Although budgetary and encumbrance entries are unique, their impact on the accounting process is somewhat limited because they do not directly affect a fund’s financial results for the period. Conversely, the method by which states and localities record the receipt and dis- bursement of assets can significantly alter the reported data. For example, because a primary emphasis in the governmental funds is on measuring changes in current financial resources, neither expenses nor capital assets are recorded in the fund-based financial statements.Probably no more significant distinction exists between the fund-based statements and the government- wide statements.
As shown previously, governmental funds report an Expenditures account in the fund-based statements. This balance reflects outflows or other reductions in current financial resources caused by the acquisition of a good or service (or some other utility). The reduction of re- sources is recorded as an expenditure whether it is for rent, a fire truck, salaries, or a computer.
In each case, a good or service is acquired. The statement of revenues, expenditures, and other changes in fund balances (Exhibit 16.4) allows the reader to see the utilization of an activity’s current financial resources. Spending $1,000 for electricity for the past three months is an
19If not already reported as restricted, a fund balance cannot be internally restricted. The restricted designation is used to indicate that external parties or applicable laws created the restriction.
20GASBStatement No. 54, “Fund Balance Reporting and Governmental Fund Type Definitions,” February 2009, para. 24.
LO6
Record the passage of a budget as well as subsequent encumbrances and expenditures.
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expenditure of a fund’s current financial resources in exactly the same way that buying a
$70,000 ambulance is:
Fund-Based Financial Statements—Expenditures for Expense and Capital Asset
Within the governmental funds, the timing of the recognition of expenditures (and revenues) follows the modified accrual basis of accounting.For expenditures, modified accrual accounting requires recognizing a claim against current financial resources when it is created. If a claim is established in one period to be settled in the subsequent period using year-end financial resources, the expenditure and liability are recorded in the initial year. However, as discussed earlier, the max- imum length of time for the change in current financial resources to occur—often 60 days into the subsequent period—should be disclosed. Thus, if equipment is received 15 days before the end of the year but payment will not be made until 75 days later, recording the expenditure is still likely to be made in the first year, depending on the recognition period utilized by the government.
The recording of expenditures rather than expenses and capital assets is one of the most distinctive characteristics of traditional governmental accounting. In fund-based statements, a governmental fund records both operating costs such as salaries and rent and the entire cost of all buildings, machines, and other capital assets as expenditures. No net income figure is cal- culated for these funds; thus, computing and recording subsequent depreciation is not relevant to the reporting process and is omitted entirely. It has no effect on current financial resources.
For the government-wide financial statements, all economic resources are being measured.
Consequently, the previous two transactions would be recorded in this second set of statements as follows:
Government-Wide Financial Statements—Recording Expense and Capital Asset
688 Chapter 16
Expenditures—Electricity . . . . 1,000
Vouchers (or Accounts) Payable . . . . 1,000 To record charges covering the past three months.
Expenditures—Ambulance . . . . 70,000
Vouchers (or Accounts) Payable . . . . 70,000 To record acquisition of ambulance.
Utilities Expense . . . . 1,000
Voucher (or Accounts) Payable . . . . 1,000 To record electricity charges for the past three months.
Ambulance . . . . 70,000
Voucher (or Accounts) Payable . . . . 70,000 To record acquisition of new ambulance.
Capital Assets and Fund-Based Financial Statements
One interesting result of measuring and recording only expenditures within the fund-based statements of the governmental funds is that virtually no assets other than current financial re- sources such as cash, receivables, and investments are reported. All capital assets are recorded as expenditures at the time of purchase or construction with that balance closed out at the end of the fiscal period. Note that the statement in Exhibit 16.3 shows no buildings, schools, com- puters, trucks, or other equipment as assets.
With the creation of government-wide financial statements, a record of all capital assets is available in the statement of net assets (see Exhibit 16.1). Thus, recording only expenditures in the fund-based financial statements does not leave a gap in the information available to inter- ested parties. In the initial production of government-wide financial statements, one problem was the reporting of “infrastructure” assets including roads, sidewalks, bridges, and the like that are normally stationary and can be preserved for a significant period of time. A bridge, for ex- ample, might last for more than 100 years. Traditionally, the formal recording of such infra- structure assets was optional. To save time and energy, many governments simply did not
LO7
Understand the reporting of capital assets, supplies, and prepaid expenses by a state or local government.
