This page covers budgetary Accounts, modified accrual basis, General Fund, Fund Balance, Restricted fund balance, current financial resources, Expenditures.
Modified accrual accounting Current Financial Resources Measurement and Economic Resource Management
Example: Modified Accrual Accounting Versus Full Accrual Accounting
Governmental Budgeting, Appropriations, Encumbrances and Estimated Revenues
Example: Governmental Budgeting, Appropriations, Encumbrances and Estimated Revenues
Example: Encumbrances Lapse at Year End and Encumbrances Don't Lapse at Year End
The most distinguishing feature of governmental accounting is the use of the modified accrual basis (and current financial resources measurement focus) of accounting.1 Although the use of modified accrual accounting is limited to one type of fund (i.e., governmental funds) and then only to the fund-basis statements, this does not mean it is inconsequential. Recall that every general-purpose government will have (at least) a General Fund, and the General Fund is commonly the largest fund when measured in terms of government expenditures. Further, since most tax revenue is received by the General and other governmental funds, these funds are of particular interest to taxpayers. Before describing exactly what the modified accrual basis is, it may be useful to describe what it is not. The modified accrual basis is not equivalent to the cash basis. Governmental funds record receivables (e.g., taxes receivable) and recognize revenues before collection, which is not true of a cash-basis system. Similarly, governmental funds record many liabilities (e.g., salaries payable) and accrue expenditures when payable, rather than waiting until payment occurs. Additionally, the modified accrual basis is also not merely a “light” version of the accrual basis, differing only in its failure to recognize long-term assets and liabilities. The modified accrual basis is a distinct system of accounting that contains financial statement elements that appear nowhere else. Among these are expenditures and fund balances. At the same time, the modified accrual basis contains other elements that are shared with the accrual basis, such as assets and liabilities. Although revenues appear in the financial statements of accrual and modified accrual funds, revenues follow different recognition criteria between the two bases. Finally, there are no expenses in modified accrual funds. The following sections describe the account structure and recognition criteria for governmental funds. The modified accrual basis evolved from the demand for accountability over public resources and is therefore closely tied to the budget function.
MODIFIED ACCRUAL ACCOUNTS
Because governmental funds report under the current financial resources measurement focus, long-term assets are not presented. Generally speaking, the assets represent cash and assets that may be expected to be converted into cash in the normal course of operations. Similarly, these funds report only those liabilities that will be settled with current financial resources. Therefore, long-term liabilities are not reported in governmental funds. Deferred Inflows of Resources represent balance sheet accounts with credit balances, similar to liabilities. However these items do not represent obligations and are therefore not liabilities. The most common example in a governmental fund is deferred taxes. Deferred Outflows of Resources represent balance sheet accounts with debit balances but are not assets and rarely appear in governmental funds. Only items specifically identified in GASB standards may be reported as deferred inflows or deferred outflows.
The account category, Fund Balance, is unique to governmental funds. Neither property owners nor voters have a legal claim on the excess of fund assets over liabilities; therefore, Fund Balance is not analogous to the capital of an investor-owned entity. However, Fund Balance serves a purpose similar to retained earnings, in that activity accounts are closed to this account at the end of each accounting period. While mathematically comparable to retained earnings, fund balances are very different in interpretation. Because only current financial resources and claims against those resources are recognized in these funds, the difference between assets and liabilities (fund balance) represents the net resources of the fund that are currently available for future spending. However, even current financial resources vary in the extent to which government managers have discretion over their future use, and this is reflected by assigning fund balance to five categories (nonspendable, restricted, committed, assigned, and unassigned).
The fund balance classifications are GASB’s response to bond investors and rating agencies who wish to understand the extent to which the net financial resources of governmental funds are constrained and how binding those constraints are. For example, fund resources can be restricted by creditors, donors, or granting agencies. Resources may also be formally committed by elected officials to specific activities. Alternatively, constraints may merely be nonbinding indications of management’s intent to use resources for a particular purpose. The five fund balance classifications reflect these varying levels of constraint.
Nonspendable Fund Balances The first step is to identify those fund resources that are nonspendable. (This is identified as step 1 in the illustration.) Inventories and prepaid items typically appear in governmental funds because they are current assets. However, these resources are nonspendable because they are used in operations rather than converted into cash. The principal (corpus) of a permanent fund that may not be spent, but is required by its donor to be maintained, would also be classified as nonspendable. Other examples include assets held for sale and long-term receivables, which are sometimes reported in governmental funds.
