Chapter 3

Issues of Budgeting and Control

1

Learning Objectives

Key Purposes of Budgets

Various ways of classifying expenditures

Key Phases of the Budget cycle

Limitations of Actual-to-budget comparisons

How an encumbrance system prevents overspending

How budgets enhance control

2

Budgets

Key Purposes of Budgets• Planning: Planning is concerned with specifying the type,

quantity, and quality of services that will be provided to constituents; estimating service costs; and determining how to pay for the services.

• Controlling and Administering: Budgets help assure that resources are obtained and expended as planned. Managers use budgets to monitor resource flows.

• Reporting and evaluating: Budgets lay the foundation for end-of-period reports and evaluations. Budget-to-actual comparisons reveal whether revenue and spending mandates were carried out. More important, when tied to an organization’s objectives, budgets can facilitate assessments of efficiency and effectiveness.

3

The General Fund and special revenue funds usually require a legally adopted budget before the government can collect revenues from taxes and other sources and incur expenditures.

Severe penalties may exist for failure to comply with the budget, so it is imperative that the accounting system facilitate accounting for the budget as well as all other operating transactions.

Budgets in Government are MUCH MORE IMPORTANT than they are in Business

4

Major types of Budgets

• Appropriation Budget: which are concerned mainly with current operating revenues and expenditures. Monitors current or operating fund (i.e. general fund). Typically covers one operating cycle.

Capital Budget Monitors construction and acquisition of long-lived assets. Typically covers multiple years.

Flexible Budget Contains alternative budget estimates based on varying levels

of output. Helps distinguish fixed and variable costs. Most useful to business-type activities where level of activity

depends on customer demand.

5

Key Phases of Budget Cycle

Preparation

Legislative adoption and executive approval

Execution

Reporting and auditing

6

Current GASB Model Vs. Old Model Old model: governments reported only their

amended budget.

Current model: requires the actual results and both the original and final appropriated budgets.

Budgetary compliance can be assured by building safeguards in the accounting systems. Journals Ledgers

7

CITY OF HOUSTONGENERAL FUND BUDGET FOR FISCAL YEAR 2008

(unaudited)(amounts expressed in thousands)

Total Budgeted Resources $ 1,984,199

Total Budgeted Expenditures 1,768,473

Designated "Sign Abatement" Amount 2,070Designated "Rainy Day" Amount 20,000Budgeted Ending Fund Balance as of June 30, 2008 193,656

Total Budgeted Expenditures and Reserves $ 1,984,199

8

Purpose: Used to record the budgetary inflows and outflows estimated or authorized in the annual budget.

Accounts: Estimated Revenues, Estimated Other

Financing Sources Appropriations, Estimated Other

Financing Uses Encumbrances: commitments to purchase

goods or services.

Budgetary Accounts

9

Revenues and Other Financing Sources increase fund balance when closed. Both are recognized on the Modified Accrual basis--when measurable and available to pay current period obligations.

Expenditures and Other Financing Uses decrease fund balance when closed. Both are recognized on the Modified Accrual basis--when incurred, if expected to be repaid from currently available resources of the fund.

Budgetary and Operating Statement Accounts

10

An appropriation is a legal authorization granted by the legislative body to incur liabilities for purposes specified in the appropriation act or ordinance.

Let’s do a simple example

11

Example A A city government incorporates its budget in

its accounting system and encumbers all commitments. Prior to the start of the year, the city council adopted a budget in which city revenues were estimated at $500,000 and expenditures of $450,000 were appropriated. Record the budget using only the control accounts.

Estimated revenues $500Appropriations $450Fund balance 50

Next slide shows what the detail might look like

12

Budget Approved on 1-1-2010: Dr. Cr.Estimated Revenues 500,000

Appropriations 450,000Fund Balance 50,000

Revenues Ledger:Taxes 300,000Licenses and Permits 50,000Intergovernmental Revenues 50,000Charges for Services 50,000Fines and Forfeits 25,000Miscellaneous Revenues 25,000Appropriations Ledger: General Government 120,000 Public Safety 150,000 Public Works 100,000 Culture and Recreations 80,000

Examples of Budgetary Journal Entries (A)

$500,000

$450,000

13

An encumbrance is an estimated amount recorded for purchase orders, contracts, or other expected expenditures chargeable to an appropriation.

Budgetary and Operating Statement Accounts (cont’d)

14

Encumbrance Prevents overspending the budget. Entry to record encumbrance is made

when purchase order is issued, a contract is signed, or a commitment is made.