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maintain a record of these assets after the original expenditure. Thus, in creating the initial set of government-wide financial statements, records were often unavailable for some or all of the infrastructure assets that were bought or constructed over the decades.
Because of the potential problem of establishing cost-based balances for all infrastructure as- sets, GASB made an exception in reporting for government-wide financial statements. A gov- ernment must now capitalize all new infrastructure assets bought or built. However, the book value of infrastructure assets acquired before the advent of government-wide financial statements only had to be approximated. GASB suggested methods by which costs incurred for highways, curbing, sidewalks, and the like could be estimated for reporting purposes. For example, current costs for such projects could be determined and then adjusted for both inflation and usage since the dates the assets were originally obtained. However, an important limitation was placed on the need for such complex calculations. This type of historical estimation and reporting is required only for major general infrastructure assets acquired or significantly improved since June 30, 1980. Thus, a city is probably not required to determine a cost approximation for a sidewalk built in 1928.
As mentioned previously, fund-based financial statements do not recognize depreciation expense in connection with governmental funds for two reasons:
1. These funds reflect expenditures rather than expenses, and the entire cost of the asset was reported as an expenditure at the time of the original claim against current financial re- sources. Reporting subsequent depreciation would reflect the impact twice: once when acquired and once when depreciated.
2. These funds traditionally do not record expenses. Reporting depreciation expense (rather than an expenditure) is not consistent with measuring the change in current financial resources.
However, the government-wide financial statements (as well as fund-based statements for pro- prietary and fiduciary funds) list assets rather than expenditures for such costs, and therefore depreciation is appropriate. Consequently, on these statements, depreciation on all long-lived assets with finite lives should be calculated and reported each period.
Discussion Question
IS IT AN ASSET OR A LIABILITY?
During the evolution of government accounting, many scholars have discussed its unique features. In the August 1989 issue of the Journal of Accountancy R.K. Mautz described the reporting needs of governments and not-for-profit organizations (such as charities) in
“Not-For-Profit Financial Reporting: Another View.”
As an illustration of their accounting problems, Mautz examined the method by which a city should record a newly constructed high school building. Conventional business wis- dom would say that such a property represents an asset of the government. Thus, the cost should be capitalized and then depreciated over an estimated useful life. However, in paragraph 26 of FASB Concepts Statements No. 6, an essential characteristic of an asset is
“a probable future benefit . . . to contribute directly to future cash inflows.”
Mautz reasoned that the school building cannot be considered an asset because it pro- vides no net contribution to cash inflows. In truth, a high school requires the government to make significant cash outflows for maintenance, repairs, utilities, salaries, and the like.
Public educational facilities (as well as many of the other properties of a government such as a fire station or municipal building) are acquired with the understanding that net cash outflows will result for years to come.
Consequently, Mautz considered whether the construction of a high school is not actu- ally the incurrence of a liability because the government is taking on an obligation that will necessitate future cash payments. This idea also is rejected, once again based on the guidance of Concepts Statement No. 6 (para. 36), because the cash outflow is not required at a “specified or determinable date, on occurrence of a specified event, or on demand.”
Is a high school building an asset or is it a liability? If it is neither, how should the cost be recorded? How is the high school reported in fund-based financial statements? How is the high school reported in government-wide financial statements? Which of these two ap- proaches provides the best portrayal of the decision to acquire or construct this building?
Can a government possibly be accounted for in the same manner as a for-profit enterprise?
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Supplies and Prepaid Items
In gathering information for government-wide financial statements, the acquisition of supplies and prepaid costs such as rent or insurance is not particularly complicated. An asset is recorded at the time of acquisition and subsequently reclassified to expense as the asset’s util- ity is consumed by use or time. However, reporting prepaid costs and supplies by the govern- mental funds within the fund-based financial statements is not so straightforward. These assets have a relatively short life. Should the cost incurred be reported as an asset until consumed or recorded directly as an expenditure at the time of acquisition?
