This page covers objectives of governmental accounting and governmental funds such as general funds, special funds, debt service funds, permanent funds and capital project funds.
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OBJECTIVES OF ACCOUNTING AND FINANCIAL REPORTING
Objectives of Accounting and Financial Reporting for State and Local Governmental Units GASB has issued six concept statements. Concepts Statement No. 1 identifies three primary user groups of government accounting information: creditors, citizens, and oversight bodies (including granting agencies and the legislature). The information needs of government creditors are not greatly different from their counterparts in the corporate world, namely to evaluate the likelihood the government will continue to make its debt payments as they come due. Citizens and oversight bodies have a very different purpose, which is to determine whether elected officials have raised and expended the public’s money in a manner consistent with law and the public’s best interest. Satisfying this citizen’s “right to know” objective is not easily accomplished and commonly requires government financial reports to provide much greater detail than can be found in corporate annual reports. One difficulty governments have in meeting the information needs of citizens is that traditional financial statements, which measure events in dollars, are not well designed to evaluate the government’s effectiveness in delivering services. For example, consider a public school system. A traditional financial report will show the sources of revenues and amounts expended, but does little to tell the reader whether the schools are doing a good job. In many cases nonfinancial measures are better indicators of performance. These might include the number of students advancing to the next grade, graduation rates, and scores on college entrance exams. Concepts Statements No. 2 and No. 5 relate to the reporting of nonfinancial measures, called service efforts and accomplishments reporting.
Concepts Statement No. 3 defines methods of presenting information in financial reports and develops the following disclosure hierarchy: When items (assets, liabilities, revenues, etc.) can be measured with sufficient reliability, they should be reported in the basic financial statements. The notes to the financial statements are intended to enhance the understanding of items appearing in the financial statements, but are not a substitute for recognition when a transaction or event can be measured with sufficient reliability. Occasionally, the GASB determines that additional information is necessary to provide context and understanding of information in the statements or notes. page 10 In such cases, the GASB requires the presentation of required supplementary information (RSI). RSI appears most commonly in the form of schedules or tables. Management’s Discussion and Analysis is also an example of RSI. The final level of disclosure includes other supplementary information that is not required by GASB standards but which the reporting government feels is useful in understanding the operations of the government. All three standards-setting organizations—the Federal Accounting Standards Advisory Board, the Financial Accounting Standards Board, and the Governmental Accounting Standards Board—take the position that the establishment of accounting and financial reporting standards should be guided by conceptual considerations so that the body of standards is internally consistent and the standards address broad issues. The cornerstone of a conceptual framework is said to be a statement of the objectives of financial reporting.
Concepts Statement No. 4 provides key definitions of items appearing in financial statements. Not surprisingly, assets, liabilities, and net position (residual equity) are each defined. However, GASB utilizes two additional elements that do not appear in the balance sheets of nongovernmental organizations: deferred inflows and deferred outflows of resources. The most common deferred inflows are taxes that have been deferred to a future period when they are expected to be available for operations. Deferred inflows and outflows are also used by GASB to record events and transactions that appear in Accumulated Other Comprehensive Income (AOCI) in commercial organizations. For example, prior service costs resulting from changes in pension terms and changes in the value of hedging derivatives are recognized as AOCI by business organizations and as deferred inflows and outflows by governments.
Finally, Concepts Statement No. 6 examines the issue of when it is most appropriate to measure assets and liabilities at historical cost and when it is more appropriate to remeasure assets to fair value or settlement amount. In general, remeasurement is appropriate for assets that will be converted to cash and liabilities where there is uncertainty over the timing and amount of payments.
Objectives of Financial Reporting by the Federal Government
The Federal Accounting Standards Advisory Board (FASAB) was established to recommend accounting and financial reporting standards to the principals—the U.S. Office of Management and Budget, the U.S. Department of the Treasury, and the U.S. Government Accountability Office. The FASAB has issued six Statements of Federal Financial Accounting Concepts (SFFACs). These concepts apply to financial reporting for the federal government as a whole and for individual reporting agencies.
