ACC410 Chapter 4

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Unformatted text preview: E1C04 03/29/2010 11:32:22 Page 64 CHAPTER 4 Governmental Activities-- Revenues CHAPTER HIGHLIGHTS Why the fund statements focus on current financial resources and use the modified accrual basis of accounting Why the government-wide statements focus on economic resources and use the full accrual basis The key distinctions between the modified and full accrual bases of accounting Exchange versus nonexchange transactions How the ``available'' criterion affects revenue recognition Accounting for the principal types of revenues I n Chapter 3, we discussed the basic financial statements and other minimum financial reporting requirements for governments. In this chapter and the next six chapters, we examine the principal transactions that underlie the basic financial statements. This chapter and Chapter 5 address what are probably the most difficult issues in accounting for governmental activities--those supported primarily by taxes and intergovernmental revenues: When should revenues and expenditures be recognized in the governmental funds and in the government-wide statement of activities (governmental activities column)? How should the related assets and liabilities be measured? Although most of the fund-accounting examples in these two chapters affect the general fund, the discussion also applies to the other governmental funds (special revenue, capital projects, debt service, and permanent funds). In Chapter 9, we examine similar issues for business-type activities and the proprietary funds used to record their transactions. WHY AND HOW DO GOVERNMENTS USE THE MODIFIED ACCRUAL ............................................................................................................. RATIONALE FOR THE MODIFIED ACCRUAL BASIS As discussed in Chapter 3, GASB Statement No. 34 requires two sets of financial statements to meet two key but potentially conflicting objectives of financial reporting: Providing information about interperiod equity (i.e., whether an entity's current-year revenues were sufficient to pay for its current-year services) BASIS OF ACCOUNTING? 64 E1C04 03/29/2010 11:32:23 Page 65 WHY AND HOW DO GOVERNMENTS USE THE MODIFIED ACCRUAL BASIS OF ACCOUNTING? 65 Demonstrating whether the entity obtained and used its resources in accordance with its legally adopted budget The government-wide statements are consolidated and use the full accrual basis of accounting, thereby demonstrating whether current-year revenues were sufficient to pay for current-year services. The fund statements, by contrast, present governmental funds--the activities of which are generally governed by a legally adopted budget--on a modified accrual basis, thereby facilitating budgetary comparisons. The modified accrual basis is far more budget oriented than the full accrual basis in that the budgets of most governments focus on either cash or cash plus selected short-term financial resources. The budgetary measurement focus of governments is determined by applicable state or local laws. Except for governments that elect or are required to budget on a modified accrual basis, as defined by GAAP, the revenue and expenditure principles that underlie their governmental fund statements may differ from those of their legally adopted budgets. Hence, as discussed in Chapter 3, the budgetary comparisons (budget versus actual amounts) that governments are required to present with their financial statements must include a reconciliation and explanations of differences between the budgetary and the GAAP basis. In developing Statement No. 34, the GASB opted to retain the modified accrual basis (with some refinements) from its previous reporting standards, rather than requiring the government's budgetary basis, for governmental fund financial statements. This approach ensures that all governments present those statements on the same basis. It thereby facilitates comparisons among entities, which is difficult if each entity reports on its own particular budgetary basis. RELATIONSHIP BETWEEN MEASUREMENT FOCUS AND BASIS OF ACCOUNTING The criteria that an entity uses to determine when to recognize revenues and expenditures stem from its measurement focus and basis of accounting. As pointed out in Chapter 2, measurement focus refers to what is being reported upon--which assets and liabilities are being measured. Basis of accounting refers to when transactions and other events are recognized. The two concepts obviously are closely linked. If an entity opts to focus on cash, it necessarily adopts a cash basis of accounting. Correspondingly, if it elects to focus on all economic resources (both current and long-term assets and liabilities), it adopts a full accrual basis of accounting. Many versions of modified accrual accounting are possible, each of which lies somewhere on a continuum between cash and full accrual accounting. Statement No. 34 requires a particular version of modified accrual accounting for compliance with GAAP. A government's budgetary basis may lie elsewhere on the continuum. Therefore, the fact that a government budgets on a ``modified accrual'' basis does not necessarily mean that it budgets on a GAAP basis. OVERVIEW OF THE MODIFIED ACCRUAL BASIS Statement No. 34 reaffirms that governmental funds should be accounted for on a modified accrual basis, with a measurement focus on current financial resources. Current financial resources have been made operational as encompassing expendable financial resources--cash and other items that can be expected to be transformed into cash in the normal course of operations. The ``other items'' include investments and receivables, but not capital assets. As noted in Chapter 3 (see Table 33) and discussed in Chapter 5, inventories and prepaid items (e.g., insurance) are also reported on governmental fund balance sheets, even though they are not, strictly speaking, financial resources. However, although these assets are not ordinarily transformed into cash (e.g., inventories are consumed, not sold for cash), they generally result in short-term cash savings because the entity does not have to expend additional cash to acquire them. E1C04 03/29/2010 11:32:23 Page 66 66 CHAPTER 4 / GOVERNMENTAL ACTIVITIES--REVENUES A government's current claims against financial resources include wages and salaries payable, accounts payable, and deferred revenues (e.g., property taxes collected in advance of the period they are intended to finance). Current claims exclude long-term obligations, such as the noncurrent portions of bonds payable and of liabilities for compensated absences. Consistent with conventional relationships between balance sheet and operating statement accounts, governmental fund revenues and expenditures include only those amounts that result in increases or decreases in net current financial resources (as opposed to increases or decreases in net economic resources, as is the case under the full accrual basis). WHAT TRIGGERS REVENUE RECOGNITION FOR NONEXCHANGE VERSUS EXCHANGE TRANSACTIONS? ............................................................................................................. A thorny issue, under both the modified accrual and the full accrual basis of accounting, is the matter of when revenues should be recognized. What key economic event in the revenue generation process should trigger the recognition of revenue and the corresponding increase in net assets? The revenue recognition issues facing governments are more difficult to resolve than those of businesses. Businesses derive their revenues mainly from exchange transactions-- those in which each party gives and receives consideration of equivalent value. The occurrence of an economic exchange is the foundation of revenue recognition for businesses and, by extension, for the business-type activities of governments. However, the governmental activities of governments derive their revenues mainly from nonexchange transactions-- those, such as property taxes and most intergovernmental grants, in which one party gives or receives value without directly receiving or giving equivalent value in exchange. When there is no exchange, it is more difficult to determine when revenue should be recognized. STATEMENT NO. 33 GASB Statement No. 33, Accounting and Financial Reporting for Nonexchange Transactions (1998), governs the recognition of nonexchange revenues on both the modified accrual basis (for governmental funds) and the full accrual basis (for proprietary and fiduciary funds and the government-wide statements). The recognition requirements are the same for both bases except that, when the modified accrual basis is used, revenues are subject to an additional, extremely significant stipulation. They cannot be recognized until they are both measurable and available to finance expenditures of the fiscal period. The need for revenue to be measurable should be intuitive. For example, if a local government does not know and cannot reasonably estimate the amount of sales taxes it is entitled to receive from the state government, it cannot recognize an amount for sales tax revenue in the financial statements. But what does available to finance expenditures of the current period mean? MEANING AND RATIONALE FOR ``AVAILABLE TO FINANCE EXPENDITURES OF THE CURRENT PERIOD'' The nonexchange revenues of governments are intrinsically associated with expenditures; they are generated solely to meet expenditures. Budgets are formulated so that each period's estimated revenues are sufficient to cover appropriated expenditures (those authorized by the legislative body for that period). Expenditures of a current period may either require cash outlays during the period or create liabilities that have to be satisfied shortly after the end of the period. For example, goods or services that a government receives toward the end of one year ordinarily do not have to be paid for until early the next year. The term available therefore means ``collected'' within the current period or ``expected to be collected soon enough thereafter to be used to pay liabilities of the current period.''1 1 GASB Statement No. 33, Accounting and Reporting for Nonexchange Transactions (December 1998), footnote 16. E1C04 03/29/2010 11:32:23 Page 67 WHAT ARE THE MAIN TYPES OF NONEXCHANGE REVENUES? 67 The liabilities referred to are only current liabilities. Recall that long-term liabilities are outside of the measurement focus of governmental funds and hence are not recorded by them. As discussed in the next chapter, under the modified accrual basis, transactions that result in long-term liabilities are not recorded as expenditures of governmental funds. How many days after the close of the year must revenues be received to satisfy the criterion of having been received soon enough to pay liabilities of the current period? With respect to property taxes only, existing standards provide that, except in unusual circumstances, revenues should be recognized only if cash is expected to be collected within 60 days of year-end.2 Because existing standards provide no specific guidance as to time periods for recognition of other revenues, this 60-day rule has become widely used to define ``available'' for all types of revenues, not just property taxes. However, many governments have established other time periods--30 days, 90 days, or even one year--for revenues other than property taxes. The period used to define ``available'' must be disclosed in the notes to the financial statements.3 WHAT ARE THE MAIN TYPES OF NONEXCHANGE REVENUES? ............................................................................................................. Statement No. 33 divides nonexchange revenues into four classes: 1. Imposed nonexchange revenues. These are assessments imposed on individuals and business entities--mainly property taxes and fines. 