Entry that records encumbrance reduces the budget available for expenditure.

Outstanding encumbrances are reported in the notes to the entity’s financial statements No longer on face of balance

sheet per GASB 54.

15

Impact of GASB 54Significant encumbrances must be reported in the

notes to the financial statements A separate display of encumbrances within fund

balance categories is not permitted In the general fund: add encumbrances not related

to restricted, committed or assigned purposes to the unassigned fund balance

In special purpose funds: add encumbrances for specific purposes to the appropriate committed or assigned fund balance

16

Let’s do an example with encumbrances

Based on the Example posted on Blackboard

17

Budgetary control of expenditures is achieved by:ensuring that a valid appropriation exists

prior to recording an encumbrance or expenditure, and

periodically comparing encumbrances and expenditures to appropriations.

Comparison is enhanced by using a common classification scheme for appropriations, encumbrances, and expenditures

Budgetary Control — Expenditures

18

Example: City Clerk's office orders a new multi-purpose machine on January 2, 2010 which had a list price in the vendor's catalog of $500.

General Fund General Journal: Dr. Cr.

Encumbrances--2010 $500Reserve for Encumb.--2010 $500

Example B - Budgetary Control

19

Appropriations (expenditure budget)

Estimated revenues & other sources of financing (revenue budget)

Encumbrances (unfilled orders)

The sum of the detailed Appropriations, Encumbrances, and Expenditure account balances of the subsidiary ledger must equal the general ledger control account balances.

Accounting Control over Expenditures

20

ASSETS = LIABILITIES + FUND BALANCE

Balance

Sheet Reserved (Nonspend + Unreserved (Unassig)

Accounts + Rest., Comm., & Assign) FB Fund Balance

(permanent)

Budgetary/

Operating Budgetary Accounts Operating Accounts

Statement

Accounts

(temporary)

Accounting model for the General Fund

21

Classification of ExpendituresGASB suggestions classifying expenditures by any of the

following: Fund

Ex. general fund, special revenue fund, debt service funds , etc. Function or Program

Def. Group of activities carried out with the same objective. Ex. general government, public safety, sanitation, and recreation etc.

Organization Unit Ex. police department, fire department, etc.

Activity Def. Line of work contributing to a function or program Ex. highway patrol, burglary investigations, etc.

Character Def. The fiscal period presumed to benefit Ex. Current, Capital, Debt Service

Object البند Def. The types of items purchased or services obtained Ex. Salaries, fringe benefits, travel, etc.

22

Most Commonly Used Budget . . .

ObjectObject Classification Classification BudgetBudget

23

Object Classification Budget Traditional and most common Facilitates control

Drawbacks: Discourages planning Promotes bottom-up budgeting than top-down

budgeting Overwhelms top-level decision-makers with

details Limits post-budget evaluation

24

Classification of Revenues and Estimated Revenues

GASB Suggestion: 1st classify by fund 2nd classify by source

FUND

SOURCE

Sources include: Taxes (Ad-valorem and self-assessing) Special Assessments Licenses and Permits Intergovernmental Revenues Charges for Services Fines and Forfeits Miscellaneous Revenues

25

On What Basis of Accounting are Budgets Prepared?

26

Basis of Accounting Neither GASB nor FASB have control over

budgeting principles– Budgeting principles are set by either the

government/organization or the government/organization that supervises them

GASB recommends using modified accrual basis of accounting.

However, most governments use the cash basis for their budgets.

27

Cash Basis Budgeting Budgeting principles are established by

individual governments or organizations and not by GASB nor FASB.

Although GASB recommends the use of modified accrual basis in preparing the annual budgets, many governments adopt cash basis or modified cash basis.

28

Cash Basis Budgeting Governments using cash basis: Assign revenues and expenditures to

the period during which the cash is expected to be received or disbursed.

Treat encumbrances equivalent to actual purchases.

Others permit recognizing taxes and other revenues in the year in which they are due and not in the year in which they are expected to be collected, as long as they are expected to be collected within a reasonable period of time.

29

Cash BasisDisadvantages:

May distort the economic impact of planned fiscal activities.

A budget that is balanced on a cash basis may be decidedly unbalanced.

It may give an appearance of a budget that has achieved inter-period equity when it really has not.

Complicates financial accounting and reporting.

30

Differences arise between the legally adopted budgets and GAAP-based financial statements.

