Chapter 11 GOVERNMENT-WIDE FINANCIAL STATEMENTS AND ...jameslchan.com/papers/Chan11V5.1.pdf · Chapter 11 GOVERNMENT-WIDE FINANCIAL STATEMENTS AND ACCRUAL ACCOUNTING ... E. Statement

ALL RIGHTS RESERVED. FOR UIC CLASS USE ONLY. J. Chan V5.1 Feb. 2007

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Chapter 11

GOVERNMENT-WIDE FINANCIAL STATEMENTS

AND ACCRUAL ACCOUNTING

Learning Objectives:

• Identify the objectives of the government-wide financial statements.

• Identify the general requirements for government-wide financial statements.

• Describe the differences between primary governments and component units.

• Demonstrate the relationship between the Statements of Net Assets and Activities.

• Compare and apply the different degrees for recognizing revenue and cost of service.

I. INTRODUCTION 2

II. GOVERNMENT-WIDE FINANCIAL STATEMENTS 2

A. Objectives of the Government-wide Financial Statements 2

B. General Requirements 5

C. Reporting Entity 5

D. Governmental and Business-type Activities 6

E. Statement of Net Assets 7

F. Statement of Activities 8

G. Summary 9

III. ACCOUNTING STANDARDS AND SYSTEM IN SUPPORT OF

GOVERNMENT-WIDE FINANCIAL STATEMENTS 9

A. Need for Standards and System Support 9

B. Accounting with a Long-term Perspective 10

C. Accrual Accounting for Revenues and Receivables 13

IV. CONCLUSION 17

APPENDIX 19

Before GASB Statement No. 34

KEY CONCEPTS AND TERMS 25

REFERENCES 25

REVIEW QUESTIONS 25

DISCUSSION QUESTIONS 25

GLOSSARY 26


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I. INTRODUCTION

In Statement No. 34, GASB requires state and local governments to produce a set

of basic financial statements that include both government-wide financial statements and

fund financial statements. This chapter discusses government-wide financial statements

and uses them to construct financial indicators and ratios to better understand a

government’s financial condition. Its content is based primarily on GASB Statement No.

34, “Basic Financial Statements… for State and Local Governments,” issued in June

1999. Chapter 12 will explain why governments use funds to organize their budgeting

and accounting systems and describe different ways of classifying funds. Then it will be

possible to understand the form and contents of the fund financial statements. We will

leave a detailed discussion of the accounting and financial statements of individual funds

to the next part. The last chapter, Chapter 13, of this part will place the financial

statements in the larger context of the Comprehensive Annual Financial Report (CAFR).

II. GOVERNMENT-WIDE FINANCIAL STATEMENTS

A. Objectives of the Government-wide Financial Statements

GASB requires state and local governments to produce two government-wide

financial statements: a statement of net assets and a statement of activities. The board

believes that these statements will help users:

• Assess the finances of the government in its entirety, including the year’s

operating results

• Determine whether the government’s overall financial position improved or

deteriorated

• Evaluate whether the government’s current-year revenues were sufficient to

pay for current-year services

• See the cost of providing services to its citizenry

• See how the government finances its programs – through use fees and other

program revenues versus general tax revenues

• Understand the extent to which the government has invested in capital assets,

including roads, bridges, and other infrastructure assets

• Make better comparisons between governments (GASB Statement No. 34,

“Preface”)


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Exhibit 11.1 – Sample City

Statement of Net Assets

December 31, 2002

Dollar amounts in thousands Primary Government

Governmental

Activities

Business-type

Activities Total

Component

Units

ASSETS

Current assets:

Cash and cash equivalents $ 13,598 $ 8,786 $ 22,383 $ 304

Investments 27,365 - 27,365 7,429

Receivables (net) 12,833 3,609 16,443 4,042

Internal balances 175 (175) - -

Inventories 322 127 449 84

Total current assets 54,293 12,347 66,640 11,859

Noncurrent assets:

Restricted cash and cash equivalents - 1,493 1,493 -

Capital assets (Note 1):

Land and infrastructure (see G-5) 118,620 34,788 153,409 751

Depreciable buildings, property, and equipment, net 51,403 116,601 168,003 36,994

Total noncurrent assets 170,023 152,882 322,905 37,745

Total assets $ 224,316 $ 165,229 $ 389,545 $ 49,604

LIABILITIES

Current liabilities:

Accounts payable $ 6,783 $ 752 $ 7,535 $ 1,803

Deferred revenue 1,436 - 1,436 39

Current portion of long-term obligations (Note 2) 9,236 4,426 13,662 1,427

Total current liabilities 17,455 5,178 22,633 3,269

Noncurrent liabilities:

Noncurrent portion of long-term obligations (Note 2) 83,302 74,482 157,784 27,106

Total liabilities 100,757 79,660 180,417 30,375

NET ASSETS

Invested in capital assets, net of related debt 103,711 73,089 176,800 15,906

Restricted for:

Capital projects 11,706 - 11,706 493 Debt service 3,021 1,452 4,473 -

Community development projects 4,811 - 4,811 -

Other purposes 3,214 - 3,214 -

Unrestricted (deficit) (2,904) 11,028 8,124 2,830

Total net assets 123,559 85,569 209,128 19,229

Total liabilities and net assets $ 224,316 $ 165,229 $ 389,545 $ 49,604

Source: GASB No. 34, p. 202, A-2 Prepared by J. Arellano, 5/23/06


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Exhibit 11.2 – Sample City

Statement of Activities

For the Year Ended December 31, 2002

Net (Expense) Revenue and Changes in Net Assets Dollar amounts in thousands

Program Revenues Primary Government

Functions/Programs Expenses

Charges for

Services

Operating

Grants and

Contributions

Capital

Grants and

Contributions

Governmental

Activities

Business-

type

Activities Total

Component

Units

Primary government:

Governmental activities: General government $ 9,571 $ 3,147 $ 843 $ - $ (5,581) $ - $ (5,581) - Public safety 34,845 1,199 1,308 62 (32,276) - (32,276) - Public works 10,129 850 - 2,253 (7,026) - (7,026) - Engineering services 1,300 705 - - (595) - (595) - Health and sanitation 6,739 5,612 575 - (552) - (552) - Cemetery 736 213 - - (523) - (523) - Culture and recreation 11,532 3,995 2,450 - (5,087) - (5,087) -

Community development 2,994 - - 2,580 (414) - (414) - Education (payment to school district) 21,893 - - - (21,893) - (21,893) - Interest on long-term debt 6,068 - - - (6,068) - (6,068) -

Total governmental activities 105,807 15,721 5,176 4,895 (80,015) - (80,015) -

Business-type activities: Water 3,596 4,159 - 1,160 - 1,723 1,723 -

Sewer 4,913 7,171 - 486 - 2,744 2,744 - Parking facilities 2,796 1,344 - - - (1,452) (1,452) -

Total business-type activities 11,305 12,674 - 1,646 - 3,015 3,015 -

Total primary government $ 117,112 $ 28,395 $ 5,176 $ 6,541 (80,015) 3,015 (77,000) -

Component units:

Landfill $ 3,382 $ 3,858 $ - $ 11 - - - 487 Public school system 31,186 706 3,937 - - - - (26,544)

Total component units $ 34,568 $ 4,564 $ 3,937 $ 11 - - - (26,056)

General revenues: Taxes: Property taxes, levied for general purposes 51,694 - 51,694 -

Property taxes, levied for debt service 4,726 - 4,726 - Franchise taxes 4,056 - 4,056 - Public service taxes 8,970 - 8,970 - Payment from Sample City - - - 21,893 Grants and contributions not restricted to specific programs 1,458 - 1,458 6,462 Investment earnings 1,958 601 2,559 882 Miscellaneous 885 105 990 22 Special item—Gain on sale of park land 2,653 - 2,653 -

Transfers 501 (501) - -

Total general revenues, special items, and transfers 76,901 205 77,106 29,259

Change in net assets (3,114) 3,220 106 3,203 Source: GASB No. 34, pp. 208-209, B-1 Net assets—beginning 126,673 82,349 209,022 16,026

Prepared by J. Arellano, 5/23/06 Net assets—ending $ 123,559 $ 85,569 $ 209,128 $ 19,229


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Exhibit 11.3. Balance Sheet with Broad Measurement Focus.