2. Derived tax revenues. These are taxes derived (i.e., taxes that result) from assessments on exchange transactions of taxpayers. They include sales taxes (derived from sales transactions) and income and other taxes on earnings or assets (derived from various income-producing commercial transactions). 3. Government-mandated nonexchange transactions. These occur when a government at one level provides resources to a government at another level and requires the recipient to use the resources for a specific purpose. For example, a state may grant funds to a county, stipulating that the resources be used for road improvements. Acceptance and use of the resources are mandatory. 4. Voluntary nonexchange transactions. These result from legislative or contractual agreements entered into willingly by two or more parties. They include grants given by one government to another and contributions from individuals (e.g., gifts to public universities). Often the provider imposes restrictions on the use of the funds. Unlike government-mandated nonexchange transactions, the recipient government is not required to accept the awards, but, if it does, it must observe the accompanying spending restrictions. Statement No. 33 establishes standards, discussed in the next sections, for each of the four classes of transactions. The standards for government-mandated and voluntary nonexchange transactions apply to both revenues and expenditures. Thus payments from one government to another should be accounted for by both governments, using the same criteria. Statement No. 33 also identifies two types of limitations that constrain when or how a government may use the resources it receives in nonexchange transactions: 1. Time requirements. These specify the period in which resources must be used or when use may begin. For example, local governments typically levy property taxes to finance a particular fiscal year. Similarly, state governments may require that their grants to local school districts be used during the state's fiscal year. 2 3 GASB Interpretation No. 5, Property Tax Revenue Recognition in Governmental Funds (November 1997). GASB Statement No. 38, Certain Financial Statement Note Disclosures (June 2001), para. 7. E1C04 03/29/2010 11:32:23 Page 68 68 CHAPTER 4 / GOVERNMENTAL ACTIVITIES--REVENUES 2. Purpose restrictions. These specify the purpose for which the resources must be used. For example, certain sales taxes must be used for road improvements, certain property taxes must be used to repay debt, and certain grants or private donations must be used to acquire specific goods or services. According to Statement No. 33, governments should not recognize revenue, expenditures, or expenses for nonexchange transactions until time requirements have been met (e.g., the start of the specific period in which resources may be used). By contrast, they should not delay revenue recognition until they have satisfied the purpose restrictions. However, they must specifically identify resources that are subject to purpose restrictions by reporting a reservation of fund balance in their governmental fund financial statements and restricted net assets in their government-wide statements. These requirements continue in force until the restricted amounts are spent for the specified purpose. HOW SHOULD PROPERTY TAXES AND OTHER IMPOSED ............................................................................................................. Property taxes are the bread and butter of local governments. Although increasingly being supplemented by other taxes and fees, they still account for more than one-fourth of local government revenues. Classified as ad valorem taxes (based on value), property taxes are most typically levied against real property (land and buildings). However, many jurisdictions also include personal property, such as automobiles, boats, business inventories, and intangible assets (e.g., securities and bank deposits) within the tax base. Property taxes are levied against the assessed value of taxable assets. Most jurisdictions are required to assess property at 100% of its appraised fair market value. Many, however, assess property at a fraction of its appraised value (perhaps in the hope of discouraging taxpayer protests) and then adjust the tax rate upward to offset the reduction in the tax base. Most governments establish the property tax rate by dividing the amount of revenue needed from property taxes by the assessed value of the property subject to tax. For example, if a government needs $400 million in property tax revenue and its jurisdiction has $22 billion in taxable property, the property tax rate is $400 million divided by $22 billion--1.818%, or 18.18 mils (dollars per thousand). In reality the computation is somewhat more complex, because allowances have to be made for discounts, exemptions, and taxes that are delinquent or uncollectible. Most jurisdictions experience a low rate of bad debts on property taxes, because they are able to impose a lien (right to seize and sell) on the taxed property. However, it may be several years before the government can actually collect from a property owner or seize and sell the property. Moreover, sometimes the amount to be recovered is not worth the collection costs and efforts. Many jurisdictions grant discounts for early payment. For example, taxpayers may be allowed discounts of from 1 to 3% for paying, respectively, one to three months before the due date. Payments after the due date are generally subject to interest and penalties. Property held by other governments (e.g., a federal building in a city) and religious institutions is ordinarily exempt from property taxes. In addition, many jurisdictions grant homestead exemptions to homeowners on their primary residences. These exemptions include basic allowances, often of a fixed dollar amount (e.g., $5,000), that are available to all taxpayers and supplementary amounts to senior citizens or members of other designated classes. Thus, if a residence is assessed at $200,000 but the homeowner is granted a $5,000 exemption, the property's net assessed value is $195,000. If the tax rate is 18.18 mils, the tax is $195,000 multiplied by .01818, or $3,545. NONEXCHANGE REVENUES BE ACCOUNTED FOR? E1C04 03/29/2010 11:32:23 Page 69 HOW SHOULD PROPERTY TAXES AND OTHER IMPOSED NONEXCHANGE REVENUES 69 SIGNIFICANT EVENTS IN THE REVENUE GENERATION PROCESS Several events in the property tax timeline have potential accounting significance: The legislative body levies the tax, establishing the tax rate and estimating the total amount to be collected. Administrative departments determine the amount due from the individual property owners, enter the amounts on the tax roll (a subsidiary ledger that supports the taxes receivable control account), and send out tax notices (bills) to property owners. The taxes are collected--most prior to the due date, some afterward. The taxes are due, and the government has the right to impose a lien on the property for which taxes have not been paid. The stated due date for property taxes must be distinguished from the substantive due date. Some jurisdictions establish a due date but do not impose interest, penalties, or a lien until a later date. The later date is the substantive due date. The question facing governments is which of the many events in a property-tax calendar warrant revenue recognition, subject (on the governmental fund statements) to the ``available'' constraint? DESIGN OF CHAPTER EXAMPLES In this and subsequent chapters, we spotlight accounting issues by using short examples followed by journal entries. We also reference the authoritative standards that relate to the topic. In many of the examples, we use a single entry to summarize what, in practice, constitutes many individual entries. The illustrated entry is intended to show the net effect of the described events on the year-end financial statements. In most of the examples, we assume, for convenience, that the entity's fiscal year ends on December 31, even though for most governments it ends on the last day of June, July, August, September, or October. EXAMPLE ........................................................................................................ In January 2012 a city levies property taxes of $515 million for the year and collects $410 million during the year. It collects another $30 million during each of the first three months of 2013 and estimates that the $15 million balance is uncollectible. In addition, in 2012 it collects $20 million in taxes that are applicable to 2013. Taxes are due on January 31 of the year following the levy, and the government has the right to impose a lien on the taxed property if it has not received payment by that date. Property Taxes GASB Standards Per GASB Statement 33, governments should recognize assets from property taxes and other imposed nonexchange revenues in the period in which they first have an enforceable claim to the assets or when they receive the assets, whichever comes first. For property taxes, the date when they have an enforceable claim is specified in the legislation authorizing or imposing the tax and is frequently referred to as the ``lien date.'' Governments should recognize revenue from property taxes in the period for which the taxes are levied (i.e., the period that the taxes are expected to finance). Therefore, governments must delay recognition of taxes collected in advance until the period for which the taxes have been budgeted, thereby satisfying the relevant time requirement. (continued ) E1C04 03/29/2010 11:32:23 Page 70 70 CHAPTER 4 / GOVERNMENTAL ACTIVITIES--REVENUES GASB Standards (continued ) In addition, in governmental fund statements, the taxes must be ``available''--that is, collected in the current period or within 60 days of year-end. If property taxes are collected prior to the period for which they are budgeted or are not collected in time to pay liabilities of the current period, the government should report an asset (e.g., ``cash'' or ``property taxes receivable'') and a deferred revenue (e.g., ``taxes collected in advance'' or ``deferred property tax revenue''). In the example, therefore, the total revenue to be recognized in 2012 on a modified accrual basis is $470 million--the $410 million due and collected during the year and applicable to it, plus the $60 million collected in the first 60 days of the next year. The $30 million to be collected after 60 days is recognized as deferred revenue. The following entries for 2012 give effect to the current guidance: Property taxes receivable Deferred property tax revenue Allowance for uncollectible property taxes To record the property tax levy Cash Property taxes receivable To record the collection of cash in 2012 Deferred property tax revenue Property tax revenue To recognize revenue on the taxes collected $515 $500 15 $410 $410 $410 $410 Deferred property tax revenue $60 Property tax revenue To recognize revenue on the taxes to be received in the first 60 days of 2013 $60 (Because this entry is made as of year-end, it may appear to recognize only an estimate of the tax receipts of the first 60 days of 2013. In reality, the government records its actual collections. Few governments are able to close their books and prepare financial statements within 60 days of year-end. Therefore, by