Environment & Characteristics

Environment & Characteristics Chapter 1

Welcome • Contrary to what you may have heard, governmental and nonprofit accounting is not a “whole new ball game” • However, it is a game played by slightly different rules • The purpose of this chapter is to lay the groundwork for those rules • The rest of the chapters will examine those rules more closely

Learning Objectives • Unique characteristics • Types of G&NP organizations • Similarities & differences between profit-seeking and G&NP organizations • Characteristics, concepts, & objectives of GNP accounting & financial reporting • Users and uses of financial information • Determining what GAAP to apply • GAAP hierarchy

Characteristics of G&NP Organizations • Absence of profit motive • Owned by constituents – no stock • Contributors of resources do not receive proportional share of benefits • Decisions made – directly or indirectly – by voters • Meetings where decisions are made usually open to the public

Types of G&NP Organizations • Governments: Federal, state, county, city, township, village, and special districts • Education: kindergartens, elementary & secondary schools, vocational & technical schools, and colleges & universities • Health and welfare: hospitals, nursing homes. • Religious: Salvation Army, and church-related organizations • Charities: United Way, Community Chest, & other fund-raising organizations • Foundations: Private trust that operate religious, educational, or charitable organizations

Similarities to the Private Sector • Operate in the same economy and compete for same resources: financial, capital, and human • Acquire & convert scarce resources into goods & services • Use of accounting & other information systems • Need to operate economically, effectively, & efficiently • Provide goods and services, many of which may be similar

Differences from the Private Sector • Organizational objectives • Sources of financial resources • Methods of evaluating performance and operating results

Businesses Operating Motive: maximize income from revenues and other resources Operational Focus: report quarterly but look to the long-tem as well G&NPs Operating Motive: maximize services provided from revenues and other resources Operational Focus: operate on annual budget, so current year is of primary importance Organizational Objectives

Organizational Objectives • In sum, whereas private business seek to increase their wealth for the benefit of their owners, G&NP organisations seek to expand their available financial resources for the benefit of their constituencies.

Sources of Financial Resources • Businesses raise resources from sales or from capital stock & debt transactions – must account for different sources separately • Governments raise resources from sales or debt transactions – typically no distinction made in sources

Unique G&NP Sources • Involuntary contributions – taxes! • Donations • Appropriations and grants from other governmental entities

Evaluating Performance & Operating Results • In business, continuing a product or service determined by success in marketplace • In G&NP organizations: • Profit not a motive and frequently cannot be measured • Services not found elsewhere so there is no competition • Face rules and regulations not found in private sector

Special Regulations & Controls Applied to Governments • Organization structure – form; board composition; number & duties of personnel • Personnel policies & procedures – who has power to appoint or hire personnel; tenure; termination policies; promotion policies • Sources of financial resources – types and amounts of taxes, licenses, fines or fees; procedure for setting user charges

Special Regulations (continued) • Use of financial resources – purposes, including legal restrictions; purchasing procedures; budgeting methods • Accounting • Financial reporting – type & frequency of reports; format; recipients • Auditing – frequency; who performs; scope & type; time & place

Development of GAAP

Both the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB) are financed and overseen by the Financial Accounting Foundation (FAF). • The GASB is responsible for establishing accounting and financial reporting standards for activities and transactions of state and local governments

Defining a “Government” Overall characteristics: • Public corporations – “an instrumentality of the state, founded and owned in the public interest, supported by public funds, and governed by those deriving their authority from the state • Bodies corporate and politic

Other Characteristics of a “Government” • Popular election of officers or appointment (or approval) of a controlling majority of members of governing body by one or more SLGs • Potential for unilateral dissolution by a government with net assets reverting to government • Power to enact and enforce a tax levy • Ability to issue tax exempt debt

Financial ReportingStandards-Setting Process

SLG GAAP Hierarchy • GASB Statements & Interpretations, which are periodically incorporated into the Codification • GASB Technical Bulletins and AICPA Audit Guides and SOPs if made applicable to SLGs and cleared by GASB • Positions of GASB EITF (does not currently exist) and AICPA Practice Bulletins if made applicable to SLGs and cleared by GASB • GASB staff Implementation Guides (Q&As) and widely accepted practice • Other accounting literature

Typical Activities of a SLG • Governmental activities – unique to SLGs • Police and fire protection • Education • Social Services • Courts • Business-type activities – similar to private sector operations • Utilities • Golf Courses • Airports

The governmental – type activity environment is unique in several aspects. These aspects include the distinctive SLG

(1) Purpose of Governmental Activities Provide goods and services that all constituents need regardless of ability to pay for goods and services

Absence of the profit motive in governmental – type activities underlies several other differences between governments and business, which are: • (1) Net income (the basic performance evaluation measure in business) does not apply to government – type activities. • (2) Most governments do not obtain significant financial resources for governmental – type activities from service charges to individual recipients in proportion to the services received.

(2) Sources of Financial Resources(not found in private sector) • Because significant revenues from sales of services are not available to finance governmental – type activities, governments must raise financial resources from other sources. Two primary examples of these revenue sources are: • Taxes and grants and subsidies.

Sources of Financial Resources(not found in private sector) • Taxes: property taxes, sales taxes, and income taxes • Taxation is thus a nonexchange transaction or event that eliminates any direct association between: • The amount and quality of the services a constituent receives from the government, and • The amount the constituent pays to the government.

Sources of Financial Resources(not found in private sector) • Intergovernmental revenues: such as grants and subsidies from other higher level governments.

