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Chapter Two

Chapter Two. FUND ACCOUNTING. Thought to Ponder: Chapter 2. “A democratic society depends upon an informed and educated citizenry." -Thomas Jefferson. Learning Objectives. After studying Chapter 2, you should understand: The nature of funds The elements of financial statements

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Chapter Two

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  1. Chapter Two Granof & Khumawala - 6e Chapter 2 FUND ACCOUNTING

  2. Thought to Ponder: Chapter 2 “A democratic society depends upon an informed and educated citizenry." -Thomas Jefferson Granof & Khumawala - 6e Chapter 2

  3. Learning Objectives After studying Chapter 2, you should understand: • The nature of funds • The elements of financial statements • The hierarchy classification of fund balances • The three basic fund types of a state or local government: • Governmental funds • Proprietary funds • Fiduciary funds • The main components of a CAFR • The primary F/S issued by governments • The difference between the fund structures and financial reports of not-for-profits and governmental entities Granof & Khumawala - 6e Chapter 2

  4. Business • One company • “Fund” used as an informal term (multiple meanings) • May refer to working capital (current net assets) • May refer to cash or investments available • May have other definitions • The company is a single fiscal and accounting entity • A = L + E (“E” usually called “Owners’ Equity”) Granof & Khumawala - 6e Chapter 2

  5. Governmental Multiple “entities” • “Fund” used as a formal term (single meaning) • “A fiscal and an accounting entity with a self-balancing set of accounts.” • Each fund is like its own “entity” • In other words, a fund is an entity with its own set of books (i.e., chart of accounts , general journal, general ledger, trial balances, and financial statements) Granof & Khumawala - 6e Chapter 2

  6. Elements of Government Financial Statements • GASB Concepts Statement No. 4: Elements of Financial Statements (2007) • Seven Key elements -Five relating to financial position and two relating to resource flows • Assetsare resources with present service capacity • Liabilitiesare present obligations to sacrifice resources • A deferred outflow of resources is the consumption of net assets applicable to a future reporting period • A deferred inflow of resources is the acquisition of net assets applicable to a future reporting period • Net position is the residual of all elements presented in a statement of financial position; that is the assets + deferred outflows - the liabilities - deferred inflows. Granof & Khumawala - 6e Chapter 2

  7. Elements of Government Financial Statements (Cont’d) • An outflow of resourcesis a consumption of net assets that is applicable to the reporting period. • An inflow of resourcesis an acquisition of net assets that is applicable to the reporting period. • GAAP:GASB Statement No. 63, Financial Reporting of Deferred Outflows of Resources, Deferred Inflows of Resources, and Net Position (2011) requires that governments, unlike businesses, must now report the deferred items in a separate category. Thus, a statement of position might be, Assets + Deferred outflow of resources - Liabilities – Deferred inflow of resources = Net Position • GAAP:GASB Statement No. 65, Items Previously Reported as Assets and Liabilities (March 2012) specifies the items that may be classified as deferred outflows and inflows of resources. Granof & Khumawala - 6e Chapter 2

  8. FUNDS Based on GASB Statement No. 63, fund accounting uses the equation • Assets + deferred outflows = liabilities + deferred inflows + fund balance • In a slightly different form Assets + deferred outflows – liabilities – deferred inflows = fund balance. An important distinction: In financial statements that are prepared on a full accrual basis, the residual amount is referred to as “net position;” in statements that are prepared on a modified accrual basis it is referred to as “fund balance.” Note: Both fund balance and net position, like owners’ equity, are residuals—the difference between assets (and deferred outflows) and the claims against those assets (liabilities and deferred inflows) Granof & Khumawala - 6e Chapter 2

  9. GASB Statement No. 54 In February 2009, the GASB issued Statement No. 54, Fund Balance Reporting and Governmental Fund Type Definitions, to improve the usefulness, and understandability of governmental fund balance information. • According to GASB Statement No. 54, the fund balance (the residual in modified accrual-based governmental funds) is reported in a hierarchy of classifications. • Thus it affects only the fund balance reported on the balance sheet of governmental type funds. Granof & Khumawala - 6e Chapter 2

  10. Brief Summary (GASB Stmt. No 54) • Fund balances of governmental type funds are now to be reported based on a hierarchy in five different classifications: • Nonspendable • Restricted • Committed • Assigned • Unassigned • The reporting of Reserve for Encumbrances is eliminated • According to GASB Statement No. 54, only the Fund balance reported on the balance sheet of Governmental type funds is affected. • It does not affect the reporting of net assets by proprietary or fiduciary funds. • It also does not affect the reporting of net assets of governmental activities in the government-wide financial statements. Granof & Khumawala - 6e Chapter 2

