CHAPTER 1: FINANCIAL REPORTING FOR GOVERNMENTAL



CHAPTER 1: FINANCIAL REPORTING FOR GOVERNMENTAL AND NOT-FOR-PROFIT ENTITIES

OUTLINE

|Number |Topic |Type/Task |Status |

| | | |(re: 12/e) |

|Questions: | | | |

|1-1 |Distinguishing characteristics of GNP entities |Describe |1-2 revised |

|1-2 |Standards-setting bodies |Contrast |1-3 revised |

|1-3 |Objectives of financial reporting |Defend |New |

|1-4 |Accountability |Explain |New |

|1-5 |GAAP |Explain |New |

|1-6 |GASBS 34 |Explain |New |

|1-7 |Comprehensive annual financial report |Explain |New |

|1-8 |Government-wide financial statements |Describe |New |

|1-9 |Fund financial statements |Describe |New |

|1-10 |Measurement focus and basis of accounting |Describe |New |

| | | | |

|Cases: | | | |

|1-1 |Research Case—Govt. or N-F-P entity? |Written report |Revised |

|1-2 |Internet Case—GFOA |Written report |New |

|1-3 |Internet Case—GASB |Internet |Revised |

| | | | |

|Exercises/Problems: | |

|1-1 |Examine the CAFR |Examine |Revised |

|1-2 |Various |Multiple Choice |New |

CHAPTER 1: FINANCIAL REPORTING FOR GOVERNMENTAL AND NOT-FOR-PROFIT ENTITIES

Answers to Questions

1-1. The major characteristics that distinguish governmental and not-for-profit entities from business enterprises include:

a. Receipts of significant amounts of resources from resource providers who do not expect to receive either repayment or economic benefits proportionate to the resources provided.

b. Operating purposes that are other than to provide goods or services at a profit or profit equivalent.

c. Absence of defined ownership interests that can be sold, transferred, or redeemed, or that convey entitlement to a share of residual distribution of resources in the event of liquidation of the organization.

Governments and not-for-profit organizations are accountable to resources providers who do not get proportionate value in exchange for the taxes or contributions they make to the organization. Consequently, they report on both fiscal accountability for spending within the legally approved budget and accountability for the operations of the government as a whole. Not-for-profit organizations report on the net assets of the organization and changes in those net assets, much like a business, but recognize that donors and consumers of the services are primary users of the financial statements, not taxpayers or owners.

1-2. Illustration 1-1 depicts the standards-setting jurisdiction of the FASB, GASB and FASAB. As shown, the FASB has responsibility for setting accounting and financial reporting standards for business enterprises and nongovernmental not-for-profit organizations. The GASB has responsibility for setting standards for state and local governments and governmental not-for-profit organizations. The FASAB has responsibility for setting accounting and reporting standards for federal agencies and departments.

1-3. Disagree. Both the Governmental Accounting Standards Board (GASB) and the Financial Accounting Standards Board (FASB) issue standards for external users of financial information—those who lack the authority to prescribe information they want and who must rely on the information management communicates to them. By contrast, the Federal Accounting Standards Advisory Board (FASAB) has identified users who are both internal and external to the government: citizens, the Congress, executives, and program managers. Not surprisingly, then, its standards address both internal and external financial information needs.

4. Public officials have an obligation to be accountable to the citizenry by demonstrating

Ch. 1, Answers, 1-4 (Cont’d)

that they have complied with spending restrictions arising from the annual, legally approved budget (i.e., fiscal accountability), as well as showing that they have used the government’s resources efficiently and effectively in meeting operating objectives (i.e., operational accountability).

5. Generally accepted accounting principles (GAAP) for state and local governments arise from the authoritative statements of the Governmental Accounting Standards Board. GAAP for not-for-profit organizations arise from the authoritative statements of the Financial Accounting Standards Board. There are accounting issues for which the guidance by GASB for governments is different than that of the FASB for not-for-profit organizations, reflecting differences in users’ financial needs and the emphasis on accountability in the government environment.

1-6. GASB, following its Concepts Statement No. 1, believes that financial information should be useful for citizens to assess whether there is “interperiod equity”; that is, whether current year revenues are sufficient to pay for services provided in the current year, and whether future taxpayers will bear the cost burden for services provided earlier. The traditional fund accounting financial reporting model did not provide appropriate information for taxpayers to assess this. Therefore, GASB added two government-wide financial statements that report on the aggregate financial position and results of operations so taxpayers now have useful information about the government as a whole.

1-7. A CAFR should have an introductory section, financial section, and statistical section. The basic financial statements required under GASBS 34 are the government-wide financial statements and fund financial statements with accompanying notes and these would be found in the financial section of the CAFR along with the auditor’s report, Management Discussion & Analysis, other required supplementary information (RSI) and any combining statements that the government chooses to include.