The remaining resources (net of liabilities) of the fund include cash and items expected to be converted into cash in the next period. These “spendable” resources are further classified according to the nature of any constraints imposed on their use, using a hierarchy of constraints. The hierarchy ranges from “restricted” for the most constrained to “unassigned” for the least.
Restricted Fund Balances Restricted fund balance (item 2a in the illustration) represents the net resources of a governmental fund that are subject to constraints imposed by external parties or law. Restrictions arising from external parties include debt covenants (such as a requirement for a sinking fund) or constraints imposed by legislation or federal and state agencies on the use of intergovernmental revenues. Restrictions can also result from legally enforceable requirements that resources be used only for specific purposes. For example, some states permit cities and counties to propose taxes on the sale of prepared food and beverages. If approved by the voters, the referendum commonly restricts the use of the tax proceeds (typically to capital projects). The unexpended resources derived from this tax would be displayed as restricted fund balance.
The net position (i.e., equity) section of the government-wide Statement of Net Position classifies net position within three categories, including restricted net position. With one exception, those resources classified as restricted net position in the government-wide statements would also be classified as restricted fund balance in the fund-basis statements. The exception is permanent fund principal. These resources are classified as restricted in the government-wide Statement of Net Position and nonspendable fund balance in the (fund-basis) Balance Sheet.
Committed Fund Balances Committed fund balance (item 2b in the illustration) represents the net resources of a governmental fund that the governing body has specified for a particular use. To be classified as committed, the resources should have been designated through ordinance or resolution by the government’s highest level of authority (e.g., state legislature, city council, or county board of supervisors). Committed resources differ from restricted in that the constraint is imposed by a government upon itself. In addition, amounts representing contractual obligations of a government should also be classified as committed fund balance, provided that existing resources in the fund have been specifically committed for use in satisfying the contractual obligation. GASB offers no examples of such contractual obligations, but it seems reasonable that they would be of sufficient significance to involve the formal action of the governing board. For example, board approval of large construction contracts would typically represent commitment of the funds.
Assigned Fund Balances
Assigned fund balance represents the net resources of governmental funds that the government intends for a specific purpose. Assigned resources differ from committed in that the committed resources require a formal action by the governing body of the government. Constraints imposed on assigned resources are more easily modified or removed. Only the General Fund will report (positive) unassigned fund balance. So, for governmental funds other than the General Fund, this is the category for all remaining fund balance after allocating to the nonspendable, restricted, and committed categories. The rationale is that the act of recording resources in special revenue, capital projects, debt service, or permanent funds is evidence of the government’s intent to use the resources for a specific purpose.
Resources in the General Fund may also be assigned to a specific purpose if that is the intent of the government. Intent may be expressed through the governing body by means other than ordinance or resolution or by committees or individuals with the authority to assign resources to specific activities. For example, placing a purchase order for office equipment is a clear expression of the intent of the government to use a portion of its available resources for a capital acquisition. Until the resources are actually expended on capital assets, that portion of the General Fund’s net resources would be classified as assigned fund balance.
Unassigned Fund Balances
Unassigned fund balance is the residual category for the General Fund. Within the General Fund, governments should not report assigned fund balance amounts if the assignment for specific purpose results in a negative unassigned fund balance. Negative fund balances could occur if expenditures for a specific purpose exceed the resources available in the fund. However, GASB does not permit the reporting of negative restricted, committed, or assigned fund balances. If this occurs, the government should reduce any assigned fund balances (in that fund) by the amount of the negative balance. If a deficit remains once all assigned fund balances are zero, the remaining negative amount should be reported as unassigned fund balance.
Unassigned fund balance receives the most attention by citizens who may view unassigned resources as justification for tax relief or spending on favored projects. Government officials may wish to understate unassigned fund balance by temporarily classifying resources into one of the other categories. However, GASB standards make it difficult for governments to do this.
