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3: CHAPTER GOVERNMENTAL OPERATING STATEMENT ACCOUNTS; BUDGETARY ACCOUNTING OUTLINE Number Questions: 3-1 3-2 3-3 3-4 3-5 3-6 3-7 3-8 3-9 3-10 3-11 3-12 3-13 3-14 3-15 Cases: 3-1 3-2 3-3 3-4 Topic Type/Task Status (re: 11/e) 3-8 New New New New 3-1 3-3 revised 3-4 revised 3-5 revised 3-6 3-7 3-2 3-9 3-11 3-13 Nonexchange transactions Recognition of transactions Direct and indirect expenses Program and general revenue Government-wide statement of activities Special revenue funds Fund equity vs. net assets Real accounts and budgetary accounts Expenditure classifications Expenditure classifications - examples Revenue classifications The budget in the accounting system Budgets - GAAP basis Recording the budget Public school systems Define Describe Define Distinguish Describe Determine Define and compare Distinguish Explain Classify Classify Explain Explain Explain Explain Budgetary accounting and GAAP Chart of accounts Property taxes and GAAP Charter school (public school academy) Evaluate Discuss Evaluate Internet 3-1 3-2 3-3 New Exercises/Problems: 3-1 CAFR 3-2 Various 3-3 GASB Statement No. 34 3-4 King City budgets 3-5 King City - appropriations (cont'd) 3-6 Allotments 3-7 Subsidiary ledgers 3-8 Appropriations, Encumbrances, Expenditures Examine Multiple Choice Multiple Choice Journal Entries Journal Entries Journal Entries Calculate Calculate Same 3-2 revised New 3-3 revised 3-6 revised 3-7 3-9 3-10 3-B. Solution to the City of Bingham Continuous Problem is at the back of this Instructor's Guide. 23 CHAPTER 3: GOVERNMENTAL OPERATING STATEMENT ACCOUNTS; BUDGETARY ACCOUNTING Answers to Questions 3-1. The GASB defines "nonexchange transactions" as external events in which a government gives (or receives) value without directly receiving (or giving) equal value in exchange. Nonexchange transactions are divided into four classes: (1) derived tax revenues (e.g., income and sales taxes), (2) imposed nonexchange revenues (e.g., property taxes and fines and penalties), (3) government-mandated nonexchange transactions (e.g., certain education, social welfare, and transportation services mandated and funded by a higher level of government), and (4) voluntary nonexchange transactions (e.g., grants and entitlements from higher levels of government and certain private donations). A city recognizes revenue from an exchange transaction much like a business would; that is, when the transaction occurs and the revenue has been earned. Revenue from nonexchange transactions depends (1) upon whether there are time requirements, and/or eligibility requirements to be met, and (2) on the type of nonexchange transaction it is. Derived tax revenues are generally recognized in the period in which the underlying exchange takes place. Imposed nonexchange revenues are recognized when there is an enforceable legal claim or when cash is received, whichever is first. Governmentmandated and voluntary exchange transaction revenues are recognized only when all eligibility requirements have been met. Direct expenses are those specifically associated with a function or program. Indirect expenses are those that are not directly linked to an identifiable function or program (e.g., interest on general long-term liabilities). Depreciation expense is reported as a direct expense when it relates to capital assets that are clearly identified with a function or program. Even depreciation expense for infrastructure assets should be reported as a direct expense of the public works or transportation function, if that is the function responsible for those assets. a. b. c. d. e. f. g. Program revenues. General revenues. Program revenues. General revenues. General revenues. Program revenues. Program revenues. 3-2. 3-3. 3-4. 3-5. The Government-wide Statement of Activities prescribed by GASB Statement No. 34 will appear very different to most readers. Expenses are shown in the first column with rows that identify the function to which that expense is directly related, e.g., General Government, Public Safety, Recreation...). From expenses are subtracted the program revenues associated with those functions in columns moving to the right. Program 24 Ch. 3, Answers, 3-5 (Cont'd) revenues are segregated into three columns, Charges for Services, Capital Grants and Contributions, and Operating Grants and Contributions. The net expense (or revenue) is then displayed as either a component of Governmental Activities or Business-like Activities. The lower half of the Statement of Activities shows the general revenues that are recognized to subsidize the net expense of the program or functions not covered by program revenues. 