8. The statement of net assets reports on the total assets, liabilities and net assets of the governmental and business-type activities of the government. The statement of activities reports on the changes in net assets (revenues and expenses) of the governmental and business-type activities of the government as a whole. Neither statement reports on the fiduciary activities of the government. A citizen could use the statement of net assets to find our how much the government has in unrestricted net assets for governmental activities before he or she decides to vote on a tax increase. A citizen could use the statement of activities to discover the total cost of a function, such as public safety, and compare it to another function, such as culture and recreation before making a request to the elected officials to shift the proportion of the budget spent on each function or program.

9. Fund financial statements are still the best way to segregate resources that come from different sources, and report on compliance with the terms that different resource providers have imposed on the government. For example, fund statements can show

Ch. 1, Answers, 1-9 (Cont’d)

accountability for spending according to the legally approved budget. Other funds, such as fiduciary funds, show net assets and changes in the assets that the government is holding for other people.

10. Governmental activities of the government as a whole focus on the total economic resources that flow into the government for the purpose of delivering governmental services. That perspective best captures the total cost of delivering services and total revenue received to do so by measuring revenues and expenses using the accrual basis of accounting. Governmental funds, on the other hand, have the primary purpose of comparing how actual revenues and expenditures for the year compare to that which was budgeted.

Solutions to Cases

1. Issue: Is Chelsea Community Library a governmental entity or nongovernmental not-for-profit entity. This is an essential determination because if the library is governmental, then the student, as auditor, will need to examine whether the library’s financial statements are in conformity with GASB standards. If it is nongovernmental, then its financial statements must conform to FASB standards.

Careful application of the AICPA criteria provided in Chapter 1 to the fact situation in this case should lead one to reach the conclusion that the library is governmental in character and therefore should conform to GASB financial reporting standards if it expects to receive an unqualified (clean) audit opinion. [Note to instructors: In order to avoid confusing students this early in the course, we have intentionally not discussed specific GASB and FASB standards applicable to not-for-profit organizations. Unusually inquisitive students can be referred to Chapter 14 for further information.]

Analysis:

There is no evidence to suggest that the library is a government, that is, a “public corporation or body corporate and politic.” Thus, it is necessary to apply the three criteria listed as a, b, and c on p. 6 in the text to determine whether the library is governmental in character. A controlling majority of its governing board is appointed or approved by the Chelsea City Council, thus, criterion a is clearly met. Criterion b is likely met as well, considering that the City could probably dissolve the museum if they wished to do so according to the original charter. It doesn’t appear that the library has the power to enact or enforce a tax levy (criterion c). Only one of the three criteria needs to be met for the library to be considered governmental in character. Criterion a is clearly met and b is likely met, so the auditor must consider the museum to be governmental and would therefore determine whether the financial statements conform to applicable standards of the Governmental Accounting Standards Board.

Ch. 1, Solutions, Case 1-2

1-2. Students will see that the GFOA was started in 1906 by municipal finance officers who wanted to standardize and improve government accounting standards. The first “Blue Book” or GAAFR was in the mid 1930s and the most recent revision is 2001. The GAAFR explains the GASBS 34 reporting model and provides nonauthoritative guidance and illustrations for preparers.

1-3. Instructors may wish to provide specific instructions for the students' brief reports. GASB’s website will change over time, but they do provide quite a bit of information about their mission, structure, and the due-process it follows in setting standards. Obviously, the content of GASB’s Technical Agenda and members of the Advisory Council will change over time. The GASB sells individual statements, codification of all the standards, and a subscription to its standards through its Publication division, so you cannot download a statement directly from GASB’s Internet website; however, you can get ordering information.

Solutions to Exercises and Problems

1. Each student should have a different CAFR; therefore, there is no "solution" to this exercise. It works well to devote class time to asking students some of the questions listed in the exercise, and perhaps tabulating the numbers of reports containing statements that are audited (1) by CPAs, (2) by state auditors, and (3) by employees of the reporting government. If such a tabulation is made, the students are interested in knowing in which states the local governmental units are located that are audited by each of the classes of auditors (or whatever other characteristic is being tabulated). Requiring that students obtain a CAFR is a good exercise in obtaining financial information. Allow students to share their experiences, as some organizations make it easier to get CAFRs than others. Remind students that a CAFR is not required, so some governments may simply refer to the statement as the “audited annual financial statement.” Budgets are often quite detailed and will be most useful for Chapter 13.

1-2. 1. c. 6. b.

2. a. 7. c.

3. d. 8. b.

4. b. 9. a.

5. c. 10. d.

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