Liabilities • Current liabilities • Long-term liabilities

o Debt related to capital assets o Bonds, notes o Operating debts, e.g. pension

payable

Assets • Financial resources

o Current financial resources ! Monetary assets ! Financial investments ! Receivables ! Inventories for sale

o Long-term financial resources ! Financial investments ! Receivables

• Non-financial resources o Inventories for use o Cultural and historical treasures o Capital assets

! Equipment and similar ! Buildings ! Infrastructure ! Land

Net Assets • Net assets invested in capital assets, net

of related debt • Net assets restricted for…

o Capital projects o Debt service o other purposes

• Unrestricted net assets o Designated o Undesignated

B. General Requirements

Government-wide financial statements are intended to provide information about the overall government.

Government-wide financial statements are required to distinguish between the primary government and its discretely presented component units. (See the “Reporting entity” subsection below for further discussion.)

The government-wide financial statements exclude information about fiduciary activities, including component units such as some public employee retirement systems. The reason is that when a government acts as a trustee or agent for others, it cannot use the principals’ resources to finance its programs.

Government-wide financial statements are required to distinguish between the governmental activities and business-type activities of the primary government.

The government-wide statement of net assets has a broad measurement focus. Assets encompass all financial and economic resources, including infrastructure fixed assets. Both short-term and long-term liabilities are presented on the statement of net assets (see Exhibit 11.3).

The government-wide statement of activities uses the accrual basis of accounting. It is designed to show whether current operations have made government better off or worse off in terms of having more or less net assets.

C. Reporting Entity

Government-wide financial statements are required to include the primary

government and its component units. The primary government is the focus of the government-wide financial statements. A total column is presented for the primary government. A total column for the entire reporting entity is optional.


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A primary government is a state government or a general-purpose (i.e. multiple service function) local government. A primary government usually has a high degree of autonomy and members of its legislature are always elected. A special district (i.e. single service function local government) can also be a primary government if it is legally independent, has a separately elected governing board, and has a high degree of fiscal autonomy. Even though component units (CU) are legally separate organizations, the primary government (PG) may be financially accountable for them. The financial accountability may derive from the power of the PG to appoint a majority of the governing board of the component unit, and either: (a) the PG can impose its will on the CU (e.g. to approve or disapprove its budget) or (b) the CU can benefit or burden the PG. If the relationship between a CU and the PG is so close that the CU is virtually a part of the PG, the CU’s financial statements should be blended (i.e. merged) with those of the PG. Otherwise, the CU’s financial statement are discretely (i.e. separately) presented alongside with the PG’s. See Exhibit 11.3.5 for examples.

Exhibit 11.3.5

Examples on Defining the Financial Reporting Entity

Blended CU

! “The City’s financial statements blend the following legally separate component units because they fare fiscally dependent on the City and perform services primarily for City employees: the Municipal Employees’ Annuity and Benefit Fund of Chicago… The Laborers’ and Retirement Board Employees’ Annuity and Benefit Fund of Chicago… The Policemen’s Annuity and Benefit Fund of Chicago… the Firemen’s Annuity and Benefit Fund of Chicago” (City of Chicago, FY 2005 CAFR, p. 47).

Determinants of Financial Accountability for Discrete Presentation of CU

Imposition of Will ! The Board of Supervisors of the City of … appoints all members of the …

Commission. The Board can remove appointed members at all.

Fiscal Dependency ! The Council of the City of … has the right to approve the fire protection districts’ tax

rates and charges.

Financial Benefit or Burden ! … The City of … operates the public education system in the City for grades

kindergarten through twelve. The City … provides a significant amount of funding for the school board.

Related Organizations – disclosure in Notes of PG’s Financial Statements

! “City [of Chicago] officials are responsible for appointing a voting majority of the members of boards of other organizations, but the City’s accountability for these organizations do not exceed beyond making appointments and no fiscal dependency exists between the City and these organizations. The Chicago Park Districts, Chicago Public Schools, Community College District No. 508, Chicago Housing Authority and the Chicago Transit Authority are deemed to be related organizations” (City of Chicago, FY 2005, CAFR, p. 47).

Joint Venture – disclosure in Notes in the PG’s Financial Statements


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! “The State [of Illinois] is a participant with the states of Michigan, Minnesota, New York, Ohio, Pennsylvania and Wisconsin in the Great Lakes Protection Fund…, an Illinois not-for-profit corporation” (State of Illinois, FY 2003 CAFR).

D. Governmental and Business-Type Activities

Management’s discussion and analysis (MD&A) summarizes and explains the government’s financial position and activities as presented in the basic financial statements. Exhibit 11.4, excerpted from the sample MD&A in GASB Statement No. 34, introduces the Statement of Net Assets and the Statement of Activities in a narrative explanation.

Exhibit 11.4. MD&A: Reporting the City as a Whole.

The Statement of Net Assets and the Statement of Activities

Our analysis of the City as a whole begins on page 186. One of the most important questions asked about the City’s finances is, “Is the City as a whole better off or worse off as a result of the year’s activities?” The Statement of Net Assets and the Statement of Activities report information about the City as a whole and about its activities in a way that helps answer this question. These statements include all assets and liabilities using the accrual basis of accounting, which is similar to the accounting used by most private-sector companies. All of the current year’s revenues and expenses are taken into account regardless of when cash is received or paid. These two statements report the City’s net assets and changes in them. You can think of the City’s net assets—the difference between assets and liabilities—as one way to measure the City’s financial health, or financial position. Over time, increases or decreases in the City’s net assets are one indicator of whether its financial health is improving or deteriorating. You will need to consider other nonfinancial factors, however, such as changes in the City’s property tax base and the condition of the City’s roads, to assess the overall health of the City. In the Statement of Net Assets and the Statement of Activities, we divide the City into three kinds of activities:

• Governmental activities—Most of the City’s basic services are reported here, including the police, fire, public works, and parks departments, and general administration. Property taxes, franchise fees, and state and federal grants finance most of these activities.

• Business-type activities—The City charges a fee to customers to help it cover all or most of the cost of certain services it provides. The City’s water and sewer system and parking facilities are reported here.

• Component units—The City includes two separate legal entities in its report—the City School District and the City Landfill Authority. Although legally separate, these “component units” are important because the City is financially accountable for them.

Source: GASB Statement No. 34, p. 184 Governmental activities and business-type activities are distinguished in the government-wide financial statements. Taxes, intergovernmental grants and other non-


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exchange revenues finance governmental activities, which produce public goods to benefit the citizenry at large. User fees are the primary sources of revenue of business-

type activities, which produce individually consumed goods or services. Business-type activities are characterized by the exchange relationship between the government as a seller and the public as buyers of identifiable and divisible goods or services. Some business-type activities in government are expected to be self-sufficient like their private-sector counterparts, while others are subsidized by taxes like governmental activities. The GASB believes that the full cost of service (including the cost of using capital assets) is useful for public policy decisions on how much to subsidy them, if any. It is also important to recognize that, similar to governmental activities, government business-type activities are subject to the public accountability requirements. Due to the public goods nature of their services, governmental activities tend to be financed primary by taxes. Unlike business-type activities, the matching of cost of service and revenue is difficult or impossible at the individual level, and often unnecessary. The ability to pay is a secondary criterion for their allocation; indeed, the public is often a passive or even reluctant recipient of service (e.g. a traffic violation citation). Therefore, governmental-activities are characterized by non-exchange relationships on both the output side and input side. Their production is financed by budget allocations determined through the political process. Together governmental activities and business-type activities influence a government’s financial position and performance detailed in financial statements. In order to facilitate public understanding, the MD&A is required to provide financial highlights. Exhibit 11.5, excerpted from the sample MD&A in GASB Statement No. 34, points out notable comparisons between the current and previous year’s results (in dollar and percentage terms). These figures were deemed by management to be worthy of bringing to the user’s attention. Keep these points in mind as you scan the government-wide financial statements on the next two pages.

Exhibit 11.5. MD&A: Financial Highlights.

• The City’s net assets remained virtually unchanged as a result of this year’s operations. While net assets of our business-type activities increased by $3.2 million, or nearly 4 percent, net assets of our governmental activities decreased by $3.1 million, or nearly 2.5 percent.

• During the year, the City had expenses that were $6.3 million more than the $99.5 million generated in tax and other revenues for governmental programs (before special items). This compares to last year, however, when expenses exceeded revenues by $8.9 million.

• In the City’s business-type activities, revenues increased to $15 million (or 5.6 percent) while expenses decreased by 1.7 percent.

• Total cost of all of the City’s programs was virtually unchanged (increasing by $800,000, or less than 1 percent) with no new programs added this year.

• The General Fund reported a deficit this year of $1.3 million despite the one-time proceeds of $3.5 million from the sale of some of our park land.

• The resources available for appropriation were $1.1 million less than budgeted for the General Fund. However, we kept expenditures within spending limits primarily through a mid-year hiring and overtime freeze and our continuing staff


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restructuring efforts.

