Understanding Budgeting and Control in Chapter 3

1. Chapter 3 Issues of Budgeting and Control

2. 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

3. 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.

4. Budgets in Government are MUCH MORE IMPORTANT than they are in Business • 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.

5. 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.

6. Key Phases of Budget Cycle • Preparation • Legislative adoption and executive approval • Execution • Reporting and auditing

7. 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

8. CITY OF HOUSTON GENERAL 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 2,070 Designated "Rainy Day" Amount 20,000 Budgeted Ending Fund Balance as of June 30, 2008 193,656 Total Budgeted Expenditures and Reserves $ 1,984,199

9. Budgetary Accounts 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.

10. Budgetary and Operating Statement Accounts • Revenuesand Other Financing Sourcesincrease 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.

11. Anappropriationis 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

12. 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 $500 Appropriations $450 Fund balance 50 Next slide shows what the detail might look like

13. Examples of Budgetary Journal Entries (A) Budget Approved on 1-1-2010:Dr.Cr. Estimated Revenues 500,000 Appropriations 450,000 Fund Balance 50,000 Revenues Ledger: Taxes 300,000 Licenses and Permits 50,000 Intergovernmental Revenues 50,000 Charges for Services 50,000 Fines and Forfeits 25,000 Miscellaneous Revenues 25,000 Appropriations Ledger: General Government 120,000 Public Safety 150,000 Public Works 100,000 Culture and Recreations 80,000 $500,000 $450,000

14. Budgetary and Operating Statement Accounts (cont’d) An encumbrance is an estimated amount recorded for purchase orders, contracts, or other expected expenditures chargeable to an appropriation.

15. Encumbrance • Prevents overspending the budget. • Entry to record encumbrance is madewhen 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.

16. Impact of GASB 54 Significant 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

17. Let’s do an example with encumbrances Based on the Example posted on Blackboard

18. Budgetary Control — Expenditures • 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

19. Example B - Budgetary Control 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 $500 Reserve for Encumb.--2010 $500

20. Accounting Control over Expenditures • 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.

21. Accounting model for the General Fund ASSETS = LIABILITIES + FUND BALANCE Balance Sheet Reserved (Nonspend + Unreserved (Unassig) Accounts+ Rest., Comm., & Assign) FB Fund Balance (permanent) Budgetary/ OperatingBudgetary AccountsOperating Accounts Statement Accounts (temporary)

22. Classification of Expenditures GASB 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.

23. Most Commonly Used Budget . . . Object Classification Budget

24. 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

25. SOURCE Classification of Revenues and Estimated Revenues GASB Suggestion: • 1st classify by fund • 2nd classify by source FUND Sources include: • Taxes (Ad-valorem and self-assessing) • Special Assessments • Licenses and Permits • Intergovernmental Revenues • Charges for Services • Fines and Forfeits • Miscellaneous Revenues

26. On What Basis of Accounting are Budgets Prepared?

27. 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.

28. 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.

29. 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 permitrecognizing taxes and other revenues in the year in which they are due andnotin 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.

30. Cash Basis Disadvantages: • 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.

31. Legally adopted budgets vs. GAAP-based Financial Statements Differences arise between the legally adopted budgets and GAAP-based financial statements. They are caused by: • Basis of accounting • Timing • Perspective • Reporting entity

32. 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.

33. Recording Budgets Example Additional examples to study (beyond textbook and ones we did in class)

34. 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.

35. 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 $5,600 Appropriations $5,550 Fund balance 50

36. 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 $5,800 Revenues 5,800 JE 3:It ordered goods and services for $3,000. Encumbrances $3,000 Reserve for encumbrances 3,000

37. 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 $2,800 Cash 2,800 b: Reserve for encumbrances $2,800 Encumbrances 2,800 JE 5: It incurred $2500 in other expenditures for goods and services that had not been encumbered. Expenditures $2,500 Cash 2,500

38. 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

39. Supporting Computations – original style

40. Example C (alternate style closing)

41. Supporting Computations – alternate style

42. City of Houston - Facts Did 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.

43. Summary • 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!