For example, GASB provides guidance on the classification of budget stabilization or rainy day funds. Rainy day funds are amounts set aside for future periods of economic downturn. Such stabilization amounts that meet certain criteria are classified as committed or (less commonly) restricted, if imposed externally or by law. GASB standards state that rainy day funds may be classified as committed only if they are created by a resolution or ordinance that identifies the specific circumstances under which the resources may be expended. Rainy day amounts that are available “in emergencies” or in periods of “revenue shortfalls” would not be classified as committed unless the emergency or shortfall condition is specified and of a magnitude to distinguish it from events that occur routinely. Rainy day funds not meeting these conditions are reported as unassigned fund balance in the General Fund.
Financial Statement Activity Accounts
Revenues and Other Financing Sources are sources (or inflows) of financial resources while Expenditures and Other Financing Uses represent uses (or outflows) of financial resources. Other Financing Sources include transfers in from other funds and the proceeds of long-term borrowing. Revenues are defined as all other inflows and include taxes, charges for services, and amounts provided by other entities such as the state or federal government. Because taxes and many other revenues do not involve exchange transactions, governments cannot determine the point at which these revenues are earned. Therefore, revenue recognition occurs when the resulting resources are deemed to be both measurable and available to finance expenditures of the current period. Revenue recognition for specific types of nonexchange transactions is described later in this chapter.
Expenditure is a term that replaces both the terms costs and expenses used in accounting for commercial businesses. Expenditures are recognized when a liability is incurred that will be settled with current financial resources. Expenditures may be for salaries (current), land, buildings, or equipment (capital) or for payment of interest and principal on debt (debt service). Transfers of cash out of one fund to other funds are classified as Other Financing Uses. An example of the use of transfer accounts occurs when a portion of the taxes recognized as revenue by the General Fund is transferred to a debt service fund that will record payments of interest and principal on general obligation debt. The General Fund would record the taxes as Tax Revenue and the amounts transferred to the debt service fund as Other Financing Uses—Transfers Out. The debt service fund would record the receipt of the transfer as Other Financing Sources—Transfer Inand the subsequent payments of interest and principal as Debt Service Expenditures. Thus, use of the transfer accounts achieves the desired objective that revenues are recognized in the fund that levied the taxes (i.e., General Fund) and expenditures are recognized in the fund that expends the cash (i.e., debt service fund).
GASB standards require governments to present a comparison of budgeted and actual results for the General Fund and special revenue funds with legally adopted budgets. Although GASB standards guide the format of this comparison, the GASB does not prescribe budgetary accounting practices and does not require governments to maintain budgetary accounts. Budgetary accounts do not appear in the general-purpose financial statements. Nevertheless, governments typically record budgets, and governmental accounting systems are designed to assure compliance with budgets. The accounts appearing in the left-hand side of Illustration 3-1, Panel 2, serve this budgetary (rather than external reporting) function of the government. A government may raise revenues only from sources allowed by law. Laws commonly establish the maximum amount of a tax or set a maximum tax rate. Revenues to be raised pursuant to law during a budget period are set forth in an Estimated Revenues budget. Resources raised by the government may only be expended for purposes and in amounts approved by the governing body or legislature. This is known as the appropriations process. An Appropriations budget, when enacted into law, is the legal authorization for the government to make expenditures for specific purposes. The amount expended may not exceed the amount appropriated for each purpose. In this manner, a government budget has the effect of law by limiting spending to approved levels. Estimated Other Financing Sources and Estimated Other Financing Uses are additional budgetary accounts reflecting anticipated inflows and outflows of resources from sources other than revenues and spending. Encumbrances and the related reserve for encumbrances are the final two budgetary accounts. When a purchase order or contract is issued as authorized by an appropriation, the government may recognize this commitment as an encumbrance. An encumbrance is not a liability because the goods or services have merely been ordered, not received. The process by which a government moves from budgetary authority to expending fund resources is described in the following section.