Source: GASB Statement No. 34, p. 183 E. Statement of Net Assets

GASB Statement No. 34 requires that the statement of net assets to have a broad measurement focus. That is, it report all financial and capital resources, and all liabilities regardless of whether they are short-term or long-term. Capital assets are reported at historical cost. Capital assets include: land, improvements to land, easements, building, building improvements, vehicles, machinery, equipment, work of arts and historical treasures, infrastructure, and all other tangible and intangible assets with useful lives longer than one year. Infrastructure assets are normally stationery and, if maintained well, they can have very long useful lives. Examples include: roads, bridges, tunnels, drainage systems, water and sewer systems, dams, and lighting systems. Generally, capital assets are depreciated over their estimated useful lives. Exceptions are those assets that are inexhaustible (e.g. land and land improvements), or are infrastructure that are reported using the modified approach (described below). GASB does not prescribe any particular depreciation methods, other than requiring systematic and rational allocation of net cost. Infrastructure assets that are part of a network are not required to be depreciated if they are managed and preserved at or above the officially established (physical) condition level. GASB has detailed requirements of this “alternative approach.” The basic idea that capital expenditures made to keep infrastructure assets in good working conditions are treated as expense; however, expenditures that add or improve them should be capitalized. The capitalized requirements for works of art and historical treasures are similar to those of FASB Statement No. 117. GASB encourages governments to present a government’s financial position as: assets less liabilities equal net assets (not fund balance or equity). Assets and liabilities are presented in order of their relative liquidity: nearness to cash for assets, and maturity dates for liabilities. As Exhibit 11.1 shows, net assets are displayed in three components:

• Net assets invested in capital assets, net of related debt, • Restricted net assets, and • Unrestricted net assets.

In effect, restricted net assets and unrestricted net assets add up to the government’s net financial assets. Restrictions result from constraints imposed by creditors, grantors or high-level governments, as well as by law (e.g. constitutional provisions or legislations) directing specific purposes for certain resources. The restrictions in the net asset section come from the fund financial statements. This will be discussed in further detail in the next chapter. F. Statement of Activities

GASB Statement No. 34 requires that the full accrual basis be used in measuring expenses and revenues for reporting periodic financial performance in a statement of activities. Under the accrual basis, expenses include not only the use of financial and capital assets, but also increases in short-term and long-term liabilities incurred for


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rendering service. Also under the accrual basis, legally enforceable claim is the basis for recognizing revenues from non-exchange transaction, and service efforts and accomplishment is the basis for recognizing sales revenue. Because of this long-term orientation, the GASB believe that the accrual basis can promote interperiod equity. Interperiod equity reflects the value judgment that people who receive services should pay for them, rather than shifting them to another period for others to finance them. The implementation of this notion will be discussed in greater detail in the next section.

The expenses of providing services through governmental activities and business-type activities are detailed in the Statement of Activities. Exhibit 11.2 shows the net expense or revenue format of reporting a government’s financial performance during a period. That is, the expense of each service function is offset by a combination of fees, grants and contributions (collectively called program revenues) that are associated with that service function. Expenses include at least direct expenses, but may also include a service function’s share of indirect expenses. If the expense is greater than the program revenues, the difference is called net expense; if the expense is less than the program revenues, the difference is called net revenue.

This format is intended to highlight the relative financial burden each service function imposes on taxpayers. As would be expected, governmental activities usually have net expenses, while business-type activities can have net expenses, net revenue or breakeven. In the aggregate, net expenses are to be financed by general revenues from taxes and other sources that are not dedicated to specific service functions.

It is important to distinguish between program revenues and general revenues. GASB provides the following guidelines (Exhibit 11.6).

In the final analysis, if total expenses exceeded total revenues, net assets would decrease during the period; if total revenues exceeded total expenses, net assets would increase during the period. In this way, the statement of activities is articulated with the statement of net assets.

Exhibit 11.6. Program Revenue and General Revenue.

Financing Sources Revenue Classification

Those who purchase, use, or directly benefit from the goods or services of the program

Always a program revenue

Parties outside of the reporting government’s citizenry

Program revenue if restricted to a specific program or programs; if unrestricted, general revenue

The reporting government’s taxpayers regardless of benefits received

Always general revenue, even if restricted to a specific program

The reporting government itself (e.g. investment income)

Usually a general revenue

G. Summary

Government-wide statements are designed to evaluate the whole government’s financial condition. The comparative statements of net assets and the statement of activities can be used to determine whether the government’s overall financial position improved or deteriorated between two year-ends. The statement of activities shows


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whether the government’s current-year revenues were sufficient to cover the expenses of current-year services to the citizenry. By means of the net expense/revenue format, the statement of activities shows the extent to which government services are financed by fees, and restricted grants and contributions, or by general tax revenues. It is noteworthy that the statement of net assets reports investment in capital assets, including infrastructure assets. With some exception, depreciation expense is calculated and included in the expense of service, and capital assets are reported at their historical cost net of accumulated depreciation.

III. ACCOUNTING STANDARDS AND SYSTEM IN SUPPORT

OF GOVERNMENT-WIDE FINANCIAL STATEMENTS

A. Need for Standards and System Support

The government-wide financial statements discussed above were a major feature of a new reporting model required by GASB Statement No. 34. Statement No. 34, issued in June 1999, was the result of a decade-long deliberation and research of how to produce a meaningful overview of a government’s finances. The reformers argued that governments should produce financial statements that would be similar to those of corporations, with capital assets and long-term liabilities on the balance sheets. The traditionalists believed that government accounting systems should focus on the availability and use of current financial resources and observe the segregation of resources in funds; consequently fund financial statements should be included in external reporting. Statement No. 34 has attempted to accommodate both points of view by requiring both government-wide financial statements and fund financial statements, which will be discussed in later chapters. See the Appendix for the way governments used to present their financial overviews prior to GASB Statement No. 34.

In order to produce the Statement of Net Assets with a broad measurement focus and the Statement of Activities using the strong accrual basis of accounting, a government’s accounting system requires the capacity to recognize and measure capital assets (along with their depreciation), long-term liabilities, as well as revenues and expenses. GASB has produced the necessary accounting standards to provide guidance to deal with related issues. Some of the requirements were also mentioned in the previous section. This section will provide a few examples to demonstrate the accounting process, which will be quite familiar to the reader as it is quite similar to business accounting. B. Accounting with a Long-term Perspective

GASB uses the terms “accrual basis” and “modified accrual” to refer to the basis of accounting applied to government-wide and governmental fund accounting, respectively. Basis of accounting refers to the timing of recognition of revenues, expenditures, expenses, and transfers -- and the related assets and liabilities -- in the accounts and reported in the financial statements. Unfortunately, GASB does not define “modified accrual” in precise terms, nor does it detail the intermediary degrees of accrual between the full accrual basis and the modified accrual basis. The author therefore proposes several degrees of accrual – strong, moderate and mild – to better define the grey area between full accrual basis and cash basis (see Exhibit 11.7).


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Exhibit 11.7. The Degrees of Accrual Concept.

Revenue Degrees of

Accrual

Expense/Expenditure

recognition on the basis of service efforts and accomplishment (SEA)

full (accrual basis)

recognition triggered by matching revenues with the economic resources used to generate them, incurrence of liabilities (regardless of maturity)

recognition on the basis of an enforceable claim

strong

use of economic resources (i.e. capital asset depreciation), incurrence of liabilities (regardless of maturity)

recognition on the basis of the availability of financial resources

moderate use of financial resources, incurrence of financial liabilities (regardless of maturity)

recognition on the basis of the availability of current financial resources

mild (modified accrual)

use of current financial resources, incurrence of current liabilities

Capital Assets and Long-term Debt. Suppose the Village of Oak Park at the beginning of last year issued $10 million of 5-year bonds to fund the replacement of its aging fleet of police cars and fire engines, and the entire amount was spent for this purpose. As Exhibit 11.8 shows, after the transactions were completed, the bond proceeds was exhausted and the government has $10 million of equipment, offset by $10 million of long-term bonds, resulting in no change in net position.

Exhibit 11.8. Accounting for Capital Assets and Long-Term Debt.

Account Classification and Title Debit Credit

A. Cash L. Bonds Payable

$10,000,000 $10,000,000

A. Equipment A. Cash

$10,000,000 $10,000,000

For accounting students, this way of accounting is common sense. For

government used to doing accounting focusing on current financial resources – cash in this simple case, incorporating capital assets and long-term liabilities into the accounts was a revolutionary act. Even if it is relatively easy to start capitalizing the spending for equipment, it is a very costly exercise to reconstruct historical records of fixed assets to present in the newly required Statement of Net Assets.

