Essentials of Accounting for Governmental and Not-for-Profit Organizations

1. Essentials of Accounting for Governmental and Not-for-Profit Organizations Chapter 6: Proprietary Funds -- Internal Service and Enterprise

2. Overview of Chapter 6 • Review of common characteristics of proprietary type funds • Internal Service Funds • Enterprise Funds • Review of Fund statements - Government type funds

3. Review of Proprietary Type Funds • Use accrual basis • Match Revenues and Expenses including depreciation • Emphasis on income measurement • Balance sheet includes both short term and long-term assets and liabilities • Can handle related construction and debt service within the proprietary funds • Typically do not record budgets or encumbrances

4. Internal Service Funds • Used for sales of service primarily to others within the government unit on a cost reimbursement basis • Purpose is to pool resources for more efficient operations • Examples of internal service fund uses: • Motor pool, cost of telecommunications, maintenance department, purchasing /supplies/central stores, insurance/risk management • More efficient to have separate department responsible for these types of services and charge cost back to other departments

5. Example Supply Fund Entries • Most entries similar to business accounting, may want to focus attention just on parts that are different • #1: Can have transfers from other funds; The accounting title “Advance” is a liability—indicates this will eventually be repaid to the Water Utility Fund, but not on short time frame • #5a and b: “Cost of Supplies Issued” is similar to Cost of Goods Sold in business accounting and “Charges for Services” is essentially equivalent to ‘Sales’ • #10: “Allowance for Depreciation” is sometimes used instead of the account title “Accumulated Depreciation”

6. Supply Fund Closing Entry • Entry #12 page 152 the closing entry for the supply fund • All revenue and expense type accounts as well as transfers are closed to Net Assets • Net Assets can be divided into three categories: • Invested in Capital Assets net of Related Debt • Restricted (if needed) and • Unrestricted for the remainder

7. Self-Insurance and Risk Management • SLGs have a choice of using the GF or an Internal Service fund for self-insurance activities • If an ISF is used the amount of premium is treated as a revenue to the ISF and as an Expense or Expenditure to other funds provided that the amount paid is a reasonable amount calculated in a manner that will yield an amount roughly equal to the amount of average long-term claims • Otherwise, treat payments as Transfers • The purpose of this accounting requirement is to prevent governments from managing their budgets by hiding part of government fund resources in a proprietary fund when they have a surplus and underfunding in other years

8. Enterprise Funds • Used for sales of service primarily to others outside the government unit such as the general public • Mandatory if: • Have debt backed solely by fees and charges • Legally required to charge fees that will recover the cost, including depreciation • Government policy of requiring cost recovery from fees

9. Use of Enterprise Fund • Not mandatory, but permitted if: • All three mandatory are not met, but would like to see business basis net loss after depreciation expense • Implication—bus system or swimming pool charging fees below cost can be handled in government or proprietary type fund

10. Common Examples of Enterprise Funds • Usually in mandatory enterprise funds • Water utilities • Gas or electric utilities • Airports • Mandatory or permissive • Bus systems • Swimming pools • Hospitals, parking garage, toll roads, public housing

11. Bonds in Enterprise Funds • Revenue Bonds: Revenue bonds promise bondholders that enterprise revenues will be used to make payments • These are listed as Bonds Payable in the enterprise funds. • Full faith and credit bonds or general obligation bonds: To get a better credit rating the government may pledge all available resources • If this is just a formality, the bonds are still listed as a liability in Enterprise Fund • Bonds are omitted from Enterprise Fund only if government agrees and fully intends to pay the bonds from other resources

12. Common Water Utility Entries • Accrual basis, most entries similar to business accounting • Entry #1 is a reversing entry. Adjustment at end of year was dr. to Accrued Revenue and cr. To Sales of Water • Adjustment last year was to account for services rendered on which meters were not yet read and/or bills not yet sent out • Nature of the “Accrued Utility Revenue” is a tentative Receivable, not a revenue account—this is just the other side of the Revenue entry • Reversed because new entry with dr. to Customer Accounts Receivable and cr. to Sales will occur when bills are processed this year

