Chapter Three

1. Chapter Three Granof & Khumawala -6e Issues of Budgeting and Controls

2. Thought to Ponder: Chapter 3 "A budget is more than simply numbers on a page. It is a measure of how well we are living up to our obligations to ourselves and one another." President Barack Obama Granof & Khumawala -6e

3. 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 Granof & Khumawala -6e

4. Budgets Key Purposes of Budgeting • Planning • Controlling and Administering • Reporting and evaluating Granof & Khumawala -6e

5. Budgeting: Planning for success Four Components: • Plan (1) • Establish mission • Develop Strategic Plan • Set Long-Range Plans • Prepare Budgets • Implement (2) • Control (3) • Measure Results and Report (4) Granof & Khumawala -6e

6. Budgeting: A Part of Planning A process of planning and control. The Budget Cycle • Preparation • based on guidelines • normally done by responsibility center managers • Review and Adoption • Implementation and Control • Evaluation of Results and Feedback Granof & Khumawala - 6e

7. 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. Granof & Khumawala -6e

8. Major types of Budgets • Appropriation Budget • Aka the Master budget - • Monitors current or operating fund (i.e. general fund) • Typically covers one operating cycle • Revenue and Other Support - a forecast of resource inflows into the organization. Revenues are earned from the sale of goods and services and the receipt of contributions and grants. Support refers to just contributions and grants. • Expenses represent the resources that an organization uses up in carrying on its activities. • A surplus or profitis the excess of revenues and support over expenses; a deficitor lossis an excess of expenses over revenues and support. Granof & Khumawala -6e

9. Budgets-Cont’d • Capital Budget • Monitors construction and acquisition of long-lived assets • Typically covers multiple years • Special types of Budgets • Special purpose budgets • Performance budgets • Flexible and Zero-based Budgets • 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 Granof & Khumawala -6e

10. Key Phases of Budget Cycle Granof & Khumawala -6e

11. Current GASB Model (#34) 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 Granof & Khumawala -6e

12. 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 Granof & Khumawala -6e

13. Budgetary and Operating Statement Accounts • Revenuesand Other Financing Sources increase fund balance when closed. Both are recognized on the Modified Accrual basis--when measurable and available to pay current period obligations. • Expendituresand 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. Granof & Khumawala -6e

14. Budgetary and Operating Statement Accounts (cont’d) • An appropriationis a legal authorization granted by the legislative body to incur liabilities for purposes specified in the appropriation act or ordinance. Granof & Khumawala -6e

15. 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 $500,000 Appropriations $450,000 Fund balance 50,000 Next slide shows what the budgetary detail might look like Granof & Khumawala -6e

16. Budgetary Journal Entry & detail Budget Approved on 1-1-2013:Dr.Cr. Estimated Revenues 500,000 Appropriations 450,000 Fund Balance 50,000 Revenues Ledger (detail): 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 (detail): General Government 120,000 Public Safety 150,000 Public Works 100,000 Culture and Recreations 80,000 $500,000 Granof & Khumawala -6e $450,000

17. 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. Granof & Khumawala -6e

18. Encumbrance • Prevents overspending the budget (it’s a control mechanism) • Entry to record encumbrance is made when 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 the face of balance sheet per GASB 54. Granof & Khumawala -6e

19. 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 • This requirement is necessary because special purpose funds cannot report a positive unassigned fund balance Granof & Khumawala -6e

20. Example with encumbrances Granof & Khumawala -6e Based on the example posted on BlackBoard

21. 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 Granof & Khumawala -6e

22. Example B - Budgetary Control Example: City Clerk's office orders a new multi-purpose machine on January 2, 2014 which had a list price in the vendor's catalog of $500. General Fund General Journal: Dr.Cr. Encumbrances--2014 $500 Reserve for Encumb.--2014 $500 Granof & Khumawala -6e

23. 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 Granof & Khumawala -6e

24. Classification of Expenditures GASB suggestions classifying expenditures by any of the following: • Fund • Ex. general fund, special revenue fund, etc. • Function or Program • Def. Group of activities carried out with the same objective • Ex. general government, public safety, sanitation, 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 • Def. The types of items purchased or services obtained • Ex. Salaries, fringe benefits, travel, etc. Granof & Khumawala -6e

25. Budgeting Formats • Line item or object of expense • Ex. - salaries, benefits, supplies, rent, etc. • Responsibility Center - units for which individual managers are held accountable • Ex. - custodial services, maintenance, public relations, development, ticket sales, etc. • Program Budgets include both revenues and expenses • Ex. - ballet, opera, philharmonic, etc. • Generally, both Responsibility Center and Program budgets are supported by line item detail. Granof & Khumawala -6e

26. Most Commonly Used Budget . . Granof & Khumawala -6e Object Classification Budget

27. 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 Granof & Khumawala -6e

28. 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 Granof & Khumawala -6e

29. On What Basis of Accounting are Budgets Prepared? Granof & Khumawala -6e

30. Basis of Accounting • Neither GASB nor FASB have control over budgeting principles • Budgeting principles are directly 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. Granof & Khumawala -6e

31. 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. Granof & Khumawala -6e

32. Cash Basis Budgeting (Cont’d) 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. • Recognize taxes and other revenues in the year in which they are due and not in the year in which they are expected to be collected. Granof & Khumawala -6e

33. Cash Basis Disadvantages: • May distort the economic impact of planned fiscal activities. • May be unbalanced as to economic costs and revenues. • It may give an appearance of a budget that has achieved inter-period equity when it really has not. • Makes it easier to transfer resources from a fund that has a budget surplus to one that needs extra resources. • Complicates financial accounting and reporting. Granof & Khumawala -6e

34. 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 Granof & Khumawala -6e

35. Performance Budgets • Supplement to object classification budgets • Focus on measurable units of efforts • Institutionalize effective decision process • The most common type of performance budget is program budget. Granof & Khumawala -6e

36. Recording Budgets Example Granof & Khumawala -6e Additional examples to study (beyond textbook and ones we did in class)

37. 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. 109-111 for budgeting entries. Granof & Khumawala -6e

38. 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 Granof & Khumawala -6e

39. Example - C (cont’d) JE 2: During the year, the government health care district collected $5,800 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 Granof & Khumawala -6e

40. 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 Granof & Khumawala -6e

41. 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 Granof & Khumawala -6e

42. Supporting Computations – originalstyle Granof & Khumawala -6e

43. Example C (alternate style closing) Granof & Khumawala -6e

44. Supporting Computations – alternate style Granof & Khumawala -6e

45. 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. Granof & Khumawala -6e