3-6. The traditional activities of a general governmental unit (e.g., police, fire, etc.) are commonly accounted for by the General Fund. Special revenue funds are created when a source of revenue is authorized by a legislative body for a specific purpose. Common examples are receipt of state gasoline taxes to be used for construction and maintenance of streets, tax assessments for libraries, or federal grants. Fund equity is the arithmetic difference between the amount of financial resources and amount of liabilities recorded in the fund. For governmental funds, fund equity is partitioned between reserved fund balance accounts and unreserved fund balance accounts. The operating statement accounts (Revenues, Expenditures, and Other Financing Sources/Uses) and budgetary accounts (Estimated Revenues, Appropriations, Encumbrances, and Estimated Other Financing Sources/Uses) are all closed to (unreserved) Fund Balance at year-end. At the government-wide level, the counterpart to Fund Equity is Net Assets (Assets minus Liabilities) that is partitioned between unrestricted and restricted net assets and Invested in Capital Assets, net of Related Debt. Definitions of these terms are given in the Glossary of the text. Below are briefer statements: a. Expenditures and Encumbrances are both charges against appropriations. An encumbrance is a charge for an estimated amount at the time the goods or services are ordered; an expenditure is a charge for an actual amount at the time the goods or services are received (accrual and modified accrual basis) or paid for (cash basis). These accounts are used in the governmental-type funds because those funds utilize budgetary accounting. Revenues are increases in net assets of the government as a whole or of a fund other than from interfund transfers or debt issue proceeds, recognized at the time the increase is earned (accrual basis), available for use (modified accrual basis) or received in cash (cash basis). Estimated revenues are amounts expected to be available for use or received under enabling legislation during a budget period. Estimated Revenues is a budgetary account. Encumbrances is defined in a above. Reserve for Encumbrances is an account representing the amount segregated from Fund Balance for expected liabilities resulting from encumbrance documents issued and will be seen in the governmental-type funds. 3-7. 3-8. b. c. 25 Ch. 3, Answers, 3-8 (Cont'd) d. Reserve for Encumbrances is defined in c above. The Fund Balance of a governmental fund is the excess of fund assets over fund liabilities, appropriations, and reserves; in short, the assets available for appropriation [defined in e below] - in governmental-type funds. Expenditures is defined in a above. An Appropriation is an authorization by the legislative branch for administrators to incur expenditures for specified purposes not to exceed specified amounts. Usually the authorization is for a limited time. Appropriations is a budgetary account. Expenditures, defined in a above, are for both costs and expenses--for asset acquisition as well as for salaries, supplies for immediate consumption, travel, etc.--whatever is specified in the appropriations and is the term used in fund financial statements. Expenses, in governmental accounting as well as business accounting, are expired costs; the full cost of services or goods consumed in providing services to citizens and others. Expenses are found in the governmentwide financial statements as well as in the proprietary and fiduciary fund financial statements. e. f. . 3-9. Each of the prescribed expenditure classification categories serves a potentially important purpose. a. By function or program. Expenses or expenditures typically are reported at the functional level (e.g., general government and public safety) in the Statement of Activities or Statement of Revenues, Expenditures, and Changes in Fund Balance. Presumably goals and objectives are formulated at the program level. Thus, aggregating expenditures at the program level would be useful in assessing the cost of achieving program objectives--sometimes referred to as "cost effectiveness." By organizational unit. This classification category affords a level of responsibility accounting, and thus helps to achieve management control and to evaluate the performance of departmental managers. By activity. This classification category helps accumulate the cost of performing activities. Combined with performance standards