They are caused by: Basis of accounting Timing Perspective Reporting entity

Legally adopted budgets vs. GAAP-based Financial Statements

31

Performance Budgets

Supplement to object classification budgets Focus on measurable units of efforts, services,

and accomplishments. They are formulated so that dollar expenditures are directly associated with anticipated units of outcomes or outputs.

Institutionalize effective decision process The most common type of performance budget

is program budget.

32

Recording Budgets ExampleAdditional examples

to study (beyond textbook and ones we did in class)

33

Recording Budgets Estimated revenues (DB) – Actual Revenues

(CR) = Remaining revenue to be recognized

Appropriations (CR) - Actual expenditures (DR) = Balance available for expenditure

Refer to pgs. 105-108 for budgeting entries.

34

Example C

A government health care district incorporates its budget in its accounting system and encumbers all purchase orders and contracts. Prior to the start of the year, the governing board adopted a budget in which agency revenues were estimated at $5,600 and expenditures of $5,550 were appropriated. Record the budget using only the control accounts.

JE 1: Estimated revenues $5,600Appropriations $5,550Fund balance 50

35

Example - C (cont’d)JE 2: During the year, the government health

care district collected $5800 in fees, grants, taxes, and other revenues. Prepare journal entries.

Cash $5,800Revenues 5,800

JE 3: It ordered goods and services for $3,000.

Encumbrances $3,000Reserve for encumbrances 3,000

36

Example – C (cont’d)JE 4: During the year it received and paid for $2,800 of

goods and services that had been previously encumbered. It expects to receive the remaining $200 in the following year.

a: Expenditures $2,800Cash 2,800

b: Reserve for encumbrances$2,800Encumbrances 2,800

JE 5: It incurred $2500 in other expenditures for goods and services that had not been encumbered.

Expenditures $2,500Cash 2,500

37

Example –C (cont’d)Prepare end of year closing entries.

JE 6: Revenues $5,800 Estimated revenues 5,600 Fund balance 200

JE 7: Appropriations $5,550 Expenditures 5,300 Encumbrances 200 Fund balance 50

38

Supporting Computations – original styleReserve for Encumbrancesdr cr balance

bal fwd $0 3 3,000 (3,000)

4b 2,800 (200)

(200)

Encumbrances (temporary acct)

dr cr balancebal fwd 0

3 3,000 3,000 4b 2,800 200 7 200 0

Fund balance (unassigned, unreserved)

dr cr balancebal fwd 0

1 50 (50)6 200 (250)7 50 (300)

Total fund balance at year end: Fund balance –committed (Reserved for encumbrances ) 200 Fund Balance Unassigned (unreserved) 300 Total 500 This should equal revenues – expenditures (since bal fwd in FB was 0)

Revenue – Expenditures = 5,800 – 5,300 = $500

39

Example C (alternate style closing)

Fund=General Fund Debit Credit

JE 6 Reverse original budgetary entry:

Appropriations $5,550

Fund balance (unassigned) 50

Estimated revenues 5,600

JE 7 Close revenue, expenditure & encumbrance accounts

Revenues $5,800

Expenditures 5,300

Encumbrances 200

Fund balance (unassigned) 300

40

Supporting Computations – alternate styleReserve for Encumbrancesdr cr balance

bal fwd $0 3 3,000 (3,000)

4b 2,800 (200)

(200)

Encumbrances (temporary acct)

dr cr balancebal fwd 0

3 3,000 3,000 4b 2,800 200

7 200 0

Fund balance (unassigned, unreserved)

dr cr balancebal fwd 0

1 50 (50)6 50 -

7

300 (300)

Total fund balance at year end: Fund Balance –committed (Reserved for encumbrances) 200 Fund Balance -Unassigned (unreserved) 300 Total 500

This should equal revenues - expenditures 5,800 since balance fwd was zero 5,300

TRUE 500

41

City of Houston - FactsDid you know?

The final sales tax revenue for FY 2009 was $507 million, 2.4 % more than FY 2008 amount.

Sales taxes comprise 21% of the city’s revenue source for governmental activities.

Total unreserved fund balance of the General Fund for FY 2009 was $281 million.

42

The General Fund and special revenue funds usually require a legally adopted budget before the government can collect revenues from taxes and other sources and incur expenditures.

Severe penalties may exist for failure to comply with the budget, so it is imperative that the accounting system facilitate accounting for the budget as well as all other operating transactions.

END!

Summary

43