Expense. Suppose the Board of Trustees of the Village of Oak Park wanted to know the cost of providing police protection in the community last year. The “cost” can be interpreted in several ways (hypothetical numbers):

(1) It could mean the cash spent on employee salaries and wages ($2,000,000) and on equipment purchases ($300,000) for a total $2,300,000.


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(2) Suppose at the end of last year, the village government owed the police officers $100,000 in salary before the payday was a few days after year-end. One would argue that the cost should be $2,300,000 cash outlay plus the $100,000 current liability, for a total of $2,400,000.

(3) Suppose that the police officers were entitled to retirement benefits equal to 20% of their salaries. One would also argue the cost of police service should include another $400,000 (=20% x $2,000,000) for retirement benefits earned by the officers and attributable to last year.

(4) Some people might object to attributing the entire $300,000 in equipment purchase as the cost for last year. Suppose a police car has a useful life of five years, one might argue that only the annual depreciation expense of $50,000 should be included.

Each one of the methods is justifiable in some ways. Method 1, using the cash basis of accounting, is based on the argument that cash spent is the most objective and obvious way of measuring cost. Method 2 may be called a modified cash basis. By including the salaries payable, Method 2 is also learning toward the accrual basis, but it is only very mild accrual because only the soon to be paid amount owed is included. The $2,400,000 may be called an expenditure, to distinguish it from the cash outlay under Method 1.

Method 3 pushes accrual further by counting the value of retirement benefits attributable to last year as part of cost of police service received by the community last year. In doing so, Method 3 ignores when the benefits would be paid and focuses on capturing the total package of compensation for which the Village government (and therefore the local taxpayers) was responsible. The retirement benefits of $400,000 may be considered as part of the expense of providing police protection to the community. So expense differs from expenditure with respect to the treatment of increase in long-term liability related to services rendered. Sometimes the $400,000 of unpaid retirement benefits is called an operating debt because it arises from providing services; in contrast the bonds payable for equipment purchase is called a capital debt.

Method 4 makes the point that last year only used 1/5 of the service potential of a police car and, as such, should be attributed only 1/5 of the total cost, i.e. $60,000 of annual depreciation expense instead of the $300,000 of the capital outlay. The depreciation expense is at best an approximation, because it is a simple straight-line allocation of the historical cost. Be that as it may, it is much closer to the cost of “using up” a police car than the acquisition cost.

Using Method 4, the total amount of expenses of providing police protection for the Village of Oak Park would be $2,560,000 (see Exhibit 11.9). Method 4 is used in arriving at the amounts of expenses for the various government services in the government-wide Statement of Activities.

Exhibit 11.9. Accounting for Expenses.


NA. Expenses A. Cash Short-term L. Salaries Payable Long-term L. Retirement Benefits Payable A. Equipment – Accumulated Depreciation

$2,560,000 $2,000,000

100,000 400,000 60,000


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Exhibit 11.10. Comparing Measures of Cost of Service.

Basis of Accounting Measure of Cost of Service Amount

cash basis Cash outlay $2,300,000

mild accrual Expenditure $2,400,000

moderate accrual Expense, not including purchase cost of equipment or depreciation

$2,500,000

strong accrual Expense, including depreciation expense $2,560,000

Exhibit 11.10 summarizes the above discussion of various measures of cost of

service, and the associated basis of accounting. Is this exercise just a play of words? In a way, it is: most people probably would not tell the difference between expenditure and expense. But it is an important kind of play of words. Words have meanings, and the different meanings carry different financial consequences. Specifically, expenditures are “decreases in net financial resources” and arise only under the mild accrual basis. Decreases in cash and increases in short-term liabilities are examples of decreases in current financial resources. In contrast, expenses include increases in long-term liabilities (moderate accrual basis) and outflows of non-financial resources (strong accrual basis).

Suppose that police protection is funded by property tax, and the property owners in the Village of Oak Park believe strongly that they should only pay for the cost of police services they receive in a year. If the village’s board of trustees asked you as the finance director how much the cost of police service was last year, what would you tell them?

You could give them the four numbers in Exhibit 11.10 and provide them with an exposition of their differences. But the board has to select one number to base the amount of property tax. Which one of the four numbers is the best?

From the point of view of the least amount, Method 1 (the cash basis) is the “best” as it would result in the smallest tax bill for the property owners last year. But Method 1 is mixed blessing: last year absorbed the $300,000 cash payment for equipment, but avoided the $100,000 wages payable to be paid in the following year, and the $400,000 retirement benefits to be paid many years later.

Method 4 is the “worst” method for the property owners as it would produce the largest amount for their property tax bills. It includes one-year depreciation expense (rather than the entire purchase cost of equipment), but it is burdened with the $400,000 retirement benefits, an increase to long-term liability.

On the other hand, Method 4 is most consistent with inter-period equity. Inter-

period equity means that the taxpayers in a year should pay for all of the cost of service provided in that year regardless of when the cost will be paid in cash. By including both personnel and capital expenses, as well as increases to short-term and long-term liabilities attributable to last year, Method 4 seeks to prevent the shifting of financial burden for current services to future taxpayers. Since GASB apparently believes in inter-period equity, it has chosen “expense” as the preferable method for measuring cost of service. Method 4 is the underlying strong accrual basis used to calculate the expenses of various services in the Statement of Activities.

C. Accrual Accounting for Revenues and Receivables


15

The accounting for the commercial activities is the same regardless if they take place in the private sector or public sector. From the seller’s point of view, cash received in advance of service delivery gives rise to a liability. Service delivered in advance of customer’s payment entitled the seller to record a receivable. In other words, sales revenue is recognized to the extent of services delivered.

Like expenses, the amount of revenue recognized depends upon the basis of accounting being applied. Thus, a framework with progressive degrees of accrual also exists for revenue recognition. Under the cash basis, the receipt of cash triggers revenue recognition. The mild accrual basis recognizes revenues when a corresponding short-term receivable is recognized. In the case of short-term taxes receivable, only the soon to be collected amount is included. The next degree, the moderate accrual basis, counts long-term receivables as revenues, in addition to cash and short-term receivables.

The strong accrual basis includes so-called in-kind payments as revenues. In-kind payments are made in lieu of cash to satisfy tax obligations. For example, a famous painter died with no money to pay off his taxes. However, his estate satisfied the tax obligation by giving paintings to the government. From the government’s standpoint, the paintings are economic resources representing revenue under the strong accrual basis. In an example with hypothetical numbers (Exhibit 11.11), the strong accrual basis yields the largest amount of revenues recognized ($2,560,000). Exhibit 11.12 compares the components of revenue recognized under each basis of accounting.

Exhibit 11.11. Accounting for Revenues.


A. Cash Short-term A. Taxes Receivable Long-term A. Taxes Receivable A. In-kind Payments NA. Revenues

$2,000,000 100,000 400,000 60,000

$2,560,000

Exhibit 11.12. Comparing Components of Revenue.

Basis of Accounting Components of Revenue Amount

cash basis Cash receipts $2,000,000

mild accrual Above, plus short-term receivables $2,100,000

moderate accrual All of the above, plus long-term receivables $2,500,000

strong accrual All of the above, plus in-kind payments $2,560,000

Governmental activities are financed primarily by taxes and grants, and

secondarily by contributions and user fees. With the exception of user fees, these other revenue sources come from what GASB calls non-exchange transactions. The GASB has defined a non-exchange transaction as an exchange in which “a government (including the federal government, as a provider) either gives value (benefit) to another party without directly receiving equal value in exchange or receives value (benefit) from another party without directly giving equal value in exchange.”

GASB in late 1998 issued Statement No. 33 “Accounting and Financial Reporting for Non-exchange Transactions” in advance of Statement No. 34 so that government


16

would know how to account for their taxes, grants and contributions on the strong accrual basis. In general, “claim” replaces “service delivery” as the basis for recognizing receivable and revenue in non-exchange transactions. A claim is an assertion of a right to someone else’s property. Such an assertion inevitably would invite the question: on what is the claim based? Several situations are described below, so that a small number of recognition criteria can be developed to justify the assertion of claims. (The term “taxing authority” will be used frequently below instead of “government” in order to focus on this important power of government.)

Tax Derived from Taxable Transactions or Activities. If it is permitted by the applicable law (e.g. constitution or statutes), a government may identify certain transactions or activities as taxable, and specify the tax rates as well as other parameters (e.g., exemptions) to arrive at the amount of tax. Examples include: sales taxes, personal and corporate income taxes, motor fuel taxes, or consumption. Since these taxes originate from an underlying transaction or activity, they are called derived taxes. Let us use sales tax for illustration.