the time they do so, they are able to determine exactly how much revenue from collections subsequent to year-end must be recognized.) Cash $20 Deferred property tax revenue $20 To record collection of property taxes received in advance of the year to which they are applicable (The advance collections are intended to cover 2013 expenditures. Hence, they should be recognized as revenue in 2013 and thereby matched with the expenditures.) The example solution follows the practice of many governments that initially defer all property-tax revenue and then recognize revenue as it becomes ``available'' to meet current-period expenditures. An alternative approach used by many governments is to recognize revenue initially and then, at year-end, reduce the revenue account and record deferred revenue equal to the amount that is not collected in time to meet the ``available'' criterion (or that had been collected in advance of the applicable fiscal year). The amounts reported as revenue and deferred revenue, respectively, on the year-end financial statements are the same under either approach. E1C04 03/29/2010 11:32:24 Page 71 HOW SHOULD PROPERTY TAXES AND OTHER IMPOSED NONEXCHANGE REVENUES 71 DELINQUENT PROPERTY TAXES At year-end, overdue taxes receivable should be reclassified as delinquent, so that they are not intermingled with the current receivables of the following year: Property taxes receivable--delinquent Property taxes receivable To reclassify uncollected taxes as delinquent $105 $105 This entry has no effect on revenues or governmental fund balances (and hence on the government's net assets). However, it provides statement readers with additional information as to the status of property taxes receivable. An increase in delinquent taxes relative to tax revenues should serve as warning of a possible economic downturn in the jurisdiction or of ineffective tax collection practices. As the delinquent property taxes are collected, they are recorded as follows: Cash Property taxes receivable--delinquent $60 $60 To record the tax collections of the first two months of 2013, which had been recognized as revenue of 2012 Cash $30 Deferred property tax revenue 30 Property taxes receivable--delinquent $30 Property tax revenue (2013) 30 To record the tax collections of the third month of 2013, which had not been recognized as revenue of 2012 PROPERTY-TAX WRITE-OFFS Despite their powers to enforce claims against recalcitrant taxpayers, governments are not always able to collect the full amount of property tax levies. In some instances, seized property cannot be sold at prices sufficient to cover outstanding balances. In others, the costs of recovery are more than the expected yield, so the governments elect not to exercise all available legal options. As a government writes off (eliminates from the accounts) uncollectible taxes, it should offset the reduction in property taxes receivable with a corresponding reduction in the allowance for uncollectible property taxes. Thus, if the $15 million of taxes (now classified as delinquent) were written off, Allowance for uncollectible property taxes Property taxes receivable--delinquent To write off delinquent taxes $15 $15 This entry has no effect on revenues, expenditures, governmental fund balance, or the government's net assets. The government gave substantive accounting recognition to the potential uncollectible taxes in the period in which it established the allowance for uncollectible property taxes. Governments may accrue interest charges and penalties on delinquent property taxes as they impose them. However, on their fund statements they should recognize revenue only when it is measurable and available. Until those criteria are satisfied, governments should offset interest and penalties receivable with deferred revenue, rather than revenue. E1C04 03/29/2010 11:32:24 Page 72 72 CHAPTER 4 / GOVERNMENTAL ACTIVITIES--REVENUES DIFFERENCES IN GOVERNMENT-WIDE STATEMENTS The general rules of revenue recognition for fund statements also apply to government-wide statements, except for the ``available'' criterion applicable to the governmental funds. Thus, in its government-wide statement of activities, a government can recognize property tax revenue as soon as it either has an enforceable claim or has collected the taxes (whichever comes first)--subject, of course, to the time requirement that the taxes not be recognized as revenue prior to the period for which they were budgeted. In the example, the city reports the following in its 2012 financial statements: Government-wide statements (governmental activities) Revenue Deferred revenue $500 $20 ($410 of 2012 taxes collected in 2012 plus the remaining $90 that the government expects to collect) (taxes collected in 2012 but applicable to 2013) Governmental fund statements Revenue Deferred revenue $470 $50 ($410 of 2012 taxes collected in 2012 plus $60 collected during the 60-day window after year-end) ($30 of 2012 taxes collected after the 60-day window plus $20 of taxes collected in 2012 but applicable to 2013) For most governments the difference between the property taxes recognized as revenues in the governmental fund statement of revenues, expenditures, and changes in fund balances and those recognized in the government-wide statement of activities is small. As long as the ratio of taxes levied to taxes collected remains fairly constant, the government-wide ``gains'' owing to the year-end accruals of taxes to be collected beyond the 60-day window are offset by the ``losses'' attributable to the taxes collected in the current year but recognized as revenues in the previous year. However, the difference in the deferred taxes to be reported on the governmental fund balance sheet and the government-wide statement of net assets, respectively, is more pronounced, because the ``available'' criterion affects the governmental fund balance sheet, but not the government-wide statement of net assets. The full amount of the deferrals that are due to the ``available'' criterion is reported on the governmental fund balance sheet as additions to liabilities (and hence reductions in the fund balance). OTHER IMPOSED NONEXCHANGE REVENUES The recognition requirements of Statement No. 33 for fines, penalties, and other imposed nonexchange transactions are the same as for property taxes in both the fund and the government-wide statements. However, the window for satisfying the ``available'' criterion in the fund statements is not specified and may be more or less than 60 days, at the government's discretion. The government should disclose the number of days used. HOW SHOULD SALES AND INCOME TAXES AND OTHER ............................................................................................................. Sales and income taxes are categorized as derived tax revenues. They are derived (i.e., they result) from impositions on the exchange transactions of taxpayers. DERIVED TAX REVENUES BE ACCOUNTED FOR? E1C04 03/29/2010 11:32:24 Page 73 HOW SHOULD SALES AND INCOME TAXES AND OTHER DERIVED TAX REVENUES 73 Sales taxes are imposed on customers who purchase goods or services. The seller or merchant is responsible for collecting the taxes and for reporting and transmitting them to the government. Unlike property taxes, which are government assessed, sales taxes are taxpayer assessed; parties other than the beneficiary government determine the tax base. Thus, the government has to rely upon merchant tax returns to become aware of the proceeds to which it is legally entitled. SIGNIFICANT DATES FOR SALES TAXES Three significant dates underlie sales tax transactions: The date of the sales transaction and the collection of the tax by the merchant The date by which the merchant is required to file the tax return and transmit the taxes (generally the same) The date that the merchant actually files the return and transmits the taxes The sale date is arguably the most significant date, because that is when the transaction producing the tax takes place, the amount of the tax is established, and the merchant's liability to transmit the tax is created. However, the government is not entitled to the tax until the date the return is to be filed and the tax paid. Moreover, except for unusual circumstances, such as when a merchant files a return but fails to make timely payment, the government does not know the amount until it actually receives the tax. EXAMPLE ........................................................................................................ In December 2012 merchants collect $20 million in sales taxes. Of this amount, $12 million is collected prior to December 15 and must be remitted by February 15, 2013; the remaining $8 million must be remitted by March 15, 2013. Sales Taxes GASB Standards Statement No. 33 requires that revenue from sales taxes and other derived nonexchange revenues be recognized at the time the underlying exchange transaction takes place. For sales taxes, that is the date of the sale. In the governmental fund statements, the sales taxes must also satisfy the ``available'' test to be recognized as revenue. Current standards do not provide guidance as to how soon after the end of the fiscal year resources must be received in order to be considered ``available.'' Hence, governments must exercise their own judgment. However, they must be consistent from year to year and disclose the period used. Statement No. 33 stipulates that governments should recognize assets from derived tax transactions in the period in which the underlying transaction takes place. Thus a government should recognize an asset, ``sales taxes receivable,'' for taxes imposed in the current year, even if those taxes are not collected in time to pay the current liabilities of that year. Assuming that the government adopts 60 days as the ``available'' window, it could recognize as 2012 revenue only the $12 million in taxes that it expects to collect within 60 days of year-end. The $8 million balance must be deferred until 2013: Sales taxes receivable Sales tax revenue Deferred sales tax revenue To summarize December sales tax activity $20 $12 8 (continued ) E1C04 03/29/2010 11:32:24 Page 74 74 CHAPTER 4 / GOVERNMENTAL ACTIVITIES--REVENUES GASB Standards (continued ) Suppose, instead, that sales taxes are imposed only on motor fuels and have to be used to construct and maintain roads. Does this purpose restriction affect the recognition of revenue? Because the revenues are restricted, they should be reported in a special revenue fund, which, like the general fund, is a governmental fund. The GASB rules (and the discussion in this chapter and in the following chapter on expenditures) apply to all governmental funds. Per Statement No. 33, purpose restrictions should not affect the timing of revenue recognition. If the underlying transaction has taken place, and the resources are measurable and available, the government has benefited from an increase in net assets and should recognize the increase as revenue. The increase in net assets also should be reported as a reservation of fund balance, until the resources are used for the purpose indicated by the restriction. DIFFERENCES IN GOVERNMENT-WIDE STATEMENTS The same general principles of revenue recognition for governmental fund statements apply to the government-wide statements, except for the ``available'' criterion. Hence, in the example, the government recognizes as revenue in its governmentwide statements the entire $20 million of taxes derived from the sales of December. (If there is a purpose restriction, the $20 million should be included in restricted net assets in the statement