SFFAC 1, Objectives of Federal Financial Reporting, outlines four objectives that should be followed in federal financial reporting. The first, budgetary integrity, indicates that financial reporting should demonstrate accountability with regard to the raising and expending of moneys. The second, operating performance, suggests that financial reporting should enable evaluation of the service efforts, costs, and accomplishments of the federal agency. The third, stewardship, reflects the concept that financial reporting should enable an assessment of the impact on the nation of the government’s operations and investments. Finally, the fourth, systems and controls, indicates that financial reporting should reveal whether financial systems and controls are adequate.
Other federal government accounting concepts statements include:
- SFFAC 2—Entity and Display,
- SFFAC 3—Management’s Discussion and Analysis,
- page 11 SFFAC 4—Intended Audience and Qualitative Characteristics for the Consolidated Financial Report of the United States Government, and
- SFFAC 5—Definitions of Elements and Basic Recognition Criteria for Accrual-Basis Financial Statements.
STATE AND LOCAL GOVERNMENT FINANCIAL REPORTING
GASB Concepts Statements stress that accounting and reporting standards for state and local governments should meet the financial information needs of many diverse groups: citizen groups, legislative and oversight officials, and investors and creditors. The primary report for meeting these diverse needs is the Comprehensive Annual Financial Report.
Comprehensive Annual Financial Report
GASB Codification Sec. 2200 sets standards for the content of the Comprehensive Annual Financial Report of a state or local government reporting entity. A Comprehensive Annual Financial Report (CAFR) is the government’s official annual report prepared and published as a matter of public record. In addition to the basic financial statements and other financial statements, the CAFR contains introductory material, an auditor’s report, certain RSI, schedules necessary to demonstrate legal compliance, and statistical tables.
Measurement Focus and Basis of Accounting. State and local governments prepare their financial reports using two general accounting methods. One method assumes an economic resources measurement focus and the accrual basis of accounting, and the other method assumes a flow of current financial resources measurement focus and modified accrual accounting. Each of these two methods is discussed below.
Economic Resources Measurement Focus and the Accrual Basis of Accounting. The government-wide statements and the fund statements for proprietary funds and fiduciary funds use the economic resources measurement focus and the accrual basis of accounting. Measurement focus refers to what items are being reported in the financial statements. An economic resources measurement focus measures both current and long-term assets and liabilities and is the measurement focus used by commercial businesses. A balance sheet prepared on the economic resources focus reports the balances in fixed assets and long-term liabilities. Basis of accounting determines when transactions and events are recognized in the accounting records. The accrual basis of accounting recognizes revenues when they are earned (and are expected to be realized) and recognizes expenses when the related goods or services are used up. Again, this is the basis of accounting used by commercial businesses.
Current Financial Resources Measurement Focus and the Modified Accrual Basis of Accounting. The fund statements for governmental funds are presented using the current financial resources measurement focus and modified accrual basis of accounting. Many of the transactions in governmental funds are nonexchange in nature; that is, they are activities undertaken in response to the needs of the public. Activities reported in governmental funds are heavily financed by taxes and involuntary contributions from persons (and organizations) who do not receive services in direct proportion to the contribution they make. GASB standards provide that accounting systems of governmental funds are designed to measure (a) the extent to which financial resources obtained during a period are sufficient to cover claims incurred during that period against financial resources and (b) the net financial resources available for future periods. Thus, governmental funds are said to have a flow of current financial resources measurement focus, as distinguished from the government-wide, proprietary fund, and fiduciary fund statements, which have an economic resources measurement focus. page 14 Activities of governmental funds are said to be expendable; that is, the focus is on the receipt and expenditure of resources. These resources are generally restricted to current assets, investments, and liabilities. Modified accrual accounting, as the term implies, is a modification of accrual accounting. Expenditures (not expenses) are recognized in the period in which the fund liability is incurred. Long-term assets, with minor exceptions, are not recognized; the same is true of most long-term debt. Capital (fixed) assets and long-term debt are not reported in governmental fund balance sheets. It should be noted that governmental funds are reported using the modified accrual basis of accounting; however, governmental-type activities are reported in the government-wide statements using the accrual basis of accounting, including fixed assets and long-term debt. As shown in Illustration 1-2, the governmental activities fund-basis financial statements and the records of general fixed assets and long-term debt serve as inputs to the government-wide financial statements.