13. Common Water Utility Entries • Entries 2 & 3 show accrual recording of bills and partial collections. Receivables from other parts of the government are recorded as “Due from…” to facilitate elimination in entity wide statements. • Entry #4: The account title “Advance to/from ” indicates a long-term receivable or payable

14. Water Utility Entries Cont’d • Cynthia Entries #5 & 6: Illustrates a perpetual inventory system with allocation of supplies to various functional areas. The Construction Work in Progress account illustrates that proprietary funds account for building projects within the proprietary fund, not in Capital Projects. • Entry #7: Illustrates allocation of salaries and payroll tax expense to functional areas. • Taxes Accrued is liability account for employers share of payroll taxes;Tax Collections Payable is the Withholding liability account; as in business -- these two might be combined into just one account.

15. Water Utility Entries Cont’d • Entries 8 & 9 show interest expense and allocation of interest to Construction • Proprietary funds capitalize interest on long-term construction in a manner similar to business accounting but modified somewhat for tax exempt bonds -- interest capitalized may be net of interest revenue rather than the gross interest expense. • Entry 10 shows completion of a project and movement to regular long-term asset account -- Utility Plant in Service • Entries 11, 12, 13 show certain unique aspects of accounting for deposits and advances made by customers in order to have service -- portion of Advances retained are moved to Capital Contributions.

16. Water Utility Entries Cont’d • Entry 14: regular payments on liability accounts • Entry 15: This is a quasi-external transaction. If figured in accordance with regular tax rates for commercial businesses, this amount can be counted as a revenue to General Fund and an Expense in the Water Utility Fund. • Entries 16 & 17 show other inter-fund movements for Advances and Transfers.

17. Water Utility Entries Cont’d • Entry 18: • A compound entry for year end adjustments for depreciation, accrued revenues and estimated bad debts • Entry 19: • Year end movements from unrestricted to restricted asset categories • Entries 20 & 21: • Closing entry and adjustment of Net Asset category for Capital assets net of debt

18. Muni. Solid Waste Landfills • Accrual basis and closure costs • Costs of complying with environmental protection laws after closure have to be estimated and accrued as a cost of operating the landfill during its life. • Each year accrue: • Post-closure expenses XX • Liability for post-closure expenses XX • After closure as maintenance costs are incurred: • Liability for post-closure expenses XX • Cash XX • This approach helps assure environmental effects are planned for and encourages cities to charge rates during landfill life that will cover post-closure outlays. • Assumes EF used for landfill; some might be in SRF.

19. Segment disclosures • Segment disclosures for businesses and SLGs alike help make sure information is not overly aggregated to the point that users cannot pick the portion of the data they need. • Segment disclosures are needed when business activities are combined in a single fund or in the nonmajor fund column IF • There is a separate bond issue for a portion of the activities -- such as a bond on water only when water is in a city water and light fund. • When segment disclosures are made the SLG should disclose • The type of activity/service being reported • And provide condensed financial statements for that activity

20. Proprietary Fund Financial Statements • Statement of Net Assets or Balance Sheet • Must classify assets and liability by current/noncurrent • Net assets 3 categories: UNRESTRICTED, RESTRICTED, CAPITAL ASSETS NET OF DEBT • Restricted means restricted by external parties or by law, not set asides by Board of the SLG • Statement of Revenues, Expenses and Changes in Fund Net Assets • Format: • Revenues - Expenses • = Operating NI • - nonoperating - capital contributions and transfers • = Change in Net Assets + Beginning Net Assets • = Ending Net Assets

21. Proprietary SCF • Direct approach required, indirect not allowed • Four categories instead of three per business stmt • 1. Operating • Interest and dividend revenue not in this section as it is in business SCF stmts. • 2. Capital Financing • Business SCF shows only principal payments on debt in financing, SLG approach includes principal and interest payments here. Purchases of long-term assets are here not in investing per business SCF. • 3. Noncapital Financing - short term loans and repayments including interest • 4. Investing - Investments and their associated revenues. Does not include purchase and sale of other long-term assets.

22. Slides prepared by • Dr. Louella Moore • Arkansas State University