of net assets.) In contrast, in its governmental fund statements, the government recognizes $12 of revenue and $8 of deferred revenue. INCOME TAXES--THE COLLECTION PROCESS Almost all states and a few major cities, such as New York, Philadelphia, and Detroit, impose personal or corporate income taxes. Some of these states impose what they call a ``franchise'' tax on businesses, but they base the tax on income. Income taxes present especially vexatious issues of revenue recognition, owing to their multistage administrative processes. Consider, for example, the following: The tax is based on income of either a calendar year or a fiscal year, elected by the taxpayer, that may not coincide with the government's fiscal year. Taxpayers are required to remit tax payments throughout the tax year, through either payroll withholdings or periodic payments of estimated amounts. Within three or four months after the close of the year, they are required to file a tax return in which they inform the government of the actual amount of tax owed. At that time, they are expected to make a final settlement with the government, by either paying additional taxes due or requesting a refund of overpayments. Thus, the taxes received by the government during the year may be more or less than the amount to which it is entitled. Governments review all tax returns for reasonableness and select a sample for audit, which may result in additional taxes due. Moreover, some taxpayers are delinquent on their payments. Thus, taxes continue to trickle in for several years after the due date. Although governments can reliably estimate the amount of late collections, based on E1C04 03/29/2010 11:32:24 Page 75 HOW SHOULD GRANTS AND SIMILAR NONEXCHANGE REVENUES BE ACCOUNTED FOR? 75 historical experience, they may not have a legal claim to the taxes until taxpayers either file their returns or agree to the adjustments resulting from an audit. EXAMPLE Income Taxes ........................................................................................................ A state imposes an 8% tax on personal income. Employers are required to withhold taxes from payroll and remit withholdings on a monthly basis, and taxpayers are required to make quarterly tax payments on income from sources other than salaries and wages. Taxpayers must file a tax return with the state by April 15 of the year following the tax year (calendar year) and must pay the remaining tax owed (or claim a refund) at that time. In concept, the state should recognize the taxes as revenue in the period in which taxpayers earn the income. Nevertheless, the GASB recognizes in Statement No. 33 that it is impractical to determine precisely the amount of taxable income that taxpayers earned during the tax year. Therefore, the state may base the amount to be recognized on the remitted withholdings and estimated tax payments, adjusted for the April 15 payments and refunds, on both its governmental fund and government-wide statements. HOW SHOULD GRANTS AND SIMILAR NONEXCHANGE ............................................................................................................. State and local governments receive grants and similar forms of financial assistance from both other governments and private sources. Some grants are mandated by a higher-level government; the lower-level government has no choice but to accept them (as when the federal government requires states to undertake environmental clean-up efforts and provides resources for them to do so). Most grants, however, are voluntary; the government can choose not to accept the resources if it is unwilling to comply with the attached conditions or to carry out the programs the grant is intended to finance. TYPES OF INTERGOVERNMENTAL REVENUES Typical intergovernmental grants and similar nonexchange revenues include the following: Reimbursement grants. The most common form of grants, these payments are intended to reimburse specific types of expenditures for designated purposes, projects, or activities. They may be mandated or voluntary. Unrestricted grants. These payments are unrestricted as to purpose, project, or activity. Contingent grants. These payments are contingent upon a specified occurrence or action on the part of the recipient (e.g., the ability of the recipient to raise ``matching'' resources from other parties). Entitlements. These are payments, usually from a higher-level government, to which a lower-level government is automatically entitled in an amount determined by a specified formula. Entitlements are often designated for a broad functional activity, such as education. Shared revenues. These are revenues raised by one government, such as a state, but shared on a predetermined basis with other governments, such as cities. Payments in lieu of taxes. These are amounts paid by one government to another in place of property taxes that it would be required to pay if it were not a government and thereby tax exempt. Such payments are an important revenue source for governments having within REVENUES BE ACCOUNTED FOR? E1C04 03/29/2010 11:32:24 Page 76 76 CHAPTER 4 / GOVERNMENTAL ACTIVITIES--REVENUES their jurisdiction substantial facilities of other governments. For example, the federal government, for which property is tax exempt, may make payments to school districts in which military bases are located, to compensate them for the cost of educating military dependents. PRIVATE CONTRIBUTIONS Examples of voluntary nonexchange revenues from nongovernment sources include private donations to school districts and universities, contributions of land from developers (often tied to a project they are undertaking), and gifts of collectible items to museums or cultural centers. Some donations are endowments--gifts that stipulate that the contribution must be invested and that only the income from the investments can be spent. GASB Standards Recipients of grants and contributions, whether mandatory or voluntary, intergovernmental or private, should recognize both revenue and related receivables only when all eligibility requirements have been met (plus, of course, the ``available'' criterion in the governmental fund statements). Resources received in advance should be reported as deferred revenue. Reimbursement grants have an inherent eligibility requirement--the recipient is eligible only if and when it incurs allowable costs. Hence, recipients typically must recognize revenue in the period in which they make reimbursable expenditures. Endowment contributions that stipulate that only the income from investing the contributions can be spent are subject to time requirements. Does that mean that the recipients can never recognize revenue from the gift? No. The GASB makes an exception to the general rule that revenue from contributions cannot be recognized until all time requirements have been satisfied. Per Statement No. 33, governments can recognize revenue from endowments and similar gifts in which the main benefit to the recipient is from the derived income, not the gift itself, as soon as they receive the resources. Similar rules apply to gifts of historical treasures and art works that the recipient agrees to hold rather than sell. EXAMPLES OF ACCOUNTING FOR GRANTS AND CONTRIBUTIONS The following six examples illustrate the accounting for different kinds of grants and private contributions. Note that, as discussed in the preceding sections, the specific features of a grant or contribution might or might not determine the timing of revenue recognition and other reporting requirements in the governmental fund and government-wide statements. EXAMPLE ........................................................................................................ In October 2012 a school district is notified that, per legislatively approved formulas, the state has awarded it $15 million in assistance. The resources are transmitted in December 2012 and may be used to supplement teachers' salaries, acquire equipment, and support educational enrichment programs. They can be used only in the year ending December 31, 2013. The grant is unrestricted. The stipulations concerning the use of the resources are not purpose restrictions. They are requirements in form, not substance, because the state is Unrestricted Grant with Time Requirement E1C04 03/29/2010 11:32:25 Page 77 HOW SHOULD GRANTS AND SIMILAR NONEXCHANGE REVENUES BE ACCOUNTED FOR? 77 demanding nothing that the district does not otherwise do. However, the grant is subject to a time requirement--the resources must be used in 2013. Hence, the school district must defer recognizing grant revenue until 2013, in both its governmental fund and its government-wide financial statements: Cash Deferred grant revenue To record the receipt of state funds in 2012 Deferred grant revenue Grant revenue To recognize grant revenue in 2013 $15 $15 $15 $15 EXAMPLE ........................................................................................................ In October 2012 a school district is notified that, per legislatively approved formulas, the state has granted it $15 million to enhance its technological capabilities. The resources are transmitted in December 2012. They must be used to acquire computers but may be spent at any time. This grant is subject only to a purpose restriction. Purpose restrictions do not affect the timing of revenue recognition; the district should recognize the revenue as soon as the grant is announced. However, owing to the purpose restriction, the district should record the grant in a special revenue fund and report a restriction on fund balance (and a restriction on net assets in its government-wide statements). Grant with Purpose Restriction EXAMPLE ........................................................................................................ In December 2012 a city is awarded a reimbursement grant of $400,000 to train social workers. The grant is subject to an eligibility requirement in that, to be eligible for the grant, the city must first incur allowable costs. During the year, the city spends $300,000 in allowable costs and is reimbursed $250,000. It expects to be reimbursed for the $50,000 balance in January 2013 and to expend and be reimbursed for the remaining $100,000 during 2013. In this example, the city can recognize the grant only as it incurs allowable costs. Thus, in 2012 it can recognize $300,000 in both revenue and increases in assets (amounts in thousands): Expenditures to train social workers Cash (or payables) To record allowable costs Cash Grants receivable Grant revenue To recognize grant revenue $300 $300 $250 50 $300 Reimbursement (Eligibility Requirement) Grant The city should recognize grant revenue of $300,000 in both its government-wide and its governmental fund statements. In contrast, if payment was not expected within the available E1C04 03/29/2010 11:32:25 Page 78 78 CHAPTER 4 / GOVERNMENTAL ACTIVITIES--REVENUES period, the fund statements should defer revenue (credit deferred revenue, instead of revenue, in the second entry), whereas the government-wide statements should recognize revenue. EXAMPLE Requirement Unrestricted Grant with Contingency Eligibility ........................................................................................................ In January 2013 a private foundation agrees to match all private cash contributions, up to $20 million, received by a state-owned museum during its 20132014 fund drive. In 2013 the museum receives $14 million in private cash contributions. The museum is eligible for the foundation's matching contribution only insofar as it receives funds