Ideally, the tax authority recognizes a sales tax receivable as soon as the underlying taxable transaction has completed, because at that time an enforceable legal claim arises (Scenario A in Exhibit 11.13, xxx symbolizes dollar amounts). Practically, the taxing authority recognizes the receivable as soon as it has information that the taxable transaction has taken place. Such information becomes available typically when the merchants periodically (e.g. monthly) remit the taxes in cash to the tax authorities (Scenario B). In the unlikely event that taxes are paid in cash in advance of the taxable transaction, the taxing authority should defer revenue recognition until the taxable transaction has occurred (Scenario C).

Exhibit 11.13. Accounting for a Derived Tax.


Scenario A A. Sales Taxes Receivable NA. Sales Revenue A. Cash A. Sales Tax Receivable

xxx

xxx

xxx

xxx

Scenario B A. Cash NA. Sales Revenue

xxx

xxx

Scenario C A. Cash L. Deferred Revenue L. Deferred Revenue NA. Sales Revenue

xxx

xxx

xxx

xxx

Imposed Taxes. Property tax is a common example of imposed taxes. According to the GASB, “The principal characteristic of these transactions is that the required


17

transmittal of resources to the assessing government is imposed by that government on an act committed or omitted by the provider (such as property ownership or the contravention of a law or regulation) that is not an exchange transaction.” Property tax is a major revenue source of American local governments, including school districts. The amount of property tax is calculated by multiplying a property tax rate by the estimated value of the taxable property (e.g., a house or commercial property such as shopping mall), adjusted by exemptions and other provisions. Property tax is usually levied on an annual basis to fund the operations of a government for a particular fiscal year. Therefore timing is an important consideration. Consider the three scenarios in Exhibit 11.14. In Scenario A, the tax authority receives property tax payments in Year 1 for use in Year 2. It should therefore defer recognition of Year 2 property tax revenue. In Scenario B, tax receipts arrive in the year for which property tax is levied; Year 2 tax revenue is recognized for the Year 2 tax payments received. In Scenario C, property taxpayers in Year 3 pay for Year 2 expenditures to be financed by Year 2 property tax levy. Since the taxing authority has an enforceable legal claim in Year 2, in Year 2 it can record property tax receivable and property tax revenue. Cash received in Year 3 reduces the amount of previously recorded property tax receivable.

Exhibit 11.14. Accounting for an Imposed Tax – Property Tax.


Scenario A: Advance tax receipt occurs in Year 1 for use in Year 2. Journal entry in Year 1

A. Cash L. Deferred Property Tax Revenue Journal entry in Year 2

L. Deferred Property Tax Revenue NA. Property Tax Revenue (Year 2)

xxx

xxx

xxx

xxx

Scenario B: Tax receipt occurs in Year 2 for use in Year 2 and journal entry is made in Year 2 A. Cash NA. Property Tax Revenue (for Year 2)

xxx

xxx

Scenario C: Tax receipt occurs in Year 3 for Year 2 property tax levy Journal entry made in Year 2

A. Property Tax Receivable NA. Property Tax Revenue (Year 2) Journal entry made in Year 3

A. Cash A. Property Tax Receivable

xxx

xxx

xxx

xxx

Grants. Local governments receive grants from their state government and the

federal governments; state governments also receive grants from the federal governments. Some grants are awarded virtually automatically to recipients who meet certain pre-specified eligibility requirements. Other grants have to be individually applied and are awarded to those who meet the criteria set by the grantor. The GASB defines


18

grants are “transactions in which one governmental entity transfers cash or other items of value to (or incurs a liability for) another governmental entity, an individual, or an organization as a means of sharing program costs, subsidizing other governments or entities, or otherwise reallocating resources to the recipients.” In general, grant revenue is recognized on the basis of the existence of an enforceable claim, which is asserted by virtue of having met all eligibility requirements, which could include defeating competing grant applicants. Again, timing is important consideration in illustration in the three scenarios in Exhibit 11.15.

In Scenario A, the potential grant recipient receives cash advance in Year 1 before meeting all eligible requirements, it therefore has to defer recognition of revenue until the requirements are met in Year 2.

In Scenario B, the grant recipient receives cash and meets all eligible requirements in Year 2, and therefore recognizes revenue in Year 2.

In Scenario C, the grant recipient meets all eligibility requirements in Year 2 (e.g. by making qualifying expenditures), and can therefore assert an enforceable claim against the grantor, providing the basis for recognizing revenue in Year 2.

Exhibit 11.15. Accounting for Grants.


Scenario A: Cash received in Year 1 in advance of meeting all eligibility requirements in Year 2. Journal entry in Year 1

A. Cash L. Deferred Grant Revenue Journal entry in Year 2

L. Deferred Grant Revenue NA. Grant Revenue (Year 2)

xxx

xxx

xxx

xxx

Scenario B: Cash received in Year 2, when all eligibility requirements are met A. Cash NA. Grant Revenue (Year 2)

xxx

xxx

Scenario B: All eligibility requirements are met in Year 2 and cash is received in Year 3. Journal entry made in Year 2

A. Grant Receivable NA. Grant Revenue (Year 2) Journal entry made in Year 3

A. Cash A. Grant Receivable

xxx

xxx

xxx

xxx

In summary, revenues from non-exchange transactions are recognized on the

basis of the ability to assert an enforceable claim. Enforceable means that there exists a basis in the applicable laws or agreements for the claim to have a reasonable chance of winning a favorable verdict in a court of law. A court battle may not be necessary or advisable, but that option is available. The claim is justified on the basis of:


19

• the occurrence of taxable transactions or activities in the case of derived tax revenues, • being able to or required to use the resources in the case of property tax, and • meeting all eligibility requirements in the case of grants.

IV. CONCLUSION GASB requires state and local governments to produce a statement of net assets and a statement of activities. Both are government-wide in scope and, as such, are characterized by a broad measurement focus. This focus, when applied to the statement of net assets, encompasses financial and economic resources, as well as current and long-term liabilities. However, fiduciary assets and liabilities are excluded from government-wide financial statements, as these resources cannot be used to finance the government’s programs and operations. Government-wide financial statements are also accounted for under the strong accrual basis of accounting. Revenues are recognized on the basis of establishing an enforceable claim. Expense recognition is triggered by the use of economic resources or the incurrence of short- and long-term economic liabilities. The degrees of accrual concept presented in Exhibit 11.7 compares the strong accrual basis with the moderate and mild bases. The latter is used in governmental fund accounting and will be discussed in subsequent chapters. Governmental and business-type activities are distinguished in the government-wide financial statements. Governmental activities produce public goods which benefit citizens as a whole and are financed by taxes, intergovernmental grants, and other non-exchange revenues. In contrast, business-type activities produce goods and services for individual consumers and are financed by user fees. The statement of net assets presents assets less liabilities equal net assets, but not fund balance or equity. The three components of net assets are net assets invested in

capital assets, net of related debt, restricted net assets, and unrestricted net assets. Restricted and unrestricted net assets form the government’s net financial assets. Restrictions are imposed by creditors, grantors, higher-level governments, and law. The statement of activities follows the net revenue or expense format. If direct expenses and the program’s share of indirect expenses are greater than program revenues, the difference is called net expense. If the reverse is true, if expenses are less than program revenues, the difference is called net revenue. In keeping with the nature of such activities, governmental activities usually have net expenses, while business-type activities can have net expense, net revenue, or breakeven. The accounting system supporting the government-wide financial statements rests upon the concepts of accounting bases and accrual. Under the cash basis, revenues and expenses are recognized with the receipt or disbursement of cash, respectively. The mild accrual basis, used in governmental fund statements, counts increases in current receivables as revenue and increases in current liabilities as expenditure. The scope broadens with the moderate accrual basis, which also recognizes long-term receivables and liabilities as revenue and expense, respectively. Lastly, the strong accrual basis used in government-wide financial statements includes economic (non-financial) measures of expense and components of revenue. Using the Village of Oak Park example (Exhibit


20

11.10), each basis produces a different measure of cost of service, with the cash basis yielding the lowest cost of service and the strong accrual basis producing the highest. The government-wide financial statements are essentially an aggregation of data found in the fund financial statements. For example, restrictions of net assets for debt service or capital projects come from the debt service and capital project fund financial statements. The next chapter discusses funds and fund accounting.


21

APPENDIX

Before GASB Statement 34

Prior to the issuance of GASB Statement No. 34 in June 1999, the National Council on Governmental Accounting (NCGA, GASB’s predecessor) required American state and local governments to report a Combined Balance Sheet and a Combined Statement of Revenues, Expenditures, and Changes in Fund Balance. Described in NCGA Statement No. 1, these statements are reproduced for comparison purposes in Exhibit 11.A-2 and Exhibit 11.A-3, respectively.