  11. GASB Stmt. No 54 (Cont’d) • Effect on Financial Statements • The next PPT slide shows the marked up area on the Balance Sheet of Governmental Funds which is impacted by this stmt. • The Fund Balance accts in the block are now presented based on the new 5 part classification as presented in the following two PPT slides ( Exhibit 1 & 2 presents the reporting of Fund Balance as illustrated by GASB under Stmt. 54). Granof & Khumawala - 6e Chapter 2

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  13. GASB Stmt. No 54 -- Exhibit 1 Granof & Khumawala - 6e Chapter 2

  14. GASB Stmt. No 54 -- Exhibit 2 Granof & Khumawala - 6e Chapter 2

  15. GASB Stmt. No 54 (Cont’d) Fund Balance should be identified between nonspendableresources and spendable resources • Nonspendable resources include amounts that are not in spendable form or are required to be maintained intact. • Inventories and prepaids (also includes assets held for sale and long-term receivables) • The principal (corpus) of a Permanent Fund • Spendable resources is the remaining balance and is to be reported in a hierarchy of classification (4 categories) based on the extent to which the government is bound by restrictions/constraints on those funds Granof & Khumawala - 6e Chapter 2

  16. Level of Constraints (GASB 54) Granof & Khumawala - 6e Chapter 2

  17. Spendable Resources - Restricted • Restricted (most constraint) includes amounts constrained to specific purposes by their providers, through constitutional provisions, or by enabling legislation. Externally imposed constraints by • creditors, bondholders, • grant providers, contributors, or • imposed by law through constitution or enabling legislation . • Enabling legislation (imposed by law) authorizes the government to assess, levy, charge, or mandate payments of resources and includes a legally enforceable requirement that the resources be used only for the specific purpose. • Thus the level of constraint on restricted fund balance is equivalent to the level of constraint on Net Position-Restricted in proprietary funds and the government-wide statement of net position. • Ex. In, Table 2-5, the balances for State statute, Special obligation, Public safety, etcare presented as FB Restricted Granof & Khumawala - 6e Chapter 2

  18. Spendable Resources – Committed • Committed fund balance—here the constraints are imposed by a formal action of the government’s highest level of decision-making authority (for ex. City council committing funds for construction contracts, rainy day fund etc). • These funds cannot be used for any other purpose unless the government removes or changes the specified use by taking the same formal action that originally imposed the constraint. • Committed funds include contractual obligations for which existing resources in the fund have been specifically committed for use. • The funds may also include “rainy day” or “stabilization funds.” • Note: In contrast to fund balance that is restricted by enabling legislation, amounts in the committed fund balance can be redeployed for other purposes with appropriate due process. • Ex. In, Table 2-5, assuming FB Reserved for encumbrances is a contractual commitment, it is presented as FB Committed. Granof & Khumawala - 6e Chapter 2

  19. Spendable Resources - Assigned Assigned fund balance –Government’s intent to use the funds for a specific purpose. Here INTENT is the key. • Intent can be expressed by the governing body itself or another body that has the delegated authority. • In the General Fund, assignment conveys that the intended use is narrower than the general purposes of the government itself. • Fund Balance in other governmental funds (except General Fund) that is not restricted or committed is considered as Assigned FB in those funds. In other words it is the residual balance of these funds. • Note: the authority for making an assignment does not have to be made by the government’s highest level of decision-making authority. • Thus, constraints imposed on assigned amounts can be more easily removed or modified than those that are classified as committed. • Ex. In, Table 2-5, the Debt Service fund (the only major fund) has FB Assigned Granof & Khumawala - 6e Chapter 2

  20. Spendable Resources - Unassigned • Unassigned fund balance –this is the residual classification of the General Fund • Includes amounts that are available for any purpose • Only the GF can report this positive Unassigned FB • For other governmental funds, this category is used to report only a negative fund balance (i.e. when expenditures have exceeded the revenues). • Ex. In, Table 2-5, as explained above, the General Fund has an Unassigned fund balance. Granof & Khumawala - 6e Chapter 2

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  22. Not-for-profit • NFP may use fund accounting internally to ensure control of funds, but they do not report these funds externally. • Classifies Net Assets into 3 groups: • Unrestricted • Temporarily restricted – used for specific purpose • Permanently restricted -explained further on later slides • FASB regulates NFP reporting for nongovernmental organizations and only requires 6 totals: • Total assets • Total liabilities • Total net assets • Total unrestricted net assets • Total temporarily restricted net assets • Total permanently restricted net assets. Granof & Khumawala - 6e Chapter 2