from other sources. Thus, in 2013 it can recognize only $14 million of matching foundation revenue (debit receivable, credit revenue) in both its fund statements and its government-wide statements (in addition, of course, to the $14 million in private donations). If collection of the foundation's matching contribution is not expected in time to meet the museum's 2013 current liabilities, the museum should report the contribution as deferred revenue in its governmental fund statements. (The matching contribution is reported as revenue in the museum's government-wide statements.) EXAMPLE ........................................................................................................ A private citizen donates $1 million to a city to maintain and repair historical monuments. He stipulates that the principal remain intact permanently and that only the income be used for the intended purpose. Endowments intended to support a government's activities, and thereby benefit the public, are accounted for in a permanent (governmental) fund. Inasmuch as the gift is intended to provide an ongoing source of income, the city should recognize the $1 million as revenue upon receipt, in both its government-wide and its fund statements. It should also report the $1 million as nonspendable fund balance and restricted (government-wide) net assets, to indicate that the gift cannot be expended. Endowment Gift EXAMPLE ........................................................................................................ A private citizen pledges $10,000 to a county to help maintain a park. Park activities are accounted for in the general fund. The government is confident that the promised donation will actually be made. Governments should recognize revenue from pledges as soon as they meet all eligibility requirements. Thus, if the county has to do nothing further to receive the donation, it should recognize a receivable and revenue at the time the pledge is made, in both the governmentwide and the fund statements. In contrast, if receipt of the donation is not expected to meet the available criterion, the county should report the pledge as a deferred revenue in the fund statements. Pledges ACCOUNTING FOR PASS-THROUGH GRANTS For some types of grants, the recipient is required to distribute the resources to other parties, or payment is made directly to a third party for the benefit of the recipient. For example, a state might receive federal funds E1C04 03/29/2010 11:32:25 Page 79 HOW SHOULD SALES OF GENERAL CAPITAL ASSETS BE ACCOUNTED FOR? 79 earmarked for each of its local school districts. Should the state record the receipt of the funds as a revenue and the disbursement as an expenditure? Or should it omit the grant from its budget and accounts on the grounds that it is merely acting as an agent of the federal government? Grants that a government must transfer to, or spend on behalf of, a secondary recipient are referred to as pass-through grants. In the past, some governments opted to exclude pass-through funds from both revenues and expenditures. Instead, they accounted for the funds off the budget--often in agency (fiduciary) funds, in which only assets and liabilities are reported. (Accounting for agency funds is discussed in Chapter 10.) In 1994 the GASB stated that governments should generally recognize cash pass-through grants as revenue and expenditures or expenses.4 An agency fund should be used only when the government merely serves as a cash conduit--that is, it simply transmits the funds without having administrative involvement. Administrative involvement is indicated if the government selects the secondary recipients of the funds (even based on grantor-established criteria) or monitors compliance with grant requirements. As a result of these requirements, governments should account for most pass-through grants as revenues and expenditures or expenses, in accordance with the requirements of Statement No. 33 for government-mandated nonexchange transactions. HOW SHOULD SALES OF GENERAL CAPITAL ASSETS BE ACCOUNTED FOR? ............................................................................................................. Governments sell capital assets for the same reasons as businesses do--the services provided by the assets can be provided more economically by another means or by replacement assets. The unique accounting problem for governments that sell general capital assets is that the financial resources received are accounted for in a governmental fund, but the assets that are sold are not. EXAMPLE ........................................................................................................ On December 31, 2012, a city purchases a new police car for $40,000. On January 2, 2013, the vehicle is nearly demolished in an accident. It is uninsured. The city sells it for $5,000. Current standards for modified accrual accounting require the following seemingly odd entry: Cash Other financing sources--sale of vehicle To record the sale of general capital assets $5,000 $5,000 Sales of General Capital Assets It is ``seemingly odd'' because, as discussed in Chapter 3, an other financing source is reported on a governmental fund statement of revenues, expenditures, and changes in fund balance (below the revenues and expenditures). Although not a revenue, it is similar to one, in that it may be budgeted as a revenue and results in an increase in fund balance. 4 GASB Statement No. 24, Accounting and Financial Reporting for Certain Grants and Other Financial Assistance (June 1994), para. 5, as amended by GASB Statement No. 34, para. 6. E1C04 03/29/2010 11:32:25 Page 80 80 CHAPTER 4 / GOVERNMENTAL ACTIVITIES--REVENUES From an accounting perspective, therefore, the accident that destroyed a $40,000 vehicle left a governmental fund $5,000 better off, even though the government's capital assets were reduced. This outcome is inevitable, because the measurement focus of governmental funds excludes capital assets. DIFFERENCES IN GOVERNMENT-WIDE STATEMENTS In their government-wide statements, governments should report their general capital assets in the governmental activities column at historical cost, less accumulated depreciation (except for nondepreciable assets, as discussed in Chapter 7). When a capital asset is sold, governments should recognize a gain or loss for the difference between sale proceeds and book value. Hence, in the example, assuming that no depreciation had yet been charged, the government-wide statements should recognize a loss of $25,000 (cost of $40,000 less sale price of $5,000). HOW SHOULD INVESTMENT GAINS AND LOSSES BE ACCOUNTED FOR? ............................................................................................................. The investment portfolios of governmental funds generally contain mainly short-term debt securities. Because they are short-term, their values are not greatly influenced by swings in interest rates. However, some portfolios also include longer-term instruments that are considerably more sensitive to changes in interest rates. In recent years, some governments--sometimes in violation of both accepted standards of sound fiscal management and common sense--have speculated in ``derivatives'' and other instruments that are extremely sensitive to interest rate changes. Until 1997, GASB standards (established by its predecessor, the National Council on Governmental Accounting, (NCGA) required that investments of governmental funds be reported at cost or amortized cost. However, many constituents, especially the financial community, believe that most investments should be reported at fair (market) value, primarily for the following reasons: For virtually all decisions involving investments, fair value is more relevant than historical cost. Investments are often held as cash substitutes. They can be liquidated with a phone call to the entity's broker or a quick computer entry. Fair values of the type of securities in which governments are most likely to invest are objective; up-to-the-minute prices are available from computer and telephone information services. The performance of investment managers, and their employer governments, is measured by total return--dividends, interest, and changes in fair values. Although prices that go up can also come down, financial statements report on performance within specified periods. An increase (or decrease) in the value of a security in a particular year is indicative of sound (or poor) investment performance in that year. Government portfolio managers are expected to achieve specified investment goals, and statement users are entitled to the information needed to assess how well they have done. E1C04 03/29/2010 11:32:26 Page 81 HOW SHOULD INVESTMENT GAINS AND LOSSES BE ACCOUNTED FOR? 81 EXAMPLE ........................................................................................................ The following table summarizes the 2012 investment activity in a county's general fund (all amounts in thousands): Cost Security A Security B Security C Security D $120 520 200 90 $930 Fair Value on Jan. 1 $120 540 200 -- $860 Purchases -- -- -- $90 $90 Sales (proceeds) -- -- $250 -- $250 Fair Value on Dec. 31 $140 540 0 75 $755 Investment Income GASB Standards In 1997 the GASB determined that governments should state their investments as fair value. GASB Statement No. 31, Accounting and Financial Reporting for Certain Investments and for External Investment Pools, requires that changes in fair value should be included in investment income in the operating statement or other statement of activities of all entities and funds. The Board made a notable exception for short-term securities that are not subject to the same volatility as long-term instruments. Governments are permitted to report money-market investments having a remaining maturity at time of purchase of one year or less at amortized cost rather than fair value. These investments include certificates of deposit, commercial paper, and U.S. Treasury obligations. Per Statement No. 31, the investments should be reported on the county's December 31, 2012, statements at their fair value--$755. The gain or loss (net change in fair value) to be reported on the county's 2012 operating statements can be determined by subtracting investment inputs from outputs. The inputs ($950) are the securities on hand at the start of the year ($860, stated at fair value as of the beginning of the year) plus the $90 of purchases during the year. The outputs ($1,005) are the securities on hand at year-end ($755, stated at fair value as of year-end) plus the $250 of proceeds from the sale of securities during the year. Thus, in the example, the net gain is $55 ($1,005 less $950). The following entry is therefore appropriate: Investments Revenue--increase in fair value of investments To record the increase in the fair value of the investments $55 $55 Note that the recognition as revenue of an increase in the fair value of investments applies to governmental fund statements as well as to the government-wide statements, even though the amount may not be available to finance current-period liabilities. Thus, the modified accrual available criterion for governmental funds does not apply to investment valuation--a notable exception to the philosophy and to most standards underlying accounting for governmental funds. E1C04 03/29/2010 11:32:26 Page 82 82 CHAPTER 4 / GOVERNMENTAL ACTIVITIES--REVENUES HOW SHOULD EXTERNAL INVESTMENT POOLS BE ACCOUNTED FOR? ............................................................................................................. Many