Traditionally, governments have used the purchases method,which simply records these costs as expenditures at the point that a claim to current financial resources is created. No as- set is recorded. For disclosure purposes, though, remaining supplies or prepaid items (such as insurance or rent) are then entered into the accounting records as assets just prior to produc- tion of financial statements. Mechanically, the asset is recorded along with an offsetting amount in fund balance—nonspendable to inform the reader that the fund is reporting assets that are not current financial resources available for spending in the future. Thus, the City of Philadelphia discloses that the “supplies of governmental funds are recorded as expenditures when purchased rather than capitalized as inventory.”
The purchases methodreflects modified accrual accounting because the entire cost is rec- ognized as an expenditure when current financial resources are initially reduced. However, many governments have chosen to have their governmental funds report supplies and prepaid items using an accepted alternative known as the consumption method.
The consumption method parallels the process utilized in creating government-wide finan- cial statements. Supplies or prepayments are recorded as assets when acquired. Subsequently, as the utility is consumed by usage or over time, the cost is reclassified into an expenditures account. As explained by the City of Birmingham, Alabama, “[i]nventory consists of expend- able supplies held in the General Fund for consumption. The cost is recorded as an expenditure at the time individual inventory items are used (consumption method).” Under this approach, the expenditure is matched with the period of specific usage. Because these assets cannot be spent for government programs or other needs, an equal portion of the Fund Balance account should be reclassified as nonspendable as is shown in the balance sheet in Exhibit 16.3.
To illustrate, assume that a municipality purchases $20,000 in supplies for various General Fund activities. During the remainder of the fiscal period, $18,000 of this amount is consumed so that only $2,000 remains at year-end. These events could be recorded through either of the following sets of entries:
Fund-Based Financial Statements—Supplies and Prepaid Expenses
690 Chapter 16
Purchases Method
Expenditures—Supplies . . . . 20,000
Vouchers Payable . . . . 20,000 To record purchase of supplies for various ongoing activities.
Inventory of Supplies . . . . 2,000
Fund Balance—Nonspendable . . . . 2,000 To establish balance for supplies remaining at year’s end.
Consumption Method
Inventory of Supplies . . . . 20,000
Vouchers Payable . . . . 20,000 To record purchase of supplies for various ongoing activities.
Expenditures—Control . . . . 18,000
Inventory of Supplies . . . . 18,000 To record consumption of supplies during period. Because a $2,000 asset
that cannot be spent remains, an equal portion of the Fund Balance is reclassified from unassigned to nonspendable. This reclassification is normally done in creating the statements, not through a journal entry.
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Accounting for State and Local Governments (Part 1) 691
Recognition of Revenues—Overview
The recognition of some revenues has always posed theoretical issues for state and local gov- ernments. For most of their revenues, such as property taxes, income taxes, and grants, no earning process exists as in a for-profit business. These revenues are referred to as nonex- change transactions. Taxes, fines, and the like are assessed or imposed on the citizens to sup- port the government’s operations rather than giving the payors a specific good or service in return for their payments.
GASB Statement Number 33, “Accounting and Financial Reporting for Nonexchange Transactions,” provides a comprehensive system for recognizing many of these revenues. This statement does not apply to true revenues such as interest or rents for which an earning process does exist. Instead, it concentrates on “nonexchange transactions,” including most taxes, fines, grants, gifts, and the like for which the government does not provide a direct and equal bene- fit for the amount received.
In a nonexchange transaction, a government (including the federal government, as a provider) either gives value (benefit) to another party without directly receiving equal value in exchange or receives value (benefit) from another party without directly giving equal value in exchange.21 For organizational purposes, nonexchange transactions are separated into four distinct classi- fications, each with its own rules as to proper recognition:
• Derived tax revenues.A tax assessment is imposed when an underlying exchange takes place. Income taxes and sales taxes are the best examples of this type of revenue. A sale occurs, for example, and a sales tax is imposed, or income is earned and an income tax is assessed.
• Imposed nonexchange revenues.Property taxes and fines and penalties are viewed as im- posed nonexchange revenues because the government mandates an assessment, but no un- derlying transaction occurs. As an example, real estate or other property is owned and a property tax is levied. The government is taxing ownership here, not a specific transaction.
• Government-mandated nonexchange transactions.This category includes monies, such as grants conveyed from one government to another, to help cover the costs of required pro- grams. If a state specifies that a city must create a homeless shelter and then provides a grant of $400,000 to help defray the cost, the city records the inflow of money using these prescribed rules. The state has mandated the utilization of the grant to meet the law. City officials have no choice; the state government has required the shelter to be constructed and is providing part or all of the funding.