  23. Types of Funds and Their Focus Granof & Khumawala - 6e Chapter 2

  24. Basis of Accounting • Full Accrual: • Revenues recognized when earned; expenses recognized when incurred • Cash: • Revenues recognized when available; expenses/expenditures recognized when paid • Modified Accrual: • Revenues are recognized when measurable and available; expenditures when incurred Granof & Khumawala - 6e Chapter 2

  25. Measurement Focus • What is measured? • Where is the focus of an entity? • Economic resources measurement focus • Report on the determination of net income, financial position, and cash flows (i.e. capital maintenance) • To measure operational accountability • Current financial resources measurement focus • Report on the inflows and outflows of current financial resources (i.e. cash or other items expected to be converted into cash during the current period) • To measure fiscal accountability; meet the legal and budget needs of government Granof & Khumawala - 6e Chapter 2

  26. Measurement Focus and Basis of Accounting Granof & Khumawala - 6e Chapter 2

  27. Types of Local Governments Counties 3,031 Municipalities 19,522 Townships 16,364 School districts 12,884 Special districts 37,203 Total 89,004 Source: U.S. Census Bureau, 2012 Census of Governments, preliminary results, August 2012. http://www.census.gov/govs/cog2012. Granof & Khumawala - 6e Chapter 2

  28. Activities of Government • Governmental Activities • Core governmental services like police and fire protection, streets, highways, etc. – Chapters 3-6. These activities are accounted under governmental funds. • Proprietary Activities • Public utilities, toll roads (Sam Houston Tollway) and toll bridges, airports (ex. Houston’s new Toyota Center, Hobby, IAH) – Chapter 9. These activities are accounted under proprietary funds. • Fiduciary Activities • Sometimes known as Trust & Agency Funds. Accounts for resources for which the government is acting in a trustee capacity (ex. Houston Foundation, MacGregor Parks Endowment) – Chapter 10. These activities are accounted under fiduciary funds. Granof & Khumawala - 6e Chapter 2

  29. Types of Funds “Funds divide a government into units to control resources or attain objectives, not functional departments or operations.” • Governmental Funds (5) • General Fund • Special Revenue Funds • Capital Projects Funds • Debt Service Funds • Permanent Funds • Proprietary Funds (2) • Internal Service Funds • Enterprise Funds • Fiduciary Funds (2) • Agency Funds • Trust Funds • Pension (and other employee benefit) • Investment Trust Funds • Private purpose Trust Funds Granof & Khumawala - 6e Chapter 2

  30. Definition of Fund Types • Governmental Funds • A generic classification used by GASB to refer to all funds other than proprietary or fiduciary • No guarantee that the funds will be reimbursed for services rendered • Proprietary Funds • Government generally makes initial contribution but thereafter the fund is expected to “pay its own way” through fees for services rendered. Also referred to as business-like or commercial-type funds. • Fiduciary Funds • Any fund held by a government in a fiduciary capacity. • Simply, the gov’t. holds someone else’s money in trust and acts as a custodian. Since it is not the government’s money, it is not expendable for the government’s own programs. Granof & Khumawala - 6e Chapter 2

  31. Governmental Funds Granof & Khumawala - 6e Chapter 2

  32. Overview • Basis of Accounting: • Modified Accrual • Measurement Focus: • Current Financial Resources • Other names: “financial flow” focus or spending focus • Only current assets and liabilities are generally included on their balance sheet (i.e. Capital assets and long-term liabilities are not included) • Reports expenditures (not expenses) of appropriations • Fund Balance (net current assets) measures “available spendable resources” • Fund Balance = Current Assets – Current Liabilities • Increased by revenues and other financing sources • Decreased by expenditures and other financing uses • Governmental fund operating statements present these increases and decreases in net current assets. Granof & Khumawala - 6e Chapter 2

  33. Required financial statements • Balance Sheet • Statement of Revenues, Expenditures, and Changes in Fund Balances • Reconciliation of the Statement of Revenues, Expenditures, and Changes in Fund Balances of Governmental Funds to the Statement of Activities at the government-wide level. Granof & Khumawala - 6e Chapter 2

  34. (1) - General Fund (GF) • The operating fund of the government-embraces most major governmental functions • Accounts for all resources that are not required to be accounted for in other funds; in essence, it accounts for all unassigned resources. • Only one per government and is the most significant single fund • General Activities of city government (ex. Fire, police) Granof & Khumawala - 6e Chapter 2

  35. (2) - Special Revenue Funds (SRF) • Accounts for financial resources that are restricted or committed (does not include assigned) to expenditure for specific purposes other than debt service or capital projects. • Accounting and budgeting usually identical to GF • Ex. City of Houston maintains over 17 SRF • Examples include • Public Safety Special Fund (9-1-1 Emergency Network) • Public Works Special Fund • Health and Housing Special Fund • Parks and Recreation Special Fund • Other Special Revenue Fund (Cable Television) Granof & Khumawala - 6e Chapter 2