Exhibit 11.A-1. A Comparison of Current and New Requirements.

Dimension Pre-34 Requirements Statement No. 34 Requirements

Report Structure Pyramid model: combining statements of funds aggregated to combined financial statements by fund type.

Dual perspective: the government-wide perspective; and the major funds and other funds.

Management’s

Discussion and

analysis

Not required; wide management discretion as to content and style in letters of transmittal.

Required supplementary information with specific guidelines as to content.

Basis of

Accounting

Depends on nature of funds and activities financed: Full accrual for business-like funds; modified accrual for governmental funds.

Depends on financial reporting perspective: full accrual for government-wide statements; no change for fund financial statements.

Relative

Emphasis

Current operations (statement of activities) receives greater emphasis.

Financial position (statement of net assets) receives greater emphasis.

Statement of

Activities

Shows the use of available resources.

Shows the net expense of services to be financed by general revenues.

Budget

Comparison

Actual vs. latest revised budget, using budgetary basis.

Actual vs. original and revised budgets, also using budgetary basis.

Fixed Assets Included in funds if belonging to proprietary funds; reported in account group if belonging to whole government; infrastructure excluded.

Reported in government-wide financial statements, supported by schedules; not included in governmental type funds.

Depreciation of

Fixed Assets

Depreciation expense and net book value reported in case of fixed assets of proprietary funds; no depreciation

Depreciation expenses and net book value reported for all fixed assets, with certain exceptions.


22

expense reported for general fixed assets.

Long-term Debt Included in funds if incurred by proprietary funds; reported in account group if belonging to whole government.

Reported in the government-wide financial statements, supported by schedules.

Account Group General fixed assets account group and general long-term debt account group required.

Account groups are abolished; substantive disclosures via schedules and notes.


23

Exhibit 11.A-2 – Name of Governmental Unit

Combined Balance Sheet—All Fund Types and Account Groups

December 31, 19X2

Dollar amounts in thousands

Governmental Fund Types

Proprietary

Fund Types

Fiduciary

Fund

Type

Account Groups

Totals

(Memorandum

Only)

ASSETS General

Special

Revenue

Debt

Service

Capital

Proj-

ects

Special

Assess-

ment

Enter-

prise

Internal

Service

Trust

and

Agency

General

Fixed

Assets

General

Long-

Term

Debt

Decem-

ber 31,

19X2

Decem-

ber 31,

19X1

Cash $ 259 $ 102 $ 44 $ 432 $ 232 $ 257 $ 30 $ 217 $ - $ - $ 1,571 $ 1,259 Cash with fiscal agent - - 102 - - - - - - - 102 - Investments,… 65 37 161 - - - - 1,239 - - 1,502 1,974 Receivables (net of allow. for uncoll.): Taxes 58 3 4 - - - - 580 - - 645 255 Accounts 8 3 - 0.1 - 29 - - - - 41 33 Special assessments - - - - 646 - - - - - 646 462

Notes - - - - - 2 - - - - 2 1 Loans - - - - - - - 35 - - 35 40 Accrued interest 0.05 0.025 2 - 0.35 1 - 3 - - 5 3 Due from other funds 2 - - - - 2 12 11 - - 27 17 Due from other govts. 30 75 - 640 - - - - - - 745 101 Advances to Internal Service Funds 65 - - - - - - - - - 65 75 Inventory of supplies,

at cost 7 5 - - - 23 40 - - - 75 71

Prepaid expenses - - - - - 1 - - - - 1 1 Restricted assets: Cash - - - - - 113 - - - - 113 273 Investments… - - - - - 177 - - - - 177 144 Land - - - - - 211 20 - 1,260 - 1,491 1,456 Buildings - - - - - 448 60 - 2,855 - 3,363 2,837 Accumulated deprec. - - - - - (91) (5) - - - (95) (83)

Improvements other than buildings - - - - - 3,888 15 - 1,037 - 4,940 3,922 Accumulated deprec. - - - - - (349) (3) - - - (352) (284) Machinery and equipment - - - - - 1,841 25 - 452 - 2,319 1,924 Accumulated deprec. - - - - - (201) (9) - - - (210) (142) Construction in progress - - - - - 23 - - 1,722 - 1,745 1,360

Amount available in Debt Service Funds - - - - - - - - - 210 210 285 Amt to be provided for retirement of general long-term debt - - - - - - - - - 1,890 1,890 1,075

Total Assets $ 494 $ 225 $ 312 $ 1,072 $ 878 $6,375 $ 185 $ 2,085 $ 7,326 $ 2,100 $21,053 $17,060


24

Exhibit 11.A-2– Name of Governmental Unit


December 31, 19X2

(continued)



Proprietary

Fund Types

Fiduciary

Fund

Type

Account Groups

Totals

(Memorandum

Only)

LIABILITIES General

Special

Revenue

Debt

Service

Capital

Proj-

ects

Special

Assess-

ment

Enter-

prise

Internal

Service

Trust

and

Agency

General

Fixed

Assets

General

Long-

Term

Debt

Decem-

ber 31,

19X2

Decem-

ber 31,

19X1

Vouchers payable $ 118 $ 34 $ - $ 29 $ 21 $ 131 $ 15 $ 3 $ - $ - $ 351 $ 223 Contracts payable 58 18 - 69 50 8 - - - - 203 1,327

Judgments payable - 2 - 23 11 - - - - - 36 32 Accrued liabilities - - - - 11 17 - 5 - - 32 27 Payable from restricted assets: Construction contracts - - - - - 18 - - - - 18 - Fiscal agent - - - - - 0.1 - - - - 0.1 - Accrued interest - - - - - 32 - - - - 32 67 Revenue bonds - - - - - 48 - - - - 48 52

Deposits - - - - - 63 - - - - 63 55 Due to other taxing units - - - - - - - 681 - - 681 200 Due to other funds 24 2 - 1 - - - - - - 27 18 Due to student groups - - - - - - - 2 - - 2 2 Deferred revenue 15 - - - - - - - - - 15 3 Advance from General Fund - - - - - - 65 - - - 65 75

Matured bonds payable - - 100 - - - - - - - 100 - Matured interest payable - - 2 - - - - - - - 2 - General obligation bonds payable - - - - - 700 - - - 2,100 2,800 2,110 Revenue bonds payable - - - - - 1,798 - - - - 1,798 1,846 Special assessment bonds payable - - - - 555 - - - - - 555 420

Total Liabilities 215 56 102 122 648 2,815 80 691 - 2,100 6,828 6,457


25



December 31, 19X2

(continued)



Proprietary

Fund Types

Fiduciary

Fund

Type

Account Groups

Totals

(Memorandum

Only)

FUND EQUITY General

Special

Revenue

Debt

Service

Capital

Proj-

ects

Special

Assess-

ment

Enter-

prise

Internal

Service

Trust

and

Agency

General

Fixed

Assets

General

Long-

Term

Debt

Decem-

ber 31,

19X2

Decem-

ber 31,

19X1

Contributed capital - - - - - 1,393 95 - - - 1,488 815 Investment in general

fixed assets - - - - - - - - 7,327 - 7,327 5,300

Retained earnings: Reserved for revenue bond retirement - - - - - 129 - - - - 129 97 Unreserved - - - - - 2,038 10 - - - 2,048 1,998 Fund balances: Reserved for encumbrances 38 47 - 941 185 - - - - - 1,211 410 Reserved for

inventory of supplies 7 5 - - - - - - - - 12 11

Reserved for advance to Internal Service Funds 65 - - - - - - - - - 65 75 Reserved for loans - - - - - - - 50 - - 50 45 Reserved for endowments - - - - - - - 134 - - 134 94

Reserved for employees’ retirement system - - - - - - - 1,426 - - 1,426 1,276 Unreserved: Designated for debt service - - 210 - 46 - - - - - 256 326 Designated for subsequent years’

expenditures 50 - - - - - - - - - 50 50

Undesignated 119 117 - 9 - - - (216) - - 29 106

Total Fund Equity 279 169 210 950 231 3,560 105 1,394 7,327 - 14,225 10,603

Total Liabilities and Fund Equity $ 494 $ 225 $ 312 $ 1,072 $ 878 $6,375 $ 185 $ 2,085 $ 7,327 $ 2,100 $21,053 $17,060

Source: NCGA Statement 1, pp.30-31, Example 1 Prepared by J. Arellano, 5/25/06


26


Combined Statement of Revenues, Expenditures, and Changes in Fund Balance—All Governmental Fund Types and Expendable Trust Funds

For the Fiscal Year Ended December 31, 19X2 Dollar amounts in thousands Totals

(Memorandum

Only)