Fund Structure for State and Local Government Accounting and Reporting
Traditionally, state and local government financial reporting has been based on fund accounting. A fund is (1) a self-balancing set of accounts that (2) separately reports the resources and activities of a part of the government and (3) is segregated because of the existence of restrictions or limitations on the use of some resources.
Note that two conditions must be met for a fund to exist: (1) there must be a fiscal entity—assets set aside for specific purposes, and (2) there must be a double-entry accounting entity created to account for the fiscal entity. This second condition requires that debits equal credits within each fund. Therefore no journal entry may debit an account in one fund and credit an account in another fund. Every journal entry must be within a single fund (debits = credits). If there are transactions between funds, two journals entries are required—one for each of the affected funds.
State and local governments use 11 fund types. These fund types are organized into three categories: governmental funds, proprietary funds, and fiduciary funds. The first issue in recording a transaction is determining where (in which fund) to record the event. Governmental accounting is very much definition driven; that is, where we account for a transaction is determined by the definition of the 11 fund types.
Governmental Funds Five fund types are classified as governmental funds:
- The General Fund accounts for most of the basic services provided by the government. Technically, it accounts for and reports all financial resources not accounted for and reported in another fund.
- page 15 Capital projects funds account for and report financial resources that are restricted, committed, or assigned to expenditure for capital outlays. As such, it accounts for the purchase or construction of major capital improvements, except those purchased or constructed by a proprietary (and less commonly, fiduciary) fund.
- Debt service funds account for and report financial resources that are restricted, committed, or assigned to expenditure for principal and interest, other than interest or principal on proprietary or fiduciary activities.
- Special revenue funds account for and report the proceeds of specific revenue sources that are restricted or committed to expenditure for a specified purpose other than debt service or capital projects. These include activities funded by federal or state grants or by taxes specifically restricted to certain activities.
- Permanent funds account for and report resources (typically provided under trust arrangements) that are restricted to the extent that only earnings, and not principal, may be used for purposes that support the reporting government’s programs. SFFAC 6—Distinguishing Basic Information, Required Supplementary Information, and Other Accompanying Information.
Objectives of Financial Reporting by Not-for-Profit Entities
FASB has issued eight concepts statements, including one dedicated to nonbusiness entities. In its Statement of Financial Accounting Concepts No. 4, the FASB identifies the information needs of the users of nonbusiness financial statements. These include providing information that is useful to present and potential resource providers in the following:
- Making decisions about the allocation of resources to those organizations,
- Assessing the services that a nonbusiness organization provides and its ability to continue to provide those services,
- Assessing management’s stewardship and performance, and
- Evaluating an organization’s economic resources, obligations, and effects of changes in those net resources.
Every government will have a single General Fund but may have multiple funds in each of the other categories. Proprietary Funds. This category of funds is used to account for a government’s activities that are businesslike in nature. Specifically, they operate to provide services to customers who pay for the services received. Proprietary funds are discussed in Chapter 6. There are two types of proprietary funds: Enterprise funds are used when resources are provided primarily through the use of sales and service charges to parties external to the government. Examples of enterprise funds include water and other utilities, airports, swimming pools, and transit systems. Internal service funds account for services provided by one department of a government to another, generally on a cost-reimbursement basis. In some cases, these services are also provided to other governments. Examples of internal service funds include print shops, motor pools, and self-insurance funds. Fiduciary Funds. Fiduciary funds, sometimes known as trust and agency funds, account for resources for which the government is acting as a trustee or collecting/disbursing agent. Four types of fiduciary funds exist: Agency funds are used to account for situations in which the government is acting as a collecting/disbursing agent. An example would be a county tax agency fund, where the county collects and disburses property taxes for other taxing units within the county, such as independent school districts. Pension (and other employee benefit) trust funds are used to account for pension and employee benefit funds for which the governmental unit is the trustee. Investment trust funds account for the external portion of investment pools reported by the sponsoring government. Private-purpose trust funds report all other trust arrangements under which principal and income benefit individuals, private organizations, or other governments.