and appropriate output measures, it assists in measuring the efficiency of performing activities. By character. This classification category provides government managers and concerned citizens the ability to determine the amount of current expenditures that provided current period benefits, the amount expended for prior period benefits (i.e., debt service), and the amount expended to provide future benefits (i.e., capital expenditures). b. c. d. 26 Ch. 3, Answers (Cont'd) e. By object. This classification provides the detail of line items needed to achieve budgetary control over expenditures. Organization unit Function Activity Activity Object Taxes Charges for services Licenses and permits Fines and forfeits Intergovernmental revenue f. g. h. i. j. f. g. h. i. j. Both character and object Program Function Organization unit Object Miscellaneous revenues Charges for services Licenses and permits Intergovernmental revenue Charges for services 3-10. a. b. c. d. e. a. b. c. d. e. 3-11. 3-12. a. The Accounting and Reporting Capabilities Principle (see Chapter 2 of the text) states that the purpose is twofold: (1) to make it possible to prepare financial statements in conformity with GAAP, and (2) to make it possible to determine and demonstrate compliance with finance-related legal requirements. A legallyadopted budget for the General Fund, special revenue funds, and possibly other governmental funds, is binding upon administrators of governmental units as explained in Chapter 3. Governmental budgets establish "finance-related legal requirements" and demonstration of compliance with legal requirements is facilitated by incorporation of budgetary accounts with the actual revenue and expenditure accounts. Appropriations set forth in a legally adopted budget are authorizations for administrators to incur on behalf of the governmental unit liabilities in the amounts specified in the appropriation ordinance or statute for the purposes set forth in the ordinance or statute, during the time specified. As of the first day of a fiscal year the total of the revenues budgeted for a governmental fund is debited to the Estimated Revenues control account, the total appropriations for that fund is credited to the Appropriations control account, and the difference is debited or credited to Fund Each Balance. control account is supported by a subsidiary ledger kept in whatever detail is specified by legal requirements. At year-end, the entry to close budgetary accounts is the reverse of the entry made to open them. b. 3-13. GASB standards identify several possible types of differences between GAAP and budgetary financial accounting. These include basis, timing, perspective, and entity. In order for budget to actual comparisons to be meaningful, actual revenues and expenditures must be reported in the same manner as the budgeted amounts. Actual revenues and expenditures reported in the Statement of Revenues, Expenditures, and 27 3-14. Ch. 3, Answers (Cont'd) Changes in Fund Balances should be on the GAAP basis. GASB Statement No. 34 requires that a reconciliation should be provided of the differences between amounts reported in the GAAP basis operating statement and those reported in the budgetary comparison schedule, either on the face of the budgetary comparison schedule or on a separate page. 3-14. In the situation described Fund Balance will increase over the amount displayed in the balance sheet as of the prior year end since expected available resources exceed expected expenditures and other uses of available resources. 3-15. Public school systems are expected to follow the classification system specified by the National Center for Education Statistics (NCES) or a state mandated system. The NCES system combines the GASB expenditure classification structure into two groups of dimensions: (1) dimensions essential to meet reporting requirements at the federal level and (2) dimensions optionally needed for internal management use. As explained in this chapter, the essential dimensions include program, function, object, and project/reporting code. The optional dimensions include level of instruction, operational unit, job classification, and special cost centers. The NCES revenue classification scheme also groups classifications into dimensions, but are generally classified by fund, source, and project/reporting code. The NCES expenditure and revenue dimensions should be compared with the corresponding GASB expenditure and revenue classifications described in this chapter. GASB standards require that expenditures be classified by