Fiduciary

Fund

Type

Year Ended

General

Special

Revenue

Debt

Service

Capital

Projects

Special

Assess-

ment

Expend-

able

Trust

Decem-

ber 31,

19X2

Decem-

ber 31,

19X1

Revenues: Taxes $ 881 $ 189 $ 79 $ - $ - $ - $ 1,150 $ 1,138 Special assessments levied - - - - 240 - 240 250 Licenses and permits 103 - - - - - 103 97 Intergovernmental revenues 186 831 42 1,250 - - 2,309 1,259 Charges for services 91 79 - - - - 170 160 Fines and forfeits 33 - - - - - 33 26

Miscellaneous revenues 20 72 7 4 29 0.2 131 112

Total Revenues 1,314 1,171 128 1,254 269 0.2 4,136 3,042

Expenditures: Current: General government 122 - - - - - 122 134 Public safety 258 480 - - - - 738 672 Highways and streets 85 417 - - - - 502 409

Sanitation 56 - - - - - 56 44 Health 45 - - - - - 45 37 Welfare 47 - - - - - 47 41 Culture and recreation 41 256 - - - - 297 286 Education 509 - - - - 2 512 512 Capital outlay - - - 1,625 313 - 1,939 803 Debt service: Principal retirement - - 60 - - - 60 52

Interest and fiscal charges - - 40 - 28 - 68 50

Total Expenditures 1,163 1,153 100 1,625 341 2 4,386 3,040

Excess of Revenues over (under) Expenditures 151 18 27 (371) (72) (2) (250) 2

Other Financing Sources (Uses): Proceeds of general obligation bonds - - - 900 - - 900 -

Operating transfers in - - - 64 10 3 77 89 Operating transfers out (74) - - - - - (74) (87)

Total Other Financing Sources (Uses) (74) - - 964 10 3 903 2

Excess of Revenues and Other Sources over (under) Expenditures and Other Uses 77 18 27 593 (62) 1 653 4 Fund Balances—January 1 202 151 183 357 293 26 1,213 1,209

Fund Balances—December 31 $ 279 $ 169 $ 210 $ 950 $ 231 $ 27 $ 1,866 $ 1,213

Source: NCGA Statement 1, p. 33, Example 2 Prepared by J. Arellano, 5/25/06


27

KEY CONCEPTS AND TERMS

Government-wide financial statements:

broad measurement focus primary government component unit

financially accountable blended presentation discrete presentation

governmental activities business-type activities net assets

net assets invested in capital assets, net of related debt

restricted net assets unrestricted net assets program revenues

net revenue (expense) general revenues

Accrual accounting:

operating debt capital debt expenditure expense

inter-period equity receivable in-kind payments non-exchange transaction

claim derived taxes imposed taxes grant

REFERENCES AND FURTHER READINGS

Governmental Accounting Standards Board, Concept Statement No. 1 “Objectives of

Financial Reporting” (May 12987).

GASB, Statement No. 34 “Basic Financial Statement – and Management’s Discussion

and Analysis – for State and Local Governments” (June 1999).

GASB, Statement No. 33 “Accounting and Financial Reporting for Non-exchange

Transactions” (December 1998).

GASB Statement No. 14 “The Financial Reporting Entity” (June 1991).

GASB, Codification of Governmental Accounting and Financial Reporting Standards

(various dates).

National Council on Governmental Accounting, Statement No. 1 “Governmental

Accounting and Financial Reporting Principles” (1979).

Gauthier, Stephen., Governmental Accounting, Auditing and Financial Reporting

(Chicago: Government Finance Officers Association ), 2005.


28

Chapter 11

REVIEW QUESTIONS

1. What are the objectives of the government-wide financial statements?

2. What are the accounting standards underlying the government-wide financial

statements?

3. Does information about fiduciary activities appear in the government-wide financial

statements? Why or why not?

4. Under what circumstances does a primary government have financial accountability

for another legally independent unit of government?

5. How are a government’s assets, liabilities, revenues and expenses classified?

6. What are the three components of net assets and their characteristics?

7. How are the Statement of Net Assets and Statement of Activities related?

8. What are the three degrees of accrual?

9. How do the different degrees of affect the recognition of cost of service?

10. How do the different degrees of accounting affect the recognition of revenue?

DISCUSSION QUESTIONS

1. Compare and contrast the following pairs of concepts or terms:

a. primary government, component unit

b. blended presentation, discrete presentation

c. governmental activities, business-type activities

d. net expense, net revenue

e. restriction, designation

2. Compare and contrast the following pairs of concepts or terms:

a. program revenues, general revenues

b. operating debt, capital debt

c. operating grant, capital grants

d. expense, expenditure

e. derived taxes, imposed taxes

3. How are the government-wide financial statements of a state or local government

different from those of the Federal Government?

4. How are the government-wide financial statement of a state or local government

different from those of a nonprofit organization that follows FASAB Statement No.

17?

5. How are the government-wide financial statements required by GASB Statement No.

34 different from the overview (“combined”) financial statements state and local

governments used to present before Statement 34 became effective (see Appendix)?

6. When and why is a primary government (PG) required to show some other legally

independent units of government in its (PG’s) government-wide financial statements?

7. Why is it necessary or useful to separate governmental activities and business-type

activities?

8. In what ways is the concept of “modified accrual” vague? How can it be made more

clear?

9. How do the government-wide financial statements required by GASB Statement No.

34 help the residents of a local community evaluate inter-period equity? Hint: A local

resident can be a voter, tax payer and user of public service.


29

10. When does government as a taxing authority have a (legally) enforceable claim

against a taxpayer for (a) a parking violation; (b) sales tax, (c) income tax, (d)

property tax?

EXERCISES

1. Conceptual Categories of Assets and Liabilities. Refer to the Statement of Net Assets

of Sample City in Exhibit 11.1. Determine the amounts of the city’s (a) current

financial resources, (b) net current financial resources, (c) financial resources, (d) net

financial resources. Required: Be sure to individually identify the elements in the

financial statements that are summed up. When in doubt, state your assumptions and

reasoning.

2. Summary of Accounting Policy. Obtain the government-wide financial statements for

the most recent fiscal year of the municipality in which your college or university is

located (the City of Chicago in the case of the University of Illinois at Chicago), and

read Note 1 to the financial statements, which summarizes significant accounting

policies. Required: Write a one-page essay summarizing those policies that underlie

the government-wide financial statements.

3. Examples of Component Units. Obtain the government-wide financial statements for

the most recent fiscal year of the State in which your college or university is located

(the State of Illinois in the case of the University of Illinois at Chicago), and read the

“financial reporting entity” section of Note 1 to the financial statements. Required: (a)

Identify the component units that are blended into the primary government. (b)

Identify the major component units that are discretely presented. (c) Identify the joint

ventures, related organizations and jointly governed organizations, which are

excluded from the government-wide financial statements.

4. Drafting Management’s Discussion and Analysis. Obtain the government-wide

financial statements for the most recent fiscal year of the municipality in which your

college or university is located. Required: (a) Write a short (1/4 page) essay to give

the municipality government’s financial highlights in that year. (b) Compare your

description in (a) with the description in the Management’s Discussion and Analysis

in the municipality’s CAFR.

5. Drafting Management’s Discussion and Analysis. Obtain the government-wide

financial statements for the most recent two fiscal years of the municipality in which

your college or university is located. Required: (a) Write a short (1/2 to one page)

essay to describe how the municipal government’s financial position and financial

performance changed between those two years. (b) Compare your description with

the description in the Management’s Discussion and Analysis in the municipality’s

CAFR.

6. Deciding Inclusion/Exclusion for the Financial Reporting Entity. Consider the

following assumed facts and decide how to report potential component units:

a. Local School Board. The City Board of Education (BOE) is a separately

elected body that administers the public school system in the city. The BOE is

not organized as a separate legal entity and does not have the power to levy

taxes or issue bonds. Its budget is subject to approval by the city council to the

extent that, under state law, the BOE has the discretionary authority to expend


30

the amount appropriated to it by the city. The BOE requests a single sum to

fund its operations; the city council can reject the BOE’s request and

appropriate a lesser amount, but it does not have the ability to modify the

individual line item amounts in the BOE’s requested budget.

b. Building Authority. The Building Authority was created by the city and

organized as a separate legal entity. The authority is governed by a five-

person board appointed for six-year terms by the mayor, subject to city

council approval. The authority uses the proceeds of its tax-exempt bonds to

finance the construction or acquisition of general capital assets for the city

only. The bonds are secured by the lease agreements with the city and will be

retired through lease payments from the city. (Source: GASB Statement No.