  36. (3) - Capital Projects Funds (CPF) • Accounts for financial resources that are restricted, committed, or assigned to expenditure for capital outlays. • Ex. Astrodome, Toyota Center, GRB Granof & Khumawala - 6e Chapter 2

  37. (4) - Debt Service Funds (DSF) • Accounts for financial resources that are restricted, committed, or assigned for the payment of interest and principal on long-term debt. • Ex. City of Houston as of 6/30/2012 • Total fund balance in DSF $148,174,000. • Total long-term liabilities $15.16 Billion (for FY 2011- $14.8 B) Granof & Khumawala - 6e Chapter 2

  38. (5) - Permanent Funds Accounts for resources provided that are legally restricted so that only earnings, not principal, may be used to support the government’s programs. Granof & Khumawala - 6e Chapter 2

  39. Proprietary Funds Granof & Khumawala - 6e Chapter 2

  40. (1) - Internal Service Funds (ISF) • Accounts for activities in which goods are services are provided to (1) other departments of the same government (2) other governments for a charge on a cost reimbursement basis • Examples include central stores, central computing, motor pools, and printing. • ISF are reported as governmental activities in the government-wide statements because they primarily benefit the government. • ex. City of Houston’s employees Health Benefits and • Long -Term disability. These funds are covered in depth in Chapter 9. Granof & Khumawala - 6e Chapter 2

  41. (2) - Enterprise Funds (EF) • Accounts for activities in which goods or services are provided to the general public for a charge • Reported as business-type activities in the government-wide financial statements • Examples include electric and water utilities, airports, parking garages, transportation systems, and liquor stores • Ex. City of Houston’s EF • Airport System • Convention & Entertainment facilities • Combined Utility system • Non-major Enterprise funds (Houston Area Water Corporation, Parking Management) Granof & Khumawala - 6e Chapter 2

  42. Overview • Basis of Accounting: • Full Accrual • Operated like a “normal for-profit” business Ex. City of Houston operates its Airports under a Proprietary fund • Measurement Focus: • Economic Resources • All assets and liabilities (both current and noncurrent) are included in the balance sheet • Accounts for expenses(not expenditures) --Depreciation expense is reported • Fund Equity (Net Position) • Net Position = Assets – Liabilities • Increased by revenues and other financing sources • Decreased by expenses and other financing uses • Segregated into contributed capital and retained earnings components Granof & Khumawala - 6e Chapter 2

  43. Required Financial Statements Similar to those of for-profit entities • Statement of Net Position • Statement of Revenues, Expenses, and Changes in Net Position (i.e. operating statement) • Statement of Cash Flows Granof & Khumawala - 6e Chapter 2

  44. Fiduciary Funds Granof & Khumawala - 6e Chapter 2

  45. (1) - Agency Funds • Accounts for financial resources in which the government is acting in an “agency” capacity • Agent - Government holds assets on behalf of another government • Accounting is simple: assets = liabilities. • No revenue and expense to accrue • No fund equity account • Examples are tax agency funds, certain special assessment funds, and pass-through agency funds Granof & Khumawala - 6e Chapter 2

  46. Overview • Both Trust funds and Agency funds account for assets held by the City in a trustee capacity or as an agent for individuals, private organizations, other governments, and/or other funds. • Therefore, the government cannot include these funds in the government-wide statements. • Basis of Accounting: • Full Accrual • Measurement Focus: • Economic Resources Granof & Khumawala - 6e Chapter 2

  47. Required Financial Statements • Statement of Fiduciary Net Position • Statement of Changes in Fiduciary Net Position • Only Trust Funds may have a change in net position Granof & Khumawala - 6e Chapter 2

  48. (2) - Trust Funds • Each trust is classified for accounting measurement purposes as either a governmental fund or a proprietary fund (ex. Houston Firefighters Relief and Retirement and Police Officers’ Funds). • Funds can be either expendable or nonexpendable. • Three types of trust funds (i) Pension (and other employee benefits) Trust Funds (one or more) (ii) Investment Trust Funds (iii) Private Purpose Trust Funds Granof & Khumawala - 6e Chapter 2

  49. Pension (and other employee benefits) Trust Fund • Accounts for financial resources in which the government (or other designated trustee) is acting in a trustee capacity for the employees of the government to provide retirement benefits. • Uses business-type accounting practices. Granof & Khumawala - 6e Chapter 2

  50. Investment Trust Funds • Accounts for external investment pools in which the assets are held for other (external) governments, along with funds of the sponsoring government • Reports the assets, liabilities, net assets, and changes in net assets corresponding to the equity of the external participants Granof & Khumawala - 6e Chapter 2

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