local governments invest what would otherwise be idle cash in investment pools maintained by their states or other government entities. Investment pools are similar to mutual funds. Each participant purchases shares in the underlying portfolio. Statement No. 31 specifies that governments should state their investments in a pool at the fair value per share of the pool's underlying portfolio. In each period, they should recognize the change in the fair value of their shares as an investment gain or loss. The government that maintains the pool reports its own shares in the pool, and resulting gains or losses, in both its governmental fund statements and its government-wide statements, because its investment in the pool supports its own programs. By contrast, other entities' shares in the pool do not support the programs of the administering government. The administering government accounts for them in an investment trust (fiduciary) fund and, therefore, does not report them in its governmental funds or government-wide statements. HOW SHOULD INTEREST ON INVESTMENTS BE ACCOUNTED FOR? ............................................................................................................. Governmental funds ordinarily do not hold investments that have a stated or coupon rate of interest (i.e., a nominal rate of interest stated on the face of the instruments, as is the case for many long-term bonds). However, if they do, the stated interest amount should be recognized as revenue in the year that the interest accrues, subject to the available criterion for governmental funds. More common for governmental funds are investments in discounted debt securities. By recording the changes in fair value of those instruments, governments automatically accrue interest as it is earned. EXAMPLE ........................................................................................................ On December 1 a town purchased a $1,000, two-year discounted note for $873, a price that reflects an annual yield of approximately 7%. As a discounted note, the security provides no periodic payments of interest. However, assuming no change in prevailing interest rates or other factors that also affect fair value, the note's fair value can be expected to increase by approximately $5 the first month. On December 31, if the fair value of the note is $878, the government adjusts the security by $5 and recognizes interest revenue (debit investments, credit revenue) of $5, which, in economic substance, is earned interest. If, on the other hand, the investment is a short-term Treasury note (one-year or less), the government does not need to look to fair value to adjust the security. Instead, it amortizes the initial discount over the life of the note by a debit to the discount account (or the investment account) and a credit to interest revenue. The impact of the two approaches on the change in both government-wide net assets and the governmental fund balance is the same. Both approaches give recognition to the interest earned and the resultant change in the value of the underlying security. The GASB approach to investments has been extremely controversial and unpopular among many government officials. It is easy to see why. To the extent that Statement No. 31 requires reporting investments at fair value, it widens the gap between financial reporting and budgeting. The investment portfolios of many governments are dominated by notes and other securities having a fixed maturity date. If a government holds its securities to maturity, year-to-year changes in fair value have no effect on the cash that is available for expenditure. Yet increases in fair value Interest Income on a Discounted Note E1C04 03/29/2010 11:32:26 Page 83 HOW SHOULD LICENSES, PERMITS, AND OTHER EXCHANGE 83 must be reported as revenues (increases in net assets), and decreases must be reported as expenditures (decreases in net assets). Imagine the difficulty of having to explain to governing board members why an increase in net assets is only a paper gain that cannot be spent. Or try telling a television reporter in 30 seconds why a decline in the value of a government's portfolio has no effect on the amount for which the securities will eventually be sold. HOW SHOULD LICENSES, PERMITS, AND OTHER EXCHANGE OR ............................................................................................................. Governments issue licenses (or permits) that allow citizens and businesses to carry out regulated activities over a specified period. However, the license period may not coincide with the government's fiscal year. The primary issue relating to licenses is whether the revenue should be recognized when a license is issued and cash is received (usually concurrently) or whether it should be spread out over the period covered by the license. In other words, is the significant economic event the collection of cash (suggesting that cash-basis accounting is appropriate) or is it the passage of time (supporting accrual-basis accounting)? The issue is by no means clear-cut in light of the following characteristics of licenses: Some license fees are intended to cover the cost of services provided to the licensee or related to the activity in which the licensee engages. Thus, they have the characteristics of exchange transactions, because the licensee pays cash and receives value in exchange. For example, the charge for restaurant licenses may be calculated to cover the cost of inspecting restaurants, thereby ensuring customers that the restaurants meet minimum standards of cleanliness. Other fees, however, may bear little relation to the cost of services provided and may be imposed mainly as a source of general revenues. They are more in the nature of nonexchange revenues. Generally, license fees are not refundable. Therefore, unless a license fee is tied to specific services (not just a time period), once the government receives the fee, it has no further obligation, either actual or contingent, to the licensee. ``EXCHANGE-LIKE'' TRANSACTIONS BE ACCOUNTED FOR? EXAMPLE ........................................................................................................ In June 2012 a city imposed license fees for the first time on barber and beauty shops. It collected $360,000. The fees are intended to cover the cost of health inspections. The licenses cover the one-year period from July 1 to June 30. License Fees GASB Standards In Statement No. 33, the GASB acknowledges that license fees and permits may not be pure exchange transactions. They may not be paid voluntarily, and rarely is the amount paid reflective of the fair value of benefits received by the licensee. Still, the GASB maintains that they are ``exchange-like'' in nature and should be accounted for as though they were true exchange transactions. Therefore, they are not covered in Statement No. 33, which addresses only nonexchange transactions. GASB standards with respect to miscellaneous exchange revenues are those of its predecessor (the NCGA) and state simply: ``Miscellaneous Revenues. Golf and swimming (continued ) E1C04 03/29/2010 11:32:26 Page 84 84 CHAPTER 4 / GOVERNMENTAL ACTIVITIES--REVENUES GASB Standards (continued ) fees, inspection charges, parking fees and parking meter receipts, and the vast multitude of miscellaneous exchange revenues are best recognized when cash is received.''5 Therefore, the 2012 activity can be summarized by a debit to cash and a credit to revenue from license fees for $360,000. Because this standard recognizes miscellaneous revenues on a cash basis, it is inconsistent with the accrual basis of accounting, which suggests that the fees be recognized over the period covered by the license. However, it is a pragmatic approach to recognizing revenues that, for most governments, are not of major consequence. In the spirit of Statement No. 34, exchange revenues of governmental activities should be accounted for in the government-wide statements on the accrual basis. However, mainly because these miscellaneous types of revenue are not of great significance, the GASB has not yet indicated whether governments should accrue them in their government-wide statements or whether they may report them on a cash basis, as they do in their governmental fund statements (the pragmatic approach). HOW SHOULD GOVERNMENTS REPORT REVENUES ............................................................................................................. A primary objective of the government-wide statement of activities is to show the relative financial burden to the taxpayers of each function or program--the amount that has to be financed out of general revenues. As discussed in Chapter 3, the government-wide statement of activities reports the net cost (or net revenue) of each of the government's main functions or programs. (See Chapter 3, Table 3-2, for an illustration.) The net cost of a function or program is its expenses less any revenues that are reported as program revenues--that is, those generated by the function or program itself (e.g., user charges or fees) or directly attributed to it by external grantors or donors. As a consequence, governments must determine which revenues should be classified as program revenues and which as general revenues. General revenues is the default classification; all revenues that cannot be classified as program revenues are considered general revenues. As a rule, revenues from charges or fees imposed upon parties that benefit from specific activities are classified as program revenues because they are generated by the program. So also are grants, from other governments or outside parties, that must be used for specific purposes of the function or program. By contrast, taxes that are imposed upon the reporting government's citizens are considered general revenues, even if they are restricted to specific programs. Thus, for example, a general sales tax is classified as general revenue, even though it might be dedicated to education or road construction. Interest and other earnings from investments, as well as other nontax revenues, such as grants and contributions, are counted as general revenues unless explicitly restricted (by law or external parties) for specific programs. As illustrated in Table 3-2, the government-wide statement of activities reports the program revenues of each function or program in three separate columns: 1. Charges for services. These include fees for services, such as garbage collection, licenses and permits, and special assessments for roads or other capital projects. This column also includes program-specific fines and penalties, such as speeding tickets generated by the police function. 5 IN THEIR GOVERNMENT-WIDE STATEMENTS? NCGA Statement No. 1, Governmental Accounting and Financial Reporting Principles (March 1979), para. 67. E1C04 03/29/2010 11:32:26 Page 85 HOW SHOULD GOVERNMENTS REPORT REVENUES 85 2. Program-specific operating grants and contributions. These include federal or state grants for specific operating purposes, such as law enforcement, education, and recreation. 