14 “The Financial Reporting Entity,” Appendix D, Examples 10, 1).

7. Deciding Inclusion/Exclusion for Reporting Entity. Consider the following assumed

facts about the State University and decide how to handle it in the State’s

government-wide financial statements:

State University. State statutes grant the university system and its institutions

broad corporate powers. The governor appoints all the members to the

institutions’ board of trustees. Each board consists of nine appointees – one

appointed each year for a nine-year term. No significant, continuing relationship

with the governor is maintained after the appointments are made. The

management personnel for these institutions are appointed by, and report to, the

board of trustees. The state plays no significant role in influencing day-to-day

operations and in directly controlling an individual institution’s budget, surpluses

or deficits, fiscal management, or the characteristics of the institution’s revenue

sources. The state’s appropriation for each institution is determined by a funding

formula that is based primarily on the type of programs offered at each institution

and the number of full-time-equivalent students enrolled. The state’s approach to

budgeting focuses on aggregate levels of support for programs as opposed to

institutional-level funding decisions. Over the past ten years the state

appropriations have averaged 55 percent of the institutions’ unrestricted

educational and general revenues. State law allows each institution to maintain its

own treasury, to spend revenue it receives without an appropriation by the

legislature, and to retain state subsidies not expended at the close of the fiscal

year. In addition to the annual appropriations to support the institutions’

operations, the state provides funding and constructs major academic plant

facilities for the institutions. The bonds issued to finance the construction of the

facilities are general obligation obligations of the state secured by a pledge to

assess special additional student fees, if the need arises. (Source: GASB Statement

No. 14 “The Financial Reporting Entity,” Appendix D, Examples and 11).

8. Deciding Inclusion/Exclusion for Financial Reporting. Consider the following facts

about the Oak Park Public Library and decide how to handle its reporting in the

government-wide financial statements of the Village of Oak Park:

The Oak Park Public Library has a separately elected governing board, which

annually determines its budget and resulting property tax levy. Upon approval

of the Board of Trustees of the Village of Oak Park, the levy is submitted to

the County of Cook, which collects property taxes for area local governments.


31

All debt of the Library is secured by the full faith and credit of the Village of

Oak Park, which is wholly liable for the debt. The Library, while servicing the

general population of the Village, does not provide services entirely to the

Village. (Source of information: Village of Oak Park, Illinois CAFR for Fiscal

Year 2002, p. 16.)


32

GLOSSARY

of Key Terms and Concepts

Government-Wide Financial Statements:

Broad Measurement Focus

Also called economic resources measurement focus. “Measurement focus where the

aim of a set of financial statements is to report all inflows, outflows, and balances

affecting or reflecting an entity’s net assets. The economic resources measurement

focus is used for proprietary and trust funds, as well as for government-wide financial

reporting. It is also used by business enterprises and nonprofit organizations in the

private sector.” [Gauthier, Glossary, p. 686]

Primary Government

“A state government or general purpose local government. Also, a special-purpose

government that has a separately elected governing body, is legally separate, and is

fiscally independent of other state or local governments. The primary government is

the focus of the financial reporting entity.” [Gauthier, Glossary, p. 706]

Component Unit

“Legally separate organization for which the elected officials of the primary

government are financially accountable. In addition, component units can be other

organizations for which the nature and significance of their relationship with a

primary government are such that exclusion would cause the reporting entity’s

financial statements to be misleading or incomplete.” [Gauthier, Glossary, p. 682]

Financially Accountable

“The financial accountability [of the primary government over component units] may

derive from the power of the PG to appoint a majority of the governing board of the

component unit, and either (a) the PG can impose its will on the CU (e.g. to approve

or disapprove its budget) or (b) the CU can benefit or burden the PG.” [Chan, Ch. 11,

p. 4]

Blended Presentation

“Presentation of the data of a component unit as though it were one or more fund(s)

of the primary government.” [Gauthier, Glossary, p. 678]

Discrete Presentation

“Method of reporting financial data of component units separately from financial data

of the primary government.” [Gauthier, Glossary, p. 686]

Governmental Activities

“Activities generally financed through taxes, intergovernmental revenues, and other

nonexchange revenues. These activities are usually reported in governmental funds

and internal service funds.” [Gauthier, Glossary, p. 692]

Business-Type Activities

“Business-type activities are financed in whole or in part by fees charged to external

parties for goods or services. These activities are usually reported in enterprise

funds.” [Gauthier, Glossary, p. 679]

Net Assets


33

“The difference between a government’s assets and its liabilities in the government-

wide statement of net assets is its net assets. Net assets should be displayed in three

components—invested in capital assets, net of related debt; restricted (distinguishing

between major categories of restrictions); and unrestricted.” [GASB 34, par. 32]

Net Assets Invested in Capital Assets, Net of Related Debt

“This component of net assets consists of capital assets… including restricted capital

assets, net of accumulated depreciation and reduced by the outstanding balances of

any bonds, mortgages, notes, or other borrowings that are attributable to the

acquisition, construction, or improvement of those assets.” [GASB 34, par. 33]

Restricted Net Assets

“Net assets should be reported as restricted when constraints placed on net asset use

are either: (a) Externally imposed by creditors (such as through debt covenants),

grantors, contributors, or laws or regulations of other governments; (b) Imposed by

law through constitutional provisions or enabling legislation.” [GASB 34, par. 34]

Unrestricted Net Assets

“Unrestricted net assets consist of net assets that do not meet the definition of

‘restricted’ or ‘invested in capital assets, net of related debt.’ In the governmental

environment, net assets often are designated to indicate that management does not

consider them to be available for general operations. In contrast to restricted net

assets, these types of constraints on resources are internal and management can

remove or modify them.” [GASB 34, par. 36-37]

Program Revenues

“In the context of the government-wide statement of activities, revenues that derive

directly from the program itself or from parties outside the reporting government’s

taxpayers or citizenry, as a whole; they reduce the net cost of the function to be

financed from the government’s general revenues.” [Gauthier, Glossary, p. 706]

Net Revenue (Expense)

“If the expense is greater than the program revenues, the difference is called net

expense; if the expense is less than the program revenues, the difference is called net

revenue.” [Chan, Ch. 11, p. 9]

General Revenues

“All revenues are general revenues unless they are required to be reported as program

revenues… All taxes, even those that are levied for a specific purpose, are general

revenues and should be reported by type of tax—for example, sales tax, property tax,

franchise tax, income tax. All other nontax revenues (including interest, grants, and

contributions) that do not meet the criteria to be reported as program revenues should

also be reported as general revenues.” [GASB 34, par. 140]

Accrual Accounting:

Operating Debt

Liabilities that arise from providing services. [Chan, Ch. 11, p. 12]

Capital Debt

Liabilities that arise from purchases of capital equipment. [Chan, Ch. 11, p. 12]

Expenditure

“Under the current financial resources measurement focus, decreases in net financial

resources not properly classified as other financing uses.” [Gauthier, Glossary, p.


34

688]

Expense

“…expenses include increases in long-term liabilities (moderate accrual basis) and

outflows of non-financial resources (strong accrual basis).” [Chan, Ch. 11, p. 13]

Inter-Period Equity

“… means that the taxpayers in a year should pay for all of the cost of service

provided in that year regardless of when the cost will be paid in cash.” [Chan, Ch. 11,

p. 13]

Receivable

“Service delivered in advance of customer’s payment entitled the seller to record a

receivable. In other words, sales revenue is recognized to the extent of services

delivered.” [Chan, Ch. 11, p. 14]

In-Kind Payments

“In-kind payments are made in lieu of cash to satisfy tax obligations.” [Chan, Ch. 11,

p. 14]

Non-Exchange Transaction

“Transaction in which a government (including the federal government, as a provider)

either gives value (benefit) to another party without directly receiving equal value in

exchange or received value (benefit) from another party without directly giving equal

value in exchange.” [Gauthier, Glossary, p. 701]

Claim

“… an assertion of a right to someone else’s property.” [Chan, Ch. 11, p. 15]

Derived Taxes

“Nonexchange revenues that result from assessments imposed on exchange

transactions (for example, income taxes, sales taxes, and other assessments on

earnings or consumption).” [Gauthier, Glossary, p. 685]

Imposed Taxes

“Revenues that result from assessments imposed on nongovernmental entities,

including individuals, other than assessments on exchange transactions (for example,

property taxes and fines).” [Gauthier, Glossary, p. 693]

Grant

“Transactions in which one governmental entity transfers cash or other items of value

to (or incurs a liability for) another governmental entity, an individual, or an

organization as a means of sharing program costs, subsidizing other governments or

entities, or otherwise reallocating resources to the recipients.” [Codification, p. 745,

par. 504]

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