following section. EXPENDITURE CYCLE Illustration 3-4 depicts the expenditure cycle and corresponding journal entries for the General Fund or a special revenue fund with a legally adopted budget. To save space, we demonstrate journal entries using control accounts for activity (revenues and expenditures) and budgetary accounts (estimated revenues, appropriations, and encumbrances). Entries to control accounts would be supported with detailed entries in subsidiary accounts. While many accounting systems have discontinued the use page 63of control accounts, in the interest of space we use summarized postings. You are encouraged to use detailed accounts (for example, revenues by source) when preparing end-of-chapter exercises. ILLUSTRATION 3-4 Expenditure Cycle The process begins with the governing board or legislature approving a budget. At first glance the budgetary accounts may appear to have balances opposite what would be expected—Estimated Revenues have debit balances and Appropriations have credit. However, the entry is designed to reflect the anticipated effect on the fund’s net resources (Budgetary Fund Balance) if everything went according to expectations. Because budgeted revenues and other financing sources exceed budgeted expenditures and other uses, fund balance is expected to increase (credit). However, if budgeted expenditures and other uses are expected to exceed budgeted revenues and other financing sources, Budgetary Fund Balance would be debited in the entry. The appendix to this chapter presents more detailed budgetary entries, including budget amendments. A department (such as police or health) cannot commit the government to expend resources until it is granted budgetary authority through its appropriations. Once that authority exists, departments can begin to commit resources by placing purchase orders or signing contracts. These commitments are reflected in the budgetary accounts through the recording of Encumbrances and the corresponding Budgetary Fund Balance—Reserve for Encumbrances. GASB requires that significant encumbrances be disclosed in the notes along with required disclosures about page 64other commitments. However, there is no separate reporting of encumbrances within the fund balance section of the governmental funds balance sheet. Rather, encumbered resources should be reported within the restricted, committed, or assigned categories in a manner consistent with the criteria for those classifications. At the very least, the existence of an encumbrance suggests that the government has an expressed intent to use resources for a particular purpose and therefore these resources should not be classified as unassigned. Encumbrance accounting may also be used in the case of contractual obligations, such as construction contracts. GASB requires that resources obligated for contractual obligations be classified as committed. We will examine the relation of encumbrances to the classification of fund balances in more detail in Chapters 4 and 5. Once goods or services are received, the government has a liability. At this point, two journal entries are necessary. The first reverses the encumbrance at its original amount. Since the government has incurred an actual liability, it is no longer necessary to reflect a commitment for the outstanding purchase orders or contracts. The second entry records the liability (Accounts Payable) and an Expenditure in the amount of the invoice. Governments can choose not to record encumbrances for some expenditures, particularly those that are relatively predictable in amount. For example, salaries may be initially recorded only as expenditures when due without having been formally encumbered. At the end of the budget period, unencumbered, unexpended appropriations lapse; that is, administrators no longer have the authority to incur liabilities under the expired appropriations. In nearly all cases, administrators continue to have the authority to disburse cash in payment of liabilities legally incurred (and recorded as expenditures) in a prior period. However, appropriations that are encumbered may or may not carry forward to the next accounting period, depending on the government’s policy. If they do not carry forward and must be appropriated again in the following year, the encumbrances are said to lapse. The entry to record a lapsed encumbrance is the same as the reversal entry when a good or service is received (debit Budgetary Fund Balance—Reserve for Encumbrances and credit Encumbrances—Control). REVENUE RECOGNITION FOR NONEXCHANGE TRANSACTIONS Under modified accrual accounting, revenues are recognized when they are both measurable and available to finance expenditures of the current period. Many governmental revenues result page 65from nonexchange transactions. Nonexchange transactions are transactions in which a government receives resources without directly giving equivalent value in exchange. These are in contrast to exchange transactions, such as the purchase of goods or services. The most common forms of nonexchange transactions are tax revenues and intergovernmental grants. Most of the activities of governmental funds are supported by revenues generated through nonexchange transactions. Before a government may recognize revenue resulting from nonexchange transactions, it must meet a number of eligibility requirements. The eligibility requirements are as follows: 1. Required Characteristics of Recipients. The recipient must have the qualifying characteristics specified by the provider. For example, a state can provide funding on a per student basis to public schools. In order to recognize this revenue, the entity must be a public school as defined by state laws. 2. Time Requirement. If time requirements (for expenditure) are specified, those time requirements must be met. For example, a state can provide funding to support park districts for the next fiscal year. In that case, the revenue would not be recognized by the park districts until that fiscal year. If the resource provider does not specify time requirements, then no condition exists and the revenue would be recognized as soon as other eligibility requirements are met. 3. Reimbursement. Many grants require the recipient government to spend money on qualifying items and then request reimbursement. For those grants and gifts that are payable only on a reimbursement basis, revenues would be recognized when the expenditures have been incurred. The government would not have to wait for the payment to be received to recognize this revenue. 