3. Program-specific capital grants. These include grants for the purchase and construction of capital assets directly associated with specific functions or programs, such as buses, jails, and roads. Some government grants are for multiple purposes. If the amounts can be identified as generated by specific programs (either through the grant application or the grant notification), they should be apportioned appropriately. If they cannot, they should be reported as general revenues. Table 4-1 summarizes the principles of revenue and asset recognition as they apply to the main types of revenue-producing transactions recorded in governmental funds, as set forth in Statement No. 33 and other GASB pronouncements. As discussed in this chapter, the same requirements apply for recognition in the government-wide statements, except that the available criterion for recognition in governmental funds does not apply. Therefore, some revenues may be recognized earlier in the government-wide (full accrual) statements than in the governmental fund (modified accrual) statements. TABLE 4-1 Summary of Asset and Revenue Recognition for Governmental Activities Transaction Class Imposed nonexchange revenues Examples: property taxes, fines Recognition Requirement Revenue: In the period in which the revenue is intended to be used Asset: When the government has an enforceable legal claim or when resources are received, whichever comes first Revenue: In the period of the underlying transaction Asset: In the period of the underlying transaction or when resources are received, whichever comes first Revenue: When all eligibility requirements, (including time requirements) have been met Asset: When all eligibility requirements have been met or when resources are received, whichever comes first Same as for government-mandated nonexchange transactions. Revenue: When cash is received Asset: When cash is received Revenue: As securities increase in value Asset: As securities increase in value (i.e., should be ``marked to market'') Derived taxes Examples: sales taxes, income taxes, hotel taxes, fuel taxes Government-mandated nonexchange transactions Example: A federal grant to pay for a federally mandated drug prevention program Voluntary nonexchange transactions Examples: entitlements, federal grants for general education, donations Exchange and ``exchange-like'' transactions Examples: license fees, permits, inspection charges Examples: investment gains and losses, shares in investment pools Note: These guidelines apply to both the government-wide (full accrual) and governmental fund statements. However, in the governmental fund statements, an additional criterion applies (except for investment valuation): Revenues should be recognized no sooner than the period in which the resources to be received are measurable and available to pay liabilities of the current period. Source: Nonexchange transaction information adapted from GASB Statement No. 33, Accounting and Financial Reporting for Nonexchange Transactions (December 1998), para. 103. E1C04 03/29/2010 11:32:26 Page 86 86 CHAPTER 4 / GOVERNMENTAL ACTIVITIES--REVENUES QUESTIONS FOR REVIEW AND DISCUSSION ............................................................................................................ 1. Why is a choice of basis of accounting inexorably linked to measurement focus? 2. What are the measurement focus and basis of accounting of governmental funds? What is the rationale for this basis of accounting--as opposed, for example, to either a full accrual basis or a budgetary basis? 3. What is the difference between an exchange and a nonexchange transaction? 4. What are the main categories of nonexchange revenues per GASB Statement No. 33, Accounting and Financial Reporting for Nonexchange Transactions? 5. What criteria must be met before revenues can be recognized on a modified accrual basis? What is the rationale for these criteria? 6. What is the general rule for recognizing property taxes as revenues? How are property taxes accounted for differently in the governmental fund statements as opposed to the government-wide statements? 7. What is the earliest point in the sales tax collection process at which revenue may be recognized? How can you justify recognizing revenue on the basis of this event? 8. Explain the distinction between reimbursement grants and entitlements. How does this 9. distinction affect the way each type of grant is accounted for? A private citizen makes an unrestricted pledge of $5 million to a city's museum. The city is confident that the donor will fulfill her pledge. However, the cash will not be received for at least two years. How does the amount of revenue recognized differ between the governmental fund statements and the government-wide statements? Explain. What are pass-through grants? Under what circumstances must a recipient government report them as both a revenue and an expenditure? A student comments: ``A government destroys a recently acquired car, sells the remains for scrap, and its general fund surplus for the year increases. That's ridiculous. Government accounting makes so much less sense than private-sector accounting.'' Do you agree? Explain why the situation described by the student arises. Until recently, governments were not permitted to recognize increases in the value of investments as revenue. What arguments might you present in support of the current position that investments be stated at fair value and that changes in fair value be recognized as either revenues or expenditures? What arguments might you present against the current position? 10. 11. 12. EXERCISES AND PROBLEMS ......................................................................................................... 4-1 Select the best answer. 1. Under the modified accrual basis of accounting, revenues cannot be recognized a. until cash has been collected b. unless they are collected within 60 days of year-end c. until they are subject to accrual d. until they are measurable and available 2. Available (as in ``measurable and available'') means a. available to finance expenditures of the current period b. subject to accrual c. collectible d. available for appropriation 3. Property taxes are an example of a. b. c. d. an imposed exchange transaction an imposed nonexchange transaction a derived tax transaction a government-mandated nonexchange transaction 4. To be considered available, property taxes must have been collected either during the government's fiscal year or within a. the time it takes for the government to liquidate its obligations from the prior year E1C04 03/29/2010 11:32:27 Page 87 EXERCISES AND PROBLEMS b. 30 days of year-end c. 60 days of year-end d. the following fiscal year 5. For its fiscal year ending September 30, 2012, Twin City levied $500 million in property taxes. It collected taxes applicable to fiscal 2012 as follows (in millions): June 1, 2011September 30, 2011 October 1, 2011September 30, 2012 October 1, 2012November 30, 2012 December 2012 $ 20 440 15 4 c. $2 d. $3 87 10. Assuming that a government collects its sales taxes in sufficient time to satisfy the available criterion, it ordinarily recognizes revenue from sales taxes in its governmental fund statements a. when the underlying sales transaction takes place b. on the date the merchant must remit the taxes to the government c. on the date the merchant must file a tax return d. when the taxes are received by the government 11. Assuming that a government collects its sales taxes in sufficient time to satisfy the available criterion, it ordinarily recognizes revenue from sales taxes in its government-wide statements a. when the underlying sales transaction takes place b. on the date the merchant must remit the taxes to the government c. on the date the merchant must file a tax return d. when the taxes are received by the government 4-2 The following information relates to Hudson City for its fiscal year ending December 31, 2012: On January 31, 2012 the city purchased as an investment for its debt service fund a three-year, 6%, $1 million bond, for $998,000. During the year, it received $3,000 in interest. At year-end, the market value of the bond was $999,500. On December 31, 2011 the Foundation for the Arts pledged to donate $1, up to a maximum of $1,000,000, to finance construction of the city-owned art museum for each $3 that the museum is able to collect from other private contributors. During 2012, the city collected $600,000. In January and February 2013 it collected an additional $2,400,000. During the year, the city imposed license fees on street vendors. All vendors were required to purchase the licenses by September 30, 2012. The licenses cover the one-year period from October 1, 2012 through September 30, 2013. During 2012 the city collected $240,000 in license fees. The city sold for $40,000 a fire truck that it had acquired five years earlier for $250,000. At the time of sale the city had charged $225,000 in depreciation. 6. The city estimates that $10 million of the outstanding balance is uncollectible. For the fiscal year ending September 30, 2012, how much should Twin City recognize in property tax revenue (in millions) in its general fund? a. b. c. d. $440 $460 $475 $490 7. Assume the same facts as in the previous example. How much should Twin City recognize in property tax revenue (in millions) in its government-wide statement of activities? a. $440 b. $460 c. $475 d. $490 8. Central City was awarded two state grants during its fiscal year ending September 30, 2012: a $2 million block grant that can be used to cover any operating expenses incurred during fiscal 2013; a $1 million grant that can be used any time to acquire equipment for its police department. For the year ending September 30, 2012, Central City should recognize in grant revenue in its governmental fund statements (in millions) a. $0 b. $1 c. $2 d. $3 9. Assume the same facts as in the previous example. How much should the city recognize in grant revenue in its government-wide statements? a. $0 b. $1 E1C04 03/29/2010 11:32:27 Page 88 88 CHAPTER 4 / GOVERNMENTAL ACTIVITIES--REVENUES 4-3 Property taxes are not necessarily recognized as revenue in the year collected. The fiscal year of Duchess County ends on December 31. Property taxes are due March 31 of the year in which they are levied and intended to finance. 1. Prepare journal entries (excluding closing entries) in the general fund (modified accrual basis) to record the following property tax related transactions in which the county engaged in 2012 and 2013. a. On January 15, 2012 the county council levied property taxes of $170 million for the year ending December 31, 2012. Officials estimated that 1% were uncollectible. b. During 2012 it collected $120 million. c. In January and February 2013, prior to preparing its 2012 financial statements, it collected an additional $45 million in 2012 taxes. It reclassified the $5 million of 2012 taxes not yet collected as delinquent. d. In January 2013 the county levied property taxes of $190 million to finance activities of 2013; officials estimated that 1.1% were uncollectible. e. During the remainder of 2013 the county collected $2.5 million more in taxes relating to 2012, $160 million relating to 2013, and $1.9 million (in advance) applicable to 2014. f. In December 2013 it wrote off $1 million of 2012 taxes that it determined was uncollectible. 2. What amount of property tax revenue should the county report in its government-wide (full accrual) statements for 2012 and 2013? Explain. 