial statements of the primary government.
Blended organizations are reported as though they were funds of the primary government. Blending is appropriate only when the component unit is so intertwined with the primary government that they are in substance the same entity. This may be the case if the two entities’ governing boards are identical or if the component unit provides services solely to the primary government. More commonly, component units are reported using discrete presentation. In discrete presentation, the financial information of the component is presented in a column, apart from the primary government and not included in the totals reported for the primary government.
Discretely presented component units appear as separate columns in the government-wide statements. If there is more than one component unit, combining statements are provided showing financial information for each component unit. Apago PDF Enhancer Overview of Financial Reporting for State and Local Governments 23 REPORTING BY MAJOR FUNDS In addition to the government-wide statement, governments are required to prepare fund financial statements within the three categories of funds: governmental, proprietary, and fiduciary. Because governments may have many governmental and proprietary funds, governments are only required to present separate columns for each major fund. The General Fund is always considered a major fund.
Other governmental funds are considered major when both of the following conditions exist: 1. total assets, liabilities, revenues, or expenditures of that individual governmental fund constitute 10 percent of the total for the governmental funds category, and 2. total assets, liabilities, revenues, or expenditures of that individual governmental fund are 5 percent of the total of the governmental and enterprise categories, combined. Similar tests are applied to determine major enterprise funds. Additionally, a government may designate any fund major if reporting that fund separately would be useful. Any funds not reported separately are aggregated and reported in a single column under the label nonmajor funds.
If the reporting government is preparing a complete CAFR, a schedule showing the detail of nonmajor funds is provided in the other supplementary information section. OVERVIEW OF THE COMPREHENSIVE ANNUAL FINANCIAL REPORT (CAFR) The Comprehensive Annual Financial Report has three major sections: introductory, financial, and statistical. The CAFR is to include blended component units and discretely presented component units. An outline of the CAFR was presented in Illustration 2–1. Information appearing in the CAFR is described and illustrated in the following sections, beginning with the Introductory Section, Illustration 2–2. Apago PDF Enhancer 24 Chapter 2 Example Comprehensive Annual Financial Report Introductory Section Introductory Section
The Introductory Section of a CAFR includes the table of contents, a letter of transmittal from the preparer (typically the government’s Finance Director), a list of government officials, and an organizational chart. If a government received a Certificate of Achievement for Excellence in Financial Reporting from the Government Finance Officers Association in the prior year,1 the introductory section will include a reproduction of that certificate. The introductory section is not audited. ILLUSTRATION 2–2 Introductory Section of CAFR Letter of Transmittal from the Finance Director List of Government Officers Apago PDF Enhancer Organizational Chart
CEO/General Manager Project Management Human Resources Information Services Finance and Administration GFOA Certificate (if awarded) Facilities Marketing Research & Development Customer Support Supply and Distribution Manufacturing/ Production 1 The Government Finance Officers Association of the United States and Canada sponsors a Certificate program to encourage and promote excellent financial reporting. To receive that certificate, a government must have an unqualified audit opinion and have its report reviewed, using an extensive checklist, by independent reviewers who are experienced in financial reporting. See www. gfoa. org Overview of Financial Reporting for State and Local Governments 25
Example Comprehensive Annual Financial Report Financial Section: Auditor’s Report Financial Section: Auditor’s Report The auditor’s report (Illustration 2–3), placed at the beginning of the financial section, normally expresses an opinion on the basic financial statements. Like other audits, CPAs are required to conduct government audits according to auditing standards issued by the American Institute of Certified Public Accountants. In addition, specialized governmental auditing standards must be followed. These standards are issued by the Government Accountability Office (GAO). GAO is an agency of the federal government and is the investigative arm of Congress.
Governmental auditing standards are discussed in more detail in Chapter 13. ILLUSTRATION 2–3 Independent Auditor’s Report Kelly & Koch, LLC Certified Public Accountants We have audited the accompanying financial statements of the governmental activities, the business-type activities, the aggregate discretely presented component units, each major fund, and the aggregate remaining fund information of the City of Salem as of and for the year ended December 31, 2012, which collectively comprise the City’s basic financial statements as listed in the table of contents. These financial statements are the responsibility of the City of Salem’s management.
Our responsibility is to express opinions on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinions.
In our opinion, the financial statements referred to above present fairly, in all material respects, the respective financial position of the governmental activities, the business-type activities, the aggregate discretely presented component units, each major fund, and the aggregate remaining fund information of the City of Salem as of December 31, 2012, and the respective changes in financial position and cash flows, where applicable, thereof for the year then ended in conformity with accounting principles generally accepted in the United States of America. Apago PDF Enhancer Additional paragraphs address required supplementary information, other supplementary information, and the statistical tables. Illustration 13–2 provides an example of a complete (unqualified) opinion. [Signature] [Date] 26 Chapter 2
Example Comprehensive Annual Financial Report Financial Section: Required Supplementary Information Management’s Discussion and Analysis Management’s Discussion and Analysis (MD&A) The MD&A (Illustration 2–4) provides an opportunity for the government to provide, in plain terms, an overview of the government’s financial activities. This section is considered Required Supplementary Information, which means that it is required and entails some auditor responsibility, but not as much as the basic financial statements. Auditors review the material to establish that it is not misleading in relation to the basic statements but do not include the MD&A in the scope of the audit. A number of specific items must be included: 1. A brief discussion of the financial statements. 2.