4. Contingencies. Resources pledged that have a contingency attached are not recognized as revenue until the contingency has been met. For example, if a donor indicates that $100,000 will be donated to build an addition to the city library provided other donors pledge an equal amount, that revenue would be recognized only after the “matching” $100,000 has been raised from other donors. Illustration 3-5 identifies the four types of nonexchange transactions and describes when revenues resulting from these transactions are recognized under the modified accrual basis of accounting. The last column of Illustration 3-5 provides representative journal entries, illustrating the application of the measurable and available recognition criteria. In some cases, revenues resulting from nonexchange transactions are recognized in different periods in the fund-basis and government-wide financial statements. For this reason, we will revisit this illustration in Chapter 8, which deals with the preparation of government-wide statements. Imposed nonexchange transactions are taxes and other assessments imposed by governments that are not derived from underlying transactions. Examples include property taxes, special assessments, and fines and forfeits. A special rule applies to property taxes. Property taxes collected within 60 days after the end of the fiscal year may be deemed to be available and recorded as revenue in the year assessed, rather than the year collected. Amounts expected to be collected more than 60 days after year-end are not recognized as revenue when assessed, but as deferred revenue. Deferred taxes are not liabilities, but are reported as deferred inflows of resources on the Balance Sheet. Derived tax revenues result from taxes assessed on exchange transactions. Examples include taxes on retail sales, income, and gasoline. The amounts due are recorded in the time period the underlying transaction took place. For example, revenues due from taxes on the sale of gasoline should be recorded along with a receivable (from the retailers) in the month that the gasoline was sold. The revenue is recognized at the time of the exchange transaction provided the cash is expected to be collected shortly after the current fiscal year. If collection is expected to take place after the period considered available to pay current period liabilities (e.g., 60 days), it should be credited to deferred inflows of resources.
REVENUE RECOGNITION FOR NONEXCHANGE TRANSACTIONS
Under modified accrual accounting, revenues are recognized when they are both measurable and available to finance expenditures of the current period. Many governmental revenues result page 65from nonexchange transactions. Nonexchange transactions are transactions in which a government receives resources without directly giving equivalent value in exchange. These are in contrast to exchange transactions, such as the purchase of goods or services. The most common forms of nonexchange transactions are tax revenues and intergovernmental grants. Most of the activities of governmental funds are supported by revenues generated through nonexchange transactions. Before a government may recognize revenue resulting from nonexchange transactions, it must meet a number of eligibility requirements. The eligibility requirements are as follows:
1. Required Characteristics of Recipients. The recipient must have the qualifying characteristics specified by the provider. For example, a state can provide funding on a per student basis to public schools. In order to recognize this revenue, the entity must be a public school as defined by state laws.
2. Time Requirement. If time requirements (for expenditure) are specified, those time requirements must be met. For example, a state can provide funding to support park districts for the next fiscal year. In that case, the revenue would not be recognized by the park districts until that fiscal year. If the resource provider does not specify time requirements, then no condition exists and the revenue would be recognized as soon as other eligibility requirements are met.
3. Reimbursement. Many grants require the recipient government to spend money on qualifying items and then request reimbursement. For those grants and gifts that are payable only on a reimbursement basis, revenues would be recognized when the expenditures have been incurred. The government would not have to wait for the payment to be received to recognize this revenue.
4. Contingencies. Resources pledged that have a contingency attached are not recognized as revenue until the contingency has been met. For example, if a donor indicates that $100,000 will be donated to build an addition to the city library provided other donors pledge an equal amount, that revenue would be recognized only after the “matching” $100,000 has been raised from other donors.
The current financial resources measurement focus and modified accrual basis of accounting are unique to the governmental funds of state and local governments. The focus is on the flow of financial resources rather than income measurement. Key elements include:
- Revenues. Inflows of net financial resources from sources other than interfund transfers and debt proceeds. Revenues are recognized when they are both measurable and available to finance current expenditures.
- Expenditures. Outflows of net financial resources from sources other than interfund transfers that are recognized when a governmental fund incurs a liability pursuant to budgetary authority provided by appropriation.
- Fund balance. The net position (assets less liabilities) of a governmental fund, which can be classified as nonspendable, restricted, committed, assigned, or unassigned.