(3) Resource Allocation Mechanisms • General government financial resource allocations are derived from processes clearly different from business enterprises. • Absence of a direct relationship between the financial resources provided by an individual taxpayer and the services provided to that individual taxpayer makes it impossible for the resource allocations to be made in the same manner as for business enterprises.

Resource Allocation Mechanisms • Two concepts determine how the allocation are made: • Restrictions placed by providers: typical of grantors, taxes for specific purposes. • One level of restriction requires that certain resources be used for a particular purpose or program.

These numerous restrictions are the primary reason for the use of funds and nonfund accounts. • These accounts are account for financial resources segregated according to the purpose for which they may or must be used and any related capital assets and long – term liabilities, respectively.

Resource Allocation Mechanisms • Budget: is an expression of public policy and intent. It is also a financial plane that indicates the proposed expenditures for the year and the means of financing them • It allocates resources to functions • Therefore, taxes and other revenues are allocated to various uses by placing even more detailed budgetary restrictions on their use.

Resource Allocation Mechanisms • An adopted budget has the force of law, It both: • (1) Authorizes amounts to be expended for various specified purposes, and • (2) Limits the amount that may be expanded for each of those purpose.

(4) Accountabilities • Accountabilities: determining to whom accountable and the focuses of their accountability. • To whom accountable: the need for accountability exists between (1) SLGs and their constituencies, (2) SLGs and other governments, and (3) the SLGs own legislative and executive bodies.

Accountabilities • Accountability focus: The financial reports for governmental – type activities focus on two types of accountability: • (1) fiscal accountability: is a government’s responsibility to demonstrate its compliance with public decision about the raising and spending of public monies in the short – term.

Accountabilities • (2) Operational accountability: is a government’s responsibility to demonstrate the extent to which it has met its operating objectives and whether it can continue to meet its objectives in the foreseeable future.

(5) Reporting Issues & Problems • Demonstrate compliance with restrictions on use of financial resources • Budgetary reporting • Impact of restrictions on revenue recognition • Difficulty in measuring effectiveness and efficiency of operations • Opportunity to hide or disguise availability of resources • Tax and debt limits • Impact of materiality of reporting certain actions

Financial Report Users • The citizenry: Those to whom the government is primarily accountable, including (citizens, taxpayers, the media). • Legislative and oversight bodies: Those who directly represents the citizens, including (members of state legislatures, city councils) • Investors and creditors: Those who lend or participate in the lending process, including (individuals and institutional investors and creditors, bond insurer).

Financial Report Uses • Comparing results with legally adopted budgets • Assessing financial condition and results of operations • Assisting in determining compliance with finance-related laws, rules & regulations • Assisting in evaluating efficiency & effectiveness

Purposes of Business-Type Activities • Provide same types of services as found in private sector • Charge fee for services received • Separate, self-sufficient operations

Issues in Business-Type Activities • Relationship between services received and resources provided by consumer • In that exchange relationship, a user fee is charged for a specific service provided. • Therefore, users of financial reports focus on measuring the costs of providing the service, the revenues obtained from the service, and the difference between the two.

Issues in Business-Type Activities • Revenue-producing capital assets • Similarly designated activities: the business – type activities of government often perform only a single function. • Nature of political process: some government business – type activities are designed to be insulated from the political process. • Budgets and fund accounting

Financial Reporting Objectives of Business-Type Activities • Enable users to assess accountability • Provide information about operating results for the period • Provide information to assess level of services provided

Characteristics of SLGAccounting & Reporting • Use of fund accounting • Funds: are separate fiscal and accounting entities and include both cash and noncash resources – segregated according to the purposes or activities for which they are to be used – as well as related liabilities.

There are two basic categories of fund accounting entities used by SLGs: (1) Governmental funds: to account for the financial assets, related liabilities, changes in net assets and balances that may be expended in its nonbusiness – type activities (fire and police protection). (2) Proprietary funds: to account for the revenues, expenses, assets, liabilities, and equity of its business – type activities ( utilities, cafeterias)

A fund of a commercial enterprise is simply a portion of its assets that has been restricted to specific uses, not a separate and distinct accounting entity. • A = L +OE

A fund in the G&NP accounting sense is a self – contained accounting entity with its own assets, liability, revenue, expenditure or expense, and fund balance or other equity accounts. • A – L = FB (fund balance) (governmental funds) • A – L = NA (net assets or fund equity) (proprietary funds)

Characteristics of SLGAccounting & Reporting • Budgets and appropriations • A fixed – dollar budget is commonly prepared for each governmental fund. That is, the organization's chief executive asks the governing body for permission to incur a specified (fixed) amount of expenditures (for salaries, equipment, supplies) during the budget period to carry out the department’s mission.

When approved by the governing body, the budgetary expenditure estimates become binding appropriations, which both authorise expenditures for specific purpose and limit the amount that can be expended for each specified purpose. • Most governments establish budgetary accounts within governmental fund ledgers to ensure control.

The cost measurement focus of proprietary fund accounting and of entity – wide financial reports of G&NP organisations, like that of business accounting, is expenses ( the cost of assets and services consumed during the period).

In contrast, The cost measurement focus of governmental fund accounting is expenditures (the amount of net financial resources expended during the period for: (1) Current operations (salaries and utilities). (2) Capital outlay (acquiring capital assets). (3) Long term debt principal retirement and interest.

Environment & Characteristics