4-4 Nonexchange revenues can be of four types. The GASB has identified four classes of nonexchange revenues: Derived tax Imposed Government-mandated Voluntary 1. For each of the following revenue transactions involving a city, identify the class in which the revenue falls and prepare a journal entry for a governmental fund for the current year (2013), as necessary. Provide a brief explanation or justification for your entry. The city received a grant of $2 million to partially reimburse costs of training police officers. During the year, the city incurred $1,500,000 of allowable costs and received $1,200,000. It expects to incur an additional $500,000 in allowable costs in January 2013 and be reimbursed for all allowable costs by the end of February 2013. Select an answer from the following list of amounts. An amount may be selected once, more than once, or not at all. ___ 1. amount of investment income that the city should recognize in its debt service fund ___ 2. reported value of the bond in the government-wide statements at year-end ___ 3. amount of investment income that the city should recognize in its government-wide statements ___ 4. contribution revenue from Foundation for the Arts to be recognized in the governmental fund statements ___ 5. contribution revenue from Foundation for the Arts to be recognized in the government-wide statements ___ 6. revenue from license fees to be recognized in the governmental fund statements ___ 7. increase in general fund balance, owing to the sale of the fire engine ___ 8. increase in net assets (government-wide statements), owing to the sale of the fire engine ___ 9. revenue in the governmental fund statements from the police training grant ___ 10. revenue in the government-wide statements from the police training grant a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. 0 1,500 3,000 4,500 15,000 40,00 60,000 200,000 225,000 240,000 600,000 998,000 999,500 1,000,000 1,200,000 1,500,000 2,000,000 E1C04 03/29/2010 11:32:27 Page 89 EXERCISES AND PROBLEMS a. In December 2013 the state in which the city is located announced that it would grant the city $20 million to bring certain public facilities into compliance with the state's recently enacted disability laws. As of year-end the city had not yet received the funds, and it had not yet expended any funds on the statemandated facility improvements. b. The city imposes a $100 tax on all sales of real estate. The tax is collected by the title companies that process the sales and must be forwarded to the state within 30 days of the transaction. In December there were 600 sales of real estate. As of year-end the city had collected $40,000 of the $60,000 that it was owed. c. In December 2013 the state announced that the city's share of state assistance for the calendar year 2014 is $120 million. d. The city imposes a tax on all boats owned by residents. The tax is equal to 1% of the assessed value of a boat (determined by the city, by taking into account the boat's original cost and its age). The tax is payable on the last day of the year prior to the year in which the tax is intended to finance. In 2013 the city levied $640,000 of 2014 boat taxes, of which it collected $450,000. e. A local resident sends to the city a copy of her will, in which she bequeaths $3 million to the city museum upon her death. f. The U.S. Justice Department announces that it will reimburse the city, up to $400,000, for the purchase of telecommunications equipment. As of year-end the city had incurred only $200,000 in allowable expenditures. g. A resident donates $10 million in securities to the city, to support a cultural center. Only the income from the securities, not the principal, can be spent. 2. What amount of revenue should the city recognize in its government-wide statement of activities for 2013 for each of the previous transactions? Explain. 4-5 Grants are not necessarily recognized as revenue when they are awarded. Columbus City was awarded a state reimbursement grant of $150,000 to assist its adult literacy program. The following were significant events relating to the grant: a. The city, which is on a calendar year, was notified of the award in November 2012. 89 b. During 2013 it expended $30,000 on the literacy program and was reimbursed for $20,000. It expected to receive the balance in January 2014. c. In 2014 it expended the remaining $120,000 and was reimbursed by the state for the $10,000 owing from 2013 and the amount spent in 2014. 1. Prepare journal entries to record the events in a governmental fund. 2. Suppose instead that the city received the entire $150,000 in cash at the time the award was announced in 2012. How much revenue should the city recognize in its governmental fund statements in each of the three years? Explain. 3. Suppose that, instead of a reimbursement grant, the state awarded the city an unrestricted grant of $150,000, which the city elected to use to support the adult literacy program. The city received the entire $150,000 in cash at the time the award was announced in 2012. How much revenue should the city recognize in its governmental fund statements in each of the three years? Explain. 4. Assume the same facts as for questions 1, 2, and 3. How much revenue should the city recognize in its government-wide statements for each of the three years? Explain. 4-6 Sales taxes should be recognized when the underlying event takes place. A state requires ``large'' merchants (those with sales over a specified dollar amount) to report and remit their sales taxes within 15 days of the end of each month. It requires ``small'' merchants to report and remit their taxes within 15 days of the end of each quarter. In January 2013 large merchants remitted sales taxes of $400 million, owing to sales of December 2012. In February 2013 they remitted $280 million of sales taxes, owing to sales of January 2013. In January 2013 small merchants remitted sales taxes of $150 million, owing to sales of the fourth quarter of 2012. 1. Prepare a journal entry to indicate the impact of the transactions on the state's governmental fund financial statements for the year ending December 31, 2012. 2. Suppose, instead, that 10% of the taxes received by the state were collected on behalf of a city within the state. It is the policy of the state to E1C04 03/29/2010 11:32:28 Page 90 90 CHAPTER 4 / GOVERNMENTAL ACTIVITIES--REVENUES 1. Ignoring dividends and interest, what amount of gain or loss should the government recognize during the year? 2. What was the government's ``realized'' gain or loss (sales proceeds less cost) for the year? Which gain or loss--that to be reported on the financial statements (as computed in question 1) or the realized gain or loss--is more indicative of the change in resources available for future expenditure? 3. Suppose that Security B is a long-term bond that the government intends to hold to maturity. What is the most probable reason for the decline in fair value during the year? In what sense is the reported loss indicative of an economic loss? 4-9 A change to the full accrual basis may have little impact upon reported revenues. A city levies property taxes of $4 billion in June 2013 for its fiscal year beginning July 1, 2013. The taxes are due by January 31, 2014. The following (in millions) indicates actual and anticipated cash collections relating to the levy: June 2013 July 2013June 2014 July 2014August 2014 September 2014June 2015 $ 100 3,600 80 150 remit the taxes to the city 30 days after it receives them. Prepare a journal entry to indicate the impact of the transactions on the city's governmental fund financial statements for the year ending December 31, 2012. 3. Suppose, instead, that it is the policy of the state to remit the taxes to the city 90 days after it receives them. How does your response to question 2 differ? Explain. Is your response the same with respect to the city's governmentwide statements? 4-7 The amount of revenue to be recognized from grants depends on the type of grant. The following information relates to three grants that the town of College Hills received from the state during its fiscal year ending December 31, 2012: a. A cash grant of $200,000 that must be used to repair roads; b. $150,000, in cash, of a total grant of $200,000, to reimburse the town for actual expenditures incurred in repairing roads. During the year, the town incurred $150,000 in allowable repair costs; c. A cash entitlement grant of $200,000 that is intended to supplement the town's 2013 budget and must be expended in that year. 1. Prepare journal entries to record the three grants in a governmental fund. 2. What amount of revenue should be reported for each grant in the town's government-wide statement of activities for 2003? Where on that statement should these revenues most likely be reported? 4-8 Unrealized investment gains and losses may be difficult to explain to legislators and constituents. A government held the following securities (all of which are either bonds that mature in more than one year or stocks) in one of its investment portfolios. The city estimates that $30 eventually has to be refunded, owing to taxpayer appeals as to the assessed valuation of their property, and $70 is uncollectible. 1. Prepare a journal entry for a governmental fund that summarizes the city's property tax activity for the fiscal year ending June 30, 2014. 2. Indicate the differences in the amounts to be reported on the government-wide statement of net assets and the statement of activities. 3. Suppose that, in the following year, the tax levy and pattern of collections are identical to those Beginning Balance Cost A B C D $100 520 200 $820 Fair Value $100 540 240 $880 Transactions during the year Purchases 330 $330 Sales 250 $250 Ending Balance Cost $100 520 330 $950 Fair Value $120 510 0 315 $945 E1C04 03/29/2010 11:32:28 Page 91 EXERCISES AND PROBLEMS of the previous year. What are the differences now in the amounts reported on the government-wide statements? 4-9 Exploring Vero Beach's Financial Report Refer to the financial statements of the City of Vero Beach in Chapter 3. 1. Per the government-wide statement of activities, how much revenue did the city recognize from property taxes? 2. What amount of property-tax revenue did the city recognize in the funds? Where is this amount reported? 3. Per the statement of activities, how much revenue did the city recognize from state sales taxes? 4. Per the funds statements, how much revenue did the city recognize from state sales taxes? If your answer is different from your answer to question 3, what is the most likely reason for the difference? 5. What amount did the city recognize in the general fund as proceeds of bonds and loans? This amount increased the fund balance. Did it also increase the city's net assets on the statement of net assets? Explain. 6. What is the total fund balance in the general fund? Can this amount be appropriated and spent for any purpose? Explain. 7. Per the government-wide statement of activities, is the Community and Youth Service self-supporting? Explain. 4-10 91 Exploring Vero Beach's Financial Report Refer to the financial statements of the City of Vero Beach in Chapter 3. 1. Per the government-wide statement of activities, how much revenue did the city recognize from property taxes? 2. If a home in Vero Beach is assessed for tax purposes at $500,000, and the tax rate is 1.94 mills, how much should the city bill the owners for property taxes? 3. Per the statement of activities, what were the total expenses of the Transportation function? How did the city finance these expenses? 4. Per the government-wide statement of activities, is the Public Safety function self-supporting? Explain. 5. What amount did the city report as capital contributions in the governmental funds statement of revenues, expenditures, and changes in fund balances? Is this contribution assigned to support a specific program or function? Explain. 6. What is the total amount of tax revenues recognized in the statement of activities? What amount is recognized in the governmental funds statement of revenues, expenditures, and changes in fund balances? What is the most likely reason for the difference? ...
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