Accounting for Governmental Funds

The unique aspects of the accounting process utilized within the governmental funds are the General Fund, Special Revenue Funds, Capital Projects Funds, Debt Service Funds, and Permanent Funds. It is in these funds where the dis­tinct approach of governmental accounting can best be seen. Because of the dual nature of the reporting process, much 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 be adjusted significantly at the end of the year to create the second set of financial statements. Initially, keeping one set of books for the fund- based statements probably is easiest. The resulting figures can then be adjusted at year-end to create the government-wide statements.

However, over time, as software programs and computer systems become more sophisticated, many governments will likely find that keeping two sets of books is more convenient. Being able to analyze complex transactions completely as they happen seems to be advantageous, and maintaining two sets of records reduces what otherwise could be a massive amount of work at the end of each fiscal year.

For that reason, transactions from both fund-based and government- wide perspectives at the same time is examined. Looking at 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.

Thus, for each example, we should be careful to note whether the fund-based financial statements for the governmen­tal funds are being affected (so that current financial resources are being measured based on modified accrual accounting) or government-wide statements for the governmental activities are being reported (following the economic resources measurement basis and accrual accounting).

The Importance of Budgets and the Recording of Budgetary Entries:

“Financing is an important part of the governmental environment, particularly for govern­mental type activities. For those activities, the budget is the primary method of directing and controlling the financial process.” In a chronological sense, the first significant accounting procedure encountered in 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 inflow of financial resources and establish approved expen­diture levels.

The budget serves several 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 pre­sents the financial plan for the government for the period.

3. Provides control because it establishes spending limitations.

4. Offers a means of evaluating performance by allowing a comparison of actual results with the levels found in the budget.

The GASB even states that “many believe the budget is the most significant financial docu­ment produced by a government unit.”

Once a budget has been produced and enacted into law, formal accounting recognition is frequently required as a means of enhancing the benefits just described. In this way, the pub­lic has the opportunity to review the amounts of financial resources expected to be received and expended. Reporting revenue projections and complying with spending limitations are considered essential for government accountability.

Furthermore, many governments must legally maintain balanced budgets. Therefore, approved budget figures are entered into the accounting records formally at the start of each fiscal year. Comparisons can then be made between actual and budgeted figures at any interim point during the period.

Because of the importance of the information conveyed by budget figures, each govern­ment must report comparisons between the original budget, the final budget, and the actual figures for the period as required supplemental information presented after the notes to its financial statements.

As an allowed alternative, the information can be shown as a separate statement within the government’s fund-based financial statements. Budget information must be disclosed for the General Fund and each major fund within the Special Revenue Funds.

As an illustration, assume that a city enacts a motel excise tax that it will use to promote tourism and conventions. Because the funding is legally restricted for this specified pur­pose, the city must establish a separate Special Revenue Fund. Assume that for the 2008 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 promotion 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 levy tax proves to be too small.

To highlight the council’s action, the accounting records of this fund include the following journal entry:

Fund-Based Financial Statement:

This entry indicates 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.

Budgetary entries also reflect a government’s interperiod equity. This term refers to the ques­tion of whether spending and revenues are in alignment for a period or whether money must be borrowed to fund current expenditures, debt that future citizens will have to pay back. If a govern­ment projects revenues as $10 million but approves expenditures 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. For example, more or less money may become available than had been anticipated so that government offi­cials vote to change the appropriations. Thus, for the year ending June 30, 2006, the City of Greensboro, North Carolina, reported that $32,276,405 had originally been appropriated for culture and recreation. That amount was later increased to $33,304,355, but only $31,335,211 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 properly approved, the original budgetary entry is adjusted:

Fund-Based Financial Statement:

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 accounting, 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 a fund will not accidentally over­spend its appropriated amount. Encumbrance accounting is appropriate in any governmental fund. At any point during the fiscal year, information on both expended and committed amounts is available to government officials.

To illustrate, assume that a city’s police department orders $18,000 in equipment. As an ongoing service activity, the police department is accounted for within the General Fund. Because only an order has been made, 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 government’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 one of the governmental funds enters into a pur­chase order, contract, or other formal commitment.

Fund-Based Financial Statement:

The Encumbrances account records the commitment that has been incurred, and the Fund Balance—Reserved for Encumbrances account is an equity-type balance indicating the amount of the city’s resources required to fulfill such future obligations.

The use of a control account here simply indicates that the government’s accounting system includes a subsidiary ledger that maintains more detailed information on this $18,000 amount. Without a subsidiary ledger, the debit entry here should be made to Encumbrances—Equipment or a similar account.

When the police department eventually receives the equipment, a legal liability replaces the commitment. Hence, the encumbrance is removed from the accounting records and an expen­ditures account is recognized. Often, because of sales taxes, freight costs, or other price adjust­ments, the actual invoice total differs from the estimated amount recorded when the order was processed. For this reason, the expenditure will not necessarily agree with the corresponding encumbrance. Assume, for illustration purposes, that an invoice for $18,160 accompanies the equipment when it is received.

Fund-Based Financial Statements:

In producing government-wide financial statements, the only entry created by this ordering and receiving of equipment is an increase in the specific asset and the related liability when legal title is conveyed. The commitment is not recorded.

Over the years, a number of different reporting techniques have been created to reflect the impact of commitments that were not fulfilled prior to the year-end. Often, state or local laws guide what happens to such encumbrances. For example, commitments may simply lapse legally and await the government’s new action in the subsequent year. In this way the official appropriation and the recorded expenditure are always in the same period. These lapsed encum­brances are reversed from the records because no current reporting is necessary.

Other governments may plan, or be legally required, to satisfy such commitments even though the concluding event occurs in a later period.

In that situation, most governments seem to prefer the following approach to report the impact of encumbrances in the current year:

i. At the end of the initial year, officials reverse the entry that established the encumbrance to eliminate it. No financial effect is reported because no transaction actually occurred during the period.

ii. On the balance sheet for the governmental fund that made the commitment, a portion of the Fund Balance figure is separated to indicate that this amount of current financial resources will be needed in the future to meet the requirements of the commitment.

For example, assume that a city has $800,000 in current financial resources (cash, receivables, and investments) and $700,000 in claims to those current financial resources so that its fund balance is $100,000. Assume that $18,000 in equipment has been ordered but not received at year-end. However, the city must meet the commitment when it eventually receives the equipment.

Using the approach just described, the only acknowledgment of the commitment is shown in the Fund Balance section of the balance sheet:

The fund balance is still $100,000, but the reader can see that $18,000 will be needed to cover a commitment made in this year that will be finalized in the subsequent period.