• Voluntary nonexchange transactions.In this final classification, money has been conveyed willingly to the state or local government by an individual, another government, or an orga- nization, usually for a particular purpose. For example, a state might grant a city $900,000 to help improve reading programs in its schools. Unless the state mandated an enhancement in these reading programs, this grant is accounted for as a voluntary nonexchange transac- tion. The decision has been made that the money will provide an important benefit, but no separate government requirement led the state to make the conveyance.
Derived Tax Revenues Such as Income Taxes and Sales Taxes
Accounting for derived tax revenues is relatively straightforward. These revenues are normally recognized in government-wide financial statements when the underlying transaction occurs.
Thus, when a taxpayer earns income, the government should record the resulting income tax revenue. Likewise, when a sale is made, the government should recognize the sales tax rev- enue that is created.
Assume, for example, that sales by businesses that operate within a locality amount to
$10 million for the current year and a sales tax of 4 percent is assessed. In the period in which the sales are made, the following entry is required of the government. The amounts should be reported net of any estimated refunds or uncollectible balances.
LO8
Determine the proper timing for the recognition of revenues from nonexchange transactions.
21GASBStatement 33, “Accounting and Financial Reporting for Nonexchange Transactions,” December 1998, para. 7.
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Government-Wide Financial Statements—Derived Tax Revenues
Receivable—Sales Taxes . . . . 400,000
Revenue—Sales Taxes . . . . 400,000 To recognize amount of sales tax that will be collected in connection
with sales for the current period. Same entry is appropriate for the fund-based statements of the governmental fund if the money qualifies as available.
For fund-based financial statements, the preceding rules also apply except for one addi- tional requirement. In connection with governmental funds, the resources must be available before the revenue can be recognized. That is, the amounts must be received during the year or soon enough thereafter to satisfy claims to current financial resources. In that way, the essence of modified accrual accounting is utilized at the fund level of reporting. As mentioned previ- ously, except in the reporting of property taxes, the government selects and must disclose the length of time that serves as the boundary for financial resources to be viewed as available. As with any revenue, if the use of the receipts is stipulated, the fund balance must be shown as restricted, committed, or assigned based on the source of the decision making.
Imposed Nonexchange Revenues Such as Property Taxes and Fines
Accounting for imposed nonexchange revenues is a bit more complicated than for derived tax revenues because no underlying transaction exists to guide the timing of the revenue recogni- tion. Interestingly, GASB set up separate rules for recognizing the asset and the related rev- enue. A receivable is to be recorded when the government first has an enforceable legal claim as defined in that particular jurisdiction (or when cash is received if a prepayment is made).
For the revenue side of the transaction, recognition should be made in the time period when the resulting resources are required to be used or in the first period in which use is permitted.
To illustrate, assume that officials of the City of Alban need to generate property tax rev- enues of at least $500,000 to finance budgeted government spending for Year 2. On October 1, Year 1, property tax assessments totaling $530,000 are mailed to the citizens. Assume that ac- cording to applicable state law, the city has no enforceable claim until January 1, Year 2 (often called the lien date). However, to encourage early payment, the city allows a 5 percent discount on any amount received by December 31, Year 1.
No entry is recorded on October 1, Year 1. Although the assessments have been delivered, no enforceable legal claim yet exists, and the proceeds from the tax cannot be used until Year 2.
However, assume that $30,000 of the assessments is collected from citizens during the final three months of Year 1. After reduction for the 5 percent discount, the collection is $28,500.
Government-Wide Financial Statements and Fund-Based Financial Statements—Property Taxes
Year 1
Cash . . . . 28,500
Deferred Property Tax Revenues . . . . 28,500 To record collection of property tax prior to the start of the levy year
after reduction for 5 percent discount.
Assume that city officials expect to collect 96 percent of the remaining $500,000 in assess- ments, or $480,000. At the beginning of Year 2, both this receivable and the related revenue can be recognized. The receivable is reported at that time because an enforceable claim comes into existence. For government-wide statements, the remaining revenue is reported in Year 2 because that is the period in which the money can first be used. In the following journal entry, note that the revenue is reduced directly by the estimate of taxes that are expected to be
692 Chapter 16
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