The remainder of this chapter presents many of the unique aspects of the accounting process utilized within the governmental funds: the General Fund, Special Revenue Funds, Capital Projects Funds, Debt Service Funds, and Permanent Funds. It is in these five funds where the distinct approach of governmental accounting can best be seen. Because of the dual nature of the reporting process, most of this accounting must be demonstrated twice, once for fund- based financial statements and a second time for the government-wide financial statements.
Much discussion has occurred as to whether governments should, for practicality, keep two separate sets of financial records (one for fund-based statements and another for government- wide statements) or merely one set that must then be adjusted rather significantly at the end of the year to create the second set of financial statements. Many governments have elected to continue maintaining only fund-based information internally that could be transformed into government-wide financial statements at year-end. However, over time, as software programs and computer systems become more sophisticated, governments will likely find that keeping two distinct sets of books is a reasonable approach. Being able to analyze complex transactions completely as they happen seems to be advantageous, and having two sets of records reduces what otherwise could be a massive amount of work at the end of each fiscal year.
Therefore, this textbook examines each transaction from both a fund-based and a government- wide perspective. Accounting for these events in two different ways seems to be an easier mental process than learning one method now and later attempting to convert that entire set of reported data into figures consistent with the second method. For each example, it is important to note the impact on the fund-based financial statements for the governmental funds (where current financial resources are measured based on modified accrual accounting) in comparison to the effect on the government-wide statements for the governmental activities (that show all economic resources based on accrual accounting).
The Importance of Budgets and the Recording of Budgetary Entries
Budgeting is an essential element of the financial planning, control, and performance evaluation processes of many governments. In contrast to commercial organizations’ planning-oriented budgetary practices, governments usually adopt budgets that have the force of law, are subject to sanctions for overspending budgetary authorizations, and have extensive controls to ensure bud- getary compliance.17
In a chronological sense, the first significant accounting procedure encountered by a state or locality is the recording of budgetary entries. To enhance accountability, government officials normally are required to adopt an annual budget for each separate activity to anticipate the
LO6
Record the passage of a budget as well as subsequent encumbrances and expenditures.
17American Institute of Certified Public Accountants, Audit & Accounting Guide, State and Local Governments, with conforming changes as of March 1, 2009, para. 11.01.
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inflow of financial resources and establish approved expenditure levels. The budget serves sev- eral important purposes:
1. Expresses public policy. If, for example, more money is budgeted for child care and less for the environment, the citizens are made aware of the decision to allocate limited government resources in this manner.
2. Serves as an expression of financial intent for the upcoming fiscal year. The budget pre- sents the financial plan for the government for the upcoming period.
3. Provides control because it establishes spending limitations for each activity.
4. Offers a means of evaluating performanceby allowing a comparison of actual results with the levels found in the budget.
5. Indicates whether the government anticipates having sufficient revenues to pay for all of the expenditures that have been approved. In the current economic climate when many governments face declining revenues, the amount and handling of proposed deficits should be of interest to every citizen.
GASB even states that “many believe the budget is the most significant financial document produced by a government unit.”18
Once a budget has been produced and enacted into law, formal accounting recognition is frequently required as a means of enhancing these benefits. In this way, the public has the op- portunity to review the amounts of current financial resources expected to be received and ex- pended. Reporting revenue projections and complying with spending limitations are considered essential for government accountability. Furthermore, many governments must legally main- tain balanced budgets. By entering budget figures into the accounting records at the start of each fiscal year, comparisons can be made between actual and budgeted figures at any interim point during the period. At the end of the year, all budget entries are reversed and closed.
Budget information must be disclosed for the General Fund and each major fund within the Special Revenue Funds. Because of the importance of the information, governments are re- quired to report comparisons between the original budget, the final budget, and the actual fig- ures for the period as required supplementary information presented after the notes to its financial statements. As an allowed alternative, a separate statement can be shown within the government’s fund-based financial statements.