Condensed financial information derived from the government-wide financial statements, comparing the current year with the prior year. GASB Statement 34 identifies 14 specific items for discussion. 3. An analysis of the government’s overall financial position and results of operations to assist users in assessing whether financial position has improved or deteriorated as a result of the year’s operations. 4. An analysis of balances and transactions of individual funds. 5. An analysis of significant variations between original and final budget amounts and between final budget amounts and actual results for the General Fund. 6. A description of significant capital asset and long-term debt activity during the year. 7.
A discussion by governments that use the modified approach to report infrastructure assets (discussed in Chapter 8), that includes: discussion of changes in the condition of infrastructure assets, comparison of assessed condition with the condition level established by the government, and disclosure of the difference between the amount needed to maintain infrastructure assets and the amount actually expended. 8. A description of any known facts, decisions, or conditions that would have a significant effect on the government’s financial position or results of operations. Apago PDF Enhancer GASB Statement 37 makes it clear that MD&A is limited to the preceding eight items. However, governments may expand the discussion of these items if deemed appropriate.
Overview of Financial Reporting for State and Local Governments 27 Example Comprehensive Annual Financial Report Financial Section: Required Supplementary Information Management’s Discussion and Analysis Management’s Discussion and Analysis ILLUSTRATION 2–4 Financial Highlights Highlights for the City of Salem’s government-wide Financial Statements ° ° ° The City’s total net assets of governmental activities were $38. 4 million at December 31, 2012. Net assets for the business-type activities were $47. 9 million. Total revenues of governmental activities exceeded total expenses by $3. 3 million. The City’s total debt at December 31, 2012, was $62. 2 million, a net increase of $6. 5 million.
The City issued $9. 7 million in general obligation bonds during 2012 to renovate the courthouse. Overview of the Financial Statements The financial section of this annual report consists of four parts: (1) management’s discussion and analysis, (2) the basic financial statements, (3) required supplementary information, and (4) other supplementary information. The basic financial statements include two kinds of statements that present different views of the City: of the City’s ° The government-wide financial statements provide readers with a broad overviewfinancial finances, including long-term and short-term information about the City’s overall status. und focus on ° The City’s financial statementsdetail thanthe individual parts of the City government, reporting the operations in more the government-wide statements. Apago PDF Enhancer Government-wide Financial Statements The government-wide financial statements report information about the City of Salem as a whole using accounting methods similar to those used by private-sector companies. The statement of net assets and the statement of activities are the government-wide statements. These statements include all of the government’s assets and liabilities using the accrual basis of accounting. All revenues and expenses are reported, regardless of when cash is received or paid. The City’s total net assets exceeded liabilities by $86 million at December 31, 2012.
The largest portion of the City’s net assets (70%) reflects its investments in capital assets, less accumulated depreciation and any related outstanding debt used to acquire those assets. The City uses these assets to provide services to its citizens and customers, therefore these assets are not available for future spending. Presented below is a table comparing the three categories of net assets for the City’s governmental, business-type, and component unit activities for fiscal years 2011 and 2012. Management’s discussion and analysis continues typically for 10 or more pages. 28 Chapter 2 Example Comprehensive Annual Financial Report Financial Section: Basic Financial Statements Government-wide Financial Statements: Statement of Net Assets Statement of Net Assets
The Statement of Net Assets (Illustration 2–5) presents the asset, liability, and net asset balances (measured on the accrual basis and economic resources measurement focus) for the entity’s governmental and business-type activities. Together, the governmental and business activities comprise the primary government. Similar information is presented in a separate column for the government’s discretely presented component units. Fiduciary activities, however, are not included in the governmentwide statements. Prior year balances may be presented, but are not required. Assets are generally reported in order of liquidity. A classified approach (presenting separate totals for current and noncurrent items) may be used, but is not required. Note in particular that capital assets (property and equipment) are presented in the governmental activities column.
This will not be the case when we examine the governmental fund basis financial statements. The capital assets include infrastructure and are reported net of accumulated depreciation. Similarly, long-term debt is presented in the governmental activities column of the government-wide Statement of Activities, but is not presented for governmental funds in the fund basis balance sheet. The difference between assets and liabilities is called net assets and is reported in three categories. Invested in capital assets, net of related debt is computed by taking the capital assets, less accumulated depreciation, and deducting outstanding debt that is related to the financing of capital assets.
Liabilities incurred to finance operations (including long-term liabilities for compensated absences or employee benefits) would not be deducted. Restricted net assets include resources that are restricted by (a) external parties, including creditors, grantors, contributors, or by laws or regulations of other governments; or (b) laws or constitutional provisions of the reporting government. The remaining amount, unrestricted net assets, is a “plug” figure that is determined by deducting the balances of the other two categories from the overall excess of assets over liabilities. Apago PDF Enhancer Overview of Financial Reporting for State and Local Governments