fund, function or program, organization unit, activity, character, and object and that revenues be classified by fund and source. Comparison of the NCES and GASB classification show that they are generally compatible; the NCES classification structure is somewhat more detailed to meet the unique reporting needs of public school systems. Solutions to Cases 3-1. The chief accountant's budgetary accounting procedures are not only inappropriate, they probably would result in a chaotic situation in which effective budgetary control would not be achievable. Although a budget and actual comparison statement could be prepared manually at year-end, the lack of integrated budgetary revenue and appropriation accounts would make it very difficult, if not impossible, to maintain day-to-day budgetary control. Further, her procedures would not permit the use of encumbrance accounting, further increasing the danger of overspending appropriations. Lack of integrated budgetary accounts would be inconsistent with the requirements of GAAP, which state that "the accounting system should provide the basis for appropriate budgetary control." a. At first blush, the simple account number structure used by the City of Belmont appears inadequate to meet the expenditure classifications specified by GAAP and 3-2. 28 Ch. 3, Solutions, Case 3-2 (Cont'd) discussed in Chapter 3. Closer analysis, however, suggests this account number structure probably is adequate, provided the software for generating financial reports can aggregate balances for appropriate object classes to calculate expenditures for particular activities and can aggregate balances for organizational units to calculate expenditures by function. The structure should be adequate for classifying revenues and other financial statement elements. b. Expanding the account number structure to perhaps 15 to 18 positions would permit the City to add classifications for functions or programs, activities, and character. The additional data fields should provide greater flexibility in terms of generating useful financial reports. Depending on the software used, such expansion could be relatively easy, or it could be infeasible. Current GASB standards support the Town Controller's position. GASB Statement No. 34 makes it clear that whether the taxes are due during the current year or the following year, as long as they are expected to be collected within the current year or within 60 days thereafter they are recognized as revenue in the current period. In the hypothetical case in which the second installment is due more than 60 days after fiscal year-end, it would not be in conformity with GAAP to recognize the second installment as revenues of the fiscal year in which the tax is levied. If allowed under state law, possible solutions would be move the levy date to a later month or change to a different fiscal year. Though not common, municipalities do occasionally switch to a different fiscal year-end. Either solution would permit recognition of revenue for both installments of the current year tax levy. 3-3. a. b. 3-4. In most states, charter schools (or public school academies) are considered public schools receiving public funds. Consequently, these schools should follow GASB standards in order to ensure that financial statements conform to generally accepted accounting principles. Generally, these schools are small and may only have need for a General Fund and a special revenue fund for their food service program. The revenues and expense classification scheme described in the Public School Appendix to Chapter 3 that is based on NCES guidance is an appropriate starting place for building a chart of accounts and an accounting information system. Budgetary accounting is required by GAAP. The U.S. Charter Schools website (www.uscharterschools.org) provides valuable guidance in developing systems of financial and operational accountability for those who are new to charter schools, as well as links to other resources. Students should check their own state's Department of Education for other guidance for traditional pre-K through 12 schools. The Michigan Association of Public School Academies also provides resources for charter schools and their accountants (www.charterschools.org). 29 Ch. 3, Solutions Solutions to Exercises and Problems 3-1. Each student should have a different governmental annual report, so will have different answers to the questions in this exercise. Some time spent in class to allow students to report on their own answers and to get an idea of the range of answers of other students is useful. 