To illustrate, assume that a city enacts a motel excise tax with the revenue to be used to promote tourism and conventions. Because the receipts are legally restricted for this specified purpose, the city must establish a separate Special Revenue Fund. Assume that for the 2010 fiscal year, the tax is expected to generate $490,000 in revenues. Based on this projection, the city council authorizes the expenditure of $400,000 (referred to as an appropriation) for promotional programs during the current year. Of this amount, $200,000 is designated for salaries, $30,000 for utilities, $80,000 for advertising, and $90,000 for supplies. The $90,000 difference between the anticipated revenue inflow and this appropriation is a budgeted surplus to be accumulated by the government for future use or in case the actual revenue proves to be too small to support budget plans.
To formally acknowledge the council’s action, the accounting records of this fund include the following journal entry. No similar entry is needed for government-wide financial statements.
Fund-Based Financial Statements—Budgetary Entry
684 Chapter 16
18GASBConcepts Statement No. 1,para. 19
Special Revenue Fund—Tourism and Convention Promotions
Estimated Revenues—Tax Levy . . . . 490,000
Appropriations—Salaries . . . . 200,000 Appropriations—Utilities . . . . 30,000 Appropriations—Advertising . . . . 80,000 Appropriations—Supplies . . . . 90,000 Budgetary Fund Balance . . . . 90,000 To record annual budget for tourism and convention promotions funded
by motel excise tax.
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Accounting for State and Local Governments (Part 1) 685
This entry indicates both an estimation of and the source of the funding (the tax levy) and the approved amount of expenditures. Each of these figures remains in the records of this Special Revenue Fund for the entire year to allow for planning, disclosure, and control. The Budgetary Fund Balance account indicates an anticipated surplus (or, in some cases, a shortage) projected for the period. Here, the size of this fund is expected to increase by $90,000 during the year.
In this way, budgetary entries also reflect a government’s interperiod equity.This term refers to the alignment of revenues and spending for a period and the possible shift of pay- ments to future generations. If a government projects revenues as $10 million but approves ex- penditures of $11 million, the extra million must be financed in some manner, usually by debt to be repaid in the future. The benefits of the additional expenditures are enjoyed today, but citizens of a later time period must bear the cost.
The original budget is not always the final appropriations budget for the year because of later amendments. For example, government officers can vote to change appropriation levels if more or less money becomes available than had been anticipated. Thus, for the year ending June 30, 2008, the City of Greensboro, North Carolina, reported that $28,983,724 had origi- nally been appropriated for culture and recreation. That amount was later increased to
$29,428,359, but only $27,794,172 was actually spent.
Assume, to illustrate, that officials in charge of tourism for this city appeal to the council during the year for an additional $50,000 to create a special advertising campaign. If approved, the original budgetary entry is adjusted:
Fund-Based Financial Statements—Budget Amendment
Special Revenue Fund—Tourism and Convention Promotions
Budgetary Fund Balance . . . . 50,000
Appropriations—Advertising . . . . 50,000 To record additional appropriation for advertising.
Assume that the city actually received $488,000 in tax revenues during the year and spent
$437,000 as follows:
Salaries . . . $196,000 Utilities . . . 29,000 Advertising . . . 125,000 Supplies . . . 87,000
This information should be disclosed as follows. The Variance column is recommended but not required:
TOURISM AND CONVENTION PROMOTIONS Year Ended December 31, 2010
Budget Comparison Schedule
Budgeted Amounts Variance with
Actual Amounts Final Budget—
Original Final (budgetary basis) Positive (negative) Resources
(inflows):
Tax levy . . . . $490,000 $490,000 $488,000 $ (2,000) Charges to appropriations
(outflows):
Salaries . . . . $200,000 $200,000 $196,000 $ 4,000
Utilities . . . . 30,000 30,000 29,000 1,000
Advertising . . . . 80,000 130,000 125,000 5,000
Supplies . . . . 90,000 90,000 87,000 3,000
Total charges . . . . $400,000 $450,000 $437,000 $13,000
Change in fund balance . . . . . $ 90,000 $ 40,000 $ 51,000 $11,000
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Encumbrances
One additional budgetary procedure that plays a central role in government accounting is the recording of financial commitments referred to as encumbrances. In contrast to for-profit ac- counting, purchase commitments and contracts are recorded in the governmental funds prior to becoming legal liabilities. This recording of encumbrances provides an efficient method for keeping up with financial commitments so that officials will not accidentally overspend a fund’s appropriated amount. Encumbrance accounting is appropriate (although not re- quired) within any governmental fund. At any point during the fiscal year, information on both expended and committed amounts is then available to aid government officials.