1. 2. 3. 4. 5. 1. 2. 3. 4. 5. c. a. a. c. c. a. d. b. c. d. 6. 7. 8. 9. 10. 6. 7. 8. 9. 10. a. b. b. c. b. b. a. b. c. a. 3-2. 3-3. 30 Ch. 3, Solutions (Cont'd) 3-4. KING CITY a. ESTIMATED REVENUES TOTAL - COMING YEAR APPROPRIATIONS TOTAL - COMING YEAR THEREFORE, FUND BALANCE AT THE END OF THE CURRENT YEAR MUST BE AT LEAST $ 9,600,000 9,700,000 $ 100,000 OR THE FUND WOULD BE THROWN INTO A DEFICIT. General Ledger Debits b. ESTIMATED REVENUES FUND BALANCE APPROPRIATIONS 9,600,000 100,000 9,700,000 Credits Subsidiary Ledger Debits Credits Revenues Ledger: TAXES LICENSES AND PERMITS FINES AND FORFEITS INTERGOVERNMENTAL REVENUES 6,000,000 1,200,000 400,000 2,000,000 Appropriations Ledger: GENERAL ADMINISTRATION POLICE FIRE HEALTH AND WELFARE PUBLIC WORKS 1,700,000 2,000,000 2,300,000 1,800,000 1,900,000 31 Ch. 3, Solutions (Cont'd) 3-5. General Ledger Debits a. ENCUMBRANCES2002 RESERVE FOR ENCUMBRANCES2002 Encumbrances Ledger: GENERAL ADMINISTRATION POLICE FIRE PUBLIC WORKS 100,000 180,000 200,000 135,000 615,000 615,000 Credits Subsidiary Ledger Debits Credits b. Purchase orders issued by a governmental fund have the effect of using all or a portion of one or more appropriations for that fund. Issuance of purchase orders or other commitment documents is a step in the expenditure of an appropriation; administrators may be subject to severe legal penalties if they overexpend appropriations. Recording encumbrances helps administrators avoid overexpending appropriations. The same situation does not exist in business organizations, although a well-managed business should keep track of outstanding purchase orders and contracts to have a clear understanding of what transactions are in process that will result in the acquisition of assets, the incurring of expenses, and the incurring of liabilities. 32 Ch. 3, Solutions (Cont'd) 3-6. CITY OF DEXTER GENERAL FUND - GENERAL JOURNAL General Ledger Debits a. ESTIMATED REVENUES FUND BALANCE UNALLOTTED APPROPRIATIONS TO RECORD BUDGET FOR 19--: 23,360,000 186,000 23,174,000 Credits Subsidiary Ledger Debits Credits Revenues Ledger: TAXES LICENSES AND PERMITS FINES AND FORFEITS INTERGOVERNMENTAL REVENUES CHARGES FOR SERVICES Unalloted Appropriations Ledger: PERSONAL SERVICES CONTRACTUAL SERVICES COMMODITIES CAPITAL OUTLAYS 10,540,000 2,560,000 5,435,000 4,639,000 11,420,000 2,740,000 3,790,000 3,010,000 2,400,000 33 Ch. 3, Solutions, 3-6 (Cont'd) General Ledger Debits b. UNALLOTTED APPROPRIATIONS 6,050,000 ALLOTMENTS 6,050,000 Credits Subsidiary Ledger Debits Credits Unalloted Appropriations Ledger: PERSONAL SERVICES CONTRACTUAL SERVICES COMMODITIES CAPITAL OUTLAYS Allotments Ledger: PERSONAL SERVICES CONTRACTUAL SERVICES COMMODITIES CAPITAL OUTLAYS 2,660,000 640,000 1,350,000 1,400,000 2,660,000 640,000 1,350,000 1,400,000 34 Ch. 3, Solutions (Cont'd) 3-7. a. $14,980,000 (the sum of the amounts presently in the Estimated Revenues column of the subsidiary ledgers). b. $15,000,000 (the sum of the 01/01 entries in the Estimated Revenues column) c. 1. Yes 2. 02/28 (45 6 entry to Property Taxes) 3. $20,000 4. Decreased d. $12,080,000 (the sum of the amounts in the Revenues column) e. Property tax revenue is being accrued; revenue from the other three sources is being recognized on the cash basis. 35 Ch. 3, Solutions (Cont'd) 3-8. a. $62,200. The refund of prior year expenditure and the refund on P.O. 350 do not add to appropriation authoritythe former is generally reported as revenue of the current year; the latter is a reduction of expenditures from this year's appropriation. Similarly, the cost of stationery transferred to the Town Water Utility is a reimbursement of expenditures from this year's appropriation. The unauthorized transfer of $46,000 from Office Supplies to Personal Services should be disregarded. b. None. The outstanding purchase orders, #378 and #385, are not for office supplies but for office equipment and should not have been charged to this appropriation. Clerical errors in recording the encumbrance for #356, the encumbrance credit for #350, and the erroneous charge of #380 to this appropriation and failure to credit Encumbrances when #380 was filled do not affect the computation of the correct answer to b, although they would need to be corrected in the account--if the "comparison" is a subsidiary ledger account. c. $1,110 (#350, $605; #356, $420; #370, $425; less $330 and $10 considered reimbursements of this year's expenditures of this appropriation). d. $61,090 ($62,200 - $1,110). 36

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