To illustrate, assume that a city’s police department orders $18,000 in equipment from a vendor. As an ongoing service activity, the police department is accounted for within the Gen- eral Fund. Because only an order has been placed, no entry is recorded at this point for the government-wide financial statements that tend to follow for-profit accounting. However, this amount of the General Fund’s financial resources has been committed even though no formal liability will exist until the equipment is received. To guard against spending more than has been appropriated, an encumbrance is recorded any time a governmental fund enters into a purchase order, contract, or other formal commitment.
Fund-Based Financial Statements—Commitment Created
686 Chapter 16
General Fund—Police Department
Encumbrances Control . . . . 18,000
Fund Balance—Reserved for Encumbrances . . . . 18,000 To record an order placed for equipment.
General Fund
Fund Balance—Reserved for Encumbrances . . . . 18,000
Encumbrances Control . . . . 18,000 To remove encumbrance for equipment that has now been received.
Expenditures—Equipment . . . . 18,160
Vouchers Payable . . . . 18,160 To record the receipt of equipment and the accompanying liability.
The Encumbrances account records the commitment that has been incurred. The use of a control account here simply indicates that the government’s accounting system includes a subsidiary ledger that maintains more detailed information about this $18,000 amount. With- out a subsidiary ledger, the debit entry should be made to Encumbrances—Equipment or a similar account.
When the police department eventually receives the equipment, a legal liability for payment replaces the commitment. Hence, the encumbrance is removed from the accounting records and an Expenditures account is recognized to show the reduction in current financial re- sources. Often, because of sales taxes, freight costs, or other price adjustments, the actual in- voice total will differ from the original estimation. For this reason, the expenditure will not necessarily agree with the corresponding encumbrance. Note that because of the current fi- nancial resource focus of fund-based financial statements, there will not be an equipment ac- count entry for this long-lived asset. Assume, for illustration purposes, that an invoice for
$18,160 accompanies the equipment when it is received.
Fund-Based Financial Statements—Order Received
In producing government-wide financial statements, the only entry created by this order- ing and receiving of equipment is an increase in the specific asset and the related liability when legal title is conveyed. As in for-profit accounting, the commitment is not recorded.
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Accounting for State and Local Governments (Part 1) 687
The handling of encumbrances at year-end has changed recently. Any commitments that remain outstanding are removed from the accounting records by reversing the original entry because no transaction has occurred. The recording of encumbrances is to help prevent spend- ing more money than the amount authorized for the period.
Assuming that the commitment will be honored in the subsequent year, the accounting issue is whether any additional reporting is needed on the current balance sheet. If the fund balance has already been reclassified as restricted, committed, or assigned in recognition of this eventual expenditure, then no further change is needed. The appropriate fund balance reflects the decision to use that portion of the fund’s net assets to meet this commitment. How- ever, if no fund balance is reported as restricted, committed, or assigned, then the amount of the encumbrance should be reclassified as either committed or assigned to denote the antici- pated use of the fund’s assets.19
To illustrate, assume that the general fund of the city that ordered the $18,000 in equipment reports assets of $600,000 and liabilities of $500,000. On the balance sheet, the fund balance shows $40,000 as assigned and $60,000 as unassigned. At the end of the fiscal year, the
$18,000 encumbrance is unfulfilled and removed from the records for that period. However, the government will pay for the equipment when it arrives in the following year. The reporting of the fund balance figures on the balance sheet can be affected in one of two ways.
• If the $40,000 fund balance—assigned already includes an $18,000 amount reflecting the commitment for this equipment, no change is necessary. The appropriate amount of the fund’s net assets is shown as assigned.
• If the $40,000 fund balance—assigned does not include $18,000 to be spent on the equip- ment, then the fund balance—unassigned is reduced by that amount and fund balance—
assigned (or possibly committed depending on the level of the decision to acquire the equipment) is increased. The assets and liabilities are not affected since the equipment has not been received, but the $18,000 figure is shown as assigned (or committed) to indicate that this amount of the net assets is not freely available to government officials. Per GASB,
“Encumbered amounts for specific purposes for which amounts have not been previously restricted, committed, or assigned should not be classified as unassigned but, rather, should be included within committed or assigned fund balance, as appropriate.”20